Affymetrix Management Discusses Q4 2012 Results - Earnings Call Transcript

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 |  About: Affymetrix, Inc. (AFFX)
by: SA Transcripts

Affymetrix (NASDAQ:AFFX)

Q4 2012 Earnings Call

January 31, 2013 5:00 pm ET

Executives

Doug Farrell - Vice President of Investor Relations

Franklin R. Witney - Chief Executive Officer, President and Director

Timothy C. Barabe - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

William R. Quirk - Piper Jaffray Companies, Research Division

Daniel Brennan - Morgan Stanley, Research Division

Bryan Brokmeier - Maxim Group LLC, Research Division

Travis Steed - Macquarie Research

Rafael Tejada

Joel Kaufman - Goldman Sachs Group Inc., Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Peter Lawson - Mizuho Securities USA Inc., Research Division

Justin Bowers - Leerink Swann LLC, Research Division

Operator

Greetings, and welcome to the Affymetrix Fourth Quarter and Fiscal 2012 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Doug Farrell, VP for Investor Relations for Affymetrix. Thank you. You may begin.

Doug Farrell

Thank you, operator, and good afternoon, everyone. Welcome to the Affymetrix Fourth Quarter and Fiscal 2012 Conference Call. At the close of the market today, we released our operating results for the fourth quarter, as well as the full year. If you haven't had a chance to review the press release yet, you can obtain a copy at our website at affymetrix.com. Joining me on the call today is our President and CEO, Frank Witney; as well as our Chief Financial Officer, Tim Barabe.

I would like to remind callers that our discussion may include forward-looking statements about future expectations, plans and prospects for the company. We believe these statements are based on reasonable assumptions, but actual results may differ materially from those indicated. Important factors which could cause actual results to differ can be found in our forward-looking statements and are detailed in our SEC filings. It's our intent that these forward-looking statements be protected under the Safe Harbor created by the Private Securities Litigation Reform Act of 1995. We encourage you to review these statements carefully, as forward-looking statements are made as of today's date, and we make no obligation to update this information. Additionally, we will be discussing GAAP and non-GAAP measures. A full reconciliation of non-GAAP measures can be found in today's press release or on our website. And as a reminder, this call is being recorded and the audio is being webcast over the Internet from our homepage at affymetrix.com.

So with that, let me turn the call over to Frank.

Franklin R. Witney

Thank you, Doug. Good afternoon, and thanks for joining us today. It's been about 18 months since I became the CEO at Affymetrix. When I joined the company, we were experiencing several years of declining financial performance and we needed a plan to stabilize the core business and revitalize the company for growth. We are now executing on a plan that has 3 phases: Phase 1 is stabilization of the core business and realignment of our portfolio, which is now essentially complete; Phase 2, which we see spanning this over 2 years, is to drive the sustainable and profitable growth and strengthen our balance sheet; Phase 3 will be the period after 2014, and our goal is to have transformed the company into a leader in translational medicine, molecular diagnostics and applied sciences.

I believe we've made real progress in stabilizing the business last year. We did this through aggressive investment in our Genetic Analysis business, a reinvigorated go-to-market strategy in Gene Expression and the acquisition of eBioscience. All these actions resulted in a realigned portfolio, which has diversified our revenue streams and opened up new avenues of growth.

In addition, we've made investments in our commercial organization in Asia Pacific, particularly in Japan and China, as well as in Brazil. We finished 2012 on a positive note, growing our revenue by 2% year-over-year in Q4, despite a challenging environment for academic spending. In constant currency, our revenues, excluding eBioscience, were down about 2% for the full year compared to 2011. We experienced a decline of 14% in 2011 compared to 2010.

We're now moving into phase 2 of our strategic plan, which is designed to drive sustainable and profitable growth through a focus on serving the growing needs of translational science and clinical diagnostic customers, as well as applied markets combined with the reduction in our operating expenses. We are committed to growing the business and being profitable in 2013, and we are targeting a non-GAAP EBITDA margin in the mid-teen range, which is based on our guidance for total revenue of $330 million or greater. This guidance assumes that legislators are able to reach budgetary agreement that would avoid sequestration and major cuts in funding to the national institute of health, which represents roughly 25% of our customer base.

In the meantime, we continue to monitor our U.S. customers closely and maintain a tight control of our costs which will enable us to better weather through a period of reduced academic funding. While we are focused on returning to sustainable top line growth, it was also clear that we had to improve our cost structure. In order to improve our profitability in 2013, we implemented a corporate restructuring that will significantly reduce our total operating expenses in 2013. We expect that this action will reduce our expenses by about $25 million on an annualized basis, including a $5 million reduction in our cost of goods sold. While these decisions are never easy, the company is evolving and so are the skill sets and infrastructures that we'll need to succeed.

Before I review each business unit, I'd like to provide some additional color on our overall array sales. In both the fourth quarter and the full year, we generated double-digit growth in array volumes, driven primarily by strong growth of our CytoScan and Axiom product lines, underscoring the robust customer demand for raising our strategic growth areas.

As we've reported in recent quarters, there was a mix shift in our Expression business to lesser expensive arrays, which contributed to the pressure on our Expression revenue. Given the increasing demand that we're seeing in both side of genetics and genotyping, we expect to see overall volumes up again this year.

I'll begin our business unit discussion with Gene Expression, which declined by 10% in the fourth quarter, within our previous guidance, we're declining in the 5% to 10% range. The gene shift segment of our Expression business declined 14%, while the Panomics business grew about 11%, driven primarily by 60% growth in our QuantiGene ViewRNA molecular pathology offering, and roughly 39% in Procarta, our multiplex immunoassay offering.

