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Affymetrix (NASDAQ:AFFX)

Q1 2011 Earnings Call

April 27, 2011 5:00 pm ET

Executives

Doug Farrell - Vice President of Investor Relations

Kevin King - Chief Executive Officer, President and Director

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

Analysts

Derik De Bruin - UBS Investment Bank

David Clair - Piper Jaffray Companies

Vijay Kumar - Deutsche Bank AG

Jonathan Groberg - Macquarie Research

Quintin Lai - Robert W. Baird & Co. Incorporated

Ramesh Donthamsetty - JP Morgan Chase & Co

Daniel Leonard - Leerink Swann LLC

Marshall Urist - Morgan Stanley

Isaac Ro - Goldman Sachs Group Inc.

Operator

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

Doug Farrell

Thank you, Scott. Good afternoon, everyone, and welcome to the conference call. At the close of the market today, we released our results for the first quarter of 2011. Joining me on the call today is our CEO, Kevin King, who will provide a commercial and operational update; followed by, our CFO, Tim Barabe, who will provide a detailed review of our financial results for the first quarter. As a reminder, today's call is being recorded, and the audio from the call is being broadcast over the Internet on our homepage 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. These risk factors are discussed in Affymetrix's Form 10-K for the year ended December 31, 2010, and other SEC reports. 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.

Now let me turn the call over to Kevin.

Kevin King

Thanks, Doug, and good afternoon, everyone. On our last call, we outlined four business objectives for 2011 that include: a return to revenue growth, including growing revenue and the validation in test markets to 25% of total sales; an improvement in gross margin of 2 points; generating positive cash flow for every quarter; and finally, achieving positive net income for the year.

During today's call, Tim and I will highlight the progress we've been making in Q1 on these objectives. Importantly, the company generated positive net income on roughly $74 million in revenue, as we achieved higher gross margins and lower operating expenses. This is the third consecutive quarter in which we have generated positive net income on a GAAP basis. Total revenue for the quarter was $74 million, down $6 million from last year. Consumables accounted for roughly 85% of Q1 revenues. Our RNA revenue were in line with our forecast of $36.5 million. While RNA array volumes grew over Q1 of last year, revenues were down by 4% due to shift towards lower cost products as well as a 50% increase in our rate plate volumes over last year. We generated year-over-year RNA volume increases and several key product lines, including IVT, gene level, microRNA and reagent products. In Q1, we introduced the new version of our microRNA array that includes this coverage of genome microRNA and allows users who still accelerate their identification of biomarkers and gene expression signatures associated with disease. This new array design doubles the contents of the prior version and offers the broadest coverage of known miRNA in the industry. The contribution from this new product helped increase miRNA revenue in Q1 by about 60% over last year.

During the quarter, a number of key scientific publications and editorial comments highlighted the major role that arrays considered to play in understanding gene function and gene regulation. These scientific papers emphasized array data accuracy, reliability, cost effectiveness and high throughput capability. For instance, a team led by Ron Davis at the Stanford Genome Technology Center, compared a custom Affy exon array to next-generation sequencing for understanding gene expression and Genome 1 identification of alternative splicing as well as infecting coding snips and non-coding transcripts. The performance of the array was examined and compared with miRNA sequencing, or RNA-Seq, over multiple independent replicate samples, and the results were published in February in the proceedings of the National Academy of Science.

To achieve comparable levels of sensitivity, the sequencing experienced cost 10x more than arrays and took much longer to complete. Even at that increased level of effort, the array had higher levels of sensitivity at the exon level. Even deeper sequencing will be required to address low abundance transcripts as well as the array did. The array has already been implemented in a multi-center clinical program involving thousands of samples, and as the author states, this platform is anticipated to have a wide range of applications and high throughput clinical studies. We believe the market for RNA arrays continues to be helping despite financial communities' concerns over potential displacement by new sequencing technologies.

In the DNA segment of our business, revenue was down $2.2 million in Q1 compared to last year, driven by continued softness in the GWAs market. As we've noted, the second wave of GWAs is largely dependent on publicly available information about rare genetic variance with frequencies below 5%. Over the past several quarters, the 1000 Genomes Project and Affymetrix had made this information available to the research community, and with this new content, researchers have begun to define and request funding for new disease and population studies.

