Mallinckrodt plc
Q1 2017 Earnings Call Transcript

Published: 8 May 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Mallinckrodt first quarter 2017 earnings conference call. As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Mr. Cole Lannum, Head of Investor Relations. Sir, please go ahead.

[Coleman N. Lannum:]

Thank you, Liz, and welcome to today's call on what will certainly be a busy say in spec pharma land. Joining me are Mark Trudeau, CEO, and Matt Harbaugh, CFO. Mark will start us off with some brief comments, and Matt will follow with details of the financials. We'll purposely keep our introductory comments quite short today so as to maximize the amount of time we can spend on your questions at the end of the call. Before we begin, let me remind you of a few details. On the call, you will hear us making some forward-looking statements, and it is possible that actual results could be materially different from our current expectations. Please note, we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially. We ask you to please refer to the cautionary statements contained in our SEC filings for a more detailed explanation of the inherent limitations of such forward-looking statements. We'll also provide some non-GAAP adjusted measures related to our financial performance. A reconciliation of these adjusted measures to GAAP is detailed in our earnings release and its related financial tables, which can be found on our website, mallinckrodt.com. We use our website as a channel to distribute important and time-critical company information, and you should look to our Investor Relations page on the website for this information. As noted in our press release, unless otherwise specified, all comparisons are to the comparable 2016 period. In addition, the revenue growth ranges we'll be discussing will be on a constant currency basis unless otherwise noted. For the first quarter of 2017, we reported GAAP diluted earnings per share from continuing operations of $0.28 compared to prior year of $0.88. After adjusting for specified items, our non-GAAP adjusted diluted earnings for the quarter came in at $1.68 per share versus $1.81 in the prior year. We made no changes to any of our previous guidance numbers this morning. We provide much greater detail on specific line items in our release, and I will refer you there accordingly. And with that, let me turn it over to Mark. Mark?

[Mark C. Trudeau:]

Thank you, Cole, and thanks to all of you for joining us on the call today. I'm pleased to report that Mallinckrodt delivered solid balanced performance overall in the first quarter 2017. Specialty Generics did better than expected, though it remained down overall. A substantial proportion of that segment is our API business, which had a notably good quarter. Results in the Specialty Brands segment were consistent with our expectations, with our diversified hospital portfolio driving modest increases across the business. As in previous quarters, INOMAX led performance in this portfolio. Acthar performed well in the quarter, delivering growth within our expected long-term range of mid-single to low double digits, reflecting gains from both volume and price. We're especially pleased with the progress in pulmonology and ophthalmology, our newer areas of focus. Of particular note, we continue to strengthen formulary positions and access to Acthar. Since the beginning of the year, we've made good progress with a number of payers, including a major insurer, major PBM, and a significant closed-model healthcare system to improve access to Acthar for appropriate patients in both the commercial and public environments. These actions include relaxing or removing previous formulary restrictions, and in at least one case, adding Acthar to a formulary for the first time. We're pleased with the ongoing progress and further stabilization we're achieving within the payer landscape and believe the high unmet medical need and low market penetration in most indications will support increased demand growth for Acthar. Going forward, our enduring focus on operational execution will help ensure we expand our reach to a growing universe of appropriate patients. In fact, operational execution remains our strategic focus across the entire portfolio, as we continue to generate evidence for key marketed products and build out an organic Specialty Brands pipeline. Our key development programs are advancing nicely, and we're very pleased with the progress of the terlipressin trial. Completion of the Phase 1 MNK-1411 study in patients with Duchenne muscular dystrophy or DMD, as well as the recently announced Phase 2 StrataGraft study in patients with full thickness severe burns. Near the mid-term, look for us to announce a number of other notable milestones, enrolling the first patients in several of our company-sponsored trials, including the randomized placebo-controlled pilot study of Acthar in multiple sclerosis flares, the StrataGraft Phase 3 trial in deep partial thickness severe burns, a prospective observational study of the use of INOMAX in premature infants, the Acthar Phase 2 trial in patients with ALS, and the Phase 2 proof-of-concept trial of MNK-1411 in the treatment of DMD. Look for us also to present data on the substantial progress we've made in the enrollment of the Acthar prospective observational registry in patients experiencing MS flares and news about our continuing efforts in scientific and HEOR [Health Economics and Outcomes Research] publications, where we've produced over a dozen in the first quarter alone. In Specialty Generics, we've completed a review of the business to maximize efficiency and productivity. This included a thorough reassessment of our generics development portfolio and prioritization of assets with the greatest potential commercial value. With existing and new projects, we're focused on more than a dozen ANDAs, targeting a few filings this year and five or more filings annually in 2018 and beyond, some of which we expect to be first-to-file opportunities. In the quarter, we again strategically allocated capital, purchasing shares and repaying debt. That said, use of capital for business development remains a top priority, with particular focus on adding both commercial and later-stage development assets to enhance and further diversify our portfolio. We expect to add these types of assets over time and will continue to focus on finding the right opportunities at the right price. Now I'll turn the call over to Matt.

