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Affymetrix (NASDAQ:AFFX)

Q3 2012 Earnings Call

November 05, 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

David C. Clair - Piper Jaffray Companies, Research Division

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

Jonathan P. Groberg - Macquarie Research

Daniel Brennan - Morgan Stanley, Research Division

Zarak Khurshid - Wedbush Securities Inc., Research Division

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Peter Lawson - Mizuho Securities USA Inc., Research Division

Bryan Brokmeier - Maxim Group LLC, Research Division

Derik De Bruin - BofA Merrill Lynch, Research Division

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, 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 our third quarter conference call. At the close of the market today, we released our operating results for Q3. If you haven't had the chance to review those, you can access the press release on our website. Joining me on the call today is Frank Witney, our President and CEO; and our Chief Financial Officer, Tim Barabe.

I'd like to remind callers that our discussion may include forward-looking statements about future projections, expectations and prospects for the company. We believe these statements are based on reasonable assumptions, but actual results may differ materially from those indicated. Important factors which could cause actual results to differ materially from those in the 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 will 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 or on our website. As a reminder, today's call is being recorded and the audio from the call is being webcast over the Internet on our homepage at affymetrix.com.

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

Franklin R. Witney

Good afternoon, everyone. As I told you when I rejoined the company last July, our priorities are to stabilize and diversify the business in the first phase of this turnaround and then focus on growth and improved profitability in the second phase. Since that time, we reorganized the company into highly-focused business units, strengthened the management team and significantly diversified and extended our product portfolio for translational medicine and clinical diagnostics through the acquisition of eBioscience, as well as internal product development.

Through these efforts, we've established the foundations for our return to growth and profitability. And for the third quarter of 2012, our total revenue excluding eBioscience declined 2% on a constant currency basis as compared to the prior year, a significant improvement over Q3 2011 and another sign that the business is stabilizing. Solid growth in our Genetic Analysis business and mid single-digit growth in our Panomics portfolio helped to offset the headwinds we continue to face in sales of our Gene Expression arrays. Our eBioscience business unit grew by about 1% currency adjusted in the third quarter and about 5% through the first 3 quarters of the year.

Turning to our business units. I'll start with Gene Expression, which is off 11% for the quarter, a rate of decline that exceeded recent trends. We experienced a 16% decline in our expression array revenue and was partially offset by growth of 5% in our Panomics expression products. Stabilizing our array-based expression revenue is our single biggest challenge. This business currently represents about 34% of our overall revenue, is under pressure from both new technologies, as well as low-priced arrays from competitors. There are a number of things we're doing to stabilize our expression revenue including introducing new products, developing newer low-cost array formats and bundling our reagents to capture more revenue per sample.

During the third quarter, we launched several new products including our SensationPlus FFPE Amplification and 3’ IVT labeling kits, which provides superior correlation between FFPE and fresh frozen samples, thereby enabling the discovery of biomarkers in Gene Expression signatures in archived FFPE samples. The SensationPlus IVT FFPE reagent has been validated on 3 IVT arrays, our value-priced PrimeView family, our industry-leading U133, as well as the new Almac Xcel Array, which has been optimized for biomarker discovery in FFPE samples.

In addition, we launched a whole new -- a new whole transcript arrays for human, mouse and rat gene 2.0 products in 3 formats, cartridges, plates and scripts with updated content. This includes adding the latest new gene content to our fastest-growing and most differentiated arrays. Both the human and mouse arrays include the addition of long non-coding RNAs associated with intervention of mRNA cell regulation in cancer.

Last quarter, we announced the partnership with Leica that is focused on automating our QuantiGene ViewRNA FISH technology for a variety of applications. I'm happy to tell you that we're in the process of placing our first early access to system from the partnership with an international and recognized researcher at a leading teaching hospital in the United States. We believe that our collaboration with Leica will help us to develop a portfolio of unique assays for translational medicine and clinical applications.

While stabilizing our Gene Expression business has been more challenging than anticipated, we believe that new product introductions can help us bring us to the revenue -- can help us bring the revenue trajectory back into the range of more modest declines at 5% to 10%. Importantly, we're making highly targeted and relatively small R&D investments in this area, mostly focused on new product introductions. This is a high gross margin and operating margin business and, going forward, we see exciting opportunities in clinical research as a complement to RNA sequencing.