In Q1, we expanded our Axiom product line with the introduction of the CHB 1 Array, a unique and state-of-the-art tool for characterizing the genetic basis of disease and studying disease associations in Han Chinese populations. To design this array, we collaborated with researchers at the Bio-X Center of Shanghai Jiao Tong University and Beijing's Fuwai Hospital, who leveraged the more than 10 million validated marketers in the Axion Genomic Database, including content drawn from the 1000 Genomes Project and the International HapMap Project. In the next few months, we'll further expand the Axiom platform with several new population-optimized arrays as well as enhanced customization capabilities.

This quarter, we continue to execute our strategy of diversifying our revenue base into the large and growing market for validation of routine testing. Last year, we estimated that about 20% of our revenue came from these segments, and Q1 net figure rose to 22%. We are seeing a steady increase in the revenue from new DNA products, including para prenatal cytogenetics, Targeted Genotyping, pharmacogenetics and cancer. The growth from these products is decreasing our dependence on the GWAS market, and it's important to note that we believe demand within these markets is growing and that the total opportunity exceeds that of the GWAS market by a factor of 3x.

In the third quarter, we'll be expanding our cytogenetic product line. You may already know that we previewed our next-generation array, called Cytoscan, with key opinion leaders at the American College of Genetics Meeting. Cytoscan will provide unprecedented resolution for studying copy number variations as well as genotypable snip content. Customers involved in the Cytoscan evaluations have indicated that we have a real game changer with great prospects for taking share and accelerating the conversion of the market to arrays. We believe this will be one of our most important growth drivers for the company in the second half of the year.

Earlier this month, we announced an enhanced OncoScan FFPE Express 2.0 at the American Association for Cancer Research Meeting. This second-generation array, designed in collaboration with thought leaders from the Stand Up To Cancer initiative, offers expanded coverage of tumor suppressors and oncogenes and the same proven performance of the first-generation technology. OncoScan FFPE Express has overcome the challenge of analyzing DNA from FFPE samples to extract important retrospective clinical data from archived samples. Version 2.0 goes beyond the limitations of standard array comparative genomic hybridization methods to yield copy number, allelic ratio and somatic mutation from only 79, 75 nanograms of input DNA, the lowest sample requirement available. This is particularly important because the increasing use of fine needle aspirates often results in relatively small amount of tumor sample to work with. OncoScan provides the highest quality data as demonstrated by greater than 90% pass rates across thousands of degraded and challenging FFPE samples analyzed thus far.

In addition to introducing innovative new products, we're expanding the reach of our products through new channels. At the beginning of the quarter, we announced the new distribution agreement with Fisher Scientific, under which Fisher is the exclusive distributor partner for our GeneAtlas platform in North America. We completed the training of the Fisher representatives in February, and they placed an initial order. We expect to begin seeing the benefits of the relationship over the balance of 2011.

To summarize our performance in Q1, our efforts to improve our operating structure continue to pay off with consecutive quarters of profitability and a $9 million improvement in profit compared to 2001 -- Q1 2010. We remain intensely focused on revenue growth in new markets, including cytogenetics and cancer, and these markets are larger and growing more quickly than basic research markets. These products represent an increasing share of our revenue base, and for the year, we expect this segment of our business to grow by more than 20% and to represent 25% of our total revenue.

I'll now turn the call over to Tim for a detailed review of our financial results.

Timothy Barabe

Thanks, Kevin. I'll begin my remarks by reviewing our financial results for the first quarter of 2011 and then close with an update on our balance sheet. For the first quarter, the company reported total revenue of $73.7 million compared to $80.2 million for the same period last year, driven by lower consumable and instrument sales.

Turning to the detail. First quarter product revenue was $67.5 million compared to $73.4 million for the first quarter of 2010, representing a decrease of about 8%. Consumable sales were $62.9 million, down 5% from $66.2 million in the first quarter of 2010. DNA revenue was $21.7 million compared to $23.9 million, down 9% from the same period last year. And RNA revenue was $36.5 million versus $38.0 million, down 4% from the prior year. The product mix remained about 2/3 RNA and 1/3 DNA and other.

Other consumables increased from $4.3 million to $4.6 million from the prior year or 7%. The other category includes reagents and biochemical products. In 2010, we integrated USB and Panomics product lines into our ERP system. As a result, we've reclassified some of the products from RNA and DNA into the other Consumables segment. This is roughly now a $20 million category that is growing at mid- to high single digits. Coming up a strong Q4 instrument number at $8.5 million, instrument sales for the first quarter were $4.6 million compared to $7.2 million in the first quarter of 2010. Service revenue was $4.5 million, in line with the first quarter of last year. Royalties in other revenue was $1.7 million versus $2.3 million in the first quarter of 2010.