The decline in the gene shift business was driven primarily by lower revenue from our legacy IVT products, down about 23%, which was partially offset by 2% growth on our whole transcriptome and mRNA line of arrays, which includes human, mouse and rat and other model organisms.

In Q4, we launched the new miRNA array on the GeneAtlas strip format, allowing us to enable miRNA screening at about $150 per sample, the most affordable price point in the industry.

For 2013, we expect the total Gene Expression will represent less than 1/3 of our total revenue, and another 30% for array expression, which includes our QuantiGene and Procarta product lines. This was down from over 50% of our total revenue just 2 years ago. This shift was driven by strong growth in our Genetic Analysis business and a significant diversification of our revenues through the acquisition of eBioscience.

Turning to genetic analysis. Continuing our year-long trend, we had a solid fourth quarter in our Genetic Analysis business unit, which grew by 31% over the prior year. For the year, we're pleased to report that Genetic Analysis grew by 17%. The primary growth drivers in the quarter and for the year were our cytogenetics platform, which grew strongly in all geographic regions, and improved commercial momentum in genotyping. Our Axiom Genotyping platform grew by more than 100% in the quarter and 45% for the full year.

In cytogenetics, our CytoScan revenue grew by more than twofold compared to the fourth quarter of 2011. For the full year, our cytogenetics portfolio grew from $10 million to about $30 million, now representing about 10% of our overall revenues, underscoring strong adoption. We have already achieved significant penetration in North America and anticipate further gains, which in conjunction with continued growth in both Europe and Asia, will help fuel strong growth in our cytogenetics revenue over the next few years.

In the last 12 months, we've more than doubled the number of customers that are purchasing our cytogenetic products and we currently have a customer base of more than 180 accounts. We are on track to submit our CytoScan product for review by the U.S. Food and Drug Administration and our filing is imminent. The initial indication that we are targeting is for postnatal applications. This will remain an important growth driver and should not be impacted by the tighter environment for academic funding nor materially impacted over the next few years by NGS. We intend to drive hard on large markets such as cancer and we plan to explore the opportunities to create companion diagnostics. It's important to note that customer feedback from the users that have scaled their usage on the platform has been extremely positive.

Shifting to genotyping. We continue to extend our portfolio of axiom-based genotyping products in both human and Ag-Bio applications. As previously mentioned, we are driving strong growth in our Axiom genotyping platform. This growth results from our expanding catalog offering, as well as targeted products designed in collaboration with researchers in both the human and Ag-Bio sectors.

Earlier this month, we attended the Plant and Animal Genome Conference in San Diego, and customer interest in our Axiom platform was strong. We recently partnered with International Buffalo Genome Consortium to develop a state-of-the-art genotyping array, which included de novo sequencing and assembly of the Mediterranean buffalo genome followed by SNP discovery and selection for the creation of a genotyping platform -- genotyping panel. Buffalo are one of the most important animals for both beef and dairy products in Italy, Brazil, and many other -- and many developing nations. We also collaborated with Breedwheat, a project driven by 13 public research units from various universities and institutes across France, as well as 13 cooperative and private companies to develop a 420K marker array for the world's most widely consumed crop. We believe that this is the most comprehensive tool for studying the genetics of wheat to identify various traits that impact yield, quality and resistance to drought and insects.

We generated healthy growth in our scientific services genotyping business in the fourth quarter doubling our service revenue over the prior year. We have a strong pipeline for genotyping services in 2013, which will provide another important avenue for growth in the year ahead.

During Q4, we also launched a new array, the Axiom Biobank array designed in collaboration with thought leaders around the world, which is designed as an advanced tool with the most up-to-date content from new sequencing efforts for screening the vast number of samples stored in human biobanks around world. We made initial shipments in Q4 and are now engaged in discussions on access to this product and customized versions of it.

In an extremely important development, in the first half of this year, we'll introduce a new Axiom 384 format, which will significantly reduce our cost of goods, as well as increase our throughput by 400%. This product format, in which 384 arrays are displayed on a single plate and processed in an automated manner on our GeneTitan system for Gene Expression and genetic variant monitoring, designed to meet the rapidly evolving needs for extremely high throughput and routine monitoring of genetic variation. We expect that this product will significantly strengthen our competitive position and help drive our growth in the Ag-Bio segment, where routine genotyping and marker-directed breeding is increasingly widespread. The Ag-Bio market currently exceeds $100 million annually, so this will be an important growth driver.

In addition, early voice [ph]of customer from the human genetics community feedback in -- from the human genetics community indicates the throughput and price point for this novel platform achieves -- that will find usage in fine mapping studies. We'll update you on our progress on the Axiom 384 format during the course of the year.

Our Life Science reagents business generated revenue of $7.8 million in the fourth quarter, flat compared to the same period in 2011. We anticipate that this business, which has roughly 30% operating margins, will grow in the low single-digits in 2013.

Turning to eBioscience. We're pleased with the team's performance as we completed the acquisition in late June. For the fourth quarter and full year, eBioscience grew revenue by 6% and 5%, respectively, on a constant currency basis, which we feel good about, given the cautious environment for academic spending. We expect that eBioscience will represent about 22% of our revenue in 2013, and grow in mid-single digits. We intend to drive future growth through continued innovation in both their flow and immunoassay platforms, through new product launches and by leveraging our global sales channel to increase our market share, especially in Europe and Asia.

