Taro Pharmaceutical Industries' (TARO) CEO Kal Sundaram on Q4 2016 Results - Earnings Call Transcript

| About: Taro Pharmaceutical (TARO)

Taro Pharmaceutical Industries Ltd. (NYSE:TARO)

Q4 2016 Results Earnings Conference Call

May 27, 2016, 08:30 AM ET

Executives

William Coote - VP and Treasurer

Dilip Shanghvi - Chairman

Kal Sundaram - CEO

Mike Kalb - CFO

Analysts

Saion Mukherjee - Nomura

Daniel Sanchez - Raymond James

Raul Jawani - IIFL

Anubhav Aggarwal - Credit Suisse

Girish Bakhru - HSBC

Kirti Chopra - Arohi Asset Management

David Mattern - Wells Fargo

Manoj Garg - Bank of America

Kartik Mehta - Deutsche Bank

Sameer Baisiwala - Morgan Stanley

Sumant Kulkarni - Bank of America Merrill Lynch

Chirag Dagli - HDFC Mutual Fund

Operator

Good morning, ladies and gentlemen and welcome to the Taro Pharmaceuticals' Year End 2015/16 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.

I would now like to turn the conference over to Mr. William Coote. Mr. Coote, please go ahead.

William Coote

Thank you. Good morning, everyone and welcome to our year end 2015/16 earnings conference call. Joining me today on the call are Mr. Dilip Shanghvi, Chairman of Taro's Board of Directors; Mr. Kal Sundaram, Taro's CEO; and Mr. Michael Kalb, CFO of Taro.

We hope you have received a copy of the earnings release, which can be found on our website at www.taro.com. We anticipate that many of you may have questions concerning not only this quarter's and year-to-date financial performance, but also our markets, operations, strategies, and other matters.

While we will try to respond to most of your queries, we will not be able to share product specific and commercially sensitive information including pipeline details. We ask that you limit yourself to one question and if you have more questions, please feel free to join the queue. As a reminder, this call is being recorded and a replay will be made available on our website for the next 12 day. A call transcript will also be placed and remain on our website.

Before I proceed, I must remind you that today's discussion may include certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the Company believes the expectations reflected in such forward-looking statements to be based on reasonable assumptions, it can give no assurances that its expectations will be attained, and should be viewed in conjunction with the risks that our business faces, as detailed from time to time in the Company's SEC reports.

I would now turn the call over to Mr. Dilip Shanghvi.

Dilip Shanghvi

Thank you, Bill. Welcome all of you and thank you for joining us today for Taro's earnings call after the announcement of Taro's year end fiscal 2015/16 financial results.

I'm pleased with Taro’s continuing solid performance and progress made especially in the area of R&D and congratulate the entire Taro team for this achievement.

In 2015/16 Taro received five approvals in the U.S., filed 10 ANDAs and has a current R&D pipeline of 36 ANDAs awaiting FDA approvals. These results along with the increased R&D investment of $71 million demonstrate Taro's commitment to continued future growth.

Taro's cash balance of over $1 billion provides us with the opportunity to continue to evaluate business development with appropriate targets. However, asset prices in the industry continue to be high. Therefore we will remain disciplined in our approach for deploying this cash.

We will continue to be diligent in facing the challenges ahead for improving the performance, developing a quality product pipeline and maintaining sustainable profitability.

I would like to turn the call over to Kal Sundaram.

Kal Sundaram

Thank you, Mr. Shanghvi. Welcome to everyone and thank you for joining us today.

Overall we are pleased with our strongest quarter and full year operating performance in terms of net sales, gross profit and operating income. Our 9% year-over-year increase in R&D demonstrates our commitment to growing our R&D pipeline. During the year we successfully passed two major regulatory agency inspections including one by USFDA of our Israel manufacturing site.

In addition to the strong results we have further demonstrated our commitment to creating shareholder value by implementing the $250 million share repurchase program which commenced in March 2016.

As a reminder in 2013, the company repurchased approximately 2 million shares. So we continue to face broader industry challenges in terms of generic landscape driven by ever increasing competition and customer consolidation. Nevertheless, we remain cautiously optimistic about our medium and long term growth and remain focused on strengthening our R&D pipelines and other initiatives that continue to keep us well positioned in the market.

I’ll now hand over the floor to Mr. Michael Kalb for a further discussion on financial performance. Mike?

Mike Kalb

Thank you, Kal. Hello everyone and welcome.

The comparisons that I'll discuss over the comparable prior year periods, I'll first discuss Q4 highlights followed by the full year comparisons. Q4 net sales were $265 million an increase of $21 million or 9% despite relatively flat overall volumes. However the volume of our U.S. business has experienced declines from last year.

