UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

COMMISSION FILE NO. 0-28218

AFFYMETRIX, INC.

(Exact name of Registrant as specified in its charter)

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

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

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

COMMON SHARES OUTSTANDING ON OCTOBER 31, 2005:66,368,946

AFFYMETRIX, INC.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

See accompanying notes.

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AFFYMETRIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

(1) Stock-based compensation related to the following:

See accompanying notes.

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AFFYMETRIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

See accompanying notes.

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AFFYMETRIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

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 condensed consolidated 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.

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

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

Royalties and Other Revenue

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

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

Research 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.

Stock-Based Compensation

At September 30, 2005, the Company has six stock-based employee and non-employee director compensation plans, which are more fully described in the Company’s 2004 Annual Report on Form 10-K. The Company has elected to continue to follow the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations for these plans.

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In the second quarter of fiscal 2005, the Company granted restricted common stock awards, pursuant to the Company’s stock option plan, to certain employees.  Upon issuance of the restricted stock awards, unearned compensation equivalent to the market value on the date of grant of approximately $2.1 million was recorded as deferred compensation in stockholders’ equity and is being amortized to expense over the appropriate vesting periods of the awards.  The Company recognized approximately $0.1 million and $0.2 million of stock-based compensation expense during the three months and nine months ended September 30, 2005, respectively, related to these restricted stock awards.

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, as amended by SFAS 148, to stock-based employee compensation (in thousands, except per share amounts):

Net Income Per Share

Basic net 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 net 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 income per share (in thousands, except per share amounts):

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In September 2004, the Emerging Issues Task Force reached a consensus on Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share”, (“EITF 04-8”) which addresses when the dilutive effect of contingently convertible debt instruments should be included in diluted earnings per share. EITF 04-8 requires that contingently convertible debt instruments be included, if dilutive, in the computation of diluted earnings per share regardless of whether the market price trigger has been met. EITF 04-8 also requires that prior period diluted earnings per share amounts presented for comparative purposes be restated. EITF 04-8 is effective for reporting periods ending after December 15, 2004. The adoption of EITF 04-8 resulted in a decrease of $0.01 and no impact on the diluted earnings per share for the three months and nine months ended September 30, 2004, respectively.

For the three and nine months ended September 30, 2005 and September 30, 2004, diluted earnings per share include certain common share equivalents from outstanding stock options (using the treasury stock method), common stock subject to repurchase, outstanding warrants to purchase common stock and convertible notes (using the as-if-converted method).

The securities excluded from the computation of diluted net earnings per share, on an actual outstanding basis, were as follows (in thousands):

Recent Accounting Pronouncement

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment”, which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. Statement 123(R) 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 Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) 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.The Company expects to adopt Statement 123(R) effective January 1, 2006 under the modified-prospective method.

As permitted by Statement 123, the Company currently accounts for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method will have a significant impact on the Company’s result of operations, although it will have no impact on the Company’s overall financial position. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future and the assumptions used in valuing share-based awards. However, had the Company adopted Statement 123(R) in prior periods, the Company believes the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share above. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current accounting standards. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

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NOTE 2—PRODUCT SALES AND PRODUCT RELATED REVENUE

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

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

NOTE 3—INVENTORIES

Inventories consist of the following (in thousands):

NOTE 4—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

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

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NOTE 5—COMPREHENSIVE INCOME

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

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 $20.3 million and $14.6 million at September 30, 2005 and December 31, 2004, respectively.

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

NOTE 7—RELATED PARTY TRANSACTIONS

Perlegen Sciences, Inc.

As of September 30, 2005, the Company, and certain of its affiliates, including the Company’s chief executive officer and members of the board of directors, held approximately 30% 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.

The Company formed Perlegen in October 2000 as a wholly-owned subsidiary and spun it off in March 2001 in a $100 million private equity financing.  The Company acquired its initial ownership interest in Perlegen in an arrangement which provides Perlegen rights to use certain of the Company’s intellectual property in its development efforts, and also provides the Company rights to use and commercialize certain data generated by Perlegen in the array field.