Further, we believe we can expand our multiplex immunoassay revenues by leveraging our Luminex partnership in combination with eBioscience expertise and antibody development.

Finally, we'll be launching this quarter an early access program for QuantiGene flow RNA, which is a novel solution for low flex analysis of RNA expression in single cells by flow cytometry. We have received very positive feedback from our beta site and look forward to establishing this unique capability as an important research tool.

In operations, we implemented a number of significant operational initiatives in the quarter. First, we converted eBioscience to a direct distribution channel in Japan for improved access to customers, new cross-selling opportunities and to drive margin expansion. We consolidate our instrument manufacturing for the RUO and DX versions of GCS 3000 in Singapore. This will result in reduced cost of goods and improved control over inventory and delivery.

In addition, we are transitioning our Procarta Luminex-based immunoassay product line to the eBioscience immunoassay center of excellence in Indiana. We anticipate reduced cost and an expanded product line as a result of this initiative. We also signed an eBioscience office facility leased to a third-party. eBioscience is only using about half the space and they've been trying to settle out the building for the last couple of years. This move should save us roughly $1 million this year with no impact on operations.

Lastly, I'd like to give you an update on the changes in our management team. As we announced earlier this month, Tim Barabe intends to retire as our CFO once we've recruited a successor. While still early on our search, I'm happy to tell you that we've identified a number of excellent candidates and we hope to have Tim's replacement on board by the middle of the year.

In closing, 2012 was a pivotal year for Affymetrix. We completed our reorganization in business units to drive accountability and improve visibility. We strengthened the management team and we completed the acquisition of eBioscience, diversify our business and open up new opportunities for growth. We firmly established our CytoScan product as a significant product in the array-based cytogenetics market and continue to gain momentum with our Axiom genotyping line.

In addition, we undertook a restructuring program aimed at driving operational efficiency, sharpening our development and commercial priorities and accelerating our return to profitability.

Now I'd like to turn the call over to Tim to review the details of our operating results.

Timothy C. Barabe

Thank you, Frank, and good afternoon, everyone. Before I review our operating results for the fourth quarter of fiscal 2012, I'd like to provide some additional color on the restructuring we announced earlier this month. While we continue to improve the fundamentals of the business including generating top line revenue growth in 2 of the last 3 quarters, our overall operating expenses were still running too high as a percentage of our total revenue.

We have significantly reduced our total operating expenses for 2013, removing more than 10% of operating expenses and roughly 4% of our cost to goods sold from the Affymetrix core business. This will drive a significant improvement in profitability for the full year.

Now I'd like to review the details of our operating results for the fourth quarter and year ended 2012. For the fourth quarter of 2012, the company recorded revenue of $84.4 million, which included $18.1 million from eBioscience as compared to $65.1 million for the same period last year. Excluding eBioscience, revenue increased $1.2 million or 2%, primarily due to higher CytoScan and Axiom revenues in the genetic analysis business unit.

For the full year of 2012, the company reported total revenue of $295.6 million, which included $37 million from eBioscience, as compared to $267.5 million in 2011. Excluding eBioscience, revenue was down $8.9 million or 3%, which is 2% on a constant currency basis, primarily due to lower chip revenues in the Expression business unit, partially offset by increased CytoScan and Axiom revenues in the genetic analysis business unit.

Turning to the detail. Fourth quarter product revenue was $76.4 million including revenue from eBioscience as compared to $58.7 million for the fourth quarter of 2012. Excluding eBioscience, consumable sales were $53.1 million, down from $54.9 million in the fourth quarter of 2011. Instrument sales for the quarter were $5.2 million compared to approximately $3.8 million in the prior-year quarter. Service and other revenue was $8 million-- $8.0 million, compared to $6.4 million in the fourth quarter of 2011.

For the full year, product revenue was $266.1 million, which includes revenue from eBioscience, as compared to $241.3 million in 2011. Excluding eBioscience, consumable sales were $210.7 million, down from $225 million in 2011. Instrument sales for the year were $18.4 million compared to approximately $16.3 million in 2011. Lastly, service and other revenue was $29.6 million compared to $26.2 million in 2011.

Turning to gross margin. For the fourth quarter ended 2012, total gross margin was 54% compared to 53% in the same period of 2011. Excluding non-GAAP adjustment such as the amortization of step up in inventory fair value of $4.6 million and amortization of acquired intangibles of $1.5 million, non-GAAP gross margin was 61%, which is 7% absolute percentage points above the fourth quarter of 2011. For the year ended 2012, total gross margin was 55% as compared to 59% in 2011.

Excluding the cost of inventory step up of $9.4 million and the amortization on acquired intangibles of $4.0 million, adjusted total gross margin in 2012 was up 1 point to 60% compared to 2011. Total operating expenses for the fourth quarter were $54.4 million, up from $45.5 million incurred for the same period last year.

Our fourth quarter 2012 expenses included the following items: Amortization of acquired intangible assets of $3.4 million; restructuring charges of $1.8 million; acquisition and integration-related charges of $600,000; and non-GAAP operating expenses of $8.1 million for eBioscience, expenses that were not incurred in 2011.

For the full year, total operating expenses were $202.6 million compared to $173.2 million in 2011. 2012 results included amortization of acquired intangible assets of $8.8 million, acquisition and integration-related charges of $8.2 million, share-based compensation expense of $8.3 million related to the acquisition of eBioscience, restructuring charges of $1.8 million and non-GAAP operating expenses of $16.5 million year-to-date for eBioscience, which were not incurred in 2011.

