Albany Molecular Research Q4 2008 Earnings Call Transcript

| About: Albany Molecular (AMRI)

Albany Molecular Research, Inc. (NASDAQ:AMRI)

Q4 2008 Earnings Call

February 09, 2009 10:00 AM ET


Thomas E. D'Ambra, Ph.D. - Chairman, Chief Executive Officer and President

Mark T. Frost - Chief Financial Officer


David Windley - Jefferies & Company

Greg Bolan - Wachovia

Eric Miller - Advisory Research, Inc.


Good day and welcome to the Albany Molecular Research Incorporated Fourth Quarter 2008 Earnings Release Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Dr. Thomas D’Ambra, Ph.D., Chairman, President and Chief Executive Officer. Please go ahead, sir.

Thomas E. D'Ambra, Ph.D.

Thank you, Alan. Good morning ladies and gentlemen. Welcome to the conference call segment of AMRI's 2008 fourth quarter and 2008 full year earnings announcement. This call is a follow-up to our press release issued this morning on Business Wire. With me is Mark Frost, AMRI's Chief Financial Officer.

We are pleased to report a fourth consecutive quarter of strong results for AMRI and an outstanding full year financial performance for 2008. These results reflect a positive return on our recent investment in talent, technologies, geographic diversity and sales initiatives. Although, we like everyone else, are facing into a challenging headwind caused by broader economic factors outside our industry, AMRI is positioned well to build on our recent gains and execute on our business plan to create greater value for the long term.

Consistent with our practice in earnings call, I am going to turn the phone over to Mark for his comments. After which I will have some additional remarks. Mark?

Mark T. Frost

Thank you, John. Before we begin, I would like to note that much of our discussion today might be termed forward-looking. Other than historical facts, such statements may concern projections, estimates and other forward-looking statements and involve a number of risks and uncertainties, including those discussed in the company's Annual Report on Form 10-K for the year-ended December 31, 2007 as filed with the Securities and Exchange Commission on March 17, 2008 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 herein. The Company undertakes no obligations to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date here.

Now I am going to present financial results for the fourth quarter along with guidance for 2009. Further details are included in our press release issued earlier today on the Business Wire.

Key highlights for the quarter and the year and other recent events include; Contract revenue for the fourth quarter grew by 22% with growth in all three service areas. For the full year Contract revenue grew by 20%.

Full year adjusted operating income increased over 100% to 28 million from 11.6 million in 2007. Full year adjusted net income was 19.8 million for 2008, up from 9.1 million in 2007.

The settlement which we reached with Teva-Barr in the fourth quarter regarding the Allegra patent infringement has we believe removed a significant risk factor for our business and will result in increased royalties to AMRI.

Turning to financial results for the fourth quarter of 2008, all comparisons are on a year-over-year basis: Total revenue was 56.4 million, increase of 19% compared to 47.2 million in 2007. Total Contract revenue was 49.6 million, an increase of 22% compared to total Contract revenue of 40.6 million in 2007.

Our total contract revenue encompasses revenue for AMRI's Discovery Services, Development and Small Scale Manufacturing and Large Scale Manufacturing Business Components. Contract revenue from Development Small Scale manufacturing was 13.2 million, an increase of 16% compared to 11.4 million in 2007. The strong performance was driven by continued demand for Development Analytical Services for emerging pharma and biotech customers in the U.S, as well as strong growth from our Indian operations.

Contract revenue from Discovery Services was 13.1 million, an increase of 13% from 11.5 million in 2007. Although we had double digit growth in U.S and Singapore medicinal chemistry, this was partially offset by a difficult quarter in Europe and the end of the amortization of our BMS licensing fee where we had been amortizing the upfront $8 million license fee over three years.

Contract revenue for Large Scale Manufacturing was 23.3 million, an increase of 32% compared to 17.7 million in 2007, reflecting the benefit of pre-launch shipments on one potential commercial product and higher development revenue. Recurring royalties from Allegra was 6.8 million, an increase of 11% from 2007. This increase was due primarily to the continued strength of the product in overseas markets and does not reflect any impact from the settlement with Barr, with Teva-Barr.

Net income was 3.1 million or $0.10 per diluted share compared to a net loss of $0.9 million or $0.03 per diluted share in 2007. The improved performance over 2007 was primarily due to increased margins in our Large Scale business which improved to 21% from a negative 9% in 2010.

Now I am going to turn to year-to-date results for full year 2008. Total revenue was 229.3 million, an increase of 19% compared to a 192.5 million in 2007. Total Contract and milestone revenue was 201 million, an increase of 22% compared to the prior year.

Total Contract revenue was a 195.5 million, an increase of 20% compared to 163.4 million in 2007. Contract revenue for Discovery Services was 57.7 million, an increase of 39% from 41.6 million in 2007. Contact revenue for Development and Small Scale Manufacturing was 56.2 million, increase of 24% from 45.4 million in 2007. This was our fourth year in a row of mid-20% growth in this component.

