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Executives

Raj Rai – CEO

Tim Dick – CFO

Analysts

Steve Crowley – Craig-Hallum Capital Group

Shibani Malhotra – RBC Capital

David Amsellem – Piper Jaffray

Elliot Wilbur – Needham & Company

Sumant Kulkarni – Bank of America Merrill Lynch

Jason Gerberry – Leerink Swann

Michael Higgins – Brinson Patrick Securities

Akorn, Inc. (AKRX) Q1 2013 Earnings Call May 7, 2013 10:00 AM ET

Operator

Please standby. We’re about to begin. Good morning, and thank you for joining the Akorn Inc’s 2013 First Quarter 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 the 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 entering the access code 3749013.

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 fact are considered forward-looking statements and are protected under the Safe Harbor of 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 actual future experience. Risks and uncertainties could affect forward-looking statements, including the failure to gain new products approvals, failure to successfully launch new products and increase the competition due to new generic product approvals.

Such risks are described from time-to-time in Akorn’s reports filed with the SEC, including Akorn’s latest Annual Report from Form 10-K and the subsequent quarterly reports from 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 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 I’d now like to turn the call over to Mr. Raj Rai.

Raj Rai

Thank you. Good morning, everyone, and thank you for joining our 2013 First Quarter Conference Call. On today’s call, I’ll summarize key highlights for the first quarter and Tim will discuss the financial results in detail.

We recorded $74 million in sales in the first quarter, a 43% increase over the first quarter of 2012. Our margins were lower than expected due to lower than expected sales from Erythromycin and other ophthalmics, which were impacted by Hurricane Sandy in October of last year as well as sequential decline in Nembutal sales from the fourth quarter of 2012, which tend to be more episodic. The lower sales from these products and increase in sales from newly launched products such as Progesterone, Pantoprazole and TD vaccine, which have a lower composite margin resulted in lower than expected gross margins.

We expect to see improved sales in the second quarter from both Erythromycin and Nembutal, as indicated by the IMS data, the Erythromycin unit market share for Akorn in December of 2012 was 22% and in March 2013 was 30% as compared to 32% in October of 2012 prior to the impact of Sandy.

In our initial guidance, we had anticipated full recovery in the first quarter from such sales. The bigger challenge that we anticipate for the rest of the year from our initial expectation is getting to higher levels of sales compliance against our expectation on the products that were launched late 2012 including with Latanoprost. This will negatively impact the guidance that we issued earlier this year. However, we feel confident to get back on plan in the second half of this year.

Let me walk you through each of these products and the corrective action plan to get back on track. Firstly, Latanoprost, we launched the Latanoprost at the end of the third quarter of 2012. We began experiencing manufacturing challenges with the contract manufacturers.

We were initially expecting the problem to be addressed sometime in the first quarter, and now expect the problem to get resolved by the end of second quarter. As a result of the constraints, we held back pursuing further sales of the product. As a backup plan, we initiated a debt transfer to our facility in Somerset, and I’m pleased to report that we recently received the FDA acceptance to manufacture the product in our Somerset plant.

With the manufacture of the product at our Somerset plant, we expect to increase our selling capacity by 100% in the beginning of the third quarter of this year. We had approximately 12% unit market share of Latanoprost based on the first quarter data from IMS.

Now to progesterone. This product was launched at the middle of the fourth quarter of last year. We were a bit delayed in obtaining new contracts being the second generic. Subsequently, we have secured new business through recent bids, and as a result expect to be at a run rate of 20% unit market share in the third quarter, up from the unit market share per IMS of 12% at the end of first quarter of 2013.

Third, Pantoprazole, we had a soft launch of this product at the end of last year. As indicated earlier, we were capacity challenged at the time of approval. We expect the increased capacity by the end of third quarter of this year with a new contract manufacture after receiving the necessity approvals from the US FDA.

And finally TD vaccine, we’re behind in our sales in the first quarter as the incumbent who had the contract to distribute this product was liquidating its residual inventory this year. We expect the product to be on course correction in the third quarter. At the end of the first quarter, a unit market share per IMS data was 12% while the incumbent’s market share was 16% for the same time period for the same product. As a result of slower than expected ramp up from these new launches, we are revising our 2013 guidance. Tim will discuss that in detail in his prepared remarks.