Gross profit of $224 million increased $25 million or 12% with gross margins expanding to 84.6% as compared to 81.8%. Cost of goods decreased $3.8 million. R&D decreased $4 million to $20 million as our R&D spending is not evenly distributed across quarters.

SG&A expenses remain relatively flat at $22 million. Operating income increased $28.2 million or 18.4% to $181.7 million and increased to 68.6% as a percent of net sales from 62.9%.

As a result of the above, Q4 EBITDA grew 18% or $28 million quarter-over-quarter to $185 million. EBITDA [technical difficulty] 70% as compared to 65% for Q4 last year. As Kal stated this is our strongest quarter in terms of these financial metrics.

Net income was unfavorably impacted by an $80 million fluctuation and foreign exchange from income of $32.5 million in 2015 to an expensive $47.5 million in 2016 principally the result of the strength of the Canadian dollar versus the U.S. dollar and increased balances in U.S. dollar denominated cash and intercompany balances on the Canadian books.

The FX is primarily balance sheet driven by U.S. dollar denominated bank accounts and intercompany balances. To illustrate, at March 31, 2016 the CAD to U.S. dollar conversion rates strengthened to 1.30 with U.S. denominated cash and AR balances approximately $550 million while at December 31, 2015 the rate was 1.38. Tax expense decreased $13.9 million to $23 million resulting in effective tax rate of 16.6% compared to 19.5%. Net income attributable to Taro was $115 million compared to $152.3 million resulting in EPS for the quarter of $2.68 versus $3.56 in Q4 last year.

Let me now briefly discuss the full year performance and comparison for last year. Net sales increased $88 million or 10% to $951 million compared to $863 million in prior year despite volume decline principally in the U.S. market. Cost of goods decreased $17 million or 9% primarily resulting from the lower volumes and our disciplined approach to spending.

Gross profit increased $102 million or 15% to $779 million while gross margin increased 350 basis points to 81.9%. R&D expenses increased $6 million to $71 million as we continue to invest in building a strong pipeline of quality products.

SG&A expenses increased $4.7 million to $92 million principally the result of marketing spend on Keveyis. Settlements and loss contingencies was $1 million expense versus a $4 million credit in 2015. Operating income increased $86.8 million or 17% to $615 million.

FX income decreased $34.5 million from $41.6 million to $7.1 million principally the result of the strengthening of the Canadian dollar versus U.S. dollar. As a frame of reference to Canadian dollar at March 31, 2014, 2015 and 2016 was 1.11, 1.27 and 1.30 respectively versus the U.S. dollar. EBITDA grew 16% or $86 million year-on-year to $629 million and gross margins - and margins improved to 66% from 63% last year. Our effective tax rate improved to 15% from 16.5%.

Net income was $541 million compared to $484 million a $57 million increase resulting in diluted earnings per share of $12.62 compared to $11.31. Our cash flows and balance sheet remains strong with cash including marketable securities increasing $308 million to $1.2 billion from March 31, 2015 with cash from operations of $385 million.

In addition, long-term bank deposits increased from $30 million to $115 million. In December 2015, Taro repaid the remaining mortgage of $6 million.

Our DSO remained at 82 days. During the fourth quarter we announced and implemented $250 million share repurchase program utilizing a 10b5-1 program. In total through May 23, Taro repurchased approximately 638,000 shares at an average price of $136.20, $163 million remains under Board authorization.

I'll now hand the floor back to Kal.

Kal Sundaram

Thanks Mike. Before we open the floors for further questions, I would like to briefly talk about our recent announcement we made earlier this month convening Keveyis. Keveyis was originally placed with an expectation of maximizing sufficient access to medicine and eventually covering millions of dollars that were invested in creating patient awareness support services, medical education, awareness of periodic paralysis and ultra rare disease with very small patient population.

Starting investment sought to improve patient's diagnostic care and cost us considerably more than the sales, the product yielded. We felt that that this product yielded. We felt that this investment was needed since so little was known about the disease even among statisticians.

After our attempting to make Keveyis available commercially, we realized that we could not susta9in these levels of investments and thus recognizing we have an obligation to the patients, we decided to make the product available free of cost to distributors.

Before we move on to your questions, I would like to thank Taro team and all our for another successful year and the continuing outstanding efforts to meet the challenges in front of us and to successfully move the company forward.

With this, I would like to open the floor for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Saion Mukherjee from Nomura. Your line is now open.

Saion Mukherjee

Yes hi. Thanks for taking my question. My first question is, is it possible to share revenues U.S. and ex U.S. for the quarter and for the full fiscal year?

Kal Sundaram

We don't -- Mike, we don't provide normally geographic split of the revenue.

Michael Kalb

It will be in the [20th] [ph].

Saion Mukherjee

So. Okay. You mentioned that the volumes have declined in the U.S. year-over-year, in terms of revenue, can you confirm whether there was a growth in the U.S. market.

