MNK (MNK) 2017-02-07 Earnings Call Transcript

Good day, ladies and gentlemen, and welcome to the Mallinckrodt quarterly earnings call for a transitional period ending December 2016. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Mr. Cole Lannum, SVP of Investor Relations. Please go ahead, sir.

Thank you, Kristy, and welcome to today's call. Joining me are Mark Trudeau, our CEO, and Matt Harbaugh, CFO. Mark will start us off with some brief comments, and Matt will follow with details of the financials, and then we'll move to Q&A. 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, we assume no obligation to update these forward-looking statements, even if actual results or future expectations change materially. We ask you, please refer to the cautionary statements contained in our SEC filings for a more detailed explanation of the inherent limitations of such forward-looking statements. We'll also provide some non-GAAP adjusted measures related to our financial performance. A reconciliation of these adjusted measures to GAAP is detailed in our earnings release and its related financial tables, which can be found on our website, mallinckrodt.com. We use our website as a channel to distribute important and time-critical company information, and you should look to our Investor Relations page of the website for this information. As noted in our press release, unless otherwise specified, all comparisons are to the comparable 2015 December quarterly period. In addition, the revenue growth ranges we'll be discussing will be on a constant-currency basis unless otherwise noted. As a reminder, the last quarter of calendar year 2016 was a planned and previously discussed transition period, as we aligned to a calendar-based financial year. For the period ending December 30, 2016, we reported a GAAP diluted loss from continuing operations of $1.67 per share. After adjusting for specified items, our non-GAAP adjusted diluted earnings for the period came in at $1.91 per share. Before I turn it over to Mark. I want to briefly review the initial 2017 guidance we gave this morning. For the full year, our guidance range is for adjusted diluted earnings of between $7.40 and $8 per share, which you'll note brackets the current consensus estimates. You'll also note that this is a fairly wide range, which appropriately reflects a number of potential factors across the Specialty Generics business in particular. We provided much greater detail on specific line items in our release, and I'll refer you there rather than repeating all the data right now. I do want to remind you, though, that two items, both the comparison to the extra week we reported in 2016, as well as the divestiture of our Intrathecal business, will cause our reported results in 2017 to be lower than actual normalized growth. If you adjust the numbers for these items, we would expect overall normalized growth to be slightly positive and growth for our Specialty Brands segment to be in the high single digits. Of course, we'll be happy to answer any specific questions you have on the guidance numbers during the Q&A portion of the call. With that, let me turn it over to Mark. Mark?

