Orexo AB

STO:ORX

Earnings Call Transcript 2019-Q1

[Operator]

Ladies and gentlemen, welcome to the Orexo AB audio conference -- teleconference Q1 2019 call. Today, I'm pleased to present Nikolaj Sørensen, Chief Executive Officer and Joseph DeFeo, Chief Financial Officer. [Operator Instructions] Speakers, please begin.

[Nikolaj Sørensen, President & CEO]

Thank you very much, and welcome to this first quarter call for Orexo in 2019. If I look back on the quarter we have just been through, it has been a very strong start of 2019. Leading a pharmaceutical company, I think the main topic is do you want to show good sales growth and we have shown good sales growth, in particular in Swedish krona, but also in local currency. It's about profitability. We have improved our profitability substantially coming from the U.S. business and even on the corporate level despite having a significant cost for [ leading ] in this quarter. It's about developing a pipeline. And while we know there's a risk in the pipeline as some projects does not progress exactly as anticipated, I'm very happy to see that we, during the quarter, had 2 projects that have shown very positive results and have enabled us to take a decision to progress these projects into the next phase. So looking at the fundamentals of running a pharma company, I believe this has been a very strong quarter and it gives us even stronger position moving forward. So moving into the report, and I will jump immediately to the third page, and we start with an overview of Q1 2019. Moving into Page #4. And if -- just to take a few of the highlights, and we'll go into more details as we progress in the presentation. Then from a financial perspective, the main highlight I want to [ lift ] up is the EBIT improvement, and that in particular when we look at the Zubsolv contribution to the overall EBIT. When we look at the EBITDA and EBIT, it's the first time ever for Orexo that we have a positive first quarter. On EBIT, it was on the margin, but in EBITDA, was a little more. But more interestingly, if we deduct the litigation cost that we had during this quarter, which was significant, we actually have had an EBITDA, which would have been plus with more than SEK 60 million. Should we even take the number and look back for the last 4 quarters, so last 12 months, our EBITDA would have been SEK 263.7 million. So a really strong financial result. However, we have had significant cost during the last 12 months, both to run our Zubsolv case, but also later to run the case for the Actavis, Suboxone and Subutex generics. When we look at what's driving the EBIT growth, it has been around the cost of goods and gross margin in combination with the sales growth in the U.S. And on the cost of goods, we set a target for the company to reach a 35% reduction compared to our base year 2017, and we actually exceeded that target already in the first quarter. So we have now upgraded the target for this full year and expect rather than having the second quarter -- second half of the year we reached this 35% reduction. We now feel confident that we can deliver that on a full year basis as well. As a side comment, we have also now got approval from the medical agency here in Sweden, so we can now start [ managing ] clinical trial [indiscernible] in our own facilities here in Uppsala. When we get to the R&D projects in pipeline, we are very happy to see that as we recorded last quarter, which was in this quarter, but it was in -- very early in the quarter so we could include in Q4 report of last year, was that OX124 data was very strong. Based on that data, we feel confident now to move on with OX124 and OX125 and take those into -- towards the clinical phase. We will start those latest 2020. We could maybe start it early -- late this year, but so far the main plan is we'll start it in 2020, in the next clinical trials.Our OX338 project, it is the pain project. We had positive in-vivo data and we are now planning to run a clinical trial in the second half of this year.The one setback we had in the pipeline was that OX382, which I always have said is the project with the highest risk as it is a very difficult topic to make buprenorphine orally available. The formulation we tested in-vivo, that means an animal test during the quarter did not support that we take the investment of moving it into clinical Phase I... So we are back to the drawing table and look at some of the other ideas we have for how we can address some of the issues we have of making buprenorphine orally available. But the project is not dead, but it's just not been -- we're not able to move it into clinical phase with the data we have right now.Then the major setback during the quarter was the Actavis legal case where the District Court found that Actavis has not infringed the '996 patent. We have taken the first step in an appeal process, but more importantly, having just talked about the legal expenses, the appeal process is associated with substantially lower cost than what we have seen in the last quarter. So we do expect to see legal expenses decline significantly as we proceed.So moving into the pipeline update on Page 5, and further on Page #6 where we have an overview of our pipeline. For Zubsolv, actually I would just mention that, here Zubsolv for the rest of the world, we have received the rights back to Zubsolv outside the U.S. So now, Orexo holding the marketing organization since April 13. We have advanced discussions with parties in multiple different geographies, so I feel quite confident that we'll have a new partner in place. One of the issues we have had is that when we saw the manufacturing process that Mundipharma were responsible for, we found that the prices that we could get from that was not competitive and we were confident that we could improve the supply prices by changing the supply chain and that's more specifically related to the packaging. So we had to go out and find a new packaging solution, which have taken some time during the first quarter, and before that was finished we couldn't proceed into final negotiations with partners of Zubsolv outside Europe, but we [ received those folks and have ] found a packaging partner that can be very competitive. So we now feel confident to take those negotiations further. Moving into the development programs, I have talked a little about OX124, OX125, I will come back to those. We have moved on this graph, moved OX125 a little further because as it's based on the same type of technology as in OX124, we feel comfortable that we are nearly ready to move it into the first clinical studies. With the Ketorolac, we received positive in-vivo data, so we have moved that up forward. So it's getting close to clinical Phase I. We expect that in the second half. And then with the OX382, we have moved that a notch back because we need to do more formulation work. Then with OX-MPI, which is a project we had with Boehringer Ingelheim that was since then acquired by Gesynta, a small Swedish pharma company, they are now ready to move into Phase I later this year. So that one can become very exciting as we progress also. But Orexo is not involved in the development of OX-MPI, but we will receive parts of the revenues generated if it succeeds. So moving into OX124 and OX125, just to give a high-level glance, and I will do this fast and for those of you who are interested, I will spend more time on that in my presentations to come. But what we have is, is we have developed some programs that are specifically addressing the need we see in particular in the U.S. from -- death from synthetic opioids. So fentanyl and the likes were the current formulations that are in the market, are designed more [ particular to ] heroin overdose. We find that the feedback we get from FDA is that there is a need for something that is stronger, that is faster and that's longer lasting and that is the objective of these 2 projects. I will also highlight that both of them are based on a completely unique nasal formulation. And this is very important because there are lot of patents in this space -- sorry, even though there are several other companies