Endo International PLC (ENDP) 2004 Q3 法說會逐字稿

Good morning. My name is Hattie and I will be your conference facilitator today. Thank you for joining the Endo Pharmaceuticals Third Quarter 2004 Earnings call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer period. If you would like to ask a question during this time, just please press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Newbould you may begin your conference.

Good morning and welcome to the Endo Pharmaceuticals Third Quarter 2004 teleconference. This call is being recorded. With us on the call this morning are Carol Ammon, Chairman and CEO, David Lee, Chief Scientific Officer, and Jeff Black, CFO.

Before we begin I would like to remind you that during the course of this call, Carol, David or Jeff may make forward-looking statements concerning such topics as future results, prior performance, anticipated timing of FDA approval of certain of the company's drugs, and possible timing of the commercial launch of certain of the company's products as well as other non-historical facts that reflect Endo's current perspective on existing trends and information.

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 statement. 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 files and under the heading "Risk Factors" in Endo's registration statement on Form S-3, filed with the SEC on April 30, 2004, as amended. We urge you to review these factors.

In addition, during the course of this call Carol, 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 Principals 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 earlier today for Endo's reasons for including these non-GAAP financial measures in their earnings announcements. And to see the reconciliation of these non-GAAP financial measures, to their most directly comparable GAAP financial measures.

Now I would like to turn the call over to Endo's Chairman and CEO, Carol Ammon.

Thanks, Bill, and good morning. Earlier today we reported our financial results for the 2004 third quarter and YTD. We welcome this opportunity to discuss the results with you as well as other recent developments. Joining me on the call this morning is our CFO, Jeff Black and Dr. David Lee, our Chief Scientific Officer.

First I'd like to briefly summarize our financial results. Led by a continuing growth of Lidoderm(R), net sales were $160.3m, up 7% from a year ago third quarter. Net sales for Lidoderm(R) were $83.8m for the 2000 third quarter versus $37.5m in the 2003 third quarter. We are pleased to note as well that Frova(R), our newest branded product that we began promoting on September 1st, contributed $5m in net sales in the third quarter.

Earnings for the third quarter of 2004 were $0.31 per diluted share compared with $0.30 per diluted share in the 2003 third quarter. Adjusted earnings per diluted share for the third quarter of 2004 were $0.31 compared with $0.33 in the comparable 2003 period.

I am pleased to report that we have a solid G&B performance as well. For the nine months ended September 30th, net sales were $457.8m in 2004 compared with $453.7m in 2003. Earnings per diluted share were $0.86 for the nine months in 2004, compared with $0.77 in the same period a year ago. Adjusted diluted earnings per share for the 2004 nine months were $0.92 versus $1.04 in 2003.

We are raising our previous total net sales guidance for 2004 based upon our year-to-date performance. We believe we are currently well positioned to achieve 2004 net sales of approximately $600m, the upper end of our previous guidance of $590m to $600m. Our previous guidance for Lidoderm(R) net sales of $300m remains unchanged.

In addition, we are revising our guidance for GAAP diluted EPS for the full year 2004 upward to approximately $1.06, and adjusted diluted EPS to approximately $1.12. I'd like to remind everyone that there can be no assurance of the company achieving these results.

I'd like to just take a moment and briefly recap some noteworthy developments that occurred during the third quarter as well. On July 14th we licensed the exclusive North American marketing rights to Frova(R) from Vernalis PLC. Frova(R) was first launched in the U.S. in June 2002, and it's indicated for the acute treatment of migraine headaches in adults. We were extremely pleased and excited to add this patent-protected product, which we feel is an excellent strategic fit and expands our pain franchise further into complimentary therapeutic areas. We were especially excited about its potential as a preventive treatment for menstrually associated migraine, which affects roughly half of all women who suffer from migraines. We expect a second confirmatory Phase III trial for the [MAM] indication will be initiated by year-end.

In August we began building our hospital-based sales force for DepoDur(TM) by adding 25 representatives. Their goal is to build advocacy for the product by educating anesthesiologists about DepoDur's(TM) clinical and pharmacoeconomic benefits as a single shot epidural that provides 48 hours of continuous pain relief. We expect to begin shipping DepoDur(TM) to our customers by year-end.

Also in August we announced an agreement with Orexo AB for the exclusive North American rights to develop and market Rapinyl(TM), a patented sublingual muco-adhesive fentanyl product, intended for the treatment of breakthrough cancer pain. Rapinyl's benefits are thought to include both a fast onset of action and added convenience, which we believe could improve compliance in cancer patients who experience breakthrough pain.

In regards to the ongoing patent litigation with Perdue Frederick over our generic OxyContin, we've been assigned an appellate court date of November 3rd. Both sides will present their oral arguments that day before a three-judge panel in the Court of Appeals for the Federal Circuit in Washington D.C. We anticipate a decision will be forthcoming approximately three to six months following that date.

In addition, we received final FDA approval of the 80mg strength of our generic OxyContin following the expiration of Teva's six-month marketing exclusivity. Now, before we take your questions, Jeff will review in greater detail our third quarter and nine-month results.

Thanks, Carol. As Carol mentioned Endo's net sales for the third quarter of 2004, were $160.3m compared with a $149.4m in the third quarter of 2003. For the nine months net sales totaled $457.8m for 2004 versus $453.7m in 2003. Net sales of Lidoderm(R) grew 124% to $83.8m for the 2004 third quarter and were up 60% to $207.3 YTD in 2004.

