Affymetrix Management Discusses Q2 2012 Results - Earnings Call Transcript

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

Affymetrix (NASDAQ:AFFX)

Q2 2012 Earnings Call

July 31, 2012 5:00 pm ET

Executives

Doug Farrell - Vice President of Investor Relations

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

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

Analysts

Matthew M. Notarianni - Robert W. Baird & Co. Incorporated, Research Division

David C. Clair - Piper Jaffray Companies, Research Division

Aaron Gorin - Morgan Stanley, Research Division

Joel Kaufman - Goldman Sachs Group Inc., Research Division

Eric Criscuolo - Mizuho Securities USA Inc., Research Division

Rafael Tejada

Zarak Khurshid - Wedbush Securities Inc., Research Division

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Operator

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

Doug Farrell

Thank you, operator. Good afternoon, everyone. Welcome to Affymetrix's Second Quarter 2012 Conference Call. At the close of the market today, we released our operating results for the second quarter. If you haven't had a chance to review the second quarter press release yet, you can obtain one from our website at affymetrix.com.

Joining me on the call today are Frank Witney, our CEO and President; as well as Tim Barabe, our Chief Financial Officer. I'd like to remind callers that our discussion may include forward-looking statements about the company's future expectations, plans and prospects. We believe these statements are based on reasonable assumptions, but actual results may differ materially from those indicated. Important factors, which could cause actual results to differ from those in our forward-looking statements, are detailed in our filings with the

Securities and Exchange Commission. It's our intent that these forward-looking statements be protected under 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 in today's press release. As a reminder, today's call is also being recorded, and the audio from the call is being broadcast over the Internet on our web page at affymetrix.com.

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

Franklin R. Witney

Thanks, Doug, and good afternoon, everyone. It was only 12 months ago when I joined Affymetrix as CEO and began to lay out my vision for returning the company to growth and sustained profitability. The first phase of this plan involved refocusing the company on a specific set of business objectives and strengthening the management team. This phase is essentially complete at this point. We have reinvigorated the team by recruiting a number of proven industry veterans in our commercial organization, including new global leadership for marketing and sales, as well as new geographic leaders in Europe, Japan and most recently, in North America.

We refocused R&D and realigned our resources with the market opportunities where we see the most robust growth opportunities and sustainable competitive advantage. Some examples of these include cytogenetics and our QuantiGene product line, where we are generating double-digit revenue growth.

We recently diversified the business and entered significant new markets through the acquisition of eBioscience, a leading supplier of flow cytometry and immunoassays reagents. As most of you know, we closed our acquisition of eBio on Monday, June 25. So our second quarter results include 4 days of sales, or approximately $1.4 million in revenue from eBio.

The integration was on track and progressing smoothly. As a reminder, we intend to run eBio as our fourth business unit out of San Diego, and the teams are working hard to create additional operating leverage going forward. I look forward to updating you on specifics over the next several quarters.

We've put comprehensive retention plans into place, and the eBio team knows that it is an important part of our future growth opportunities. Now that the eBio team is part of a public company, we're able to offer equity incentives to help create long-term value that directly aligns with our employee interest -- directly aligns our employees' interests with those of our shareholders.

Before I move into a discussion of our progress by business unit, I'd like to make a few general observations. Now that we've closed eBio, we'd expect the mix of our business in the second half of the year to be roughly 36% gene expression, 24% genetic analysis and clinical, 22% eBio, 10% life science reagents and 8% general corporate that includes licensing and royalties and field services.

During the second quarter, we generated consistent performance across all of our major geographic regions, and importantly, began to see improvement in North America, which has been our most challenged market. During the second quarter, North America was up about 1%, and Europe and Asia were down 1% and 2%, respectively, on a reported basis. While the trends in Europe and Asia are similar for the first half of the year, North America improved significantly from being down 8% for the first half to being slightly up in the second quarter.

From a customer mix perspective, academic revenue was down by 8%, against the backdrop of more challenging macro conditions, while industrial revenue was up by 8%, relative to the prior year.

