Penwest Pharmaceuticals Co. Q3 2009 Earnings Call Transcript

Penwest Pharmaceuticals Co. (PPCO)

Q3 2009 Earnings Call

November 5, 2009 11:00 am ET

Executives

Jennifer Good - President and CEO

Frank Muscolo - Corporate Controller and Chief Accounting Officer

Analysts

Jim Tumbering - BMO Capital Markets

David Watson

Scott Henry - Roth Capital

Arthur Friedman - Friedman Asset Management

Presentation

Operator

At this time, I would like to welcome everyone to the Penwest third quarter 2009 financial results conference call. (Operator Instructions)

The matters discussed herein contain forward-looking statements for the purpose of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. That involves risks and uncertainties, which may cause the actual results in future periods to be materially different from any future performance suggested herein. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects, intends, potential, appears, estimates, projects, targets, may, could and similar expressions are intended to identify forward-looking statements.

Important factors that could cause results to differ materially, include the following risks related to the commercial success of Opana ER, including our reliance on Endo Pharmaceuticals Inc. for the commercial success of Opana ER and risks of generic competition the need for capital, regulatory risks relating to drugs in development, including the timing and outcome of regulatory submissions and regulatory actions, uncertainty of success of collaborations, the timing of clinical trials whether the results of clinical trials will be indicative of the results for future clinical trials and will warrant future clinical trials, warrant submission of an application for regulatory approval of, or warrant the regulatory approval of the product that is the subject of the trial; whether the patents and patent applications owned by us will protect the company’s products and technology. Actual and potential competition and other risks as set forth under the caption Risk Factors of in Penwest’s quarterly report on Form 10-Q filed with the Securities and Exchange Commission on August 10, 2009, which risk factors are incorporated herein by reference.

The forward-looking statements contained in this press release speak only as of the date of the statements made. Penwest disclaims any intention or obligation to update any forward-looking statements and these statements should not be relied upon as representing the company's estimates or views, any date subsequent to the date of this release. TIMERx is a registered trademark of Penwest. All other trademarks referenced herein are the property of the respective owners. Thank you.

Ms. Jennifer Good, you may begin your conference.

Jennifer Good

Good morning, welcome to our review and discussion of Penwest's results for the third quarter and nine months ended September 30, 2009. Joining me on the call today is Frank Muscolo, Penwest's Corporate Controller and Chief Accounting Officer. This was a historic quarter for Penwest as we achieved our first profitability, a quarter earlier than planned. This was driven by strong top-line sales growth of the royalties from Opana ER and revenues from our drug delivery business as well as meaningful reduction in our overall operating cost.

We believe this profitability is sustainable, although it is highly depended on Endo sales of Opana ER. Coupled with the improving financial performance of the company we also made further progress against the focused goals we set for ourselves for 2009. We believe that achievement of these goals will not only contribute to the short-term financial performance of the company but will also enhance the company's long-term growth potential.

As you may recall, the following are the four key goals that we set out at the beginning of 2009. Maximizing the value of Opana ER with our partner Endo Pharmaceuticals; Advancing the development of A0001, our promising compound for mitochondrial diseases; monetizing the value of the company's proven drug delivery technologies and drug formulation expertise and aggressive managing the company's overhead and other cost.

I will review our progress on each of these goals. Let me begin with maximizing the value of Opana ER. For the third quarter of 2009, we recorded royalty revenues from Opana ER of $4.9 million. Endo has strong net sales growth for this product, both over the third quarter of last year but also sequentially over the second quarter of this year.

Net sales for the third quarter of 2009, Opana ER were $45 million compared with $32 million in the third quarter last year, representing an increase of 40%. Sequentially, Opana ER net sales increased 11% from the second quarter to the third quarter of this year.

Underlying demands for the product has remained strong. According to IMS, the TRX data for the third quarter of 2009 was approximately 160,000 scripts for the quarter. This represents an increase of 43% from scripts in the third quarter of 2008 and an increase of 6% sequentially from the second quarter of 2009.

Market share for Opana ER has also continued to increase steadily, with market share recently exceeding that of Avinza as well as Kadian. We believe that these increases were driven by the significant selling and marketing effort by Endo as well as the managed care coverage they’ve put in place.

