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InterMune, Inc. (NASDAQ:ITMN)

Q3 2012 Earnings Call

November 7, 2012 4:30 pm ET

Executives

Jim Goff – Vice President Corporate Communications & Investor Relations

Daniel G. Welch – Chairman, Chief Executive Officer and President

John Hodgman – Senior Vice President and Chief Financial Officer

Giacomo Di Nepi – Senior Vice President and Managing Director, Europe

Analysts

Brian Abrahams – Wells Fargo Securities, LLC

Y Katherine Xu – William Blair & Company, LLC.

Michael Yee – RBC Capital Markets

Matthew Harrison – UBS Securities LLC

Ritu Baral – Canaccord Genuity

Ravi Mehrotra – Credit Suisse

Roger Kumar – Goldman Sachs & Co.

Anupam Rama – JP Morgan Securities Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the InterMune Third Quarter Earnings Conference Call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded November 7, 2012.

I would now like to turn the conference over to Jim Goff, Vice President of Investor Relations with InterMune. Please go ahead sir.

Jim Goff

Thank you, operator. Good afternoon everyone and welcome to the InterMune earnings conference call. This afternoon, we issued a press release that provides details of the Company's unaudited financial results for the third quarter and first nine months ended September 30, 2012. The press release is available on our website at www.intermune.com.

During the course of this conference call, we will state our beliefs and make projections and other forward-looking statements regarding future events and the future financial performance of InterMune. We wish to caution you that such statements are predictions and expectations, and that actual events or results may differ materially.

We refer you to the Company's publicly filed SEC disclosure documents for a detailed description of the risk factors affecting our business, including those discussed in our Form 10-K filed with the SEC on February 29, 2012 and Form 10-Q filed with the SEC on August 8, 2012. These documents identify important factors that could cause our actual results to differ materially from our projections and other forward-looking statements, these risk factors include regulatory, revenue, intellectual property, clinical development, capital resources, and other risks relating to our business.

On the call today are Dan Welch, InterMune's Chairman, Chief Executive Officer, and President; and John Hodgman, our Chief Financial Officer. Joining us for questions and answers will be Giacomo Di Nepi, our Managing Director for Europe. I will now turn the call over to Dan Welch.

Daniel G. Welch

Thank you, Jim, and thank you everyone for joining us today. We're very pleased to report today solid progress in the third quarter and recent weeks. Among the highlights, in the third quarter, we achieved the fourth out of four consecutive quarter of Esbriet revenue growth since its initial launch in Europe in September 2011.

We made important progress in our pricing and reimbursement discussions in a number of European countries. And we received approval to market Esbriet in Canada following a priority review by Health Canada. With the continued growth of Esbriet in Germany, the launch of Esbriet and as many as a dozen countries in Europe during the period between September of this year and the middle of next and the launch of Esbriet in Canada on January 1, we have began a period of sustained annual sales growth.

During this period of sustained sales growth in our European and Canadian markets, we believe that the successful completion of our ASCEND Phase III study, which is nearing full enrolment will lead to the U.S. registration of Esbriet and provide an acceleration of our sales growth. Therefore we strongly believe that we would successfully established Esbriet as a major brand in Europe, Canada and U.S.

After that brief overview, I'll focus on some of the specific aspects of our third quarter and recent progress. We today reported Esbriet net revenue in the third quarter of 2012 of $7.5 million, which is about 91% of which came from Germany. This $7.5 million compares with Esbriet revenue of just over $100,000 in the same quarter last year when we launched Esbriet in Germany at the end of the third quarter.

Sequentially Esbriet revenue of $7.5 million in Q3 was approximately $2 million or 36% higher than in the second quarter of 2012. Of this $2 million increase about $500,000 as related to favorable adjustments to revenue primarily related to foreign currency exchange fluctuation. Therefore excluding these adjustments the Esbriet revenue growth between Q2 and Q3 of 2012 was roughly 27%.

Earlier this year we predicted that new patient start to be somewhat negatively affected by the relatively long vacations of European doctors and patients during the summer months. We indeed saw the summer affect, but despite this effect we continue to show growth in new patient start during the quarter. Specifically we estimate that 450 new patients started Esbriet therapy in Q3 in Germany and this compares with 300 and 400 new starts in quarters one and two respectively.

And I'll focus on the excellent progress we made during the quarter towards realizing our goal of building a valuable Esbriet franchise in Europe, Canada and United States.

On September 11, we announced that the final procedural step for pricing reimbursement of Esbriet in France have been made, we currently expect to begin the commercial launch of Esbriet in France in the second half of this month. We expect to generate substantial Esbriet revenues in France as we build the market and the brand overtime.

In the first week of the launch, we expect to see modest revenues as we did in Germany during its first weeks of launch. We also remind you that in France, contrary to Germany, there were virtually no patients transitioning from the named patient program to commercial product.

As a big picture summary of our progress on pricing and reimbursement for Esbriet in Europe, we have now successfully secured attractive pricing and reimbursement for Esbriet in 9 European countries, Austria, Belgium, Denmark, France, Germany, Iceland, Luxemburg, Norway and Sweden.

Now an update on the core EU countries for which Esbriet pricing and reimbursement has not yet been secured. Regarding Italy, we today reported that Esbriet successfully passed the Italian technical scientific commission review in October and we currently plan to conclude the pricing and reimbursement process in December of this year though this timing is not within our control.

After successful conclusion of our discussions with the Italian health authorities in December, we will launch Esbriet in Italy as soon as possible thereafter and after securing various authorizations required before launching in that country.

Regarding Spain, a Royal Decree introduced in 2012 affecting pharmaceuticals and health care expenditures, and the continuing economic challenges that the country faces, have made forecasting of the timing of pricing and reimbursement decisions for new products more challenging for all pharmaceutical manufacturers. As a result, we currently believe that it is more likely that a decision regarding pricing and reimbursement of Esbriet in Spain will occur in the first half of 2013 instead of the fourth quarter of this year.

Regarding the UK, we today confirmed previous guidance that the appraisal by the National Institute for Health and Clinical Excellence or NICE is expected to be completed in March of 2013. Here some new details regarding the NICE process for Esbriet.