that have a nasal spray ongoing, we believe several of those will have issues with the existing patents that are for Narcan in the U.S., but we believe that our projects should all outside the existing patents as they are unique in this way, we have designed them. The market -- I'm moving to Page 8, the market we're looking at is something that is growing dramatically. It's growing because of the need, of course, but also because the preventive actions that are made by the U.S. authorities to make these products available for patients who have high prescriptions of opioid painkillers. It is for people who are in a risk segment, so or people who are among them. So if you have a family member who is a misuser, there is a lot of activities to make these rescue medications available. And then as, of course, the first responders, emergency personnel where people can get access, we'll have it in a firetrucks or the ambulances, policemen and so forth. So all of this is when we see how the market were a few years ago, it was predominantly sitting with emergency staff, but now there's so much move to make this available on the broader scale. And for example, FDA has just, a few months ago -- a few weeks ago, called for action to make this OTC, which have a some pros, it enabled a bigger market, but it also have some cons as it makes a good [ motive once you get ] insurance coverage. We have a good discussion with FDA on these topics, but just looking at the market opportunity, this could be a very substantial market. And although there is a strong existing incumbent there are a lot of pipeline projects. We actually believe that we have a unique angle on this and we definitely [ should ] fall within the patent protection there are of the existing projects.So moving to Page #9. Just to summarize on OX124 and patents on OX125. We had successful data of Phase I study showing substantially higher plasma concentration than the leading competitor in the U.S., which is a product called Narcan. We have received positive feedback from FDA with regards to the concept and now we continue the discussion with FDA. So how do we do the final clinical development plan, and in particular, the pivotal pharmacokinetic study that we're now planning for 2020, and with an estimated submission in 2021. We are looking for ways how we can accelerate this. The same goes for OX125. In those it's a unique API. It's in some parts building on the same technology and we are, again, expecting to have our first clinical trial with OX125 in later 2020. Moving to OX338, which is our Ketorolac product, the pain product. The idea behind this project is that what we hear from the patients using Zubsolv is that the predominant explanation as to why people got addicted to opioids was that they got their first exposure after a legitimate pain incident. And it can be everything from dental procedures to trauma, broken legs and so forth. And there is a clear need in the U.S. for an alternative to opioids. We know from interviewing physicians in the U.S. that up to 30% of the patients who get into an emergency room who actively say I don't want an opioid. And I think that's due to 2 causes: one is that you're seeing the negative side and you heard about people who got addicted by getting opioids in the hospitals or from the doctors; and the other part is that there is a very fast unfortunately growing population of people who have had issues with misuse of opioids that don’t want to get that risk again. So having something that is well known to deliver the same pain relief as opioids, I think, will be something that will be well received by the market in the U.S. Moving to Page #11. We have now completed our formulation work and we've done Proof-of-Concept testing in-vivo, which has been successful and that enable us to start the first pharmacokinetic study in humans later this year. Depending on the development plan, we estimate FDA submission could be as early as 2021, but if we decide to do more [ because it started it ] might take this to 2022. Moving to Page #12. So the OX-MPI project, as I said before, has been progressing into clinical trials, and we look forward to get the results and get some sort of data probably late this year or early next year. They have secured the financing, so now they are on good track to develop a product for microvascular diseases. But again, we don't have a lot of details about this as it's run by Gesynta Pharma, but we do have rights to future income. When it gets to OX382, we have done in-vivo testing and this is difficult to control the metabolism of buprenorphine. So the data we got from our in-vivo test that we did during this quarter did not support the investment to move it into humans. That does not mean that we have discontinued the project because all of our project is based on a problem. We define a problem and we try to solve that problem through different formulation. But what this mean is that a formulation we have tested didn't work in animals, it doesn't mean that we stop the project, it just mean that we have to work with other formulations. That said, we are very happy to see 2 other projects that are going very well. And we, of course, will focus on those 2 getting closer to the market if we end up in a situation where we have to prioritize it, but we will still continue to work on OX382 to see if we can solve the problem around making buprenorphine orally available. Moving to Page #13, the key market and sales and further onto Page 14. And this picture is taken for our capital markets day where we have a U.S. consulting firm, Clarion who have done estimates about how the market would evolve. Those estimates were done during the summer last year and based on 2017 and historic data and they believe that we would see a growth rate in this market of about 12% moving forward and if that is correct we would like to see the market could double when we get to 2023. So about 1.8 million patients could be eligible for buprenorphine treatment. Looking at how the market evolves, moving to Page #15. We actually see -- saw that Clarion, at least for the first year, have been a little too pessimistic as the market has grown with 13%. If we look at adjusted first quarter, it's this first quarter compared to last year that, of course, is up 13%, but just looking quarter-over-quarter Q1 over Q4 we have seen that the public market has continued to grow, although at a little slower pace than we saw in the previous quarters, whereas the commercial market has actually gone back to the same seasonality as we have seen in the previous quarters. If you look at the blue line on Page 15, you will see that basically in every Q1 you see a small dip down, this year it was a little more prominent, partly explained by how the vacation days were placed in this first quarter, but also we normally see that the commercial market dip down in the first quarter simply due to the way that the reimbursement system works in the U.S. All in all, the market was basically stable the 2 quarters. There's no real development in the market between Q1 and -- Q1 to Q4 last year with compared to Q1 last year, it has been a quite strong growth of 13%. Looking at Zubsolv on Page 16. We did see in the -- we have a dip here, which is explained by 2 thing early this year. One part is around the holiday seasons and this year there were a lot of public holidays during Christmas. And also continued into the Q1. There have been several public holidays in the U.S., which have been placed on days that normally are associated with high sales. But we did see that we have had an all-time high, it was actually in this first quarter in 1 single week and in particular what's interesting with that week was it was a week where we had no [ explanation ] from vacation days or similar but we had 1 week where we reached 111,000 tablets. So a little dip in Q1 as expected as Orexo has a disproportionately large share of our sales in the commercial sector. Then if you have a disproportionately large share in a segment that is declining a little that, of course, hits us a little more. But what is interesting that should we take out the