Contract revenue for Large Scale Manufacturing was 81.5 million, an increase of 7% compared to 76.3 million in 2007. Milestone revenue resulting from our licensing agreement with Bristol-Myers Squibb was 5.5 million, more than doubling from 2007. Recurring royalties for Allegra for 2008 were 28.3 million, up 5% from 27.2 million in 2007.

Net income under US GAAP was 20.6 million or $0.65 per diluted share compared to net income of 8.9 million or $0.27 per diluted share in 2007. Net income in 2007 on adjusted basis was 9.1 million or $0.28 per diluted share, when you exclude Large Scale Manufacturing restructuring charges of a 177,000, net of taxes. Net income for 2008 on adjusted basis were 19.8 million or $0.62 per diluted share, when you exclude the charges related to the restructuring of our Hungarian operations as well as the tax benefit from the third quarter.

This represents a greater than a 100% improvement in net income driven by increased margins in our Large Scale segment, access fee revenue from natural product collaborations and leverage benefits from our U.S lab operations drove double digit revenue growth during the year. For the full year 2008, we generated approximately 25 million in cash from operation, which is down from 32 million, due primarily to working capital investment as a result of a 20% increase in contract revenue for the year.

Our balance sheet remains strong with cash, cash equivalents and marketable securities, net of debt of 74 million at December 31, 2008 which excluded the upfront sublicense fee of 10 million which we received from sanofi-aventis in January 2009.

Now going to transition to a discussion of margins for the full year 2008; overall gross margin on our Contract Services business were 25% in 2008 compared to 19% in 2007. Our U.S Large Scale manufacturing business was a key driver to margin improvement, where margins increased to 16%, up from 11% last year. This increase was the result of improved utilization of Rensselaer's plant capacity as our customer's compound moved closer to the end of Phase III trial and approached their NDA submission points.

In our Discovery and Development segments, gross margin for the full year 2008 increased to 33% from 28% in 2007. DDS margins benefited from access fee revenues which increased the margin 300 basis points in 2008 as well as better utilization at our U.S., India and Singapore lab operations which provided leverage to our fixed cost base.

Earnings before interest, taxes, depreciation and amortization, EBITDA for 2008 was 46 million, a 61% increase from 2007. EBITDA margin return was 20% compared to 12% in 2007. Contract Services EBITDA, excluding milestone, royalty revenue and R&D expenses was 26.8 million, a 97% increase from 2007. EBITDA margin return was 12% compared to 6% in 2007.

Now I am going to turn to our financial guidance for 2009. First, let me run through our contract revenue guidance after which I will provide updated guidance on Allegra royalties.

For the full year 2009, we estimate contract revenues to range from 197 to 207 million, an increase of up to 6% from 2008. To get to the range of a 197 to 207 million, we project Discovery Services revenue to range from 55 to 58 million, an increase of up to 1% over 2008 level.

While we are continuing to experience a strong demand in this area, the benefit from the access and licensee fees in 2008 is limiting the growth rate in 2009. It has been our practice to exclude these items from our guidance until such time as we have strong visibility for these revenues.

We pulled out the value of the access fees, BMS upfront licensee amortization, which were 5.5 million over 2008 revenue. Underlying revenue growth would be up to 11%. With an expected overall flat market in 2009, this is a positive indicator, evidence that AMRI will further strengthen its market position.

We anticipate Development and Small Scale revenue to range from 53 to 57 million, an increase of up to 1% from 2008. As indicated earlier, we have had four years of 20% plus growth. However, the current funding environment for many of our customers is causing the growth to slow significantly in 2009. Further evidence has been a drop in our Phase I, Phase II compounds from 59 to 55. We continued to believe the outsourcing market will be robust in the future but we are expecting a market decline in 2009 in this segment.

We project Large Scale revenue to range from 90 to 92 million, an increase of up to 13% over last year. Growth in this segment is resulting from increased demand for near commercial and new commercial products, which also garnered higher margins in the legacy products in our portfolio.

A further point for our contract revenue guidance is that excludes any potential milestone revenues from AMRI's biogenic amine's collaboration with Bristol-Myers Squibb as well as any license fees or any additional programs in R&D portfolio.

Moving from contract revenue, we expect royalty revenues to range from 31 to 34 million, an increase of up to 20% from 2008 level. The increase is driven by the new royalty stream that we'll be earning in Teva sales of fexofenadine as well as the amortization of the sublicense fee we received from sanofi-aventis.

Turning to margins. We expect gross margins to decrease 2 to 3% due primarily to the access and license fees previously mentioned, as well as pricing pressures which we believe we will experience in our Development and Small Scale business. This is offset in part by higher margins in our Large Scale Business as that segment experiences greater capacity utilization in 2009, despite the fact, that we'd be facing head winds on margin for our GE product which coincides with the extension of this contract till 2013.

