Endo International PLC (ENDP) 2005 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Endo Pharmaceuticals report second quarter 2005 results conference call. (OPERATOR INSTRUCTIONS) Thank you. I will now turn the call over to Mr. Bill Newbould, Vice President of Corporate Communications. Sir, you may begin your conference.

Thank you. Good morning, and welcome to the Endo Pharmaceuticals 2005 second quarter teleconference. This call is being recorded. With us on the call this morning are Peter Lankau, President and Chief Executive Officer; David Lee, Chief Scientific Officer;and Jeff Black, Chief Financial Officer.

Before we begin, I would like to remind you that during the course of this call, 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 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 effect 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 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, Peter, David, or Jeff may refer to non-GAAP financial measures such as consolidated EBITDA, adjusted net income, adjusted diluted earnings per share, or similar terms. These non-GAAP financial measures are not prepared in accordance with accounting principles generally accepted 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 its earnings announcements 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 President and Chief Executive Officer, Peter Lankau.

Thanks, Bill, and good morning, everyone, and thank you for joining us on our call this morning. As Bill mentioned earlier today, we released our financial results for the second quarter and the first half of 2005, and I'm pleased to report that we had a strong quarter. Net sales for the second quarter increased 36% to $196.4 million compared to $144 million in the second quarter of 2004. Net income rose 56% to $49 million compared with $31.5 million in the year ago second quarter.

As detailed in the supplemental financial information in the press release today, adjusted net income for the three months ended June 30, 2005, was $49 million compared with $37.8 million in the same period of 2004. Diluted earnings per share for the three months ended June 30, 2005, were $0.37 compared with $0.24 in 2004. Adjusted diluted earnings per share for the three months ended June 30, 2005, were $0.37 compared with $0.28 in the same period of 2004.

The primary factors behind the strong quarterly performance were as follows. The continued growth of Lidoderm sales, which were 100 million -- $100.5 million. Market demand remains strong for Lidoderm, our topical analgesic patch indicated for the treatment of pain associated with post-herpetic neuralgia. We believe we are on track to achieve our previously stated guidance of 390 to $400 million in net sales for this product for 2005.

The second major factor behind our strong quarter was the successful introduction of all four strengths of our generic OxyContin, which we launched on June 7, the same day we received a favorable Appellate Court decision in our patent litigation with the Purdue Frederick Company. We are pleased by our sales performance on this product to this date, which is in the early stages of the six months of marketing semi exclusivity for the 10, 20 and 40 milligram strengths. Our launch of this product followed the unanimous affirmeds by the U.S. Court of Appeals for the federal district -- for the federal circuit of the decision issued in our favor by the U.S. District Court of the southern district of New York on January 5, 2005 -- 2004. Excuse me. On June 21, 2005, Purdue filed a petition with the federal circuit seeking rehearing of the case by the federal circuit panel that issued the June 7, 2005 decision, or alternatively, by the entire court. Today the federal circuit has not acted on Purdue's petition nor requested briefing from the Company.

Primarily due to the additional revenues that we expect from our generic OxyContin, we are revising our guidance and currently expect net sales in 2005 to be approximately 800 to $825 million, up from our previous guidance of 650 to $660 million in net sales. We estimate adjusted earnings per share for 2005 to be approximately $1.68 to $1.73, up from our previous guidance of $1.13 to $1.15, which excludes estimated up front payments to partners. Of course there can be no assurances of Endo achieving these results. Our guidance does not reflect the impact of stock compensation charges, nor does it reflect the launch of our generic transdermal fentanyl patch, which is currently awaiting FDA approval.

We continue to be excited and encouraged about our prospects for continued success in 2005 and beyond. With the growth that we expect from Lidoderm, combined with the ongoing launches of Frova and DepoDur and the depth of our development pipeline, which includes two new patches we end licensed in March of this year, we believe we have positioned ourselves well for the future. Now, I'd like to turn the call over to Jeff Black, who will discuss our second quarter and six-month financial results in detail.

Thanks, Peter. As noted earlier, Endo's net sales for the second quarter of 2005 were $196.4 million compared with $144 million in the second quarter of 2004. For the first half of 2005, net sales were $334.1 million compared with 297.5 million in the same period of 2004. Net sales of Lidoderm were $105 million versus $58.2 million for the second quarter of 2004. The increase is a result of the continued growth of the product as well as our customers reducing their Lidoderm inventory during the second quarter of 2004.

Prescription growth for Lidoderm was up 40% and dispense unit growth was up 43% in the second quarter of 2005 versus the comparable 2004 period. We estimate that prescription demand for Lidoderm in the second quarter 2005 was approximately $105 million. For the first half of 2005, net sales of Lidoderm were $164.6 million compared with $123.6 million in the same period a year ago. Prescription growth for Lidoderm was up 41% and dispense unit growth was up 44% for the first half of 2005 from the comparable 2004 period. Based on IMS data, the run rate on Lidoderm sales now is approximately $440 million. Given the continued strength of the underlying prescription demand for Lidoderm, we continue to estimate that net sales of Lidoderm will be approximately 390 million to $400 million in 2005.