WellCare effect, we would actually have grown faster than the market. So it's really the WellCare that had a negative impact. If you look at the WellCare contract, it was associated with substantial rebates, and what is interesting now is that we actually earned more money from the WellCare contract than we have done ever before despite having less volumes. Because the rebates were simply so much lower.So -- and that we saw also with Maryland last year and now we have here the same situation with Humana where Humana Med D has opened up for generic film. And with that movement, our rebates will go down. And we don't need to keep that much of the market share before it actually become financially more profitable for the company on a total amount not on the individual patients, but on the total amount that we have when we were exclusive. Moving to Page 17. And this has been a very interesting quarter from a market perspective. We, of course, had the continuous development of Sublocade and Indivior, Depot. We thought that we would have competition from Braeburn or the Swedish company Camurus' Depot formulation. It didn't happen because it was restricted by the FDA, and it can't launch before end of 2020. But then the most important impact has been around the Suboxone Film generics where we now have 4 generic products in the market led by Sandoz which is the authorized generic Indivior. And then Alvogen, Dr. Reddy's and Mylan. And I just have to note on this that this is done all at risk. So there are no -- there are still patents around the Indivior, Suboxone that last long after the dates we have right now. So we can -- I believe that [ patents' ] all the way up to 2030. Then there are some settlements that would allow other generics to come in, in 2023, I believe. But there's actually a lot of patents that have not been settled in this space. So the companies -- Dr. Reddy, Alvogen and I believe, Mylan, and Mylan could have an agreement with Alvogen, but Dr. Reddy and Alvogen are doing this all at risk. When we look at the Sublocade launch on Page 18 and this is just illustrative and I just have to highlight. It's not necessarily that it won't become a commercial success. But I think what's important for us to note is that even though Sublocade have had large expectations and so have the Depots, after 1 year, which I think is until March this year, the market share in March was 0.13%. Then I know Indivior came out with their result today, and showed a decent sales uptake in the first quarter, but it's really not been at the cost of the sublingual tablets and it's difficult to see that it will have a substantial impact on the sublingual tablets moving forward. Then they are priced significantly higher than the sublingual tablets, so the [ business case can still be solvable ] for Indivior and Camurus but I don’t think that will be cannibalizing into our market.The one that has had a bigger risk of entering our market and where it has created a lot of turmoil and I think both opportunities and risk for Orexo has been the sublingual film, which is on Page 19. Orexo said that we were quite certain that this would predominantly have an impact on the Suboxone Film market and looking at where we are until, I think, it's the last week of data we have here, we have seen that the impact on Suboxone has really been minimal. We have lost a little market share, but that can actually be explained solely by WellCare and some of the growth in the public sector. And when we look at the patient per patient basis, we don't see any cannibalization so far to the generic film. But, of course, the generic film has now -- are getting closer and closer to have taken half of the market from Suboxone Film. Then that said, Suboxone Film still have shown a strong resilience in the market and that becomes important when we get to market access and that's coming on the next page. So on Page 20. The market access and the commercial plans, we continue to improve. So we have a new agreement in place with Blue Cross North Carolina. I think [ we have informed about them before ] so we're now at about 97% coverage. But when it became important with Suboxone Film is in the public market because really what has been blocking us from getting even better access in the public plans is not the generics, it is Suboxone Film that has a brand-exclusive agreement with a lot of the Medicaid and Medicare plans. And as long as they still have sizable volumes in the market, I'm pretty sure that Indivior has -- I know that they have less incentive to cancel the contracts and also for the insurance companies to cancel the contracts. But as we see that the generic versions of Suboxone Film gain market share, we believe that there should be opportunities for some of these plans that are today [ blocking ] Zubsolv would open up for another branded alternative. But right now because of the resilience of Suboxone Film, we haven't really seen a lot of movement in the public space yet. So moving to Page #21. So what does this mean for our U.S. business? And this is really the one that, I think, is the core for Orexo because everything else equal, this is what is paying for our salaries, this is what is paying for the growth opportunities, this is what is enabling us to invest into R&D and business development. And looking at how it has moved, we have seen our EBIT in the last 12 months has improved 130%. So just comparing last 12 months, for the last 12 months Q1 2018 to including Q2 2017, we have seen a substantial growth. That's predominantly coming from the growth in the gross profit, which is coming in -- which is explained by the reduction that we see in COGS. And actually in this quarter, we saw our COGS, on average, declined with 43% compared to the baseline we have used in 2017. That's about a 35% reduction when we compare to 2018.When we look at the EBIT adjustment this quarter, the EBIT margin is 44.5%. It's still, I think, on the 37-ish if we look at the last 12 months. But it's really if we look at the individual quarter, we have now broken to 40%, and if we compare this quarter to last year, it's gone up from 19.3%. And the EBIT growth just in the individual quarter is actually 144% in dollars. If we should have looked at the Swedish krona due to the Swedish -- weakening of the Swedish krona, I believe it would have been 180% growth in Swedish krona EBIT contribution from our U.S.Moving to Page 22. So just to summarize our U.S. business, we have seen -- we still see positive demand growth. We did expect and we always have seen for Orexo's part, the Q1 is a little tougher. It's difficult to continue growth quarter-over-quarter compared to Q4. And that's seasonality in the U.S. We did succeed to increase the price in the quarter. And as we didn't see any significant changes in the gross to net, most of the prior increases have fallen through down to the bottom line. That, and together, the demand and the price increase have resulted in a strong EBIT growth in both the Swedish krona and the U.S. [ krona ] , a strong EBIT margin growth from nearly 20% to more than 40% this quarter. And just looking ahead, we have a market where we continue to be critical to win market access and get reimbursement. And with -- despite the increased generic competition, we have succeeded to improve our market share. And it's interesting to see when we take away WellCare and others and look at plans where we have equal access to AA, Express Script, CVS Caremark then we have seen in both the Express Script and CVS Caremark that we actually outpaced the market having the same market access as the generics as the branded alternative. And I think the biggest impact of the generics, increased generic competition has been that we have some increased competition in some plants. However, some of that impact on the bottom line is actually positive as to rebates, for example, both WellCare and previously Maryland, the reduction in rebate was much higher than the loss of sales. So the gross profit from these plants actually increased.With that, I will take a pause and leave it over to Joe DeFeo to take us through our financials. Joe, please.

