Penwest Pharmaceuticals Co. Q4 2009 Earnings Call Transcript

Executives

Jennifer Good – President and CEO

Frank Muscolo – Corporate Controller and Chief Accounting Officer

Analysts

Greg Gilbert [ph]

Arthur Friedman – Friedman Asset Management

Penwest Pharmaceuticals Co. (PPCO) Q4 2009 Earnings Call March 4, 2010 11:00 AM ET

Operator

Welcome to Penwest fourth quarter and year-end earnings call.

The matters discussed herein contain forward-looking statements for purposes of the Safe Harbor provisions 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 facts maybe 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

The timing of clinical trials such as the Phase IIa clinical trials referenced above and the risks related to the patient enrollment, risks relating to the commercial success of Opana ER, including our reliance on Endo Pharmaceuticals Incorporated for the commercial success of Opana ER, risks of generic competition, and risks at Opana ER will not generate the revenues anticipated, the need for capital, regulatory risks relating to drugs in development, including the timing and outcome of regulatory submissions and regulatory actions with respects to A0001 whether the results of clinical trials will be indicative of the results for future clinical trials and will warrant further 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 in Penwest’s quarterly report on Form 10-Q filed with the Securities and Exchange Commission on November 9, 2009, which risk factors are incorporated herein by reference.

The forward-looking statements contained in this press release speak only as of the dates 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 as of any dates subsequent to the date of this release. TIMERx is a registered trademark of Penwest. All other trademarks referenced herein are the property of their respective owners.

I’ll now turn the call over to Ms. Jennifer Good, President and CEO. Please go ahead.

Jennifer Good

Good morning, welcome to our review and discussion of Penwest's results for the fourth quarter and year ended December 31, 2009. Joining me on the call today is Frank Muscolo, Penwest's Corporate Controller and Chief Accounting Officer. I will start with a review of our progress against our goals for 2009 and provide an update on the overall business. Then Frank will review the financial results for the quarter and yearend as well as provide financial guidance for 2010. I will close with a discussion of our 2010 deliverables. We will then open up the call to any questions you may have.

I am very pleased with the significant progress the company made in 2009 and I’m excited about the outlook for 2010. The company is stronger overall financially, and is well positioned to grow both earnings and cash this year.

This financial growth is being driven by strong top line growth of the royalties from Opana ER as well as revenues from our growing drug delivery business. The work we've done over the past couple of years to reduce our overall cost structure is also contributing to this earnings and cash growth.

Coupled with the company's improving financial performance, we made demonstrated progress against the focused goals we established in early 2009. We believe that our achievement of these goals not only contributed to the company's short-term financial performance but also will enhance its long-term growth potential.

As you may recall, we set out the following four key goals at the beginning of 2009. Maximizing the value of Opana ER with our partner Endo Pharmaceuticals, advancing the development of A0001, a compound we have under development for mitochondrial diseases, monetizing the value of the company’s proven drug delivery technologies and drug formulation expertise and aggressively managing the company’s overhead and other costs. I will review our progress in 2009 on each of these goals and give you an update on where we are today.

Let me begin with Opana ER. For the fourth quarter 2009 we recorded royalty revenue from Opana ER of $5.5 million and royalty revenue of $19.3 million for the full-year of 2009. Endo had strong net sales growth for this product not only over the fourth quarter of last year, but also sequentially over the third quarter of this year. Net sales for Opana ER for the fourth quarter of 2009 were $47 million, compared with $40 million in the fourth quarter of 2008, representing an increase in net sales of 17%.

Sequentially Opana ER net sales increased 5% from the third to fourth quarter of 2009. Underlying demands for the product has remained strong and has driven this growth. According to IMS, the TRX data for the full year of 2009 was approximately 609,000 scripts, representing annual script growth of 46% compared to 2008. Market share for Opana ER has also continued to increase and now exceeds that of both Avinza and Kadian. We believe that these increases in demand in market share were driven by Endo’s significant sales and marketing efforts, as well as by the managed care coverage that Endo has put in place. Importantly, the product has also performed well for patients that have used Opana ER.

