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Executives

Doug Farrell - Vice President of Investor Relations and Treasury

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

Gavin Wood - Chief Financial Officer and Executive Vice President

Analysts

Brian Turner

Joel Kaufman - Goldman Sachs Group Inc., Research Division

Reginald Miller - UBS Investment Bank, Research Division

Peter Lawson - Mizuho Securities USA Inc., Research Division

Bryan Brokmeier - Maxim Group LLC, Research Division

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

David Lin

Michael Clerico - Morgan Stanley, Research Division

David Moskowitz

Affymetrix (AFFX) Q3 2013 Earnings Call October 30, 2013 5:00 PM ET

Operator

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

Doug Farrell

Thank you, operator, and good afternoon, everyone. Welcome to Affymetrix' conference call for the third quarter of 2013. At the close of the market today, we released our operating results. If you have not a chance to review the press release yet, you can get one on our website at affymetrix.com.

Joining me on the call today are our President and CEO, Frank Witney; as well as our Chief Financial Officer, Gavin Wood.

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 our actual results to differ from those in forward-looking statements are detailed in our filings with the Securities and Exchange Commission. It is 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 documents carefully as forward-looking statements are made as of today's date and we make no obligation to update this information.

Additionally, we'll be discussing GAAP and non-GAAP measures. A full reconciliation of the non-GAAP measures to GAAP can be found on today's press release or on our website.

As a reminder, today's call is being recorded. The; audio from the call is being webcast over the Internet on our homepage at affymetrix.com. With that, let me turn the call over to Frank.

Franklin R. Witney

Good afternoon, and thank you for joining us. Before I review our commercial and operational performance for the third quarter, I'd like to reiterate our goals for the second phase of our strategic plan which spans 2013 and 2014. Our primary goal is to return the company to growth. Our second goal is to achieve sustained profitability. Our third goal is to strengthen our balance sheet and increase our strategic flexibility.

Overall, we believe that our efforts are beginning to pay off. We continue to execute on our strategy of expanding our reach into the translational science, molecular diagnostics and applied markets. By doing so, we expect to achieve our goals and exit Phase 2 of our turnaround plan in 2014 with a sharpened business focus, revenue growth, strengthened balance sheet and sustained profitability.

Let's look at some of the key metrics that we used to track our progress on these objectives. With regard to growth, our third quarter revenue of $80.4 million represents a modest year-over-year growth. That said, we believe our growth momentum will continue with new product offerings, such as OncoScan, our Human Transcriptome Array, QG FlowRNA and by building on the strength of our CytoScan and Axiom franchises.

As for profit, our EBITDA for the third quarter of 2013 was $13.7 million or 17% of sales, and year-to-date our EBITDA was $38 million or 16% of sales. We remain committed to achieve an EBITDA margin of approximately 15% of sales for the full year of 2013.

In addition, we made significant progress and strengthened our balance sheet since our last quarterly report. Earlier this month, we announced that we sold our Anatrace business and significantly reduced our outstanding debt. We also refinanced our senior debt to reduce our ongoing interest experience. Gavin will provide more details on both initiatives later in the call.

Our operating results have improved over the last couple of quarters despite the ongoing uncertainty around academic spending in North America. For example, our consumable revenue increased by 6% over the prior year. As a reminder, consumables now represent more than 90% of our total revenue. From a geographic perspective our business strengthened in both Europe and North America, while Japan remained challenging.

Now I'd like to give you a little more color in each business unit, beginning with our fastest growing segment, Genetic Analysis. For the third quarter, our cytogenetic product revenue increased by approximately's 36% over the prior year and currently represents 12% of our revenue. The growth in this product line is driven by increased business in existing accounts, reflecting the reliability and performance of our product, as well as expanding our geographic footprint and our application base deeper into the translational medicine and molecular diagnostics market. For example, we are seeing increased usage of our research-use-only CytoScan in oncology applications.

Our FDA filing is still proceeding well, and we maintain our view that the review process will take about a year from the time of our filing.

We had another strong quarter of growth in genotyping, where Axiom revenue was up about 80% over the prior year. This was driven by expanding our menu of standard products, continuing success of our custom array programs and our strengthening competitive position in winning new opportunities in Biobanking and Ag-Bio. We are in active discussions on potential collaborations in consumer genetics and expect this market will provide another leg of growth in our genotyping business. I look forward to sharing the details once they're finalized over the next couple of quarters.