Turning to gross margin. In the first quarter, total gross margin exceeded our target of 60%, coming in at 63%, representing an increase of about 4 points over the first quarter of 2010. This was driven primarily by lower excess and obsolescence costs that we outlined in the fourth quarter of 2010 as well as a favorable mix shift toward higher margin consumables and reduced material costs. These improvements were partially offset by lower cost absorption in the first quarter of 2011 as compared to the first quarter of 2010. For the year, we expect our gross margins to be about 60%.

Total operating expenses for the quarter were approximately $43.5 million, down 13% from the $49.9 million for the same period last year. First quarter 2011 R&D expenses were $16.3 million, down 12%, compared to $18.5 million for last year. SG&A expenses in the first quarter were $27.2 million compared to $31.4 million, down 13% for the same period last year. For the second quarter, we expect operating expenses to be around $45 million.

The substantial improvement in gross margins, combined with continued operating expense controls, enabled us to report positive operating income of $3.1 million for the first quarter compared to a loss of $2.7 million for the comparable period last year.

Turning to other income and expense, the company recorded net interest and other expense of approximately $1.9 million in the first quarter compared to a net expense of $3.6 million in the prior year's quarter. This was partially offset by lower interest expense from the redemption of roughly $150 million convertible debt in 2010.

In the first quarter, we recognized income tax expense of approximately $300,000. Our income tax expense for the first quarter is principally driven by foreign income taxes. For the first quarter, net income was slightly above break even or $0.00 per diluted share. This compares to a net loss of $9.6 million or $0.14 per diluted share in the first quarter of 2010.

To facilitate the analysis of the company's core operating results, I would like to summarize non-core adjustments to our net income for the quarter and their impact on pretax earnings per share. In aggregate, these adjustments amounted to a net $1.5 million or $0.02 per share on GAAP net income and include, within gross margin, $533,000 or roughly $0.01 per share in the amortization of acquisition-related intangibles; and in operating expenses, $1 million or $0.01 per share in acquisition-related intangibles amortization.

Let me take a moment to summarize our balance sheet. We ended the first quarter of 2011 with total cash and available for sale securities of approximately $244 million compared to $237 million at the end of the fourth quarter of 2010. Our current net cash is more than $148 million, an increase of almost $50 million over the prior year. In Q1, the company generated about $8 million in cash flow from operations. Capital spending was $1.2 million, resulting into free cash flow of roughly $7 million for the quarter. Depreciation and amortization was approximately $8 million, including the amortization of acquired intangible assets. Operating expenses for the first quarter included $2.6 million of stock option expensed compared to $2.3 million in the first quarter of 2010.

Turning to inventory. Net inventory for the first quarter of 2011 was $49.1 million, down slightly from $49.4 million at the end of 2010. Year-over-year, inventory is down by about 12%.

To summarize, on a revenue base that is $6 million below the prior year, product gross margins increased by about 4 points, operating expenses were reduced 13% or more than $6 million and operating income improved by about $6 million. Net income was up by nearly $10 million, cash flow from operations was $8 million, and including capital expenditures, free cash flow was over $7 million. And we ended the quarter with net cash of nearly $150 million.

At this point, we'd like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Mr. Marshall Urist with Morgan Stanley Smith Barney.

Marshall Urist - Morgan Stanley

So first question was just on the DNA business and the comments about going into cytogenetics and where the increasing mix of cytogenetics and sort of applied market. Could you maybe just talk us through mix there? I mean, that mix is increasing, which I would think should be accretive from an ASP perspective, but where would -- sort of the reported revenue on the DNA side has sort of been in this $20 million, $21 million, $22 million range for the past few quarters. So are there other parts of the business that are kind of under pressure? Or where you're seeing more kind of negative price mix related to PEG? Or could you just talk us through kind of where we are in that cycle? That'd be helpful.

Kevin King

Sure. Marshall, this is Kevin. It's pretty straightforward and consistent with the comments that we made here. It's really the large GWAs study market that is very soft that's dragging down the total DNA number for us. As I mentioned in previous calls, there is a steady stream of follow-on projects, GWAs projects, that were done previously that we continue to sell into, but the low variant contents, market or GWAS market for low-bearing content. It really hasn't materialized yet, and that's where you're seeing the drag. Average selling prices are relatively stable. In fact, in some cases prices are up. And as you articulated here, it's really the traction with mix of new products in cytogenetics and in cancer to offset from the decline there in GWAS.

