Infinity Pharmaceuticals Inc (INFI) 2005 Q3 法說會逐字稿

Good day and welcome to today's Discovery Partners International third-quarter 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. I would like to welcome you to Discovery Partners' third-quarter 2005 financial results conference call. With me today are Craig Kussman, Chief Financial Officer and Dr. Michael Venuti, Chief Scientific Officer of Discovery Partners.

In this call, we plan to review the results of the quarter and the nine months ended September 30, 2005. To review the Company's offering in the market and provide guidance for the fourth quarter of 2005. As you know, I am obliged to remind you to consider the following Safe Harbor statement regarding forward-looking statements.

Statements in the conference call that are not strictly historical are forward-looking statements within the meeting 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 risk and uncertainties that exist in the Company operation, our research and development efforts and our business environment, including whether the company's relationship with Pfizer and the National Institute of Mental Health, or NIH, continue beyond the contractual term, the mix and timing of revenues from sales of services based on our backlog, our ability to establish and maintain cooperation, execute more profitable business and realize operating efficiency, our ability to achieve expected results in 2005, the level of expenditure necessary to enable the Company to achieve its objectives of focusing its business on providing drug candidate to pharmaceutical companies. Our ability to successfully commercialize on market (indiscernible) technology, our ability to acquire complementary business or capability and the integration of acquired business of capability, the trend towards consolidation of the pharmaceutical industry, quarterly sales durability, technological advances by competitor and other risks and uncertainties more fully described in the Company's annual report on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission and other SEC filings.

Backlog measures are not defined by GAAP and our measurement of backlog may vary from that used by others. While we believe the long-term backlog trends serve as a useful metric for assessing the growth prospects for 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 answer to questions on past, current or future results, to non-GAAP financial measures but will only highlight the magnitude of any changes included in the various periods.

As those of you who are listening by webcast now, this conference call is publicly available by live webcast on our website 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 earning 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, 2005 were $11.1 million, 12% below the third quarter of 2004 and 2% below the second quarter of 2005. Decrease versus the second quarter was primarily due to the decrease in chemistry services revenues caused by decreased level of shipments of compounds and provision of other services to Pfizer, which accounted for 57% of our revenues for this quarter as well as the decreased level of procurement activity relating to our NIH contract and the completion of two chemistry services contracts. This decrease more than offset increases in screening services revenues, including a success fee from Allergan and an increase in product sales from our recently divested instrumentation systems business unit.

The decrease versus prior year was caused by lower revenue in all service and product categories. The reduction in screening service revenue was due to lower level of screening service activity. The reduction in chemistry service revenue was due to lower chemistry service activity caused by the completion of two chemistry service contracts and lower revenue from Pfizer, which more than offset new revenue from the NIH. The reduction in product revenue was caused by lower Crystal Farm shipments to our distributors during the quarter due to their inventory levels. As a result of our previously announced sale of our Discovery Systems product line to Nexus Biosystems, in future periods, the Company will not report any product revenues or related expenses and historical operating results relating to the net assets sold will be recorded as discontinued operations.

The financial tables included in the earnings release show the pro forma impact of the discontinued operations on the results of the Company. Gross margin as a percentage of revenue for the third quarter of 2005 was 41%, down from 46% in the third quarter of 2004 and up from 33% in the second quarter of 2005. The increase in gross margin as a percentage of revenue versus the second quarter resulted from higher product and screening service volumes and an improved mix of revenues, including the previously mentioned success fee.

The decrease in gross margin as a percentage of revenue versus last year resulted from lower volumes in all revenue categories and from a shift in the mix of chemistry services revenues to lower margin revenues, which offset the favorable impact of the success fee and lower inventory write-offs.

