Akorn, Inc. (NASDAQ:AKRX) Q4 2016 Earnings Conference Call March 1, 2017 10:00 AM ET
Stephanie Carrington - ICR LLC
Raj Rai - CEO
Duane Portwood - CFO, EVP
Dana Flanders - JPMorgan
David Steinberg - Jefferies LLC
Sumant Kulkarni - BofA Merrill Lynch
Matt Hewitt - Craig Hallum Capital Group
Greg Fraser - Deutsche Bank
Randall Stanicky - RBC Capital Markets
Elliot Wilbur - Raymond James Limited
David Amsellem - Piper Jaffray & Co
Jason Gerberry - Leerink Partners
Tim Lugo - William Blair & Company
Donald Ellis - JMP Securities
Andrew Finkelstein - Susquehanna Financial Group
Good day, ladies and gentlemen. And welcome to the Akorn Fourth Quarter and Full Year 2016 Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call maybe recorded.
I would like now to introduce your host for today's conference, Miss Stephanie Carrington, Investor Relations. Ma'am, you may begin.
Thank you, Shane. Good morning and welcome to Akorn's fourth quarter and full year 2016 conference call. I am joined today by Raj Rai, Akorn's Chief Executive Officer and Duane Portwood, Akorn's Chief Financial Officer.
I trust that you have seen the fourth quarter press release that 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 for the fourth quarter 2016 and discuss the outlook for 2017. Duane will then review the company's fourth quarter and full year 2016 financial results and provide guidance for the full year 2017. 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 belief, expectation, anticipation or intent, as well as those that are not historical fact are considered forward-looking statements and are protected by the Safe Harbor provisions of the Private Securities Litigation Reform Act.
With that, I will turn the line over to Raj.
Thank you, Stephanie. Good morning, everyone and thank you for joining our call today. I am very pleased to report solid results for the fourth quarter and record revenue and earnings for the year 2016. For the full year of 2016, we reported revenues of nearly $1.12 billion or an increase of 13% from the previous year. And the GAAP earnings per share up 20% from the same period in the previous year. It is important to note that this is a significant milestone for Akorn as we crossed $1 billion in revenues for the year. This milestone was reached a couple years ahead of the schedule based on our long-term plan that was developed in 2014. Our financial results were also ahead of the internal target set for 2016. The primary growth driver was an Ephedrine which represented approximately 19% of our fourth quarter sales. The margins remained stable from previous year despite pricing challenges and a drop in market share for handful of our key products such as Clobetasol, Lidocaine Ointment and HydrALAZINE due to competitive and other market dynamics.
The sales on the balance of our multi source portfolio remain reasonably stable. Let me review a few key highlights from 2016. We launched nine new products throughout 2016 contributing $22 million in revenues. We are pleased with this result and as with all launches we expect that sales will continue to ramp over the coming months as we seek to achieve our market share targets.
We filed 12 new ANDAs and three new in ANADAs, or animal health filing in 2016. With the two approvals received in January of 2017 as of mid February, our total countdown for ANDAs pending with FDA was 90 within addressable combined branded and generic market of $9.5 billion per IMS Health data.
In November, we were exceptionally pleased that PTAB ruled in our favor and declared the Durezol patent invalid. This is a significant milestone for us as it is our first sole first- to-file opportunity. Alcon's Durezol is an approximately $190 million product for IMS Health data. However, we are lagging behind in our expectations on approvals received. This is due at least in part to the delay in approvals from our Decatur facility. As we indicated in our December 12, 2016 press release, the FDA completed their re-inspection of our Decatur facility on December 9 and had no Form 483 observations. This resulted in achieving an NAI or No Action Indicated status for our Decatur facility. We were fortunate to have the re-inspection done in a short period of time, although it took several weeks before the compliance status of the facility was update in FDA's systems.
As we announced yesterday, we have received the approval of Mycophenolate, our first ANDA approval from the Decatur facility since the re-inspection. This implies that we should now expect to receive approvals for other filings including an ephedrine from our Decatur facility that was delayed due to the compliance status. On Ephedrine, we are up-to-date with our filing and there are no pending queries as of today by the FDA. We continue to believe that we will receive the approval shortly.
In 2016, we executed against an aggressive capital plan, focusing on several key enhancements. These included investments in manufacturing capacity, utility and facility infrastructure and compliance initiatives. We recently completed a comprehensive site master technical plan aligned with Akorn's growth priorities. This plan will guide future investments over the next five years. One of our more significant capital intensive compliance initiatives is utilization. I am pleased to report that we are on track to meet the statutory deadline of manufacturing sterile product beginning in November 2017.
