Jody Burfening - IR, LHA Sal Guccione - President & CEO Doug Roth - CFO

Matt Hewitt - Craig Hallum Capital

Thank you, Ellen. Good morning everyone, and welcome to Aceto Corporation's second quarter fiscal 2017 earnings conference call.

On today's call, Sal Guccione, President & CEO; and Doug Roth, CFO; will lead the discussion about the quarterly financial results and business performance. Walter Kaczmarek, Aceto's Chief Operating Officer is with us today to participate in the Q&A session.

Company issued its second 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 website 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 words such as believe, expect, anticipate, plans, projects, seeks and similar expressions and 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 set forth in the company's filings with the securities and exchange commission.

cautions listeners that these statements are not guarantees of future performance or events and are subject to a number of uncertainties and risks. Factors that could cause actual results to differ materially from those anticipated or implied are set forth in the company's filings with the Securities and Exchange Commission.

Also on today’s call, management will refer to certain non-GAAP financial measures. These measures Aceto's adjusted net income and Aceto's adjusted earnings per share are defined as net income excluding amortization of intangible, debt extinguishment and amortization of debt discounts and debt issuance cost and cost related to acquisitions.

These non-GAAP measures allow investors to compare results of operations in the current period to prior period results based on the Company's fundamental performance and analyze operating trends of the business. With those housekeeping items out of the way, I would now like to turn the call over to Sal.

Good morning, Sal.

Good morning, Jody. Thanks and good morning, everyone.

Thank you for joining us on Aceto's second quarter fiscal 2017 earnings conference call. Overall, we turned in performance for the second quarter that was below what we reported last year.

While the downward comparison is not unexpected it is nevertheless disappointing. The main driver for the year-on-year drop as we saw in the first quarter is increased competition that we are experiencing in our generic form of business.

We'll get back to that in a minute but first I'd like to just note that I am pleased with the completion of the acquisition of Citron's product lines prior to the end of the second quarter which is within the timeframe we anticipated when we announced a transaction last November. The transaction adds complementary product portfolio to Aceto and also strengthens our asset life operating model.

As a result, our ongoing strategic transition towards Human Health continues to proceed with the Human Health and pharma ingredients business segments collectively accounting for a record 72% of our total sales in the second quarter. As a percentage which we expect will move higher in the third and fourth quarters with the full period inclusions of the Citron product lines.

We have new leadership in place at Rising and together with our new Chief Operating Officer, Walter Kaczmarek, we are well positioned to execute on our Human Health plans. Net sales for the second quarter of fiscal '17 were $125.6 million which is about 4.5% decrease from the $131.7 million we reported in the second quarter of fiscal 2016.

Our total gross profit for the quarter was $30.8 million which is about $5 million lower than the $35.9 million we achieved in the second quarter of fiscal 2016. Our gross margin for the quarter was 24.5%, that compares to 27.2% in the prior year period.

Regarding our segments, Doug will provide details but I would note that our Human Health sales and gross profits decreased by about $5 million each during the quarter which is essentially the entire quarter drop in both sales and gross profit. This is a reflection of the lower sales at Rising, partially offset by contributions from the products we acquired from Citron and Lucid in late December.

Our pharma ingredient segments saw sales grow by 7.5% in the quarter versus last year but they had a similar percentage decrease in gross profits. While on the other hand performance chemicals reported higher gross profits on lower quarterly sales.

In both of those segments product mix was an important contributing factor in the performance versus a year ago. As we've seen for the past six months now, Q2 continues to feel the effects of increased competition at our Rising pharmaceuticals business.

Some of that competition is related to specific new engines against some of our products at Rising, while some is related to high end price competition that we're seeing generally in the industry. As a reminder, we expect a specific product competition will be a drag on year-over-year comparisons until we lap the start of this trend sometime towards the end of fiscal '17.

The second quarter results were impacted by supply interruptions on two of our commercial products at Rising as we previously noted during our first quarter earnings call. Those products were having API supply issues during the first quarter and into the second quarter, and I'm happy to say that through excellent work by Aceto's API team, we're now -- I'm now able to report that both those API issues have now been resolved.

