Repligen Corporation (RGEN) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Repligen Corporation Earnings Conference Call. My name is Tahitia, and I will be your operator for today. [Operator Instructions] I would now like to turn the call over to your host for today's call, Mr. Jonathan Lieber, Treasurer and Finance -- Chief Financial Officer for Repligen. Please proceed.

Thank you, and good morning. The purpose of today's call is to discuss our second quarter 2013 results, Q2 business highlights and to update our financial guidance for the year 2013. Joining me today is Walter Herlihy, our President and CEO. At the outset, I would like to state that this discussion may contain forward-looking statements. These statements are subject to risks and uncertainties, which may cause our plans to change or results to vary. In particular, unforeseen events outside of our control may adversely impact future results. Additional information concerning these factors is discussed in our Annual Report on Form 10-K, the current reports on Form 8-K we filed today and other filings we make with the Securities and Exchange Commission. Except as required by law, we assume no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. This morning, we reported results for the quarter ending June 30, 2013. For the quarter, we recorded a bioprocessing product revenue of $13 million, an increase of approximately 12% from the prior year. Bioprocessing revenue growth in the second quarter was driven by strong demand for several products including Protein A affinity ligands and OPUS Pre-Packed Chromatography Columns. Total revenue for the quarter, including royalty and research revenue, was $17.5 million, which represented an increase of approximately 13% over the prior year period. Net income for the quarter was $4.5 million or $0.14 per diluted share, compared to net income of $1.6 million or $0.05 per share for the quarter ended June 30, 2012. Cash and marketable securities totaled $62.8 million, an increase of $12.8 million from December 31, 2012. Our bioprocessing gross margin in the second quarter was approximately 59% versus approximately 42% in the first quarter, or 51% year-to-date. Product gross margins in the second quarter were positively impacted by higher capacity utilization, particularly in Sweden, which has a high fixed cost base; revenue from our product development collaboration on a new Protein A ligand that was recognized in Q2 for which the costs were primarily incurred in Q1; positive variances in manufacturing in Sweden and normal variations in manufacturing yields. You may recall that our 42% gross margin in the first quarter was negatively impacted by the sale of higher cost material from our Swedish manufacturing facility that was produced in 2012, which resulted in a reduction of Q1 gross margin of approximately 10%. Research and development expenses in the second quarter were $2.3 million versus $2.9 million in the second quarter of 2012. The decline is primarily due to a reduction in R&D expenditures on our therapeutic programs in this quarter relative to the second quarter of last year partially offset by higher spending on bioprocessing R&D in connection with programs designed to drive future organic revenue growth. Selling, general and administrative expenses in the second quarter decreased to $3.1 million from $3.4 million in the second quarter of 2012. The growth in revenue combined with the improvement in margins resulted in an increase in operating income to $6.1 million in the second quarter of 2013 from $1.3 million in the second quarter of 2012. Income tax expense in the second quarter was approximately $1.5 million, which represents an effective tax rate of 25%. Today, we are updating our financial expectations for 2013. We now expect total revenues of between $65 million and $67 million compared to our prior expectations of $63 million to $65 million. We continue to forecast bioprocessing revenue -- product revenue of $46 million to $48 million, bioprocessing gross margins of approximately 50%, and operating income of between $20 million and $22 million in 2013. Shifting to taxes and net income. We now expect that our effective U.S. GAAP tax rate for 2013 will be between 22% and 26%. This is based primarily on a blended average of our statutory rates of 34% in the U.S. and 22% in Sweden. However, it's important to note that actual tax payments will be substantially lower than our reported expense due to the benefit we derived from our U.S. net operating losses or NOLs. In fact, we expect 2013 cash income tax payments to be approximately 13% of pretax income or $3 million, which is consistent with our previous cash flow projections. We currently have over $44 million of U.S. federal NOLs to offset U.S. tax liabilities and these NOLs do not begin to expire until 2021. As a reminder, in Q4 2012, we recognized a $3 million tax benefit from our NOLs based on expected U.S. profitability in 2013, which in effect gave us credit in 2012 for 2013 tax liabilities. At that time, we believed there would still be some additional tax benefits from NOLs in 2013 and, in fact, we now anticipate nearly $1.4 million in additional tax benefits during the year. We have also anticipated recognizing even more tax benefits in 2013 to reflect profitability in future periods much like we did in 2012. However, we now expect to recognize those benefits in the year those profits are earned avoiding such out-of-period adjustments as experienced in 2012 and this year. As a result of our updated and reaffirmed guidance including our anticipated effective tax rate, we now expect net income of between $16 million and $18 million. In addition, we're lowering our expectations of capital expenditures to between $3 million and $4 million, down from $5 million to $6 million as some of the investment in the expansion of our Waltham facility will occur in 2014. And we are increasing our projections for year end cash to between $66 million and $70 million, up from our prior estimate of $65 million. Our guidance is based on expectations for our existing business and does not include the impact on our revenue and expenses of additional out-licensing agreements for our remaining clinical assets, potential bioprocessing acquisitions or fluctuations in foreign currency exchange rates. To summarize, we've had a very strong quarter, highlighted by record bioprocessing revenue, strong margins and significant cash flow. Based on our strong performance through the first half of 2013, we have seen a potential for gross margin improvement in our business and have established a goal over the next few years of driving our bioprocessing gross margins to approximately 55%. We believe this is an achievable objective and a metric that will put Repligen in the top quartile of life sciences tools companies over the next few years. Now, I'll turn the call over to Walt, who will discuss business highlights for the quarter.

