Akorn (AKRX) Raj Rai on Q2 2016 Results - Earnings Call Transcript

| About: Akorn, Inc. (AKRX)

Akorn, Inc. (NASDAQ:AKRX)

Q2 2016 Earnings Call

August 04, 2016 10:00 am ET

Executives

Stephanie Carrington - Senior Vice President, ICR, Akorn, Inc.

Raj Rai - Chief Executive Officer

Duane A. Portwood - Chief Financial Officer

Analysts

Matthew G. Hewitt - Craig-Hallum Capital Group LLC

Dana C. Flanders - JPMorgan Securities LLC

Gregg Gilbert - Deutsche Bank Securities, Inc.

Randall S. Stanicky - RBC Capital Markets LLC

Louise Chen - Guggenheim Securities LLC

Jason M. Gerberry - Leerink Partners LLC

Timothy F. Lugo - William Blair & Co. LLC

David A. Amsellem - Piper Jaffray & Co. (Broker)

David Michael Steinberg - Jefferies LLC

Sumant S. Kulkarni - Bank of America Merrill Lynch

Andrew Finkelstein - Susquehanna Financial Group LLLP

Elliot Wilbur - Raymond James & Associates, Inc.

Operator

Good day, ladies and gentlemen and welcome to the Akorn Second Quarter Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions follow at that time. . As a reminder, this conference is being recorded.

I would like now to introduce your host for today's conference, Miss Stephanie Carrington, Investor Relations. Ma'am, you may begin.

Stephanie Carrington - Senior Vice President, ICR, Akorn, Inc.

Thank you, Gracia. Good morning everyone and welcome to Akorn's second-quarter 2016 conference call. I am joined today by Raj Rai, Akorn's Chief Executive Officer; Duane Portwood, Akorn's Chief Financial Officer; and Jennifer Bowles, VP-Corporate Strategy.

I trust that you have seen the second quarter press release that is – was issued this morning before market. If you have not, the press release is available on the Investor Relations portion of Akorn's website.

Raj will first provide a business update on – for the second quarter 2016. Duane will review the company's second quarter 2016 financial results and provide additional details related to the outlook for 2016. We will then open the call to your questions and expect this call to last approximately 60 minutes. As a reminder, the conference call and webcast are being recorded and will be available on Akorn's Investor Relations website shortly following the conclusion of today's call.

Before we begin, I would like to remind everyone that any statements made on this conference call today that express the beliefs, expectation, anticipation or intent, as well as those that are not historical fact are considered forward-looking statements and are protected under the Safe Harbor provisions of the Private Securities Litigation Reform Act.

With that, I'll turn the line over to Raj.

Raj Rai - Chief Executive Officer

Thanks, Stephanie. Good morning everyone and thank you for joining our call today. I am pleased to announce our second quarter net revenues came in at a record $281 million and were in line with our expectations, and up 27% from the prior-year quarter.

As anticipated, we saw a 5% sequential growth compared with the first quarter of 2016 due to growth from contract awards won earlier in the year and products launched so far in 2016.

Our margin was slightly higher in the second quarter despite the partial sequential growth in business came from the ramp-up in sales of fluticasone and new product launches, both having lower margins than our composite margins. This in part was due to an improvement in our cost of goods as a result of our planned initiatives at each of our facilities to lower the cost of goods through improved purchasing, increase in productivity, yields, and output.

I'm also pleased to announce that our board of directors have approved a share buyback program which allows us to purchase up to $200 million of Akorn's outstanding common stock. Duane will discuss this in more details in his prepared remarks.

Let me now provide some commentary on pricing. As expected, we experienced a higher loss in market share and margins, which were isolated to some of our key products such as clobetasol, lidocaine, and hydralazine due to increased competition in 2016 as compared to 2015.

Across the balance of our multi-source product portfolio, you have seen a mid-single-digit pricing decline, as forecasted. We expect margins to be stable for the remainder of the year given the current competitive dynamics. Our ANDA pipeline is comprised of 86 ANDAs pending with the FDA as of July 31, with an addressable market value of $9.1 billion per IMS Health data.

Approximately 60 of these filings are under active review by the agency, as we have received complete response letters or information requests. We continue to believe that it is possible to receive approval on about 25 products by March 2017. The estimated annual sales per IMS Health of these products are approximately $1 billion.

Of these 25 products, 15 products have annual sales of nearly $500 billion per IMS Health and currently have the brand or brand plus one generic on the market. We have a handful of products already approved that are planned for launch this year, and we are preparing to launch the other products that will receive approval over the remainder of 2016.

