**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON,D.C. 20549

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**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**FOR THE FISCAL YEARENDED DECEMBER 31, 2006**

**OR**

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

**FOR THE TRANSITIONPERIOD FROM              TO             **

**COMMISSION FILE NUMBER 0-28218**

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**AFFYMETRIX, INC.**

(Exact name 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’s telephone number, including area code)

**Securitiesregistered pursuant to Section 12(b) of the Act:**

| **Title of Each Class**         |   | **Name of Each Exchange on Which Registered** |
|---------------------------------|--------|-----------------------------------------------|
| Common Stock, $0.01 par value   |   | The Nasdaq Global Market                      |
| Preferred Stock Purchase Rights |   | The Nasdaq Global Market                      |

 

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

None

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

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 thebest of 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

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

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

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No x

Theaggregate market value of the registrant’s common stock held by non-affiliatesof the registrant at June 30, 2006, based on the closing price of suchstock on the Nasdaq Global Market on such date, was approximately $936 million.The number of shares of the registrant’s Common Stock, $0.01 par value,outstanding on February 20, 2007, was 68,213,103.

**DOCUMENTS INCORPORATED BY REFERENCE**

Certain sections of theProxy Statement to be filed in connection with the 2007 Annual Meeting ofStockholders are incorporated by reference into Part III of this Form 10-Kwhere indicated.

 

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**AFFYMETRIX, INC.**

**FORM 10-KDECEMBER 31, 2006**

**TABLEOF CONTENTS**

| Item No. | ** ** | ** ** | ** ** | **Page**                                                                                                              | ** ** |
|---------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|
|          |       |       |       | PART I                                                                                                           |       |   |   |   |   |
|          | 1.         |       |       | Business                                                                                                              |       |   | 3 |   |   |
|          | 1A.        |       |       | Risk Factors                                                                                                          |       |   | 25 |   |   |
|          | 1B.        |       |       | Unresolved Staff  Comments                                                                                            |       |   | 35 |   |   |
|          | 2.         |       |       | Properties                                                                                                            |       |   | 35 |   |   |
|          | 3.         |       |       | Legal Proceedings                                                                                                     |       |   | 35 |   |   |
|          | 4.         |       |       | Submission of  Matters to a Vote of Security Holders                                                                  |       |   | 35 |   |   |
|          |       |       |       | PART II                                                                                                          |       |   |   |   |   |
|          | 5.         |       |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer  Repurchases of Equity Securities |       |   | 36 |   |   |
|          | 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                                                           |       |   | 55 |   |   |
|          | 8.         |       |       | Financial  Statements and Supplementary Data                                                                          |       |   | 58 |   |   |
|          | 9.         |       |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                 |       |   | 99 |   |   |
|          | 9A.        |       |       | Controls and  Procedures                                                                                              |       |   | 99 |   |   |
|          | 9B.        |       |       | Other Information                                                                                                     |       |   | 101 |   |   |
|          |       |       |       | PART III                                                                                                         |       |   |   |   |   |
|          | 10.        |       |       | Directors, Executive  Officers and Corporate Governance                                                               |       |   | 101 |   |   |
|          | 11.        |       |       | Executive  Compensation                                                                                               |       |   | 101 |   |   |
|          | 12.        |       |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                      |       |   | 101 |   |   |
|          | 13.        |       |       | Certain  Relationships and Related Transactions, and Director Independence                                            |       |   | 101 |   |   |
|          | 14.        |       |       | Principal  Accounting Fees and Services                                                                               |       |   | 102 |   |   |
|          |       |       |       | PART IV                                                                                                          |       |   |   |   |   |
|          | 15.        |       |       | Exhibits and  Financial Statement Schedules                                                                           |       |   | 103 |   |   |
|          |       |       |       | Signatures                                                                                                            |       |   | 107 |   |   |

 

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**PART I**

**ITEM 1.** BUSINESS

**Forward-LookingStatements**

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.

**NarrativeDescription 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 markets and are recognized as a market leaderin creating 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. Our integrated GeneChip® microarray platform includes: disposableDNA probe arrays (chips) consisting of nucleic acid sequences set out in anordered, high density pattern, certain reagents for use with the probe arrays,a scanner and other instruments used to process the probe arrays, and softwareto analyze and manage genomic or genetic information obtained from the probearrays. Related microarray technology also offered by us includes licenses forfabricating, scanning, collecting and analyzing results from complementarytechnologies.

Our business strategy is to capitalize on ourleadership position in the DNA microarray field by marketing our GeneChip®technologies to customers based on two central applications: gene expressionmonitoring and DNA variation detection. Due to the novel, massively parallelapproach to studying biological systems that GeneChip® technology enables,numerous discoveries across many disciplines have already been made, asevidenced by the over 7,000 peer-reviewed publications that have citedGeneChip® technology. The application of GeneChip® technologies for diagnosingand guiding treatment of disease is an emerging market opportunity that seeksto improve the effectiveness of health care by collecting information about DNAvariation and RNA expression in patients at various times from screening anddiagnosis through prognosis and throughout therapeutic monitoring. We currentlysell our 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. We also sell ourproducts through life science supply specialists acting as authorizeddistributors in Latin America, India, the Middle East and Asia Pacific regions,including China.

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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 (administrationand array research and development), Emeryville, California (bioinformatics andsoftware development), South San Francisco, California (manufacturing andresearch and development), Bedford, Massachusetts (instrument development andmanufacturing), Singapore (probe array manufacturing, administration, and sales),China (representative office), and additional sales offices in the UnitedKingdom, Singapore, and Japan.

**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 sequences is estimated to be significantly larger than the number ofprotein coding genes in the human genome.

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 

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that many years ofresearch will be required to gain a better understanding of the complexities ofthe genome, and its characteristics in normal and diseased conditions. Webelieve that this will lead to a new healthcare paradigm where disease isunderstood at the molecular level, allowing patients to be diagnosed accordingto genetic information and then treated with drugs designed to work on specificmolecular targets. Ultimately, in addition to diagnosis and treatment,prevention and cure of disease might also be possible based on geneticinformation.

While scientists arelearning more and more about the functions of genes and their variability, thereis a great deal more to discover. We believe that the efforts of science tounderstand the complexities of gene expression, the interaction of genes withour environment and the role of genes in disease and health will continue toprovide growth opportunities for our existing gene expression and DNA analysisproducts, and will continue to create new opportunities in clinical medicine.Toward this end we have partnered with the National Cancer Institute toassemble the first complete map of the human transcriptome (a catalog of all ofthe RNA transcripts made by the genome). This ongoing effort has already led tothe discovery of many novel protein coding and non-protein coding sequencesthat we have started to include in some of our new products. This effort isalso prompting continued development of our sample preparation, array,instrumentation and data 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 scientists to attain ambitiousgoals, from identifying genetic variations associated with disease todiscovering new drug targets, but also simplifies, accelerates and reduces thecost of understanding this genetic information.

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*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 intricate illuminationpatterns allow us to build high-density arrays of many diverse DNA sequences ina small area. Unlike conventional synthesis techniques, which generally use alinear process to create compounds, our synthesis technique is combinatorial,in that the number of different compounds synthesized grows exponentially withthe number of cycles in the synthesis. Currently available commercial arrayscontain over 6.0 million unique sequences. Each unique sequence is 25nucleotides in length and is represented millions of times within a specifiedarea of the probe array. Just as in the semiconductor industry, we manufactureprobe arrays in a wafer format. Each wafer is approximately five inches squareand can contain over 300 million unique probe sequences based on currenttechnology. Whole wafers have been used by a related party of Affymetrix,Perlegen Sciences, Inc., in its work to resequence multiple samples of thehuman genome. For our commercial array products, we can manufacture a largenumber of identical or different DNA probe arrays on a glass wafer, which isthen diced into individual chips. Given the large amount of unique sequencesrepresented in our probe arrays, our technology enables the efficient analysisof a multitude of DNA probes to analyze 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 information contentand lower cost of goods sold or decrease the number of chips per wafer andincrease the information content. We expect that we will continue to benefitfrom this manufacturing leverage as our technology development activitiesenable further feature shrink. We believe that our unique manufacturing processis a significant competitive advantage.

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***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 and 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, isreferred to as an “assay.”

We currently market products for two principalapplications: monitoring of gene or exon expression levels and investigation ofgenetic variation (DNA analysis including single nucleotide polymorphism (SNP)genotype analysis and resequencing). Our GeneChip® expression monitoring arraysenable our customers to qualitatively and quantitatively measure gene or exon expressionlevels in a number of frequently studied organisms. Our catalog GeneChip®expression arrays are available for the study of human, rat, mouse and a broadrange of other mammalian and model organisms. Human, mouse and rat exon analysisarrays are also available. Additionally, we market CustomExpressTM, CustomSeqTMand NimbleExpressTM products, which enable our customers to design their owncustom GeneChip® expression arrays or sequence arrays for organisms of interestto them. Our GeneChip® DNA analysis arrays and variant detection systemsare available to enable researchers to perform high throughput polymorphismanalysis and to carry out large scale resequencing (comparing the DNA sequenceof multiple samples against a known reference sequence, e.g. the published humangenome sequence). With its unique, parallel analysis capability, GeneChip®technology enables our customers to perform accurate and cost-effective geneticanalysis, using minute amounts of sample DNA, in their own laboratories on ascale that was previously only possible in specialist high throughput centers.

In addition, we believe that genetic analysis andtesting products will be a core component in the area of clinical research andmolecular diagnostic applications. We are developing our GeneChip® system forclinical research and diagnostic analysis of both gene expression and DNAanalysis. The GeneChip® System 3000Dx (GCS3000Dx) is the first microarrayinstrumentation system for molecular diagnostic laboratories. The GCS3000Dx is510(k) cleared and CE marked for in vitro diagnostic use in conjunctionwith the Roche Diagnostics AmpliChip CYP450 Test. The AmpliChip CYP450 Test isthe first microarray based diagnostic test and the first product to be releasedthrough the Powered by AffymetrixTM Program.

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Together with ourcollaborative partners, we are focusing on the development andcommercialization of diagnostic products in cancer, osteoporosis,cardiovascular, inflammatory, metabolic, infectious and other diseases, andbelieve that our GeneChip® assays will facilitate more efficient and effectivedisease detection, prognosis and treatment selection, leading to overallimproved patient management. To further our clinical research and moleculardiagnostics strategy, we have established partnerships and customerrelationships with leading academic researchers, pharmaceutical andbiotechnology companies, including F. Hoffmann-La Roche Ltd. (“Roche”),bioMérieux, Inc. (“bioMérieux”), and Veridex, LLC, a Johnson &Johnson company (“Veridex”). We believe that the rapid growth of the clinicalresearch and the diagnostic devices markets holds the potential for GeneChip®technology applications ranging from basic research to clinical trials and,ultimately, diagnostic devices. As a result we are working with leaders inmolecular diagnostics to provide custom made GeneChip® probe arrays to theirspecifications. Our partners subsequently package the chips into kits, seekregulatory approval for their diagnostic use, and sell them into the diagnosticmarkets using their sales channels. We are leveraging our partners’ strengthsin research, development, regulatory practices and distribution whileleveraging our strengths in array technology. These products are marketed asbeing Powered by AffymetrixTM.

*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 or exons ofinterest. By synthesizing specific probes for multiple genes or exons on asingle probe array, we enable researchers to quickly, quantitatively andsimultaneously monitor the expression of a large number of genes or exons ofinterest. By monitoring the expression of such genes under different conditionsand at different times, researchers can use the probe arrays to understand thedynamic relationship between gene expression and biological activity. Webelieve such information will be an important tool in understanding genefunction and for the development of new drugs and diagnostic tools.Increasingly, clinical research is showing that gene expression patterns intissue samples, particularly those from cancerous tissues, can be used tocharacterize disease sub-types and hopefully to predict therapeutic responsesand likely outcomes.

The range ofGeneChip® Expression products is described below:

·       *Standard Expression Monitoring Arrays*.   We arecurrently 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), Xenopus laevis(frog), Danio rerio (zebrafish), Saccharomyces cerevisiae (yeast), Escherichiacoli (bacteria), Pseudomonas aeruginosa (bacteria), Plasmodium falciparum(malarial parasite), Anopheles (mosquito vector of malaria) and Arabidopsisthaliana (plant) organisms.

·       *Custom Express Arrays*.   We have established a GeneChip®CustomExpressTM Array Program enabling customers to design affordable arraystailored to their specific research needs. Our CustomExpressTM arrays allowcustomers to select probes from any of our probe sequences on our catalogarrays and/or to incorporate probes from their own proprietary gene sequences.These arrays are then produced utilizing the same manufacturing technologies asour other GeneChip® whole genome expression arrays.

·       *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 no longeravailable as catalog products.

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·       *GeneChip® ExonArrays.*   Ourexon arrays combine a novel array design strategy with the highest-densityarray manufacturing capability to provide for the first time, exon-levelexpression profiling at the whole-genome scale on a single array. The arraysoffer new dimensions for researchers to explore the genome so they caninvestigate global expression of individual exons to uncover and document novelalternative splicing events. They can also obtain more direct comparativegenomic information and combine genome-wide exon-level expression data withsequence information to reveal the phenotypic splicing patterns resulting fromgenetic variations.

·       *Whole Genome Tiling Arrays.*   Weoffer tiling arrays for the genomes of a number of major organisms includinghuman, mouse, drosophila, C.elegans and yeast. These designs use evenly spacedprobes across the non-repetitive portion of the genome and rely only on genomicDNA sequence and not functional annotation for their design. The arrays areused for mapping the entire collection of transcribed elements (includingnon-coding RNAs that are used for structural and regulatory purposes),identifying protein binding and methylation sites and identification of genomicorigins of replication. These products are currently available in either EarlyAccess or Technology Access programs, which allow our customers to obtainpre-released versions of our products prior to full commercialization.

*DNA Analysis Arrays*

As genes and regulatory regions in the human genomeare mapped, identified, and sequenced, the value of understanding the variabilityof sequences among individuals increases. Researchers seek to determine thenormal sequence of the gene, which mutations or polymorphisms exist in apopulation, and whether these variations correlate with a disease or otheraspect of the human condition. Studies of the genetics of complex diseases havehistorically been challenging due to the high costs of sequencing or genotypingof large numbers of affected and unaffected individuals. Genetic variation alsoimpacts how individuals respond to therapeutics. The study of these effects isknown as pharmacogenetics. This is part of the broader field ofpharmacogenomics, which seeks to understand how the overall composition andexpression of the genome affects therapeutic response, drug efficacy and the incidenceof adverse side effects to therapy. We believe pharmacogenomics will becomeincreasingly important both in clinical drug trials and patient care. By usingour resequencing and genotyping technologies, we believe that our GeneChip®probe arrays could significantly reduce the cost and time required forhigh-volume polymorphism analysis, which is currently performed through morelabor-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:

·       *SNP 5.0 Array.  *The new single-chip SNP 5.0 Array wasmade available as a limited release in December 2006 and was commerciallylaunched in February 2007. The new array features single nucleotidepolymorphisms (SNPs) from the original two-chip 500K Array Set, as well as morethan 420,000 additional probes designed to measure other genetic differences,such as copy number variation. At the time of the commercial launch of the SNP5.0 Array, Affymetrix software does not support the analysis of these additionalprobes. The SNP 5.0 Array gives researchers a significant increase ininformation above the original 500K Array Set for the same price, whilereducing the array processing time. The Affymetrix SNP 5.0 Array was developedin collaboration with the Broad Institute of Harvard and the MassachusettsInstitute of Technology to better identify and understand the geneticvariations associated with complex diseases such as autism, autoimmunity,bipolar disease, cancer, diabetes and heart disease.

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·       *GeneChip® Human Mapping 500K Set.  *The Mapping 500K Setis the third product in a family of tools for large scale genome-widegenotyping using a simple, scalable, one-primer assay. The 500K Set genotypesover 500,000 SNPs on a two array set. The 500K Set is enabling novel geneticexperiments (called genome-wide association studies) to understand the genesinvolved in complex disease and drug response using real-world diseasepopulations. Researchers have for many years sought to study major diseases inunrelated populations, but the information density (hundreds of thousands ofmarkers) and experiment size (hundreds or thousands of samples) made theseexperiments unaffordable. The 500K Set is the first and market leading productin making large scale whole genome analysis cost effective.

·       *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 over100,000 SNPs on a two array set and the 10K Array genotypes over10,000 SNPs on a single array. The 100K Set was the first product toenable genome-wide association studies and is also used for chromosomal copynumber analysis. The 10K Array is used primarily for linkage analysis, thestudy of the inheritance of disease in families.

·       *Targeted Genotyping Products.  *Weoffer a variety of targeted genotyping products for the analysis of between1,500 and 20,000 SNPs per sample, using a highly multiplexed assay for use withGeneChip® Universal Tag Arrays. This innovative assay enables customers togenotype selected SNPs in a single assay with only one primer per SNP. We offerthe widest variety of standard panels of pre-selected SNPs for major diseases(e.g., inflammatory disease), model organisms (e.g., mouse), and specificapplications (e.g., drug metabolizing enzymes). This assay and the productsoffered through this product line represent the technology and productsacquired through the ParAllele acquisition described elsewhere in this report.

·       *GeneChip**® CustomSeqTM Resequencing Arrays*.   Version2 of this product line was released in 2005, increasing sequence content perarray by 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 fullmitochondrial genome sequencing.

*DNA AnalysisProducts Powered by AffymetrixTM*

·       *Roche AmpliChipTM CYP450*.   The Poweredby AffymetrixTM program and collaboration with Roche announced in January 2003resulted in the June 2003 release of the Roche AmpliChipTM CYP450microarray. The AmpliChip CYP450 microarray allows for complex sequenceinformation to be analyzed for the purpose of genotyping the CYP2D6 and CYP2C19genes. Sequence variation in these genes can result in marked differences inthe way individuals metabolize, and hence respond to, an estimated 25% of alldrugs. In late 2004, Roche obtained in-vitro diagnostic status for the productin the United States and Europe.

·       *FoodExpert-ID assay.  *bioMérieux has developed and iscommercializing the GeneChip® based FoodExpert-ID assay under an industriallicense and supply agreement with Affymetrix. The FoodExpert-ID assay detectsand identifies, in parallel, DNA sequences from 40 different commerciallyrelevant animal species (and the classes: mammal, fish, bird) in raw andprocessed food products and in animal feed samples. The FoodExpert-ID assayoffers a reliable and sensitive method of authenticating food and animal feedthat can be integrated into routine use. The final report of the FoodExpert-IDassay is a permanent record of the vertebrate animal species 

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composition of afood or animal feed product verified by a DNA signature and can be consideredas a “product identity card”. We manufacture the GeneChip® array, the mostcritical component of the FoodExpert-ID assay, and it is marketed by bioMérieuxas part of our “Powered by Affymetrix” business model.

*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.

***Reagents for Our GeneChip®Systems***

We offer target labeling and control reagents for usewith GeneChip® expression analysis and GeneChip® DNA analysis arrays.

For our gene expression analysis, we offer thefollowing reagents:   *3’ In VitroTranscription*—One-Cycle Target Labeling and Control Reagents,Two-Cycle Target Labeling and Control Reagents, HT One-Cycle Target Labelingand Controls Kit, for use with the GeneChip® Array Station, and GeneChip®Hybridization, Wash, and Stain Kit; Blood RNA Concentration Kit andGlobin-Reduction RNA Controls; *WholeTranscript Analysis*—For use with Exon and Tiling Arrays—GeneChip® WTSense Target Labeling and Control Reagents, GeneChip® WT cDNA Synthesis andAmplification Kit, GeneChip® WT Terminal Labeling Kit, GeneChip® WTDouble-Stranded cDNA Synthesis Kit, GeneChip® WT Amplified Double-Stranded cDNASynthesis Kit, GeneChip® WT Double-Stranded DNA Terminal Labeling Kit, andGeneChip® Hybridization, Wash, and Stain Kit; *Prokaryotic—Foruse with Prokaryotic Arrays—*Control Oligo B2, 3nM, DNA LabelingReagent, Poly-A RNA Control Kit, and GeneChip® Hybridization, Wash, and StainKit.

For our DNA analysis, weoffer the following reagents:   Control Oligo F1, GeneChip®Application-Specific Fixed Assays, GeneChip® Custom SNP Kits and ResequencingAssay 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 for hybridizationof the test sample to the probe array. The second device is a fluidics stationthat controls exposure of the probe array to solutions containing preparedsample and labeled detection reagents across the probe array. The fluidicsstation can process four probe arrays simultaneously. The fluidics stationprotocols conclude with a reagent wash that leaves the labeled, hybridized testsample 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.

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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.

·       *GeneChip**® Scanner 3000*.   TheGeneChip® Scanner 3000 uses proprietary laser scanning technology and highresolution optics to read the fluorescent signal from GeneChip® arrays. TheGeneChip® Scanner 3000, developed and manufactured by Affymetrix, representsthe next generation in scanner technology. The Flying ObjectiveTM scanningtechnology incorporated into this scanner has been adapted to provide fasterscanning of GeneChip® probe arrays with a high degree of image uniformity andaccuracy. The current version of the GeneChip® Scanner 3000 has been validatedto allow imaging of GeneChip® arrays with feature sizes as small as 5 micronsand can support multicolor assays. The GeneChip® Scanner 3000 is purchased witha computer 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-arraycarousel that automatically loads and unloads arrays from the scanner, helpingresearchers automate their array processing and providing walk-away use in thelab. The GeneChip® Scanner with AutoLoader can load and scan 48 current catalogarrays in 28 hours or less, depending on the feature size and array formatthat is 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 collaborationwith Caliper Life Sciences, Inc., we launched the Affymetrix GeneChip®Array Station that has the capacity to process hundreds of biological samplesper 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® ArrayStation adapts the same industry-standard GeneChip® technology to astandard 96-well microtiter plate, and runs on an automated system builtwith off-the-shelf robotic components. In addition, we launched the GeneChip®HT Scanner that utilizes CCD based technology for imaging of the new arrayplates. The GeneChip® Array Station automates the most labor intensive steps inGeneChip® probe array processing, dramatically reducing the cost per assay. Thedecrease in cost and increase in throughput makes the GeneChip® 

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Array Station wellsuited for downstream development applications such as compound profiling,molecular toxicology and clinical trials.

***Software for Our GeneChip®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.

Customers may choose operating or other softwareproducts provided 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 Roche DiagnosticsAmpliChipTM 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, obtainregulatory approval for, and commercialize probe arrays and instrumentation. Weanticipate broader use of probe arrays as components of diagnostic products andclinical research applications. We believe that to support large centrallaboratories, additional instrumentation and automation will need to bedeveloped to allow for handling the large volume testing of the clinicaldiagnostic setting. To further our molecular diagnostics strategy, we haveestablished a number of collaborations with leading academic researchers,diagnostic companies, pharmaceutical and biotechnology companies.

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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 ourGeneChip®technologies, Roche intends to develop and market diagnostic tests fordiseases such as cancer and osteoporosis and cardiovascular, metabolic,infectious and inflammatory diseases.

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.

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 CollaborativePartners**

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 

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collaboration will be todevelop improved methods for the use of PreAnalytiX technology with GeneChip®expression analysis arrays. By combining PreAnalytiX and Affymetrixtechnologies, our goal is to develop a complete, standardized process forexpression profiling starting from whole blood samples.

*Invitrogen Corporation.*   In November 2003we signed a collaboration and supply agreement to develop and market a new lineof GeneChip® brand expression reagents including two new cDNA Synthesis Kits.Both of the new cDNA Synthesis Kits were developed in collaboration withInvitrogen and contain Invitrogen’s industry-leading SuperScriptTM reversetranscriptase (RT). These reagents have been optimized for use with AffymetrixGeneChip® technology, offering a standardized target preparation system that iseasier to use and will help customers produce more robust and consistent arrayresults. The One-Cycle cDNA Synthesis Kit offers reagents for standard targetlabeling. This protocol has been used by the majority of Affymetrix customersalready, but the new kit provides improved configuration and greaterconvenience. The Two-Cycle cDNA Synthesis Kit offers customers a streamlinedprocedure for preparing samples using a small amount of material, such asbiopsy or laser capture dissected samples. This agreement was extended for twoadditional years in May 2005.

*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-wafertechnology developed by Affymetrix, Perlegen focuses on identifying themillions of genetic variations (known as single nucleotide polymorphisms or “SNPs”)among individuals, and finding patterns in those variations that might bepredictive of disease susceptibility or drug response. In January 2003, weobtained accelerated access to Perlegen’s SNP database which was used to helpdevelop our 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, seeItem 7: “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and Note 12 to our Notes to Consolidated FinancialStatements of this Form 10-K.

*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 molecular diagnostic tests whichincorporate these probe arrays. Under the terms of the agreements, bioMérieuxprovided research and development support and made payments to us uponachievement of certain milestones. In addition, bioMérieux pays specified pricesfor the supply of probe arrays and royalties on any resulting product sales. InDecember 1997 and January 1998, we expanded the collaboration withbioMérieux to include the non-exclusive development of DNA probe arrays formolecular diagnostic tests in the fields of virology and food and industrialtesting. In March 2003, the collaboration agreement was amended in orderto reinstate bioMérieux’s licenses and in March 2005, the collaborationwas further expanded to include breast cancer. bioMérieux has launched theFoodExpertID array under this collaboration. See Item 1, Business: “DNAAnalysis Products Powered by AffymetrixTM” on this Form 10-K.

*F.Hoffmann-La Roche Ltd*.   In February 1998,we entered into a non-exclusive collaborative development agreement with F.Hoffmann-La Roche Ltd. (“Roche”) to initially develop human probe 

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array-baseddiagnostic products. Under the terms of the agreement the parties arecollaborating to develop mutually agreed upon arrays, as well as associatedinstrumentation, software, 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 and the agreement also includes abroad range of other compensation payable by Roche to Affymetrix throughout thelife of the agreement based on royalties on sales of diagnostic kits andmilestone payments for technical and commercial achievements. As part of theagreement, Affymetrix will manufacture and supply Roche with microarrays andrelated instrumentation based on Affymetrix’ GeneChip® platform. In 2003, Rochelaunched the AmpliChip® CYP450 array product initially for research use only,but in late 2004 obtained CE marking and FDA regulatory approvals of theproduct for in-vitro diagnostic use.

The parties amended the collaborative developmentagreement in December 2006. Under the terms of the amendment, Roche isrelieved of certain future license installment payments that would have beenpayable by Roche to Affymetrix under the agreement beginning in 2008,Affymetrix is relieved of certain “most favorable terms and conditions”obligations to Roche, and Roche has agreed to pay to Affymetrix additionalmilestone payments related to future commercial achievements. The licenseagreement is subject to Roche’s option to terminate on December 31, 2010or any time on or after December 31, 2015, with one year’s prior notice.As part of the arrangement between the parties, Affymetrix will continue tomanufacture and supply Roche with microarrays and related instrumentation basedon Affymetrix’ GeneChip® platform.

