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Cubist Pharmaceuticals Inc. (NASDAQ:CBST)

Q1 2008 Earnings Call

April 17 2008 5:00 pm ET

Executives

Michael Bonney - President and CEO

Chris Guiffre - SVP, General Counsel and Secretary

David McGirr - SVP and CFO

Rob Perez - EVP and COO

Analysts

Tom Shrader - Rodman & Renshaw

Tom Russo - Robert W. Baird

Howard Liang - Leerink Swann

Jason Kantor – RBC

Matt Duffy - Black Diamond Research

Steven Weimer - Thomas Weisel Partners

Joel Sendek - Lazard

Rachel McMinn - Cowen & Company

Biren Amin - Stanford Eagle

Meg Malloy - Goldman Sachs

Scott Harland - SEC Global

Eun Yang - Jeffries & Company

Tom Bracle - Federated Investors

Operator

Welcome to today's Cubist Pharmaceuticals Incorporated First Quarter 2008 Earnings Call. At this time all participants are in a listen only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions).

It is now my pleasure to introduce your host, Mr. Michael Bonney, President and CEO. Thank you, Mr. Bonney. You may begin.

Michael Bonney

Thank you, operator. Good afternoon everyone and thank you for joining us. With me for the call today are Rob Perez, Cubist's Chief Operating Officer; David McGirr, Chief Financial Officer; and Chris Guiffre, General Counsel. We will focus today on the first quarter 2008 financial results and business developments. But before we begin, I'll ask Chris to read the Safe Harbor statement and describe the context for use of non-GAAP financial measures.

Chris Guiffre

Thanks Mike. Forward-looking statements may be made during this call relating to, among other things, projected product revenues, company financial performance and our products in pipeline. These statements are neither promises nor guarantees, and are subject to a variety of risks and uncertainties, that could cause actual results to differ materially from those projected or suggested today. Such risks and uncertainties are detailed in the company's periodic filings with the Securities and Exchange Commission, including our most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q.

Cubist is providing this information as of the date of today's call and does not undertake any obligation to update any forward-looking statements made during this call or contained in the slides to follow, as a result of new information, future events, or otherwise.

During this call, in order to provide greater transparency regarding Cubist's operating performance, we will be referring to certain non-GAAP financial measures that involve adjustments to GAAP figures. In particular, we will present information on non-GAAP net income and net income per share. Any non-GAAP financial measures discussed should not be considered an alternative to measures required by GAAP, and are unlikely to be comparable to non-GAAP information provided by other companies.

Any non-GAAP financial measures disclosed are reconciled to the most directly comparable GAAP financial measure in the table included in our press release issued this afternoon and available in the news section of our website. A further discussion of why we feel these measures are important to investors and the reasons for which our management uses these measures is also included in the press release.

I'll now turn the call back to Mike.

Michael Bonney

We started the year with another historic quarter for CUBICIN. US net product revenues in the first quarter of 2008 are up 50% versus the first quarter of 2007. As Rob will discuss later in the call sales pattern suggests we are on track for another year of very significant growth. At this time we are updating and in fact raising our revenue guidance for 2008 US net product revenue to a range of between $380 million and $395 million.

CUBICIN continues to grow in acceptance as an important therapy in the infectious disease armamentarium. It does not appear that continued growth will be threatened by new competition, branded or generic any time soon. Potential branded competitors continue to experience delays in their regulatory reviews as we noted in our news release on March 13, there are no signs of an ANDA filing on Daptomycin. We continue to have confidence in our patents and are fully prepared to assert them vigorously should the challenge materialize.

Q1 2008 was our seventh consecutive quarter of GAAP profitable operations. Our consistent pattern of bottom line growth contributed to the decision last month by Standard and Poor's to add Cubist to the S&P's Small Cap 600 Index. David will be providing a review of Cubist performance across key financial metrics for the quarter later in the call.

In our January call our report on the start of "Act 2" for Cubist as a growing acute care biopharmaceutical company. In February we were pleased to announce that Dr. Steve Gilman an experienced scientist and biotech leader had joined Cubist as Chief Scientific Officer with responsibility for discovery and in non-clinical development.

Steve is leading in the development of a number of promising preclinical programs. As announced in January, we expect to file two INDs by year end. For the HCV product candidate we acquired with the purchase of Illumigen at the end of last year and for the antibiotic CDAD candidate we mentioned in our last call.

We also continue to make very good progress with our preclinical Gram negative antibiotic program. Our pipeline building activities also include a business development focus on identifying later stage programs for in-licensing our acquisition. Here our focus is on leveraging what we have felt in particular, we're looking for late stage products that would be used in the hospital or outpatient transition environment.

We now have a 164 clinical business managers calling on a variety of specialist to US hospitals and we believe we have unique expertise when it comes to selling in the acute care environment.

Now, David will review the financial results for the quarter.

David McGirr

Thanks Mike. Cubist continues to deliver strong financial results, in line with our guidance. Q1 2008 total revenues of $88.3 million are up 48% from Q1 of 2007. US net product revenues of $86.1 million are up 50% from the previous year, a great job by our commercial team. As we guided, gross margin has improved to around 78% in the quarter.

Operating expenses are generally in line with our expectation. R&D for the quarter came in at about $22.4 million. This will grow through the year as we advance our Phase II and Phase IV CUBICIN trials, and ready our preclinical programs for IND filings. We continue to expect the full year R&D expenditure to be in the range of $100 million to $110 million.

