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Celgene Corporation (NASDAQ:CELG)

Q3 FY08 Earnings Call

October 23, 2008, 9:00 AM ET

Executives

David Gryska - CFO

Sol J. Barer, Ph.D. - Chairman and CEO

Robert J. Hugin - President and COO

Analysts

Katherine Kim - Banc of America Securities

Geoffrey Meacham - JPMorgan

Charles Duncan - JMP Securities

Geoffrey Porges - Sanford C. Bernstein

Rachel McMinn - Cowen & Company

John Sonnier - William Blair

Jason Zhang - BMO Capital Markets

Operator

Good morning. My name is Kristin and I will be your conference operator today. At this time, I would like to welcome everyone to the Celgene Quarterly Conference Call. As a reminder, today's call is being recorded.

I would now like turn the call over to David Gryska, Chief Financial Officer. Please go ahead sir.

David Gryska - Chief Financial Officer

Good morning, everyone and thank you for joining us today. I'm Dave Gryska, Celgene's Chief Financial Officer. I'd like to welcome you to Celgene's Third Quarter 2008 Conference Call. With me are Celgene's Chairman and Chief Executive Officer, Sol Barer and President and Chief Operating Officer, Bob Hugin.

The press release reporting our third quarter financial and operating results was issued earlier this morning. The results are available on our corporate website. Sol will start the call today with a strategic overview, then I'll take you through our financial results and outlook for 2008. Bob, will then review our operational and commercial results for the third quarter and give you his global perspective on remainder of the year.

Before we start, we want to remind you, there are certain statements made during this conference call may be forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and within the meaning of 21E of the Securities Act of 1934. Certain forward-looking statements, which involve known and unknown risks, delays, uncertainties and other factors not under our control, may cause our actual results, performance or achievements, to be materially different from results, performance or other expectations implied by these forward-looking statements.

These factors include the results of current or pending clinical trials, research and activities, our products failing to demonstrate efficacy or an acceptable safety profile, actions by the FDA, EMEA and/or other U.S or international regulatory bodies, the financial conditions of suppliers including their solvency and ability to supply products and other factors detailed in their filings with the Securities and Exchange Commission, such as our Form 10-K, 10-Q and 8-K reports are referred to in the press release issued this morning.

Now, I'll turn the call over to Sol.

Sol J. Barer, Ph.D. - Chairman and Chief Executive Officer

Thank you Dave and good morning everyone. We are very pleased with our results for the quarter, which encompass a 68% increase in total revenue to $587 million led by a 72% increase in revenue to $343 million, a 50% increase to VIDAZA to $64 million overall resulting in a non-GAAP EPS of $0.40 per diluted share.

We made great advances in the quarter financially, operationally, clinically, commercially and strategically. I'd like to take a few minutes to provide you with a strategic perspective, then turn it over to Dave for a detailed financial review of the quarter and Bob, for an operational perspective and review.

We now have three important commercial therapies poised for long-term growth, in addition to a promising and exciting pipeline. Our lead product REVLIMID has a multibillion dollar global potential in haematological malignancies and potentially solid tumors. Our newest compound VIDAZA has excellent prospects in MVS and it's poised for global leadership in this indication.

Multiple product launches to more than 65 countries all on plan, bringing us closer to our goal of delivering disease-altering therapies to patients in nearly 100 countries over the next five years. The commercial launches of REVLIMID, thalidomide and VIDAZA will continue to support the ambitious goal of nearly 60% growth year-over-year by exceeding our total revenue forecast for 2008 of $2.2 billion and earnings of a $1.50.

Celgene is strategically positioned to deliver superior top line and bottom-line growth for years to come. We are now in an extraordinarily positive position, having become a global hematology/oncology powerhouse. We have become a major hematology company in the EU and U.S. with three major products having the pre-eminent position in our current areas of focus multiple myeloma and MDS.

Additionally, we are strengthening this position with progress towards expanding our REVLIMID label to include the important indications and major market of newly diagnosed myeloma, with both aggressive and Phase III pivotal filing strategies, chronic lymphocytic leukemia with FDA approval and initiation of out first pivotal trial in maintenance therapy and Non-Hodgkin's lymphoma with FDA approval and initiation of our first pivotal trial in mantle cell lymphoma later this quarter.

Furthermore, our hematology trials include maintenance therapy, where REVLIMID's oral convenience, efficacy and safety and lack of cumulative toxicity, make it a unique drug to investigate in this critical indication. The broad biological activity of REVLIMID can also expand into other hematological malignancies and solid tumors. With the near-term anticipated approval of VIDAZA in the EU, we will have the first therapy for MDS in 29 countries in Europe and the only therapy proven to increase overall survival.

Additionally, we are progressing with the launch of REVLIMID and Thalidomide in the EU throughout the remainder of 2008 and 2009. Our operations have resulted in exceptional financial strength, a critical asset in these turbulent times. Our cash exceeds $2 billion. Our tax structure is among the best in the industry; our cash flow exceeds $200 million per quarter. We have no debt and our business prospects are solid. We have maximized our financial opportunity for VIDAZA towards realizing its full commercial potential by the purchase of the VIDAZA royalty stream for Pfizer. This allows us to realize the full commercial benefit of this product.