[Joseph DeFeo, EVP & CFO]

Good afternoon. If you go to Slide 24, I'll start on our revenues. As you can see from this, our net revenues grew 24.8% versus prior year and this was driven mainly by Zubsolv, which had growth of 23.3% and 9.3% in local currency.You can also see both on quarter-over-quarter and the last 12 months, the Zubsolv growth is actually more than what we have in royalties. So now the royalty of just Zubsolv alone is bigger than the previous year in total revenue. So that's a substantial increase in our revenue.If you go to the second Slide 25, you can see the evolution of Zubsolv. Zubsolv, as we mentioned, grew over 23%. The demand growth was 6%, but as Nikolaj mentioned earlier, this was muted somewhat by the WellCare decision to allow generics. That 6% would be closer to 11%, if it's without the effect of WellCare.You can also see that we did have a slight reduction in our sales. That was due to wholesalers destocking in Q1, which due to the leveling of the demand a bit and the WellCare situation, that brought the inventories down to wholesale level.We also had a price increase of 4% as Nikolaj mentioned, which really goes right to the bottom line and a positive currency effect, which I also noted, you're probably aware the U.S. dollar continue to get stronger into Q2. So we expect this to also be positive for us as we go into Q2.Go to the next slide, Slide 26. This is our overall P&L. And as Nikolaj mentioned, for the first time we've had a positive EBIT in Q1. And this EBIT would have been closer to SEK 50 million without the litigation cost. We met -- we talked about the revenue, Nikolaj mentioned the significant improvement in our COGS. We've also continued to optimize our spending across the board in operating expenses outside of litigation cost. Our spending is less and our selling expense slightly less and R&D is down because we're being efficient about what we produce on our programs in our R&D pipeline.We also had positive impact from the exchange, which also helped our operating cost as well. And you could see they are [ not net ] -- our EBITDA is also profitable. Next slide. This is to give more details on the COGS improvement. We use 2017 as our baseline. You can see in Q1, we more than exceeded our full year goal of 65%. Our index in Q1 was 57%, and we anticipate continuing this for the rest of the year. So very successfully we've been able to reach our full year 2019 goal right in the first quarter of 2019. So this will continue to improve our profit contribution from the U.S. and our overall profitability.If you go to Slide 28, you will see that our -- we had a good increase in our cash flow of over SEK 50 million. We have a very positive cash position and this gives us a lot of great financial flexibility. We have almost SEK 650 million of cash, and I'll also note that a good portion of this in U.S. is in U.S. dollars earning interest, which has given us also a benefit due to the strengthening of the U.S. dollar, puts us in a very good position.And then finally, if you go to Slide 29, we continue to advance and improve on our record-breaking performance in 2018 in Q1 of 2019. You can see the 25% growth in net revenue, 81% growth in EBITDA, and our EBIT is up over 148%.And our cash position, as I mentioned, we have almost SEK 650 million and our net cash position after debt is SEK 326 million. So a very strong cash position, we have very good strong cash flow, good growth profitability. So we continue to have a very strong performance going into the rest of 2019.Nikolaj, I turn it back to you for the outlook.

