Executives
Chip Merritt - Senior Director of Investor Relations
Frank Baldino - Chief Executive Officer
Bob Roche - Worldwide Pharmaceutical Operations
Kevin Buchi - Chief Financial Officer
Lesley Russell - Worldwide Medical and Regulatory Operations
John Osborn - General Counsel
Analysts
Jim Birchenough - Lehman Brothers
David Buck - Buckingham Research
Donald Ellis - Thomas Weisel Partners
Gregg Gilbert - Merrill Lynch
Corey Davis - Natexis
Michael Rockefeller - Morgan Stanley
Bret Holley - CIBC World Markets
Eric Schmidt - Cowen and Company
Annabel Samimy - UBS
Gary Nachman - Leerink Swann
Ronny Gal - SanfordC. Bernstein
Cephalon, Inc. (CEPH) Q3 2007 Earnings Call November 8, 2007 5:00 PM ET
Operator
Good day everyone, and welcome to the Cephalon Third Quarter2007 Earnings Call. Today's call is being recorded.
At this time for opening remarks and introductions, I wouldlike to turn the call over to Mr. Chip Merritt, Senior Director of InvestorRelations. Please go ahead, sir.
Chip Merritt
Thank you. Today we will review Cephalon's financialperformance for the third quarter of 2007. Before we begin, let me remind youthat certain statements on this call may be forward-looking and are subject torisks and uncertainties associated with the company's business.
These statements may concern, among other things, guidanceas to future revenues and earnings, operations, transactions, prospects,intellectual property, litigation and other legal matters, development ofpharmaceutical products, clinical trials and potential approval of our productcandidates.
The company also may discuss certain non-GAAP financialmeasures within the meaning of Regulation G during today's call. Theinformation required by Regulation G is available in the earnings pressrelease, and in the Newsroom section of our website at www.cephalon.com.
Additional information and risk factors affecting thecompany's business and financial prospects, and factors that would causeCephalon's actual performance to vary from our current expectations, isavailable in the company's current Form 10-K on file with the SEC.
During this call, we will update full year 2007 guidance andintroduce 2008 guidance. Please note that the guidance will remain in effectunless the company provides subsequent modifications or updates.
Our earnings press release is available at www.cephalon.com.Investors with further questions should contact me at 610-738-6376. Thisconference call is being webcast via the Cephalon homepage, and will bearchived for one week after the call.
Speaking on today's call will be Dr. Frank Baldino, ChiefExecutive Officer, Bob Roche, Worldwide Pharmaceutical Operations, and KevinBuchi, Chief Financial Officer. Also joining us today, Dr. Lesley Russell, WorldwideMedical and Regulatory Operations and John Osborn, General Counsel. Followingremarks by Frank, Bob, and Kevin, we will be pleased to answer your questions.
Now, Frank Baldino.
Frank Baldino
Thanks, Chip, and good afternoon, everyone. Today we aregoing to discuss the highlights from the third quarter, talk about ouropportunities for growth, and provide insight on our 2008 sales and earningsexpectations.
Let's start with the business results for the quarter. Wecontinue to deliver strong financial performance this year, in the face of whatwe knew would be a challenging transitional year. Our adjusted sales during thethird quarter were $428.7 million, coming in at the high end of our guidancerange of $420 million to $430 million.
Adjusted net income was $72.5 million, exceeding the highend of our guidance of $57 million to $63 million by $9.5 million, truly anexcellent result. During the quarter, our R&D and business developmentactivities created great opportunities for future growth. Here are a couple ofthe key achievements.
We obtained rights to AMRIX, the only once-a-day skeletalmuscle relaxant approved in the United States.Bob Roche, our Head of Worldwide Pharmaceutical Operations will discuss thisexciting opportunity in greater detail later in the call.
We successfully completed our study with FENTORA, in opioid-tolerantpatients with non-cancer breakthrough pain, and later this month, we will filean sNDA seeking to broaden the label. We filed an NDA for the TREANDA for thetreatment of chronic lymphocytic leukemia, or CLL.
We successfully completed our Phase III program, evaluatingthe efficacy and safety of TREANDA, and the treatment of refractory non-Hodgkin'slymphoma patients. And we are on track to file an NDA for this indication bythe end of the year.
Also during the quarter, we reached an agreement inprincipal with the U.S. Attorney's Office in Philadelphia,to settle all federal and related state Medicaid claims concerning themarketing and promotion of our products.
Kevin will discuss the financial and accounting impact ofthe settlement later in the call. We operate in a highly regulated industry,and as such, we have always been committed to compliance in all areas of ourbusiness.
Over the past several years, we have worked to enhance ourpolicies and practices in our commercial operations, and are not onlyconsistent with the letter, but also the spirit of the law. In thisever-changing environment, we are committed to being on the leading edge ofthis evolutionary process.
To that end, we recently elevated the Chief ComplianceOfficer position to an Executive Vice President, reporting directly to me, witha dotted line to the Audit Committee of the Board. Our goal is to buildcompliance into the very fabric of our operations.
Obstructive sleep apnea is one of the most common sleepdisorders. In the United Statesalone, there are approximately 18 million patients suffering from thisdebilitating disease, almost 2 million of whom utilize Continuous PositiveAirway Pressure, or CPAP devices, the main treatment therapy today.
Recent publications demonstrated that significant numbers ofOSA patients are suffering from excessive sleepiness are not adequatelytreated, despite compliance with CPAP devices. In fact, an article in the Juneissue of Journal of Sleep stated that despite up to seven hours of CPAPcompliance per night of use, 50% of patients showed objective signs ofexcessive sleepiness.
This translates into almost 1 million OSA patients in Americawho may be excessively sleepy, despite being CPAP compliant. During thequarter, our CNS sales and marketing teams have been focusing additionalefforts on promoting PROVIGIL for the treatment of excessive sleepinessassociated with OSA.
Other articles in the Journal of the American MedicalAssociation, and the Annals of General Psychiatry reported that OSA is linkedwith several other medical and psychiatric conditions, including obesity,hypertension and depression. Understanding the comorbidities of these conditionscould help physicians better recognize patients who may be suffering fromexcessive sleepiness associated with OSA.
