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Akorn, Inc. (NASDAQ:AKRX)

Q4 2012 Earnings Call

February 26, 2013 10:00 a.m. ET

Executives

Raj Rai - Chief Executive Officer

Tim Dick - Chief Financial Officer

Analysts

Steven Crowley - Craig-Hallum Capital Group

Elliot Wilbur - Needham & Company

Traver Davis - Piper Jaffray

Jason Gerberry - Leerink Swann

Sumant Kulkarni - Bank of America-Merrill Lynch

David Steinberg - Deutsche Bank

Operator

Good morning. And thank you for joining Akorn Incorporated 2012 Fourth Quarter and Year-End Conference Call. If you have not yet had a chance to read the earnings release, you may access it through the Investor Relations section at Akorn’s website. Raj Rai, Chief Executive Officer; and Tim Dick, Chief Financial Officer will host this morning’s call.

The call is expected to last about 30 minutes and may be accessed through our website at akorn.com. A replay of the conference call will be available shortly after this call. Interested parties can access the replay by dialing 888-203-1112 in the United States or 719-457-0820 internationally, and enter the access code of 3343969.

Before we get started, I’d like to remind everyone that any statements made on the conference call today that express a belief, expectation, anticipation or intent, as well as those that are historical facts, are considered forward-looking statements and are protected under the Safe Harbor of the Private Securities Litigation Reform Act.

These forward-looking statements are based on information available to Akorn today and we assume no obligation to update these statements as circumstances change. These forward-looking statements may involve a number of risks and uncertainties, which may cause the company’s results to differ materially from such statements.

Forward-looking statements are qualified by the inherent risks and uncertainties surrounding future expectations, generally and may materially differ from the actual future experience. Risks and uncertainties could affect forward-looking statements, including the failure to gain new product approvals and lines of new products.

Such risks are described from time to time in Akorn’s reports filed with the SEC, including Akorn’s latest annual report on Form 10-K and the subsequent quarterly reports on Form 10-Q. Also, the company urges caution in considering any trends or guidance that may be discussed on the conference call.

In addition, as required by Regulation G, reconciliation of the non-GAAP financial measures mentioned during our call today to the most comparable GAAP financial measures can be found in our press release.

Thank you. And now I’d like to turn the call over to Raj Rai.

Raj Rai

Thank you. Good morning everyone. And thank you for joining our 2012 fourth quarter and year end conference call. As you know last month we had issued our 2013 guidance and in the call I went through the details of our accomplishments in 2012 and roadmap for 2013. So I am going to make a quick comment on the fourth quarter results and turn the call over to Tim for his prepared remarks and financial details.

Our fourth quarter revenues were over $71 million, or a growth of 68% over the same quarter in 2011. Our revenues for the fourth quarter were slightly higher than expected as a result of earlier than anticipated launches of couple of products namely, Pantoprazole and Td vaccine. Our gross margins continued to be strong and at the expected levels. For the year we achieved a record revenues of $256 million or up 27% from 2011 and adjusted EBITDA of $96 million which more than doubled from 2011. We achieved our record results due to strong execution on our strategic initiatives, including acquisitions, new product launches and continued investment in R&D.

I will now turn the call over to Tim. Tim?

Tim Dick

Thank you, Raj. This is the 14th consecutive quarter of core revenue growth for Akorn. Consolidated revenue for the fourth quarter of 2012 was $71.5 million, up 68% over the comparable prior year quarter consolidated revenue of $42.6 million. The increase in consolidated revenue was largely driven by the Lundbeck and Kilitch acquisitions and the sale of newly approved and relaunched products offset by decreases in the U.S. contract services business.

Fourth quarter 2012 ophthalmic segment revenue was $28.7 million versus $19.6 million in the prior year quarter. Year-over-year growth was driven by the organic growth of established products, new product launches such as Latanoprost Ophthalmic Solution and the relaunch of previously marketed products offset by the impact of hurricane Sandy which reduced sales of our ophthalmic pointing (ph) products in the fourth quarter of 2012.

