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Albany Molecular Research, Inc. (NASDAQ:AMRI)

Q4 2012 Earnings Call

February 12, 2013 10:00 am ET

Executives

Thomas E. D’Ambra – Chairman, Chief Executive Officer and President

Michael Nolan – Vice President, Chief Financial Officer and Treasurer

Analysts

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Operator

Please standby, we’re about to begin. Good day ladies and gentlemen and welcome to the AMRI Fourth Quarter 2012 Earnings Release Conference Call. As a reminder, this call is being recorded. At this time, I’d like to turn the call over to your host, Dr. Thomas D’Ambra, Chairman, President and Chief Executive Officer. Please go ahead, sir.

Thomas E. D’Ambra

Thank you, Tim. Good morning ladies and gentlemen. Welcome to the conference call segment of AMRI’s 2012, fourth quarter and 2012 full year earnings announcement. This call is a follow-up to our press release issued earlier this morning over PR Newswire.

With me on the call today is Michael Nolan, AMRI’s Vice President, Chief Financial Officer and Treasurer. I’m pleased to report that in the fourth quarter, AMRI exceeded expectations and guidance, delivered strong EPS growth and improved our cash position. These results were driven in part by continued strength in our Large Scale Manufacturing operation led by a record quarter and full year performance by our Rensselaer Large Scale API operations on both the top and bottom line.

Rensselaer performance is anchored by several long-term supply agreements put in place or renew during 2012. I will speak more about these in later remarks. These agreements set the stage for long-term visibility of AMRI’s Large Scale operations starting in 2013 and extending several years beyond.

In addition to the impressive Large Scale performance, our fourth quarter and full year results also benefited from previous and continuing actions to improve the company’s cost structure. Tough decisions that were implemented over the past 18 months are resulting in improved operating performance and high margin pull-through to the bottom line as we grow our contract revenue.

Whereas API demand for our Large Scale segment has been strong, demand for discovery and early development services continues to be soft relative to prior period. Nevertheless, AMRI’s 2012 performance also benefited from new strategic relationships put in place such as the Lilly insourcing collaboration and the NIH translational discovery contract both of which ramped up to full scale during 2012.

I believe that multiyear relationships such as these two, signaled the beginnings of a shift and focus in pharmaceutical outsourcing for discovery work to strategic driven decision making by our customers and could ultimately mere some of the larger relationships announced between big pharma and leading clinical CROs.

At anyway these new relationships represent the beginning of an evolution of thinking regarding outsourcing in which sponsors are making decisions for strategic reasons versus tactical procurement driven decision making and commoditization that it marked much of the last decade.

While we continue to focus on operational excellence and opportunities for improvement, we also continue to focus efforts to address and anticipate changes in the marketplace, strengthening AMRIs position as a top provider of Discovery, Development and Manufacturing Services.

I’m going to pause now and turn the phone over to Mike Nolan for his comments afterwards, I will have additional remarks. Go ahead, Mike.

Michael Nolan

Thank you, Tom. Before we begin, I would like to note that much of our discussion today might be termed forward-looking. Other than historical facts, our statements may contain projections, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those disclosed in the company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission on March 15, 2012 and the company’s other SEC filings.

While these statements represent management’s current judgment on the future direction of the company’s business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested here in. The company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date herein. I’m now going to present financial results for the fourth quarter and full-year 2012 and financial guidance for the first quarter and full-year 2013. Further details are included in our press release issued this morning over PR Newswire.

I’d like to underscore some highlights on a year-over-year basis. These includes streamlining our U.S. and European operations resulting in expected annual savings of roughly $800,000 in 2013, and in line with our previously communicated full-year run rate benefit of $2 million.

We conducted a European operations view which led to the decision to close our Hungary operations and then strengthen our services for our customers out of Asia, including moving key capabilities to our site in Hyderabad, India. We also announced the realignment of our Biology business and the resulting closure of our Bothell, Washington facility and movement of our full biology service offerings to our site in Singapore strengthening our integrated offering there.

Larger Scale Manufacturing finished the year at record levels with $116.4 million of revenue, which represents a growth of over 2011 of 22%. In addition to a strong performance from our contract business, we also announced a new royalty stream with Actavis in the third quarter and recorded $4.7 million of royalties in 2012.

This new royalty agreement extends for five years with the rolling window based upon any new product launch by Actavis using AMRI’s amphetamine salts. The royalty stream commenced in June 2012 and then extended further with a second product launch from Actavis in November 2012.

Turning to financial results for the fourth quarter 2012, all comparisons are on a year-over-year basis. To begin with, adjusted operating income in the fourth quarter excluding royalties, milestones, restructuring charges, and executive transition costs was $500,000. This compares to a negative $12.1 million in the fourth quarter of prior year with a strong pull-through on our increased contract revenue and returning the company to profitability excluding royalties. Total revenue was $67.2 million, up 44%. Total contract revenue is $59.1 million, an increase of 50%.

Total contract revenue encompasses revenue from AMRI’s Discovery Services, Development and Small Scale Manufacturing and Large Scale Manufacturing business components. Contract revenue from Discovery Services was $10.6 million, an increase of 12%. The increase reflects continued improvement with our insourcing agreement of Lilly along with several improvement in our Asian Medicinal Chemistry business.

Our Biology business in both U.S. and Singapore is down slightly, sequentially we saw improvement in our discovery portfolio between the third and fourth quarter. Contract revenue from Development and Small Scale Manufacturing was $10.4 million, an increase of 41%.