Turning to Genetic Analysis. We had another solid quarter in our Genetic Analysis business unit which grew in all geographies. Revenues grew 16% over the prior year, primarily attributable to growth in our research use-only Cytogenetics portfolio and our Axiom family of genotyping products, which grew at a double-digit rate sequentially for the third quarter in a row.

So we told you on our last call, we have a good pipeline of opportunities in catalog in Targeted Genotyping, including Ag-Bio, and we expect to build on this momentum into 2013. In cytogenetics, we continue to add new customers and have more than 100 customers that are up and running.

During third quarter alone, we added more than 20 new customers, including a number that converted from competing platforms. Further, we have an extensive roadmap of opportunities to grow our cytogenetics business in postnatal, prenatal and cancer applications. We expect to complete the clinical validation of our CytoScan Dx test in the next 2 months, allowing us to file for FDA clearance for this product.

Now talking about our Life Science Reagents business. We continue to recover in the third quarter following last year's termination of a significant distribution agreement. We expect this business will return to growth in the fourth quarter and in the meantime, it continues to generate healthy operating margins.

Our eBioscience business unit generated a revenue of about $17.6 million during the third quarter. In constant currency, sales through eBioscience direct channels in North America and Europe were up 3% and distributors, which currently constitutes about 20% of revenue, were up 11%. This was partially offset by a decline in OEM business, which declined from about $1 million in Q3 of 2011 to about $400,000 this quarter.

Flow products, we're up 3% in the quarter, and immunoassays were up 8%. EBITDA for this business was in line with expectations of 30%. We are forecasting improved growth in Q4 and for the full year, we expect eBioscience revenue to grow in the mid-single-digits relative to the prior year.

The integration is going well and we continue to identify commercial and operational synergies. We are in the process of integrating our Procarta multiplex immunoassay line into the eBioscience R&D operations commercial teams, giving us additional scale for this product line. Growing eBioscience revenue by extending the geographic reach of this business is an important part of our growth plan, especially in Asia. For example, during the third quarter, we began selling eBioscience products directly in Japan rather than using distributors, which will help us to better serve customers and to expand our margins.

Finally, we're exploring novel product opportunities to take advantage of our combined expertise in flow cytometry and Gene Expression analysis which we will expand on in upcoming quarters. We remain very enthusiastic about the strategic fit of our eBioscience -- of eBioscience into our focused plan to serve translational medicine and diagnostic customers, as well as the long-term growth potential and overall financial contribution from our eBioscience product portfolio.

Turning to operations. During the third quarter, we successfully completed a planned routine level 1 inspection by FDA of our reagent manufacturing site in Cleveland. Our excess and obsolete inventory expense came in at about $800,000 in Q3 2012, which is down by 76% from $3.3 million in Q3 of 2011. This is primarily due to an improved sales and operations planning process. We also announced the expansion of our license agreement with Siemens Health Diagnostics for the use of branch [ph] DNA for in situ products, including in vitro diagnostics.

In closing, for the third quarter, our revenue in constant currency, excluding eBioscience, declined by about 2% from the prior year. Our Genetic Analysis business grew by about 16% as compared to the third quarter of 2011, in line with our guidance. As projected, our cytogenetic revenues are on track to be about 10% of our revenue -- of our company revenue for the full year and we had another sequential quarter of double-digit growth in our Axiom genotyping product line.

Revenues from our Expression BU, our most challenging business unit, now represents 34% of the total revenue. We've implemented a strategic goal-setting process for 2013, which involves senior management reviewing in detail our commercial and operational objectives for 2013 and beyond. In addition to executing against key growth drivers, such a cytogenetics and flow cytometry, we're also focusing on leveraging our operating expenses, improving cash flow from the business, and paying off our senior secured debt.

Now I'd like to turn the call over to Tim, to review our third quarter financials.