*Veridex,LLC.**  *InDecember 2004, we entered into a non-exclusive collaboration agreementwith Veridex LLC, a Johnson & Johnson company, to develop and commercializeGeneChip® based diagnostic products for use in the field of oncology. Veridexwas granted long-term and comprehensive access to our GeneChip® technology tocreate and market in-vitro diagnostics for cancer. The agreement, made underthe Powered by AffymetrixTM program, gives Veridex non-exclusive rights toAffymetrix’ patented arrays, instrumentation systems and planned improvementsto these technologies.

*Sysmex Corporation.**  *In December 2006, we entered into two agreementswith Sysmex Corporation of Kobe, Japan, to distribute, develop and marketin-vitro diagnostic tests. A Clinical Development and Marketing Agreementgrants Sysmex exclusive rights to distribute Affymetrix’ diagnostic microarrayproducts and instrumentation in Japan with the opportunity to expand intocertain Asia Pacific countries. In addition, a Powered by AffymetrixTM agreement gives Sysmex non-exclusive access toAffymetrix microarray technology to develop and market in-vitro diagnostictests on a worldwide basis. Sysmex will carry out all registration, sales andcustomer support activities for the diagnostic instrumentation, array andreagent products as the Affymetrix distributor for Japan. The Powered byAffymetrixTM agreement enables Sysmex to incorporateAffymetrix’ patented arrays into its diagnostic products. It is expected thatthe resulting microarray-based tests will enable clinicians to provide moreefficient and complete methods to diagnose, classify and manage thesedisorders.

*OtherCollaborations*

*BroadInstitute of Harvard and the Massachusetts Institute of Technology.**  *In September 2004, we enteredinto a supply and research collaboration agreement with the Broad Institute andMassachusetts 

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Institute of Technology.The agreement 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 and high throughput expression analysis. TheAffymetrix SNP 5.0 Array was developed in collaboration with the BroadInstitute to better identify and understand the genetic variations associatedwith complex diseases such as autism, autoimmunity, bipolar disease, cancer,diabetes and heart disease.

*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 tiling arrays interrogating atresolutions and throughput rates never before attempted. The transcriptome isdefined as the complete collection of transcribed elements of the genome. Inaddition to well characterized protein coding transcripts, it also representsnon-coding RNAs that are used for structural and gene regulatory purposes.Alterations in the structure or levels of expression of any one of these RNAsor their proteins could contribute to disease. An understanding of thetranscriptome may provide valuable insights in the research for novel drugs. Wehave made the data from this initiative freely available to the publicdatabases located at the National Cancer Institute, UC Santa Cruz, GeneExpress,and Affymetrix public websites. This collaboration was extended during fiscal2003 through mid 2007 to complete the transcript mapping of the entire humangenome. In addition to studies performed to detect sites of transcription ourtechnology has been used to map sites of binding by transcription factorregulatory elements, modication of chromatin proteins and DNA and genomicorigins of DNA replication.

*Caliper Life Sciences, Inc.*   In January 2004, we signed a collaborationand supply agreement to develop and provide automated target preparationinstruments for the GeneChip® Probe Array system. These new automation systemsare expected to cut array processing, reduce variability and labor costs, andenable researchers to industrialize their genomic research. The two companieswill develop products that leverage Caliper’s expertise in high-throughputautomation and microfluidics with our expertise in microarray technology andapplications. The first products were launched in 2004 and automate GeneChip®microarray target preparation steps including hybridization, washing andstaining for expression and DNA analysis. The automated system enables a singleoperator to run up to 96 RNA samples at a time, compared to the manual rate of20 to 24 samples. In 2005 we launched the Affymetrix GeneChip® ArrayStation that has the capacity to process hundreds of biological samples perweek with minimal human supervision, reducing operating costs and variabilityin target preparation. The GeneChip® Array Station is designed to performtarget preparation for both cartridges and array plates as well as perform thewash 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.

***CapitalBio Corporation, BeijingChina.******  ***InDecember, 2005 we entered into an agreement with CapitalBio Corporation todevelop and manufacture certain advanced instrumentation for Affyemtrixmicroarray processing. This agreement was amended in December 2006 toexpand the scope of our original instrumentation Development and SupplyAgreement. The new agreement establishes a basis for CapitalBio tocomplete the development of the instrumentation. As part of the agreement,CapitalBio was also granted limited marketing and distribution rights forthe instrumentation and associated consumables within China.

**Marketing andDistribution**

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 

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productscompanies, as well as academic research centers, laboratories in governmentagencies, private research foundations and clinical and industrial referencelaboratories. The following factors, among others, influence the size anddevelopment 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 anddevelopment and outsourced spending by biotechnology, pharmaceutical anddiagnostic companies 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. In markets outside of North Americaand Europe, we sell our GeneChip® products principally through third partydistributors, primarily in Mexico, India, the Middle East and Asia Pacific, includingChina. 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, Veridex, a Johnson & Johnsoncompany and Sysmex. For additional information concerning our collaborativepartners, see Note 5 of Notes to Consolidated Financial Statements: “CollaborativeAgreements” and Item 1, Business: “Our Collaborative Partners” on this Form 10-K.

**Manufacturing andRaw 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, a number ofthird-party software suppliers develop, market and sell genomic dataanalysis software that interfaces with data files generated by our GeneChip®system.

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.

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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 and in our new manufacturing facility in Singapore. Wealso maintain a manufacturing process engineering and development facility in SantaClara, California, and a manufacturing and development facility in Bedford,Massachusetts to support our instrumentation products. In September 2006,we announced our plan to close our Bedford, Massachusetts based instrumentationmanufacturing and development facility. We plan to consolidate the Bedfordfacility’s instrument manufacturing operations with our probe arraymanufacturing facility in West Sacramento, California. Our instrumentationdevelopment capabilities will be consolidated with our principal research anddevelopment facilities located in Santa Clara, California. Implementation ofthe plan began in the fourth quarter of 2006 and is expected to continue intothe first half of 2007 and will eliminate or transfer certain positions. SeeNote 3 of Notes of the Consolidated Financial Statements on this Form 10-K.

All of our commercial instrument and arraymanufacturing facilities comply with Good Manufacturing Practices as a subsetof the Quality System Regulation (21 CFR 820). In 2006, we added capacity toour West Sacramento facility and brought on line and qualified a dedicatedGeneChip® probe array manufacturing facility located in Singapore. Thisfacility is fully operational and expected to ramp to high volume production in2007. In addition, we have put in place the capability to rapidly addincremental capacity if required by demand. See Item 7. Off-Balance SheetArrangements and Aggregate Contractual Obligations for further 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 party reagentsat our Santa Clara facility to verify performance of reagent components andassembled reagent kits. We have qualified second source vendors for labelingreagents and oligonucleotides. We perform manufacturing and quality controltesting on certain of our reagents at our South San Francisco facility. We alsoperform services to run certain of our assays on customer samples at our SouthSan Francisco facility.

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 thesevendors are 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 sufficient quantitiesor under acceptable terms. Alternative sources of supply may be time consumingand expensive to qualify. In addition, we are dependent on our vendors toprovide 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.

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**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 31,2006, 2005 and 2004, were $86.3 million, $77.4 million and $73.4 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 any organism.We plan continued software and instrumentation development efforts to enhancethe 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 in 1994 to 5microns in 2005 with the introduction of our Human Exon Array product. We arecontinuing 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.

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**IntellectualProperty**

We rely on a combination of patent, copyright, and trade secret laws,know-how and 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. 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 are new and rapidly evolving. Currently,our principal competition comes from existing technologies and other DNA arraytechnologies that are used to perform many of the same functions for which wemarket 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), and Beckman Coulter, Inc.. Other companies developing ormarketing potentially 

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competitive DNA arraytechnology include: Agilent Technologies, Inc., Applied Biosystems, Inc.,BD Biosciences, Clontech, CombiMatrix Corporation, Digital Gene Technologies, Inc.,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.. For example,companies such as Agilent Technologies, Inc., Applied Biosystems, Inc.,and Illumina, Inc. have products for DNA analysis which are directlycompetitive with our GeneChip® Mapping Array products. In order to competeagainst existing and emerging technologies, we will need to be successful indemonstrating to customers that the GeneChip® system provides a competitiveadvantage.

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. We havesignificantly expanded our network of approved service providers in America,Japan, Europe, and China. 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. Inaddition, we have several other third party licensees that could offer productsthat compete with our product offerings.

**GovernmentRegulation**

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 are developing with our collaborative partners may requireregulatory approval by governmental agencies when distributed outside of theresearch 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 these regulationsrequire the expenditure of substantial resources over a significant period oftime, and there can be no assurance that any clearances or approvals will begranted on a timely basis, if at all. Once granted, a clearance or approval mayplace substantial restrictions on how the device is marketed or labeled or towhom it may be sold. In addition, various 

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federal and state statutes and regulationsgovern or influence the manufacturing, safety, storage of our products andcomponents 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 clinical laboratory willbe subject to extensive federal and state regulation including the requirementsof the Clinical Laboratory Improvement Act of 1988 (CLIA). CLIA is intended toensure the quality and reliability of clinical laboratories in the UnitedStates by requiring all laboratories to meet specified standards in the areasof personnel qualification, administration, participation in proficiencytesting, patient test management, quality control, quality assurance andinspections. There can be no assurance that regulations under and futureadministrative interpretations of CLIA will not have an adverse impact on thepotential 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 to reimbursementissues. The ability of our collaborators to commercialize such products maydepend, in part, on the extent to which reimbursement for the cost of theseproducts will be available under U.S. and foreign regulations governingreimbursement for clinical testing services by government authorities, privatehealth insurers and other organizations. In addition, we are establishing a diagnostic clinical laboratory whichwill provide subcontract services to primary clinical laboratories.

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 futureroyalties and product sales.

**EnvironmentalMatters**

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 the currentregulatory structure allow for “strict liability,” holding a party potentiallyliable without regard to fault or negligence. We could be held liable fordamages and fines as a result of our, or others’, business 

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operationsshould contamination of the environment or individual exposure to hazardoussubstances occur. We cannot predict how changes in these laws or development ofnew regulations will affect our business operations or the cost of compliance.

**Employees**

As of February 20,2007, we had 1,128 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.

**Financial Information 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.

**Financial Information About Geographic Areas**

Our consolidated productand product related revenue from customers outside of the United States forfiscal years 2006, 2005, and 2004 was $168.0 million, $176.7 million and $159.2million, or 51.9%, 50.5% and 48.1%, respectively, of our consolidated productand product related revenue. A summary of revenues from external customersattributed to each of our geographic areas for the fiscal years ended December 31,2006, 2005 and 2004, is included in Note 18 of our Consolidated FinancialStatements 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, and allamendments 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 fileelectronically with the SEC. The address of that site is *http://www.sec.gov*.

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**ITEM 1A.**        RISK FACTORS

In evaluating ourbusiness, you should carefully consider the following risks, as well as theother information contained in this annual report on Form 10-K. Ifany of the following risks actually occurs, our business could be harmed.

**We may not maintainprofitability.**

We incurred losses each year from our inceptionthrough the year ended December 31, 2003 and have incurred a loss for theyear ended December 31, 2006. As a result, we had an accumulated deficitof $120.4 million at December 31, 2006. We expect to continue experiencingfluctuations in our operating results and cannot assure sustainedprofitability. Our losses have resulted principally from costs incurred inresearch and development, manufacturing and from selling, general andadministrative 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.

**Our quarterly results have historically fluctuated significantlyand may continue to fluctuate unpredictably and any failure to meet financialexpectations may disappoint securities analysts or investors and result in adecline in our stock 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. Additionally, license revenue may alsobe unpredictable and may fluctuate due to the timing of payments ofnon-recurring licensing fees. Because our expenses are largely fixed in theshort to medium term, any material shortfall in revenues will materially reduceour profitability and may cause us to experience losses. In particular, ourrevenue growth and profitability depend on sales of our GeneChip® products.Factors that could cause sales for these products to fluctuate include:

·       competition

·       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;

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

·       changesin the attitude of the pharmaceutical industry towards the use of geneticinformation and genetic testing as a methodology for drug discovery anddevelopment.

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 meetthese expectations has adversely affected the market price of our common stockand may continue to do so.

**We may lose customers or experience lost sales if weare unable to manufacture our products and ensure their proper performance andquality.**

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.

Although we have taken 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. Forexample, manufacturing and product quality issues may arise at the newSingapore facility or as we increase production rates at our West Sacramentofacility and launch new products. In addition, we base our manufacturingcapabilities on our forecasted product mix for the quarter. If the actualproduct mix varies significantly from our forecast, we may not be able to fillsome orders during that quarter, which could adversely impact our financialresults. Difficulties in meeting customer, collaborator and internal demandcould also cause us to lose customers or require us to delay new productintroductions, which could in turn result in reduced demand for our products.

We manufacture our GeneChip® instrumentation productsat our manufacturing facility in Bedford, Massachusetts. In the third quarterof 2006, we announced that we will be consolidating our Bedford instrumentationmanufacturing facility with our probe array manufacturing facility in WestSacramento, California as part of our previously announced efforts to reduceexpenses in the general and administrative functions including therationalization of our facilities. The successful reorganization of ourinstrumentation manufacturing capabilities to our West Sacramento site willrequire regulatory approvals, including the registration of our West Sacramentosite with the United States FDA, and is expected to be substantially completedby the third quarter of 2007. This transition is subject to risks anduncertainties that may cause interruptions in our ability to supply GeneChip®instrumentation products to our customers, which could result in lost revenueand seriously harm our business, financial condition and results of operations.

We rely on internal quality control procedures toverify our manufacturing processes. Due to the complexity of our products andmanufacturing process, however, it is possible that probe arrays that do notmeet all of our performance specifications may not be identified before theyare shipped. If our products do not consistently meet our customers’performance expectations, demand for our products will decline. In addition, wedo not maintain any backup manufacturing capabilities for the production of ourGeneChip® instruments. Any interruption in our ability to continue operationsat our existing manufacturing facilities could delay our ability to develop orsell our products, which could result in lost revenue and seriously harm ourbusiness, financial condition and results of operations.

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

The genetic sequence information upon which we rely todevelop and manufacture our products is contained in a variety of publicdatabases throughout the world. These databases are rapidly expanding andevolving. In addition, the accuracy of such databases and resulting geneticresearch is dependent on various scientific interpretations and it is notexpected that global genetic research efforts will result in standardizedgenetic sequence databases for particular genomes in the near future.

Although we haveimplemented ongoing internal quality control efforts to help ensure the qualityand accuracy of our products, the fundamental nature of our products requiresus to rely on genetic sequence databases and scientific interpretations whichare continuously evolving. As a result, these variables may cause us to developand manufacture products that incorporate sequence errors or ambiguities. Themagnitude and importance of these errors depends on multiple and complexfactors that would be considered in determining the appropriate actionsrequired to remedy any inaccuracies. Our inability to timely deliver acceptableproducts as a result of these factors would likely adversely affect ourrelationship with customers, and could have a material adverse effect on ourbusiness, financial condition and results of operations.

**We face risks associated with technologicalobsolescence and emergence of standardized 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 there can be no assurance that ourproducts will emerge as the standard for genetic research. The emergence ofcompeting technologies and systems as market standards for genetic research mayresult in our products becoming uncompetitive and could cause our business tosuffer.

**Our success depends on the continual development ofnew products and our ability to manage the transition from our older productsto 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,including the development of new assay protocols and training our customers, wewill 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 

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managethe transition from older products to minimize disruption in customers’ordering patterns, avoid excessive levels of older product inventories andprovide sufficient supplies of new products to meet customer demands. When weintroduce new or enhanced products, we face numerous risks relating to producttransitions, including the inability to accurately forecast demand anddifficulties in managing different sales and support requirements due to thetype or complexity of the new products.

**If we do not attract and retain key employees, ourbusiness could be impaired.**

To be successful, we must attract and retain qualifiedscientific, engineering, manufacturing, sales, and management personnel. Toexpand our research, product development and sales efforts we need additionalpeople skilled in areas such as bioinformatics, organic chemistry, informationservices, regulatory affairs, manufacturing, sales, marketing and technicalsupport. Competition for these people is intense. We will not be able to expandour business 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.

We also rely on ourscientific advisors and consultants to assist us in formulating our research,development and commercialization strategy. All of these individuals areengaged by other employers and have commitments to other entities that maylimit their availability to us. A scientific advisor’s other obligations mayprevent him or her from assisting us in developing our technical and businessstrategies.

**We expect 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, and Illumina have products for geneticanalysis which are directly competitive with our GeneChip® products. In addition,pharmaceutical and biotechnology companies have significant needs for genomicinformation and may choose to develop or acquire competing technologies to meetthese needs. In the molecular diagnostics field, competition will likely comefrom established diagnostic companies, companies developing and marketing DNAprobe tests for genetic and other diseases and other companies conductingresearch on new technologies to ascertain and analyze genetic information.Further, in the event that we develop new technology and products that competewith existing technology and products of well established companies, there canbe no guarantee that the marketplace will readily adopt any such new technologyand products that we may introduce in the future.

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 instruments in several markets, including clinical and reference laboratories,which are not compatible with the GeneChip® system and could deter acceptanceof our products. In addition, these companies have formed alliances withgenomics companies which provide them access to genetic information that may beincorporated into their diagnostic tests.

**Recent accounting pronouncements may impact our futurefinancial position and results of operations.**

There have been newaccounting pronouncements that may have an impact on our future financialposition and results of operations. For instance, in July 2006, the FASBissued Interpretation No. 48, 

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“Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”(“FIN 48”). Under FIN 48 a company would recognize the benefit from a taxposition only if it is more-likely-than-not that the position would besustained upon audit based solely on the technical merits of the tax position. FIN48 clarifies how a company would measure the income tax benefits from the taxpositions that are recognized, provides guidance as to the timing of thederecognition of previously recognized tax benefits and describes the methodsfor classifying and disclosing the liabilities within the financial statementsfor any unrecognized tax benefits. FIN 48 also addresses when a company shouldrecord interest and penalties related to tax positions and how the interest andpenalties may be classified within the income statement and presented in thebalance sheet. FIN 48 is effective for fiscal years beginning after December 15,2006 and is required to be adopted by us effective January 1, 2007. Thecumulative effects, if any, of applying FIN 48 will be recorded as anadjustment to accumulated deficit as of the beginning of the period of adoption.We are currently evaluating FIN 48 and its possible impacts on our financialstatements and are not yet in a position to determine such effects, if any.

**Our effective tax rate may vary significantly.**

Our operations are subject to income and transactiontaxes in the United States and in multiple foreign jurisdictions. Significantestimates and judgments are required in determining our worldwide provision forincome taxes. Some of these estimates are based on interpretations of existingtax laws or regulations. The ultimate amount of tax liabilitymay be uncertain as a result.

Certain jurisdictions have lower tax rates, and theamount of earnings in these jurisdictions may fluctuate. If we do not haveprofitable operations in these jurisdictions, our tax rate could be adverselyimpacted. Changes in tax laws and regulatory requirements in the countries inwhich we operate could have a material impact on our tax provision. To theextent that we are unable to continue to reinvest a substantial portion of ourprofits in our foreign operations, we may be subject to additional effectiveincome tax rate increases in the future. Tax authorities may challenge theallocation of profits between our subsidiaries and we may not prevail in anysuch challenge. If we were not to prevail, we could be subject to highertax rates or double tax.

We rely on our ability to project future taxableincome to assess the likelihood that our net deferred taxasset will be realized. To the extent we believe that realization is notmore likely than not, we establish a valuation allowance. Significant estimatesare required in determining any valuation allowance to be recorded against ournet deferred tax assets. Changes in the amount of valuation allowance requiredmay adversely impact our financial results of operations.

Other factors that couldaffect our effective tax rate include levels of research and developmentspending and nondeductible expenses such as stock based compensation or mergerrelated expenditures.

**Our business depends on research and developmentspending levels for pharmaceutical and biotechnology companies and academic andgovernmental research institutions.**

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,reductions in operating expenditures by these customers could result in lowerthan expected GeneChip® array and reagent sales. These reductions and delaysmay result from factors that are not within our control, such as:

·       changesin economic conditions;

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

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

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

·       otherfactors affecting research and development spending.

**Our success in penetrating emerging marketopportunities in molecular diagnostics depends on the efforts of our partnersand the ability of our GeneChip® technologies to be used in clinicalapplications for diagnosing and informing the 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.

**We may not successfully obtain regulatory approval ofany diagnostic or other product or service that we or our collaborativepartners 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. Delays orrejections 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 

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incur significant costs inobtaining or maintaining our foreign regulatory approvals. In addition, theexport by us of certain of our products which have not yet been cleared fordomestic commercial distribution may be subject to FDA or other exportrestrictions.

Our diagnostic clinicallaboratory is subject to extensive federal and state regulation includingthe requirements of the Clinical Laboratory Improvement Act of 1988 (CLIA).CLIA is intended to ensure the quality and reliability of clinical laboratoriesin the United States by requiring all laboratories to meet specified standardsin the areas of personnel qualification, administration, participation inproficiency testing, patient test management, quality control, qualityassurance and inspections. There can be no assurance that regulations under andfuture administrative interpretations of CLIA will not have an adverse impacton the potential market for our diagnostic clinical laboratory.

**Healthcare reform and restrictions on reimbursementsmay limit our returns on molecular diagnostic products that we may develop withour 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.

**We depend on a limited number of suppliers and we willbe unable to manufacture our products if shipments from these suppliers aredelayed 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 are availablefrom 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.

**Our success will require that we establish a strongintellectual property position and that we can defend ourselves againstintellectual property claims from others.**

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 

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costs in legal fees andcould substantially affect the scope of our patent protection. We cannot assureinvestors that any such patent applications will not have priority over our patentapplications. Also, our intellectual property may be subject to significantadministrative and litigation proceedings such as opposition proceedingsagainst our patents in Europe, Japan and other jurisdictions. Because of thesize and breadth of our patent portfolio we may or may not chose to pursuelitigation or interferences against those that have infringed on our patents,or used them without authorization, due to the associated expense and timecommitment of monitoring these activities. In addition, we have incurred andmay in future periods incur substantial costs in litigation to defend againstpatent suits brought by third parties or initiated by us. For example, wecurrently are engaged in litigation regarding intellectual property rights withEnzo Life Sciences, Inc. For additional information concerningintellectual property litigation and administrative proceedings, see “Part I,Item 3: Legal Proceedings” of this Form 10-K. If we fail to protector to enforce our intellectual property rights successfully, our competitiveposition could suffer, which could harm our results of operations.

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 we are unable to maintain our relationships withcollaborative partners, we may have difficulty developing and selling ourproducts 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;

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·       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

·       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.

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**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, commercialize theacquired technology, or if key employees of that business leave, theanticipated benefits of an acquisition would be jeopardized. The time, capitalmanagement and other resources spent on an acquisition that fails to meet ourexpectations could cause our business and financial condition to be materiallyand adversely affected. For example, on October 21, 2005, we completed theacquisition of ParAllele BioScience, Inc. We may not realize the anticipatedbenefits of the acquisition because of integration and other challenges whichinclude, among others, unanticipated incompatibility of corporate andadministrative infrastructures, the ability to retain key employees, includingkey scientists, the diversion of management’s attention from ongoing businessconcerns, and the potential adverse reaction of customers to an acquisition orresulting changes to the combined company’s product and services offerings. Inaddition, acquisitions can involve substantial charges of stock basedcompensation that could adversely affect our results of operations.

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

The market price of our commonstock is volatile. To demonstrate this volatility, during the twelve-monthperiod ending on December 31, 2006, the volume of our common stock tradedon any given day ranged from 179,200 to 12,591,300 shares. Moreover, duringthat period, our common stock traded as low as $17.50 per share and as high as$48.00 per share.

Furthermore, volatility inthe stock price of other companies has often led to securities class actionlitigation against those companies. Any future securities litigation against uscould result in substantial costs and divert management’s attention andresources, which could seriously harm our business, financial condition andresults of operations.

**Thematters relating to our internal review of our historical stock option grantingpractices and the restatement of our consolidated financial statements may havea material adverse effect on us.**

During 2006, we conductedan internal review, performed under the direction of our Audit Committee of theBoard of Directors, of our historical stock option granting practices from January 1,1997 through May 31, 2006. As a result of this review, we restated ourconsolidated financial statements for the years ended December 31, 2005,2004 and 2003 to record additional non-cash stock-based compensation expenseand the related tax impact resulting from stock options granted during fiscalyears 1997 to 1999. We have been, and may in the future be, subject tolitigation or other proceedings or actions arising in relation to ourhistorical stock option granting practices and the restatement of our priorperiod financial statements. For example, three purported derivative lawsuitshave been filed against us and several of our current and former officers anddirectors alleging that the defendants breached their fiduciary duty bybackdating stock option grants, as well as violations of federal securitieslaws in 

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connectionwith the dissemination of our financial and proxy statements, violations ofGenerally Accepted Accounting Principles, violations of Section 162(m) ofthe Internal Revenue Code and violations of state law including violation ofthe California Corporations Code. In addition, we have received notice from theSecurities and Exchange Commission that it is conducting an informal inquiryinto our stock option practices. Litigation and any potential regulatoryproceeding or action may be time consuming, expensive and distracting from theconduct of our business. The adverse resolution of any specific lawsuit or anypotential regulatory proceeding or action could have a material adverse effecton our business, financial condition and results of operations. Also, as aresult of our delayed filing our Form 10-Q for the quarter ended June 30,2006, we will be ineligible to register our securities on Form S-3for sale by us or resale by others until we have timely filed all periodicreports under the Securities Exchange Act of 1934 for one year. We may use Form S-1to raise capital or complete acquisitions, which could increase transactioncosts and adversely affect our ability to raise capital or completeacquisitions of other companies during this period.

**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. 

|                         | ** ** | **Approximate**  | ** ** | ** **                               | ** ** | ** **               | ** ** |
|-------------------------|------------|------------------|------------|------------------------------------------|------------|--------------------------|------------|
| **Location**            | ** ** | ** **       | ** ** | **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     |       | 167,000  sq. ft. |       | Manufacturing                            |       | Own  (land and building) |       |
|                         |       | 10,000  sq. ft.  |       | Clinical  lab                            |       | Lease  expires 2011      |       |
|                         |       | 3,800  sq. ft.   |       | Warehouse                                |       | Lease  expires 2007      |       |
| 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

Information pertaining tolegal proceedings can be found in “Item 8. Financial Statements andSupplementary Data—Note 13. Commitments and Contingencies” to the consolidatedfinancial statements, and is incorporated by reference herein.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted during the fourth quarter ofthe year ended December 31, 2006.

