Infinity Pharmaceuticals Inc (INFI) 2003 Q4 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Discovery Partners International fourth quarter 2003 financial results conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the Company, we will open up the conference for questions and answers after the presentation. I will now turn the conference over to Mr. Riccardo Pigliucci, Chairman and CEO of Discovery Partners International. Please go ahead, sir.

Thank you and good morning. I am Riccardo Pigliucci, Chairman and Chief Executive Officer of Discovery Partners International, and I would like to welcome you to Discovery Partners fourth quarter 2003 financial results conference call. With me today is Craig Kussman, Chief Financial Officer of Discovery Partners. In this call, we plan to review the results of the quarter and the year ended December 31, 2003, and update the guidance for 2004.

As you know, I am obliged to remind you to consider the following Safe Harbor statements 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 they involve a high degree of risk and uncertainty. The Company's actual results may differ materially from those projected in those forward-looking statements due to risk and uncertainty that exist in the Company operation, our development efforts and our business environment, including the establishment of off-shore chemistry operations; our ability to establish and maintain collaboration, executive more profitable businesses and realize operating efficiency; our ability to achieve expected growth and earning per share in 2004; the integration of acquired business; and (indiscernible) towards consolidation of the pharmaceutical industry; quarterly sales variability; technological advances by competitors; and other risks and uncertainty more fully described in the Company's annual report on Form 10-K for the year ending December 31, 2002, as filed with the Securities and Exchange Commission, and other SEC filings.

In addition, in response to Reg G, we will no longer refer in our commentary or in answers to questions on past, current or future results to non-GAAP financial measures, such as EPS or gross margin before restructuring charges, or other provisions, but will only (indiscernible) the magnitude of the charges included in the various periods. As those of you listening by webcast know, this conference call is publicly available by live webcast on our web site at www.discoverypartners.com. This is call is the property of Discovery Partners. A copy of the prepared remarks on this call, as well as the earnings press release issued this morning, have been furnished to the Securities and Exchange Commission on Form 8-K. Now I will turn the call over Craig Kussman, Discovery Partners CFO, to discuss our financial performance.

Thanks, Riccardo, and good morning. Revenues for the fourth quarter ended December 31, 2003, were a record $14.5 million, 17 percent above the fourth quarter of 2002 and 27 percent above the third quarter of 2003. The increase over the third quarter was primarily due to the completion of $2.1 million of newly-contracted compound supply business with Pfizer that had to be delivered by December 31, 2003. The increase over prior year was due to this Pfizer business and due to the continued ramp-up of our pre-existing chemistry collaboration with Pfizer. Pfizer accounted for 65 percent of our revenues for the quarter.

Gross margin as a percentage of revenue for the fourth quarter of 2003 was 42 percent, up from 27 percent in the fourth quarter of 2002 and up from 40 percent in the third quarter of 2003. The increase in gross margin as a percentage of revenue versus the third quarter resulted from the favorable overhead absorption of the additional Pfizer business and higher screening volumes, which were offset by lower instrumentation margins. The increase in gross margin percentage versus prior year resulted from the higher chemistry compound production volumes, savings and material costs, higher screening volumes and other operating efficiencies, offset by lower instrumentation margin.

Research and development costs for the fourth quarter of 2003 were $0.6 million (ph), down from $1.1 million in the fourth quarter of 2002 and up slightly from $0.5 million in the third quarter of 2003. The decrease in research and development costs versus prior year resulted from the redeployment of development scientists and engineers to the direct revenue generating activities of customer-funded R&D programs and collaborations.

SG&A costs for the fourth quarter of 2003 were $4.1 million, up from $2.4 million in the fourth quarter of 2002 and $3.4 million in the third quarter of 2003. The increase in SG&A costs versus the third quarter resulted from higher levels of incentive compensation accruals, offset by savings resulting from the closure of our Tucson facility in April 2003. The increase in SG&A cost versus prior year resulted from higher incentive compensation accruals, increased business development costs and the absence of the required reversal of bad debt reserves that occurred in the fourth quarter of the prior year, when the related receivable was paid, which offset savings resulting from the closure of our Tucson facility.

