Patheon's future up in the air as profits plummet

By Gregory Roumeliotis

- Last updated on GMT

Related tags: Puerto rico, Patheon

Patheon's move to Puerto Rico is shaping up to be the worst
decision the contract manufacturer has ever made, resulting in
massive losses in the third quarter of 2006 and leading management
to entertain the possibility of a sell-out.

Numerous problems in its manufacturing operations in Puerto Rico forced Patheon to write down a whopping $254.7m (€199.2m) for goodwill and depreciable assets in Q3 of 2006, creating a net loss of $257.2m compared with net earnings of $3.5m in Q3 of 2005. As a result the Canadian company has appointed a special committee to "evaluate strategic and financial alternatives"​ while putting on hold its search for a new CEO, a tell sign that the sale of the firm is one of the options considered. 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 struggled to streamline operations since then. The most serious problem in the third quarter in Puerto Rico occurred at the Caguas facility, where it was discovered that some batches of an undisclosed product might not achieve their expected shelf life. Patheon decided to temporarily stop production, and after considering data accumulated from stability studies conducted throughout the month of August, the company took corrective actions and in early September it allowed the release of shipments of finished product representing approximately 90 per cent of the total production volumes. Meanwhile, an inactive ingredient for a different product made at the Carolina facility was temporarily unavailable, though this did not disrupt the client's inventory and the situation has now been remedied. Additionally, there has been a year-over-year decline in volumes of a generic product manufactured in Puerto Rico as one of Patheon's clients lost a major account earlier this year, while volumes of Merck's blockbuster cholesterol drug Zocor (simvastatin) have also dropped due to its patent expiration last summer. All these issues, in conjunction with the cost of corrective action the company had to take to address production issues with Abbott's antibiotic Omnicef (cefdinir), were responsible for earnings before interest, tax, depreciation and amortisation (EBITDA) in Puerto Rico of $3.5m in losses in the third quarter, compared with a positive EBITDA of $4.8m in the same period last year. Even if it wasn't for Puerto Rico and the $254.7m impairment charge that wiped off Patheon's earnings, the company would have still shown a net loss of $13.6m from a $13.2m net profit a year ago. This is because the efficiencies and cost savings in Patheon's global manufacturing operations promised last quarter with the launch of a vague "Performance Enhancement Programme"​ have not yet materialised; as a percentage of revenues, the EBITDA margin was 8.5 per cent in Q3 2006, compared with 14.5 per cent in the same period a year ago. In Canada for example, gains from higher capacity utilisation, particularly at the Whitby and Toronto York Mills facilities, were small and offset by the impact of the strengthening of the Canadian dollar, so EBIDTA there dropped $0.2m to $6.6m. Across the pond in Europe, gains in sterile product volumes at the two manufacturing sites in Italy were offset by declines in mature product volumes at Swindon, UK and Bourgoin-Jallieu, France, resulting in an EBITDA of $8.3m, a $1m year-on-year decrease. Nevertheless, in a conference with financial analysts, Patheon's president Nick DiPietro defended the restructuring scheme. "A lot of work has been done by the company over the past three months, we have come up with a restructuring initiative in consultation with an outside firm that has solved many problems, like eliminating backorders at Whitby, and we will launch the same programme in Puerto Rico,"​ he said. "A more detailed plan with more comprehensive initiatives will be shown to the committee to consider within the context of the whole strategic review we are undertaking."​ Even if Patheon is not put up for sale, the company's 5,900 employees who work at 14 facilities in North America and Europe fear that reforms may cut many jobs. Yet there is some consolation in that revenues jumped 6 per cent to $189.2m, driven by commercial manufacturing services for prescription drugs in Europe, over-the-counter manufacturing in North America and product development services (PDS) growth in both North America and Europe. In PDS, Patheon's EBITDA was $5.9m, up $1.6m year-on-year, mainly thanks to the Swindon unit where additional laboratory space was brought on line in Q3. Moreover, the transfer of products into Italy and France from two carve-out initiatives has reached its final stages, while there has also been progress in the construction of a new facility in Swindon dedicated to lyophilized cephalosporins, as the equipment and the operating systems have been fully commissioned, validation batches are expected to be completed in October and the site is on track for commercial production in August 2007. Looking ahead, Patheon did not issue specific guidance but said that revenues in the fourth quarter of 2006 are expected to be slightly lower than the third quarter. In Canada, there will be a reduction in volumes at the Whitby facility as the backorder position has been resolved, while in Europe, results will be impacted by normal summer shut downs, the company suggested. The future in Puerto Rico looks brighter, since shipments have resumed of the product manufactured in Caguas for which stability-related issues had been previously identified and volumes are also expected to increase in Carolina as clients build inventory levels in preparation for the cough and cold season. Taking into account that Patheon will have to renegotiate its North American loans following the $254.7m write-off to be in compliance with its debt-to-EBITDA covenants, the new committee that has been put together will now have to decide if the company rides the storm through restructuring or flirts with potential buyers - Hospira and Cardinal Health are rumoured to have already shown interest.

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