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**PART II**

**ITEM 5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASESOF EQUITY SECURITIES

Ourcommon stock is traded on the Nasdaq Global Market under the symbol of AFFX.The following table sets forth, for the periods indicated, the low and high bidprices per share for our common stock as reported by the Nasdaq Global Market.

| ** **     | ** ** | **Low** | ** ** | **High** | ** ** |
|----------------|------------|---------|------------|----------|------------|
| **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 |   |
| **2006**       |       |    |       |     |       |
| First Quarter  |       | $       | 29.80      |     | $          | 48.00 |   |
| Second Quarter |       | $       | 25.60      |     | $          | 35.62 |   |
| Third Quarter  |       | $       | 17.50      |     | $          | 26.26 |   |
| Fourth Quarter |       | $       | 20.27      |     | $          | 27.75 |   |

 

As of February 20, 2007, there were approximately451 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 commonstock held by brokerage firms, banks and other financial institutions asnominees for beneficial owners are deposited into participant accounts at DTCand therefore are considered to be held of record by Cede & Co. as oneshareholder.

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.

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**Performance Graph**

The graph below comparesthe cumulative total return* on our common stock for the period commencing onDecember 31, 2001 and ending December 31, 2006 compared to the CRSP TotalReturn Index for the Nasdaq National Market (U.S. companies) and the CRSP TotalReturn Index for the Nasdaq Pharmaceutical Stocks (SIC 283).  The stock price performance shown on thegraph below is not necessarily indicative of future price performance.

**Comparison ofFive-Year Cumulative Stockholder Return (*)**

****

| ** **                               | ** ** | **12/31/2001** | ** ** | **12/31/2002** | ** ** | **12/31/2003** | ** ** | **12/31/2004** | ** ** | **12/31/2005** | ** ** | **12/31/2006** | ** ** |   |
|------------------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|--------|
| Affymetrix, Inc.                         |       |           | 100.0      |           |       |           | 60.6       |           |       |           | 65.2       |           |       |   | 96.8 |   |   |   | 126.5 |   |   |   | 61.1 |   |   |
| Nasdaq Stock Market  (U.S. Companies)    |       |           | 100.0      |           |       |           | 69.1       |           |       |           | 103.4      |           |       |   | 112.5 |   |   |   | 114.9 |   |   |   | 126.2 |   |   |
| Nasdaq Pharmaceuticals  Stocks (SIC 283) |       |           | 100.0      |           |       |           | 64.6       |           |       |           | 94.7       |           |       |   | 100.9 |   |   |   | 111.1 |   |   |   | 108.7 |   |   |

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*       Assumes $100invested on December 31, 2001 in our common stock and in each index listedabove.  The total return for our commonstock and the indices used assumes the reinvestment of dividends, even thoughdividends have never been declared on our common stock.

The information under thecaption “Performance Graph” is not deemed filed with the Securities andExchange Commission and is not to be incorporated by reference in any filing ofAffymetrix under the Securities Act of 1933, as amended, or the SecuritiesExchange Act of 1934, as amended, whether made before or after the date of this10-K and irrespective of any general incorporation language in such filings.

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**ITEM 6.**                SELECTED FINANCIALDATA

Thefollowing selected historical consolidated financial information has beenderived from our audited consolidated financial statements. The balance sheetdata as of December 31, 2006 and 2005 and statements of operations datafor each of the three years in the period ended December 31, 2006 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,**                            | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                 | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **(unaudited)** | ** ** |
| ** **                                                 | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statement of  Operations Data:**            | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Revenue:                                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Product and product related revenue                        |       | $                                                                     | 323,783    |   | $ | 350,190 |   | $ | 330,885 |   | $ | 280,780 |   |   | $ | 248,538 |   |   |
| Royalties and other revenue                                |       | 16,840                                                                |       | 8,339 |   | 9,832 |   | 10,556 |   |   | 19,777 |   |   |
| Revenue from Perlegen Sciences                             |       | 14,694                                                                |       | 9,073 |   | 5,245 |   | 9,460 |   |   | 21,559 |   |   |
| Total revenue                                              |       | 355,317                                                               |       | 367,602 |   | 345,962 |   | 300,796 |   |   | 289,874 |   |   |
| (Loss) income  from operations                             |       | (18,545                                                               | )          | 57,413 |   | 59,719 |   | 15,820 |   |   | 1,191 |   |   |
| Net (loss) income(1)                                       |       | $                                                                     | (13,704    | ) | $ | 65,787 |   | $ | 47,608 |   | $ | 12,561 |   |   | $ | (5,705 | ) |   |
| Basic net (loss)  income per common share                  |       | $                                                                     | (0.20      | ) | $ | 1.03 |   | $ | 0.79 |   | $ | 0.21 |   |   | $ | (0.10 | ) |   |
| Diluted net  (loss) income per common share                |       | $                                                                     | (0.20      | ) | $ | 0.96 |   | $ | 0.74 |   | $ | 0.21 |   |   | $ | (0.10 | ) |   |
| **Consolidated  Balance Sheet Data:**                      | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Cash, cash  equivalents, and available-for-sale securities |       | $                                                                     | 247,752    |   | $ | 284,932 |   | $ | 205,715 |   | $ | 459,883 |   |   | $ | 361,458 |   |   |
| Working capital                                            |       | 290,302                                                               |       | 349,679 |   | 226,211 |   | 192,778 |   |   | 371,708 |   |   |
| Total assets(2)                                            |       | 781,215                                                               |       | 775,094 |   | 499,771 |   | 700,164 |   |   | 601,403 |   |   |
| Long-term  obligations(3)                                  |       | 134,662                                                               |       | 139,790 |   | 153,845 |   | 166,586 |   |   | 380,222 |   |   |

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(1)          In the third quarter of2006, we initiated a restructuring plan (“the plan”) to better align certain ofour expenses with our current business outlook. The primary focus of the planwas in the general and administrative functions and included rationalizing ourfacilities. In August 2006, we terminated certain employees in theselling, general and administrative functions. Additionally, in September 2006,we announced our plan to close our Bedford, Massachusetts based instrumentationmanufacturing and development facility. We plan to consolidate the Bedfordfacility’s instrument manufacturing operations with our probe arraymanufacturing facility in West Sacramento, California. Our instrumentationdevelopment capabilities will be consolidated with our principal research anddevelopment facilities located in Santa Clara, California. Implementation ofthe plan began in the fourth quarter of 2006 and is expected to continue intothe first half of 2007, will eliminate or transfer certain positions. We expectthe closure of our Bedford, Massachusetts facility to be substantially completeby the third quarter of 2007.

During the third and fourth quarters of 2006, werecognized approximately $13.5 million of expense which was presented in asingle line item labeled “restructuring” in our Statement of Operations.

(2)          On October 21,2005, we completed the $122.4 million acquisition of ParAllele BioScience, Inc.(“ParAllele”), a provider of comprehensive genetic discovery solutions tothe life science research, pharmaceutical and diagnostic sectors.

(3)          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. 

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In August 2001, werepurchased $5.0 million principal amount of the 4.75% notes for totalconsideration of $3.3 million. In connection with the transaction, werecorded an extraordinary gain of approximately $1.7 million in fiscal2001 which was reclassified during fiscal 2002 to interest income and other,net in accordance with Financial Accounting Standard (“FAS”) 145, “Rescissionof 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 the 4.75% notes for total considerationof approximately $0.9 million. In connection with the transaction werecorded a gain of $0.2 million which is included in interest income andother, net. In the second quarter of 2003, we repurchased $53.4 millionprincipal amount of our 4.75% convertible subordinated notes due in 2007 and$48.0 million principal amount of our 5.0% convertible subordinated notesdue in 2006. In connection with these transactions, we recognized a net loss ofapproximately $1.0 million which was included in interest income andother, net. In December 2003, we issued $120.0 million principalamount of 0.75% senior convertible notes. In January 2004, we completedthe redemption of our 5.0% notes ($102.0 million face value). Inconnection 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-termobligations in 2003 through 2006 is the long term portion of deferred revenuerelating primarily to our collaboration agreement with Roche. In January 2003,we expanded our collaboration with Roche. Under the terms of the collaborationagreement, Roche paid us an up-front, nonrefundable license fee of$70.0 million. We are recognizing this amount as a component of productrelated revenue over the research and product development phase, which isexpected to approximate five years.

**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 thisAnnual Report on Form 10-K that are not historical are “forward-lookingstatements” within the meaning of Section 21E of the Securities ExchangeAct of 1934 as amended, including statements regarding our “expectations,” “beliefs,”“hopes,” “intentions,” “strategies” or the like. Such statements are based onour current expectations and are subject to a number of factors anduncertainties that could cause actual results to differ materially from thosedescribed in the forward-looking statements. We caution investors thatthere can be no assurance that actual results or business conditions will notdiffer materially from those projected or suggested in such forward-lookingstatements as a result of various factors, including, but not limited to, therisk factors discussed in this Annual Report on Form 10-K in Item1A. We expressly 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.

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*Restatement ofConsolidated Financial Statements*

On August 9, 2006, we concluded that ourconsolidated financial statements for the years ended December 31, 2005,2004 and 2003 should be restated to record additional non-cash stock-basedcompensation expense, and the related income tax impact, resulting from stockoptions granted during fiscal years 1997 to 1999 that were incorrectlyaccounted for under U.S. generally accepted accounting principles. Our decisionto restate our financial statements was based on the results of an internalreview of our historical stock option granting practices from January 1,1997 through May 31, 2006 performed under the direction of the AuditCommittee of the Board of Directors. The internal review identified certainerrors and documentation lapses but did not find any pattern or practice ofinappropriately identifying grant dates with hindsight in order to provide “discounted”or “in-the-money” grants.

We concluded that there was a material accountingerror as a result of a documentation lapse in July 1999, in which theoption grant for an aggregate of 1.99 million shares should have been measuredfor accounting purposes as of a later date. In light of the restatementrequired by this matter, we also included in this restatement correctionsrelating to certain other errors and documentation lapses in the fiscal years1997 and 1998. Approximately 97% of the charges relating to the restatementarose from the documentation lapse in July 1999.

We have determined that the cumulative, pre-tax,non-cash, stock-based compensation expense resulting from revised measurementdates for options granted between 1997 and 1999 was approximately$21.5 million. Accordingly, we recorded stock-based compensation expenseof $0, $0, and $1.7 million for the years ended December 31, 2005,2004 and 2003, respectively, and $19.8 million for the five years preceding2003, based on the vesting periods of the respective grants. In addition, werecorded an income tax benefit of $8.3 million in 2005. Principally as aresult of cumulative losses incurred through 2004, we recorded a full valuationallowance against all deferred tax assets for the years ended December 31,2004 and 2003 and consequently, there is no income tax effect of the additionalstock-based compensation expense recorded in those years. The cumulative effectof the restatement adjustments on our consolidated balance sheet at December 31,2005 was an increase in additional paid-in capital of $21.5 million offset byan increase in the accumulated deficit of $13.2 million, which results in a neteffect on stockholders’ equity of $8.3 million. The adjustments increasedpreviously reported basic and diluted net income per common share by $0.13 and$0.12, respectively, for the year ended December 31, 2005 and decreasedbasic and diluted net income per common share by $0.03 for the year ended December 31,2003 as reported on our Form 10-K/A for the year ended December 312005 and our quarterly report filed on Form 10-Q/A filed on August 30,2006.

As part of our review, weassessed generally whether there were other matters that should have beencorrected in our previously issued consolidated financial statements. Apartfrom the errors underlying the restatement described above, no other mattershave come to our attention that should be adjusted in our previously issuedconsolidated financial statements.

*Overview*

We are engaged in the development, manufacture, saleand service of consumables and systems for genetic analysis in the lifesciences and clinical healthcare markets and are recognized as a market leaderin creating breakthrough tools that are advancing our understanding of themolecular basis of life. There are a number of factors that influence the sizeand development of our industry, including: the availability of genomicsequence 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 

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companies, the applicationof genomics to new areas including molecular diagnostics, agriculture, humanidentity and consumer goods, and the availability of genetic markers andsignatures 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 and Europe. We also sell ourproducts through life science supply specialists acting as authorizeddistributors in Latin America, India, the Middle East and Asia Pacific regions,including China. Although we have achieved profitability for the three previousconsecutive fiscal years, we incurred a net loss for fiscal 2006. The followingoverview describes a few of the key elements of our business strategy and ourgoals:

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

*Improve operatingefficiency.**  *Weintend to leverage our expanded manufacturing capacity and decrease unit coststo improve our product gross margins. We will monitor our expenses closely toensure our research and development and selling, general and administrativestructures remain in line with our revenue growth.  In July 2006, we announced our intent torestructure our general and administrative cost structure, includingrationalizing our facilities requirements in order to bring our operatingexpenses in line with our current business requirements. We began those effortsand have incurred charges of approximately $13.5 million in 2006 and saw adecrease in headcount related expenses in our general and administrativefunctions beginning in the fourth quarter of 2006. We expect to incuradditional charges through the third quarter of fiscal 2007 of approximately $14.5million related to this effort.

*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.

The results of operationsof ParAllele have been included in the accompanying consolidated financialstatements from the date of acquisition. See Note 4 for further informationregarding this acquisition.

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***CRITICAL ACCOUNTING 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 withU.S. generally accepted accounting principles. The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenue and expenses, andrelated disclosure of contingent assets and liabilities. Management bases itsestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates 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, orchanges in the accounting estimates that are reasonably likely to occurperiodically, could materially impact the financial statements. Managementbelieves the following critical accounting policies reflect its moresignificant estimates and assumptions used in the preparation of the ConsolidatedFinancial Statements.

***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, if required, hasoccurred. Changes in the allocation of the sales price between delivered toundelivered elements might impact the timing of revenue recognition, but wouldnot change the total revenue recognized on any arrangement.

***ACCOUNTS RECEIVABLE***

We evaluate the collectibility of our tradereceivables based on a combination of factors. We regularly analyze oursignificant customer accounts, and, when we become aware of a specific customer’sinability to meet its financial obligations to us, such as in the case ofbankruptcy filings or deterioration in the customer’s operating results orfinancial position, we record specific bad debt allowances to reduce therelated receivable to the amount we reasonably believe is collectible. We alsorecord allowances for bad debt on a small portion of all other customerbalances based on a variety of factors including the length of time thereceivables are past due, the financial health of the customer, macroeconomicconsiderations and historical experience. If circumstances related to specificcustomers change, our estimates of the recoverability of receivables could befurther adjusted.

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**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.

***NON-MARKETABLE 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. Ournon-marketable equity securities are carried at cost unless we determine thatan impairment that is other than temporary has occurred, in which case we writethe investment down to its impaired value. We periodically review ourinvestments for impairment; however, the impairment analysis requiressignificant judgment in identifying events or circumstances that would likelyhave significant adverse effect on the fair value of the investment. Theanalysis may include assessment of the investee’s (i) revenue and earningstrend, (ii) business outlook for its products and technologies, (iii) liquidityposition and the rate at which it is using its cash, and (iv) likelihoodof obtaining subsequent rounds of financing. If an investee obtains additionalfunding at a valuation lower than our carrying value, we presume that theinvestment is other than temporarily impaired. We have experienced impairmentsin our portfolio due to the decline in equity markets over the past few years.

***INCOME 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,nondeductible expenses, changes in overall levels and geographical mix ofpretax earnings and ultimate outcomes of income tax audits.

***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.

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***ACCOUNTING FOR STOCK-BASED COMPENSATION***

Beginning January 1, 2006, we account foremployee stock-based compensation in accordance with FASB Statement No. 123R,“Share-Based Payment” (“SFAS 123R”). Under the provisions of SFAS 123R, weestimate the fair value of our employee stock awards at the date of grant usingthe Black-Scholes option-pricing model, which requires the use of certainsubjective assumptions. The most significant of these assumptions are ourestimates of the expected term, volatility and forfeiture rates of the awards.The expected stock price volatility assumption was determined using acombination of historical and implied volatility of our common stock. Wedetermined that blended volatility is more reflective of market conditions anda better indicator of expected volatility than historical volatility. Theestimate of these key assumptions is based on historical information andjudgment regarding market factors and trends. As required under the accountingrules, we review our valuation assumptions at each grant date and, as a result,we are likely to change our valuation assumptions used to value employeestock-based awards granted in future periods.

SFAS 123R requires that employee stock-basedcompensation costs be recognized over the requisite service period, or thevesting period, in a manner similar to all other forms of compensation paid toemployees. Accordingly, in 2006, we recognized employee stock-basedcompensation of $1.4 million in cost of product sales, $3.7 million in researchand development expense and $10.0 million in selling, general andadministrative expenses, which includes approximately $1.1 million related tothe modification of an executive officer’s stock option grant to increase theassociated exercise period. We also incurred a charge of $7.5 million which wasincluded in restructuring related to the modification of a research anddevelopment employee’s equity awards, all of which became fully vested underthe terms of a prior severance agreement when he was involuntarily terminatedas part of our cost reduction efforts. We adopted SFAS 123R on a modifiedprospective basis. As of December 31, 2006, $20.4 million of totalunrecognized compensation cost related to non-vested stock options not yetrecognized is expected to be allocated to cost of products sales and operatingexpenses over a weighted-average period of 1.6 years.

There was no stock-basedcompensation expense related to employee stock options recognized under SFAS123R during the fiscal years prior to 2006.

***RESTRUCTURING***

We have recently engagedin, and may continue to engage in, restructuring actions, which requiremanagement to utilize significant estimates related to expenses for severanceand other employee separation costs, lease cancellation, realizable values ofassets that may become duplicative or obsolete, and other exit costs. If theactual amounts differ from our estimates, the amount of the restructuringcharges could be materially impacted. For a full description of ourrestructuring actions, see Note 3.

**RECENT ACCOUNTINGPRONOUNCEMENT**

In July 2006, theFASB issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes, an interpretation of FASB Statement No. 109” (“FIN 48”). Under FIN48 a company would recognize the benefit from a tax position only if it ismore-likely-than-not that the position would be sustained upon audit basedsolely on the technical merits of the tax position. FIN 48 clarifies how acompany would measure the income tax benefits from the tax positions that arerecognized, provides guidance as to the timing of the derecognition ofpreviously recognized tax benefits and describes the methods for classifyingand disclosing the liabilities within the financial statements for anyunrecognized tax benefits. FIN 48 also addresses when a company should recordinterest and penalties related to tax positions and how the interest andpenalties may be classified within the income statement and presented in thebalance sheet. FIN 48 is effective for fiscal years beginning after December 15,2006 and is required to be adopted by us effective January 1, 2007. Thecumulative effects, if any, of applying FIN 48 will be recorded as anadjustment to accumulated 

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deficitas of the beginning of the period of adoption. We are currently evaluating FIN48 and its possible impacts on our financial statements and are not yet in aposition to determine such effects, if any.

**RESULTS OFOPERATIONS**

The following discussioncompares the historical results of operations for the years ended December 31,2006, 2005 and 2004.

**PRODUCT SALES**

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

| ** **           | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|----------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Probe arrays         |       | $                                          | 170,359    |                         | $          | 197,949                          |       | $ | 168,243 |   | $ | (27,590 | ) | $ | 29,706 |   |   | (14 | )% |   |   | 18 | % |   |
| Reagents             |       | 43,283                                     |       | 42,428                       |       | 31,744                           |       | 855 |   | 10,684 |   |   | 2 |   |   |   | 34 |   |   |
| Instruments          |       | 47,101                                     |       | 62,636                       |       | 77,269                           |       | (15,535 | ) | (14,633 | ) |   | (25 | ) |   |   | (19 | ) |   |
| Total product  sales |       | $                                          | 260,743    |                         | $          | 303,013                          |       | $ | 277,256 |   | $ | (42,270 | ) | $ | 25,757 |   |   | (14 | ) |   |   | 9 |   |   |

 

Total product sales decreased in 2006 as compared to2005. Probe array salesdeclined primarily due to a decrease of $25.4 million in revenue relatedto the reduction of the average selling price of our probe arrays primarily dueto a decrease in the selling price of our current two-chip 500K genotypingproduct and a decrease of $2.2million in revenue due to a decline in unit sales. Instrument sales decreasedprimarily due to a decrease of $9.7 million in revenue related to a decline inunit sales of our GeneChip® Scanner 3000, a decrease of $2.3 million dueto a drop in unit sales of our GeneChip® Scanner 3000 high-resolution upgradesand a decrease of $3.2 million in unit sales of our automation equipment.

In July 2006, we announced a decrease in theselling price of our current two-chip 500K genotyping product as we believethis will enable scientists to run more samples, and thereby increase the powerof their genetic association studies. We believe this decrease in the sellingprice could cause our future probe array revenues to decline from prior periodsif unit sales do notincrease.

Total product salesincreased in 2005 as compared to 2004. Probe array sales increased primarilydue to an increase of $69.3 million in revenue related to growth in unit salesof our GeneChip® probe arrays. This increase was partially offset by a decreaseof $39.6 million in revenue related to a decline in the average sellingprice of our arrays due to a change in product mix. Reagent sales increasedprimarily due to an increase in the average selling price of our reagentsrelated to a change in product mix and growth in reagent unit sales associatedwith increased probe array unit sales. Instrument sales decreased primarily dueto a decrease of $16.4 million in revenue related to a decline in unit sales ofour GeneChip® Scanner 3000 upgrades as we end our GeneArray® Scanner 2500upgrade cycle as well as a decrease of $4.4 million in revenue related to adecline in unit sales and in the average selling price of our Fluidics Station450. These decreases were partially offset by growth of $4.4 million in revenuerelated to increased unit sales of our new automation equipment and growth of$4.1 million in revenue related to increased unit sales of our GeneChip®Scanner 3000 high-resolution upgrades.

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**PRODUCT RELATEDREVENUE**

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

| ** **                          | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Subscription fees                   |       | $                                          | 7,237      |                         | $          | 12,448                           |       | $ | 20,669 |   | $ | (5,211 | ) | $ | (8,221 | ) |   | (42 | )% |   |   | (40 | )% |   |
| Service and other                   |       | 41,235                                     |       | 20,172                       |       | 15,526                           |       | 21,063 |   | 4,646 |   |   | 104 |   |   |   | 30 |   |   |
| License fees and  milestone revenue |       | 14,568                                     |       | 14,557                       |       | 17,434                           |       | 11 |   | (2,877 | ) |   | — |   |   |   | (17 | ) |   |
| Total product  related revenue      |       | $                                          | 63,040     |                         | $          | 47,177                           |       | $ | 53,629 |   | $ | 15,863 |   | $ | (6,452 | ) |   | 34 |   |   |   | (12 | ) |   |

 

Total product related revenue increased in 2006 ascompared to 2005 primarily due to an increase in service and other revenue ofapproximately $19.3 million in revenue related to our genotyping servicesbusiness. This increase was partially offset by the decline in subscriptionfees earned under our GeneChip® array access programs as we continue totransition customers to volume-based pricing on array sales.

In January 2003, under the terms of anexpanded collaborative agreement, Roche paid us an access fee of$70 million, which we are recognizing as a component of productrelated revenue in license fees over the estimated research anddevelopment period of approximately five years. The expanded collaborationagreement includes a broad range of other compensation payableby Roche to Affymetrix throughout the life of the agreement based on royaltieson sales of diagnostic kits and milestone payments for technical and commercialachievements.

The parties amended the collaborative developmentagreement in December 2006. Under the terms of the amendment, Roche isrelieved of certain future license installment payments that would have beenpayable by Roche to Affymetrix under the agreement beginning in 2008,Affymetrix is relieved of certain “most favorable terms and conditions”obligations to Roche, and Roche has agreed to pay to Affymetrix additionalmilestone payments related to future commercial achievements. The licenseagreement is subject to Roche’s option to terminate on December 31, 2010or any time on or after December 31, 2015, with one year’s prior notice.As part of the arrangement between the parties, Affymetrix will continue tomanufacture and supply Roche with microarrays and related instrumentation basedon Affymetrix’ GeneChip® platform.

Total product relatedrevenue decreased in 2005 as compared to 2004. The decrease was primarily dueto the decline in subscription fees earned under our GeneChip® array accessprograms as we continue to transition customers to volume-based pricing onarray sales. Additionally, the recognition of $2.2 million in milestone revenuedue to the achievement of substantive goals as defined by our collaborativeagreements in 2004 contributed to the decrease. Service and other revenueincreased in 2005 primarily due to an increase of approximately $3.2 million inother revenue related to DNA analysis services pertaining to the completion ofcertain contracts assumed by us upon the acquisition of ParAllele in the fourthquarter of 2005 and due to increased sales of service contracts for ourGeneChip® Scanner 3000.

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

| ** **                   | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Royalties and  other revenue |       | $                                          | 16,840     |                         | $          | 8,339                            |       | $ | 9,832 |   | $ | 8,501 |   | $ | (1,493 | ) |   | 102 | % |   |   | (15 | )% |   |
|                              |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in royaltiesand other revenue in 2006 as compared to 2005 was primarily related to therecognition of $9.5 million related to a license agreement entered into in thesecond half of 2006 with no continuing performance obligations. We alsorecorded an additional $5.3 million in deferred revenue related to this licenseagreement which will be recognized when the payment is received which weanticipate will occur during 2008.

Royalties and otherrevenue decreased in 2005 as compared to 2004 primarily due to a decline in thenumber of our non-core license agreements and the recognition of one monetaryand one non-monetary license agreement with no continuing performanceobligations in 2004 partially offset by the recognition of a $1.5 millionlicense agreement with no continuing performance obligations in the fourthquarter of 2005.

**REVENUE FROM PERLEGEN SCIENCES, INC. (inthousands, except percentage amounts)**

| ** **                      | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue from  Perlegen Sciences |       | $                                          | 14,694     |                         | $          | 9,073                            |       | $ | 5,245 |   | $ | 5,621 |   | $ | 3,828 |   |   | 62 | % |   |   | 73 | % |   |
|                                 |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Perlegen revenue increasedin 2006 as compared to 2005 primarily related to increased demand by Perlegenfor our commercial probe arrays. The increase of $11.2 million was partiallyoffset by a decrease in demand for wafers used by Perlegen for internalresearch and development of $3.1 million. Probe arrays and wafers used byPerlegen for use in their internal research and development activities are soldat our fully burdened cost of manufacturing. We also earn a royalty on certainof these wafers if they are used by Perlegen for certain revenue activities.Royalties recognized were $0.9 million and $­­2.8 million in 2006 and 2005,respectively. We rely on reports from Perlegen to recognize royalty revenue.

Perlegen revenue increasedin 2005 as compared to 2004 primarily due to increased demand by Perlegen forour probe arrays and whole wafers. Probe arrays and wafers used by Perlegen foruse in their research and development activities are sold at our fully burdenedcost of manufacturing. We also earn a royalty on certain of these wafers ifthese products are used by Perlegen for certain revenue activities. Royaltiesrecognized were $2.8 million and $1.4 million in 2005 and 2004. Beginning inthe fourth quarter of 2005, we also began selling probe arrays and reagents toPerlegen for use in certain new applications, with 2005 revenues totaling $1.0million.