We are continuing our efforts to optimize of ophthalmic capacity across the site. And in 2016, we began manufacturing the first couple of products out of a dozen products to be transferred to our Hettlingen site. This project continues to be high priority initiative as demand has grown significantly for several ophthalmic products meet out of our Somerset facility.
Turning to Akorn India. I am pleased to report that all aspects of the projects are progressing well, including quality system redeployment, physical plant remediation, validation and expansion. For our plan, we are on track to resume making exhibit batches in the third quarter and begin submitting filings to the FDA early 2018.
Now turning to outlook for 2017. We expect 2017 will be a transition year for Akorn. Three of our top products, Ephedrine, Lidocaine Ointment and Clobetasol had experience tremendous and rapid growth due to market dynamics over the last couple years. And this growth was way beyond our expectations. These products are expected to decline in sales due to competitive landscape which will affect the trajectory of our growth in 2017.
Together with hump, we are focused on a couple of growth initiative that we believe will ultimately result in positive comps in 2018 and beyond. Execution of new product launches and business development initiatives. With new product launches internally we are acutely aware that 2017 is the year that we have to execute with excellence. This truly is the highest corporate priority. In 2017, we expect to launch 15 to 20 products throughout the year. While it is difficult to predict the timing of approvals, we expect to generate between $30 million to $60 million in new revenue from these product launches.
With a strong balance sheet and easy access to capital, we have a significant amount of flexibility to pursue business development opportunities. We are active and are currently participating in various processes for both products and businesses that fit within our strategy and focus. We expect to know the outcomes of these processes over the course of next two three months. Any positive outcomes from such efforts are expected to be incremental to our projections.
In 2017, we will continue to build our R&D capacity by adding new employees, and increasing efficiencies by combining our East Coast R&D sites into new Cranbury, New Jersey site. We believe that combining these two teams will increase productivity as scientists will be better able to work together and share ideas. Our development pipeline currently consists of approximately 75 projects and includes several high value complex generics. We expect to file about 15 to 20 ANDAs by the end of 2017.
In addition, we are focused on building our consumer health segment both organically and through acquisitions. On the OTC front, we have refreshed some of our key brands in 2016 and have initiated development of new products. We plan to rollout new marketing initiatives to promote our dry eye TheraTears product line, as well as diabetic care products later in the year. We are also evaluating certain acquisition opportunities to boost our product offering to the consumers.
On the animal health front, we are accelerating the development of generics and plan to build a robust pipeline. We expect the consumer health segment to be a meaningful growth driver and a contributor to our revenues over the next three to five years.
Turning to broader industry comments. We look forward to the reauthorization of PDUFA will be enactment of the proposed PDUFA part II commitments. In particular, we value the proposed increase in communication and transparency throughout the process especially as it relates to the development of complex generics. This should benefit us with several of our development initiatives.
I'll close my remarks with some comments in response to the continued tension on pharmaceutical pricing. As a generic drug manufacture, we believe strongly that we are a part of the solution to the rising healthcare cost. This is reflected with the recent rebranding of Generic Pharmaceutical Association or GPHA to the Association for Accessible Medicines or AAM. According to the recent published 2016 generic drug saving and access report, generics are 89% of prescriptions but only 27% of the total drug cost. In fact, generic drugs make less than 3% of the total US spend on healthcare. And generics delivered $227 billion in savings in 2015 alone. Yet somehow the value proposition of generics gets lost in the conversation.
With that I'll turn the call over to Duane for his prepared remarks? Duane?
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 fourth quarter 2016 unaudited financial results and full year 2016 audited results. Please note that we intend to file our 2016 Form 10-K after market close today. When discussing our fourth quarter and full year 2016 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 the items that are included in our adjustments.
Moving to our fourth quarter results, net revenue for the quarter ended December 31, 2016 was $284 million, an increase of 1% over the prior-year quarter. The $4 million increase was due to organic growth with increased volume being mostly offset by negative price. The negative price impact for the quarter was driven by price decrease experienced in the larger products within our multi source generic drug portfolio predominately Lidocaine and Clobetasol, which more than offset the positive price impact from the ephedrine. During the fourth quarter, ephedrine sulfate continued to be our largest product and accounted for approximately 19% of our quarterly net revenue.