From a geographic standpoint, we had growth in our U.S. Development and Small Scale Manufacturing offset slightly with some softness in our UK and India operations. Contract revenue for Large Scale Manufacturing was $38.1 million, an increase of 69%. This increase was primarily attributable to a strong API business particularly at a Rensselaer facility along with some improvement at our UK and India operations.

Our compounds in Phase I and Phase II development programs now stands at 48 as of the end of the fourth quarter. The number of compounds in Phase III that we are working on with clients is 23 as of the end of the fourth quarter. Overall, royalties were $8.1 million, an increase of 13%.

Royalty revenue for the fourth quarter of 2012 includes royalties from the Allegra product as well as $1.4 million earned by the company on net sales of a generic product sold by Actavis for which the company also manufacturers the active pharmaceutical ingredients at a Rensselaer in New York facility.

The increase is due to the addition of royalties from Actavis. R&D costs were down $1.7 million from the prior year reflecting the company’s reduced internal R&D focus. Selling, general and administrative costs were up 4.6% on a pro forma basis, excluding one-time charges related to executive transition, reflecting an increase in incentive-based compensation in line with business performance.

Adjusted earnings per share on the fourth quarter of 2012 were $0.17 per diluted share, compared to the fourth quarter in 2011 of negative $0.19 per diluted share. Adjusted earnings per share exclude cash and non-cash charges for a previously announced closure for our Bothell facility, as well as executive transition costs.

Moving to full-year results, our contract revenue of $189.9 million was up 12% and above the top end of our guidance of 10% growth. Large Scale Manufacturing was up 22% driven by a record year at our Rensselaer facility with continued strength in our API business. We also had significant growth in our UK Large Scale business offset slightly with some softness in our India Large Scale operations.

Our Aseptic Fill business located in our Burlington facility, which is also included in our Large Scale Manufacturing business was also up 25%. Overall, contract margin improved to 12% versus 1% in the previous year. The improvement in contract margin reflects a strong pull-through of incremental revenue over our fixed cost base along with an improved mix of business.

Contract margins for the year was 16% in Large Scale business, up from break-even in 2011 as a result in a strong pull-through of incremental revenue over our fixed cost base. Contract margins in our Discovery and Development and Small Scale segment improved by 2% to 4% from 2011. The improvement versus prior year was driven primarily by an increase in Discovery margins because of higher revenue and the resizing of our U.S. cost structure. This was offset to a degree because of lower small scale demand.

SG&A expense excluding one-time charges primarily due to executive transition costs reduced by 1% compared to 2011 and ended the year on a pro forma basis around 21% of contract revenue.

R&D expense for the year decreased by $7 million and ended at $0.9 million. Reductions in R&D spending are consistent with the company’s decision to reduce its focus on internal R&D programs, while continuing to pursue out-licensing opportunities as a way to leverage our existing intellectual property of state.

Adjusted earnings per share for the year was $0.25 per diluted share compared to 2011 of negative $0.42 per diluted share. Adjusted earnings per share exclude cash and non-cash charges for the previously announced closure of our Bothell and Hungary facility, as well as executive transition costs.

A few points on our cash position; during the year, we generated $15.3 million of cash from operations and exceeded our second half increase in unrestricted cash and cash equivalents of $6 million, by $3.9 million. Our cash, cash equivalents and restricted cash increased to approximately $28.5 million with 2012 CapEx of $9.9 million.

I will now provide our full-year and first quarter 2013 guidance – financial guidance. Looking at full-year 2013, we expect our contract revenue to range from $205 million to $213 million, an increase of up to 12% from 2012. Our book-to-bill ratio ended the year at 1.3, excluding the impact of a number of multiyear contracts.

To get to the range of $205 million to $213 million, we project Discovery Services revenue to range from $39 million to $42 million, which is up potentially 11% versus 2012. We’re expecting a small impact from closing Bothell, which will reduce our revenue, although improve our margins.

We are seeing significant interest in insourcing relationships like Lilly, but we have not built these potential future opportunities into our 2013 guidance. We’ve also not included any costs or opportunities, related to the Buffalo undertaking that has recently been announced by Governor Cuomo. This initiative will be discussed by Dr. D’Ambra later in the call.

Turning to the Development and Small Scale, we anticipate revenue to range from $35 million to $38 million, an increase of up to 7% from 2012. We are starting to see stronger signals on demand and this component have made some sales changes, which we think will yield dividend and drive improved growth as we progress through the year.

We project Large Scale revenue to range from $131 million to $133 million, an increase of up to 14% from last year. Our U.S. API demand continues to remain robust reflecting U.S. specialty pharma and biotech customers moving forward in their later stage compound as previously commented. In addition, we are projecting a stronger year in Aseptic Fill business in Burlington along with continued improvement in our UK and India Large Scale operations.

Turning to contract gross margins, we are guiding to improve our contract margin some 12% in 2012 to the midpoint of 15% in 2013. We expect to see improvement in contract margin from the first quarter as contract revenue increases through the year.

We will also see some benefit resulting from the closure of our Bothell facility at the end of the first quarter. R&D investment is expected to remain flat around $1 million, focused on opportunities to make new niche generic products for improved process efficiencies in the plan and also further our out-licensing opportunities.

We project SG&A costs to be flat versus 2012 based on ongoing cost savings offsetting inflation. As a percentage of sales, SG&A will approximate 18%, which is down 3% versus 2012. Pro forma SG&A for 2012 excludes the impact of one-time executive transition costs.

As we have stated in our last call and in the last few announcements issued, we have undertaken cost steps to ensure we reach profitability excluding royalties by the end of 2013 on a run rate basis. The cost steps of realigning our Discovery Services as well as managing down our SG&A and R&D spend should reduce our annual cost structure to improve our goal of being profitable excluding royalties and milestones. These actions along with our outlook for contract revenue should improve our profitability in 2013.

