AFFYMETRIX INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE PERIOD ENDED MARCH 31, 2005

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 incorporation or organization)		(I.R.S. Employer Identification Number)

3380 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 ý No o

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

COMMON SHARES OUTSTANDING ON APRIL 30, 2005: 63,105,476

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(UNAUDITED)

	March 31, 2005			December 31, 2004
				(Note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	62,950		$	42,595
Available-for-sale securities	191,480			163,120
Accounts receivable	68,908			89,441
Accounts receivable from Perlegen Sciences	4,624			3,964
Inventories	19,849			17,997
Prepaid expenses and other current assets	5,854			5,833
Total current assets	353,665			322,950
Property and equipment, net	65,414			64,179
Acquired technology rights, net	62,905			64,334
Goodwill	18,601			18,601
Notes receivable from employees	1,935			1,900
Other assets	28,759			27,807
	$	531,279		$	499,771

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	49,646		$	62,963
Deferred revenue — current portion	37,292			33,776
Total current liabilities	86,938			96,739
Deferred revenue — long-term portion	25,942			29,463
Other long-term liabilities	4,310			4,382
Convertible notes	120,000			120,000
Stockholders’ equity:
Common stock	630			616
Additional paid-in capital	434,893			407,258
Deferred stock compensation	(4,265		)	(4,265		)
Accumulated other comprehensive loss	(2,336		)	(3,371		)
Accumulated deficit	(134,833		)	(151,051		)
Total stockholders’ equity	294,089			249,187
	$	531,279		$	499,771

Note 1: The condensed consolidated balance sheet at December 31, 2004 has been derived from the audited consolidated financial statements at that date included in the Company’s Form 10-K for the fiscal year ended December 31, 2004.

See accompanying notes.

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

	Three Months Ended March 31,
	2005			2004
Revenue:
Product sales	$	73,551		$	61,091
Product related revenue	11,317			13,522
Total product and product related revenue	84,868			74,613
Royalties and other revenue	1,560			2,371
Revenue from Perlegen Sciences	2,187			1,649
Total revenue	88,615			78,633

Costs and expenses:
Cost of product sales	19,279			20,732
Cost of product related revenue	2,505			2,856
Cost of revenue from Perlegen Sciences	1,242			1,371
Research and development	17,090			17,296
Selling, general and administrative	29,597			28,269
Stock-based compensation (1)	83			324
Total costs and expenses	69,796			70,848
Income from operations	18,819			7,785
Interest income and other, net	714			1,075
Interest expense	(427		)	(9,834		)

Income (loss) before income taxes	19,106			(974		)
Income tax provision	(2,888		)	(859		)
Net income (loss)	$	16,218		$	(1,833	)

Basic net income (loss) per common share	$	0.26		$	(0.03	)
Diluted net income (loss) per common share	$	0.24		$	(0.03	)

Shares used in computing basic net income (loss) per share	62,351			59,903
Shares used in computing diluted net income (loss) per share	69,081			59,903

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

Research and development	$	—	$	258
Selling, general and administrative	83		66
	$	83	$	324

See accompanying notes.

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

	Three Months Ended March 31,
	2005			2004
Cash flows from operating activities:
Net income (loss)	$	16,218		$	(1,833	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	5,024			5,177
Redemption premium and related write-off of debt issuance costs	—			8,095
Amortization of intangible assets	1,929			944
Amortization of investment discounts, net	(68		)	(1,693		)
Stock-based compensation	83			324
Realized loss on sales of investments	55			57
Realized loss on equity method investment in Perlegen Sciences	938			—
Write down of equity investment	—			1,442
Amortization of debt offering costs	189			197
Accretion of interest on notes receivable	(35		)	(12		)
Loss on write-off of equipment	12			404
Change in operating assets and liabilities:
Accounts receivable, net	19,873			6,199
Inventories	(1,852		)	1,731
Prepaid expenses and other current assets	(100		)	(2,365		)
Accounts payable and accrued and other current liabilities	(11,857		)	(9,297		)
Deferred revenue	(5		)	1,546
Other long-term liabilities	(72		)	337
Net cash provided by operating activities	30,332			11,253

