Lannett Company, Inc. (LCI) Q4 2016 Earnings Call Transcript
Published at 2016-08-24 17:00:00
Welcome to the Lannett Company Fiscal 2016 Fourth Quarter and Full-Year Financial Results Conference Call. My name is Adriyan, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. I will now turn the call over to Robert Jaffe. Jaffe, you may begin.
Thanks, Adriyan. Good afternoon, everyone, and thank you for joining us today to discuss Lannett Company's fiscal 2016 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 the cautionary statement and remind everyone that all of the information discussed on today's call is covered under the safe harbor provisions 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 U.S. 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 fiscal 2016 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 the fiscal 2017 full-year, followed by Arthur's concluding remarks. We will then open the call for questions. With that said, I’ll 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 calls 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 or ensure my first [thought][ph] in the generic drug industry. Erwin, an ex-FDA 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 culture side, but he was an excellent mentor and became my closest friend for the last 48 years. If you’re listening Erwin, thank you for your business lesson, your guidance and your friendship. Now down to business. Today, we reported record net sales for both fiscal 2016 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 fiscal 2016 fourth quarter and full-year includes the operations of Kremers Urban since that date. For fiscal 2016 fourth quarter, net sales increased 70% to $169 million from $99 million in last year's fourth quarter. The increase was driven by addition of 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’ll 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 saving 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 our generic insulin product. In July, we announced that our alliance partner received an acceptable 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 cost 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 fiscal 2017, which projects the significant earnings growth rate in the mid-teens compared with the run rate of the second-half of fiscal 2016. This is truly outstanding and reflects the great confidence we have in Lannett’s future. With that brief overview, I’ll 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. The reconciliation of a 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 the schedule of our fourth quarter and full-year net sales by medical indication. Now, to the financial results. For the fiscal 2016 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 fiscal 2015 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 fiscal 2017 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 fiscal 2017 in the range of $55 million to $65 million. Regarding the phasing of the quarters in fiscal 2017, we expect first quarter net sales and adjusted income before taxes to be similar to our fiscal 2016 fourth quarter. However, due to a tax benefit recorded in the fourth quarter of fiscal 2016, we expect adjusted net income for the fiscal 2017 first quarter to be lower than in the fiscal 2016 fourth quarter. We expect the fiscal 2017 second, third and fourth quarters to be similar to each other and slightly higher in quarter one. We are very excited about our outlook for fiscal year 2017. And as Arthur indicated earlier, these projections reflect an earnings growth rate in the mid-teens compared with our annualized fiscal 2016 second half. In addition, while we have the 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 benefit of any potential acquisitions or strategic alliances. With that, I will now turn the call back over to Arthur.
Thanks Marty. Fiscal 2016 was a transformational year for Lannett. We integrated the operations of Silarx and successfully completed the acquisition of Kremers Urban. Our acquisition strategy had 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 fiscal 2016 and we are on track to meet the synergy target in the current fiscal year and beyond. To-date, we have completed a 10% workforce reduction and made meaningful headway, transferring our manufacturing and packing operations from our Philadelphia sites to our Seymour, Indiana, facility. We have completed the transfer of two of our key products and made significant progress of 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 fluoxetine extended release tablets, a product that we have 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 certification pending [FDACA] [ph]. We continue to develop a number of other products, which are on various stages of development. Our plans call for continued significant investments in R&D. In addition to our old filing, 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 will now like to address any questions you may have. Operator?
Thank you. We’ll now begin the question-and-answer session. [Operator Instructions]And your first question comes from Gregg Gilbert from Deutsche Bank. Please go ahead.
Thanks. Good afternoon, gentlemen. I have a couple. First, on the base business, can you describe in as much detail for us how you’re building in sort of competitive 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 and tying it for target action dates or any other data points? And lastly, it sounds like debt pay down remains the priority, what's 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 smaller company. But the goal now is to integrate Kremer's and make sure we have everything settled down. We have our foundation strong underneath us, before we look at other acquisition target. We’re certainly being offered opportunities and we’re certainly looking at them. But I think right now there is nothing serious on our plate except for the focus on integrating the companies. With regards to the other question, I think I’ll 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 not being spectacular with the exception of the thyroid product where we did have a record quarter 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 the 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.
