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| CBM > SEC Filings for CBM > Form 10-K on 7-Feb-2013 | All Recent SEC Filings |
7-Feb-2013
Annual Report
Executive Overview
The Company's business consists of three manufacturing facilities and one biocatalysis center. These facilities primarily manufacture APIs, pharmaceutical intermediates and, to a lesser extent, other fine chemicals. The Company also owns a 51% stake in Zenara, a pharmaceutical company with final dosage form manufacturing capabilities based in India.
The following significant events, which are explained in detail on the following pages, occurred during 2012:
· Gross sales in 2012 increased 9.2% to $277,931 from $254,475 in 2011. Foreign currency exchange unfavorably impacted sales 3.4%.
· Operating profit increased 49.9% to $35,695 from 2011.
· Debt, net of cash, decreased $25,630 during 2012.
· Release of a valuation allowance on domestic deferred tax assets of $36,287.
Gross sales in 2012 of $277,931 were $23,456 or 9.2% higher than 2011. Excluding foreign currency, sales increased 12.6% as a result of higher volumes sold (14.9%) partially offset by lower pricing (-2.3%). Sales volumes increased in most of the Company's product categories including controlled substances, generic APIs, custom development and products utilizing the Company's drug delivery technology. These increases were partially offset by lower pricing for controlled substances and products utilizing the Company's drug delivery technology.
The Company also experienced a modest increase in its custom manufacturing product category. This category includes APIs, pharmaceutical intermediates and other pharmaceutical products sold to innovator pharmaceutical companies. Increased demand for certain APIs was partially offset by a newly approved product in which the customer built up inventory in 2011.
Gross margins in 2012 increased to 32.6% compared to 29.1% in 2011. 2012 gross margins included a 0.2% favorable impact from foreign currency versus 2011. Excluding the foreign currency impact, gross margins were positively impacted by higher production volumes (3.7%), leading to increased plant efficiency, and favorable product mix (2.6%), partially offset by lower pricing in 2012 which eroded margins (-1.4%).
The Company reported income from continuing operations of $63,229, or $2.09 per diluted share in 2012, compared to $13,735 or $0.46 per diluted share in 2011. The increase in 2012 includes a tax benefit of $36,287, or $1.20 per diluted share, resulting from the release of a valuation allowance on deferred tax assets and higher gross profit resulting from increased sales.
Critical Accounting Estimates
The Company's critical accounting estimates are those that require the most subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company bases its estimates on historical experience and on other assumptions that are deemed reasonable by management under each applicable circumstance. Actual results or amounts could differ from estimates and the differences could have a material impact on the consolidated financial statements. A discussion of the Company's critical accounting policies, the underlying judgments and uncertainties affecting their application and the likelihood that materially different amounts would be reported under different conditions or using different assumptions, is as follows:
Revenue Recognition
Revenues are generally recognized when title to products and risk of loss are transferred to customers. Additional conditions for recognition of revenue are that collection of sales proceeds is reasonably assured and the Company has no further performance obligations.
Amounts billed in advance are recorded as deferred revenue on the balance sheet. Since payments received are typically non-refundable, the termination of a contract by a customer prior to its completion could result in an immediate recognition of deferred revenue relating to payments already received but not previously recognized as revenue.
Sales terms to certain customers include rebates if certain conditions are met. Additionally, sales are generally made with a limited right of return under certain conditions. The Company estimates these rebates and returns at the time of sale based on the terms of agreements with customers and historical experience and recognizes revenue net of these estimated costs which are classified as allowances and rebates.
The Company bills a portion of freight cost incurred on shipments to customers. Amounts billed to customers are recorded within net revenues. Freight costs are reflected in cost of goods sold.
Asset Valuations and Review for Potential Impairments
The review of long-lived assets, principally fixed assets and other amortizable intangibles, requires the Company to estimate the undiscounted future cash flows generated from these assets whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. If undiscounted cash flows are less than carrying value, the long-lived assets are written down to fair value.
