Ligand Pharmaceuticals Inc (LGND) 2004 Q3 法說會逐字稿

Welcome to your conference today with David Robertson.

As a reminder to everyone the conference is being recorded for replay purposes. (OPERATOR INSTRUCTIONS).

At this point I will turn the call over to you, sir.

And thank you for using Sprint.

Good afternoon, this is Paul Maier, the Chief Financial Officer of Ligand, and I am joined with David Robinson, our Chairman, President and CEO.

Today we would like to discuss our third-quarter financial results and also several other recent developments.

Before we get started though I would direct your attention to our Safe Harbor statement.

And during the course of the call today we may make some projections or forward-looking statements.

And I would refer you to our SEC filings for a more complete and thorough review of our previous disclosures.

Would that I would turn it over to David to welcome you to the call.

Thank you all for joining us today, this afternoon.

We understand this is the first of our calls in the afternoon, and so we recognize that your time is tight.

We will try to succinctly get to the perspectives and the issues that we would like to bring to your attention in reviewing our results.

This has been a busy quarter of activity since the second quarter and much progress has been made.

I will cover four or five major items in my comments to provide perspective.

And then I will ask Paul to cover the results and management guidance going forward.

We hope that by now the earnings release has reached your hands, as we are at the end of our filing process things got pretty tight, so we hope that everything has caught up to you and apologize if any of you had difficulty in getting it.

First, I would like to focus on our record quarter of product sales growth for the third quarter, with product sales up 59 percent.

We are encouraged with the continued demand growth during this quarter for Avinza and for ONTAK, and as well encouraged that Avinza and ONTAK, the sales mix and geographic demand changes that impacted our net product sales in the first half of the year in the form of increased rebates and returns, have stabilized, and provide a more predictable foundation now for our forward planning and for your understanding of our business.

While encouraged, we are not satisfied.

We do believe that additional measures are necessary to improve Avinza results going forward.

And together with our copromotion partner, we've taken those actions that we'll cover and outline in some more detail as I talk through the product sales.

We also reported out recently several important transactions.

And I will cover those in some more detail in a moment.

During this quarter we completed the hiring of BDO Seidman as our new auditors.

And I am pleased to say that we filed our 10-Q on schedule.

I believe that from a shareholder perspective that underscores the strength of the Ligand finance and accounting team.

As all of you can well imagine, the amount of work and the tight time lines that the finance and accounting team had to complete this quarter to keep everything on schedule.

We believe that with the completion of the 3Q work and the review of prior quarters that this brings our auditor transition process to completion.

And I believe it is fair to say that you'll note from this call that while we had that additional workload for the quarter, it did not take the management team's eye off of the fundamental business of the Company going forward.

We simply tackled those challenges in addition to it.

And we're pleased that process is complete.

I would like to turn now to several key transactions that were completed, and offer some perspectives and rationale for those transactions, as we believe they are significant for our going forward operations and for continuing growth in shareholder value.

The three transactions I'll talk to are the Royalty Pharma transaction, the Lilly ONTAK royalty stream restructuring, and to a lesser extent the X-Ceptor sale.

We believe that these transactions have reduced uncertainty for us of the revenue line.

They have secured both the results for 2004 and enabled continued accretion of results for operating income improvements for 2005.

I will turn to first the Royalty Pharma transaction.

We are pleased to confirm that Royalty Pharma has accelerated and increased their royalty purchase to 32.5 million as a substitute for the final two options that existed.

That basically has resulted in the acceleration to the fourth quarter of the receipt of both that cash and revenue, the elimination of the uncertainty of those two options, and has resulted in the sale of 1.625 percent of the SERM product net sales.

We believe that that transaction is very important both for our objectives for this year, more importantly for the cash enablement to complete the ONTAK royalty stream restructuring with Lilly.

We are very confident that with this the security of our financial profile for this year now will be able to be understood.

And at the same time our operational earnings for next year going forward in the form of improved ONTAK gross margins and improved EPS will be in Ligand's hands with the cash to be able to exercise that.

So I'll turn now to the restructuring of the ONTAK royalty stream.

Under the terms of this agreement Ligand will have two options.

