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Executives

Bill Newbould - VP, Corporate Communications

Nancy J. Wysenski - COO

David A.H. Lee, M.D., Ph.D. - EVP of Research & Development and Chief Scientific Officer

Charles A. Rowland, Jr. - EVP, CFO and Treasurer

Analysts

Adam Greene - JP Morgan

Ian Sanderson - Cowen & Co., Inc

Gregg Gilbert - Merrill Lynch

David Windley - Jefferies & Company

Gary Nachman - Leerink Swann

David Buck - Buckingham Research Group

Rich Silver - Lehman Brothers

David Lickrish - Broadpoint Capital

John Boris - Bear Stearns

Ken Trbovich - RBC Capital Markets

Annabel Samimy - UBS

Tim Chiang - FTN Midwest Securities

Angela Larson - SIG Investment

Michael Tong - Wachovia Securities

Lei Huang - Summer Street Research

Endo Pharmaceuticals Holdings, Inc. (ENDP) Q4 FY07 Earnings Call February 22, 2008 11:00 AM ET

Operator

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2007 Endo Pharmaceuticals Earnings Conference Call. My name is Eric. I will be your coordinator for today. We will try to keep this conference to one hour today. At this time, all participants are in a listen-only mode. We will facilitate the question-and-answer session towards the end of the conference. [Operator Instructions].

I would now like to turn your presentation over to your host for today's call, Mr. Bill Newbould, Vice President of Corporate Communications. Please proceed sir.

Bill Newbould - Vice President, Corporate Communications

Thank you. Good morning and welcome everyone. With us on the call this morning are Nancy Wysenski, Chief Operating Officer; Charlie Rowland, Chief Financial Officer; and David Lee, Chief Scientific Officer.

I would like to begin by reminding you that during the course of this call, Nancy, Dick [ph] Charlie, or David may make forward-looking statements concerning such topics as future results, product performance, anticipated timing of FDA approval of certain of the company's drugs, or generics thereof, and possible timing of the commercial launch of certain of the company's products, as well as other non-historical facts that reflect Endo's current perspective on existing trends and information.

By their nature, these forward-looking statements involve known and unknown risks and uncertainties that may cause the company's actual results to be materially different from any future results expressed or implied by these forward-looking statements. Listeners should not rely on any forward-looking statement, and the company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Important factors that may affect Endo's future results include, but are not limited to, those factors discussed under the heading Forward-looking Statements' in Endo's SEC filings and under the heading of Risk Factors' in Endo's 2006 Annual Report on Form 10-K, filed with the SEC on March 1, 2007. We urge you to review these factors as well as those risk factors in Endo's 2007 of Annual Report on Form 10-K which we expect to file shortly.

In addition, during the course of this call, Nancy, Charlie, or David may refer to non-GAAP financial measures that are not prepared in accordance with accounting principles generally accepted in the United States and that may be different from non-GAAP financial measures used by other companies. Investors are encouraged to review Endo's earnings press release issued earlier today for Endo's reasons for including these non-GAAP financial measures in its earnings announcements and to see the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures.

Before we begin the quarterly review, I'd like take a few moments to introduce you to Nancy Wysenski. Nancy joined Endo as Chief Operating Officer in September 2007 with about 30 years of experience in the healthcare industry. Prior to joining Endo, she was President of EMD Pharmaceuticals, the U.S subsidiary of Germany-based Merck KGaA. In this role, Nancy had responsibility for the operations of this division in U.S and also for Dey Laboratories, which is a specialty respiratory pharma business. Her extensive background also includes senior executive roles at NetGenics, a start-up company and Astra Merck.

Now, I would like to turn the call over to Nancy.

Nancy J. Wysenski - Chief Operating Officer

Thank you, Bill and good morning to everyone. I'm pleased to have the opportunity to participate in today's call. Since joining Endo, I have been extremely impressed with the company's strategic focus, highly talented and motivated workforce, strong fundamentals and evidenced by our most recent financial results. I believe all the pieces are in place for Endo's continued growth and success, and I'm really excited to be a part of it.

Over the next few minutes, I'll briefly review some recent developments. Then I'll turn the call over to David Lee, our Chief Scientific Officer, who will provide an update on our pipeline, and then to Charlie Rowland, our CFO, who will take us through the fourth quarter and full year financials, before we open up the call for your questions.

As disclosed on January 28th, Peter Lankau resigned as President and CEO and as a Director to pursue other interests. We are very grateful for Peter's devoted service since 2000 and for his substantial contribution to the growth of Endo during that period. We wish him all the best, in the future. The Board has retained the executive search firm, Russell Reynolds and is currently interviewing prospective CEO candidates. Until our new CEO is appointed, Charlie and I have assumed day-to-day responsibility for the running the company. Charlie's areas of responsibility include Investor Relations in addition to finance. I am responsible for operations and we are sharing oversight of R&D in the generics business, with continuing counsel and support from David Lee.

I would like to emphasize that the Board and management continue to be fully aligned on the company's strategic plan and on all business development activities that are continuing without interruption. Our executive team is well versed in all aspects of the new business opportunities we are pursing, as is the Board's transaction committee and we continue to work with outside advisors as appropriate.

In another development following the end of the fourth quarter, we announced on January 25th, that we filed a lawsuit against IMPAX Laboratories, in connection with IMPAX's abbreviated new drug application or ANDA for OPANA ER. The lawsuit is in response to IMPAX's notice to Endo and our partner Penwest, announced on December 17, 2007, advising that as of November 23, 2007, the FDA accepted for substantive review IMPAX's ANDA containing a paragraph for certification. This follows the previous suit that we filed on November 15, 2007 in response to IMPAX's initial notification of the same ANDA, the acceptance of which the FDA subsequently rescinded. As it stands now, we believe we are entitled to a 30-month stay, beginning on December 14, 2007.