In the third quarter, we launched our new OncoScan FFPE Assay Kit, which enables whole-genome profiling from solid tumor FFPE tissue samples in just 48 hours. Over the last 2 years, we have offered access to our OncoScan technology as a service that we provided internally. In August, we launched the complete kit, which includes arrays, reagents and analysis and display software, a powerful combination that allows customers run samples and perform the analysis in their own labs. OncoScan is a powerful tool that enables researchers and clinicians to perform high-quality whole-genome copy number studies from retrospective or prospective FFPE tumor samples.

The limit amount of sample and the greater demodified nature of the target DNA presents a significant challenge for next-gen sequencing. There's increasing evidence of the importance of copy number changes in oncogenesis. We've already had early commercial successes with this product. In particular, the recent paper published by the Cancer Genome Atlas Project has further reinforced the significant impact of copy number variations in cancers. We consider OncoScan a significant revenue opportunity, and I look forward to updating you on customer adoption.

Turning to eBioscience. This business grew by 13% compared to the third quarter of 2012. Almost half of this growth was driven by moving our Procarta products, which was a Panomics product line, into the eBio business. This is one of the synergistic initiatives that we executed this year. Organically, eBioscience grew by 6%, which is the third consecutive quarter of improved year-over-year revenue growth. We're encouraged by this result given the significant exposure eBioscience has to academic spending in North America. We continued to see strong growth in Europe and Asia-Pacific with modest improvements in North America.

The team at eBioscience continues to innovate and expand their product portfolio to drive growth. We launched some important new products, like QuantiGene FlowRNA, which allows simultaneous measurement of gene and protein expression in single cells on the global installed base of flow cytometers with the applications in growing areas such as cancer and stem cell research. We're also taken advantage of the high-quality antibodies manufactured by eBioscience to expand our Procarta multiplex immunoassay product line, which runs on a Luminex platform.

Life Science Reagents generated sales revenue of approximately $7.8 million in the third quarter, including Anatrace. Our Anatrace forecast for the fourth quarter was about $1.5 million. For the third quarter, our Life Science Reagents business including Anatrace was down 4% over the prior year, with the biggest challenge in the molecular biology line. While the Anatrace line was profitable, the impact to our EBITDA going forward is not expected to be significant. We expect LSR to be flat to slightly down over the next couple of quarters as we work to improve the performance of this business.

Our Gene Expression revenue was down 12% year-over-year in the third quarter, representing the third consecutive quarter in which the trends in this segment improved. Year-to-date, we significantly reduced the decline in our Expression review, which was down 29%, 18% and 12% over last 3 quarters, respectively, as compared to last year.

We are encouraged by the customer response to our new Human Transcriptome Array, or HTA, which is the primary driver for our improved performance. HTA is a powerful product for global gene expression profiling and is economically priced. We have reagents for clinically relevant sample types such as blood and FFPE, and customers can go from sample to discovery in a week's time. We are gaining adoption of this product from customers in the translational sciences, who maybe considering RNA seq but appreciate the performance, simplicity and economics of HTA. These attributes enable large-scale genome-wide transcription profiling studies over very large sample sets. We are in the process of expanding this product line as it represents our new-generation expression arrays, kits and software.

To summarize, our third quarter results, we continue to make important progress against our corporate goals. We launched a significant number of new products and applications over the last few quarters, creating new market opportunities where we believe we will have sustainable competitive advantages. For example, next year, we intend to launch new automated molecular pathology assays that we've developed through clinical collaborations. We grew our total revenue modestly over the prior year, generated EBITDA of about $14 million and significantly improved our outstanding senior debt position.

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

Gavin Wood

Thank you, Frank, and good afternoon, everyone. Before I review our quarter results, I'd like to provide more details on certain initiatives that Frank mentioned earlier, first to the side of the product line and then second to the refinancing of our secured debt.

Last year we took on $85 million of senior secured debt to fund the portion of the eBioscience transaction. This debt was a 5-year loan at 6.5% coupon. After the end of the second quarter, our total senior secured debt outstanding is $63.7 million. Following a review of our asset portfolio, we recently completed the sale of our Anatrace product line of detergents, which was formerly part of our Life Science Reagents business. We made this divestiture because the Anatrace business is non-core to our strategy. We're focusing on translational medicine and molecular diagnostics and applied markets, and this enables us to focus on our key growth drivers. We used the proceeds of the sale as well as additional cash on hand to reduce our senior debt to $46.7 million as of today.