Thank you, Cole. And thanks to all of you for joining us on the call today. I'm pleased to report that in the transition period Mallinckrodt again delivered strong results, with predominately volume-based growth across our Specialty Brands segment once more offsetting ongoing challenges in Specialty Generics. These results in Specialty Brands continued to be supported by our ongoing efforts to build significant bodies of scientific data and evidence behind our branded products, with roughly 25 clinical and health economic articles and presentations in the period, a dozen of which were for Acthar. We've been active in other ways as well. In the last few weeks alone, we continued to streamline and consolidate our portfolio, closing the sale of our Nuclear Imaging business and announcing plans to divest the Intrathecal Therapy business, monetizing non-core assets to further refine our focus and help fund future growth. And, as I'm sure you've all seen, we recently reached agreement with the FTC in five states to resolve the legacy investigation into Questcor's acquisition of Synacthen Depot. Although we strongly disagree with the allegations outlined in the FTC's complaint, this resolution removes the long-term distraction and overhang of litigation and allows us to more fully concentrate on growing and expanding our business. Before we go on, I think it's important to take a moment to reflect on the settlement related to Synacthen Depot in the context of our overall strategic plan to grow Acthar and the progress we've made over the last two and half years. Since acquiring Acthar, we've consistently focused on two things to create long-term sustainable value. First, expand access and reach to appropriate patients, and, second, work deliberately and systematically to resolve overhanging legacy issues we inherited when we acquired the drug. We've made great progress in both areas. To expand access and reach to appropriate patients, we've invested heavily in creating additional clinical and health economic data to help physicians and payers better assess which patients will benefit most from Acthar's existing indications, where outside of infantile spasms, the drug is often most valuable and used in later-line refractory patients who have failed on other therapies. And through focused efforts at payer engagement, we've turned around the situation we inherited with private payers, growing from having virtually no commercial lives under contract in early 2015 to today, where just under 60% of commercially insured patient lives are covered by contract. With these steady coverage gains in commercial plans, our overall payer mix for Acthar between private and public plans has become and stayed relatively stable. With these efforts, we've also seen growth in Acthar in the mid-single to low double digit range, driven predominately from volume increases in both commercial and public payer plans as we expand marketing efforts into traditional on-label indications such as pulmonology and ophthalmology, and simply achieve greater reach in appropriate patient populations and key indications. We expect these trends to continue. On the second front, we've worked diligently to resolve the legacy issues predating the acquisition, including investigations like the FTC settlement that, although not directly related to Acthar, created some confusion within certain audiences. We've moved methodically, resolving both commercial cases and government investigations, and are working to resolve remaining overhanging litigation. We'll also apply this same steady approach to any new or follow-on actions that arise. While most of these matters are already in the public domain, such as recently filed private shareholder litigation, we've begun work on additional new items, including an SEC subpoena generally related to the same subject matter. Also, like many other pharmaceutical companies, we have now received a subpoena from the U.S. Attorney's Office in Massachusetts related to patient assistance programs. All of these matters are in very early stages and will obviously (8:15) be disclosed in our 10-Q. Now let me turn back to the transition period and provide a few highlights on the performance of our business segments and key products in the period. Specialty Brands continued to produce strong results, with an overall increase of 12% in the period, with this volume-driven performance across the brand's portfolio once again offsetting an 18% decline in Specialty Generics. Moving on to key brands, Acthar results were again fueled by strong volume-based performance, coming in at the high end of our long-term expected range of mid-single to low double digit growth. This is being driven by strength across a broad spectrum of marketed indications and continued good progress in the ophthalmology pilot program. Mallinckrodt's primary goal is to ensure that patients who need and are prescribed Acthar receive it, those for whom it may be one of very few remaining options. And that means steadily adding to the $0.25 billion investment we've already made in the drug, while continuing to keep any pricing action modest. In the two and a half years we've owned Acthar, list price adjustments have averaged mid-single digits, aligned with this practice, but net price for all payers after contracting, discounting, and government rebates reduced that price change impact by roughly a third. Overall, we continue to believe that the high unmet medical need and low market penetration in most indications will support growth in demand for Acthar. And our ongoing focus on data generation and payer outreach will ensure we expand our reach to a growing universe of appropriate patients. Turning to Inomax. Following an exceptionally strong 2016, driven by our contracting strategy and new ATS/AHA infant treatment guidelines, Inomax delivered good growth, beginning to return, as we expected, to a more traditional mid-single digit growth rate, although notably off a much higher base. Going forward into 2017, we anticipate Inomax growth rates will be more consistent with the product's historical norms and higher in the first half of the year than it will be in the second half, taking into account year-on-year comparisons that reflect the 53rd week. While Therakos revenues were impacted by the XTS kit issue, the resolution is well underway. And, as a result, we've accelerated our planned market transition from the older XTS device to the newer model Cellex photopheresis unit. We expect virtually all customers to be converted to the new Cellex platform by the end of 2017. Beginning in the second quarter 2017 and for the remainder of the year, Therakos is expected to again deliver high single digit growth. We're very pleased see Ofirmev continuing to deliver strong volume-based growth, as our message of improved clinical and health economic outcomes associated with non-opioid pain management gains traction with hospitals and physicians. And in hemostasis products, while we've said consistently we expect Recothrom to flatten or decline over time, we are well underway with the introductions of Raplixa and PreveLeak. As is typical with most hospital product launches, we anticipate initial uptake to be relatively slow as physicians and surgeons gain experience with the brands, but we remain quite comfortable that we will see the business deliver double digit growth later in 2017, off the historical guidance provided of $40 million to $45 million. Now let me update you on the latest developments in science and technology, where we continue to focus resources in support of key inline products and build out a robust organic pipeline in Specialty Brands. We've made progress on a number of fronts and are looking ahead to more milestones in the coming year. We enrolled patients at the pace expected in the pivotal Phase III terlipressin study, as well as in both of our ongoing company-sponsored Phase IV studies of Acthar in the treatment of lupus and rheumatoid arthritis; completed our Phase I trial of MNK-1411, previously referred to as Synacthen Depot, for DMD in healthy volunteers, allowing dose selection for patients in our Phase II trial; initiated preparations for a spring start of the Phase II proof-of-concept, company-sponsored placebo-controlled clinical trial of Acthar in the treatment of ALS, also known as Lou Gehrig's disease. And we've progressed preparations for the Phase III clinical trial of StrataGraft human skin substitute for treatment of severe deep partial thickness burns and its Phase II trial for treatment of severe full thickness burns. Let's now spend a moment on capital deployment. Mallinckrodt has been very focused on deploying capital across the range of levers that we believe bring the greatest value to shareholders. Business development remains a top priority, with particular focus on adding both commercial and late-stage assets to enhance and diversify our portfolio. We're pleased with the 2016 acquisitions of Stratatech and the hemostasis products, and in the coming year, expect to be very active with business development and believe there are a number of highly attractive assets that fit well with our strategic objectives. We'll continue to focus on finding the right assets at the right price. Now I'll turn the call over to Matt. Matt?