Turning now to gene expression. Tim will review some specifics later in the call, but qualitatively, we're pleased with the performance of our expression business unit for the quarter. Expression was down 8% for the quarter versus 14% year-to-date, indicating we continue to make progress stabilizing the business.

While there's been a lot of speculation about the future demand for microarrays, I can tell you that our unit volumes grew at a double-digit rate year-over-year. This was offset by a mixed shift to higher-throughput plate formats and other lower-priced products that drove a lower average selling price.

We believe that arrays will continue to be the platform of choice for high-volume and certain clinical applications because of the performance, ease-of-use and high-throughput capabilities relative to alternative technologies.

Revenues from the sale of our QuantiGene and Procarta family of RNA and protein expression products were also captured within our expression revenue. The combined revenues of these product lines grew by double digits for the second consecutive quarter.

We are very encouraged by the interest in our QG ViewRNA FISH technology and announced a partnership with Leica in the quarter to automate the process for a variety of applications.

We had another outstanding quarter in our Genetic Analysis and Clinical business. This business grew by nearly 20% in Q2, driven largely by sales of our research-use-only cytogenetic portfolio, which is accelerating as we take share from competitive platforms and convert customers from microscope-based approaches.

CytoScan HD revenue grew in all of our major geographies. Our CytoScan clinical trials are underway and progressing well. Our cytogenetic portfolio is less dependent on academic funding, and we think it will fuel our long-term growth in a significant way.

While overall Genetic Analysis business unit growth was strong, genotyping revenue was still challenging in Q2. However, we are seeing improving traction with our Axiom product line, which sequentially grew at a double-digit rate for the last couple of quarters. Our Axiom and OncoScan service business was also strong in Q2 at more than $2 million in revenue.

In addition, our backlog of services and products in genotyping exceeds the combined revenue for both categories for the first half of 2012. We are competing for a number of new projects, and we expect to see continued growth from genotyping in the second half of the year.

Shifting gears to eBio, the business grew in mid-single digits in Q2. Notably, the flow reagents grew nearly 10% on a constant currency basis in the quarter. Gross margin for the business was roughly 75%, and the operating margin exceeded 30%, both on a non-GAAP basis. Both metrics match historic levels for the business. We are optimistic about the long-term growth prospects for the business and believe that eBio will be a major contributor to our performance going forward.

Revenue in our Life Science Reagents business was down 8% in the second quarter, about in line with Q1 results. As a reminder, we terminated a distribution agreement in North America in one of our key products late last year, and we expect to see a temporary headwind as we transition to direct sales. We anticipate a return to low- to mid-single digit growth with this business in the second half of the year.

Moving now to operations. We did a good job of controlling expenses in the quarter. I do want to draw your attention to the roughly $13 million in acquisition-related costs that we incurred. Excluding these one-time charges, we would have generated cash in the second quarter.

Excluding eBioscience, we reduced our inventory by 3% at very little -- very low E&O expense and generated gross margin of 58%, which is about 200 basis points above our guidance.

We told you that we intend to grow the business this year, and we are confident we'll achieve this important goal in the second half of 2012. I'm proud of what we've accomplished over the last 4 quarters, and we're executing against a detailed plan to drive continued improvements in the business.

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

Timothy C. Barabe

Thank you, Frank, and good afternoon. I'd like to review our operating results for the second quarter of 2012. For the second quarter, the company reported total revenue of $66.4 million compared to $64.7 million for the same period last year. Revenue was up almost 3% from the prior year, driven primarily by increased revenue from scientific services and partial-period revenue of $1.4 million, as Frank mentioned, from eBioscience, offset by negative currency impact of about 2% for the quarter. This increase was partially offset by lower chips revenue.

Excluding eBioscience revenue, we were up 3% over the prior period quarter currency adjusted. As Frank told you, we're making steady progress in stabilizing our business, as indicated by the fact that this is the fifth consecutive quarter in which we have generated revenue in the mid-$60 million range.

Turning to the detail. Second quarter product revenue was $58.5 million, including partial period revenue of $1.4 million from eBioscience as compared to $58.1 million for the second quarter of 2011. Consumable sales were $54.7 million, up slightly from $54.3 million in the second quarter of 2011. Also, in 2012, it included a partial period revenue of $1.4 million from eBioscience. Instrument sales for the quarter were at $3.8 million compared to approximately the same number in the prior-year quarter.