We have also vertically integrated our manufacturing for REVLIMID and Thalidomide and are planning to do so for VIDAZA resulting in significant strategic and financial advantages. Moreover, being cognizant of the turbulent, political, and economic times we are in, it is a most fortunate position for us to be in to have life-saving therapies and we are supporting such, by building the state-of-the-art global health economies capability. Our patient access programs have been rated among the best and we're among the most generous in helping patients, ensuring the availability of our critical drugs.

Our financial and commercial strength provides us the resources to advance our deep and diversified pipeline encompassing Celgene discovered compounds, including first-in-class molecular entities and our programs in partnership with cutting-edge science-based companies. We have made progress in advancing our proprietary IMiD compound franchise, including Pomalidomide which is demonstrating activity in multiple myeloma and potential myelofibrosis.

Additionally and significantly, we advanced our anti-inflammatory franchise with the Celgene-discovered Apremilast and CC-11050. Apremilast has demonstrated promising activity in the controlled Phase II trial in moderate to severe psoriasis, is in trial psoriatic arthritis and recalcitrant psoriasis, which is now fully enrolled and its in a broad based program as an oral TNF alpha agent. We expect to see additional top-line data for Apremilast in 2009.

Additionally, CC-11050 our next PDE-14 alpha has been demonstrated to be safe and well tolerated in healthy unit volunteers and will be evaluated in a number of these diseases. Our promising first-in-class JNK inhibitor CC-930 has now advanced to Phase Ib and has a significant therapeutic potential in a wide range of indications encompassing important unmet medical needs.

We also advanced our proprietary IMiD compound 10015 with the filing of IND for evaluations for safety in scleroderma, accelerating our strategy of developing this class for serious autoimmune and inflammatory illnesses in addition, to our core strength in hematology/oncology.

Furthermore, our landmark for this quarter was the filing of an IND for our proprietary to the central stem cell-base therapy initially for Crohn's disease. We continue to make exciting progress in the field of the central device stem cell research, where we are a pioneer in the manufacturing, research and development of these proprietary, biological agents in human disease.

Our commercial and financial strengths allows us to be opportunistic as we identified companies, technologies and products, which kind of advance our overall strategy. One of our exciting partnerships is with Acceleron, where a Phase II clinical trial was initiated to evaluate the very high potential active inhibitor ACE011.A fundamentally unique bone anabolic agent to treat cancer-related bone loss and initially in multiple myeloma. We are excited by the potential of this compound to provide profoundly different therapeutic effects across a range of indications, including osteoporosis, where we expect data at the International Osteoporosis Foundation Annual Meeting in December and indeed in other indications.

The advancement of collaborative programs reflect our corporate objective of ensuring the diversification of our pipeline towards unique and high-potential novel mechanisms, exemplified by exciting partnerships with Array BioPharma in both oncology and immunology and with PPC Therapeutics, encompassing a new and unique mechanistic approach toward oncology therapeutics.

We have also taken equity positions in cutting-edge private companies, focused on new science and compounds, having transformational potential in the treatment of serious diseases. These and other programs address our corporate objectives of ensuring the strategic and science-based diversification of our pipeline. We look forward to the upcoming American Society of Hematology meeting where we expect data for REVLIMID, VIDAZA, Thalidomide and our pipeline.

We have grown in diversified and commercial activities and revenue by the successful global expansion with operations in place around the world and the achievement of important approvals in Europe, Australia, Latin America and Canada. We've expanded our operational capabilities to new markets in Eastern Europe and Asia-Pacific, setting the stage for longer term successes in these emerging regions as we move closer to our goal of providing our therapies in more than 100 countries over the next five years beginning in 2009. We are committed to realize our significant long-term growth potential and to help improve and extend the lives of patients worldwide.

I am also very pleased with the progress we have made in completing the Pharmion integration. Our original assumptions regarding the strategic human resource, commercial, clinical and financial driving forces have been validated. Our sales forces have been merged into an effective and industry-leading team. The two leading products have advanced with the approval of Thalidomide in Europe, the label expansion of VIDAZA in the U.S and its anticipated approval in the EU. We are Amrubicin in a global Phase III pivotal trial for the treatment of small cell lung cancer. All of this has resulted in a focused, world-leading hematology/oncology company with a diverse and potent pipeline in cancer and inflammation.

In summary, Celgene is now in a fortunate position. Our business is strong. Our drug is exceptional and saving lives. Our research is exciting and productive, our expansion is steady throughout the world diversifying our commercial activities and growing our business. Our regulatory in clinical program is advancing. Our finance is strong with multiple revenue streams. Our tax structure is very favorable. Our manufacturing, integrated and seamless and our people, among the very best in the industry. We are in an enviable position as we look to the next several years with a sense of confidence and pride.

