Fagron NV (FAGR) Earnings Call Transcript

Ladies and gentlemen, thank you for holding, and welcome to the 2021 Semiannual Results of Fagron. [Operator Instructions] I would like to hand over the conference to Fagron. Go ahead, please.

Hello, and welcome to Fagron's first half of 2021 conference call. Today, Rafael Padilla, CEO; Karin de Jong, CFO; and Andrew Pulido, President of Fagron North America, will guide you through the results for the first half of 2021. We will refer to a presentation that can be downloaded at our website, investors.fagron.com. There will be an opportunity to ask questions after the presentation. I will now hand over to Rafael. He will start on Slide 3 of the presentation.

Thank you very much, Constantijn. Good morning all. And Constantijn, congratulations with your new appointment as Area Leader EMEA. For sure, you're going to do a very good job. It's very good that today, also, we have our colleague, Andy Pulido, so please feel free to ask a lot of questions regarding the growth propeller of Fagron in the upcoming years. So Andy, thank you very much for being here.

Thank you.

So when we move to the first slide of the presentation, the first semester highlights. Financially, our sales decreased 0.8% to EUR 276.6 million, that is a growth of 5.9% on constant exchange rates. Our gross margin decreased 140 basis points to 58.4% due to, as we indicated today in the press release, temporary COVID-related impact; we will elaborate later on. Our EBITDA decreased 11% to EUR 56 million. Our operating cash flow increased 15.1% to EUR 31.3 million. Our net financial debt/REBITDA ratio was 2.18 at 30th of June 2021. And the outlook for 2021, we foresee further growth in sales with a REBITDA margin between EUR 118 million and EUR 124 million. When we move to the next slide.

Yes, so one of the key highlights in the first half of 2021 was the acceleration of our sales growth at Wichita at our Fagron sterile services businesses. Towards the end of the second quarter, we realized a run rate of roughly $70 million annualized. That can be attributed to the launch of 15 new SKUs, primarily focused on RIB bags, which we see a tremendous opportunity. We also invested in our headcount with the addition of a second shift, so roughly 60 new FTEs in order to prepare for more accelerated growth. We also announced this morning the acquisition of the activities of U.S. Compounding. And so based on the factors that we saw in the first half of the year, the onboarding of roughly 400 new accounts and then the acceleration of our new product development pipeline, where we added 15 new SKUs, we are confident in the stated target from $118 million, plus the activities of U.S. Compounding to create a $125 million run rate in 2022.

Thank you, Andy. We stay in the operational highlights of the year. As we have stated, indicated many times, we started the movement of our production activities in the repackaging -- GMP repackaging raw materials in our new facility in Poland. You can see here the pictures of the warehouse, the lab and the front door. We started then, as we said, as we indicated, in the mid of this year, the first products are now, as we speak, coming out of the new factory, and we're going to see a structural annual contribution margin of EUR 2 million as from 2022. As well, we're very proud to share with you that we have completed the construction of a new lab in Iran (sic) [ Israel ]. As you know, the acquisition of Pharma Tamar last year. And the Israelian market is very attractive for us as we offer a full service to the industry there. So we sell the raw materials, the brands, the compounding services, not-sterile and steriles. So we invested in this attractive market in Israel. Also, as we have indicated today this morning in the press release, we have here indicated that our management structure has been reshaped a bit in order to have more efficiency in a decision-taking process. We have, of course, next with CEO and CFO indicated at person for M&A activities, that is Johan Verlinden, our colleague, Johan Verlinden. And next to the 3 of us: Andy, North America; Ivan, Latin America; and Constantijn, EMEA. You can see a diversified colleagues in terms of nationalities and also with a lot of experience, as you can see in the years being in the company.

Good morning, everybody. The next slides will explain the H1 2021 results per region. The first slide represents the geographical breakdown of the sales of Fagron. EMEA is the biggest region of Fagron with EUR 128.9 million of sales and shows growth of 6.3%, including acquisitions. North America increased sales by 2.7% to EUR 82.3 million, which was an increase of 12.3% against constant exchange rates. Finally, Latin America increased sales by 7.2% to EUR 65.4 million or 25.2% against constant exchange rates.

