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Applera Corporation Teleconference October 24, 2001 First Quarter Fiscal 2002 Earnings Call

- October 24, 2001

Peter Dworkin

Good morning and thank you for joining Applera Corporation management to discuss the first quarter fiscal 2002 financial results that were issued earlier this morning.

Present today are Tony White, CEO of Applera; Dennis Winger, Applera's Chief Financial Officer; Mike Hunkapiller, president of Applied Biosystems; Craig Venter, president and chief scientific officer of Celera Genomics; and Kathy Ordoņez, president of Celera Diagnostics.

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 today and in Applera's filings with the Securities & Exchange Commission.

Mike Hunkapiller will begin by commenting on the recent performance of Applied Biosystems. Craig Venter will then review the first fiscal quarter for Celera Genomics. Then Dennis Winger will discuss the financial performance and outlook for both businesses. Please note that the text of these prepared remarks will be posted on the Investor Relations section of the Applera web site during this call.

Mike Hunkapiller

Revenues from instruments fell 12 percent in the first quarter, the second consecutive quarter of declining instrument revenues. We continue to attribute this decline to tough comparisons against calendar 2000 when large publicly funded sequencing labs and commercial genomics customers were expanding or equipping their genome factories.

One of the standout performers during the first quarter was the 3100 Genetic Analyzer. Our newest electrophoresis system, the 3100 was launched in April 2000. Sales of the 3100 increased 75 percent in the first quarter of fiscal 2002 compared to the same quarter last year. This versatile system has 16 capillaries instead of the 96 capillaries in the 3700. As we expected, the 3100 is proving popular with manyclasses of customers -- basic research labs, pharmaceutical and biotech customers, forensic labs, and diagnostic labs. The reason is that the 3100 supports many research applications, from DNA sequencing to SNP discovery, validation, and screening as well as forensics and diagnostics. The instrument gives long read lengths, does highly accurate base calling, and can easily be switched from one application to another.

Another very strong performer was the new API 4000 mass spectrometer for the drug metabolism and pharmacokinetics market. Led by the 4000, revenues from our two high-performance triple-quadrupole mass spectrometers, the 4000 and the 3000, increased approximately 80 percent in the first quarter year-over-year. The 4000 began shipping in limited quantities in the June quarter, and as we have said, we expect manufacturing to be at full production capacity for the 4000 during the current - that is, during the December - quarter. Customer interest in this instrument is high due to its superior sensitivity in detecting low levels of drug metabolites in preclinical and clinical studies.

Other product areas with revenue growth in excess of 20 percent were real-time PCR (Sequence Detection Systems) for gene expression and genotyping applications, DNA synthesis, forensics and paternity tests, and informatics.

Sales of consumables during the first quarter increased 20 percent and were up in all major categories of consumables. The solid growth in our consumables revenues signals that while some customers have reduced capital spending in recent months, the pace of experimentation across our broad customer base continues to rise.

Let me say a word about capital spending trends. Many biotech customers are being more cautious in the current environment about placing large equipment orders. Some pharmaceutical customers seem to be slower than usual to make capital spending decisions, perhaps due to the integration of recent mergers, the economy, or company-specific factors.

We expect that overall demand for instrumentation from commercial customers will continue to be somewhat soft for the December and March quarters, although wider adoption of unique new instruments like the API 4000 should continue. Longer-term, we believe the competitive advantages of our products and the imperatives of commercial R&D - the need for maximum efficiency and more success in drug discovery and development - will drive a return to higher rates of spending on productivity-enhancing research tools.

Some of the new products coming in calendar 2002 include the TOF/TOF mass spectrometer - which we expect will ship in the March quarter -- and the microarray system for high-throughput genotyping under development with Illumina. We are excited about both systems as they get closer to product launch.

This month we are commercializing the first product offering from the genomic assay product development program we announced in July. At the Genomic Sequencing and Analysis Conference (GSAC) tomorrow, Applied Biosystems will launch the Assays By Design' service. Assays By Design means we are ready to make customized, validated assays for SNP genotyping and gene expression studies for any human or non-human DNA sequence supplied by the customer. We already have orders from a pharmacogenomics customer, a large life science customer, and a service company.

In the coming months, we plan to roll out the next phases - the core phases -- of our program, called Assays on DemandTM. Applied Biosystems intends to develop and market validated assays to every gene and gene variant and to 200,000 SNPs distributed across the genome. "Validated" means we will test the assays and be confident that they work. We intend to build an inventory of these assays - hence the name Assays on Demand -- to provide rapid turnaround times to customers.

