Lannett Company Inc (LCI) 2016 Q4 法說會逐字稿

Welcome to the Lannett Company FY16 fourth-quarter and full-year financial results conference call. My name is Adrienne, and I will be your operator for today's call.

(Operator Instructions)

I will now turn the call over to Robert Jaffe. Robert Jaffe, you may begin.

Thanks, Adrienne. Good afternoon, everyone, and thank you for joining us today to discuss Lannett Company's FY16 fourth-quarter financial results. On the call today are Arthur Bedrosian, Chief Executive Officer; and Marty Galvan, Chief Financial Officer. This call is being broadcast live at www.Lannett.com. A playback will be available for three months on Lannett's website.

I would like to make a cautionary statement and remind everyone that all of the information discussed on today's call is covered under the Safe Harbor provision of the Litigation Reform Act. The Company's discussion will include forward-looking information reflecting management's current forecast of certain aspects of the Company's future, and actual results could differ materially from those stated or implied.

In addition, during the course of this call, we refer to non-GAAP financial measures that are not prepared in accordance with US generally accepted accounting principles, and may be different from non-GAAP financial measures used by other companies. Investors are encouraged to review Lannett's press release announcing its FY16 fourth-quarter and full-year financial results for the Company's reasons for including non-GAAP financial measures in its earnings announcement. The reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is also contained in the Company's earnings press release issued earlier today.

This afternoon, Arthur will provide a brief overview of the quarter. Then Marty will discuss the financial results in more detail, including the Company's guidance for its FY17 full year, followed by Arthur's concluding remarks. We will then open the call for questions.

With that said, I will now turn the call over to Arthur Bedrosian. Arthur?

Thanks, Robert, and good afternoon, everyone.

As some of you know, the music that you listen to while waiting for our call to begin usually has a connection to our financial performance. Today we selected an aria called Nessun Dorma from Puccini's opera, Turandot. In addition to the relationship to our results, I chose this aria to honor Irwin Shorr, my first boss in the generic drug industry.

Irwin, an ex-FDAer and a fellow New Yorker, long ago taught me the generic drug business. Along the way, he also added culture into my life by introducing me to opera. I am still a student on the cultural side, but he was an excellent mentor, and became my closest friend for the last 48 years. If you are listening, Irwin, thank you for your business lessons, your guidance and your friendship.

Now down to business. Today we reported record net sales for both the FY16 fourth quarter and full year. As a reminder, we completed the acquisition of Kremers Urban Pharmaceuticals on November 25. Accordingly, our financial results for the FY16 fourth quarter and full year include the operations of Kremers Urban since that date.

For FY16 fourth quarter, net sales increased 70% to $169 million from $99 million in last year's fourth quarter. The increase was driven by initiative KU's operations and higher sales of key products. Most notably, our thyroid deficiency category generated net sales of $45.9 million, a record for that category. In addition, we benefited from the first full quarter of sales of clarithromycin, a product we distribute for ATC, our alliance partner based in China.

On the operational front, we recently completed a number of initiatives that enhance our prospects for continued growth and profitability. I will highlight just a few. First, we refinanced all $250 million of our 12% senior notes, the high interest-rate component of our capital structure. This will result in cash interest savings of approximately $170 million over the life of the notes. On a related topic, I'd like to add that paying down our debt remains one of our strategic goals.

Second, we expanded our pipeline with large market opportunity products. In April, we announced plans to co-develop a generic insulin product. In July, we announced that our alliance partner received an Acceptable for Filing letter from FDA of its ANDA for fentanyl transdermal system. And third, we made solid progress on our integration and restructuring programs. Our efforts to reduce costs and implement synergies continues, and are a major focus for the team.

To sum up, we are very excited about our business and the outlook for next year. In a few moments, Marty will be providing guidance for FY17, which projects a significant earnings growth rate in the mid-teens compared with the run rate of the second half of FY16. This is truly outstanding and reflects the great confidence we have in Lannett's future.

With that brief overview, I will turn the call over to Marty to discuss our financial results in more detail. Marty?

Thank you, Arthur, and good afternoon, everyone.

As was mentioned earlier, I will be referring to non-GAAP financial measures. A reconciliation of the GAAP to non-GAAP numbers can be found in today's press release. In reviewing our financial results, I will focus my comments on our fourth quarter. I also want to note that our earnings release today includes a schedule of our fourth-quarter and full-year net sales by medical indication.

Now to the financial results. For the FY16 fourth quarter, net sales increased to a record $168.9 million from $99.3 million in last year's fourth quarter. Adjusted gross profit was $91.9 million, or 54% of net sales compared with $72.2 million, or 73% of net sales. The decrease in the gross profit percentage was primarily due to the addition of KU's lower-margin business.

