Cambrex Corporation (NYSE:CBM)
Q1 2016 Results Earnings Conference Call
April 29, 2016, 08:30 AM ET
Greg Sargen - EVP and CFO
Steven Klosk - President and CEO
Drew Jones - Stephens, Inc.
Matt Tiampo - Craig-Hallum
Dmitry Silversteyn - Longbow Research
Steven Schwartz - First Analysis
Good day, and welcome to the Cambrex First Quarter 2016 Earnings Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Greg Sargen. Please go ahead, sir.
Thank you, Lindy, and good morning, everyone. Welcome to Cambrex's first quarter 2016 earnings conference call.
Today's discussion will contain forward-looking statements regarding expected operational and 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, and 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 and forward-looking statements portions of our 2015 Form 10-K, as well as the forward-looking statements section in both our first quarter 2016 Form 10-Q and 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, May 6th, and will also be available on the investors section of our website.
Today's call will begin with a business review by Steven Klosk, our President and CEO. I will follow Steven with comments on our financial results before opening up the call for Q&A. With that, it's my pleasure to introduce Steven Klosk. Steven?
Thank you, Greg, and good morning, ladies and gentlemen. We are very pleased with our strong first quarter 2016 results. And we remain confident in our financial guidance for 2016, which projects continued strong growth.
Sales in the first quarter were $94 million, compared to $78 million during the first quarter last year, a 21% increase on a constant currency basis. Adjusted EBITDA in the first quarter was $27 million, an increase of $9 million, or 52%, compared to the first quarter last year.
First quarter revenue growth was driven by strong results in all three product categories, innovator, generic APIs, and controlled substances. Profit margins were strong in the quarter, helped by favorable product mix, continued high capacity utilization, and foreign exchange.
We continue to expect full year 2016 sales to grow between 8% and 12% on a constant currency basis, and adjusted EBITDA to be between $142 million and $148 million, a 13% improvement over 2015 at the midpoint.
We continue to see positive market dynamics, something I'll comment on in a bit more detail shortly. In light of these dynamics and to support our pipeline, we invested just over $60 million in capital projects during 2015 and expect to invest $70 million to $75 million in capital projects during 2016.
This is an aggressive level of investment within our industry, and it is designed to ensure that we're able to meet the continuing strong demand for Western cGMP manufacturing capacity.
The expansion of large scale capacity at our Charles City facility is now expected to come online at the end of the second quarter, about three months later than previously anticipated. As described in this morning's release, we experienced delays in the delivery of certain equipment and a few unexpected installation challenges, but were able to adjust the site's production schedule to ensure that we continue to meet customer demand for 2016 deliveries.
These delays are always a possibility with such large, complex expansions. And accordingly, we had contingency plans to ensure that there was no material impact on the business. The project remains on budget from a cost perspective.
The initial build out this expansion, which we call Pharma 3, is expected to support approximately $40 million to $60 million in annual revenues at full capacity. And our production plan for the second half of 2016 includes a ramp up in the utilization of this facility as the year progresses.
This expansion at Charles City anticipated future growth beyond the initial build out. Accordingly, the project includes a shell with necessary infrastructure but no manufacturing equipment, which we call Pharma 4. When we decide to complete Pharma 4, the existing shell and infrastructure will shorten the lead time to bring the facility online.
This substantially reduces the remaining investment versus a typical new manufacturing facility build out. We would expect Pharma 4 to support another $40 million to $60 million in revenue when fully utilized.
Of course, the timing of the ramp up and the mix and number of products that are eventually produced in Pharma 3 and Pharma 4 are highly variable and may result in higher or lower sales levels.
Let me now move to a review of each of our product categories. I'll start with innovator, our largest category. Innovator revenues were $45 million in the first quarter, a 9% increase over the first quarter last year. Sales of both commercial and clinical phase projects drove the increase.
Our primary strategy to grow sales within the innovator product category is to win later stage clinical projects. We continue to expect a significant increase in revenues from clinical stage projects in 2016.
Production and delivery schedules for these projects will drive high capacity utilization for much of the year in key assets. As such, our business development teams continue to be primarily focused on selling capacity for the latter part of 2016 and early 2017.
