Fagron NV (FAGR) Earnings Call Transcript

Hello, and welcome to the Fagron's Third Quarter 2022 Trading Update Call. My name is Laura and I will be your coordinator for today's event. Please note this call is being recorded. [Operator Instructions] I will now hand you over to your host, Karen Berg, to begin today's conference. Thank you.

Thank you, and good morning, everyone. My name is Karen Berg, Head of Investor Relations at Fagron. Thank you for joining this call where we will discuss the Q3 trading update for Fagron. We will start with an explanation of the results by Rafael Padilla and then we will hand the floor over for questions which will be answered by Rafael and Karin, our CFO. Thank you all. And I would like to hand over to Rafa.

Thank you, Karen. Good morning, all. Welcome to our Q3 and 9 months trading update. Before Karin and I take your questions, we'll go through the presentation where we will explain our Q3 and 9 months' revenues. We will then elaborate on our current macroeconomic developments and how these play in the different regions where we operate. We'll discuss on the increasing regulatory environment and how we work to ensure the highest quality standards. And we'll then finalize later in the year our full year guidance. Moving to the next slide. When we look at our 9 months revenue, we see an increase from the EUR 419 million of last year to the EUR 0.5 billion mark supported by all regions, strong M&A execution and ForEx tailwind. When we deep dive in the quarter, EMEA shows a 10% growth supported by the 3 business segments where we operate, essentials, the raw materials, brands, our added value products and compounding services, both sterile and non-sterile. LatAm shows the same picture, with 60% total growth supported by all 3 segments. In North America, with 39% total growth with compounding services and essentials strong and brands showing a decrease being a reflection of current operating environment. Moving to the next slide regarding our Q3 operations. At a global level, we continue to see a disrupted supply chain and inflationary pressure. A good example is sterile syringe shortage in Wichita. We counteract, as explained several times, globalizing our procurement and supply teams in order to limit this impact. Following our sustainability strategy, we committed to set science-based emission reduction targets. On an organizational note, we have appointed Geraldino Neder as LatAm Area Leader. Geraldino has more than 30 years' experience in the Brazilian compounding market, being 12 years already at Fagron. He brings strong commercial and innovation expertise. Jumping to the regions. EMEA's growing trajectory continues as a result of the strategic actions taken, a centralized production, streamlined back office and brand rationalization in the Benelux. In a very relevant note, our Compounding Services activities in the Netherlands continue showing further stabilization. For this region, continuous progress on price pass-through exercise is very important and we are making good progress here. Finally, our GMP repackaging facility in Poland is fully operational and we start seeing the benefits out. Going into LatAm, we see a continuation of softened end-user demand this quarter, resulting in increased competitive intensity. In order to maintain market leadership and drive operational efficiencies, we're executing on back and front office projects and centralizing all our warehouses activities, being this finalized at the second semester of next year and optimizing our brands by merging 3 of them into 1 to gain efficiency and improve innovation capabilities. To finalize, we continuously assess opportunities to strengthen our market leading position in the second biggest compounding market in the world. Moving into North America. We clearly see a strong underlying demand on the 3 segments where we operate. Going to each one then. During this third quarter, at our B&E division and due to the Minneapolis warning letter, we have started the transfer of sales to our Letco facility. This part of our original integration plan has been now accelerated. Within the frame of the remediation plan of the Minneapolis warning letter, we have voluntarily put some batches on hold, causing a displacement of sales into the next 2 quarters as we satisfactory release that. Moving into FSS, with a current run rate of 88 million (sic) [ $83 million ] and as we flagged at the semester update, we continued experiencing strong syringe shortage, worsened during this quarter. We do not expect to get it better during this fourth quarter. To remedy this and secure constant supply, we are, as we speak, validating 2 new syringe suppliers. This process takes approximately 6 months. We are very pleased with the evolution of our new FSS Boston facility, as our commercial team is onboarding several new customers and taking advantage of the sterile-to-sterile IV bags capabilities we have there. Integration with Boston is going according to plan. Finally, on our Health and Wellness division, Anazao, we see good developments in the third quarter, especially at our Vegas facility. As during the last week of the last month, our Tampa facility could not ship because of the Hurricane Ian. Also the rest of our business in North America could not ship into the Southeast, especially in Florida, due to the hurricane. One final note, and clearly post COVID, we see increased regulatory scrutiny of the FDA. And moving to the next slide, we will take the chance to explain how the FDA's audit process works. A facility is being normally inspected under 2 years. After that, in most of the cases, an observational report is being prepared. The company, in a real basis, updates agency and depending how this evolves, it can be closed or a warning letter is issued where the same process of regular updates continues. When we look at our facilities in the U.S., currently at Minneapolis, we are updating regularly the agency on our remediation plan. As said, a displacement of sales to the next 2 quarters and transfer to the Letco facility is now ongoing. In Wichita, we received an audit in March this year with 6 observations. We delivered our final response in April and now we wait for the close-out report. At Anazao, Vegas, we were audited in July and received 5 observations. We are now in the response process. For the other facilities, at Tampa, we received the last inspection in 2019. At Letco, in March this year and at Boston, a remote assessment in 2021, all of them with no pending observations. And as quality leadership -- moving to the next slide, Karen, please, is in our industry a differentiation factor. We, as the global market leader in the niche market of pharmaceutical compounding, we benefit from a resilient business with diversified geographical presence and the broadest product portfolio in the industry with favorable underlying trends as demographics and personalization. As we have seen, we have strong M&A execution capabilities and we have as well strong financial profile with high cash generating operations and a net debt-to-EBITDA ratio of 2.2. And finalizing, going to the next slide, Karen. We reiterate our full year guidance. We will, excluding the Boston acquisition, book revenues between EUR 670 million and EUR 600 (sic) [ 690 ] million with better margins in the second semester compared to the first one. Thank you very much. Now time for questions.

