Sepracor Q2 2007 Earnings Call Transcript

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Sepracor Inc. (SEPR)
Q2 2007 Earnings Call
July 27, 2007 8:30 am ET

Executives

Adrian Adams - President and CEO
David Southwell - CFO
Mark Corrigan - EVP of R&D
Bob Scumaci - EVP of Corporate Finance, Administration, and Technical Operations
Jonae Barnes - SVP of IR and Corporate Communications

Analysts

Greg Gilbert - Merrill Lynch
Rich Silver - Lehman Brothers
Larry Neibor - Robert W. Baird
Biren Amin - Stanford Group Company
Marc Goodman - Credit Suisse
Bert Hazlett - BMO Capital Markets
Nathan Sedati - Highside Capital
Steve Sabba - Bob Partners
Andrew Swanson - Citigroup
Jim Kelly - Goldman Sachs
Ronny Gal - Bernstein Research
Ian Sander - Cowen & Co
Annabel Samimy - UBS

Presentation

Operator

Welcome to Sepracor's Second Quarter 2007 Earnings Call. Hosting the call today from Sepracor is Mr. Adrian Adams, President and Chief Executive Officer. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions, following the presentation. (Operator Instructions).

It is now my pleasure to turn the floor over to our host, Mr. Adrian Adams. Sir, you may begin.

Adrian Adams

Thank you, Mellissa, and good morning everyone. Thank you so much for joining us for our second quarter 2007 financial results webcast. With me this morning are David Southwell, Chief Financial Officer, Mark Corrigan, Executive Vice President of Research and Development; Bob Scumaci, Executive Vice President of Corporate Finance, Administration, and Technical Operations; and Jonae Barnes, Senior Vice President, of Investor Relations and Corporate Communications.

Before I proceed, Jonae will you please read out our forward-looking statements.

Jonae Barnes

Good morning everyone. Various remarks that we make about our future expectations, plans, and prospects constitute forward-looking statements for purposes of the SEC Safe Harbor provision. Actual results may differ materially from those indicated by these forward-looking statements, as a result of various important factors which are discussed in our most recent quarterly report on Form 10-Q, which is on file with the SEC and other reports that we file with the SEC.

In addition, these forward-looking statements represent the company's expectations only as of today. While we may elect to update these forward-looking statements, we specifically disclaim any obligation to do so. Any forward-looking statements should not be relied upon as representing our estimates or views as of any date subsequent to today. Thank you Adrian.

Adrian Adams

Thank you Jonae. I would like to start by saying that this past quarter was indeed a challenging one for Sepracor. However, as we transition to the next phase of our company development we have begun to make productive strides in our overall corporate strategy. A strategy focused on more fully leveraging our product franchises, creating a deeper research and development pipeline of assets, and aggressively pursuing and securing successful corporate development on license and opportunities, this is our evolving plan for success.

I would now like to focus on slide 2, that contain a summary overview of our financial results for the quarter before providing further commentary on each of our commercialized products.

For the quarter, we recorded total revenues of $278.1 million, which represented an increase of 5.2% over revenues recorded during the same period last year. With LUNESTA and XOPENEX HFA posting increases over revenues from the same period last year of 2.7% and 670% respectively.

Revenues from sales of XOPENEX inhalation solution were lower compared to the same period last year by approximately 9.3%. We believe that this was principally attributable to the Centers for Medicare or Medicaid Services decision to reduce reimbursement for the product on the Medicare Part B. I will go into further explanation of this decision later in the web cast.

BROVANA, which was launched in April of this year, had revenues of $5.5 million for the quarter. Our revenues for the first half of 2007 were solid with total revenues reaching $609.6 million, an increase of 10.8% over the first-half of 2006.

Earnings per share in the same period increased 39% to $0.25 and included in this first-half earnings per share was an after-tax charge of $0.28 that we recorded in the first quarter, resulting from the settlements of litigation related to tecastemizole.

Our balance sheet remained strong and as of June 30, we had cash and short-and long-term investments at $860.9 million.

Let me now go to each of our products starting with LUNESTA on slide number 3. As you can see from the chart on the left side of the slide, overall market share has remained flat. LUNESTA continues to show a solid year-over-year growth in overall total prescription volume.

Of particular significance more recently is the fact that market share has held steady in the phase of the introduction from a generic competitor to zolpidem. We believe that the market dynamics have now stabilized and is a strong indicator that we have weathered the storms of competition from generic Ambien.

Despite this however, during the quarter we saw a drawdown of LUNESTA inventory at the wholesaler level, due to the anticipation of decreased LUNESTA demand as generic zolpidem became available in the late April.

In fact LUNESTA inventory levels at the end of the second quarter decreased by half a week. Going forward, we are focused on maximizing on the data from our Phase IIIB/IV studies in patients with insomnia co-morbid with other medical conditions. This is differentiating data and reinforces the overall LUNESTA profile, of fast sleep onset, effective sleep maintenance, ability of the products we use in the majority of patients together with patients getting a fresh start to the next day.

This is a profile with the potential to make LUNESTA the number 1, patient requested sleep-aid, a key objective. Related to this as can been seen on my next slide, slide number 4, we are rolling out a new campaign that gives particular emphasis to the fresh start to the day attribute. Market research has shown this to be a significant factor for patients and doctors.

This positioning will also be integrated into a new directed consumer campaign scheduled to rollout in the fall. This will provide an overall new look and feel to LUNESTA promotion. We are excited about this.

Of course another key strategic objective with LUNESTA is being to further strengthen our managed care position particularly when compared to AMBIEN CR.