Thanks, Mark. You've seen that the December transition period results were solid, with Specialty Brands and operating margins coming in ahead of expectations. Net sales were $830 million, representing growth of 3%. Net sales in the period for the Specialty Brands segment were $603 million, representing growth of 12%, reflecting strong performance from key brands and ongoing focus on driving volume. Acthar came in at the high end of our expected long-term growth range in the transition period, with sales of $325 million, growing 14%. As Mark noted, Inomax results were more aligned with historical norms, albeit off the higher base established over the past several quarters, and the product generated $118 million in net sales, a 7% increase. Turning to Ofirmev, we were pleased to see another increase in volume demand for the period, resulting in $73 million in net sales, an 8% increase. The Therakos business was flat for the period operationally, due to the XTS kit supply disruption, with net sales of $47 million. We saw net sales in the Specialty Generics segment of $213 million, representing an 18% decline over the prior-year quarter, and expect this downward trend to continue for the foreseeable future. Turning to methylphenidate ER specifically, preparations for the FDA's hearing process are ongoing. However, we expect to see additional AB-rated entrants in the market as well in the coming months, further devaluing this product. These additional entrants, coupled with declining volumes and channel consolidation across the segment, resulted in the company recording a non-cash goodwill impairment charge of $207 million in the Specialty Generics segment in the period. As you saw in our guidance today, and similar to the prior year, we project our Specialty Brands business will help mitigate the challenging results we foresee in Specialty Generics. Total company adjusted gross profit as a percentage of net sales decreased in the period to 75.2%, due primarily to the decline in Specialty Generics. R&D expense as a percentage of net sales for the period was 8%, with an increase in absolute spend over prior year, and a higher concentration of total spend was devoted to further investment in Specialty Brands. Our adjusted effective tax rate in the period was 15.7% compared to 16.1%. Turning to the balance sheet and liquidity, in the transition period, we generated free cash flow of $130 million. We repurchased shares during the period and continue to repurchase shares in early 2017. While we expect ongoing robust cash flow from the business, it's important to recognize that year-over-year cash flow for 2017 will decrease due to divestitures and weakness in Specialty Generics in particular. We continue to have a manageable net debt leverage ratio, coming in at 3.7, slightly higher than the previous quarter, as you can see posted on our website this morning. Similar to the prior quarter, this calculation excludes the cash proceeds of $574 million we received upon closing the Nuclear Imaging divestiture in late January, which should be netted against the $102 million settlement for the FTC matter and the $22 million investment for Mesoblast. At this point, I'll turn it back over to Cole, who will take us into Q&A.

Thanks, Matt. Before we start the Q&A session, I want to remind you to please limit yourself to a single question with a brief follow-up if needed. Over the last couple of earnings calls, you guys have done a really good job of adhering to that request, and I and the rest of the listeners appreciate it. Please do ask only one question. Feel free to put yourself back in the queue afterwards. I promise we'll get through as many questions as possible as time allows. With that, operator, may we please have the first question?

Operator, we're quickly coming up to the bottom of the hour. Let's see if we can get one, maybe two, more questions in. So let's please go to the next question.

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

Good morning, Mark and Matt. Can you give a little more insight around the pricing environment and pricing decisions? For the longest time, you held steady on pricing for all of your products, even though there's been some confusion about that by some. But is the pricing environment, or the rebate environment, is that getting tougher or the same? And maybe just provide a little bit of a detail on the price increases that you've taken on Ofirmev and Acthar. What do you realize on those kind of net price versus gross price increases? Thank you.

Yeah. So let me take that. I think the pricing environment certainly is not really any different from a public policy perspective than what we've seen certainly over the last year or so. I think what you've seen us do is try to match our pricing strategy with value. And, again, one of the things that you've clearly seen us do is consistently publish information that supports the positioning and value of our products relative to the price that we charge. And so we believe that the pricing actions that we've taken - and you pointed out correctly, we didn't take really any price on our major brands for the last 18 months, or even longer in the case of Ofirmev, for example. But as we've continued to generate data to demonstrate the value that these products bring to the healthcare market, we believe that that the pricing is appropriate given that relative value. And again I'd just go back to our original prepared comments, and I think a question that was asked earlier regarding net gain. If you look at our pricing policy typically, we're going to be something in the mid-single digits when we do take a pricing action, which is consistent with what you've seen with Ofirmev and Acthar. And, again, if we net out everything - discounts, rebates, payments to governments, and so on - typically, we reduce the net impact of that by about a third.

So but my question is, is it a trend of that rebating impact and all the other discounting. If we - Mark presented some information earlier this month on - that that's been increasing over the last several years. Is that the same case with Mallinckrodt?

Again, we haven't given a lot of history here, because recognize that a lot of this is still relatively new in our portfolio. But, again, if you think about the fact for a product like Acthar, where there weren't discounts given before, now with our contracting strategy and our rebating strategy, clearly we have 60% or almost 60% of commercial covered lives under some form of contract. So there has been some increase in discounting and rebating. But, again, we've built our contracts in a way that they're really volume based. And so, while we may give a modest discount upfront, typically we're going to be realizing good value on these contracts, if they perform, because we're getting the volume at the end that we expected. So over time you could suggest that there is a trend towards more gross to net difference, but again it's been relatively modest for us up to this point, and we would expect that relatively modest trend to continue going forward.

Yeah. The only thing I would add is, I just want to make sure that third in the prepared remarks was specific to Acthar.

Great. Thank you very much.

Thanks, David. Operator, I know we have a bunch more questions queued up. Let's see if we can sneak one more and before the bottom of the hour, and then we'll have to wrap up.

Our last question is from the line of Jason Gerberry of Leerink. Your line is open.

Hi. Good morning. Thanks for taking my question. Question for Matt, just on the generics business. Can you talk to us conceptually how you think about going through two years where this business has declined at around 20%? As you think about 2018 and beyond, are you kind of just washing out meth ER and some of the pricing increases in 2014-2015 such that it should now start to look more just like a mature generics business with limited pipeline, that's sort of declining in the 7% to 10% range? And secondarily to that, can you just comment on sort of the timing of maybe when some of these license ANDAs could start to contribute to that business?

