Mallinckrodt plc
Q3 2016 Earnings Call Transcript

Published: 2 Aug 2016

[Operator:]

Good day, ladies and gentlemen. Welcome to the Mallinckrodt Third Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. Cole Lannum, Senior Vice President, Investor Relations. Sir, you may begin.

[Coleman N. Lannum:]

Thank you, Taria, and welcome to today's call. Joining me are Mark Trudeau, President and Chief Executive Officer and Matt Harbaugh, our Chief Financial Officer. Mark will start us off with some brief introductory comments, followed by Matt, who will provide details on our financials. And then, we'll go into our customary Q&A session. Before we begin, let me remind you of some important details. On the call, you'll hear us making some forward-looking statements and it's possible that actual results could be materially different from our current expectations. Please note that we assume no obligation to update the information contained in 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 financial measures with respect to our 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 the Investor Relations page of our website for such information. As noted in our press release, unless otherwise specified, all comparisons of quarterly performance are to the third quarter of fiscal 2015. In addition, the revenue growth ranges we'll be discussing are on a constant currency basis unless otherwise noted. This morning, we provided an adjusted diluted earnings guidance range for calendar year 2016, the 53-week period ending December 30, 2016, of $8.50 to $8.80 per share. We also noted that we now expect results from fiscal year 2016, the period ending September 30, 2016, to come in above the high end of the previously provided range of $8.15 to $8.50 per share. For the June quarter, we reported GAAP diluted earnings per share from continuing operations of $1.79. After adjusting for specified items our non-GAAP adjusted diluted earnings came in at $2.20 per share. Now, I'll turn it over to Mark who'll go into more detail on the third quarter results. Mark?

[Mark C. Trudeau:]

Thanks, Cole, and thanks to all of you for joining us on today's call. I'm pleased to report that Mallinckrodt delivered another very strong quarter, driven by outstanding performance across the Specialty Brands portfolio and a more moderate decline than we expected for Specialty Generics. Our excellent performance reflects an ongoing focus on execution, especially in our Specialty Brands commercial and scientific organizations, as we continue to generate compelling new data and clinical evidence for key brands and work to bring this data to new physicians and patients, clear evidence that our acquire-to-invest strategy is creating performance momentum. Net sales were up 11% for the third quarter, led by steady volume increases across the Specialty Brands segment, which as a whole was up 32%. Adjusted diluted earnings per share growth was notable as well, up 9% for the quarter. This volume-based performance in Specialty Brands continues the trend established over the past several quarters and, looking ahead, we see opportunities to continue to drive volume growth in this segment. Our strong showing here clearly demonstrates that we are executing against our strategy by investing in our Specialty Brands to create near- and long-term value for patients and shareholders. In Specialty Generics the decline in the quarter was somewhat less steep than we had anticipated, and this segment continues to generate solid cash flow. But while this quarter's performance was more positive, our expectations remain consistent with those we described a year ago, and we foresee pressure on this segment for at least the next several quarters. Our focus on execution across the business is contributing to our progress as we continue to make strategic investments to build our brand assets and grow volumes in areas of high unmet medical need. Let me illustrate that further. We're building on the growing body of evidence for our products by generating new clinical and health economic data. In the quarter, we had approximately 40 data presentations in publications, including nearly 20 for Acthar and more than a dozen for INOMAX, bringing our overall year-to-date total to roughly 80 publications and presentations. More than a quarter of these have focused on quantifying health economic outcomes, and we anticipate this overall level of data generation to continue. Perhaps most importantly, in fiscal 2016, we have initiated six company-sponsored, randomized, controlled clinical trials for our products and in coming quarters expect to initiate several additional new studies, including a number for Acthar. I'll provide a bit more detail on some of our R&D programs in just a moment. Now let me turn to Specialty Brands and give you some additional perspective on our performance. As in previous periods, publication of new data, combined with commercial and medical affairs focus, contributed to another strong quarter for Acthar, with net sales up 11% in the period, driven entirely by volume. This volume growth was propelled by solid demand, increased contracting, and expanded access in more recently promoted indications such as lupus and sarcoidosis, as well as more mature indications such as infantile spasms and nephrotic syndrome. We're particularly encouraged that our efforts are beginning to reach a whole new generation of physicians, providing them strong data on the benefits of this tried-and-true medication to treat patients suffering from complex and often devastating conditions such as infantile spasms and lupus. In infantile spasms, renewed focus has resulted in substantial share growth, improving reach to this fragile patient population. In the past several months, we believe recently published data on Acthar use in lupus patients has continued to help a new cohort of physicians better understand the value Acthar can provide to appropriate patients afflicted with this devastating disease. We're also seeing strong ongoing adoption in other indications as well, particularly steady increases in pulmonology prescribing as physicians absorb recently published data detailing Acthar's use in sarcoidosis. In the Hospital business, INOMAX, our second largest product, delivered another stellar quarter, with net sales up 24% on a pro forma basis, reflecting both a favorable contracting cycle and an increase in demand. Utilization of nitric oxide has also been supported by treatment guidelines recently published jointly by the American Heart Association and the American Thoracic Society. While we believe this business is likely to see near-term growth rates higher than historical norms, we anticipate a return to more traditional mid-single-digit growth rates longer-term. I'm happy to report we achieved 14% revenue growth for OFIRMEV in the quarter, results wholly driven by volume. Our strong performance is the result of commercial execution, bolstered by recent presentations of health economic data and a growing acceptance of the benefits multimodal analgesia brings to patients and the healthcare system. We remain confident that growth for OFIRMEV will continue, allowing us to further expand patient reach. We continue to be encouraged by the performance of Therakos, with net sales growth of 16% on a pro forma basis, and are especially pleased that this performance is the result of increased demand and significant growth across multiple geographies. Since acquiring the business nearly a year ago, we've advanced the service component of Therakos to better align with that of INOMAX. And we're evaluating various commercial models to reach the best value proposition for customers and expand patient access. Longer-term, we expect Therakos growth to settle more in the historical high-single-digit range. Closing out Specialty Brands, we've recently begun the launch cycle for PreveLeak, expanding our U.S. hemostasis portfolio, and remain on track to launch RAPLIXA later this year. As we've said previously, this portfolio is expected to see double-digit growth longer-term over its 2016 base of $40 million to $45 million, largely driven by the planned launches of these new products. Turning to Specialty Generics. Net sales were down 14% versus last year's historical high. Despite these results, this business generates valuable cash flow and provides benefits to patients and the healthcare system with safe, cost-effective medicine. Many factors are contributing to the market volatility in this sector, and we still expect the business to face significant headwinds for at least the next several quarters. Providing some additional detail in science and technology, we continue to invest heavily in programs to support key inline and developmental products, particularly in Specialty Brands and, in the quarter, announced the first patient enrolled in our company-sponsored trial for Acthar in a key nephrotic syndrome called FSGS, the largest trial yet undertaken for this condition. In other areas of the portfolio, we completed preparations for the Phase 3 Terlipressin registration trial, began recruiting patients and saw the first patient treated last month. We completed our company-sponsored controlled pharmacokinetic study evaluating the interaction profile of OFIRMEV given with IV morphine, compared to oral acetaminophen given with IV morphine, and we expect to report the data in coming months. And we're pleased to report the first patient has entered our company-sponsored Phase 4 study comparing OFIRMEV with oral acetaminophen in total knee replacement. Recruitment in this study is ongoing. As announced, we submitted an Investigational New Drug application to the FDA for the study of Synacthen in patients with Duchenne muscular dystrophy and continue to drive developments of this product. And finally, our company-sponsored Phase 3 clinical trial to assess the effectiveness of Therakos therapy in pediatric patients with steroid refractory acute graft-versus-host disease is proceeding to plan. On the business development front, we continue to be very active in optimizing our commercial and development portfolio. Key areas of focus remain building on our Specialty Brands growth platforms as well as the Specialty Generics business. We're assessing attractive opportunities, both commercial stage and developmental, and expect to further add to our portfolio in coming quarters. As we look ahead, we remain confident in our ability to execute on our proven strategy to bring value to patients and shareholders. Now I'll turn the call over to Matt. Matt?