Net sales of Percocet were 24.8 million for the three months ended June 30, 2005, versus $13.6 million in the same period in 2004. This comparison primarily reflects the reduction in inventory carried by our customers during the second quarter of 2004. We estimate that prescription demand for Percocet in the second quarter 2005 was approximately $25 million. The current run rate on Percocet sales is approximately $100 million. Net sales of Percocet were 52.2 million for the first half of 2005 compared with 44.4 million in the same period in 2004.

Net sales of Frova were $8.7 million and $14.8 million for the three months and six months ended June 30, 2005, respectively. As previously announced, during the first quarter of 2005, we increased the size of our sales forces and realigned our sales representatives and their management to maximize the product opportunities for both Lidoderm and Frova. Although growth has been slow in this crowded market, we believe that the message regarding the unique characteristics of Frova, as well as our focused efforts have begun to resonate with our targeted physicians.

Net sales of DepoDur were $2.3 million for the three and six months ended June 30, 2005. Endo began shipping DepoDur in December 2004 and began the full commercial launch with its 70 representative hospital sales force earlier this year. DepoDur is intended to provide consistent pain management over the 48 hours after major surgery. We believe DepoDur has the ability to change the paradigm of pain management and the postoperative setting. We are encouraged by the usage of DepoDur that we have seen to date.

On June 7, 2005, we began commercial sale of all four strengths of our extended release Oxycodone, the generic equivalent of OxyContin. Net sales of our extended release Oxycodone were $29.2 million for the second quarter of 2005, representing the initial trade load of this generic product. Net sales from our other generic products decreased to $28.4 million in the second quarter 2005 from $69 million in 2004. For the first half of 2005, net sales of the Company's other generic products decreased to $65.6 million from $122 million in the first half of 2004. These decreases in other generic products are due to increased generic competition with both Endocet and the Company's morphine sulfate extended release tablets.

Gross profit for the second quarter 2005 was $154.1 million versus $115.1 million in the second -- in the year ago second quarter and was $262.3 million for the first half of 2005 compared with $235.7 million in the same period a year ago. Gross profit margins declined to 78.5% for the quarter and six months in 2005 versus 79.9% and 79.2% in the respective periods of 2004 due to the introduction of more costly, single pouch, child resistant packaging for Lidoderm during the second quarter of 2004 and continued competition and pricing pressure on our generic Endocet and morphine sulfate extended release products.

Selling, general and administrative expenses for the second quarter 2005 were $56.1 million versus $43 million in the same period of 2004. For the six months, SG&A expenses were $109.7 million in 2005 and $81.8 million in 2004. The quarter and year to date increases in 2005 are primarily due to the expansion of our sales force in the early -- in early 2005, along with additional investment in marketing and promotional support for our new product launches. Research and development expenses for the quarter were $17.2 million versus 19.2 million in the same period of 2004. During the second quarter of 2004, we made milestone payments to our partners of approximately $10 million, excluding milestones, research and development expenses were nearly doubled the amount in 2004. We expect to continue our investment in our R&D pipeline to continue our success in the future.

Research and development for the first six months of 2005 totaled $48 million versus $29 million for the first half of 2004. The year to date increase in R&D spending is in part due to the up front fee of $10 million we paid for the exclusive license to develop and commercialize the sufentanyl transdermal patch and the $10 million up front payment we made to develop and commercialize the once-daily Ketoprofen topical patch.

Diluted earnings per share for the second quarter of 2005 were $0.37 versus $0.24 in the comparable 2004 period. As detailed in the supplemental financial information in today's press release, adjusted diluted earnings per share for the second quarter of 2005 were $0.37 compared with $0.28. Adjusted to reflect milestone payments to partners net of tax for the second quarter of 2004. Diluted earnings per share for the six months ended June 30, 2005, were $0.47 compared with $0.55 in the first half of 2004. As detailed in the supplemental financial information in today's press release adjusted EPS for the first half of -- first half was $0.57 per diluted share in 2005 compared with $0.61 per diluted share in the first half of 2004.

The increase in our accounts receivable, which are recorded on a gross basis, compared to net sales, which are recorded net of chargebacks, rebates and similar deductions, is substantially attributable to the timing of purchases by our customers during the quarter. We had significant sales in the month of June 2005 as compared to the month of December 2004. Our days sales outstanding on a gross receivables to gross sales basis was approximately 48 days at June 30, 2005 and December 31, 2004. We expect our day sales outstanding to increase in the near term due to a more significant portion of our sales coming from our generic products in the near term because of our launch of our extended release Oxycodone product. Our generics have payment terms of 60 days compared to the payment terms on our brands of 30 days.

During the second quarter of 2005, we began to manufacture additional batches of our generic extended release Oxycodone product in anticipation of launch. In addition subsequent to the favorable June 7, decision we built additional inventory to supply market demand. In prior years we had built inventory of this product and fully reserved that inventory due to the uncertainty regarding the timing or outcome of the patent challenge. All of the fully reserved inventory has been destroyed due to expiration of its shelf life.

Net cash used in financing activities increased primarily due to the approximately $21 million tax sharing payment the Company made to Endo Pharma LLC pursuant to the tax sharing agreement in the second quarter 2005 related to estimated tax deductions that the Company used in 2004. Our cash and cash equivalents were $276 million as of June 30, 2005. We feel our strong financial position with good cash flow and no debt will continue to afford us the ability to pursue further acquisitions and other strategic alliances and licenses, which would, we believe, accelerate our growth as a premier specialty pharmaceutical company. I would now like to turn the call over to Peter for some additional comments.