Turning to R&D. R&D expenses for the fourth quarter of 2012 were $14.5 million, which included $1.9 million of R&D expenses from eBioscience. This compares to $16.7 million during the fourth quarter of 2011. Excluding eBioscience, R&D expenses were down $4.1 million or 25% in the quarter ended December 31, compared to the fourth quarter of 2011. The decrease was primarily due to lower headcount-related costs partially offset by increased spending on clinical trials.

For the full year, R&D expense was $57.9 million, which included $3.8 million of R&D expenses from eBioscience. This is compared to $63.6 million in 2011. Again, excluding eBioscience, R&D expenses were down $9.5 million or 15% in 2012 compared to 2011. The decrease was primarily due to lower headcount-related costs partially offset by increased spending on clinical trials.

SG&A expense was $38.1 million during the fourth quarter of 2012, including $9.5 million from eBioscience. After adjusting for eBioscience and the amortization of acquired intangibles and integration-related costs totaling $1.0 million, Affymetrix non-GAAP SG&A expenses were $27.6 million. This compares to fourth quarter of 2011 non-GAAP SG&A expenses of $25.1 million, which included a non-GAAP adjustment of $765,000 related to the amortization of acquired intangible assets and $2.9 million of acquisition-related expenses. The increase in adjusted SG&A expenses of $2.5 million or 10% was primarily related to increased spending on sales and marketing activities. For the full year of 2012, SG&A was $142.9 million compared to $109.6 million in 2011. Included in 2012 expenses are $26.1 million from eBioscience, $8.3 million in share-based compensation costs on accelerated stock options, $7.1 million in acquisition-related costs, and $2.7 million in amortization of acquired intangible assets. Without these charges, SG&A was $98.8 million, which was slightly below the adjusted 2011 amount of $103.6 million.

As previously discussed, following the announcement on January 28, 2013 of the reduction in workforce, the company recorded $1.8 million in restructuring-related charges in the fourth quarter of 2012. The remaining estimated total amount of $5 million will be recognized in the first quarter of 2013. Interest expense and other net was approximately $1.6 million in the fourth quarter of 2012, primarily due to interest expense from increased debt obligations from the acquisition, offset by the recognition of $500,000 gain on the sale of our West Sacramento facility. This compares to an interest expense and other net of $3.7 million for the prior-year quarter.

For the year ended December 31, 2012, interest expense and other was $7.5 million compared to $10.1 million in 2011. 2012 figures included a net impairment on the West Sacramento property of $3.5 million, offset by the recovery of a note receivable of $2.2 million. Overall interest expense increased due to our increased debt obligations.

In the fourth quarter of 2012, we recognized a $1.4 million tax provision. For the full year 2012, we had a benefit of $35.9 million, primarily due to $37.5 million recognized related to the acquisition of eBioscience. During the fourth quarter of 2012, we generated a net loss of $12.3 million or $0.17 per diluted share. Non-GAAP net loss was approximately $1.3 million or $0.02 per diluted share. This compares to a non-GAAP net loss in the fourth quarter of 2011 of $8.3 million or $0.12 per diluted share.

For the full year, we generated a net loss of $10.7 million or $0.15 per diluted share. Non-GAAP loss last year was approximately $6.8 million or $0.10 per -- sorry, non-GAAP net loss in 2013 was approximately $6.8 million or $0.10 per diluted share, and this compares to an adjusted non-GAAP loss in 2011 of $13 million or $0.18 per diluted share.

To facilitate the analysis of the company's core operating results, I'd like to summarize non-core adjustments to our net loss for the quarter and their impact on pretax earnings per share. In the aggregate, these adjustments amounted to $10.9 million or about $0.15 per share, decreasing GAAP net loss and include within gross margin, $6.1 million or $0.09 per share in the amortization of acquisition-related intangibles, including $1.5 million for acquisition-related intangibles and a step up in fair value of $4.6 million.

In operating expenses, approximately $220,000 in R&D and $3.2 million in SG&A for a total of $0.05 per share at acquisition-related intangibles amortization. We also had integration-related costs of $600,000 or $0.01 per share in SG&A expenses. We had $1.8 million in restructuring charges or $0.03 per diluted share.

Now I'd like to turn to the balance sheet. We ended the fourth quarter of 2012 with total cash and available for sale securities of $35.7 million as compared to $39.6 million at the end of the third quarter of 2012. This ending balance includes the impact of paying the entire 2013 principal of our senior debt or $9.6 million in December. Capital spending was about $1.7 million and we incurred licensing charges of roughly $100,000. Depreciation and amortization was approximately $15.3 million, including the amortization of acquired intangible assets and inventory step up. Operating expenses for the fourth quarter included $2.4 million in stock based compensation charges. Accounts receivable were $53.9 million, up from $52.5 million at the end of the third quarter of 2012, due to the increased revenue recognized during the fourth quarter.

Net inventory for the fourth quarter of 2012 was $84.5 million, down $5.1 million or 6% compared to the third quarter of 2012, primarily driven by $4.6 million amortization expense recognized in the fourth quarter on a fair value inventory step up. Compared to December 31, 2012, inventory increased $41.6 million, primarily representing the acquisition of eBioscience. We exited the fourth quarter in strong financial position with total cash and available securities of $35.7 million versus $73.3 million in senior secured debt, leaving us with approximately $38 million in net debt excluding convertible debt. In early January, we completed a tender for the remaining $3.9 million of our 3.5% convertible debt from 2007. We generated $2 million in cash from operations in the fourth quarter and we expect to be strongly cash flow positive in 2013. Our plans are to continue to aggressively pay down our senior debt and we plan to repay our principal obligations for 2014 in the 2013 fiscal year.

