Taro Pharmaceutical Industries Ltd (TARO) 2005 Q2 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Taro second quarter 2005 conference call. (OPERATOR INSTRUCTIONS). This recording will be archived and can be heard at any time following this call through August 4, 2005. To hear the archived call, log into www.taro.com and click on the link on the home page, or telephone 888-286-8010 for domestic U.S., or plus 617-801-6888 international, and provide the pass code 82524360 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 from participants on the call.

At this time, let me review the following Safe Harbor statements. 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, including statements about the Company's goals or statements about which the Company has confidence, or is optimistic, or similar language, the Company's continuing research and clinical trials, the robustness of the Company's pipeline, the growth of prescriptions filled with the Company's pharmaceutical products, cost reductions, cash conservation and inventory control 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 divestiture or marketing of proprietary over-the-counter products, the launch of the Company's Lustra Ultra products, and marketing of the Company's Lustra products, the Company's capacity needed for growth, efficiencies required to remain competitive, the Company's research and facilities expansion program, Taro's current and future 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 obtained. 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 demands 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 report on Form 20-F.

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 developments or re otherwise.

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

Good day to listeners on the Taro conference call. On the call today are Dr. Barrie Levitt, Chairman of Taro Pharmaceutical Industries, and Kevin Connelly, our Chief Financial Officer. After some brief remarks, Barrie, Kevin and I would open the call to a question and answer session. And to begin with, we will turn the call over to Dr. Levitt.

Good morning. Thank all of you for joining us on this conference call. I am pleased that Taro reported record sales for the second quarter and first half of '05. The second quarter sales did not include certain revenues from the divested Kerasal and ElixSure products, which were included in the sales of prior periods. The Company's overall performance improved for the second quarter on both a sequential and year-over-year basis, despite intensifying competition in the U.S. market for generic pharmaceuticals.

For the last four quarters Taro has reported sequential improvement in operating income and net income. In the second quarter net income increased 29% compared with the first quarter of '05, even after an investment in research of $2.1 million. That is an increase in the investment in research of $2.1 million. We continue to be vigilant in our expense control and cash management program. Inventories decreased, and selling, general and administrative expenses were lower on both an absolute basis and as a percentage of sales.

Taro's performance in the first half of 2005 gives us confidence that we have taken the right steps to return the Company to sustained profitable growth. Key measures indicate that we are strengthening the fundamentals of our business. Our market initiatives are continuing to increase the number of prescriptions filled with Taro's generic and proprietary products. The company has reduced expenses, and is maintaining the investments that we believe are necessary for a healthy future.

Taro continues to invest in three areas that we believe are essential to future profitable growth, manufacturing quality, research and development, and proprietary product initiatives. As a result of capital investments of over $250 million during the past four years, Taro products are manufactured in state-of-the-art facilities in Israel and Canada. These investments provide the Company with the capacity needed for growth and the efficiencies required to remain competitive in the global pharmaceutical environment.

These investments have helped us to maintain our record of compliance with current good manufacturing practices required by regulatory authorities in Israel, the United States, Canada, Europe and other jurisdictions. Our research programs have provided us with a robust pipeline of filings at the U.S. Food and Drug Administration and at regulatory agencies in other countries. In the second quarter we invested 15.1% of sales in research. Our research investment during the past 2.5 years has exceeded $100 million. Today we have 28 filings pending at the U.S. FDA.

While most of our research investment has been directed toward generic drug research, a growing amount is focused on the development of proprietary products, including T-2000, the first of Taro's novel class of non-sedating barbiturates. We're currently conducting small clinical trials to refine the design of our Phase III studies of T-2000 in Canada. The Phase III studies in Canada will be directed toward the treatment of essential tremor. The Company is also conducting research on related proprietary compounds. These compounds may also be effective in a variety of neurological disorders.

Of course, there can be no assurance of the successful completion of Phase III testing, or of the approval by any regulatory authority of any of Taro's proprietary drugs for any indication, or of the commercial success of these drugs, if and when approved.

