Taro Pharmaceutical Industries Ltd (TARO) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Taro third-quarter 2004 conference call. At this time I would like to inform you that this conference call is being recorded for rebroadcast at that all participants are in listen-only mode.

This recording will be archived and can be heard at anytime following this call through November 4, 2004. To hear the archived call, log into www.taro.com and click the link on the homepage, or telephone 888-286-8010 in United States or 617-801-6888 from overseas. When prompted provide pass code 28430887 to request the Taro call.

Today's call will begin with a presentation by Taro's executives. Then at the request of the Company, we will open the conference to questions and answers from participants on the call.

At this time let me read you the following Safe Harbor statement.

Certain statements in this conference call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements that do not describe historical facts and statements that include the words "hope", "will", "believe", "anticipate", "expect", "plan", "intend", or "designed to", "happen", or "exists", or similar language, and statements concerning the Company's sales and profitability, the impact of strategic initiatives and cost reductions on future performance, studies of T2000, and the market size for the Company's pipeline. Although the Company believes that such statements are based on reasonable assumptions and reliable sources, it has no assurance thereof.

Factors that could cause actual results to differ include general economic conditions, industry and market conditions, changes in buying patterns by any of the Company's customers, regulatory actions, and legislative actions in the countries in which Taro operates, future demand and market size for products under development, marketplace acceptance of new or existing products, either generic or proprietary, and other risks detailed from time to time in the Company’s SEC reports, including its 2003 Annual Report on Form 20-F.

On an ongoing basis, the Company reviews (and, if appropriate, revises) its estimates, including those related to reserves for customer charge-backs, bad debts, income taxes and contingencies.

The Company bases its estimates on currently available information, historical experience and various other assumptions that it believes to be reasonable under circumstances prevailing from time to time.

The results of these assumptions are the basis for determining the carrying values of assets and liabilities that are not readily apparent from other sources. Since the factors underlying these assumptions are subject to change over time, the estimates on which they are based are subject to change accordingly.

Forward-looking statements speak only as of the date on which they are made.

The Company undertakes no obligations to update, change or revise any forward-looking statement, whether as a result of new information, additional or subsequent developments or otherwise.

I'd like to now turn the call over to Mr. Daniel Saks, Vice President, Corporate Affairs. Please go ahead, sir.

Thank you, David, and good morning. Thank you for joining us on today's conference call. With me today are Dr. Barrie Levitt, Chairman of Taro Pharmaceutical Industries, and Kevin Connelly, our the Chief Financial Officer. Barrie, Kevin and I have some brief remarks, and then we're going to open the call to your questions. Now to get started we'll turn the call over to Barrie.

Thank you, Dan. The results of the third quarter, while below those of a year ago, showed improvement compared with the second quarter of this year. I would like to take this opportunity to provide an update on the continuing initiatives that we've undertaken to improve Taro's performance.

In the conference call that we conducted at the end of the second quarter, we described four initiatives -- first, we targeted inventory reduction; second, as we lowered inventories we plan to adjust production and purchasing accordingly; third, we said that we would undertake a comprehensive review of all of Taro's costs in order to reduce the Company's expense profile; and finally, at the end of the second quarter we discussed deferring non-core initiatives, including some capital investments.

First, with respect to inventories, we have seen a reduction in the third quarter compared with the second quarter of this year. In fact, the Company would have recorded a greater reduction in inventories were it not for a weakening of the US dollar compared with the Canadian dollar at the end of the quarter. Second, reductions in production purchasing are proceeding as we rationalize and optimize our manufacturing operations. Third, our review of Taro's expense profile is continuing, and measures have been taken, including a reduction in Taro's workforce worldwide. Finally, the review of non-core initiatives continues, several initiatives have been postponed until market conditions require their implementation.

Overall, we are taking the steps that we believe are prudent to achieve our long-term goals for profitable growth. However, in addition to cost reductions, we are continuing a number of growth initiatives in the United States and elsewhere in the world. For example, we're continuing to invest in Taro USA's TaroPharma division. TaroPharma recently expanded its product portfolio with the addition of Lustra and Lustra-AF. Taro's professional medical representatives have just begun promoting these in-license products to physicians together with other proprietary products in their portfolio.

Taro USA's consumer health care products division continues to expand its Kerasal line of foot care products, including Kerasal AL cream which is developed by Taro Research. The Kerasal products are now among the leaders in their category.

