Executives
Doug Farrell- Vice President Investor Relations & Treasury
Kevin M. King – President and Chief Executive Officer
John C. Batty - Chief Financial Officer
Analysts
Tycho Peterson - J.P. Morgan
Ross Muken - Deutsche Bank North America
Doug Schenkel - Cowen and Company
Marshall [Uris]
John [Grover]
Quintin Lai - Robert W. Baird & Co., Inc.
Isaac Ro - Leerink Swann
Un Kwon-Casado - Pacific Growth Equities
Derik DeBruin - UBS (US)
Eric [Crisculo] - Thomas Weisel Partners
Bill [Quark]
Matthew Scalo - Canaccord Adams
Affymetrix, Inc., (AFFX) F1Q09Earnings Call April 22, 2009 5:00 PM ET
Operator
Good afternoon, my name is Kara and I will be your conference operator today. At this time I would like to welcome everyone to the Affymetrix Q1 2009 Earnings Call. (Operator Instructions) I would now like to turn the call over to Doug Farrell, Vice President of Investor Relations.
Doug Farrell
Thank you, Kara. Good afternoon everyone and welcome to the conference call. At the close of the market today we released our operating results for the first quarter of 2009. Joining me on the call today is our CEO, Kevin King who will provide a commercial and operational update. After that our CFO John Batty will provide a detailed review of our operating results for the first quarter as well as our guidance for the second quarter.
As a reminder today’s call is being recorded and the audio from the call is being web cast over the internet on our home page at affymetrix.com. During this call we may make various remarks about the Company’s future expectations, plans and prospects that constitute forward-looking statements for purposes of Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties that could cause actual results to differ materially for Affymetrix from those projected. These risk factors are discussed in Affymetrix’s 10-K for the year ended December 31, 2008 and other SEC reports including our quarterly reports on Form 10-Q for subsequent periods. We encourage you to review these documents carefully as forward-looking statements are made as of today’s date and we make no obligation to update this information.
With that introduction, let me turn the call over to Kevin King.
Kevin King
Good afternoon everyone. Our year is off to a good start with Q1 total revenue coming in ahead of our guidance at $78.6 million. I am particularly pleased that our product and services revenue grew around 7% versus last year, driven by our expansion into new markets and new instrumentation revenue. Services show strong growth driven by four large genotyping projects in the quarter. We continue to make steady progress against our corporate goals of expanding into new markets, reengineering our technology platform, and improving our operating leverage.
I will spend the next few minutes providing an update on each of these goals and highlighting some of our accomplishments in the first quarter before turning the call over to John for a detailed financial discussion.
We see promising market opportunities and applications that are down stream from genome wide analysis, particularly in validation and routine testing. These high growth markets are less constrained by research funding and are more likely to generate recurring revenue streams. Our recently acquired QuantiGene Plex has been received well by our customers for biomarker analysis, drug compound screening, in situ gene expression, RNAi monitoring, and DNA copy number applications.
We introduced two major QuantiGene products in Q1. The QuantiGene 2.0 DNA analysis assay quantifies DNA copies and copy number variation. This new low-plex assay is a down stream compliment to our gene chip copy number products including 6.0 and our new cytogenetic research product. Targeted end-user markets include direct discovery, disease research, agricultural and biotech breeding programs.
The second product is QuantiGene view RNA HTS. This assay uniquely detects single RNA and DNA molecules in single intact cells. It will be used to screen millions of compounds against genes that are predictive of disease type and response to therapy. Many of our pharma partners have expressed interest in the high trouper screening capabilities of this assay.
We expect the QuantiGene assays and Procardo protein based products to contribute to our growth in 2009 and beyond and we’ll continue to invest in these markets and create synergies with our GeneChip arrays and instrumentations.
On the GeneChip side we’re making significant progress with our next generation of technologies that include new array formats, array chemistries, enzymology, and instrumentation. Over the last couple of quarters we have been phasing in products based on some of these next generation technologies. This began with the launch of our new Gene Titan system in the fourth quarter and continued with the introduction of our new cytogenetics products in the first quarter. The first of these is an exciting new family of cytogenetic products that use two important components of our new technologies. A new whole genome amplification assay, and new array chemistries for higher sensitivity and specificity for SNP and copy number detection. The result is an improved cytogenetic research product that is faster, easier to use and an even higher resolution.
We have already seen good uptake of our SNP 6.0 product for cytogenetic analysis and we feel that our new cytogenetic research products extend our performance against traditional methods like cariotyping as well as competitive array based offerings.
In March we also announced the launch of a solution for micro RNA research studies. Micro RNAs are emerging as a major component in the regulation of gene expression because of their ability to down regulate expression by binding to and modulating the translation of specific messenger RNAs. Our product provides comprehensive micro RNA coverage for 71 organisms on a single array. The species covered include human, mouse, rat, canine, and monkey, all of which are critical models for pharmaceutical and academic scientists working in oncology, stem cell research, toxicology, neuroscience, infectious disease and other areas.
The recent studies published in the New England Journal of Medicine that uses the Affymetrix DMET technology have highlighted the direct link between genetic variation and clinical outcome. In these the carriers of at least one copy of a non-functional metabolic enzyme appear to have reduced clinical benefit from the anti-platelet effects of Plavix. These patients will be better served by a test that comprehensively measures the metabolic status such as DMET Plus. For this reason pharmaceutical companies are increasingly interested in applying our DMET product in their pharmacogenomic studies with a particular focus on metabolism and transport.
Our new DMET product is the industries most comprehensive tool for standardizing drug metabolism studies.
Another example of the application of our DMET Plus product is provided by the work of Dr. Michael Christman, president and CEO of the Coriell Institute for Medical Research. The Coriell Institute for Medical Research is combining the power of SNP 6.0 and DMET Plus products in the greater than 10,000 sample Coriell Personalized Medicine Collaborative: a research study that explores the use of genome information in medical care and is aimed at identifying genetic variance affecting drug toxicity and efficacy.