Timothy C. Barabe

Thank you, Frank, and good afternoon. Now I'd like to review the details of our operating results for the third quarter of 2012. For the third quarter, the company reported total revenue of $79.6 million including $17.6 million from eBioscience as compared to $64 million for the same period last year. Excluding eBioscience, as Frank said, revenue was down $1.9 million or 2% in constant currency, primarily due to lower chip sales.

Turning to the detail. Third quarter product revenue was $72.7 million which included revenue of $17.6 million for eBioscience as compared to $57.0 million for the third quarter of 2011. Excluding eBioscience, consumable sales were $50.5 million, down from $52.9 million in the third quarter of 2011. Instrument sales for the quarter were $4.6 million compared to approximately $4.1 million in the prior year's quarter. Lastly, service and other revenue was $6.9 million compared to $7.0 million in the third quarter of 2011.

Looking at the results from the business unit perspective, revenue from our Expression business unit decreased by $3.4 million or 11% compared to the prior year. Our non-array Panomics products increased by more than 5% year-over-year, demonstrating our strategy of specialized sales forces is paying dividends.

Our Genetic Analysis revenue increased by about $2.9 million or 16% compared to the same period in the prior year, primarily due to higher sales of our research-use only cytogenetics and Axiom family of genotyping products. The increase was partially offset by a decline in sales of our SNP 6.0 Arrays.

Revenue from our Life Sciences Reagents unit was down by about $250,000 or 3%. This slowdown resulted from our decision to move to a direct sales channel rather than use an existing distributor late last year.

Turning to gross margin. Our product gross margin was 53% in Q3 and our total gross margin was 52%, which was down 4% over the third quarter of 2011. The primary driver for the decreased gross margin was the cost of inventory step-up of $4.5 million acquired and associated with the eBioscience transaction and the amortization of intangibles of $1.6 million. Excluding these non-GAAP items, total gross margin was up 2% to 60% compared to the third quarter of 2011.

Turning to operating expenses. Total operating expenses for the third quarter were approximately $52.8 million versus $42.2 million incurred in the same period last year. Our third quarter expenses included $1.9 million in acquisition-related charges, $3.9 million in increased spending on our clinical trials for CytoScan and $11.5 million in operating expenses from eBioscience. These costs were offset by savings in headcount and facilities costs. On a non-GAAP basis and excluding eBioscience, our overall operating expenses were down by about $2.1 million or 5% from the prior year.

R&D expenses for the third quarter of 2012 were $16.5 million which included $1.9 million of R&D from eBioscience. This compared to $15.3 million during the third quarter of 2011. Excluding eBioscience, R&D expenses decreased by $700,000 or 5% in the 3 months ended September 30, 2012, as compared to last year. The decrease was primarily due to lower headcount-related costs partially offset by increased spending on clinical trials.

SG&A expense was $36.3 million during the third quarter of 2012 which included $9.6 million from eBioscience. After adjusting for eBioscience and non-GAAP items of $667,000 related to the amortization of acquired intangible assets and $1.3 million of acquisition-related transaction and integration costs, Affymetrix non-GAAP SG&A expenses were $24.8 million. This compares to third quarter of 2011 non-GAAP SG&A expenses of $26.2 million, which included a non-GAAP adjustment of $765,000 related to the amortization of acquired intangible assets. The decrease in SG&A expenses of $1.4 million or 6% was primarily related to lower spending on facilities costs.

Turning to other income and expense. Interest expense and other net was approximately $6.9 million in the third quarter of 2012, due primarily to the recognition of impairment of $4 million on our West Sacramento manufacturing facility and higher interest expense from increased debt obligations from the acquisition. This compares to interest expense and other net of $3.1 million for the prior year quarter.

In the third quarter, we recognized a nominal income tax benefit. Our Q2 income tax benefit previously reported has been decreased by $7.2 million due to the income tax impact associated with the final valuation of acquired eBio assets. During the third quarter of 2012, we generated a net loss of $17.9 million or $0.25 per diluted share. Costs associated with the eBioscience acquisition and integration of $1.9 million, impairment recognized on our West Sacramento facility of $4.0 million, amortization of inquired intangibles of $5 million, amortization of inventory fair value of $4.5 million, would have resulted in a net loss of $2.4 million or $0.03 per diluted share. This compares to a net loss in 2011, excluding amortization of intangibles, of $1.5 million, impairment charges on investments of $700,000 and a reserve of $2.2 million recognized on a note receivable from a private biotechnology company of $5.4 million or $0.08 per diluted share.

