ACET - NASDAQ

Salvatore Guccione - President and CEO Douglas Roth - CFO Jody Burfening - IR, LHA

Matt Hewitt - Craig-Hallum Capital Steve Schwartz - First Analysis Claire Mencke - Sidoti & Company John Vandermosten - Singular Research Kevin McKenna - Main Line Capital Management

Welcome to the ACETO Fiscal 2016 Third Quarter Financial Results Conference Call. My name is John, and I’ll be your operator for today’s call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Jody Burfening.

Thank you, John. Good morning, everyone, and welcome to ACETO Corporation's third quarter fiscal 2016 earnings conference call. This is Jody Burfening of LHA. With me today are Sal Guccione, President and CEO; and Doug Roth, Chief Financial Officer. The company issued its third quarter earnings press release yesterday after the market closed. For those of you who have not yet seen the release, a copy is available in the Investor Relations section of the company's Web site at www.aceto.com. Before starting the call, I’d like to remind you that today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, that can be identified by such words as believe, expect, anticipate, plans, projects, seeks and similar expressions that involve numerous risks and uncertainties. The company's actual results could differ materially from those anticipated or implied in these forward-looking statements, as a result of certain factors as set forth in the company's filings with the Securities and Exchange Commission. In addition, on today’s call, management will be referring to non-GAAP adjusted net income and earnings per share. ACETO defines these non-GAAP measures as excluding all transaction costs related to acquisitions, amortization of intangibles, debt extinguishment and amortization of debt discount and debt issuance costs. With those housekeeping items out of the way, I would now like to turn the call over to Sal. Good morning, Sal.

Thank you, Jody. Good morning, everyone. Thank you for joining us on ACETO's third quarter fiscal 2016 earnings conference call. I’m very pleased with our third quarter performance. Our top line growth this quarter was a solid 8.3% with each of our three business segments growing sales at mid-single digit range or better. And particularly this quarter, Pharma Ingredients produced an above average contribution to company’s total sales growth. On a year-to-date basis, our business mix continues to demonstrate our ongoing transition towards Human Health with the Human Health and Pharma Ingredients business segments collectively accounting for just under 70% of our total sales and just over 75% of our total gross profit. Consistent with our business mix shift, and as we saw in the first half of fiscal 2016, our performance this quarter generated earnings growth on both the GAAP and non-GAAP basis well ahead of net sales growth. On the 8.3% net sales increase, we grew GAAP EPS by almost 21% to $0.35 a share and non-GAAP EPS by 24% to $0.42 a share, so very pleased with the continuation of that leverage we’re seeing in our business. Looking at individual segments, Human Health sales grew by 4.5% in the quarter to just under $59 million. Higher sales at Rising Pharmaceuticals more than offset a modest decline in sales at our nutritional products business. Gross profits in Human Health fell 4.2% to $19 million in the quarter and gross margin declined from 35.4% to 32.5%, and Doug will speak a little bit more about that in a couple of minutes. During the quarter, we launched three new products. In January, we launched

