Taro Pharmaceutical Industries Ltd (TARO) 2005 Q1 法說會逐字稿

Good morning and welcome ladies and gentlemen to the Taro First Quarter 2005 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 May 3, 2005. To hear the archived call, log into www.taro.com and click the link on the home page or telephone 888-286-8010 or 617-801-6888 and provide the pass code 97176788 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 up to Q&A 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 are not describing historical facts and statements about events or circumstances the Company anticipates, expects, plans, intends, designs, believes, hopes, or wants to happen or exist, including statements about the Company's goals or statements about which the Company is optimistic or similar language; the Company's continuing research and clinical trials; 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; arrangements made for the marketing of proprietary OTC products; the Company's research and facilities expansion programs; Taro's filings with the FDA and the Company's overall growth and expansion.

Although Taro Pharmaceutical Industries Ltd. believes the expectations reflected in such forward-looking statements to be based on reasonable assumptions, it can give no assurances that its 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 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 marketed by Taro or through agreements with other companies; and other risks detailed from time to time in the Company's SEC reports, including its Annual Reports on Form 20-F. 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 statements, whether as a result of new information, additional or subsequent developments, or otherwise.

I will now turn the conference over to Mr. Daniel Saks of Taro. Please go ahead, sir.

Thank you Steven 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 CFO. Barrie, Kevin, and I have some brief remarks and then we're going to open the call to your questions.

And now, to get started, we'll turn the call over to Barrie.

Thank you Dan and thank you all for joining us on this conference call.

In the first quarter of 2005, the Company made continued progress in its efforts to improve its performance by controlling costs and reducing inventory. However, our gross profit margin did not change, compared with the fourth quarter of 2004, as unit costs reflected our reduced levels of production.

Compared with the fourth quarter of 2004, sales, gross profits and net income increased slightly. Operating income of $7.3 million in the first quarter of 2005 was an increase of $3.2 million, compared with the fourth quarter of 2004.

We believe that our cost control initiatives were largely responsible for the improvement in operating income. It's worth noting that the improvement in operating income occurred despite significant advertising and promotional expenses in support of Kerasal and ElixSure. These products were divested in March and these expenses will not recur.

Also, our research programs continue to provide us with a robust pipeline of filings at the U.S. FDA and at regulatory agencies in other countries. We remain steadfast in our commitment to research. Taro invested more than 12% of sales in R&D in the first quarter and has invested more than $80 million in the last two years. We believe that this investment is a key factor in putting Taro on the path to sustained and profitable growth.

In the first quarter of 2005, the Company made a strategic decision to focus on its core competencies in developing, manufacturing, and marketing prescription products. Indeed, according to industry sources, total prescriptions filled with our products continue to increase.

In the light of the decision to focus on prescription products, our proprietary OTC products were no longer part of the Company's strategic plan for maximizing returns to shareholders. Having established brand name recognition and national distribution for Kerasal and ElixSure, we monetized the Company's investment in these product lines. In March, we licensed the North American marketing rights for Kerasal and ElixSure to Alterna LLC.

Alterna is a company with an experienced management team and primary commitment to the OTC marketplace. We believe that Alterna will continue developing Kerasal and ElixSure to their full potential. Under our agreements with Alterna, Taro will receive manufacturing revenues, royalties and have a 5.0% equity position in Alterna.

Of course, as I noted before, Taro will not incur further marketing expenses for these products in North America. Taro retains its patents and other intellectual property associated with the proprietary Non-Spil Liquid Drug Delivery System for use with prescription products.

The Company is continuing to focus on the development of its novel class of non-sedating barbiturates. We're conducting small clinical trials to refine the design for our first Canadian Phase III trial of T2000 in essential tremor. Of course there can be no assurance of the eventual success of this trial or the successful commercialization of T2000 or any other new chemical entity in development at Taro.

In summary, our performance is improving, the number of prescriptions filled with our products is increasing, our pipeline remains strong and we believe that we have not yet seen the full impact of our cost reduction initiatives. All of these factors lead us to believe that Taro is on the path to profitable growth.

