Cambrex.'s (CBM) CEO Steven Klosk on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: Cambrex Corporation (CBM)

Cambrex. (NYSE:CBM)

Q2 2014 Earnings Call

August 01, 2014 8:30 am ET

Executives

Gregory P. Sargen - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Steven M. Klosk - Chief Executive Officer, President and Director

Analysts

Daniel D. Rizzo - Sidoti & Company, LLC

Steven Schwartz - First Analysis Securities Corporation, Research Division

Dmitry Silversteyn - Longbow Research LLC

Operator

Good day, and welcome to the Cambrex Second Quarter 2014 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Greg Sargen. Please go ahead.

Gregory P. Sargen

Thank you, Vicki, and good morning, everybody. Welcome to Cambrex's second quarter 2014 earnings conference call.

Today's discussion will contain forward-looking statements regarding expected operational or financial performance, and these statements may occur during our prepared remarks or during the question-and-answer session. These statements are based on Cambrex's current expectations that involve risks and uncertainties that could cause actual outcomes and results to materially differ from those included in the forward-looking statements.

For further information regarding such risks and uncertainties, please refer to the risk factors in the forward-looking statement portions of our 2013 Form 10-K filed with the SEC, as well as the forward-looking statement section in our earnings release issued this morning.

During this conference call, in order to provide greater transparency regarding Cambrex's operating performance, we refer to certain non-GAAP financial measures that 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, August 8, and a webcast will also be available on the Investor 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 comments on our financial results before opening up the call for Q&A. With that, it's my pleasure to introduce Steve Klosk. Steve?

Steven M. Klosk

Thank you, Greg, and good morning, ladies and gentlemen. We had a very strong quarter. Sales were $98 million, an increase of 58%, excluding the impact of foreign exchange compared to the second quarter last year. EBITDA was $21.2 million, an increase of 86% compared to $11.4 million in the same period last year. The increase in sales was driven by strong growth in all product categories, which also drove the significant increase in EBITDA.

For the first half of 2014, sales were $164 million, up 20% over the same period last year. Sales of all product categories increased, but first half growth was primarily driven by particularly strong growth in custom manufacturing and controlled substances.

EBITDA through the first 6 months of the year was $29.5 million, an increase of $1.3 million over the first half of 2013. Based on our strong first half results and expectations to the second half of the year, we are increasing our full year 2014 sales and profit guidance. We now expect full year sales, net of Zenara Pharma and the impact of foreign currency, to increase between 13% and 16% and EBITDA to be between $74 million and $78 million.

Comparing the mid-points of our current guidance with prior guidance, this represents an increase of 4.5 percentage points for sales and $3 million for EBITDA. As this guidance suggests, we expect a strong second half of the year, driven by an especially strong fourth quarter. I will now provide some commentary on second quarter performance within each of our product categories and an update on 2014 expectations for each category.

All growth rates exclude the impact of foreign currency between the respective years unless indicated otherwise.

Custom development revenues were $3.7 million in the second quarter, compared to $1.9 million in the same quarter last year. We added 3 new late-stage clinical projects during the first quarter and one moved successfully into custom manufacturing as a commercial product, resulting in 15 Phase III products heading in into the second quarter.

During the second quarter, 1 clinical trial was discontinued by our customer, so we now have 14 active Phase III projects. In order to enhance our commercial reach and continue our recent success securing development and manufacturing business for late-stage clinical programs, we recently strengthened our commercial team by adding new business development and marketing personnel. We currently expect 2014 full year revenues in the custom development category to be between $21 million and $25 million, versus our previous expectation of $28 million to $32 million. The reduction, compared to prior guidance, primarily represents delays in the timing of certain projects compared to prior expectations, and to a lesser degree, the discontinuation of a Phase III trial by a customer.

We believe that our quality systems and reliability are being increasingly recognized among our customers and potential customers. During the second quarter, we earned strategic supplier status with 1 large pharmaceutical customer. And after a thorough assessment of our capabilities, we're told by another customer that we are well positioned to win future projects within a fast-growing area of specialized chemistry.

