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Applera Corporation Teleconference January 24, 2002 Second Quarter Fiscal 2002 Earnings Call

- January 23, 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 second quarter fiscal 2002 financial results that were issued yesterday after the market close for Applied Biosystems Group and Celera Genomics Group.

Present today are Tony White, CEO of Applera and acting President of Celera Genomics; Dennis Winger, Applera's Chief Financial Officer; Mike Hunkapiller, president of Applied Biosystems; Kathy Ordoņez, president of Celera Diagnostics, a joint venture between Applied Biosystems and Celera Genomics; 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 yesterday and in Applera's filings with the Securities & Exchange Commission.

Our first speaker this morning will be Mike Hunkapiller, who will comment on second quarter results of Applied Biosystems. Tony White will then review the quarter for Celera Genomics. Next, before we take questions, Dennis Winger will discuss the financial performance and outlook for both 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

Revenues in the second quarter were flat with the previous year quarter at 411 million dollars. Instrument sales declined 4 percent year-over-year, while consumable sales were flat. Revenues from other sources - this category includes service contracts, royalties, licenses, and contract research - increased 16 percent.

The 4 percent year-over-year decline in instrument sales was due primarily to the continuing challenge of very difficult comparisons for the 3700 DNA Analyzer. To put a finer point on that statement, sales of new 3700's declined approximately 80 percent from the level of a year ago, reflecting the fact that most of the largest genome centers and commercial genomics companies have adequate sequencing capacity for their near-term needs.

In contrast, several major instrument lines sold well during the second quarter. New second-generation Sequence Detection Systems (SDS) for gene expression and single nucleotide polymorphism (SNP) analysis helped the SDS instruments category grow by more than 70 percent over the year-earlier quarter. Revenues from mass spectrometry systems increased approximately 25 percent, led by the new API 4000 triple quadrupole mass spectrometer for studies of drug metabolism and pharmacokinetics. Revenue gains of approximately 16 percent were achieved with our low- and mid-throughput capillary DNA sequencers, the ABI PRISM 310 and 3100 Genetic Analyzers.

Revenues from consumables were flat due largely to decreases in sales of DNA sequencing consumables to both Celera and the large public human genome labs. These labs continue to exploit the sensitivity of the 3700 DNA Analyzer through the use of smaller sample volumes and greater dilution of sequencing reagents. In addition, Celera has decreased its whole genome shotgun sequencing activities as it begins to ramp up its resequencing efforts for the Applera genomics initiative. In fact, consumables sales increased about 17 percent year-on-year, excluding the five largest academic genome labs and Celera Genomics. A bright spot in the consumables story was a significant increase in shipments of TaqMan probes and associated primers for use on our SDS systems.

In terms of spending trends by customer type, in the second quarter most of our global pharmaceutical customers continued to purchase equipment and consumables at reasonably healthy levels compared to the previous year. On the other hand, some of our smaller biotechnology and genomics customers appear, as they have in previous quarters, to be slowing their investments in infrastructure relative to the previous year. This could be seen most clearly in U.S. sales, which lagged those in the rest of the world in growth during the quarter. The absence of an approved National Institutes of Health fiscal 2002 budget during Applied Biosystems's entire second fiscal quarter appears to have restrained purchases by government labs and academic centers, although purchases by certain government labs increased due to special appropriations for various research initiatives against bioterrorism. As Dennis Winger will discuss in a few moments, we expect the fact tha t the NIH budget for fiscal 2002 was signed into law on January 10, almost three and a half months into the government's fiscal year, may hurt Applied Biosystems' sales in our third quarter, due to the time it takes for new funds to be available to government labs and academic centers. Overall, however, we expect to see a positive impact from the 15 percent annual increase in funding for the National Institutes of Health.

As Tony mentioned in the press release, we and our customers are transitioning to a new era in biological research. After a few years when "Big Biology" projects such as the sequencing of the human genome dominated the headlines, the emphasis is changing from generating genomic information in a few large centers to applying that information to specific areas of biomedical research and discovery. This means that "Small Biology," the work done in thousands of individual labs, will once again play an increasingly important role.