Thank you and now I'll turn the call over to Kevin who will provide more details about our first quarter results. Kevin?

Thanks Barrie and good morning and good afternoon, everybody. I'd like to review certain items related the Company's performance in the first quarter of '05.

Sales for the first quarter were $78.5 million, which was 7.0% below the first quarter of '04. However, Q1 '05 sales were up 1.0% from the fourth quarter of '04. In the first quarter, approximately 86% of Taro sales took place to customers in the U.S., 8.0% were in Canada, and the remaining 6.0% of sales took place in Israel and our other international markets.

Our gross profit for the quarter was $43.4 million, compared to our gross profit of $56.4 million for the year-ago quarter. The gross margin of 55% for the quarter reflected the impact of several factors that Barrie mentioned earlier. Gross margins in the first quarter were affected by higher unit costs resulting from decreased production in line with our inventory reduction programs.

In addition, gross margin was influenced by price erosion, which is inherent in the generic pharmaceutical industry. The COGS was increased by several factors, including higher unit costs, the costs of closing the Company's Long Island, New York factory and transferring its production to Taro's Canadian facility, and the decrease in the value of the U.S. dollar. Which impacts our costs because most of our production takes place outside the U.S. Therefore, as the U.S. dollar weakens, our cost of production increases.

In the first quarter, SG&A expenses continued to decline to the lowest level in the last five quarters. SG&A expenses were $26.4 million in the first quarter of 2005 compared with $34.1 million in the year-ago quarter and $29 million in the fourth quarter of 2004. We achieved this reduction in the first quarter of '05 despite incurring advertising expenses to support Kerasal and ElixSure during January and February prior to the divestiture of those products.

Our commitment to R&D continues with $9.8 million or 12% of sales invested in R&D during the first quarter of this year, compared with $11.7 million, approximately 14% of sales a year ago. Approximately 80% of this amount was invested in our generic pipeline and the remaining 20% was invested in our proprietary pipeline.

We are developing branded prescription products to add to our portfolio and we are continuing to work on our new non-sedating barbiturate compounds. We currently have 26 filings at the U.S. FDA and numerous filings with regulatory agencies in other countries.

Our operating income was $7.3 million in the first quarter '05, compared with operating income of $10.5 million in the same quarter a year ago. The decrease reflects the decline in revenues and the increase in unit costs, which were not entirely offset by our cost reduction efforts.

Our operating income did show sequential improvement, increasing $3.2 million from the fourth quarter of 2004, as our cost reduction initiatives continue to show positive results. Our net income for the quarter was $5.0 million or $0.17 per share, compared with $0.16 in the previous quarter and $0.38 in the year-ago quarter.

Now let me also review some items from the quarter-end balance sheet.

Cash, restricted deposits, and long-term investments stood at $106.1 million as of the end of the quarter. This represents a decrease of $19.1 million, from the end of '04. Now, of this amount, $11.1 million was used to record borrowings. In addition, cash was used to temporarily fund certain capital projects. For example, the purchase of our New York office and laboratory building was completed with our own funds.

Trade accounts receivable totaled $129.9 million compared with $124.7 million at the end of last year and DSOs remain at the higher end of their historic range.

The Company's cost control measures initiated at the end of the second quarter included reductions in purchasing and production. As a result, inventories at the end of the quarter totaled $80.6 million, compared with $101.7 million at the end of the second quarter of '04 and $86.6 million at year-end '04. We believe that the current inventory levels will permit the Company to maintain high levels of customer service without interruptions in supply.

A total of $20.9 million was invested in property, plants, and equipment in the first quarter of 2005. Capital projects in the quarter included the purchase of our New York laboratory and office building for approximately $12 million and that allows us to consolidate some of our U.S. operations. And we also undertook an additional expansion of our production facilities in Israel, which will help us achieve greater efficiencies in the future.

In conclusion, we believe that our ongoing R&D initiatives, our S&M focus, and our cost reduction measures are achieving the goals we have set for ourselves.