For royalties, we are projecting a range of $35 million to $39 million including between $6 million and $8 million from Actavis royalties. I want to point out that 2012, Actavis royalties of $4.7 million, which started in June of 2012, included large quantities. So year-over-year comparison is not linear. Also important to note is that the 2% portion of the Allegra royalties for sales in the U.S. end in November 2013.

Given the range of revenue, royalties and mix impact on our effective tax rate our guidance for earnings per share results in a wide range. For full-year 2013, we currently expect an adjusted earnings per share range of $0.34 to $0.52. If possible, we will update this range as the year progresses. At the midpoint, our adjusted earnings per share guidance represent a 72% increase over our adjusted earnings per share of $0.25 in 2012.

Our adjusted earnings per share guidance for 2013 excludes the impact of our previously announced closure and restructuring charges of our Bothell facility. As a result of our increased operating performance, ongoing working capital management and disciplined capital program, we predict a strong cash flow in 2013. Operating cash will range from $20 million to $25 million before CapEx of between $12 million to $14 million.

For the first quarter, we expect contract revenue growth compared to prior year to range from 1% to 5%. As the year progresses, we anticipate higher growth in contract revenues through the middle of the year with a tougher comparable by the end of the year as a result of the strong fourth quarter we had in 2012. To get to the first quarter range of $40.5 million to $43.5 million, we projected Discovery Services revenue to range from $19.5 million to $10.5 million, up potentially 3% from 2012 at the midpoint.

We anticipate Development and Small Scale revenue to range from $7.5 million to $8.5 million, which is potentially down negative 18% at the midpoint from 2012 levels. We are concerned about the level of demand in this area, although we believe our sales actions should benefit later quarters. We also experienced strong first quarter 2012 sales as a result of 2011 fourth quarter sales being delayed making the comparable more difficult.

We project Large Scale revenue to range from $23.5 million to $24.5 million, an increase of up to 3% at the midpoint from 2011. We project royalty revenue will range from $11 million to $13 million, up slightly due to the additional Actavis royalties.

We expect contract gross margin in the range of 19.5% to 14.5%. SG&A and R&D will be slightly down in the first quarter versus prior year, primarily driven by lower R&D spend. For the first quarter, we expect adjusted earnings per share to range from $0.08 to $0.12. Adjusted earnings per share exclude cash and non-cash restructuring charges from our previously announced closure of Bothell facility.

I will now turn the call over to Dr. D’Ambra, who will continue with additional comments.

Thomas E. D’Ambra

Thank you, Mike. Approximately a year ago, we rolled out AMRI’s SMARTSOURCING as a new branding and sales approach, three focused outsourcing decision making to outcomes our result versus decision making being only driven by the lowest price.

One year in AMRI SMARTSOURCING is yielding results. For example, our marketing partner conducted a survey comparing AMRI’s brand awareness at the end of 2012 versus one year previously. Industry perceptions in AMRI in terms of company awareness and favorability ranking improved 18 percentage points over the past year.

As early R&D spending grows to higher levels, AMRI is positioned to be a partner of choice. We intend to continue and increase our marketing and business development efforts, and the AMRI SMARTSOURCING branding strategy is poised to begin the New Year with the next-generation approach.

Throughout 2012 as we have noted before, market demand for discovery and early development has been somewhat soft as a majority of large pharmaceutical companies have cut overall R&D spending from peak levels and focused on increasing slice of the budget’s late-stage pipeline.

Smaller biotech and startups that have no revenue and need continued cash infusions to survive have had to endure a drought and venture funding, equity markets close to IPOs, and a tighter and tougher licensing environment for their programs. These factors have contributed to current soft demand levels for outsourcing of early stage research resulting in a more competitive environment in an excess of capacity in discovery and early development competing for fewer projects overall.

Against this backdrop, AMRI announced a number of cost-cutting measures and tough decisions beginning in the second half of 2011, which continues up to the present with our announcement in early December to close our Bothell operations, and consolidate AMRI’s Bothell Discovery biology and related services into our Singapore and Albany locations.

As we begin 2013 and speak with customers and other industry leaders about the marketplace, the view for the near future remains similar to the past year. Most companies remain focused on late-stage pipelines and costly Phase III clinical studies continue to heat up a disproportionate share of R&D budgets. This puts a squeeze on a number of early-stage program that can be funded.

As the late-stage programs conclude, however, is anticipated that more R&D funding will be available to refill the pipeline. Several customers have indicated that they anticipate 2014 budgets to provide more funding for earlier-stage research.

The good news for the drug industry is that the FDA approved 39 new entities in 2012, which was the most since 1996. A significant number of these approvals were for breakthrough treatments for significant unmet need. Several industry reports suggested that the high approval rate of 2012 is projected to continue at this level through 2015 or beyond. This bodes well for the industry and its stakeholders and availability of capital to reinvest in early R&D efforts should improve.

And one thing for the company’s pipeline, the proper analogy is the funnel, because the high attrition rate in clinical development requires multiple compounds to end of the pipeline at early stages for every [NTE] that makes up the market. We believe there are already signs of the customer R&D environment has stabilized and it’s beginning to improve.

Most pharmaceutical companies have completed the consolidations and program and facility rationalizations and layoffs that marked much of the 2011 and early 2012 period and are now focused on improving efficiency and productivity with leaner business models. Against this backdrop and because of these factors, we believe that customers are beginning to rely more significantly on outsourcing as a variable and accountable resource to support their R&D initiatives.