The Company accounts for its ownership interest in Perlegen using the equity method as the Company and its affiliates do not control the strategic, operating, investing and financing activities of Perlegen. Further, the Company has no obligations to provide funding to Perlegen nor does it guarantee or otherwise have any obligations related to the liabilities or results of operations of Perlegen or its investors. 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 September 30, 2005 the Company had reduced its investment to zero through the recording of its proportionate share of Perlegen’s operating losses it incurred since February 2005, which is included as a component of interest and other income, net, in the Company’s condensed consolidated statement of operations for the nine months ended September 30, 2005.

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In January 2004, the Company sold 400,000 shares of Perlegen common stock for a gain of $0.6 million, which was included as a component of interest and other income, net, during the first quarter of 2004.

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

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 September 30, 2005, no expenses have been incurred.

NOTE 8—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 third quarter of 2005, the Company adjusted its warranty reserve by approximately $2.0 million for anticipated costs associated with its decision to replace 500K Mapping Arrays purchased by certain of its early access customers.  Information regarding the changes in the Company’s product warranty liability for the three and nine months ended September 30, 2005, respectively, was as follows (in thousands):

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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

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

Germany

In the actions pending in Germany, 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 has abandoned its appeal of the decision nullifying the European Patent 0 134 215.

United States

In the U.S. action, on August 13, 2003, the Company commenced proceedings in the United States District Court for the Northern District of California seeking a declaratory judgment that eight Multilyte patents are not infringed and are invalid. Multilyte has agreed that the Company does not infringe five of the eight named patents. On October 24, 2003, the Company filed an amended complaint seeking a declaratory judgment as to three of the original eight named patents—U.S. Patents 5,432,099, 5,599,720 and 5,807,755. Multilyte answered the Company’s complaint for declaratory judgment and asserted counterclaims against the Company alleging infringement of the three patents named by the Company in its complaint. Multilyte has submitted the three patents-in-suit to the United States Patent and Trademark Office for voluntary re-examination. These patents remain in re-examination in the USPTO. On April 28, 2005, the Court granted the Company’s motions for summary judgment of non-infringement and entered a final judgment in the action in favor of the Company against Multilyte. On May 5, 2005, Multilyte filed a notice of motion to amend the judgment asserting that the Court’s entry of final judgment was premature because it did not give Multilyte the opportunity to present evidence showing infringement under the Court’s most recent claim construction. On June 23, 2005, the Court again granted summary judgment of non-infringement. The Court then entered judgment in favor of the Company.  Multilyte has appealed the Court’s decision to the United States Court of Appeals for the Federal Circuit.

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

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Enzo Litigation

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

On November 10, 2003, the Company filed a complaint against Enzo in the United States District Court for the Southern District of New York for declaratory judgment, breach of contract and injunctive relief relating to the 1998 agreement. In its complaint, the Company alleges that Enzo has engaged in a pattern of wrongful conduct against it and other Enzo labeling reagent customers by, among other things, asserting improperly broad rights in its patent portfolio, improperly using the 1998 agreement and distributorship agreements with others in order to corner the market for non-radioactive labeling reagents, and improperly using the 1998 agreement to claim ownership rights to the Company’s proprietary technology. The Company seeks declarations that it has not breached the 1998 agreement, that it is entitled to sell its remaining inventory of Enzo reagent labeling kits, and that nine Enzo patents that are identified in the 1998 agreement are invalid and/or not infringed by it. The Company also seeks damages and injunctive relief to redress Enzo’s alleged breaches of the 1998 agreement, its alleged tortious interference with the Company’s business relationships and prospective economic advantage, and Enzo’s alleged unfair competition. The Company filed a notice of related case stating that its complaint against Enzo is related to the complaints already pending in the Southern District of New York against eight other former Enzo distributors. The Southern District of New York has related the Company’s case.  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 expected to be subject to significant additional administrative and litigation actions. For example, in Europe and Japan, third parties are expected to oppose significant patents that the Company owns or controls. Currently, Multilyte Ltd. and ProtoGene Laboratories, Inc. have filed oppositions against the Company’s EP 0 619 321 patent in the European Patent Office.  PamGene B.V. has filed an opposition against the Company’s EP 0 728 520 patent and it was revoked at oral proceedings in January 14, 2004.  Affymetrix has appealed this ruling.  Also, Abbott Laboratories, Applera, Clondiag and CombiMatrix are parties in opposition against the Company’s EP 0 834 575.  An oral hearing was conducted by the Opposition Division which upheld the patent on December 4, 2004, and this decision has been appealed.  Abbott Laboratories, CombiMatrix, PamGene B.V., Applera and Dr. Peter Schneider filed an opposition against the Company’s EP 0 834 576 patent.  The Opposition Division revoked the patent during an oral hearing on February 23, 2005 and Affymetrix has appealed this ruling.  CombiMatrix has filed an opposition against EP 0 695 941, Agilent, CombiMatrix, Clondiag and Applera have filed an opposition against EP 0 853 679, Applera has opposed EP 0 972 564 and Degussa AG has filed an opposition against EP 1 086 742. These procedures will result in the patents being either upheld in their entireties, allowed to issue in amended form in designated European countries, or revoked.