Thanks, Jeff. And before we take your questions, I'd like to share with you some of the key milestones that are upcoming and some significant events for Endo. We are encouraged by the progress that has been made with the ongoing launches of Frova, DepoDur, and our generic Oxycodone extended release product. We eagerly await FDA approval so we can launch generic Duragesic. We expect to complete the Phase III clinical program for Oxymorphone extended release and immediate release tablets. We continue to believe that we are on track to file a complete response in early 2006 to the FDA's approvable letters for this important product. And finally, we look forward to the continued advancement of our development pipeline and to pursuing additional opportunities to expand our substantial pain franchise into complementary therapeutic categories. Now, we would be happy to take your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Ian Sanderson from SG Cowen.

Good morning. Thanks for taking the call and congratulations on a great quarter.

Good morning, Ian. Thank you.

First concerns Lidoderm and the -- could you remind us of the price increase in Q1 and whether that has held through the middle of the year. And secondly, how many inventory management agreements have been signed at this point and do you expect others to be signed soon and maybe with that, give your view on what the trade inventory levels of your major products looked like at June 30.

Sure. We took a 7.5% price increase on Lidoderm effective January 1, of 2005. We have not taken another price increase on Lidoderm this year. As you may recall from prior calls, we -- about a third of the business of Lidoderm is in Medicaid. In addition, there are obviously some managed care agreements that have taken place and as we had announced, we have entered into one inventory management agreement in the fourth quarter of 2004, which also has a discount to the invoice price, so we don't get to see the full results of the 7.5% price increase we took. We still have only entered into the one inventory management agreement. Our expectations for the year is that we may enter into other ones with primarily the two other large wholesale customers as well as maybe some of the other customers as well. So our expectation is that this is the way of the future, entering into these inventory management agreements and our expectation is we will enter into others over the course of this year.

Then in terms of the trade inventory levels for the major product at the end of the quarter?

Yes, they are substantially where they were at the end of the first quarter. Our sales for Percocet, Frova, Lidoderm all substantially were in line with what the underlying IMS demand would dictate. We were at a few weeks for Lidoderm and Frova at the end of the first quarter and we remain there at the end of the second quarter. Percocet's a little bit more than that, but pretty much in line with where it has been.

Okay. Thank you very much.

Thank you.

Your next question comes from Dave Windley from Jefferies & Company.

Hi, thanks. Congrats on the quarter from me as well. Couple of clarifications to start. Jeff, just to make sure, the OxyContin sales in the quarter did not include any of the formerly written off inventory built, such that there was no, say, 100% margin OxyContin sales in the quarter.

That's correct.

Okay, and secondly, did I understand correctly that on the AR front, obviously that grew a lot and you said you actually expect DSOs to grow in the near term, say, third -- and I guess define the near term for me.

We do expect DSOs to grow. Our branded terms are 30 days. The generic terms are payment within 60 days. Our historic DSO has been somewhere around 50 days. We were able to get that to 48 days as of December 31, 2004, and it remains at 48 days as of June 30, 2005. We do expect because of the significant increase in the ratio of branded to generic products with the introduction of the generic of OxyContin that -- and obviously that's going to be -- generics will be a larger component of our sales that, we would expect DSO to increase as well from where we are today at 48 days.

Okay, so maybe a slightly different way to ask is in the move from 1Q to 2Q, the growth in AR was, what, maybe triple the sales recorded for OxyContin. What are the factors that caused the, say the non-OxyContin sales portion of AR to go up?

Yes, just -- from a clarification standpoint, though, our accounts receivable are gross, so they are not net of chargebacks, rebates, and other discounts, which on the generic side of the business are fairly substantial, and with hospital-based products they are fairly substantial as well, so it's tough to look at our net sales versus our gross receivables and reasonably calculate a DSO, which is why we tried to disclose that to the market based on a gross to gross, apples to apples comparison.

The other products, there haven't been significant discounts going on in any of the generics, the pricing has held up this year pretty well, or at least for the second quarter pretty well for the other major generics and the brands don't have substantial discounts. A lot of it is just the timing of when our customers purchase inventory as you're well aware, the IMS demand prescriptions and units is a very reasonably consistent measure of how the world's going, but since there is a middle man between, or several middle men between us and ultimately the prescription being dispensed there are fluctuations in wholesalers inventories that occur on a monthly basis, as well as quarter over quarter and that really is what drives it. So if more of product X is purchased in June than it was in March, then that's going to impact what our fluctuation in accounts receivable is on it over that period.

Okay, and then a last clarification, you talked briefly about R&D expense and continuing to invest there. Is the 17 million and change number in the second quarter then to be interpreted as a sustainable level, or was that a little bit high?

Our guidance for the year has been and continues to be that we expect to spend more in R&D excluding milestones than we did in 2004. We don't, as you know, give quarterly guidance or can't really comment as to whether that's reflective. I will say that we're pretty significantly into the Oxymorphone extended release studies and that, we expect to be concluded over the course of this year with us being in a position to file the complete response in early 2006. As you know, we also are advancing Rapinyl, which we expect to be in Phase III this year and we did add two new products, the topical ketoprofen patch and the transdermal patch in March of this year, so, you know, and lowered our guidance as a result that have because of the R&D spending that was expected.

