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Akorn, Inc. (NASDAQ:AKRX)

Q2 2013 Earnings Call

August 6, 2013, 10:00 AM ET

Executives

Raj Rai - Chief Executive Officer

Timothy Dick - Chief Financial Officer

Analyst

Steve Crowley - Craig-Hallum Capital Group

David Amsellem - Piper Jaffray

Jason Gerberry - Leerink Swann

Elliot Wilbur - Needham & Company

Sumant Kulkarni - Bank of America Merrill Lynch

Operator

Good morning and thank you for joining Akorn Inc's 2013 second 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 maybe 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 entering the access code 6338126.

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 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 actual future experience.

Risks and uncertainties could affect forward-looking statements, including the failure to gain new product approvals, failure to successfully launch new products and increased 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 on Form 10-K and subsequent quarterly reports on Form 10-Q.

Also, the company urges caution in considering any trends or guidance that maybe 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 would now like to turn the call over to Raj.

Raj Rai

Thank you. Good morning everyone and thank you for joining our 2013 second quarter conference call. On today's call, I'll summarize the key highlights for the second quarter and Tim will discuss the financial results in detail. We recorded $77 million in sales in the second quarter, a 22% increase over the second quarter of 2012. In the second quarter, we experienced a consistent sequential growth across the board from all our marketed products outside the late 2012 new product launches.

However, the contract sales in India were below the first quarter sales as a result of the intervention of Government of India's drug price control order to revise the methodology in calculating the manufacturer's retail pricing for certain essential litigations.

The new prices were finally published in June and July and as a result the shipments to our key customers were delayed beyond our control. We expect the sales to catch up in the third and the fourth quarter. In addition, we had a record cash flow from operations boosting our cash reserves to $58 million at the end of the quarter.

Overall, our results were in line with our expectations as we focused on resolving the sales issues, I had highlighted in our first quarter conference call. From first, Erythromycin sales impacted by super storm Sandy; second, the decline in Nembutal sales; and third, the lower than expected sales from the four new products launched late 2012.

I am pleased to report that we have made good progress since our last call. Let me give you an update on each of the products. The Erythromycin sales have made a full recovery. Our market share in the second quarter per IMS was 34%, up 200 basis points from the pre-Sandy levels. Nembutal sales were up 14% sequentially from the first quarter.

In the second quarter we've fixed the manufacturing issues around Latanoprost with the contract manufacturer and expect increased production in the third quarter and that coupled with the site transfer to our Somerset facility, would provide us sufficient capacities to meet current customer demands and future expectations.

The Progesterone were up 15% sequentially. We expect sales to further accelerate in the third quarter due to new customer wins and expect our market share to be at the run rate of approximately 25% by the end of third quarter versus of 16% market share in the second quarter.

We also expect the sales of TD vaccines to increase in the fourth quarter as the inventory from the previous distributor gets depleted from the channels.

And finally on Pantoprazole, we do not see building capacities till the end of this year for an effective launch and given that the average selling price for this product has dropped considerably we plan to revalue the strategy around this product.

We will provide you with an update in our next conference call. All our other strategic initiatives are on track as discussed in the last conference call. We took a pause from evaluating acquisition opportunities in the second quarter. We're now actively pursuing new opportunities that are good strategic fit to our platform. Given the improvements and the progress that we have made in the last few months we are reaffirming our guidance issued with the first quarter conference call.

Now, I'll turn the call over to Tim for his prepared remarks. Tim?

Timothy Dick

Thank you, Raj, and good morning. Consolidated revenue for the second quarter of 2013 was $77 million, up 22% over the comparable prior-year quarter consolidated revenue of $63.3 million. This increase was primarily the result of our launch of new products along with increases in sales volumes for existing products, partially offset by increases in average sale price on new products and revival products launched in the prior year quarter as well as lower sales from our subsidiary in India, Akorn India Private Limited.

Second quarter 2013, Ophthalmic segment revenue was $28.5 million versus $25.2 million in the prior year quarter. Year-over-year growth was driven by volume growth on established products, as well as new product launches such as Latanoprost Ophthalmic Solution, which were partially offset by price erosion. Sequential quarter growth in ophthalmics came from seasonal allergy product sales, growth in AVR private label program and growth in our new active unit dose product.