[Matthew K. Harbaugh:]

Thanks, Mark. Our first quarter 2017 results came in largely as expected. Net sales were $811 million, roughly flat operationally over the prior year. Net sales in the period for the Specialty Brands segment were $557 million, representing growth of 5% and reflecting solid performance from our key brands. We were very pleased to see Acthar once again deliver results within our expected long-term growth range, with net sales of $272 million. INOMAX generated $128 million in net sales, an 11% increase. Its growth continued to benefit from our contracting strategy and from the cumulative effects of commercial execution, international growth, and the ATS/AHA guidelines. We do expect future quarters to be more aligned with historical pre-acquisition norms for this product, albeit off a significantly higher base than anticipated at the time of the acquisition. We've been very pleased with the performance of INOMAX in the two years since we've owned it. Turning to OFIRMEV, the product delivered $73 million in net sales, a 3% increase on difficult prior-year comparisons. We do think growth rates will strengthen in coming quarters, driven by productive engagement with our customers and innovative contracting strategies. Despite residual impact of the now-resolved XTS kit issue, the Therakos business was up 7% for the period, with net sales of $51 million, increases driven in large part by kit growth in Europe and overall commercial execution. Our accelerated market transition from the older XTS device to the newer model Cellex Photopheresis unit is ongoing, and we expect virtually all customers to be converted to the new Cellex platform by the end of the year. Therakos is expected to deliver high single-digit growth through the remainder of 2017. In the Specialty Generics segment, we saw net sales of $239 million, representing a 10% decline over the prior-year quarter. While this performance was somewhat better than anticipated, the strength came largely in our lower-margin API business, due in part to the cold and flu season along with one-time orders. As previously disclosed, we expect continued pressure on the segment from competitive entrants and market pricing in coming quarters. Turning specifically to methylphenidate ER, the delay of the FDA hearing combined with later impact from competitive entrants should provide somewhat stronger contributions from the product in coming quarters than originally expected. In the longer term, we still anticipate sales of this product to decline. I want to highlight some important details as it relates to operating expenses. Total company adjusted gross profit as a percentage of net sales decreased slightly in the period to 73.4% from 73.7% in the prior year. As we have said previously, we are seeing ongoing impact on this metric due to price and volume pressures from our Specialty Generics business. Because of this, you should expect another sequential gross profit decline in the second quarter. Adjusted SG&A was also higher than expected for a couple of specific reasons. First, as we have said, the impact of leave-behind costs from the nuclear imaging and intrathecal divestitures are currently at their maximum, although we expect to restructure some of these costs out over the next several quarters. The remaining increase consisted of various factors, including higher compensation costs, charitable contributions, legal expenses, and professional fees. We expect higher SG&A expenditures to continue into the current quarter. R&D expense as a percentage of net sales for the period was 7.7%, a 60 basis points increase over prior year, and a higher concentration of total spend was devoted to further investment in Specialty Brands. Our adjusted effective tax rate in the period was 15% compared to 13.4%. Turning to the balance sheet and liquidity, Mallinckrodt's cash used in operating activities was $97 million in the quarter, a free cash flow outlay of $150 million. This was driven largely by one-time payments of the previously disclosed FTC legal settlement, termination of our long-term defined benefit pension plans, and higher tax payments. We expect free cash flow will improve in the current quarter and anticipate we will end the year with strongly positive free cash flow. As evidence of our expectation that cash flow will remain strong, we repurchased $276 million in shares in the first quarter and paid down $209 million of debt. Notably, over the last 12 months, we have repaid just under $500 million in debt. We continue to have a manageable net debt leverage ratio, coming in at 3.8 times, slightly higher than the previous quarter, as you can see posted on our website. At this point, I'll turn it back over to Cole, who will take us into Q&A.

[Coleman N. Lannum:]

Thanks, Matt. Before we start the Q&A session, and I see a number of you have already queued up, thank you. I want to remind you to please limit yourself to a single question with a brief follow-up if and only if needed. Feel free to put yourself back into queue afterwards, and I promise we'll get through as many questions as possible and let you get on your way as the market opens. With that, Liz, may we please have the first question?

[Operator:]

Our first question comes from the line of Gary Nachman with BMO Capital Markets.

[Gary Nachman:]

Hi, good morning. Could you just elaborate on the improving access for Acthar, where you are in terms of percentage of lives under coverage? And I think you said, Mark, price increased in the first quarter. How can it be – how are you not seeing any pricing pressure as you improve reimbursement?

[Mark C. Trudeau:]

Yeah. Thanks, Gary. So we're very pleased, as you know, with the progress that we continue to make with regards to Acthar and its access in managed care in particular. And while our percent of commercial covered lives under contract is still in that 60% range, in this quarter we've done something which I think is significantly different. We're actually now getting stronger formulary positions across a number of payers in both the public and the commercial sector, and that means formularies and payers that used to have restrictions on Acthar are starting to relax those or in some cases remove them altogether. And in this particular quarter, we actually put Acthar onto a significant formulary for the very first time where we were not previously able to promote into that environment. And now given the fact that Acthar has gone onto the formulary, we're able to promote openly across our label. So this marks a significant change I think in the approach and the success with regards to Acthar access in managed care. And we believe that this is a very good sign and gives us good confidence that we can continue to drive the long-term growth rate expectations in the mid-single to low double-digit range. With regards to pricing, it's true that we did take a price increase for the first time in almost two years in January, and we did see some benefit from that price in the quarter. The growth of Acthar was a mix between both growth and volume in the quarter. And again, we're very pleased that we were able to deliver in that mid-single to low double-digit range, as we have been consistently over many, many quarters now in a row.