Moving to custom manufacturing, which includes Commercial Products sold to innovator pharmaceutical companies, revenues were $45.5 million during the quarter, an increase of 59% compared to $28.6 million in the same quarter last year. The increase was primarily driven by shipments of 1 large product, for which we had no second quarter sales in 2013. 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 will typically negotiate a supply agreement to provide commercial volumes that were ported in this product category. We also have had success obtaining supply positions for late-stage in approved commercial molecules, where we can offer an improved cost position or other innovative benefits to the customer.

Due to increases in second half orders for certain large commercial APIs for innovative pharmaceutical companies, we now expect 2014 revenues in the custom manufacturing product category to be between $175 million and $180 million, a $15 million increase over prior guidance. Our combined custom development and custom manufacturing revenues for the full year 2014 are now expected to be between $196 million and $205 million, a 14% to 19% increase over last year's $172.7 million in combined revenue. This represents an $8 million or 5% increase over the prior guidance range for the 2 combined product categories.

Sales of generic APIs in the second quarter were $28.9 million, an 18% increase versus $24 million in the same quarter last year. Developing and launching new products is one of the key components to continued growth of generic APIs. We are increasing our R&D spending in order to expand and accelerate our efforts to bring new generic APIs and controlled substances to market.

During the first half of the year, we increased the number of generic APIs in our development pipeline from 15 to 17. Order levels for generic APIs were up significantly through the first 6 months of 2014 compared to the first half last year. We are cautiously optimistic that generic orders will remain strong as of the year progresses, and believe we have enough visibility to raise our expectations for full year 2014 generic API revenues to an increase of between 5% and 10% compared to 2013. We previously expected a low- to mid-single digit percentage increase.

Sales of controlled substances, which we define as those classified as Schedule II products by the DEA were $14.1 million in the second quarter, compared to $3.5 million in the same period last year. Increased revenues were driven by strong sales of our ADHD APIs.

Cambrex's position 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 are developing abbreviated new drug applications, or ANDAs, to enter the ADHD market.

We are currently developing 2 additional controlled substance products, both opiates, an important segment of the market in which we do not currently participate. While we do not expect commercial sales for these products until late 2015 or early 2016, this remains a key strategic initiative for future growth in this product category.

We still expect full year 2014 in 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 $4.9 million during the second quarter, $1.3 million higher than the same quarter last year. We now expect full year drug delivery revenues to be up between $1 million and $3 million in 2014 versus prior guidance of flat to slightly higher.

During the second quarter, we purchased the remaining 49% of Zenara Pharma, a generic finished dosage form business in Hyderabad, India. Upon buying out the minority shareholder, we assigned a team of Cambrex employees to support the Zenara management team. The team is actively identifying new markets for Zenara's formulated NRT products and new finished dosage form contract manufacturing opportunities. Greg will say more about this transaction shortly.

To wrap up my comments as this morning's release stated, we are very pleased with the performance of the business. We are confident that we will obtain the orders we need achieve our second half expectations. And as such, we are focused on meeting customer delivery schedules and maintaining strong commercial momentum into 2015. We expect a strong second half of the year, including an especially strong fourth quarter, and as a result, are pleased to increase our full year sales and profit guidance as indicated earlier.

I look forward to updating our progress after the third quarter. I will now turn the call over to Greg.

Gregory P. Sargen

Thanks, Steve. Steve covered our sales performance so I will comment on certain other financial statement items.

Gross margin for the second quarter was 34%, compared to 31% in the same quarter last year, resulting primarily from a positive product mix, which more than offset our price decline of 1.8%. Excluding impact of currency, second quarter 2014 gross margins would have been closer to 35%.

Selling, general and administrative expenses for the second quarter were $14.6 million, an increase of $3.9 million compared to the second quarter. Higher SG&A expenses included higher personnel-related costs, expenses related to the buyout of the remaining Zenara shares and higher level of spending on due diligence for acquisition opportunities.

Personnel-related costs during the quarter included higher bonus accruals, higher performance-based equity compensation expenses due to the increase of first half actual and full year sales and profit projections, as well as increases in the share price.

Research and development expense increased $900,000 compared to the second quarter last year, primarily driven by a higher level of personnel and an increased level of products in the R&D pipeline. As we indicated at the beginning of the year, we recently added R&D resources at all sites to support or accelerate the development of an expanded set of products, primarily for the generic and controlled substance markets, where we now have a total of 19 products in development.