In addition to research on proprietary products, we've increased our portfolio of branded prescription products through our business development initiatives. In 2004 we acquired Lustra and Lustra-AF, two treatments for skin discoloration. We are about to launch Lustra Ultra, a new addition to the Lustra line. We believe that Lustra-Ultra is a unique product for the treatment of dyschromia. Lustra products were promoted to physicians by our Taro pharma professional medical representatives.

To put all of our initiatives into context, it is important to understand the environment in which we are operating. The United States is our largest market. For a variety of reasons we believe that the U.S. pharmaceutical market is undergoing change. First, government and the insurance industries are increasingly involved in every component of health care costs, including the price of drugs. Second, low-cost pharmaceutical manufacturers in India, China and Eastern Europe are making their presence felt both directly and indirectly in the United States.

Third, branded pharmaceutical companies are utilizing authorized generics to maintain market share after generic competition is introduced. And finally, the FDA's Office of Generics Drugs is experiencing an increase in the number of ANDA filings. All of these factors contribute to the new reality in which we operate.

On the other hand, we believe that the Medicare Modernization Act should increase the utilization of generic drugs, as coverage will expand to an increased segment of the U.S. population. In addition, industry sources estimate that during the next five years more than $100 billion of branded prescription drugs will lose patent protection. Our ability to compete effectively in this environment will be to a significant extent a function of our capacity to develop and produce high-quality products in an efficient and cost-effective manner. We have built state of the art chemical and pharmaceutical manufacturing facilities, which emphasize efficient production, minimizing the direct labor cost component. We have well-trained, experienced personnel, including the talented international team of research scientists.

In addition to the products filed with regulatory agencies, we have a robust pipeline of future filings. During the first half of this year we invested more than $21.5 million in research. We achieved our operating results in the first half of this year with only a few FDA approvals. We're confident in the quality of our submissions to the FDA, and we believe that our pipeline at the FDA will have a significant impact on the Company when the filed products are approved. We believe that we have the pipeline, the products, the plants, and most importantly, the people, to permit us to move confidently into the future.

Thank you. And now I would like to turn the call over to Kevin, who will provides more details about the second quarter results.

Good morning everyone. I would review certain items related to the Company's performance in the second quarter of 2005. Sales for the second quarter were $78.6 million compared with $49.1 million in the second quarter of 2004. In the second quarter approximately 86% of Taro sales were to customers in the U.S., 9% were in Canada, and the remaining 5% in Israel and international markets.

Our gross profit for the second quarter of '05 was 43.5 million compared to a gross profit of 23.5 million for the year ago quarter. Our gross profit continued to be influenced by several factors, including erosion in some drug prices, the mix of products sold, and the divestiture of higher margin branded OTC products.

As part of our cash conservation and inventory control programs, we reduced both purchasing and production throughput. Since overhead remained relatively constant, the overhead component of each unit manufactured increased. Our inventory control program resulted in a reduction of inventories of nearly $23 million, or more than 20%, from June of '04 to June of '05.

SG&A expenses were 23.3 million in the second quarter of '05 compared with 30.6 million in the year ago quarter, and 26.4 million in the first quarter of this year. SG&A expenses have been declining steadily from 41% of sales in the first quarter of '04 to 30% of sales in the quarter just ended. Overall, Taro spent 15 million less on SG&A in the first half of '05 than in the first half of '04. Now this improvement was achieved through the cost reduction initiatives undertaken in the second half of '04, and the divestiture of Kerasal and ElixSure brands to Alterna, which took place in March of this year. We no longer incur marketing expenses for these products.

We increased our investment in research and development to 11.8 million during the second quarter of this year compared with 10.5 million a year ago. Approximately 80% of this amount was invested in our generic pipeline, and the remainder was invested in our proprietary initiatives. In addition to a substantial generic drug program, we are developing branded prescription products to add to our portfolio, while continuing to work on our new non-sedating barbiturate compounds.