As many of you know NICE is appraising the cost effectiveness of Esbriet as health intervention within the National Health Service or NHS in England and Wales. To do this NICE requires a price for Esbriet in order to conduct the various quantitative appraisals of the medicine and make recommendations regarding its reimbursement.

On behalf of the four UK regions of England, Scotland, Wales and Northern Ireland, the English Department of Health as acknowledged the UK maximum NHS list price for Esbriet as recently submitted by InterMune to the NHS. This price is 26,100 British pounds per full year of treatment at current rate of exchange this is equivalent to roughly €32,000 and $42,000 per patient per year.

In addition to being the price which NICE completes its quantitative appraisal of Esbriet, UK list price of Esbriet is referenced in many markets in Europe and outside of Europe as an official or unofficial price reference. The first meeting of the NICE appraisal committee for Esbriet was conducted on October 24. We have not received any feedback from NICE on this meeting.

A first draft appraisal of Esbriet will be developed by NICE, which will be published for consultation. We expect this draft first appraisal to be published in late November. So what should you expect to see posted in late November on the NICE website regarding the first appraisal of Esbriet.

Historically almost two thirds of all products receive a negative recommendation by NICE on the first appraisal, and we would expect Esbriet to follow this historical trend. Of the two-thirds of files that get a negative recommendation at this first appraisal, roughly one half eventually secure a positive recommendation from NICE.

Consultation period of approximately one month follows the first – with the publication of the first appraisal. In our case, this consultation period will be from the end of November until about the end of December, but considering the holiday season it could easily extend into early January. During this consultation period, anyone can provide comments on the first appraisal of NICE.

Following this consultation period, the appraisal committee may meet again in late January after which they’re expected to publish their final guidance for the NHS in England and Wales. We expect this to be in March of next year.

As already reported, we expect the NICE appraisal process to be completed in March of 2013, and if we secure a successful outcome from the NICE process, we will launch Esbriet as soon as practical [draft].

We now turn to an update on the pricing and reimbursement in launch status in the company, 10 targeted mid-sized countries in Europe. As a remainder these countries are very meaningful in terms of revenue potential for Esbriet. These 10 countries typically support high prices for pharmaceutical products and their collective population is quite significant, approximating 60 million people.

Put some prospect, the population of our 10 mid sized countries roughly equals that of France which is the second largest country in Europe. And for the American prospective the population of our 10 mid sized countries is roughly equal to combined population of California and Texas, our two most popular states. We are pleased to report that we have already secured attractive Esbriet pricing in seven of these 10 targeted mid-size countries. As of September 1 of this year, we begin the full launch of Esbriet in six of these mid-sized countries which included field based sales and medical professionals.

In addition, we today announced the company secured Esbriet pricing and reimbursement in Belgium effective December 1, 2012. The Belgium price of Esbriet is EUR30,240 per patient per year or roughly US$36,500 at the current exchange rate. We plan to launch Esbriet in Belgium in January of 2013. Finally, we expect to launch Esbriet in the remaining three mid-sized countries which are the Netherlands, Finland and Ireland in the first half of 2013 assuming of course that acceptable pricing and reimbursement conditions are negotiated in these countries.

So to summarize, our outlook for our EU business by the end of second quarter of next year, we expect to have launched Esbriet in all of five and the 10 mid-sized countries in Europe, which will comprise 75% of the EU population and about 80%, 85% of the EU pharmaceutical market value.

A quick word on NPP named patient program. As many of you know, Esbriet is available to physicians and their patients through an NPP. This program was started in April of 2011 and as already announced we concluded enrolment of new patients as of September 30 of this year. Each patient enrolled in the NPP will continue to receive Esbriet free of charge until the product is commercially available in that patient’s country. As of today, a total of 1,527 patients have initiated Esbriet therapy in European countries, excluding Germany.

Let’s look at our business in Canada. On October 2, we announced that Health Canada had approved Esbriet for the treatment of mild-to-moderate IPF in adult patients. IPF affects approximately 5,000 to 8,000 Canadians and we will make Esbriet available in Canada starting in the first of next year with the commercial organization of between 18 and 20 at the time of launch, including a field force of 10. We expect the final price of Esbriet will be in the range of between CAD $36,000 and CAD $42,000.

So let’s change gears to 2013. We’ve been asked by many of you when we visited in the last few months, if and when we intend to provide revenue guidance for 2013? As we just explained between now and the middle of next year, we plan to be launching Esbriet in a dozen or more European countries and in Canada. We believe we need at least three quarters of revenue history in a given country to be able to provide reliable revenue guidance.

Taking into account the European launch timing that we shared with you today, we won’t have three quarters of launch history until well until 2013. So we do not plan to provide 2013 revenue guidance until at the earliest mid-next year. However, we can offer the following outlook and metrics based on the information we have at this time. So I’ll go country-by-country.

We expect German sales of Esbriet to continue to post steady, incremental, quarterly sales growth that is typical of successful orphan drugs in this country. We expect Esbriet to continue this incremental growth overtime and to remain one of the most successful orphan drug ever launched in that country. We expect slow but steady improvement in the persistence rate overtime. For Q4 2012 and 2013 modeling, we remind you to take into account 11% price decrease effective as of September 15 of this year.

Now to France, in France, we expect new patient starts per capita to be similar to the very strong results that we saw in Germany in the first four quarters of launch. We expect a higher persistence rate than what we observed in Germany and this is because the reimbursement criteria in France will discourage Esbriet to use in patients with severe and advancing IPF.

Unlike Germany where we had 172 NPP patients who transitioned to commercial Esbriet during the first three months of launch, we have virtually no NPP patients in France. Big picture, we expect Esbriet to register steady incremental growth overtime and become eventually a very strong brand in France.

Now to Italy, as we already shared on the call, we currently expect the launch in Italy to begin sometime in the first few months of next year assuming of course successful completion of pricing and reimbursement next month. As we experienced in France, we expect it will take two to three months from the conclusion of pricing and reimbursement discussions before we can begin the Esbriet launch via two or three months. This is due to the time it takes for the government to publish the pricing and reimbursement is the best fit and for the company to complete its launch preparations, notably the recruitment and training of our field-based sales and medical personnel. As we have shared before, various regional authorizations must be secured before meaningful revenue pull through can occur and this usually takes several months.

