Applera Corporation Teleconference, July 25, 2002, Fourth Quarter Fiscal 2002 Earnings Call
- July 25, 2002
Good morning. I am Peter Dworkin, Vice President, Investor Relations, for Applera Corporation.
Thank you for joining Applera Corporation management to discuss the fourth quarter and year-end fiscal 2002 financial results that were issued this morning for Applied Biosystems Group and Celera Genomics Group.
Prepared statements will be provided by Tony White, CEO of Applera; Dennis Winger, Chief Financial Officer of Applera; Mike Hunkapiller, President of Applied Biosystems; Kathy Ordoņez, President of Celera Genomics and Celera Diagnostics, our 50/50 joint venture between Applied Biosystems and Celera Genomics. Other business managers are present to assist in answering your questions.
During this call we will be making forward-looking statements about Applera's businesses. These statements are subject to the risks and uncertainties that are referred to in the releases issued this morning and in Applera's filings with the Securities & Exchange Commission.
Our first speaker this morning will be Tony White. Then Mike Hunkapiller will comment on fourth quarter results of Applied Biosystems and Kathy Ordoņez will review the quarter for Celera Genomics and Celera Diagnostics. Next, Dennis Winger will discuss the financial performance and outlook for the three Applera businesses. Please note that during this call the text of these prepared remarks will be posted on the Investor Relations section of the Applera web site and on the separate Investor Relations sites within the Applied Biosystems and Celera Genomics web sites.
Tony, would you begin, please.
Good morning. We have just completed a challenging year in the life science industry, in the economy, and in the stock market. At Applera, we were not just reactive to market events. Rather, we took a series of steps to redefine our businesses to better serve our customers and to build an even stronger foundation for growth.
At Applied Biosystems, we launched new sequencers that we believe will reinvigorate our sequencing business. We also introduced new systems for studying proteins and small molecules that are being enthusiastically received by customers. We developed a broad portfolio of genomic assays that we believe will make molecular biology research more productive. We extended the vision of the genomic assays by announcing the unique concept of the Applied Biosystems Knowledge Business. We anticipate that the web-based Knowledge Business will enable researchers to query the best and most relevant genomic information culled from diverse sources to use that information to design experiments online, and then to conveniently order Applied Biosystems assays and other products that are optimized to perform those studies. To facilitate this, in April, Applied Biosystems and Celera Genomics entered into a marketing and distribution agreement whereby the Celera Discovery System' online platform will be integrated into the Knowledge Business.
This arrangement should be a win-win for all Applera shareholders. Content from Celera Genomics should help drive orders for Applied Biosystems' assays. Celera Genomics, in turn, will earn royalties from Applied Biosystems' product sales for 10 years, thus extending the economic life of the Celera Discovery System.
At Celera Genomics, the CDS agreement substantially completed Celera's transformation to a biopharmaceutical discovery enterprise. The other critical piece of this transformation was the installation of new management at Celera Genomics. In just three months, Kathy Ordoņez and her senior managers have provided greater focus and business discipline around the discovery programs, collaborations strategy, and expense management.
The third Applera business, Celera Diagnostics, organized in April 2001, has grown quickly into an organization with top diagnostic talent and technology capabilities. With its research infrastructure now in place, Celera Diagnostics is conducting its first large-scale disease gene association study, in Alzheimer's disease. Celera Diagnostics is currently developing novel tests for cystic fibrosis and hepatitis. The alliance announced last month with Abbott Labs will create a large diagnostic discovery and development program and provide access to Abbott's global distribution network for diagnostic products.
Innovating and embracing change are hallmarks of the Applera culture, and both were clearly evident in fiscal 2002. We did not back away from investing in our future to dress up short-term performance. I believe strongly in the substantial R&D investments we made across our businesses. I am also pleased that Applied Biosystems, our largest business, remained profitable and cash flow positive during fiscal 2002.
In times like these, financial strength becomes a strategic advantage. The healthy balance sheets at Applied Biosystems and Celera Genomics provide resources to continue to invest in the most promising technologies for the life sciences. So despite a difficult and disappointing year, we see better times ahead and are optimistic about the opportunities to increase shareholder value for both groups.