Fourth quarter 2012 hospital drug and injectable segment revenue was $37.4 million versus $20.5 million in the prior year quarter. Fourth quarter 2012 sales benefited from the Lundbeck product sales, the relaunch of certain injectable products, the launch of new products in 2012, including vancomycin hydrochloride capsules, progesterone capsules and the earlier than anticipated launch of Pantoprazole Sodium for injection and TD vaccine which together contributed almost $2.4 million in sales in the quarter.

Fourth quarter 2012 contract services segment revenue was $5.5 million compared with $2.5 million in the prior year quarter. Akorn India contributed sales in the quarter of $4.3 million, which is an anticipated drop sequentially from Q3 related to the seasonality of that business. U.S. contract sales continued to be down year-over-year as a result of a deliberate de-emphasis on this business to our U.S. manufacturing locations. Total U.S. contract sales were $1.2 million compared with $2.5 million in the prior year quarter.

Consolidated gross margin for the fourth quarter of 2012 was 58.7% compared to 60% in the comparable prior year period. Gross margin for the fourth quarter of 2012, excluding the impact of Akorn India, was 60.8%. Sustained improvements were the result of higher margin products acquired from Lundbeck offsetting in part the lower margins of our Akorn India book of business as well as our new partner products vancomycin hydrochloride capsules and progesterone capsules both of which include a gross profit split with our manufacturing partner, as well as other lower margin new products which include Latanoprost Ophthalmic Solution, Pantoprazole Sodium for injection and TD Vaccine.

Fourth quarter 2012 gross margin by segment were as follows: ophthalmic 52%, hospital drug and injectables 68%, and contract services 32%. Ophthalmic margins were impacted by lower sales of our ophthalmic ointment products as well as unabsorbed costs associated with the two-week shutdown following hurricane Sandy and by Latanoprost Ophthalmic Solution which was launched in Q3 and generates lower margins than our base book of business.

Selling, general and administrative expenses totaled $14.4 million in the fourth quarter of 2012 compared with $9.6 million in the prior year quarter. This year-over-year increase can be attributed to the previously announced expansion of our field sales force, the addition of Akorn India and the accumulation of smaller spend items necessary to support the growth of the business.

Research and development expense was $6 million in the fourth quarter 2012 compared with $3.8 million in the prior year quarter, and up sequentially from $2.9 million in Q3 of 2012. The increase was the result of the achievement of external development milestones as well as the implementation of the new FDA generic drug user fee act and the resulting ANDA backlog fees as well as fees on new ANDA filings in the fourth quarter.

There should be an expectation of natural variability between quarters related to the timing of certain internal development activities as well as the achievement of external development milestones. Quarter to quarter R&D expenses can vary materially depending on the timing of these items.

Net income for the fourth quarter of 2012 was $8.8 million or $0.08 per diluted share compared to net income of $5.7 million or $0.05 per diluted share in the comparable prior year quarter. Fourth quarter 2012 net income was impacted by two key items: non-cash interest expense and a catch-up in the effective tax rate for the year. The non-cash interest expense relates to the marking to market of contingent deal consideration in the Lundbeck acquisition. This impacted non-cash interest expense by $1.5 million in the quarter. It’s important to note that none of the effects of change around this contingent liability and we still anticipate making the second payment of $10 million three years post the acquisition as has been previously disclosed.

GAAP requires this obligation to be shown at fair market value i.e. a discounted value on the onset which accretes over time to the $15 million odd and with the amount accreting to $15 million showing up as non-cash interest expense.