Getting through this transition imposes a short-term cost that we are now paying in the form of uncharacteristically low growth. However, Applied Biosystems is well positioned for this evolution in our markets as we continue to invest heavily in R&D associated with new technologies and products. The recent introductions of our newest SDS systems and the 4700 Proteomics Analyzer with TOF/TOFTM Optics, as well as our new and forthcoming genomics assays for resequencing, gene expression, and SNP genotyping, are examples of the fruits of this R&D program that we expect to contribute to the sales growth recovery we expect later this year.

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

Tony White

Thanks Mike. Let me start out with a few comments regarding Tuesday's announcement and Craig Venter's future role in Celera. Applera's executive management team, the Board of Directors and Craig agreed that Craig can best serve Celera by stepping down as president and chief scientific officer and by serving as the chairman of Celera's scientific advisory board. Over the last three plus years, Craig has contributed leadership and scientific vision, leading to the sequencing of the human genome and other genomes, the creation of a rapidly growing online business, and most recently, to Celera's move into therapeutic discovery. He also created a culture based upon a high throughput, industrial approach to biology, with the view that speed matters. Clearly, this is a concept we want to preserve at Celera. To maximize the Group's success in therapeutics, we need leadership with substantial experience in drug discovery and development. I will serve as interim president of Celera while we move quickly to bring in that leadership and experience.

I would like to move forward and update you regarding Celera's therapeutic initiatives. We have made good progress integrating the Axys Pharmaceuticals organization. Recently we have made announcements regarding progress in our two leading therapeutic collaborations. Merck extended its osteoporosis drug discovery collaboration with Celera for a sixth year. We also announced an additional research milestone payment from Aventis as part of the Cathepsin S inhibitor collaboration between the companies. This milestone marks the selection of Celera Cathepsin S inhibitor compounds as Early Development Candidates for inflammation and autoimmune diseases. Both collaborations have the potential to lead to IND filings and clinical trials, which may generate additional milestone payments and eventually royalties for Celera.

Celera's goal is to use its expanded range of high throughput capabilities to establish a new paradigm in drug discovery based on the parallel identification and validation of therapeutic targets and candidate compounds. There are two drivers behind this approach. First, our business model is not to sell poorly validated targets to pharmaceutical and biotech companies which are awash in poorly characterized targets. We do not see this as a solid path to value creation. Secondly, we believe we can speed the discovery process and reduce process costs through approaches such as chemical annotation and structural proteomics. Toward that end, we recently announced new collaborations with Syrrx and Graffinity.

Proteomics has made progress over the last quarter, generating data that validates our approach. This approach focuses on identifying differentially expressed proteins with the greatest statistical significance and therapeutic promise.

We continue to evaluate collaborative therapeutic discovery opportunities, with the objective of moving our discoveries toward clinical trials and commercialization. We are considering our options to partner compounds targeted to factor viiA for thrombosis and cathepsin F for inflammation and autoimmune disease, and broader collaborations based on the application of our proteomics platform against specific disease areas.

Now I will turn to the online business. Celera's goal is to make this business profitable during fiscal 2002, while continuing to add content and functionality to the Celera Discovery System. Our assembled mouse genome, the quality of the annotation of the human and mouse genomes, and a growing list of third party data and tool providers are driving subscriber growth. We announced three new commercial customers, and added 30 new academic and institutional customers during the quarter, a 20 percent quarterly gain for this segment. The combination of more customers and lower costs has the online business on track toward profitability for this fiscal year.

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

Dennis Winger

First, let's discuss Applied Biosystems.

As we announced, Applied Biosystems earned 24 cents per diluted share, excluding a one cent per diluted share non-recurring charge for acquired in-process research and development related to the acquisition of Boston Probes, Inc. during the quarter. Earnings per share in the second quarter of fiscal 2001 were 25 cents per diluted share, excluding a gain of one cent per diluted share from the sale of investments.

Net income in the second quarter of fiscal 2002, excluding non-recurring items, was 51.2 million dollars compared to 56.0 million dollars in the comparable period last year. Foreign currency had a negligible impact on year-over-year comparisons of operations.

Gross margin in the second quarter was 52.2 percent, compared to 51.8 percent in the same period a year ago. The improvement in gross margin was due primarily to product mix and price increases in certain product lines. As we have previously said, we made a decision not to hold down R&D spending during this period of slow sales growth, and in the second quarter research, development, and engineering expenditures increased 26 percent. These investments supported a range of product development programs that we believe will enable Applied Biosystems to emerge from this sales slump in a strong position. Selling, general, and administrative expenses declined 1 percent from the prior year due to a focused effort to manage expenses.

