OSI Pharmaceuticals, Inc. Q3 2008 Earnings Call Transcript

Oct.23.08 | About: OSI Pharmaceuticals (OSIP)

OSI Pharmaceuticals, Inc. (OSIP) Q3 2008 Earnings Call October 22, 2008 5:00 PM ET

Executives

Kathy Galante – Senior Director, Investor Relations

Colin Goddard – Chief Executive Officer, Director

Michael G. Atieh – Chief Financial Officer, Executive Vice President, Treasurer

Gabriel Leung – Executive Vice President; President, (OSI) Oncology Business

Anker Lundemose – Executive Vice President and President, OSI Prosidion

Analysts

[Terry – JPMorgan Chase & Co.]

Jessica Li – Goldman Sachs

Han Li – Stanford Group Company

Katherine Kim – Banc of America Securities

Steve Harr – Morgan Stanley

Howard Liang - Leerink Swann & Company

Jason Zhang – BMO Capital Markets

Brian Rye – Janney Montgomery Scott

Tom McGahren – Merrill Lynch

Derek Jellinek – Susquehanna Financial Group

Stephen Willey – Thomas Weizel Partners

Jim Birchenough – Barclays Capital

Geoffrey Meacham – JPMorgan Chase & Co.

Operator

Ladies and gentlemen please stand by. The conference is about to begin. Good day everyone and welcome to today's OSI Pharmaceuticals third quarter 2008 financial results conference call. Today's call is being recorded. At this time I would like to turn the call over to Ms. Kathy Galante, Senior Director, Investor Relations. Please go ahead.

Kathy Galante

Thank you. Good afternoon and welcome to our second quarter earnings call. Joining me today, I have Colin Goddard, our Chief Executive Officer, Mike Atieh, our Chief Financial Officer, Gabe Leung, President of our Oncology Business, and Anker Lundemose President of our Diabetes and Obesity business.

We'll begin with Mike, who will provide you with a summary of the financial results, after which Colin will come back to discuss corporate developments in our oncology and diabetes obesity programs.

Before we begin, I would like to remind you that we will be making forward-looking statements relating to the financial results and clinical and regulatory development on the call today. These statements cover many events that are outside of OSI's control and are subject to various risks that could cause the results to differ materially from those expressed in any forward-looking statement. I refer you to our SEC filings for a detailed description of the risk factors affecting our business.

And now, over to Mike.

Michael G. Atieh

Thank you, Kathy and good afternoon everyone. This afternoon we reported that net income from continuing operations for the third quarter of approximately $35 million or $0.56 per share compared to $36 million or $0.59 per share a year ago. As I review the quarter in detail, I will comment on any updates to guidance for the full year 2008 as appropriate. You should assume that unless specifically updated, our prior guidance on individual items still applies.

Global net sales of Tarceva reported by Genentech and Roche for the third quarter totaled $275 million, a 23% increase over the prior year period. Sales in the US market were $110 million after the negative impact of an $11 million reserve adjustment, which I will address in a moment. As a result, we recorded 46 million in revenue for our unconsolidated joint business related to the US sales.

On a sequential quarter basis, Tarceva produced low, single-digit volume growth. As communicated in our 8-K last week, Genentech is responsible for estimating reserves for anticipated reserves of Tarceva and for monitoring these reserve levels to insure that they are adequate. Genentech has modified its product returns policy relating to Tarceva, increased reserves for estimated future returns, and continues its effort to better understand inventory management practices within the retail channel with a view of minimizing reserve adjustments in the future. The reserves now reflect Genentech’s updated estimate of return rates in the retail channel for a high value, low volume drug like Tarceva. Originally Genentech was recording reserves for returns expecting they would be less than the industry average. After overcoming the issue of short-dated inventory that was put into the distribution channel at launch, recent experience has shown that returns are slightly in excess of the industry average causing an appropriate increase in reserves for potential future returns.

I do want to point out, however, that while returns have affected Tarceva’s reported sales results in three of the last six quarters since the launch of Tarceva in November of 2004, cumulative returns in related product return reserves total less than $70 million compared to cumulative US gross sales of approximately $1.6 billion or approximately 4% of gross US sales. International net sales of Tarceva by Roche for Q3 were 169 million and were up 35% versus Q3 2007. This resulted in royalty income to OSI of 34 million.

On a sequential quarter basis, sales were down slightly versus Q2 2008 sales levels due to a stronger US dollar and August being a traditionally slow month outside of the US. Excluding the impact of the stronger dollar, sales were up modestly on a sequential quarter basis. Including the amortization of all milestones, all Tarceva-related revenue totaled 81 million for Q3 and we now anticipate that it will approximate 340 million for the full year 2008. This reflects our view that estimated global net sales of Tarceva for the full year 2008 will be approximately 1.15 billion having been impacted by the increase in Genentech’s product return reserves and a strengthening US dollar.

Our guidance for Tarceva sales assumes a relatively stable US dollar for the remainder of 2008. Please also note that our guidance on global net sales of Tarceva represent our view only and not necessarily the views of Genentech and Roche.

The license milestones and other revenues lines includes revenue relating to our DP-IV patent estate, which totaled $13 million this quarter, all from royalties on Merck sales of Januvia and Janumet. This contrasts sharply with a year ago when license milestones and other revenues included two significant revenue items. The final amortization of 8.3 million and the $25 million upfront payment received from Lilly relating to PSN-010 and 7.5 million representing our share of the upfront payment Renovo received from Shire for their TGF beta deal.