Prescription growth for Lidoderm(R) was up 51% and dispensed unit growth was up 57% in the third quarter of 2004 versus the comparable 2003 period. Prescription growth for Lidoderm(R) was up 61% and dispensed unit growth was up 67% for the first nine months of 2004 versus the same period of 2003.

Based on the IMS data, we estimate that prescription demand for Lidoderm(R) in the third quarter of 2004 was approximately $80m. Lidoderm(R) inventory levels at our customers remain at relatively low levels compared to historical levels. We expect our customers' inventory levels for Lidoderm(R) to remain at these levels for the remainder of the year. Based on the IMS data, the run rate on Lidoderm(R) is now approximately $325m.

Net sales of Percocet(R) were $26m for the three months ended September 30th of 2004, versus $59m in the same period in 2003. For the first nine months of 2004 net sales of Percocet(R) were $70.4m, compared with $166.9m in the year-ago nine months. Net sales for Percocet(R) have been adversely affected during 2004 due to the introduction of generic versions of Percocet(R) 7.5/325 and 10/325 during the fourth quarter of 2003.

In addition, due to the generic erosion of Percocet(R), inventory at our customers increased above normal levels during the second quarter of 2004. The company had expected that inventory levels of Percocet(R) at its customers would return to normal levels during the third quarter. However, they remain approximately three to four weeks higher than normal at the end of the third quarter of 2004. The company anticipates that its customers would be back to normal inventory levels by the end of 2004.

Based on the IMS data, we estimate that prescription demand of Percocet(R) in the third quarter of 2004 was approximately $28m. In addition, based on the IMS data, the current run rate on Percocet(R) sales is in excess of $100m.

Net sales of Frova(R) were $5m for the three months ended September 30, 2004. We began shipping Frova(R) upon closing of the license agreement in mid-August, 2004, and initiated our promotional efforts in September 2004. We believe that Frova(R) has differentiating features from other migraine products, including the longest half-life in the tryptan class and a very low reported recurrence rate in its clinical program. We believe these distinct characteristics have yet to be fully exploited in the North American market, and that we will be able to capitalize on Frova's(R) clinical benefits and commercial potential by effectively leveraging the relationships and reputation that Endo has built with the neurology and pain specialist community over the years. Further, Frova's(R) potential future application for the prevention of menstrually associated migraine makes it one of the company's most promising products.

Net sales from Endo's generic products were $42.7m for the three months ended September 30, 2004 compared with $49.2m in the same period in 2003. Net sales from our generic products were $164.7m for the nine months in 2004 compared with $138m in the same period of 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 has been offset by a launch in the fourth quarter of 2003 of two new strengths of Endocet(R). During the third quarter of 2004, we have begun to experience both pricing pressure as well as a reduction in our share for both Endocet(R) and our morphine sulfate extended-release tablets. We expect that competitors will continue to have an impact on our market share and price of both of these generic products, which will adversely affect the net sales and profitability of our generic products.

Gross profits for the third quarter of 2004 was $122.1m, essentially unchanged from the $122.3m in the same period a year ago. For the nine months in 2004, gross profit was $357.8m versus $372.8m in the comparable period of 2003. Gross profit margins declined at 76% and 78% for the quarter and nine months, respectively, in 2004 versus 82% in both of the same periods of 2003.

A shift in the product mix reflecting a higher proportion of net sales from generic products and pricing pressures on our generic products, combined with the introduction in April 2004, of more costly single-pouch child-resistant packaging for Lidoderm(R), were the primary factors affecting the gross margins for the third quarter and year-to-date in 2004.

Selling, general and administrative expenses for the third quarter of 2004 rose 22% to $43.5m. For the nine months SG&A expenses were $125.3m in 2004, up 10% from the same period in 2003. This increase is due to our continued investment in promotional, educational, as well as other support for our growing business, including our products Lidoderm(R), Frova(R) and DepoDur(TM).

Research and Development expenses for the quarter were $9.5m, versus $20.7m in the year ago quarter. It should be noted that R&D expenses in 2003 third quarter included a $5m milestone payment to our partner SkyePharma and higher costs associated with phase three clinical trials for our since-discontinued oral mucositis product. For the year-to-date, R&D expenses were $38.5m in 2004 compared with $42.2m in 2003.

Net income for the third quarter of 2004 was $41.4m, up slightly from $39.9m in the comparable 2003 period. Diluted earnings per share for the third quarter of 2004 were $0.31 compared with $0.30 in the third quarter of 2003. Adjusted diluted earnings per share for the third quarter of 2004 were $0.31 versus $0.33 in the comparable 2003 period.

We anticipate GAAP earnings per diluted share for the year ended December 31, 2004, to be approximately $1.06 per share and adjusted diluted earnings per share to be approximately $1.12 in 2004. Adjusted diluted earnings per share estimates for the full year of 2004 exclude estimated payments to partners for successful achievement of regulatory milestones, net of tax of $0.04 per share, and exclude the costs associated with the termination of Endo's development agreement with Lavipharm Laboratories, Inc., net of tax of $0.02 per share.

Regenerated cash flow from operating activities of $69.6m for the nine months in 2004 versus $168m in the same period of 2003. This decrease primarily reflects both an increase in accounts receivable and an increase in our inventory levels in 2004. The increase in accounts receivable was substantially attributable to the timing of purchases by our customers during the third quarter of 2004 versus the fourth quarter of 2003.