On our income tax provision we have a fluid situation in India as it relates to the tax deductibility of goodwill. In the third quarter, the Indian Supreme Court ruled that goodwill is tax deductible which was incorporated into the calculation of our effective rate resulting in a lowering of that rate. During our year-end review of uncertain tax position it was determined due to the newness of the Supreme Court ruling in a specific fact set in that ruling of certain portions of the Kilitch transaction goodwill may not at this time be deductible in India. We have reversed the deferred tax assets related to this – to these portions of goodwill and we’ll continue to monitor on a go-forward basis. The impact of this change was a $1.1 million increase in our provision for income taxes in Q4. We do not anticipate a change to our 2013 income tax rate guidance.

Non-GAAP adjusted net income for the fourth quarter of 2012 was $14.6 million or $0.13 per diluted share compared to non-GAAP adjusted net income of $11.4 million or $0.11 per diluted share in the comparable prior year quarter. Q4 2011 non-GAAP adjusted net income per share benefited from the remaining federal NOLs the company had at the time and was calculated using the combined the state tax rate of 8.5%.

The diluted share count for the fourth quarter 2012 was 110.8 million shares. Fourth quarter 2012 non-GAAP adjusted EBITDA was $24.9 million, up 74% compared with $14.4 million in the comparable prior year quarter. Non-GAAP financial measures are defined further in our earnings release under non-GAAP financial measures.

The company generated operating cash flow of $4.9 million in the fourth quarter of 2012 and ended the quarter with $40.8 million in cash and cash equivalents and full availability of our revolving line of credit. Fourth quarter operating cash flows were impacted by a semi-annual interest payment on our convertible debt as well as annual FDA fees and new niche generic drug filing fees.

Also within the quarter the company restricted $3.3 million in cash related to our India business resulting in a $3.3 million reduction of cash flow from operating activities. The company generated $27.2 million in positive cash flow from operating activities for the full year 2012. It’s important to note that operating cash flows for the year were reduced by certain portions of the Kilitch acquisition consideration which were accounted for as operating expenses.

Adjusting for these as well as the cash restricted to the fourth quarter the company would've reported operating cash flows over $39 million for the year.

Finally, fourth quarter 2012 capital expenditures were $5.7 million, up from $2.5 million in the prior quarter. Fourth quarter capital expenditures included the Somerset expansion project as well as the beginning of planned spending on our Indian manufacturing facilities. This concludes our prepared remarks. So I will now turn the call back over to the operator to open up the line for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from Steven Crowley with Craig-Hallum Capital Group.

Steven Crowley - Craig-Hallum Capital Group

On Pantoprazole, it seems like not only did that have an earlier contribution, it seems like you're doing well there. You’ve talked to us about capacity constraints for that product. Have you mapped out and started to execute a plan to better deal with that?

Raj Rai

Yes, Steve, this is Raj. We are working on expanding the capacity and we have been looking with the CMO, and they are ready to make an exhibit batch which is coming up in the first or second week of March. So I think we will be ready to expand that capacity as soon as the filing is done with the FDA hopefully in the next 90 days or so. So I think the second half as we have said would be the time where -- of this year where we would see an expanded capacity for the product.

Steven Crowley - Craig-Hallum Capital Group

Great. On the topic of capacity expansion it seems like New Jersey is now, Somerset is now in a position to come on stream and does that dovetail nicely with what you can do with Latanoprost, I mean how quickly can you do that?

Raj Rai

Well, Latanoprost is – was not an issue with the expansion or expansion challenges with the Latano products. And again like with Pantoprazole, we are filing to bring the product to the U.S. in our operations in New Jersey so that is also underway. So again it would be in the next 90 days or so before we can start manufacturing the product in our facility.

Steven Crowley - Craig-Hallum Capital Group

Okay, so that’s Latanoprost into New Jersey, so even though I may have confused that a little bit, looks like you have a play there. And then just an additional question on new product launches, with your TD vaccine experience so far besides it’s contributing a little bit earlier than you thought. What can you tell us about effectiveness of the sales force with that product again and the seeming receptiveness or lack thereof of the marketplace for it?

Raj Rai

So we shipped product at the end of last year and our sales force has been trained to market that product and so the launch is underway at the moment. So we should start to see the results in short order but also given the fact that the incumbent has some product in the channels. So we expect to see the sales picking up slowly in Q1 but I think Q2 we’ll start to see the uptick.

