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Aceto (NASDAQ:ACET)

Q2 2014 Earnings Call

February 07, 2014 9:00 am ET

Executives

Jody Burfening - Managing Director and Principal

Salvatore J. Guccione - Chief Executive Officer, President and Director

Douglas Roth - Chief Financial Officer, Principal Accounting Officer, Chief Administrative Officer, Senior Vice President, Treasurer and Assistant Secretary

Analysts

Frank Charles DiLorenzo - Singular Research

Operator

Welcome to the ACETO Fiscal 2014 Second Quarter Financial Results Conference Call. My name is Vivian, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now like to turn the call over to Ms. Jody Burfening. You may begin.

Jody Burfening

Thank you, Vivian. Good morning, everyone, and welcome to ACETO Corporation's second quarter fiscal 2014 conference call and audio webcast. This is Jody Burfening, LHA. With me today are Sal Guccione, President and CEO of ACETO; and Douglas Roth, CFO of ACETO.

ACETO issued its second quarter earnings press release yesterday afternoon, copy of the press release is available in the Investor Relations section of the company's website at aceto.com.

Before starting the call, I'd like to remind you that today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 that can be identified by words such as believe, expect, anticipate, plans, projects, seeks and similar expressions and involve numerous risks and uncertainties. The company's actual results could differ materially from those anticipated or implied in these forward-looking statements, as a result of certain factors as set forth in the company's filings with the Securities and Exchange Commission.

With that, I would now like to turn the call over to Sal. Sal?

Salvatore J. Guccione

Great. Thanks, Jody. Good morning, everyone, and thanks for joining us on ACETO's second quarter conference call.

Before I begin with my regular remarks, I'd like to make [Technical Difficulty] -- I'd like to begin with some separate comments. I want to point out that a number of financial media outlets significantly misreported analysts estimates concerning ACETO's revenues. We've investigated the matter and learned that FirstCall incorrectly posted a third quarter revenue estimate as a second quarter estimate. We understand that FirstCall is in the process of correcting the error. ACETO is issuing a press release on the matter this morning.

As we will shortly discuss in greater detail, the key facts are that the second quarter revenues increased 2.2% over the prior year period to $116.5 million, and earnings per share were $0.24, up 41% versus last year's second quarter. With that misunderstanding cleared up, we'll now move on to the review of ACETO's second quarter performance.

A little over 3 years ago, with the acquisition of Rising Pharmaceuticals, ACETO began a strategic transformation to expand our opportunities for future growth and move the company further up the pharmaceutical food chain. Our thinking was that, with the many finished drugs coming off-patent each year, the generics pharma market would provide ACETO with a strong platform for future growth. That growth platform would be supported by advantages derived from ACETO's core competencies in sourcing, regulatory support and quality assurance. We've been executing on that strategy. And now with a smooth management transition at Rising behind us, and Satish Srinivasan, Rising's new President and COO, he has been expanding Rising's management team and investing in its pipeline of new drugs. I'm pleased with our financial results for the second quarter, which reflect the ongoing successful execution of our strategic plans.

The second quarter's net sales for the company were $116.5 million compared to $114 million last year. Strong sales growth in Human Health segment was offset somewhat by lower sales in Pharmaceutical Ingredients and Performance Chemicals segments. For the first time since we acquired Rising, all 3 of our business segments, each contributed nearly equal proportions to the company's total net sales.

The Human Health segment accounted for 34% of ACETO's net sales, up sharply from the 26% for the year-ago quarter. Positive product mix changes during the past 12 months resulted in expansion of our gross margin by about 500 basis points in the quarter to 23%, up from 18% last year. This margin expansion led to a 50% increase in net income this quarter to $6.8 million for the quarter or $0.24 a share compared to $4.5 million or $0.17 a share the same quarter last year.

