Mallinckrodt plc
Q2 2018 Earnings Call Transcript

Published: 7 Aug 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Mallinckrodt Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Daniel Speciale, Investor Relations and Strategy Officer. Sir, you may begin.

[Daniel J. Speciale:]

Shannon, you're breaking up a bit.

[Operator:]

Mr. Speciale, you may begin.

[Daniel J. Speciale:]

Thank you, Shannon. Good morning, everyone, and welcome to today's call. Joining me today are Mark Trudeau, our CEO; Dr. Steve Romano, our Chief Scientific Officer; and Matt Harbaugh, our CFO. Before we begin, let me remind you of a few important details. On the call, you will hear us make some forward-looking statements, and it's possible that actual results could be materially different from our stated expectations. Please note, we assume no obligation to update these forward-looking statements, even if actual results or future expectations change materially. We encourage you to refer to the cautionary statements contained in our SEC filings for a more in-depth explanation of the inherent limitations of such forward-looking statements. We will also provide selected non-GAAP adjusted measures related to our financial performance. A reconciliation of these adjusted measures to GAAP is available in our earnings release, 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 the Investor Relations page of our website for this information. We use this channel, for example, to post our net debt leverage ratio on a quarterly basis. And as you can see today, it's down from the first quarter. As noted in our press release, unless otherwise specified, all quarterly comparisons are to the comparable 2017 calendar period. And the net sales growth ranges we will be discussing are on a constant-currency basis. As you likely saw this morning, we raised our 2018 guidance for the net sales growth range to 4% to 7%. And the adjusted diluted earnings per share guidance has been raised from $6.50 to $6.90. With that, let me turn the call over to Mark. Mark?

[Mark Trudeau:]

Thanks, Dan. We're pleased with our overall results for the quarter, which built on a solid first quarter performance. With this, and with continued strong execution, our confidence has increased on the outlook for 2018; and we've raised our guidance for the fiscal year. Today, we'll cover some of the highlights from the quarter and some of the key milestones you can look forward to. Our strong performance in the second quarter demonstrates the progress we're making against our strategic goals. We drove solid top line growth in our billion-dollar hospital portfolio, and we continue to anticipate growth rates in the mid to high-single digits with this franchise for the balance of the year. Acthar performed essentially as expected, and we continue to believe that the product's 2018 net sales will be in excess of $1 billion. We also continued to advance our pipeline, which Steve will go through in his comments. As we've said in previous quarters, we believe 2018 is a transformative year for the company. We focused on our strategic priorities that support and accelerate our journey to become an innovation -driven specialty pharmaceutical growth company focused on improving outcomes for patients with severe and critical conditions. Let me update you on the advances we've made on several of these priorities. In the quarter, we executed well on our first and most critical priority to maximize the productivity and contribution of both in-line brands and the near-term development portfolio. For Acthar, we remain focused on the brand's pathway to recovery through our ongoing data generation and modernization activities. In particular, the preliminary interim data presented in the quarter from company-sponsored studies in rheumatoid arthritis and multiple sclerosis provides further support for the drug's utility in certain highly refractory patients. In coming quarters, we look forward to additional data reports, all of which will help guide providers in determining how the product can help appropriate, difficult-to-treat patients with high unmet needs. In addition, we continue to dialogue with payers to ensure access for appropriate patients, especially in light of emerging data sets. On INOMAX, we expect short and long-term customer demand to remain constant and are pleased with the continued robust uptake for the cardiovascular indication in Japan. Increasing and ongoing customer demand for non-opioid or multimodal pain management continues to drive strong OFIRMEV results, and we anticipate this trend to reduce opioid use will persist. Focused sales efforts particularly in Europe drove strong Therakos results. And AMITIZA and Rescula performed as expected, and we continue to believe the combined net sales for these products will be approximately $200 million in 2018. Our second priority is further streamlining our organization. We're making sustained targeted reductions in our SG&A expenses to enable enhanced investments in programs and capabilities that will drive growth. We're on the right path with SG&A, down roughly 5 percentage points in the quarter, while R&D spending has increased to a level consistent with that of an innovation-driven specialty pharmaceutical company. Additionally, as a reminder, we took an important step earlier this year by moving the Specialty Generics Disposal Group to discontinued operations, and we continue to look at strategic options for this business. The third priority is ensuring we execute a highly disciplined capital allocation strategy with notable focus on debt reduction in 2018. We're making strong progress on that front, and Matt will go into the details in a moment. We continue to remain opportunistic regarding share repurchases and business development. So, we're pleased to be advancing our strategic priorities, which we believe will help us deliver solutions for underserved patients with severe and critical diseases. We believe that our significant data generation activities will continue to build and extend the value of our products. We look forward to maintaining our overall momentum and reporting on additional important data emerging on many of our products, starting with VTS-270 in the near-term. I'll now ask Steve to provide a detailed update on some of our key development and life cycle activities. Steve?