Okay, and Peter, one last question for you. The Frova trends seem to be a little sluggish and I wonder if you could possibly provide some color into some of the, maybe some of the micro trends below the consolidated script numbers that might be factors that are encouraging you as to the uptake of that message to the specialty market? Thanks.

Sure, Dave. As we had mentioned on our previous conference call, we are really trying to take advantage of the patience that are more intractable and therefore find themselves in the neurology practice. We've seen a certain growth in the neurology uptake of Frova over the last eight weeks or so. We're starting to get very encouraged actually that we are not only gaining share and gaining volume within the neurology community, but that's starting to actually turn into the primary care. So as we have indicated over the course of previous calls for the success of this product, it is being -- in a very competitive market, but one which with a different type of marketing approach for those patients, particularly menstrually associated, menstrually-related migraines, we believe that Frova has the clinical characteristics that make it an ideal product and we're starting to see that begin to translate with new prescriptions in the neurology specialty practice. So I think over the course of the remainder of this year, we continue to be very optimistic.

Okay. Thank you.

Your next question comes from David Buck from the Buckingham Research Institute.

Yes, good morning. Thanks for taking the question. First, a follow-on for Jeff on the cash flow. Thanks for some of the explanation there. You talked a little bit about the inventories being built going forward. Can you give us a sense of where you would expect cash flow from operations to trend in the next couple of quarters? You did burn a significant amount of cash this current quarter, as you did year ago, but can you give us some trends, where the debt line item goes and then I've got a couple of R&D questions.

Sure. Similar to last year, as you can see from the press release, cash flow from operating activities in the first six months has not been significant as to where it ends up for the full year. A lot of that is based on obviously, a lot of that is sitting in accounts receivable and/or inventory. We obviously expect to get paid. The accounts receivable numbers over the course of this year, so we expect the trend to increase as it has similarly in the past years and obviously with us raising our guidance on both the revenue and in earnings per share earlier today, we would expect there to be an increase in cash flow from operating activities for the course of this year.

And turning to a quick question on DepoDur for Peter and perhaps the R&D questions are for you as well, but can you give us some sense of what success stories you've had, what issues you've had with DepoDur over the last six months and whether the sales number we saw this quarter is reflective of actual end demand at this point or whether there is still some deferred revenues and what, if any, R&D programs need to be done in DepoDur to get actual use of that product? And then finally, just some commentary about the pain market after the Duragesic warning last week and what that does to your R&D programs there. Thanks.

Sure. On the DepoDur, we have clearly, as we've indicated in the past, been building momentum with regards to getting the product reviewed before the individual hospital formulary committees, as we've mentioned in the past this is a brick by brick approach. We have had quite a bit of success rate in those formularies that have reviewed the product. We are very encouraged by the process whereby the product is get ago approved and then beginning to be used in these major surgeries over a period of time as more and more anesthesiologists become familiar with the product. There is a significant educational component to this because it is a change in the paradigm for how postoperative pain is treated, a single shot versus a postoperative patient controlled analgesia. That educational process, when it's been put in place has resulted in significant increases in utilization in an individual hospital basis. So we're actually quite encouraged, particularly over the last month or two, about how the product sales have begun to be trended, relating to the withdrawals of inventory out of the wholesaler environment and into use in the institution.

With regards to the programs that we're looking at, we've got a couple of studies that we are looking to conclude sometime later this year that will allow us to demonstrate the ability for DepoDur to either eliminate or completely, or reduce the incidence of PCA, patient controlled analgesia, an oral -- DepoDur to oral study. We will use that as a Phase 4 marketing approach to help not only formulary committees adopt the product, but also to help justify the former economic advantages that we believe are there. And we've also got some ongoing studies to measure the use of DepoDur, particularly as it relates to the continuing use of local anesthetics and how to best ensure that the DepoDur's use can be done in a safe and effective manner. I'll let David answer the questions with regards to the pain market effects as it results from the Duragesic news flow the last week or so.

Yes, I, I think we've seen really particularly in the post bio era, that the FDA is increasingly sensitive to potential safety issues, not only with products in development, but also marketed products. I think this is something that we all have to be very aware of and ensure that all the development programs that we conduct have substantial safety databases and in particular, we're in a position to demonstrate the benefits of the product in comparison to the risks that the product may have.

We can't escape from the fact that any product that we're developing is going to have side effects. Everything has side effects if it's going to work, and it's very much important for us to demonstrate an adequate benefit to risk ratio, which is something that all of our development programs are aimed at doing. In addition to that, of course, in relation to any opioid, particularly potent extended release opioids, risk minimization action programs, what used to be known as risk management programs, are now required, are very important, and we have had a lot of experience in putting these programs together and of course in relation to the approval of our generic content we did reach an agreement with the FDA on the content of that risk minimization action plan. So I think we have some good experience going forward.

Just a follow-up, David, can you give us a sense of timing of when we'll see the data from the additional trials in Oxymorphone.

We are still on track to file the complete response to the approvable letter in early 2006, assuming that the results of the clinical trials are positive. If you sort of work back from that, allowing for the fact that it's going to take us some time to compile or recompile the summaries that we need to do in order to file this complete response, we would anticipate having top line results towards the end of this year.

Okay. With study completion at some point before then?

In any circle.

Okay. Thank you.

Your next question comes from Angela Larson from CE Unterberg Towbin.