Now, let me turn the call over to David Gryska, who will present an overview of our financial results for the quarter

David Gryska - Chief Financial Officer

Thanks Sol. The third quarter revenues and earnings reached a new highs, despite some seasonalities and our foreign exchange headwinds. During the quarter, we substantially increased revenue and earnings and continued our global expansions with more products in more countries building a solid foundation for sustained growth worldwide.

For the third quarter, we reported non-GAAP total revenue of $587 million, an increase of 68% year-over-year. Total non-GAAP product sales increased to $561 million for the third quarter, up 69% from $331 million in the year-ago quarter. The increase was due to the growth of REVLIMID, the addition of VIDAZA to the product portfolio and Thalidomide sales.

Non-GAAP diluted earnings per share were $0.40, as Sol stated, for the quarter and $1.13 for nine-month period ended September 30, 2008. We believe our results demonstrate our commitment and ability to maximize our global commercial regulatory opportunities in the long term, while still providing shareholders with impressive bottom-line growth.

Now, I would like to discuss some expense trends as compared to the prior quarter. During the third quarter, we increased funding of R&D to advance clinical development of our pipeline and support global regulatory filings. These increased expenses support clinical progress in multiple proprietary development programs, including significant incremental investment for advancement of REVLIMID in NHL and CLL. The development of Amrubicin, Pomalidomide, Apremilast and our ongoing collaboration with Acceleron.

As a point of reference our non-GAAP R&D expenses were $385 million for nine-month period ended September 30th, which demonstrate a substantial support for R&D programs. Selling, general and administrative expenses decreased as compared to the prior quarter, primarily due to realized Pharmion merger synergies of the commercial organization.

SG&A is expected to increase in the fourth quarter in support of the re-launch of VIDAZA in the U.S. with improved survival label, launch preparation for VIDAZA in Europe and ongoing European product launches of REVLIMID and Thalidomide. We expect total non-GAAP SG&A expenses for the year to be between $605 million and $610 million. The global integration process of Pharmion is nearly complete.

We'll incur one-time integration costs primarily related to SG&A and clinical expenses approximate $30 million in 2008 of which approximately $26 million has been spent year-to-date. Our non-GAAP gross profit margin for third quarter was approximately 89% compared to approximate 88% in the prior quarter. The expansion gross margin was primarily due a change in product mix.

For the remainder of the year, we expect gross margins to be near 90%. Tuning to taxes; our tax rate for the quarter was approximately 24% which is consistent with the prior quarter. Due to increasing international profitability, we expect a slight decrease in the tax rate the next quarter.

During the third quarter, as you know the dollar has strengthened as compared to the euro. In terms of sequential foreign exchange effect our revenues, the impact of foreign exchange on third quarter of 2008, represents about 1% of total revenue through the quarter. During the third quarter, we enhanced our foreign currency hedging program and expect all aspects of this program to be in place over the next two quarters.

In addition to hedging balance sheet foreign currency exposures, during the third quarter, we began hedging our exposure related to inter-company foreign currency transactions and had a slight benefit, as a result of those activities. At the beginning of the fourth quarter, we began hedging a portion of our exposure to Europe-based product sales. As our international operations grow, our objective is to minimize revenue and earnings exposure to foreign currency volatility and to further refine predictability of our financial performance.

Now, I would like to discuss the significant fourth quarter transaction involving VIDAZA. VIDAZA has a royalty obligation payable to Pfizer. Analysts' projections indicate that growth payments of the VIDAZA royalty obligation over the next ten years are estimated to exceed $1 billion. In the first week of October, we bought out the future royalty obligation through Pfizer for $425 million. Approximately 325 million of this amount will be expensed in the fourth quarter, because it relates to international VIDAZA which is not yet approved.

The remaining 100 million of the payment relates to U.S. rights, which will be capitalized. As, result of this transaction, we now have no other obligation to pay royalties on VIDAZA including oral formulations. In addition, we expect to see improvement in our VIDAZA gross margins, with the anticipated international launch of the product in the first quarter of 2009.

And now, a few words about our cash flows and balance sheet. We ended the third quarter with cash, cash equivalents and marketable securities of approximately $2.4 billion. We expect this balance to be approximately $2.2 billion by the end of the year, after taking into consideration the VIDAZA royalty transaction. Moreover, our cash and marketable securities do not include any self sub-prime mortgage-backed securities, credit derivatives, collateral debt obligations and auction rate preferred investments. Our cash is invested in high-grade U.S. government in government agency securities and money market funds. We have incurred no impairment charges related to our cash and marketable securities for the year. In addition, we have no debt.

We want to reiterate our strong financial outlook for 2008. Based on strong financial performance for the first nine months and greater visibility around commercial and regulatory developments and time lines, we expect total global revenue to exceed our earlier guidance of $2.2 billion. Non-GAAP diluted earnings per share should also exceed our earnings guidance of $1.50 for the year. In conclusion, we believe our strong financial standing enables to maximize our commercial, clinical and regulatory potential in markets around the world and it will support superior top line and bottom line long-term growth.

