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Edited Transcript of PTHN earnings conference call or presentation 16-Mar-17 12:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Patheon NV Earnings Call

Amsterdam Mar 16, 2017 (Thomson StreetEvents) -- Edited Transcript of Patheon NV earnings conference call or presentation Thursday, March 16, 2017 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Tyler Gronbach

Patheon NV - VP, Communications & IR

* Jim Mullen

Patheon NV - CEO

* Stuart Grant

Patheon NV - EVP & CFO

* Michel Lagarde

Patheon NV - President

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Conference Call Participants

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* Tycho Peterson

JPMorgan Chase - Analyst

* Ricky Goldwasser

Morgan Stanley - Analyst

* Ross Muken

Evercore ISI - Analyst

* Dave Windley

Jefferies & Co. - Analyst

* John Kreger

William Blair - Analyst

* Erin Wright

Credit Suisse - Analyst

* Sarah Silverman

Wells Fargo Securities - Analyst

* Sean Wieland

Piper Jaffray - Analyst

* Matthew Mishan

KeyBanc Capital Markets - Analys

* Michael Baker

Raymond James - Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the Patheon first-quarter 2017 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Tyler Gronbach, Vice President of Communications and Investor Relations for Patheon. Thank you. You may begin.

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Tyler Gronbach, Patheon NV - VP, Communications & IR [2]

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Good morning and thank you for joining us this morning. I'm Tyler Gronbach, Vice President of Communications and Investor Relations and welcome to Patheon's first-quarter fiscal year 2017 financial results conference call.

With us today is Jim Mullen, Chief Executive Officer; Michel Lagarde, President of Patheon; and Stuart Grant, Chief Financial Officer. At the conclusion of their opening remarks, we will open up the line for Q&A.

Before we begin, the management team will be referring to a presentation that is available through the IR page at patheon.com. Please refer to the disclaimer on slide 2 and note that we will be making forward-looking statements in this call, all of which involve certain assumptions, risks and uncertainties that could cause our actual results to differ materially from these statements. Any forward-looking statements apply only as of today's date and we undertake no duty to update any of these statements. We expect to file our 10-Q later today.

In addition, the presenters will be discussing certain supplementary non-GAAP financial measures on this call. A reconciliation of our non-GAAP measures to the corresponding GAAP measures and related definitions are included in the news release distributed earlier today. I would now like to turn the call over to Jim.

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Jim Mullen, Patheon NV - CEO [3]

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Thank you, Tyler and welcome, everybody. It's good to be back with you after another quarter. I'm briefly going to cover the recent business highlights, then Stuart will walk through our Q1 financial results and Michel will conclude with a more in-depth review of the current business trends that we are seeing and our updated full-year outlook.

So now going to page 4, let me just cover the highlights of Q1 and the recent business developments. So Q1 revenue increased by 13% year-over-year to $457 million and adjusted EBITDA was $83 million. Growth was driven in all three segments. I think the pattern for 2017 revenue and EBITDA is shaping up to be similar to what we saw in 2016, a lighter first half and a much more robust second half.

We recorded $453 million of new TCV in the quarter and this includes approximately $100 million for our Roche take-or-pay contract and as a reminder, we typically see these lower sales in Q1 due to fewer selling days around the holidays.

So immediately following the quarter, we completed our previously announced plans to add Roche's Florence, South Carolina API site to our network. This site provides us new enhanced capabilities, as well as additional capacity, which will at least temporarily help to alleviate the capacity constraint of our API business.

Adding this state-of-the-art facility and a multi-year supply agreement for a nominal upfront cash outlay allows us to continue investing in other areas of our business. We are making resource investments in the first half to support a record level of recent wins and expect a 60% year-over-year increase in tech transfers. That's going to drive growth obviously through the year and into the outer years.

Additional investment in our quality infrastructure as we have mentioned in the past and we've also invested in additional sterile capacity at our Greenville and Monza sites, and we are completing work on our continuous manufacturing suite in Greenville, North Carolina, which is expected to come online later this year.

Now, turning to the full-year outlook, we are updating our guidance to reflect current exchange rates and our latest view of the business. While we delivered healthy growth and margin expansion in the first quarter, the results were short of our expectations. This was due to lower-than-anticipated volumes and our investment activity, some of which I have just mentioned and Stuart will discuss these factors and the Q1 performance in more detail in a few minutes. Then Michel will discuss the drivers of our updated full-year outlook, which is now -- you can see on the right-hand side of the chart, revenue in the range of $1,000,990,000 to $2,010,000,000, adjusted EBITDA in the range of $430 million to $450 million and adjusted EPS in the range of $1.05 to $1.20 and our full-year total contract value target remains in the range of $2 billion to $2.2 billion.

Despite the changes in our full-year guidance, the underlying trends supporting our long-term outlook, as well as our strategy remain intact. We continue to see strong client demand for our full suite of services. We are well-positioned to consolidate the industry allowing us to add scale and incremental capabilities. We remain focused on driving operational excellence across our network, generating greater productivity and cost savings and we continue to believe capitalizing on these trends will allow us to drive long-term revenue growth and margin expansion.

I will now turn it over to Stuart to discuss the Q1 results.

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Stuart Grant, Patheon NV - EVP & CFO [4]

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Jim, thank you and good morning, everybody. On slide 5, you can see that Q1 revenue was at $457 million. That was 13% higher than last year and that was driven by solid growth across all of the areas of the business. Adjusted EBITDA in the quarter was up 40% year-over-year to $83 million and that's a margin of 18%, up 350 basis points from last year.

