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Affymetrix Blames 12 Percent Q2 Sales Drop on Weak European Performance, Sales Reorganization

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This article was first posted on July 22.

By Justin Petrone

Affymetrix last week reported that delays in instrument purchases in Europe and an internal sales reorganization led to a 12 percent decline in second-quarter revenues as a profit swung to a loss.

Still, the firm's management tried to assuage investors last week that all anticipated orders remain in its pipeline, and that any "disruption" associated with sales restructuring has passed.

Revenues for the three months ended June 30 dropped to $71.7 million from $81.6 million year over year. Affy's net loss for Q2 2010 was $5.5 million compared to a profit of $7.3 million for the second quarter of 2009.

The Santa Clara, Calif.-based array vendor had expected Q2 sales to be between $80 million and $82 million, but earlier this month revised its guidance to $72 million, citing delays in instrument purchases, particularly from customers in Europe, which typically represent a third of Affy's sales (BAN 7/13/2010).

R&D spending decreased around 13 percent to $17.8 million from $20.4 million, while SG&A expenditures fell 10 percent to $28.4 million from $31.7 million.

Affy finished the quarter with $77.2 million in cash and cash equivalents.

Affy shares were trading at $5.52 on July 6, the day before it announced that it would not meet its revenue guidance for the quarter, and plummeted 28 percent the following day to $3.95. They have since inched back up and were trading at $4.32 on Thursday morning, the day after the company announced its Q2 earnings, roughly even with the prior day's close.

In a research note published this week, Leerink Swann analyst John Sullivan noted that, given the firm's revised guidance, shareholders were unlikely to "respond dramatically" to the results.

Sullivan said in the note that new investors will wait for signs of revenue growth before buying in. He noted that the company had made recent gains in efficiency, and was "especially impressed with the gain in product gross margin."

However, he noted that revenue growth is "still a challenge" for Affy, which is looking to offset a decline in demand for discovery-oriented products with new offerings for downstream validation and routine testing.

What Went Wrong

President and CEO Kevin King said during an earnings call last week that the firm identified "three primary factors" that caused it to miss its revenue guidance. The first was delays in orders for new instruments, which comes at a time when Affy is looking to place newer systems, like the high-throughput, automated GeneTitan, and the benchtop GeneAtlas.

King said that in June Affy began to experience a "general lengthening of the purchase cycle and delays for instrumentation that were expected to close in the second quarter." He said the delays were "largely associated" with academic accounts in Europe as planned spending "slowed in response to economic uncertainties," and as a result of budget cuts by endowments and by private foundations.

King said he was "both disappointed and surprised" at the change in Europe during the quarter, and that the firm's European business, which typically accounts for around a third of all sales, tends to be "relatively stable" and "predictable." He said that while Affy experienced delays in purchases in other regions, around two-thirds of such delays occurred in Europe.

"The miss in Europe was quite substantial and instruments clearly had a big factor associated with it," said King. "Did it come on suddenly? Yes, it came on suddenly, because I was forecasting on our business and our European team was generally a pretty good team for forecasting dollars and amounts and so forth," he said.

Still, he said that even though purchases were delayed, the company expects they will close. "Those opportunities remain in the funnel," King said. "If we knew at this point or knew sometime during the end of the second quarter that funding had been rejected, we would have removed those from our sales funnel," he said. "They’re still there, and that funnel continues to grow."

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A second factor was an internal sales realignment. King said that in the first quarter the company made "significant changes" to its US and European territory-management structures that included several weeks of product training.

The sales reorganization was made primarily to integrate Affy's Panomics sales team — which had remained independent since Affy acquired the company in 2008 — into the firm's global sales channels. However, the restructuring "temporarily disrupted the dynamics of the business," causing dips in sales for Panomics QuantiGene and Procarta kits.

King noted that when Affy acquired Panomics, it left its organization separate, as "changing sales organizations is a very difficult thing to do; sales reps have strong relationships with customers, [and] they know where the business is."

At the same time, he argued that the sales organizations "needed to change. Otherwise, the business couldn't continue to grow.

