APP Pharmaceuticals Inc. Q1 2008 Earnings Call Transcript

May.13.08 | About: American Pharmaceutical (APPX)

APP Pharmaceuticals Inc. (APPX) Q1 2008 Earnings Call May 8, 2008 11:30 AM ET

Executives

Maili Bergman - Investor Relations

Patrick Soon-Shiong - Chairman

Richard J. Tajak - CFO

Tom Silberg - Chief Executive Officer

Analysts

Hank Rauch - Liberty Mutual

Alan Sebulsky - Apothecary Capital

Operator

Good day, ladies and gentlemen. And welcome to the APP Pharmaceuticals first quarter 2008 financial results conference call. My name is Heather, I’ll be your coordinator for today. At this time, all participants are in a listen-only mode. We’ll be facilitating a question-and-answer session toward the end of today’s conference. (Operator Instruction)

I would like to turn the presentation over to your host for today’s conference, Maili Bergman, Director of Investor Relations. Please proceed.

Maili Bergman

Thank you. Good morning, everyone, and thank you for joining us today to discuss APP Pharmaceutical’s 2008 first quarter financial results. On the call today are Patrick Soon-Shiong, Chairman of the Board of APP, Tom Silberg, our president and CEO and Richard Tajak, the company’s Chief Financial Officer.

Please be advised that this conference call is being broadcast live on the Internet at www.apppharma.com as well as www.earnings.com. A playback of this call will be available for one-year and may be accessed on the Internet at both websites.

Before we begin, I would like to make the requisite cautionary statements and remind everyone that all of the information discussed on the call today is covered under the safe harbor provisions of litigation reform act. The company’s discussion today will include forward looking information, reflecting management’s current forecast of certain aspects of the company’s future and that our actual results could differ materially from those stated or implied.

With that said, let me turn the call over to Dr. Patrick Soon-Shiong. Patrick?

Patrick Soon-Shiong

Thanks, Maili. Good morning everybody. Thank you for joining us today. During this call, Richard Tajak will review APP’s financial results for the quarter ended March 31, 2008. And Tom will then provide an update on our operations and we’ll then open the call for questions.

First, let me welcome Tom and Rich to their new rolls. Most of you know Tom, who added the responsibilities of Chief Executive Officer to his role as President of APP. Tom is highly qualified and well deserving of this promotion, I’m highly confident he will take this company to the strengths as it is now.

Rich recently joined APP’s finance team as CFO, and has more than 20 years of experience in the pharmaceutical industry. Both executives bring diverse skills and will work diligently to bring – to build a strong organization.

For the 2008 first quarter, revenues were 148 million, an increase of 6% over the prior year first quarter revenues of 140 million. Gross profit was 70 million, an increase of 7%, compared to the 2007 first quarter gross profit of 65 million. Net income from operations increased by 11% to 32.5 million. Details of this – financials will be provided by Tom and Rich in the call as we proceed.

This quarter APP received four product approvals and launched four products continuing our strong record of the leading ANDA approvals in our industry. As many of you know, over the past few months, we have faced a heparin crisis in this country. We are proud to state that our organization has worked very closely with the FDA to avert a potential market shortage of heparin and we are committed to ensuring the supply of this critical life saving product to the United States.

We continue to work with the FDA as well as our raw material partner in China to ensure the security of the very complex supply chain involved in the procurement of our heparin API supply. Unfortunately, this crisis has expanded globally and has now affected heparin supply around the world. As a consequence the demand for safe supply of crude heparin has increased, with the corresponding dramatic increase in raw material cost. In just the past three months alone, the industry price of the API has increased in excess of 200%. Some of you may be aware that in 2007 already as a result of a viral disease, the price of crude had already increased dramatically.

Our efforts to meet the country’s demand for heparin has required us to hire employees and increase the number of shifts at our production facility. Including weekends and holidays. In addition, the need to ramp up production lines in favor of heparin has impacted the production in certain anti-infective and sales in this quarter. Shipments of increased heparin units occurred by mid March.

I would like to really thank our manufacturing staff, our customer service team and our shipping department as well as the tremendous efforts by all members of our team. All of who are have worked long hours to ensure that no shortage of this vital product occurred. We are now manufacturing at the capacity of 12 million vials a month, sufficient to meet the needs of the entire country. This full impact of our increased heparin sales will be seen in the second and third quarters as we meet the entire demand of the country’s needs.