[Nikolaj Sørensen, President & CEO]

Thank you, Joe. So moving to Page #31. So very short, I believe that the value driver for us should be apparent now. It's -- we have a growing key market. We've never seen as much growth in the number of prescribers as we have done during this quarter. So there is a strong belief internally that this market will continue to show strong double-digit growth.We have a financial position, which is stronger than ever, and in particular our U.S. EBIT now exceeding 40%. It's something that will help us substantially move forward in our ambition to develop more products where we have a track record of developing today 4 products to the market. We have now 2 projects that are within a few years from being ready to file, if everything goes like planned. That will help us a lot, both having the financials and the background of knowledge of how to do that. In business development and M&A, we have some ongoing discussions, but I have learned through my tenure as a CEO that these deals are never done before the signature is ready. So let's wait and see how they materialize, but we have some interesting discussions ongoing at the moment. And then our pipeline is, as I said, we -- as you would expect, when you 3 programs, it's actually a pretty good track record to have of 2 of them progressing into the next phase and then one of them had to take a small step back. So I believe we have a good position in the pipeline to show some good and interesting data, later this year will be OX338 and next year from the nasal formulations of OX124 and OX125. Looking at our outlook. I'll only highlight the one change that we have had in this outlook is that we now have update of our COGS where we believe that we will have a 35% reduction in the second half and now we have expanded that to be a full year effect of 35%. That's a 30% reduction compared to 2018. And now you can say, okay, you reached already an index of 57%, 43% in the first quarter, why wouldn't we see that decline further during the year? Then you just need to note that the way that the COGS works and the way we have to work with our COGS estimates is really depending on how much volume we manufacture and as we, during this first quarter, have manufactured a decent amount of product in our new manufacturing site in a large scale, that has helped us to reduce the COGS in this quarter, and depending on the demand in the markets, then we will see how that impacts moving forward. But there's no doubt that we continuously turn every stone we can to improve our competitiveness in the COGS. With that, I will open up for questions, operator.