Thank you, John. As we discussed in May, our R&D efforts include the development of 5 new products for line extensions. Today, we'd like to highlight progress on 3 of these programs including 2 collaborative projects and an expansion of our OPUS product line. First, we completed the scale up and validation of a new Protein A ligand, which has been developed in collaboration with a large life sciences company. As John noted earlier, we recorded a milestone payment in connection with the transfer of this product to our partner who will now complete development of a new Protein A media. Second, we substantially completed the research phase of a second collaboration with a large partner on a new Protein A media, which has been specifically designed for use with our OPUS Pre-Packed Chromatography Columns. This project has now transitioned to the scale up and manufacturing validation phase, which is being carried out jointly. Assuming no delays, we expect both products to be launched by our partner's commercial teams later this year or in early 2014. For both products, we have retained defined long-term manufacturing rights. A third research program is directed towards creating larger scale OPUS purification columns with 2x to 4x greater capacity than our largest column size. This program is in direct response to customer requests based on the increasing size of disposable fermentors, which in turn requires purification columns with greater capacity. I am pleased to say that we made significant progress in solving a key engineering problem that arose as we tried to extend the current technology platform to larger sizes. While there's much work yet to be done, we believe we have our first working prototypes this year, which, if successful, would result in a launch in early 2014. We're excited about the opportunity to be the first company to offer such a product and thus, the only company with a complete product line. To protect our investment in OPUS technology, we have filed a patent application on the current OPUS column design and expect there will be additional intellectual property associated with the larger size columns now in development. We are also following important trends in the biopharmaceutical manufacturing that could expand the application of our current OPUS products through the use of pre-packed columns for commercial scale manufacturing, which is a larger potential opportunity than our current target market of clinical scale manufacturing. We have identified several potential customers who are developing new commercial purification schemes in which one very large column is replaced with an array of smaller ones, which are in the size range of our current OPUS offering. If implemented at commercial scale, this new purification strategy has the potential to generate demand for more than 100 columns per year per process. To pursue this opportunity, we have begun discussions with several companies about their specific requirements for pre-packed columns in commercial applications. In one case, this has led to an active R&D collaboration with a large biopharma company to make an OPUS column customized to their specific manufacturing requirements. In anticipation of the potential expanded use of OPUS columns, we are proactively addressing customer questions about our manufacturing capacity and the quality standards suitable for columns to be used in commercial production. Our ongoing facility expansion includes 2 new larger clean rooms dedicated to OPUS, which will enable us to produce more than 500 columns a year. In addition, these rooms are engineered to operate a level of cleanliness, which will meet or exceed the standards of most demanding customers or the FDA. We expect the new facility to be operational in the fourth quarter of this year. While it will take time for these new purification schemes to be integrated into commercial processes, it is clear that this application is moving forward and creates a significantly greater market opportunity than the initial application of OPUS for manufacturing of clinical trial materials. We believe our continued investment in new products and line extensions will enable us to sustain double-digit organic growth. Turning now to our therapeutic assets. In January, we announced a worldwide license agreement with Pfizer for our spinal muscular atrophy program, in alignment with our strategic goal to out-license our portfolio of therapeutic assets. During the second quarter, we substantially completed the transition of this program to Pfizer. Second, we completed patient dosing in a Phase I trial of RG2833, our product candidate for Friedreich's Ataxia. Analysis of a disease biomarker showed that RG2833 had the desired activity in patients and that most of the patients in the highest dose level group showed a significant increase in the biomarker. While the drug was well tolerated in the short-term study, we did observe unexpectedly high levels of a metabolite, which has the potential for toxicity if administered chronically. As such, we believe there are other compounds in our library of HDAC inhibitors that are better suited in RG2833 for clinical development. We are currently in discussion with both nonprofit and for-profit groups about assuming the funding of these future development activities. Finally, we met with the GI division of the FDA to determine if there's a streamlined path to initial approval of RG1068 for GI uses, which would complement a potential partner's efforts to conduct a second Phase III trial in radiology. We'll received written feedback from the agency and we'll incorporate this in this potential path forward in our out-licensing discussions. In summary, it's been 1 year since we announced our strategic shift to focus on our bioprocessing business. We have made significant progress in the past year growing revenues and improving our operating performance particularly our gross profit margin. Our R&D efforts have delivered several new products, which will be launched in the next 6 months and we have strengthened our sales and technical support infrastructure enabling us to sell OPUS and other products directly to most of the world's leading biopharmaceutical companies. These accomplishments are the first steps in building a best-in-class life sciences company focused on the development, manufacture and sale of high-value consumables for biomanufacturing, which will enable us to capitalize on the expanded market for biological therapies and to build sustainable shareholder value over the long term. We look forward to updating you on our progress. I would now like to turn the call back over to the operator for our question-and-answer period.