And our next question comes from Andrew Finkelstein from Susquehanna. Please go ahead.
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 in 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, 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 of 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, more potential upside because of price decline, so you don’t lose the customer. You can take him to supply the same supply 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 increased opportunity for our existing products. So typically what happens to our business 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’re finding that the target action date are not reliable, so we don’t want to get involved in predicting an approval and a launch while we are not sure we’re going to get that approval when the target action day was actually given to us. So we tend not to include any of those things in our guidance. We’re trying to guide with our existing products, things we know how to manufacture and things we know we’re going to be selling and we already 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 and predicting on the items we have in our line. Could I tell you which ones are going to have competition? No that’s not easy to tell all the time. Generally you have some indication that a competitor is coming on the market. And 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 get opportunities elsewhere and pick up market share from a new competitor. So kind of balances out a little bit. And in our case, we’re actually end up growing each year even with all of that give and take that’s going on in the market. I hope that’s the best way I can explain it because you know what are not prophets here.
No, I appreciate it. And if I could follow up, is there anymore you can say about what guidance includes for the products you’ve just launched recently or approved in launching shortly you talked about the Sumatriptan and paxil and a couple of others. I think last quarter you talked about volume on the base business stabilizing. Is that how you are 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 [indiscernible] established and at this moment we don’t have any orders. We’re bidding on directly that we get awarded from them, but that’s the normal process you go through. You bid on the number of items, and of course, 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 want to 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 our 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 low revenue coming in from the sale. We - 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 [of the samples] [ph] I sell. But they look at the opportunities to sell product. They look at opportunities to get more customers, penetrate the market further with our products and also occasionally price increases weighing on those matters as well. It depends on the opportunity. But it is in a focus of Lannett and certainly it has been. Previous two years we know that there has been what I called an aberration, where prices have gone up quite a bit on a number of products. But that’s not in our guidance. We generally don't guide for price increases. We presume that those opportunities, as I said that was an aberration or over, but doesn’t mean that I am not going to raise the price tomorrow. The opportunity presents itself. Sometimes we have no choice because our raw materials go up. Our FDA requirements are greater than the ever log before. So sometimes you have no choice, but the rates apply or discontinue at our product, if you’re not going to make money on it. So all that really goes into all the thinking, it’s hard to kind of summarize a 100 products, that is what I just did. I think that is probably the best thing. Would you want to add anything to that Marty?
No, I think Arthur has had good understand in it.
All right. Thanks very much.
And your next question comes from Elliot Wilbur from Raymond James. Please go ahead.
Thanks. Good afternoon. If I could just ask a couple of specific or product specific questions, I guess, first, on that 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 possible if you could just maybe comment a little bit on sort of 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 that 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 kind of hearing, what you're thinking about in terms of that market for 2017?
Okay, well that will make me give you a little background 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 while we ended up having higher revenues that we 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 never tell me that, next April they’re going to increase their revenue on an item, it’s just the opportunities present themselves and we are suppliers 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 a building, and that’s been one of our strength to make sure we have plenty of inventory on hand. So the customer comes out of blue and want to switch an item and I’m able to take that order and process, but usually when you get a customer like that they don’t leave you, because they’ve left somebody else not getting good service. We don’t usually lose anybody because of bad service. So, I would probably come and ask if you have a 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 possibility of another rent urn in that market?
A few years ago, we heard about few 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, they don’t keep talking about something that’s not going to happen comparably. We always hear about people filing or having application 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 is a number of people who will claim that they filed or will be filing an ANDA for this drug and we’ve been told as per the past five years and quite honestly while I do worry about it, I’m not naive to things that were going to be alone forever or be one of the third people [indiscernible]. We wanted three people in the marketplace forever. We expect competition and we always planned for it. The longer it takes to come into 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 index 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 reason we’re not as concerned about losing market share, our partners at Jerome Stevens still make the best products that’s on the market today and I think the best product of all the products in our market including all the brands. And I think the patients who take that 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 the question around the methylphenidate XR franchise. Number one, specifically if there is anything that you could tell us in terms of updated dialog 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 a last – for the latest week or so, I mean 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 kind of our right gauge or right metric to be thinking about in terms of what you’ve been able to retain, but maybe you could just sort of talk about how much you’ve been able to recapture retain of the business that was loss because of the customer defection prior to the close of the KU deal?