Turning to our individual business segments, AMRI’s 2012 performance was led by our Large Scale Manufacturing operations and our Rensselaer, New York, API plant headed the pack. Rensselaer operations benefited from orders to support a number of recent regulatory submissions and/or commercial launches in which we are a major or the primary supplier of the active ingredient.

In addition, during 2012, we entered into or renewed commercial supply agreements to provide multiyear visibility for business at the plan. Among these was the announcement in the fourth quarter of the renewal and extension the commercial supply agreement with GE Healthcare for which we provide large quantities of an intermediate play diagnostic imaging agent. This product relationship with GE Healthcare has been an important one for AMRI since full acquisition of the Rensselaer plant in 2003, and at this time remains our largest commercial supply arrangement.

This contract continues to position AMRI as a strategic supplier to GE Healthcare and provides a consistent and high quality revenue source for the Large Scale Manufacturing business segment through 2016.

We also announced in October the renewal and five-year extension of the supply agreement with Shire US Manufacturing Inc., a subsidiary of Shire PLC. The agreement extends that previously existing agreement between our two companies and the partnership lays the groundwork for AMRI that they considered by Shire for future development and manufacturing opportunities.

AMRI has been manufacturing the active ingredient for Vyvanse since it was discovered and developed by New River Pharmaceuticals, which was subsequently acquired by Shire. In addition to the above two agreements, AMRI entered into an additional commercial API supply agreement at the end of 2012 for a new prescription oncology drug that was approved by the U.S. FDA during the summer of 2012.

We supplied large quantities during the year and are working on orders for additional material in 2013. The customers requested confidentiality at this time. This new product represents a promising improvement over existing therapeutics, although will likely take time for volumes of this new product to reach peak sales, early indications are promising.

In addition, the above three customers for Rensselaer, 2012 results benefited from the preparation of the active ingredient used in alogliptin for Takeda which has been on the market in Japan since mid-2010. Three alogliptin products received U.S. FDA approval at the end of January this year. Further commencements by Takeda suggest that they anticipate entering the marketplace by early summer.

Another notable milestone for Rensselaer’s performance was achieved late in the second quarter as our customer Actavis Inc. received approval of their AMDA for the launch of amphetamine salts as a generic treatment for ADHD. AMRI’s relationship with Actavis extends back to an agreement with the Rensselaer site from the year 2000.

In addition to supplying the active ingredient for this generic, AMRI will also be receiving royalties on net sales of generic products incorporating are active. The term of this agreement extends until five years after the launch of the last product that uses the active ingredient. Based on the launch of a separate generic product in November, the terms of this agreement currently extend through late 2017.

For 2012, royalties to AMRI from net sales of this generic amounted to $4.7 million. As this generic is currently ramping up and gaining market share, we cannot provide visibility on how much growth and market share our customer will acquire. Therefore, as Mike has mentioned, we are currently estimating total royalties for 2013 to be approximately flat with 2012 driven by growth in this new royalty stream offset by a commensurate decline of royalties anticipated from worldwide sales of Allegra products.

It should be noted that any revenues or royalty stream from sales of amphetamine salts are subject to market competition.

If additional generic launches occurred during the term of our agreement with Actavis, these additional products may adversely affect revenues and royalties we’ve received from this product. That being said, we’re not aware of any pending further generic approvals of amphetamine salts at this time.

As a result of the second record year in a row for our Rensselaer site, we are pleased to acknowledge the outstanding performance and customer service of the Rensselaer leadership team and staff. In spite of another record year for demand and particularly in terms of supporting new customer launches, the team at Rensselaer delivered an outstanding job in meeting multiple deadlines and deliverables.

In recognition of this outstanding leadership, we were also pleased to announce at the beginning of January, the promotion of Richard A. Saffee to Vice President and General Manager of Global Large Scale Manufacturing. Rick was recently assigned over site of AMRI’s Global API Manufacturing Operations and he and his team have already taken steps to better integrate our operations, personnel and procedures across all global manufacturing sites, which encompass the U.S., Holywell, Wales, and UK and a rank of that India.

He is also noteworthy to point out that the Rensselaer site was audited once again by the FDA at the end of January 2013. Consistent with the sites history of the plant again received high marks for quality systems, performance and inherent to regulation. Although, a Form 43 was issued from this inspection, the observation noted was minor and has already been remediated.

We have continued to invest in targeted capital upgrades, the Rensselaer plant in order to be able to handle increasing demand. Utilizing additional capacity in both Wales and India is also part of our strategy to handle this growing demand for APIs and advanced intermediate.

As mentioned in prior period, we have received FDA and MHRA approval for our facilities in Wales. We have been executing the plan to bring additional large volume capacity in Wales to U.S. FDA standard. These investments and work are expected to be completed by the end of this quarter.

Wales has significant large scale capacity that positions AMRI to be able to manufacture active ingredients for our customers from the U.K., as well as from Rensselaer in the U.S.

Also, as part of an evaluation of capacity and utilization at Rensselaer, we’ve begun to take steps to move some production to Wales. In addition to upgrades in Wales, a quality improvement initiative is also underway at our Aurangabad facility in India. Currently, the site in India can only manufacture GMP registered intermediate and starting materials.

Our goal for India is to complete these investments by midyear and subsequently trigger both the U.S. FDA and European reviews. These investments will ultimately allow us to also supply selective APIs out of India to western market. All of these strategic undertaking should allow us to significantly ramp up our volume and therefore revenue from our global manufacturing facilities without excess or out of the norm capital spending required.

