Fagron NV (FAGR) Earnings Call Transcript & Summary

Good day, and welcome to the Fagron conference call regarding the publication of the first quarter 2020 trading update. Today's conference is being recorded. At this time, I would like to turn the conference over to Fagron. Please go ahead.

Good morning to you all, and thank you for joining the conference call Fagron. This morning at 7:00 a.m., we have published a trading update for the first quarter of 2020. As we are currently living in unprecedented times with the corona pandemic impacting our daily lives and businesses, we can imagine that there will be a lot of questions for Fagron. We have decided to structure this call a little bit different this time. Instead of an introduction and presentation by our CEO, Rafael Padilla; and our CFO, Karin de Jong, we will open the floor immediately for questions. Rafael will conclude the call with some closing remarks. Rafael and Karin are ready now to take your questions. Operator?

[Operator Instructions] We will now take our first question.

Yes. Matthias Maenhaut, Kepler Cheuvreux. Can you hear me, please?

Yes, Matthias.

All right. I have 3 questions. I will ask them one by one. My first question is actually looking at the guidance. If I read the guidance, I would say that overall, you have become, I would say, more conservative, more cautious on the outlook for 2020. Nevertheless, if I look at Q1 performance, I would say there's absolutely no reason to be so. So I just want to have a little bit more, I would say, feeling if this change in tone is more driven out of cautiousness or if you already see any risks building at this present, at Q2 performance, for example. And also, could you give us a little bit more feeling on your financial flexibility as of today? So maybe some color on what the gross cash position is and what the financial flexibility is at this point in time. That's my first question, please.

Yes. Thank you, Matthias. I will take the first part of the guidance. And then, of course, Karin will take the financial side of your first question. Regarding the guidance, as you know very well, we don't give quantitative guidance. And we always give qualitative guidance at the beginning of the year, right? And we would love to confirm our qualitative guidance for -- as we said during our call in February. As you said very well, first quarter was a very good quarter for us. Of course, during March, we have seen -- we have all seen this unfortunate turbulence that for us has, again, as we said in the press release, we have done a good job with it. Though the future is uncertain and we don't know what's going to happen, what we can say is that we see 2 very clear facts. The first one is that Compounding is now playing a vital role in this pandemic. And you can see [indiscernible] outsourcing medication. You can see response for protection and prevention and you can also see a novel treatment. So that's first, a vital role of pharmaceutical compounding. And the second fact is that we are really impressed by how our teams reacted worldwide. We are very proud on the resilience of our teams. Of course, having a multicultural team structure, you get the Da Vinci effect. So you get people from different parts of the world coming together on daily calls. And we are serving very professionally the health care professionals. So we are very happy with this as well. So -- and therefore, we feel that at these times, we need to be cautious with any qualitative guidance that we may give.

Okay. Now moving to the second question. Matthias, on our cash flow, so if you look at the balance sheet at the end of 2019, we have cash on the balance sheet of over EUR 100 million. If you look at our facilities, so we have 2 facilities, 1 bank facility, which was closed last year for an amount of EUR 375 million with restrictions on covenants, so net debt-to-EBITDA restricted to a maximum of 3.5%. Next to that, we have USPP notes of USD 60 million, which mature next year. And our net debt-to-EBITDA levels at the end of 2019 were 2.33% for the banks. If we look at the first quarter, we see again a good performance. Sales is very good. We see margins that are in line with our margins of 2019. So as you all know, Fagron has a strong operating cash flow. So at the end of the first quarter, we don't see any liquidity issues at this point. Of course, future is uncertain. So we took some precautionary measures to balance that. But at this point, we do not see any liquidity issues or covenant issues as of today.

All right. Then the second question is actually on the U.S. Fagron Compounding Services, or more specifically, Fagron Sterile Services in Wichita. I note that you mentioned that there is some pressure on the growth driven by the fact that there is a delay in elective care. I appreciate that. But could you give us a little bit more color on the overall impact on the operations at Wichita? Is there a delay in product validation? Is there a delay in audits from customers? Or are these presently still ongoing? And once this COVID-19, I would say, uncertainty and disruption would abate, would we then see a catch-up in growth in Wichita? Or should we not expect that immediately?