We expect Esbriet to experience a market penetration per capita in Italy similar to that of the strong results we saw in Germany and overtime develop into very successful brand. We expect a persistence rate closer to that of France than that of Germany. For Spain, as stated in our press release today, for various reasons it’s somewhat more difficult to predict the exact timing of a decision on pricing in reimbursement.

We currently believe that the decision is more likely to be taken in the first half of next year than in the fourth quarter of this year. As this is the case in Italy, after pricing and reimbursement is secured in Spain steps are required at the regional level to clear the path for revenue pull through and these steps take several months.

We expect the penetration rate per capita in Spain during the launch that is somewhat lower than that of Germany due to the regional hurdles that exists in Spain, but the persistent rate higher than that of Germany. And I want to reiterate here is that, we expect the penetration rate per capita in Spain during the first 12 months of launch, that is somewhat lower than that of Germany due to the regional hurdles that exists in Spain.

We expect the persistence rate higher than that of Germany. Once clear of the national and regional hurdles which will take several months, we expect Esbriet to grow into an important revenue contributor in Spain. We gave you an update today on U.K. and assuming success with NICE, we except the final NICE assessment in March and a launch quite soon thereafter. We have very strong KOL support in the UK as we do in all the targeted countries and assuming NICE support, we expect to build Esbriet into a strong brand over the coming years.

To the mid sized countries as you know the largest of these just began their full launch in September of this year. We expect all 10 countries to be launched by mid next year assuming successful outcomes on pricing and reimbursement with revenue contribution from these countries becoming meaningful in the second half of next year.

Recall that collectively these countries roughly equal the population in France where we estimate they are between 6,000 and 8,000 patients with mild-to-moderate idiopathic IPF and these countries enjoy somewhat higher price points for Esbriet from the EU average.

For all countries we encourage you account the effect of the summer months on new patient visits and therefore growth rates for all medications in EU including Esbriet. Regarding Canada with the substantial population on a strong price, we expect Canada to also develop into very important market overtime is attractive opportunity will take some time to develop. This is because about a third of IPF patients in Canada covered by private insurance and we expect those insurers to start coverage in the first half of next year.

Esbriet revenues will therefore firstly build in this private insurance segment and the public or provincial drug reimbursement plans which cover about two thirds of that patient is typically secured within 12 months to 18 months of marketing approval providing the support for the full development of the Esbriet market and continued revenue growth in that territory.

For compliance grades that we think you should assume we believe than an assumption of 80% compliance per year is reasonable for all countries concerned.

Let’s turn out to our plans to make Esbriet available to patients in the U.S. and gain access to the country that will continue and accelerate our Esbriet revenue growth. Esbriet saw enrollment of our Phase III pirfenidone study, ASCEND, in the U.S. and certain additional territories is tracking to completion of full enrollment around the end of this year.

ASCEND is a double-blind placebo-controlled trial with 52 weeks duration with a primary endpoint of change in forced vital capacity between baseline and Week 52. ASCEND is planned to enroll about 500 IPF patients with mild-to-moderate impairment in lung function and also certain characteristics that the company firmly believes will enhance the probability of a successful study outcome. We continue to expect the results from ASCEND will be available on the first half of 2014.

So in summary, during 2013, we expect a study progression of Esbriet launches in a dozen or more countries in Europe and Canada that will provide the foundation for consistent revenue growth during 2013 and beyond, and towards the realization of our vision to build Esbriet into a very successful brand overtime in Europe, Canada and the United States.

I’ll now turn the call over to our CFO, John Hodgman for the financial discussion. John?

John Hodgman

Thank you, Dan, and good afternoon, everyone. Net loss for the third quarter of 2012 was $45.4 million or $0.70 per share compared with a net loss of $38.2 million of $0.63 per share in the same quarter for 2011. Net loss for the first nine months of 2012 was $91.5 million or $1.41 per share, compared with a net loss of $110.2 million or $1.88 per share in the first nine months of 2011. Per share amounts in the first nine months included gains from discontinued operations of $0.82 per share and $0.14 per share in 2012 and 2011, respectively.

InterMune reported total revenue in the third quarter of 2012 of $7.5 million compared with $0.1 million in the third quarter of 2011. Third quarter 2012 revenue included $0.5 million of favorable adjustments to revenues primarily related to foreign currency exchange fluctuations. Approximately 91% of revenues in Q3 2012 were from Germany as the mid-sized countries for which pricing and reimbursement is grouped only began active promotion of Esbriet starting in September of 2012.

Included in the third quarter 2012 figures was the effect of approximately 11% price decrease of Esbriet in Germany, which became effective on September 15, 2012 as previously announced. InterMune reported total revenue for the first nine months of 2012 of $18 million compared with $2.7 million in the first nine months of 2011.

Research and development expenses in the third quarter 2012 were $26.2 million, compared with $17 million in the third quarter 2011, an increase of 54%. R&D expenses were $74.6 million for the nine months ended September 30, 2012 compared with $54 million in the same period of 2011, an increase of 38%. Higher R&D expenses in both the three and nine-month periods of 2012, compared with the same periods in 2011, reflect expenses related to conduct of the ASCEND trial, which was initiated in 2011.

Selling, general and administrative expenses were $23.8 million in the third quarter of 2012, slightly higher than the $23.7 million in the same quarter of 2011. SG&A expenses were $75.7 million in the first nine months of 2012, an increase of 21% from $62.7 million in the comparable nine-month period of 2011. The increased spending for the nine-month period in 2012, compared with the same period in 2011, is primarily attributable to the creation of InterMune's European infrastructure and investments in the launch and pre-launches of Esbriet in Germany and other European countries.

As a result of the June 19, 2012 divestiture of Actimmune, historical Actimmune revenue and cost of goods sold and operating expenses are reported in discontinued operations in this and future financial statements and are therefore not included in previous discussion. As of September 30, 2012, the company had cash, cash equivalents and available-for-sale securities of approximately $351.4 million.