Adjusted R&D expenses increased to $13.1 million from $7.0 million in the prior-year fourth quarter. Adjusted SG&A expenses were $17.8 million compared with $12.3 million. Adjusted operating income increased to $61.0 million from $52.9 million for the prior-year fourth quarter. Adjusted interest expense was $21.8 million compared to $88,000. And lastly, adjusted net income attributable to Lannett was $27.5 million, or $0.73 per diluted share, compared with $35.2 million, or $0.94 per diluted share for the FY15 fourth quarter.

Now turning to our balance sheet, at June 30, 2016, cash, cash equivalents and investment securities totaled $238.9 million, and total debt outstanding was $1.16 billion. As previously stated, in the fourth quarter, we refinanced our high interest-rate debt, which will generate significant savings for the Company. A key objective continues to be to use our free cash flow to de-lever as quickly as possible.

Turning now to our guidance, for the FY17 full year, on an adjusted basis, we currently expect net sales in the range of $690 million to 700 million; adjusted gross margin as a percentage of net sales of approximately 55% to 56%; adjusted R&D expense in the range of $49 million to $51 million; adjusted SG&A expense ranging from $67 million to $69 million; adjusted interest expense in the range of $71 million to $72 million; full-year adjusted effective tax rate to be approximately 34%; and capital expenditures in FY17 in the range of $55 million to $65 million.

Regarding the phasing of the quarters in FY17, we expect first-quarter net sales and adjusted income before taxes to be similar to our FY16 fourth quarter. However, due to a tax benefit recorded in the fourth quarter of FY16, we expect adjusted net income for the FY17 first quarter to be lower than in the FY16 fourth quarter. We expect the FY17 second, third and fourth quarters to be similar to each other, and slightly higher than quarter-one.

We're very excited about our outlook for FY17, and as Arthur indicated earlier, these projections reflect an earnings growth rate in the mid-teens compared with our annualized FY16 second half. In addition, while we have a deep pipeline, including a large number of product applications currently pending at the FDA, our guidance does not include sales from these products, nor does our outlook include the benefits of any potential acquisitions or strategic alliances.

With that, I will now turn the call back over to Arthur.

Thanks, Marty.

FY16 was a transformational year for Lannett. We integrated the operations of Silarx, and successfully completed the acquisition of Kremers Urban. Our acquisition strategy has nearly doubled the size of our Company and significantly expanded our product offering and scale. We have now grown our portfolio in generic drug space to over 100 products.

Our efforts to grow through acquisition were not without challenges. Fortunately, our team responded, and rose to the occasion. I am pleased to report that we continue to make excellent progress on integrating Kremers Urban and advancing the cost savings plan that we announced in early February.

We successfully met our synergy goal of $27 million in FY16, and we are on track to meet the synergy targets in the current fiscal year and beyond. To date, we have completed a 10% workforce reduction and made meaningful headway transferring our manufacturing and packaging operation from our Philadelphia site to our Seymour, Indiana facility. We have completed the transfer of two of our key products, and made significant progress on another five of our top-10 products.

During the fourth quarter, we received approvals for two products, neomycin sulfate tablets and diazepam oral solution. We expect to launch these products shortly. Also, we recently received approval for Paroxetine Extended Release Tablets, a product that we've already launched. The launch of sumatriptan, our first nasal-dosage product, has also commenced.

And with regard to our pipeline, we currently have 30 ANDAs, including 12 with Paragraph IV certifications pending FDA's CA. We continue to develop a number of other products which are in various stages of development. Our plans call for continued significant investments in R&D. In addition to our own filings, we have 10 filings with the FDA through our alliance partners.

In summary, these accomplishments provide the basis for our confidence in Lannett's future. With that overview, we would now like to address any questions you may have. Operator?

(Operator Instructions)

Gregg Gilbert, Deutsche Bank.

Thanks, good afternoon, gentlemen. I had a couple. First, on the base business, can you describe in as much detail for us for how you're building in [petative] intensity on your base business over the course of the year?

And secondly, I know you're excluding new launches from your guidance, but can you describe the potential outlook for launches, tying it to target action dates or any other data points? And lastly, it sounds like debt pay-down remains a priority. What is your appetite for deals, Arthur, and what types of things are you looking at or considering at this time? Thanks.

Well, I always have an appetite, but I'm afraid that, that's not something I want to focus on right now. I think the important thing is for us to integrate the two companies. We certainly successfully integrated Silarx, albeit it was a much lower company. But the goal now is to integrate Kremers and make sure we have everything settled down, we have our foundation strong underneath us, before we look at other acquisition targets. We're certainly being offered opportunities, and we're certainly looking at them, but I think right now there's nothing serious on our plate, except for the focus on integrating the Companies.

With regards to the other questions, I think I will let Marty answer them. As far as the strength on our products, it really is our growth across most of the products in our product line. Nothing spectacular, with the exception of the thyroid product, where we did have a record quarter for, I believe it was $45.9 million in revenue for that product.

So we are seeing growth in all of our areas. It's being offset to some degree in declines in additional competition in some of the areas and some of the products that we acquired when we acquired KU. But nothing that hasn't been offset by the growth in the Lannett product line. I guess that's probably the best way to answer that question.