Yeah. Thank you, Jason. So I do think that 2018, as evidenced by the guidance we provided, is tough, and it's going to be tougher with the guidance we provided than what we've historically said around Specialty Generics, because the pressure on methylphenidate ER is going to be significant. We already have competitive entrants out there in the marketplace, as you know. Mylan is in the marketplace at this point; we do anticipate other competitors coming in. A couple things, though, I would say that we do see playing out in 2017 that may abate as we move into 2018 and beyond. If you look at the market share of the three large players that dominate downstream the generics industry, it's been highly, highly, highly consolidated over the last couple of years. And so I think the price harmonization that's been going as these entities have been brought together, it's going to slow just by nature of there's less to consolidate to further reduce margins. So I do think 2017 is the year where methylphenidate ER will drop. And more than likely this time next year, we probably won't be getting asked too many questions about it, because of its relative size when compared with the portfolio we have. I don't think the price harmonization - while it will always continue, I don't think it'll be as extreme as we've seen in, say, the last six months and moving into the first half of this year in particular. As it relates to your question around the pipeline and the ANDAs, it's hard to predict, principally because you have the ANDA approvals coming out of FDA that have accelerated pretty significantly over time. Rest assured, we're doing whatever we can you get those ANDAs queued up as early in the process as possible to maximize the value opportunity to drive ROIC.

So, Matt, those are the products that don't have target action dates associated with them yet? Is that fair to say?

We've not put that in the public domain.

Okay. Thanks.

Thanks, Jason. With that, we're going to call it. We're passed the 9:30 cutoff. Again, I want to thank everybody for joining us. A couple reminders for you. First of all, this call will have a replay. It'll be available on our website later on today. Secondly, Dan and I will be available throughout the day to answer any questions if you need any clarification on any of the things we talked about today. Thanks for joining us on what I know is another busy day in Spec Pharma Land with a lot of things going on. Have a great week, and we'll talk to all of you soon. Thanks.

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

Thank you. Our first question is from the line of Louise Chen of Guggenheim. Your line is open.

Hi. Thanks for taking my question. I'm just curious as to why you're not being more aggressive with share repurchase here?

Yeah. Good morning, Louise. Thanks for the question. I would say we were relatively aggressive. We spent $158 million in the quarter. We bought back 2.6 million shares at an average price per share of $62. Keep in mind, though, we also had a lot of activity going on, as it related to Nuclear, and also Gablofen was - excuse me, Intrathecal Therapies is what we were working during that period. I would also point you to, Louise, the fact that we did say that we've continued to buy shares into 2017. And the benefit we have is now that the Nuclear divestiture in particular has been closed, our cash balance is very significant.

Thanks, Louise. Next question please?

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

Great. Thank you. Just had a question on margins. With the changing business mix post the divestitures and with Generics now a smaller piece of the business, can you just run through how we should be thinking about SG&A margins in 2017 and beyond? I guess specifically, is there further room to rationalize your overhead from here? And how much of an opportunity should we think about for operating margin expansion over the next several years? Thank you.

Yeah. Chris, I'll take a shot. So you're absolutely right. We are seeing pressure on our gross profit as a percent of sales, and one of the areas where we do see longer term an opportunity to mitigate some of that impact is through SG&A. We're very focused on investment in R&D, so you should not expect to see that particular line item go down over time. We've got a wonderful opportunity to reinvest across our portfolio, particularly in Specialty Brands. I would point you to the fact that three years post-spin we closed out our first restructuring program of $100 million to $125 million, right in line with our commitment of three years. And at that point in time, we had a new program in the same amount come out, and we have started to see some charges going against that reserve. So we do see more opportunity to get leverage out of SG&A, but it's going to take some time. And an example we've used is around the Nuclear business. Now that the Nuclear business is in the hands of its new owners, there are leave-behind costs that we were able to take out of base Mallinckrodt.

Thanks, Chris. Next question please?

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

Hi. Good morning. Just wanted to ask a quick question on Acthar. I saw that you took a price increase recently. This is the first pricing action, I believe, that you've taken since you've owned the asset. Just curious on your expectations, how much will be realized on a net basis in both your commercial as well as government programs? Thank you.

Yeah, thanks, Doug. It's Mark. I'll take this question. Yeah, you're right, we did take a price increase on Acthar. This is the first price increase we've taken in roughly 18 months. It was in the mid-single digit range, 6.9%, very consistent with our overall strategy and corporate policy, as I mentioned. And I think I also mentioned in the prepared comments that, if we net out all of the discounts and rebates and payments that we make to various payers and governments, that typically these price increases are going to be reduced in magnitude by about a third, so that's the way you should think about it.

Okay. And will that be across both commercial as well as government, or will that sort of net adjustment sort of be skewed one way or the - or sort of different for those respective payer groups? Thank you.

Yeah, we don't necessarily break it out that way. So I think the way to think about, again, is the fact that you take the nominal list price adjustment, and you reduce the impact by about a third across the board.

Okay. Thank you.

Thanks, Doug. Next question, please.

Thank you. Our next question is from Gary Nachman of BMO Capital Markets. Your line is open.

Hi, good morning. Mark, can you give a little more on the type of growth you're forecasting for Acthar in 2017 guidance and where you think most of that growth will come from? And can ophthalmology be a bigger contributor going forward?

