Cambrex Corporation's CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 2.14 | About: Cambrex Corporation (CBM)

Cambrex Corporation (NYSE:CBM)

Q1 2014 Earnings Conference Call

May 2, 2014 03:30 ET

Executives

Greg Sargen – EVP & CFO

Steve Klosk – President & CEO

Analysts

Daniel Rizzo – Sidoti & Company

Dmitry Silversteyn – Longbow Research

Steve Schwartz – First Analysis

Operator

Good day and welcome to the Cambrex First Quarter 2014 Earnings Conference Call. (Operator Instructions). At this time, I would like to turn the conference over to Mr. Greg Sargen. Please go ahead, sir.

Greg Sargen

Thank you Lisa. Good morning, everybody. Welcome to Cambrex's First Quarter 2014 Earnings Conference Call. Before we begin, I'll provide the following comments regarding forward-looking statements. Today's discussion will contain forward-looking statements, including statements regarding expected performance, especially expectations with respect to consolidated or product category sales, gross margins, operating expenses, EBITDA, earnings per share, cash flows, capital expenditures, acquisitions, divestitures, collaborations, agreements or other expansion opportunities that may occur during our prepared remarks or during the question-and-answer session. These statements are based on Cambrex's current plans and expectations and involve risks and uncertainties that could cause actual outcomes and results to materially differ from those included in the forward-looking statements. Further information regarding such risks and uncertainties, please refer to Item 1A under the heading Risk Factors and to the Forward-Looking Statements portions of our 2013 Form 10-K filed with the SEC as well as the Forward-Looking Statements section in this morning’s release.

During this conference call, in order to provide greater transparency regarding Cambrex's operating performance, we'll refer to certain non-GAAP financial measures that involve adjustments to GAAP results. Any non-GAAP financial measures presented should not be considered to be an alternative to financial measures required by GAAP and are unlikely to be comparable to non-GAAP financial measures provided by other companies. Any non-GAAP financial measures referenced on the call are reconciled to the most directly comparable GAAP financial measure in a table at the end of our earnings press release issued this morning and available on our website at cambrex.com. A replay of the call will be available shortly after we end today through next Friday, May 9th, by calling (888) 203-1112 domestically and (719) 457-0820 internationally. Please use the pass code 2786828 to access the replay. A webcast will also be available on the Investors section of the Cambrex website.

Today's call will begin with a business review by Steve Klosk, our President and CEO. I'll follow Steve with a few comments on our financial results before opening up the call for Q&A.

With that, it is my pleasure to introduce Steve Klosk. Steve?

Steve Klosk

Thank you Greg. Good morning ladies and gentlemen. Sales were $66.2 million in the first quarter down 11.9% excluding the impact of foreign exchange compared to the first quarter of last year. EBITDA was 8.4 million compared to adjusted EBITDA of 16.8 million in the same period last year. With decline in sales was driven almost entirely by the timing of orders and the decline in EBITDA is due to a combination of lower consolidated revenues and lower production levels at one of our sites both of which I will talk about in more detail momentarily.

As we indicated when we gave full year guidance in early February, we expected a slow start to the year. However as our release stated this morning, we remain confident that full year sales should increase between 8% and 12% and EBITDA should be between $70 million and $76 million consistent with our prior guidance. We also expect the second quarter to be a very strong quarter for us resulting in growth in both revenues and EBITDA for the first half of 2014 compared to the first half of 2013.

I will now provide some commentary on first quarter performance with an each of our product categories and update on 2014 expectations for each category. All growth rates exclude the impact of foreign currency between a respective years and less indicated otherwise. Custom development revenues were $1.7 million in the first quarter compared to 3.2 million in the same quarter last year.

As I indicated with regard to consolidated revenues the low level of revenues for custom development projects in this quarter simply reflects the timing of deliveries. We’re very pleased; we have added three new clinical phase projects during the quarter reflecting the continued success of our business development strategy in this category which is to secure development and manufacturing business for late stage clinical programs.

In addition to adding these three projects one prior late stage product is now being sold commercially. But we now have 15 active phase three projects compared to 13 at the end of 2013.

To support continued growth we have recently added talented new business development and marketing personnel. Excluding the impact of 2013 revenues for clinical projects, now included within customer manufacturing’s. We expect 2014 full year revenues in this category to increase by approximately $20 million to $24 million to between $28 million and $32 million.

Moving to custom manufacturing which includes commercial products sold to innovator pharmaceutical companies, revenues were $22.9 million during the quarter compared to $27.8 million in the same quarter last year. The decline was also due to the timing of orders primarily for two of our larger APIs.

