Mallinckrodt plc
Q2 2016 Earnings Call Transcript

Published: 3 May 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2016 Mallinckrodt Earnings Call. At this time all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Mr. Cole Lannum, Senior Vice President Investor Relations. Please go ahead, sir.

[Coleman N. Lannum:]

Thank you, Kristi, 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 releases 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 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 this morning of quarterly performance are to the second quarter of fiscal 2015. We reported diluted GAAP earnings per share from continuing operations of $1.07. After adjusting for specified items, our diluted non-GAAP adjusted earnings came in at $2.01 per share. As a reminder the revenue growth ranges we'll be discussing this morning are on a constant currency basis unless otherwise noted. Now I'll turn it over to Mark who will go into more detail on the second quarter. 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 excellent quarter, driven by strong performance across the Specialty Brands portfolio. The business performed ahead of our expectations both for this quarter and for the first half of fiscal 2016. We remain focused on company-wide execution, giving us confidence that we'll continue to make steady gains throughout the balance of the year. As Matt will cover in more detail later, we've raised our adjusted EPS guidance range today for the second time since giving initial guidance back in October. Net sales were up nearly 13% for the second quarter, driven by robust commercial performance in Specialty Brands where we continued to see steady volume gains across the portfolio. Adjusted EPS growth was notable as well, as Cole mentioned, up more than 18% for the quarter. This strong showing clearly demonstrates we are executing against our strategy to drive volume based growth and create near and long-term value for patients and shareholders. Our accelerated pace on a number of strategic fronts was reflected in the progress we made in the quarter. Let me share just a couple of key highlights with you. We've continued to generate new clinical and health economic data, building on the growing body of evidence for our products. In the quarter we had approximately 10 data presentations in publications, the majority of which were for Acthar and OFIRMEV, bringing the overall total of publications to roughly 40 in the first half of the year. And importantly, as I mentioned, we continued to execute against the key commercial levers we've identified to drive volume in both top and bottom line growth across the Specialty Brands segment. This enabled us to more than offset the ongoing challenges we faced in the Specialty Generic segment. We expect continued pressure in that business for the foreseeable future, consistent with previous guidance. Let me step back a moment to put our Specialty Brands performance into perspective. Growing volumes across this segment equate to expanded patient access to powerful, potentially life-changing therapies. Here are just a few examples. More surgical patients may benefit from receiving OFIRMEV as part of a multimodal approach to surgical pain management, potentially reducing their hospital stay and complications and thereby reducing healthcare system costs. We can reach more infants suffering from hypoxic respiratory failure who can benefit from INOMAX therapy. More lupus patients experiencing an exacerbation of their disease can potentially achieve relief through Acthar treatments. Increased numbers of infants suffering from infantile spasms are able to receive Acthar therapy to treat their devastating symptoms. And we're enabling more patients suffering from skin manifestations of cutaneous T-cell lymphoma to harness the power of their own immune systems to fight this condition through Therakos immunotherapy. These examples illustrate why we believe so strongly in our established acquire-to-invest strategy identifying under-resourced highly durable assets with significant volume growth potential and investing in them to expand access to underserved patient populations. Our formula for continued growth is working well and, looking ahead, we remain focused on sustaining this performance. Now let's look at key products in Specialty Brands. Focus on commercial execution across all therapeutic categories delivered another strong quarter for Acthar with net sales up nearly 9% in the period, propelled predominantly by steady volume growth. Pulmonology and rheumatology, where we believe we're beginning to see positive prescriber response to our recently published lupus data, continued to demonstrate strong growth. We've also begun to see a steady uptick in growth in market share for infantile spasms where we're concentrating on further expanding access in this population of fragile patients. We're also very pleased that with our ongoing focus on expanding access to Acthar, we've continued to sign new payer agreements. At this point, we've reached our initial goal to have greater than 50% of covered commercial lives under contract a bit earlier than expected. Market access for Acthar will remain an area of high focus for us. Now let me give you some color on INOMAX, our second largest product. Once again the business delivered another strong quarter with net sales up 14% on a pro forma basis, as we continue to successfully execute on our contracting strategy. This business has now exceeded historical growth rates in each of the three full quarters we've owned the asset, driven by strong commercial execution as appropriate patients have greater access to INOMAX. Longer-term, we anticipate a return to more traditional mid-single-digit growth rates with growth closer to historical norms in the back half of the year. Still focused on hospital products, in our second full quarter of ownership, we continue to be very pleased by the performance of the Therakos platform with net sales growth of 13% on a pro forma basis on a constant currency basis. While we're pleased with this strong initial performance, we expect to see growth going forward to be in the historical high-single-digit range. Moving into the surgical space, I'm happy to report that we were able to achieve 4% revenue growth for OFIRMEV, a return to year-on-year growth earlier than we had expected. These results were principally driven by volume growth through strong execution by the commercial team. We remain confident this upward trajectory will continue in the second half of fiscal 2016, bolstered by recent presentations of additional health economic data and growing acceptance the benefits that multimodal analgesia brings to patients and the healthcare system. Closing out Specialty Brands, we were pleased that our latest acquisitions in the hemostasis space also performed well, although it's still very early. We're investing in the commercialization of all of these products, leveraging our OFIRMEV sales organization to promote RECOTHROM, in addition to the contracting model traditionally employed. As noted previously, we expect to launch PreveLeak and RAPLIXA late in the back half of this fiscal year. Turning to Specialty Generics, we continue to value the cash flow generated by this business and the benefits it provides to patients. But the business continues to face significant competitive headwinds that we've been anticipating for some time, with net sales down 27% for the quarter. Though this downward trajectory may level out slightly in the fourth quarter, we anticipate the challenges in this business will likely continue to be compounded by the impact of downstream consolidation of pharmacy providers and heightened competition. Touching on Science and Technology or S&T, we continued to invest in programs to support key inline and developmental products, particularly in Specialty Brands. Among these investments, we expect the first patient to be enrolled in the coming weeks in our company-sponsored randomized, placebo-controlled, multi-site double-blind trial for Acthar in a key nephrotic syndrome condition called FSGS. We also continued to evaluate opportunities to conduct Acthar Phase 4 controlled trials in other key disease areas and will update you when these decisions are made. Simultaneously, we continue to generate additional data sets for Acthar, including preclinical and clinical data, patient registries and health economic assessments, as well as sponsoring investigator initiated trials. Here are some key S&T highlights for other areas in the portfolio for the quarter. We engaged in productive discussions with the FDA regarding final comments on our Special Protocol Assessment submission for the terlipressin registration trial and I'm pleased to report we recently received approval for the Phase 3 protocol. We plan to start the trial later this fiscal year. We also saw continued progress in several OFIRMEV Phase 4 clinical trials, with data expected on a portion of these later this year. As I mentioned earlier, we're pursuing a robust program to develop health economic data for OFIRMEV with a number of recent presentations highlighted in press releases that can be found on our website. 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 ongoing. On the business development front, our key areas of focus remain building on our Specialty Brands growth platforms of hospital and autoimmune and rare diseases as well as Specialty Generics. We are actively assessing a robust set of highly attractive opportunities and expect to continue adding developmental and commercial assets to our portfolio in coming quarters. As we look ahead to the second half of 2016, the message is simple