[Operator Instructions] We will now take our first question from Frank of Degroof.

Frank Claassen, Degroof Petercam. Three questions, please. First of all, you mentioned the Hurricane Ian as impacting your revenues. Could you quantify this in Q3? And will it also have an impact in Q4? Then on the Boston facility, the acquisition, what did you do so far on the integration? And what level -- you indicated now run rate roughly $15 million. What kind of run rate do you envisage to get to the breakeven target for the end of next year? And then finally, on pricing. Could you elaborate here what did you do so far? How easy is it to pass on the higher raw material prices? And does it also have an impact on your gross margin already?

So thank you, Frank. Maybe to start with your first question on the hurricane. So indeed, we have a facility in Tampa, so that's the Anazao facility that was impacted by the hurricane in the last couple of days of September. So the last couple of days of the months were impacted. Those sales will be shipped out in the first week of the next quarter. So there we see some impact, but it's limited to a couple of days. And next to that, we also see that shipping into the states to customers we have in specific states was difficult during that period. So that impacted also the other companies we have shipping into that specific states, but again, as mentioned, that sales that will be shipped in the early of quarter 4. So we don't quantify it. It's a couple of days which moved from one quarter to another quarter.

Thank you, Frank. Let's take the Boston question. When we acquired the Boston facility, as we speaked during the semester call, we had revenues of low double digit at that time. Now what we're doing, we are, first of all, integrating on the sales side all the activities. So this means that our existing commercial team that was, of course, selling the Wichita plant, is now offering as well the solutions that we make -- we produce in Boston. That's mainly the sterile-to-sterile IV bags. So this is now taken in their portfolio. And next to this, as we also explained, we are applying for new licenses. We are now licensed in 11 states and we're applying for 9 states like California, Texas and Florida.

Maybe on your third question on the pricing element. So indeed, as we explained during our semester results, we see inflationary impact throughout our businesses. But we are able to pass on price increases towards our customers despite the fact that it's different within the different regions. So in the U.S., it's easier to pass on price increases. Brazil is a very dynamic market, so there's always price competitiveness on top line. For EMEA, we can pass on our price increases over time. So we start doing that already early this year and we see that continuing very well. So we'll keep on doing that for the next couple of quarters. So we can pass on the price increases and compensate for the inflationary impact we see through the regions.