Considering the proximity to the year-end 2012, we today provided greater precision in regarding our revenue and operating expense guidance for 2012 provided earlier on July 23, 2012. Esbriet revenue in 2012 was currently anticipated to be in a range of $20 million to $25 million and we expect to be at or slightly above the high end of the range. R&D expenses, is currently anticipated to be in the range of $90 million to $105 million, and we expect it to be at the high end of the range. SG&A expense is currently anticipated to be in the range of $110 million to $130 million and we expect to be at the low end of that range.

We are now ready to answer your questions. Operator, please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Brian Abrahams with Wells Fargo. Please proceed with your question.

Brian Abrahams – Wells Fargo Securities, LLC

Hi, thanks for taking my question, congrats on a steady growth, and appreciate all the country-by-country color. Just couple of quick questions on Germany, I was wondering if you could talk a little bit more specifically on the dynamics around dropouts there. Are you seeing any shifts and severity of patients starting treatment? And did you see any impact on prescribing patterns starting in the middle of September once Esbriet was removed from physician’s budget as a line item? Thanks.

Daniel G. Welch

So, thanks for the question. Thanks for the congrats on the continued growth of Esbriet in Germany and in Europe. So to your question around persistent rate for Esbriet, it's a little early to draw any conclusions whether to what extent the growth in the third quarter was attributed to Esbriet coming off officially, the budgets of practitioners particularly out in community or the Tier 2 accounts, because that only would have happened in mid-September. So I doubt that’s very much of a roll although Giacomo can correct me after I finished my preliminary response.

In terms of the persistence, it’s early to call, we believe we might be seeing the beginning of the stabilization and perhaps improvement on that. And what we have noticed is that whether you look at the named patient program, whether you look at the recap rollover from capacity and anyway look at it, Germany appears to be an outlier in terms of the persistence rate. So this is why based a whole host of metrics, we believe that the persistence would be better in countries other than Germany and will improve in Germany as we deploy, as we recently deployed the new sales force, the new campaigns around messaging et cetera around proper patient selection.

So overtime we expect this to improve, but I would not want to suggest that we would have a very rapid improvement because this takes some time as patients move through the system.

Operator

Our next question comes from the line of Katherine Xu with William Blair. Please go ahead.

Y Katherine Xu – William Blair & Company, LLC.

Hi, good morning. I’m sorry, good afternoon. So what is the drop-out rate, Dan, did you mention that, you mentioned the compliance rate was 80% and right now what is the drop-out rate in the real world? And then we were talking about 20%, 30% and where is it lying at this moment?

Daniel G. Welch

Yeah, in terms of the compliance rate, 80% is what we think is reasonable for your modeling going forward in a given year. We think it’s a good idea. There was a reasonable assumption to assume 80% compliance. In terms of persistence rate in Germany, we’ve had it in kind of the 65% to 70% range and that is where it was last quarter. Like I said, it’s early, but we’ve seen stabilization in this and perhaps movements towards the higher persistence rate. But in the other countries, we are seeing a even higher persistence rate on Esbriet. So we believe that over time persistence will improve in all countries including Germany.

Y Katherine Xu – William Blair & Company, LLC.

All right and then the other question is curious about how you guys are looking at breakeven in Europe, are you making money, you probably or probably in Germany but other countries, how you are approaching scaling the operations to the opportunity in that country and then what are the goal that you are striving from a profitability perspective?

Daniel G. Welch

Yeah, we haven’t given guidance on profitability neither in Europe nor for the corporation as a whole. That said, the gross margin on Esbriet is quite attractive of course when we are launching the product and our volumes are not yet to scale, the gross margin is not what it’s going to be, it’s going to improve steadily as we scale with our volumes.

The infrastructure, for example, in Germany is quite modest of 30 people 25, 30 people and with the cost per patient per year in the neighborhood of EUR25,000, EUR30,000 it certainly take a lot of patient to generate a very nice business and we’ve just begun launching. Between September 1 of this year until mid next year, we expect to be launching as many and probably more than a dozen countries in Europe and not including Canada.

So, high gross margins, low operating expenses, big market, unmet need. The market is there, the patients are there, it will take time. This is a market to be developed, it’s a new market. We are the first product in the market. But in Germany, we are showing the fourth consecutive quarter of growth, the fourth of four and we expect that much to be the same case in every country. Quarterly growth, quarter-by-quarter over time and this is how the grants are built in Europe, this is how Tracleer was built in Europe quarter-by-quarter over time. So I know I didn’t answer your question, but I maybe gave you some color that it will be a very, very profitable business in Europe we are convinced.

Y Katherine Xu – William Blair & Company, LLC.

Thanks. And one last question if I may on the pipeline sort of comparative landscape. If you look at right now is sort of ASCEND versus the BI2 Phase 3 study both are coming up in first half of 2014. And then so those are the Phase III kind of fight. And then going if you look at earlier stage compounds, there are quite a number of them in a pipeline and then for you in a defensive position I mean are you very focused on commercial now? I mean what are your investments and focus on the pipeline development in trying to defend your leadership position just given the competitive landscape?

Daniel G. Welch

Good question. It’s a great time – it’s a great time for R&D and IPF if you look five, six years ago the number of compound in R&D particularly D was very small compared to what it is. And so I think it speaks a lot to how the field has matured, the contribution InterMune has made in leaving the development of the design and execution of good clinic studies and ultimately the first drug ever approved for the disease. There are – beside Boehringer Ingelheim which is in Phase III, when you get past that, there is really nothing that we see that is meaningful proof of concept against placebo controls that really hit our radar as what we would call something that we are worried about or at least watching as a high probability competitor, which is not to say we are – we’re grid and sleek. We do watch of course the competitive landscape. We have a number of families of our compound in our research laboratories and collaboration with universities then the other vendors.

Interesting molecules of interesting mechanisms, but its early, we will talk more about those compounds if and when they get to the clinic. But it’s a feel that’s big, the number of patients is very large, there is lot of room for competition. And we think in the future, it probably will be a combination therapy. What we’re excited about is Esbriet is a very relatively safe product especially when you compare it to other products like the BI compound in terms of patients’ ability to stay on medicine, tolerate the medicine. So that usually often all things considered, all things equal that would be the therapy of choice, which to combine other medicines going forward. So hope I’ve answered your question.

