Cephalon Q2 2007 Earnings Call Transcript

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Cephalon, Inc. (CEPH)
Q2 2007 Earnings Call
July 31, 2007 5:00 pm ET

Executives

Chip Merritt - Senior Director of IR
Frank Baldino - CEO
Bob Roche - EVP of Worldwide Pharmaceutical Operations
Kevin Buchi - CFO
Lesley Russell - EVP of Worldwide Medical & Regulatory Operations
John Osborn - General Counsel

Analysts

David Buck - Buckingham Research
Greg Gilbert - Merrill Lynch
Corey Davis - Natexis
Jim Birchenough - Lehman Brothers
Ronny Gal - Bernstein
Donald Ellis - Thomas Weisel Partners
Eric Schmidt - Cowen & Company
Dave Windley - Jefferies & Company
Annabel Samimy - UBS
Michael Rockefeller - Morgan Stanley
Brett Holley - CIBC World Markets
Gary Nachman - Leerink Swann

Presentation

Operator

Good day, everyone and welcome to the Cephalon Second Quarter 2007 Earnings Announcement. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Chip Merritt, Senior Director of Investor Relations. Please go ahead, sir.

Chip Merritt

Thank you. Today we will review Cephalon's financial performance for the second quarter of 2007. Before we begin let me remind you that certain statements on this call may be forward-looking and are subject to risks and uncertainties associated with the Company's business.

These statements may concern among other things guidance as to future revenues and earnings, operations, transactions, prospects, intellectual property, litigation and other legal matters, development of pharmaceutical products, clinical trials, and potential approval of our product candidates.

The Company also may discuss certain non-GAAP financial measures within the meaning of Regulation G during today's call. The information required by Regulation G is available in the earnings press release and in the newsroom section of our website at www.cephalon.com.

Additional information and risk factors affecting the Company's business and financial prospects and factors that could cause Cephalon's actual performance to vary from our current expectations is available in the Company's current Form 10-K on file with the SEC. During this call, we will reiterate full year 2007 guidance and provide third quarter guidance.

Please note that guidance will remain in effect unless the Company provides subsequent modifications or updates. Our earnings press release is available on the Internet at www.cephalon.com. Investors with further questions should contact me at 610-738-6376. This conference call is being webcast via the Cephalon homepage and will be archived for one week after the call.

Speaking on today's call will be Dr. Frank Baldino, Chief Executive Officer; and Kevin Buchi, Chief Financial Officer. Also joining us today are Bob Roche, Worldwide Pharmaceutical Operations; Dr. Lesley Russell, Worldwide Medical and Regulatory Operations; and John Osborn, General Counsel. Following remarks by Frank, and Kevin we will be pleased to answer your questions. Now, Frank Baldino.

Frank Baldino

Thanks, Chip. Good afternoon, everyone. It is a pleasure to announce that we continue to deliver strong financial performance during a transitional year for the company. Second quarter sales exceeded the high end of our guidance by $10 million led by our CNS sales increase of 18% and an increase of other sales up 15% over the second quarter of 2006. As expected, ACTIQ sales have declined significantly since the launch of generic oral transmucosal fentanyl citrate last year. Nevertheless our pain franchise deliver sales of $131.2 million during the quarter.

Today, we report a $75.6 million of adjusted net income which is at the very high end of our guidance. We achieved this despite $6.1 million increase in the adjusted R&D spending over the first quarter as we began to ramp our NUVIGIL and oncology programs. We report a basic adjusted income per share of a $14 which also is at the high end of our guidance. Some of the highlights of the quarter included; we will see the approval of our next-generation wakefulness product NUVIGIL. We are very excited about this product and the opportunity we have to further explore its clinical utility. We found that efficacy supplement for 10-minute onset of breakthrough cancer pain relief for FENTORA that we believe will be an important differentiating feature of this product. And on R&D day, we announced that we’ll be following an NDA for TREANDA in the treatment of chronic lymphocytic leukemia in the third quarter accelerating our timetable for this promising drug candidate.

Before the discussion of the third quarter in more detail, I want to take a moment to address the ongoing investigations of our sales promotion and marketing practices. As many of you know, the entire pharmaceutical industry has been under intense scrutiny in recent years from both federal and state regulators.

In response to evolving government policies, sales and promotional practice in industry have been going undergoing radical changes to ensure compliance with all applicable laws or regulations. We also have been engaged in ongoing efforts to evaluate and appropriately modify our commercial policies and practices. In fact, Cephalon is determined to play a leadership role in this area and is firmly committed to doing all we can do to meet the expectations of federal and state authorities.

As we have discussed for some time, Cephalon is cooperating with these investigations as we intend to resolve these matters as quickly as possible. Later in the call, Kevin will discuss the accounting aspects of a $56 million settlement reserve we recorded in the quarter.

Let's now look at the business in more detail. PROVIGIL prescription growth remained solid during the quarter with IMS data reporting a 12% increase over the second quarter of 2006. With millions of patients suffering from excessive sleepiness associated obstructive sleep apnea, shift work sleep disorder and narcolepsy, we expect continued strong PROVIGIL sales as a growing number of primary care physicians begin to feel more comfortable with the safety and efficacy of the drug and these indications.

During the quarter, there was an important study published that should help physicians better serve their patients suffering from obstructive sleep apnea, published in the June edition of the journal Sleep. The study showed among other things that despite up to seven hours of CPAP compliance, 50% of the patients showed objective signs of excessive sleepiness. These new data suggest that a meaningful market for PROVIGIL exists in CPAP compliance OSA patients.

During the quarter, we secured the approval of our next-generation wakefulness product NUVIGIL. With the PROVIGIL secured until 2012, the NUVIGIL approval presents us with a rare opportunity to more fully investigate the utility of this product prior to launch. Our data suggest that NUVIGIL may have the potential to improve outcomes for patients suffering from excessive sleepiness, fatigue and cognition, symptoms that are commonly associated with numerous diseases.