On my next slide, slide number 5, we expect additional growth of LUNESTA which gain from our managed care coverage. This chart illustrates our position as of July 2007.Compared with last year LUNESTA's unrestricted formulary positions have increased in the commercial managed care segment. We now have unrestricted coverage in 87% of managed care lives in tier 2 or 3 positions. This compares very favorably with a level of 79% for AMBIEN CR.

We believe that this creates a great footprint position for potential growth in the future and we will continue to execute our contracting strategy to remain the branded formulary leader for the AMBIEN CR in the insomnia market.

Now let's turn to slide number 6, and focus on XOPENEX Inhalation Solution. The second quarter was a challenging one for XOPENEX Inhalation solution as it relates to reimbursement on the Medicare Part B.

As background for those who may not already be aware, on May 18, the Centers for Medicare and Medicaid Services or CMS announced that they were terminating the unique reimbursement codes for XOPENEX Inhalation Solution and generic albuterol inhalation solution from the Medicare Part B, and a decision to bundle these two products together in the same temporary reimbursement code.

CMS believes that this action is required based on its interpretation of the Medicare Modernization Act. The new bundled reimbursement code for XOPENEX Inhalation Solution and generic albuterol inhalation solution went into effect on July 1st.

Other than new reimbursement code, reimbursement for XOPENEX Inhalation Solution and generic albuterol inhalation solution is based on the blended average selling price for the two products. The result is that the new blended reimbursement rate significantly lowers the reimbursement pay for XOPENEX Inhalation Solution and significantly raises the reimbursement pay for generic albuterol. This, in turn, is creating a reimbursement scenario for generic albuterol that has the potential to impact physician prescribing decisions based on financial incentives.

Earlier this week, the U.S House of Representatives released draft legislation as part of the States Children's Health Insurance Program reauthorization that includes language addressing this reimbursement differential for generic albuterol. The Draft Legislation provides the XOPENEX Inhalation Solution and generic albuterol will be paid at the lower of their respective standalone average selling prices or the blended XOPENEX Inhalation Solution generic Albuterol average selling price.

For generic albuterol, this will lower the reimbursement Medicare pays for the product to a standalone average selling price, which was $0.20 a vial for the second quarter of 2007.

For XOPENEX Inhalation Solution, this would mean that reimbursement will continue to be paid at a blended XOPENEX generic albuterol average selling price.

Sepracor welcomes this legislative action as we believe that it would [impulse] remove the financial incentives that were created for generic albuterol through the CMS bundling action.

Sepracor realizes however, that there remains a great deal of work that needs to be done on both the House and Senate sides before the legislations passed by Congress, at which point it would still need to be signed into law by President Bush. Should the proposed legislative action become law, it will be effective on January the 1st 2008. The impact of this potential legislative action on XOPENEX Inhalation Solution revenues in the Medicare market in 2008 is not yet known.

As we stated in this morning's press release, in anticipation the implementation of the new reimbursement rate and with the subsequent expectation of decrease XOPENEX Inhalation Solution dispensation, in June we saw home healthcare pharmacies reducing the demand ahead of the July 1st implementation date.

Our overwriting concern is the many thousands of Medicare beneficiaries, who have relied on XOPENEX Inhalation Solution for years, still have access to the product. To that end, we have been contracting with home healthcare and retail pharmacy providers to retain the continued availability of XOPENEX Inhalation Solution to Medicare Part B beneficiaries.

From a financial perspective, it is our expectation that this contracting will enable us to continuously receive revenue from Medicare Part B. However, we believe that revenue contributions for Medicare will be significantly lower than historic levels. Later in the call David will provide our revised guidance, which will reflect our estimate of the impact this action will have on XOPENEX inhalations solution revenues for the remainder of this year.

On the retail side for XOPENEX Inhalation Solution, I want to emphasize on the graph to the left on the slide in front of you. This graph represents the product retail position volume and shows for the second quarter of 2005, 2006 and 2007. As you can see market shares have remained steady. Although its still early, as of now, we still have not seen any impact from the Medicare decision translating to the retail side.

Turning now to slide number seven on to XOPENEX HFA, the product continued to show strong gains in prescription and share growth as illustrated. We closed the quarter with a total prescription share of 7.2% and a new prescription share of 8.4%. Along with the second quarter came the start of the low asthma season. This in turn translated into wholesale inventory reductions.

Looking ahead, we continued to see a large opportunity for XOPENEX HFA in the ongoing CFC to HFA market transition. Half of the short-acting beta agonist market is still CFC based at this time. But the market is scheduled to complete the transition to non CFC products from the end of 2008 deadline

Our objective is to continue to leverage the Xopenex HFA product profile and emphasize the product role into the continual care of patients with respiratory disease.

Regarding Xopenex HFA in managed care, our positions have continued to increase in the commercially managed-care segment over the last year. Over this time XOPENEX HFA's competitive positions in tier 1 and tier 2, have improved by 15% and we have a competitive position versus PROAIR. This is a further opportunity for growth.

I would now, on slide number 8, like to refer to the newest additions on respiratory franchise BROVANA, this product was commercially introduced in April and have revenues of $5.5 million for the second quarter of 2007. BROVANA is a long-term, twice daily, maintenance treatment of bronchial constriction in patients with chronic obstructive pulmonary disease. Most patients with COPD are older patients and the majority of them are therefore covered by Medicare.

At the time of launch however, BROVANA was not covered by Medicare. And it was not until mid-June that CMS announced the coverage criteria and billing instructions for BROVANA under a miscellaneous reimbursement code thus enabling reimbursement on the Medicare.. As a result home healthcare companies as a group did not except our filled orders of BROVANA until this reimbursement decision in mid-June. This led to a much slower than anticipated prescription uptake.