Marshall Urist - Morgan Stanley

Okay. Perfect. So if you just took out the cytogenetics and the cancer piece, what kind of growth are you seeing there on the DNA side?

Kevin King

If we took it out?

Marshall Urist - Morgan Stanley

No, if that was just that isolated, kind of how was that growing?

Kevin King

Well, year-over-year, it's got to be over 20%.

Marshall Urist - Morgan Stanley

Okay. Got you. And then if you think strategically kind of how you're investing behind the cytogenetics market, could you kind of layout the strategy there in terms of what you guys are doing and what kind of new products you see as key to sort of continue to drive penetration of arrays into the cytogenetics market?

Kevin King

Sure. So the first V-Chat, if you will, is in postnatal cytogenetic disorders. Following on with that are prenatal applications, preimplantation applications, liquid tumors, leukemia lymphoma as well as solid tumors with our FFPE product. That's all around the array base side. Looking at the quantitative genome assay that we have been talking about, the single-cell, single-transfer protection product that we have and also for detection of copy number, there are follow-on products in that area as well for looking at chromosomal aberrations at a single-cell level, both for the perinatal applications as well as for cancer. And so we're pretty confident that we're going to build on a very large portfolio of products here that really stream from looking at single cells and events within single cells all the way up to entire genomes, both for the perinatal as well as for the cancer market.

Marshall Urist - Morgan Stanley

And when you look at that customer base from an instrument installed base point of view, does there need to be sort of a placement cycle to continue to drive that market? And are you seeing that in terms of where incremental placements are going on the instrument side?

Kevin King

Yes, great thought. So most of our instrument sales now are going into clinical markets as opposed to core research labs. I think you know that we've got placements in nearly every academic medical center around the world that does genetic analysis. And penetrating that further is a challenge. So most of the instruments there that we have now are going into the labs, that are molecular pathology labs, in academic medical centers or in industrial accounts. And the manual products that can run on the instruments include the products that I mentioned as well as all of the assays from our Powered by Affymetrix partners. So Pathwork and Skyline and the other folks that have products on market can also enhance our menu offering to our customers.

Marshall Urist - Morgan Stanley

Okay, that was helpful. And then just one last one for me. Kind of where are you guys in terms of internal discussions about reinstating guidance and maybe thinking more about either on a quarterly or yearly basis for the top line?

Timothy Barabe

Yes. I think on a quarterly basis, we don't have any intention of reinstating guidance on the top line. I think as we become more confident in the launches of our new products, that we could get to a point where we will reinstate annual guidance. Kevin, do you have anything to say after that or?

Kevin King

I think that's a fair comment.

Operator

[Operator Instructions] Our next question is coming from the line of Mr. Ross Muken with Deutsche Bank.

Vijay Kumar - Deutsche Bank AG

Yes. Hi. This is Vijay in for Ross. Thanks for taking the question. My first question was on what are you seeing from a geographic perspective? The ES -- the U.S. versus the EU, I'm sorry. Just given NIH budgetary environment sort of paying out, we've heard that Europe is being seasonally slow. Have you guys seen any geographic difference?

Kevin King

Yes. This is Kevin again. I think you said it best. For us, Europe has continued to be the most challenging recent region for us to expand our business, for a variety of funding and economic reasons. I highlighted that last year in Q2. And I would say things have either been stable or marginally better, but the most difficult region for us. Asia is our fastest growing region. And in Asia, we also include Japan when I use that number. Japan, we were less affected in Q1, probably could've done more business in Japan had the incident not happened there, but we did fairly well. We think our supply chain into Europe -- into Japan is okay. But we're not really sure how the Japan research market is going to continue to move forward. I think a lot of that has to do with if there's any other unfolding effect here as a result of the tragedy there. The Americas market, if you look at both from the industrial side and the academic side, I think the industrial side is fairly solid. There have been a lot of Pharma consolidations. And at the same time, we found new customers in our industrial marketplace. So overall, I think that business is doing fairly well, but the pain of the consolidations has really taken a toll on certain house on other companies as well. By the academic funding environments, I would say it's challenging. I wouldn't say that we're feeling the effects of lower funding as much as probably just competing for other technologies and that makes it challenging for us with respect to vying for dollars.