Let me quote Dr. Christman “the potential impact that this research can have on the healthcare field is profound and the products Affymetrix has to offer make our goals possible and cost effective”. This technology enables us to measure genetic variation among our study participants giving us not only the potential to discover genes associated with complex disease and drug metabolism, but also the opportunity to improve health outcomes by integrating this data into ones medical care. Moreover, data generated using Affymetrix DMET Plus sets the stage for the adoption of genetic analysis tools for use in personalized medicine. Ultimately, genome informed medicine will improve safety, quality, and effectiveness of healthcare for everyone resulting in better health outcomes and lower healthcare costs.
In addition to these advances we have also made excellent progress in reengineering our technology platform. This includes the combination of automated instrumentation, powerful new biological assays, and new array designs and content that will result in a significant expansion of our product line.
The new Gene Titan system, our next generation mid to high-end instrumentation platform represents a revolutionary change in how researchers conduct array based experiments. This product has generated very positive responses from both industrial and academic customers and the system brings compelling advantages. By automation array processing workflow, customers realize a substantial reduction in hands on time, decreasing the time required to process nearly 100 samples from seven hours down to only 30 minutes. This fully automated solution leads to higher data quality by removing or minimizing many sources of variation in the laboratory.
In addition to our cartridge-based formats we are transitioning many of our Legacy products to the new peg array format. We intend to provide a complete menu of gene expression and genotyping applications. We already offer our IVT products and in Q2 we will offer our whole transcript gene expression, and alternative splicing arrays in the peg format. Similarly, our new genotyping platform will be available in the second half of the year and all of this makes the Gene Titan the ideal system for both mid and high true put laboratories.
In the second half of the year we are going to introduce a major new family of genotyping products that will provide even more comprehensive tools for genome wide association studies and focus customizable content for targeted genotyping applications. These new products will take advantage of several next generation technology developments including flexible array formats and new assay chemistries.
In addition, our internal screening program, which has generated more than 10 billion genotypes to date will provide additional validated and novel content for our new products. This will also provide researchers with a database of new content to further drive the study of genetic variation in the context of human disease. Furthermore we expect the putative genetic content releases by the Thousand Genomes Project to provide even more genetic content for future products.
Finally, this morning we announced that scientists in Europe and America have discovered six genes associated with the risk of heart attacks. Researchers use both SNP 6.0 and the mapping 500K array set to conduct three separate large-scale gene association studies. Each of them was published in Nature Genetics in February.
Coronary heart disease is the leading cause of death in the US with almost 1.3 million heart attacks occurring every year of which 37% of the victims die. The findings offer hope that someday we’ll be able to answer important questions that could lead to the early identification of individuals at risk of heart attack or disease. Discoveries such as these also support Affymetrix
Continued investments in next generation genotyping technologies that are scheduled for launch later this year.
In Q1 we successfully completed the transfer of our array manufacturing to Singapore. This was a very large undertaking for the business and was completed on time. In the first quarter we also began shipments from our America’s Distribution Center located in Louisville, Kentucky. Our America’s based customer shipments will flow from this new state of the art center and in Q2 we will complete the consolidation of our reagent manufacturing in Affymetrix Ohio as well as the outsourcing of our instrument manufacturing.
We projected $20 to $25 million reduction in annual operating expenses as a result of this transition and we will begin to realize these savings in the second half of 2009.
Before close I would like to take the opportunity to invite all of you to the Investor Day event that we will be hosting at the NASDAQ Market Site in Times Square on the morning of June 3. This will be a great chance for you to get to meet our management team and hear more about recent and planned product introductions.
In summary, in Q1 we delivered quarterly revenue that was above guidance and continued to make excellent progress towards achieving our corporate goals. Our technology investments are generating new products that will expand our total addressable markets. In addition, we are optimistic about the potential impact of increased NIH funding and government stimulus dollars that have been allocated for the Life Science research.
I look forward to updating you on our progress as the year advances. I will now turn the call over to John for a discussion of our financials.
John Batty
Thanks Kevin and good afternoon and thanks everyone for joining us today.
I will begin my comments with a detailed review of our financial results for the first quarter followed by an update on our balance sheet, before closing with our financial outlook for the second quarter.
For the first quarter of 2009 the Company reported total revenue of $78.6 million which includes a negative foreign exchange impact of about $2.8 million. This compares to our first quarter of 2008 revenue of $169.6 million which included a $90 million intellectual property payment.
Net loss for the quarter was $25.2 million or $0.37 per diluted share, versus net income of $46.3 million or $0.58 per diluted share in the first quarter of 2008.
Q1 2009 net income includes a pre-tax restructuring charge of $2 million or $0.03 per diluted share as compared to $13.9 million or $0.17 per diluted share in the prior year quarter.
Now turning to the detail: First quarter product revenue was $64.9 million as compared to $62.8 million for the first quarter of 2008.
Consumable sales were $59.7 million and represented an increase of approximately 2% from the first quarter of 2008.
DNA revenue was down approximately 4% year-over-year to $20.3 million and was offset by RNA which was up approximately 3% to $37.9 million. Year-over-year the mix of RNA and DNA revenue remained about 2/3 and 1/3 respectively.
Additionally, instrument sales were $5.2 million as compared to $4 million in the prior year quarter. We shipped 26 GeneChip systems and scanners in the quarter bringing cumulative systems shipped to about 1,840.
Service revenue was $11.6 million as compared to $8.4 million in the first quarter of last year. This strong services revenue included contributions from the Welcome Trust Case Control Consortium, as well as the Women’s Health Initiative and two NIH projects. Royalties and other revenue were $2.1 million versus 498.3 million in the first quarter of 2008 which, as you know, included the recognition of $90 million in revenue in connection with an IT payment.
In the first quarter product gross margin declined to 46.9% primarily due to $4.6 million or 7 margin points associated with closing our West Sacramento facility. The remaining margin differential was primarily driven by volume, mix, price, and lower manufacturing absorption.
Finally, service revenue margins of 34.4% improved 1.8 points over the first quarter of 2008 on higher revenue and a more favorable mix of programs.