Year-to-date total revenues are 281 million and we now estimate full-year revenues will be approximately 380 million with reduction from Q2 guidance related to our share of Genentech’s negative reserve adjustment on US Tarceva sales and a stronger US dollar impacting our royalties on the rest of the world’s sales offset by an improved outlook on DP-IV royalties, which we now expect to be approximately $40 million for 2008.

Turning to expenses, total operating cost from continuing operations for the quarter amounted to 58 million, which includes equity-based compensation costs of approximately 5.1 million. R&D costs for Q3 were 33 million with approximately 75% related to Oncology and 25% related to diabetes and obesity.

Tarceva related spending was approximately 32% of our oncology expenditures. Similar to 2007, we expect that R&D expenses in 2004 will be higher than the first three quarters’ run rate, especially in light of the fact that the company now has four candidates in Phase I clinical trials; therefore, we are maintaining our previous guidance for R&D for the full year 2008.

SG&A totaled $22 million from Q3, representing a 10% decline versus a year ago, primarily due to one-time items included in Q3 2007. Commercial expenses were 38% of SG&A for the quarter.

As I previously mentioned, fully diluted EPS from continuing ops was $0.56 per share for the quarter and totaled $1.70 for the first nine months of the year. Our guidance for the full year 2008 is now approximately $2.12 per share, which takes into account our revised revenue guidance.

Turning to the balance sheet, we exited the quarter with $488 million of cash and investments. Our cash and investments continue to be conservatively managed with over 80% invested in AAA and A1/P1 (ph 00:09:14) rated securities. Remaining investments are primarily in highly-rated investment grade corporate debt. Your overall average credit rating of the portfolio is AA+. Our investments in money market funds are in US registered AAA rated funds that are participating in the US Treasury Department’s temporary guarantee program. While this conservative strategy has reduced our investment returns, we believe it is the right approach in these difficult times.

Now, some comments about our discontinued eye disease operation. As previously announced, we sold the eye disease assets on August 1, 2008. The results for Q3 reflect the accounting for the sale and the disposition and resolution of some contractual and balance sheet items including the reversal of deferred revenue.

Finally, I want to remind you that there will potentially be important changes to our financial statements for 2009. First, with the issuance of FSP APB 14-1 effective 01/01/09, we will be required to reflect interest expense on some of our convertible bonds based on a borrowing rate tied to our hypothetical credit rating. This will increase interest expense in our 2009 GAAP financial statements by approximately $14 million; however, it will not affect the amount of cash interest we actually pay. What we report for 2009, we will also reflect this accounting for previous year’s financial results as required by the FSP. The 2008 impact will be approximately $13 million.

Secondly, as we previously alerted you at last year’s R&D analyst day meeting in November, as a result of our sustained profitability, we continue to evaluate our ability to utilize our fully reserved deferred tax assets, primarily our net operating loss.

If we conclude it will be more likely than not that we will utilize these assets before their expiration, we will reverse all or a portion of evaluation reserves. If we reach this conclusion in the fourth quarter of this year, it will result in a substantial credit to our income tax provision in 2008 and of course find an increase in reported earnings per share. In addition, it will require us to include a full tax provision in our 2009 financial statements resulting in a substantial reduction of our reported after tax EPS. Again, these will be non-cash items with our actual cash-based tax liabilities being essentially statutory alternative minimum tax rates approximating 3 to 4%. Therefore, as you begin to project 2009, please keep this in mind as you build your models, including your cash flow models.

Let me turn it over to Colin.

Colin Goddard

Thanks, Mike. We got (ph 00:12:13) the announcement on the 6th of October that the BETA Lung trial had failed to meet its end point of improving the overall survival of second-line non-small cell lung cancer patients receiving Tarceva rosuvastin compared to those receiving Tarceva plasplacebo (ph 00:12:23) was a surprising disappointment based on the prior Phase II data sets. First and foremost, this was a big disappointment for lung cancer patients and their families. The BETA Lung trail offered the attractive prospect of an all-target therapy combination (ph 00:12:44) that could have materially moved care forward in a difficult disease setting well despite all the progress of recent years, there is still much to accomplish in a huge unmet clinical need.

Every time we or another company with another product experiences a Phase III trial failure like this, we have to acknowledge the stark reality of what this means for cancer patients and hopefully use it to redouble our efforts on their behalf.

The BETA Lung results show that the median survival of the second-line non-small cell lung cancer patients receiving the Avastin/Tarceva combination was similar to that seen for those patients receiving Tarceva with a placebo. The study did show substantial evidence of biological activity for the combination in terms of improvements in response rates and impressive progression-free survival. No new or unexpected (inaudible 00:13:39) were seen in either arm of the study. We and our partners will continue to evaluate the data from the study over the coming months in order to fully understand the implications of these results, and the data will be presented at the upcoming IMPACT meeting in Chicago between November the 13 and the 15, 2008.

