MorphoSys AG (MOR) 2006 Q3 法說會逐字稿

Good morning ladies and gentlemen and welcome to today's Morphosys AG third quarter report conference call. For your information this conference is being recorded. At this time, I would like to hand the call over to your host today, Dr. Simon Moroney. Please go ahead sir.

Good morning this is Simon Moroney CEO of Morphosys. And I'd like to welcome you to Morphosys' Q3 results conference call. Dave Lemus, our CFO is with me on an external line and will participate in question and answers after the statement.

I'll start by giving you an overview of the third quarter and continue with a review of the financial results for the first nine months of 2006. Afterwards, I'll open the call up to your questions.

Before I start, I want to remind you that during this conference we'll present and discuss certain forward looking statements concerning the development of Morphosys' core technologies, the progress of its current research programs and the initiation of additional programs. Should actual conditions differ from the Company's assumptions, actual results and actions may differ from those anticipated. You are, therefore, cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof.

We have a very strong quarter behind us. The financial results show that both sides of the business, Therapeutic Antibodies and Research Antibodies are performing very solidly. We fully expect to meet our financial targets for the year. Perhaps even more importantly, in the area that is the biggest driver of future value, mainly drug development programs, we are ahead of plan for the year.

We started the year with 29 active pilot therapeutic programs based on our HuCAL technology. Our goal for this year was a net gain of nine, meaning we aimed to reach 38 active programs by year end. The secondary goal reflecting the growing maturity of the pipeline was for at least 10 of these ongoing programs to be in pre-clinical development up from seven at the beginning of the year.

We're happy to announce today that we now have 40 active HuCAL based Therapeutic Antibodies programs ongoing in our partnerships. Of these, two are in Phase I clinical trials, namely the antibody we made for GPC Biotech for lymphoma and the antibody we made for Roche for Alzheimer's disease.

Out of the 40, 14 are now in pre-clinical development, twice the number at this stage of development at the start of the year. On both counts, total number of active programs and number of pre-clinical projects, we are, therefore, ahead of target for the year. The pre-clinical programs are particularly important because, of course, it is from this group that the next Phase I trials will come. We currently have 24 patent programs in discovery.

Looking forward, we expect further growth in the pipeline as our existing partners add new projects and as new yet unsigned partnerships are entered. Overall, interest in Therapeutic Antibodies as a class of drugs continues to be strong in the industry. We see no reason why the increase in the number of HuCAL based pilot programs cannot continue to be strong in the years ahead. This is essential to our strategy as the more HuCAL based drugs make it through development to market, the more Morphosys will benefit from lucrative milestone and royalty payments.

Turning to our proprietary drug programs, these continue on track. During the third quarter, we entered into a manufacturing agreement with Crucell and DSM, under which DSM will manufacture our MOR103 antibody for rheumatoid arthritis in Crucell's PER.C6 cell line.

We were delighted to enter this agreement since we believe PER.C6 offers attractive advantages based on yield, added to the fact that as a human cell line, it will endow our fully human antibody MOR103 with a fully human-like oscillation pattern. This we believe will be an advantage for a drug of this type for a chronic condition such as arthritis. Additionally, the cell line if safe and FDA approved, which were important decision criteria for us.

The second proprietary program, MOR202, for multiple myeloma also continues on track. The next milestone here will be the decision on a candidate for formal development, which we expect to make by year end. In respect of both of these programs, I'd like to take this opportunity to remind you not to anticipate announcements. As such time as we have significant news, we will let you know, as we did in the case of the agreement we signed with Crucell and DSM around the manufacture of clinical grade MOR103.

Turning to the research side of the business, integration of Serotec into our ABD unit will be complete by year end as planned. We fully expect to hit our financial targets on this side of the business, even though revenues through three-quarters are about 5% below the required run rate. The reason for this is that although revenues on this side of the business are much more predictable than those on the therapeutic side which, as you know, are often impacted by big milestone payments. Bigger industrial orders for research and or diagnostic antibodies can be a source of lumpiness in ABD.

Two bigger orders that may easily have flowed in Q3 will actually come in Q4. This means obviously, that Q3 revenue was a little lower than we originally expected, but will be compensated for in Q4 so that overall, we are on track for the year.