Lastly, service and other revenue was $7.9 million compared to $6.5 million in the second quarter of 2011, primarily due to increased scientific services revenue.

Looking at the results from the business unit perspective, revenue from the expression business unit decreased by $2.7 million, or 8%, compared to the prior year. Our non-array Panomics products increased more than 12% year-over-year, indicating our strategy of specialized sales forces is paying dividend.

Our genetic analysis revenue increased by $2.9 million, or 17%, compared to the same period in the prior year, primarily due to higher sales of our research-use-only cytogenetics products. This product line continues to exceed our budget, and customer feedback is very positive. This increase was partially offset by a decline in sales of our SNP 6.0 arrays.

Revenue from our Life Science Reagents unit was down by about $700,000 or 8%. We believe that this is a slowdown that resulted from our decision to move to a direct sales channel last year, and we believe that it is temporary in nature. Our product gross margin was 58.4% in the second quarter, and our total gross margin was 58.3%, just down about 2% over the second quarter of 2011. The primary driver for the decreased gross margin was product mix. This was partially offset by decreased excess and obsolescence costs on inventory.

Turning to operating expenses. Total operating expenses for the second quarter were $54.1 million versus $42 million incurred in the same period last year. Our second quarter expenses included about $13 million in acquisition-related charges, as well as $600,000 in operating expenses from eBio. We expect third and fourth quarter operating expenses to be slightly higher than our targeted run rate of $42.5 million due to increased spending for our clinical trials for CytoScan.

Second quarter R&D expenses were $13.6 million, down 11% from the $15.3 million for the same period last year, primarily driven by decreased compensation and benefits due to the reduction in R&D headcount that occurred in the fourth quarter of 2011, as well as lower variable compensation expenses. R&D expenses included about $100,000 from eBio.

SG&A expenses of $40.5 million for the second quarter of 2012 increased by 51.9% compared to the same period in 2011 of $26.7 million. SG&A included $4.7 million in acquisition-related expenses and an $8.3 million stock-based compensation charge for accelerated stock options for eBioscience employees. It also included about $500,000 in SG&A expenses from eBio.

Adjusting for these items, SG&A would have been up about 1%. Interest income and other net was approximately $2 million in the second quarter of 2012, due primarily to the receipt of a note receivable from a nonmarketable investment that had previously been written off. We also realized a net gain on the sale of available-for-sale securities of $500,000 as a result of the eBioscience acquisition. This compares to an interest expense and other net of $400,000 for the prior-year quarter.

In the second quarter, we recognized an income tax benefit of approximately $44 million, associated with the eBio acquisition. Our federal NOLs currently exceed $160 million, or about $2 per share, and we expect that we'll be able to begin utilizing them already next year.

During the second quarter of 2012, we generated a net income of $30.9 million, or $0.43 per diluted share. This is primarily due to a one-time income tax benefit of $44 million, realized as part of the eBioscience acquisition. Excluding that income tax benefit, as well as associated -- costs associated with the eBioscience acquisition of $4.7 million, the one-time stock-based compensation charge of $8.3 million, the income recorded on the notes receivable of $2.2 million, amortization of acquired intangibles of $1.5 million and amortization of inventory fair value of $300,000, net loss was approximately $1.2 million or $0.02 per diluted share.

This compares to a net loss, excluding amortization, of about $1.5 million of intangibles, up $2.1 million, or $0.03 per diluted share, for the same period in 2011. 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 $32.1 million, or about $0.45 per share, increase in GAAP net income and include, within gross margin, $786,000, or roughly $0.01 per share, in the amortization of acquisition-related intangibles. In operating expenses, $246,000 in R&D and $830,000 in SG&A for a total of $0.02 per share in acquisition-related intangibles amortization.

Within other income and other expense, a $2.2 million or $0.03 per share gain from a note receivable. Within taxes, a $44.7 million or $0.62 per share benefit associated with the acquisition of eBio.