At this point, I'd like to turn the call back to Frank for closing comments.

Franklin R. Witney

Okay. Thanks, Tim. Looking ahead, in 2013, we expect to grow our revenues to $330 million or greater, which is built on the assumptions that we generate solid, double-digit growth in our genetic analysis unit, mid-single digit growth in our eBioscience business unit, low single-digit growth in our LSR business, and roughly decline 10% in our Gene Expression business unit. We'll continue to maintain tight controls in our operating expenses, identify opportunities for margin expansion, and we expect to achieve non-GAAP EBITDAO operating margin that is in the mid-teen range.

As you can see from our non-GAAP reconciliation, we expect to generate EBITDAO of more than $50 million in 2013, which will drive strongly positive cash flow. We intend to use our positive cash flow to accelerate the payment of our senior debt that which will strengthen our balance sheet and provide greater strategic flexibility for the company.

At this point, we'd like to open up the call for any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Bill Quirk with Piper Jaffray.

William R. Quirk - Piper Jaffray Companies, Research Division

First question, Frank, can you elaborate on the -- what looks like in an acceleration in your new customer wins for cytogenetics, if I'm doing the math right here, I think, you added about 80 customers or so in the fourth quarter versus, I believe, 20 in the third quarter. I guess, what's -- can you talk to us a little bit about what's driving this acceleration here?

Franklin R. Witney

Well, I think, to a certain extent, we're getting more and more recognized as having a superior product for this particular application. We're establishing a broad and expanding customer base in North America and we're also driving hard in Europe and in Asia. I think the community is recognizing, discussing amongst themselves that the product is a very strong product, and so we're just continuing to gain momentum. Clearly, the drivers of that are the dilution and the copy numbers, analysis, as well as the SNP content on the array. So I think the product's reputation is very good. People are getting great results. It's an integrated community, and people are recognizing the value of the product that we're delivering to them.

William R. Quirk - Piper Jaffray Companies, Research Division

Okay. And then secondly, Frank, you talked about some of the initiatives that are coming along that are part of the restructuring program in terms of finding a subletter for space, shifting formats on the Axiom array. Can you help us think a little bit about the pacing of the cost savings throughout 2013? It sounds it will probably -- it's probably going to accelerate as the year goes on?

Franklin R. Witney

Yes, let me make a quick comment and I'll turn it over to Tim, but we took the majority -- the majority of the actions were taken in early January, and we took a -- Tim will detail it, we've taken a majority of the charge for that. So we spent several months in the planning stage, and then when we announced the restructuring, we're good to go on the vast majority of the cost savings. Tim?

Timothy C. Barabe

I would just add that -- to reiterate what Frank said that the vast majority of the cost savings are happening now. In terms of facility consolidation, eBioscience moves into their new building tomorrow, so those savings will start immediately. Someone else has taken over the lease that we previously had. We are working on a few other facilities consolidations that will probably happen over the next few months. But I would say the lion's share of the savings are being realized already. There are few more that will probably trickle in to the second and third months of this quarter. But by and large, the savings are occurring now.

William R. Quirk - Piper Jaffray Companies, Research Division

Okay, perfect. And then last one for me. My last question actually is, I think, probably an appropriate one for you Tim, an accounting question. And that is just thinking about the working down in the long-term inventory. Any risk here to have it to maybe take a charge or write any of these down by chance?

Timothy C. Barabe

Yes, good question, and thanks for asking it. We have very, very healthy reserves on the inventory. The vast majority of the increase in the inventory was the step up. EBioscience has very high margins. We've indicated to you before that their margins are in the order of 70%. So we had to write their inventory up to fair market value. So the vast majority of that will disappear over the next 2 or 3 quarters. They do hold a little bit of work process that's longer than a year or so, so there's a little bit that will go on past that. But they have very good procedures for recognizing reserves on inventory, and we think we're more than adequately protected, both the eBio business, as well as the Affymetrix business. And I think I would just note that with -- and I'm knocking on wood here, certainly, excess and obsolete inventory was less than half in 2012 what it was in 2011. So we feel that we've gotten that situation under control.

Operator

Our next question comes from the line of Daniel Brennan with Morgan Stanley.

Daniel Brennan - Morgan Stanley, Research Division

First off, just on sequestration. Guys, can you just -- so you're not factoring that in, I guess, to your guidance. And sorry if I missed this in the prepared remarks, but how should we think about it if it actually comes to transpire? What will be the impact in new business and kind of what are you guys prepared to do in order to kind of offset some of the headwind from that?

Franklin R. Witney

Yes. It's difficult to model it down with the level of precision. As we said, 25% of our customer, our global customer base is funded by NIH money. We're continuing to control -- look at our cost very carefully and monitor North America customers. On the other hand, there's an offset to that in a sense that our Cyto business is not -- would not be largely impacted or at all by the sequestration. And some of the things we're doing in the -- some of the things that we're doing in the genotyping space like 384 is primarily ended up at -- is primarily driven towards routine applications. So our business is shifting to areas that are less impacted by governmental funding. We think that the impact could be on back of the envelope calculations in the low single-digits, but again, it's not easy to model as the information that we aren't privy to any specific information about exactly how or when the cuts will be implemented.

