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Albany Molecular Research, Inc. (NASDAQ:AMRI)

Q4 2013 Earnings Conference Call

February 12, 2014 10:00 a.m. ET

Executives

William S. Marth – President and CEO

Michael M. Nolan – VP, CFO and Treasurer

Analysts

Paul Nouri – Noble Equity Fund, LP

Operator

Good day, ladies and gentlemen, and welcome to the AMRI Fourth Quarter Earnings Release Conference Call. As a reminder, this call is being recorded. At this time, I would like to turn the call over to your host Mr. William Marth, President and Chief Executive Officer. Please go ahead, sir.

William S. Marth

Thank you, Shannon. Welcome everyone and thank you for joining us today to review AMRI’s results for the fourth quarter and full year 2013. This call is a follow-up to the press release we issued earlier this morning over PR Newswire, a copy of which is also on our website.

Also with me on the call today is Michael Nolan, AMRI’s Chief Financial Officer, Vice President and Treasurer. I will ask Mike to remind all of our listeners about forward-looking statements that we make today, Mike.

Michael M. Nolan

Thank you, Bill. Good morning everyone. Before we begin, I’d 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 discussed in the company’s Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on March 18, 2013 and the company’s other SEC filings.

While these statements represent managements’ 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 obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date here.

I would also like to remind you that our non-GAAP operating results are adjusted from our U.S. GAAP operating results for certain items that we described in our press release issued this morning. A reconciliation of our GAAP to non-GAAP results is included in the release.

I will now turn it back over to Bill.

William S. Marth

Thanks Mike. It has been another positive and busy quarter for AMRI. Before we get into the results, I’d like to take a moment to thank Dr. Thomas D’Ambra for his tremendous leadership as Founder, President and CEO over the last 22 years. Under his guidance our teams have executed very well to achieve strong results against the backdrop of change in transition. As I begin my first quarter as CEO, I believe these changes have strengthened AMRI well to achieve to greater growth and value for our customers, employees and our shareholders.

So, onto our results. I’m pleased to report that in the fourth quarter we achieved record contract revenue and exceeded our EPS target achieving our objective of being profitable excluding royalties and milestones by the end of the year.

Additionally, we generated cash flow from operations at the top end of our forecast. Fourth quarter contract revenue was $59.7 million, up slightly quarter-over-quarter. We made significant progress at the Burlington facility this quarter with the lifting and the warning letter.

We’re already experiencing a significant increase in activity at the Burlington facility and anticipate our contract sales from that facility to grow by greater than 50% in 2014. Importantly, overall contract revenue margins continue to improve. During the fourth quarter contract margins increased 300 basis points from fourth quarter 2012 to 21% and were driven by the disciplined approach we took in managing our assets and cost structure.

As a result, we finished the quarter with an adjusted operating income of $2.7 million excluding royalties. Bottom-line, fourth quarter adjusted EPS increased 29% to $0.22 per share exceeding our forecast. For the full year our contract services delivered a 11% year-over-year growth and total revenue grew 9%. Increasing royalties from our alliance with Actavis on amphetamine salts kept royalties essentially unchanged for the year in spite of reduction in the Allegra royalty. Full year EPS increased 280% to $0.70 per share again above our forecast.

Cash flow for the year was at the top end of our guidance and together with a $115 million bond offering we completed in November, we finished the year with a $180 million in cash. So, considering 2013 was a transition year, we achieved or exceeded our objectives for the quarter and the year delivered great EPS growth and strengthened our cash position. Importantly management and structural changes we’ve made in our business have put us in a position to capture more value going forward.

We essentially realigned our business into three key divisions. Discovery development, API large scale and manufacturing services and drug product in formulation and have new leaders for each of these businesses. Within discovery and development we realigned discovery services and reduced our overall cost structure. Recall that we recently closed our Hungary and Bothell Washington operation, we consolidated our library operations from Hungary into our Hyderabad R&D Center in India and will continue to grow the business from that location. Also with the Bothell operations transferred to our Singapore site, we’re recognizing savings and our position to expand further into the growing biology contract business.

More recently, Dr. Michael Luther joined us in November from Charles River Labs to lead our discovery and development services business. Michael brings both large pharma and contract research experience to our efforts and will be under his leadership that we will work to further expand our discovery business. Longer term, we will look to extend ourselves into pharmacology and deeper into biology and our Singapore and India facilities are well suited for that.