[Steven Romano:]

Thanks, Mark. With a number of potential product launches in the next few years, more than a dozen clinical trials ongoing, and numerous publications and data generation activities to support our existing portfolio, we have a lot to talk about. Let's first touch on development of our pipeline. For VTS-270, our development product to treat Niemann-Pick Type C, a rare neurodegenerative and ultimately fatal disease that commonly presents in childhood, we are preparing for upcoming final discussions with the FDA on the statistical analysis plan. We expect top line results from the registration study in the near term and continue to engage with the advocacy community. Two of our most advanced late-phase programs, terlipressin and StrataGraft, are doing well. Patient recruitment is currently over two-thirds complete in the terlipressin Phase 3 trial for the treatment of Hepatorenal Syndrome type 1. On StrataGraft, our regenerative skin therapy in development trials for treatment of deep partial and full thickness burns, study enrollment is ongoing with nearly half the planned patients enrolled in the deep partial thickness study. Given the RMAT designation we will continue to engage with the FDA to evaluate an earlier submission if the data are supportive. In May, we met with the European Medicines Agency to define clinical aspects of Phase 3 program there, and we're outlining a path forward. And just announced last week, our Phase 2 Duchenne Muscular Dystrophy study for MNK-1411 recently enrolled the first patient and received approval for the European orphan drug designation. Regarding Stannsoporfin, we expect to hear from the FDA by the August 22 PDUFA date. Turning to activity supporting M line (08

[Matthew K. Harbaugh:]

Thanks, Steve. Net sales for the quarter were $632 million, an increase of 5%. We reported GAAP diluted loss per share from continuing operations of $0.34 compared with income per share of $0.19 in the prior year. Our non-GAAP adjusted diluted earnings per share was $1.78 versus $1.36. Acthar net sales were $293 million, an 8% decrease, reflecting the continued residual impact of patient withdrawal. Looking further at our hospital franchise, INOMAX generated $131 million in net sales, a 4% increase; and OFIRMEV continued to see strong growth with $86 million in net sales, up 13%. Therakos also performed well in the quarter with net sales of $57 million, an increase of 9%. AMITIZA generated net sales of $48 million in the second quarter. Now, let me share some details on operating metrics. Total company adjusted gross profit as a percentage of net sales increased in the period to 84.1%, up from 81.6%, primarily due to product mix. Our adjusted SG&A as a percentage of net sales was 30.1%, as compared to 34.8%, resulting primarily from the benefits of 2017 restructuring initiatives and synergies from our most recent acquisition. As you can see in the results announced this morning, we are well on our way to executing on our initiative to reduce our annual SG&A run rate by $100 million. Notably, R&D expense, as a percentage of net sales, increased to 12.9%, as compared to 8.7%, reflecting increased investments in advancing our pipeline and generating data for the in-line portfolio. You can expect to see both absolute R&D spending and R&D as a percentage of net sales to increase in coming quarters, as we continue to move products toward launch and support our key in-line brands. Turning to liquidity, operating cash flow for the quarter was $244 million with free cash flow of $211 million. And we anticipate greater than $500 million in free cash flow for the year. As we have previously stated, our primary focus for 2018 capital allocation is debt reduction. Debt was decreased by $460 million in the second quarter. And we paid an additional $75 million on the revolver following the quarter close, bringing the total debt repaid since the first quarter to $535 million. We will continue to update you on repayments throughout the year. Now, let me turn the call back to Dan, who will take us into Q&A.

[Daniel J. Speciale:]

Thanks, Matt. I'd like to remind each of you to please limit yourself to a single question with a brief follow-up if needed. Feel free to put yourself back in queue afterwards, and we'll work to get through as many questions as possible. With that, operator, may we please have the first question?

[Operator:]

Our first question comes from Dana Flanders with Goldman Sachs. Your line is open.

[Dana Flanders:]

Hi. Thank you very much for the questions. My first one here is just on Acthar. Can you just give us an update and maybe how we should think about the pushes and pulls for the product as we head into 2019? I know you lapped easier comps. Is this a product that you expect to grow again next year? And then, I have a quick follow-up.

[Mark Trudeau:]

Yeah. Thank you, Dana. In terms of the performance for Acthar, it is in line with what we've expected and consistent with what we've described throughout 2018. We expect the product to continue to be in excess of $1 billion in 2018. We're not yet ready to talk about 2019. Obviously, as we get closer to that year, we'll give you some more direction in that regard. But with regards to pushes and pulls, obviously, the payer environment continues to be volatile and variable, and we expected that, that's going to continue for a variety of specialty products, and Acthar is no different. But we're quite pleased with the degree of dialogue that we're having with payers and also with prescribers. But I think the big push, if you will, for us, in a positive direction, is the emergence of the clinical data. And you've seen already some of the preliminary results that Steve referred to on RA and multiple sclerosis, which we think are very promising. And we look forward to completing those trials and reporting out more data through the balance of the year. But as we get into 2019 and 2020, this is really just the start of a whole set of data readouts that are going to occur over the next 12 to 24 months. Keep in mind, we have six clinical trials that are ongoing in key primarily on-label indications and also one potential indication for ALS. So, it's a potentially very robust data set that we'll be reporting on. And that should be a significant driver for Acthar in the future. Recognize that we believe that the opportunity for Acthar is primarily in highly refractory patients, patients that have very few alternatives, and that's where the focus of our clinical trials are. And we believe that, over time, the growth opportunity for Acthar is really driven by volume, that there's a clear opportunity for us to provide more value to those patients who have relatively few alternatives. And the data should support that, if in fact, it reads out positively. But we're highly encouraged by the preliminary results that we see so far.

[Dana Flanders:]

Okay. Great. And maybe just a quick follow up on VTS-270. How are you just thinking about – again, I know you're entering into final FDA discussions on the statistical plan. Maybe just likelihood and confidence going into that, that you can kind of get the outcome that you want ahead of data coming soon. Thank you.

