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Applera Corporation Teleconference April 25, 2002 Third Quarter Fiscal 2002 Earnings Call

- April 25, 2002

Peter Dworkin

Good morning. I am Peter Dworkin, Vice President, Investor Relations, for Applera Corporation.

Thank you for joining Applera Corporation management to discuss the third quarter fiscal 2002 financial results that were issued this morning for Applied Biosystems Group and Celera Genomics Group.

Present today are Tony White, CEO of Applera; Dennis Winger, Applera's Chief Financial Officer; Mike Hunkapiller, president of Applied Biosystems; Kathy Ordoņez, president of Celera Genomics and Celera Diagnostics, a joint venture between Applied Biosystems and Celera Genomics; David Block, COO of Celera's therapeutics business; and Mike Venuti, General Manager of Celera Genomics, South San Francisco.

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 Mike Hunkapiller, who will comment on third quarter results of Applied Biosystems. Tony White will then review the quarter for Celera Genomics. Next, Kathy Ordoņez will give an update on Celera Diagnostics and the Applera Genome Project. Then, before we take questions, Dennis Winger will discuss the financial performance and outlook for the ABI and CRA 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.

Mike Hunkapiller

As we had anticipated, the third quarter proved to be a very challenging period for Applied Biosystems, with the delay in the release of NIH funds, continued strength of the US dollar, pharmaceutical and biotechnology customer caution, and difficult year-to-year comparisons all constraining revenue growth. Revenues in the third quarter were down 7 percent from the year-ago quarter at 409 million dollars. Excluding the effect of foreign currency, the decline was 5 percent. During the quarter, sales to Celera Genomics were 4.6 million dollars, representing 1 percent of total revenue and a decline of 71 percent from 16.1 million dollars, or 4 percent of total revenue, in the prior year. Instrument sales declined 12 percent year-over-year, while consumables sales declined 6 percent. Revenues from other sources - this category includes service contracts, royalties, licenses, and contract research - increased 14 percent.

The 12 percent year-over-year decline in instrument sales was due primarily to the continuing challenge of very difficult comparisons for the 3700 DNA Analyzer. During this quarter, total sales of 3700s declined approximately 61 percent from the prior year. Earlier this week, we introduced a second-generation family of high-throughput, production-level DNA sequencers, the ABI 3730 and ABI 3730XL DNA Analyzers. We believe that the performance enhancements (particularly in data quality, read length, and sample throughput) embodied in these systems can be an essential element in allowing the large sequencing labs to meet their growing needs for cost-effective large-scale genome sequencing programs.

During the quarter, we also observed some decline in our market share in the low- and mid-throughput DNA sequencer segment due to a price gap in our product line between our models 310 and 3100 DNA Analyzers, a gap we feel has now been filled with the recent introduction of the Model 3100 Avant.

While DNA sequencer sales were weaker in the quarter, sales of mass spectrometer instruments were strong, increasing approximately 28 percent year-over-year. The latter was fueled by strength in our API 4000 LC/MS/MS product and by the recently released 4700 Proteomics Analyzer with TOF/TOFTM Optics. During the remainder of calendar 2002, we plan to introduce additional application software suites for the 4700, including support for our ICATTM protein quantitation reagents.

We believe the 6 percent year-over-year decline in consumables sales during the quarter was due largely to a lower rate of growth in our installed sequencer base and a decrease in sales of DNA sequencing consumables to Celera Genomics and the five large academic genome labs, from 31.3 million dollars to 12.5 million dollars. Reagent dilution, diversion of much of the Celera sequencing capacity to the Applera Genome Project (for which Applied Biosystems does not recognize revenue), and a winding down of the sequencing phase of the Japanese Millenium Project have driven this decline. Excluding sales to these six customers, consumables revenues increased 7 percent during the quarter.

During the third quarter, we introduced our custom Assays By DesignTM SDS reagents for genotyping and gene expression. During the current quarter, we will begin rollout of our validated Assays On DemandTM reagents arising from the Applera Genome Project. These assays will be key components of our new Knowledge Business that is expected to integrate genomic assays, database content, informatics tools, contract research services, and analytical systems.