Kal Sundaram

Yes, but it is substantial part of majority, substantially major part for revenues coming from U.S. and I'll say, the increase in revenues again substantially contribute [indiscernible], if not totally, substantially contribute [indiscernible] the U.S. market.

Saion Mukherjee

Okay. That's helpful. And my second question is I know you have [indiscernible] commentaries on the pricing environment in the U.S., are you seeing anything which is significantly different or out of trend in the recent past or the last three, six months with respect to pricing compared to what you saw earlier.

Kal Sundaram

What I'll say will be we're talking about that in the context of increasing customer consolidation, consolidation of wholesalers, consolidation of insurers. Naturally, we'll put pricing pressure on the manufacturer, nothing out of the ordinary or unusual, but a steady increase in the trend for, but pressure on pricing.

The other dimension that we got to keep in mind is as the FDA is speeding up approvals, in as much as we'll get more approvals for our product, we got to realize that our competitors also will be getting approvals for product that will compete with us.

So a combination of stronger customer bargaining position and probably more increase in number of competitors competing with our products will have ongoing pricing pressures that's what we had in our mind when we mentioned that.

Saion Mukherjee

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Elliot Wilbur of Raymond James. Your line is now open.

Daniel Sanchez

Hi. This is Daniel Sanchez on for Elliot Wilbur. I wanted to continue with the pricing thematic here and get some color from you in regards to the extent and impact of any deflation you may have witnessed and if you've noticed any areas that have demonstrated outsized resilience to deflationary pressures in the market? Thank you.

Kal Sundaram

Okay. I don't want to get down to individual product level to talk about pricing pressures. It's basically rule of economics when you have more competition, there will be more pricing pressure. It's known that in the U.S. market, probably there are some 4 or 5 customers command 90% of the market share.

So when you've got such a consolidated customer base and, so in such a situation if there are let's say four or five competitors, the product will come under intense pricing pressure.

So if you look at our portfolio, we have number of products that are either exclusive, semi exclusive, but equally we have given our product base, we also have products which face significant competitor intensity. So those products naturally will continue to come under pricing pressure.

Daniel Sanchez

Thank you.

Operator

Thank you. Our next question comes from the line of Raul Jawani of IIFL. Your line is now open.

Raul Jawani

Hi Sir. Thanks for taking my question. Sir, if we look over the last three years, Taro’s top line has grown by around 12% CAGR. So would it be possible for us to split out this growth between price, volume and new product introductions?

Kal Sundaram

Like I mentioned, [more fraught] [ph] to keep our confidentiality of information to our competitors, I prefer not to, I'll say it's a mix of price, it's a mix of volume, it's a mix of product mix and it's a mix of new products.

Raul Jawani

So just some clarity would help over the past three years what would be the volume decline in the market or in the market?

Kal Sundaram

I don't have that information ready.

Raul Jawani

Okay sir. Bye, that's it for me. Thank you.

Operator

Thank you. Our next question comes from the line of Anubhav Aggarwal Credit Suisse. Your line is now open.

Anubhav Aggarwal

Yes, one question, on the sequential increases here that you reported in this March quarter over the December quarter, would you say that this is simply the full benefit of price increase that you've taken in the past now partially was visible in December quarter and now fully visible now, or is it like more than the price increase this growth is driven by?

Kal Sundaram

I'll answer the other way. On a full year basis, our growth is what Mike about 10% or so, the last quartet growth is about 9%. So I don't see anything significant, it’s normal trend line in our sales that you're seeing the full quarter of sales being equally stronger compared to last year.

Anubhav Aggarwal

Yes, but just clarity there that you're talking about year-over-year growth, but sequential growth will be driven by what because is it like you mentioned losing volumes as well.

Kal Sundaram

Like I mentioned it's a combination of product mix also. So we not assume everything is driven by price or volume. It's a combination of product mix. We look at Mr. Shanghvi mentioned we got five new product approvals last year and some of the approvals came through in the last quarter.

Anubhav Aggarwal

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Girish Bakhru of HSBC. Your line is now open.

Girish Bakhru

Hi. Just on Keveyis, would it be possible to share the number of say cost of investment you would have made in creating this asset and creating higher access for this asset?

Kal Sundaram

Okay. Once again, we don't give product level information. What I'll say will be what we spent was significantly higher than the sales that we made, which continuing that would have made the product certainly ineffective, would have had a negative impact on the overall P&L.

In the context of the overall company, I'll say that it's not that significant. We're a billion dollar company so we got to take that in the context, but [indiscernible] the product between sales and revenues, there is a significant mismatch in terms of what we’ve spent to what we realized.

Girish Bakhru

Right. And just to understand this where are the real challenges if I see is it in just simply finding the patients who will see incremental benefit or in per say generating prescriptions from the doctors in terms of whether this really helps or not?