Now I will turn the call over to President and Chief Operating Officer, Bob Hugin to expand on the global commercial, clinical and regulatory achievements of the third quarter and give us a look as to what's coming up for the fourth quarter and beyond.

Robert J. Hugin - President and Chief Operating Officer

Thanks, Dave. David and Sol provided you with a good overview of the results of the quarter and an overview of the business strategy that guides us. For the next few minutes, I'll give you a more granular and operating view of our quarterly results and to connect these results to our key corporate objectives and to our positive outlook for our businesses, over the next several years.

During the quarter, we made excellent progress towards our key corporate goal of maximizing the full potential of REVLIMID. Let me begin with a review of our commercial activities. You've already heard the numbers, 72% increase in year-over-year revenue, $955 million of REVLIMID sales in the first nine months of the year. And with an encouraging start to the fourth quarter, REVLIMID revenue is now over $1 billion for the year.

There are several other important metrics from our major markets that provide insight on the relative strength of the REVLIMID commercial performance and give us confidence that we have excellent growth opportunities within our approved indications. In the U.S., REVLIMID myeloma prescriptions grew by 7.5% quarter-over-quarter despite the summer months, economic uncertainty and the full impact of the Velcade launch of the expanded newly diagnosed myeloma label. This strong performance was fueled by excellent demand for REVLIMID across all lines of myeloma therapy, including the frontline sector with a continued positive response for the presentation of the ECOG and SWOG data at major medical meetings affects physician practice.

Despite the strong market share increases over the past year, we see the opportunities for continued market share gains in the U.S. Our optimistic outlook and the role of the U.S. market in growing REVLIMID to its full potential is illustrated in the treatment duration data generated this past quarter. Our analysis indicates that during the quarter, average REVLIMID duration of therapy in myeloma continued its march upwards adding another half months of duration since our last call, now averaging 9.5 months. This steady constantly increasing duration is reflective of the durability of patient responses and the long-term tolerability of the drug, leading to its extended use. The potential of further increases in treatment duration offer significant additional upside in the US myeloma markets for REVLIMID.

To further support REVLIMID's market position, we're committed to expanding our labeled indications to include the newly-diagnosed patient population, as soon as possible. We're proceeding on multiple paths to achieve this objective. We have fully included MMO-15, Malfalan, Prednisone, REVLIMID versus Malfalan Prednisone's Phase III trial which we believe may have regulatory utility in both the U.S. and in international markets.

In the U.S., we now have ECOG and SWOG data in house and are going through final data quality checks and queries, prior to our presentation of the data to the FDA for the discussion of its potential usefulness as a regulatory filing. In addition to the significant continued opportunity in the United States, we view the international market as major growth opportunities for REVLIMID in myeloma and other indications over the next several years. The growth in international markets should come from market share gains in existing markets, usage in earlier stages of disease, territorial expansion through new regulatory and reimbursement approvals and ultimately for extended duration of therapy.

Though confronted with the foreign exchange headwind, the usual summer seasonal patterns and expected price reductions REVLIMID revenue grew in Europe with volume gains of nearly 10% quarter-over-quarter. Euro weakness and expected price reduction had an approximately $17 million impact on third quarter results. The volume increases reflect the continued market share gains made in major European markets. Across Europe, REVLIMID achieved strong initial positioning with significant upside as it moves from a substantial forward line position to a leader in the second line of therapy in many countries.

There are also a number of important markets in which we have not yet filed for a regulatory approval and are awaiting regulatory or reimbursement decisions. We were very pleased that earlier this month, Health Canada approved REVLIMID for previously-treated multiple myeloma and look forward to positive potential reimbursement decisions in the first half of next year.

We have regulatory filings under reveal in multiple countries, including Russia and Turkey and plan to file for myeloma in Japan in the first half of next year. Though launch in Japan is not scheduled until sometime in 2010, we believe that it could become our second largest individual market in a reasonably short period of time. We are waiting reimbursement outcomes in Australia and The U.K. in the coming months. Though we expect a negative initial NICE assessment, we look forward to reviewing the issues that could lead to a positive final assessment in the first quarter of 2009. All in all, the REVLIMID commercial results for the quarter were solid. In the context of the challenges of the quarter, they were quite strong.

Our clinical commitment to the myeloma market is strongly evidenced by the recent initiation of the largest newly diagnosed multiple myeloma trial ever undertaken, MM020, the 1590 patient trial evaluating RevDex versus Malfalan and Prednisone, Thalidomide in the upfront myeloma setting has begun to accrue significant numbers of patients, reflecting the international enthusiasm for these highly effective oral treatment regimens.

We're also advancing several important REVLIMID trials designed to demonstrate its value proposition and survival advantage in the maintenance setting, essential for the appropriate longer-term positioning of the drug. Data from these large Phase III cooperative group studies is expected in 2009.

Though multiple myeloma is the key driver of REVLIMID's today, our press release this morning highlighted the significant progress being achieved in examining REVLIMID's potential in other hematological malignancies. Specifically, we have initiated our first pivotal Phase III CLL registration trial. This study which received XPA approval in September and is named the Continuum Trial, is designed to prove the REVLIMID when given as a maintenance therapy in patients after second line therapy, prolongs progression-free and overall survival.