We believe that elevating the awareness among OSA sufferersthat treatment exists for excessive sleepiness associated with this disease maymake these patients more likely to seek treatments. In 2008, we intend to begina focused, direct-to-consumer campaign, highlighting PROVIGIL for the treatmentof excessive sleepiness associated with OSA.
With renewed messaging and an effective DTC campaign, and1,000 representatives detailing the product, we expect to continue to grow thisfranchise in 2008 and beyond. To secure the future way for this franchise, wecontinue to study broader medical applications for NUVIGIL to realize its fullpotential.
To this end, the studies with NUVIGIL are underway, tofurther develop the clinical utility of this next generation wakefulnessproduct. We soon will complete patient enrollment for a clinical trial withNUVIGIL, examining the effects of cognitive deficits of schizophrenia, and in aseparate trial, continue to enroll for a study in bipolar depression.
Later, in the fourth quarter, we will begin a new program toprobe excessive sleepiness associated with medical conditions, such asParkinson's disease and others, in the hopes of securing a broader wakepromoting claim in our NUVIGIL label.
We also will begin interim work examining the effects ofNUVIGIL on cancer-related fatigue. In addition, we are conducting a Phase IVprogram designed to further differentiate the product from PROVIGIL within theexisting label indication. We believe that data generated by all of theseprograms will enable us to successfully differentiate the launch of NUVIGIL.
Our pain franchise continues to show great promise. We successfullycompleted three registration trials that we believe demonstrate the broadclinical utility of FENTORA, in opioid-tolerant patients suffering frombreakthrough pain.
These studies are part of an sNDA, including a comprehensiverisk management plan that we will file with the FDA later this month. We expectthe standard review period, and believe our clinical data supports a broaderindication for this product.
Now let's turn to two products, AMRIX and TREANDA, whichwill lead our growth in the near term. Let's start with AMRIX, which weacquired in August. I have asked Bob Roche to say a few words about this newproduct opportunity.
Bob Roche
Thank you, Frank. AMRIX represents a terrific newopportunity for Cephalon. It is the only once-a-day skeletal muscle relaxant,or SMR, approved in America.And this along with its favorable efficacy and safety profile, will position itvery competitively in this big and growing market.
The active ingredient in AMRIX is cyclobenzaprinehydrochloride, and this molecule is well known to most physicians as Flexeril,a drug they have been prescribing for many, many years. Flexeril, and otherproducts in this space like Skelaxin and Soma, are typically dosed three orfour times a day, and while they do work pretty well, their dosing regimens cancreate major compliance problems for patients resulting in suboptimaltherapeutic outcomes.
For years, once-a-day dosing has been the Holy Grail in theSMR market, and now only AMRIX has it. Probably linked to this once-a-daydosing, AMRIX also has a very low incidence of somnolence, which is the mostproblematic side effect of the current SMRs. Our label clearly states thatAMRIX has lower rates of somnolence than Flexeril, when dosed three times aday.
The market for muscle relaxants in the United States is very large and growing, withapproximately 45 million prescriptions written in the past year.Cyclobenzaprine the market leader by prescriptions enjoys almost a 38% marketshare, or around 17 million scrips.
Clearly physicians know this product well, and are verycomfortable using it. The market research we've done indicates that aonce-a-day formulation, together with a low incidence of somnolence, will be astraightforward, compelling message to these doctors.
They tell us that they will use AMRIX because it will allowthem to provide tremendous clinical benefit and convenience for their patients.AMRIX is being sold by our CNS and pain sales forces, and the fit with existingproducts is very close.
Most of their current doctors already prescribe significantamounts of SMRs, but we are also adding new physicians to the call universe ofboth the CNS and pain teams. As these realignments are complete, we will beable to reach 40,000 to 50,000 of the top tier prescribers of skeletal musclerelaxants.
In October, we made AMRIX available to pharmacies, andconcentrated our efforts on stocking the distribution channel. We also beganselective call activity on high prescribers and key opinion leaders, to ensurethat they got some early experience with the product.
November marks the beginning of the widespread promotion ofAMRIX, and already the feedback is very positive. We think AMRIX is going to bea great product. It will grow into a significant revenue generator in its ownright, and help to bridge the company through the launches of TREANDA, NUVIGIL,and the extended indications of FENTORA in the years ahead.
Frank, back to you.
Frank Baldino
Thanks, Bob. Our Oncology business unit continued to makeexcellent progress during the quarter. On September 21st, we submitted an NDAto the FDA requesting approval of TREANDA, for treatment naive patients with chroniclymphocytic leukemia.
This NDA represents a significant milestone in our oncologyportfolio as our first NDA filing for this franchise. If approved by FDA,TREANDA would be the first new therapy approved for the treatment of CLL since2001. CLL is a slowly progressing disease of the blood and bone marrow, with anestimated 15,000 new cases diagnosed every year in the United States, according to the National CancerInstitute. TREANDA has an Orphan Drug Designation for this indication.
The Phase III trial in CLL evaluated the safety and efficacyof TREANDA compared to chlorambucil, in patients who were not previouslytreated for their disease. TREANDA met both of its primary end points, overallresponse and progression-free survival, and demonstrated an acceptabletolerability profile compared to chlorambucil.
We also recently announced positive results from our PhaseIII trial of TREANDA for the treatment of patients with indolent non-Hodgkin'slymphoma, or NHL, for a refractory to Rituxan. A disease that affects anestimated 25,000 to 30,000 new individuals every year in the United States.
The study evaluated the efficacy and safety of a singleagent TREANDA in the 100 patients. The overall response rate as assessed byIndependent Radiological Committee was 75%, and reached statisticalsignificance, and the median duration of the response was 40 weeks, or 9.2 months.
The results are consistent with what we saw in our Phase IIstudy, and if approved, this treatment will represent a needed alternative toexisting therapies. Results from these studies with TREANDA for CLL and NHLwill be presented at the American Society of Hematology meetings in December.
Beginning next year, we will be studying TREANDA incombination with the monoclonal antibody Rituxan, in patients with relapsed indolentand mantle cell NHL. The data that we have in hand in both CLL and indolent NHL,gives us great optimism that TREANDA will have an important role to play in thetreatment of these hematological cancers.
