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Suffering from Pharma Sales Slump, Affy Discloses ‘Strategic Plan’ to Halt Decline

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Amid a tumultuous week in which Affymetrix lowered its full-year financial forecast, expanded an ongoing restructuring initiative, and saw its shares plummet, company officials last week disclosed a “strategic plan” to arrest an ongoing decline in sales and investor confidence.
 
Weaker-than-expected demand from pharmaceutical clients contributed to a slight decline in second-quarter revenue, disclosed last week, while net loss widened.
 
Also last week, the company lowered its 2008 full-year financial forecast for the second time this year. The move prompted several analysts to ask during the firm’s earnings conference call whether jt has the technology or the resources to survive in an increasingly competitive life-sciences market.
 
Affy’s shares plunged more the 20 percent the day after it reported its earnings. The company’s stock has lost more than two-thirds of its value since January, and its current share price, $7.42, hovers just above its all-time low of $6.62, recorded in July 1996 soon after it went public.
 
Affy last week also announced another series of restructuring plans, this time reducing its number of manufacturing facilities to three from five, with the bulk of GeneChip manufacturing slated for the firm’s Singapore plant.
 
During the call, Affy also provided an update on its next-generation microarray platform, scheduled to launch in the fall, and discussed its $25 million acquisition of True Materials, a San Francisco-based start-up that is developing a digital-encoded, microparticle-based technology for low- to mid-multiplex assays.
 
According to Affy President Kevin King, the manufacturing consolidation, the True Materials acquisition, and the new platform roll-out are all part of the firm’s “strategic plan” to revitalize its business in the face of increasing competition and soft pharma sales.
 
“Our strategic plan has three points: the introduction of new array technology and a product platform with a lower cost basis and higher flexibility, reducing our overall cost of goods, and targeted acquisitions to expand revenue opportunities,” King said during the earnings call.
 
‘Ongoing Weakness’
 
For the three months ended June 30, Affy reported that total revenues dipped 1.5 percent to $86.9 million from $88.3 million in the comparable period of 2007.
 
Second-quarter product revenue rose 9.6 percent to $75 million from $68.4 million in the year-ago period. For the current quarter, array and reagent sales generated revenue of $68.9 million and instrument sales contributed $6.1 million. Affy said it shipped 22 GeneChip systems in the quarter.
 
Service revenue, meantime, fell 25 percent to $9 million from $12 million in the second quarter of 2007, while royalties and other revenue dropped 63 percent to $2.9 million from $7.9 million.
 
The company also lowered its full-year forecast due to “predicted ongoing weakness” in pharmaceutical revenue. As a result, Affy now expects 2008 revenue to be in the range of $455 million to $460 million, including a $90 million payment from Illumina related to litigation between the firms.
 

“What can you possibly give us to give more confidence that you guys are still going to be here next year?”

The company had already lowered its revenue forecast for fiscal 2008 to between $490 million and $510 million from an initial forecast of between $505 million and $525 million (see BAN 4/15/2008).
 
“We are experiencing continued softness in our pharmaceutical sales,” King said during the call. “As a result of reduced spending in the pharma industry and the closure or downsizing of pharma research centers, our sales into pharma have declined, particularly in the area of capital spending on instrumentation.”
 
King said that Q2 was the “second consecutive quarter” where Affy saw pharma sales down 30 percent year-over-year. In contrast, he noted that the company’s academic revenues grew 12 percent year-over-year and 20 percent sequentially since Q1.
 
Sales of the firm’s gene-expression products rose 9 percent during the second quarter, dominated by adoption of its exon, tiling, and gene-level array products. Revenues related to its genotyping products, led by its SNP 6.0 array, were up 26 percent year-over-year, Affy said.
 
“Clearly we have taken a large haircut in our pharma business, including both consumables and instruments,” Chief Financial Officer John Batty said during the call. Batty, however, said that positive signs from Affy’s academic customers would somewhat make up for the lack of demand from pharma clients.
 
“Given the strong growth rate in academics, I think we are going to end with stronger revenue in the second half of the year relative to the first,” said Batty. He added that the launch of Affy’s next-generation microarray platform, scheduled for the fall, could lift instrument sales over the next two quarters.
 
Strategic Shuttering
 
As part of an effort to streamline expenses, Affy also said last week that it has decided to close its West Sacramento, Calif., manufacturing facility in an expansion of a restructuring plan it disclosed in March, which called for moving the “majority” of its probe array manufacturing from West Sacramento to the firm's Singapore facility by the end of the year (see BAN 3/4/2008).
 
Under the expanded restructuring plan, Affy said it will move all of its manufacturing operations to Singapore and Cleveland, and close the West Sacramento facility by the end of the second quarter of 2009.
 
Affy said it expects the expanded reorg will add $42 million in charges, $26 million of which will be recorded during the remainder of fiscal 2008 while around $16 million will appear in 2009.
 
According to King, the consolidation is part of the company’s effort to reduce what it spends on technology manufacturing while introducing a more flexible array platform. Specifically, Affy’s new platform — which King, CEO Stephen Fodor, and others referred to in the call as a “peg format” — will begin shipping in the fall with human, mouse, and rat peg-formatted expression chips as the first products.
 
