Albany Molecular Research's (AMRI) CEO William Marth on Q4 2015 Results - Earnings Call Transcript

| About: Albany Molecular (AMRI)

Albany Molecular Research, Inc. (NASDAQ:AMRI)

Q4 2015 Earnings Conference Call

February 17, 2016 8:30 a.m. ET

Executives

William Marth - President and CEO

Felicia Ladin - SVP, CFO and Treasurer

Chris Conway - SVP Discovery and Development Solutions

Patty Eisenhaur - Head of Investor Relations

Analysts

Tejas Savant - JP Morgan

Mark Rosenblum - Morgan Stanley

Steve Schwartz - First Analysis

Operator

Good day ladies and gentlemen and welcome to the AMRI Fourth Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]

I would now like to hand the conference over to Patty Eisenhaur, Head of Investor Relations. Please go ahead.

Patty Eisenhaur

Good morning, everyone and thank you for joining us today to review AMRI’s results for the fourth quarter of 2015 and our forecasts for 2016. This call is a follow-up to the Press Release AMRI issued earlier this morning, a copy of which is on AMRI’s website. Please note that we will be using a presentation to complement today’s call. The presentation is also available on our website. Today’s call is being broadcast live via webcast, which will be available on AMRI website for 90 days.

With us on the call today is William Marth, AMRI’s President and Chief Executive Officer; and Felicia Ladin AMRI’s Senior Vice President, CFO and Treasurer. Also available for the Q&A portion of today’s call is George Svokos, Chief Operating Officer and Chris Conway, SVP Discovery and Development Solutions; and Milton Boyer SVP Drug Product Manufacturing.

Before we begin, I’d like to note that much of the discussion today might be termed forward-looking other than historical facts or statements may contain projections, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed in the Press Release issued this morning and in AMRI’s Annual Report on Form 10-K for the year-ended December 31, 2014 as filed with the Securities and Exchange Commission on March 16, 2015 and the company’s other SEC filings.

While these statements represent management’s current judgment on the future direction of the company’s business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. The company undertakes no 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’d also like to remind you that AMRI’s reported non-GAAP operating results are adjusted from U.S. GAAP operating results for certain items that are described in the Press Release issued this morning. A reconciliation of our GAAP to non-GAAP results is included in the release and the presentation.

I’ll now turn the call over to Bill.

William Marth

Thank you, Patty. Welcome everyone and thank you for joining us today. I am pleased to report that AMRI delivered another strong quarter, completing what has been an important and pivotal year for us going into 2016. We achieved contract revenues of $123 million in the fourth quarter, our second consecutive quarter of contract revenue over $100 million, up 52% when compared to the fourth quarter of 2014.

Organic revenue was strong led by our drug product business and acquisitions completed in the last 12 months contributed $34 million to this quarter versus the prior year. Full year 2015 contract revenue was $385 million and despite of the loss of Allegra royalty we surpassed the $400 million mark with $402 million in total revenue for the full year.

Adjusted contract margins were also very strong at 30% for the fourth quarter and 26% for the full year, achieving an aggressive target we set for ourselves. Recent acquisitions, including the addition of Gadea together with improved product mix and API and the operational efficiency programs we implemented contributed to the strong margin performance. Certainly these margins set us up well for going into 2016.

Adjusted EPS was very strong as well. We reported adjusted earnings per share of $0.40 for the quarter and for the full year adjusted EPS increased 48% to $0.96, in line with our expectations. Our strong performance clearly demonstrates the effectiveness of our strategy to grow both organically and inorganically, create sustainable contract revenue and EBITDA and provide valuable differentiating services and products for our customers.

Let me provide a few highlights on the quarter. We had a strong finish to the year in drug product with revenue of $28 million in the quarter and full year revenue of approximately $90 million. We’ve seen significant improvements in our Albuquerque operations this year and Burlington received its first product approval following a successful FDA audit, a key milestone for the site.