Andrew Finkelstein, Susquehanna.

Hi, good evening. Congratulations on the quarter, and thanks for taking the question. Could you give any more detail on how you think about pricing and volume, the mix, as you look at the guidance for 2017? Anything product-specific is, of course, helpful. And we know -- how do you measure, to the extent -- you're looking at price erosion or price stability for the portfolio as a whole? How are you measuring that, particularly with more competition on certain of your key products and a couple selective price increases?

Well, I'm going to let Marty jump in on this one. But quite frankly, this is a typical generic drug business. You lose market potential, let's say, because of price declines. So you don't lose the customer, you're continuing to supply the same number of units. You might even be growing the units, but you're selling them at a reduced price. So that certainly does contribute to a decline.

On the other side of the coin though, is, the product approvals and the launches and the increased opportunities for our existing products. So typically what happens to our business, it just seems to be a balancing act. You lose opportunities on the left side, you pick them up on the right side.

With regards to the new products, we have not talked about any of the launches because, quite frankly, we are finding that the target action dates are not reliable. So we don't want to get involved in predicting an approval and a launch when we're not sure we're going to get that approval when the target action date was actually given to us. So we tend not to include any of those things in our guidance.

We are trying to guide with our existing products, the things we know how to manufacture, the things we know we're going to be selling and we already know we have customers. And of course, penetrating the market with additional sales per unit would help grow the business. And then any of those launches that come about over the course of the year will just add to our guidance. But we're trying to stay conservative, as we always are, in predicting on the items we have in our line.

Could I tell you which ones are going to have competition? No, that is not easy to tell all the time. Generally, you will have some indication that a competitor is coming on the market. We usually don't lose the whole market to a competitor. So you tend to lose a little piece of the market, but then you can get opportunities elsewhere to pick up market share from a competitor.

So it balances out a little bit. And in our case, we actually end up growing each year, even with all of that give and take that is going on in the market. I hope that's the best way I can explain it, because, [without profiteer].

Yes, I appreciate it. And if I could follow up, is there any more you can say of about what guidance includes for the products you've just launched recently or are approved in launching shortly? You talked about the sumatriptan and Paxil and a couple of others. And I think last quarter you talked about volume on the base business stabilizing. Is that how you're looking at it? And is there any update with your customer base, particularly in regards to Red Oak? Thanks.

No. The relation with Red Oak was re-established, but as of this moment, we don't have any orders that we are bidding on directly that we've been awarded from them. But that's the normal process you go through. You bid on a number of items they request bids on, and sometimes you get an opportunity to get an award, and other times you don't. But certainly, the relationship is there, so there is no issue that we won't do business eventually with each other.

With regards to the other question, it really is hard to say where we are with the products. We grow the market based on what we expect to have in the marketplace, the customers we already have. So you're making some of your predictions on your guidance on existing business, existing customers. The fact that you might lose a customer usually doesn't weigh in on the thinking. It's usually you might lower the price to match a competitor's quote, so you keep the customer, keep the units, but you have a lower revenue coming in from the sale.

As you know, we've been aggressive with regards to pricing our products. We certainly look at opportunities there. It's just part of the analysis we do when we look at our markets. And quite frankly, I can't speak to it directly, because it's handled by sales. But they look at the opportunities to sell product, they look at opportunities to get more customers and penetrate the market further with our products, and also patiently price increases weigh in on those matters as well. It depends on the opportunity.

But it isn't a focus of Lannett. It certainly it has been the previous two years, we know that there's been what I called an aberration, where prices have gone up quite a bit on a number of products. But that is not in our guidance. We generally don't guide for price increases. We presume that those opportunities -- as I said, that was an aberration. But it doesn't mean that I'm not going to raise the price tomorrow if the opportunity presents itself.

Sometimes we have no choice, because our raw materials go up. Our FDA requirements are greater than they ever were before. So sometimes you have no choice but to raise the price, or discontinuing a product if you're not going to make money on it. So all that really goes into all the thinking. It's hard to summarize 100 products better than I just did. I think that's probably the best thing. Would you want to add anything to that, Marty?

No, I think that's fine. No, I think Arthur has given you a good understanding, Andrew.

Thanks very much.

Elliot Wilbur, Raymond James.

Thanks, good afternoon. If I could just ask a couple of product-specific questions, first on the thyroid franchise. Obviously a strong quarter. If you look back over the last couple of quarters, you guys have faced some pretty significant pricing headwinds there. So if at all possible, if you could just maybe comment a little bit on the relative price-volume dynamics in that product in this particular quarter?

And then, Arthur, in the past you've opined as to whether or not you thought there may be additional competition on the product in the form of a new ANDA approval in your current fiscal year. And I don't know if you have any updated thoughts on that, but certainly would be interested in hearing what you're thinking about in terms of that market for 2017.