From a cost standpoint, we project R&D to grow by 10 to 13%, as we continued to move our tubulin inhibitor program through Phase 1 clinical trials and advance our pre-clinical programs through additional statistics.

We expect SG&A growth to moderate from prior year and increase from 5 to 8%. We are estimating earnings per share for 2009 to a range from 40 to $0.46 as mentioned in our earnings release. Our guidance excludes any revenue from milestone payments from our collaboration with BMS as well as any upfront license fees from potential new collaborations. These items contribute 11 million in revenue and $0.22 in earnings per share in 2008.

And finally, we are estimating 25 to 30 million in capital expenditures in 2009 as we complete our in-process expansions in both Bothell, Washington and Budapest, Hungary as well as the initiation of our GMP Compliant Manufacturing Facility in India.

I will now discuss quarter one guidance. For the first quarter of 2009, we estimate contract revenue to range from 40 to 42 million, a decrease of up to 12% from 2008. To get to the range of 40 to 42 million we project Discovery Services revenues to range from 11 to 12 million, a decrease of up to 20% from 2008 level. The majority of the decrease is due to the completion of the funded research on our BMS collaboration.

We anticipate Development/Small Scale revenue to range from 9 to 10 million, a decrease of up to 29% from 2008, with the decrease being driven by slower acceptance process from our customers.

Our outstanding bid levels have increased from their levels at this time in 2008 which gives us some comforts that it will be pushed back to later in 2009. We project large scale revenues to range from 20 to 22 million, an increase of 6 to 11% over last year. We expect royalty revenues to range from 9 to 10 million with a midpoint reflecting a 15% increase from quarter one 2008.

We expect gross margin to decrease by 5 to 8% from first quarter of 2008 levels because of the lower revenue in our DDS segment. From a cost standpoint, we project R&D to grow by 20 to 25% from first quarter 2008 and SG&A to increase by 5 to 7%. We are estimating earnings per share for quarter one 2009 to be from negative $0.01 to $0.02 per share, down from $0.l0 per share in the first quarter of 2008.

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

Thomas E. D'Ambra, Ph.D.

Thank you, Mark. I'd like to add my comments about our business performance for the fourth quarter of 2008 as well as the full year and its entirety.

Beginning with contract services, we are pleased to announce another quarter of strong performance with growth for the full year in contract revenue up 20% over 2007 figures. This represented an acceleration of growth over prior years as previous annual growth rates have been running at about a 10% clip. Prior to the economic collapse that deepened in the fourth quarter and threatens 2009, AMRI's contract service business continued to show positive signs of continued accelerating growth.

For our Discovery Services operations, growth was led by both our U.S. and Singapore locations. Besides growing our business from large U.S. based customers, our market penetration both Japan and Western Europe continues to gain traction. Results from Singapore were particularly noteworthy. 2008 marked the first full year of profitability for contract services in this location.

In addition to the completion of the 10,000 square foot site expansion, doubling lab capacity and adding in vitro biology capabilities, the site has significantly strengthened its leadership team with the hire of several locally based chemistry leaders as well as the strengthening of non-scientific leadership.

As we announced early in 2008, a number of changed initiatives have been completed or are underway at our Hungary operations that we believe sets this location up for success. These are included during 2008, a restruction of operations to reduce head count, a new facility expansion project which is underway to consolidate and better focus product and service offerings. And most importantly the deliberated strengthening of the leadership team at this location as we previously announced last year.

So I believe that these operational measures in tandem with planned marketing and sales initiatives put this business on track for increased revenues and customer orders for the second half of 2009.

Based on the successes of the 2008 and our continued ability to leverage our global locations for both pull through sales and the use of our hybrid model, we retain a positive outlook for a business performance in Contract, Discovery Services for the year ahead.

Contract services and Development and Small Scale Manufacturing inclusive of both the U.S. and Hyderabad had another successful year with 24% revenue growth for the full year 2008, making this the fourth consecutive year of plus 20% growth from this segment.

As we experienced during the recession that followed September 11, 2001, our Development and Small Scale segment was the first to experience the slowing of demand as projects in this segment tend to be on demand so to speak and subject to customer confidence in both their pipeline and their ability to weather a soft economy. Not surprisingly our developments in Small Scale segment began to experience a softening of demand in the second half of the fourth quarter.

Our RFP and bid flow continued strong through the end of the year for this segment and into January. However, we've experienced a noticeable slowdown and acceptance for these bids as our customers evaluate their cash positions and their ability to remain viable during a protracted economic slowdown and uncertain financing environment.

While we expect softening in the first half of 2009 for our Development/Small Scale business, we project a stronger second half of the year resulting in an overall year that is positive for the segment. A real bright spot for our developmental segment is the performance of our Hyderabad, India location which is now contributing profitably to our overall Contract operation.

The combination of Hyderabad and U.S. resources provides a competitive mix of technologies, geographic proximity and cost structures which continues to be well received by our customers. Hyderabad, in particular continues to experience strong demand and is on pace to have an excellent year.