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

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

NOTE 9—EQUITY

During the nine months ended September 30, 2005, the Company issued approximately 2.4 million shares of common stock in connection with exercises of employee stock options, warrants and restricted stock awards.

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NOTE 10—INCOME TAXES

The tax provision principally consists of taxes currently payable on the taxable profits generated by the Company’s foreign operations, and federal and state taxes offset by the utilization of net operating losses.  The increase of 151% or $0.9 million in the third quarter and 160% or $3.6 million in the first nine months of 2005 as compared to the same periods in 2004, is primarily due to an increase in pretax income of approximately $15.7 million in the nine month period ended September 30, 2005 verses the nine month period ended September 30, 2004.  Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”) provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes the Company’s historical operating performance and previously reported net losses, at September 30, 2005, the Company continues to maintain a full valuation allowance against its remaining net deferred tax assets as they are not yet considered realizable.

NOTE 11—ACQUISITION

On May 31, 2005, Affymetrix entered into a definitive agreement to acquire 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.  The acquisition was approved by ParAllele stockholders on October 20, 2005 and was completed on October 21, 2005.  Affymetrix expects 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 Affymetrix’ core assay development capabilities.

In connection with the completion of the acquisition, the stockholders of ParAllele will be receiving approximately $120.8 million in merger consideration in the form of approximately 2.29 million shares of Affymetrix common stock and $11.7 million in cash in exchange for all of their outstanding shares and the assumption of all of ParAllele’s stock options.

The preliminary estimated total purchase price of the ParAllele merger is as follows (in thousands):

The estimated fair value of $100.2 million was derived using the average market price of Affymetrix’ common stock of $43.84, which was based on the closing price for a range of trading days (October 18, 2005 through October 24, 2005) around the measurement date.

Affymetrix intends to account 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 will record as its cost the assets of ParAllele less the liabilities assumed, with the excess of such cost over the estimated fair value of such net assets reflected as goodwill. Additionally, certain costs directly related to the merger will be reflected as additional purchase price in excess of net assets acquired. The Company’s statement of operations will include the operations of ParAllele beginning on October 21, 2005.

A preliminary valuation of the purchased assets was undertaken by a third party valuation specialist to assist Affymetrix in determining the estimated fair value of identifiable intangible assets, including acquired in-process research and development projects. The preliminary analysis resulted in $15.0 million of the purchase price being allocated to acquired in-process research and development which will be charged to expense in the fourth quarter of 2005.

On September 1, 2005, in connection with the transactions contemplated by the merger agreement, Affymetrix and ParAllele entered into a loan agreement under which Affymetrix agreed to extend a loan to ParAllele for the ongoing operation of its business. Pursuant to terms of the loan agreement, on September 1, 2005, ParAllele borrowed the full $4.5 million permitted under the loan agreement.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations as of September 30, 2005 and for the three and nine month periods ended September 30, 2005 and 2004 should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2004.