Longer term, we plan to increase our investment in R&D. We are expanding that R&D footprint by setting up a new facility in Cranbury, New Jersey. This facility is expected to be operational in the fourth quarter of this year. This facility initially will house nearly 40 scientists. Product development at this facility will focus on alternative dosage forms – alternative dosage form generics, and we are actively recruiting for a number of new R&D scientists and leadership positions to be based in this facility. Our R&D teams are focused on replenishing our pipeline, and we are on track to file approximately 20 new filings in 2016.

Let me now give you an update on key product filings, first, ephedrine sulfate. As you may know, the PDUFA date for ephedrine sulfate was July 15. A few weeks prior to this date the FDA conducted a preapproval inspection, as is customary for new product approvals and which also coincided with our biannual inspection cycle of the Decatur manufacturing site. The inspection resulted in a handful of observations that were responded to prior to the PDUFA date. Our responses are currently under review by the FDA Chicago District Office. We believe our filing is approval pending the completion of the review of our responses. In the meanwhile, we continue to market our existing product.

With respect to cyclosporine, there is little new to report. We anticipate that the earliest decisions from the courts or the PTAB on the patent challenges will be in December 2017. And there will be most certainly an appeal that follows. With respect to the approval of our ANDA, we continue to work with the FDA to ensure that our product is approvable.

As far as the OTC fluticasone, we are still working with the FDA to get a product approved. Meanwhile, we are focused on increasing our presence and improving our margins in the Rx market, which is still very large and reasonably stable at over 40 million units a year.

Turning to Akorn India, the key initiatives around quality systems redeployment, infrastructure remediation, and expansion are well under way, with a target to commercialization by 2018. Domestically, we have been progressing very well on our initiatives around modernization of our plants, improving our cost of goods through process improvements, and improved supply chain management.

In addition, we are on track with our projects on serialization for track and trace, as well as ophthalmic product transfers to our Hettlingen manufacturing site in Switzerland to optimize and enhance capacities.

Finally, we expect to aggressively pursue business development activities with a focus on expanding our capabilities and product offerings in the areas of human generics in alternate dosage forms; animal health generics; over-the-counter brands; and branded ophthalmics.

In summary, our record second quarter results reflected the strength of the entire organization and were bolstered by sales from our single-source products, new contract wins, and new products. We're making progress on our objectives, our strategic initiatives, and our continued investment in both human capital and physical infrastructure.

With that, I'll turn the line over to Duane for his prepared remarks. Duane?

Duane A. Portwood - Chief Financial Officer

Thank you, Raj, and good morning, everyone. I hope you've had a chance to read the press release we issued earlier today outlining Akorn's second quarter 2016 unaudited financial results. When discussing our second quarter 2016 unaudited financial results this morning, I will be referring to a number of non-GAAP figures. Please refer to today's press release for our GAAP to non-GAAP reconciliations and a listing of items included in our adjustments.

So moving to our second quarter results, net revenue for the quarter ended June 30, 2016 was $281 million, an increase of $60 million, or 27% over the prior-year quarter. The increase in revenue was driven by organic growth, with approximately two-thirds attributed to price and approximately one-third to increased volume.

During the second quarter, we continue to be the sole supplier of ephedrine sulfate, which accounted for approximately 21% of our quarterly net revenue.

Gross margin for the second quarter was 61.2%, compared to 58.1% for the prior-year quarter. The increase in the company's consolidated gross margin was principally due to favorable product mix. Note that both Q2 2016 and Q2 2015 gross profit included about $400,000 of non-cash stock compensation that was included in our adjusted EPS reconciliation.

SG&A expense was $54 million for the second quarter of 2016, compared to $35.2 million for the prior-year quarter. For the second quarter 2016, we incurred $14.2 million of expense related to the financial statement restatement effort, an increase of $9 million from the prior-year quarter.

Salaries and related costs increased $4.4 million from the prior-year quarter, reflective of increases in our employee base and investments in our processes and systems infrastructure.

Please note that the second quarter 2016 SG&A expense included the aforementioned $14.2 million of expenses related to our financial statement restatement efforts and $3 million in non-cash stock compensation, both of which are included in our adjusted EPS reconciliation. In comparison, Q2 2015 SG&A expense included $5 million of expenses related to our financial statement restatement efforts and $3.2 million in non-cash stock compensation, both of which are included in our non-GAAP reconciliation table.

Research and development investment in the second quarter of 2016 was $8.9 million, compared to $10.6 million in the second quarter of 2015. Of the R&D expense incurred in the second quarter of 2015, it's important to note that approximately $2.6 million was due to the impairment and write-off of two in-process R&D projects acquired through the VersaPharm acquisition.

The effective tax rate for the second quarter of 2016 was 22.8%, compared to 35.4% in the comparative prior-year quarter. The reduction in the tax rate was a result of the adoption of FASB accounting standards update 2016-09, titled Improvements to Employee Share-based Payment Accounting. That changes the way the income tax benefit from employee stock option exercise is recognized in the financial statements.

