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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Amneal Pharmaceuticals’ Third Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mark Donohue, Vice President, Investor Relations and Corporate Communications. Please go ahead.
Thank you, and good morning. Welcome to Amneal's Third Quarter 2019 Earnings Call. Earlier this morning, we issued Press Releases reporting our quarterly results. The press releases as well as the slides that will be presented on this call are available on our website at amneal.com. We are conducting a live webcast of this call, a replay of which will also be available on our website after its conclusion.
Please note that today's call is copyrighted material of Amneal and cannot be rebroadcast without the Company's expressed written consent. I would also like to remind you that during the course of this call, management will make projections or other forward-looking remarks regarding future events or the future financial performance of the Company.
It's important to note that such statements about estimated or anticipated in Amneal results, prospects or other non-historical facts are forward-looking statements and reflect our current perspective of existing trends and information as of today's date. Amneal disclaims any intent or obligation to update these forward-looking statements except as expressly required by the law. Actual results may differ materially from current expectations and projections depending on a number of factors affecting the Amneal business. These factors are detailed in our periodic public filings with the Securities and Exchange Commission, including, but not limited to, the Amneal Pharmaceuticals, Inc. Form 10-K for the period ended December 31, 2018.
Our discussion today also includes certain non-GAAP measures as defined by the SEC. Management uses both GAAP financial measures and the disclosed non-GAAP financial measures internally to evaluate and manage the Company's operations and to better understand its business.
Further, management believes the inclusion of non-GAAP financial measures provides meaningful supplementary information to and facilitates analysis by investors in evaluating the Company's financial performance, results of operations and trends. A reconciliation of GAAP to non-GAAP measures is available in this morning's press release and in the appendix of today's presentation.
On the call this morning are Chirag Patel and Chintu Patel, Amneal's co-CEOs; as well as Todd Branning, our Chief Financial Officer. Following their prepared remarks, we will hold the Q&A session. Also on the call and available for Q&A is Andy Boyer, our Executive Vice President of Commercial Operations; Joe Todisco, Senior Vice President of Specialty Commercial; Pradeep Bhadauria, Chief Scientific Officer; and David Buchen, Chief Legal Officer and Corporate Secretary.
For our agenda today, Chirag and Chintu will begin with a discussion of our strategic direction, following that, Todd will review detailed financial results. We will have a and answer session followed by prepared remarks. And with that I would like to turn the call over to Chirag.
Thank you, Mark. Good morning everyone and thank you for joining us today to review and Amneal’s our third quarter results. When Chintu and I returned as Co-CEOs in August, we promised that we would evaluate every aspect of our business and come back to you with our point names and a plan to return Amneal to growth.
In the last three months we have done just that. As you know we were passionate and enthusiastic about Amneal when we - made the Company. Today, we are equally excited about this business and opportunities ahead.
Let me share why we are optimistic, despite the near-term results. Since our August 5th, we have done a top to bottom analysis of our business and our operations, we have visited our plans, talked to our employees at all levels, met with customers and commercial partners to find ways to work more closely together, while conversations are continuing the majority of our review is complete.
Before we discuss our findings and action plan let me summarize where we are today. First and foremost, we believe contacts is important particularly as a pertains to original business. The generics industry is a critical part of the healthcare system, it is an important force in the delivery of healthcare that is affordable to all, put simply it is a growth industry. That is not to understate the challenges, but in a necessary and essential industry there will be winners and we believe we have the foundation to create a winner.
Second, our review only serve to reinforce our belief that Amneal is a fundamentally strong Company with the robust generic portfolios cross multiple dosage forms. We have worked hard to earn a leading track-record of producing high quality products.
And today our diverse pipeline including injectables, ophthalmic and other complex products that drive value for multiple years. In addition, we have a strong specialty franchise that has the opportunity to serve as an exciting platform for growth.
Third, 2019 is a transition year for Amneal, we can’t expect results overnight, we believe the right way to create value is by being thoughtful and really getting to the heart of the issues. In other words, developing tangible plans and executing on that.
Importantly, we are strategically adapting our business to stay ahead of the curve as the market continues to evolve. And finally, Amneal’s strengths far out way its weaknesses. Over the last three months, we believe we have identified the root causes of the Company’s issues.
We have developed and begin implementing strategies to attack the drivers of underperformance head-on. At the same time, reinvigorate the business and we are already seeing improvements, while our pivot to growth won’t happen overnight. We have the platform and capabilities in place to drive our transformation.
Now let’s turn to our technical plan. To drive higher revenue and profitability, our initiatives include maximizing the value of our base business portfolio of more than 225 marketed products, which has incremental. Improving our gross margin by increasing plant utilization, streamlining our inventory and supply chain management, improving our gross-to-net sales conversion and right sizing our operating expenses.
Refocusing our R&D efforts to better leverage the strong assets we have in place and ensure new product launch preparedness and execution, continuing to invest in growth our specialty franchise and finally utilizing M&A and business development activities to augment our organic growth initiatives.