Okay, let me take your first question, first. Ironically, just yesterday we heard from the FDA that we heard – that they still haven't made up the 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 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 respect, 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 AV rating. Secondarily, the market share, we have picked up some market. We certainly placed 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 back to – go to vacation, excuse me, they’re taking off the product when they go back to school, they stop describing the product again. It still would be x rated product and until gets to be an AB-rated it’s probably going to stay where we are with the product. We continue to try to get more customers to switch to more product though. So that effort does not end it. 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. And 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 may be about customer retention or relationship retention. So maybe you could just sort of comment on the trends in that business?
Well, you kind of hit on in yourself. Actually we've got an additional competitor, the same firm on two of our item and as a result, we were market leader so of course they went after our market share and did take some customer business away from Kremers Urban. So, yes, they have 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 think we have of being an engineering industry. We have anticipated some of these losses when we made the acquisition. We really looked at their existing pipeline to where the growth would come. The manufacturing area that we needed as well, in addition to the products down on the market. So we expected the products down on the market to decline. Was it going to happen so quickly? No, that was not in our numbers, but that’s the business we're in. So it happens faster than we anticipated, I believe we gave 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 for that. Again, we bought it for the pipeline and for manufacturing space more so of their existing products. So, I’m not dismayed or I’m disappointed a little bit obviously but I’m not dismayed by what you just say.
The next question comes from Matt Hewitt from Craig-Hallum. Please go ahead.
Good afternoon, gentlemen. Congratulations on a strong finish to the year.
A couple of question for me. First of all, you mentioned 30 ANDA is currently sitting at the FDA. Do you have the market size for that portfolio?
Not at the moment, no, but I think I will do after the call.
Okay. Secondly, the competition, has there been your experience here over the past couple of quarters that they're entering rationally that is that they're 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?
So a little bit of both. I mean, 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 like it said, the customers have the right approach to refusal on your agreement, which means they go, some competitor comes in with a price, the existing supper has a chance to match it, before the customer could go someplace else. So price usually doesn’t get you to 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 and the compliance the work that has to be done for each in the application. 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 that are going to go down. So we’re still facing a lot of expertise of the business. I think that in itself moderates some of the crazy behaviors that are occurring when some countries decided to enter the U.S. market and grab market share. As a result, I’ve seen those people have been maturing in the market in realizing they need to make it profit as well in the United States.
Okay. That’s actually a really good segue, last question for me. So 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, while you ask about what should – what's a normalized profit margin for generic industry, but when you step back and look at the higher costs whether it's the FDA facility inspection fees or the end of 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 the bigger picture, how do you inform everybody? Hey, listen, our costs are going up, that’s what we're feeding on. How do you, I guess, get that out?