In clinical trials, we will examine the effects of NUVIGIL on cancer related fatigue, excessive sleepiness associated with Parkinson's disease and other medical conditions, bipolar depression and the cognitive deficits associated with schizophrenia. These studies will include over 1000 patients and provide important data to expand the label indications for NUVIGIL.

In our pain franchise, total FENTORA prescriptions continue to grow while our branded ACTIQ shows considerable resiliency in the face of generic competition. The combined sales of FENTORA and branded ACTIQ in our generic oral transmucosal fentanyl citrate through Watson have enabled us to effectively transition the pain franchise to a difficult period caused by generic entry into the ACTIQ market.

The FDA approved label for FENTORA already positions it very positively for the treatment of breakthrough cancer pain in opioid-tolerant patients. We now have an opportunity to further improve upon the FENTORA label.

Several weeks ago, based upon new clinical data we found an efficacy supplement to modify the existing label to reflect 10-minute onset of breakthrough cancer pain relief. For patients suffering from the debilitating breakthrough cancer pain minimizing the time to onset of pain relief is essential.

Recognition in the product label of 10-minute onset will enable us to highlight this important benefit to physicians.

We also have two new opportunities to potentially expand these to FENTORA. One is to introduce higher strength doses of FENTORA to address those opioid-tolerant cancer patients who are suffering from extreme breakthrough pain and need a higher dose to treat their pain. We will initiate trials to study higher doses later this year and pending positive results will follow supplement to the agency for consideration of higher dose of strengths.

The second and more important opportunity is to expand the FENTORA label to include additional indications beyond breakthrough cancer pain. We conducted clinical studies of FENTORA that demonstrated statistically significant pain relief at 10-minutes in patients suffering from breakthrough lower back and breakthrough neuropathic pain. In addition, our all-comers breakthrough non-cancer pain study is now complete, and we expect to have the data by early September. We plan to submit an sNDA in the fourth quarter of this year with positive data from all three of these studies.

Opioid is already widely used -- a widely used treatment option for patients suffering from severe chronic pain, the majority of whom also suffered from breakthrough pain episodes. Of the approximately 3 million patients receiving opioid prescriptions today, 32% are for the treatment of back pain and 32% for the treatment of neuropathic pain. In contrast only 12% of these patients receive prescriptions to treat cancer pain. Clearly expanding label indications of FENTORA to opioid-tolerant patients beyond breakthrough cancer pain represent a large opportunity to help additional patients.

We continue to make progress developing the market for the business role. Sales continue to grow steadily, it will take time to fully develop this opportunity and we continue to believe that VIVITROL will become an increasingly important treatment option for patients suffering from alcohol dependence.

On June 28, we hosted our Research & Development Day in New York. Our executive R&D team highlighted promising compounds from our early stage research projects to late stage clinical programs. We shared data from numerous studies that demonstrate the robustness of our pipeline. Let me talk about a few of these opportunities in more detail.

In June, we announced that our European partners had conducted a clinical trial with TREANDA that evaluated safety and efficacy as compared to chlorambucil in the treatment of naïve chronic lymphocytic leukemia patients. Well the data is embargoed until the American Society of Hematology meetings in December of this year, this study met its primary end-point of overall response rate and warrants a submission as an NDA.

Our anticipated third quarter 2007 NDA filing accelerates our launch time-line for its exciting new products. Moreover, we expect to receive an orphan drug designation for TREANDA and the treatment of CLL. But over 15000 newly diagnosed patients each year, CLL is the most common leukemia and represents a promising new opportunity for the company.

Our plans for TREANDA for the treatment of Indolent non-Hodgkin's lymphoma or NHL remain on track. Indolent NHL affects some 25,000 to 30,000 new individuals every year in the United States. Indolent non-Hodgkin's lymphoma remains an incurable disease. And Phase II studies in TREANDA has showed a 94% response rate, and relapsed NHL patients and combination therapy with Rituxan and when used as myelotherapy a 76% response rate in NHL patients refractory to Rituxan and other chemotherapies. We have completed enrolment in our Phase III study and anticipate completing the study and submitting the data to the FDA in the fourth quarter of this year.

With lestaurtinib or CEP-701, we expect to complete our Phase II/III clinical trial for the treatment of acute myeloid leukemia or AML in the first half of 2008. CEP-701 is a potent inhibitor of selective tyrosine kinase including FLT3.

Annually in United States, there are 13,000 newly diagnosed AML patients. 25% to 30% of those patients are estimated to have the FLT3 mutation. CEP-701 is shown to be cytotoxic to AML blasts with this specific mutation. In addition, we have begun a Phase II trial on myeloproliferative disorders based upon CEP-701’s ability to inhibit JAK2.

With CEP-11981, potent reactive Tie-2/VEGFR inhibitor, we've planned on beginning of Phase I study in the third quarter. Avastin has validated VEGFR as an appropriate target and that part has become an important treatment option.

Our preclinical data suggest that the combination of Tie-2 and VEGFR may provide additional benefits compared to only targeting VEGFR alone.

CEP-18770 is a novel reversible protease inhibitor that pre-clinically demonstrates a comparable or better anti-tumor efficacy with an improved tolerability profile and therapeutic index versus VELCADE in multiple myeloma and other cancers.

Our target is to enter Phase I with this compound before year-end. We've also developed an oral formulation for this product that we believe will serve to further differentiate 18770 from VELCADE.

As we demonstrated at our recent R&D day, we are science-driven company with a solid pipeline of both early and late stage compounds many in the oncology space. These provide us with additional opportunities for growth in the years ahead.

Our products and product candidates were highlighted at a number of important medical meetings during the quarter. At the American Society of Clinical Oncology or ASCO in June that definitely was shown as a promising cognitive enhancer in breast cancer survivors. Also at ASCO, we've shown that TRISENOX improved the well fare in overall survival among patients with Acute Promyelocytic Leukemia or APL. And moreover, the investigators for the inter-group trial concluded that TRISENOX should be incorporated at the frontline therapy for patients with untreated APL.