During Q3 we announced the sole-source contract from the USAMRIID, an organization of the U.S. Army Medical Research and Material Command and lead Medical Research Laboratory for the U.S. Biological Defense Program for the delivery of antibodies against potential bioterrorism agents. This deal highlighted the utility of HuCAL in an area that was new for us and potentially very important in the future. To highlight the speed with which we can generate antibodies, delivery has already been made within five weeks of receipt of the antigens.

With that I conclude my review of the quarter and I'll now continue with the review of the financial results beginning with revenues.

Group revenues grew by 64% in the first nine months of 2006 to EUR39m compared to EUR23.8m in the same period of last year. Total Company organic growth amounted to 26% compared to the prior year. Revenues are rising from the Therapeutic Antibodies segment amounted for 67%, or EUR26m, of total revenues, while the ABD segment generated 33%, or EUR13m, of the total.

On the Therapeutic side of our business, revenue growth amounted to 26% compared to the same period in 2005. Reasons for the increase were mainly due to the success-based payments from existing collaborations, which represented EUR6.3m in revenue for the first nine months, or roughly 24% of total segment revenues.

On the Research side of our business, the ABD segment achieved 26% organic growth of the prior year, inclusion of the Serotec group revenues contributed EUR9.1m to the total.

Turning to operating expenses for the first nine months of 2006, total operating expenses increased by 56% to EUR31.2m. The increase in operating expenses of EUR11.2m was manly due to two reasons. First, cost of goods sold increasing by EUR3.6m, which arose from the inclusion of the Serotec Group and consolidated accounts. And second, the increased personnel expenses at Morphosys AG.

The acquisition of Serotec Limited, including its affiliates, had the effect of increasing operating expenses by EUR8.5m.

Stock-based compensation expenses are presently embedded in COGS, SG&A and R&D expense amounts. Stock-based compensation for the first nine months of 2006 amounted to EUR1m and changed little over the previous year, remaining as a non-cash charge.

A purchase price allocation, or PPA, was carried out for the Serotec acquisition. The resulting preliminary values were retroactively recognized to the purchase date, an amortization as well as depreciation of assets identified, was included in total operating expenses during the quarter. Total PPA effects on operating profit, including the Serotec acquisition, amounted to EUR1.2m compared to EUR0.4m in the same period of the last year.

Cost of goods sold rose to EUR5.5m in Q3 2006 compared to EUR1.9m in the same period of the prior year. The main reason for the increase was the inclusion of Serotec Group company's cost of goods sold amounting to EUR3.4m in Q3 2006. Higher revenues stemming from existing customer HuCAL business also influenced COGS.

Finally, COGS was affected by depreciation stemming from inventories under the PPA exercises in the amount of EUR0.5m in the first nine months of the year.

As a result of higher expenses for products and technology development in the amount of EUR1.4m, costs for research and development increased to EUR11.7m. Amortization of intangibles associated with the Serotec PPA amounted to EUR0.6m and were accounted for as research and development expenses.

Sales, general and administrative expenses amounted to EUR14m compared to EUR7.9m in the same period of the previous year. This resulted mainly from higher personnel and other operating expenses arising out of the Serotec Group of EUR5.1m, as well as increased personnel expenses of Morphosys AG.

Morphosys' investment in property, plant and equipment amounted to EUR1.1m for the first nine months of 2006 compared to EUR0.4m for the same period of the prior year. Depreciation of property, plant and equipment for the first nine months of 2006 accounted for EUR1.4m of expense compared to EUR0.6m in the same period of the previous year. The single most significant contributor was a charge of EUR0.6m for depreciation of stock in connection with previous purchase price allocation exercises.

During the first nine months, the Company invested EUR0.3m in intangible assets. Amortization of intangibles amounted to EUR2m, an increase of EUR0.3m in comparison to the first nine months of 2005. This was mainly due to the amortization of intangible assets acquired in the Serotec deal. Non-operating expenses amounted to EUR0.5m, mainly due to increased foreign exchange effects and bank fees. This effect was partly offset by gains on securities sold in the first quarter in connection with financing the acquisition of Serotec Limited. For the first nine months of 2006, the Group presented an operating profit in the amount of EUR7.8m a near doubling over the same period of the prior year.