Good morning, and thank you for taking the question.

Sure, Angela.

The gross margins on generic OxyContin, is it similar to the gross margins you experienced on your other generic products, or could you give us any color?

I guess it probably depends on what stage of the lifecycle. Obviously we're in a competitive market with generic OxyContin as we are with Morphine and Endocet, different stages of their life. It is a very high priced brand, so we are able to enjoy good margins from our generic Oxycodone, even at a discount to the brand, as we do with our other generic products, our strategy is that we want to compete in areas that we think we can compete, where there are few players, there's barriers to entry. We think we've demonstrated we can do that through our MS Contin and now OxyContin generic. So that's the types of areas we want to compete and the margins we've been able to generate historically for our generic products are the ones that we expect to generate in the future for those types of products, so sort of a long-winded answer to say, yes, I guess they are relatively consistent.

Okay, and the gross margins on the new brands, DepoDur and Frova versus Lidoderm. We know that Lidoderm's gross margins sell as you change some of the packaging.

Yes. As far as DepoDur that, margin, we, I guess sort of have disclosed. There is a royalty that is payable to SkyePharma for sales of DepoDur that starts at 20%, and SkyePharma is responsible for the cost of goods of that product. So de facto the margin is ballpark 80% on it. For Frova, we haven't disclosed the specific margin, nor have we disclosed the royalties outside of once the MRM approval occurs, but it is a favorable branded margin product.

Okay. Then if I could go back to the R&D activities and the comparisons to last quarter. Given how many products have come into the pipeline and your continued activity on existing products, are you looking at this quarter as an ongoing run rate?

We haven't given specific guidance as to what we expect. Other than we expect R&D to be up year-over-year from -- excluding milestones in 2005 versus 2004. Every quarter has its own little quirks in terms of where various products are. The Oxymorphone studies are well on their way for the complete response in early 2006. Those types of studies, or at least that advanced level of those two studies may not exist in quarters coming. There's a lot of work being done on some of the newer products we brought initially and some of the earlier stage products may not have that much work to do in the future compared to what they do sort of in the initial transition period. So it's going to vary, unfortunately, quarter by quarter based on where the various projects are in their lifecycle of development.

Okay. Thank you.

Thank you.

Your next question comes from Robert Uhl from FBR.

Thank you, and good morning.

Good morning.

I just wanted to go back to one of David Buck's questions because I may have missed the answer and it's about the deferred sales versus sales in the quarter. So is the 2.3 for DepoDur what you shipped in the quarter, or is some of it still being deferred, or is some of that from a prior period?

It's probably a little of both. It's not necessarily reflective of the underlying demand of the product. The underlying demand of the product, there is unfortunately no IMS prescription data here, but based on chargebacks that have come in to date, and also based on the DVD data, which demonstrates what our wholesale customers are shipping to hospitals, we got into a position saying, yes, I think it's time to book revenue on this product. Some of that is related to product that had been shipped in prior quarters. Some of it relates to what was shipped during the quarter. There is still some deferred revenue out there and we believe we have become -- come into a position where we can now reasonably estimate what the returns are based on our history with this product as well as our history with other hospital-based products. So, yes, there is still some deferred revenue and some of the, some of the sales relate to prior quarters as well as stuff we shipped this quarter.

Okay, and then with generic OxyContin, is there anything deferred there, or is that really what you shipped in the quarter less whatever you are taking for rebates.

There's nothing deferred on that. We think we have a pretty good handle on what returns will be for that product, so there's no deferred revenue for OxyContin generic.

Okay, and then with the FDA's interest in alcohol interaction studies and narcotics, as evidenced by their Palidone and Avinsa (ph) action of late, what are you anticipating that you may have to do with regard to Oxymorphone in terms of maybe perhaps in vivo alcohol extraction studies or even human alcohol interaction studies?

At the moment we're just tracking events as they develop, and clearly if we think it is appropriate we will certainly consider what studies we may need to do. We understand our products already fairly well, but we will watch events as they unfold and we'll see. Of course the key issue here is formulation. Based upon publicly available information that we have been able to determine, the issue with both Palidone and Avinsa would appear to be formulation. Both of them are 24-hour products formulated in a capsule with sort of time release pellets in the capsule whereas our extended release products are solid oral dosage tablets, so we would not, at least at the moment, anticipate a similar situation.

But have you not done any kind of alcohol studies of any kind with your formulation, have you?

That's not something that I would be in a position to comment on at the moment. Again, we just will make sure that in any submissions to the FDA that we provide them with all of the information that will confirm the benefit of the drug in relation to its risks.

Okay. Thank you.

Your next question comes from Scott Henry from Oppenheimer.

Thank you for taking the question. Just -- I was hoping you could give some color on what you're seeing in the OxyContin generic market. Are you guys surprised that you're getting the bulk of the generic penetration so far versus the other competitors out there, and as well, do you expect to continue this kind of majority share? Additionally, are you surprised not to see any other players out there for the 80-milligram strength since your launch, and do you think that is indicative that perhaps the OxyContin generic market could still be relatively sustainable, although at smaller shares, post the six-month exclusivity ending?