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 compare and answer as to why we raised the 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 noticed through one of our competitors events today has based some grief. So justified the price on 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 make a lot of money, and one-third is just – it’s a routine product, but say reasonable margin, kind of couples the overhead like that. Our business is really not focused on anyone product. We have to make a profit on all of the products, otherwise we would be discontinuing products that we lose money on and they’re creating shortage into the marketplace. The public needs those drugs. We’re in a healthcare field. So we’re trying to do the right thing. Price our products, so we make the profit. So we survive and we can file ANDAs. The more profits I make the more ANDAs I can file. We don’t have any corporate justice on our tarmac and we are working very hard file ANDAs and reduce the cost of healthcare in the U.S. But sometimes to do that, you have to raise the price when you have an opportunity. So, what we’ve did is, we put together all of the costs that have increased throughout. Every guidance that we received from the FDA, all the regulations in the path, including Obama Care 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 manufacture 90% of our products in the United States. So we’re a US-based manufacturer. I have a high cost of operating in the United States and training fairly reasonable salaries to the staffs that works for us here. Other my competitors come from offshore countries where they don't have those things standard. 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 prepare for this kind of media questions is put together our position paper that addresses the whole issue, not a specific question about specific product, because that’s just a sound bite. We're not interested in sound bite. We’re interested in telling the public why did the price go up over year, because nobody not one media person asked us why do we lower our price. We don’t that inquiry. It goes down every month. We lower price here and there. No one ask you why didn’t you lower your price, no problem. But raise the price and everybody wants to jump on a bit lagging 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 advance notices inspection. We need to be ready 24 hours a day on-site in 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 kind of separate ourselves from some of our competitors. As far as the quality, as you know we’re in our 74th year and Kremers is over 115 years, neither one of us never 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, in their 28 years not received a warning letter either. So these three companies 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 products, there's no data integrity issues here. The FDA is not bearing manufacturing facility from exporting or shipping into the United States from a U.S. location. But that is happening across the globe and that’s the unfortunate thing nobody wants to talk about. That 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 prices occasionally on our products. It really boils down to that, sorry to get off of my [indiscernible] now.
No, that was very helpful and insightful. Thank you, Arthur.
And next question comes from Rohit Vanjani from Oppenheimer. Please go ahead.
Hi, Arthur, Marty, thanks for taking the question.
You mentioned Levo jump this quarter, was there any inventory or stocking for that product?
No, no Rohit, nothing of that nature.
Okay. So – and then I just want to confirm, so for fiscal 2017, is that the right run rate you’re using for the guidance, you’re using this quarter’s run rate and no additional competition as the assumption?
We’re using this quarter and the third quarter.
You said second half of this fiscal year is the run rate we're referring to.
Okay and no additional competition for fiscal 2017, that’s the assumption?
Well, I mean there's always - on a 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 with benzene, Terbutaline, Sulfate, and Clindamycin, are you anticipating those price increases? Can you talk about it all, what the impact of those price would be for fiscal 2017?
No, because they’re all merged together with our budgets in our regular revenue stream and are forecast. So, we don’t actually forecast based on price increases. We look across at what we're selling the product for, but it’s all mixed together with all the other products. Remember there is over a 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 shares you're embedding in your guidance there or again is it all mixed it?
We just launched the product. So we are happy with the share we’ve received so far, you know that market share rose. One of the histories of Lannett, we're about the fourth or fifth person into an item, and yet if you look back a year later and you find out you grab the 10% of the market and sometimes 40% to 50%. So we’re the quiet enter I might say, we get into the market and we gradually build our market share once we’re out there. I can only tell you that we’re happy where we are with the product. We just launched it so it's always been out there about a month now. And I do expect to build that market share over the rest of the year going forward.
Okay. And then if we’re going back Phenazine have you noticed any share shift after taking that price increase or Lannett’s share kind of stayed constant?
We see no share shift at all. Ironically, there were two other competitors in the market and we believe one of them has dropped down, because we know they’re not supplying any other customers. So that happened coincidentally for us getting into the market after we had already raised the price. And so I think it’s one of the competitors ourselves. So we’re not losing any market share to the other competitor. We’re actually picking up market share because the other company left just as we joined the market, so we benefited there. But soon to tell, it is just 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 in a favorable product mix, but you didn’t anticipate seeing that or repeating that for this quarter. Is that what you did see that you didn’t see those manufacturing efficiency or did some of those benefits repeat themselves?
Yes, we do not see – Rohit, we do not see those benefits that we were seeing in the third – back in the third quarter. We get 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 strengthened our expenses in the third quarter. All of those expenses are based on keeping the milestones with our partners in R&D. So we had a bit of a spike higher in our third quarter and our fourth quarter R&D came in lower than we were anticipating. We also have a lower – in our fourth quarter in R&D, you see the impact of some of the efforts in the merger of the two companies now. And then lastly, on the third thing of course the benefit in the third – in the fourth quarter was the tax rate. We saw a benefit related to the acquisition of KU it was a favorable impact on our state deferred tax asset as we sold through the acquisition. And that we do not expect – that you want to see [indiscernible] but those are the factors that contributed this for the quarter.
