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Hitting Profitability in Q3, Affymetrix To Pour $1.5 Million Extra into R&D


Affymetrix, finally bringing in more money than it spends, is now turning its eyes to the labs that will create the products that it will send down its semiconductor assembly line at its factory near Sacramento.

The company announced the financial milestone of GAAP (generally accepted accounting principles) profitability last week in reporting its third- quarter financials, and said it would spend almost an additional $1 million on its research and development efforts in the next 90 days.

“We have substantially invested in growth; now we are intensifying our research and development efforts on new product development,” Steve Fodor, the company president, said.

The company plans to spend $18.5 million for research and development in the fourth quarter, for a total of $70 million for the year, he said.

While quarterly revenues have grown to $72.7 million in the third quarter, from $55.4 million for the third quarter of 2001, Affymetrix has kept its R&D spending on a fairly flat line, on average, $16.6 million a quarter over each of the last four quarters, about 23.25 percent of revenues (see chart).

Management gurus such as Peter Drucker calculate that each 1 percent increase in spending on research and development yields a better than 4 percent increase in measurements of a company’s value.

In its 10-K report issued earlier this year, the company foreshadowed this increased focus, stating that substantial R&D investment was “essential to a long-term sustainable competitive advantage and critical to expansion into additional high throughput markets such as toxicogenomics, pharmacogenomics, clinical applications and health management.”

A company spokeswoman confirmed that R&D is focusing on these more downstream applications of microarrays. “New areas where the technology is being adopted include drug mechanism of action studies, target validation, toxicology, and clinical trials; not to mention consumer goods companies such as Procter and Gamble and Nestle” as well as agricultural genomics companies Monsanto and Syngenta, said the spokeswoman, Anne Bowdidge. “Many of these applications, certainly in toxicology, require high-throughput formats and we are developing our technology to meet these needs.”

In the clinical development area, Affymetrix is taking what Bowdidge called “a GeneChip Inside” approach. Like the user-friendly computers with Intel Inside, the company is working to develop easy-to-use clinical diagnostics tools that have GeneChips embedded in their infrastructure to provide the raw expression data, which the tools will transform into a clinical diagnostic answer.

But even for ideas that don’t make it into the clinic, the company still stands to enrich its patent portfolio. And, as IBM’s example has shown, IP alone can be a substantial cash cow. IBM owns what is regarded as the world’s largest patent portfolio on hardware and software, which it rigorously defends, collecting royalties at the rate of $1 billion a year. Affymetrix has already gained its own reputation for vigorous defense of its patents, which number over 160 in the US alone, and could follow further in IBM’s footsteps in turning them into a continuing source of licensing revenue.

Affymetrix has recently dropped one of the fruits of its research effort, going into the earnings season by launching its CustomSeq chip a week before announcing third quarter results. The next products to hit the loading dock in the company’s Sacramento factory will be the GeneChip brand 10K SNP chips, which are already being distributed to the company’s preferred customers.

So, despite a dreadful macroeconomic atmosphere, the company is expanding with a sense of exuberance that many others in this sector can not hope to match.

“We are seeing a great demand for GeneChips,” said Fodor with the understatement of a man who is given to dressing up by wearing a leather jacket and no tie.

The numbers backed him. He said the company sold 98,000 chips in the quarter, up 28,000 over the second quarter, into an installed base of 740 units, up by 50 over the second quarter: Each system sold fattened the till by as much as $200,000.

“We were shipping four systems a week from the factory,” said Fodor. More than half of the units shipped were for new customers, he said.

The company is preparing to take sole possession of sales in Japan, ending a distribution agreement with Amersham. It expects to hire about half of the sales and technical support staff serving the Japanese market and will transfer key employees in sales and support in the near future.

Europe, said Fodor, is the company’s fastest growing region and the academic market the fastest growing sector. In product lines, the human chips are the biggest sellers, followed by its murine chips, then the rat chips.

The toxicology area is the fastest growing sector and the rat chips mirror that growth, said Fodor.

Product Pipeline

The company faces a March 2003 end to its relationship with Agilent, which provides the scanner that is sold in the GeneChip brand systems.

Fodor low-keyed the transition, saying the company had sold several different scanners in its history, and was not ready to announce what product would replace it.

“We are in our second or third version of [scanners sold],” said Fodor. “We will improve the instrument, looking at how it evolves with chip density.”

Affymetrix acquired instrument maker GMS to improve the instrumentation that comes with the GeneChip brand system. That would not include spotters, however, as they have become “fairly immaterial to our business,” said CFO Greg Schiffman.

Competing Technologies

New technologies are a long time coming, Fodor said, noting that Affymetrix, which was nurtured on government grants, is just entering its teen-age years. “We have sat on a lot of review committees looking at a lot of new technology. There aren’t a lot of compelling technologies coming around. We’ll keep our eye on them and would take advantage of them as we see them."


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