Let me take a moment to summarize our balance sheet. We ended the second quarter of 2012 with total cash and available-for-sale securities of $37.6 million compared to $170 million as of the end of the first quarter of 2012. The decrease is due to the acquisition of eBioscience, which we funded using a combination of cash on hand, sale of available-for-sale securities, proceeds from third-party financing and the issuance of senior convertible notes.

Capital spending was about $3.8 million, and we incurred licensing charges of roughly $1 million. Depreciation and amortization was approximately $7 million, including the amortization of acquired intangible assets.

Operating expenses for the second quarter included $10.2 million of stock-based compensation expense, of which $8.3 million was related to the acceleration of eBioscience stock options. Excluding the eBio-related expense, stock compensation was $1.9 million, which compares to $1.8 million in the second quarter of 2011.

Accounts receivable were $53.4 million, which included $9.4 million of eBioscience receivables. Excluding eBio, accounts receivable is $43.9 million, down slightly from $44.8 million at the end of the first quarter of 2012.

Turning to inventory and other balance sheet items. Net inventory for the quarter was $92 million, of which eBio was $52 million. Excluding eBio, inventory was $40 million, down $1.3 million compared to the first quarter of 2012. Compared to December -- the end of December 2011, inventory is down about 6.2%. It's important to note that the eBioscience inventory has been written up and that the $52 million actually represents market value of inventory as opposed to cost.

To summarize, during the second quarter, we completed the acquisition of eBioscience, which opens large, new, commercial markets and diversifies our revenue base. We continue to make progress in stabilizing the business, generating our fifth consecutive quarter of revenue in the mid-$60 million range. And we exited the quarter in a strong financial position, with more than $37 million of cash on hand.

Excluding one-time acquisition-related charges, we would have generated cash in the quarter, and we expect to do so for the remainder of the year after interest and principal payments. In addition, we have access to a $15 million revolving credit facility for increased flexibility.

Now I'd like to turn the call back to Frank for our closing remarks.

Franklin R. Witney

Okay. Thanks, Tim. In closing, we believe that we're well positioned to return the company to modest growth in the second half of 2012. As we described, we're making some progress in stabilizing our expression business, but still have more work to do, including the launch of a number of new products for biomarker discovery and clinical applications.

Our Genetic Analysis business unit is on track to achieve the 20% growth that we outlined at the beginning of the year, and we believe our Life Science Reagents business will improve on a comparable basis in the second half of the year.

We're excited about the strategic and financial contributions that eBio will add to Affymetrix and are very pleased to welcome this great team to our family. As you're all aware, eBio is a blue-chip asset in the cellular analysis field with a long track record of success. We are very much looking forward to incorporating eBio into our portfolio and execute on the opportunities that emerge from the competition -- from the combination.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Matt Notarianni with Robert W. Baird.

Matthew M. Notarianni - Robert W. Baird & Co. Incorporated, Research Division

Frank, you're about a year under your belt now with Affy. Just kind of wondering if you could just take some time to talk about how some of the changes that you've made in this first year will lead to progress and what sort of milestones we can tract to kind of gauge further progress as we look at year 2 with you at the helm?