Burlington has achieved profitability since the second quarter and will be a key contributor in drug product’s performance in 2016. Glasgow has remained strong throughout its integration and the site’s capabilities expanded this year with the addition of a new cytotoxic filling line. We’ve also started the first phase of installation for a state-of-the-art pre-filled syringe line in Albuquerque, New Mexico which is expected to come online next year, a new addition that our customers have been asking for, for some time.

Turning briefly to the drug product pipeline. We really expanded the pipeline of development programs this year, notably the volume of early-stage programs we gained with Glasgow acquisition and generic programs we are working on. Our partner, Eagle Pharmaceuticals’ approval of an alcohol-free Docetaxel brings our 20 late-stage programs down to 19 and brings the number of commercial products up to 18. What we are most excited about are the 21 generic development programs, many of which are co-development alliances where we share in the development costs and upon regulatory approval we’ll supply the products and receive a royalty on the end market sales, creating an additional revenue stream beginning in 2017.

Turning to discovery and development services, revenue was up 25% to $24 million in the quarter and up 21% to $90 million for the year. Importantly, DDS adjusted margins expanded 6 points quarter over quarter to 29%. While DDS growth this year is largely attributable to the acquisition of SSCI, we made great strides in positioning this business for continued growth in 2016. Of note, we saw the launch of our integrated biology and chemistry services in Buffalo which now has its first customers. We’ve had great success in recruiting high caliber talent to this site as Buffalo is gaining broader traction, and nothing like it exists today in the US market.

Also, our newly established Compound Library Consortium is fully underway in Hyderabad. Members of this consortium include Biogen and two other major pharmaceutical companies who all share in the development of about 1700 compounds a month that they will screen. The longer term goal is this work will become future development work down the road. We have about 45 chemists dedicated to this program and hope to bring on an additional consortium member this year. This was a very important alliance that was established in 2015.

Under Chris Conway’s leadership in the DDS business, it is operationally aligned to execute and meet our customers’ needs. Testament to this was the extension of the Lilly in-sourcing contract, extended two years early and the long term chemical development contract with GSK at our Aurangabad site.

Operationally we’ve seen strong profitability for DDS and are encouraged by the high level of visibility we have on programs this year. Lastly, the acquisition of Whitehouse Labs in December is another great building block for this business with its experts focused on specialty testing methods like CCIT or container closure integrity testing, this business will have an impact across the AMRI network as we expect to expand their services to our customer base and also provide the additional services to the customers that they have been serving in this very specialized base.

On the API business, revenue was up over 50% to $71 million in the fourth quarter, and up 40% to $205 million for the full year. While we achieved record revenue at both our Rensselaer and Cedarburg sites, production delays for a couple of products shifted some revenue into 2016. Gadea's Crystal Pharma continues to exceed our expectations and lastly, the Holywell UK site ceased operations in the fourth quarter as planned and we have successfully transitioned activity to other sites within the network.

We entered 2016 with 148 API programs and 14 late-stage development programs. One program moved from development into commercial in the fourth quarter and we will be supplying commercial product in 2016. We also filed 9 DMS in 2015 bringing our total DMS count to 27. These are generic APIs that are available now for commercial supply, so we have healthy portfolio of APIs that we can supply now and that will provide future revenue on top of the commercial APIs we currently manufacture.

The API business has really transformed this year, and with the appointment of Dawn Von Rohr who recently joined us after two decades leading Mallinckrodt's Global API business, we’re really excited about the future of this business.

Lastly, we are very pleased to welcome several new members to our board of directors. Tony Maddaluna, EVP and President of Pfizer’s global supply brings over 40 years of global manufacturing and supply chain experience to AMRI and will be a great resource for us as we look to expand and optimize our manufacturing network. Also, David Deming, former managing director at JP Morgan and Ken Hagen who is retired from PricewaterhouseCoopers brings us extensive M&A and tax expertise, that will be invaluable as we continue to pursue our growth strategy.

I’d like to thank Gabe Leung who retired from the board for his dedicated service to AMRI over the last five years. His expertise in the pharma industry has been an asset to us and we wish him the best in his new ventures.

Let me turn the call over to Felicia for the details on our financial results and our outlook and I will finish up with some additional thoughts. Felicia?