Yeah, so thanks, Gary. We're real pleased with the way Acthar's performing, and as I said again in the prepared comments, we think this has a lot to do with a number of different things: the data that we're generating, the way we're positioning this product, particularly within the managed care environment, as a drug that's very appropriate for refractory patients, where their options are very few by the time they get to Acthar. And, from a long-term perspective, we've been very consistent to say that the long-term projected growth rate for Acthar should be in the mid-single to low double digits. And again, while we're very pleased to post something towards the higher end of that range in this quarter, the way you should think about the long-term growth rate is right in that range. And keep in mind, as we've said I think many times before, you shouldn't be surprised if, in a given quarter, we post something higher than that range or in another quarter something lower than that range. But overall, on a normalized basis, you should expect us to be in that range of mid-single to low double digits. And if you look at the quarters that we've posted since we've owned the asset, we've kind of been right in the middle of that virtually the entire time. In terms of growth opportunities, one of the things we're very pleased to see is that we're getting good growth across the portfolio, across the range of indications and across the payer mix, whether it's public payers or private payers. Particularly, we've seen very good growth in pulmonology and rheumatology; that's been very consistent over the last several quarters. And as we mentioned the ophthalmology pilot is showing some interesting signs of a nice opportunity for us longer term. It's still very small. We would expect over time this could be a nice opportunity for us, but it's still too early to tell.

Let me add one more thing on the cadence of what to think about Acthar. We've talked over and over again about the 53rd week dynamic. I'm not going to go into too much detail here; I think most people have taken that into account. But remember, for all of our products in the September quarter this year, there will be an optical 6 to 9 percentage point impact from that extra week comparison. So you want to make sure you take that into account. The other point that I wouldn't think that we'd have to reiterate again, but I think some of you may have forgotten about this, is remember that the first calendar quarter, the March quarter, tends to be seasonally weak for Acthar. It's the same way every single year; you can go back historically and see that. So if any of you are making the mistake of just blindly looking at sequential nominal numbers and rolling those forward, you'll see that that could get you to a weird-looking number in the first quarter. We encourage you take a look at year-over-year growth rates that would correct for any of that seasonality. And, if you do that, I think you'll see that everything that Mark said, we feel very comfortable that we should be in those kinds of ranges. With that, next question, please.

Thank you.

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

Yes, morning. Just specifically on the Generics business, can you give us a flavor for gross margins in the fourth quarter, how you think about them for the full year of 2017? And maybe you could just give us a sense of - I don't know, whatever numbers you give us with or without Concerta and how you're factoring that Concerta in? And maybe just for helping us what were the peak gross margins in the Generics business so we can get a flavor for it? Thanks.

Sure, Marc. Let me take a stab at it, and then Mark and Cole can jump in. As it relates to gross margins, they were definitely under pressure in the fourth quarter. I would say the fourth quarter also had a fair bit of APIs that were sold, which also come at a lower margin, which put further pressure on the gross margin line. That's why in my prepared remarks I went out of my way to specifically address that the pressure we're seeing is from Specialty Generics. You should expect that to continue. I'd say in particular with methylphenidate ER, that product has always had very high margins. And as we see competitive entrants come in, not to mention the FDA issue that is uncertain, that pressure is going to continue to manifest itself throughout 2017. This being said, as we said in the prepared remarks, we took into consideration methylphenidate ER in the guidance that we provided this morning. And if things play a little bit better for us, we'll probably get in the higher end of the range. If this pressure continues and it's more extreme or we see more competitive entrants, you'll see that impact. The good news is that our Specialty Brands business has been steadily growing, very strong quarters consistently over many, many quarters. And so we do get the benefit of having a right of offset. (28:24)

Yeah. And I think I would note, we talked about in the last quarterly call that you should expect some sequential declines in gross margins. You saw that this quarter. I think you'll see an even larger magnitude decline sequentially as we go into the first quarter. Again, let me reiterate that that first quarter is seasonally weak for Acthar. You would expect that to have a negative impact on sequential gross margins. If you look historically, the first quarter is almost always the lowest quarter of the year from a gross margin standpoint. So you want to make sure you take that into account, because we're certainly going to get some weaknesses, as Matt talked about, from the impact of the Generics business.

Yeah. I'd actually like to go back too, to Chris Schott's question earlier, because what we are seeing in our Specialty Brands business is that we are getting leverage on the SG&A line. We've really staffed up the sales and marketing organization and all the organizations that support those products. And so there is a mix shift going on where we do have some underlying restructuring going on. But as we're delivering really strong top line results across brands, that does also help us in getting our SG&A percent down.

So, Matt, you're saying that the Specialty Brands gross margin has been increasing over the past five, six, seven quarters, which is - ?

No, I was referring to operating margins. Sorry, I was going back to Chris Schott's, how should I be thinking about it from an operating (29:49) -

But I mean, if you were just talking about gross margin, obviously the Generics gross margin has been going down and you're saying the Specialty Brands has been flattish, or has that been going up and masking some of that Generics decline?

Yeah. We don't really comment on that, but there's nowhere near as much volatility in Brands than what you see in Specialty Generics.

Okay. Thanks.

Thanks. Next question, please?

Thank you. Our next question is from Annabel Samimy of Stifel. Your line is open.

Hi. Thanks for taking my question. I just want a clarification point on the guidance. When you talk about the variability at top end versus bottom end of the guidance, does that assume no methylphenidate ER versus some methylphenidate ER, and are there any other variables in the Specialty Brands that we should be thinking about, or in the operating expenses? And then, can you give us some expectations for data releases in 2017? Thanks.