[Operator Instructions] Your first question comes from the line of Drew Jones from Stephens Inc.

I guess, first question, how big was the milestone payment from the Protein A partner, and is there potential for another milestone payment on -- with -- from your media partner?

So, the milestone payment was between $400,000 and $500,000 from the collaborative partner, and that project's now finished. The other partnership is being developed jointly. So it's structured differently in that there are no milestones involved in that arrangement, it's more of a profit-sharing arrangement.

Okay. And then, I guess, looking at the bioprocessing guidance, revenue guidance. I understand there is typically a little bit of 4Q seasonality but if we look at where you maintained it, looked at what you did in the first half of the year, is there anything we should be aware of, or is that just conservatism shining through?

Well, I think you put your finger on it, Drew. In the -- December is often a soft month as many of our large customers shut their facilities down for maintenance and repair. And so that can often have an effect of slowing sales in the fourth quarter then as sometimes is the case you see a rebound in the first quarter. So we're just being cautious about -- as we approach Q4, get better visibility and if 3 months from now, we have that visibility, then we can address that.

Okay. And then, I guess, my last question is growth factor. I know that's been a big focus within the marketing effort since the first of the year, I guess, you're co- promotional rights there. Any update as far as how that's going?

Well, we had a good quarter in growth factor. It was in line with expectations and I think we continue to see that as a real growth opportunity for us through expanding, access and direct marketing activities.

[Operator Instructions] Your next question comes from the line of Michael Wood from LSA.

First of all, Walt, maybe you could talk about in general, what's going on in the monoclonal antibody space given that your business is tied to that secular industry. Any new developments, any trends that we should be aware of that you think you could discuss with us?