[Matthew K. Harbaugh:]

Thanks, Mark. Let me take a few moments to go a little deeper into our financials. As Mark said, second quarter fiscal 2016 was very strong and Specialty Brands results fueled by our volume growth strategy were exceptionally robust. Net sales from continuing operations were $918 million, representing growth of 13%. As noted in the press release issued this morning, we are increasing our fiscal 2016 adjusted diluted earnings per share guidance on a full year basis to a range of $8.15 to $8.50. This raises the low end of the range by $0.30 per share and the upper end by $0.20. Second quarter net sales for the Specialty Brands segment were $535 million, representing growth of 60% achieved through ongoing focus on driving volume across the portfolio and in part through the inclusion and positive performance of INOMAX, Therakos and the recent addition of RECOTHROM. Acthar outperformed our longer range expectations in the quarter with $248 million in net sales, a 9% increase. As we've said, we continue to believe that this franchise will grow at the lower end of the mid-single to low-double-digit range for at least the next several quarters. We're pleased to report that INOMAX generated $116 million in net sales, a 14% increase on a pro forma basis. With this continued strong performance, it's clear that the growth rate for INOMAX will be higher for fiscal 2016 on a full year basis, but we continue to believe that the long-term compound annual growth rate for INOMAX is likely to be in the mid-single-digit range. The Therakos business also performed well with net sales of $50 million, a 13% increase on a pro forma basis. Turning to OFIRMEV, we were very pleased to see another increase in volume demand for the quarter, with revenue growth of 4%. As Mark noted, we're pleased to have the hemostasis portfolio integrated into our hospital business, and we continue to stand by our long-term estimate of low-double-digit growth driven substantially by the product launches late this fiscal year. Now let's turn to our Specialty Generics segment which continues to be challenged by increased competition across a number of categories. We saw the toughest comparisons yet in the second quarter, with net sales of $264 million, representing a 27% decline over prior year and anticipate similar results next quarter. While we expect comparisons to ease somewhat in the fourth quarter, we believe we're likely to see continued tough competitive market dynamics into fiscal 2017. Segment net sales for nuclear imaging for the quarter were $102 million, a 5% decline. This reflects the anticipated return to historical performance indicated on our first quarter earnings call. Total company adjusted gross profit as a percentage of net sales declined as anticipated. Tough comparables in Specialty Generics drove these results, albeit they were partially offset by strong Specialty Brands performance. While absolute R&D spending in the quarter was up slightly over prior year, this came in below our expectations. We're focused on accelerating investments in key opportunities for the company in the second half of fiscal 2016 and beyond. R&D for the quarter came in at 6.4% of net sales overall with investment in our Specialty Brands segment higher. Adjusted SG&A as a percentage of net sales declined as we continued to achieve savings from restructuring. Looking to the second half of the year, we expect some additive SG&A expense related to normal business activities as well as launch costs around our two new hemostasis products, PreveLeak and RAPLIXA. Our adjusted effective tax rate in the second quarter was 15.7% compared to 20.2%. We expect some upward pressure on this percentage in the second half of the fiscal year due primarily to business mix. Turning to the balance sheet and liquidity, in the second quarter we generated free cash flow of $186 million. We also repurchased 3.4 million shares of stock in the quarter, returning $225 million of cash to shareholders. Overall liquidity and leverage remained very manageable. We ended the quarter with a cash balance of $341 million, despite the outlays for the hemostasis acquisition and the aggressive share repurchases. Our net debt leverage ratio was a modest 3.6 as you can see posted on our website this morning. We continue to focus on free cash flow combining excellent cash conversion from earnings with a vigilant eye on working capital management, and we expect our strong free cash flow to continue throughout 2016 and beyond. At this point I'll turn it over to 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 to please limit yourself to a single question and a brief follow-up if needed. Over the last couple of calls, some of you have deviated from this practice. It's a busy morning with a lot of calls out there. I'm going to ask you really keep to that or else I may have to cut you off, so please don't make me do that. Feel free to put yourself back in the queue afterwards and I promise we will get through as many questions as possible. With that, operator, may we please have the first question?

