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Akorn, Inc. (NASDAQ:AKRX)

Q3 2008 Earnings Call Transcript

November 3, 2008, 5:00 pm ET

Executives

Arthur Przybyl – President and CEO

Jeff Whitnell – CFO, SVP, Treasurer and Secretary

Analysts

Scott Hirsch – Credit Suisse

Operator

Good day and welcome to the Akorn Incorporated conference call. Today's conference is being recorded. At this time, for opening remarks and introduction, I would like to turn the call over to your host President and CEO, Mr. Arthur Przybyl. Please go ahead

Arthur Przybyl

Thank you. Good afternoon, ladies and gentlemen, and welcome to Akorn's conference call. My name is Art Przybyl, and presenting our financial position today is Jeff Whitnell, our Chief Financial Officer. We will hold a brief question-and-answer period at the end of the presentation.

Our third quarter operating results were strong and demonstrate our execution to our business strategies and an evolving and improving business model. We realized large year-over-year increases in revenues and gross profit, improved margins, and flat overall operating expenses. All segments of our business model contributed, Ophthalmics, Hospital Drugs and Injectables, Vaccines, Contract Manufacturing, and our newly launched Akorn-Strides Joint Venture. The result of this was profitability and positive EBITDA. Our third quarter EBITDA was approximately $3.9 million which represented a year-over-year EBITDA turnaround of approximately $7.1 million. Our positive cash flow and availability of working capital remained sufficient to run our business for the foreseeable future. More importantly, recently announced and still expected near-term significant business catalysts should help us to continue our momentum.

Total revenue for the third quarter was $31.9 million, an increase of approximately 102% over the prior year period and a sequential 50% increase over the second quarter 2008. These are record quarterly revenues for us. Gross profit for the quarter was $9.9 million, an increase of 234% over the prior year period. The increase in third quarter gross profit was due to revenue growth in all business segments but primarily due to vaccine segment revenues which contributed $5.3 million of gross profit. Gross margins improved to 31.1% as compared to 18.8% in the prior year period. Sequentially, gross margins improved by 8 points from 22.7% to 31.1%.

Our Ophthalmic business segment revenues increased by 2% to $5.1 million over the prior year period. Currently we have 12 Ophthalmic products under development of these six are on file with the FDA and six are under development. Recently we received our NDA approval for Akten and have subsequently announced that we have launched the product. As part of our Akten marketing launch, we have scheduled our formal product launch and clinical presentation to be kicked off at the American Academy of Ophthalmology Annual Meeting in November in Atlanta, Georgia. To date we have 190 trials ongoing representing $570,000 of potential annual sales and early results from 11 completed trials have all been very positive. We believe our total market opportunity for Akten is approximately $275 million as we pursue our objectives to establish Akten as a standard of care whenever a topical anesthetic is required during an ophthalmic surgical procedure.

In our Hospital Drugs and Injectables business segment excluding DTPA, revenues increased by 50% to $6.2 million as compared to the prior year period. Strong year-over-year sales in analgesic and antidote poison control products contributed to the increase. Additionally revenue increases and year-over-year group purchasing organization contract compliancy have been a direct result of our investment in our hospital field sales team. Currently we have 31 Hospital Drug and Injectable products under development of these 9 are on file with the FDA and 22 are under development. We continue to expect near term product approvals but just the one we announced earlier today for Adenosine and significant product approvals such as our Vancomycin ANDA to further revenue increases for this business segment. We have several Vancomycin type product opportunities under development. At the same time we continued to discuss the opportunity for a forward deployment order for DTPA, our nuclear radiation anecdote, and expect to provide a more detailed update in the near future.

The Vaccine business segment currently generates the majority of our revenues and gross profit and has become an increasingly important part of our business model. Vaccine business segment revenues totaled $17.9 million an increase of 278% over the prior year period when we initially launched vaccines. Revenues include approximately $12.8 million for Tetanus Diphtheria vaccine sales and $5.1 million for Flu vaccine sales. Our Td market share continues to increase, over 1500 hospitals are now buying our product and every major distributor has purchased the unit dose Td vaccine. Our inaugural Flu sales met our expectations and continued residual Flu sales will be realized in the fourth quarter. Regarding vaccine development we have a scheduled pre-IND meeting with CBER in the fourth quarter as we attempt to determine the bridging clinical trial requirements towards filing for a biologic license application for hepatitis B. This is our first partnered vaccine with Serum Institute that we intend to commercialize in the United States. As our vaccine model continues to mature, we expect to generate continued market share gains for both our Td and Flu vaccine products an example of the long-term value associated with biologics application vaccine products. Akorn remains committed to providing affordable vaccines for US Healthcare and its consumers.