Sales and marketing came in at about $20 million for the quarter. As Rob will discuss, we have completed the sales team expansion. We continue to forecast sales and marketing expense for 2008 in the range of $78 million to $83 million. G&A at $11.4 million reflect some onetime expenses in Q1 including those associated with accelerated depreciation of leasehold improvement in connection with our lab build out this is all non-cash.

As predicted other income reflects the lower interest, we earned on our cash balance. This is adjusted for the onetime net gain in Q1 2008 of $2.2 million from the buyback of $50 million of convertible debt at a discount at par. Income before tax was $18.5 million; this is an increase of 221% from Q1, 2007.

Our Q1 tax provision continues to be a combination of alternative minimum tax at the federal level along with some state tax. On a GAAP basis EPS basic was $0.32 and $0.26 fully diluted. On a non-GAAP basis adjusted for FASB 123(NYSE:R) and the write-off of the assets disposed off to build the new lab space, EPS basic was $0.41 and $0.34 fully diluted.

Now to cash. At the end of Q1, 2008 we had cash, cash equivalent and investment of $331 million after adjusting the convertible debt buyback. Mike is going to up to date on our revenue guidance and this slide now shows all the elements of our guidance, as of April 17, 2008. The increase in expected sales leads to an increase in cash generated expected to $85 million. This is subject to change of course based on the success of any of our business development activity.

Now, over to Rob.

Rob Perez

Thanks, David. We now estimate that CUBICIN has been used in more than 500,000 patients in the U.S alone. This milestone validates CUBICIN’s broad acceptance as a well established antibiotic therapy for patients with serious Gram-positive infection. It also shows the confidence physicians have gained in CUBICIN safety profile. With more than half a million patients treated, CUBICIN’s adverse event profile remains consistent with what was observed in clinical trial.

As David discussed for the U.S alone, year-to-year net revenue growth in Q1 was 50%. This was extraordinary momentum for a drug that has just completed the first quarter of its fifth year since launch in the U.S. The continued growth of CUBICIN reflects four key drivers. First, vancomycin is being used with greater care and its share of market continues to erode down to 72% for the three months ended February.

As we have seen in publications particularly over the past year, there is mounting evidence that the clinical efficacy of vancomycin is unreliable at MICs of one or two. A study published in April also takes a close look at what happens when vancomycin dosing is increased to deal with concerns about its potency. This analysis shows a significant relationship between high dose vancomycin that is at least 4 grams per day and both the occurrence and time to nephrotoxicity.

The changes we see in prescribing behavior continue to happen on a hospital by hospital basis. In a number of institutions across the country, changing protocols demonstrate a more cautious attitude to the use of vancomycin. Examples of changes we see in some academic centers and large community hospitals include, testifying that vancomycin should not be used when MIC90s are two or in some cases one, calling for a switch from vancomycin after just or in some cases one, calling for a switch from vancomycin after just a few days when there has been no clinical improvement and using CUBICIN empirically for Staph aureus bacteremia.

The second reason for the continued momentum we see has to do with the power of CUBICIN's unique label. Adoption of CUBICIN as the go to therapy for MRSA bloodstream infections is growing. Based on the full year 2007 AMR data systemic infections will now account for 35% of overall CUBICIN usage in hospitals versus 28% a year earlier.

Third we have seen the success of our strategy to drive use of CUBICIN in the outpatient setting, which represents close to 45% of CUBICIN sales. It continues to be apparent that the attributes of the drug of once a day 30 (inaudible) with a predictable safety profile make it a good fit for the outpatient setting.

While we are on this chart I want to point out that we seen a nice growth in the in patient setting this quarter as well. This growth is testimony to our ability to penetrate from the internal medicine specialties to see a lot of bacterium as well as the fact that IVs are moving CUBICIN up in the treatment hierarchy.

During Q1 as we said we would, we completed the hiring an initial in-depth training of an additional 29 clinical business managers in the U.S. We also added a few more regional access managers who work with the outpatient infusion providers to make sure that they are familiar with CUBICIN. We have realigned the territories and each CBM now will have less ratio time and more time to spend in their target institution.

The newer reps are now getting established with their new customers. Meanwhile, potential competitive products are still not here and some are working their way through approvable letters and clinical site inspection. It appears by the time any new agents are launched, CUBICIN will have a head start of five years, cumulative US revenues of more than $1 billion and it will have been used in the treatment of several hundreds of thousands of patients.

As we said before, we'll be ready for new competition if and when it comes. However, I will remind you that our most significant competitor now and in the future will continue to be vancomycin. Frankly, we believe that CUBICIN will benefit from others raising their voices about efficacy concerns with this one time standard of care.

A final but quite important growth driver for CUBICIN of course, is the fact that MRSA continues to be a pathogen of great concern, both in the hospital and in the community. Well, our long-term forecast assumes that growth of the overall market for MRSA agents will moderate overtime; we're not seeing this yet. We continue to see year-to-year growth rates for days of therapies for MRSA agents in the mid-teens.

MRSA is a problem in many countries outside of the US as well. Last year, we completed partnership agreement to ensure pass forward for CUBICIN in most countries around the globe. As we've reported in the past, we will continue to see choppiness in the revenue from international sales, due to the way which we booked these revenues.

We're encouraged by our recent interactions with our partner for Europe, Novartis. They have made adjustments in their approach to the hospital market opportunity in the EU, but CUBICIN was initially approved in 2006 and they are interested in what they can learn and apply for markets set with CUBICIN in the US.

