Affymetrix 10Q 2006 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO .

COMMISSION FILE NO. 0-28218

AFFYMETRIX, INC.

(Exact name of Registrant as specified in its charter)

DELAWARE		77-0319159
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

3420 CENTRAL EXPRESSWAY
SANTA CLARA, CALIFORNIA		95051
(Address of principal executive offices)		(Zip Code)

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

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

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large 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 check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

COMMON SHARES OUTSTANDING ON AUGUST 24, 2006: 67,677,616

AFFYMETRIX, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

	Item 1.	Financial Statements (Unaudited), as restated	3

		Condensed Consolidated Balance Sheets at June 30, 2006 and December 31, 2005, as restated	3

		Condensed Consolidated Statements of (Loss) Income for the Three and Six Months Ended June 30, 2006 and 2005, as restated	4

		Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005, as restated	5

		Notes to Condensed Consolidated Financial Statements, as restated	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25

	Item 4.	Controls and Procedures	25

PART II. OTHER INFORMATION

	Item 1.	Legal Proceedings	27

	Item 1A.	Risk Factors	27

	Item 4.	Submission of Matters to a Vote of Security Holders	34

	Item 5.	Other Information	34

	Item 6.	Exhibits	35

SIGNATURES			36

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(UNAUDITED)

	June 30, 2006		December 31, 2005
			Note 1 (as restated)
ASSETS
Current assets:
Cash and cash equivalents	$ 76,031		$ 100,236
Available-for-sale securities – short-term	184,572		184,696
Accounts receivable, net	65,049		93,028
Accounts receivable from Perlegen Sciences	2,688		4,082
Inventories	45,091		35,980
Deferred tax assets—current portion	26,390		26,230
Prepaid expenses and other current assets	7,594		12,622
Total current assets	407,415		456,874
Available-for-sale securities – long-term	8,626		—
Property and equipment, net	122,108		85,560
Acquired technology rights, net	59,286		61,426
Goodwill	124,063		124,498
Deferred tax assets—long-term portion	17,594		17,594
Notes receivable from employees	1,853		1,824
Other assets	26,949		27,318
	$ 767,894		$ 775,094

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$ 62,111		$ 71,551
Deferred revenue — current portion	38,980		35,644
Total current liabilities	101,091		107,195
Deferred revenue — long-term portion	8,505		15,606
Other long-term liabilities	4,763		4,184
Convertible notes	120,000		120,000
Stockholders’ equity:
Common stock	676		672
Additional paid-in capital	649,208		646,186
Deferred stock compensation	—		(10,799	)
Accumulated other comprehensive loss	(1,397	)	(1,227	)
Accumulated deficit	(114,952	)	(106,723	)
Total stockholders’ equity	533,535		528,109
	$ 767,894		$ 775,094

Note 1: The condensed consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date included in the Company’s Form 10-K/A for the fiscal year ended December 31, 2005.

See accompanying notes.

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF (LOSS) INCOME

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
				(as restated)						(as restated)
Revenue
Product sales	$	61,043		$	69,213		$	127,015		$	142,764
Product related revenue	14,407			10,934			27,650			22,251
Total product and product related revenue	75,450			80,147			154,665			165,015
Royalties and other revenue	2,419			1,993			4,294			3,553
Revenue from Perlegen Sciences	2,197			1,911			7,498			4,098
Total revenue	80,066			84,051			166,457			172,666

Costs and expenses:
Cost of product sales	19,646			17,952			38,720			37,231
Cost of product related revenue	7,412			2,459			13,853			4,964
Cost of revenue from Perlegen Sciences	1,074			1,750			2,658			2,992
Research and development	21,597			20,799			45,098			37,889
Selling, general and administrative	39,476			32,540			78,242			62,137
Stock-based compensation	—			33			—			116
Total costs and expenses	89,205			75,533			178,571			145,329
(Loss) income from operations	(9,139		)	8,518			(12,114		)	27,337
Interest income and other, net	3,720			953			8,007			1,667
Interest expense	(400		)	(289		)	(824		)	(716		)

(Loss) income before income taxes	(5,819		)	9,182			(4,931		)	28,288
Income tax provision	(4,235		)	(845		)	(3,298		)	(2,507		)
Net (loss) income	$	(10,054	)	$	8,337		$	(8,229	)	$	25,781

Basic net (loss) income per common share	$	(0.15	)	$	0.13		$	(0.12	)	$	0.41
Diluted net (loss) income per common share	$	(0.15	)	$	0.12		$	(0.12	)	$	0.38

Shares used in computing basic net (loss) income per share	67,313			63,214			67,275			62,785
Shares used in computing diluted net (loss) income per share	67,313			70,227			67,275			69,703

See accompanying notes.

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

	Six Months Ended June 30,
	2006		2005
			(as restated)
Cash flows from operating activities:
Net (loss) income	$ (8,229	)	$ 25,781
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization	11,028		10,160
Amortization of intangible assets	4,154		3,803
Amortization of investment discounts, net	(298	)	(355	)
Stock-based compensation	8,882		116
Realized loss on sales of available for sale securities	68		253
Realized loss on equity method investment in Perlegen Sciences	—		2,000
Deferred tax assets	(160	)	(1,752	)
Write down of equity investment	108		62
Tax benefit from employee stock options	—		6,096
Amortization of debt offering costs	379		379
Accretion of interest on notes receivable	(29	)	(49	)
Loss on write-off of equipment	—		7
Change in operating assets and liabilities:
Accounts receivable, net	29,373		26,602
Inventories	(9,111	)	(7,840	)
Prepaid expenses and other current assets	3,474		(5,670	)
Accounts payable and accrued and other current liabilities	(10,044	)	(11,712	)
Deferred revenue	(3,765	)	(5,685	)
Other long-term liabilities	579		171
Net cash provided by operating activities	26,409		42,367

Cash flows from investing activities:
Capital expenditures	(47,576	)	(12,568	)
Purchases of available-for-sale securities	(67,986	)	(191,662	)
Proceeds from the sales or maturities of available-for-sale securities	59,961		109,615
Proceeds from the capital distribution of a non-marketable equity investment	—		411
Purchase of non-marketable equity investment in Perlegen Sciences	—		(2,000	)
Purchase of non-marketable equity investment	(250	)	(250	)
Purchase of technology rights	(250	)	(500	)
Net cash used in investing activities	(56,101	)	(96,954	)

Cash flows from financing activities:
Issuance of common stock through the Company’s stock option plans	5,378		38,675
Net cash provided by financing activities	5,378		38,675
Effect of exchange rate changes on cash and cash equivalents	109		284
Net decrease in cash and cash equivalents	(24,205	)	(15,628	)
Cash and cash equivalents at beginning of period	100,236		42,595
Cash and cash equivalents at end of period	$ 76,031		$ 26,967

See accompanying notes.

AFFYMETRIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2006
(UNAUDITED)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on August 30, 2006.

Restatement of Prior Period Information

The financial results of operations for the six months ended June 30, 2005 have been restated to correct certain errors resulting from the recording of additional non-cash stock-based compensation expense, and the related income tax impact. Refer to the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2005 for a detailed discussion of the restatement.

Use of Estimates

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

Revenue Recognition

Overview

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product or system is required, revenue is deferred until all the acceptance criteria have been met.

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

EITF 00-21 provides guidance on accounting for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. In accordance with EITF 00-21, the Company allocates revenue for transactions or collaborations that include multiple elements to each unit of accounting based on its relative fair value, and recognizes revenue for each unit of accounting when the revenue recognition criteria have been met. The price charged when the element is sold separately generally determines fair value. In the absence of fair value of a delivered element, the Company allocates revenue first to the fair value of the undelivered elements and the residual revenue to the delivered elements. The Company recognizes revenue for delivered elements when the delivered elements have standalone value and the Company has objective and reliable evidence of fair value for each undelivered element. If the fair value of any undelivered element included in a multiple element arrangement cannot be objectively determined, revenue is deferred until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements.

Product Sales

Product sales, as well as revenues from Perlegen Sciences, include sales of GeneChip® probe arrays, reagents and related instrumentation. Probe array, reagent and instrumentation revenues are recognized when earned, which is generally upon shipment

and transfer of title to the customer and fulfillment of any significant post-delivery obligations. Accruals are provided for anticipated warranty expenses at the time the associated revenue is recognized.

Product Related Revenue

Product related revenue includes subscription fees earned under GeneChip® array access programs; license fees; milestones and royalties earned from collaborative product development and supply agreements; equipment service revenue; product related scientific services revenue; and revenue from custom probe array design fees.

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

The Company enters into collaborative arrangements which generally include a research and product development phase and a manufacturing and product supply phase. These arrangements may include up-front nonrefundable license fees, milestones, the rights to royalties based on the sale of final product by the partner, product supply agreements and distribution arrangements.

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

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

Revenue from scientific and DNA analysis services are recognized upon shipment of the required data to the customer.