Kal Sundaram

Like I mentioned, this is an ultra rare disease starting from diagnosis by the patient and the doctors, it's a very poorly understood disease. And by epidemiology, one is still we're talking about say somewhere in the region of possibly 3,000 patients being affected by the disease.

So within that the number of patients probably actively accessing or needing the product is much smaller. So a combination of very small pool or patients accessing treatment and the disease being poorly diagnosed resulting in very, very few significantly small -- even smaller number of patients being adequately diagnosed and prescribed.

Girish Bakhru

Right. Just second question was on the Onychomycosis product, which recently completed the Phase 2 study. If you could throw some comment on how that asset is developing and if any differentiation aspect you could share on that product?

Kal Sundaram

I think what you say the study that we did, the signals are positive, but we're going to be doing a larger scale Phase 2B study. When the study gets completed, we can say it with any confidence that the product will meet the expected efficacy and safety that are needed. The initial results are directionally speaking, seems to be encouraging.

Girish Bakhru

That's helpful. Thank you.

Operator

Thank you. Our next question comes from the line of Kirti Chopra of Arohi Asset Management. Your line is now open.

Kirti Chopra

Hi. Good morning. In your press release, you mentioned about your cautious optimistic view on the medium to long term growth of the business. Would you please elaborate the sources of this growth?

Kal Sundaram

Nothing other than our own pipeline that you would say and the fact that we're a specialty generic company, our product qualities, I'll say it's flawless and more flawless. Our customer service will be probably some of the best in the industry. It's a combination of high quality and good quality services and the high quality pipeline position us well even the phase of the increase in competition.

And also you know that we have a strong balance sheet also and that is what you saw good acquisition opportunity that meets our financial as well as strategic criteria that also will further strengthen our business.

Kirti Chopra

So this business or as we see it today, we're confident that the growth should be more than good to offset the price erosion, the genital price erosion in the industry?

Kal Sundaram

Our belief is that on one side we'll have sort of continuing pricing pressure. On the other side of new products will enable us to grow. So at this stage, net, net, I'll still see a positive real trend going forward.

See I don't want to speculate too much about how much pressure or how much pricing pressure, how much new product impact etcetera. It's more a qualitative statement. Yes, we do see ongoing pricing pressure, but we believe we've got a very good pipeline, increasing pipeline and we'll continue to spend more on R&D to make sure that we strengthen our pipeline.

Kirti Chopra

All right. Thank you. Just one request if you can consider holding the conference calls on a quarterly basis, it will be beneficial for all the investors.

Kal Sundaram

Sorry, I missed it.

Kirti Chopra

I request on conducting the conference calls on a quarterly basis.

Kal Sundaram

No, not yet. So we'll discuss internally.

Kirti Chopra

Yes. Thank you.

Operator

Thank you. Our next question comes from the line of David Mattern of Wells Fargo.

David Mattern

I apologize if you've already addressed it, but I know there is a little bit of discussion on margin earlier in the…

Kal Sundaram

David the call is not very clear.

David Maris

Okay, I'll jump back in then.

Operator

Thank you. Our next question comes from Manoj Garg of Bank of America. Your line is now open.

Manoj Garg

Yes, good morning and thanks for taking my question. Kal, congrats on good set of numbers. I just like to understand, when we look at the - some of the competitors who are operating in the same segment of [indiscernible] U.S. like Perrigo and [Corn][ph] and look at the gross margins in the generic divisions, obviously like Taro has a significant harm compared to those competitor even they are operating the same segment.

So just would like to understand from you like, how confident we are in terms of maintaining that trajectory and what gives us that extra alpha in terms of those high gross margins?

Kal Sundaram

If you're talking about people like Perrigo, I don't say - I’m not going through the 20F for their annual accounts, but fact of the matter is they have a significantly stronger OTC business, OTC business by definition the margins will be - will won't be as stronger from a margin.

Manoj Garg

I'm talking about the generic division margins, it's excluding OTC division.

Kal Sundaram

So like I said, I haven't gone through that part of it and it's not appropriate for me to set of comment about them or they can set of phase. We are a specialty generic company, so by definition our portfolio will be sort little narrow, but set of focused. We operate in niche market, smaller volumes, but better priced. The combination of that and when it comes to sort of manufacturing quality set of functions et cetera, we have very efficient missionary.

So capacities are well utilized. We turn around our stocks to set up fairly well. So a combination of internal efficiencies and operating in specialty market gives us this margins whether this will continue or not it's speculation.

Our aim will be to continue to create shareholder value but whether it’s going to be sort of really through higher sales growth or diluted margin et cetera too difficult to say at this point.

Manoj Garg

And Michael just the second question for you. We have seen significant reduction in the trade payables and other current liabilities in this year, which has come down from $309 million to $245 million, any specific reason or you would like to give any color on that?

