Endo International PLC (ENDP) 2004 Q2 法說會逐字稿

Good morning. My name is Babs and I will be your conference facilitator. At this time, I would like to welcome everyone to the Endo Pharmaceuticals second-quarter 2004 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. (Operator Instructions). At this time, I will turn the call over to Bill Newbould, Vice President of Corporate Communications. Sir, you may begin.

Thank you. Good morning and welcome to the Endo Pharmaceuticals second-quarter 2004 teleconference. This call is being recorded. With us on the call this morning are Carol Ammon, Chairman and Chief Executive officer; Peter Lankau, President and Chief Operating Officer; David Lee, Chief Scientific Officer and Jeff Black, Chief Financial Officer.

Before we begin today, I would like to remind you that during the course of this call, Carol, Peter, David or Jeff may make forward-looking statements concerning such topics as future results, product performance, anticipated timing of FDA approval of certain of the Company's drugs and possible timing of the commercial launches of certain of the Company's products, as well as other nonhistorical facts that reflect Endo's current prospectus on existing trends information. As you would expect, these statements will be made with appropriate qualifying language, such as we believe, expect, plan, anticipate, predict or similar expressions. By their nature, these forward-looking statements involve known and unknown risks and uncertainties that may cause the Company's actual results to be materially different from any future results expressed or implied by these forward-looking statements. Listeners should not rely on any forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Important factors that may affect Endo's future results include but are not limited to those factors discussed under the heading forward-looking statements in Endo's SEC filings and under the heading risks factors in Endo's registration statement on form S3 filed with the SEC on April 30th, 2004, as amended. We urge you to review these factors.

In addition, during the course of this call, Carol, Peter, David or Jeff may refer to non-GAAP financial measures, such as consolidated EBITDA, adjusted net income and adjusted diluted earnings per share. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles in the United States and may be different from non-GAAP financial measures used by other companies. Investors are encouraged to review Endo's earnings press release issued yesterday for Endo's reasons for including these non-GAAP financial measures in their earnings announcement and to see the reconciliation of these non-GAAP financial measures through their most directly comparable GAAP financial measures. Now, I would like to turn the call over to Endo's Chairman and Chief Executive Officer, Carol Ammon.

Thanks, Bill, and good morning and thank you all for dialing in. Yesterday evening, we reported our financial results for the second quarter and first half of 2004 and announced the license of an on-market product, Frova, for the treatment of acute migraine. We're delighted to be able to add to our portfolio a proprietary brand such as Frova, which is patent protected until 2015 by a number of patents, including a composition of matter patent and pleased to be partnering with Vernalis, a company dedicated to the discovery and development of novel medicine to treat human disease. We see Frova, our first brand of neurology product, as an excellent strategic fit that will reinforce our leadership position in pain management while expanding our franchise into a complementary therapeutic area, such as CNS disorders. We expect that the transaction, which is subject to antitrust clearance by the Federal Trade Commission, will be completed within the next 30-60 days.

I'm going to ask Peter Lankau, our President and Chief Operating Officer, to provide some additional comments on the license agreement with Vernalis and to explain why we are excited by the opportunity to market Frova. But first, let me make some comments about our second quarter and year-to-date results.

Total net sales for the second quarter of 2004 were 144 million, compared with 152 million in the same period a year ago. Net income for the second quarter of 2004 was 31.5 million, versus 45.2 million in the same period of 2003. Adjusted net income for the 2004 second quarter was 37.8 million, compared with 46.1 million in the year ago second quarter. Diluted earnings per share for the three months ended June 30, 2004 were 24 cents, compared with 34 cents in the same period of 2003. On an adjusted basis, diluted earnings per share were 28 cents for the second quarter of 2004, versus 35 cents in the comparable year ago period.

Despite generic competition with Percocet and our extended release morphine sulfate product, we believe that the continued growth of Lidoderm, the upcoming launch of DepoDur, the addition of Frova and the advancement of our near-term pipeline, including our extended release and immediate release oxymorphone, our generic extended release oxycodone and our generic transdermal Sentinel patch, we are well prepared for the future. A detailed summary of adjusted net income and adjusted earnings per share for the quarter was provided in yesterday's press release. We are raising our financial guidance for 2004 and believe that we are currently well-positioned to achieve 2004 net sales of approximately $590 to $600 million.