Prior to the current year, accounting guidance required the benefit to be recorded directly to equity. The new accounting guidance requires that for current and future years, the tax benefit be recorded in the income tax provision in the quarter the stock options are exercised.

The adoption of this accounting standard did not impact the income tax provision for the first quarter of 2016 as there were no stock option exercises. During the second quarter of 2016, approximately 1.5 million stock options were exercised, which resulted in approximately $11.5 million of tax benefit.

This benefit lowered the Q2 GAAP effective tax rate to 22.8% and contributed approximately $0.09 to GAAP diluted earnings per share. In the non-GAAP reconciliation table in our press release, we have backed out the $11.5 million income tax benefit from stock option exercises in the second quarter of 2016.

Diluted earnings per share for the second quarter of 2016 were $0.50 compared to $0.27 from the prior-year quarter. The EPS of $0.50 included the $0.09 tax benefit impact from the new accounting guidance I just discussed. On an adjusted basis, fully diluted earnings per share were $0.58 for the second quarter of 2016, compared to $0.41 for the second quarter of 2015. Please see the press release for a reconciliation of GAAP EPS to non-GAAP EPS.

We ended the quarter in a strong capital position, with $156 million of cash at June 30, 2016, compared to $346 million at December 31, 2015. As a reminder, in the first quarter of 2016, we made a debt prepayment of $200 million.

Our adjusted EBITDA for Q2 2016 was $131 million compared to $97 million in the prior-year quarter. Again, please see the press release for the reconciliation of EBITDA to adjusted EBITDA. On a trailing 12-month basis, our net debt-to-adjusted EBITDA ratio was approximately 1.3 times at June 30, 2016. And we expect the ratio to be close to 1.1 times at the end of 2016, absent the large acquisition, share repurchase, or debt issuance.

For the six-month period ended June 30, 2016, we generated approximately $36 million of cash flow from operation compared to $181 million for the comparable period in 2015. The primary drivers of the change were an increase in cash income tax payments of approximately $114 million, as well as an approximate $54 million increase in accounts receivable in the current period, versus an approximate $60 million decrease in accounts receivable in the 2015 period. These items were slightly offset by a $34 million increase in GAAP net income.

While we expect the pressures from income tax payments and receivable collections to moderate for the remainder of 2016, we now expect cash flow from operations for the full year to be in the range of $175 million to $200 million.

As of June 30, 2016, long-term debt outstanding was $832 million. And during the quarter ended June 30, 2016, the remaining 43 million of convertible notes were converted and settled into shares of Akorn common stock, and the convertible note was retired. As Raj mentioned, Akorn's board of directors has authorized a stock repurchase program for up to $200 million of the company's common stock. The authorization has no time limit and allows for repurchases on the open market or in privately negotiated transactions.

Our first priority for cash use continues to be investment in the business, both for organic and inorganic opportunities. In those times when our cash on hand exceeds our investment needs, we would look to this authorization to return capital to our shareholders.

Finally, turning to earnings guidance, we now expect that the full-year net revenue will be at the upper end of the previously communicated range of $1.060 billion to $1.080 billion. In addition, we expect that full-year GAAP diluted earnings per share and adjusted diluted earnings per share will be at the upper end of the previously communicated ranges of $1.56 to $1.66 and $2.10 to $2.20, respectively.

And with that, we're ready for your questions. Operator?

Question-and-Answer Session

Operator

And our first question is from Matt Hewitt from Craig-Hallum Capital. Your line is now open.

Matthew G. Hewitt - Craig-Hallum Capital Group LLC

Good morning. Congratulations on the strong quarter, and thanks for taking our questions.

Raj Rai - Chief Executive Officer

Hi, Matt.

Matthew G. Hewitt - Craig-Hallum Capital Group LLC

I guess one question then I'll ask a follow-up. Regarding the inspection that occurred a couple of weeks prior to the PDUFA date, what types of observations were found? Were these recordkeeping? Any color there would be helpful.

Raj Rai - Chief Executive Officer

Yeah, so I mean, it was a two-pronged inspection. It was a preapproval inspection as well as, as I said in my prepared remarks, that it coincided with our biannual FDA inspection for GMPs. And the observations that we got were routine, and I think that's all I can say this point. And we are working with the agency to get the resolution on these 483s as soon as possible.

Matthew G. Hewitt - Craig-Hallum Capital Group LLC

Okay. And do you anticipate that – I mean, how should we think about the timing of the re-inspection? Is that something that could happen relatively quickly, or are we talking months?

Raj Rai - Chief Executive Officer

There's no re-inspection. It is just our responses are under review with the FDA at this moment.

Matthew G. Hewitt - Craig-Hallum Capital Group LLC

Okay. And then, I guess, regarding M&A, what types of opportunities are you seeing out there? How should we think about those opportunities? Are you looking for more products, product lines, much like Merck and Lundbeck deals? Or are you looking for companies, and potentially large companies, that you could fold into your mix? Thank you.