Now, Mike Hunkapiller will discuss Applied Biosystems.
Thank you, Tony.
Although fiscal 2002 proved to be a very challenging period for Applied Biosystems, I am pleased to be able to report a return to revenue growth for the Group during the fourth fiscal quarter. Revenues in the fourth quarter increased 3 percent to $417 million from the year-ago quarter. Excluding the effect of foreign currency, the increase was approximately 2 percent. During the quarter, sales to Celera Genomics were $2.9 million, representing less than 1 percent of total revenue and a decline of 82 percent from $16.3 million, or 4 percent of total revenue, in the comparable prior year period. Instrument sales increased 4 percent year -over year, while consumables sales declined 3 percent. Revenues from other sources - this category includes service contracts, royalties, licenses, and contract research - increased 17 percent.
In the fourth quarter, mass spectrometry revenue growth of 41 percent over the prior year period was driven by the continuing success of the API 4000TM LC/MS/MS instrument in the drug metabolism and pharmacokinetics market, as well as demand for the Applied Biosystems 4700 Proteomics Analyzer with TOF/TOFTM Optics. During the quarter, we also started shipping the Q TRAPTM system, a unique hybrid triple quad/linear ion trap that we introduced at the American Society for Mass Spectrometry in early June. In addition, we recently introduced the GPS Explorer software application package for the 4700, which includes support for our ICATTM protein quantitation reagents. While I am pleased with this success, we anticipate that this rate of revenue growth for the mass spectrometry product line will moderate somewhat as we move past the first full year of substantial API 4000TM instrument sales.
Sales of our Sequence Detection Systems and other applied genomics products also were strong in the fourth quarter, with year over year growth of approximately 23 percent. Both SDS instruments and reagents posted solid revenue gains, with instrument growth driven by the ABI PRISMŪ 7000 system.
During the fourth quarter, we announced the business model for our new Knowledge Business, including, as Tony said, marketing and distribution rights to the Celera Discovery System' online platform. As part of the Knowledge Business, we launched our validated Assays-on-DemandTM SDS reagents in the fourth quarter. The initial set, which is available for purchase on the Applied Biosystems website, today consists of approximately 86,000 assays for SNP genotyping and 7,000 assays for quantitative gene expression analysis. The Assays-on-DemandTM products are the first commercial offering resulting from the Applera Genomics Initiative announced in July 2001. We believe they represent the broadest collection of functionally validated, ready-to-use assays based on the human genome, and we anticipate that this product line should accelerate the path to discovery by enabling scientists to accomplish their research objectives in days or weeks rather than months or years.
Regarding our DNA sequencing product line, we have begun to see a slowing of year over year revenue declines and are optimistic that our new sequencing instrument introductions should return this product category to a period of growth. At the end of the quarter, we began to ship our second-generation high-throughput, production-level DNA sequencer, the Applied Biosystems 3730xl instrument, to our early access partners, which include many of the world's leading genome centers. While it is too early to draw conclusions about the success of this new 96 capillary system, we are very encouraged by the feedback that we have received from these centers. Additionally, early indications of customer interest for the 48 capillary 3730 instrument are also encouraging. Finally, we are pleased with the continuing success of the 3100-Avant system, our four-capillary sequencer targeted for the low- and mid-throughput markets.
Relative to the 3700 instrument, the 3730 product line offers both increased sensitivity and, for the Applied Biosystems 3730xl instrument, higher throughput. Because of this increased sensitivity, these instruments require less reagents per reaction. It is too early to predict whether or not increases in the number of reactions performed will compensate for the lower reagent requirements. In addition, we cannot predict the mix of applications that will be run on these instruments. While some applications require longer read lengths and thus require less reagent usage, those utilizing shorter read lengths can lead to higher throughput and higher reagent consumption. Consequently, we remain cautious about the outlook for DNA sequencing consumables revenue growth.
Let me conclude my remarks by saying that, even in this uncertain business climate, we remain fully committed to a program of strong R&D investment. Although it is never possible to fully predict the timing of new product introductions or the rate of customer acceptance of new products, we remain optimistic that our significant new product offerings will be strong contributors to our future growth.
