Infinity Pharmaceuticals Inc (INFI) 2004 Q3 法說會逐字稿

Good day, everyone, and welcome to today's Discovery Partners International third-quarter 2004 earnings conference. As a reminder, today's conference is being recorded. For introductions and opening remarks, I will turn the call over to Mr. Riccardo Pigliucci, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you and 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' third-quarter 2004 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 for the quarter and the nine months ended September 30, 2004 and update the guidance for the remainder of 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 involve a high degree of risk and uncertainty. The Company's actual results may differ materially from those projected in the forward-looking statements due to risks and uncertainty that exists in the Company's operation, our development efforts and our business environment, including whether the Company's contract with the NIH continues to its four-year term, the mix and timing of revenues from sales of products and services based on our backlog, the establishment of (indiscernible) chemistry operations, our ability to establish and maintain collaboration, execute more profitable business and realize operating efficiencies, our ability to achieve expected growth in earnings per share in 2004, the integration of our acquired businesses, the trend towards consolidation in the pharmaceutical industry, quarterly sales variability, technological advances of our competitors, and other risks and uncertainty more fully described in the Company's annual report on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission and other SEC filings and our other SEC reports.

Backlog measures are not defined by GAAP and our measurement of backlog may vary from that used by others. We believe that the long-term backlog trends serve as useful metric for assessing the growth prospects of our business. Backlog is not a guarantee of future revenues and provides no information about the timing on which future revenue may be recorded.

In addition, in response to Regulation 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 highlight the magnitude of the changes included in the guidance periods, if any.

As those of you who are listening by webcast know, this conference call is publicly available by live webcast on our Web site at www.DiscoveryPartners.com. This 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 to Craig Kussman, Discovery Partners' CFO, to discuss our financial performance.

Thanks, Riccardo, and good morning.

Revenues for the third quarter ended September 30, 2004 were $12.6 million, 10 percent above the third quarter of 2003 and 3 percent below the second quarter of 2004. The decrease versus the second quarter was primarily due to a decrease in chemistry services business with Pfizer and Merck. The increase over prior year was due to increased Crystal Farm product shipments and increased screening services revenues, which more than offset decreases in chemistry services and license and development contract services revenues. Pfizer accounted for 53 percent of our revenues for the quarter.

Gross margin as a percentage of revenue for the third quarter of 2004 was 46 percent, up from 40 percent in both the third quarter of 2003 and second quarter of 2004. The increase in gross margin as a percentage of revenue versus the second quarter resulted from higher screening services volumes, the redeployment of chemistry resources to R&D and business development initiatives and lower losses on one of our exclusive chemistry services contracts. These factors were partially offset by a lower level of the per-compound margin benefits resulting from the modification to the Pfizer contract, combined with lower compound production volumes and a higher obsolete inventory adjustment for legacy instrumentation. The increase in gross margin percentage versus prior year was due to higher screening service and instrumentation product margin, resulting from higher volumes and from per-compound margin benefits resulting from the modification of the Company's chemistry agreement with Pfizer, which were partially offset by decreased chemistry compound production volumes, legacy instrumentation inventory adjustments, and uARCS amortization.

Research and Development costs for the third quarter of 2004 were $1.3 million, up from $0.5 million in the third quarter of 2003 and up from $0.9 million in the second quarter of 2004. The increase in Research and Development costs versus prior year and prior quarter resulted from the redeployment of development scientists and engineers from direct revenue-generating activities of customer-funded R&D programs and collaboration to internal drug-discovery, process improvement and instrumentation product-development activities.

SG&A costs for the third quarter of 2004 were $3.7 million, up from $3.4 million in the third quarter of 2003 and up from $3.6 million in the second quarter of 2004. The increase in SG&A costs versus the second quarter was due to higher business development costs resulting from the redeployment of development scientists to business development activities, which were partially offset by lower incentive compensation accruals. The increase in SG&A costs versus prior year resulted from higher business development costs, which offset savings resulting from the closure of our Tucson facility and lower incentive compensation accruals.

The Company reported no restructuring expense during the second and third quarters of 2004, compared to $1.6 million and $0.3 million recorded in the second and third quarters of 2003 respectively, when the Company closed its Tucson chemistry operations.

The Company reported a $0.4 million profit from operations during the third quarter of 2004, down $0.2 million versus the second quarter of 2004 results, and up from a $0.1 million result, including $0.3 million in restructuring costs related to the Tucson closure in the third quarter of 2003. The decrease in it versus the second quarter of 2004 is due to higher R&D, SG&A and deferred compensation costs, which more than offset higher gross margin. The improvement versus prior year is due to the improvement in gross margin and the absence of the restructuring charges, which more than offset increases in R&D, SG&A, and deferred compensation costs. This marks the fifth consecutive quarter of operating profit.

Interest income was $0.4 million for the third quarter of 2004, up from $0.3 million in the second quarter of 2004 and unchanged from the third quarter of 2003. This increase versus the second quarter is due to higher average cash balance and due to higher yields on our investment portfolio.

