Endo International PLC (ENDP) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter 2008 Endo Pharmaceuticals earnings conference call. My name is Lauren and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference, at which time you may press star one for questions. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Blaine Davis, Vice President of Investor Relations and Communications.

Thanks, Lauren, and good morning, everyone. Thanks for joining us to discuss Endo's 2008 second quarter performance. Here with me this morning to discuss our results are Dave Holveck, our President and Chief Executive Officer; Nancy Wysenski, Chief Operating Officer; Ivan Gergel, head of R&D; and Charlie Rowland, our CFO. We'll begin the call with some prepared remarks from each of the executives who joined me this morning followed by a Q&A session. Any of their forward-looking statements may involve risks and uncertainties that may cause the Company's actual results to be materially different from future results, expressed or implied by these forward-looking statements.

Listeners should not rely on any any forward-looking statements and the Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Important factors that may affect Endo's future results include but are not limited to those factors discussed under the heading "Forward-looking Statements" in Endo's SEC filings, under the heading "Risk Factors" on Endo's 2007 annual report, on Form 10-K filed with the SEC on February 26, 2008. We encourage you to review these factors. In addition, during this call, we may refer to non-GAAP financial measures that are not prepared in accordance with accounting principals 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 current report on Form 8-K filed with the SEC earlier today for Endo's reasons for including those non-GAAP financial measures in its announcement.

The reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is contained in our sales and earnings press release issued earlier this morning. Now I would like to turn the call over to Dave Holveck, our President and CEO.

Thanks, Blaine. I would like to begin with some brief remarks about my first few months here at Endo and our recent reviews of the Company's business operations and R&D programs. Then I'll have Nancy, Ivan, Charlie report on more details on our current outlook, R&D plans and financial results. One of my top priorities when I joined Endo in April was to evaluate the Company's competitive strengths, human resources, R&D focus, and financial position to see how we could make the business more successful. Specifically, we looked at what we could do quickly to accelerate product development, increase product sales and improve operating efficiency.

With the help of my colleagues, and the new head of R&D, Dr. Ivan Gergel, we have now completed that review and made some important decisions. First, we have decided to discontinue Endo's participation in the development of Rapinyl for break-through cancer pain, and the topical ketoprofen patch for acute pain. We're in the process of transitioning these activities back to our partners so we can focus on other compounds in our pipeline, and free up resources for other development activities. I think this is a prudent decision, which will allow us to focus on other development projects as well as to increase our focus on searching -- excuse me -- for new drugs to enlicense and to partner for development and commercial sales. Ivan will say more about this in our R&D commentary in a few minutes.

Second, we have cut overhead by eliminating some positions and reducing our utilization of outside consultants. As a result, we took severance charges of $6.4 million in the second quarter to cover these reductions, which we do not -- which do effect our field sales force. Third, we're recognizing certain functions to make Endo more responsive to the dynamic market, make us more competitive, and more profitable. For example, we're building and enhancing some key capabilities within the R&D function, while within the broader organization, we have eliminated certain redundancies, increased span-of-control, and focused on maximizing return of our sales force efforts. Nancy will say more about this in a moment. Fourth, we're expanding our business development activities to encompass a broader range of potential product acquisitions, equity investments, strategic alliances, and promotional opportunities. Endo remains a leader and a player in pain management, but we must begin to look beyond this category and look at other indications and other opportunities, which are associated with pain where we have expertise, and where we can be competitive.

We see promising opportunities in areas such as CNS and oncology. In addition we are currently exploring various platforms such as large and small molecule and devices that we believe have the potential to generate multiple growth opportunities for Endo. We will provide you with additional updates as we progress through the year, but I wanted to give you a sense of how we're thinking about this area from a high-level perspective. As a final point, though we take seriously the importance of meeting or beating our financial guidance. So this, I believe we need to be transparent, yet conservative when projecting revenues and expenses. Since we are not changing our guidance for the balance of 2008, even though we have cut certain personnel and program expenses, you can assume that we are now taking a more conservative posture towards revenue guidance.