Let me start with our base business, when we came on-board our main generics business was eroding significantly in each quarter, in order to reverse this decline we identified and evaluated roughly 25% of our approximately 225 marketed commercial products, in which we can win new business and grow volumes.
In fact we have already won the awards for 20 base business products that will be incremental in 2020. In addition we are more than 30-year product opportunities in the works demonstrating in a short time how we can maximize our existing asset base to support incremental volume and growth.
We expect meaningful value and volume growth in 2020 across many dosage forms that will help offset inevitable price pressure. In some areas such as transdermals, liquids, injectables we expect even more uplift.
Now turning to second area of focus improving our gross margin. In the last 18-months generics gross margin has declined from around 50% to 30%. There is no question that the industry has changed there is more compensation and more concentration in volume group power today. However these level of compression has been pretty unacceptable and unsustainable. More importantly we believe it is fixable.
The first and most obviously way to improve gross margin is to drive high plant utilization and new product launches. As I said earlier, we are acutely focused on winning more base business and launching new high value products, which will help further our manufacturing footprint.
We are working to stream line our inventory and supply chain management. We are strengthening our forecasting improving coordination across finance operation, supply chain, R&D and with our customers and leveraging our scalability and network of reliable supplies.
We expect these changes will drive improvement in our business by reducing inventory obsolescence charges and back orders. In terms of supply chain we are delivering a centralizing in telling the data based focused on providing easy access to machine critical product data which will increase our supply chain efficiency.
These efforts is already well underway and will generate very little savings in our cost-of-goods sold. Specifically in the areas such as failure to supply penalties from our customers that penalties cost of our business value our revenue and within our control to reduce.
Collectively we believe the initiatives we have already taken and those we are targeting will enable us to expand our gross margins while we are still evaluating a number of moving pieces we are confident that an appropriate target for the generics business is a gross profit margins of at least 40% once the components of our plan fully take up price.
I will now turn the call over to Chintu to discuss our plans for optimizing our R&D spend and for the specialty franchise.
Thank you, Chirag. Good morning everyone. I would like to echo my brother’s comments and express my enthusiasm for the opportunity to reposition Amneal as a growth Company. We look forward to the next chapter in our story, while 2019 is a transition year we have every reason to believe we will return to growth and enhance profitability in 2020.
Let me start out with R&D, which has been and remains the primary engine for the growth of our business, as the generics market has become more competitive we have refocused our R&D efforts away from commodities products and more towards complex products.
First to market opportunities, sterile injectables, biosimilars, ophthalmic, inhalation and 505(b)(2) specialty product, which Amneal is very uniquely positioned to deliver. Importantly, we are prioritizing our R&D spend on opportunities where we see the best ROI. While we remain disciplined about our operating expenses we are committed to refocusing our R&D efforts and taking a thoughtful approach to better leverage our infrastructure and asset base.
Indeed over the last 30 days, we have added 15 products to our development portfolio and by end of 2019, we expect to have filed 15 to 17 ANDAs with FDA and next year we expect to file 25 to 30 products. As we discussed on our last call, we are shifting our products selection and channel focus. We are already putting this strategy into action, we have filed the ANDAs in almost all the - forms referenced among, and we anticipate filing our first inhalation product in the coming months.
This shift in our product mix is already generating results, for example through a combination of base business wings and new product launches, we anticipate double-digit volume growth in 2020 for transdermal, oral liquids and sterile products, which will also drive improvement in our margins. We expect this focus to become even more evident over the next 18-months to 24-months as we work to launch approximately 15 complex products.
Additionally to meet that expected production requirements of the large sterile business, we also recently made the decision to expand capacity in 2020 at our injectable facility with the addition of new ophthalmic and the vial line.
Turning to new product launch strategy, we are focused on complex product launches to drive long-term top-line growth and operating cash flows. For instance, our R&D and track horse teams have are already implemented enhancement to our new product launches that increases our speed to market.
These efforts have delivered 10 successful new product launches since early August, including paliperidone, aminocaproic acid oral solution and Fulvestrant injection. Things we returned in August, we have already reduced our approval to launch timelines substantially and expect to expedite it even further overtime. Looking ahead we expect to continue this momentum with potential in the fourth quarter and into next year.
Turning now to specialty business we are keenly focused building pipeline opportunities and growing top line in this business. We are strategically building our branded business in a discipline and cost effective manner including completing our ongoing IPX 203 development program and identifying and executing on new pipeline development candidates that fit our investment criteria.
With respect to IPX203 patient enrollment in the study is ongoing and we currently expect to have top-line result by end of 2020. Specially over the past three months we have made several advances in strengthening our capabilities and strategy for the specialty business.
First we are pleased to announce today that we have entered into a licensing agreement with Kashiv BioScience for the development and commercialization of K127 pyridostigmine for the treatment of Myasthenia Gravis.