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 $15.4 million or $0.22 per share decrease in GAAP net loss and include, within gross margin, $6.1 million or roughly $0.09 per share in the amortization of acquisition-related intangibles of $1.6 million and inventory fair value step-up of $4.5 million.

In operating expenses, approximately $250,000 in R&D and $3.2 million in SG&A or $0.04 per share in acquisition-related intangibles amortization. We also had SG&A expenses of $1.9 million or $0.03 per share in acquisition- and integration-related costs. In other income and expenses, a $4.0 million or $0.06 per share impairment on our West Sacramento facility.

Let me take a moment to summarize our balance sheet. We ended the third quarter of 2012 with total cash and available-for-sale securities of $39.6 million compared to $37.6 million as of the end of the second quarter of 2012. This ending balance includes the impact of prepaying $2.1 million of our senior secured debt at the end of September. Capital spending was about $1.3 million and we incurred licensing charges of roughly $300,000. Depreciation and amortization was approximately $11.1 million, including the amortization of acquired intangible assets. Within operating expenses for the third quarter, there were $2.3 million in stock-based compensation charges.

Accounts receivable was $52.5 million, down from $53.4 million at the end of the last quarter. Included in this figure was eBioscience accounts receivable of $9.1 million, which was down from $9.3 million at the end of the second quarter of 2012.

Turning to inventory and other balance sheet items. Net inventory for the third quarter of 2012 was $75 million, of which eBioscience was $31.3 million. Excluding eBioscience, inventory was $43.7 million, up 9% compared to the second quarter of 2012, primarily driven by our decision to build safety stock following the termination of a third party manufacturing relationship. The inventory balance was net of a $4.5 million amortization expense on the fair value step-up. Compared to December 31, 2011, inventory is up slightly at about 2%.

We exited the quarter in a strong financial position with total cash and available securities of $39.6 million. We generated cash in the quarter and we expect to do so in the fourth quarter as well, net of interest and principal payments.

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

Franklin R. Witney

Okay. Thanks, Tim. In closing, with the reorganization into business units, building out the commercial organization, and the acquisition of eBioscience, we have stabilized the business, diversified our revenues, and laid the foundation for growth. We will continue on our broader growth strategy by aggressively pursuing opportunities in clinical research and diagnostics, as well as genotyping and growing our eBioscience business. With respect to array-based Gene Expression and Life Science Reagents, we will continue to be selective and make our investments in attractive growth areas. Going forward, our priorities are growing the top line, leveraging our operating expenses, and paying off our senior secured debt to improve profitability.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from David Clair of Piper Jaffray.

David C. Clair - Piper Jaffray Companies, Research Division

So I appreciate the update on the Gene Expression business. I was just hoping you could give us some additional details here on kind of the products and initiatives to slow the declines. And when do you think we should start to see the impact of these initiatives?

Franklin R. Witney

Yes, well, as we've talked about in the pretax [ph] , we're launching a number of products that are primarily aimed at expanding the number -- the types of samples that we can analyze that are driven at FFPE samples which are important in cancer research and clinical diagnostics. So that's really where our focus is on. It is a challenging business because of the obvious macros that you're aware of. And this quarter was a little bit worse than some of the quarters we've seen, a couple of quarters we've seen previously. So we continue to work on this. Again, it's a high-profit business. We're investing R&D selectively in areas that we think are going to grow. We're also very optimistic about some of the RNA assays we're developing through the Panomics channel, in particular the QG View Assays. We talked about the relationship with Leica and our initial installation. So we continue to see opportunities that are primarily preclinical and clinical and continue to work on those.

David C. Clair - Piper Jaffray Companies, Research Division

Okay, great. And then it sounds like clinical trials for the cytogenetics product is expected to ramp up in the next couple of months. Does that mean we can expect the FDA filing in 1Q '13?

Franklin R. Witney

So we're on track to complete our clinical validation of CytoScan in the next 2 months. And based on our progress to date, we expect to file for FDA clearance shortly thereafter.