Next, Kathy Ordoņez will provide updates regarding Celera Genomics and Celera Diagnostics.
I would like to start by updating you on the progress we have made during my first 90 days as President of Celera Genomics. The first priorities addressed during this period included the alignment of our organizational structure with our therapeutic mission, and planning and budgeting for fiscal 2003. We also conducted a review of our technologies, therapeutic programs and resource deployment in Rockville and South San Francisco. This exercise led to a number of key conclusions:
On June 11, we moved forward with the task of restructuring, and announced plans to eliminate 16 percent of Celera's workforce, primarily positions in sequencing, online customer acquisition and administration. The restructuring was planned to minimize disruption of our therapeutic program and service to existing customers. During fiscal 2002, Celera increased the number of employees assigned to therapeutic programs from approximately 40 to 327.
We also announced our intention to add a seasoned head of R&D. We wanted someone who could help integrate our current discovery organization, participate in decisions about the product portfolio, and map out and implement our strategy for the addition of development capabilities. I am pleased that Dr. Robert Booth will join us as Senior Vice President of R&D on August 5. Robert brings over 20 years of experience in the pharmaceutical industry and he has worked in a number of disease areas, including inflammatory, bone and viral diseases.
We have also established a cohesive set of internal goals that have been communicated to the entire Celera Genomics organization. And we have just finalized a budget that reduces non-strategic expenses and addresses the cash burn, while fully supporting therapeutic discovery and our commitments to customers.
We thus enter fiscal 2003 with the core management team in place, with clear goals and with an organizational structure to achieve those goals. Financially, we enter fiscal 2003 with $889 million in cash and short-term investments, budgetary discipline and cash flow from the online/information business.
During the coming year, Celera plans to identify differentially expressed proteins in lung cancer, and to validate a number of these proteins as therapeutic targets to proceed into screening. Much of this work will be done in our proteomics facility, which includes a mix of ABI mass spectrometry equipment. Based on experience gained through our pancreatic cancer pilot study, Celera is rebalancing its proteomics capacity through the addition of new Applied Biosystems Q TRAPTM and Q-STARTM systems in the place of some 4700 proteomics analyzer and Mariner ESI/TOF systems. The wide breadth of mass spec technology within the AB Proteomics portfolio and now in our proteomics factory is an important asset in making our process successful.
Celera further plans to evaluate potential targets identified from the disease association studies ongoing at Celera Diagnostics and bioinformatic analysis of other genomic data. We also intend to select compounds from our existing unpartnered preclinical programs to advance toward the clinic. In particular, we are looking at our two most advanced unpartnered compounds against Factor VIIa for deep vein thrombosis, and Cathepsin F for asthma and other inflammatory diseases.
Let me turn now to Celera Diagnostics.
Fiscal fourth quarter revenues for Celera Diagnostics increased to $2.8 million, compared to $1.6 million in the same period last year. Reported sales for fiscal 2002 totaled $9.2 million, which corresponds to $11.6 million in end-user product sales. Sales growth is largely due to continued strength in demand for our cystic fibrosis analyte specific reagents. We concluded the year with 173 employees.
During the fourth quarter, Celera Diagnostics received additional questions from the U.S. Food and Drug Administration regarding its 510(k) application to market the ViroSeqTM HIV-1 Genotyping System. We expect to respond to these questions by the end of the current quarter.
Last month we announced a strategic alliance with Abbott Laboratories to jointly develop and market new molecular diagnostic products, with both parties equally sharing profits from the project. The alliance will work to discover novel genetic markers for disease, and to configure these and other known diagnostic markers into robust clinical tests to be provided to physicians and their patients through hospitals and clinical laboratories throughout the world.
During the fourth quarter, we also made progress toward completing the Applera Genomics Initiative. Two-thirds of the planned sequencing has been completed at Celera Genomics, and we expect to complete the balance by the end of October and close out the project by the end of December. Extrapolation of results obtained to date suggests the Initiative may double the number of known functional SNPs. Some of these novel coding SNPs have the potential to become diagnostic markers for Celera Diagnostics and therapeutic targets for Celera Genomics, while being incorporated into Applied Biosystems' Assays-on-Demand' product line.
