Infinity Pharmaceuticals Inc (INFI) 2002 Q2 法說會逐字稿

Good morning, and welcome, ladies and gentlemen, to the Discovery Partners International second-quarter 2002 financial results conference call. At this time, I'd like to inform you that this conference is being recorded for rebroadcast, and all participants are in a listen-only mode.

At the request of the company, we will open up the conference for questions and answers following the presentation. I would now like to turn the conference over to Mr. Riccardo Pigliucci, chairman and CEO of Discovery Partners International. Please go ahead, sir.

Thank you. Good morning. I'm Riccardo Pigliucci, chairman and chief executive officer of Discovery Partners International, and I would like to welcome you to Discovery Partners' second-quarter 2002 financial results conference call. With me today is Craig Kussman, chief financial officer of Discovery Partners.

During this call, we plan to review the results of the quarter and the six months ended June 30, 2002, and the guidance for the remainder of the year. As you know, I'm obliged to remind you to consider the following safe harbor statement regarding forward-looking statements.

Statements in this conference call that are not strictly historical are forward-looking statements within the meaning of the private Securities Litigation Reform Act of 1995 and involve a high degree of risks of uncertainties. The company's actual results may differ materially from those projected in the forward-looking statements due to the risks and uncertainties that exist in the company's operation, development efforts, and business environment, including integration of our core businesses, a trend towards consolidation of the pharmaceutical industry, [inaudible] sales [inaudible] technological advances by competitors, and other risks and uncertainties more fully described in the company's annual report on form 10-K for the year ended December 31st, 2001, as filed with the Securities and Exchange Commission and other SEC filings.

In addition, this conference call is publicly available by a live webcast on Discovery Partners International's website at www.discovery Partners.com. This call is the property of Discovery Partners and any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Discovery Partners is strictly prohibited.

Before Craig begins with the financial overview of the quarter, I would like to put into context our decision announced this morning to reserve access to our proprietary chemistry compound and capabilities, exclusively to companies entering into integrated [inaudible] discovery, chemistry or screening [inaudible] with us. And to exit the non-exclusive chemical compound supply market.

This decision comes as a result of significant shifts in the marketplace and it is motivated by our desire to preserve the value of our proprietary chemistry, and to leverage our other assets in biology and computational chemistry.

Over the past several months, the markets for [inaudible] compounds has been changing rapidly and moving whale from large diversity based library of non-purified compounds to highly purified and target-specific chemical compound collections. Our historical business model developed chemistry and then sell [inaudible] libraries has become too unpredictable and unprofitable at the prices expected in the market and has been a major contributor to our shortfall in revenues this quarter. We had, in fact, only received orders for and shipped less than 15% of the approximately $2.5 million expected revenues for non-exclusive compounds for the first half of 2002. As you may recall, at the beginning of this quarter, we did communicate our concern of lower than expected backlog. Now, the main reason at that time was the lack of [inaudible] commitment to this portion of our operation. Now, after [inaudible] we have refuse reevaluated the fundamentals of this business and we have concluded that Discovery Partners would derive much higher strategic [inaudible] access chemistry intellectual property with the rest of the [inaudible] platform, rather than making it available to the [inaudible] compound. Our strategy of making our chemistry available exclusively to companies entering into specific collaboration with us in chemistry [inaudible] chemistry we leverage our strength and integrated capability and greatly increase the value we can expect to receive in the form of future milestones [inaudible].

Our revenue stream should become more predictable and we will be reducing the amount of R and D investment and inventory assets at risk. We already brought off in Q3 2001 most of our [inaudible] compound inventory. Now we are recognizing the remaining amount for the [inaudible] compound. This provision for discontinued products is not [inaudible] different from that - from that which we taken in Q3 2001 had we decided to take this action at that time. Over the past nine months, our additions to inventory [inaudible] of the same order of magnitude as the inventory [inaudible]. This action will not result in any reduction in personnel, as all the people associated with this business have been or in the process of being transferred to revenue-generating contract R and D projects.

After Craig details the financial review, I will continue with more details on the operation's achievement in Q2, with an outlook for the remainder of the year, and then start with the Q and A session.

Now I will turn the call over to Craig Kussman, Discovery Partners' CFO, to discuss our financial performance.