Last week, we announced that we've entered into an amended credit agreement with GE Capital and Silicon Valley Bank. This provides, amongst other things, a new term loan in aggregate principal of $48 million with a 5-year term loan. The amended agreement reduced the interest rate to LIBOR plus 3.75% and amended both the nature and terms of the financial covenant ratios. As a result of reducing our overall debt and refinancing to a lower interest rate, we expect to save approximately $4 million in interest over the next 5 years. After the prepayment of our senior debt, our cash on hand as of the 25th of October exceeded the principal amount of our senior debt.

For the third quarter 2013, the company reported total revenue of $80.4 million, which included $19.9 million in revenue from eBioscience, as compared to $79.6 million for the same period last year, including $17.6 million from eBioscience.

Turning to the details. Third quarter product revenue was $74.8 million as compared to $72.7 million for 2012, up $2.1 million or 3%. Total consumable sales were $72 million, up 6% from $68.1 million in the third quarter 2012.

Instrument sales for the quarter were $2.8 million compared to approximately $4.6 million in the prior year quarter. Service and other revenue was $5.6 million compared to $6.9 million in the third quarter 2012. This includes sales and scientific service revenues of $5.1 million and royalty and other revenue of $500,000.

Our scientific service revenue is project driven and we expect to see this revenue increase materially as we begin to run samples for the U.K. Biobank in the next few months. As a reminder, we expect to recognize the majority of the U.K. Biobank revenue in 2014.

Turning to gross margin. For the third quarter 2013, total GAAP gross margin was 55% as compared to 52% in the same period of 2012. Excluding non-GAAP adjustments such as the amortization of step-up in inventory fair value of $2.9 million and amortization of acquired intangibles of $1.3 million, non-GAAP gross margin was approximately 61%.

Looking at operating expenses. Our total operating expenses for the third quarter were approximately $45.1 million versus $52.8 million incurred in the same period last year, including GAAP operating expenses of $11.3 million for eBioscience, as compared to $11.5 million in the third quarter of 2012. Excluding the amortization of acquired intangible assets of $3.2 million, total operating expenses were $41.9 million, down from $46 million in the third quarter of 2012, which we have adjusted to exclude the amortization of acquired intangible assets and acquisition-related transactions.

R&D expenses for the third quarter 2013 were $11.5 million, which included $2.2 million of R&D expenses from eBioscience. This is compared to $16.5 million in the third quarter of 2012, which included $1.9 million from eBioscience. Excluding eBioscience, R&D expenses were down $5.3 million or 36% in the quarter ended 30th of September, as compared to the same period in 2012. Decrease is primarily due to lower cost related to reduced headcount and variable compensation, lower IT costs and reduced spending on supplies and consulting, together with the timing of spend on certain projects.

SG&A expense was $33.6 million for the third quarter, which included $4.2 million from eBioscience, as compared to $36.3 million in 2012, which included eBioscience expenses of $3.6 million. Excluding eBioscience, the $3.3 million or 11% decrease was primarily due to lower headcount related and variable compensation costs.

Interest expense and other was approximately $2.6 million in the third quarter, primarily being interest expense. This compared to interest expense and other net of $6.9 million for 2012 that included the impairment of our West Sacramento facility of $4 million and interest expenses of $3 million.

In total, during the third quarter of 2013, we generated a GAAP net loss of $4.2 million or $0.06 per diluted share. Non-GAAP net income was approximately $3.3 million or $0.05 per diluted share. This compares to a non-GAAP net loss in the third quarter 2012 of $2.4 million, or $0.03 loss per diluted share.

Turning to non-GAAP adjustments. To help facilitate the analysis of the company's core operating results, I'd like to summarize the non-core adjustments to our net loss for the quarter and their impacts on the pretax earnings per share. Impacts of these adjustments amounted to a net $7.4 million or about $0.10 per share, within gross margin of $4.2 million or approximately $0.06 per share and the amortization of acquisition-related intangibles of $1.3 million and inventory step-up in fair value of $2.9 million. In operating expenses, approximately $100,000 in R&D and $3.2 million in SG&A or $0.04 per share in acquisition-related intangibles amortization.