In U.S. large scale operations, while revenue gains in manufacturing over 2008 were modest, operating margins and profits were up significantly, attributed to the success of our continued focus on efficiency and productivity improvements.

Also very important at the end of 2008, was the extension of our longstanding manufacturing supply agreement with our largest customer, GE Healthcare as noted in our 8-K filed on January 12th. This supply agreement was set to expire at the end of 2010 and the extension noted runs through 2013.

In driving this extension as Mark alluded to in his remarks, we conceded some margin benefits to GE in exchange for moving out the term. This extension removes a significant short-term risk factor by providing stability and capacity utilization for the plant over the next several years. We believe we can make up any loss of margin to GE with continued productivity and utilization gains.

To further support the success of these operations and improve on the synergy of Large Scale with our Small Scale and Development segment were several key hires announced recently.

In early January, we announced the hire of Dr. Junan Guo, who joined us as a Senior Director of Analytical and Quality Services, to fill the leadership gap left by the September 2008 promotion of Dr. Steven Hagen to Vice President of Pharmaceutical Development.

Also joining us is Dr. Michael Ironside in the role of Director, Global Project Management. Some of you may recall Dr. Ironside's role as a former key leader of our Development Chemistry operations. After about a two year absence, Mike returns to AMRI was newly created role, responsible for the seamless transfer of projects across AMRI technologies and locations.

He is working now with AMRI customers, staff, systems and equipment. I am his ability to quickly make a positive impact for both AMRI and their many customers involved with complex projects that touch on multiple departments, technologies and locations.

Also last week we were pleased to announce the hire of Richard Saffee as General Manager of our U.S. Large Scale site in Rensselaer. Rick brings over 23 years of chemical manufacturing and leadership experience, most recently at Pfizer Global Manufacturing.

Both Dr. Guo and Mr. Saffee bring expertise in Lean Six Sigma and we look forward to their assistance in gaining further traction on continuous improvement efforts begun and yet to be considered. In India, large scale operations were marked by a number of building improvements, construction and an acquisition.

Early in 2008, we announced the purchase of FineKem Laboratories in Aurangabad, a small manufacturing facility located near our recently acquired site. This addition accelerates our ability to manufacture custom power scale intermediates in India. Later in 2008, we also completed an extension of a multipurpose pilot plant in Aurangabad providing non-GMP manufacturing services up to the 1,000 liter scale. This plant opened in October is now fully operational.

Heading into 2009, Contract Manufacturing Services is emerging as a strong area of growth for the year. The improved visibility for our Large Scale business is a reflection of the success of our long term strategy to work with and support customers with cutting edge development and analytical support fully in their compound development, offering ability to support our customers as their potential new drugs move through clinical studies and ultimately be in a position to secure commercial manufacturing services for their API.

This strategy has led to a strong second half performance for our large scale segment in 2008 and provides good visibility for 2009. Including our small scale development segment we begin 2009 supporting 55 customer compounds in Phase 1 and Phase II Clinical Trials and 15 others in Phase III. These relationships are more strategic than shorter term synthesis projects and are better positioned to continue even in this tough economic environment.

Most importantly, as some of these drugs are approved by the FDA, we are in a position to receive annually recurring orders for the active ingredient. Our commercial agreement with Shire for the active ingredient for Vyvanse is a clear example. As stated previously, we began working on this project at a Large Scale and supported its development terminating in a commercial supply agreement to manufacture annual demand for the API.

Overtime we believe that our experience with Vyvanse can be repeated with multiple products and provide us solid visibility for plant revenues, which along with the extension of our GE Healthcare contract will serve as a base on which to grow an expanding large scale business.

Shifting from our Contract business to AMRI's R&D investments, progress in our Discovery Research and Development programs in the fourth quarter continues to move forward. In September, AMRI submitted initiation of new drug application and subsequently initiated Phase I Clinical test into our tubulin inhibitor compound in cancer patients with previously untreatable progressive tumors. Escalation of dosing in patients continues. We expect this trial to run through most of 2009 and continue to seek a partner for this program.

Also announced in 2008 were several positive events in connection with our collaboration with Bristol-Myers Squibb for the development compounds to treat CNS diseases.

Phase 1 testing of an AMRI development compound continues, as does advance pre-clinical testing of another AMRI developed compound selected by BMS in the third quarter of 2008. If the compound continues to exhibit a positive safety profile, it is possible that this candidate may ultimately be taken in also in to Phase I clinical testing possibly later this year.

In addition research continues at BMS focused on identifying and evaluating further backups to also potentially going forward. We remained very optimistic about the long-term prospects for this technology. As Mark noted, our guidance does not include any further milestone payments from additional positive developments from this program.