[Matthew K. Harbaugh:]

Thanks, Mark. Let me take a few moments to go a little deeper into our financials. You've seen the third quarter fiscal 2016 was very strong, fueled largely by our higher margin Specialty Brands segment coming in ahead of expectations. Net sales from continuing operations were $971 million, representing growth of 11%. Third quarter net sales for the Specialty Brands segment were $589 million, representing growth of 32%, reflecting especially strong performance from key brands and ongoing focus on driving volume. Acthar performed at the high end of our expectations in the quarter with $298 million in net sales, an 11% increase. We're also pleased to report that INOMAX generated $121 million in net sales, a 24% increase on a pro forma basis. This was exceptional for INOMAX, and we believe the factors contributing to this growth will continue to be drivers in the near-term. But we also anticipate that longer-range INOMAX performance will be closer to historical growth levels in the mid-single digits. Turning to OFIRMEV, we were very pleased to see another increase in volume demand for the quarter, with revenue growth of 14%. The Therakos business also performed well with net sales of $53 million, a 16% increase on a pro forma basis. Now let's turn to our Specialty Generics segment, which performed a bit better than we expected in the quarter, though challenged by increased competition across a number of categories. We saw net sales of $263 million, representing a 14% decline over prior year. Segment net sales for Nuclear Imaging were $104 million, a 5% decline. Total company adjusted gross profit as a percentage of net sales declined slightly less than anticipated. Tough comparables in Specialty Generics continue to drive these results, albeit they were partially offset by strong Specialty Brands performance. We're very pleased to report R&D spending in the quarter was up over prior year at 7.8% of net sales overall. We continue to be focused on accelerating investments in key opportunities for the company in the fourth quarter of fiscal 2016 and beyond. In the third quarter, investment in our Specialty Brands segment was well above that spend level, with particular focus on Acthar. Our adjusted effective tax rate in the third quarter was 18.6%, compared to 16.8%, affected primarily by business mix. In transitioning from a Specialty Generics and Imaging business to one dominated by Specialty Brands, Mallinckrodt has undergone significant organizational change in the last three years. And we expect this transformation to continue and even accelerate near-term, though it will eventually level off. Accordingly, our original three-year restructuring program was completed in the fiscal third-quarter and our board has authorized new restructuring in the amount of $100 million to $125 million to continue to refine our cost structure. Turning to the balance sheet and liquidity. We generated free cash flow of $412 million in the third quarter, bringing the year-to-date total to $861 million. Given the strong cash position in the quarter, we elected to pay $150 million of borrowings under our revolving credit facility. At the same time, we returned $100 million in cash to shareholders in the form of share repurchases, bringing the total shares repurchased under our authorized program in the past four quarters to $675 million or 9.9 million shares, 8.3% of total fully diluted shares outstanding. Despite these actions, we ended the quarter with a cash balance of $522 million and very manageable liquidity and leverage, with a net debt leverage ratio of a modest 3.5, as you can see posted on our website this morning. Notably, in July, we utilized cash to pay off the remaining balance of $250 million on our revolving credit facility. We will continue this focus on working capital management and while not anticipated at the levels achieved in the third quarter, we expect continued strong free cash flow generation through the remainder of 2016 and beyond. Our robust cash position continues to provide us significant flexibility as we consider additional business development opportunities. At this point, I'll turn it back over Cole who will take us into Q&A.

[Coleman N. Lannum:]

Thanks, Matt. Before we start the Q&A session, I want to remind you again to please limit yourself to a single question with brief follow-up, if needed. Feel free to put yourself back in queue afterwards and I promise we'll get through as many questions as possible. With that, operator, may we please have the first question?