I now want to discuss our efforts along with Endo’s to protect the Opana ER franchise in the US. Penwest and Endo are currently suing multiple companies for their paragraph IV ANDA filings. Our expectation is that the trial will be held in the second half of this year. In parallel, both Endo and Penwest are prosecuting multiple additional patent applications. Let me provide a quick update on the status of these applications.

As we have disclosed, Endo had multiple patent applications that had been rejected by the examiner, and had been appealed to the USPTO Board of Patent Appeals. In the first quarter of 2010, Endo received a ruling by the USPTO Board of Patent Appeals on three of these applications. Unfortunately, the Appeals Board affirmed the examiner’s rejection of the claim. Endo is exploring its options and continuing the ongoing prosecution of the patent applications with the examiner. I note that as a result of this decision, both Endo and Penwest now have more guidance from the PTO as to what would be acceptable claims for issuance.

Another important goal for 2009 was to maximize the value of Opana ER through signing collaborations for the development, marketing and selling of Opana ER in certain international territories. As previously announced, Endo complete a deal with Valeant Pharmaceuticals in 2009 for Canada, Australia and New Zealand. In addition, Endo is actively seeking potential partners in select other territories. We will continue to support this process. We jointly own this drug worldwide with Endo and will share 50:50 in the economics of any collaboration.

Now I would like to turn to A0001 the company’s internal development program. We have completed a lot of work on this compound to advance it into two Phase IIa studies. We completed the Phase I testing of A0001 in healthy volunteers in 2009 to gain a preliminary understanding of the safety profile. In parallel, we have conducted animal toxicology work including six-month’s rat and dog tox studies to position the compound for longer term clinical studies. Having completed these important aspects of development, we have now initiated Phase IIa patient trials in two different diseases as a proof of concept for efficacy.

The first study which we initiated in December 2009 is in patients with Friedreich's Ataxia or FA. FA which afflicts one in 50,000 people in the US is a debilitating, life shortening, degenerative neuromuscular disorder. FA patients have gene mutations that limit the production of a protein call frataxin, an important protein that functions in the (Technical Difficulty) – and thus affects energy function. Onset of symptoms can vary from childhood to adulthood. There are currently no approved treatments in the US or Europe.

The study with A0001 is being conducted at a single site of Children’s Hospital of Philadelphia. The Phase IIa clinical trial is a double-blind randomized placebo controlled trial that includes two dosage strength of A0001 and placebo. Penwest is targeting 30 patients to complete this study with a 2:1 randomization of drug to placebo. The patients will be dosed b.i.d. for 28 days. The primary objective of this study is to investigate whether treatment with A0001 has a discernible impact on various functional, biochemical and subject clinician rated scales relevant in the treatment of FA. This study is certainly screening patients and we expect data in the third quarter of this year.

The second study which we initiated last month is in patients with the A3243G mitochondrial DNA point mutation an impaired mitochondrial function. This point mutation is commonly affiliated with the MELAS syndrome, a rare progressive neurodegenerative disorder that involves multiple system organs, including the central nervous system, skeletal muscles, eye and cardiac muscle. There is no known treatment for the underlying disease which is progressive and fatal. This study is being conducted at the single site of Newcastle upon Tyne Hospitals in Newcastle, England. A specialist neuroscience center that offers comprehensive services for both adults and children suspected of having rare mitochondrial disorders.

The Phase IIa clinical trial is a double-blind, randomized, placebo-controlled trial that includes a single dose of A0001 and placebo. Penwest is targeting approximately 21 patients to complete the study with a two to one randomization of drug to placebo. The patients will be dosed BID for 28 days.