We have also been working closely with Endo to expand the revenue stream from Opana geographically. As we discussed last quarter, we announced in June, our licensing deal with Valeant Pharmaceuticals for the Opana ER franchise in Canada, Australia and New Zealand. Upon completion of this deal, our continued sourcing of leads in other territories and our licensing efforts going on at Endo beyond Opana, we agreed with Endo to transition the Opana licensing efforts to its BD team with the assurance that these efforts will remain a priority for Endo.

Going forward, we will be supporting Endo’s efforts toward completing deals in relevant territories. These agreements are ultimately signed between Endo and a third-party with Penwest sharing in the economics through the [side letter].

So, it makes sense at the appropriate time for Endo to be in the lead on these discussions. Of course, as we jointly own these rights with Endo, the economics of any deal will be split between us 50-50.

Now, I'd like to turn to A0001, the company's lead internal development program. The third quarter was extremely busy for our R&D team as we prepared to initiate two Phase IIa trials. The two patient groups we plan to study are Friedreich's Ataxia and in patients with the MELAS syndrome. The goal of these trials will be to determine if A0001 has biological activity in those indications. Both trials are working through the IRB review process and we expect both studies to be initiated by year end.

There is a lot of excitement around both of these studies internally at Penwest, in the medical community and in the patient community. We consistently receive calls from patients and physicians wanting to understand our drug, its potential benefits and the timing related to its trials. We hope that the results of these upcoming trials will result in progress toward treating each of these diseases, both of which currently have no approved medical treatments.

Additionally, this quarter we selected an NCE candidate from Edison, our collaborator on A0001 that we were entitled to under our agreement. In the third quarter, Edison presented us with an NCE candidate that had been prioritized by our joint teams. After completing initial toxicology and pre-formulation work, we selected this compound which we believe could be a valuable follow-up candidate to A0001 in mitochondrial based diseases.

I do want to make clear that the company does not plan to commence additional development work on this compound until after it reviews the results of the Phase IIa studies of A0001. And in fact, we do not plan to commence any new development work on A0001 either until we have the results of the two Phase IIa studies. Based on those results, the passport for both compounds will be reviewed and determined.

The third goal in our business plan for 2009 is expanding and executing on our drug delivery collaborations thereby further monetizing our drug delivery technology. On that front we hit a very important milestone during the quarter, having achieved the target board levels in a Phase I pharmacokinetic clinical trial conducted by Otsuka of a formulation of an Otsuka product we developed using our TIMERx drug delivery technology. Reaching this important milestone in the development of the compound also resulted in a financial payment to Penwest.

Our relationship with Otsuka has become an important one within the company. We are currently completing significant work under our collaborations with them and we are seeing tangible progress. Our goal for these drug delivery technology collaborations was to further monetize our drug delivery technology and cover internal overhead of our R&D infrastructure while retaining the upside should these drugs go to market. Having already reached the one important development milestone Otsuka, we are hopeful that this success can lead to our achieving future milestones and related royalties.

Drug formulation using our proven drug deliver technologies is a core capability within the company and has resulted in some significant successes over the past decade, such as matching Procardia XL and the development of Opana ER. I am very pleased that we are still able to leverage this capability in a manner that is not only financial meaningful in the short-term, but could also bring the long-term value to our shareholders. We will exceed our revenue targets for the year for this business and are well positioned with additional work to be done as we head into next year.

Our business development team continues to be active in discussions on additional drug delivery collaboration opportunities in both the US and Europe. We have committed to two deals this year, one of which is being completed and the other which we continue to actively pursue.

Our final goal for the year was to aggressively manage the company's overhead and other cost. I want to spend a few minutes talking about the financial discipline with which we are continuing to manage our company, which I believe is clearly reflected in our financial results. This is the sixth straight quarter in which we have demonstrated a meaningful reduction in our operating cost compared with the year earlier quarter and I would note that we accomplished this despite incurring approximately $1.3 million in cost on the proxy contest and the related litigation this year. We are continuously challenging every aspect of our spending in light of our strategy and business plan.

As the result of these efforts we announced today that in order to further lower our overhead cost, the company is reducing its staff from 48 to 39 employees and plans to consolidate our Danbury, Connecticut head quarter’s office space into our Paris and New York facility as of January 1, 2010.

The company has also decided to defer any new development work on A0001 other than two Phase II studies, pending review and analysis of the results of those studies. We expect that these actions will result in a total annual cost savings to our plan of approximately $3 million.

I want to talk for a few minutes about these efforts. In this economic climate there is a tremendous amount of pressure on companies to operate as leanly and efficiently as possible. We are no exception. The Board and management team at Penwest has paid attention to this and has been working very hard over the past 18 months to streamline our operations as much as we can without impairing our ability to execute on our commitments and our focused business calls.