Boy, that's - certainly seems more than a single-part question, but I'll try with the guidance number. So, anytime you put ranges in there, there are a lot of assumptions and different things that can push you to the higher or lower end of that. We certainly do expect to report some revenues from meth ER. Remember, it's already February. We're still selling the product, at least for the time being. And so there will be some revenues there. Clearly, though, and I don't want anyone to miss this, even if we continue to sell the product for the entire calendar year, outside of the situation we have with the FDA right now, we're still going to have some pretty significant competition there. So it's still going to be down a lot year over year. So we've tried to take all those scenarios into account. So, even a best-case scenario and a worst-case scenario for meth ER, we've tried to incorporate into the numbers we've given you. Now obviously, other parts of the business could do much better than we expect or worse than we expect, and still drive things higher or lower within the range, or even outside the current range we've given you, and as time goes by and we have more evidence, we'll update those ranges, if necessary, throughout the year. But we've tried to really take into account most of the impacts of meth ER in those numbers, even in a worst-case scenario. Hopefully that answered your question.

Yeah. Let me take the question about data releases in 2017. If we refer back to the prepared comments, we mentioned that we published in just this quarter, or this past transitional quarter, about 25 data sets across our portfolio, and that's been pretty consistent, the type of volume of data that we've been generating for the past several quarters, and we would expect that trend to continue. And recognize that, of the 25 or so that we published in the quarter, about 12 of those, about a dozen or so, were for Acthar. And again, we would see that type of data generation continuing in 2017, and that'll be a variety of different types of data, including clinical data as well as health economic data. We're also very excited about the prospects for our organic pipeline, and I articulated a number of things that we're doing in the pipeline to further develop some of our late-stage assets like terlipressin, like StrataGraft, as well as some of the commitments and data sets that we're generating regarding clinical trials for Acthar. So those will continue to progress. And we will update you as we get new information throughout the course of the year.

Thanks. Operator, next question, please?

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

Thanks. Matt, I was hoping you could expound on your comments on cash flow outlook for the year. Heard that you expect it to be down for the reasons you cited. Could you be more specific about your cash flow specific goals for the year, and maybe some of the key pushes and pulls in more detail than you offered in the prepared remarks? Thanks.

Sure, let me give you a little color around the transitional quarter, and then give you some data points to think about as it relates to 2017. You'll see that our cash flow dropped pretty significantly year over year. That's nothing to be concerned with. The single largest line item in there is that we did have a significant increase in our tax payments to the IRS in the quarter. You'll see CapEx was modestly up. That's because we're investing in the future of the company. And then obviously, we've talked a bit about business mix with the pressure we saw in Specialty Generics. So, while free cash flow was low, those are the key drivers that we saw in the quarter. As we're turning into 2017, we're going to see a couple hundred million dollars in decrement as we're thinking about year-over-year impact. And the drivers of that are very straightforward. You have the Nuclear business coming out, which Cole said on the last earnings call was over $100 million. You have the Gablofen divestiture, which we announced recently. And then we also have the challenges we've been talking about throughout this call in Specialty Generics. Those are the three primary drivers. This being said, we still continue to look to mine some cash off the balance sheet. And the Brands business is continuing to generate strong cash flows, and we expect that to continue, as evidenced by the guidance we gave today. So there is a bit of mix in there. I would also highlight for you, Gregg, that our cash coffers are very significant right now, as a result of closing on the Nuclear divestiture in particular. And so, as it relates to reinvesting for the future in business development or share repurchases or debt buybacks, we really don't feel constrained. And it's just kind of the realities of the transition period that we didn't get that cash in to show our net debt leverage as being lower, which it is now than where it was at the end of the transitional period.

Thanks.

Thanks, Gregg. Next question, please.

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

Hi. Thanks for the taking the question. Can you elaborate a bit more on that subpoena with the patient assistance program, and just wondering if you've had to change any marketing practices or any kind of work with patient foundations in either your Medicare or commercial books of businesses? Thanks.

Yeah. Thanks, Irina. So, with regards to the patient assistance program subpoena, this is something that came from the U.S. Attorney in Massachusetts. Recognize that this particular attorney has issued subpoenas to a number of pharmaceutical companies over the last several quarters. We've now been included in that group. We received a subpoena in the transitional quarter. And it specifically speaks to practices around patient assistance programs. We'll detail a little bit more of that in our 10-Q. But again it appears to us to be quite consistent with similar subpoenas that many other pharmaceutical companies have received around this matter.

Thanks.

(37:34) Next question, please?

Our next question is from Sumant Kulkarni of Bank of America. Your line is open.

Good morning. Thanks for taking my question. Could you characterize your level of urgency in diversifying away from Acthar in terms of the assets that may be out there. And how core is your Specialty Generics business?

How core is the business, Sumant? Was that the question?

Yes.

Okay.