Thanks, Riccardo, and good morning. Revenues for the second quarter ending June 30, 2002, were a disappointing $8.4 million, 24% below the second quarter of 2001. This figure was significantly below our own internal plan, as well as Wall Street estimates, due to: (a), the lack of compound sales from inventory which Riccardo has discussed; B. our inability to close some of the second-quarter revenue opportunities that we had in our pipeline in time to benefit the quarter; and (c) scientific issues ranging from delays in customers' assay development in biology to scale-up and production and verification of chemistry.

Gross margin as a percentage of revenues for the second quarter of 2002, excluding a $5.8 million provision for discontinued products, and a $1.5 million [inaudible] were [inaudible] from our decisions to keep offering non-exclusive compounds for sale was 25.4%, below the 50.3% gross margin for the second quarter of 2001.

This decrease is primarily due to the expected impact of the Pfizer collaboration, as well as unabsorbed biology capacity, and nonrecurring inefficiencies associated with ramping up our chemistry verification facility.

As mentioned in our last two quarterly conference calls, we anticipated offsetting impacts to cost of revenues and research and development expenditures as a result of the multiyear, multi-million dollar chemistry collaboration signed with Pfizer in the fourth quarter of 2001. In this collaboration, which began to ramp up during the first quarter, we shifted the risk of development of new chemical libraries over to Pfizer.

As a result, a significant amount of cost was historically classified as research and development and is now included in cost of revenue. As Riccardo discussed earlier, during the quarter we made the decision to cease offering compounds out of inventory for sale to customers so that we may better exploit their value as part of future collaborations with our business partners. As a result of this decision, the carrying value of our chemical compounds formerly held for sale has been reduced from $5.8 million to zero.

Unfortunately, due to remaining obligations under contractual arrangements, we cannot immediately cease manufacturing of these compounds, and therefore, we have accrued an estimated loss of $1.5 million related to fulfilling these obligations. Expenditures for research and development for the second quarter of 2002 were $1.9 million, 36% below the second quarter of 2001, due to the impact of the Pfizer collaboration.

Selling, general, and administrative expenses for the second quarter of 2002 were $3 million, up 12% over the second quarter of 2001, due to onetime costs associated with external consulting fees and additions to staff.

On January 1, 2002, we implemented the new FASB 141 and 142 accounting standards for business combinations and other intangible assets. Given the number and size of acquisitions Discovery Partners had completed prior to July of 2001, this accounting change has a significant impact on the company's P and L in 2002 and beyond.

In the second quarter of 2002, Discovery Partners reported zero amortization of goodwill expense compared to $1.5 million in the second quarter of 2001. We have completed our goodwill impairment testing process in connection with our adoption of FAS 142, and have determined that our goodwill was not impaired as of year end 2001.

The company ended the quarter with a net loss of $9.7 million, or 40 cents per share, compared to a net loss of $0.9 million or 4 cents per share in the second quarter of 2001.

Our cash and short-term investment balance remains healthy at $74.1 million, down $3.1 million from our cash balance at year end, primarily due to a $2 million prepayment of royalties to Abbott in connection with our [microarch] technology. Cash flow from operations for the second quarter of 2002 was negative 0.5 million. Excluding a 0.8 million impact of changes in foreign exchange rates on our intercompany balances, cash flow from operations was a positive 0.3 million.

Let me conclude with the financial guidance for the remainder of 2002.

Consistent with 2001, our plans for 2002 had anticipated that the sale of compounds from inventory, excluding preexisting contracts, would range from 8 to 10% of our total revenues. Due to our decision to exit this product line, this figure for the second half will now be immaterial, and in the very short term, it is unlikely that it will be replaced by increased collaboration business.

As a result of this, and other market softness, we now expect the 2002 full-year revenue growth will range between 2 and 10% over the 2001 reported revenue.

Excluding non-exclusive chemical compound sales from inventory from both years, we expect our adjusted revenue growth rate to range between 8 and 15%. These estimates and those that follow do not include any scientific risk that may impact our ability to deliver against our shippable backlog of projects.

For the third quarter, we expect revenue to range from $11.5 million to $12.5 million, and EPS to be between minus 4 cents per share and minus 1 cent per share.

For the fourth quarter, we expect revenue to range from $12 million to $14 million, and EPS to be between 1 cent per share and 7 cents per share.