Thank you very much, Karin. Well, we move now into EMEA. We can see the sales decrease of 6.3%, organically at 10%. Of course, what we indicated, we have seen lockdowns in different countries in the European region and all the restricted COVID-19-related measures, and this impacted the demand of our Essentials segment and the nonsterile Compounding. We will see in the third bullet, of course, that we see a nice development in the Compounding Services that decreased only 3.9% during the second quarter compared to the decline of 18.8%. Of course, we'll see in the next slide, the recovery of the first issued prescriptions right in the Dutch market. So that's very positive for us because the funnel is now being filled. And as we also explained last time, our 100 new prescription -- 100 prescriptions, sorry, 20 come from the first new and 80 from repetition. When we go then into the further explanation of the sales in EMEA, we can see that the demand of specific COVID-19 items was absent during the first 6 months of the year. And of course, again, we have seen the sterile compounding and the brands were performing strongly. Our REBITDA was down 14.4% to EUR 28.6 million, a decrease of 210 basis points. As we also indicated, this is temporary impact on the gross margin due to COVID-19-related issues in the supply chain, and of course, a temporary increase in costs relating to the new factory in Poland that we saw. In the next slide, of course, we see the scripts that we said indicated in the second bullet on the sales. Then we go to Latin America. In Latin America, we continue our strong performance. The number of doctor's visits and prescriptions increased, again, in the first semester of 2021. We strengthened our leadership with good sales growth in the Brands and Essentials. Our activities in Colombia, Compounding Service activities, grew 52.1% at constant exchange rates. And our REBITDA was up 1.9% to EUR 13 million. The margin dropped 100 basis points. And here, we see, again, impact on the supply chain issues as an example that we have spoken. We see, for example, a container that normally cost $800 to bring for Far East to Sao Paulo, and it was increased during this first half for 10x. Then we move into the next slide, North America.

Yes. Moving into North America. You saw an increase in the first half of this year versus the same period last year of 12.3% at constant exchange rate, 2.7% in euro. And our -- when you look at the underlying data, you saw a 2.7% decline in constant exchange rate in our Brands and Essentials business. This was primarily related to demand for our COVID-19-related products, almost absent this year versus prior periods, albeit the underlying business is very, very strong. When we move to our Compounding Services businesses, particularly Fagron Sterile Services, we saw very exciting developments in the first half of this year. We were up 32.3% on a constant exchange rate. When you look at quarter 2 of last year, we were more or less on a run rate of $3.2 million per month when we wrapped up quarter 2. This year, we're on a run rate of $70 million. And so very exciting developments. This can be attributed to a launch of new SKUs as well as rolling out our IV bags, which we have large expectations for. That, in combination with the acquisition of the assets of USC, we've raised our target to $125 million for 2022 run rate for FSS. At our Anazao business, we saw a 16.8% increase in constant exchange rate due largely to favorable industry dynamics as well as clinics reopening in the second quarter of 2021. Moving down to our REBITDA. We were down 14.1% year-over-year. So we did EUR 14.4 million. This is primarily related to 2 factors. The first one being an impact on our gross margin due to COVID-19-related issues and our supply chain, so mostly increased cost of goods and increased transportation cost, as Rafa mentioned, that we've seen in other regions. Traditionally, we have been -- or historically, we've been very successful in being able to pass these temporary price increases on to our customers. So we are monitoring that situation very closely. Secondly, we made a strategic investment in our FSS business to increase another shift in order to prepare for our accelerated growth in the second half of this year in 2022. So we added 60 new FTEs. And so by doing this, we feel like we're very well positioned and are very confident to hit the guidance that we've given for the $125 million. We also are confident in our ability, as we continue to grow the business, to bring EBITDA margin structurally to 20% as we stated below in 2020 -- or as we stated before in 2022.

Thank you, Andy.