However, as previously disclosed, the silver lining in the results of this study can be seen in the performance of patients who received Tarceva alone. This was the first prospective randomized Phase III trial in which Tarceva was dosed with purely second-line non-small cell lung cancer patient population. And the results, which were in turnly consistent with the Br-21 subsets are compelling from a Tarceva perspective. The median survival in 9.2 months may help address one of the concerns raised by some in the oncology community who had tended to compare the median survival of 6.7 months observed in the second and third-line patients involved in our Br-21 registration trial with the 8.3 months (inaudible 00:14:50) and the 7.9 months (inaudible 00:14:52) seen in the alupta (ph 00:14:54) non-small cell lung cancer registration trial, which like Br-21 was conducted in an all second-line setting. The 9.2 median survival in the Tarceva arm of the BETA study is consistent with the earlier second-line subset finding from Br-21 and in substantiating this, BETA Lung Tarceva results also continue to support our belief in the design of the satin (ph 00:15:19) data study which was largely designed on the basis of the Br-21 data set. The satin database cleaning and lock process continues and we continue to expect top-line data from the crucial Phase III study this quarter.

From a planning perspective, the BETA Lung outcome does require us to make some adjustments. Tarceva is an important anchoring therapy in the treatment of lung and pancreatic cancer patients. It was before the BETA result, and it remains so after it. As such, some of the revenue growth possibilities particularly in the US markets that would further have accelerated our ability to grow the business aggressively will not be available to us following BETA. However, if we have a satin success, we believe that the Tarceva can still anchor the growth of the business despite the BETA outcome.

We have already been working to refine and adjust our thinking on the future level of reinvestment in the business as a result of this disappointing outcome. And this assessment will be an important part of the briefing we will provide investors at our upcoming research analyst day on December the 4th.

Aside from the BETA Lung data, the quarter was a strong one for Tarceva from a competitive and regulatory perspective. In granting Lilly’s alupta (ph 00:16:37), first-line approval in non-small cell lung cancer, the FDA also took the anticipated step of excluding the squamous cell population, which makes up approximately 25 to 35% of all non-small cell lung cancer patients. From the alupta line in all lines of therapy (ph 00:16:57) both the migration of alupta to front line and the opportunity for Tarceva to establish a leadership position in the squamous population represent real opportunities for us.

In addition to this, the (inaudible 00:17:09) was successful in executing a clinical program and regulatory process that resulted in important label update on Tarceva dose modification in those non-small cell lung cancer patients who continue to smoke. The Tarceva label now states that cigarette smoking has been shown to reduce a lot with exposure and that a cautious increase in the dose of Tarceva not exceeding 300 milligrams is an available option to physicians treating lung cancer patients who continue to smoke.

The label points out that efficacy and long-term safety data of a high dose has not yet been established in patients who continue to smoke. The label change also means that our sales specialists can now refer physicians to this important aspect of optimizing Tarceva therapy. We consider this to be a very successful outcome from a PK=based study program designed from subset analyses of our Br-21 database.

Other scientists at (ph 00:18:10) also updated the US Tarceva label based on new information from a Phase I post-marking (ph 00:18:17) pharmacokinetics clinical study evaluating Tarceva in patients with pre-existing hepatic impairment. New information has been added to the Tarceva package insert as a warning, not a contraindication, alerting physicians to closely monitor patients with hepatic impairment during Tarceva therapy.

We are pleased to report that in September, the appraisal committee of Nice issued a final appraisal determination recommending Tarceva as a cost-effective choice of therapy when compared to docetaxil. This is an encouraging development and if no appeal is issued against this determination, we expect final guidance from Nice in the second half of November. We look forward to Tarceva being an available choice to patients in England, Whales, and Northern Ireland as soon as possible following the final guidance.

Finally, on Tarceva, we will update investors and analysts of the upcoming research and estates on our thinking in terms of any potential adjustments to our current Tarceva lifecycle plan investments and also on some proposed new study initiatives.

While Tarceva remains the focal point of attention in the near-term and will be the primary driver of revenue flows for the medium term, the opportunity for significant long-term value creation in the business resides primarily in the progress of our development pipeline and in the validation and credibility attached to our technology platforms. In this respect, we have made significant progress throughout the year and during the last quarter we were able to pass a milestone of getting all four of our key development candidates into clinical development. As such, we now have ongoing Phase I programs for both oncology candidates OSI-906, our IGF-1 receptor inhibitor and our SI-027, our TORC 1 TORC 2 inhibitor and both diabetes obesity candidates, PSN-821, our GPR119 Agonist and PSN602 our next generation subutrime competitor compound. The programs of both of OSI-027 which began clinical trials in July and PSN-821 where the Phase 1 Program started in September were initiated during Q3.

Comprehensive translation of research efforts are associated with both oncology development programs as we continue to look for patient selection opportunities that can guide the optimal use of our (inaudible 00:20:47) agents either by exploiting target biology or in combination with other agents, exploiting our emerging understanding of the process of epithelial (inaudible 00:20:58) in tumor host biology. We have made appreciable progress in building a body of work to substantiate our leadership positionship in the NT and our diabetes and obesity team has identified uritrine control of body weight and glyciamia as an anagoulous area of focus in the diabetes obesity arena.

Our goal is to move forward into 2009 with these two clearly defined focus areas in both (inaudible 00:21:24) setting where are relatively limited compared to our Pharma and Big Buy Tech competition and carefully managed preclinical research budget can be deployed in a manner that still enables the deliverer of differentiation, excellence and scientific leadership in important areas of endeavor in oncology and diabetes and obesity.

Clearly as we move into the final part of the year we are focused on the outcome of the SATURN study and our ability to capitalize on this study if successful moving forward into 2009. We look forward to updating you in our plans in our research (inaudible 00:22:02) in New York on December 4th.

And with that (inaudible 00:22:04) to opening it up for questions.

Question-and-Answer Session

Operator

Thank you sir. The Question and Answer Session will be conducted electronically. (Operator instructions) We will take our first question from Geoffrey Meacham, with JPMorgan. Please go ahead.