Data presented at the Pan Pacific Lymphoma Conference suggested that Bendamustine or TREANDA may provide benefit over single agent Rituxan and patients with Mantle Cell Non-Hodgkin's Lymphoma.

Our FENTORA study on breakthrough neuropathic pain was presented at the American Academy of Neurology and the International Congress on Neuropathic Pain.

We are pleased with the positive response that these data generated from physicians, who attended these meetings. I want to remind you that these studies do not currently represent the FDA approved labeling for these products. Nevertheless, they highlight the potential future labeling of our products that I mentioned at the beginning of this call.

Today, we believe we have a product portfolio that continues to deliver solid earnings growth for the foreseeable future.

Additional products that we can realize from our R&D pipeline together with M&A opportunities will further accelerate this growth.

Now Kevin will discuss our financial performance during the quarter.

Kevin Buchi

Thank you, Frank. Today, we reported financial results for the second quarter of the transitional 2007. We reported sales of $435.2 million compared to $430.7 million for the second quarter of 2006 and basic adjusted income per common share of a $1.14 compared to $1.51 per share over the same period last year.

Second quarter sales exceeded the high end of our guidance by $10 million and basic adjusted income per common share of $14 was at the high end of our $5 to $15 guidance range.

CNS franchise sales increased 18% to $230.2 million. Pain franchise sales were $131.2 million, with FENTORA sales reaching $36.3 million. Other sales were $73.7 million, a 15% increase over the same period last year.

Wholesale inventory level of our U.S. branded products remained relatively unchanged from the end of last quarter. Combined R&D and SG&A expenses in the second quarter of 2007 as adjusted to certain items detailed in the press release increased to approximately 12% from a year ago.

When compared to the first quarter of 2007, R&D expense as adjusted to certain pro forma items increased $6.1 million, reflecting the spending ramp of our NUVIGIL and oncology clinical programs. When compared to the first quarter of 2007, SG&A increased $36.6 million to $189.1 million. Approximately $17 million of this increase is because Alkermes is no longer reimbursing us of VIVITROL related launch cost.

Our adjusted tax rate for the quarter was 35.6%, which is in line with guidance. During the quarter, there were several adjustments that were made to arrive at adjusted net income. The most significant of these was a $56 million reserve we established related to our estimate of the minimum liabilities to resolve the investigation by the U.S. Attorney's office, and the office of the Connecticut Attorney General into our sales and marketing practices. These offices have not agreed that $56 million is sufficient to settle these matters. U.S. GAAP requires that we estimate and recognize a minimum liability when a loss is probable, but no single more probable outcome or range of outcomes can be identified.

As we previous disclosed, we are engaging ongoing discussions and negotiations regarding these matters. We are hopeful that we ultimately will be able to reach a resolution to these matters; however, it is reasonably likely that the amount of any settlement or resolution will materially exceed the $56 million we accrued in the second quarter. Therefore, you should not regard this reserve amount as a representative of the ultimate amount of any settlement.

In addition to this adjustment, we excluded $21 million related to ongoing amortization of acquired intangible assets. We excluded $16.5 million related to payments in Research & Development collaborations. We excluded $5.8 million associated with the gain realized in the sale of certain investments, and we excluded the tax effect of these items.

Our full year 2007 guidance remains unchanged. Total sales guidance is $1.675 billion to $1.725 billion. Guidance for the CNS franchise is between $925 million and $950 million. The pain franchise is between $425 million and $450 million, and our guidance for other product sales is between $300 million and $325 million. Adjusted R&D and SG&A expenses are targeted to be between $315 million and $335 million, and the $685 million and $715 million respectively.

Guidance for adjusted net income is $292 million to $298 million, which equates to basic adjusted income per common share of between $4.40 and $4.50, assuming 66.3 million shares outstanding. Our assumed tax rate for the year is approximately 36%.

The company is introducing third quarter 2007 sales guidance of between $420 million and $430 million. Adjusted net income of between $57 million and $63 million, and basic adjusted income per common share of between $0.85 and $0.95 based on 66.6 million shares outstanding.

That concludes our opening remarks. We will now open this call to you and your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from David Buck with Buckingham Research.

David Buck - Buckingham Research

Hi, yes. Thanks for taking my question. Just three quick questions. First for Frank or Kevin, what precipitated the reserve and the timing of the reserve for the investigations? Secondly, for either Frank or Bob Roche, on the Takeda co-promo, can you give an update how you are tracking productivity of that and we really haven't seen at least from our expectation, some of the prescription growth we had expected from primary care and if you could talk about when you see that happening? And for FENTORA, should we be assuming a similar growth rate absent, any new indications? I mean, basically, just some incremental sequential growth for that product. Thanks.

Frank Baldino

Thanks David. I think regarding the timing of this, I think it's just straight to say, we recorded this reserve, as we know it's appropriate to do so. The most important thing about this reserve is what Kevin said in his comments that you should look at this as nothing more than the reserve that we put on the books, and that the final outcome will likely be materially larger than this. I think that's enough said about that. Bob, do you want to answer David's question on both FENTORA and PROVIGIL?

Bob Roche

Yes, sure. David, good afternoon. Yes, with regard to PROVIGIL first, David, I think we remained very positive on the effects of Takeda is both offering now and will continue to offer as we go through the end of the year. We are embarking on a number of pretty exciting new initiatives with PROVIGIL and these are ones which we are working very closely on with Takeda and expect will continue to really energize this partnership and drive even better results.

And Frank mentioned in his opening remarks, our new initiatives in obstructive sleep apnea and the exciting new data which has come out just recently that not only demonstrates how tired these people continue to be even after a good solid usage of their [C-Path] devices but also other data that demonstrate the really high levels of co morbidities with these disease that many of which I think exacerbate these issues of sleepiness and tiredness of these people feel thing such as diabetes, obesity, depression and cardiovascular disorder, so we are very excited about the opportunities in OSA and have just recently as a matter of fact trained our sales force on a whole variety of new messaging and new promotional techniques for this particular market. And Takeda is following that lead.