Thank you, Sal, and good morning, everyone. I'll walk you through our financial statements for the third quarter. Net sales were 157.9 million, an increase of over 8% from the 145.8 million reported in the third quarter of fiscal 2015. Euro currency fluctuation had a negligible impact on sales in the quarter as compared to last year. Gross profit was 38.3 million, an increase of 4.6% compared to 36.6 million in the third quarter of fiscal 2015. Our gross margin was 24.2% compared to 25.1% in the prior year period. On a reported segment basis, Human Health segment sales were 58.8 million, an increase of 4.4% from the third quarter of fiscal 2015. Rising Pharmaceutical sales increased by 2.9 million or 6.7% primarily due to price increases on certain products taken last year while sales on the nutritional side declined modestly. Gross profit in the Human Health segment fell to 19.1 million, a 4.2% decrease from the prior year’s quarter. The decrease in gross profit was a result of lower profitability of Rising primarily due to price protection taken on certain products, increased chargebacks for the quarter and product mix. Our Pharmaceutical Ingredients segment sales were 45.8 million, an increase of 13.1% versus the third quarter 2015 on strong sales gains abroad in both our active pharmaceutical ingredients and our pharma intermediate business. Gross profit in the third quarter increased 29.6% to 8.6 million from 6.7 million a year earlier as a result of our higher sales volume. Performance Chemicals segment sales increased 8.9% to 53.3 million largely due to an increase in sales of our agricultural protection products. Gross profits rose 5.5% to 10.5 million versus 10 million in the prior year quarter while our gross margin declined due to a mix as these agricultural protection products sales carried a lower profitability. Turning to our SG&A expense for the third quarter, we registered 19.5 million, an increase of 2.3 over last year’s level. Our R&D spend totaled 2.3 million compared to 2.1 million in the comparable period last year. Our R&D expenses represent investment in our generic finished dosage form product pipeline, and as Sal mentioned before, the majority of these expenses are milestone based and therefore tend to fluctuate quarter-to-quarter. Our mid-single digit gross profit growth compared to good expense management led to a 6.8% gain in our operating income to 16.5 million versus 15.4 million last year. The absence of foreign exchange losses we took in last year’s third quarter combined with the reduced tax rate of 32.9% due to increased profits and lower tax jurisdictions resulted in a comparatively stronger gain in our after-tax profits. Our GAAP net income rose 23.9% to 10.4 million or $0.35 per diluted share compared to net income of 8.4 million or $0.29 per diluted share for the third quarter of last year. Non-GAAP adjusted net income rose 24.2% to 12.5 million or $0.42 per share in the third quarter compared to 10 million or $0.34 last year. Our EBITDA for the third fiscal quarter was 21 million, an increase of 3.4 million or 19% over the same quarter last year. Now turning to our balance sheet. As of March 31, 2016, we had cash and cash equivalents and short-term investments of over 55 million. Our working capital was 241 million and shareholder equity of just under 300 million or $10.10 per share. As a result of our convertible offering, our long-term debt was 117.2 million and we had no outstanding balance under our senior credit facility. Our trade receivables increased by over 15 million during the nine months ended March 31, 2016. The increase in trade receivables reflect higher sales during the period as well as slightly higher DSOs. The increase in DSOs reflects the seasonal nature of our agricultural protection products, increased sales from our foreign subs and higher chargebacks in our Rising business. I would now like to open up the call for questions. Operator, please.

Thank you. I’ll begin the question-and-answer session. [Operator Instructions]. Our first question is from Matt Hewitt from Craig-Hallum Capital.

Good morning, gentlemen. Congratulations on the good quarter.

Thank you.

Good morning, Matt.

A few questions. First, in the Human Health segment, how much of the decline sequentially can be attributed to the nutraceuticals versus some of the competition and the other items that you mentioned in the generics segment?

The nutritional decline as we mentioned was modest for the quarter, okay, so that contributed but the bigger contributor was Rising. And as we said before it was – we took price protection on one product. We had increased chargeback and product mix.

And regarding those chargebacks, typically we’ve seen those in relation to price increases. Was that the case and if so, should we anticipate a nice bounce back in that business in the fourth quarter?

The price protection, if you will, was related to the price increase. The chargebacks were unrelated to the price increase and the chargebacks are larger than our normalized run rate and they’re being disputed with some of our customers. So if we’re successful with the dispute, then we should see some clawback in future quarters.

Okay. Just out of curiosity, what prompted the chargebacks in the first place? Was there a competitor interaction? Did one of your competitors do something with price that kind of filtered through the rest of the group? Or help me understand that situation a little bit better.

No, Matt. This is Sal. Chargebacks, and again it’s a complicated industry in a way products are priced and sold and things like this. But chargebacks unrelated to price protection are just kind of a normal part of business. They happen all the time, because we’ll sell to our customers which are typically wholesalers and they’ll sell ultimately to the pharmacy chains. And depending on the price that a wholesaler might sell to the pharmacy chain, there may be what’s called a chargeback which is the wholesaler comes back to us and says, listen, I didn’t quite get what I thought I was going to get and therefore I’m coming back to you to get kind of a refund, if you will. So that’s a normal part of business. In this quarter, it happened to be larger than normal, larger than we would expect.

Can you disclose the amount of those? Are we talking $1 million, $2 million?

Yes, it was 1% or 2% of our net sales in Rising, so it was just short of $2 million.

Okay. Perfect. All right, thank you. Moving on another topic, obviously API, fantastic quarter. Were there some one-time contracts that hit here in the third quarter or can we anticipate another good quarter in Q4? And how should we be thinking about that going forward?

So a combination of things. I think we’ve talked about in the past we have this one or two particularly high margin, high value type APIs. So this quarter, we did see some of that and it’s not to the extent in the past where there were these large swings, but we did see more of it than we had seen earlier in this year. So that’s part of it. And that one, you can continue to see bumping up and down over time. The other is, we’ve been investing over the years in our business development selling infrastructure and particularly outside of the States. And we think we’re beginning to see some nice results from that and that should be business that does stick with us. And that’s more the typical kind of smaller business with APIs that you just kind of pick and shovel and eventually you land some business and it starts to pick up for you. So, I’d say it’s somewhere between depending on the kind of two causes of it.