Operating profit increased to $15.2 million, compared to $5.9 million in the second quarter last year. Year-to-date operating profit was $17.7 million compared to adjusted operating profit of $17.3 million through the first 6 months of last year. Year-to-date 2013 adjusted operating profit excludes a $4.7 million gain on the sale of an office building during the first quarter.

EBITDA for the quarter was $21.2 million, compared to $11.4 million in the same quarter last year. Year-to-date, adjusted EBITDA was $29.5 million, or 18% of sales, through the first 6 months of 2014, compared to $28.2 million, or 20.7% for the same period last year.

At the mid-point of our sales and EBITDA guidance, EBITDA, as a percentage of sales, will be approximately 21% for the full year 2014.

As Steve noted, we completed the purchase of the minority stake in Zenara during the second quarter for $2.7 million. All Zenara results subsequent to the purchase of the minority stake will be fully consolidated within our financial statements.

Prior to the second quarter buyout, the company had recorded $4.4 million of cumulative translation adjustments within the equity section of the balance sheet due to changes in the exchange rate between the Indian rupee and the U.S. dollar. U.S. GAAP require that we recognize this translation adjustment as a loss on the income statement upon our purchase of the minority stake. This is the primary driver of the $4.3 million loss recorded during the quarter within the equity and losses of partially-owned affiliates line of our income statement.

We continue to expect revenues of low single-digit millions for Zenara and a small EBITDA loss for the full year 2014.

The company revised projections of domestic profitability, and accordingly, its ability to utilize foreign tax credits in the U.S. for which it had previously recorded a valuation allowance.

The second quarter 2014 provision for income taxes includes a benefit of $14.2 million related to the reversal of valuation allowances pursuant to these projections. Excluding this benefit and the loss on the Zenara transaction, the second quarter effective tax rate would have been 33%, consistent with the rate during the second quarter last year.

The company expects to further reduce the valuation allowance against U.S. tax assets by approximately $3 million during the second half of 2014, which will reduce full-year reported tax expense accordingly. The actual amount of the reversal may be higher or lower, depending on the amount and type of U.S. income during the rest of the year. Excluding this benefit and the impact of the Zenara transaction described earlier, we continue to expect our full year 2014 effective tax rate to be between 33% and 36%, and we likewise continue to expect to pay only a small amount of cash taxes in the U.S. during the year.

Capital expenditures were $6 million and depreciation was $5.9 million for the quarter. Year-to-date capital expenditures were $10.1 million and depreciation was $11.7 million. 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, net of cash of $54.6 million, or $16.4 million increase during the quarter, reflecting inventory build for second half shipments and in preparation of a standard plant maintenance shutdowns later in the summer. We still expect debt net of cash to improve by between $25 million and $30 million for 2014.

In line with higher full year sales and EBITDA expectations that Steve discussed, revising our guidance for adjusted income from continuing operations for 2014 to be between $1.07 and $1.15, computed in a manner consistent with the first quarter results in the table at the end of this morning's release. Previous expectations were between $0.99 and $1.10 per share.

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

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Daniel Rizzo with Sidoti & Company.

Daniel D. Rizzo - Sidoti & Company, LLC

I have a question. In the press release, you have a line that says expenses related to due diligence on various acquisition opportunities. I was just curious if you can clarify what you're referring to with that.

Steven M. Klosk

Yes, we had more activity than usual in the first half of the year, and especially in the second quarter, looking at various M&A opportunities where unfortunately, end up hiring a fair number of lawyers, accountants and outside experts to kind of evaluate these opportunities.

Daniel D. Rizzo - Sidoti & Company, LLC

Are those expenses expected to continue? I mean, is it...

Gregory P. Sargen

No, we have them at -- they'll continue. We have them at a lower level in the second half than in the first half, but at least as far as what we're expecting. But the first half was a little -- was heavier than normal.

Daniel D. Rizzo - Sidoti & Company, LLC

And I mean -- I guess my real question is, does that mean the pipeline is more robust now currently or did those...

Gregory P. Sargen

No, I think the pipeline for opportunities has been fairly robust. I think, as you know, we're pretty picky and prudent when it comes to what we might eventually end up buying, if anything. And we looked at a couple of transactions pretty intently and went a little bit further down the road than we had in recent times on a few of them, so that ended up costing a fair bit more than we had previously spent.