Before I turn this back to Mike, I'll comment briefly on additional data we will be developing to support the optimization of CUBICIN. On the last call, I provided top line data from our high dose short duration skin trial. At the time, I mentioned that feedback from the clinical community has encouraged us to do more work in studying higher doses for the most serious infections. As a result we soon will initiate a safety study of CUBICIN at 10 milligram per kilogram for patients with MRSA bacteremia.

Our phase II competitive dose study of CUBICIN at 6 and 8 milligrams per kilogram for prosthetic joint infection continues to enroll. As we mentioned in January this is a difficult study to do and enrollment is slow. Even if we complete enrollment by the end of 2009 we will have not have data to report until 2010.

Pediatrics, we will initiate the safety and efficacy study for 7 to 17 year olds with skin infections later this year. The soonest we would expect data is the end of 2009 more likely the first half of 2010.

We also will begin a PK study with two to six year old this year. The PK study with these very young children will be a (inaudible) 1.07-11 study so data permits is expected in 2010.

We are on target with our regulatory commitment. The two part study of skin infections in renal-compromised patients, the first phase of safety and PK trial in hemo and peritoneal dialysis patients is due to be completed in the third quarter of this year. Our therapy study for patients with infected endocarditis to be treated with CUBICIN at 6 milligrams per kilogram with and without Gentamicin will begin shortly.

In conclusion another great quarter as CUBICIN continues to grow in historic fashion. The entire commercial organization including the new additions to the team are really charged up. We are poised for continued success in the months and years to come as we progress to our expected peak year sales of greater than $750 million in the US alone. Now, back to Mike.

Michael Bonney

We continue to focus on building long-term values through the optimization of CUBICIN, as well as the development of an acute care product pipeline. Most of our specific 2008 milestones for both CUBICIN and the pipeline are tied to events later this year. We are particularly looking forward to the expected achievement this year of our first, $100 million net revenue a quarter as well as progress on the pipeline.

With that let’s open the line up for questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we’ll now be conducting a question and answer session. (Operator Instructions)

Our first question comes from the line of Tom Shrader with Rodman & Renshaw. Please proceed with your question.

Tom Shrader - Rodman & Renshaw

Hey, good afternoon. Not a bad first quarter I would say.

Michael Bonney

Thanks, Tom. We think it's a terrific first quarter.

Tom Shrader - Rodman & Renshaw

Your guidance, is there anything in the marketplace that changed or is it just the lack of competition?

Michael Bonney

No it's really -- I think that the lion share of why we changed guidance was because of what we are seeing and feeling quite frankly in the marketplace. We are very pleased with the revenue that was developed in the first quarter and the qualitative feedback we continue to get from the field force also encourages us that, increasingly CUBICIN is not the new kid on the block. It's becoming a very strong standard of care and in certain circumstances and it continues to move up the treatment paradigms. So, it's hard to quantitate, but certainly the major reason we've raised guidance is because what we’ve seen and heard about what's going on in the marketplace.

Tom Shrader - Rodman & Renshaw

So you didn't have much competition before or either?

David McGirr

We thought it was going to be relatively late in the year and given the slope of new product introductions in this marketplace we never thought it was going to be a huge issue in 2008.

Tom Shrader - Rodman & Renshaw

Okay, (inaudible) can you describe a little bit on what the sale forces look like that number seems like its taking a while to build?

Rob Perez

Yeah Tom this is Rob. It is going a little slower than I think we would like and that's the way the Novartis would like. It really isn't the fact that they don't have -- they have a strong commitment in resources. I don't know the exact amount of Novartis people on the product. But they definitely have a strong commitment to the product and we've been encouraged with our discussions with Novartis that they are looking very hard at this market and making the changes necessary to see pickup in sales as the year progresses.

Tom Shrader - Rodman & Renshaw

Are they completely dedicated the way your people are or are they selling something else?

Rob Perez

Many of them are completely dedicated. In some countries they're selling one or two other things but most of them are dedicated to CUBICIN.

Tom Shrader - Rodman & Renshaw

Okay. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Tom Russo with Robert W. Baird. Please proceed with your question.

Tom Russo - Robert W. Baird

Good afternoon. Thanks for taking the questions. The first one is just real quick, is there any reason why gross margin should go down over the course of the year as sales go up?

David McGirr

Right in a given year it is unlikely I mean there are a lot of particulars, of course, depending upon production volumes and what gets cleared and so forth and so on. But in general, we think that the margin is going to be in the range that we've guided to.

Tom Russo - Robert W. Baird

Okay. And then I think we've talked about this before offline but can you give us a sense how you're thinking about the recent CMS proposal for fiscal '09 and if there is any scenarios where business could be impacted positively or negatively?

David McGirr

Yeah. We're obviously paying a close attention to this. The proposals of CMS were put out for 2009, in many cases, look a lot like the proposals for 2008 for which they got some pushback from the acute care hospital community. We think net-net; it's unlikely to have a dramatic negative impact.

There is a possibility that if they proceed with some of the restrictions in terms of what they are going to pay, that hospitals would be intended to get patients out of the hospital more quickly. And as I think, Tom, we have pretty good data in skin infection as well as bacteremia and endocarditis that the use of CUBICIN does achieve that objective getting patients out a bit more quickly and saving the hospital money.

So, if they are going to limit reimbursement or eliminate reimbursements for certain types of MRSA infection, we think that the data and performance of CUBICIN to-date well positions us to treat those patients.

