Taro Pharmaceutical Industries Ltd (TARO) 2004 Q4 法說會逐字稿

Good morning and welcome ladies and gentlemen to the Taro Fourth Quarter 2004 conference call. At this time, I would like to inform you that this conference call is being recorded for rebroadcast and that all participants are in listen only mode. This recording will be archived and can be heard at any time following this call through March 3, 2005.

To hear the archived call, log into www.taro.com and click the link on the homepage or telephone 888-286-8010 for domestic U.S. or press 617-801-6888 for international and provide the passcode 77052125 when prompted. 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 for 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 are not describing historical facts, events or circumstances the company anticipates, expects, plans, intends or designs, believes, hopes or wants to happen or exists.

Including statements about the company's goals or statements about which the company is optimistic. The company's continuing research and clinical trials, the expansion of the company's base business, engineer pharmaceuticals, the growth of the company's Taro pharma line of proprietary products, cost reduction measures, the return of the company to meaningful, sustained or profitable growth, consumer, physician or marketplace acceptance of the company's new or existing products, comments concerning marketing on proprietary products including elixir (ph), exherenthol (ph) products, a potential benefit of elixir product, initiatives undertaken by the Taro consumer healthcare products, and Taro pharma group, the company's research and facilities expansion programs, Taro's filings with the FDA and the company's overall growth and expansion.

Although Taro pharmaceuticals industrial LPD believes the expectations reflected in such forward-looking statements to be based on reasonable assumptions, it can give no assurance that it's expectations will be attained. Factors that could cause actual results to differ include general economic conditions, industry and market conditions, slower than anticipated penetration of new markets, changes in the company's financial position, regulatory actions and legislative actions in the press release in which Taro operates, future of demand and market guide for products under development, markedly accessing 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 annual report on form 20F.

Forward-looking statements speak only as of the date on which they are made. The company undertakes no obligation to update, change or revise any forward looking statement, whether as a result of new information, additional or subsequent development or otherwise. I will now turn the conference over to Mr. Daniel Saks of Taro, please go ahead, Sir.

Thank you, Amanda, and good day to listeners on the Taro conference call. With us today are Dr. Barrie Levitt, Chairman of Taro pharmaceutical industries and Kevin Connelly, our 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. Good morning, or good afternoon as the case may be. Taro's performance in the second half of '04 was clearly improved compared to the first half of the year. In the first half of the year, the company experienced an unexpected shortfall in sales in the United States at a time when we were undertaking a major initiative in the marketing of proprietary consumer products and maintaining our investment in research and development.

The shortfall in sales and the costs associated with this marketing initiative, combined with our commitment to maintain investments in key generic and proprietary research programs led to a decline in profits, particularly in the second quarter. In the second half of the year, both sales and profitability improved as the corrected actions we implemented took hold.

I would like to take this opportunity to discuss our 2004 results and to try to put them into perspective. The initiatives that we undertook to improve performance have begun to achieve many of their goals. These initiatives comprised a reduction in inventory, a decrease in rationalization of production and an overall lowering of expenses including a reduction in force of about 10%.

Inventory at June 30 was approximately $102 million at September 30, $98 million and at December 31, $87 million. The actual reduction would have been greater but for the effect of the weakness of the U.S. dollar. Gross margin and cost of goods in the fourth quarter were effected by higher unit costs as the company kept production in line with its inventory reduction program initiated in the third quarter.

Gross margin was also reduced by price erosion, which is an integral part of the generic pharmaceutical market. Cost of goods was effected by several additional factors including the decrease in the value of the U.S. dollar, the transfer of the company's Long Island, New York, manufacturing facility to Canada and costs associated with a reduction in manufacturing personnel.

As always, the company maintained its attention to product quality and compliance with good manufacturing practices. In fact, in late '04 and early '05, our Canadian facilities were again inspected by both the FDA and it's Canadian equivalent, no form 483 issued by the FDA and no findings of material deficiencies by the Canadian authorities.

Similarly, the Irish Medicines Board, representing the European regulatory authorities inspected our Israeli plants and found us to be in good shape there as well. So in general, administrative expenses decreased progressively throughout '04. In the first quarter, they were $34 million, $31 million in the second quarter, $30 million in the third and $29 million in the fourth.