"When we changed, we changed pretty quickly … and we got a lot of the disruption behind us," King said. "We’re moving aggressively to get this back on track as quickly as possible."

A third factor was further deterioration in European currencies, which shed around $1 million off the company's top line. King said that "despite the market and commercial challenges that impacted our revenue during the second quarter," Affy remains confident in its strategy of "expanding the business in the large and growing validation and routine testing markets."

During the call, Chief Financial Officer Timothy Barabe also attributed the firm's lower-than-expected Q2 performance to an anticipated decline in service revenues.

"Much of our service business is being migrated to third-party service providers, and we believe this transition is largely behind us now," Barabe said.

RNA, DNA, and Instruments

Product revenue during Q2 slipped to $65.1 million from $67.2 million during the same period in 2009. Affy breaks its consumables business into two areas: RNA, which is largely equivalent to products used in gene-expression profiling, and DNA, which is mainly comprised of tools used in genotyping.

During the quarter, RNA revenue declined 9 percent to $35.1 million, partially due to the fall in Panomics sales, while DNA revenue grew 7 percent to $23.6 million. King attributed this growth to increased sales of chips for use in genome-wide association studies.

To this end, the firm has released several products so far this year geared to researchers conducting GWAS. The first was the firm's Axiom Genome-Wide ASI Array, which was designed specifically for East Asian population-specific studies.

The Q2 product mix was about 60 percent RNA and 40 percent DNA.

Additionally, Barabe said that instrument sales for the quarter declined to $4.5 million from $5 million in the prior year.

While RNA sales declined during the quarter, King said that array volumes continue to grow and that adoption of the firm's new peg-format Array Plates, which are used with its GeneTitan and GeneAtlas instruments, is "progressing nicely." Sales of peg-format arrays represented about 25 percent of total array shipments during the quarter, King noted.

"On the RNA side of our business, market research among large US academic and industrial labs points toward continued expansion and demand for RNA microarrays," King said. "In our RNA business, volumes were up."

He added that there is an "increasing trend toward the use of our arrays for clinical applications related to cancer, targeted drug therapy and response and custom applications," and that the company has not seen any impact from next-generation sequencing on its RNA array business.

"Related to the impact of sequencing on the microarray RNA market space, [we] certainly hear a lot about it," but "it hasn’t translated in this point into reduced array volumes for us," he said.

This week, the company began offering customers the ability to design custom Axiom arrays using content in Affy's internal database of common and rare SNPs. "This inherent flexibility allows researchers to conduct genome-wide association, replication, fine mapping, and candidate gene studies on a single platform," said King.

According to King, Affy can offer custom Axiom arrays of between 50,000 SNPs and 2.6 million SNPs per sample. He pledged to expand custom array density to allow customers to look at more than 5 million SNPs per sample "in the near future."

Illumina, Affy's main rival in the GWAS market, is similarly planning to debut a 5-million SNP array by the end of this year (BAN 6/29/2010).

"We believe this ongoing expansion of our Axiom platform will increase our market share in both whole-genome as well as targeted genotyping markets and stimulate researchers to initiate new studies of health and disease," said King.

He said the firm's "funnel" of orders related to GWAS is "significantly larger" than it has been in recent quarters, but that the sizes of the studies do not compare to previous rounds of GWAS.

Still, there is renewed interest in doing association studies. King said that there are a number of ethnic population-centric studies being planned in the US, Europe, and Asia, and that there are also a "large number of follow-on studies" to previous GWAS projects that intend to look at rarer variation content.

GWAS has also lifted demand for GeneTitan. King said the pipeline of demand for the instrument is "full, if not fuller than it’s ever been," though he acknowledged the company has experienced "some quality issues associated with the manufacturing build" of the system.

"We’ve had a handful of customers that have had sort of fits and starts, if you will, related to manufacturing and components, and so we’ve had customers that have been down and so forth," said King. "We’ve been able to get those people back up and running … so we’ve had some issues, [but] I think those are behind us."

King said initial customer demand for Affy's benchtop GeneAtlas has been "favorable," and said that the firm placed "several" of the lower-throughput instruments during the quarter. Affy launched the GeneAtlas earlier this year.

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