Investigators have stated that REVLIMID is particularly attractive as a maintenance therapy in CLL because of the efficacy it has shown in previous trials, its safety profile and oral convenience. This registration study will take place in over 200 sites around the world and will include approximately 680 patients. This is the first in a series of registration trials, we will be conducting to investigate REVLIMID's role as a standard treatment for patients with CLL. In the meantime, we're also pleased that REVLIMID as a treatment for CLL is now compendia listed, offering patients an additional path to its clinical benefits. Important new data is expected to ASH in CLL, which we believe will further broaden knowledge of REVLIMID's potential in CLL and assist in the rapid accrual of our global regulatory programs.

The progress of REVLIMID in NHL is on a similar pace. Data from NHL 002 or Phase II study of REVLIMID in heavily pre-treated patients with aggressive sub-types of NHL will publish in the October edition of the Journal of Clinical Oncology. These data demonstrated an overall response rate of 35% and a 53% response rate in the subset of patients with mantle cell lymphoma. We are looking forward to the presentation of updated data from NHL 003. Our Phase II multi-center single arm open-label study of REVLIMID in patients with relapse reflectory aggressive NHL at ASH.

Similar to CLL, we will be initiating several trials in the area of mantle cell lymphoma in other NHL population in the coming months. The first of these are Phase II EMERGE registration trial, received SPA approval during the quarter and we anticipated enrollment of the first patient in the next three months. The EMERGE trial will evaluate the efficacy and safety of REVLIMID in approximately a 130 previously treated mantle cell lymphoma patients. We are also encouraged by the growing global cooperative group support for our expanding NHL program. Recently published and soon to be presented data should also assist in further acceleration of our NHL program.

To give you a sense of our commitment to expanding REVLIMID into CLL and NHL, there are now over 65 REVLIMID trials completing, accruing or soon to be initiated in these indications. We are indeed fortunate that our product portfolio includes another breakthrough hematology/oncology product with significant growth potential; VIDAZA.

VIDAZA revenue for the quarter rose to $64 million, which represents a 50% increase over the year-ago quarter. In late August, the FDA approved the addition of the survival data from the AZA-001 trial into the VIDAZA label in the United States. This trial demonstrated a nearly doubling of the two-year survival rate to over 50% for higher risk MDS patients treated with VIDAZA and a 24 month median survival versus a 15 month medial survival for the conventional care arm.

The US re-launch of VIDAZA began in earnest in the middle of September. Positive trends have begun to emerge in just the first few weeks. These market share gains have been driven in large part by the ability to promote the exceptional survival data and the increasing awareness of the failed EORTC trial for decitabine. A focused sale and marketing effort led by our specialized MDS sales team is making a difference. We expect further data presentations at ASH and peer reviewed publications to aiding this effort over the coming months.

We believe that VIDAZA has a specially high growth potential in Europe. We're following regulatory approval, will be a beneficiary of ten years of orphan-drug regulatory exclusivity. This potential was the driving factor behind our decision to buyout the royalty on VIDAZA. We will now capture the full benefit from our commercial activities over the coming ten years. Before we continue our VIDAZA commercial activities in Europe, we obviously require regulatory approval. We're very optimistic that we will receive a positive recommendation for the EMEA imminently and a full approval from the European Commission in a couple of months.

On the REVLIMID MDS front, we are anticipating the data base slot of the MDS-004 trial before the end of the year. This study is our Phase III multi-center randomized double-blind placebo-controlled three arm study of two doses of REVLIMID versus placebo in the recent 5Q MDS patients. Though REVLIMID and VIDAZA are the key growth drivers for Celgene, we are making study progress navigating the country-by-country health ministry sign out procedures required for approval of risk management and reimbursement authorizations in the major European countries for Thalidomide. We expect that we'll be able to begin active commercial activities in these major markets late this year and the first half of 2009.

To achieve our corporate objective of producing high and long-term growth, we are also focused on leveraging the clinical regulatory and commercial potential of multiple promising compounds in our pipeline. Sol outlined the significant progress achieved in advancing this promising pipeline, including Pomalidomide, our lead anti-inflammatory compounds, our proprietary placental stem cell program, our high potential external collaborations and other promising earlier stage research activities. We're fortunate to have multiple promising programs that offer transformational potential.

As we look forward, we are on track to achieve the ambitious financial and corporate goals that we set for our global team at the beginning of the year. But we are all well aware of the many challenges of difficult economic times. We believe that our business model is sound and that we are in fact strategically positioned to gain a competitive advantage during periods of economic uncertainty. Our powerful lead products, REVLIMID and VIDAZA, our strong commercial clinical research and regulatory organizations, our promising pipeline and strong financial profile allow us to focus on building exceptional long-term shareholder value.

Thank you very much for your attention during our presentations. And now I'll ask the Operator to open up the call to questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. We'll go first to Katherine Kim with Banc of America Securities.