David C. Clair - Piper Jaffray Companies, Research Division

Okay. And any thoughts on how the outcome of the election might impact your business?

Franklin R. Witney

I think there could be multiple answers to that question, so we'll just have to wait and see.

Operator

The next question is from Jeff Elliott of Robert W. Baird.

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

I was wondering if you could provide some more color on what you saw from the academic end markets during the quarter? And if you could update us on what you've seen so far in fourth quarter.

Franklin R. Witney

Yes. So we'd -- certainly some of our more run rate businesses were impacted -- we think were impacted by academic funding challenges, and we expect that the academic funding is going to remain challenging in the near term. We didn't see any -- there wasn't any step change, but there was some -- in some of the businesses that are more sort of day-to-day type businesses, we certainly saw some impact of softness on the academic side. So far this quarter, it's been not dissimilar to last quarter short of -- the storm, certainly, hurt us a little bit in the last [indiscernible] -- in some of our more run rate businesses.

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

And then just on the Gene Expression business, can you break out the kind of the price versus dynamics -- versus volume dynamic and any commentary on the average selling price? I think you mentioned increased competitive pressures there.

Franklin R. Witney

Yes. So I would say at a very high level, we're certainly seeing a decrease in unit volume. I would say the contribution to the decline -- this again is the Array part, not Panomics part. The decline, I would say, we're seeing contributions in decline in volume as well as decline in pricing. We are seeing some growth -- we're seeing some growth in some of our Gene Expression products. For example, some of our lower-cost IVT Arrays, for example, but that's also causing a mix shift, which is impacting the net sales numbers as well. So those are the dynamics of the business we're dealing with. We are seeing declines in volume and pricing, as well as a shift to some of the lower-end products. So it remains a very challenging business.

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

I know early here, but 2013, is that the year we kind of return to profitability?

Franklin R. Witney

That's certainly our intention. We're going through our planning process now and that's the goal we're setting out for ourselves at this point.

Operator

And our next question is from Jon Groberg of Macquarie.

Jonathan P. Groberg - Macquarie Research

Maybe just relative to kind of what you'd expect during the quarter, can you maybe just talk about what came up short? Was it eBio? Was it the Expression relative to your own internal views?

Franklin R. Witney

I think, no -- as we discussed, we were -- we had lower-than-expected revenues out of the eBioscience business. We're more optimistic for Q4 to get back to growth and more expected growth in that business. And the Expression business for us certainly came in slightly below what we were anticipated. The clinical side and genotyping side, as we talked about, showed nice growth dynamics.

Jonathan P. Groberg - Macquarie Research

And just what are -- so at Expression, I think we all get and maybe it's stabilized, maybe it accelerates, or declines. What -- on the eBio side, can you maybe talk about why you think exactly it was a little bit light? Why you think it's going to get better? And maybe the expectation -- just kind of what you're seeing there and what gives you the confidence that, that business will continue to grow?

Franklin R. Witney

If you look down at the component pieces, on a quarterly basis, we had reasonable growth in the direct channels, which is roughly 70% of the business, that's North America and Europe. That was up 3% in the quarter and year-to-date, that's up almost 6%, these are on constant currency basis. The distributors were up in the quarter, which is about 20% of business, was up 11% and that's roughly what we've seen year-to-date. What we saw -- we saw a pretty dramatic drop off in the OEM business, as we mentioned. So and if you look at the -- on the product side, flow was up about 3%, immunoassays was up a little more than 8%, whereas the smaller segments of the business was down pretty dramatically. So I think in general, we feel that the product lines that eBio has are very competitive. We're going through a transition to direct sales in Japan which will be helpful for us. So we feel the fundamental drivers are there, and our indications are that Q4 will be more typical and on into next year. So we feel very good about the business, the people at the company are very strong, deep knowledge in their area. And for us, it gives us another toolbox to go sell to people that are deep in translational medicine and preclinical work. So we feel that while the quarter was light for us, what we had expected, I don't think it makes us feel any differently about the business going forward.