One will be in January and one will be in April.

Those options for a total consideration of 33 million will allow Ligand, when exercised, to eliminate all royalty payments due on U.S. sales through year-end 2006, and to eliminate all future royalties on U.S. sales of 38 million per year or less going forward.

Thereafter the terms of that agreement will provide, beginning in 2007, for Ligand to pay royalties on ONTAK sales to Lilly on a reversed tiered scale of from 20 percent to 10 percent on annual U.S. sales in excess of 38 million for the minimum tier, and in excess of 72 million for the maximum tier.

The results of that restructuring are both financial and strategic.

Strategically it enables Ligand to continue to invest to broaden the base of indications, and therefore the applications of ONTAK to larger and larger markets, and to continue to build ONTAK into an important revenue and earnings driver for our shareholders.

At the same time we achieve a very substantial improvement in gross margins that allowed this to be accretive beginning in 2005 going forward.

And we believe the accretion to be substantial for our shareholders.

The gross margin improvement will bring ONTAK into line with the overall gross margin of the Corporation's commercial product business of around 75 percent, making ONTAK an attractive specialty product.

We would note that the two transactions, while independent, for some of you wondering how the options got structured, they were negotiated in parallel.

And of course until the very end, we were not completely sure that we would be able to complete both.

As it turned out, we were able to complete both.

So the nature of structuring the options really has little more to do than with a little bit of staggering of cash flow for the Lilly transaction, and a mutual preference for the structure of the transaction.

It is not really designed to be gaining any clinical data or anticipating any clinical data.

These are more business issues, and we're very pleased now with both transactions completed that we are in control to exercise the options as they come due.

Clearly we feel that that is an important step forward for our shareholders.

And we feel the two transactions together, not only is the Lilly ONTAK royalty buy down accretive, but the two transactions taken together also are accretive over the next three or four years for our shareholders.

I would like to turn now to some comments and perspectives on product sales.

For those of you who have noticed the 59 percent is a record for the Company for the quarter and half quarters.

That strong growth was driven principally by Avinza and by Targretin caps and gel.

The Avinza demand and market share growth of the third quarter did continue, but we did not see a further acceleration of Avinza demand growth.

And that was impacted by several factors, an overall market growth slowdown and a slower impact on demand than expected from the increased sales calls to primary care physicians and the long-term care and hospice plans of the copromotion partners.

We saw an 11 percent increase in prescriptions.

And if you look at the overall NPS growth for the quarter, that is both retail and nonretail segments, we saw about a 21 percent growth in dollars as monitored by IMS.

We did see continued share growth monthly and quarterly, with the monthly prescriptions shares increasing from 4 percent in June to 4.3 percent in September.

And the quarterly market share increases from 3.8 percent in the second quarter to 4.2 percent in the third quarter.

So we would focus on that we are encouraged by that growth, but we're not satisfied with it.

We believe that the productivity increase expected from the expanded Avinza sales call plans on primary care physicians that we saw in the third quarter was slowed by some imbalances of the Avinza target physicians at the territory level.

When you look at the primary care territories there was a range of 20 to 120 Avinza target physicians per territory, which made a consistent quality call, that is reach and frequency, difficult to sustain on those targets.

With vast differences in workload, we were not getting the sustained personal sales call time that would drive the productivity from the larger numerical call rates.

So this did substantially impact the subscription response to that expanded call plan.

We have dialogue and addressed that with our partner.

And as a part of a larger corporate sales force restructuring, that is encompassing all of Organon sales representatives, a restructuring and territory rebalancing was implemented effective November.

This results in a new balanced set of primary care territories that are now fully built and structured around the Avinza targets, that is the 25,000 primary care physicians that make up the bulk of sustained released opioid prescriptions.

The new territories are built around those targets.

Each one now with a more balanced workload of around 60 physicians per territory, and that is, as opposed to how the original Avinza targets were in fact added to existing territory boundaries.

This important rebalancing and the increased focus on Avinza targets that will result from that is expected to substantially improve the prescription response to our expanded sales call plans.

And that will also make Ligand sales force calls on the targets more more productive as well.