Turning to the balance sheet. We ended the third quarter 2013 with total cash and cash equivalents of $50.6 million. This compares to $44.1 million at the end of the second quarter of 2013. As I mentioned earlier, subsequent to the close of the quarter, we used the proceeds of the sale of our Anatrace product line and additional cash on hand to significantly reduce our outstanding debt. As of last Friday, our cash balance exceeded the principal amount of our senior secured debt.

Other balance sheet items include capital spending during the third quarter of approximately $0.7 million, as well as $200,000 in licensing fees. Depreciation and amortization were approximately $12.5 million, including the amortization of acquired intangible assets and inventory step-up. Accounts receivable were $48.5 million, up slightly from the $47 million at the end of the second quarter 2013 due primarily to timing of transactions and related recovery of outstanding amounts compared to the prior period. I remain pleased with our credit control function's global performance in a challenging environment.

Turning to inventory. Our net inventory for the third quarter of 2013 was $71 million, down 6% from $75.7 million at the end of the second quarter 2013, primarily driven by $2.9 million amortization expense recognized in the third quarter on the fair value step-up, as well as low inventory levels due to capital inventory [ph] management and higher revenues.

In summary, we are pleased with our execution and operating results for the third quarter of 2013. We grew our total revenue over Q3 2012, we generated non-GAAP EBITDA of $13.7 million, we maintained cost controls, and our non-GAAP operating income was $3.3 million, an improvement of nearly $5.7 million over the same period last year.

We exit the third quarter with a stronger balance sheet, reduced senior debt and a lower ongoing interest expense.

And this point, I'd like to open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Brian Turner from Levin Capital Strategies.

Brian Turner

What I'd like to do is just if you could, just provide a little color around the Expression business. Down 12% seems like a fine result to me. I'm sort of curious what went into that and in terms of the contribution from Panomics, that would sort of be helpful. That's the first question. The second question just deals with Biobank. Can you just give us an update there where you are? And any similar type deals like Biobank? Anything there in your future -- maybe not of the same size, but I'm sure there's a few out there that we could see. Third question, just is on your cash. We have a buildup. I'm just wondering when you start to think about using that. And then just the fourth question is on Japan. Just curious about the changes you've made there and that affect that that's had in terms of sales. And if any color in Japan would be helpful.

Franklin R. Witney

Sure. Thanks, Brian. So your first question on Expression. We have a very aggressive initiative inside the company to provide customers our Human Transcriptome Array solution for genome-wide expression profiling at the gene level including splice variant analysis. We think this is a very important product. It's priced appropriately. It gives people very quick results from sample to biology. And it's starting to resonate with consumers. We're still seeing declines in IVT business, but that's being offset, as we'd hope with our HTA business -- our HTA sales. We've just scratched the surface there. We've got new products in that line that we can put out. We have reagent kits associated with it. We have a new software package called Transcriptome Analysis Console that gives a nice visualization of splice variant analysis, which is important in biology. So we're -- that's really the primary difference. Panomics was relatively flat, to your question there, but the real driver was our HTA product. Your second question, on Biobank, and we continue to work with the U.K. Biobank team. The majority of the revenues, as we've said, will be realized in 2014, but everything is on track there. In terms of new opportunities, as you know there are numerous biobanks around the world that are building up repositories. We're in active discussions with a number of them and feel very good about our competitive position. Customers want standardization. The customers are obviously -- they're in discussions with each other. And our early success with U.K. Biobank we feel is helpful as we talk to other similarly situated customers

Cash usage, I'd let Gavin talk about the cash usage.

Gavin Wood

So Brian, on cash, I mean, we're very pleased with the way that we generated cash. The divestment and cash on hand was used to pay down our debt. That remains a primary goal of ours. So I think in the short-term, as we generate cash, we'll use that to reduce the debt. Clearly, we were also looking at making some investments in the organization and in R&D. But at the moment, our focus is getting the debt balance down.

Franklin R. Witney

And to your last question on Japan, we still continue to struggle with the IVT business in Japan, which was the majority of the commerce that we're doing over there. We've got a lot of initiatives that we believe will pay off in 2014 that are allowing us to more aggressively market and sell or grow our stronger growth areas and our Genetic Analysis business. So many of us have made trips over to Japan to get the team up to speed on the genotyping business as well as the cytogenetic business. And we've launched the OncoScan product there. And on the Expression side, we're trying to team up and the Japanese customers on our HTA product. So it's really a strong company-wide effort to get our stronger growing businesses established in the Japan market.