Second quarter 2013 Hospital Drug and Injectable segment revenue was $42.6 million versus $30.3 million in the prior year quarter. Year-over-year growth came mostly from new product launches and product relaunches, which were offset partially by price erosion on new product launches and revival products launched in the prior year quarter. Sequential quarter growth in Hospital Drug and Injectables came from a recovery in Nembutal sales and continued growth of new products namely Progesterone capsules.

Second quarter 2013 Contract sales segment revenue was $5.9 million compared with $7.9 million in the prior year quarter. The year-over-year decline was entirely attributable to lower sales for Akorn India for reasons, Raj mentioned in his comments and to a lesser extent and lower rupee dollar conversion rate.

Consolidated gross margin for the second quarter of 2013 was 54.7% compared to 56.5% in the comparable prior year period, included within gross profit as a reduction to cost of sales was $1.3 million reversal of a product warranty reserve upon termination of the underlying obligation by agreement between the parties involved.

The year-over-year decrease in gross margin was primarily the result of various new products launched late in 2012, which generate lower gross margins as a result of being either partnered with royalty or profit sharing arrangements or products manufactured through third parties.

Second quarter 2013 gross margins by segment were as follows: Ophthalmic 55%, Hospital Drug and Injectables 59% and Contract Services 25%.

Selling, general and administrative expenses were $13.1 million in the second quarter of 2013 compared with $10.9 million in the second quarter of 2012. The increase is largely a result of expanding the sales force to support the company's growing product portfolio as well as the addition of Akorn India.

Research and development expense was $5.1 million in the second quarter of 2013 compared with $4.1 million in the prior year quarter and down sequentially from Q1 of this year.

The year-over-year increase was a result of three factors: the new Generic Drug User Act fees associated with this year's abbreviated new drug application filings; the cost of bio equivalence studies associated with high-value pipeline products; and the increased internal R&D cost due to the build out and staffing of our new R&D facility.

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 and our quarter-to-quarter R&D expenses can vary materially depending on the timing of these items.

Net income for the second quarter of 2013 was $12.6 million or $0.11 per diluted share compared to net income of $9.6 million or $0.09 per diluted share in the comparable prior year quarter. Second quarter 2013 GAAP net income benefited from the previously mentioned $1.3 million reduction to cost of sales related the reversal of our product warranty reserves.

Non-GAAP adjusted net income for the second quarter of 2013 was $15.3 million or $0.14 per diluted share compared to non-GAAP adjusted net income of $12.6 million or $0.11 per diluted share in the comparable prior year quarter and excludes the impact of the product warranty reserve reversal. Second quarter 2013 non-GAAP adjusted EBITDA was $26.8 million compared with $23.3 million in the comparable prior-year quarter. Non-GAAP financial measures are defined further in today's earnings release under non-GAAP financial measures.

The company generated record operating cash flow of $14.5 million in the second quarter 2013 and ended the quarter with $58.4 million in cash and cash equivalents and full availability of our revolving line of credit.

Second quarter 2013 capital expenditures were $2.5 million. This number does not reflect planned spending for Akron India to add additional capacity and capabilities.

Finally, on 2013 outlook. The look remains unchanged and it excludes the impact of any new product approvals after August 6, 2013. The guidance detail is included in today's earnings release.

That concludes our prepared remarks. We'll turn it over to the operator to open the line up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first to Steve Crowley with Craig-Hallum Capital Group.

Steve Crowley - Craig-Hallum Capital Group

In terms of the pipeline that continues to build at the FDA, what can you tell us about the seaming progress, the dialogue, essentially post-GDUFA? What you're seeing on that front?

Raj Rai

Well, some products obviously, we are seeing a consistent feedback. Now, obviously we had spoken about this in the past that since GDUFA has come in, FDA has changed how they review the application. So you get a complete response letter from the FDA on all of the pending deficiencies. In the past, it used to be piece piecemeal, so it is definitely causing a bit of a delay on some of the filings.

So net-net, we've got a complete responses to certain products that that were in the half for over a longer period of time, few we haven't. So I think the overall, sort of, review time is expected to be longer than what it used to be, so we've got about 16, 17 products that are over 24 months with the FDA. And so that number is growing. So we had not really expected major approvals yet this year, we were looking at just a couple or three more that we expected to get, but outside those, I think the approvals will start coming in next year.