Further, we reaffirmed our previous guidance for Lidoderm. We expect net sales to be approximately $300 million in 2004. In addition, we anticipate GAAP diluted earnings per share for the year ended December 31, 2004 to be approximately 88 cents to 90 cents per share and adjusted diluted earnings per share to be approximately 95 to 97 cents. Our guidance includes the revenue and cost associated with the launch of DepoDur and Frova and factoring in the additional clinical trials for our immediate release and expanded release oxymorphone. Of course, there can be no assurance of us achieving these results. Now I would like to turn the call over to Jeff Black, who will discuss our second quarter and six-month financial result in detail. Jeff?

Thanks, Carol. As Carol mentioned, Endo's net sales for the second of 2004 were 144 million versus 152 million in the year-ago second quarter. For the first half of 2004, net sales were 297.5 million in 2004 and 304.3 million in 2003. Net sales of Lidoderm were 58.2 million for the quarter, compared with 50.6 million for the second quarter of 2003. For the first half of 2004, Lidoderm net sales were 123.6 million versus 92.1 million in the year ago first half. Lidoderm dispensed units, according to IMS data, are up 67 percent for the second quarter of 2004 compared to the second quarter of 2003 and rose 74 percent year to date compared to the first six months of 2003.

Due to the buying patterns of our customers, net sales of Lidoderm in the second quarter were not reflective of the underlying demand. Based on IMS data, we estimate that prescription demand for Lidoderm in the second quarter of 2004 was approximately $70 million. On account of the buying patterns of our customers during that time however, we estimate that inventory levels at our customers are currently well below normal levels and this adversely affected net sales of Lidoderm in the second quarter of 2004. Based on IMS data, the run rate on Lidoderm sales now is approximately $288 million. Given the strength of the underlying prescription demand for Lidoderm, we believe that net sales of Lidoderm will be approximately $300 million in 2004.

Net sales on Percocet were $13.6 million for the three months ended June 30, 2004, versus 52.4 million in the same period of 2003. For the first six months of 2004, net sales of Percocet were 44.4 million, compared with 107.9 million in the year ago first half. Again, we do not believe net sales of Percocet in the second quarter were reflective of the underlying demand for this product. Net sales of Percocet have been adversely affected during 2004 due to the introduction of generic versions of Percocet 7.5 325 and 10 325 during the fourth quarter of 2003.

In addition, on account of the generic erosion of Percocet, inventory levels of our customers increased above normal levels. Inventory levels at our customers are in the process of being brought back to normal levels and has adversely impacted net sales of Percocet in the second quarter of 2004. The Company anticipates that its customers will be back to normal inventory levels during the third quarter of 2004. Based on the IMS data, we estimate that prescription demand of Percocet in the second quarter of 2004 was approximately $27 million. In addition based on the IMS data, the current run rate on Percocet sales is in excess of $100 million.

Led by growth in Endocet, net sales from Endo's generic products rose to 69 million for the three months ended June 30, 2004, compared to 40.9 million in the same period in 2003. Net sales from our generic products were $122 million for the six months ended June 30, 2004, compared with 88.8 million in the same period in 2003. During 2004, Endo has experienced a decrease in net sales of its morphine sulfate extended release tablets due to generic competition introduced in the third quarter of 2003. However, this was offset by our launch in the fourth quarter of 2003 of two new strengths of Endocet.

During the second quarter of 2004, another competitor announced that it had received approval to market two of the five strengths of morphine sulfate extended release tablets. In addition, during the second quarter of 2004, another company received approval for a product that competes with Endocet 7.5 325, 7.5 500, 10 325 and 10 650.

Overall in the second quarter, branded sales were negatively impacted due to both, one, the buying patterns of our customers, particularly as they relate to Lidoderm; and two, our efforts to bring Percocet inventory at our customers to normal levels after the generic erosion of the Percocet 7.5 325 and 10 325. Based on the underlying prescription demand of both Lidoderm and Percocet, we believe the impact on the branded net sales that we experienced in the second order will not continue. Conversely, we expect additional competition to both Endocet and our extended release morphine sulfate to adversely impact our market share in price of both of these generic products, which will adversely impact the net sales of our generic products.

Gross profit for the second quarter of 2004 was 115.1 million, versus 125.8 million in the year ago second quarter and was 235.7 million for the first half, compared with 250.5 million in the same period a year ago. Gross profit margins declined to 80 percent for the quarter and 79 percent for the six months in 2004, versus 83 percent and 82 percent in the respective periods of 2003. A shift in the product mix, combined with the introduction in April 2004 of the more costly single pouch child-resistant packaging for Lidoderm were the primary factors affecting the gross margins for the quarter and year to date in 2004. Although we expect further competition with our generic products to have a negative impact on our margins in the future, due to our selective focus on hard to do generic products where we believe barriers to entry will limit competition, we continue to maintain a highly profitable generic business.