Okay, great. Thanks for taking the questions.
And your next question comes from Scott Henry from ROTH Capital. Please go ahead.
Thank you. Good afternoon, guys, and congratulations on the quarter and the strong guidance.
Thank you, Scott. Thanks so much.
I’m going to just hit you with a couple of specifics. I know you 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, I mean, do you think we could be looking at $160 million or I mean flat in itself would be pretty strong, but I mean, that's kind of what I'm hearing, I just wanted to confirm that?
We have that safe dealing, we will use flat as an example, where we do believe we will maintain that revenues.
Okay, great. And then, the gallstone line, it looks like Q4 is kind of annualizing around $50 million to $55 million. How should we think about 2017 on gallstone, Marty?
We have – we’re thinking it’s – we had – first of all, we had a slowing first-half of the year. So, it’s for normalize it’s looking more like something like the second-half of fiscal 2016 are wrapping up the numbers we’re are looking at somewhat directionally like that. So it's not as good as we saw in the first-half of fiscal 2016.
Okay. And then we’re all kind of new to the Kremers categories, but a couple of them are pretty big, particularly GI and C&S. How should I think about 2017 relative to the Q4 run rate? Is there any noise there, or I'm just, just trying to get an idea of how I should think about those categories which are pretty large?
It’s always putting us as flattish right now in the new thinking. Arthur already mentioned about the new competitor we saw in a couple of large products that we took on from KU. For now, I’m just kind of using something similar for fiscal 2017 and second-half, so much what we saw in the fiscal 2016 in those products. In those categories.
So, I mean, 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. I mean, is that a fair statement, at least, at this point in time?
I think it’s fair to say there will upsize and downsize 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 for the second – of the second-half of fiscal 2016.
Okay, and that’s great. And then I guess, 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. Yes, how do you see that playing out in 2017? Are there any levers that 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, but they’re not in my guidance. So, I don't want to brag until I get the approvals, but - and we also have patented processes for that raw material. So that will start to ratchet up what we’re doing in company. So I’m very pleased with the applications that are pending in the agency. So that is moving along, that is still moving forward with its plans to expand its facility on another side out there. So nothing has really changed. We’re focusing and getting a lot of help with consultants, because expanding in coding is a serious decision to make, we want to make sure it’s the right one. So far we've been very supported by our outside consultants who are looking at the potential marketplace, not building buildings. We’re talking about people think that the controlled drug market will grow further as we do. So we’re pleased with the direction we’re taking there.
Okay, great. And then I guess, final question here, I’m just looking at the respiratory franchise for Kremers kind of jumps around a lot $5 million in Q3, $3 million in Q4, how do I think about that line? It is more or like Q3 or Q4?
I would – what is basically is the largest single product in that category is [indiscernible]. And with the –it’s a seasonal drug. So depending upon the season, the flu season, it either sells well or it’s not so well. That’s why you see the choppiness there between our third and fourth quarter. Third quarter pick up some of the winter, the fourth quarter we are not. So, I would for now, as it depends on the – what we see in terms of the flu season Scott, so I would probably project that take the second-half of our fiscal year and use that number for now, and I think you’re right on it, see what we do in our first quarter of fiscal 2017.
Okay, great. That makes a lot of sense. Guys thanks again for taking the questions.
Okay. Thank you, Scott. Thank you.
And your next question comes from Andrew Finkelstein from Susquehanna. Please go ahead.
Hi, thanks for taking the follow-up. I just wanted to check a couple of things here. One on the controlled substance side, I assume that generic Vicodin hydrocodone acetaminophen would be within that bucket of products that you're favorable about.
And then if I could drill a bit on the gross margin, it dipped a bit in this quarter and the guidance for the coming year is a bit higher. Can you just talk about – a little bit about the pushes and pulls and is there any phasing to it, given ongoing product transfers or anything else?