With regard to our API large scale manufacturing and services division, we’re very pleased with the performance from our Rensselaer facility and its experienced team in achieving another record year. Further, many of you may know George Svokos, who recently joined us from Teva to lead our expanding API effort. I’m very excited about the opportunity we have with the strong AMRI team and the leadership and experience George brings to our API business.

Also Vijay Batra recently joined us after spending a decade at Teva building their Indian and Chinese API operations. He currently oversees all our India operations and will be leading the redesign of our API platform in India.

Before we get into further details on our priorities, let me turn the call over to Mike for more details on our financial performance and our forecast. Go ahead, Mike.

Michael M. Nolan

Thanks, Bill. I’m now going to present financial results for fourth quarter and full year 2013 along with financial guidance for 2014. Further details are included in our press release issued this morning over PR Newsletter.

I would like to underscore some highlights on a year-over-year basis for both fourth quarter and full year 2013. First of all, we finished the year at $0.70 a share for our adjusted and diluted EPS which was $0.03 above our guidance provided at the end of the third quarter and up 180% from 2012.

Second, our adjusted operating income in the fourth quarter was positive at $2.7 million excluding any royalties which was an inject we shared with you at the start of the year. As Bill mentioned, contract revenue of $59.7 million for the fourth quarter and $210 million for the full year were both records for AMRI. Additionally contract margin performance continue to improve through the year as we saw increased volume leverage and previous cost actions resulting in a strong margin pull-through will fourth quarter contract margins of 21%.

Adjusted EBITDA for the year was $49 million which is up 56% from 2011 and is 20% of total revenue. Finally, operating cash flow for 2013 was $28.2 million which is the top end of the range we provided in our guidance. As a result of this strong cash flow performance as well as our bond offering in the fourth quarter, we now have $176 million of cash available to us for organic, the inorganic growth opportunities.

We’re pleased with the improving trend in our contract business with 2013 being a pivotal year for the company and we’re now poised to move forward with the healthier business, the strong team and the resources to grow.

Turning to the financial details for fourth quarter and full year 2013, all comparisons are on a year-over-year basis. To begin with, adjusted operating income in the fourth quarter was $9.6 million this compares to $7.9 million in the fourth quarter of the prior year with a strong pull-through on our increased contract revenue.

Excluding royalties and milestones, adjusted operating income increased $2.2 million and incremental contract revenue of $600,000. Total revenue was $67.1 million flat fourth quarter 2012, total contract revenue is $59.7 million, an increase of 1%.

Full year revenue ended at $246.6 million including $36.6 million of royalty revenue. Contract revenue was $201 million which is up 11% from full year 2012. Contract margins for the fourth quarter 2013 were 21% compared with fourth quarter of 2012 at 18%. Full year contract margins were 18% compared with 11% in 2012. Both fourth quarter and full year contract margins were driven primarily by increased capacity utilization and lower operating costs.

I’ll now provide a breakdown of contract revenue and contract margins to discovery services, development and small scale manufacturing and large scale manufacturing. Contract revenue from discovery services was $9.6 million in the fourth quarter a decrease of 9%. The decrease is primarily driven by the shutdown of our biology business in the first quarter of 2013 Bothell.

Full year discovery services revenue was $41.9 million, up 11% from full year 2012. Contract revenue from development in small scale manufacturing in the fourth quarter was in line, their expectations of $8.8 million a decrease of 16% primarily due to difficult comparison to a strong fourth quarter 2012 for the business. Full year development in small scale revenue is $35.5 essentially flat with 2012. Contract margins for our discovery services and development of small scale manufacturing segment 13% in the fourth quarter, up 9% in the fourth quarter of 2012 driven by increased capacity utilization and reduced cost of operations.

For the full year contract margins were 14% for our discovery services and development of small scale manufacturing segment up from 4% in 2012 reflecting increased capacity utilization and reduced operating costs. Contract revenue for our large scale manufacturing segment was a record $41.3 million, an increase of 8% with both U.K. and Burlington operations having a very strong quarter. Full year large scale manufacturing revenues $132.6 million, up 14% from full year 2012. Contract margins for large scale manufacturing were 25% in the fourth quarter up from 23% in fourth quarter of 2012 driven by increased capacity utilization and reduced cost of operations. For the full year contract margins were 21% for large-scale manufacturing up from 16% in 2012 reflecting again increased capacity utilization and reduced operating costs.

Overall fourth quarter 2013 royalties were $7.4 million down $0.7 million driven by lower Allegra royalties offset partially by the $2.3 million earned by the company on net sales of the generic product sold by Actavis. Full year Allegra royalties were $27.6 million with royalties earned from Actavis sales of $9 million.