Our primary strategy to grow custom manufacturing revenues is to win late stage clinical phase projects. If these products were approved for commercial sale we expect to and we will negotiate a supply agreement to provide commercial value that are reported in this product category. We have also had success obtaining supply positions for late stage and approved commercial molecules but we can offer an improved cost position or other innovative benefits to customers.

We continue to expect 2014 revenues in the custom manufacturing product category to be between a $160 million and $165 million. Accordingly our combined custom development and custom manufacturing revenues for the full year 2014 are still expected to increase 9% to 14% to between a $188 million and a $197 million.

Sales of generic APIs in the quarter were $23.1 million versus 26.6 million in the same quarter last year. In 2013, the first quarter was the highest quarter of the year for sales of generic APIs while based on current expectations the first quarter of 2014 will be the lowest quarter of the year. We scale back production of generic APIs in the first quarter of this year at one of our manufacturing facilities as part of the full year production plan to arrive at targeted year-end generic inventory levels.

This resulted in production levels that were significantly lower than the first quarter last year at that site resulting in negative impact on gross margins for the quarter.

We had 15 new generic APIs in development during the quarter and as we stated in February we’re increasing our R&D spending in order to expand and accelerate our efforts to bring new generic APIs and controlled substances to market.

Order levels for generic APIs was strong in the first quarter compared to all four quarters of last year and as such we still expect sales of generic products in 2014 to increase in the low to mid-single digit percentage range. We’re cautiously optimistic that orders will remain strong as the year progresses possibly generating higher than expected growth in generic API sales.

As we indicated last quarter we are forecasting approximately $2 million in R&D expense during 2014 to co-develop one or more generic finished dosage form drug products with one or more generic drug company partners. We entered into one such arrangement during the first quarter for which we will contribute a portion of the development cost through regulatory approval and receive a proportionate share of the future commercial profits. We will consider additional opportunities moving forward.

Sales of controlled substances, which we define as those classified as Schedule II products by the DEA, were $15 million in the first quarter compared to $14 million in the same period last year. Cambrex is positioned as a primary or secondary supplier to most of the key players in the growing ADHD markets that we serve and we expect to be the primary supplier of API to several customers who filed or developed and abbreviated new drug applications or ANDAs to enter the ADHD market.

We continue to develop additional controlled substance products, including opiates, an important segment of the market in which we do not currently participate. But we do not expect commercial sales for these products until late 2015; this remains a key strategic initiative for Cambrex.

We still expect full year 2014 controlled substances revenues to be between $44 million and $48 million, an increase of approximately $6 million to $10 million or 17% to 27% over 2013.

Sales of active ingredients utilizing our drug delivery technology, primarily related to the Nicotine Replacement Therapy, or NRT market were $3.5 million during the first quarter, a 0.5 million higher than the same quarter last year. We now expect drug delivery revenues to be approximately flat to slightly higher in 2014 compared to 2013.

Zenara Pharma, a generic pharmaceutical business in which Cambrex owns a 51% stake, continued to manufacture a non-NRT finished dosage form product for a large generic customer, generating nearly $1 million of sales in the first quarter and we have additional orders for the next several months. The Zenara facility in Hyderabad is approved as a supplier of this product in several European markets.

Zenara continues to make an NRT gum for a large consumer health company to support their marketing effort in India.

To wrap up my comments as this morning’s release stated we remain confident that full year sales should increase between 8% and 12% and EBITDA should be between $70 million and $76 million. We also expect a strong second quarter to result in sales and EBITDA growth for the first half of the year compared to the first half last year. I look forward to updating our progress on the next call.

I will now turn the call over to Greg.

Greg Sargen

Thanks Steve. Steve covered our sales performance so I will comment on certain other financial statement items. Gross margin for the first quarter was 25% compared to 33% in the same quarter last year resulting primarily from lower production volumes at one of our facilities compared to the first quarter last year. As generic orders track below expectations in the early and middle parts of 2013, we scaled back production during the second half of last year and continued into the first quarter of this year. As Steve mentioned generic orders have been stronger so far in early 2014 so we will continue to evaluate order levels along a full year production plan in order to arrive at our targeted generic inventory levels at year-end.

Prices were lower by 2.6% during the quarter also negatively impacting margins partially offset by a positive product mix during the quarter. We do not currently foresee any meaningful changes to our full year gross margin expectations that were included in the basis of our initial 2014 guidance in February.

Selling, general and administrative expenses increased $500,000 and research and development expense increased $300,000 both primarily driven by higher personnel related expenses. Off the $2 million forecasted within R&D for the co-development of finished generic drug products in 2014 that Steve discussed we spent a negligible amount in the first quarter. As we mentioned in February we are adding R&D resources at all sites in 2014 to support for accelerated development of an extended set of products primarily for the generic and controlled substance markets.