[Operator:]

Thank you. The first question is from David Risinger with Morgan Stanley. Your line is open.

[Coleman N. Lannum:]

Hi, Dave.

[David R. Risinger:]

Yes. Thanks very much and congrats on the release. So I was hoping that you could just talk through the 4-5-4 accounting at Mallinckrodt. We're getting a lot of questions today about whether there were any extra selling days for Mallinckrodt in the March quarter. My understanding is no, but obviously you've already described how your fiscal fourth quarter will benefit from Leap Year accounting, so maybe you'd just explain that? And then my quick follow-up is simply what should we expect for year-over-year Acthar growth in the upcoming June quarter? Thank you.

[Coleman N. Lannum:]

So, Dave, let me take the 4-5-4 thing because it is important that people understand that. One of the great advantages of using that accounting system is that every quarter begins on the same day of the week. Every quarter ends on the same day of the week and, therefore for the vast majority of time, you have very good comparability. So we didn't have any more or any fewer "selling days" this quarter than we do in any other quarters. But as you noted and as you've heard us talk about and I'm going to take this opportunity to remind you, one of the things that happens with this accounting convention is every five to six years there's a one-week catch-up period. We will have that affecting us in our fiscal fourth quarter, the September quarter of this year. And that will give us 14 weeks of revenues and earnings that quarter versus our typical 13 week quarter. And of course that will be a comparable that we'll have to compare against the next year. Hopefully, that addresses your question. Mark, do you want to address the...

[Mark C. Trudeau:]

Yeah, I'd be happy to take the Acthar question. First of all, let me say that we are very pleased with the Acthar performance that we've seen in the first half of the year and certainly in this quarter. It's performed a bit stronger than we expected. In terms of a go-forward growth rate, again, we believe that this product will continue to grow in that mid-single to low-double-digit range, kind of on the lower end for the next couple of quarters and the rationale for that is pretty straightforward. I mean, we were very pleased to announce today that we've continued to sign payer contracts to procure and secure longer-term access for Acthar within the managed care environment. Clearly, that has downward pressure on pricing for us and, again, while we feel very comfortable that Acthar will continue to grow in that mid-single to low-double-digit range, because of this dynamic, we would expect it'll be towards the lower end of that range near-term. We would expect longer-term for the growth rate to accelerate over time. Now we're very pleased that we've achieved our initial goal of having the majority of commercial lives under contract now for Acthar, but we're not done. We want to continue to engage with payers, continue to drive access for Acthar over the long-term.

[Coleman N. Lannum:]

Thanks Dave. Next question please.

[Operator:]

Thank you. Next question is from David Amsellem of Piper Jaffray. Your line is open.

[David A. Amsellem:]

Thanks, so I have a high level question about the Generics business. Can you talk about the strategic fit for that business? Whether you would explore divesting it? And given the dynamics that you've cited, would it even be saleable? Thanks.

[Mark C. Trudeau:]

Yeah, thanks David. So look – and when we look at our overall portfolio, we are very pleased that we have a diversified portfolio. If you keep in mind we have three platforms now, each of which are roughly a billion dollars or more in revenue, and we like that diversification. The Generics business for us specifically is a bit over a billion dollars in annualized revenue. It generates great cash flow for us and clearly it provides a lot of benefits to patients for the generic products that we supply in the markets in which we compete. There's no doubt that this is a challenging and very competitive market at the moment. The dynamics are such where we're seeing a lot more competition. Just saw some statistics recently where the rate of ANDA approvals through the FDA is accelerating, so there's certainly been more competition in our space and across the generics space. We're also seeing some consolidation, certainly on the customer sides of things, which are driving prices down. And again, I think we've seen some of our competitors in this space deliver some challenging results in the last couple of quarters. However, at the end of the day, this is a tremendous cash-flow-generating business for us and we use that cash flow very effectively to build out our portfolio. We build out our portfolio in Specialty Brands by harvesting and leveraging the cash that's generated from Generics. We'll continue to do that. We'll continue to acquire assets to further diversify our portfolio. Longer-term the Generics business for us is one that we want to have as a steady growth business. And so therefore, it may make sense for us to consider looking at alternatives to build out that business as well, and that's likely to come through acquisition and that would largely be augmenting our portfolio of both commercial products as well as developmental opportunities.

[Coleman N. Lannum:]

Thanks David. Next question, please.

[Operator:]

Thank you. Our next question is from David Maris of Wells Fargo. Your line is open.

[David Maris:]

Good morning. There was a lot of confusion around the treasury action in early April. Now that you've had time to review the proposals or the rules in greater detail, do you see any impact on your expected longer-term tax rate or cash management? Or what's your expectations for the impact? Thank you.

[Matthew K. Harbaugh:]

Yeah, David, good morning, thank you for the question. As it relates to the treasury action, we have had plenty of time to digest that. I would say the impact is modest and it's out a number of years, and so it's not overly impactful to Mallinckrodt at this point in time. It's something we can certainly navigate.