Cash flows from investing activities:
Capital expenditures	(6,271		)	(5,391		)
Purchases of available-for-sale securities	(67,319		)	(86,392		)
Proceeds from the sales or maturities of available-for-sale securities	38,736			100,771
Purchase of non-marketable equity investment in Perlegen Sciences	(2,000		)	—
Purchase of technology rights	(500		)	—
Net cash (used in) provided by investing activities	(37,354		)	8,988

Cash flows from financing activities:
Issuance of common stock	27,254			15,819
Redemption of convertible subordinated notes	—			(271,778		)
Net cash provided by (used in) financing activities	27,254			(255,959		)
Effect of exchange rate changes on cash and cash equivalents	123			(205		)
Net increase (decrease) in cash and cash equivalents	20,355			(235,923		)
Cash and cash equivalents at beginning of period	42,595			275,928
Cash and cash equivalents at end of period	$	62,950		$	40,005

See accompanying notes.

AFFYMETRIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 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 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 March 31, 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.

The following table illustrates the effect on net income (loss) and net income (loss) 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):

	Three Months Ended March 31,
	2005			2004
Net income (loss)—as reported	$	16,218		$	(1,833	)
Add: Stock-based employee compensation expense included in reported net income (loss), net of tax	—			324
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of tax	(3,999		)	(4,446		)
Pro forma net income (loss)	$	12,219		$	(5,955	)

Net income (loss) per share:
Basic net income (loss) per common share—as reported	$	0.26		$	(0.03	)
Diluted net income (loss) per common share—as reported	$	0.24		$	(0.03	)
Basic net income (loss) per common share—pro forma	$	0.20		$	(0.10	)
Diluted net income (loss) per common share—pro forma	$	0.18		$	(0.10	)

Net Income (Loss) Per Share

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

	Three Months Ended March 31,
	2005			2004
Numerator:
Net income (loss)—basic	$	16,218		$	(1,833	)
Add effect of dilutive securities:
Interest on convertible notes	414			—
Net income (loss) — diluted	$	16,632		$	(1,833	)
Denominator:
Weighted-average shares outstanding	62,423			59,987
Less: weighted-average shares of common stock subject to repurchase	(72		)	(84		)
Shares used in computing basic net income (loss) per share	62,351			59,903
Add effect of dilutive securities:
Employee stock options	2,773			—
Common stock subject to repurchase	72			—
Warrants to purchase common stock	15			—
Convertible notes	3,870			—
Shares used in computing diluted net income (loss) per share	69,081			59,903
Basic net income (loss) per share	$	0.26		$	(0.03	)
Diluted net income (loss) per share	$	0.24		$	(0.03	)

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 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 $0.01 decrease in diluted earnings per share for the three months ended March 31, 2005 and had no impact for the three months ended March 31, 2004.

For the three months ended March 31, 2005, 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). For the three months ended March 31, 2004, all of these securities have been excluded since they were anti-dilutive.

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

	March 31,
	2005	2004

Employee stock options	1,418	9,175
Common stock subject to repurchase	—	82
Warrants to purchase common stock	—	52
Convertible notes	—	3,870

Total	1,418	13,179

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. Statement 123(R) must be adopted no later than July 1, 2005. On April 14, 2005, the Securities and Exchange Commission announced the adoption of a new rule that defers the implementation date from July 1, 2005 to January 1, 2006. Therefore, 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 our result of operations, although it will have no impact on our 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. However, had we adopted Statement 123(R) in prior periods, 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 literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized for such excess tax deductions was $0.3 million for the three months ended March 31, 2005 and none for the three months ended March 31, 2004.

NOTE 2—PRODUCT SALES AND PRODUCT RELATED REVENUE

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

	Three Months Ended March 31,
	2005		2004
Probe arrays	$	47,727	$	37,977
Reagents	9,916		7,548
Instruments	15,908		15,566
Total product sales	$	73,551	$	61,091

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

	Three Months Ended March 31,
	2005		2004
Subscription fees	$	3,317	$	5,559
Service and other	4,229		4,098
License fees and milestone revenue	3,771		3,865
Total product related revenue	$	11,317	$	13,522

NOTE 3—INVENTORIES

Inventories consist of the following (in thousands):

	March 31, 2005		December 31, 2004
Raw materials	$	8,085	$	6,719
Work-in-process	4,680		4,181
Finished goods	7,084		7,097