We are now seeing however the increasing numbers of home healthcare company accepting and filling BROVANA orders and we expect that this will continue to make gains in this area throughout the remainder of this year.

Also we were pleased when in the second quarter the CMS announced that it is recommended that BROVANA be awarded a uniquely reimbursement code that would further simplify the process for billing the products in the Medicare of Part B. The final decision is expected in the fourth quarter and if favorable would go to effect on January 1st, 2008.

As I mentioned, we are optimistic about BROVANA's future growth. Feedback from physicians remains positive and we remain encouraged by our findings from market research studies. We estimate the market opportunity for our long-acting beta-agonist in an Inhalation Solution to be greater than $1.5 billion. As there in an estimated $24 million people in the United States with COPD, we've only about half of these patients currently being diagnosed.

Discuss the individual products, so before handing over to David, I would like to say a few words, we have the exciting collaboration with Eisai in Japan as highlighted on slide number 9. Last night, we announced in concern with Eisai is truly milestone event for Sepracor. This collaboration is reflective of our overall global corporate strategy to fully leverage our product franchises across the globe.

Eisai is a large and well recognized pharmaceutical company based in Japan with a strong focus in the CNS therapeutic area. We are very excited about this partnership and feel that the expertise in CNS as well as the established sales force in Japan, makes a perfect faithful LUNESTA. The partnership includes an initial milestone payment, subsequent payments upon various development, regulatory and pricing milestones, royalties on product sales, and compensation for providing the product's active ingredient.

It is an initial 15-year term agreement and for reference the Japanese insomnia market was estimated at approximate $500 million in 2006. Turnover of the Sepracor anticipates the submission of the Japanese marketing application in the 2010/11 timeframe. Again, we and Eisai look forward to developing a strong relationship going forward.

I would now like to pass the call over to David Southwell, who will recap our financial performance during the quarter of the first half of this year. David?

David Southwell

Thank you Adrian and good morning. Total revenues for the second quarter increased to approximately $278.1 million, which reflected a 5.2% increased from second quarter 2006 revenue of $264.4 million. Inventory levels were low in this quarter on both the units and with cover basis, as compared to the first quarter and consistent with our inventory management agreement.

Specifically, the reduction of inventory cover in the quarter represented an approximately $23.1 million reduction in total revenue. With LUNESTA inventory decreasing by a half a week and XOPENEX Inhalation Solution inventory decreasing by a week and half. Totaled revenues for the six month ended June 30, 2007 was $609.6 million which was a 10.8% increased over the same period in 2006 for which totaled revenues were $550.1 million.

Moving to slide 11, net income for the quarter was approximately $6.1 million or $0.05 per diluted share compared to $11.0 million or $.0.10 per diluted share for the second quarter of 2006. Net income for the six months ended June 30, 2007 was approximately $28.7 million or $0.25 per diluted share versus $21.1 million and $0.18 per diluted share for the six months ended June 30, 2006. Included in the results for the six months ended June 30, 2007, there is an after-tax charge of $32.9 million or $0.28 per diluted share that was applied during the first quarter and relates to the settlement of two class action lawsuits relating to tecastemizole.

With that I would like to hand the call over to Dr. Mark Corrigan for our R&D update.

Mark Corrigan

Thank you, David, and good morning. R&D at Sepracor has made significant progress over the last quarter as our investments in discovery are yielding exciting new drug candidates.

To move you through our pipeline; for our XOPENEX franchise, we are honoring our FDA commitments, commencing pediatric study to support on Metered-Dose Inhaler program.

You have heard from Adrian on the progress we've made in Japan, successfully partnering with Eisai advancing our clinical program.

We've formed a group of [suite] of investigators to deliver the final clinical studies requested by the Japanese health authorities and look forward to transitioning that effort to Eisai. I will be elaborating on our regulatory process progress in Europe. Also with respect to our second major study in insomnia and co-morbid depression, testing of LUNESTA in combination with fluoxetine is underway in 11 countries in Europe.

In the US, we are complying with the FDA requested pediatric programs as well renewing our focus on life cycle improvements for LUNESTA. Indeed we have brought renewed focus on product improvements across the portfolio of marketing products.

For BROVANA, our Phase IV program commencing and we are complying with the FDA's post-marketing approval requirements. Our earlier stage portfolio continues to advance as we look to be leaders in the development of treatment approaches to depression.

SEP-289 our novel, triple reuptake inhibitor is on track for both the PET imaging study and proof-of-concept study this fall. SEP-162 our dual reuptake inhibitor is in experimental medicine studies currently. The PET study of SEP-162 is due to start in fall and is on track for large scale proof-of-concept studies next year.

Exciting breakthroughs this summer have been the clinical candidate nominations of SEP-425 and SEP-432. These new molecular entities are on track for investigation of new drug applications or INDs by the end of the year and represent further additions to our armamentarium of triple reuptake inhibitors with different monoamine affinities. These not only represent product opportunities in depression, but could have broader clinical applications to conditions such as pain, ADHD, bipolar disease, and fibromyalgia.

SEP-900 is our first D-amino acid oxidase inhibitor to receive nomination as a clinical candidate and is on track for an IND early next year. DAAO is a novel mechanistic approach for the treatment of schizophrenia and cognition. We believe SEP-900 would be the first in this class of drugs to go into the clinic. Early next year, we have to elaborate further on our growing discovery portfolio.