There are few changes that occurred recently that allowed us to take the further step. First; with Endo having resumed to lead on licensing Opana ER in ex-US territories, our need for certain business development activities within the company has reduced.

And second, A0001 has advanced into clinical studies which reduced the activities of our pharmaceutical development team. Third, our lease on the Danbury corporate office space is up at the end of this year. One we first moved to Danbury, we had a total of 76 employees, with the staff reduction announced today, and we have 39 employees remaining. Therefore, we believe that having one company location will suffice going forward and we have chosen to centralize our entire operation to where our labs are located.

As these changes show, we constantly monitor the money we are spending and will make cuts whenever possible without impairing our ability to achieve our business plan. Importantly, I do want to note that with a staff of 39, we have preserved what I believe is an important capability around drug formulation and drug delivery expertise. We will be able to advance the development of A0001 to the two Phase IIa trials, continue to execute on our drug delivery plans and continue to support maximizing the Opana asset by prosecuting our patent estate and supporting Endo's licensing activities.

Based on the focused objectives for the company, I believe we are operating very efficiently and based on the progress made against our objective this year also very effectively. Nevertheless, we will continue to make expense management a high priority for the company in order to maintain a maximum financial flexibility to create value for our shareholders.

Before turning things over things over to Frank to review the numbers, I'd like to address one further point and that is the Board's response to the non-binding wind down resolution. The simply answer is that the Board does not plan to wind down the company at this time. Let me elaborate.

In January 2009 the Board of Directors after much discussion regarding the company's strategy, the company's resources and the economic environment adapted the four focus goals I have just reviewed. As I described we've had demonstrated success in each of these areas. Since the annual meeting the full Board has debated and challenged the company's strategy and the appropriate cost structure to support that strategy and it will continue to do so. The cost cutting that we have announced today is the product of that process but a wind down would mean not supporting our drug delivery business at a time when that business is becoming potentially more valuable and would mean shutting down A0001 when we are just a few months away from having clinical data that could bring real value to the company. We don't believe that would be in the best interest of the company or its shareholders.

With that, I'll now turn it over to Frank.

Frank Muscolo

I will spend a few minutes reviewing our financial results for the third quarter and nine months ended September 30, 2009. For the third quarter of 2009, we earned a net profit of 383,000 or $0.01 per share compared to a net loss of $7.3 million or $0.23 per share for the third quarter of 2008. The profit we achieved this quarter represents our first quarterly net profit. This improvement in operating results primarily reflects the increase revenue from Opana ER as well as reduction in our total operating expenses of $2.7 million compared with a third quarter of 2008.

I'll now review each of these components in more detail. Total revenues for the third quarter 2009 were $6.3 million compared with $1.4 million from the third quarter of 2008. This increase in revenues was primarily due to $4.9 million of royalties recognized from Endo on it's net sales of Opana ER and increased revenues recognized from collaborative licensing and development, reflecting a milestone payment we recognized under one of our collaboration with Otsuka as well as revenue from overall increased development activity on these collaborations, which generally result from higher reimbursement of our costs and on upfront payments we received.

As a reminder our royalty from Endo is currently being paid at 1.5 of our contractual royalty rate, currently 11%, while we pay down the $28 million of unfunded development cost Endo was entitled to recover. As of quarter-end, there was approximately $9.3 million remaining of the unfunded development cost and based on Endo's sales projections, we expect that during the first quarter of 2010, Endo will have fully recovered that amount. Royalty calculations will then revert to the full royalty rates in our agreement which range from 22% to 30% based on annual net sales of Opana ER.

Another thing I want to point out is that we contractually receive 22% royalties on the first $150 million of annual net sales of Opana ER, and then the rate increases to 25% on every incremental net sales dollar above $150 million.

At the end of the third quarter, Endo had recognized approximately $125 million of net sales for 2009 year-to-date with $45 million recognized in the third quarter. Therefore, for the fourth quarter, we expect to be paid at the rate of 11%, one half of the 22% contractual rate on the first $25 million of net sales, and at a rate of 12.5%, one half of 25% rate on a reaming net sale on the quarter.