Felicia Ladin

Great. Thanks, Bill and good morning. I will start my comments by summarizing our overall quarterly performance after which I will provide more insights to the performance of our three reporting segments. Details of our performance and outlook can be found in our fourth quarter earnings release and in the earnings presentation posted on our website.

Total revenue in the fourth quarter was $126.4 million, up 46% from fourth quarter 2014. Contract revenue was $123 million, an increase of 52% reflecting our four acquisitions: Gadea, SSCI, Glasgow, and for a very small portion of the quarter, Whitehouse Labs.

Adjusted contract margins for the fourth quarter were 30% compared with fourth quarter 2014 of 23%. The benefit of the acquisitions, the impact of the cost reduction initiatives and facility optimization coupled with a strong mix within our drug product business contributed to the margin expansion. Royalty revenue in the fourth quarter was $3.4 million, down $2.5 million or 43% from last year. Royalties on fexofenadine have ended. So this quarter reflects $2.4 million of revenue from our sales of amphetamine salts to Allergan as well as $1 million of royalties from an API sourced from Spain.

Beginning in the first quarter, we will reflect these royalties in the operating segment results and no longer have a corporate royalty line item.

Moving now to the segments and margins. Fourth quarter contract revenue for our DDS segment was $24.2 million, up 25% from fourth quarter 2014, reflecting the addition of SSCI and a small portion from Whitehouse Labs, offset by a decrease in discovery revenue in Singapore. Revenue from discovery services was $10 million, a decrease of 8% and development in small-scale manufacturing was $14.2 million, up 65% from the prior year.

Adjusted contract margins for the DDS segment were 29% in the fourth quarter, an improvement of 6 percentage points, driven by the addition of SSCI and higher capacity utilization resulting from previous cost reduction initiative. Looking forward, we anticipate DDS contract margins will continue to expand reflecting the addition of Whitehouse Labs and continued growth in the development side of our business.

Contract revenue for our API segment was $70.9 million, an increase of 52% and adjusted contract margins for API were 31%, an increase from 26% last year driven primarily by the margins realized on Gadea’s revenue, offset by a product mix at our other API facilities.

Looking forward we anticipate API margins will remain in the low 30s but will fluctuate quarter-to-quarter based on product mix. Contract revenue for our Drug Product segment was $28 million, an increase of $13.2 million from fourth quarter 2014, reflecting higher commercial products and services revenue and the addition of our Glasgow facility.

Drug Product adjusted contract margins were 28% in the fourth quarter, up from 12% in 2014, reflecting increased contribution from our Burlington facility and the addition of Glasgow and commercial product mix. Looking forward we expect Drug Product margins will moderate in the low 20s in 2016.

Adjusted EBITDA in the quarter was $26.7 million, an increase of 51% from 2014. Our tax rate on an adjusted basis was 18.3% in the fourth quarter reflecting product mix and the favorable tax treatment associated with the non-recurring items which we don’t expect to repeat in 2016. We’ve assumed a tax rate between 29% and 30% as part of our 2016 guidance. Adjusted earnings per share in the fourth quarter of 2015 was $0.40, reflecting the benefit of the lower tax rate offset by 2.2 million additional shares issued as part of the Gadea acquisition.

For the full year, we reported adjusted EPS of $0.96, in line with our expectations. Full year EPS from our contract business was approximately $0.63, up from $0.17 in 2014, and EPS royalties were $0.33, a decrease of $0.15 per share over the last year in favor of our more sustainable contract business.

Moving to cash flow on the balance sheet. At the end of the quarter AMRI had cash, cash equivalents and restricted cash of $52 million compared to $82 million at September 30, 2015. The change in cash reflects $54 million for the acquisition of Whitehouse Labs, $12.3 million in capital expenditures, offset by a $30 million draw on our line of credit to partially fund the acquisition and $5 million of cash generated by operating activities.

For the full year 2015, cash flow from operations was $44 million and CapEx was $26 million. We finished the fourth quarter with total debt of $421.5 million, and a pro forma debt to trailing EBITDA ratio of 4.3 times.