So, yeah, as we said in the prepared remarks, and I think we've said several times, business development is a fundamental focus for us going forward. Our objective is to further diversify and enhance our portfolio, and that's really focused on both commercial-stage assets, as well as late-stage development assets. So we always have a high sense of urgency to do good deals. We don't have a high sense of urgency to do bad deals. And of course our long-term objective is to be very well-diversified with no single product representing more than a third of our business. And, again, that would continue to be our objective in long term. I think the good news here is that, as you've heard Matt describe, we still have very robust cash flow, we've got a lot of capacity, and we think that there are a number of very attractive assets out there that fit our strategic objectives, both for diversification as well as future cash flow generation, as well as opportunities to broaden and deepen our organic pipeline. So we're very optimistic about our opportunities in business development. We expect to be very active in 2017. We would certainly prefer to do bigger deals, but certainly we're very happy with the deals that we've done in 2016, like hemostasis and StrataGraft. So, again, we'll continue to drive forward on business development, a high sense of urgency to do very, very good things that are going to be consistent with our strategic objectives and drive a good return for shareholders.

Thanks, Sumant. Next question, please?

Thank you. Our next question is from Elliot Wilbur of Raymond James. Your line is open.

Thanks. Good morning. Just going back to some of the earlier commentary on capital deployment, use of discretionary cash flow. With respect to your adjusted EPS guidance for 2017, were there any additional debt paydown or accelerated share repurchase activity embedded in those numbers beyond what you've already talked about? Maybe you could just remind us how much is left under existing share repurchase program activity after some of the share repurchases that you've completed in the current quarter? Thanks.

Yeah, so let me start on the share repurchase side, and I'll let Matt chime in here as well. Elliot, we don't specifically comment on how much or historically the time period of when we might be buying back shares. We prefer to keep that close to the vest and let you know afterwards. I think it's safe to say that given the current share price, given our past history, given the current authorization that we have and our liquidity, given the opportunity, you should expect us to buy more shares during the year. But, again, we're not going to give any specific, quantitative levels. We will certainly let you know after the fact. We'll get you how much we have on the authorization, and, Matt, why don't you take the debt question?

Yeah. So we did pay down some debt modestly in 2016. And we are constantly monitoring that debt capital markets to see if there's debt that we can expire that makes good economic sense from an ROIC perspective for share owners. So I would say - I would look at the transitional period results, particularly in the 10-QT that we're going to be filing here shortly, and look at what we did over the last year, because the past is an indicator of the future. And I would say that we're looking at all three levers with business development, share repurchases, and debt paydown all being something that we're constantly considering.

Cole, I might come back to a question that I missed that Sumant asked, which was regarding Specialty Generics and whether or not it was core to our business. So if we just look at our long-term objectives for the company, we expect to be a well-diversified specialty branded business. And if you look at the mix of our business today, roughly three-quarters or so of our business today is in that Branded portfolio, with Generics now representing a quarter or less going forward. It's a still very important part of our business, both from a diversification standpoint and also from a cash flow generation standpoint. But we operate these businesses very differently. They're very different businesses, and Generics is very focused on cash generation. And the Brands business is focused very much on driving growth for the long term. So right now we like the mix of those businesses. And over time we would expect the Branded portion of our business to get larger as a proportion of overall sales, predominantly because that side of the business is likely to grow faster than our Generics business. So again that's the way we're thinking about a long-term view of the company.

And to answer your question on the share repurchase authorization. As of the end of December, we still had authorized just north of $260 million on current authorizations. But, as Matt said, we've continued to buy shares into calendar 2017. Next question, please.

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

Anthony, you there?

Hello.

Oh. Now, how we can hear you. Go ahead, Anthony.

Oh, apologize for that. Thanks. And good morning. Maybe just a follow-up to Mark's comments on Generics, specifically as it relates to the ANDA portfolio. Understanding that that Generics is geared toward cash generation, but just an update on where the ANDA portfolio sits, and if there's any priorities to grow that? And then a quick question would be just a recap on the remaining litigation issues that may still be surrounding Synacthen and Acthar. Thanks - post the FTC settlement. Thanks.

Yeah. So, Anthony, I'll answer your question around ANDAs, and then Mark will comment around the FTC issue and other litigation. We have been working on ANDAs. Over the years we have not disclosed them generally. But I will tell you we have been active from a licensing perspective over the last year. We see a number of players out there in the Specialty Generics landscape that are looking for organizations such as ourselves that have good commercial reach. As you've seen, there's been significant channel consolidation - customer consolidation, if you will - in the marketplace. And, as a result of that, I do think your portfolio has to resonate with these larger players that are looking for large volumes. So we're looking for ANDAs that do fit under the moniker of Specialty Generics. They're hard to make, they're complex, they've got REMS programs. And we're trying to balance kind of organic ANDA production with licensing in products that make good sense for our portfolio.

Right. So, with regards to litigation, regarding the FTC matter, we believe that's settled and behind us. Obviously we will continue to comply with the requirements of that settlement, and we're in the process of doing that, although it's obviously very early days. So again, if we look at the number of legacy litigation and other investigational issues that we inherited when we bought Acthar, we've resolved the majority of those things. Now the kind of largest remaining issue is still an ongoing investigation that was initiated by the DOJ regarding past marketing practices that Questcor engaged in very early on in its life as an independent company. So that's been going for a number of years. There's nothing further to report on that, but like we do with all of these investigations, we comply and cooperate completely with all government agencies to resolve these things to the best of our ability.

Thanks, Anthony. Next question, please?

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

Operator, could you check - Elliot already asked a question. Could you check the queue?

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

Thank you.

Hey, this is Sameer on for David. Just a quick one here. Can you provide specifics on the sales mix for Acthar between MS, NS, rheumatology, and any other uses? And then on the gross to nets and how you expect those to trend for 2017 versus 2016?