Research and development costs for the third quarter of 2005 were $1.8 million, up from $1.2 million in the third quarter of 2004 and up from $1.6 million in the second quarter of 2005. The increase in research and development costs versus the second quarter resulted from the inclusion for the full quarter of our natural compound based discovery business purchased from Biofrontera Discovery GmbH. The increase in research and development costs versus prior year resulted from the acquisition of the natural compound business and from the redeployment of development scientists and engineers from direct revenue generating activities of customer funded R&D programs in collaboration to internal programs focused on targeted libraries, Insilico tools, screening assays and drug discovery process development. These increases offset lower R&D costs in our Discovery Systems unit.

SG&A costs for the third quarter of 2005 were $3.5 million, down slightly from the $3.7 million result in the third quarter of 2004 and the $3.6 million result in the second quarter of 2005. The decrease in SG&A costs versus both periods is due to reductions in business development and administrative staffing levels combined with lower incentive compensation costs.

The Company recorded a nominal restructuring credit during the third quarter of 2005 related to an estimated accrual associated with the completion of remediation activities and the shutdown of our Tucson facility that we announced in 2003. There were no restructuring costs in the second quarter of 2005 or in 2004. Amortization of stock-based compensation for the third quarter of 2005 was $0.3 million, down nominally from both the third quarter of 2004 and the second quarter of 2005.

The Company reported a $0.9 million loss from operations during the third quarter of 2005 compared to an operating profit of $0.5 million in the third quarter of 2004 and a $1.8 million loss from operations in the second quarter of 2005. The reduction in the loss in the third quarter versus the second quarter is primarily due to the improvement in gross margin and lower SG&A costs, which offset higher R&D costs. The loss in the quarter versus the prior year result is primarily due to the reduction in gross margin driven by lower revenue volumes and higher R&D costs, which offset lower SG&A costs.

Net loss for the quarter ended September 30, 2005 was $0.3 million or $0.01 per share compared to net income of $0.8 million or $0.03 per share in the third quarter of 2004 and a net loss of $1.4 million or $0.05 per share in the second quarter of 2005.

Revenues for the nine months ended September 30, 2005 were $29.5 million, 21% below the $37.4 million result in 2004. The decrease in revenue for the 2005 period versus 2004 was due to lower revenue in all service and product categories. The primary driver of the decreased services revenue was lower chemistry service revenue from Pfizer and lower screening service revenue caused by a lower level of screening service activity.

Decrease in chemistry service revenue was partially offset by new revenue from the NIH. The reduction in product revenue was caused by the lower Crystal Farm shipments to our distributors due to their inventory levels. Gross margin as a percentage of revenue for the first nine months of 2005 was 34%, down from 43% in 2004. The year-over-year decrease in gross margin as a percentage of revenue resulted from lower service and product margins caused by lower volumes.

Research and development costs for the first nine months of 2005 were $4.6 million, up from $3 million in 2004. The year-over-year increase in research and development costs resulted from the acquisition of the natural compound based discovery business from Biofrontera Discovery GmbH and from the redeployment of development scientists and engineers from direct revenue generating activities of customer funded R&D programs in collaboration to internal programs focused on targeted libraries, Insilico tools, screening assays and drug discovery process development. These increases offset lower R&D costs in our discovery systems unit.

SG&A costs for the first nine months of 2005 were $11.2 million, up from $10.9 million in 2004 resulting primarily from costs related to the separation agreements with former executives. The Company recorded a $0.1 million restructuring charge during the first nine months of 2005 related to higher-than-expected facility remediation costs related to the shutdown of our Tucson facility that we announced in 2003. There were no restructuring costs in 2004.

Amortization of stock-based compensation for the first nine months of 2005 was $0.9 million, up from $0.6 million in 2004 due to additional restricted stock grants made during the third quarter of 2004 and second quarter of 2005. The Company recorded an impairment charge during the first nine months of 2005 related to the partial write-down of our toxicology based intangible assets as the loss of a customer due to bankruptcy indicated the carrying value was not recoverable. There were no impairment charges in 2004.