[Steven Romano:]

Yeah, so this is Steve, and I'll take that. So, obviously, it's a blinded trial, so although the trial is complete, we haven't unblinded it. But I think, as new owners of this program, we got a really excellent opportunity to evaluate the analysis plan all towards optimizing likelihood of a positive outcome. And that's just what we've done. So, we've taken a very serious look at the design of the trial; the measurements in the trial; we took a look at blinded data, which a sponsor has the opportunity to do; and based on our views of that, we're going forward with a SAP that we'll discuss with the agency, actually, in just a couple of weeks from now. So, we think this certainly optimizes the likelihood of a positive study. But, again, a blinded trial is a blinded trial, so we'll know soon enough. The other thing I want to say is, remember, this is a very important product for a group of patients, who have nothing really to treat them. So, we want to make sure we optimize the likelihood of outcome. So, we're feeling good going into this, but obviously, blinded trial, you have to wait till it's unblinded to finally know the results.

[Daniel J. Speciale:]

Okay. Operator, next question, please.

[Operator:]

Our next question comes from Dewey Steadman with Canaccord. Your line is open.

[Dewey Steadman:]

Hi, guys. Thanks for taking the question. I just wanted to take an update from you guys on the progress of the disposition of the generics unit, and sort of your thoughts on that business, and how likely it is to go at one big chunk, or could it potentially be creatively broken up into various units to facilitate a sale?

[Matthew K. Harbaugh:]

Yeah, Dewey. Thanks for the question. This is Matt. Obviously, we haven't announced anything just yet as it relates to Specialty Generics. We're looking at a number of different alternatives, as you might imagine, but these things do take time. The one thing I would like to highlight though about the generics business is in the last call, we talked about the fact that we thought that the first quarter was going to be the most pressured quarter this year in that particular business, and that certainly is the case. We'll be filing our 10-Q here soon enough, and you'll see in the discontinued operations numbers that the decrease in net sales was about half what it was in the first quarter. So, the business itself, we have seen some momentum there, less of a decrease in net sales. But again, from a strategic perspective, we have nothing to announce today.

[Dewey Steadman:]

Thanks.

[Daniel J. Speciale:]

Thanks. Operator, next question.

[Operator:]

Our next question comes from David Risinger with Morgan Stanley. Your line is open.

[Unknown Speaker:]

This is Xu Shin (20

[Mark Trudeau:]

Go ahead.

[Matthew K. Harbaugh:]

Yeah. As it relates to SG& A – thanks for the question. This quarter, we were really pleased with the results, and we're likely to see SG&A kind of in the same range as what we saw on the quarter. Obviously, there'll be some quarterly variation, but we really saw a good efficacy in some of our internal programs around restructuring. And then, I would also add, with the Sucampo acquisition, we're well ahead of the schedule in driving out the synergies we had in the deal model.

[Unknown Speaker:]

Great. Thank very much.

[Daniel J. Speciale:]

Thank you very much. Next question, please.

[Operator:]

Our next question comes from Ami Fadia with Leerink Partners. Your line is open.

[Ami Fadia:]

Hi. Good morning. Could you go back to Acthar? It certainly performed better than what we had expected in the quarter. Can you give us any color on any immediate progress you've made, with respect to improving access with peers? And then separately, just on the CPP-1X, it sounds like the results are coming earlier than anticipated. We were expecting next year. Any color you could provide there would be helpful. Thank you.

[Mark Trudeau:]

Yeah. I'll take the Acthar access question, and maybe I'll ask Steve to comment on the CPP-1X program. With regards to discussions with payers, they continue, as they always do. And we've had some very positive dialogue with those payers, certainly about not only current access but future access. And recognize that those discussions are really tied pretty closely to the emergence of data. And that's why we're excited about the future of Acthar because of the volume of data and the type of data that we're starting to introduce to the marketplace. And so, this is an environment though that continues, as I said earlier, to be highly variable and volatile, and we expect that to be the case for specialty products, including Acthar going forward. But overall, as I said we're pleased with the performance of Acthar. It's performing essentially in line with our expectations internally. And we continue to believe that the product will result in net sales in 2018 and greater than $1 billion.

[Steven Romano:]

Yeah. I'm happy to comment about CPP-1X/sulindac. So, the study, in fact, is going to be completed by year end. And those were in my comments I made just previously. The actual results though will be available – in other words, the top line results wouldn't be available till early in 2019, but we're moving forward to completion of the study by year-end.

[Daniel J. Speciale:]

Thank you very much. Operator, next question please.

[Operator:]

Our next question comes from Chris Schott with JPMorgan. Your line is open. Chris Schott, your line is open. Please check your mute button.

[Daniel J. Speciale:]

Let's go on ahead, and we'll come back to Chris then.

[Operator:]

Our next question comes from Annabel Samimy with Stifel. Your line is open.

[Unknown Speaker:]

Hi, guys. This is Andrew (24

[Mark Trudeau:]

Maybe I'll start with that, and Steve might want to add a couple of comments. So, I would say that our focus is on patients, particularly, underserved patients with severe and critical conditions, which may or may not include rare diseases. Certainly, we have a couple of programs that are in rare diseases

[Steven Romano:]

Yeah. And I don't really think I have much to add to that. I think Mark covered that nicely. Terlipressin, StrataGraft, MNK-6105 and MNK-6106, which are the Ocera compounds, all of those are really targeting severe and critical conditions

[Unknown Speaker:]

Great. Thank you.