Operator

From Needham & Company, Elliot Wilbur.

Elliot Wilbur - Needham & Company

I would assume it's fairly safe to conclude that there haven't been any changes to the guidance parameters that you guys offered back on January 17th, but specifically just thinking about SG&A, obviously the fourth quarter run rate quite a bit higher than normal, I would assume just kind of true up of year end expenses, stock comp and the like but I just want to confirm in fact that, that is going to moderate obviously over the course of 2013.

Raj Rai

Yes, that's a safe assumption. We did have a little bit of catch up in a few areas with some incentives for our sales team that came into play at the year end. But you’d expect to see SG&A consistent with what we guided towards.

Elliot Wilbur - Needham & Company

And then specifically with respect to the margin performance in the injectable segment, I guess I would have expected more of moderation from 3Q, and not rather strong sequential performance which you turned in. I guess my assumption previously was that Pantoprazole was a contract product and that would have a lower than average gross margin. So I'm not sure if that is incorrect, or is it better product mix? Maybe probably a little bit of color in terms of what drove this drug’s sequential margin performance.

Raj Rai

Sure, sure. Yes, generally a better product mix, although as you’ve noted Pantoprazole does carry a lower margin than our – than a base that has been layered on to as does TD vaccine. So that restrict in -- clearly in our higher margin products that were offsetting the impact of those products layering on.

Elliot Wilbur - Needham & Company

One final question for you, Tim, as well. Not that it's that germane to our estimates anyway, since we all exclude it in terms of adjustments, but can you just walk through again what your comments were surrounding the accrual of the Lundbeck payment? I mean obviously something changed that sort of triggered the recognition of that contingent portion of that liability. I don't know if it's just the passage of time or certain performance levels around the product but maybe just --

Tim Dick

Sure, sure, first of all, we established that contingent liability at the onset when we did our purchase accounting with the anticipation of rate in $15 million – a second payment of $15 million three years the acquisition. The way GAAP has you account for that as you arrive at a discount rate, which in part is based on the probability of making that payment and that you discount it back, and what you’re carrying as a liability is a discounted value and then over time that is going to accrete up to $15 million by the time that contingent liability will mature three years out. In the meantime the difference between what you discounted it to and the $15 million is being expensed through the P&L as non-cash interest expense. So GAAP requires you to re-measure that and to make sure that your discount rate is still appropriate and so the true-up really related only to that discount rate.

Operator

Next, we’ll go to David Amsellem with Piper Jaffray.

Traver Davis - Piper Jaffray

Hey guys, this is Traver Davis on for David Amsellem. Just a couple, one on Erythromycin ointment, so obviously as you track third-party script data for Erythromycin, it’s sort of been showing pretty continued growth. I guess the question is, is that a function of the expanded capacity at Somerset and also how much of the Erythromycin ointment market can you supply given that you’ve expanded the capacity at least in phase 1 at Somerset?

Raj Rai

Traver, let me just clarify. I think we haven’t seen the impact of the expanded capacity as yet because we are going through the regulatory filings with the FDA. The construction is complete, everything is going well, now we have to go through some filings with the FDA which are customary when you install new footprint. So we haven’t really seen the impact of that capacity, so what you may be seeing now is, I don’t know what data or the timeframe that you are looking at for the scripts, but we had obviously a bit of a slowdown in Q4 as a result of the disruption but you probably are starting to see some sales coming back up again.

Traver Davis - Piper Jaffray

And is that just as a result of remediation of the two-week shutdown, or it appears that you’re still grabbing little bit more share from the market, is that a sound assumption?

Raj Rai

We haven’t really seen – I think there is just, I think, a catch-up effect, probably that is happening. So we’re not really seeing a huge growth there right now. Once that has come online, obviously we can support additional units of that product and other orphan products.