Michael Kalb

Principally it's due to taxes payable. Yes, the reductions, tax payables in part.

Manoj Garg

Okay. Thank you. That's all from my side. Wish you all the best.

Operator

Thank you. Our next question comes from Kartik Mehta of Deutsche Bank. Your line is now open.

Kartik Mehta

Hi, just trying to understand, Kal can you throw some light on the number of ANDAs that we expect to file over the next two years and some color on the existing 36 products that we have – which are there for approvals. Thanks.

Kal Sundaram

Kartik you would have seen our trend in R&D is continuing to increase. So other thing is being equal that continued increase in R&D spend should result in either more products being filed or more complex products being filed.

So we got sort of stock on a trend line basis, I would expect - anticipate to possibly maintain and hopefully improve the number of products that we file and the quality of products we filed. And you asked something about the ANDAs are waiting for approval -

Kartik Mehta

Yes.

Kal Sundaram

What you want to know about it?

Kartik Mehta

If there is any color on this in terms of - if it is anything - is it fair to assume that most of them are in derma or if possible the addressable markets size of all 36, I mean any color of this will be helpful Kal.

Kal Sundaram

Okay. So Kartik again talking at a sort of product level or even portfolio of products will be difficult for me to give you quantified answer. Pretty much a significant portion of our pipeline is dermatology oriented. Outside of dermatology - I’m talking about the generic business we operate on oral solids, narrow therapeutic index, so product which requires very, very sort of strict tolerance levels this is what we focus on.

So pipeline also is continued to be focused on both derm as well as narrow therapeutic indexed, oral solid we will have certainly some therapeutic OTC products but I’m talking more about the generics.

Kartik Mehta

And on the $1.2 billion cash that we have on the books, you had mentioned in the earlier earnings call that acquisition was actually one of the real sort. You actually spoke about the valuations being expensive, I mean would you define if there is a benchmark for payback or if there is an opportunity to go outside the - if we did for psoriasis also.

I mean just to understand your thought, would it be primarily in derma or if anything like also is - where you would be interested.

Kal Sundaram

Karthik in the U.S. number of companies paid [indiscernible] bought assets as valuations probably we would not have bought and when you analyze number of those companies in terms of share price have experienced a significant decline. So that again sort of confirms our belief and operating principle that whatever we buy it has to have the ability to create additional shareholder value even after the premium that we will pay to acquire the assets.

So again that's a directional principle again what will we buy, I’ll sort of probably quantify that in two terms, our familiarity, our comfort levels are sort of significantly with U.S. So anything sort of U.S. again it has to be largely specialty oriented or when it comes to sort of significant - new geography attraction.

So to a combination of this set will continue to evaluate available opportunities in the market.

Operator

Thank you. Our next question comes from the line of David Maris of Wells Fargo. Your line is now open.

David Maris

Hi, actually my question on margins was answered but just to be clear, you mentioned that - may be you could just talk about sustainability of that not so much quarter-to-quarter and just sort of high quarter, next quarter lower but just in general relative to other generic companies your margins are much higher and they been for a while.

So, you just talk about the sustainability of that and the business model scalability and then separately the question on the balance sheet use of cash, is there any thought on just returning a lot of that cash to shareholders relative to keeping a lot of dry powder to do deals.

Kal Sundaram

Okay. I'll take your question in two fold, the first one relates to what is the sustainability of margins. Large depends on competitive intensity which is not in our hands. My own set of belief is that this being a specialty business and the products require complex formulation, clinical development, so to a degree that by itself will has an ability to limit competition but within that how many competitors will set up which product when difficult to predict.

So that's a reason we have been extraordinarily sort of transparent and we have been cautious. We have been continuing to caution the shareholder about that what you say the vulnerability of our ability to sustain these margins. So, beyond that it will be difficult for me to say.

Then as far as cash is concerned, you would have seen again sort of we have put $250 million to buy the shares back two years ago, Mike, I think we spent close to $200 million to buy the shares back.

I think given so - number one that we are effectively returning cash to the shareholder and then I'll still got to say, we go to keep cash, is there a good opportunities that arise. We got to have the ability to step in and buy. We are in the business of creating both short and long-term value to the shareholders.

So it’s a sort of fine balance and I strongly believe that we're maintaining the balance.

David Maris

Thank you very much.

Operator

Thank you. Our next question comes from the line of Sameer Baisiwala of Morgan Stanley. Your line is now open.

Sameer Baisiwala

Yes, thank you so much. Kal just on Keveyis, it looks like it's an in-market failure where you have not been able to convert the patients. I would have thought you would have done before putting capital to work behind this molecule, you would have probably done groundwork would have met open end leaders just to identify the size of the market and you know the potential to convert the patients into - for actual treatment but looks like you got, you tried to do all this after the launch and did not - you don't get the desired results?