Adjusted net income was $21 million in the quarter and adjusted EPS was $0.14 a share. We ended the quarter with about $90 million of cash on the balance sheet and our leverage position decreased from the fourth quarter and is currently at 4.5 times on an LTM basis. We had liquidity of $278 million at the end of the quarter and as a reminder, we typically use cash in the early part of the year and build cash in the back end of the year.

If you look at the segments on slide 6, we had top-line and bottom-line growth across all three segments. In the drug substance business, that business grew by 31% year-over-year to $130 million in Q1 with margins of 25%. The drug substance business continues to see solid demand from both the API business and our biologics business.

In the first quarter, our PDS business grew by 8% year-over-year to $52 million and delivered solid margin of 31%. Our drug products business was up 6% year-over-year in the quarter to $275 million with a margin of 22%. Drug products generally benefited from higher volumes for the quarter; however, those volumes were partially offset by the headwinds that Jim mentioned, which primarily related to delays from customer-supplied material.

And with that, I will hand off the call to Michel and he will update you on the rest of the year.

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Michel Lagarde, Patheon NV - President [5]

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Thanks, Stuart; good morning, everybody. I'm on slide 7 where we have summarized the key drivers of our revised outlook on the left.

First, the exchange rates. I think we get some feedback last time that we significantly confused some of you, so we are trying to learn from that and we have now updated our guidance to just be reflected at current spot rates, which we think are $1.05 mainly for the euro/US dollar rate.

Secondly, we've now included the financials related to the Roche Florence facility that Jim mentioned. Just to make sure we all remember this transaction, we paid $1 million upfront. There will be a significant accounting gain on the asset of around $150 million in Q2, but we are really excited about this transaction because it gave us capacity that we can now fill up and the Roche take-or-pay component basically covers all the cost in that facility.

And the third reason to update the guidance is the timing of customer volumes and key product approvals, to give you a little bit of insight into that. One of our largest planned product launches was significantly delayed by the FDA, so the customer, on whose behalf we are launching this, has now revised its timeline and as a result, a lot of that launch benefit will come now in 2018.

Another example of a shift is a large development project in biologics that took significantly longer to get signed up given its size and complexity. It is now signed up. It's unchanged in terms of size, but now has moved to the right and most of that benefit will show up again in 2018.

Lastly, we are making and stepping up our investment levels to support our record levels of business wins. For instance, again, in biologics where we are seeing our portfolio shift towards more commercial work, this was a portfolio that was largely a development business a couple years ago and we are now getting ready for that shift and are making pretty significant investments in our biologics side in order to handle that shift and that growth.

We are expecting about a 60% increase in tech transfers this year. That's an incredible increase in the number of new products coming into our sites and as a result, the resources required to execute those projects according to our customer requirements require us to invest into that. And all of that gets summarized, as Jim mentioned, in the revised numbers on the right.

On slide 8, a little bit more insight into revenue. As you can see here, the FX component of the revenue is highlighted on the slide. That basically is a result of the dollar/euro exchange rate going from $1.11 to $1.05. Previously we talked about 10% constant currency growth and in our current outlook of the business, we are revising that to 8% to 9%, mostly impacted, as I mentioned, by some of these transfers in time, as well as obviously the addition of the Roche facility.

Also, on the slide, we mentioned specifically what happens in Q2, which we now think revenue will be in the $460 million to $470 million range. That sets us up for a second half of about 55% of full-year revenues, which is about the same as we experienced last year.

On slide 9, you'll see the bridge on EBITDA. The prior guidance was at $470 million. There's a bit of currency impact there and here you see the new range in the $430 million to $450 million range. Obviously, EBITDA is impacted by some of the delayed product approvals that I talked about. Those are particularly impactful because we obviously carry the cost, even though the revenue that we can record is pushed to the right.

The other thing to keep in mind is that, even though in some of our facilities, take, for instance, in the DSS segment, there is significant activity going on. The way we record revenue when we in the end ship the product means that there is a bit of a mismatch, particularly in Q2, again, around activity level and revenue recorded. That obviously will all balance out through the year, but also here you see that, for Q2, we are saying we are going to come in between $85 million and $95 million, which means the second half is going to represent about 60% of the full-year EBITDA number, not very much change in terms of cadence throughout the year as in our last fiscal year.

If we then turn to slide 10 where we are giving you the update for adjusted EPS, here the components of depreciation, interest expense and tax only marginally changed. The real change is the EBITDA change that then also has an impact on adjusted net income and obviously divided then by the number of shares, which again the share count is also in fact versus our prior guidance gets you to an adjusted EPS of $1.05 to $1.20.

So in closing, although we are experiencing some shift in the business this year, our view of the long-term opportunity remains completely intact. Our strategy is unchanged. We see continued strong demand for our services, record level of tech transfers and we believe that we are well-positioned in this industry and we're working very hard to capitalize on these trends. That brings us to the end of our presentation, so now we can open it up for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Tycho Peterson, JPMorgan.

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Tycho Peterson, JPMorgan Chase - Analyst [2]

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I guess starting with margins, I know you talked about losses on FX contracts being a headwind. Can you maybe just talk about some of the other gives and takes? I guess with the Ferentino ramp, you have a little bit of a tailwind, so can you maybe just walk through some of the other moving pieces on margin?

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Stuart Grant, Patheon NV - EVP & CFO [3]

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Yes, again, in terms of Ferentino, we think of the ins and outs of the business. We had some benefit there. We had some product and (inaudible) as we closed some of our contracts that went the other way. So I think overall the ins and outs of that business didn't make a significant change.