Meanwhile we will continue to make steady progress on ourclinical trial with lestaurtinib, or CEP-701. We expect to complete enrollmentby the end of the first quarter in 2008, and file an NDA for the treatment of acutemyelogenous leukemia, or AML, during the second half of 2008.
Annually, in the United States, there are 13,000 newly diagnosed AMLpatients, 25% to 30% of whom have an activating mutation of the receptortyrosine kinase FLT3. CEP-701 is a potent inhibitor of selective tyrosinekinase, including FLT3. And CEP-701 has shown to be cytotoxic to AML blastswith this specific mutation.
In addition, based on CEP-701's ability to inhibit JAK2, wehave begun a Phase II trial on myeloproliferative disorders. There have beenseveral publications suggesting that JAK2 may have a role to play in MDS.
During the third quarter, we initiated a Phase I study withCEP-11981, a potent orally active TIE-2/VEGFR inhibitor. Genentech's Avastinhas validated VEGFR as an appropriate target. It is a life-saving treatmentoption that is currently being evaluated in dozen of disease states.
Our preclinical data suggests that a product such asCEP-11981, which inhibits both TIE-2 and VEGFR may provide additional benefits,compared to targeting VEGFR alone, by preventing angiogenesis, when escapearound VEGF occurs.
Our proteasome inhibitor CEP-18770 has entered Phase Idevelopment. We are also developing a PARP inhibitor with CEP-9722, an H3antagonist, a tamper resistant opioid and other promising compounds. We havethe strongest research pipeline of both early and late-stage compounds in ourhistory, providing us with multiple opportunities for growth in the yearsahead.
Finally, while we continue to make steady progress inincreasing the sales and positioning awareness for VIVITROL, we have decided toright size the VIVITROL commercial activity. We reduced the sales force andsharpened the marketing program, which we believe will allow us to betterexploit our opportunities to drive sales.
These efforts should result in improved operatingperformance of this franchise. We continue to believe that VIVITROL will becomean increasingly important treatment option for patients suffering from alcoholdependence. We also expect, with a rationalized spending approach, VIVITROLcould meaningfully contribute to our future earnings.
By 2010, we expect to have launched TREANDA, lestaurtinib,and NUVIGIL, and relaunch FENTORA with an expanded label. With a solid corebusiness and a robust R&D pipeline, we have created a diversified businessthat can continue to deliver strong earnings growth for many years. Inaddition, we will continue our practice of seeking out M&A opportunities toaccelerate our growth.
Now Kevin will discuss our financial performance during thequarter, and our expectations for 2008.
Kevin Buchi
Thank you, Frank. As Frank mentioned in his introduction, wereported adjusted sales of $428.7 million for the quarter, compared to $457.2million for the third quarter of 2006, and basic adjusted income per commonshare of a $1.08, compared to a $1.71 per share for the same period last year.
CNS franchise adjusted sales increased 9% to $230.9 million.Pain franchise adjusted sales were $121.8 million, with FENTORA sales of $33.2million, and branded ACTIQ sales of $56 million, and other adjusted sales were$76 million, a 20% increase over the same period last year.
We came in at the high end of our sales guidance range,reported lower than anticipated cost of goods sold and operating costs, todeliver adjusted net income $9.5 million above the high end of our thirdquarter net income guidance.
Our goal is to maintain inventory levels of between two tothree weeks for each of our key products. At the end of the third quarter, wewere near the low end of this range. When compared to the third quarter of2006, R&D expense, as adjusted for certain pro forma items, decreased $7.9million.
SG&A increased $27.3 million over the same period lastyear to $186.5 million. This increase was due to lack of reimbursement onVIVITROL spent and increased selling expenses, principally associated with ourTakeda co-promote agreement.
During the quarter, we increased our existing reserverelated to the U.S. Attorney's investigation by $369 million to $425 million,to reflect the agreement in principal reached during the quarter. Because weare continuing to work to finalize the terms of this settlement agreement, wehave not yet recognized any tax benefit related to the aggregate $425 millionreserve.
Our adjusted tax rate for the quarter was 39.2%, or 37% on ayear-to-date basis. During the quarter, there were several adjustments thatwere made to arrive at adjusted net income. In addition to the adjustments tothe increase in the settlement reserve, we excluded $22.3 million related toongoing amortization of acquired intangible assets.
We excluded $15 million in recognition of a milestonepayment related to our NDA filing for TREANDA. We excluded a $5.3 million gainassociated with the extinguishment of debt. And we excluded the tax effect ofthese items. We have increased our full year 2007 earnings guidance.
Total sales guidance remains between $1.675 billion and$1.725 billion. The guidance for the CNS franchise is between $875 million and$900 million. The pain franchise is between $475 million and $500 million, andour guidance for other product sales is between $300 million and $325 million.
Adjusted R&D and SG&A expenditures are targeted tobe between $320 million and $330 million, and $715 million and $725 million,respectively. Guidance for adjusted net income has been raised to be between$296 million and $303 million, which equates to a basic adjusted income percommon share of between $4.45 million and $4.55 million, assuming 66.6 millionshares outstanding.
Our assumed tax rate for the year is approximately 37%. Keepin mind that we are increasing our guidance, despite the increased spend anddilution associated with the launch of AMRIX during the fourth quarter. We arealso introducing full year 2008 guidance based upon the following keyassumptions.
An additional generic ACTIQ will enter the marketplace bymid-year, TREANDA will be approved and launched around mid-year, interestincome will be reduced by $20 million, or around $0.20 per share, as a resultof the settlement with the U.S. Attorney's Office.
Our sales guidance for 2008 is between $1.8 and $1.85billion. This is an increase of $125 million over our current 2007 salesguidance. CNS sales guidance, which includes PROVIGIL and GABITRIL, is between$975 million and $1 billion. Pain sales, which include FENTORA, AMRIX, ACTIQ,and generic ACTIQ is between $500 million and $525 million.
To provide greater transparency into our growing oncologyfranchise, we offer oncology sales guidance of between $110 million and $120million. Our oncology guidance includes U.S.sales of TREANDA and TRISENOX, and European sales of ABELCET, MYOCET, TARGRETIN,and TRISENOX.
Our guidance for other sales is between $190 million and$205 million. Consistent with previous years, our sales guidance does notinclude other revenues. Our SG&A guidance is between $710 million and $730million, and R&D guidance is between $340 million to $360 million. Adjustednet income is between $344 million and $351 million.