Jonathan P. Groberg - Macquarie Research

Okay, just one last one in eBio, and then I'll hop in the queue. But if you -- I know we talked last quarter, 2 quarters ago, about kind of retaining people. Have you -- you mentioned the strength there. Can you maybe give us an update? Have you lost any key people there? Just kind of what's going on with the business from a personnel standpoint?

Franklin R. Witney

We haven't lost any key people at this point.

Operator

The next question is from Daniel Brennan of Morgan Stanley.

Daniel Brennan - Morgan Stanley, Research Division

First, Frank, can we go back to the Gene Expression business again? Can you help us maybe just dissect a little bit of that 34% of your business that, that represents. Like can you give us any more granularity within that about -- apart from that business, maybe the whole Gene Expression really declining versus the pieces that are growing, just kind of parse that a little bit just to give us confidence toward seeing that stabilization toward 5 to 10, like of how do we get there?

Franklin R. Witney

Yes, so if you look at the component pieces, roughly let's say 30% of that is arrays and 5% is -- another 5% of our total business is the Panomics piece. The Panomics piece was a little slow this quarter. We were up 5% and we had been up more strongly in previous quarters and we anticipate that, that business will continue to grow. The big piece in the Expression business is our IVT products, our most, let's call them, classic products. And they were -- we've seen some pretty dramatic declines in the IVT business and we're shoring that up again, as we talked about, by essentially extending the sample types to more clinically relevant samples like FFPE, and taking those assays into people that are doing clinical research. Some of the other products that we just -- we've launched are still relatively early in the game. We launched the Human Transcriptome Array, which we think is a complement to next-gen sequencing in the sense that it's a relatively -- it's a reasonably priced array that can be used in validation of biomarkers or clinically relevant RNA signatures. But 70% of the business is IVT, and that's the business that was seeing the biggest declines that are due to volume, as well as a shift to lower-cost products, and we're attacking that again with additional bundling assays in from the products that we talked about here, the Sensation products and the other IVT reagent kits. And as well as expanding out the portfolio of sample types that we can address. So again, I think it's important to realize that this product line is highly profitable, and we're again making selective investments in it, but we have a very good team working on it, we're putting out a number of new products, and -- but not at the expense of being able to make significant investments in some other areas that have probably higher growth potential at this point in time.

Daniel Brennan - Morgan Stanley, Research Division

And one of the biggest reason for this shortfall, and I'm sorry if you said this in the prepared remarks, but was it primarily just the environment, just the more significant spending austerity that you're seeing on academic markets, whether it be the U.S. and the Europe? Or was there something competitively that was out, whether another modality in sequencing or price competition from the big competitors [ph]? What was the big culprit for the step-down function this quarter?

Franklin R. Witney

Well, I think, if you look quarter-over-quarter, we certainly -- I would say, that the biggest piece of that was in our Expression Array business. I think that's probably...

Daniel Brennan - Morgan Stanley, Research Division

Right. I mean -- I'm sorry, I mean in terms of that business decelerating to the point it did surprise you, was it just the environment? Researchers are just more fiscal -- kind of tight with their budgets? Or is there something -- are you seeing there's an accelerating trend towards sequencing as price points come down? Or it's just you kind of think about -- like what is it that caused kind of the shortfall this quarter, if you can put your finger on it.

Franklin R. Witney

Yes. Again, the sequencing -- obviously, sequencing is having a big impact on our business. It's a big driver. And so, we're seeing -- we're certainly seeing a drive -- we're seeing a shift to lower-cost products which is having a net effect on the revenue side. And I think that's superimposed on a pretty tight academic funding environment. So I would say those are probably the 3 biggest factors that we're seeing. So we're certainly being impacted by sequencing. We're seeing some price erosion, as well as volume erosion and that's superimposed on the funding environment. So I think those would probably be your 3 big factors.

Daniel Brennan - Morgan Stanley, Research Division

And then maybe just one related. So if sequestration were to take effect next year, what types of actions would you guys be prepared to make or possibly could make if, in fact, this pressure just continuing and you weren't able to offset it with some of your initiatives about new products and things like that?

Franklin R. Witney

Yes, I think we'll address that when that happens, but there's certainly levers that we can pull like everyone else has.

