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Analysts Say Affy Turnaround 'Remains on Track' after Firm Posts 3 Percent Rise in Q2 Revenues

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Affymetrix this week reported a slight uptick in its second-quarter revenues, which increased 3 percent to $66.4 million from $64.7 million in the year-ago period, beating the average analyst estimate of $65.6 million.

After Affy posted its Q2 results, analysts for several investment firms who follow the Santa Clara, Calif.-based company argued that the positive performance was a sign that the company has at last reversed a negative trend in its business that saw organic revenue diminish quarter over quarter for the past two years.

RW Baird's Jeffrey Elliot said in a research note that Affy has "reached an inflection point" after returning to organic revenue growth following "eight quarters of shrinkage," a trend that the investment firm expects will accelerate in the second half of this year. "Momentum appears to be improving," said Elliot, adding that RW Baird thinks that Affy now makes an "attractive investment vehicle."

Likewise, Leerink Swann's Dan Leonard called Affy's Q2 performance a "reasonably solid quarter," and Mizuho Securities' Peter Lawson said that the firm's turnaround "remains on track," citing the double-digit growth of its CytoScan HD and Panomics product lines and the expected "benefits" from the firm's acquisition of flow cytometry reagents provider eBioscience at the end of the June.

Isaac Ro of Goldman Sachs, meantime, cautioned that "end-market headwinds" on Affy's base microarray business will "continue to offset growth from the acquired eBio franchise" and argued that Illumina's array market dominance will make it "challenging" for Affy to recover. He noted, however, that he sees "strength" in eBio's momentum and "potential for integration" with Affy's Panomics products over time.

For CEO Frank Witney, Q2 marked the end of his first year at the helm of the two-decade-old array vendor. During an earnings call this week, Witney attributed Affy's Q2 performance in part to the initial plans he set in place when he took over, especially changes in management.

Over the past year, Affy has "reinvigorated" its management team, Witney said, by recruiting a "number of proven industry veterans" into its commercial organization, including "new global leadership" for marketing and sales, as well as "new geographic leaders in Europe, Japan, and most recently, in North America."

The biggest change of Witney's tenure at Affy occured during the last few days of Q2, when the company closed its buy of eBioscience, an acquisition it first announced last November (BAN 12/6/2011). The acquisition of the privately held San Diego company alters the mix of Affy's revenue sources going forward, making it less dependent on its declining gene expression array business.

Affy's 2011 revenue composition was roughly 43 percent expression; 29 percent genetics, mostly made up of the company's genotyping chips; 13 percent reagents; 7 percent instruments; 4 percent services; and 3 percent royalties.

But with eBioscience, Witney said, in the second half of the year Affy expects its gene expression business to contribute about 36 percent to total revenues; its genetic analysis and clinical business 24 percent; eBioscience revenues 22 percent; and its life science reagents business 10 percent; with the remaining 8 percent coming from general licensing royalties and field services.

While buying eBioscience allows Affy to be less reliant on expression array sales, Witney noted that the company's management changes, new product introductions, and increased focus on growing product lines have revived its array business overall. Despite the increasing ubiquitousness of next-generation sequencing, the number of arrays shipped in Q2 actually grew at a "double-digit rate" year over year. At the same time, Affy is recognizing less revenue per chip than it has in the past, as customers shift to higher-throughput plate formats and "other lower-priced products that drove a lower average selling price," Witney said.

Overall, Witney said that Affy believes that "arrays will continue to be the platform of choice for high-volume and certain clinical applications" because of the "performance, ease-of-use and high-throughput capabilities relative to alternative technologies."

With growth in the array business, and eBioscience now contributing to its revenue streams, Affy is positioned to return to "modest growth" in the second half of the year, Witney said.

'Encouraging Signs'

After Witney became CEO, Affy reorganized into three business units: genetic analysis and clinical, largely comprised of genotyping chips; expression, which includes its expression arrays plus its Panomics product lines; and life science reagents, largely consisting of products developed by USB, a company Affy acquired in 2008. With the acquisition of eBioscience, Affy now maintains four business units, and Witney and other executives provided an update on each during this week's earnings call.

While the company did not break out revenues for each unit, Chief Financial Officer Tim Barabe said that Affy's genetic analysis and clinical revenues increased by $2.9 million, or 17 percent, in Q2, compared to the same period last year. The company's cytogenetics research products, especially its CytoScan HD offering, drove sales, and Barabe said that the CytoScan HD product line "continues to exceed" its expected sales, and that customer feedback is "very positive."

Witney said that CytoScan HD sales grew in all of Affy's "major geographies" and that clinical trials are "progressing well." Affy intends to submit CytoScan HD to the US Food and Drug Administration by the end of the year for use in clinical constitutional cytogenetics (BAN 6/26/2012). Noting that CytoScan sales are "less dependent on academic funding," Witney said that that he believes the product will "fuel [Affy's] long-term growth in a significant way."

While cytogenetics-related sales were up in Q2, the company did experience a decline in sales of its SNP 6.0 whole-genome genotyping array. Affy first launched the 1.8-million marker chip in 2007. Originally marketed for use in genome-wide association studies, it later became a core component of the company's first cytogenetics offering, and is the best selling genotyping array in Affy's history (BAN 7/6/2010).

