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Affymetrix Advances

After an abysmal 2006, Affymetrix (Nasdaq: AFFX  ) continues to turn things around. Yesterday, the company even announced a small second-quarter profit.

Revenue was up 10%, mainly thanks to new product introductions. The top line also got a boost from $4.4 million in sales to Affymetrix's genome analysis subsidiary, Perlegen Sciences, more than doubling the year-ago amount. Perlegen is using Affymetix's technology to map the genomes of 50 individuals, then using that data to help collaborators, including Genentech (NYSE: DNA  ) and Pfizer (NYSE: PFE  ) , find targets for drugs. Unfortunately, revenue from Perlegen will decline in coming quarters as that large project winds down.

More importantly, the company was also able to swing its bottom line from a year-ago loss of $10.1 million to a gain of $1.2 million this quarter, thanks partly to a 13% reduction in operating expenses. The company is growing more efficient, managing to decrease selling, general and administrative costs despite increased sales.

 Still, Affymetrix has a ways to go to regain the heights of its 2005 heyday. For this quarter, it actually had a net loss from operations, saved only by interest from its cash and securities. The company has built up capacity faster than sales, depressing gross margins as the factories making its chips work at less than capacity. As the company continues to increase sales, gross and net margins should rise, pulling income from operations into the black.

New products and services
Affymetrix launched its new Genome-Wide Human SNP Array 6.0 this quarter, a few months ahead of schedule. The chip contains more than 1.8 million genetic markers -- more than twice the markers available on its 5.0 chip. More importantly, it contains 800,000 more markers than its rival Illumina's (Nasdaq: ILMN  ) largest chip.

The higher density of the markers on the chip means that researchers can often get sufficient data from just one experiment per sample. With previous lower-density chips, researchers have to do a general scan of the genome with one chip. They must then repeat the experiment with another chip containing a higher density of markers from the interesting area of the genome discovered in the first experiment. In bioscience research, time is money; halving the number of experiments is certainly a strong selling point for Affymetrix's new product.

Customers are adopting the 6.0 chip relatively quickly, even with a 50% higher price tag than its predecessor. The new chip was only available for the last four weeks of the quarter, but it represented about 35% of the sample volume for all of the company's genome products.

In addition to expanding its product line, Affymetrix has moved into the clinical services field through its subsidiary, Affymetrix Clinical Services Laboratory (ACSL). In April, it received Clinical Laboratory Improvement Amendments (CLIA) certification from the state of California. The CLIA certification allows ACSL to begin offering microarray-based molecular diagnostic patient and clinical trial testing services. The lab will offer personalized medicine by testing for the presence or absence of certain genes. That profile gives doctors a better understanding of which drugs a patient will respond to. In addition, the company will collaborate with drug-development companies to test patients before they are enrolled in clinical trials. By only enrolling patients who are likely to respond to a drug, pharmaceutical companies can increase the likelihood of getting positive clinical trial results.

ACSL currently has two pharmaceutical projects under way, and it's recently teamed up with DOCRO, a contract research organization (CRO) that specializes in the commercialization of in vitro diagnostic (IVD) biomarker technologies. That collaboration should allow ACSL to bring in more diagnostic customers, because the pair can now offer a one-stop shop for customers developing IVDs.

The competition
Rival Illumina swiped substantial market share from Affymetrix last year, and it continues to set record sales volumes. Because of the high cost of the machines that run the chips, many labs will pick only one type of machine, then be stuck with that type of chip until the device is retired. Thus, having the technology with the largest number of markers on its chips not only results in instrument sales now, but drives chip and other reagent sales well into the future. We'll have to see whether placement of Affymetrix machines increases now that it has the industry's largest chip.

Illumina and Affymetrix seem to be slightly distinguishing themselves from one another. Affymetrix is getting into clinical diagnostics, while Illumina is venturing into sequencing with this year's acquisition of Solexa. The two will certainly clash in the genome analysis field, trying to one-up each other with the most markers on their chips. But with both companies announcing deals with genome centers almost every week, it appears that there's plenty of market share to go around.

Determining which gene chipmaker to invest in really comes down to how quickly Affymetrix can emerge from its slump. A full quarter of sales of the 6.0 chip should give investors a better idea of the demand for the new product. If Affymetrix can increase demand and continue to lower its cost of operations, it won't need a high-tech test to predict stronger profits ahead.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Affymetrix is a Rule Breakers recommendation. Pfizer is an Inside Value selection. The Fool's disclosure policy is rock-solid.

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