Let me now discuss some operational and other highlights from the first quarter. I’m pleased to announce that we have relocated our R&D center to a new facility in Vernon Hills in Illinois. Designed and planned to accommodate 35 to 40 ANDA filings per year with capabilities to develop specialty formulation such as carbapenems, hormones, and oncolytics. We plan to increase the head count for our R&D team during the remainder of 2013 to support our initiatives.

In the first quarter, we filed four ANDAs and completed the development of additional 15 products with combined annual IMS market size of approximately $1 billion and expect to file these products with FDA in the near future. We remain on track to file 25 ANDAs this year and two applications for animal health.

In the first quarter, we received the approval for clindamycin phosphate injection in 5% dextrose. We plan to launch the product at the end of second quarter and will provide you with an update on the sales expectations after the launch. We’ve also concluded our expansion and modernization projects in our Somerset facility. We expect the expanded capacity for commercialization in the third quarter.

On the OTC front, the retail sales of our flagship brand TheraTears continued to remain strong. According to industry data, during the first quarter, the TheraTears brand sales grew 20% over last year sales outpacing the dry eyes category sales of 6.6%. We are also on track to meet our private label objectives for 2013.

We currently have 10 active private label store brands products on the shops. This includes the recently approved naphazoline hydrochloride, the generic version of Visine-A.

And finally an update on our India business. Our top priority for India business is to implement the U.S. FDA readiness strategy. As a first step, we have implemented our global quality policies and are now focused on strengthening the quality management team.

As a next step we are in the process of developing and filing ANDAs for FDA side approvals. We expect the first filing by the end of third quarter of this year followed by three others by the end of first quarter of 2014. Our second priority to grow the international business through approvals of product registration, they’re currently pending in various countries.

We also plan to increase in various regions around the world where pharmaceutical spend is projected to grow by double digits in the next few years such as CIS countries, Middle East, Africa,and Latin America.

We currently have over 60 product registrations under review and are on target to file 30 new product registrations in the second quarter in eight countries in the target regions. In addition, we are bringing new customers on board domestically in India with a focus on our products such as hormones and carbapenems. And third, we have initiated the expansion projects as outlined in our guidance and expect the completion in the second half of 2014. I know we have a – we have hit a bump in the road, but are determined to get back on track in the second half of this year.

I will turn the call over to Tim for his prepared remarks. Tim?

Tim Dick

Thank you, Raj, and good morning. This was the 15th consecutive quarter of core revenue growth for Akorn. Consolidated revenue for the first quarter of 2013 was $73.9 million, up 43% over the comparable prior-year quarter consolidated revenue of $51.7 million. The increase in consolidated revenue was driven by the sale of new products launched late in 2012, organic growth of established products and products relaunched in prior periods and a full quarter sales generated by Akorn India.

First quarter 2013 Ophthalmic segment revenue was $25.7 million versus $21.8 million in the prior-year quarter. Year-over-year growth was driven by the organic growth of established products new product launches such Latanoprost Ophthalmic Solution and the relaunch of previously marketed products, offset by the slower than expected recovery on the sale of products impacted the unplanned shutdown of Somerset following Hurricane Sandy.

First quarter 2013 Hospital Drug and Injectable segment revenue was $40.4 million versus $27.4 million in the prior-year quarter. First quarter 2013 sales benefited from the sale of new products launched late in 2012 including progesterone capsules and Pantoprazole Sodium for injection, and TD vaccine as well as Vancomycin Hydrochloride capsules, which launched in the second quarter of 2012. And finally, from the organic growth of established products and products relaunched in prior periods.

First quarter 2013 Contract Services segment revenue was $7.7 million, compared with $2.5 million in the prior-year quarter. Akorn India contributed sales in the quarter of $5.1 million, with the remaining $2.6 million coming from U.S. Contract sales.

Consolidated gross margin for the first quarter of 2013 was 53%, compared to 59.8% in the comparable prior-year period. The decrease in gross margin was primarily the result of lower margins from Akorn India, which began operations upon completion of the Kilitch acquisition on February 28, 2012.

As well as the impact of various new products launched late in 2012, which generated lower gross margin as a result of either of being either partnered as is the case with Vancomycin Hydrochloride capsules and progesterone capsules or manufactured through third-parties as is the case with Latanoprost Ophthalmic Solution, Pantoprazole Sodium for injection and TD vaccine.