[Gary Nachman:]

Okay, quick follow-up, I promise. With the lifting of the restrictions that you mentioned, which indications are being helped the most? Just highlight that quickly. Thanks.

[Mark C. Trudeau:]

In many cases where we had restrictions for Acthar, as you probably know, historically the drug had been restricted to a certain set of indications, typically things like IS, MS, infantile – NS, nephrotic syndrome. And in these cases that I'm referring to, we've actually now opened up the full Acthar label to enable us to be able to promote widely across the label. Again, for appropriate patients, and for us appropriate patients is typically those that are highly refractory, meaning they've typically tried and perhaps failed or had unsatisfactory results on other therapy. So it's a significant change I think in the way managed care is starting to think about Acthar. And we believe it's the result of two things. One, it's the result of our appropriate positioning of the product for these highly refractory patients. And two, it's the result of we believe the significant data generation that we've been successful with here over the last number of quarters, including this past quarter, both clinical data, pre-clinical data, as well as health economic data that we believe is helping us position well Acthar in the managed care environment for appropriate patients and enabling us to relax or remove restrictions.

[Gary Nachman:]

Okay, thanks a lot.

[Coleman N. Lannum:]

Thanks, Gary. And might I add, good job of complying with the related follow-up. Well done, sir, next question please.

[Operator:]

Our next question comes from Annabel Samimy with Stifel.

[Annabel Samimy:]

Hi, thanks for taking my question. I wanted to talk a little bit about the competitive environment. There have been some developments there. And I was just wondering on Acthar, are you familiar with what methods are being used to analyze components of purified corticotropin, or how close can one get to precisely identifying these components? And are they by methods known by industry, and do you think FDA – what do you think FDA needs to see to determine equivalency to Acthar? And then a follow-up to that is, given the development in other indications, the competitive development in other indications, can you just remind us what the breakdown is of Acthar sales coming from the different areas and where you're seeing most of the growth right now? Thanks.

[Mark C. Trudeau:]

Maybe I could ask you just to clarify which competitive developments you're referring to.

[Annabel Samimy:]

ANI Pharmaceuticals.

[Mark C. Trudeau:]

ANI Pharmaceuticals?

[Annabel Samimy:]

Yes.

[Mark C. Trudeau:]

Okay, so we're unaware frankly that there's been any significant competitive developments with regards to ANI or any other product. And our position on competition for Acthar is very similar to what we've continued to say for a number of quarters, that we believe that any product that comes to the market as a corticotropin product that would conceivably be a competitor to Acthar will be an individual come likely through the NDA route, meaning it would be a specific brand, and we believe that that's the case. And we believe that while there's likely to be corticotropin competition for Acthar over time, based on the regulatory environment as we understand it, it may take some time and be fairly complex for that process to occur. With regards to your question on sales by TA, again, historically, Acthar has been in the range of about 30% in the neurology indications, 30% in nephrology, 30% in rheumatology, and the remainder primarily pulmonology. What we now see is that rheumatology and pulmonology have grown substantially, and those now represent larger proportions than they did historically, nephrology roughly about the same, and the neurology indications have declined as a proportion over time.

[Annabel Samimy:]

I think you were mentioning that you had growth in ophthalmology in the past. Are you still seeing that growth?

[Mark C. Trudeau:]

We are. And I mentioned in the prepared comments that we're very pleased with the growth that we're seeing in ophthalmology. But let's recognize that we're still in a pilot phase for that indication, so we're seeing very good growth but on a pretty small base. But that growth has now been consistent over the several quarters that we've been conducting this pilot, and we're quite positive about that indication going forward.

[Annabel Samimy:]

Okay, thank you.

[Coleman N. Lannum:]

Thanks, Annabel. Liz, next question, please?

[Operator:]

Our next question comes from Chris Schott with JPMorgan.

[Christopher Schott:]

Great, thanks very much for the question. Can you just elaborate a little bit more on the leave-behind costs associated with the divestitures? Are those numbers you're able to quantify at this point? And when should we think about that expense normalizing in the P&L basically? Is that over the coming quarters, or is that a longer-term process? And maybe just as a follow-up to that, longer term, I think in the past you talked a little bit about an SG&A target as a percent of sales. I know the mix has changed quite a bit since then. Is there a rough target you can guide us towards as we think about the longer-term models just as we're trying to think about how the P&L evolves over the next few years? Thanks so much.

[Coleman N. Lannum:]

Sure, Chris, let me take a shot on the leave-behind costs. Some of those are very specific such as transition service agreements between us and the businesses that we sell. And some of these are just mathematical; i.e., if we have some SG&A costs that remain the same. Think about my salary. It remains the same, but now we have fewer revenues over which to allocate it, and that affects the SG&A as a percentage of sales concept. And of course, there are lots of things like that. In addition, you have businesses where there were collocations where now we may have lost some of the employees because they've now gone with the businesses that have gone away, but some of the fixed cost overhead in the short term are still there. Think office buildings and again back-office functions. Those are things we think we can restructure over time, but we may not be able to do in a very, very short period of time. While we have not quantified it specifically, we did say that with the nuclear business, you were going to see a pretty significant piece of an impact just because that was such a large business to us.