Royalties and Other Revenue

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

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

Research revenues result primarily from research grants received from U.S. Government entities or from subcontracts with other life science research-based companies which receive their research grant funding from the U.S. Government. Revenues from research contracts are generated from the efforts of the Company’s technical staff and include the costs for material and subcontract efforts. The Company’s research grant contracts generally provide for the payment of negotiated fixed hourly rates for labor hours incurred plus reimbursement of other allowable costs. Research revenue is recorded in the period in which the associated costs are incurred, up to the limit of the prior approval funding amounts contained in each agreement. The costs associated with these grants are reported as research and development expense.

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

Transactions with Distributors

The Company recognizes revenue on sales to distributors in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition,” or SAB 104. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable, and collectibility is reasonably assured. The Company’s agreements with distributors do not include rights of return.

Net (Loss) Income Per Share

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

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
				(as restated)						(as restated)
Numerator:
Net (loss) income —basic	$	(10,054	)	$	8,337		$	(8,229	)	$	25,781
Add effect of dilutive securities:
Interest on convertible notes (inclusive of amortization of debt issuance costs)	—			415			—			829
Net (loss) income — diluted	$	(10,054	)	$	8,752		$	(8,229	)	$	26,610
Denominator:
Weighted-average shares outstanding	67,443			63,296			67,395			62,862
Less: weighted-average shares of common stock subject to repurchase	(130		)	(82		)	(120		)	(77		)
Shares used in computing basic net (loss) income per common share	67,313			63,214			67,275			62,785
Add effect of dilutive securities:
Employee stock options	—			3,061			—			2,963
Common stock subject to repurchase	—			82			—			77
Warrants to purchase common stock	—			—			—			8
Convertible notes	—			3,870			—			3,870
Shares used in computing diluted net (loss) income per common share	67,313			70,227			67,275			69,703
Basic net (loss) income per common share	$	(0.15	)	$	0.13		$	(0.12	)	$	0.41
Diluted net (loss) income per common share	$	(0.15	)	$	0.12		$	(0.12	)	$	0.38

The following securities were excluded from the computation of diluted net (loss) income per common share, on an actual outstanding basis, as they were anti-dilutive (in thousands):

	Three Months Ended June 30,		Six Months Ended June 30,
	2006	2005	2006	2005

Employee stock options	7,069	257	7,069	1,420
Common stock subject to repurchase	130	—	120	—
Convertible notes	3,870	—	3,870	—

Total	11,069	257	11,059	1,420

Change in functional currency

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

NOTE 2—RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

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

The Company concluded that there was a material accounting error as a result of a documentation lapse in July 1999, in which the option grant for an aggregate of 1.99 million shares should have been measured for accounting purposes as of a later date. In light of the restatement required by this matter, the Company also included in this restatement corrections relating to certain other errors and documentation lapses in the fiscal years 1997 and 1998. Approximately 97% of the charges relating to the restatement arose from the documentation lapse in July 1999.

The Company determined that the cumulative, pre-tax, non-cash, stock-based compensation expense resulting from revised measurement dates for options granted between 1997 and 1999 was approximately $21.5 million. Accordingly, the Company recorded stock-based compensation expense 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 years preceding 2003, based on the vesting periods of the respective grants. In addition, the Company recorded an income tax benefit of $8.3 million in 2005. Principally as a result of cumulative losses incurred through 2004, the Company recorded a full valuation allowance against all deferred tax assets for the years ended December 31, 2004 and 2003 and consequently, there was no income tax effect of the additional stock-based compensation expense recorded in those years. The cumulative effect of the restatement adjustments on the Company’s consolidated balance sheet at December 31, 2005 was an increase in additional paid-in capital of $21.5 million offset by an increase in the accumulated deficit of $13.2 million, which resulted in a net effect on stockholders’ equity of $8.3 million. The adjustments increased previously reported 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 and diluted net income per common share by $0.03 for the year ended December 31, 2003.

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

The following tables set forth the effects of the restatement on certain line items within the Company’s consolidated statements of income for three and six months ended June 30, 2005 and condensed consolidated balance sheet as of December 31, 2005:

	Three months ended June 30, 2005		Six months ended June 30, 2005
Income tax provision:
As previously reported	$	1,371	$	4,259
As restated	$	845	$	2,507

Net income:
As previously reported	$	7,811	$	24,029
As restated	$	8,337	$	25,781

Basic net income per share:
As previously reported	$	0.12	$	0.38
As restated	$	0.13	$	0.41

Diluted net income per share:
As previously reported	$	0.12	$	0.36
As restated	$	0.12	$	0.38

	December 31, 2005
Deferred tax assets – current portion:
As previously reported	$	22,117
As restated	$	26,230

Deferred tax assets – long-term portion:
As previously reported	$	13,436
As restated	$	17,594

Additional paid-in capital:
As previously reported	$	624,727
As restated	$	646,186

Accumulated deficit:
As previously reported	$	(93,535	)
As restated	$	(106,723	)

Certain other footnotes appearing in these financial statements were impacted by the error corrections reflected in the restatement. Refer to footnotes 1, 3, 8, and 12.

NOTE 3—STOCK-BASED COMPENSTION

Stock-Based Compensation Plans

The Company has a stock-based compensation program that provides the Board of Directors broad discretion in creating equity incentives for employees, officers, directors and consultants. This program includes incentive and non-qualified stock options and non-vested stock awards (also known as restricted stock) granted under various stock plans. Stock options are generally time-based, vesting 25% on each annual anniversary of the grant date over four years and expire 7 to 10 years from the grant date. Non-vested stock awards are generally time-based, vesting 25% on each annual anniversary of the grant date over four years. As of June 30, 2006, the Company had approximately 1.1 million shares of common stock reserved for future issuance under its stock-based compensation plans. New shares are issued as a result of stock option exercises and non-vested restricted stock awards.

Adoption of SFAS 123R

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R using the modified prospective transition method. Under the modified prospective transition method, prior periods are not restated for the effect of SFAS 123R. Commencing with the first quarter of 2006, compensation cost includes all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and compensation for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes the fair value of its stock option awards as compensation expense over 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 related to stock options granted on or after January 1, 2006 is recognized on a straight-line basis.

Prior to the adoption of SFAS 123R, the Company applied SFAS 123, amended by SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148), which allowed companies to apply the existing accounting rules under APB 25, “Accounting for Stock Issued to Employees,” and related Interpretations. In general, as the exercise price of options granted under the Company’s plans was equal to the market price of the underlying common stock on the grant date, no stock-based employee 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 prior to 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-based awards, as if the fair-value-based method defined in SFAS 123 had been applied.

As a result of adopting SFAS 123R, the Company’s loss before taxes, net loss and basic and diluted loss per share for the three months ended June 30, 2006 was $4.4 million, $3.2 million, $0.05 lower, respectively, than if the Company had continued to account for stock-based compensation under APB Opinion No. 25 and for the six months ended June 30, 2006 was $7.6 million, $5.1 million and $0.08 lower, respectively. In accordance with SFAS 123R, the Company is also required to present excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows. No income tax benefit was realized from stock option exercises during the six months ended June 30, 2006, therefore no such amounts are presented as financing cash flows.

The following table sets forth the total stock-based compensation expense resulting from stock options and non-vested stock awards included in the Company’s Condensed Consolidated Statements of (Loss) Income upon the adoption of SFAS 123R (in thousands):

	Three Months Ended June 30, 2006			Six Months Ended June 30, 2006
Costs of product sales	$	377		$	718
Research and development	1,042			2,104
Selling, general and administrative	3,700			6,060
Total stock-based compensation expense	$	5,119		$	8,882
Income tax benefit	(798		)	(1,730		)
Total stock-based compensation expense, net of tax	$	4,321		$	7,152

Selling, general and administrative expense included a $1.1 million charge in the second quarter of 2006 due to the modification of an executive officer’s stock option grant to include an extension of time to exercise as well as the vesting of certain stock options without a requisite service period.

As of June 30, 2006, $26.6 million of total unrecognized stock-based compensation expense related to non-vested awards is expected to be recognized over the respective vesting terms of each award through 2010. The weighted average term of the unrecognized stock-based compensation expense is 1.7 years.

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

	Three months ended June 30,						Six months ended June 30,
	2005			2005			2005			2005
	(as previously reported)			(as restated)			(as previously reported)			(as restated)
Net income—as reported	$	7,811		$	8,337		$	24,029		$	25,781
Add: Stock-based employee compensation expense included in reported net income, net of tax	—			—			—			—
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of tax	(3,948		)	(3,948		)	(7,947		)	(7,947		)
Pro forma net income	$	3,863		$	4,389		$	16,082		$	17,834
Net income per share:
Basic net income per common share—as reported	$	0.12		$	0.13		$	0.38		$	0.41
Diluted net income per common share—as reported	$	0.12		$	0.12		$	0.36		$	0.38
Basic net income per common share—pro forma	$	0.06		$	0.07		$	0.26		$	0.28
Diluted net income per common share—pro forma	$	0.06		$	0.06		$	0.24		$	0.26

Stock Options

The fair value of options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
Risk free interest rate	5.1	%	3.6	%	5.1	%	3.8	%
Expected dividend yield	—	%	—	%	—	%	—	%
Expected volatility	39.4	%	48.9	%	39.4	%	49.8	%
Expected option term (in years)	4.5		3.1		4.5		3.3

The risk free interest rate for periods within the contractual life of the Company’s stock options is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term is derived from an analysis of the Company’s historical exercise trends over ten years. The expected volatility for the three and six months ended June 30, 2006 is based on a blend of historical and market-based implied volatility. The expected volatility for the six months ended June 30, 2005, is based solely on historical volatility. The Company’s management changed its expected volatility estimation approach based upon the availability of actively traded options on the Company’s common stock and because management believes this blended method is more representative of future stock price trends than historical volatility alone. Using the assumptions above, the weighted average grant date fair value of options granted during the three months ended June 30, 2006 and 2005 was $11.27 and $18.09, respectively, and for the six months ended June 30, 2006 and 2005 was $12.15 and $17.50, respectively.