Two additional patents that expire in 2013 were listed in the FDA's Orange Book for OPANA ER during the fourth quarter. IMPAX did certify against these patents as well during the fourth quarter. These additional patents bring the total number of Orange Book listed patents for OPANA ER to four, and we and Penwest have a number of patents applications currently under various stages of review at the U.S. Patent and Trademark Office.

As we have previously stated, Endo intends to pursue all available legal and regulatory channels in defense of OPANA ER, including enforcement of our intellectual property rights and approved labeling. In addition, we remain enthusiastic about the commercial potential for the OPANA franchise, and we are committed to a lifecycle management strategy for the OPANA franchise, that includes not only intellectually property efforts but also product development and regulatory initiatives.

Late last week, we and Penwest announced that we have received a notification of a Paragraph IV certification against OPANA ER from Actavis South Atlantic LLC, which certified against all four Orange Book listed patents. As in the case of the IMPAX filing, we intend to vigorously pursue all available legal and regulatory avenues in defense of OPANA ER, including enforcement of our intellectual property rights.

Now, I would like to turn the call over to our Chief Scientific Officer, David Lee, who will provide a brief update on the pipeline.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Thank you very much Nancy. At the end of December, we further enhanced our pipeline when we signed an agreement with Alexza Pharmaceuticals for the exclusive clinical development and commercialization rights in North America for Alexza's Staccato fentanyl product, which we have since renamed as EN-3294. EN-3294 is a handheld drug-delivery system that uses Alexza's proprietary Staccato Inhalation Technology to deliver fentanyl for the treatment of breakthrough pain. Early clinical data suggest that EN-3294 which is patent protected until 2022 could potentially have a rapid onset of action comparable to intravenous administration of fentanyl, and we believe that the product could also be tamper-resistant. We have evaluated many technologies and product opportunities in the pain field and believe that the Alexza's Staccato technology is best-in-class for the inhalation approach to pain management.

Also back in December, we have reported positive results from the previously announced planned interim statistical analysis of the Phase III placebo-controlled double blind trial of our development product Rapinyl. The data from the analysis of 61 patients demonstrated that Rapinyl met its primary endpoint of some of pain intensity difference from baseline to 30 minutes, and the results were highly statistically significant with the P-value of 0.0004.

In addition, all the secondary endpoints were met. Statistically significant separation from placebo of the mean intensity pain difference was seen as early as ten minutes. Enrollment is continuing in the safety portion of this trial and also in the second Phase III trial, which we need to complete in order to meet the requirements for additional safety data to allow us to file a New Drug Application.

At this time, we are not intending to provide any further updates on our pipeline. We have initiated a comprehensive review of our late-stage programs and we will have further information when we've completed this process. We are anticipating that the results of this review will be available for our new CEO and our new Head of R&D.

I would now like to turn the call over to Charlie Rowland, who will take you through the financial results. Charlie.

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Thanks David and good morning everyone. Earlier today, we announced our financial results for the fourth quarter and full year ended December 31, 2007. I am pleased to report another record-breaking year, with annual revenues exceeding the $1 billion level for the first time in our ten-year history, as well as record annual earnings per share and record cash flow from operations.

Driven by the continued strong growth from each of our major products, net sales in the fourth quarter rose 17% to $304.6 million compared with $259.5 million in fourth quarter of 2006. For the year, net sales were $1.086 billion in 2007, a 19.4% from the $909.78 million in 2006. The 2006 performance included $57.1 million contributions from Oxycodon ER, a generic product that Endo ceased selling on December 31, 2006. This strong growth was led by Lidoderm, our topical analgesic patch indicated for postherpetic neuralgia, a form of neuropathic pain. For the fourth quarter of 2007, net sales of Lidoderm were $208.7 million, a 20% increase from a $173.5 million for the 2006 fourth quarter.

In 2007, net sales of Lidoderm grew nearly 25% to $705.6 million versus $566.8 million in 2006. The continued growth of Lidoderm can be attributed primarily to the expansion of our sales force in mid 2006 and again in the second half of 2007, as this has increased the number of physicians we detail and extended our reach and frequency among the middle [ph] child specialist and primary care physicians who treat patients with postherpetic neuralgia.

We estimate that both prescription growth and dispensed unit growth were up 12% in the fourth quarter versus the comparable 2006 period. We estimate that prescription demand for Lidoderm in the fourth quarter was approximately $202.8 million. Prescription growth for Lidoderm was up 14% and dispensed unit growth was up 15% for the 12 months ended December 31, 2007 from the comparable 2006 period. As expected, the inventory draw downs in the first nine months of 2007 which were the result of increased deficiency in the distribution channel began to stabilize in the fourth quarter.

As 2008 unfolds, we should see a closer correlation between factory sales and demand. Combined net sales for the OPANA franchise were $28.9 million for the fourth quarter and were $107.1 million for the full year in 2007. The 2007 results include the recognition of $13.8 million in deferred revenue for commercial shipments of OPANA ER and OPANA made to customers in 2006. We estimate that prescription demand for OPANA ER and OPANA in the fourth quarter was $26.1 million. We are pleased by the performance we have seen in the OPANA franchise and expect steady growth in 2008 due to the continued impact of our marketing initiatives, sales force expansion and managed care programs.