Yes. Thank you, Matthias, again. So first, it's important to reiterate the long-term guidance for FSS U.S., the 2 Wichita facilities. Of course, despite the current uncertain times, there are, for us, 2 very clear fundamentals is that drug services and outsourcing are very important, right? And those 2 elements have driven always our business case on Wichita. At this moment, of course, as we stated, we do not see any impact. What we do see, yes, and that's also the part of your question, the shift on demand, right, so we see a slight decrease on products for private clinics, right? And we see an increase compensating it for products for intensive care, right? And you can think about sedatives or you can think about pain medication or neuromuscular blockers. Unfortunately, and again, as we said at the beginning, some minutes ago, due to this time, for us, it's very difficult to guide 2020 in Wichita as well, though, we see this shift on demand, right? And regarding the launching of products, right, on the development of new SKUs, that is very important. As you were asking now, we have launched this year already 6 new products. Now we're totalizing 112 because this is an element that is important for all of us to measure. And now we are developing 10 new brand SKUs, new products that are related to corona to help and support our customers, our hospital system customers.

All right. And in terms of audits, I guess that is delayed at this point in time, or are they still ongoing?

The audits from our customers, you mean, and regulators, right?

Yes. Customers, yes.

Of course. Yes. Postponed, postponed. Those are postponed for sure.

Yes. Okay. Then maybe last question is on Europe and Fagron Compounding Services, also more specifically on the performance of The Netherlands. I can imagine there's also an impact there of COVID-19. But on top of that, there's, of course, the loss of exclusivity with one of the major wholesalers in The Netherlands. Could you maybe give us a little bit more color on what the organic growth was at Fagron Compounding Services in The Netherlands? And what was the impact or the loss of clients from that loss of exclusivity contract and how far you will be able to mitigate that? And how far there was actually an impact of COVID-19? So...

Yes. So as we said during the call, on the 2019 results, and this first quarter has confirmed it, we have not seen and we do not see now in the present. And of course, we do not foresee, Matthias, any materiality in the fact that a new competitor has entered this new market. Of course, as you get a new competitor, you see a slight decrease in some of the products regarding the Compounding Services activities in The Netherlands. Though we want to reiterate and make it very clear that we don't expect any materiality in this one.

Okay. And can you give us an organic growth rate for Compounding Services in The Netherlands in Q1?

No. We always disclose the European ones and not the Dutch ones. Specifically for the European ones, we see a small decrease in growth for Compounding Services, and that's driven by 3 factors. First is the registration of certain products indeed in the Dutch market. We see an increase in Premium Pharmaceuticals driven by that. Secondly, what we see, and that's also what Rafa explained, is that we have some delay in nonessential procedures in hospitals, which impacts our compounding also in Europe. And thirdly, it's also what Rafa mentioned, the competitor. So you see a slight decrease in Compounding Services for the first quarter for Europe.

We will now take our next question.

Yes. This is Frank Claassen, Degroof Petercam. Can you hear me?

Yes, Frank, we can hear you very well.

Good. A couple of questions. First of all, on the supply chain, what were your main challenges? And what kind of hurdles could come up in the future? Now for instance, India has locked down. Yes -- what are you seeing currently in the supply chain?

Yes. In the supply chain, as we also stated during the call in February, we have done our homework. And of course, we have an extensive supply network worldwide from our 3 main regions. So we had purchased at that time some strategical stock. Nevertheless, we also need to say that our partners, our providers, our stores, our suppliers have done an excellent job supplying the products that we have required. So we have not seen any delay in the deliveries. Regarding the lockdown in India, before the lockdown was imposed by the Indian government for some of the products that we thought that they would be important for us, strategical for us, we have made also our homework buying extra quantities. And what we hear now from our contacts there is that in the month of May, the deliveries will be again available. And therefore, taking all these measures into account, we have not seen any supply issue. Of course, we cannot foresee what's going to happen in the future. But what we can now say is that coincidentally, we have now the best availability product in our recent history, and we are very happy for that.