Over the next few weeks, we will be working closely with the FDA as well as the USP to provide input into the standards needed to ensure the production of the highest quality and purity of this vitally needed product.

So with that, let me turn the call over to Rich Tajak. Rich?

Richard Tajak

Thank you very much, Patrick and good morning, all. It’s certainly been a pleasure for me to be part of the APP team for the past five weeks and I too would like to offer my congratulations to Tom and his appointment to the position of CEO.

Before I start with the financial review, I’d like to clarify that APP’s business for both the 2008 and 2007 reporting periods is reported on a continuing operations basis. Abraxis BioScience business on the other hand is reported solely in 2007 as discontinued operations. Also, in addition to GAAP reporting, we continue to believe that it is important to look at APP’s operations on an adjusted income from continuing operations basis. We believe this metric provides excellent insight into our business by excluding certain nonrecurring or non-cash items such as the discontinued Abraxis BioScience business, stock compensation expenses, separation related costs, amortization of purchase product rights, merger related intangible amortization as well as pre-launch costs related to our facility in Puerto Rico.

Now turning to 2008 first quarter financial operating results, as Patrick mentioned, net revenues were $148 million, a 6% increase over revenues of 140 million in last year’s first quarter. Net sales of the core product lines included critical care product sales of 91 million versus 85 million in the 2007 period. Anti-infective product revenues of 43 million versus 40 million in prior year first quarter and oncology product sales of $11 million essentially the same as last year. Gross profit in the 2008 first quarter was $74 million or 50% of net sales compared with $70 million or 50% of net sales in last year’s first quarter.

Both profit results exclude 4.1 million for amortization of purchased product rights. R&D expense was 12 million versus $10 million in the prior year first quarter. The rise in R&D spend was primarily due to increased product development activity to support our strategic initiatives.

Selling general and administrative expenses were $21 million or 14% of net sales versus $22 million or 16% of net sales in the 2007 period. Importantly, income from operations before interest expense for the 2008, first quarter increased by 11.2% to 32.5 million compared with 29.2 million in the 2007, first quarter.

Net interest expense was $16 million, compared with 4 million in last year’s first quarter; this increase was due to the additional borrowings following the separation of the two companies in November 2007.

The effective tax rate was 45% in the 2008, first quarter versus 47% in the 2007 period. In both periods, we were only able to utilize a very small percentage of Puerto Rico operating expenses to offset pre-tax income.

On a GAAP basis, and reflecting the strong operating income offset by higher interest expense, net income from continuing operations was 9.1 million or $0.06 per diluted share compared with 13.6 million or $0.08 per diluted share in last year’s first quarter.

On an adjusted basis, net income from continuing operations was $22 million or $0.14 per diluted share compared with $26 million or $0.16 per diluted share for the 2007 first quarter.

Adjusted income from continuing operations excludes Puerto Rico facility prelaunch costs, amortization of purchase product rights and merger intangibles, separation related costs and stock compensation. And finally, on a GAAP basis, net income was $9 million or $0.06 per diluted share, this compares with net income for the prior year first quarter of $11 million or $0.07 per diluted share, which includes a $2.5 million loss from discontinued operations net of tax.

Now, briefly turning to the balance sheet, as of March 31, 2008, APP had approximately $1 billion of net debt outstanding. The terms of the debt agreement call for a 5 million dollar principle repayment in 2008 and total repayment over the next 6 years.

In addition, we have a revolving credit facility of $100 million, which is currently unused. And also during the quarter, we entered into a one-year interest rate swap arrangement, which effectively fixes our average debt rate at about 5.75%.

I’d now like to turn the call over to Tom Silberg to provide an update on APP Pharmaceutical’s operations.

Tom Silberg

Thanks, Rich. I’d like to comment in general on the overall growth of the APP business and then provide an update on some of the key aspects of our operations. APP continues to be a leader in the industry. In addition to the results you’ve just heard, thus far in 2008 we have received four NDA approvals and launched four new products.

These new approvals along with those launched in the second half of 2007 will add significant revenue in the course of 2008 as they continue to gain market share. Diprivan continues to perform well in the face of competitive pressure. Due to its unique patented formulation, Diprivan remains the market leader with 4% market share, while maintaining a premium price.