Okay, well, that one we can give you a little background on it, because obviously we did a little homework on that one. We did actually offer lower prices. So we lowered prices on that particular product. And even though we lowered the prices and expected lower revenue coming in because of the lower prices, we were surprised that we picked up additional market from some competitors on that same product.

So as a result, the net result was, we ended up having higher revenues than they anticipated, which offset the price decline, because we picked up more market share. And I think what you'll see eventually in the IMS data is our market share on that product has grown, and that's where the benefit has come in. It wasn't anything you could predict, because sales can then tell me that next April, they are going to increase their revenue on an item.

It's just -- the opportunities present themselves. And we're a supplier to our customers, probably one of the best in the industry. So when anybody is needing a product, we generally have plenty of inventory on hand, and we can capture a customer and service them immediately. We don't have to build any inventory for them, because we already have it on the floor of our building. And that's been one of our strengths, to make sure we have plenty of inventory on hand, so if a customer comes out of the blue and wants to switch an item, I am able to take that order and process it.

And usually when you get a customer like that, they don't leave you. Because they've left somebody else, and they're getting good service. We don't usually lose anybody because of bad service. So that would probably cover that particular question.

And just quickly to follow up on that, anything that you or your team has learned in terms of competitive intelligence, from talking to folks in the channel about the possibility of another entrant in that market?

Well, a few years ago, we heard about two people that were planning to get into the market, and now it's almost three years now. And I stopped talking about it, because at some point, you don't keep talking about something that's not going to happen, apparently. We always hear about people filing or having applications at the agency for this product. But either they haven't been successful in getting approval, or they are running into delays like we do with some of our products.

Either way, we know there are a number of people who claim that they filed or will be filing an additive to this drug, and we been told that for the past five years. And quite honestly, while I do worry about it, I'm not naive to think that were going to be alone forever or be one of the third people who -- or, I shouldn't say alone, be one of three people in the marketplace forever. We expect competition and we always plan for it. The longer it takes to come in, the better off we are, but we're expecting competition on every one of our products, always.

But on this one, it is a very difficult drug to make, and people don't want to switch these narrow therapeutic [and mixed] drug to another vendor. So some vendors are not going to be successful even if they get their product approved. And I think that's the other side of the coin.

So that some of the reasons we're not as concerned about losing market share. Our partners at Jerome Stevens still make the best product that's on the market today, and I say the best product of all the products that are marketed, including all the brands. And I think the patients that take the Lannett product know that and want to stay with it. So I'm less concerned about additional competition on the Levothyroxine Sodium release.

Okay. And if I could follow up with a question around the Methylphenidate XR franchise. Number one specifically, if there's anything that you could tell us in terms of updated dialogue with FDA regarding the possibility of regaining an AB rating on that product?

And then number two, in looking at, at least IMS prescription data in the last, well, for the latest week or so, it looks like that product has hung in there at around 60% to 70% of the prescription level that existed prior to your acquisition of the Kremers business. So I don't know if that's a right gauge or right metric to be thinking about in terms of what you've been able to retain. But maybe you could just talk about how much you've been able to recapture or retain of the business that was lost because of the customer defection prior to the close of the KU deal?

Okay, so let me take the first question first. Ironically, just yesterday, we heard from the FDA, and we heard that they still haven't made up their mind yet. That's exactly what their email said. It's been very frustrating for us, because we continue to pressure them. Because this is a study that was submitted in May of 2015, and certainly at this point, they should have had some decision with regards to it, and they still don't have it.

I believe the longer the delay, the better off we are, in some respects. But that's the latest. As of yesterday, they still have not made up their mind what they're going to do with regards to the AB rating.

Secondarily, the market share, we have picked up some market. We certainly replaced some of the lost business that occurred rather quickly after the KU acquisition, and we continue to maintain that market share. As you know, it's a seasonal product, so when the kids go to vacation, they are taken off the product; when they go back to school, they start prescribing the product again.

It's still a PX-rated product, and until it gets to be an AB rated, that's probably going to stay where we are with the product. We continue to try and get more customers to switch to our product though, so that effort has not ended. And I believe it will probably hold steady here for a while.

Okay. And then my last question for you is with respect to specifically just volume growth metrics in a lot of the acquired Kremers Urban products or portfolio. A lot of folks in our industry have looked at the trends in that business and have commented that it looks like volume trends in a lot of these products have been pretty soft over the past couple of quarters.

It's hard to tell how much of that's just been due to incremental competition on certain products such as omeprazole and oxybutynin. But the concern has been raised maybe about customer retention or relationship retention. So maybe you could just comment on the trends in that business?

Well, you kind of hit on it yourself. Actually, we got an additional competitor, the same firm, on two of our items. And as a result, we were the market leader, so of course they went after our market share, and it did take some customer business away from Kremers Urban. So yes, two of the products you mentioned we have competition on, a new competitor, and Kremers has lost some market.