Total	$	19,849	$	17,997

NOTE 4—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

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

	March 31, 2005		December 31, 2004
Accounts payable	$	15,693	$	14,000
Accrued compensation and related liabilities	14,672		27,416
Accrued interest on convertible notes	262		37
Accrued taxes	8,803		10,158
Accrued legal	1,556		694
Accrued royalties	354		581
Accrued warranties	4,234		4,113
Other	4,072		5,964

Total	$	49,646	$	62,963

NOTE 5—COMPREHENSIVE INCOME (LOSS)

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

	Three Months Ended March 31,
	2005			2004
Net income (loss)	$	16,218		$	(1,833	)
Foreign currency translation adjustment	123			(205		)
Unrealized (loss) gain on debt securities	(236		)	515
Unrealized gain on hedging contracts	1,148			170
Comprehensive income (loss)	$	17,253		$	(1,353	)

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 $16.5 million and $14.6 million at March 31, 2005 and December 31, 2004, respectively.

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

For the Year Ending December 31,	Amortization Expense
2005, remainder thereof	$	5,603
2006	7,459
2007	7,459
2008	7,447
2009	6,586
Thereafter	28,351
Total expected future annual amortization	$	62,905

NOTE 7—RELATED PARTY TRANSACTIONS

Perlegen Sciences, Inc.

As of March 31, 2005, the Company held approximately 30% ownership interest in Perlegen Sciences, Inc. (“Perlegen”), a privately-held biotechnology company in which two members of Perlegen’s board of directors are also members of the Company’s board of directors. In addition, certain affiliates, including the Company’s chief executive officer and members of the board of directors, hold direct or indirect equity interests in Perlegen.

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 February 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 is included in the Company’s balance sheet as a component of other assets. Since the closing date of the Series D preferred stock financing, the Company has recorded $0.9 million related to its proportionate share of Perlegen’s operating losses, which is included as a component of interest and other income, net, in the Company’s condensed consolidated statement of operations.

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.

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. Information regarding the changes in the Company’s product warranty liability for the three months ended March 31, 2005, respectively, was as follows (in thousands):

	Three Months Ended March 31, 2005
Beginning balance	$	4,113
New warranties issued	658
Repairs and replacements	(537		)
Ending balance	$	4,234

Funding Commitments

The Company has invested $7.5 million and is committed to invest up to an additional $2.5 million in a venture capital limited partnership. The investment is included on the condensed consolidated balance sheet as a component of other assets and is accounted for under the equity method.

Non-cancelable Supply Agreements

As of March 31, 2005, the Company had approximately $6.3 million of non-cancelable inventory supply agreements that are in effect through 2005 and an additional $1.0 million of non-cancelable inventory supply agreements that are in effect through 2006.

Indemnifications

From time to time the Company has entered into indemnification provisions under certain of its agreements with other companies in the ordinary course of business, typically with business partners, customers, and suppliers. Pursuant to these agreements, the Company generally indemnifies, holds harmless, and agrees to reimburse the indemnified parties on a case by case basis for losses suffered or incurred by the indemnified parties in connection with any U.S. patent or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification provisions is generally perpetual from the time of the execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. In addition, the Company has entered into indemnification agreements with its officers and directors. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As of March 31, 2005, the Company had not accrued a liability for this guarantee, because the likelihood of incurring a payment obligation in connection with this guarantee is remote.

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’s 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. The motion to amend the judgment is currently scheduled to be heard on June 9, 2005.

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.

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. On April 9, 2004, the Company filed its answer to Enzo’s complaint. Enzo filed an answer to the Company’s complaint on May 13, 2004. On September 14, 2004, the Southern District of New York conducted a consolidated status conference for the various Enzo litigations and scheduled a claim construction hearing for the Enzo patents on June 30, 2005 to July 5, 2005. 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. 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.

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 March 31, 2005 and for the three month periods ended March 31, 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 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 the Company’s 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.

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. 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 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 and Europe. We also sell our products through life science supply specialists acting as authorized distributors in Mexico, India, the Middle East 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 is to achieve solid growth in probe arrays and reagent sales by expanding our product lines and adding new customers. While we anticipate instrument revenue to be up slightly as compared to 2004 due to continued revenue growth related to sales of new instruments and automation equipment, this growth will be partially offset by the eventual completion of our GeneArray® Scanner 2500 instrument upgrade cycle, and our largest opportunity for growth will likely be through sales of our GeneChip® products.