Raj Rai - Chief Executive Officer

So, Matt, the combination of product/product lines in the areas that I've outlined in my remarks and small bite-sized acquisitions at the moment, as we had said earlier this year. That's what our focus is going to be. And then at some point in time, once we get comfortable with our remediation work in accounting, and then we'll start to look at some larger transactions.

Matthew G. Hewitt - Craig-Hallum Capital Group LLC

All right, thank you.

Operator

Our next question is from Dana Flanders from JPMorgan. Your line is now open.

Dana C. Flanders - JPMorgan Securities LLC

Hi, thanks for the questions. I guess just my first one, on the ephedrine sulfate, how are you viewing – I mean, does the lack of an approval here impact the market dynamics for that drug at all? And just I guess what's the runway you have here before that could become an issue as Flamel builds market share?

And then my second question, just on the pipeline, it sounds like you're still expecting a ramp-up in approvals over the next six plus months. What's the communication with the FDA and level of confidence? And the 483 observations, would that impact any of those approvals that you're expecting if that is not resolved? Thank you.

Raj Rai - Chief Executive Officer

So, Dana, as far as ephedrine sulfate is concerned, you know, business as usual for us. We are actively marketing our product. We don't know exactly when the competitive product is going to be introduced to the market, so until such time we are going to market our product. And as and when – I mean, I'm very hopeful and confident that we'll get through our response and review with the FDA. And what we know today is that our product is approval, pending the review from the FDA. And so I don't expect any issues there at this point.

As far as product approvals are concerned, it's all about timing and getting through reviews. I don't think that the 483s are sort of the – sort of the issue here for getting those products approved. It's just matter of time. We've had a number of CRLs and IRs that we had responded to a lot of products, and it's just going through a normal review with the FDA.

Dana C. Flanders - JPMorgan Securities LLC

Great, thanks.

Operator

And our next question comes from Gregg Gilbert from Deutsche Bank. Your line is now open.

Gregg Gilbert - Deutsche Bank Securities, Inc.

Thank you. I have a couple. First, based on our competitive intensity work, it's obvious there are some approvals out there against your base that haven't been launched yet. So, Duane, how do you factor those in? Is it sort of a specific, bottoms-up, product-by-product assessment? Or is it a more general approach of sort of building those types of things into base erosion? And then I have a follow-up.

Duane A. Portwood - Chief Financial Officer

No. It's a bottoms-up, product-by-product approach.

Gregg Gilbert - Deutsche Bank Securities, Inc.

And tied to your comments on buyback, in terms of doing buybacks if your cash balances exceed your investment needs, can you help us understand sort of when that might occur or how we should think about that concept? And lastly, can you talk us through what's going on with receivables? Thanks.

Duane A. Portwood - Chief Financial Officer

From a buyback perspective, I can't really project on when we'll execute the first buyback or how smooth or lumpy that might be over the time horizon. I guess I would say I'm fairly comfortable with current cash balances. Back in February we had $350 million of cash balances, and we used a portion of that to repay debt. So at that kind of level we probably have excess cash. And if we feel that is large enough, and we don't see anything on the near-term horizon, then I would look to the authorization. But other than that, it's going to be completely opportunistic.

From a receivable perspective, we're at the – we are greatly impacted, obviously, by the big three wholesalers and the timing of how they administer their credit memos and the like. So we were in a favorable track a year ago. We've kind of normalized in this year. If you look at our DSO at the end of June 30, it's actually at a fairly normal level. So I don't expect a lot of pressure from that going forward. And but again, there's some things that are outside of our control as they process their invoices.

Gregg Gilbert - Deutsche Bank Securities, Inc.

Thank you.

Operator

And our next question is from Randall Stanicky from RBC. Your line is now open.

Randall S. Stanicky - RBC Capital Markets LLC

Great. Thanks, Raj. I just have a couple questions. First, what is your level of competitive intelligence around a possible third ephedrine NDA filer?

And then, secondly, one of the things I think a lot of investors are struggling with a little bit is 2016 has decent visibility. Obviously, the quarter and outlook have been raised. But as you think about 2017 there's some moving parts. So is there any way that you could give us some level of comfort? Obviously, you're probably not prepared to provide guidance, but some level of comfort that 2017 is shaping up to continue the momentum that you're putting up this year? Obviously, Sagent's complete response letter on Nembutal has to help, but is there anything else that you could help us with there? Thanks.

Raj Rai - Chief Executive Officer

So, Randall, your first question around ephedrine, obviously we have to assume that we are in a highly competitive business, and if a product is of decent size and opportunity, there will be more than one or two players vying for that product. So we do expect that there are other players, perhaps monitoring the sales of this product and working on developing their own generic versions of it. So I wouldn't rule that out. And so that – we'll always have to keep that in our radar and then watch.