Taro's ElixSure product line now includes ibuprofen in a spill resistant vehicle. Market research among consumers suggests an increased level of awareness of the ElixSure product line as we enter this cough/cold season. We continue to support this initiative. The success of the ElixSure line will depend upon actual consumer acceptance and the purchase of the ElixSure products, for which of course there can be no assurance.

Regarding proprietary research, we're continuing to develop into our class of non-sedating barbiturates which include T2000 and T2001. We're continuing our preparations for definitive studies in Canada on the safety of efficacy of T2000. We're also continuing our generic drug research programs for both topical and oral dosage form products.

We are confident in the quality and determination of the people working at Taro, both on the scientific and commercial sides of our business. I am certain that they will give a good account of themselves as we move forward.

Now I will turn the call over to Kevin who will provide more details on our results.

I want to review certain items related to the Company's performance in the third quarter of 2004.

Sales for the quarter were 73.3 million, which was 12 percent below the third quarter of 2003, but up 49 percent from the second quarter of 2004 as we saw an increase in orders across all classes of trade. The shortfall in sales from the year-ago quarter primarily reflects reduced orders from the wholesale class of trade. In the third quarter, approximately 87 percent of Taro's sales took place in the US, 7 percent were in Canada, and the remaining 6 percent were in Israel and other international markets.

Our gross profit for the quarter was 42.5 million compared to our gross profit of 56.6 million for the year-ago quarter. This decrease reflects the impact of the revenue shortfall versus a year ago, product mix, price erosion and the impact of a strengthened Canadian dollar on our production costs. As you may recall, the majority of our production takes place outside of the US, so a weakening US dollar impacts our overall production costs. Our gross profit margin of 58 percent for the quarter is up sequentially against Q2 of this year when our margin was approximately 48 percent.

Taro's SG&A expenses in the third quarter of 2004 were 29.6 million compared with SG&A of 25.7 million in the third quarter of '03. Included in this quarter's costs are the full expenses of our TaroPharma sales force of approximately 70 people calling on dermatologists and pediatricians. In addition, the Company continues to invest in its proprietary OTC product lines, Kerasal and ElixSure. Our efforts in controlling costs continued during the quarter as overall SG&A expenses declined by approximately $1 million from Q2 of this year.

Our commitment to research and development continues with 10.5 million invested in R&D during the third quarter of this year compared with 11.2 million a year ago. Approximately 80 percent of this amount was focused on our generic pipeline and the remaining 20 percent was focused on our proprietary pipeline, which includes products that use our NonSpil drug delivery system and also our new class of non-sedating barbiturate compounds.

We currently have 25 filings at the US FDA and numerous filings with regulatory agencies in other countries.

Our operating income was 2.4 million in the third quarter of this year compared with operating income of 19.7 million in the same quarter a year ago. This decrease reflects the change in revenues and the impact of the increased marketing expenses described earlier.

Our net income for the quarter was $4 million or 14 cents per share. Year-to-date, our sales totaled 206.5 million and our net income totaled $6.3 million or 21 cents per share.

Before we take your questions, I will also review some items from the quarter-end balance sheet.

Cash, restricted deposits and long-term investments stood at 115 million as of the end of the quarter. This represents a decrease of 50 million from the and of '03 as we funded our working capital requirements, capital investments, and product acquisition programs.

Accounts receivable trade totaled 102 million compared with 121 at end of last year or compared with 119 million at end of the prior quarter.

The inventory level of 98 million was built in accordance with our policy of maintaining the finished goods required to meet anticipated customer demand, as well as new product launches. We're taking a number of steps to control inventories and other related costs, and these efforts have begun to impact our overall inventory levels.

A total of 12 million has been invested in property, plant and equipment in the third quarter of this year. Now combined with the 45 million we invested in the first half of the year, this brings the year-to-date total of capital investments to $57 million. These projects include our new distribution center in New Jersey, and ongoing projects in Israel, Ireland, and Canada. And we intend to invest a total of 10 to 15 million in capital projects for the remainder of 2004 as our current capital investment programs near completion.

The activities of the third quarter included the in-licensing of the Lustra product line for Medicis with a purchase option. We believe this addition to the product line of our TaroPharma sales force will enhance the profitability of this division.