Impairment of goodwill and other intangibles in the fourth quarter of 2003 was zero compared to $51.1 million in the fourth quarter of 2002. At December 31, 2003, the Company had $8.7 million of intangible assets, which primarily consist of a $6 million investment in the MicroARCS technology and a $2.1 million investment in our Xenometrix patent. In accordance with our accounting policy, we will continue to periodically evaluate the carrying value of these assets for potential impairment. In addition, we expect that we will begin to amortize our MicroARCS investment in 2004 as we begin to derive revenues from the technology.

The Company reported a $1.1 million profit from operations during the fourth quarter due to the improvement in gross margin, which more than offset the increase in SG&A costs. This marks the second consecutive quarter of operating profit. Interest income was $0.3 million for the fourth quarter of 2003, a decrease of $0.2 million from last year due to declines in U.S. interest rates and a marginal decrease in the average cash balance. Interest income was down $0.1 million versus the third quarter of 2003. Net income for the fourth quarter ended December 31, 2003, was $1.5 million, or 6 cents per share, compared to a net loss of $50.9 million, $2.09 per share, including the $51.1 million, or $2.10 per share, impairment charge in the fourth quarter of 2002.

For the 12 months ended December 31, 2003, revenues were $49.8 million, up 21 percent from the $41.3 million result in 2002. The increase in year-over-year top-line performance reflects the continued ramp-up of our exclusive chemistry collaboration and increases in screening revenues, which has offset declines in non-exclusive chemistry compound supply revenue. Gross margin as a percentage of revenue for 2003 was 36 percent, up from 14 percent in 2002, which included $7.3 million, or 18 percent of revenue, of provisions related to our decision to exit the non-exclusive compound supply division. The year-over-year increase in gross margin percentage resulted from the lack of such provisions, higher exclusive chemistry compound production volumes, savings in materials cost, higher screening volumes and other operating efficiencies, offset by lower instrumentation margins.

Research and development costs for 2003 were $2.6 million, down from $6.2 million in 2002. The decrease in research and development cost resulted from the redeployment of development scientists and engineers to the direct revenue generating activities of customer-funded R&D programs and collaborations, as well as the discontinuation of development of chemical compounds to be sold out of inventory. SG&A costs for 2003 were $14 million, up from $12.3 million in 2002. The increase in SG&A costs versus 2002 is primarily due to higher incentive compensation accruals and increased business development costs, offset by savings resulting from the consolidation of facilities. Restructuring costs related to the Company's Tucson facility were $1.9 million in 2003. The Company did not incur a similar expense in the same period of 2002.

The Company reported a $0.7 loss from operations during 2003, which includes the $1.9 million of restructuring cost. This compares to an operating loss of $64.4 million in 2002, which included a $51.1 million impairment charge and $7.3 million of provisions related to the exit of the non-exclusive compound supply business. The substantial improvement, which is primarily due to the lack of impairment charges and other provisions, also underscores the significant degree of operating leverage that exists in the business. Interest income for 2003 was $1.8 million, down from $2 million last year due to declines in U.S. interest rates and our average cash balance.

Net income in the 12 months ended December 31, 2003, was $1.1 million, or 4 cents per share on a fully diluted basis, including $1.9 million or 8 cents per share of restructuring costs, compared to a net loss of $62.1 million, or $2.55 per share, including the $51.1 million, or $2.10 per share, impairment charge and $7.3 million, or 30 cents per share, of provisions related to the exit of the non-exclusive compound supply business for the same period of 2002. Cash and short-term investments at December 31, 2003 were $72.6 million, up $2.6 million from our cash balance at September 30, 2003, primarily due to net cash flow provided by operations. Now let me ask Riccardo to review the operations for Q4 and the key milestones for 2004.