The Company reported a $7.8 million loss from operations during the first nine months of 2005 compared to an operating profit of $1.7 million in 2004. The loss in the first nine months of 2005 versus the prior year result is primarily due to the reduction in gross margin caused by lower revenue volumes, higher R&D, SG&A and stock-based compensation costs and the impairment charge. Net loss for the nine months ended September 30, 2005 was $6.3 million or $0.24 per share compared to net income of $2.5 million or $0.10 per share for the comparable period in 2004.

Cash and short-term investments at September 30, 2005 were $80.7 million, an increase of $0.7 million from the balance at June 30, 2005 due primarily to a reduction in working capital and net fixed asset requirements, which more than offset the net loss.

Now let me ask Riccardo to review the operations for the third quarter of 2005 and on the key milestones for the remainder of 2005.

Thank you, Craig. Let me start by commenting on the sale of certain assets of our legacy system business to Nexus Biosystems. This is an important transaction for Discovery Partners, not necessarily for its immediate financial implication, but more importantly as it represents another major step in focus in the Company on collaborative joint discovery activities. The legacy system business, at its original name IRORI, was a foundation which we built DPI and established our name and reputation with most pharmaceutical companies.

Over the years, however, the segment represented a diminishing percentage of our revenue and increasingly to compete with other investment aimed at sustaining our core business. For the past few months, we have been working towards identifying a strategy that would preserve the legacy capability of this operation while reducing our exposure. We are pleased that the management team of this business was able to effect this transaction and was able to retain all the employees that were associated with this business thus providing continuity of service to our customers and minimum impact to their R&D provenance.

We have retained full access to all the technology transferred to Nexus and thus we are positioned to satisfy current or future collaboration, such as split (ph) and pull (ph), centers for our (indiscernible) corporation or compound storage system for the NIH or other compound management activities.

I am pleased to report that, since our last call, we have entered into a new significant collaboration with Ono Pharmaceutical, renew the collaboration with Mitsubishi and received a milestone payment from Allergan for the identification of a new compound in our multiyear multitarget collaboration. All of these announcements are an indication of the level of activities in the area that we have chosen as our focus. As also Michael Venuti, our CSO, reported last quarter, we have assembled a technology platform that can carry out and successfully execute essentially every phase of that discovery process from assays development on new biological target through to lead compound optimization and selection for (indiscernible) assessment.

In addition to our efforts in Japan, we are in serious discussion with several European and U.S. companies and I hope to report in the next few months that we have entered into at least a few pilot programs involved with cleaning, lead follow-up and lead optimization using both our synthetic chemical and natural (indiscernible).

I know that a question on everybody's mind is the future of our relationship with Pfizer. But unfortunately at this time I am still not in a position to give you any indication, positive or negative, as to the level of business, if any, that we might be able to obtain after the expiration of our current contract in January 2006. Once we have better visibility in this area, we would also be able to give you an indication of our expected performance for fiscal 2006.

Our current twelve-month backlog is just over 17 million, lower than what we reported last quarter due to the pending expiration of our Pfizer contract. Days on our current business visibility, we reaffirm our estimates of revenue for the second half of 2005 at approximately the same level as the first half. Our loss for the full year however, assuming no restructuring or impairment charges or M&A activity, is expected to be between 8 and $9 million versus the expected loss in excess of $12 million that we had communicated on our last call as a result of the sale of the legacy system business and other cost containment measures implemented in the past quarter.

We continue to estimate the cash at the end of 2005 will be in excess of $75 million absent any further M&A activities or restructuring activities or stock repurchases under our current optimization.

This concludes the first part of our conference call. We are 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 or questions regarding acquisition, financial results or financial guidance following the conclusion of this conference call. Operator.

(OPERATOR INSTRUCTIONS). Bill Nasgovitz, Heartland Funds.