[Terry - JPMorgan Chase & Co.]

Hey, guys. This is Terry calling in for Jeff today. Thanks a lot for taking the question. Just on the maintenance opportunity, just wondering following the Alenta data at ASCO, (misspelled 00:22:48) have your feelings changed at all on the opportunity in maintenance and maybe if you could just give qualitatively what has been the feedback from physicians vis a vis the SATURN Trial? And I have a follow-up after.

Michael G. Atieh

So, the Alenta presented at ASCO was clearly a positive study with a very good (inaudible 00:23:14) ratio and given the fact that we always believe that in the second and third line setting Tarceva , by and large on the efficacy standpoint behaved pretty much like Alenta. That in a way ─ Alenta’s success do increase our confidence that we should be able to achieve efficacy endpoint in SATURN as well.

It was very clear in our discussion with opinioned leaders after the Alenta’s data become available that maintenance—or adoption of maintenance therapy will very much be a decision that looked at both risk versus benefit balance. So obviously showing a meaningful efficacy improvement is important. At the same time how much toxicities the patients have to put with will also enter into the equation. Then it is our hope that SATURN Study will again show or reaffirm the tolerability profile of Tarceva being favorable as compared to classical (inaudible 00:24:24) agents.

[Terry - JPMorgan Chase & Co.]

I guess my question really is our impression following the meeting was that physicians were actually a little under whelmed by the data. So, I’m just wondering if that’s something that you’ve observed as well and if there’s something that you think will be different about Tarceva in this setting.

Colin Goddard

Yeah, I think one big discussion after the actual presentation was the questions about whether maintenance Atlanta is meaningful when you look at sequential I guess, or maybe second line delayed. Maybe that’s the right word. The delayed use of Alenta would give the same results. So that is actually the debate and the SATURN Study does not directly address this issue either. The patients are randomized after chemotherapy if they achieve a non-progression to either Tarceva or placebo and then when they do progress they are all (inaudible 00:25:29) but we will be tracking subsequent therapy and will gain some teaching off of that when the data become available.

[Terry - JPMorgan Chase & Co.]

Okay, thanks. And then just a question on the royalty side. Just looking at the numbers that Merck reported today it looks like the royalty was a little over 3% on the DPT floors. I’m just wondering if this how we should be thinking about this going forward or modeling this.

Michael G. Atieh

Terry, its Mike Atieh. As we mentioned in the past there is a tiered royalty with Merck, we haven’t talked what those tiers are. The quarter did include a little bit of catch-up adjustment, not very large, but a little bit of a catch-up adjustment so that is impacting that number relationship that you’re calculating so. So, the only thing we can say is yes, there is a tiered royalty and they had a good quarter and we’re happy about it.

[Terry - JPMorgan Chase & Co.]

Okay, thanks.

Operator

We will take our next question May-Kin Ho with Goldman Sachs. Please go ahead. (Operator instructions)

Jessica Li – Goldman Sachs

Hi, this is Jessica Li for May-Kin. Just quickly, in the past you mentioned that you see Tarceva as a $2 billion plus dollar product, potentially supported by SATURN, Beta Lung and ATLAS, given the outcome from the Beta Lung would you still put out $2 billion potential or what would the potential be?

Colin Goddard

So, when we look at the Beta Lung result it’s obviously disappointing. We always tended to regard that as some or more important to the U.S. market then the global market as a whole. And as you know, Tarceva continues to be a larger product exuentent in the U.S. Obviously in the near term a significant driver of value is going to the SATURN result, but having said that behind that there are multiple other elements in the life cycle plan including our Radiant Study in the actual onsetting in lung cancer. And as you look longer term and forward to December we expect to be able to share with you some other investments in the life cycle plan that will continue to expand and we think build on potential uses for Tarceva going forward. So, yes we believe there still is significant long term growth potential in the (inaudible 00:28:13).

Jessica Li – Goldman Sachs

Great, thank you. Just quickly, how much of the Tarceva sales were from Japan third quarter, did you see any sequential unit growth there?

Michael G. Atieh

It’s Mike Atieh. The sales in Japan were relatively flat Q3 versus Q2, Gross reported these numbers in Swiss Francs and I believe there 11 million Swiss francs for Q2 and 10 million Swiss Francs for Q3.

Jessica Li – Goldman Sachs

Okay, thank you.

Operator

We will take our next question Han Li with Stanford Group. Please go ahead.

Han Li – Stanford Group Company

Yes, just a couple of housekeeping questions. Where are we regarding the 2023 (inaudible 00:29:02) note, the $150 million you mentioned you were buying back?

Michael G. Atieh

Yes, Han, it’s Mike Atieh. The 2023 notes were the put date came due in September 5th, turns out, and just to refresh your memory, there were a $150 million originally we did buy back $50 million of those notes so there’s only $100 million remaining. $50,000 came in the door before the put date so right now there is—call it $99.95 million remaining. The next put date is essentially five years from now although we now have call on those notes and the strike price is $50 per share.

Han Li – Stanford Group Company

Okay and also on the Tarceva patent reapplication, you mentioned earlier this year, can you walk us through the events that we should expect assuming that there could a potential generic filing next month.

Colin Goddard

Well, the process continues to unfold at the PTO. We’re awaiting feedback on the central thesis of the reissue. We did get a minor update on the certificate of correction request that was part of that submission. That was the easy part of it. And that process continues we will update you as events unfold there. The second aspect of that which was events overseas, we seen the withdrawal of an application for compulsory license in the poll by one the Indian generic companies so that’s a positive development there as well.