We currently have 14 active late stage clinical projects. One product moved into commercial phase during the first quarter of 2016, and one product was removed from our list of active projects.
With respect to the product we removed, low initial demand resulted in the customer's decision not to qualify an additional supplier at this time. If volume eventually picks up, this product could become an active project in the future. If these late stage therapeutics are approved for commercial sale, we expect to negotiate supply agreements to provide commercial volumes.
Our expectations of revenue potential to Cambrex at maturity for these 14 active late stage products are as follows; two products have the potential to generate over $10 million in annual API revenues for Cambrex at maturity; 10 products could generate between $5 million and $10 million; and two products less than $5 million.
The product that was removed from the list due to low initial demand had been expected to generate less than $5 million in annual revenues. Of course, future Cambrex revenue from these products will depend on each product's regulatory approval, success in the market, and the share of commercial supply that we secure, among other variables.
During 2016, we expect one to three of our current late stage products to move to commercial status in addition to the one that moved in the first quarter. For the sake of clarity, we consider a product to be commercial status when it has been approved by the relevant regulatory authority for commercial sale and we have completed validation batches for our customer. Revenues for both clinical phase and commercial phase products are included within our innovator product category.
The US innovator market continues to be characterized by a deep clinical development pipeline, continued strong funding of clinical stage projects, and positive trends in FDA and EMA approval levels. Innovators continue to have a strong preference for experienced Western suppliers like Cambrex, with strong regulatory records and world-class quality systems.
Pharmaceutical companies are continuing to reduce their small molecule manufacturing footprint, and there is limited large scale GMP capacity in the US. Anecdotal comments from customers and competitors suggests that capacity utilization in Europe is exhibiting similar characteristics.
We believe our strategy remains aligned with these positive market dynamics. We continue to expect full year 2016 revenue in the innovator product category to growth between 12% and 15% compared to last year.
I will now move to our generic API category. First quarter sales of generic APIs were $24 million, an increase of 14% on a constant currency basis compared to the same quarter last year.
Developing and launching new products is one of the key drivers of continued growth of this product category. In 2015, we completed the development of three generic APIs and three controlled substances, and during the first quarter of 2016 we completed the development of two more generic APIs.
We now have 13 generic APIs and one controlled substance in later stages of development. We have several more generic APIs in earlier stages of technical and economic evaluation that will be moved into development if they meet our criteria.
For 2016, we continue to expect revenues from generic APIs to increase low to mid single digits. Sales of controlled substances, which we define as those classified as Schedule II products by the DEA, were $25 million in the first quarter, 59% higher than the first quarter last year.
While demand was more evenly spread throughout the calendar year in both 2014 and 2015, historically marketers of controlled substances have often frontloaded their API purchases in the first part of the calendar year in order to utilize their initial DEA quota.
Should demand support it, they will then have time to apply for and potentially obtain additional quota later in the year. This dynamic was likely a driver of the very strong first quarter performance in this category. Accordingly, we still expect full year 2016 sales for this product category to increase by mid single digit percentage points, consistent with our prior guidance.
Now let me move to our generic drug product initiative. We believe we can add value to our customers' supply chain by providing finished dosage form generic drug products in addition to leveraging our capabilities in developing and producing generic APIs.
As we described last quarter, we have selected several niche generic drug products for development. These products, and others being evaluated for development moving forward, may be natural extensions of our generic API platform.
This may also work in reverse, where the decision to develop the generic drug product drives the decision to develop the related API. This allows us to consider the opportunities in both generic API and finished dosage form generic drug products when selecting products for development.
We have identified formulation development and manufacturing partners, and expect to work with generic marketing partners to sell these products. We continue to anticipate the filing of one abbreviated new drug application, or ANDA, during 2016 and another in mid 2017.
We expect additional ANDAs to be filed in late 2017 and beyond as the development work and filings progress. Some of these arrangements are co-development arrangements with eventual profit sharing, and for some we are funding all of the development costs with no backend profit sharing.
To sum up, we are excited about the positive start to 2016. Market dynamics remain favorable, and we continue to have high visibility for a large percentage of expected orders for the year.