Tom Shrader - Rodman & Renshaw

Okay. I have a follow-up question. Regarding the publication of the Pharmacoeconomic study, has that happened yet or is that still to come this year?

David McGirr

We've had data that has been presented at meetings and the publication has not occurred just yet.

Michael Bonney

It's been submitted but it hasn't been printed yet. But we expect later this year.

Tom Shrader - Rodman & Renshaw

Okay, thanks for taking the questions.

Operator

Thank you. Our next question comes from the line of Howard Liang with Leerink Swann, Please proceed with your question.

Howard Liang - Leerink Swann

Thanks very much. I just have a basic financial question. Can you talk about the cash flow the cash flow was meant to be down compared to last quarter. I know there is some buyback of the debt that, but is it just paying down the accounts payable? Can you talk about operational cash flow please?

David McGirr

Sure, Howard. The first quarter is of generally a cash helpful quarter for various reasons and we added to that by buying down the debt where we spent about $47 million. We also pay $23 million in royalty to Lilly in the quarter and you remember that we actually sent the cash for the Illumigen acquisition in Q1 even though we bought the company at the end of Q4. And then at year end, we payout all our bonus in the sense of comp. Sorry, we had in the first quarter for the previous year. So, when you add all those things up, you have a tough cash outflow quarter. But clearly going forward you generate cash.

Howard Liang - Leerink Swann

Great, thank you very much.

Operator

Thank you. Our next question comes from the line of Jason Kantor with RBC. Please proceed with your question.

Jason Kantor – RBC

Great, thanks. Just a follow-up question there… Can you explain the royalty payment of $23 million to Lilly you save it up and pay it all at end of the year or how does that work?

David McGirr

Yeah, we pay it slowly as we can Jason. We own Lilly royalty twice a year in February and in August. And so, you hit the different quarters that you'll obviously accrue it for the P&L [if you use] the cash that's only present [the door] twice a year.

Jason Kantor – RBC

Okay. And then another modeling question, can you run through you've this other income from a net line. Can you run through interest income, interest expense and other…

David McGirr

The other income there the $3 odd million, $3.3 million. What that represents in this case is the gross benefit from buying down the bonds at a discount. However, you have to offset the accelerated write-off of new issue discount so the net benefit is $2.2. They come out in different lines, but that's what that shows.

Jason Kantor – RBC

Okay. And I know you try to address this and we talk about it every quarter and [probably] is that for so ever is does the European sales I mean, is there any diligent provision for Novartis to actually sell the stake and how are your attempts to get it back going?

David McGirr

There are diligent provisions in the contract that are focused on the amount of resource that they need to put against promoting daptomycin, CUBICIN, in their territory. They are certainly meeting those obligations.

I think that as Rob stated earlier, Jason, I don't think anyone is satisfied with the results that have been generated in EU yet, neither we nor Novartis. You may all know that there have been a significant series of management changes with Novartis over the last six or eight month.

We have found that they have been much more interested in understanding at a granular level the difference between the way they've gone to market with CUBICIN and the way that we've gone to market with CUBICIN, and they have also indicated that they are, and we have seen this not only in language but actually in behavior, that they are going to make some changes to more closely benefit, if you will, or align their go-to-market strategy with ours.

So they say, they continue to be committed to the product. They are putting significant resources against this, and they are making some changes in their model. The other thing I would say with respect to the EU sales is remember that the way that the EU sales were booked, there is going to be a lag between a sales pickup if one should come and when it will be reported on our P&L.

We book a transfer price when we send them the vials and then after they sell the product, we true-up the difference between the transfer price and our royalty rate, which means that in essence, the true-up is always lagged by some meaningful period of time form when we send the vials out the door. And that's the choppiness that Rob was referring to in the comments.

Jason Kantor - RBC

Do you think it's just a selling issue or is there something fundamentally different about the marketplace in Europe that makes this less attractive?

Michael Bonney

I think there is a couple. The market clearly is a bit different. There is an additional competitor in the EU relative to the US in teicoplanin, another glycopeptide related to vancomycin. In addition, there is a great variability across the EU in terms of the rate of MRSA.

That said, I think that when we look at the relative performance of CUBICIN for, say, Zyvox in the EU compared to the CUBICIN performance relative to Zyvox in the US, it's clear that there is a difference and that's well recognized by our partners. And they, I think, are being aggressive about trying to take steps to address that difference.

Jason Kantor - RBC

Thank you.

Operator

Thank you. Our next question comes from the line Matt Duffy with Black Diamond Research. Please proceed with your question.

Matt Duffy - Black Diamond Research

Hi, thanks for taking the question. A couple of things Rob, in one of your slides, you showed gross increase in sales are a little over 7%, but the report in the US was only about 3%. What accounts for that difference there?

Rob Perez

It's really timing that in terms of gross versus net when the sales are booked. This includes the final days of the months, whereas the net sales don't and also how according to us is better year. So, it's really the difference between what we do in finance what our support folks do when they put that work together.

Matt Duffy - Black Diamond Research

Okay. And I guess on a more granular level and the hospital level, we're hearing a lot about hospital looking much harder at vancomycin MICs. I am trying to figure out whether they are one or two or in between one and two? Give any sense nationally how many hospitals are doing Etest or other tests to determine things more than just greater than or less than two and what impact that's having on those individual accounts?