As far as 2017 is concerned, we are working on some BD opportunities and then to tee up growth inorganically through acquisitions while focusing on new products. New product approvals and launches are going – and the execution on that is going to be very, very critical going forward, and that's where our focus is.

So we will have a two-pronged approach, which has been the success of Akorn going back in time; so applying the same rules, same strategy. We haven't seen much growth coming out of this year from new products, but which I think is going to be towards the end of the year. And with that, coupled with some smart acquisitions, I think we'll be well-positioned for 2017.

Randall S. Stanicky - RBC Capital Markets LLC

And Raj, as we think about the back half, pointing to the upper end of the range, what is the primary driver of that? I mean, Nembutal clearly helps a little bit, but are there other drivers of the move? I mean, clearly, if you take the upper end of your range, it's still implying that your earnings will be down from the first half, but you'll obviously have some momentum coming out of the second quarter.

Duane A. Portwood - Chief Financial Officer

Yeah, Randall, this is Duane. I mean, really, the confidence in the upper end is – it actually more stems from ephedrine. So we were – the competition that we were expecting is slightly slower to materialize, but we still expect it. But that's the confidence in the upper end.

Raj Rai - Chief Executive Officer

And then Randall, obviously we don't have in our estimates new product approvals and launches. So if they come sooner than expected or we are able to execute on them more efficiently, that's added on top of what we've already provided you guidance on.

Randall S. Stanicky - RBC Capital Markets LLC

Got it. Great. Thanks, guys.

Operator

And our next question is from Louise Chen from Guggenheim. Your line is now open.

Louise Chen - Guggenheim Securities LLC

Hi, thanks for taking my questions. So my first one is on the commentary on the 25 product approvals between now and first quarter 2017. Just curious if there's anything that could be a large opportunity for you in there? And then how many of those do you think could come in 2016?

And then secondly on generic Restasis, I was wondering if you could give us an update? I think in the past you had mentioned the FDA had listed some new requirements for generic approvals. Just seeing where you are with that. And wanted to also see if you had the manufacturing capability for generic Restasis, or if you would have to partner with somebody? Thanks.

Raj Rai - Chief Executive Officer

So, Louise, from your first question, as I said in my prepared remarks, that of the 25 products that we expect approval on from now until March of 2017, more than – nearly half of those products have approximately half the value of those approvals, which is around $500 million. And those 15 products currently have either no generic competition or perhaps has one generic entrant already.

So those are sort of the high value opportunities that are imminent to us, given what we know today. And so I think those are the higher value opportunities that we are focused on in terms of preparing for launches and expecting approval on shortly.

On the generic Restasis, as I said in the prepared remarks, nothing has really changed since the last time we talked about it. And we expect some determination and outcomes from the PTAB office by the end of this year. And we've been working with the FDA to get – work through some questions and queries that have come through and then getting to a product approval hopefully in the near future. We've already partnered with someone to manufacture the product because we don't have the capability of manufacturing the product. So that's already been lined up, and filed from that, the manufacturing partner site.

Louise Chen - Guggenheim Securities LLC

Okay. Thanks.

Operator

And our next question is from Jason Gerberry from Leerink Partners. Your line is now open.

Jason M. Gerberry - Leerink Partners LLC

Hi. Thanks for taking my questions. First question for me just, Raj, can you just talk about the durability of the McKesson contract wins on the Flonase and the Myorisan business? And then just my second question the 2016 guidance does look somewhat conservative given the wins that you saw in Nembutal and the delayed Akovaz launch. I'm just kind of curious, have you gotten more conservative on any other parts of the business? Thanks.

Raj Rai - Chief Executive Officer

Okay. So Jason, on your first question in terms of durability, I'm not sure what you mean by that. We have – we had a pretty fair decent wins through their contract and we have launched some of those products. And so that's already factored in and baked into our guidance.

Jason M. Gerberry - Leerink Partners LLC

I just meant, Raj, in the second half should we expect to see kind of continued strength on those two products from the McKesson bid, I guess?

Raj Rai - Chief Executive Officer

Yes. Yes. The answer is yes. We've got a contract there. So I think – so that's – we're good to go there. As far as the – from a guidance perspective, what we know today and then we'll find out more next week when a couple of the companies involved here would be reporting their results and provide more color and commentary on the respective products. But at this point we have factored in that we have competition that is coming, so – unless something else changes.

Jason M. Gerberry - Leerink Partners LLC

Okay, thanks.

Operator

And our next question is from Tim Lugo from William Blair. Your line is now open.

