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Somaxon Pharmaceuticals, Inc. (NASDAQ:SOMX)

Q3 2012 Earnings Conference Call

October 31, 2012, 16:30 PM ET

Executives

Richard Pascoe -- President and CEO

Tran Nguyen -- SVP and CFO

Matt Sheldon -- IR

Analysts

Scott Henry -- Roth Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Somaxon Pharmaceuticals' Third Quarter 2012 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, October 31, 2012.

I would now like to turn the call over to Mr. Matt Sheldon, Investor Relations. Go ahead, sir.

Matt Sheldon

Thank you. Good afternoon, everyone, and thank you for joining us today to discuss Somaxon Pharmaceuticals' third quarter 2012 financial results. On the call today are Richard Pascoe, the Company's President and Chief Executive Officer; and Tran Nguyen, the Company's Senior Vice President and Chief Financial Officer.

First some housekeeping issues before we start. Earlier today, Somaxon issued a news release announcing the Company's financial results for the third quarter of 2012. If you have not received this news release, if you'd like to be added to Somaxon's fax and e-mail list to receive Company information, or if you'd like to change your contact information, please contact Somaxon Investor Relations at 858-876-6500. We encourage everyone to read today's news release as well as Somaxon's quarterly report on Form 10-Q that will be filed tomorrow.

In addition, be advised that this conference call is being broadcast live on the Internet at investors.somaxon.com/eventdetail.cfm. A playback of this call will be available and may be accessed at that site.

Please note that certain of the information discussed on the call today is covered under the Safe Harbor Provisions of the Private Securities Litigation Reform Act. I caution listeners that during this call Somaxon management will be making forward-looking statements. Actual results could differ materially from those stated or implied by these forward-looking statements due to risks and uncertainties associated with the Company's business. These forward-looking statements are qualified by the cautionary statements contained in Somaxon's press releases and SEC filings including its annual report on Form 10-K and quarterly reports on Form 10-Q.

This conference call contains time-sensitive information that is accurate only as of the date of this live broadcast, October 31, 2012. Somaxon undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call.

I'd also like to point that any discussion of non-GAAP measures during this conference call is an addition to and not a substitute for or superior to measures of financial performance prepared in conformity with GAAP measures.

With that said, let me turn the call over to Richard Pascoe. Rich?

Richard Pascoe

Thank you, Matt, and good afternoon everyone. We appreciate you joining us to discuss our financial results for the third quarter of 2012 and our future plans and outlook. During the third quarter of 2012, we've continued to focus on our key corporate objective relating to Silenor commercialization, intellectual property protection, our financial position and our strategic alternatives process.

Commercially, we have continued to stabilize Silenor prescription volume quarter-over-quarter, and we have made solid progress in our managed care efforts, particularly with respect to the Medicare Part D market.

In addition, we settled our Silenor paragraph IV litigation with three of the four generic filers, bolstered our balance sheet through a registered direct offering and we continue to manage our operating expenses in an effort to drive towards profitability.

Our progress on all of these fronts has allowed us to be actively engaged in our previously announced strategic alternatives process led by our advisor, Stifel Nicolaus Weisel.

I will provide more details regarding our activities and progress in a few minutes. But first, I would like to have Tran, briefly review our financial results for the third quarter of this year. Tran?

Tran Nguyen

Thanks Rich, and good afternoon, everyone. For the third quarter of 2012, we reported net product sales of Silenor of $2.1 million, compared to net product sales of $3.7 million for the third quarter of 2011. This decrease in net product sales of Silenor was primarily due to the reduction of our sales and marketing efforts in the fourth quarter of 2011.

Our total operating costs and expenses for the third quarter of 2012 were $6.6 million, including $0.6 million of non-cash, share-based compensation expense and an expense of $2 million related to our paragraph IV settlement agreements, which will be paid over a period of time, entered into during the third quarter of 2012, compared with $18.8 million, including $1.7 million of non-cash, share-based compensation expense for the third quarter of 2011. Again, the decrease compared to the comparable prior year period was primarily due to the reduction of our marketing efforts and our reduction in force in the fourth quarter of 2011.