Selling, general and administrative expenses for the second quarter 2004 were 43 million versus 41.8 million in the same period of 2003. For the six months, SG&A expenses were 81.8 million in 2004 and 77.9 million in 2003. We continue to invest in the educational and promotional efforts for our products, as well as support our new product pipeline in anticipation of product launches. Research and development expenses for the quarter rose to 19.2 million in 2004 from 9.4 million in the same period 2003 and total 29 million year to date in 2004 versus 21.5 million for the first half of 2003. The increase in R&D spending reflects a milestone payment of $5 million in the second quarter of 2004 to our partner, Skye Pharma, for the initiation of the Phase III program of Skye's development product, Propofol IDDD, and a $5 million milestone due to Skye Pharma for FDA approval of DepoDur.

Diluted earnings-per-share for the second quarter of 2004 were 24 cents versus 34 cents in the comparable 2003 period. As detailed in the supplemental financial information in yesterday's press release, adjusted diluted earnings-per-share for the second quarter 2004 were 28 cents, adjusted to exclude the impact of the previously discussed milestone payments to Skye Pharma, compared with 35 cents for the second quarter of 2003. Diluted earnings-per-share for the six months ended June 30, 2004 were 55 cents, compared with 46 cents in the first half of 2003. As detailed in the supplemental financial information in yesterday's press release, adjusted EPS for the first half was 61 cents per diluted share in 2004, compared with 71 cents per diluted share in the first half of 2003.

Cash flow from operating activities with 15.1 million for the six months ended June 30, 2004, versus 139.1 million for the same period a year ago. This decrease primarily reflects both an increase in accounts receivable and an increase in our inventory levels. The increase in accounts receivable is substantially attributable to an increase in the proportion of revenues of our generic products, which have payment in terms of 60 days, compared to our branded products, which have payment terms of 30 days, as well as the timing of purchases by our customers during the quarter. During the second quarter, our inventory levels increased as well. The increase was substantially due to an increase on our inventory levels of Lidoderm. Historically, we have carried low inventory levels of Lidoderm due to our manufacturing not being able to keep up with the product demand. This year, additional capacity has been added and our manufacturing of Lidoderm has not only been able to keep up with demand, but we've been able to build a safety stock of Lidoderm inventory. We are at this time, however, carrying more Lidoderm inventory than we would like to. Although there is not a risk of obsolescence with this inventory, we and our manufacturer will be working together over the remainder of 2004 to bring the Lidoderm inventory levels more appropriate levels.

In addition, during the second quarter of 2004, we made the decision to manufacture an additional 4.5 million of our generic oxycodone extended release. We did not reserve for this inventory and remain confident that the district court decision declaring produced Oxycontin patents unenforceable will be affirmed by the Court of Appeals at the federal circuit.

As announced last night, under the terms of the license agreement with Vernalis for Frova, we will pay Vernalis an upfront fee of $30 million anniversary payments for the first two years of $15 million each year and a $40 million milestone payment upon the FDA approval for the (indiscernible) indication. In addition, we will pay onetime milestone payments for achievement of defined net sales targets in a year. These sales milestone payments increased based on increasing net sales targets, ranging from a milestone of $10 million on $200 million in net sales to a milestone of $75 million on 1.2 billion in net sales. These sales milestones could total up to 255 million if all the defined net sales targets are achieved.

In addition, we will also pay royalties to Vernalis on net sales of Frova. We will also be providing Vernalis a loan facility and Vernalis will issue us a five-year, $50 million 5 percent note. These amounts under the loan facility will first be used to repay all of Vernalis' outstanding obligations to Elan.

Our cash and cash equivalents were 232 million at June 30, 2004. We feel we remain in a solid financial position with good cash flow and no debt which will continue to provide us an opportunity to pursue further acquisitions and other strategic alliances and licenses, which would we believe, accelerate our growth as a premier specialty pharmaceutical company.