Okay, great. Thank you. Maybe last for me and then I’ll hop back into queue. Last night there was lots of headlines regarding the Teva asset sale. It wasn’t clear to me whether or not those had been split up into several different buckets or if they were doing one large transaction. One, what do you know on that front? And two, obviously if they did split it up into different baskets, is there any opportunity for ACETO to maybe capture one of those pieces? Thank you.

Sure. This is Sal. I’ll just answer generally on that. It’s public that Teva is looking to sell products and we would be interested in it. I don’t have any particulars on it at this point. But as far as I know, the last time I knew, it seemed to be a little bit on the larger side, a little bit too large for ACETO in terms of the chunks that they might be selling off. But that’s about all I have at this point in time.

All right, great. Thank you.

Thank you.

Our next question is from Steve Schwartz from First Analysis.

Good morning, gentlemen.

Good morning, Steve.

Hi, Steve.

You mentioned like you did for Matt on the chargebacks, can you walk us through exactly what’s happening with price protection because if I recall correctly that element – you had a little more tension starting as far back as the second quarter of last fiscal year. So it sounds like there was a headwind to the business, but it doesn’t certainly read like it when we talk about price increase?

Okay. The price increase that we took in this quarter, in our third fiscal quarter, was something separate than the price increase that you’re referring to in our second fiscal quarter of last year. So, we identified an opportunity in the marketplace for a particular product in this third quarter and we took a price increase. As part of that price increase, there’s something known in the industry as price protection where you actually have to pay the wholesalers money in the form of price protection or shelf stock for the ability to raise the price. So while there was pain in this quarter, we expect to re-benefit of the price increase in future quarters.

Steve, what I’ll add to that is – and you’ll see this from time to time because again it’s kind of just a normal part of the way the business is conducted. In other words, when you have a price increase, which by the way there’s not a plethora of opportunities, but from time to time you get some opportunities, you end up first taking a charge, a price protection charge and then you get the benefits later on. So every so often you’ll see this.

I see, okay. That’s very helpful. That clarifies it. And then just a follow-on, in Pharmaceutical Ingredients, the majority of that business is in fact domestic. Is that correct?

It’s a mix. I’d say it’s more like 50-50, something like that.

So 50-50 and you commented on the international. Can you talk a little bit then about the domestic business? Was it up, down in the quarter?

Domestic, I don’t have it top of my head. Domestic also had I believe a pretty good quarter but it was mostly driven by the international growth.

Okay, very good.

I’ll check that out before we get off the call.

Okay, that sounds good. Thank you.

Thank you.

Our next question is from Claire Mencke from Sidoti & Company.

Hi. Very good quarter.

Thank you.

So many of my questions have been answered. I just had one remaining one about the decrease in gross profit and margin in Human Health. And I wondered you spelled out three factors; product mix, chargebacks and price protection and about how important was each of those in the equation?

Claire, I can fill in those blanks. I think I mentioned before that the price protection was – pardon me, the chargebacks was in and around $2 million that affected our gross profit and our price protection was $1.5 million or so for the quarter. In terms of product mix that’s a more difficult number to get our arm around. But I think the two should help close the gap.

I think so. Okay. Thanks a lot.

Thank you.

Our next question is from John Vandermosten from Singular Research.

Good morning.

Good morning.

Hi, John.

Okay, great. And wanted to ask on the transaction that didn’t work out. Can you highlight maybe some of the reasons behind that? Was it price? Was it maybe strategy or some of other factor?

I think two things. A, as I mentioned, it is a very competitive market out there. So price is always a factor. So that’s one. And then the other frankly, just as the more work we did just for – and more so the structure of the transaction didn’t come together in a way that we were comfortable.

Okay. And those costs that you incurred, are those internal costs or do you have a third party come in and help out with that?

So those that you see are external.

Okay.

We hire consultants, et cetera.

And generally and maybe I just couldn’t find it and you provided a slide updating kind of the pipeline and everything. Is that something that will be available I guess maybe for the next conference presentation or something?

That will be on our Web site today.

John, I think it went on last night actually. So the new --

It did.

In terms of our aging and our development and pipeline, I believe the numbers that Sal was speaking to today, they are on the Web site.

Perfect. And can you comment – I try to keep a close eye on kind of how the FDA is trending, if they are able to push things through more quickly. Can you give me kind of an update since the last time you commented on it kind of where the FDA – are they improving in terms of getting things through or are they slowing or any sense there?

So from our perspective we see and we think we’re hearing this in the industry generally but we see definite pickup in the activity of FDA correspondence, evaluation and ultimately decision making approvals or denials. And as I noted in our call, we have nine products that have been approved and are pending launch. So that’s a lot better than we’ve seen in a long time, so definitely a pick up.