With our business review completed and key decisions implemented, our operating priorities going forward are to increase sales of branded products, pursue new business opportunities, support the development of our most promising drug candidates, and support our generics business. My charge to the team is to work harder, more efficiently and opportunistically to grow our business. We'll continue to build on our core competencies and add talent where we need it. And yes, I think we're off to a strong start. As you'll hear from Nancy and Charlie in a moment, we had a strong second quarter, driven by healthy increases in sales of our branded products. This growth and our strong cash position gives us the flexibility to invest in new products, new partnerships, new opportunities to make Endo a much stronger company.

Nancy?

Thanks, Dave, and good morning, everyone. I would like to take the next few minutes to provide you with an update on our commercial business. As Dave stated, we had strong second quarter performance from our inline brands. Net sales for the second quarter 2008 were $306 million versus $257 million in the same period in 2007. This represents 19% growth year-over-year. Lidoderm continued its strong growth, reporting net sales of $185 million for the second quarter 2008. This represents 10% growth over the prior year. During the quarter, the total RXs increased approximately 7%, according to Wolters Kluwer data versus the prior year.

The difference between prescription demand and net sales is primarily attributed to the positive impact of price increases taken both in July of 2007 and April of this year, offset by the negative impact from increases in managed care rebates, as well as a slight inventory workdown. We recognize that the growth of this product is beginning to slow as it has begun to mature, and competition in the topical pain market has always begun to increase. Lidoderm remains an important product for our business, and we have initiated activities that we hope can sustain its growth during the second half of the year and in to 2009. Some of these activity include a renewed and targeted focus on the high-prescribing physicians who treat patients with PHN, the continued education of primary-care physician of the benefits of Lidoderm usage in PHN, as well as the exploration of certain appropriate non-personal selling techniques that we believe may bolster growth. I would now like to take just a minute to address a question that arose on our first quarter call that at the time, we were unable to answer.

The question concerned the gap between our reported net sales for Lidoderm during the first quarter versus what we reported as our first quarter demand sales. Beginning in the latter part of 2007, we began to analyze the various data inputs that went in to our calculation of demand sales. Following our first quarter earnings announcement, this activity was expanded and we began working closely with external data providers, including Wolters Kluwer and IMS to better understand the sampling and projection methodologies utilized by these providers to collect data on our marketed products, specifically Lidoderm and to some extent Opana. We have completed our analysis and have concluded that the methodgy utilized by the data providers to capture total prescriptions results in an overstatement of the total prescriptions for Lidoderm and an understatement in total prescriptions for Opana. While this obviously does not affect the growth rates year-over-year or quarter-over-quarter, it does affect our ability to accurately calculate demand sales.

As a result, Endo will no longer calculate demand sales as a metric to measure the performance of our business. We'll instead focus on net sales growth as compared to total prescription growth over prior periods to provide you with more clarity and transparency on how we measure our business performance. Let me take just another moment and address the specific questions that arose on our first quarter call around Lidoderm, utilizing the total prescription data versus our reported net sales. During the first quarter, our net sales for Lidoderm grew approximately 17% over the prior year versus total RXs growing at 11%. The majority of this delta was the result of the price increase taken in July of 2007 on Lidoderm, which you may recall was 5%. We did not have any major changes in inventory levels in the first quarter of '08 versus the prior year and did not see significant changes in rebating during the quarter. So now let's go back to the second quarter results. Our other products performed very well during the second quarter with Opana growing 86% reporting net sales for the second quarter of 2008 at $46 million.

The total RXs for the quarter increased 97%. The difference between prescription demand and net sales can be attributed primarily to the impact of managed care rebates on net sales for the second quarter of '08, resulting from increased contracting with managed care organizations offset by the price increase. We continued to invest in Opana and believe that the future growth of this product will be more heavily influenced by pain specialists. We're currently in the process of modifying our physician targeting to focus on the specialists, and particular primary care practitioners who treat patients with long-acting opioids and can identify the most appropriate patients for treatment with Opana. We're also encouraged by the results of our recent launch of Voltaren gel. We have seen very positive trends thus far and prescriptions are currently tracking ahead of our internal forecast. The business is currently being generated from both primary-care physicians as well as specialists. During the second quarter, we brought on additional sales representatives from our contract sales organization, and have seen a positive impact from the addition of these resources.