Y Katherine Xu – William Blair & Company, LLC.

Thank you.

Daniel G. Welch

Welcome.

Operator

Our next question comes from the line of Michael Yee with RBC Capital Markets. Please proceed with your question.

Michael Yee – RBC Capital Markets

Hey, thanks. Question about Germany, you sort of implied that there was a somewhat lower persistence rate as you started just because of the type of patients that were coming on. Can you sort of quantify what coverage of the population you think you are capturing there, which you would label (inaudible) versus say the other four countries where you think you’d have a higher persistence rate. I just wanted to try to understand how that group of patients would differ than the other four?

And my second question was on the UK, you gave sort of what I think you implied as a max price. On your experience you are looking back at other drugs in the UK and there are max prices, how does that compare versus what eventually ends up happening since you have to go through first and second pass or so?

Daniel G. Welch

Yeah, both good questions. So I’ll deal with the second one first because it freshens in my mind. So UK the price that – the price that and you understand that, I’m going to be little guarded in my response to you because we are in negotiation with lots of different counties and so, so you hopefully beat patience with that reality?

So, like we said, about two-thirds of – the first assessment what happens is the, the company puts in a price, that price is the basis for the calculations of cost for incremental quality adjusted life here. And I will split the number and just like any negotiation typically speaking, a manufacturer puts in a first price that feels that it’s defensible plus it may or may not be room to negotiate that price.

So what happens, what’s been happening more and more in the UK is that companies are entering patient access schemes, which can take any shape and form to decrease what is essentially the price, but that varies on the product that varies on circumstances. So we don’t have any reliable figures, because companies don't disclose whatever patient (inaudible), so it’s hard to really give you firm answer on that Michel, because that’s not published, that’s not available.

Michael Yee – RBC Capital Markets

Okay.

Daniel G. Welch

So about two thirds get a negative first analysis and then about half of those that got to negative, ultimately get a positive through subsequent discussions, negotiations, perhaps price decreases or other mechanisms. On your first question on persistence, in general where we do believe that and we have the information to support it that at launch there were more patients as the percentage of total, who had – what we would call severe or more advanced IPF then what we would call mild-to-moderate IPF, and so what is the consequence of that; consequence is they’re secure, they are probably progressing and therefore the benefit risk to that patient is probably harder to see those patients might be in general more (inaudible) and less able to tolerate any medicine including Esbriet.

So as a result we put in place a number of educational events, CMEs the sales reps are talking very strongly now about proper patient selection, which is mild-to-moderate, and we think overtime this will take hold and take effect. We think, we might be seeing the first signs that this is stabilizing if it’s not slightly improving. When we look at the other countries, the way we got here in terms of expecting it higher persistence rate is that we have pretty good experience with name patient program, and also recap rollover, patients from rollover from the capacity program into the recap experience, and that’s an open label experience, not monitored, no coaching by the pharmaceutical company to keep patients on medicine and all of that, and in those experiences all of them have had a persistence rate meaningfully higher than that which we saw in Germany.

So we think over time it will improve in Germany and from the start it will be better and nearly every country compared to Germany the persistence rate partly because of mechanical or structural reasons for example in France it’s very strictly defined that an FBC below 50% I think it is 50% predicted, you can’t get Esbriet, which means severe patients aren’t going to get it at least the start.

So that will probably be similar in most countries and so in that way, I think that’s a very good encouraging sign that persistence will on average be better in other countries than we have seen so far in Germany, but in Germany we expect over time that that will also improve..

Michael Yee – RBC Capital Markets

Okay. Thank you very much. I appreciate that.

Daniel G. Welch

You’re welcome Michael.

Operator

Our next question comes from the line of Matthew Harrison with UBS. Please proceed with your question.

Matthew Harrison – UBS Securities LLC

Hi good afternoon, thanks for taking the questions. First one on revenue, you implied that there was an exchange rate that caused the decrease of about 500,000, but when I looked at sequential exchange rates it looks like that are now 2% to 3%. So if you could just walk me through what you’re trying to say there, and then second on gross margin was about 45% last quarter and jumped to 73% this quarter, if you could just tell me what the major drivers of that were there and then third on SG&A, your guidance implies a fairly large jump for the fourth quarter assuming that involves some expansion in Germany, France, but can you just walk me through exactly what that imply? Thanks.

Daniel G. Welch

Sure. Thank you, Matthew. So I think I'll hand this over to my financial colleagues, so three questions why SG&A bumps, why the change in gross margin improvement, and the third was kind of the currency fluctuation how we included that further?

John Hodgman

Hi, Matt. John Hodgman. Regarding the currency fluctuation, we actually had about $0.5 million improvement benefit increase in revenue due to fluctuation within that $500,000 predominantly on the $500,000 it is fluctuation towards some other one-time adjustments that were smaller.

Regarding cost of good sold, there is a number of reasons one we have to get a certain level of volume going right, so low volume sales makes cost of good sold quite small and makes it appear much larger. We also have an amortization for the $20 million milestone for the approval in Europe. In addition we announced that we had a one time progress payment for potential second source supplier it's also included in that COGS number. And we also have infrastructure for worldwide manufacturing organization. So all of those components create an element within the cost of good sold and revenues getting up to $7.5 million, you’re going to see it continue to decline as revenues continues to grow.

And as far as the SG&A broad base that continues to grow because we continue to build infrastructure and nature of the various countries. We’ve added personnel in Canada as we got that approval we continue to France we’re now hiring sales personnel both sales reps as well as medical and including the mid sized countries. So there are certain places where we’re need offices and we continue to expand to grow in those areas.

Matthew Harrison – UBS Securities LLC

Just to be clear on the SG&A, the guidance implies that all those get lumped into the fourth quarter and now is none of that activity in the third quarter?

Daniel G. Welch

I think that’s pretty accurate, because as we mentioned the MSC countries that really only begin the promotion in the September 1. France we only announced the reimbursement in pricing approval also in September, and so and we were holding off being prudent about hiring all the sales force field based medical personnel et cetera. And similar, so yeah that advice there was a kind of basal level in Q3 that becomes different in Q4 as we build businesses to build the brand.

