Cambrex's (CBM) CEO Steven Klosk on Q1 2018 Results - Earnings Call Transcript

Cambrex Corporation. (NYSE:CBM) Q1 2018 Results Earnings Conference Call May 3, 2018 8:30 AM ET

Executives

Tom Vadaketh - Executive Vice President and Chief Financial Officer

Steve Klosk - President and Chief Executive Officer

Analysts

John Kreger - William Blair

Drew Jones - Stephens Incorporated

Dmitry Silversteyn - Longbow Research

Steve Schwartz - First Analysis

Operator

Ladies and gentlemen, good day and welcome to the Cambrex First Quarter 2018 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Tom Vadaketh. Mr. Vadaketh, please go ahead, sir.

Tom Vadaketh

Thank you, David, and good morning everyone. Welcome to Cambrex’s First Quarter 2018 Earnings Conference Call. My name is Tom Vadaketh, and I am the Chief Financial Officer at Cambrex.

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 2017 Form 10-K as well as the forward-looking statements section in both our first quarter 2018 Form 10-Q and the earnings release issued this morning.

During this call, we will be referring several times to changes in revenue, all of which are made on a constant currency basis. Also during this call, 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 Thursday, May 10, and will also be available on the Investors section of our website.

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

With that, it's my pleasure to introduce Steve Klosk. Steve.

Steve Klosk

Thank you Tom, and good morning, ladies and gentlemen. Our first quarter performance was in line with our expectations, and we are on track to meet our full year 2018 guidance. We added two new late stage Innovator projects to our pipeline, both with the potential to generate more than $10 million in peak API sales.

And customer demand for new projects remains robust. To meet this strong demand for both early and late stage clinical development and manufacturing services, we continue to invest for growth.

And in the first quarter, we made good progress on and several of our capacity expansion projects. I'll begin today by commenting on our consolidated first quarter financial results and expectations for 2018. All references to revenues and EBITDA that I will make will be under the prior U.S. GAAP recognition standard.

Tom will cover our 2018 transition to the new standard during his remarks. Net revenue in the first quarter was $104 million compared to $105 million during the first quarter last year, a 5% decrease on a constant currency basis. Higher revenue in the Innovator product category was offset by declines in Controlled Substances and generic APIs.

Adjusted EBITDA in the first quarter was $21 million, a 39% decrease compared to the same quarter last year, driven by certain inventory related charges and unfavorable manufacturing variances in the quarter as well as a year-over-year change in product mix. Tom will cover these items in more detail during his remarks.

We continue to expect revenue growth for the full year of 2018 to be between positive 2% and negative 2% on a constant currency basis, and adjusted EBITDA to be between $150 million and $160 million.

Let me now move towards a review of each of our product categories, starting with Innovator, our largest category. Innovator revenues were $55 million in the first quarter, a 12% increase over the first quarter last year on a constant currency basis. Growth in the quarter was primarily driven by increases in revenue of certain commercial APIs.

As many of you know, our largest product is an API is in the Innovator category that is used by our customer to produce an anti-viral drug. As we've said in prior calls, our customer's requirements for this product have decreased, and therefore, we expect our sales of this product to decline significantly over the next few years.

We have a firm commitment towards significantly reduced volumes of this product for 2018. We also have a defined minimum volume for 2019, which represents a further significant decline versus 2018. There is no minimum volume stipulated in the agreement for 2020, the last year of our current supply agreement.

For 2018, we expect Innovator revenues to be in a range of up low single digits to down low single digits. Excluding our largest product, we expect Innovator product category revenues to grow in the mid-to-high teens. This growth compares favorably with our estimates for growth in the broader custom development and manufacturing market for Innovator APIs, which is between 5% and 8% annually.

This market growth continues to be driven by several positive trends that we have spoken about before: A strong preference among innovators for large Western suppliers with end-to-end API development and manufacturing capabilities, a robust and growing small molecule clinical development pipeline and an increasing desire by large pharmaceutical companies to reduce their small molecule manufacturing footprint and outsource more.

Small molecule approvals were strong in 2017, with 34 new chemical entities approved by the FDA.

Our goal is to continue growing our Innovator product category annually by double digits over the next few years, excluding the expected decline of our biggest product, a growth rate that would be significantly greater than the market.