Daniel Brennan - Morgan Stanley, Research Division

And kind of like are the significant restructuring you've already announced, I guess, that would basically be kind of used as an offset to the headwinds from sequestration, if it doesn't follow, it would be additional actions we'd expect you to take?

Franklin R. Witney

We think we're -- everyone will -- if the sequestration hits, everybody is going to suffer for sure. But we believe that we're in -- because of the cuts we took, we'll closely monitor the situation. But we don't think additional cuts will be required to navigate through this particular situation.

Daniel Brennan - Morgan Stanley, Research Division

Okay. And then just back on Cyto, like could you provide a specific kind of expectations for Cyto in '13? I mean, you doubled it, I believe, in '12, and I know you've given growth estimates for the different divisions, but within that, what's in place for expectations for your Cyto business?

Franklin R. Witney

We haven't given out particular guidance but we expect very strong -- another great year for the product.

Daniel Brennan - Morgan Stanley, Research Division

Okay. And then finally, just in terms of other initiatives in '13, I mean, restructuring is significant, a lot of changes in '12. As you look towards '13, and kind of next phase of kind of the business plan, are there anything, like what are the focal points beyond just kind of executing what's in front of you? Are there any other kind of initiatives that we should be kind of aware of or things whether on the cost side or the acquisition side or product investment side? Just anything to think of about as we go through '13.

Franklin R. Witney

Well, notwithstanding major hits to NIH, we feel we're in very good position to execute on our business plan. We laid out some of the really key initiatives for us. At the top of the list, of course, is our filing for CytoScan, which is as we said is imminent. We intend in the clinical space to launch our OncoScan product midyear for cancer mutation monitoring. And the 384, we think, is extremely important because we're having those conversations with people in the Ag-Bio space where we think throughput and the cost position makes us -- puts us in very strong position there, as well as in the human space in fine mapping. The one initiative -- the other initiative that's joint program between the core Affy and eBio is the TG flow where we're able to do multiplex RNA monitoring by flow cytometry. So those are really the key-est initiatives that are brand new for us, if you will. But otherwise, we feel like we're ready to -- we've made the lion's share of the changes that we need to make and we can drive forward from here.

Operator

Our next question comes from the line of Bryan Brokmeier with Maxim Group.

Bryan Brokmeier - Maxim Group LLC, Research Division

You reported fourth quarter revenue that's in line with expectations despite the fears of sequestration throughout the quarter. We're now one month into the first quarter. Are you seeing any impact to your customer orders due to continued fears of sequestration and is there any change from what you saw in the fourth quarter?

Franklin R. Witney

We haven't seen any material change from the fourth quarter.

Bryan Brokmeier - Maxim Group LLC, Research Division

Okay. And you're taking a lot of cost out with the restructuring, does that position you to still be profitable and if we're unable to avoid sequestration?

Timothy C. Barabe

Yes. I think, it depends on whether you're talking about profit on a GAAP or a non-GAAP basis. I mean, clearly, on a GAAP basis, we got the inventory step up coming through the P&L and the interest expense from the debt that we took on, but on a non-GAAP, it takes perhaps -- absolutely, sure. No question.

Franklin R. Witney

I think it's fair to say that our customers have been spending conservatively for quite a period of time. But again, the specifics of what the post sequestration world exactly looks like is not something we have complete visibility on.

Bryan Brokmeier - Maxim Group LLC, Research Division

Okay. And Tim, you said that the vast majority of the cost savings are happening now. And so most of the heavy lifting and the restructuring is done and there will be very little left after you leave and the new CFO comes on in midyear, that's correct, right?

Timothy C. Barabe

That's correct.

Operator

Our next question comes from Jon Groberg with Macquarie.

Travis Steed - Macquarie Research

This is actually Travis Steed in for Jon today. I just wanted to see if you could give a little more color on the $25 million restructuring? It's not the first time you've done this. And is there anything that you saw in the business that made you decide to go through with it now?

Timothy C. Barabe

Well, I think we haven't gone this deeply before. I think what we did is we benchmarked. We've been benchmarking ourselves for a while. It's pretty obvious that we had a cost structure that was out of line with our competition. We're also smaller than our competition, and I think that the catalyst for that was 2012 coming in a little bit down from 2011. So Frank and I were a little bit disappointed. We were hoping that we're going to be able to report a revenue year that was slightly up. And we just decided that -- actually, Frank decided and I completely support him that we had to get our EBITDAO into the mid-teens to 20% range. And the only way we could do that was to look at every single group, every single department and take out everything that wasn't absolutely necessary. Clearly, Affymetrix has been cutting for a while, but they were cutting -- we were cutting from a very, very large cost base. I think this one was we wanted to make one more cut and cut as deeply as we can, maybe cut even deeper than we wanted to cut and have to add back as opposed to come through again later. We felt, this time, it was take out everybody who's not essential to getting this business turned around. Because we should be making money on that $300 million sales number.

Travis Steed - Macquarie Research

Got it. And what do you think about R&D expenses going forward? I know you've mentioned in the past, maybe at long term being 15% of total sales. I want to know if that's something that -- if you have more clarity on it at this point?

Timothy C. Barabe

I think we're tending towards 15%. I think, in 2013, our R&D expenses will be positively impacted by our Cyto filing which is imminent, so we won't be having the clinical trial expenses that we had in 2012, so we should -- and of course, eBioscience spends more in the 10% range of sales as opposed to our 20% plus. So I think we're rapidly approaching that 15% range. Frank, I don't know if you've got a goal past that, a couple of years out?