As the launch has progressed, however, our initial assumption that each prescription would eventually result in the sale of five tubes, has not yet been met. Each prescription is currently closer to two tubes per prescription. We will continue to execute against our launch plan that has lead to the prescription growth exhibited by the product thus far and focus on increasing the number of tubes per prescription through the education of both physicians who are prescribing and the pharmacists dispensing the product. One final comment about the recent changes to our organization. As Dave mentioned, we completed the review of our business, and we made some strategic decisions to strengthen our commercial organization.

We have eliminated certain redundancies, increased spans of control, and we're focused on maximizing the return of our sales force efforts. Specifically within our commercial organization, I have enhanced our business analytics function, and reorganized the brand marketing team. The field sales force has not been affected by the organizational changes. I believe these are the right moves to strengthen our commercial business, and that we have the right strategies to support revenue growth. Now I would like to turn the call over to Ivan to provide you with a few comments on R&D. Ivan?

Thanks, Nancy, and good morning, everyone. I would like to take a moment to take you through the results from our recent R&D review, as well as provide you with some commentary around our R&D focus, priorities, and future. Over the past few months, we have gone through an extensive review of our R&D organization. The review encompassed a thorough analysis of our current R&D pipeline, including a rigorous analysis of each product commercial potential, development time lines, and the investment requires to bring them to market.

As a result of this review, we have decided to discontinue develop of Rapinyl, the sublingual fast-dissolving tablet of fentanyl being studied for the treatment of break-through cancer pain, and the topical ketoprofen patch, which was being studied for the treatment of acute pain associated with soft-tissue injuries. Endo of course will work closely with our development partners to ensure smooth transition of work as we transfer these activities back to our partners. We currently intend to continue the development of the oral rinse for the prevention or delay of severe oral mucositis. As has been previously disclosed, this program has been placed on clinical hold by FDA. We are currently conducting preclinical studies, as we attempt to better characterize and provide clarity around the questions that lead to the clinical hold, and we expect to complete this work at some point later this year, and will provide you with an update when we have additional information.

We're also continuing the development of the transdermal sufentanil patch, for the relief of moderate to severe chronic pain. This program is currently in Phase II, and we expect to have data by the end of 2008, which will help determine the path forward for the program. And depending on the results of the Phase II program, we hope to hold an end-of-Phase II meeting with the FDA either in late 2008 or early 2009. We're also going to continue the development of Staccato Fentanyl that uses Alexza's proprietary Staccato system inhalation technology to deliver fentanyl for the treatment of break-through pain. This program remains, of course, in an early stage and we'll update you when appropriate.

There, of course can be no assurance that any of the aforementioned development projects will progress and if they do, that they will be successful. I also want to take a moment to make some comments around our R&D priorities and focus for the future. As a result of the discontinuation of the programs that I have just discussed, we're currently refocusing the R&D organization on our remaining development assets and partnering with our business development colleagues to provide the scientific evaluation of new business opportunities. Our priorities are to expand and grow our pipeline to include both near and long-term assets that can contribute to the future growth of Endo. In order to do this, we must begin to enhance our R&D capabilities, and over the next few months, I intend to expand our R&D competencies, including the addition of key positions in the discovery area, in pharmaceutical development, and in clinical development.

We believe that this expansion will allow us to further improve our competencies in early and later stages of development. It will enhance our ability to invest in semi virtual forms of research and development, and it will expand our expertise in evaluating business development opportunities and platforms that will contribute to Endo's future growth. What I would like to do now, is to turn the call over to Charlie for a summary of our financial performance.

Thanks, Ivan. I'm pleased to announce another quarter of strong financial performance for Endo. For the three months ended June 30th, 2008, net income was $59 million or $0.48 per diluted share on net sales of $306.2 million. This compares with net income of $60.5 million or $0.45 per diluted shares on net sales of $251 million in the second quarter of 2007.

On an adjusted basis, a detail in the supplemental financial information in today's press release net income was $70 million in the second quarter of 2008 versus $64.3 million in the second quarter of 2007. Adjusted diluted earnings per share were $0.57 for the second quarter of 2008, compared with $0.48 in the second quarter of 2007, a 19% increase. Nancy provides you with a summary of our product performance, so I will summarize our expenses for the quarter.