The impact of the reduction in force near the end of the third quarter was offset in part by the increase promotional costs for elixir in the fourth quarter. Thus, in the second half, SG&A continued to decrease while sales improved. During the past year, there have been questions about the company's level of advertising and promotional expenses. We intend to continue to support the needs of our customers.

Good relationships with our customers are an essential part of building a sound business. At the same time, we are very sensitive to the needs of our shareholders. After the first quarter of '05, the current quarter that we're in, we want every Taro product group to be a profit center.

Regarding proprietary research, we are refining the study design for our first Canadian phase III trial of T2000, an essential tremor. Of course, there can be absolutely no assurance of the success of this trial or of the successful commercialization of T2000 or of any other new chemical entity in development at Taro. We are also continuing our generic drug research programs across a broad range of delivery systems.

In 2004, Taro filed 10 NDAs and received approvals for 15 ANDAs and one NDA. Six of the ANDA approvals were first to market generics. Taro remains committed to providing our customers with reliable levels of service, continuous supply of high quality products and new products that meet market needs.

We believe that in serving our customers, we should also meet the objectives of our shareholders for meaningful, sustainable and profitable growth in the years to come. In closing, I would like to specifically acknowledge the support and hard work of Taro's employees throughout last year. Thank you and I will now turn the call over to Kevin who will provide more details about our fourth quarter and full year results. Kevin?

Thank you, DR. and welcome everybody. I'd like to review certain items related to the company's performance in the fourth quarter as well as the full year of '04. Sales for the fourth quarter were $77.7 million, which was 12% below the fourth quarter of '03. Fourth quarter sales, however, were up 6% from the third quarter of '04, indicating a continued upward trend since the second quarter of '04.

In the fourth quarter, approximately 88% of Taro sales took place in the U.S., 6% were in Canada and the remaining 6% took place in Israel and our other international markets. Our gross profit for the quarter was $42.3 million, compared to our gross profit of $62.1 million for the year ago quarter.

Now the gross margin of 55% for the quarter reflected the impact of the factors that Barrie mentioned earlier. These factors included the costs associated with transferring the production of our facility in Long Island to our topical product facility outside Toronto as part of the rationalization of our manufacturing operation.

We believe that the consolidation of these two facilities will provide us with greater efficiencies and production in the future. Cost of goods was also effected by expenses related to our reduction in manufacturing personnel. Regarding the implements of foreign exchange, we should note that the majority of our production takes place outside of the U.S. so a weakening U.S. dollar increases our overall production costs.

SG&A expenses continued to decline in the fourth quarter as compared to both the third and second quarters of this year. SG&A decline in both dollars and as a percentage of sales in the fourth quarter as compared to the third. Our SG&A was 37% of sales in Q4 of '04, compared to 40% of sales in Q3 of '04. The improvement in SG&A is related to the company's false reduction initiatives, including a reduction in force which occurred at the end of the third quarter.

However, some of these savings were offset by the seasonal ramp up of promotional spending on the elixir line of spill resistance cough and cold medicines for children. Our commitment with research and development continues with $9.2 million or 12% of sales invested in R&D during the fourth quarter of this year and that compares with $11.1 million, also 12% of sales a year ago.

Approximately 75% of this amount was focused on our generic pipeline and the remaining 25% was focused on our proprietary pipeline. We are developing branded prescription products to add to our Taro pharma portfolio and we are continuing to work on our non-sedating barbiturate compounds.

We currently have 27 filings at the US FDA and numerous filings with regulatory agencies in other countries. Our operating income was $4.1 million in the fourth quarter of '04 compared with operating income of $18.9 million in the same quarter a year ago. The decrease reflects the decline in revenues, the increase in unit costs and a continued investment in the marketing of our proprietary consumer and prescription products.

Net income for the quarter was $4.8 million or $0.16 per share and for the year, our sales total $284.1 million and our net income totaled $11.1 million or $0.37 per diluted share. I'll also now review some of the items from the quarter of the year end balance sheet. Cash, restricted deposits and long-term investments stood at $125 million as of the end of the quarter.

This represents a decrease of approximately $40 million from the end of '03. As we funded our working capital requirements, our capital investments and our product acquisition programs. Accounts receivable trades hold $123 million compared with $121 million at the end of last year.

DSOs remain at the higher end of their historic range at the end of '04. The company's cost control measures initiated at the end of the second quarter included reductions in purchasing and production. As a result, inventories, which totaled $102 million at the end of the second quarter of '04 were $87 million as of year end.

