Thursday, May 14, 2009

More 'Aaugh' Moments at Affymetrix

Affymetrix (AFFX-$4.44) reported a 12 percent drop in product gross margin to 47 percent of sales for the March quarter, due to costs associated with the closing of its West Sacramento plant and average selling price declines in RNA consumables. Nonetheless, chief executive Kevin King told analysts on the earnings call that the genotype instrument maker continued to make steady progress against corporate goals of expanding its GeneChip ® technology platform into new markets and improving operating leverage. The 10Q Detective is less sanguine about the company’s ability to deliver sustainable profitability and generate growth in markets that are downstream from genome-wide analysis, such as pharmacogenomics.

Expanding into new markets

Looking to expand the diversity of its customer base beyond the cytogenetics market, Affymetrix purchased Panomics in November 2008. The acquisition will complement the company’s recently acquired liquid array technology, enabling the company
to address low to mid-plex genetic analysis requirements more effectively in the future, according to Rob Lipshutz, Affymetrix’s senior VP, corporate development. Although Affymetrix now offers a scalable, cost-effective platform with applications in fields from copy number research to drug metabolism solutions (identifying chromosome abnormalities that impair metabolism), investors should remember that business depends on the research and development spending of customers, specifically in the life sciences. As companies in the pharmaceutical industry continue to cut their own costs because of the economic downturn and lost sales to generics (as blockbuster drugs lose patent protection), further reduction in demand for Affymetrix’s products is likely in coming quarters.

Another restructuring

In recent years, Affymetrix has engaged in numerous initiatives to reduce costs across its operations and generate sustainable profitability. The latest restructuring plan to “optimize production capacity and cost structure,” started in February 2008 and involves moving probe array manufacturing from Sacramento to Singapore, consolidating reagent manufacturing to the Cleveland facility, and outsourcing the instrument manufacturing operations. At December 31, the accumulated deficit stood at $416.4 million.

Relocation Assistance

On the conference call, King projected a $20 to $25 million reduction in annual operating expenses as a result of the ongoing steps, with realization of these savings beginning in the second half of 2009. Of subtle interest, King has yet to buy a home in California—two years after being hired by the company. Does this suggest a dearth of confidence in his rhetoric? In 2008, Affymetrix reimbursed $138,996 to King for his “temporary” housing expenses, according to the
2009 proxy filed on Monday.

Should I stay or should I go now?
Should I stay or should I go now?
If I go there will be trouble
An if I stay it will be double
So come on and let me know
~ The Clash

King joined the company as president in 2007 and took over the top job from Affymetrix founder Stephen Fodor on January 1, 2009. As part of the December 2006
offer letter to King, the board also agreed to absolve him of any potential loss in the sale of his primary residence in New Jersey. As a result of market conditions, the company recognized a loss of approximately $400,000 upon the resale of the house in April 2008.

In aggregate, stockholders are on the hook for more than $419,000 in relocation expenses (plus a $100,000 signing bonus). Given continued softness in customer demand and falling prices per data point for genotyping over the last two years, we remain unconvinced that Affymetrix will realize the expected benefits from recent restructurings and new hires, including that of King.

Editor David J Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

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