[Matthew K. Harbaugh:]

The only thing I'd add, Chris, is that you'll see in the reconciliation that we put out this morning, we did incur some significant restructuring charges. So as we think about the longer-term horizon, we still feel that there's leverage on the SG&A line to take out further costs, but it's going to be over time and it's going to take a fair bit of time. The other thing is I would add that our Brands business has been performing very well, as you can see this morning. And so there also is investment going into that side of the house, and the evidence of that is in our prepared remarks around we do have higher compensation expense and professional fees to really support that side of the business. We have been adding head count in a pretty significant manner in building out the New Jersey office as it relates to our Specialty Brands business. And so I just want to make sure it's crystal clear to investors that we do believe our SG&A is going to continue to be high into the second quarter, and then we'll see some of that leverage as we get into the back half of the year. Part of the reason why we put the restructuring program in and got that approval was because we knew we had to invest but we also knew that we had further opportunity to reduce our cost base.

[Coleman N. Lannum:]

Chris, this is Cole again. Let me add one more thing. We noted in the prepared remarks that, as Matt just said, we're going to see these higher SG&A as a percentage of sales numbers, certainly through the second quarter and maybe even a little bit elevated beyond that, but certainly the second quarter. I think it's important you think as you do your modeling, because of these higher SG&A costs compared to where the Street has been and partially because of lower gross margin that we've talked about, again, we discussed in the prepared comments, primarily coming from the Specialty Generics business, as we move into the second quarter, you should be looking at an EPS number that's probably more in line with what we printed in the first quarter. Although I would note, and I think this is important, we specifically didn't change any of our guidance ranges for the year because we still feel very, very comfortable about the numbers for the year but from a cadence standpoint, you really want to make sure you take a look at those second quarter numbers both in SG&A and gross margin. Operator, next question please.

[Operator:]

Our next question comes from Marc Goodman with UBS.

[Marc Goodman:]

Yes, good morning. Mark, last quarter, it sounded like you were more interested in M&A moving to a larger deal rather than several smaller deals or medium-sized deals which you've done in the past. And I was curious if there was something in particular that maybe went away. Or if not, do you still feel that same way or maybe if I'm going down the wrong path, you could just help me with how are we thinking about M&A and has it changed? Thanks.

[Mark C. Trudeau:]

Thanks, Marc. Our thoughts on M&A haven't changed at all actually. And as we said in the prepared remarks, we believe that longer term, continuing to do M&A in the way that we've done it previously, which diversifies our commercial portfolio and adds breadth and depth to our development portfolio, is a very important approach for the business to continue to thrive. In any given quarter, though, we may or may not have attractive opportunities. And when we are unable or don't have attractive opportunities, we look to other levers of our capital allocation such as we did in this quarter, repurchasing shares and paying down debt. Particularly given where our share price has been most recently, it makes very good sense, we believe very good economic sense to continue to buy back shares. But our long-term view is this is a business that we believe can thrive as a well-diversified specialty branded pharmaceutical business that has a well-diversified portfolio and a very strong, deep, and broad pipeline, because our long-term objective is to be a growth company on a sustainable organic basis. And we believe that the way we're likely to get there is through M&A as well as development of our own technology. So we're well on our way but we're not all the way there yet, and we want to continue to add very attractive both large and small opportunities to our portfolio over time.

[Marc Goodman:]

And just to clarify one thing you mentioned before with respect to the Generics business, the review is done. So if the review is done, does that mean you're committed to the Generics business or staying in the Generics business?

[Mark C. Trudeau:]

So the Generics business for us is clearly non-strategic. Non-strategic doesn't mean it's not important. In fact, it's very important to us. It generates tremendous cash flow. And what we've attempted to do here over the last six or eight months is take a hard look at the Generics business, reorganize it and refocus it so that we can operate it much more efficiently so we can drive more cash out of it. But simultaneously, we've looked to enhance the development pipeline. And as a result, over the course of the last year or so, we've been slowly accumulating some additional ANDAs. We've also been looking very carefully within our own company at ANDAs that we can generate, including first-to-file opportunities. Now that that review is complete, now that we have refocused the business and are operating it really almost as a standalone unit within Mallinckrodt, we believe we're likely to see more efficiencies over time. And we're very excited to see that, as we disclosed today, we've got over a dozen projects on the ANDA front that should result in filings, including a couple in this year and on the order of five or so starting in 2018 and going on into the future. So again, we think that that's going to give good balance to this business over time. In terms of our long-term view, we would expect the business would continue to get larger as a proportion in the Specialty Brands arena, primarily because we're likely to grow faster in Specialty Brands than we are on the Generics side. But I think the actions that we've taken here over the last six to eight months should start to bear fruit over time and put the Generics business on much firmer footing that it has been in the last year and a half or so.

[Matthew K. Harbaugh:]

And the only thing I'd add is a fair bit of the restructuring charges that we took in the quarter were related to the Specialty Generics business. So this is real time in these results.