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 dramatically improve experimental throughput. We believe that our high-throughput automation solutions will enjoy commercial success in high-throughput 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.

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. Our goal has been and continues to be to limit the increase in our operating expenses to about half the growth rate of our product and product related revenue. If we control the growth rate of our operating expenses in this way, we should be able to continue our recent trend of profitability.

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. There have been no 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 months ended March 31, 2005 and 2004, respectively.

Product Sales

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

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Probe arrays	$	47,727	$	37,977	$	9,750
Reagents	9,916		7,548		2,368
Instruments	15,908		15,566		342
Total product sales	$	73,551	$	61,091	$	12,460

Total product sales increased 20% or $12.5 million in the first quarter of 2005 as compared to the same period in 2004. The increase in GeneChip® probe arrays was primarily due to growth of $20.3 million related to increased unit sales of our GeneChip® probe arrays which was partially offset by a decrease of $10.5 million related to a decline in the average selling price of our arrays due to a change in product mix. Reagent sales increased $2.4 million primarily due to an increase in the average selling price of our new products. Instrument sales were relatively flat from the same period in 2004. We had growth of $3.6 million related to increased unit sales of full GeneChip® instrumentation systems including our new GCS 3000Dx system, and growth of $1.5 million related to increased unit sales of our new GeneChip® Array System and High-throughput scanners. These increases were partially offset by a unit decline in GeneChip® Scanner 3000 instruments and upgrades of $3.6 million as we near the end of our GeneArray® Scanner 2500 upgrade cycle and a decrease of $1.3 million related to a decline in the average selling price of our GeneChip® instrument systems.

Product Related Revenue

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

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Subscription fees	$	3,317	$	5,559	$	(2,242	)
Service and other	4,229		4,098		131
License fees and milestone revenue	3,771		3,865		(94		)
Total product related revenue	$	11,317	$	13,522	$	(2,205	)

Total product related revenue decreased 16% or $2.2 million for the first quarter of 2005 compared to the same period in 2004. The decrease was primarily due to a decline in subscription fees earned under GeneChip® array access programs as we continue to transition customers to volume-based discounting on product sales.

Royalties and Other Revenue (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Royalties and other revenue	$	1,560	$	2,371	$	(811	)

Royalties and other revenue decreased 34% or $0.8 million for the first quarter of 2005 compared to the same period in 2004. The decrease was primarily due to a decline in the number of our non-core license agreements.

Revenue from Perlegen Sciences (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Revenue from Perlegen Sciences	$	2,187	$	1,649	$	538

Revenue from Perlegen Sciences, a related party, increased 33% or $0.5 million for the first quarter of 2005 compared to the same period in 2004. The increase was primarily due to $0.9 million of royalties earned by us for probe arrays and whole wafers used by Perlegen for their revenue generating activities. This royalty was partially offset by decreased demand by Perlegen for our probe arrays and whole wafers, which we sell at our fully burdened cost of manufacturing to Perlegen for use in their research and development activities. Any probe arrays and whole wafers used by Perlegen in their revenue generating activities are royalty bearing to Affymetrix.

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

							Dollar /
	Three Months Ended March 31,						Percentage change from
	2005			2004			2004

Total gross margin on product sales	$	54,272		$	40,359		$	13,913
Total gross margin on product related revenue	8,812			10,666			(1,854		)

Total gross margin on product and product related revenue	$	63,084		$	51,025		$	12,059

Product gross margin as a percentage of product sales	73.8		%	66.1		%	7.7		%

Product related gross margin as a percentage of product related revenue	77.9		%	78.9		%	(1.0		)%

The gross margin percentage on product sales increased from 66.1% to 73.8% in the first quarter of 2005 as compared to the same period in 2004. Of the 7.7% increase in product gross margins, approximately 1.8% of the increase can be attributed to an increase in probe array gross margins due to the conversion of a royalty bearing technology license from Oxford Gene Technology to a fully paid-up non-royalty bearing license in the second half of 2004. The remainder of the gross margin increase can be attributed to increased utilization of our probe array manufacturing facility due to increased sales volume, increased manufacturing efficiencies and a change in our overall product mix towards consumables such as probe arrays and reagents.