Let me now address the business outlook for Applied Biosystems. In these uncertain times, forecasting is particularly difficult. For the third quarter of fiscal 2002 (March), sales currently are expected to be flat to slightly lower than in the comparable quarter a year ago. Several factors influence this outlook. One factor is the anticipated continuation of current trends in spending by certain commercial customers. A second factor is the expected currency effects stemming from year-to-year weakness in the Japanese yen and, to a lesser extent, the Euro. A third factor is the delays in the disbursement of U.S. government funds to federal laboratories and U.S. academic grantees following the late adoption of the FY 2002 National Institutes of Health's budget.

For the fourth quarter of fiscal 2002 (June), the Group expects sales growth of approximately 10 percent compared to a year ago. Higher year-on-year sales growth is expected in the first and second quarters of fiscal 2003 (September and December). Factors contributing to the expected higher growth rates starting in the fourth quarter of fiscal 2002 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.

We currently expect diluted earnings per share for fiscal 2002 to be in the range of 80 to 90 cents. The revised outlook on earnings per share is attributable to the Group's continued commitment to increase spending on new product development, as well as to lower sales expectations, including the impact from negative currency effects.

Research, development, and engineering expenditures are expected to increase, in percentage terms, in the mid to high teens during the balance of fiscal 2002 compared to the comparable period in the prior year. Research, development, and engineering expenses include the Applied Biosystems component of Applera's anticipated 75 million dollar fiscal 2002 investment in the Applera genomics initiative involving Celera Genomics and Celera Diagnostics. The initiative has recently been expanded to include gene validation and expression, which the Company believes will require approximately an additional 25 million dollar investment in fiscal 2003.

Now, I'd like to briefly review financial results for Celera Diagnostics, which I would like to remind you is a joint venture between Applied Biosystems and Celera Genomics. Celera Diagnostics' pre-tax loss for the quarter was 8.5 million dollars. Our expectation for pre-tax losses related to the Celera Diagnostics joint venture remain unchanged at 55 to 65 million dollars for fiscal 2002.

Now I will move on to Celera Genomics. During the recently completed quarter, revenues for Celera were 35.0 million dollars, 72 percent higher than the same quarter a year ago. The increase in revenues was partially the result of a temporary increase in service and grant revenue. Recall that in our last quarterly release, we forecasted that the allocation of a larger portion of our sequencing capacity toward revenue generating customer commitments, such as the rat genome, would shift the timing of 4 to 6 million dollars of revenue to the second quarter from the fiscal third quarter, and to a lesser extent, from the first quarter. Our outlook for fiscal year revenue growth remains unchanged in the 40 to 50 percent range.

Included in this quarter's results is a 99 million dollar, non-cash, non-recurring charge for acquired in-process R&D from Axys. Excluding this special charge, Celera's net loss decreased to 18.9 million dollars, or 29 cents per share. This was primarily the result of higher revenues and lower R&D expenses and amortization. Our R&D expenses related to therapeutic discovery continue to increase, but this was more than offset by lower expenses associated with sequencing the human and mouse genomes, projects which are essentially complete. SG&A decreased slightly. Celera's results include a pre-tax loss of 8.5 million dollars from its interest in the Celera Diagnostics joint venture.

We have updated our full year R&D expenses outlook to a range of 140 to 150 million dollars. This revision reflects reductions within programs outside of therapeutic discovery. Over the remainder of the year, R&D expenses should increase, reflecting the impact of programs assumed from Axys, and Celera's share of the Applera genomics initiative previously discussed.

The Group again had SG&A expenses below the comparable quarter of last year, and our full year SG&A outlook continues to be in the range of last year's level of 58.3 million dollars.

As I mentioned, our expectation for pre-tax losses related to the Celera Diagnostics joint venture remain 55 to 65 million dollars.

Based on the expectations I have outlined, the most likely range for the Celera's fiscal 2002 net cash use remains between 155 and 170 million dollars. Most of the anticipated benefit of lower R&D expenses should be offset by retirement of debt assumed from Axys.

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.

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.