This is a 16% increase over our current 2007 guidance, andequates to a basic adjusted income per common share of between $5.10 and $5.20,based upon 67.5 million shares outstanding, and a tax rate of approximately37%.
This concludes our opening remarks. We will now open thiscall to you and your questions.
Question-and-AnswerSession
Operator
Thank you. (Operator Instructions) We will take our firstquestion from Jim Birchenough with Lehman Brothers.
Jim Birchenough -Lehman Brothers
Hi, guys, and congratulations on the quarter, just aquestion on the settlement agreement. Given your requirements to maintaining acertain cash balance and the settlement that you will be paying: do you foreseeneeding to do any financing to fund part of the settlement?
Frank Baldino
Absolutely not. Let's have Kevin talk about your commentabout minimum cash balances.
Kevin Buchi
Hey, Jim, it's Kevin. We ended the quarter with cash of over$700 million in the bank. I think I would probably start to feel a littleuncomfortable on an operating basis if cash got below about $150 million. Asyou are aware, the business is generating a fair amount of cash, so a $425 millionsettlement in and of itself will not require a financing.
Jim Birchenough -Lehman Brothers
And, then just a quick question on your oncology salesguidance: What portion of that is assumed by TREANDA? And secondarily, just onTREANDA specifically: should we expect any Rituxan combo data at the upcomingASH meeting?
Frank Baldino
Jim, let's let Lesley Russell answer the expectations atASH, and then we will come back to Kevin for the breakout you requested.
Lesley Russell
We are pleased to have say we have three presentations atASH. The first one is the results of the CLL study that we have talked to youabout, only showing that the data was positive with statistical significance onthe primary end points. The second presentation will be around our own lymphomadata, so in the Rituxan monotherapy, a resistant monotherapy study.
And then finally, we do have a platform presentation by MathiasRummel, who has conducted a study comparing Rituxan CHOP to Rituxan TREANDA infirst line patients, and that will receive a platform presentation.
Frank Baldino
So basically: we have three presentations on TREANDA at theASH meeting, right?
Chip Merritt
Kevin, do you want to comment on Jim's second question?
Kevin Buchi
Yeah. I am going to dodge your second question, Jim, if Imay. One of the nice things about having several products in the mix is to geta little bit of a portfolio effect going on. And so I would rather not provideguidance on a product-by-product basis. And that is kind of consistent with whatwe do in the CNS franchise and in the pain franchise also.
Jim Birchenough -Lehman Brothers
Thanks for taking the questions.
Chip Merritt
Thanks, Jim.
Operator
We will move on to David Buck with Buckingham Research.
David Buck -Buckingham Research
Thanks for taking the question. Good afternoon. In the 2008guidance, Frank or Kevin: what level of prescription growth are you assumingfor PROVIGIL? And: also for FENTORA? Secondly: what gives you the confidencethat there is no additional generic ACTIQ until mid-2008?
And: if you don't want to give TREANDA specific guidance,can you give at least a base for 2007? What you think in round numbers theoncology franchise will do?
Frank Baldino
Hey, David, this is Frank. I will answer the generic question.There is absolutely no information available to us that is legitimate out thereon whether or not a generic will come in at any point in time, or whether itcomes in at all. We put an assumption in the model, not based on anyinformation, but just to be conservative.
We wanted to make sure that you guys know that we areconsidering it, and if no generic comes in until mid-year, as Kevin said, thenthere is no downside to us, and of course if it's delayed beyond that, if it comesin at all, then there is nothing but upside here.
David Buck -Buckingham Research
Just a follow-up Frank: what about the efforts on the riskmanagement program? Do you see that as perhaps an entry for generics?
Frank Baldino
For the generic ACTIQ products, you're talking about, ingeneral?
David Buck -Buckingham Research
Yes.
Frank Baldino
Yes, sure. I think the FDA does require a risk managementplan, and VAR and plots are our collaborators, if you will, on ACTIQ are underour license to use our risk management plan today. If a third party were tocome in, they would have to create their own and manage their own. And wemanage it for our partners. So that is just one data point and I am glad youbrought it up.
David Buck -Buckingham Research
Okay.
Frank Baldino
I think you had some more questions for Kevin, I believe.
David Buck -Buckingham Research
Yes.
Frank Baldino
Do you remember the question?
Kevin Buchi
I actually think they were for Bob. I think they had to dowith prescription growth on PROVIGIL and FENTORA. So if it's okay, I will puntit over to him.
Bob Roche
That's fine. Yes, David, hi. Bob here. I think the growthnumbers that are in the targets for 2008 certainly represent a mix ofprescription and price. I am not going to get into exactly what we anticipatefor either one right now, but I think, suffice to say, that we are anticipatinga pretty positive result of our efforts for PROVIGIL as we move through the endof 2007 and 2008.
This year, there has been a fair amount going on in the commercialefforts around PROVIGIL, as you can imagine. We have got a completely newpromotional message focused on obstructive sleep apnea and excessivesleepiness.
We have a lot of very exciting new data on that particularindication, which has really allowed us to get very meaty with the message, andbuild a very strong promotional platform. And I am really very encouraged bythe kind of results we are seeing there.
There have been certain changes in our promotional practicesbased on what we anticipate coming to an agreement on the corporate integrityagreement with regards. And finally with the preparation for the AMRIX launch,there has been a lot of territorial movement.
We have been focusing on different physicians. We have beengearing up for a whole new product and so forth. And so it's really notsurprising to see some kind of a softening of the growth trend, but keep inmind we are still growing quarter on quarter at 9% here a product that on themarket for almost 10 years.
With regards to FENTORA, this drug has had some negativepress, as we are all aware, and our Dear Healthcare Professional and HealthcareAdvisory Warnings certainly haven't helped our ability to keep the growth trendmoving forward, but I think we are going to have all that behind us.
We have got the sales force really focused on the positivemessages around FENTORA, and I believe that we are going to see growth goinginto 2008, and especially when we have the opportunity to promote the expandedlabel that Lesley is going to be giving us hopefully at some point late nextyear.
David Buck -Buckingham Research
Right. And just a final: a base for oncology for 2007?