We currently expect total R&D expense for 2014 to be between $4 million and $5 million higher than 2013 which includes the $2 million co-development initiative. While this obviously impacts our short term profit growth, we believe this increased divestment while drive sustainable growth and higher returns in the future.

Operating profit decreased to 2.5 million compared to 11.5 million in the first quarter last year. Last year’s first quarter operating profit excludes a $4.7 million gain on the sale of an office building. The company’s 51% share in Zenara’s net loss just $346,000 and the company shares in Zenara’s EBITDA was a loss of $117,000 for the quarter. We continue to expect revenues of low single digit million for Zenara and the small EBITDA loss for the year.

The company expects reduce the valuation allowance against certain U.S. tax assets by approximately $5 million throughout the remainder of 2014 which would reduce full year reported tax expense accordingly. The actual amount of the reversal may increase or decrease depending on the amount and type of U.S. income during the rest of the year. Excluding this benefit we continue to expect our full year 2014 effective tax rate to be between 33% and 37% and we likewise continue to expect to pay a small amount of cash taxes in the U.S. during the year.

Capital expenditures were $4.1 million and deprecation was $5.8 million for the quarter, we continue to expect capital expenditures to be between 35 million and 39 million and depreciation to be between $25 million and $27 million in 2014.

We ended the quarter with debt at a cash of $38.2 million reflecting a high level of collections of accounts receivable which help generate free cash flow of $18.3 million during the quarter.

We still expect debt at a cash to improve by between $25 million and $30 million during 2014. We continue to expect adjusted income from continuing operations for 2014 to be between $0.99 and a $1.10 per share computed in a manner consistent with the first quarter results in the table at the end of this morning’s release.

I would now like to open up the call for questions. Lisa?

Question-and-Answer Session

Operator

(Operator Instructions). And we will take our first question from Daniel Rizzo from Sidoti & Company.

Daniel Rizzo – Sidoti & Company

The new products that you mentioned that are in Stage III trial, how should we think about those in terms of size? Is it something (indiscernible) the one from last year or is it something maybe a little bit more smaller in scale?

Steve Klosk

Dan, there is three new Phase III that we want. I would say that one of them has a potential to be $10 million in revenues in annual API revenues and the other two to be between 5 million to 10 million.

Greg Sargen

We just qualify that, the 10 million one I would say is 10 million and up depending on how things go out.

Daniel Rizzo – Sidoti & Company

And the ones you already had roughly $5 million to $10 million range as well correct?

Steve Klosk

I would characterize sort of the total portfolio in the following way. I think five of them we would put in the 10 million plus range, seven of them would be in the $5 million to $10 million annual API revenues and the remaining three at something less than 5. So it's a pretty robust pipeline.

Daniel Rizzo – Sidoti & Company

And then I think in the past year your generic API customers are having issues potentially they are losing market share and just kind of driving down inventory. It appears that has ended, is that accurate?

Greg Sargen

Yes it looks like any inventory drawn down is at least based on current order trends or go in the other way and it's always a guessing game as to understand what our customers are doing from a market share perspective, so it's usually in arrears that we have a sense of that. Right now the order has been running pretty strong so far through 2014 and we will continue to monitor them and right now we’re cautiously optimistic.

Operator

And we will take our next question from Dmitry Silversteyn from Longbow Research.

Dmitry Silversteyn – Longbow Research

Couple of questions if I may. Zenara continues to drive a little bit of a negative profit for you and you talked about the new product that you’re developing for the non-Nicorette and obviously they are looking at the large customer to launch, the Nicorette product or the Nicotine product I should say in India what will it take to swing that business to profitability, is it just the question of these projects wrapping up or do they need to do something else to get profitable in 2015?

Steve Klosk

Dmitry, I think we have got a reasonable base at this point to finally start growing the business if the non-NRT custom manufacturing product does continue to ramp up. The NRT gum product, we’re still hopeful. We will start to ramp up and as we look at the business we have got business development opportunities in the NRT area both from a custom manufacturing point of view and from our own product point of view and we’re pretty confident that we will be able to get some more non-NRT custom manufacturing business.

Ultimately we also want to use this business to develop our own generic drug products because it does give us that low cost platform. So as we have said in the past, I have said in the past it's slower than we thought but I think it's slowly getting to a point where it's at a reasonable base going forward.