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 risks and uncertainties that could cause actual results to differ materially for us from those projected, 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 and personnel retention; risks related to our ability to achieve hoped-for manufacturing yields for certain array products, including the ability to identify and resolve manufacturing problems; 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 our 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.

Acquisition

On May 31, 2005, Affymetrix entered into a definitive agreement to acquire 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.  The acquisition was approved by ParAllele stockholders on October 20, 2005 and was completed on October 21, 2005.  Affymetrix expects 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 Affymetrix’ core assay development capabilities.

In connection with the completion of the acquisition, the stockholders of ParAllele will be receiving approximately $120.8 million in merger consideration in the form of approximately 2.29 million shares of Affymetrix common stock and $11.7 million in cash in exchange for all of their outstanding shares and the assumption of all of ParAllele’s stock options.

The preliminary estimated total purchase price of the ParAllele merger is as follows (in thousands):

The estimated fair value of $100.2 million was derived using the average market price of Affymetrix’ common stock of $43.84, which was based on the closing price for a range of trading days (October 18, 2005 through October 24, 2005) around the measurement date.

We intend to account 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, we will record as its cost the assets of ParAllele less the liabilities assumed, with the excess of such cost over the estimated fair value of such net assets reflected as goodwill. Additionally, certain costs directly related to the merger

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will be reflected as additional purchase price in excess of net assets acquired. Our statement of operations will include the operations of ParAllele beginning on October 21, 2005.

A preliminary valuation of the purchased assets was undertaken by a third party valuation specialist to assist us in determining the estimated fair value of identifiable intangible assets, including acquired in-process research and development projects. The preliminary analysis resulted in $15.0 million of the purchase price being allocated to acquired in-process research and development which will be charged to expense in the fourth quarter of 2005.

On September 1, 2005, in connection with the transactions contemplated by the merger agreement, Affymetrix and ParAllele entered into a loan agreement under which we agreed to extend a loan to ParAllele for the ongoing operation of its business. Pursuant to terms of the loan agreement, on September 1, 2005, ParAllele borrowed the full $4.5 million permitted under the loan agreement.

The following discussion and analysis does not reflect the impact of the ParAllele acquisition.

Overview

We are engaged in the development, manufacture, sale and service of systems for genetic analysis for use in the life sciences and in clinical diagnostics, and emerging markets outside of healthcare including agricultural markets, environmental testing and bio-defense applications. Our industry is affected by a number of factors that influence its size and development. These factors include the availability of genomic sequence data for human and other organisms, technological innovation that increases throughput and lowers the cost of genomic and genetic analysis, the development of new computational techniques to handle and analyze large amounts of genomic data, the availability of government 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 Mexico, India, the Middle East, South America, South Africa and Asia Pacific regions. We have incurred net losses and negative cash flows from operations in the past, but have now achieved profitability for two consecutive fiscal years. The following overview describes key elements of our business strategy and our goals for fiscal 2005:

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 decrease the unit costs of our GeneChip® products, we aim to encourage our customers to expand their research uses for our GeneChip® system, which will create new market opportunities for us.

Our goal in 2005 is to achieve solid growth in probe arrays and reagent sales by expanding our product lines and adding new customers. While we now anticipate instrument revenue to be down from 2004 due to the completion of our GeneArray® Scanner 2500 instrument upgrade cycle we expect continued revenue growth related to sales of new instruments and automation equipment, and continue to believe our largest opportunity for growth will likely be through sales of our consumable GeneChip® products in 2005.

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.

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Maintain our operating margins.  Management is focused on growing the business and increasing its operating profitability at the same time. In addition to the revenue growth opportunities described above, we will continue to closely manage our manufacturing costs and operating expenses.

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 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. There have been no significant changes to our critical accounting policies from those included in our Form 10-K for the year ended December 31, 2004.