Vijay Kumar - Deutsche Bank AG

Sure. Those are very helpful. And maybe a quick housekeeping question on the interest income, and I apologize if I missed this on your prepared remarks. But you could you walk me through the reversal of the interest income, I mean, sequentially from the fourth quarter?

Timothy Barabe

From the fourth quarter?

Vijay Kumar - Deutsche Bank AG

Yes.

Timothy Barabe

Okay. So we reported interest income and other of a charge of $1.9 million, and included in that would be foreign currency. We hedge on a quarterly basis, and we go out normally on a hedging basis, so there'd be some hedging transactions in there and minor write-downs of some minor assets that have been on our balance sheet.

Vijay Kumar - Deutsche Bank AG

And maybe a quick follow-up. How should I think about this sort of going forward?

Timothy Barabe

In other income, other expense?

Vijay Kumar - Deutsche Bank AG

Yes.

Timothy Barabe

I would say that the hedging transaction -- the euro, obviously, has strengthened dramatically that's helped us in the top line, hurt us a little bit in our hedging activity. And I would tell you, the -- it would be a lot lower than that going forward, I'd expect it to be a minimal in the quarters ahead.

Operator

Our next question is coming from the line of Mr. Dan Leonard with Leerink Swann.

Daniel Leonard - Leerink Swann LLC

Were there any initial stocking orders with Fisher in the quarter on outlets that maybe were onetime and not sustainable?

Kevin King

Stocking orders, onetime, but they purchased -- I'd try to answer it more directly, and if it doesn't help, just let me know. But they purchased initial demo inventory. So they've got dozens and dozens of sales reps who are now selling the product. And that product needs to be demonstrated, so we received orders from them for those. That demo inventory traditionally is sold and then replenished with either new demo inventory or customers who purchase directly new equipment.

Daniel Leonard - Leerink Swann LLC

Okay. So presumably, they're going to hold inventory of your instrument or not? Are you going to drop ship that instrument?

Kevin King

We drop ship to the customer. We talked about that last quarter as well, but it goes directly to the customer.

Daniel Leonard - Leerink Swann LLC

And how should we think about the royalty lines for the rest of the year?

Timothy Barabe

I would say the royalty rough line, if you look back over the last couple of years, it's been pretty much a steady $2 million.

Operator

Our next question is coming from the line of Mr. David Clair with Piper Jaffray.

David Clair - Piper Jaffray Companies

Yes. I guess the first question for me, just kind of a housekeeping one for Tim. But after posting a 63% gross margin in the quarter, can you just kind of explain how we get to 60% for the year?

Timothy Barabe

Okay. Well, there are a couple of factors. Number one, we have, from a production standpoint, we will have some manufacturing various headwinds going into the second quarter, which will affect the gross margin in a negative way a tiny bit. In addition to that, we had very high margin sales of our chips, and to the extent that we have more services, the mix turns more quite set of services and instruments that would naturally drive the gross margin down as well. But I don't want to explain away what was a fantastic achievement by our manufacturing organization. I mean, this was -- I mean, we were telling you where we're striving to get to 60%. Now we're saying we're going to be there. So it's a whole different thing from trying to strive to get there to being there. So we are hopeful that we'll continue to sustain this range, but I don't want you guys to build too much in given that we have a couple of things that might be going the other way.

David Clair - Piper Jaffray Companies

Okay. Fair enough. And then I had a quick one on the Fisher distribution arrangement that you have. Just how should we think about that kind of evolving throughout the year, I guess, throughout 2011 and maybe any color you can have on 2012? I mean, do you -- how should we think about this ramping?

Kevin King

Well, we haven't given guidance or really discussed volumes. But that said, Fisher has a fairly large dedicated sales force in genomics that are calling on new customers, customers that have not done quite [indiscernible] didn't have. Our market surveys indicate that this is potentially a very large market of users and instrument placements. And that sort of attracted Fisher to want to work with us. I think the ramp will be progressive as they continue to get leads and close those leads out and would expect that we'll finish the year quite strong for [indiscernible].

Operator

Our next question is coming from the line of Mr. Jon Groberg with Macquarie.

Jonathan Groberg - Macquarie Research

Kevin, I appreciate the comments upfront around the Array business and some of the studies that suggest that it's not going to be taken away by something like a next-gen sequencing. But not withstanding that, you obviously see that revenues continue to shrink. So just curious, is there any thought of using some of your cash to diversify away from the Array business just as you go through the challenge there of rightsizing a portion of it and having the more applied market start to grow?