As you know our sales are reported net of deductions for items such as charge backs and rebates. Our accounts receivable are reported on a gross basis prior to these sales deductions with a corresponding liability on the balance sheet for these deductions. On a comparative basis, either gross-to-gross or net-to-net our day sales outstanding, or DSO, was approximately 52 days as of September 30, 2004, unchanged from our day sales outstanding as of December 31, 2003, which was 52 days as well.

The increase in our inventory levels was due primarily to an increase in our inventory of Lidoderm(R). Historically, we have carried low inventory levels of Lidoderm(R) 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(R) has not only been able to keep up with demand, but we've been able to build a safety stock of Lidoderm(R) inventory. That said, we are, at this time, however, carrying more Lidoderm(R) inventory than we would like to. Although there is not a risk of obsolescence with this inventory, as there is sufficient product demand and sufficient expiration dating, it is more inventory than we want to be carrying. We, and our manufacturer, will continue to work together over the remainder of 2004 and into 2005, to bring the Lidoderm(R) inventory levels to more appropriate levels.

In addition, during the second quarter of 2004, we made the decision to manufacture an additional $4.5m of our generic oxycodone extended-release. We did not reserve for this inventory and remain confident that the District Court decision declaring Perdue's OxyContin patents unenforceable will be affirmed by the Court of Appeals for the Federal Circuit.

During the three months and nine months ended September 30, 2004, net cash used in investing activities includes the $30m license fee paid to Vernalis PLC for the marketing rights to Frova(R), $50m for the loan made to Vernalis, and $10m to Orexo AB for the right to market and develop Rapinyl(TM).

During the three months and nine months ended September 30, 2004, net cash used in financing activities includes the $8.3m payment to Endo Pharma LLC, a limited liability company that currently holds the majority of Endo common stock, in which affiliates of Kelso & Company and certain members of management have an interest. This payment was made pursuant to the tax-sharing agreement between the company and Endo Pharma LLC, which requires the company, under certain circumstances, to pay Endo Pharma LLC the amount of the tax benefits that are usable by the company as a result of the exercise of stock options granted pursuant to the Endo Pharma LLC stock option plans, which stock options are exercisable only into shares of Endo common stock held by Endo Pharma LLC and, accordingly, do not dilute the ownership of the company's public stockholders.

Due to the sale of the 11 million shares of Endo common stock by Endo Pharma LLC and others during the third quarter of 2004, a liquidity event, as defined in the Tax Sharing Agreement occurred, furthering the company's obligation to pay Endo Pharma LLC the tax benefit attributable for 2001 and 2002, and 50% of the 2003 tax benefit.

Additionally, during the fourth quarter of 2004, the company will make a payment of approximately $5.2m to Endo Pharma LLC for the remaining 50% of the 2003 tax benefit. Assuming the company will be able to use compensation charges resulting from the Endo Pharma LLC stock option plans to reduce its taxes in 2004, due to the sale of the 11 million shares of Endo common stock by Endo Pharma LLC and others during the third quarter of 2004, the company will be obligated to pay to Endo Pharma LLC a tax benefit amount of approximately $22m.

Our cash and cash equivalents totaled $185m at September 30, 2004. In addition, we currently have an unused revolver of $75m. We feel our strong financial position provides us the opportunity to utilize our cash and cash flow from operations to continue to pursue acquisitions, licenses and other strategic alliances within the therapeutic areas of pain management, neurology, peri-operative care and supportive-care oncology. We believe this provides us the opportunity to accelerate our growth as a premiere specialty pharmaceutical company.

I would now like to turn the call back to Carol for some additional comments about our expectations for the coming months.

Well, thanks, Jeff. And before we take your questions, let me just take a couple of moments here to review with you some of the upcoming milestones. We do look forward to the November 3 court date for the generic OxyContin in the Court of Appeals for the Federal Circuit in Washington, where both sides will have the opportunity to present their oral arguments before a three-judge panel. We anticipate receiving their decision approximately three to six months following the hearing.

We're excited about our launch of DepoDur(TM) and we are encouraged by the progress of our new hospital-based sales force in building advocacy for the product among the anesthesiology community. Assuming approval by the FDA, we also look forward to the launch of generic Duragesic in late January 2005.

And looking to 2005, we're excited about our prospects. We'll be actively promoting Lidoderm(R), Frova(R) and DepoDur(TM), and expect to launch all strains of our generic versions of the two largest-selling opioid analgesics on the market today, Duragesic and OxyContin.

Now I'd like to open it up to any question that you may have.

+++ q-and-aOperator: [operator instructions]

Your first question comes from David Buck of Buckingham Research.

Yes, hi, good morning, thanks for taking the question. A couple of questions. First on DepoDur(TM) for Carol. Have you decided on pricing and what type of level of sales do you expect to be shipping for DepoDur(TM) this year for stocking, and is that included in the guidance, is the first one. And then just the second one for Jeff, can you give us a sense of what R&D and SG&A spending might be for the fourth quarter?

Sure, if you don't mind, I'd like to take them all.

Sure, okay.

As far as SG&A and R&D spending, we do expect those rates to increase in the fourth quarter, you know, with the launches of Frova(R) and DepoDur(TM), and we expect that intensity to increase here during the fourth quarter in the SG&A line. In the R&D line we also expect increased spending on the oxymorphone clinical trials that we're doing in response to the approvable letter that we received. So we expect both SG&A and R&D to increase here in the fourth quarter.