Total operating expenses for the first quarter were approximately $57.2 million which included $2 million or $0.03 per share on restructuring expenses. This compares to $68.2 million for the same period last year, which included restructuring and in process R&D charges of approximately $14.7 million in aggregate or $0.17 per share.
Q109 operating expenses included $1.7 million of stock compensation expense as compared to $2.3 million in the first quarter of ’08.
First quarter 2009 R&D expenses were $21.3 million as compared to $18.8 million for the same period last year.
SG&A expenses in the first quarter of 2009 were $34 million, down approximately $1 million compared to the prior year.
The Company recorded a net interest and other income expense of about $4 million in the first quarter, as compared to $3.3 million in the prior year quarter. This included interest income of approximately $1.4 million, interest expense of $3.2 million, currency losses of $1.8 million and a net loss on investments of $1.2 million.
Interest income decreased to lower average cash balances and a decreased yield on marketable securities.
In the first quarter we recognized income tax expense of about $0.5 million. Our income tax expense for the first quarter is principally driven by foreign taxes.
Net loss was $25.2 million or $0.37 per diluted share versus a net income of $46.3 million or $0.58 per diluted shared in the first quarter of 2008.
Fully diluted shares for the first quarter of 2009 were 68.6 million shares as compared to 83 million in the first quarter of 2008 and reflect the fact that at higher income levels our convertible securities are dilutive.
In order to facilitate the analysis of the Company’s core operating results, I would like to summarize non-core adjustments to our net loss for the quarter and their impact on pre-tax earnings per share. In aggregate these adjustments accounted for $10.1 million or $0.15 per share which breaks down as follows: Within gross margin there were $5.5 million or $0.08 per share of adjustments which included $900,000.00 for the step up to fair value of inventory acquired in the Panomics acquisition. This is now fully amortized and won’t impact us going forward. In addition, it included $4.6 million of costs related to the closure of the Sacramento facility.
Restructuring expenses accounted for $2 million or $0.03 per share and were associated with the consolidation of our manufacturing capacity.
Finally, there were $2.6 million or $0.04 per share of acquisition related expenses. Those are broken down between gross margin and operating expense. About $0.5 million of intangibles amortization impacted gross margin and within operating expenses there were $2.1 million that included contingents to consideration and intangibles amortization.
Let me now take a moment to summarize our balance sheet.
We ended the first quarter of 2009 with total cash and available for sale securities of approximately $388 million. The decrease in cash of $9.4 million compared to the prior quarter was primarily due to the semi-annual interest payment on our convertible debt as well as capital expenditures.
First quarter DSOs were 68 days as compared to 72 days in the prior quarter. Also in the first quarter capital expenditures were about $3.8 million and depreciation and amortization was approximately $13.2 million including the amortization of acquired intangible assets.
Inventory for the first quarter was $48 million down about 6% from $51.3 million in the fourth quarter driven principally by a draw down of Q4 inventory levels that were built in anticipation of transitioning manufacturing capacity from West Sacramento. As compared to the prior year, net inventory was down from $51.8 million.
Now I would like to review our guidance for the second quarter of 2009.
The company expects total revenue for Q2 to be in the range of $75 to $78 million roughly in line with our first quarter results. For Q2 we are targeting gross margins of around 49% which includes the remaining $4 million of our previously announced plant consolidation costs. We continue to execute against our planned improved gross margin percent through improved factory utilization and the introduction of new products that carry higher margins.
As Kevin told you, the transition of our array manufacturing from Sacramento to Singapore is on track and will be completed during the second quarter. As a result we expect to benefit from reductions in our manufacturing expenses beginning in the second half of the year.
The Company expects total operating expenses between $53 and $55 million in Q2 including restructuring expenses of approximately $0.5 million.
Overall tax rate for 2009 will depend both on the level and geographic mix of earnings and we expect our Q2 tax expense to be roughly in line with the first quarter. We now expect that our cash taxes in 2009 should approximate $2.5 million.
In summary, we’ve made good progress against our three corporate goals leading to improved product revenue growth, a path to gross margin expansion and improved profitability. As Kevin highlighted in his introductory comments, we expect growth in the second half of 2009 to be driven by an expanded portfolio of genotyping products as well as contributions from new products and markets including cytogenetics and drug metabolism solutions.
Now we would like to open up the call for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Tycho Peterson.
Tycho Peterson - J.P. Morgan
I am wondering if you would be willing to take a crack at breaking out organic revenues versus contributions from acquisitions.
John Batty
I think we talked about the USB business is becoming interweaved with the rest of our business as it begins to manufacture or in source reagents for our GeneChip product line, so it is difficult to really break out the contribution from the historical USB business versus the products that they are now manufacturing for the gene array business. I think we said last year that that was approximately a $25 million business.
For Panomics in our last call we estimated that it would be somewhere in the range of $3.5 to $4 million per quarter and it was approximately that again this quarter.
Tycho Peterson - J.P. Morgan
Okay that’s helpful. As we think about the end markets here, there has been a fair amount of discussion around kind of a pending slow down or a near term slow down in genome wide association studies and then obviously we have the stimulus potential heading into the back half of the year. Can you just comment on some broader market dynamics as we think about also some of the new products ramping?
Kevin King
Yes, so there is a lot of discussion going on now about the rate of growth with respect to whole genome association studies. I would share the similar views that we’ve heard from others that that portion of the marketplace is changing. I think in the past genome association studies were first done with the premise that there was a linkage between common diseases and a common variant. The first path of studies that have been done over the last maybe three years or so have shown that we’ve been identifying linkages between genetic variation and disease, but we don’t account for all of the disease associated risk. So now what people are doing is taking a step back and looking at two things. One is structural variance or copy number and the second one is the possibility that lower frequency variants may play a major role here. People are gearing up for that.
As I mentioned in the call here we’ve been screening about 10 billion genotypes in hopes of finding lower frequency alleles associated with various ethnic populations. We have found many, many new variants that will be on our products.
I think the combination here is that both structural variance and these min allele frequencies will create a new wave of growth for both whole genome associations as well as down stream targeted genotyping applications in the future.