Regarding another programs in the AMRI pipeline, two other projects are close to identifying clinical candidates for nomination. These two programs target obesity and irritable bowel disease respectively. We are hopeful that a pre-clinical candidate maybe identified at one and/or both of these areas in the coming months. We've also made some positive strides in our efforts to identify partnership opportunities for these programs and remain committed to partnering one or both of these programs in due course.

Discussion about AMRI business and progress in the fourth quarter would not be complete without mention of the settlement of our patent infringement litigation with Teva Pharmaceuticals and Barr Laboratories related to Allegra and Allegra D-12 products which we announced in November. Besides moving the risk of an at-risk launch of Allegra D-12 by Barr/Teva, AMRI will be receiving a more diversified Allegra royalty stream, which as Mark mentioned, will increase our royalty revenue from 2008 level. This settlement agreement affirms the validity and enforceability of our Allegra patents, improving our position against other defendants in the continuing patent infringement litigation.

In addition to potential additional upside from ongoing litigation, this agreement clarifies the visibility of potential Allegra royalties we will receive through the 2013 to 2015 period, and removes the risk that an adverse litigation ruling will further the risk launch of Allegra-D in the U.S. will erode this revenue stream.

Changing topics back to our overall business and looking ahead at 2009, we like everyone else are concerned about how events in the broader economy will impact our business. As already described, we are experiencing a leveling of demand relative to the strong growth of 2008. As we look at our forecast for the full year, our Discovery Services business, Hyderabad and combined Large Scale segment are particularly bright spots for our business. We believe that all of our Contract business segments can improve over their strong 2008 performance.

Our intent is to globalize our services, further diversify our business, beef up our leadership team and improve our sales operations have led to our recent success and position us well to weather this tough economic environment.

This is the third recession we have lived through since AMRI's inception in 1991. Lessons learned some the hard way during this prior periods are with us today and will be applied as appropriate in the weeks and months ahead.

As a financial guidance by Mark reflects, we acknowledge that it is likely that the business climate will be difficult and somewhat unpredictable for sometime ahead. It is likely that our customer base will continued to be under pressure not only from the M&A and poor financing environment, but also in the U.S. because of continuing political and regulatory pressure to cut healthcare costs and minimize risk.

Long-term, we believe these pressures will lead to an increase in outsourcing. We also believe that our customers will see our balance sheet as a sign of our ability to survive without cutting corners and to service their needs for the long-term as it would be economically detrimental for them to choose a supplier whose financial violability is in question. Well we cannot predict to be immune to the broad changes impacting not only us but our customers and competitors, we can predict that AMRI remain focused on providing the highest quality in customers service, creating innovating solutions to help our customers to keep their budgets on track and their timelines short and continue to look at/for and act upon opportunities to make continuous improvement that will make us the better organization.

We believe that with adversity also comes opportunity and that with commitment and vision, we can remain on track for solid performance in 2009. I would like to conclude by thanking our employees and colleagues at AMRI. Their dedication and contributions are the reason that AMRI is successful today and in position to have a great future.

Thank you also for your interest in the AMRI. At this point, we'll be happy to answer any questions.

Question-and-Answer Session


Thank you. So the question-and-answer session will be conducted electronically. (Operator Instructions). And we'll take our first question from Dave Windley of Jefferies & Company.

David Windley - Jefferies & Company

Hi. Good morning, gentlemen. Nice work on the quarter. Few questions here; on the GE Healthcare contract that you spoke about in call and previously disclosed, is it possible to quantify the margin impact and then I think going back and reading in my notes, some of the disclosure that you put out at the time, I think there is a short reference to amends... certain terms related to pricing and quantity and I wondered, were the amendments for quantity up or down? Thanks.

Mark Frost

Sure, Dave this is Mark. First I'll talk about that. We have provided margin relief to GE in exchange for higher volumes through the life of the contract. So,

David Windley - Jefferies & Company


Mark Frost

Most of those higher volumes will actually start in 2010 through 2013. So we will be gaining a benefit on the volume side from that. We have not disclosed the amount of volume.

From a margin stand point, it can roughly create about 2% headwind for 2009. That is on top of actually a 3% margin benefit we provided GE last year. So actually our improvement in Large Scale was actually up 7% versus the 4% that we disclosed overall. So to Tom's point, Dave we believe strongly where we are on our portfolio that we will able to overcome that margin impact, but we felt that was a reasonable trade-off to ensure our supply through the 2013 time period.

David Windley - Jefferies & Company

Okay. While we are on that topic, I think Tom made some mention of opportunities as clients that are approaching filing or waiting for an FDA decision et cetera that could drive some volumes in the Large Scale. Is it possible to be more specific around PDUFA dates or I suspect maybe one or more of those clients are past their PDUFA date and are waiting patiently. Just wondering what the picture was on that?

Thomas D’Ambra, Ph.D.

Dave, this is Tom again.

David Windley - Jefferies & Company


Thomas D’Ambra, Ph.D.

We have one client that has a PDUFA date mid year without being more specific.

David Windley - Jefferies & Company


Thomas D’Ambra, Ph.D.