Selling, general and administrative expenses for the third quarter of 2009 were $1.8 million, compared with $2.2 million for the third quarter of 2008. The decrease of 489,000 was primarily attributable to a non-recurring, non-cash credit we received relating to the cash surrender value of life insurance policies we hold for our supplemental executive retirement in deferred competition plans for a former CEO, lower compensation expenses, as a result of staff reductions we implemented in the first quarter of 2009 and the lower share base compensation expenses.

Research and product development expenses for the third quarter of 2009 were $3.3 million compared to $5.9 million for the third quarter 2008. This decrease of $2.6 million reflects lower contractual payments to Edison in the third quarter of 2009 under our collaboration agreement with Edison as we have no further obligations for quarterly sponsored research payments as noted earlier this year.

The decrease in our third quarter 2009 R&D expense also reflects that we did not incur significant expenses in the quarter related to the development of any compounds other than A0001and that we had lower compensation expenses, primarily due to increased allocations of internal R&D costs related to our drug delivery technology collaborations to the cost of the revenues and the staff reductions we implemented in the first quarter of 2009.

The net loss for the nine months ended September 30, 2009 declined significantly to $2.7 million or $0.9 per share compared with the net loss of $24.5 million or $0.83 per share for the nine months ended September 30, 2008. The decrease in the loss primarily reflects the increased revenue from Opana ER as well as a reduction in our total operating expenses of $8.6 million compared with the nine months ended September 30, 2008.

Total revenues for the nine months ended September 30, 2009 were $16.8 million, compared with $3.4 million for the nine months ended September 30, 2008. The increase in revenues was primarily due to $13.7 million of royalties recognized from Endo on [internet] sales of Opana ER. Partially offsetting the increase in royalties in Opana ER, where lower royalties from Mylan Pharmaceuticals on Mylan's net sales of Pfizer 30 milligram generic version of Procardia XL.

Selling, General, and Administrative expenses for the nine months ended September 30, 2009 was $7.4 million, compared with $9.6 million for the nine months ended September 30, 2008. The decrease of $2.3 million was attributable to several factors, including lower share-based compensation expenses, largely due to a credit we recorded in the first quarter of 2009 that resulted from the forfeiture of stock options held by former employees, and lower compensation expenses primarily due to the staff reductions we implemented in the first quarter of 2009.

The decrease also reflects the $1 million reserve established in the first quarter of 2008 in connection with the $1 million loan the company made to Edison and the credit noted above related to cash surrender values of our insurance policies. Partially offsetting these decreased expenses were $1.3 million in cost we incurred in our first and second quarter of 2009, in connection with this year's proxy contest and a related litigation.

Research and product development expenses for the nine months ended September 30, 2009 were $9.7 million compared to $16.8 million for the nine months ended September 30, 2008. This decrease of $7.1 million reflects that we had lower contractual payments to Edison under our collaboration agreement with Edison in the first nine months of 2009, as we have no further obligations for quarterly sponsored research payments as noted earlier this year.

The decrease also reflects that for the nine months ended September 30, 2009, we incurred no expenses related to the development of nalbuphine ER and PW4153 and had lower compensation expenses, primarily as a result of the staff reductions implemented in the first quarter of 2008 and the first quarter of 2009, and increased allocations of internal R&D costs related to our drug delivery technology collaboration to the cost of revenues. These decreases in our R&D expenses were partially offset by increased expenses for our pre-clinical and clinical work on A0001.

I'll now take a moment to discuss our cash position as of quarter-end and highlights of the cash flows for our first nine months of the 2009. At quarter-end September 30, 2009, we had cash and investments of $11.5 million compared with $16.7 million at December 31, 2008. For the first nine months of 2009, our net cash used in operating activities was $1.3 million compared with $20.4 million of net cash used in operating activities for the first nine months of 2008.

Cash used in financing activities in the first nine months of 2009 included 4.1 million in principal payments on our term loan payable with GE Capital compared with principal payments of 1.8 million in the first nine months of 2008 as our scheduled principal payments increased in January 2009 in accordance with our loan agreement.

At quarter ended September 30, 2009, we have 5.5 million of principal remaining on our term loan which is expected to be fully paid off in September of 2010. In connection with the licensing agreement with Valeant Pharmaceuticals signed in the second quarter, we received payment from Endo in the third quarter for our share of the upfront payment which amounted to $764,000. We recorded this payment as deferred revenue and began recognizing revenue range of payment during the third quarter. We anticipate we will recognize this revenue over the expected marketing period of Opana ER in the licensed territory.