Moving on to slide 13, we are very pleased to be able to report today our submission of the MAA to the European authorities for LUNIVIA which occurred even earlier than expected. This MAA submission includes a very robust clinical data set and is comprised of the pre-clinical and clinical data that were part of our US NDA filing.

The results of our phase IIIB/IV studies of LUNESTA in patients with insomnia and comorbid conditions and our two six-month placebo-controlled studies among others. We are targeting approval of LUNIVIA MAA for the second half of 2008.

From a commercialization planning perspective, we are pursuing a partner for marketing in Europe.

With that, I would like to hand the call back over to David.

David Southwell

Thank you, Mark. As Adrian discussed previously, we are changing our 2007 guidance in significant part due to the CMS changes on XOPENEX Inhalation Solution and reductions in inventory.

Total revenue guidance is now $1.23 to $1.3 billion. The revenues guidance by product is as follows. LUNESTA $595 to $615 million; XOPENEX Inhalation Solution $495 to $515 million. XOPENEX HFA $85 to $100 million. BROVANA $15 to $25 million and royalty revenue $40 to $45 million.

On the expense side, we are lowering SGNA expense guidance to $800 million, which does not include the $34 million expense associated with the settlement of the tecastemizole litigation that was recorded during the first quarter. We are also lowering our R&D expense guidance to $205 million for the year. We expect to end the year with cash, long and short term investments of approximately $900 million.

Our guidance for full year fully diluted EPS is now $1 to $1.30, based on waited average shares outstanding of a 118 million shares. This EPS guidance includes an after-tax charge for the settlement of the tecastemizole litigation of $0.28 per diluted share. Adrian?

Adrian Adams

Thank you David and Mark. I would like to like to finish on slide number fifteen by stressing on near-term key objectives for Sepracor. In line with our objectives to drive enhanced productivity within the company, we have initiated reorganization and a restructuring of the commercial functions with the focus to developing best practice and peak performance sales and marketing functions.

We have some great people and this project is all about structuring and resourcing for success in a sustainable and productive way. Integral to this as I had mentioned, we have aligned the company to fully leverage our existing product franchise.

This objective includes accelerating LUNESTA volume and share growth, growing the XOPENEX franchise, and successfully growing BROVANA. In all the components of our overall near-term corporate strategy is to deepen our research and development pipeline with a continued advancements to our clinical pipeline. Initiation of three Phase II proof-of-concept studies and the filing of two to three INDs as we move into next year.

Also fundamental to our evolution is the aggressive pursuit of synergistic corporate development in license and opportunities. Obviously, one of which is to identify a partner for LUNIVIA in Europe and elsewhere.

We are very interested in identifying early and late stage products that could help fill out our development pipeline and potentially broaden our therapeutic reach. Of course, we will continue to access M&A opportunities as well.

At this point, I would like to open the call off for questions and answers. Melissa, please give instructions.

Question-and-Answer Session

Operator

The floor is now open for questions. (Operator Instructions). Your first question comes from Greg Gilbert of Merrill Lynch. Please go ahead.

Greg Gilbert - Merrill Lynch

Thanks and good morning. I have it's a two part question on the XOPENEX. First, what percentage of sales does the 30% of volume represent?

And the second part of the XOPENEX question, do you have any specific info that might make people comfortable that your commercial business will not suffer or do you just assume that it won’t be affected by the Medicare situation because you haven’t seen any effects yet?

Adrian Adams

On the second of point that question, I think, one of the points I emphasized in the presentation is that market share in the retail segment, remained very steady. But over the course of the last number of weights as we have been tracking, there is no sign that there has been any impact in the retail segment. To point that obviously that this market is in the retail segment, it is very focused on the pediatric area and obviously primarily in tier 3 positions, so we remain been pretty confident, about impacts on the retail side, but it's a early days as yet. On the former question, David?

David Southwell

Well, it's hard to precisely figure out what percentage of sale the 30% reduction of volume is because we had inventory reduction and other changes during the quarter, which were blended in with that. Obviously, we reduced our guidance due to the CMS decision and I would highlight that the new legislative initiative that Adrian talked about is not included in our annual guidance. But we are assuming that doesn't change anything this year.

Greg Gilbert - Merrill Lynch

Okay. And I'll get back in line after this one strategic question for Adrian. I realized that you are very focused on pipeline building at this stage, but I would think there has to be a point at which you think the board ought to consider share repurchases. Is that even in your vocabulary at this point or are you just very focused on external drivers at this stage?

Adrian Adams

Well, that is a question that we anticipated obviously, when one looks at our overall goals whether they be short, medium or long-term, as a company, we look and assess at all possibilities. And obviously we'll continue to assess that within context of all other activities as well. But we welcome the question and will see how things in the course of the next number of months.

Greg Gilbert - Merrill Lynch

Thanks.

Operator

Thank you. Your next question is coming from Rich Silver with Lehman Brothers. Please go ahead.

Rich Silver - Lehman Brothers

David you mentioned that $23 million in revenues from inventory work down and then you outlined LUNESTA at a half a weeks XOPENEX Inhabit one and half weeks but I think Adrian did mentioned there've been worked down on HFA as well. I think quantify that as well?

David Southwell

Now the primary change in inventory came from XOPENEX Inhalation Solution and there was a smaller amount that was represented by LUNESTA in that number.

Adrian Adams

Let me jump in this. The MDI, Richard, they had come down but because of the seasonality, which covers roughly the same. So, there is a unit decrease, but what David thought about on that $23 million is on a risk covered apparent basis.