We expect our gross margin as a percentage of revenues will range between 29% and 32% in the third quarter, and between 31% and 40% in the fourth quarter, which is above Q2 results, in line with our plans, and below our historical levels, due to our continued shift away from a product model towards a collaborations model.

As for R and D, we expect this to be [inaudible] or below 11% of revenues for each of the third and fourth quarters, also below historical levels due to the same phenomenon.

We expect that SG and A will increase somewhat during the third quarter, as a result of increased costs associated with relocation and recruiting expenses to increase our head count to handle the additional volume.

SG and A should return to first-half 2002 levels during the fourth quarter.

We expect that our cash position will remain at or above current levels, excluding minor fluctuations in working capital, the impact of acquisitions, if any, and, of course, any share repurchases under the company's stock repurchase program.

We expect that the recent weakness on the U.S. dollar to have an impact on the cost of our Swiss operation but minimal impacts on our revenues as the large majority of our business is transacted in U.S. dollars.

Now, let me ask Riccardo to review the operations for Q2 and the key milestones for the remainder of the year.

Thank you, Craig. As you just heard, Q2 has been a very challenging one with a variety of developments, some positive, some disappointing.

Starting on the positive side, on July 9th, we announced the appointment of Taylor Crouch position of president and chief operating officer. Taylor, previously [inaudible] brings to DPI over 20 years of experience in the pharmaceutical industry, having held significant positions at [inaudible]. We are delighted to have him join our management team. With Taylor focused on the [inaudible] I plan to invest more time in exploring opportunity for additional expansion through acquisitions, technology licensing, and strategic alliances.

A second major achievement in Q2 has been the completion of the R and D phase of the macro-arch program, the [inaudible] screening technology developed by Abbott. During the past 18 months, we have successfully transformed this technology into a robust platform that can be easily used by any good discovery operation. We have re-engineered the instrumentation to prepare the high-density compound [inaudible], develop proprietary algorithms to detect real positive hits and weed out the false ones. We have reformatted biological assay in preparation for new collaboration, and we have prepared and submitted scientific papers [inaudible] at various symposia, including the upcoming [inaudible] meeting in Boston in August, demonstrating the quality of the results that can be achieved.

Finally, we have started to promote [inaudible] services as well as technology transfer to pharmaceutical companies. So far, we are very encouraged by the response to our marketing efforts. The advent of this revolutionary assay format is another contributing reason for our decision to exit the compound supply business, as we feel that coupling our proprietary chemistry with the proprietary [microarch] technology will substantially increase the value and uniqueness of our discovery platform. During the second quarter, we started fulfilling our obligation both the Pfizer and the Merck contracts.

[Inaudible] some unexpected setbacks. We already described the impact on non-exclusive [inaudible] business. In the first half, the shortfall in just this business versus our revenue plans accounted for over $2 million. In addition, we encountered a variety of scientific challenges that resulted in either the postponement of revenue recognition or in the decrease of recognized profit margin.

The cost associated with ramping up our [inaudible] operation was a major contributing factor to our margin shortfall. In biology, we divested [inaudible] personnel to the [inaudible] and we suffered from delays in obtaining assay material from some of our collaborators. This, of course, impacted both revenues and expenses.

As Craig already mentioned, these issues have lowered our margin below an acceptable level. We expect most of the chemistry scale-up problems to be behind us, and efficiency in our biology operation to be restored with higher backlog.

You do not need my assessment or the general business in the pharmaceutical or [inaudible] are slower. People are [inaudible] every project and [inaudible] further delay. We expect the recently announced merger between Pfizer, our largest customer this year, and Pharmacia, to have a very good long-term implication for DPI, given an excellent relationship with Pfizer, and as they become stronger, they can only benefit. In the short term, however, as usual, the uncertainty that [inaudible] only creates apprehensions. In this environment, any projection of future performance has to be taken with appropriate caution. We are proceeding very judiciously to curve our cash and as demonstrated by our actions in Q2, to reassess or exit any business that does not show the proper returns or that increases our risk profile.