The focus for Celera Diagnostics in fiscal 2003 includes successful implementation of the alliance with Abbott, additional disease association studies, and new product launches. Celera Diagnostics and Abbott plan to migrate sales from existing products into the alliance over the coming year, and to introduce new products. During fiscal 2003, we also plan to complete the Alzheimer's disease association study, and at least three additional large-scale association studies. Through the alliance with Abbott, Celera Diagnostics plans to introduce several new products, including the next generation cystic fibrosis reagents currently under evaluation, and analyte specific reagents to genotype and to monitor viral load in hepatitis infections.
Next, Dennis Winger will provide a summary of Applera's financial results.
Thank you, Kathy. First, let's discuss Applied Biosystems.
As we announced, during the fourth quarter, Applied Biosystems earned 20 cents per diluted share, excluding a special item, versus 22 cents in the fourth quarter of fiscal 2001. During the fourth quarter of fiscal 2002, we recognized an $8.2 million pretax charge for the write-down of investments. Including this charge, earnings per diluted share were 18 cents.
During the fourth quarter, operating income was 14.1 percent of sales in fiscal 2002 versus 16.3 percent in fiscal 2001. While gross margin actually increased to 52.1 percent in fiscal 2002 versus 51.0 percent in fiscal 2001, the decline in operating margin is a function of two factors. The first and largest factor is that R&D as a percent of sales increased to 13.9 percent in the fourth quarter of fiscal 2002, versus 12.1 percent in the same period in fiscal 2001, largely as a result of funding for the Applera Genomics Initiative, support for new products in development, and compensation related expenses. Second, SG&A expense rose to 24.2 percent of sales in the fourth quarter of fiscal 2002, versus 22.6 percent in the prior year, due primarily to higher compensation and benefits expenses, as well as incremental costs associated with new product initiatives.D
uring the fourth quarter, Applied Biosystems generated extremely strong cash flow performance. Cash flow from operations was $115.7 million, and capital expenditures were $31.1 million. This strong cash flow generation allowed us to use $69.0 million to repurchase 3.9 million shares of Applied Biosystems stock during the quarter and still increase our cash and short-term investments balance by $23.3 million to $471.0 million.
As of June 30th, accounts receivable were $376 million, representing 72 days sales outstanding, versus $360 million, or 68 days at the end of the third quarter. Inventory was $143 million, representing 3.3 months of inventory on hand.
While forecasting continues to be particularly difficult, we remain optimistic that year over year revenue comparisons will continue to improve for the Applied Biosystems Group in the near future. At this time, we reiterate our expectation of last quarter that revenue percentage growth in fiscal 2003 will be in the high single digits to low teens. We continue to expect that growth in fiscal 2003 will be heavily influenced by the adoption of new products, including the 3730 product line, Assays-on-DemandTM, the Assays-by-DesignSM service, the 3100-Avant system, and the Q TRAPTM system.
Gross margin in fiscal 2003 is expected to approximate fiscal 2002 levels, while we expect SG&A expense to rise somewhat more slowly than revenue during the year.
While the Group anticipates that the Applera Genomics Initiative will be largely completed by the end of calendar year 2002, spending for this initiative, as well as development costs related to the Knowledge Business, is expected to lead to significantly increased levels of overall R&D spending during the first two quarters of fiscal 2003. For fiscal 2003, the Group expects R&D expenses to approximate 14 percent of revenue. This outlook includes approximately $12 million in expenses, the majority of which are expected to be spent during the first half of fiscal 2003, for Applied Biosystems's share of the Applera Genomics Initiative funding.
The Group expects that the effective tax rate for fiscal 2003 to be approximately 29 percent. Future tax legislation may repeal or replace the existing U.S. export tax regime, as well as significantly change other international tax provisions of the Internal Revenue Code. Such changes may result in a change in the effective tax rate for the Group.
The Group expects diluted earnings per share for fiscal 2003 to be in the range of 85 cents to 95 cents. Despite our forecasted revenue growth, the Group expects diluted EPS during the first and second quarters of fiscal 2003 to be approximately flat with the prior year due to the high levels of R&D spending anticipated during those periods. The Group anticipates year over year EPS growth in the second half of fiscal 2003.