We expect K127 to obtain orphan drug designation from the U.S FDA and believe the product to meet highly synergistic with our commercial deployment as well as internal clinical capability. This is the first of many new specialty products we expect to add into clinical development over the next 24-months, 36-months.
Second we also announced the expansion of our specialty sales capabilities by successfully bringing approximately 30 contracts sales reps in house, which will allow us to be more nimble and targeted in our commercial outreach.
Amneal’s commercial infrastructure in specialty is a valuable asset, which we leverage not only with new brand product launches, but for certain complex generics and biosimilar launches as well. Which do not fit the traditional generic retail distribution model.
In closing I would like to thank our customers, suppliers and employees worldwide for their continued support and to reiterate our intense focus on driving growth and profitability through operational improvements including plant utilization, supply chain optimization, inventory management and product launch readiness.
I will now turn the call back to Chirag to discuss our framework for M&A.
Thanks, Chintu. Last, but not certainly least is M&A and business development. As we discuss last quarter the actions we are taking to send in our business we lay the foundation for accelerating and evaluating inorganic growth in both generics and specialty, including potentially transformation M&A.
Specially this could include opportunities to expand into new distribution channels and key international market through strategic partners, which will enable us to access new customers. We are also looking at smaller transaction along the way, on the specialty side we continue to believe 505(b)(2) opportunities and sterile manufacturing in the United States offer compelling returns on our investment. And we are actively analyzing a number of these.
Before I turn the call over to Todd, let me summarize by saying that while we are extremely disappointed with this U.S results we are doing exactly what we said we would do. We are digging into the business, identifying the issues that are holding us back and attacking them head-on.
We recognize that the market environment is not going to make the task any easier. That said, we are working with urgency and are confident that actions we are taking will make 2020 a growth year for the company. We have an incredibly strong foundation and have already uncovered improvements that we will show in the coming quarters.
I wanted to take a moment to thank our customers for their tremendous support since we have come back to Amneal, because of our customers Amneal is able to provide important generic drugs to patients and continue its essential role in the United States Healthcare System.
Finally, I would like to thank our global workforce for their remarkable contributions they have made to Amneal and for the commitment they have shown to the ongoing transformation of our Company, we couldn’t do any of these without you.
Now, I would like to turn the call over to Todd to discuss our financial results for the quarter. Todd.
Thanks, Chirag. Good morning everyone. Let me first start by commenting that we share in the disappointment of our shareholders with respect to our Q3 results and our forecast for the balance of the year. It takes a challenging generics marketplace and we have compounded those challenges with internal inefficiencies that have and continue to hamper our results.
The good news as Chirag and Chintu said is that we have many areas in which opportunities exists to drive performance improvements. It will take time to convert those opportunities into better financial performance, while we appreciate the importance and interest in short-term results. Our focus will always be on long-term value creation.
Total net revenue was $378 million compared to $476 million in last year’s third quarter. The decline was primarily attributable to price and volume erosion in the generic segment including the impact of new competition, the divestitures of our international businesses, ongoing Epinephrine supply constrains and the loss of exclusivity on our Albenza in our specialty segment.
We offset some of the decline with sales from Levothyroxine and from products launched in 2019. Our gross margin in the third quarter was negatively impacted by product sales mix, manufacturing and supply chain inefficiencies, generic price erosion and the loss exclusivity of our Albenza.
We are tightly managing operating expenses across the organization and with combine this cost reductions from last year’s combination with impact adjusted R&D and SG&A expenses declined $18 million or 16% in aggregate.
Adjusted EBITDA and adjusted diluted earnings per share for the third quarter of 2019 declined to $71 million and $0.04 respectively as a result of lower sales and unfavorable manufacturing cost. There were some positive financial developments during the third quarter, these included strong cash flow from operations driven by improvement in working capital and reduced failure to supply penalties.
Moving to review of our generic segment results; compared to last year’s third quarter net revenue decreased 26% to $291 million, excluding divestitures and a product sale re-class, revenue declined 20%. The decrease was primarily due to the new competition, a decline of $12 million and international revenues from divestitures and Epinephrine supply issue. The decrease was partially offset by $40 million from sales of Levothyroxine and $19 million in new product launched in the first nine-months of 2019.
Additionally, this year's third quarter included minimal sales of Oxymorphone because we re-classed $17 million of third quarter sales to our specialty segment due to its status as a single source generic product. We sell this product through branded wholesalers and consistent with our existing practice, we won't be promoting or marketing this product.
On a sequential basis, compared to the second quarter of 2019 net revenues were lower by 13%. Excluding divestitures and product re-class revenue declined 9%. The decline was primarily a result of the Oxymorphone re-class additional generic competition on the base business and minimal sales of Oxycodone as we exhausted our annual third-party supply agreement quarter quota. The decrease was only partially offset by contribution from new product launches during the third quarter.