Franklin R. Witney

Thanks for the question. Yes. So I think we've made progress in a number of areas that are set -- that sets us up for growth in the future. I think it's -- let's start with the commercial organization, which we've -- we've added some terrific new people, including our global head of sales, new people in North America, parts of -- certain parts of Asia, global marketing. We've done a lot to reorganize the sales organization to be in line with the business units, and I feel that we have a very rational and scalable approach to the market. I think along those lines, the business units that we formed up and all organizational structures have pluses and minuses, but the business units are very focused on the task at hand in allowing us to manage our entire portfolio. I feel extremely good about the progress we're making on the clinical side in our Genetic Analysis business unit, that I think we're -- we've said all along that we -- at the end of the year, we want our cytogenetics product to be a significant part of our revenue, and that's certainly the case. The new products we've introduced in that area, CytoScan and the follow-on products, are -- we're very optimistic about. And we're -- as we talked about on the call, we're starting to see progress with our Axiom line, which has a number of -- we've made progress in a number of areas. In expression, we've put out new, several new products that are just gaining traction. These are products that could be in concert to next-gen sequencing or have a presence in clinical or biomarker discovery applications. So I think our commercial organization and our business units, this is in the core Affy assets. I think, also, -- I feel very, very good about the eBio team and what -- the products and the opportunities that they bring as a stand-alone organization, as well as the things that we can do in concert with some of the technologies. We'll be more granular on that as the next several quarters play out, but it's a blue-chip asset that has a long track record of success, and there's things that we can do together. In terms of milestones, we want to return to top line growth, and that's a clear milestone that we set out at the beginning of the year. And we certainly intend to follow -- to follow through on that. I think we're even better shaped now with eBio, but we certainly intend to grow the core Affy assets going forward. We want to close the gap on operating income and start to -- be sustainably profitable. I think that's the second milestone. I think we want to gain market share in cytogenetics, and I think we're certainly executing against that everyday and gain market share in genotyping, which we are now, we think, we're well positioned to do. And we reported an 8% decline in gene expression this quarter. We certainly -- it's now -- it's roughly 1/3 of our business, down from where we were pre-eBio, but it's still a significant part of our business, and we're working very hard to stabilize that. And so that's another check point that I think you can look at to gauge our progress. And certainly, finally, the integration of eBio. We're working very hard to make sure that goes smoothly, that we maintain the great track record they've had and then look for opportunities to leverage eBio into our current organization. So I think you look across the portfolio and across the organization, while we still obviously have a lot of work to do, we feel good about where we're at right now.

Matthew M. Notarianni - Robert W. Baird & Co. Incorporated, Research Division

And then just one follow-up, really just related to kind of the end market outlook. We've heard from a lot of other players kind of in the space on how things evolve, particularly some commentary around weakening late in the quarter. Just any insights there from what you guys have seen would be helpful.

Franklin R. Witney

We didn't -- yes, thank you. We didn't see any weakening late in the quarter. We certainly pick up the same drumbeat as everyone else about the academic markets in the U.S. We're -- our ear is to the ground in Europe, but we haven't heard anything dramatic from the European team. But I think everyone is pretty cautious about end markets.

Operator

The next question is from Bill Quirk with Piper Jaffray.

David C. Clair - Piper Jaffray Companies, Research Division

It's actually Dave Clair here for Bill. First question from me. I think you mentioned on the call that eBioscience was up mid-single digits. That's a little bit lower than what we've heard when you guys announced the deal. I think the last update was 8% to 10% range. Are you still thinking 8% to 10% is the right growth target in the near term? Or has that come in a little bit...

Franklin R. Witney

Yes, that's in reported. They were up 7% in constant currency. So they had a little bit of currency headwind, maybe a little bit of a drop due to the -- the acquisition took a little bit longer than we thought. That may have impacted some of their distributor sales a little bit. But we're still very optimistic about the long-term growth prospects for that segment of our business.

David C. Clair - Piper Jaffray Companies, Research Division

Okay, great. And then, Tim, I think you mentioned in the commentary that operating expenses, we should think that they'll be a little bit north of $42 million for each quarter in the back half of the year?

Timothy C. Barabe

Yes, especially the third quarter, Dave. We're still looking at -- the clinical trials are ramping up, so we're going to have heavier spend in the third quarter, plus we did hire quite a few of our commercial people, who we're adding as well. And we've got other products we're working on. Certainly, OncoScan is one of the products that we're working on. So it'll -- I mean, we're still keeping a very, very, very close, close watch on operating expenses, and everybody has their targets. But it should drift up a little bit in the third quarter.

David C. Clair - Piper Jaffray Companies, Research Division

So there's really not much of an impact from the eBioscience addition?

Timothy C. Barabe

Oh, that's without eBioscience. eBio will be another $8-ish million or so on a full quarter. So I mean, if you look at eBio, they -- last year, they were $71 million in sales, 75% gross margin. They're growing, as we've said. Currency adjusted, they grew 7. They only grew mid-singles on an actual basis. The margins are still holding up, but their running in the low-30s in terms of operating expenses. So we'll have a full quarter of them. So you'd have to add that as well.