Capital spending in fiscal 2003 is anticipated to be approximately $170 million, including approximately $80 million for the facilities expansion in Pleasanton, CA.
Now I will move on to Celera Genomics. During the recently completed quarter, Celera's net loss before special items was $23.1 million or 33 cents per share, compared to a 56 cents per share loss in the fourth quarter of last year. This improvement was mainly the result of lower expenses, particularly in cost of sales and SG&A. Included in the loss for the recent quarter was a $2.8 million special charge related to the restructuring announced on June 11, and a $6.0 million write down of investments. Including these special items, the fourth quarter 2002 net loss was $28.8 million, in comparison to $101.7 million in the same quarter a year ago.
Revenue for the quarter was $28.1 million, compared to $27.4 million for last year's fourth quarter. Online revenues increased 39 percent to $19.8 million compared to the same quarter last year. Other revenues decreased compared to fourth quarter 2001, due to two factors: Firstly, Celera's decision announced last quarter to forgo new contract sequencing and service business unrelated to drug discovery, and, secondly, the utilization of its sequencing capacity to support the Applera Genomics Initiative.
Celera ended fiscal 2002, with $889 million in cash and short-term investments. Cash use for the year was $106.6 million. For the year, Celera reported a net loss before special items of $86.1 million, or $1.30 per share, compared to a net loss of $119 million, or $1.96 per share, for fiscal 2001. The main factors behind this improvement included a 35 percent increase in revenues, lower R&D and SG&A expenses, and non-amortization of goodwill due to an accounting change implemented July 2001. The special charges for the year are summarized in the press release. Including the special charges, the reported net loss for the year was $211.8 million, or $3.21 per share, compared with a prior year net loss of $186.2 million, or $3.07 per share. The Online business contributed $72.7 million in revenue and approximately $13 million in operating income, excluding any of the expenses of the Applera Genomics Initiative
Our press release provides additional information regarding our financial outlook for Celera for fiscal 2003. We expect our cash balance to decrease by $75 to $85 million during fiscal 2003.
We currently expect fiscal 2003 R&D expenses in the range of $130 to $140 million. This outlook includes approximately $12 million for Celera Genomics'share of the Applera Genomics Initiative. Most of the expenses for the Initiative should be recorded during the first half of the fiscal year. Other R&D expenses are expected to be fairly evenly distributed over the four quarters. This outlook is for established research activities only and does not include expenses for downstream development capabilities we may choose to add in the future.
We expect fiscal 2003 SG&A expenses to total between $30 and $35 million, a substantial reduction from prior year levels. The fiscal 2003 revenue outlook for Celera remains unchanged from the guidance provided in April.
Now let me turn to Celera Diagnostics. Celera Diagnostics reported an operating loss of $14.5 million and net cash use was $15.2 million for the fiscal fourth quarter. The fiscal 2002 pre-tax loss was $44.7 million, while the cash use was $45.9 million for the fiscal year.
For fiscal 2003, Celera Diagnostics anticipates pretax losses of $50 to $60 million. Celera Diagnostics anticipates end-user sales, including those from its alliance with Abbott Laboratories, in a range of $18 to $22 million. Effective October 1, Abbott will assume distribution from Applied Biosystems and record most end-user sales. The cash burn at Celera Diagnostics is expected to be in the range of $55 to $65 million, including capital spending of approximately $10 million. We believe strong growth is sustainable going forward, supporting our goal of achieving profitability during fiscal 2005 or 2006.
These comments reflect management's current outlook. The Company does not have any current intention to update this outlook and plans to revisit the outlook for its businesses only once each quarter when financial results are announced.
We will now take your questions.
Thank you for participating in this call today. Management's remarks should now be posted on our web site. The audio replay will be available today by dialing the phone numbers listed in today's press releases.
Certain statements made during management's prepared remarks for this conference call, including the Financial Outlook sections, are forward-looking. These may be identified by the use of forward-looking words or phrases such as "believe," "expect," "should," and "planned," among others. These forward-looking statements are based on Applera Corporation's current expectations. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for such forward-looking statements. In order to comply with the terms of the safe harbor, Applera Corporation notes that a variety of factors could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in such forward-looking statements.