Finally, as Jennifer discussed, we are taking steps in the fourth quarter to further reduce our costs. As a result, we expect to take a restructuring charge in the fourth quarter of 2009 of approximately $250,000 primarily relating to the staff reduction and facility consolidation.

Now, let me turn the call back to Jennifer for some closing remarks.

Jennifer Good

Before Frank and I take your questions, I would just sum up by saying that as we promised back in January, we were going to spend this year executing at focused business plans with well defined milestones. I think we have demonstrated excellent progress against those goals to-date. We have completed several of our deliverables for the year and believe we can execute on the remaining deliverables.

We believe that executing on our plans builds value. The company is financially sound and we are now profitable. We believe that sometimes in the first quarter we will revert to the full royalty rate on Opana ER and at that time can begin to build meaningful cash. During the year, we have completed additional deals around our assets including both the drug delivery technology collaboration as well as the out licensing of Opana ER, advanced A0001 to Phase II and continued our efforts to decrease costs.

I want to give credit to our team who has kept their eye on the ball throughout the year and remain keenly focused on execution. Despite the pressures of the economy, the opportunity to create value for our shareholders, our partners and patients is extremely motivational and the people here at Penwest are working hard to do so.

I look forward to working with our teams to complete our deliverables for the year and reporting to you on our successes. Frank and I will now be happy to open up the call to any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Bert Hazlett from BMO Capital Markets.

Jim Tumbering - BMO Capital Markets

It’s Jim Tumbering with Bert. Two questions. First, maybe if you could just quantify the financial benefit going forward of some of the additional restructuring efforts. And then secondly, you booked in one milestone payment from Otsuka. You have several other deals with them. Can we expect any other milestone payment from in the future? Thanks.

Jennifer Good

So the financial benefits, there are sort of two things in the $3 million. There is about $2 million that will be sort of a recurring annualized amount from salaries and benefits and also facility savings. The extra $1 million was things that were in the plan that we've removed and your second question on can you expect to see further Otsuka development milestones there, so this milestone that we earn was on our first agreement Otsuka, you probably know Jim we have three different deals with Otsuka. So this is on the first one. This was actually the first eligible milestone. It was an important one and having hit that target we are eligible for not only additional milestone under first agreement but we have significant amount of work going on, on both agreements two and three. So, I would hope so.

Jim Tumbering - BMO Capital Markets

Any further clarity you can give us on timing of those or too early to tell?

Jennifer Good

It's too early to tell because it really becomes up to Otsuka how they prioritize these and move them ahead and also there are discussion about giving timeline guidance. So I don't have any additional guidance.

Operator

Your next question comes from the line of David Watson, Individual Investor.

David Watson

I am wondering if you have any update on the patent extensions. I know in the last call you talked about the likely decision would be this quarter, so I don't know the quarter is sort of half way done I don't know if you have any insight into that?

Jennifer Good

There are two big buckets of patents. Patents we're prosecuting and patents Endo is prosecuting. The patents Endo is prosecuting, many of them have been put up for appeal which is all available on the PTO website. They are in different buckets, so there will be several different appeals heard. The first bucket of appeals of these patents includes about four different patents which were un-expedited review. The timing has been firmed up about oral arguments which will be heard this quarter. We now expect or Endo expect the decision likely in the first quarter of next year.

David Watson

You talked about A0001, when would you expect to have data that you can sort of decide what you are going to do with A0001? When would that data be sort of ready and analyzable?

Jennifer Good

We're running two different trials, one in the US and Europe and so we expect that sort of two different time points, but I think by mid-next year, roughly June, July, we’ll have the data on both of those trials.

David Watson

At this point, assuming that you don’t have any, the patents aren’t extended. When would you expect to have generic competition for Opana?

Jennifer Good

For our current patterns that are in place last till 2013. We believe those are valid claims and we’re litigating on those claims as you probably know. That core case fortunately has gone very slow, so the next key milestone is the pre-trial conference sharing which is in March of 2010. At that point of time, they’ll actually set a trial base. So, it still has got to work to the legal review process and likely any appeals that would happen. So, that kind of the process that goes on.

David Watson

What’s the final kind of burn? If I look at the last quarter you had sort of the SG&A and R&D, I’ll call it burn of 4.9 million and with the 1 million reduction, it kind of gets you down to roughly 4.1 million burn rate. Is that about right?

Jennifer Good

Are you talking about our expenses essentially?

David Watson

Yes.