Great. Thank you guys and great quarter.

Thank you.

Our next question is from Kevin McKenna from Main Line Capital.

Good morning, gentlemen. Great quarter as usual.

Thank you. Good morning, Kevin.

And now for the snarky part of the question. Look, it makes me ask why the convert? I know that you guys are now, what, six months past issuing the convertible to get the deal to grow the business and that’s what it’s all about. So now we see a charge for a deal that hasn’t come to fruition, which kind of might be the reason why there’s been so much pressure on the stock not only what’s happening in the marketplace against this entire industry. So it makes you question clearly there is an overhang in the marketplace here. If you don’t get yourself to a deal in the next three or six months, shouldn’t you consider the use of that available leverage on your balance sheet to start acquiring ACETO common shares in the market? Wouldn’t you be able to take up as much as maybe 20% or even 25% of the outstanding common? This stock is clearly worth significantly more than it’s selling at rate now. With this earnings history that you’ve stated, you’re going to do your numbers. You clearly are on a glide path to achieve your goals for growth this year. This stock is worth a lot more. Shouldn’t you be demonstrating that and buying it?

So there’s a lot in that. I appreciate the comments. With respect to the convert, Kevin, we felt it was the right thing to do. We still feel it was the right thing to do for a number of reasons. One, to get balance sheet in a good position to go ahead and execute on a deal whether that’s the deal that we noted here that we didn’t do or whether some other future deal. One of the things that ACETO needs to be aware of as it’s looking at properties is we’re often going up against much larger competition with much larger market caps and balance sheets. So we need to be in a position to be able to push a button and do the deal, if we want to do a deal of size. So we can’t be in a position and say, okay, great. Well, we think we want to buy this but now we’ve got to go back and figure out how we’re going to finance it. So we’re comfortable with the decision. Not to mention again, longer term we feel the rate that we locked into is very good. So we continue to be very pleased with that decision. I understand your point about, should we be doing things with the cash? That’s a Board decision that will be discussed with other board-type questions each time we meet. But for now, the notion is have our balance sheet in good shape to execute on growth plans.

Just as a follow up, just as a comment. The stock was well over $30 before we even saw these results and I know what’s going on in the industry with Mallinckrodt and all of the news that’s coming out. But if there is such a significant discount existing at this time, wouldn’t some entity that you acquire be interested in having your common stock given to them so that they can share in that future. The discount is just too much here.

Listen, I would hope that – again, deals are kind of difficult. Every seller has a different objective, right, but I would hope that if a deal came along that we liked and part of the consideration was going to be stock that that person, whoever they would be, would want to happily take those shares, because of the potential of working [ph] together.

Thank you very much.

Thank you, Kevin.

Our next question is from Matt Hewitt from Craig-Hallum Capital.

Just one follow up. How many target action dates or GDUFA dates do you guys have I guess over the next – I don’t know how you want to characterize it, the next six months or next 12 months?

To be honest, I don’t have it in that way. What I can tell you is that the 49 [indiscernible] we’ve got 30 target action dates.

Okay, great. Thank you.

Thank you. And by the way, a question was asked earlier I’m forgetting who at this point about the domestic API results. They were flat this year versus last year, so the growth was on the API side entirely ex-U.S.

Our next question is from Steve Schwartz from First Analysis.

Thanks for that answer and thanks for taking the follow-on. Sal, can you talk a little bit about the acquisitions that you’ve seen with that? You mentioned that you walked away from some potential deals. So can you give us some flavor on what you’re seeing and why you walked away?

Yes, so a couple – what we’re seeing and again I would say within the generic pharma space, it’s been and I think continues to be highly competitive in terms of the multiples that are being paid, the level of aggressiveness by other potential acquirers, which drives up the price tag. And the price tag could be in one or two ways. For what we consider to be a good business, highly diversified product line, good pipeline, et cetera, you’re seeing multiples of 13, 14, 15 and I think we saw even north of that maybe six months ago or so, something like that. And then for businesses that are paying mediocre, maybe they’re very high product concentration or something like that, you’re still seeing 10 times. So the prices are high and there are not a lot of opportunities. So it’s a difficult landscape. That said, we’ve got our list that we’re going to continue to pursue and hope to get one in the fold.

Are you coming up against major companies, is it medium-sized or is it smaller companies like yourself? What’s the situation there?

You come up against all of them but in many cases, the competition has market caps larger than us. So that is one of the challenges that we have.

Okay. You mentioned nine products approved and pending launch and I think you mentioned you plan on doing four of the nine this year. With the remaining five, what determines the timeline which you’ll roll those out?