I was just looking at the last six years, Riccardo. We have been a long-term shareowner of this business for many, many years. And we're back to where we were in 2000 in terms of sales. Except equity per share has dropped from 696 to $4. Sales are where they are and since 2000, we have accumulated losses of $14 million. Has the Board explored just selling this business, merging it out, whatever? We have $100 million of equity here, which has produced no earnings cumulatively here for six years. When are shareholders going to -- maybe I'm the only guy that is frustrated here but when are shareholders going to demand a reasonable return on their investment? And has the Board addressed this question?

Well, Bill, I am just as disappointed in terms of our performance recently. Clearly the whole pharmaceutical industry has gone through significant changes over the past few years and we find ourselves probably in the most competitive area of the business that we certainly did not expect to be so hard. I think we have been very careful in our use of our cash and therefore, not made crazy acquisitions just for the sake of growing the business like many other companies in our space have done. Clearly our Board is looking at all strategic alternatives possible for the Company and will continue to do so all the time to try to maintain -- to put it in the best interest of our shareholders. And clearly it is difficult for us to make any major decision of any kind until we have better visibility on our major customer that, as you know, represented over half of our revenues for the past few years. There is a point when the Board will have to make some decision.

Who is the lead independent director on the Board?

The independent director on the Board (multiple speakers). It's Harry Hixson*

Harry Hixson. Thank you.

Rodney Hathaway, Heartland Funds.

Just some follow-up here to Bill's comments but could you give us an update, Riccardo, on the medicinal chemistry business initiative you began earlier in the year? Trying to get the Company and position the Company into some of the higher value added chemistry businesses. Any traction there, any potential initial customers in that area yet?

Sure. You see in the announcement that we've done about Ono, Allergan, Mitsubishi but let me ask Mike Venuti to address your question because he has been in front of customers for the past few months and has probably more first-hand (indiscernible) he can bring forward. Mike.

Hi, Rodney. We have been meeting with big and small companies, regional, specialty pharmas and large biotechs since I joined the Company in April. We have actually received a fairly good response to our offering that says that we would carry out drug discovery work in screening and in (indiscernible) follow-up and lead optimization and structure a deal where we were able to realize significant gains based on intermediate success fees and milestones up through the filing of an IND. Right now, the sensitivity I'm finding from folks who control R&D budgets is that they don't want to offer any impairment to their marketing groups and their clinical development groups in the way of royalties.

But these companies are willing to put more cash on the table based on identifying compounds that meet their specs. Significantly, we have gotten a lot of traction with the argument that these kinds of advanced compounds, what could be valued in the marketplace, is if they were being in-licensed and, as you know, the cost of in-licensing for pharma and biotech has skyrocketed over the last two to three years. Those numbers have gone from say $1 million upfront to 5 to $10 million upfront in some cases where you have got a drug that has a clean tox profile and our oral bioavailability. So we're going to try to structure our deals to be able to work on targets where we know the companies have interest, where we know what their product target profile is and where we deliver those molecules to them.

Instead of doing projects on spec ourselves where we might or might not pick targets that folks like and we might or might not produce compounds that would meet developability criteria. So working with these guys early on is going to be a big benefit in terms of producing a high-quality product.

Right now, we are in serious discussions with companies. Some companies have tens of targets that they want us to look at. Smaller regional pharmas and biotechs have maybe three or four over the next year or so. The commonality is that they all will want to do a pilot study upfront because most of them are new customers to DPI's roster and that is where we are right now in terms of assessing their targets, assessing the protocols and costing out how we would carry those pilots out to get to the first project. So I consider that piece of it very promising, Rodney. Thanks for your question.

As far as the chemistry, the core chemistry business and we saw the announcement from ArQule. They are not seeking to renew the contract with Pfizer. How does that impact your negotiations, Riccardo, and I guess some -- if you can give us anymore insight as far as -- I thought they needed to give us at least a 90 day go or no go decision since the contract expires at the end of the year and we're well into that 90 day period now. So can give us an idea of why there hasn't been an announcement so far?