**PRODUCT AND PRODUCT RELATED GROSS MARGINS (inthousands, except percentage amounts)**

| ** **                                                               | ** ** | **Year ended December 31,** | ** ** | **Dollar /Point  change from** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                   | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Gross margin on  product sales                                           |       | $                                          | 166,167    |                                     | $          | 218,305 |   | $ | 195,556 |   | $ | (52,138 | ) | $ | 22,749 |   |
| Gross margin on  product related revenue                                 |       | 33,891                                     |       | 35,627                                   |       | 43,995 |   | (1,736 | ) | (8,368 | ) |
| Gross margin on  product and product related revenue                     |       | $                                          | 200,058    |                                     | $          | 253,932 |   | $ | 239,551 |   | $ | (53,874 | ) | $ | 14,381 |   |
| Product gross  margin as a percentage of product sales                   |       | 63.7                                       | %          | 72.0                                     | %          | 70.5 | % | (8.3 | )% | 1.5 |   |
| Product related gross  margin as a percentage of product related revenue |       | 53.8                                       | %          | 75.5                                     | %          | 82.0 | % | (21.7 | )% | (6.5 | ) |

 

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The 8.3 point decrease in product gross margin in 2006as compared to 2005 is primarily due to the following three factors:  3.2 points of the decrease can be attributedto a decrease in the average selling price of our probe arrays primarily due toa decrease in the selling price of our two-chip 500K genotyping product; 3.5points of the decrease is due to underutilized capacity in our probe array andinstrument manufacturing facilities and increased manufacturing costs for ourchips; 1.5 points of the decrease is due to start-up costs for our newSingapore manufacturing facility. These decreases were partially offset by a1.6 point increase in product gross margins as we sold more of our highermargin products.

In July 2006, we announced a decrease in theselling price of our current two-chip 500K genotyping product as we believethat this will enable scientists to run more samples, and thereby increase thepower of their genetic association studies.

The 21.7 point decrease in product related grossmargin in 2006 as compared to 2005 was primarily due to an increase in expensesrelated to our genotyping services business as well as the continuing declinein sales of our access agreements as we continue to transition customers tovolume-based discounting on product sales.

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 attributed to a $2.0 million warranty adjustment and related yieldissues associated with the release of our Mapping 500K Array product in thethird quarter of 2005.

The gross marginpercentage on product related revenue decreased in 2005 as compared to 2004.The margin decreases were primarily due to a decline in sales of our accessagreements as we continue to transition customers to volume-based pricing onarray sales and the recognition of $2.2 million in milestone revenue due to theachievement of substantive goals as defined by our collaborative agreements in2004. We also incurred costs related to the completion of contracts enteredinto by ParAllele in the fourth quarter of 2005.

**COST OF PERLEGEN REVENUES (in thousands, exceptpercentage amounts)**

| ** **                              | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cost of revenue  from Perlegen Sciences |       | $                                          | 5,218      |                         | $          | 5,154                            |       | $ | 3,611 |   |   | $ | 64 |   |   | $ | 1,543 |   |   | 1 | % |   |   | 43 | % |   |
|                                         |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of Perlegen revenue was flat in 2006 as comparedto 2005 primarily due to decreased demand by Perlegen for wafers used forinternal research and development which are sold at our fully burdened cost ofmanufacturing which was offset by an increase in the costs of commercialproducts purchased by Perlegen.

Cost of Perlegen revenueincreased in 2005 and increased as compared to 2004 primarily due to increaseddemand by Perlegen for our probe arrays and whole wafers.

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**RESEARCH AND DEVELOPMENT EXPENSES (in thousands,except percentage amounts)**

| ** **                | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Research and  development |       | $                                          | 86,296     |                         | $          | 77,404                           |       | $ | 73,405 |   | $ | 8,892 |   | $ | 3,999 |   |   | 11 | % |   |   | 5 | % |   |
|                           |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in research and development expenses in2006 as compared to 2005 was primarily due to an increase in headcount relatedcosts of $5.6 million primarily due to our acquisition of ParAllele as well asan increase in new hires in the first half of 2006 and an increase of $3.7million of stock-based compensation expense related to our adoption of SFAS123R.

The increase in researchand development expenses in 2005 as compared to 2004 was primarily due to anincrease in the consumption of development supply materials of $2.1 million andan increase of $1.9 million in co-development costs. These increases are as aresult of our preparation for new product introductions and applicationsexpected to be introduced in the next twelve months. These increases werepartially offset by a decrease of $2.5 million in performance basedcompensation.

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

| ** **                          | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Selling, general and administrative |       | $                                          | 145,126    |                         | $          | 121,952                          |       | $ | 116,973 |   | $ | 23,174 |   | $ | 4,979 |   |   | 19 | % |   |   | 4 | % |   |
|                                     |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in selling general and administrativeexpenses in 2006 as compared to 2005 was partially due to $10.0 million ofstock-based compensation expense related to our adoption of SFAS 123R. Ourstock-based compensation expense included a $1.1 million charge in the secondquarter of 2006 due to the modification of an executive officer’s stock optiongrant to include an extension of time to exercise as well as the vesting ofcertain stock options without a requisite service period. Additionally, legalexpenses increased by $4.1 million in 2006 as we continue to defend our patentrights. In the third quarter of 2006, we also incurred approximately $1.1million in costs related to our stock option review. Lastly, we saw an increaserelated to higher headcount-related costs of $6.3 million in 2006.

We anticipate the cost reduction elements of ourrestructuring plan implemented in the third quarter of 2006 will decrease our headcountcosts in future periods as we continue to bring our general and administrativecosts in line with our current business requirements. We expect legal costs tovary substantially as the intensity of legal activity changes. There can be noassurance that we have adequately estimated our exposure for potential damagesassociated with pending or future litigation.

Selling, general andadministrative expenses increased in 2005 as compared to 2004. These increaseswere primarily due to higher headcount-related costs from hiring new employeesand normal salary increases for existing employees of $6.3 million and anincrease of $2.5 million in consulting costs. Our increased headcount expensesand consulting costs were primarily due to our continued internationalexpansion, investments in new strategic initiatives, and in anticipation of ournew product introductions. These increases were partially offset by a decreaseof $6.2 million in performance based compensation.

**STOCK-BASED COMPENSATION (in thousands, exceptpercentage amounts)**

| ** **                | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Stock-based  compensation |       |                                       | $          | —                       |       |                             | $          | 1,106 |   | $ | 920 |   | $ | (1,106 | ) | $ | 186 |   | (100 | )% |   | 20 | % |   |
|                           |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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With our adoption of SFAS 123R on January 1, 2006all stock-based compensation expense has been included in cost of productsales, research and development expenses, selling, general and administrativeexpenses and restructuring charges. Under SFAS 123R, stock-based compensationcost is calculated on the date of grant using the Black-Scholes method. Thecompensation cost is then amortized straight-line over the vesting period.

In 2005, we recordedstock-based compensation expense related to restricted stock awards granted tocertain employees and one fully vested restricted stock award granted to a non-employee that were calculated using prioraccounting standards. Also in 2005, stock-based compensation includedthe amortization of deferred stock compensation generated upon the acquisitionof ParAllele in October 2005. Theamortization of deferred stock-based compensation was principallyattributable to research and development and selling, general andadministrative employees. In 2004, stock-based compensation related tothe amortization of deferred stock compensation generated upon the acquisitionof Neomorphic in October 2000.

**ACQUIRED IN-PROCESS TECHNOLOGY (in thousands, exceptpercentage amounts)**

| ** **                      | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Acquired in-process  technology |       |                                       | $          | —                       |       |                             | $          | 8,315 |   |   | $ | — |   |   | $ | (8,315 | ) | $ | 8,315 |   | (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, the DNAgenotyping project was 33% complete and the RNA & other projects were40% complete. We expect to incur costs of approximately $5.6 million tocomplete the DNA genotyping project and costs of $1.5 million to complete theRNA & other projects. As of December 31, 2006, there was nosignificant update to the percentage of completion of the projects, nor theanticipated costs to complete as certain of the projects were temporarilydelayed during 2006 as we re-prioritized our efforts in connection with therestructuring plan. These projects are expected to resume in 2007.

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.

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**RESTRUCTURING (in thousands, except percentageamounts)**

| ** **    | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **    | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Restructuring |       | $                                          | 13,497     |                         |       | $                                | —     |   |   |   | $ | — |   |   | $ | 13,497 |   |   | $ | — |   |   |   | 100 | % |   |   | — | % |   |
|               |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In the third quarter of2006, we initiated a restructuring plan (“the plan”) to better align certain ofour expenses with our current business outlook. Our primary focus of the planwas in the general and administrative functions and included rationalizing ourfacilities. In August 2006, we terminated certain employees in theselling, general and administrative functions. Additionally, in September, weannounced our plan to close our Bedford, Massachusetts based instrumentationmanufacturing and development facility. We plan to consolidate the Bedfordfacility’s instrument manufacturing operations with our probe arraymanufacturing facility in West Sacramento, California. Our instrumentationdevelopment capabilities will be consolidated with our principal research anddevelopment facilities located in Santa Clara, California. Implementation ofthe plan began in the fourth quarter of 2006 and is expected to continue intothe first half of 2007 and will eliminate or transfer certain positions. Weexpect the closure of our Bedford, Massachusetts facility to be materiallycomplete by the third quarter of fiscal 2007.

We estimate that the totalrestructuring expenses to be incurred in connection with the plan will beapproximately $28 million. Of this total, we estimate that $19 million relatesto employee severance and relocation benefits, $7 million relates to contracttermination costs associated with vacating the leased Bedford facility, andapproximately $2 million relates to other restructuring costs such asfixed asset write downs and equipment and inventory relocation costs. We haveincurred restructuring expenses beginning in the third quarter of 2006 andexpect to continue incurring related expenses through the third quarter of2007. Cash outlays incurred in connection with these restructuring activitiesare estimated to be approximately $20 million. In accordance with SFAS 146, “Accountingfor Costs Associated with Exit or Disposal Activities” (“SFAS 146”), the costsrelating to employee severance and relocation will be accrued over theremaining service periods of the employees.

During the third and fourth quarters of 2006, werecognized approximately $13.5 million of expense which was presented in asingle line item labeled restructuring in our Statement of Operations, of whichapproximately $7.5 million of the expense related to the modification of aformer Neomorphic employee’s equity awards, all of which became fully vestedunder the terms of a prior leave of absence agreement when he was involuntarilyterminated in connection with the plan.

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

The components of interestincome and other, net, are as follows:

| ** **                            | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest income                       |       | $                                          | 11,283     |                         | $          | 8,118                            |       | $ | 4,189 |   | $ | 3,165 |   | $ | 3,929 |   |   | 39 | % |   | 94 | % |
| Realized loss in  Perlegen            |       | —                                     |       | (2,000                       | )          | —                           |       | 2,000 |   | (2,000 | ) |   | 100 |   |   | (100 | ) |
| Write down of equity  investment, net |       | (211                                       | )          | (171                         | )          | (2,283                           | )          | (40 | ) | 2,112 |   |   | (23 | ) |   | 93 |   |
| Currency gains (losses),  net         |       | 3,003                                      |       | 470                          |       | (458                             | )          | 2,533 |   | 928 |   |   | 539 |   |   | 203 |   |
| Other                                 |       | 3                                          |       | 323                          |       | 869                              |       | (320 | ) | (546 | ) |   | (99 | ) |   | (63 | ) |
| Interest income and  other, net       |       | $                                          | 14,078     |                         | $          | 6,740                            |       | $ | 2,317 |   | $ | 7,338 |   | $ | 4,423 |   |   | 109 |   |   | 191 |   |

 

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Interest income increased in 2006 as compared to 2005due to an increase in the returns on our cash and marketable securitiesbalances. In  2006, we also realized a$1.6 million currency gain on assets held in various foreign currencies. In2005, we realized losses related to the recognition of our proportionate shareof Perlegen’s net loss. The carrying value of our investment in Perlegen waswritten down to zero at December 31, 2005; therefore, to the extent we donot make any additional future investments in Perlegen, we do not expectfurther expenses related to this investment.

Interest income and other, net, increased in 2005 ascompared to 2004 primarily due to an increase in our cash and marketablesecurities balances as generated by positive cashflows from operations andfinancing activities. However, these increases were partially offset by arealized loss related to the recognition of our proportionate share ofPerlegen’s net loss.

**INTEREST EXPENSE (in thousands, except percentageamounts)**

| ** **       | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **       | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest expense |       | $                                          | 1,600      |                         | $          | 1,545                            |       | $ | 11,102 |   |   | $ | 55 |   |   | $ | (9,557 | ) |   | 4 | % |   |   | (86 | )% |   |
|                  |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest expense remainedflat in 2006 as compared to 2005. Interest expense in 2006 and 2005 primarilyconsists of interest and amortization of the debt issuance costs associatedwith our $120.0 million 0.75% senior convertible notes issued in December 2003.Interest expense was higher in 2004 primarily due to the write off ofapproximately $3.8 million in issuance costs plus $4.3 million in redemptionpremiums incurred by us in connection with the redemption of our 5% and 4.75%convertible subordinated notes in January 2004.

**INCOME TAX PROVISION (BENEFIT) (in thousands, exceptpercentage amounts)**

| ** **                      | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005**                     | ** ** | **2004**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income tax  provision (benefit) |       | $                                          | 7,637      |                         | $          | (3,179                           | )          | $ | 3,326 |   | $ | 10,816 |   | $ | (6,505 | ) |   | 340 | % |   | (196 | )% |
|                                 |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The provision for income taxes in 2006 is more thanthe 35% U.S. federal statutory rate applied to consolidated loss before incometaxes primarily due to losses incurred in foreign jurisdictions which do notresult in tax benefits and the tax impact of non-deductible stock basedcompensation expenses under SFAS 123R. The renewal during the fourth quarter ofthe federal research and development tax credit in the United States reducedour income tax provision by approximately $702K or 12%. In 2005, the benefitfor income taxes was more than the 35% U.S. federal statutory rate primarilydue to the reduction in the valuation allowance for certain deferred taxassets. In 2004, the provision for income taxes was more than the 35% U.S.federal statutory rate primarily due to the full valuation allowance againstnet deferred tax assets.

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. Asof December 31, 2006, current net deferred tax assets totaled $13.5million. Non-current net deferred tax assets totaled $29.2 million. Weconsidered whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized, using historical book income, thescheduled reversal of temporary differences, and projected future book andtaxable income in making this assessment.

Based upon the weight of available evidence, as of December 31,2006, we provided for a valuation allowance of $68.0 million against our netdeferred tax assets. $58.7 million of the valuation allowance is recorded tooffset benefits relating to stock options. This amount of the valuationallowance will not be 

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reduced until the benefitreduces tax that would otherwise be due. The remaining $9.3 million is relatedto acquired company tax benefits which will reduce goodwill when recognized.

If we determine that we would not be able to realizeall or part of our net deferred tax assets in the future, we would record acharge to income and an adjustment to the deferred tax assets in the period wemake that determination.

As of December 31,2006, we had net operating loss carryforwards of $110.7 million for U.S.federal purposes, which expire in the years 2018 through 2025. For statepurposes, we had net operating loss carryforwards of $52.3 million, whichexpire in the years 2010 through 2015. Additionally, we have federal and stateresearch and development tax credit carryforwards and other various tax creditcarryforwards of approximately $40.5 million, which expire in the years 2008through 2026 if not utilized. Utilization of our net operating loss and taxcredit carryforwards may be subject to substantial annual limitations due tothe ownership change limitations provided by the Internal Revenue Code andsimilar state provisions. Such an annual limitation could result in theexpiration of the net operating loss or tax credits before utilization.

**LIQUIDITY ANDCAPITAL RESOURCES**

*Cashflow (in thousands)*

| ** **                                                           | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net cash provided  by operating activities                           |       | $                                          | 31,262     |   | $ | 64,613 |   | $ | 48,932 |   |
| Net cash used in  investing activities                               |       | (22,350                                    | )          | (82,304 | ) | (46,785 | ) |
| Net cash provided  by (used in) financing activities                 |       | 9,758                                      |       | 74,846 |   | (235,083 | ) |
| Effect of foreign  currency translation on cash and cash equivalents |       | 157                                        |       | 486 |   | (397 | ) |
| Net increase (decrease)  in cash and cash equivalents                |       | $                                          | 18,827     |   | $ | 57,641 |   | $ | (233,333 | ) |

 

**Net Cash Providedby Operating Activities**

Cash provided by operating activities is net (loss)income adjusted for certain non-cash items and changes in operating assets andliabilities. Cash provided by operating activities was comprised of a net lossof $13.7 million, non-cash depreciation and amortization of $22.8 million,non-cash stock-based compensation expense of $15.1 million and restructuring of$13.5 million. Significant changes in assets and liabilities are as follows:

Our total accounts receivable, including Perlegen, was$77.8 million at December 31, 2006, a decrease of $19.3 million from December 31,2005. The decrease is primarily due to lower product sales of probe arrays andinstruments.

Our inventory balance was $46.5 million at December 31,2006, an increase of $10.5 million from December 31, 2005. The increase isprimarily due to the buildup of consumables as we continue to transitionproduction to our Singapore facility.

Our accounts payable andaccrued liabilities balance was $62.9 million at December 31, 2006, adecrease of $8.7 million from December 31, 2005. The decrease wasprimarily due to the payment of accounts payable related to our manufacturingexpansion in West Sacramento and capital costs on our new manufacturingfacility in Singapore.

**Net Cash Used inInvesting Activities**

Our investing activities, other than purchases, salesand maturities of available-for-sale securities, primarily consist of capitalexpenditures, strategic investments and purchased technology rights.

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Cash used for capital expenditures was $79.3 million,$40.2 million and $21.9 million for the years ended December 31,2006, 2005 and 2004, respectively. Our capital expenditures in 2006 primarilyrelated to our manufacturing expansion in West Sacramento and capital costsrelated to our new manufacturing facility in Singapore. Capital expenditures in2004 and 2005 related to continued expansion in our operating facilities,investments in information management systems, and purchases of production andlab equipment.

In  2005, wemade a $2.0 million purchase of non-marketable equity investment in PerlegenSciences. Additionally, we used $10.9 million in cash, net of cash assumed, forour acquisition of ParAllele in October 2005.

In 2004, the primarycomponent of purchased technology rights related to a $41.9 millionlicense payment to OGT.

**Net Cash Providedby (Used in) Financing Activities**

Our financing activitiesprimarily consist of activity under our employee stock plans. Cash provided bythe issuance of stock under our employee stock plan was $9.3 million, $74.7million and $36.2 million in 2006, 2005 and 2004, respectively. Net cash usedin financing activities in 2004 was primarily attributable to the $271.8million cash outflow for the redemption of our 5% and 4.75% convertiblesubordinated notes.

*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, 2006, we arenot involved in any SPE transactions.

Theimpact that our contractual obligations as of December 31, 2006 areexpected to have on our liquidity and cash flow in future periods is as follows(in thousands):

| ** **                               | ** ** | **Total** | ** ** | **2007** | ** ** | **2008-2009** | ** ** | **2010-2011** | ** ** | **After 2011** | ** ** |
|------------------------------------------|------------|-----------|------------|----------|------------|---------------|------------|---------------|------------|---------------------|------------|
| Senior convertible  notes(1)             |       | $         | 120,000    |     | $          | —        |       | $             | 120,000    |                |       | $ | — |   |   |   | $ | — |   |   |
| Interest on  senior convertible notes(1) |       | 1,800     |       | 900      |       | 900           |       |          | —     |                |       |   | — |   |   |
| Operating leases                         |       | 50,617    |       | 10,488   |       | 17,421        |       |          | 11,975     |                |       |   | 10,733 |   |   |
| Purchase  commitments(2)                 |       | 9,937     |       | 9,608    |       | 329           |       |          | —     |                |       |   | — |   |   |
| Other commitments(3)                     |       | 1,100     |       | 500      |       | 600           |       |          | —     |                |       |   | — |   |   |
| Total contractual  obligations           |       | $         | 183,454    |     | $          | 21,496        |       | $             | 139,250    |                |       | $ | 11,975 |   |   |   | $ | 10,733 |   |   |

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(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 $0.5 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.

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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, 2006,we had cash, cash equivalents, and available-for-sale securities ofapproximately $247.8 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 $35 million for the year ending December 31,2007, which includes the completion of our manufacturing 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. Our long-termcapital expenditure requirements will depend on numerous factors including: theexpansion of commercial scale manufacturing capabilities; our ability tomaintain existing collaborative and customer arrangements and establish andmaintain new collaborative and customer arrangements; the progress of ourresearch and development programs; initiation or expansion of research programsand collaborations; the costs involved in preparing, filing, prosecuting,defending and enforcing intellectual property rights; the effectiveness ofproduct commercialization activities and arrangements; the purchase of patentlicenses; and other factors.

As of December 31,2006, 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 additional funds to continue the development of ourtechnologies. There can be no assurance that such funds will be available onfavorable terms, or at all. To the extent that additional capital is raisedthrough the sale of equity or convertible debt securities, the issuance of suchsecurities could result in dilution to our stockholders. If adequate funds arenot available, we may be required to curtail operations significantly or toobtain funds by entering into collaboration agreements on unattractive terms.Our inability to raise capital would have a material adverse effect on ourbusiness, financial condition and results of operations.

**ITEM 7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURES 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.

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Thetable below presents principal amounts and related weighted interest rates byyear of maturity for our available-for-sale securities and debt obligations,are primarily denominated in United States dollars, and the fair value of eachas of December 31, 2006 and 2005. Our available for sale securities areclassified on our balance sheet in cash and cash equivalents,available-for-sale securities—short-term and available-for-sale securities—long-term.

| ** **                                    | ** ** | **Periods of Maturity** | ** ** | ** ** | ** ** | **Fair  Value at  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                          | ** ** | **2008**   | ** ** | **2009**                                   | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **2006** | ** ** |
| **ASSETS:**                                   |       |                              |       |       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Available-for-sale  securities                |       | $                                 | 128,331    |       | $          | 10,564                                     |       |   | $ | — |   |   |   | $ | — |   |   | $ | 138,895 |   |   | $ | 138,997 |   |   |
| Average interest  rate                        |       | 3.5                               | %          | 4.8        | %          |                                       | —     |   |   |   | — |   |   |   |   |   |   |   |   |
| **LIABILITIES:**                              |       |                              |       |       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 0.75% senior  convertible notes due 2033 |       | $                                 | —     |       | $          | 120,000                                    |       |   | $ | — |   |   |   | $ | — |   |   | $ | 120,000 |   |   | $ | 120,473 |   |   |
| Average interest rate                         |       |                              |       | 0.75       | %          |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |

 

| ** **                                    | ** ** | **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                                       | %          |   |   |   |   |   |   |   |   |   |   |

 

*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 2 of  “Notesto Consolidated Financial Statements” included in this report on Form 10K.)Our hedging program reduces, but does not entirely eliminate, the impact ofcurrency 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, 2006 and2005, total outstanding contracts included the notional equivalent of $35.8million and $21.6 million in foreign currency forward exchange contractswith a fair market value of zero and $0.8 million. As of December 31,2006, all contracts were set to expire at in the first quarter of 2007. Thebank counterparties in these contracts expose us to credit-related losses inthe event of their nonperformance. However, to mitigate that risk we onlycontract with reputable institutions. We apply hedge accounting based upon thecriteria established by Statement of Financial Accounting Standards No. 133(“SFAS 133”), whereby we designate our derivatives 

56

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for revenue hedgingpurposes as cash flow hedges. We have elected not to designate our derivativesfor balance sheet purposes as fair value hedges under SFAS 133 and haveappropriately recorded 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, 2006. 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 $3.6 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 $3.6 million.

57

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTSAFFYMETRIX, INC.**

|                                                          | ** ** | **Page No.** | ** ** |
|----------------------------------------------------------|------------|-------------------|------------|
| Report of Independent Registered Public Accounting  Firm |       |              | 59         |   |   |
| Consolidated Balance Sheets                              |       |              | 60         |   |   |
| Consolidated Statements of Operations                    |       |              | 61         |   |   |
| Consolidated Statements of Comprehensive Income (Loss)   |       |              | 62         |   |   |
| Consolidated Statements of Stockholders’ Equity     |       |              | 63         |   |   |
| Consolidated Statements of Cash Flows                    |       |              | 64         |   |   |
| Notes  to Consolidated Financial Statements              |       |              | 65         |   |   |

 

58

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofAffymetrix, Inc.

We have audited the accompanying consolidated balancesheets of Affymetrix, Inc. as of December 31, 2006 and 2005, and therelated consolidated statements of operations, comprehensive income (loss),stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2006. 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 the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Affymetrix, Inc. at December 31, 2006 and 2005, and theconsolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2006, in conformity with U.S.generally accepted accounting principles. Also, in our opinion, the relatedfinancial statement schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly in all material respectsthe information set forth therein.