Our adjusted gross margin declined in the third quarter to 30% compared to 50% in last year's third quarter and 34% in this year's second quarter. Our margin compression was primarily due to the impact of competition, product sales mix, unfavorable manufacturing variances and inventory obsolescence charges.
During the third quarter, we made significant progress on reducing our failure to supply penalties by $10 million from this year’s second quarter. As Chintu noted, we have initiated action plan to address underutilized plant capacity in order to improve efficiency and drive gross margin expansion in the future.
Adjusted operating income in the third quarter compared to last year's third quarter decreased $91 million to $40 million. On a sequential basis, adjusted operating income was down $25 million compared to the second quarter of 2019 lower revenue and gross profit were partially offset by a reduction in expenses as we realize the benefit of cost synergies and other initiatives.
Turning to our specialty segment results, on a year-over-year basis, net revenues increased 2% to $87 million. Higher sales of the Unithroid and Rytary and the re-class of Oxymorphone sales in the generic segment were offset by $15 million decline in sales of Albenza as a result of the loss of exclusivity in September 2018.
On a sequential basis, net revenue in the third quarter increased 25% due to the addition of Oxymorphone and higher sales of Unithroid and Rytary compared to this year’s second quarter. Adjusted gross margin for the third quarter was 74%, down from 79% in the prior year primarily due to the addition of lower margin Oxymorphone and a significant decline in sales of Albenza.
On a year-over-year basis third quarter 2019 adjusted operating income declined by $3 million, primarily due to the decline in gross margin. And on a sequential basis, adjusted operating income for the third quarter increased $2 million to 441 million. This year's third quarter was impacted by higher rebates and Medicare part D coverage Liability, which we expect or will normalizing this year's fourth quarter.
Now for a review of our cash flow and balance sheet information. We ended the third quarter with $217 million in cash up $160 million compared to the second quarter of 2019. As a result of an improvement in operating cash flow and $43 million received from the cash surrender value of life insurance policies used to fund the legacy impact non-qualified deferred compensation plan.
Our cash flow from operations improved in the third quarter to positive $140 million as a result of improvement in working capital. This included $117 million reduction in accounts receivable from the second quarter of 2019. During the third quarter we executed an interest rate swap to hedge exposure to interest rate fluctuations. We estimate this action will reduce our current annual interest expenses by approximately $8 million.
Turning to our revise 2019 outlook, we have updated our full-year guidance to reflect the impact of our third quarter results and fourth quarter outlook. We currently expect fourth quarter adjusted EBITDA will be similar to our third quarter of 2019. As Chirag and Chintu noted in their remarks we are aggressively working to improve operations and gain greater efficiencies, drive gross margin expansion and generate growth in 2020 and beyond.
Even though we are navigating through internal challenges and changes, we continue to operate in a solid financial position with no near-term debt maturities or covenant compliance concerns. We are generating cash flows to more than fund their debt service while investing in internal and external growth initiatives.
Thank you. With that I will turn the call back to Mark.
Thank you, Todd. So before we open up the line for questions, I would ask you to please keep questions to one and one follow-up so we can get through a number of callers in the queue. So with that, I will turn the call back to Elysea to open it up for questions please.
Thank you. We will now begin the Question-&-Answer session [Operator Instructions] Your first question today comes from Randall Stanicky of RBC Capital Markets. Please go ahead.
Hey, good morning. This is dab Busby on for Randall. Your updated guidance probably is roughly flat performance in 4Q relative to 3Q as you just said. Is that the right run rate to think about as we enter in 2020. And as a follow-up can you provide any details around what specifically from the pipeline can support the business in 2020. Thank you.
Thank you, Dan. This is Chirag. You should not take the fourth quarter as a run rate guidance. As we just reiterated that the actions we have taken to increase the base business, launching new products the 2019 new launches becoming annualized in 2020, as well as 2020 new launches incurred in some high value launches will make the 2020 growth year.
Okay. And any specific details around some of the products we could see launch in 2020?
Well, we have disclosed no earning in the fourth quarter, it is still on target and we have disclosed few others and then last was in patients. So we will be updating our new product launches when we talk about our guidance. But six to eight more complex products are in-line to be launched next year in 2020 and we will give you more details when we talk about 2020 guidance.
Okay. Great. Thank you.
Thank you.
The next question comes from David Amsellem of Piper Jaffray. Please go ahead.
Thanks. So, I’m just struggling with the concept of returning to growth and I understand the initiatives that you are trying to articulate. But give us a sense of how you expect to get there particularly by a pipeline when it is clear that there are many other companies with sophisticated dosage form capabilities, many companies that are trying to get out of retail and into more non-traditional, non-retail channels. It sounds like you are articulating the kind of vision that many other generic companies aspire to. So I'm just trying to understand you know how you drive growth in the business in the context of the competitive landscape where many of your peers are trying to do the same thing. Thanks.