With regard to our guidance, the outlook for our existing on-market products remains strong for the remainder of the year, and now we will be launching two new additional proprietary products into the marketplace later this year. Significant investment will be made over the course of 2004 in both DepoDur and Frova. Prior to the Frova deal, we were ready to confirm our full year guidance, even after considering the pleasant but unexpected additional spending required to launch DepoDur. However, after considering the strength of our base business as well as the contribution of Frova, we're raising our financial guidance to approximately $590 million to $600 million in net sales and 95 cents to 97 cents per share in adjusted diluted earnings-per-share. I would now like to turn the call over to Peter to comment on the license of Frova.

Thanks, Jeff, and good morning everyone. Last night, we announced that we have entered into an agreement granting us exclusive rights to market Vernalis' Frova in North America. Launched in the U.S. in June of 2002, Frova is indicated for the acute treatment of migraine headaches in adults. Net sales of Frova in the U.S. were $37.5 million in 2003.

Frova has differentiating features from other migraine products, including the longest half-life in the triptan class and a very low reported recurrence rate in its clinical program. These distinct characteristics have yet to be fully exploited in the North American market. We believe that we will be able to capitalize on Frova's clinical benefits and commercial potential by effectively leveraging the relationships and the reputation that Endo has built with the neurology community over the years in marketing our topical analgesic patch, Lidoderm.

Further, Frova's potential future application for the treatment of menstrually associated migraine makes it one of Endo's most promising products. Our intent is to promote Frova to a targeted group of neurologists, pain specialists and other physicians that we believe are the appropriate audience for the clinical benefits of Frova. We believe by employing more of a focused medical marketing approach whereby we will position Frova within the neurology community in a manner that fully exploits its clinical benefits, we will create an advocacy base from which the product will build its foundation. We do not expect to compete in a significantly with the large pharma companies promoting similar drugs substantially to the primary care audience. We believe that this emphasis on the specialty physician audience and by appropriately positioning Frova based on its clinical benefits, we can grow Frova significantly beyond the revenue it has been able to achieve in its two short years on the market.

Now, Frova is also being studied as a potential prophylactic treatment for menstrually associated migraine, also known as MAM. In April of 2003, data were presented at the American Academy of Neurology Meeting from an initial clinical study into the efficacy of Frovatriptan as a preventative treatment for MAM, which affects roughly half of all women who suffer from migraine. The data from this study demonstrated a highly statistical, significant improvement in the number of patients who are headache-free during the perimenstrual period from both of the study dose regiments of Frovatriptan compared to placebo. More than half of the patients at the higher dose regiments were headache-free during their menstrual period. This study is considered a definitive Phase III study.

A long-term open-label Phase III study is underway and a confirmatory Phase III efficacy trial is planned to be initiated in the second half of 2004. If positive, this confirmatory study, together with the already completed and positive Phase III study, will form the basis of a supplemental NDA filing to support extension of the existing Frova label to include this novel indication. Now if approved for this indication, we believe that Frova would be these first triptan to be indicated for the prevention of any type of migraine. We anticipate filing a supplemental new drug application for this indication following Vernalis' completion of the second of two Phase III clinical efficacy trials, assuming of course that the results of the confirmatory trial are positive. In the meantime, we expect to expand both our primary and our specialty sales forces in early 2005 by approximately one-third to ensure the commercial success of Frova in the United States and with the possibility for additional expansion in the future based on the product's growth and the potential approvals by the FDA for the MAM indication. So now, I would like to turn the call back to Carol for some additional comments.

Thanks, Peter, and in a moment, we'll take your questions. But we do have a number of upcoming key milestones and significant events to Endo. And I would like to just take a moment and highlight those. We are very pleased to add Frova. It strengthens our product portfolio and it expands our reach into the new, but very complementary therapeutic area. We look forward to closing the transaction and launching this exciting treatment, which we believe has significant potential. And following the recent FDA approval of the DepoDur, we have been busy recruiting a new hospital-based sales force and implementing other premarket initiatives to ensure that we have a successful launch by year end. And now that we've reached agreement with the FDA on the trial design, we expect to initiate our Phase III clinical trial for Oxymorcone (ph) extended release some time over the next few weeks.

We also expect to finalize the trial design and protocol on a short-term repeat dose study for our oxymorphone immediate release tablets within the next few weeks. The briefing process has concluded in the generic oxycodone litigation and we await a date for oral arguments, which we currently anticipate to occur before this year end. And we await the outcome of the FDA's review of the ANDA for generic Duragesic submitted by our development partner Noven (ph) and we're hopeful that we will be in a position a launch this product in late January 2005 when Duragesic's pediatric exclusivity expires.