And finally gross margin was negatively impacted by a shift in product mix on established products namely Nembutal and Erythromycin Ointment.

First quarter 2013 gross margins by segment were as follows are Ophthalmic, 54%, Hospital Drug and Injectables 56% and Contract Services 21%.

Selling, general and administrative expenses totaled $12.3 million in the first quarter of 2013, compared with $10.3 million in the prior-year quarter. This year-over-year increase can be attributed to the expansion of our field sales force, and the addition of Akorn India.

Research and development expense was $6 million in the first quarter of 2013, compared with $2.9 million in the prior-year quarter and flat sequentially from Q4 2012. The year-over-year increase was the result of three factors, the Generic Drug User Fee Act fees associated with a projected 25 abbreviated new drug applications that we anticipate filing for 2013. The cost of our full length studies associated with high value products and the increased R&D cost due to the build out and staffing of the new R&D facility.

There shouldn’t be the expectation of natural variability between quarters related to the timing of certain internal development activities as well as the achievement of external development milestones and quarter-to-quarter R&D expenses can vary materially depending on the timing of these items.

Net income for the first quarter of 2013 was $10.8 million or $0.10 per diluted share compared to net income of $3.1 million or $0.3 per diluted share in the comparable prior year quarter. First quarter 2012 GAAP net income included $8.3 million in deal consideration on the Kilitch transaction which were treated as acquisition related costs.

First quarter 2013 net income included a $600,000 R&D tax credit for research and development activities in 2012. The 2012 R&D tax credit was not incorporated into the company’s 2012 effective tax rate because extension of the R&D tax credit into 2012 was not passed into law until early 2013.

Non-GAAP adjusted net income for the first quarter of 2013 was $14.4 million or $0.13 per diluted share compared to non-GAAP adjusted net income of $10.6 million or $0.10 per diluted share in the comparable prior year quarter. The diluted share count for the first quarter 2013 was 111.6 million shares.

First quarter 2013 non-GAAP adjusted EBITDA was $24.5 million, up 23%, compared with $19.9 million in the comparable prior-year quarter and this as well as other non-GAAP financial measures are defined further in our earnings release under non-GAAP financial measures.

The company generated operating cash flow of $6.9 million in the first quarter of 2013 and ended the quarter with $45.9 million in cash and cash equivalents and full availability of our revolving line of credit.

First quarter 2013 capital expenditures were $2.6 million, down from $5.4 million in the prior quarter. And this sequential quarter decrease was a result of completing the Phase I Somerset facility expansion in the fourth quarter of last year.

Moving onto 2013 outlook, the company’s 2013 outlook has been updated to include the impact of slower than expected sales and products launched late in 2012 and a slower than expected recovery of sales of products impacted by the unplanned shutdown of our Somerset, New Jersey plant as a result of Hurricane Sandy.

The 2013 outlook excludes the impact of any new approvals after May 6, 2013, and it also excludes the already approved Clindamycin Phosphate injection and 5% Dextra premix, which the company anticipates launching early in the third quarter.

2013 outlook in detail, 2013 revenue is projected to be between $305 million and $315 million. 2013 gross margins are projected to be between 53% and 54%, which assume Nembutal and Erythromycin recovering, and new products increasing in the third and fourth quarter.

2013 SG&A expenses projected to be approximately $50 million, 2013 R&D expenses projected to be between $24 million and $26 million, intangible asset amortization is projected to be approximately $7 million, 2013 effective income tax rate is expected to be approximately 36%. However since Q1’s rate was lower as a result of the 2012 R&D tax credit quarters two, three and four will have a great tax provision rate of approximately 37%.

2013 adjusted net income is projected to be between $60 million and $62 million. 2013 adjusted EPS is projected to be between $0.53 and $0.55 and capital expenditures are projected to be approximately $25 million with the focus primarily on our India and U.S. sold injectable facilities.

The quarterly progression of revenue and earnings for the remainder of the year is expected to be flat Q1 to Q2 and then accelerating in quarters three and four. That concludes our prepared remarks.

I’ll turn the call back over to operator to open the line up for Q&A.