We did see in the third quarter a nice improvement in the deciles of physicians where Ligand mirrored sales force is calling on the same targets as Organon, we did see improved market share penetration.

And we think with the more even territories we will see a substantial further improvement.

In a similar manner, the reorganization is expected to improve the response to long-term care and hospice plans under progress right now.

We made good progress in the contract level with long-term care and hospice, but suffered lags in pull through from the uneven coverage of physicians and consulting pharmacists that often drive the pull through from the contracts.

The overall promotion plans that now cover primary care, specialists and long-term care and hospice, now blended between the two companies, we believe will allow us to deliver consistently around 850,000 quality calls per year with the reach and frequency that is essential for the productivity improvements that we seek.

And we believe that is now in place and will begin to drive the business for the rest of this year, certainly it will make an important improvement in 2005.

In addition to those changes, which in part were driven by our partner's timetable and their larger corporate restructuring, Ligand also made some additional organizational changes to integrate into business units the marketing and sales for pain products and the marketing and sales for oncology products, such that we now have unified leadership of the each of those business unit areas.

We believe this will facilitate the implementation of joint commercial plans between Ligand and Organon to support Avinza.

Several other comments that I would make to understand the progress on Avinza.

We did meet or exceed the new pharmacy stocking for the quarter.

And I think we're nicely on track to meet or beat our goals.

We have looked carefully at the channel inventories, and we estimate that there was no significant overall expansion or reduction of wholesale and chain inventories during the quarter.

That is consistent with our annual goal and our business plan for this year, and with the parameters of the major wholesaler distribution service agreements, which were completed for all the major wholesale customers.

Our third quarter sales mix was impacted by the expansion of business under commercial contracts like PDM's, GPOs and HMOs.

The expansion of business under those discount-based contracts is fundamental for future retail demand growth, as they expand national and regional formulary access for Avinza.

Near term they do increase the deductions from gross to net.

Our Medicaid prescription activity as a percent of our overall business began to slow during the third quarter.

And we expect the current proportion of rebates will remain consistent throughout the remainder of 2004.

We also would note that product returns normalized to a more predictable level across all of our geographic territories as Avinza began to grow and as the positive effect of DSA's, both the information flow and the closer working relationship with the wholesalers, progress throughout the quarter.

And we believe that that is a nice solid foundation going forward.

We completed the DSA's with all over major wholesalers across all of our products, Avinza included.

And we have opened dialogue with additional smaller wholesale customers and expect to complete additional agreements, DSA agreements with them during the fourth quarter.

We think this puts us well into the front-line of companies that have restructured an important relationship with our wholesale partners for our product lines.

And we are very pleased that that work is largely completed.

A few comments on our in-line oncology products.

We had a good quarter where product sales increased 34 percent.

And that was led importantly by Targretin capsules and gel.

ONTAK unit demand shipments grew 19 percent and 25 percent for the third quarter and nine months.

We did have a net sales decline, and that was largely due to increased charge backs and net rebates, which resulted from a change in mix of patients that instead of being treated in private physician offices were treated in hospitals.

And that shift in mix of patients was driven in large part as a result of reimbursement changes that were put into effect for 2004.

Third quarter also saw those mix changes come to stability so that going forward we would expect unit growth and dollar growth to be marching much more closely in lock step with ONTAK.

They're having a good demand growth year for ONTAK.

And now with the mix absorbed that has been driven by the reimbursement changes we certainly expect to see ONTAK continue to grow strongly going forward.

Targretin had strong growth in Europe, and overall in net sales a solid growth versus prior quarter in the U.S. and in Europe.

We continued to monitor and are seeing some increased activity resulting from the CMS formal implementation of Section 641.

And so that underpinning going forward as we move through this year and into '05 we do expect to see continued improved access for Targretin CTCL patients as that program becomes more and more implemented in the marketplace.

And that is prior to any of the SPIRIT I, SPIRIT II data availability.

I would confirm, as you can see from our press release, that we are on track with our SPIRIT I and SPIRIT II internal work for data release in the first quarter of '05.

A tremendous amount of work is going on there, and I would say that things are tracking nicely to that.

We did release additional data at important medical meetings in Europe.