Activity under the Company’s stock plans for the six months ended June 30, 2006 is as follows (in thousands, except per share amounts):

	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	843		30.25
Exercises	(252	)	21.92
Forfeitures, cancellations or expirations	(279	)	34.00

Outstanding at June 30, 2006	7,069		$	31.42	4.8	$	16,479

Exercisable at June 30, 2006	4,457		$	30.03	4.1	$	14,056

Vested and expected to vest at June 30, 2006	6,717		$	31.25	4.8	$	16,323

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on the last trading day of its second quarter of 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2006. This amount changes based on the fair market value of the Company’s stock. Total intrinsic value of options exercised is $0.7 million and $16.0 million for the three months ended June 30, 2006 and 2005, respectively and $4.2 million and $44.5 million for the six months ended June 30, 2006 and 2005, respectively.

Restricted Stock

The following table summarizes the Company’s non-vested restricted stock activity for the six months ended June 30, 2006 (in thousands, except per share amounts):

	Number of Shares		Weighted-Average Grant Date Fair Value
Non-vested stock at December 31, 2005	121		$	56.54
Granted	176		29.10
Vested	(10	)	51.05
Forfeited	(1	)	45.08

Non-vested stock at June 30, 2006	286		$	39.83

Total fair value of shares vested is $0.3 million and $0.1 million for the six months ended June 30, 2006 and 2005, respectively.

NOTE 4—ACQUISITION

On October 21, 2005, the Company acquired 100% of the outstanding shares of ParAllele BioScience, Inc. (“ParAllele”), a provider of comprehensive genetic discovery solutions to the life science research, pharmaceutical and diagnostic sectors. Affymetrix accounted for the merger under the purchase method of accounting in accordance with the provisions of Statement of Financial Accounting Standards No. 141, “Business Combinations.” Under this accounting method, the Company recorded the assets acquired and liabilities assumed at their estimated fair value, with the excess purchase price reflected as goodwill. Additionally, certain costs directly related to the merger were reflected as additional purchase price in excess of net assets acquired. The results of operations of ParAllele have been included in Affymetrix’ condensed consolidated financial statements for the three and six months ended June 30, 2006.

Upon the adoption of SFAS 123R, the Company reversed all unamortized deferred stock-based compensation against additional paid in capital. There have been no other significant changes in the ParAllele acquisition compared to the disclosures in Item 8 of the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2005.

NOTE 5—INVENTORIES

Inventories consist of the following (in thousands):

	June 30, 2006		December 31, 2005
Raw materials	$	15,379	$	13,094
Work-in-process	10,602		10,423
Finished goods	19,110		12,463

Total	$	45,091	$	35,980

NOTE 6—ACQUIRED TECHNOLOGY RIGHTS

Acquired technology rights are comprised of licenses to technology covered by patents to third parties and are amortized over the expected useful life of the underlying patents, which range from one to fifteen years. Accumulated amortization of these rights amounted to $26.5 million and $22.2 million at June 30, 2006 and December 31, 2005, respectively.

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

For the Year Ending December 31,	Amortization Expense
2006, remainder thereof	$	4,163
2007	8,326
2008	8,314
2009	7,446
2010	6,676
Thereafter	24,361
Total expected future annual amortization	$	59,286

NOTE 7—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

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

	June 30, 2006	December 31, 2005
Accounts payable	$ 22,339	$ 29,718
Accrued compensation and related liabilities	17,968	20,419
Accrued taxes	10,860	10,354
Accrued legal	1,988	1,357
Accrued warranties	5,083	6,223
Other	3,873	3,480

Total	$ 62,111	$ 71,551

NOTE 8—COMPREHENSIVE (LOSS) INCOME

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

	Three Months Ended June 30,					Six Months Ended June 30,
	2006			2005		2006			2005
				(as restated)					(as restated)
Net (loss) income	$	(10,054	)	$	8,337	$	(8,229	)	$	25,781
Foreign currency translation adjustment	113			161		109			284
Unrealized gain on debt securities	344			427		325			191
Unrealized (loss) gain on hedging contracts	(336		)	1,288		(604		)	2,436
Comprehensive (loss) income	$	(9,933	)	$	10,213	$	(8,399	)	$	28,692,

NOTE 9—RELATED PARTY TRANSACTIONS

Perlegen Sciences, Inc.

As of June 30, 2006, the Company, and certain of its affiliates, including the Company’s chief executive officer and members of the board of directors, held approximately 25% ownership interest in Perlegen Sciences, Inc. (“Perlegen”), a privately-held biotechnology company. In addition, two members of Perlegen’s board of directors are also members of the Company’s board of directors. See the Company’s most recent Proxy Statement as filed on May 1, 2006 for further information.

The Company accounts for its ownership interest in Perlegen using the equity method as the Company and its affiliates do not control the strategic, operating, investing and financing activities of Perlegen; however, the Company does have significant influence over Perlegen’s operating activities. Further, the Company has no obligations to provide funding to Perlegen nor does it guarantee or otherwise have any obligations related to the liabilities or results of operations of Perlegen or its investors. Through January 2005, the Company’s investment in Perlegen had no cost basis; accordingly, the Company has not recorded its proportionate share of Perlegen’s operating losses in its financial statements since the completion of Perlegen’s initial financing. In February 2005, the Company participated in Perlegen’s Series D preferred stock financing and recorded a $2.0 million investment related to this transaction, which was included in the Company’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 zero through the recording of its proportionate share of Perlegen’s operating losses.

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

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

On June 28, 2005, the Company executed an agreement with a customer pursuant to which the Company agreed to provide genotypic data in the context of whole genome association studies. The Company has subcontracted certain elements of this agreement to Perlegen which will use Affymetrix GeneChip® technology to provide the genotypic data. The Company may incur up to $3.6 million in expenses related to subcontract services from Perlegen through the term of the agreement, which is expected to end in 2006. As of June 30, 2006, no expenses have been incurred.

On April 7, 2006, Perlegen announced its intention to file its initial public offering.

NOTE 10—COMMITMENTS AND CONTINGENCIES

Product Warranty Commitment

The Company provides for anticipated warranty costs at the time the associated revenue is recognized. Product warranty costs are estimated based upon the Company’s historical experience and the warranty period. The Company periodically reviews the adequacy of its warranty reserve, and adjusts, if necessary, the warranty percentage and accrual based on actual experience and estimated costs to be incurred. In the first quarter of 2006, the Company adjusted its warranty reserve by approximately $0.4 million for anticipated costs associated with its decision to replace certain gene expression products. Information regarding the changes in the Company’s product warranty liability for the three and six months ended June 30, 2006, respectively, was as follows (in thousands):

Beginning balance at December 31, 2005	$	6,223
New warranties issued	849
Repairs and replacements	(1,312		)
Adjustments	391
Ending balance at March 31, 2006	6,151
New warranties issued	812
Repairs and replacements	(1,880		)
Adjustments	—
Ending balance at June 30, 2006	$	5,083

Legal Proceedings – General

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

Multilyte Litigation

As previously reported Multilyte Ltd., a British corporation, and Affymetrix have been engaged in legal proceedings in Germany and the United States to address allegations made by Multilyte that the Company infringes certain patents owned by Multilyte (the “Multilyte patents”) by making and selling our GeneChip® DNA microarray products. As reported in the Quarterly Report on Form 10-Q for the period ended March 31, 2006, Affymetrix prevailed in the United States infringement proceedings.

In the German action, on July 18, 2003, Multilyte filed proceedings in the state court of Düsseldorf, alleging infringement of the Multilyte patents. In a separate action in Germany, on October 15, 2003, the Company commenced nullity proceedings in German Federal Patent Court in Munich alleging that the German part of Multilyte’s two European patents (EPs 0 134 215 and 0 304 202) are invalid. On June 29 and 30, 2004, the German Federal Patent Court in Munich held that both Multilyte European patents are invalid in Germany. Following that ruling, on July 12, 2004, the Düsseldorf court stayed both sets of infringement proceedings before it, pending Multilyte’s appeal of the decisions of the German Federal Patent Court in Munich nullifying both Multilyte patents. The Company was notified on April 5, 2005 that Multilyte had abandoned its appeal of the Munich court’s decision nullifying the European Patent 0 134 215 and the Düsseldorf court dismissed the corresponding infringement proceedings applicable to such patent, on May 12, 2005. The Company was notified on March 16, 2006 that Multilyte had abandoned its appeal of the Munich court’s decision nullifying the European Patent 0 304 202 and the Düsseldorf court dismissed the corresponding infringement proceedings applicable to such patent, on April 25, 2006. On July 12, 2006 the German Federal Supreme Court held that the nullity proceedings against both European patents were terminated due to the fact that Multilyte had withdrawn the appeal against the Munich court’s decision to revoke these patents.