You know Rich, we have mentioned the low asthma season and the opportunities when we moved into September, October, is obviously that the season picks up. If you delay on not the dynamics of what is still half of the market to transition to HFA, our best product. So we see that as an opportunity having got out of this of course low period.

Rich Silver - Lehman Brothers

Okay. And just may be bit more clarification given that the decline in HFA sales doesn't seem to be reflected in the scripts. Is there any thing else, there that would be impacting the decline in the sales that you haven't mentioned?

Adrian Adams

No, I think, obviously if one looks at our position, I think, as we emphasize I think in the managed care segment, we've been very successful of getting a very competitive position in that arena. And obviously our drive is to make sure that we have strong footprints in the managed care area to drive market share, as I mentioned, our TRx and NRx shares. As I move through the second quarter, we still remain stronger and we are looking forward to about accelerating as we move toward the end of this year.

Rich Silver - Lehman Brothers

So the implication is that there has may be been some additional discounting?

David Southwell

We don't comment overall in our discounting strategy obviously to all. I think what we want to do is to get to a position. As you know, the transition from CFC to HFA will be completed by the end of 2008. The winners in this market are going to be ones that really drive, enhance market share growth and that's exactly what we are focused on.

Rich Silver - Lehman Brothers

And one last one just on the $0.28 charge, I think the EPS includes or excludes because I think you said that SG&A excludes.

David Southwell

Yeah. The SG&A guidance that we gave Rich exclude that number because we are trying to give your sort of an ongoing SG&A number. The EPS number that we quote includes it. So there is the different treatment of that in those two numbers.

Rich Silver - Lehman Brothers

Okay, thanks.

David Southwell

Thanks Rich.

Operator

Thank you. Your next question is coming from Larry Neibor with Baird. Please go ahead.

Larry Neibor - Robert W. Baird

I expect the reorganization and restructuring the commercial functions to take, and what would be the goals for the organization coming out of that in terms of market share for your key products especially LUNESTA? And secondly, how will the discounting you are doing in MDI area impact your market share relationship versus PROAIR?

Adrian Adams

I will address the first point. As mentioned on the call, I think I have initiated operating of the marketing and sales organization and looking broadly at the resources, but we have to enhance productivity. In the end, I think we were at the fact that if I look at the LUNESTA market share, looks at the aspects of some of the challenges that we have brought in the organization that enhanced productivity is expected and certainly one that I am very focused on.

When it comes down to the best sales and marketing, I think we are investing and growing our current people but also looking to enhance the overall skill sets in marketing in commercial analytics. And in the sales force, we have initiated a project with an external company looking to see what is the right structure, right resources not only to fully leverage what we have in a more productive way, but also in a sustainable way to be able to maximize the opportunities going ahead. And obviously if one looks forward to this year and move in into 2008, clearly the object is to get better market share evolution particularly with LUNESTA.

I think with a product that is so highly differentiated, it will be the basics that matter and this is with what is a clear differentiated profile is making sure that those call we make are on the right decile doctors, with right level of frequency, with high quality [selling] and good people.

David Southwell

With respect to your question on the MDI, our primary objective is to increase our market share and increase overall revenues on that product. So, we primarily think that we have a better product in generic albuterol which PROAIR as I thought. And we think that that's being increasingly reflected in our improved and good managed coverage on that product.

Discounting. As Adrian said, we don’t comment specifically on discounting. But clearly there is a price component to these things. And primarily we feel that we have a better product. So, we really think that our benefits and our growth against competitors such as ProAir are primarily based on the quality of our product.

Larry Neibor - Robert W. Baird

Thank you.

Operator

Thank you. Your next question is coming from, Biren Amin with Stanford Group. Please go ahead.

Biren Amin - Stanford Group Company

Hi, How are your hearing, can you hear me okay.

Adrian Adams

Yes, Biren.

Biren Amin - Stanford Group Company

Okay. I was wondering if you can maybe discuss some of your business development initiatives, specifically, have you thought about possibly growing topline through in-licensing products that are near market or in the market?

Adrian Adams

Well I think clearly, as I mentioned this a fundamental part of our strategy going forward. In essence, I think at any one point in time we are just like any other pharmaceutical companies. We have a lot of discussions ongoing, a lot of initiatives and plans and we hope that some of them will come to fruition over the course of the next year or so.

We have some very clear objectives, obviously we were able to in-license products that would be synergistic from a therapeutic point of view, whether it be end of Phase II, early Phase III stage of things we would be very interested in those.

In addition I think if one looks at other therapy areas, we would consider other therapy areas, if it makes strong financial and strategic sense and also I think during the course of the months I think there has been a number of opportunities that we have been assessing and we look to see whether or not those things come to fruition over the course of time.

One of the most frustrating things about working in corporate and also licensing is you always have lots and lots of things going on at one point in time. That is down to translating that into success and we are very, very focused on them.

Biren Amin - Stanford Group Company

Okay, thanks.

Operator

Thank you your next question is coming from Marc Goodman with Credit Suisse, please go ahead.

Marc Goodman - Credit Suisse

Yeah, on the expense side you lowered your numbers for SG&A and R&D. Can you give us a sense of what you are actually giving up? Did you lower DTC spending or is it just a doctor marketing programs that you have taken away from SG&A. And on R&D can you just give us a sense of was it just a just a build in there or is it a product that was given up.

And then just the second question Adrian just kind of a bigger picture question, I mean obviously you have weathered the storm pretty well from the Ambien generic just to say you are holding in there and we are all you know looking forward to better productivity as the organization stabilize things like that.