Earnings before interest and taxes, EBIT, amounted to EUR7.4m compared to an EBIT of EUR3.8m in the same period of the previous year. Net income after taxes, of EUR6.1m was achieved for the first three quarters of 2006, compared to a net income of EUR3.9m in the same period of 2005. The resulting diluted net profit per share for the nine months ended of September 30, 2006 amounted to EUR0.93 compared to EUR0.67 over the same period of the previous year.

On September 30, 2006 the Company held EUR 66.3m in cash, cash equivalents and available for sale financial assets compared to a year end 2005 balance, of EUR53.6m. Cash flow from operations amounted to a very strong EUR15.7m in the first nine months of 2006. That concludes the financial analysis.

As is typical during our conference calls, we would like to take the opportunity to update our financial guidance and hereby confirm the guidance given on the Q2 results conference call.

Under such guidance, we foresee an EBIT of up to EUR6m on up to EUR52m of revenues, and EUR46 to EUR49m of operating expenses. We don't exclude the possibility of out performance due to lower expenses, but as this is currently too uncertain to call, we would simply like to guide towards the lower end of the EUR46 to EUR49m expense range.

That concludes our financial analysis for the first nine months of 2006. We'd now like to open the call up to your questions.

Thank you. [OPERATOR INSTRUCTIONS]. We will now pause for just a moment to give everyone an opportunity to signal for a question. We will now take our first question from Thomas Schiessle from Equities. Please go ahead.

Yes, thank you for taking my question. Good morning everybody around the globe. Congratulations on this quite impressive operational performance in this period.

To my questions, actually the question is you have a very impressive cash flow on the operational level. What about the decision making process concerning your dividend -- paying a dividend in the future? This is the one question.

The other is concerning the depreciation you mentioned in your talk. There is a EUR1.4m ordinary depreciation in the nine month period, where -- and within this EUR1.4m there is an extraordinary depreciation, because of impairments of -- in the connection with Serotec. Is this impairment -- yes, the full impairment of those stocks within Serotec? Or is there something to come in the future? Now, this is the second question.

And the third one a totally different question, is there any news on the Schering Bayer theme concerning the collaboration between you and those two, or in the future the new Company Schering Bayer? Thank you so far.

Thank you Thomas and good morning. I'll take your questions one and three. And Dave may want to add something in respect to question one. And I'm sure he'll answer question two for you.

First of all we have no plans to pay a dividend. We've consistently said that. And in saying that, we're making ourselves consistent with almost the entire biotech industry. As you know, it's widely regarded that the best strategy for biotech companies is just to reinvest as much as they can in future product and technology development. And that's what we intend to do. And, therefore, we have no plans to pay a dividend.

Regarding Schering Bayer, or Bayer Schering, we -- just as reminder, we have existing ongoing deals with each of the predecessor companies. And, of course, given that the two companies are coming together, some consolidation of those two contracts is to be expected.

Discussions are ongoing, but at this stage it's too early to say how they will resolve. But, of course, we proceed under the rather obvious assumption that there will be a necessary consolidation of those two contracts.

Dave, do you want to take the question regarding depreciation and the impairment for Serotec?

Yes. And there may have been a -- how do you say misinterpretation of your part of the speech Simon. Then -- in fact, there was no impairment of Serotec assets. So, that may have been a misunderstanding. That was -- Serotec impacts on the COGS through PPA through normal depreciation of stock, which is bumped up to fair market value in conjunction with the PPA exercise. So, in fact, again I must stress there was no -- there is no impairment involved with the Serotec.

Okay. That's good news. Additional news -- additional question on that is the PPA already concluded? Or is there still, yes, decision making in process, so to speak?

Yes. We think that it's more or less final. Of course, as you know, Thomas, under IFRS we have the ability to change that until 12 months after the acquisition --

Indeed.

Which would be roughly middle of January next year but, at this point, we don't anticipate any changes to that.

Okay, wonderful. Thank you.

We will now take our next question from Nick Turner of [Maribu] securities. Please go ahead.