As far as DepoDur(TM) pricing, we have made a determination as to the pricing of that. We're currently not disclosing that number yet, and we're going out now to start -- or continue to work with formularies to get it accepted onto there. As far as our guidance for the full year, we have not included any sales of DepoDur(TM) in our guidance. We do expect to ship the product by the end of the year to wholesale customers and do expect some pull-through. Under Generally Accepted Counting Principles you can't recognize sales if you don't have a reasonable ability to be able to predict returns of the product.

Right.

Until such time we get a better handle on the formulary acceptance and the pull-through of the product, we're not going to be able to recognize sales. So having said that, we have not included it in our guidance. There is a possibility we may recognize some sales this year if we're able to get comfortable, and we can predict level of returns potentially of DepoDur(TM).

If I look, Jeff -- for the hospital sales force, how much of the expenses were actually in the third quarter, the 25 reps?

They began in August, substantially.

Okay, for the third quarter?

So probably two of the three months.

Two of the three months, okay. Okay, that's it for me for now, thanks.

Your next question comes from Angela Larson of Unterberg Towbin.

Good morning and thanks for taking the question. I wanted to see if you could expand a little bit on the sales force expansion side. If you could give us some of the timing you've talked about, you know, expanding the focused group, as well as the more general group and then continuing to expand the hospital group. If you could give us, you know, some of the size and timing of that.

Sure, we -- as we just mentioned on the DepoDur(TM), we did begin with the building of a 25-person force for the advocacy period, and we do anticipate shipment towards the end of the year of the commercial quantities. And then we would look, in the beginning part of next year, then, to expanding that out to about 70 people. So we'd be adding approximately 45 people in that first-quarter time period.

Additionally, we are also then looking to expand our specialty and our community-based force, which is currently at a 230-person force, 70 in the specialty, 160 in the community-based force, and we look to increasing that by about a third, so about another 70 representatives will be added in the earlier parts of 2005.

Should we be building it in for first quarter?

We hope to be substantially fully staffed as early as possible during the first quarter.

Great. And the last question, if you wouldn't mind, is oxymorphone's status. You have the special protocol approval, where are you on getting that out into live trials?

Well, as we announced back in July, we had reached agreement with the FDA on the design of protocols of oxymorphone extended-release that we had submitted using the special protocol assessment rule. We were particularly keen on using that process because that was the only way that we felt that we could guarantee that we would get a response within a defined timeframe from the FDA on the study design. And it is the study design that was critical, we felt, in being able to make sure that we didn't run into the issues that we've run into with the earlier pivotal studies that we had conducted.

Following that agreement we completed all of the back office work necessary to initiate the clinical trial, identifying the investigative sites, [inaudible] the approval, the investigators meeting and so forth. And then we received an additional comment from the FDA relating to the analysis of the data, and we just felt at that time - we, I think, announced that back in September -- at that time we felt that given the past history, our past experience with this division of the FDA that to actually begin patient enrollment prior to having every period, "t" crossed, and so on, "i" dotted -- would be inappropriate. And as you're probably aware, once you begin enrollment, patient enrollment, the SPA process is terminated, and so you can't rely on any agreement that had been made with the agency. So we've taken the decision that we want to have every unresolved issue finally sorted out including any aspect of the analysis before we begin patient enrollment.

That having been said, we have actually begun patient enrollment in a backup study, a second study of oxymorphone extended-release. This is using exactly the same study design as the one we have agreed with the agency, but we're using patients now who are opioid-experienced as opposed to the first protocol, in which we would enroll patients who are opioid-naive. The second study, as I said, it will be identical in every aspect to the protocol that is going through the SPA process, and because it is in itself [now] going through the SPA process, we are in a position to amend it if that is going to be necessary on the basis of any further comments that we get from the FDA on the, as I say, on the first SPA protocol.

But we do also anticipate that because the second protocol will in other ways in all respects be identical, that all agreements made on first protocol will also, we can rely on for the second protocol.

So when you intend to file your complete response will you include both studies?

I'm sorry, Angela, I didn't hear the last part of your question.

Will both studies be included in your complete response to the FDA at the time of re-filing the product?

Yes, you know, I can't answer that at the moment. We have undertaken to provide an additional study for the FDA and so I think at the present time we'll leave our options open and see how these studies roll out, particularly in terms of recruitment and obviously when they complete and then we'll make the decision.

Okay, thank you.

Your next question comes from David Windley of Jefferies and Company.

Good morning, thanks for taking the question and congratulations on the quarter. A couple of questions, first on Frova(R) -- what are your assumptions or what are you including for the fourth quarter and then in -- therefore, in the $600m for the year for Frova(R)?

I would say that we have given our guidance of $600m in sales for the year, but we don't give individual guidance on these products. So other than the guidance that we reaffirmed for Lidoderm(R) of the $300m, but we are in the launch phase of that product and actively detailing it.

Yeah, I'd probably just add a little more color. Based on IMS data, the run rate annualized is probably about $37m on the product. There is probably a little bit more inventory out there than we would expect. There's probably about two-and-a-half months of inventory out there, primarily related to one customer who has a lot. And so we have been able to ship product this quarter to the customers that didn't have too much inventory, but hopefully there will be some correction of that during the course of the fourth quarter.

Okay, thanks, Jeff, that's helpful.

Sure.

A more general question -- gross margin, kind of finally seeing that impact that you've been talking about with both shift and mix and then the new packaging on the Lidoderm(R) -- is this an appropriate level to expect, going forward, or as your brand of products launch, maybe it's moving back up a little bit? Can you give some color on that?