Dmitry Silversteyn – Longbow Research

In terms of the gross margin commentary at the large generic manufacturing plant, to direct [ph] down your gross margin as you were working up inventories and running the plant sub-optimally. I believe Greg said that it was going on since the second half of 2013 but just looking back at the margins on the gross margin line it certainly didn’t seem to have impacted your ability to post a higher gross margins for the back half of 2013. So what was sort of different this time around 2014 first quarter that caused the margin to decline, that margin was just sort of magnitude of vague inventory drawn down and now that it's over what should we think about sort of the delta going the other way how quickly can gross margins improve as you return to normal production schedules and normal fixed cost absorption in that plant in the second half of 2014?

Greg Sargen

Couple of questions in there, the first quarter was more significant of a drawn down of production levels than we saw in the back half of last year and the back half of last year also had some other significant items kind of driving numbers in Q3 and Q4. So, I think it was a bit embedded in the overall numbers last year but nonetheless it was more dramatic in the first quarter. Going forward as I said in our call I think that nothing has changed with respect to our full year gross margin expectations and we have said it in the past that we pretty much expect those numbers to be in the low-30s give or take based on current volume levels that we’re expecting in reasonable upticks from there.

So I don’t see anything from the first quarter kind of trending into Q2 through Q4, so I think we will look back to kind of full year expectations in line with our profit guidance.

Dmitry Silversteyn – Longbow Research

So again to the low-30s and for the year, it requires for low to mid-30s profitability in the remaining quarters of the year, is that the right way to think about it?

Greg Sargen

Yes if that’s what the math yields then that’s what we expect to have.

Dmitry Silversteyn – Longbow Research

And then finally you mentioned that (indiscernible) was down a little bit over 2%, will that specifically in generic businesses for the continuing the trends that we have seen before or is that still related to custom manufacturing you have made in custom development, can you talk a little bit about sort of the pricing expectation for 2014?

Greg Sargen

Yes we expect a little bit more price erosion in 2014 than we have in the past and we typically have a 1% to 3% erosion in generic space and on the innovator side it tends to be driven either by volume tier pricing arrangements where we increase volumes and slip into next tier or renegotiations of contracts or in some cases where we’re working under master service agreement sometimes just renegotiation of price on certain volumes from year-to-year.

We expect a little bit more price erosion but again that’s embedded into our guidance, there is nothing at this point in the year that we didn’t see it coming into the year as far as overall impact on profitability or margins.

Dmitry Silversteyn – Longbow Research

Okay so the pricing was down and sort of normally in generics and then maybe little bit because of the timing of the contract negotiations for the custom manufacturing?

Greg Sargen

Yes, that’s fair.

Operator

(Operator Instructions). And we will go now to Steve Schwartz from First Analysis.

Steve Schwartz – First Analysis

Yes Steve in your prepared remarks you talked about the opiates APIs in development, mentioned it would be a factor in 2015. How is that moving along in terms of development and can you give us some idea of the scale of that contribution?

Steve Klosk

Well the products, I would describe one of the product is potentially a fairly large product in terms of the end market; the other one is smaller but higher margin. So the way this goes we’re going to sample customers, we’re going to get a net formulations, we hope that will take 15 to 18 months and then in late 2015 as I said and in 2016 we’re going to hope we will have some sort of substance [ph] commercial sales. But it takes a bit of time but it's a really important part of the market to enter.

Steve Schwartz – First Analysis

Okay and then on the last conference call you talked a little bit about some existing customers who were considering expanding their relationship with you to I think the Sweden facility and it sounded like that could be a significant contributor to growth? Do I have that right and how is that moving along?

Greg Sargen

I think what we have said is that based on some of the demand in the U.S. for large scale commercial assets and the limited supply of those assets in the U.S. that customers once they get comfortable with our quality system have been more than willing to consider our two other main manufacturing facilities, not only Sweden but also Italy and I don’t think we have seen any change there, you know the customers that we do have relationship with as we consider additional products within. They are willing, I can’t say in every case but they are generally willing and have seen more instances of them being willing to look at manufacturing and other sites within Cambrex.

Steve Schwartz – First Analysis

And then just lastly if I can just talk about the white elephant in the room. Your major innovator customer is clearly have incredible success with their drug. I’m just wondering how you see that potentially affecting you this year.

Greg Sargen

We’re not going to comment specifically on demand for any one product as we have kind of said in the past for multiple reasons. Suffice to say that we will endeavor to supply whatever they need from us and we try to stay in contact with them to make sure that our capacity is lined up with their near term expectations and we have models that we can run to kind of include that product in with many other products to make sure that we’re ahead of that game from a capacity planning perspective and we will continue to do so moving forward.

Steve Schwartz – First Analysis

How would you as best within your relationship with them, can you characterize how things are going? You know the first half of this year versus the second half of last year?