Our Human Health segment reported net sales of about $40 million this quarter. That's a 33% year-over-year increase. Rising continued to benefit from the 9 generic products that we launched during fiscal 2013. To date, in fiscal 2014, we have launched one new drug, which we expect will be a smaller revenue contributor relative to the drugs we launched last year.

Having said that, I would note that we anticipate launching 4 additional drugs in the second half of this fiscal year, and another 9 are projected for launching in fiscal 2015.

We're committed to further expanding our pipeline of new drugs and have been increasing our research and development spend to enable us to capture a growing set of opportunities that fit with the Rising's focus on niche or difficult-to-produce generic drugs.

We've budgeted increased spending on R&D for the third and fourth quarters of this year, with current estimates of R&D spend at approximately $4.5 million for this full fiscal year, up significantly versus the $2.8 million we spent last year.

Turning to the other component of Human Health, our nutraceutical business, that business also had a strong quarter, with sales increasing about over 35% compared to last year. Those increases are due to the introduction of some new products, the addition of some new customers, as well as royalty income on a proprietary product.

Turning to the Pharmaceutical Ingredients segment, its sales were $37.5 million for the quarter. It was a decrease of almost 6% versus second quarter of last year. The decrease primarily reflects lower sales of certain pharmaceutical intermediates in Europe. Segment's margins did, however, increase nicely in the quarter to 20.7%, up from 13.8% last year. Sales of the high-margin API drove that expansion, helping the segment's gross profits reach $7.8 million for the quarter, up from $5.5 million last year.

Performance Chemicals had sales of $39.2 million in the quarter. That's about 11.5% lower than last year's second quarter sales. In this case, the sales decline is due primarily to some lower sales of low-margin broad-spectrum herbicide within our agricultural protection products. Gross margins for the segment were up during the quarter.

During the second quarter, we acquired a French distributor of ingredients to the cosmetics and personal care industries. That's a small acquisition, but it's strategic for our European Specialty Chemicals business.

Overall, for the company, we delivered strong performance in the first half of fiscal 2014, with earnings per share increasing about 88% versus last year's first half. So really, a very solid first half for ACETO versus last year's first half. The growth, as I said before, is due to strong gains within the Human Health segment as well as a large contribution from reorders of a high-margin API.

I'd note that with respect to timing, we also saw sales of that same high-margin API during the third quarter of fiscal 2013. And that fueled strong growth and a strong quarter for us in last year's third quarter. As we've indicated the past, and as was noted in our earnings press release, ACETO's business could fluctuate on a quarterly basis in part because of the timing and size of our orders. That said, we're presently not expecting any additional sales of the high-margin API to occur in the second half of this fiscal year.

Also, we are experiencing some increased competition at certain Rising products. For those reasons, one should not simply extrapolate our strong first quarter results -- our strong first half results into the second half.

Looking ahead, I'm confident that ACETO is well positioned for the future, supported by our strong balance sheet and multiple growth opportunities.

With that said, I'll now turn the call over to Doug for the financial overview of our second quarter before opening the call up to questions. Doug?

Douglas Roth

Thank you, Sal, and good morning, everyone. Net sales for the second quarter of fiscal 2014 were $116.5 million compared to $114 million last year, an increase of 2.2%. On a reporting segment basis, Human Health sales were approximately $40 million, a year-over-year increase of about 33%. Pharmaceutical Ingredients sales were $37.5 million, 5.8% lower than last year's second quarter, and Performance Chemicals sales declined by 11.5% to $39.2 million.

Our sales mix continues to shift. Human Health accounted for 34% of the second quarter sales; Pharmaceutical Ingredients accounted for 32%; and our pharmaceutical -- pardon me, our Performance Chemicals was 34%.

For the second quarter last year, Human Health accounted for 26% of sales, Pharma Ingredients accounted for 35%, and Performance Chemicals was 39%. This is the first time that the 3 segments have been roughly equal in size and very different from ACETO's sales mix just a few years ago.