Thank you, David. I like to just go a bit to back in 2007 when we launched our first label so we probably were the last people entering the generics industry in a big way, and we became the fastest growing genetics Company from 2007 to 2017 in the United States.
So we are used to operating in a competitive field. After all we are providing affordable medicines, so it will be competitive. Yes, it has become more competitive, so how do we differentiate our results, we have a very large portfolio, our focus is United States market, we are the largest U.S domicile company with various dosage form, great quality track record, great customers supply track record with quality over years in multiple dosage forms, relationship are super.
We know that the high value products always creates more demand more value even though there are companies talking about that they would launch multiple products or multiple complex products. The capacity is at question.
The timing is always a question and we realized higher value and won with the investing in R&D over last 10-years have strengthened our pipeline to launch these products and understand we have delays in last couple of years which every companies suffers through on a complex product.
You saw Sandoz Neulasta got approved after probably 10-years. So we are confident with as I said in the base business, the growth our new pipeline coming through and our specialty franchises which is growing. So this is why we are comfortably - growth year in 2020.
And just to add few things David, you know we a very large portfolio of 225 commercial products, with group products is 327, we see lot of opportunities into our base and just like to reiterate what we have been talking since morning even in our scripts, is that we see operational inefficiency which can be fixed and everything is fixable on the areas of plant utilization, inventory management, our failure to supply and managing our supply chain in a robust way itself is we can provide substantial growth for 2020.
Secondly we are confident about expiration on complex, I mean we are very unique Company where we filled and commercialized complex product in each of the dosage category except for integration. So that is a key differentiator that now our Company’s expiration become reality and going forward as we are stated, we are confident of 15 successful launches in next 18 months to24 months and included six to eight in 2020.
And margin improvements, I think margin expansion is must. The gross margin we are running at today 30% is on sustainable and we know that it can be fixed, we already have taken actions and its nice thing that when problems are in-house you can fix that.
Okay. Thank you.
Thank you, Dave.
Thank you, Dave.
The next question comes from Gary Nachman of BMO Capital Markets. Please go ahead.
Hi. Good morning. So what is the strategy longer term to go after even more high value complex opportunities in the pipeline. Can you achieve that organically or will you need to do some bolt-on deals. And at such high leverage do you have capacity to do any deals at this point. And then how aggressively are you looking at products rationalization to help improve profitability. Thank you.
Thank you, Gary. I will start and my brother will jump in. So the complex products fortunately we do have a great pipeline of our own complex products including three biosimilars, ophthalmic products, injectable products, medical device products. So, we do not need to - we may look for a deal in biosimilars, the other complex generics I have covered.
On a specialty side as we announced today one partnership, our team is going through global footprint on where we may have a Phase I, Phase II assets, the 505(b)(2) which is the development cost would be around 15 million to 40 million so we can afford it. And those would be singles and doubles, but that is how we are building our specialty until it becomes larger, then we will move into the larger scale of specialty business as well.
So, our complex generics injectable within that ophthalmic inhalation will be filing and coming in several years we like that space, as well as the biosimilars, which is maturing over next two years, three years, four years, our strategy is to be third or fourth or fifth at this point as we see market maturing and we are setting up our commercial and regulatory expertise we already have for the biosimilars as well.
And the rationalization of R&D, we would still be investing almost 10% of our revenue in R&D. And we will be allocating smartly to specialty products, to biosimilars and injectables, inhalation, ophthalmic and all solid do not take lot of investments, but we still have those. We believe in retail generics as well as institutional and specialty which we are focusing today.
And just to add one thing Gary that, we are very uniquely positioned, because we are very robust in pressure today, scientific capabilities in-house. So - complex product our call, we will have a very cost execution and through large many years Amneal was first mover on many complex dosage form.
So we have acquired knowledge help accelerate the future filing in a complex dosage forms that is in ophthalmic transdermal including biosimilars. So, I think that would fuel the growth, but we are extremely looking, we don’t shy away from CMO and other parties if there is opportunity we will bring that in-house.
And on specialty products, we did announce that I think space really fits well with our specialty franchise and we really leverage our existing salesforce to capitalize and we expect this product - we are looking at product which does not have heavy investment or the long clinical trials, but still improvise the right value. So we are excited about the products set and will looking at five to six more specialty products over the next 18-months to 24-months to bring into our portfolio.
Okay. Thank you.
The next question comes from Greg Gilbert of SunTrust.
Thank you, I have a couple. Let me start gross margins and if I could ask you Todd to help us understand how you can get from 30% to 40% is there anything about 30% that is temporary that would lead us to a starting point that is not a 1000 bps below where you can get. So I guess the question is, how much is your control, how much of the product mix and things that are kind of more hopeful on the gross margin specifically and then I have a follow-up.
