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Affymetrix, Looking to Curb High Costs and Revive Sagging Sales After Weak Q2, Plans to Restructure

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The story has been updated to reflect the fact that Affymetrix's 96-well reader will not be supplied by CapitalBio.

Affymetrix dipped into the red for the first time in two and a half years this week as rising costs, growing competition in the genotyping market, and lagging sales conspired to turn profit to a $10 million loss.
 
In response to what CEO Stephen Fodor called “the single most challenging year for Affymetrix in [its] 13-year history,” the company pledged to speed efforts to cut operational costs while introducing new products to reinvigorate sales, especially for genotyping and instrumentation.
 
The company said total revenues for the quarter ended June 30 slipped 4.7 percent to $80.1 million from $84.1 million year over year. Affymetrix also posted a net loss of $10.1 million for the second quarter, compared to net income of $7.8 million in the year-ago period.
 
The company said that its GAAP net loss for the quarter includes the effects of stock-based compensation expense related to the US Securities and Exchange Commission’s FAS 123R regulation. Excluding the impact of FAS 123R, Affymetrix said that its non-GAAP net loss for the quarter would be $6.2 million.
 
Investors reacted negatively to Affy’s performance, sending the firm’s stock down 17 percent to $18.48 at noon Tuesday, the day after the company released its earnings. Affy’s shares have lost more than half their value since the beginning of the year and nearly 70 percent since last summer. The shares are now trading at their lowest levels since April 2003, and investment banks Thomas Weisel and Infinium Securities downgraded the stock this week.
 
Affymetrix attributed the revenue decline to increased competition and operational difficulties. According to Chief Financial Officer Greg Schiffman, product revenue was down in all categories.
 
Arrays and service revenue for the second quarter fell to $44.8 million from $45.9 million during the same period last year, while genotyping revenues were $4.5 million. Affy did not report genotyping revenues last year. Revenues from sales of reagents fell to $9.6 million from $9.8 million in the year-ago quarter, and instrument sales declined 17 percent to $11.2 million from $13.5 million year over year.
 
Schiffman said during a conference call with investors that the company’s gene-expression business was in line with its initial guidance “with the exception of our exon and tiling products, where the rate of adoption was slightly lower than expected.” He added that the decline in instrument revenue was driven by reduced sales of system upgrades, and automation.”
 
Meantime, operational costs ballooned. Sales, general, and administrative costs rose 18 percent to $39.5 million for the quarter from $32.5 million in Q2 2005, while Affy’s total costs increased 15 percent to $89.2 million from $75.5 million in the second quarter of 2005. 
 
Schiffman said the increase in SG&A includes approximately $5.2 million associated with stock-option expensing under FAS 123R and ongoing costs associated with the acquisition of ParAllele.
 

“We did a good job of opening up the field. Unfortunately, a lot of our operations mistakes created an opportunity for competition to come in and launch their own products.”

“The remaining delta over the prior year was driven by increased litigation expenses,” he said. Affy is currently involved in several patent-infringement cases, including one against Illumina and another against Enzo Biochem (see BAN 4/19/2006, BAN 7/25/2006).

 
R&D spending increased to $21.6 million from $20.8 million in the year-ago period. As of June 30, Affymetrix had $76 million in cash and cash equivalents.
 
Reshuffling Operations
 
Affy officials said that the second-quarter results spurred the firm to double its efforts to streamline its organization. According to Fodor, the company now has two objectives: to increase revenues with new products in the genotyping market, expression arena, and clinical diagnostics, and to decrease operational costs.
 
“Since we have entered into a period of operating loss, our general and administrative cost structure has become out of line for the revenue base of the company,” Fodor said.
 
“During this quarter we will reduce our expenses by restructuring corporate, general, and administrative expenses while continuing our strong focus on sales, product R&D, and product launches,” he added.
 
In addition, Fodor said that Affy has “opened a search for a senior-level commercial operations leader. Our objective is to transition our established markets into long-term growth opportunities.”
 
Affymetrix announced its first round of administrative changes, including the resignation of former company president Sue Siegel, in April prior to reporting its first-quarter results (see BAN 4/25/2006).
 
During the call this week, Schiffman said that Affy has “realized that … we were spending outside of a lot of the industry norms, and we [have now] put a model in place that we are looking to grow operating expenses half the rate of revenue.”
 
“I think that as we look at where we are at right now, growing into our cost structure in terms of the G&A, it makes sense to structurally just make the changes now,” he said. Schiffman added that Affy may begin some “facility rationalization” as well, and the company may take a charge in the third quarter related to that. [We are] understanding the facilities we have, what makes sense, and how do we want to move forward from where we are at,” he said.
 
At the same time, Affy is in the midst of a major facility expansion. According to Schiffman, the company has nearly completed validating its new $5.5-million 100,000 square-foot chip-manufacturing plant in Singapore and expects to begin shipping product from that space before the end of the year.
 
Additionally, the company will open Affymetrix Clinical Laboratories, a CLIA-approved testing laboratory in West Sacramento, Calif., this fall, with plans to offer dozens of different molecular tests, Fodor said.
 
Renewed Focus on Genotyping, Instrument Sales
During the call Fodor admitted that Affy’s challenges have been “compounded by increased competition, especially in the genotyping market.” The company’s Q2 showing was in contrast with its top genotyping rival Illumina, which last month posted a 163-percent surge in second-quarter revenues (see BAN 7/25/2006).
 
Fodor noted that while Affy was first to market with a whole-genome genotyping product, internal operational errors had set the company back in the marketplace and emboldened its rivals.
 
“We did a good job of opening up the field. Unfortunately, a lot of our operations mistakes created an opportunity for competition to come in and launch their own products,” he said.
 

“During this quarter we will reduce our expenses by restructuring corporate, general, and administrative expenses while continuing our strong focus on sales, product R&D, and product launches.”

To invigorate its position in that market, Affy late last month cut the cost of its two-chip 500K Array Mapping Set by roughly half to $250, and promised to launch a single 500K chip this fall and a 1 million SNP-genotyping product on two chips for early-access customers in the fourth quarter (see BAN 7/25/2006).

 
Fodor said that the reputation of the firm’s 500K product had suffered since its launch in October 2005 as a manufacturing glitch and scaling issues have affected orders of the chip. He said that the decision to launch the 1 million genotyping set was an attempt by the company to raise the stakes in the market for array-based whole-genome genotyping.
 
“As we started to look at this, we really thought we could incrementally approach this business area or we could really try to drive the whole field to a new level, and that is what we decided to do,” he said.
 
Affy is also touting is upcoming GeneChip reader, which could push up its sliding instrumentation sales.
 
“In Q4, we will be introducing a new, 96-well reader that will provide core laboratories the ability to transition to automated high-throughput expression analysis,” Schiffman said.
 
He added that “over the coming quarters, many of the assays now provided in cartridge format will be adapted to the 96-well format.”

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