Hello Simon, I wonder if you could perhaps update on what's happening as far an internal Therapeutic Antibody programs are concerned. You start to generate quite nice amounts of cash. And I just wonder whether or not you might be expanding the initiative in terms of own programs?

And then also, could you perhaps update on collaborative programs? How many of those are currently active in development? How many are in the clinic? And when do you think we might hear something on the Roche Alzheimer's disease trial?

Yes, morning Nick. Yes, first of all, regarding the internal Therapeutic Antibody programs, we currently have two ongoing. Expenditure there will start to ramp, as I'm sure you know, as soon as you start making material for clinical trials and, indeed, entering the clinic, as we intend to do next year for MOR103, it starts to get more expensive. So, you should expect to see investment and spend in that area start to ramp in any case.

We're always looking at the possibility of starting additional new programs. However, philosophically, we are very cautious regarding target choice. And we need to be very confident in the quality of the target before we pursue a program around it. So, therefore, we're not jumping on new programs every day or even every month.

So, perhaps in summary, we're certainly interested in new programs and, as and when we feel that a new program is merited, we would consider starting a new program. But we fully intend to continue on with the two existing programs we have. As I said, the next key event in regard to MOR202 is the choice of a candidate by the end of this year.

Regarding the collaborative programs, as I mentioned during the talk, we currently really have 40 active collaborative programs spread between our Therapeutic Antibodies partnerships. Of those 40, two are currently in phase one clinical trials, 14 are now in pre-clinical development and 24 are in the discovery phase.

Regarding the Roche antibody for Alzheimer's disease, that phase one study started I believe in May of this year. And we currently have no information of when that study will be completed. And I'd just like to remind you and the other participants that we're not actually involved in running that study. The decision making process there is fully in the hands of Roche. And, therefore, should you need further, or be interested, in further information I would suggest that you contact Roche directly on that.

Thanks.

[OPERATOR INSTRUCTIONS]. We will now take our next question from Hanns Frohnmeyer from LBBW Bank. Please go ahead.

Yes, good morning, Hanns Frohnmeyer from LBBW. I have two questions. One is related with your future costs. So, you mentioned that your production of MOR103 is starting now with your PER.C6 cell. Can we get a feeling how -- when the costs will arise in this -- with this respect? It's already in the fourth quarter or is it only in 2007?

And then I just found that you started an office in RTP for Serotec. What do you think are the costs there?

In addition, I found that your margins for the Therapeutic Antibody business increased from 46 to 54%. What are the reasons for this strong increase?

Okay, let me start with a couple of those. First of all, regarding the costs for manufacture of the MOR103 material for clinical trials, those costs are actually spread over the period on -- in which the service is provided by the contract partner. And so, therefore, you shouldn't expect to see a lump sum hit the expenses in any particular quarter. Those costs are spread over that period which is, of course, a number of months.

And regarding the office in Research Triangle Park in Raleigh in North Carolina, we actually always had an office there, which we acquired through the acquisition of Serotec. And what we've done is simply relocate them to a more appropriate premises from the previous premises they were in, which were not really appropriate. So, therefore, we haven't actually made any significant increase in costs there. It's simply a move to a new premises.

Okay, so you don't expect anything there?

We don't expect anything unusual there. We expect costs to carry on as previously.

And Dave, do you want to say anything about the margins on the Therapeutic Antibodies side of the business?

Well, actually I just wanted to make another comment before I talked about the margins, which was a comment related the costs of MOR103.

As you may have read in our report, we had projected for the full year roughly EUR4m worth of product and technology development spend. A large part of that, of course, is involved with the production costs of MOR103. Of that EUR4m, we've spent roughly EUR1.4m to date. Meaning, we still have potential EUR2.6m to spend.

Okay.

We think that there's a good chance that much of that monies will be spent in the fourth quarter. Of course, as Simon pointed out, the way we recognize some of those costs as we spread it over the time of performance. If the performance is done in the fourth quarter, then all the costs would land in there. If it exceeds that, then some of the costs would be pushed into the following year.

Okay, I got it.

Okay, regarding margins were you referring to the quarterly margins? Or were you referring to the cumulative margins?

I didn't -- sorry again?

Was your question regarding the margins?

Operating margins, just from your segment report.

Yes?

The operating results.