Matthew Harrison – UBS Securities LLC

Thanks.

Daniel G. Welch

Yeah.

Operator

Our next question comes from the line of Ritu Baral with Canaccord Genuity. Please go ahead.

Ritu Baral – Canaccord Genuity

Hi guys, thanks for taking the question. Going back to I guess the idea of persistence, one of the things that you had spoken up previously is the idea of dose reduction and communicating to doctors how to better dose reduced patients who are experiencing side effects rather than just taking them off therapy. How has the messaging in Germany and other countries gone on that initiative?

Daniel G. Welch

Hi, Ritu. Thanks for the question. So it’s early days because we started that probably really in earnest in the late part of July and August. But you know what happens in July and August in Germany, most people will be on vacation. So it started in earnest in September, that’s also when we headed our five or six more reps in Germany. So it’s a little early to say.

The message is understood. It's clear. We basically – we can reference back the capacity study that have high-dose and the low-dose groups and both groups did better than placebo. So we can show the dose reduction even for extended period of time, if not for a short period of time, benefit the patients and it is better than placebo. It is better than that. So the message is well received, we’ve tested them with market research. They are well communicated. And I don't want to overcall this, this is early but we think we’re seeing the first the signs that it is stabilizing and maybe somewhat improving, but it will take time.

Doctors are creatures of habit like we all are and they need to move them through. I think also as the severe patients move through the system and the percentage of mild-to-moderate as a percentage of the total increases that also will naturally mathematically help the persistence rate, because those patients will tend to stay on medicine longer than patients who are said to say very advanced and probably progressing rapidly towards that. So a full host of things will be happening that I think we’ll resonate in our clinical trials, which [grants] it is the totally different story than commercial realized practice. And we were very successful in being able to dose titrate down and after a period of time of stabilization dose titrate back up and keep patients on medicine. That’s also part of our messaging referencing the positive experience we had in our clinical trial.

So I think our messages are right. They are strong, they are clear, they are going to take a little time to take total hold in Germany. But as we launch in new countries, coming out of the blocks, we are starting of course with this message proper patients are good selection, dose titration and also we’re helped in those other countries besides Germany with reimbursement restrictions that make it very difficult that’s not impossible to put a place to start a patient on Esbriet if they have to be IPF.

Ritu Baral – Canaccord Genuity

And could you proceed firstly what sort of premarketing activities you are doing in France and Italy in anticipation of those launches. I mean you had mentioned conferences like the AIR conferences that you guys hosted in Germany. Are you doing comparable things for France and Italy?

Daniel G. Welch

We are in fact in the month of October a very successful AIR meeting in France and also one in Italy. And perhaps Giacomo big picture can describe these events very well tend to better, but Giacomo, could you maybe give some color on AIR France and AIR Italy leading with…

Giacomo Di Nepi

Try that highly though.

Daniel G. Welch

And describe for everybody is there, that would be helpful.

Giacomo Di Nepi

AIR is our initiative, the educational initiative in the field of pulmonary fibrosis. In fact it means advances in IPF research. And it’s basically based at two levels, one there is a Pelican AIR initiative that is done once a year, last year was done in Germany. And these are saying let’s say to the KOLs at European level in their immediate report. We had something like 150 odd people or 400 people last year.

And then there are National AIR, which are basically led by the National Health Community at the European level done in the different nations. We had one in Germany, we had actually – there were one day after the other two weeks ago one in France and one in Italy, which are little bit less oriented to the research but oriented towards the therapy, the management of patient cases, how to make a proper diagnosis, how to work multidisciplinary groups set and so on and so forth with a number of national KOLs and regional KOLs within the nation with 100 plus people in each of the campaign.

And our mission is to make AIR becoming one of the reference in IPF in Europe and actually possibly the largest and most recognized educational event in Europe fully dedicated to IPF.

Ritu Baral – Canaccord Genuity

Gotcha. And last question, can you address persistence and compliance in Canada since you are looking forward to that as well?

Daniel G. Welch

Sure. In persistence and compliance in Canada, I think in Canada it's a different story in fact even better than most of the countries in Europe that control the reimbursement in a way that I think will help persistence. In Canada what is available to the pharmaceutical industry is services that actually take an active role in monitoring patients sending the medicine to their homes, reminding them to take their medicines, calling them if they are not refilling their orders, it's done under all the proper privacy laws, et cetera. And this is also done in the United States, so these are specialty pharmacy operations with direct distributors.

So we would expect in Canada, because of this program, which is very active with patients this is used for example with tack (inaudible) similar medicines like this. We’d expect persistence rates here to be quite good as well as compliance rates to be also quite good both probably better than Europe. And when we get to the point of the U.S. we would be employing a similar system where companies do this now and they enjoy persistence and compliance rates that are quite high. Of course the company have to make an investment in the service, it’s not in expensive, but it's in terms of return on investments it’s very, very interesting for the manufacturer.

Ritu Baral – Canaccord Genuity

Great. Thanks for taking the question and congrats on Germany.

Daniel G. Welch

Thank you.

Operator

Our next question comes from the line of Ravi Mehrotra with Credit Suisse. Please go ahead.

Ravi Mehrotra – Credit Suisse

Hi guys, can you hear me?

Daniel G. Welch

Yes we can hear you, Ravi.

Ravi Mehrotra – Credit Suisse

Okay. Let me have my congratulations Dan for the steady progress. Can I just really focus on the specific issue, which you have done a great job in explaining, but just so I’m 100% clear, a 65% business level that you see in Germany, so you’re basically telling us of 35% patients since the start – holding up or is that a year, could you break those 35% down into those that were died, those would you think – the patients and those which drops off the tolerability? Or might just try and cut this certainly. And lastly, could you just update some of the addressable market size given what you just said about tolerability and how you want to focus it more to moderate patient populations? Thank you.

Daniel G. Welch

Sure. Thanks for the question, Ravi and I will probably ask Giacomo to back me up on this. So for Germany, which will probably we think is going to be the highest figure in this regard, sorry the lowest figure in this regard persistence rate, we think is in the range of 65% to 70% and the reasons for drop out or manifold, they have to do with for patients progressing, patients dropping off and what we’ve noticed is those who progress drop in half have a high – there is a correlation with those who have more severe advent disease.