We believe Assays By Design and Assays On Demand will save customers the substantial time, money, and manual labor that they currently must invest to develop and validate home-brew assays. Our goal is to enable a new level of high-throughput, low-cost genotyping and gene-expression research. These assays run on our real-time PCR instruments - the 7700, the 7900, and a new lower-throughput instrument called the 7000 that was introduced in July.

Next, Craig Venter will review the quarter at Celera Genomics.

Craig Venter

Thanks Mike. Let me start out with a few comments regarding Celera's results for the quarter and the online business. We announced overall revenues for the quarter of 27.3 million dollars. Celera's goal is to make the online business profitable during fiscal 2002, while continuing to add content and functionality to the Celera Discovery System, the business's online platform and primary product. We announced several new commercial customers, including today's announcement regarding Genentech and Immusol, and we experienced a sharp 50 percent gain in the number of academic and institutional customers from the previous quarter. During the quarter we delivered through CDS the assembled and annotated mouse genome, along with an updated assembly of the human genome. Celera is the only source for an annotated mouse genome. The response to these additions has been very positive. The combination of more customers and lower costs has the online business on track toward profitability.

Our discovery strategy builds upon the online business, and provides Celera with a promising portfolio of future commercial opportunities. We are pleased with the progress we are making in building Celera's biopharmaceutical discovery capabilities, and our team is looking forward to the anticipated close of the Axys acquisition in mid-November, and the complementary capabilities it brings.

We have two approaches to therapeutic target identification-a gene based approach, and a disease specific approach. The first approach leverages the information we generated in the sequencing of the human genome. We have already identified some novel genes associated with protein families of interest to Celera, such as proteases. We anticipate that the project we announced July 24 to resequence the genes and regulatory regions of 40 to 50 individuals will reveal a larger number of genetic variations associated with disease; this is a likely source of additional candidate therapeutic targets and diagnostic markers derived from genomics.

Our disease specific approach to target identification is primarily based on differential protein expression analysis. We have established sources of biological samples associated with lung and pancreatic cancer, our first areas of therapeutic focus. The proteomics factory is in the initial stages of its production mode, with an increasing volume of biological samples in evaluation. We have had early success in the identification and quantification of differentially expressed proteins.

While we are applying significant resources to target identification and validation, we are increasing our focus on identifying therapeutic candidate compounds, including antibodies and cellular immunotherapies. Soon we expect to have small molecule discovery capabilities, acquired through the proposed acquisition of Axys.

Our biologics group is preparing to handle the anticipated volume of targets from proteomics. We are now producing a variety of immunogens and antigens--synthetic peptides, recombinant proteins and DNA plasmids--that we plan to use to produce antibodies against candidate targets identified through genomics and bioinformatics. These targets may be relevant in lung and pancreatic cancer. The objective of this work is two fold--validation of these proteins as potential targets for antibody and cellular immunotherapies, and preparation for future research utilizing antibodies to validate differential expression of proteins identified by Celera's platform technologies.

The capabilities we are building are based on high throughput processes and designed with scalability and our discovery goals in mind. Celera plans to move its first protein-based targets into screening against small molecule therapeutic candidates following the anticipated close of the proposed acquisition of Axys. Concurrently, we are evaluating a number of collaborative therapeutic discovery opportunities, with the objective of moving our discoveries toward clinical trials and commercialization.

The proposed acquisition of Axys is expected to accelerate Celera's goal of building value from unique programs in drug discovery and development. To support that strategy, we will continue to evolve our management organization. We anticipate adding individuals with strong pharmaceutical/biotechnology industry experience to our senior management team. At the same time, Peter Chambré, who has helped facilitate our evolution to a discovery business, is stepping down from his Chief Operating Officer position and is taking on a new role in the organization working with Tony White and myself to ensure an effective transition.

Now, I will turn it over to Dennis for a summary of the financial results.

Dennis Winger

First, let's discuss the first quarter financial performance of Applied Biosystems.

As we announced, revenues increased 1 percent to 367 million dollars. Revenues were affected by declining instrument sales, which were due primarily to year-to-year declines in 3700 shipments. September 11 caused an estimated 15 million dollars in lost revenue. We believe about half of that was instruments and half was consumables. Currency was also mildly negative during the first quarter.

Net income decreased 34 percent to 32.2 million dollars and 22 percent excluding a 12 million dollar pretax gain on the sale of investments in the prior year. Currency effects reduced net income by one cent per share.

Earnings per diluted share were 15 cents, 21 percent below last year's 19 cents. The 19 cent EPS from the first quarter of fiscal 2001 excludes a 3 cent gain on the sale of investments. The 15 cents in EPS was somewhat higher than expected and was primarily due to lower than expected selling, general, and administrative expenses.