Our exclusive pain product Naropin continued to grow at a strong pace in the first quarter of 2008 and we anticipate Naropin will respond positively to medical education program efforts, which were initiated this past March.

As Patrick mentioned we continued to increase our heparin production, just began in March and we expect to recognize a substantial increase in our heparin revenues beginning in the second quarter.

Additionally, we are actively managing the distribution of heparin to ensure that product is available for the patients, who are in need. We are working closely with the FDA, as well as the institutions that are servicing these patients and the specialty distributors supplying dialysis centers across the country.

APP is currently the only source for therapeutic heparin in the U.S. I’d like to point out that in order to increase production of heparin, we have delayed the manufacturing of several other products to avert the potential market shortage of this very critical care product.

We are currently manufacturing approximately 12 million vials per month compared to our previous average is 3 to 4 million to meet the current needs of our customers. We anticipate the demand to level off, to a more traditional level of approximately 7 to 8 million vials, once hospitals and dialysis centers have backfilled their supplies and we have restocked the traditional wholesalers supply chain.

As a result, of this escalation in our production, during the quarter we have incurred an incremental increase in our overhead expenses related to the following. First additional shifts and overtime on weekends and holidays, the hiring of 30 additional employees. An increase of customer calls by almost 250%.

And additional analytical testing of our product including the H-NMR spectroscopy tests and the capillary electrophoresis test. The most dramatic increase of our production cost though has been the increase in the price of the underlying active pharmaceutical ingredient, heparin USP.

The combined results has been a major increase of our overall production cost of heparin since the beginning of the year. We will continue taking appropriate internal actions to ensure our ability to produce heparin at these elevated levels.

We currently have over 60 product candidates in current stages of development and have 27 ANDAs pending at the FDA, which represents approximately $5 billion of 2007 IMS branded sales. We continue to be proud of the performance and growth of APP and believe that there are numerous opportunities that will allow us to further expand the business throughout 2008.

With that, I will turn the call back over to Patrick. Patrick?

Patrick Soon-Shiong

Thank you, Tom and thank you, Rich. So, with the time available now I would like to address any questions you may have. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Hank Rauch with Liberty Mutual. Please proceed.

Hank Rauch - Liberty Mutual

Yeah. Thank you. I was wondering, I jumped on the call a little bit late, so if you already talked about this, I apologize. But can you give us a sense of what you expect your capital spending to be this year?

Richard Tajak

Yeah. This is Rich Tajak speaking. In the current forecast is in excess of 50 million.

Hank Rauch - Liberty Mutual

Okay. And based on your 10-K, I think you had spent closer to 80 million in the past couple years?

Patrick Soon-Shiong

Yeah. We’ve and this is Patrick, yeah, I think in the – a large part of that initiative was in the investment globalization capacity, which I think we have significantly accomplished and also, enhancement of our Grand Island facilities in Puerto Rico.

Hank Rauch - Liberty Mutual

Okay. So you expect to spend more than 50 but less than 85?

Patrick Soon-Shiong

Correct. That’s right.

Hank Rauch - Liberty Mutual

Okay. It would be helpful maybe if you could narrow that down for your next call or your next earnings update. The other question I have you have a lot of cash on the books, it looks like you’re going to generate a lot of cash flow this year. What are your plans to do with that cash?

Patrick Soon-Shiong

Well, we have some obligations to pay down the debt and we will obviously pay down the debt and we remain in anticipation pay the debt down in advance of our obligations.

Hank Rauch - Liberty Mutual

I mean you have no obligation on the A-loan this year, that doesn’t start until 2009 and the B-loan is pretty deminimous.

Patrick Soon-Shiong

Right.

Hank Rauch - Liberty Mutual

Again you’ve got 60 million cash currently. What’s the run rate, do you think you’re going to run the business in terms of cash?

Patrick Soon-Shiong

Well, I think from our perspective, we’re in good strength. Tom can speak a little bit to it, I think as we evolve, especially with the heparin opportunity and evolve the opportunity to expand our business, maybe into Europe and the rest of the world, I think we need to hold on to some of the cash, so we can expand opportunistically without products offset to Europe. Now they hand – there’s no need for us to hold up the cash if indeed we can pay down some of the debt. We’ll move forward to do so as well.

Hank Rauch - Liberty Mutual

Okay. And are acquisitions a part of the company strategy going forward or are you more of a – you like to develop stuff internally?