Daniel D. Rizzo - Sidoti & Company, LLC

But you walked away?

Gregory P. Sargen

Yes, we don't comment on that status of M&A, so. [indiscernible] level.

Daniel D. Rizzo - Sidoti & Company, LLC

Okay. With Zenara, with -- do you have, like, a timeframe when you think it might be contributing to earnings?

Gregory P. Sargen

Well, I'll start off and maybe if Steve chime in. I mean, it's possible, at least at an EBITDA basis, that it might contribute this year. It's kind of, give or take, it's most likely in a loss position, but there are scenarios where it could be positive. Once you included the amortization of intangibles and all the other stuff, it will inevitably be a net loss. But -- so we haven't given up hope yet. I think the expected case is that it will lose something this year and I then think next year and the years beyond will depend on whether the team that's been assigned finds the right opportunities out there for the NRT products and various other contract manufacturing opportunities. I don't, Steve, if you want to add something to that.

Steven M. Klosk

Yes, the only thing I would add, Dan, is the -- being in full control with Cambrex is already stimulating more potential business opportunities than we saw. And so that's positive as we have an integrated business development team take advantage of the teams in Europe and the United States. So we're optimistic that it will be a contributor. It's just going to continue to be slow in that regard.

Operator

We'll go next to Steve Schwartz with First Analysis.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Just to continue the conversation on Zenara. The $2.7 million that you paid is in SG&A? Do I understand that correctly?

Gregory P. Sargen

No, that's what we paid for the shares. So that's an asset on our balance sheet ultimately, based on the -- it's not the only asset that's on our balance sheet, but it's included with the original amount we paid less various adjustments to that based on earnings and other things over time since 2010. So they're now consolidated into our full financial statement, so there's no one line item. The 4...

Steven Schwartz - First Analysis Securities Corporation, Research Division

Okay. That makes sense.

Gregory P. Sargen

What I referred to on the prepared remarks was a $4.4 million, which resulted in a $4.3 million on the line item with a few other things in there. That loss was related to the recognition of the cumulative translation adjustments that had built up in Cambrex's equity section of the balance sheet over time based on the exchange rates since 2010 through now between the rupee and the dollar.

Steven Schwartz - First Analysis Securities Corporation, Research Division

And that ties into the $4.1 million that you list as a loss on acquisition of Zenara shares?

Gregory P. Sargen

Correct.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Is that correct?

Gregory P. Sargen

Yes, there's various -- so that line item includes a potpourri of things based on the transaction and the actual performance of Zenara and the 51% that we were -- we owned prior to the transaction and then the full control afterwards. The actual results for the quarter were relatively immaterial. There was a small gain recorded against the loss on translation, and so forth. That all netted out to about $4.1 million, but by far, the single biggest component was the $4.4 million write-down of translation adjustments.

Steven Schwartz - First Analysis Securities Corporation, Research Division

And your option to purchase this 49% was -- you were right set for 2016. So what prompted you to step it up 2 years and go after the remaining assets?

Steven M. Klosk

We just thought, Steve, and I think it will end up being that case, that having full control and having an integrated Cambrex business development effort was going to give us a chance to accelerate the success there. So we felt strongly about that. We talked about it, our business development guys are positive about it, so we decided not to wait.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Okay, and you mentioned the potential for contract manufacturing. Didn't you or haven't you, in fact, already started doing some manufacturing with those assets that was outside the original scope when you entered the agreement?

Steven M. Klosk

Yes, we currently are producing product under custom manufacturing -- on a custom-manufacturing basis for a large generic pharmaceutical customer. And that was the primary driver of the revenues in the quarter, so we're producing product. We expect to continue to produce that product. And frankly, we'd -- we want to add additional projects like that. And we think there is the opportunity too.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Yes, okay. And my last question, you noted in the release in your prepared remarks that you achieved strategic supplier status with one customer. And I'm just wondering, what that bestows upon you? Is there any particular advantage gained from that going forward?

Steven M. Klosk

Yes, generally, if you achieve that status, it means that this large pharmaceutical customer will give you access to bidding on and have visibility to new projects going forward. And so generally, they'll start with that group of strategic suppliers before they go to a larger group. It gives us an early and better look at new business.