Sure, I can't speak into '05, but for the remainder of '04 as far as downward pressure, we do expect potential continued downward pressure on both Endocet(R) and morphine sulfate from the competition that we have with [inaudible] cross introduction in both those areas, which has caused some price and share decline for us. So there could be additional gross margin pressure.

The branded products that we're launching are good margin products. So that could offset a portion of that decline from the generic products. But without sort of giving a specific number, it's, unfortunately, somewhat dependent on product mix.

Okay, and then I want to go back to Frova(R) and just ask one more question. I think I heard one comment within the context of the prepared remarks about Frova(R) being one of the most attractive new products in the pipeline. Was that in the context of the [MAM] indication? Is that --

I think we're excited about the product just on a couple of fronts and one being that it does have a very long half-life and it does have a low recurrence rate on the migraine. We believe that that's a product that just fits perfectly for us within the neurology franchise, which we've been developing with our Lidoderm(R) product over the past couple of years. So from that perspective we're certainly excited about the product. But also the study that [inaudible] did complete on the [MAM] indication appears to be a very good study, and we're looking forward to the confirmatory study and believe if we have the opportunity then to gain an indication for the menstrually associated migraine, it's going to open up more avenues for us. So it was really an excellent product for us to be able to add to our portfolio of products and into our pipeline for this further indication.

And Carol, how long would the confirmatory study run, and when would you be in a position to file for that indication?

The confirmatory study will basically be a replication of the study that was done earlier. We are anticipating being able to initiate that study towards the end of this year. We have met with the FDA, and we're just finalizing the details of the protocol. And we're anticipating now, assuming that that study is positive, that we will be in a position to file a supplemental NDA in the first half of 2006.

Okay, thanks, David.

Your next question comes from Ian Sanderson of SG Cowen.

Good morning, thanks for taking the question. First, and it would be Jeff, could you walk through the tax benefit payment to Endo Pharma LLC again and specifically what's expected in Q4? Will that payment be the $5.2m, the $22m or a combination of those?

Sure.

And secondly, on the oxymorphone ER, and I think you went through this, and I missed it but, again, when, roughly, do you expect to arrive at a final protocol agreement with the FDA and enroll, what I guess is the second study? And then finally on the Percocet(R) sales in the quarter, a very significant sequential jump, yet you say that the inventory levels are still quite high. Can you just tell us what you saw out there? Was there, at some accounts, inventory rebuild?

Sure. As far as the tax-sharing payment I'll let David answer the oxymorphone question and then come back to Percocet(R). But the tax-sharing payment, the payment we made in the third quarter, related to options that were exercised and diluted or reduced the number of shares held by Endo Pharma LLC during 2001 and 2002, and 50% of the payment that was due from 2003.

Okay.

The payment that will be made in the fourth quarter is the other 50% of 2003 option exercises, which the tax benefit that the company was able to utilize and reduce its own taxes will be paid to the Endo Pharma LLC, and that's $5.2m in the fourth quarter. Based on the sale, the 11m shares as we talked about, that triggered the liquidity event because about 4 million-ish options were exercised as part of that $11m share sale. That triggered a tax benefit of approximately $22m.

Okay.

We have to pay 50% of that, assuming we use the tax benefits. In 2004, 50% of that would be paid within 30 business days of the filing of our 10-K and the other 50% is paid to Endo Pharma LLC within 30 business days of the filing of our tax return, which we expect to be in September of 2005. So the $22m, if we use it for our tax benefit -- or for reducing our 2004 tax payments, $11m of it will be paid, call it March/April timeframe, the other $11m will be paid somewhere in the sort of October timeframe.

So even though the tax benefit is -- you pay 100% of the tax benefit back to Endo Pharma, LLC.

To the extent the company has been able to use it to reduce its taxes, yes.

Okay, and why wouldn't that -- I guess this is a consolidation issue -- I was going to ask why wouldn't that payment that was made in Q3 run through the P&L?

It's viewed as sort of a distribution to a shareholder.

Okay.

When the stock options were exercised or, I'm sorry, when the stock option vested, it created equity for the company paid in capital. So the accounting is you debit compensation expense, and you credit equity paid in capital. What this does is then reduce the amount of contributed capital by the vesting of those options upon the exercise in the payment as a reduction of equity.

Okay.

With respect to oxymorphone, yeah, I wouldn't like to predict when the FDA is going to finally sign off on this. We obviously anticipate it will be very soon because we have reached agreement on the study design, and it is just a final masses relating to the analysis. So I can only say that I hope it will be very soon, but in the end, of course, that is for the FDA to decide. We are, of course, ready to begin patient enrollment when we have final agreement with the FDA.

That having been said, I'd just like to reiterate that on the second study in opioid-experienced patients, which will be done with the identical protocol and the identical rules, patients' enrollment has already been initiated.

Okay.

And then just getting back to your Percocet(R) question. By the end of the second quarter, the June 30th quarter, we got to a position where we had about three to four weeks' too much inventory. Historically with Percocet(R) our customers have carried, call it five-ish, weeks of inventory on hand for that product. With the generic erosion of the product, what was a normal level of inventory quickly becomes more than a normal level of inventory as more of the product is being dispensed as a generic and less to the brand.