As much as Q2 has been disappointing, we feel we are in a much better position today than 90 days ago. Our management team is stronger. The financial infrastructure that Craig has been building in the past eight months is [inaudible] helping us to better manage and evaluate our business. Our shippable backlog for Q3 is over 45% higher than in the same time in Q2, and many of the [inaudible] problems in our chemistry [inaudible] have been identified and tackled. We certainly had a difficult quarter, but we feel that the company has a customer base, the people, and the resources to [inaudible] profitable for the end of the year. This concludes the first part of our conference call. I am available to answer questions at this time, and we urge investors and analysts to ask any and all questions, as we will not be responding to individual calls on questions regarding our positions, financial results, or financial guidance following the conclusion of this 00:21:13 conference call. Operator?

Thank you, gentlemen. The question and answer session will begin at this time. If you're using a speakerphone, please pick up the handset before pressing any numbers.

Should you have a question, please press star 1 on your push-button telephone. If you'd like to withdraw your question, please press star 3. Your questions will be taken in the order they are received. Please stand by for your first question.

Our first question comes from Ian Gilson. Please state your affiliation followed by your question.

This is Ian Gilson, my friend. I have one question on the second quarter, and one - I have a technical question regarding your comments about the conference call being a property of DPI, so I'll get the hypothetical question out of the way first. And then I'll ask my question on the operation.

So Riccardo, as an author of research reports, may I quote the comments made in this conference call, and in your press releases without requesting permission beforehand, or am I required to submit to you for your comments after the fact?

No, I think you can quote provided with attribution that it was my comment on the conference call. I don't see any problem with that.

Fine. Okay. Now, with regard the margins in the second quarter, I'm admittedly confused here. Did that include losses on the library revenue or does the 1.5 million only impact the future quarters? Will any revenue be recognized on the sale of library products in the future or do you take that down to zero? In other words, it's now a discontinued operation.

Let me - let me see. There are two pieces of the issue. The 1.5 million regards the extra costs that we are going to be incurring to fulfill certain contracts that have - are non-- that are compounds that we still have on the books. So we will record revenues for those contracts, but with no margin. That's the answer to your question. But we will not record any more revenue for any other sales of compounds because we are not - we will not be promoting any more compound sales.

Okay. The development of assays, was this on the regular business and the [inaudible] operation -

Uh-huh.

- and have we now developed the required assays for the Pfizer account, which I believe generates revenues starting in the current quarter?

The Pfizer account is only on the chemistry side, and there is no implication in [inaudible] on the assay development for the Pfizer contract per se, so the Pfizer contract is on target and will start generating revenues in terms of shipment of chemistry in Q3 and in Q4.

The mention as I had made before about assay development was not related to Pfizer. It was other contracts whereby our customer had a problem sending to us the proteins that we required for running the assay. But that's - is a separate contract, not the Pfizer one.

Okay. And the [microarch] business is currently sort of internal in the sense that you offer it as an availability within contracts. When do you schedule that as a product for sale and are those library cards part of the street's continued assumptions in the fact that you're no longer selling proprietary libraries?

Okay. Let me take it one at a time. First of all, the situation with the [microarch], you're correct, it is available currently with a series of assay that our customers can access and a series of compounds for those assays that we put on [inaudible] cards.

Also, already we are discussing with large pharmas about potential technology transfer of these technology to them, so we already started the marketing of the [microarch] to individual pharma companies and they are starting to set up evaluation plans and so on.

Regarding the compounds themselves, obviously the compounds - the business that we're talking about is one of selling certain amount of micromoles or milligrams of compound to customers. We are no longer in that business, but we will continue to be in the business of providing those compounds in other forms. Like, for instance, in the [microarch] as part of a total package, a total solution or platform for discovery, both internally and as a solution for biotechnology companies.

Okay. Finally, on the NanoKan and the pre-NanoKan business, what you might call the capital spending side, how do we stand there? Is that effort still going on, and are the existing NanoKan plans that you have out in the hands of customers generating any disposable revenue.

Yes. The situation with the IRORI business is that the disposable part actually is going very well, and is generating, according to our plan, both for the MicroKan business as well as the NanoKan, as well as the people that are using the NanoKan here in our facility in San Diego.

On the capital spending side, there is a - the normal business, a little bit tougher than usual, like anybody else in the capital business, on the instrumentation side for IRORI but nothing drastic. The more disappointing area is the sale of large can on can systems. Even the current capital environment, really there is no credible expectation to sell NanoKan in the foreseeable future.

But you are still continuing the development of that system? I presume it does - does have opportunity for enhanced performance.