With regards to FENTORA, I think we launched this product very successfully into the small group of physicians who had historically been the real targets for ACTIQ, breakthrough cancer pain is not being treated anywhere near as actively today as we believe that it should be, and therefore we are really very excited about the opportunities that FENTORA continues to offer us in the short-term and then obviously with the new indication to some point next year, even more so. But, as get out of that, that very small type target audience that we originally launched the product into and get into a much broader group of high opioid prescribers who never really caught on to the ACTIQ band wagon. And we are very pleased with the original initial uptake we're seeing here and expect even better results as we go through the end of 2007 and in the next year.

Frank Baldino

Did that cover it all, David.

David Buck - Buckingham Research

I think so, thank you.

Operator

We will take our next question from Greg Gilbert with Merrill Lynch.

Greg Gilbert - Merrill Lynch

Thanks. Frank, I was wondering if there is anything you can tell us to put some brackets around the potential size as a liability. If you can’t comment on that, can you at least provide some color on the process and time line from where you sit today. I know you said you didn’t want to say more about it, but I think it maybe wanted to at least put some brackets around the process if not the numbers?

Frank Baldino

I think Greg first of all, we really have it historically and will not today or in the future talk about any government discussions, whether it be FDA or what have you.

Greg Gilbert - Merrill Lynch

Okay.

Frank Baldino

So, it's really we just don’t think it's appropriate to do so. I mentioned -- Kevin rather mentioned the size of the $56 million number that we put in the financials this quarter and there is really nothing more we can really say about it.

Greg Gilbert - Merrill Lynch

Okay. Fair enough, can you at least then provide some examples of what practices that you have changed or intend to change? You mentioned taking a leadership position in that regard, is there any color you can?

Frank Baldino

I think as the industry evolves, we are watching it carefully, we are part of the process, we see what settlements have occurred. In the past, we try to update our compliance, every chance we get, try to change our practices to fit more within the norm of what the industry is doing. And this has been an ongoing process for the last several years and my guess is the way things are going we will continue for several year to go on the future, sometime there are certain changes, sometimes they are large important changes, but in the end I think we haven’t been public on any of the changes we have made or where the industry is going, so we really don’t think its appropriate doing on this call either.

Greg Gilbert - Merrill Lynch

Okay. Two quickies and Kevin what do you assume for additional generic ACTIQ competition in your numbers and then the close out Frank, what are your most important priorities in business development at this point, thanks?

Kevin Buchi

In terms of generic as you know there is no such generic entrant in the ACTIQ market yet, and we have no information that we have seen to indicate that one is anticipated in the near term and so we continue to expect just from a modeling perspective that one will occur late in the year, Greg no change there.

Greg Gilbert - Merrill Lynch

Okay.

Kevin Buchi

And as far as the business development priority I don’t think we are a CNS pain and cancer company and we think we are good at those things, so you should expect us to look for more opportunities in those arenas. Plus to go outside those arenas would be [prolific] and I really don’t have any plans to do so in the near future. We talked of it in the last quarter about initiatives in Europe, I think we have got a good growing business in Europe, we’d like to sort of leap that forward a bit and that would take lot of focus in the year ahead and also we have our eyes on the Asian markets. We’d like to see what we can do there as well simply because it’s a new market; it’s a growing market, a lot of pressure on US market. We know that Europe has dropped and it makes sense just to diversify our marketing opportunities somewhere else in the world.

Greg Gilbert - Merrill Lynch

Thank you.

Operator

Once again our next question from Corey Davis with Natexis.

Corey Davis - Natexis

Thanks, very much. I guess maybe for Frank, I've asked you this before on a couple of occasions I’m not asking for guidance for ’08 and beyond --

Frank Baldino

Yeah, that might -- fairly we should take it.

Bob Roche

Nice try there, Corey.

Corey Davis - Natexis

Alright, I have no further questions. Not asking for guidance, but is there an internal aspirational target for earnings guidance or earnings growth rate once you get through kind of this transition here?

Frank Baldino

That’s a hard one Corey, because once you start throwing out numbers like that then, there is really no upside for us to talk about that. But, I mean is there an opportunity to leverage our operating margins in a meaningful way in the years ahead? Yes, there are. I mean, we've invested heavily over the years. We have a really sound infrastructure today. We don't see adding to the infrastructure the meaningful way. With one exception maybe on the primary care space once we get the broader labeling opportunities for our FENTORA in the future, etcetera. So, I think, yes, there is leverage opportunity to increase our operating margins. We certainly have a goal to do that in the years ahead, and the board of Cephalon's Board of Directors has encouraged us to continue the efforts we've made in that area.

So, I think you are going to see some of that. That’s put a number on it, I just don't think we are going to do it. I think I gave you the same answer last time you asked me as well.

Corey Davis - Natexis

Yes. Fair enough. I just want to make sure you are not changing. Then maybe two for…

Frank Baldino

Two for Kevin you mean?

Operator

Sir, your phone line is open. Please check your mute button.

Bob Roche

Looks like we lost [cord].

Operator

We'll move on to Jim Birchenough with Lehman Brothers.

Jim Birchenough - Lehman Brothers

Hi, guys. A few questions. I'm just trying to understand your pain franchise guidance a bit better. It seems like you've had a couple of quarters where sales have stabilized in the $130 million range, but if I look at your guidance it would suggest a pretty precipitous decline in the second half of the year. I'm just trying to understand that a bit better if that’s possible?