In conclusion, Taro's fundamentals remain strong. First, Taro's generic market position is solid. Prescriptions for Taro's generic products continue increase, and the TaroPharma group is increasing demand in prescriptions for our proprietary products. Second, Kerasal has become a leader in the foot care category and is making a positive contribution to our financial performance. Third, we have a robust product pipeline at the FDA, as well as an excellent research program developing products to be filed in the coming months. Finally, our current capital investment program is largely complete and we're reducing our overall expense profile.

Dan, let me turn it over to you, and then I'm sure we will take some questions.

Before we take questions I'd like to offer some perspective on Taro's R&D pipeline.

Taro has had 12 approvals so far this year and there are currently 25 filings in our pipeline at the FDA. These consist of 24 ANDAs and 1 NDA related to NonSpil. 16 of the filings are for topical products and 9 are for oral dosage and other form products. The current market value of the ANDAs in the pipeline remains more than $1 billion.

To begin our question-and-answer session, let me remind you of 3 of our communications guidelines. First, in line with long-standing communications policies, we do not provide guidance, nor do we comment on analyst estimates. Second, for competitive reasons, and to be fair to our customers, our policy is not to discuss individual customers, nor do we provide information on sales and profitability of individual products. Third, again for competitive reasons, we do not disclose the products filed with the FDA.

Thank you. Now we will be happy to respond your questions. David, we will start the question and answer session.

(OPERATOR INSTRUCTIONS) Rich Watson, William Blair & Co.

Good morning and thanks for taking the call. If I could, just a couple of questions. Trying to get an idea around the tax benefit for the quarter. Can you just walk us through that a little bit, whether that's related to the US business and how that kind of played out? And then the second question, I am curious as to the difference between T2000 and T2001, where you'll be concentrating the bulk of your R&D resources going forward. And then if I could, just in terms of the non-core activities that are being deferred, does this possibly include your European expansion plans? And on this topic, if you could just provide us an update on when this part of the business could become a meaningful contributor? Thanks.

I will take the taxes first, Rich, and then I'm sure Barrie will probably do a better job on T2000 and T2001.

The taxes are a function of the different tax rates in the various countries that we operate in and the income recognized in each of those individual areas. Now in Israel our tax rate is much lower than that in the US or Canada. There's no doubt that the impact of the reduced sales this year has been primarily a US issue. So the reduced income and the reduced tax burden has also been recognized primarily in the US.

In the past, with a higher level of sales and profitability we saw an average tax rate, I think, in 2002, 2003 somewhere between 17 and 20 percent. It's always difficult to predict what the rate is going to be for us going forward because it's obviously a function of the level of sales and the profitability of the Company overall. And I need to know what that was to estimate a tax rate. And quite frankly that's just something I don't know right now.

Rich, I'll take the other 2 parts. Let's start with European operations, because that's simpler.

We have been investing in our European operations right along. We intend to continue to invest in our European operations. Obviously we can't start shipping from our European facilities until we get the regulatory approval, both for the facility initially, and for the products that are being developed for manufacture at that facility. So we're again, unfortunately, dependent upon regulatory authorities. And as soon as we start getting approvals, we will announce them promptly, and then you'll be able to draw the appropriate conclusions. We do make a point of announcing any significant material approval within hours of the time it's received so that you'll certainly be in the picture. And we will be disclosing whether the product came from Israel, Canada or Europe.

With respect to T2000 and T2001, T2001 is a bio-transformation product of T2000. Both drugs are active. There are certain advantages that T2000 has biologically and pharmacologically and certain advantages that T2001 has.

Our studies, the initial studies will probably be in man with T2000, simply because it's much further advanced than T2001. However, given the particular attributes of T2001, including the fact that it can be put into solution and can be given perentharally (ph), we will be developing T2001 as well.

And I think that you're going to see not just these 2 compounds, but other compounds and derivatives as we go forward if this -- if, if -- this class of compounds turns out to be safe and effective. Obviously I can't predict whether they will be safe and effective. And as you know just from reading the newspapers, it's very difficult to predict even after a drug is approved whether or not it's going to stay on the market. So with all the caveats associated with new drugs and new drug development, if we're successful in what we do -- and if is I guess the largest word in the English language -- then we will continue to invest in this class of compounds. But I really can't say much more than that, and I hope I have answered your question.

That's helpful. Thank you.

Greg Gilbert, Merrill Lynch.

I have a couple first financial ones. Can you quantify or estimate the sales and margin effects of the weak US dollar to give us some sense of what that delta was? And can you estimate the cost savings that you could see with the headcount reduction once it filters through?