We made progress in the second quarter and got it down to about four weeks more than what we had -- about four weeks more than what we normally would expect there to be. The amount of IMS demand during the quarter of about $28m exceeded what we shipped this quarter of about $26m. By contrast, in the second quarter what we shipped was about $13m, and the IMS demand exceeded that and was about $30m. So we were able to bring it down pretty substantially in the second quarter. Made $2m of progress, so to speak, in the quarter but still have about three to four weeks extra inventory on hand by the end of September.

Okay, thank you very much.

Sure.

Your next question comes from Andrew Swanson of Citigroup.

Thanks very much. I just wanted to follow up on the inventory levels that you're holding. You mentioned the impact of generic oxycodone and you touched on Lidoderm(R) as well. I was hoping we could get a further breakdown on what products make up that inventory and if that inventory includes any products that haven't yet been disclosed?

The reason for the increase is entirely the two products we mentioned. Both Lidoderm(R) and the $4.5m of generic OxyContin are more than 100% of the increase. They are more than the increase that occurred. The remaining products, finished goods raw materials, actually decreased a little bit for the quarter. But Lidoderm(R) and the generic OxyContin make up the entire increase in our inventory balance.

Thank you very much.

Your next question comes from Corey Davis of JP Morgan.

Thanks. Jeff have you been surprised that Teva's erosion of the 80mg oxycondone has flat-lined at around 40% for the past couple of months -- and that's just the erosion of that 80mg brand as well. Do you think that's the way we should model the 10, 20 and the 40, assuming that you win the appeal and launch?

"I don't know" is the real answer, but what we do suspect potentially is that, given probably the level of discounting to the brand and the amount of money that a pharmacist is making on the generic of the 80mg, it probably hasn't financially motivated enough pharmacists to carry both a brand expensive bottle of 80mg and a relatively expensive bottle of the generic, as well, on their shelf. So if, you know, the 80mg is not that frequently used, it's a lot of the dollars, but it's only about 13% of the prescriptions. So if people don't come in as frequently for the 80mg, so it's very expensive to carry both a brand and a generic for the amount of visits they get from patients taking the 80mg.

In contrast we believe the 10, 20 and 40, which comprise 63% of 2003 dollars, but 87% of the prescriptions are certainly more frequently used, and that could favorably impact us versus what Teva has been able to garner. On the flip side, Teva probably is enjoying a very high profit margin given probably not a high discount to the brand and the exclusivity that they've been able to enjoy.

It shouldn't be a problem for you to get whatever kind of quota you think you'd need from the DEA to say, if you thought you could erode 70% in six months. The DEA stuff wouldn't be limiting.

The DEA stuff is not limiting to us. As everybody who follows us knows, we've built a lot of OxyContin inventory over the years with no sales to show for it. So we do not have a problem with quota.

And did you say that in terms of Frova(R) that the proportion of the quarter that both the revenues and the expenses hit was about two months?

We closed, now, for DepoDur(TM) the hospital sales force was on board for about two months, we've hired them substantially August 1st. For Frova(R) we closed it in mid-August so we had about a month-and-a-half of sales and expenses related to that.

But you think even in Q4 there's enough excess inventory that it still shouldn't be normalized in terms of your Frova(R) sales booked in Q4?

Yeah, we don't know yet what normal is for this product, what a comfortable level of inventory carry is for products that aren't used as much. Sometimes customers will carry a higher level of those inventory levels versus ones that turn and turn and turn and turn, that they're able to carry lower levels of inventory. So just about two-and-a-half months of inventory out there now is high relative to most of our products that we carry. But, for all we know, that could be what normal is. So we expect the two-and-a-half months to decline over the course of the fourth quarter, but we don't know what normal is yet.

And lastly, just with respect to your new full-year guidance, because if I calculated things correctly, you effectively just raised your guidance by the amount that you beat in this quarter, and that's looking like Q4 revenue would be around $142m, which would be down sequentially $18m from this quarter. And I guess what I'm asking is kind of given the fact that you have beat so many quarters in a row, is that being conservative or is there a reason you would expect a dramatic sequential drop in revenue?

The reasons for the potential sequential drop are we expect continued pressure from morphine sulfate and Endocet(R) on the generic side from Mallinkrodt and others as both on a price and a share basis. Our expectation that we just talked about on Frova(R), that we expect there to be potentially an inventory adjustment out there based on how much inventory was out there prior to us acquiring the product.

We also expect Percocet(R) to inventory out at our customer level to decline as well in the fourth quarter. It did not in the third quarter. The demand for Lidoderm(R), you know, is about $100m run rate. The quarterly demand, based on that IMS, was about $28m, but we expect to bring that down a few weeks during the fourth quarter. If that doesn't happen, obviously, there's a potential we could be higher than our guidance. But we expect some correction, so to speak, in inventory.

Okay, great. And Carol, by the way, you were very good on CNBC this morning.

Oh, thank you very much.

Your next question comes from Michael Tong of Wachovia Securities.

Hi, thanks. Good morning. Jeff, I remember in prior conference calls you've mentioned that '04 R&D is going to be slightly higher than '03. Given that three quarters have passed, do you still stand by that statement? Secondly, can you remind us of the prior generic OxyContin inventory that you have built up, how much of that is still saleable and how much of that has already expired? Thanks.

Sure. As far as the inventory question, including the $4.5m we built in the second quarter, we have sufficient launch quantities at this time, you know, without getting into the numbers. Certainly, if we do end up launching it and essentially have free cost of goods because the stuff is fully reserved, we would disclose the amount of the free cost of goods in that quarter that we are launching the goods that have no cost to them.