Now let me turn it over to Dan and then we'll take some questions.

Thank you, Kevin and before we take questions, I'd like to offer some perspective on Taro's R&D pipeline and highlight some of the discussion points and questions regarding Taro that currently are under some consideration by the investment community.

Regarding our research pipeline there are currently 26 filings in our pipeline with the FDA. These consist of 25 ANDAs and 1 NDA related to Non-Spil; 12 of the filings are for topical products and 14 are for oral dosage and other products. The current market value of the ANDAs in the pipeline remains more than $1.0 billion.

For the YTD, we have received 3 approvals from the FDA. These were for generic version of terconazole 0.4%, miconazole nitrate 4%, and ciclopirox olamine cream 0.77%.

Let me address some of the frequent discussion topics regarding Taro. First, regarding our recent transaction with Alterna, in which we divested the Kerasal and ElixSure marketing rights in North America, the details of the financial terms of this arrangement have not been disclosed.

To touch on some additional questions we received, we will not provide guidance as to whether the first quarter revenues represent the run rate for 2005 or whether sales to individual classes of trade have normalized in the first quarter.

And now, to begin our Q&A, I'd like to remind you of three of our communications guidelines. First, in line with long-standing communications policies, we do not provide financial 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 specific 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'll be happy to respond to your questions and Steven, we'll start the Q&A.

[Operator Instructions] Our first question comes from Greg Gilbert of Merrill Lynch.

Thanks. I have a couple. First, Kevin, can you give us some flavor on the affect of new product launches in the quarter as well as the consumer products, product sales in the quarter? Secondly, can you give us some flavor of the gross margin sensitivity to production levels?

Absolutely, Greg, good morning to you, by the way. Yes, we had some new product launches during the quarter. So sales of product approved in December and January, such as mometasone cream and terconazole 0.4% did contribute to our sales growth overall. However, you're correct in pointing out that we did divest both the Kerasal and ElixSure product lines in early March.

As you know, a lot of our product sales usually take place in the last month of the quarter, so we suffered a little bit from divesting those products just before we usually have our peak sales month within the quarter. So, quite frankly, the contribution from the new products did offset slightly what we lost by divesting Kerasal and ElixSure.

And as to the sensitivity on the margins, we definitely are affected by the reduction in our overall production. Obviously we are selling out much more than we're producing and thus the reduction in the overall inventory levels. So the biggest contributor in the reduced margins, compared to where we were a year ago, is definitely the fact that we've scaled back on production.

At some point in time, we're obviously going to get to an equilibrium where we're going to be producing what we're selling and when that happens, the overhead absorption should allow us to enjoy an improvement in our overall margins.

Is it safe to assume, Kevin, that it may take a couple quarters to get to the point where you're selling what you're producing?

I think we're not done yet with our overall inventory reduction program. But I think we're going to see some continued improvement in our inventory levels for the next quarter or two. But towards the end of the year I would think that, based on what we're seeing, that we should be pretty much, as I said, back to that equilibrium stage.

And last question on the brand side. Based on what you're currently selling, do you expect to spend more, later in the year, or expand the sales force? Or are you pretty much status quo there, from an SG&A standpoint on brands?

No, I think we're very satisfied with the level of investment we've made into our branded division. We have over 60 reps right now out in the field. They're being very successful, in our estimation, and they definitely have some room to contribute to increasing our sales, so I don't think, at this point in time, we need to add any more to our overall total reps that are out there. And I don't think we're going to increase our spending material for advertising or promotion around those products.

There'll be some spikes here and there. I mean, obviously there's different timing of promotional activities, but overall I think we're pretty satisfied with the level of investment that we're making in our branded divisions.

Thank you.

Rich Watson of William Blair & Co.

Hi, thanks for taking the call - just a couple of questions. First, in terms of your overall business, can you give us a little bit of color as to sort of the breakout between the U.S. operations versus sort of all other, and going forward, how you expect that to sort of track a little bit? I know you can only give us so much, but just trying to get a flavor for how the international business is growing relative to the U.S. and what are sort of reasonable expectations around that are.