Net sales of FROVA, our triptan for the acute treatment of migraine headaches in adults, were $14.1 million for the three months ended December 31, 2007, a 23% increase from the $11.5 million in the fourth quarter of 2006. For the year, net sales of FROVA grew 29% to $52.4 million versus $40.6 million in 2006. Prescription growth was up 17% for the fourth quarter and 12% for the year versus the comparable 2006 periods. We estimate that prescription demand for FROVA in the fourth quarter of 2007 was approximately $13.5 million. We believe this strong growth reflects the impact of increased detailing in commercial activities for this product and growing awareness in the marketplace of FROVA's clinical attributes, particularly as an acute treatment for menstrual migraines.

Gross profit for the fourth quarter of 2007 was $242.5 million compared with a $199.6 million in the same period a year ago. For the 12 months, gross profit was 868.2 million versus $700.8 million in the prior year. Gross profit margins were 79.6% for the quarter and 80% for the year, versus 76.9% and 77% for the respective prior-year periods. This increase is primarily attributed to the favorable mix in product revenues, as we derived a higher proportion of our total revenues from higher margin branded products compared to the revenues. In addition, we benefited from lower cost from our third party suppliers. This favorability was partially offset by the inclusion in cost of sales of royalties to Vernalis on FROVA, which became payable beginning in 2007.

As disclosed earlier this week, we renegotiated the terms of our outstanding loans to Vernalis of approximately $55 million. As consideration for extinguishing this loan, Vernalis has paid us $7 million in cash and agreed to forego future royalties on U.S. sales of FROVA, until annual U.S sales exceed $85 million. For annual sales in excess of $85 million, the license agreement remains unchanged. Vernalis also announced that it has terminated its co-promotion of FROVA in U.S, effective February 19, 2008.

Selling, general and administrative expenses for the fourth quarter of 2007 were $119.5 million versus $89.4 million for the same period in 2006. For the year, SG&A expenses were $411.9 million compared to $346.3 million in 2006. The year-over-year comparisons reflect increased promotional support behind our key on-market products, including the full year impact of the expansion of the bill [ph] force that occurred in the second half of 2006, combined with the incremental clinical and promotional expenses, continuing investments in infrastructure to support our long-term growth and the addition of approximately 100 sales representatives during the second half of 2007.

Research and development expenses for the fourth quarter of 2007 were $54.6 million. This included $26.8 million is upfront and milestone payments to partners compared with $0.3 million occurring in the year ago quarter. For the year-to-date, R&D expenses were $138.3 million in 2007, versus $86.6 million in 2006. This increase is primarily attributable to upfront and milestone payments to partners of $34.9 million in 2007, compared with $10.7 million in 2006, plus the ongoing clinical development of Rapinyl our topical ketoprofen patch, our transdermal sufentanil patch and our oral rinse for mucositis.

We anticipate that our R&D spending will rise substantially in 2008, reflecting the clinical development programs in support of these mid-to-late stage development products. Net income for the fourth quarter of 2007 was $50.6 million, versus $14.8 million in the comparable 2006 period. Diluted earnings per share for the fourth quarter were $0.38, compared with $0.11 in the fourth quarter of 2006, which included 31.3 million in pre-tax impairment charges related to our DepoDur and Synera intangible assets, and a $26 million charge for the writ-off of purchased in-process research and development in connection with the October of 2006 acquisition of RxKinetix.

Adjusted diluted earnings per share for the three months ended December 31, 2007 were $0.52 compared with $0.42 in the same period in 2006, an increase of 24%. For the full year, net income was $227.4 million compared with a $137.8 million in 2006. As detailed in the supplemental financial information in today's press release, adjusted net income for 2007 was $258.1 million compared with $220.8 million in the prior year, which included the aforementioned in other adjustments.

Diluted earnings per share for the year ended December 31, 2007 were $1.69 compared with a $1.03 in the same period of 2006. As detailed in the supplemental financial information in today's press release, adjusted diluted EPS for the year was $1.92 compared with $1.65 in 2006, an increase of 16%.

I am pleased to announce that based on our stronger than expected financial performance for the fourth quarter and full year of 2007 and the continuing growth and demand for our key products, we are revising the guidance for 2008 that we issued in early January. We are now estimating that net sales for 2008 will be between $1.225 billion and $1.250 billion, up from the previous guidance of $1.215 billion to $1.240 billion. We expect the adjusted diluted earnings per share for 2008, excluding estimated milestone payments to partners, certain severance costs and the expensing of stock-based compensation charges will be in the range of $2.18 to $2.22, up from the previous guidance of $2.10 to $2.15. Of course, there can be no assurance that we will achieve these results.

As you are aware, we have a number of ongoing business development activities and this revised guidance does not include the potential impact of future business expansion opportunities, such as company or product acquisitions, product licensing transactions or collaborative research deals. At such time, we'll revise our guidance accordingly.

We generated record cash flow from operating activities of $365.7 million during the year ended December 31, 2007 versus $345.3 million for all of 2006. This performance was driven by our strong earnings growth, combined with a reduction in day sales outstanding from 55 to 45 days. Our cash and cash equivalents in current marketable securities, including a crude interest totaled $663.7 million at December 31, 2007. In addition, we have $283.3 million of long-term marketable securities that we have reclassified due to the current conditions in the auction rate securities market. We tend to leverage our financial strengths to the licensing and acquisition of assets and we will build shareholder value by diversifying our revenue base and building out our pipeline.