Net income for the third quarter ended September 30, 2004 was $0.8 million, or 3 cents per share, compared to net income of $0.7 million, or 3 cents per share, in the second quarter of 2004 and net income of $0.5 million, or 2 cents per share, including $0.3 million, or 1 cent per share of restructuring charges in the third quarter of 2003.

For the nine months ended September 30, 2004, revenues were $37.4 million, up 6 percent from the $35.4 million result in 2003. The increase in year-over-year topline performance is due to increased Crystal Farm product shipments and higher screening services revenues, which offset declines in chemistry services and license and development contract services revenues.

Gross margin as a percent of revenues for the nine months ended September 30, 2004 was 43 percent, up from 34 percent for the same period in 2003. The year-over-year increase in gross margin percentage resulted from higher screening service and instrumentation product margins, resulting from higher volumes, and from per-compound margin benefits resulting from the modification of the Pfizer contract, which were partially offset by lower chemistry production volumes, legacy instrumentation inventory adjustments, and uARCS amortization.

Research and Development costs for the first nine months of 2004 were $3.1 million, up from $1.9 million in the same period of 2003. The increase in Research and Development costs resulted from the redeployment of development scientists and engineers from direct revenue-generating activities of customer-funded R&D programs and collaborations to internal drug-discovery process improvement and instrumentation product-development activities.

SG&A costs for the first nine months of 2004 were $10.9 million, up from $9.9 million in the same period of 2003. The increase in SG&A costs versus 2003 is due to higher business development costs, which offset savings resulting from the consolidation of facilities and lower incentive compensation accruals.

There were no restructuring costs for the first nine months of 2004, versus 1.9 million in the same period in 2003 related to the closure of the Company's Tucson facility.

The Company reported a $1.6 million profit from operations during the first nine months of 2004, compared to a loss from operations of $1.9 million for the same period in 2003, which included $1.9 million of restructuring costs. This substantial improvement is primarily due to the improvement in gross margin and the lack of restructuring charges.

Interest income for the first nine months of 2004 was $1 million, down from $1.4 million for the same period of last year, due to lower yields on our investment portfolio. Net income in the nine months ended September 30, 2004 was $2.5 million, or 10 cents per share on a fully diluted basis, compared to a net loss of $0.4 million, or 2 cents per share, including $1.9 million or 8 cents per share of restructuring cost for the same period in 2003.

Cash and short-term investments at September 30, 2004 were $78.9 million, an increase of $1 million from the balance at June 30, 2004, due primarily to net cash flow provided by operations.

Now, let me ask Riccardo to review the operations for the third quarter and the key milestones for the remainder of 2004.

Thank you, Craig.

During the third quarter, Discovery Partners continued to perform and deliver the expected financial and scientific performance. We successfully expanded our collaboration with Celltech, now UCB, to a second target, expanded the lead-finding collaboration with our largest Japanese client for an additional year, and received positive feedback from Merck in a public presentation at the annual conference of the Society for Biomolecular Screening in Orlando, Florida on the use of our uARCS technology for the identification of G-protein-coupled receptor agonists.

The highlight of this quarter was the award of a multiyear contract from the NIH to set up and maintain the Molecular Library's Small Molecule Repository as part of the NIH Roadmap Initiative. The estimated funding available to DPI under this contract for the base period from August 2004 to December 2008 is approximately 24 million, assuming that the contract continue through its full-term with option to expand the term subject to the availability of further funding.

The NIH Department of Health and Human Services funds this contract in its entirety. The repository will be located at DPI's facility in south San Francisco, California. Building upon the results of the human genome project, the NIH Roadmap has been established to accelerate medical research progress in the area of drug-discovery. The ultimate goal of the repository is to offer public sector via (ph) medical researchers access to hundreds of thousands of small organic molecules, which can be used as chemical probes to study cellular pathways in greater depth. These compounds are expected to help validate new targets for drug therapy more rapidly and enable other researchers in the public and private sectors to take these targeted end (ph) compounds and move them through the drug-development pipeline.

The Molecular Library's small Molecule Repository will handle, store and distribute a mechanically diverse small molecule collection of up to 1 million compounds with the goal of progressively populating biologically relevant chemical space. This collection will be established for commercial compound suppliers and ongoing programs within the NIH. It will include FDA-approved drugs, compounds with nonaction, a structurally diverse collection of compounds of unknown activity, compounds derived from natural (indiscernible) templates, molecules submitted for the public and private sectors, and new compounds generated by diversity-oriented and target-oriented synthesis.

The collection will be used for screening of known and novel targets at the molecular level screening centers with distribution of compound of nonaction to investigators in academia and industry. This contract is a major achievement for DPI and is a major contributor to the 10 percent increase in our committed backlog since June 30, 2004.

As of September 30, 2004, our backlog of products and services under contract and deliverable in the twelve-month period ending September 30, 2005 was over 34 million. This is over 3 million higher than the comparable figure of 31 million as of June 30, 2004. The NIH contract, however, would only have a minor impact on 2004 results, as we are still setting up our facility and consulting with the NIH advisory panel on what compounds to procure.