Kevin Buchi

Hi, it's Kevin, Jim. I would be happy to try to address that one. I mean, first of all let me reiterate that we haven’t changed our guidance for the year. I think if you look forward in the pain franchise, what we were anticipating will happen is what we have kind of been anticipating throughout the year, and maybe hasn’t happened to date quite as quickly as we would have thought, and that is the generics are going to continue to penetrate the ACTIQ market. ACTIQ still has pretty respectable share given how long it's been [genericized], and ACTIQ as you know is a quite expensive, quite profitable product. We would expect that FENTORA would as ACTIQ shrinks, we would expect FENTORA would grow, but the FENTORA sales price is below the ACTIQ one. And so that will impact total sales in the pain franchise going forward. The logic is really as simple as that, and I would like to reiterate one other time that we have not changed guidance for the year in the pain franchise or sales guidance in general.

Jim Birchenough - Lehman Brothers

And just a follow up to an earlier question, it strikes me that you are investing in R&D at a higher rate than most pure played biotech's, at 18% of sales. As you think ahead, what’s an appropriate level of R&D investment for a company like Cephalon that has a pretty dominant end-licensing model?

Frank Baldino

Well, I think first of all, I’ll answer the second, and comment on the model first, and then talk about that a bit. We do have an end-licensing model, M&A model for sure, but we also have a pretty good R&D capability and lot of things we bring in we have to develop, and lot of things we develop include rather clinical development costs which are extraordinary these days. So, it's not like you are buying something that’s on market, when you are end-licensing something with these development like PROVIGIL, we develop PROVIGIL worldwide completely, and that’s a quite a bit of R&D spend. So, our M&A model is not just for products that are in the market and if they're not in the market, it triggers a substantial spend in the R&D category.

Regarding this 18% that you just mentioned, I think if you look at R&D in this quarter specifically and compare it to last quarter, you'll see it dump a bit over last quarter. And the reason for that is that trials were initiated this quarter, were initiated last quarter, they were supposed to be initiated last quarter, they moved into this quarter and they are ramping nicely. We're recruiting patients very nicely in those studies and therefore spend up. And also, we had an opportunity with CLL that we didn’t have before. We announced at R&D day that we have, going to file an NDA that nobody expected ahead of schedule. That takes time and money to do that. So, I think you see a reflection of the extraordinary opportunity that we have in R&D and that’s where it is. We would like R&D spend to be more in line with traditional pharma business here. In the future, we see it coming down as a percentage of top-line over the years, and I would look at this quarter as a little bit extraordinary relative to that.

Jim Birchenough - Lehman Brothers

Just one quick follow-up, Frank, and then I'll jump back in the queue, but for TREANDA, with the -- in pending NDA filing, any intention to start a combo trial with Rituxan and CLL?

Frank Baldino

Well, we have Dr. Lesley Russell with us today. He will be happy to comment on that for you.

Lesley Russell

Yeah, clearly we are thinking about what should we also be doing with TREANDA and an obvious one is to combine with Rituxan with TREANDA and CLL. We know from our lymphoma data that it’s a very synergistic combination and, I would expect to be that in CLL too. The other one that investigators are expressing interest is more on the lines of SGR regiment that we might want to think about adding TREANDA to fludarabine along with Rituxan too. That would be a more of Phase I program, but certainly Rituxan and TREANDA is a very attractive combination.

Jim Birchenough - Lehman Brothers

Thanks for taking the questions.

Frank Baldino

Sure.

Operator

And we will take our next question Ronny Gal with Bernstein.

Ronny Gal - Bernstein

Thanks for taking my question. First Frank I am just asking you again on VIVITROL situation, when do you think it will be time to start reviewing the product or are you still happy with the progress so far? You basically are looking for this to continue to grow into the future or you're going to go back and start looking whether this product is liable and then a good follow-on?

Frank Baldino

Ronnie I think those kinds of evaluation happen all the time, but I am going to remind you that VIVITROL first years sales we saw $25 million with PROVIGIL, that’s sort of the ballpark you see VIVITROL is today; and PROVIGIL is turning out to be a great success. I think what you are seeing is sort of a market development product in VIVITROL and slow growth, it’s a lot of education required. But every quarter, we still have more drug in the quarter before, its making progress in the right direction, all this, wish it were faster, I know how come these wishes it were faster. But in the end, it’s a good drug. And I think with time and I think its going to be as big as PROVIGIL is, but what we are seeing in the first full year sales of VIVITROL is not that it is similar to what we saw PROVIGIL is, first year. So it will take a little time.

Ronny Gal - Bernstein

Okay, thanks. And Dr. Russell, a couple for you. First around CEP-701 and TREANDA, can you give us a report, I know it’s not your trials, but where they study by the NHL on CEP-701 understands can we hear some results from there? And similarly on TREANDA, the Phase I against [hotshot] by the German cooperative study?

Lesley Russell

Oh I think the National Health Services is one in the UK is that’s what you are referring to?

Ronny Gal - Bernstein

Yeah.

Lesley Russell

To be honest I don’t know where they are in enrolment with that, I mean I think they added in an arm with 701 to their standard induction therapy for FLT3 mutated patients, this is a huge program and these ones tend to go on for a number of years, so where they actually are, I am afraid, I don’t know. In terms of the [hotshot] versus bendamustine Rituxan has been conducted in Germany. Certainly at ASCO this year the principle investigator said he was hoping to have top line data attached and I haven't heard otherwise.

Ronny Gal - Bernstein

Okay. Thanks. Then just a quick follow-on for that. In terms of few problems of 701, are you looking at the drug for maintenance therapy as well.

Lesley Russell

There is the ability once the actual part with the induction therapy is over, there is ability for those who are in remission to stay on mentioned 701.

Ronny Gal - Bernstein

So, right now it's just an investigation or you have not actually studied, studied just for that any particular indication?

Lesley Russell

Not for that particular indication. It is an extension of our ongoing program because one of the endpoints in the program is survival. So there is the ability to follow-up these patients for longer-term.

Ronny Gal - Bernstein

Great. Thank you very much.

Operator

We'll take our next question from Donald Ellis with Thomas Weisel Partners.

Donald Ellis - Thomas Weisel Partners

Thank you, good afternoon. Just a couple of questions. First one is on FENTORA, I guess, this would be for Frank. With the faster [Avastin] action and availability of FENTORA, can you describe the type of patient that would prefer ACTIQ?