Question-and-Answer Session

Operator

Think you. (Operator Instructions). We’ll take our first question from Steve Crowley with Craig-Hallum Capital Group.

Steve Crowley – Craig-Hallum Capital Group

Good morning gentlemen and thanks for the granularity on your plans to get things a little bit more on track here over the near term. In terms of a follow-on question related to some of the distortions you think are short-term as it relates to Erythromycin and Nembutal.

Your confidence in getting the market share back in Erythromycin seems to be bolstered and supported by the IMS data, but what can you tell us about the landscape there to give us a little more color and why you are confident in doing that?

Raj Rai

Steve, we had expected to be product to get into full recovery mode in the first quarter. And its seems like the customers who needed the product probably bought more at the end of December from our competitors and continue to do that because we were not in the market. And – but our sales people were focusing on compliance as we got the product and we didn’t expect that this would last for that long, but it continued throughout the first two months in the first quarter. So I think we are back on track and all indications are we’ll be on full recovery in the second quarter.

Steve Crowley – Craig-Hallum Capital Group

And then in terms of Nembutal, you mentioned there is some lumpiness, I don’t know if it’s seasonal or just more episodic?

Raj Rai

Go ahead.

Steve Crowley – Craig-Hallum Capital Group

But is there any – there is no competitive shift in the marketplace with new entrants or pause in front of that, that you can discern, this is just lumpiness or how would you characterize it?

Raj Rai

Well, the product is episodic. It’s generally bought or used when there is a need and people don’t really stock up on the product to the extent. So and we have a mechanism to shift the product overnight to the customer as and when it’s needed. So, we saw the shipments drop in Q1 and we are starting to see again the recovery in Q2.

Steve Crowley – Craig-Hallum Capital Group

And is there anything on the competitive landscape that you’re now aware of that you haven’t been aware of in Nembutal since that’s usually a topic of questions and answers on this call?

Raj Rai

No. We don’t know if any – anything changing in the landscape. We know that this product is sort of the last resort for sedation. And if things – other therapeutics don’t work, then the physicians resort to this product. So, nothing that we know has really changed.

Steve Crowley – Craig-Hallum Capital Group

Final question from me, on Clindamycin, which is your recent approval, can you help us understand the market landscape? I know there’s variables that are determine – will determine how much share you get. But can you help us understand the size of the market and the potential opportunity for you or the range of opportunities for you?

Tim Dick

Sure. So, this product has a various presentations. The number presentation in terms of sales, it’s a premixed solution that comes in plastic bags. And the second presentation is it comes in vial and which has to be reconstituted or mixed. Our product is sort of a hybrid. So, we come – we come as a premix in a vial, okay. So, we are in between the plastic bag and the vial product.

And so, this will require some sales efforts on part of our sales team to convince the buyers to buy our product because of the convenience. And so, we have sort of a hybrid version.

Steve Crowley – Craig-Hallum Capital Group

Okay. And what is the advantage of the hybrid version that you think can resonate with the customer base.

Raj Rai

Yeah. Steve, over the vial product it has the benefit because it comes in a premix solution comparable to the plastic bag.

Steve Crowley – Craig-Hallum Capital Group

Is it significantly disadvantage relative to the bag or just in the eyes of some – is it preference or is there a bit of a disadvantage there for you.

Raj Rai

Well, it could be preference, but from storing the product in the hospital in dispensing machines, it will be easier to use this product, and it definitely has advantages over the vial product because it’s premixed, and just for your information there are more units of vials that are stored versus the premix bags.

Steve Crowley – Craig-Hallum Capital Group

Thanks for taking the questions. That’s helpful.

Raj Rai

Yeah.

Operator

We’ll take our next question from Shibani Malhotra with RBC Capital.

Shibani Malhotra – RBC Capital

Hi. Thanks. Thanks for the question, so I’ve got a few, so one I guess Dick, this is for you, can you just help us understand why you aren’t including potential revenues from clindamycin and dextrose in your full year guidance especially given your lowering revenue guidance, I mean is there risk that those products may not be launched, is that one reason?

Second, is just a follow-up on the question on Nembutal, are you seeing anything out there, which suggests that there’s an increased risk of generic this year or next year, and also you mentioned as you said the last resort is the availability of certain products going to changing the way Nembutal is used, competitive products anything there that we should be aware of, and then finally a question for Raj, and this is a broad question.