[Operator:]

Certainly, our first question comes from the line of David Maris of Wells Fargo. Your line is now open.

[David Maris:]

Good morning, Mark and Matt. Mallinckrodt's really been clicking operationally in 2016. So maybe if you could step back and tell us what you think has changed from 2015 organizationally to account for this? Is it just the jellying of the businesses? Or is there managerial changes that you made after the disappointment of last year? Thank you.

[Mark C. Trudeau:]

Well, thanks, David. So yes, we're very pleased with the fact that operationally the businesses is doing quite well and continues to exhibit strong volume-generated growth. Much of that has to do with the approach that we've taken to the business, which is a combination of activities between what I would call traditional commercial activities, sales force and market access, combined with a significant enhancement of our approach to medical affairs activities. And if you noticed in our prepared comments, we did highlight the fact that it's this combination of factors. We've been very clear to say that we believe that we have a product portfolio that has significant volume upside opportunities. And we're demonstrating volume-driven growth across our Specialty Brands portfolio. That happens through this combination of efforts and for a variety of our products we've focused on generating new data, some of that data is the form of clinical studies, some of that data is in the form of health economic studies, but there are many other forms of data. It's that combination of data generation with the commercial activities that we believe is driving the execution across the board. From an organizational standpoint, we do operate our Brands business in a fairly focused manner, in the sense that we have an organization that focuses specifically in the hospital area and another organization that focuses specifically in the autoimmune area. That enables us to have sufficient firepower and focus on those businesses and those customers to ensure that we execute our volume-based strategy going forward.

[Coleman N. Lannum:]

Thanks, David. Next question, please.

[David Maris:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from David Risinger of Morgan Stanley. Your line is now open.

[David R. Risinger:]

Thanks very much. I was hoping that you could please quantify the evolution of payer access for Acthar. I know that you've improved the access, but if you could put it into numerical terms so we can understand the progression over the past couple of quarters and where the product stands today, that would be very helpful? Thanks very much.

[Mark C. Trudeau:]

So yes, David, thank you for the question. And again, our strategy around Acthar and driving growth opportunities for Acthar I think has been quite clear since the beginning. We said from the very beginning that our belief with this product is, one, that it's a very durable asset. It's a very durable asset that also has relatively low patient penetration. Those two things combined enabled us to start to invest in that product. And we have been investing significantly in data generation activities around Acthar. And our belief is that we can drive long-term volume growth and greater patient penetration through a combination of market access activities as well as data generation. The way we think about it is market access kind of gives us the opportunity to drive data into new patients – or sorry, new physicians and new patients, and we're seeing that type of momentum being created. So if we think about our objective, our objective in managed care was to ensure that we had open access to the indication set that we have for Acthar, which is extensive as you know, with 19 separate indications. And our focus in managed care was and continues to be ensuring that we have this open access. So the approach there has been to contract for covered lives, particularly in the commercial sector. And our stated objective was to ensure that Acthar was under some form of a contract for open access in the majority of covered commercial lives. And when we started that proposition, when we acquired the product in 2014 Acthar was covered under contract by – the proportion of covered lives under contract for Acthar was essentially zero. So over the course of the last two years or so, we have moved that from zero to now greater than 50%. And we have reported a couple of times on the progress that we've made. And so we've been able to get the commercialized under contract through I believe some very attractive approaches in the managed care arena. Our objective longer-term would be to continue to drive even greater access. We don't anticipate that we'll ever get to 100%, but we want to continue to ensure that Acthar has long-term access in managed care because as we generate more data it gives us a greater opportunity to further drive that product's volume growth longer-term.

[David R. Risinger:]

That's very helpful. And one quick follow-up, any inflections ahead, meaning any incremental coverage changes in the next quarter or that you expect in January?

[Mark C. Trudeau:]

Well, we would always hope to be able to improve Acthar's coverage and Acthar's access. And as we have opportunities and as we have successes in that area, we'll report on those from time to time. We're not necessarily giving any specific quarterly projections on how we'll progress, but we're quite pleased with the fact that we've been able to get greater than 50% of commercial covered lives under contract actually a bit sooner than we expected.

[David R. Risinger:]

Thank you.

[Coleman N. Lannum:]

Thanks, David. Next question.

[Operator:]

Thank you. Our next question comes from Chris Schott of JPMorgan. Your line is now open.

[Chris Schott:]

Great, thanks very much for the question. On the Specialty Generic business, the results were better than you expected this quarter. So can you maybe just elaborate on your cautious views in the environment going forward? I guess what are you seeing out there and what are your latest thoughts on when and at what sales level this business could start to bottom out? Thank you.

[Matthew K. Harbaugh:]

Yeah. Good morning, Chris. I would start by saying we're nowhere near out of the woods yet in the Specialty Generics business and that's why we were cautious in our comments. What we're seeing now obviously is that the Specialty Brands business performance has been so strong that it has been able to mitigate the impact of Specialty Generics. I would also highlight that the Specialty Generics segment is 27% of the revenue of Mallinckrodt. So – and coming out of gates, kind of going back to David Maris' question earlier, it was nearly 50% at spin. And so one of the ways we've been able to mute the risks and the challenges in the Specialty Generics business is the robust growth and the additions that we've made to the portfolio in Specialty Brands. So generally what I would say is we were pleased with the performance in this quarter, but I would say, really, the weakness in the Generics business is likely to be similar to what we expected earlier in the year. And this recent strength is really just going to be pushed out. And so we do foresee more challenges. But again, with it now being 27% of the revenue, that enabled us to increase guidance this morning as well because we're able to mitigate that risk.

[Mark C. Trudeau:]

Chris, let me add, too. I mean, we do have a bit of vision into some of the competitive folks that are coming in down the line and the reality is some of those haven't hit yet. They will over the next couple of quarters. We realize that and that's something we're going to have to just manage through.