[Coleman N. Lannum:]

Thanks, Mark. Operator, next question please.

[Operator:]

Our next question comes from Douglas Tsao with Barclays.

[Douglas Tsao:]

Hi, good morning. Thanks for taking my questions. Just following up on Generics, obviously this is the first we've heard about your ongoing development efforts and building out a little bit of an ANDA pipeline. I'm just curious. Is there any particular focus? Traditionally, you've always emphasized that you're a Specialty Generics player largely in controlled substances. Are these development efforts remaining targeted in that area, or are you looking to build out a little bit more of a broad-based Generics business? And would there be an opportunity or have you thought about deploying capital on that front?

[Mark C. Trudeau:]

So we have historically been a company that's been almost exclusively focused on controlled substances, and a lot of the clarification of our pipeline still is focused around those capabilities and what we can generate within controlled substances. And that extends beyond opioids to other controlled substances, as you know, such as things like methylphenidate ER. But we're not restricting ourselves to that. What we're looking for are things that are more difficult to manufacture, produce, or may have other challenges associated with them that will enable us to have a bit of a competitive advantage in the marketplace. So while we're likely to still have a strong focus on controlled substances, we have expanded our aperture a bit to other difficult to develop generic products.

[Douglas Tsao:]

Okay, great. Thank you.

[Coleman N. Lannum:]

Thank you, Doug. Liz, next question please.

[Operator:]

Our next question comes from Anthony Petrone with Jefferies.

[Anthony Petrone:]

Thanks and good morning, maybe just a couple quick ones on generics and then one on INOMAX. Maybe are any of the ANDA filings this year that you're expecting to get clearance on first-to-file? And then maybe what's the update on the revenue opportunity of the ANDA portfolio? And then maybe just an update on the Praxair litigation with respect to INOMAX. Thanks.

[Mark C. Trudeau:]

So let me start with the generics, Anthony. And we're not necessarily disclosing a lot of the details just yet, as you might imagine from a competitive perspective what our first-to-files are likely to be, but it's unlikely that it would happen this year. Again, that's why we gave the direction that said we'll be having a couple or several filings this year but we're targeting five or more starting in 2018, including a couple first-to-files. And again with regards to revenue, we literally just completed the review, and we'll be giving more information about how we think about our ANDA pipeline in coming quarters. With regards to INOMAX, again, we continue to feel very positive about the durability of this asset. Even as we went through the trial that just wrapped up in March, recognize that INOMAX has extensive intellectual property around both the drug and the device as well as a very unique commercial model and a significant installed base in NICUs around the country. And we continue to feel very, very good about the durability in the INOMAX product over the long term.

[Anthony Petrone:]

Thanks.

[Coleman N. Lannum:]

Thanks, Anthony. Next question, please.

[Operator:]

Our next question comes from David Amsellem with Piper Jaffray.

[David A. Amsellem:]

Thanks, just a question on OFIRMEV, a long-term question here. Once it goes generic, do you have or can you speak to any potential lifecycle management strategies there? And it's something you haven't talked about in a while. And I guess the second part of that question is, what initiatives or what are your thoughts on maintaining a presence in the acute care space, at least in post-operative pain, even amid the loss of exclusivity on OFIRMEV longer term? Thanks.

[Mark C. Trudeau:]

Yeah. Thanks, David. So with regards to lifecycle management for OFIRMEV, we continue to work on opportunities there. And of course, we wouldn't necessarily be tipping our hand this early given that we have exclusivity on that product through the end of 2020. But if we also think about our overall acute care pipeline beyond OFIRMEV, we have both StrataGraft as well as ExpressGraft and terlipressin that would fit squarely into that acute care arena. We also have our hemostasis portfolio, which again is in the acute care space. And long term, we would continue to be interested in the management of pain associated with surgery in the acute care environment.

[Matthew K. Harbaugh:]

David, from a modeling standpoint, we've encouraged people just to assume a typical market genericization in 2021. And then, as Mark said, as we get closer to that, if something changes around that, we'll let you know at the appropriate time.

[David A. Amsellem:]

Thank you.

[Matthew K. Harbaugh:]

Thanks, David.

[Operator:]

Our next question comes from Elliot Wilbur with Raymond James.

[Elliot Wilbur:]

Thanks, good morning, just a follow-up question around some of the commentary with respect to the Specialty Generics segment. Specifically in the quarter, could you talk a little bit about gross and operating margin performance and particularly trends relative to the December quarter, which was pretty light and I know influenced by higher contribution from API? And as a corollary to that, as we think about modeling this business, obviously the contribution of methylphenidate has a big impact on margins going forward. And outside of market dynamics, has there been any update with respect to the AB rating status in terms of your interaction with FDA since the last disclosure? Thanks.