The review of the carrying value of goodwill and indefinite lived intangibles is conducted annually or whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable utilizing a two-step process. In the first step, the fair value of the reporting units is determined using a discounted cash flow model and compared to the carrying value. If such analysis indicates that impairment may exist, the Company then estimates the fair value of the other assets and liabilities utilizing appraisals and discounted cash flow analyses to calculate an impairment charge.
The Company has investments in partially-owned affiliates. It does not separately test an investee's underlying assets for impairment but will recognize its share of any impairment charge recorded by an investee in earnings and consider the effect of the impairment on its investment. A series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred that is other than temporary. A loss in value of an investment that is other than a temporary decline would be recognized as an impairment if the fair value of that investment is less than its carrying amount.
The determination of fair value is judgmental and involves the use of significant estimates and assumptions, including projected future cash flows primarily based on operating plans, discount rates, determination of appropriate market comparables and perpetual growth rates. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and the magnitude of any such charge.
Income Taxes
The Company applies an asset and liability approach to accounting for income taxes. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities, and tax credit carryforwards, on a taxing jurisdiction basis using enacted tax rates in effect for the year in which the differences are expected to reverse or the tax credit carryforwards are expected to be realized. The recoverability of deferred tax assets is dependent upon the Company's assessment that it is more likely than not that sufficient future taxable income of the appropriate character and in the appropriate taxable years will be generated in the relevant tax jurisdictions to utilize the deferred tax assets. When the Company determines that future taxable income will not be sufficient to utilize the deferred tax assets, a valuation allowance is recorded. After release of a portion of the Company's domestic valuation allowance in the fourth quarter of 2012, the remaining domestic valuation allowance primarily relates to federal foreign tax credits. Prior to 2012, domestic valuation allowances also included alternative minimum tax credits, research and development tax credits and other net deferred tax balances, excluding deferred tax liabilities on indefinite-lived intangibles. The Company's foreign valuation allowances primarily relate to NOL carryforwards in foreign jurisdictions with little or no history of generating taxable income or where future profitability is uncertain. The Company's accounting for deferred taxes represents management's best estimate of those future events. Changes in current estimates, due to unanticipated events, could have a material impact on the Company's financial condition and results of operations.
Assumptions and Approach Used in Assessing the Need for a Valuation Allowance
The Company considers both positive and negative evidence related to the likelihood of realization of deferred tax assets. If, based on the weight of available evidence, it is more likely than not the deferred tax assets will not be realized, the Company records a valuation allowance against all or a portion of the deferred tax assets to adjust the balance to the amount considered more likely than not to be realized. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified.
This assessment, which is completed on a taxing jurisdiction basis, takes into account a number of types of evidence, including the following:
· Nature, frequency, and severity of current and cumulative financial reporting losses. A pattern of objectively-measured recent financial reporting losses is heavily weighted as a source of negative evidence. The Company generally considers cumulative pre-tax losses in the current three-year period to be significant negative evidence regarding future profitability. The Company also considers the strength and trend of earnings, as well as other relevant factors. In certain circumstances, historical information may not be as relevant due to changes in the Company's business operations;
· Sources of future taxable income. Future reversals of existing temporary differences are heavily-weighted sources of objectively verifiable evidence. Projections of future taxable income exclusive of reversing temporary differences are a source of positive evidence only when the projections are combined with a history of recent profits and can be reasonably estimated; and
· Tax planning strategies. Prudent and feasible tax planning strategies that would be implemented to maximize utilization of expiring tax credit carryforwards are evaluated as a source of additional positive evidence.
Valuation Allowance Assessment
In 2003, the Company's assessment of the need for a valuation allowance against domestic deferred tax assets considered current and past performance, cumulative losses in recent years from domestic operations, and a shift in the geographic mix of forecasted income. Considering the pattern of then-recent domestic losses, the Company gave significant weight to projections showing future domestic losses for purposes of assessing the need for a valuation allowance. This assessment resulted in a determination that it was more likely than not that domestic deferred tax assets would not be realized, and as such, a valuation allowance against net domestic deferred tax assets was recorded.