Moving to the next slides. The next slides will summarize the financial results of the first semester of 2021. So the first slide represents the turnover development in the different regions for the first semester. Sales decreased slightly from EUR 278.8 million last year to EUR 276.6 million at the end of the first semester. EMEA shows a decrease of 10%. We see Compounding Services in EMEA recovering compared to the first quarter of 2021. Elective care is starting up again in our main markets, and a number of prescriptions are increasing. However, this is compensated by a drop in Essentials sales because of decreased demand for COVID-related products. Latin America shows a growth of 25%, driven by a combination of price and volume increases. U.S. sales increased by 12.3% or EUR 8.8 million. The Essentials business increased by 16%, while the Brands decreased by 23.1% as a result of COVID-related sales decreasing. Sterile services increased by 23.7%. There's a negative FX impact because of weakening of the Brazilian real and the U.S. dollar of EUR 18.6 million. On top, there is EUR 6 million of acquisition growth, mainly because of the acquisition of Tamar, resulting in a total sales of EUR 276.6 million. Moving to the next slides. The gross margin shows a decrease of 114 basis points to 58.4% compared to last year. The main reason for the decline is the impact we have from various COVID-related developments, resulting in limited availability of products and higher costs. We estimate the impact roughly around 1%. The operating cost, excluding subscription rights, increased slightly by 0.7%, resulting in a REBITDA of EUR 56 million, a decrease of 11%. Moving to the next slides. The nonrecurring costs are EUR 0.7 million, which are mainly related to the restructuring costs we had in EMEA and a release of a contingent liability in Latin America. EBITDA decreased to EUR 55.3 million. Depreciation and amortization also decreased to EUR 14.6 million. Going to the next slide. The financial result decreased by 15% to EUR 6.1 million. In April of 2021, we repaid USD 60 million of outstanding notes, which resulted in a decrease of the interest cost of Fagron. The effective tax rate is 22.2%, and the cash tax rate is 27.4%. The reasons for the increased cash tax rate is a combination of decreased profitability and timing of payments. This all results in a net profit of EUR 26.9 million, a decrease of 14.6%.

Thank you very much, Karin. So to finalize this presentation, what can we expect for 2021? We can expect further growth in sales with a REBITDA of between EUR 118 million and EUR 124 million. We also -- and this is a job that we did in the last 9 months, we streamlined the EMEA region with the back office with the facility in Poland, but also rationalization of our front office activities in important markets like The Netherlands. And now Constantijn can take it over, and of course, can make a big success out of it. We are going to leverage as, Andy said, customers, 400 new accounts and SKUs totally on track for 2022, 180, 200 new SKUs. Now we're going to launch also [indiscernible], right Andy?

Yes.

Correct. Also, we are working on our strong R&D pipeline with products in our Brands and Essentials aimed at prevention. Our sterile compounds, we are the global consolidator of the sterile market worldwide with activities in 6 countries. And of course, the global platform of Fagron Genomics that are an enabler of our Brands and Essentials business, totally aligned with personalizing medicine. And as we saw today with the acquisition of the book of business of U.S. Compounding, an active and disciplined acquisition strategy focused at EMEA and North America and with also, as we stated, within the team, a dedicated colleague in order to execute this strategy. And now we open the time for questions. Thank you very much.

[Operator Instructions] The first question is from Mr. Frank Claassen, Degroof Petercam.

Yes. First question on the impact on the gross margin of the COVID-related raw material increases and the transportation costs. How quickly can you -- do you think the situation can normalize? And what are you doing? Are you -- yes, can you, for instance, quantify the price increases? Are you opening up -- breaking up existing contracts? So could you elaborate, yes, how you think this situation will evolve going forward?