Tycho Peterson - J.P. Morgan
Okay that’s helpful and one last one on margin. I think in your comments you talked about mix price and volume. Can you just comment on pricing dynamics right now and whether ASPs have held?
Kevin King
Sure. Do you want a comment on the genotyping side or DNA side of our business?
Tycho Peterson - J.P. Morgan
Both would be helpful.
Kevin King
DNA prices have been stable. We’ve been talking about that for quite a while. On the RNA side prices have trended down. I think prices have trended down as a function of a few things. One is we have offered newer, lower priced products, which on a mixed basis will drag our average selling price down. Also we see increased competition on the lower end and that has lowered our price overall as well for gene expression.
Tycho Peterson - J.P. Morgan
Great, thank you.
Operator
Your next question comes from Ross Muken.
Ross Muken - Deutsche Bank North America
Can you talk a bit about the early interest in the gene tide and whether or not the sole focus today on gene expression makes that a bit limited in terms of its initial use given the price point. Once the Gen Titan capabilities are available what are you expecting that box to contribute to instrument sales?
Kevin King
The Gene Titan began shipments in the fourth quarter. It ramped up pretty significantly here in the first quarter. The people that are using it, as you said, can only use it for gene expression right now, but many of those customers are mixed customers in that they do both DNA and RNA studies and so they are anticipating the DNA product will come out in the second half.
I think when that DNA product is available we will see an even greater ramp in Gene Titan sales. Overall I would say that the outlook for this product is very strong. Funnels are building. Customer interest is quite enthusiastic. I think it’s priced right. It’s about a $300,000.00 list price instrument and that really provides enormous value for customers in terms of improved workflow, through put, data quality, flexibility, and also lower sample costs. So in conversations with customers it doesn’t take much conversation for them to figure out that this compelling value proposition for them and I think we’re going to do quite well with the product.
Ross Muken - Deutsche Bank North America
John, in terms of the gross margin trajectory, what is the thought where we can leave this year based on the restructuring. Are we on a path to kind of where we left last year and that was kind of in the $55 range or do you think given the current cost structure, assuming volumes are stable, can you get back to the $60s?
John Batty
Yes, I think our objective is to try to move our gross margins back up to the low to mid 60s. A significant piece of that really gets behind us after we clear the second quarter. In the current quarter, I mentioned that approximately 6 points were attributable to the shut down and transition costs in Sacramento. That is largely the acceleration of equipments where we had to accelerate the terminal life and had to recognize that depreciation. So that gets behind us, so call that somewhere around 6 points. Once you eliminate the operating costs of that factory that is going to get you a couple more points. Then we have the affect of absorption.
As we’re successful in generating top line growth we’ll see much better factory utilization for the factory in Singapore and then layer on that the contribution from higher margin new products that are based on those peg based format.
It is a complicated equation and it is really a function of top line growth in the second half of the year. It is a function of the mix of new products, but if we execute to our plan we fully expect to get back up to those low to mid 60 kind of gross margins.
Ross Muken - Deutsche Bank North America
From a gene expression perspective, can you talk about the end market demand there contrasting academic versus pharma and whether you’re seeing any of these pharma consolidations change any of the historical utilization patterns?
Kevin King
With respect to pharma I would say that Q4 and Q1 were pretty consistent with one another in terms of mix of expression sales and the dollar amount to pharma in those quarters. As you know Q1 through Q3 of last year was a very different picture for us in terms of our ability both to predict as well as a whole lot of change going on in pharma. I think pharma is probably more stable now from our perspective than in the past. I will say that, like everyone else, I don’t think we can predict if there will be further consolidation, but at this point our sales teams and our customer base seem to be more stable than they were last year.
Ross Muken - Deutsche Bank North America
Great, thank you.
Operator
Your next question comes from Doug Schenkel.
Doug Schenkel - Cowen and Company
I understand that spending related to the stimulus is probably a couple quarters away. Specific to instruments is there any impact you have seen on instrument spending in anticipation of stimulus funding coming later this year?
Kevin King
I would say no, I wouldn’t say that instrumentation has slowed down nor accelerated in anticipation of the stimulus spending. We are very, very active with our customer base in terms of making sure that they understand and have interpreted the capabilities or the intentions of the stimulus package with respect to instrumentation. There are two instrumentation grants that have been put forth and are in stall basis looking at those. Our customers are looking at those together with your sales teams. It’s tough to call as to when that stuff would materialize. We are hopeful that we’ll get our fair share of it.
Doug Schenkel - Cowen and Company
You said, which makes sense, you said that many customers who are currently using Gene Titan in an early going do both gene expression and genotyping at their labs. Are most of these customers largely using Gene Chip scanners at this point for genotyping currently and once the genotyping products are launched what do you anticipate happening, if that is the case, to the Legacy instruments?
Kevin King
The only other instrument platform we have is the GeneChip GTS 3000.
Doug Schenkel - Cowen and Company
Yes, I’m sorry. I’m trying to get a sense of are most of the Gene Titans being placed at labs where that’s the case or is there a chance that you’ll actually be able to capture some share from labs where they’re using other genotyping platforms from other competitors?
Kevin King
Well yes, we’re always targeting growth in new accounts. There aren’t that many accounts that don’t have Affymetrix products to begin with, but we’re always targeting new ones. New biotech study merge, competitive accounts where we may not install, I think those cases are probably few and far between, but there are instances there. We’ll also continue to sell the GeneChip system on the diagnostic side to many customers as well, so that product will continue to go forward.
Doug Schenkel - Cowen and Company
Panomics is an RNA platform; you got about $3.5 million in revenues there. If I back out Panomics it looks like RNA declined a bit year-over-year. Is this largely a function of pricing or just market trends? I’m trying to figure out what’s pricing, what’s market, and what’s share loss.
Kevin King
I would say that first quarter typically is a seasonally lower quarter and together with what’s happened in the pharma business, even if you were to back that $3.5 out we would only be down $2.5 million in total and that’s really not a bad result given that things happened in the pharma space.