I think what we've continued to do is invest ahead of growth as we come up into the back end of this year as Michel talked about and into fiscal 2018, particularly in the biologics space where that business is becoming more focused on the commercial opportunity as opposed to development. That requires an infrastructure that maybe the development business doesn't need. So we've chosen to continue to invest in that and given there's a little bit of a shortfall on the top line, we've maintained that cost structure to support growth as we go forward. So I think those are the main dynamics that impacted us in the quarter.

Obviously, any top-line miss with our fairly fixed cost structure does flow through to EBITDA at a fairly high rate. So I think those are the -- and again, the top-line shift in revenue, don't see the benefit of that; and shift in costs obviously they stay in the quarter.

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Tycho Peterson, JPMorgan Chase - Analyst [4]

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And then on Florence, can you maybe just talk to ramp timelines, what the pipeline looks like there for non-Roche work and what you specifically embedded in guidance for the remainder of the year?

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Michel Lagarde, Patheon NV - President [5]

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Regarding the ramp, obviously, the business as we produce it today is for Roche. We have a pretty active development pipeline of products we were working on already that we wouldn't have had the commercial capacity for that we now obviously can transfer into the site. So I think you'll see that the rampup of new business, non-Roche business into the site will actually be pretty quick because it's not like we are starting from a standing start.

So we expect first revenues to show up there in a meaningful way in the next fiscal year and then in the next couple of years, we think that, as we mentioned previously, that facility can ramp to north of $100 million.

So in the current year numbers, there is virtually only Roche included and that component of the take or pay is about $30 million and as I said, that covers the cost of that facility for this year.

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Tycho Peterson, JPMorgan Chase - Analyst [6]

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Okay. And then, lastly, can you quantify the delays in DPS and it sounds like some of those may have come through? What's the timeline for a turnaround there?

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Jim Mullen, Patheon NV - CEO [7]

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The delay there, there were a couple of them, but both of them, which were of any size, shifted basically six months and one product is approved; the other one is signed and started or will start rather. So they just shifted out by about six months each.

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Stuart Grant, Patheon NV - EVP & CFO [8]

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Yes, and I would say two-thirds of that is in drug products, Tycho, and the rest are in the biologics space, so it impacts drug products and drug substance.

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Tycho Peterson, JPMorgan Chase - Analyst [9]

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Okay. Thank you.

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Operator [10]

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Ricky Goldwasser, Morgan Stanley.

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Ricky Goldwasser, Morgan Stanley - Analyst [11]

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So if we can get some more color on starting with the delay in the customer supply material. So have these delays -- one, have they been resolved and, second of all, what's the upstream cause of these supply issue and are you seeing it coming from a specific customer or is it something that you're seeing across a group of manufacturers?

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Jim Mullen, Patheon NV - CEO [12]

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So it's not a specific customer. There's a few customers that are worse than others. I was just, before this call, going through all the details on that. It's actually pretty broadly spread; you can't really track it back to either a single customer or a single API supplier. And it does appear that maybe this is just an episodic thing, but these API late deliveries or delays of customer-supplied API have affected pretty much every one of the sites at one point or another.

Some of it is just in the noise level of the business. It really shows up when we are set up to run a long campaign for somebody and we don't have the API and we don't have enough time to shift into somebody else's material or we don't have the material for their campaign, which was going to start a month later.

It's a good question because I think we are trying to pay a bit more attention to it to see if there's any real trend in this, or whether this is just a couple of products that really effected this quarter. A lot of them are just small products and it's just noise, but some of them are pretty substantial products.

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Michel Lagarde, Patheon NV - President [13]

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I think it's also, Ricky, a structural observation we have about this industry. Most people's supply chains are complicated, involve many, many parties and the data and information flow is not connected. This is the key pitch that we have to our customers in one source where we say let us handle all of it so that we can have full visibility into all of the steps in your supply chain and as a result, we can manage these types of hiccups much better because had we had obviously forward information, we could have adjusted our timeline somewhat.

So I think even though we cannot point to a specific customer, it's a structural observation we have and we look forward to handling more and more of the API for our customers so that we can smoothen out that supply chain.

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Jim Mullen, Patheon NV - CEO [14]

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Yes, and better integration up and down of where their inventories are, whether it's the inventory of finished product on the back end or the supply side of where is the API and what's that inventory and delivery situation. Customers so far are not very transparent on that.

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Ricky Goldwasser, Morgan Stanley - Analyst [15]

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Okay. And just to clarify, these delays in APIs for products that are already existing in the marketplace?

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Michel Lagarde, Patheon NV - President [16]

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Yes, these are all commercial products. So they are launched and we don't know whether that's because they maybe changed an API supplier and that caused the hiccup or whether key steps were missed, but these are not new products. These are just running commercial products.

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Jim Mullen, Patheon NV - CEO [17]

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Yes, these are not teething pains of a new launch.

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Stuart Grant, Patheon NV - EVP & CFO [18]

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I think the bulk of the ones we saw in Q1, Ricky, we will see that coming back certainly in the rest of this year.

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Ricky Goldwasser, Morgan Stanley - Analyst [19]

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Okay. And when we think about the magnitude of the change to your guidance revision, we can back out the FX impact, but if we think about the remainder and the split between this upstream issue versus just the normal course of business where product launches are delayed or there's issues in development, what percent of the revision to the outlook is coming from supply issues versus product launch delays?