Michael Bonney

Yes, I don't have an output number, but I can tell you that it's growing and that's increasing. We hear every week, every month about more institutions using Etest and just doing other using other methods to actually get an MIC for vancomycin. So the concern is out there that when you just get the flexibility report, it says susceptible, intermediate and resistant. That really isn't enough information anymore.

Matt Duffy - Black Diamond Research

Right.

Michael Bonney

So, I think that's a very good thing for us, because the more institutions get an actual MIC the more they start to see ones and twos and the more quickly they switch.

Matt Duffy - Black Diamond Research

Okay. And then lastly, the average dose in skin and bacteremia, that sort of thing, and has that being moving over the last few quarters?

Michael Bonney

It's been moving up slightly. The average dose for skin is slightly above 4 milligram per kilogram. The average dose for bacteremia is slightly below 6. And those numbers have moved, but slightly. So, I think suffice it to say, we still have some work to do in order to convince people, as much as we say to convince people, that they have to use 6 milligrams per kilogram for bacteremia and endocarditis.

And I think what we could be seeing is some kind of rounding that goes on with patients and maybe sometimes pharmacists and physicians just want to use a vial or something like that. So, the way I can tell you is the sales growth that you are seeing is not being driven by significant changes in dosing.

Matt Duffy - Black Diamond Research

Thanks very much, guys.

Operator

Thank you. Our next question comes form the line of [Steven Weimer] with Thomas Weisel Partners. Please proceed with your questions.

Steven Weimer - Thomas Weisel Partners

Hi. Thanks for taking my question. Have you decided if you're going to relax the criteria of entering the prosthetic joint trial?

Michael Bonney

No. Our strategy to date has been to enroll more accounts basically to open up more centers to enroll patients. Given the fact that there is a surgical component and a medical component to the treatment of prosthetic joint infections were uncomfortable with relaxing the criteria because you may run or fall with 1 or 2 or the other of those two kinds of treatment modality. So, our strategy has been and we've seen some pickup in enrollment as a result of this to open up more centers.

Steven Weimer - Thomas Weisel Partners

Great. And then lastly can you maybe just comment on the business development landscape right know are you seeing more companies essentially looking to do deals now that the financing window is kind of shut a little bit?

David McGirr

We've I think it's fair to say that over the first quarter of 2008 we've seen a broader and more rich range of deal possibilities and we've seen during my tenure at Cubist. And I think that one of the drivers of that which you mentioned.

Steven Weimer - Thomas Weisel Partners

Great, that's helpful. Thank you.

Operator

Thank you. Our next question comes from the line Joel Sendek with Lazard. Please proceed with your question.

Joel Sendek - Lazard

Hi, thanks a lot. I've three questions. The first one David I'm wondering if you could just mention what the accelerated depreciation amount was in the G&A line?

David McGirr

It's $2.3 million.

Joel Sendek - Lazard

$2.3 million. Okay and no other onetime was part of that?

David McGirr

Apart from the bond and buyback, which obviously had some onetime effects, but they wash out.

Joel Sendek - Lazard

But that wasn't in the G&A line?

David McGirr

It's in the other income line.

Joel Sendek - Lazard

And did you -- maybe I missed it on the slide did you give the guidance number for G&A for the year?

David McGirr

Yes we do it. But it's still we expect to come in around $38 million.

Joel Sendek - Lazard

Okay, all right thanks. A follow-up from the last question… Are there copious possibilities, as far as business development, to be on the buy side of that, which was the thinking behind retiring part of the debt. It seems to me you have got more…

David McGirr

We're generating once we get beyond this quarter Joel, we'll be generating a fair amount of cash and we believe for the deals that are most prominent in front of us, we've plenty of cash to deal with those opportunities. And perhaps this was not an opportune moment given the fact that the debt had followed the share price, which we think is relatively low compared to the value that we're actually creating. So, it's an opportune moment to retire some of that debt at advantageous terms.

Joel Sendek - Lazard

All right, good I understand that. And then the last question; you issued a press release on March 13 saying no sign of an ANDA filing. In the event that you do get disclosure of that will you issue a press release, let's say…

David McGirr

Yes we'll.

Joel Sendek - Lazard

Okay, that's it. Thanks.

Operator

Thank you. Our next question comes from the line of Rachel McMinn with Cowen. Please proceed with your question.

Rachel McMinn - Cowen & Company

Thanks very much. Just two questions from me and I guess another one following up on the [BB] opportunity. Mike, can you just talk a little bit about your goals again? Is it just going to be cash? Will you be looking at something that would be very (inaudible). What were kind of I guess things that you're willing to sacrifice in order to get a late stage product? And then the second question is just on tax. David, if you've any updated comments on when you expect the bookings tax in the P&L? Thanks.

Michael Bonney

Sure. I know that there is a lot of interest in this first question about what would we be willing to pay for an opportunity. It's a difficult question to answer because it will of course depend on the opportunity. Are we willing to take some dilution, potentially but it will have to be a compelling opportunity. We also think about operating expense, post transaction differently then the actual transaction to get access to a product, whether it be a licensing deal or actual acquisition.

So, it is likely that to acquire the products we've to take something upfront. But then we'd like to operate and develop the product or launch it whatever the case maybe depending on its phase within our current view of what our cash flow would be in and continue to retain profitability.

So, we remain disciplined about this. But I can't answer absolutely what we will be willing to do, because clearly buying a billion dollar product would require a different kind of decision making than buying the $250 million opportunity. With respect to tax, David?