[Operator:]

Our next question comes from Sriker Nadipuram with Barclays. Your line is open.

[Sriker Nadipuram:]

Hi. Thanks, everyone, for taking the question. I'm on for Doug Tsao. I just wanted to drill down a little bit more on specifics for Acthar. What makes you confident that in 2019 we could possibly return to growth? Are we seeing any specific recovery in specific indications, or is it still on kind of a patient-to-patient basis? And then, a quick one on the Washington U partnership. Do you have any areas of focus, or is this just going to be a broad technology partnership? Thanks.

[Mark Trudeau:]

So, let me take the Acthar question, and then, I'll ask Steve to comment on the Wash U partnership. So, again, we're not speaking specifically about 2019 at this point. But in general, as we look at opportunities for growth, I want to emphasize, again, our focus is on underserved patients, patients that typically are highly refractory, have tried and failed many times on a number of other therapies, and Acthar may be an alternative that is well down the line. But there are plenty of patient opportunities for those types of highly refractory patients. The opportunities for growth, we think, over time, are essentially aligned with our data generation activities. So, for example, we reported today on a study that just occurred in transplant patients that have tried and failed in other therapies that have FSGS, that's a nephrology therapeutic area, if you will. And of course, we've referenced our rheumatoid arthritis and multiple sclerosis trials that are ongoing, but you also know we have things going on in lupus, in pulmonary sarcoidosis. So, a whole range of therapeutic areas. And again, we have seen a pretty strong correlation historically when we have been able to produce robust data sets with that information, providing a good basis for both prescribers and payers to identify these appropriate hard-to-treat and refractory patients. So, again, I would look to where our clinical trials are aligned, and that's where we would see the potential for growth long term for Acthar.

[Steven Romano:]

Yes. Regarding Wash U collaboration, yeah, we're very excited about this opportunity to work with one of the premier research organizations in the country. So, it is a bit biased, I would say, towards rare disease, but in fact, what we'll do is we'll have a governance structure that is represented by scientists and researchers from both institutions, MNK as well as Wash U. And we'll really look at all research opportunities, particularly, again, that focus in areas of mutual interest. So, the overlap in rare disease is obvious, but there will be other critical conditions that we might support as well. I mean, for instance, they're also doing wonderful work in certain areas such as autophagy, which is really sort of evaluating how the cell processes waste, if you will. And that's an area that, if that progresses, could apply to whole list of different indications and disease conditions. So, we're very interested in some of that kind of breaking science that the university is looking to bring from the bench into the clinic.

[Daniel J. Speciale:]

Thanks. Operator, next question please.

[Operator:]

The next question comes from John Boris with SunTrust. Your line is open.

[John T. Boris:]

Thanks for taking the questions. It's really just one centered on Acthar. Have you conducted any awareness research on the RA and MS data, and especially on the length of therapy that's been used within the trial? Second question just has to do with the data that you have. Have you been able to take that to payers to amend certain contracts for that length of therapy? And then, the third part of the question has to do with publication of the results. Will you publish the 60 patient results, or will you wait for the full 230 before you actually publish the open-label RA and MS data?

[Mark Trudeau:]

Yeah. So, maybe I'll start, and I'll ask Steve to comment a little more specifically on some of the details of your questions. So, again, I would go back to the fact that, historically, we have seen very good response to robust clinical data sets. And in fact, the data sets now that we're producing are perhaps the most robust we've ever produced. Keep in mind, the RA trial is 230 patients, and it is a very well-designed, very robust trial. And it's designed primarily to help physicians and payers identify not only appropriate patients for Acthar, but to identify the appropriate length of therapy. And so, again, we're quite pleased with the preliminary results. And, of course, we're anticipating being able to report out on a larger interim data set, and then the final set certainly for RA. So, again, we can use this data appropriately with payers and prescribers, as it emerges, and we'll continue to do that appropriately. With regards to publication, and Steve, may be some thoughts on the design of the trial, you might want to make some comments there.

[Steven Romano:]

Yeah. So, just to remind folks, the study was designed really to answer a number of questions. One, it, number one, focuses on patients who are not responding to other therapies. And these patients with RA have been on foundational therapies, like methotrexate, other DMARDs oral as well as biologics and are still evidencing high levels of disease activity. And the goal is to put Acthar to treat these patients with Acthar and get them to low disease activity levels, which is what we'll find in the study. So, there's a 12 week period during which they are treated in an open-label manner. And then, those who respond, who meet that rigorous criteria for response and are moved to lower levels of disease activity, are then blindly randomized to either continuation drug for an additional 12 weeks or placebo withdrawal. That way, we answer the question, not just of the response rate acutely, which is a 12-week period of open-label treatment, but also the durability of that effect. And that will help folks who treat and make decisions about treatment access; how long you need to treat; what to expect after, say, several months of treatment; do you need to treat patients for a further three months or not, get a sense of the durability and getting patients over the hump with regards to their flare or their smoldering disease. Now, around publication, we will publish, if you will, that is make public the data at research meetings. So, we've made public the 60 patients, first 25% open-label. We'll do the same for 120 patients, 50%. But we will wait for a manuscript and a final publication probably for the end of the study, since the study has enrolled so rapidly, which I think underscores the need for something to treat these toughest-to-treat patients. It enrolled so rapidly, we will actually complete the study by year end, have the results sometime in first quarter of next year, and be able to move very rapidly to publication.