Operator

Our next question comes from Isaac Ro with Goldman Sachs.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

It's actually Joel Kaufman on for Isaac today. Just a quick one. Out of the HSG this year, we heard Alumina talking about lower content, lower priced arrays at higher volumes. Can you just walk us through how you're thinking about these comments and how they fit into your overall strategy?

Franklin R. Witney

Yes. We concur. If you look at the Biobank -- if you compared GWAS to Biobanking, the samples -- the numbers of samples people want to run are materially higher but they're less complex arrays. So that's consistent with what we're seeing, and that's consistent, for example, with our Biobank transaction.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

Okay. And then another one, just on new products. Could you just talk about what -- how much new products contributed to your growth this year? And then how are you thinking about that going forward? Just for the first 9 months.

Franklin R. Witney

I'm not sure we track. We don't have a specific metric. We do at eBioscience, where roughly -- and typically 10% to 15% of the revenue is driven by new products in the eBio business, and they continue to hit that metric. The fastest-growing part of our business this year is in our Genetic Analysis business, which is our CytoScan product for we're growing in our current customers, as well as establishing new applications in new geographies. The genotyping, of course, is constantly a set of new products, or if you will, and that business is going very well. HTA, as we talked about, is contributing materially. OncoScan is new; will not have a material impact on revenues this year, but we are optimistic for next year. Some of our newer products in that we're working on very hard is some of the Panomics products, like QG Flow and our molecular pathology assays, QG ViewRNA, which are not going to contribute this year but we believe will contribute next year. So we feel we have a nice set of new products and then extensions of our Axiom and our Cyto line into new markets and new geographies.

Doug Farrell

So Joel, this Doug. Maybe just to add a little bit to that, I think historically, we've launched a lot of new products in a year. This year we have a lot of new platforms as well, so there is a ramp-up time. There are customers that actually need to get new hardware to make these things happen. So historically, when it's a whole new rollout of a platform, it's several quarters over which it starts to ramp up. So I think that the timing -- the benefits of things like OncoScan and QG Flow are going to be much more important in 2014 than it will be this year.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

Okay, great. And then just one final one. Just on the economics on your diagnostic customers, like Veracyte, I was wondering what kind of economics you guys get on those type of deals.

Franklin R. Witney

Yes, we obviously can't reveal the inner workings of our relationship, but it's relatively modest. It's relatively modest economics on our side.

Operator

Our next question comes from Daniel Arias from UBS.

Reginald Miller - UBS Investment Bank, Research Division

This is Reggie Miller in for Dan Arias today. First question, just wondering if you could talk a little bit more about the OncoScan opportunity that you're thinking about contributing next year and how you see that playing out in the market?

Franklin R. Witney

Well, we've done an extensive customer -- voice of customer. We've got -- we have a large pipeline of perspective customers that are primarily interested in doing genome-wide copy number analysis on tumor explants, as it gives very good results in measuring DNA copy number in FFPE. So we're in early-stage discussions to late-stage discussions with our wide constellation of customers, and we think it will make a material contribution to our revenues next year.

Reginald Miller - UBS Investment Bank, Research Division

Great color there. And maybe I guess, looking at instrument performance for this quarter. Looking into 2014, what do you see kind of a mix playing out to be? What do you guys seeing internally between consumables and instruments? Is there any kind of internal targets, maybe?

Franklin R. Witney

I would envision that next year, the ratio between consumables and instruments will be roughly the same. We don't see any material difference at this point, but looking forward.

Reginald Miller - UBS Investment Bank, Research Division

Okay, great. And then maybe last one for me. Can you talk a little bit about the price elasticity that you're expecting in genotyping?

Franklin R. Witney

Well, certainly, as the -- in very large studies, Biobank-level studies, people are -- they want to run a very large number of samples, and so it's price competitive. On the other hand, the studies are very large and they're material revenues for us. So it's a balance between those 2. The other advantage that we have, we believe we have is our 384 format that allows us to drive our genotyping platform into routine applications, such as Ag-Bio or some of the human fine mapping areas. So it is definitely -- there's been a change over the last several years to lower-complexity, higher-volume studies, and the price point has to be appropriate for those types of studies.

Operator

[Operator Instructions] Our next question comes from Peter Wilson (sic) [Lawson] with Mizuho Securities.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Hey Frank, just around the various businesses, which is still a drag on EBITDA?