Greg Sargen

Yes it's always been a good relationship and we will endeavor to continue to make it a good one that’s as much as I can say. There is really no change in the relationship.

Steve Klosk

We would characterize it as, we have got a good relationship. I think they consider us a highly reliable supplier as Greg said. We’re focused on making sure we can meet their needs when they need it.

Operator

And we will take a follow-up question from Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn – Longbow Research

Yes, I just wanted to touch base on DEA controlled substances business, I think the expectations were for the first quarter for that business to be driving a little bit year-over-year actually comped up. So just a question on timing of orders or did you get higher quotas than you expected to? Should we sort of expect the near pocket [ph] later in the year as the quotas are fulfilled perhaps faster than -- and sort of more in the first half and the second half. Can you talk about your sort of visibility on the DEA controlled substance business?

Steve Klosk

So the demand as we expected Dmitry is good. I think our current guidance is to increase 17% to 27%. We will be well above 2012 levels which you know is the highest sales we have had in controlled substances. So this year we expect a record year for us and controlled substances. So far our customers have been able to get deviate quota that then matches our ability to get quota to manufacture. If it ramps up as you point out, there is always that variable about how quickly the customer can get quota and then how quickly subsequently can we can get quota. But we’re really pretty good with that, so if they give us orders and they can get quotas and we will be right at fulfilling orders.

Greg Sargen

Dmitry just to clarify, I think what we said from an expectation perspective was that the revenues for the year would be relatively evenly spread unlike some prior years so that’s not to say that there won't be a little bit of a quarter-to-quarter volatility but I think we base them on what we know so far that this year will be much more evenly spread than those years that we have seen in the past. In the past we have seen a pretty strong slug of orders come through in the first half of the year. Folks used to up their DEA quotas and then applied for additional quota that they may or may not get on the back half of the year and this year right now based on where our customers are until I guess from what we see from how the DEA is issuing quota and a bit more “rational” way compared to some years passed that we will see even more even spread there.

Dmitry Silversteyn – Longbow Research

And then final question as you sort of look at your main business, you know generic has caused some development and perhaps I will put in the DEA controlled substances in there in terms of revenue and profit impact. Where do you see sort of the most chance for doing better than your current guidance if things play out little bit more favorably for you and where do you see sort of the biggest potential for things perhaps decelerating in sort of half of the year because of unmet expectations or something like that.

Greg Sargen

It's a product by product basis more so than product category by product category basis. Some products if we add in typically controlled substances is one if more come through and drive that number up that tends to have a high contribution margin. Again there are certain products where that’s less so and certain products where that’s more so. So, because we are running fixed cost facility, then incremental revenue tends to have a fairly high contribution margin in the short run and vice versa on the downside. So we have as any company when we put together guidance and forecast we have a series of upsides and the series downsides and our job here is to maximize those upsides and do everything we can to kind of get those downsides off the list and bake them into our number. So I don’t think this year is any different than any other year, so we have opportunities to kind of come in on the high end of the guidance if not surpass it and there is situations that could put a (indiscernible) to the low end of the guidance. So we will continue to slug away at maximizing the good and misaiming the bad.

Operator

And now we will take a follow-up question from Daniel Rizzo from Sidoti & Company.

Daniel Rizzo – Sidoti & Company

Just one more question, so you indicate that your meat capacity as demanded by your large innovator customer, just given the size of that product for that customer is I guess are you worried at all about potential capacity constraints where you may not meet the demand or is this kind of been planned I guess?

Greg Sargen

We stay in touch with our customer to make sure that we don’t -- if we see capacity issues coming on the horizon, we try to address them. So we think we have capacity in each of our plans for all of our products and it's not just our largest product that we do this with to address near term expected demand and we have sophisticated capacity models that we kind of run at each plant to try to make sure we have the right visibility and enough time to be able to put in additional capacity as we need. It's not to say that that will always work perfectly but suffice to say we think we’re relatively good at it.

Daniel Rizzo – Sidoti & Company

So it's not something that you’re concerned with at this point?

Steve Klosk

We’re not concerned in the short run Dan. As Greg said, we are really pretty good at running our capacity planning models. So we talk regularly to not only the large innovator customer but all of our customers and our plants are busy. That’s the good news. All the plants are busy particularly the innovator plants. So we look at it and we talk to them and we will plan accordingly but I don’t see any issues for 2014.

Operator

And gentlemen we currently have no more questions over the phone at this time.

Greg Sargen

All right we thank everybody for their time and we look forward to talking with you again in July. Have a great day.

Operator

Ladies and gentlemen this does conclude today’s conference and we thank you for your participation.

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