Can you talk about whether you’re still seeing any impact from shortages, I think you had said most of that’s gone? And how you look at the industry going forward in terms of the consolidation that some of your competitors have been talking about? Thanks.

Raj Rai

Shibhani, as far as your first question is concerned on Clindamycin, it’s – generally we’re not practice to give any guidance around new products before they are launched. So, just sticking to that sort of philosophy, we won’t give the guidance.

And I think the second part of your first question was is there a risk? There is no risk, it’s just the timing and the effort that will be required to promote the product. So, we’re not concerned about the risk of the product. It’s just that we feel that we have a convenient presentation that has definitely significant advantages over a vial product.

Shibani Malhotra – RBC Capital

Okay. Can you – sorry, are you talking about Clindamycin?

Raj Rai

That is correct.

Shibani Malhotra – RBC Capital

Yes. Okay. So, there is not risk on the launch or anything like that you are not being conservative? Okay.

Raj Rai

No, no. The second part of your question was on Nembutal. The second question was Nembutal and I think we addressed that in Steve Crowley’s question. We don’t see anything that has changed in the landscape of sedatives that are being used or not being used.

The product, again is episodic. When the hospitals need it, they buy it. And we have distribution mechanism in place that we are – we can ship them overnight the product. And obviously, this product comes on with a premium in terms of a price over the rest of the sedatives. So, that’s why it’s sort of the third line of defense or the last line of defense when the practitioner use the product. But nothing has really changed in the landscape.

Shibani Malhotra – RBC Capital

Nothing on the potential generic front that you are hearing?

Raj Rai

I’m going to sound like a broken record, as I have done for the last year and half. I mean, we’ll be ready when the generic comes in, I mean at this point I have no information, I would suggest that the generic is evident.

Shibani Malhotra – RBC Capital

Okay. And then my final question was on shortages, are you still seeing any benefit and where do you think in often terms of the industry in consolidation?

Raj Rai

The – most of the shortages, the acute part of the shortages have been resolved. I mean once in a while there may be a product here and there, you may see that goes on shortage for a variety of reasons, but it’s not as rampant as it was in 2011 and early part of 2012.

Shibani Malhotra – RBC Capital

Okay.

Operator

We’ll take our next question from David Amsellem from Piper Jaffray.

David Amsellem – Piper Jaffray

Thanks. Just a few. So I just want to clarify regarding the disruption from Sandy. I think you had said that it would be minimal and I just want to be sure that we shouldn’t be concerned that there is some business that you lost that you will not be able to get back. So can you just clarify that?

Raj Rai

Sure, David, we didn’t lose a customer, we lost the sale because we obviously did not have the product available. Now obviously in our estimation when we were giving guidance in January, we had no reason to believe that the customer would be not come back right away, and that was a thought process. And – but in reality, what happened was the customers had enough product from the competitor and they didn’t buy our product. And as suggested by the IMS data, our unit volume is back up to where it was pre-Sandy.

David Amsellem – Piper Jaffray

Okay. And then, second question on IV Pantoprazole, with the increased capacity that is going to come online later in the year, can you give us some sense of what portion of the market you think you’re going to be able to supply? And just clarify for us if any of that product is being made indicator or is it going to be made solely by a third party or a mix of both?

Raj Rai

The product is going to be made, most of it by the third party, though we have plans in place to make a filing out of our indicator facility, which from a pricing standpoint, from cost standpoint may not be the most conducive strategy. This would just be a backup in the event we’re not able to get the product. So, we already have one contract manufacturer who is making the product for us, but they have just miniscule capacity as compared to what the market is.

And so the other CMO will not come online until the end of third quarter of this year. We’ve done the tech transfer. So, we have a strategy mapped out, obviously we’ll have to go through regulatory approvals with the U.S. FDA before we can get that site. The site is already FDA approved. It’s just a matter of getting their product approved out of that site.

David Amsellem – Piper Jaffray

And what portion of the market is in that new CMO supply?

Raj Rai

I think the combined with our indicator facility, the CMO out in India as well as the new CMO we should be able to get to close to 50% of the total market, which is up to 30 million units a year.

David Amsellem – Piper Jaffray

And is it your expectation that you are going to see other generic entrants on the product as the year progresses?