Kevin King

Jon, we have fairly active business development dashboard, and we're always looking at acquisitions that could help both top line and bottom line. So I think the short answer is yes. That said, I think within our portfolio, we're quite confident in the applied market growth that I've indicated here for cytogenetics and cancer. We really feel very strongly about the QuantiGene View capability for applications and immunohistochemistry, as well as in other pathology applications for RNA as well as for copy number. It has very unique capabilities in its ability to measure regions of the genome that can't be assessed by protein-based assays. We think that that's really going to help in a big way. So we think the portfolio of that will resolve and grow it where we need to be.

Jonathan Groberg - Macquarie Research

Okay. If I could just follow up, I guess, on some of these products. There's been some -- a lot of conversation around on the cytogenetics side, what needs to be done in order for these to get greater traction in the clinical community. Any -- it sounds like you are developing some of these products and so that we use kind of this lab development test, any thought of -- or how was that, I guess, those conversations, how are they shaking out in terms of needing to perhaps do something more regulated from an FDA standpoint?

Kevin King

Well, we've talked previously about a regulatory strategy and a pathway to getting our products, our cytogenetic and cancer products, FDA approved. I think you know that there are a number of chips already on the market place that are approved and our instruments are. And we said that later this year, we'd be outlining the exact path for getting cytogenetic FDA approval in the United States. So we're a little bit early in terms of disclosing the exact timing of that but certainly on the road map. And we think we've got excellent relationships with the FDA and have a good roadmap for getting there.

Jonathan Groberg - Macquarie Research

But I guess, I mean, in the near term, you're still able to sell these products, you're not feeling pressure that you from the FDA to hold off on some of these products until that there's more visibility there?

Kevin King

Well, the products are sold today as research use only. And there are large numbers of customers that use them on a regular basis for research applications. We talked in the past about lab core. It's the largest testing laboratory in the United States. It uses our product quite extensively for a variety of research applications, and they continue to grow. Other large labs have followed suit as well as many academic medical centers. And this is a part of our business that feels very strong and robust to us. And as I said in the remarks here, we're extending the product line with yet another product, so this will be our fifth cytogenetic product in our portfolio, and I think we're beginning to really build a good book of business here.

Operator

Our next question is coming from the line of Quintin Lai with Robert W. Baird.

Quintin Lai - Robert W. Baird & Co. Incorporated

I guess to continue on the cancer cytogenetics line of questioning here, the cancer diagnostics seems to be kind of -- a lot of companies have approached it from a services base as opposed to kind of selling it as a platform. And I know that at onetime, you had a clear lab. Have you thought about kind of restarting it from that point as well? Or do you think that just going straight and selling instruments and boxes and consumables is the way to go?

Kevin King

Well, right now, we offer the OncoScan product as a service, and we're running it for customers. I think really going forward, it's really the box play. And there's really a couple of aspects we're, Quintin, that are -- we're commenting on here. First, we've got about 200 Dx systems installed around the world now or we did at the end of the fourth quarter and we're adding the Q1 shipments as well, so over 200 systems that are in place now. Secondly, still a fair amount of cancer discovery is taking place on these instruments using the OncoScan assay. So it's a genome-wide copy number so that in mutation and snip array. So people are doing biomarker discovery within these clinical environments. And then more importantly, what they're doing is they're using them for therapy determination. They're really not a first-line diagnosis. People with breast cancer or colon cancer are often diagnosed in other ways, and the real clinical question is, what therapy route should you take? And here, these broad genetic signatures, if you will, are really good for identifying therapy or course of -- or therapeutic action. And that's kind of a sweet spot, and customers tell us they want that stuff in-house. They don't necessarily want to send it out to a service lab and for both the expense, as well as the control over the sample as well as the data quality that they think they can get from in-house testing.

Quintin Lai - Robert W. Baird & Co. Incorporated

And then one quick, just kind of housekeeping question there. What was the impact of FX on the topline this quarter, Tim?

Timothy Barabe

It was about $1 million, favorable.

Operator

Our next question is coming from the line of Mr. Isaac Ro with Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc.

Just first off, Tim, I wonder if you could maybe walk us through the gross margin dynamic this quarter and what changed sequentially. I think you guys were about maybe $11 million lower on revenue this quarter, but the gross margin was up over 400 bps on that lower base. So I'm just wondering how much of that was new product mix? Or is there something else extraordinary there this quarter that's sort of onetime in nature?