The gross margin percentage on product related revenue decreased from 78.9% to 77.9 % for the first quarter of 2005 as compared to the same period in 2004. This 1.0% decrease was primarily due to a 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)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Cost of revenue from Perlegen Sciences	$	1,242	$	1,371	$	(129	)

Cost of Perlegen revenue decreased 9% or $0.1 million for the first quarter of 2005 compared to the same period in 2004 primarily due to decreased demand by Perlegen for our whole wafers.

Research and Development Expenses (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Research and development	$	17,090	$	17,296	$	(206	)

Research and development expenses for the first quarter of 2005 were slightly lower as compared to the same period in 2004. The first quarter 2005 costs were lower than expected primarily because of the timing of supply purchases which are anticipated to be incurred later in fiscal 2005. 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.

Selling, General and Administrative Expenses (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Selling, general and administrative	$	29,597	$	28,269	$	1,328

Selling, general and administrative expenses increased 5% or $1.3 million for the first quarter of 2005 as compared to the same period in 2004. This increase was largely due to higher headcount related expenses and legal expense associated with ongoing patent litigation. Selling, general and administrative expenses are expected to continue to increase as we expand sales, marketing, and technical support functions, management and administrative functions, prosecute and defend our intellectual property position and defend against claims made by third parties in ongoing litigation. We expect legal costs to vary substantially as the level of legal activity changes. There can be no assurance that we have adequately estimated our exposure for potential damages associated with pending or future litigation.

Stock-Based Compensation (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Stock-based compensation	$	83	$	324	$	(241	)

Stock-based compensation decreased 74% or $0.2 million for the first quarter of 2005 as compared to the same period in 2004. For the first quarter of 2005, we recorded stock-based compensation related to a fully vested restricted stock grant to a non-employee. For the first quarter of 2004, stock-based compensation related to the amortization of deferred stock compensation. Upon the acquisition of Neomorphic in October 2000, the fair value of unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by employees were deducted from the purchase price and allocated to deferred stock compensation. This balance was amortized to stock-based compensation over the remaining vesting terms of the individual equity awards, generally two to four years. We ceased amortizing $4.3 million of deferred stock compensation related to an executive level Neomorphic employee who commenced a leave of absence during the latter part of fiscal 2001. The remaining $4.3 million balance will be amortized if and when the employee resumes active employee status with us.

Interest Income and Other, Net (in thousands)

Interest income and other, net, decreased 34% or $0.4 million for the first quarter of 2005 as compared to the same period in 2004. The components of interest income and other, net, are as follows:

	Three Months Ended March 31,						Dollar change from
	2005			2004			2004
Interest income	$	1,389		$	1,280		$	109
Realized loss in Perlegen	(938		)	—			(938		)
Write down of equity investment	—			(1,442		)	1,442
Currency (losses) gains, net	(136		)	695			(831		)
Other	399			542			(143		)
Interest income and other, net	$	714		$	1,075		$	(361	)

Interest Expense (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Interest expense	$	427	$	9,834	$	(9,407	)

Interest expense decreased 96% or $9.4 million for the first quarter of 2005 as compared to the same period in 2004. Interest expense for the first quarter of 2005 primarily consists of interest and amortization associated with our 0.75% senior convertible notes. Interest expense was higher during the first quarter of 2004 primarily due to the write off of approximately $3.8 million in issuance costs plus $4.3 million in redemption premiums incurred by us in connection with the redemption of our 5% and 4.75% convertible subordinated notes.

Income Tax Provision (in thousands)

	Three Months Ended March 31,				Dollar change from
	2005		2004		2004
Income tax provision	$	2,888	$	859	$	2,029

The provision for income tax increased 236% or $2.0 million for the first quarter of 2005 compared to the same period in 2004. In both periods, the provision principally consists of taxes currently payable on the taxable profits generated by our foreign operations, federal alternative minimum tax, and state taxes. The increase is primarily due to having pretax income in the first quarter of 2005 versus a pretax loss in the first quarter of 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 our historical operating performance and previously reported net losses, at March 31, 2005, we continue to maintain a full valuation allowance against our net deferred tax assets as they are not yet realizable. We expect our effective tax rate to be approximately 15% for the full year ending December 31, 2005. In estimating our effective tax rate, we anticipate that we will utilize net operating losses and other deferred tax assets that are unrelated to the exercise of stock options during fiscal 2005.