[David Maris:]

Is there anything that you can put like brackets around what the impact would be? Is it 100 basis points longer-term to a tax rate? Or what should we expect when you say it's modest, I mean, inconsequential, or?

[Matthew K. Harbaugh:]

Yeah, I would say closer to inconsequential. I mean, there's some impact, but it's nothing to be worried about.

[David Maris:]

Great. Thank you.

[Coleman N. Lannum:]

Thanks, David. Next question, please.

[Operator:]

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

[Christopher Schott:]

Great, thanks for the question. You were very active with share repo in the quarter, can you just elaborate a little bit more how you're thinking about capital allocation in this environment given where your stock is currently trading relative to potentially lower asset values for some of the targets you might be looking at? And as we're thinking about just capital allocation, how much capacity do you have at this point for additional deals and potentially further repo? Thanks very much.

[Matthew K. Harbaugh:]

Sure, so I'll take that. So we were very careful to say in our prepared remarks that we're focused on share repurchases, debt reduction and business development. And if history serves as a guide as you've looked over the last six months for instance, in the first quarter, as you know, we repurchased $275 million in shares. We've repurchased $225 million in shares in the second quarter, and we've been buying throughout the last two quarters and our share price is kind of in the range that it was this morning. So certainly that is an indication of how we're thinking about share repurchases. We did some modest debt reduction in the first quarter. We didn't do much in the second quarter and that's because the spreads tightened pretty significantly. And from a return perspective, from a return on invested capital perspective, we felt it made more sense to focus on share repurchases. As it relates to business development, you're absolutely right, there are a lot of assets out there that are attractive right now, as Mark said in the prepared remarks. And I'd say we continue to be very active on the business development front. You won't see us do one or the other; you'll see us do a combination of all three. We stay very active in focusing on looking at the markets and the returns on an ongoing basis.

[Mark C. Trudeau:]

Yeah, let me just add I think that capital allocation question is a really important one and the thing that I want to emphasis that Matt said is that we have the flexibility, the capability and the desire to execute all of our capital allocation levers and we'll continue to do that. However, keep in mind that we're building a business for long-term value creation, and we believe very strongly that there are a tremendous number of assets out there that fit the businesses that we're trying to grow and develop. And that's – we have a need to further diversify our overall portfolio, both commercially and developmentally. We're very pleased with the diversification that we have today, but we want to build on the commercial platforms that we've created and you can see we're starting to build some momentum now from a research and development standpoint. When we buy things we invest in them. We enhance the labels. We create more data. We bring new products to market in the case of terlipressin. If, in fact, we're successful with that development program, we want to continue to want to add to both our commercial portfolio as well as our development portfolio because we think that's the recipe for success to driving long-term value.

[Matthew K. Harbaugh:]

Yeah, coming back to your other question around how much access to cash we have, we finished the quarter at $341 million, as you know. And I can tell you we've been generating a ton of cash since then. And then in addition to that, we do have our revolver of which we still have $100 million in capacity there. Certainly, if we wanted to we could likely increase the size of that revolver. So I would just say we don't feel constrained from the perspective of being able to accomplish business development and share repurchases. Keep in mind, we spent $175 million on the hemostasis products in early February. We repurchased $225 million in shares, and we ended the quarter with $341 million in cash. So fortuitously for us, the opportunity set for us is really being very careful on how we drive return on invested capital long-term.

[Christopher Schott:]

Thank you very much.

[Coleman N. Lannum:]

Thanks, Chris. Next question please.

[Operator:]

Sumant Kulkarni of Bank of America, please go ahead.

[Sumant S. Kulkarni:]

Good morning, thanks for taking my question. This is on the Generics side of your business, could you quantify the pricing erosion on your finished dose formulation and on the API side? And on business development there, how far away from your traditional core of controlled substances would you be willing to stray, I guess?

[Matthew K. Harbaugh:]

So as it relates to the 27% decline in revenue in the Generics business year-over-year, definitely the lion's share of that is driven by price, so that's how you should be thinking about it. And as we think about Q3, it's going to be a similar dynamic and that's because we've got a number of competitors coming into the marketplace. The only exception to that would be methylphenidate ER which is the change in rating to BX, which we've talked about now for a good year-and-a-half. But as it relates to the broader controlled substance business Roxicodone, hydrocodone and so on, price is where we're getting a lot of pressure. Price was down for sure for total Mallinckrodt in the second quarter. Fortuitously for us, we were able to offset that with volume, particularly in our Specialty Brands business, as Mark mentioned earlier. As it relates to supplementing the portfolio, I'd say we're agnostic to the therapeutic areas, but we're interested in products that have a limited amount of competitive intensity. So we intentionally call our segment Specialty Generics because we don't want to compete in broad generic businesses. We like more niche areas in the Specialty Generics space. And I'd be first to tell you there's a number of opportunities out there. I think there's a viewpoint externally that there aren't a lot of opportunities from the business development front in the Specialty Generics landscape. In fact, there's a lot of opportunities out there.

[Mark C. Trudeau:]

Yeah, I would definitely say that we're not looking to create a specialty generics business that's very broad. We do like being in that niche space, as Matt described. But clearly, controlled substances is a very, very narrow niche. And while we will continue to develop new ANDAs for controlled substances, if we're going to have a longer-term, more sustainable, potentially growth business, we're going to need to branch out a bit more into a few other niches and, again as Matt described, we're going to focus on those with lower competitive intensity.