But these are some of the advantages you might say we have of being in the generic industry. We anticipated some of these losses when we made the acquisition. We really looked at their existing pipeline as to where the growth would come, the manufacturing area that we needed as well, in addition to products they have on the market. So we expected the products there on the market to decline.

Was a going to happen so quickly? No, that was not in our numbers. But that's the business we're in. So it happened faster than we anticipated. I believe we gave it about 18 months in our projections when we acquired the company, and it happened within six.

But we've been able to make up some of those losses in revenue from the Kremers side, on the Lannett side. But still, on a net basis, we have a decline in revenue from the Kremers acquisition. But we have a lot of facilities there, and we have a lot of opportunities to grow products. And some of the products that we're not putting in our guidance are approvals that we expect Kremers to get and launch.

So I do see an upside to that. Again, we've owed it to the pipeline and to the manufacturing space more so than their existing products. So I am not dismayed -- I disappointed a little bit, obviously, but I am not dismayed by what you just said.

All right, thank you.

Thank you.

Matt Hewitt, Craig-Hallum.

Good afternoon gentlemen. Congratulations on the strong finish to the year.

Thank you.

A couple questions for me. First of all, you mentioned 30 ANDAs currently sitting at the FDA. Do you have the market size for that portfolio?

Not at the moment, no. I can get it to you after the call.

Okay. Secondly, competition. Has it been your experience here over the past couple of quarters that they are entering irrationally? That is, that they are not coming in with steep discounts, and as a result, it's a little bit easier to adjust your pricing strategy, maintain volumes and all that? Or has anything maybe changed on the competitive front, given the faster-moving FDA?

It's a little bit of both. You do have some irrational players in the marketplace that are trying to get market share with price. But we all know that doesn't work, because 90% of the customers have a right of first refusal on their agreements. Which means they know if some competitor comes in with a price, the existing supplier has a chance to match it before the customer could go someplace else.

So price usually doesn't get you the results you want. So I think a lot of people have learned that lesson by now. But some of the dumber, newer companies continue to go down that path, because they haven't figured it out yet for themselves. But I do see occasional situations like that, but not a lot.

Most of us in the industry are facing bigger demands from the agency with regards to compliance, regulatory compliance, facility compliance ANDA compliance, the work that has to be done for each of the applications. There's a lot more that we have to spend to file an ANDA. As you know, the facilities fees are going to be going up greater than the fee for the applications are going to go down.

So we're still facing a lot of extra fees in the business. I think that in itself moderates some of the crazy behavior that occurred when some countries decided to enter the US market and grab market share. As a result, I've seen those people maturing in the market and realizing they need to make a profit as well in the United States.

Okay, that's actually a really good segue. Last question for me. And you touched on this a little bit earlier, and then you just had a good lead-in. So the industry, the generic industry specifically, has been facing higher costs. And I think that there's a larger debate going on about: well, yes, but what's a normalized profit margin for a generic industry?

But when you step back and look at it, the higher cost -- whether it's the FDA facility inspection fees or the ANDA fees, or maybe even the components, the API and what have you, as those fees go up and it does put some pressure, and maybe you do take up price, how do you, from a media and bigger picture, how do you inform everybody: hey, listen, our costs are going up, that's what were feeding on? How do you get that out?

Well, that's a good question. We did our homework here, because I anticipated someone at some point was going to ask us those questions. And we did a lot of research internally and externally to be able to prepare an answer as to why we raise a price, how we price our products.

And everybody seems to want to focus on an individual item. So the questions always come, not necessarily to us, but I notice to one of my competitors these past few days, has faced some grief to justify the price of one specific item. They neglect to realize that according to IMS, and I just read this recently, one-third of our products lose money, one-third makes a lot of money, and one-third is just a routine product with reasonable margins, covers the overhead, let's say.

Our business is really not focused on any one product. We have to make a profit on all the products. Otherwise, we would be discontinuing products that we lose money on, and then creating shortages in the marketplace. The public needs those drugs. We are in the healthcare field, so we're trying to do the right thing: price our products so we make a profit, so we survive and we can file ANDAs. The more profit they make, the more ANDAs they can file.

We don't have any corporate justice sitting around in on our tarmac. And we are working very hard to file ANDAs and reduce the cost of healthcare in the US. But sometimes to do that, you have to raise the price when you have an opportunity. So what we did is, we put together all of the costs that have increased for us. Every guidance that we receive from the FDA, all the regulations that have been passed, including Obamacare and what have you, to be able to justify why we have to raise prices.

And if you look at the costs that have gone up against the manufacturing industry -- and let me remind everybody, we manufacturer 90% of our products in the United States. So we are a US-based manufacturer. I have the high cost of operating in the United States and paying very reasonable salaries to the staff that works for us here. Other of my competitors come from offshore countries where they don't have those same standards, so that puts us at a little bit of a disadvantage. The only way to overcome that, of course, is either go offshore, which we don't want to do, we want to continue to be an American manufacturer, or raise our prices as we can.