And do you already see, as a result, the gross margin improvement because of these price increases?

Yes. As said, this is of course a trading update, but we reiterate the guidance we have given. So we expect that we see an improvement in our profitability for the second half of this year.

Okay. That's clear. And coming back on Boston. What kind of run rate of revenues do you need to get to breakeven? Could you elaborate on that?

Yes. So in the original plan, as we communicated, it will take approximately between 12 to 18 months to bring it to breakeven. We are on track with the plan. And again, we are very pleased because we're onboarding new customers with the existing sales force that we have now.

But no number to...

Yes, sure, Frank. As we explained during the last call, during the full year results, we will elaborate on the figures of the Boston facility.

Okay. That's fair enough.

Thank you. We'll now take our next question here from Stijn of ING.

Yes. Three questions if I may and all are related to Wichita. The first one is basically on '23 (sic) [ '22 ] as you are cutting your year-end sales guidance by some EUR 30 million in sales, should we factor in a similar cuts to our '23 assumptions? So what confidence do you have that you can recuperate these sales over the course of the year? Is it simply a function of pent-up demand which you can cater to as the syringes come in? Or are there additional risks related to the ramp-up? Secondly, I think a couple of quarters ago, you mentioned the double shift and hiring of 70 new people. Does this -- is this plan somewhat affected by the recent events? Or is it still continuing as progress? And actually there then be an impact on the margin that you can sort of earn on Wichita? And then the last question is on the new syringe suppliers. You mentioned that it takes 6 months. When exactly did you start with that process of finding new suppliers and when should we sort of think about the problem to be resolved? These are the questions I have.

Okay. Thank you, Stijn. Maybe to start, and Rafa will also jump in on the more specifics regarding the syringes. So on the run rate, indeed, what we see is that there's supply chain shortages on the syringes. Most of our products that is coming from Wichita are the syringes. So we see impact on our run rate and sales going forward. However, we do see this as a temporary impact. The underlying demand in that market is very strong. So from that point, any issues going forward, it's more on the supply side. And there, we took action on getting 2 new suppliers for the syringes on board. So we expect this to be temporary. And that doesn't mean that we go back on the fact that we expect the run rate to keep on growing. It grew slightly in the third quarter. We expect to continue to grow in the fourth quarter despite the fact that we see an impact on the syringe supplies for that sector.

Sorry, if I may here. When you say that the run rate grew slightly in Q3 versus Q2, is that including Boston or organically?

No, that's organically. Organically.

That's, Stijn, the 88 million (sic) [ $83 million ] that we said during the presentation, right? And on the -- on your question specifically on the operations, the third shift is in place. So we are prepared because, as Karin said, the demand is strong. The underlying demand is very strong in that market. And on the onboarding of those 2 new suppliers, so we received already the syringes. And now we are in the validation process. So this means that the SKUs that we prepare on the prefilled syringes, we need to do validation studies and this takes approximately 6 months. So we'll have these new suppliers ready to go ahead, ready to go into the production during the first semester next year.

Okay. And then on the sort of margin that you could expect given the new hires and sort of lower run rate sales which would suggest that sort of breakeven point is a bit -- I mean not breakeven point that, that operationally or profitability-wise, it could be somewhat lower also for '23.

Yes. So on the longer term, I think there's enough volume to create leverage and increase profitability levels for that -- for Wichita, for that site. It, of course, will have a slight impacts. But again, we reiterate our guidance and we will see for the overall an improvement in profitability. On the longer term, we believe that a third shift is needed to cover the volume and we will create some leverage.

Thank you. We'll now move on to our next question from Matthias of Kepler.

Yes. Maybe three left. Maybe first on Latin America. There, clearly, organic growth is slowing further. Could you maybe elaborate on the price volume mix and also on the measures you have taken? You mentioned streamlining operations. Could you maybe elaborate on what that just implies and how you are going to revive the organic growth there? That's my first question. I will ask them one by one.

