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Despite Genotyping Growth, Expression Decline Leaves Analysts Skeptical of Affy Turnaround


Weakness in Affymetrix's gene expression microarray business continues to blot the company's outlook, according to observers, despite its recent acquisition of eBioscience and continued growth in cytogenetics and other market segments.

A $17.6 million contribution from eBio enabled Affy this week to report a 24 percent jump in third-quarter revenues, which rose to $79.6 million from $64 million a year ago. However, Affy's Q3 performance missed the consensus Wall Street estimate of $80.7 million and, excluding eBio, Affy's revenues for the three months ended Sept. 30 dipped 2 percent year over year, largely due to a decrease in gene expression array sales.

Affy divides its business into four units: expression, which is 34 percent of its revenue and consists mainly of gene expression arrays and Panomics branched DNA products; genetic analysis, which is 26 percent of Affy's revenue and includes its genotyping arrays for cytogenetics and other applied markets; eBioscience, the San Diego immunoassay and flow cytometry reagents provider the company bought in June, which now generates 22 percent of the firm's revenues (BAN 8/7/2012); and life science reagents, which generates the remainder of its revenues and consists of products gained through its 2008 acquisition of USB.

Of the four business units, Affy's gene expression business continues to face the most challenges. Company executives said during an earnings call that expression sales declined 11 percent year over year, due to a number of factors including competition from next-generation sequencing and lower-priced arrays sold by rivals, as well as a tight academic funding environment.

In the call, CEO Frank Witney conceded that Q3 expression array sales were "a little bit worse than some of the quarters we've seen," but pledged to slow the erosion of the company's expression business to a "more modest" decline with the introduction of new products, such as the firm's recently launched SensationPlus FFPE Amplification and 3' IVT labeling kits. He also noted that Affy's Panomics bDNA kits sold well during the quarter, growing by 5 percent year over year, yet it was not enough to offset the 16 percent fall in expression chip sales.

"While stabilizing our gene expression business has been more challenging than anticipated, we believe that new product introductions can help us bring the revenue trajectory back into the range of more modest declines of between 5 percent and 10 percent," Witney said.
Yet analysts in several research notes this week raised doubt about Affy's prospects to stabilize its ailing expression business. Goldman Sachs' Isaac Ro wrote that Affy's core gene expression business "continues to face structural headwinds" and that the investment bank is "skeptical that visibility will improve in the near term given continued difficulties in the funding environment."

Meantime, RW Baird analyst Jeffrey Elliott wrote that while Affy's management is taking steps to slow the decline, the investment bank is "taking a cautious view on expression" in 2013. And while he wrote that Affy's Q3 decline in expression sales was "not surprising," he called it "disappointing in magnitude."

Other analysts were similarly wary. Dan Leonard of Leerink Swann forecast "greater declines" for the firm's expression business ahead, projecting a 15 percent decline in expression sales compared to Affy's anticipated decline of between 5 percent and 10 percent in coming quarters. And Piper Jaffray's William Quirk predicted that the recent findings of the Encyclopedia of DNA Elements, or ENCODE, consortium will "accelerate the shift from gene expression arrays to alternative methods," such as RNA-seq, a point that Illumina CEO Jay Flatley made during that company's most recent earnings call (BAN 10/30/2012).

"While management is working to stabilize the business, through introducing new products, developing lower-cost array formats, and bundling reagents to increase revenue per sample, we expect the unit to show revenue declines through 2013," Quirk wrote.

'Best Opportunities'

In spite of the projected declines in Affy's expression business, both Leonard and Quirk wrote that they believe the firm will eventually make good on its ambition to return to profitability, with Leonard expecting the firm's business to stabilize in 2014 and Quirk forecasting a "return to positive growth and profitability" next year.

Witney affirmed on the call that Affy's intention is to return to profitability in 2013. "We're going through our planning process now and that's the goal we're setting for ourselves at this point," he said.

If Affy makes good on that objective, it will be due in part to increased growth in its genetic analysis business, especially its arrays for cytogenetics research. Leonard noted that the firm's genetic analysis business has been "gaining traction," and Quirk called Affy's CytoScan offering for the cytogenetics market "one of the best opportunities for [Affy's] legacy array business."