With respect to one of the finished dose products related to one of those API our manufacturing partner reached commercial production for us in late Q2 and we're now back up and selling that product. While for the other one we expect to reach commercial supply in late Q3.

Our ability to gain synergies across Aceto's business unit will continue to be an area of focus for us and I'm optimistic that this approach will lead us not only solutions as I just described but also to new business opportunities. Somewhat mitigating the headwinds that we have just described, we launched two new products during the quarter bringing our total for the year-to-date to five products.

In mid-November we launched Oxybutynin Chloride extended release tablets which are used for the treatment of overactive bladder. Shortly thereafter we launched Erythromycin and Benzoyl Peroxide Topical Gel which is used for the treatment of acne.

Consistent with a rising strategy of pursuing opportunities in niche markets each of those products addresses markets that are valued roughly at or between a $100 million and $150 million as defined by IMS health data. Also shortly before we completed the acquisition of the Citron product lines, two of those products were launched during the quarter; one is called [indiscernible] and the other is Cyclobenzaprine.

The former is used for treatment of H.pylori infections and ulcers, while the latter is used for pain and stiffness caused by muscle spasms. IMS date on those two products, one is about $35 million and the others about $10 million.

Heading into the second half of fiscal '17, we're now much better positioned with a larger commercial offering of over 110 products in our generic pharma portfolio, as well as with the addition of several highly talented generic pharma industry experts in a variety of disciplines. We continue to focus on expanding our product portfolio and still expect to launch between 12 and 15 Rising generic products during fiscal '17.

However, a launch schedule does now call for a launch of most of the remaining 7 to 10 products in the fourth quarter. We also expect to launch about 15 of the approved products we acquired from the Citron, we expect to launch those in the second half of this fiscal year and particularly in the fourth quarter, as we're in the process right now to changing the old working labels over to the Rising brand.

At the same time we continue to work on our developing pipeline. We currently have 175 projects in our pipeline including 43 and is currently on file with the FDA, and 41 approved or latently [ph] approved products.

Turning to our outlook for the balance of fiscal 2017, we have updated our expectation since reporting our first quarter results and completing the acquisition of the Citron and Lucid product lines in December. As I just noted, we now expect most of the new product launches to cover later in the year, mostly in the fourth quarter.

We also expect that one of our previous API constrained products will resume sales in the fourth quarter and that's versus the prior expectation of a third quarter assumption. So primarily as a result of those items we now expect to see those fiscal 2017 sales growth to be in the mid to high teens percentage range and the non-GAAP adjusted EPS to be roughly flat with fiscal 2016.

On a GAAP basis, I would reflect deal related cost and non-cash purchase accounting charges. We expect EPS to be below last year by about 45%.

Finally, with respect to our pipeline project at Rising we expect R&D spends for the year to be somewhere between $6 million and $8 million; and as you know most of those expenditures are a milestone based. In summary, where we are resolving the supply chain issues and back orders at Rising.

We have completed the acquisition of Citroen and Lucid's product lines and now have an expanded portfolio of commercialized products contributing to our results going forward. We have solid product launch plans lining up, mostly for the fourth quarter and we have new and expanded leadership at Rising and Aceto.

With those factors in place we believe it positions us well to deliver sequential non-GAAP EPS growth in the third quarter versus the second quarter, and then again in the fourth quarter versus the third quarter which will allow us to exit 2017 well positioned to resume robust growth in EPS and fiscal 2018. So with that said, I'll now turn the call over to Doug and then we'll turn it open to questions.

Doug?

Thank you, Sal, and good morning everyone. I will now walk you through our financial results for the second quarter.

As Sal mentioned earlier, we closed the acquisition of the Citron and Lucid product lines and related assets on December 21, 2016. The financial statements for the second fiscal quarter include Citron and Lucid sales of approximately $5 million and financial activity for the 10 day stock period between December 22 and December 31, as well as the preliminary purchase accounting adjustments.

The consolidated net sales were $125.6 million, a decrease of $4.6 million from $131.7 million reported in the second quarter of fiscal 2016. Our gross profit was $30.8 million, a decrease of $14.1 million compared to $35.9 million in the second quarter of 2016.