Yes. Thank you, Frank, for the question. Yes, indeed, we see a decrease of our margins. We believed initially we will see recovery this semester. However, we saw a rapid rise in the price of certain raw materials and packaging, partly as a result of COVID-19 and the global vaccination programs. We see transportation costs risen substantially. And on the current contracts, these cost increases cannot always be passed on in full or only with a delay, resulting in a temporary negative impact on our gross margin. That said, we believe it's a temporary impact. We believe we can pass price increases with the customers and can come back to levels pre-COVID, so that's around 60%. However, we do not know how the new developments regarding COVID, especially the outbreak of the Delta variant can impact us, so it's difficult to provide an indication of timing. That said, we are positive that by the end of the year, we would see a recovery in the margins again.

Okay. And could you also quantify the price increases you have to pass on? Is that quantifiable?

Yes. That differs a little bit per market. So you know Brazil is pretty dynamic. So we can pass part of the price increases a bit easier, although we do see that with the huge increases in Brazil that we are not able to pass it all at this moment. So when we see the growth in Brazil, it's a combination of price and volume. Price, double digits, so a little bit over 10% is price driven. Yes, we see price increases way over that. So at that point in time, it's for us difficult to increase even more in that already very dynamic market. Other markets are a bit more easier. But, for instance, in Europe, we have contracts that are running. So it's not that easy to immediately increase prices. But over time, we are positive that we can increase those prices.

Okay. And then you helped us on the gross margin the impact, but there were also some extra costs in the first half for the packaging facility and also for Wichita. Could you roughly indicate how much, yes, additional costs you've added because of these 2 reasons?

Yes. No, so we indicated indeed that the OpEx remained stable here around EUR 103 million compared to last year. And we see indeed that on the one side, the increased costs are in U.S. Compounding part to accelerate that growth. You also see that in the EBITDA margin of the U.S. We see an increase in Poland. We also believe that's temporary because we have -- we are transferring products from The Netherlands to Poland. So there are double cost in that process. So we believe that's a temporary impact. Of course, we see, on an absolute amount, also an increase because of the acquisitions. Those costs are being compensated by savings we realized there. We mentioned last year that we had a reorganization. So that's compensated partly of the OpEx we invest in the business. And this is the level of details we want to give, Frank.

The next question is from Mr. Matthias Maenhaut, Kepler.

Yes. Two questions from my end. First one is on the guidance. You have a guidance bracket to arrive at full year adjusted EBITDA between EUR 118 million and EUR 124 million. I'm just willing to try to understand a little bit better what's going to be the swing factor for Fagron, arriving either, respectively, at the low end or at the high end of that guidance? And maybe also some more color per region on what to expect? And then second question is actually on the strategic investments done in the Wichita facility. And so a second shift, I was just wondering next to this initiation of a second shift, what is still needed to get to full capacity of the facility? And can we just -- can you confirm actually that with these investments, there's the potential to do more than $125 million? And how much more? That's my second question.

Yes. Thank you very much, Matthias, and good morning. Regarding the range that we gave today and how do we see the shift, what we see is that our fundamentals remain strong or even stronger during this pandemic we have seen. And we also see improvements in, again, 2 strategic elements, what we said in the presentation. That's one, the fund service activities in Europe, that is mainly The Netherlands that we see a positive trend. We're coming from minus 18.8% to minus 3.9%. So that's a good positive trends aligned with the issued prescriptions. So that's one element. The second one, of course, the ramp-up on our Wichita facility in the U.S., as we said, the propeller for our growth. Of course, Q1 sales were somehow weak with an improvement in the second quarter, more toward at the end of the second quarter. So that's another element. Of course, what we have said today, we have seen some margin erosion during this first semester due to the COVID-related situation in the supply chain, also with the new Wichita 60 FTEs that you're going to leverage now, Andy, and the movement of the Polish facility. So all these elements give us confidence in order to give the range of EUR 118 million, EUR 124 million, right? So then moving to the regions, what we see in LatAm? As we indicated, we see continuous strong growth there. Of course, with the pricing that we monitor on a daily basis with this dynamic of the markets, we will also continue passing through this price increase that we have seen in the supply chain to our customers. And there, we are very well positioned because also we made the step of building some strategical inventories there in order to stay as we are very much competitive in the U.S. Of course, Andy, you will elaborate how the margin will evolve in the semester, but we are very confident. And in the EMEA region, of course, with the project that we have done the last 9 months on streamlining the organization, on centralizing the back office, on the operational side, on having this delay of price increase in some of the contracts, we are also very confident that we'll see also an improvement there. Andy, maybe you can tackle the second question on Wichita?