Gross margin in the first quarter was 51.1 percent compared to 53.4 percent last year. The causes of the change in gross margin were primarily higher license fee income last year - which of course is very high margin - and product mix, especially the year-to-year drop in 3700 shipments.

Applied Biosystems continued to spend aggressively on research and development during the first quarter. R&D increased 13 percent to 52.3 million dollars. By contrast, SG&A increased only 2 percent, due to controls on discretionary expenses during this time of low sales growth as well as unanticipated reduced travel after September 11.

Before I address the outlook for Applied Biosystems, let me underscore what should be obvious - that the combination of a weak global economy and the uncertain political and military situation stemming from September 11th makes forecasting especially difficult today.

Absent further difficulties in the economy, the stock market, or the world situation, the Group's expectations for Applied Biosystems performance for the full fiscal year 2002 remain unchanged from the outlook given in the Group's July 26, 2001 earnings release. However, we believe we may see softness in the next two quarters relative to the outlook given three months ago.

Revenue: Year-to-year sales growth rates for the second and third quarters of fiscal 2002 are currently expected to be in the low to mid single digits, rising to double digits in the fourth fiscal quarter (June 2002) and accelerating in the second half of calendar 2002 toward the Group's annual target of 20 percent top-line growth. For fiscal 2002 overall, we continue to anticipate, as we did during our last quarterly earnings call, sales growth of approximately 7 to 9 percent assuming current currency rates remain unchanged.

Earnings: While we continue to expect diluted earnings per share for fiscal 2002 to be in the range of 95 cents to one dollar, recent events indicate it is likely to be toward the low end of this range. Our current forecasts indicate that diluted earnings per share will be flat versus prior year in the second and third quarters and attain substantially higher growth in the fourth quarter as better year-to-year comparisons and a ramp up in sales of newer products accelerate sales and profit performance.

Gross Margin: We expect gross margin to be in the range of 50 to 52 percent for the balance of fiscal 2002.

R&D: We anticipate that research and development expenditures will increase, in percentage terms, in the mid teens in fiscal 2002 over prior year levels and will approximate 12 percent of sales in fiscal 2002.

SG&A: Selling, general and administrative expenses are expected to rise somewhat more slowly than revenue during the full fiscal year 2002.

Capital Expenditures: Capital spending in fiscal 2002 is anticipated to be approximately 110 million dollars.

Before I get into details regarding Celera's results, I would like to bring your attention two changes in our financial reporting since our last conference call. As the Celera Genomics group's activities developed into a commercial business, costs for activities previously performed as R&D in fiscal 2000 have been appropriately reclassified as cost of sales during fiscal 2001. You can find a historical reclassification of cost of sales and R&D expenses in our 2001 annual report.

Secondly, Applera has adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets," and as a result, Celera no longer amortizes goodwill.

During the fiscal first quarter, revenues for Celera were 27.3 million dollars, 49 percent higher than the same quarter a year ago. In the current fiscal quarter, we plan to allocate a larger portion of our sequencing capacity toward revenue generating customer commitments such as the rat genome. This is expected to 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 recently completed quarter. The key takeaway is that our outlook for fiscal year revenue growth remains unchanged from last quarter's call-we still expect revenue growth in the 40 to 50 percent range.

Celera's net loss decreased 39% compared to the previous year to15.6 million dollars, or 25 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 whole genome sequencing. In the first quarter of fiscal 2001, R&D expenses included significant costs related to mouse genome sequencing. SG&A decreased slightly. Celera's results include a pretax loss of 9.4 million dollars from its interest in the Celera Diagnostics joint venture with Applied Biosystems.

We have updated the outlook to reflect the anticipated impact of the proposed Axys acquisition, based on an expected mid-November closing date. Note that Celera expects to issue approximately 5.5 million shares as a result of this transaction, based on today's Celera share price and the number of Axys shares outstanding.

Celera continues to expect a 40 to 50 percent increase in revenue in fiscal 2002.

Previously, we expected fiscal 2002 research and development expenses, adjusted for our reclassification of some R&D expenses to cost of sales, to be approximately 145 to 160 million dollars. Based on the expected impact of Axys, we are updating our full year R&D expenses outlook to 165 to 180 million dollars.

The Group had lower year over year SG&A expenses in the first quarter. Even with the acquisition, we expect only a modest increase in full year SG&A expenses compared to 2001 expenses of 58.3 million dollars.

Our expectation for pre-tax losses related to the Celera Diagnostics joint venture remain unchanged at 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 is between 155 and 170 million dollars. This outlook reflects the expected impact of lower interest rates on interest income, and approximately 11 million dollars in anticipated one time costs related to the Axys transaction.

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 take your questions.

Peter Dworkin

Thank you for participating in this call today. As I mentioned at the beginning of this call, management's remarks are now 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.