While our overall revenue results for fiscal 2002 have not met our expectations, most of the shortfall has been confined to our DNA sequencing product line. For the first nine months, DNA sequencing products (including instruments, accessories, rentals, software, reagents, service, and royalties), declined 18 percent, and now account for 38 percent of total revenue, compared to 46 percent of total revenue in the equivalent period in fiscal 2001. During the same nine-month period, revenues from our SDS and other applied genomics products increased 23 percent; our mass spectrometry products increased 24 percent; core DNA synthesis and PCR product revenues declined 5 percent; and other product lines increased by 1 percent. More information on year-to-year product line performance is in today's press release.

Let me conclude my remarks, by saying that, despite the current uncertain business climate, we continue to be excited about the prospects represented by both our recently announced products and those we expect to introduce over the next several quarters. While we have restrained spending in the SG&A categories, we have maintained our commitment to a robust R&D program to drive these new products to market. While there is always uncertainty concerning project schedules leading to product introductions, as well as adoption cycles of new technologies by our customers, we remain confident that this investment in new products will fuel our future growth.

Now, Tony White will review the quarter at Celera Genomics.

Tony White

Thanks Mike. I want to reiterate how pleased I am to have Kathy as President of both Celera Genomics and Celera Diagnostics. I believe she is going to provide the leadership and focus Celera Genomics needs to become a successful drug discovery company. She had made substantial progress in building the strategy and team at Celera Diagnostics. We are looking forward to seeing the same type of performance within Celera Genomics.

Celera Genomics' core mission is the discovery and development of new therapeutic targets and drugs. Let me first update you regarding its proteomics and small molecule programs. The Group's proteomics lab is completing its pilot study in pancreatic cancer samples. This study has succeeded in identifying known proteins with differential expression in diseased versus healthy cells, as well as novel differentially expressed proteins not recognized in literature. This was the desired outcome, as it provides validation for the platform and identification of a number of proteins for further study. Celera Genomics has recently initiated proteomic studies related to non-small cell lung cancer.

Celera South San Francisco now has eight programs that are in late pre-clinical evaluations, including safety/tox and in vivo models. Three of these programs are partnered, including the two that we have discussed on past calls with Merck and Aventis, and the apoptosis induction program with Maxim Pharmaceuticals. In addition to these eight, several other oncology programs are in earlier pre-clinical evaluations. Kathy and her team will evaluate the unpartnered programs to establish prioritization and a path forward for each. In addition, work is going on with Rockville to select candidate targets from proteomics and genomics.

Consistent with its core mission, the Group has eliminated activities and distractions that are not central to its drug discovery goals. First, Celera sold the animal genomics business of AgGen to MetaMorphix. It completed a marketing and distribution agreement, under which the Celera Discovery System will be exclusively marketed through Applied Biosystems. As we explained in detail Monday, this agreement provides Celera with ongoing revenue and cash flow by facilitating the integration of CDS into a broader information and product platform, while otherwise permitting Celera Genomics to retain control of the technology to help support its therapeutic business. The agreement maintains Celera's access to data and its control of strategic intellectual property.

In today's release, we also emphasized our intention not to pursue new sequencing grants and contract services agreements that are unrelated to therapeutic discovery. Overall, contract and grant sequencing has not contributed to Celera Genomics' profitability. These business activities were the right thing to do when the Group had excess capacity in its sequencing facility, and while it had significant lease costs and other overhead to cover. Today, most of the 200 sequencers at Celera Genomics are off lease, and most of the sequencing capacity in Rockville is committed to the Applera Genome Project. Thus there is not the same rationale to pursue low margin business that is not related to drug discovery.

Kathy and her team plan to complete the organizational redesign and strategic planning process started over the last couple months. This will influence our program priorities and our expense outlook for fiscal 2003, as we intend to scale our activities and organization to meet the goals established in this process.

In a couple of minutes, Dennis is going to talk about Celera Genomics' revenue outlook for the balance of 2002 and 2003. We anticipate total revenues of 85 to 95 million dollars for fiscal 2003. This forecast is based in part upon the Group's plan not to pursue new grant and service business going forward. We plan to manage Celera Genomics with an emphasis on generating cash flow for downstream drug development activities. Our attention to cash generation and preservation has paid off; we have reduced Celera's cash burn projection for fiscal 2002 by a minimum of 35 million dollars.