Patrick Soon-Shiong

Well, historically we’ve really been in internal growth organization in organic growth. With other than the AstraZeneca portfolio, we’ve really been our compounded annual growth rate has been 20% since last seven years, purely organically and if you add AstraZeneca, it’s about 23%. So I think we have such an incredible efficient strong organization as a development organization, we prefer to organically grow. But obviously there’s opportunistic products that actually generate revenue. Tom and Rich will clearly be on the look out for those.

Hank Rauch - Liberty Mutual

Okay. Thank you.

Patrick Soon-Shiong

Okay.

Operator

(Operator Instructions) And your next question comes from the line of Alan Sebulsky with Apothecary Capital. Please proceed.

Alan Sebulsky - Apothecary Capital

Just wondering if we could just follow up on the heparin discussion little bit in the sense that obviously with the significant increase in raw material costs. I know pricing is a sensitive subject in a torrid situation like this. But are you able to pass at least some or all of that cost along in the prices you’re receiving for heparin and is there any sense you can give us for where the average selling price of the heparin is likely to be, in either now or over the near future?

Patrick Soon-Shiong

Yeah, this is Patrick. And you absolutely are right. I mean, you know, I don’t know if you’ve heard or watched the congressional hearings that happened last week in which in Congress – they presented data that showed in ‘07. I think the last half of ‘07 it was an interesting chart, I couldn’t see it very well on the TV, but it appears that the crude heparin pricing in ‘07 almost exceeded the cost of finished dosage heparin as the prices of crude expanded, so clearly heparin has always been razor-thin margins. With – now unfortunately, the run on crude heparin vis-à-vis the Europeans, I think the Europeans – unfortunately Europeans and Japanese have also had recalls, and they are desperately trying to enter the Chinese market to buy as much of the crude heparin as possible.

Having said that, we have, the only supply to our knowledge of finished product heparin, including crude, which is a secure supply chain, meaning we do not go through consolidators, and we go straight from our (inaudible) to full control of the intestinal mucosa to our purification plant and I personally went to China to ensure that in fact that supply chain is in tact and sufficient to supply the entire country’s needs. That’s the good news, the bad news, in order for us to access intestinal mucosa, the combination of the dollar dropping and the cost of pigs now almost quintupling. We need – we eventually absorbed significantly the increased costs ourselves because we felt very sensitive during this time of crisis to try and absorb as much of this as possible.

But I think the time has now come where we need to look at these costs and we are doing that now. And as Tom has indicated, the combination of the increased raw material as well as the combination of our increased production costs, increased testing and I think the increased testing is absolutely appropriate. We’re working with USP and FDA to even put in more tests to ensure the safety and supply of this product.

Putting that all together, we’ll be working very closely with the endusers and Tom and I will be personally meeting with the CEOs of hospitals and CEOs of Dallas’ units where these are mostly used and trying to work appropriately with what the pricing of this product will be or should be. I think the comparative, if you look at the comparative, the only comparative out in the market now that’s available is low molecular-weight heparin and enoxaparin and Fragmin are the two, and they’re about 80 dollars a vial. The traditional average selling price of heparin has been roughly about a dollar a vial, which is quite remarkable. The other product, the angiomax. I think the medicines company product out there, and they also presented at Congress is 500 dollars a vial. So if you look at 80 dollars a vial and 500 dollars a vial as available alternatives in the market and heparin at razor edge margins, it’s obviously, we’re going to have face increasing heparin price so that we can actually ensure that at least the United States captures a important share of the crude intestine and the crude material. So that’s the dilemma, we’ve been working with now. And now that we’ve actually met and ensured that there’s no shortage in the industry and we’ve very, very adequately allocated that, I think our next step in the next month or two is to very much carefully work through what the increased price should be.

Alan Sebulsky

Thank you.

Operator

As there are no further questions at this time, I’d like to turn the call back over to Dr. Soon-Shiong for closing remarks.

Patrick Soon-Shiong

Well, thank you all for joining us this morning. If anyone has any further questions, please don’t hesitate to contact the Investor Relations team at APP. And this concludes our call today. And again I want to welcome Tom and Rich and I think in the future they’ll be taking most of these calls and I’ll be sitting in quietly listening. And then I thank you all for your attention today. Bye-bye.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference, this concludes the presentation. You may now disconnect. Have a great day.

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