But we don’t have to my knowledge maybe Giacomo can correct me, we don’t have precise figures on of that balance of the 65% or 70% persistence rate, what are the exact percentages for each type of drop out, and I missed you, I forgot your second question.

Ravi Mehrotra – Credit Suisse

(Inaudible) it is in your more focusing of the patient population?

Daniel G. Welch

Yeah, yeah, yeah, the epidemiology and how that affects the addressable market, sorry. So Giacomo could you expand upon the third question if you think is necessary and if not then go to the second question?

Giacomo Di Nepi

No, just one fact persistence issue, and we say the rate is about 65% in Germany. We made some research, but it’s very indicative and basically the indication is the first course its disease progression, which includes both the patient who died and the progression of the disease most tend to be a patient. And the second color, the third is request of the patient, but of course this again probably forth down in the first and the second. And we’ll say these are the two predominant courses and this is how much we get from the research.

One thing that maybe interesting that has not been covered before is, I mean in the reason for the other countries that we believe that persistence is going to be better that in Germany. It of course what Dan mentioned the fact of course that we will comment from day one, the same strategy that we are implementing in Germany, well into the launch. The fact that maybe specific conditions of reimbursement that will lead into these directions, but I would say also that in other countries there is not this migration of patients from the big centers into the territory pulmonologist, as pronounced in Germany.

Other countries then to be much more [Audio Gap] down the ranks into the lower level pulmonology that we have in Germany. So I think also there is a structure of the market and the way the patient is followed in this market that will help in this direction. Now the question on the IPF technology was…

Ravi Mehrotra – Credit Suisse

I mean you’ve given us very specific (inaudible) what you think the addressable market. Has that changed given your slight weak focusing of the patient population? I think to be valuable that the modern population of these numbers? Obviously those numbers haven’t changed?

John Hodgman

That's correct, that's correct. The mile to moderate numbers we have quoted in the recent months, those haven't changed.

Ravi Mehrotra – Credit Suisse

Okay. That's all I had. Thank you, Giacomo, Thank you, Dan.

Giacomo Di Nepi

Thank you, Ravi.

John Hodgman

Thank you, Ravi.

Operator

Our next question comes from the line of Terence Flynn with Goldman Sachs. Please proceed with your question.

Roger Kumar – Goldman Sachs & Co.

Hey, this is Roger Kumar settling in for Terence. Thanks for taking the question. You guys had mentioned on a 11% price decrease, I was just kind of wondering maybe at higher level what's your thoughts were on pricing going forward both in Germany and maybe if you could touch on some of the other EU territories as well appreciated. Thanks.

John Hodgman

Thank you, Roger for the question. So the 11% price for everyone’s benefit from price increase effective September 15 of this year and that was the program price reduction, which is part of the so-called AMNOG law. Price is renegotiated 12 months after launch and that was the case for Esbriet.

In terms of big countries, we are priced in nine countries so far in Europe, the most recent in Belgium, and the pricing is the lowest price is €25,000 and France goes up into the mid to upper €30,000 whether it's Norway for example or Austria €36,000.

Going forward there are mechanisms in place in some countries, but not all to reference prices of their neighbors and make adjustments. Some do it on a regular basis, some do it every two years. So it’s hard to really kind of forecast this only to say that there are mechanisms in place in some countries to reference their neighbors and make adjustments I probably can’t give any more precision around that.

Roger Kumar – Goldman Sachs & Co.

Okay. Maybe just in the big five markets or maybe just net of all those adjustments, what’s your thought might be there in terms of price adjustments?

John Hodgman

So you are talking about price adjustments as a result of reference pricing?

Roger Kumar – Goldman Sachs & Co.

Yeah, exactly.

John Hodgman

That's hard also took to predict, first of all we are not priced yet in many of those countries in the top five. So it will be real speculation of this I’m afraid.

Roger Kumar – Goldman Sachs & Co.

Okay.

Giacomo Di Nepi

John, if you wish I can add a couple of things, let's say in the big five there is some reference usually at the moment, that to negotiate the price, but not much afterwards. There would be one in Germany that as you know and as we described previously when we will reach a certain threshold of sales, which is $50 million then at this point there will be a new negotiation within the frame of the (inaudible) and this will include also the reference into that type of countries versus Germany.

But to the other countries I would say as much more the referencing is at the moment of the negotiation and of the initial setting of the price and not afterwards accepting in the long run or in specific cases. The one that they tend to earn more automatic mechanism of reference like the one that Dan described before are typically smaller countries that they don't dedicate so much effort in the initial negotiation and they sort of feedback the other countries in Europe.

On the other hand, these are exactly the countries in which deliberately we priced at the beginning because since everybody's referencing everybody else and intelligent company price to try to introduce the product first in the high-priced markets. So basically you moved the full structure of the prices upward and then from there you are certain decline in adjustment towards your target price level. And this is deliberate and what the lines way of doing.

Roger Kumar – Goldman Sachs & Co.

Okay, great. Thanks very helpful.

Operator

Our next question comes from the line of Liisa Bayko with JMP Securities. Please go ahead.

Unidentified Analyst

Hi guys can you hear me?

Daniel G. Welch

Yes.

Unidentified Analyst

Hi, this is Heather in for Lisa. Just have a couple of questions for you. The first one is just on the new patients out in Germany considering the summer months. We are pretty impressive, and I wondered if you could just give some color on the dynamic of what was going on or if it was more sort of back end loaded to September, if you can just give us any color on that?

Daniel G. Welch

Hi, Heather thanks, thanks for the question. I would say we are in – it’s obvious we are still in the launch phase, and we’re enjoying that launch phase of sequential quarterly growth, so you know I think in the context of the summer months, I agree with you to the new patient as are good, they are quite good. And we wouldn’t have expected otherwise, we may have seen somewhat less than, we probably we saw somewhat less than we might have seen in the quarter. Giacomo, I don’t know if you want to add something more to that.