Kal Sundaram

No, Sameer and I - we know each other for some time. We did all whatever that you mentioned three markets what is a, research to understand the patients expectations, the requirements and then say research and everything was done.

Having said all that, if we are talking about there is 200, 100 million patients, the probability of us getting 10% of that, 20% of that will be very different from which we are talking 200 patients.

So the 1000 level is fairly small, so despite number one we knew that the number of patients are going – not going to be large but nobody anticipated that what we’re going to get is even much less than what we anticipated, that is what has happened.

We have been working on this product for years and I will say three years, five years we have been even providing free access to patients within the sort of regulatory framework and constraints. So if at all anybody in the sort of consumer will have - from a manufacturer point of view, who have a better understanding of disease that will be Taro.

Sameer Baisiwala

Do you think at some point time in the future, you can revise this product in terms of commercialization or?

Kal Sundaram

We have no planned at this point Sameer.

Sameer Baisiwala

Okay. And just one final point on guidance, Kal is a request, if like your parent company Sun gives some sort of guidance in topline et cetera. If Taro too can do that will be wonderful and many other American pharma companies do that. So just a thought for you?

Kal Sundaram

Sure, Sameer leave it to this, we will think to that.

Sameer Baisiwala

Okay.

Operator

[Operator Instructions] Our next question comes from the line on Anubhav Aggarwal of Credit Suisse. Your line is now open.

Anubhav Aggarwal

My question is on cost of sales. The cost of sales I’m just looking sequentially December to March quarter, it has declined by 8%. Now if you see on the currency side, both Canadian dollars and Israel shekel has been adverse to us and despite that cost of sales have declined by 8%, can you just help with that what would have resulted in this?

Michael Kalb

Again I would say primarily some volume decline and continued efficiencies.

Kal Sundaram

Anubhav it is a good question, give us a little bit of time so we will study and then revert.

Anubhav Aggarwal

Okay, sure. Let me ask another question that, the one question the balance sheet to Mike on the inventory side Mike, the inventories are up like $12 million quarter-on-quarter which is almost 10% increase like 127 going to 139. And given the gross margins that we guys have almost 80%, 85%, if this is destocking of products for the launches in the future quarter, that like potentially means very large amount of stocking that we're going to see in the sales conversion. Can you just throw light, what would this inventory increase be leading to?

Michael Kalb

Sure. A portion of it is our raw material and a portion of it is finished goods, some of it is quite honestly some timing, if we have products with some longer dating, we will build some inventory and some new products as well.

Kal Sundaram

On sort of the yearly basis when you look at it my rate collection you're talking about give or take about 10% increase in the inventory level. And given that sort of it happened in your new product approvals also, I would think the inventory buildup is a -

The other aspect that we forgot to mention is, as what do you say as risk management and backup process, we also try to add dual sites to what we make. So that process also will require us to make - what do you say, build inventories at two levels that maintains safety stock till the other site comes on stream et cetera. So that also adds cost some level up inventory buildup.

Anubhav Aggarwal

Sure. That's very helpful. Thank you.

Operator

Thank you. And our next question comes from line of Kartik Mehta of Deutsche Bank. Your line is now open.

Kartik Mehta

I just wanted to know is there any expenses on account of psoriasis which was discontinued which would have been booked in FY '16 which would not be there in FY '17 of the profit and loss account.

Kal Sundaram

The topline was insignificant.

Kartik Mehta

Yes trend expenses.

Kal Sundaram

As far as expenses, I would expect what is a some level of savings that we had spent last year which won't affect going into the current year.

Kartik Mehta

Would you quantify that or you -

Kal Sundaram

No Kartik, what you say - product level information we don't.

Kartik Mehta

Okay. And on the share repurchase Kal, how does Taro decide on this in 2013 we had about $600 million of cash now we have about $1 billion. So is it a function of the business condition or is it surplus cash where you feel that there is no asset that you can acquire and then you allocate this same amount.

So I just want to understand how do you decide on the timing of the reconstruction.

Michael Kalb

I think it's hard to give some variety of factors. Many of which you just mentioned given our relative flow things like that.

Kal Sundaram

I think we generate about $400 million plus annually in cash. So while we set of - we have enough to go for acquisitions, and at the same time we need surplus which we feel that we can safely return to the shareholder which we are doing.

Kartik Mehta

Is it fair to assume that over the next two years you have no asset to acquire the value that you would want, you would continue to do a share repurchase because that might be one of the only ways to add the value to the overall shares apart from the performance that here in professional level?

Kal Sundaram

Sure Kartik, we'll evaluate all options including buying assets, including returning cash, whatever set of appropriate for us to create value, we look at all those options.