Our operating income was 8.3 million in the second quarter of '05 compared with an operating loss in the same quarter a year ago, and an operating income of 7.3 million in the first quarter of '05. Our net income for the quarter was 6.5 million, or $0.22 per diluted share, compared with a loss in the year ago quarter, and net income of 5 million, or $0.17 per diluted share, in the first quarter of '05.

Now also I will review some items from the quarter end balance sheet. Cash, restricted deposits and long-term investments stood at 85.4 million in the second quarter. This represents a decrease of 19.8 million from December 31 of '04, but essentially no change from where we were at the end of the first quarter.

Trade Accounts Receivable totaled 139 million compared with 125 million at the end of last year, and 130 million at the end of the first quarter of '05. This increase resulted from some extended terms around the Alterna deal and the payment patterns of some of our large wholesale customers. We are addressing our level of Accounts Receivable by continuously monitoring our customer balances and engaging in active and intensive collection efforts. We're confident in the credit worthiness of our customers.

Regarding CapEx, approximately 9.5 million was invested in property, plant and equipment in the second quarter of '05. We believe that we now have sufficient manufacturing capacity to meet our anticipated needs.

In conclusion, our operating results continued to improve. We believe that the strength of our pipeline bodes well for the future. And our cost reduction measures are achieving the goals we have set for ourselves. Now, Dan, let me turn it over to you. And then I think we open it up for some questions.

I would like to offer some additional background on Taro's research pipeline, and then review a few of our communications guidelines before taking your questions. There are currently 28 filings in Taro's pipeline at the FDA. As mentioned previously, these consist of 27 ANDAs and 1 NDA related to our novel spill resistant delivery system. Eleven of the filings are for topical products and 17 are for products utilizing oral and other dosage forms. According to industry sources the current market value of the ANDAs in the pipeline remains more than $1 billion.

For the year to date we have received four approvals from the FDA. These were for Terconazole Cream 0.4%, Miconazole Nitrate Cream 4%, Ciclopirox Olamine Cream 0.77%, and Fluticasone Propionate Ointment 0.005%.

Now I will review three of our communications guidelines before opening the call to your questions. First our policy is not to provide information on the sales environment, such as revenue and profitability of individual products, nor do we talk about individual customers. This policy maintains fairness for our customers and preserves the confidentiality of competitive information.

Second, again for competitive reasons, we do not disclose the products filed with the FDA. And third, Taro's policy throughout the years has been to avoid providing financial guidance or comment on analyst estimates. There are several reasons for this policy. Taro's growth is to a large extent dependent on product approvals received from the FDA and other regulatory agencies. We do not know when these approvals will be received. In addition, we do not know when competing companies will receive regulatory approvals. Therefore we cannot predict the competitive environment and pricing levels for current and future products. We can't predict the impact of consolidation among our competitors or customers. And we can't predict the purchasing patterns and future inventory planning of our major customers. Lastly, we can't predict the impact of the change in regulatory environment.

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

(OPERATOR INSTRUCTIONS). Gregg Gilbert with Merrill Lynch.

What kind of background work are you doing on T-2000 before Phase III begins? Are you trying to validate a scale, or can you give us more color as to what you're doing and when you might start Phase III?

I think that the whole area of essential tremor has not been one that has been well worked out. There aren't many drugs that are effective in essential tremor. I think there is only one that is approved. So it is terribly important for us to be sure that we've got the scale right, that we have the patients properly defined, that we understand the parameters that need to be studied. And we want to be sure that our study design for Phase III is efficient. So in order to do this we are performing a number of small pilot studies before we begin the larger scale studies.

Any other indications are looking at, perhaps in Phase II?

There are potential other indications, but the Phase II studies have been focused primarily -- were focused primarily on essential tremor. That is not to say that in the future we may not explore other indications. We certainly are exploring other indications in animal studies.

And then another question on the generic side, do any -- are any of the non-topical products in your ANDA pipeline from the Irish facility yet?

There are a few, yes.

Thanks.

I think I should -- operator, may I continue my response to that question?

Certainly, sir.