And there is no expiration, a timing of expiration issues with the built-up inventory, other than the $4.5m that you billed in Q2 and did you make more in Q3?

We did not make more in Q3. We have had some expire on us certainly and have thrown away a fair amount of that inventory. But again, we have -- all that stuff was fully reserved prior to the $4.5m we built in the second quarter so no impact on this year. And, again, we have sufficient quantities to be able to launch the product.

Okay, and on the R&D side?

Sure. We expect R&D to be slightly up over where it was for 2003, that's still our expectation.

On a full-year basis.

On a full-year basis.

Great, thank you.

Your next question comes from Richard Watson of William Blair and Company.

Good morning and thanks. Just a question on DepoDur(TM) now that you've got a few reps out there in the hospitals, can you give us a little color on what they're seeing in the field and what are some of the positives and negatives based on the reception you're getting from your target audience at this point in time?

Sure, and probably preface this completely that it's all anecdotal and until you start fully detailing the drug and seeing the prescriptions, this anecdotal stuff may or may not make sense, but I think the doctors that we're seeing and the thought leaders -- there is some excitement for the product. I think people do recognize that the 48 hours of consistent pain relief of the product from a patient-benefit standpoint versus some of the peeks and valleys you experience with the PCA pump post-surgically, is certainly seen as a very positive sign within anesthesiology and pain-management communities. So we're encouraged by what we have seen anecdotally.

Obviously, the negatives are always going to be we're trying to get on hospital formulary and, to a certain extent, compete with generic morphine and generic Fentanyl. However, what the story we're trying to tell is not only is there better patient pain relief and satisfaction from having consistent 48 hours of pain relief post-surgically, but also there are some pharmacoeconomic benefits to this. So you can't really compare DepoDur(TM) cost versus generic morphine cost. There is the cost of the PCA pumps, the nursing time, things of that nature, that also need to be added into the equation.

So now that we have set price and are beginning to roll that out, we'll probably get some more information on the acceptance of the price, but we believe we've set an appropriate price for what is a superior product in today's marketplace and very cost competitive.

Okay, thanks a lot, that's very helpful.

You have a follow up question from David Buck of Buckingham Research.

Yes, as I look at Lidoderm(R) - thanks for the detail on the prescription side versus the unit dispense. Can you talk a little bit about why you think the prescription sides have gone up? What's changed in the use of Lidoderm(R), if anything? And, Carol, could I just confirm that the 70 reps are about a 33% increase in your sales force for next year will also be dedicated towards Lidoderm(R) -- so basically Frova(R) and Lidoderm(R) for next year?

Yeah, absolutely. The increase in that sales force for specialty in the community will be dedicated towards Frova(R) and the Lidoderm(R). And relative to the increase in the overall prescription size, the indication on the product or the usage on the product is up to three patches per 12 hours for the patients. And what we did see in the beginning was it started out, if I recall correctly, it was somewhere around an average of about 26 patches per prescription, and it really was, over time, as patients, I think, and physicians became more familiar with the product that the actual usage and amount of prescriptions started to -- number of patches per prescription started to increase and that really evolved over time. We saw a fairly steady but slow increase to where we are today, and it's probably somewhere in the range of about 44 patches or so per prescription.

Yeah, we were about 37 last year, and we're running at about 39 and change this year.

Okay, and is there any additional data that you're expecting in the first half on Lidoderm(R) that might be triggering usage? Lower back pain or additional studies?

I don't believe there's any data expected to be out early next year.

Okay, so the main driver of Lidoderm(R) growth would likely be extension of the sales force next year?

Just, yeah, continued physician awareness, thought leader advocacy, the medical education that we do, as well as the increased promotion based on number of reps, although they will be promoting both Frova(R) and Lidoderm(R), versus this year the 230 were substantially dedicated to Lidoderm(R).

And the gross margin, as you would, the packaging for Lidoderm(R), the gross margin was a bit higher than we had thought this quarter. Is that now fully in the P&L in terms of the change in packaging for Lidoderm(R)?

Yes, beginning in the second quarter it was fully in the P&L for Lidoderm(R). Obviously, because Lidoderm(R) is "X" percent of sales for the quarter, that may impact the margin itself. But we've been selling the higher cost of goods, Lidoderm(R), since April of this year, and none of the lower-priced stuff has been reflected since then.

If I could just sneak in one more for Carol, I guess, or Jeff. When I look at the other generics beside OxyContin generic and Duragesic for next year, would you expect anything in the pipeline to be launched next year, and where do you stand on additional Percocet(R) strengths?

Yeah, we do get that question a lot. Relative to additional Percocet(R) strengths, because of the situation relative to the fact that what we do there is not patent-protected or currently has not been patent-protected, we really do not disclose what we're working on or when we would anticipate launch of any new lifecycle projects relative to Percocet(R). And certainly we are looking forward to the OxyContin and to the Duragesic. But in a like fashion, too, we have not made any public pronouncements relative to what we are working on in our generic portfolio. So we have not made any disclosure around that, David.

Okay, is it fair to say you have some things other than those disclosed?

I just would add that we continue to believe that generics are an important part of the business. We believe in having lower cost alternatives available and will continue to support the generic portfolio, however, in a very selective fashion. We do look to have products that we believe we are going to be able to bring to market that are difficult to develop or are difficult to manufacture, and where we have more limited competition. So with all of that in mind, that's essentially where we are, vis-à-vis generics.