Timothy F. Lugo - William Blair & Co. LLC

Thanks for taking my question and congratulations on the results this quarter. Raj, you mentioned potential larger transactions as well as maybe BD filling whatever gap eventually occurs from ephedrine. Can you put some brackets around what you consider larger? Are those along the line of Hi-Tech or now that you are a larger company obviously it could be larger than Hi-Tech? And since the buyback has no time limit, I assume if a transaction occurs, the buyback and acquisition likely won't occur in parallel?

Raj Rai - Chief Executive Officer

Right. So Tim, as I said before and I said it earlier today, that I think this year the focus is going to be more on sort of bite-sized acquisitions and opportunities. Next year perhaps we will evaluate a little bit more larger transactions.

But again, I think the question is – we are, along with a few others, in sort of the Tier 2 generic companies and there are a lot of smaller generic opportunities that are there. And we have to be very selective in what we buy. And we want to stay within our key verticals and not necessarily detract from that strategy.

And so there are not a whole lot of larger opportunities available that are complementary to our business model at the moment. And so it's going to be a question of what we do first, but right now the focus is going to be smaller bite-sized acquisitions...

Timothy F. Lugo - William Blair & Co. LLC

Okay.

Raj Rai - Chief Executive Officer

...that focus around a product line or complementary dosage forms that we would like to acquire.

Timothy F. Lugo - William Blair & Co. LLC

Okay. And you have a number of products relatively early in their launch cycle. Are there maybe any products in there, maybe it's the isotretinoin 30 mg which could eventually become the size of an ephedrine?

Raj Rai - Chief Executive Officer

Well, you never know, but it depends. But again, I can't really answer the question. We worked through larger opportunities in the pipeline and some medium-sized and smaller-sized, through a combination of all of them. So I can't really pinpoint to one that would be a big one.

Timothy F. Lugo - William Blair & Co. LLC

Okay, thank you.

Operator

And our next question is from David Amsellem from Piper Jaffray. Your line is now open.

David A. Amsellem - Piper Jaffray & Co. (Broker)

Thanks. Just a quick question about your manufacturing capacity. So you've obviously talked about a lot of potential launches between now and next year. So can you maybe give us some color on your capacity? How much idle capacity you have and should we be worried about any constraints to the extent that you get a lot of these products approved?

Raj Rai - Chief Executive Officer

So, David I think – near term I think we'll be in a good position in terms of our capacity, as you know that we've got an initiative in place where we are optimizing our ophthalmic manufacturing capacities. We acquired a facility in Hettlingen, Switzerland, last year. So we are transferring some products from the U.S. over there to make room in the U.S. where we acquired products to launch more products.

On the injectable side we have capacity right now to launch new products as they are pending with the FDA. Longer term, India, as you know, is a big focus. And that will help the injectable capacities where we could see a lot of larger products which are currently lower margin, if you were to manufacture them here, would be coming out of India and a few other differentiated injectables.

And then as far as oral liquids and nasals, we've got plenty of capacity through the -- and topicals through the Hi-Tech acquisition that we did a couple of years ago. So I think short term for most therapeutic forms, we are well-prepared. We have few products that are partnered that come from outside the Akorn manufacturing sites, so there is obviously capacity there to be addressed. So we're covered short term. And then longer term we are building more capacity for ophthalmics and injectables.

David A. Amsellem - Piper Jaffray & Co. (Broker)

And if I may sneak in a follow-up just on Myorisan, do you expect over the long term that we'll see any additional competition, given that you've got REMS around that product class?

Raj Rai - Chief Executive Officer

I think that product there's already a lot of players in that business. And having the REMS program does help, and we are able to have more visibility if there is a new competitor coming in advance. So at this point we don't see anything, but you can never rule out. We are, again, in a very competitive, dynamic space.

David A. Amsellem - Piper Jaffray & Co. (Broker)

Okay. Thank you.

Operator

And our next line is from David Steinberg from Jefferies. Your line is now open.

David Michael Steinberg - Jefferies LLC

Yes, thanks and good morning. Question on the buyback, I know you didn't rule it out previously, but in prior commentary it was something to the effect that it's pretty low in the order of shareholder value enhancements. Just curious what the subtle change in thinking was? And is there any read-through to the fact that perhaps prices of assets are still on the high side? I know you'd commented on the last call that, particularly for private companies, sellers were talking about pretty rich valuations. And where does pricing stand now, both on the private side and public side assets you're looking at? Thanks.

Duane A. Portwood - Chief Financial Officer

David, this is Duane. I think I'll – I guess I'll let Raj talk to the acquisition opportunities, but from a stock repurchase perspective, not really a change in focus. Simply the acquisition opportunities are certainly lumpy. And so we'll look at them all the time, but those things that we'll transact really can't be predicted. In the meantime, there's no – as cash balances grow, we need an avenue in place to return that cash to shareholders. Our leverage ratios are low, so don't feel the need to pay down any debt, certainly. And so the authorization is simply put in place so that in those times where we find ourselves with more cash than we need, that we can use that as a vehicle.