I just think it is important to point out that the Irish facility has been reviewed and approved by the Irish Medicines Board for the European Community, but that we have not yet had an FDA inspection. But while we can feel better about products that are pending in Ireland and England and elsewhere in Europe, it would be premature to suggest that any of our ANDAs are ripe for approval until after the plant has been inspected.

Elliot Wilbur with CIBC World Markets.

I have two questions. First, one for Dr. Levitt, and then a quick financial question for Kevin. Barrie, you mentioned the significant cumulative investment in R&D over the past couple of years. And I guess if you look at the run rate in R&D spend this quarter, I think it is at a record level. But given everything that has gone in the generic industry recently, and couple that with maybe somewhat slower than expected pace of approval for you guys in the past 12 or 18 months or so, are you guys still confident? And I guess how can shareholders still be confident that you're going to be able to hit your required hurdle rates with respect to the acceleration in R&D spend?

And then you mentioned something in your commons that I wanted to ask about. You see a lot of commentary now in the generic industry about companies outsourcing R&D to lower cost areas. And I understand a lot of your R&D is done in Israel where you have a relatively lower cost base. But as a Company, have you thought about turning to some of the emerging markets, perhaps sourcing some more of your pipeline products?

First of all, with respect to the investment in R&D. Our investment in generic R&D is divided into two parts, pharmaceuticals and chemical. It is not a secret that there is a lot more competition now than there was ten years ago. So there is an intensification of competition. But one of our competitive advantages in this competitive environment is the vertical integration, the ability to produce both the active ingredient and the finished pharmaceutical dosage form.

So when you look at our chemistry -- our research in chemistry -- that does involve a fair amount of research spending. And a lot of the work we do in chemistry, which involves finding newer, less expensive ways of making chemicals which results -- which we try to protect with patents -- takes a little bit longer than just the dosage form.

So that there are two things going on. There is research in chemistry as well as research in pharmaceuticals. Will we be able to accommodate the hurdle rate? I can't predict the future. I have great confidence in our chemical scientists. I have great confidence in our pharmaceutical researchers. And I think that we -- at least I hope -- they will give a good account of themselves going forward.

As a shareholder, and I am a very significant shareholder, I can only tell you that I feel comfortable that we're not playing with our chemistry sets, but we're actually doing constructive work that is going to lead to meaningful commercialization of products. And we believe that we are going to be able to get our fair share of the markets, in spite of what is going on in the world around us.

I think our gross profit, even though it is not as high as it once was, is certainly fairly high for the industry. And I have every confidence that if we do the right things that we will -- and if we do get approvals, or if and when we did get approvals -- that we may even see a more normalized P&L for Taro.

With respect to the outsourcing. Yes, it is true that, as I said in my opening remarks, that there are increasing competitors in various parts of the world where costs are less, especially human costs. We are participating, and we have participated, with companies in India and China and other parts of the world in developing products. So we're not doing everything ourselves. We obviously don't believe we have all the knowledge in the world, all the expertise in the world, and so we are utilizing all that is available to us as we pursue our research. And we will probably be doing more of that in the future. I know that is a forward-looking statement, but it is reasonable for us to try to optimize the research dollars that we spend. And if we can spend those dollars more effectively in other countries -- in countries other than the ones in which we currently operate, we will.

I hope I have answered your question both about the nature of the investment, the question about dealing with the hurdle rate in front of us, and the question of outsourcing with respect to India, China and other countries.

Yes, I appreciate your response. I wanted to ask a quick follow-up question of Kevin on the gross margin line as well. Trends have been I guess roughly flattish now over the last three quarters. And I know you had talked last period about maybe sort of once the inventory work down program was completed, and we kind of saw the base business come back to more normalized levels that we might see some sequential progression in margin trends, just based on the current portfolio of products.

I guess I'm wondering at this point do you think this is kind of a new sort base margin level than going forward that any incremental gain is going to be essentially all top line driven from new product approvals?