And finally, we will remain active in pursuing further in-licensing and acquisition activities in pain management and complementary therapeutic areas. We feel that with Frova, DepoDur and Oxymorcone extended release and immediate release, combined with our generic equivalence of Oxycontin and Duragesic, the two largest opioids on the market, we have an unsurpassed portfolio of branded and generic management products that leave us well positioned for growth. Our financial condition is solid, allowing us to successfully pursue new business opportunities, such as Frova and we are pleased to operate in the large growing market for pain management products. Now, Peter, David, Jeff and I will be happy to take your questions.

(Operator Instructions). David Windley, Jeffries & Co.

First of all, Jeff, are there any external issues or changes in posture at the wholesalers that would have them at unusually low Lidoderm inventory levels?

From what we can tell, and I guess what we have read in the public domain, the wholesalers, which is a substantial portion of our business, are changing their business model to more to a fee for service type of business model from previously where there was speculative buying in advance of price increases. So that phenomenon does seem to be occurring out there. Is that specifically what is affecting inventory levels at Lidoderm? I don't know. What we do know is inventory levels of Lidoderm are way below normal levels, and in fact, the lowest level they have been since the launch of the product in '99. So if I were to guess, that probably had some impact on those levels because certainly the prescription demand of Lidoderm dictates that inventory levels should continue to be strong because it is still a growing product in terms of prescription demand year-over-year.

And as a quick follow-up on that, have you had conversations with customers to in fact verify that your internal analysis of inventory levels squares with what they see on the shelf?

We do exchange information with them, some more than others, and it would confirm what our belief is, yes.

And one more question. On the gross margin, you had talked last quarter about the introduction of the new packaging on Lidoderm. And then of course, there was a seemingly a pretty meaningful shift in Q1 to Q2 revenue mix towards your generic products. I am wondering how sequentially gross margin improved in light of those factors?

Sure. Well, Lidoderm did not contribute as much to this quarter's sales as it did to last quarter's sales. And I guess I would reemphasize that, although intuitively people believe that once products shipped from branded products to generic products that there is going to be a margin squeeze. But we have a very selective focus on generic products where we believe for lots of reasons competition could be limited.

Because of that, even with some competition, we're able to enjoy very high gross margins on our generic products. In fact, some of our generic products still have better margins than some of our branded products. So although intuitively a shift from brand to generic would lead you to down the road that margins will decrease. And in fact, we do expect margins in our generics to decrease because of increased competition that will be coming later this year, it's not necessarily true that a shift from brand to generics in our business model is going to cause the gross margin contraction.

Thank you that is very helpful. I'll jump out.

David Buck, Buckingham Research.

Good morning. I have a couple of financial questions for Jeff and then a Frova question. Jeff, on the gross margin, can you give us a sense of what you think the normalized margins might be? The mix shift surprised us (indiscernible) I guess five full points higher than expected. But did you get any negative impact at all for Lidoderm and the change of packaging, or was that washed out during the quarter so it would be more of a third-quarter event?

No, we started shipping the new packaging for Lidoderm during the second quarter right at the beginning of the second quarter. So that impact was felt in the second quarter. But Lidoderm as a percentage of our sales in the second quarter were not what they were necessarily in prior quarters or what we expect them to the over the course of the remainder of the year.

So they're going down, but do you think they're still in the 75 percent-plus range of the remainder of the year?

We haven't really given specific margin guidance, other than to say we do expect potentially with additional competition on our morphine sulfate product and additional potential competition on Endocet that we would expect to have to give up additional price, as well as market share on those products. And given the significance of those two products to our overall product line, we see margins for the remainder of the year to be decreasing. We just have not specified to what level.

On Percocet inventories, you had pointed out that you thought prescription demand was about $100 million. But you are expecting more generic erosion. I guess my question is -- why would you expect the wholesalers to rebuild inventories if there is expected generic competition that remains in the increase?

The competition we're referring to mostly is competition with our market share on Endocet, the generic of Percocet. The Percocet family is substantially generically eroded. The two strengths that just recently went generic I guess a little bit less than a year ago, the 7.5 325 and 10 325, are retaining a little bit under 20 percent of the market share of their strengths. So the generics are taking 80 percent of those strengths. All of the other generics have taken substantially most, if not all, of the brand business. So there is still probably a little bit of erosion that will continue with the Percocet 7 325 and 10 325. It will drop below a 20 percent retention and continue down to 10 and 5 over time. But most of that competition has probably already been felt in the sales numbers.