Bob Roche
A base for oncology franchise 2007?
Kevin Buchi
I haven't formally provided it, but it's in the neighborhoodof $90 million to $100 million.
David Buck -Buckingham Research
Okay, thank you.
Frank Baldino
Thanks, David.
Operator
And we'll move on to Donald Ellis with Thomas WeiselPartners.
Donald Ellis - ThomasWeisel Partners
Thank you. Good afternoon. I just have three questions. Thefirst one is: will the misdemeanor violation of the FDA affect regulatoryapprovals in any way whatsoever?
Chip Merritt
John? John Osborn is here, our General Counsel, Don he cananswer that for you.
Donald Ellis - ThomasWeisel Partners
Thanks.
John Osborn
No, Don, I don't believe it will.
Donald Ellis - ThomasWeisel Partners
Okay. Next one is: what exactly does a corporate integrityagreement imply, as far as: how you guys run your business?
John Osborn
Well, I think, the way we have been working with thegovernment, it's pretty clear that the changes and the programs and thepolicies that we have been instituting over the last couple of years, and morefervently over the last year, have really sort of put us in line with thegovernment's thinking on the corporate integrity agreement. And we believe thatwhat we have in place today will be memorialized by that agreement, and whatyou are seeing is what you are going to get here.
Donald Ellis - ThomasWeisel Partners
Right. Great. Last quick question for Kevin: can you breakout D&A, and SG&A and R&D for us?
Kevin Buchi
Yes, I can do that. R&D depreciation, $5.3 million,G&A depreciation, $2.2 million during the third quarter.
Donald Ellis - ThomasWeisel Partners
Thank you very much.
Kevin Buchi
You are welcome.
Frank Baldino
Thanks, Don.
Operator
We will now moving on to Gregg Gilbert with Merrill Lynch.
Gregg Gilbert -Merrill Lynch
Thanks. I have a couple. First, on the settlement: what is thedifference between the claims you are settling, and the ones being made by Connecticut?Are they similar? Or: fundamentally different?
Chip Merritt
John?
John Osborn
Well, they are based on different statutes, Gregg. Withoutgetting into a lot of the technical stuff, the claims that we are settling arebased upon alleged violations of the Federal Food, Drug, and Cosmetic Act, andthey also cover any reimbursement claims under the Federal Medicaid program.
Connecticuthas raised questions that also relate to our promotion and marketing, in thatsense they are similar but the law that is basis of their concern, is a statecivil consumer fraud statute. So in that sense, it is very different.
Gregg Gilbert -Merrill Lynch
Okay. For Bob: can you quantify managed care access forAMRIX? Or: provide any statistics on the different tiers you either have orexpect to have for '08?
Bob Roche
Yes, I can. And what we are anticipating for AMRIX isrelatively straightforward access into managed care. We have done analysis outthere of currently marketed products, and we have done some research as to howthe plans are going to be dealing with AMRIX, and between the third tier andsecond tier sorts of programs, we are looking probably at about 90% of thecoverage for the product.
Prior authorizations do not appear to be a big issue here. Weare not expecting them for AMRIX, and I'll anticipate somewhere less than 10%of the scrips would be prior off, and we have got the mechanisms in place to beable to work with those as well.
Frank Baldino
Why don't you put that in context of our experience withFENTORA and PROVIGIL for him?
Bob Roche
I think that it's going to be a lot more straightforwardthan either FENTORA or PROVIGIL. As you can imagine, many of the physicians whoare prescribing PROVIGIL and FENTORA, are doing so for a variety of uses thatthey believe are absolutely correct for the product.
But managed care will always try to push back if theybelieve that they have got any kind of a foundation for potentially ducking ascript here, and these are pretty expensive scrips. Conversely, scrips for theSMRs are pretty cheap.
These are on average only about 15 days of therapy, and theyare not typically prescriptions that managed care would tend to really put up alot of barriers against.
Gregg Gilbert -Merrill Lynch
Thanks. And then lastly for Lesley, a NUVIGIL question: whatlabel additions or promotional claims, and can differentiate between the two ofthose, do you expect to get before the launch and after the launch? Thanks.
Lesley Russell
We are looking for sort of, we are looking at NUVIGIL in avariety of indications. So our longer-term goal is to explore opportunitiesoutside of sleep, so that is the area of cognition and schizophrenia and the bipolar.
We are also planning an additional indication, in a muchbroader indication for excessive sleepiness, that would take us outside of thepure sleep disorder. So excessive sleepiness associated with medicalconditions, such as Parkinson's disease, depression, or even traumatic braininjury. We would hope very much to have that program completed in 2010, in timefor launch.
In addition, we are also conducting a Phase IV program togive us some promotional claims. And for example, one of those programs is,based on the literature, where there is very high comorbidity of OSA indepression, we are actually looking at a study in NUVIGIL for the treatment ofexcessive sleepiness in patients with OSA and depression.
So that will allow us to say and talk a little bit about thecomorbidity. That is just one example of a promotional claim.
Gregg Gilbert -Merrill Lynch
Thanks.
Operator
And now we will go to Corey Davis with Natexis.
Corey Davis - Natexis
Thanks very much. The language in the press release withregard to the settlement also says that some states are involved in thesettlement. Can you elaborate on which specific states are involved? And:outside of Connecticut that hasalready been discussed, can we assume that more states might try to get intothis? Or: is that done at the state level?
Frank Baldino
Let me, before I turn over to John, talk about the specificsof the settlement, Corey. Let me give you sort of a blanket industry statement,about what's happening when these kind of settlements occur. You should, excuseus for the technology problem here.
Any way what happens routinely to every company involvingthese kind of settlements is that normally state, local, and private litigationensues to various degrees with every single company in space, and you shouldexpect that we are not going to be any different in that regard.
Now the question you have about the specifics of thesettlement related to states in general, John has an answer for you.
John Osborn
Yes, Corey, let me make sure this is very clear, because wecertainly try to be very clear in the language in the release. The release talksabout our settlement of Federal and State Medicaid claims and as I said momentago, that covers claims that are based upon reimbursement, both the all Federalportion and all State Medicaid portion reimbursement claims.