I am very pleased to again report that our results have significantly exceeded our prior guidance and expectations. This strong finish allowed the Company to achieve positive EPS for the year on a U.S. GAAP reported basis, including the charges for the closure of our Tucson chemistry operation. Although we had forecasted positive results in Q4, our overachievement is entirely due to our ability to rapidly deploy our operating capacity to respond to the unexpected demand from Pfizer. The additional chemistry volume again produced, as in the third quarter, excellent operating leverage and improved margin.

Since our last quarter earnings report, Discovery Partners has achieved several other substantial milestones, including the strengthening of our R&D relationship with Allergan by entering into a (indiscernible) finding collaboration for multiple unique GPCR and enzyme targets of significance to ophthalmology and neurology (ph) therapeutic areas, and the establishment of a new drug discovery collaboration with Celltech to discover potential new (indiscernible) compounds for one of Celltech's selected targets involved in intracellular signal transaction.

Looking back at 2003, we are very proud of our achievements. We delivered what we promised by becoming profitable and increasing our cash operations. The substantial improvement in our chemistry operations allowed us to fully satisfy the requirements of our key customer while improving our financial results. We expanded existing collaborations and we announced new deals with AstraZeneca in the field of gene expression profiling, and with Inspire Pharmaceuticals for the optimization of lead compounds in the P2 receptor family. We have entered into a three-year drug discovery collaboration with Actelion in Switzerland and we strengthened our Japanese customer base by forming new collaboration with Seikagaku, (indiscernible) and Kyrorin. Operationally, we closed our facility in Tucson, Arizona, and started chemistry operation in India. Finally, we entered into strategic collaborations with Bruker AXS for the worldwide distribution of our Crystal Farm protein crystallization and imaging system.

However, all of this is in the past. In 2004, we need to continue to improve in order to maintain profitability and growth in a pharmaceutical and biotechnology market which remains under pressure. Although the flood (ph) of new business in 2003 is indicative of the acceptance of our capabilities in the marketplace, in light of the uncertain economic environment, it is still appropriate to reaffirm our prior guidance or revenue between $53 million and $55 million, and earnings in the midteen cents per share range for fiscal 2004, as previously communicated with our third quarter earnings release and conference call. 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 questions and calls and questions regarding acquisitions, financial results or financial guidance following the conclusion of this conference call.

(OPERATOR INSTRUCTIONS) Sean McKenna with Merriman.

Nice job. Just wanted to make sure I understand that the guidance you are reiterating, the work or the relationship with Allergan and Celltech -- the relatively new (technical difficulty), that is accounted for in the guidance?

Yes, it is.

Okay. I wanted to know, could you give us a little bit of color on how much more work you expect to do with Pfizer. It seems like that relationship is really positive as you (ph) increase work for them. Could you comment a little bit on that and also you mentioned (ph) that the guidance is sort of based on your ability to be able to deliver work to Pfizer. Are there any capacity issues?

No, I don't think there is any specific capacity issue. The relationship with Pfizer continues to be excellent, as you can see from our additional business in Q4. We always said that over the 4 (ph) years of our contract, we expected to deliver anywhere between 90 and $95 million. We are still not changing at all our expectation and those numbers are built into our forecast, our guidance for 2004. When we're talking about not changing the guidance, basically nothing fundamental has changed in the economy (ph) since -- when we issued the first guidance at the end of Q3. And therefore -- and will be expected a year end around $47 million. So on an absolute basis, the same numbers that we expect at the end of Q3 is what we are expecting now.

So it is fair to assume then that you had expected to do some work for Allergan and Celltech?

We always do expect a certain percentage of our business to be new business that is in the pipeline that will come through. So, yes.

And currently with Pfizer, you are two years into that four-year contract or how far --?

Yes, correct.

Okay, thanks a lot.

Gene Mannheimer with Roth Capital Partners.