While, as I just mentioned, we continue to receive business from new and current customers, we have not yet experienced the usual year-end surge of large pharma business, or a strengthening of our pipeline for new major contracts. It is too early to judge if this signals a tightening or a reallocation of expenditures following the recent well-reported product-related issues from several large pharmaceutical companies. However, we feel the need at this time to spend additional time to better understand and evaluate the current market drivers prior to issuing specific financial guidance for 2005.

Regarding the remainder of 2004, our current backlog should be sufficient to allow us to meet at least the low end of our (indiscernible) cents earnings per share guidance for 2004.

This concludes the first part of our conference call, and I am available to answer questions at this time. We urge investors and analysts to ask any and all questions, as we will not be responding to individual calls and questions regarding acquisitions, financial results, or financial guidance following the conclusion of this conference call. So, operator --?

Thank you. The question-and-answer session will be held electronically. (OPERATOR INSTRUCTIONS). Phil Nadeau, S.G. Cowen.

Good morning. Congratulations on the solid quarter. My first question is actually on your R&D expense line. You said that the increase in R&D expense was due to the reallocation of resources to some internal development projects. Should we model this same level of R&D expense, going forward, for the next several quarters, or was this more of a one-quarter phenomenon?

I would think this is probably higher than usual, but I would expect to start investing some R&D in improvement in some of the technology that we have internally. We also are embarking into the development of other instrumentation, so the level of R&D that you see now is probably something that you should continue to use for the foreseeable future.

Okay. Second, on your comments on the backlog not increasing -- or not the backlog, the pipeline not necessarily increasing, how far in advance of booking revenue does a project typically enter the pipeline? What I'm getting it is I understand that you are okay for 2004 but as we look forward to 2005 and the end of the Pfizer contract, would we start to see the pipeline developing to replace those revenue now or is it still much too early for that?

I would save this is the beginning. I would say that usually it is anywhere between 6 and 18 months, depending on the size of the project. If it's a very large project, it usually takes quite some time. A year ago at this time, we were discussing with Pfizer for the next two years. We haven't seen a project of that magnitude two years out yet. That doesn't mean that necessarily it's not going to happen; it's just to say that at the present time that we haven't seen many. The NIH was much faster, as an example. It depends, but I just wanted to highlight the fact that our basic pipeline of large deals hasn't changed too much in the last quarter.

Okay, fair enough. Thank you.

Mike Balkin, William Blair.

I just wanted to touch base. You've got almost $79 million in cash and cash equivalents. I know you've looked at some alternatives for how to deploy that cash, but one thing certainly I would think, as a shareholder, we would like to see is some level of a share buyback if you haven't found any acquisitions with which to put the cash to work. I am just wondering if you have any comments there.

Well, we had a share buyback program in the past and clearly, the major idea of utilizing cash for us was to do an M&A transaction. I do agree that if we cannot find, in a reasonable amount of time, some viable M&A opportunities, that then (inaudible) certain the Board might consider some action like you have suggested.

Okay. In terms of a reasonable period of time, I mean, what would you kind of estimate that would be? I mean, are we looking sometime -- if you haven't found something maybe by the first quarter or so, that we can anticipate that? Because I know you've been working on several and I'm sure they are all at various stages.

I wish I could be more precise but it's very difficult for me to put any timing on anything of this kind, as you well know.

Okay. All right, thank you.

(OPERATOR INSTRUCTIONS). Gene Mannheimer, Roth Capital Partners.

Good morning. Do you recall what your 12-month backlog was for the year-ago quarter ended September of '03?

No, we didn't track it at that time. We didn't really begin tracking a twelve-month rolling forward backlog until the beginning of January.

Okay. Next question -- on the NIH contract, what's the scalability of that contract? In other words, does that have the potential to extend to a screening agreement in addition to the repository?

Yes, it does, actually. The contract -- if you actually go to the NIH Web site, there's a very good overview of the overall project. The project contemplates several screening centers and we, among many others, have applied to become one of the screening centers. Whether we win that contract or not, obviously we don't know, but there is a potential of scaling up this activity more than just the repository but also the screening, as well as of course there is the potential of doing some of the laboratory compounds potential (indiscernible) synthesis and providing a quantity of compounds and so on.

In addition, (indiscernible) NIH, the same type of activity that we are doing for the NIH can be provided to commercial companies. So any pharmaceutical company, small or medium or large, that wants to -- rather than do it internally, outsource the old repository compound, QA (ph), QC (ph) and distribution of compound among the various sites; we can provide that service to them as well. So it is not just a straight one-off NIH contract but it's a line of business that the Company can get into.

That's great. Thanks, Riccardo.

(OPERATOR INSTRUCTIONS). Gentlemen, it appears we have no further questions standing by. I will turn the conference back over to you for any additional or closing comments.

Well, thank you. I just would like to thank all of you for participating on this teleconference, and I look forward to talk you again soon. Thank you very much.

Thank you, and this does conclude today's conference. We do appreciate your participation. You may now disconnect.