So, you think that the base of the tail of your branded sales is about $100 million? Based on prescription demand?

Yes. We would expect it to decline again because the 20 percent retention on those two strengths won't continue; it will drop down to 10 and 5 over time. But there is still a pretty strong retention amongst the other strengths as well.

If I can turn to a question for Peter on Frova, sounds like you're not going to head to head with the other triptan marketers, which is probably a positive. My understanding is the main marketing message in that class has been quicker onset of action, and obviously Frovatriptan is a bit different there. Can you give us some sense of how many prescriptions are written in the specialist market, what the growth rate has been and what do you think the opportunity right be for Frova if you don't get the additional indication from MAM actually?

Sure. The market as a whole is growing at about a 2.5 percent compounded growth rate as of May of this year. Of that, about 18 percent of the prescriptions are written in the neurologists' specialty office and about 61 percent in primary care and the rest in all other. We see the opportunity for the neurology specialists to become the advocate for Frova, based on the fact that the majority of patients who are being treated with triptans do in fact have recurrence. In fact, somewhere on the order of 70 to 75 percent of migraine sufferers will have some recurrence within the first 24 hours. Because of the clinical benefits of Frova, we believe that this would be an ideal opportunity for urology specialists to be able to address the recurrence rates amongst these patients. And once they have really have adopted this profile, we believe that that will have a significant influence on our ability to spread the word through the rest of the medical community.

Okay, thanks.

Ian Sanderson, SG Cowen.

Thank you for taking the call. First of all on Lidoderm, have you seen any reorder flow this month that would give you some comfort in that 300 million projection? And on Endocet, I don't know what you can say here, but it appears that there was a pretty large inventory fill in Q2 of that product, perhaps against -- ahead of the new generic competition. So I don't know if you can talk about what inventory levels looked there. And then third, can you just touch on, in rough terms, what the SG&A spending levels may look like in the back half of this year and in rough numbers, maybe 2005, and the sales force target numbers once Frova is onboard?

Sure. I can't comment on the Lidoderm third quarter sales results. But the reason we remain confident in the $300 million for the full year is in fact the prescription demand that we see. That, to us, is clearly the indicator of how strong or weak a product is. What we shipped out of Memphis, Tennessee is important clearly. But because we are not shipping directly to an end customer, how much is in the channel, whether it's too much, too little right on, is something that we watch very closely. So our confidence level in Lidoderm is completely based on the prescription demand that we have seen for the course of the year, including the monthly scrips in June, as well as what we expect for the remainder of the year.

As far as Endocet inventory levels, those are actually at pretty normal levels as it stands today. Endocet typically is about a month, month and a half type of inventory levels, and that's where we stand today. Clearly, if there is competition and we lose market share, that month, month and a half normal inventory level will increase beyond a month or a month and a half, because we'll have less market share. So the math will dictate that. So we will, in advance of competition or additional competition, try to monitor that such that we don't end up having more inventory out there than we want in Endocet. But as it stands today, it is at normal inventory levels.

SG&A for the remainder of the year -- clearly, with the launch of DepoDur later this year, including hiring the first 25 hospital sales reps during the third quarter and beginning to build the efficacy of that product over the course of this year, as well as with Frova, although we have to still wait for FTC clearance of it, so we won't start booking sales likely until late third quarter, early fourth quarter of this year, but we will start promoting the product. We do see that we need to invest significantly in that product to capitalize on what we believe are benefits of this product that can differentiate itself from some of the other products as it relates to the urology community that we are targeting.

As far as 2005 sales force targets, at least what we've communicated publicly, is that we expect the DepoDur sales force, which is the separate sales force in the hospital, to start with 25 people this year, adding an additional 45 at the beginning of next year for a total of 70 hospital reps. That number may increase over time if needed to reach to more hospitals.

As far as Frova, we plan on increasing both the specialty sales force we have, plus the primary care sales force we have, which targets high riders of pain medications by about a third. So that's somewhere in the 70-80 range on the existing 230 base we have. Beyond that, there's no plans to increase the sales force. But as we mentioned in the past, we continue to look at products, both in the pipeline and on market and we would love to add an additional product which would require us to increase our sales force, but again, focusing on niche therapeutic areas where someday again, we will probably be able to raise our sales force, but not competing with some of the big pharmaceutical companies.