Jennifer Good

We gave expense guidance, our operating and Frank, correct me, if I’m wrong but our operating expense guidance, our SG&A expense guidance was $9 million to $10 million for the year and our expense guidance or R&D was $12 million to $14 million. We still believe that’s good guidance.

David Watson

That’s for 2010?

Jennifer Good

That’s for 2009. We’ve not provided 2010 guidance yet.

David Watson

Your current quarterly SG&A, R&D expense was 4.9 and with a 1 million reduction that gets me down to 4.1 or 4.2. Does that sound right?

Jennifer Good

I guess until we give guidance. The guidance is based on sort of the strategic plan and the goals set by the board for the year. You're right. I don’t think there is a good reason to believe our current existing burn rate is going to significantly increase. We've obviously made a lot of attempts to try and manage that tightly, but until I get aligned with the board on sort of the goals for next year, I really don’t want to get out with guidance on 2010.

David Watson

You guys have started accumulating cash relatively rapidly during 2010. For some reason I seem to recall back when they set the goals in early 2009, they talked about if A0001 doesn’t really work, you should know that by mid-2010. So, with all that cash, if A0001 doesn’t work, are you guys planning on taking that cash and going out and buying another company or what’s the thought process from that cash?

Jennifer Good

I think there's clearly been a loud discussion from our shareholders that they'd like to see that cash. I think that’s been heard by the Board loud and clear. I think if we were going to get out and in-license our buy things, you would have probably seen us active on that front. We've also been very clear throughout the year that if A0001 does not show biological activity, we'll stop development on that program. I think we're further demonstrating that by not commencing development work on the new compound until we see results from that.

I think the Board is starting to address the issue of what we're going to do with this rise in cash. I think, clearly they're going to have in mind what's the best way to get shareholder value for that and I think there is a lot of optionality for them on the table and so hopefully over the next sort of three to six months, we'll be able to give more clarity on that.

David Watson

How large are your NOL's?

Frank Muscolo

We had lost some of our NOLs at the end of last year; when we did change in control analysis and let me just refer…

Jennifer Good

At the end of last year we had $91 million and then we've accumulated only a little this year (inaudible) lost $2.5 million.

Operator

Your next question comes from the line of Scott Henry from Roth Capital.

Scott Henry - Roth Capital

Just citing how to follow through these questions; I guess for starters as you addressed Jennifer, I mean the shareholders voted roughly 2 to 1 to "Take prompt and thoughtful action to wind down the company." Now as you've mentioned the Board has decided not to do that, I guess my question is, do you expect to disclose the analysis and rationale for that decision in an 8-K or do you think that a sentence on a conference call is more than enough to justify that?

Jennifer Good

I don't think the Board has any separate communication plans in place at this time. As I explained we reviewed the various scenarios and communicated what the priorities of the company are, so I don't think you should expect to see an 8-K analysis of what was discussed in internal Board meeting.

Scott Henry - Roth Capital

Keeping in mind the Board represents the shareholders and this was voted out at a meeting, do you think that is enough? I mean it's not even in the press release. I guess I would agree to disagree.

Jennifer Good

That’s fine.

Scott Henry - Roth Capital

My second question and this is way I think that most of the shareholders look at the stock. If you drop down the Opana royalty to the bottom-line, it would be about a $0.15 gain for the quarter or roughly 25% yield at current prices on the stock. So if the company is taking the choice to invest $0.14 of that royalty for future income, can you talk to me about the analysis that goes into making that reinvestment decision? What means of evaluating those future profits are you using?

Jennifer Good

I’m not going to get into specific internal Board discussions, but clearly the buckets are one as you know we’re a public company, so there is virtually no company that trades on NASDAQ that has no expenses associated with that. So, there is certain level of overhead and I benchmarked our SG&A cost to gain some multiple other small companies and we’re on the very low side of that. So I’m comfortable with that. Clearly, we look at incremental activities we’re investing in around Opana and sort of did that analysis. We’ve also looked at the drug delivery business. Fortunately, we have the benefit of being active in the market. We’ve got real deals and we’re making tangible progress, so we can do some valuation work around that.

A0001, as we always stated is sort of our longer shot higher risk, but probably highest reward in the portfolio. So on balance, these are looked at and that was deemed that make sense to make this investment. Now, clearly there’s definable points where there is data that’s going to be looked at and if it doesn’t meet expectations, you will see this Board take decisive action as you have seen it take over the last 18 months.