Okay. That sounds clear. Then focusing on the U.S. raw materials, Brands and raw materials business, fantastic growth, 39%. Can you elaborate on that? How much is driven by COVID? How much is maybe driven by the extra APIs at Humco? Can you give some color on the, yes, fantastic growth there?

Yes. Thank you very much. We're also very happy, Frank, because as we always said in the first quarter in 2018, also, if you recall, we worked together in Amsterdam, that we said that the Brands and Essentials in the U.S. was for us extremely important because we are global leaders for Brands and Essentials. And in the biggest market, that is the U.S., we are -- we were #4, right? So what you see here in the first quarter is an impressive performance of our teams. Our 3 companies, so Humco, Fagron and B&B, are really cooperating and working together. And that's very nice to see. And of course, we have seen an increase of our portfolio in all our portfolio lines, driven by gaining new market share, driven by a traction of the market as well. And of course, during the month of March, we have also seen a traction on products for protection like disinfectants, like alcogels and so forth. [ With all of those, ] this combination brings to these fantastic results for the first quarter in Brands and Essentials in the U.S.

Okay. Then maybe focusing on Brazil. Well, still good growth. But of course, there's also more lockdown impact, I would guess, there. Because yes, there's also -- measures are being taken and it's mainly a consumer-driven market. Are you already seeing impacts that -- yes, there was less traffic or maybe the price increases are having effect on volume growth, yes. Can you elaborate on Brazil, please?

Yes. Sure, Frank. So what we have seen so far is that, again, our Brazilian success story has been crystallized during the first quarter. Again, as we said with Wichita or Brands and Essentials in U.S., we cannot predict the future and the future is uncertain. What we now see in the lockdown is some of our customers, mainly those that are in the shopping malls, those are growth even though it's a small part of it. Though on the other hand, we also see that other customers are serving the market. And of course, Compounding plays an important and vital role. And in the Brazilian compounding market, there is [ attendance ] on prevention, so products to prevent and to have your body ready to fight any infection that you may have, and we see the traction in Brazil there. So we can see that we are happy with the development so far, though we cannot see what is going to happen. So what we also see and we have seen historically in the last 10 years that we are in that market is that our Brazilian teams and also the Brazilian society is very resilient and has very good characteristics on adaptation on the environment.

Okay. And then a final question, M&A. I can imagine that now you're in a cost and cash control mode that is lower on the management agenda. Or are there any opportunities coming up? What is your view on that, please?

Yes. So Frank, M&A is -- indeed, we have, besides organic growth, also an M&A strategy. Currently, because of the uncertain future, we put it temporarily on hold. Of course, when there's more clarity on the future, we will again start our M&A. And currently, we are still having conversations. We keep the conversations running. But we're not actively pursuing any acquisitions on the very short term.

We will now take our next question.

Yes. Stijn Demeester from ING. Can you all hear me?

Yes, Stijn.

Yes, we can hear you.

Okay. So my first question is on the European Compounding business. So I estimate -- I calculate that sales declined 7% in the first quarter in the whole of Europe. I assume that is mostly driven by The Netherlands, given your large exposure to that market. You mentioned a couple of factors impacting that sales growth, your competitor and also COVID-19. But could you somewhat be more specific as to the importance of the 2? Because as I understand it, your competitor is only in the process of ramping up. COVID-19 impact should be seen as something that started to impact in March. So should we see then even larger sales decline in the coming quarters since these -- or in the second quarter since these 2 [ effects are only ] getting larger? Or how should we see growth from here on that?