Katherine Kim - Banc of America Securities

Hi. I have several questions. The first is for David. Can you just talk about the Pfizer royalty stream that you brought back. What is effect on your... if you can give us some detail on the effect on your internal EPS projections over time? And, then second question is the hedging strategy that you've put in place, if you can discuss a little bit more detail on the hedging strategy in terms of its impact on revenues in the fourth quarter?

David Gryska - Chief Financial Officer

Okay. So, the first question in the VIDAZA. As I said in the prepared remarks, the $425 million payment we wrote off, we have expensed $325 million of that which relates the international VIDAZA, because the product is not yet approved, although we expect approval any day now. As a result of that we are not going to be seeing any inclusion of that potential of that royalty in the cost of goods sold. So that obviously helps earnings on the go-forward basis.

But the second part I think, of this also is of that $325 million that relates the international. Some of that relates to the international cash, so it will use our international cash more effectively without triggering a taxable event. So, I can't quantify for you today what the impact will be on EPS because we are still evaluating it. But, there will not be a element in cost of goods sold of this royalty on go-forward basis which is approximately 20%.

Part two, the hedging strategy; The hedging strategy, we have is really in three parts, Katherine. First, as we hedge our balance sheet risk, which we have been doing now for two or three quarters. Number two, we hedge our inter-company risk, which is our cash flows. We're doing a really good job at that and as I said in my prepared remarks, we have slight benefit from that of about $3 million, which helped on the overall operating results.

And finally, we are starting to hedge our revenue exposure. Beginning in the fourth quarter, we start to look at our euro revenue exposure and we hedged less a 50% of that. But as we continue to roll out our strategies over the next two quarters, we'll look at other currencies in different countries like Australia or Swiss franks or pound. So, the strategy is good, we have a very good strategy in place and very good programs in place. And, quarter-over-quarter we expect to keep moving out and hedging more and more revenue as we move out in the international arena.

Operator

We'll take our next question from Geoffrey Meacham with JPMorgan.

Geoffrey Meacham - JPMorgan

Hi guys. Thanks for the question. A follow up on VIDAZA. Two questions, following the European approval, can you give us sense for the rollout picture and how that looks? Is that so more to REVLIMID or faster? Just given broader compassionate units. And, then second part is we just ask VIDAZAN question a little bit more specifically. After you pay down the royalties or after you buy them back, what will you approximate gross margins be for VIDAZA. Is it closer to REVLIMID or closer to this Thalidomide? Thanks.

David Gryska - Chief Financial Officer

Okay. So all we have to do the later part of the question first. As it relates to international VIDAZA, with the pay off of the royalty say international pieces, we'd expect the growth margins to be good now, we are just doing the actual cost to producing the products with no royalty. We expect the gross margins to be kind of in that of 90% to 93% range okay? Not as good as REVLIMID, but obviously very good. Okay?

Robert J. Hugin - President and Chief Operating Officer

And then Geoff on the roll out for VIDAZA, if we receive the positive recommendation shortly and then two months later we'd anticipate the European Commission. Then we can begin the process of the pricing and reimbursement in all those markets. I think on the balance, the roll out is going to in fact be very similar to the roll out of REVLIMID. I think at some fronts, it will be a little bit quicker in the sense. I think that we have a stronger organization today and really understand how we need to deal with these individual countries.

On the other hand MDS is a much less developed market in Europe in the sense that you don't see a lot of active treatment and so there's awful lot of watch and wait. So there is a more intense education process going to be required there. So, on the balance, as I look at things, I think we really feel that we'll have some positives in terms of the rollout. But I think it'll be very similar over time in the sense of what has happened with the REVLIMID rollout.

Operator

Okay. Our next question is from Charles Duncan with JMP Securities.

Charles Duncan - JMP Securities

Hi, guys. Thanks for the question and congratulations on a good year in your financial performance. I wanted to perhaps fast forward one to three years on REVLIMID. Despite Bob's overview, how do you see the REVLIMID market potential and the key factors driving growth? Also, if you could give a little bit more color on what is encouraging to you as you look at the early fourth quarter performance?

Robert J. Hugin - President and Chief Operating Officer

I think a number of things. And I think...when we look at to REVLIMID over the next couple of years, the U.S. has two things; we've made good market share gains, very clearly of the couple of years that we have been on the market, since approval in myeloma. So strong market share gains already. But we saw an upside in the U.S. to further penetrate in the market. And obviously that's going to be more challenging to get to higher levels of market share.

But we will still see good opportunity for market share gains and significantly, as we talk about, we continue to see good duration gains. So that's the U.S. Internationally, we really have the combination of... we are still in the rollout stage in terms of getting the drug approved in lots of different markets. You heard about Canada recently. We still have reimbursement in Australia, Japan is in next year, the regulatory filing. Russia, we filed, we're waiting for approval. It takes sometimes for reimbursement, lots of different other countries that are rolling out. So clearly one territorial expansion is very key to getting our feet on the ground and approved in as many markets as possible.