We believe the real opportunity for increased shareholder value is in Celera's therapeutic discovery platforms, its emerging preclinical pipeline, and its fifty percent ownership interest in the Celera Diagnostics joint venture. The CDS marketing and distribution agreement is expected to contribute 200 to 300 million dollars in positive cash flow over the term of the agreement. Celera Genomics has over 900 million in cash to support future drug discovery and development activities.

Next, Kathy will update you regarding Celera Diagnostics.

Kathy Ordoņez

Thanks Tony. Fiscal third quarter revenues for Celera Diagnostics were 2.7 million dollars. In the same period last year, sales of these same products totaled 1.8 million dollars. This result is largely due to sales of our cystic fibrosis product, which have been driven by a recent recommendation by the American College of Obstetricians and Gynecologists for increased use of CF testing.

Our 510(k) submission for the ViroSeqTM test for genotyping the HIV virus has been under review by FDA since July of last year. We responded to all of FDA's questions regarding the test in February and expect a response from them by mid-May. This response may be in the form of additional questions from FDA.

At the end of the third quarter, Celera Diagnostics had 140 employees, including all key management positions. Our high throughput gene-association discovery suite is now equipped with 30 ABI Prism 7900 Sequence Detection Systems and a custom automated robot for reaction assembly. Bioinformatics capability to support the effort is now on-line and validation of the first several thousand SNP-specific assays is well underway and increasing rapidly. We are also beginning to incorporate novel functional SNPs identified through the Applera Genome Project into the program. During the first week of May, Celera Diagnostics is expected to begin its first major association study to identify SNPs associated with the diagnosis of Alzheimer's disease, incorporating approximately 1,000 samples from matched cases and controls. Large sample and case control cohorts have also been identified for two future association studies.

The Applera Genome Project, involving the re-sequencing of the coding and regulatory regions of approximately 40 individuals plus a chimpanzee, is proceeding rapidly. The Project's aim is to identify novel SNPs in and around genes that have the potential to alter patterns of gene expression and protein products. The program is currently finding twelve SNPs per gene, of which sixty percent are believed to be novel and fifteen percent are believed to impact protein coding. The SNPs identified by this project, along with others already identified, are being assembled into large reagent sets for genetic studies to advance the understanding of human biology and evolution. They are also expected to provide a framework for a haplotype map of the human genome. These SNP and haplotype data and reagents are expected to become available to researchers through Applied Biosystems as part of its Knowledge Business. Celera Diagnostics is using these discoveries to conduct association studies to identify novel diagnostic markers, which it intends to configure into tests to diagnose and monitor disease.

In conclusion, I would like to say I am pleased to be taking on the role of President of Celera Genomics. Celera is neither a traditional pharmaceutical or biotech company. It has a unique and powerful combination of genetics and proteomics discovery platforms, complemented by expertise in small molecule chemistry. Additionally, Celera Diagnostics holds the promise of augmenting our therapeutic discovery efforts by supporting our clinical and regulatory activities. Our first task is to define a plan to unlock the strategic value of these assets and capabilities, and then to align the appropriate resources behind them to move our discoveries into the clinic.

Next, Dennis will provide a summary of Applera's financial results.

Dennis Winger

Thank you, Kathy. First, let's discuss Applied Biosystems.

As we announced, Applied Biosystems earned 23 cents per diluted share during the quarter. Earnings per share in third quarter of fiscal 2001 were 26 cents per diluted share.

Net income in the third quarter of fiscal 2002 was 49.1 million dollars compared to 57.7 million dollars in the comparable period last year. Foreign currency effects reduced net income by approximately 3 million dollars, or 1 cent per diluted share.

While revenue growth in the third quarter was disappointing, we were pleased with the quality of our earnings as evidenced by our gross margin expansion and accounts receivable management. Gross margin in the third quarter was 52.9 percent, compared to 52.6 percent in the same period a year ago. Excluding the effects of foreign currency, the gross margin was slightly higher, reflecting previously implemented price increases and a shift in customer mix.

As we have discussed previously, we made a decision not to hold down R&D spending during this period of slowing sales, and in the third quarter R&D expenditures increased 19 percent. These investments supported a range of product development programs, including the Applera Genome Project, which we believe will enable Applied Biosystems to emerge from this period of weak sales in a strong position. Selling, general, and administrative expenses declined 11 percent from the prior year due to our ongoing effort to manage expenses.

