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Patheon 'dissatisfied' as profits stagnate

By Gregory Roumeliotis , 05-Jun-2006

Canadian contract manufacturer Patheon saw pre-tax profits remain idle in the second quarter of 2006, leaving it struggling to find ways to boost profitability.

Plaguing Patheon were lost revenues from a generic product, a spat with the US Food and Drug Administration (FDA) over the manufacturing of Abbott's antibiotic drug Omnicef in Puerto Rico, and the lack of enough new deals to boost the bottom line.

Pre-tax profits in Q2 of 2006 barely moved at $5.8m (€4.5m), while profit margins remained stable at 5.6 per cent.

The company sustained a big hit in Puerto Rico from its manufacturing operations, where earnings before interest, taxes, depreciation and amortisation (EBITDA) plunged 55 per cent to $4.4m, mainly because one of Patheon's clients lost a major customer and also because of additional costs incurred as part of the corrective action plan to address FDA issues relating to Omnicef production.

The Mississauga-based firm now claims Omnicef is being manufactured on three production lines and volumes have returned to levels prior to receiving the warning letter from the FDA in Q1.

Patheon acquired Puerto Rican drug manufacturer MOVA for $350m in late 2004, attracted by Puerto Rico's low corporate tax rate and low labour costs, but has battled to streamline operations since then.

Although volumes there increased in Q2 of 2006 at the Carolina facility, they were not enough to compensate for the volume declines at the Caguas and Manati sites.

There was better news in Canada where higher capacity utilisation led to a doubling for EBITDA to $4.9m, thanks to gains in the firm's Toronto and Whitby facilities.

Across the pond there was improvement too, with EBITDA from Europe rising 49 per cent to $7.5m, thanks to increased parenteral volumes at the Italian sites resulting from one of two client carve-out initiatives underway in Europe, increased sterile lyophilisation volumes, and continued improved performance at Swindon, UK, where Patheon clinched a seven-year contract with a major pharmaceutical company to produce a promising innovative cephalosporin product against methicillin-resistent Staphylococcus aureus (MRSA).

Overall, growth in the second quarter came primarily from commercial manufacturing services for prescription drugs in both North America and Europe but was wiped out by a 6 per cent decline in over-the-counter (OTC) manufacturing revenues.

Indeed, the Canadian manufacturer seems unable to reverse its fortunes in the OTC arena and may in fact have given up; prescription manufacturing and development services represented 86 per cent of revenues in the last quarter, compared with 84 per cent for the comparable period in 2005, as the company admits to focusing on attracting more profitable prescription manufacturing and PDS business to its facilities.

As far as Patheon's pharmaceutical development services (PDS) are concerned, EBITDA declined by 31 per cent to $3.4m, since growth at the Cincinnati and Puerto Rico PDS units was offset by lower earnings from the Canadian PDS operations, where there were fewer late-stage projects.

Patheon responded to the disappointing results by launching an eye-catching "performance enhancement programme" which was completely void of detail as the company said it will be two or three months before any plans are made public.

Thus begins a period of uncertainty for Patheon's 6,100-strong workforce, still the management stressed that the company's future is secure.

"There is no way we are talking up this company for sale, it has got huge inherent value and we are going to develop that value," Patheon's chairman Peter Green told a press conference.

"As to how we go into the future, whether we stand alone in the very long term or whether we find strategic relationships, who knows?"

Green also said the company will leave "no stone unturned" in its quest for a new CEO to replace Robert Tedford, who announced his retirement last month.

An immediate challenge for Patheon now is the patent expiry of cholesterol drug Zocor this month.

Zocor is Merck's biggest seller with $1.063bn revenue in Q1 of 2006, so the loss of its patent protection is expected to trigger a fall in Patheon's manufacturing revenues.

Nevertheless, Patheon points out that Zocor represents only 3 per cent of its income, and even this full impact will be deferred until 2007, as the company expects to manufacture an authorised generic version of the product for at least the six months following the patent expiry.

The company also anticipates that operating efficiencies at Whitby will continue, operations in Toronto will benefit from higher volumes of high-potency products, while in Europe, revenue growth will be driven by the two carve-out initiatives in France and Italy, which reflect 25 products in more than 900 dosage and packaging formats.

To date, six products have been transferred to Patheon's Italian facilities and three to its facility in Bourgoin-Jallieu, France, including three in the second quarter.

The transfers will be completed in 2007 and Patheon expects them to contribute in the range of $35m to $40m to the revenue base of Patheon's European operations in 2008.

Yet in the nearer future, earnings in the second half of 2006 are expected to remain stable, reflecting the limits of Patheon's cost-cutting exercise.

Much depends on whether the company will manage, thanks to repositioning its operations, to reduce its effective tax rate - despite the pre-tax profit of $5.8m in Q2 of 2006 Patheon made a net profit of $3m after it was hit by a huge tax bill of $2.9m.