Gross margin for the quarter was 59.7% compared to 62.3% for the prior-year quarter. While the increase in the ephedrine net revenue positively impacted the Q4 gross margin rate, this impact was more than offset by the following. First, as discussed earlier and throughout the year excluding ephedrine we've seen pricing erosion in the larger products in our multi source generic portfolio again led by Lidocaine and Clobetasol. Second, excluding an ephedrine sulfate we have experienced decrease margin due to unfavorable product mix as a result of increased volumes of lower margin products such as fluticasone and Myorisan. And third, during the quarter we incurred cost related to price changes on certain products as well as cost related to customer claims.
Please note that the fourth quarter 2016 and fourth quarter 2015 gross profit included $0.5 million and $0.4 million respectively of non-cash stock compensation which was included in our adjusted EPS reconciliation.
SG&A expense was $47 million for the fourth quarter of 2016 compared to $52 million for the prior-year quarter. For the fourth quarter 2016, we incurred $3.5 million of expense related the financial restatement efforts, a decrease of $9.1 million compared to prior-year quarter expense of $12.6 million. This decrease was somewhat offset by increases in spending in India as we ready that facility for FDA approval and increase salaries and related cost reflected of increases to our employee base.
Please note the fourth quarter 2016 SG&A expense included the aforementioned $3.5 million of expenses related to our financial restatement and $3.4 million of non-cash stock compensation. Both of which are included in our adjusted EPS. In comparison, fourth quarter 2015 SG&A expense included $12.6 million of expenses related to our financial restatement efforts and $3.2 million in non-cash stock compensation, both of which again are included in our non-GAAP reconciliation tables.
Research and development expense for the fourth quarter of 2016 was $13.7 million compared to $10.4 million in the fourth quarter of 2015.
During the fourth quarter of 2016, we recorded $3.8 million of impairment related to in process R&D on two pipeline products due to changing market dynamics for those products. Excluding this impairment charge, R&D expenses decreased approximately $0.8 million due primarily to lower milestone payments. The aforementioned impairment charge was included in our non-GAAP reconciliation table.
During the fourth quarter of 2016, we also impaired the intangible assets related to seven currently marketed products given changes in the market dynamics for those particular products. The total impairment expense in the fourth quarter was $31.2 million. In the fourth quarter of 2015, we impaired an intangible asset related to one currently marketed product and recorded an impairment charge of $30.4 million. Both the 2016 and 2015 impairment expenses are included in our non-GAAP reconciliation table.
The effective tax rate for the fourth quarter of 2016 was 34.1% compared to 33.7% in the comparative prior-year quarter. The slight increase in quarterly tax rate was principally due to slightly less favorable discreet tax items in the quarter.
Diluted earnings per share for the fourth quarter of 2016 were $0.26 compared to $0.27 from the prior year quarter. On an adjusted basis, fully diluted earnings per share were $0.58 for the fourth quarter of 2016 compared to $0.60 for the fourth quarter of 2015. Please see the press release for reconciliation of GAAP EPS to non-GAAP EPS.
Our adjusted EBITDA for the fourth quarter of 2016 was $125 million compared to $135 million in the prior-year quarter. Again please see the press release for reconciliation of EBITDA to adjusted EBITDA.
Turning to the full year. 2016 revenue of $1,117 million represented an increase of $132 million over the prior year revenue of $985 million. The 13.4% increase was primarily due to increase sales of ephedrine which for the full year accounted for approximately 20% of consolidated net revenue. This increase was somewhat offset by decline in other products most notably Clobetasol, Lidocaine and HydrALAZINE.
Gross margin rate for the full year 2016 was 60.4% compared to 60.5% for the prior year. The relatively flat gross margin year-on-year was a result of favorability from increase to ephedrine, offset by price erosion on the larger products in a multi source generic portfolio particularly Clobetasol and Lidocaine. Unfavorable mix driven by increased fluticasone and Myorisan and decreased HydrALAZINE. Increased inventory write ups and other increased cost related to price changes on certain products and customer claims.
Please note that the full year 2016 and 2015 gross profit included $1.5 million and $1.3 million respectively of non-cash stock compensation that was included in our adjusted EPS reconciliation. In addition, 2015 gross profit included $5.1 million of inventory gross-up amortization that was also factored into our adjusted EPS reconciliation.
SG&A expense was $198 million for the full year 2016 compared to $162 million for the prior year. For the full year of 2016, we incurred $35 million of expense related to our financial restatement efforts, an increase of $6 million compared to the prior year expense of $29 million. Aside from this increase the remainder of the increase in SG&A was driven by increased salaries and related cost, increased spending on India and increased technology spending as we invested in people, systems and processes and readied India for FDA approval.