Our gross margin was 24.5% compared to 27.2% in the prior year period. On a reporting segment basis, Human Health segment sales were $54 million, a decrease of $8.6 million from the second quarter of fiscal 2016.

Rising pharmaceutical sales decreased by $8.7 million, primarily due to the -- as Sal mentioned before, the increased competition in price erosion on certain generic products in our portfolio. While the sales in the nutritional side declined by $1.4 million which is due to certain orders being pushed into our second half as well as a slowdown in orders in our European market.

Somewhat offsetting these declines were sales of $5 million from the acquisition of the Citron and Lucid product line in that period. Gross profit in the Human Health segment fell $16.9 million, a 22% decrease from the prior year's quarter.

The decrease in gross profit again was primarily caused by increased competition on certain products at Rising, as well as an unfavorable product mix resulting from both price erosion on certain products and the back orders on certain other products. Turning to our pharmaceutical ingredient, segment sales were $36.8 million, an increase of 7.4% versus the second quarter of 2016, largely on the strong sales gain abroad and our pharma intermediate business.

Gross profit in the second quarter decreased 7.4% to $5.7 million from $6.1 million a year earlier as a result of lower reorders for a certain API which typically yields a higher gross margin, partially offset by both increased sales volume abroad into pharma intermediate and a more favorable intermediate product mix. Our performance chemical segment sales decreased 9.3% to $34.5 million due to a decline in our domestic sales of specialty chemicals, including a $4.2 million sales drop in our agricultural dye and pigment intermediate product line.

As has been the case in recent quarters, lower cost in raw materials, specifically China due to the strengthening of the dollar has caused downward topline pressure in the specialty chemical business. However, the gross profits rose by 2.6% to $8.2 million versus $8 million in the prior year's quarter and our gross margin increased 280 basis points to 23.7% which was driven by the more profitable mix of sales of our agricultural protection products.

Turning to SG&A, our SG&A expenses for the second quarter were $28.1 million which is an increase of over 45% over last year's number [ph]. With higher SG&A expenses include $7.2 million of the deal related transaction costs plus $300,000 of deal related integration and $600,000 of non-cash amortization expense associated with the Lucid and Citron product purchase.

Absent these items, our SG&A would have risen roughly 3.8% over last year. R&D totaled $1.3 million for the quarter as opposed to $2.5 million in the comparable quarter last year.

Once again our R&D expense represents an investment in our generic pharma product pipeline and the majority of the expenses are milestone based and therefore tend to fluctuate quarter-to-quarter. During this transitional quarter, we are reporting a net loss of $600,000 or $0.02 per diluted share compared to net income of $8.3 million or $0.28 per share during the second quarter of last year.

You will note that our the diluted EPS includes approximately $0.17 worth of deal related integration and non-cash accounting charges. Our non-GAAP adjusted net income is about 31.9% or $7.3 million to $0.24 per share for the second quarter as compared to $10.7 million or $0.36 per share last year.

Turning to our balance sheet you will see that the acquisition we made late in the quarter has significant impact on our legacy or traditional balance sheet. As of December 31, 2016 had cash and cash equivalents and short-term investments of just under $70 million.

Our working capital was $252 million and our shareholder equity was $396 million or $0.1316 per share. Total bank and convertible debt was $382.9 million which included $265 million on borrowings under our amended and restated senior credit facility which we had recently expanded to $375 million during the quarter.

Our senior secured net debt leverage ratio was 3.7 times as of December 31. Regarding the fiscal 2017 forecast Sal provided to you earlier, I do have a few clarifying comments I'd like to make.

First, in accordance with purchase accounting rules our full year GAAP numbers will include an inventory step up adjustment of approximately $4.5 million which we expect to be charged to -- within our cost of goods sold over our third and fourth quarter. Second, I would like to remind you that our 2017 full year profit guidance does not include any net synergy benefit from the Citron products.

As I had mentioned in our last call, the synergy we do -- we do stand to realize this year are expected to be fully offset by course required to achieve them. But finally, we believe that we remain on-track to realize annual SG&A synergies of approximately $4 million by the end of fiscal 2018.

Now I'd like to turn the call over to questions. Operator?