Kartik Mehta

Okay.

Operator

Thank you. Our next question comes from the line of Sumant Kulkarni of Bank of America Merrill Lynch. Your line is now open.

Sumant Kulkarni

Thanks for taking my question. So other than asset prices remaining high, how would you characterize the availability of U.S. assets and what capabilities in specialty generics do you have that you do not currently have what you think makes sense to buy not.

Kal Sundaram

So you're going beyond pricing, sort of see what we will buy, what we will - it will be easy for me to sort of rule out things that we are unlikely to buy suppose an asset that's requiring an - some 700, 800 deal force. Certainly we are not in that business. So what you say a branded math market product if it becomes available, I don't think at this point, I'll never say never to anything, but if you look at what is our focus capability that won't suit us.

Suppose something becomes available very good value, potential to grow, we can add to the paid value, if it is in dermatology of course we will go for it. Almost everything else is going to be in the grey zone depends what it is, depends what the value is, depends what our familiarity is.

As far as generic market is concerned, we understand the U.S. market quite value. If it gets too branded certainly we will be lot more focused.

Sumant Kulkarni

Thank you.

Operator

Thank you. And we have time for two more questions. Our next question comes from Chirag Dagli of HDFC Mutual Fund. Your line is now open.

Chirag Dagli

Yes. Thank you for the opportunity. So, when you sort of look at your U.S. genetic dermatology market share and you sort of look forward how do you see that number, do you see that number improving, increasing or decreasing or remaining as it is?

Kal Sundaram

Again largely depends not only us, it depends on how many competitors are going to be entering. What I'll say will be given a sort what you say, given a set of products or set of competitors, I’ll sort say we are well positioned.

This market share tends to be much better than - one has to talk about the average share, a fair market share how market share will be probably. Most of the times will be better-off than what I sort of say, one can say we deserve. That's because our customers have very good confidence in our product quality, there is some level of loyalty.

So how much market share we can maintain depends on how many more players come and how much they are willing to undercut us.

Chirag Dagli

So just to get my numbers right, so the way I understand the genetic dermatology in U.S. is about $5 billion to $6 billion and we have a share less than $1 billion in the US. So, we have roughly about 20% kind of market share.

Kal Sundaram

I think if you look at the IMS numbers probably like-for-like the numbers will be higher than what you are suggesting.

Chirag Dagli

The market share will be higher?

Kal Sundaram

Higher

Chirag Dagli

Okay. And this we hope to maintain going forward.

Kal Sundaram

This year our aim will be to maintain that or improve that.

Chirag Dagli

Are there substantial number of flattened expires in dermatology, going forward say next 3, 5 years?

Kal Sundaram

Unlike the blockbuster products, dermatology is an area where we are not going to see a $1 billion - I’m talking about small molecules, dermatology product going up flattened. It is sort of slow and steady and because it is sort of slow and steady and being complex, the number of players will be, on day one you are not going to see some 15 players entering. It’s not that type of business.

So, smaller market, smaller number of competitors, higher level of spend, and I'll say it will take between 3 to 5 years from the sort of we start developing to the time you file the product got approval. And depending upon how long FDA takes, then you are talking about that upwards that 5 years, 6 years, 7 years before you launch the product.

Operator

Thank you. Our next question comes from the line of David Maris of Wells Fargo. Your line is now open. Again David Maris, your line is now open.

David Maris

The question and I apologize if you have answered this because I had to dial back in. The quarter you have just reported, were there any volumes in the quarter or any inventory destocking or anything that might make this quarter more than normal.

Kal Sundaram

It's not an unusual quarter.

David Maris

Okay. So as we are talking about a weeks of inventory on hand or in the channel as the start of it, or start of the last quarter versus this end of this quarter -

Kal Sundaram

No David. Again I go back to what Mike said, if you look out sort of what you say, data levels that also will give you an idea will be what you say, that will be quite in line with the proportions of sales of previous quarters so nothing unusual.

David Maris

Great. Thank you very much.

Operator

Thank you. And our last question comes from the line of [Rahul Deshmukh] [ph] Private Investor. Your line is now open.

Unidentified Analyst

Hi, this is Rahul Deshmukh actually. And first of all congratulations to the TARO team for having this spectacular quarter. The question I had was regarding this asset buybacks and for potential acquisition of assets and Mr. Shanghvi in his opening remarks said that the asset prices are ready inflated at this time but what I would like from - to hear from you is, if you can reconcile as far as Sun Pharma goes over the last three years, they have made purchases 4, 5 billion from Ranbaxy to Dusa to insight at Novartis portfolio, the GSK and the Marco Biologic.