Enzo Litigation

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

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

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

Administrative Litigation and Proceedings

The Company’s intellectual property is subject to a number of significant administrative and litigation actions. For example, in Europe and Japan, we expect third parties to oppose significant patents that the Company owns or controls. Currently, third parties, including several of Affymetrix’ competitors, have filed oppositions against several of the Company’s European patents in the European Patent Office. These opposition proceedings are at various procedural stages and will result in the respective patents being either upheld in their entirety, allowed to issue in amended form in designated European countries, or revoked. Further, in the United States, the Company expects that third parties will continue to “copy” the claims of its patents in order to provoke interferences in the United States Patent & Trademark Office. These proceedings could result in the Company’s patent protection being significantly modified or reduced, and could result in significant costs and consume substantial managerial resources.

NOTE 11—INCOME TAXES

For the six months ended June 30, 2006, the tax provision principally consists of federal, state and foreign taxes partially offset by a $1.3 million reduction in an income tax reserve based on the conclusion of an audit of a foreign tax authority in the first quarter of 2006. Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”) provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Additionally, SFAS 123R prohibits the recognition of a deferred tax asset related to the excess tax benefit resulting from the exercise of employee stock options that has not been realized. Based upon the weight of available evidence, which included an analysis of projected future book and taxable income, as of June 30, 2006, the Company has provided for a valuation allowance of $76.6 million.

NOTE 12—SUBSEQUENT EVENTS

Restructuring

In its earnings announcement for the quarter ended June 30, 2006, the Company announced its intent to restructure its corporate, general and administrative expenses in the third quarter of fiscal 2006 in order to bring the Company’s general and administrative cost structure in line with its current business requirements. The restructuring actions will consist of a combination of reducing headcount in general and administrative functions and rationalizing of the Company’s facility requirements. The Company expects the benefits of the restructuring actions will be reflected in lower operating expenses and anticipate savings from these initiatives will begin to be realized in the fourth quarter of fiscal 2006. At this time, the Company cannot reasonably estimate the total restructuring charge as not all the Company’s restructuring initiatives have been finalized.

Default Under Convertible Notes

The Company violated the reporting covenant under the indentures governing the Company’s $120 million aggregate principal amount 0.75% Senior Convertible Notes due 2033 (the “Notes”) as a result of the Company’s failure to file its Form 10-Q for the quarter ended June 30, 2006 by the required deadline. As a consequence of these violations, the holders of the Notes have the right to accelerate the maturity of such Notes if they or the trustee provide the Company with notice of the default and the Company is unable to cure the default within 60 days after that notice.

NASDAQ Notice

On August 17, 2006, the Company announced that it will request a hearing before the NASDAQ Listing Qualifications Panel (the “Panel”) in response to the receipt of a NASDAQ Staff Determination letter dated August 17, 2006 indicating that the Company is not in compliance with the filing requirements for continued listing as set forth in Marketplace Rule 4310(c)(14). As anticipated, the letter was issued in accordance with NASDAQ procedures due to the delayed filing of the Company’s Form 10-Q for the quarter ended June 30, 2006. Pending a decision by the Panel, Affymetrix shares will remain listed on the NASDAQ Stock Market.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations as of June 30, 2006 and for the three and six month periods ended June 30, 2006 and 2005 should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K/A for the year ended December 31, 2005.

All statements in this quarterly report that are not historical are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act as amended, including statements regarding our “expectations,” “beliefs,” “hopes,” “intentions,” “strategies” or the like. Such statements are based on our current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, risks of our ability to achieve and sustain higher levels of revenue, higher gross margins, reduced operating expenses, market acceptance, personnel retention, global economic conditions, the fluctuations in overall capital spending in the academic and biotechnology sectors, changes in government funding policies, unpredictable fluctuations in quarterly revenues, uncertainties related to cost and pricing of Affymetrix products, dependence on collaborative partners, uncertainties relating to sole source suppliers, uncertainties relating to FDA, and other regulatory approvals, risks relating to intellectual property of others and the uncertainties of patent protection and litigation.

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

Restatement of Consolidated Financial Statements

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

We concluded that there was a material accounting error as a result of a documentation lapse in July 1999, in which the option grant for an aggregate of 1.99 million shares should have been measured for accounting purposes as of a later date. In light of the restatement required by this matter, we also included in this restatement corrections relating to certain other errors and documentation lapses in the fiscal years 1997 and 1998. Approximately 97% of the charges relating to the restatement arose from the documentation lapse in July 1999.

We determined that the cumulative, pre-tax, non-cash, stock-based compensation expense resulting from revised measurement dates for options granted between 1997 and 1999 was approximately $21.5 million. Accordingly, we recorded stock-based compensation expense 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 years preceding 2003, based on the vesting periods of the respective grants. In addition, we recorded an income tax benefit of $8.3 million in 2005. Principally as a result of cumulative losses incurred through 2004, we recorded a full valuation allowance against all deferred tax assets for the years ended December 31, 2004 and 2003 and consequently, there was no income tax effect of the additional stock-based compensation expense recorded in those years. The cumulative effect of 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 by an increase in the accumulated deficit of $13.2 million, which resulted in a net effect on stockholders’ equity of $8.3 million. The adjustments increased previously reported 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 and diluted net income per common share by $0.03 for the year ended December 31, 2003.

As part of our review, we assessed whether there were other matters that should have been corrected in our previously issued consolidated financial statements. Apart from the errors underlying the restatement described above, no other matters came to our attention that should have been adjusted in our previously issued consolidated financial statements.

Overview

We are engaged in the development, manufacture and sale of consumables, systems and services for genetic analysis in the life sciences and clinical diagnostics fields. Other emerging markets we are focused on include agricultural, environmental testing, pathogen detection and bio-defense. There are a number of factors that influence the size and development of our industry, including: the availability of genomic sequence data for human and other organisms, technological innovation that increases throughput and lowers the cost of genomic and genetic analysis, the development of new computational techniques to handle and analyze large

amounts of genomic data, the availability of government and private funding for basic and disease-related research, the amount of capital and ongoing expenditures allocated to research and development spending by biotechnology, pharmaceutical and diagnostic companies, the application of genomics to new areas including molecular diagnostics, agriculture, human identity and consumer goods, and the availability of genetic markers and signatures of diagnostic value.

We have established our GeneChip® system as the platform of choice for acquiring, analyzing and managing complex genetic information. Our integrated GeneChip® platform includes disposable DNA probe arrays (chips) consisting of gene sequences set out in an ordered, high density pattern; certain reagents for use with the probe arrays; a scanner and other instruments used to process the probe arrays; and software to analyze and manage genomic information obtained from the probe arrays. We currently sell our products directly to pharmaceutical, biotechnology, agrichemical, diagnostics and consumer products companies as well as academic research centers, government research laboratories, private foundation laboratories and clinical reference laboratories in North America, Europe and Japan. We also sell our products through life science supply specialists acting as authorized distributors in Latin America, the Middle East and Asia Pacific regions, including China. We have incurred net losses and negative cash flows from operations in the past, have achieved profitability for the three previous consecutive fiscal years, but have now incurred a net loss for the second quarter of fiscal 2006. The following overview describes key elements of our business strategy and our goals:

Continue to develop and expand sales of our GeneChip® system. We intend to continue to enhance our GeneChip® technology through substantial investments in research and development and collaborations. As we continue to enhance the functionality and work to decrease the unit costs of our GeneChip® products, we aim to encourage our customers to expand their uses for our GeneChip® system, which we believe will create new market opportunities for us.

Leverage our technologies into new markets. A key driver will be increasing the breadth of scientific and diagnostic applications of our technology, while also industrializing, automating and standardizing our technology to open new markets which will assist us in driving revenue growth. The aim of our automation efforts is to reduce the cost per experiment, minimize operator variability and improve experimental throughput. We believe that our automation solutions will enjoy commercial success in industrial applications and high-volume markets just as our bench-top systems have in the research markets. We have several active collaborations aimed at extending our existing technologies and products into diagnostic applications and we continue to look for new applications for our technology, new collaborative opportunities and new markets.

Strengthen our product line. Our goal is to grow our product and product related revenue. We can achieve this goal through growth in sales of our consumable probe arrays and reagents as well as instruments and related services as we focus on new product solutions for the genotyping market, new advances in the espression arena, and continued progress in the clinical products market. We expect a decline in instrument sales for 2006 as we finish our instrument upgrade cycle.