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Stuart Grant, Patheon NV - EVP & CFO [20]

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I would say the bulk of the shift in the top line is coming from those two significant things that Jim talked about -- one, the approval delay that is now approved and will come later and the long contract signing in the drug substance space. The bulk of it is about. There's other bits and pieces of movement, but those are the main drivers.

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Ricky Goldwasser, Morgan Stanley - Analyst [21]

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Okay. And then, lastly, on the US capacity, when you think about once these facilities are up and running, what percent of capacity are you going to have now in North America versus rest of the world and how should we think about that facility in terms of its margin structure compared to the rest of the business? Thank you.

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Jim Mullen, Patheon NV - CEO [22]

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You are asking about the Florence facility, right? So I think we will have -- I'm sorry, is that correct, Ricky?

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Ricky Goldwasser, Morgan Stanley - Analyst [23]

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Yes, that's correct.

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Jim Mullen, Patheon NV - CEO [24]

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Okay. So I think we will end up with about half of our API capacity in North America, so we will have two commercial sites, one in Florence, South Carolina, one in Greenville, South Carolina and then development activities in both South Carolina and in Europe. So it will be pretty much 50/50 split down.

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Michel Lagarde, Patheon NV - President [25]

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That's capacity and then obviously utilization in Europe is full and obviously we are ramping utilization here of our new capacity in North America.

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Ricky Goldwasser, Morgan Stanley - Analyst [26]

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Okay. We are just thinking ahead if, with tax reform, there's going to be broader transfer issues. How could this be an opportunity long term and if you have the capacity in North America ready to accommodate any potential demand from customers?

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Jim Mullen, Patheon NV - CEO [27]

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Well, so far, I think all the customers are trying to figure out what it's all going to mean, probably as we are, but let's assume there's the border tax and there's pressure to bring stuff back into the US and incentive. Obviously, we are going to be really well-positioned for that. API probably benefits earlier because it's on average easier and faster to move that around.

Drug products, also, you would probably see some of that come back into the US and we are very well-positioned with our North American -- particularly our US drug products on both the oral solid dose and the sterile product side. So I think if it comes back, we are going to be a net beneficiary in the US.

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Michel Lagarde, Patheon NV - President [28]

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And I think that's also where you see us, of the $100 million of growth CapEx that we spend, a significant portion of that is allocated to the US in all of these areas that Jim mentioned. We are adding sterile capacity. We are adding continuous manufacturing. We are adding biologics capability. So I think in regards to capacity availability, we are well-positioned.

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Ricky Goldwasser, Morgan Stanley - Analyst [29]

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Thank you.

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Operator [30]

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Ross Muken, Evercore ISI.

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Ross Muken, Evercore ISI - Analyst [31]

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So we think about this business as one that's highly predictable and has a lot of contracted backlog and so obviously a bit of a surprise in terms of the shifting. Can you help us put in context in the forecasting process what can be a known? What is an unknown as you enter a year with some of these different aspects that have influenced?

And then secondarily, help us think about what this means for the trajectory into 2018 because it does seem again like a number of these items are timing-related, which would suggest while obviously we are having a bit of a curtailed growth event to initial expectation for 2017, the ultimate 2018 outcome could theoretically somewhat make up for that. So help me sort through those two points.

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Jim Mullen, Patheon NV - CEO [32]

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The business predictability is from the long-term nature of the contracts. That predictability doesn't typically translate into a quarter. It translates into a year, in particular because of the lumpiness of the business.

The forecasting, I think where we have the least visibility and I think it's just inherent is we have done a lot of product launches over the last couple of years and more coming with all the tech transfers we are doing and so that comes with two variables that we can't control and our customers don't control.

One is it's just inherently difficult to forecast launch demand and I've been on the other side of that and I think we were wrong by 100% in every direction every time. So that's just inherently difficult.

The other is the timing. So it's just difficult to predict the timing both of are you going to get the approval on your PDUFA date, but also how are other regulatory approvals going to flow out, EMA, etc., over time.

And so those two things together drive a bit more variability and these products that are newer in their lifecycle are becoming a larger proportion of our business. So I would say that creates a little bit more variability or volatility or fog, if you will, in the forecasts when you look at a 6-month, 12-month, 18-month horizon.

Having said all of that, when you look at the new launches coming through and the products that we've got, as well as you look backwards in the development area and the pipeline and the number of late-stage products that are ongoing in all stages of the business and all segments of the business, the long-term trends continue to look good. So I think the long-term trend for us to be able to grow and grow these businesses at above-industry rates still looks very much intact.

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Michel Lagarde, Patheon NV - President [33]

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The only other thing I would add, Ross, is that we run a very highly diversified business with very little customer concentration. However, these launches are somewhat concentrated because, of all the launches we do, there's a couple of large ones and if there then is movement as a result then it shows up in the growth rate. And I think you are right on your assumption that a little of that is timing. We haven't fully baked our 2018 views here, but certainly these two that we talk about, this big development project that is signed up and that we are going to start on and is a big launch that was delayed but is now approved obviously are elements that are going to contribute to our 2018 [growth].

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Ross Muken, Evercore ISI - Analyst [34]

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And maybe just on a few finer items. Can you just give us what the FX hit was -- maybe I missed it -- to revenues for the quarter and then how should we think about the tax rate cadence for the rest of the year because it seemed like the full-year assumption hasn't changed materially, but obviously it felt like Q1 was maybe a little bit heavier certainly than we anticipated, so I am just trying to understand the pacing?