Doug Schenkel - Cowen and Company
In terms of market share you’re feeling it’s stable and this is really just a function of what’s going on in the bio pharma end market?
Kevin King
I think maybe just a couple of points here to clarify. So, not all of the Panomics businesses, RNA business, there is the DNA copy number product as well that we’re selling, so that takes a little bit off the $3.5, but probably more the area is rounding there. John is correct in that the pharma decline is probably the thing that’s impacted our expression business the largest. Almost all of our pharma business had been gene expression in the past. Probably more like 80%, 85%, just going off the top of my head of our revenue there from a consumables standpoint was probably gene expression and the rest DNA.
There are portions of the marketplace that have been purchasing extremely low cost basic gene expression arrays that we don’t compete in, so I wouldn’t necessarily say that that’s loss of share as much as maybe a new market that’s opening up. We intend to address that as well as we go forward.
Operator
Your next question comes from Marshall Uris.
Marshall Uris
My first question was just on instruments in the quarter. You got a good sequential up tick from the fourth quarter. Could you just talk a little bit about what drove that? Was that pharma academic, where that was going and do you see that kind of level continuing in the second quarter?
Kevin King
I guess sequentially it was pretty evenly split year-over-year. It was a little bit stronger in the pharma space, but I’m not sure I draw too many conclusions from it in terms of the split. And certainly going forward our intention would be that gene typing volume will increase as a percent of the total.
Marshall Uris
Okay and then there have been a lot of questions about the pharma end market. I want to get your comments on what you’re seeing on the academic side in terms of RNA versus DNA and where are you seeing interest on the RNA side from a product point of view?
Kevin King
Not much really has change on the academic side in terms of both product mixes as well as spend. I think the single most important point to note here was what I said earlier in the first question about the whole genome association study, market itself sort of being in a trough right now. Aside from that, I think markets are pretty good. We really don’t break out RNA and DNA into that level of detail as well, but just at a high level I don’t think anything major is happening there other than the comment on whole genome association studies.
Marshall Uris
My last question is on the balance sheet and how you’re thinking about acquisitions. Are you guys comfortable in terms of your net cash position to continue to do acquisitions or are you sort of holding off now to wait and see how Panomics goes over the next few quarters?
John Batty
We only burnt $4.2 million of cash from operations on a large loss, so we fully expect that we’ll be cash flow positive for the year. What that tells you is we don’t need the excess liquidity that we have to run and manage the business. We continue to be opportunistic in terms of evaluating business development opportunities and they range across the full spectrum.
Right now we’re focused on getting our business back on track to growth and profitability, but we’ll certainly look at options on how we might use that cash to maximize shareholder value.
Marshall Uris
On true materials and the new platform there, any update on timing or anything you can tell us?
John Batty
I think we’ll be talking more about that in the Investor Day in June. We’ll have some highlights for you on progress as well as initial applications and timing.
Marshall Uris
Okay, great. Thanks guys.
Operator
Your next question comes from John Grover.
John Grover
I would like a few clarifications since a lot of competitors provide pro forma numbers. It looks like you had about $10.1 million in adjustments both from a gross margin and on the operating expense line. Is that right?
John Batty
Correct yes.
John Grover
Then on the interest line is that $1.8 million in currency loss and the $1.2 million investment loss, do you expect those to be 1x or is there something that’s going to be carrying forward over the next few quarters?
John Batty
No, on the currency loss we had extraordinary volatility as compared to Q108, even as we exited the fourth quarter of ’08. When you look at the euro it was up 19.8%, the yen declined by 6% and the British pound actually increased by 39%. From the fourth quarter the single largest change was the British pound, that changed 7.2% within the quarter and that really kind of caught us off guard. We have an active and unusually effective hedging program, but the profile of the British pound during the first quarter really stung us.
As I look forward, typically even in a perfectly hedged environment, because of interest cost points on hedges I would be expecting somewhere in the neighborhood of about $0.5 million per quarter if we do everything right.
On the investment loss I wouldn’t expect that to continue as well. That was more of an extraordinary item.
John Grover
Okay and then on the acquisition that you talked about, the USB acquisition closed at the end of January of 2008, is that right? In the first quarter it was largely Panomics that would have been something that was additive on a year-over-year basis?
John Batty
Yes the incremental revenue here, this sort of organic revenue would largely be Panomics based, right.
John Grover
Then on the gross margin lines it looks like in the fourth quarter you were around 59% on the product gross margin side. You had around $66.5 million in revenues in the first quarter. It looks like you were at about 56.2%, so I’m just curious was that just mix or what kind of happened on a sequential basis there? Or maybe you could just talk a little bit more on gross margin.
John Batty
I think the largest impact on gross margins was clearly the manufacturing restructuring. I suppose on a year-over-year basis we had a decline in our licenses, royalties, and revenues so even excluding the IP payment that we received a settlement in the first quarter, our licensing, which is 100% margin, declined by about $6 million. So, that had a rather profound impact on our business. Even in looking at the change sequentially from the fourth quarter we were down $1.3 million in licensing.
We did see a substitution affect in mix and typically our Expression business carries a higher margin than our DNA business and because of that that sort of watched the bubble bounce. We do see shifts in mix between the product lines which do impact our gross margins.
The service business typically carries a lower overall margin. Although it was up this quarter over the last quarter it is still lower than the average company gross margin. What you will see there is again negative substitution.
John Grover
On the consumables it looks like they were again kind of up on a year-over-year basis from $58 million to $60 million, but yet both RNA and DNA were down on an absolute basis. What is the difference there between the two?
Kevin King
I think maybe we misspoke, or it wasn’t communicated properly. Expression was up and DNA was down and the net was up about 2% for consumables.
John Grover
I thought you said $37.9 million and didn’t you do $38.5 million in the first quarter of ’08 for RNA?
Kevin King
It was $36.8.
John Grover
On the DNA side do you get the sense because of potential new products coming out and the Gene Titan is your sales force giving you the sense that maybe people are delaying some DNA purchases and that’s why it has maybe not performed as well in the last three months or so, or is there something else going on there?