Cost of product sales was $0.2 million for the third quarter of 2012, compared to $0.5 million for the comparable prior year period. Gross profit for the third quarter of 2012 was $1.9 million, compared to $3.2 million for the third quarter of 2011. Expressed as a percentage of net product sales, gross margin was 89% for the third quarter of 2012 and 88% for the third quarter of 2011.

SG&A expense was $4.4 million for the third quarter of 2012, compared to $18.1 million for the third quarter of 2011. The decrease in SG&A expense was again primarily due to the reduction of our marketing efforts and our reduction in force in the fourth quarter of 2011.

We had no research and development expense for the third quarter of 2012. Research and development expense for the third quarter of 2011 was $0.2 million. Our net loss for the third quarter of 2012 was $4.5 million, or a loss of $0.65 per share, compared with a net loss of $17 million, or a loss of $2.86 per share, for the third quarter of 2011. These per share numbers reflect our 1-for-8 reverse stock split that we effected on October 11 of 2012.

Also as a helpful – as a useful supplementary financial measure to facilitate additional analysis by investors, our non-GAAP operating expense for the third quarter and nine months ended September 30, 2012 was $3.8 million and $12.3 million, respectively, which was calculated by adjusting our 2012 GAAP operating costs and expenses for the third quarter and nine months ended September 30, 2012 of $6.6 million and $17.1 million, respectively, to exclude cost of product sales, non-cash, share-based compensation expense and an expense related to the Company's paragraph IV settlement agreements entered into during the third quarter of 2012.

As of September 30, 2012, we had 7.2 million shares outstanding and 9 million shares on a fully diluted basis. Again these figures are adjusted for our recent reverse stock split. As of September 30, 2012, we had cash and cash equivalents totaling $8.2 million and no debt. As of December 31, 2011, we had cash and cash equivalents totaling $10.7 million and no debt.

With that, I'd like to turn the call back over to Rich.

Richard Pascoe

Thanks, Tran. During the third quarter, we continue to deploy our commercial resources in an efficient and effective manner with the objective of achieving positive cash flow and profitability by maximizing prescriptions and the net sales of Silenor while managing our operating expenses.

Our field sales activity focuses on both current Silenor prescribers and high branded prescribers where we have favorable managed care coverage in order to increase current prescribing of Silenor by those physicians. In addition, we recently deployed a targeted inside sales team to maintain gross Silenor prescriptions with high valued prescribers where we do not currently build an outside sales force.

Prescription demand in the third quarter has continued to stabilize and when compared to prior quarters, while net sales were down in the third quarter of 2012 as compared to the second quarter as a result of wholesalers adjusting their inventory levels. Our net sales are calculated by looking at product shift to wholesale customers which is correlated to prescription data but not always equivalent to the number of prescriptions filled.

Total prescriptions filled for Silenor during the third quarter of this year normalized to a 30-count equivalent unit or 24,565 compared to 25,891 prescriptions for the second quarter of this year. In contrast, total Silenor units shift during the third quarter of 2012 normalized to a 30-count equivalent unit or 18,685 compared to 28,973 for the second quarter of this year. We believe that if we are able to continue to generate stable prescription demand, net sales will also stabilize over time.

In addition to our sales and marketing activities, we have also been focused on increasing the utilization of Silenor through managed markets contracting and encouraging the increased use of our patient loyalty programs to encourage retails and more effectively penetrate the elderly patient population.

Specifically, with respect to this last area, we our leveraging Silenor's unique safety profile in discussions with Medicare Part D plans. We recently agreed to terms with MedImpact, the national Medicare Part D pharmacy benefit manager covering approximately 100,000 Medicare Part D insomnia prescriptions per year and they placed Silenor on this formulary in a Tier 2 unrestricted access status starting in October.