Whereas Taro the only acquisition they made was in a preclinical molecule where Taro does not have any expertise for 3.8 million and they wanted to invest $250 million in an wind energy project at some point. So, there is a big disconnect in terms of how Mr. Shanghvi the Chairman at Taro and the MD of Sun thinks about asset prices and why do we see the disconnect between how Sun evaluates asset prices versus how Taro evaluates asset prices given the fact both the managements are similar.

Kal Sundaram

Okay. That one good question, number one, I can't answer first one, so that question probably were sort of taken with Shanghvi that have been talk to you. What I’ll say we got to compare the difference between Sun and Taro. Sun is a global company so if you sort of look at - I’m sort of saying what was that I’m saying with the information that's available in public.

So Sun has a huge present in India, Taro is absent in India. Sun has a significant percent in emerging market and we have next to no presence. And if you look at Ranbaxy, these are set of areas where distinct lies.

So if Taro has to go to acquire Ranbaxy, honest to lot of modest sort to say, we don’t had a management bandwidth to manage certain acquisition. So, there are – it's not what you say, it’s not like for like what Sun can do or Taro can do or on the reverse - whatever in the specialty area in which we are operating what Taro can do, I can’t say whether Sun can do it or not.

Unidentified Analyst

I appreciate that. If I may and project like Dusa for example it’s a pure dermatologic company Merck, psoriasis drug is a pure dermatologic drug. So, you have the capability with $1.2 billion on your balance sheet which is not earning much, we are not returning that money to the shareholder.

So, its genuine request that you evaluate the options more carefully and also with regards to volume decreases, there is just agreement - agreement on conformity and assessment between Europe and Israel specifically to allow drugs to be sent to the European region and Taro is not doing that either that they are not shipping any drugs to Europe or not trying to create new market even the current portfolio.

We are not even talking about acquisitions, we are talking about expanding your market based on the right factor Taro has because it is a Israeli company. So I’d very much appreciate if you consider doing taking these initiatives expanding into the European markets just like Teva has to bring more shareholder value.

Kal Sundaram

Once again I appreciate to what you are saying. I’m going to probably give two fold answer. As far as assets that Sun acquired, you’ll have to ask number of these are not over to my knowledge I don't think Merck sort of public process to divert the asset.

The relationship Sun has enjoyed with Merck, Taro does not. Again I'm saying some public information, my recollection is Sun and Taro, Sun and Merck had a joint venture.

So all in all, you got sort of a number of these things come by invitation, whatever sort you get invited on, I can assure you that we actively review that. Then your point about sort of expanding geographies is a good point. If you go back sort of in the last five years, we have strengthened our base and my recollections have been to Sun acquired Taro.

We were struggling even in the U.S., so from that we’re in a sort of strong position and we are improving our pipeline and Europe market again to the best of my understanding both in terms of size, average price, competitive intensity or economy of scale is certainly not as same as what you see in the U.S.

So much of our focus has been to see how we can consolidate and strengthen our sales in the U.S. but all the same you will find it’s a good point, we will continue to evaluate expansion into other known regulated sophisticated markets.

Operator

Thank you. And our next question comes from Sameer Baisiwala of Morgan Stanley.

Your line is now open.

Sameer Baisiwala

Hi, thank you. Thanks for taking me. There is a quick question, Kal when you invest behind R&D and I’m looking at sort of $70 million spend and about 10 ANDA filings. It looks like per filing is a meaningfully higher cost, now when you do your product selection, do you have some threshold minimum revenue expectation and if you can share that with us?

Kal Sundaram

Yes, see it’s very well structured process Sameer. First in terms of sort of technology development capabilities, how does it marry with what we have internally and you are also right, let’s say $70 million and 10 products not all the $70 million was sort of solely spent on U.S. but substantially speaking spent on U.S.

Remember bulk of our products will be correctly in development. So that's an additional cost that you didn't see when you file in or solid. So the investment levels are high and we have very structured process in terms of financial evaluation size, of what we will get, we forecast what is a bigger market forecast in sort of our sales so on and so forth.

And to ensure that risk adjusted we still come cash positive meeting our internal return on investments on R&D, yes.

Sameer Baisiwala

Okay. And any numbers that you want to share, $20 million, $30 million per product sort of revenue targets or is it materially above or below?

Kal Sundaram

It varies Sameer.

Sameer Baisiwala

Thank you so much.

Kal Sundaram

It varies depending upon where there is sort of you are starting completely from a Phase 1, part of it is an ANDA a sizeable scaled Phase 3 studies.

Sameer Baisiwala

Okay. Thank you so much.

Operator

Thank you. Ladies and gentlemen that was our last question. I'll now hand the call back to Mr. Coote for closing remarks.

William Coote

Thank you everyone for joining us today. Thank you for the time to be on our fiscal 2016 earnings call. We look forward to speaking to you again on our next earnings call. This concludes our conference. Again thanks for joining.

Operator

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a good day everyone.

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