And that information is available, I believe, on our website.

The most interesting of that data was data from a Phase II study of Targretin in a chemo combination Benzabene (ph) versus platin, also in first-line lung cancer patients which was conducted at the University of Maryland.

And that showed a strong median survival of 12.7 months and that remains interim data.

That compares quite favorably to that of controls from other studies at the same institution and with large-scale trials using the same chemo agents.

That now brings the total to 5 Phase II trials that have consistently pointed to the same improvement in survival when Targretin is added to other chemo doublet regiments.

So at this point I will finish my comments and turn it over to Paul to update you on our guidance, and cover in more detail our operating results.

We're making some adjustments to guidance for this transition year to profitability.

But we remain very committed to that goal of profitability.

Even if it is occurring with a different mix of revenues and expenses, we believe this is an important year for that and we expect from the information we had put out there and our revised guidance that you will see us with a continued commitment to that goal.

As David mentioned earlier it was a record quarter for the Company in the third quarter of '04 for product sales, 44.7 million.

And that exceeded our previous high which was in the fourth quarter of '03.

Coupled with our other revenue in the quarter, our total revenues for the third quarter were 49.5 million.

And that was up 58 percent for the quarter in '03 in the same period.

Our gross margins continued to improve, and we had a 75 percent gross margin for the quarter on our product sales.

And that is compared to 70 percent for the third quarter in '03.

Our expenses have grown within our range of expectations on the low-end of our previous guidance, and they had behaved exactly how we expected they would.

As a result of these factors, our operating loss for the quarter came down 52 percent substantially, and it was 3.9 million.

And so we made very good progress this quarter in that regard.

If we look at the product sales, Avinza at 28.3 million was up sequentially 21 percent over the second quarter.

And our oncology products were up sequentially 15 percent over the second quarter of this year.

And given the third quarter operating results and the continued growth of our product revenues, as David mentioned, we do look forward to a -- in this year of transition -- another breakthrough quarter in the fourth quarter where we will expect a very strong quarter of results with our sales and other revenue and EPS sufficient to bring us to our first full year of profitability.

And I would just note a couple of transactions that will fall within the fourth quarter before I get into the guidance.

And as was mentioned earlier, the Royalty Pharma transaction, which is a fourth quarter '04 transaction, will generate 32.5 million in other revenue, and cash of course, which will provide a substantial other revenue for us for the full year.

And obviously because of the certainty of the transaction having been concluded, gives us a very high comfort level in terms of our guidance for other revenue.

As well, one of the transactions that was completed in the fourth quarter was the sale of X-Ceptor to Exelixis.

And with that transaction it will impact our P&L in a positive way.

We expect to record in the fourth quarter approximately 2.9 million in other income, so that would be below the operating line, which will benefit us in our fourth quarter results.

So as we take a look at the guidance -- the revised guidance for the full year our revenues are expected to be -- total revenues between 216 and 231 million.

And that comes about as a result of net product sales expected between 178 and 180 million, and the balance between 46 and 51 million would be our other revenue.

And I would just note that post the Royalty Pharma transaction, 80 to 90 percent of that other revenue has already been achieved for the full year.

We expect our gross margin for the full year to continue to improve to be in the range of 76 to 77 percent.

And as we have noted the slower growth in expenses has evolved during the year.

We now expect our total operating expenses to be between 166 and $170 million, and that does include the copromotion expense, but it excludes the cost of products sold.

When you net all of that out we would expect our full year operating income to be between 11 and 16 million.

And with the other income and expense items that would translate to a basic EPS for the full year between 3 cents and 9 cents per share, with the upper range more sensitive to the timing of product milestones, which as you know, are a little less predictable.

We do believe that our financial goals for this transition year to profitability can be achieved through continued reasonable expense discipline, through the continued product sales growth which we have seen these quarter during the year, and without significantly higher other revenue, which will help us partially offset the Avinza and ONTAK sales mix changes.

And we of course remain, as David said, very committed and focused to achieve these goals.

And we do expect our business going forward to be driven by the growth of our product sales and the milestone in other revenues will become less important in the future as a component of our total revenue.