As with the last few years, we are asking our plant teams to sustain a high level of operational execution, and we are confident they will continue to meet or exceed our expectations. As such, we remain confident we will achieve our financial guidance for 2016.
I look forward to reporting our second quarter results and providing a business update in July. I'll now turn the call over to Greg.
Thanks, Steven. Revenues were covered by Steven, so I'll comment on certain other financial statement items.
Gross margin for the first quarter was 41%, compared to 37% in the same quarter last year. Half of this gross margin improvement, or 2 percentage points, was driven by a positive sales mix and higher capacity utilization at our plants.
Foreign currency also positively impacted gross margin by 2 percentage points due to marking our foreign currency forward contracts to market at the end of the quarter.
Selling, general, and administrative expenses for the first quarter were relatively flat at $14 million. R&D expense on a constant currency basis increased $1 million, related to increased internal spending on generic API development and external spending on the development of generic drug products, compared to the first quarter last year.
Adjusted operating profit was $22 million in the first quarter, an increase of $9 million compared to the operating profit during the same quarter last year. And adjusted EBITDA for the first quarter was $27 million, compared to $18 million in the same quarter last year.
The first quarter 2016 effective tax rate was 31%. We continue to expect our 2016 effective tax rate to be between 32% and 34%. Of course, geographic mix and the results of various global tax matters can cause substantial changes in reported effective tax rates.
Adjusted income from continuing operations was $0.50 per diluted share for the first quarter, compared to $0.29 for the same period in the prior year. The table at the back of this morning's release reconciles these amounts to GAAP results.
Capital expenditures were $18 million, and depreciation was $5 million in the first quarter. We continue to expect full year 2016 capital spending to be between $70 million and $75 million.
We ended the first quarter of 2016 with net cash of $86 million, a $72 million improvement in net cash during the quarter. During the quarter, we received $39 million related to advanced payments, which will reverse in 2020. We also received payments during the first quarter for $21 million that will be credited against invoices, or effectively returned, in the second quarter of this year.
Excluding the impact of these two items, net cash would have increased by $12 million during the quarter, primarily driven by net profits.
For 2016, we continue to expect free cash flow, defined as the change in net cash, to be between $60 million and $70 million. We expect free cash flow for 2016 to benefit by approximately $18 million due to advanced payments related to supply agreements.
We expect 2016 sales to increase between 8% and 12% on a constant currency basis and adjusted EBITDA to be between $142 million and $148 million, both consistent with prior guidance. We still expect adjusted income from continuing operations to be between $2.46 and $2.58 per share. Adjusted income and related earnings per share is computed in a manner consistent with the table at the end of this morning's release.
I would now like to open up the call for questions. Lindy?
[Operator Instructions] Our first question comes from Drew Jones with Stephens, Inc. Please go ahead. Your line is open. Drew Jones, your line is open.
Thanks. Good morning. Just a quick question on Pharma 3 and the slippage into 2Q. How much 2Q revenue from Pharma 3 was included in guidance, the original guidance?
I don't have that number specifically, but it would have been minimal. We would have been starting up the facility and ramping it slowly as the year - so, it'll just accelerate our ramp of that facility in Q3 and Q4. But, the financial impact to Q2 was negligible.
And then I know you guys talked about the three products that were falling out of innovation into custom manufacturing by the end of last year. Now that we're one quarter in, can you give us an update on how those three are ramping?
Are you talking about the products that we thought might ramp from clinical phase to commercial phase?
Yes. So, we had one graduate in the first quarter, and we have - so, we started the year with two to four. We now have one to three.
We still believe that will be between one and three. It just - it will depend on clinical outcomes and whether or not the timelines that our customers are hoping for occur. So, obviously in the best case it would be all three. In the downside case, it could be one, or theoretically it could be zero if none of them get approved.
I guess - but the ones that fell out before year-end 2015, I think there was one that was - $10 plus million were the expectations. How has that looked now that you've got a quarter or so under your belt?
I see. I see what you mean. You mean that they graduated to commercial and how are they doing.
Yes. I think the - any product that graduated last year, or actually in recent years, is tracking relatively to what we expected. Some are slightly exceeding or some are slightly declining or are slightly less than what we'd have expected.