Giacomo Di Nepi

No, I think, I mean clearly the fact that you start seeing an expansion of the penetration of the doctors, doctors that have follower, start to follow. That has been the clarity on reimbursement. That certainly has taken away some anxiety, there has been the expanded sales force. So if you want the transition from simply therapy, so there is number of factors that we see behind that and most of them would see them as continuous factors. Think of the doctor penetration of course, liking to drive you at early about there is – put many patients, maybe most of the patient on the drug. There are also laggard who are still waiting, but the vast majority of the doctors has really put a few patients try to see and then they get confidence, and they got to put more and then they get in to the product and they put more and so on and so far, so I think it’s really a number of elements that propels what we believe it’s a continuous quarter-to-quarter sequential growth over time.

Unidentified Analyst

Okay, great. Thanks that helps. And then just one question on Canada with the price range that you’ve mentioned when will that vary between private and public reimbursement or will it be one price for the whole country or how does that work within that pricing range that you gave us?

Daniel G. Welch

Yeah, that would be the price for the whole country. The provincial governments sometimes negotiate of relatively modest discount, and I think the negotiation process, but that’s essentially the pan-Canadian price.

Unidentified Analyst

Great, thank you.

Operator

Our next question comes from the line of David Friedman with Morgan Stanley. Please go ahead.

Unidentified Analyst

Hi, thank you its Sara calling for Dave. Just want to dig in a little deeper on some of these other countries that you’ve been in for just like sometimes for the ones in like the Austria and Sweden group. I’m wondering if you can give a little more detail on why these countries have been flow to contribute to sales and what are your expectations going forward for some of those smaller countries when do you expect them to kick in a little bit more. Thanks.

Daniel G. Welch

Sure. Thanks Sara that’s a good question. So we’ve targeted 10 so called mid-type countries collectively, it’s a big basket of population 60 million patient population as we said. We also mentioned that we really didn’t start promotion with field-based sales reps, with field-based Medical Science Liaisons, Medical Directors, et cetera until September 1 of this year. So I think that’s the best explanation, I think we really – we were doing what I would call very soft launch with the General Manager visiting the key opinion leaders at the very top of the pyramid making sure the system was greased, the reimbursement forms were filled and all the administrative things just getting ready. And then September 1 is when really put feed on the street in those six countries. We will add a seventh very soon with Belgium.

Unidentified Analyst

May I add Dan that, sorry.

Daniel G. Welch

Go ahead, John.

Unidentified Analyst

May I add that in September, 1 we really put the feet on the ground in the biggest of the countries? Because Sweden and Austria, which we had reimbursement before that now we got to full reimbursement (inaudible) that the largest countries with the population that is doubled than the line of Denmark or the line of Norway, which we put our feet on the sales before. So it's a question of timing and also sequence of the size within that.

Daniel G. Welch

So, collectively for your thinking we figure they are probably in the range of $6,000 to $,8000 IPF patients in these ten countries, its mild-to-moderate IPF patients in these 10 countries, and we think we expect we have seven in bag now I mean in pricing in reimbursement, there are few more coming we expect Netherlands, Ireland and I have forget…

Unidentified Analyst

Finland.

Daniel G. Welch

Finland. And so we expect those to come on stream in first half of next year. So second half of next year, we would expect those to start contributing, just because it takes time to build a new market and introduce the first product into that market, but we expect just like we saw in Germany continued incremental sequential launch overtime building important brand in each of the country. So the same story every country is going to be steady, incremental Q-on-Q growth building a market, building a brand, and it will take overtime building an important business. So we think second half of next year is when we start to see some meaningful contributions beyond what we've seen so for the reasons we explained.

Unidentified Analyst

Okay, great. Thank you.

Daniel G. Welch

You are welcome.

Operator

Our next question comes from the line of Geoff Meacham with JP Morgan. Please proceed with your question.

Anupam Rama – JP Morgan Securities Inc.

Hi, this is Anupam Rama in for Geoff Meacham. Just a quick broader question, once you work through the top five and sort of ten mid-sized EU markets, are there other countries outside of Europe that you could potentially file for approval based on the capacity studies alone and can we expect any other regulatory activity in 2013? Thanks.

Daniel G. Welch

Thanks, thanks for the question. The short answer is yes. It’s probably a very small number. At least that can be done in a reasonably short period of time. There are countries like Russia, that’s a long haul its four to five years before you get a product approved there. So if you think about which one that come in the timeframe as you mentioned probably not. We are however looking at the countries. Beyond the 15 that we've described, there is another 15 or 17 more in Europe. Something we've got our eye on a few of those, a handful of those that will probably go into what we call geographic expansion sometime later next year, and we haven't talked about those countries because we are doing the market assessment right now to figure out where it makes sense to go after the first 15, with the first 15 that covers 80%, 85% of the pharmaceutical market in Europe. So we are not leaving a lot on the table by not covering those next 15 or so. Outside of Europe small number of completes we think will be meaningful and that could get registered reasonably quickly on the data that we have and we are definitely looking at those. So, thanks for that question.

Anupam Rama – JP Morgan Securities Inc.

Okay, thanks for taking my question.

Operator

We have no further questions at this time.

Daniel G. Welch

Thank you, operator. So in conclusion we are very pleased with our progress on all aspects of our business, and our team has executed, we believe very well despite some very challenging headwinds in Europe in particular. Our launch of Esbriet in Germany ranks among the best orphan drug launches in that country in terms of revenues and patients on therapy after a year of commercialization.

We made some really good progress in our efforts to secure pricing in reimbursement for Esbriet in Europe including France second biggest country in Europe. And Esbriet is now attractively priced in nine EU countries. We expect a steady progression of Esbriet launches during 2013 and more than a dozen countries in Europe and Canada that we believe will provide the foundation for consistent incremental revenue growth during 2013 and beyond and towards realizing our vision to building Esbriet into a very successful brand overtime.

And we expect to complete the enrolments our Phase III study since around the end of this year and we remain quite optimistic for successful outcome to support registration in the U.S. providing further acceleration of our revenue growth and value potential.

In summary, we are at the beginning of a very exciting time for our company and for IPF patients that we served and we look forward to updating you as our progress continues. Thanks for joining us today and good bye.

Operator

Ladies and gentlemen, this does conclude the conference for today. We thank you all for your participation. Ask that you please disconnect your lines.

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