Importantly, because of Silenor's unique safety profile starting in January of 2013, this plan will place a step-edit on generic Ambien, Ambien CR and Sonata, thus requiring Silenor to be used first over the generic GABA agonist in an effort to provide access to non-high-risk medications for the elderly.

In addition to the success with MedImpact, earlier this month, we were notified by Coventry Healthcare that Silenor has been added to Coventry's 2013 Medicare Part D formulary in a Tier 3 non-restricted position. Silenor will be made available to Coventry's 1.7 million Medicare eligible members for a reasonable out of pocket cost beginning in January of next year.

These managed care successes represent recognition of Silenor as a non-high-risk medication for use in the elderly and we are consistent with recent updates by the Pharmacy Quality Alliance of its prescription drug list entitled 'Use of High-Risk Medications in the Elderly' and by the American Geriatrics Society of its 'Beers Criteria for Potentially Inappropriate Medication Use in Older Adults.'

In the PQA's updated list, Silenor was not included as a high-risk medication for the elderly. In the updated Beers Criteria, doses of doxepin of 6 milligrams, those are the doses that are recommended for adult and elderly patients with Silenor under the stated rationale that low-dose doxepin has a safety profile comparable to placebo. Doxepin 3 and 6 milligram of course is the active ingredient in Silenor.

This is in contrast to the inclusion on the Beers list of the active pharmaceutical ingredients in Ambien, Ambien CR, Lunesta and Sonata, together with the recommendation that such medications are not to be used chronically, defined as greater than 90 days.

We intent to continue to use these acknowledgements of Silenor with safety profile to gain more favorable Medicare coverage as part of CMS's Five-Star Quality Rating System. That system provides bonus payments to Medicare Advantage Plans based upon the plans quality rating, of which drug safety in the elderly population is a key component.

And while we can provide no assurances that we will be successful in replicating our Part D win with MedImpact, we intend to vigorously pursue all available avenues by which we can make Silenor available to the elderly insomniacs.

In addition to our commercial efforts, we continue to make progress in our defense of Silenor's intellectual property against the generic challengers, with the goal of protecting its market exclusivity, while allowing us to remove uncertainty and to reduce the cost of litigation.

In July, we entered into separate settlement arrangements with Mylan, Par and Zydus to resolve the pat litigation with each of them involving Silenor 3 milligram and 6 milligram tablets. The settlement agreement with Mylan, grants Mylan the exclusive right to begin selling an authorized generic version of Silenor on January 1, 2020, or earlier under certain circumstances.

Mylan's right to sell the authorized generic product could extend for a period of as long as 360 days, after which Mylan will have the non-exclusive right to sell a generic version of Silenor under its ANDA. In connection with the settlement agreement, the parties also entered into a supply agreement, under which Mylan has agreed to supply us with commercial quantities of Silenor both 3 and 6 milligram tablets.

The settlement agreements with Par and Zydus grant each of them the right to begin selling a generic version of Silenor, 180 days after the earlier of the date with a third party generic version of Silenor is first sold in the United States under a license from us or a final court decision that the litigated patents are not infringed, invalid, or unenforceable or earlier under certain circumstances.

We will continue to defend Silenor's intellectual property against the remaining generic challenger Actavis with a goal of protecting its market exclusivity, while allowing us to minimize further uncertainty and the cost of litigation.

We also took steps since the beginning of the quarter to bolster our balance sheet and to maintain our listing on the NASDAQ Capital Market. In July we completed a registered direct offering of approximately 1.2 million shares of our common stock and warrants to purchase up to approximately 0.6 million additional shares of our common stock to institutional investors at a combined public offering price of $2.56 per share and for a warrant.

Aggregate gross proceeds to us were approximately $3 million before deducting selling commissions and expenses. Earlier this month, we effected a 1-for-8 reverse stock split of our common stock for the purpose of maintaining our listing on the NASDAQ Capital Market. The reverse split was accompanied by a decrease in the number of authorized share of our common stock from 100 million to 25 million shares. The reverse stock split and the decrease in the number of authorized shares of common stock were approved by our stockholders at a special meeting held on October 5 and our first post-split day of trading on NASDAQ was October 12.