[Matthew K. Harbaugh:]

Sure. Let me take a shot at answering that for you, Elliot. So as it relates to the margins, you ask a really good question. If you think about gross margin or gross profit, we did acknowledge in the prepared remarks that it did decline year over year, and that was driven by the Generics decline. The brand businesses tend to have more stable gross profit or gross margin as a percent of sales. And what we had going on in this quarter is a mix shift. So if you look in our release, it's down in the other controlled substances and other products line items, where probably there's a lot of interest as it relates to the results. And what's going on in there is the cough/cold season was stronger. Our acetaminophen franchise, which does have a low margin, was actually up pretty significantly when compared with past years. And so that doesn't really drive a lot on the bottom line as it relates to our operating margins. And then we also had a one-time order in there, which is a product category that we don't talk about very often, but that would be in the peptides. That would be a little under a $15 million order, and that's one-time type of an order. We get those from time to time, but typically they're not to that order of magnitude. And again, it comes at a lower margin. So the gross profit was definitely pressured because of that mix, as was operating margins. As it relates to methylphenidate ER and an FDA update, the only change from where we were when we had our last call in early February is that the date that was supposed to occur in March has been postponed, and we don't have a new date. And it was hard to model at that time whether – when methylphenidate ER might get impact from any decision that came out of the agency. And so we were pleased with the results we posted in the quarter. There is no real change to the margin profile of methylphenidate ER. It's more around what happens longer term to that product as it relates to the agency. This being said, it is going to go down. Obviously, Mylan is out there in the marketplace at this point. We have other competitors that have acknowledged that they're likely to come into the marketplace later this year. So we do expect competitive entrants to chip away at the base that we have.

[Coleman N. Lannum:]

Let me add one more thing back on the gross margin question. We've talked about this from time to time, but I want to make sure everyone understands this. In the Generics business, we did have, of course, much higher gross margins a couple of years ago. And right now, we're facing a confluence of a couple of things. Some of the volume declines that hit us last year are just coming through the P&L today because as we manufacture new product, that goes in inventory and then it eventually flows out, so those higher costs are being seen today. And you're combining that with some of the current price pressure that we're seeing on the Generics business today. So both of those negative impacts to gross margin in the Generics business are happening right now. In addition, within Generics, the highest gross margin portion of our large Specialty Generics business is in this end market tablet-linked part of the business that's seeing the pressure right now. So let me emphasize again, all of this we have taken into account in the guidance that we gave earlier in the year that were not changing at all, but this phenomenon around gross margins is a real thing that we're having to manage through.

[Matthew K. Harbaugh:]

And the only thing I would add on this, Elliot, and it goes back to Chris Schott's question earlier this morning around SG&A, you've got intrathecal coming out. You've got nuclear coming out. And so that is causing our SG&A to go up right now, which we still need to chip away at, as I said earlier, but that also is impacting our operating income. I would also say that we continue and plan to continue to invest in R&D. And so you saw a modest uptick in that in the quarter. And I would expect current levels and greater levels as we move forward into the future, which relates to David's question around the future pipeline. A lot of the products that we have, they're all pretty much coming in before or after the loss of exclusivity on OFIRMEV, whether it's DMD or terlipressin. And so we need to invest there to realize the pipeline as well. So I hope that gives you a full picture of the P&L, to your questions.

[Coleman N. Lannum:]

Thanks. Operator, next question please.

[Operator:]

Our next question comes from the line of David Maris with Wells Fargo.

[David Maris:]

Good morning. During the past year, the government has been very interested in and around opioids and separately drug pricing. Have you seen any activity on those areas in this past quarter or so far in this quarter? And then separately, I know they've asked a number of companies for information around opioids. Can you describe what they seem to be looking for?

[Mark C. Trudeau:]

Right. So with regards to both of these topics, opioids and drug pricing, these have been an area of focus certainly at the government level and the media now for a number of quarters, maybe a year or so. So these topics continue to be top of mind. And of course, we have been very focused on what we've actually done from both a pricing strategy, which has been relatively modest. And if you look at our website, we have a pricing pledge that we've published as well. As well as we've continued, we believe, to be on the forefront of working with government to address the opioid situation that's in the U.S. One of the things that we've done, for example, is we've sponsored with local communities across the country a variety of different drug take-back programs, including providing free of charge to these communities drug disposal pouches, where unused opioids can be disposed of safely and effectively. And we do know that that tends to be one of the primary sources for people getting access to opioids; that is, using other people's medication that was unused. So we continue to be focused in both of these areas. Our pricing approach we believe is representative of the value that our products bring to the marketplace, and we're very focused on equating price with value. And we feel that we're part of the solution with regards to opioids and continue to work very actively with governments across the country to try to address this issue.

[David Maris:]

Thank you.

[Coleman N. Lannum:]

Thank you, David. Next question, please, operator.

[Operator:]

Our next question comes from the line of Gregg Gilbert with Deutsche Bank.

[Gregg Gilbert:]

Thanks, good morning. Mark, some investors see the government portion of your Acthar business as more at risk than your commercial business for some reason. Can you offer your view on that subject? And my related follow-up is on the R&D side for Acthar. Within the MS flares study you mentioned, can you talk about what specific setting you're picking there and what you're comparing your active group to? Thanks.