[John T. Boris:]

Thanks.

[Daniel J. Speciale:]

Thanks for the question. Next question, please.

[Operator:]

Our next question comes from Gregg Gilbert with Deutsche Bank. Your line is open.

[Gregg Gilbert:]

Thanks. Good morning, team. Looks like ANI based on FDA feedback plans to file their Acthar-like product in early 2020. Do you expect competition from that product, if approved, to be on an indication-by-indication basis based on how ANI studies it, or do you think the system could be open to adopting a competitive product across the indication range regardless of where the studies were done? And my follow-up is INOMAX. Matt, you've talked in the past about having been active on the contracting front. Can you talk about your thoughts on timing of generic competition, whether you've heard any footsteps in that regard, and comment on the growth outlook for that product line? Thank you.

[Mark Trudeau:]

Yeah. So, with regards to competition for Acthar, let's keep in mind that Acthar has competition today for every single indication, whether it's from a variety of different classes of drug. And we would expect additional competition for Acthar over time. With regards to ANI, what they will do, how they will do it, that really remains to be seen. It's really up to them in terms of their strategy. But with regards to competition for Acthar, we compete every day. And we expect that where the drug is currently positioned, there are a tremendous number of patients that can benefit that are highly refractory. And again, we think the production of the data that we're generating really speaks to the opportunity there. And Steve commented a little bit specifically on the RA trials. But again, if you look at the comprehensive number of trials that we're creating, we think that there's a tremendous opportunity for the product long term. With regards to INOMAX, again, nothing has really changed there. It's business as usual, certainly, from our standpoint in 2018. We're quite pleased with what we see from INOMAX. In 2019, certainly, the opportunity for the appeal should occur in the first part of the year. But recognize that INOMAX is a product that we believe has a tremendous amount of attraction as a kind of a drug device combination but also the service model that we run. And so, regardless of whatever competition may come for INOMAX, we think those will continue to be a tremendous opportunity for this drug to treat these highly fragile patients, particularly, in the NICU. Let's also recognized that we're in the process of continuing to update and add to both the intellectual property, as well as the overall business model. We have a next-generation device, for example, in development, which we'll likely introduce to the market over the next couple of years. So, we would see INOMAX as being a product that's going to continue to be a very important part of our portfolio over time.

[Matthew K. Harbaugh:]

Gregg, the only other thing I would add around on contracting is you'll see when we file the 10-Q in the not too distant future. We're roughly around page 10 in that filing for 2019 and going into 2020. You'll see that we have roughly about a fifth of our revenue already contracted. So, I think that's notable and something to pay attention to when we file the Q.

[Mark Trudeau:]

Yeah. That's a good point. We've been very pleased with the fact that we've seen customers continuing to talk about long-term demand for INOMAX. And again, that's reflective of the types of information that Matt was just describing. Again, that gives us good confidence that this is a product that has significant sustainability over time.

[Daniel J. Speciale:]

Thank you. Next question, please.

[Operator:]

Our next question comes from David Amsellem with Piper Jaffray. Your line is open.

[David A. Amsellem:]

Thanks. So, along the lines of potential competition on Acthar, I wanted to get your thoughts on the Depomed's synthetic product. And I mean, you've said that you expect competition over the long term, but for non-substitutable product with one or two indications on the label, what's your thoughts, longer term, on how impactful that could be to the Acthar franchise? And then, secondly, just switching gears to OFIRMEV. Is there anything you could do on that product to try to extend the life of that franchise in terms of next-gen or new presentation? Any kind of life cycle management there? Thanks.

[Mark Trudeau:]

Yeah. Thanks, David. So, again, I go back to the same answer really on competition, whether it's Depomed, ANI, or frankly, any other competitive product in any other class competing for highly refractory patients, or patients in general, for the indications that we promote. We would continue to see Acthar as a very attractive option for these highly refractory patients. And again, in particular, I've said it probably half a dozen times, but I'll say it again, we think the key to all of this is the robustness of the data. That's why we've invested so heavily in these six clinical trials. And again, from a competitive standpoint, whether it's corticotropin competition or a competition from another class, our belief is very strong that if you have very good data in the patients that you're targeting, which for us is the high refractory group, you're going to have a good opportunity to continue to drive growth. With regards to OFIRMEV, again ,we continue to look for opportunities to extend the product life cycle, but at this point, that's probably unlikely. Obviously, we're very pleased with the performance that we're seeing with OFIRMEV. We think this is a combination of both some very sound commercial execution, combined with the market environment that's quite favorable for non-opioid pain relievers , of which OFIRMEV is one of the very few alternatives. And so, we continue to see this as a very good opportunity for us going forward. And it's really contributed largely to the raise in guidance that you've seen today. We continue to believe that, in total, our hospital business for 2018 will grow in the mid to high-single-digit range.

[Daniel J. Speciale:]

Thank you very much. Next question, please.

[Operator:]

Our next question comes from Gary Nachman with BMO Capital Markets. Your line is open.

[Gary Nachman:]

Thanks. Good morning. First, on Acthar, and I apologize if you addressed it, but how has net pricing trended? And has average size of prescriptions for the different indications changed that much with some of the managed care pressures? And then generally speaking, how comfortable are you with the number of shots on goal you have with the pipeline? How much urgency is there to expand that? And then, finally, just what else do you plan to do to leverage your new GI presence with AMITIZA? Anything with Acthar, specifically, or maybe on the BD side? Thanks.

