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Affy Hopes Rx-Development Apps, New Platform Will Drive Growth After 'Tough' 2008

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Affymetrix last week reiterated its commitment to deliver on three main business priorities to reinvigorate its gene-expression and genotyping businesses after a year of sluggish sales attributed to declining demand for its array products amid weak pharma spending.

According to CEO Kevin King, Affy's three-pronged strategy includes targeting downstream genomic-analysis markets with the new products gained through its acquisitions of Panomics and True Materials last year; rolling out new genotyping assays on its GeneTitan array platform, and consolidating its manufacturing facilities.

"I would say that our strategy is in moving into spaces where pharma is spending probably more money or as much money as they have in the past, now that really is in drug development," he said. "We think we are positioning a portfolio of products to be in more of a sweet spot of where pharma needs to spend in drug development."

King made his remarks during Affy's fourth-quarter earnings call, where the Santa Clara, Calif.-based array vendor reported that its Q4 revenue declined 27 percent year over year and that it took an impairment charge of $239.1 million, leading to a large loss for the quarter and year.

Affy brought in revenues of $78.6 million for the three months ended Dec. 31, 2008, compared to $107.6 million for Q4 2007. The firm had cautioned in October that its fourth-quarter revenue would be essentially flat with its third-quarter revenues of $75.2 million.

During the call, Chief Financial Officer John Batty said that Affy's product revenue, which includes arrays, reagents, and instruments, fell 25 percent to $66.6 million in Q4, compared to $89.2 million in the year-ago period. Sales of arrays and reagents alone fell $17 million, while genotyping and expression sales, which Affy breaks out as its DNA and RNA businesses, declined 31 percent and 17 percent, respectively. Instrument sales declined by half during the quarter, Batty said. Affy posted $5.1 million in instrument sales in Q4, compared to $10.7 in instrument sales in Q4 '07.

"I am grateful that 2008 has come to an end as it was a very tough year," Batty said.

According to Batty, Affy's customers have typically been split between academics, sales to whom represent about 65 percent of revenues, and biotechs, pharmas, and other customers, sales to whom are accountable for the remaining 35 percent. Batty said that a decline in demand from pharma accounts in particular was partially responsible for Affy's Q4 losses.

"In previous years, we had enormous amount of consumables revenue — both chip and reagent revenue — and sort of year-end spending money from pharma and to some extent even on the instrumentation side and that really did not materialize to the extent that it had, say, in 2007, and I think that's a big factor in the decrease in sales from Q4 '07 to Q4 '08," Batty said.

King said that fourth-quarter spending declined among all Affy's pharma customers, but particularly at GlaxoSmithKline. "All of the big eight or 10 pharma customers were good-size customers of Affy," King said. "I would say in the past, GSK was probably the largest with tens of millions of dollars of business with us. That business has really gone down pretty dramatically," he said.

With regards to pharma accounts, King said Affy "shook out a lot of business in 2008 over 2007" and it is "difficult to say" whether the company has "hit bottom" in terms of sales.

King said that Affy is "working very closely on the outsourcing side, as pharma takes a look at other places to do their work." He said Affy has "very good relationships" with a number of clinical research organizations that could "help offset any shift in dollars."

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Three Priorities

To win back that business, Affy will have to move its focus from selling research tools for upstream R&D purposes to selling assays for downstream genomic analysis and validation. He described the downstream market as "high growth," "less constrained by research funding," and "more likely to generate recurring revenue streams."

Central to Affy's downstream move is the integration of Panomics' branched DNA-based QuantiGene assays. Affy acquired Panomics in December 2008 for $73 million to bolster its presence in the markets for biomarker analysis, drug compound screening, in situ gene expression, RNAi monitoring, and DNA copy number analysis tools (see BAN 11/11/2008).

King said that Panomics' QuantiGene assays are sold into an "installed base of more than 5,000 instruments and represent an addressable market of over $1.5 billion." He claimed that the platform is "more accurate" than rival RT-PCR assays; performs well on blood and formalin-fixed, paraffin-embedded sample materials; and is scalable for different throughputs. He said Novartis uses the assay to evaluate "up to 25,000 compounds in a single day."

King said that the company expects adoption of Panomics' assays to contribute to growth in 2009 and predicted that revenues attributable to Panomics' products would bring in around $3.5 million this quarter. Part of Affy's efforts to grow Panomics' business will be to use its sales and marketing resources to spur adoption of QuantiGene assays by Affy's most diehard customers: academics.

"As a company, the vast majority of Panomics' revenue was in industrial segments," King said. "Being a fairly small company, they tended to focus on big customers and industrial customers," he said. "Our opportunity is to take the Panomics products into the academic accounts; our sales teams are now being trained on those products and [will] be able to take to those products to the marketplace," he added.

Priority number two for Affymetrix is to debut new assays to run on the GeneTitan platform it launched in October. The fully automated, 96-sample instrument offers array processing from hybridization to data analysis. Affy has already migrated its existing human, mouse, and rat whole-genome expression arrays to the peg-array format that runs on the GeneTitan and expects to add new genotyping and cytogenetic assays, as well as whole-transcript expression products, to the GeneTitan later this year (see BAN 1/20/2009).