When does it come to a point where you look at market share just to say, is it three months from now, six months from now and we should notice a real change. And if we don't see that change we should know that you are going to do something differently on the expense side again to kind of right size the organization from expensive infrastructure, if that were to take place?

Adrian Adams

Yeah I think very good questions I think on the bigger picture point of view, I think clearly, I think the key to success over the course of the next number of years is more fully leveraging that we have. There is no doubt that there is a lot of potential for increasing our productivity.

But we are very focused and we have some very good people in our sales force. And the project that we are initiating, which we hope to have completed by the end of October, beginning to November. Is what I am just looking out of the resource allocation, the opportunities that are in the respiratory and insomnia markets and making sure that we have the appropriate levels of resources to drive enhanced productivity and market share in high decile doctors.

Well, we are in at a time where we can share the output of that and the impact was, as we move into 2008 with absolute focus on talking for success, we will communicate that. But right now, we are in the initial stages of that project, where folks are making sure that our campaigns are very specific, very fine tuned on leveraging differentiating profiles, and that's how we'll move forward into the future. As I mentioned with LUNESTA, I think the new campaign that we are rolling out which have a broader focus on a fresh start of the day and I think very, very innovative and we are looking forward to see the impact of that.

On your second question, on research and development, obviously, as we mentioned in guidance, I think, we reduced R&D expense $205 million. I would say but absolutely critical to this organization moving forward from a medium to long-term point of view as to make sure that managing this business, we maintain our focus on innovation and in particular, I think in those reduction we mentioned in R&D expense that has not laid to any delays or significant events in a relation to driving our innovation forward. Organic sales growth in the future from innovative research and development is fundamental a gain for this organization, but we will not put that at risk.

Marc Goodman - Credit Suisse

On the first question?

David Southwell

On the SG&A side, they are very specific in nature of broaden category. There is some DTC component, but not a significant amount in the reduction. Nothing there, none of the reduction would cause any impact on the objectives for the year, as stated in the guidance.

Operator

Thank you. Your next question is coming from Bert Hazlett with BMO Capital Markets. Please go ahead.

Bert Hazlett - BMO Capital Markets

Yes, thanks for taking the question. I have a follow-up to Marks, question. I guess Adrian, just trying to get a little more precision with regard to the productivity initiative, so would you expect there to be some results due to these initiatives that would be tangible either on the top or bottom line in 2008?

Adrian Adams

Obviously, we don't know the position and to give any guidance or direction as far as 2008 is concerned. Obviously, the absolute focus of this is to make sure that we get enhanced productivity. By doing enhanced productivity, you can do that in a number of ways. As I mentioned, we got some good people and in terms of fine tuning of the targeting with the decile doctors making sure that the structure and resource in that we have is consistent with where the levels of potential are across the United States is the focus.

The driver of this is structuring for success and I would not like to speculate at this point in time in relation to what impact that will have in terms of resources in 2008. But clearly my absolute focus is to get greater levels of productivity as we move in to next year. Our shareholders deserve that, our people deserve that, and most certainly our patients do as well.

Bert Hazlett - BMO Capital Markets

And just another quick one, do you expect inventory levels to rise from these levels, is that the rash now behind the commentary regarding inventory level?

Adrian Adams

I think we are at weeks covered now that will be consistent for the rest of the year. However, the seasonality associated with specifically resulting in X franchise to the inventory unit levels increase in the back half of the year due to seasonality.

On LUNESTA, it might remain flat as far as overall inventory levels, so I would say that the unit would be consistent between now and end of the year.

Bert Hazlett - BMO Capital Markets

Okay. Thank you.

Adrian Adams

Thank you, Bert.

Operator

Thank you. Your next question is coming from [Nathan Sedati] with High Side Capital.

Nathan Sedati - Highside Capital

Hi, guys, thank you for taking the question. I just have a quick issue question with respect to UDV. Can you just talk about what component of the private payer market is sort of used in pediatric setting versus and adult setting is sort of the first question?

And then secondly, do you think you guys are going to putting any sort of pricing reductions or were not to try and entice private payer to continue use the product significantly?

Adrian Adams

Sure, predominately with the inhalation solution, it's used by the pediatric market. So, it's an ultimate product and it's primarily used by the pediatric market. With respect to your question on, I think your second question is on pricing. Again, we are trying to, we are competitive. We believe we have a better product on the retail side. We really don't see as Adrian said, any change in that business on the retail side as a result of the CMS decision. So we really see that business staying level. On the CMS side, we are trying to adjust to what CMS has done and we are going to continue to adjust to that.

Nathan Sedati - Highside Capital

And then just if I could ask a quick follow up. On the retail side, are those sort of changes reviewed on an ongoing basis for most of your contracts, or there is sort of biannual or annual reviews in terms of sort of what, taking a look at what products they are using or what they are paying and stuff like that?

Adrian Adams

Yeah. I mean, there is ongoing review, I mean if one looks at contract and I think different managed care organizations of different approaches and they range from annual kind of contracts to those that are renewed on a more frequent basis. And obviously we have a good managed care group that deals with the dynamics of that. And our strategy is to remain ahead of them not to be reacting to it.

Nathan Sedati - Highside Capital

Right. But, is it correct for me to assume that it could take a little while to really sort of see what their shake out is here?

Adrian Adams

I don't think it's correct to assume that. As we have mentioned in the call when one looks at our strategies in relation to XOPENEX Inhalation Solution and BROVANA and HFA MDI. It's a dynamic situation and where we see opportunities, we'll grasp them.

Nathan Sedati - Highside Capital

Okay, thank you.

Adrian Adams

Alright.

Operator

Thank you. Your next question is coming from Steve Sabba with [Bob Partners]. Please go ahead.