Han Li – Stanford Group Company

Do we expect (inaudible 00:30:57) filing in the coming November?

Colin Goddard

Well, that will be up to companies who may chose or chose not to make such a move. Obviously the fourth anniversary of launch and approval is in November and that’s the first opportunity with which they can do that. But as we said, repeatedly, we continue to be very confident in the fundamental inventiveness in the composition and master patent for Tarceva and full expect to be in a strong position there as we go through it.

Han Li – Stanford Group Company

Got it, thank you very much.

Operator

Okay, we’ll take our next question from Katherine Kim with Banc of America Securities. Please go ahead.

Katherine Kim – Banc of America Securities

Hi, thank you for taking my questions. I have a few here. First off, does your revised Tarceva guidance for this year include, assume any sales from U.K. and also any increase in the penetration from Alenta moving to front line?

Michael G. Atieh

Katherine, its Mike Atieh. It kind of takes into account the potential opportunities there but in a very limited way, when you think about what might happen between now and the end of the year with only a couple of months left.

Katherine Kim – Banc of America Securities

Okay, so it does take some but it’s very minimal. Is that fair?

Michael G. Atieh

I’m sorry?

Katherine Kim – Banc of America Securities

You’re saying that it does take some but it’s very minimal.

Michael G. Atieh

Yes.

Katherine Kim – Banc of America Securities

Last year on your R&D day you gave guidance for 2008 last year. So do you intend to give guidance for 2009 as well, and let’s assume at that point the SATURN data is not out? Would your guidance just basically assume no effect from SATURN?

Colin Goddard

If you recall last year, it gave some initial headlines around the concepts of where we’re heading in 2009. We haven’t decided—in 2008, sorry. We haven’t decided yet whether we’ll be doing that for 2009. The focal point of the research day will be on our Tarceva plans going and on our R&D portfolio going forward and it may well be much more likely to expect formal guidance to our year-end results in February of 2009.

Katherine Kim – Banc of America Securities

Okay, and then on your percentage that you recognize from Tarceva U.S., it was around 41% this quarter versus higher in the first half, so what’s happening there and should we just we just expect it to be similar in the fourth quarter?

Michael G. Atieh

Katherine, it’s Mike Atieh. I mean essentially what has happened is that this $11 million reserve adjustment in effect comes through at a very, very high gross margin and we eat half of that and that impacts your so called conversion factors. So, you add that back in you would add it back in to both sides and you’ll see a much higher conversion factor and that is the type of expectation I would set going forward.

Katherine Kim – Banc of America Securities

Okay and I have one final question. In the Beta Lung Trial I don’t know if you’ve seen any more deeper into the data, but do you have the median survival in the sub-group of patients who are chemo sensitive? (Inaudible 00:34:34)

Colin Goddard

Obviously we’ve continued to analyze the data based from Beta but obviously we’re pointing towards the meeting coming up, the (inaudible 00:34:45) for further expansion and presentation of data from the study.

Katherine Kim – Banc of America Securities

Okay, thank you.

Operator

We will take our next question from Steve Harr from Morgan Stanley. Please go ahead.

Steve Harr – Morgan Stanley

Good evening. You may have discussed this a little bit before, but do you guys feel like you (inaudible 00:35:11) grasp on product returns and when should we expect this to end or is this going to be an ongoing issue with a longer tail then most of us supposed when it first started, earlier this year.

Michael G. Atieh

Steve, its Mike Atieh. A couple of comments. You know when the returns issue began in the second quarter of last year, it was really focused on the wholesale, and distributor channel and what we’ve now is that we’ve seen some returns coming in that were unexpected from the retail channel. After doing some investigation we learned a lot of things. And one of the things that we did learn is that one large retailer essentially stocks Tarceva at something like two-thirds of their pharmacies and obviously if a pharmacy is not using Tarceva the return window opens and it’s sent back.

Another large chain we’ve learned upon the filling of a Tarceva prescription, automatically restocks that bottle and obviously there are individuals that don’t come back for their potential refills for many different reasons including the fact that they’ve passed away. So I think what, and I feel good about the work that Genentech done, they’ve really taken a hard look at both the wholesale and retail channels and tried to come up with what they think is their best estimate. As I mentioned during my commentary we started out booking returns thinking it would be lower than an industry average and in reality they’re higher then industry average, as they through how would a low volume high value product like Tarceva is treated in the retail channel.

So, this has been a tough one for everyone obviously. It is $70 million on $1.6 billion. It just so happens that these numbers float through a quarter and they impacted. Is it over? Well, we think as we said the last time, we think we’ve booked a reserve that properly reflects an estimate for future returns on existing sales that have taken place. Could there be a change in the future? Sure, there could be depending upon whether or not these returns fluctuate. I think right now I feel very, very good about the work that Genentech done to try to come to grips with kind of inventory management practices in the retail and wholesale channels.

Steve Harr – Morgan Stanley

How do you guys feel about price increases in the current environment, you and Genentech, they play an important part of the growth story for this drug.

Colin Goddard

Genentech and us has been in terms of the value that Tarceva bring to the market for quite some time now and has been an agreement as to what (inaudible 00:38:17) we should have taken in the last couple of years so we will continue this interactive dialog and continue to look at the relative value that Tarceva is bringing to cancer patients rather than to competitor products and continue pricing decisions real times.