I cannot comment into details of any specific discussion we're having with Pfizer. I can only tell you that if you listen to other companies that are in our same space -- I was listening myself to the Tripos conference call last week. We are all in exactly the same situation is this particular time. That is the way the discussions are progressing between any of Pfizer collaborators and Pfizer at this time. So I really cannot comment more in details on this.

Can you comment on why one of your biggest competitors has chosen not to renew this contract? Can we glean any information as far as pricing trends for this business going forward?

No, actually, you're probably referring to ArQule. I think ArQule made a strategic decision about three or four years ago and they actually announced it that way that they were moving from being in a business of providing compounds to other people into the business of developing their own drugs in the cancer area. They did make an acquisition in that area. They put money into it. And basically it used the Pfizer contract, which was the only customer actually they had. They did not sink anymore new customers. They used it as a way to provide cash for their operation in their own drug discovery. So this was another (indiscernible) they have compound and entering the clinic and entering into a later phase of development. This was an opportune time to clean up and be a pure drug discovery company for them. So I think that that is the coronation of something that has started three years ago and it was pretty much expected in the industry.

Lastly, with the divestiture of the IRORI business, you broke out the pro forma income statement with and without the business going forward. The thing I guess I noticed is the -- at least currently the pro forma SG&A is still pretty high considering you will be losing over $1 million in revenue in just this last quarter. Can you give us an idea going forward what the SG&A structure will look like? Will there be any rationalization of comps on that line with this divestiture?

Well, clearly the divestiture of the IRORI business came from certainly the basic infrastructure of the conference. When they moved out, they moved out as a fairly small entity and left behind all of the infrastructure that the company already had. Clearly, we are looking at ways of reducing our overall SG&A both by looking at more automation computer systems and the like and nationalizing whatever is necessary in order to bring it to a more viable level. I don't know if, Craig, if you want to add anything to it.

We will be looking at ways that we can reduce SG&A going forward. I think there are still minimum costs of remaining a public company. So we will bounce up against those types of barriers. But we are looking to constrain costs as much as possible.

Will you be able to give us an update at the end of the quarter on what the new cost structure will look like or how soon will you be able to give us some guidance on what the new cost structure will look like?

I would expect to be in a position to give guidance on that at the time that we are aware of what our Pfizer business looks like going forward.

(OPERATOR INSTRUCTIONS). Philip Nadeau, SG Cowen.

Good morning. Thanks for taking my questions. My first is actually a follow-up just to that last question. Do you plan on announcing your level of Pfizer business as soon as that is known to you or is that something that you would wait for your fourth-quarter call to disclose to investors? Most likely, I feel that most investors are expecting us to say something one way or the other when we have visibility on Pfizer. So I will be announcing positive or negative news on Pfizer as soon as I have them.

Another follow up to the last question, how elastic is your expense structure? Of the 14 to $15 million in expenses in SG&A you have this year, how much of that could you pare back should you lose Pfizer approximately and same thing with R&D expense?

I will (indiscernible) because it depends on what kind of level of Pfizer business we're getting is the amount of overall expense structure that we can -- we need to employee or we can reduce. So I think it is premature at this time for me to put a number on the table.

And one of your more recent announcements -- I think it was perhaps the collaboration with Ono -- described that collaboration as a significant collaboration. Could you maybe elaborate a bit more on what you mean by significant?

Well historically we have used adjectives to define sizes of business. As you know, we don't normally announce anything which is less than $0.05 million unless it's the first time or unless it is a particularly novel important point. Significant for us is something over $1 million. That is basically our normal threshold and otherwisely, if it's a multi million dollars, we say so. If it's multi-year, we say so.

Great. Those are all my questions. Thank you.

(OPERATOR INSTRUCTIONS) At this time, there are no further questions. I would like to turn the conference back over to your host for any concluding or closing remarks.

Thank you. And I would like to thank all of you for participating in this teleconference and I look forward to talking to you again soon. Thank you very much.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect your line.