And I would just plain out in our expectations for this coming fourth quarter, even without the Royalty Pharma transaction, which obviously is contributing a significant amount of revenue, 32.5 million, with our product sales growth and our other milestones and what have you, we would still expect we would have a very profitable and strong fourth quarter.

So it is just accentuated by the certainty of having completed this transaction.

So with those comments, I think we will open it up now for Q&A.

And we appreciate your participation in the call.

(OPERATOR INSTRUCTIONS).

Jim Reddoch.

How are you planning for Palladone, which is now coming out, and even though it is a sort of a controlled launch, it still looks like it is going to be bumping up against the Avinza target population, at least in terms of specialists?

And secondly, how are you -- how much time did this sales force lose in this recent optimization -- the sales force in November that you mentioned?

A couple of good questions.

Let me tackle the second one first.

I think as we dialogue with our partner about the restructuring that was driven by their corporate needs, we obviously had opportunity to input into the detailed execution of that as it would impact Avinza.

As best they can surmise from that planning, which we got a look into, clearly there is a substantial amount of change at the territory level that would be new reps with new doctors that has an immediate effect of a need for a learning curve at the micro territory level.

It has another effect of a new rep gets a second shot at converting a doctor that the old rep wasn't having success with.

So there is some positive and some negative.

I think as we look at the what I would call the dividing line, which is really November, early in November the entire plan was put in place, which probably means that for a couple of weeks there were reps that knew they were moving from one territory to the other.

And so as we look at the weekly data, I think we're not surprised by a little bed of softness in the final weeks of October.

We will watch anxiously as we move into November to see the renewed vigor at the micro territory level where everybody now has their new docs.

They've got a nice balanced territory.

They really can focus and execute their sales call plan because they are manageable territories.

And Avinza is what it is all built around.

So net net we think a couple of weeks of softness is probably what we're seeing.

We would certainly hope that as we move through November that remotivated, refocused and much more balanced territories will start to show up.

Clearly this is a move that -- there is never a good timing to do this.

We understand our partner's needs for the larger restructuring.

We look to 2005 as where most of the big gains will come from this, but I think that we should be through that transition stage pretty quickly in November.

The planning I think for Palladone really revolves around two things.

First and foremost we believe that the advent of another once a day with an around the clock control of pain label is a positive thing for the marketplace.

It will reinforce the major messages that we have been delivering about the value of a once a day product for these patients.

The competition will be focused on specialists.

We largely will have primary care without promotionable competition from Palladone.

So the dialogue at the specialists level is going to be focused on the once a day message, but they're going to be focused and restricted to once a day largely where other opioids already are.

And it is not highly likely that satisfied patients are where the battleground will be.

I think most companies would judge it to be inappropriate, if not unethical, to request doctors to change medicines for a satisfied and stabilized patient.

So as it relates to our Avinza business, we have an extremely high satisfaction rate of patients who are on Avinza.

So we don't see a major exposure there.

We are in the 85 to 90 percent satisfied patient range with Avinza.

So we think that most of the competition is going to be for those patients coming off of shorter acting opioids, or not satisfied on shorter acting opioids, or unsatisfied on the longer acting opioids, where a particularly potent opioid with all the attendant and disclosed risks will have to be a balanced judgment of the physician.

We think that is a fairly limited and narrow range, so we will be competing for -- with Palladone for the unsatisfied current opioid user that could be Oxycontin, unsatisfied Oxycontin users, unsatisfied shorter acting opioid users.

And we believe that Avinza's track record and the profile is a good bet to use before you go to a much more potent opioid.

So we think we will do very, very well there.

But they will be focused and they will obviously be calling upon good relationships with the specialists.

So it will be some increased competition.

We do know exactly when they will be coming on, but sometime in the first half of next year is when we expect them.

I had another question but I will get back in the queue.

David Amuno (ph).

IMS had reported sales of 38 million approximately for the quarter.

And we're seeing 28.3 in net sales.

Can you elaborate on what accounts for that $10 million discrepancy?

Is this more of rebates and returns, or is it another item that we haven't heard about?

Good question, David.

A couple of big picture comments.

We have been trying to provide more and more information so that everyone can have a better handle on this.