We have a clear vision for growth. We seek to maximize shareholder value by acquiring growth assets that will diversify our revenue base in the near term and strengthen our pipeline for the long term. Towards this end, we continue to evaluate acquisitions of companies that are closely aligned with our specialty physician focus and in high-growth therapeutic areas. And of course, we tend to deepen our penetration in the pain market by pursuing earlier-stage opportunities that are clinically differentiated and offer a long-term patent protection. This sector will primarily include not only product licensing such as our recent licensing of the inhaled fentanyl product Alexia, but also company acquisitions as well. In addition, we will continue to pursue selective development of difficult-to-formulate high barrier to entry generic products. And finally, we will continue to maintain our focus on driving the growth of our existing business by maximizing the potential of our key on-market products and our pipeline.

Now Nancy, David and I will open up the call for questions.

Question And Answer

Operator

[Operator Instructions]. First question comes from the line of Adam Greene with JP Morgan. Please proceed.

Adam Greene - JP Morgan

Thanks, good morning everyone. On OPANA, the value per script has steadily increased throughout most of 2007, I think end of the year around $287 per script based on our Rx demand. What's the right number we should think about for 2008? Then also, I think the last price increase you have was in July of last year. Should we assume that your peak annual price increases on OPANA?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Hey, Adam, this is Charlie. I would basically say that the average selling price that you are coming up with for 2007 would be something that I would use going forward in your models. We don't really disclose the actual prices, but you have sort backed in based on our revenue and the scripts that are out there. That was good news anyway I'd see for someone to model with, I think going forward.

In terms of pricing, we do not talk about when we plan for the extensive price increases in the future. So again there, you look at what we have done historically and make your best guess.

Adam Greene - JP Morgan

And do you have room relative to others in the long-acting opiod market? Is there room to increase pricing more?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Yes. Our product is priced lower than the competing products for the same day... same amount of daily therapy.

Adam Greene - JP Morgan

Great. Thanks.

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Okay.

Operator

Your next question comes from the line Jeff Goater with Cowen Company. Please proceed.

Ian Sanderson - Cowen & Co., Inc

Hi, it's Ian Sanderson. First for Charlie, what is the major catalyst to the increased guidance? It appears that you have raised your margin assumption more than anything and so wanted to get the outlook there. Second, given the strong start that we have seen for Alpharma's Flector Patch, have you seen an impact on Lidoderm prescribing other than what we see in the prescription trends, and have you formulated a counter-detail message? And related to that, a year ago Peter was more cautious on the '07 pricing outlook for Lidoderm given what he was seeing in the formulary contract negotiations, can you provide us some color on what you see in 2008?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Okay, so let's start off with the Lidoderm question. I'll turn that over to Nancy and then I'll come back to you guidance question.

Nancy J. Wysenski - Chief Operating Officer

Thanks Charlie. We do have anecdotal evidence that Alpharma is targeting Lidoderm physicians. But we really have seen no evidence of the negative on Lidoderm to total Rx's in our weekly data since the launch of the Flector Patch. We should note however that these products do have different indications, different active ingredients and different mechanisms of action, and therefore we should not be looking for direct comparisons.

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

And Ian, when it comes to guidance, there were a couple of things that really in the fourth quarter drove us to reconsider our guidance. One is that the prescription trends continue to be very strong across our promoted products. Second, as we continually update our business and as David had pointed out, we've been revaluating our development portfolio and the timing of one barrier [ph] studies would be initiated and then with favorable mix, and also renegotiating the outstanding loan with Vernalis and a couple of other things we've done contractually. We're getting better pricing on product supply. With all those things factored in, we were very bullish that we needed to take up our guidance for the year and that's really what's reflected in that continued over performance.

Ian Sanderson - Cowen & Co., Inc

Okay and actually can I follow-up, could you just give us what the accounting treatment of the renegotiated deal with Vernalis might yield? You'd obviously tick away the loyalty obligation in the near term. But then do you amortize out the debt forgiveness?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Yes, so Ian what we end up doing there is we take the loan balance and we recharacterized it as a intangible and we are amortizing that over the remaining life of the agreement, after 2015 on the products and then, that is going to cost a goods sold. And then, the royalty we're no longer paying and that was recorded in cost of goods sold. Net-net cost of goods sold would go down.

Ian Sanderson - Cowen & Co., Inc

Okay. Thank you very much.

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Okay.

Operator

The next question comes from the line of Gregg Gilbert with Merrill Lynch. Please proceed.

Gregg Gilbert - Merrill Lynch

Thanks. Good morning. I want to start with a bigger picture question; can you talk about the criteria and the timeline for the CEO and Head of R&D searches and in addition to those searches, is the Board formally exploring all strategic options for the company in parallel? And then I'll have a follow-up, thanks.

Nancy J. Wysenski - Chief Operating Officer

Sure, thanks for the question, Gregg. The Board related to us yesterday during the meeting that they have been quite pleased with not only the number of individuals who have expressed interest in this opportunity, but also with the caliber of the candidates. They are committed to filing this role as quickly as possible, of course balancing their obvious drive to really recruit someone who is exceptionally well-suited to this opportunity. I don't think one can ever comment on timelines associated with those processes, but it does work quite favorable at this point. I'm sure the Board continues to consider all options as they always do. But I don't think that this situation has altered their direction in any substantial way

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Your first question in terms of deals and so forth, the Board is always interested in driving business and maximizing shareholder value and we will continue to do that.

Gregg Gilbert - Merrill Lynch

I have another question about the guidance. Can you give us a little flavor for SG&A and R&D, Charlie, for '08? And also, are there any generic launches in your '08 guidance and if not, are [ph] generic launches possible if ever?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

We have not disclosed anything new on the generic front in terms of whether they would be ANDA filed or launched during the year. We would announce those at the appropriate time. We do not want to give any one a heads-up from a competitive standpoint that we have some filing in the works.