[Chris Schott:]

Great. Thanks very much.

[Operator:]

Thank you. Our next question comes from Louise Chen of Guggenheim. Your line is now open.

[Louise Chen:]

Hi. Thanks for taking my question. So one thing that we often get from investors is the curiosity behind how you're going to diversify your sales away from Acthar. So, curious to see if we could get your thoughts here. Thanks.

[Mark C. Trudeau:]

Yeah. Thanks, Louise. Well, I think we've continued to diversify our portfolio. If you look at our Hospital business now, for example, you have a business that now is comprised of roughly six different brands and that total portfolio of products is about $1 billion. So if you look at our overall portfolio, we're roughly $1 billion of Acthar, $1 billion of Hospital, $1 billion of Generics and a few other things. So we actually think we have a quite diversified portfolio. And again, we're quite pleased with the growth that we are seeing in that Hospital business, between OFIRMEV, the outstanding performance of INOMAX, the strong performance of Therakos. These products are growing in the double-digit range across the board. And so we're quite pleased with the diversification of that portfolio. And in addition now, we're launching additional products, and we've got a late-stage development asset in Terlipressin, which will also add to this portfolio over time. So we think the diversification of our portfolio is actually quite strong now, but we're not done and we want to continue to enhance, develop, deepen our portfolio of both commercial assets as well as developmental assets. And we'll continue to do that through business development. If you look at our business in autoimmune and rare diseases, which today is primarily Acthar, we really have presence – commercial and scientific presence now in at least four or five different therapeutic areas. Our objective long-term would be to build diversified businesses around those therapeutic areas and then continue to further expand our platform in the hospital, which is really a channel strategy and it enables us to bring in a variety of different unique assets, all of which serve the hospitalized patient. So we like the strategy that we've set up. We believe we have two very scalable platforms in ARD and Hospital. We believe there are some very, very attractive assets out there, both commercial as well as developmental assets. And we want to continue to use our strong cash flow that you saw demonstrated in this quarter to go out and acquire those assets to diversify ourselves so that we have a well-diversified portfolio, even more so than today, of both commercial and developmental assets. Our long-term objective for this business is to have a well-diversified portfolio that can grow organically in the mid-single digits, and we believe we're well on our way to achieving that objective.

[Matthew K. Harbaugh:]

Yeah, and I would just add from a financial perspective and a business development perspective, as Mark highlighted, I mean, we generated operating cash flow $454 million in the last quarter alone. Free cash flow was $412 million. If there was any question mark around our ability to generate cash or get to that guidance we provided a year ago of approximately $1 billion in free cash flow, you see the evidence of what we saw this time last year when we were providing that guidance. And since we've also been able to pay down the revolver and we also have very modest net debt leverage, as you can see on the website we posted the reconciliation this morning of 3.5, we have plenty of room to accommodate any incremental business development.

[Coleman N. Lannum:]

Thanks, Louise. Next question, please.

[Operator:]

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

[Sumant S. Kulkarni:]

Good morning. Thanks for taking my question. My question is around INOMAX, which is becoming a more and more important product. How is the company thinking about duration of that asset given the IPR process and the conventional people challenge coming to head over the next few months? And what exactly would be the logistics of generic penetration there if Acthar is able to launch?

[Mark C. Trudeau:]

Yeah, thanks Sumant. Yes, we're very pleased with the INOMAX business. Keep in mind that this was the business when we bought it a little over a year ago that had been growing in the mid-single-digit range for a number of years. And we're very pleased that we've been able to fairly dramatically accelerate that growth rate over the last several quarters. And we think that's the combination of effects. One is that we've clearly been able to contract effectively. Two, we're clearly seeing additional demand. And as you may recall in our primary indication for INOMAX, which is for neonates in the NICU, we believe we had about a 50% patient penetration rate. And we believe as a result of our contracting strategy, we're able to significantly now enhance that penetration rate and that's certainly leading to some of the volume increases that we're seeing. We believe, again, this is a very durable asset. We've got intellectual property and patent protection for this asset both on the drug side as well as the device side that go out well into the late 2020s and into the 2030s. And you may have noticed that we actually just posted three additional new patents around this particular asset. We were also very pleased that we prevailed in kind of the first round of the IPR activities, particularly on four out of the five drug patents. And keep in mind in order to keep our exclusivity out into the late 2020s around the drug side, we only need to prevail on one of the claims in one of the patents and there are multiple claims across multiple patents. So, we feel quite strongly about this and we'll continue to generate more intellectual property and patent estate, as you've just seen us do as we go forward. Again, we think it's a very, very durable asset. In terms of a generic entry coming in, we think that's a highly unlikely proposition, certainly not before the late 2020s at this point.

[Sumant S. Kulkarni:]

Thank you.

[Coleman N. Lannum:]

Next question, please.

[Operator:]

Our next question comes from Douglas Tsao of Barclays. Your line is now open.

[Douglas Tsao:]

Good morning. Thanks for taking the questions. Just, Mark, maybe you can provide a little color in terms of the Therakos performance. Obviously, you sort of pointed to an increase in demand across multiple geographies. In particular in terms of demand, is that primarily in CTCL? Or are you seeing other uses of the system? Thank you very much.