Franklin R. Witney

I think, at this point, we want to keep our pipeline fresh with exciting new products, which I believe we're doing. But I would say the 15% range is in the ballpark of what we would be targeting going on a steady-state basis.

Operator

Our next question comes from the line of Derik De Bruin with Bank of America.

Rafael Tejada

It's Rafael in for Derek. Just a couple for me, just another one on cytogenetics. I just wanted to get, I guess, your sense of what do you think is the size of cytogenetics market at this point domestically and abroad? And as you’re looking at 2013 and beyond, I guess, what do you think are your aspirations for market share of that market?

Franklin R. Witney

Yes, we see the market -- the postnatal market is around $200 million, roughly $100 million on the array side and $100 million in classical karyotyping. We've made enormous amount of progress this year and both from taking market share from competitors, as well as conversion of people in the $100 million karyotyping bucket. The much larger market is in blood cancers, which is probably on the order of $500 million, and we're really just scratching the surface there, and we're working very hard with our customer base and our applications to be able to serve that market as well. So the aggregate market is probably $700 million, $800 million. We feel it has healthy growth prospects, minimally impacted by NGS, so we're going to continue to invest in driving this star product for us.

Rafael Tejada

Okay. And this might be a bit of a follow-up on, I guess, just on restructuring. I think, late last year, there was a divestiture or, I guess, a product line that was sold from eBio to another company. I guess, Frank, as you look at the company and assess the different products, are you, I guess, how happy are you with the composition of the product portfolio at this point and are you looking to add or potentially sell any assets that might not be -- that might not fit appropriately with the rest of the portfolio?

Franklin R. Witney

Yes, good question. We feel very good about our portfolio as we articulated in the first part of the call. We will look for nonstrategic assets. And just as a matter of course of the business, divest things that are non-core. We sold the building in West Sacramento, the product you were talking about was the western block product that didn't fit well with eBio's portfolio, it was very small but it was, again, a nonstrategic asset and we'll continue to review our portfolio as a manner of business practice.

Rafael Tejada

And last one. Just on companion diagnostics, it seems like a lot of other companies are interested in this market as well. I guess, just wondering what you think you could do differently and better than some of the competitors.

Franklin R. Witney

Yes. In regards to the companion diagnostics market, we feel we have a number of areas throughout our product line, expression, cytogenetics, OncoScan, the QG View product line that could well be companion diagnostics. We want to drive harder into that space by collaborations with pharma or other area, other people that are potentially looking at companion diagnostics. We think our portfolio, as part of a matter of course, and moving more to the clinical and routine markets, we will have -- we will look for those types of opportunities to partner up and then develop companion diagnostics.

Operator

Our next question comes from the line of Isaac Ro with Goldman Sachs.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

It's actually Joel in for Isaac. You guys mentioned you expect Gene Expression to be soft again in 2013. I was just wondering what your assumptions were for pricing and volume in that business.

Franklin R. Witney

Yes. We're targeting a decline of 10%. There are obvious headwinds in that particular business, primarily people converting to sequencing approaches or to our lower cost products. We feel we're doing a lot of things right in the Expression area. We've launched a number of new products that are more -- that would be more used in clinical research such as our FFPE product lines. We have arrays that are -- that will be used for biomarker discovery. But again, given the trend to lower-cost products and NGS, that product line is likely to decline again in that range. And we certainly have taken that account in our planning.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

And then just a follow-up on the restructuring. How are you guys thinking about balancing your cost containment plans and investing in channel development as part of your diagnostic strategy recognizing that can be pretty costly?

Franklin R. Witney

Yes. We certainly -- like anybody going through a process like this, we clearly define what our priorities were. And channel development in the translational clinical space was one of our highest priorities. And so those expenses will come at the expense of other things that we won't be able to do. So we were trying to be very clear-minded about it, drive backwards from priorities and certainly, cytogenetics is at the top of our priority list. And so -- as well as taking some of our other products into the translational space. In the case of eBioscience, they were unaffected by the restructuring. They have a pretty well-developed channel for immunology and trying to drive more into other related areas such as cancer. So we were looking at ways that we can leverage across the 2, the core Affy, as well as eBioscience, try to get additional leverage across the 2 companies. So we certainly were -- we feel we're in a good position to drive the clinical business and we made those investments as part of the restructuring.

Timothy C. Barabe

I would just add that the restructuring certainly hit all areas, but it hit G&A harder than it did sales and marketing.

Operator

Our next question comes from the line of Tycho Peterson with JPMorgan Chase.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Just going back to the question a minute ago on Expression and, Frank, you mentioned the 10% decline expectations, what's the confidence level in light of sequestration? I mean, I realized obviously, that's more related to technology shifts but what's your confidence level in light of the funding environment?

Franklin R. Witney

Well, we've had -- I guess I would answer 2 ways. One, we've had 3 quarters in a row the decline has been roughly 10%, and we have a number of new products that have not -- that were really launched late in the year. So my confidence level without sequestration would be quite high that we would be in that band. With sequestration, I think it just adds another level of uncertainty. I really can't speak with mathematical certainty.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

And then Expression is now less than 1/3 of revenues as you guys have highlighted. And presuming you're not investing as much as you had historically, but what percentage of EBITDA is coming out of Expression at this point?

Timothy C. Barabe

We don't get into that, but it's clearly a cash cow. There's no doubt that we're using the cash from the Expression business to fund our investment in things like our 384 Ag-Bio business and cytogenetics.