Scott Henry - Roth Capital

A traditional company would look at a ten-year pro forma, maybe you do the discounted cash flow analysis; maybe you use the return on investment. What mechanisms are you using because what I’m hearing about is milestones in news flow but what kind of quantitative measures that are being used?

Jennifer Good

The Board looks at long term cash flow projections. In every one of our Board meetings, we looked at some of the parts analysis on the entire business. The company is not that complicated. So it’s fairly easy to do the analysis, lots of different ways. So the board has looked at this multiple ways in these discussions.

Scott Henry - Roth Capital

I guess in the absence of specifics, I'll just have to go with the management and the Board. Could you tell me, during the past quarter, have you brought any shares or has the Board or other management.

Jennifer Good

Scott, I would think you’d know this in your job, but any trading that’s been done on the stock would be filed on [Form 4].

Scott Henry - Roth Capital

I'll have to go back and review this.

Operator

(Operator Instructions) Your next question comes from the line of Arthur Friedman from Friedman Asset Management.

Arthur Friedman - Friedman Asset Management

I have several questions here. Some of them are the kinds of things I've asked in the past for the last year or so. So, the first question, lets get right to it, you're reducing your staff from 48 to 39. Can you tell us the nine people that are leaving, what roles they play? Are they sales people? Are they research scientists, who are they?

Jennifer Good

It’s a good question. It’s about 50-50. Half of them are SG&A folks. We don’t actually have sales folks, although we did have a couple strategic marketing folks that helped us look at opportunities and that function has been eliminated. There is about four or five SG&A and I think four R&D folks that are leaving. So it’s fairly equally split. Of our remaining staff, just to give you a sense of what the 39 looks like, we have 29 folks in R&D and 10 folks in SG&A.

Arthur Friedman - Friedman Asset Management

29 and 10. Okay. I might be looking at the wrong information today. What is the cash on hand right now because the information I have I don't see that?

Frank Muscolo

We have 11.5 million cash in investments.

Arthur Friedman - Friedman Asset Management

11.5.

Frank Muscolo

As of quarter-end.

Arthur Friedman - Friedman Asset Management

I have another question that I always ask, because it's sort of complicated I know, so your answer to that is. Can you take us through the current Opana revenue where we are in the milestones and what you see coming up next in terms of anticipating about how much revenue is going to be coming in to the company, because every time I ask this question for the last year, year-and-a-half I always think that the next quarter is going to bring in more revenue from Opana then it seems to. So I just want get an idea. I am not knocking the 4.9 million, but I thought it would be a lot higher. So, I guess I am not still clear on that.

Jennifer Good

This year we're still in this 50% reduction of our royalty rate, because of this unfunded liability that we owe back to Endo. As of the end of the quarter and Frank has the number we have 9…

Frank Muscolo

9.3.

Jennifer Good

$9.3 million remaining Arthur that we still need to repay them. So if think about the fact that we just got 4.9, we're still going to be in the 50% reduction for the fourth quarter. Our estimates are that somewhere in the first quarter we'll move into getting this full royalty rate. So, to your point by the second quarter of next year and even partially to the first quarter our royalty rates will essentially double just based on repaying this unfunded development amount. Not to mention just the increasing sales trends that are going on naturally with the product.

Arthur Friedman - Friedman Asset Management

Okay, that's excellent, okay. What about Europe, any news on that? You were going to try and we had this discussion remember about Endo wanting Penwest to do more of the marketing in Europe, so any leads there any information?

Jennifer Good

What happened is we worked through the Valeant deal in Canada, Australia, New Zealand and actually got a good [office] place with our colleagues. At the end of the day, the rooms were set up, got all the agreements in place, sort of haggle through all the issues. In parallel, while Endo was finalizing the agreements because these agreements are actually signed by Endo and the partner. We did a lot of the initial sort of first half of the work and then turned it over and they sort of finished out the contract. And, (inaudible) we were outsourcing essentially interest in three other territories, South America, Asia and Europe. Have had good interest and gotten people under CDA, got them initial information, data rooms, et cetera.

At that point of time, Endo finished up with Valeant. They were active. Their out-licensing efforts have been reenergized for other things they’re doing in their business and we felt it made sense to basically layer this in with what they were doing. So, Endo is now in the lead actually and they are making, we just got a full update from them in the last week and they’re making good progress there. So I would still expect to see additional deals come in but just to be clear, we’ve essentially handed that up back to Endo at this point with these deals to closure.