Selling, general and administrative cost excluding some one time executive transition charges were $9.9 million in the fourth quarter of 2013 which are 17% of contract revenue. Adjusted full year SG&A cost as a percent of contract revenue were 18% which is down from 21% for full year 2012. Adjusted earnings per share in the fourth quarter of 2013 were $0.22 per diluted share compared to fourth quarter 2012 of $0.17 per diluted share. Full year adjusted earnings per share were $0.70 per diluted share compared with the full year 2012 $0.25 per diluted share, an increase of 180%.

Adjusted earnings per share exclude restructuring and executive transition cost as well as other cost that are detailed in our press release is issued today. Adjusted EBITDA for 2013 was $49.1 or 20% which compares with the $31.4 million or 14% in 2012.

Operating cash flow for 2013 was $28.2 million ending the year at the top end of our guidance and above 2000 in cash from operation of $15.3 million. Capital expenditures were $11.1 million for the year as a result of our strong cash flow from the past years and the bond offering in the fourth quarter 2013. We now have roughly $176 million of cash available for organic or inorganic growth opportunities.

I will now provide full year financial guidance for 2014. Full year contract revenue is expected to be between $231 million and $240 million up 12% of the midpoint from 2013. Full year royalty revenue is expected to be between $25 million and $27 million which is down from 2013 royalty revenue of $36.6 million driven by reduced Allegra royalties with the expected drop of $10 million to $12 million between the two periods. Actavis royalties are expected to be roughly flat 2013 levels at approximately $9 million.

Breaking down revenue for the year, we are projecting the following. Discovery services grow to between $46 million and $48 million up 12% at the midpoint. Development in small scale grow to between $37 million and $38 million up 6% at the midpoint. Large scale manufacturing growth to between $148 million and $154 million up 14% at the midpoint. For contract gross margins, we are guiding to improve our contract margins from 18% in 2013 to midpoint of 22% in 2014. Increased margins are the result of the increased improved capacity utilization ongoing cost management.

We project the adjusted SG&A cost for 2014 to approximate 17% of the contract revenue which is down 1% versus 2013. Adjusted SG&A excludes one time executive transition cost. R&D investment is expected to increase slightly to just less than $1 million focused on improved process efficiencies in the plants as well as development activities for generics. Adjusted earnings per share guidance for 2014 is between $0.72 and $0.80 representing an increase of 9% at the midpoint from 2013. Important to point out that although we anticipate approximately $10 million to $12 million lower royalty revenue from Allegra, we are still increasing our adjusted earnings per share guidance and the ongoing growth of our contract business in 2014. Our adjusted earnings per share guidance for 2014 excludes the impact of executive transition cost.

Any impairment and restructuring charges with an estimated $0.20 impact for the interest and amortization charges associated with the bond offering. Adjusted EBITDA for 2014 is forecasted between $51 million and $55 million or 20% of revenue. Operating cash flow is forecasted in between $33 million and $37 million in 2014 before capital expenditures between $14 million and $16 million. Cash coupon interest on our $150 million bond will be $3.4 million in 2014.

Before turning the call back over to Bill, I would like to emphasize how pleased we are with the accomplishment of our objective of being profitable without royalties through continued top line growth and increased margin pull-through from previous cost actions.

The momentum has been positive and we are confident with the outlook for 2014. I will now turn the call over to Bill, who will continue to concluding marks.

William S. Marth

Thanks, Mike. AMRI had come a long way from its origin as a research orientated company largely dependent on royalties. We also find ourselves on the frontline of an evolution of thinking within the pharmaceutical industry regarding strategic outsourcing and are poised to grow and go where our customers’ needs take up.

We are well known for our deep science root and are considered the go to source for pharma in discovery and development expertise. Pharma companies are recognizing the good science doesn’t just exist within their four walls and are turning to Academia and pharmaceutical services for ideas and answers.

Also outlining the manage and multitude partners customers are trying to AMRI for more program oriented work versus just activity oriented projects.

Lastly, recognizing that 90% of projects that don’t move forward, pharma customers see pharmaceutical sourcing as a flexible alternative. Importantly we have connected our chemistry and development work with the drug product and API manufacturing businesses and if leveraging these linkages and helping companies transition products seamlessly through these critical junctures that differentiates us. The opportunity to help customers transition from discovering development stage to API and finish drug product is the reason why our goal to grow beyond industry rate is attainable.

We’d also like to extend our drug product and formulation capabilities further to include higher values specialty products in complex drug forms and to expand our capabilities in capacity to accommodate larger commercial scale products on behalf of our clients. We will also be looking to grow both organically and inorganically in all of our businesses.