David C. Clair - Piper Jaffray Companies, Research Division

That's where the confusion came in. All right. That's it for me. Oh, again, I'm sorry, one last one, and -- for the CytoScan FDA submission, do we have any kind of update there?

Franklin R. Witney

Yes. Our clinical trials are ongoing. Our intention is to file within -- to file late this year, and that's the plan we're operating to.

Operator

The next question is from Daniel Brennan of Morgan Stanley.

Aaron Gorin - Morgan Stanley, Research Division

It's Aaron Gorin on for Dan today. I guess on that cost structure question, can you guys just go in to your kind of leverage in terms of -- your top line has been fairly consistent over the last past 5 quarters, but you've previously spoken about you're operating leverage. If the top line were to accelerate, can you just kind of talk through where we could look for that and where you think the revenues will need to get to for more operating leverage?

Timothy C. Barabe

Well, I think if you look at the quarter and you strip out the acquisition-related expenses, we came pretty close to breakeven at the operating income line for Affymetrix on its own, and we're going to have a full quarter of eBio coming up. We feel that we do not need to add significantly to our operating expenses into our headcount, certainly not for the sales increases that we expect to come. We added the commercial people. I mean, we subtracted people out of R&D, we put more into commercial. So we expect to get the leverage without significantly increasing the costs over the short to midterm. And I think eBio is the same way. I think, probably going out over time, I'd say that we would expect operating expenses to grow at half the rate of sales. So there should be plenty of leverage.

Aaron Gorin - Morgan Stanley, Research Division

Okay. And then second question, unrelated. On this Leica deal, can you just kind of give us a sense for the pacing of the opportunity, as well as the size?

Franklin R. Witney

So the Leica -- So the relationship we have with Leica is to automate our QG View assay, our in situ RNA FISH assays for molecular pathology in tissues. We're working hard on the protocols and finishing that off, and we would anticipate being in a position to offer a solution later this year, hopefully within this calendar year. It may slip a little bit, but we're working very hard on it. The opportunity, we think, is very interesting. There's a tremendous amount of interest in situ RNA detection, and we're seeing some very nice growth out of the product in a manual format. So we think it's an area that's going to grow very, very nicely for us over the next couple of years. And the automation part of it is essential as it moves into more routine applications.

Operator

The next question is from Isaac Ro of Goldman Sachs.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

This is actually Joel in for Isaac. I was wondering if you could comment on pricing, specifically for your eBio business and the visibility you're seeing in the backlog there?

Franklin R. Witney

Pricing is -- we don't see any real pressure on the pricing at this point. The margins have held up very well. So the business has run at very nice gross margins for many years. And while there may be some pressure on pricing going forward, there are certainly lower-cost suppliers or potential for lower-cost suppliers in the industry. We don't see any major changes in the pricing or in the gross margins that we're going to obtain out of the business. In terms of the backlog, we're driving to a forecast that they traditionally have done very well versus their plans, and so we feel that the business will continue to perform very, very well.

Joel Kaufman - Goldman Sachs Group Inc., Research Division

Great. And then just longer-term, thinking about your expense structure, as you push more on to the clinical markets, how are you thinking about the expenses that are required to really grow that part of your business, specifically the SG&A and R&D?

Franklin R. Witney

Yes. So we feel we're very -- our R&D is very well staffed. We've added people with backgrounds in molecular biology and the combination of medical applications and biomarker discovery and the transition of those to the clinic. We've added regulatory people. So we feel we've made those investments. We've just started on the commercial side, we've added people with expertise in the sales of products to clinical customers, and we're building that out. So we don't see any major changes going forward as we've laid a lot of that infrastructure in already. And I think, as Tim mentioned earlier, we don't see that our -- that we certainly want to bring our ratios in a position to generate operating income, and so we'll be very, very careful on operating expenses going forward, certainly growing them slower than we grow sales.

Operator

The next question comes from Peter Lawson of Mizuho Securities.

Eric Criscuolo - Mizuho Securities USA Inc., Research Division

This is Eric, filling in for Peter. Frank, I think before, in your comments, you said that the North American market showed some improving trends in the quarter. I was wondering if you could just kind of talk about that?