Gross profit margins for the three months ended June 30th, 2008, were 79.4% versus 78.7% in the second quarter of 2007. We expect our gross margins to decline over the balance of 2008, as we anticipate paying royalties on the net sales of Opana ER. Selling, general, and administrative expenses for the second quarter of 2008 were $127 million versus $88 million for the same period in 2007. The year-over-year comparisons reflect the launch of Voltaren gel, the continued investment in our commercial business and infrastructure to support our key on-market products, including the impact of the expansion of the sales force that occurred in the second half of 2007. Selling, general, and administrative expenses for 2008 also include the impact of accruals for certain separation benefits.

Research and development expenses for the second quarter of 2008 were $27 million, compared with $28 million for the same period in 2007. The reduction in expense for the second quarter when compared to the prior year is driven by the decision to discontinue the development of Rapinyl, which resulted in the reversal of an accrual for our milestone payment of approximately $4.5 million that had been recorded during the first quarter of 2008, partially offset by a $3 million impairment charge taken on property, plant, and equipment. During the quarter, we also wrote down the remaining balance of our Rapinyl intangible asset of $8.1 million, making the total impairment charge due to the decision to discontinue the development of Rapinyl $11.2 million. We also recorded a $6.4 million charge related to staff reductions. As a result of the business and R&D review, that took place during the second quarter and the activities we have understood taken following the completion of these events, let me try to provide you with some comments on how we view our expenses for the remainder of 2008. On the SG&A line, the second quarter included incremental launch costs, both advertising and promotion and for the contract field organization for Voltaren gel. This is in line with what we discussed on our first quarter call.

Moreover as a result of completing this business review, we are in the process of changing our business structure to reduce our utilization of outside consultants and create a more efficient operating model. We expect this will slightly offset some of the growth in SG&A seen in the second quarter in the upcoming third and fourth quarters of 2008. As is stated in the press release and earlier by Ivan, we have discontinued the development of two assets in the R&D pipeline. While we expect some benefit to the R&D line over the long term, as a result of these decisions, keep in mind that we have contractual and other obligations to ensure smooth transition and unwinding of these programs. Also, as Ivan mentioned earlier, we have expanding -- or we are in the process of expanding on and building core competencies in this area, and this will affect our R&D spend as we go forward. The tax rate for the second quarter of 2008 was 32%, down from 37% in the first quarter. The second quarter tax rate was lower as a result of resolution of certain issues that were effectively settled with taxing authorities for various tax years after 2002, and we expect the full-year tax rate to be slightly higher than the full year 2007 effective tax rate.

We reiterate our guidance for total 2008 net sales to be between $1.245 billion, and $1.280 billion and adjusted EPS to be between $2.15 and $2.19. Our financial guidance does not include the potential impact of future business expansion opportunities such as company or product acquisitions, product licensing transactions, or collaborative research deals. At such time we would revise our guidance accordingly. Now as you know in early April, the Endo Board of Directors approved the repurchase of up to $750 million of stock over the next two years -- over two years. As we stated on our previously -- previous quarter call, as part of the accelerated share repurchase program initiated in April 2008, we repurchased 11.9 million shares. We expect approximately an additional 1.3 million shares to be delivered under this program during the third quarter of 2008. Also during the second quarter we repurchased on the open market an additional 2 million shares. These changes have been factored in to our EPS guidance.

In closing, we are pleased that Endo had another quarter of strong performance, we are focussed on executing against our strategic plan to grow the business while managing our expenses. Let me turn the call back over to Blaine to begin the Q&A session. Blaine?

Thanks, Charlie. Lauren, I think we're ready to go to the Q&A session.

Thank you. (OPERATOR INSTRUCTIONS). And your first question comes from the line of Gregory Gilbert with Merrill Lynch.

Thanks, good morning I have a few, then I'll get back in line. First for Dave, can you provide some more color on the level of cost savings that you are targeting and perhaps the timing of those?