Good morning, gentlemen, thanks for taking the questions. A couple for me; first, the generics have weighed on the Human Health segment, specifically the ones that you're seeing increased competition or some praise erosion, have those markets stabilized or is it still influx, meaning that there could be some changes even here in Q3 and Q4?

It's obviously difficult to tell but I'd say on the product -- and again, it is two things we talked about, one is pricing generally in the industry and one is of specific products. On the specific product it appears that that's now stabilized, and we kind of know what it is and it's got to work its way through the channel in Q3 and Q4.

On the industry there seems to be this general kind of consensus 10% price erosion right now and to be honest, I don't know if that's stabilize or not, how long that's going to go for not -- so that's a little of wild card, that's hard to tell but I think it's kind of 50-50 depending on the type of competition we're talking about.

Okay. And then as you look at your launch or your expectations here over the second half of the year, particularly it sounds like it's going to be a heavy Q4.

Can you talk a little bit about your relationship with your CMO partners, as far as -- how much confidence do you have that you'll be able to get those products that are already approved launched in a relatively timely fashion? Is there any risk that things get pushed out into Q1/Q2 and what steps can you take today to make sure that that doesn't occur?

Okay, and maybe I'll have a lot common afterwards also but certainly the '15 at Citron, we feel really good about. It's -- as we've talked about in the past call, it's -- one supplier sort of window, we lined them up and we think we have a high confidence that we'll get those out.

The ones at Rising, I think we have made good progress and we do have confidence in our suppliers, so I think we do expect to get them off. There is a couple in this projection that are -- so most we are talking about are approved Okay, and launched.

There are a couple of our projections for the balance of the year that we're expecting yet to get FDA approval shortly and then launch, those are the ones that I think at this point that would be obviously the most speculative because we could get surprised and not get approval that we're expecting. So -- but otherwise I think we feel pretty confident we'll get these products launched.

Okay, and then as you look at those portfolios that you expect to launch for the end of the year, would you characterize any of those as sizable opportunities? And how are you looking at the launch schedule, I mean are you looking at biggest market opportunity, fierce competition; just help us think about that launch schedule a little bit better.

Again it's a mixed bag, as you know for most of our products we tend to go with the niche products in general, so none is going to be a blockbuster. But within that the mix that we're talking about, it's probably I'd say three or four that are chunkier for us, that we need to you know we need to execute on those.

Okay, one last one. Maybe Doug, this is for you, there was a bit of a step up in DSO in the fourth quarter, I'm assuming that's related to the late in the quarter acquisition of the all these products; is that accurate?

And should we expect that to step back down here in Q3?

Well, there are two things happening in our Q2. One as you mentioned is, we have a tough period of sales and activity for Citron and Lucid.

You know the Citron and Lucid, the pro forma DSOs are -- will have an [indiscernible] that they might creep up a few days but not anything meaningful. But just because in that industry they tend to be longer but also fiscal second quarter, when you look at the sales patterns are Rising business and our Human Health business, it was more oriented towards the December month as opposed to the October month and that also happened, that also increased the DSOs.

Thanks a lot. Go ahead.

That's fine. Thank you.

Thanks guys. I'll hop back in the queue.

Good morning. Could you run through again your debt breakdown please in terms of what the revolver size is now and what you have brought drawn down in the total debt level?

Sure. You'll be able to see our balance sheet -- with release yesterday and 10-Q will go out later today but our [indiscernible] $375 million which consist of term loan of $150 million which is completely drawn down and then a revolver of two in a quarter of which we borrowed $115 million.

So we borrowed $150 million of the two in the quarter so we have plenty left.

Okay, thank you.

Good morning, I'd like to ask two questions If I could direct the first to Doug please and then I'll follow-up to Sal. At the annual shareholder meeting we had a conversation, I think I was all confused and I wanted to clarify today that share account outstanding going forward; the 3 million shares or the equity share as part of the total consideration for the deal -- they don't invest for three years, December three years from now -- do those get counted in the fully diluted share count three years from now or at the end of this year; can you clarify that Doug?

Sure, that's a great question. First of all, the amount of equity that was part of the consideration was by 5.1 million shares, not 3 million.

And to answer your specific questions, yes, it includes -- the full 5.1 million is included in the calculation of the diluted and basic. There is only 10 days' worth but going forward the full $35 million will be in our diluted and our basic calculation.

