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Little Hiccup Costs Affy $10M-$12M in Q3; ParAllele Acquisition Delayed to Q4

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Affymetrix said last week that technical issues with the manufacturing process of its 500K GeneChips have caused third-quarter revenues to be around 13 percent shy of earlier expectations, and warned that while it claims to have rectified the problems, it will "be careful about claiming that anything is resolved."

The company also said that it has postponed its acquisition of ParAllele Biosciences, which will now close in the fourth quarter rather than the third quarter.

Affy's third-quarter revenues are projected to be between $10 million and $12 million lower than the $92 million the company had expected. During a conference call last week, the array market leader laid blame squarely on a manufacturing "glitch," which held up deliveries of its new GeneChip Mapping 500K Array Set for whole-genome interrogation.

"Due to low initial production yield, shipments of our new commercial version of the 500K Mapping array have been constrained. In turn, this has affected revenue-generating shipments," said Greg Schiffman, Affy's chief financial officer, during the call.

According to Affymetrix co-founder and CEO Stephen Fodor, the company "hit a glitch" as it began to gear up for the launch of the 500K product. "What we found was once we started to scale up into large quantities of large volumes we did hit a glitch [so] that the yield variability went beyond what our normal specs are and [what] our normal expectations for introduction of a new product are," Fodor explained during the conference call.

Schiffman, echoing Fodor, said the company had experienced a "little bit of a hiccup with our ability to ramp productions and get yields to where we need to have them." The problem, Schiffman said, was the "mask aligners."

"That is really where the capacity shortfall sits. That's the device that we use that you put the masks on and essentially build up the chips," Schiffman explained in response to an analyst during the call.

Shiffman said that replacements for the faulty aligners "have been on order for essentially nine months. We are just putting [the new] aligners into [our] current clean room," he said.

Now that the company has these replacements, it has proclaimed the "hiccup" over. "We have gotten to a point where the pressure has been let up in terms of manufacturing yield and we're now able to produce a substantial quantity of these," Fodor said.

"We anticipate that coming into the next quarter we will be actually shipping many tens of thousands of these products. We are at a point now where we feel the pressure has been let off at least for the near term," he said during the conference call.

However, because the improvements in yield occurred late in the quarter, Affy projects that it will be "unable to produce enough commercial 500K product to meet our revenue target for the quarter," Schiffman explained. He added that the manufacturing problems would not affect other new Affymetrix technologies, such as the Human Exon 1.0 ST Array that launched last week.

While the company blamed its manufacturing woes on the faulty aligners, it is also plowing ahead with serious capital investments in manufacturing capacity — perhaps a sign that either that the company had insufficient capacity in the first place, or that its next-generation products may be even more demanding to manufacture than the current 500K set.

According to Greg Schiffman, the company is planning to ramp up capacity at its Sacramento facility by 60 percent by 2006, as well as add a plant in Singapore next year to meet demand.

"To ameliorate future manufacturing constraints we are currently increasing our Sacramento array manufacturing capacity by about 30 percent. We expect to add an additional 30 percent in the first half of 2006," Schiffman said during the call.

"Additionally in 2006 we will be expanding our manufacturing operations to include a plant in Singapore. This will give us redundancy for array manufacturing as well as a source of product for our growing international business, which is now roughly half of our revenue," said Schiffman.

Representatives from Affy declined to elaborate on the plans for the Singapore or Sacramento facilities, although further details may emerge later in the month, they said.



"We have to be careful about claiming [that] anything is completely resolved."

While it wasn't cited as a reason for the anticipated shortfall, Affy officials discussed customer demand during the call. Fodor said that the 500K set already had 200 customers and described the orders as "pretty chunky."

Also, Schiffman said that "customers that had previously ordered the early-access version of our 500K had opted to convert their orders to the new commercial 500K chip set. This further compounded supply constraint for the new commercial version of the product."

ParAllele Acquisition Delayed, but Investors Remain Unfazed

In another setback for the third quarter, Affy officials said that it will take one more quarter for its acquisition of ParAllele Biosciences to close.

According to Schiffman the deal "won't close until next quarter." The acquisition was expected to close in the third quarter, with Affy paying $120 million in stock for the company, and accruing a $15 million merger-related charge "for in-process R&D" as well as operational charges of between $4 million and $7 million for the company's fiscal year '05 results (see BAN 6/8/2005).

During the conference call, Schiffman said it would be "difficult" to predict what effect the product-derived shortfall could have on Affy's Q3 or FY 2005 results.

But investors reacted favorably to Affymetrix over the past week, despite the expected shortfall in product-derived revenue and the postponed purchase of ParAllele, perhaps spurred on by three new product launches (see People & Products, this issue) and the perception that demand is high for Affy's new chips.

On Monday, investment bank Leerink Swan upgraded Affy's stock to "outperform" from "market perform," while Lehman Brothers upgraded Affy's stock to "equal-weight" from "underweight" and investment bank Robert W. Baird moved Affy's stock to "neutral" from "underperform," last week.

Following announcements of the company's new Array Station, Mapping 500K Array Set, and Human Exon Array, investors sent Affy's stock up 14.5 percent, to $48.60 on Monday afternoon, from a closing price of $42.46 on Sept. 27, the day before the revenue shortfall was announced.

Still, CEO Fodor warned in the conference call that the company is not entirely in the clear.

"We are feeling — given the increase of capacity that we're going to add plus at the current yield rate — that we are at a good position to push commercialization during Q4," Fodor said. "[But] we have to be careful about claiming [that] anything is completely resolved."

— Justin Petrone ([email protected])

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