In terms of our guidance on in individual areas of spend, I really haven't... they haven't changed since our January guidance call. We expect increases in G&A or SG&A. I would sort of mile that off of the '07 trends, if I were doing a model. You are factoring your own inflation rates and so forth. Sales and marketing, again I said you could use the Q4 trends going forward for that so. There is really nothing unusual other than as we have said R&D, we do expect to have a significant increase do to the number of mid to late-stage compounds that we have in development.

Gregg Gilbert - Merrill Lynch

Charlie, I think on guidance what you last said for SG&A was similar levels to '07? Is that still fair or did I mishear that on the January call?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

I would... similar levels, but just to clarify that we did expect it to grow at around inflation.

Gregg Gilbert - Merrill Lynch

Okay, thanks I will get back in line.

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Okay.

Operator

Your next question comes from the line of David Windley with Jefferies & Company. Please proceed.

David Windley - Jefferies & Company

Hi thanks for taking the questions. Wanted to follow up on the questions Ian asked on FROVA. Just to try the bottom line that is it possible to quantify how much of the increase in guidance is related to the change in terms of the further deal?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

We have not disclosed that.

David Windley - Jefferies & Company

Okay. Can you... is the stock-based compensation charge in 08, will it run about the same dollar value as we just saw in the fourth quarter or will that increase in 08, on a run rate basis?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

For the 08 number, it will increase slightly.

David Windley - Jefferies & Company

Okay, and then you mentioned Charlie that you expected sales in scripts to run a little bit more in line with each other. That said, the fourth quarter sales for most of the top revenue products were above user demand. Do you expect to see some pullback or should sales be somewhat below prescription trends or end-user demand in 1Q or about in line?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

I think what you'll start to see is that the inventories will fluctuate, based on seasonality in terms of... if the wholesaler still thinks there is possible snowstorms and things like that, the inventory will probably stay where it is at the end of the first quarter. But I would expect, at least in the second and third quarters, for the inventory levels to come down to... so that where they were earlier for us at the end of the third quarter, and then I would expect them to come back up again at the end of the fourth quarter to where they are pretty comparable to where we left this year.

David Windley - Jefferies & Company

Okay thanks. And one last follow up question, to Ian's earlier question on the Flector Patch I know that... I mean you made the comments that different active, different label indication et cetera that we all know that Lidoderm used very heavily off-label than discussed on these calls in the past extensively. Is it realistic not expect that Flector from some of that's on-label indications would affect some of Lidoderm's off-label use?

Nancy J. Wysenski - Chief Operating Officer

Clearly, just a reminder that we do not promote Lidoderm for any indication other than postherpetic neuralgia and it's difficult to speculate. We will obviously all have more data as time moves on. We can only report what we have today.

David Windley - Jefferies & Company

Okay.

Operator

Your next question comes from the line of Gary Nachman with Leerink Swann. Please proceed.

Gary Nachman - Leerink Swann

Hi, Good morning. First to Charlie, didn't seem you had real pressure from formularies on the rebase and discounting for Lidoderm and OPANA in 2007. How do you think that's going to play out now in 2008. Do you have visibility on that?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

If I were looking at this, I'd basically say Gary that between the price increases that we would take and the pull through of managed care with the discounts that we have there that our average selling price probably won't be affected all that materially over the course of the year from where we leave 2007.

Gary Nachman - Leerink Swann

Okay. And then, you have guys have talked about a lot of pending deals in Harper [ph]. Do you think you can get some of those done without a CEO in place, whereas do you need to have that in place before you sign those deals?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Yes, I mean the one thing that you have to remember is that the management team and the Board, and the Board has a transaction committee, are very aligned on the strategy and the things that we are pursuing. And so yes, there would be no hold up on closing any licensing deals or what have you it, there that are in the works if we were able to get those closed.

Gary Nachman - Leerink Swann

Okay, and then for David, I know you are not giving a real pipeline update. But can you say if anything has been put on hold, like to the ketoprofen studies or those currently ongoing? And also if you have a timeline for filing the revenue NDA that will be great. Thanks.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

It moves out. Just to your first question, we have nothing on-hold about programs that are proceeding. We, as I indicated it in the prepared comments, we are really not prepared at this time to provide any further updates on timelines. We are undertaking a reevaluation or reassessments of our pipeline, and we want to have that obviously in place. [Inaudible]. I think at that time, we will feel... also it's been a better position to provide any further updates or guidance on timelines.

Gary Nachman - Leerink Swann

Okay. So could you just elaborate what needs to get done at this point for Atheno [ph] could you just over that, where you could file?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Yes, as we have announced, the efficacy trial that we are running has came out very positive with onset of action with in 10 minutes of the drug after pain release, 10 minutes of administration. We do have to complete the collection of data from patients who are treated with the product for a longer period of time for up to three months to meet the FDA filing requirements, and those activities are ongoing at the moment. Again once we've completed our reassessment, we will be in a better position to provide an update on the entire month.

Gary Nachman - Leerink Swann

Okay. Thanks.

Operator

Ladies and gentlemen, please ask one question at a time for a follow-up, please join the question queue. The next question comes from the line of David Buck with Buckingham Research Group. Please proceed.

David Buck - Buckingham Research Group

Yes thanks. Just a couple of quick ones actually if I could. Just on pricing, can you just review when the last price increases were? Are there any this quarter in particular for your products and just a reminder of the last one for Lidoderm. And on FROVA, can you talk about what you think might be behind the continued strength of that product. Obviously the new indication didn't have them but in terms of scripts, it continued to be strong and just wanted to get as sense of why you think that is?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

David I'll answer your first question on price increases and then I'll turn over to Nancy on... for FROVA. In terms of pricing, we have not raised any price or taken any price increases in the fourth quarter. I believe our last round of price increases were in July.