In regards to the cost savings, as you know, it's our policy not to provide guidance. So it wouldn't really be right for me to speculate. But we thought it was prudent to reduce our expenses in response to the reduced sales. We did actually see a reduction of approximately 150 people or 10 percent of our workforce, a lot of that taking place late in the third quarter. So we're looking forward to an additional contribution of that reduction as we go out in the next several quarters.

But it's important to note if you're just looking at the SG&A line that the personnel costs are only a small part of that. We have also reduced personnel in our manufacturing sites; a little bit in the R&D group. So basically across the board we instituted our reduction. And quite frankly, we're continually reviewing all of our costs and we're trying our best to optimize our performance. So I don't think I can give you a number right now. It's just not our policy to do that.

In regards to the FX impact, we normally talk in the past about somewhere between half to two-thirds of our production taking place in Canada. And the other piece of that usually takes place in Israel. So depending upon how each of those currencies moves, that obviously impacts the inventory levels and eventually the margins.

Right now I think the Canadian dollar strengthened to the tune of about 5 or 6 percent, just in the last several weeks. So that will obviously have an impact on the margins as we go out. But we're doing everything we can to make sure that our capital investments that we put into the facilities offset any of those type of currency adjustments. We have to obviously become more efficient. And our groups both in Canada and Israel I think are up to the challenge. We're hoping that we can mitigate the impact of the currency by really increasing just the efficiency of the facilities.

Could you estimate for us or tell us whether or not your branded Rx business adds or subtracts to operating income at this point?

Again, we don't break out the individual groups at this point in time, but I think we have mentioned the fact with the acquisition of the Lustra product line we're looking forward to the improved contribution of our TaroPharma group. So I think from that you can read into the fact that we're happy with how that group is performing, and that it is making a positive contribution to the overall performance of the Company.

Last question is for Barrie regarding pipeline. Are you finding that as you look for ANDA projects for future years, is it becoming any more difficult to find opportunities in your core topicals area or will mix sort of have to shift towards orals and other dosage forms over the next couple of year period?

On the generic side I think there's still plenty of targets, different targets. And some of them are more complex in terms of the kind of studies that are required as we move forward, which I must say, while it may be more expensive, it flows more to within our area of core competence, namely clinical research, especially clinical research in dermatology. There's still 20 topical products with sales in the aggregate of over $2 billion. So I think that we're going to have enough work to do there. But I also think that when we look in the topical area we're also going to be looking at proprietary products; products developed by us and by others. And there's going to be a fair amount of research going in there.

We believe, at least we hope, that by focusing part of our energies on proprietary products we will get longer life at higher margins. Of course as you know, Greg, the 2 are exact opposite almost or mirror images of each other. The generic product starts out with the maximized revenue and it falls off as price erosion and competition enters the market. The proprietary product is the other way around; it starts off with a lot of expense to get the product into the market, and then you really only get the maximum benefit just before use lose your patent protection and then somebody comes in and now it becomes the equivalent of a generic product.

But we do think as we look forward over the next 5 to 6 years that the effort in topicals has to be balanced between both proprietary and generic on the prescription side. We think we're equal to the task. I think we have the personnel, both the clinical personnel, the research personnel, the regulatory personnel, to keep ourselves growing in dermatology. We've made some long-term strategic initiatives -- we have some long-term strategic initiatives in dermatology and this is something we're going to stick with.

Thanks.

Elliot Wilbur, CIBC World Markets.

Just a follow-up question on your comments regarding the recovery in the wholesaler volume patterns in the quarter. Was it evenly distributed among all your principal customers or is there maybe 1 customer that's still is -- you haven't seen the recovery in orders that you would have anticipated?

Can I just say something about the wholesalers? The wholesalers really play a vital role in the distribution of healthcare products in this country. They supply healthcare products to more than 50,000 pharmacies as well as thousands of hospitals, nursing homes, Veterans Administration and all kinds of other locations, which would be a daunting task for us or any other pharmaceutical company to try to do on its own. So we think the wholesalers are a very important part of our business and everyone's business, and they play a vital role in the supply chain. I just want that on the record in terms of what we feel about the wholesalers.

We have excellent relationships with our wholesale customers. I don't think that we can single out 1 or another. The whole class has improved somewhat quarter-over-quarter; not back to where they were a year ago, but the world keeps changing and we have to keep changing with it. We're going to work with our wholesale customers to achieve common goals, distribution of drugs and profitability for both groups. And I think that we're equal to the task and we're very confident that we will be able to maintain good relationships with the wholesalers.