Sure. We're using it internally ourselves, and we are listening to people like [inaudible] and Aventis, whatever improvement they're looking for, and we're working with them. We're not putting an extraordinary amount of R and D into it pending seeing what the capital market is doing in terms of - the capital equipment market is doing.

Okay. Fine. Thank you.

Thank you. Our next question comes from Eric Miller. Please state your affiliation followed by your question.

Yes. Eric Miller. Actually, it's Bill [Mascovitz], Heartland funds.

Good morning. Riccardo, I appreciate all the comments here on the quarter, really it's been, I think, six disappointing quarters in a row here in terms of, you know, profitability trends and sales trends, and it's sort of getting long in tooth, long of tooth, and could you please, you know, tell your, you know, long and patient shareholders here on this call when we can expect profitability? I think that's a reasonable question. You've been public now for I think two years, haven't you? Two years plus or something like that?

When do you expect to be profitable? When can we start to see a return on our valuable shareholders' investment?

As I believe Craig mentioned in his comments, we expect positive EPS in Q4.

In Q4.

Yes.

And you expect all of next year to be profitable as well?

Well, we have not a specific bottom-up plan at this time for next year, but it is usual practice once you turn to profitability, you try to stay there. So, I mean, again, it's too early in the fiscal year to have a specific quarter-by-quarter bottom-up plan for 2003, but obviously the norm is once you turn the corner, you try to stay on the positive side.

Okay. Thank you.

You're welcome.

Thank you. Our next question comes from Margot [Durow]. Please state your affiliation followed by your question.

SWS Securities. A couple questions. Craig, first of all, with regard to SG and A, did I understand you correctly to say that in the third quarter, SG and A will be going up because of reallocation - relocation expenses, but in the fourth quarter, maybe it will come down below 3 million?

It should come down to roughly the 3 million level, which is about where it's been for the first half.

By the fourth quarter?

Correct.

But in the third quarter, it will be quite a bit higher, then in.

Yes.

I mean are we talking something like 3-and-a-half or 4 million in the third quarter.

Probably the bottom range of that I think would be a - a [inaudible] estimate.

Okay. Three-and-a-half. All right. With the - Riccardo, I was writing as fast as I could write, and I'm afraid I missed a few things.

You referred in your - in the press release to technical problems associated with assay development, and then I think you said in response to another question that a customer was having trouble shipping the target to you.

That's correct.

Could you be more - was that the - was that it? Was - he could not get the target to you for whatever reason?

Correct. I mean they had some problems themselves and they try to [inaudible] target for us to develop the assay, and that's something that unfortunately happens in biology sometimes, and it is all fine in a 10-year [inaudible] for a customer but obviously it's a big deal for us when we expected to have revenues this quarter for it.

All right. So the - the problems with - as far as the biology operation goes really was the customer's problem, not yours?

Yeah. At the end, unfortunately [inaudible] with it.

Right. Now, what is the scale-up problem with the chemistry operation? Can you explain what that issue was?

Yes. In the case of both Pfizer and Merck, we have to deliver a substantial amount more in absolute milligrams of compounds at a specific purity level with a certain very clear specification, and in order to do that, we have to process much - many, many more compounds and a much higher quantity and as such, we had to scale up what we historically had been doing for ourselves or for our [inaudible] customers. So like in any process, the first time you fire it up, you have startup problems. The level of the yield, which means either the quantity coming out or the process of purification or the number of compounds that make the cut both in terms of purity and weight, was a little bit below our expectation, so we know what the problems are now, we fixed them and we can scale up again, and reach the amount that we need in order to fulfill our obligation to Pfizer in the third quarter and in the fourth quarter. So those are the - the issues, so basically we've put in - we lost more [inaudible] than we would have expected and therefore, that [inaudible] cost of sale.

And in the third and fourth quarter, Craig you mentioned the fact that revenues in the third quarter would be about 11 and a half to 12 and a half million and [inaudible] so should I assume that the incremental sequential gain in revenue is going to come almost entirely from the Pfizer contract?

I think that's a fair assumption.

Okay. What are we talking, in terms of the Pfizer contribution next year to total revenue? Is it - what are we talking about, roughly, in terms of revenue contribution next year for Pfizer?

I would say on an ongoing rate, I would expect the Pfizer to be within 30 and 40% of our business.

Next year? Okay.