Secondly, if not uncommon in those markets that you begin, the therapy and the use of the drug in the later stage of the disease. So we have both the combination of one increasing market share in the indications of where we've launched the drug and we're getting traction and the benefit over time of moving it to as positioned and the different market, the benefit of moving REVLIMID earlier in treatment. And then over time, we're doing so much work in the maintenance study area. That's so critical and I tried to highlight it in the presentation. We've got a very large, 600 person patient trials looking at REVLIMID as a maintenance therapy. One, is to demonstrate the very significant advantage of taking REVLIMID for patients for a long period of time, demonstrating the survival advantage.

We've got fully accrued trials there that we'll see the data in '09. So even in the markets with our clearly cost concerns et cetera, I think that data will be instrumental in getting us to have the kind of duration gains that we're seeing here over the past six to nine months in the U.S. and we look forward to seeing those going forward. So, I think myeloma is clear. We've got still opportunity. We think to broaden the MDS label. As I mentioned, we're locking the old forward database. We're hopeful that will be a trigger to some markets that we can see increasing the MDS markets there. And as you heard, that will probably not going to see it in next one to two years, but we're making good progress on the Phase III programs in CLL and NHL.

Charles Duncan - JMP Securities

Thanks. Bob. What about fourth quarter, your... any additional colors on the encouraging signs?

Robert J. Hugin - President and Chief Operating Officer

I think that we have to be careful. I think the first three weeks of the accrual has certainly been encouraging in the sense that when you look at the currency in Europe, despite that we're making good traction. And it's both in U.S. and in Europe, I don't think there is anything specific affecting that. I do think we have to be balanced in the outlook. It's still only three weeks in the quarter and it's certainly is encouraging. The economic situation, whether it's in Europe or the United States is clearly a concern, in the sense that budgets are going to be under pressure if we see the kind of economic downturn that many people are concerned about, over the coming six to nine months. So on the balance, we're feeling good but we certainly know that we have to prepared to be very aggressive in making sure we make our case as a value proposition for REVLIMID in all countries and all payers.

Charles Duncan - JMP Securities

Thanks for the added color.

Operator

We will go next to Geoffrey Porges with Bernstein.

Geoffrey Porges - Sanford C. Bernstein

Thanks for taking the questions. Quickly Bob, you've talked in the past about the OUS component of revenue and what trend you are seeing there. Could you give us some light on that and perhaps give us a sense of when you might actually disclose OUS revenue overall, because I think it's going to be helpful as we think about all the hedging and other components. And secondly, operating margins were somewhat better than street expectations this quarter in prior periods. Can you comment on the sustainability of your operating margins at his level or higher in the future? Thanks.

David Gryska - Chief Financial Officer

So Geoffrey, I'll deal with the operating margins, the second part of the question. I'll give the first part to Bob in a minute. The operating margins what we saw is the synergies of the Pharmion acquisition in SG&A line. And as I said in my prepared remarks, once we take out those $30 million of integration costs, which by the way are one-time costs, obviously that's going to show an improvement in next year.

So we are seeing the leverage of the acquisition but we said we'd acquire the company in March that would be leverage you are seeing it now in the second quarter or third quarter because of the integration of the commercial teams. And as we go out quarter-over-quarter and get ready for the VIDAZA launch in Europe, you are going to see more leverage. So, I don't want get too far ahead of what talk about in January, but you're seeing now the benefits of the acquisition, the leveraging, the synergy and the integration of all our activities across the globe both for U.S. and in Europe? Bob you want to say.

Robert J. Hugin - President and Chief Operating Officer

I think the third quarter, reinforces our view on the balance of revenue for REVLIMID as well we exit the year to be in the two-third, one-third US, ex-US. I don't think we've seen any change in that trend is what we expect there. And they go overtime, clearly we... our view is that we going to see significant growth outside the United States and we are of the opinion and our goal is that it is significantly higher revenues outside the United States and in the United States.

Specifically to your question of the transparency of ex-US revenue versus US revenue, it is something that I do think... we go look at 2009, when we look at our strategy for what guidance we provide and how we communicate at the marketplace, we will absolutely reconsider that. I think the offset to that transparency is the competitive disadvantage or advantages that we have with RevAssist and STEPS. But we know exactly what the trends are et cetera.

Obviously we can get to the competitive drugs trends though different agencies. But now we're not even going to get the U.S. numbers on the competitive drugs probably but twice a year if we even get them twice a year. We are committed to reviewing the strategy for 2009 in the balance of the benefit of giving people a better sense of what's happening in the products in different geographic regions, versus the benefit of the competitive advantage of when and where to respond and how to deal with it. So we'll look at it as we go forward.

Operator

We'll take our next question from Rachel McMinn with Cowen.

Rachel McMinn - Cowen & Company

Thank you very much. Two questions, one, when you say that REVLIMID myeloma prescriptions in the U.S. were up 7.5% sequentially, is this comparable to what you said in prior quarter? Could you give us the overall prescription trends in the U.S.? And then just following on that, if you were to add the Thalidomide and REVLIMID total prescriptions in the U.S. and see flanged REVLIMID, I'm curious if you're seeing overall market share gains or if it's just the REVLIMID swapping out for Thalidomide? Thanks.