As discussed in Note 1 to the consolidated financialstatements, in 2006 Affymetrix, Inc. changed its method of accounting forstock-based compensation in accordance with guidance provided in Statement ofFinancial Accounting Standards No. 123(R), “Share-Based Payment”.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of Affymetrix, Inc.’sinternal control over financial reporting as of December 31, 2006, basedon criteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated February 23, 2007 expressed an unqualified opinion thereon.

| /s/ ERNST &  YOUNG LLP |   |   |
|---------------------------------|--------|--------|
| Palo Alto, California,          |
| February 23, 2007          |

 

59

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

| ** **                                                                                                                                                   | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS:**                                                                                                                                                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                              |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                    |       | $                     | 119,063    |   | $ | 100,236 |   |
| Available-for-sale securities—short term portion                                                                                                        |       | 118,088               |       | 184,696 |   |
| Accounts receivable (net of allowances of $1,534 in  2006 and $415 in 2005)                                                                                  |       | 75,553                |       | 93,028 |   |
| Accounts receivable from Perlegen Sciences                                                                                                                   |       | 2,290                 |       | 4,082 |   |
| Inventories                                                                                                                                                  |       | 46,506                |       | 35,980 |   |
| Deferred tax assets—current portion                                                                                                                     |       | 13,534                |       | 26,230 |   |
| Prepaid expenses and other current assets                                                                                                                    |       | 8,858                 |       | 12,622 |   |
| Total current assets                                                                                                                                         |       | 383,892               |       | 456,874 |   |
| Available-for-sale  securities—long term portion                                                                                                        |       | 10,601                |       | — |   |
| Property and  equipment, net                                                                                                                                 |       | 141,322               |       | 85,560 |   |
| Acquired  technology rights, net                                                                                                                             |       | 55,125                |       | 61,426 |   |
| Goodwill                                                                                                                                                     |       | 124,916               |       | 124,498 |   |
| Deferred tax  assets—long-term portion                                                                                                                  |       | 29,170                |       | 17,594 |   |
| Notes receivable  from employees                                                                                                                             |       | 2,186                 |       | 1,824 |   |
| Other assets                                                                                                                                                 |       | 34,003                |       | 27,318 |   |
| Total assets                                                                                                                                                 |       | $                     | 781,215    |   | $ | 775,094 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY:**                                                                                                              |       |                  |       |   |   |
| Current liabilities:                                                                                                                                         |       |                  |       |   |   |
| Accounts payable and accrued liabilities                                                                                                                     |       | $                     | 62,893     |   | $ | 71,551 |   |
| Deferred revenue—current portion                                                                                                                        |       | 30,697                |       | 35,644 |   |
| Total current liabilities                                                                                                                                    |       | 93,590                |       | 107,195 |   |
| Deferred  revenue—long-term portion                                                                                                                     |       | 9,562                 |       | 15,606 |   |
| Other long-term  liabilities                                                                                                                                 |       | 5,100                 |       | 4,184 |   |
| Convertible notes                                                                                                                                            |       | 120,000               |       | 120,000 |   |
| Commitments and  contingencies (Note 13)                                                                                                                     |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                   |       |                  |       |   |   |
| Convertible redeemable preferred stock, $0.01 par  value; 5,000 shares authorized; no shares issued and outstanding at  December 31, 2006 and 2005      |       | —                |       | — |   |
| Common stock, $0.01 par value; 200,000 shares  authorized; 67,922 and 67,220 shares issued and outstanding at  December 31, 2006 and 2005, respectively |       | 679                   |       | 672 |   |
| Additional paid-in capital                                                                                                                                   |       | 674,428               |       | 646,186 |   |
| Deferred stock compensation                                                                                                                                  |       | —                |       | (10,799 | ) |
| Accumulated other comprehensive loss                                                                                                                         |       | (1,717                | )          | (1,227 | ) |
| Accumulated deficit                                                                                                                                          |       | (120,427              | )          | (106,723 | ) |
| Total stockholders’ equity                                                                                                                              |       | 552,963               |       | 528,109 |   |
|                                                                                                                                                         |       | $                     | 781,215    |   | $ | 775,094 |   |

 

See Accompanying Notes

60

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

| ** **                                                           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **REVENUE:**                                                         | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product sales                                                        |       | $                                          | 260,743    |   | $ | 303,013 |   | $ | 277,256 |   |
| Product related revenue                                              |       | 63,040                                     |       | 47,177 |   | 53,629 |   |
| Total product and product related revenue                            |       | 323,783                                    |       | 350,190 |   | 330,885 |   |
| Royalties and other revenue                                          |       | 16,840                                     |       | 8,339 |   | 9,832 |   |
| Revenue from Perlegen Sciences                                       |       | 14,694                                     |       | 9,073 |   | 5,245 |   |
| Total revenue                                                        |       | 355,317                                    |       | 367,602 |   | 345,962 |   |
| **COSTS AND EXPENSES:**                                              |       |                                       |       |   |   |   |   |
| Cost of product sales                                                |       | 94,576                                     |       | 84,708 |   | 81,700 |   |
| Cost of product related revenue                                      |       | 29,149                                     |       | 11,550 |   | 9,634 |   |
| Cost of revenue from Perlegen Sciences                               |       | 5,218                                      |       | 5,154 |   | 3,611 |   |
| Research and development                                             |       | 86,296                                     |       | 77,404 |   | 73,405 |   |
| Selling, general and administrative                                  |       | 145,126                                    |       | 121,952 |   | 116,973 |   |
| Stock-based compensation                                             |       | —                                     |       | 1,106 |   | 920 |   |
| Acquired in-process technology                                       |       | —                                     |       | 8,315 |   | — |   |
| Restructuring charges                                                |       | 13,497                                     |       | — |   | — |   |
| Total costs and expenses                                             |       | 373,862                                    |       | 310,189 |   | 286,243 |   |
| (Loss) income  from operations                                       |       | (18,545                                    | )          | 57,413 |   | 59,719 |   |
| Interest income  and other, net                                      |       | 14,078                                     |       | 6,740 |   | 2,317 |   |
| Interest expense                                                     |       | (1,600                                     | )          | (1,545 | ) | (11,102 | ) |
| (Loss) income  before income taxes                                   |       | (6,067                                     | )          | 62,608 |   | 50,934 |   |
| Income tax  (provision) benefit                                      |       | (7,637                                     | )          | 3,179 |   | (3,326 | ) |
| Net (loss) income                                                    |       | $                                          | (13,704    | ) | $ | 65,787 |   | $ | 47,608 |   |
| Basic net (loss)  income per common share                            |       | $                                          | (0.20      | ) | $ | 1.03 |   | $ | 0.79 |   |
| Diluted net  (loss) income per common share                          |       | $                                          | (0.20      | ) | $ | 0.96 |   | $ | 0.74 |   |
| Shares used in  computing basic net (loss) income per common share   |       | 67,386                                     |       | 63,816 |   | 60,512 |   |
| Shares used in computing  diluted net (loss) income per common share |       | 67,386                                     |       | 70,586 |   | 66,878 |   |

 

See Accompanying Notes

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**AFFYMETRIX, INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)(In thousands)**

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net (loss) income                                                                          |       | $                                          | (13,704    | ) | $ | 65,787 |   | $ | 47,608 |   |
| Other comprehensive  (loss) income:                                                        |       |                                       |       |   |   |   |   |
| Foreign currency translation adjustment, net of tax                                        |       | 157                                        |       | 486 |   | (397 | ) |
| Unrealized (losses) gains on available-for-sale and  non-marketable securities, net of tax |       | (192                                       | )          | 119 |   | (1,500 | ) |
| Reclassification adjustment for gains (losses) in  net income (loss)                       |       | 107                                        |       | (157 | ) | 287 |   |
| Unrealized (losses) gains on cash flow hedges, net  of tax                                 |       | (18                                        | )          | 544 |   | (1,152 | ) |
| Reclassification adjustment for (losses) gains in  net income (loss)                       |       | (544                                       | )          | 1,152 |   | 963 |   |
| Net change in  other comprehensive (loss) income                                           |       | (490                                       | )          | 2,144 |   | (1,799 | ) |
| Comprehensive (loss)  income                                                               |       | $                                          | (14,194    | ) | $ | 67,931 |   | $ | 45,809 |   |

 

See Accompanying Notes

62

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

| ** **                                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Convertible redeemable  preferred stock:**                                                            | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, beginning of year                                                                              |       | $                                          | —     |   | $ | — |   | $ | — |   |
| Balance, end of year                                                                                    |       | —                                     |       | — |   | — |   |
| Common stock:                                                                                           |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | 672                                        |       | 616 |   | 595 |   |
| Common stock issued                                                                                     |       | 7                                          |       | 56 |   | 21 |   |
| Balance, end of year                                                                                    |       | 679                                        |       | 672 |   | 616 |   |
| Additional paid-in  capital:                                                                            |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | 646,186                                    |       | 428,717 |   | 391,763 |   |
| Issuance of common stock upon exercise of stock  options and warrants and issuances of restricted stock |       | 9,248                                      |       | 77,285 |   | 36,220 |   |
| Issuance of common stock from acquisition of  ParAllele                                                 |       | —                                     |       | 107,112 |   | — |   |
| Stock based compensation expense from stock options  and restricted stock                               |       | 15,050                                     |       | — |   | — |   |
| Stock based compensation expense from stock options  recorded as restructuring charges                  |       | 7,544                                      |       |   |   |   |   |
| Income tax benefit from employee stock option  exercises                                                |       | 7,199                                      |       | 33,072 |   | 734 |   |
| Reclass of deferred compensation into APIC pursuant  to SFAS 123R                                       |       | (10,799                                    | )          | — |   | — |   |
| Balance, end of year                                                                                    |       | 674,428                                    |       | 646,186 |   | 428,717 |   |
| Notes receivable from  stockholders:                                                                    |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | —                                     |       | — |   | (428 | ) |
| Repayment of notes receivable                                                                           |       | —                                     |       | — |   | 454 |   |
| Accretion of interest on notes receivable                                                               |       | —                                     |       | — |   | (26 | ) |
| Balance, end of year                                                                                    |       | —                                     |       | — |   | — |   |
| Deferred stock  compensation:                                                                           |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | (10,799                                    | )          | (4,265 | ) | (5,185 | ) |
| Reclass of deferred compensation into APIC pursuant  to SFAS 123R                                       |       | 10,799                                     |       | — |   | — |   |
| Amortization of deferred stock compensation                                                             |       | —                                     |       | 1,022 |   | 920 |   |
| Unearned stock compensation, net of cancellations                                                       |       | —                                     |       | (7,556 | ) | — |   |
| Balance, end of year                                                                                    |       | —                                     |       | (10,799 | ) | (4,265 | ) |
| Accumulated other  comprehensive (loss):                                                                |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | (1,227                                     | )          | (3,371 | ) | (1,572 | ) |
| Unrealized loss on investments, net of tax                                                              |       | (85                                        | )          | (38 | ) | (1,213 | ) |
| Unrealized (loss) gain on hedging contracts, net of  tax                                                |       | (562                                       | )          | 1,696 |   | (189 | ) |
| Foreign currency translation adjustment, net of tax                                                     |       | 157                                        |       | 486 |   | (397 | ) |
| Balance, end of year                                                                                    |       | (1,717                                     | )          | (1,227 | ) | (3,371 | ) |
| Accumulated deficit:                                                                                    |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | (106,723                                   | )          | (172,510 | ) | (220,118 | ) |
| Net (loss) income                                                                                       | ** ** | (13,704                                    | )          | 65,787 |   | 47,608 |   |
| Balance, end of year                                                                                    |       | (120,427                                   | )          | (106,723 | ) | (172,510 | ) |
| Total stockholders  equity                                                                              |       | $                                          | 552,963    |   | $ | 528,109 |   | $ | 249,187 |   |
| **Number  of shares of common stock**                                                                   |       |                                       |       |   |   |   |   |
| Balance, beginning of year                                                                              |       | 67,220                                     |       | 61,588 |   | 59,474 |   |
| Issuance of common stock for cash or services                                                           |       | 702                                        |       | 3,346 |   | 2,114 |   |
| Issuance of common stock for acquisition of ParAllele                                                   |       | —                                     |       | 2,286 |   | — |   |
| Balance, end of  year                                                                                   |       | 67,922                                     |       | 67,220 |   | 61,588 |   |

 

See Accompanying Notes

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

| ** **                                                                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                      | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss) income                                                                               |       | $                                          | (13,704    | ) | $ | 65,787 |   | $ | 47,608 |   |
| Adjustments to  reconcile net (loss) income to net cash provided by  operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                                   |       | 22,796                                     |       | 20,467 |   | 19,660 |   |
| Amortization of intangible assets                                                               |       | 8,315                                      |       | 7,731 |   | 6,075 |   |
| 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                                                        |       | (101                                       | )          | (1,177 | ) | (1,142 | ) |
| Excess tax benefits for stock-based compensation                                                |       | (504                                       | )          | — |   | — |   |
| Stock-based compensation                                                                        |       | 15,050                                     |       | 1,106 |   | 920 |   |
| Restructuring charges                                                                           |       | 13,497                                     |       | — |   | — |   |
| Write down of equity investments                                                                |       | 211                                        |       | 172 |   | 2,283 |   |
| Realized loss on equity method investment in Perlegen  Sciences                                 |       | —                                     |       | 2,000 |   | — |   |
| Realized (gain) loss on the sales of investments                                                |       | (45                                        | )          | 145 |   | 859 |   |
| Deferred tax assets                                                                             |       | 8,755                                      |       | (10,971 | ) | — |   |
| Amortization of debt offering costs                                                             |       | 758                                        |       | 759 |   | 756 |   |
| Accretion of interest on notes receivable                                                       |       | (62                                        | )          | (98 | ) | (26 | ) |
| Loss on disposal of equipment                                                                   |       | 781                                        |       | 12 |   | 657 |   |
| Changes in  operating assets and liabilities:                                                   |       |                                       |       |   |   |   |   |
| Accounts receivable, net                                                                        |       | 19,267                                     |       | (94 | ) | (22,062 | ) |
| Inventories                                                                                     |       | (10,526                                    | )          | (15,137 | ) | 4,635 |   |
| Prepaid expenses and other assets                                                               |       | (7,978                                     | )          | 3,143 |   | (2,867 | ) |
| Accounts payable and accrued liabilities                                                        |       | (15,173                                    | )          | (4,115 | ) | (7,535 | ) |
| Deferred revenue                                                                                |       | (10,991                                    | )          | (13,203 | ) | (10,126 | ) |
| Other long-term liabilities                                                                     |       | 916                                        |       | (229 | ) | 1,142 |   |
| Net cash provided by operating activities                                                       |       | 31,262                                     |       | 64,613 |   | 48,932 |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                      |       |                                       |       |   |   |   |   |
| Capital expenditures                                                                            |       | (79,339                                    | )          | (40,166 | ) | (21,885 | ) |
| Purchases of available-for-sale securities                                                      |       | (103,977                                   | )          | (227,290 | ) | (182,876 | ) |
| Proceeds from sales and maturities of available-for-sale  securities                            |       | 162,341                                    |       | 206,395 |   | 202,780 |   |
| Purchase of non-marketable equity investments                                                   |       | (1,125                                     | )          | (3,500 | ) | (1,741 | ) |
| Purchase of non-marketable equity investments  in Perlegen                                      |       | —                                     |       | (2,000 | ) | — |   |
| Capital distribution from non-marketable investment                                             |       | —                                     |       | 411 |   | — |   |
| Purchases of technology rights                                                                  |       | (250                                       | )          | (750 | ) | (43,063 | ) |
| Issuance of loan to ParAllele BioScience, Inc.                                             |       | —                                     |       | (4,500 | ) | — |   |
| Acquisition of ParAllele BioScience, Inc., net  of cash acquired                           |       | —                                     |       | (10,904 | ) | — |   |
| Net cash used in investing activities                                                           |       | (22,350                                    | )          | (82,304 | ) | (46,785 | ) |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                      |       |                                       |       |   |   |   |   |
| Issuance of common stock                                                                        |       | 9,254                                      |       | 74,705 |   | 36,241 |   |
| Excess tax benefits for stock-based compensation                                                |       | 504                                        |       | — |   | — |   |
| Repayment of notes receivable from stockholders                                                 |       | —                                     |       | 141 |   | 454 |   |
| Redemption of convertible subordinated notes                                                    |       | —                                     |       | — |   | (271,778 | ) |
| Net cash provided by (used in) financing activities                                             |       | 9,758                                      |       | 74,846 |   | (235,083 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                                   |       | 157                                        |       | 486 |   | (397 | ) |
| Net increase (decrease) in cash and cash equivalents                                            |       | 18,827                                     |       | 57,641 |   | (233,333 | ) |
| Cash and cash equivalents at beginning of year                                                  |       | 100,236                                    |       | 42,595 |   | 275,928 |   |
| Cash and cash equivalents at end of year                                                        |       | $                                          | 119,063    |   | $ | 100,236 |   | $ | 42,595 |   |
| **SUPPLEMENTAL DISCLOSURE OF  NONCASH ACTIVITIES:**                                             |       |                                       |       |   |   |   |   |
| Recognition of deferred tax assets relating to tax  benefits from employee stock plans          |       | $                                          | 7,635      |   | $ | 32,853 |   | $ | — |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH  FLOW INFORMATION:**                                          |       |                                       |       |   |   |   |   |
| Cash paid for interest                                                                          |       | $                                          | 900        |   | $ | 900 |   | $ | 10,623 |   |
| Cash paid for  income taxes                                                                     |       | $                                          | 2,945      |   | $ | 2,001 |   | $ | 1,127 |   |

 

See Accompanying Notes

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**AFFYMETRIX, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2006**

**NOTE 1—NATURE OFOPERATIONS**

Affymetrix, Inc.(“Affymetrix” or the “Company”) is engaged in the development, manufacture,sale and service of systems for genetic analysis for use in the life sciencesand in clinical diagnostics. Affymetrix has developed its GeneChip® system andrelated microarray technology as the platform of choice for acquiring,analyzing and managing complex genetic information. The Company’s integratedGeneChip® platform includes: disposable DNA probe arrays (chips) consisting ofgene sequences set out in an ordered, high density pattern, certain reagentsfor use with the probe arrays, a scanner and other instruments used to processthe probe arrays, and software to analyze and manage genomic informationobtained from the probe arrays. Related microarray technology also offered byAffymetrix includes instrumentation, software and licenses for fabricating,scanning, collecting and analyzing results from low density microarrays. TheCompany currently sells its products directly to pharmaceutical, biotechnology,agrichemical, diagnostics and consumer products companies as well as academicresearch centers, government research laboratories, private foundation laboratoriesand clinical reference laboratories in North America and Europe. The Companyalso sells some of its products through life science supply specialists actingas authorized distributors in Latin America, India, the Middle East and AsiaPacific regions, including China.

**NOTE 2—SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

**BASIS OFPRESENTATION**

The consolidated financial statements include theaccounts of Affymetrix and its wholly owned subsidiaries. All significantintercompany accounts and transactions have been eliminated. The Company hasaccounted for its ownership interest in Perlegen Sciences, Inc.(“Perlegen”) using the equity method since March 30, 2001 (seeNote 12). In addition, the Company acquired ParAlleleBioScience, Inc. on October 21, 2005 and it is included in theCompany’s operations from that date (see Note 4).

On August 9, 2006, the Company concluded that itsconsolidated financial statements for the years ended December 31, 2005,2004 and 2003 should be restated to record additional non-cash stock-basedcompensation expense, and the related income tax impact, resulting from stockoptions granted during fiscal years 1997 to 1999 that were incorrectlyaccounted for under U.S. generally accepted accounting principles. TheCompany’s decision to restate its financial statements was based on the resultsof an internal review of the Company’s historical stock option grantingpractices from January 1, 1997 through May 31, 2006 performed underthe direction of the Audit Committee of the Board of Directors. The internalreview identified certain errors and documentation lapses but did not find anypattern or practice of inappropriately identifying grant dates with hindsightin order to provide “discounted” or “in-the-money” grants.

The Company concluded that there was a materialaccounting error as a result of a documentation lapse in July 1999, inwhich the option grant for an aggregate of 1.99 million shares should have beenmeasured for accounting purposes as of a later date. In light of the restatementrequired by this matter, the Company also included in this restatementcorrections relating to certain other errors and documentation lapses in thefiscal years 1997 and 1998. Approximately 97% of the charges relating to therestatement arose from the documentation lapse in July 1999.

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The Company determined that the cumulative, pre-tax,non-cash, stock-based compensation expense resulting from revised measurementdates for options granted between 1997 and 1999 was approximately$21.5 million. Accordingly, the Company recorded stock-based compensationexpense of $0, $0, and $1.7 million for the years ended December 31,2005, 2004 and 2003, respectively, and $19.8 million for the five yearspreceding 2003, based on the vesting periods of the respective grants. Inaddition, the Company recorded an income tax benefit of $8.3 million in2005. Principally as a result of cumulative losses incurred through 2004, theCompany recorded a full valuation allowance against all deferred tax assets forthe years ended December 31, 2004 and 2003 and consequently, there is noincome tax effect of the additional stock-based compensation expense recordedin those years. The cumulative effect of the restatement adjustments on theCompany’s consolidated balance sheet at December 31, 2005 was an increasein additional paid-in capital of $21.5 million offset by an increase in theaccumulated deficit of $13.2 million, which results in a net effect onstockholders’ equity of $8.3 million. The adjustments increased previouslyreported basic and diluted net income per common share by $0.13 and $0.12,respectively, for the year ended December 31, 2005 and decreased basic anddiluted net income per common share by $0.03 for the year endedDecember 31, 2003 as reported on the Company’s Form 10-K/A forthe year ended December 31 2005 and the Company’s quarterly report filedon Form 10-Q/A filed on August 30, 2006.

As part of the Company’sreview, the Company assessed whether there were other matters that should havebeen corrected in its previously issued consolidated financial statements.Apart from the errors underlying the restatement described above, no othermatters have come to the Company’s attention that should be adjusted in itspreviously issued consolidated financial statements.

**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 of non-U.S. subsidiaries thatuse the local currency as their functional currency are translated to U.S.dollars at exchange rates in effect at the balance sheet date, with theresulting translation adjustments directly recorded to a separate component ofaccumulated other comprehensive income (loss) within stockholders’ equity.Income and expense accounts are translated at average exchange rates during theyear. Foreign currency transaction gains and losses are recognized in interestincome and other, net and were comprised of net gains of $3.0 million,$0.5 million and $0.5 million for the years ended December 31,2006, 2005, and 2004, respectively.

Beginning April 1,2006, Affymetrix, UK Ltd, a wholly-owned subsidiary incorporated in theUnited Kingdom, and Affymetrix Pte Ltd, a wholly-owned subsidiaryincorporated in Singapore, changed their functional currencies from their localcurrencies to the U.S. dollar. The change in the functional currency of thesesubsidiaries is in accordance with SFAS 52, “Foreign CurrencyTranslation”, (SFAS 52) and reflects the changed economic facts andcircumstances pertaining to these subsidiaries. Under the requirements of SFAS52, the Company assessed the various economic factors relating to Affymetrix,UK Ltd and Affymetrix Pte Ltd and concluded that due to changes infacts, circumstances, scope of operations and business practices, the U.S.dollar is now the currency of the primary economic environment in which thesesubsidiaries operate. Consequently, these subsidiaries will no longer generatetranslation adjustments which would impact the balance of accumulated othercomprehensive income. Translation adjustments from prior periods will continueto remain in accumulated other comprehensive income.

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**CASH EQUIVALENTS,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, 2006 and 2005, the Company’sinvestments in debt securities are classified as available-for-sale and arecarried at fair value with unrealized gains and losses reported in accumulatedother comprehensive 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. The Company includes itsavailable-for-sale securities that have an effective maturity of less thantwelve months as of the balance sheet date in current assets and those with aneffective maturity greater than twelve months as of the balance sheet date innon-current assets. The Company monitors its investment portfolio forimpairment on a periodic basis. In the event that the carrying value of aninvestment exceeds its fair value and the decline in value is determined to beother-than-temporary, an impairment charge is recorded and a new cost basis forthe investment is established. Fair values for investments in public companiesare determined using 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.

**DERIVATIVEINSTRUMENTS**

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. The Company enters into foreign currency forwardcontracts to manage a portion of the volatility related to transactions thatare denominated in foreign currencies. The Company’s foreign currency forwardcontracts are entered into for periods consistent with the related underlyingexposures 

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and do not constitutepositions that are independent of those exposures. In addition, the Companydoes not enter into foreign currency forward contracts for trading orspeculative purposes, is not party to any leveraged derivative instrument, andmay only enter into derivative 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 ANDEQUIPMENT**

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.

**GOODWILL ANDACQUIRED 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 earlierif indicators of potential impairment exist, using a fair-value-based approach.As of December 31, 2006 and 2005, goodwill relates to the acquisition ofNeomorphic in October 2000 and the acquisition of ParAllele inOctober 2005. There is no impairment of 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 OFLONG-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 

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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. 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. The Company must then assess the likelihood that the resultingdeferred tax assets will be realized. To the extent the Company believes thatrealization is not more likely than not, the Company establishes a valuationallowance. Significant estimates are required in determining the Company’sprovision for income taxes, our deferred tax assets and liabilities, and anyvaluation allowance to be recorded against our net deferred tax asset. Some ofthese estimates are based on interpretations of existing tax laws orregulations. The Company believes that its estimates are reasonable and thatits reserves for income tax related uncertainties are adequate. Variousinternal and external factors may have favorable or unfavorable effects on theCompany’s 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,nondeductible expenses, changes in overall levels and geographical mix ofpretax earnings (losses) and ultimate outcomes of income tax audits.

**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 fee is fixed ordeterminable, 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 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 

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standalonevalue and the Company has objective and reliable evidence of fair value foreach undelivered element. If the fair value of any undelivered element includedin a multiple element arrangement cannot be objectively determined, revenue isdeferred until all elements are delivered and services have been performed, oruntil fair value can objectively be determined for any remaining undeliveredelements.

*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;equipment service revenue; product related scientific services revenue; andrevenue 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 ratably over theresearch and product development period, and at-risk substantive based milestonesare recognized when earned. Any payments received which are not yet earned areincluded in deferred revenue.

Revenue related to extended warranty arrangements isdeferred and recognized ratably over the applicable periods. Revenue fromcustom probe array design fees associated with the Company’s GeneChip®CustomExpressÔ and CustomSeqÔproducts are recognized when the associated products are shipped.

Revenue from scientificand DNA analysis services are recognized upon shipment of the required data tothe 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.

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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 the Company’s technical staff and include thecosts for material and subcontract efforts. The Company’s research grantcontracts generally provide for the payment of negotiated fixed hourly ratesfor labor hours incurred plus reimbursement of other allowable costs. Researchrevenue is recorded in the period in which the associated costs are incurred,up to the limit of the prior approval funding amounts contained in eachagreement. The costs associated with these grants are reported as research anddevelopment 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 ANDDEVELOPMENT 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.

**SOFTWAREDEVELOPMENT 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 $2.6 million and $0.5 million costs incurred subsequent to theestablishment of technological feasibility for the years ended December 31,2006 and 2005, 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 related products.

The Company appliesStatement of Position No. 98-1, “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.” In 2006, the Companycapitalized approximately $4.8 million related to the implementation of anenterprise resources planning system. The costs associated with softwaredeveloped for internal use will be amortized at the time in which the softwareis ready for its intended use.

**ADVERTISING COSTS**

The Company expensesadvertising costs as incurred. Advertising costs were $1.5 million for2006, $1.9 million for 2005, and $1.9 million for 2004.

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**STOCK-BASEDCOMPENSATION**

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of FASB Statement No. 123R, “Share-Based Payment” (“SFAS 123R”) usingthe modified prospective transition method. Under the modified prospectivetransition method, prior periods are not restated for the effect of SFAS 123R. Commencingwith the first quarter of 2006, compensation cost includes all share-basedpayments granted prior to, but not yet vested as of January 1, 2006, basedon the grant date fair value estimated in accordance with the originalprovisions of SFAS 123, and compensation for all share-based payments grantedsubsequent to January 1, 2006, based on the grant date fair valueestimated in accordance with the provisions of SFAS 123R. The Companyrecognizes the fair value of its stock option awards as compensation expenseover the requisite service period of each award, generally four years.Compensation expense related to stock options granted prior to January 1,2006 is recognized using the graded method while compensation expense relatedto stock options granted on or after January 1, 2006 is recognized on astraight-line basis.