Yes. So Stijn, indeed, if you look at Fagron Compounding Services, for the first quarter, we see a small decrease. And indeed, it has to do with 3 factors. Of course, The Netherlands is the biggest market in Europe. So we see there the impact of the registrations, which we also saw last year. So we see an increase in Premium Pharmaceuticals driven by that and decrease in Compounding Services because of those registrations. Next to that, we see, indeed, a postponement of surgeries. It's very difficult to predict what will happen in the second quarter relating to those surgeries. What we do see is that we have some additional demand from hospitals for compounding certain pain medication, Morphine [ cases ] and so on. So we see it compensating partly, but not fully. So we have that impact. And we do not know what the impact in the second quarter will be. On the competitor, it's indeed a new competitor. It's a contract we lost. So as indicated, early February, we do not expect any material impact. And what we see in the first quarter is that we do not have that. So we confirm that. Of course, it's very difficult to say what the second quarter will be, especially regarding COVID and also when clinics or certain surgeries will start again. So that, for us, is difficult to predict at this point, Stijn.

Okay. Do you see an impact? Do you see an impact in terms of pricing in the Dutch market already because of the increased competition?

No, we don't see an impact on pricing yet.

Okay. Clear. Then a follow-up on Wichita. It's a bit of the same question. There's a slight decrease if you look -- if you compare to the fourth quarter in sales. So again, is that purely driven by the pandemic impact, which should be something at the end of March, I think? Or was it already a more difficult situation given the change in contract structure in the first 2 months? And then related to that, you stated there could be a [ delay ] as to the ramp-up. In which way could COVID-19 impair the rollout story, which, yes, as I understand it, is driven by structural growth of the market? So what is the scenario that you're thinking about when you say that there could be [ delays ] to the sales target in 2020 -- 2022?

Yes. Thank you. Thank you very much for the question, Stijn. As you said it now very well, we see a combination of both the business model, the COVID situation that we explained in the last call on the service side. And then also the impact of COVID in some of the [ non-elemental ] surgery procedures that we see a slight decrease there, though we also see a compensation on products used for intensive care. And this is what we all said some minutes ago regarding the development of new products. We have launched 6 new products. And now have in the pipeline 10 new products that are or will be used for [ 5, 6 ] pandemic. And here, you may think products for intensive -- in intensive care and those products are sedatives, right? So before you put a respirator to a patient, you need to sedate the patient, also pain medications, of course, they are very important and neuromuscular blockers to let the body relax in order to put to the respirator, right? So we see a traction there. And again, what we've now seen is very clear for us is that the 2 main fundamentals have gained relevance during this pandemic. And those 2 are drug shortage because there is more usage of these products that now we're seeing in the intensive care units. That is first. And that's something, an impact, that we also see in the Sterile Services outsourcing. Of course, hospitals now are busier. And hospital pharmacies are now -- or we think that they will outsource more their sterile productions.

But why is that not visible in -- do you expect this to become visible in the next quarters? And then is there a way to fast track these validation tracks for these new products? Or is it the regular 3 to 4 months that you should expect?

So again, for us, it's very difficult to predict what is going to happen because this whole situation is unpredictable. We have seen many governments and policies. And then on the development of new products, what we see is that we, of course, follow all the steps that we need to follow, though our teams are now being focused on the products that are being asked to fight this pandemic. But we are following all the required steps in order to launch products.

We will now take our next question.

I think actually most of them have been asked. But can I just have a view on how do you expect the competitive environment in Europe and U.S. to change due to COVID, given your M&A strategy is so important to the long-term growth?

Yes. Sure. So what we see in, of course, the different segments where we are present, regarding Brands and Essentials, of course, we see that we are the global consolidator in this market for pharmaceutical compounding. And sourcing and sourcing networks are now very important in the seller's market, right? So we are working with our supply network in order to have the product available. And what we also see that our competitors maybe have a bit more of difficulties in order to fulfill these needs. This is one. Also, on the sterile facilities, of course, we have a global network as well in order to leverage the product development and the product data. And what is happening in one country may occur in another country in weeks later. You have seen it started in Italy, then went to Spain, then the Rest of Europe, then to the U.S., now to South America. So our global network also helps us in order to be prepared for the outcome of new demands in countries where the outbreak is not still there. So we're leveraging those 2 elements. And of course, we don't know how the competition is strategically, right, though we foresee that this global leverage will help us.