Raj Rai

The product still has some patent life left, so one has to challenge the patent before they can get the approval. Now, keep in mind the innovative was shelling this product for let’s say around $4 a unit and it will not be very attractive for the second generic to come in, unless they have this tremendous cost position in manufacturing the product. And keep in mind this is a good product.

David Amsellem – Piper Jaffray

Okay. Last question I have is, can you break out the contribution if you can on the, of the OTC eye care business and that includes survival as a portion of the overall Ophthalmic revenue. And then give us a sense, what kind of growth trajectory we’re seeing there for the OTC piece of the business both for TheraTears and private label ? Thanks.

Tim Dick

So, David, this is Tim. In terms of what the OTC business contributed to Q1 in Ophthalmic’s it was roughly $6.5 million to the quarter.

David Amsellem – Piper Jaffray

Okay. And that includes private-label or is that just TheraTears.

Raj Rai

That’s a combination.

David Amsellem – Piper Jaffray

Okay. And how should we think about the growth trajectory going forward. I mean is this a double-digit grower or are you still looking at more private-label launches in order to get this to more of a higher growth trajectory?

Raj Rai

Well, we’ve – as I said in my prepared remarks, I mean the retail sales are up 20% year-over-year in the first quarter and outpacing the entire dry eye category. So the product is definitely growing, I mean we are doing two things to continue to accelerate the growth there from clinical marketing efforts and private-label will play a pretty good role going forward and we are actually very excited about the opportunities as I mentioned we have 10 store brands that we will be actively selling and marketing and we have few more in development.

And so by the end of this year the private-label OTC business becomes a significant part of the overall OTC business. And so I think the overall segment of ophthalmology in the over-the-counter business, I think is definitely a double-digit growth business.

David Amsellem – Piper Jaffray

Okay, all right. Thank you.

Operator

We’ll take our next question from Elliot Wilbur with Needham & Company.

Elliot Wilbur – Needham & Company

Good morning. Thanks.

Raj Rai

Good morning.

Elliot Wilbur – Needham & Company

Raj, a question for you. I guess one of things that always surprises us as analysts and investors as well as that sometimes things seem to change or change much more quickly than one would think sort of given the size of the business. And I guess it has been three months since we last heard from you guys with respect to guidance and that can be a long time in the generic industry.

But I guess – and looking sort of that some of the key factors you said in terms of the guidance reduction for the year. Is there any one of those that maybe just in the last couple weeks or last month or so just really fell short relative to projections or have these things been sort of just kind of occurring all along and you just really weren’t able to get any of these products to the levels that you had really expected.

I’m just trying to figure out sort of, if there is any just one factor here that’s more responsible than another and whether there was any sudden shift in any one of these issues that may have cause the overall reduction to your full year expectations?

Raj Rai

Well. Elliot the things really started to solidify for us in terms of what was going to happen was some time in the middle of the quarter after we were done with our year end conference call. And, I mean few are mechanical issues, I mean purely technical in terms of getting some fix on the manufacturing, few things beyond our control in terms of being dependent on third parties to make the product for us.

And few things were advent, I mean the market tends to be in the generic space as you know very, very resistant, and the contracting becomes a bit of a challenge getting products on contract in the middle of a contract cycle.

And so I think with this combination of everything and then for example the TD vaccine, we were not sure about how much inventory the incumbent actually had and now we know what exactly that they have and what they were trying to do.

So something like that is going to get, go through course correction on its own as they liquidate the inventory and we’ll get our market share back up again. So I think it’s just the combination of everything and a big part of the problem here is the reliance on third parties to make the product. If I were to assess that, the whole situation.

Elliot Wilbur – Needham & Company

Yeah, exactly How this process in mind. This is – and I guess in sort of speaking with investors this morning, I mean, I think one of the impressions that seems to be out there is that somehow some of the capacity constraints of the company has experienced in the past have sort of caught up with you this quarter.

But at least I’m sort of looking at the key factors you’ve cited in terms of the overall reduction in financial expectations for the year. Again, a lot of these are either market-specific issues or attributable factors outside of the company’s control.

But maybe, Raj, if you could just a little bit about sort of current capacity constraints, if any that you’re experiencing at any of the facilities? And then, specifically thinking about, bringing Latanoprost in-house and essentially we’re looking for 100% a year volume to come, internally what that may do in terms of putting additional strains on your existing Ophthalmic capacity?