Franklin R. Witney

Sorry Peter. Could you repeat? You broke up a little bit there.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Oh, just around the various businesses, which is still a drag at the company level on the EBITDA line?

Franklin R. Witney

We actually don't report out at that level of granularity. I will say that we've made good progress. We believe we've made good progress on the cost structure throughout all of our businesses, and we pay -- we pay a lot of attention to that aspect of it. But in terms of the reporting specific granularity, we just don't do that.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Okay. And then just on the eBioscience business, do think that's getting back to normalized growth? Or do you think that can go higher?

Franklin R. Witney

Well, we strive for high single-digit to double-digit growth, and we're working very hard on that both from a product perspective, integration and Affy perspective and geographic perspective so we're very proud of that business. It's more and more integrated all the time. And this quarter was up 6% organically on a like-to-like basis. And so we're feeling better about the business. It's still very tough in North America. The sequesters is a real challenge, but it's a challenge for everybody.

Peter Lawson - Mizuho Securities USA Inc., Research Division

And then just on Gene Expression, when do you think that business flattens out and what do you think is going to help contribute to kind of extending that decline?

Franklin R. Witney

Well, our stated goal has been to have that business decline in the 5% to 10% range. We think we can actually do better than that, but we want to be realistic. And the driver of that is new products like the HTA product. And we're also -- we've seen nice response from microRNA product, for example, and we'll be putting out a new round of that particular product relatively shortly as well. So it's the gene level arrays and the shift from the IVT. So this quarter we were down 12%, which is an improvement. And we continue to make appropriate investments in our Expression business to achieve our goal of modest declines.

Operator

Our next question comes from Bryan Brokmeier with Maxim Group.

Bryan Brokmeier - Maxim Group LLC, Research Division

Yes, on the Expression business. It was only down 12%, which was helped by, as you said, the Human Transcriptome Array. If you back out the Japanese business, how much would the Expression business have been down?

Franklin R. Witney

Well, I haven't got the specific math available. But certainly, we're still declining with the IVT business in Japan, so that would've helped at some percentage. I just don't know the specific number.

Bryan Brokmeier - Maxim Group LLC, Research Division

Okay. And I think wasn't the Expression business down in Japan in the first quarter, it's down closer to -- I believe it's -- I think you said 40% or so in the first quarter. So is it about the same magnitude of a difference between the rest of the Expression business? So the overall business -- the overall Expression business was down about 30% -- sorry, it was down about 29% in the first quarter, and if I remember correctly, I think that it was something along the line of 40% in Japan. Is it still down about that level of magnitude in Japan?

Franklin R. Witney

The improvements we saw were in North America and in Europe, and in particular, in our gene level arrays, HTA being in the most important of those. Japan is still challenged, as we said a few questions ago. The newer initiatives around HTA and some of that genetic analysis products are really going to impact Japan next year, so the challenges we're seeing have been year-long challenges in Japan, particularly with being so exposed to the IVT business.

Bryan Brokmeier - Maxim Group LLC, Research Division

Okay. And just lastly, what changed in the quarter that allowed the CytoScan to really start to gain traction in oncology markets?

Franklin R. Witney

Well, more and more people are doing their validation studies and doing work with the product in that particular area. Our sales team and our commercial organization is pushing hard. There's more publications coming out on the utility cytogenetic microarrays for that application. And so we believe this will be a growing application. As we've said many times, the market for oncology is larger than the constitutional market, but it's going to be slower -- it's adopting more slowly behind it. So we're hoping to catch that or believing we're going to catch that wave.

Operator

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

Shaun Rodriguez - Cowen and Company, LLC, Research Division

So continued really solid growth from Cyto, so I have some few follow-ups on that. So first, can you maybe provide us some additional detail on how much of the more recent uptick is coming from conversions from microscopy versus competitive takeaways? And second, you noted continued strong growth from existing accounts. So a couple of the bigger independent reference labs are publicly disclosed customers of CytoScan -- LabCorp and ARUP, to name a couple. So I was hoping you could discuss the utilization trends within some of these key accounts and whether there's any notable revenue concentration that exist at this point.