But, all in all, there's no - I don't think there's anything meaningful or significant to report with respect to what our initial expectations were.
And then the last one for me. This is, Steven, the second quarter you've kind of talked about the anecdotal commentary around capacity in Europe. How is that impacting bidding activity? Is there anything that we can quantify that with in terms of how it could potentially benefit Cambrex?
Well, I think in general, Drew, obviously we'd prefer the industry to be busy. When you have excess capacity utilization, you tend to have lower pricing or bids at a lower level.
So, we're busy. We're filling capacity there. I think that the industry is as well. So, I only view that as positive. Particularly with our balance sheet, we're able to invest and we've been investing more than competitors. So, if we need to do that, we'll do that. But, in general, that's good for the market. It's good for us.
And our next question comes from Matt Tiampo with Craig-Hallum. Please go ahead. Your line is open.
Good morning, gentlemen, and congratulations on a good start to the year. I just want to maybe follow up on Drew's first question in terms of the timing of Pharma 3 and when you can start to get products moved into that and how quickly after validating. And then also, how much of 2016 guidance was predicated on being able to move a bunch of product into Pharma 3? And are you going to be able to accelerate the move in Q3 and Q4 enough to make up for the lost three months? Thanks.
Okay. So, let - I'll try to address some of those and ask Greg to address it as well.
So, I think first, the way we look at Pharma 3 is this is a large and complex project. It is not unusual at all for there to be delays of some type, meaning equipment from a supplier is late. Equipment comes in and maybe it's damaged and you have to repair it. So, it's not a surprise in that regard. And when we put together our guidance for the year, we modified it, if you will, to assume the potential for delays.
So, as we said, we reconfirmed our guidance for 2016. So, I'm not concerned about that delay. With the fact that it is delayed and because we do have business, we expect that we'll accelerate the capacity utilization in that asset in the second half because the business is there to do so.
So, I think that's the situation with Pharma 3 as we see it going through the rest of the year.
Yes. Matt, I think just to maybe top that comment off is we anticipated when we committed to customers that this was a possibility, given the complexity of the startup of such an operation. So, we tried not to make any firm commitments that we knew might be impacted by any kind of delay here.
So, we feel pretty good about how our contingency plan is working out. And we're - feel that there's a relatively low risk that there'll be any further delays. So, we feel pretty good about what's going on right now.
Great. Thank you. Maybe just one more from me. In terms of your largest customer, can you give us some color as to how they - what their impact was this quarter and how much of the innovator growth came from both their largest product but also the rest of their portfolio that you're working on?
Yes. I guess the short answer is no, given the supplier agreement that we have and the confidentiality provision. So, I think we're going to report annually on what the revenues are from that customer.
And in the meantime, we'll get them everything they need and want, and unfortunately not going to be able to make quarterly comments on that product or any product and that customer's contribution, unfortunately.
Yes. The only thing I would say, it was a good quarter for innovator. And I think what we said is we really had several APIs that contributed to that growth.
Our next question comes from Dmitry Silversteyn, Longbow Research. Please go ahead. Your line is open.
Good morning, guys, and congratulations on such a strong start. A couple of question, if I may. First of all, on the innovator strength that you saw in the quarter, do you get the sense if there was a pull-forward similar to what you may be experiencing with the controlled substances or was this just an indication of sort of a stronger year, or perhaps you're at the top end of your expectations when you provided the annual range?
Yes, I think our guidance for the full year is 12% to 15% on innovator. And I think we were only up 9% in the quarter, so technically we've got a little more growth to come in the future quarters if things work out as expected.
So, I think, again, nothing out of the ordinary. It's still what we expected coming in the quarter, and it was a variety of products contributing. So, we're still pretty comfortable with what's going on in the innovator space. And I don't think anything's really changed from what our view was three months ago.
Wonderful. Thank you, Greg. And on the Phase 3 Pharma of - Pharma 3, I should say, ramp up, by the end of the year you're talking about you'll be catching up and making up the three months delay here in the first quarter. What does that imply? I mean, are we talking about sort of full kind of 75%, 80% utilization rates, or is it just going to ramp up in line with the original expectations but there's going to be plenty of capacity left to continue the ramp in 2017, or continue to grow revenues in that plant in 2017?