David McGirr

As we said in Q1 we still are really working up on AMT that's where we're until we get to the position where the circumstances and facts would cause us to reverse our valuation allowance and then following that you'd see a more normal tax rate that's the moving target.

I think we discussed this on the year end call. There is no set date of which you do that. There is no set of information you've to consider where you're as a company. What the future looks like and have these discussions with your outside advisors. And so for the time being we're with AMT plus the few states where we pay some tax.

Rachel McMinn - Cowen & Company

And I'm sorry just to follow-up on the duties commentary Mike. I guess I'm a little bit confused. So, I mean, if your volumes comes in at stage III, clearly you're going to pay more or else they're going to have operating and you're saying that you'd just make portfolio decisions internally and spend less cash on some of the pre-IND program is that something you're looking sort of doing to offset the cost of running of expense of clinical trials?

Michael Bonney

We'll certainly look at all available levels. Our basic operating philosophy once you get beyond whatever the price to acquire the product that could be an acquisition price, it could be a licensing upfront whatever that maybe. It is our intent to operate the company with additional products in the pipeline in a way that it retains not only our profitability but a reasonable level of profit growth.

Rachel McMinn - Cowen & Company

And based upon what you are seeing today, it sound, I guess, more enthusiastic than you have in the past. Should we be I guess expecting something relatively soon or at least this year?

Michael Bonney

As I've said many times over the past year or so, this is an important part of our corporate strategy, Rachel. So we're not going to change who we are fundamentally as human beings in order to get a deal done, but it is a very high priority for us and we're very pleased with the range and number of opportunities that have presented themselves over the last three or four months.

Rachel McMinn - Cowen & Company

All right, thanks very much.

Operator

Thank you, our next question comes from the line of Biren Amin with Stanford Eagle. Please proceed with your question.

Biren Amin - Stanford Eagle

Hi, thanks for taking my questions. First one is, it's been about a year, I guess, since Zyvox received a warning letter on catheter-related bacteremia. So I wanted to get your thoughts on it. This in fact has been a key driver in your success in the systemic setting in the US and if it has, why hasn't Novartis capitalized on the same warning letter in Europe considering you've stated earlier in the call, that Zyvox is a formidable competitor?

Rob Perez

Hey, Biren, this is Rob. Actually, we looked pretty closely at this phenomenon when it happened and because it did coincide with an increase or up tick in our sales growth and actually but it also kind of coincided with a real change in the way people were looking at Vancomycin. As we look at the Zyvox phenomenon, we weren't able to see any real significant changes due to Zyvox, it was much more associated from everything we could tell on the changes in viewing Vancomycin.

As a matter of fact we even went from looking at account-by-account analysis looking at the accounts that changed up for Cubist and down for Zyvox and there was really not much correlation between our growth and some reduction in the use of Zyvox.

So, we really, the fact that we are here by first quarter of our fifth year with 50% net sales growth I think has much more to do with the fact that CUBICIN is very well accepted at this point. Physicians don't see it as new any more. I think they have a comfort level with the safety profile and the fact that Vancomycin is been viewed as not as good as it used to be its much more fast than problems with Zyvox.

Biren Amin - Stanford Eagle

Okay and maybe a second question for you Rob as well. The outpatient market I guess the growth in this quarter was a little bit softer than in previous quarters. Are there some factors that lead to this?

Rob Perez

Yes usually our outpatient business consists more of skin, as you can imagine that the more serious infection bacteremia and endocarditis are treated more inpatient. So the skin season usually occurs more in the second and third quarters. So it's not unexpected to have a little bit softer growth in outpatient. In Q1 what we are really happy to see with our inpatient business was so healthy in Q1 and I think what's again signaling that the bacteremia side of the business is doing very well.

Biren Amin - Stanford Eagle

Okay thanks.

Operator

Thank you. (Operator Instructions) Our next question comes from the line Meg Malloy with Goldman Sachs. Please proceed with your question.

Meg Malloy - Goldman Sachs

All right, thanks very much. I just want to follow-up on that last part in terms of bigger sources of growth. Clearly this is a big quarter for you all. Can you pinpoint, maybe more by indication where you've seen the biggest growth and what gives you comfort that that growth will persist?

Michael Bonney

Yeah, thanks Meg. We don’t have a breakdown for quarter of where the growth came from, from an indication standpoint. You get that data only from AMR, which comes out biannually, as well as our market research. What we've seen from AMR data which is kind of year-over-year is that we are increasing in systemic infections.

So, we are seeing differential growth with the more serious infections and I think, once again the beauty of this drug is even though skin infections may be a tougher more competitive environment, the fact that we have such a strong outpatient business makes us differentially, gets well suited for that market as well. So, I was very pleased to see the inpatient growth this quarter and I think we'll have to see what happens in outpatient skin infections in the quarters to come.

Meg Malloy - Goldman Sachs

All right. And if I could just follow-up on CMS, just to make sure I'm clear in terms of the coverage, I mean right now if you get a hospital acquired MRSA infection, there is a bunch of different buckets that you could potentially be covered through. So that even if changes were implemented requiring specific codes, it still seems to me that there are a lot of avenues for coverage. Could you just kind of walk through the logistics of how things work today and what could be changed?

Chris Guiffre

Yeah, for this current year, the only CMS rule that has any impact really in our space is that nosocomial post-surgical infections the CMS has decided not to reimburse. So, obviously, some of those post-surgical infections are MRSA, and daptomycin could be used there.