[Mark C. Trudeau:]

Yes. Thank you, Doug. Yeah, again, very pleased with Therakos. Again 16% growth in the quarter is significantly higher than the historical growth rate that we had seen with this product before we acquired it roughly a year ago. Our hypothesis was that we could use some of the elements of the INOMAX approach and apply those to Therakos and certainly on the service side, the back-office side, we've already done that integration. And we believe that some of the enhanced growth that we're seeing in Therakos is the result of some of those synergies that we've been able to capture from the INOMAX model. We think there are also opportunities longer-term for us to look at other commercial ways that we can further provide greater patient access to Therakos therapy by looking at the INOMAX model, although recognizing that sales organizations are separate, given that the sales approach in INOMAX is really into the neonatal population and in the Therakos case is a bit more into the adult population. We believe that the opportunities are significant in CTCL for the simple reason that patient penetration rates there for appropriate patients are only on the order of about 10% to 15%. And we believe that the growth opportunity is primarily in that space near-term. Obviously, we are also conducting additional work for Therakos to further expand the label and our study in pediatric patients with acute graft-versus-host disease is ongoing, as we mentioned in the prepared remarks. And we would expect, assuming that that trial is positive, that that could potentially lead to an expansion in the Therakos label, which again would give us greater volume growth opportunities longer-term rate.

[Douglas Tsao:]

Great. And then, Mark, if you could just provide a little more color in terms of some of those back-office activities that you referenced? And when do you expect the graft-versus-host study to read-out? Thank you.

[Mark C. Trudeau:]

Yeah. The way the back-office piece of it works is very simple in the sense that these are – both INOMAX and Therakos our drug device combinations, which adds to their exclusivity, if you will, and durability is assets. And as such, there's a certain amount of training and a certain amount of service that goes along with any kind of a device drug combination and that approach was finally honed in the INOMAX case. And so, we've used that service and training approach with Therakos, a capability that wasn't quite as well developed. And again, we're seeing that benefit, we think, in the access to the accounts as a result of that streamlined sales and service model – or primarily service and training model that we have from the INOMAX side. In terms of acute graft-versus-host disease, this is a study that will read-out probably in the next two to three years. So again, this is a longer-term opportunity for Therakos. And we believe that near-term there's plenty of opportunity for us to drive patient penetration and volume in CTCL.

[Coleman N. Lannum:]

Thanks, Doug. Next question, please.

[Operator:]

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

[Gregg Gilbert:]

Thanks. Good morning. Matt, not that I'm complaining about the cash flow, but can you talk about any timing or one-time issues that helped in the quarter, given how much higher it was than net income?

[Matthew K. Harbaugh:]

Yeah. Thank you, Gregg. Obviously, the third quarter was incredibly strong. And so generally, our third quarter tends to be our strongest cash flow quarter, if you look at it over time albeit it was eye-popping. Gregg, there were a few kind of one-timers in there, but the lion's share by far of the cash delivery was the strength that we saw in the Specialty Brands business, particularly INOMAX and Acthar generated very strong cash for us. And then with Generics being a bit stronger than what we were anticipating earlier in the year, the amount of cash that it generated was greater than what we had expected, but it will certainly moderate. But I can tell you when we gave guidance a year ago that we were looking to see approximately $1 billion in free cash flow. I was really happy to see such strong cash in the third quarter because it puts us in good shape to deliver on that commitment.

[Gregg Gilbert:]

And as a follow-up, could you quantify the negative price effect for Acthar in the quarter? Thanks.

[Matthew K. Harbaugh:]

Yeah. So, it was negative and it was – Acthar was entirely driven by volume. The pricing impact was not huge in this quarter, but it will be more material and more significant as we move into future quarters because it directly correlates with what Mark was talking about earlier around the commercial covered lives and the contracts that we've signed. There is a lag effect. When you sign those contracts it tends to take some time for them to really kick in and the rebating cycle to increase. So there will be more pressure on price in future quarters, but obviously, we're very happy with the volume we saw for Acthar.

[Mark C. Trudeau:]

Yeah, and I would just add, Gregg, we've been very consistent to say the growth rate to expect for Acthar is in that mid-single-digit to low double-digit range and we've consistently been delivering on that range, including this quarter. We've taken into account fully the potential pricing impacts of our contracting strategy and giving that direction and we're quite comfortable in that range going forward.

[Coleman N. Lannum:]

Thanks. Next question, please.

[Operator:]

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

[David A. Amsellem:]

Thanks. So, you talked about all the clinical trial activities surrounding Acthar. I was wondering if you could call out potentially important or noteworthy data read-outs presentations that you think we should be aware of over the next six to 12 months. Or maybe put another way, what kind of data presentations over the next six to 12 months could be impactful along the lines of the lupus data, for instance, that you presented at ACR last November. Thanks.

[Mark C. Trudeau:]

Yeah, thanks, David. So yeah, we're very excited about the potential for Acthar. And again, given the durability of this asset, we believe the investments on the clinical side are very important and are likely to continue to drive Acthar volume long-term. We're in the process right now, as you know, of essentially wrapping up some of the trials that had been initiated under previous ownership, but we're also dramatically and significantly increasing our investment across the board in Acthar data generation, including a number of clinical trials. As you saw, each quarter, we've been reporting on the number of data sets that read-out. A lot of the data that we've been generating that's new, if you will, is on the health economic side because, as you might imagine, there's a wealth of data available in the marketplace for this product that just needs to be analyzed, quantified and presented. And so we'll focus near-term on using that information and bringing it to the marketplace. And we believe that's certainly having an impact on a variety of different physicians and in managed care organizations as we really now quantify the pretty significant data set that currently exists for Acthar. On the clinical side, as we mentioned in the prepared remarks, we've initiated six clinical trials this year. We plan to initiate several more; that's across our branded portfolio. And several of these will be in the Acthar arena. We already gave you some insight into the fact that we're going to be doing another trial in lupus, significantly larger than we had done initially or had been done initially, which we would consider to be a pilot trial and we were very pleased with the outcome of that pilot trial, which gives us very good confidence to go ahead and invest further in lupus. But there are other areas in the Acthar label that we believe could give us significant opportunities through additional controlled clinical trials. And as we finalize the details of those trials, we'll be reporting on those. But those trials are now just initiating, and so they'll typically take a couple of years before they read-out. The way I think about this though is much like we did in the lupus arena, we want to focus the controlled clinical data, particularly that of which is either active control or placebo control in patient sub-populations like we did in the lupus arena, which is a particularly standard way that one would go about generating clinical data for indications that you already have on label. Again, our focus will be primarily on generating data for on-label indications, and we will continue to look for other opportunities to drive Acthar growth through data generation in the coming years.