Kevin King
Our DNA product line is rapidly expanding from a single product which was the 6.0 array to a family of products. Our drug-metabolizing product is beginning to ramp up now. That is a DNA based product. We just launched, last month, the new cytogenetics research product. That will ramp up and then this new genotyping platform that we’ve been talking about will come in the second quarter.
I don’t think that customers are holding back as a result of an intended product launch other than that the product launch will deliver new content. I don’t think there’s less value in necessarily 6.0 from a product perspective, but I think it’s the content that people really want and that will be a function of this new database and this new family of products that we have.
John Grover
So, John, I would like just one last clarification again. If you kind of stated the same revenue number that you’re talking about, by the kind of third quarter call it, you’re saying that gross margins should be up about 6 points once everything rolls off?
John Batty
Yes, at least 6 points, because we had $4.5 million of manufacturing transition expenses in the last quarter, with $4 million expected in Q2. Those go away and that is 5/6 points by themselves. As we exit the second quarter the operating expenses that are contained in the Sacramento facility go away as well. All of the people that are redundant there will have completed their job and will be gone, as well as heat, power, light will be turned down, so we won’t be incurring those expenses. So, there is probably a couple of points there.
John Grover
Okay, great. Thanks a million.
Operator
Your next question comes from Quintin Lai.
Quintin Lai - Robert W. Baird & Co., Inc.
Just as you were taking a look at the second quarter guidance, you gave overall revenues. What are you expecting with respect to the mix between reagents and instruments?
Kevin King
You mean consumables and instruments?
Quintin Lai - Robert W. Baird & Co., Inc.
Yes, consumables and instruments. I’m sorry.
Kevin King
Our instrument business is going to be a function of the take rate on our Gene Titan for the Expression applications. The genotype applications on Gene Titan are not available until the second half of the year, although some customers are likely to procure Gene Titan’s in advance of the availability of consumables. Because we have a variety of programs, in order to induce customers to purchase the Gene Titan system, we may see a more smooth profile for the instrument take up. As an example, we have outright sales for the instruments. We have a reagent rental program. We have a lease program, trade-ins and so on and so forth. What you will see is a smoother profile on instruments; however, with the new products that we already have available on the cartridge format, which includes the cytogenetics product as well as the new DMET product, those products should drive consumables growth.
Quintin Lai - Robert W. Baird & Co., Inc.
That explains a lot, because as we were looking at the first quarter the average instrument revenue for 26 system place was a little lower than what you’ve had historically. So, is part of that kind of the lease and reagent rental impacting the instrument revenues?
John Batty
I think it’s difficult to do the, what is the consumables per systems, in the research only environment. In a diagnostic application where you’re running the system 24 hours a day, or even in sequencing applications I think it works because of the capital intensity. A lot of our researchers will conduct experiments and then they’ll leave the system alone. They are working on the bioinformatics and really analyzing the data.
Quintin Lai - Robert W. Baird & Co., Inc.
Oh no, John, what I was talking about was instrument revenue. So, it looked like it would average out to $200,000.00 per system at $5.2 million at 26.
John Batty
Oh, I see, I’m sorry. I missed the question.
Quintin Lai - Robert W. Baird & Co., Inc.
And that’s a little lower than what we’ve seen in the past.
Kevin King
I think that is probably part of the equation. I think the other part of the equation is instrument revenue was not only systems, but it’s stand alone fluidic station, hybridization ovens and other types of things and that mix can change dramatically in a quarter as well.
I guess in the long run you could probably do that math, on an individual quarter it might be a little bit harder to pinpoint a variance there.
Quintin Lai - Robert W. Baird & Co., Inc.
And then Kevin, in March we saw an announcement that you were handing over the CLEO Lab stuff to Navigenics. How does that change any revenues that you once had in 2008 that you won’t get in 2009?
Kevin King
The CLEO Lab revenues weren’t really that significant for us. The big learning that we had here and the big reason for starting the CLEO Lab a couple years back was really to enable our partners to get to a test, right, a lab developed test and then ultimately too a path for FDA clearance. Initially we thought that this could actually be a big recurring revenue stream for us. So, we had lots of partners, 15, 20, 30 partners that we would be working on projects. Often times the projects were fairly small and when the projects were over and they had their test validated the first thing they said to us was they wanted to open their own CLEO Lab.
So, it really wasn’t much of a recurring revenue stream for us, it was more of a job shop, which was fine, because we are enabling our partners to use our consumables and so forth. But, it really wasn’t going to turn out to be the big multi-million dollar business model that I think at one point in time we thought it might be. It was really the combination of this non-recurring revenue stream and the idea that all of our partners or most nearly all of our partners wanted their own CLEO Lab environment that we just said look this isn’t a good business model for us and we turned it over.
Now, access to CLEO Labs is pretty easy and so I’m not concerned about not having a CLEO Lab in the future.
Quintin Lai - Robert W. Baird & Co., Inc.
Thank you very much.
Operator
Your next question comes from Isaac Ro.
Isaac Ro - Leerink Swann
Just getting back to the commentary before on GUS studies and how you expect to see follow up work done on C&D and lower frequency variants. I’m just wondering, isn’t it fair to assume that a lot of that work isn’t going to get done on custom arrays, not necessarily pre spotted arrays?
I am also just wondering, based on what we’re seeing out there in the competition, how you expect to go up against people that are either developing their own custom array technologies or partnering with those that have them?
Kevin King
I’m not so sure that I would agree that future whole genome association studies that would include low frequencies and copy numbers are going to be custom products. I think there will continue to be either ethnic populations or disease centric arrays that people will want to have fabricated. We do a fair amount of our business today in a customs format where we can manufacture for people just about any configuration of a chip that they want. Then I think lastly this data screen that we’ve generated, these 10 billion genotypes have given us a lot of information for people to pick and choose their own content that would go on arrays once this next generation of genotyping products is introduced. I think we’ll have it covered, in both instances where there will be catalogue products and then sort of configurable products.