Again, we haven't seen any real impact on this. I think most hospitals would say, "Okay, if that's the case, then we're going to use whatever we can to get the patient healthy and home as quickly as possible." And we have (inaudible) in the skin to that end.

What's being proposed for next year is a bit broader, and it includes the same proposal for nosocomial MRSA septicemia that they had in 2008, but the hospitals pushed back. And the fundamental issue here is that it's very difficult to determine even if the patient is colonized with MRSA. And if they develop septicemia in the hospital, whether it's nosocomial or whether it is just because they carried the bacteria in with them and ceded their own blood.

So, we'll have to stay tuned to see how that actually results itself for 2009. But again, our view is that even if they decide they are not going to reimburse for that, that will tend the hospitals to strike at these patients, who have the SAP, and daptomycin has the strongest data with respect to that.

Meg Malloy - Goldman Sachs

But just practically speaking, particularly given the risk of spread, it's hard in managing scenario where you are in the hospitals and you've got MRSA, it's not going to be addressed?

Rob Perez

Yes, they cannot treat them. I mean particularly MRSA in the blood stream, that's untreated in the pre-antibiotic era, which carries 95% mortality.

Meg Malloy - Goldman Sachs

Right. There is something just put with the practical realities here.

Michael Bonney

And that's why I think the bottom line takeaway is we're certainly watching the CMS potential changes, but we think the bottom line here is, if they're going to be reimbursed less, then their incentive will be to treat those patients as efficiently as possible and get them out of the hospital, not incur more days of hospital stay than possible. And that's where CUBICIN benefits will come into play.

Meg Malloy - Goldman Sachs

Okay. Thanks a lot.

Operator

Thank you. Our next question comes from the line of [Scott Harland] with [SEC Global]. Please proceed with your question.

Scott Harland - SEC Global

Hi. I've got a couple of questions for you. You've indicated that you had a $23 million royalty payment to Lilly?

Michael Bonney

Right.

Scott Harland - SEC Global

And how is that calculated and where will this show up on the line item? I didn't see anything?

Michael Bonney

The way it hits the P&L, Scott, is that it's embedded in the cost of good. So, whenever we sell a vial, we book the Lilly royalty that is associated with that vial. (inaudible) the two payments period that David talked about.

Scott Harland - SEC Global

That's like cost, okay. So that's always embedded in there?

Michael Bonney

Yes. There is no change in that, and frankly there is no change in our payment schedule to Lilly. We've always paid on the same schedule, first and third quarters.

Scott Harland - SEC Global

Okay. So then all it does is affect how your actual amount of cash at the end of the quarter, is that correct?

Michael Bonney

Correct.

Scott Harland - SEC Global

Because otherwise, you're saying your cash would have been $23 million?

Michael Bonney

Correct.

Scott Harland - SEC Global

Okay. Number two, how is the revenue in the EU calculated? Because I mean, obviously, when you got in the US to your sales reps and everything, you count it in a dollar-for-dollar, right?

Michael Bonney

Right.

Scott Harland - SEC Global

When you're over there, what is it, $0.50 on the dollar or somewhat --?

Michael Bonney

The way that it works is our relationship with our partners, and this is true of not only Novartis, but the other partners, we are paid a royalty on the sales that they make. And we have not disclosed that royalty historically, but I think most of sell-side analysts have us around 35%. So, for every dollar that they sell, we would get $0.35. The rate actually flows. The P&L is a bit more complex in that.

Scott Harland - SEC Global

Okay.

Michael Bonney

The way it flows to the P&L is when we sell them a shipment of vials, we book a transfer price, which is essentially the cost of manufacturing those vials, cost a little bit and then once they sell the vials out of their inventory into the marketplace, there is a true-up that occurs between the transfer price and the royalty that they ultimately owe us.

But because that sell-through takes time, we don't book that true-up until some months after. Once we get the report from them, some months after the vials have actually gone out the door and been booked on a transfer price basis.

What we are reporting is a combination. For any given quarter, it's a combination of what ever number of vials went out the door to the partner in that quarter, plus the difference between the transfer price and the royalty payment they owe us for a preceding period.

Scott Harland - SEC Global

Okay. So basically, what you are saying is overall if you show $2 million with international sales, it really represents about $6 million worth of sales.

Michael Bonney

Sort of, yes.

Scott Harland - SEC Global

And then lastly, the effect of the additional sales reps you have got, what kind of effect do you expect that to have on your sale?

Michael Bonney

Well, we expect to be very positive. We have run through a process really each year since we've been in the market to look at where we are in the promotional response curve for the last representative hired and project where if we increase reach in frequency by one rep, two reps, et cetera, where we think we would be and we've put -- someone would argue a more conservative metric there than most organizations would do and that we expect that the last rep we hire in the expansion will generate sufficient gross margin to pay for themselves in the first year. So, we do expect that this additional 29 people that we hired in the first quarter this year will generate additional growth given where we were at the end of last year on the promotional response curve.

Scott Harland - SEC Global

And any further thoughts on additional buy downs of the debt or is that as you see your opportunities?

Michael Bonney

Yeah, I don't think that it, I think we would be opportunistic and certainly we're not going to have a planned buy down of the debt.

Scott Harland - SEC Global

Okay and then again that royalty payment, that's included in that 22% or 23% of your product your cost you say?

Michael Bonney

That's right. Essentially part of that is the cost of actually manufacturing the drug and the vial and shipping it to the customer and part of that is the little bit royalty.

Scott Harland - SEC Global

Okay. Thanks, guys.

Michael Bonney

Thanks.