Maintain our operating margins. Management is focused on growing the business and increasing its operating profitability. We will continue to closely manage our manufacturing costs and operating expenses. We expect a decline in gross margins for 2006 as we continue to expand our manufacturing capacity to support our anticipated sales growth in consumables and forward price our 500K genotyping product in expectation of launching this onto one chip later this year. In addition, we will see increased operating costs and expenses related to our adoption of SFAS 123R and our integration of the ParAllele acquisition. In July 2006, we announced our intent to restructure our general and administrative cost structure, including rationalizing our facilities requirements in order to bring our operating expenses in line with our current business requirements.

Acquisition

On October 21, 2005, Affymetrix acquired 100% of the outstanding shares of ParAllele BioScience, Inc. (“ParAllele”), a provider of comprehensive genetic discovery solutions to the life science research, pharmaceutical and diagnostic sectors. ParAllele’s products and services utilize a unique approach that leverages novel biochemical processes rather than complex instrumentation to discover and analyze minute variations in the human genome. We expect the acquisition to accelerate the development and commercialization of new products and create greater opportunities for market penetration and revenue generation as well as increase our core assay development capabilities.

The results of operations of ParAllele have been included in the accompanying consolidated financial statements from the date of acquisition. See Note 4 for further information regarding this acquisition.

Critical Accounting Policies & Estimates

General

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

Certain accounting policies are particularly important to the reporting of our financial position and results of operations and require the application of significant judgment by our management. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements.

Revenue Recognition

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

Accounts Receivable

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

Inventories

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

Non-marketable Securities

As part of our strategic efforts to gain access to potential new products and technologies, we invest in equity securities of certain private biotechnology companies. Our non-marketable equity securities are carried at cost unless we determine that an impairment that is other than temporary has occurred, in which case we write the investment down to its impaired value. We periodically review our investments for impairment; however, the impairment analysis requires significant judgment in identifying events or circumstances that would likely have significant adverse effect on the fair value of the investment. The analysis may include assessment of the investee’s (i) revenue and earnings trend, (ii) business outlook for its products and technologies, (iii) liquidity position and the rate at which it is using its cash, and (iv) likelihood of obtaining subsequent rounds of financing. If an investee obtains additional funding at a valuation lower than our carrying value, we presume that the investment is other than temporarily impaired. We have experienced impairments in our portfolio due to the decline in equity markets over the past few years.

However, we are not able to determine at the present time which specific investments are likely to be impaired in the future, or the extent or timing of the individual impairments.

Deferred Taxes

Income tax expense is based on pretax financial accounting income under the liability method. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We must then assess the likelihood that the resulting deferred tax assets will be realized. To the extent we believe that realization is not more likely than not, we establish a valuation allowance. Significant estimates are required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance to be recorded against our net deferred tax asset. Some of these estimates are based on interpretations of existing tax laws or regulations. We believe that our estimates are reasonable and that our reserves for income tax related uncertainties are adequate. Various internal and external factors may have favorable or unfavorable effects on our future effective tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, changes in the valuation of our deferred tax assets or liabilities, future levels of research and development spending, and changes in overall levels and mix of pretax earnings.

Contingencies

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

Accounting for Stock-Based Compensation

Beginning January 1, 2006, we account for employee stock-based compensation in accordance with SFAS 123R. Under the provisions of SFAS 123R, we estimate the fair value of our employee stock awards at the date of grant using the Black-Scholes option-pricing model, which requires the use of certain subjective assumptions. The most significant of these assumptions are our estimates of the expected term, volatility and forfeiture rates of the awards. The expected stock price volatility assumption was determined using a combination of historical and implied volatility of our common stock. We determined that blended volatility is more reflective of market conditions and a better indicator of expected volatility than historical volatility. The estimate of these key assumptions is based on historical information and judgment regarding market factors and trends. As required under the accounting rules, we review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value employee stock-based awards granted in future periods.

SFAS 123R requires that employee stock-based compensation costs be recognized over the requisite service period, or the vesting period, in a manner similar to all other forms of compensation paid to employees. Accordingly, in the first six months of 2006, we recognized employee stock-based compensation of $0.7 million in cost of product sales, $2.1 million in research and development expense and $6.1 million in sales, general and administrative expenses, which includes approximately $1.1 million related to the modification of an executive officer’s stock option grant to increase the associated exercise period. We adopted SFAS 123R on a modified prospective basis. As of June 30, 2006, $26.6 million of total unrecognized compensation cost related to non-vested stock options not yet recognized is expected to be allocated to cost of products sales and operating expenses over a weighted-average period of 1.7 years.

There was no stock-based compensation expense related to employee stock options recognized under SFAS 123R during the six months ended June 30, 2005.

Results of Operations

The following discussion compares the historical results of operations for the three and six months ended June 30, 2006 and 2005, respectively.

Product Sales

The components of product sales are as follows (in thousands, except percentage amounts):

	Three Months Ended June 30,									Six Months Ended June 30,
	2006		2005		$ Change			% Change		2006		2005		$ Change		% Change
Probe arrays	$	40,177	$	45,941	$	(5,764	)	(13	)%	$	83,379	$	93,663	(10,284	)	(11	)%
Reagents	9,641		9,746		(105		)	(1	)	20,081		19,662		419		2
Instruments	11,225		13,526		(2,301		)	(17	)	23,555		29,439		(5,884	)	(20	)
Total product sales	$	61,043	$	69,213	$	(8,170	)	(12	)	$	127,015	$	142,764	(15,749	)	(11	)

Probe array sales for the second quarter of 2006 as compared to the same period in 2005 declined primarily due to a decrease of $8.8 million in revenue due to a decline in unit sales partially offset by an increase of $3.0 million in revenue related to an increase in the average selling price of our probe arrays due to a change in product mix. Instrument sales decreased primarily due to a decrease of $1.3 million in revenue related to a decline in unit sales of our GeneChip® Scanner 3000 and a decrease of $0.9 million due to a drop in unit sales of our GeneChip® Scanner 3000 high-resolution upgrades.

Probe array sales in the first six months of 2006 as compared to the same period in 2005 declined primarily due to a decrease of $10.4 million in revenue due to a decline in unit sales. Instrument sales decreased primarily due to a decrease of $4.9 million in revenue related to a decline in unit sales of our GeneChip® Scanner 3000.

In July 2006, we announced a decrease in the selling price of our current two-chip 500K SNP genotyping set as we believe this will enable scientists to run more samples, and thereby increase the power of their genetic association studies. We believe this decrease in the selling price could cause our future probe array revenues to decline from prior periods if unit sales do not increase.

Product Related Revenue

The components of product related revenue are as follows (in thousands, except percentage amounts):

	Three Months Ended June 30,									Six Months Ended June 30,
	2006		2005		$ Change			% Change		2006		2005		$ Change			% Change
Subscription fees	$	1,716	$	3,153	$	(1,437	)	(46	)%	$	3,709	$	6,470	$	(2,761	)	(43	)%
Service and other	9,112		4,199		4,913			117		16,824		8,429		8,395			100
License fees and milestone revenue	3,579		3,582		(3		)	—		7,117		7,352		(235		)	(3	)
Total product related revenue	$	14,407	$	10,934	$	3,473		32		$	27,650	$	22,251	$	5,399		24

Service and other revenue increased for the second quarter of 2006 and in the first six months of 2006 as compared to the same periods in 2005 primarily due to increases of approximately $4.6 million and $8.3 million, respectively, in other revenue related to our genotyping services business. These increases were partially offset by declines in subscription fees earned under our GeneChip® array access programs as we continue to transition customers to volume-based pricing on array sales.

Royalties and Other Revenue (in thousands, except percentage amounts)

	Three Months Ended June 30,								Six Months Ended June 30,
	2006		2005		$ Change		% Change		2006		2005		$ Change		% Change
Royalties and other revenue	$	2,419	$	1,993	$	426	21	%	$	4,294	$	3,553	$	741	21	%

The increases in royalties and other revenue for the second quarter of 2006 and in the first six months of 2006 as compared to the same periods in 2005 were primarily related to the recognition of $0.4 million related to a license agreement with no continuing performance obligations in the first quarter of 2006 and the recognition of $0.5 million related to a license agreement with no continuing performance obligations in the second quarter of 2006.

Revenue from Perlegen Sciences (in thousands, except percentage amounts)

	Three Months Ended June 30,								Six Months Ended June 30,
	2006		2005		$ Change		% Change		2006		2005		$ Change		% Change
Revenue from Perlegen Sciences	$	2,197	$	1,911	$	286	15	%	$	7,498	$	4,098	$	3,400	83	%

The increase in the first six months of 2006 as compared to the same period in 2005 was primarily due to increased demand by Perlegen for our probe arrays and whole wafers used for certain new applications, which generated additional revenues of $5.4 million. This increase was partially offset by a decrease in demand for wafers used by Perlegen for internal research and development. Probe arrays and wafers used by Perlegen for use in their research and development activities are sold at our fully burdened cost of manufacturing. We also earn a royalty on certain of these wafers if they are used by Perlegen for certain revenue activities. Royalties recognized were $0.9 million and $0.8 million in the first six months of 2006 and 2005, respectively.