So I think what we've done here is to prepare for this media question is put together a position paper that addresses the whole issue, not a specific question about specific products, because that's just a sound bite. We're not interested in sound bites. We're interested in telling the public, why does the price go up over here?

Because nobody, not one media person asks us why do we lower our price. We don't get that inquiry. It goes on every month. We lower prices here and there, and no one asks you: why did you lower your price on the product? But raise the price, and everybody wants to jump on the bandwagon and put a microphone in front of you. It's sad.

But we have to operate in the United States with the regulatory bodies that visit us and stay here for a couple of weeks at a time. We don't get phone calls and advanced notice of inspection. We need to be ready 24 hours a day, on-site, at all our locations. And all the locations are located, as you know, in the United States. So that's one of the reasons why we separate ourselves from some of my competitors.

As far as our quality, as you know, we are in our 74th year, and Kremers is over 115 years, neither one of us ever receiving a GMP warning letter from the FDA. That doesn't happen without an intended cost to it. We're proud of the record both companies have. And I might include, Silarx has been there 28 years, never received a warning letter either.

So these three companies that have combined to be Lannett today have had an extraordinary record of compliance. But it isn't cheap to be compliant. And I think that's the message that needs to get out there. To put this on an even playing field, let's look at all the companies and really make our product.

And no data integrity issues here. The FDA is not banning my manufacturing facility from exporting or shipping into the United States from a US location. But that is happening across the globe. And that's the unfortunate thing nobody wants to talk about.

That's some of the reasons why American companies like myself and some of my competitors have to charge a little bit more, and have to raise the prices occasionally on our products. It really boils down to that. Sorry to get off my soapbox now.

No, that was very helpful and insightful. Thank you, Arthur.

You're welcome.

Rohit Vanjani, Oppenheimer.

Hi, Arthur, Marty. Thanks for taking the questions. You mentioned Levo jumped this quarter. Was there any inventory or stocking for that product?

No, Rohit, nothing of that nature.

Okay. And then I just want to confirm, so for FY17, is that the right run rate you are using for the guidance? You are using this quarter's run rate and no additional competition as the assumption?

We're using this quarter and the third quarter. We're using the second half of this fiscal year now as the run rate we're referring to.

Okay. And no additional competition for FY17, that's the assumption?

Well, there's always -- on a product-to-product basis, there's always some competition.

I meant for Levo specifically.

I'm sorry. Correct. No new entry in the market.

Okay. And then can you also say how much contribution -- we were talking about price increases, and there was some price increases that you took on a couple of products, fluphenazine, terbutaline sulfate and clarithromycin. Are you anticipating those price increases, or can you talk about at all what the impact of those price increases would be to FY17?

No, because they are all are merged together with our budgets and our regular revenue stream and our forecast. So we don't actually forecast based on price increases. Of course, we look at what we're selling the product for, but it's all mixed together with all the other products. Remember, there's over 100 products in our line now. So we don't separate the products out that way.

Okay. And then for Paroxetine, can you talk at all about maybe what you're expecting there in terms of share, or what share they are embedding in your guidance there? Or again is it all mixed in?

No, we just launched the product, so we're happy with the share we've received so far. That market share grows. One of the histories of Lannett is we have about the fourth or fifth person into an item, and yet, you look back a year later and you find out you've grabbed over 10% of the market, and sometimes 40% or 50%.

So we are the quiet enterer, you might say. We get into the market and then gradually build our market share once we are out there. I can only tell you that we are happy where we are with the product. We just launched it, so it's only been out there about a month now. And I do expect to grow that market share over the rest of the year going forward.

Okay. And then, for going back to fluphenazine, have you noticed any share shift after taking that price increase? Or has Lannett share stayed constant?

No, we see no share shift at all. Ironically, there were two other competitors in the market, and we believe one of them has dropped out, because we know they are not supplying any other customers. So that happened coincidentally for us coming into the market, after we had already raised the price. So at least one other competitor ourself.

So we are not losing any market share to the other competitor. We are actually picking up market share, because the other company left just as we joined the market. So we benefited there. But it's too soon to tell. It's the second month of our new fiscal year, so I don't want to count my chickens before they hatch.

Okay. And then -- and the last one for me. I think last quarter you mentioned seeing some manufacturing efficiencies and a favorable product mix, but that you did not anticipate seeing that or repeating that for this quarter. Is that what you did see, that you didn't see those manufacturing efficiencies? Or did some of those benefits repeat themselves?

We do not see, Rohit -- we do not see those benefits that we were seeing in the third -- back in the third quarter. We dipped down a couple of percentage points versus our expectations in gross margin. The benefit of the quarter was very much Levothyroxine had such a strong quarter.

Research and development expenses were down a little bit versus our expectations. But we had [spent] in our expenses in the third quarter, and all of those expenses are based on achieving the milestones with our partners in R&D. So we had a bit of a spike high in our third quarter, and our fourth-quarter R&D came in lower than we were anticipating. Also, the lower -- the fourth quarter in R&D, you see the impact of some of the synergy efforts in the merger of the two Companies now.