[Coleman N. Lannum:]

Thanks, Sumant, next question please.

[Operator:]

Douglas Tsao of Barclays, your line is open.

[Douglas Tsao:]

Hi, good morning. I was just hoping you could provide some context around the performance that we saw from Acthar this quarter that was quite strong. Are you seeing a meaningful expansion in terms of the number of prescribing physicians? And if so, what sort of therapeutic areas or indications are you seeing this growth in prescribing doctors?

[Mark C. Trudeau:]

Yeah, Doug, thanks. So yeah, again, we're real pleased with the performance of Acthar in the quarter. It's been a bit stronger than we anticipated and it's for a couple of reasons I think. One is that the pulmonology business continues to grow substantially. And again, I think that's on the basis of much like many of the other indications that Acthar has. As we improve, enhance and modernize the data set, which we've been very aggressive in doing, that information then enables us to demonstrate the value of Acthar and the benefit that Acthar can bring to patients and that's been very true in the pulmonology space where there's been an emerging body of evidence to come out here in recent months around Acthar's use in sarcoidosis where there are very few alternatives for patients. We've also seen a continued strength across the rheumatology portfolio, but clearly the lupus data is starting to gain some traction with many physicians. And again, we will be reporting on the open label extension on the lupus trial that we reported on a little bit earlier. That open label extension we expect we'll be able to report out that data towards the second half of this year. But again, we continue to invest in a variety of different data sets for Acthar and those are the types of pieces of evidence that are helping us have appropriate conversations with physicians and with payers about the appropriate position for Acthar across the portfolio. But we've also seen certainly a bit of a resurgence in the use of Acthar for infantile spasms. We've refocused some of our activities into child neurology. Keep in mind, Acthar has very, very strong data for use in infantile spasms. Again, this is a tremendously devastating disease for patients. And so we've seen now a steady uptick in the growth in market share for infantile spasms as a result of our reemphasis on that particular specialty and that particular indication.

[Douglas Tsao:]

Okay. Thank you very much.

[Coleman N. Lannum:]

Thanks, Doug. Thank you. Next question please.

[Operator:]

Gregg Gilbert of Deutsche Bank, your line is open.

[Gregg Gilbert:]

Yes, thanks. Good morning. I was wondering if you're seeing up through today any meaningful volume changes in the opioid market based on your insights in either API or finished dose. It's a Mallinckrodt question, but also an industry one. And my quick follow-up is, do you have anything to update us on in terms of non-core business sales and whether you would consider a sale if it had a negative effect on your leverage ratio? Thanks.

[Matthew K. Harbaugh:]

Yeah. Thanks, Gregg. As it relates to volume changes in Generics, I'd say that we factored in the change in CDC guidelines. We factored in a number of things as we were thinking about the guidance we provided in October. And I would say from a volume perspective, the market fortuitously for us is probably pretty close to playing out as we expected it to. This being said, I think the market dynamics have changed materially over the last six to nine months as we've seen more competition come in. We've seen channel consolidation downstream. And we've seen, as Mark mentioned earlier, the pace of ANDAs coming out of the agency from an approval perspective increasing, which led to our comments earlier around we see some of the challenges in this space continuing into 2017. As it relates to a divestiture or sale, we are very open as it relates to anything that makes good financial sense where we can drive our return on invested capital for the long haul. So in this market environment if someone were to offer us a great premium for any asset in the portfolio, we would certainly take a look at it. We are very focused on our leverage ratio. Obviously, our preference if someone were to buy pieces of the portfolio, we would want to get cash for those assets so that we could continue to navigate our balance sheet. This being said, we feel that our balance sheet is very manageable at this point.

[Gregg Gilbert:]

Thanks.

[Coleman N. Lannum:]

Thanks, Gregg. Next question, please.

[Operator:]

Marc Goodman of UBS, your line is open.

[Marc Goodman:]

Yes, you've talked a lot about Acthar, but if we could just get back to a little bit and just give us a sense of volume versus price as far as the 9% increase in revenues in the quarter? And then if you could also talk about what's going on with the hub? I know this is a major change that you were doing. Are we completely done with that and everything is straight there? And if you can give us a sense of just number of patients on Acthar, just some quantitative measures here? You talked about infantile spasms. You know that you're increasing share. I know in the past you talked about – you used to have like 50% share and it moved lower. I mean, are we back to where that share was? And then just a quick follow-up, the gross margins seemed a little light if you could talk about that? Thanks.

[Coleman N. Lannum:]

Hey, Marc, that's clearly more than one question, we're going to see if we can try to get as much of that as we can, but bear with us.

[Mark C. Trudeau:]

It's four, but we'll try to go through it. So Acthar volume versus price very straightforward, it's predominantly volume and we would expect it to be volume going forward. Price is increasingly less of a dynamic for Acthar on a go-forward basis. And certainly in this quarter, the bulk of the growth on Acthar, the 9% growth that we demonstrated in this quarter was volume related. With regards to the hub, again, this is kind of a continuous improvement type project. So we will probably never be done with the hub. We're always looking to continually improve our efficiency in that particular aspect of our distribution chain. Keep in mind though that even if we were completely 100% perfect in the hub, which is our objective over time, that this is not necessarily a significant driver of Acthar volume. What really drives Acthar volume, frankly, are our market access activities that we continue to report on. It's the generation of new data, which again we continue to make significant progress around and it's our commercial and medical affairs activities that are really going to drive the volume growth for Acthar over time. In terms of number of patients on Acthar, again, we're in that range of 10,000 to 11,000 patients or so in any given year on Acthar. And again, our objective is to create more access for Acthar longer-term to drive that 3% to 4% patient penetration rate that we have, certainly to something significantly higher than that over time. And the two levers to do that are securing access in managed care and generating new data and that's our primary strategy for Acthar over the long-term. I'll ask Matt then to discuss a bit about the gross margin.