Franklin R. Witney

Yes, to your first question. We believe there's still a strong conversion from microscopy traditional cytogenetics or karyotyping to cytogenetic microarrays, but these are relatively smaller labs at this point. But for example, we're seeing the conversion in Asia as well as in Europe. The specific numbers -- I'm not sure exactly I know the specific contribution of the converted labs, but we're certainly seeing that. We're seeing that trend, although it's still -- these are still relatively early adopters. So it's probably not a big contributor to the growth there -- to the growth. In terms of the large publicly disclosed reference labs, we don't talk about specific customer information, so I'll have to take a pass on that one.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Okay that's fair. And let me see. So how does pricing compare between the OncoScan, the FFPE kit and the service offering on a per sample basis? And any sense for the proportion of your service customers who might be kind of a low-hanging fruit to bring that in the near-term? Really just trying to get a sense for how incremental this might be in the earlier phases of the launch here.

Franklin R. Witney

Yes, certainly, people who have run service are low-hanging fruit, and we're talking -- and many of those people are considering OncoScan in their own lab. oncoScan service was a relatively small business for us, and we certainly had -- and we're told by customers that until we had it in a kit form with software that could be run in their own labs, it will be -- we're going to have limited success with the product. So we've revised the product. We think it's much more powerful and now it's -- we have kits, we have reagents, arrays and software that should be well adopted. So we feel very good about it. And certainly the people who run service are obvious are early adopters for the kit format.

Doug Farrell

Shaun, this is Doug. So maybe just to add to that. From a gross margin perspective, clearly product sales in consumables are a much stronger margin than services for us. So from an incremental contribution, certainly, on the margin side, we'd expect over time that will be a positive.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

And then last for me, did you provide a specific genotyping revenue or growth rate for the quarter?

Doug Farrell

We provided a growth rate. Axiom specifically was up 80% over the prior year. We didn't give full revenue breakdowns on them.

Operator

Your next question comes from Jeff Elliott calling from Robert W. Baird.

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

A couple of housekeeping ones first. The growth rates that you gave for Gene Expression, can you clarify whether or not that includes Panomics? And then the future commentary on the LSR business, does that adjust for the sale of Anatrace?

Franklin R. Witney

Yes, so the Expression number does in fact include the Panomics business? The LSR, the flat to slightly down takes into account -- is assuming that it's on an organic basis without the Anatrace business.

Jeffrey T. Elliott - Robert W. Baird & Co. Incorporated, Research Division

Got it, okay. And then shifting gears over to the academic end market, can you talk about what you're seeing in the U.S. given the combined impact of sequestration and the federal budget standoff? And then just to clarify, on the debt reduction, do you have any targets in mind in terms of the senior debt as to where you'd want to reduce that?

Gavin Wood

Yes, I think on the senior debt, I've got a target in mind, but perhaps not just -- I wouldn't share it just yet. But we've certainly got a target.

Franklin R. Witney

Yes, we'd only say we certainly are -- one of our high priorities is to continue to reduce our senior debt, and we work on that -- we're working on that very aggressively. North America is challenging. We saw some very nice results with our -- we saw some very nice results with our Cyto business and our Expression business in North America. I feel that our more project-based -- the eBio business improves slightly in North America, what we've seen in the prior quarters. So the funding is still very difficult in North America and we're working through it.

Operator

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

David Lin

It's actually David in for Derik. Just a couple of quick ones for me. So there's a lot of talk about pricing in molecular diagnostics. So I was wondering if any of that -- any of the reimbursement issues are affecting you guys at all possibly in cytogenetics? Or is that not an issue?

Franklin R. Witney

Well, at this point, it's not an issue. But there certainly is a lot of discussion and there's a lot of work going into the reimbursement side across the industry, as you point out. We monitor closely. We're tracking it. But at this point, it's not the biggest driver.

David Lin

Okay. And secondly, so I think you said last quarter that R&D would generally be pretty flat from Q1 levels going forward. But now it's been down 2 quarters in a row. How should we think about that going forward?

Franklin R. Witney

Well, in Q3 of last year, we had some very large expenses around the launch of our OncoScan, the work on our OncoScan platform as well as our FDA filing, so those were more onetime. But we expect R&D to be relatively stable going forward.

Gavin Wood

And if I add [ph] as well, David, we're running around about 14% to 15%, which I think we were shooting for a while. So it's more or less in the right place at the moment.

Operator

Our next question comes from Daniel Brennan with Morgan Stanley.

Michael Clerico - Morgan Stanley, Research Division

This actually Michael Clerico on for Dan. Question, we've seen some consistent growth for you guys for some time. This with restructuring that's passed. How should we think about normalized margins going forward, assuming something like a low single digit top line growth? What kind of leverage would you get off of that?