Steve Crowley - Craig-Hallum Capital Group

And then in terms of other FDA developments in the quarter, there was this draft guidance on Restasis in the pathway for development on Restasis, and I am wondering what the implications of that draft guidance might be for your efforts around that specific opportunity and other ophthalmic opportunities in your pipeline either in motion or to be in motion?

Raj Rai

Well, I mean, the guidelines that was published was definitely in favor of a generic coming into the market. And obviously there is a response time that the innovator has to will respond probably, but I think it's a good first-step, in terms of giving the guidance on a potential generic coming in the marketplace. Now, we obviously don't comment on products in the pipeline for obvious reasons, but this guidance could also have an impact for some other similar products in Ophthalmology.

Steve Crowley - Craig-Hallum Capital Group

And in terms of the quarter in a launch that you have that did come in Q2 versus early Q3. Clindamycin, can you talk to us a little bit about early success or I guess progress or status really of that launch, and whether or not that, launch will continue in the early part of Q3 or you'll really wait for reorders and market progress to gauge progress?

Raj Rai

Well, we had a launch at the end of Q2. So the launch is ongoing as we speak and we've made some progress in converting a number of hospitals to use our product. Now, this is a unique presentation because the market is divided in vials as well as the premixed bags, and we are sort of hybrid where we have the pre-mix in a vial. So it's a differentiating strategy that we had in place and overall early indications are the launch is going to develop.

Steve Crowley - Craig-Hallum Capital Group

And will you be able to pull from both of those segments or you're really going after the vial that's not pre-mixed?

Raj Rai

Both.

Operator

We'll go next to David Amsellem with Piper Jaffray.

David Amsellem - Piper Jaffray

Just a few, so let's start with the Lidocaine Jelly, where are you on the larger tube size? Anyway you can quantify how that tube size will expand sales of the product category?

Raj Rai

David, this is Raj. I am not sure what the larger tube size, you've actually mean the batch size, right?

David Amsellem - Piper Jaffray

Yes. That's right.

Raj Rai

So the expanded batch size, we are making the product right now. So effectively we have increased our capacities for making ointments and gels in that facility.

David Amsellem - Piper Jaffray

And anyway to quantify how you think that will expand your presence in the market?

Raj Rai

There are two things that we're going to do; first, is going to prevent any back order situations that we've had. And we will be able to build a good safety stock and to avoid situations like what happened with Sandy when we lost willpower. So I think it's going to mitigate some of those risks that were there. Number two, obviously, we can aggressively now pursue new opportunities to sell more of ointment products, so sort of, a twofold improvement with those kinds of product lines.

David Amsellem - Piper Jaffray

And then switching gears another product generic from me prometrium, what are your thoughts on the potential from more entrance over the next, say, 12 to 18 months? How should we think about the trajectory of that product?

Raj Rai

Hard to say, obviously there is a limited capacity for making soft sales and there are a few companies that have that capability. Some are dually contract manufacturer and some companies have their own manufacturing. So not sure, if another companies want to come into the mix, but obviously we'll keep our eyes open.

David Amsellem - Piper Jaffray

And then in terms of your Injectable capacity and also your Ophthalmic Solution capacity, to the extent that you start to see a big pick up in approvals, should we be worried in any way as we get into 2014 that you may bump up against capacity constraints? Maybe give us a sense or quantify for us, how much free capacity you have in Decatur and how much free solution capacity you have in Somerset to support all these new launches that you're guiding to?

Raj Rai

Let's just talk about the David, about the Ophthalmic capacity. So I think for now we have sufficient capacities to meet the needs of any opportunities that we may have to launch new products in the next 12 to 18 months. And then beyond that obviously, we have to look at adding more capacity. And so we completed the Phase I, which was monetization of plant increasing the ointment capacity.

So the next phase that we've always talked about was to just take a breather from Phase I because it's obviously taken as longer than we had expected. We'll come back and invest more in adding the solution capacity in Somerset. So that would address the Ophthalmology issue. From Injectable perspective, as you know we are going to build bring the Akorn India online. And that would be our answer to the growing need that we may have with R&D on the Injectable front.

David Amsellem - Piper Jaffray

So to be clear for 2014, I am just thinking about 2014 not so much Akorn India longer-term, but to be clear though, you don't expect the bump up against any constraints in, say, the next 12 to 18 months as approvals pick up?