Raj Rai - Chief Executive Officer

David, this is Raj. And just to echo what Duane said, having the share buyback plan in place it's another arrow in our quiver. It's a good corporate governance to have it and then use it when we really need to use it. And we strongly believe in the fundamentals of our business and the long-term prospects of Akorn.

To your second question on sort of the multiples and pricing, I think they have – slowly are coming down in terms of private entities that are looking to sell. And so I think we should be able to take advantage because we are not seeing a lot of competition for products. And again, we have to really find a good asset. So even if it's worth a little bit more and provides us with long-term growth prospect, it would be prudent to even pay a slightly higher premium.

David Michael Steinberg - Jefferies LLC

Okay, thanks.

Operator

And our next line is from Sumant Kulkarni from Bank of America. Your line is now open.

Sumant S. Kulkarni - Bank of America Merrill Lynch

Good morning. Thanks for taking my questions. The first one is on Akorn India. It's been roughly five years since you acquired the facilities there. What exactly needs to happen from a logistics perspective, either from a regulatory or anything else for that to become a contributor? And second, on your cash flow outlook for the year, would that be considered a normalized cash flow, all else equal, going forward, I mean?

Raj Rai - Chief Executive Officer

So let me answer the first question. I think Duane will answer the second part of your question. So Akorn India we acquired that asset back in 2012. So it's been about four years that we acquired the asset. And as you may recall, the business that we acquired was not only the physical infrastructure, but it came with a large contract manufacturing business for domestic consumption in India, which was sort of the largest portion of the business.

And they had some international filings and business that they were doing. So I think the big issue that we had over there for us to succeed in our primary objective or in terms of turning that platform into an FDA-approved facility was to get out of the local domestic contract business, which took a little bit longer than we had expected. And as we did that, we found there were certain things that needed to be remediated.

And so that brings us to where we are today. And we have now the right investment, the right process, and the right strategy in place to get through that hurdle in terms of achieving the FDA approval. So I would say we are about two years behind than what we had originally thought.

Sumant S. Kulkarni - Bank of America Merrill Lynch

Thanks.

Duane A. Portwood - Chief Financial Officer

Sumant, on the cash flow question, I would say – I mean, so if you recall, in 2015 we generated $297 million of operating cash flow. In my remarks I said we're looking probably at $175 million to $200 million this year. So I guess from just a general direction perspective, our cash flow generation in 2015 was quite healthy, probably a little bit more healthy than normal. Some of that unwound in 2016, so I think this year is a little bit less than normal, much of which has to do with the way cash tax payments are working out. So on a going basis I would expect us to be in the $200 million to $250 million range, given our current size.

Sumant S. Kulkarni - Bank of America Merrill Lynch

Thanks.

Operator

And our next line is from Andrew Finkelstein from Susquehanna. Your line is now open.

Andrew Finkelstein - Susquehanna Financial Group LLLP

Good morning. Thanks very much. First of all, did I hear right that ephedrine was 21% of sales, so about $58 million in the quarter?

Duane A. Portwood - Chief Financial Officer

You did. You heard right.

Andrew Finkelstein - Susquehanna Financial Group LLLP

Okay. And given what I assume was a healthy contribution for the injectables portfolio overall, which is high margin and contributed to the gross margin progression, can you talk a bit more about the relative ramp from 1Q? There was about a $10 million gain in ephedrine. How much did Flonase or any of the other lower margin products gain to help us understand why the gross margin wasn't even higher? Or how you're thinking about gross margins in the second half of the year where you're factoring in some more competition on one of your higher margin products?

And then if we think about spending, you talked about the new R&D facility. What pace can we expect in terms of picking up the quarterly run rate in R&D, given the importance you put on those investments for the long-term growth?

Duane A. Portwood - Chief Financial Officer

So from a margin perspective, you're right on. Obviously ephedrine is a positive there. The products like fluticasone, progesterone, that contributed into the – in the second quarter, I'm sorry, offset that a bit. It's good topline growth, but those are clearly lower margin products for us.

As it relates to the kind of the remainder of 2016, Raj alluded to the fact that we believe margins will be pretty stable company-wide. So right now the pricing on ephedrine we expect to hold for the near term. Obviously that may change going forward, but for the balance of the year that's how we're comfortable with our margin range.

Raj Rai - Chief Executive Officer

And then we also have, again, initiatives around lowering our cost of goods, which will continue throughout the year. So that would offset some of the gains that we see from lower margin products, such as fluticasone, as well as launches of new products, like Myorisan and a few others. So I think it will be a good balance at the end of the day. And so I think we are comfortable with the outlook in terms of margins. That also speaks about our – the balance of our portfolio, and that we have some resilience given that we are focused on alternate dosage forms.