And then lastly, and the third thing that caused the benefit in the fourth quarter was the tax rate. We saw a benefit related to the acquisition of KU that was a favorable impact on our state deferred tax asset as a result of the acquisition. And that you won't see repeating itself. But those are the factors that contributed to the strong fourth quarter.

Okay, great. Thanks for taking the questions.

Thank you.

Scott Henry, Roth Capital.

Thank you. Good afternoon, guys, and congratulations on the quarter and the strong guidance.

Thank you, Scott.

I'm going to just hit you with a couple specifics. I know you'll have been asked some of these questions already, but just trying to get an idea. First on thyroid deficiency, that category put up about $162 million in 2016. Within the context of your 2017 guidance, do you think we can be looking at $160 million? Flat in itself would be pretty strong, but that's what I am hearing. I just wanted to confirm that.

Yes, we have a [safe dealing net], so we will use flat as an example. But we do believe we will maintain that revenue.

Okay, great. And then the gallstone line, it looks like Q4 is annualizing around $50 million to $55 million. How should we think about 2017 on the gallstones, Marty?

We're thinking it's -- well, first of all, we had a slowing first half of the year. So in our minds, it's looking more like -- something like the second half of FY16, wrapping up -- the numbers we're looking at are somewhat directionally like that. So it's not as good as we saw in the first half of FY16.

Okay. And then we're all new to the Kremers category, but a couple of them are pretty big, particularly GI and CNET. How should I think about 2017 relative to the Q4 run rate? Is there any noise there? I'm just trying to get an idea of how I should think about those categories, which are pretty large.

I would probably put them at flattish right now in your thinking. Arthur earlier mentioned about a new competitor we saw in a couple of the large products that we took on from KU. For now, I would just guide it using something similar for FY17, as the second half of -- similar to what we saw in the second half of FY16 for those products, those categories.

Okay. it sounds like really, Q4, even down to the gross margins, is really stretching into 2017. And it seems like we're not seeing any deterioration in the cycle anymore. Is that a fair statement, at least at this point in time?

I think it's fair to say, with all the upsides and downsides, on balance, it supports the guidance we provided. We think the earnings will come in at our expectations right now. The guidance is 15% more or less mid-teens increase in the earnings compared to the run rate of the second half of FY16.

Okay, and that's great. And then Arthur, one area -- you haven't really needed it, but I know it's been kind of one of your longer-term growth initiatives, is pain management. How do you see that playing out in 2017? Are there any levers you can pull to get that back on track?

Yes, actually we're waiting for an approval from FDA on a few of our products, and we're expecting to launch them this year. They are not in my guidance, so I don't want to brag until I get the approvals. And we also have patented processes for that raw material, so that will start to ratchet up what we are doing in Cody. So I'm very pleased with the applications that are pending at the agency. So that is moving along.

Cody Is still moving forward with its plans to expand its facility on another site out there. So nothing's really changed. We're focusing and getting a lot of help with consultants, because expanding in Cody is a serious decision to make. We want to make sure it's the right one.

And so far, we been very supported by our outside consultants, who are looking at the potential marketplace, not building buildings. We're talking about people who think that the controlled drug market will grow further, as we do. So we are pleased with the direction we are taking there.

Okay, great. And then final question here. I'm just looking at the respiratory franchise for Kremers. It jumps around a lot, $5 million in Q3, $3 million in Q4. How do I think about that line? Is it more like Q3 or Q4?

I would -- well, what is basically -- the largest single product in that category is Tussionex. And with the -- it's a seasonal drug. So depending upon the season, the flu season, it either sells well or it is not sold well. That's why you see the choppiness there between our third and fourth quarter. Third quarter would pick up some of the winter, the fourth quarter would not.

So it depends on what we see in terms of the flu season, Scott. So I would just probably project that -- take the second half of our fiscal year and use that number for now. And keep your eye on it, and see what we do on our first quarter of FY17.

Okay, great, that makes a lot of sense. Guys, thanks again for taking the questions.

Okay, thank you Scott. Take care.

Andrew Finkelstein, Susquehanna.

Thanks for taking the follow-up. I just wanted to check a couple things here. One, on the controlled substance side, I assume that the generic Vicodin or hydrocodone acetaminophen would be within that bucket of products that you are favorable about?

And then if I could drill in a little bit on the gross margin, it dipped a bit in this quarter, and the guidance for the coming year is a bit higher. Could you just talk a little bit about the pushes and pulls? And is there any phasing to it, given the ongoing product transfers, or anything else?

A couple things, Andrew. We have a -- projecting a lower gross margin in the first quarter compared to the other three quarters. In terms of the phasing effect, in essence, we had included in our expectations for FY17. So I think you mentioned it earlier, so there's a couple of price increases that we implemented some weeks ago. At this stage, those price increases are being rolled out.