The primary objective of this study is to investigate whether treatment with A0001 has a discernible impact on patients using metabolic imaging, a number of functional assessments, biochemical measures and patient/clinician-rated scales relevant in the treatment of MELAS. This study is currently identifying patients and we expect data in the third quarter of this year for this study as well.

The third goal in our business plan for 2009 was expanding and executing our drug delivery collaborations to further grow that business. This business continued to achieve tangible milestones in 2009 through the addition of new deals and the achievement of development milestones.

Our relationship with Otsuka has become an important one, and at the end of the year we find our fourth agreement with them achieving our goal to sign two additional deals in 2009. Our goal for these drug delivery technology collaborations is to further monetize our technology and cover internal overhead of R&D expertise, while retaining the upside should these drugs go to market. Having already reached one important development milestone with Otsuka, we are hopeful that this success can lead to our achieving future milestones and related royalties.

Drug formulation using our proven drug delivery technologies is one of our company’s core capability, and I am very pleased that we are able to leverage this capability in a manner that is not only financially meaningful in the short-term but also could bring long-term value to our shareholders. We exceeded our revenue targets for the year for this business, and are well positioned with additional formulation and development work to be done in 2010.

Our final goal for the year was to aggressively manage the company's overhead and other costs. 2009 is the second year in a row in which we demonstrated a meaningful reduction in our operating costs compared with the prior year. Over the past two years we have reduced our SG&A and R&D costs by 42%, cutting our costs almost in half. These cost reductions have required us to continuously challenge every aspect of our spending in light of our strategy and business plan.

Both our board and management team have focused intently on this effort, working very hard over the past two years to streamline our operations as much as we can without impairing our ability to execute on our focused business goals and meet our commitments. I believe these efforts have paid off in our ability to leverage the increasing profitability and cash increases from our royalties from Opana ER and increasing drug delivery revenues.

Importantly, I believe that with our current staff of 39 we have preserved what I believe is an important capability around drug development. With this team in place, we will be able to advance the development of A0001 through 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.

With that, I'll now turn it over to Frank to discuss the numbers and our financial guidance for 2010.

Frank Muscolo

Thank you, Jennifer, and good morning everyone. I will spend a few minutes reviewing our financial results for the fourth quarter and full year ended December 31, 2009.

For the fourth quarter of 2009, we earned a net profit of $1.2 million or $0.04 per share, compared with a net loss of $2.2 million or $0.07 loss per share for the fourth quarter of 2008. This was our second consecutive quarter of profitability. This improvement in operating results reflects the increased revenue from Opana ER as well as a reduction in our total operating expenses of approximately $1.5 million compared with the fourth quarter of 2008.

I'll now review each of these components in more detail. Total revenues for the fourth quarter of 2009 were $7 million compared with $5.1 million for the fourth quarter of 2008. This increase in revenues was primarily due to $5.5 million of royalties recognized from Endo on its net sales with Opana ER, an increase of 1.1 million, and increased revenues of 759,000 from collaborative licensing and development, substantially all as a result of increased development activity under our collaborations with Otsuka, which resulted in increased revenues recognized from reimbursements of our costs and on upfront payments we received.

As a reminder, our royalty from Endo is currently being paid at one half of our contractual royalty rate, while we paid down the $28 million of unfunded development cost Endo is entitled to recover. As of yearend, there was approximately $3.7 million remaining of unfunded development cost, and based on Endo's sales projection 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 ranged from 22% to 30% based on annual net sales of Opana ER. Therefore, the first quarter's effective royalty rate will be a blend of 11% and the full rate of 22%.

Another thing I want to remind you of is that we contractually received 22% royalties on the first 150 million of annual net sales of Opana ER, then the rate increased to 25% on every incremental net sales dollar above $150 million.

For the full year 2009, Endo recognized approximately $172 million of net sales with approximately $47 million recognized in the fourth quarter, on roughly half of which we earned royalties at a rate of 12.5%, one half of the 25% rate.