First of all, I think IMS monitoring at the NSP level is probably about as good a dollar data as is available.

But I would caution that it isn't necessarily each and every quarter consistently predicting the Company's growth sales.

So there is always some difference in variation there.

And in each quarter it may be different as to what the differences are between IMS monitored NSP dollars and the Company's gross sales.

So with that kind of background, the differences between what you see in the IMS gross and our reported net sales include a whole range of deductions from gross to net.

They include things like cash discounts, when the wholesalers pay 2 percent net 30 days.

They include returns.

They include charge backs and rebates for Medicaid sales.

They include any gross and to net deductions for allowances that we might have given in a quarter to wholesalers.

They include the distribution service agreement fees, so whatever fixed fees we have get taken off of gross before we report out net.

And they would include things like the cost of our coupon program.

So as coupons come in we also deduct those from gross to net.

You might recall, and I think this is the importance story of 2004, which to be honest we have worked hard to get our hands around.

During 2003 our gross to net deducts were typically under 10 percent.

Now as our business has grown through different channels of distribution that gross to net has also expanded.

That is normal, so it is not to be unexpected.

It happened with a speed as a result of the enhanced capability of the copromotion partners, we did a lot of bids and contracting.

We did a lot of PPM, GPO and other contracting work that prior to that Ligand alone was not able to do.

So that kind of exploded on us.

And I think it is fair to say we have probably now caught up with it in the third quarter, such that it isn't striving adjustments that we have to do, but it is reflecting a larger gross to net deduction.

No over time there are pieces of that gross to net which will start to change.

As you can see it is over 20 percent for this quarter.

Typical retail products are in the 10 to 20 percent gross to net.

So what has happened with Avinza is it has grown so rapidly and in certain channels that it hasn't found its complete level yet.

We would expect that with the distribution service agreements that are now fixed dollar fees per quarter that that percentage that is consumed by the DSAs would in fact shrink.

We would expect that as the retail prescriptions grow, that is non-Medicaid retail prescriptions, that that portion of our business that is represented by Medicaid would also shrink.

So there are several things, the couponing is shrinking.

That has a deduct from gross to net as the new patients starts aren't so big a percentage of our total prescriptions.

So there are a number of dynamics in that gross to net that we think during the third quarter stabilized.

And as we continue to grow now we do feel that we will see some improvement in that gross to net.

Our guidance has assumed that the gross to net will remain constant for the fourth quarter.

And I think as our PCP calls pickup, we would expect that to improve going forward into 2005.

I don't know whether those comments were helpful to you, David?

Yes.

Just one follow-up on that.

In the prior quarter, prior two quarters, you had quantified the amount of returns and the portion of the Medicaid discount that had accrued in prior period.

Can you do that this quarter as well?

We didn't have a repeat in third quarter of the kind of adjustments that we had to do in first and second quarter, which means as we highlight it we felt we had the right rates for the third quarter.

And I think the fact that we're not reporting out any adjustments for the quarter means we pretty much saw that stabilize within our range -- expected rates going forward.

So there really is not an exception item to report out for third quarter.

Just finely, in terms of the breakdown of Medicaid versus retail patients is that -- are the retail patience currently growing or can you break that out for us?

I will hop off after that.

Thanks.

Keep in mind that Medicaid patients do show up in the MPA retail prescription data.

So they are considered a retail Patient.

But we break down the retail prescriptions so far into PDMs, GPOs and HMOs and into Medicaid prescriptions.

We don't disclose the detail breakdown of that for competitive reasons.

What I can give you are some big -- bigger parameters.

For all SR opioids, medicaid prescriptions are typically in the 15 to 18 percent range and that various by brand.

We're right now slightly above that.

And as the rest of our retail business, that is the PDM business and others, which are much lower discount business, as they grow and expand, now that we have those contracts in place, we should see Avinza percentage of Medicaid prescriptions coming back down towards the market rate.

Now that will clearly take us into next year.

But the start up of these big PDM contracts is exactly what you look for.

Once you put those in place your volume starts growing.

We have the PDM, GPO and HMO business that is actually growing faster now that our Medicaid business.

So we need to see that gap open up over time.