That's just an estimate. As I said before, I don't have a bottom-up plan yet for next year, but that's the order of magnitude that we would expect.

Thank you.

You're welcome.

Thank you. Our next question comes from Rodney Hathaway. Please state your affiliation followed by your question.

Heartland Advisors. Just first thing, a clarification on the accrual you did for the discontinued contract business. Was that 1-and-a-half million? You said for revenues? Anticipated to lose over the next six months?

No. It's an accrual for the anticipated loss on the remaining contracts that we have yet to fulfill. We expect about rough - in the order of magnitude, about two million of revenue to come from those contracts, and we expect about a million-and-a-half more in costs in order to fulfill those contracts, and therefore, we've accrued as the million-and-a-half dollar loss. So what we'd be showing, likely, over the next 12 months, would be this $2 million figure over the next four quarters, with no margin on it.

Okay. And will that be pretty much a cash loss?

Yes.

Okay. Back to your revenue guidance for the back half of this year, the, you know, 11-and-a-half to 12-and-a-half million in the third quarter and the 12 to 14 in the fourth quarter, can you give us an idea of how much of that revenue is under contract and has pretty good visibility and how much of that guidance is still in business you have to go out and win?

The majority of it is under contract. I will say that for the third quarter, about 90% of that revenue is in backlog, and for the fourth quarter, roughly 80% of that is in backlog.

And is any of that guidance budgeting in revenue per [microarch]?

No. What we have done, again, to stay on the safe side, we have assumed that we will be getting [microarch] revenue but we have taken down our assumption of new revenue from biology, from other [inaudible] contract. In other words, we have assumed that our customers will be the first to adopt the [microarch] and switch contracts from what they're doing today to the [microarch], so there will be no absolute increase in revenues. But that is the most conservative way I can forecast it.

So it will be a wash on revenues with your initial release? How about operating income?

It's difficult to say when you're launching anything, so I've not made any assumption of additional operating income because of it. There might be, but I haven't made any specific assumption in the number we've given you.

Can you give us a sense for - for next year what kind of impact [microarch] might have as far as a percentage of your business? 5%? 10%?

I would love to give you a number, and I will say I would be in a much better shape to give you visibility [inaudible] at the end of Q3 [inaudible] of promoting the product and running it and everything else, and also we will have a more detailed budget and look for the rest of - for 2003. So I really rather be conservative at this point and give you a number that then I have to change.

Okay. Thanks.

Thank you. Our next question comes from Ralph [inaudible]. Please state your affiliation followed by your question.

Pacific venture group. I have a couple of questions, Riccardo. The press release speaks to the fact that in the second quarter, discovery has concluded a collaboration agreements with several companies. I'm not - I have not received any announcements of that. Are - what specifically did we close in the second quarter, and what is the significance of those contracts?

We closed - we continue to close contracts all the time. Not always we send out a press release. We try to send out press release on two occasions. (a) they are significant, meaning over a million dollars type of collaborations; and (b) if the customer allows us to do it. Several customers, and especially Japanese customers not necessarily want us to publicize that they give us new business and there are several of those that have done that, and also a couple of European large pharma companies giving us some new business. But I have not send press releases out, you're correct.

But collaborations, you know, definition are different than routines. Let me ask this. Were there any significant, you know, over a million, large collaborations that were entered into in the second quarter with customers who requested that you not announce them.

There was no over a million dollar collaboration. There was no request that it not be announced.

So you had several small collaborations.

Right.

The second question is - I think we're all trying to get some hair on some - some specifics on [microarch]. It's been - you know, much has been made in prior quarters. Are there any metrics at all you can give us on a current basis to indicate, you know, how the introduction has gone to date? You know, anything specific?

Well, we have done [inaudible] for a second because everybody says my God, this thing is late and it takes a long time.