[Mark C. Trudeau:]

Certainly. So yes, with regards to Acthar and the type of reimbursement that that product has, we've been able to grow this product in both the commercial sector as well as the public sector and have continued to do so really since about the middle of 2015. The proportion of Acthar that is in the public sector has grown, and it grew substantially between 2014 and 2015. And it's continued to grow between 2015 and 2016, albeit at a much more modest rate. That largely has to do with the fact that the mix of business, as I alluded to before in an earlier question, has started to favor diseases more of the aged, including things like rheumatologic conditions, some ophthalmic conditions, as well as pulmonology. These are all diseases where Acthar really can provide a solution to patients that don't have very many options once they get to Acthar, and many of these patients tend to be the elderly. So our mix of business has just naturally shifted towards a population that is typically going to be reimbursed much more in the Medicare space. With regards to the MS flare study, what we're doing here is we're doing a couple of different things. One is we're actually doing a registry where we record and document patients that have been on Acthar for MS flares and look at the course of history and look at their previous utilization of drug. We also look at what their experience has been on Acthar. With regards to the actual study itself, again, typically what we're looking at are patients that are appropriate for Acthar, meaning they've had MS flares. They have perhaps tried and failed on steroids previously or other therapies, and so Acthar is likely to be a very attractive alternative for those types of patients. And what we're trying to do here is reflect the real world of how Acthar patients are typically treated across virtually every indication that we have with the exception of infantile spasms. I go back again to the managed care access discussion that we had earlier. We believe very strongly that when we position Acthar for appropriate patients; that is, for those patients where many other therapies have tried and failed, and the alternatives to Acthar may be less attractive, either financially less attractive or for whatever reason, clinically less attractive, we believe it's that appropriate positioning for Acthar backed up by the data that we've created, both health economic and clinical data, that has led to these stronger formulary positions that we're now experiencing. I think this is a dramatic shift or potentially the start of a dramatic shift in the way the managed care environment thinks about Acthar. And again, if I go back to when we first acquired Acthar, we described that we would focus on two primary things. One was to engage with managed care and appropriately position the product for refractory patients, and we would work diligently to generate more data. And we believe we're starting to get to the point where we're achieving somewhat of a critical mass. We have a lot further to go, but we're very pleased with the progress that we're seeing in managed care formularies that cover both commercial patients as well as Medicare patients.

[Coleman N. Lannum:]

And, Gregg, I want to make sure it's clear too, because I know I hear some of the same kinds of things rolling around someplace. Just to expand on Mark said, we don't think there's any more particular risk with Acthar with government payers than there is with any other drug with government payers. There seems sometimes to be some thoughts that Acthar might be different, but we wouldn't consider it any different than any other drug in terms of government reimbursement.

[Mark C. Trudeau:]

I think that's a very good point, and maybe I didn't hit that hard enough. Our view again is the proportion of Acthar that's reimbursed by Medicare is an outcome of the mix of business. And our belief is, at least based on what we see with regards to the healthcare system in the U.S., that Medicare Part D, where Acthar is typically reimbursed, has been one of the most successful government programs regarding healthcare that I think we've seen historically. And again, just based on where it appears that healthcare and healthcare reform may be going, that Medicare Part D program appears to us to be very stable because I think of the past successes this program has had. It has served elderly patients very well, and it's been a program that typically has performed under budgetary expectations. So we think it's a pretty strong and stable place to be. But again, it's not necessarily a strategy of ours. It's an outcome based on the mix of patients.

[Gregg Gilbert:]

Thanks, that's helpful.

[Coleman N. Lannum:]

Thanks, Gregg. Next question, please?

[Operator:]

Our next question comes from the line of David Risinger with Morgan Stanley.

[David R. Risinger:]

Thanks very much. Good morning, everyone. So my question is related to expanded managed care customer access. I just wanted to understand and I guess confirm that the rebating strategy continues to be modest. I think in the past, you've suggested that it's in the single-digit percentage range, and I just wanted to make sure that's still the case. And also in terms of understanding the impact on your ability to promote, I guess you mentioned that with respect to a significant customer in the first quarter. When were you able to start promoting? Was that in January? Was that in March? Is it just starting now? Because I want to understand when a potential benefit to volumes for that customer will start to be seen in your revenue line. Thank you.

[Mark C. Trudeau:]

Thanks, David. So let me take both of these questions. With regards to expanded access, again, we haven't disclosed specifically what our discounting and rebate strategy or impact has been on gross-to-net adjustments. What we have said is that the types of contracts that we've been engaging with managed care around Acthar have been fairly standard contracts, typical contracts of other products in the industry, meaning that we typically will provide a modest upfront discount to give access to the full range of Acthar indications, and then we follow that up with a rebating strategy that's typically based on volume. So if volumes are a bit higher, we pay a bit higher rebate. If volumes are a bit lower than expected, we pay a bit lower rebate. And we have been embarking on that contracting strategy primarily in the commercial side of the business since roughly the middle of 2015. So we now have some experience with these contracts. They're typically going to be annual contracts. We've got some good experience with these contracts. And for the most part, these contracts have performed at or better than our expectations. As is usually the case, sometimes these contracts don't perform. But every time you do a contract and you see how it performs, it helps inform your contracting strategy going forward. With regards to the enhanced access that I referred to, again, typically if Acthar has been restricted on a formulary or in some very small number of cases Acthar has not been on the formulary at all, we're typically not able to promote for anything except what's in the restricted formulary access. When we go in and we relax those restrictions, then we're able to promote broadly across the indication set. That's why we contract and that's why we negotiate with payers to ensure that we get broad access to Acthar, so we're able to promote for appropriate patients within the managed care arena. In the case where we have now a significant customer where we've put Acthar on the formulary for the first time, that enables us to go into that particular payer's patient base and promote broadly across the Acthar label, again, only for appropriate patients, and that's very important. We only promote Acthar for patients where Acthar can provide benefits where other products cannot. And that contract or that agreement we've just wrapped up. We haven't started to see any promotional impact of that just yet. And we should expect to see some potential benefit of that towards the second half of the year.