Franklin R. Witney

Yes. I'm not sure that the market showed improving trends. We certainly showed improvement in our own performance. We're focusing very hard on that part of our business. It's been problematic for us. We changed leadership in North America. After we changed leadership with our global team, we feel very good about the team that's in place, the region manager and the district managers underneath them. We've also changed our go-to-market strategy in North America, as well as in Europe. And so I think our execution is improving. We're not there yet all the way, but we certainly saw improved performance, very nice performance with our clinical products. We did better with our expression products in North America, and we're starting to see some, what we think, is encouraging signs with our genotyping business as well. So I think it's more -- it's less macro-market improvements, where I think everyone recognizes there are some headwinds more to -- we feel good about the start of an improved execution format for the -- for how we sell our products in North America.

Eric Criscuolo - Mizuho Securities USA Inc., Research Division

And speaking of the expression business, did you say that the volumes were higher but the pricing was lower, and that led to the decline in the expression business overall?

Franklin R. Witney

Yes, we're certainly seeing a mix to our higher throughput, lower-cost products. So our units were up, but our total revenues were down. And that's certainly a reality of that business as we respond to customers' requests for higher throughput and larger experiments, higher throughput experiments, which is of course a strength of arrays, as you can do many, many, many experiments on the platform. But at the same time, we're seeing a shift to our lower cost product such as plate arrays or our lower cost cartridge products or our gene-level products. So that's something that we're dealing with, but I think it's responding to the market needs.

Eric Criscuolo - Mizuho Securities USA Inc., Research Division

And just lastly, staying on the arrays, do you think there's a -- is there a catalyst for the whole-genome arrays, the SNP 6.0, to start growing again? Or do you think that's going to be kind of a treading water or maybe even declining as we go further and further out.

Franklin R. Witney

Well, I think SNP 6.0 is an iconic product in the history at Affymetrix, and it's still selling very, very well, but it is declining, and that we anticipate that won't turn around. However, what we are seeing is very encouraging signs in the genotyping area. SNP 6.0 had uses in cytogenetics, which is being replaced by our CytoScan product. But in the genotyping area, we talked about it on the call, we've had sequential growth for 2 quarters and double digits with our Axiom product line, and we feel we're building momentum and backlog with Axiom. So we're encouraged, we still have a lot of work to do in genotyping to regain the kind of reasonable market share. That's one of our goals. But we feel that the signs are encouraging.

Operator

The next question is from Derik De Bruin of Bank of America.

Rafael Tejada

It's Rafael in for Derik. First one, Frank, you made some comments sort of in -- general comments on the key end markets, noting some slowing in academic and government but some strength in industrial. Just wondering if you could give a little more color on those end markets. And as a follow-up, just also wondering if you have any trends that you observed during the quarter in terms of demand for instrumentation, either for the core Affy business or the eBio business.

Franklin R. Witney

So on your last question first. On the instrument business, we were roughly flat year-over-year in instruments, and we continue to push on our GeneAtlas scanners and associated arrays. But roughly, the instrumentation business was flat, and no major deviations from the trend there. I think the issue with the academic markets is pretty well noted, and we're monitoring it very closely. I don't know that anyone knows exactly how that's going to play out, but it's certainly having some impact on the Affy business, as well as the eBio business, as we've talked about earlier.

Rafael Tejada

The other one was just on the industrial demand.

Franklin R. Witney

So on the industrial side, we saw some encouraging signs on the industrial side. We're doing well. We're doing pretty well across our entire product line there and probably less subject to -- obviously, less subject to governmental spending. And so we will just continue to play that out, don't have a real crystal ball on it, but we certainly had better results there than we did on the academic side.

Rafael Tejada

And just, Tim, clarification on the eBio impact on gross margins for the remainder of the year. I think before you -- the company was talking about a 200-bp impact on gross margins. Is your current model still implying something along those lines?

Timothy C. Barabe

On a non-GAAP basis, yes, but we have an inventory step up. So we'll have to go through cost to goods sold. So that will depress the margins on a GAAP basis. But on an unadjusted non-GAAP basis, yes, we do feel that'll add about 200 basis points.