Turning now to our outlook for 2016. We are forecasting total revenues between $465 million and $490 million, up 19% at the midpoint. In order to get a true comparison of 2015 to our projections for 2016, we look at our revenue for 2015 on a pro forma basis. We finished 2015 with total revenue of just over $400 million. As we entered 2016, we’ll benefit from a full year of Gadea and Whitehouse Labs which will be offset by the expiration of a key discovery program in Singapore. We have also built in some FX headwinds which influenced the top line more than the bottom line and the decline in royalties giving us adjusted baseline pro forma 2015 revenue of about $440 million. Growth from $440 million in 2015 pro forma revenue to our 2016 guidance at the midpoint of $478 million represents just over 8% organic revenue growth, in line with industry trends of high single digit growth.

Turning to our segment outlook. DDS revenue is estimated to grow over 20% to approximately $104 million at the midpoint. We anticipate modest growth in our discovery business and over 25% growth in our development services and small scale business, reflecting our continued organic growth and the addition of Whitehouse Labs. Note that for 2016, $6.9 million in revenue and $1.6 million in operating income has been moved from DDS 2015 results to drug product. This largely is related to analytical services work previously booked in development services which directly supports our finished drug product activity.

API revenue is estimated to grow over 25% to approximately $260 million at the midpoint, reflecting a full year of Gadea and the transition of certain development programs into commercial supply. In addition, we expect API will have approximately $10 million of royalties primarily on amphetamine salts. As a reminder, beginning in 2016 royalties will be reflected in the segment.

Lastly, drug product revenue is estimated to grow 8% to approximately $105 million, reflecting largely organic growth. As I mentioned earlier, forecast for drug product reflects $6.9 million in revenue and $1.6 million in operating income moving from DDS to drug product. As we continue to formalize our business units, this recast will be reflected in our historical reporting periods and will look to provide you with further details before we report our first quarter results.

For adjusted contract margins, we expect to continue to improve from 26% in 2015 to a midpoint of 30% in 2016, reflecting the addition of higher margin businesses and the efficiencies we have gained, including the UK site closure.

On an absolute basis, SG&A is expected to increase 18% with about half due to recent acquisitions but as a percentage of revenue, it will remain steady at about 15%. As our business grows, we need to continue to grow our key supporting functions, such as corporate quality and compliance, procurement and finance as well as make investments in training and developing our people.

R&D investment is expected to be about $9 million, reflecting our continued investment in new APIs and our co-development alliances which Bill will discuss further. Adjusted EBITDA is forecasted to increase over 20% to between $91 million and $97 million, or approximately 20% of revenue.

Adjusted earnings per share for 2016 is forecast between $1.00 and $1.10, up 8% over 2015 at the midpoint, reflecting a full year of earnings from Gadea, the acquisition of Whitehouse Labs and continued organic growth. We’ve assumed a tax rate between 29% and 30%.

Turning briefly to capital expenditures and interest expense. We expect to invest about $45 million in CapEx in 2016. There are a number of notable projects that we will be investing in, including the new prefilled syringe line in Albuquerque that Bill mentioned as well as investment in additional R&D and manufacturing capacity to support increased customer demand for our specialty manufacturing. CapEx also includes the ongoing investment in our ERP upgrade.

Cash interest on our $150 million bond and term loan will be around $17 million in 2016. As a reminder, based on historical trends, we typically see revenue and earnings billed for the year with the first quarter typically being our lowest quarter. We anticipate that, that will be the case again this year. We expect 45% of our revenue and EPS in the first half of the year and the corresponding 55% of revenue and EPS in the second half of the year.

I’ll now turn the call back over to Bill for closing remarks.

William Marth

Thanks, Felicia. So overall it has been truly a pivotal year for AMRI. If we reflect on the last 24 months, what have we achieved? We’ve completed six acquisitions deploying roughly $440 million of capital, picking up about $200 million of revenue and about $45 million of sustainable EBITDA. As a result, we have significantly expanded our capabilities in API and drug product, including a platform of niche API and end-to-end parenteral capability.