We remain committed to driving the full capacity utilization of the investments we have already made in manufacturing facility with targeted capacity improvements and upgrades as needed. With the completion of these facility and quality upgrades in Wales and India, AMRI will be able to support the manufacture of active ingredients for our customers utilizing our global network of facilities. These investments are important in allowing our Large Scale operations to continue to support growing demand.

As of December 31, we continued to manufacture the active ingredient or drug product for 23 compounds in Phase III. This is slightly down from 25 compounds in development at the end of the third quarter. We currently manufacture 34 commercial active ingredients in one drug product for multiple clients. This has not changed from the prior quarter.

In addition to supporting Phase III and commercial compounds, AMRI is manufacturing the active ingredient or drug product for another 48 compound; our customers are evaluating in Phase I or Phase II clinical studies. This has decreased from 53 at the end of the third quarter.

Note, the customer compounds in Phase I or Phase II maybe manufactured at one of our Large Scale facilities or in the development of Small Scale of GMP suites, one of our other facility. While we have solidified our Large Scale business for the number of multiyear commercial manufacturing agreements as described earlier in my remarks, we continue to support a large number of additional compounds and development.

While one would expect that not every compound in clinical development will lead to a commercial product, the large number of compounds that AMRI is supporting in development represent the potential to enter into additional manufacturing agreements in the future for products that are successfully commercialized and augurs well for the continued growth and opportunities for future business for our Large Scale Manufacturing activities.

Shifting focus to our Burlington, Massachusetts, perennial dosage form fill and finish operations, Burlington continues to make progress in growing its business revenues, which grew 25% over the prior year. I’d like to remind everyone that this facility is fully functional and serving customers from around the world.

The pipeline of opportunity is stronger than any time since Burlington was acquired, but we continue to experience the headwind of the FDA warning letter, which was received in August of 2010. The FDA last inspected the Burlington operations in June of 2011, right after the site resumed production following closure to remediate the observations in the warning letter. Based on communications with the FDA, New England District Office during the third quarter of 2012, we’re expecting the FDA to audit Burlington in the near future. We continue to be in a state of readiness for this audit while also seeking opportunities for continued improvement.

This is noteworthy that the Burlington site was audited by perspective customers 13 times during 2012, including by two different large pharmaceutical companies and was approved as a supplier every time. As a result, we remain optimistic that the headwinds of the overhang from the warning letter could be turned to tailwinds from a successful FDA inspection.

In the meantime as I mentioned above, we’re operating without restriction in supporting a number of customer programs by supplying drug products for clinical trials. It should be noted, however, that we cannot guarantee that a follow-up FDA inspection will not uncover additional observations that could prevent the warning letter from being closed out.

That being said, a successful outcome will likely allow more potential customers to add AMRI Burlington to their list of preferred suppliers. With regard to AMRI’s Discovery and Early Development, as noted, these segments of our contract services continue to experience soft demand.

Nevertheless, contract revenues for Discovery and Early Development were both essentially flat over the prior year with revenue growth for U.S. Discovery chemistry offsetting a roughly $3 million decrease from the prior year as a result of our discontinuation of operations at our former Budapest, Hungary Discover facility, which seized operations at the end of the first quarter in 2012..

We have completed the transfer of selected AMRI Hungary assets and compound library synthesis technology to our Hyderabad facility and the Hyderabad group is in the process of completing its first major library production contract. Additional Hungary relationships were transitioned to both AMRI’s Hyderabad and Singapore labs. Consolidated AMRI’s former Hungary operations in India and Singapore was in response to customer preferences and better positions these services to compete in an evolving marketplace.

As previously stated, growth in U.S. Discovery Services was driven by the insourcing collaboration with Eli Lilly for chemical synthesis and the contract with the U.S National Institute of Health, Neurological Diseases Institute for Medicinal Chemistry and related translations services to benefit the NIH’s blueprint program for advancing novel technology developed by academic and other small organizations.

Both the Lilly insourcing relationship and the NIH contract are multiyear relationships and reached near full staffing during 2012. We believe there are opportunities for growth of both relationships in the future, as well as opportunities for additional insourcing models with other companies similar to the contract pioneered with Lilly.

An additional highlight for Discovery Services during 2012 was the Discovery contract with Knopp Biosciences announced in September. Under this two-year agreement, AMRI is providing various Discovery related services that include medicinal chemistry, DMPK and computer-aided drug discovery or CADD. Since 2006, AMRI has worked with Knopp to provide early process development work, route development and small-scale and large-scale GMP manufacturing, as well as analytical method development and validation support.

On the Development and Small Scale part of our services business, performance remained flat over the prior year. But we continue to maintain several significant relationships and support the development of multiple new products that may eventually transition to our Large Scale business segment.

The previously mentioned closure of AMRI’s former Hungary operations was part of several cost-cutting initiatives that began in the second half of 2011 and continued during 2012. In addition to closing Hungary, we suspended funding internal R&D compound discovery and development and right-sized our US-based operations, which yielded approximately $17 million of savings on an annual run rate basis.

We also outlined in early December last year, our plan is to further reduce our global footprint and cost basis by taking steps to close our Bothell, Washington location. This recent action is expected to provide a further $2 million plus in annual run rate savings.

If we compare AMRI’s expense footprint when we ended 2011 to our expense footprint entering 2013, we have or will have cut a total of approximately $20 million in spending and have not factored into our planning, a drop in revenue. We are becoming leaner and more focused on meeting our customers evolving needs related to the location of business services.

