Amphastar Pharmaceuticals, Inc. annual report, FY2016

Amphastar Pharmaceuticals, Inc. — FY 2016 Form 10-K

Business context and reporting period. Specialty pharmaceutical company developing, manufacturing and selling generic and proprietary injectable, inhalation and intranasal drugs, plus insulin active pharmaceutical ingredients (API). This annual report covers the year ended December 31, 2016; it also reports fourth-quarter results. The company had 19 marketed products and a pipeline of 15 generic ANDAs, three biosimilar candidates and six proprietary candidates. Financial statements received an unqualified audit opinion; the auditor did not opine on internal-control effectiveness.

Financial performance and position

Metric	FY 2016	FY 2015
Net revenue	$255.2 million	$251.5 million
Gross profit / margin	$104.2 million / 40.8%	$77.3 million / 30.7%
Operating income (loss)	$15.7 million	$(6.9) million
Net income (loss)	$10.5 million; $0.22 diluted EPS	$(2.8) million; $(0.06) diluted EPS
Operating cash flow	$38.6 million	$10.7 million
Cash and cash equivalents	$72.4 million	$66.1 million
Working capital	$123.5 million	$116.0 million
Total debt and capital leases	$37.7 million	$41.1 million

• Revenue increased about 1% year over year. Finished pharmaceuticals generated $240.2 million, up 7%; API revenue was $14.9 million, down 44%.
• Research and development expense was $41.2 million, up 11%; general and administrative expense was $41.8 million. Interest expense was $1.0 million; income-tax expense was $4.4 million, versus a $7.6 million tax benefit in 2015.
• Investing cash outflow was $39.5 million, including $21.4 million for property, plant and equipment and $12.5 million for acquisitions. Financing provided $7.1 million. Inventory increased $9.7 million to $79.8 million.
• Unused revolving-credit capacity was $37.1 million; the company reported compliance with debt covenants at year-end. Cash, cash equivalents and short-term investments totaled $74.3 million, including $18.3 million held by foreign subsidiaries that management said was not available to fund U.S. parent operations.

Material changes versus comparable periods

• Gross margin rose to 40.8% from 30.7%, principally reflecting improved pricing on epinephrine, phytonadione and lidocaine, lower enoxaparin input costs, and a more favorable product mix. The year included a $7.3 million inventory and purchase-commitment write-down.
• Enoxaparin revenue fell 30% to $59.3 million from $84.5 million, reflecting lower prices and retail volumes. Its share of total revenue declined to 23% from 34%. Actavis’s distribution agreement ended in December 2016; shipments to Actavis ceased in August, and direct retail sales resumed only at year-end.
• Naloxone revenue rose 23% to $47.5 million. Lidocaine, phytonadione and epinephrine revenues also increased, to $36.6 million, $33.3 million and $25.7 million, respectively.
• API revenue declined as MannKind did not buy its 2016 minimum commitment; FY 2016 API gross profit was a loss of $1.9 million versus $3.2 million profit in 2015. The amended MannKind contract shifted minimum purchases through 2023 and reduced near-term annual commitments, while preserving the aggregate commitment.
• Fourth-quarter revenue was $63.5 million, down from $76.9 million a year earlier; fourth-quarter net result was a $2.7 million loss versus $7.5 million income in Q4 2015.

Outlook, commentary, risks and unusual items

• Management provided no quantified revenue or earnings guidance. It expects gross margin to vary with product mix, continued competitive pressure on enoxaparin, and increased R&D spending over coming quarters and years. It stated that cash reserves, operating cash flow and borrowing availability should fund operations for the next 12 months.
• The FDA issued a December 2016 complete response letter for Primatene Mist, requiring further packaging, labeling and consumer-use studies. In February 2017, the FDA issued a complete response letter for intranasal naloxone, requiring additional human-factors, delivery-accuracy, device-reliability and pediatric-use work. Approval and timing remain uncertain.
• In March 2017, the FDA requested discontinuation of the epinephrine injection USP vial product, marketed under the Prescription Drug Wrap-Up “grandfather” exception. That product generated $18.6 million of FY 2016 revenue; the company was discussing timing of discontinuation. A $3.3 million charge was recorded for related inventory and firm purchase commitments.
• FDA inspections during 2016 produced multiple Form 483 observations at several sites, including South El Monte and Rancho Cucamonga. The filing also reports multiple observations at a South El Monte pre-approval inspection in January–February 2017. The company described responses and corrective actions as underway; outcomes could affect manufacturing or approvals.
• Enoxaparin patent litigation with Momenta and Sandoz was pending, with trial scheduled for July 2017. In March 2017, the First Circuit reversed dismissal of Amphastar’s antitrust case against those parties and remanded it; a separate False Claims Act case and potential sanctions proceedings also remained unresolved.
• Other material risks include dependence on enoxaparin and naloxone, single-source suppliers, customer concentration (AmerisourceBergen, Cardinal Health and McKesson together represented 64% of revenue), MannKind demand and credit, competition and pricing, unapproved legacy products, foreign-exchange exposure, and significant capital commitments. Contractual obligations totaled $107.6 million, including $41.9 million in purchase obligations and $15.0 million for Nanjing facility construction.
• The company reported that a 2015 material weakness in controls over complex transactions was remediated in 2016 through additional accounting personnel and stronger review procedures. Management assessed controls as effective at year-end; the external auditor did not provide an internal-controls attestation.

Most important facts for investors to verify

• Whether replacement retail distribution or direct sales can offset the loss of Actavis and stabilize enoxaparin sales, prices and margins.
• FDA decisions and remediation status for Primatene Mist, intranasal naloxone, the epinephrine vial product and South El Monte manufacturing operations.
• MannKind’s ability to meet revised minimum purchase and payment terms, and the resulting utilization and profitability of the French API facility.
• Inventory recoverability and the sustainability of FY 2016 margin improvement, given the $7.3 million write-down and continued pricing competition.
• Developments, potential damages and costs in the enoxaparin patent, antitrust and False Claims Act litigation, including possible sanctions.
• Execution and funding of manufacturing expansion and contractual commitments, while preserving liquidity and covenant compliance.
• Whether the 2016 control remediation remains effective and whether customer, supplier and product concentration risks change.