Applied Biosystems also had strong cash flow performance during the quarter. Cash flow from operations was 35.9 million dollars, and capital expenditures were 15 million dollars. As of March 31st, accounts receivable were 360 million dollars, representing 68 days sales outstanding, or an increase of one day from 67 days at the end of the second quarter, continuing our aggressive accounts receivable management. Inventory was 135.8 million dollars, representing 3.4 months of inventory on hand. Cash and investments at quarter-end were 447.7 million dollars.

Let me now address the business outlook for Applied Biosystems. As you know, last year Applied Biosystems was the first company in the life science tool sector to comment on industry changes that have since affected many firms. Since then, we have tried to be as candid as possible about changing market conditions. As we stated in our press release, due to the factors discussed this morning, including the uncertain business climate, we have lowered our fiscal fourth quarter (June) revenue guidance to reflect flat to slightly positive growth versus the prior year. While forecasting continues to be particularly difficult, we remain optimistic that the fourth quarter of fiscal 2002 (June) will mark an improvement in year-over-year revenue comparisons for Applied Biosystems. Factors contributing to this expected improvement include the impact of new products and expected healthy spending by U.S. basic research customers as more funds become available from the new budget of the NIH and other government agencies.

The Group expects diluted earnings per share for the fourth fiscal quarter to be in a range of 18 cents to 21 cents. R&D expenditures are expected to increase, in percentage terms, by the high-teens during the fourth quarter of fiscal 2002 compared to the comparable period in the prior year largely as a result of increased spending for the Applera Genome Project.

In fiscal 2003, new offerings, including the 3730 product line and Assays on DemandTM, are expected to drive a return to financial growth. On a preliminary basis, the Group anticipates that fiscal 2003 revenue percentage growth will be in the high single digits to low-teens. Given our confidence in the long-term prospects of our business, we anticipate maintaining our commitment to our investment in R&D. After further analysis of the projected adoption rate of its new products, the Group will provide additional revenue as well as expense and EPS guidance for fiscal 2003 in July in conjunction with its fourth fiscal quarter earnings release.

Now I will move on to Celera Genomics. During the recently completed quarter, revenues for Celera were 30.5 million dollars, in comparison to 23.4 million dollars in the same quarter a year ago. The increase in revenues was attributable to new subscription agreements signed over the past 12 months. We also for the first time are breaking out subscription revenues, which were 18.5 million dollars, or 61 percent of total Celera sales. Included in this quarter's results are 25.9 million dollars of special charges related to Paracel. These charges are comprised of 23million dollars related primarily to the impairment of all remaining goodwill and other intangibles, and an accrual for excess lease space included in other special charges, and a 2.9 million dollar write down of inventory included in cost of sales. Excluding special charges, Celera's net loss decreased to 28.5 million dollars, or 42 cents per share. The lower net loss was attributable prim arily to continued growth in subscription revenues and lower R&D expenditures and amortization of goodwill. Higher development expenses within the Celera Diagnostics joint venture with Applied Biosystems and lower interest income partially offset these factors. Celera's results include a pre-tax loss of 12.3 million dollars from its interest in the Celera Diagnostics joint venture.

For the nine months ended March 31, 2002, Celera reported a net loss before special charges of 63 million dollars, or 97 cents per share, compared to a net loss of 84.5 million dollars, or $1.40 per share, for the comparable period in fiscal 2001. The special charges during this period included the Paracel-related charges and a 99 million dollar non-cash charge related to the acquired in-process R&D associated with the Axys acquisition. Including the special charges, the reported net loss for this period was 183million dollars, or $2.82 per share. During this period, Celera's share of the expenses for the Applera Genome Project was 11 million dollars.

Total revenues for this period were 92.8 million dollars, with Online/Information revenues totaling 52.8 million dollars. In the same period last year, total revenues were 62 million, with 34.3 million dollars attributable to the Online/Information business. Through the first nine months of fiscal 2002, operating income for the Online/Information business, before allocation of expenses for a portion of the Applera Genome Project, was approximately 6 million dollars.

Revenue for the fourth fiscal quarter 2002 is expected to be between 27 million dollars and 29 million dollars, including approximately 20 million dollars of Online/Information sales. Revenues for fiscal 2003 for existing subscriptions and Knowledge Business royalties are expected to be in the range of 75 to 80 million dollars. Total Celera revenues should be between 85 and 95 million dollars. This outlook is consistent with our emphasis on cash flow, and the elimination of non-strategic service activities.

