Affymetrix Gets Chipped Again

The woes continue for Motley Fool Rule Breakers recommendation Affymetrix (Nasdaq: AFFX  ) , the leading provider of high-density microarray products used in genetic analysis. Costs have spiraled out of control, and first-quarter results were far from impressive.

As expected, gross margin dropped to 68% on account of costs related to the opening of a new manufacturing facility in Singapore in the second half of the year. But a significant increase in SG&A expenses proved an unwelcome surprise, pushing operating margins into negative territory. The company was able to toss a life preserver to earnings through an increase in interest income to $4.3 million from $0.7 million, and a $0.9 million income tax benefit. Even with these large non-operational contributions, diluted EPS still dropped to $0.03, compared to $0.24 in Q1 of 2005.

Negative revenue growth was a big disappointment as well. The company was expecting $91 million in revenues but could only muster $86.4 million. One positive in the revenue numbers: a significantly larger contribution from the company's closest partner, Perlegen, of which Affymetrix owns a 25.4% stake. The biggest problem the company is currently facing is that customers have not been properly trained to use its newest chip, the 500K Mapping Array. With customers not using their inventories, reorders are not being placed. Because Perlegen, whose researchers are proficient in using the new arrays, has been placing reorders, it's likely that solid growth will return once the company has finished addressing the problem in the near future.

Even though Affymetrix has a near monopoly in its gene expression products, and exceptional growth prospects in the genotyping market, the management team remains a concern. First, it has decided to no longer provide guidance. While I normally view this as a good thing, the reason stated was that the market for new genotyping products will be difficult to forecast. This seems like a convenient excuse, considering it comes following several consecutive quarters of missing its own guidance.

What may be happening is that current management may simply not be capable of running a company of this size. A number of missteps over the past year suggest that this may be the case. Product yields for the 500K arrays were initially very poor, forcing the company to unexpectedly speed up its investment in the Singapore facility. Now, operating costs continue to rise while revenues remain stagnant. Unanticipated situations are still plaguing the company.

It seems like a similar situation to that of former Motley Fool Hidden Gems darling FARO Technologies (Nasdaq: FARO  ) . Co-founder Simon Raab decided that he would not be the right leader to take the company to the next level and decided to transition the CEO position to Jay Freeland. He may have been too slow in making the move; operating costs for FARO have skyrocketed, and the last several quarters were well below expectations. If the poor performance continues for Affymetrix, it may be time for co-founder and CEO Stephen Fodor to consider a similar move.

Affymetrix is a Rule Breakers pick. Take the newsletter dedicated to finding the best up-and-coming companies for a free 30-day trial.

Fool contributor John Bluis owns shares of FARO Technologies. He does not own shares of any other company mentioned in this article. The Fool has an ironclad disclosure policy.

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