A sustained period of domestic profitability along with expectations of future domestic profitability of sufficient amounts and character is required before the Company would change its judgment regarding the need for a full valuation allowance against net domestic deferred tax assets. During 2012, the Company noted that it continued to approach three-year cumulative profitability and that it was possible it would conclude by the end of the year that a portion of its domestic deferred tax asset valuation allowance could be reversed in the fourth quarter of 2012. During the fourth quarter of 2012, the Company completed its long range planning process and all necessary analyses and concluded that its three-year cumulative domestic profitability through the end of 2012 and expectations of future domestic profitability warranted the reversal of all of the domestic valuation allowance attributable to net federal temporary differences, alternative minimum tax credits, and research and experimentation tax credits. Additionally, the Company released a portion of the domestic valuation allowance attributable to federal foreign tax credits. These valuation allowance releases resulted in a tax benefit to continuing operations of $36,287.
Environmental and Litigation Contingencies
The Company periodically assesses the potential liabilities related to any lawsuits or claims brought against it. See Note 19 to the Company's consolidated financial statements for a discussion of the Company's current environmental and litigation matters, reserves recorded and its position with respect to any related uncertainties. While it is typically very difficult to determine the timing and ultimate outcome of these actions, the Company uses its best judgment to determine if it is probable that the Company will incur an expense related to a settlement for such matters and whether a reasonable estimation of such probable loss, if any, can be made. If probable and estimable, the Company accrues for the costs of clean-up, settlements and legal fees. Given the inherent uncertainty related to the eventual outcome of litigation and environmental matters, it is possible that all or some of these matters may be resolved for amounts materially different from any provisions that the Company may have made with respect to their resolution from time to time.
Employee Benefit Plans
The Company provides a range of benefits to certain employees and retired employees, including pensions and health care benefits. The Company records annual amounts relating to these plans based on calculations, which include various actuarial assumptions, including discount rates, assumed rates of return, turnover rates, and health care cost trend rates. The Company reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends when it is deemed appropriate to do so. The effect of the modifications is generally recorded and amortized over future periods. The Company believes that the assumptions utilized for recording obligations under its plans are reasonable.
The discount rate used to measure pension liabilities and costs is selected by projecting cash flows associated with plan obligations which are matched to a yield curve of high quality bonds. The Company then selects the single rate that produces the same present value as if each cash flow were discounted by the corresponding spot rate on the yield curve.
Results of Operations
2012 Compared to 2011
Gross sales in 2012 increased 9.2% to $277,931 from $254,475 in 2011. Foreign currency exchange unfavorably impacted sales 3.4%. Excluding foreign currency, sales volumes increased in most of the Company's product categories including controlled substances, generic APIs, custom development and products utilizing the Company's drug delivery technology. These increases were partially offset by lower pricing for controlled substances and products utilizing the Company's drug delivery technology.
The Company also experienced a modest increase in its custom manufacturing product category. This category primarily includes APIs and pharmaceutical intermediates sold to innovator pharmaceutical companies. Increased demand for certain APIs was partially offset by a newly approved product in which the customer built up inventory in 2011.
One customer, Gyma, a distributor representing multiple customers, accounted for 12.5% of the Company's 2012 consolidated sales. One API, sold to multiple customers, accounted for 11.9% of 2012 consolidated sales.
Gross profit in 2012 was $90,487 compared to $74,084 in 2011. Gross margins in 2012 increased to 32.6% compared to 29.1% in 2011. Excluding a 0.2% favorable impact from foreign currency, gross margins increased to 32.4% in 2012 versus 2011. Excluding the foreign currency impact, gross margins were positively impacted by higher production volumes (3.7%), leading to increased plant efficiency, and favorable product mix (2.6%), partially offset by lower pricing in 2012 which eroded margins (-1.4%).
Selling, general and administrative expenses of $45,248 or 16.3% of gross sales in 2012 increased from $39,227 or 15.4% in 2011. This increase is due primarily to higher employee compensation (approximately $4,800), sales and marketing (approximately $900) and medical expenses (approximately $600) partially offset by a favorable impact from foreign exchange (approximately $1,300).