The cessation of AMRI’s Bothell operations is expected to be completed by the end of the first quarter of this year. As a result of this decision, besides biology capabilities in certain customer projects will transition to AMRI’s integrated discovery location in Singapore and certain analytical capabilities will consolidate into AMRI’s analytical quality group in Albany, New York.

On Tuesday, December 4, New York Governor, Andrew Cuomo announced a number of initiatives that are expected to receive significant investment as part of his economic development plan to reinvigorate the economies of several communities across Upstate New York. As part of this plan, the Governor announced that New York will invest $50 million in state-of-the-art biomedical research equipment and facilities in Buffalo. AMRI is preparing plans to locate newly established biology centered operation in Western New York at the Buffalo Niagara Medical Campus or BNMC, the site chosen by the state for the first phase of this exciting new initiative.

New York’s investment, $35 million of which will go towards new biology equipment and $15 million of which will go towards improving existing lab space is expected to leverage additional private investment and create hundreds of jobs, is a participation of multiple companies.

Governor Cuomo’s upstate investment strategy is based on recreate in western New York what nano-science research and development did for the Albany region by investing in core infrastructure and equipment providing a state owned foundation for private sector job growth. This approach made the Albany region an international center for nano-scale research and now commercial development in the field of chip manufacturing.

The Governor through his Buffalo initiative is focused on replicating this approach in Western New York building upon existing infrastructure and leadership in life sciences research development already there. AMRI is pleased to be working in the state of New York on this important initiative. AMRI’s long-term commitment to the Upstate New York region is unparalleled as shown by our location of operations in Albany, Rensselaer, and Syracuse.

This new initiative with recognized institutions like the Jacob’s Neurological Institute of the University at Buffalo and the College of Nanoscale Science and Engineering or CNSE is being designed to create an open-access platform that fosters great competitive collaborations between pharmaceutical industry partners, equipment providers, and related industrial providers and a host of statewide and national universities in small biotech entity.

As an anchored tenant for this initiative, AMRI is excited to be working with the Governor and our other partners in making this vision a reality. The state is currently in discussions with other third-party organizations to collocate and these yet to be filled facilities alongside AMRI.

As Mike mentioned in his earlier remarks, our guidance for 2013 does not incorporate any costs or revenues from this initiative. Current discussions already sensitive stage and final details are still being worked out. Therefore, we are not in a position to comment further on this initiative.

Although in late 2011, we discontinued new funding of internal R&D efforts directed at discovering and partnering new chemical entities in selected therapeutic areas. Those efforts have yielded intellectual property and partnering relationships that continue to pursue the development of AMRI discovered compounds.

Yesterday, we announced the election of the option by Bessor Pharma’s wholly-owned subsidiary Chai Therapeutics, LLC to pursue the continued development of AMRI’s novel tubulin inhibitor. The lead compound ALB 109564(a), the novel analog from an established and marketed class of tubulin inhibitors to vinca alkaloids, which kill cancer cells by preventing cell mitosis and are currently marketed and used expensively in any cancer chemotherapy as single entities and in many combination cocktails.

In pre-clinical testing ALB 109564(a) showed several advantages over existing agents and its class, including greater efficacy, activity against a broader range of tumor types, indications of reduced side effect potential, as well as potential for our greater safety margin.

ALB 109564(a) has reached late Phase I clinical testing at three different centers in Boston, the four was discontinued as part of an earlier cost-cutting action. With the exercise of the option by Bessor Pharma, AMRI received an undisclosed upfront payment. More importantly, Chai Therapeutics’ formation and election to excise the option will result in completion of the Phase 1 activities and additional activities will be initiated with a goal to identify an optimal use and further advance the compound.

AMRI will receive a share of any consideration ultimately received upon further licensing or commercialization of ALB 109564(a) or any of the analogs covered by the agreement. With regard to other partnered programs, we believe that 2013 could be an important year for AMRI’s CNS program that was licensed to Bristol-Myers Squibb in late 2005.

The program has resulted in milestones received for four lead compounds, the fourth compound being identified in milestone accrued in third quarter of 2012. The lead compound from our collaboration farthest advanced BMS-820836 is currently in two Phase II clinical studies for treatment resisting depression.

Both studies have projected end points during 2013 at which point the data will be unblinded. A positive decision to proceed to Phase III clinical studies would be a material statement as to the potential for this compound to provide treatment for unmet need in this important therapeutic area.

It should be noted that there is no guarantee that BMS will choose to advance BMS-820836 to Phase III clinical trial. Today, AMRI has received over $34.9 million in total consideration from BMS in license fee, research funding, and milestones and is eligible to receive up to $66 million in milestone payments per compound for the first two compounds commercialized and royalties in the mid to upper single-digits on net sales of any compound that makes it to market.

A third anti-bacterial program was licensed to Genentech in 2011. This program is still at a pre-clinical research stage. In addition to the above three internal R&D programs that have resulted in license agreements, several other internal R&D initiatives have resulted in intellectual property of potential value.

While we discontinued R&D funding at the end of 2011, we continued to dedicate limited efforts to secure additional licensing partnerships and continue to discuss licensing opportunities with interested parties. The financial crisis begin in 2008, however, changed the licensing patterns of potential pharmaceutical partners, where previously companies would be willing to enter into a licensing agreement for compounds or technologies at pre-clinical stages, which is a stage which our CNS program was licensed to BMS.

Licensing partners are primarily interested today only in programs which have achieved Phase 2 proof-of-concept in clinical studies. This is meant that Discovery companies need to invest further and hold onto assets to multiple clinical trials.

As a result, the remaining AMRI programs that were suspended the further development by an external party to generate enough data and interest in today’s licensing environment. There are selective entities that have as their business models the further development of assets to the proof-of-concept stage and this is where our current partnering efforts are devoted.