Our primary strategy to do so is to win later-stage clinical projects and supply positions for commercial products. We have 17 such projects today, and our goal over the next few years is to ramp up the number of projects we are working on at any time to about 25.

To support the demand for clinical stage development capacity we have and we will continue to make investments in the growth of the company.

During 2017, we completed large-scale capacity expansion projects at our Charles City, Iowa, and Karlskoga, Sweden, facilities. And we now are adding technical resources and expanding laboratory capacity at our two large Innovator sites, which we expect to come online during 2018 and into early 2019.

Additionally, we are working hard to address the growing demand for highly potent compounds for oncologic and other therapeutic classes, which now represent about 30% of the global clinical pipeline and one third of all approvals for small molecules.

Highly potent compounds require specialized containment and handling facilities. We are well positioned to meet clinical stage demand in this category with our existing development and smaller scale high potency capabilities at the Charles City site.

We are also making new investments in a high potency active ingredient manufacturing facility at that site, which will expand our capabilities and position us to serve the full range of customer needs, from clinical material to commercial products.

We expect this facility to be operational in the first half of 2019 and the total cost of the project to be approximately $25 million.

Another element of our strategy in the Innovator category is to meet our customers' needs for earlier clinical stage development capabilities, which also broadens the funnel of opportunities for us to win late-stage projects when some of these projects progress to later-stage clinical programs.

We deliver these services from our High Point, North Carolina facility. Demand for this earlier clinical stage work is strong. And during the first quarter, we completed the addition of analytical laboratory capacity and multiple continuous flow reactor platforms to adjust these segments of the market.

During the first quarter, we also completed the purchase of the property where our facility is located for $10 million which doubles our footprint and provides us with the ability for further significant expansion in the future.

We remain very pleased with the positive impact that our High Point team has had on our overall business development, and are working on the tech transfer and scale up of three projects from High Point to our larger scale facility in Charles City.

During the quarter, we added two new products to our late stage clinical development pipeline, both of which we expect to generate over $10 million of revenue for Cambrex at maturity.

One product was removed from the pipeline due to the customer's decision to stop work on this therapeutic. So we had a total of 17 late-stage products in our pipeline at the end of the quarter. And we are actively participating in the request for proposal process for several new late-stage opportunities.

As a reminder, we characterize a project as late stage from the time the product is in Phase III until it is approved and the production process is validated in our facility.

We generally group our late stage portfolio into three categories: Those that we expect to generate over $10 million in annual revenue for Cambrex at maturity, those between $5 million and $10 million and those less than $5 million in sales.

As these projects progress to the development stage, we often adjust our initial estimates of the volume potential.

Our current late-stage portfolio breaks out as follows: We have six products in the over $10 million category, one of these products is expected to generate more than $20 million in annual revenue for Cambrex, beginning in 2018; we have six products that could each generate between $5 million and $10 million; and five products that are each expected to generate less than $5 million annually.

Future Cambrex revenue for the products in our pipeline will, of course, depend on each product's regulatory approval, success in the market and the share of commercial supply that we secure among other variables. We expect one to two late stage products to move to commercial status during 2018.

To reiterate our expectations for 2018, we expect net revenues in the Innovator category to be in a range of up low single digits to down low single digits compared to the full year 2017. Excluding our largest product, we expect net revenues in the Innovator category to grow in the mid-to-high teens.

I will now move to our generic API category. Net revenue in the quarter was $27 million, a decline of 5% excluding the impact of foreign currency compared to the prior year. The decline in net revenues due to the timing of shipments of certain products, and we continue to expect revenues for the full year to be in line with guidance.

Developing and launching new products are the key growth drivers for our generic API product category. Once launched, we will typically generate revenue from selling validated samples of a new generic API to our customers, until such time that the customer's product is approved as a commercial generic product.

The timeframe between the completion of development and commercialization is typically between a few years and as long as 10 years, as generic marketers have increasingly begun working on products well before anticipated patent expirations including as early as clinical Phase III.

We currently have 12 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. We are seeing strong demand in the market, and orders for generic APIs in the first quarter were higher than in 2017.

For 2018, we expect net revenue growth from generic APIs to be about flat with underlying growth in the low to mid-single-digit range, being offset by the impact of certain of our customers discontinuing sales of a few products in the U.S. market, thereby, reducing sales for several of our generic APIs.