Yes. So on the question -- second question on Wichita about full capacity in the 60 new FTEs. Of course, we took the decision to make a strategic investment in 60 new full-time hires for the operation to create the second shift. When you looked at our business last year, on a monthly basis, in the second quarter, we were a little over $3.2 million per month. Of course, now as we wrapped up the second quarter this year, we were around $5.8 million per month. You look at the acceleration of the new product development pipeline and the onboarding of roughly 400 new accounts, which take more or less around 4 to 6 months to fully onboard, especially for the larger hospital systems. So that gives us a lot of confidence that adding these 60 new FTEs is the right decision in order to continue the accelerated growth in the second half of this year as well as in 2022. As it relates to capacity, I think more or less, we should have sufficient capacity in the facility up to around $200 million or so, which we previously communicated in the past. The team is doing a great job rolling out our IV bags and whatnot, and you can feel the energy and the enthusiasm as we continue to accelerate the business.

All right. If I may follow up? To get to that $200 million, are there any additional investments still necessary in terms of equipment, et cetera? And what would be like a reasonable time frame to get to the $200 million? And also from a, yes, I would say, product innovation perspective, what can we still expect for the remainder of the year?

Yes. Yes, Matthias. Andy, you will answer now, right? But just for the benefit of doubt, Matthias, we -- when we stated $200 million, it's not a new guidance whatsoever. And when are we going to get there, right? So we were at $118 million. With this movement with the book of business of U.S. Compounding, we feel comfortable with the $125 million. We are on track. And the $200 million is the capacity of the current facility, right? Just for -- and if you want to add here something, Andy, what are the investments necessary?

Yes. Of course, we're always looking at different automation techniques and whatnot. Part of the facility is automated and whatnot. When we think about our new product development, we've traditionally played and serviced our customers with OR syringes. We strategically launched our IV bags in the first half of this year, which we have already seen a nice impact from. And so we will continue to see further developments and new product development efforts in that category. But when we look towards next year, we're really focused on being a one-stop shop, full-service provider for hospital outsourcing. And so we really need to be in 4 key categories. The first one, OR syringes, which is our historic business that we focused on; our second, IV bags, which we launched in the first half of this year; and the second and third are epidurals and CADD cassettes, which you will see us rollout in the second half of this year and the first half of 2022. Those products, all in combination, give us significant confidence that leaves us enough headroom to be able to continue to grow, not only to the $124 million but beyond.

Yes. And maybe, Andy, also we can explain to Matthias about the investments that, for us, of course, quality was always the first driver for success in Wichita, right? So far, we have done a good job there, but that we invest in service levels, right? That is a very important for the industry, correct?

Yes. So as I'm sure you could imagine with our -- the largest player in the marketing -- or the largest player in the market exiting at the beginning of 2020, the need is greater than ever for really strong, reliable hospital outsourcing partners. So from our standpoint, we have, over the last year, been very targeted in how we think about our growth and onboarding new customers as well as the way in which we roll SKUs out, so that we can ensure that we service our customers with very high service levels. Right now, we're more or less around 97%, which is, I believe, industry-leading. And so that gives us quite a bit of confidence that the way in which we're doing it, adding on the second shift that we can continue to accelerate our growth in the second half of the year and next year as well.

The next question is from Mr. Lenny Van Steenhuyse, KBC Securities.

I was wondering also a bit on the U.S. operations. So some questions on that. I was wondering if you could elaborate a bit on the acquisition of U.S. Compounding? How's the product offering and customer base compared to the existing one of Fagron in the U.S.? And then question. On top of that, you mentioned the 400 new accounts being added, how do you feel in terms of overall market share in that Compounding segment? How is that shifting in the U.S. through the lingering pandemic effects? How much do you feel of that could be sticky? Or do you expect still some churn, let's say, of the overall market share?