[Matthew K. Harbaugh:]

Yeah. David, the only thing I would add is, to get back to your question, the rebating strategy was fully considered in the guidance that we provided. And as you know, for Acthar, that's mid-single to low double digit, which if you go back over time since taking ownership of the product over two years ago now, we've pretty much gone within that range very consistently throughout that whole period with few exceptions, one being one quarter was on the low end, and then we had two that were on the high end of that range. But I would say all of that has been factored in. The second thing I would add is typically when we sign these contracts, you don't see a sudden or immediate impact. It takes time. And so in future quarters, we'll probably see some benefit from this, but lots of moving parts within Acthar. I would just anchor you to the mid-single to low double that we've been saying now for well over two years.

[Mark C. Trudeau:]

That's a very good point. Again, signing contracts is a very good thing because I think it gives us good confidence that managed care feels confident in the appropriate positioning of Acthar. But just as Matt said, signing a contract, adding Acthar to formulary doesn't guarantee any business by any stretch. But what it does do, it gives us the opportunity to go in and promote for appropriate patients across the Acthar label.

[David R. Risinger:]

Great. Thanks so much.

[Coleman N. Lannum:]

One more thing before we get to the next question, I want to clarify what I said earlier. I don't want there to be any misunderstanding. On the guidance numbers, we obviously didn't change any of the EPS numbers, but we're also not changing any of the rest of the guidance information that we gave earlier this year. Everything remains the same. All the revenue ranges for all the segments, the adjusted effective tax rate range, the net interest expense range, all the ranges that we gave on the last call in February remain unchanged at this time. Operator, next question.

[Operator:]

We have a follow-up question from the line of Elliot Wilbur with Raymond James.

[Elliot Wilbur:]

Thanks, good morning. I just want to go back to some of Mark's earlier comments regarding deployment of discretionary capital and cash flow. And obviously, you guys have been a very good steward of capital the last couple years and been regularly returning capital to stakeholders. But I guess observationally, with the benefit of hindsight of course, if you look at the intended effect of share repurchase programs, certainly would have hoped for a more positive impact than what we have seen. So I'm just wondering if there's any change in your internal thinking regarding the relative attractiveness of deploying capital with respect to accelerated debt paydown versus share buyback opportunity given that the external reward mechanisms for share repurchases don't seem to be functioning as we would normally expect. Thanks.

[Matthew K. Harbaugh:]

Yeah. Elliot, let me start answering your question and perhaps Mark or Cole will want to jump in. The answer is no. We feel strongly that our approach to capital is judicious. I would say particularly as it relates to share repurchase programs, you can't react to any one quarter or any given week. It's over the long term, three and five and seven years, when you see the benefit from those types of programs. And as you can see with the share price under pressure, we were very aggressive in the last quarter, repurchasing rounded $276 million and 5.6 million shares. We also paid down debt. And when we file the 10-Q here shortly, you'll see that we pared back as we refinanced our debt, the term loan. We also paid down our AR securitization program, and then our revolver was left undrawn. And the way we think about that is that gives us dry powder, particularly around the revolver. I'll just remind you that in late February, early March, we announced that we upsized the revolver from $500 million to $900 million. And again, that's completely undrawn at this point, which gives us plenty of opportunity to continue to deploy capital. So the answer to your question simply is we feel very good about the measures that we've taken on capital deployment. And in the absence of business development, we'll still chip away, likely on the debt side. And then we also have a very significant share repurchase authorization that we received in early March, of which we were buying against that authorization throughout the month of March.

[Coleman N. Lannum:]

And the one thing I would add, almost from a philosophical or existential standpoint, none of us has perfect insight as to what equity markets are going to be tomorrow or next week or next year. Clearly, we would like to buy the shares at lower prices rather than higher prices, just like most of you out there do. But remember, regardless of what's happened in the pricing side of things, we've taken out 16% of the company, which means that all of the owners of our company now own more of the equity output that this company puts out there than they would have otherwise. And from a conceptual standpoint, that's how we look at giving cash back to shareholders in that manner. And as Matt said, we'll see over a period of time whether that makes a difference or not. Usually, that type of leverage from an equity standpoint does make differences over long periods of time, but we'll see how that goes.

[Coleman N. Lannum:]

With that, I think we're at the bottom of the hour, so we're going to wrap up for the morning. And I appreciate all of your patience as we've gotten through the call this morning and thank you for the good questions. In terms of the rest of the day, there will be a replay of this call on the website later on today, and Dan [Speciale] and I will be available to take your calls throughout the day and tomorrow. Thanks and have a great morning.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone have a great day.