Contract Pharmaceutical Manufacturing business segment revenues totaled $2.6 million an increase of 78% as compared to the prior year period. Revenues from three new contract customer agreements one signed in 2007 and two in 2008 contributed to the improved results. We expect our revenues to continue to increase since we still have four new customer agreements that had not yet launched at the end of the third quarter. One customer agreement has launched in October 2008 and the other three are expected to launch in 2009. Of the six new agreements signed this year, two are for Injectable products and four are for Ophthalmic products.

Finally, our Akorn-Strides Joint Venture launched its first commercialized product and generated joint venture income of $447,000 representing Akorn’s equity earnings from its 50% position in the Joint Venture. The Joint Venture has now received 12 product approvals and has six products on file with the FDA and 11 products under development. Several Joint Venture products are scheduled to be launched in the near future.

I would now turn the conference call over to Jeff for an update on our financial position.

Jeff Whitnell

Thank you Art. Good afternoon, ladies and gentlemen. Total revenue for the third quarter 2008 was $31.9 million versus $15.8 million in the third quarter 2007, an increase of $16.1 million or 102%. Third quarter 2008 revenues are the highest ever recorded by Akorn with year-over-year increases in revenues realized in all four of our business segments. Ophthalmic business segment revenues increased 2% over the prior year revenue total which included sales of approximately $2 million from the reintroduction of IC-Green. Hospital Drugs and Injectables business segment revenues increased 36% over the prior year revenue total as a result of strong antidote and analgesic product sales. The vaccine business segment revenues increased 278% over the prior year revenue total when the company initially launched Td vaccine and includes the impact of Flu vaccine product sales. Contract Pharmaceutical Manufacturing business segment revenues increased 72% over the prior year revenue total and reflects the impact of three new customers as well as a marketing fee that was earned on sales by the Akorn-Strides Joint Venture.

Gross profit for the third quarter 2008 was $9.9 million as compared to $3 million in the third quarter 2007. Year-over-year revenue increases in each of our four business segments also contributed to year-over-year gross profit increases in each business segment. However the aggregate increase in the third quarter 2008 gross profit of approximately $6.9 million is due primarily to product sales of unit-dose Td vaccines and antidotes which contributed approximately $5 million and $1.1 million respectively. Gross margin for the third quarter 2008 was 31.1% versus 18.8% in the prior year period, and reflects the impact of high margin antidote and unit-dose Td vaccine product sales.

Selling, general, and administrative expenses totaled $6.2 million in the third quarter 2008, an increase of $900,000 over the comparative prior year period. This increase is primarily due to the expansion of our sales team from 30 to 65 representatives which was completed in the first quarter 2008. Research and development expenses were $1.1 million in the third quarter 2008 versus $2.1 million in the comparative prior

year period and reflect lower milestone payments for new product development activities. Interest and other income and expense for the third quarter of 2008 totaled $271,000 versus interest income of $140,000 in the comparative prior year period and reflects higher borrowing cost and increased debt which were partially offset by a $25,000 gain on the sale of fixed assets.

Also during the third quarter of 2008, the Akorn-Strides Joint Venture initiated its first commercial product launch Rifampin for Injection, a drug product used in the treatment of all forms of tuberculosis. The positive operating performance of the Joint Venture contributed approximately $447,000 of non-operating income to Akorn representing our equity earnings from the 50% position we hold in the Akorn-Strides Joint Venture.

Net income for the third quarter of 2008 was $2.4 million or $0.03 per fully diluted share versus a net loss of $4.7 million in the third quarter of 2007 or $0.05 per fully diluted share. The September fully diluted share count for the company is approximately 90 million.

I would now like to draw your attention to the balance sheet. As of today, the company has cash and restricted cash equal to $7.3 million plus approximately $4.2 million of undrawn upon availability under our credit agreement. Trade receivables as of September 30, 2008 totaled $15.7 million and reflect increased product sales in all four business segments. The financial strength and liquidity provided by enhanced operational cash flows will enable us to continue to reduce the outstanding balance on our credit agreement revolver. To date, we have used our revolver primarily to fund our investment in Td vaccines. As of September 30, 2008, our carrying value on the balance sheet for unit-dose Td vaccine was approximately $13.8 million, an increase over the second quarter of 2008 of $2.9 million. During the third quarter of 2008 we completed the exchange of our entire multidose Td vaccine inventory for unit dose preservative free Td vaccine with our supplier and are now selling unit dose preservative free Td vaccine exclusively. In order to facilitate this inventory exchange we negotiated a $5 million subordinated note that is due and payable in July 2009. Td vaccine shipments continued to accelerate in the third quarter 2008 due to increased unit dose Td vaccine sales to US hospitals and distributors. We believe that as our presence in the hospital market and the office space position market for Td vaccine continues to increase, we will remain cash flow positive and have sufficient working capital to meet our business requirements. The other addition to our balance sheet during the third quarter of 2008 is a caption for capital leases of approximately $1.8 million which represent the value of tenant improvements at our new distribution facility in Gurnee, Illinois and our new corporate headquarters in Lake Forest, Illinois.