[David A. Amsellem:]

Thank you.

[Coleman N. Lannum:]

Thanks. Next question, please.

[Operator:]

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

[Gary Jay Nachman:]

Hi. Good morning. Mark, just a follow-up on the commercial side for Acthar, where is most of the incremental growth coming from in terms of indications? And are you seeing a real meaningful increase in the number of prescribers? Or is it still very concentrated? How much has the increased sales force helped? And could you potentially take it up even more? Thanks.

[Mark C. Trudeau:]

So again in the prepared remarks, Gary, I think we were pretty clear to say that across the board really we're seeing growth for Acthar in most of the therapeutic indications. Infantile spasms, for example, we're seeing significant growth in market share as we refocus the neurology sales force into this area and that's certainly a significant benefit for patients. And as you know, we have very, very strong data for Acthar's use in infantile spasms. We're seeing a lot of growth in the rheumatology arena, again, across the board. And we believe based on market research that the lupus data that was presented in two tranches for Acthar, both the controlled phase as well as the open-label phase, is starting to open up to a whole new cohort of physicians a further opportunity for those physicians to provide benefit to their lupus patients. We're seeing significant growth in the area of sarcoidosis, as data was presented earlier this year which shows Acthar's utility in that space where there are really very, very few options for these very, very sick patients. So across pulmonology, rheumatology, certainly in infantile spasms, these are the areas that are continuing to drive growth. In terms of sales force, I think that we have a significant and appropriately sized sales organization. Keep in mind that each one of our sales forces is really focused primarily on a given therapeutic area, which means that each one of these sales forces is highly specialized. And I think while the sales force certainly is having an impact, it's really the intersection of the activities that we're generating between market access, the sales organization and then really the generation of significant additional data, particularly on the health economic side, which together these three things, I believe, are really starting to open up a whole new group of physicians and their interest in Acthar and the prescribing and the volume that we're seeing as a result of that combination of factors.

[Matthew K. Harbaugh:]

Yeah, and if you think about it in the theme of acquire-to-invest I would go back to the prepared remarks in my section, Gary, around the increase we saw in R&D spending. We also saw an uptick in SG&A, which we had predicted earlier in the year as well. And this reinvestment is reaping great rewards for us as we saw today with the strong earnings per share, which in turn translated into cash. So we're not surprised to see that uptick. In fact, we're happy to see that uptick, particularly in the R&D line, but also in the SG&A because we're getting a return for all that effort.

[Gary Jay Nachman:]

Okay. Thanks, guys.

[Coleman N. Lannum:]

Thanks. Next question, please.

[Operator:]

Our next question comes from Marc Goodman of UBS. Your line is now open.

[Marc Goodman:]

Yes, morning. Mark, I heard your comments on M&A, but I was wondering if you could just talk about what are your priorities in M&A right now? And I mean that from the perspective of do you feel like the Generics business needs more critical mass? Or you're happy with that? Or do you feel like the growth of the assets that you've already acquired over the past couple of years are doing great and it's more important to buy an asset that's in the pipeline versus commercialized assets? And how does your priorities match up with what you're seeing out there? Thanks.

[Mark C. Trudeau:]

Yes. So I would say that our objective is to enhance the portfolio, further diversify it both on the commercial side as well as the development side. With our objective, again, being having a well-diversified portfolio that can grow organically over time in that mid-single-digit range. So all else being equal, we would be quite interested in enhancing our Specialty Brands portfolio, whether it's in the ARD arena or in the hospital arena. And you know we like both commercialized assets, but we have a significant need to further enhance our development portfolio. And so we're happy to bring in assets that do both of those things or either of those things. And an asset like we did with the Ikaria acquisition, for example, is a very good one. We bring in a great commercialized asset in INOMAX and a late-stage development asset in Terlipressin. So we would love to do those types of acquisitions. And we see plenty of opportunities out there that are both accessible and will make very good strategic sense in the areas of focus that we have, which is hospital and ARD. On the Specialty Generics side, we're certainly very opportunistic there as well. And I think in particular being able to further enhance the stable of ANDAs that we have in our portfolio would make very good sense. So again, across our portfolio with some primary focus on the Specialty Brands side and more opportunistic focus on the Generics side, we're quite happy to bring in both commercial and developmental assets.

[Marc Goodman:]

Just a follow-up on the Generics side, you mentioned ANDAs. So you are looking to potentially acquire some ANDAs. Do you have ANDAs that are on file or potentially will be filed? Just curious what the pipeline is there on your Generics side.

[Matthew K. Harbaugh:]

Yeah, Marc; it's Matt. We do have a few ANDAs that we've been working on over time and we're looking to accelerate that both with internal organizational development as well as licensing end products. What we have found is that there are a number of organizations out there that have actually reached out to us and want to work collaboratively on bringing products to market. I think as you see downstream consolidation, channel consolidation, some of the smaller companies out there are looking for a larger organization such as ourself that can help commercialize these assets longer-term. So, anything we can do to supplement the ANDA pipeline that makes financial sense and drives return on invested capital, we'll do it.

[Coleman N. Lannum:]

Thanks, Marc. Next question, please.

[Operator:]

Our next question comes from Jason Gerberry of Leerink Partners. Your line is now open.

[Etzer Darout:]

Hi. Thanks for taking my call. This is Etzer filling in for Jason. Just a quick question. Wanted to know if you could comment on what is driving the INOMAX 23.5% pro forma growth? And how well penetrated is this new contracting strategy into the key hospitals for INOMAX? And what are the future opportunities for these institutions to upsize contracts? Is it further penetration of the more moderate disease patients? Thanks.