A new scanner will also launch at that time. An Affy spokesperson this week said that the firm will be releasing a “new high-throughput system for array processing and scanning” that will allow its customers to “increase productivity and efficiency by increasing throughput and overall number of samples that can be processed.”
 
Fodor said during the call that “peg-based consumables will be roughly one-fourth the size of our current products,” increasing the number of arrays manufactured per wafer.
 
“We have been working on and are deep into a technology revision cycle that should fundamentally improve our cost basis,” said Fodor. “We expect that smaller, higher-density, and more flexible chip formats will be a very successful platform for new generations of consumables and instruments.
 
“This new platform will provide new products across the portfolio of gene expression and genotyping that will have significantly lower manufacturing costs, greater flexibility, and enable us to reach new customers and generate growth,” he added.
 
True Materials
 
Also last week, Affy announced it paid $25 million in cash to acquire True Materials, a microparticle-technology firm based at the University of California, San Francisco’s Mission Bay Campus.
 
True Materials is developing a digitally encoded microparticle technology that Affy said will enable it to enter low to mid-multiplex markets and compete with bead-based platforms. Affy said that the technology is also applicable to the research, applied, and diagnostic markets.
 
True Materials founder Randy True has joined Affy as a vice president of research and development.
 
“We are targeting large new markets with the acquisition,” Fodor said during the call. He said True Materials’ technology offers advantages over bead-based technology because it is “much more scalable and cost effective.
 
“This technology uses digitally encoded microparticles that carry out assays in solution so that tests will have shorter processing times, simplified workflows, and will use a minimal amount of sample,” said Fodor. He said that it is capable of multiplexing tests ranging from several to 10,000 markers and can be used in the research, applied, and diagnostic markets.
 
“These are very small particles; they exhibit very nice solution-like behavior,” Fodor said. “Many of the products that are in this realm do very well down to 20-30 multiplex but then start to break down once you do 100 and certainly up into the thousands. At the same time when you get down into the low thousands, the arrays struggle on a cost-per-sample basis, so the two technologies overlap.”
 
While Affy did not provide further information on the technology, it could compete against other low- to mid-multiplex platforms offered by rivals. Illumina, for example, sells its digital microbead-based BeadXpress system to customers that Affy is likely to target. Other companies, like Sequenom, specifically target the low- to mid-multiplex genotyping market.
 
Fodor said that True Materials’ R&D work will be brought inside Affy. He added that True Materials is “pretty far along” in getting its technology into the marketplace.
 
“This small company had plans to actually get things to the market in early 2009; we’ll take a look at those plans and will evaluate how much sense that makes,” said Fodor.
 
The company also believes that its next-generation array platform will be able to read True Materials’ assays. “There will be instrument opportunities, certainly we are evaluating that, but we are planning that it can be read on our next-gen instruments,” he said.
 
‘Particularly Pessimistic’
 
Though Affy officials provided several examples of the company’s strategic plan, Wall Street was not convinced. Affy shares were trading at $7.40 on Tuesday morning, down nearly 30 percent since its Q2 earnings were reported on July 24. The stock has declined more than 66 percent since the beginning of the year.
 
Meantime, at least two analysts asked during the call how the company will be able to pull itself out of its current predicament.
 
“How can we be convinced that Affymetrix has the right technological answer to be able to keep you in the market in the face of rapid advances by all of your competitors?” Derik DeBruin, a research analyst at UBS, said during the call. “What can you possibly give us to give more confidence that you guys are still going to be here next year?
 
DeBruin clarified his question in an e-mail to BioArray News this week. “I was asking, ‘What can you tell us about your product pipeline that will give us confidence Affymetrix has a viable technological answer to the competition?’” he wrote.
 
Ross Muken, a research analyst at Deutsche Bank, wasn’t as forgiving. In a research note released last week, he said that “after another quarter of missteps, poor performance, and eroding end-markets, we are officially throwing in the towel on Affymetrix.
 
“We think that the company does not currently have a technology capable of competing in an increasingly innovative market,” he said. “The new microarray platform should help, but we think [Affy] has missed the boat on a full technology cycle and think they need to take serious steps to rebuild both customer and investor credibility.”
 
He also cautioned that while the “company is working hard to come out with new products to help rebuild some market share ... this will be a long and arduous process.” Muken said that Deutsche Bank remains “particularly pessimistic on the company’s outlook,” but said that there is “stronger potential now for a sale of the company given the cheap value of the asset.”
 
In response to DeBruin’s question during the call, King said that the firm has “good growth prospects” though admitted that Affy has been “weak on the pharma side for some time.”
 
Affy reported a net loss of $3.6 million, or $0.05 per diluted share, in the second quarter of 2008, which includes a pretax restructuring charge of $900,000, or $0.01 per diluted share. In the year-ago period, the company posted net income of $1.2 million or $0.02 per diluted share, which included a pretax restructuring charge of $1.8 million, or $0.03 per diluted share.
 
R&D spending was nearly flat at $19.6 million compared to $19.4 million in the second quarter of 2007, while SG&A costs decreased by 12 percent to $29.6 million from $33.6 million in the prior-year period.
 
As of June 30, Affy had $326 million in cash and cash equivalents.

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