[Operator]

[Operator Instructions] Our first question comes from Andy Smith from Edison.

[Andy Smith, Analyst]

I've got a couple of questions, I'll try and fit them both in. The first one is related to the increased selling expenses on the quarter. You mentioned in your announcement that this is due to -- this included market research spend and some sales force expansion. I wonder if you give a little more detail on that in terms of, I was thinking, it would be directed against either a counter detailing or some initiatives to counter the Generic or Suboxone entries. So what spend can you see is changing because of Suboxone entry, Generic entry is still uncertain over time. So will that spend increase? Will those initiatives still have kept if they have kept Generic or Suboxone not impacting Zubsolv, were they likely to increase over time? And the second question was on your R&D spend. It's down year-on-year, but in the meantime you've managed to advance at least 2 products and particularly OX124 into Phase II. So that implies a greater investment, but Joe mentioned also that there have been efficiencies that have resulted in R&D spend coming down. I wonder if you give us a little more color on how you were able to do that at the same time as advancing the investment in the program?

[Nikolaj Sørensen, President & CEO]

Thank you, Andy. So taking your first question, it was around how we see the selling expenses and the increase in the selling expenses. So the one increase that we have is actually associated -- the biggest increase that we have apart from the dollar exchange rate because in the -- all of our selling expenses are in dollars. But if you look at the one single expense that have gone in is actually that we have expanded our field force in Ohio and that's not a reaction to the -- it's not a reaction to the entry of Generic, Suboxone, it's a reaction of Orexo getting a preferred position with Ohio Medicaid, which is more than 50% of the market in Ohio. So that's a good [ move from an ] opportunity, we got improved market access. We do believe that our market access could further improve, in particular, Medicaid actually indirectly as a result of the Suboxone Film generics. Because when they get more -- even more market share it's likely that the plans or Indivior will cancel the existing agreements, which are blocking Zubsolv from coming to the market and that could lead to further investment. But it's not a defensive move, it's actually more an offensive move. We see an opportunity and we move to expand on that opportunity. The marketing expenses are actually related to our business development efforts and due diligence we need to do on some of those to decide whether that's the right place to spend our money. On R&D, the biggest reason why it's down is actually last quarter -- the first quarter last year we had some cost associated with our supply efficiency program. So even when we do manufacturing efficient -- our manufacturing development, then it comes under R&D. So when we move from a small scale to a high scale, it actually goes into R&D cost. So the one efficiency improvement that will come moving forward, but has not really been there historically is that we now have an ability to manufacture clinical trial material here in our Uppsala facility even though some of these programs we're running would still require some manufacturing outside our own facility. And the investments in R&D will really go up and down with clinical trials. So if you have a -- when we get into the second half it will be a small study, but I think when we get to the pivotal studies of OX124, for example, next year then that will be so many patients, so that quarter we'll probably see the cost go up, but I don't see that as -- we can't do that much about the clinical trial cost [indiscernible]. I hope that addresses your questions. Any other questions?

[Andy Smith, Analyst]

Just -- if I could just add one on that confirmation. So you've mentioned all those moving parts, Nikolaj -- well, it's a marketing and R&D spend, but that's still inside of your guidance for SEK 500 million of total operational expense guidance for the year?

[Nikolaj Sørensen, President & CEO]

Yes. No. I think the one expense that, to be transparent, was a little higher than what we anticipated, ended up with the legal expenses, where it's so difficult to predict what will happen then you need to react depending on what your counterpart is doing. So that one went a little higher, but we have built that into our outlook. The one thing that could lead to a higher expenses, if we decide to accelerate some of the clinical trials on OX124 and OX125 into 2019 rather than 2020, then that would increase -- we will increase our guidance for this year. But if we take that decision we will inform the market when we do that.