Operator

Our next question is from Zarak Khurshid of Wedbush Securities.

Zarak Khurshid - Wedbush Securities Inc., Research Division

I guess just kind of a big picture question. As we think about eBioscience and some of the challenges over the next 12 months, I mean, do you think of it as being less sensitive to the fiscal cliff? Or a little bit more -- are you more optimistic about some of the growth trajectories within that business?

Franklin R. Witney

Well, again, we feel that the fundamentals of the eBioscience business are very good, and they're going to be -- they'll certainly have a big academic business that could be impacted in certain situations. But at this point, we feel that the fundamentals of their flow and immunoassay business, some of the things we can do with the channel, as well as some potentially new products or new ways to market and sell some of the current Affymetrix products leads to a good future for the business. We're feeling good about it at this point, but certainly, they are exposed to -- that business is exposed to academic funding environments for sure.

Zarak Khurshid - Wedbush Securities Inc., Research Division

And as we think about your profitability goals for next year, what are the key levers that you can pull on to get to those goals?

Franklin R. Witney

Well, again, we're not going to provide any guidance going forward at this point, but we would certainly like to return to growth next year. We'd like to get leverage on that growth at the bottom line. So we feel that while we're, again, we're not in a position to talk about next year at this point, we feel that we have elements in place to give us growth next year and it'll be driven primarily by -- we believe it'll be driven by growth in the eBioscience business, continued growth in our Cytogenetics business as well as our Genotyping business, and then we're going to look very carefully to -- at where we're spending our money to make sure that we get leverage on that growth.

Operator

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

Shaun Rodriguez - Cowen and Company, LLC, Research Division

You touched on this, but can you provide some additional detail on how much of the early uptick for the RUO cyto product is coming from microscopy conversions versus competitive takeaways? And related to that, just some description perhaps of how the competition is behaving there?

Franklin R. Witney

Our growth is coming as a combination of people that are converting from microscopes as -- which is -- both of these are significant. We're winning labs that are converting as well as from labs that are converting from alternative platforms. I think -- we feel very, very good about our product. The customer feedback has been outstanding, it's working extremely well in peoples' hands, and the community is certainly talking about our product as something that has a very, very strong contribution to the rate base cytogenetics world. So I think we're gaining in both areas. I don't want to put specific numbers around that, but we're gaining traction in both segments you described.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Okay, that's helpful. And can you talk about the validation process for labs bringing on the cyto product, maybe how long it's taking for them to go from getting the product to processing clinical samples.

Franklin R. Witney

It varies. It would say that it could be anywhere from a 2- to 4-month process by the time they run enough samples to feel very good about it. It's not an extremely long process, but there is some internal work that has to be done, either comparing to alternative platforms or to alternative technologies. So it's -- we're certainly supporting those customers very strongly with a -- we have a high-level of expertise in the company and we do everything possible to help with that conversion process with our future customers.

Shaun Rodriguez - Cowen and Company, LLC, Research Division

Okay, and one more quick one, if I might. I apologize if you provided this. But Tim, is the clinical trial-related expense for the cyto development done in Q3 or will that go on into Q4?

Timothy C. Barabe

The vast majority of it occurred in Q3. There will be some trickle into Q4, but a lot of the spend was Q3.

Operator

The next question is from Isaac Ro of Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

If I can just ask one on the eBio, it has obviously, been a double-digit growth business. And appreciating there's some short-term disruptions, if you could put some color around the reasoning behind that? Was there a transition there? And have you guys taken ownership of the business there that caused the disruption? Or was there a channel-based reason? Just curious as to the reasoning why it was a little slower growth this quarter. And then secondly, why you expect it to improve again sequentially?

Franklin R. Witney

Yes. So I think the disruption was a relatively minor factor. I think the bigger factor was probably the macro environment caused some slowness, as well as the degradation of the OEM business were probably the 2 biggest factors. Even just looking at the OEM business, that was about a 4% down on growth just right there. So that's a pretty big hurdle to overcome in a very tough funding environment. But as we look out into Q4 into next year, again, when we look down in the detail at the various product lines and the initiatives that are happening, that we're working on, we feel that the business will return to the kinds of growth figures that we anticipated when we acquired the business.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Okay. And then just follow-up on the storm. I know you guys mentioned in your prepared comments that you expect some impact there. Just wondering how you're framing that. And any color you can provide around how quickly you think that will resolve, that will be helpful.