Gross profit for the second quarter was $27 million, a 30% increase from the second quarter of fiscal 2013, driven by the strong profitability in our Human Health and Pharmaceutical Ingredients business. Gross margin expanded to 23.2% compared to 18.2% for our year ago.

Gross profit in the Human Health segment was $13 million for the quarter, which is 46% higher than a year-ago period. In the Pharmaceutical Ingredients segment, gross margins were 20.7% compared to 13.8%. This increase was primarily due to product mix in the quarter, which included a reorder of a high-margin API product. This drove a gross profit increase of 42% to $7.8 million for the quarter.

Our Performance Chemicals, although sales declined, gross profit was only 2.3% lower than last year. This segment's favorable profit mix resulted in gross margins of 15.8% as compared to last year's margins of 14.3%.

Our SG&A expenses for the quarter were $15.1 million or 12.9% of sales, which was approximately 70 basis points higher than the second quarter of fiscal 2013.

As Sal mentioned earlier, our -- we continue to invest in our research and development, and those expenses were $1.2 million this year compared to only $200,000 in the prior year, and up from $600,000 in the first quarter of 2014.

Gross profit gains more than covered the increased investment in research and development. As a result, our operating income grew to 62.5% to $10.7 million compared to $6.6 million last year. And net income for the 3 months ended December 31, 2013 increased just short of 50% to $6.8 million or $0.24 per share compared to net income of $4.5 million or 17% for the comparable quarter of fiscal 2013.

Our EBITDA for the 3-month period was $13 million, a 38% increase from the second quarter of fiscal 23 -- of fiscal 2013. Pardon me.

Now looking at the 6 months. Net sales for the 6-month period ended December 31, 2013 were $245.8 million, an 8.9% increase from the $225.7 million reported for the comparable period of 2013. First half sales benefited from reorders of a high-margin API product. If you remember, we received the initial order for this API in the third quarter of fiscal 2013.

Gross profit for the second half of 2014 -- Pardon me. Gross profit for the first half of fiscal 2014 was $60.7 million, an increase of almost 44% compared to the $42.2 million in the prior year period. Operating income totaled $28.2 million compared to $14.2 million last year, an increase of 98%. Net income was $18.1 million or $0.64 per diluted share compared to $9.3 million or $0.34 per diluted share for the prior 6-month period, which represents an increase of 93% and 88%, respectively.

During the second quarter, we reduced our bank borrowing by an additional $1.8 million, leaving us with bank debt of only $24.5 million as of December 31. Cash and cash equivalents and short-term investments totaled $43.7 million, and our working capital is $146 million. And shareholder equity reached $218 million, which we believe provides us with a strong financial platform for future growth.

One final comment before turning the call over to our Q&A. Earlier this week, we received some calls from shareholders asking about an article in The Record, which is a Bergen County, New Jersey newspaper regarding Arsynco, a subsidiary whose operations were shut down 21 years ago. As the article noted, Arsynco is in the process of undertaking an environmental cleanup, or otherwise known as a remediation, at the site, which is located in Carlstadt, New Jersey. The article also noted that the anticipated remediation costs could be as much as $10 million. I want to assure you that this story is not new. We have disclosed the remediation on our financial statements for many years, and the estimated costs have been fully reserved.

Now I'd like to open up the call up for questions. Operator, please.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Frank DiLorenzo of Singular Research.

Frank Charles DiLorenzo - Singular Research

On the Performance Chemicals side, the chemical reportings -- I mean, the margins have been solid and you've made a few small acquisitions. However, the year-over-year sales growth, we've seen a decrease in that for few quarters. Is there an expectation on your side that there'll be at least a modest resumption on the revenue growth side for that segment in the second half of your current fiscal year?

Salvatore J. Guccione

Thanks, Frank, for the comments. As we've talked about it in the past, that segment is expected to be, from our side at least, our slower-growing segment and it often gets impacted, not only by the markets it's in, but also by some of the larger-volume, lower-margin products that we are strategically trying to prune out of the business. But putting the pruning aside, we do expect the business to grow modestly but begin to pickup here at the end of this year and then into next year.