Sales of Controlled Substances, our third product category, which we define as those classified as Schedule II products by the DEA, were $22 million in the first quarter, a decline of 29% versus the same quarter last year, the decline was primarily driven by delays in the release of 2018 quotas from the DEA, causing a shift in the timing of shipments to later in the year. We currently do not expect this delay to impact our revenue expectations for the full year.

We participate primarily in the non-opiate controlled substances market and do not have a meaningful revenue from opiate-based controlled substances. We are especially focused on ADHD market, which we estimate will continue to grow at rates similar to or faster than the overall API market. We seek to position ourselves as the primary supplier to all existing and new customers, entering the key controlled substances markets in which we compete.

We are in the process of developing one new controlled substance API, and one new ADHD product is awaiting FDA approval by our customer and is expected to begin to generate commercial sales in early 2019.

For 2018, we expect net revenues from Controlled Substances to grow in the mid-single-digit range versus the full year 2017, which was a very strong year.

Now let me move to our generic drug product initiatives. We filed three Abbreviated New Drug Applications, or ANDAs, during 2017 and continue to develop a number of additional generic drug products. We anticipate filing a few more ANDAs during 2018.

We are working with formulation development and manufacturing partners and expect to work with generic marketing partners to sell these products when they are approved. We expect to see revenues from these initiatives beginning in late 2019 to early 2020.

In summary, the first quarter was consistent with our expectations entering the year, and we continue to have a high level of visibility into 2018 demand. We have tight production schedules that require our site teams to execute on their operating plans, while we also make progress on the strategic investment projects that are underway. Market demand is strong and our pipeline of early and late stage projects continues to grow.

To reiterate, we expect net revenue growth in the range of a positive 2% to negative 2% net of currency impact, and adjusted EBITDA to be in the $150 million to $160 million range. I look forward to updating you on our progress next quarter.

With that, I'll turn the call over to Tom.

Tom Vadaketh

Thanks, Steve. Well, Steve has commented on revenue and EBITDA. Let me add a few additional remarks relating to revenue.

As I mentioned in our last call, based on our current visibility of customer demand and our production schedules, we expect revenue in the second half of 2018 to be stronger than the first half.

We've adopted U.S. GAAP's new revenue recognition standard, beginning on January 1, 2018. Adoption of the new standard has changed our revenue recognition methodology for roughly half our revenue, where we are providing product to specific customers with no alternative use for the product. Previously, we had been recognizing this revenue upon delivery to the customer.

From January 1^st, 2018, we are recognizing this portion of our revenue over time effectively as we produce the product.

However, to make comparisons between years easier, we are providing revenue guidance under the old methodology. Steve's remarks on revenue were all based on the old revenue standard.

As a reminder, revenue in the first quarter of 2018 on this basis was $104 million, a decline of 5% versus the prior year. Revenue in the first quarter under the new standard was $141 million.

On January 1st, 2018, we recorded a cumulative effect adjustment to equity as a result of adopting the new standard, effectively reducing 2018 revenue that would have been recorded in the income statement by $52 million.

In addition, revenue relating to partially completed products we had in process at the end of the first quarter were recorded as revenues that would have previously not been recorded until shipment occurred. The effect of adoption for the first quarter of 2018 was an increase in revenue of $37 million. Further details on these adjustments as well as the related impact on net income and EBITDA can be found in this morning's earnings release as well as the Form 10-Q, which was filed earlier today.

For the rest of this year, we will report our actual performance under the new standard, but we'll also continue to provide revenue and profitability information as it would have been reported under the previous standard. We believe this is the most transparent way to transition to the new standard for revenue recognition.

Let me move on to a few other financial statement items. Please note that where are applicable and consistent with our approach to providing guidance, I'll discuss each item under the old revenue recognition standard first, before providing the corresponding information under the new standard.

Gross margin for the first quarter was 33% compared to 45% in the same quarter last year. The decline in margins was driven by certain inventory charges due to batch failures, unfavorable manufacturing variances and product mix.

Gross margin for the first quarter under the new revenue recognition standard was 36%. As we have mentioned previously, we have been running at high capacity utilization levels, which we expect to become more manageable as we bring on additional capacity and volumes of our largest product decline.