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Stuart Grant, Patheon NV - EVP & CFO [35]

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So the FX impact in the quarter was about $12 million top-line impact and the EBITDA was probably about $2 million or thereabouts negative impact. We had guided to about $40 million to $60 million of tax expense for the full year. That remains our view. I think the number in Q1 was about $14 million, so we are still holding that 20% to 25% tax rate for the year. That translates to roughly $40 million to $60 million and you'll see that spread through the rest of the quarters.

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Ross Muken, Evercore ISI - Analyst [36]

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Got it. Thank you.

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Operator [37]

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Dave Windley, Jefferies.

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Dave Windley, Jefferies & Co. - Analyst [38]

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I was hoping to understand a little better the timing of investments that you have to put in place relative to tech transfers and product wins and things like that and tied to that variability. So more specifically, the revenue -- obviously we are hitting on -- the prior questions are hitting on the negative leverage to the business from some of the timing that you are describing and having to keep that cost. From one of the answers you gave, I think you said you lost about six months of time on those two particular delays and so does that mean -- can I interpret that to mean you expected those to drive commercial revenue in the second half of fiscal 2017 and those costs are already in place today, or is there an ability to delay the costs that you put in place as those delays hit you?

And then secondly, as you are talking about making some investments for this year, I think particularly in biologics for future opportunity, are those physical plant investments, or are they people investments and if the former, why aren't those capitalized and not expensed through the P&L? Thanks.

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Jim Mullen, Patheon NV - CEO [39]

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I'm going to leave the accounting question to Stuart, but let me tackle the other one. So timing investment varies a little bit by the business, but think of a tech transfer, typically requiring 9 to 12 months. And so that will require a couple dozen people working on it, as well as some manufacturing campaigns to qualify/validate the manufacturing processes, etc.

Our customers put a high price or a high value on our ability to be able to launch product, label/launch product the day after they get an approval. So we are typically working to their PDUFA dates and in some cases, we've even had to accelerate that -- I can think of a couple last year, oncology products where they requested us to accelerate our preparedness to launch. And so those costs go in -- you start six to nine months in advance and, yes, we get paid for some of that, but it really is a bit of a drain on the overall margin.

One of those big products should have launched sometime in 2016. It will launch, but it was a big number, so we've had the costs sitting in place more or less to support that over the last quarter or so. So I think that hopefully helps give you a little bit.

On the biologics side, you have investment both in facilities and equipment, so that's CapEx, that's where you see that. But a lot of it is, as we ramp up more activity in biologics, as well as get prepared to launch more commercial products, that requires a different level of infrastructure and people and quality systems in particular and so those kind of investments go in place 6 to 12 months in advance.

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Stuart Grant, Patheon NV - EVP & CFO [40]

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And those are the ones that hit the P&L, as Jim says. Obviously any physical assets we add to the building, those are being capitalized, but the rampup of the quality organization, the quality systems, people getting trained ahead of growth, all of that is rightly expensed to the P&L.

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Dave Windley, Jefferies & Co. - Analyst [41]

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Okay. And a follow-up on -- so it does sound like you are beginning -- that some biologic opportunities, revenue opportunities, are coming, call it, out of the fog to use a word you used earlier and becoming more clear, particularly at a commercial scale. Can you give us commentary, visibility relative to magnitude and timing of when that will hit? That sounds like maybe 2018? How much visibility do you have to that and how big could it be I guess is the question? Thanks.

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Michel Lagarde, Patheon NV - President [42]

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That's a good question, Dave. Look, I think we obviously built a biologics business largely on the back of a development portfolio. So when we got into the biologics business back in 2014 and then later with the Gallant* acquisition, the vast, vast majority of all the revenues are still today in the development stage. We now see a good flow-through of those starting to get approved. We are seeing great stickiness in regards to -- when we worked on the development scale, we end up being the commercial manufacture, so our strategy I think is sound. And indeed, I think, in 2018, you'll start to see a shift of more commercial products.

And then in terms of count, the number of projects we work on, it will obviously still be very much skewed to development, but in terms of dollars, once these products launch, they are pretty significant products. So as a result, our revenue mix in biologics starting a little bit this year, but particularly next year, you'll see a more pronounced switch towards more commercial business.

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Dave Windley, Jefferies & Co. - Analyst [43]

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Got it. Thank you. Appreciate the answers.

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Operator [44]

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John Kreger, William Blair.

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John Kreger, William Blair - Analyst [45]

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Stuart, can I just clarify your comment a few minutes ago around tax rate? Has your expectation for rate remained unchanged, or has your expectations for your ultimate tax liability, which would imply a higher rate given the lower EBITDA expectation?

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Stuart Grant, Patheon NV - EVP & CFO [46]

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John, we've said for the full year 20% to 25%. We think that's still the right range. That translates to $40 million to $60 million for the year, $14 million of which happened in Q1, so we haven't changed our expectations there.

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John Kreger, William Blair - Analyst [47]

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And what swings the rate between 20% and 25%? Is that just geographic mix?

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Stuart Grant, Patheon NV - EVP & CFO [48]

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Yes, primarily. If we are in high tax jurisdiction areas like the US and Italy, if the makeup of the business is more focused there, that would drive the rate up a little bit, yes.

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John Kreger, William Blair - Analyst [49]

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All right, thanks. Jim, maybe if you could just spend a little bit more time on -- it sounds like you are getting significant success in terms of wins in these tech transfers. What does that tell you about how the business might change over the next couple of years? I guess what I am getting at is are you seeing any changing on the pricing front of these new relationships? Do they tend to be sole source or multisource and are you seeing more growth more on the active ingredient or on the finished (inaudible) side? Thanks.