I think the level of cost savings, you know, basically have come out and was mentioned in the call relative to, one, reductions in some of the R&D programs, and then obviously, the personnel reductions, and I think from the standpoint of those two, the other probably third notable one was the consultants. There was a fair number of consultants that were being plied in to the IT area, Again, maybe of the overstated umbrella from all of the direction I have given of the complexity of the business was -- was reduced, and I think what we have today going forward is an opportunity to create a more dynamic organization, and I think we're in a position to be more flexible and can produce a higher level of return.

Go to the next question, Lauren.

Your next question comes from the line of Gary Nachman with Leerink

Hi, good morning. For Ivan, can you talk about the decision to divest Rapinyl? It seemed that you guys had an accelerated path for the product. So it is more the market dynamics that have changed for break-through pain? Just go through the rationale there.

Yes, as I said earlier we did a very extensive review. We looked at the whole pipeline, and that included a very rigorous analysis of each product's commercial potential, the development time lines, and the investment required to bring each of them to market, and when we put that all in, and we thought about it, and we discussed it, our decision was that we should discontinue development of Rapinyl.

Go to the next question, Lauren.

Your next question comes from the line of Ken Trbovich with RBC Capital.

Thanks for taking the question. I appreciate the clarification you have provided with regard to the outlook on some of these products. I'm just trying to understand how we should be thinking about discounts and especially as it relates to our own models, these deficiencies and the data sources? How should we adjust for that? Should we just compensate through higher price for Opana going forward? What are your recommendations on that front, Charlie?

You know, I guess the way I would start doing it is taking, sort of the historical numbers and applying the growth factors. That's probably going to be the best way to go. Because the adjustments factor would vary month to month, quarter-to-quarter, and tha problems is data providers actually restate history, and so I can't give you a -- adjust this factor by X and you'll be at the right amount. So I would look at it more from the standpoint of, what is our historical sales that are reported, and then what are your projected growth rates?

Go to the next question, Lauren.

Your next question comes from the line of Rich Silver with Lehman Brothers.

Yes, can you just perhaps elaborate again on the R&D? It sounds like it be a bit of a wash in terms of the projection for this year versus your previous expectation, given that you would be dropping two programs, but also expanding at the same time. So is that the message that we really shouldn't be looking for much change versus previous expectations in total spending in R&D?

I would -- this is Charlie. I would expect that you are not going to see a drastic reduction in the R&D spend because as we mentioned on the call we have contractual obligations to unwind, transfer and transition some of these either to a new partner or back to the old partner, but as a result of some of the operational efficiencies and things that both Dave and Ivan talked about, you will see a slight decrease from where we were in the second quarter.

Go to the next question.

Your next question comes from the line of James Kelly with Goldman Sachs.

Great. Thank you. On the oral rinse product, I'm just interested -- is the preclinical exploration more focused on the active ingredient of Progel's matrix. I believe the active ingredient has been around for a while. I'll just interested in what the FDA is interested in there. Thank you.

As we said previously there is -- an issue same up in a preclinical study and they asked us to put it on hold. We're currently undertaking studies and we hope to provide data back to the NDA at the latter part of this year to address their issues.

Thanks, Tim. Can we go to the next question?

Your next question comes from the line of David Buck with Buckingham Research Group.

Yes, thanks. Two quick questions. First, for Charlie. Can you give us a sense of what an appropriate price might be now for Voltaren gel that we should be using modeling. And for Dave. In your R&D strategy and comments, it seems like you are looking a lot further afield than obviously just pain. Can you talk about -- you know, in your evaluation along with Ivan, how you came to the conclusion that say, oncology might be a target area for Endo given -- CNS, given I guess a higher risk profile than your core pain management area? Thanks.

I think that -- again, I want to be able to put a little bit of -- of context around the comments I made and certainly the question, but I'm not going to go very -- very far, because I have obviously more detail that I still want to work through. I think what we have seen is that -- number 1, the pain area certainly extends in to that, so maybe a better way to say is how we look at oncology is maybe through the eyes of -- of how it relates to our -- our pain experience in the context in that way. I think from the standpoint of the technology platforms, which I had mentioned, I -- I think, as you said, looking afield, small molecule, large molecule, related device, and again, those areas that are associated with both how therapies can be formulated as well as how they can be delivered. I think again, you have a -- a broader field for us to work in. Now the challenge, I think, in just staying in the -- in the pain area per se, is -- is again, you know, very highly regulated, and -- and I also say that the -- the mechanism of actions are still in the future, and we want to look at growth more in the near term, with some continued investment for the long term in the pain. So I guess that's sort of the framing they would -- I would like to put around those comments, more to come between now and certainly our next call, but at this point, that's -- that's our thinking.