David Buck - Buckingham Research Group

Okay nothing in the first quarter then either, correct?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Not to-date.

David Buck - Buckingham Research Group

Okay.

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Nancy.

Nancy J. Wysenski - Chief Operating Officer

Related to your question on FROVA, we think there may be two factors; one is the impending loss of exclusivity that is coming soon, on a major competitor in the checks and all the formulary reconsiderations so forth. And in addition, although we did not receive an approval letter, I believe that an awareness of our interest in this area has heightened physicians' confidence in using our product for the acute treatment of menstrual migraine as it is currently indicated.

David Buck - Buckingham Research Group

Got you. And one quick one again for Charlie; you mentioned the reclassification of some of your marketable securities to longer-term. Can you talk about what market developments might actually trigger something in terms of write down of those securities?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Sure. Right now, in terms of the securities that we have, most of them are auction rate securities. A big portion of those, probably about 60% to 65% of that are student loans that are backed by the U.S. Department of Education through their FFEL program. So we are not holding any privately issued students loans. All of the underlying issuers have AAA ratings. Historically, there has been a very low default rate on these types of loans. We have already seen some of these issues being called at par by the individual issuers, because they need to refinance these. So they can bring the interest rates down. And in terms of other things that we were holding, in terms of our municipal bond securities and so forth, we have been able to liquidate most of those. So at this point in time, we don't anticipate there being an impairment of any... of any type. It's more of a liquidity issue versus a credit issue at this point in time.

David Buck - Buckingham Research Group

And just the full amount is what's listed as the $283 million?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

Correct.

David Buck - Buckingham Research Group

Okay, thank you.

Operator

Your next question comes from the line of Rich Silver with Lehman Brothers. Please proceed.

Rich Silver - Lehman Brothers

Hey, just a quick couple on the gross margin sequential change, can you give us some sense of what was behind that? I know it does fluctuate quite a bit and what that might mean for the gross margin going forward? And then the second question is in terms of the decision not to provide pipeline update. At what point do you expect to be providing a pipeline update? And if you don't replace your R&D ahead, will we still at some point this year gain a pipeline update?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

So Rich, in terms of margin. What drove our margin performance in the fourth quarter was mix as a larger portion of our revenue comes from branded products with higher margins. I would basically not expect as much of an impact of the mix change going forward. I would think that the mix is probably pretty steady from this point forward.

Nancy J. Wysenski - Chief Operating Officer

Rich, in response to your other question, I think that during the times of transition such as this, it's not really unusual for companies to reexamine any aspect of the business. And thus our comments about the comprehensive review of our R&D pipeline, I believe that by the time the new CEO arrives, or shortly thereafter we should have some further news to share.

Rich Silver - Lehman Brothers

Okay, thanks very much.

Unidentified Company Representative

Okay.

Operator

Your next question comes from the line of David Lickrish of Broadpoint Capital. Please proceed.

David Lickrish - Broadpoint Capital

Good morning and thanks very much for taking the call. Most of them were answered right now. My questions were related to the pipeline, but it doesn't sound like you are prepared to share much detail. So, I wanted to just ask you about OPANA. You went through some fairly significant changes to the sales force implemented as of October 1st. Can you... and I missed... might have missed it in the opening comments. But can you describe where you are in that process? And how you see that affecting scrip turns going forward?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Sure David. As we've talked about before. I mean the main reason we expanded the field force originally was because where we already had overlap, we had seen much better market shares than where we did not. And even though we have only had a few months of Durect [ph] data since the expansion, the growth trends in the specialty audience that the new reps are focusing on is promising. In the fourth quarter, the rate of Durect share growth and the especially audience was four times that of the primary care audience. So we are doing additional ROI analysis on this expansion based on the data that we have and we will continue to do that through Q1. And we will probably talk more about that at the end of the first quarter on the earnings call, as we have more data.

David Lickrish - Broadpoint Capital

Sorry, just to complete the thought, are you saying that you are satisfied with the restructuring as it was implemented as of October 1st and then it's obviously an ongoing analysis change as made required, but to-date it's in line with your prior expectations at the time it was implemented.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Exactly.

David Lickrish - Broadpoint Capital

Okay. And my only comment would be given the importance of the pipeline and the need for visibility here, any additional details if you can share with regards to some of those later stage programs, I think is only going to be helpful for everybody.

Nancy J. Wysenski - Chief Operating Officer

We will keep that in mind.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Thank you.

Operator

Your next question comes from the line of John Boris with Bear Stearns. Please proceed

John Boris - Bear Stearns

Thanks for taking the question. Just a pretty broad question for Nancy; having a fresh set of voice coming into to Endo and looking at its operations, can you just comment about the efficiency of the operation and what your priorities are at least going forward for the organization? And then on R&D, can you just comment also on at least what you believe to be maybe not in specific terms, but the NPV of the pipeline that you have within the portfolio how satisfied you are with the assets that you currently have? And how you see that shaping your business development and M&A strategy going forward? Thanks.

Nancy J. Wysenski - Chief Operating Officer

Thank you, John. That was a long run question; let me see if I can hit it. If I miss something, maybe you'll help me. First of all, my view of Endo is that it's a very strong company with extremely talented into their job. And I see nothing, but a great future. I also think what's going on in the marketplace around us, we are very well positioned because of our cash reserves that offer an advantage over other companies, who are in any sort of transaction would have to use the debt markets to move forward. So, I think we are extremely well positioned. And also that makes us a very attractive company for the new CEO candidate.