[Andy Smith, Analyst]

And that one you mentioned, Nikolaj, could be quite an expansion, couldn't it? I mean you could move into Phase III pretty quickly, it's [ active ] . So it's just your delivery system that's different.

[Nikolaj Sørensen, President & CEO]

Yes. I think actually the biggest -- some of the -- what the data we got on OX124 was -- so very bluntly, it was better than what we had hoped for. So the data we got from there gave us so much confidence that we believed we could accelerate the program faster. But when you do a development program, it's kind of the full development, it's not faster than your slowest moving item and that's one item we can't really move on and that's the need for creating stability data for the FDA. And while our first formulations are designed to test the efficacy. The final formulation, we need to build into the measures is to ensure that we have a stable product also. And now we got so good data so we could. If it's just in for the clinical trials, we could have done the pivotal study more or less right now, but now we have to work on the manufacturing side also, and I'm sure that we have products that are stable in all of the different environments that you would have because one of the things to remember with these estimate cases is that they need to pass what you can call the [ dashboard ] test. So if a police car in Texas is driving around with this lying up in the windshield, it needs to work. Similar as it needs to work if a police car is driving around in Alaska during the winter time and have it in the windshield and that, of course, is much more stressful to a product than having something that is in a normal room temperature. And that takes a little time for us to finalize the test more than to finalize the formulations.

[Joseph DeFeo, EVP & CFO]

Nikolaj, I would just add a clarifying point. One caveat on operating expense in our guidance is where the exchange rate goes to. As discussed early on selling expense, selling expense was actually down versus prior year if it was not for the exchange rate. The exchange rate through Q1 was 9.2. The exchange rate now is closer is 9.5. Since we have a lot of cost base in the U.S. where the exchange rate goes will also be a caveat around our SEK 500 million or more on operating expense. Of course, that is a net positive for us if the exchange rate moves even more because their gross profit and that revenue will more than offset the operating cost, but there is a risk of the operating cost being higher solely because of the exchange rate, but the profitability will more than offset that increase.

[Operator]

[Operator Instructions] The next question comes from Klas Palin from Redeye.

[Klas Palin, Equity Analyst]

And my first question, if you could just give some indication on your legal expenses going forward in 2019 and particularly this current quarter? And also if you could help me out a little bit with the depreciations, I guess, you have -- or now using IFRS 16 and I just wonder if the level in Q1 is what we should expect going forward? And lastly, about the U.S. business, is there any further room for improvement in profitability from 44%?

[Nikolaj Sørensen, President & CEO]

So I can take number 1 and number 3 and then Joe has to talk about the depreciation. So the legal expenses, it will decline more than substantially in the second quarter. So it's on the completely different level than what we have seen in the first quarter. But as we haven't guided specifically on that, I think I will need to keep it on this level. You can say the cost that is driving in the first quarter is the court case and the preparation of all of the witnesses, preparation of all of the material, and during the first quarter, there was also pretrial conferences, there were a lot of motions that were sent back and forward. The cost from now on is basically some paperwork from the lawyers and it does not require any other external involvement from that. So it is a cost level that is incomparable to this. Maybe you can look at the first quarter last year as an example of quarter where we still have an ongoing court case, the appeal case with Zubsolv, but there was really, really little expenses associated with that court. I think we spent about SEK 8 million or something in the last -- first quarter last year. And then for the rest of the year, it's similar. The big cost in the legal part is -- would come if we go all the way and there is a decision to do a retrial, which is actually what's needed here. So it's a jury trial, then there will be some cost, not to the same level as we have seen before, but that quarter when you would have a retrial that would be a substantial cost, but then we are looking quite far ahead before that can happen. When we get to the U.S. business and further profitability, and you said on the -- I think you were alluding to the cost of goods?

[Klas Palin, Equity Analyst]

No. The operating margin in the U.S. business.

[Nikolaj Sørensen, President & CEO]

I think that -- so we have reached this operational leverage point. So when we see volume growth in the U.S., most of that added profitability will go -- added gross profit will move straight down to the bottom line. So as we -- I don't see that we will need a lot more resources to drive the U.S. business or some additional growth. But it depends a little on how the opportunities exist. But just moving with the market as it is right now, I don't see any need for us to have add cost even remotely close to the increase in the sales. When it gets to another important parameter is the cost of goods, and here we had a very good quarter. I think on a long-term there are still things we can do on the cost of goods to improve. We still have some substantial packaging cost in the U.S., which we potentially could move on. We do have some -- our large-scale manufacturing is only for some of the strengths as we -- if we see more volume growth, we could put more strength into the -- to the large scale, which would further reduce the cost of goods. But right now, based on what we see at the moment with the current volumes, the guidance we have is 35% reduction. But if we see continuous volume growth, then I think a good opportunity is to reduce that further. Joe, you have to answer the depreciation, IFRS 16 here.