When I look in the quarter I see ACTIQ plus the generic at 95 million roughly in sales and FENTORA 36, I just don't understand why FENTORA hasn't taken all the market?

Frank Baldino

Well, I think a lot of it has to do with patients comfort. Doctors don't like to change things that work. ACTIQ works well it's effective. The same active ingredient, it works very well. It's a titration play more than FENTORA is and certain population of patients enjoy the titration opportunities that ACTIQ presents. And yeah, unless there is a problem with the drug the doctor are not going to change.

Remember, we never started the FENTORA program as a switch program with ACTIQ. We thought ACTIQ had a nice little market; it was 30,000 patient or 40,000 patients or so that used ACTIQ at its peak day of sales and we are hoping to bring FENTORA to a much larger audience of cancer breakthrough pain patients and we think we can do that, so its really we are not looking for switches. I think we got caught little bit by surprise when the drug was launched, so we got so many switches out of the box of ACTIQ to FENTORA and I think that led people to believe that its going to grow faster than it is today, even though its on our internal schedule the way it is, so I think patients haven’t changed some of you guys, docs aren’t interested in change and they are doing well and they are happy with ACTIQ.

Donald Ellis - Thomas Weisel Partners

Okay, then my second question for Kevin, can you give us the allocation of your depreciation to SG&A and R&D for the quarter?

Kevin Buchi

I can indeed. $5 million depreciation was allocated to R&D, $3.5 million of depreciation was allocated to SG&A in the second quarter.

Donald Ellis - Thomas Weisel Partners

Great, thank you very much.

Kevin Buchi

Okay.

Operator

And we will go next to Eric Schmidt with Cowen & Company.

Eric Schmidt - Cowen & Company

Yeah, question for Bob I guess on PROVIGIL it’s been while since we have seen a price hike there, maybe there has been one reason that I am not aware of it, could you just give us your views on pricing?

Bob Roche

Hi, Eric, we have not had a PROVIGIL price hikes since the beginning of the year, we are mot scheduling one at this point in time and we’ll be evaluating the price sensitivity of this product as we go through the end of the year to determine whether or not we can do the same in 2008 or potentially be a little bit more aggressive.

Keep in mind that we do have a lot of room with PROVIGIL pricing today when we bring NUVIGIL onto the market and that is consideration just the any other exact position of the two and making certain that this is always viewed as the excellent value that it truly is.

Eric Schmidt - Cowen & Company

Okay. And do you think that the -- I don’t know, change in marketing practices that Frank eluded to in terms of the background here on the settlement have impacted perpetual sales trends at all?

Bob Roche

That’s really hard to say Eric, and keep in mind that we have been trying to keep ahead of the curve on sales and marketing practices for years now and don’t anticipate any major change in kind of outcome or performance as a result of these. They are changes which we need to be making, they are changes that are right that we make and that we're keeping up with other companies in the industry on, and hopefully keeping ahead of others with. The short answer is no, I don’t view these as being a major impact in the short-term on any of our products performance.

Eric Schmidt - Cowen & Company

Okay. And then, question for Kevin, I think you mentioned, Kevin, that there was an incremental of $17 million in VIVITROL spending in Q2 relative to Q1. Did you have responsibility for essentially the entire three months of Q2 there or is that partial quarter?

Kevin Buchi

It's almost all the quarter. I don’t think it was completely all the quarter, you know what I mean. But essentially, it was all quarter yes.

Eric Schmidt - Cowen & Company

So, not a big boost into the subsequent quarters?

Kevin Buchi

No, I think that’s a number that you should expect to see going forward.

Eric Schmidt - Cowen & Company

Great, thanks a lot.

Operator

We'll take our next question from Dave Windley with Jefferies & Company.

Dave Windley - Jefferies & Company

So, thanks for taking the question. Eric's last question answered part of mine. So that was good chunk in the sequential increase in SG&A with the VIVITROL. Can you comment on what rest of the sequential increase went to?

Frank Baldino

Yes, the rest of the sequential increase was essentially marketing spend on both PROVIGIL and FENTORA.

Dave Windley - Jefferies & Company

Okay. And then, Kevin, the incremental increase sequentially in the share count was that just average trading price of the stock or what drove that?

Kevin Buchi

The primary shares outstanding didn’t change significantly. I mean it changed because of option exercises and those types of things. The fully diluted number increases with share prices correlated to share price which -- it's kind of why we provide guidance the way we provide it. There is a table in our 10-Q which you can go to, which kind of allows you to calculate how many shares you should include in the fully diluted calculation based upon you forecast of what the average share price would be for the quarter.

Dave Windley - Jefferies & Company

Okay. And maybe a question for Bob. So, we were also looking at prescription growth by PCP versus specialist, and on the specialist side, looks like that year-over-year growth number has slowed pretty steadily over the last four quarters to now as a low single digit number. You commented that -- to Eric’s questions, it's your answer about the settlement and the issues around the marketing practices involved in those discussions. Your answer seemed prospective to me, is it also the same if we look retrospectively that it has not affected you marketing practices in the last six to nine months that would then attribute to this down in specialist prescribing on PROVIGIL?

Bob Roche

I hold to my comments, and now, as I look back I don’t believe that marketing practice changes had any impact there, I think what we are seeing is largely environmental issues at play. We manage care-related issues around getting products like PROVIGIL approved and prescriptions are actually filled, gets tougher by the day as you can imagine and these are within psychiatry that some of the specialist related prescriptions tend to be some of the more difficult to get through the system.

Dave Windley - Jefferies & Company

Yes.

Bob Roche

As we get in to the primary care and the prescriptions that we're getting out of that group continue to grow more rapidly, especially around approved indications such as obstructive sleep apnea, those issues fade away.