Focus, I think it's probably similar to what you have heard in the past. We are continuing to support our sales and marketing efforts. We are confident regarding the forecast that we have submitted, and we are going to do everything that we can to achieve or exceed those forecasts. We, as we have stated repeatedly, are continuing with our business development efforts. And again are confident that there are opportunities for us there. And lastly in looking at R&D, I think that David did a nice job of stating where we stand. We've had some good news lately with Rapinyl and also with our acquisition of the license from Alexza. But I would hesitate to comment on any specific MPVs relative to what we have shared about the full review of the product pipeline. We are happy to do... to share a little more detail on that once the work is complete. And did I hit all these pieces of that question?

John Boris - Bear Stearns

You have, thank you.

Nancy J. Wysenski - Chief Operating Officer

Thank you.

Operator

Your next question comes from the line of Ken Trbovich with RBC Capital Markets. Please proceed.

Ken Trbovich - RBC Capital Markets

Thanks for taking my call. Nancy, just really quickly if you could give us some specifics, I know you said that you believe the 30 months stay started December 14th, could you give us a sense as to when we can say that is definitively started that is actually in place?

Nancy J. Wysenski - Chief Operating Officer

That... it was really up to the determination of the court, so I can't give you any further information.

Ken Trbovich - RBC Capital Markets

Okay and then Charlie just really quickly on the Vernalis guidance, I understand the $49 million for the re-characterization. Could you give us the royalty that you no longer pay?

Unidentified Company Representative

We've never disclosed the base royalty.

Ken Trbovich - RBC Capital Markets

Okay, is it single digit or double digit? Is there someway... you are saying it net positive, but we don't know how much of that factors into this margin that we keep trying to get around for the 08 numbers?

Unidentified Company Representative

Yes, it's not something that we normally disclose; we are in agreements with our partners.

Ken Trbovich - RBC Capital Markets

Okay, and then lastly I know you are not specifically discussing any programs, but is there any reason to think that any of these programs are in jeopardy of not moving forward? I mean David's comment about all of them are essentially proceeding. I am assuming that means that there is no reason to believe any of these are going to be terminated.

Unidentified Company Representative

That's correct at this time, yes.

Ken Trbovich - RBC Capital Markets

Okay. Thank you.

Operator

Your next question comes from the line of Annabel Samimy with UBS. Please proceed.

Annabel Samimy - UBS

Hi, it's Annabel Samimy. Just a couple of quick questions on Lidoderm; first in terms of the guidance on Lidoderm, again some of you mentioned earlier that there is an assumption of increased Medicare contracts in 2007 that is to pay out; are there any kind of assumptions regarding Medicare contract in 2008 or is that just not an area that you going to pursue now?

Unidentified Company Representative

No, Let me now reiterate what I said earlier on that. We anticipate in 08 that the discounting in managed care across our product line that will increase as we get greater pull thorough will probably be offset to a very large extent based on the price increases that we take. So I am not expecting to see a major shift in the average selling prices over the course of 08.

Annabel Samimy - UBS

Okay. And then another quick question on Lidoderm; I mean we talk a lot about business development; now there is a lot of opportunities. How you have lifecycle management plan for OPANA, but what exactly is the life cycle management plans for Lidoderm?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Well, with Lidoderm, we believe we have a very strong IP situation. We have a method of used patent that goes out through 2012. We then have a formulation patent that we believe has also been strengthened by the preliminary guidance put out by the FDA in terms of the patch has to be the same size, same shape, same prior drug load, same residual drug load. And then also with the Citizen's and things that we are working with the FDA in the end if they end up requiring someone to do clinical trials to prove efficacy and their product works in the same mode as Lidoderm, we believe we can actually have exclusivity beyond 2015.

Annabel Samimy - UBS

I guess I wasn't so much talking about the IP, but rather are there any follow-on products you have for our life cycle plan for the whole franchise?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Yes, again that is not something we would comment on prior to when we will be ready to launch, as we don't want to disclose any of that to our competitors.

Annabel Samimy - UBS

Thank you.

Operator

Your next question comes from the line of Tim Chiang with FTN Midwest Securities. Please proceed.

Tim Chiang - FTN Midwest Securities

Hi thanks. Does the updated guidance still include payments to Penwest later this year, and I was just trying to figure out, how far along are you into the royalty holiday. I guess there is an escalating royalty that starts at 22% to Penwest. I has there been any discussion with the Board in terms of potentially looking at Penwest, given where Penwest stock is these days?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Tim, first off our guidance does include the royalties that we anticipate paying in 2008. We have not disclosed where we are in terms of eating through the royalty holiday. What we have disclosed is that on the first... they have 150... $185 million of sales. We pay no royalty, and then on the next $256 million worth of cumulative sales, we pay 50% or 11% royalty rate, and then beyond that we would go into the base royalty rate at 22%.

Tim Chiang - FTN Midwest Securities

Okay. But the royalty rate begins to escalate beyond that, doesn't it?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

It does once you hit certain annual sales thresholds, which are fairly high.

Tim Chiang - FTN Midwest Securities

Okay, great. Thanks.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Okay.

Operator

Your next question comes from the line of Angela Larson with SIG. Please proceed.

Angela Larson - SIG Investment

A quick one for you, Charlie, on what happened to depreciation and amortization? And then also if you can give us a little more color on what was the reason for the pipeline review at this time. Why did you feel compel to start it before you had a new CEO? Was it the balance of products Phase II versus Phase III or was it the distribution of the products therapeutically?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Okay, Nancy is going to start off first on your pipeline question.