There may be, in certain states, programs at a state levelthat are other than the Medicaid program and so without giving you any sense ofwhether or not the claims are legitimate, I am simply trying to clarifyfactually for you that the vast majority of any claims that would be made byany government entity are covered by this settlement. There are Federal claimsand State Medicaid claims.
Corey Davis - Natexis
Hopefully you are seeing growth.
John Osborn
And the Connecticutclaim, again just to clarify, that is based upon a separate consumer fraudstatute. There are other payments that might be made by Connecticut,but they are those that are relatively small and outside of the Medicaidprogram.
Corey Davis - Natexis
I guess, to ask it another way: outside of Connecticut,can we expect any more big numbers?
Frank Baldino
I think, Corey, the way we look at this is that the bigsettlement with the Feds, as John just iterated, it encompasses morecomprehensive than people have imagined, and covers a lot of issues. There willbe, most likely, state, local, private litigation, but that is not going toaffect our business today and will not affect our business going forward.
John Osborn
Other states and private parties, Corey, but not bignumbers.
Corey Davis - Natexis
Not big numbers. Thank you. You didn't want to break outTREANDA, so, I am assuming that you don't want to break out AMRIX from thegroup?
Frank Baldino
No. It's not Corey.
Corey Davis - Natexis
But my question is: which one do you think will be bigger?
Frank Baldino
Look, I would put my money here and there.
Corey Davis - Natexis
That is a fair question.
Frank Baldino
It's a really great opportunity, it's approved, it's on themarket, it got a great label and that's our near-term focus. We are excitedabout TREANDA and we'll see where we are at the end of the year with AMRIX.
Corey Davis - Natexis
So, AMRIX is going to be bigger. My last question is forKevin: tax rate at 37%?
Kevin Buchi
That is correct, Corey.
Corey Davis - Natexis
What is that?
Kevin Buchi
I am sorry, go ahead?
Corey Davis - Natexis
I was going to say, tax rate at 37%, higher than where it'sbeen at 36%: anything going on we should be aware of?
Kevin Buchi
No, I don't think so. I think all you are seeing, if youlook at kind of the tax rate that a U.S.taxpayer would pay on a top marginal basis, you are at 38%, 39% between Federaland State. Clearly, as we develop new products, we are going to try to do thatin a way, which is more tax efficient than our current structure, but I think37% is a reasonable estimate for 2008.
Corey Davis - Natexis
Congrats on getting the settlement done, I know that hasbeen a big burden for you.
Frank Baldino
Thanks, Corey.
John Osborn
Thank you, Corey.
Operator
And now we will move on to Michael Rockefeller with MorganStanley.
Michael Rockefeller -Morgan Stanley
Hi. So, question for Lesley. I was just wondering: if youcould remind us some of the benefits of using TREANDA versus the currentstandard of treatments, in both the NHL setting, and the CLL setting? Thanks.
Lesley Russell
Let me start with CLL and I think the study that we've doneCLL was an active comparative study with chlorambucil, which is an old drugused pretty commonly in Europe.
Surprisingly, because I was surprised by this, it is stillused a reasonable amount by community oncologists as their treatment of choice,because it is easy to give. And I think TREANDA will be a very good alternativefor chlorambucil in those types of practices.
I also think that advantages against some of the moreintensive regimens is that it is probably better tolerated and I think once youstart giving fludarabine, cyclophosphamide, and Rituxan combinations, it is nota regimen for the lighthearted.
It is a fairly toxic regimen and bare in mind that many ofthe patients are elderly, I mean the median age for this disease is in the '70s.So, this is an elderly population that can't tolerate huge amounts ofchemotherapy and I think bendamustine or TREANDA is pretty well tolerated,especially in the dose that was used in the CLL study.
As we move to non-Hodgkin's lymphoma, the space that will bewith TREANDA we will be entering is that space occupied currently by theradioisotopes. So, that was an [impact]. And the reason why those drugs arereally not used very extensively is because they are very complicated drugs togive, they are given by the nuclear medicine department, they have cold chainand then have to have to isotopes attached to them, so they are difficultcompounds to use, but they are very effective. And I think our data withTREANDA is as good as those drugs and we have a much more convenient drug togive, so I think that is a good alternative to those regimens.
Michael Rockefeller -Morgan Stanley
And just to follow-up, in the NHL setting. What does theprofile of TREANDA look like versus CHOP?
Lesley Russell
Well, I mean, I think that it's a single agent, so the maintoxicity is hematologic, not surprising, so neutropenia, a bit of thrombocytopenia.Once you start going to regimens like CHOP, you are adding in Adriamycin, sowith cardiotoxicity you are adding in vincristine with the neurotoxicity.
So, as a single agent, this is bound to be better toleratedthan CHOP and we know from our Phase II data, where we combine TREANDA withRituxan, it was very well tolerated. We haven't done an active comparativestudy, but side-by-side the tolerability of bendamustine/Rituxan is clearlybetter than CHOP or our CHOP.
Michael Rockefeller -Morgan Stanley
Thank you.
Operator
And now we will move on to Bret Holley with CIBC.
Bret Holley - CIBCWorld Markets
Hi. Thanks for taking my question. Lesley, I wanted tofollow-up on the question of: TREANDA versus CHOP and really going into ASH. Whatyour expectations are for the relative efficacy of TREANDA versus CHOP? I wouldexpect that the TREANDA would be better tolerated, but the question is: do youhave to have as good efficacy to really kind of drive adoption of TREANDA inthat setting?
Lesley Russell
Well, I think the data you are going to see at ASH, you haveto bear in mind; it's not my study, so I am not in a position to tell you theresults. But I think the comparison that Dr. Rummel did undertook was Rituxan/CHOPversus RITUXAN/bendamustine. And he clearly believed going into the study thathe could go for comparable efficacy and I think he powered his study to havefor a non-inferiority of no more than 10%.
So, he is expecting overall response rates to be prettysimilar and clearly expecting the tolerability of a two-drug regimen to bebetter than a five-drug regimen. And you are going to see that data at ASH, soyou will be able to judge it for yourself.
Bret Holley - CIBCWorld Markets
Okay. And then, Kevin, just for one of us, something yousaid in the question-and-answer period: did you say that the 2006 oncology,2007 oncology sales would be about 90 to 100?
Kevin Buchi
Yes, I did.