Now we believe that current inventory levels will permit the company to maintain high levels of customer service without interruptions in supply. A total of $16 million was invested in property, plant and equipment in the fourth quarter of '04. Now combined with the $57 we invested in the first nine months of the year, this brings the full year total of capital investments to approximately $73 million.

Included in the projects, are our new distribution center in New Jersey, an ongoing project in Israel, Ireland and Canada. Now in conclusion, the measures we have taken are achieving the goals we have set for ourselves. We're controlling costs, we're optimizing production and reducing inventories while continuing to invest in marketing and research programs.

I believe that our financial programs are providing a solid basis for growth in both the near and long-term. Now Dan, let me turn it over to you.

Thank you, Kevin. Before we take your questions, I'd like to offer some perspective on Taro's R&D pipeline. And highlight, a few of the discussion points and questions regarding Taro currently are under consideration by the investment community. Regarding our research program, Taro had 16 final approvals and 10 filings in 2004 and an additional approval so far on the first quarter.

Among the approvals, were six goes to market generics, there are currently 27 filings in our pipeline at the FDA and these consist of 26 ANDAs and one NDA related to nosgol (ph). Fourteen of the filings are for topical products and 13 are for oral dosage and other foreign products.

The current market value of the ANDAs in the pipeline remain more than $1 billion. To address some of the frequent discussion topics on TARO, we do not know if fourth quarter revenues represent a run rate for 2005. And a related question we got, we don't know if sales to wholesalers have normalized in the fourth quarter.

Regarding promotional spending on OTC products in the fourth quarter, we noted that SG&A expense in the fourth quarter decreased sequentially from the third quarter. However, this overall reduction in SG&A expenses in the fourth quarter included an increase in promotional spending in support of OTC products in the fourth quarter compared with the third.

And to begin our question and answer session, let me remind you of three of our communications guidelines. First, in line with our long standing communications policies, we do not provide guidance, nor do we comment on analysts estimates. Second, for competitive reasons and to be fair to our customers, our policy is not to discuss individual customers nor do we provide specific information on sales and profitability of individual products.

And third, again, for competitive reasons, we do not disclose the products filed with the FDA. Thank you, and now we'd be happy to respond to your questions. Amanda we'll get started with the question and answer session.

[OPERATOR INSTRUCTIONS].

And your first question comes from Greg Gilbert of Merrill Lynch.

First, for Kevin, could you give us a little color on some of the products that added to sales from 3Q, and some that maybe were negative. And then a question for Barrie, what are your thoughts on the consolidation that's going on or starting to pick up in the generic industry, and what plans does Taro have, if any, to participate in that in some way. Thanks.

Okay, I guess I'll talk a little bit about some of the approvals we had during the fourth quarter that would have added to the sales. I mean, let's see, we had - if memory serves me correctly, Greg, we received about five approvals during the fourth quarter. A lot of those coming in December. I believe we had mometasone ointment, which we got approved in mid-December, halobetasol ointment, which we also got approved in mid-December, hydrocortisone buterate ointment I believe we also got approved in December as well. So there were a lot of products that we got improved in December. They contributed somewhat to the products, the increase in sales, but quite frankly because a lot of those approvals happened late in the quarter, we're still looking for some continued contribution from them as we go out in the full quarter of obviously Q1 and beyond.

So they were helpful, but we're looking for obviously their continued contribution as we go forward. So, Barrie, I guess you're taking the second part of that?

Yes, the consolidation question. Frankly, at the present time, we feel that we don't need help from another company with respect to the critical factors for success. We have the products, we have a strong pipeline, we have the right people, we have the plants and facilities that we need to be able to achieve our goals. So I think that we can achieve our goals better alone than we can by complicating our lives with an involvement with another company at this time.

Any thoughts on when we might get phase II data for T2000 released publicly?

As soon as the data is releasable, as soon as it's been written up properly, I assume it will be made public, but I can't give you any specifics. T2000 is a highly speculative undertaking. Even after a drug is approved, as we all know, there can be some very big bumps in the road. And I think that you've got to recognize that we're still in the very beginning of phase III and it's really very early to count any chickens with respect to T2000.

Thanks.

And your next question comes from Arnie Ursiner (ph) of CGS Securities.