[Mark Trudeau:]

So, let me try to get all of those in here. In terms of net pricing, as we've said from the beginning, we expect net pricing to be marginally positive for Acthar in 2018. That's what we've seen so far in the first half of the year; that's what we would anticipate for the full year. With regards to the average size of prescriptions, again, that's been relatively stable across the indication set. Now, again, one of the things that you've heard Steve describe is the RA trial, for example, as is the case with several of our trials is designed to give both payers and prescribers more information about the duration of therapy for the product and the benefit that corresponds to that duration of therapy. So, as that data emerges, the size of prescriptions could change, but at this point, it's been relatively stable. With regards to pipeline urgency to extend, we're very pleased with the number of products that we have in development. I mean, we're looking at – potentially, it's up to half a dozen new products being launched out of our pipeline over the next three years, which is a significant number of things. And some of the SG&A savings that we're realizing, we're obviously turning that into some R&D expenses, as well as some launch preparation expenses. So, we think that we have a very attractive near-term pipeline. But certainly, over time, as I've alluded to, we want to continue to feed that pipeline, and we want to make sure that we have an ongoing pipeline of both products up and down the stages of development, as well as some technology platforms that we'll continue to drive organic growth over time. With regards to GI focus, again, I think we've been very clear to say, that is not our primary focus. But we did with the acquisition that brought AMITIZA primarily, because of the income stream. And we're very pleased with the performance that we've seen so far with AMITIZA. And again, we continue to believe that should deliver on the order of about $200 million in combination with Rescula for 2018. But in terms of further pursuing a GI focus, we don't really see that. Our focus is predominantly in some of the areas that Steve described, which would be in underserved patients with severe and critical conditions that are more aligned with the pipeline that we have. Of course, we were quite interested in both pipeline assets that the acquisition brought onboard, but VTS-270 is the one that fits squarely in our areas of focus with it being pediatric, primarily, neurodegenerative disease. So, those are the types of areas of focus that you're likely to see from us going forward.

[Matthew K. Harbaugh:]

Yeah. The only other thing I would add, Gary, this is Matt is I just want to highlight the fact that our R&D expense was 13% in the quarter, which is probably the highest it's ever been. And I just want to repeat what I said in the prepared remarks to make sure everyone hears it, which is you can expect to see both absolute R&D spending and R&D as a percentage of net sales to increase in coming quarters. So, the investment there is significant and growing.

[Gary Nachman:]

Okay. Thanks, guys.

[Daniel J. Speciale:]

Thank you. Operator, next question please.

[Operator:]

Our next question comes from Anthony Petrone with Jefferies. Your line is open.

[Anthony Petrone:]

Thanks, again. One on Acthar, and then maybe one on, actually, terlipressin. Don't think it came up on the call. So, just on Acthar, I know one of the issues – and just to maybe to parse out the detail on prior authorization denials and just funnel to maybe a sense of how the frontline funnel is exiting this quarter versus the last quarter, where do denials and prior authorizations sit this quarter versus last quarter? And then, the follow-up on terlipressin would just be on timelines for data readouts. And any updates you can give on terlipressin would be helpful. Thanks.

[Mark Trudeau:]

Yeah. Thanks, Anthony. So, I'll take the Acthar question. Steve, you can give an update on terlipressin. With regards to the performance Q2 versus Q1, as you see, we're slightly improving quarter-on-quarter. But recognize that virtually every Acthar prescription outside of IS, is going to go through a prior authorization process. Again, that's just the nature of the types of patients that we target, these highly refractory patients. And so, whether it's the top of the funnel or the bottom of the funnel, the status on that, the number of patients coming in versus getting approved is largely consistent with our expectations. And, again, it is improving slightly, certainly, over the quarter. And clearly, we look to be on a path to recovery, which we said in the prepared remarks. But in general, the product's performing just about where we expected it to. And I just want to reiterate, we continue to believe it'll be in excess of $1 billion in 2018.

[Steven Romano:]

Now, regarding, terlipressin, just remember, terlipressin is being developed for Hepatorenal Syndrome type 1, and it's an orphan drug status, so it's an area of certain need in the U.S. and Canada as well. It's a standard-of-care across the world, so it's a shame that the product hasn't reached the shores of the U.S. to treat our patients yet, but hopefully, it will be. And keep in mind, also, we have a special protocol assessment in place, which allows us to feel fairly certain that if the study is positive, we really can progress to submission and, hopefully, approval. So, we had 50% interim analysis that was completed earlier this year. I mentioned that briefly at the last meeting. That had a very high hurdle for stopping the trial for efficacy purposes. So, we passed that IA but it did not suggest stopping the trial. We have over 200 patients to-date enrolled, so we are enrolling actually a bit ahead of our expectations. This is a 300-patient study. We'll probably complete the study in the first half of 2019, so we'll have results in the back half of 2019. We're very much looking forward to that. We'll be able to submit the product and then look forward to approval, as I mentioned earlier, in 2020.

[Anthony Petrone:]

Helpful. Thank you.

[Daniel J. Speciale:]

Next question, please. Thanks, Anthony.

[Operator:]

Our next question comes from Elliot Wilbur with Raymond James. Your line is open.