This is year to year or quarter to quarter?

It's nine months report.

Nine months 2006 versus 2005?

Yes, the Therapeutic Antibody business.

Okay, well, the reason why you would see a pick up in the margins comparing one year to the next would be related to the fact that in 2006 we have the Serotec Group numbers included in our numbers, that be number one.

Number two, the gross margin involved with the Biogenesis business has really taken off. Last year it was close to 50%. This year it's well in excess of 60%. And that has a lot to do with the fact that a lot of the synergies we have expected along with that -- how do you say, that acquisition, have now come to fruition. And that business is performing extremely well.

So, I think the combination of those two things, the inclusion of the Serotec Group in 2006, whereas it was not included in 2005. And as well the Biogenesis Group performing really at top -- in top gear, in top form, has contributed to a higher gross margin performance.

But in addition the Therapeutic Antibody business itself has also grown in the margins?

Yes.

If you look at the segment result in comparison to the revenues. Therefore, I'm asking whether you get an increase in the Therapeutic Antibody business.

Okay, yes partially. The way we get compensated in the Therapeutic business is a combination of license fees, success based payments and funded FTEs being refunded to us through our partners.

I would say that in terms of total success payments, we're probably ahead in terms of a percentage compared to the previous year, which would, of course, lend the higher profitability on the Therapeutic side also.

Thanks.

We will now take our next question from Daniel Wendorff from WestLB. Please go ahead sir.

Yes good morning everybody. Unfortunately, a number of my questions are now already answered. I have one remaining left. I think I did not quite full understand the upcoming development plan of MOR103 and MOR202. Could you update me on that again please?

Yes sure, hello Daniel.

Good morning.

It's -- in respect to MOR103 -- in respect to both of these things nothing has changed. Both of them remain on track. In respect of MOR103, we've now entered the manufacturing agreement with Crucell and DSM. The next significant milestone that you should expect will be the filing of an IND application in the second half of next year.

Okay, got it.

And in respect of MOR202, we're currently evaluating a couple of candidate molecules here, with the goal of identifying one formal development candidate by the end of this year. What we then decide to do with that particular candidate, we haven't yet communicated.

Okay.

And may not communicate until the beginning of next year.

Okay perfect. I wasn't sure about that.

Okay.

[OPERATOR INSTRUCTIONS]. We now have a follow up question from Thomas Schiessle from Equities. Please go ahead.

Thank you. My follow up question is on the margins in the segment report. Dave, you give us the indication that if it comes to ABD business, Biogenesis is, yes, running on the top gear so to speak. And that's wonderful, nice to hear.

What about the Serotec business? Is this business going well or strong, or is there improvement possible? And overall -- in the overall picture, ABD is still in the -- not in the profits. So, you need some more top line. How would you like to generate the top line? This the one question.

The next question is concerning the -- your guidance. Simon, you said in your speech that there might be the possibility that the overall operating expenses will be on the lower end of your corridor, you indicated. That's fine. On the other hand, you said in your speech that you are ahead of plan, concerning the active collaborations you are pursuing right now.

So, on the one hand, there is the possibility of less expenses. That's good news. On the other hand you are ahead of plan if it comes to total revenues. That would be an additional positive news. So, is there, indeed, the possibility of exceeding your guidance revenues target? That is the second question. Thank you.

Okay, maybe I can start with that one and then I can hand over to Dave to talk about the margin question, your first question.

We -- although you're right, we are working on more programs. Or let me put it that way, that there are more active programs ongoing in partnerships than we had planned for. That doesn't necessarily mean that all of those programs are ongoing here. One simple example, the Roche or the GPC programs, which are now in the clinic, we count as active programs. But, of course, we're not working on them here, which means we neither have expense nor revenue.

Until such time as milestones get hit, we don't book revenues unless those revenues are FTE related revenues. And that's the reason why at this stage, we see no reason to increase the revenue side of the guidance and prefer to leave it at the EUR52m.

So, to be more precise, there is no trigger out of the extra collaboration, so to speak?

The --

The [nil] revenue trigger.

The logical first revenue trigger beyond FTE funding is a success payment when an antibody gets handed over.

Indeed.