Prior to the adoption ofSFAS 123R, the Company applied SFAS 123, amended by SFAS 148, “Accounting forStock-Based Compensation—Transition and Disclosure” (SFAS 148), which allowedcompanies to apply the existing accounting rules under APB 25, “Accountingfor Stock Issued to Employees,” and related Interpretations. In general, as theexercise price of options granted under the Company’s plans was equal to themarket price of the underlying common stock on the grant date, no stock-basedemployee compensation cost was recognized in the Company’s net income (loss)for periods prior to the adoption of SFAS 123R. As required by SFAS 148 priorto the adoption of SFAS 123R, the Company provided pro forma net income (loss)and pro forma net income (loss) per common share disclosures for stock-basedawards, as if the fair-value-based method defined in SFAS 123 had been applied.See Note 16 for further information regarding stock based compensation.

**COMPREHENSIVEINCOME (LOSS)**

Comprehensive income (loss) is comprised of net income(loss) and other comprehensive income (loss). Other comprehensive income (loss)includes unrealized gains and losses on the Company’s available-for-salesecurities that are excluded from net income (loss), changes in fair value ofderivatives designated as and effective as cash flow hedges, and foreigncurrency translation adjustments. Total comprehensive income (loss) has beendisclosed in the consolidated statement of comprehensive income.

Thecomponents of accumulated other comprehensive income (loss) are as follows (inthousands):

| ** **                                                                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Foreign currency  translation adjustment, net of tax                                             |       | $                     | (752       | ) | $ | (909 | ) |
| Unrealized  (losses) gains on available-for-sale and non-marketable securities, net  of tax |       | (947                  | )          | (862 | ) |
| Unrealized  (losses) gains on hedging contracts, net of tax                                      |       | (18                   | )          | 544 |   |
| Accumulated other  comprehensive loss                                                            |       | $                     | (1,717     | ) | $ | (1,227 | ) |

 

**NET INCOME (LOSS)PER COMMON SHARE**

Basic net income (loss) per common share is calculatedusing the weighted-average number of common shares outstanding during theperiod less the weighted-average shares subject to repurchase. Dilutedincome (loss) per common share gives effect to 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).

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

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator:                                                                        |       |                                       |       |   |   |   |   |
| Net (loss) income—basic                                                      |       | $                                          | (13,704    | ) | $ | 65,787 |   | $ | 47,608 |   |
| Add effect of dilutive securities:                                                |       |                                       |       |   |   |   |   |
| Interest on convertible notes (inclusive of  amortization of debt issuance costs) |       | —                                     |       | 1,659 |   | 1,655 |   |
| Net (loss) income—diluted                                                    |       | $                                          | (13,704    | ) | $ | 67,446 |   | $ | 49,263 |   |
| Denominator:                                                                      |       |                                       |       |   |   |   |   |
| Weighted-average shares outstanding                                               |       | 67,479                                     |       | 63,912 |   | 60,591 |   |
| Less: weighted-average shares of common stock  subject to repurchase              |       | (93                                        | )          | (96 | ) | (79 | ) |
| Shares used in  computing basic net (loss) income per common share                |       | 67,386                                     |       | 63,816 |   | 60,512 |   |
| Add effect of dilutive securities:                                                |       |                                       |       |   |   |   |   |
| Employee stock options                                                            |       | —                                     |       | 2,799 |   | 2,380 |   |
| Common stock subject to repurchase                                                |       | —                                     |       | 96 |   | 79 |   |
| Warrants to purchase common stock                                                 |       | —                                     |       | 5 |   | 37 |   |
| Convertible notes                                                                 |       | —                                     |       | 3,870 |   | 3,870 |   |
| Shares used in  computing diluted net (loss) income per common share              |       | 67,386                                     |       | 70,586 |   | 66,878 |   |
| Basic net (loss)  income per common share                                         |       | $                                          | (0.20      | ) | $ | 1.03 |   | $ | 0.79 |   |
| Diluted net (loss)  income per common share                                       |       | $                                          | (0.20      | ) | $ | 0.96 |   | $ | 0.74 |   |

 

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,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **(in thousands)**                    | ** ** |
| Employee stock  options                 |       | 6,466                                      |       | 1,427 |   | 2,613 |   |
| Restricted stock  subject to repurchase |       | 93                                         |       | — |   | — |   |
| Convertible notes                       |       | 3,870                                      |       | — |   | — |   |
| Total                                   |       | 10,429                                     |       | 1,427 |   | 2,613 |   |

 

***RESTRUCTURING***

The Company has recentlyengaged in, and may continue to engage in, restructuring actions, which requiremanagement to utilize significant estimates related to expenses for severanceand other employee separation costs, lease cancellation, realizable values ofassets that may become duplicative or obsolete, and other exit costs. If theactual amounts differ from the Company’s estimates, the amount of therestructuring charges could be materially impacted. For a full description ofthe Company’s restructuring actions, see Note 3.

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**RECENT ACCOUNTINGPRONOUNCEMENT**

In July 2006, theFASB issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes, an interpretation of FASB Statement No. 109” (“FIN 48”). Under FIN48 a company would recognize the benefit from a tax position only if it ismore-likely-than-not that the position would be sustained upon audit basedsolely on the technical merits of the tax position. FIN 48 clarifies how acompany would measure the income tax benefits from the tax positions that arerecognized, provides guidance as to the timing of the derecognition ofpreviously recognized tax benefits and describes the methods for classifyingand disclosing the liabilities within the financial statements for anyunrecognized tax benefits. FIN 48 also addresses when a company should recordinterest and penalties related to tax positions and how the interest andpenalties may be classified within the income statement and presented in thebalance sheet. FIN 48 is effective for fiscal years beginning after December 15,2006 and is required to be adopted by the Company effective January 1,2007. The cumulative effects, if any, of applying FIN 48 will be recorded as anadjustment to accumulated deficit as of the beginning of the period of adoption.The Company is currently evaluating FIN 48 and its possible impacts on theCompany’s financial statements and is not yet in a position to determine sucheffects, if any.

**NOTE 3—RESTRUCTURING**

*Fiscal 2006Restructuring Plan*

In the third quarter of 2006, the Company initiated arestructuring plan (“the plan”) to better align certain of its expenses withthe Company’s current business outlook. The Company’s primary focus of the planwas in the general and administrative functions and included rationalizing itsfacilities. In August 2006, the Company terminated certain employees inthe general and administrative functions. Additionally, in September, theCompany announced its plan to close its Bedford, Massachusetts basedinstrumentation manufacturing and development facility. The Company plans toconsolidate the Bedford facility’s instrument manufacturing operationswith its probe array manufacturing facility in West Sacramento, California. TheCompany’s instrumentation development capabilities will be consolidated withits principal research and development facilities located in Santa Clara,California. Implementation of the plan is expected to begin in the fourthquarter of 2006 and continue into the first half of 2007 and will eliminate ortransfer certain positions. The Company expects the closure of its Bedford,Massachusetts facility to be substantially complete by the third quarter offiscal 2007.

The Company estimates that the total restructuringexpenses to be incurred in connection with the plan will be approximately $28million. Of this total, the Company estimates that $19 million relates toemployee severance and relocation benefits, $7 million relates to contracttermination costs associated with vacating the leased Bedford facility, andapproximately $2 million relates to other restructuring costs such asfixed asset write downs and equipment and inventory relocation costs. The Companyhas incurred restructuring expenses beginning in the third quarter of 2006 andexpects to continue incurring related expenses through the third quarter of2007. Cash outlays incurred in connection with these restructuring activitiesare estimated to be approximately $20 million. In accordance with SFAS 146, “Accountingfor Costs Associated with Exit or Disposal Activities” (“SFAS 146”), the costsrelating to employee severance and relocation will be accrued over theremaining service periods of the employees.

During the third and fourth quarters of 2006, theCompany recognized approximately $13.5 million of expense which was presentedin a single line item labeled restructuring in the Company’s Statement ofOperations, of which approximately $7.5 million of the expense related to themodification of a former Neomorphic employee’s equity awards, all of whichbecame fully vested under the terms of a prior leave of absence agreement whenhe was involuntarily terminated in connection with the plan.

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The activityin the accrued restructuring balances related to the plan described above forthe year ended December 31, 2006 was as follows:

| ** **                                  | ** ** | **Balance as**             | ** ** | ** **        | ** ** | ** **         | ** ** | ** **                | ** ** | **Balance as**             | ** ** | **As of  December 31, 2006** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|-------------------|------------|--------------------|------------|---------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **of  December 31,  2005** | ** ** | **2006  Charges** | ** ** | **Cash  Payments** | ** ** | **Non-Cash  Settlements** | ** ** | **of  December 31,  2006** | ** ** | **Total  costs  to date**              | ** ** | **Total  expected  costs** | ** ** |
| Employee severance  and relocation benefits |       |                            | $          | —            |       |               | $          | 13,497                    |       |                            | $          | (1,823                                      | )          |   |   | $ | (7,544 | ) |   |   | $ | 4,130 |   |   | $ | 13,497 |   |   | $ | 19,000 |   |   |
| Contract  termination costs                 |       |                            | —     |              |       | —             |       |                      | —     |                            |       |                                        | —     |   |   |   | — |   |   | — |   |   | 7,000 |   |   |
| Other  restructuring costs                  |       |                            | —     |              |       | —             |       |                      | —     |                            |       |                                        | —     |   |   |   | — |   |   | — |   |   | 2,000 |   |   |
| Total restructuring costs                   |       |                            | $          | —            |       |               | $          | 13,497                    |       |                            | $          | (1,823                                      | )          |   |   | $ | (7,544 | ) |   |   | $ | 4,130 |   |   | $ | 13,497 |   |   | $ | 28,000 |   |   |

 

**NOTE 4—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 greater opportunitiesfor market penetration and revenue generation as well as increase Affymetrix’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 have been includedin Affymetrix’ consolidated financial statements since October 21, 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.

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*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 hadentered into a two-year product collaboration agreement in which Affymetrixdistributed ParAllele products and supplied ParAllele with probe arrays. Novalue was assigned to this pre-existing relationship in the purchase accountingsummarized above. Current assets include $0.6 million of trade receivables fromAffymetrix and current liabilities include $0.7 million of trade payables toAffymetrix as well as $4.5 million loan from Affymetrix to fund ParAllele’soperations. Upon completion of the acquisition, these balances were eliminatedin Affymetrix’ consolidated financial statements.

*Intangible Assetsand 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 $0.7 million for the year endedDecember 31, 2006 related to these acquired patents and technology. The$0.3 million value assigned to backlog was amortized to selling,general & administrative expenses within one year. Goodwill of $105.7million was recorded as the excess of the purchase price over the net assetsacquired. No goodwill was deemed to be deductible for income tax purposes.

*Deferred StockCompensation*

The $5.0 million of deferred compensation representsthe intrinsic value of the unvested stock options assumed by Affymetrix in thetransaction. This amount was amortized through December 2005 to theappropriate costs and expense line items over the remaining vesting periods ofthe underlying equity awards. Beginning on January 1, 2006, any remainingdeferred compensation was reversed in connection with the Company’s adoption ofSFAS 123R.

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*In-processTechnology*

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.These projects primarily included the development of a DNA genotyping productand to a lesser extent certain RNA and other expression products. The fairvalues of these projects were determined using the Income Approach wherebymanagement estimated each project’s related future net cash flows between 2005and 2015 and discounted them to their present value using a risk adjusteddiscount rate of 28%. This discount rate is based on our estimated weightedaverage cost of capital adjusted upward for the risks associated with theprojects acquired. The projected cash flows from the acquired projects werebased on estimates of revenues and operating profits related to the projectsconsidering the stage of development of each potential product acquired, thetime and resources needed to complete the development and approval of eachproduct, the life of each potential commercialized product and the inherentdifficulties and uncertainties in developing products and services based oncomplex genetic technologies and biochemical processes. The Company expectssignificant cash flows from these projects to begin in 2006 and is notanticipating any material changes to its historical pricing, expense levels orgross margins related to these products.

As of October 21, 2005, the DNA genotypingproject was 33% complete and the RNA & other projects were 40%complete. The Company expects to incur costs of approximately $5.6 million tocomplete the DNA genotyping project and costs of $1.5 million to complete theRNA & other projects. Upon consummation of the acquisition on October 21,2005 and completion of our valuation efforts, $8.3 million was charged toacquired in-process technology in the Consolidated Statement of Operations. Asof December 31, 2006, there was no significant update to the percentage ofcompletion of the projects, nor the anticipated costs to complete as certain ofthe projects were temporarily delayed during 2006 as the Company re-prioritizedits efforts in connection with the restructuring plan. These projects areexpected to resume in 2007.

*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, certain transactionsrelated to the Company’s pre-existing relationship with ParAllele have beenexcluded as well as accretion charges associated with ParAllele’s preferredstock. These pro forma amounts do not purport to be indicative of the resultsthat would have actually been obtained if the acquisition had occurred as ofthe beginning of the periods presented or that may be obtained in the future.

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                           |       | $                                      | 55,760     |   | $ | 24,889 |   |
| Basic net income  per common share   |       | $                                      | 0.85       |   | $ | 0.40 |   |
| Diluted net income per  common share |       | $                                      | 0.79       |   | $ | 0.38 |   |

 

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**NOTE 5—COLLABORATIVEAGREEMENTS**

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 also has research agreements with manyuniversities and research organizations. The Company’s material agreement isdescribed below:

***F. Hoffmann-La Roche Ltd. (“Roche”)***

In February 1998, the Company entered into a non-exclusivecollaborative development agreement with F. Hoffmann-La Roche Ltd. (“Roche”)to initially develop human probe array-based diagnostic products. Underthe terms of the agreement the parties are collaborating to develop mutuallyagreed upon arrays, as well as associated instrumentation, software, andreagents. In January 2003, the Company expanded its collaboration withRoche by granting Roche access to our GeneChip*®*technologies to develop and commercialize GeneChip® diagnostic laboratory testsfor DNA analysis, genotyping and resequencing applications, as well as for RNAexpression analysis, in a broad range of human disease areas. Using ourGeneChip® technologies, Roche intends to develop and market diagnostic testsfor diseases such as cancer and osteoporosis and cardiovascular, metabolic,infectious and inflammatory diseases. Affymetrix and Roche believe thatdeveloping targeted microarray expression profiles for cancer, plus genotypingand resequencing profiles for other diseases will enable the creation andcommercialization of novel standardized diagnostic solutions. These solutionsultimately will allow physicians to better diagnose and treat human disease.Under the terms of the collaborative agreement, Roche paid the Company anaccess fee of $70 million and the agreement also includes a broad range ofother compensation payable by Roche to Affymetrix throughout the life of theagreement based on royalties on sales of diagnostic kits and milestone paymentsfor technical and commercial achievements. As part of the agreement, Affymetrixwill manufacture and supply Roche with microarrays and related instrumentationbased on Affymetrix’ GeneChip® platform. In 2003, Roche launched the AmpliChip®CYP450 array product initially for research use only, but in late 2004 obtainedCE marking and FDA regulatory approvals of the product for in-vitro diagnosticuse.

The parties amended the collaborative developmentagreement in December 2006. Under the terms of the amendment, Roche isrelieved of certain future license installment payments that would have beenpayable by Roche to Affymetrix under the agreement beginning in 2008,Affymetrix is relieved of certain “most favorable terms and conditions”obligations to Roche, and Roche has agreed to pay to Affymetrix additionalmilestone payments related to future commercial achievements. The licenseagreement is subject to Roche’s option to terminate on December 31, 2010or any time on or after December 31, 2015, with one year’s prior notice.As part of the arrangement between the parties, Affymetrix will continue tomanufacture and supply Roche with microarrays and related instrumentation basedon Affymetrix’ GeneChip® platform.

The Company has assessed the revenue recognition ofthe December 2006 collaborative agreement amendment in accordance withEITF 00-21 to account for the multiple deliverables in the arrangementand to evaluate the revenue allocated to each of the units of accounting (theresearch and development period and the manufacturing and supply period). TheCompany has established objective and reliable evidence of fair market valuefor the manufacturing and supply period undelivered unit of accounting based onanalysis of the pricing for similar manufacturing and supply agreements sold toother Powered by AffymetrixTM partners on a standalone basis that do not containa research and development period. The Company has determined that the producttransfer pricing, royalties on sales of diagnostic kits and milestonepayments for technical and commercial achievements for the manufacturingand supply period unit of accounting in the amended Roche collaborativeagreement reflects the established fair market value for these deliverables. Inaddition, the Company re-assessed the estimated remaining research and 

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development period anddetermined that Roche’s one-time, upfront payment of $70 million under thelicense agreement, which was paid to Affymetrix in the first quarter of 2003,should continue to be recognized as a component of product related revenue overthe remaining estimated research and development period, which is currentlyestimated to be through December 2007.

Research revenue under this contract wasapproximately $14.2 million for each of the three years ended December 31,2006, 2005 and 2004, respectively. Milestone revenue earned under this contractwas zero for the two years ended December 31, 2006 and 2005, respectivelyand $1.5 million for the year ended December 31, 2004. The associatedresearch costs are not significant for each of the years presented.

**NOTE 6—CONCENTRATIONSOF 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 accountsreceivable.

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 willbe available in commercial quantities at acceptable costs from other vendorsshould the need arise. If the Company is required to seek alternative sourcesof supply, it could be time consuming 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 52% 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.

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**NOTE 7—AVAILABLE-FOR-SALESECURITIES AND OTHER FINANCIAL INSTRUMENTS**

***Investments in Debt and Equity Securities***

Thefair values of all available-for-sale securities are based on quoted marketprices and are included in cash and cash equivalents, available-for-salesecurities—short term and available-for-sale securities—long term on theCompany’s Consolidated Balance Sheet based on the securities maturity. Thefollowing is a summary of available-for-sale securities as of December 31,2006 (in thousands):
|                                                    | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|----------------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| U.S. Government  obligations and agency securities |       | $        | 16,800     |                         |       | $                             | —     |                |       |   | $ | (34 | ) |   | $ | 16,766 |   |
| U.S. corporate  debt securities                    |       | 120,967  |       |                         | 86         |                          |       |                | (135       | ) |   | 120,918 |   |
| Non-US equity  securities                          |       | 2,000    |       |                         | —     |                          |       |                | (707       | ) |   | 1,293 |   |
| Total securities                                   |       | $        | 139,767    |                         |       | $                             | 86         |                |       |   | $ | (876 | ) |   | $ | 138,977 |   |
| Amounts included  in:                              |       |     |       |                         |       |                          |       |                |       |   |   |   |   |
| Cash equivalents                                   |       | $        | 10,288     |                         |       | $                             | —     |                |       |   | $ | — |   |   | $ | 10,288 |   |
| Available-for-sale securities                      |       | 129,479  |       |                         | 86         |                          |       |                | (876       | ) |   | 128,689 |   |
| Total securities                                   |       | $        | 139,767    |                         |       | $                             | 86         |                |       |   | $ | (876 | ) |   | $ | 138,977 |   |
| Amounts mature  in:                                |       |     |       |                         |       |                          |       |                |       |   |   |   |   |
| Less than one year                                 |       | $        | 129,121    |                         |       | $                             | —     |                |       |   | $ | (745 | ) |   | $ | 128,376 |   |
| One to two years                                   |       | 10,646   |       |                         | 86         |                          |       |                | (131       | ) |   | 10,601 |   |
| Total securities                                   |       | $        | 139,767    |                         |       | $                             | 86         |                |       |   | $ | (876 | ) |   | $ | 138,977 |   |

 

Thefollowing is a summary of available-for-sale securities as of December 31,2005 (in thousands):
|                                                          | ** ** | **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 |   |

 

Realized gains and losses for the year ended December 31,2006 were $0.2 million and $(0.2) million, respectively. Realized gainsand losses for the year ended December 31, 2005 were $0.1 million and$(0.4) 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, 2006 and 2005,above were primarily 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 

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the related unrealizedlosses, the Company has not recorded any other-than-temporary impairments onthese 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 impairment losses on certain investments in bothpublicly-traded and non-marketable equity securities of $0.2 million,$2.2 million and $2.3 million during the years ended December 31,2006, 2005 and 2004, respectively. Net investment losses are included ininterest income and other, net on the Consolidated Statement of Operations.Depending on market conditions, the Company may incur additional charges onthis investment portfolio in the future.

***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 net realized foreign currency gains (losses) related to the foreigncurrency forward contracts related to revenue were $0.3 million,$1.4 million and $(1.1) million for the years ended December 31,2006, 2005 and 2004, respectively. The Company also hedges a percentage of itsassets that are held in nonfunctional currencies of our subsidiaries withforward contracts and the gains or losses on these contracts largely offsetgains and losses on the change in value of the underlying asset. The Company’sbalance sheet hedging policy is designed to reduce the fluctuations in earningsdue to changes in foreign currency exchange rates. The Company does not usederivative contracts for speculative purposes. During the years ended December 31,2006 and 2005, all of the Company’s hedges were deemed effective. At December 31,2006 and 2005, total outstanding contracts included the notional equivalent of$35.8 million and $21.6 million, respectively, in foreign currency forwardexchange contracts with a fair value of zero and $0.8 million,respectively, which are included in other current assets (liabilities) in theConsolidated Balance Sheets. As of December 31, 2006, all contracts wereset to expire in the first quarter of 2007. The Company applies hedgeaccounting based upon the criteria established by Statement of FinancialAccounting Standards No. 133, “Accounting for Derivative Instruments andHedging Activities”  (“SFAS 133”),whereby the Company designates its derivatives for revenue hedging purposes ascash flow hedges. The Company has elected not to designate its derivatives forbalance sheet purposes as fair value hedges under SFAS 133 and haveappropriately recorded any changes in fair value to interest income and other,net.

***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, 2006 and 2005 (inthousands):

| ** **                       | ** ** | **2006**             | ** ** | **2005**                       | ** ** |
|----------------------------------|------------|----------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
| Assets:                          |       |                 |       |                           |       |   |   |   |   |
| Non-marketable equity securities |       | $                    | 18,739     |                           | $          | 18,739 |   | $ | 18,120 |   | $ | 18,120 |   |
| Note receivable from Nuvelo      |       | —               |       | —                         |       | 5,240 |   | 5,240 |   |
| Employee loans receivable        |       | 2,186                |       | 2,186                          |       | 1,824 |   | 1,824 |   |
| Liability:                       |       |                 |       |                           |       |   |   |   |   |
| Convertible notes                |       | 120,000              |       | 120,473                        |       | 120,000 |   | 189,886 |   |
|                                  |            |                      |            |                                |            |  |  |  |  |  |  |  |  |

 

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The fair value estimatesprovided above for the Company’s convertible notes were based on quoted marketprices available at December 31, 2006 and 2005. All other fair values werebased on current market rates, liquidation and net realizable values.

**NOTE 8—INVENTORIES**

Inventoriesconsist of the following at December 31, 2006 and 2005 (in thousands):
|                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
| Raw materials   |       | $        | 21,612     |     | $          | 13,094 |   |
| Work-in-process |       | 13,127   |       | 10,423   |       |
| Finished goods  |       | 11,767   |       | 12,463   |       |
| Total           |       | $        | 46,506     |     | $          | 35,980 |   |

 

**NOTE 9—PROPERTY ANDEQUIPMENT**

Property andequipment consists of the following as of December 31, 2006 and 2005 (inthousands):
|                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Property and equipment:                         |       |     |       |     |       |
| Construction-in-progress                        |       | $        | 75,870     |     | $          | 25,233 |   |
| Equipment and furniture                         |       | 130,355  |       | 115,143  |       |
| Building and leasehold improvements             |       | 62,872   |       | 55,477   |       |
| Land                                            |       | 1,310    |       | 1,310    |       |
|                                            |       | 270,407  |       | 197,163  |       |
| Less accumulated  depreciation and amortization |       | (129,085 | )          | (111,603 | )          |
| Net property and  equipment                     |       | $        | 141,322    |     | $          | 85,560 |   |

 

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 10—ACQUIREDTECHNOLOGY 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 $30.2 million and $22.2 million at December 31, 2006 and2005, 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 non-exclusiveroyalty bearing license to certain OGT patents to a fully paid up license. TheCompany determined that the $41.9 million cash payment is less than thenet present value of the future estimated royalty obligations under the termsof the original license agreement. In accordance with Statement of FinancialAccounting Standard 142 (“SFAS 142”), *Goodwilland Other Intangible Assets*, the $41.9 million was recorded asan intangible asset. Consistent with the guidance in SFAS 142 and withStatement of Financial Accounting Standard 141 (“SFAS 141”), *Business Combinations*, this fully paidlicense is being amortized over its remaining useful life of approximately tenyears.

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Theexpected future annual amortization expense of the Company’s acquiredtechnology rights is as follows (in thousands):
| For the Year Ending December 31, | ** ** | ** ** | ** ** | **Amortization  Expense** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|---------------------------|------------|
| 2007                                                      |       |       | $          | 8,326                     |       |   |
| 2008                                                      |       |       | 8,314      |                      |       |
| 2009                                                      |       |       | 7,446      |                      |       |
| 2010                                                      |       |       | 6,676      |                      |       |
| 2011                                                      |       |       | 6,280      |                      |       |
| Thereafter                                                |       |       | 18,083     |                      |       |
| Total expected  future annual amortization                |       |       | $          | 55,125                    |       |   |

 

**NOTE 11—ACCOUNTSPAYABLE AND ACCRUED LIABILITIES**

Accountspayable and accrued liabilities as of December 31, 2006 and 2005 consistof the following (in thousands):
|                                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Accounts payable                              |       | $        | 23,248     |     | $          | 29,718 |   |
| Accrued  compensation and related liabilities |       | 19,050   |       | 20,419   |       |
| Accrued taxes                                 |       | 6,362    |       | 10,354   |       |
| Accrued legal                                 |       | 2,426    |       | 1,357    |       |
| Accrued  warranties                           |       | 6,801    |       | 6,223    |       |
| Other                                         |       | 5,006    |       | 3,480    |       |
| Total                                         |       | $        | 62,893     |     | $          | 71,551 |   |

 

**NOTE 12—RELATEDPARTY TRANSACTIONS AND NOTES RECEIVABLE FROM EMPLOYEES**

***Related Party Transactions***

*Perlegen Sciences, Inc.*

As of December 31, 2006, theCompany, and certain of its affiliates, including the Company’s chief executiveofficer and members of the board of directors, held approximately 22% 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 inPerlegen using the equity method as the Company and its affiliates do notcontrol the strategic, operating, investing and financing activities ofPerlegen; however, the Company does have significant influence over Perlegen’soperating activities. Further, the Company has no obligations to providefunding to Perlegen nor does it guarantee or otherwise have any obligationsrelated to the liabilities or results of operations of Perlegen or its investors.Through January 2005, the Company’s investment in Perlegen had no costbasis; accordingly, the Company has not recorded its proportionate share ofPerlegen’s operating losses in its financial statements since the completion ofPerlegen’s initial financing. In February 2005, the Company participatedin Perlegen’s Series D preferred stock financing and recorded a $2.0million investment related to this transaction, which 

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was included in theCompany’s balance sheet as a component of other assets. As of June 30,2005, the Company had reduced the carrying value of its investment to zerothrough the recording of its proportionate share of Perlegen’s operatinglosses.