I wanted to ask you a follow-up question, Barrie, on ElixSure. As I guess we head into the heavier stocking season here in the next couple of months, anything that you're doing differently this time around based on your experience last year that you can share with us?

We are doing some things to differently, but I don't think I can share them with you, simply because we're in a very competitive environment, and I'm sure that the people with whom we're competing would like to know what we're going to do. So I would love to discuss it after the cough/cold season is over or after the initiative has been undertaken. There has been some -- if you watch television, you will see some change in the advertising strategy. That's very public. But some of the other things that we're doing I would just like to reserve judgment.

Yes, we have learned from last year. Yes, we are going to try to do some things to differently. The only thing that we can't -- I think based on the data we have, we think it's prudent for us to continue to support this initiative. I can't guarantee anybody's success. This is a very competitive market. We think we've got a great product, but other people have great products also, so we're just going to have to see how it plays out. But I appreciate your interest in ElixSure.

And certainly anyone who's listening who has got small children certainly should at least try ElixSure because if you try it I'm sure you're going to like it, and I'm going sure you're going to use it again and again. I'm sure your kids are going to like it, and they're going to ask you to give it to them again and again. Excuse the sales pitch please.

Thank you.

I think we will have time for another question.

Arnold Ursaner, CJS Securities.

Good morning. Barrie, I have a question for you. It looks like you clearly are continuing to focus as you have on the long-term spending for R&D. Care to expand a little bit more on that, if you would?

You're absolutely right. We're trying not to manage the Company on a quarter-to-quarter basis, but we're trying to look at the long-term. I know I've been with this Company more years than I care to admit publicly. And we are going to maintain our research expenditures for both proprietary and generic drugs at a level that we feel is appropriate to achieve the long-term goals of the Company. There are going to be ups and downs in terms of the number of filings or the number of approvals. we didn't pick easy targets, but we hope that by picking targets that aren't easy we will have less company when we get into the market, and therefore be able to return more value to our shareholders over the long-term. I feel looking back over the last 5, 6, 7 years, I think that people that have invested with us have borne the fruits of some of the work that we've done and the long-term investments that we done. And I'm hoping we will be able to continue to select targets properly. I am hoping that we will be able to execute the research as we have in the past, and that we will be able to continue to deliver the results to our shareholders as we go forward.

1 more question, if I may. I gather authorized generics didn't come up as a topic of conversation on your call. Can you comment on how you see this impacting your Company? And have you considered taking on authorized generics even though it may lower your overall gross margins?

It's a matter of record that we have been both impacted by authorized generics and we have been an authorized -- or we are an authorized generic. It is part of the new reality. We're going through a phase. People have been through that phase in Canada. We have been through that phase in Israel. And we're going through that phase in United States where the proprietary companies try to use authorized generics as a method of prolonging the life of their products after patent protection has expired.

I think that an authorized generic is a generic competitor. The only difference is that you're competing with the branded company as opposed to another generic company. I think it's very much on a case-by-case basis depending upon the product and depending upon who the authorized generic is the way this plays out can be very different as you go from 1 product to another.

So the answer is yes, we are prepared to be and we have been an authorized generic where we feel that's appropriate for us. And we do take authorized generics into account in all of our plans, including product selection going forward. We can't create the reality. We play with the cards we're dealt. But I think that we are keenly aware of all of the changes going on in the competitive environment. I think that we're small enough to be able to react in a flexible and appropriate manner to changes in that environment.

I just want to clarify 1 thing on the R&D spend. We had very few if any new products submitted for ANDAs. I assume that's nothing other than just timing.

That's right. We are dealing with -- the research program is moving according to plan. And we are going to file what we have to file when it's ready. It's very important that the filing that we do be quality filings. We're not filing in order to look good; we're filing in order to be good. Therefore, we want to be sure that whatever we do, we do it right the first time. And that will apply to T2000, T2001, and to our topical products, to our generic products. It is just across the line. Excellent is something that we strive for, and we try to deliver to the FDA and other regulatory agencies files that can be reviewed expeditiously.

Thank you.

I'd like to now turn the call back to Mr. Daniel Saks for some closing marks. Please go ahead, sir.

Thank you very much for joining us today on the call, and we look forward to our next quarterly conference call. Thank you again.

Thank you, sir. Thank you, ladies and gentlemen, today for your participation. This concludes your conference call. You may now disconnect. Have a great day.