Right. And then maybe also on the supply chain. How long do you expect your supply chain to kind of withstand the current product mix? And how -- what's the view on sort of key suppliers maybe in terms of their own ability to keep operating, should we go into a more acute recession?

Sure. So what we saw and, of course, we have 3 sourcing markets this way locally, so providers in each ones of the regions where we're present. And then Asia, that is China and India. And at the beginning of the year, of course, China, there was severe lockdown, though the producers or the partners that we have in China have fulfilled our need. And of course, we're very happy and proud to have these contacts and network. And then for India, as we said some minutes ago, there is a total lockdown. And what we foresee during the month of May, the lockdown will be -- will not be there anymore, so the country will open again. And then we foresee that these products will be shipped into Latin, North America and Europe. This is first. And then for the local markets, what we see is that local producers, even producers that are located in Italy or in Spain, are fulfilling also our needs as they are considered essential business, right? So here, we're also in the local side. We're also in safe side. Though what we really want to reiterate is that this is what we have experienced so far, though we don't know how this will evolve.

We'll now take our next question.

This is Lenny from KBC. Can you hear me?

Yes, we can hear you very well.

We can.

Yes.

Yes. I was just -- I still have one single question outstanding, I would say. As you need to shift suppliers perhaps to more local suppliers for certain APIs and probably prices also start to fluctuate on critical products, I was wondering how does that affect your current margins? And then again, what is also the policy on transferring these dynamics into your own selling prices?

Yes. So Lenny, currently, as we look at the current situations, we see that our margins are not impacted. So of course, we do see a shift in demand in certain product categories. But overall, we do not see a shift in margin. Of course, we do not know how it will develop. We -- if we see huge increases, of course, we will try to pass it on towards our customers. But it's too early to say if we can pass that all to our customers. But as we now see at the first quarter, we didn't have a material impact on our margin levels. Of course, the dynamics between the product groups is different because of that shift in demand.

[Operator Instructions] We'll now take our next question.

This is Eric Wilmer speaking from ABN AMRO. Can you hear me?

Yes, Eric.

Three questions from my side, with my first one quite related to the last question. My understanding is that in the U.S., you shipped quite some products by plane. I was wondering whether you experienced significant cost inflation because of this and whether your sales as well as your competition are increasing prices. Secondly, do you observe any change in payment terms behavior from your customers? And finally, to what extent could there have been stocking effects in Q1 that could result in lower sales in Q2?

Yes. So maybe to start, Eric, with the first question on inflation on transportation costs. So we do not encounter that yet. And I can imagine we also had an image that we will see that, see an increase of those logistic costs. But currently, we do not see that. So there's no huge cost inflation for the transportation. If we look at the payment terms from our customers, we monitor that closely, so as well on the supplier side with different conditions and on the customer side for payment terms. On the payment side, we do not see changes yet, but we monitor that very closely. On the supplier side, there are some suppliers requesting prepayment. But at this point, it has limited impact. However, it's difficult to say how that's going to evolve in the first quarter and to quantify the impact on that on working capital. But currently, we don't encounter big changes in payment behaviors.

Yes. And regarding the demand side, of course, the market has changed. We see a shift on demand from one product group to another product category. That's clear for us. What we also see is that every day we encounter -- we get new requests for different products. As we said, compounding is also very useful for introducing new products in a very fast way. An example, of course, is the chloroquine -- hydroxychloroquine, but [indiscernible] that there was a study 1 week ago, and we were able 1 day after to deliver product in some hospital pharmacies. And the first days of April show the same [ tendance ] as the month of March. So we are also happy despite the pertinent situation. Of course, we are also happy with the start of the first days of April. Though also as we reiterated, every day is a new day and we cannot predict what is going to happen, of course.