I do believe that the biggest contributor to our future growth is going to be the R&D pipeline and new product approvals. But even in line, I think that there are certain things we can do to improve that margin. Even this quarter I think that we did lose some sales from our higher margin OTC products. Now we offset that a little bit with some growth on our Taro pharma products, and some efficiencies coming out of our investment in facilities over the past several years.

So we did see -- if you wanted to kind of normalized it, we saw a loss in the margin with the divestiture of the Kerasal ElixSure products, but we were able to offset that with some growth in our branded division, and some efficiencies coming out of the new factories. So I think what we would like to see is the efficiency side of that keep growing and contributing to an improvement in margins, but as we get new products, and we've talked a lot over the years about leverage in the business, that will really be the one that is the biggest contributor to an improvement in margins as we continue on.

Rich Watson with William Blair.

Just a couple of questions. First, Dr. Levitt, you mentioned some of the competitive dynamics that may be affecting the generic space currently. I was wondering if you would be willing to comment a little bit regarding whether you think some of those dynamics may be affecting how some of your sort of usual competitors in the topical space are acting on price and trying to get market share and protect their turf, so to speak?

We have seen some of your most recent products that were approved, it seemed like maybe the market share was a little lower for some of them than we might have expected traditionally. So I wondered if you could comment on your specific topical market, how some of your usual suspect competitors are behaving there?

And then I just was hoping you could maybe -- Kevin could give us a little more color on the DSOs? And specifically give us some comfort as to why we shouldn't be concerned about potential write-downs there?

First of all, I have great respect for our topical competitors. There aren't that many of them, and I think they're all good companies. As we get approvals for products where others are already in the market, we are generally careful, cautious and deliberate in the way in which we pursue market share. Obviously, keeping a focus on profitability, which means preserving our own profitability, and it obviously means preserving the profitability of our competitors, we try to move slowly. As I think I have said before many times, we don't confuse market share with profitability. And we're not interested in how we look, we are interested in what our bottom line is going to look like next quarter and the quarter after, and the quarter after that.

If you look at our products historically, I think you will see that even when they come in fourth or fifth, and you follow us out for a few years, you find that our market share increases progressively. And I have great confidence in our salesforce, and I have confidence in their judgment. So I think that they will give a good account of themselves, and I'm not terribly concerned if in the first few months after an approval when others are already entrenched that our growth is relatively modest.

I think that the growth is according to plan. We are pleased with the way in which our salesforce is handling new products. So I hope I have answered your question. And I let Kevin go on to the other one.

Rich, on the DSOs side, it is really just a matter of the fact that the customers we sell to are much bigger than we are. They still have a quarterly buying pattern. And to some extent when they pay us, if they decide to pay us a little bit late, it obviously impacts our DSOs. The comfort you should take is the fact that these customers are bigger than we are. And they are all in relatively very good financial straits. So not that I want to predict how well they're going to do, but from a credit and collection worthiness standpoint, we're very comfortable that the three main wholesalers that we're selling to, the Wal-Marts of the world, the major chains that we're selling to little pay us, and that their credit worthiness is pretty good.

Arnold Ursaner with to CJS Securities.

I have two strategic questions for Dr. Levitt, if I can. Number one is, you obviously grappled with the consumer business over the last few years. It was a pretty good management distraction. Perhaps you could expand on now that that is behind you, how it is changing the way you're thinking strategically about your business?

And also, if I could, there's a pretty big change on the way in the entire generic business with authorized generics. In addition to impacting the value of your pipeline, are you -- and you obviously have to invest years ahead of commercial reality. How are you addressing the issue of authorized generics, and are you considering, or are you moving into that space as an opportunity?

First I want to try to -- I hope I understood the first part of your question about strategic direction. The shift in strategic direction away from consumer products, or at least away from proprietary consumer products, is that the question?

And the distraction it has had on management team, and the volatility to earnings (multiple speakers).