We hope to have more to share with you about positive outcomes during the coming year. The original impetus for dedicating funding for internal R&D efforts was driven in part by the royalty stream that AMRI has continued to receive on global sales of Allegro products.

Allegro royalties have provided significant capital to invest in and grow our business over the years. It should be noted that the expiration of the patents underpinning the Allegro royalty stream begins in 2013 with the expiration of one of the patents at the end of November this year. A second important patent that expires in May of 2014, and last two expire patent ends in mid-2015.

With the addition of a new royalty stream from Actavis for generic amphetamine salts that extends until November of 2017, AMRI will continue to benefit from some level of royalty for the foreseeable future.

As we have indicated many times, however, we are focused on rebuilding a contract service and manufacturing business that is profitable on a standalone basis and we made significant progress towards that end in 2012.

During 2013 as Mike mentioned, we plan to continue this progress, allowing us to rebuild our cash balances through the royalties setting the stage for a stable long-term business that is not dependent on royalty income.

In addition to realigning our infrastructure and driving strategic relationships and long-term supply agreements, AMRI took several steps during 2012 to strengthen and enhance our leadership team and Board of Directors. At the Board of Direct level, we are pleased to welcome the addition of Bill Marth, who joined the AMRI Board in May of 2012. Bill replaced Dr. Paul Anderson, who retired from the Board after a decade of distinguished service.

Mr. Mark has extensive experience in leading organizational and operational initiatives at global pharmaceutical companies. Mr. Mark currently serves as Senior Advisor to the CEO at Teva Pharmaceutical Industries. Up until November of 2012, Mr. Mark served as President and Chief Executive Officer of Americas for Teva from June 2010. After servicing as President and Chief Executive Officer of Teva North America from January 2008 to June 2010, and as President and Chief Executive Officer of Teva USA from January 2005 to January 2008.

Mr. Mark is a valuable addition to the Board and is already making an impact as a leader, advisor, mentor, and colleague.

On the management side, we are pleased to announce the September 2012 appointment of Michael Nolan as Vice President, Chief Financial Officer and Treasurer of AMRI. Mike has hit the ground running and has quickly come up to speed with our business and services. He has brought a fresh look at our operations and business. In just short period of time, Mike has demonstrated a solid graph or global operating platforms and brings a good managerial acumen for his financial role. Mike’s strategic focus, financial expertise and global experience supports our ongoing initiatives and is helping us realize our plan for future growth and profitability.

Most recently, we promoted two of our top executives within the Pharmaceutical Development and Manufacturing and Large Scale Manufacturing business segment, which are in recognitions for the important contributions in performance made and delivered during 2012 and to further bolster our global SMARTSOURCING initiative.

Dr. Steven R. Hagen was promoted as Senior Vice President of Pharmaceutical Development and Manufacturing. Steve has the responsibility of the segments of our business that delivered approximately three quarter of AMRI’s contract revenue during 2012.

He has put in place the procedures, systems, leadership team and operations staff that delivered in 2012 and will continue to deliver the performance that is needed in order to enhance our SMARTSOURCING approach, while continuing to improve profitability in our pharmaceutical development and manufacturing business sectors. Reporting to Steven Hagan is Richard Saffee, who as I previously mentioned was promoted to Vice President and General Manager of Large Scale Manufacturing assuming oversight for global Large Scale Manufacturing.

We also made targeted appointments, annual promotions to our India operations and global business development organization and have streamlined the ladder under the global leadership of Christopher Conway and Louis Garguilo. Chris and Louis have created a seamless global team of business development and marketing professionals, responsible for over 1,540 proposals to customers during 2012.

As a result of the diligent efforts of these leaders and their team, AMRI achieved a book-to-bill ratio of approximately 1.3 for the full year of 2012. This important measurement reflects the continued potential for contract revenue growth in 2013 with the amount of business entered into during the year was greater than the amount of work completed during the same period. In addition, the responsibility for global business development, Louis Garguilo also assumed responsibility for AMRI’s Marketing Communications Activity.

As I wrap up my prepared remarks this morning, I’d like to summarize several points that we want to leave with you today. First and foremost, AMRI delivered significant improvement in financial performance in 2012 relative to 2011 in increased contract revenue, a new royalty stream, increased earnings per share, operating margins, and cash flow. These results reflect an increase in business driven in part by our Large Scale operations, but importantly also reflect the cost actions we have taken over the past 18 months.

Secondly, as we entered 2013, the actions that we have taken during the past 12 to 18 months, particularly with our SMARTSOURCING approach are setting the stage for continued growth and financial improvement over 2012 and put us on the path to meet the stated objective to make our operating businesses profitable on a run rate basis without considering our royalty stream.

Third, our efforts to foster more long-term strategic relationships and long-term manufacturing supply agreements are beginning to bear fruit as evidenced by announcement of several multiyear strategic relationships. We believe these are evidence of the shift by the customer base or beginning to focus on fewer, but more strategic relationships with high-quality trusted providers like AMRI.

We remain committed on a global basis to the highest standard of quality, safety, customer service and value regardless of where, when or who we might be interacting with. We continue to implement best-in-class practices, services and technologies and we remain committed to making AMRI a premier provider across the range of technologies and services of our business.

As always, I’d like to thank my colleagues at AMRI for the dedications and significant contributions as we enter 2013. The past few years have been a challenging period on many fronts and the dedication and commitment and hard work of my colleagues is appreciated in valued now and more than ever. Thank you also for your interest in AMRI.