Right, okay Greg, thanks for the question. I will answer our gross margin. So maybe I will answer that. If you look at the generic sides of the business and if I do a quick bridge - between the Q2 gross margin we generated and where we landed related in Q3, so in Q2 we were about 34% to 35% and in Q3 on the generics business we were about 30%.
Probably about 60% to 65% of that margin compression has come from price erosion both the majority in our generics business, but also to some degree in our specialty business given the coverage gap liabilities we have at this point in the year.
The rest of that compression has coming from things like manufacturing plants, under utilization, generating absorption variances for us, it comes from inventory obsolescence charges and some element of product mix. So that is how we get from where we were in Q2 to Q3, but we then think how do we go from where we are right now up to what we think is achievable in terms of 40%.
Some portion of that is going to come from fixing the internal inefficiencies we have that lead to things like variances lead the things like failure to supply penalties, back orders where we can’t ship to customers and overall control of our spend at the manufacturing plant level.
So that will be part of the story, but we will also need some improvement in pricing in our generics business, in particular, which we expect to achieve through introduction of new product launches, so we are trading out lower margin, heavily commoditized products for newer products that will be part of it. And the second of it, we have to look at ways we can improve our gross-to-net sales conversion ratio, which has dropped significantly over the last few quarters.
We have got to find some ways to the call some of that back, look at products where perhaps we are even selling below our cost and how can we improve that particular position as well as look at other areas where there might be some leakage that occurs which we need to capture that ourselves. So that is how we would expect to go from where we are at 30% to hopefully 40%.
Yes sorry Todd, sorry about that. Just so I’m clear that failure supply stuff is pretty backed out in the 30 correct?
No, there is still the supply penalties that we have that are part of our gross margin and while we were lower in Q3 than we were in Q2, we still did have some in Q3.
Okay, maybe we will follow-up more on that -.
I may add, Greg sorry, just on a gross margin, so historically Amneal has operated between 45% to 55% gross margin, this is unsustainable level. And many things are under our control to get to 40% incremental base business, which increases man utilization, the launching of these 10 new product that we have done recently, we already won 20 incremental products at new base business and we are going after 30 more.
We are producing more transdermal next year than we did this year, more liquid products, more injectable products. So with all that along with as Todd mentioned, the gross-to-net, we have certain products where we have to evaluate thoroughly early from the returns perspective from Medicaid expense perspective and find way or be smart about the product - to have that gross-to-net ratio appropriate because its taking a lot of a big dollars there.
And failure just supply, the throwing money we have same thing with inventory obsolescence which is large number this year. So we expect the improvements at all of those and we have already put an action, the plans to do all these, its underway in last 93 days.
Great. Alright. So my follow-up question maybe a bit bigger picture for Chirag and Chintu. With this massive sort of restructuring and turnaround underway, I was surprised to hear you talk about in your prepared remarks things like international expansion and alternate sort of distribution method, which is something the prior management team spoke about, not so much the international. But are you actually considering such things in the near-term and if so can you put finer point on those, because I think folks would be a bit surprised to see you do major sort of international and business model evolution type moves here in the midst of what seems to be very serious turnaround effort. So maybe if you could just put a little bit more context around what you meant comments in terms of whether there near-term priorities or just functionalities. Thanks.
Thank you, Greg. Excellent question. So, let me start with what do we mean by international expansion. We have certain of our assets are highly valuable in other markets whether they are Eastern European markets or China or any other markets. So those two look very interactive. So how do we strategically partner in those areas with the top five players in those markets and maximize the value of our assets.
So, we are not planning to go and buy a company, all we are doing is expanding our asset base or maximizing the value of key assets we have in our portfolio in the international market. And as you can imagine everybody likes the U.S. FDA approved products as well as products made in our United States plants and our Ireland or Indian plants which are FDA approved. So we are excited about that opportunity.
And when I say channel expansion, again we are the largest U.S. domicile company, the large U.S. manufacturing footprint and we are going to do everything to stay here, we are serving the communities in America and like to manufacture in America and there are channels that are untapped, like government channels, the unit dose channels. So those will be expanding and add additional sales channels for our products.
Thank you.
The next question comes from Elliot Wilbur of Raymond James.
Thanks, good morning. Maybe I could just ask you to provide a little bit more color on the portfolio optimization process that you referred to prepared to of course in your prepared commentary and in the deck. Specifically with respect to identifying opportunities what looks like about 50 of your base products, fairly large number and I guess my observational analysis at this point would be that if you are successful at least on the majority of those that would seem to provide sufficient volume growth to offset any additional price erosion in 2020 such that you would actually be able to generate positive growth in the current base, at least relative to what we saw in the third quarter. So I'm just wondering what your feedback maybe on those observations.
And then I guess secondly in terms follow-up for Todd help us a little bit with operating cash flow, numbers have been volatile, a little bit difficult to predict still I guess sort of underperforming in terms five cash conversion, I'm looking at adjusted net income, but I guess as we think about the balance of year, help us think about cash conversion relative to adjusted net income projections. And if we look at 2020 should we still be thinking about sort of the same pronounced operating cash flow pattern, where you are very light in the first half and then heavy in the second half. Thanks.