Sure, Scott. I think with regards to the OxyContin launch, as you are probably well aware, at the time of launch both Endo and Ivax were in the marketplace on the day of the Appellate Court decision. We had both been very active, I'm sure, in trying to ascertain customer preferences, at the point of launch, within a matter of days both Ivax's product and Endo's product found its way into relative levels of market penetration, and I think what you're seeing in the prescription data today reflects the relative strength that Endo has within the marketplace as a predominant player with C2 opioids.

I think that with regards to the 80-milligram, as far as we are aware, there are no other approved ANDAs that the agency has put forth and therefore the four players that are in the market today, we would anticipate at least for the near term those to be the only four players. It would appear that both Endo and Impax, and Ivax are in the minority of the market share, it seems to retain a fairly significant portion of that milligram strength, but over the course of time, I think that that will start to play itself out.

At the expiration of the six-month period, we certainly would see that those four players that I identified would probably be the four players that will be in the market for all four strengths and therefore while probably its share in price will decline, post that exclusivity period, or semi exclusivity period, we don't see an onrush of new players coming into the market any time soon, at least not from what we can see from the -- both the competitive landscape as well as from any pronouncements from the agency and therefore we expect an ongoing annuity of product revenue to be achieved once the exclusivity period has expired. What that share will be and what that value will be, I think is to be determined at the time that all four players come into the market.

Thank you.

Your next question comes from Kim -- I'm sorry. Ken Trbovich.

Question on the call. I was wondering if you could follow up on the comment regarding the expiration of the exclusivity period. Based on your historic experience regarding increased competition in a generic market, do you expect that the existing brands that you have today in the form of DepoDur, Frova, Percocet, and Lidoderm will be able to grow sufficiently to offset any market share losses that we'll see on the Percocet franchise so that we can expect '06 to be a flat or growing year or are you dependent on a launch either of a new version of Percocet or Oxymorphone to really provide that growth?

We haven't really given guidance yet for 2006. Certainly when there is more competition post the six-month exclusivity period, we would expect, as Peter mentioned, market share and price to come down, although with four players, we expect that to not be too dramatic and expect there to still for all four players be a reasonable revenue and earnings stream available in the marketplace, so certainly we would expect some decline, although we'll have 12 months of being out there versus six months and change in 2004.

As far as the other products, Percocet is -- has been relatively flat this year and the last few quarters, the run rate has sort of been about $100 million, for the last few quarters, although we did experience a lot of the generic erosion during the course of 2004, it sort of, it's a slowish climb at this point in its life and with price increases we're able to keep it somewhat steady. The other generic products, we don't expect a whole lot more players coming into the marketplace that would change that dynamic of the narcotic area, it's not a very crowded marketplace, which is why we compete there. We expect Lidoderm to continue to grow. Lidoderm is our biggest product. The run rate, as we mentioned on the call is $440 million based on the June data, to achieve our number of 390 to $400 million, we need to have an exit run rate of somewhere around $475 million. We wouldn't expect it to go flat at that point, so there will still be some growth in it here in the future, whether -- and that's all within the existing label and promoting it for the existing label without potentially expanding the label in the future.

We expect Frova and DepoDur to both grow. We didn't buy -- we don't buy products and we don't launch products for just sort of flat, steady state cash flow. We buy products because we expect them to grow. Frova, within its existing indication, as well as potentially the MRM indication and DepoDur has just started and has made a lot of progress in the recent weeks. So without giving guidance for '06, we still think there's a lot of opportunity on the branded side of the business for growth of our existing products.

Sure, and I guess the question really simply was whether or not that's going to be sufficient to offset the market share erosions that you guys have experienced in the past on generic brands? Entering this year, that was part of the question and I think it's obviously the question that everybody's looking forward to to figure out. Within that, could you respond as to whether or not you expect the FDA to require restrictive marketing for Oxymorphone as they did with Palidone?

It's always very hard to predict what the FDA's going to do. We are still working very much on the principles of the labels that we'll get and our promotional platform will be reflective of the clinical trials program that we've carried out. Ever since we began the development of this product amid -- it has always been our policy to do an extensive broad-based development program to show the potential of the product in all sorts of chronic pain types, including cancer pain, lung cancer pain, osteoarthritis, low back pain, and so on. And of the clinical trials that we've done, including the trials that we are running at the moment and that will be a part of our complete response, are all very much part of that policy. We have opioid experience patients. We have opioid naive patients and our anticipation is that we will demonstrate efficacy in a satisfactory risk benefit in all types of these populations and that the label will eventually reflect that.

Okay, and, Jeff, one question for you. I apologize. On the R&D front, obviously you guys have guided to higher expenses. If I run the numbers right and I back out the one time items for last year, you had 37 million in R&D expenses. You've already had 27 million for the first half of the year, so it would seem that even with just one additional quarter worth of R&D expense, you would be higher for the year. Should we expect there to be other Phase III trials, for example, on the ketoprofen patch that would carry R&D expenses at a higher level than we've historically seen as the averages, regardless of whether it's the current quarter or prior quarters?

We've actually said that we anticipate being in Phase III with Rapinyl before the end of the year. With the ketoprofen patch, I think that we still have some further discussions that we need to have with the FDA before we finalize the program that the agency will require to get this product approved. As you know, that product already has two positive placebo control trials that were conducted in Europe, and we are in discussion and will continue in discussion with the agency to determine what, if anything, they require in addition to those, though we are anticipating that at least one additional Phase III trial will be necessary, but it may be the early part of next year before that would be initiated.