And then the other question I wanted to ask is about talking about wholesaler inventories and specifically, in the U.S., what portion of sort of working-down inventories is associated with levels being above normal in 2004, versus wholesalers actually working down inventories below levels that were once maintained. If you could give a little color around that, that would be helpful. Thanks.

[Inaudible - microphone inaccessible] try. With respect to the U.S. versus all other, I don't think I'm telling tales out of school to say that [inaudible] Canadian business isn't very robust, if that's an appropriate adjective. We don't have de-stocking issues in either of those two markets and there's been growth in sales in both markets.

With respect to the U.S., its very hard to predict what the financial condition of the wholesalers is going to be - or wholesalers in any other class of trade, for that matter is going to be - in the future, what's going to happen to interest and what decisions will be made about what levels of inventory are appropriate in the future.

Our hope is that as we introduce new products for which there are no inventories in the trade, that we will see some improvement in sales. However, to the extent that there are other forces at play, de-stocking and price erosion, you end up with a result of these complex forces and it's difficult to predict. And I think it would wrong for us to try to predict.

And of course the critical question about, well, when are you going to get some important new approvals, of course that's dependent on the regulatory authorities, not upon us. So we're doing our level best to do the best we can in doing our research efficiently, completing our clinical trials on time, filing in the best way that we can, and we hope that we will continue to have success with the regulatory authorities.

So there are some imponderables. I'd like to give you more flavor and more color, but unfortunately the architect of the color palette is not in our Company. It's in the regulatory authorities and obviously we also don't control interest rates and we don't control the management decisions that are made by our principle customers in various classes of trade.

Okay. Thanks.

Elliot Wilbur of CIBC World Markets.

Hi, good morning. I wanted to ask a question with respect to the SG&A line. Obviously the step down in the quarter, I think, was a little bit more than anyone was expecting. I know you guys don't like to talk in terms of absolute numbers, but I guess it would be fair to assume that that probably will decrease in the second quarter as well?

And then, going forward in the second of the year, do you think it's reasonable to assume that you could see some additional SG&A leaving? Or do you think second quarter most likely will represent the low point, then perhaps track in line with sales growth in the balance of the year? And then I want to ask a follow-up question on the top line as well.

Elliot, you're right that we're looking to see some continued improvement in the SG&A line into Q2. I think Barrie mentioned that some of the promotional activities around ElixSure and Kerasal that we incurred in January/February will not recur, going out into Q2. So we're looking for some improvement there on the SG&A line.

And I don't think you're -- I mean, our focus here is to control costs. So we're doing everything we can to make sure that the levels of expenditures are in line with the revenues and gross profits that we're enjoying. So, I think that overall, as a Company, we are focused and we're making progress in controlling our costs.

So we are not going to stop reviewing the expense levels and doing everything we can to drive those down. Just because we've enjoyed some success is no reason for us to stop, so we're going to continue on the path.

Okay and then a question on the mometasone cream agreement you have with Clay Park. Would the full benefit of that agreement have been recognized in the quarter or is there some sort of lag? I'm not sure exactly how the economics work, but do you benefit in the quarter once you actually ship product to Clay Park or is there a bit of a lag in the revenue recognition?

We've been asked not to disclose the terms of the deal, so I'll have to keep you a little bit more in the dark as to whether there's a lag or not a lag. But I can tell you that the progress in the market share that's been achieved with mometasone product is very encouraging. I think that based on the information that we've seen from you, actually, I'm seeing scripts or market share of over 70% for the Clay Park-Agis product that we are supplying to them.

Yes and next I kind of want to lead into my next question here. It's actually been pretty impressive, the uptake, and I think one of the questions that we have in dialoging with people this morning, one pocket of uncertainty seems to be on the kind of lack of sequential progression in the top line. I mean, I think you've had like 8 approvals now, since over the last two quarters and really didn't seem to get much of a tailwind in the quarter. I'm trying to figure out if there are perhaps some pockets of weakness in the base business that maybe just aren't evident in script trends or maybe the Elocon agreement has a lag to or something. Just wondering, perhaps to the extent you can, Kevin, just elaborate on that a little bit?