[Matthew K. Harbaugh:]

Yeah, so, Marc, I read your write-up this morning around our gross margin or gross profit as a percent of sales being a little light. I would encourage you to go back and reflect on what we said on February 3 where we did say our gross profit/gross margin was going to be light. And principally what was driving that comment back on February the 3rd and what you see today is what has happened in the Specialty Generics business, which is in line with what we were thinking back then and in line with what we were thinking back in October. And going forward, you certainly will see continued pressure on this line. I would say if you look at the earnings per share beat, if you will, from this morning, we continue to get great efficacy out of our restructuring, so our SG&A is probably better than external estimates. I was happy to see that. This being said, we do have some investments we need to do in the back half of the year and then our share repurchases certainly also helped us from an earnings per share perspective. So it's very manageable. We are going to navigate through it, but I hope that people heard us very clearly on February the 3rd and are not expecting it to change dramatically as we move forward from where it is today.

[Coleman N. Lannum:]

Thanks, Marc, you've now used up all of your questions for the next 12 months. Next question, please.

[Operator:]

Jason Gerberry of Leerink Partners, your line is open.

[Jason M. Gerberry:]

Thanks. Good morning and congrats on the quarter, guys. Just a quick question on the Acthar managed care update that you guys provided, I think 50% of lives now covered. My understanding is that as you guys kind of move towards this pay-for-performance type of dynamic that we might be heading into a situation around this quarter and next quarter that there might be greater gross to net deductions and sort of a net impact on pricing. But it sounds to me like you're not getting any negative impact on pricing and you're getting the performance -- I guess aspirations or targets, they're growing without any pressure on price. So is it fair to assume now that this strategic shift to contracting is paying out as planned?

[Mark C. Trudeau:]

Well, I think it's still early days, Jason. We just started signing contracts now less than a year ago and it'll be in another few months where we actually see whether or not these contracts are performing or not. But clearly, we believe that the long-term opportunity for Acthar is significantly enhanced by having greater access in managed care and signing contracts and having the majority of covered lives, covered commercial lives under contract, we believe is a great opportunity for Acthar. And again, this opportunity is one that really just creates access and then it's up to us to come in with the appropriate data and that's why we're so focused on data generation. That's data generation across the spectrum of data sets whether it is preclinical or clinical data, whether it's health economic assessments, whether it's patient registries, there's a whole variety of data modernization activities that we're undertaking. And again, that's why we have consistently described the fact that we believe that the long-term normalized growth rate for Acthar is in that mid-single to low double-digit range. We're doing a lot of the work upfront with managed care now to ensure access and then bringing the data in behind it. Yes, there are some gross to net reductions that are going on and, again, that's why we believe going forward the majority of Acthar growth in that range that we've described is likely to be predominantly if not wholly volume driven and that's our objective; that's our strategy across the board. We look for opportunities where we can drive volume, where there's lots of patient penetration opportunities and Acthar is really a classic example of that. So again, we're real pleased with the Acthar performance in the quarter, very pleased with the Acthar performance in the first half of the year. It's been a bit better and a bit stronger than we had anticipated, but we're very pleased that we're generating more data and creating more access in managed care through our contracting strategy.

[Coleman N. Lannum:]

And Jason, I'll point you back to what we said in the prepared remarks, there's a reason why we still are cautious and think you should be at the lower end through the next several quarters as these contracts come in, and we think that's still the better place to be probably well into 2017.

[Jason M. Gerberry:]

Okay. Thanks, guys.

[Coleman N. Lannum:]

Next question please.

[Operator:]

Anthony Petrone of Jefferies, your line is open.

[Anthony Charles Petrone:]

All right. Thanks and good morning. Maybe just to stay on the topic of Acthar and maybe get a recap of where ultimately you think managed care coverage will go. So I guess it was 30% last quarter, 50% this quarter. So what is the ultimate goal there? And then the follow-up would be on INOMAX. Can we just get maybe an update on what percentage of the hospital installed base has actually transitioned to the service model at this point and maybe where do think that goes towards the end of the year?

[Mark C. Trudeau:]

So again, with regards to Acthar and having covered lives under contract, our objective is to get the majority of covered lives under contract. Now you could argue at greater than 15% now, we've achieved that initial goal. But long-term, we would like to get that number to significantly higher than that. What's the ultimate number is hard to predict at this point. And again, when we sign contracts, it's not about signing contracts. We could get 100% covered lives under contract if we chose to. We want to sign contracts that are beneficial both for the business, and for the plan and give us an opportunity to generate greater access for Acthar. So again, the number certainly longer-term is higher than 50%. We continue to engage very actively with managed care organizations to look for contracting opportunities. It is less than 100%, so it's somewhere between 50% and 100% is our longer-term objective. With regards to INOMAX, we are very, very pleased with the performance that we've seen with INOMAX. Again keep in mind, historically, this is a business that had grown in the mid-single-digit range and since we've been the owners of this asset, we've clearly accelerated that now for three straight quarters. This is a result of a different approach to the marketplace from a commercial perspective where we contract primarily with major accounts to provide unlimited access. And that's good for patients because more patients have access to this therapy which can be life-changing. It typically takes price off the table for many accounts because you're contracting for unlimited use, so providers don't have to choose which patients get INOMAX and which don't. And we're essentially giving accounts certainty in what their budget is. So it's a significant advantage for our business as well and you can clearly see that we've been able to accelerate the growth rate of that business now into the low-double-digit range. And for 2016, it's clear that INOMAX will grow at a rate significantly higher than the traditional mid-single-digit growth rate. In any given year, the majority of our customers are likely to be on some form of a contract. Again, the typical INOMAX model is to contract for the entire bucket of services which includes the drug, the device, the training, all of the disposables, that's the type of model that we've established and it seems to be very appealing and very successful to the majority of our customers.