Just as a follow-up to that, in line with your strategy to pitch Frova for prevention of recurrence, I think that has been an anticipated marketing (indiscernible) on this drug since its launch. And whether for Elan's lack of focus or what, it never really sunk. Do you have plans to do a major promotional effort with the relaunch of this product?

Well certainly, we expect to do expect to be able to reposition Frova within the urology community. The product currently, as you know, is indicated for the acute treatment of migraine in adults, yet the utilization of this product for the physician that we've identified is having fairer (ph) significance in the population; that is, recurrence rates. We don't feel that that has been fully exploited to this point. The indication for the prophylaxis of MAM, menstrually associated migraine, we clearly see as that having a significant upside opportunity for this product. And frankly, with the already completed positive Phase III study that Vernalis has conducted, we do believe that we have the opportunity to duplicate that and to potentially have an indication that we could file for in 2005 with the potential approval in '06, late '06, that would significantly differentiate this product from competition.

So I think that we certainly believe that this will require a relaunch effort. We are expecting over the next 30-60 days to revisit the strategy that has been employed previously. We've done our own market research on this product and we have identified some particular areas of opportunity that we expect to exploit. And as we have done in the past with our ability to medical market with Lidoderm, we certainly expand that that same strategy will help us to optimize the opportunity for Frova.

Thank you.

Robert Uhl, Wells Fargo.

Thank you and good morning. I have just a few questions. I believe on the call to discuss first-quarter results, you said that it was likely R&D expense in 2004 would be a little bit below 2003. Is that still the case, and if not, what is the new expectation? And the inventory of Oxycodone ER that you've built in the quarter, the $4.5 million, is that whole number included in cost of goods? So, if we really wanted to know the gross margin on what you sold, we should back that out and come to a number that I think is the highest gross margin you've ever achieved in the history of your company? And then finally, the 30 million Frova payment, does that all hit in one quarter whenever you close the deal? Thank you.

Sure. I will take them in order. As far as R&D, we did say in the first quarter that we expected it to be essentially flat or maybe a little bit down year-over-year. However, with the launch of both DepoDur and the launch of Frova this second half of this year, we're going to be doing a lot of Phase IV studies for these products to help support the marketing message. And so although we're late in the year now, so there's probably limitation, R&D is probably going to be flat, maybe a little bit up versus where it was last year, excluding milestones payments to partners.

As far as the $4.5 million of inventory we built, that is not included in cost of goods sold. We did not reserve for that inventory, so it's sitting on our balance sheet in inventory with no reserve against it. If we had reserved it, it would've gone through cost of goods sold and we would have, as you said, achieved the highest margins in our history. But we did not reserve for that because we remained confident and are confident that we will prevail and be able to launch this product, and therefore, no reserve for this inventory that we decided to build in the second quarter of 2004 was appropriate.

As far as the $30 million, that will actually be capitalized as an upfront license fee and amortized over the estimated useful life of the assets that we're buying, including the patents and the license rights to Frova. So that will be reflected through depreciation and amortization in future periods over its useful life.

Okay, thank you.

Rich Watson, William Blair & Co.

Good morning. Just a couple of more clarification questions on Frova. One of the things in Vernalis' press release mentioned, in terms of royalties, that they would be tiered from 20 percent beginning with when the product is approved for the MAM indications. So I was wondering if you could give us some idea of what kind of royalty, assuming there is a royalty from the get-go, we should think about for this product? And the other question I just had is -- Vernalis also mention some kind of potential co-marketing arrangement down the road, and whether you could walk us through that and how that works a little bit?

As far the royalty rate, we have not disclosed the royalty rates. We believe they are competitive with other types of transactions like this. There is a 20 percent royalty upon achievement of the MAM indication. That could increase over time in a tiered fashion, based upon achievement of certain sales levels. But beyond that, royalties have not been disclosed on this product.

With regards your question on Vernalis' comarketing, it's actually a co-promotion option that Vernalis has that gives them the option to exercise to employ up to 25 representatives, representatives for which we would have otherwise employed ourselves. And so as we look to the expansion opportunities in the years ahead, Vernalis will have an option to exercise a portion of those representatives, based on our own expansion plans. So they will -- in that fashion, then, we will fund the cost of those representatives, and of course, handle the promotional materials and the training and the other ancillary expenses associated with them. In essence, they will be Vernalis employees, but they will be primary, full-time equivalents, I should say, based on what we would have employed, had Vernalis not exercised the option.

Okay, thanks.

Corey Davis, J.P. Morgan.