[Mark C. Trudeau:]

Yes, so again, very pleased with what we're seeing with INOMAX, although we don't anticipate we'll continue to drive 20-plus% growth quarter-on-quarter. As we said quite clearly, we expect that INOMAX growth in the near-term will be higher than it has been historically, but longer-term it's probably going to migrate closer to what it has been historically in the mid single-digit range. We believe that the enhanced growth for INOMAX – and keep in mind, we've been growing INOMAX since we acquired it at multiples of the historical growth rate. We think that has to do, one, with the enhanced contracting strategy. And again, this is good for the accounts. It's good for the business, and it's good for the patients. And our contracting strategy is pretty straightforward in that we offer INOMAX in an unlimited use fashion, which then enables physicians, particularly in the NICU not to have to make a choice between a patient that's very sick and another one that's not quite as sick in terms of whether they get INOMAX or not. And we believe that is likely to drive additional patient penetration in appropriate patients in the NICU. We've also, we believe, have benefited a bit from the guidelines around the use of nitric oxide that were recently published in the last year or so jointly by the American Heart Association – or American Hospital Association and the American Thoracic Society, which advocate the use of nitric oxide earlier in patients to provide additional benefit. So we believe that it's the combination of those factors, plus a significantly enhanced set of commercial activities that that we've been driving to take advantage of the contracting strategy that are leading to this enhanced performance. Again, longer-term, we would expect that because we've been benefiting upfront from significant contracting activities that that's going to level out over time, which is why we're projecting that the growth rate is likely to settle in longer-term to that historical growth rate. So again, very pleased with INOMAX. We're very pleased with the things that we've been able to do with it in the last year so to enhance the growth rate. Then we will continue to invest in this product to provide benefit for more patients.

[Coleman N. Lannum:]

Thanks, Etzer. Next question.

[Etzer Darout:]

Thank you.

[Operator:]

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

[Anthony Petrone:]

Thanks and good morning. Maybe just shift back to Generics. I'm just wondering if you can give an update on oxycodone and hydrocodone trends. Surprised to see that tick up. And maybe just a little bit of background on what you're seeing in terms of the CDC guidelines shift for opioid prescription trends? Anything shifting out there? And then a follow-up quickly for, Mark, would a recap on where the max net debt ratio level is? Just wondering where the upper bound on the debt ratio is? In the past, I think it approached 6X, following cadence. Be great to just get an update there as well. Thanks.

[Matthew K. Harbaugh:]

Yeah. So we didn't take it anywhere near six, but it did get into the low fives, but we de-levered very quickly as you know, Anthony, particularly when we brought Acthar into the portfolio, we were able to get our net debt leverage down pretty significantly in a quick period. And a lot of that had to do with the fact that we focused on buying assets that had good LTMs and had very strong cash flow. As you saw in the release this morning, we were at 3.5 from a net debt leverage perspective. The difference between here and there was back then we're generating $150 million to $200 million in cash flow and here we are a few years out, we're generating $1 billion as you saw with our performance in the third quarter. It puts us in great shape to deliver on that, as I said earlier. So, we haven't really given a specific number on net debt leverage, but if we take it up, we de-lever relatively quickly. Haven't seen any material impact from the guidelines on the business. Typically these types of guidelines you can see them coming for miles. And so, yes, there's pressure. Yes, there's downward pressure on controlled substances in this country. And so that's factored into all of our guidance and all of the thinking that we've provided this time last year, quite frankly, on the earnings call. As it relates to oxycodone and hydrocodone, I would say they were better than what we were expecting in this quarter and that's why we're forecasting more challenges as we move into future quarters.

[Coleman N. Lannum:]

Anthony, you heard me talk earlier about the fact that we know we're going to be seeing some more competition in some of our Generic areas. The reality is that our business is very specific in a specific piece of controlled substances. And oxycodone, hydrocodone are good examples of places where we think we will be seeing more competition over the next several quarters. And we understand that's it's our challenge to manage through that, but it's also important that you understand that, as Matt said earlier, we're not out of the woods yet in this business.

[Mark C. Trudeau:]

And Anthony, I just wanted to add regarding the question around net debt leverage, it's that the question behind it was capacity and how we think about that. I've been pretty clear to say that we believe there are a number of very attractive assets available in marketplace that are accessible that we think meet our strategic and financial objectives. We don't feel constrained at all, frankly, in our ability to acquire those assets, primarily because of the fantastic cash flow that we have. But as Matt said, if there's an opportunity that's out there that requires us to take on some debt, we will do that, but we will pay it down quickly. As we've done, as you've seen us do even in this quarter we've paid down our debt dramatically. So again, we would look for things that make great financial sense, great strategic sense. And again, if our net debt leverage goes up for a bit, we want to make sure that we can de-lever very quickly, as Matt said. And the bottom line is we don't feel constrained at all in our ability to acquire very good assets, and we believe a number of those are out there.

[Anthony Petrone:]

It's all helpful. Thanks.

[Coleman N. Lannum:]

Thanks, Anthony. Next question, please.

[Operator:]

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

[Irina R. Koffler:]

Hi, good morning. Congrats on the quarter. My question is related to generic Acthar. So Teva has publicly stated that it may try to pursue a generic for Acthar and given that FDA has previously approved generics for difficult-to-characterize animal sourced drugs like Lovenox, how challenging do you think it has to create substitutable copy of Acthar? Is it more or less complex than Lovenox? And what defenses can Mallinckrodt employ to prevent a generic entry? Thanks.