Raj Rai

That’s a good question. Actually, just to address your first point in terms of the capacity is really – constraints have really go up to the company. Now, I mean, we were obviously capacity challenged. Last year and especially in our ointments line in the Somerset facility. That was a whole genesis of investing in the expansion for formulation in that facility.

Now, where we fell behind was getting the construction completed last year. So, we lost approximately six months. And then, it was unfortunate that Sandy hit at the same time. So it was sort of being at a perfect storm, I wish we had gotten past the expansion project six months earlier, we won’t be dealing with situation now.

So, we are tight on capacity especially on the ointments, which will get addressed in the second half of this year, because I think it’s complete now. And so we have – we’ll be ready for business. The other question you had was on Latanoprost. Yes, you’re correct that if you bring Latanoprost in Somerset, they would then max out the capacity of our solution line.

And then – and which sort of dovetails into sort of the other question that we had planned a Phase II expansion in our Somerset facility sometime this year after we completed Phase I. So the timing wouldn’t have any better as we move the product into Somerset, we will start focusing on the Phase II part of our expansion that would be adding another solution line in the Somerset facility, for which some of the work was included in the Phase I. So, that conversation has started within our management team.

Elliot Wilbur – Needham & Company

Okay. Then just two quick follow-ups for you. In early, 2013, as part of your initial guidance parameters, you issued a fairly detailed table in terms of launch expectations with respect to the ANDA pipeline for the next couple of years, specifically just thinking about 2013, has there been any dramatic change there in terms of the timing of expected new approval activity?

Raj Rai

Yeah. No. I mean, we said we were on target for three to four products this year, and I think we’re still on target for that. Nothing has really changed.

Elliot Wilbur – Needham & Company

Okay. Then last question, when you’re filing so many ANDA’s and engage in so many CV30 requests, have new lines coming out that tends to invite a lot of visits from the FDA, anything there that investors needed to be concerned about in terms of inspections that have resulted in 483s or new observations?

Raj Rai

Last year, both of our facilities went through a couple of FDA inspections and that was predominately around the drug-approval inspection. So, we had some 483s that we responded to and had no ongoing issues with the FDA.

Elliot Wilbur – Needham & Company

All right. Thank you.

Operator

We’ll take our next question from Sumant Kulkarni with Bank of America Merrill Lynch.

Sumant Kulkarni – Bank of America Merrill Lynch

Good morning. Thanks for taking my questions. The first one is on the products that were impacted by Sandy. We’re seeing some of the unit share creep back up, but what has that meant in terms of pricing, has there been a big difference in terms of pricing going down to get back that share?

Tim Dick

Sumant, this is Tim. No, the contract prices haven’t changed. As Raj had mentioned earlier, there wasn’t a loss of customers, just a loss for a sale at a point in time. And then, where we are multi-sourced on those products. If the customer looked somewhere else, they may have continued to, and we just have to go back to them and remind them that we’re back, and to start buying from us again, but it hasn’t. It required a price reduction in order to bring them back.

Sumant Kulkarni – Bank of America Merrill Lynch

Okay. And on the delayed launches that have been pushed out to the second half, are those now date certain or is there something that is out of the company’s hands that could push them out further?

Tim Dick

Well. Except for one product that’s Pantoprazole, that is dependent on the third-party contract manufacturer to get FDA approved for the product, I think the rest is pretty much in our hands to push the sales out.

Sumant Kulkarni – Bank of America Merrill Lynch

Okay. And in terms of margin structure, is there something that is – going forward is there something structurally different given that you have taken down the margin outlook for the year or is this just a something like a temporary blip and is usually dependent on product mix?

Tim Dick

It is very dependent, Sumant on product mix. And it’s slightly below the bottom end of our original guidance for the year, which is 54% to 56%. And so it’s based on the particularly in Q1 lighter Nembutal and Erythromycin both of which have nice margins higher than our composite margins and not been able to recover that and get a stack up into that range for the full year.

Sumant Kulkarni – Bank of America Merrill Lynch

Okay. And on Sandy as to what happened there and what’s been happening in terms of getting those products back. Is there something fundamentally different in the way you’re treating inventories on hand and that’s going to impact your working capital requirements for this year and going forward?