Operator

Thank you. Our next question comes from the line of Jason Kantor with RBC. Please proceed with your question.

Jason Kantor - RBC

Hi, thanks. Just a quick follow-up, the warning letter that went out regarding contamination with [back-home] pump devices. Do you have any update or thoughts as to how that might impact sales if at all?

Michael Bonney

Yeah, we haven't seen any impact at all on it, in fact we are offering to reimburse customers who had bought vials and mixed it up and put it in those pumps, and so far we have had less than 20 vials come back. So I think it's, as a serious issue we currently want to make sure the patients are protected and so the letter to the physicians. But in terms of the percentage of market that was using this pump it appears to be very, very low. And I would stress that when you said pump, it is one pump so there we have tested at least one other that where we have not seen it contaminated, not all pumps.

Jason Kantor - RBC

Okay, great. Good to know. Thank you.

Operator

Thank you, our next question comes from the line of Howard Liang. Please proceed with your question.

Howard Liang - Leerink Swann

Thanks. If you can just go over the difference in the growth rate between the growth sales and net sales again whether this is unique to the first quarter I think that in the past quarter they seem to be more comfortable?

Michael Bonney

Yeah, I'll. Let me see if could clarify that. I assume that you are referring to a question someone else asked earlier. I guess he asked about the inpatient versus outpatient. The fundamental issue here is not a difference in gross net. The fundamental difference is that the data set upon which we've based the inpatient versus outpatient is the slightly different dataset than the financial books and records for the first quarter, which is why you see it slightly different absolute growth rate in the two. We're comparing apples-to-oranges essentially what we are doing here, very close in time, but they are not exactly the same in time, hence you have a slight difference there.

Howard Liang - Leerink Swann

Right. So, I am talking of slide that you sent could make it at the sources CUBICIN gross sales, so those were actual --.

Michael Bonney

It is CUBICIN gross sale. It is that dataset that shows the inpatient versus outpatient is a gross sales numbers, as opposed to net sales, which is what we reported for us. But the difference between gross to net moves very, very slowly and has to do with reserves that you take for return product in the future, Medicare rebates and that kind of thing that moves very, very little. The reason that the growth rate represented by that slide is different from the growth rate we reported is because it uses a slightly different time period to represent the first quarter than what's in the books and record.

Howard Liang - Leerink Swann

Okay. So, I guess I'm really wondering is whether a form of demand perspective, whether the growth rate is 7% or may be 3% quarter-over-quarter.

David McGirr

From 3% is really the number you should use when you're comparing Q1 of 2008 to Q1 of 2007 there it's based on our revenue recognition policy et cetera.

Howard Liang - Leerink Swann

Okay, all right. Thanks. Then can you talk about the inventory level and also when was your last price increase and whether the absence of near term competitors affect your ability to raise the price?

David McGirr

So, inventory levels, we have plenty of inventory to meet projected demand going forward. There is no change in our distribution methods. So, there is no inventory in the major wholesalers. The inventory that is held for this product is either on our books and inventory or it's with the hospitals of the home infusion companies or the other out-patient infusion centers.

There has been no change in order patterns that we've seen. So, we presume that the inventory levels that are held for hospitals and the other customers is about constant to date or about three times a month on average.

Second part of the question was price increase

Howard Liang - Leerink Swann

Price increase.

David McGirr

Price increase, last price increase was January first. And we don't make any forward-looking commentary about future price increases.

Howard Liang - Leerink Swann

Thank you.

Operator

Thank you. Our next question is from the line of Eun Yang with Jeffries. Please proceed with your question.

Eun Yang - Jeffries & Company

Thanks. I think this question is to David. On the [HepeX-B] CUBICIN sales, the first quarter was a $1.8 million and you are still keeping the guidance. So, is it because do you expect fluctuations on a quarterly basis?

David McGirr

No and it really goes back to this issues that the $1.8 million is an amalgam of two numbers that's bulk sales of vials plus [true option] from previous time. These times we draw a straight line and get the year.

Eun Yang - Jeffries & Company

Okay, thanks.

Operator

Thank you. Our final question is from the line of Tom [Bracle] with Federated Investors. Please proceed with your question.

Tom Bracle - Federated Investors

Hi guys.

David McGirr

Hi, Tom.

Tom Bracle - Federated Investors

This royalty buy down in 2005 that you did the royalty still really looks -- starts looking pretty good. I was wondering are there additional possibilities to talk with Lilly about the royalties that you're paying.

David McGirr

All right something that we've talked to Lilly from time-to-time about and I think we've discussed as well that we've have learned sometime ago that Lilly has done some transactions with financial investors. And as far as we're aware today Lilly no longer has any interest in the CUBICIN royalty. It is now being placed with financial investor.

Tom Bracle - Federated Investors

And it doesn't make sense to talk with the financial investors about buying down those royalties?

David McGirr

Well they are tough people to deal with as you know Tom.

Tom Bracle - Federated Investors

Okay, very good. Thank you.

Operator

Thank you. There are no further questions at this time. Gentlemen, do you have any closing comments?

Michael Bonney

I just thank everybody for joining us for today's call. We're very enthusiastic about the quarter and we feel very comfortable raising guidance at this point for the balance of 2008. I'd also ask people to mark the calendars for our Q2 call, which will be on July 17 at 5.00 p.m. Thanks a lot. Have a great evening.

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Cubist Pharmaceuticals Inc. Q1 2008 Earnings Call Transcript
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