Hi, good morning, follow up question for Barrie first if I could. Barrie, in the press release, you indicated you're refining the study design for the Canadian phase III trial. Can you expand a little bit on what is the issue that's causing you to refine the study design?

Well, it's not an issue - we're planning, anyhow, the phase III study in Canada, but we want that study to be acceptable to regulatory authorities in other countries besides Canada, and so we have to explore study designs that would be acceptable in other parts of the world. And we don't want to rush, and we have some preliminary work that we want to do to be sure that we get it right the first time.

Phase III studies are very expensive, and we have to be very careful with the shareholders' money.

Okay, and a question if I could for Kevin. Kevin, obviously, the 55% gross margin is lower than you've run for quite a while, and you attributed it to a number of very specific factors. While I know you can't use the word one-time, perhaps, can you give us a feel for can you return back to something more in the low 60s on margins after you get rid of a few items you did discuss.

It's always difficult to project, and as you know, Arnie, we don't give guidance. But we'd like to believe that the transfer of the production out of the Long Island facility up to Canada will help us in the long run. Obviously, consolidating facilities should reduce overall cost and then that's going to have a positive impact on our margins as we go out. And that facility is being closed in Q1.

The additional costs associated with transferring that production, you have to do certain batches up in Canada, make sure that they're within specifications, et cetera, to get the FDA to approve the transfer of the sites. So there's additional costs associated with that, and then obviously there's the overhead absorption factor of slowing down on production as we're bringing our inventory back in line with our goals.

So we'd like to think, really, that both of those items are more one time as opposed to indicative of what the cost of goods is going to be in the future. So, difficult to quantify, but definitely two of the major items that contributed to the 55% margin are more timing issues than a permanent issue around the company's performance.

I might add that Kevin doesn't have any insight into the rate of exchange going forward, but we would appreciate any insight or guidance that people could share with us.

As you know, Arnie, most of our production now with the transfer out of the U.S. into Canada is taking place kind of offshore. And I would say a more permanent impact, at least at this point in time, based on the exchange rates, is the fact that it is going to cost us a little more to produce products out of our Canadian facility. But what we are hopeful for is that the investment we've made on the capital side is going to increase our efficiency so we can offset the impact of the strengthening Canadian dollar.

If I may ask one more, I know you won't comment on the Litra (ph) spend and things like that, but on the SG&A line, obviously Q4 included some spending, as will Q1. Can you give us a feel for what savings you think you've accomplished with your headcount reduction, which would be more permanent in the SG&A structure.

Well, I think overall we cut our expenses, or at least our personnel expenses, by at least 10%. So I'd like to think that that holds true for pretty much all of the categories across the board, although not all of that reduction was just focused on SG&A. We did see a reduction in some of our R&D efforts. We saw some reduction in our manufacturing personnel.

But on the SG&A front, we also cut back on personnel there, and it was probably about 10% within that group as well.

Okay, thank you.

And your next question comes from Rich Watson with Taro.

Hi, it's Rich Watson, William Blair. If I could, just a question on your ANDA filings. A year ago, your ratio of topical to oral and other ANDA filings was about two to one and is currently about one to one. Anything to read into this regarding strategy going forward, or just a reflection of where you're getting approvals and we'll see replenishment going forward?

It's Barrie Levitt. There's still about $2.4 billion at last year's IMS market rate of topical products available as targets. And I know it sounds sort of piratical to view other people's products as targets, but in the generic industry, that's sort of the name of the game. So if there is an adequate of targets available.

The ANDA filings that we do we do after we do the bio studies, and some of the products, some of the topical products that we file require complex clinical studies. So it's not that we're working less in the area of topical products, but that the filings happen when we finish the studies.

So I don't think that one should read into it. It is true that we are working across a broad line of dosage forms, because we would like to compete across a broad range of products and not be pigeonholed into just one area. However, having said that, the topical niche is a very good niche. It's one where we have an awful lot of expertise. We have, as Kevin has just pointed out, highly efficient manufacturing, especially in Canada but even in Israel, so this is an area that we would like to stay in.

I don't think that I would read too much into the ratio at any particular point in time.

Okay, if I could, just quick follow up, any change in your position on API sales to third parties? Thanks.