On October, 26 the NASDAQ Listing Qualifications Department formally notified us that we had regained compliance with this requirement. And as a result, shares of our common stock will continue to be listed and trade on the NASDAQ Capital Market, and the matter is now closed.

We have also been actively working with our advisor, Stifel Nicolaus Weisel, to evaluate strategic alternatives with the goal of fully leveraging Silenor for the benefit of our stockholders.

In addition to seeking to leverage Silenor's in the US prescription market, this strategic process will entail working to generate value from both ex-US and OTC rights for Silenor. I would like to say a few words about each of these.

In April, we entered into a collaboration with CJ Corporation, pursuant to which CJ will commercialize Silenor in South Korea, if approved. We received an upfront payment of $600,000, and if Silenor is approved in South Korea, we will be eligible to receive sales-based milestone payments as well as a royalty, based on net sales of Silenor in South Korea. We will also supply CJ's requirement for commercial quantities of Silenor in South Korea at a separate transfer price.

We also previously announced that our licensee Paladin Labs filed a new drug submission for Silenor in Canada that is under review by Health Canada. If approved, Silenor is expected to be the first and only prescription product approved for the treatment of insomnia in Canada that is not a controlled substance. To-date, the Canadian prescription sleep aid market has consisted mainly of Zopiclone and older medication, that despite its limitations, has driven the market to exceed $87 million in 2011 for Zopiclone alone, an increase of 10% over the previous year.

If Silenor is approved and commercialized in one or more of the licensed territories, most notably Canada, Somaxon will be eligible to receive sales-based milestone payments of up to $129 million US as well as tiered double-digit proceeds on net sales. According to Paladin's most recent earnings call, Paladin is expecting approval of Silenor by Health Canada in late 2012, and to launch the product in Canada in the first half of next year.

Our deals with both CJ and Paladin represent our commitment to partnering to drive Silenor revenue from all markets where it can be cost effective. We expect to continue to see partnerships in other ex-US regions, where there's an unmet need for a highly differentiated insomnia treatment.

We are also seeking to leverage rites to an over-the-counter version of Silenor. The FDA has provided clinical and regulatory guidance related to a Silenor OTC program that we believe provides a clear path-forward for this important Silenor life cycle management opportunity.

As we've stated before, we believe that Silenor's characteristics, including its lack of addiction potential and its clinical efficacy and safety profile make it an ideal candidate to be the first prescription insomnia therapy to be converted to an OTC product. The leading OTC products currently available for the treatment of insomnia utilize diphenhydramine or Doxylamine as their active ingredient. Both of these compounds are listed in the 2012 Beers Criteria as medications to be avoided for use in older adults, given their safety and tolerability profile.

And with over 70 million insomniacs in US alone, where 80% or roughly 56 million of those do not use a prescription treatment, coupled with a lack of differentiation and/or safety concerns with an existing OTC sleep aid, we believe that an approved over-the-counter version of Silenor has significant commercial potential in the US over-the-counter sleep aid market.

In conclusion, we are pleased with the progress we are making in our business and with the continuous stabilization of our Silenor prescription business, the progress we have made in defending Silenor exclusivity, the potential we see in an OTC version of Silenor and our continued focus on positive cash flow and profitability, we're excited about the potential to execute on our operating plan during the remainder of this year as we seek to maximize the value of Silenor in every way possible for the benefit of our stockholders.

With that, and with the remaining time available, Tran and I would be happy to address any questions that you may have. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). And our first question is from the line of Scott Henry with Roth Capital. Go ahead.

Scott Henry -- Roth Capital

Thank you and good afternoon. Just a couple of questions. First, does the Company currently have any guidance out there that we should be aware of or would you like to put any out there in terms of revenue and/or expenses?