[Elliot Wilbur:]

Thanks. Good morning. First question for Mark and a follow up for Matt. Mark, I know Express Scripts is out this morning with this commentary on some formulary changes for 2019, for which Acthar is not mentioned. But maybe, if you could just provide us some of your thoughts, or early color, or read on the 2019 contracting season, whether or not you think there's potential for major movement in Acthar's positioning based on discussions thus far? And then, for Matt, maybe you could just provide us with a little bit of color in terms of expectations for operating cash flow performance over the balance of the year, and how we should be thinking about debt reduction levels versus what has been paid down thus far. Thanks.

[Mark Trudeau:]

Yeah. So, with regards to Acthar access, again, I hate to sound like a broken record, but we're pretty pleased with the dialogue that we're having with payers. That would include Express Scripts, as well as other PBMs and other insurers. But again, this is an environment that continues to be somewhat variable, somewhat volatile, and somewhat unpredictable. And so, we saw a bit of that happen to us last year, and we just want to make sure going forward that we have good visibility to access. That's the primary objective is working closely with payers and then data generation. And the two go hand in hand. I can't emphasize that enough. Our position with payers and our – the strength of position with payers and prescribers is enhanced dramatically when we go in with new large robust data sets. And that's the whole strategy and has been from the beginning with Acthar, is invest in clinical data, which we've done to the extent of these six clinical trials and engage with payers proactively and continuously. And that will be the strategy for Acthar going forward. We're very excited frankly about what the next 12 to 24 months will bring with regards to Acthar data. And of course, our dialogue with payers and prescribers can change dramatically in a positive way if those data sets are positives. And of course, we're quite pleased with what we've seen on early read so far.

[Matthew K. Harbaugh:]

Yeah. Elliot, with regard to your question around operating cash flow, or free cash flow, I would say, the change that I would highlight for you in the prepared comments earlier today is that in the first quarter, we said we anticipated roughly $500 million in free cash flow for the year. Today, we said, we anticipate greater than $500 million in free cash flow. And the way to think about that is, six months in, we've generated about $200 million in free cash flow, because as you know, in the first quarter, we had a lot of noise as it related to closing on the Sucampo acquisition. So, we're at about $200 million; and we've said, greater than $500 million. So, you can come to your own conclusions as to the calendarization, but that's what we foresee. Notably, I would also add that we did pay an additional $75 million on the revolver, following the close of the quarter. And despite this, as we sit here today, our cash balance is still above $200 million. So, you can see we had about $235 million in cash at the end of the second quarter. We've already paid off another $75 million on the revolver, yet we still have greater than $200 million in cash. So, the cash cycle has continued to remain very strong.

[Daniel J. Speciale:]

Thank you. Operator, next question please.

[Operator:]

Our next question comes from Irina Koffler with Mizuho. Your line is open.

[Irina R. Koffler:]

Hi. Thanks for taking the questions. I had two follow-ups to two prior questions. One is on Acthar net pricing. You said there was a positive net pricing benefit slightly in 2018. Just wondering if that can continue longer term with the entry of lower cost products or competitors in the market. Can you still continue to take price? And then, the second question is on the free cash. How much of that came from your discontinued ops generics business? Thank you.

[Mark Trudeau:]

Yeah. So, with regards to Acthar net price, yes, Acthar net price is marginally modestly positive in 2018. With regards the pricing environment long term, whether it's the policy environment, or whether it's the competitive environment, that's going to evolve over time, and it really remains to be seen.

[Matthew K. Harbaugh:]

Yeah. With regard to your question around disc ops and its impact on cash, in the second quarter – and you'll see this when we file the 10-Q, in the second quarter, the generics business did generate a notable amount of cash, so a bit of a bump from what we saw in the first quarter. The first quarter was kind of around that $30 million range. And as we're looking at the back half of the year, it's going to be in the same zone. So, that'll kind of give you the color I think you need for your modeling.

[Irina R. Koffler:]

Thank you.

[Daniel J. Speciale:]

Thanks, Irina. Next question, please.

[Operator:]

Our next question comes from Jason Gerberry with Bank of America Merrill Lynch. Your line is open.

[Jason M. Gerberry:]

Hi. Good morning. Thanks for taking my question. My question just pertains to the Trump drug pricing blueprint. And one of the options that was framed was just, for high-cost drugs, looking at sort of indication-specific pricing, providing mechanism for Part D plans, I guess, to pay different pricing based on the indication. And I guess, one of the stated rationales was, if you have varying degrees of efficacy in different disease states to enable Part D plans to, I guess, negotiate different pricing. So, my question is, as you think about that potential proposal and impact on Acthar, I think, the last disclosure was Part D exposure was about 50% of revenues. And I guess as I think about it, a lot of plans have kind of framed only infantile spasms and MS as the two medically necessary indications. So, I'm wondering, if that's a potential risk that you could see differential pricing down the line. Thanks.