On the API front, we have upgraded our Aurangabad facility and the site is now ready for U.S. FDA inspection, that inspection most likely will be triggered as part of the customers’ FDA product review and we are hopeful that that will happen by the end of 2014.

We are also looking to expand our API capabilities further. API is the $14 billion addressable market consisting of brand generic and OTC. Today AMRI primarily services the brand market, but there is no reason we cannot expand it to these other growth markets as well. We intend to leverage our capabilities in Rensselaer, Holywell and Aurangabad to capture greater market share.

Areas of interest include complex molecule, study toxic steroids, peptide and controlled substances that would complement our current offerings. We see potential API expansion on two fronts, the scale and capabilities. A good portion of our customer base come from small and midsize pharmaceutical companies they don’t have or choose not have development and manufacturing infrastructures.

Increasingly, we are seeing a large pharma choosing to move away from large fixed cost and look to watch for enhanced productivity and cost efficiencies. In return we can provide the needed scientific expertise and flexibility they are looking for.

In addition, our global footprint provides timely and cost effective solution for our customers. For us we benefit from the efficiently leveraging our assets across our broad and diverse customer base.

In closing, we pledge, we will be profitable without royalties by year-end and we’ve done just that. The 2014 we are looking to continue growing the top line by double digits and will continue our current management efforts to maintain a profitable and growing contract business excluding royalties. Royalties like those from our Actavis alliance will now be additional profit on top of our base that we can deploy for further growth in shareholder value.

We sit here today with the diversified portfolio of customers over 300 plus from large pharma and biotech specialty as well as adjacent spaces and a result of these contracts we have a good pipeline visibility for the future.

We finished 2013 strong with a $180 million in cash and are looking for smart investment opportunities in the areas that I described earlier. There are wide variety of opportunities out there. What’s more important is how we capitalize on these opportunities that we see and how they are integrated.

Doing good due diligence and smart integration are key here and that’s the skill set that our new AMRI leaders bring. The bottom-line for us is AMRI is really well positioned to capture what we believe are attractive growth opportunities in a market that continues to benefit from outsourcing.

Thanks. And I will now turn the call back over to the operator so we can take your questions. Shannon?

Question-and-Answer-Session

Operator

(Operator Instructions) We will take our first question from Greg Bolan with Sterne, Agee.

Unidentified Analyst

Hey guys thanks for taking our question. This is Mike Warden for Greg Bolan. I am just wondering how active is the company on business development and what are some of the accretion or RIC parameters used to evaluate these opportunities?

William S. Marth

Thanks a lot. Let me start off and then I will let Mike chime in here. First of all, we are taking a great deal of caution looking at how we spend our money as I mentioned in the script. Couple of the areas that we mentioned that we would be interested in expanding our API from steroids, into steroids and peptide side of toxic controlled substances, complex molecule. Those are all areas that are smaller but more profitable niches and that’s where we would put our API business.

Same on dosage form right, we would do some oral solid dose, but we are also liking other technologies like emulation, liquid cream and ointments, more steroid finish that is really challenging here in the U.S. So those are areas we would like to grow. If you think about it as well, we would also like to expand our discovery business and more services and capabilities there. Dr. Mike Luther’s comment and I think it's going to do a great job in building our biology platform to a larger, to a much larger place but and also adds pharmacology to it but I think jump starting that would be helpful. When you think about accretion, dilution, we would be looking for any project that we would do to be accretive within the first year. That is the goal that we set for ourselves and that scenario we would take that we would really stretch on any acquisition. Mike any other points you want to add to that?

Michael M. Nolan

Yeah, just reinforce the return characteristics of any transaction would of course be accredited within the first year of goal. As you look at our broader let’s say ROIC would improve, the ROIC of the company.

Unidentified Analyst

Great. Thank you.

Michael M. Nolan

You are welcome. Thanks for the question. Thanks for being on the call.

Operator

And next we go to Paul Nouri with Noble Equity Fund.

Paul Nouri – Noble Equity Fund, LP

Hey, good morning. To hate your guidance next year, it looks like from my estimation you have done a pretty robust gross margin, contract margin and it looks like the 21% or so we saw this quarter is the highest since 2008. Is this a sustainable level for the gross margin?