Witney described the SNP 6.0 array as an "iconic product" and said that it is still selling "very well," but acknowledged that after five years on the market, sales are declining and "that won't turn around." Despite this, he pointed to "very encouraging signs" in the genotyping arena, with sequential, double-digit growth over the past two quarters for the firm's line of Axiom genotyping arrays.

"We still have a lot of work to do in genotyping to regain the kind of reasonable market share, that's one of our goals," said Witney. "But we feel that the signs are encouraging."

One genotyping product Affy hopes will aid in its recovery is OncoScan, a cancer-related mutation detection platform that it currently offers only as a service. Witney said earlier this year that Affy planned to launch a kitted version of OncoScan by the first quarter of 2013 (BAN 2/14/2012).

However, this week he seemed to push the launch date back, telling an analyst on the call that Affy hopes to have an OncoScan kit out by "mid-year 2013." Witney added that customer feedback on OncoScan has been "very strong," its development team is "making very great progress," and "we think that's going to be a real contributor to us going forward."

'Temporary Headwind'

Affy's gene expression and life science reagents businesses did not fare as well as its genetic analysis and clinical business did during the quarter. Revenues derived from expression-related sales fell 8 percent in Q2, or by about $2.7 million. Witney said, though, that Affy has made "progress" in stabilizing its hemorraging expression array menu, noting that the same business unit declined by 14 percent in the year ago period.

Part of that decline is due to Affy's shift to lower-priced, higher-throughput products, which means that it sold more expression arrays in Q2 than it had in the same period last year, but that its total revenues were still down. Witney described the scenario whereby it sells more arrays but makes less money as a "reality of that business" as it responds to customers' requests for more arrays to power larger, higher-throughput experiments. "That's something that we're dealing with, but I think it's responding to the market needs," he said.

Despite the decline, Barabe noted that Affy's Panomics products increased by about 12 percent year over year. Witney had led Panomics prior to its acquisition by Affy in 2008, and upon taking the helm of Affy reverted to a preexisting, specialized sales force to sell its branched DNA products, some of which are run using Luminex's xMAP technology.

During the quarter, Affy announced a deal with Leica Microsystems, a Danaher company, to automate its Panomics QuantiGene View RNA ISH Tissue Assay on the Leica Bond RX staining platform for research applications.

Specifically, under the deal an optimized QuantiGene View RNA staining protocol will be preloaded on the Leica system, and a complete staining kit with probes and detection components will be available from Affy. The firms pledged in May to have the automated assay available in the third quarter, and this week Witney said that Affy still anticipates rolling out the paired offering later this year.

"There's a tremendous amount of interest in in situ RNA detection, and we're seeing some very nice growth out of the product in a manual format," he said. "We think it's an area that's going to grow very, very nicely for us over the next couple of years, and the automation part of it is essential as it moves into more routine applications."

Another ailing business that Affy expects to rebound in coming quarters is its life science reagents unit. Barabe said that revenues derived from the unit fell by about $700,000, or 8 percent, during Q2. He said that Affy terminated a distribution agreement in North America for a "key" life science reagents product and that it expects to see a "temporary headwind" as it transitions to direct sales.

"We anticipate a return to low- to mid-single digit growth with this business in the second half of the year," said Barabe.

Integrating eBio

Regarding Affy's newest business unit, eBioscience, Witney said that the company is trying to ensure the integration of the San Diego firm "goes smoothly." He said that Affy has put "comprehensive retention plans into place" to maintain current eBioscience employees and that the "eBio team knows that it is an important part of our future growth opportunities."

Witney added that since the eBioscience team is now part of a public company, "we're able to offer equity incentives to help create long-term value that ... directly aligns our employees' interests with those of our shareholders."

According to Barabe, eBioscience posted $71 million in sales last year, with about 7 percent year-over-year revenue growth. "We are optimistic about the long-term growth prospects for the business and believe that eBio will be a major contributor to our performance going forward," Barabe said.

Q2

Breaking down its 3 percent Q2 increase in revenues, Affy said that the eBioscience business contributed $1.4 million to total revenues.

Product sales for the quarter totaled $58.5 million, up nearly 1 percent from $58.1 million a year ago, while services and other revenues were up 22 percent to $7.9 million from $6.5 million a year ago.

Product revenues consisted of $53.3 million in consumables revenues, $3.8 million in instrument revenues, and the $1.4 million in eBioscience revenues. That compares to $54.3 million in consumables revenues and $3.8 million in instrument revenues during Q2 2011.

Affy lowered its R&D spending during the quarter 11 percent year over year to $13.6 million from $15.3 million. Its SG&A costs, however, increased 52 percent to $40.5 million from $26.7 million.

Barabe attributed the spike in SG&A to $4.7 million in acquisition-related expenses and an $8.3 million stock-based compensation charge for accelerated stock options for eBioscience employees. He said that the firm's total SG&A also included about $500,000 in SG&A expenses from eBio.

The company turned a profit of $30.9 million, compared to a net loss of $3.7 million a year ago.

The recently completed quarter included an income tax benefit related to the eBioscience deal of $44.7 million; acquisition-related non-recurring costs of $4.7 million; a stock compensation charge of $8.3 million related to the acceleration of stock options held under eBioscience equity incentive plans; and a recovery of a $2.2 million note that had been provided for in full.

On an adjusted basis, Affy had a net loss of $1.2 million.

Affy exited the quarter with $27.4 million in cash, cash equivalents, and restricted cash.

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