But in respect of programs that have only just been started now, one can't expect that such success milestones would be payable in this year.

Yes, maybe if I could add to that Simon, real quickly. In terms of the revenue guidance, of course, there's always a possibility of out performance. Not only due to number of programs ongoing but, as you pointed out, Thomas, the hitting of milestones and so forth within a collaboration.

I think what Simon mentioned this morning was that we felt comfortable with the upper end of our revenue guidance, which was EUR52m at this point.

Okay.

In terms of expenses maybe since -- I just continue with that real quickly. I think we feel pretty comfortable with the lower end now, in terms of the EUR46m. And I think what was pointed out this morning, and what we also talked about on this call, was that there are a number of events, which could potentially impact that EUR46m to make it slightly lower. But, at this point, according to our planning, we think that we'll land pretty close to that EUR46m. So, at the same time, we can guide towards the lower end of the expense guidance.

Okay.

Dave, do you want to pick up on that -- on Thomas' question about margins in the various areas?

Yes, I think Thomas' question if I remember correctly was the Serotec Group, how are things performing and are things meeting our expectations there? And if that was the question, then I would comment that things are going according to plan.

I think when we do an acquisition, and the history of Biogenesis was that it typically takes us about a year to integrate these units. Once these things are integrated, and I have to admit that there is some disruption during the integration and particularly in the case of Serotec, where we've now consolidated sites -- all of our sites into on U.K. platform and as well now into the U.S.

There is some disruption. It does take time to realize some of the synergies. But typically, as I said, with these integration projects you can start to see the fruits of these integration projects about one year afterwards. So, it was never planned that we would realize massive synergies as it related to Serotec. That being said, as I said before, we are now starting to see the fruits of the Biogenesis acquisition in terms of the synergies.

All in all, and Simon, you might want to comment on this, I would say that the Serotec unit is performing exactly where we expected to perform.

Yes, I think overall that the fact that we're well on track to meet targets for the year for that unit as a whole. And I think really of the unit as a whole, because there are so many overlapping activities going on now that it's really misleading to talk about Biogenesis or Serotec as units, because we see the thing as a whole. Overall, the fact that the integration has gone so smoothly and the fact that we're absolutely on track to meet our goals for this year is a tribute to how well we've managed that integration process.

That would mean being frankly, in my [reckon] work, I had foreseen a little -- a quite better net margin in the ABD business, because you -- on the top line you improved your -- the run rate of revenues. You doubled, so to speak, the run rate of your revenues in the three month period of the third quarter. But, unfortunately, the segment profit, yes, increased -- or the segment loss increased, so --

Yes. And that again had a lot to do with the fact that one of the reports --

That's integration?

Q1 and Q2 we also reported that those were extraordinary quarters and that we didn't expect that to continue. As now history has now shown, that run rate didn't continue.

That being said, we currently have a gross margin of about -- just under 60%. And we've always said that the target margin for that unit is 60%. We actually think that over time we should be starting to do better than that.

And one of the reasons, for example, that we can expect to see better improvement in that result would be the fact that under these PPA exercises when you have a bump up in the fair market value inventory, these bump up in values are then charged to COGS over a very short period of time.

Now, a lot of those COGS amortizations, or rather depreciations, have been put into previous financials. And in terms of the Serotec Group, we expect amortization for one more year. So, once those extraordinary effects related to the PPA wear off, we should start to see margins improve also. Just from -- by virtue of the fact that that PPA depreciation is no longer in.

Okay. Thank you, Dave.

As there are no further questions at this time, I would now like to turn the call back over to Dr. Moroney for any additional or closing remarks.

Thank you. If there are no further questions, I would like to close by reminding you of the main message to take away from this conference call.

The significance in the near term, we're solidly on track to reach our financial targets for the year. Perhaps even more importantly, we've already surpassed our objectives for the year in terms of the number of active HuCAL based Therapeutic Antibody programs.

Strength in the pipeline today is an indicator of the value of tomorrow, and in this regard Morphosys is very well positioned.

That concludes the call. Should any of you wish to follow up with us directly, I'm in the office here in Munich. Thanks again for participating and good bye.

Ladies and gentlemen that will conclude today's conference call. Thank you for your participation you may now disconnect.