Please note that the 2016 SG&A expense included the aforementioned $35 million of expenses related to our financial restatement efforts and $30 million in non-cash stock compensation. Both of which are included in our adjusted EPS reconciliation. In comparison 2015 SG&A expense included $29 million of expenses related to our financial restatement efforts and $11 million of non-cash stock compensation.
For 2016, consolidated net income was $184 million, up $33 million or 22% from 2015. And on a GAAP basis, diluted earnings per share for 2016 were $1.47 per diluted share compared to $1.22 in 2015.
Including a net adjustment of $99 million to net income for non-GAAP items, adjusted diluted earnings per share were $2.25 for 2016 compared to a net adjustment of $103 million to net income for non-GAAP items and adjusted diluted earnings per share of $2.02 in the prior year. Please refer to the press release for the reconciliation of GAAP EPS to non-GAAP EPS.
As outlined in today's release, full year 2016 results included the impact of the adoption of ASU 2016-9-09 improvements to employee share based payment accounting. They are required the income tax benefit from employee stock option exercises to be recognized through the income tax provision in the period in which stock options are exercised. Previously, this benefit was recognized directly to equity. For the full year 2016, the company recognizes an aggregate $11 million tax benefit or $0.09 per diluted share.
The effective tax rate for the full year was 32.1% compared to 35% for 2015. This decrease was the result of the aforementioned accounting change. Note that for adjusted EPS purposes we exclude this tax benefit.
EBITDA was $442 million in the fiscal year 2016 compared to $401 million in the prior year. Adjusted EBITDA was $509 million in fiscal 2016 as compared to $460 million in the prior year. Please see the press release for reconciliation of EBITDA to adjusted EBITDA.
We ended the year in a strong capital position with $201 million of cash at December 31, 2016 compared to $346 million at December 31, 2015. As a reminder, in the first quarter of 2016 we made a voluntary debt prepayment of $200 million. And as of December 31, 2016, long-term debt outstanding was $810 million net of deferred financing cost.
Also as a reminder, the remaining $43 million of convertible notes were converted and settled into shares of Akorn common stock and the convertible notes were retired during the second quarter of 2016. On a trailing 12 months basis, our net debt to adjusted EBITDA ratio was approximately 1.2x at December 31, 2016. During the fourth quarter, we repurchased approximately 900,000 shares of common stock at an average price of $22.06 per share. For the year, we repurchased approximately 1.8 million in shares for $45 million and have 155 million repurchase authorization availability remaining. These open market purchases did not significantly impact our quarterly or full year EPS result.
For 2016, we generated approximately $168 million of cash flow from operations compared to $298 million in 2015. The primary drivers of this change were an increase in cash income tax payments of approximately $98 million, as well as an approximate $133 million increase in accounts receivable in 2016 versus an approximate $40 million decrease in accounts receivable in 2015. These items were offset somewhat by a $33 million increase in net income.
The increase in accounts receivables primarily the result of gross to net adjustments and the timing in which they are settled with our customers relative to our invoice terms. Generally, our terms are 60 to 65 days with our customers. However, charge backs are generally settled within days of product shipment and much of our rebase are generally settled within 30 days of shipment. As a result of the difference in timing of settling the gross to net deductions specifically charged back in rebase and our collection terms, in periods where charge backs and rebase are growing faster than net sales. The customers are able to apply these credit invoices which increase our net accounts receivable.
For 2016, the amount of charge backs and rebase increased as a result of increased volume on products such as Clobetasol, Lidocaine and others which allow the related credits to be applied invoice at a quicker pace. And thereby increasing our accounts receivable and putting pressure on our cash collections. Near the end of the fourth quarter, we've reduced our WACC price on fluticasone and handful of other products in order to reduce the spread between our gross and net prices and mitigate the impact on our networking capital investment. We've begun to see the impact of these actions as our cash collections in January and February have been quite strong resulting in a current cash balance in excess of $325 million, up from $201 million just two months ago.
Turning to earnings guidance. I first want to point out that our guidance for 2017 includes the impact of launches from our product pipeline. In other words, launches of products that are expected to be approved in 2017 but not yet approved are now included in our guidance.
With that we expect full year net revenue to be in the range of $1,010 million to $1,060 million. With respect to ephedrine, there is now a third competitor in the market and we expect that competitive landscape for the remainder of 2017. As mentioned earlier, ephedrine was approximately 20% of consolidated 2016 net revenue. For 2017, we do not expect ephedrine to exceed 10% of consolidated net revenue.