Research and development expenses of $9,544 were 3.4% of gross sales in 2012, compared to $11,037 or 4.3% of gross sales in 2011. The decrease is primarily due to increased absorption of R&D expenses into inventory and cost of goods sold as a result of increased revenue generating custom development activity and a favorable impact from foreign exchange.
Operating profit was $35,695 in 2012 compared to $23,820 in 2011. The increase is due to higher gross profit, partially offset by higher selling, general and administrative expenses discussed above.
Net interest expense was $2,439 in 2012 compared to $2,373 in 2011. Higher interest rates were partially offset by lower average debt. The average interest rate on debt was 2.2% in 2012 versus 1.6% in 2011. The increase in the interest rate in 2012 is mainly due to the Company's interest rate swaps entered into in the first quarter of 2012 which fixed the interest rate on $60,000 of its variable rate debt.
In November 2010, the Company acquired a 51% equity stake in Zenara for approximately $18,900. Zenara is a pharmaceutical company focused on the formulation of final dosage form products based in India. Cambrex accounts for its investment in Zenara using the equity method of accounting. The impact of its ownership stake in Zenara was a loss of $1,976 and $1,621 in 2012 and 2011, respectively, and is located within "Other expenses/(income)" as "Equity in losses of partially-owned affiliates" in the Company's income statement. These amounts include amortization expense of $965 and $1,106 in 2012 and 2011, respectively and depreciation expense of $132 and $149 in 2012 and 2011, respectively. Equity in losses of partially-owned affiliates also includes a gain of $210 in 2012 related to an investment in a European joint venture.
The Company recorded a tax benefit of $31,861 in 2012 compared to expense of $6,202 in 2011. The tax benefit for 2012 includes a benefit of $36,287 for a reversal of domestic valuation allowances. Additionally, 2012 and 2011 include benefits of $8,818 and $9,546, respectively, for changes in valuation allowances to offset expense and benefit generated from domestic income, tax credits, and losses in certain foreign jurisdictions. The reversal of the valuation allowance in 2012 resulted from the Company's assessment of realizability of domestic deferred tax assets and tax credit carryforwards due to expected future profitability in the U.S., among other factors. Since 2003, the Company had maintained a full valuation allowance on the tax benefits arising from domestic pre-tax losses, U.S. tax credits, and net deferred tax balances, excluding indefinite-lived intangibles. Excluding the effect of the valuation allowance reversal and the effect of remeasuring certain foreign deferred tax liabilities due to a change in enacted tax rates, the effective tax rate was 18.3% in 2012 compared to 31.1% in 2011. This reduction was mostly due to significantly higher U.S. income in 2012 for which the Company was able to utilize fully valued domestic tax attributes, prior to release of the domestic valuation allowance, to mitigate tax expense.
In 2009, a subsidiary of the Company was examined by a European tax authority, which challenged the business purpose of the deductibility of certain intercompany transactions from 2003 and issued two formal assessments against the subsidiary. In 2010, the Company filed appeals to litigate the matter. The first court date related to this matter was held in 2011, after which the court issued its ruling in favor of the Company. The tax authorities appealed this ruling and the appeals court also ruled in the Company's favor in the fourth quarter of 2012, however this ruling only applies to the smaller of the two assessments. The first court date for the larger of the two assessments was held in September 2012, and the Company has not yet received the court's ruling. In 2012 the Company increased its reserve for unrecognized tax benefits for this matter by $664, including $116 of foreign currency translation, primarily due to a change in the potential penalties that could be levied against the Company. The Company still believes this dispute to be in the early stages of the judicial process since any ruling reached by any of the courts may be subject to further appeals, and as such the final date of resolution of this matter is uncertain at this time. However, within the next twelve months it is possible that factors such as new developments, settlements or judgments may require the Company to increase its reserve for unrecognized tax benefits by up to approximately $8,000 or decrease its reserve by approximately $6,000, including penalties and interest. If the court rules against the Company in subsequent court proceedings, a payment for a substantial portion of the judgment, including any penalties and interest, will be due immediately while the case is appealed. The Company has analyzed these issues in accordance with guidance on uncertain tax positions and believes at this time that its reserves are adequate, and intends to vigorously defend itself.