Steve Sabba - Bob Partners

Yeah hi, thanks for taking my question. I have two questions, one is on, can you just give us an update on the litigation over XOPENEX the nebulizer solution because the 30 months, they will be up by believe early in 2008 on the first ANDA filing. And also litigation with Dey's pharmaceuticals.

And a second question is in Japan, I believe as eszopiclone the parent drug of LUNESTA has been available as AMOBAN and you is that still available as branded? Has it gone generic? Could you just give us some update on what the marketplace looks like in Japan?

Adrian Adams

In Japan, as I mentioned, we see this has been a significant opportunity. That product is still available in Japan. But clearly, as part of the Eisai's assessments of the opportunity for LUNESTA, and one of the aspects that was taken into consideration is the overall profile of our product. And in particular the skill-set that we've been able to put in place to agree on British studies. That we think will further reinforce the profile of products in Japan.

Mark Corrigan

This is Mark, you might add, the one of the interesting things that AMOBAN is that, it is available in Japan at the 10 milligram level, which is extraordinarily high. So actually its usage is principally in very old patients. I think both depends on for the Japanese physician to prescribe lower dosages, as well as the data set that we have we will strongly differentiate our product LUNESTA from AMOBAN and the clinical population that’s used in Japan.

Adrian Adams

On your first question on litigation, obviously we are well aware of timeframes and the litigation aspects that there in place. We've no different from any other pharmaceutical company in that regard as, from historically within Sepracor and my history and my prior company, it is not wise for any company to comment on any litigation, which is ongoing. Its suffice to say that we believe our intellectual property is not only valuable and is strong and we will continue to settle that in that area and we will see how that progresses as we move into next year and we will communicate as and when appropriate it circumstances allows us.

Steve Sabba - Bob Partners

Okay. Do you have any court dates or anything?

Adrian Adams

Not, not as yet.

Steve Sabba - Bob Partners

Okay, thank you.

Operator

Thank you. Your next question is coming from Andrew Swanson with Citigroup. Plead go ahead.

Andrew Swanson - Citigroup

Thanks. I just want to ask that resource question, which has been asked a couple of times already, maybe slightly differently, which is, do you have evidence that the Phase IV programs on that are actually driving market share, and is there evidence that the new reps are driving market share, the DTC is beneficial to you? Where do you feel like you are getting return on your SG&A investments? And as we think about where resources could go over the course of the next 12 to 18 months?

And then secondly I was just interested on your thought on the HFA market and how that's going to pay out over to next 12 to 18 months in terms of the availability of CFC propelled inhalant and any inventory stocking or destocking?

Adrian Adams

What is the impact to direct to consumer advertising, I said that clearly, that you should expect with a quality organization I think we have measures, tactics, market research in place to look at the impacts of all different components. If one looks at all the things that are driving Lunesta, at this point in time. Obviously, we have a promotional campaigns direct-to-consumer et cetera. So, it's very difficult to highlight impacts of particular one. On direct-to-consumer, we know there are evidence responded to that our campaign has been very successful in driving patients into the surgery.

The key, when patients get into the surgery. When they ask or talk about an issue with insomnia. The doctor immediately defends the product in his or her own mind but he is trying to differentiate it. So, in the end the biggest driver of market share, the biggest driver of differentiation is going to be sales force. And that is where our focus is on. Just making sure that not only we give them all the right tools but obviously we have resourced effectively to drive enhanced productivity and that's what the project we are doing at this point in time is all about. And by the way that is what each and every one of our sales person to focus on at this point in time.

And clearly, as we develop our budget for 2008, which we can't comment on at this point in time, we are just initiating that, part of that we are looking to how we assess the different components of the drivers of market share. And we will make decisions accordingly and we have flexibility in that regard.

Mark Corrigan

This is Mark, there are two points in addition, first, the term surgery that they are doing just used it in the US would be just the clinic, as opposed to a surgical application that we think of. The second is that with the differentiating data in the IIIB/IV program, we would precisely the interest that will allow us to drive forward our regulatory strategies both in Europe and Japan.

Adrian Adams

So good bye British Consolation.

Andrew Swanson - Citigroup

Thank you.

Adrian Adams

We have to deal with a lot of that.

Operator

Thank you. Your next question is coming from Jim Kelly with Goldman Sachs. Please go ahead.

Jim Kelly - Goldman Sachs

Good morning a couple of questions, if I may, first on the deal for LUNESTA with Eisai it mentions milestones or any milestones recognized in any part of the P&L at this point and are those milestone included in any of the guidance? And then, on the Inhalation Solution, two key questions, first what are the mechanisms inside the contracting with home health care and retail pharmacy providers to sort of rating sense any contracting price dislocation, so it doesn't leak out into non Part B people? And then, could you just remind us on what the acquisition costs are inside Part B for these home health providers for both XEPONEX and Albuterol, does it sounds like the legislation inside the SCHIP, it looks like it make with both of them potentially at a loss in acquisition but it's one a greater loss even though it definitely changes the -- what's fitting in that legislation now, does change some of the incentives. Thank you.

David Southwell

Let me just answer the first one quickly. There are no expenses in the second quarter associated with Eisai milestones. So, there is nothing in there is associated with that. I hand over to Adrian.

Adrian Adams

Or revenue. So and then your point on, point two, Jim, can you just reiterate those again please?

Jim Kelly - Goldman Sachs

Absolutely, what re-inferences Medicare, and what re-inferences any sort of active contracting inside Medicare Part B and then just coming to this point of active contracting with home health and retail pharmacy that you retain uninterrupted Inhalation Solution availability for Part B, what you said there and keeps those prices in contracting strategies from looking into retail?