Results of Operations

The following discussion compares the historical results of operations for the three and nine months ended September 30, 2005 and 2004, respectively.

Product Sales

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

Total product sales increased 11% or $6.7 million for the third quarter of 2005 as compared to the same period in 2004.  Probe array sales increased 19% primarily due to an increase of $12.8 million in revenue related to growth in unit sales of our GeneChip® probe arrays.  This increase was partially offset by a decrease of $6.2 million in revenue related to a decline in the average selling price of our arrays due to a change in product mix. Reagent sales increased 28% primarily due to an increase in the average selling price of our reagents related to a change in product mix and growth in reagent unit sales associated with increased probe array unit sales.  Instrument sales decreased 16% from the same period in 2004.  The decline was primarily due to a decrease of $4.0 million in revenue related to a decline in unit sales of our GeneChip® Scanner 3000 upgrades as we end our GeneArray® Scanner 2500 upgrade cycle.  These decreases were partially offset by growth of $1.1 million in revenue related to increased unit sales of our new automation equipment and growth of $1.2 million in revenue related to increased unit sales of our GeneChip® Scanner 3000 high-resolution upgrades.

Total product sales increased 14% or $26.7 million in the first nine months of 2005 as compared to the same period in 2004.  Probe array sales increased 25% primarily due to an increase of $57.3 million in revenue related to growth in unit sales of our GeneChip® probe arrays.  This increase was partially offset by a decrease of $30.4 million in revenue related to a decline in the average selling price of our arrays due to a change in product mix. Reagent sales increased 37% primarily due to an increase in the average selling price of our reagents related to a change in product mix and growth in reagent unit sales associated with increased probe array unit sales.  Instrument sales decreased 17% from the same period in 2004.  The decline was primarily due to a decrease of $14.8 million in revenue related to a decline in unit sales of our GeneChip® Scanner 3000 upgrades as we end our GeneArray® Scanner 2500 upgrade cycle as well as a decrease of $2.5 million in revenue related to a decline in unit sales and in the average selling price of our Fluidics Station 450.  These decreases were partially offset by growth of $3.6 million in

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revenue related to increased unit sales of our new automation equipment, growth of $3.6 million in revenue related to increased unit sales of our complete GeneChip® instrumentation systems and growth of $2.6 million in revenue related to increased unit sales of our GeneChip® Scanner 3000 high-resolution upgrades.

In the third quarter of 2005, probe array shipments were constrained due to low initial production yields on our 500K Mapping Array which led to capacity constraints.  These capacity constraints may continue in the fourth quarter of 2005.

Product Related Revenue

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

Total product related revenue decreased 25% or $3.5 million for the third quarter of 2005 and decreased 20% or $8.3 million in the first nine months of 2005 as compared to the same periods in 2004.  The decreases were primarily due to the decline in subscription fees earned under our GeneChip® array access programs as we continue to transition customers to volume-based pricing on array sales.  Additionally, the recognition of $0.8 million and $2.2 million in milestone revenue due to the achievement of substantive goals as defined by our collaborative agreements in the third quarter of 2004 and the first nine months of 2004, respectively, contributed to the decrease.  Service and other revenue decreased $0.4 million for the third quarter of 2005 primarily due to a decrease in other revenue related to DNA analysis and other product related scientific services and increased in the first nine months of 2005 primarily due to increased sales of service contracts for our GeneChip® Scanner 3000.

Royalties and Other Revenue (in thousands)

Royalties and other revenue decreased 37% or $1.0 million for the third quarter of 2005 and decreased 36% or $3.0 million in the first nine months of 2005 as compared to the same periods in 2004.  These decreases were primarily due to a decline in the number of our non-core license agreements and the recognition of $0.9 million in non-monetary revenue resulting from the receipt of preferred stock in a non-public company in exchange for a license agreement with no continuing performance obligations in the third quarter of 2004 and the recognition of one monetary and one non-monetary license agreement with no continuing performance obligations in the first nine months of 2004.

Revenue from Perlegen Sciences (in thousands)