A couple things, Andrew. The – we have – protecting a lower gross margin in the first quarter compared to the other three quarters. The – in terms of the phasing of that effect, we have included in our expectation for fiscal 2017. So, I think you mentioned earlier some – there’s a couple of price increases that were 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. At least for right now, in our fiscal first quarter that we’re in right now for fiscal 2017, you’re only seeing a partial – a best partial, at best a partial impact our price increases, it’s almost zero in our first quarter a year. So that has the effect kind of having our first quarter gross margin being lower than the remaining quarters. And then also the other dynamic in our phase-in quarter's gross margin perspective is the impact of the synergies that we’re on target for. We were on target with achieving over 127 million that we committed to for fiscal 2016, in fact, we’re about 15% over that number for fiscal 2015. And in fiscal 2017, we’re expecting synergies in the range of $40 million and those synergies phase-in during the four quarters of fiscal 2017. So at zero dynamic you will see that, hence to drive up gross margin as we go through the quarters. But again, it’s really the first quarter gross margin that’s were distinctively lower than the other three quarters.
You’re welcome. Thank you.
And your next question comes from Elliot Wilbur from Raymond James. Please go ahead.
Thanks. Just a couple of real quick follow-ups for, Marty, I suppose. Could you perhaps comment on the depreciation and amortization outlook for fiscal 2017, if you have those numbers in front of you?
Yes, I do. The depreciation in fiscal 2017, we exited the year 2016 about $14 million, we’re seeing it move to about $18 million in fiscal 2017. Amortization, it is actually get the full-year effect, whereas in fiscal 2016, we only had partial year effect of the amortization numbers that came into the KU acquisition. So amortization in fiscal 2017 is about $35 million for the full-year.
Okay. And then with respect to your interest expense guidance for fiscal 2017, is there any additional debt pay down embedded in that, doesn’t look like it’s flat?
No. We do have a mandatory payment that’s we’re starting to see affecting the P&L, of course. But there’s a mandatory debt payment that, yes, that 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 and the short-term is to continue to delever. But is there a specific level of debt, which at this point we think the company is comfortable maintaining?
No, I’m not comfortable. I’m the one who doesn't like that at all.
That's why I asked, Marty.
But he would feel comfortable. Marty and I pulled this coffee.
Yes, that's why I asked, Marty, the question.
I think always the number we would like to get down to the level was about two times trailing EBITDA, some number like that. So the value is about $600 million to $700 million range. I think it is best level, Arthur that is one I would feel comfortable with looking forward. But right now, I feel $1.16 billion as we mentioned in our prepared remarks, the – our priority either one of the priority is to reduce that debt.
Okay. And then just last question real quickly for Arthur, could you talk to us a little bit about cocaine, that products can trend you?
Sure. I got a specific going in to-night.
I know that product has been trending upward last couple of quarters, and you’ve talked in the past about having kind of a direct selling initiative there, and maybe just kind of an update in terms of what's going on there with the direct selling initiative and any updates on the status of the trial and NDA filing and the like? Thanks.
Well, the trial – the main trial that one is virtually over there actually doing the statistical analysis now. And we’re also negotiating with the FDA to the pediatric study. We don’t believe what is that study, that 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 sales force out there in the marketplace. And I would say some of the headwinds we are facing there is coming from the compounders and in that particular area, we do seem to lose out because the compound will offer the product that 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 knew at this brand business as you know, but we have brought in the right measure of people to help us oversee us and so we’re not trying to do this as a generic company, because we don’t know the brand. So I’m pretty comfortable that we’re starting to see some increase in that going into the fall. We have a little bit of a setback in the sense that we were expecting 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’re facing some of the same trials and tribulations brand companies think when we launch a product, the slow uptake in getting these staff ready. But we are committed to this and we believe we got the right people. We’ve had some people leave us and that always hurts. We don’t really have the whole team out there. I think we have 13 of the 16 on the market currently. But we’re adjusting that and we’re comfortable that C-Topical will get filed. Hopefully, we’ll 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 to this drug the more we talk to the physicians. So I’m still very excited about the potential for that drug. Hope that covers the question?
Hello, disconnected. Operator?
I believe he was finished. That concludes our question-and-answer session. I’ll now turn the call back over for final comments.
Okay. We’ll thank you everyone for joining us on our conference call today. We look forward to meeting you again on our next earnings call.
Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.