We expect the reduction in capacity utilization levels to result in some gross margin compression. We are able to manufacture our largest product quite efficiently, given the volumes and the number of years we've been making it and continually improving our processes.

We expect the change in product mix as volume of this product is replaced with other products over the next few years to also result in some gross margin compression. As a result and as we described last quarter, we expect gross margins to trend to the high 30s to 40% range over the next few years. We believe this will still be at industry leading levels.

Selling, general and administrative expenses for the first quarter were $17 million, up slightly versus the prior year. Research and development expense for the first quarter was $4 million, essentially flat versus the same period last year.

Operating profit was $14 million in the first quarter, a decrease of $14 million, driven by the decrease in gross profit. Operating profit under the new revenue recognition standard was $30 million.

Adjusted income from continuing operations was $0.37 per diluted share for the first quarter compared to $0.60 for the same period in the prior year.

Adjusted income from continuing operations for the first quarter under the new revenue recognition standard was $0.77.

Capital expenditures were $24 million, and depreciation and amortization was $8 million in the first quarter of 2018. We continue to expect full year 2018 capital spending to be between $70 million and $80 million. As we said in our last call, this includes approximately $15 million of spending previously expected in 2017 that was carried over into our 2018 capital spending projection.

Additionally, 2018 capital expenditures also includes $10 million that we spent to purchase the land and buildings at our Cambrex High Point site during the first quarter. We ended the first quarter with a cash balance of $188 million, an increase of $4 million in the quarter. Strong collections of receivables were partially offset by increases in inventory.

For 2018, we continue to expect free cash flow, defined as the change in debt net of cash, to be between $35 million and $45 million. With the exception of our net revenue guidance, which is net of foreign currency impacts and tax guidance, our financial guidance for 2018 assumes that currency rates primarily the Swedish krona and the euro, remain reasonably stable at current rates and relative to each other.

We continue to expect adjusted income from continuing operations to be between $2.80 and $3.03 per share. Depreciation and amortization expense for 2018 represents approximately an $0.08 per share increase versus 2017.

Our effective tax rate for the first quarter was 19%, this includes the impacts from the new tax reform, including the benefits of foreign-derived intangible income provisions in the new legislation.

For 2018, we expect an effective tax rate of between 23% and 25%, excluding the tax benefits from the stock based compensation standard, which are difficult to predict.

We are continuing to evaluate the impact of the new tax reform legislation, as specific guidance start to be issued by the IRS. And to the extent we identify any changes in our initial view of the full year, we will update our guidance. We expect the cash tax rate for 2018 to be in the 20% to 22% range.

Adjusted income and related earnings per share is computed in a manner consistent with the table at the end of this morning's release.

With that, I would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from John Kreger with William Blair.

John Kreger

Hi, thanks very much. Tom, just to expand a little bit more on the conversion from 605 to 606. Will this change any of your expense recognition policies, or is this purely a revenue recognition change?

Tom Vadaketh

So up to gross margin, it does impact the way we recognize, and cost of goods as well. So effectively when we start making a product, we have a good idea what the standard margins are going to be or the gross margins are going to be. And as the product is produced, we're recognizing revenue and -- somewhat on a pro rata basis, recognizing the cost so far that we've incurred to get the product up to that stage. So in that sense, we are -- both are being recognized on an equivalent basis. Below gross margin, SG&A, R&D, et cetera, is continuing to be recognized as we have in the past.

John Kreger

Okay. And then the first two of the three factors you talked about is driving gross margin down in the quarter. Are those resolved at this point? Or do you think those carry into the second quarter? So I'm talking about the batch failures and the unfavorable variance?

Tom Vadaketh

Yes. I'll provide a little bit of color, but just the direct answer to your question, those are more sort of one-time in nature. So, we certainly don't expect to see that recurring. But as you know, we are a pharma chemicals manufacturing company. We produce in batches, and occasionally, we can have manufacturing issues. Sometimes we can reprocess the product at that point. So we recover most of the inventory. We may lose a bit of yield.

But sometimes, as happened this quarter, we had to write the batch off and start again. And just to quantify, to give you an idea, about half -- if you think about the gross margin decline from -- last year it was exceptionally high, almost 45%, as you know, but about half of that decline year-on-year was due to this issue.