Sol J. Barer, Ph.D. - Chairman and Chief Executive Officer

I think in the balance between myeloma and MDS and REVLIMID, the growth is all in myeloma. And our challenge is now with the specialized MDS sales force. Obviously, VIDAZA as the key focus there. We're hopeful that we are going to get more attention to the Rev5 QNDS labeled indications, and we see a change to the time which has been a very flat MDS trend. So in that prescription point of view.

And related to the question about the market share and relationship of Rev versus Thal, other drugs in the sector, it's clear that the position of Thal is the one that that is being challenged or being impacted by both REVLIMID and Velcade and that's were some of the gains are coming, but if not just from Thal. We are seeing other therapy that are more widely use in a range in different ways of therapy also suffering. So I think overall we're getting a very significant benefit in terms of overall market share between Thal and rev together at the expense of others, but obviously, Rev is taking from Thal and Velcade is taking some from Thal.

So the tradeoff is a good one. The challenge for us over time is going to be clearly the benefit of Rev in a new diagnose setting and a maintenance settings and then ensuring that Thalidomide has its position later in therapy. So that is clearly a therapy that if someone suffering from myeloma in the course of the therapy, should be getting all the three major therapies before the course of treatments are ended. So I think we haven't seen yet that happen. And so we're hopeful that we'll see positive trends in Thalidomide over the next couple of years as it moves to later stage of up therapy. But that's really what is happening.

Operator

We'll go next to John Sonnier with William Blair.

John Sonnier - William Blair

Thanks for taking the question and congrats on a lot of good progress. Dave, your commentary on how to think about margins going forward was actually really helpful. And I'm wondering if you can also provide us with some guardrails as on how to think about your tax rate. It looks like it continues to improve here. How do we think about that over the next years?

David Gryska - Chief Financial Officer

I think for next quarter as I said in my prepared remarks, we will see a slight improvement in the tax rate, because of just the international profitability of about less than a hundred basis points. And, then getting into next year, we look to '09. If you look at our overall tax rate for '08 versus '09, I'd think we would think see at least another 100 basis point improvement. So if we take the overall tax rate for this year of about 24%. I can see that increase getting better next year by at least a 100 basis points next year, if not better as we fully put forward some of our tax strategies and the international profitability of our company.

John Sonnier - William Blair

That's real helpful. Then Bob, I think you mentioned that duration growth with Rev in the quarter increase by about half a month which is encouraging. I think you talked also about half the growth rate that we have seen in some of the prior quarters. And, can you talk a little bit about what's behind that?

Robert J. Hugin - President and Chief Operating Officer

I don't think the duration in growth rate has been much more than that in any previous quarter. It's a pretty consistent growth rate and obviously some of it's depending on as you get more and more patience on therapy the percentage of new patients becomes a smaller number. So you may actually see a little bit of an acceleration potentially over time. I don't John that there really has been any kind of reduction in the change of the slop of the increased duration. And I think that what we have seen in the third quarter is consistent and very encouraging on the duration front. So I don't want paint an overly optimistic picture, where we're going to go we're hopeful that when you look at the data about what is potentially in and we have patients that are being on the stroke for more than five years continues. So there is lot of upside, but we have to be careful.

But I don't think there is anything in the third quarter that would leave you, but an encouraging sign of duration. And, clearly, over time as you see, what stage of therapy people and that will also effect duration. I think the message for duration is we continue to be encouraged as consistent with what we're seeing and we got to continue to prove it and see what happens, but it's a clearly a potential upside.

Operator, can we take... we have time for one additional question.

Operator

Yes. Our final question will come from Jason Zhang with BMO Capital Market.

Jason Zhang - BMO Capital Markets

Hi, thanks. Bob, the question... REVLIMID sales from U.S. versus ex-U.S. In the past, you have said that international sales accounts for about 10%. And obviously another 43 that you reported for this quarter, how much is actually from outside of U.S.? I assume it's probably more than 10%. If it is, and is it significantly more or just slightly more than 10%?

Robert J. Hugin - President and Chief Operating Officer

Yes. I think, that what we have said is that the trend as we are moving forward is that we would expect to exit 2008 with the REVLIMID numbers for the year running at about two-thirds U.S. and one-third outside the U.S. And what we have seen in the third quarter is reflective of where we're going exiting the year. And obviously, our optimism is that in 2009 and beyond that will begin to shift as we see stronger growth outside the United States and leading to a higher percentage of the overall revenue is coming from International.

Sol J. Barer, Ph.D. - Chairman and Chief Executive Officer

Thanks Bob and thanks Dave. So, thank you everybody for participating in this conference call. We are obviously very pleased with our results for this past quarter. We are very excited about the future. We look forward to seeing you hopefully at our ASH investor event and our next conference all. Thank you everybody.

Operator

This concludes today's conference. Thank you for participating and have a good day. .

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