Operator

Anything further Mr. Harr?

Steve Harr – Morgan Stanley

No, I’m done.

Operator

Okay, we’ll take our next question from Howard Liang with Leerink Swann. Please go ahead.

Howard Liang - Leerink Swann & Company

If I could ask you to talk about your take on the impact on the IPAT Trial (inaudible 00:38:55) in the first line and what other data effect your clinical and commercial efforts in anyway?

Colin Goddard

So, the IPATH Study in a way is a strong reaffirmation of what we all believed to be true for quite some time which is EGFR inhibitors at least the TKIDs seem to work extraordinarily well. The amount of patients who (inaudible 00:39:25) cancers are driven by EGFR mutations. So we have heard that opinioned leaders now declare on podiums that if a patient’s lung cancer are driven by EGR mutation, EGFR TKIs inhibitor should even be considered at (inaudible 00:39:42) therapy instead of chemotherapy. So I think we will continue to see how the Ipath data will transpire (inaudible 00:39:53) action in Japan.

And globally we will continue to monitor trends of adoption. Unfortunately, obviously, a lot of patients do not really get their tissue typed in such a way to really know whether they are EGFR immune or not, but we will see if actually the practice will start changing in that direction, but I think it is, you know, a positive data set further reinforcing that EGFR-TKIs work with (inaudible 00:40:02) really well.

Howard Liang - Leerink Swann & Company

And my second question is, do you have a view on the prospect of Ericet, a European application, which is based on the interest trial, whether you think that will get approval?

Gabriel Leung

Well, we obviously have our own opinions and assessments, but at the end of the day what counts is what the European authority decides to do and we are eagerly awaiting for their decision.

Howard Liang - Leerink Swann & Company

Okay, then I’ll say why is the Japanese sales flat, or with limited growth?

Gabriel Leung

Well, I think, you know, giving it a launch mode and we are seeing, you know, (inaudible 00:40:20) a spike going from Q1 going to Q2, I mean, I think that a one-quarter trend does not really constitute a trend, so I think it is too early to conclude one way or another. We will continue to monitor, calling for feedback from our colleagues in Japan, for instance to be – continue on track with their launch.

Howard Liang - Leerink Swann & Company

My understanding, there is for 3,000 patients there is additional monitoring required after that; would that accelerate quotes after that is passed?

Gabriel Leung

Yeah, I understand that you guys are in continuous dialogue with the Japanese authority as to the proper follow-up of the initial (inaudible 00:41:47) of 3,000 patients, and I don’t think any firm decisions, you know – or the study is clearly not concluded yet.

Howard Liang - Leerink Swann & Company

Okay, thanks very much.

Operator

We will take our next question from Jason Zhang with BMO Capital Markets. Please go ahead.

Jason Zhang – BMO Capital Markets

Thanks. Question on SATURN’s enrollment. I heard that SATURN could have enrolled a proportionally high numbers of smokers and maybe even heavy smokers, and I wonder whether you can talk about that, whether that would impact the outcome of the study?

Colin Goddard

Well, Jason, the results and outcome of SATURN will be known to us all very soon. There is nothing that we are aware of to suggest that multiple cell lung cancer population enrolled in SATURN is anything surprising to us. But we will all see that very soon.

Jason Zhang – BMO Capital Markets

And also could you – I mean, the smoking status is one of the stratification factors; is that correct?

Gabriel Leung

Yes, smoking is a stratification factor.

Jason Zhang – BMO Capital Markets

Okay, and then another question is about Tarceva trial in (inaudible 00:43:14), you have mentioned that this is an area that you are very interested in. I am wondering, when will be that program to start, or even will it start?

Colin Goddard

Jason, I think we will be in a better position to update you on our specific plans there at the research date on December 12, but it remains an area of considerable interest to us.

Jason Zhang – BMO Capital Markets

Thanks.

Operator

Okay, we will take our next question from Brian Rye with Janney Montgomery. Please go ahead.

Brian Rye – Janney Montgomery Scott

Good afternoon, gentlemen, and thanks for taking my question. I guess just two quick housekeeping items, I wanted to make sure I heard the number right, but Mike, could you please reiterate the guidance for the full year? I think you said $2.12, and then also just I guess following up on an earlier question about the 2023 notes, would you mind just running through the entirety of the debt and where albeit the notes stand?

Michael G. Atieh

Sure, and $2.12 was the guidance number. Right now we have three convertible bonds outstanding. There are the 2023 notes, which essentially are $100 million remaining balance. The next put date is five years from now. We have the 2025 notes – the 2025 notes are $115 million dollars. The conversion price there is $29 but we have a call spread overlay that effectively reduces the dilution or takes the dilution out to $40 a share. The first put date for those notes is in 2010, December of 2010. And then we have the 2038 notes, which we just issued this year, early part of this year, $200 million face value, very high strike price of about $70 or more per share, and the first put date, first call date is essentially five years from now.

Brian Rye – Janney Montgomery Scott

Great, thank you. And then I’m sorry, just on the guidance itself, the $2.12 implies I guess around a $0.42 EPS result for the fourth quarter which is, you know, somewhat of a significant or meaningful decline. Sequentially you mentioned the higher R&D expenses; is that the only expense item that would expect to maybe jump a bit more than you would otherwise see?