[Mark C. Trudeau:]

Again, we've talked about this I think many, many times. We believe that Acthar is an exceptionally durable asset. While theoretically anything is possible and we fully would expect competition over time to Acthar, enhanced competition over time because there's a lot of competition to Acthar today. We would expect that that type of competition between the corticotropin areas is likely to come through the NDA route and if it does come through the NDA route, it's likely going to be a fairly complex process to get there. We continue to believe that the likelihood of an AB-rated generic Acthar is very, very low. Again, this is a product that today is a complex mixture of a variety of active naturally derived agents. It's significantly more complex than Lovenox. Lovenox is essentially a single peptide. And we believe that the opportunity as it exists today for an AB-rated generic is exceptionally low because a pathway currently doesn't exist. The active agents Acthar are very complex, only some of which are fully characterized. And we just believe that this pathway is highly unlikely. Although anything is theoretically possible, we think this is perhaps the least likely area in the near-term and perhaps in the long-term for future Acthar competition.

[Coleman N. Lannum:]

Thanks, Irina. Operator we'll try to get through two more questions then we need to wrap-up. Next question, please.

[Operator:]

Thank you. Our next question comes from David Buck of Northland Capital. Your line is now open.

[David G. Buck:]

Hi. Yes. Thanks for taking the question. Just a quick one on OFIRMEV, can you talk a little bit about whether you see the growth rate in the quarter as being sustainable near-term? And any update or timing for when we'll get an update of the potential lifecycle management behind OFIRMEV? And just a housekeeping one, for the guidance for calendar 2016, can you talk a little bit about what sales growth and gross margin assumptions are embedded there? Thanks.

[Mark C. Trudeau:]

So yes, so, on OFIRMEV, David, yes, we're very pleased with the 14% growth that we posted in the quarter. And again, as you heard in the prepared comment, we're quite confident that we'll be able to continue to drive OFIRMEV growth. And again, the growth in the quarter was wholly volume. We believe we'll be able to continue to drive volume growth for OFIRMEV going forward, primarily because of the fact that this is a product that we continue to demonstrate has significant both clinical utility as well as a very positive pharmacoeconomic proposition. And in the quarter and in this past year, we've consistently been posting a number of different data sets, highlighting the pharmacoeconomic benefits of OFIRMEV. So again, very pleased with the performance and we think we can continue to drive growth. The other piece of it I think is that it clearly looks like a multimodal analgesia is the approach that many institutions are now moving towards in the management of pain associated with surgery. And OFIRMEV fits very squarely in that type of a protocol. So, we think the factors are moving in the right direction to continue to support the volume growth of OFIRMEV going forward.

[Coleman N. Lannum:]

Yeah. David, on the guidance question, let me hit a couple points. We're not going to give any specific updates on revenues and I think, as you know, we don't give specific gross margin guidance anyway. But I think it's a good point to remind people that because of our 4/5/4 accounting structure that we've talked about ad nauseam in the September quarter that we're in right now, we're going to have been extra week. We've talked about that. And clearly, it means the September quarter is probably going to look pretty good on the revenue side of things. It's going to look pretty good on the margin side of things. I would note that – and I salute the sell side out there because if you look at the cadence of estimates that are out there, it looks like you guys have already pretty much taken into account the fact that we've got the extra week in September and so it certainly shows that way when you look at the cadence of numbers throughout the year. Obviously, in the June quarter, we had very, very strong fundamentals that you just saw. In the September quarter, we've got that extra week going for us. The reason why I bring that up is once we get into the December quarter, we should be back to a much more normal kind of run rate again. And I think it's important you take that into account when you're comparing the quantitative numbers, both the really good numbers that you saw that we announced this morning as well as the probable pretty good numbers that you're going to see in the September quarter. Hopefully, that helps. One last question, then we need to wrap.

[Mark C. Trudeau:]

I just needed to go to – I neglected address David's question around lifecycle management for OFIRMEV. Yes, we continue to work on a variety of different lifecycle management activities for OFIRMEV. And in terms of updates on those, as you might imagine, it's going to make sense for us to withhold some of those or at least discuss some of those much later in the cycle. Keep in mind our loss of exclusivity today for OFIRMEV is projected to be the end of 2020. So as we further develop our lifecycle management strategies, those would likely be employed as we got a lot closer to that loss-of-exclusivity date, and we'll update you as we get closer to that.

[Coleman N. Lannum:]

Last question operator.

[Operator:]

Our last question comes from Rohit Vanjani. Your line is now open.

[Rohit Vanjani:]

Great, thanks for taking the question. On the generic pricing environment, what did you see for the quarter? Was pricing stable? And then have most of your big wholesaler contracts been negotiated for the calendar year? And when are they up for renewal again?

[Matthew K. Harbaugh:]

So renewals come and go. There's no one point in any year where everything is kind of wrapped up, if you will, for the future. So, those are constantly on an ongoing basis so that's why we haven't historically really talked about it. The pricing environment, the business was down 14% in this quarter and so pricing was under pressure. And we continue to see more pricing pressure in future quarters. And the pricing environment is relatively in line with what we were thinking it was going to be this time last year. I think the difference is, is we see more pressure in future quarters, as we mentioned earlier in the prepared remarks.

[Rohit Vanjani:]

The big three, the big three wholesalers they come and go; they're not in the first half or second half of the year? There's not a specific time that those renewals come up?

[Mark C. Trudeau:]

Contracts come throughout the year and we're in constant dialogues with them, but there isn't any one contract that I would point you to over the 12-month cycle that is hugely material when compared with contracts we're signing in other months and quarters.

[Rohit Vanjani:]

Great. Thanks for taking the question.

[Operator:]

Thank you. And at this time I would like to turn the call to Cole Lannum for closing remarks.

[Coleman N. Lannum:]

Thank you, operator, and I want to thank, everyone, once again. I know it's a busy time in the middle of earnings season; you have other earnings and calls going on. I also want to say, I really do appreciate everyone pretty much sticking to the one question rule. I was glad we were able to get through all the questions. As a reminder, we are going to have a replay of this call that will be posted to our website later on today. And of course, I'm around all day to answer any questions you may have. Have a great day and a great week. Thank you very much. Bye-bye.

[Operator:]

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