Timothy Barabe

Yes. I wouldn't call it onetime in nature because the major extraordinary item, really, was the reduction in excess and obsolescence that probably contributed up to over 2 percentage points to that total. So clearly, that's one of the aspects and that we are confident that we have gotten that under control. And you saw us speak about that in the fourth quarter for sure last year on. And that's why the fourth quarter gross margins were lower than they might ordinarily have been. In addition to that, the revenue was down, but we're getting more and more revenue from chips, and our PEG-based systems are -- they're higher margin products. And so that mix shift -- and as I said earlier, to the extent that that mix goes a little bit more toward services and instruments, it's going to pull it down a tiny bit. But we think we've made sustainable improvements in gross margin. So these are not -- we're not -- I'm knocking on wood, but we're not going to the mid-50s again. We've got sustainable improvements that are in place and will continue to yield results.

Isaac Ro - Goldman Sachs Group Inc.

And then maybe secondly, on the instrumentation side of the business, can you maybe give us a sense of what your goal for GeneTitan and GeneAtlas placements will be this year, qualitatively at least? And then in general, do you expect instrumentation to be a positive contributor to your growth?

Kevin King

Isaac, this is Kevin. I just wanted to -- before I answer that, I just wanted to go back to your earlier comment. You mentioned that our revenue was down $11 million. It was actually down $6 million year-over-year, and gross margin was up 4 points so.

Timothy Barabe

Yes.

Isaac Ro - Goldman Sachs Group Inc.

Yes, I thought so sequentially, and my apologies, sequentially.

Kevin King

So on the instrument side, yes, instrument growth this year will be positive relative to last year. And it will be determined by placements in 3 areas: the X2 to instruments that I had just mentioned when speaking with Quintin, those for diagnostic applications; GeneAtlas placements from Fisher, which, as I said earlier, will progress throughout the year and we'll see the bulk of that in the back half of the year; and then continued GeneTitan placements. And I think the GeneTitan placements are probably going to be in line with what we did last year. You heard in my prepared remarks that our RNA chip volume was up, plate volume was up 50% year-over-year, so we're increasingly seeing customers be attracted toward the high-throughput, high-quality nature of GeneTitan and also it's lower price point. So I think that's going to continue to pull demand for GeneTitan. Now as we begin to grow our revenue in Targeted Genotyping, more and more there are instrument placements associated with that. And those, of course, would be GeneTitans.

Operator

Our next question is coming from the line of Tycho Peterson with JP Morgan.

Ramesh Donthamsetty - JP Morgan Chase & Co

This is Ramesh Donthamsetty stepping in for Tycho. I just wanted to ask you about Ag-Bio. There's been a lot of questions and talk on cytogenetics. But you mentioned last quarter about your moving to testing on animals with the bovine chip. Can you talk a little bit about performance there and also trends and pricing in other animal testing market as well as plant and crop testing within the Ag-Bio end market?

Kevin King

Sure. Can you clarify that the pricing question that you're asking?

Ramesh Donthamsetty - JP Morgan Chase & Co

Yes, so pricing, however, you think about per array. I mean, are volumes generally picking up in this area and pricing generally stable? We're just trying to understand because we know that volumes are generally higher in this category.

Kevin King

Yes, exactly. Okay. I got it. So we have a very good quarter for the BOS 1 Array, the Bovine Array that we introduced at the end of the year. We made initial shipments. We exceeded our plan for that product in the quarter. And we're continuing to build out more of a funnel for future customers and future applications. We also launched another array in the quarter, a plant array, the Rice Array, and that is getting good traction as a 44K Rice Array and we have other planned products on the horizon as well. We're very optimistic about the Ag-Bio market largely because the demand for food and the growing population in a less arable land, et cetera, is really putting a crunch on growers, whether they are plant growers or animal growers. And people really see that genetic testing can really help to strengthen the output of those -- of their efforts. On the pricing side, I would say that pricing tends to be lower in both plant and animal applications largely because the volumes, as you're mentioning. We have to be a little bit careful there because a lot of times the cost is on a sort of cost per marker base. And so the volumes could get very, very high if you're doing low, low plex, maybe 1,000 to 2,000 plex, you're looking at pennies per snip as opposed to looking at a whole-genome like with the BOS 1 Array. The BOS 1 Array is probably about 2/3 of the cost of the Human Genotyping Array. Volumes are probably comparable.