The risks and uncertainties that may affect the operations, performance, development, and results of Applied Biosystems include but are not limited to (1) rapidly changing technology could adversely affect demand for Applied Biosystems' products, and its business is dependent on development of new products; (2) uncertainty of successful integration of the Celera Discovery System' into the Applied Biosystems Knowledge Business and market acceptance and adoption of Knowledge Business product offerings; (3) Applied Biosystems' sales are dependent on customers' capital spending policies and government-sponsored research; (4) Applied Biosystems' significant overseas operations, with attendant exposure to fluctuations in the value of foreign currencies; (5) risks associated with Applied Biosystems' growth strategy; (6) the risk of electricity shortages and earthquakes, which could interrupt operations; (7) uncertainty of the availability of intellectual property protection and the ability to protect trade secrets, and the risk of infringement claims; (8) Celera Diagnostics' reliance on existing and future collaborations, including its strategic alliance with Abbott Laboratories, which may not be successful; (9) Celera Diagnostics' unproven ability to discover, develop, or commercialize diagnostic products, the risk that clinical trials of products it does discover and develop will not proceed as anticipated or may not be successful, the uncertainty that such products will not be accepted and adopted by the market, and the risk that such products will not receive required regulatory approvals; (10) the possibility of delays in making Celera Diagnostics' manufacturing facility fully operational, and Celera Diagnostics' unproven ability to scale up manufacturing as products sales increase; (11) the risk that certain raw materials and equipment required by Celera Diagnostics may not be available or may not be available at acceptable prices; (12) potential product liability or other claims against Celera Diagnostics as a result of the testing or use of its products; (13) intense competition in the industry in which Celera Diagnostics operates; and (14) other factors that might be described from time to time in Applera Corporation's filings with the Securities and Exchange Commission. All information in this press release is as of the date of the release, and Applera does not undertake any duty to update this information, including any forward-looking statements, unless required by law.
The risks and uncertainties that may affect the operations, performance, development, and results of Celera Genomics' businesses include but are not limited to (1) operating losses are expected for the foreseeable future; (2) reliance on Applied Biosystems' emerging and unproven Knowledge Business for incremental revenues to Celera Genomics from the Celera Discovery System and Celera Genomics' related information assets; (3) Celera Genomics' and Celera Diagnostics' unproven ability to discover, develop, or commercialize proprietary therapeutic or diagnostic products, the risk that clinical trials of products they do discover and develop will not proceed as anticipated or may not be successful, the uncertainty that such products will not be accepted and adopted by the market, and the risk that that such products will not receive required regulatory approvals; (4) reliance on existing and future collaborations, including, in the case of Celera Diagnostics, its strategic alliance with Abbott Laboratories, which may not be successful; (5) Celera Genomics' reliance on access to biological materials and related clinical and other information, which may be in limited supply or access to which may be limited; (6) intense competition in the industries in which Celera Genomics and Celera Diagnostics operate; (7) potential product liability or other claims against Celera Genomics or Celera Diagnostics as a result of the testing or use of their products; (8) Celera Genomics' reliance on scientific and management personnel having the technical background necessary for Celera Genomics' business; (9) potential liabilities of Celera Genomics related to use of hazardous materials; (10) uncertainty of the availability of intellectual property protection and the ability to protect trade secrets, and the risk of infringement claims; (11) Celera Genomics' dependence on computer hardware, software, and Internet applications; (12) legal, ethical, and social issues which could affect demand for Celera Genomics' products; (13) risks associated with future acquisitions by Celera Genomics, including that they may be unsuccessful; (14) uncertainty of the outcome of existing stockholder litigation; (15) the possibility of delays in making Celera Diagnostics' manufacturing facility fully operational, and Celera Diagnostics' unproven ability to scale up manufacturing as products sales increase; (16) the risk that certain raw materials and equipment required by Celera Diagnostics may not be available or may not be available at acceptable prices; and (17) other factors that might be described from time to time in Applera Corporation's filings with the Securities and Exchange Commission. All information in this press release is as of the date of the release, and Applera does not undertake any duty to update this information, including any forward-looking statements, unless required by law.
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