Adrian Adams

Well, I think if one looks at all contracting strategy at this point in time. I don't want to go into any details on this. But suffice to say over the course of last number of month, we been very active in this area. And this brings some flexibility. But, I don't want to get into details of what we are doing.

On the points on retail, as we have emphasized I think if one looks over the course of last few weeks, we have seen no impact as yet in the retail segment of the market. If one looks at that market which is obliviously very pediatric focus, we have a position, though the product has been used in tier-3 and we believe that there is going to be a little impact moving forward in that area.

Jim Kelly - Goldman Sachs

And the differential on the acquisition cost associated with the proposed SCHIP legislation.?

Adrian Adams

We can't comment on that.

Jim Kelly - Goldman Sachs

And just lastly, thanks David for mentioning about the milestones be included in the second quarter, but are they included in the '07 guidance?

David Southwell

Yes, not on the specific revenue line.

Jim Kelly - Goldman Sachs

Thank you.

Operator

Thank you your next question is coming from Ronny Gal with Bernstein. Please go ahead

Ronny Gal - Bernstein Research

Thanks for taking the questions. Couple of them, first regarding the R&D expenses, with moving all those plans into clinic in '08 and '09, how should we think about R&D, I know you are not willing to give guidance at this point. But we are going talking about a very significantly change here or just an incremental change in line with from past few years? And second, coming back to comments about looking at the SG&A lines, are you potentially counterplanning a position where you would consider exiting the PCP model that was building on in focusing potentially more on a specialist like model?

Adrian Adams

I think on that particular back to the R&D question, I think clearly if one looks at the business model that we have at Sepracor, it's a very compelling business model and very persuasive when talking to the partners. I think we have the ability moving all the way through from discovery with a renewed focus now on NC developments, all the way through to commercialization with the capability of both primary care and specialist.

Within the corporate developmental world and when one looks at partnerships, increasingly I think if one looks at companies who have asset that they want to develop, but have no capabilities to be able to leverage at primary care area, that is a very compelling partly equation. So, we have no intentions at this point in time, as we moved out of the primary care area. It's a high differentiating feature in partnership discussions and it will remain that way. So, no plans to exit the primary care area.

From an R&D perspective, I think you are right to comment that in moving three programs into Phase II, two in depression, one in anxiety that obviously if they are successful and moving forward into Phase III, clearly that is going to lead to enhance the expenses on the R&D line. I would suggest both, that is a great problem to have.

And obviously in looking forward, I think the absolute key to enhancing shareholder value is to be able drive organic sales growth beyond just the franchise we have at this point in time. That is going to come from corporate development and licensing and productivity from research and development. I would love to be wrestling with our problems in 2009.

Operator

Thank you. Your next question is coming from Ian Sander with Cowen. Please go ahead.

Ian Sander - Cowen & Co

Hi good morning, thanks for taking the question. Just wanted to dig a little deeper on the SG&A guidance and what it implies to the back half of this year. It seems to imply similar trends to a year ago when the MO was to really cut back on the DTC spending and try to focus on the more cost effective sales force effort, and yet it sounds like you are not at a stage where you are going to cut back on the sales force effort, and it sounds like you’ve got a new promotional campaign rolling out in the second half.

So can you just clarify exactly what we should expect in terms of promotion behind LUNESTA in the second half of the year?

David Southwell

No, we were promoting in the first half, so while there is a different promotional campaign in the second half, the actual expenditures on media and such don’t necessarily changes the result of that. I think as we mentioned earlier, we expect substantially all of the programs that are expense through SG&A line to remain. So we don’t think that there is going to be any loss of productivity as a result of our reduction in the SG&A guidance, and we also don’t want to be more specific, we specifically or not specific on the sub-components of the SG&A expense.

Ian Sander - Cowen & Co

Okay and one other question. Is the seven day free trial prescription program for LUNESTA still active and should we assume that remains active through the second half?

Adrian Adams

That program we announced was active until the end of May.

Ian Sander - Cowen & Co

Okay, so that’s gone. Okay, thank you.

Adrian Adams

Okay, thank you very much. We have time for one final question

Operator

Thank you. Your final question is coming from Annabel Samimy with UBS. Please go ahead.

Annabel Samimy - UBS

Hi, thanks, most of my questions have been answered, but just going back turn back to XOPENEX trial. One second you mentioned that most of the sales in the retail channel are pediatric. Do you have -- can you give us exactly more of am exact the percentage of COPD patients who are in the retail channel and what do you make of CMS's comments that they had insufficient data to determine that XOPENEX was clinically different than albuterol and how might effect the thinking in that retail channel?

David Southwell

I don’t think that they said that and we don’t want to comment too extensively on what’s going on with CMS because we obviously have a relationship with CMS and we don’t want to sort of – we don’t want to extensively get in to that with them.

Annabel Samimy - UBS

Okay thanks.

Adrian Adams

Thank you, I think, operator, that wraps up the Q&A session, I would like to thank you all for joining us this morning and to your questions, interest and challenge with respect to Sepracor. Everyone of our valued employees is committed to drive in enhanced productivity and value to our shareholders, customers and patients. With this in mind, I will look forward to update you on our progress on our next quarter conference call. Good day.

Operator

Thank you. This does conclude today’s teleconference. An audio replay of today's call will be available for one week starting today at 10:30 am Eastern Standard Time. The dial-in number is 973-341-3080, and the pin number is 9031075. Please disconnect your lines at this time and have a wonderful day.

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