Yes Elliot, thank you very much this is Chirag again. On incremental base business we have identified as we said 50 products and 20 we have already won incremental business and 30, our commercial team is actively pursuing. We may have few more to add which we are working through whether we are bringing back as from the discontinue to continue, there are a few more we can add in government segment as well.
So we are very, very optimistic and very excited about the base business in case and this is what should have done over 18-months which can offset now, we would always have decline in our base business as these new competition comes in.
But we are aggressive and working hard and utilizing all our plants and capabilities we have, we can offset that and grow the business and plus we have new product launches, which are lined up. All the launches we did in 2019 becoming full-year in 2020 and also we have six to eight complex product launches coming up as well. So you correctly stated that would help us offset the competition from our business.
One more thing is better now than 2018 is we are not highly concentrated. We had few products driving lot of EBITDA in generic side, now it is not concentrated and we have enough of new high value products to be launch, which will add to the Top 20 list and constantly replace those Top 20 list, as we must do in generics business.
And just to add one more point on it. As part of the merger we had many products in our Hayward, California plant and also some of the CMO. The process started, but there was lot of inventory at the home cost. So as we are bringing products in-house form the CMO in our Hayward, California plant. This will improve our cost of groups and it will give more a profitability.
And also as Chirag mentioned we have 225 commercial product, but actually approved product is 327. So we still see some of opportunity to even increase base business in that. And third, we are actively working on streamlining our supply chain where we are looking at second source qualification and overall bring the cost down. So I think all these ingredients would help us to a growth year in 2020.
And now regarding cash sort of from operations, we are actually very pleased with the cash flow that we have generated in the third quarter and the conversion we saw there. This is probably since I became the CFO, the first quarter that seems to be a little bit more normalized for us in terms of cash flows.
Having said that, we did have some benefits towards the very end of the quarter in terms of the timing of charge backs and timing of payments in our international operations that probably helped the balance right at the very end of the quarter.
So, I would not be surprised to see some decline in that as we proceed through the fourth quarter in terms of cash position and the cash flow from operations just giving the timing of those, but that is sort of always the case especially when you get to the end of the quarters.
In terms of 2020, it is a little pre-mature I mean to talk about that right now, we are still working on all our detail plans for next year. So I think a lot more to say about cash flow projections for next year once we get into 2020 we would share that.
Thanks, Elliot. Next question, please.
The next question comes from Chris Schott of JPMorgan.
Hi, this is [Katerina] (Ph) on for Chris. And just a question from me. Can you talk about how you are thinking about the leverage profile for the Company overtime. Where would you like leverage to go if you have target leverage profile in mind. And how you balance that against that need to diversify the business some of these external opportunities you are looking at. Thanks.
So, thanks Katrina. This is Todd, I will take that question. There isn’t a let’s say a hard numbers that we put around leverage that we are focused on, it is elevated and it will be more elevated with the guidance that we expect now for the balance of 2019.
We are not in a position to comment at this point on what it might look like in 2020. Certainly cash flow generation is going to be a priority for us and we are going to be very heavily focused on that as we proceed for the balance of this year and into 2020 and beyond for that matter.
My view is to try to maintain our financial position in the stronger shape as we can and provide the flexibility that we as a business need to be able to not only service our debt and obligation we have, but also to be able to fund our capital allocation priorities both internally and the extent that we see the opportunity externally to be able to do that as well.
So we are going to be disciplined in our purchase to that, where we balance and how we view, we will be prioritizing cash flow, but there is not a particular leverage target let say that we have in mind that we are working around.
And I may add, this is Chirag, we put on Amneal to 2007 to 2017 around 4x leverage or sometimes less sometimes a little higher. I deal with Todd, we can’t the number, but we are mindful of having the right leverage personally as an entrepreneur I do not like highly levered company and we have many growth opportunities organically to boost our EBITDA which will take care of the leverage ratio and then we can appropriately grow.
Great. Thank you.
Thank you.
The next question comes from Ami Fadia of SVB Leerink.
Hi good morning. Thank you for the questions. I have got two broad questions. When you talk about the expansion in gross margin from 30% to 40% range, how much of that - internal initiatives divide and applied and how much of it - upon launching - complex product that you indicated - 2020 and how much did you have today in the likelihood of the - fruition next year and then I have a second question.
Todd do you want to?
Sure. I mean you were breaking up a little bit there, but what I think we are gaining the basis just around the expansion in the gross margin and how much is let's say controllable versus reliance on new product launches or other revenue increases.
So it is the combination of both of those as we look to expand our gross margin. I think in broad terms you can probably think that we should be able to go from the 30% we generated in the third quarter to probably mid-30s, just simply on the basis of fixing the internal inefficiencies that we have reducing supply, inventory obsolescence charges utilizing our plant capacity.