Wonderful quarter, congratulations. Just a couple of questions. Again, elaborate a little bit more on Pfizer. The agreement ends in December of 2005 -- is that correct?

Correct.

So that is currently 65 percent of revenues. When that agreement ends, then you're going to need to see kind of the other agreements sort of replace that revenue or do you anticipate a renewal in the Pfizer or an amendment to the Pfizer agreement?

A couple of points. The first one about a 65 percent; this was our percentage of revenue in Q4. That is not necessarily the ongoing percentage. And going forward, we would expect the percentage to decline to around in the 50s for 2004 and possibly in the last (ph) of 2005. In other words, we are trying to grow the revenues of the Company in addition to whatever Pfizer gives us. So that is the situation now. 2005 is still quite a while away -- it's 24 months away -- and I have no idea what other business can we get between now and then. And certainly we are structuring our business development to provide a pipeline of business that can replace whatever Pfizer would not decide to continue, if it doesn't. I have no idea at the present time how much or what is going to be the Pfizer volume for us in 2006, '07, or '08.

Thanks, Riccardo. Two more things. Gross margin, very impressive the last couple of quarters -- in the 40 percent plus range. Craig, do you think this is sustainable throughout '04?

I would expect it probably slide back to the high 30s during the beginning of '04. Part of the reason it has been in the 40s is that we have been able to run our production volumes fairly high in our chemistry operation, and we anticipate those coming back a little bit for 2004, but not really a significant change from these levels.

Thanks, Craig. Finally, I notice there was a spike in depreciation and amortization to about 4.8 million, or three times what has been your typical pattern. Can you comment there?

Not really a big change in depreciation and appreciation amortization per se. It has been running at about -- in fact, it has been coming down. For Q4 it was $1.1 million. It was $4.8 million for the year. And that is pretty consistent. It has been coming down I think from the mid to low $5 million range in 2002, 2003 to where it is now. We basically have enough physical plant and equipment to really handle, I think, at least the next year, two years of growth in the business. So I wouldn't expect the depreciation-amortization number to really grow from there.

Right, Craig. My mistake. I was looking at the full-year number rather than the quarterly number. Sorry about that. Thanks, guys. Great quarter.

Sean McKenna with Merriman.

Relative to Q1 versus Q4 last year, Q1 '04, are you guys expecting revenues to be flat or would there be a downtick relative to --?

We are not giving quarterly guidance out at this time, but I would -- in light of the very strong Q4 that we had with the additional $2.1 million of business, I wouldn't expect Q1 to be quite at that level. But I would say that the growth rate year-over-year from Q1 of last year to Q1 of this year, I would not change it much for what we're showing for the overall annual growth rate.

Great. Finally, tax rate. Do you guys expect to pay taxes in '04 and when do you expect to be taxed (ph)?

Right now, we are actually in the high-class position of having to calculate a tax provision for this year, which is always a good position to be in. For 2004, I would not expect a tax provision of any significance. There may be some small de minimus foreign taxes that might show up on our tax provision line, but our current estimates and forecasts don't show us paying taxes. This is really for two reasons. One, we do carry a fairly significant level of NOLs from the historical results of the business. And then secondly, the Company's acquisition of Axxess (ph) Advanced Technologies back in 2000 was structured as a taxable acquisition, so we are able to deduct probably $3.5 million or so of goodwill a year on our tax return. So that also helps.

That is very good. So I mean in terms of NOLs, you have so much (indiscernible) that you cannot even -- when would you begin paying taxes (indiscernible)? '06 year or --?

Possibly an '05 or '06 time frame.

Okay, great. Thanks.

(OPERATOR INSTRUCTIONS) If there are no further questions, I will turn the conference back to Mr. Riccardo Pigliucci.

Thank you. It is always a pleasure to report good results and I would like to thank all of you for participating in this teleconference. I look forward to talking to you again soon. 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 I.D. number of 331301. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.