Okay. Thank you.

Your next question comes from Rich Watson from William Blair and Company.

Thanks. Just a quick question on the generic OxyContin market. It looks like most of your activity has been in 10, 20, and 40-milligram strengths, which isn't all that surprising, but could you just comment whether you expect that to continue going forward and whether -- any particular dynamics that might be going on in that regard, and then as a follow-up, if I could just ask with Palidone out of the market for the time being, Avinsa, potential issues emerging there, could you just characterize a little bit what the market looks like going forward for Oxymorphone ER, if it is approved and maybe even taking into account other products that are in development, extended release opioids, in particular, some of the abuse deterrent products. Thanks a lot.

Sure. With regards to the market dynamics, I think that certainly what we've seen over the last several weeks seems to be a fairly good indicator of stability in the market, both in share and in terms of where pricing has settled. That's not to say that there might not be some shifts here and there as customers work through existing inventories of the 80-milligram. Clearly, Teva had been in the market for well over a year in advance of us getting there, and Ivax getting there. You saw that Impax did not have a significant share to close out 2004, so the inventory levels there were pretty significant on that milligram strength and I think over the next several months, if in fact there is to be a shift, we'll start to see that, I would suspect, but clearly the biggest change in the dynamic in the market will exist on or about December 7, of this year when the six-month exclusivity period expires.

I think with regards to the market dynamic for Oxymorphone and the issues associated with Palidone and Avinsa, certainly the size of the market that Palidone had been able to attract at this stage was still relatively small. We do believe that it being out of the market will not have a substantive change on the market dynamics. Avinsa, we don't know what it will be. Ultimately the outcome there as it appears the agency is in discussions to revise the labeling, it may not necessarily mean any substantive change in the usage of the brand, but we think that with Oxymorphone coming into the marketplace, there's no doubt that having a new molecular entity available for particularly patients who have tried one form of opioid or another and either are not tolerant to it or have significant side effects, having a new choice will be an important addition to the pain specialists and potentially the remaining physicians in the market to the own moratorium. So we do think that clearly the share voice for which Endo will be able to achieve, if in fact Avinsa is still on the market, which we certainly expect at this stage, not knowing the outcome of Palidone, even if those were still enjoying promotional activity, we would expect Endo's share voice to be quite substantial. We do expect to increase our penetration to the market upon the Oxymorphone approval with additional sales representatives to be determined at the time of the approval, and I think that clearly we would look to Oxymorphone being a primary promotional emphasis for us, given the fact this marketplace, this opioid marketplace continues to grow at quite healthy paces beyond double digits so. We do think that there is still a very viable and a very prosperous market for Oxymorphone to be launched into.

Thank you.

You're welcome, Rich.

Your next question comes from Ed Arcie from First Albany.

Hi, Adam Greene, I think I have the only question that hasn't been asked yet on OxyContin. How much of the 29 million that you reported was for trial gains since we're only on the market for two to three weeks? And also on Frova, are you still -- I don't think I heard you reiterate the guidance for 45 to 50 million for the year is it still your guidance and is that included in your updated guidance for '05?

Sure. The majority of what we sold in the month of June, stocking without getting into specific numbers, but obviously the market doesn't turn that quickly, although prescriptions are more than 50% towards the generic now in the 10, 20, and 40. As far as Frova, yes, our guidance remains the same as it has been and is included in our full year guidance.

Thank you.

Your next question comes from Corey Davis from JP Morgan.

Thanks. That actually answered my first question, which was Frova guidance, but from that, should we imply that the entire amount of your increase in guidance is driven by the generic OxyContin and corollary to that would be the same thing on EPS, or did you take the opportunity to increase your internal budget for SG&A and R&D?

The increase from revenue in earnings per share is primarily driven obviously by the generic OxyContin product. We've never really limited ourselves in terms of what we wanted to invest in from either an R&D, sales and marketing perspective. We expect to use this cash flow and always have expected to use our cash flow to invest in the business from R&D, sales and marketing and importantly as well, the corporate and business development standpoint. So it's sort of tough to spend it that quick. You can't just start an R&D program overnight. So we -- we'll continue to invest in both R&D and sales and marketing in the future as we have in the past and build our growth from there.

And, Peter, did you say that the reason that the 80 mg hasn't been more penetrated by you and Ivax was because you haven't had inflated inventory levels out there?

No, that's not what I said, Corey. But what I did imply was that as any wholesaler or chain store would have, they have a certain months of supply. Whatever that might have been as normal for them of the type of brand or the type of generic, rather at the time of our introduction. And what we certainly would expect to see is any change in that market share for the 80-milligram would of necessity require a bleeding down of inventory to allow either Endo's product or Ivax's product to replace the type of product. So over the course of the remainder of the month of June, we would certainly see that where we are going to see increases in 80-milligram share, that we would have seen very little of that in the month of June and would expect to see any increase in the July and the following months, as that inventory bleeds down.

And so is the pricing strategy on the 80 different than the other strengths?

Well, we certainly haven't commented on the strategy by strength, but I will say that there are four players in the market for the 80-milligram, and it certainly may appear that the dynamic for 80-milligram is being taken advantage of by some customers to bid out the 80-milligram strength with four players, we certainly are looking at the fact that we have a package of four strengths to offer and we're applying our pricing strategy to customers on the basis of a four product offering.