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

							Dollar /									Dollar /
	Three Months Ended June 30,						Point change from			Six Months Ended June 30,						Point change from
	2006			2005			2005			2006			2005			2005

Total gross margin on product sales	$	41,397		$	51,261		$	(9,864	)	$	88,295		$	105,533		$	(17,238	)
Total gross margin on product related revenue	6,995			8,475			(1,480		)	13,797			17,287			(3,490		)

Total gross margin on product and product related revenue	$	48,392		$	59,736		$	(11,344	)	$	102,092		$	122,820		$	(20,728	)

Product gross margin as a percentage of product sales	67.8		%	74.1		%	(6.3		)	69.5		%	73.9		%	(4.4		)

Product related gross margin as a percentage of product related revenue	48.6		%	77.5		%	(28.9		)	49.9		%	77.7		%	(27.8		)

Of the 6.3 point decrease in product gross margin for the second quarter of 2006 as compared to the same period in 2005, approximately 5.7 points of the decrease can be attributed to start-up costs for our new Singapore manufacturing facility, additional warranty and royalty costs and the inclusion of costs related to our adoption of SFAS 123R. An additional 1.6 points of the decrease is due to increased unit costs of certain reagents. These decreases were partially offset by a 2.3 point increase in product gross margins as we sold fewer of our lower margin GeneChip® Scanner 3000 upgrades.

Of the 4.4 point decrease in product gross margin in the first six months of 2006 as compared to the same period in 2005, approximately 4.3 points of the decrease can be attributed to start-up costs for our new Singapore manufacturing facility, additional warranty and royalty costs and the inclusion of costs related to our adoption of SFAS 123R. An additional 0.8 points of the decrease is due to increased unit costs of certain reagents. These decreases were partially offset by a 1.8 point increase in product gross margins as we sold fewer of our lower margin GeneChip® Scanner 3000 upgrades.

In July 2006, we announced a decrease in the selling price of our current two-chip 500K SNP genotyping set as we believe this will enable scientists to run more samples, and thereby increase the power of their genetic association studies. We believe this decrease in the selling price may unfavorably impact our product gross margin in the second half of fiscal 2006.

The 28.9 point and 27.8 point decrease in product related gross margin for the second quarter of 2006 and in the first six months of 2006 as compared to the same periods in 2005 were primarily due to an increase in expenses related to our genotyping services business as well as the continuing decline in sales of our access agreements as we continue to transition customers to volume-based discounting on product sales.

Cost of Perlegen Revenues (in thousands, except percentage amounts)

	Three Months Ended June 30,									Six Months Ended June 30,
	2006		2005		$ Change			% Change		2006		2005		$ Change			$ Change
Cost of revenue from Perlegen Sciences	$	1,074	$	1,7500	$	(676	)	(39	)%	$	2,658	$	2,992	$	(334	)	(11	)%

Cost of Perlegen revenue decreased for the second quarter of 2006 and in the first six months of 2006 as compared to the same periods in 2005 primarily due to decreased demand by Perlegen for wafers used for internal research and development which are sold at our fully burdened cost of manufacturing.

Research and Development Expenses (in thousands, except percentage amounts)

	Three Months Ended June 30,								Six Months Ended June 30,
	2006		2005		$ Change		% Change		2006		2005		$ Change		% Change
Research and development	$	21,597	$	20,799	$	798	4	%	$	45,098	$	37,889	$	7,209	19	%

The increase in the second quarter of 2006 as compared to same period in 2005 was primarily due to an increase in headcount costs of $1.6 million primarily due to our acquisition of ParAllele and an increase of $1.0 million of stock-based compensation expense related to our adoption of SFAS 123R. These increases were partially offset by a decrease in our spending on supplies and co-development expenses of $1.8 million as we completed multiple product launches in the prior year.

The increase in the first six months of 2006 as compared to same period in 2005 was primarily due to an increase in headcount related costs of $4.0 million primarily due to our acquisition of ParAllele as well as an increase in new hires and an increase of $2.1 million of stock-based compensation expense related to our adoption of SFAS 123R. We also increased spending on supplies of $1.7 million as the company completed multiple product launches in the first quarter of 2006. We believe a substantial investment in research and development is essential to a long-term sustainable competitive advantage and critical to expansion into additional markets and expect our expenses to increase in absolute dollars as we integrate our ParAllele acquisition, develop new products and incorporate our stock-based compensation charges related to our adoption of SFAS 123R.

Selling, General and Administrative Expenses (in thousands, except percentage amounts)

	Three Months Ended June 30,								Six Months Ended June 30,
	2006		2005		$ Change		% Change		2006		2005		$ Change		% Change
Selling, general and administrative	$	39,476	$	32,540	$	6,936	21	%	$	78,242	$	62,137	$	16,105	26	%

The increases in the second quarter of 2006 and in the first six months of 2006 as compared to the same periods in 2005 were primarily due to $3.7 million and $6.1 million, respectively, of stock-based compensation expense related to our adoption of SFAS 123R. Our stock-based compensation expense included a $1.1 million charge in the second quarter of 2006 due to the modification of an executive officer’s stock option grant to include an extension of time to exercise as well as the vesting of certain stock options without a requisite service period. In addition, we saw an increase related to higher headcount-related costs of $2.2 million and $7.1 million, respectively, from hiring new employees. Our increased headcount expenses were primarily due to our continued international expansion, investments in new strategic initiatives, and in anticipation of our new product introductions. We also increased legal expenses by $1.5 million and $1.7 million in the second quarter of 2006 and the first six months of 2006 as we continue to defend our patent rights.

In our earnings release for the quarter ended June 30, 2006, we announced our intent to initiate restructuring actions in the the third quarter of fiscal 2006 in order to bring our general and administrative cost structure in line with our current business requirements. The restructuring actions will consist of a combination of headcount reductions and rationalizing of its facility requirements. We expect the benefits of the restructuring actions will be reflected in lower operating expenses and anticipate savings from these initiatives will begin to be realized in the fourth quarter of fiscal 2006. At this time, we cannot reasonably estimate the total restructuring charge as not all actions have been finalized.

Stock-Based Compensation (in thousands, except percentage amounts)

	Three Months Ended June 30,									Six Months Ended June 30,
	2006		2005		$ Change			% Change		2006		2005		$ Change			% Change
Stock-based compensation	$	—	$	33	$	(33	)	(100	)%	$	—	$	116	$	(116	)	(100	)%

With our adoption of SFAS 123R on January 1, 2006 all stock-based compensation expense has been included for the second quarter of 2006 and the first six months of 2006 in cost of product sales, research and development expenses and selling, general and administrative expenses. Under SFAS 123R, stock-based compensation cost is calculated on the date of grant using the Black-Scholes method. The compensation cost is then amortized straight-line over the vesting period. For the first six months of 2005, we recorded stock-based compensation expense related to restricted stock awards granted to certain employees and one fully vested restricted stock award granted to a non-employee that were calculated using prior accounting standards.

Interest Income and Other, Net (in thousands, except percentage amounts)

The components of interest income and other, net, are as follows:

	Three Months Ended June 30,										Six Months Ended June 30,
	2006			2005			$ Change		% Change		2006			2005			$ Change			% Change
Interest income	$	2,988		$	1,842		$	1,146	62	%	$	5,835		$	3,231		$	2,604		81	%
Realized loss in Perlegen	—			(1,062		)	1,062		100		—			(2,000		)	2,000			100
Write down of equity investment	(62		)	(62		)	—		—		(108		)	(62		)	(46		)	(74	)
Currency gains, net	776			432			344		80		2,342			296			2,046			691
Other	18			(197		)	215		109		(62		)	202			(264		)	(131	)
Interest income and other, net	$	3,720		$	953		$	2,767	290		$	8,007		$	1,667		$	6,340		380

Interest income increased for the second quarter of 2006 and in the first six months of 2006 as compared to the same periods in 2005 due to an increase in the returns on our cash and marketable securities balances. In the first quarter of 2006, we also realized a $1.6 million currency gain on assets held in various foreign currencies. In the first and second quarters of 2005, we realized losses related to the recognition of our proportionate share of Perlegen’s net loss. The carrying value of our investment in Perlegen was written down to zero at December 31, 2005; therefore, to the extent we do not make any additional future investments in Perlegen, we do not expect further expenses related to this investment.

Income Tax Benefit Provision (in thousands, except percentage amounts)

	Three Months Ended June 30,								Six Months Ended June 30,
	2006		2005		$ Change		% Change		2006		2005		$ Change		% Change
			(as restated)								(as restated)
Income tax provision	$	4,235	$	845	$	3,390	401	%	$	3,298	$	2,507	$	791	32	%

The provision for income tax increased approximately 401% or $3.4 million in the second quarter and increased approximately 32% or $0.8 million in the first six months of 2006 as compared to the same periods in 2005. For both periods, the provision principally consists of federal, state and foreign taxes. The increase in the second quarter and first six months of 2006 is primarily due to lower than expected profitability in foreign jurisdictions with rates lower than the statutory U.S. tax rate.