[Joseph DeFeo, EVP & CFO]

Yes. On that -- yes, the Q1 levels, you should expect for the rest of the year because there is a stable expenses that will continue at the same level through the rest of the year.

[Operator]

The next question comes from Andy Smith from Edison Group.

[Andy Smith, Analyst]

I had one on OX124. I know, Nikolaj, you talked about stability and the timing to get that done even with accelerated stability programs, but I wonder if that's not so much an issue, but from the other end, the actual clinical studies, when you get into a final formulation, which you may already be at already, the timing taken to clinical studies will be much quicker -- that's the question. Is the timing to run a clinical study for OX124 quicker than you would expect for many other projects -- products, because you know pretty quickly whether the patient responds and whether it takes one or two doses, how much medication to use. So is that clinical program likely to be shorter than many others that we would look at?

[Nikolaj Sørensen, President & CEO]

No, it will be even shorter than the one you're anticipating right now because the only thing we need to show is the pharmacokinetic profile that we are at least as fast and at least at the same by bioavailability of the products. But -- that you have the same naloxone in the drug as you have with injected naloxone of 1.4 milligrams. So we only do the study in healthy volunteers and you basically just monitor the concentration of naloxone during a certain time period and we need to show that we are at least as good as the existing alternative unless we had some very strong data in our first study on exactly those parameters. We feel comfortable that we have a product that can meet those criteria. So I think when we get to the clinical program, it will be -- we don't have to do it in any patients. We just need to do it in healthy volunteers.

[Andy Smith, Analyst]

That's very interesting. And if I could just follow on from that. You did mention that there are opioid antidotes spray that soon to be, they are not already available over-the-counter in the U.S. or proposed to be over-the-counter. If -- and obviously 124 is going to go as a prescription product first, but if that is seen as a potential progression or line extension for OX124, that would more be a partnered product, wouldn't it? Rather than something Orexo would do by themselves?

[Nikolaj Sørensen, President & CEO]

So to my knowledge, it doesn't exist as a OTC because there is a standing order that the pharmacist can prescribe it, so you don't need to go to your doctor, you can go to a pharmacy and they can prescribe it. The issue of OTC given the cost of the nasal sprays is that it won't be available to the reimbursement system. So -- and that is tricky also for the patients that there are, of course, some advantages that it's more convenient, just go in and buy a spray. But just knowing, as I do, what the cost is of the devices and filling the devices, this is much more costly than having a normal nasal spray for cold or something because the function -- you need to ensure that it worked every time on every condition as it's an emergency product. So it's very difficult to bring the cost down to very low levels and, of course, without market access and reimbursement, then it will limit some of the patients' access to product. I think there are a lots of pros and cons. But we have a discussion with FDA about what that would mean for OX124 and OX125, and we have not made a decision on where to place those products, and I think you could -- OX124 could be made an OTC product maybe in one shape or form. We haven't made that decision, and should that be, I also agree that it's likely we would work with a partner rather than doing it ourselves.

[Operator]

Thank you. There appear to be no further questions. I return the conference back to you, speakers.

[Nikolaj Sørensen, President & CEO]

Okay. Thank you very much to all of you who have had the patience and staying on the line until the end now. As I started on, I actually think this first quarter was a very strong quarter. If you look behind the scenes of legal expenses and look at what really matters, it's gross margins, it's pipeline progression, and on all of those parameters, it's -- it was a very strong quarter. I do know that there are some concern about the progression Q1 over Q4, but I also want you to remember the last Q1s over Q4s that this is actually seasonality we're seeing more or less every year, and this particular Q1 we have a lot of public holidays in inconvenient places from a sales perspective as they were on what are normally high sales day. So I don't think that Q1 or Q4 is that important. I think it's important for us also to understand that we do sometimes get setbacks in our market access and even though WellCare was positive on the bottom line impact from a market share and volume impact that it was negative. But as Joe said, had we not had that we would have seen double-digit demand growth in Q1 over Q1 last year. And that I think it's showing the strength of the underlying business. And with that, I would like to thank you for your attention and wish all of you good Thursday and good weekend as it's approaching. Thank you very much. Goodbye.

[Operator]

Thank you. Ladies and gentlemen, this does conclude today's conference call. Thank you very much for attending. You may now disconnect your line.