Isaac Ro - Leerink Swann
Conceptually speaking and maybe this is unfair, but it does seem like these very low frequency variants, a lot of the data coming out of sequencing is in many ways exceeding the capacity of the researchers to actually analyze it, right? So, if a lot of these low frequency variants emerge how you do keep up with the pace if the demand for these custom products evolves that quickly? I mean it seems like it would still lend itself more so to custom platforms. Am I thinking about this the wrong way?
Kevin King
I don’t know if you’re thinking about it the wrong way. Maybe I can make a couple of remarks that might help clarify, at least our thinking about it. I think the sequencing projects that are ongoing now, largely driven by the 1,000 genomes, are discovering what we refer to as putative disc SNPs They are found in many cases in one individual or a couple of individuals, but may not be representative of the linkage to disease or a particular population. The real question here is you have to do a large statistical study looking at a large population in order to validate those.
In that sense what we did with our screen that we’ve done here, we’ve validated the DB SNP screen against 1,300 individuals and have uncovered SNPs that do occur at lower frequency than what people might have thought. The only way to do that was to do a very large study of 1,300 samples.
Isaac Ro - Leerink Swann
Okay and then just on the placements in the quarter. I think you mentioned that brings your cumulative shipments to like 1,800 or there about. Do you have an estimate as to what you think the active number of systems out there in the field is today, out of that 1,800?
Kevin King
We get that question a lot. The way that I look at this, is I look at this by service contract coverage. So, if our service contract coverage were declining it would imply to me that equipment was not being used. Our service contract rates have been stable since I’ve been here which is just about two years. I think that that is consistent with where Affy’s been in the past. I would say a large fraction of these are in use. There has been some after market as some genomic centers have closed and people have done that. We’ve either taken equipment back or it has gone on a secondary market and other people have bought it, but I think a large percentage of them are still there. We know who they are and our sales reps call on them and we’ve got a pretty big customers relations management database that we track activity for on a regular basis. We know every customer and I have a pretty good feel that a lot of them are out there.
Isaac Ro - Leerink Swann
Then lastly based on changes to the operating structure you mentioned with the new facilities and so forth. What kind of a hurdle rate do you think you need to be at on revenues to get to a cash flow break-even standpoint at this point?
John Batty
Well we’re pretty close. I mean I think what we’ve been talking about is somewhere north of $80 million. This quarter we had our semi-annual bond interest payment which is about $6 million and we were $4.5 million on an operating cash flow basis negative and that was in a quarter where we lost money. On a free cash flow basis it was about $8 million including our CapEx. We run typically around $3 million of CapEx per quarter. We’ve got roughly $13 million of DNA, so you can kind of titrate from there with improving operating margins going forward our break-even level should begin to decline.
Isaac Ro - Leerink Swann
All right, so it is fair to say with some of the gross margin improvements you talked about earlier, if the growth rate as you talked about continues through this year we might see it towards the year end or? Would you care to put timing around that?
John Batty
Again, our gross margins are expected to increase in the second half of the year as we break lose of a factory and then the rest of it will be a function of top line growth and certainly working capital requirements. We are running the factory pretty efficiently right now.
Isaac Ro - Leerink Swann
Okay, thanks very much.
Operator
Your next question comes from Un Kwon-Casado.
Un Kwon-Casado - Pacific Growth Equities
I was wondering with respect to your instrument shipments, could you break out the number of Gene Titans within that?
John Batty
We set the numbers in this quarter. We haven’t disclosed that at this point in time. I think this is a product that this is really the first complete quarter that it was available. I think we’ll have more to say about that as we go throughout the year.
Un Kwon-Casado - Pacific Growth Equities
Okay, thank you and then did you guys have any sort of an FX impact on your top line this quarter?
John Batty
Yes, it was about $2.8 million to the negative. I mentioned that at the outset of the conference.
Un Kwon-Casado - Pacific Growth Equities
Okay sorry about that, I missed it. Then with respect to your next generation genotyping product cycle is one of the competitive differentiators that you are going to highlight to your customers is the fact that your content has been functionally validate versus those of your main competitor? To your point you said that they are putative SNPs at this point?
Kevin King
Yes, I think that is clearly one of the handful of significant advantages that we have that we have validated content that we’ve invested a lot of time and money to ensure that it is validated, yes.
Un Kwon-Casado - Pacific Growth Equities
Okay and then are you also planning on coming up with Chips using the 1,000 genomes project content as well?
Kevin King
Absolutely; there are two releases of that information, that I think are in the public domain already and we have begun work on that as well.
Un Kwon-Casado - Pacific Growth Equities
Okay wonderful. Thanks very much.
Operator
Your next question comes from Derik DeBruin.
Derik DeBruin - UBS (US)
How do we look at the service revenues going forward? Are there a number or products in the pipeline? Could you give us a little color on how to model that?
John Batty
I appreciate the question. It is one of those areas that it is hard to model because it is characterized typically by a number of large projects and those projects often times can extend across quarters. So, if we pile on a couple of large projects then we’ll see revenue increase. It tends to be a lumpy business. I think we’ve got a pretty good handle on it and we’re spending a lot of time trying to get visibility into it by managing a customer pipeline.
Derik DeBruin - UBS (US)
Okay, straight out question, do you expect a similar magnitude in Q2 that around at $11 million or is it still too early to tell in the quarter?
John Batty
Yes, I would model about the same for the next couple of quarters.
Derik DeBruin - UBS (US)
Okay that is helpful. When you look at the next generation genotyping products, I realize they are not going to be available until the second half of the year, but I’m just curious if any of your customers have, do you have beta testers that have seen prototypes of this? I am just wondering if there is any buzz at all outside in the scientific community.
Kevin King
We have been working with a number of customers, largely in a non-disclosure way, to preview the product, its capabilities, its workflow, configuration, costs, and so forth and we’ve gotten very good feedback and a lot of good anticipation about it. We have not created any intentional buzz about it at this point.
Derik DeBruin - UBS (US)
Okay and could you just talk about the interest expense? Do you have any plans for retiring additional debt? Also do you think the interest expense of about $3.2 million is pretty stable?