Operator

Our next question comes from Shaun Rodriguez with Cowen and Company.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

So last quarter, you pointed out that OEM and I think just some of the smaller product classes within eBio had a pretty tough quarter and dragged down a broader segment. Can you just give an update on how those recovered or didn't in Q4? And if they did, kind of what was behind that?

Franklin R. Witney

Yes. We still have time -- we believe that we still have a number of opportunities in the custom and OEM business at eBio. But Q4 was still a difficult quarter in that particular space. The flow business, the immunoassay business in the quarter grew in 6% to 7% range on a currency adjusted basis, but we still had challenges in the custom space.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Okay. And on cytogenetics, I guess, building off of an earlier question, when you look at your 2013 assumptions and I know you don't want to provide detailed revenue guidance for this product, but how much of the growth for cyto do you expect to be driven by getting new labs onboard versus utilization or pull-through growth?

Franklin R. Witney

Yes, I think we're actually in very, very good shape because these are annuity sales, they're not project-driven, they're routine sales. And so given the customer base that we have, and again, we don't want to provide a high level of guidance in this particular area, but we feel that the customer base that we have, which is in very good shape, and on top of that, we'll continue to aggressively secure new customers across the world. So we feel we're in really, really good shape to have another great year in cytogenetics.

Operator

Our next question comes from the line of Peter Lawson.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Frank, sorry, I joined late on the call. But just regarding expectations for the 2013 for various product classes, you mentioned Expression down 10%, what about genotyping and life science?

Franklin R. Witney

Yes. So the -- we would expect another very strong year out of our genetic analysis business unit, both in the genotyping space, as well as the cytogenetics space. The Life Science Reagents business, we expect to grow in the low single-digits and eBioscience in the mid-single digits.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Perfect. And then eBioscience, do you feel that's kind of back to a normalized growth pattern or is it going to take into this second half of 2013?

Franklin R. Witney

Well, I think, given the academic funding environment even, which -- as we talked about, people are being very conservative with their money and certainly, [indiscernible] very tough funding environment for people applying for grants. We certainly would like the business to grow more higher over time, and we think we're doing things that will enable that with, for example, the QG flow or things we're doing around with the immunoassay line, the Procarta line, taking advantage of their capabilities in immunoassays. We have geographic expansion in Japan and through some of our own current operations but I think, given everything and the uncertainty around academic funding that mid-single digits is what we would expect out of eBio in 2013.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Got you. And then just some of the divestitures and restructuring, have you lost -- what scale of revenue have you lost going into 2013?

Franklin R. Witney

De minimis.

Timothy C. Barabe

De minimis.

Franklin R. Witney

The product line we divested was...

Timothy C. Barabe

$500,000.

Franklin R. Witney

$500,000 product line.

Operator

Our next question comes from the line of Justin Bowers with Leerink Swann.

Justin Bowers - Leerink Swann LLC, Research Division

Just one quick one on sequestration again. What does your guidance actually presume in terms of the NIH baseline budget? In other words, are you assuming like flat or down 2% or?

Franklin R. Witney

Well, we're -- yes, I think that would be fair that we would expect -- I guess, our guidance would be based on having the same difficult environment that we're currently in and no change to that current environment.

Justin Bowers - Leerink Swann LLC, Research Division

Okay. And then just back to cytogenetics, since it's such a huge part of the growth story here. But what do you view as the secular growth rate for that business?

Timothy C. Barabe

Double-digits for sure. I mean, there are 2 parts, right? You've got the potential market share part where Agilent is the clear leader, but you've also got the conversion from karyotyping. So it's a clear double-digit grower.

Franklin R. Witney

And then the third would be adoption in the blood cancer space.

Justin Bowers - Leerink Swann LLC, Research Division

Right. And in terms of that market segment, what do you view as timing for actually rolling out some products there?

Franklin R. Witney

Well, it would be -- our current CytoScan -- our CytoScan product is currently configured as appropriate for -- and being used by many of our customers including podium presentations and publications. OncoScan which is a cytogenetic product, but it's designed to do copy number and somatic mutation calls out of cancer samples, out of FFPE samples with tiny amounts of DNA, is something we'll be rolling out in midyear. It won't have a really large impact on our revenues in 2013, but if we launch it in the second half of the year, it should be a contributor for us in 2014 as part of our clinical array program.

Justin Bowers - Leerink Swann LLC, Research Division

Okay, great. And then just in terms of your current sales mix, is that -- how does that breakout between North America and rest of the world?

Franklin R. Witney

North America's about half of our business. Europe is roughly 30%, and rest of the world is 20%.

Justin Bowers - Leerink Swann LLC, Research Division

Okay, great. And then just real quickly. I may have missed this but what was the revenue number for genetic analysis?

Timothy C. Barabe

I don't think we give that number but we gave the -- the cytogenetics number at $30 million.

Operator

Ladies and gentlemen, I would now like to turn the floor back to management for any closing comments.

Doug Farrell

Thank you, operator. Thank you, all, for taking the time to join us today on the call. If you did miss any portion of the call, a phone replay will be available for the next 7 days, beginning at around 5:00 Pacific Time today. To access that replay, domestic callers, please dial (877) 660-6853. International callers, please use (201) 612-7415. The pass code for both is the same, 406352. Alternatively, an audio replay will be available on the Investor Relations section of our website at affymetrix.com. So thanks again for joining us. Have a great day.

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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