Bret Holley - CIBCWorld Markets
Okay. So: can we just extrapolate that you're talking aboutTREANDA sales in the range of 10 million to 20 million in 2008?
Kevin Buchi
I deliberately tried to dodge that. I will dodge it againwith your permission.
Bret Holley - CIBCWorld Markets
Okay. But that is not crazy math on my part, correct?
Kevin Buchi
Your arithmetic is not crazy.
Bret Holley - CIBCWorld Markets
Okay. Thank you very much.
Operator
Now we will go to Eric Schmidt with Cowen and Company.
Eric Schmidt - Cowenand Company
Thanks for taking my question. Another one on TREANDA, maybefor Bob or Frank. Just wondering: how you think about pricing this drug? And:if there are any “comparator oncology agents” you would point us to, as thingsthat you are looking at when you make this decision?
Frank Baldino
I think, Eric, this is a great question, but unfortunately,we are not in the position to talk about how we're going to price this yet. Wewould like to get the NDA filed on the NHL. We would like to spend some timeworking with our experts and talk about how this thing should be priced.
Sometime before the launch, we will be more forth comingabout pricing expectations. I know this makes it a little tough for you guys togenerate models, but unfortunately, we are just not in a position to do thatnow.
Eric Schmidt - Cowenand Company
Okay. Couple of nits on the guidance for Kevin, if I might?Firstly, revise the CNS franchise guidance for 2007, if I do the math therethat implies a pretty significant down quarter-over-quarter in Q4. Are thereany sort of inventory issues we should be aware about or anything there or am Ireading too much into your relatively broad guidance?
Kevin Buchi
I think you are probably reading too much into therelatively broad guidance. I think we are expecting a relatively flat Q4 overQ3, which is kind of what we've normally seen with the product. There is nochange in inventory.
The only inventory change that I noticed Q3 versus Q2 was aslight drawdown in branded ACTIQ inventories, which you would expect as theproduct is now generic. Inventories are a very low level and I am not expectingany significant change over year-end.
Frank Baldino
Don't forget, Eric, Bob's comments about the disruptionaround the AMRIX launch, and the readjustment and alignment of territories thathas been involved. So, that's also factored into Kevin's thinking in the fourthquarter.
Eric Schmidt - Cowenand Company
Okay. And then: is there a basic share count for 2008 thatgoes along with that EPS guidance?
Kevin Buchi
Yes, there is. It was 67.5 million shares.
Eric Schmidt - Cowenand Company
Okay. And last question is just going forward: given theguidance on oncology franchise sales, are you going to be breaking out thosesales for us or not?
Kevin Buchi
Yes, we will break them out on the press release when wehave actual results as we do with the other franchises, yes.
Eric Schmidt - Cowenand Company
Starting next year?
Kevin Buchi
Yes, starting next year.
Eric Schmidt - Cowenand Company
Thanks a lot.
Operator
And we will take the final question. Actually, we will moveon to Annabel Samimy with UBS.
Annabel Samimy - UBS
Hi. Thanks for taking the question. Just on TREANDA for aminute: have you done any, have you conducted any kind of pre-marketingresearch that gives you a sense of the level of awareness of TREANDA at thispoint and laid out what kind of market preference it may have based on itscurrent product profile?
Bob Roche
Yes, Annabel, Hi, Bob here. We have been building up momentumwithin the oncology franchise, really since the ASH meeting last year and arenow gearing up the overall business unit in preparation for the TREANDA launchin early 2008.
We are out there right now recruiting for our sales team, weare building up the MSL team, we have got a lot of outreach to key opinionleaders going on through the end of this year, focusing on ASH, and thenthroughout early 2008.
So I think there is going to be a lot of enthusiasm, and alot of excitement building up around the product, especially when the databegins to flow through the system as we go through early 2008.
Annabel Samimy - UBS
Have you done any market share preference estimates at all?
Bob Roche
We are not getting those right now. I suspect that prior tolaunch, we will be doing all of the market research required. Based on theevolving profile of the product, to really get a sense as to how it is going tostack up against other treatment opportunities.
Annabel Samimy - UBS
Okay. Then one other question, if I may. Not to believe thatthe point, but with the settlement, and you mentioned that this was the bignut, and there should be smaller settlements afterwards: did that include Connecticutor not?
Frank Baldino
John will answer for that you, Annabel.
John Osborn
Annabel, I didn't mean to suggest that there would be othersettlements. I just wanted to clarify that the potential liability, the scopeof the sales that we are talking about here, when you are talking about Federaland State Medicaid, would dwarf any potential claim by a state non-Medicaid-basedallegation. So I really that's all I am saying. We are not saying there will beany other settlements.
Annabel Samimy - UBS
And this excludes discussion about Connecticut?
John Osborn
We continue to have discussions with them, but I am notsaying anything about where that might go.
Annabel Samimy - UBS
Okay. Thanks.
Operator
And now we will move on to Gary Nachman, with Leerink Swann.
Gary Nachman -Leerink Swann
Hi. Good afternoon. First, Bob: could you describe the rightsizing for VIVITROL? Were those sales reps moved over to something else, orwere they let go? And: what is exactly the plan to grow the sales force forTREANDA next year?
Bob Roche
Thanks a lot for the questions, Gary.I am not going to get into specifics about the numbers of individuals. Sufficeit to say that now between ourselves and Alkermes, we have got about 70 folkswho are fully focused, 100% of their time on this product opportunity.
Most of those obviously are here at Cephalon. We have movedsome of the guys who were selling VIVITROL into other roles here. We arestaffing up the oncology team, as we speak. We are finding new opportunities inthe CNS and AMRIX sales teams, and we will continue to do that through the endof the year.
With regards oncology, I don't know that we have spokenabout the specific size of this group, but it's certainly going to becompetitive with the other mid-sized oncology teams that you see out there.
We are going to have all of the field-based resources thatwe need in place shortly after the first of the year. That's sales, that'smanaged care, that's MSLs, and that's other field-based key opinion leaderdevelopment groups, and so forth. So, I am really excited about this. We havegot a great team building in that area, and I think the launch of TREANDA nextyear is going to be a very exciting one.
Gary Nachman -Leerink Swann
What is that number? Is that 75 to 100, in that range?