According to Witney, Affy's genetic analysis revenues rose 16 percent in Q3, with growing demand in all geographies for the firm's CytoScan offering and its Axiom family of genotyping products. In the cyto market, Witney said that Affy has 100 customers using its products, 20 of whom adopted its platform in Q3. These new customers are both existing array users who are switching from using competitors' platforms, as well geneticists who were previously using older, microscope-based approaches, Witney said.

The company also expects to finish the clinical validation of CytoScan in the next two months, followed by a submission of the tool to the US Food and Drug Administration for clearance so that it can be used in clinical settings. Affy had previously said it would file CytoScan with the FDA this year, but it now appears that it may happen in the first quarter of 2013 (BAN 6/26/2012). Illumina has also said it plans to submit a package for array-based cytogenetic testing to the FDA this year. Piper Jaffray's Quirk said that the investment bank believes that Affy's San Diego rival could file its offering with the agency before Affy, "potentially being first to market" with an FDA-cleared cytogenetics product.

eBio Integration

One of the reasons that Affy acquired eBioscience was to diversify its revenue streams, given the ongoing declines in its expression business. As the firm projected after announcing the deal last November, after buying eBio, expression sales would comprise 33 percent of its revenues. At the time, expression sales made up 43 percent of Affy's 2011 revenues (BAN 12/06/2011).

At the time of the announcement, Affy executives also noted that eBio was projected to generate $70 million in revenues in 2011, and was growing at around 15 percent annually. But in its first full quarter as part of Affy, eBio revenues grew just 1 percent, leaving some analysts nonplussed about the business unit's performance.

During the call, Goldman Sachs' Ro noted that eBio has been a "double-digit growth business" in the past, and asked management if the acquisition had caused the disruption in growth.

Witney said that the less-than-anticipated Q3 revenues could mostly be attributed to the loss of a large customer that had resulted in eBio's original equipment manufacturing-derived revenues — roughly 10 percent of its total revenues — falling 60 percent in the quarter.

Despite the loss of that client, Witney said that the integration of eBio into Affy is "going well" and that the company forecasts improved growth in the business for the fourth quarter and expects eBioscience revenue to grow in the "mid-single-digits" in 2012 relative to the prior year.

In addition, Witney said that Affy continues to identify "commercial and operational synergies" with eBio, such as integrating its Procarta multiplex immunoassay product line into eBio's commercial operations, and growing eBio's revenue by "extending the geographic reach" of the business, especially in Asia. As an example, he said that Affy began selling eBio products directly in Japan in Q3, rather than relying on distributors, which should help the firm "better serve customers" and expand its margins.

"We remain very enthusiastic about the strategic fit of eBioscience into our focused plan to serve translational medicine and diagnostic customers, as well as the long-term growth potential and overall financial contribution from our eBioscience product portfolio," Witney said.

Elsewhere in Q3

With the addition of sales of eBio's flow cytometry and immunoassay reagents, Affy's product revenues increased to $72.7 million from $57 million a year ago, a 28 percent increase, while services and other revenues narrowed 1 percent to $6.9 million from $7 million a year ago, the firm said.

Within product revenues, consumables revenues totaled $50.5 million, excluding eBioscience, down from $52.9 million a year ago, while instrument revenues were up to $4.6 million from $4.1 million a year ago.

Affy's R&D costs of $16.5 million in the quarter increased 8 percent from $15.3 million a year ago. Its SG&A spending rose 35 percent to $36.3 million from $26.9 million.

Affymetrix's net loss for the third quarter shot up to $17.9 million from a net loss of $9.8 million in the third quarter of 2011.

The net loss for the recently completed quarter included $1.9 million in acquisition-related and integration costs; $4 million in impairment of its West Sacramento facility; recurring amortization of acquired intangible assets of $5 million, and $4.5 million in fair value in the release of step-up inventory. Excluding these items, net loss would have been $2.4 million, Affy said.

Affy ended the quarter with $29 million in cash and cash equivalents and $691,000 in restricted cash.