Thanks. Jeff, if inventories of Lidoderm don't come back up; in other words, if the wholesalers think that whatever level they're at right now is the new normal, are you still going to hit 300 million for the year?

That is our guidance, to hit $300 million for the year. So, whether they bring them back up to normal levels or leave them at existing levels, which are at an all-time low, we would expect to hit $300 million for the year.

What are those levels? Is it below a month?

The existing levels?

Yes.

It's about two weeks.

And how about Percocet and Endocet? Around the same level?

Endocet inventories, and mostly narcotics, are usually a little bit more than normal. Lidoderm averages probably a little over a month historically. It swings obviously based on wholesaler buying patterns and when we take price increases. Percocet and Endocet typically carry more like five to six weeks on average. Endocet currently is at that point. Percocet is probably closer to a little over 2.5 months out there. So there's still another month of excess inventory out there that we expect to be able to bring down in the third quarter.

And did I hear you correctly that Endocet actually has higher gross margins than Lidoderm?

I didn't say that, no.

Is that an incorrect statement?

We don't comment on individual margins of products.

The milestones, you said that the upfront was going to be amortized over the life. How about everything else? And I guess how should we think about the increase in your DNA line as a result of the deal?

As far as the increase in the DNA line, the license agreement is for 20 years. There are patents on it as well that impact that term. The patents go through 2015, so we have not selected what the amortization period would be but it is likely to be somewhere around the patent life and/or the term of the license agreement.

As far as the remaining payments, the two $15 million payments; we're currently looking at that to determine whether they should be expensed in the year that we make those payments immediately or whether that, since they are guaranteed part essentially part of the upfront payment for the license of the deal, and therefore, amortized over the life of the agreement. So we have not made a determination as to that accounting as to whether there would be onetime payments of $15 million dollars in both next year and the year after upon the anniversary or whether those would be capitalized and amortized over the -- whatever the useful life as we determine. If demand is approved by the FDA and we make the $40 million payment, that would be expensed immediately for that contingency.

Sales milestone payments are expensed in the year incurred, and essentially we would have to start thinking about, to the extent we're going to achieve some of those milestones, expensing portions of that during the year that we believe we'll have to make those onetime payments. Royalties obviously are deducted in the year incurred.

On Frova, is there any protection in the deal from what might be channel stuffing by -- I don't know if it's Vernalis -- it seems to happen with product acquisitions in general in the past, or aren't you worried that inventories on Frova are excess right now?

We have looked at inventories levels, and without commenting on them, the way the deal works is to the extent that product was sold prior to the closing of the transaction, the obligation is to Vernalis to the extent that the product is sold subsequent to the closing, them the obligation is ours. So to the extent returns do occur related to inventories sold prior to the closing of the deal, that would be Vernalis' to absorb.

And how long has it been since this product has been actively promoted?

Corey, we believe the last active promotion appeared in the second quarter of this past year. We know that the agreement for transition services to Vernalis from Elan occurred in May. And our estimate is that sometime earlier in the second quarter, the promotion from Elan did cease.

Second quarter of '03 or '04?

'04.

So, it has been promoted right up until recently?

It has had active promotion, but we don't believe that it has had primary focus whatsoever.

Okay, thanks guys.

Date Windley, Jeffries & Co.

Thanks. My questions have actually been answered.

Alan Sebulski (ph), Apothecary Capital.

Just on the MAM indication, it would seem to meet that that market would be primarily the OB/GYN that patients would be talking to. If in fact that's the case, does ultimately the MAM approval lead you into a new market area? How do you think about that?

Certainly, there will be a portion of the patient population who will see treatment from their OB/GYN. However, we estimate that the neurology market still continues to be the prime driver for this indication, because it is often a very difficult migraine treatment to employ. So there is a fair number of migraine sufferers who are seeking specialty treatment. And we would expect that we would have that trickle-down effect referred to earlier that would impact the ability for both primary care and OB/GYN to realize the benefits of Frova for this type of a headache. There clearly is a priority here, however, on developing the specialty market. And as this product continues to grow, we will revisit the need for coverage of OB/GYN as we get there.

Thank you.

At this time, I will now turn the call back over to Carol Ammon.

I would like to thank everybody for being on the call today. We really appreciated the opportunity to update you with a little bit more information relative to the deal on Frova and speaking more about our earnings. We really look forward to keeping you apprised of progress on all of the other milestones and activity going on at Endo, so thank you very much.

Thank you. That concludes today's conference call.