John Kreger

Thank you. And one more, can you talk maybe broadly, to the extent you're willing to share, about capacity utilization across your network, as your largest product declined significantly and you bring capacity on. Do you foresee sort of -- any sort of a timing mismatch that could cause utilization to dip down materially? Or are you pretty comfortable of that you can sort of replace that freed-up capacity with new projects?

Tom Vadaketh

I mean, we think about -- John, about production scheduling as a whole for the year, right. So we mentioned that this year -- in the first quarter, as you know, part of the reason for the gross margin decline was less manufacturing, absorption, unfavorable variances than we had last year. So that's an indication of the production volumes in any one quarter can vary. But as we think about the whole year, we have a pretty good line of sight into what we're making, when we're making. And that's baked into our expectations for the year.

Steve Klosk

Yes. The only thing I would add, John, to what Tom said is, we'll have the large-scale capacity that we need to support that mid to high teens growth, obviously, excluding the big product in the Innovator product category, and that's really what we need. We're focused on growing that category double digits, and we'll have the right capacity availability to do that.

John Kreger

Yes. Thanks guys.

Steve Klosk

Thank you.

Operator

Our next question comes from Matt Hewitt with the Craig-Hallum Capital Group.

Unidentified Analyst

Hi. This is Charlie [ph] on for Matt. I've got a couple here. First, can you touch on how the expansion projects that you've announced over the last couple of years and completed have impacted your ability to kind of add new opportunities? And then, how that related to the two that you announced today?

Steve Klosk

Yes. As you know, Charlie, the large scale capacity as well as the pilot plant capacity and lab capacity is that we're adding are really critical to allow us to win and be able to service more annotator [ph] of projects and products. So they really go hand to hand, a good example was, you know the first quarter was a good quarter, winning two $10 million plus large scale late-stage projects is exactly what we want to do, exactly what the strategy is to offset the decline in the big products. So, our strategy has been and will continue to be to really invest in all of those areas where we need to support that pipeline growth.

Unidentified Analyst

And then, I guess, related to that, the sizing of the RFPs that you're currently in, are those larger opportunities? Or how should we be thinking about that?

Steve Klosk

Well, obviously, we want to focus on large API volume projects. Again, the two that we won were good wins. We now have six as we said in the $10 million-plus category, that's up from four in the prior quarter. Really what we want to be able to do is increase our ability to handle at any time 25 late-stage projects, we're at 17. So that's the key. The bigger the better. If you think about it, if you win higher volumes, then you really can handle fewer of the small volumes.

Unidentified Analyst

Okay. That sounds great. Thank you.

Operator

Our next question comes from Drew Jones with Stephens Incorporated.

Drew Jones

Thanks. Good morning, guys.

Steve Klosk

Good morning, Drew.

Drew Jones

Looking at Controlled Substances and some of the delays with DEA releasing there, did that lessened as far as 2Q?

Steve Klosk

We got some quota that we needed in Q2. It's one of the reasons that we're feeling, at least currently, good about maintaining our guidance. Every year, which is typical policy, we always ask, Drew, for supplemental quota. And this year will be no different. And hopefully, we'll get that and be able to produce the product that's in our production schedule.

Drew Jones

Okay. And then you guys called out some due diligence costs being a little bit higher than normal this quarter. Is that something that's ongoing? Or is that an opportunity that maybe you've addressed and moved on from?

Tom Vadaketh

We expect that to be ongoing. So we continue to be active, Drew, in the market. And looking at a few opportunities, I expect to continue to do that through the year.

Drew Jones

Thanks, guys.

Operator

[Operator Instructions]. Our next question comes from Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn

Good morning. Thanks for taking my call. I'm kind of trying to understand what the growth of Innovator of 12% in the first quarter and your guidance of flattish to plus or minus low single-digits for the balance of the year implies. Should we be thinking about kind of the back end of the year, which is when you shipped most of your high-volume product to your customer, being most impacted by that year-over-year comp? So the second quarter should still have a pretty decent comparison, and then we should start getting into the more questionable period in the second half of the year. Is that the right way to think about the progression of earnings? Or is this new way of reporting revenue allows you to basically book those revenues through the year? And that's going to be less of an issue as it smooths out your revenue reporting?