Raj Rai

No.

David Amsellem - Piper Jaffray

And then I just wanted to ask a follow-up on Restasis and realizing that I know that you're not going to comment expansively, but do you believe that the guidance opens the door for multiple generic entrants, maybe along the lines of how many entrants we have on Xalatan. And then secondly do you believe that this is a fairly straight forward pathway. In other words do you think it's not going to be all that difficult for a number of players to actually show equivalence, what are your thoughts there?

Raj Rai

Well, I mean there are two issues here. One is manufacturing issue and the second is more scientific issue. So from a manufacturing issue, obviously what we understand is the product is little bit more difficult to manufacture, having a process. And not to say that different companies cannot come with a solution to make the product. So that is first, the one hurdle. The second hurdle is obviously being Q1, Q2 and getting by equivalency, by doing a dissolution testing.

So those are two hurdles, but I think the bigger hurdle here is definitely manufacturing. So one has to address both because this is not a familiar product where you can easily formulate this product and then come out with a generic. So people who cannot demonstrate Q1 to Q2 obviously will have to do full clinical trials, which could be a humongous task in my opinion.

Operator

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

Jason Gerberry - Leerink Swann

Just a couple, I guess, maybe just starting with Nembutal, it seems like IMS is becoming less of a predictive tool for tracking this product and just kind of wondering if you can help us at all think about the second half, if you think that results could be lumpy at all based on anything that you are seeing there? And I noticed one of your competitors this morning talked about in their guidance watching generic Nembutal by yearend 2013. So if you could just talk maybe about how you think about how much market share you'd lose with a single generic competitor?

Raj Rai

Obviously, to answer your first question we know this product is more episodic. So hospitals buy the product when they needed, so they don't necessarily stock it. And we have created a distribution platform that we can serve the customer really well directly through our shipping into our facilities.

And we have established a relationship with the customers. It has taken us over a year getting to the most of the customers. So that's one of the reasons where you will not see IMS being a predictor of the sales. But again to emphasize that this is an episodic product, so sales can go up and down quarter-over-quarter.

What we're not seeing at the moment is any issues with the product. I know we've heard many of times in almost every conference call since we acquired the product about a generic product coming. So we'll be ready in the event when generic is coming, whether that's having the relationship or having the distribution strategy that we have in place that will give us definitely an advantage.

I cannot predict how much business a generic will bake with that obviously is dependent on how much you want to lose at the end of the day. But we've got the customer base, we know who buys it. It's hard to find the customers if you're just planning to sell this products through the wholesale channel.

Jason Gerberry - Leerink Swann

And if I could just add follow-up. Can you just provide any update in terms of manufacturing or FDA manufacturing inspections, any status on outstanding 483, is that you think are worth noting or could be material?

Raj Rai

We obviously get inspected expected very frequently. And our last inspection was in April in our Decatur facility and we have responded to the 483. That's far as we know right now there are no open questions from the FDA.

Operator

We'll go next to Elliot Wilbur with Needham & Company.

Elliot Wilbur - Needham & Company

Maybe I'll just ask a quick follow-up to the one questioning that was just post by Jason on the 483s, maybe more specifically I guess with those respect to Somerset and Decatur, anything there in terms of recent inspection observations that have caused you to materially change any sort of quality procedure or has there been any actual impact on production as a result of 483, in some of the things that you're going to address the issues raised?

Raj Rai

So Elliot, obviously when FDA comes in, there is always a room to improve on issues that gets lagged and we respond to those kinds of questions and follow the guidance that FDA would give us. Somerset we had our inspection early this year, and so we don't really have any outstanding issues there. Decatur was more recent. We have responded to the FDA. We haven't changed our production. Our production has not changed as a result of the FDA inspection.

Elliot Wilbur - Needham & Company

And then, I apologize I jumped in the call a little bit late here Raj. But if you haven't yet already, could you provide us with an update on the FDA regulatory strategy for Kilitch?

Raj Rai

Yes. So we're on track on making a product, which is an NDA product, which we're transferring from the U.S. over to India. Alongside with, we've got another five products that are going to get made out of those different facilities. And so our goal is still to get the filings in short order and prompt an FDA visit sometime in 2014.