In accordance with Financial Accounting StandardsBoard Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51” as amended, theCompany has concluded that Perlegen is a variable interest entity in which theCompany holds a variable interest, and that the Company is not the primarybeneficiary.

In December 2003, the Company sold 950,000 shares of Perlegenpreferred stock and realized a gain of $1.4 million which was included ininterest and other income, net. Additionally, in January 2004, the Companysold 400,000 shares of Perlegen preferred stock and realized a gain of$0.6 million which was included in interest income and other, net.

In June 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 had subcontracted certainelements of this agreement to Perlegen which will use AffymetrixGeneChip® technology to provide the genotypic data. The agreement ended in thethird quarter of 2006 and no expenses were incurred.

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

***Notes Receivable from Employees***

The Company has notesreceivable from employees totaling $2.2 million and $1.8 million asof December 31, 2006 and 2005, 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%.

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**NOTE 13—COMMITMENTSAND CONTINGENCIES**

***Operating Leases***

Affymetrixleases laboratory, office and manufacturing facilities under non-cancelableoperating leases that expire at various times through 2016. Some of these leasescontain renewal options ranging from two to five years and escalation clauses.Rent expense related to operating leases was approximately $10.9 million in2006, $8.9 million in 2005 and $8.6 million in 2004. In connectionwith some of these facility leases, the Company has made security depositstotaling $2.6 million, which are included in long-term other assets in theConsolidated Balance Sheets. Future minimum lease obligations at December 31,2006 under all non-cancelable operating leases are as follows (in thousands):
| Year Ending December 31, | ** ** | ** ** | ** ** | **Amount** | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|
| 2007                                    |       | $          | 10,488     |       |
| 2008                                    |       | 10,159     |       |
| 2009                                    |       | 7,262      |       |
| 2010                                    |       | 6,191      |       |
| 2011                                    |       | 5,784      |       |
| Thereafter                              |       | 10,733     |       |
| Total minimum  lease payments           |       | $          | 50,617     |       |

 

***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, ifnecessary, the warranty percentage and accrual based on actual experience andestimated costs to be incurred. In the third quarter of 2005, the Companyadjusted its warranty reserve by approximately $2.0 million for anticipatedcosts associated with its decision to replace its Mapping 500K Array setspurchased by certain of its early access customers. In the fourth quarter of2006, we reserved approximately $1.3 million to replace chips damaged due to amanufacturing process defect. This manufacturing process error has beenresolved as of December 31, 2006. Information regarding the changesin the Company’s product warranty liability for the years ended December 31,2005 and December 31, 2006 is as follows (in thousands):
|                                    | ** ** | **Amount** | ** ** |
|------------------------------------|------------|------------|------------|
| 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      |       |
| New warranties issued              |       | 5,964      |       |
| Repairs and replacements           |       | (6,643     | )          |
| Adjustments                        |       | 1,257      |       |
| Balance at  December 31, 2006 |       | $          | 6,801      |   |

 

***Funding Commitments***

The Company has invested$9.5 million and is committed to invest up to an additional$0.5 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.

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***Non-Cancelable Supply Agreements***

As of December 31,2006, the Company had approximately $1.1 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 amountof future 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, 2006, the Company hadnot accrued a liability for this guarantee, because the likelihood of incurringa payment obligation in connection with this guarantee is remote.

***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.

*ShareholderDerivative Lawsuits*

Three shareholders of theCompany have filed purported derivative lawsuits on behalf of the Company,which lawsuits name the Company (as nominal defendant) and several of theCompany’s current and former officers and directors, and allege that theseofficers and directors breached their fiduciary duties and breached other lawsby participating in backdating stock options grants. Two of these lawsuits werefiled in the United States District Court for the Northern District ofCalifornia on August 30, 2006 and September 13, 2006 and the thirdwas filed in the Superior Court of the State of California on October 20,2006. The substance of the allegations in all three lawsuits is similar, andindeed, the two federal actions have been consolidated. The plaintiffs in thefederal actions filed a consolidated complaint on January 10, 2007. Allegationsmade in the consolidated complaint or the state action include allegations 

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ofbreaches of fiduciary duty, unjust enrichment as a result of the receipt andretention of backdated stock option grants, violations of federal securitieslaws, violations of Generally Accepted Accounting Principles, violations of Section 162(m) ofthe Internal Revenue Code, and other violations of state law includingviolations of the California Corporations Code. In one or both of theseactions, the plaintiffs seek to recover, on behalf of the Company, damagesresulting from the alleged violations, including treble damages pursuant toCalifornia law, disgorgement or voiding of any backdated stock options or theproceeds of any such exercised stock options from the individual defendants,changes in the Company’s corporate governance and internal control procedures,other equitable relief, punitive damages, an award of attorneys’ fees andcosts, and other relief. The Company may be subject to other lawsuits fromprivate plaintiffs concerning this subject matter based on allegations similarto those described above. As previously disclosed in the Company’s Form 10-K/Afor the year ended December 31, 2005, the Company’s decision to restateits consolidated financial statements was based on the results of an internalreview of its historical stock option granting practices from January 1,1997 through May 31, 2006 performed under the direction of the AuditCommittee of the Board of Directors. The review did not find any pattern orpractice of inappropriately identifying grant dates with hindsight in order toprovide “discounted” or “in-the-money” grants. The Company does not believethat the claims in these derivative lawsuits have merit and the Company intendsto vigorously defend the cases.

*SEC InformalInquiry*

On September 12,2006, the Company received written notice from the Securities and ExchangeCommission that it is conducting an informal inquiry into the Company’s stockoption practices. The Company is responding to the request for information andis cooperating fully in the informal inquiry. The Company was advised in theSEC’s notice that the SEC’s request should not be construed as an indication bythe SEC or its staff that any violations of law have occurred, nor should therequest be considered an adverse reflection upon any person, entity or security.

*Enzo Litigation*

On October 28, 2003, Enzo Life Sciences, Inc.,a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively “Enzo”)filed a complaint against the Company that is now pending in the United 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 oftermination of 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 andinjunctive relief relating to the 1998 agreement. In its complaint, the Companyalleges that Enzo has engaged in a pattern of wrongful conduct against it andother Enzo labeling reagent customers by, among other things, assertingimproperly broad rights in its patent portfolio, improperly using the 1998agreement and distributorship agreements with others in order to corner themarket for non-radioactive labeling reagents, and improperly using the 1998agreement to claim ownership rights to the Company’s proprietary technology.The Company seeks declarations that it has not breached the 1998 agreement 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 

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advantage, and Enzo’salleged unfair competition. The Company filed a notice of related case statingthat its 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 theCompany’s case. There is no trial date in the actions between Enzo and theCompany.

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.

*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, third parties, including several ofAffymetrix’ competitors, have filed oppositions against several of the Company’sEuropean patents in the European Patent Office. These opposition proceedingsare at various procedural stages and 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, theCompany expects that third parties will continue to “copy” the claims of itspatents in order to provoke interferences in the United States Patent &Trademark Office. These proceedings could result in the Company’s patentprotection being significantly modified or reduced, and could result insignificant costs and consume substantial managerial resources.

**NOTE 14—CONVERTIBLESUBORDINATED NOTES**

On September 22, 1999, the Company completed thesale of $150 million principal amount of 5% convertible subordinated notesdue 2006 (the “5% Notes”). On January 9, 2004, the Company completed theredemption of its 5% Notes ($102.0 million face value). In connection with theredemption, the Company recorded a charge of $3.2 million to interest expensein the first quarter of 2004, related to the unamortized issuance costs andredemption fee associated with the repurchased notes.

On February 14, 2000,the Company completed the sale of $225.0 million principal amount of 4.75%convertible subordinated notes due 2007 (the “4.75% Notes”). OnFebruary 19, 2004, the Company also completed the redemption of its 4.75%Notes ($165.5 million face value). In connection with the redemption, theCompany recorded a charge of $4.9 million to interest expense related tothe unamortized issuance costs and redemption fee associated with therepurchased notes.

**NOTE 15—SENIORCONVERTIBLE NOTES**

On December 10, 2003, the Company issued$120.0 million of 0.75% Senior Convertible Notes (the “0.75% Notes”) dueDecember 15, 2033. The net proceeds after issuance costs (which will beamortized over 5 years, the earliest term for redemption outside of theCompany’s control), from the 0.75% Notes offering were $116.0 million. The0.75% 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, 

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at any time after the saleprice of the Company’s common stock on any date is greater than 130% of thethen current conversion price, (3) during the five consecutive trading-dayperiod in which the average of the trading prices for the notes was less than98% of the average of the sale price of the Company’s common stock multipliedby the then applicable conversion rate, (4) the 0.75% Notes are called forredemption, or (5) specified corporate transactions 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 16—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) a number of Rights for each share of Series AA Preferred Stockof the Company equal to the number of shares of common stock into which suchshare of Series AA Preferred Stock was convertible. The dividend was paidon October 27, 1998 (the “Record Date”) to the stockholders of record onthat date. Each Right entitles the registered holder to purchase from theCompany one one-thousandth of a share of Series B Junior ParticipatingPreferred Stock, par value $.01 per share, of the Company (the “Series BPreferred Stock”) at a price of $62.50 per one one-thousandth of a share ofSeries B Preferred Stock, subject to adjustment. The Rights will beexercisable if a person or group hereafter acquires beneficial ownership of 15%or more of the common stock of the Company or announces a tender offer for 15%or more of the common stock. The Board of Directors will be entitled to redeemthe Rights at one cent per Right at any time before any such person acquiresbeneficial ownership of 15% or more of the outstanding common stock. If aperson or group acquires 15% or more of the outstanding common stock of theCompany, each Right will entitle its holder to purchase, at the Right’sexercise price, a number of shares of common stock having a market value atthat time of twice the Right’s exercise price. Rights held by the 15% holderwill become void and will not be exercisable to purchase shares at the bargainpurchase price. If the Company is acquired in a merger or other businesscombination transaction after a person acquires 15% or more of the Company’scommon stock, each Right will entitle its holder to purchase, at the Right’sthen-current exercise price, a number of the acquiring company’s common shareshaving a market value at that time of twice the Right’s exercise price.

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 toFebruary 2010. Under the amended plan, each Preferred Share Purchase Rightentitles stockholders to buy one one-thousandth of a share of Series BJunior Participating Preferred Stock of the Company at the new exercise priceof $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.

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***Stock-Based Compensation Plans***

The Company has a stock-based compensation programthat provides the Board of Directors broad discretion in creating equityincentives for employees, officers, directors and consultants. This programincludes incentive and non-qualified stock options and non-vested stock awards(also known as restricted stock) granted under various stock plans. Stockoptions are generally time-based, vesting 25% on each annual anniversary of thegrant date over four years and expire 7 to 10 years from the grant date.Non-vested restricted stock awards are generally time-based, vesting 33% oneach of the second, third and fourth anniversaries of the grant date. As of December 31,2006, the Company had approximately 1.4 million shares of common stock reservedfor future issuance under its stock-based compensation plans. New shares areissued as a result of stock option exercises and non-vested restricted stockawards.  A more detailed description ofthe Company’s current stock option plans is as follows:

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 ofDirectors adopted the 2000 Equity Incentive Plan (the “2000 Stock Plan”), whichwas amended and restated in 2001, under which restricted shares, stock units,stock options and stock appreciation rights may be granted to employees,outside directors and consultants. Options granted under the 2000 Stock Planexpire no later than ten years from the date of grant. The option price shallbe at least 100% of the fair value of the Company’s common stock on the date ofgrant (110% in certain circumstances), as determined by the Board of Directors.Options may be granted with different vesting terms from time to time asdetermined by the Board of Directors. In 2004, the 2000 Stock Plan was amendedand restated to increase share availability by 2,500,000 shares bringing thetotal shares of common stock authorized for issuance under the 2000 Stock Planto 7,500,000.

***Adoption of SFAS 123R***

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of SFAS 123R using the modifiedprospective transition method. Under the modified prospective transitionmethod, prior periods are not restated for the effect of SFAS 123R. Commencingwith the first quarter of 2006, compensation cost includes all share-basedpayments granted prior to, but not yet vested as of January 1, 2006, basedon the grant date fair value estimated in accordance with the originalprovisions of SFAS 123, and compensation for all share-based payments grantedsubsequent to January 1, 2006, based on the grant date fair valueestimated in accordance with the provisions of SFAS 123R. The Companyrecognizes the fair value of its stock option awards as compensation expenseover the requisite service period of each award, generally four years.Compensation expense related to stock options granted prior to January 1,2006 is recognized using the graded method while compensation expense relatedto stock options granted on or after January 1, 2006 is recognized on astraight-line basis.

Prior to the adoption of SFAS 123R, the Companyapplied SFAS 123, amended by SFAS 148, “Accounting for Stock-Based Compensation—Transitionand Disclosure” (SFAS 148), which allowed companies to apply the existingaccounting rules under APB 25, “Accounting for Stock Issued to Employees,”and related Interpretations. In general, as the exercise price of optionsgranted under the Company’s plans was equal to the market price of theunderlying common stock on the grant date, no 

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stock-based employeecompensation cost was recognized in the Company’s net income (loss) for periodsprior to the adoption of SFAS 123R. As required by SFAS 148 prior to theadoption of SFAS 123R, the Company provided pro forma net income (loss) and proforma net income (loss) per common share disclosures for stock-based awards, asif the fair-value-based method defined in SFAS 123 had been applied.

As a result of adopting SFAS 123R, the Company’s lossbefore taxes, net loss and basic and diluted loss per share for the year ended December 31,2006 was $14.1 million, $10.0 million, $0.15 lower, respectively, than if theCompany had continued to account for stock-based compensation under APB OpinionNo. 25. In accordance with SFAS 123R, the Company is also required topresent excess tax benefits from the exercise of stock options, if any, asfinancing cash flows rather than operating cash flows. Income tax benefit of$7.2 million was realized from stock option exercises during the year ended December 31,2006.

The following table sets forth the total stock-basedcompensation expense resulting from stock options and non-vested stock awardsincluded in the Company’s Condensed Consolidated Statements of (Loss) Incomeupon the adoption of SFAS 123R (in thousands): 
|                                                     | ** ** | **Year Ended   December 31, 2006** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| Costs of product  sales                             |       |                                                   | $          | 1,389 |   |   |
| Research and  development                           |       |                                                   | 3,653      |   |   |
| Selling, general  and administrative                |       |                                                   | 10,008     |   |   |
| Restructuring                                       |       |                                                   | 7,544      |   |   |
| Total stock-based  compensation expense             |       |                                                   | $          | 22,594 |   |   |
| Income tax  benefit                                 |       |                                                   | (4,567     | ) |   |
| Total stock-based  compensation expense, net of tax |       |                                                   | $          | 18,027 |   |   |

 

##### Selling, general and administrative expense included a $1.1 millioncharge in the second quarter of 2006 due to the modification of an executiveofficer’s stock option grant to include an extension of time to exercise aswell as the vesting of certain stock options without a requisite service period.Restructuring expense included a $7.5 million charge in the third quarter of2006 due to the modification of a former Neomorphic employee’s equity awards,all of which became fully vested under the terms of a prior leave of absenceagreement when he was involuntarily terminated in connection with the Company’sthird quarter restructuring effort.

As of December 31, 2006, $20.4 million of totalunrecognized stock-based compensation expense related to non-vested awards isexpected to be recognized over the respective vesting terms of each awardthrough 2010. The weighted average term of the unrecognized stock-basedcompensation expense is 1.6 years.

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Thefollowing table illustrates the effect on net income and net income per shareif the Company had applied the fair value recognition provisions ofSFAS 123, as amended by SFAS 148, to stock-based employee compensation (inthousands, except per share amounts): 
|                                                                                                                              | ** ** | **Year  Ended   December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| Net income—as  reported                                                                                                 |       | $                                                  | 65,787     |   | $ | 47,608 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net  of tax                  |       | 384                                                |       | 920 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value  method for all awards, net of tax |       | (15,800                                            | )          | (15,984 | ) |
| Pro forma net  income                                                                                                        |       | $                                                  | 50,371     |   | $ | 32,544 |   |
| Net income per  share:                                                                                                       |       |                                               |       |   |   |
| Basic net income per common share—as reported                                                                           |       | $                                                  | 1.03       |   | $ | 0.79 |   |
| Diluted net income per common share—as reported                                                                         |       | $                                                  | 0.96       |   | $ | 0.74 |   |
| Basic net income per common share—pro forma                                                                             |       | $                                                  | 0.79       |   | $ | 0.54 |   |
| Diluted net  income per common share—pro forma                                                                          |       | $                                                  | 0.74       |   | $ | 0.51 |   |

 

***Stock Options***

The fair value of options was estimated at the date ofgrant using a Black-Scholes option pricing model with the following weightedaverage assumptions: 
|                                  | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Risk free  interest rate         |       |                                       | 5.0        | % |   |   | 4.1 | % |   |   | 3.2 | % |   |
| Expected dividend  yield         |       |                                       | 0.0        | % |   |   | 0.0 | % |   |   | 0.0 | % |   |
| Expected  volatility             |       |                                       | 40         | % |   |   | 45 | % |   |   | 56 | % |   |
| Expected option term (in  years) |       |                                       | 4.5        |   |   |   | 3.6 |   |   |   | 3.4 |   |   |

 

The risk free interest rate for periods within thecontractual life of the Company’s stock options is based on the U.S. Treasuryyield curve in effect at the time of grant. The expected term is derived froman analysis of the Company’s historical exercise trends over ten years. The expectedvolatility for the year ended December 31, 2006 is based on a blend ofhistorical and market-based implied volatility. The expected volatility for theyears ended December 31, 2005 and 2004 is based solely on historicalvolatility. The Company’s management changed its expected volatility estimationapproach based upon the availability of actively traded options on the Company’scommon stock and because management believes this blended method is morerepresentative of future stock price trends than historical volatility alone.Using the assumptions above, the weighted average grant date fair value ofoptions granted during the years ended December 31, 2006, 2005 and 2004was $11.61, $18.97 and $12.99, respectively.

 

 

 

 

 

 

 

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Activity under the Company’s stock plans for the yearended December 31, 2006 is as follows (in thousands, except per shareamounts): 
|                                                              | ** ** | **Shares** | ** ** | **Weighted-Average   Exercise Price   Per Share** | ** ** | **Weighted-Average   Remaining   Contractual Term** | ** ** | **Aggregate   Intrinsic Value** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                   | ** ** | ** ** | ** ** | **(in Years)**                                                   | ** ** |
| Outstanding at  December 31, 2005                       |       |       | 6,757      |                                                                  |       |                                                               | $          | 31.31                                     |       |   |   |   |   |   |   |   |   |   |
| Grants                                                       |       |       | 1,056      |                                                                  |       |                                                               | 28.90      |                                      |       |   |   |   |   |   |   |   |   |
| Exercises                                                    |       |       | (495       | )                                                                     |       |                                                               | 19.00      |                                      |       |   |   |   |   |   |   |   |   |
| Forfeitures                                                  |       |       | (533       | )                                                                     |       |                                                               | 33.25      |                                      |       |   |   |   |   |   |   |   |   |
| Expirations                                                  |       |       | (319       | )                                                                     |       |                                                               | 37.17      |                                      |       |   |   |   |   |   |   |   |   |
| Outstanding at  December 31, 2006                       |       |       | 6,466      |                                                                  |       |                                                               | $          | 31.42                                     |       |   |   | 4.4 |   |   |   | $ | 6,846 |   |   |
| Exercisable at  December 31, 2006                       |       |       | 4,565      |                                                                  |       |                                                               | $          | 31.06                                     |       |   |   | 3.83 |   |   |   | $ | 5,856 |   |   |
| Vested and expected to  vest at December 31, 2006  |       |       | 6,153      |                                                                  |       |                                                               | $          | 31.37                                     |       |   |   | 4.34 |   |   |   | $ | 6,736 |   |   |

 

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value (i.e., thedifference between the Company’s closing stock price on the last trading day ofits fourth quarter of 2006 and the exercise price, multiplied by the number ofin-the-money options) that would have been received by the option holders hadall option holders exercised their options on December 31, 2006. Thisamount changes based on the fair market value of the Company’s common stock.Total intrinsic value of options exercised is $6.2 million, $74.2 million, and$29.5 million for the years ended December 31, 2006, 2005 and 2004,respectively.

***Restricted Stock***

Thefollowing table summarizes the Company’s non-vested restricted stock activityfor the year ended December 31, 2006 (in thousands, except per shareamounts): 
|                                                         | ** ** | **Number of Shares** | ** ** | **Weighted-Average   Grant Date Fair Value** | ** ** |
|---------------------------------------------------------|------------|--------------------------------|------------|------------------------------------------------------------------|------------|
| Non-vested stock  outstanding at December 31, 2005 |       |                           | 121        |                                                             |       |   | $ | 56.54 |   |   |
| Granted                                                 |       |                           | 260        |                                                             |       |   | 26.63 |   |   |
| Vested                                                  |       |                           | (85        | )                                                                |       |   | 58.82 |   |   |
| Forfeited                                               |       |                           | (49        | )                                                                |       |   | 23.64 |   |   |
| Non-vested stock  outstanding at December 31, 2006 |       |                           | 247        |                                                             |       |   | $ | 30.81 |   |   |

 

Total fair value of shares vested is $7.6 million and$2.5 million for the years ended December 31, 2006 and 2005, respectively.The Company did not grant restricted stock prior to the year endedDecember 31, 2005.

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Thefollowing table summarizes information concerning currently outstanding andexercisable options at December 31, 2006:
|                                             | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number**                   | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** | **Weighted-Average  Exercise Price  Per Share** | ** ** | **Number** | ** ** | **Weighted-Average  Exercise Price  Per Share** | ** ** |
| ** **                                  | ** ** | **(in thousands)**      | ** ** | **(In Years)**          | ** ** | **(in thousands)** | ** ** |
| $0.26 - $20.38                              |       |                         | 779        |                         |       |   | 3.19 |   |   |   | $ | 14.95 |   |   |   | 692 |   |   |   | $ | 15.21 |   |   |
| $20.39 - $24.44                             |       |                         | 1,332      |                         |       |   | 3.50 |   |   |   | $ | 23.36 |   |   |   | 1,228 |   |   |   | $ | 23.46 |   |   |
| $24.47 - $30.32                             |       |                         | 1,325      |                         |       |   | 5.18 |   |   |   | $ | 27.14 |   |   |   | 576 |   |   |   | $ | 26.47 |   |   |
| $30.34 - $34.51                             |       |                         | 1,115      |                         |       |   | 4.93 |   |   |   | $ | 31.33 |   |   |   | 704 |   |   |   | $ | 31.33 |   |   |
| $34.56 - $45.94                             |       |                         | 678        |                         |       |   | 5.40 |   |   |   | $ | 40.57 |   |   |   | 286 |   |   |   | $ | 38.99 |   |   |
| $45.97 - $50.07                             |       |                         | 932        |                         |       |   | 3.99 |   |   |   | $ | 47.86 |   |   |   | 842 |   |   |   | $ | 47.86 |   |   |
| $50.28 - $133.50                            |       |                         | 305        |                         |       |   | 5.55 |   |   |   | $ | 57.10 |   |   |   | 237 |   |   |   | $ | 57.84 |   |   |
| Total                                       |       |                         | 6,466      |                         |       |   | 4.42 |   |   |   | $ | 31.42 |   |   |   | 4,565 |   |   |   | $ | 31.06 |   |   |
|                                             |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Reserved Shares***

At December 31, 2006, the Company has sharesreserved for future issuance as follows (in thousands):
| Options outstanding                  |   | 6,466  |   |
|--------------------------------------|--------|--------|--------|
| Options available  for future grants |   | 1,415  |   |
| Convertible  subordinated notes      |   | 3,870  |   |
|                                 |   | 11,751 |   |

 

**NOTE 17—INCOMETAXES**

Thefollowing table presents the U.S. and foreign components of consolidated income(loss) before income taxes and the provision for income taxes (in thousands).Note, certain prior year information has been re-classified to conform tocurrent year presentation:

| ** **                                                 | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **INCOME (LOSS) BEFORE INCOME TAXES:** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S.                                                       |       | $                                          | 14,760     |   | $ | 127,382 |   | $ | 48,208 |   |
| Foreign                                                    |       | (20,827                                    | )          | (64,774 | ) | 2,726 |   |
| Income (loss)  before income taxes                         |       | $                                          | (6,067     | ) | $ | 62,608 |   | $ | 50,934 |   |
| **PROVISION (BENEFIT) FOR INCOME  TAXES:**                 |       |                                       |       |   |   |   |   |
| Current:                                                   |       |                                       |       |   |   |   |   |
| Federal                                                    |       | $                                          | 13,203     |   | $ | 30,380 |   | $ | 437 |   |
| State                                                      |       | 888                                        |       | 2,663 |   | 280 |   |
| Foreign                                                    |       | 41                                         |       | 1,969 |   | 2,609 |   |
| Subtotal                                                   |       | 14,132                                     |       | 35,012 |   | 3,326 |   |
| Deferred:                                                  |       |                                       |       |   |   |   |   |
| Federal                                                    |       | $                                          | (5,565     | ) | $ | (36,536 | ) | $ | — |   |
| State                                                      |       | (1,261                                     | )          | (905 | ) | — |   |
| Foreign                                                    |       | 331                                        |       | (750 | ) | — |   |
| Subtotal                                                   |       | (6,495                                     | )          | (38,191 | ) | — |   |
| Provision (benefit)for  income taxes                       |       | $                                          | 7,637      |   | $ | (3,179 | ) | $ | 3,326 |   |

 

 

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Thedifference between the provision (benefit) for income taxes and the amountcomputed by applying the Federal statutory income tax rate (35%) toincome(loss) before taxes is explained as follows (in thousands):

| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Tax at federal  statutory rate                      |       | $                                          | (2,123     | ) | $ | 21,913 |   | $ | 17,827 |   |
| Previously  unbenefited losses                      |       | —                                     |       | (57,550 | ) | (17,503 | ) |
| State taxes, net                                    |       | 704                                        |       | 4,042 |   | 182 |   |
| Non-deductible  stock compensation                  |       | 3,840                                      |       | 281 |   | 322 |   |
| Foreign rate  differential                          |       | 7,018                                      |       | 29,120 |   | 1,657 |   |
| Alternative  minimum taxes                          |       | —                                     |       | — |   | 1,751 |   |
| Non-deductible  in-process research and development |       | —                                     |       | 2,910 |   | — |   |
| Research credits                                    |       | (2,163                                     | )          | (2,137 | ) | — |   |
| Export tax  benefits                                |       | —                                     |       | (1,142 | ) | — |   |
| Domestic  manufacturing deduction                   |       | —                                     |       | (840 | ) | — |   |
| Other                                               |       | 361                                        |       | 224 |   | (910 | ) |
|                                                |       | $                                          | 7,637      |   | $ | (3,179 | ) | $ | 3,326 |   |

 

Deferred income taxesreflect the net tax effects of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts used for income tax purposes. Significant components of theCompany’s deferred tax assets are as follows (in thousands):

| ** **                                   | ** ** | **December 31,** | ** ** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|------------|
| ** **                                   | ** ** | **2006**              | ** ** | **2005**   | ** ** | ** ** |
| Deferred tax assets:                         |       |                  |       |       |   |   |
| Net operating loss carryforwards             |       | $                     | 38,779     |       | $ | 51,678 |   |   |
| Tax credit carryforwards                     |       | 32,268                |       | 29,024     |   |   |
| Deferred revenue                             |       | 7,843                 |       | 12,899     |   |   |
| Capitalized research and development costs   |       | 2,416                 |       | 3,126      |   |   |
| Intangibles                                  |       | 1,339                 |       | 2,242      |   |   |
| Stock-based compensation                     |       | 6,215                 |       | 3,837      |   |   |
| Accrued compensation                         |       | 2,882                 |       | 3,492      |   |   |
| Accrued warranty                             |       | 2,673                 |       | 2,452      |   |   |
| Inventory reserve                            |       | 7,103                 |       | 4,452      |   |   |
| Reserves and other                           |       | 8,813                 |       | 9,505      |   |   |
| Depreciation and amortization                |       | 4,198                 |       | 900        |   |   |
| Other, net                                   |       | 476                   |       | 1,339      |   |   |
| Total deferred tax assets                    |       | 115,005               |       | 124,946    |   |   |
| Valuation  allowance for deferred tax assets |       | (68,029               | )          | (76,643    | ) |   |
| Net deferred tax assets                      |       | 46,976                |       | 48,303     |   |   |
| Net deferred tax  liabilities:               |       |                  |       |       |   |   |
| Acquired intangibles                         |       | (1,498                | )          | (1,825     | ) |   |
| Other, net                                   |       | (2,774                | )          | (2,654     | ) |   |
| Total deferred tax liabilities               |       | (4,272                | )          | (4,479     | ) |   |
| Net deferred tax  assets                     |       | $                     | 42,704     |       | $ | 43,824 |   |   |

 

As of December 31, 2006, the Company had totalnet operating loss carryforwards of $163.0 million, comprised of $110.7 millionfor U.S. federal purposes, which expire in the years 2018 through 2025 if notutilized, and $52.3 million for state purposes, which expire in the years 2010through 2015 if not utilized. 