Gavin Wood

I think our margins actually over the last 3 quarters on a non-GAAP basis have been fairly stable around about a 60% mark. As we look into 2014, certainly without being too specific, the buyback will leave some erosion at the top-level margin. But we'd either thought mid to high 50s is very, very reasonable into 2014, though we are in the middle of working that through the 2014 budget.

Michael Clerico - Morgan Stanley, Research Division

Okay, great. And also with the U.S. government shutdown and sequestration, what impact are you seeing from there? And how does that read for Q4?

Franklin R. Witney

Well, the shutdown, we believe, will have a temporary effect, and it's not significant in the quarter. The sequestration has been around for quite a little bit of time, so we're not seeing any fundamental step changes between Q1, Q2 and Q3 in terms of funding levels. It's very difficult, as many companies have pointed out. But nothing -- it's -- we're all waiting for budgets to be worked out.

Operator

Our next question is from David Moskowitz with Empire Asset Management.

David Moskowitz

The Genetic Analysis business, it tends to be a little bit lumpy on a quarter-to-quarter basis. Can you again talk about some of the trends? You talked about CytoScan in oncology, but what are the trends that are out there? And importantly, are there any large population studies that drove revenues in the third quarter? And what can you say about this business from a large study standpoint going forward?

Franklin R. Witney

Well, we continue to track the Biorepository, Biobank population type studies. There was nothing particularly notable in Q3 around the genotyping revenues. With the Biobank deal, U.K. Biobank transaction, we do have access to market our products in a way that we couldn't previously so we're continuing to pursue those kinds of opportunities. But we're tracking a large number of these and feel that we're in a very competitive situation.

David Moskowitz

Okay. So nothing unusual this quarter that you guys can note?

Franklin R. Witney

It's -- we have an ongoing genotyping business that we -- the Axiom -- our Axiom product line has grown -- is growing very well over the last 5 or 6 quarters and we continue to expand the business out.

David Moskowitz

And on the Gene Expression business, still about 30% of overall sales. What do you think the target level for that is on the long term?

Franklin R. Witney

Well again, we think that our products in the HTA line are very important products that have a very real value proposition for our customers, whether they're in our genotyping space or whether they're in our cytogenetics space or other parts of translational medicine. So we're aggressively pushing and providing the information to our customers and selling that particular product line. That's where the growth is coming from, and we'll continue to pursue that. Our stated goal is to have the business decline in the 5% to 10% range, relatively modest range, and that's the metric we're tracking ourselves of. We were -- effectively, we're just a little bit outside of the band in Q3, but we're at the very early days of our HTA product. And as I said earlier, there's other products that we're going to put out in the HTA line that we think that can help. So we believe that, that business can be managed in this minus 5% to minus 10% breakout band.

David Moskowitz

Okay, great. And last question, you just mentioned that you have a target in mind for the senior debt level. Can you tell us what that target is? And if you can't, can you tell us what the decision making is on the optimal capital structure for the business?

Gavin Wood

Yes, if you think back a few months, it was 85. We mentioned to cut that in half in that period. Going forward, certainly it would be unreasonable to expect something approximately like that. We cannot discuss in detail at the moment. But certainly, our stated aim is to reduce our debt. We've been successful in doing that, and we will continue to keep that a high priority, as Frank touched on right at the top of the call.

David Moskowitz

I guess my question is not -- are you guys ultimately striving to pay it all down? Or is there some level of debt that you think the business...

Gavin Wood

I think there's some level of debt -- as a mix of, funding, some level of debt would be appropriate. We've just signed a 5-year loan, and over the course of that, we'll address the right funding as the company goes forward and as we look to investing in other areas as well. So without being specific, the debt is higher than I would like, but I don't want to say where -- just quite where we're getting to.

Operator

And ladies and gentlemen, there are no further questions at this time. I'll turn the conference back over to management. Thank you.

Doug Farrell

Very good. Thank you. Thanks, everybody, for taking the time to participate in the call today. 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 the replay, domestic callers, please dial (877) 660-6853. And international callers please dial (201) 612-7415. The passcode for both is the same: 421484. Alternately, an audio replay will be available under our Investor Relations website at affymetrix.com. This concludes the call. Thank you again for joining us today.

Operator

Thank you. All parties may disconnect. Have a great day.

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