[Coleman N. Lannum:]

Thanks. Next question, please.

[Operator:]

Louise Chen of Guggenheim. Your line is open.

[Louise Chen:]

Hi, thanks for taking my question. So I just wanted to ask you about Specialty Generics again. How should we think about forecasting this business longer-term, given headwinds from buyer consolidation and also FDA efforts to curb the use of opioids? Thanks.

[Matthew K. Harbaugh:]

Yeah, so as we said in the prepared remarks, Louise, we do expect the third quarter to be challenging and, hopefully, get some moderation in the fourth quarter. But we do expect continued pressure in the Specialty Generics landscape as we move into 2017. As I mentioned earlier, we have dialed in to our forecast and have since last year some of the changes. We kind of figured that a lot of these things were going to occur and so we're well aware of what that impact is on our forecast as we move forward. So a very dynamic environment, very competitive, lots of pricing pressure, but as Mark mentioned earlier, the one thing that I think people don't fully appreciate is just how much cash the Specialty Generics business generates for us, which we need to put back to work whether it be share repurchases or business development or debt buybacks.

[Coleman N. Lannum:]

Thanks, Louise. Next question, please.

[Operator:]

Irina Koffler of Mizuho. Your line is open.

[Irina R. Koffler:]

Thanks for taking my question. I just wanted to understand some of the dynamics that are leading to INOMAX and Therakos strength in the first half of the year and then a more moderate growth towards the back half of the year? And then a quick one on OFIRMEV, so last quarter I think you guys destocked it, was there any stocking this quarter? Thanks.

[Mark C. Trudeau:]

Yeah. So on INOMAX and Therakos, clearly the strength thus far on INOMAX has been the result of the contracting strategy that I just described. And so again, we've been able to go into a number of accounts and deliver some very appealing terms on unlimited use for INOMAX. And again, that's been the primary driver in the first couple of quarters of this double-digit growth. Longer-term, again, we would expect this business to be in that mid-single-digit range that it's been historically, simply because of the fact that the number of – the patient opportunity, if you will, would kind of continue to grow at the rate of population growth. So again, we've changed the dynamics here in 2016. We've given it a lift, but we would expect longer-term for that business to return to more historical growth rates. And again, we're seeing the same type of dynamic with Therakos. First couple of quarters have clearly been a bit above what the historical growth rates have been, but we would expect the dynamics to return back to what they've been historically, again, just based on patient opportunities and patient population. In terms of OFIRMEV, your second question, again, real pleased with OFIRMEV that we were able to demonstrate year-on-year growth. As we mentioned in the last quarter, we were expecting OFIRMEV to grow year-on-year in the second half of the fiscal year, and we were hopeful that we could accelerate that a bit into the second quarter and that's in fact what happened. Certainly, there was some destocking that went on in the previous quarter. Some of that has continued in the second quarter, and we would expect that now by the back half of the year, most of that effect has moved out.

[Coleman N. Lannum:]

Thanks, Irina. Next question please.

[Operator:]

David Buck of Northland Capital, your line is open.

[David G. Buck:]

Yes. Thanks for taking the question, just a quick follow-up on the last question. So OFIRMEV, is the growth rate then for the remainder of the year sustainable in that 4% to 6% type range? And for INOMAX it sounds like the slowdown in growth is really just anniversarying the contracting. Is that the way I should be reading it, that the contracting changes run their course, then you get back to patient growth? So just a follow-up on that, and can you give maybe a little bit more detail on terlipressin's Phase 3 and what type of costs you may have for that study, et cetera? Thanks.

[Mark C. Trudeau:]

Yeah. So with regards to OFIRMEV growth rates, again, we continue to be very pleased by the steady volume growth that we've seen in that business and, again, we think this is the result of additional utilization, primarily by existing accounts, broader use across a number of different surgical settings, and we would anticipate growth to continue on a similar trajectory in the second half of 2016. With regards to INOMAX again, you're exactly right, the return to historical growth rates over time is likely to be the result of some of the anniversarying of the contracts, again, over time. Let me just finish up on terlipressin. Again, we're very pleased with the progress that we've made on the terlipressin registration trial. We have a single Phase 3 protocol where we've established an SPA with the FDA. We've recently come to an agreement on that protocol, so both the company and the FDA are in complete agreement as to how the protocol will be structured, and we'll be starting that trial in the second half of this fiscal year. Terlipressin is a very interesting product for us. It's an orphan drug, but it's used outside the U.S. as standard-of-care for patients that have a very devastating condition called hepatorenal syndrome type 1. Life expectancy for patients that get diagnosed with this condition can be measured in weeks. This product is not available in the U.S. and it's one that we think fits very squarely within our strategic objectives and would be a very important hospital product for us. So this will take several years for us to develop this protocol, but we believe the opportunity is very attractive and very consistent with what we're trying to do strategically.