David, this is Nancy, if I could maybe pick up the call on the pricing for Voltaren gel. Our WACC as we have disclosed earlier is 2210, and as you might imagine since this product has only been marketed for a little more than one quarter, it has not been added to a great deal of formularies.

Go to the next question.

Your next question comes from the line of Scott Henry with Roth Capital.

Thank you. First, are there any updates with regards to the Opana life cycle management targets as well as a potential for European partner? And second, along the intellectual property front, are there any changes to the requirement for Lidoderm generic, are you getting any feedback since the last call with regards to that? And along that line, given your -- as new management, given your review of the assets under management, do you have any thoughts on the confidence level for extending the intellectual property for Opana? The prior management had -- had appeared to express confidence, and I just wanted to see if that feeling was felt by yourself as well.

Sure. As -- as you might imagine, we continue to evaluate life cycle management opportunities for Opana as well as geographical expansion and Europe is certainly one of the markets that we look at, and continue to look at. Moving along, you know, I believe we are very confident in the skill sets that are here, and the capabilities to support both the further development efforts of this drug, as well as our abilities to continue to prosecute any challenges that -- that may arise related to Opana. On the topic of Lidoderm generics, we -- we are not aware of any change in that situation. There have been no paragraphs for notices brought to our attention, and we continue to feel quite confident that the five patents we hold will continue to support the product through 2015.

And if I could add in terms of the IP behind Opana, we continue to vigorously prosecute patents with the PTO, and we feel as confident as ever that we'll get some more IP.

Can we go to the next question?

Your next question comes from the line of Ian Sanderson with Cowen.

Good morning, and thanks for taking the question. Sorry for the background noise. Just a follow-up on the prosecution of the patents with the PTO development on Opana. Can you give us kind of an update on where they -- I believe it's 192 patent stands and when you expect the next feedback from the FDA? And secondly, on the pipeline, do you still consider yourself to have rights on the LidoPAIN program that's ongoing at EpiCept -- and if there's any update there?

I'll cover the first question on Opana. We don't comment on individual patent applications that we're in the middle of prosecuting. So we're going to leave it at that.

Could you please repeat the second question?

Can we actually just go to the next question?

Sorry.

Your next question comes from the line of Annabel Samimy with UBS.

Hi, thanks for the clarification on the Lidoderm and Opana. Do you think you can give us-- quantify the variability or the overstatement or understatement on each of those products, on the average that you have seen? And also on Lidoderm, you had some 10 million drawdown last quarter, and a little bit more drawdown this quarter. Can you quantify the drawdown this quarter, and is there any more -- is there any further -- more to come out?

Annabel, as you might imagine, the changes in the projection methodology and where those fall out vary from quarter-to-quarter. It's extremely complex when you look at all of the variables, and that's exactly why we have decided to -- to step away from that, and -- and -- and just really stick to sharing net sales and relating that to our TRX rate. On Lidoderm for this quarter, I believe you were asking about, we have had a slight inventory workdown, but I think the differences that you see between the 10% increase in net sales and the 7% increase in total prescriptions are primarily created by balancing that slight inventory workdown against the price increase in April, and then some further contracting pricing reductions that are coming through in part D.

And Annabel, on the first quarter call, we did talk about the inventory pattern that we expect to see consistently year from year now. Where in the second quarter and third quarter we will have slight workdowns. First and fourth quarters we will have inventory builds. But year to year we should not have fluctuations that are significant in inventory.

I just want to take a chance to go back to Ian's second question. Charlie does have actually a response to that.

Yes, Ian, your question about the patent rights or the IP rights to EpiCept's LidoPAIN and so forth. Yes, we do have all of that still.

Thanks, Lauren. Can we go to the next question?

Your next question comes from the line of Michael Tong with Wachovia Capital Markets.