Sounds great. I think that's all I had for you. Thanks, guys.

Great. Thank you.

Your next question comes from Michael Tong from Wachovia Securities.

A question, I'm going to try to beat this dead horse again. Looking at R&D, would you expect your second half R&D expense level to be closer to the first half run rate or the second quarter run rate? Secondly, for Lidoderm, can you update us on any activities relating to label expansion, like chronic back pain and things like that? And then finally, can you remind us how your sales force is right now organized and aligned.

Sure. Let me answer the last two questions. I'll let Jeff answer the first one on the run rate of R&D. On Lidoderm, label expansion, we are conducting a exploratory Phase II trial in chronic low back pain to really determine a number of parameters for which a determination will be made to pursue a Phase III program, such as length the of application, different types of patient, measurement parameters, a litany of different types of metrics that will allow us to determine if do in fact we have an ability to demonstrate to the agency's requirements that Lidoderm is in fact efficacious and safe in the treatment of chronic low back pain. That Phase II trial right now is in fact a three-month trial that is ongoing. So if successful, and we are able to make a determination that we've got the right parameters to put in place for a Phase III program, we would certainly expect to do that in order for us to be able to expand the label.

The sales force configuration right now, we do have three distinct sales forces, our specialty sales force number's about 100 representatives and they call on primarily pain management specialists, as well as oncologists and other specialists, neurologists, anesthesiologists, primarily for Lidoderm and secondarily for Frova. Our primary care team numbers about 200 representatives and they focus primarily on internal medicine, GP, FP, docs. Then our hospital team, which has been launched in order to bring DepoDur into the marketplace is 70 representatives that we hired late last year and early this year, highly experienced and very expert team to be able to traverse the formulary pathways within each of the hospitals out in the marketplace. David, perhaps you want to speak to the R&D -- Jeff, perhaps, the R&D run rate.

I'm probably going have to let the dead horse be dead. Again, we expect to increase R&D year-over-year. We've given top line and bottom line guidance and prefer not to play out things other than on an annual basis in terms of our guidance. We're trying to focus more longer term and so we have not been in the habit of giving quarterly guidance or six-month guidance.

Your final question is a follow-up question from Ian Sanderson from SG Cowen.

Great, thanks for taking the follow-up. Actually a follow-up on the sales force question, do you have any -- you've got a 70 rep hospital sales force out there pushing DepoDur and at this point it looks like the uptake is slow. Do you have any plans to leverage that in the near term by additional products, and secondly, could you update us on the Lidopain development status and differentiate that, I believe the target indication there is for acute low back pain. If you could just confirm that.

Sure. Yes, the Lidopain status is that EpiCept is the partner that is responsible for the development program. They are currently executing a, what's termed a Phase II-B study that will, again, similar to Lidoderm allow us to understand what the parameters will be for developing a Phase III program for acute low back pain and our agreement with EpiCept is in fact for an acute low back pain indication for Lidopain along with the acquisition of the patents for low back pain that would apply to both Lidopain and to Lidoderm.

With regards to the second, the sales force issue, the 70 representatives and the second product opportunity, yes, clearly there's going to be an opportunity for us to leverage this sales force for additional products. When we initially put together the hospital sales team, the expectation was that we would have some period of exclusivity and promotion on DepoDur in order to establish its position within the market. We still are encouraged that the process is underway as we had expected, that it is in fact a longer-term view of how that product's promotion and ultimate acceptance in the market will be achieved, so the concentration here is actually something that we think is positive. We had originally known that we would add substantive products to the team. Propoful IDDD being one of them that would be added eventually to that team. Oxymorphone in 2006, assuming that it is approved in its ER and IR form. We also have available an IV formulation, which will be used for hospitalized patients who need an IV formulation of an opioid. So that's an opportunity for us to leverage the hospital sales team as well.

But we are also clearly in our business development activities looking at opportunities to expand the usage of our hospital team in its expertise and in the institutional environment, as we are for the rest of our portfolio. Certainly if we find the right opportunity, for either a non market or close to market product that would be leverageable in the hospital environment, we would certainly be looking at that as one of our primary targets.

Do you think something might be added in the current year?

I can't say for sure, Ian. I think if the opportunity presents itself, we would certainly be very encouraged to look at it and potentially add it to the portfolio, but certainly we want to make sure that it's the right opportunity to leverage the situation that we currently have with DepoDur and to date, we obviously haven't found that opportunity, or at least have not announced that opportunity and we continue to look in the market place and when we do see one that's reasonable for us to add, both strategically as well as financially, we'll certainly look to do so.

Okay, and then finally, just on the two back pain Phase II studies for Lidoderm and Lidopain, when might we see results or would we see results from those?

I can't speak for EpiCept. They are responsible for the Lidopain study, as Peter indicated. They I think have announced that they are anticipating initiating a Phase II-B study in the second half of 2005. Our Lidoderm study will probably be complete around the turn of the year or the early part of next year. I am not sure whether the results would be material enough for us to announce it will -- but I think depend on what our future strategy may be around the product, so we'll decide later on.

Thank you very much.

Okay. I think that perhaps concludes the questions. So I would like to thank you all for being with us on the call today. We certainly appreciate your continued support and we all look forward to speaking with you again soon. Thank you very much, everybody.

This concludes today's conference call. You may now disconnect.