Michael G. Atieh

That is exactly right. What you are seeing in terms of our – embedded in our guidance is an expectation because of the increased spending on our fourth – drugs that are in Phase I trials, some increased spending on Tarceva in fourth quarter, some increased spending on some core research spending with respect to the (inaudible 00:46:00) that we are going to see increased spending in Q4 related to R&D, slightly increased spending from our quarterly run rates in G&A but still hitting our original guidance there, so it adds up to about $2.12 per share.

Brian Rye – Janney Montgomery Scott

Okay, great. Thank you, Mike.

Operator

Okay, we will take our next question from Tom McGahren with Merrill Lynch. Please go ahead.

Tom McGahren – Merrill Lynch

I have more of a strategic question. With the pipeline pretty early stage in both oncology and IVs, are you thinking about end licensing or acquiring some product that you could launch or sell? Would you have a preference?

Colin Goddard

Well, I think they should know there are lots of reasons to be looking at the moment. It would appear to be a buyer’s market in some respects, but we intend to do so maintaining a very strong sense of discipline in what we are looking for, and what, if anything, can add value to the business.

It is extremely difficult to buy quality in late stage development assets, a little easier to look for quality earlier stage. Late stage is pretty clinical and early clinical. And even there I think we look at this with a high degree of need to see a strong fit with our ongoing focus and our internal programs, and as I say, I think yes, we are looking, but it will be in a very disciplined and focused manner.

Tom McGahren – Merrill Lynch

Would it be associated with oncology or diabetes and obesity, or are you looking to go off the reservation into some other area?

Colin Goddard

Very much staying on the reservation.

Tom McGahren – Merrill Lynch

Okay, thanks a lot.

Operator

We will take our next question from Derek Jellinek with SIG. Please go ahead.

Derek Jellinek – Susquehanna Financial Group

Great, thank, good evening. I’ll stay on the reservation here with my questions. Would you guys please comment on your current traction in squamous and how you kind of stack up against Gemzar and Taxotere here, and any kind of thoughts on Erbitux if it kind of gets a green light in front-line here, and then secondly, would you comment on what your thoughts are on ATLAS and kind of commercial potential there/ Thanks.

Gabriel Leung

Oh, ATLAS? Sorry, I did not catch your last one. Yeah, we are monitoring the market trend and we do see a slight uptake in the squamous business – even the second-, third-line setting. Again, too early to really call that a trend or – but yes, we will continue to monitor that. I mean Taxotere was the only other approved product on the second-line setting, and based on the Alimta versus Taxotere database, I think it is fair to assume that Taxotere works in squamous as well, so they will be a competitor. We think that the toxicity profiles between Taxotere and Tarceva are probably more different than it was between the Alimta and Tarceva, so we may have some opportunity there. Gemcitabine’s second-line data are quite inconsistent, so it is too early to say whether Gemcitabine, what role Gemcitabine will play in the squamous setting.

So the other question is ATLAS. So ATLAS, we felt will be available according to Genentech sometime next year, and the study designed there is actually quite similar to SATURN in a way, except that it has a Avastin in the background, so that will be another opportunity to look at the A/T combination by answering a Tarceva question, because that is A/T versus A, whereas BETA is A/T versus T, which is really another Avastin question, not a Tarceva question. So obviously if ATLAS is positive, that would help establish potentially a role for A/T in the maintenance setting as well complementing a potentially successful SATURN in that regard.

Derek Jellinek – Susquehanna Financial Group

And if not as successful in the A/T front, how do you see reimbursement shaking out? Would the Avastin’s more favorable reimbursement kind of offset Tarceva’s reimbursement?

Gabriel Leung

Actually, as long as the products are approved, we are not seeing major reimbursement problems in the state, you know, as long as the approvals are there, the indications are there, or sometimes even the guidelines are mentioning how they will use it. Reimbursement generally is not a problem.

Derek Jellinek – Susquehanna Financial Group

And I wanted to pull back just quickly to the squamous question. I threw out Erbitux, if it does get the front-line setting, how do you look at the squamous in the given sequential use of EGFRs? Do you think that will be a problem in that?

Gabriel Leung

Yeah, I mean, again, the (inaudible 00:51:00) database is an interesting one because you see this in a week, one month benefit, but the benefit – the pattern of benefit does not seem to match what you typically would expect from an EGFR inhibitor, you know, because you see Asians getting actually not only not benefited, we can argue that they are actually getting hurt if they go on Erbitux, which is, you know, very atypical. And we haven’t seen any never-smoker data, for example, you know, which you would also expect, maybe, you know in EGFR inhibitor should do better. It begs the question, you know, of whether an antibody in that setting is actually helping chemotherapy out through more of an ADCC (inaudible 00:51:44) in a typical EGFR effect, so those are all hypothesis. But you know, I think we need to see the data and more complete data when it gets published and then see how it goes through the regulatory process.

Derek Jellinek – Susquehanna Financial Group

Great, thanks for taking the questions.

Operator

We will take our next question from Stephen Willey with Thomas Weizel Partners. Please go ahead.

Stephen Willey – Thomas Weizel Partners

Yeah, hi, thanks for taking my question. Just a question on the reimbursement status of that stepped-up Tarceva dose in patients who continue to smoke given the change in the label. Is that a fully reimbursable dose now?

Gabriel Leung

Yeah, with the 300 mg mentioned in the dosage section, we do not anticipate that we will have major problem with reimbursement, you know, we have not – it is too early in market so we will continue to monitor that if that is not the case, but we do not anticipate that to be a problem.