In addition, we added expertise in high demand solid-state chemistry and now have extensive analytical and drug product testing capabilities that address the expanding regulatory demand our customers are facing. Our achievements aren’t all inorganic. As I noted earlier in the year, we have done things such as extend our key contracts, GE ABA, the Lilly in-sourcing program and GSK for a key intermediate Advair.

We’ve expanded our discovery capabilities to include high throughput and high content screening. And we have integrated biology and chemistry with innovative informatics platforms, streamlining data sharing with our customers. We’ve also continued our advance in generics with multiple co-development programs where we will capture revenue three ways: through development; commercial supply and ultimately royalty revenue. As I mentioned earlier, we have over a dozen of these programs which effectively – which collectively will address over 3 billion in market value, and could generate over $200 million in annual royalties within five years.

Looking at our forecasts on an EPS basis, we entered 2016 with an estimated $0.16 per share headwind due to lower royalties, primarily due to the Allegra patent expiration. We expect to offset that loss with about $0.50 per share of growth with one-third of that growth, organic and about two-thirds of that from acquisitions we have done over the last 12 months. We have much better visibility on our business going into 2016 than we have ever had in the past. This stems from the businesses we have acquired, the customers we serve, and the organization that we have built.

We have done a lot of the heavy-lifting of building the platform for AMRI to be a sustainable $1 billion contract research, development and manufacturing company. But as we’ve grown quickly, it’s also important for us to continue to invest in our people and infrastructure. As such, we will reinvest about a third of our profit this year on building out key supporting functions that need global scale talent as we grow. We have built a strong platform for our business and as we begin 2016, our priority will be to stay the course on our strategy. We will maximize the value of our current acquisitions, continue to drive organic growth and delivery quality, reliable and innovative services and products our customers demand. Further we will continue to look for creative ways when appropriate to expand in this challenging financial environment. Based on the traction we have established, we are confident we will reach our goals.

Before we turn the call over to Q&A, I would like to thank our employees and convey my appreciation for their continued hard work, their passion for innovation and ongoing commitment to the needs of our customers. Also, thank you, our shareholders for your continued support. Karen?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Tycho Peterson from JP Morgan.

Tejas Savant

Hey guys, it’s Tejas on for Tycho. Thanks for taking the questions. Just one here on DDS, did you – if I heard you right, did you say something on expiry for discovery services contract in Singapore? Can you just elaborate on that, how large it was, and whether you think it’s going to offset a full year of Gadea and Whitehouse Labs in 2016?

William Marth

The expiration of – we’ve extended the Lilly contract to 2021. The Singapore contract was more – Chris, do you want to comment on that?

Chris Conway

Sure, this is Chris Conway. Yes, that was – that contract expired this year and to answer your question, no, it will not offset the other pieces that you mentioned, it was essentially the results of that expiration of the contract derisked our customer profile in Singapore and put us into a more profitable position to grow in that site. So the impact is not very significant.

Tejas Savant

And then Bill, in terms of API you said something about a product delay slippage. I mean just looking at the numbers here, it looks like the segment was flat ex Gadea. So just trying to quantify that and will the benefit from that slippage all be in 1Q ’16 or will it be sort of spread out over the next several quarters?

William Marth

They were scheduling issues and those will go into 2016 but they don’t all first quarter, right, because you have a schedule. So there’s only so much hold in the first quarter to produce products. So to the extent that we move some of that into the first quarter of 2016, it pushes something else into the second quarter of 2016 and it pushes along. So those items will be made up within the context of 2016 but a different date at different points within the year.

Tejas Savant

And then one final one here on your M&A, I mean, obviously inorganic growth is a key part of your story. So just trying to get a sense here that obviously Gadea was a pretty large deal, you’re well on your way to sort of digesting that if you will. But your cash position of 52 million and leverage of over 4 turns here. To what extent does that constrain meaningful deals in 2016? Will you look to take on more leverage, perhaps use equity financing? The stock’s obviously gotten cheaper even since Jan. So just trying to get a sense of the cadence for inorganic growth here and what your targets are and what you are looking at, how valuations look at the moment?