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Jim Mullen, Patheon NV - CEO [50]

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Yes, let me work it where the growth is. Certainly we continue to see very nice growth in the biologics and strong demand there and pricing continues to be robust in that space. API, as you will recall, we were very capacity-constrained last year so we had to be very picky and choosy about what we were taking. We've opened that funnel up again.

I think overall that API business is probably a 4%-ish, 5%-ish growth business in the marketplace, but now we've got good opportunity there. Mostly what we are dealing with in those first two instances are sole-source relationships because we are really focused on new and complex chemistry on the one hand and in biologics, people typically early on don't try to dual source it just because it's too complicated and expensive to do.

In the drug product business, we continue to see very strong growth, particularly in the parenteral products. Some of that of course is coming from the broader mix of biologics coming through the pipeline and in the oral solid dose, these hard-to-formulate molecules continue to be the trend and so we see more and more of that also. On average, probably the injectable business is growing at a faster rate than the oral solid dose.

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John Kreger, William Blair - Analyst [51]

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Great. Thank you. One last quick one. The Roche facility, as you think about 2018, are you thinking more closer to breakeven with a gradual ramp, or are you thinking a faster ramp and EBITDA margin potential as you add new client business to that facility? Thanks.

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Michel Lagarde, Patheon NV - President [52]

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Yes, look, we certainly expect EBITDA contribution from that side in 2018. That will be on the back of successfully transferring in some of these development projects that I previously mentioned, as well as selling new business. If you have an opportunity to go visit the site, I think you'll be impressed. The customers that we have shown it certainly are impressed. This is high-quality capacity with some really great capabilities that we didn't have elsewhere in the network.

So this is a business where the sales cycle is long, but we do expect EBITDA contribution in 2018 and then, as I said, a further ramp in the outer years. Ultimately, the margin profile of that site should be the same as other API facilities. So should have somewhere in the high 20%s EBITDA margins when it's reasonably utilized.

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John Kreger, William Blair - Analyst [53]

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Great. Thank you.

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Operator [54]

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Erin Wright, Credit Suisse.

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Erin Wright, Credit Suisse - Analyst [55]

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How would you characterize the overall M&A environment right now and broader industry consolidation? Are multiples egregiously high or low out there and what are you seeing also from a political standpoint? Is the political uncertainty out there impacting you at all? Thanks.

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Michel Lagarde, Patheon NV - President [56]

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Regarding M&A, I think our views on that are unchanged. We think that this is an industry that needs to be consolidated. We think we are one of the people that will do that. In order to complete a deal, three things need to happen. It needs to fit with our strategic view on the value add that an acquisition would bring strategically; secondly, due diligence needs to pan out. For those that have been in the M&A business, you know that you need to kiss a lot of frogs and not all of them turn into a prince. And the third thing that needs to happen is that the value-creation potential needs to be there, meaning the price in relation to the value creation opportunity needs to be right.

And only when those three things are met, we will execute a transaction. I think we've stayed very disciplined throughout the last five, six years in which we have done these deals and that's the same discipline that we currently apply. So we are very active. We see a good list of opportunities and we are pretty bullish about our ability to continue to play this role of industry consolidator.

With regard to the political climate, that's a difficult question because it's a little unclear where all this will go and how it will impact our business.

I think net-net, we feel we are pretty well-positioned. If I take two big themes that we hear people talk about, one is, of course, will there be pressure on pharma companies with regards to their pricing. Well, if that's the case, I think they will be forced to accelerate their abilities to reduce costs. We think outsourcing is a primary component of that, so we and other industry participants I think ultimately benefit from that.

And two, the big question around border tax and where do you produce. Again, I think we are somewhat biased, but we think we are well-positioned because we have capacity everywhere that people want to manufacture. Whether that's here in North America or in the US, all of our divisions and business units and capabilities, we have capacity available in this country.

So we certainly don't pretend to be having a crystal ball on the way it all flows out, but there is nothing currently on the political horizon that we have seen that gives us great worry.

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Erin Wright, Credit Suisse - Analyst [57]

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Okay, great. Thank you so much.

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Operator [58]

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Tim Evans, Wells Fargo.

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Sarah Silverman, Wells Fargo Securities - Analyst [59]

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This is Sarah Silverman on for Tim. Just to switch gears a little bit. How are you guys thinking about your capital structure? I know you guys have some notes out there that were recently callable. Just wondering what you are thinking about this? Any improvements maybe that could be made to bring down interest expense and then more generally what leverage ratio are you guys comfortable at?

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Stuart Grant, Patheon NV - EVP & CFO [60]

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We continue to look at what we should do with the balance sheet. I think there's an opportunity potentially to reduce that interest burden, extend the maturity of the paper. So that's something we are looking at and we will continue to watch that, but we do see some opportunity there.

And the second part was leverage. So we are at 4.5 LTM today. We tend to [rank] forward [MTM], so we are pretty comfortable at the area that we are operating in today. It continues to come down. It will continue to come down as we go through the year absent any additional M&A activity and if we need to take it up a little bit, as long as we saw a path back there into that 4, 4.5 range, we are pretty comfortable. As long as we feel we are generating the free cash flow cushion and we continue to feel that, we are comfortable with today's level.

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Sarah Silverman, Wells Fargo Securities - Analyst [61]

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Okay, great. Thank you.

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Operator [62]

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Sean Wieland, Piper Jaffray.

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Sean Wieland, Piper Jaffray - Analyst [63]

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So Trump this morning has proposed an NIH budget cut of about 19%. I'd love to just here first your knee-jerk reaction to that and secondly, any impacts to the business.