Arthur Friedman - Friedman Asset Management

That’s actually great for Penwest. I’m glad I asked the question and I’m glad I flushed that out because I think that’s important for us to know because there are obviously a bigger (inaudible). Now, let me ask one more question and I hate to put you on the start, I’ve never done that before but from my point of view, we're protecting our investment and we want transparency too. So a little different than Scott’s take, I’m going to do the reverse question and that is in terms of the new members of the Board who [waged] that very costly proxy site that caused the company and our investment a lot of money. I would like to know in terms of transparency, Jennifer, the new Board members, what value added have they brought to the table so far. Have they given you any business leads? Have they come up with any ideas for cost cutting measures? What exactly has been their value?

Jennifer Good

There is absolutely no upside in the ever answering questions about any Board member, new or old. I learned that a long time ago and I think Arthur; I think I would never get into sort of individual discussions within the Board room. I mean that’s the value I think of being able to shut the door and go out some of these issues. So, I understand the question you're asking but unfortunately I'm not going to be able to answer it just because I think the Board's open discussing, Joe and Kevin have been active. They clearly both have a lot of experience and I think I'll just leave it at that at this point.

Arthur Friedman - Friedman Asset Management

I didn't mean to put you on the spot, but I want the other Board members, the new Board members who are on this call and are now on our Board to understand that the other investors are just as important as they are and we want to protect our interest too. Thank you.

Operator

Your next question comes from the line of Ronald (inaudible). Your line is open.

Unidentified Analyst

Thank you and thank you Jennifer and Frank for a wonderful briefing. Rather than a question I have merely a brief comment to attest to the tremendous excitement that Jennifer was reporting throughout the Friedreich's Ataxia community. I'm the Founder and President of the Friedreich's Ataxia Research Alliance and both in our scientific community and in our patient community and throughout our foundation there is tremendous excitement about A0001. Our foundation invested rather heavily in the early development of A0001 and as a direct result of the Phase I clinical trial and plan for the Phase II clinical trial we have and I would add the basic research that has been done on A0001, we have tremendous confidence in both the molecule called A0001 and in the way that Penwest is handling it. So, we would like to thank you.

Jennifer Good

Didn't expect you on this call, but I appreciate it.

Operator

Your next question comes from the line of David Watson, Individual Investor. Your line is open.

David Watson

When are you expecting generic competition on Opana?

Jennifer Good

I can't give you exact date. I tried to answer that by giving you parameters. Our patents expire in 2013 unless additional patents are granted. So, based on the current patent of state that's sort of the outside window of these, of course we're prosecuting between Endo and Penwest something like 12 to 15 additional patents. So the hope here is we're able to get additional patent coverage. Those patents could extent this to 2023 but those are not yet issued. And then the only other sort of book end I can give you is where the litigation stand which I had mentioned in the [pre-trial] conference hearing is in March. I think we would expect some kind of trial in the second half of 2010, but we obviously think our patents are valid and we're defending them. But I can't sit here and predict the outcome of litigation and sort of how the timeline plays out.

David Watson

I guess my question is a little different which was the set of patents that you guys are pursuing with the patents office, when will you get decisions on whether or not they are going to extend those patents to you?

Jennifer Good

The first set of Endo's patents that are going to on appeal, we expect a decision in the first quarter of next year. There are two I think at least two or three other buckets of patents as well that are on appeal that will stage out at different time points to the year. We don't have as much clarity although we do believe we'll get decision throughout 2010 on those. So, it’s obviously great if Endo gets those patents in the first quarter. I think that’s good value for everybody. If they don’t, there are several other patterns still working their way to appeal and the 192 pattern actually comes along a little bit later in the year. So that’s really much color as I can give you. You can follow up with Endo. They may give you more details because it’s their patent.

David Watson

Did you guys sign an agreement with one of the generic makers that they could launch no later than 2011?

Jennifer Good

There are four parties we sued and one of them was Actavis. We did do a settlement agreement with them. They were second to file, both Endo and Penwest have to sign those agreements and they have two strengths that they were first to file and it was no later than mid-2011. The other strength they were not first to file on, so they will not be able to launch after impact who was first to file on the rest of the strength since there are a 180 days of exclusivity. The two strengths that Actavis has first to file on is only about 7% of the marketplace so really the biggest majority here is [unfavorable] around the impact’s timing.

Operator

There are no further questions at this time.

Jennifer Good

I want to thank you for your time today and I am available in the offices if any of you would like to follow-up with additional questions.

Operator

This concludes today’s conference call. You may now disconnect.

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