Okay, great. Thanks.

Okay, thanks.

You have a follow up from Angela Larson of Unterberg Towbin.

Great, thank you for taking the follow-up. Two questions, one is just when should we expect to receive 2005 guidance? And the second is, given the significant size of the surprise this quarter, if you could expand a little bit on your philosophy on how you set earnings guidance, and did you have surprises that actually occurred during the quarter that led to this upside, or do you give guidance where you feel you have given yourself room for significant surprise?

Sure. As far as the timing of the 2005 guidance, we'd expect to give 2005 guidance by the end of 2004, consistent of how we've done it in the past. As far as philosophy, we do our best test to make what we think the impact could be potentially from competition of certain products, with growth of certain products; what our expectations are, obviously, about selling in our development pipeline as well. During this quarter, I think, somewhat surprising was the impact, although we felt it with the generic MS Contin and the Endocet(R) products. We have, and we felt that mostly on price, we have been able to retain a larger share of, especially Endocet(R), than we probably expected coming into this quarter.

So I think that did contribute to the quarter because although pricing has declined, we have retained a bigger share than we expected. That's probably the biggest surprise I can think of.

That's great, thank you.

We have a follow up from David Windley of Jefferies and Company.

Thank you very much. On DepoDur(TM), I was wondering if you could maybe detail the specific to-do list items that you would have between now and when you would feel comfortable shipping first product.

The product is really planned for shipment towards the end of the year, and our partner, SkyePharma, has been in the process of doing the validation batches and preparing the launch quantities so that we have sufficient quantity to go out. And during this timeframe we're really using this as an opportunity to really get into the institutions, really being able to work with the pharmacists and to the anesthesiologists on an advocacy basis. And we want to make certain that when this product is first used that there's really good understanding as to how to use it so the appropriate dosages are being used so that the anesthesiologists and, more importantly, the patients are having the type of experience that one would expect from the product. So essentially we'll be ready at year-end for the commercialization of the product and, really, in the meantime, doing the advocacy.

Yeah, I guess I can add onto that that we are doing some Phase IV studies with the product in order to help physicians be able to understand the appropriate use of the product that we expect some time early next year. So there is ongoing efforts, as Carol mentioned, not only in the advocacy building and getting acceptance on formulary, but there's also some additional studies that we expect to be able to roll out pretty close to the product launch, which will help the anesthesiologist understand how to use the product.

Okay, great. So I understand that you wanted to do a very intensive education campaign. Is it fair, then, to say that the rate-limiting step is the commercial manufacturing quantities?

No, I don't think so.

Oh, okay. Okay, moving on then. Is there any color that you can provide around timing of an FDA response on generic Fentanyl patch?

Just that we hope to have it certainly in time for the launch of the product. But there is no -- as you're aware -- there's no PDUFA date on the generics, but we continue to work and communicate [inaudible] with the FDA. So we basically just have to wait and see.

Okay, and then as a final, have you taken or do you plan to take, in the near future, a Lidoderm(R) price increase?

We took a price increase March 1st of this year. We don't disclose when we anticipate taking price increases, we try to stagger them so as speculative buying doesn't occur. So there's no consistency to when we take price increases on purpose. But I think there still potentially can be price increases on the product at some point in the future.

All right. Okay, so, Jeff, March 1st was the last one that you had taken?

That's correct.

Okay, great. Thank you.

We have a follow-up from Ian Sanderson of SG Cowen.

This is just a quick question on your hospital sales force. Seventy reps is a fairly sizable hospital sales force. Do you have general plans to leverage this with additional products at some point?

Certainly. We are very active in corporate development, business development, both in the acquisition and licensing strategy. We have historically been substantially in pain management. We've now expanded somewhat into neurology and with DepoDur(TM) somewhat peri-operative care. We certainly expect to continue to look at that area to fill the bag of the hospital sales force with additional products, potentially also including Propofol, which advanced into phase three clinical development earlier this year with SkyePharma. So we're not waiting for that product necessarily to fill the bag. We're looking actively to try to buy additional products to help the hospital sales force have more products to sell.

Might that happen before you add the 45 reps?

I don't think we can ever predict the timing or certainty of any sort of license or acquisition. So we're going ahead with the 45 reps solely for DepoDur(TM). Hopefully, we'll have another product in there at some point but whether that's before we hire the 45 or after, I can't really say.

We have a follow-up question from Michael Tong of Wachovia Securities.

Hi, thanks. Just a quick follow-up, actually, on the generic portfolio. Can you confirm whether you have pending ANDA's on file at FDA other than perhaps some dosage strength modification of Percocet(R) and Duragesic if you count that one?

We don't talk about how many ANDA's we have or how much potential dollars and brand dollars they have on file with the FDA. Probably in part because it wouldn't be an impressive number because we are very specialized in our generic focus, and we try to do niche products that we believe will have limited competition and high profitability to us. But also it's more we're very selective in what we do but don't disclose the timing or where they might fit the FDA review.

Okay, thanks. Thought I'd try.

Good try.

At this time our time for questions has run out. Would you like to make any closing remarks?

Sure. I would just like to thank everybody for joining us on the call today. We were pleased to be able to talk about the strong quota that we did have and the opportunities we see out in front for us in 2005. So thanks very much. Take care. Bye.

Thank you for participating in today's conference call. This now concludes today's Endo Pharmaceutical conference call. You may now disconnect.