It's hard to be 100% sure of the impact, and how we will do with those increases, and if they will stick, let's say. But at least for right now, in our fiscal first quarter that we're in right now for FY17, you're only seeing a partial -- at best, a partial impact on price increase. It is almost zero in our first quarter here. So that has the effect of having our first-quarter gross margin being lower than the remaining quarters.

And then also, the other dynamic in our phase in the quarters from a gross margin perspective is the impact of the synergies that we are on target for. We were on target with achieving over the $27 million we committed to for FY16. In fact, we are about 15% over that number for FY16. And then FY17, we're expecting synergies in a range of $40 million. And those synergies phase-in during the four quarters of FY17.

So that's the other dynamic. You see that tends to drive the gross margin as we go through the quarters. But again, it's really the first-quarter gross margin that's more distinctively lower than the other three quarters.

Thanks very much.

You're welcome. Thank you.

Elliot Wilbur, Raymond James.

Thanks. Just a couple of real quick follow-ups for Marty, I suppose. Could you perhaps comment on the depreciation and amortization outlook for FY17, if you have those numbers in front of you?

Yes, I do. The depreciation in FY17, we exited the year 2016 with about $14 million. We're seeing a number of about $18 million in FY17. Amortization, you essentially get the full year effect, whereas in FY16, you only had a partial-year effect of the amortization numbers that came in with the KU acquisition. So amortization in FY17 was about $35 million for the full year.

Okay. And then with respect to your interest expense guidance for FY17, is there any additional debt pay-down embedded in that? It doesn't look like it.

No. We do have a mandatory payment that we -- it's [hard] to see it effecting the P&L, of course, but there is a mandatory debt payment that we will be making during the year.

Okay. And then just last one for you, Marty. Is there -- so obviously the priority in terms of excess free cash flow, in the short term, is to continue to de-lever. But is there a specific level of debt which, at this point, you think the Company is comfortable maintaining?

No, I am not comfortable. I am the one who doesn't like debt at all. So (multiple speakers).

(Laughter) That's why I asked Marty.

Marty [looks [like taffy].

Yes, that's why I asked Marty the question.

I think, Elliot, we like to get down, and as quickly as possible, to a level of about 2 times trailing EBITDA, some number like that. So now you're in about the $600 million to $700 million range. I think that is the level Arthur -- I'll quote Arthur -- that's the one he would feel comfortable with, looking forward. But right now, with $1.16 billion, as we mentioned in our prepared remarks, our priority, maybe the number-one priority, is to reduce that debt.

Okay. And just last question real quickly, for Arthur, could you talk to us a little bit about cocaine? Net product has been trending --

(Laughter) Sure, I have a shipment coming in tonight.

I heard that product has been trending upward the last couple of quarters, and you've talked in the past about having kind of a direct selling initiative there. And maybe just an update in terms of what's going on there with the direct selling initiatives? And any updates on the status of the trial and the ANDA filing, and the like? Thanks.

Well, the trial, the main trial, that one is virtually over. They are actually doing the statistical analysis now. And we are also negotiating with the FDA for the pediatric study. We don't believe one is necessary, but of course FDA wants all new drugs that you file to have a pediatric study, unless the product will never be used in children. So we're working on that issue with the agency at the moment.

With regards to the sales, we do have the salesforce out there in the marketplace. And I would say some of the headwind we are facing there is coming from the compounders. And in that particular area, we do seem to lose out, because the compounders will offer the product at a lower price.

But we have some good salespeople. Getting a team together and taking it on since February has been a challenge, because we're new at this brand business, as you know. But we have brought in the right measure of people to help us oversee it. So we're not trying to do this as generic company experts, because we don't know the brand world. So I'm pretty comfortable that we are starting to see some increase in that going into the fall.

We've had a little bit of a setback in the sense that we were expecting more sales from -- more sales revenue from the sales effort. But that hasn't come through. But we are getting a lot more physician meetings set up, and that's usually the beginning of the key opinion leaders and the leadership role these physicians take.

So I just think that we are facing some of the same trials and tribulations brand companies face when they launch a product, the slow uptake in getting the staff ready. But we are committed to this, and we believe we've got the right people. We had some people leave us, and that always hurts. So you don't really have the whole team out there. I think we have 13 of the 16 on the market currently, but we are addressing that.

And we are comfortable that C-Topical will get filed. Hopefully, we will resolve the pediatric study the FDA wants shortly, and get that started, or not. And then be on our way to fulfilling the market potential for C-Topical. We still continue to find more opportunities for this drug the more we talk to the physicians. So I am still very excited about the potential for that drug.

Hope that covers the question. Hello? What it disconnected? Operator?

I believe he was finished. That concludes our question-and-answer session. I will now turn the call back over for final comments.

Okay, well, thank you, everyone, for joining us on our conference call today. We look forward to meeting you again in our next earnings call.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, and you may now disconnect.