That is an extension from a PDUFA date that had been scheduled for last year. It clearly is, as you know the FDA because of their head count shortage has been pushing things back. We think that because it's been pushed back previously that this one will be real. So that is the potential, commercial opportunity. And then we have a couple of other compounds that are at the... close to the NDA filing state. So as customers are looking at or validating and getting launch quantities prepared these are opportunities for additional commercial contracts, not in 2009 but for beyond.

David Windley - Jefferies & Company

Okay. Moving away from Large Scale, just on a couple of things; if I understood the guidance correctly you did not include BMS related milestones in 2009 and I wondered if I interpret that as being conservative and wondering what opportunities might there be for milestones in '09 and what will trigger those?

Thomas D’Ambra, Ph.D.

As I mentioned that in my remarks, in the BMS program there is a second development candidate that was identified last year that we got a development milestone for that compound, work will continue going forward. And then the Phase I clinical trials that could trigger another milestone, that is possible that could happen this year, because the uncertainty about number one; the continued safety testing and development as well as the decision by BMS whether to go forward or not? We have not put that in our guidance.

I also mentioned there's an additional back-up compound, potentially being identified that trigger another smaller development milestone. And then from another programs if we were to kind of say the partner of any of those, there could be some payments accrued for any licensing type fees.

David Windley - Jefferies & Company

Okay, great. And then one more and I will jump back and let others get in. On the Hungary facility, I was curious about the two comments around restructuring that you have done in 2008 which did take head count down, but also you mentioned investing in a facility expansion to consolidate. And I was hoping you could provide some color on that on its face those sound like kind of counteracting initiatives.

Mark Frost

They are and they are not. When we look at Hungary, what we did is we have multiple locations around the country.

David Windley - Jefferies & Company

Got it.

Mark Frost

And the original location had a contract that was not favorable. So by going to a new location we have got productivity by consolidating our locations around Hungary as well as we got a significant rate cut in the new lease rate. So that brought productivity.

The other key thing about the Hungary restructuring is we went at the structure associated with legacy strategy of that which was to do primarily official library work and what we've continued to make progress on as Tom talked at last call was building high level, high-end discovery capabilities in our organization. And that's why we are moving forward to further build and we would build into a new facility that will provide that both from an organization and physical capacity standpoint.

David Windley - Jefferies & Company

Okay, that's helpful. Thank you.

Mark Frost


Thomas D’Ambra, Ph.D.

Thanks, Dave.


(Operator Instructions). We'll take our next question from Greg Bolan of Wachovia.

Greg Bolan - Wachovia

Good morning, nicely done. So, beyond the amortization of the cash payment associated with the Allegra settlement, Mark are you assuming any other drivers to Allegra royalties in 1Q or is that just seasonal strength and maybe stronger momentum with Telfast sales?

Mark Frost

No. There is three major pieces of it: one, is the amortization that you mentioned. Secondly, I alluded to this in the call but we did receive our 10 million prep license fee in January, which is not an official acknowledgment that we passed FTC but it's in acknowledgement by Teva and sanofi that we think were pretty much through the SEC review. That will then trigger that we start receiving royalties on Barr/Teva's Allegra generic product. So, that will be the second driver to our increased Allegra royalties.

And thirdly, we are going to start receiving a higher rate on the D-24 product, which has not gone generic. And we hope will not for a while. So those will be three principle reasons for why royalties are going to go up.

Greg Bolan - Wachovia

Okay, it's very helpful, thanks. And then if I extract royalties from your 2009 earnings guidance, and it appears to me that you contract services are expected to the marginally profitable, I guess my high level question would be, you are building a fairly robust part of cash here. From a strategic standpoint, what's the plan going forward in terms of lessening in the company's dependence on Allegra royalties? I mean, service offerings like formulation and packaging makes a lot of sense to me. Can you share any thoughts on all of those interests in those particular areas or any others?

Thomas D’Ambra, Ph.D.

Sure. Strategically, expanding our services service offerings as you mentioned is something we've been looking at. We actually began offering formulation development and as a first step into being able to supply product for early clinical trials as a step in that area.

As you mentioned with the cash, obviously in this economic environment there may be opportunities to put that cash to work and we continue as always to see things come across our desk, and I think that pace is starting to pick up. So there may be opportunities strategically expand our business. And as we talked in the past, we would look at things, a one plus one equals to three type of an opportunity, versus just adding a little bit more capacity.

So strategically there may be opportunities to expand our business. And I think it's important to note, however with the Allegra settlements that it gives some clarity through the 2013, 2015 timeframe. And as some of our R&D initiatives go through the clinical trials, process as Allegra's wrapping up, we're hopeful that we're going to be in a position where something even greater will be in queue to take its place.

