Evotec OAI AG - Financial Results 2002, Sustained Growth in Challenging Markets

Financial Highlights:

  • Group Revenues EUR 70.0 million, up 11%
  • Discovery and Development Services revenues EUR 58.6 million, up 13%
  • EBITDA EUR (2.2) million, exceeding company October 2002 guidance (EUR (3)
  • to (6) million); positive EBITDA in Q4 2002
  • Strong liquidity build-up towards 2002 year end to EUR 21.3 million
  • 2003 order book of EUR 57 million as of February 2003, representing 73% ofanalysts' revenue forecasts
  • On track for positive EBITDA in 2003


Operational Highlights:

  • New three-year agreement signed with Pfizer
  • Innovative three-year agreement as preferred supplier to portfolio companies of
  • Oxford Bioscience Partners
  • First clinical milestone achieved from collaboration with Vertex
  • Major building project started in Abingdon to expand Medicinal Chemistry capacity
  • Organisational spin out of Evotec Technologies completed
  • Discovery Programs Division established

Joern Aldag, President and Chief Executive Officer of Evotec OAI, commented: "This was an excellent performance against a background of continuing tough market conditions, which have adversely affected many of our customers. Our unmatched range of Target-to-IND products and services continued to make us the partner of choice for the pharmaceutical and biotech industry, underlined by important new or extended agreements with Pfizer, Roche, Amgen and Oxford Bioscience Partners, among many others. We have reacted swiftly to the changing business environment, and with our excellent market position and strong order book we are confident that we have put the Company on track for positive EBITDA earnings in 2003."