Frank Charles DiLorenzo - Singular Research

Okay. Just one quick follow-up. I know in the past you've provided some updates on the potential acquisition side with regards to possible strategic fits for your generics business. So I was wondering if we could get an update on that. And also, if you've considered, separate from that within the Human Health segment, any type of acquisition that might complement the nutraceutical side of the business?

Salvatore J. Guccione

I'm sorry. Could you just repeat the question? I just missed the question.

Frank Charles DiLorenzo - Singular Research

Can you give us an update on the acquisition front as far as any potential acquisitions for the Human Health segment regarding something that might complement Rising or something that could potentially complement the nutraceutical side of the business?

Salvatore J. Guccione

Okay. Thank you. So as we've stated in the past, we're certainly, as part of our everyday duties, we are -- we do look for acquisitions, in particular in the Human Health part of the business, and then probably more so in the -- on the generic drug side of Human Health, although both generate drugs and nutraceuticals. So we're looking. I don't have anything for you. We don't really forecast acquisitions. And when we find one that fits our objectives, we're going to go ahead and execute on it. But there's no further updates other than we do continue to look as far -- in the ordinary course of our everyday activities.

Frank Charles DiLorenzo - Singular Research

Just a quick follow-up to that. Have the hurdle rates changed with regards to potential acquisitions due to the fact over the past 3 years here we've had a strong market, valuations has gone up that you had to reevaluate maybe potential benchmarks you're looking at for acquisitions and sort of change your threshold level as far as what's you're looking to buy and what you're willing to pay?

Salvatore J. Guccione

I think, pricing, let's put it this way, multiples are up versus the time when we bought Rising. So we need to be aware of that. And we put that into our calculations in our minds when we're looking at acquisitions. So to a certain extent, yes, we take that into account. Obviously, at the end of the day, we have our internal hurdles that we need to pass. And those are not changing. It's just a question of being aware of what's happening in the marketplace and prices are up a bit.

Operator

[Operator Instructions] And we have a question from Lester Petrozzi [ph].

Unknown Analyst

I'd like to probe a little. I know you don't give guidance. But you have -- I thank you for the color on the second half. Saw your comments. It's a tough quarter comparison that we're in now because we had that $0.30 result a year ago as a result of that high-margin API. And you've told us to reduce our expectations as to whether that will repeat at all in the second half. And so you've cautioned us not to just duplicate the first half and -- as we model our projections. But during the last call, you said that, after reporting the great 40% or $0.40 result because of that API, that we should look for this quarter to be more, I think you said, of a normalized earnings level, which we see now as the $0.24. Would you say in the next 2 quarters, finishing the year, we should also look then for a more normalized level of earnings? And Douglas, if you would just give me the 6-month EBITDA.

Douglas Roth

Lester, can you just -- while I'm looking up the EBITDA, just restate the first question in terms of your question about normalized?

Unknown Analyst

Yes. In the last conference call, when you reported that outside the result of $0.40 resulting from that shipment or the one high-margin API, at the time, you indicated -- Sal indicated that for the quarter that we just reported and for the balance of the year, we should look for more normalized level of earnings. They returned to more normalized, in other words, not looking for these large $0.40 earnings per share. And so my question is, you advised that we shouldn't look for that big quarterly result because that API will probably not repeat. But would -- should we model a more normalized level of earnings again, I mean, for this third quarter and the fourth quarter?

Salvatore J. Guccione

I think, Les, as you know, we don't give specific guidance. I think you just noted it yourself. We try to give you and everyone else kind of a strong sense to how we view the business. I'm not sure at this point heading into normalized and not normalized. But I think we've noted that the second half of this year will not have those API business in it. And we are going up against, depending how you look at the business, the first half of this year or the second half of last year, both of which did have it. So I think beyond that, you got to kind of do your own modeling and pull your own conclusions. But we tried to give you a sense for the significant movement on the business. Hopefully beyond that you can put your model together.