I think there is some difficulty within the quarter in trying to get a clear picture as to the performance of the new approvals, because of the divestiture of Kerasal and ElixSure, so that does, quite frankly, muddy the waters a little bit.

Unfortunately, our policy is not to break out individual product sales. So we can't give you much more clarity into that, other than to tell you that we are satisfied with the R&D and with the approvals and the production we're getting out of these new products as they're launched.

So, overall, I think that the R&D investment is really turning out to be the best way to grow the business, at the end of the day and we're going to continue on that path. I mean, we've talked before our commitment to R&D and that 12% is paying off for us.

So, I apologize for having a little bit of not being able to give you some clarity as to exactly how much each of those individual products are contributing. But that's just part of our policy in regards to, I guess it's [inaudible - microphone inaccessible] or getting into giving you a little bit more visibility into each individual product line.

We don't do that and that's just part of our overall guidance and policies. So that's the best I can do for you, at this point in time, sorry about that.

All right. Thanks for taking the question.

Arnold Ursinger of CJS Securities.

Hi, good morning, a very simple one first on Kerasal and ElixSure. Do you have any financial exposure to returns on that product?

Nothing material.

Okay. Can you comment, second, on your capital spending for the balance of the year? Obviously you have some of what I would call nonrecurring expenditures in the quarter, like buying a building. Can you comment on your overall capital spending plans for the year?

Yes, we can help you out a little bit with that. I mean, the building, you're correct, we spent a total, Arnie, of about $20 million in capital investments during the quarter and about a little over $12 million of that was for the building. So, I think, if you back that out you get a better picture of what our normal or maintenance CapEx will be for the rest of the year.

Okay and a question for Barrie, if I could. You obviously pick your wording extremely carefully related to T2000 and there's a little bit of a change that you're now actually conducting preliminary clinical studies to refine the study design for your Phase III trial. Can you be a little clearer about the types of trials you're running, how long they may last and any additional information you can give us about these preliminary clinical studies?

You obviously were very clear and precise in repeating what I said. We are with essential tremor a little bit in uncharted waters. No one has really done definitive studies adequate for regulatory submission for essential tremor ever. So there's no clear path and we have to sort of cut our way through the jungle to try to define the path. And there are lots of questions that have to be answered before we launch a major trial that will acceptable to regulatory authorities in other parts of the world besides Canada.

And those are questions such as, "What is the scale that you're going to use for improvement? What are the endpoints going to be? What are patient characteristics going to be?" and a myriad of other clinical questions. And we are trying, in a series of small studies, to try to get some answers. So that when we start the major study, that we will be able to get a definitive answer.

We want to have an efficient design for our studies in order to be cost-effective. We don't want to end up spending millions and millions of dollars unnecessarily. So, in order to get the Phase III trial right, we want to be sure that it's an efficient trial, that it will meet regulatory requirements, that it will represent and increase to the body of knowledge about essential tremor.

Frequently, at least in my experience when I used to work for the regulatory authorities, which I did for over 20 years, you find that you learn an awful lot about a disease when you start doing the clinical trials that define the controlled clinical trials. You learn more about the disease than you do about the drug to start with, and I think that that's going to be the case here.

So, I think that it's a tremendous opportunity, if the drug is successful. We want to be careful to try to do it right the first time and there's no doubt that we're going to try to control our costs and to try to get it right. There are expenses associated with doing these smaller trials but I think, in the end, it's going to be cost-effective. So you'll just have to bear with us, as we proceed.

Nobody is more anxious than we are to get this done, to get this underway. But I have to say again what I said in my talk, namely that there's no guarantee that we're going to be successful. Even drugs that are approved can run into trouble years after they're approved and heaven knows that can happen before they're approved.