Traver Davis - Piper Jaffray

And then switching gears real quick, so what does your latest intelligence tell you about who is out there potentially even working on an maybe tall generic product, if any and just more of a hypothetical question I guess, what would you to say your 2013 guidance if we saw generic launch say in the second half of this year?

Raj Rai

Well, we’ll stick to what we said before in the last call, last month that when we made the acquisition of these products in Lundbeck, we had assumed that there was a generic (inaudible) vaccine, that’s how the deal was structured. And so we were prepared to face the generic competition right at the time when we acquired the product. So now the guidance that we have given obviously does not include the impact of a generic product coming in. So we haven’t factored in a generic coming in, so once that happens we will obviously – we will have to update on that.

Operator

From Leerink Swann, we’ll go to Jason Gerberry.

Jason Gerberry - Leerink Swann

Just a question on Precedex actually, you’ve got pending of approval, it looks like Sandoz hasn’t closed that warning letter for its injectable facility which raises questions about first to file, forfeiture consideration and then Hospira’s pediatric extension is -- the product is manufactured out of Rocky mount, so questions at least in the investor community about whether they will actually get pediatric extension, is it -- would you guys be ready to launch mid-year if Sandoz were to forfeit its exclusivity, what if you can comment on that opportunity?

Raj Rai

Well, obviously it purely depends on what happens with Sandoz. And I don't have the intelligence whether they are going to forfeit the exclusivity or not but in the event that happens, obviously we'll be ready to launch the product sometime in the second half of next year -- of this year, sorry. We were preparing for the launch some times in early 2014.

Jason Gerberry - Leerink Swann

And then just on the pipeline question, I apologize if this has been asked maybe in past calls. But what are your guys’ thoughts on the Restasis market opportunity? Obviously that patent goes away in 2014, are the costs too prohibitive given some commentary from agency representatives that clinical trials may be required? Is that something you guys consider?

Raj Rai

We would consider but at the moment there is no guidance available from the FDA as to what needs to be done with the product, what the clinical trial requires or you can get a bio-equivalence, we don’t know where FDA stands with that at the moment. But from a manufacturing standpoint, we have partnerships where we can actually have the products made but the lack of visibility in terms of the guidance from the FDA is obviously a bit challenging as to what direction it has to take.

Jason Gerberry - Leerink Swann

Have you thought about guidance being issued on that particular product opportunity?

Raj Rai

No. We have not, and obviously it’s the most coveted product in the ophthalmology today.

Operator

Next we will go to Sumant Kulkarni with Bank of America.

Sumant Kulkarni - Bank of America-Merrill Lynch

The first question is could you give us an update on your generic Tobramycin filing? There could be some loss of exclusivity there on the first file potentially.

Raj Rai

So our filing is active with the FDA right now. So we’re going through the approval process, and responded to any questions that FDA has, and I mean that’s all I can tell you in terms of where we stand with the generic Toby.

Sumant Kulkarni - Bank of America-Merrill Lynch

And could you give us an update on the timeline for an inspection of the FDA plant in India? What's the earliest that the FDA could get in there? And we know there's an India product that is potentially on a PDUFA clock, so what would the timeline be?

Raj Rai

The timeline would be, I'm assuming in the first half of 2014 that we should expect the FDA to be there, if everything goes well, and we are in the process of making the test batches for the India product as we speak. And so we are on track to get that filing with the FDA this year.

Sumant Kulkarni - Bank of America-Merrill Lynch

On the clawback on generic drug (ph) have, could you give us some color on how that works, just in case a generic drug comes in, let’s say, mid-year, so what kind of cash impact would it have on Akorn’s statement?

Tim Dick

Sure, Sumant, this is Tim. I will take that question. So there was the deal structure with two payments $45 million that was initially paid, and three years post we would pay an additional $15 million. The way it was structured is that, if we did not achieve sales of $45 million in the first three years, we would clawback dollar for dollar I guess that $45 million and the same would apply to the $15 million payment after three years. So the longer we go on less likely there is any potential clawback against, certainly that first $45 million.