Income from continuing operations in 2012 was $63,229 or $2.09 per diluted share, versus $13,735, or $0.46 per diluted share in 2011. The increase in 2012 includes a tax benefit of $36,287, or $1.20 per diluted share, resulting from the release of a valuation allowance on deferred tax assets and higher gross profit resulting from increased sales.
2011 Compared to 2010
Gross sales for 2011 increased 12.4% to $254,475 from $226,436 in 2010. Foreign currency exchange favorably impacted sales 4.8%. Excluding foreign currency, the main drivers of the higher sales include higher volumes of an API to a customer who experienced a disruption in its supply chain for most of 2010, increased volumes for a recently approved product, increased demand for an API manufactured under a long-term supply agreement and higher sales of imaging and crop protection chemicals. These increases were partially offset by lower pricing across several product categories, lower revenue from clinical phase projects and lower sales of a product that was discontinued by a customer of the Company in December 2010.
The Company also experienced higher generic API sales due to higher volumes partially offset by competitive pricing. Sales of controlled substances, which the Company defines as drugs falling under Schedule II of the U.S. Drug Enforcement Agency's classification system, showed continued growth in 2011.
One customer, Gyma, a distributor representing multiple customers, accounted for 10.8% of the Company's 2011 consolidated sales. One API sold to multiple customers, accounted for 13.4% of 2011 consolidated sales.
Gross profit in 2011 was $74,084 compared to $66,866 in 2010. Gross margins in 2011 decreased to 29.1% compared to 29.5% in 2010. Excluding a 0.6% unfavorable impact from foreign currency, gross margins increased to 29.7% in 2011 versus 2010. Excluding the foreign currency impact, gross margins were positively impacted by higher production volumes, leading to increased plant efficiency, and favorable product mix, partially offset by lower pricing in 2011, and the result of the benefits in 2010 for insurance proceeds related to a business interruption claim and fees related to the cancellation of a supply contract.
Selling, general and administrative expenses of $39,227 or 15.4% of gross sales in 2011 increased from $34,024 or 15.0% in 2010. This increase is due primarily to higher employee compensation (approximately $4,100), unfavorable foreign exchange (approximately $1,500) and higher sales and marketing costs (approximately $400) partially offset by lower pension expense (approximately $1,200).
Research and development expenses of $11,037 were 4.3% of gross sales in 2011, compared to $10,305 or 4.6% of gross sales in 2010. The increase is primarily due to unfavorable foreign exchange.
During 2010, the Company finalized a plan to restructure its operations at a manufacturing site which resulted in a reduction in workforce of 32 employees. The plan included certain one-time benefits for terminated employees, all of which will be paid in cash. Costs related to this plan are recorded on the Company's income statement under the caption "Restructuring expenses" and totaled $1,293 in 2010.
Operating profit was $23,820 in 2011 compared to $20,247 in 2010. The increase is due to higher gross profit, partially offset by higher depreciation expense and selling, general and administrative expenses discussed above. The 2010 results include restructuring costs and merger and acquisition expenses of $1,293 and $997, respectively.
Net interest expense was $2,373 in 2011 compared to $4,391 in 2010. The average interest rate on debt was 1.6% in 2011 versus 3.3% in 2010. Interest rate swaps expired in October 2010 resulting in a lower weighted average interest rate in 2011.
In November 2010, the Company acquired a 51% equity stake in Zenara for approximately $18,900. Zenara is a pharmaceutical company focused on the formulation of final dosage form products based in India. Cambrex accounts for its investment in Zenara using the equity method of accounting. The impact of its ownership stake in Zenara was a loss of $1,621 and $286 in 2011 and 2010, respectively, and is located within "Other expenses/(income)" as "Equity in losses of partially-owned affiliates" in the Company's income statement. These amounts include amortization expense of $1,106 and $185 in 2011 and 2010, respectively and depreciation expense of $149 and $25 in 2011 and 2010, respectively.
The Company recorded tax expense of $6,202 in 2011 compared to $5,665 in 2010. The tax expense for 2011 and 2010 includes benefits of $9,546 and $14,246, . . .
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