Operator

The next question is from Zarak Kurshid of Wedbush.

Zarak Khurshid - Wedbush Securities Inc., Research Division

Can you speak to just the overall growth or overall market growth for array-based cytogenetics? And then any thoughts on kind of which indications are driving your growth? In other words, if you could compare postnatal, prenatal, cancer opportunities, that'd be very helpful.

Franklin R. Witney

Yes. We think the underlying growth rate in the cyto market is very, very robust. That would be driven both by -- in the people already using arrays, increasing the use of arrays for a variety of applications, we'll get to that in a minute, as well as people can converting, particularly in the postnatal karyotyping market, converting from microscopes to arrays. So that market, we think the underlying growth rate is well in double digits, and we feel we're very well positioned to both grow our business from -- due to the general growth of that market, as well as capturing market share, as well as conversion of people from microscopes to arrays. In terms of applications, we -- there's a wide variety -- there's an interest in a wide variety of applications, including postnatal. There's an interest certainly in oncology, blood cancers, for example where we're seeing a lot of interest out there, as well as other prenatal applications. So we feel all those markets are very robust in cytogenetics, and we feel we're very well positioned to compete for business in all of those areas.

Zarak Khurshid - Wedbush Securities Inc., Research Division

Understood. And then any thoughts just on the competitive landscape? Are you taking share from folks? Have there been any major disruptions in terms of the number of competitors or products in the marketplace?

Franklin R. Witney

Well, I guess the biggest change has really been Roche NimbleGen that's withdrawn from the market in terms of macro competitors. We feel we are taking market share. There's a number of cases where we've won business away from our competitors. When we go into nascent labs, we certainly are winning more than our share. So we feel we're -- those people who are converting to arrays and haven't been running arrays before, we feel we're in very good shape to win those -- to win business in those accounts, as well as conversion accounts. And we're certainly going after all opportunities out there. And the success that we're seeing so far this year makes us feel very good about the long-term prospects in a variety of areas, in which arrays are useful, in pre and postnatal side of genetics.

Timothy C. Barabe

I just like to add that we said that we would double our share from 5% to 10%, and we're well on track in postnatal.

Operator

The next question is from Shaun Rodriguez of Cowen and Company.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

You noted a good quarter for demand for the OncoScan offering. And Tim, I believe you mentioned it in the context of being an area of increased R&D investment in the second half. So is it reasonable to expect seeing an OncoScan product in, maybe, early 2013, versus the continuation of that as a service offering?

Franklin R. Witney

Yes, we're certainly intending to put the product -- OncoScan technology out as a product. We have a very strong team working on it, and we're making the investments required. The voice of the customer has come back resoundingly, that having a robust tool to do copy number and FFPE samples in addition to somatic mutation is something that's going to meet customer needs. In terms of absolute timing for the launch, it may be a little bit later than what you mention here, but we certainly intend to have a product out by midyear 2013 to maybe slightly slower, slightly faster as we see how the development goes. But the customer feedback that we've gotten is very strong. The team we have on it is making very great progress, and we think that's going to be a real contributor to us going forward.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

And one on cyto, if I could. Can you talk about what you're doing in terms of working with customers on bringing down the instrument purchase component of the transaction as a hurdle -- as a potential hurdle to adoption, and then maybe how the mix of reagent rental contracts is trending, and maybe the types of implications that might have on the broader business over the next few quarters.

Franklin R. Witney

Yes, we're working on it on a case-by-case basis, it really depends on how -- what the demand is at the site. There are some cases in which the demand is relatively low, and we have to be more aggressive. And in some cases it's is not really an issue. It's really a case-by-case basis.

Operator

We have no further questions at this time. I would like to turn the floor back over to management for closing remarks.

Doug Farrell

Thank you, operator. Thank you for taking the time to join us 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 that replay, domestic callers, please dial (877) 660-6853. International callers, please dial (201) 612-7415. You'll need the account number 376, and the passcode is the same for both, 397718. Alternatively, an audio replay will be available on the Investor Relations section of our website at affymetrix.com later today. Thanks again for joining us, and have a great day.

Operator

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

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