Good morning. Just a quick question for Charlie. I just wanted to see if you can clarify, as you have given us some additional clarity on the R&D and SG&A trend going forward for the second half of '08. Are those numbers off of the Q2 GAAP number, or an adjusted number? In other words, should I look at R&D in Q2 to be closer to $31 million rather than $26 million and SG&A as something lower than $126 to begin with?

They are off of the GAAP numbers that are there. But I -- I think -- to be fair, on the R&D number, it would be the lower number, the $26 million that we -- we ran that off of.

Can we go to the next question?

Your next question comes from the line of Dave Windley with Jefferies & Company.

Hi, broader overall question here, two parts. The first is you mention your -- your review of core competencies. I was hoping if you could get in to a little bit more granular detail about what you concluded from that review as to which are the core competencies? And secondly, in R&D where you talked about adding competencies in other areas. Should we interpret that as your intent to -- to complete or pursue that -- that -- those elements of R&D in-house, or bringing competencies in-house to oversee outside vendors doing that work.

Dave Holveck here. Let me -- again, go back to the comment that we want to work, you know, broader than just the pain areas, so from the standpoint of -- of competencies, as we look forward, and -- and again, look forward in -- in a growth plan and the strategic direction, it's obvious that -- you know, some of the elements that we want to pursue, we think have growth, did not exist. I think from that standpoint, we want to fill those positions. I think from the position of -- of -- where Ivan was coming from, and again, it falls in the same line, we're -- we're again looking at specific areas where we think are growth, and beyond just what our normal -- I guess business mode was -- was more of a 505 B2 perspective. And again, where we see a higher growth, a higher value, and more sustainable, will require -- a greater control over more of the early development, and again, early on. Ivan any comments that you want to make on that?

Yeah, so we're suddenly looking our current R&D organization. We have a lot of competencies. We're going to be refining that. And that will certainly including building out more core capabilities and function. It will allow us to execute a more virtual form of research at earlier stages of development, but without having to build significant infrastructure. And hopefully this new R&D model will allows to invest in targets at earlier stages of development that we hope can increase the sustainability of our business over the longer term.

Thanks. Can we go to the next question, please.

Your next question comes from the line of Tim Chiang with FTN Midwest Securities.

Thanks, question for Ivan. As you guys evaluated the pipeline, Rapinyl and the topical ketoprofen patch, was it the lack of efficacy or was it the lack of IP that sort of lead you to discontinuing these two late-stage programs. Or was it both -- I just want to get your thoughts on how you sort of got to the conclusion of getting rid of these two?

Yes, as I said earlier, we did a very extensive review internally. We did a very thorough analysis of a number of factors, including looking at the overall pipeline, each product's commercial potential, the development time lines, and also the investment that will be required to put in to them to put in to market.

Thanks. Can we go to the next question, please.

Your next question comes from the line of Lei Huang with Summer Street.

Hi, thanks. I have two questions. Can you just clarify in terms of the -- some of the charges you break out in your press release and to separate the milestones? Can you clarify exactly where those fall in the P&L? Whether it's [cogs], SG&A or R&D? And number 2, you talked about a revised operating model, and new operating priorities increasing brand sales new business opportunities, supporting R&D programs, et cetera. They don't sound very different from things you were focusing on prior to this corporate review that you have done. So I just want to understand what has changed or been tweaked as a result of this review that you have done? Thanks.

Well, let me take the first or the last part of your question, and Charlie can take the first part. This is Dave Holveck by the way. I would agree -- we're -- the words themselves probably don't sound any different not only from the last call or maybe from other calls that people will have. I think we haven't provided you with enough of the context of what is behind those words. I think you should take some heart and maybe some of the words surrounded by the by the reductions that we have made relative to the both the pipeline allowing again for increased elements in our core competencies to go after our other things. I think the opportunities of allowing ourselves less complexity, again, to enable us to -- to move in a -- little bit more aggressive fashion to pursue new opportunities, but until, until we come forth with more of the details, which -- which will be forthcoming, and -- and some of the actions that we'll be taking, again, those words candidly are probably no different, and will probably have a hollow ring, but assure you that the last four months of what we have been through was done on the direction to make sure this business was on a sound footing going forward, and we'll -- we'll step off on that platform in the future calls.