Yes. So on the U.S. Compounding book of business acquisition, it's more or less $6.5 million annualized with a product portfolio that is quite similar to our product portfolio. We do have the ability to add on a few new SKUs from this deal, albeit there will be a transition in order for that to take place. And so really what this deal gives us is, it gives us access to new customers, and it gives us the ability to take customers that we share together and expand the share of the wallet with our launch of IV bags. So we're quite excited about that. Again, for the first half of this year, we do expect a transition with the quality standard, CGMP, CFR 210 and 211. It does take some time to transition these customers properly in order to have long-term relationships with them. So we expect some time there. But mostly, this is an opportunity for us to further strengthen the relationship that we have with customers that we share and to gain new customers. As it relates to the 400 new accounts that we added in the first half of this year, we see a really great potential to grow with these accounts. It takes about 4 to 6 months on average to really fully onboard these accounts. So for the accounts that we landed at the beginning part of the year, January, February, March, you saw some of that revenue coming in the second quarter, which is why we were able to realize a run rate of roughly $70 million in June. For the folks that we added on towards the back half of the semester, we will see those customers come into fruition at the end of the third quarter, at the beginning of the fourth quarter. And so that, in combination with being a more one-stop shop, we feel like that gives us a lot of stickiness. Our customers, once they make a transition because of the quality standards and because of the involvement and as I'm sure you can imagine, the larger the hospital system, the more challenging it is to move their hospital pharmacy operations to us. It requires high service levels. And when you have high service levels and you can provide one-stop shopping with a top-notch customer experience, they tend to stick with you. And so that gives us a lot of confidence that we won't have very much customer churn if we do our job operationally to keep the service levels very high, which we are confident at.

All right. And perhaps if I can squeeze in another last question also on the EBITDA margin guidance? Just a quick one. Does the guidance take into account or assume similar increased costs for the second half of this year? Or is there already some alleviation expected in costs for the coming months?

Yes. So maybe to answer that one, so for North America, we, of course, expect to see leverage based on the investments we now do on the 60 FTE and the sales increase. For Poland, we do expect that when the transfer is finalized somewhere in Q3 and early Q4 that those costs will run out of our P&L.

And how does that relate to the gross margin in terms of costs?

Yes, so the EUR 2 million we communicated earlier related to the transfer of Poland, that's a gross margin improvement, which we will see the full benefit of that in 2022.

The next question is from Mr. Stijn Demeester, ING.

Yes. The first one is also on Wichita, I'm afraid. So basically, you are adding -- you're expanding your workforce by 30% in Wichita on basically the same sales target. So can you help me understand what has changed or yes, how you will be able to recoup these added costs of these FTE increase on a sales number that is roughly the same as before, including the $6.5 million of acquired sales? So what has changed that you can pass on these higher FTE costs given that your margin target of 20% is basically unchanged? That's my first question.

As it relates to the 60 EFTs, it was certainly something we needed to go from the $3.2 million to the $5.8 million. And so part of it is to be able to keep our high service levels through the business that we've already added on. But part of the benefit of the way that you land these contracts, so we saw the 400 new accounts in the first half of the year as well as the acquisition of USC's $6.5 million more or less a business, we felt that it was imperative to prepare for the future. As I'm sure you could imagine, in a CGMP facility with top quality, you can't make decisions overnight. And so in order to be able to grow really efficiently and swiftly in the second half of this year, we felt that the 60 new FTEs were needed in order to put that infrastructure in place. When you add on the second shift, as you think about our first shift and what we were able to realize, when you look at the second shift, I would expect that what we've added remains somewhat fixed because you will get leverage there, and you do get synergies when you're adding these shifts and when you look at our manufacturing process. So I would expect that the new 60 FTEs will give us sufficient room in order to be able to grow and realize the operational leverage.

Sure. I appreciate that. But where do you aim to recover those costs of this workforce increase if there is not another change in the market as to pricing, for example?