[Mark Trudeau:]

So, we believe that the best policy, frankly, is to deliver the appropriate drug to the appropriate patients at the best possible price. And we believe very strongly in that. We continued to look at creative ways to provide value to patients, prescribers, and payers in health care systems. And things like indication-specific pricing, frankly, we could see as a potential opportunity for Acthar or any of our other products down the line. One of the things that we're very encouraged by is the development of our self-injection device, which would certainly give us and give the marketplace more options and opportunity for us to consider a whole range of things that we could do, again, that would deliver more value to the marketplace. That allows us to tie it again to data generation activities that we have in place. And so, we would see all of these as what we call modernization activities around Acthar. And again, as the pricing environment changes and we fully expect that it will from a policy standpoint, we're preparing ourselves to be flexible and to certainly take opportunities where they may present themselves, whether it's indication-specific pricing or any other pricing mechanisms that will deliver value to the health care system. With regards to Acthar and Part D, yes, our Medicare – the proportion of business that is typically reimbursed for Medicare is about 50%, and it's been relatively stable in that range for some time now.

[Jason M. Gerberry:]

Great. Appreciate the feedback.

[Daniel J. Speciale:]

Thank you very much. Operator, it looks like we've got a time for a couple more questions. Please feel free to go ahead.

[Operator:]

Our next question is from Louise Chen with Cantor Fitzgerald. Your line is open.

[Louise Chen:]

Hi. Thanks for taking my question here. I had a few. So, first question I had was on the Acthar sales. In the quarter, they were obviously stronger than expected. Was this all demand-driven? Was there any stocking? And then secondly, on the cost base for Acthar, how much is variable versus fixed? And then, the last question I had was just on your priority review voucher for VTS-270 from Sucampo. Is this something that you plan to keep, that you plan to monetize, and what are your thoughts there?

[Mark Trudeau:]

Yeah, so maybe I'll take the first part of the Acthar question. I'll ask Matt and Steve to comment on the balance of the questions. With regards to Acthar sales, again, this is essentially demand-driven. We're not seeing a lot of variability going on in terms of stocking quarter-to-quarter. So, yes, everything that you're seeing is primarily demand-driven. And recognize, while it might have been a bit better than the marketplace anticipated, it's clearly in line with what our expectations are. And again, we continue to believe this product is going to be in excess of $1 billion in 2018. So, maybe we can pick the other two

[Matthew K. Harbaugh:]

Yeah. I'm not entirely clear on what your specific question is. Can you reframe it?

[Louise Chen:]

Yeah, sure. So, I was just curious, given the fact that there could be competition coming for Acthar and the sales moved around a little bit, there's a lot of debate on the go-forward sales, just curious, if something were to happen to the sales unexpectedly, is there any amount of cost that you can cut out of the system to keep the product profitable?

[Matthew K. Harbaugh:]

Yeah. We would certainly look to do that if that were to be the case. But as you know, we've invested very heavily on Acthar, whether it be modernizing the manufacturing, all of the stuff that Steve went through as it relates to Acthar, all these trials. So, we believe strongly that the cash flows for Acthar are going to continue well into the future. Yes, there is some variable expense associated with it. We really aren't thinking about it that way right now. We're really in an investment phase for Acthar to bring the data forward to capture more patients and to be able to get more data in front of payers in particular. So, we're not really thinking about it the way you're framing the question. I think that's why I needed you to clarify it.

[Steven Romano:]

Yeah. And then, just lastly, and briefly on the VTS-270 priority voucher. Remember, priority vouchers aren't actually given until you achieve approval. So, our first step forward here is ensuring that the study has its best opportunity for positive outcome. And then, following actual approval of a product, we would receive that. At that time, we will determine what the best disposition for that particular opportunity. Thanks.

[Louise Chen:]

Thank you.

[Daniel J. Speciale:]

Thank you. Next question. Our last question, please.

[Operator:]

And our last question is from David Buck with B. Riley FBR. Your line is open.

[David George Buck:]

Yes. Thanks for taking the question. Just a couple of quick ones. Maybe for Steve, can you talk a little bit about just your best sense of timing with VTS-270, when we'll actually hear the data? I know you've mentioned the SAP plan, going over that with the FDA. Is your sense that you'll have that process completed by, say, September, or what's the best guess there? And then for Matt, what's the sort of the bogey for R&D spending the rest of the year? I know you mentioned going up sequentially in absolute and percentage of sales, but is that something that could actually approach $350 million for next year or go above that? What should we be looking at, going forward? Thanks.

[Steven Romano:]

Yeah. So, very briefly on the VTS-270, as I mentioned, we have a meeting with the FDA in just two weeks. It's a Type A meeting, and that is to review the SAP and come to an agreement on our final plan. We will very soon afterwards be able to lock the database, at which point, probably within four to six weeks, we'll have that data. So, looking forward, early fall, essentially, we're going to have that data, very soon.

[Matthew K. Harbaugh:]

Yeah. As it relates to the spending, David, we were in a very, very busy period, as you can tell. I mean, Dr. Romano has a lot of activities going on all right now. We also have some incremental onetime payments that'll be going out associated with some of the products in the pipeline, and we see those both in the third and fourth quarter. And that's what's leading us to provide you with the commentary track around expecting to see both absolute R&D spending and R&D as a percentage of net sales to increase in the coming quarters. It's a little too preliminary to talk about 2019 just yet, as it relates to R&D spending, but at the levels we're at right now, it is notable and significant when compared with the past, and we expect it to continue.

[Daniel J. Speciale:]

Thanks, David. I think that'll wrap up our questions for today. I'd like to thank everyone for joining our call this morning. As a reminder, a replay of the call will be available on our website later today. I'll also be available throughout the day to answer any follow-up questions any of you have. So, thanks, everyone, and have a nice day.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thanks for your participation, and have a wonderful day.