And certainly with the big PBMs like Advanced PCS, Merck Medco, as they are coming on stream, we think that sales mix well enrich and back towards the market normals.

There's no reason for Avinza not to be trending back towards the market normals.

Great.

Thank you.

Was that helpful?

Yes, thanks very much.

Meagan Shonota (ph).

Just a question on the category growth.

It appears to have decelerated for the last three months.

And I was just wondering if you could comment on that?

Yes.

Our perception of what is driving that is first and foremost the absence of major promotional activity of the market leader.

If we look at the audits, they are not very good the ones we have, but if we look at the promotional audits, there's no question that Purdue has cut back its investments.

And that always, to a certain extent, impacts overall market growth when you have a market that is promotion sensitive.

So in the first instance we believe some of what we are seeing is that.

Purdue will clearly start to come back in around Palladone and at least in the specialty segment, we should see some further support to the category from those activities.

So that is the first factor.

The second factor is probably more related to some sensitivities around the use of sustained-release opioids.

It almost seems that every other year market growth is impacted by concerns about misuse and abuse. 2003 was a good year after a slowdown in 2002.

And 2004 seems to be slightly impacted there.

Clearly physicians are sensitive to that, and so I think that is the second factor we would point to.

George Farmer.

Paul, I guess implying that you're going to meet your 76 to 77 percent gross margin I think for the year that would imply that you could have an 80 percent gross margin for the fourth quarter.

Is that reasonable to assume?

If the arithmetic works out such that is somewhat dependent on the sales mix.

So you did the calculation, but basically we've seen each square the product margins improve.

And it is based on volume, because we have two components, as you know, of gross margin that go into the calculation that are fixed.

The amortization of the ONTAK and Avinza technology is fixed at about 2.7 million per quarter.

So as the sales of those two products increase, it brings up the overall margin.

And probably our highest margin product, Targretin, as those sales increase that also helps.

So it all comes down to a mix what the actual number will be.

Thanks.

And David, are you seeing penetration of ONTAK into the any other indications, into NHL specifically?

Where we continue to see a lot of interest, and this comes as a result of M.B.

Anderson (ph) data that has been published, is in the refractory B-cell non-Hodgkin's lymphoma patient population, where for those immune compromised patients they simply don't have any other choices.

And because ONTAK doesn't further depress their immune system, this is viewed as a very positive option for them.

So that data having been published shows some pretty good response rates.

And so that is where a lot of the interest is coming.

The second area is in peripheral T-cell lymphoma.

While it is a very difficult small market, it is about the size of CTCL.

And once again there are virtually no good therapies for peripheral T-cell lymphoma patients.

And while the data is limited out there we have several trials going on that oncologists who are treating these needy populations are aware of.

And the drug seems to work pretty well there.

So those are the two principal areas.

I would say we're getting a little bit of use in rat versus host disease because of some pretty good data there, but that is relatively very small patient populations.

I think the principal two are the ones I mentioned, a little bit of CLL use as well.

Jason Aryu (ph).

Let me -- I know that you have addressed this in your remarks, but regarding the Lilly deal and the timing of the option exercises, it seems very much to coincide with when you should be receiving a lot of clinical data, Q4 of this year to early next year.

I am just wondering can you explain the timing of those options?

And it may be in an overall sense, obviously it seems from what you're paying Lilly that you expect ONTAK to grow beyond a 30 to $40 million drug annually.

And so can you just give us your mindset into that deal?

Yes.

First I would reconfirm that the timing of the options really have nothing to do with clinical data or other milestone events around the product.

They were the result of a cash flow negotiation and a revenue timing negotiation.

And that is probably about the best explanation I can give.

We negotiated the transaction independent of knowing for sure that we have the cash from the Royalty Pharma negotiations.

It was quite possible that after going through the process in parallel that we could wind up with one and not the other.

So I think there were cash flow considerations and timing between the parties.

And that really is all the story there is there, Jason.

There is not anything else.

We do, and I would certainly confirm, we would not be investing to bring this product to an attractive gross margin -- we are investing 33 million -- if we did not believe that there was a significant future for ONTAK well beyond the 30 to 50 million range.