Excluding ephedrine, we expect our existing or base business to be essentially flat with 2016 with assumed price erosion offset by volume increases. Finally, we expect launches of new products to generate $30 million to $60 million of net revenue. I do want to point out that these launches are expected to occur throughout the year but the revenue generated will be weighted towards the back half of the year.
While the decline in the ephedrine has significant impact on a year-over-year net revenue, we expect that net revenue excluding ephedrine will grow 3% to 8% in 2017 including the impact of new product launches. The lower concentration of ephedrine has a dampening effect on our gross margin rate, but we expect gross margins to remain healthy and to be in the 54% to 55% range. We expect adjusted SG&A to be approximately $161 million for the year essentially flat with our Q4, 2016 run rate. We expect that adjusted R&D will be approximately $43 million or slightly accelerated from the Q4, 2016 run rate as we continue to add R&D talent to the team.
We expect that full year 2016 GAAP diluted earnings per share to be in the range of $0.99 to $1.18 and adjusted diluted earnings per share to be in the range of $1.53 to $1.72. Additionally, we expect adjusted EBITDA to be in the range of $363 million to $401 million.
Finally, I'd like to give an update on our efforts to strengthen our internal controls and remediate our material weaknesses. I am very happy to report that all of the material weaknesses identified during the 2015 audit have been fully remediated and I want to thank the finance team for their hard work during this remediation effort. This was a tremendous accomplishment which is significantly strengthened our internal controls over financial reporting. Now although each of these prior year material weaknesses have been fully remediated, during the course of our current year end close we identified a material weakness in the internal control surrounding the process in which we evaluate intangible assets impairment.
It is important to note that no financial statement adjustments were needed as a result of this weakness. However, given the significance of the size of intangible assets on our balance sheet, the existing control structure is now where it needs to be. The good news with respect to this weakness is that we have a full line of site into the necessary remediation step and we expect to be able to fully remediate before the end of 2017 with little to no financial cost.
With that we are ready for questions. Operator?
Our first question comes from Dana Flanders with JPMorgan. You may begin.
Hi. Thank you for the question. Just my only question on the change in guidance including new product launches, which you haven't done in the past, can you just talk a little bit about the rationale for doing so? Is that just greater visibility on pipeline approvals and so forth, or just what's the root cause for that? Thank you.
Dana, good morning. It's Raj. And that's exactly the reason actually what you just said. I think we have now more visibility and our pipeline is getting matured by the hour by the day and so we expect now that we should start getting approval pretty soon. I mean it's hard to project and predict the timing of the approvals. But knowing in terms of the feedback that we've received from the FDA on our filings and the type of questions and queries that we are receiving we feel very comfortable that we can get through, getting our products approved this year more than ever. And in fact we got an approval yesterday and which we filed the press release for this Mycophenolate injection and subsequent to us filing the press release, we got another product approved for Decatur. So I think we are very optimistic and feel good about the prospects there.
Thank you. Our next question comes from David Steinberg with Jefferies. You may begin.
Thanks. You had touched on the dry eye opportunity. I think you have a product called TheraTears, and you mentioned that you might I think expand the opportunity. I assume this is because with the new entrant the prescription markets increase substantially. Could you comment on what share you have of the OTC market, what sort of investment you're considering putting in, and with that investment, where you think you could take your share of dollar level, and is that included in the guidance?
So we have approximately 5% to 6% of the total market share for dry eye product on the OTC front. And I would say we are among the top four five brands in the business. As you know, the prescription -- because of the awareness campaign that have been launched for new product launches as well as both by Shire and Allergan I think we are seeing an opportunity that from a timing perspective to get going with an aggressive marketing campaign. Now we haven't really put out any timelines for it. None of that is factored into a guidance in terms of the expense, but we believe that would be done towards the end of 2017 and the opportunity is pretty significant. And we obviously want to increase the market share. I mean we've done sort of the prep work if you may to get the campaign sort of going, we refreshed the brand in 2016, so sort of these products are primed and we've been working some new products within that product line so I think as time goes by throughout the year I think we'll be able to give you more clarity as to what our plan is and what it could result in going forward.
Thank you. Our next question comes from Sumant Kulkarni with Bank of America Merrill Lynch. You may begin.
Fine. Thanks for taking my question. On your gross margin guidance, we understand that ephedrine competitive dynamics probably have a part in that. But would you say this would be a new baseline level because your older baseline levels used to be closer to the 60% range?