"We think that GeneTitan platform is a terrific platform for the mid- to high-throughput users," King said. "This probably represents upwards of 50 percent of our install base that we will going after. Those are largely core labs, pharmaceutical companies, biotech companies and so forth that use our products."

Two other genotyping products Affy hopes will drive growth in '09 are its DMET Plus panel, which the company recommends for standardizing drug-metabolism studies, and its Cytogenetics Solution, introduced last year, which is used by some diagnostic labs, such as Laboratory Corporation of America, for identifying constitutional genetic abnormalities in neonatal patients.

According to King, Affy's third priority is to continue its consolidation of its manufacturing facilities. King said that in Q4, Affy produced 80 percent of its GeneChip arrays at its plant in Singapore and will manufacture all of its arrays there by the second half of this year. Overall, the company hopes to save between $20 million and $25 million in annual operating expenses thanks to the consolidation.

Over the past three years, Affy has undertaken several restructuring activities. According to the company's most recent filing with the US Securities and Exchange Commission, in 2007, the firm closed its Sunnyvale, Calif., facility and folded its resources into its Santa Clara campus. In July 2008, it decided to close its array-manufacturing facility in West Sacramento and to move GeneChip manufacturing to Singapore.

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Wall Street 'Highly Cautious'

While Affy's fourth-quarter results beat analysts' lowered expectations, Leerink Swann analyst Isaac Ro said in a research note that "we continue to think the core array-based franchise will be challenged as customers increasingly allocate their limited research budgets to [second-generation sequencing] and other novel technologies."

Ro noted that Affy's management is "taking continued steps to re-orient the business," but identified the market's "technology shift" to sequencing as a "key issue" facing the company. "New products and acquired assets are positive, but we think the long-term franchise remains challenged," Ro said.

According to Ro, "research dollars for incremental technology improvements," such as the GeneTitan system, are "scarce" and he expects that Affy will have to be "aggressive when seeking to place these new systems." Regarding Panomics, Ro said he is "unconvinced that this technology can meaningfully offset the pressure in the core research arrays business."

Meantime, Ro predicted that "declining microarray spending among drug companies will accelerate as cost-cutting takes center stage in 2009," hitting a third of Affy's business.

Likewise, Thomas Weisel Partners analyst Peter Lawson said in a note, "We believe Affymetrix possesses competitive product offerings, but sluggish gene-expression markets, pullbacks in pharma spending, and intense competition keep us highly cautious."

Regarding the company's ongoing strategy to rebuild its business, Lawson said that, "While these actions could eventually help to turn around Affymetrix business, we are waiting to see several consistent quarters and clear signs of a turnaround before becoming more constructive."

Shares of Affy's stock were trading at $3.32 on Tuesday morning, down 20 percent from an opening of $4.10 on Thursday, the day when Affy reported its Q4 results. The shares have lost 82 percent of their value since this time last year.

Q4 and FY '08 in Full

Affymetrix reported last week that its fourth-quarter revenues declined 27 percent year over year to $78.6 million for the three-month period ended Dec. 31, compared to $107.6 million for Q4 2007.

Of its total revenues in the quarter, $61.5 million came from sales of consumables, $5.1 million came from instrument sales, $8.5 million came from services, and $3.5 million was derived from royalties and other revenues. Affy noted that it shipped 23 of its flagship GeneChip systems during the quarter, bringing its total systems shipped to 1,813.

Affy posted a net loss of $318.7 million, or $4.65 per share, for the quarter compared to a profit of $12.8 million, or $.17 per share, for the fourth quarter of 2007. The most recent quarter included a $239.1 million charge for impairment of goodwill. It also includes a restructuring charge of $14.3 million compared with a restructuring charge of $2.4 million in the fourth quarter of 2007.

Affy's R&D costs increased 44 percent year over year to $25.4 million from $17.6 million, while its SG&A expenses dropped around 4 percent to $34.4 million from $35.7 million.

For full-year 2008, Affy generated revenues of $410.2 million, compared to $371.3 million for 2007. Those results include $90 million Affy received from Illumina during the first quarter of 2008 related to a legal settlement.

Affy's consumable revenue for the year was $248.9 million, its instrument revenue was $21.5 million, its service revenue was $32.1 million, and its royalties and other revenues were $107.7 million — which includes the payment from Illumina.

The company's 2008 net loss was $307.9 million, or $4.49 per share, versus a profit of $12.6 million, or $.17 per share, for 2007. Its R&D spending increased 16 percent to $84.5 million from $72.7 million, and its SG&A expenses decreased 8 percent to $127.2 million from $138.5 million.

Affy finished the year with $113.3 million in cash and cash equivalents.

Affy officials said that due to the current economic environment and the uncertain role it will have on the firm's business they would only give guidance for the next quarter and not for full-year 2009. The firm expects its first quarter revenues of between $72 million and $75 million.

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