Stephen Willey – Thomas Weizel Partners

Maybe just getting back to the bypass question for a minute. Will there be any kind of push to maybe start screening patients for EGFR activating mutations in front-line, and maybe if you could just remind us of what percentage of patients actually have those mutations, have that phenotype?

Gabriel Leung

Yeah, in the Western world, the best estimate we have is around 10% of patients have the activating mutation. We think in major cancer centers around the country they probably do the testing but that would – you know, that would represent a minority of cancer patients. In the community setting, it is probably not a standard procedure.

Stephen Willey – Thomas Weizel Partners

Great, thanks.

Operator

Okay, we will take our next question from Jim Birchenough with Barclays Capital. Please go ahead.

Jim Birchenough – Barclays Capital

Yeah, hi guys, a couple questions. Just on SATURN timing, is there any possibility that the data could come after year-end, early ’09?

Colin Goddard

Jim, we have stayed to our guidance the second half, no reason to change that, so it is still very much likely you are going to see it in the next eight weeks or so.

Jim Birchenough – Barclays Capital

And then just on the trial itself, we have had several maintenance studies where there has been an improvement in PFS but no benefit of overall survival, and that has been – has held that as a reason for pushing back against maintenance therapy. If you show the same result, an improvement in PFS and no benefit in overall survival, can you really make a go of it as a maintenance therapy? So I am trying to get some comments on importance of overall survival versus PFS in a maintenance study.

Colin Goddard

Well, I guess there is two things going on there that are worth thinking about. One, of course, is a trend in the earlier study with the Alimta, and there is generally an offset when your primary endpoint is PFS for the time to the survival data to mature, so we have to wait and see there, and we would expect to see that all come to pass appropriately with Tarceva and SATURN.

This also caused an emergence of an increase propensity to use multiple rounds of therapy in lung cancer, and at some juncture we will have to ask questions there about the role of therapy, I am sorry, the role of PFS as an endpoint becoming more and more meaningful, just as it did in breast cancer, but that debate still has to be had.

Jim Birchenough – Barclays Capital

And just finally, Europe seemed like it flattened out sequentially. I am just wondering whether you have got any feedback from Roche as to why that was, if there were any one-time items and what could re-accelerate Europe for Tarceva in the fourth quarter?

Gabriel Leung

Obviously if we do end up with a NICE approval that would add a big country into the mix in terms of possible growth, and partly the quote-unquote flatness has to do with exchange rate aberration as well too, so I do not think it is necessarily a true reflection of the volume trends.

Colin Goddard

And just to comment on exchange for a second. On a sequential quarter basis we – you know, we estimate that it was about a 5 percentage point impact, so you can do some math and look at what the underlying growth would have been, strength in the U.S. dollar.

Jim Birchenough – Barclays Capital

Okay, great, thanks, that is helpful.

Colin Goddard

Cynthia, we’ll take one more question.

Operator

We will take our final question, and it is a follow-up from Geoffrey Meacham with JP Morgan. Please go ahead.

Geoffrey Meacham – JPMorgan Chase & Co.

Hey guys, thanks for taking the follow-up. Just actually I am wondering, the initial trends that you have seen in the second- and third-line settings, as Elimta has moved into the first-line setting, and then I guess just a follow-up to that would be, in a worst-case scenario of a failed SATURN trial, what do you think is the peak potential in those, in the second- and third-line settings? Thanks.

Gabriel Leung

Yeah, so in the way our second-line penetration has been – second-, third-line penetration has been gyrating around, you know, a plateau for quite some quarters now, interestingly, we actually are beginning to see an unintended up in the front-line setting, which obviously is the setting where we do not actively promote, because that is not in our indication. So we are trying to actually understand the dynamic there a little bit better. Actually in case of an unexpected failure of SATURN, it would be interesting to see how the EGFR mutant population will play out as well, because that may well change some of the dynamics of choice of therapy.

Geoffrey Meacham – JPMorgan Chase & Co.

Okay and then real quick follow-up. Does your guidance for worldwide Tarceva sales assume any more inventory adjustments?

Michael G. Atieh

It assumes that the reserves that are booked right now are adequate to cover future returns, so the answer to that is no.

Geoffrey Meacham – JPMorgan Chase & Co.

Okay, great, thanks.

Operator

Ladies and gentlemen, this will conclude today’s question and answer session. Dr. Goddard, I will turn the conference back over to you for closing comments.

Colin Goddard

Thanks, Cynthia. Obviously, these are difficult times in both the markets and the economy, but we actually continue to believe we have the company really well positioned to manage through them and to emerge beyond them in a position of some strength. Obviously we are $488 million in cash and investments on the balance sheet and a balance sheet that is very conservatively managed and well-invested, and a substantially profitable business around Tarceva, we consider ourselves fortunate against some of the challenges confronting some of our biotechnology brethren, but it is also pleasing now to see that plat line we’ve been incubating and working on for several years really starting to emerge, and as we look forward to 2009 and an assumption of success in SATURN that we hope to see delivered on, we believe we will have Tarceva still a very strong growth story, a pipeline behind it, and a very financially strong position with which to navigate 2009 and beyond.

So, we continue to look forward with some confidence to the future. We appreciate you joining us on the call tonight and we will look forward to sharing with you a lot more about our R&D plans and our Tarceva life-cycle plans on the R&D day on December 4.

Thanks very much for listening.

Operator

This will conclude today’s OSI Pharmaceuticals Third Quarter 2008 Financial Results Conference Call. We do thank you for your participation, and you may disconnect at this time.

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