Unknown Analyst

Okay. Fair enough, you can't fault me for asking. I just want to -- while Doug is working on my EBITDA number, just a question about the Arsynco property. I was also very surprised, as a long-term shareholder of much more than a dozen years and as I read, you reported the progress you've made on characterizing the cost of that remediation as science and engineering has developed and you've characterized it and it's been accrued for on the balance sheet. I was surprised that the fact that, that article would appear 2 days before the earnings, following a rather large jump in the short interest rate in the last period up to 85% -- I think it was 80%. I'll leave others to wander the grassy knoll about that. But my question is, I recall that BASF, the largest chemical company in the world, and the former owner of the Arsynco site is also on the hook for the remediation costs. It was like 50-50 or 60-40 so that even it went above the $10 million, and I know you expect it to maybe even come in lower than that, but we have a partner to share in the cost of that remediation. That's my last question.

Salvatore J. Guccione

Yes, Les, thanks for your questions and we appreciate it. You're absolutely right. The site was owned by others before us. BASF is a "partner" in this. They share the cost of the remediation with us.

Douglas Roth

At 45%.

Salvatore J. Guccione

We've got 55%, they've got 45%. Doug, do you have anything on that?

Douglas Roth

Yes. And then, Les, in terms of the EBITDA for the first 6 months, it was just under $33 million. It was $32.8 million.

Operator

And we have a follow-up of Frank DiLorenzo from Singular Research.

Frank Charles DiLorenzo - Singular Research

Just a follow-up regarding the API side of things. Last fiscal year, you had 2 really strong quarters related to the same API. I know you never disclosed specifically the company or the product and you don't expect that to recur in the second half of fiscal year '14. Is there the potential for a reorder there in fiscal year '15? Separate from that, is there a potential in the second half of this current fiscal year '14, maybe next fiscal year '15 for you of a possibly another major or moderately-sized API order for another product?

Salvatore J. Guccione

Okay. Thank you. So with respect to the particular product that we had last year and this year, at least at this point, as we said, we don't expect it for the second half of this year. We do expect reorders of that product in the future, including in 2015. At this point, we just -- we don't know which quarter or quarters it will come in and we don't know how much it'll be, whether it'll be the same more or less as this year in total. We just have no information on that right now. But we do expect that this is going to be an ongoing product for us, but it's just not kind of settled in yet, so to speak. And so I can't give you more than that on that one. In terms of other products like that of a large nature that might come in this year, we work on lots of projects. There is always a chance of something. But we don't -- at this moment, I can't think of anything that I'm expecting will come in and have that kind of impact in the second half of this year.

Frank Charles DiLorenzo - Singular Research

Okay. I'll just ask one another quick question and I'll be done. On the nutraceutical side of just the business, the industry, in the past we've seen some companies acquired that provide vitamins to the market. Some of the bigger pharmaceutical players have made purchases like that, not that you'd be able to make a purchase like that. But there are maybe smaller niche companies out there that provide vitamins that might provide performance enhancement products for people that exercise, things like that. Is that something that you would consider, that type of purchase for the Human Health segment? I'm just wondering if that's something you've ever considered or would consider?

Salvatore J. Guccione

Sure. With -- the specific products, I'm not so sure. I think you're maybe talking about the potential of going into the kind of the finished dose. That's not high on our list right now. It's a little bit different business than our finished dose generic in terms of that [indiscernible] market. So that's really not high on the list. I guess I never say never, but it's not something that we're looking for. We'd focus on the ingredients that go into these products.

Operator

[Operator Instructions] I will now turn the call back over to Sal Guccione for closing remarks.

Salvatore J. Guccione

Okay. Well, again, thank you for listening in on our call here. We're pleased, again, with the first half of this year and look forward to speaking with you in the next quarter. Thank you so much.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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