Yes. I think, well if you look at our gross margin rate performance over the last five years, it's --we've been as high as we were in 2015. We've been in the low 50s as well. So going forward absent kind of market events like we saw with the ephedrine. Yes I would say mid to high 50% is a probably a good baseline to think about.
Thank you. Our next question comes from Matt Hewitt with Craig-Hallum Capital. You may begin.
Good morning. Thank you for taking the question. Maybe you could help us a little bit with the cadence, you provided full year guidance, I am just curious how we should be thinking about in particular an ephedrine but the revenue cadence for 2017, is it going to be a gradual decline given the new entrant in the ephedrine or how should we thinking about the top line? Thank you.
Hi, Matt. This is Duane. I think I am not really going to get into quarterly guidance but as it relates to the trend, I mentioned with new products that -- the impact of that is going to be more back end loaded from an ephedrine perspective, obviously the third entrant into that market is reasonably new. So, yes, the ephedrine will follow that trajectory throughout, essentially throughout the quarter- second quarter.
I think we should start see the impact going through -- in the second quarter.
Thank you. Our next question comes from Greg Fraser of Deutsche Bank. You may begin.
Thank you. It is Greg Fraser on for Gregg Gilbert. I just had a follow-up question on the guidance. Would you say that the contribution you included for generics, pending approval, is for high probability products where you have very good visibility on approval and that there could be upside to that number driven by other approvals, or does the range sort of represent the best case set of circumstances? I'm just trying to get a sense as how much conservatism you factored into that $30 million to $60 million range.
So, Greg, I mean obviously where we feel comfortable in terms of the product that will get approved and launched is what we have projected. And again I would emphasize by saying that the timing is critical. We can't really project exactly when a product is going to get approved. But it's our best estimate.
How many launches are in that $30 million to $60 million number?
About 15 to 20
Thank you. Our next question comes from Randall Stanicky with RBC Capital Markets. You may begin
Great. Thanks guys. Raj, of the 15 to 20 launches, how many of those are currently approved versus anticipated to be approved? And then Duane, I just wanted to follow up on a prior question just to help with modeling and not looking at quarterly numbers. But is there a way to give us a first-half, second-half revenue split just so that we understand directionally how that is going to look throughout the year?
So, Randall, it's Raj. So your first question around the approved products that are projected in terms of launches. Approximately I would we got a handful of products that are currently approved that we would be launching.
And then Randall, as it relates to kind of the full year, yes, I would expect revenue generated in the back half to be slightly more than revenue generated in the first half.
Thank you. Our next question comes from Elliot Wilbur with Raymond James. You may begin.
Thank you. Good morning. Just a quick question for Duane. With respect to 2017 guidance, it looks like your cash conversion cycle as defined by operating cash flow relative to adjusted EBITDA is vastly improved versus what we've seen from the Company over the past 18 months. Just curious if that -- obviously it seems to kind of reflect the cycling through of some of the unusual occurrences in terms of the rebate adjustments and things that I think impacted first-half results. I want to make sure that is in fact accurate. And then number two, if we should think about the relative ratio of operating cash flow versus adjusted EBITDA in 2017 as being a sort of normal number going forward. And then could you clarify what -- you mentioned a couple of costs related to certain customer claims and also costs related to price changes in the quarter. Where the price changes -- was that shelf stock adjustments or were those changes taken related to actual price increases? Thanks.
Okay. I'll see if I can remember all the questions. As it relates to -- yes, so what we've experienced thus far in 2017 is I think definitely we had massive working capital investment in 2016, both in terms of changes in income tax payments and our net accounts receivable experience. So I would say what's happening now is not necessarily a correction but a return to normal particularly was driving that some of our WACC price changes that we took in last 2016. I would say as it relates to the relationship between operating cash flow in 2017 and adjusted EBITDA 2017 expected ratio is kind of much more normalized and what we saw in either 2015 or 2016. And then as it relates to the cost in Q4, yes, the aforementioned WACC come with a cost and that was shelf stock adjustment was incurred in the fourth quarter. And then with the customer claims is that can be lumpy but our -- all of our customers will do audits of all the transactions that have taken place over certain period of time and if differences are seen and agreed to then we true that up at that point.
Thank you. Our next question comes from David Amsellem with Piper Jaffray. You may begin.