Mark Frost

Yeah, just building in to Greg, we have been adding further services. We've added in vitro biology in the second half of last year, and clinical we're looking at that. To Tom's point of formulation development we're actually are going on a greenfield basis to start offering by probably end of second quarter or beginning of third quarter, formulations for Phase 1, Phase 2 products. So we are going that route, and to Tom point that's clearly an area we will look at on the acquisition front. But it's got to make strategic sense and our sense to Tom point is I think something is going to be coming on the market that we're going to look pretty hard at.

Greg Bolan - Wachovia

That's great. And then Tom, Mark, can you give us an idea, what are your plan of Greenfielding that facility?

Thomas D’Ambra, Ph.D.

Can you repeat the question, why we are building the facility?

Greg Bolan - Wachovia

Yeah, where are you going, are you going to build here in North America or abroad?

Thomas D’Ambra, Ph.D.

Our formulation development and initial clinical formulations will be right here in the Albany, Rensselaer location.

Greg Bolan - Wachovia

Okay, great. And then I guess lastly, can you talk about your longer term goals for sustainable large scale and DDS gross margins? Are you still thinking about call it mid 20% for LSM and maybe 40% for DDS, on sustainable gross margins?

Thomas D’Ambra, Ph.D.

I think, I would agree with that. I think what's going on right now is a short term hurdle which will potentially impact margins particularly in the lab side of the business.

However some of the investments we made... we saw accelerating growth last year, some of the difficulties, big pharma and our other customers are going through now, I think long term is going to probably change business models somewhat to lead what we think eventually even greater outsourcing particularly from big pharma. And not just on the economy front but on some of the regulatory decisions that sort of the well, actually down the FDA, the potential over the new Commissioner coming in and changing course, as well Congress taking a look at the whole healthcare pricing issue. I think long term its going to drive more outsourcing.

On the Large Scale front, we continue to believe that by working with customers early on and supporting their development we are in a great position to get these manufacturing agreements. We have a number of successive build already and we want to build on that by building our Indian Large Scale business that positioned us better to offer greater value and better margin as well.

Mark Frost

Just building on that too Greg, I think the timing is probably switched though on our ability to get to mid 20 on the Large Scale side and I'd proudly say mid 30s, high 30s on the large side grow, before we would say we will get their back on the large side of what's going to happen in 2009, that's probably has put us on a year behind, put as we were moving that forward and the progress made in the Large Scale has accelerated I think are past and to get towards that mid 20 kind of range in the Large Scale side.

Greg Bolan - Wachovia

Yeah, totally understandable. Nice talking so much.

Thomas D’Ambra, Ph.D.

Thank you.


And we will take our next question from Eric Miller from Advisory Research Incorporated.

Eric Miller - Advisory Research, Inc.

Yeah, congratulation on 2008 guys.

Thomas D’Ambra, Ph.D.

Hi Eric.

Mark Frost

Hi Eric.

Eric Miller - Advisory Research, Inc.

A question Mark embedded within your '09 estimate what fee projection for R&D?

Mark Frost

We are assuming R&D will roll 10 to 12%, which has been the range. We ended up actually in 2008, being flat because of timing on the clinical trials. But our expectation is probably up another million, about 10%.

Eric Miller - Advisory Research, Inc.

Okay. And I am assuming you are not forecasting or budgeting any partnering offset?

Mark Frost

We have not built in our guidance. As we've said on previous calls, we are making a lot of progress in a number of our programs and view our interests. So, our hope is, in within the year we'll have some news hopefully.

Eric Miller - Advisory Research, Inc.

Okay. And last question, the SG&A is sort of one area where you didn't get a whole lot of leverage on the... I mean it marginally came down as a percentage of sales but not much. Can you give me some thoughts on that area?

Thomas D’Ambra, Ph.D.

Eric, this is Tom. And just to make a further point on the R&D partnering, clearly there is interests. We think... there is some great things happening and we'd like to partner those. But it have to be a deal that we would proud to bring forward to our shareholders. So, we hope to do that.

To your question on the SG&A, we've been building over the last couple of years significant investments in our sales force, both in terms of its leadership, development, training and expansion to cover a global business. And that's consumed some of that increasing spend.

Similarly on the IT front, that in 2008 we've made some changes there, here and part of our SG&A investments has been to strengthen our organization for the global corporation that would be coming. So, some of the SG&A expand is really been an investment that create the infrastructure for a much larger organization as we go forward. And we think that's important and we'll continue to be important as we look at potentially opportunities to continue grow on our business to potential M&A. But clearly that's also something on our radar screen if our 2009 starts to be different than we forecast, there is opportunities to make some cuts there as well.

Mark Frost

Yeah. And just building on that a little further, I mean we did go to some investments, we did make some investments on fixed therapy in '08 as well as IT. And also in '08, we did have some challenges with the size of Russia and Hungary and India, we took action already and in Hungary. We're looking at somebody our India, SG&A structure. So, we will be working on that. So, I think we have some leverage points to Tom that we will get leverage in '09 from our SG&A structure.

Eric Miller - Advisory Research, Inc.