Normally, a project of this magnitude in a company that develop a new technology will take between 3 to 4 years of R and D. You've been exposed to this from day one, when we took the project from Abbott 18 months ago. And at that point, it was what in the jargon of a technology development company you would call a phase 0 [inaudible] or a feasibility. In other words, they're using it internally but it is not a commercial product. What you've been witnessing over the last 18 months is basically all realtime, the progress of the technology through R and D, and to do a project of that magnitude in 18 months has been an achievement. So I'm not - I want to make sure that people understand that this is not something that's going to wrong and my God, it's not coming out yet. So it's actually happened in 18 months, which is pretty good given the technological hurdle that we had to go through to make this a robust technology. Over the past six months, the majority of the work has been actually in biology rather than in the mechanical side or the [inaudible] side. And we've been extremely careful in repeating as, comparing assay done on [microarch] to work diagnosis done on MicroPlate, comparing our results of what Abbott was obtaining [inaudible] running thousands and thousands of compounds blindly by different people in different places to see that the results, indeed, are the same. All of that has been done and we've been extremely pleased with the results that we obtained.

Now, these are the results that we are showing our potential collaborators, and as potential collaborators, we are talking about, obviously, the top big pharma. We're talking to our key customers, and I don't want to mention any names until, obviously, I have something in my pocket that I can talk about, but I can tell you that all of our top customers have been exposed to the results that we can obtain and are being shown what we can achieve with [microarch] and all have been extremely impress the. Now, from there to get an order, it takes more time. It takes, obviously, people to try and to give us their own compounds, their own assay, to see how we can do, and give us a project. And that's where we are at the present time. We are in a situation where we are individually discussing plans for large pharma to test the technology by using their own - their own assay, as well as on a routine way for our current customers to be turned over to - to the [microarch] format, being convinced that they're going to get the same results they would have got otherwise.

Thanks. Let me get one question back into the collaboration. We've not had anything significant in the second quarter. We - the near-term guidance is almost exclusively Pfizer and a couple of older collaborations. Is there any - what do you see as the near term, next couple of quarters, for new significant collaborations that might benefit the growth in the future?

We have closed some business. I mean, our backlog at the end of Q - [inaudible] time versus three months ago is a couple of million dollars higher, so two or three million dollars higher, so as such, we have increased the backlog, so we're getting business. It's not that we are not getting business.

It is difficult to get business, especially in one sector of the business, which is the biotechnology world. As you well know, you see many announcements sometimes of collaboration. Unfortunately I'm an old fashioned guy. I only get the deal if I can pay for it. And there's a lot of collaboration in this industry [inaudible] to burn rate with future royalty and future milestones only as the only form of payment. We are not doing that. We want to get paid for our work, and that sometimes means turning back some business or turning down some business, and I'm [inaudible] company's size and growth rate the way that I can make money and I'm determined to do so and I intend to do so and I'm not going to change half the way through by saying now I'm going to do collaboration so I can hide my unobserved inefficiency as R and D cost.

Thank you.

Thank you. Our next question comes from Karen Roz Brenner. Please state your affiliation followed by your question.

Hi. I'm with shaker investments. I realize you don't have specific guidance for 2003 but can you give us any sort of guidelines of what you're thinking for revenues and bottom line?

I rather not give you any specific numbers. We have announced in the past an overall goal of a growth rate on the 15 to 20%. If you look at the growth rate that we actually going to be achieving on a comparable base this year, it has been - which we said before has been 8 and 15%. If you take out from both years the effects of the discontinued [inaudible] business. So the order of magnitude that we - that we would expect for next year is on the order of 20%. That's what we would aim for.

This is not a guidance. I want to make sure people understand that. It's what we are - we would be - in our planning session, we will be aiming at.

Does it - does your current visibility into 2003 make it look like these numbers - those 15 to 20% is achievable?

Well, we have the full - the Pfizer contract will be running at full steam. The Merck contract will be running at full steam. There is a lot of stuff in the pipeline, and that's what we would like to get to, and I would expect [inaudible] visibility at the same time last year we were in a heck of a better position this year than we were last year.

Okay. Thank you.

Thank you. Our next question comes from Iris Francesconi. Please state your affiliation followed by your question.

Hi. It's UBS Warburg. I'm still trying to understand a little bit that shift in strategy whereas on one hand, you're saying you're discontinuing the library, the non-exclusive library business. On the other hand, you're saying you're using those libraries and basically now offering these same libraries on an exclusive basis to customers, and I'm not exactly sure how that would change the interest in the compounds as they seem to stay the same.

My second question is, with regard to the scale-up problem, I'm still trying to figure out [inaudible] synthesis process or in the pure indication? I think I've heard both. And on the synthesis side, is that related - should it be on the synthesis side, is that related to basic the NanoKan technology really being made for like the highest [inaudible] but not really for scale-up.