Well, we're still pretty much trying to keep ourselves supplied with APIs. Some APIs are difficult to get, or expensive, so those represent opportunities for us. So the business model is still the same. We will continue to supply APIs to established customers, but the APIs per se don't represent an independent profit center. They represent part of the overall pharmaceutical profit center, principally the generic right now. Right now, principally the generic part of our business, but we're also going to be making APIs for the other part of the business, the proprietary part of the business.

So, we are so far - our model is to supply ourselves so that when we make a retail sale, we're selling not just the pharmaceutical product but the API but that we have the profit from the API as well as the profit from the finished dosage form. However, we do sell APIs to the generic industry around the world when we have an excess, or to establish partners that we've been supplying for years and we feel that we have a duty to continue to supply those customers, and so we do. I hope I've answered your question.

Yes, that's great. Thanks.

And your next question comes from Colleen Lahey of CIBC World Markets.

Hi, good morning, guys. We understand that you're still not 100% back on track with inventories, but to what extent do you see the reductions in the inventory balance impacting gross margins in '04 and how should we look at this going forward?

Just on a clarification, you're referring to our inventories, is that correct?

I know you said you were...

We went through, as Kevin pointed out - we went through a period in the third and fourth quarter of a reduction in throughput and a reduction in purchasing as we tried to bring our inventories in line with what looked like a new business model. As sales improve, we are going to have to start increasing - I would like to keep inventories pretty much where they are, but I would like to increase throughput and hope that increased throughput is going to be in response to increasing sales, so that as sales increase, the throughput will increase. And if the overhead stays the same or goes down, then we should see an improvement as a result of it. So we have to maintain a certain level of inventories to maintain continuous supply to our customers, which is paramount, because the structure of the business is very dependent upon maintaining good relations with customers, and supply is the thing that the customers are most concerned about.

Obviously, they're concerned about price, but at the end of the day, they can't operate from empty shelves. So we have to maintain a certain level of inventory to keep our customers supplied as sales increase. Plant throughput should increase and the trick would be to try to keep your inventory level while the throughput increases. Now, we're not going to be able to do that as sales increase. Beyond a certain level, we're going to have to start increasing our inventories again.

Sure.

I hope I've answered the question. It's not an easy question because we can't foretell the future.

No, I know.

And we don't want to get too deep into cost accounting details.

I know, and I understand that. Just if there's any way that you could sort of quantify it in terms of the gross margin going forward. Do you see yourself coming back up to mid 60 level, and how much do you think of the inventory balance is reflected in the third and fourth quarter gross margin?

Well, we took down the inventory levels within one quarter by about 12% or 14%, I believe. I think we took out about $12, $13 million out of inventory, I believe, just from the end of Q3 until the end of the year, and that's a pretty dramatic increase in the inventory levels, and obviously we accomplished a lot of that by reducing the throughput in the facility.

As we increase that throughput, we're going an improvement in the margins. To exactly predict, that's not what we do, but definitely as the plans kind of gear back up and we get more into a replacement mode as opposed to a reduction mode, we should see an improvement in the margins.

That helps. Thanks, Kevin.

You're welcome.

And we do have time for one more question, and it will come from Paul Elliott (ph) of Burnham Asset Management.

Hi, how's it going? Anyway, the question relates mostly to the balance sheet and the financial statements. It's obvious that the company has considerable corporate liquidity. I was just wondering whether the board has considered a buyback of shares.

Paul, it's Barrie. It's nice to hear your voice.

Likewise.

As Kevin pointed out, the company does have cash, but I believe that the best application of those financial resources are to invest in the business. I believe that we will achieve the best return to our shareholders by increasing our sales, increasing our pipeline, increasing the breadth of our product line, making our plants more efficient, acquiring new products, and as everyone has been sort of pushing us in the direction of trying to improve our margins, trying to improve our margins as opposed to simply going out and buying the shares back. So we think that the best place to invest the money is in the business.

Thank you.

Okay, operator, I think that's what we have time for today, and we want to thank you very much for participating with us on this call and look forward to our next quarterly conference call. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program. Have a wonderful day. As a reminder, this recording will be archived and can be heard at any time following this call through March 3rd. To hear the archived call, log into www.taro.com and click the link on the homepage. Or telephone, 888-286-8010 in the United States, or 617-801-6888 from overseas. When prompted, enter the passcode 77052125 to request the Taro call.

Again ladies and gentlemen, thank you for your participation. Have a wonderful day.