Chief Executive's Review
Operational Review
The Company made significant progress in 2002, despite an unprecedentedly challenging year for the biotechnology and pharmaceutical industries, characterised by a continuing decline in new molecular entities. Strong margin pressure has prompted many pharmaceutical companies to reduce their expenses. Weak equity markets also caused funding restrictions for small biotechnology companies, resulting in reduced R&D spending by a number of our customers. We are seeing this trend reversing now, with customers increasing their R&D spending in order to avoid losing strategic momentum.
Against this challenging background we continued to develop our position as the preferred provider of services for the life sciences research industry, and to add to our unmatched network of customers, which now totals more than 120. We extended our multi-year partnerships with companies including Pfizer, Roche, Amgen and Solvay Pharmaceuticals and thereby again achieved significant growth in discovery services.
We extended our long-term assay development and technology partnership with Pfizer for another three years. A contract value potentially in excess of $25 million makes this extension significantly larger than the original agreement signed in 1999 - a strong validation of our scientific concepts and technological platforms.
We also signed an innovative three-year umbrella agreement with Oxford Bioscience Partners (OBP), a U.S. venture capital firm, positioning us as the preferred supplier and discovery partner for many of OBP's portfolio companies. The arrangement gives us a strong head start in the US biotech market and encourages this group of venture-stage companies to outsource activities that lie outside their core expertise rather than build in-house discovery capabilities, and we have already signed agreements with Elixir Pharmaceuticals, Psychiatric Genomics and Dynogen Pharmaceuticals.
The quality and value of our contract research was underlined by the first clinical milestone from our collaboration with Vertex.
Other agreements during the year were signed with Achillion Pharmaceuticals, Avidex, British Biotech, Infinity Pharmaceuticals, the Institute of Medical Technology Magdeburg, KeyNeurotek, Oxagen, Prolysis, Taisho Pharmaceutical Co and U3 Pharma.
As part of our strategy of focusing Evotec OAI on drug discovery, we completed the spin out of our instrumentation and technology business into the majority-owned subsidiary, Evotec Technologies GmbH (ET). The aim of the spin-out was to eliminate the cash burden on our core business, to allow ET to streamline its operations, make it profitable and to ultimately find a strategic partner. As part of the contract extension with Pfizer, Pfizer decided to acquire a 10% stake in ET and to become its first equity partner.
In parallel, Discovery Programs was established as a new division in 2002, which engages in selected discovery activities to develop compounds for out-licensing. This division enables us to benefit from the increasing trend by pharmaceutical companies to strengthen their pipelines through the acquisition of intermediary products such as qualified leads, pre-clinical development candidates and INDs. The strategic objective of this activity is to generate proprietary intellectual property that can provide Evotec OAI with additional long-term financial upside through more significant milestone and royalty agreements.
Financial Review
Despite the difficult market conditions described above, total revenues increased by 11% to EUR 70.0 m (2001: EUR 63.2 m). While the growth rate for the first half of the year was in line with our target of 20% to 30% annual growth, a broad deterioration in market conditions affected many of our customers later in the year. Biotech companies delayed R&D spending decisions to conserve cash, and pharmaceutical companies also restricted spending. With a substantial amount of revenues generated in sterling, the weakness of the British pound against the euro also affected performance, reducing reported revenues by EUR 1.6 m compared with 2001 exchange rates.
While our pilot plant and chemical process development services were affected strongest by this market trend, our core service lines of discovery chemistry and biology continued to grow healthily. Overall revenues from Discovery and Development Services rose by 13% to EUR 58.6 m  (2001: EUR 51.7 m).
The operating loss was EUR 135.5 m (2001: EUR 152.5 m), an improvement of 11%, largely due to the discontinuation of goodwill amortisation offset by impairment of goodwill. Operating losses before amortisation or impairment of goodwill and other intangible assets amounted to EUR 14.1 m (2001: EUR 12.3 m). This increase was primarily due to a different sales mix, resulting in lower gross margins of 45% (2001:47%), and planned idle capacity costs at our new pilot plant.
R&D expenditure was held at 2001 levels, totalling EUR 23.0 m (2001: EUR 23.0 m), reflecting our continued strong commitment to the core areas of R&D, which are critical to our long-term success. These include the continuing enhancement of our discovery service and discovery programme activities. Reductions in headcount were initiated in tools and technology development following the successful completion of our EVOscreen® platform, which will require a significantly lower level of R&D activity to support planned growth.
Selling, General and Administrative (SG&A) costs increased by 7% to EUR 20.5 m (2001: EUR 19.2 m), primarily due to the expansion of our corporate and business development resources in 2001. In the third quarter of 2002, we took action to cut costs to reflect the current environment, and these reductions will have their full impact in 2003.
Earnings before interest, tax, depreciation and amortisation or impairment (EBITDA) totalled EUR -2.2 m, only slightly below last year's level (2001: EUR (1.0) m) and significantly better than our October 2002 guidance (EUR (3) to (6) m). Despite slower than expected growth in the second half of 2002 we maintained our major R&D projects, continuing to build strategic position.