Selling, general and administrative expenses for the fourth quarter of 2009 were 2.1 million compared with 2.4 million for the fourth quarter of 2008. The decrease of $359,000 was primarily attributable to lower compensation expenses as a result of staff reductions we implemented in the first quarter of 2009 and lower share-based compensation expenses resulting from the first quarter and fourth quarter staff reductions, which we announced previously.

Partially offsetting these decreased expenses were the restructuring charges recorded in the fourth quarter of 2009, related to those additional staff reductions as well as the consolidation of our Danbury, Connecticut facility into our Paterson, New York laboratory and offices.

The related fourth quarter charge to SG&A expense totaled approximately 260,000 and was primarily related to severance arrangements for the affected employees. We will see the financial benefit of these staff reductions in our facility consolidation throughout 2010.

Research and product development expenses for the fourth quarter of 2009 were 2.7 million, compared to 4.2 million for the fourth quarter of 2008. This decrease of 1.5 million reflects lower expense from contractual payments to Edison in the fourth quarter of 2009 compared to the fourth quarter of 2008.

The decrease in our fourth 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 A0001 and 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 revenues, as well as the staff reductions we implemented in the first quarter of 2009.

The net loss for the year ended December 31, 2009, declined significantly to 1.5 million or $0.05 per share, compared with a net loss of 26.7 million or $0.89 per share for the year ended December 31, 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 $10 million compared with the year ended December 31, 2008.

Total revenues for the full year 2009 were $23.8 million, compared with $8.5 million for the full year 2008. The increase in revenues of $15.3 million was primarily due to $19.3 million of royalties recognized from Endo on its net sales of Opana ER, representing an increase of $14.2 million compared to 2008, and a $1.4 million increase in revenues recognized under our drug delivery technology collaborations.

These increases were partially offset by lower royalties from Mylan Pharmaceuticals on Mylan’s net sales of Pfizer’s 30 milligram generic version of Procardia XL. As previously disclosed, during the fourth quarter, Mylan notified us that they were not renewing their supply and distribution agreement with Pfizer which expires in March 2010. As a result, we do not expect to receive royalties from Mylan after the first half of 2010.

Selling, general and administrative expenses for the full year 2009 were $9.4 million compared with $12.1 million for the full year 2008. The decrease of $2.6 million was attributable to several factors including lower share based compensation expenses, largely due to credits we recorded in the first and fourth quarters of 2009, and a decrease in expense due to the reduction in a number of outstanding stock options both of which 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 related to the collectability of a $1 million loan the company makes to Edison and a nonrecurring non-cash credit we received in the third quarter of 2009 relating to the cash surrender value of the company’s life insurance policies. Partially offsetting these decreased expenses were $1.3 million in costs we incurred in 2009 related to the proxy contest in connection with the 2009 annual meeting of shareholders and the related litigation.

Research and product development expenses for the full year 2009 were $12.4 million, compared to $21 million for the full-year 2008. This decrease of $8.6 million reflects that we had lower contractual payments to Edison under our collaboration agreements with Edison in the full year 2009.

The decrease also reflects that for the full year 2009 we incurred no significant expenses related to the development of product candidates other than A0001, had lower compensation expenses, primarily as a result of 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 collaborations to the cost of revenues. These decreases in our R&D expenses were partially offset by increased expenses for our preclinical and clinical work on A0001.

I’ll now take a moment to discuss our cash position as of year end and highlights of the cash flows for the full year 2009. At December 31st, 2009, we had cash and investments of $11.5 million compared with $16.7 million at December 31, 2008. For the full year 2009, our operating activities provided net cash of 73,000, compared with $26 million of net cash used in operating activities for the full year 2008.

Cash used in financing activities in the full year 2009 included $5.5 million in principal payments on our term loan payable to GE Capital compared with principal payments of $2.4 million in the full year 2008, as our scheduled principal payments increased in January 2009 in accordance with our loan agreement. At December 31, 2009, we had 4.1 million of principal remaining on our term loans, which is expected to be fully paid off in September of 2010.