Liquidity and Capital Resources

Cashflow (in thousands)

	Three Months Ended March 31,
	2005			2004
Net cash provided by operating activities	$	30,332		$	11,253
Net cash (used in) provided by investing activities	(37,354		)	8,988
Net cash provided by (used in) financing activities	27,254			(255,959		)
Effect of foreign currency translation on cash and cash equivalents	123			(205		)

Net increase (decrease) in cash and cash equivalents	$	20,355		$	(235,923	)

The increase in our net cash flow from operating activities of $19.1 million was primarily due to an increase in net income and higher cash collections on our trade receivables following record sales in the fourth quarter of 2004.

Our investing activities, other than purchases, sales and maturities of available-for-sale securities, primarily consisted of capital expenditures of $6.3 million and a $2.0 million purchase of non-marketable equity securities for the three months ended March 31, 2005, as compared to capital expenditures of $5.4 million for the three months ended March 31, 2004. Capital expenditures during the three months ended March 31, 2005 related primarily to purchases of manufacturing equipment as well as furniture and computer equipment necessary to supplement our expanding infrastructure.

Net inflows of cash for the first quarter of 2005 were due to cash receipts of $27.3 million from the issuance of common stock for stock option exercises pursuant to the Company’s equity incentive plans. Net outflows of cash for the first quarter of 2004 were primarily attributable to the $271.8 million cash outflow for the redemption of our 5% and 4.75% convertible subordinated notes.

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 for the year ended December 31, 2004.

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 for the year ended December 31, 2004.

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 except as described below.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

General

We have been in the past and continue 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 our business, financial condition and results of operations. If in any pending or future intellectual property litigation involving us or our collaborative partners, we are found to have infringed the valid intellectual property rights of third parties, we, or our 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 our products. In addition, if we are unable to enforce our patents and other intellectual property rights against others, or if our 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 our GeneChip® brand technology, and our competitive position could suffer. We expect to devote substantial financial and managerial resources to protect our intellectual property rights and to defend against the claims described below as well as any future claims asserted against us. 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 we infringe 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, we 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’s 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 decision of the German Federal Patent Court in Munich nullifying both Multilyte patents. We were 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, we 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 we do not infringe five of the eight named patents. On October 24, 2003, we 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 our complaint for declaratory judgment and asserted counterclaims against us alleging infringement of the three patents named by us in our 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 our motions for summary judgment of non-infringement and entered a final judgment in the action in favor of us against Multilyte. On May 5, 2005, Multilyte filed a notice of motion to amend the judgment asserting 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. The motion to amend the judgment is currently scheduled to be heard on June 9, 2005.

We believe that Multilyte’s remaining claims against us are without merit and have filed the declaratory judgment and nullity actions to protect our interests. However, we cannot be sure that we will prevail in these matters. Our failure to successfully defend against these allegations could result in a material adverse effect on our business, financial condition and results of operations.

Enzo Litigation

On October 28, 2003, Enzo Life Sciences, Inc., a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively “Enzo”) filed a complaint against us that is now pending in the United States 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 we 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 us 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 us with a notice of termination of the 1998 agreement effective on November 12, 2003.

On November 10, 2003, we 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 our complaint, we allege that Enzo has engaged in a pattern of wrongful conduct against us 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 our proprietary technology. We seek declarations that we have not breached the 1998 agreement, that we are entitled to sell our 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 us. We also seek 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. We filed a notice of related case stating that our 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 our case. On April 9, 2004, we filed our answer to Enzo’s complaint. Enzo filed an answer to our complaint on May 13, 2004. On September 14, 2004, the Southern District Court of New York conducted a consolidated status conference for the various Enzo litigations and scheduled a claim construction hearing for the Enzo patents on June 30, 2005 to July 5, 2005. There is no trial date in the actions between Enzo and us.

We believe 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 our interests. However, we cannot be sure that we will prevail in these matters. Our failure to successfully defend against these allegations could result in a material adverse effect on our business, financial condition and results of operation.