John Osborn

Maybe, another way to look at this, at about two years ago we sort of anticipated that the specialty markets would slow, and we look for [inaudible] and we discussed these just about with everybody publicly of how we were going to expand the market opportunity for PROVIGIL, and the decision we made was to bring it to a new universe of physicians, namely the primary care physicians. So we did that with our partner Takeda. And as we expected, as the specialty market decreased the primary care market increased. Today, as opposed to two years ago our biggest market is the primary care marketplace. More primary care physicians are running prescriptions than specialty docs and the highest growth market we have are the primary care physicians versus the specialty markets namely psychiatry. So, we saw the shift happening, we wanted to continue growth and we did that with our colleagues at Takeda. So, we see a transition from the specialty markets and the primary care markets. I think that's what you are looking at.

Dave Windley - Jefferies & Company

Right. And last question, I'll jump at, you mentioned to an earlier question that you are ramping up some programs with Takeda around the marketing and sales of PROVIGIL. You were also those who had moved into the second half of facing steeper compares from the second half of 2006. How should we view those two offsetting factors as affecting the growth rate? And one for Bob, why don’t you talk a little bit about the plans you have for PROVIGIL?

Bob Roche

Okay.

Dave Windley - Jefferies & Company

Consumer or the extraordinary opportunities.

Bob Roche

Absolutely, beyond the programs that I have already described David I think we are recognizing as PROVIGIL continues to grow and expand into broader markets that its really an opportunity for us to take it to a level that we haven’t yet explored historically and as we go though the end of the 2007 year we are going to be piloting a number of innovative programs and one that you may see yourself is the very first consumer activation or direct to consumer program for PROVIGIL that will be focused on obstructive sleep apnea, this is something which we have contemplated and planed for a quite a period of time now and are ready to go through the final stages of negotiation with the agency and ultimately piloting the series in the latter stages of this year and we anticipate that it's based on the return that we've seen in market research that this is going to have a pretty substantive effect on patient behavior and physician performance and that associated with the general I think highly energized messaging that we are delivering ourselves and then our partner at Takeda are delivering in both specialty markets and very importantly in primary care we’ll continue to drive growth across the board but especially in the all important primary care segment where this drug has got to ultimately continue to perform and to reach the lofty stages that we envisioned for.

Dave Windley - Jefferies & Company

Thank you, appreciate that.

Operator

And we will take our next question from Annabel Samimy with UBS.

Annabel Samimy - UBS

Hi, thanks for taking my call. I had a few question, the first one was related to access in each is not fair. Do you get any sense that FDA in general is a little bit more hesitant to free drugs of this nature and could that potentially be a hurdle for other generics to come into the market. And then separately on TREANDA, to be given any further thought to TREANDA and still how make position within the treatment paradigm object for the approved treatment paradigm but also the ones that are used in clinical practice.

And then finally in NHL, what kind of hurdle are you looking for in terms of responses. And what kind of, can you give us an idea of what we should be looking and where you thought your, what number you’ve got your head around in terms of the response of [that you want to see]

Frank Baldino

Annabel, before I let Leslie answer those clinical questions regarding the FDA’s sort of reluctance if you will, a reticence to approve another generic in the ACTIQ space. They are already approved to and my guess is they are not going to change anything. We just don’t know if any third generic is coming along. And I don’t think they are going to discriminate against companies, so they never have in the past. So, I don’t think there is any chance. Leslie, answer further during the rest.

Lesley Russell

For the TREANDA and non-Hodgkin's lymphoma, if we see a response rate that is in line with what we saw in the Phase II study which was an overall response rate of $0.75 then I think we will be fine. The differences between the two study is the Phase II with the overall response rate of $0.75 in the Phase III is that. The Phase II study actually includes some transform patients. So, they would moved more aggressive form disease. They are not included in the Phase III. So, I feel quite comfortable that we should at least replicate the Phase II later. I think your, I could just get you to repeat the CLL result where we've envisaged it's being used in the market place, can you just go back to that question?

Annabel Samimy - UBS

Yeah, just curious about the way you see it today and sort of see in that paradigm but various clinical practices that have become more common in CLL recently.

Lesley Russell

Yeah I mean I think that the CLL, the first line space where assuming approval that’s where TREANDA would be launched into, I think that we actually have any approved medication so that is actually chlorambucil which I must say I was surprised to see that it is still pretty widely used even in the United States, very commonly used in Europe predominantly by the sort of community physicians, so I think that what we would have is clearly a better chlorambucil so I think for the community physician TREANDA might be a very useful alternative to chlorambucil, I mean although it's not approved in the first line space we have for tiagabine and some other more aggressive regiment, I think CLL is a disease of the elderly and these are fairly toxic regiments, so I really see TREANDA has an alternative to some of those most toxic regiment and certainly a replacement for chlorambucil, so I think that it could have some pretty broad usage in CLL.

Annabel Samimy - UBS

Okay, great thank you.

Operator

We will take our next question from Michael Rockefeller with Morgan Stanley.

Michael Rockefeller - Morgan Stanley

Good evening. Frank as you think about your goals for the rest of the year, strategically what’s the single most important thing that you’d like to accomplish in 2007 and if you can't narrow it down to one and then maybe a couple of your top priorities?

Frank Baldino

I think, operationally and strategically, I think. First, I would like to get this Justice Department settlement done this year. I think that would be an important milestone for the company for two reasons. One is, it gets us beyond it and you guys stop asking about it. Okay, the second thing we'd like to do, I think is to broaden our portfolio. There's a great many opportunities out there. You saw R&D day, we have a lot of stuff in development. We have to move forward. We are pretty satisfied with our pipeline. It's pretty robust, but I still think we can acquire some product that fit our space. I don't want to say that they drop into what we're doing because it never seems to work that way, but there's products that we think we can license or acquire that would really round out the portfolio, give us a number of products in the market, a number of products in late stage development and certainly a nice early stage pipeline as well.

So from priority-to-priority perspective, I think continuing to acquire products that fit in for the CNS oncology and main space, and that's probably our highest strategic priority going forward. Building at Europe, we have plenty of infrastructures in Europe, we need more assets there. So, you should look to us to enhance the asset base in Europe. I think that's an important priority, I said it last year and we're focused on it again this year.