For the full year of 2010, we expect revenue to be in the range of 43 million to 45 million as compared with 23.8 million in revenue for 2009. We expect SG&A expense to be in the range of 6.5 million to 7.5 million, and R&D expense to be in the range of 10.5 million to 11.5 million. As a result of these forecasts, we expect to be profitable for the full year 2010. This guidance for revenues and profitability is dependent upon projections that we have received from Endo for their net sales of Opana ER in 2010.

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

Jennifer Good

Thank you, Frank. I'd like to close with an overview of our business objectives for 2010, which are outlined in our press release. Our five business objectives for this year are

Working closely with Endo to maximize the value of Opana ER and sharing the benefits of these efforts with Penwest shareholders to the contemplated special cash dividend announced in our press release today; completing both Phase IIa trials of A0001 in patients with Friedreich's ataxia and MELAS syndrome and making a go/no-go decision on this compound; exploring potential licensing opportunities for A0001 in anticipation of completion of the Phase IIa trials; four, continuing to grow the company's drug delivery business, both by completing formulation work on compounds under development and by signing additional deals; and finally, continuing to aggressively manage the company's expenses to ensure its costs are appropriate given its priorities.

We believe that by executing on this plan we can build value, not only in the short term but over the long term as well. The company is financially sound and we now have turned profitable. During 2010, we expect to build meaningful cash from the royalties on Opana ER as well as from our drug delivery technology collaborations. We have a development program in A0001 that if it generates positive data in the Phase IIa trials could be meaningful for our shareholders; if it does not, then we would likely discontinue its development.

I believe that in 2009 we demonstrated that we can execute effectively against our plan and adapt to changes as necessary. We have a strong and focused team in place that has been integral to building and executing this plan. In closing, we are pleased with the board's intent to share the benefits of our success directly with our shareholders through the special cash dividend of between $0.50 and $0.75 per share that the board intents to declare in the fourth quarter. The board and management are committed to returning value to our shareholders, and I believe this is tangible evidence of that commitment.

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) Our first question comes from the line of Greg Gilbert [ph]. Your line is open.

Greg Gilbert

Thanks. Hi, Jennifer.

Jennifer Good

Hi, Greg.

Greg Gilbert

As you make important decisions on how to deploy cash and make other investments, how are you thinking about the duration of the Opana ER income stream, and how can you be confident that there won't be, for example, the possibility of an at-risk launch this year by impacts? Thanks.

Jennifer Good

Yes, good question, and obviously one our Board’s discussed at length. We have not planned for an at-risk launch by impacts this year. We don't anticipate a lower court trial until the second half of this year, so I think it will be late in the year before there is a decision, so not that it’s not conceivable but I think it is not likely. From going forward from the fourth quarter on, I think the Board will continue to monitor the status of Opana ER as we move into 2011, and contemplate dividends sort of as we go along with new information.

Greg Gilbert

In the event that Endo does decide to launch an AG at some point, do you share in that the same way you share in the branded sales?

Jennifer Good

We do. We get the same royalty percentage on branded sales, authorized generics, follow-on products in the international deals; they're sort of tied to us for oxymorphone ER.

Greg Gilbert

And then lastly given the importance of the stream to you guys, are you willing to discuss anything at least generally about tamper-resistant or abuse [ph] the trend type formulations that maybe in the works or deals that you're jointly involved with, with Endo, another party?

Jennifer Good

No. We've gotten this question before, Greg, and Endo has made the decision not to talk much about their lifecycle management, although as you know they do and acknowledge there tamper-resistant work going on. So I really can't comment much beyond that.

Greg Gilbert

Okay. Thank you.

Jennifer Good

Okay. Good to talk to you.

Operator

(Operator Instructions) Your next question comes from the line of Arthur Friedman. Your line is open.