Maybe to start with the price volume mix. So we see that we are slightly increasing our volumes, but we do have negative pricing impact in that market.

Yes. Matthias, on the streamlining projects that we are launching in LatAm, especially in Brazil, so when you look at the back office side, we have already centralized all the back office admin activities in Sao Paulo. And now we are centralizing all our warehouse activities. So each brands have their own warehouse and now we bring them together into a centralized warehouse that will, of course, improve our logistics and our service capabilities to the market. Nextly, on the front side, we are now starting an exercise of optimizing our brand. So we took 3 of our 6 brands in the Brands and Essentials division, and we're going to bring it into one. And by this, we're going to have more innovation power because -- and going to your last question on how are we going to grow again organically? There, you need to have 2 things. First of all, availability of products and for good starting price. We are quite solid there. We are a market leader. We maintain market leadership position. So we are good there. And then on the second side, innovation. So it's the market that innovation and branded products really help and we are proving our innovation pipeline. And of course, with this branch optimization, this one will improve.

Yes. Okay. Would you say you're losing market share at this point in time in Brazil?

Not at all. Not at all. We are maintaining market share. It's a market where data it's -- is very clear. And at this moment, we are maintaining our current market share.

Okay. So it's more a market-related issue than a company-specific one?

Yes, softening of consumer. You see it on the 4 years and it's not new for us. We have seen also in the past, on the 4 years, you have election, you have World Cup, consumer demand decreases a bit and then you fill it back. Nevertheless, with the actions that we already have taken and as well we forgot to mention on the new GMP packaging site we have in Annapolis. It's giving us muscle power in order to maintain and improve our market leadership.

Okay. Then the second question is actually on Wichita and the syringes. Could you maybe just elaborate on the process it takes to add additional suppliers, because this is an issue that was effectively flagged at H1 results already. And I hear from Karin that you have onboarded additional suppliers. I was just wondering, is there a reason why you can't move faster? Because clearly, it's impacting your Q3 but will also impact your Q4 sales. So if you would maybe elaborate a little bit on that onboarding process and what -- why it's effectively taking quite a while before you have additional suppliers?

Sure, Matthias. And we have seen during Q3 that the situation did get worse, right, on the supply of these sterile syringes. So we have onboarded 2 new suppliers. And how it worked, you get the syringe, you make the media fills and then you go into validation process. And when all the tests are satisfactory, then business supplier is being validated and now you can go into production. And this takes approximately 6 months.

Okay. And then last question is effectively on this third shift and we then --I am a bit puzzled. Can you maybe elaborate on what the margin headwind is from that third shift? Because previously, when you added from 1 to 2 shifts, the impact was quite substantial. And I still see that you guide for H2 margin ahead of H1. So I am a bit puzzled given that your organic growth performance is clearly below your own expectations effectively, if I look at your guidance. So could you maybe give us a little bit more color on what kind of margin headwind we would expect maybe on North American and group level from this third shift? And what is going to be the driver that your H2 margin will be above H1, please. What gives you this confidence?

Yes. So maybe on the third shift, so that's not easy to quantify. Of course, we monitor the number of people with the volumes that go into the facility, yes. So it's a balancing act on how many people you add to your third shift and what the impact on profitability is. So we do expect some growth in the fourth quarter and we balance the number of people in the facility based on the expected production batches and volumes we have. So we will have some impact. However, we are positive that the market continues to develop in the right direction. So demand is growing. Overall, I think for the entire group, if you look at the profitability margin, I think we start increasing prices towards our customers in EMEA. We started that a couple of quarters ago. We continuing doing that, has been positive benefit from that point of view. Also the operational excellence we achieved by the facility in Poland which we have positive benefit. We expect to -- Brazil in H2 to be better than H1. Traditionally, so Q4 is always good. So we are positive. We don't see that the third shift will have a huge impacts on the profitability margins for the group in total.

Okay. And just as a background, if you say we can balance a little bit this third shift and function of the volumes that we can. Let's say rehire those people quite quickly at the day that your supply chain issues are resolved and you have to cater for the strength of the market.