So, on Durezol, and I apologize if I missed this, but there is a revised FDA draft guidance on bioequivalence that's published in February, so I just wanted to see where you are in terms of being in line with that guidance in terms of the work you need to do to get to an approval, bearing in mind that there is still litigation ongoing, but maybe you can talk to that. Thanks.
David, this is Raj. So you know we meet the revised guidelines, and I mean that's what I can talk about not going into too many details.
Thank you. Our next question comes from Jason Gerberry with Leerink Partners. You may begin.
Hi, good morning. Thanks for taking my question. Just going back to new products, if we do kind of the math, it seems like it averages about $3 million to $5 million a product. It's very second-half weighted. So what I'm wondering ultimately is, is this just kind of a small contribution that you get per product given that it's a late launch, and maybe you won't have a ton of inventory built up to recognize the opportunity in a big way? Is there some chunky product in there, or are they just kind of slow to launch type products? Any kind of clarity you can provide on some of the product opportunities embedded in the guidance that would be great.
I think Jason that's a combination of what you just highlighted. And we may have some products that have high values, some products have low value. And the number kind of let's out to what you just said. And we want to make sure that -- we don't over promise in terms to the customers. And so the timing is properly calculated when we make the product and launch it. So, yes, these things can take some time. Some products will be better prepared, some would be will take a time to launch them.
So, Raj, is it fair to say that there's a healthy carryover effect with these types of products in 2018 and that you might get better revenue in 2018 versus the second-half contribution in 2017?
Yes. So that's what I said in my prepared remarks that hopefully we can -- we need to look past there is ephedrine and some of our big products that we had a run up and I think 2018 would be the year when we will try to sort of reverse course in terms of the declines in revenues. And that is all in my opinion going to come from the launch of new products. So I think you will see a bigger impact of these new product approval and launches going into 2018.
Thank you. Our next question comes from Tim Lugo with William Blair. You may begin.
Thanks for the question. And just to verify, is the Durezol approval included within your guidance, and can you remind me what the opportunity is for that product?
Well, Tim, we are not giving any guidance on a given product in that number so I would refrain from answering that. As far as the opportunity as we said it's close to $200 million in IMS value. So we are first to file, it's a great opportunity for us to drive sales over the product in the future.
Would you update us on the vintage of that ANDA?
Could you please repeat --?
The vintage of ANDA?
I don't have that. It's an NDA, oh it's ANDA, sorry, ANDA
Thank you. Our next question comes from Donald Ellis with JMP Securities. You may begin.
Thanks for taking the question. I was just wondering if you could explain a little more about how reducing the WACC price for fluticasone and that other drug has improved your cash collection. It's interesting. Thanks.
It's all related to the relationship of our gross price which is typically around WACC versus the net price that we actually collect from the customer. For fluticasone there was a very large difference there. So the WACC price, the price that we actually met is significantly well below the gross and because of that, that creates the ability -- that creates big charge backs and our customers that buy fluticasone from us are able to take those charge back almost immediately upon when they receive the product and apply that against any receivable balance that we have. So with that when we reduce the WACC like we did in December that reduces the amount of charge back that they have available to apply against our receivable balance. And therefore allows us to collect cash, net cash quicker or more net cash I should say.
Thank you. Our next question comes from Andrew Finkelstein with Susquehanna. You may begin.
Hi. Thanks for taking the question. I was hoping you could comment just a little bit more about the expectation for approvals in the coming year. You said 15 to 20 products. Previously, the number was a little bit higher. Could you characterize at all what types of products FDA seems to be moving faster on and you have more visibility versus those where the time line takes a little bit longer? And then noting that ephedrine sales were down quarter-on-quarter, are there any things you can point to as the products that had the most quarter-on-quarter growth from 3Q to 4Q? Thanks.
So to your first question around the approval. So I think what we said that we are going to launch 15 to 20 products this year. We did not this time around try to guess number of products approval and because we've been wrong in the past and taking odd -- trying to guess as to how many products we are going to get approved. So I think we have a good visibility now on in terms of the maturation of the product pipeline. As we said earlier to one of the question that based on our experience, we are building experience actually because we have not had with the guidance changing and the review process changing I think we are building the experience now I think given that the product pipeline is matured, the level of questions, the type of questions that we are receiving and we are seeing that the review process sort of winding down on bulk of the products that have been aged. So that gives a little bit more confidence. We just can't take aims at figuring out what the actual number of approval are going to come but we feel comfortable giving the size of the -- or the number of launches that we can project.
Since you do give some detail on your pipeline pending by the dosage form, is there any trend in which buckets of products are moving through more swiftly versus those where FDA is moving slower?