I'll let Steven chime in. But, I think the goal is to accelerate the utilization of that facility such that we're putting in really production, I guess, over six months versus what we would have put in over eight or nine months, at the end of the day.
So, I don't think we have a percentage capacity utilization that we're reporting on. I know the internal plans probably would allow us to calculate that. It's probably not something we're going to talk about specifically.
So, I think we're okay there. It's just a delay. We know we had previously put out a public target, and a lot of questions and interest around that. So, I think we'll start this up just a couple - a few months later than we anticipated and just ramp it up a little faster.
Yes. The only thing I would add to that is we're expecting a significant increase in our clinical phase business this year over last year. That's the type of work that then gets scaled up in the large facility.
So, there is demand. We do obviously have Pharma 4 that we'll have to begin to think about and look at as we forecast capacity utilization in Pharma 3.
Got it. So, if I could paraphrase what you said, the ramp up or the ability to put new sales and new projects into that plant basically will last into 2017. You're not going to be thinking about Pharma 4 probably until about 2018, at the earliest. Is that the right way to think about that?
I think we're thinking about Pharma 4 now and will continue to think about it. But, we'll get Pharma 3 up and running and see how that acceleration of the capacity utilization goes, see how orders come in on the back half of the year, see how some of our late stage projects progress. And probably towards the end of this year or early 2017 we'll have a much better bead on timing of Pharma 4.
But, we'll keep you posted. I think each quarter we'll just give a comment if there's anything definitive that we're setting in motion there.
Sounds good, Greg. A quick question on the foreign exchange. It was about a 1% hit to revenue in the first quarter. What is your outlook for the year? Do you expect it to be basically a push or maybe a little bit of a positive guy? I'm just trying to understand sort of getting from 8% to 12% fixed currency growth that you've guided to an actual revenue that you guys are going to be putting up and then we're going to be modeling.
Yes. So, I guess we'll strip it out for our 8% to 12% guidance. So, whichever way it goes, it won't affect that. So, right now I could see it having a somewhat positive effect, given that the European currencies, mainly the Swedish kroner and the euro that we sell in, are strong than they were last year.
But, for the first quarter on average, they were about 1.5% stronger, so not much of an impact in the grand scheme of things. And the mix in any given quarter is going to determine whether it has a meaningful impact or not.
At the profit line right now, if things stayed where they were, it would end at - it was a bit of positive in the first quarter because we marked to market a bunch of forward contracts that we have in place for the full year. So, that benefit kind of gets frontloaded based on that dynamic.
But, the translation impact over the following three quarters would be somewhat negative, to more or less offset that or then some, depending on how it plays out. So, I would say right now, if things stayed where they were, it would be a slight positive to sales and a slight negative to operating profit.
That's very helpful, Greg. Thank you. And then final question on the balance sheet. I couldn't find any debt in your balance sheet reported this morning. You guys paid off everything you have and you're basically debt free?
Okay. And then, the second question, you obviously have significant cash balance now. So, I know you have accelerated CapEx plans over the next two or three years, but it looks like you're still going to be generating free cash flow even with that. So, what are you looking to do with that cash, and how are you looking to use it to benefit shareholders?
Yes. So, I'll comment first on just the balance sheet part and then Steven can comment on what we're going to do with that.
So, we do expect - as we talked about, there were some advance payments in the first quarter that will reverse in the second quarter. So, I wanted to make sure we were being pretty transparent on $72 million of free cash flow in the quarter was not a normal quarter, by any stretch, at this point.
So, we do see some of that reversing in Q2 and seeing the full year come back to where it was, just to kind of add some clarity there. And I'll let Steven comment on what we plan to do with the money.
Yes. I mean, Dmitry, as we've said for the past couple years, we're proactive in terms of our M&A activities. We are seeing consolidation going on in the industry. I do think that there will be properties available maybe later this year going into 2017. And we'll be active.
Okay. So, the first sort of - the first use of cash would be acquisitions' debt, and then share repurchases, if any, would follow after that. Do you have an active share repurchase program currently authorized?