Okay, great, thank you. And Sal, if you would I'm going to take a stab at this, this is obviously going to be a big hockey stick year in the fourth quarter with those 22 or 25 product launches.

And you said of course on the slide deck all the IMS data; some of its genericized already, some of it isn't. Could you just take a stab at that for us, as a revenue range what that might look like given a wide range in the fourth quarter?

And then as a follow-up, you said that you're going to earn about flat with last year and last year's I think was $1.51. So we reported $0.51 in the first half, so that would imply at least a minimum of $1 in the second half and it's not $0.50 equal quarters, you're saying it's going to be skewed.

So you're going to probably guide us not to annualize the fourth quarter or it will be a $2.5. So my question to you is are you in receipt of information now and all your planning and all your knowledge of the business from your C-suite that would inform you to state emphatically that you cannot earn north of $2 next year?

Thank you.

Okay, there is a lot in there. So with respect to next year, I respectfully -- let us get through our budget process, we do our budgets in May, June, July and let us get through that with us.

With respect to what you're saying in terms of the calculations, yes we've done roughly the $0.52 or so for the first half of this year. We are expecting sequential improvements in Q3 and Q4 which assuming we execute on those plans should bring us up and around $1 for the for the second half of this year.

And then I know where you're going with the balance into 2018 and we would expect at this point if we can execute on these launches and the rest of our plans that we should be able to grow nicely in '18 and I think we said return to double digit growth. Beyond that I don't want to go because we haven't done our budgeting process but we're -- we are at this point doing the best we can to have 2017 be as successful as possible but also then position us for a solid 2018.

Does that fourth quarter -- injection of all those new products, will those repeat again in the following fourth quarter or will you see report -- I mean repeated orders throughout 2018? And I'm trying to get a sense of how lumpy the business is.

I'm not sure I'm understanding the question. Say it again.

Well, currently we're back to this lumpiness now with this for a lot of reasons but it looks like we're going to be skewed with a lot of product launches in the fourth quarter; once those are successfully launched, however many they are, will we see those every quarter repeat sales or will they -- do they tend to buy once a year in the channel?

No, no, so on those products -- once we get them launched those should become part of our base and that business should repeat. Obviously the headwind that we've been facing is, you know, industry comp and it intensifies industry competition, price competition, etcetera so there will be the launches and they will become part of the fabric of the company but subject to the normal competition, that's number one.

Number two, we expect next year then to continue to launch products in particular, you know, the balance of the Citron approved pending launch products. So the way we're looking at the business is, again, we just begin to see it start to pick up here in Q3 and grow in Q3 and Q4, consolidate those gains that maybe some other future losses that we're going to have to take into account due to general industry competition but then continue to launch products in 2018 or so.

I just seem like there is a robust future and I'm trying to understand what informs this tone of dividends I would call it in the conference call and in past conference calls, I mean you have a real earnings sales and earnings power curve you're ridding here. I mean why not flush that out?

I was asking about the fourth quarter revenue, we remember a company called Cambrex [ph] or I can even talk about Dow Chemical, it gives us a range of EBITDA and a range of revenue and a range of earnings for at least a year; so something to give the Street. I mean I see somebody's downgraded it to a whole of a price targeted '18, I mean it's silly, the stock is going to double or treble in 36 months.

You know, why not try to get that story out and inform the investment community. That's not really a question, it's a statement.

Thank you.

Just one question, regarding the margins. Obviously you've seen some compression there over last couple of quarters in that Human Health in particular which was weighing on the total corporate gross margin.

Once we get through the next couple of quarters, as you get those product launches out, could you anticipate that getting back on the track of increasing year-over-year? Thanks.

Yes. So we've got to get through the -- as we keep calling, the spike of competition, again it was a significant product that's under attack as we've talked about.

Once we get through that then we should expect the launches that margins start increasing again.

Alright, great. Thank you.

Okay, well, thank you. Thanks so much for joining us and we definitely appreciate the questions and comments.

Lest [ph], we appreciate your comment and we will take that also under advisement here. And thanks to all for your support and look forward to speaking to you again in May for our third quarter earnings call.

Thank you.