Administrative Litigation and Proceedings

Our 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 we own or control. Currently, Multilyte Ltd. and ProtoGene Laboratories, Inc. have filed oppositions against our EP 0 619 321 patent in the European Patent Office. PamGene B.V. has filed an opposition against our 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 our 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 our EP 0 834 576 patent. The Opposition Division revoked the patent during an oral hearing on February 23, 2005. 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, we expect that third parties will continue to “copy” the claims of our patents in order to provoke interferences in the United States Patent & Trademark Office, and we may copy the claims of others. These proceedings could result in our patent protection being significantly modified or reduced, and could result in significant costs and consume substantial managerial resources.

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

ITEM 5. OTHER INFORMATION

RISKS RELATED TO OUR BUSINESS

We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. The following discussion highlights some of these risks and others are discussed elsewhere in this Quarterly Report on Form 10-Q.

We have only recently achieved profitability.

Prior to the year ended December 31, 2003, we incurred losses each year since our inception, and as a result have an accumulated deficit of approximately $134.8 million at March 31, 2005. 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, including the costs of patent related litigation.

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.

Our quarterly results have historically fluctuated significantly and may continue to fluctuate unpredictably, which could cause our stock price to decrease.

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.

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 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.

We may lose customers 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 cannot be sure we fully understand all of the factors that affect our manufacturing processes or product performance. Manufacturing and product quality issues may arise as we increase production rates at our manufacturing facility and launch new products. As a result, we may experience difficulties in meeting customer, collaborator and internal demand, in which case we could lose customers or be required to delay new product introductions, and demand for our products could decline. Although we rely on internal quality control procedures to verify our manufacturing process, due to the complexity of our products and manufacturing process, 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.

Our success in penetrating emerging market opportunities in molecular diagnostics depends on 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 diagnostic 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 which we or our collaborative partners develop.

The United States Food and Drug Administration 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 in-vitro diagnostic products outside of the research environment that we or our collaborators may develop, may depend upon successful completion of clinical trials. Clinical development is a long, expensive and an 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 of testing. 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.

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, such as the hybridization oven, certain reagent kits and lithographic masks as well as certain raw materials used in the synthesis of probe arrays, 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 one of only a few suppliers. 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.

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 competitive advantage. 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, 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 be no assurance that we can effectively protect our copyrights, trade secrets or other proprietary information. If we cannot obtain, maintain or enforce intellectual property rights, competitors can design probe array systems similar to our GeneChip® technology.

Our success 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.

We expect to face increasing competition.

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, Becton Dickinson, Bayer AG, Celera Diagnostics, Roche Diagnostics, Johnson & Johnson, bioMérieux and Beckman Coulter have the strategic commitment to diagnostics, the financial and other resources to invest in new technologies, 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.

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 Applied Biosystems, Illumina, GE Healthcare (through its acquisition of Amersham Biosciences) and Agilent Technologies have introduced new products for gene expression research and analysis. 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.

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, ParAllele BioScience, Inc. for assays 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.

Our success depends on the continuous development of 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. 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. If we fail to keep pace with emerging technologies our products will become uncompetitive, our pricing and margins will decline and our business will suffer.

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 a similar or higher density to our microarray technology. Other companies may begin to offer products that are directly competitive with, or are technologically superior, to our products. Although we know of no such technology at the present time, 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.

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 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; or changes in tax laws or interpretations thereof.

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

There may be potential new accounting pronouncements or regulatory rulings that may have an impact on our future financial position and results of operations. 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. The adoption of Statement 123(R)’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. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend, in part, on levels of share-based payments granted prior to the date of adoption.

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. In addition, acquisitions can involve substantial charges and amortization of significant amounts of deferred stock compensation that could adversely affect our results of operations.

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.
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).

AFFYMETRIX, INC.

EXHIBIT INDEX

MARCH 31, 2005

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.
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).

PART I. FINANCIAL INFORMATION

	Item 1.	Financial Statements (Unaudited)	3

		Condensed Consolidated Balance Sheets at March 31, 2005 and December 31, 2004	3

		Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004	4

		Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004	5

		Notes to Condensed Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

	Item 4.	Controls and Procedures	21

PART II. OTHER INFORMATION

	Item 1.	Legal Proceedings	22

	Item 5.	Other Information	24

	Item 6.	Exhibits	31

SIGNATURES			32

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

May 10, 2005