Cash flow from operating activities amounted to EUR -1.0 m (2001: EUR -2.5 m). Cash consumption was mainly driven by R&D spending, slightly lower gross margins and increased inventories, primarily as a result of existing customer contracts with Merck and Pfizer. These were however largely offset by reduced trade accounts receivables.
Capital expenditure was focused on the further expansion of our laboratory capacities in Abingdon and the screening factory in Hamburg. As planned, we invested a significantly lower amount, EUR 8.7 m (2001: EUR 17.5 m),  in tangible and intangible assets. To finance parts of this capital expenditures we drew down long-term bank loans of EUR 4.9 m and entered into capital lease agreements of EUR 1.4 m.
At 31 December 2002, our cash and cash equivalents totalled EUR 21.3 m, up from EUR 14.9 m at the end of Q3 2002. With this healthy liquidity position, combined with the cost cutting measures initiated in the second half of 2002, we remain confident that Evotec OAI can deliver on its business plan and finance continued strong growth of its services business.
The net loss for the year, including the non-cash effects relating to the impairment of goodwill and other intangible assets, improved to EUR 131.6 m (2001: EUR 147.8 m). This reduction was again mainly a consequence of lower goodwill impairment compared to the previous year's goodwill amortisation. Non-operating income of EUR 1.1 m as well as favourable tax treatments contributed to a reduced net loss. We reported EUR 2.8 m net tax benefits in 2002, resulting from EUR 3.2 m deferred tax benefits from the amortisation of developed technology and customer list and EUR 0.2 m deferred tax expenses in the UK, as well as EUR 0.2 m current taxes worldwide.
The loss per share improved to EUR 3.71 (2001: EUR 4.17).
Goodwill amortisation/impairment - compliance with SFAS 142
Evotec OAI adopted the new accounting standard SFAS No. 142, "Goodwill and Other Intangible Assets" as of 1 January 2002. This rule requires that goodwill (and other intangible assets with indefinite useful lives), primarily created in the merger with Oxford Asymmetry International (OAI), may no longer be amortised, but tested for impairment at least once a year. At a first review of our goodwill as of 1 January 2002, we saw no indication for an impairment charge. In light of the developments in the financial and customer markets and with the decline of our market capitalisation, we decided to perform a second impairment review as of 31 October 2002 and indicated in our Q3 report that we expect to impair EUR 110 to 130 m in Q4. This prudent review finally resulted in a non-cash impairment charge of EUR 109.4 m in Q4 2002. This is less then the goodwill amortisation which we would have accounted for under the rules prior to the changes of US-GAAP literature, when we amortised goodwill over a three-year period, incurring annually EUR 127.6 m goodwill amortisation. Additionally we will continue to amortise the other merger-related intangible assets over three to five years, resulting in an annual amortisation charge of around 12.0 m Euro a year including other intangibles.
Management changes
In December, Ian M. Hunneyball was appointed President, Services Division, the Company's core business, and a member of the Management Board, leading Evotec OAI's operations in Abingdon and the services operations in Hamburg. The appointment reflects the increasing demand for integrated "Target-to-IND-Services" covering all biology and chemistry aspects of drug discovery. Dr Hunneyball has more than 24 years of business experience in the pharmaceutical and biotech industry, and was most recently at Entomed S.A and Knoll Pharmaceuticals Ltd. (BASF Pharma).
In June, Dr John Kemp was appointed Chief Executive Officer of Evotec Neurosciences GmbH, the subsidiary focussing on Alzheimer's Disease and related programmes. Dr Kemp has 18 years' research experience in the area of Central Nervous System and joined Hoffmann-La Roche in 1994, where most recently he was Vice President and Head of Preclinical CNS Research.
Looking ahead to 2003, we are fundamentally well positioned, having built the critical mass and capabilities that make us an attractive long-term partner to our current and prospective customers. We expect to achieve growth of 10-15% in 2003, assuming that the outsourcing market remains weak. However, we continue to believe that we can reach mid- to long-term growth of 20%-30% p.a., once the markets recover. As of February, the order book for 2003 amounted to EUR 57 m, covering 73% of current analyst revenue expectations for 2003 (analyst consensus: EUR 78 m). This compares favourably to contracted 2002 revenues of EUR 37 m at the same time in 2002. With our strong order position and stringent cost management, the Company is on track to reach its target of positive EBITDA in 2003.
About Evotec OAI AG

Evotec OAI has established itself as the partner of choice for drug discovery and development services for the world's premier pharmaceutical and biotechnology companies, maintaining its leadership role through innovation and unmatched customer service.

Our business strategy is clearly focussed on drug discovery. We have established the most comprehensive technology platform and skills that integrate our world-class biology and chemistry capabilities. We leverage this discovery engine in providing assay development and screening through to compound optimisation and drug manufacturing services to a broad and stable network of customers. In addition, we engage in selected discovery programmes ourselves to develop drug candidates for early out-licensing. Our instrument and technology business is now successfully handled by our affiliate, Evotec Technologies.

With over 600 people in Hamburg, Germany and Abingdon, UK, Evotec OAI is dedicated to returning value to its shareholders and employees through a sustainable business strategy that balances short-term and long-term revenue opportunities.