Well, I think the -- certainly, and since we last had a conference call, the news that came out of ASCO, the American Society for Clinical Oncology, certainly highlighted a new class of antibody called anti-PD-1. And Bristol and Merck certainly took center stage at that conference with mid-stage data they presented -- particularly, melanoma where there was some very robust responses and low numbers of adverse events in late stage melanoma patients, which was quite impressive. I think most observers of the cancer world certainly see that as a vanguard. And both of those are monoclonal antibody-based programs. So we think that there's significant opportunity for growth in the areas of solid tumors. Those companies are expanding from melanoma to kidney cancer and lung cancer and other large populations. So, I think, that was a pretty exciting opportunity for the antibody world.

Okay, and also, a question for Jonathan on the financials. You talked about a long-term goal of getting to 55% gross margins in the bioprocessing business. If I'm doing my calculation correctly, I think you were at 51% gross margin year-to-date. Can you share with us any details on how you get will get to this target?

Sure. I think there are sort of a few different elements do that. One important element is improved capacity utilization. And that's particularly the case in Sweden. We think that there are opportunities as we grow and we continue the integration of the businesses, most of the which, the initial integration, obviously, is already done but we expect to get some greater purchasing and sourcing efficiencies. And lastly, we think that there are opportunities to improve product yields that will also help gross margins and then, of course, changes to product mix are all examples of things that can drive COGS improvement. So we feel very comfortable with that target and think that, that's going to place us really nicely in the tools -- in the life sciences tools universe in terms of our performance.

Your next question comes from the line of Ron Chez from private -- he's a private investor.

Would you like to comment about the difference you talked about an array of small OPUS columns? What is the average selling -- or do you think the average selling price is and the size of the market versus what you had originally thought?

Well, the new purification schemes that are being developed might replace one very large column with anywhere from 3 to 12 smaller columns, which are continuously recycled, thereby accomplishing the same amount of purification as the single large column. And these columns without any pass-through charge, for me, it's just the actual plastic body of the column and the service of packaging could range from $10,000 to $50,000 per column. And the way these schemes are set up, the columns are used in these, as I said, arrays of 3 to 12 and they might be replaced every month, for example. So you could see, there's quite a proliferation of columns to accomplish what that one large column that cycled less frequently has done. So we think the opportunity here is certainly, potentially several fold larger than in the clinical manufacture realm. At the moment, it's led by few vanguard companies. Not every company's going to do this right off the bat, but we do think this is the future of -- this represents -- as some people refer to it as the factory of the future for biomanufacturing. And so we're very pleased to be sort of getting out at the front of that trend by already working with those vanguard companies who are pioneering the application of this technology.

So this has -- so it has expanded the potential market, right?

Absolutely.

And is any of this going to be pre-packaged media?

Well, these columns will be the ones that we would pack for customers and we would ship the arrays of columns to them as an integrated, maybe 5 columns in a pack and, they would be ready for the customer to simply snap into their pumping stations and tubing sets and they'll be ready to purify. So it's a plug-and-play type of product.

Your next question comes from the line of Larry Smith from Smith On Stocks.

I had additional questions on OPUS. I thought that was a good rundown on the previous question, but much of your comments centered on OPUS and projects that you're doing and the move from clinical to commercial space being a great opportunity. It's very hard for me to put this all in perspective. And I was wondering if you could give us some metrics that we could use to judge your progress and come up with sales projections. And along that line, would you consider breaking out Protein A sales, OPUS sales, growth factor sales so that we could follow these disparate lines of business a little bit more accurately than just by looking at a gross bioprocessing revenue number?

We certainly have given guidance in the past that the Protein A sales or the bulk of the revenue in that sort of 60-some percent range and the remainder of the business is divided between the chromatography products, of which OPUS is one and the fastest-growing one and on thirdly, the growth factors. So that's the current makeup. We do believe that, that mix will shift as time goes by because the growth factor segment and OPUS in particular are growing faster than the Protein A -- the base Protein A business. It's difficult, Larry, to give you exact projections of how that shift will go in 2014 and 2015 and beyond, but we do think that OPUS this year, 2013, is, since it was launched in February of last year, is making a meaningful contribution that will probably come in around 5% of sales. And I think that OPUS will grow potentially, significantly in 2013 particularly as we start to work with these commercial partners and they start ordering large numbers of columns. If a process -- 1 process consumes 100 columns, that would be double that current run rate in the clinical manufacturing area. When that will happen is very difficult to predict because it's regulated by the FDA, of course, and it's at the initiative of the partner company. But we have no doubt that we are in a position now, as these companies are coming to us, that we are in a position to have the leading pre-packed chromatography line in the world, and I think that's an important step for us.