Again, taking a step back in terms of our model, we have a partnership base model. So we don’t do the manufacturing. So we need to coordinate with the manufacturing partners, number one. So that’s one. But typically would be, okay, you’ve gotten approval. Now it’s the logistics around sourcing APIs, getting the label – it’s basically the logistics of the manufacturing usually. In the meantime while you’re waiting to get your approval and a shortage came about, it makes it more difficult to launch. But otherwise it’s typically the validation batches that can run, the labeling logistics projects second and then the launches.

I got you. Okay. And then just to give your folks in the Performance Chemicals its fair do, ag is showing strength and yet we hear from companies like FMC where ag is suffering in certain areas. Can you talk a little bit about what’s driving your strength in the business growth?

Sure. Again, clearly we’re not months ahead to FMC or any of those guys. Our ag business is a little bit like Rising is kind of a niche based business. So we have our licenses. We tend to go after specialty areas, because that’s what we need to do in order to compete because we can’t go penny a pound sort to speak with the large players. And so for us, it’s been a combination of some new products – actually one product I think, some good market conditions, some good weather and specialty products.

Okay, weather and specialty. And should we assume then that the specialty chemicals business is still facing some headwinds and was perhaps down on a year-over-year basis?

Doug will take a look at that. In terms of the headwinds, again what I would say is just to be clear, the headwinds that specialty chem has seen have been on the top line due to the devaluation of the currency. We’ve been improving the bottom line through mix shift, through pruning and through this devaluation also having a positive effect while we pass some of those savings along that we’re getting on the devaluation, we’re also holding on to some that’s improving the bottom line.

Okay. All right, that’s a great update. Thank you, Sal.

Thank you.

Your next question is from Lester Petruzzi [ph], a private investor.

Congratulations once again fellows.

Thank you.

Thanks, Lester.

I want to return on the last, maybe the question that beat the dead horse but I want to return to the question of the convert and the deal you just – I was going to ask, is it multiple deals that comprise the 1.2 deal cost? But clearly from the exchange with the last three representatives, you’re all talking about one deal. So I’m assuming there was one deal in which you incurred that cost and you for whatever reason didn’t close it. Someone mentioned it’s been six months and we all know why the investors in these convertible instruments tend to protect their position with pilling on shorts and that causes a depression in the stock. But there are two costs I guess to us to look at. The banking fees of $10 million $12 million I think was disclosed six months ago but also the soft costs within our stock [ph] taking this big depression which if you were to use the stock as currency on a future deal, which you’ve hinted that because you’ve increased the authorization count, there’s a cost to us there. So the question I have for you is really more of a strategic one if you’ll indulge me in an earnings conference call. Sal, I heard you say in response to the last couple of questions that ‘if we want to do a deal of size, if a deal comes along we liked’ didn’t sound like a real strategic statement. It sounded like more to me as an opportunistic statement. So the question comes down to this. Is there a strategic will, forgive the word, or strategic intent preferably to do one large deal like perhaps the one you were working at that would get us to the 90% to 100% Human Health pure play or more pure play or should we expect that it could be a multiple of deals like the size of the two that you’ve done over the next three years that would get us to that level? So my question is, is there a focus, is there a strategic intent to do one or the other or both? Thank you.

Thanks, Les. Listen, I don’t think it has to be one or the other. We are pursuing – and when I say comes along, trust me it’s not like some random let’s just see who knocks on the door. So if that’s the impression you got, that’s not the case. We would like to and we are pursuing and actively looking at deals of size, okay. So that’s number one. And to the extent we can locate one and engage in a deal size, we would like to do it obviously assume that we as a company are comfortable that it makes sense. Second, we are very happy with the way the Rising acquisition took place and occurred as well as the PACK acquisition. And so to the extent we can pursue a deal of that size and it makes sense strategically and financially, we will do that too. We would prefer and it would be easier if we could do it in one fell swoop, i.e. a larger deal. The cost of doing with the time and effort of doing a smaller deal as I say is just as much as doing larger deals, so we prefer to be larger. At the same time we need to do it right for ACETO and so if another PACK comes along and it makes sense to us, I’m sure we’ll look at it.

That’s very helpful. Thanks for the clarification, Sal.

Thank you.

[Operator Instructions]. I see no further questions. I’ll turn it back over to you, Sal, for closing remarks.

Okay, thank you. Again, thank you everybody for joining us today. We’re happy with the third quarter and our year-to-date was also fair, and we think it’s painting a clear picture of our steady top line growth and strong profitability and leverage. So happy with that and we look forward to speak with you again in late August. Thanks so much. See you soon.