Ramesh Donthamsetty - JP Morgan Chase & Co

Do you -- and just as a quick follow-up, do you currently see more opportunity for arrays in one area versus the other type of the plant and crop versus animal test?

Kevin King

I would say that the plant market is probably larger for 2 reasons. One, just the diversity of plants that are studied, both just for research, genetic research as well as for agricultural applications. But also now we're beginning to add biofuel applications into that with things like switch crafts and others where people are looking to try to convert those types of plants into biofuels, and there's a fair amount of activity there. So I would say that the plant side is probably the larger.

Operator

Our next question is coming from the line of Shaun Rodriguez with Cowen and Company.

Shaun Rodriguez

I just wanted to dig a little bit more on the gross margin discussions. I think you have noted in the past that about half of your Axiom demand has come from custom content design. So my first question there is, is this proportion still about accurate? And secondly, is there a gross margin differential on those products relative to the off-the-shelf products?

Kevin King

So on the gross margin side for Axiom, I would say it's more related to -- pricing is more related to volume than it is whether it's customer off-the-shelf. The incremental cost for developing or creating a customer array for a customer is really pretty marginal. Really, every array requires some type of mass design, and that mass design cost has come down significantly over the years. I don't think from a cost perspective, it's a difference between -- if there's a difference between the two. Volume, however, does play a big, big role in pricing. And so your first question, though, there hasn't been much of a change in custom versus catalog arrays for Axiom in the quarter. Although we just announced just yesterday or the day before -- it was in one of the news there, BioArray News, if you will -- a whole new family of population-specific arrays for European, African, Latin American ancestry, and those are catalog arrays that at one point were customer arrays and are actually coming out of UCSF. We develop them in conjunction with them. And so that's a case where we converted from custom to catalog.

Shaun Rodriguez

Got it. That's helpful. Thanks. And one more. In the context of your comments about certain applications, where there have been some studies that suggest micro arrays still hold some distinct advantages relative to sequencing, can you just remind us what proportion of your RNA business is still whole transcriptome analysis?

Kevin King

Specific to the WT Assay that we have? Or...

Shaun Rodriguez

No. I'm basically just trying to get an idea of how important whole transcriptome RNA array products are currently.

Kevin King

Oh, it's a significant part of our RNA business for sure. That said, the users are very, very diverse, ranging from, as we talked earlier, plants and animal studies to Pharma drug discovery, to Pharma validation, to human applications and to clinical applications. So it's quite diverse. The vast majority of our power by Affymetrix Partners, of which there are about 14 and 60 tests that are under development are all using a whole-genome RNA array for the basis of their clinical signatures.

Operator

Our next question is coming from the line of Mr. Derik De Bruin with UBS.

Derik De Bruin - UBS Investment Bank

The $45 million in operating expenses you're expecting in Q2, is that -- it seems to be a little bit higher than I would have thought. You've mentioned you're trying to control costs. What's kind of built into your expense? Is that, I guess -- is that a run rate for the rest of the year?

Kevin King

It's -- I think Tim can help answer this. I think on one side, Derik, we've been extending our sales force and putting more feet on the street for our new products on the clinical side. And as you know, that we have been gearing up our Panomics business as well. So that's a portion of the increase. Tim, you might want to talk about what the other marginal effects here as well?

Timothy Barabe

Sure. I think the other effect is merit increases, which were not in the first quarter and are in the second quarter. So that will have an impact as well.

Derik De Bruin - UBS Investment Bank

Okay. That's helpful. So do you have a -- I know it might be too early to ask this, but can you give us some direction on the percentage of sales that are being contributed to from the cyto, in the cytogenetics and the cancer products? Just kind of give us a better sense on what the opportunity is, where they are and how we can kind of model that a little bit better.

Timothy Barabe

Yes. So we walked here about those products being in this validation and test category, which was 22% of our revenue. I really don't want to break out more than that, but that's the component of it, and I would say that that's a fairly large fraction of it.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Doug Farrell

Great. Thanks for taking the time to join us 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 tonight. To access that replay, domestic callers should dial (877) 660-6853. International callers, please use (201) 612-7415. The passcode for both is the same, 370998. Alternatively, an audio replay will be available under the Investor Relations section of our website at affymetrix.com. So thanks again for joining us, and have a great day.

Operator

Ladies and gentlemen, this conclude today's teleconference. You may disconnect your lines at this time. Thank you very much for your participation, and have a wonderful evening.

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