Okay. Thanks a lot.


(Operator Instructions). And we will take a follow up question from Dave Windley of Jefferies and Company.

David Windley - Jefferies & Company

Hi. Thanks for taking the follow-up. So I just want to follow-up on Greg's question around long-term gross margin targets. You began to elaborate interestingly I got on some of your thoughts about how you see the industry, kind of evolving over what may be the next several years, potentially leading to some increased outsourcing opportunities and things like that. Some of those pressures that you talked about, may be pharmaceutical pricing in the U.S et cetera, how do you think as this evolves in and your clients outsource more to you that the pricing of your services will evolve?

I mean you mentioned in your prepared remarks some potential margin pressure or pricing pressure in '09, but I guess I'm thinking longer term, do you think that pricing pressure will alleviate down the road or is that something that's probably here to stay for the foreseeable future?

Thomas D’Ambra, Ph.D.

Well, I think if we had a crystal ball we probably wouldn't be here, none of us. But I think it's reasonable to expect that pricing pressure is going to continue. Now, where we get clear margin benefit is in expanding capacity. We've seen this already as we start out in some of our global locations that you have to build that fixed costs, and as you add capacity you don't have to raise price to see margin improvements. So, just by increasing capacity on our locations we can benefit from margin by staying competitive on price.

The other thing is that we're early on in some of the efficiency and productivity improvements we're putting in place, particularly on our manufacturing side. So, we think we can continue to drive down our costs to allow us to be competitive, remain competitive on pricing, but at the same time generate margin improvement. And I think the large scale performance in 2008 is a clear example where your revenues didn't go up that greatly and yet there were significant margin benefit that our people were able to deliver.

Mark Frost

And just building on that a little bit Dave, one other things working this year is an interesting one which we've lived through in the past, which is we are starting particularly on the Development and Small Scale side to see some desperation pricing from competitors. And our view and Tom talked about that is this is not sustainable for a lot of our competition. And so we have the strength to work through this and withstand that but some of our competition will not. So you are going to see some further consolidation in the market. Once that happens, you'll have less pressure on price there. But I would agree with Tom, it will probably for a while be more pressure on price. But I think we will be able to offset that with productivity.

David Windley - Jefferies & Company

Okay. So longer-term I mean if we assume that pharma's plight is not going to change that much through this patent, from a way the patent cliffs, I guess my concern is that they are going to as they seemed to be with many others, they are going to be asking you to share some of that efficiency with them?

Thomas D’Ambra, Ph.D.

I think, we review large pharmas and opportunity. And I think as we've talked about in the past, we don't have a lot of exposure in business to them as they, after 9/11 really took a lot of their business to India and China. So, we think it's an opportunity.

We've already seen some evidence of the return to high value outsourcing and quality, having some of the work... more of the work done in the U.S. And we think that's an opportunity to grow. But, I think we are well positioned to be a player in that phase as they increase our outsource and I suspect they are going to start to use it differently.

If you look at what pharma has done, in focusing on price they have given up some of the things that drive greater value and I think as they outsource more you are going see more of the return to win-win type relationships where they are looking for value add, not just to lower its price. And AMRI is, I think very well positioned to be a key competitor in that format.

David Windley - Jefferies & Company

Okay. That actually segregates real nicely into my last question which is in some of this other spaces we've seen some lab purchases by CROs from pharma, these staff transfer for re-gauging (ph) efforts as they have been called, things like there's maybe a bigger push in Europe part of the development chain to move abroad and so this may not be as applicable, but I wanted to throw the question out there. Are there opportunities or discussions ongoing where instead of investing in CapEx and greenfielding new lab space where you might be able to buy capacity from industry on the cheap and expand your capacity that way?

Thomas D’Ambra, Ph.D.

We have... pharma has taken that approach with manufacturing sites over the last ten years or so. And you are selling off the facility in exchange for some supply agreements and that's how we got our Rensselaer site.

David Windley - Jefferies & Company


Thomas D’Ambra, Ph.D.

The history hasn't been that great for a lot of the sales. For example, European, our UK assets were... pharma has abandoned the buyer.

So we are wary of that. We did take notice of the... some of the moves that Lilly's made by moving a lot of their services to Covance, for example in the development support. And that... those may be opportunities as we go forward. So this is something that may be a trend that it's early... little early to tell but that might be an opportunity. Obviously if there were discussions we would be in a position to talk about it.

David Windley - Jefferies & Company

All right okay. Thank you.

Thomas D’Ambra, Ph.D.

Thank you, Dave.


(Operator Instructions). As there are no further questions at this time, Dr. D'Ambra, let's turn the conference back over to you for any additional or closing remarks.

Thomas D’Ambra, Ph.D., Ph.D.

Thanks, Alan. This concludes our 2008 fourth quarter earnings call. Thank you again for your interest in AMRI.


And that does conclude today's conference. We thank you for your participation. Have a great day.

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