I would say moving beyond that it is certainly going to be reliant more on the ability to launch new products at higher margins to rationalize our portfolio in smart ways and to generate a better gross-to-net conversion than what we are right now.
Incremental base business.
And in incremental base business to better utilize our plants.
Which we already have 20 products in the mix of the manufacturing sites and more are coming. So I would say pretty is within our control and new product launches are lining up to deliver that as well.
Okay. And the second question I had was probably more broadly for Chirag and Chintu and how you think about - over a last year, year and half we have seen uncertainties around the timing of new product approval and as far as that how do you think about balancing the ebbs and flows in the generic side of the business with maybe building out more on the specialty side. You talked a little bit about bringing in some contracts, sales reps, but if you could elaborate on that that would be helpful. Thanks.
Sure, Ami thank you. The timing of new product launch has always been tricky, but what is most important which we have put in place is the response to the queries and working proactively with that FDA and we so far have good news on product flow that is coming in rest of the year and next year.
And also what is most important is preparedness, preparedness to launch all of these complex products, it requires lot of efforts to be ready, especially for the medical device products or any other complex products is by relation or other activity building inventory, we have done that and constantly the process is in-place to do that just how we used to do that, which will allow us to launch on approval.
On the specialty side, yes we have 130 specialty salesforce, we would as we add more product that are more other assets or partner with companies, we will like add into - add our specialty courses, which is our net movement disorder and endocrinology today. Those are the two areas we are focusing on, very excited about as I said we are going to hit singles and doubles before we reach certain size and then do the big things on specialty.
Thank you Ami.
The next question comes from Dana Flanders of Guggenhime Securities.
Hi. Thank you for the questions. I guess my first one here, just coming back to that question around growth into next year. I guess very few generic companies are saying they expect to grow. And it is not just a base business problem, but also a pipeline problem where the value of complex launches has moved lower. So, I guess the question is just how are you valuing the complex pipeline. And just how many of these are actually first-to-file, first-to-market versus multi tossed. And then just my second question, and I just keep getting asked this and I’m not sure if you can add any color to it, but I keep getting asked about the disconnect between your loans where your loans are trading and the equity. So just curious if there is anything you can add on that. Thank you.
Thank you, Dana. I will take the first one and I will pass the second one to Todd. So growth in 2020 while it is - 2019 is a down many years, so we are starting from underperformance 2019 which not good way to say that helps in the growth.
But what we are excited again, we have found the opportunities within our base business, this is why we acquired the Impax and merged because we have larger portfolio, we can have diverse portfolio, we are capitalizing on that portfolio.
So excited about that, excited about the new product launches, some of them have been delayed which are now catching up such as annuity, we have a couple of ophthalmic launches coming up next year as well, couple of good injectable launches coming up, a liquid launches coming up.
So, we are very excited about those launches, many of them are first-to-market, I cannot predict if there would be another competitor with us, but we believe whether - we will be in the first batch to market some of those products. So, this is why we and our specialty business is doing really well and we expect that as well.
So with that we are very sure about 2020 as the growth year and beyond what we are doing, as entrepreneurs we have build out for next five years, 10-years, every year we would enjoy the growth of activities we do every day.
And just a last thing on certain complex generics also we have potential CGT and exclusivity. So that has on the first-to-market product where we have the six months exclusivity as the firs united in the market. And we have several products that meets that criteria. And we are heavily focused on R&D, it is competitive, it is all about who will get to the finish line first.
I think we have the tools and the infrastructure and people to really focus and Amneal was first movers on many complex products and so it took a little longer, but now we have the learning and it expedited the future approvals and launches.
Dana one thing is the value, you are absolutely right, it is not what it used to be in 2013, 2014, 2015, 2016, 2017 it has changed. So value of each of those high value products is lower than what it used to be and we do keep that in mind.
Dana I will add. This is on the trading level of the term loan B, so it is certainly influenced by our product Company performance and the deterioration in the financial performance of the Company is affecting that. Its influenced probably to an extent by the maturity of our term loan B, which it doesn’t mature until May of 2025, so it is still a bit of a long period of time before that matures.
You know it is also influenced by just the sentiment around the overall sector and the risk around potential exposures that everyone faces but in terms of their debt but also their equity. We know there has been some softening at the trading level of term loan B, at our particular rating.
So have all factored into it. We are cognizant of where the debt trades at. But it is all trading in the second market and outside of us improving our performance probably not a lot we can expect to do in the near-term to be able to influence that.
Okay. Thank you.
Thank you Dana. Unfortunately we are out of time for today. We really appreciate you joining our call. Investor relation is available today and rest of the weekend to follow-up questions. So again thank you.
Thank you.
Thank you.
Thank you.
The conference has now concluded. We thank you for attending today’s presentation. You may now disconnect.