Tran Nguyen

So, as you know, Scott, we haven't actually put out a revenue guidance out there, but what we did do in the fourth quarter of 2011 earlier this year in March, we put out our non-GAAP operating expense guidance between $15 million and $16 million. So that number would relate to the $12.3 million that we've done through the first nine months of this year. So we believe we're still on track to meet that $15 million to $16 million guidance?

Scott Henry -- Roth Capital

Okay, fair enough. And when I look at SG&A, the $4.377 million figure, I know you've already pulled out $2 million for the settlement costs, but is there – of that $4.4 million, how do you mix that up in the baskets? I'm trying to get an idea of what kind of the core SG&A is currently?

Tran Nguyen

So it's basically predominately G&A and sales and marketing make up the bulk of that $4.4 million. $0.6 million of that is share-based compensation expense between the two sales and marketing and G&A.

Scott Henry -- Roth Capital

Okay. So there is no litigation within that $4.4 million…

Richard Pascoe

There's also litigation cost in terms of the lawyer side of it, the expenses that we pay for WilmerHale to do their work. As far as the settlement, as you can see from our press release, the $2 million that we pulled out is for the settlement of paragraph IV.

Scott Henry -- Roth Capital

Okay, fair enough. And then I guess just to ask another way, what do you think you could get down to per quarter in SG&A? If once all the litigation is settled and you brought in costs as tight as you can, is there some sort of core quarterly SG&A we should think about?

Tran Nguyen

So we put the non-GAAP operating expense reconciliation in the press release and we spoke about it on the earnings call, it directionally points you there which is we did about 3.8 here for the third quarter of 2012. We believe that's clearly, as you just noted, it includes litigation expense that we pay WilmerHale. So once we have that in our rearview mirror, we believe we can get the 3.8 further down. So we think that 3.8 could potentially go lower, so we'll leave it at that and I think we'll do clearly in the fourth quarter call for 2012, we'll make another guidance for what we believe 2013 will be.

Scott Henry -- Roth Capital

Okay. And I think – I just want to make sure I heard this correctly early in the call. The Silenor number of 2.1 million, it seems like it was artificially low, I guess contraction of inventories. Did I interpret that correctly?

Richard Pascoe

That's right, Scott. And I noted in the remarks and we can certainly provide more color here if need be, but the prescription demand quarter-over-quarter has stabilized and we're seeing that continue here through the present day. And so -- this phenomenon in the third quarter where a wholesaler inventories are coming down, I think reflects that change in the quarter-over-quarter decrease and overall net revenue. But having said that, the number we continue to watch and believe in is our prescription demand. And as that continues to stabilize, it gives less confidence that demand on the prescription side and what we see flow through the trade will come in the equilibrium.

Scott Henry -- Roth Capital

Okay. And I guess just a final question when we think about data points to follow. What would be the next data point on the OTC version of Silenor? And finally with regards to the strategic review, is there any pending data points we should think about there?

Richard Pascoe

Well, as we've noted here today and in past calls, we are running our process through Stifel Nicolaus Weisel. The OTC opportunity along with the Rx opportunity and the Company itself are all part of that process. Once we conclude our process with Stifel, we'll be obviously discussing with our shareholders that outcome and I'll expect that over the course of the next couple of months, we'll have more clarity on that.

Scott Henry -- Roth Capital

Okay, great. Thank you for taking the questions.

Operator

(Operator Instructions). And gentlemen, it appears there are no further questions at this time. I will turn it back to you.

Richard Pascoe

All right, thank you, operator. Thank you all for joining us this afternoon. As always, we appreciate your continued support and interest in our Company. If anyone has any further questions, please do not hesitate to contact the corporate or Investor Relations team at Somaxon. That concludes our call today. And we thank you for your interest in Somaxon.

Operator

Ladies and gentlemen, this does conclude your Somaxon Pharmaceutical's third quarter conference call for today. Thank you for your participation and for using AT&T conferencing. You may now disconnect.

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