But as you look at it internally, and as Jonathan makes up his budgets, what are the metrics that you're looking at in OPUS? Is it a projection of number of columns along with the mix of columns in accordance with size? How do you do it internally? How do you come up with your OPUS projections?

Well, we consider all of those factors. We consider whether the columns will be -- we'll buy the media or our customers will supply the media. We think ultimately, they'll be sort of 50-50 mix of that, which is that pass-through cost. And we have very aggressive projections that we're making. But this is a brand-new product. This is disruptive technology. So it's difficult for us to -- we have a budget, we're going to meet or exceed our budget. We think it will contribute 5% of sales this year. It's too early to say whether it will contribute 7% or 9% of sales in 2014. These new applications are just coming onto the radar screen and we're identifying new customers every week.

It sounds like it's a pretty explosive business and it's going to be a very key driver of the stock. So, I mean, I think, all of us are looking for a way to model it as accurately as possible.

I certainly understand that. We do believe it's a key driver of the business in 2014 and beyond. And we're putting our money where our mouth is and investing in the facilities I alluded to in my talk because we're quite sure that this business will mature into a significant driver. And there's no reason why OPUS can't be as big as Protein A or larger at sometime in the future. When we'll get there is hard to say.

Your next question comes from the line of James Gowen from Kalmar Investments.

I wonder if you could just go back on the growth factor opportunity and just talk a little bit about how to think about that in out years as far as your customers maybe going through an evaluation phase and then adopting that into their processes and how we should think about that relative to the overall bioprocess growth.

Well, I think there's 2 drivers for the growth factor business. One is we do have existing customers who are using growth factor in their commercial products. And so, as those commercial products grow or as those customers bring other products through the pipeline, into Phase II and Phase III trials, there's a driver for increased demand there. And then secondly, layered on top of that, there's the opportunity to begin to sell the growth factor to new customers who have not previously used it in their process, they may have used insulin, for example, in their prior processes. That will be a somewhat slower uptake because you have to go through Phase I, Phase II processes. But it just adds to the very robust growth were seeing from the existing customer base right now. Another opportunity that we're looking at is the potential to substitute our growth factor for insulin in the stem cell markets. It's a smaller market to be sure but we have a product that can be directly substituted, we believe, for insulin, and we're developing the technical data to support that claim throughout the second half of this year. So for the growth factor, I think I've given guidance before that if the overall company guidance is 10% to 15%, we think the growth factor can exceed the 15% mark and therefore, be a driver of the overall business.

Great. And you all provided a summary balance sheet. Any comments as far as royalty receivables? And then inventory, particularly, I think you had some inventory carryover from first quarter? If that's pretty much through?

So, sure. The -- so the royalty receivables is just -- I would call it natural timings of when quarters begin and end and when we get payments from Bristol-Myers, primarily, on Orencia, of course. With respect to inventory piece that I think you're referring to, you're going back to the older inventory that provided a headwind for us against gross margin in the first quarter. We thought we'd got about I'd say $400,000 to $500,000 of that inventory left on our books and we will sort of, if you want to say, bleed that off over the balance of the second half of the year, that would be one way to certainly think about it. So most of that is certainly behind us.

Okay. And any comment on just capacity utilization across the 2 facilities where you are right now?

The capacity utilization here in Waltham is high, approaching 100% in Sweden. This quarter, because of the uptick in demand for affinity ligands, the Swedish facility ran it close to its 5-day capacity. We do not have a 7-day work week there. And we think over the year, the capacity utilization in Sweden will probably be in a sort of 70% to 80% range.

Ladies and gentlemen, we have no more questions in the queue. I would now like to turn the conference back over to Mr. Walter Herlihy for any closing remarks.

I want to thank everyone for participating in today's call. And as always, if you have any additional follow-up questions, please feel free to contact us directly through Investor Relations. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.