John Batty
Well we certainly had very low interest income on our invested cash balances. We only earned about a point and a half and that was down. So, we do have negative spread results on our money. We will continue to look at that. I’m not sure exactly what your question is, so maybe if you could clarify.
Derik DeBruin - UBS (US)
That’s okay you answered my question. That’s it, thanks.
Operator
Your next question comes from Eric Crisculo.
Eric Crisculo - Thomas Weisel Partners
Thanks for taking my question. I am just filling in for Peter Lawson. Just getting back to the cost savings, you had said that there was about $4.5 million this quarter for the manufacturing and another $4 million in Q209. What else can we expect going forward?
John Batty
Those are the expenses that we will no longer need to carry beyond the second quarter and it is principally the accelerated depreciation for equipment that will no longer be in service. Then beyond the second quarter the operating expense is for the Sacramento facility, which will no longer be in operation, will also be dialed down. Then as we go forward into the second half of the year the Singapore facility will be producing all of our arrays and we’ll benefit with increased volume in terms of absorption.
Eric Crisculo - Thomas Weisel Partners
Okay and did you put a number on those expected savings or?
John Batty
No. I mean I talked basically about the possible effects as we go on. I think Kevin in his introductory comments talked about annual savings of between $20 and $25 million. That includes the benefit from all of the manufacturing consolidation activities including reagents and that is an annualized savings.
Eric Crisculo - Thomas Weisel Partners
Okay great thanks. Then as far as the dynamics for the genotyping chips are researchers telling you that they want to wait for the new content to come onto the chips before they start buying or are they in the middle of kind of association studies and so they don’t need to buy the chips because they already have. Is there a dynamic you can address in that regard?
John Batty
I think there are at least two categories of buyers right now. There are studies that are ongoing that people continue to purchase SNP 6.0 arrays. Coriell Institute for example started working with us a while ago. The papers that were recently published that we mentioned here in the prepared comments, those types of studies continue. The Welcome Trust Study continues and so forth, so people have had studies ongoing who want to stay with the same platform, I would say, that’s one portion of the market place.
When you look at this common disease, common variant situation that I described earlier, I think people believe that they have done a lot or most of the common disease studies that they would want to do and now want to try to understand more deeply the role that structural variants and lower frequency variants might play and they are waiting in anticipation of those products. We think that that wave of products will occur in the second half of the year as this new platform rolls out and then the building of that platform will continue to take place over several subsequent quarters as new content continues to be developed. Which, I guess, all is good news because we are in a rapidly growing and changing market and we’ve got a brand new platform that we think is going to be able to take advantage of that.
Eric Crisculo - Thomas Weisel Partners
Okay, great. Thank you.
Operator
Your next question comes from Bill Quark.
Bill Quark
I have a couple of clarifying questions. First off, did you complete all of the four service projects, that you mentioned, in the quarter? I am guessing based on your answer to Derik’s question the answer is probably no, but I guess I might as well ask it right?
Kevin King
I think two of the projects were completed and I think two of them are still ongoing.
Bill Quark
Okay very good and then secondly, John, did I hear you correctly when you said $20.3 million in DNA for the quarter?
John Batty
On the consumable side, $20.3 correct.
Bill Quark
Okay so if I am adding that with RNA and instruments I’m coming up a little short on the overall product revenue. What am I missing here?
John Batty
There are some other products and consumables that are neither DNA nor RNA, so proteins and other products.
Bill Quark
Okay perfect. That’s all I have, thank you.
Operator
Your final question comes from Matthew Scalo.
Matthew Scalo - Canaccord Adams
I will keep it short here. Just as far as your comments in regards to not thinking about a revenue per Gene Titan system kind of metric here. I just think the total mid to high volume centers out there. Could you provide me with kind of a target number of customers that fits into the research side? Is it 300, 500, even more?
Kevin King
So your question is related to what’s the addressable market for Gene Titan?
Matthew Scalo - Canaccord Adams
I am trying to figure that out.
Kevin King
Yes, I think it’s about half of our install base. We tend to divide our customers more into the number of sample used, which I guess could be proxied into dollars and when we think about mid to high through put users, I think that represents about half of our install base in total.
Matthew Scalo - Canaccord Adams
Okay that’s helpful and as far as the average ASP or even the consumables that are used on the Gene Titan I would assume that as that install base expands it could actually help gross margin?
Kevin King
Yes. The new peg array formats, as we’ve spoken in the past, cost less and they also sell for less to the end user, so we think overall it would be a win, win for both customers as well as to ourselves in terms of gross margin.
Matthew Scalo - Canaccord Adams
Okay terrific. Then my last question, I have to go back to the service side here. Just talking about the incremental sequential change, the $3 million increase quarter, was that planned in your guidance when you offered it on the fourth quarter call, or was the timing of these projects accelerated? I’m just trying to figure out how you measure the timing on some of these projects.
Kevin King
The service projects often have very, very long lead times for sample availability. So, you can often win an award and not see the samples for quite awhile; so these things tend to get stacked up like planes at Newark, if you will. So, you see them with some level of visibility a couple of quarters out. I think in the fourth quarter we have pretty good visibility of Q1. We’ve had pretty good visibility of Q2 and we’re sort of building the rest of the year perspective if you will. Now some planes get turned back to the runway and new planes come on, but overall we’re reasonable at understanding the business and it does have, I’m probably dragging the metaphor out a little bit, but it does have air traffic problems at times in terms of it being lumpy and so forth.
Matthew Scalo - Canaccord Adams
I completely understand. Thank you, guys.
Operator
That was your final question in queue. You may proceed with your presentation or any closing remarks.
Kevin King
John Batty
Doug Farrell
Great, thank you everyone for taking the time to join us on the call today. If you did miss any portion of the call a phone replay will be available for the next seven days beginning at around 5:00 Pacific Time today. To access that replay domestic callers should dial 800-642-1687, international callers please dial 706-645-9291. The pass code for both numbers is the same, 91451164. Alternatively there is an audio replay that will be available under the Investor Relations section of our website at affymetrix.com.
Thanks for joining us and have a great day.
Operator
That concludes today’s conference call.
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