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Jim Mullen, Patheon NV - CEO [64]

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Well, it will be a knee-jerk reaction. Yes, so, look, that NIH funding goes to the academic institutions predominantly. Actually this area up here in Boston and certainly the San Francisco area are big recipients of NIH funding. And it is relatively important for, I would say, some of the really foundational science basic discovery work that goes on across life sciences. So that will obviously crimp that over a long period of time. If that were to remain in place, that is going to limit the number of new discoveries and technology opportunities coming out of academia, which has been in part the lifeblood of these startup biotech companies.

So over a long period of time, I think it can have an impact. Over a short period of time, if it's a one or two-year phenomenon, it is probably not going to have a big impact over a 10-year period of time. So that is my knee-jerk.

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Sean Wieland, Piper Jaffray - Analyst [65]

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And so how long is that time from the head of the stream at the NIH to your factory floor?

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Jim Mullen, Patheon NV - CEO [66]

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10 years, at least.

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Sean Wieland, Piper Jaffray - Analyst [67]

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Okay. Thanks. And then just one other one. I'm just trying to piece together some dots on API. Is there API capacity constraints across the industry or what are the reasons for the delay in some supply materials? Does it have to do with anything in capacity constraints within the industry?

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Michel Lagarde, Patheon NV - President [68]

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Well, I think there's two observations. One, if you look at high-quality API capacity that is located mostly in the Western Hemisphere, I think you'll see that all of those companies, and some of them are public, are pretty full.

So I think what we are seeing with regards to the robustness of our API business is what others are seeing as well. I think in part that's just industry activity. In part, it's also because a lot of what previously went further East has come back after people have suffered through significant quality issues or unreliability, if you will.

To tie that to the current disruptions we are seeing, that's a little harder for us to do because, as said, we don't have full visibility into what really caused the specific delays that we are confronted with in Q1. So the question is really whether those are indeed structural issues that they are facing in their supply chain with perhaps quality issues or whether it was just somebody screwing up down the line. But it certainly has been the case that a little of that API production has been won by our API business and others that have high-quality facilities here in the US, as well as in Europe.

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Jim Mullen, Patheon NV - CEO [69]

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I mentioned we don't typically have very good visibility into the inventory levels upstream or downstream of us and we would dearly like to get more of that and I don't know if some of this is people are just tightening up their inventory policies and so carrying a little bit less inventory in different places.

The other piece that we see work its way in here is controlled substances, so anything that requires a DEA quota, we are probably seeing on average a bit more disruption around that.

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Sean Wieland, Piper Jaffray - Analyst [70]

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Can you comment on the pricing environment in API?

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Jim Mullen, Patheon NV - CEO [71]

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Our pricing environment remains good and the margins remain good as long as we stay disciplined on where we can compete and compete well, which is new products, complex chemistry, API [of] an ultimate step of [registered] starting materials and we don't start messing around with commoditized products or intermediates. I think that is similar to what all the other good competitors out there, AMRI, Cambrex, etc. are doing. So I think if we remain disciplined around where we are focused, the pricing will remain pretty good.

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Michel Lagarde, Patheon NV - President [72]

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And our strategy, Sean, you know this, but our strategy in API is obviously to perform those high value-add steps in our own facilities and then source the earlier chemistry steps from those low-cost providers. So our strategy is not to have a bunch of capacity to make this commoditized stuff. We have access to it. We have our own networks in those regions to get access to it so we can source it on behalf of our customers, but that is not work we would put into our own factories.

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Sean Wieland, Piper Jaffray - Analyst [73]

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All right. Thank you very much.

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Operator [74]

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Matthew Mishan, KeyBanc Capital Markets.

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Matthew Mishan, KeyBanc Capital Markets - Analys [75]

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Wanted to shift to biologic production from development [did] for margins. How should we think about that with mix?

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Stuart Grant, Patheon NV - EVP & CFO [76]

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Probably neutral to positive. I think overall the development business, we do have good margins both from development for drug products and for development in biologics, but the commercial opportunity is going to be a bigger opportunity and I think there's no reason that we would see -- I think Michel said earlier high-20%s margins and there is no reason why that wouldn't be neutral to positive.

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Jim Mullen, Patheon NV - CEO [77]

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And you would hope over time, as you run these products, there's a learning curve and you pick up efficiency over time when you get to do the same thing again and again, which is not really so much true in the development business where we may run at one and done if it never gets to the second stage.

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Matthew Mishan, KeyBanc Capital Markets - Analys [78]

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Okay. And maybe I'm going a little bit into the weeds here, but one of your larger vendors has been talking about [exceeding] driving standardization software, moving regulatory testing and data to the cloud. Can you talk about how you are thinking about that and what the benefit of that would be for you?

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Jim Mullen, Patheon NV - CEO [79]

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I'm going to actually go up a level even from there. Where we want to take this data interchange with customers to is to get much better visibility upstream and downstream because this is where both we and they encounter difficulties in their supply chain.

Part of that, of course, is being able to just simply transmit and get data back and forth much more quickly with our customers, and so looking at things where we can get batch records or quality release or even inventory data or whatever it might be up into the cloud that's much more accessible than it typically is -- and this industry to be honest is not very far along in that journey. There's still a lot of stuff that happens, dare I say, by fax machine. I don't know who uses one of those anymore, but too much of it still happens non-electronically and non-linked. So I think there's actually a lot of opportunity there, and then, of course, it also means you can -- once you start to get this stuff into an electronic format up in the cloud, being able to look for trends and tracking is going to also enhance the supply chains I think for our customers as well as our operations.