[Operator Instructions] We will now take our next question.

Matthias Maenhaut, Kepler Cheuvreux. Two more questions from my end, actually. If I look at the organic growth in Latin America, which is predominantly Brazil, would it be possible to split it out into a pricing and then to a volume effect, please? Because if I look at the changes or the fluctuations in currency in the Brazilian real U.S. dollar rate, would seem that it is mainly pricing. So could you give us a little bit more color on that? And then I have another question on the U.S., please.

Yes. So Matthias, to answer your question, if you look at, indeed, Brazil, we see a weakening of the Brazilian reais, that happened during the first quarter. What we see also in Brazil is there's a shift in demand in certain products. So if you look at the volume analysis, certain product categories have a decrease. But others we can see a huge increase, indeed mostly the prevention part where we see a huge increase, so it will shift. But overall, we see an increase in volume. What we used to do in the past and where we were very successful in passing any price increases of our raw material due to the fact that we source in dollars, we pass those through to our customers. We try to do that as much as possible. But you can imagine, with the sharp decreases in valuation and so a sharp increase in our raw material price, that's more difficult to do on a fully base. So it's difficult to split in price and volume. Of course, there's a pricing impact, but we did see volume from -- especially from certain products groups related to prevention, we see that increasing. What we can expect for the second quarter in volatility of the reais and if we're able to fully pass price increases towards the customers, that's difficult to answer at this point in time. So the impact on margins will be for Brazil in the second quarter based on uncertain development, it's difficult to say, Matthias.

Yes. Okay. Clear. And then I had a final question maybe on AnazaoHealth. You mentioned that the growth number is, of course, impacted by the phasing out of the nuclear business. Could you maybe give us the impact in the second quarter? And overall, we note a slowing of growth, I would say, in recent quarters at AnazaoHealth. Could you give us a little bit more color, if there is something structural or is there something that is playing? Or is this just also this quarter purely a COVID-19 impact, please?

Yes. Thank you, Matthias. So [indiscernible] said it very well, we see the impact on phasing out of our nuclear activities -- in our whole nuclear activities. Regarding the COVID, we also see -- what we see in other parts of the world and also in the U.S. as well, we see a shift in demands, right? So we see a slight decrease on the lifestyle products, though we see an increase on products for modulating and regulating immune systems and you may think of vitamins, minerals. So we see also this shift on demand as well at AnazaoHealth.

[Operator Instructions] It appears there are no further questions. So I'd like to hand the call back to our speakers for any additional or closing remarks.

Okay. We want to thank you all for your questions and interest in Fagron. And I would now like to give the call back to Rafael for his closing remarks.

Yes. Thank you, Constantijn, and thank you, Karin, as well. So what we see is that our generation is facing its biggest historical challenge. Governments, public and private sector need to work as close and aligned as possible in order to restore welfare state. Prevention and personalizing shipments play a crucial role in this. Pharmaceutical compounding is the tool for drug shortages, combination therapies and palliative care. Pharmaceutical compounding also plays an important role as it reduced the time to introduce novel treatments to prevent, control and treat this pandemic. Fagron, as the global leader in this market, has a moral obligation to support society in this fight. For now, we live the purpose of together we fight coronavirus. Our teams are trained to be extremely resilient and have full commitment to serve the healthcare community in all their current and future needs. We have an extended supply network. We are shaping our product and service offering with personal protection equipment and supplying global markets with the materials needed to maintain patient care at the highest possible level. We believe in prevention and a regulated immune system as the key success factors to win this battle, and therefore, our customers can count on our brand to offer the best to their patients. We would like to thank all our stakeholders, our employees, our suppliers and partner, our customers, our shareholders, analysts and our Board for their support in these turbulent times. We're deeply convinced that when this situation is over, our company, our teams will be stronger than ever. Thank you very much. Operator?

Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.