I think it's a combination each product or even we've seen some products that were filed couple of years ago are getting approval so and it's across the board of our dosage form.
And in terms of 4Q versus 3Q, products were up?
Yes. So I mean you are right, ephedrine did decline quarter-on-quarter. I would say the vast majority of our portfolio increases, there is no one big increase to call out just kind of overall good performance outside of what we saw with ephedrine and then continued pressure on Lidocaine and Clobetasol but no big driver that offset that. Its nice broad increases.
Thank you. [Operator Instructions] Our next question is a follow up from Sumant Kulkarni with BofA Merrill Lynch. You may begin.
Thanks for the follow-up. I have a quick couple. So in the past you have said that R&D you target as roughly in the 5% to 6% range, but this year, it's lower than that. So would the 5% to 6% range still be valid? And second, for Raj, could you let us know what your latest initiatives are on the animal health part of the business?
On the R&D front, I'd say our aspiration is to be in that percentage for 2016 obviously we were we missed that mark. A lot of that had to do with we had rapid growth in our net sales. And we were unable to grow R&D and hire the people necessary commensurately. That percentage is increasing in 2017. Right now the increase is modest but again driven by increasing the talent base in R&D. So as we take on more people and get more projects and then I think then we'll start to get closer to that aspiration but again that's more of a long term aspiration than it is short intermediate term.
Then Sumant on the question on animal health, as you know for the last few years we've been learning animal health business and I think we feel very comfortable that we can execute on an aggressive strategy in terms of developing our own filings. And we filed few products over the last couple of years but we are going to accelerate that going forward. So we have identified certain products, maybe a couple dozen products that we are embarking on them right now as we speak. So there is going to be a greater emphasis on animal health going forward.
Thank you. Our next question is from Matt Hewitt with Craig-Hallum Capital. You may begin.
Just to follow-up maybe on the last question there, as you look at the M&A opportunities, and I think you talk about this in your prepared comments, specifically over the next few months, you have some targets that you are looking at. Is there an area in particular, without getting too specific, but are there areas within your portfolio that you would like to bolster via M&A? Is it the animal health or other areas, or is it wherever you find the best opportunities both from a value and market perspective? Thank you.
That's a good question, Matt. I think we are looking at across the board. Our offerings and capabilities and so whether it's human generics again we are focusing on complex generics alternate dosage forms. We are looking at consumer health products, OTC as well as animal health. So I think it's especially across the spectrum of our product portfolio.
Thank you. Our next follow up is from David Steinberg with Jefferies. You may begin.
Thanks for taking the follow-up. I just wanted to get some of your insights behind your assumptions on the ephedrine forecast for this year. It looks like you're assuming that you're going to retain about a third of the market. And I was curious. What are some of your thoughts in terms of -- it's unusual to have the market leader only have a third of the market. Usually, you keep a slightly larger share. What are the assumptions in terms of pricing or attributes of the product? Is that sort of an average for the year, or is that share exiting the year? And then the final related question is you've been explicit about what percent of total revenues ephedrine has been, I think 19% in the fourth quarter. At the midpoint of that share range, what would be your percent of total revenues forecasted this year that would be ephedrine? Thanks.
So, David, I think to answer your first question, the entire acute care market is disproportionately sort of split with different sizes of customers. So I think our goal is that would able to retain the 32% to 35%. If one customer may have a big chunk of the market share so depending on who retains what drives that. And so I don't know if I answered the question because we have different GPOs with different sizes and different market share that they have in terms of their membership. So it's kind of difficult to sort of figure out where the market shakes out at the end of the day but our goal is to get that one third of the market. And yes so I don't know if I answered that question to you.
Sort of. Is that the average for the year? Is that exiting the year? And then also, could you share, assuming the midpoint of that range, what percent of your forecast would actually be ephedrine revenues?
So let me just quickly answer, Duane is going to answer your question but from a timing perspective we have now three players in the market. And as we speak right now so the share distribution will start starting this month. I mean that's what is going to happen.
Yes. And then David my commentary about not exceeding 10%, there is going to be -- for the first quarter I would expect ephedrine to be over 10% of the sales. And as we go forward in the year with the impact of new competitive landscape along with new product launches that we are intending by the end of the year, it will be less than 10% of our overall and for the year the average would be around that number is our guess.
Thank you. I'll now like to turn the call back over to Raj Rai for closing remarks.
Thank you for joining the call. We appreciate the continued support and patience and look forward to speaking with you soon. Thank you.
Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.
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