Liquidity and Capital Resources

Cashflow (in thousands)

	Six Months Ended June 30,
	2006			2005
Net cash provided by operating activities	$	26,409		$	42,367
Net cash used in investing activities	(56,101		)	(96,954		)
Net cash provided by financing activities	5,378			38,675
Effect of foreign currency translation on cash and cash equivalents	109			284

Net increase in cash and cash equivalents	$	(24,205	)	$	(15,628	)

Net Cash Provided by Operating Activities

Cash provided by operating activities is net (loss) income adjusted for certain non-cash items and changes in assets and liabilities. Cash provided by operating activities was comprised of a net loss of $8.2 million, non-cash depreciation and amortization of $11.0 million, and non-cash stock-based compensation expense of $8.9 million. Significant changes in assets and liabilities are as follows:

Our total accounts receivable, including Perlegen, was $67.7 million at June 30, 2006, a decrease of $29.4 million from December 31, 2005. The decrease is primarily due to lower product sales of probe arrays and instruments.

Our inventory balance was $45.1 million at June 30, 2006, an increase of $9.1 million from December 31, 2005. The increase is primarily due to the buildup of consumables as we prepare to transition some of our manufacturing capacity to our Singapore facility.

Net Cash Used in Investing Activities

Our investing activities, other than purchases, sales and maturities of available-for-sale securities, primarily consist of capital expenditures and strategic investments. Cash used for capital expenditures was $47.6 million and $12.6 million in the first six months of 2006 and 2005, respectively. Our capital expenditures in the first six months of 2006 primarily related to our manufacturing expansion in West Sacramento and capital costs related to our new manufacturing facility in Singapore. In the first quarter of 2005, we made a $2.0 million purchase of non-marketable equity investment in Perlegen Sciences.

Net Cash Provided by Financing Activities

Our financing activities consist of activity under our employee stock plans. Cash provided by the issuance of stock under our employee stock plan was $5.4 million and $38.7 million in the first six months of 2006 and 2005, respectively.

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

There have been no other significant changes in our off-balance sheet arrangements and aggregate contractual obligations as compared to the disclosures in Item 7 of our Annual Report on Form 10-K/A for the year ended December 31, 2005 other than the increase of approximately $22.0 million in our purchases commitments, which primarily relates to future capital expdentitures relating to the expansion of our manufacturing facilities Our total purchases commitments were $32.0 million as of June 30, 2006 as compared to $10.0 million as of December 31, 2005.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no other significant changes in our market risk compared to the disclosures in Item 7A of our Annual Report on Form 10-K/A for the year ended December 31, 2005.

ITEM 4. CONTROLS AND PROCEDURES

(a) Disclosure controls and procedures.

Our principal executive officer and our principal financial officer, based on their evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that our disclosure controls and procedures are effective for ensuring that information required to be

disclosed by us in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b) Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Information pertaining to legal proceedings can be found in “Item 1. Condensed Consolidated Financial Statements – Note 10. Commitments and Contingencies” to the interim condensed consolidated financial statements, and is incorporated by reference herein.

ITEM 1A. RISK FACTORS

In evaluating our business, you should carefully consider the following risks, as well as the other information contained in this quarterly report on Form 10-Q. If any of the following risks actually occurs, our business could be harmed.

The matters relating to our internal review of our historical stock option granting practices and the restatement of our consolidated financial statements may have a material adverse effect on us.

We have conducted an internal review, performed under the direction of our Audit Committee of the Board of Directors, of our historical stock option granting practices from January 1, 1997 through May 31, 2006. As a result of this review, we have restated our consolidated financial statements for the years ended December 31, 2005, 2004 and 2003 to record additional non-cash stock-based compensation expense and the related tax impact resulting from stock options granted during fiscal years 1997 to 1999. We may in the future be subject to litigation or other proceedings or actions arising in relation to our historical stock option granting practices and the restatement of our prior period financial statements. Litigation and any potential regulatory proceeding or action may be time consuming, expensive and distracting from the conduct of our business. The adverse resolution of any specific lawsuit or any potential regulatory proceeding or action could have a material adverse effect on our business, financial condition and results of operations.

Also, as a result of our delayed filing of this Form 10-Q for the quarter ended June 30, 2006, we will be ineligible to register our securities on Form S-3 for sale by us or resale by others until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for one year. We may use Form S-1 to raise capital or complete acquisitions, which could increase transaction costs and adversely affect our ability to raise capital or complete acquisitions of other companies during this period.

We may not maintain profitability.

We incurred losses each year from our inception through the year ended December 31, 2003, and as a result we had an accumulated deficit of approximately $115.0 million at June 30, 2006. We expect to continue experiencing fluctuations in our operating results and cannot assure sustained profitability. Our losses have resulted principally from costs incurred in research and development, manufacturing and from selling, general and administrative costs associated with our operations.

Our ability to generate significant revenues and maintain profitability is dependent in large part on our ability to expand our customer base, increase sales of our current products to existing customers, manage our expense growth, and enter into additional supply, license and collaborative arrangements as well as on our ability and that of our collaborative partners to successfully manufacture and commercialize products incorporating our technologies in new applications and in new markets. If our revenues grow more slowly than we anticipate, or if our operating expenses increase more than we expect or cannot be reduced in the event of lower revenues, our business will be materially and adversely affected.

Our quarterly results have historically fluctuated significantly and may continue to fluctuate unpredictably and any failure to meet financial expectations may disappoint securities analysts or investors and result in a decline in our stock price.

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

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

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

· the frequency of experiments conducted by our customers;

· our customers’ inventory of GeneChip® products;

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

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

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

· weakness in the global economy and changing market conditions;

· general economic conditions affecting our target customers;

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

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

· changes in the competitive landscape.

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

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

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

Although we are taking steps to increase our manufacturing capacity, including the expansion of our existing West Sacramento, California probe array manufacturing facility and the development of a new probe array manufacturing facility in Singapore, there are uncertainties inherent in the expansion of our manufacturing capabilities and there can be no assurance as to when any additional capacity may be available to us. For example, manufacturing and product quality issues may arise as we begin our manufacturing operations at the new Singapore facility or as we increase production rates at our West Sacramento facility and launch new products. In addition, we base our manufacturing capabilities on our forecasted product mix for the quarter. If the actual product mix varies significantly from our forecast, we may not be able to fill some orders during that quarter, which could adversely impact our financial results. Difficulties in meeting customer, collaborator and internal demand could also cause us to lose customers or require us to delay new product introductions, which could in turn result in reduced demand for our products.

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

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

The genetic sequence information upon which we rely to develop and manufacture our products is contained in a variety of public databases throughout the world. These databases are rapidly expanding and evolving. In addition, the accuracy of such databases and resulting genetic research is dependent on various scientific interpretations and it is not expected that global genetic research efforts will result in standardized genetic sequence databases for particular genomes in the near future.

Although we have implemented ongoing internal quality control efforts to help ensure the quality and accuracy of our products, the fundamental nature of our products requires us to rely on genetic sequence databases and scientific interpretations which are continuously evolving. As a result, these variables may cause us to develop and manufacture products that incorporate sequence errors or ambiguities. The magnitude and importance of these errors depends on multiple and complex factors that would be considered in determining the appropriate actions required to remedy any inaccuracies. Our inability to timely deliver acceptable products as a result of these factors would likely adversely affect our relationship with customers, and could have a material adverse effect on our business, financial condition and results of operations.

We face risks associated with technological obsolescence and emergence of standardized systems for genetic analysis.

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

Our success depends on the continuous development of new products and our ability to manage the transition from our older products to new products.

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

Our failure to successfully manage the transition between our older products and our new products may adversely affect our financial results. As we introduce new or enhanced products, we must successfully manage the transition from older products to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories and provide sufficient supplies of new products to meet customer demands. When we introduce new or enhanced products, we face numerous risks relating to product transitions, including the inability to accurately forecast demand and difficulties in managing different sales and support requirements due to the type or complexity of the new products. For instance, many of our existing customers are currently scaling up production on the Mapping 500K Array Set and some of these customers are experiencing challenges in the scale up which may affect the timing of future 500K Set product reorders.

We expect to face increasing competition.

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

The market for molecular diagnostics products is currently limited and highly competitive, with several large companies already having significant market share. Companies such as Abbott Laboratories, Bayer AG, Beckman Coulter, Becton Dickinson, bioMérieux, Celera Diagnostics, Johnson & Johnson and Roche Diagnostics have made strategic commitments to diagnostics, have financial and other resources to invest in new technologies, and have substantial intellectual property portfolios, substantial experience in new product development, regulatory expertise, manufacturing capabilities and the distribution channels to deliver products to customers. Established diagnostic companies also have an installed base of instruments in several markets, including clinical and reference laboratories, which are not compatible with the GeneChip® system and could deter acceptance of our products. In addition,

these companies have formed alliances with genomics companies which provide them access to genetic information that may be incorporated into their diagnostic tests.

Recent accounting pronouncements may impact our future financial position and results of operations.

There have been new accounting pronouncements or regulatory rulings that will have an impact on our future financial position and results of operations. For instance, on December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends FASB Statement No. 95, “Statement of Cash Flows”. Generally, the approach in SFAS 123R is similar to the approach described in Statement 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. We adopted SFAS 123R effective January 1, 2006 under the modified-prospective transition method. The adoption of SFAS 123R’s fair value method will have a significant impact on our result of operations, although it will have no impact on our overall financial position.