William Marth

I think that’s an important point, and that’s why we wanted to mention it. At the end of the day, acquisitions are part of our story and we’re going to continue to look at. We’re continuing to look at them at this point in time. We are not going to do acquisitions just for the sake of doing acquisitions. As you mentioned, valuations are going to have to come in line. We’ll have to use equity at some point but we feel our equity is way too cheap at this point. So we will need a creative deal to do something early. If not, we’ll just continue to move ahead, working on our integrations, delivering a great 2016 and we believe things will turn around. But I think it was important for us to note that we’re just not going to go chase things regardless of the market situation.

Tejas Savant

And just one final one here, in terms of the $1 billion revenue target in 2018, obviously that calls for a doubling of revenue relative to your 2016 guidance, or in fact, more than a doubling. What – can you just help us the bridge to that number? I mean, how much of that is inorganic in your mind, how much of that is going to be sort of organic growth? And if so, what are the key segments that get you there?

William Marth

Yeah, I think that we would love to do a deal in 2016. Again, the market puts us where we want to be somewhere in the range of $200 million to $300 million deal, and that would get us more than halfway to our goal. And then we’d be looking for a deal in 2017 and 2018 that would close the gap. I think the best areas for us to look at continue, we’re looking for – we’d be happy in API to add to some of our capabilities within sterile, we’d like to add some of our capabilities within controlled substance. We still haven’t added peptide and we still would like to add proteins. Again, that’s a very expensive market right now. So I don’t think that there is anything else that will drive that. So those are the areas we’ll be looking there.

Also, I’d be thinking drug product and again in drug products we are today essentially just parenteral. So we still would like to add things such as inhalation, blow-fill-seal, liquids, creams, ointments, patches -- patches, thin films, all those areas we think are interesting and of course, remember, I mentioned Tony Maddaluna joining the board before and I think he’s really helpful in guiding us there. And lastly, don’t forget those royalties that will be coming in, in 2017 and beyond – as much as $200 million annually, that will help drive growth as well.

Operator

Thank you. And our next question comes from the line of Ricky Goldwasser from Morgan Stanley.

Mark Rosenblum

Hi, guys. This is Mark Rosenblum on for Ricky. Just on the margins expanding to 30%. Obviously great margin expansion year over year, and you mentioned a few of the drivers. But are you guys -- do you see that as peak margins? Is there room in the near term to expand further?

Felicia Ladin

I think when we look at 2016, and I think 30% is a good place to be. As we look to continue to acquire, we will likely acquire in ex-US markets where the margins are probably a little bit lower. So although I think there is room for expansion, I think when you are looking long term at the margins, staying around the low 30s is probably appropriate given the acquisition strategy.

Mark Rosenblum

And then in terms of the drivers, Felicia, I think you mentioned closure of the UK site and then mix from higher-margin acquisitions. Then there was an offset. I didn't quite catch it. Could you comment on that?

Felicia Ladin

I think in this quarter, in Q4 in API in particular, our acquisitions had really strong margins, offset by some lower margins in I guess our base business. But we expect going forward that, all around will be in the low 30s for API.

Mark Rosenblum

And then --

William Marth

Mark, I think your other point about the offset, it goes back to the question around Singapore and that business that left Singapore was relatively minimally profitable.

Mark Rosenblum

And then in terms of organic growth you mentioned what you're anticipating for ‘16. What was the organic growth in the quarter?

Felicia Ladin

I think when you look at the organic growth in the quarter, it was pretty high. I think looking at it on a quarterly basis is a bit of a challenge because of the fluctuations in terms of timing of shipments. When you look at it annually, our organic growth for 2015 was over 10% but again if you look, part of the driver there is Burlington has really hit its stride and had strong growth versus 2014. So overall really good growth on an annual basis of about 10% which is probably a little higher than normal. Moving in 2016 really the 8% organic growth is really in line with the high single digits that we are expecting long term.

Mark Rosenblum

And then we talked about M&A pipeline a little bit. Are you guys still looking for that large transaction in 2016, or have the markets and valuations kind of thrown off those plans for right now?