[Matthew K. Harbaugh:]

And David, to your question around reinvestment, it certainly will fall into our R&D line item in the P&L. And we do expect that as a percent of net sales, if you will, and the absolute spending to increase as we move into the back half of the year and into future years, our reinvestment in R&D is going to pick up.

[Coleman N. Lannum:]

Thanks, David. Operator, we're going to try to get in at least one or two more questions. Next question please.

[Operator:]

Rohit Vanjani of Oppenheimer, your line is open.

[Rohit Vanjani:]

Hi, morning. Thanks for taking the questions. Mark, in the past you have talked about the Generics portfolio being diversified enough that if you saw pressure in opioid and controlled substances something else in the portfolio might pick up to help balance that. Are you seeing that? And if so, what specifically is picking up? And then secondly, in mid-April the FDA site listed a manufacturing change or additions to Acthar. Can you speak to what that was about?

[Matthew K. Harbaugh:]

Yeah, so as it relates to your question around Generics, there are two things really leading to the results that we posted today. Part of it is methylphenidate ER and that was a rating change which I mentioned earlier and then the other is the ongoing pressure we see from competitors coming into the marketplace, particularly for some of our large volume products like hydrocodone and oxycodone. You're absolutely right, I'd say years ago if one product category was down, we tended to see another one that was up. We don't see that occurring in the portfolio right now. There's broad pressure across the Specialty Generics segment.

[Mark C. Trudeau:]

And with regards to your second question regarding the manufacturing for Acthar, this is just an example of our acquire-to-invest strategy. One of the things that we do is we look for undervalued assets where we can add additional value through investment. And in fact if you look, there have been a number of notes around manufacturing changes for Acthar. It just relates to modernizing the manufacturing. We'll continue to do that on an ongoing basis and that's an ongoing dialogue that we have with the regulatory agencies.

[Rohit Vanjani:]

Great. Thanks.

[Coleman N. Lannum:]

Thank you. Next question please.

[Operator:]

Douglas Tsao of Barclays, your line is open.

[Coleman N. Lannum:]

Doug, we have a follow-up question. Good job. Go ahead.

[Douglas Tsao:]

Hi. So since it's a follow-up, maybe I'll try to ask two. But just maybe Matt, first on the Specialty Generics, you sort of highlighted sort of changes on the purchaser side of the business. That's a little different from what I think the message was earlier last year in terms of some of the challenges. And so is that representing some incremental pressure on the business that you hadn't necessarily foreseen? Or when you think about that guidance in terms of next quarter and then in the balance of the year and then leveling off in the fourth quarter, what's that balance on a go-forward basis between competitive dynamics versus pressure on the purchasing side? And then just my follow-up is in terms of diversification of the business, you'd sort of talked about getting one piece below or trying to get one piece above 35% of EBITDA. How do you think about that given the performance of Acthar has been quite strong? Is there a little less urgency there right now? And how do you think about it in the context of potential divestitures of the business, especially when we think about nuclear imaging?

[Matthew K. Harbaugh:]

Sure. So let me start with your question around Specialty Generics. I would say crystal balls tend to get less robust the longer you're figuring out the long-term. And so I would say, Doug, to your question, the dynamics in Specialty Generics have changed, and they've gotten a bit tougher. And that's why we put in our prepared remarks that we expect this pressure to continue into 2017. I'd say from how it's unfolded for the first half of year and how we're thinking about the back half of the year, it's in keeping with where our thinking was late last year. And we started the discussion around the challenges in the Specialty Generics business in May of last year on our earnings call. Actually, we're at the anniversary of it. We highlighted it again in August and so we've been talking about this for some time, and I'd say the near-term from where we were in May and where we were in August is playing out in line with expectation. It certainly occurred, but I'd say the competitive marketplace has gotten tougher and that's where the lion share of that pressure is coming from.

[Mark C. Trudeau:]

With regards to diversification, Doug, the answer is still the same. We continue to have as an objective to have no single product represent more than a third of our operating income. And again, in the last quarter, we mentioned that on a pro forma basis, we believe we'd be within a couple hundred basis points of that in 2016. And nothing has changed. In fact, the strength of some of our other branded businesses, particularly INOMAX and Therakos growing as fast as they are, very good margin businesses, certainly helps us in that objective. But longer-term as I mentioned earlier in the call, we want to continue to diversify our business around the three platforms that we have, and we believe that there are tremendous opportunities out there to do that and we want to pursue those aggressively and we are. And that applies to both commercial assets as well as developmental assets.

[Matthew K. Harbaugh:]

Yeah. And to your question around the nuclear franchise, if we were able to get a price for that asset that made economic sense, we would obviously want to put that cash back to work. This being said, the nuclear franchise is roughly 10%, 11% of our total revenue, so it would be modestly impactful if something were to occur there. But we are by no means done from a business development perspective as it relates to further diversifying the portfolio.

[Coleman N. Lannum:]

And operator, we're coming up on the bottom of the hour, so I'm going to wrap it with that. Thank you. Almost everyone really did stick to the one question rule and I appreciate that. I'll deal offline with those of you who didn't. I want to remind everyone that a replay of this call will be available on our website later today and, of course, we'll be seeing some of you in Boston later on this week. Good luck with earnings week. Enjoy the rest of your day. Bye-bye.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.