I can't deny that we -- first of all, I think we were quite successful with the Kerasal. And I believe that Kerasal still enjoys a very successful place in the market. It's got considerable momentum. I notice that Alterna is still using Taro's advertising when I watch television at night myself. I think that we -- it is not that we didn't do a good job, but I think you're right. The over-the-counter business -- the over-the-counter consumer business did consume resources, both financial resources and management resources. And we made a strategic decision earlier -- very late last year and the beginning of this year that we would get better shareholder value by applying our research and applying our marketing dollars to prescription drugs, be they generic prescription drugs or proprietary prescription drugs. And so when we had an opportunity to monetize the investment that we had made in over-the-counter drugs, we availed ourselves of it. And I think we described that last quarter.

And we are now focusing primarily, both in chemistry and in pharmacy, on prescription products, both generic and proprietary. So there has been a strategic shift away from consumer products, at least in the United States market. And there are other markets where we are enjoying success with consumer products. And we will continue to promote those products in those markets, if, as long as they return -- they make a positive contribution to our bottom line, and don't provide a distraction from the major strategic focus, which is prescription drug products. So that was -- I believe there was another part to that question.

The authorized generics --.

The authorized generic issue. First of all, authorized generics are a fact of life. They have been a fact of life in Canada for a long time, and they have become a fact of life in the United States now. I think our business in Canada is thriving, despite authorized generics. We're doing very well in the Canadian market. And with respect to authorized generics in the United States, we have to compete with them as another competitor, which means that you're never, or you're almost never alone, even though on some instances we have been privileged in introducing products and and finding that there is no authorized generic for a good long while.

On the other hand, we are also guilty of being an authorized generic. I have to plead guilty to -- for at least two products, Taro being an authorized generic. Obviously, the marketing department and business development groups do what they have to do in order to maximize the return to shareholders. So whether we like authorized generics or don't, whether we agree with them or don't agree with them, they are a fact of life. And therefore we factor them into our marketing and sales equation.

And I think that in terms of our own internal projections, we take them into account as we move forward. I don't believe -- because I don't know what the value of our current pipeline -- I can't put a number on it, because this is not a business school exercise. This is real life. But I do think that we still retain a tremendous amount of value in the pipeline in spite of the fact that there will be competition from branded companies.

Mark Taylor with Roth Capital Partners.

Thanks for taking the question. I just have one for Dr. Levitt, and again not to really belabor this discussion of R&D, it is just so important to our thesis here. Can we infer from the increased R&D spend in this quarter, and certainly in the first half, that -- which implies to us probably more clinical trials -- can we infer from that that the topical targets that you're going after possibly require comparative trials versus vasoconstriction in some of the more simple assays that you may have done in the past? And can we also infer that some of this spend might be geared towards approvals for Taro pharma branded approvals, which we may see commercialized in the next 12 months?

I can't speak -- I don't work for the FDA anymore -- I used to. So I can't tell you what is going to be approved in the next 12 months. But I think the rest of your thesis I can endorse almost completely. Yes, we are seeing more clinical studies for both proprietary and generic drugs. Yes, we hope that some of these are going to be filed. Obviously you can't file until you finish the clinical studies, so we hope that after the completion of the clinical studies we will be filing. And then we hope that congestion at the Office of Generic Drugs, for the generic ones at least, will be relieved so that we will be able to get expeditious approval.

We certainly go to great lengths to try to make sure the studies are well performed, and that they are presented to the FDA in a clear, concise and simple matter in order to facilitate approval. But actually, a lot of the things you said I could have -- I couldn't say them better myself. I don't want to sound like Lee Iacocca, but you really did say it quite eloquently.

Well, thank you.

Gentlemen, that is all the time that we have for questions today. Please proceed with your closing remarks.

We want to thank you very much for joining us today. And we will end the call here. Thank you.

Ladies and gentlemen, this recording will be archived and can be heard at any time following this call through May 3. To hear the archived call, log on to www.taro.com, and click on the link on the home page, or telephone 800-286-8101 in the United States, or 617-801-6888 from overseas. When prompted enter the pass code 82524360 to request the Taro call. (OPERATOR INSTRUCTIONS).

Ladies and gentlemen, this concludes the presentation for today. Thank you for your participation. You may now disconnect.