Nancy J. Wysenski - Chief Operating Officer

Again, Angela, I think that when there is a change in leadership, it's pretty typical to reassess your business and all the key component. And so we are looking at the entire business, but specifically at this point in time in reexamining in a comprehensive way, the late stage product.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

So... and then on your question in terms of depreciation and amortization, we reclassified that to SG&A and R&D based on the underlying assets and that's all you sell there.

Angela Larson - SIG Investment

Okay, that's helpful.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Okay.

Angela Larson - SIG Investment

Thank you.

Operator

Your next question comes from the line of Michael Tong with Wachovia Securities. Please proceed

Michael Tong - Wachovia Securities

Thanks, just one quick one for Charlie; when you talk about R&D increasing significantly in 08, is your base line the reported number or your base line the adjusted number excluding the milestones?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

It would be the adjusted number excluding the milestones.

Michael Tong - Wachovia Securities

Great, and then the follow-up for Nancy, you commented that the Board and management are aligned from a business development perspective. I think late last year, there were some discussion about near term opportunities that may include in the venturing outside appeal management area; is that still part of the process or have you decided otherwise?

Nancy J. Wysenski - Chief Operating Officer

Yes Michael, our strategy suggest that we will consider therapeutic areas outside of pain management, so we are continuing. We obviously have a definitive interest in the pain space, and expanding it and going earlier, so we will be looking at both.

Michael Tong - Wachovia Securities

Great, thank you very much.

Operator

Your next question comes from the line of Lei Huang with Summer Street Research. Please proceed.

Lei Huang - Summer Street Research

Hi, thanks. It's Lei from Summer Street. I missed part of the call; I apologize if you've already said this. Did you provide any timetable on when you might have a new CEO or a Head of R&D?

Nancy J. Wysenski - Chief Operating Officer

Sure, Lei, we did talk about that a little bit basically what we commented on was the fact that the Board is quite active in that process the Russell Reynolds is the search firm assisting them. They have good number of candidates that they are having discussions with. And they are impressed with the quality. Beyond that as you can imagine, in any particular search effort, one can really never predict the timing.

Lei Huang - Summer Street Research

Okay, fair enough. And then just looking on the business development fund; can you give us some level of confidence that we are more likely to see more deals being actually execute and announce this year than in the past. I know it's always hard to predict that, and it sounds like that there is a lot of things going on. But is there anything that you are seeing or hearing or observing that gives you more confidence, yes there will be a steadier flow of announcement coming in 2008 or since what the 2007?

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

I guess our commentary has been consistent in that, we have a lot of activity that's ongoing with number of transactions that we are pursuing. We cannot and do not comment on potential timing or number of transactions that we've done, because they are really not predictable, yet they are willing buyer and seller and terms that are agreeable and we just don't comment on how many and like timing.

Lei Huang - Summer Street Research

Okay, thank you.

Operator

Your next question is follow-up question from the line of Gregg Gilbert with Merrill Lynch. Please proceed.

Gregg Gilbert - Merrill Lynch

Thanks. I have two follow-ups. Charlie, sorry to beat this, but you are now saying that there will not be pressure on ASPs for a kind of here on Lidoderm, and that's different from a few months ago. Is this due to a change in your strategy on pricing, or just an increase in understanding on the different variables to go into the pricing assumption?

Charles A. Rowland, Jr. - Executive Vice President, Chief Financial Officer and Treasurer

I think it's more of a basis updated analysis with better data on what the pull through and the rate of that would be through the managed care plans versus the rate of the price increases that we would take. And we have gotten comfortable that net-net you're not going to see a large deterioration of our average selling price.

Gregg Gilbert - Merrill Lynch

Okay. And then for Nancy on the Head of R&D thing, do I understand it correctly that search will be really the new CEO's job from a timeline standpoint? I know you can't predict the CEO timeline, but will the Head of R&D be a separate search after the CEO situation is figured out?

Nancy J. Wysenski - Chief Operating Officer

The Head of R&D search has been ongoing. We have identified some very strong candidates, but it is probably less than likely that we would move on that prior to the new CEO arriving.

Gregg Gilbert - Merrill Lynch

Great. And lastly going back to the Board considering strategic alternative that I asked about earlier, I think you said the Board is always considering all strategic options, but isn't this a different situation, and can we at least assume that when a new CEO is named, a formal process to explore our options have been completed? Thank you.

David A.H. Lee, M.D., Ph.D. - Executive Vice President of Research & Development and Chief Scientific Officer

Our position there again is that management and the Board have been completely aligned on the strategic direction and the types of things we are pursuing. And one of the criteria that the Board is evaluating as they interview CEO candidates are they aligned as well with the strategy, because there is no disagreement internally with inside the company, and with the Board on strategy.

Gregg Gilbert - Merrill Lynch

Okay, thank you.

Operator

This concludes our Q&A session. I would like to turn the call over to Nancy Wysenski for closing remarks.

Nancy J. Wysenski - Chief Operating Officer

I'd like to thank you all for your ongoing interest and participation in today's call. But before we close, I would like formally acknowledge Endo's employees, whose hard work and dedication have been instrumental to the success that we demonstrated in 2007. There is singular focus on improving alliance of patients in pain is central to our goal of becoming the leading pain management company, and we thank them for these efforts. Thanks for joining.

Operator

Thank you for your participation in today's conference. This concludes our presentation. And you may now all disconnect. Have a good day.

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Source: Endo Pharmaceuticals Holdings, Inc. Q4 2007 Earnings Call Transcript
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