Tom Vadaketh

So, Dmitry, good morning. Let me -- maybe I'll start with just reiterating our guidance on Innovator, right. So we expect Innovator as a whole to be, as you said, in that flattish range of between up 2% and down 2%. If you exclude our largest product, we expect the remaining part of that category to be growing in the mid to high teens range, so a pretty significant growth.

Now to your question on, so we did -- how come we did 12% this quarter and how we're going to balance out? Yes, sure, it's timing. We had a very large Q4 last year, and the second half was very strong. So I don't want to go into which quarter we shift our largest product and all that stuff, but yes, because of timing, you can expect the Innovator overall growth to flatten out. But we are very excited about our ability to grow the remainder of the category in the mid to high teens.

Steve Klosk

The only thing I would say, Dmitry, is just referring back to Tom's script, in that overall sales, we expect the second half to be stronger than the first half.

Tom Vadaketh

Yes, this year too, yes.

Dmitry Silversteyn

Okay. I guess I'll take it offline, because I'm still not understanding how the progression is going to go. Let me ask you a question a little bit differently. You reported $141 million in revenues with this new accounting standard, part of that standard is it allows you to recognize revenues earlier. So does that mean that we're going to have sort of a smooth -- if we go with the standard, does that mean we're going to have a smoother sort of quarter-to-quarter performance and not as back end loaded as your revenue cadence has been in the past few years? Or more not related [ph]?

Tom Vadaketh

Yes. So first of all, I'll go back to our guidance, right. So the flat guidance or flattish guidance that we've provided on the revenues is based on the old revenue standard. We have not provided any guidance under the new methodology. But specifically to your question, that's an accurate way of thinking about it, because we're now going to be recognizing revenue as we produce about half of our products -- half of the volume that we sell. And that should have a smoothing out impact over time versus the patterns you'd have seen in the past, where our revenue profile was a bit more lumpy.

Dmitry Silversteyn

Got, it, okay. And then just you're dealing with a lot this year in terms of capacity expansions, in terms of trying to manage the decline of a large product and the ramp-up of business that will take its place. Where does all of this activity place your efforts in the M&A market? Is that still something that's a high in your priority list? And can you consummate a deal and do right by it, given everything else that you're doing this year and probably into next year?

Steve Klosk

Yes, Dmitry, as Tom said, we did have some due diligence or M&A-related costs in Q1. We expect that to continue. We are being proactive in chasing some opportunities, and we believe we'll be able to -- if we do a deal and consummate a deal, as you said, we believe we'll able to integrate that business or those businesses while we're focused on our base business.

Dmitry Silversteyn

Okay. So it hasn't diminished the urgency of that part of your strategy. Okay. And then final question, you talked about ramping up over time to about 25 active products from the 17 that you have currently. If I'm thinking about sort of how long it's going to take you to get there, because you've been bouncing around kind of 15, 17 for a while now, is this an aspirational goal with no particular time frame? Or do you have -- did you have plans or at least intentions that have some timing around it?

Steve Klosk

Well, we're investing so that we can ramp to that. I mean, the key is, besides the large-scale capacity, you have to have the technical resources and the laboratory capacity and pilot-plant capacity to get there.

So I see us ramping up to that over the next few years. And remember, if the goal here is for products to graduate, if you will, from those late-stage pipeline into commercial supply agreements. So we want to replenish, and now what it means is we'll have to replenish at a faster rate than they're graduating. But we always want them to be coming out of that pipeline and going into commercial supply agreements.

Dmitry Silversteyn

Okay. So I mean -- so if I can ask this differently. If five years from now or three years from now, we're sitting here and you still have 17 to 20 products in your pipeline, would you consider that to be not having met your goal? Or is your goal something that's 10 years out?

Steve Klosk

No. The goal would be over the next few years to be ramping to that number.

Tom Vadaketh

If we're still at 17 in five year's time, we'd be disappointed.

Dmitry Silversteyn

Okay. That's what I was looking for. Thank you, Tom.

Operator

Our next question comes from Steve Schwartz with First Analysis.

Steve Schwartz

Good morning. So Tom, you had mentioned the couple of things that impacted gross margin, and of course, one was the batch failures. What were some of the other items you mentioned?