Yeah. So just consistent with what we've said in prior quarters, if you looked over the last year or two, we used to think about the mix of business for Acthar being roughly 30% between neurology, nephrology, and rheumatology, with the remaining all other being predominantly pulmonology. What we now see is that actually rheumatology is growing, continues to grow relatively rapidly, so it's a bigger portion than 30%. Neurology is probably a bit lower than 30%, and nephrology is roughly in the same zone. Pulmonology, though, has grown, so that it's a bit bigger than it was historically. And I mentioned that we have a very early stage ophthalmology pilot that's still a very, very small part of our business. One of the things we continue to be very pleased by is that Acthar is now growing consistently, really across the range of therapeutic areas that we just described, even within neurology, where we've had some challenges regarding MS. Again, the product is typically marketed for exacerbations of MS. And frankly we just are seeing fewer of those going forward. We're actually seeing stabilization of our MS business, and we're continuing to see good gains in market share in the treatment of infantile spasms. So neurology is an area that seems to be stabilizing, while the other areas, like rheumatology, pulmonology, and nephrology, are exhibiting very good growth, along with the very early stages for ophthalmology.

As it relates to your question around gross to net, that's fully baked into the guidance that we've provided of mid-single to low double. So you shouldn't expect to see significant volatility out of that.

Thanks. Next question, operator?

Our next question is from Stephan Stewart of Goldman Sachs. Your line is open.

Great, thanks. (49:40) Just to follow up on Acthar payer mix, I think you guys mentioned good growth across public and private. Maybe, can you give some more color around how that growth is trending for each, and specifically on private, how that growth has trended over the past 12 months, let's say?

Yeah, very happy to. Again, this is another, I think, real strength of the brand, is that, not only are we seeing good growth across the range of therapeutic area indications, but we're also seeing very good growth across the payer mix. Just to give you a little bit of perspective, when we inherited Acthar, we also inherited some challenges in the commercial sector. If you recall, we had a number of payers who had made some restrictions to their formularies regarding Acthar before we took possession of the drug. And so between 2014 and 2015, we had some real work to do on the commercial side of the business. And through our contracting and engagement strategy with commercial payers, we actually stabilized that situation and returned the situation to growth between 2015 and 2016. So now we've got very good growth in both commercial as well as public payers. And again, our payer mix of business has been relatively consistent now for quite some time, certainly throughout 2016.

Thanks.

Thank you. Operator, next question, please.

Next question is from David Risinger of Morgan Stanley. Your line is open.

Yeah. Thanks very much. (51:19) So, I was hoping, Mark, if you could just talk about aspiring to do bigger deals in the face of the prospect of the government eliminating the benefit of deducting interest expense on debt potentially in 2018. I bring it up only because it seems like that's actually more of an area of consensus among Republicans than some others with respect to tax reform. And so just wanted to get your perspective on the outlook for levering up for other deals. (52:00) Thank you.

So, David, you were breaking up a lot there. So, maybe we could repeat your question back a little bit. So you're asking about some of the concepts about big deals, is that correct?

Yes. Sorry. So there was a comment about aspiring for bigger transactions than you've done recently. Just want to understand how generally you're thinking about levering up in the face of the potential for interest deductibility to be eliminated under future tax reform. (52:22-52:40) And I ask the question because it seems like a lot of Republicans are in favor of eliminating interest deductibility.

Yeah. So, let me just talk about our concept of doing deals. And I'll also speak a bit about our views on where we think tax reform may go. And Matt may want to add on this. So right now, I think that - the consensus appears there's likely to be some form of tax reform. But beyond that, the details of what that may look like are pretty murky at this point. And as you might imagine, we are staying pretty close to this, both at the government level as well as at the tax expert level. So I think it really remains to be seen what the tax environment will be. And I think importantly, we don't know what the implementation timing will be for that. What we're hearing is that there would likely be a significant transition period, if and when tax reform does occur. But I think with regards to deals, keep in mind that we've never done deals that were dependent on tax. Tax was typically not a major consideration for any deal that we did. We've typically looked for things that we believe are undervalued, that are typically assets that are highly durable, address patients that are relatively underserved, and the products themselves may be underinvested in. This is our whole acquire-to-invest strategy, and we believe there continue to be a number of those assets out there. We've been very clear to say we have two fundamental platforms that we build around: autoimmune rare diseases and our hospital channel. And we believe those are very broad platforms to enable us to bring in additional assets that leverage the capabilities that we have as a company. And I think we've developed a very good track record of not only being able to identify these undervalued assets, but to invest in them and to execute in ways that create shareholder value, and that's our fundamental philosophy for doing deals. Has nothing to do with tax at the end of the day. So, when we look at opportunities going forward, we clearly want to continue to diversify our portfolio. We want to build a broader and deeper pipeline, and we would prefer, all else being equal, to do bigger deals that move us along those strategic objectives faster. And as typically has been our history, when we've had to lever up to do larger deals, we've typically done so in a way that enables us to rapidly delever. And that's the way we would think about it going forward. And that's why we believe that, with the assets that we're pursuing, we think we have a significant amount of capital and resource available to us. And we don't feel capital constrained to capture those assets and to further our strategic objectives. Let me pause there and see if Matt wanted to add anything.

I think you covered it very well. Yeah.