Finally, I would like to briefly review the statement of cash flows. During the third quarter 2008, we generated EBITDA of approximately $3.9 million.

Thank you for your time and attention, I will now turn the teleconference back to you Art.

Arthur Przybyl

Thank you Jeff. This concludes our narrative and we would like to open the teleconference to any questions that anybody might have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will take our first question from Scott Hirsch with Credit Suisse.

Scott Hirsch – Credit Suisse

Good evening guys, how are you?

Arthur Przybyl

Hi Scott.

Scott Hirsch – Credit Suisse

Handful of questions for you. I want to start with the vaccines, you mentioned that you have 1500 hospitals in all the major distributors, can you give us a sense of how contracting goes on at this point, what is less under contracts for the rest of this year? When do these GPOs re-contract?

Arthur Przybyl

Sure, it is an excellent question. Contracting with GPOs is typically for several years, two to three years in duration. So we are on every major group purchasing organization contract in the United States for our Td vaccine and our ability to continue to achieve market share gains in hospital market is dependent upon our sales reps converting hospitals from a competitor’s product over to our Td vaccine through contract compliancy and through a greater affordability or lesser cost than we typically offer as compared to our competitor. We continue to see market share gains in the hospital market on a monthly basis and we have seen that also in the month of October which is going to reach a record number of throughput sales in the hospital market, that is relevant because Td vaccine is somewhat seasonal but obviously we continued to see market share gains as we have grown from in essence a launch of the product in January. Our market share in hospitals now is approaching 25% market share in the United States. In the office space physician market, we have relationships with every major distributor in the United States who is buying our unit dose vaccine and we are beginning the transition of the office based physician market from the multiple dose vial product to the unit dose vial product through our major distributors. Some examples of major distributors in the vaccine market would be Henry Schein Physician Sales and Service, McKesson General Medical

and several others that I could name. Then our CDC contract which we initiated for a public health and government purchases I believe in July of this year is good for one year and again we continued to see increases in Td volumes purchased directly from us through the CDC contract on a monthly basis but that contract still has quite a way to go certainly before it reaches maturity. We are not yet at our stated market objective for Td vaccine which is 50% and so from our perspective we still have the opportunity for additional revenue increases over the next year and certainly several months.

Scott Hirsch – Credit Suisse

Okay and so is it more contract compliant on the hospital side or really penetrating this office based segment?

Arthur Przybyl

It is really contract compliant on the hospital side because the competitor had a monopoly there, that market size is approximately $80 million to $90 million and we are really at a run rate of about 25% share in that area and with office based physicians they to a certain extent already had some of the market versus the competitor but I will tell you that one distributor recently is going with our unit dose product exclusively now and so that is very important to us. We do not still have the ability to drive a lot of market share in the office based physician market except by going through the large distributor base that we have and so we are to a large extent dependent on them to drive share based on the cost advantage and the greater profit that we can offer them in marketing and selling our Td vaccine to office based physicians.

Scott Hirsch – Credit Suisse

Right and while we are on that theme can we touch base on Flu, pretty good number this quarter, are you guys seeing any sort of I guess early signs of a Flu season one way or the other?

Arthur Przybyl

You know it is hard for us to tell that Scott because the numbers that we are posting for Flu are quite frankly insignificant compared to the overall size of the Flu market which is about $900 million. So we are going to see some residual sales in the fourth quarter but this is our first quarter into Flu, we are learning how to compete in this market, it is a much lower margin products for us but helps us offset some of the expenses of our vaccine sales team, leverages it up versus the Td vaccine and certainly we think there is room for vast improvement in terms of revenue generation in the second season although we launch Flu again next year. But we are not a good indicator as to whether we are going to have a bad Flu season or a mild Flu season.

Scott Hirsch – Credit Suisse

Okay, fair enough. To some of the new products, I think you said this is our first quarter of seeing some of the JV Akorn-Strides partnership at equity income and you said there is 12 product approvals, what is the run rate here, what is the potential here over the near term for this partnership that you have?