And the regulatory climate is such - and I think it's appropriate - that the barrier is increased, especially with drugs for chronic use where you're going to take something for a lifetime. Whether it's an antiinflammatory drug for arthritis or antineoplastic drug or a drug for high blood pressure or a drug for essential tremor.

The government - all governments - are going to be a lot more careful about the safety issues. They're going to want to see a lot more patient exposures. They want to be sure that they've got -- that the drugs really are effective. And since all drugs are poisons, you always expect side effects. We've been lucky so far, but I think that one needs to take all of this into account.

So, even if we're successful in getting regulatory approval, it doesn't mean that we would be successful commercially or that this represents a home run. We just don't know. So I think you need to take this all with a grain of salt and be very careful about drawing any conclusions from what I've said.

Okay. A final question, if I could, for Kevin? Kevin, your inventories have been worked down a fair amount. Can you give us -- I know you won't comment by channel, but could you comment, perhaps, on desired overall inventory levels and how much further you think you can go?

I think the best thing to look at is the target in regards to inventory turns and I think, right now, we're turning our inventory about 1.76 times a year. I think we should be looking for at least turning our inventory twice a year. So, based on where our sales levels come out, that'll help determine what the level of inventories needs to be. But I think our target - and we've stated this before - is to probably turn our inventories about twice a year, so you can figure out what our goal is, in regards to inventory levels, based on that.

Okay. Kevin, did you give or have you given a more specific cost of closing the Long Island facility, because clearly that's a onetime item in the SG&A and will not continue? And we're all trying to kind of get a better handle on where SG&A levels should be inching up.

That wasn't an SG&A level. The closing --

Yes, that was more the closing of Long Island, of the old [Temps] facility is more in the line of COG. So, no, we have not broken that out specifically. A lot of the work that's done has been the transfer of the production of the goods from Long Island up to Canada and there's a bunch of differently regulatory requirements that are involved in doing that and that obviously cost some money.

But the good news is that facility is not closed and we have consolidated most of our cream and ointment production now into Canada. A little bit more goes on in Israel, but most of our cream and ointment production is now coming out of Canada. So we've consolidated those two facilities into one.

Okay. Thank you.

Mark Taylor at Roth Capital Partners.

Hi, good morning. Thanks for taking my question. I have two. I'm just curious, a little bit, to the extent you can discuss this, on your strategy with Taro Pharma. You were calling on Peds and Derms with the 60 reps. I know Ovide is - or I think it is - a bit of a seasonal product.

So, with the divestiture of Kerasal, which I think you were doing some detailing work in the ethical channel, does that leave you with a void with the deployment of that force in Peds and do you look to fill that void with acquisitions or perhaps co-marketing? Or would you concentrate more efforts in dermatology? That would be the first question.

And again, not to ask too much about competitive aspects here, but I noticed that Warrick came in the lotrisone lotion market recently. And I was just wondering if we could expect the same kind of penetration that we saw, with the lotrisone cream, when it looks like Warrick entered back in September of 04. Any color there would be helpful. Thanks.

Well, I'll take the first part. The second part I don't know how to predict. With respect to pediatrics, we are really interested in pediatrics. Incidentally, pediatric dermatology is an important area. I mean, children get skin rashes also and so pediatrics continues to be an important focus for us and we do have an active drug development program in pediatrics.

So we're not abandoning pediatrics at all and we're obviously committed to dermatology. So that dual focus of pediatrics and dermatology is going to continue. I think that that's pretty clear, in terms of the way we're looking at the future not just in terms of our marketing, but also our development programs.

With respect to lotrisone penetration by Warrick, I guess you might have more information than I do. I have no way of predicting how successful they're going to be.

Fair enough. Thank you.

Ladies and gentlemen, this recording will be archived and can be heard at any time following this call through May 3rd. To hear the archived call, please log in to www.taro.com and click the link on the home page or telephone or telephone 888-286-8010 in the United States or 617-801-6888 from overseas. When prompted, enter pass code 97176788 to request the Taro call.

We thank you for your participation toady. This does conclude the presentation. You may now disconnect. Have a good day.