Franklin R. Witney

We saw some impact on our run rate businesses. That may not necessarily be totally recovered by the end of the year as people lose time out of their labs. We feel the shipping -- the reports I'm hearing is that the shipping is in much better shape than it was -- although it's recovering over the last few days for the most part. So we think that the impact will -- there will be some impact, but we don't think it will be dramatic.

Operator

Our next question is from Peter Lawson of Mizuho Securities.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Just on that eBioscience business. What was the weakness in the OEM business? And can that be reversed or was it just lost business?

Franklin R. Witney

It was really lost business to one large customer. Whether we recover that or not, we'll be conservative in our going forward on the assumption that would -- about whether we will recover that particular future or not[ph]. But it was primarily a single large customer that was -- had been anticipated in the quarter and it wasn't realized.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Did you lose on price or availability of product or portfolio?

Franklin R. Witney

Yes. I think, we'll just leave it that we lost a large amount to a -- it was really to a single customer.

Peter Lawson - Mizuho Securities USA Inc., Research Division

And with ASHG this week, are there any new products or data releases you're expecting?

Franklin R. Witney

Well, we announced the launch of our Biobank array in a press release late last week, which is a genotyping array that we have a lot of optimism for, that brings together a lot of very novel content in a very novel array. So we feel very good about that, and we'll be making an additional announcement tomorrow morning on another genotyping array as well. We have lots of workshops and customer events scheduled, so we have a very busy week ahead of us. But the 2 genotyping arrays are the -- will be the 2 announcements.

Peter Lawson - Mizuho Securities USA Inc., Research Division

The weakness you're seeing from the funding environment, has that gotten worse in the last month or so?

Franklin R. Witney

Not anything that we can see that's showing up in daily bookings.

Operator

The next question is from Bryan Brokmeier of Maxim Group.

Bryan Brokmeier - Maxim Group LLC, Research Division

You continue to expect Cyto to grow to 10% of revenue at year end. How should we think about that to continue to ramp over the next year or 2?

Franklin R. Witney

Well, we think -- we believe we're -- it was talked about it earlier, the 2 -- maybe there's 3 ways to think about that. We'll continue to win accounts from existing platforms, we'll convert people to -- we'll convert people that are currently running microscope-based assays, and we're going to expand out our application bases. So again, we don't want to give specific numbers, but when we think about 2013, we continue -- we expect to see continued aggressive growth in our Cytogenetics business.

Bryan Brokmeier - Maxim Group LLC, Research Division

Okay. And also, if there is sequestration and your business is negatively impacted, is profitability in 2013 still possible? Or will that really be too significant of a headwind for you to offset?

Franklin R. Witney

I think at this point in time, I'd rather not comment on that.

Operator

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

[Audio Gap]

Derik De Bruin - BofA Merrill Lynch, Research Division

on the adjusted basis. About a point lower that what we were looking for. I guess the question when you sort of look at the gross margin, it's like, when does that sort of start ticking back up to the 60% level? What sort of volumes do you need to push through, and what needs to happen?

Timothy C. Barabe

I guess, well, if you're talking about including eBioscience, we have said that we expected to be at the 60% level and were for the quarter. I would say that Gene Expression clearly is a higher-margin business, and we were affected by the shortfall in Gene Expression for the quarter, for the third quarter for sure. So that impacted the margins. And to the extent that we can stem that decline, obviously, margins will be better. But we've also got some nice products. I mean, clearly eBioscience margins are quite high, but we also have cyto and other margins that -- growing businesses that will help our margin going forward.

Operator

We have no further questions in queue at this time. I'd like to turn the floor back over to management for any closing remarks.

Doug Farrell

Thank you, all 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 the replay, domestic callers, please dial (877) 660-6853. International callers, please dial (201) 612-7415. The passcode for both is the same, 401334. Alternatively, an audio replay will be available on the Investor Relations section of our website at affymetrix.com. 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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