And thirdly, my question is a financial one with regards to the R and D. I had actually anticipated that after you were basically going to shift the R and D costs into cost of goods sold, you would have a drop in R and D. Now, that has obviously not occurred, so where does the extra R and D come from?

Okay. Let me get them one at a time. Let's start from the - the scale-up or the purification. The problem was on the purification side another synthesis related problem and has nothing to do with the NanoKan or MicroKan technology. It's simply the amount of material. As you know, when you go from an analytical environment for purification to a much larger quantity, that you have to purify, there are - [inaudible] issues, there are scale-up issues. It always happens and that's basically what happens to us as well. So it's a purification issue which is not totally unexpected, so it's not a question of how much yield we got out of it. So it's nothing to do with the synthesis, only the purification side.

On the compound business, what we have done historically with the compound business has been to develop spending R and D money ourselves and then use the R and D money, develop libraries, and sell them then to a restricted amount of people without any - anything coming back for us later on. I mean, in other words we sold so many milligrams of compounds to company A, B, and C and that was it. We also retained internally the ability to use it ourselves for screening or for - or for whatever other application we wanted to.

The way you're selling this compounds has been one of well, we have a library and we go out and the people like the compound or they don't like the compound, but it's a choice after the fact. So after people have already looked at what compounds they have.

What we intend to do going forward is to use those libraries ourselves and the chemistry that we can have ourselves in order to develop [inaudible] assays and decide which compound we are going to use for a particular assay, but we make that decision rather than leave that decision uniquely to the - to the customer buying compounds.

We will basically use our overall libraries that we have unencumbered by somebody else using it, and therefore, being able to ask for more value in terms of the price for a hit or for a lead or for something going forward, so we'll be able to get much higher potential royalties or milestones on the compound that are not being used by anybody else, so the compounds are just exclusive to us.

Finally, on the financial in R and D, what you see on the R and D line today, after the first half, is also some R and D expenses related to developing those compounds. Those will go down. They will be disappearing as of Q3. You will not see them anymore. Other things that appear on the R and D line is R and D for - for [microarch], for development of assays, as well as R and D on the IRORI side, on the instrumentation side, for some new technologies which we have not announced that we are in the process of developing that we'll be launching towards the end of the year.

Okay. Now, one follow-up question. If you're not shifting basically your sales strategy to offering, I guess, the compounds as part of an overall service package, what impact is that going to have on the sales cycle? And how long - you know, how many lengthening do you expect from the currently already fairly long, I guess, sales cycle?

I would say - I mean, let me put it this way: The compound, it was one of our short-term valuables, one of those that at the beginning of the quarter is a percentage of unknown on pipeline. Had it been predictable, there would have been no problem. Unfortunately, it came in lumps, totally unpredictable and under incredible price pressure, and the reality is that I'd rather not have - I'd rather have maybe a longer sales cycle but much more predictability than what I've been having in the past.

So the sales cycle is the going to be the one of collaborations rather than the one of product sale. But even now, selling compound has been on the order of, you know, from the first time you meet somebody to the time you get an order, probably be three to six months anyway.

Okay. Thank you.

Thank you. Our next question comes once again from Margot due row. Please restate your affiliation followed by your question.

SWS Securities. Craig, can you give us the depreciation and amortization amount for the quarter? And Riccardo, I had more gotten to ask you the first time. This customer that had a problem with the target, shipping the target to you, do you still expect them to do that? I mean, is this still a customer that you're planning on working with?

Yeah. Let me answer that one very quickly. Actually, they are doing the assay development now.

Okay.

And the answer to the D and A question was, we had 1,438,000 of depreciation and amortization, and then we also had $174,000 on amortization of deferred compensation.

Thank you.

You're welcome.

If there are any further questions at this time, please press star 1 on your push-button telephone.

If there are no further questions, I will turn the conference back to Mr. Pigliucci to conclude.

I'd like to thank all of you for participating to the call. I know it's been a tough quarter, but we're looking forward to talking to you again in the next 90 days, results of Q3 [inaudible] what we've seen so far, and by popular request, some guidance for 2003. Thank you very much.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-800-428-6051 or 973-709-2089 with an ID number much 251436. This concludes our conference call for today. Thank you all for participating and have a wonderful day. All parties may now 00:53:29 disconnect.