Tom Vadaketh

We had some unfavorable manufacturing variances. And there was another questions earlier. So that's really stems sometimes from just price variances, but sometimes from how much you're making in any one quarter. And that tends to smoothen out over the year. We know what we're going to be producing over the year, and that's what we factored into our guidance, of course. But as we're doing this year-on-year comparison, we had less favorability, if you like, on manufacturing this year than we had in the same quarter last year.

There was some FX, right. So, about 100-plus basis point impact year-on-year just from FX on gross margins. And this is where revenue benefited from FX, but because our costs don't move in the same direction, we had a negative impact. And then there was some mix -- negative mix between the two years.

Steve Schwartz

Okay. In our manufacturing variances, Tom, can you [Indiscernible] essentially comes down to you were doing more runs, but they were smaller. Is that the correct way to characterize that?

Tom Vadaketh

No, I don't think I'll draw that conclusion, Steve. It's just that it's a quick case of how much you're utilizing your plants, right. And so we were just not -- in total, not making as much this year and during that timeframe as we did last year.

Steve Schwartz

Okay. And then John had already asked you about this, but with respect to the batch failures, but I'd like to go back to it, if I could. To the extent that you can talk about it, what were the nature of those failures? I mean, are these new projects that you're taking on? Or -- because I think we all know that Cambrex has an outstanding operational reputation in the industry. So just kind of wondering what causes that hiccup?

Steve Klosk

Steve, I'll try to address it. So you know very well that in chemical operations, even with products that you've been producing for a period of time, you can have issues, whether it's an equipment issue, a valve, a part that fails, there are lots of things that can go on in a chemical plan. It's complicated. We're running a lot of products. So whereas you would think, logically, it shouldn't happen to a product you've been running for a long time, it can. And then when you're running new products, you certainly can, because it's a new process and you're not quite sure how it's going to scale or variables happen that you weren't anticipating. So I would say, in Q1, it was a bit of a combination.

Steve Schwartz

Got it. Okay. And then just generally speaking. Here's my last question. Just with respect to generics market, I mean, certainly, Western Hemisphere, Europe, North America, is still in great turmoil. Well, I've asked this on previous calls, but I just want to revisit it. In the macroenvironment, how are you looking at that business right now? And are you seeing any major potential disruptions?

Tom Vadaketh

Steve, from our point of view, actually, the business looks very positive. So as Steve said in his remarks, year-on-year, orders are much higher this year than last year. Now it remains to be seen if that will be sustained for the full year. We haven't changed our guidance or outlook for the year, but we feel very good right now in terms of what we're seeing on demand for our product. So we're not seeing what you're referring to kind of cascade down to the API demand.

Steve Klosk

And Steve, one of our key strategies is growing in other markets. And so growing in other markets and frankly, adding new customers in other markets is going well for us.

Steve Schwartz

Yes, okay. And I guess, if I could add one on, and this is more of a strategy question. I think some of your competitors in the controlled substance arena are going after the cannabis market, cannabidiols and what have you. So have you considered that? Is that an opportunity for Cambrex?

Steve Klosk

It's not really one that has been in our R&D or development queue. I mean, that could change if we had customers that wanted us to do that.

Steve Schwartz

Okay. So it's not like you could use your existing manufacturing assets in that arena, it's just, potentially, a different manufacturing environment?

Steve Klosk

Well we would -- I mean, we'd certainly do it in the United States, and we would commit to do that in Charles City. I just don't know without really looking into the process and the chemistry what it would take in terms of new -- if we would have to have new contained assets.

Steve Schwartz

Okay. Understood. Okay. Thanks for taking the questions.

Steve Klosk

Sure.

Operator

Our next question comes from Daniel Thomas [ph] with Thomas Capital.

Unidentified Analyst

Good morning. I know I've missed some of the call, I'm not sure if I missed this part, but did you discuss the variance between the gross margins under the new revenue recognition and under the old recognition? I guess, the question is, can we make any assumptions about why the gross margins were higher on the -- on what was recognized under the new recognition policy?

Tom Vadaketh

Yes. I think what it implies is that -- right, so that additional revenue that is being recognized under the new methodology is product that's partially produced that effectively would be sitting in inventory in the old world. And so what you can deduce from that is that the margins, the profitability of that product is higher. So that's about it really, but we -- Yes?