Raj Rai

No, no. I mean, the one thing we will do as soon as we have the increase production part of our ointment and gel line post phase I expansion in summerset is to increase our safety stock particularly on those products that we were impacted on as that won’t be our meaningful dollar value step up in inventory.

Sumant Kulkarni – Bank of America Merrill Lynch

And my last question is more of an industry one, we have seen some structural changes at the office of generic drugs with things being moved around with PDUFA coming in, have you seen anything that suggests earlier or later than usual approvals of ANDAs because of those changes?

Raj Rai

Well, according to the PDUFA Act, FDA made it pretty clear that it will take them approximately three years to catch up before they can really implement the timelines as stipulated in the PDUFA Act, so I don’t really expect to see anything different, so I think it’s business as usual till FDA gets caught up with the pending approvals of the filings.

Sumant Kulkarni – Bank of America Merrill Lynch

Thanks.

Operator

We’ll take our next question from Jason Gerberry with Leerink Swann.

Jason Gerberry – Leerink Swann

Good morning, Raj. Thanks for taking my question. Let me just- first question on gross margins. Here as it looks like that the consensus is somewhere in the 56% to 58% range for margins kind of returning to 2012 levels, which are well above the kind of the industry norms in your respective dosage forms.

So just curious, I mean, assuming, then we Nembutal sticks around as an exclusive product for you guys, do you agree? Could you see – because the margins bouncing back to those levels or should we be looking at the gross margins in the 2013 guidance as more reflective of the long run rate?

Raj Rai

No, Jason. I do see them coming back to – to the kind of the 56%, 58% range you’re talking about, if – certainly when you’re looking at to, say 2015, we’re expecting – our ANDA facility to start contributing sales to the U.S., which is going to have a margin impact.

And again, keep in mind that the step down in 2013 was specifically around these handful of products that I don’t believe are indicative of the full pipeline that we’re building, given that there’s very few products in that – in our pipeline today that are partnered and have shared economics, and on the oral Vancomycin, Progesterone where we are sharing 50% or 50% of the gross profit, it’s obviously going to be a drag on the net composite margins.

Jason Gerberry – Leerink Swann

Okay. And in terms of this very big guidance for 2013 revenues and gross margins, as we look at the spreads to the low side, I mean are there still risks to the Ophthalmic Erythromycin business or is the range really, the range of outcomes really more around the new product launches that kind of came on board in late 2012?

Raj Rai

Yes. And obviously this does not factor in any new entrant that comes in place to compete with us in ophthalmology or any for key product segments. So without that I think we feel comfortable that we should be okay within the guidance range.

Jason Gerberry – Leerink Swann

Got it and then last question is if you can provide for hospital injectables what’s the gross margin in that business if you backed out of Nembutal, and I don’t know if you can provide that?

Raj Rai

No. That’s different stats that we provided or gotten in to the granularity of what individual products are contributing.

Jason Gerberry – Leerink Swann

Okay. Thanks.

Operator

(Operator Instructions). We’ll take our next question from Michael Higgins with Brinson Patrick Securities.

Michael Higgins – Brinson Patrick Securities

Thanks a lot, good morning guys.

Raj Rai

Good morning.

Michael Higgins – Brinson Patrick Securities

Just one remaining question on my list. Any particular plan that you have or any change there in looking at small and medium size assets of businesses in 2013?

Raj Rai

Could you repeat that question. I’m sorry.

Michael Higgins – Brinson Patrick Securities

In the remainder of the year any changes in your outlook for acquiring businesses of small and medium size whether it be business or assets?

Raj Rai

Right now the top priority Michael is to get back on track with our sales for newly launched products. So I think I’m not saying that we’re not going to look at acquisition opportunities, but I think the bigger priority is to and the focus is to get back on track with sales but, we’ll look at any opportunity that comes along. But I would still give preference to our task on hand is getting back on track on sales.

Michael Higgins – Brinson Patrick Securities

All right, very good. Thanks guys.

Operator

And it appears there are no further questions over the phones at this time.

Raj Rai

Thank you for your continued support and patience, we’ll look forward in speaking with you in our next conference call. Thank you once again.

Operator

This concludes today’s conference. Thank you for your participation.

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