We do not. We have - we routinely have a dialogue with the Board to talk about that. And at this point we feel that the mandate to look at opportunities for inorganic growth through acquisition is the top priority, so we're going to keep that there.
Okay, sounds good. So, it sounds like there is enough in the pipeline for you to be confident that that cash and then maybe some debt will be put to good use in the M&A market.
I think that's a fair statement.
Thank you very much.
And we’ll go next to Steven Schwartz with First Analysis. Please go ahead. Your line is open.
Good morning, gentlemen. So, just to pick up from where Dmitry was talking about FX and gross margin, it sounds like that 200 basis point boost you had this quarter will dissipate across the rest of the year.
Is that - yes, if that's a question I think that FX pick up will not repeat throughout the year. If anything, it might be a slight headwind.
Okay. And with respect to Pharma 3, since it's an accelerated startup - I'm sorry, I don't think I heard this in the Q&A. But, since it's an accelerated startup, you don't expect additional costs or overhead or what have you types of hits to gross margin.
Nothing of a meaningful nature. Obviously, not starting it up on time has certain implications to how overhead costs are absorbed and so forth. And that was a small negative in the quarter. And we would - again, if things go according to plan, we would expect to make that up on the back half of the year.
Okay. And with respect to the generic drug product initiative, where you have these partnership arrangements I presume there are milestone payments that you will make or receive?
Yes, we won't comment on the specific arrangements with each of the partners. But, for the most part, they're pretty straight vanilla co-development arrangements where we share in the development of costs and then we will share in the net profits.
Okay. So, at this stage, we don't need to account additionally in R&D expense for any major milestone payments.
No. I think that's a fair statement. We indicated last quarter that we expected to spend - I think it was between $4 million and $6 million is what we said. It's still in that range of incremental R&D spending on this initiative compared to 2015.
And I think that's kind of a steady state run rate right now. And we'll see where that initiative goes in the future.
Okay. And Greg, when you were talking about cash flows, you talked about $39 million in advance payments. Did any of that show up in the P&L, or is it just cash flow?
No, it's just - if you look at our balance sheet, you'll see - I believe it shows up as deferred revenue on the balance sheet, or advance payments, actually, for $39 million. And there's another $21 million in there.
Based on how GAAP works, that's spread between that line and in the short term category of our P&L. There's $39 million in long term because that's not reversing until 2020. There's $21 million spread between a couple of accounts within current working capital. That will reverse in Q2.
Okay. But, nothing we'll see in the P/L or --?
No, that whole arrangement is just a cash flow transaction. Everything else happens as normal with respect to costs and revenue recognition and so forth when we deliver product.
Okay. And then my last question is just with respect to the cadence of innovator revenue through the rest of the year. Your second quarter last year was pretty sizeable. It then dipped down in the third quarter and then you had a very strong fourth quarter. How do you see the rest of this year playing out for innovator revenue?
Well, I'm not going to comment on that, because we try like crazy to avoid quarterly guidance because a lot of things can shift from one quarter to the next.
Last quarter - last year's second quarter was about $106 million of revenue, which, on a $433 million year was pretty much, you could argue, right in line with kind of 25% of the year, more or less. And obviously the fourth quarter was big to distort that.
So, nothing out of the ordinary in the quarter and no particular cadence to the rest of the year, especially at this point, that we're going to comment on. We'll probably end up with a much strong quarter and a weaker quarter along the way. But, at this point it's too early to say which one it's going to be.
So, if your innovator is down year-over-year in the second quarter, we shouldn't be surprised by that. I think you had $66 million or something like that in innovator revenue in the second quarter of last year.
Yes, I don't know what you should be surprised by necessarily. I think we're not giving guidance to the respective quarters, and especially by product category. So, I'm not going to comment on whether it could be up, down, or neutral, frankly.
Yes, I mean, the innovator guidance remains up 12% to 15%. We did 9% in the first quarter, so we're going to have a good remaining three quarters.
That's better said.
Okay, thank you.
And it appears we have no further questions at this time.
Well, great. We'd like to thank everybody for their time. We look forward to talking to you next quarter. And have a great day.
This does concludes today's program. You may disconnect at this time. Thank you, and have a great day.
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