Bob Roche
In that range, yes.
Gary Nachman - LeerinkSwann
Okay. And also, since we are on this topic, for AMRIX: howmany sales reps in total will you have detailing the product? And: in whatposition?
Bob Roche
The AMRIX team is going to be built on both our CNS and painorganizations, right now those numbers close to 500, and AMRIX will be a fulllaunch mode detail for both of these teams as they go through the end of 2007,and throughout at least the early part of 2008.
We are going to give this product absolutely everything thatit needs, in terms of sales force resource and out of pocket spend, to makesure that it is a big success.
Gary Nachman -Leerink Swann
Thanks. Frank did you say, in your prepared remarks, thatyou will be working on Rituxan/TREANDA combo on your own next year? And I guessmaybe this is for Lesley also: do you have plans to actually go for that firstline indication down the road? You can both answer.
Frank Baldino
I think Lesley will tell you exactly what we plan to do, butsuffice it to say, we like all of you, are very excited and anxious about thedata that is going to be presented at ASH. So we have got to look at that data,we have got to see how the trials are done, and if that trial passes a veryhigh standard of excellence, and one that we think will suffice for aregistration study, we would very much like to file it.
So I have to see what the study looks like and what theaudits tell us. And based on that data information, I think it will guideexactly what we do in the end. And Lesley, do you want them what we haveplanned?
Lesley Russell
Well, little to add on top of that, we are clearly lookingat a program with TREANDA in a number of indications; clearly combining it withRituxan is a very obvious thing to do. I think there is clearly synergisticactivity between TREANDA and Rituxan. So there is opportunities in lymphoma,there is opportunities to explore more in CML, and other indications whereRituxan is used, so we are very excited about it.
Gary Nachman -Leerink Swann
Okay. And then, last question for Frank, I know you guyswant to continue to grow PROVIGIL, but, let's just say that PROVIGILprescriptions don't accelerate, then: does it make sense to consider launchingNUVIGIL sooner than 2010?
I am sure you guys talk about it a lot, but: how often doyou revisit that strategy? And: is there a possibility that you could launch itsooner, if PROVIGIL doesn't turn out to be the way you want it?
Frank Baldino
Great question, Gary.I think Bob, he probably thinks we ask that question hourly here. But there area lot of factors that influence our judgment here. One is our belief thatPROVIGIL has got some growth in it. We have talked about guidance in 2008, thatpoints to a pretty successful PROVIGIL year.
We think the scrips growth could be driven by two things.One is all the new data we have been telling you about, and some data oncomorbidities with OSA and the excessive sleepiness associated with OSA thatstill exists, I think it is over 50%.
If you look at the OSA scrips today, specifically, at leastmarket research point, OSA has grown from a 3% market share to roughly 11% orso, in just a three to four month of period of time with the new messaging, sowe think there is a high-growth opportunity there.
And Bob will tell you also I think is that the direct-to-consumercampaign that we have planned should add some demand for PROVIGIL in themarketplace. So your assumption of what we do with NUVIGIL is predicated on, Iguess, your assumption that PROVIGIL will not grow. We are just not in the sameplace on that.
We think it still will. That's however, we find that we arewrong, then all options are on the table.
Gary Nachman -Leerink Swann
Okay. That is helpful. Thanks.
Operator
We have time for one more question. We will take that fromRonny Gal, with Bernstein.
Ronny Gal - Sanford C. Bernstein
Good evening, guys, and congratulations on a great quarter.
Frank Baldino
Thank you, Ronny.
Ronny Gal - Sanford C. Bernstein
Just a couple of questions, just for clarification. First,regarding the integrity agreement with the Inspector General, you still have alot of doctors using both ACTIQ and PROVIGIL off label very effectively for thepatient, in multiple niches, both pain specialists and MS docs using PROVIGIL.
Are you going to be able to continue to support those guysunder the integrity agreement? That is: if a doctor does not specifically treatcancer, or deals with a niche that is not covered by your current labels, wouldyou be able to just continue to give them scientific information?
Frank Baldino
One question at a time, Ronny, because I am getting older,and I am going to forget the questions if you ask too many in a row. You canask again when I am done here.
Ronny Gal - Sanford C. Bernstein
No, we just go to help you with that.
Frank Baldino
Yeah, that's helpfully. Regarding your corporate integrityagreement comment, I think we have in place today, and I think I said thisearlier, and we have been working very closely with the government on thisissue, we have in place today, what we believe, and we've had it in place forthe last six months, what we believe are the essential components of acorporate integrity agreement.
And the final agreement from our understanding, and what weare planning on will simply memorialize all these tremendous changes that wehave made. So where we are today in the marketplace, I think, is where we willbe in the future. And the corporate integrity agreement will focus onmethodologies and opportunities that we need to pursue to promote our drugs on label.
It doesn't speak to, nor does it address, how physicians usethe drug in the marketplace. That is between them and the patients. So I thinkwe will be in a good place.
Ronny Gal - Sanford C. Bernstein
Okay. And just a follow-on for Lesley, I think there wassome comments about the ability to use the Rummel study as a basis for filing. Isthat the impression you got about that study? Because that was not the one Igot from talking to Dr. Rummel. Is there room that this study could be used asa basis for submission for the FDA?
Lesley Russell
I think we have to look at the data. And with ProfessorRummel's permission, we will look at the data, and see whether it meets thestandards required by FDA for submission. And once we have had the ability tolook at how he collected the data, what the documents all say, how the siteshandled data, we can make a determination on whether we could potentiallyexplore filing that with the FDA.
We don't know yet, but it clearly is, that the study wasconducted to a standard that would meet FDA expectations, and we certainly wantto explore that.
Frank Baldino
I think, Ronny, my comments earlier, I think we are going toall learn a lot when we see the data, and better understand how it wasconducted. It's going to have great impact, not only on whether or not we filedthe study, but whether or not we do a trial on our own.
So there is going to be a whole lot of decisions made basedupon what we learn at ASH, what we learn with our discussions with the investigator,and what we learn about the conduct of the study.
Ronny Gal - Sanford C. Bernstein
Great. Thank you very much, guys.
Chip Merritt
Okay. Thank you all for joining us today, and that concludesour third quarter conference call. Take care.
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