William Marth

Mark, this is Bill. No, I mean, we are still looking. There’s still plenty of targets available, and I think the asset valuations are beginning to fall in line with where the market is today. So we keep looking. I think the important part for us is nothing’s changed on the strategy, acquisition part of the strategy, that’s where we want to go. We’ll use the right resource when the time comes but we have to time the right deal. It has to fit our strategy and if it fits our strategy, and there is a way we can get to doing the deal in a sensible manner, we will do it. If we can’t, then we’ll just wait. We don’t feel any pressure. We’ve put out a $1 billion target. We don’t feel that we have to do a deal just to do a deal. We feel that we’ve always told the market that the $1 billion is our aspirational goal and that’s where we’re headed. We quite frankly think we’re right on target to achieve that. That said, we won’t do anything silly.

Operator

[Operator Instructions] Our next question comes from the line of Steve Schwartz from First Analysis.

Steve Schwartz

First question. Just on the API business guidance, you're looking for $260 million and that includes about $10 million in royalties. So if you really look at this, you are going from $205 million in 2015 to $250 million on an apples-to-apples basis, and that's a $45 million difference. I'm estimating $40 million of that is from Gadea. So if we're really looking at $5 million, maybe $10 million, $5 million in organic growth on the base business in API. Why are your assumptions so low?

Felicia Ladin

Steve, it’s Felicia. Let me clarify. So the $260 million does not include the $10 million of royalties. So the royalties are on top of the $260 million. So when you think of API, in total you’re really looking at $270 million for 2016. The other item to keep in mind as well, is we did assume about $5.5 million headwind for FX. So when you look at the organic growth in API in 2016, taking those elements into account plus a very high organic growth that we had in 2015, we’ve moderated the growth down from the 10% -- over 10% that you saw in 2015 to still a very reasonable level in 2016.

Steve Schwartz

So based on those numbers then, it's ex-foreign currency, or it’s $60 million less $40 million from Gadea, and you are back at 10% revenue growth on the base business, roughly speaking?

Felicia Ladin

Roughly.

Steve Schwartz

And with respect to the contract margin then, 30% guidance that you are giving, that does exclude the $10 million from royalty now, or is that going to now be factored in?

Felicia Ladin

That’s correct. It’s just on the contracts business.

Steve Schwartz

And maybe I missed this in your prepared remarks, but R&D spending is going up by 50%. What’s driving that?

Felicia Ladin

So there’s two elements. One is we are continuing to invest in developing our own DMFs and also the co-development agreements that we share and some of the R&D costs that Bill talked about. In addition, when you look at Gadea and you look at what they incurred in the first half of the year, it’s really pretty much run rate, when you combine the three different elements. But I think about it really as the investment in the DMFs and the co-development agreements that are a key part of our strategy going forward.

Steve Schwartz

And as we all start to publish our 2017 and even 2018 estimates, does that $9 million then go down in the out years, or does it -- you think the DMFs, new DMFs, what have you continue to keep it at this higher level?

Felicia Ladin

Yes, I would probably keep it at – yes, I would probably keep it at the same level. I wouldn’t necessarily decrease it as it will be part of the ongoing strategy to continue entering into these co-development agreements to generate some top line revenue and then to continue also to look at the potential – to develop our own DMFs. So I would keep it pretty steady.

Steve Schwartz

And then my last question is around Burlington, and just generally speaking the profitability of that business. You noted that in recent quarters it's turned profitable. And where are we on the trajectory, the trend of recovery? Does the overall profitability on a percentage basis continue to improve going forward, or do you think you have that pretty well lined out?

Felicia Ladin

I think at this point we have that pretty well lined out. I mean I think the facility has really hit its strides in 2015, and we expect it to continue on in that way. So I think we are at a good point and there is always opportunity for expansion in margins as we continue to evaluate the business.

End of Q&A

Operator

Thank you. I have no additional questions at this time. I would like to turn the conference back over to management for any additional comments.

Patty Eisenhaur

Well, thank you everyone for joining us today and feel free to follow up with us directly with any questions that you might have after the call today. Thanks again and Kathy, if you could give the replay information, that would be great. Thank you.

William Marth

Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. And you may now disconnect. Everyone have a good day.

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