And Lei, to answer your first question, the milestones -- the development milestones, they all fall in to the R&D line. The IP charge that we took actually has its own line, the $8.1 million. There was another $3.1 million that was related to writing off some property plant and equipment, that was in the R&D line, and then the severance charge is actually split between the two.

Thanks. Can we go to the next question, please?

Your next question comes a followup from the line of Gregory Gilbert from Merrill Lynch.

A couple of mild questions for Nancy and Charlie. If we assume that we will not see significant inventory fluctuations year -- in the quarters versus prior year's quarters, how should we think about what portion of future price increases will actually stick in light of your contracting efforts? Are you still expecting 20 to 30 million for Voltaren gel and if not what offsets that to keep the guidance the same on the top line? And lastly, for Dave, what is your strategy in generics going forward? Is there any activity there now? Any filings, et cetera? Thanks.

I'll start off on your first question on inventory and then turn it over to Nancy. The way I would look at inventories is the first and fourth quarters is your inventories will be the highest levels, second and third quarter, at their lowest levels. Year-to-year, though, at the end of the year, you are not going to see any change. Next year will be the year that you probably won't see fluctuations from quarter-to-quarter, but last year was not 100% down at the lower levels of inventory.

Craig, I'll take the question of Voltaren gel. As I said earlier in the call, we're quite pleased with the response from the marketplace, and I don't think we have changed our views on how that product will perform this year.

Relative to the generic side, you know, we think it's a strategic element within -- within our business going forward. I believe that -- you know, the generics business as -- as a business itself begins to gain certainly more importance in our healthcare delivery system. I think it's becoming more stratified in the sense that, you know, there's the very low-hanging fruit and little bit more complex formulations. So going forward we really want to direct ourselves in to more of the complex higher value, but we think it can be a contributor in the near term.

Thanks. Lauren, I think we have time for about two more questions.

Your next question is a follow IP from the line of James Kelly with Goldman Sachs.

Great. Thank you. I want to just revisit the decisions on Rapinyl and ketoprofen patch on one particular line. And it has to do with whether or not it was the market opportunity that was an important driver. I want to ask that one again, principally because I'm interested in whether or not revisiting products in these portions of -- in these subcategories inside pain is something that the company will continue to do going forward? Thank you.

Let me step a little bit in to this. Again, a lot of what -- you know, I saw the potential of the company, and -- and it's ability to move forward in this changing environment within the healthcare is, again, to broaden its position in the marketplace. And again, I would say the overriding element was to me the timing and the business return on the investment relative to what I think other opportunities that -- that we can -- we can pursue. And it was always in alignment with how I wanted to be able to see us grow from -- from the core competency area, and move beyond just again the 505 B2, if you would strategies. I would say it was more heavily driven from -- from the business perspective and sustainable long-term growth. There was a second part of the question. I missed something. Maybe that was the overriding element of it, but that's -- that was what I would portray as the underpinning of the decision there.

Thanks. I think we have time for one more question.

Your last question is a follow-up from the line of Rich Silver with Lehman Brothers.

Can you just review the status of the products that are slated for continued development? Where exactly they are, and what we can expect in terms of timetable and milestones to mark them to market?

Well, I'll give you some update on the products that continue under development. We intend to continue development of the oral rinse, which is being studied for the prevention or delay of severe oral mucositis; the sufentanil patch, which is being studied for the relief of moderate to severe chronic pain; and the Staccato Fentanyl product. With more specifics, we're currently working to understand the issues related to the clinical hold that has been placed on the oral mucositis product, and we hope to have additional information later this year, which will allow us to determine the path forward for this development program. Regarding sufentanil patch, we hope to meet with the FDA for an end-of-Phase II either at the end of this year or the beginning of next year to discuss the results of our Phase II, and discuss our plans for Phase III. And, once again, that will allow us to better characterize the path forward for that program. And of course we'll continue to work with our partner, Alexza, regarding the Staccato Fentanyl. But, of course, this one's in the very early stage of Phase I.

So, with that, that's the completion our Q&A session. I want to thank everyone for joining us to discuss the second quarter 2008 financial performance. If anyone has any follow-up questions, following the completion of the call, you have can contact me directly in my office. Thanks again for joining us.

And thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Good day.