Michael M. Nolan

Thanks Paul, I appreciate the question and thanks for being in the call. So it's Mike. The answer is yes and what you perhaps seen in the last couple of years is the increased margin pull-through as we right size the operations and seen our contract business grow, you have seen margins come through with a more attractive rate. Now we are able to expand margins 300 basis points as an example most recently. So our expectation is that with, for instance our business in Burlington which has a very attractive margin profile as we grow that business, as we start to see our Hyderabad about facility moving to ideally regulated markets for sales and as we continue to improve the mix, let’s say in our branded business with API, that’s an area where we see we can expand our margins. So it's really capacity utilization which is something we have seen over the past few years and nice portfolio of attractive margin business.

William S. Marth

Yeah Paul, this is Bill Marth, just as a filling on that, I think it's Mike hit it right on the head it's really a lot of it is about capacity utilization as many projects that we can shift from Rensselaer, we still has capacity by the way to Holywell to fill up that facility and other things that can be done in our Aurangabad facility that kind of balance our network if you will. AMRI has been largely concentrated on brand API as an area for a long time and we are well known for making X-candy for medication as well as Vyvanse for Shire and other branded products but we also have a lot and lots of opportunities in the generic space as well and that’s more than 80% of the dispensing in the U.S. alone and there is no reason why we shouldn’t take a greater profile on that particular area. So again it goes back to that utilization.

Paul Nouri – Noble Equity Fund, LP

Have you noticed the competitive landscape changing at all for past 12 months versus the couple of years before that, I know there have been some maybe over capacity issues before that?

William S. Marth

You know, are you talking in respect to API in particular?

Paul Nouri – Noble Equity Fund, LP

Yeah.

William S. Marth

We don’t see that because at the end of the day Paul, it's what you make and often times what you don’t make. People look at the opportunity here in the market and they think, many of the companies of course like the Tevas and the [Indiscernible] who are vertically integrated make everything themselves and but they can't, right? They certainly don’t have the capability, they can make a lot of their own API, but they can't make it all. And so that gives opportunities if you have the right portfolio and that’s the key, choosing the right product. Today we are strong in controlled substances. We have capabilities to do cytotoxic. We do have the capabilities to do complex products and we need to, we obviously need to add more to that but being in the right place is kind of get you away from that over capacity issue and instead of making just the typical plain white powder.

Paul Nouri – Noble Equity Fund, LP

Okay. And then turning to deals a couple of questions. Are you looking for more transformative or tuck in deals or maybe both a, and then b, how is the pipeline of deals? Are you finding enough deals to look over or is there not much out there?

William S. Marth

I will answer the later first. Any time someone sees that you raise money, you get lots of phone calls, the deal flow is really good and through my years at Teva, I have got a great network and so we have no shortage of projects to look at. So that’s certainly a good thing for us. As far as the deal type, I don’t think you would expect to us to go out and do an immediate transformative deal. I just don’t see that. Again I think we’ve laid out our strategies very well, I don’t think you would expect us to forward integrate into a products company or anything like that. We have our initials picked up, we want to work on that. So that would suggest to you that our deals would be at this point in our growth to be tuck in and those types of deals we would like to do. Now it doesn’t mean if we couldn’t get ourselves an opportunity to do an inversion deal that we wouldn’t be interested in that, we certainly would and we are well aware of that but right now we want to satisfy the needs of our strategy.

Paul Nouri – Noble Equity Fund, LP

Are you finding that there are deals that are reasonably priced or with valuation increased companies are expecting more?

William S. Marth

There is two factors to that Paul, other manufactures, there are two that I really look at. By definition all deals are overpriced in some way or have stayed performed. It's really what can you do with the deal? What are the things that you can do with that companies that whoever is disposing of it that cannot when combined with your own company it creates something else, the one plus one becomes three. And what can you do on the synergy levels? That’s an area that we spend a lot of time in the years with Teva and that’s something we believe we can extract. We believe that we can extract synergy and we believe we have a strategic vision in mind and so we are looking for companies that match that. And so, I am not as worried about over paying as one might be if they didn’t have those factors.

Paul Nouri – Noble Equity Fund, LP

All right, thank you.

William S. Marth

Thank you.

Operator

And it appears there are no further questions in queue at this time. I would like to turn the conference back over to management for any additional or closing remarks.

William S. Marth

Well, thank you very much for listening to our call today. Everything will be available on the website channel. We will let you know about that. We hope to do follow-up calls with many of you. Thank you very much.

Operator

And that does conclude today’s conference. A replay for today’s webcast will be available at the company’s website starting tomorrow February 13, at 9 a.m. central time, to access the replay please use the audience URL you received for this webcast today. We do appreciate your participation, you may now disconnect.

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