At this point, we’ll be happy to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll take our first question from Himanshu Rastogi with Sterne, Agee.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Hello, this is Himanshu.

Thomas E. D’Ambra

Hi, Himanshu.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Hello, can you hear me?

Thomas E. D’Ambra

Yes, we can.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Good morning, Tom and Mike. How are you doing?

Thomas E. D’Ambra

Great, how are you?

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Very good. Congratulations on a great quarter. First Mike, a few house keeping questions for you. What’s included in the other income line?

Michael Nolan

Can you repeat the question – yeah, repeat the question, sorry.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Yeah, what is included in the other income line, $0.9 million line other income, what is in there?

Michael Nolan

Those include some of our interest adjustments, if you will on debt and as well investments, so the interest income. And then as well as our milestone payments that we received in 2012.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Could you break those out for me, different components in there because I though you also have some non-recurring charges in there?

Michael Nolan

Yeah, the non-recurring what we’ve communicated is a pro forma excluding any adjustments, like any one times. So there should be…

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Right.

Michael Nolan

We should be looking at the pro forma run rate other income.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Is there a half a million non-recurring item in that other income line?

Michael Nolan

Are you looking at the GAAP measure or are you looking at the – you’re looking at the press release?

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Yeah, based on the press release, it has a $931,000 other income line. Just wondering if there were any one time items in that line?

Michael Nolan

The $971,000 that you see in December?

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Right. Is it purely GAAP numbers or there are some one time items in there that I should exclude?

Michael Nolan

Well, that’s supposedly GAAP. It’s unaudited. So the $0.07 is a GAAP measure, the $0.17 is the adjusted measure. There is no material one time items in the $971,000. So for instance, favorable one-time…

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Okay. Okay and what caused that almost $3 million sequential improvement in Small Scale Manufacturing revenue?

Thomas E. D’Ambra

So you’re talking about from Q3 to Q4?

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

That’s right, Q3 to Q4, yeah?

Thomas E. D’Ambra

That was just facility utilization in our Small Scale.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Yeah.

Michael Nolan

It’s a mix of products, Himanshu, somethings require several months to complete, so lot of it just timing of when their shift out in revenue is recognized. As you know, there is some lumpiness from quarter-to-quarter across Development and Small Scale, as well as Large Scale.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Okay. And is that the reason for the decline in 1Q revenue versus 4Q 2012 in Small Scale Manufacturing look at a guidance for 1Q?

Michael Nolan

Yeah, that’s right. So we had a difficult comp, because Q4 2011 Small Scale just due to some of the timing ended up being recognized in Q1 2012. So that’s why moving into…

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Okay.

Michael Nolan

…2013, we have the difficult comp on that line item.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

And looking at your 1Q 2013 guidance for contract gross margin, that’s a pretty wide range, could you just describe what are the drivers are for the low end and the high end for…?

Thomas E. D’Ambra

Yeah, so I mean…

Michael Nolan

Sure, good question. I mean one of the challenges we have with the margin is a couple for, one is the mix of business that we have in any given quarter could vary. While over a year, we kind of can look at that and have a degree of comfort, where it ends up like Tom’s comment on the Small Scale for instance just because of some other timing. That creates a challenge for being able to target margins in any given quarter, so that’s kind of one of the issues.

The other is the mix of our business could be inside the U.S., it could be from Indiana, it could be from the UK. So we have a mix across the portfolio as well, it plays into the overall results.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Okay. And my last question for Tom. If you look at Small Scale Manufacturing again, how would you characterize the demand – how the demand this year compared to the same period last year? Is it getting better or it’s still flat?

Thomas E. D’Ambra

I think it’s similar. I think as I mentioned in the remarks, there are indications that things are starting to look better longer-term. I think it’s a moment, we’re seeing the continuation of the trends over last year. But as I mentioned in the remarks, companies are starting to think about their early pipeline now and efforts to refill those will be ongoing.

I think you’ll see first pickup in Discovery as more R&D dollars go there, but as products move out of Discovery towards clinical trials, that should impact Development. So the market remains somewhat like last year. But I think right now as we look at the year, there are signs by the end of the year, things will have changed for the better. I think we’ll get a better handle on that as we get in over the next few months.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Okay. And one last question, this is on LSM revenues. They increased sequentially every quarter in 2012. Do we see a similar trend happening in 2013?

Thomas E. D’Ambra

There is some lumpiness as Mike has said as well. It depends on when some of these things are shift. As you probably remember in 2012, we had to build a lot of inventory and there were a number of orders that completed in Q4, which led to the very large fourth quarter we had. So, some of that sequential growth will depend on one thing shift.

If you go back over the last few years, there is lumpiness there and a lot of that’s due to timing because again, many of these products take months to complete. So it’s really about scheduling when customers want us to deliver and when we complete production.

Michael Nolan

Yeah and so in my prepared remarks, the first quarter was going to be the low point on our scale was my comment. And then it will grow in Q2 and Q3 and then from a comp now on a nominal basis, that will be still strong in Q4. But from a percent basis, that will be a tougher comp given our Q4 2012 performance.

Himanshu Rastogi – Sterne, Agee & Leach, Inc.

Okay. Thank you very much.

Thomas E. D’Ambra

Thank you.

Michael Nolan

You’re welcome.

Operator

And at this time, there are no other questions in queue. I’ll turn it back to our presenters for any closing remarks.

Thomas E. D’Ambra

Thank you, Tim. This concludes AMRI’s fourth quarter 2012 and full-year earnings call. Thank you again for your interest in AMRI.

Operator

That concludes today’s conference call. We appreciate your participation.

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