Elliot Wilbur - Needham & Company

And I think that prior expectations was hopefully that would be done, at least the first filing would be done sometime in the end of the third quarter, is that still on track?

Raj Rai

It would be delayed by few days, but we are on track.

Elliot Wilbur - Needham & Company

And just the last question. You mentioned that you've recently, sort of, reengaged the strategic process and I am curious what you're seeing in terms of opportunities out there I mean there seems to be an incredible arms race amongst the larger generics to grab capacity in Injectables and increasingly Ophthalmics.

I mean people look at the acquisition affair by pair ago, and seems to be a very rich valuation paid for what, essentially on the surface it looks to be one product driving the majority of revenue. I am just curious what you're seeing in terms of opportunities that you think that represent good acquisition candidates for you guys, where you not effectively have to deplete an auction processes or pay, what looks to be relatively high multiples?

Raj Rai

So Elliot, our focus is more on, sort of, to niche products that fit well with our platform, so the basket of products that we could acquire. It's not that easy to acquire Injectables because of just the nature of the business, the high demand for Injectable products due to drug shortages. So I think we may have to look at it from dosage point, but again more in the niche areas and some products that we could acquire that fit well into our distribution model.

Elliot Wilbur - Needham & Company

Just as a follow-up to that, would you be able to, in theory, acquire perhaps older branded Injectables where there maybe relatively high level of generic penetration, perhaps even things that have been discontinued and immediately transfer them into

Kilitch, I mean would they be able to use their own filings and under some, sort of, CBE filings to get those transferred or is the gaining factor still that initial NDA in inspection?

Raj Rai

No, I think we are opened to acquiring actively marketed products, whether they have gone through a life cycle management. But acquiring a product that was discontinued it's hard to revive it. I mean you have to start all over again. So the focus would be to look at some of those opportunities that we could buy some of these branded Injectable products, but that have a higher value on the generic side rather than the branch side, which could be good products to transfer to Kilitch.

Operator

We'll go next to Sumant Kulkarni with Bank of America Merrill Lynch.

Sumant Kulkarni - Bank of America Merrill Lynch

The first one is a follow-up on potential generic of Restasis, do you have the manufacturing technology for that in-house or would you need to partner that product if you are developing it?

Raj Rai

We'll have to go outside.

Sumant Kulkarni - Bank of America Merrill Lynch

And in general terms, how much time would it take to formulate a product like that given that we have these new drug deadlines out?

Raj Rai

I'll be purely be guessing, but if you start from scratch it could take you six months to a year to formulate. Then obviously you'll have to do the bio-equivalency, we were testing, and the dissolution testing that you'll have to do. That could take you another six months to a year. So you're talking about couple of years.

Sumant Kulkarni - Bank of America Merrill Lynch

And moving onto the types of assets that you might be looking at, you have been reengaged you said. Are you looking at companies or products would you still stay in these niches that you are in now or look at other different niches and what might be attractive there?

Raj Rai

Well, we will look at again niche businesses, smaller, obviously we have to be within the size constraints, so what we can acquire and that would make sense, but Ophthalmology and Inject were definitely the highest priority, but we may look at some other niche areas that are complementary and strengthen our position with our customers i.e. the retailers and or the GPOs.

Sumant Kulkarni - Bank of America Merrill Lynch

And if you were to go for a sizeable transaction, what size would you be comfortable at and would you be open to a stock or debt or which one would you prefer?

Raj Rai

Well, that would be purely speculative on my part depending on what the deal is, if it make sense. I mean at the moment you can borrow money at a very reasonable cost. So raising debt to do a deal probably is more fashionable right now than doing a stock deal. But again purely it depends on the transaction.

Sumant Kulkarni - Bank of America Merrill Lynch

And my last one is, do you worry at all about capacity in the industry especially when Kilitch is scheduled to come online, other bigger players may come online or may have brought into the industry?

Raj Rai

There is always a room for another player, so we believe that our strategy in getting new facilities online at a cost advantage in terms of, I think, will give us the leverage to compete effectively.

Operator

And it appears that there are no further questions at this time. Mr. Rai, I'd like to turn the conference back to you for any closing or additional remarks.

Raj Rai

Thank you. Thank you once again for joining the call. We look forward in speaking in our third quarter conference call with you in November. Thanks, once again. Bye, bye.

Operator

This does conclude today's conference. Thank you for your participation.

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