Michael Rockefeller - Morgan Stanley

Okay. Thank you very much.

Operator

And we'll go next to Brett Holley with CIBC World Markets

Brett Holley - CIBC World Markets

Yes. Hi, I guess just a question for Bob. I just wanted to get more detail on what kind of penetration PROVIGIL has in CPAP compliance, sleep apnea patients now. I am just trying to get an idea of how many patients do you think are really out there in that segment of the market?

Bob Roche

I am sorry. What kind of penetration PROVIGIL has into the marketplace?

Brett Holley - CIBC World Markets

Yes.

Bob Roche

Yes. First of all, let's start with the overall market size. There are -- depending on what source you look at between 15 and 25 million sufferers of obstructive -- of sleep apnea, many of whom are not diagnosed. Most of those who are diagnosed are being managed to some degree. But at any given point in time, there is probably between 1 and 2 million patients who are actually utilizing continuous positive airway pressure devices here in the United States. So a couple million people using these devices, and the PROVIGIL penetration into that audience is relatively low. And keep in mind that the label for PROVIGIL does not absolutely require that the patients be taking CPAP, that the CPAP compliance is that the position be treating the underlying condition in whatever way he or she sees fit, but usually as CPAP. But the amount of patients, the number of patients percentage that are properly treated with CPAP that still are sleepy is between 40% and 50% and every single one of these patients is a candidate for PROVIGIL. So, I mean of that's 1 million or so patients that are out there, that are using there CPAP, that are still quite sleepy, we see a tremendous market opportunity for the product.

Brett Holley - CIBC World Markets

And I have a follow up there is why at this point given the relative maturity of the PROVIGIL kind of franchise, is the penetration so low in those patients?

Frank Baldino

Well, I think. This is Frank talking. I mean, Bob, you can expand on this but this is the publication we've referred to earlier showing that CPAP compliant patients, about 50% of them still have significant excessive sleepiness. So much so, that it needs to be treated. This is new information. This is not the information that was available to us five years ago. With this new information, our job is to take that new information and then put PROVIGIL in that marketplace and we see this as Bob said 50% of a million patients using CPAP as a great many patients relative to where PROVIGIL is today. So, I wouldn’t say they are why so late, I mean the data just came out probably end of last year.

Brett Holley - CIBC World Markets

Okay, thank you very much.

Operator

And we will take our next question from Gary Nachman with Leerink Swann.

Gary Nachman - Leerink Swann

Hi, good afternoon. Bob first, what's the price per x we should be using for ACTIQ and FENTORA, and could you talk about the mix in our excess with dosage strength and the trends that we’ve been seeing there?

Bob Roche

Can you repeat the questions?

Gary Nachman - Leerink Swann

Yes, I'm sorry, the price per x we should be using for ACTIQ and FENTORA, and also just the mix in our access with dosage strength and the trends that we've been seeing there?

Bob Roche

Hold on a second. Okay. FENTORA, ACTIQ, average ACTIQ prescription at [whack] is approximately $2800. These data are three or four months old, right, because we only get these data on a quarterly basis.

Gary Nachman - Leerink Swann

Okay.

Bob Roche

$2800, and for FENTORA about $1500 to $1600.

Gary Nachman - Leerink Swann

Okay. I think last quarter you said that ACTIQ was about $2600. So, did you guys take a price increase, and is there actually some headroom there for more price increases?

Bob Roche

To answer your second question is quite possibly, and the answer to the first question is, no, we did not.

Gary Nachman - Leerink Swann

And then Lesley, how long would it take to run studies for FENTORA in the higher dosage strength. What's the time line there?

Lesley Russell

It largely depends on what FDA wants us to do. It should be pretty straight forward and we would require dose proportion analysis studies of higher doses which would actually, that’s all of which is to lower the higher doses of ACTIQ. So, in terms of relative comfort at the agency should be fine. But clearly we would need to take guidance from there. But, the program that we are running right now with straight quarters force now to go in for the higher doses which we think could lead to CMC supplements later next year.

Gary Nachman - Leerink Swann

Okay, so is this a clinical study in patients and how many patients is required?

Lesley Russell

No this is actually a straight forward, normal volunteer study, so we obviously do it among [ourselves in brocade] and it’s a pretty simple straight forward [pharmacokinetic] study.

Gary Nachman - Leerink Swann

Okay, thanks. And then couple of quick ones for Kevin, what are the 26.5 billion of R&D collaboration payments that hit in the quarter and if you could us the cash flow from operations in the quarter, if you have that, thanks?

Kevin Buchi

Sure I mean I think the R&D collaboration somewhere was 16.5 not 26.5, these were milestone payments associated with successful completion of – alright someone else is writing stuff for me.

Gary Nachman - Leerink Swann

How do you know that’s 26.5 for six months, 16.5 for the three months there?

Kevin Buchi

The 16.5 was for the quarter. These are third party collaborations. We did not disclose who we made the payments to, but that’s success payments based upon the successful completion of milestones within these collaboration agreements.

Gary Nachman - Leerink Swann

And should we expect more of those before the end of the year?

Kevin Buchi

I mean its part of the reasons, and honestly the part of the reason that we highlight them and perform them out to you, is it's difficult to anticipate precisely when these milestones will be met or impact if they will be met at all, so that’s a real hard one for me to answer going forward.

Gary Nachman - Leerink Swann

Okay, and then just cash flow --

Kevin Buchi

Sorry that’s not very helpful is it.

Gary Nachman - Leerink Swann

Cash flow?

Kevin Buchi

Cash flow from operations, six months was $151 million.

Gary Nachman - Leerink Swann

Thanks.

Kevin Buchi

No problem.

Operator

Okay, that concludes today’s second quarter conference all. We appreciate you participation. Thank you.

Operator

That does conclude today's conference. We do thank you for your participation, and you may disconnect at this time.

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