For fiscal 2002, we have revised our expense outlook downward in several categories, including R&D, SG&A and for the Celera Diagnostics joint venture with Applied Biosystems. We believe R&D expenses will be in the range of 135 to 140 million dollars. The outlook for SG&A expenses has been lowered to a range between 50 and 55 million dollars. Pre-tax losses related to the Celera Diagnostics joint venture are now expected to be approximately 50 million dollars.

Based on the expectations I have outlined, the most likely range for the Celera's fiscal 2002 net cash use is between 110 and 120 million dollars, substantially below our prior range of 155 to 170 million dollars. The lower expected cash use is primarily due to lower R&D expenses, lower development expenses within Celera Diagnostics, and higher than anticipated cash receipts from the exercise of stock options.

These comments reflect management's current outlook on the Applied Biosystems and Celera Genomics businesses. The Company does not have any current intention to update this outlook and plans to revisit the Groups' outlook only once each quarter when financial results are announced.

We will now take your questions.

Peter Dworkin

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 are forward-looking. These may be identified by the use of forward-looking words or phrases such as "believe," "expect," "intend," "anticipate," "should," "planned," "estimated," and "potential," 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 businesses include but are not limited to (1) rapidly changing technology and dependence on development of new products; (2) sales dependent on customers' capital spending policies and government-sponsored research; (3) the successful integration of the Celera Discovery System into the Applied Biosystems' Knowledge Business and market acceptance and adoption of the product offering; (4) significant overseas operations, with attendant exposure to fluctuations in the value of foreign currencies; (5) future growth strategy; (6) electricity shortages and earthquakes; (7) Celera Diagnostics' unproven ability to discover, develop, and commercialize novel diagnostic tests and the uncertainty that Celera Diagnostics will become profitable; and (8) other factors that might be described from time to time in Applera Corporation's filings with the Securities and Exchange Commission.

The risks and uncertainties that may affect the operations, performance, development, and results of Celera Genomics' businesses include but are not limited to (1) expected operating losses; (2) uncertainty of revenue growth; (3) unproven use of genomics information to develop or commercialize products; (4) intense competition in the industry in which Celera Genomics operates; (5) dependence on customers in, and the risks that affect, the pharmaceutical and biotechnology industries; (6) reliance on its strategic relationship with the Applied Biosystems Group; (7) potential product liability claims; (8) potential liabilities related to use of hazardous materials; (9) lengthy sales cycles; (10) dependence on the unique expertise of its scientific and management staff; (11) uncertainty and availability of patent, copyright, and intellectual property protection and the ability to protect trade secrets, and the risk that Celera Genomics may become the su bject of infringement claims; (12) dependence on computer hardware, software, and Internet applications; (13) the potential adverse effect on Celera Genomics' intellectual property protection and the value of its products and services due to public disclosure of genomics sequence data; (14) Celera Genomics' need for access to biological materials; (15) legal, ethical, and social issues which could affect demand for products; (16) the possibility of disruptions which could be caused by rapid growth of the business; (17) potential for government regulation of Celera Genomics' or its customers' products and services; (18) risks associated with future acquisitions, including that they may be unsuccessful; (19) uncertainty of the outcome of existing stockholder litigation; (20) the lengthy and uncertain development cycle for therapeutic and diagnostic products, and Celera Genomics' unproven ability to develop or commercialize such products; (21) the risk that the collaborations established by Axys will not be successful and that clinical trials will not proceed as anticipated or may not be successful; (22) Celera Diagnostics' unproven ability to discover, develop, and commercialize novel diagnostic tests and the uncertainty that Celera Diagnostics will become profitable; (23) the successful integration of CDS into the Applied Biosystems' Knowledge Business product offering and market acceptance and adoption of the product offering; and (24) other factors that might be described from time to time in Applera Corporation's filings with the Securities and Exchange Commission.

Notice To Readers: Celera's press releases, presentations and printed remarks are included on this website for historical purposes only. The information contained in these documents should be considered accurate only as of the date of the relevant document. This information may change over time, and therefore visitors to this website should not assume that the information contained in these documents remains accurate at a later time. We do not have any current intention to update any of the information in these documents.