Sumant Kulkarni - Bank of America-Merrill Lynch

Okay. And you've launched your first vaccine now, how would you characterize the opportunity in that business? Is that something you're still invested in, and could you go about that in a bigger way?

Raj Rai

So the market opportunity over there is around north of $50 million, I mean it’s a two player market and we used to sell this product back in 2009 and then we discontinued that. So we’re now restarting, and we now resell this product, so it could be decent opportunity but we’ve got initial challenge in terms of the incumbent’s inventory being in the market at the moment. I think we’d be able to give you a better view on that in the first quarter conference call.

Operator

From RBC Capital Markets, we will go to Shibani Malhotra.

Unidentified Analyst

This is Florence (ph) on behalf of Shibani. On the 2013 conference call, you talked about an interest in pursuing both basket of products as well as company acquisitions. Can you talk a little bit more about whether you’re looking primarily on just the generics or the ophthalmology side, or obviously potentially be looking to build the complementary assets that are brought into new areas?

Raj Rai

So when we – on the call we discussed that we are open to an acquisition of injectables, ophthalmic products, over the counter healthcare products as well as expanding our base into those areas in the animal health business as well. So we have sort of a broader range of companies and products and portfolios to look at. So we are aggressive in pursuing that plan.

Operator

From Deutsche Bank we will go to David Steinberg.

David Steinberg - Deutsche Bank

Just a follow up on that question, you made a series of very good strategic and financial accretive acquisition in quite a while, since you made one at the Kilitch. Just curious piggybacking of the last question, are you seeing more competition, is the pricing – you’re very disciplined, is pricing high, what can you say about sort of pricing opportunities competition for both smaller products and larger companies?

Raj Rai

So David, obviously we took a pause after we closed on Kilitch transaction in India, as we needed to spend some time preparing that, and throughout last year we saw some opportunities that were specific branded injectables, so maybe eight products and just like the Nevitol (ph) but the valuations of the expectation were quite high and so we had to pass upon on bunch of those opportunities. So we haven’t really found something that was very interesting to us and would be a good fit and complementary to what we do.

Operator

We’ve got a question from Steven Crowley with Craig-Hallum Capital Group.

Steven Crowley - Craig-Hallum Capital Group

Just a couple of follow ups, I noticed in one of your recent presentations Raj that it looks like you gained some decent traction in the veterinary business out of the shoot, can you tell us how that's going and how your plans are evolving in that vet animal health marketplace?

Raj Rai

Yeah, Steve, when we embark on the veterinary business, obviously we did that from ground zero cross selling even these products into direct market through private labelling with vet distributors. That’s what we have done. Now our focus is to file veterinary products with the FDA’s vet division and that is one part of the strategy. The other part of the strategy is to look for acquisitions of either ophthalmic and/or injectables in that space.

Steven Crowley - Craig-Hallum Capital Group

And kind of a similar question about the status of the OTC private label human business and whether or not you’ve got some things in motion that are notable?

Raj Rai

Yes, I think the good news over there is that we have started to see lot of traction and momentum in launching the OTC private label products, store brand with their retailer. So I think we will see a decent growth this year, throughout this year in that side of the business.

Steven Crowley - Craig-Hallum Capital Group

One more in terms of India, in terms of the outside India, non-U.S. opportunity set, I know you’ve got a bunch of different of individual company market, individual product opportunities, is there anything to report on that front as to some progress spotty or otherwise?

Raj Rai

As we have said in the 2013 guidance and we are on track on our plan in India, on these filings in similarly relative markets for different products. So nothing has really changed, we are on track.

Operator

Gentlemen, all questions have been addressed.

Raj Rai

Good. Thank you everybody for your participation today. We look forward to speaking you soon. Thanks again.

Operator

Ladies and gentlemen, that does conclude today’s presentation. We do thank everyone for your participation.

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