Arthur Przybyl

I think the partnership from our perspective is self-funding at this point in time. We have funded further development in the fourth quarter through some of the income that the Joint Venture achieved in the third quarter and the Joint Venture is also able to pay for its own inventory purchases from Strides at this point in time. We will get the better indication in our next conference call as to what we think the opportunity for the joint venture will be in 2009 and I think we will do that in conjunction with our partner Strides as well on a go-forward basis but we certainly have several product launches teed-up for the fourth quarter and certainly the first quarter and I think all of those are certainly positive events for the Joint Venture.

Scott Hirsch – Credit Suisse

Right. Any early signs of Akten yet?

Arthur Przybyl

We have completed 11 trials, we have some big trials going on in major hospital institutions as well as large synergy centers. We had very good pick up from our authorized Ophthalmic distributors. For Akten we have chosen the five large Ophthalmic distributors that are also authorized distributors for Lucentis because we believe that product is very well married to the intravitreal injection type products like Lucentis and Macugen and so we are pleased with the progress to date. We certainly have had no failures with any of our trials. We like the comments that we are getting back from our physicians that say the product does what you say it is going to do and then they obviously place additional orders beyond the trial order that we are seeing. I think we are going to post expected numbers for Akten in the fourth quarter and obviously expect this product to be a significant revenue and margin contributor for us over the next several years.

Scott Hirsch – Credit Suisse

How do you price it relative to I guess (inaudible) gel, is it a premium or is it a –

Arthur Przybyl

It is absolutely a premium, this is a premium product, the advantages that we present to the physicians that we have heard are overwhelming versus what is in the marketplace today the fact that there is no stinging effect and because it is preservative free there is no opportunity for corneal infection and then we even have had physicians tell us that it is a non-refrigerated product versus other indicative products for Ophthalmic and it is (inaudible) that are indicative. It potentially removes the opportunity for Lignocaine injections in the eyelid sometimes and each physician has come back to us in many cases with their reason why they like the product. Pricing has not been at this point in time an issue in the marketplace, it has been well received from what we have seen and obviously we have done some initial climbing of our distribution channels through ophthalmic distributors and wholesalers, we have moved the product on to hospital GPO contracts and obviously we are important with some of these larger hospital groups getting on formulary as well. So we have had I think very good success in the short time that we have actually launched Akten and we look forward to the notoriety that we hope the product will receive when we are at the AAO convention in Atlanta.

Scott Hirsch – Credit Suisse

Right. I heard you mentioned that you will update us later on DTPA, any update on the schedule to narcotic?

Arthur Przybyl

No I don’t have an update on the schedule to narcotic at this point in time expect that we continue to expect it in the near future.

Scott Hirsch – Credit Suisse

Right. Then just, I know Jeff mentioned briefly, on the balance sheet you are leveraging – I know that inventory looks like it has gone up a little bit maybe that is Akten, what can we expect from a balance sheet perspective going forward with you guys kind of posting some EBITDA numbers now, how much are you going to be putting towards driving down the revolver? How much should flow through to the bottom line?

Jeff Whitnell

Okay Scott, let me take that question, we did have a net increase in the balance sheet in our inventory of about $3 million this quarter and I would expect that to be comparable for the fourth quarter as well as we continue to grow market share obviously we will bring that down but at this point our projections for cash flow are to drive the revolver balance to essentially at or near 0 by year end. So we don’t see any build in inventory that might occur to support our vaccine business segment being offset by any increases in cash flow from operations.

Arthur Przybyl

I think that is important Scott. I echo what Jeff said that our cash flow position through the end of the year based on our current revenue run rate is to be undrawn upon revolver by year end.

Scott Hirsch – Credit Suisse

Then just lastly, any sense where gross margin growth rate is, is it still moving from here, I know Akten is a very high margin product or are we kind of getting a big jump from last quarter, does it still go up here?

Arthur Przybyl

It sure does and for two reasons. Number one, bear in mind the $5 million worth of Flu vaccine sales at a commoditized margin of somewhere between 10% and 15% and so those sales obviously to a certain extent will disappear in the fourth quarter and certainly almost entirely in the first quarter as we move out of Flu season replaced by higher margin sales certainly on the Akten product. So, you are going to see the overall gross margins of the company continue to improve.

Scott Hirsch – Credit Suisse

Thanks very much and congratulations on your first quarter possibility.

Arthur Przybyl

Thank you Scott.

Operator

(Operator instructions)

Arthur Przybyl

Very good, if we have no further questions, I would like to conclude the meeting by saying that Jeff and I will be presenting at the Oppenheimer Healthcare Conference tomorrow in New York City and certainly if you are located there, we would love to see you there and have a chance to chat face to face with you. Thank you very much for attending our presentation this afternoon, have a good night.

Operator

That does conclude today’s program, we thank you for attending and have a great day.

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