Unidentified Analyst

Is that higher because it's higher-margin products or because it's higher capacity utilization products and therefore, you could say that maybe it's your largest product? Or can we not go there?

Tom Vadaketh

It'll be a combination of all of the above.

Unidentified Analyst

Okay. And I mean, just broadly speaking, I mean, to me, the analysts all have to be nice on this call. But if you look at this, the gross margin profile of the business, you were high 20s, low 30s, you got the big drugs, you went up to 40s, and so the big question, I think, in people's mind is this beginning of the long walk down to reality on the gross margins? And I know you guys have given your guidance, but what's the probability that you guys are really just walking this thing down and it's going to be 36%, 35%, 33%, so saying we're just going to go back to where we were sitting before, three years ago?

Tom Vadaketh

Well, as you said, we've given our longer-term outlook on gross margins. We expect that to be in that high 30s to 40% range, right, as overall planning horizon. But this year, you can -- we haven't provided guidance on gross margins, but you can kind of back into it from -- just from our EBITDA guidance. And we -- as Steve said, we remain confident that both the top line and the bottom line, we have visibility and demand, and we're confident that we'll able to deliver that. So I don't know it that answers...

Unidentified Analyst

I mean, you guys had drifted, you pretty much have had -- correct me if I'm wrong, but you pretty much have had just as many drugs in the pipeline plus or minus going back the last number of years, and they've all kind of had that same breakout of the revenue potential, the only big outlier has been the blockbuster that you guys have, right?

So I just -- and you guys have been, I don't know, what I would call, unnecessarily opaque about how you kind of get to the capacity utilization, what that utilization has been the last couple of years, where we are today and how a similar product mix gets you to the same utilization to keep the margin rates up?

So, I just -- if you give investors any more comfort, because I think what's going to happen is over the next couple of quarters if you -- if we are both again in a lock down, I mean, the stock is just going to get crushed, and we're all going to be sitting here as investors getting screwed.

Steve Klosk

Well, we just reiterated our guidance for the full year. So whether or not...

Unidentified Analyst

Happens all the time though, right, I mean, I have been doing this long enough where I can point to a lot of companies who reiterate their guidance, but you know that you've got the forward-looking statements. So I'm just trying to push you a little bit and say, do you really think that, that's what's going to happen?

Steve Klosk

Well, we said it. So we have confidence that we can do it at this point. If you look at our track record, over the last three to five years, you'll see how we've done vis-à-vis our guidance. So we wouldn't say it at this point in time, we didn't think we were going to be able to do it. So the key for us is, as you've said, and as we've said, is the pipeline. So we need to replace. We need to offset the decline in the big product. We have -- in order for this year. We have a minimum for next year.

So we know what that number is, and therefore, we know what we have to do in terms of winning new business to be able to offset that. And the only way to do it is what we've said is to continue to -- is to grow our Innovator product category double digits, that's the decline in that product. So the market is strong, it's as strong as I've seen it since I've been in this business. We now have the capacity and the ability to win more products, we wanted $20 million product, so that's a large product.

We've just won two more that are $10 million plus. That's the business we're in, that's what we do. We've invested to do it, and we have the capacity available to do that. So that's what gives us the confidence to be able to grow through over the period of time.

Unidentified Analyst

Okay. Last one question on this. When you say the pipeline, because I know you got the minimum for this year or the guarantees for this year and the minimums for next year. Is your confidence in the ability to meet the margin guidance based on a pipeline that's locked in? Or how much of that pipeline is locked in? Like how much variability of your pipeline you have to win to get that, like we've got to win 70% of it, we've got to win 100% of it? And then where does that win rate skew to where your historical win rate is, just for that gross margin confidence?

Steve Klosk

For 2018, which is really the only year we're giving guidance for. As we've said, we have a high visibility to demand for this year. The key question is, and similar to past years, it's been the ability to execute on that plan. So we know the business, it's not a lot of new business that we have to win for this year.

Unidentified Analyst

Fair now. Thank you for answering candidly. Thanks.

Steve Klosk

Thanks.

Operator

At this time we have no further questions in the queue.

Tom Vadaketh

All, right. Thank you, everybody. We'll talk to you next quarter.

Operator

Ladies and gentlemen, that concludes this morning's presentation. You may disconnect your phone lines, and thank you for joining us this morning.