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Michel Lagarde, Patheon NV - President [80]

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Yes, we are quite intrigued by the last point that Jim makes. I think where we sit -- maybe that is to your question on what role CMOs play -- we probably sit in a pretty unique spot in the supply chain because we work with so many different customers, so many different products, both in development and in commercial, both in API and [into] our product. So the data set that we have accumulated over the last 5, 6, 10 years is pretty impressive and I think the ability to start to organize that data efficiently, to mine it, to look for trends and to then make that into a business is certainly one that we are intrigued by because, again, I think the CDMOs in particular sit on pretty rich data, much more so than an individual pharma company. So we are at the early innings of all that, but I think we can play a meaningful role.

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Jim Mullen, Patheon NV - CEO [81]

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Yes, and where it's going to show up first actually is in serialization, because just coming out, it's all going to be in the cloud. So that will leapfrog over some of these old manual systems we have in other places of the business.

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Matthew Mishan, KeyBanc Capital Markets - Analys [82]

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Okay, great. That's really interesting. And then last question, there seems to be a little bit of a conflict of interest with some of the larger biologics producers and their ability to go after the biosimilar business. How do you see that opportunity presenting itself over the next several years?

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Jim Mullen, Patheon NV - CEO [83]

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Conflicts of interest -- well, I haven't followed exactly who's doing what on each molecule, but we do work on a number of biosimilars on behalf of clients. It's been pretty much always our model where we do not go exclusive on anything. So we don't have that inherent conflict and it occasionally comes up in a conversation that somebody says we want you to make something exclusively to be a biosimilar or something else and I think we pretty quickly walked people through that so it doesn't really become an issue.

So from our point of view, we are Switzerland. We make product for everybody and it's our obligation to protect all of their trade secrets and know-how and we've never really had any particular issues with that and I think, because we don't make any products on our own behalf, customers have been comfortable with it. And by the way, that's one of the reasons we divested products that we acquired along the way in some acquisitions that we were making on our own behalf and we divested all of that business so that we could be Switzerland.

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Matthew Mishan, KeyBanc Capital Markets - Analys [84]

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I like Switzerland. Thanks very much, guys.

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Operator [85]

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Michael Baker, Raymond James.

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Michael Baker, Raymond James - Analyst [86]

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Jim, I was wondering if you could give us a sense for how large pharma is responding to your end-to-end solution, particularly given some of the pressures that they are feeling. Is it still where you have to work through the siloed approach? Just trying to get a sense if anything is moving towards your direction?

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Jim Mullen, Patheon NV - CEO [87]

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Well, I'm going to come back to large pharma. Our strategy from the beginning on this one-source opportunity has really been to work in the middle of the market because we think that the middle of the market is much more receptive to this based on their history, what internal capabilities they may or may not have and we are seeing good reception there. And so increasingly people are wanting to talk about one-source solutions and end-to-end solutions.

We are having a number of conversations with the large pharma guys as well, but pharma, large pharma, as we all know, moves relatively slowly. Where we are having those conversations, we are typically above the silos, but there's usually some internal warfare there as the silos want to defend their turf.

I think we are in the early innings with the big pharma guys. I think the next few years will be interesting, but my view is really unchanged in that we will change this from the middle of the market and then the big pharma guys will follow.

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Michel Lagarde, Patheon NV - President [88]

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I think the other element in some of these conversations with big pharma is that, yes, they see the strategic need to change, but certainly not in all cases. I think what is being proposed is a win-win for everybody and again, I think the discipline as we have applied it to our business will stay intact.

This blind pursuit of revenue at no margin, that was I think the Patheon strategy a decade ago, will not make a return and I think a lot of these big pharma folks are pretty sincere about where they want to go next, but then when it gets all translated, some of their bad habits show up. And again, we have no interest in participating in those. We think we can be a meaningful partner and a helpful partner, but it needs to be a win-win and we love this business and I think we love where it sits in the industry and we love the opportunity set as it sits in front of us and that allows us to be I think a little bit more selective on the ones that we can really pursue and engage with.

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Michael Baker, Raymond James - Analyst [89]

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Thanks for that. I had one question for Stuart. I was just wondering if you'd be willing to give any kind of cash flow expectations for the year and maybe maintenance CapEx.

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Stuart Grant, Patheon NV - EVP & CFO [90]

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Maintenance CapEx will be probably about $50 million, Mike. The total CapEx number will be about $150 million. Cash flow generation will be in line with our normal expectations. We drain at the first half of the year; we pick up in the back half.

The interest burden remains at about $110 million; CapEx about $150 million. Taxes, we've said about two-thirds of the $40 million to $60 million is cash and a little bit of working capital, so I think that's the math that we start from EBITDA and take those off and you get to the free cash flow number.

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Michael Baker, Raymond James - Analyst [91]

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That's helpful. Thank you.

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Operator [92]

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Thank you, ladies and gentlemen. We have come to the end of our time allowed for questions. I will now turn the floor back to management for any final remarks.

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Jim Mullen, Patheon NV - CEO [93]

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A lot of good questions. Thank you. I know quite a bit of data for you guys to digest, but I would go back to where we started, which is I think the long-term trends look great. The sales pipeline continues to look robust. We are doing a lot of tech transfers, so I think the long-term trends and pieces certainly remain intact and we appreciate all the very interesting and detailed questions and thoughtful questions today and we will talk to you in 90 days, if not before. Thanks.

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Operator [94]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.