Operator

At this time, we have one question remaining in queue. [Operator Instructions] We'll go next to Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn - Longbow Research LLC

Questions I have is on the custom development and custom manufacturing businesses. You talked about losing 1 custom-development contract because the customer decided not to go ahead with it for whatever reasons, that the clinical trial results or whatever it may be. Can you talk about sort of what your second half expectations are in terms of the projects that you're working on? And whether we can see that '14 -- that '14 number project increase perhaps to back to '15, '16, '17? And also if there's any upcoming graduations, if you will, from Phase III in custom development business to commercial production and custom manufacturing business in the second half of the year?

Gregory P. Sargen

Yes, this is Greg. To answer the last question, there's -- we expect at least 1 graduation in the second half if things go according to plan, and there might be one other one in there. It's always a bit uncertain, but at least based on current expectations, one, maybe 2 that would get approved. With respect to whether or not we're going to add 3, 4, 5, as we did in the first quarter, to that pipeline, I mean, that's the -- business development team's goal, pretty much every day that they're out there, is to add as many late-stage projects that fit our assets as possible. So it's kind of hard to say if there's always a bunch of them in queue in the pipeline being worked. So if I knew the answer to that, I'd be a smarter guy than I currently am, but the plan is to add them going forward. We preferably like to add 3 or 4 of those a year, if not 5, and have a couple graduate each year, such that those go up. But it's a bit difficult to project. But that's definitely the goal.

Dmitry Silversteyn - Longbow Research LLC

Got you. In terms of Zenara, the impact on the P&L, I mean, how should we think about the gross margin impact or operating margin impact of having this business now fully consolidated and not having to pay anything out on the lowered interest line?

Gregory P. Sargen

Yes, I think it's negligible for the quarter and will be relatively small for the year again, given mid-single-digit millions of sales and small EBITDA loss. The loss will be a little bigger including the depreciation, amortization of intangibles that's there. It's not included in the guidance, figures that we gave, so the Zenara kind of stands separately from that just to be consistent with what we did previously, so it's not the kind of compare apples and oranges to previous and current guidance.

Dmitry Silversteyn - Longbow Research LLC

Okay, but if we do roll Zenara into your current guidance, because in the second half of year, it will be part of the company.

Gregory P. Sargen

Yes.

Dmitry Silversteyn - Longbow Research LLC

Should we be thinking about then perhaps earnings at the lower end of the range that you provided?

Gregory P. Sargen

No, it's probably a $0.01 to $0.02 impact in the grand scheme of the year that we've rolled in, probably closer to $0.02. But again, it's not in the adjusted net income guidance that we gave.

Dmitry Silversteyn - Longbow Research LLC

Okay. All right. And then, finally, can you provide any updates or talk at all about your initiative to develop some custom over-the-counter generic drug formulation. You mentioned that you had a couple of development agreements with some generic marketers.

Steven M. Klosk

Yes, Dmitry. We're still working on one product that we're codeveloping together. That's progressing. We continue to look at and consider several others. We don't have anything formal yet on those, but it is a concerted and conscious effort to codevelop more going forward.

Dmitry Silversteyn - Longbow Research LLC

This one product development, just it's because the first time you're doing this, so it's sort of the first time of watching you do this. What's kind of the expectation for -- I mean, is it a 2- to 3-year project? Is it a 5-year-plus project? Is it a 12- to 18-month project? How should we think about it?

Steven M. Klosk

Well, I think -- our forecast or our look forward is said it will start generating revenue in late 2017 or perhaps 2018.

Dmitry Silversteyn - Longbow Research LLC

Okay. So a 3- to 4-year project? Okay. I just needed to understand.

Gregory P. Sargen

Yes, let me just clarify that we would spend dollars this year and primarily next, and even arguably, probably the early part of next year if things went according to plan. The bulk of the dollars we'll have spent. And then our partner would file the abbreviated new drug application, and then you’re waiting for approval and/or patent expiration to kind of go there. So that's how the timing tends to work out. So you spend, and then you file and you wait.

Operator

At this time, we have no further questions in queue. [Operator Instructions]

Gregory P. Sargen

All right, Vicki, if we have no further questions in the queue, we will thank everyone for their time and look forward to speaking to you next quarter. Thank you very much

Operator

That does conclude today's conference. We thank you for your participation.

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