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Additionally, the Companyhas federal and state research and development tax credit carryforwards andother various tax credit carryforwards of approximately $40.5 million, whichexpire in the years 2008 through 2026 if not utilized. 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 before utilization.

The valuation allowance wasdecreased by $8.6 million and $45.7 million for the years ended December 31,2006 and 2005, respectively. The remaining valuation allowance as of December 31,2006 is $68.0 million, primarily due to the benefit of stock options that havenot been realized on a tax return. In assessing the realizability of itsdeferred tax assets, the Company considered whether it is more likely than notthat some portion or all of the deferred tax assets will not be realized. TheCompany considered historical book income, the scheduled reversal of deferredtax assets, and projected future book and taxable income in making this assessment.Based upon a detailed analysis of historical and projected book and taxableincome, the Company determined that the realization of certain deferred taxassets is considered more likely than not.

Approximately $58.7 million of the valuation allowanceas of December 31, 2006 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 $9.3 million as of December 31, 2006 is attributable to theacquisition of certain ParAllele taxattributes, the benefit of which will be credited to goodwill when, and if,realized.

As of December 31,2006, cumulative unremitted foreign earnings that are considered to be permanentlyinvested outside the United States and on which no U.S. taxes have beenprovided were approximately $10.0 million. The residual U.S. tax liability, ifsuch amounts were remitted, 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 $7.6million and $33.1 million for the years ended December 31, 2006 and 2005respectively.

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**NOTE 18—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 reports operatingresults on an aggregate basis to the chief operating decision makers of theCompany. The Company reported product and product related revenue by type andby region as follows (in thousands):

| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total product and  product related revenue: |       |                                       |       |   |   |   |   |
| Probe arrays                                |       | $                                          | 170,359    |   | $ | 197,949 |   | $ | 168,243 |   |
| Reagents                                    |       | 43,283                                     |       | 42,428 |   | 31,744 |   |
| Instruments                                 |       | 47,101                                     |       | 62,636 |   | 77,269 |   |
| Subscription fees                           |       | 7,237                                      |       | 12,448 |   | 20,669 |   |
| Service and other                           |       | 41,235                                     |       | 20,172 |   | 15,526 |   |
| License fee and milestone revenue           |       | 14,568                                     |       | 14,557 |   | 17,434 |   |
| Total product and product related revenue   |       | $                                          | 323,783    |   | $ | 350,190 |   | $ | 330,885 |   |
| Customer  location:                         |       |                                       |       |   |   |   |   |
| United States                               |       | $                                          | 155,737    |   | $ | 173,496 |   | $ | 171,674 |   |
| Europe                                      |       | 108,215                                    |       | 108,907 |   | 100,553 |   |
| Japan                                       |       | 37,403                                     |       | 47,920 |   | 43,488 |   |
| Other                                       |       | 22,428                                     |       | 19,867 |   | 15,170 |   |
| Total                                       |       | $                                          | 323,783    |   | $ | 350,190 |   | $ | 330,885 |   |

 

There were no customersrepresenting 10% or more of total revenue in 2006, 2005 and 2004.

**NOTE 19—DEFINED-CONTRIBUTIONSAVINGS 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 $3.8million in 2006, $3.3 million in 2005 and $3.0 million in 2004.Company contributions vest to employees ratably over four years.

***Director and 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 termination ordeath 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 

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terminatethe Plan or revise or amend it in any respect, except that no such action mayreduce vested amounts credited to deferral accounts, and such accounts willcontinue to be owed to the participants or beneficiaries and will continue tobe a liability of the Company until paid. For the years ended December 31,2006 and 2005, the Company incurred no significant expenses in connection withthe Plan.

**NOTE 20—UNAUDITED QUARTERLY FINANCIAL INFORMATION**

| ** **                                     | ** ** | **2006**                                                              | ** ** | **2005**                                                              | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Fourth  Quarter(3)**                                                | ** ** | **Third  Quarter(2)**                                                 | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** | **Fourth  Quarter(1)** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
| ** **                                     | ** ** | **(in thousands, except per share amounts)** | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Total revenue (excluding  Perlegen)            |       |                                                                  | $          | 101,585                                                               |       |   |   | $ | 80,079 |   |   | $ | 77,869 |   |   | $ | 81,091 |   |   |   | $ | 108,734 |   |   |   | $ | 81,227 |   |   |   | $ | 82,140 |   |   |   | $ | 86,428 |   |   |
| Perlegen revenue                               |       |                                                                  | $          | 2,603                                                                 |       |   |   | $ | 4,593 |   |   | $ | 2,197 |   |   | $ | 5,300 |   |   |   | $ | 2,755 |   |   |   | $ | 2,220 |   |   |   | $ | 1,911 |   |   |   | $ | 2,187 |   |   |
| Total cost of goods sold  (excluding Perlegen) |       |                                                                  | $          | 38,675                                                                |       |   |   | $ | 32,477 |   |   | $ | 27,058 |   |   | $ | 25,515 |   |   |   | $ | 30,653 |   |   |   | $ | 23,410 |   |   |   | $ | 20,411 |   |   |   | $ | 21,784 |   |   |
| Perlegen cost of goods sold                    |       |                                                                  | $          | 914                                                                   |       |   |   | $ | 1,646 |   |   | $ | 1,074 |   |   | $ | 1,584 |   |   |   | $ | 803 |   |   |   | $ | 1,359 |   |   |   | $ | 1,750 |   |   |   | $ | 1,242 |   |   |
| Net income (loss)                              |       |                                                                  | $          | 8,680                                                                 |       |   |   | $ | (14,155 | ) |   | $ | (10,054 | ) |   | $ | 1,825 |   |   |   | $ | 30,609 |   |   |   | $ | 9,398 |   |   |   | $ | 8,337 |   |   |   | $ | 17,444 |   |   |
| Basic net income (loss) per  common share      |       |                                                                  | $          | 0.13                                                                  |       |   |   | $ | (0.21 | ) |   | $ | (0.15 | ) |   | $ | 0.03 |   |   |   | $ | 0.46 |   |   |   | $ | 0.15 |   |   |   | $ | 0.13 |   |   |   | $ | 0.28 |   |   |
| Diluted net income (loss) per common share     |       |                                                                  | $          | 0.13                                                                  |       |   |   | $ | (0.21 | ) |   | $ | (0.15 | ) |   | $ | 0.03 |   |   |   | $ | 0.43 |   |   |   | $ | 0.14 |   |   |   | $ | 0.12 |   |   |   | $ | 0.26 |   |   |

----

(1)             On October 21,2005, the Company recorded a charge of approximately $8.3 million relatedto acquired in-process technology in connection with our acquisition ofParAllele BioScience, Inc. (“ParAllele”), a provider of comprehensivegenetic discovery solutions to the life science research, pharmaceutical anddiagnostic sectors.

(2)             In the thirdquarter of 2006, the Company recorded restructuring charges of $10.0 millionrelated employee severance and relocation benefits pursuant to its plan toterminate certain general and administrative functions and consolidate its Bedford,Massachusetts based instrumentation manufacturing and development facility withits manufacturing facility in West Sacramento, including $7.5 million relatedto  the modification of a former employee’sequity awards.

(3)             In the fourth quarterof 2006, the Company recorded an additional $3.5 million, related to itsrestructuring plan.

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**Disclosure Controlsand Procedures**

As required byparagraph (b) of Exchange Act Rules 13a-15 or 15d-15,Affymetrix’ management, including our Chief Executive Officer and InterimPrincipal Financial Officer, conducted an evaluation as of the end of theperiod covered by this report, of the effectiveness of Affymetrix’ disclosurecontrols and procedures as defined in Exchange Act Rule 13a-15(e) and15d-15(e). Based on that evaluation, our Chief Executive Officer and InterimPrincipal Financial Officer concluded that Affymetrix’ disclosure controls andprocedures were effective as of the end of the period covered by this report.

**Management’s Reporton 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, 2006 based on the framework in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Based on that evaluation, ourmanagement concluded that our internal control over financial reporting waseffective as of December 31, 2006. Management’s assessment of theeffectiveness of our internal control over financial reporting as of December 31,2006 has been audited by Ernst & Young LLP, an independent registeredpublic accounting firm, as stated in their report which appears below.

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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, 2006, 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 reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the company’s internal control over financial reporting basedon 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 

99

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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.

In our opinion, management’s assessment thatAffymetrix, Inc. maintained effective internal control over financialreporting as of December 31, 2006, 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, 2006, based on the COSO criteria.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Affymetrix, Inc. as ofDecember 31, 2006 and 2005, and the related consolidated statements ofoperations, comprehensive income (loss), stockholders’ equity, and cash flowsfor each of the three years in the period ended December 31, 2006 ofAffymetrix, Inc. and our report dated February 23, 2007, expressed anunqualified opinion thereon.

/s/ Ernst & YoungLLP

Palo Alto, California,February 23, 2007

100

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**Changesin 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.

**ITEM9B.**       OTHER INFORMATION

Not applicable.

**PART III**

**ITEM10.**         DIRECTORS, EXECUTIVE OFFICERSAND CORPORATE GOVERNANCE

Information regarding ourdirectors and executive officers is incorporated by reference to the sectionsof the Company’s proxy statement for the 2007 Annual Meeting of Stockholders(the “Proxy Statement”) entitled “Election of Directors” and “Management.”

The information concerningour corporate governance, including our audit committee, required by this Itemis incorporated by reference to the sections of the Proxy Statement entitled “Governanceof the Company” and “Report of 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,”“Compensation Discussion and Analysis,” “Compensation Committee Report,” “CertainTransactions” and “Compensation of Directors.”

**ITEM12.**         SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

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

**ITEM13.**         CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS,AND DIRECTOR INDEPENDENCE

Incorporated by referenceto the sections of the Proxy Statement entitled “Certain Transactions” and“Governance of the Company.”

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**ITEM14.**         PRINCIPAL ACCOUNTING FEESAND SERVICES

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

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(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**                                                                                                                                                         |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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          | )          | Amendment No. 1 to the 1996 Nonemployee  Directors Stock Option Plan of Affymetrix, Inc.                                                                                  |   |
| 10.8(15          | )          | Amended and Restated 1996 Non-Employee Directors  Stock Plan.                                                                                                                       |   |
| 10.9(16          | )*         | Common Terms Agreement between F. Hoffmann-La Roche  Ltd. and Affymetrix, Inc. dated January 29, 2003.                                                                    |   |
| 10.10(16         | )*         | License Agreement between F. Hoffmann-La Roche Ltd.  and Affymetrix, Inc. dated January 29, 2003.                                                                         |   |
| 10.11(16         | )*         | Affymetrix Instrument and Chip Supply Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                          |   |
| 10.12(16         | )*         | Research & Development Collaboration  Agreement between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc.  dated January 29, 2003.                             |   |
| 10.13(16         | )*         | Diagnostic Product and Instrument Agency Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                  |   |
| 10.14(16         | )*         | Affymetrix Instrument Agency Agreement between  F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                              |   |
|                  |            |                                                                                                                                                                                     |  |  |

103

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| 10.15(17 | )       | Lease between Sobrato Interests and Affymetrix dated  July 3, 2002 (3420 Central Expressway, Santa Clara, CA).                                                                                                             |
|----------|---------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16(17 | )       | First Amendment to Lease between Sobrato Interests  and Affymetrix dated September 30, 2003 (3420 Central Expressway, Santa  Clara, CA).                                                                                   |
| 10.17(17 | )† | 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. |
| 10.18(18 | )† | Affymetrix, Inc. Amended and Restated 2000  Equity Incentive Plan.                                                                                                                                                         |
| 10.19(19 | )† | Form of Non-Qualified Stock Option Agreement  under the Affymetrix, Inc. Amended and Restated 1996 Non-Employee  Directors Stock Plan.                                                                                |
| 10.20(19 | )† | Form of Stock Option Agreement under the  Affymetrix, Inc. Amended and Restated 2000 Equity Incentive Plan.                                                                                                           |
| 10.21(20 | )† | Affymetrix, Inc. Deferred Compensation Plan.                                                                                                                                                                               |
| 10.22(21 | )       | Fifth Amendment to Lease between Sobrato Interests  and Affymetrix, Inc. dated July 3, 2002 (3380 Central Expressway,  Santa Clara, CA).                                                                              |
| 10.23(21 | )       | First Amendment to Lease between Sobrato Interests  and Affymetrix, Inc. dated July 3, 2002 (3450 Central Expressway,  Santa Clara, CA).                                                                              |
| 10.24(22 | )       | Lease between Keppel Logistics Pte Ltd. and  Affymetrix Pte Ltd. dated as of January 1, 2006 (7 Gul Circle,  Singapore 629363).                                                                                       |
| 10.25(22 | )† | Form of Restricted Stock Agreement under the  Affymetrix, Inc. Amended and Restated 2000 Equity Incentive Plan.                                                                                                       |
| 10.26    | †  | Agreement between the Company and Thane Kreiner,  Ph.D. dated May 10, 2006.                                                                                                                                                |
| 10.27(23 | )† | Agreement between the Company and Susan E. Siegel  dated May 30, 2006.                                                                                                                                                     |
| 10.28(24 | )† | Offer Letter from the Company to Kevin M. King dated  December 18, 2006.                                                                                                                                                   |
| 10.29(25 | )**     | Amendment Agreement dated December 22, 2006 by  and among F. Hoffmann-La Roche Ltd., Roche Molecular Systems, Inc. and  Affymetrix, Inc.                                                                         |
| 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 Interim Principal 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 Interim Principal Financial Officer  Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                               |

----

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

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

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

       (4) Incorporated by reference to Registrant’s Form 8-K asfiled on June 13, 2000 (File No. 000-28218).

       (5) Incorporated by reference to Appendix C of Registrant’sDefinitive Proxy Statement on Schedule 14A as filed on April 29, 1998(File No. 000-28218).

       (6) Incorporated by reference to Registrant’s Form 10-Q asfiled on May 15, 2001 (File No. 000-28218).

104

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       (7) Incorporated by reference to Registrant’s Form 8-K asfiled on October 16, 1998 (File No. 000-28218).

       (8) Incorporated by reference to Registrant’s Form 8-A asfiled on October 16, 1998 (File No. 000-28218).

       (9) Incorporated by reference to Registrant’s Form 8-A/A asfiled on March 29, 2000 (File No. 000-28218).

(10) Incorporated by reference to Registrant’s Form S-3 asfiled on January 29, 2004 (File No. 333-112311).

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

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

(13) Incorporated by reference to Registrant’s Report on Form 10-Kas filed on March 31, 1999 (File No. 000-28218).

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

(15) Incorporated by reference to Registrant’s Form 10-Q asfiled on May 15, 2001 (File No. 000-28218).

(16) Incorporated by reference to Registrant’s Form 10-Q asfiled on May 15, 2003 (File No. 000- 28218).

(17) Incorporated by referenceto Registrant’s Form 10-K as filed on March 15, 2004 (File No. 000-28218).

(18) Incorporated by reference to Registrant’s Form 10-Q asfiled on August 9, 2004 (File No. 000-28218).

(19) Incorporated by reference to Registrant’s Form 10-Q asfiled on November 9, 2004 (File No. 000-28218).

(20) Incorporated by reference to Registrant’s Form 8-K asfiled on December 14, 2004 (File No. 000-28218).

(21) Incorporated by reference to Registrant’s Form 10-K asfiled on March 16, 2005 (File No. 000-28218).

(22) Incorporated by reference to Registrant’s Form 10-K asfiled on March 9, 2006 (File No. 000-28218).

(23) Incorporated by reference to Registrant’s Form 8-K asfiled on May 30, 2006 (File No. 000-28218).

(24) Incorporated by reference to Registrant’s Form 8-K asfiled on December 19, 2006 (File No. 000-28218).

(25)   Incorporated by reference toRegistrant’s Form 8-K as filed on December 22, 2006 (File No. 000-28218).

*                    Confidentialtreatment granted

†                    Management contract, compensatoryplan or arrangement

**             Confidentialtreatment requested

105

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**AFFYMETRIX, INC.Schedule II—Valuation and 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, 2006: |       |                                           |       |                                           |       |              |       |                                         |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts    |       |                                           | $          | 415                                            |       |              |       | $                                            | 1,486      |   |   |   | $ | (367 | ) |   |   | $ | 1,534 |   |   |
| 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 |   |   |

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(1)          Uncollectible accountswritten off, net of recoveries.

106

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**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 1, 2007 |   | 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 1, 2007 |
|   |       | Stephen  P.A. Fodor, Ph.D.           |     | Board and Chief  Executive Officer   |       |               |
|   |       |                                 |     | (Principal Executive  Officer)       |       |               |
| By:    |       | /s/ JAMES  R. GIBSON                 |     | Interim Principal  Financial Officer |       | March 1, 2007 |
|   |       | James  R. Gibson                     |     | and Principal Accounting  Officer    |       |               |
| By:    |       | /s/ PAUL  BERG, PH.D.                |     | Director                             |       | March 1, 2007 |
|   |       | Paul  Berg, Ph.D.                    |     |                                 |       |               |
| By:    |       | /s/ SUSAN  D. DESMOND HELLMANN, M.D. |     | Director                             |       | March 1, 2007 |
|   |       | Susan  D. Desmond-Hellmann, M.D.     |     |                                 |       |               |
| By:    |       | /s/ JOHN  D. DIEKMAN, PH.D.          |     | Director                             |       | March 1, 2007 |
|   |       | John  D. Diekman, Ph.D.              |     |                                 |       |               |
| By:    |       | /s/ VERNON  R. LOUCKS, JR.           |     | Director                             |       | March 1, 2007 |
|   |       | Vernon  R. Loucks, Jr.          |     |                                 |       |               |
| By:    |       | /s/ DAVID  B. SINGER                 |     | Director                             |       | March 1, 2007 |
|   |       | David  B. Singer                     |     |                                 |       |               |
| By:    |       | /s/ ROBERT  H. TRICE, PH.D.          |     | Director                             |       | March 1, 2007 |
|   |       | Robert  H. Trice, Ph.D.              |     |                                 |       |               |
| By:    |       | /s/ JOHN A.  YOUNG                   |     | Director                             |       | March 1, 2007 |
|   |       | John A. Young                        |     |                                 |       |               |

 

107

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**INDEXTO EXHIBITS**

| EXHIBIT   NUMBER  | ** ** | ** **                                                                                                                                                                           | ** ** | **DESCRIPTION   OF DOCUMENT** |
|------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|
|   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)               |       | Amendment No. 1 to  the 1996 Nonemployee Directors Stock Option Plan of Affymetrix, Inc.                                                                                   |
| 10.8(15)               |       | Amended and Restated  1996 Non-Employee Directors Stock Plan.                                                                                                                        |
| 10.9(16)*              |       | Common Terms Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                                                    |
| 10.10(16)*             |       | License Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                                                         |
| 10.11(16)*             |       | Affymetrix Instrument and  Chip Supply Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                           |
| 10.12(16)*             |       | Research &  Development Collaboration Agreement between F. Hoffmann-La Roche Ltd.  and Affymetrix, Inc. dated January 29, 2003.                              |
| 10.13(16)*             |       | Diagnostic Product and  Instrument Agency Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                   |
| 10.14(16)*             |       | Affymetrix Instrument  Agency Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                               |
| 10.15(17)              |       | Lease between Sobrato  Interests and Affymetrix dated July 3, 2002 (3420 Central Expressway,  Santa Clara, CA).                                                                 |
| 10.16(17)              |       | First Amendment to Lease  between Sobrato Interests and Affymetrix dated September 30, 2003 (3420  Central Expressway, Santa Clara, CA).                                        |

108

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| 10.17(17)† |   | 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. |
|-----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18(18)† |   | Affymetrix, Inc. Amended  and Restated 2000 Equity Incentive Plan.                                                                                                                                                         |
| 10.19(19)† |   | Form of  Non-Qualified Stock Option Agreement under the Affymetrix, Inc. Amended  and Restated 1996 Non-Employee Directors Stock Plan.                                                                                |
| 10.20(19)† |   | Form of Stock  Option Agreement under the Affymetrix, Inc. Amended and Restated 2000  Equity Incentive Plan.                                                                                                          |
| 10.21(20)† |   | Affymetrix, Inc.  Deferred Compensation Plan.                                                                                                                                                                              |
| 10.22(21)       |   | Fifth Amendment to Lease  between Sobrato Interests and Affymetrix, Inc. dated July 3, 2002  (3380 Central Expressway, Santa Clara, CA).                                                                              |
| 10.23(21)       |   | First Amendment to Lease  between Sobrato Interests and Affymetrix, Inc. dated July 3, 2002  (3450 Central Expressway, Santa Clara, CA).                                                                              |
| 10.24(22)       |   | Lease between Keppel  Logistics Pte Ltd. and Affymetrix Pte Ltd. dated as of January 1, 2006  (7 Gul Circle, Singapore 629363).                                                                                       |
| 10.25(22)† |   | Form of Restricted  Stock Agreement under the Affymetrix, Inc. Amended and Restated 2000  Equity Incentive Plan.                                                                                                      |
| 10.26†     |   | Agreement between the  Company and Thane Kreiner, Ph.D. dated May 10, 2006.                                                                                                                                                |
| 10.27(23)† |   | Agreement between the  Company and Susan E. Siegel dated May 30, 2006.                                                                                                                                                     |
| 10.28(24)† |   | Offer Letter from the  Company to Kevin M. King dated December 18, 2006.                                                                                                                                                   |
| 10.29(25)**     |   | Amendment Agreement  dated December 22, 2006 by and among F. Hoffmann-La Roche Ltd., Roche  Molecular Systems, Inc. and Affymetrix, Inc.                                                                         |
| 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 Interim  Principal 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 Interim Principal Financial Officer  Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                               |

----

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

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

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

       (4) Incorporated by reference to Registrant’s Form 8-K asfiled on June 13, 2000 (File No. 000-28218).

       (5) Incorporated by reference to Appendix C of Registrant’sDefinitive Proxy Statement on Schedule 14A as filed on April 29, 1998(File No. 000-28218).

109

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       (6) Incorporated by reference to Registrant’s Form 10-Q asfiled on May 15, 2001 (File No. 000-28218).

       (7) Incorporated by reference to Registrant’s Form 8-K asfiled on October 16, 1998 (File No. 000-28218).

       (8) Incorporated by reference to Registrant’s Form 8-A asfiled on October 16, 1998 (File No. 000-28218).

       (9) Incorporated by reference to Registrant’s Form 8-A/A asfiled 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 to Registrant’s Registration Statement on Form S-1(File No. 333-3648), as amended.

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

(13) Incorporated by reference to Registrant’s Report on Form 10-Kas filed on March 31, 1999 (File No. 000-28218).

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

(15) Incorporated by reference to Registrant’s Form 10-Q asfiled on May 15, 2001 (File No. 000-28218).

(16) Incorporated by reference to Registrant’s Form 10-Q asfiled on May 15, 2003 (File No. 000- 28218).

(17) Incorporated by reference to Registrant’s Form 10-K asfiled on March 15, 2004 (File No. 000-28218).

(18) Incorporated by reference to Registrant’s Form 10-Q asfiled on August 9, 2004 (File No. 000-28218).

(19) Incorporated by reference to Registrant’s Form 10-Q asfiled on November 9, 2004 (File No. 000-28218).

(20) Incorporated by reference to Registrant’s Form 8-K asfiled on December 14, 2004 (File No. 000-28218).

(21) Incorporated by reference to Registrant’s Form 10-K asfiled on March 16, 2005 (File No. 000-28218).

(22) Incorporated by reference to Registrant’s Form 10-K asfiled on March 9, 2006 (File No. 000-28218).

(23) Incorporated by reference to Registrant’s Form 8-K asfiled on May 30, 2006 (File No. 000-28218).

(24) Incorporated by reference to Registrant’s Form 8-K asfiled on December 19, 2006 (File No. 000-28218).

(25) Incorporated by reference to Registrant’s Form 8-Kas filed on December 22, 2006 (File No. 000-28218).

*                    Confidentialtreatment granted

†                    Managementcontract, compensatory plan or arrangement

**             Confidentialtreatment requested

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