Our effective tax rate may vary significantly.

Our future effective tax rates could be adversely affected by various internal and external factors. These factors include, but are not limited to, earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates; changes in the valuation of our deferred tax assets and liabilities; establishing or changing our valuation allowance; or changes in tax laws or interpretations thereof; changes in tax rates, future levels of research and development spending, and changes in overall levels of pretax earnings. Any new interpretative accounting guidance related to accounting for uncertain tax positions could adversely affect our tax provision.

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

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

· changes in economic conditions;

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

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

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

· other factors affecting research and development spending.

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

The clinical applications of GeneChip® technologies for diagnosing and informing the treatment of disease is an emerging market opportunity in molecular diagnostics that seeks to improve the effectiveness of health care by collecting information about DNA variation and RNA expression in patients at various times from diagnosis through prognosis and on to the end of therapy. However, there can be no assurances that molecular diagnostic markets will develop as quickly as we expect or reach what we believe is their full potential. Although we believe that there will be clinical applications of our GeneChip® technologies that will be utilized for diagnosing and informing the treatment of disease, there can be no certainty of the technical or commercial success our technologies will achieve in such markets.

The molecular diagnostics market is relatively new for us and presents us with new risks and uncertainties. Our success in this area depends to a large extent on our collaborative relationships and the ability of our collaborative partners to

successfully market and sell products using our GeneChip® technologies. As a result, we are also dependent on the ability of our collaborative partners to achieve regulatory approval for such products in the United States and in overseas markets. Although Roche received FDA approval of the first diagnostic genotyping test for use with our GeneChip® System 3000Dx in late 2004, there can be no assurance that other products using our GeneChip® technologies will achieve needed approvals.

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

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

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

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

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

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

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

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

We depend on our vendors to provide components of our products in required volumes, at appropriate quality and reliability levels, and in compliance with regulatory requirements. Key parts of the GeneChip® product line are currently available only from a single source or limited sources. In addition, components of our manufacturing equipment and certain raw materials used in the synthesis of probe arrays are available from limited sources. If supplies from these vendors were delayed or interrupted for any reason, we would not be able to get manufacturing equipment, produce probe arrays, or sell scanners or other components for our GeneChip® products in a timely fashion or in sufficient quantities or under acceptable terms. Furthermore, our business is dependent on our ability to forecast the needs for components and products in the GeneChip® product line and our suppliers’ ability to deliver such components and products in time to meet critical manufacturing and product release schedules. Our business could be adversely affected, for example, if suppliers fail to meet product release schedules, if we experience supply constraints, if we fail to negotiate favorable pricing or if we experience any other interruption or delay in the supply chain which interferes with our ability to manufacture our products or manage our inventory levels.

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

Maintaining a strong patent position is critical to our business. Litigation on these matters has been prevalent in our industry and we expect that this will continue. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and the extent of future protection is highly uncertain, so there can be no assurance that the patent rights that we have or may obtain will be valuable. Others have filed, and in the future are likely to file, patent applications that are similar or identical to ours or those of our licensors. To determine the priority of inventions, we will have to participate in interference proceedings declared by the United States Patent and Trademark Office that could result in substantial costs in legal fees and could substantially affect the scope of our patent protection. We cannot assure investors that any such patent applications will not have priority over our patent applications. Also, our intellectual property may be subject to significant administrative and litigation proceedings such as opposition proceedings against our patents in Europe, Japan and other jurisdictions. In addition, we have incurred and may in future periods incur substantial costs in litigation to defend against patent suits brought by third parties or initiated by us. For example, we currently are engaged in litigation regarding intellectual property rights with Multilyte Ltd. and Enzo Life Sciences, Inc. For additional information concerning intellectual property litigation and administrative proceedings, see Part II, Item 1, Legal Proceedings, of this Form 10-Q.

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

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

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

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

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

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

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

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

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

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

· our collaborations may be unsuccessful; or

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

The size and structure of our current sales, marketing and technical support organizations may limit our ability to sell our products.

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

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

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

We may be exposed to liability due to product defects.

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

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

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

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

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

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

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

Our strategic equity investments may result in losses.

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

Future acquisitions may disrupt our business and distract our management.

We have previously engaged in acquisitions and may do so in the future in order to exploit technology or market opportunities. If we acquire another company, we may not be able to successfully integrate the acquired business into our existing business in a timely and non-disruptive manner, or at all. Furthermore, an acquisition may not produce the revenues, earnings or business synergies that we anticipate. If we fail to integrate the acquired business effectively or if key employees of that business leave, the anticipated benefits of the acquisition would be jeopardized. The time, capital management and other resources spent on an acquisition that fails to meet our expectations could cause our business and financial condition to be materially and adversely affected. For example, on October 21, 2005, we completed the acquisition of ParAllele BioScience, Inc. We may not realize the anticipated benefits of the acquisition because of integration and other challenges which include, among others, unanticipated incompatibility of corporate and administrative infrastructures, the ability to retain key employees, including key scientists, the diversion of management’s attention from ongoing business concerns, and the potential adverse reaction of customers to the merger or resulting changes to the combined company’s product and services offerings. In addition, acquisitions can involve substantial charges and amortization of significant amounts of deferred stock compensation that could adversely affect our results of operations.

The market price of our common stock has been volatile.

The market price of our common stock is volatile. To demonstrate this volatility, during the twelve-month period ending on June 30, 2006, the volume of our common stock traded on any given day ranged from 215,200 to 12,591,300 shares. Moreover, during that period, our common stock traded as low as $25.60 per share and as high as $59.73 per share.

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

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

(a) Date of Meeting

The Annual Meeting of the Stockholders of Affymetrix, Inc. was held on June 15, 2006.

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

		For	Against	Withheld
1.	To elect directors to serve until the next meeting of stockholders or until their successors are elected.
	Stephen P.A. Fodor, Ph.D.	56,753,799	—	1,635,240
	Paul Berg, Ph.D.	57,884,888	—	504,151
	Susan D. Desmond-Hellmann, M.D.	34,962,010	—	23,427,029
	John D. Diekman, Ph.D.	41,663,703	—	16,725,336
	Vernon R. Loucks, Jr.	57,871,169	—	517,870
	David B. Singer	43,065,492	—	15,323,547
	Robert H. Trice, Ph.D.	58,084,375	—	304,664
	John A. Young	56,912,127	—	1,476,912

				For		Against		Abstain
2.		To ratify the appointment of Ernst & Young LLP as independent registered public accounting firm as auditors of the Company for the fiscal year ending December 31, 2006.		57,944,571		423,900		20,566

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibit Number		Description of Document
3.1(1)		Restated Certification of Incorporation.
3.2(2)		Bylaws.
3.3(3)		Amendment No. 1 to the Bylaws dated as of April 25, 2001.
4.1(4)		Rights Agreement, dated October 15, 1998, between Affymetrix, Inc. and American Stock Transfer & Trust Company, as Rights Agent.
4.2(5)		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(6)		Indenture, dated as of December 15, 2003, between Affymetrix, Inc. and The Bank of New York, as Trustee.
4.4(6)		Affymetrix, Inc. 0.75% Senior Convertible Notes due 2033 Registration Rights Agreement dated December 15, 2003.
10.1(7)		Agreement between Affymetrix, Inc. and Susan E. Siegel dated May 30, 2006.
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002

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

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

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

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

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

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

(7) Incorporated by reference to Registrant’s Form 8-K as filed on June 5, 2006 (File No. 000-28218).

SIGNATURES

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

	By:	/s/ GREGORY T. SCHIFFMAN
	Name:	Gregory T. Schiffman
	Title:	Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

August 30, 2006

AFFYMETRIX, INC.

EXHIBIT INDEX

JUNE 30, 2006

Exhibit Number		Description of Document
3.1(1)		Restated Certification of Incorporation.
3.2(2)		Bylaws.
3.3(3)		Amendment No. 1 to the Bylaws dated as of April 25, 2001.
4.1(4)		Rights Agreement, dated October 15, 1998, between Affymetrix, Inc. and American Stock Transfer & Trust Company, as Rights Agent.
4.2(5)		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(6)		Indenture, dated as of December 15, 2003, between Affymetrix, Inc. and The Bank of New York, as Trustee.
4.4(6)		Affymetrix, Inc. 0.75% Senior Convertible Notes due 2033 Registration Rights Agreement dated December 15, 2003.
10.1(7)		Agreement between Affymetrix, Inc. and Susan E. Siegel dated May 30, 2006.
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002

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

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

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

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

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

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

(7) Incorporated by reference to Registrant’s Form 8-K as filed on June 5, 2006 (File No. 000-28218).

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Avg

Affymetrix (AFFX) Inactive 10-Q2006 Q2 Quarterly report

Content analysis

Restricted Stock

Total fair value of shares vested is $0.3 million and $0.1 million for the six months ended June 30, 2006 and 2005, respectively.