As far as the R&D is concerned, yes, we should start to see the ramp-up. I mean, we're a little bit behind in getting our people hired. And we had to make a decision that we open up a new facility in sort of the pharma corridor so we can attract talent. So there is some catch-up to do. We had factored it into our guidance for the first half. There was some product milestone payments that were to be paid that did not happen, and we expect them to pick up sometime in the second half of this year. So I think we will start to see the increase in the R&D spend ramping up in – by the fourth quarter of this year.

Andrew Finkelstein - Susquehanna Financial Group LLLP

Thanks very much.

Operator

And our next question comes from Gregg Gilbert from Deutsche Bank. Your line is now open.

Gregg Gilbert - Deutsche Bank Securities, Inc.

Hi, just a clarification, Raj. It sounds like you're not worried about the 483s' potential effects on approvals. But specifically, can you tell us whether your outstanding 483s need to be closed out before certain ANDAs are approved?

Raj Rai - Chief Executive Officer

I think the first – well, obviously, the product is – well, I should not say that I'm not concerned. I mean, we should always be concerned. In fact, the best solution is not to get any 483s. I mean, we strive for that. But ephedrine is one that is sort of the imminent product approval that we are expecting. And so closing out those 483s are very important for us to get through with the approval for ephedrine. As far as the other products are concerned, they are filed out of Decatur. At the moment they are not tied up with the responses that are under review.

Gregg Gilbert - Deutsche Bank Securities, Inc.

Thank you for that clarification.

Operator

And our next question is from Elliot Wilbur from Raymond James. Your line is now open.

Elliot Wilbur - Raymond James & Associates, Inc.

Thanks. Perhaps just a follow-up question for Raj. I guess in addition to Decatur, any other recent inspections that have resulted in 483s at Amityville or Somerset or anything that we should be aware of on that front?

Raj Rai - Chief Executive Officer

No, there's not been any – I mean, we always go through and we have an annual or a biannual FDA inspection that we do expect to see in the mode of filing new products. You expect to get prior approval, preapproval inspections, and as we've gone through that and nothing is really pending right now.

Elliot Wilbur - Raymond James & Associates, Inc.

Okay, thanks. And then with regard to the outlook for the second half, I mean you've talked about having some approvals in hand and then gearing up for launches. But I guess I've lost count in terms of how many approvals you have, actual approvals that you're still gearing up for or where you have not yet launched products versus expecting to receive new approvals for the second half.

Raj Rai - Chief Executive Officer

So there are pending five product launches. And we are going to prioritize those products depending on near term any other products that we manage to get approval. So we're going read – sort of reprioritize through the landscape of the launches in the future. And so some we have already planned to launch out of those five. But again, if we do get a product that is of high priority that would take precedence over the few products that we have to launch for the remainder of the year.

Elliot Wilbur - Raymond James & Associates, Inc.

Okay, thanks. And just last question, I think over the last couple conference calls, or in the recent past anyway, you've talked about stepping up initiatives on the 505(b)(2) front. I'm just wondering if there's anything new to share there or if there's anything that has actually been filed that you can talk about at this point? Thanks.

Raj Rai - Chief Executive Officer

So we are evaluating certain opportunities and we are also – we're going to look at partnership opportunities that may be available because that's not really the company's focus at the moment. But that's something that we are going to look at going forward either through internal development or partnerships.

Operator

Your next line is from Jason Gerberry from Leerink Partners. Your line is now open.

Jason M. Gerberry - Leerink Partners LLC

Hi, thanks for taking the follow-up question. Raj, just curious on the ephedrine sulfate given that it's presumably a much higher margin product, what is the contribution to EBIT? One could assume it's a lot higher than the revenue contribution. So just kind of curious if you can frame that discussion?

Raj Rai - Chief Executive Officer

So Jason, we don't really give guidance or any color around a product in terms of their EBIT contribution. So that's not really something that we have done or we will do.

Yes, it's a decent product. I mean, if you recall, going back in time we had a product called Nembutal, which we are still selling. That was a significant contributor. And then we have sort of graduated from that one product to many other products. So I think what will happen with ephedrine is it will be one of our decent-sized products in the future, but we will have a few other products that will be of the same nature.

So I mean, given the kind of business that we are in, things can move and change around pretty rapidly. And we have some new high value products that we are looking to get an approval and launch. And so I think overall it will be a significant product, but we will have other opportunities to offset it if there is – once a generic competitor comes into the space.

Jason M. Gerberry - Leerink Partners LLC

Okay, thank you.

Operator

I am showing no further questions. I would like now to turn the call back to Raj Rai for further remarks. Sir, you may begin.

Raj Rai - Chief Executive Officer

Thank you again, everyone, for joining our call, and we look forward in speaking with you soon. Thank you once again.

Operator

Ladies and gentlemen, that does conclude today's call. You may now disconnect. You have a good day.

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