Certainly we want to take ONTAK, even in the presence of a win with Targretin in non-small cell lung cancer front line, even in the presence of that, we want to continue to grow ONTAK.

Now that we've solved the strategic and financial dimensions of the product, it will return to shareholders a very attractive rate of earnings.

The infrastructure to support that product, that is a liquid tumor sales force capability is in place, paid for, and at the commercial level it is returning -- even prior to this operational profitability -- its returning a margin or what we would call a net contribution margin.

This will enhance that and bring gross profit margin up by well over 15 percentage points.

So for each dollar we generate of incremental sales, ONTAK will now be a very much more substantial contributor to EPS.

And so as we try to drive the product from 50 to 75 and above the schedule of -- or tiers of royalties, it will be very profitable for our shareholders.

And so with that we certainly will continue to invest in the R&D and in the second generation product to make ONTAK as much as we can make it in the liquid tumor business.

The growth that you see, is that from -- and I know we have trials going on and I think coming to fruition shortly in CLL, NHL in non-small cell lung, is it one of those disease states that you see the growth or --?

I think right now our game plan is towards the end of this year when we have the data from the ongoing trials in CLL, and I think we have most of the data in NHL with one more coming in.

We will make a decision between the two.

I think right now the feedback from the market seems to be saying the refractory B-cell patients after they have been given chemo and Rutuxin they really are needy and their immune system are such they can't take another immunosuppressant therapy, that is white cell immunosuppressive.

So ONTAK is a great product for them, and it seems to be working, the clinical data looks good.

So we haven't made that decision yet, but I think the feedback from the market is NHL.

And then we will wait to see how strong the data finishes up in CLL.

Laque Salle (ph).

My question has been answered.

Thank you.

I'm glad we got to it.

Chris Tanocca (ph).

I had a question regarding the sales force reorganization on Avinza.

You mentioned earlier that there were around 120 doctors in each rep's territory before, and now that is going to be 60.

Could you explain what portion of that change is based on a narrowing of your focus of your target prescribing audience and how much of that is based on actually increased headcount of reps?

Yes, great question, Chris, and thanks for the opportunity to clarify.

The range that we gave in the press release for the prior to reorganization territories was from 20 Avinza targets up to 120.

So you can imagine if a large number of the territories that existed prior to the organization, some had 20, it means a rep didn't have enough Avinza targets to be a good, let's say, or outstanding presenter of Avinza.

Because 20 docs, he can't even hardly in a call cycle get one or two calls a day.

So that rep was under worked, and he was working on other things trying to get in his Avinza calls around the rest of his workload.

In the territory where there were 120 Avinza targets, the representative was not able to cover those.

And so there was an attempt in the overall call plan to try and even that workload by asking reps to help each other out.

That just didn't work very well, because while for a period of time they could try to get some coverage, it wasn't sustainable.

The workload were just too imbalanced.

And because of the imbalance, I think we probably had more turnover in vacant territories than was healthy for the brand.

So in the restructuring what was addressed was to get to -- what I will call Avinza territories, that is all the boundaries are going to be drawn around an efficient call plan for 60 Avinza targets.

And so if you assume that the same 25,000 doctors are being called on, and they are, that is primary care physicians, and you have -- this is roughly 400 territories, that is where you come up with the 60 doctors per territory.

I see. (multiple speakers).

And so what we've got now is the workload of these reps has been prioritized and focused on Avinza, and they have little else to do on a priority basis.

So it is all P1 calls.

It is all focused on Avinza targets.

And now they can efficiently cover those doctors.

Just to contrast it with Ligand territories, our specialty reps and our primary care reps have about 100.

So their workloads are related exclusively to Avinza, and they have nothing else to do.

And they can cover about 100 with the reach and frequency and the deciling that we want.

So this restructuring really does get to where each rep from the Organon side can become really good at selling Avinza, can cover and service his physicians, and can give us the reach and frequency sustainably that we're looking for.

Thank you.

My other question is on generic Oxycontin and how that might affect either your marketing or your pricing of Avinza?

We -- near term and I would say -- I would break it down into 2005, the first competitor that has entered the Oxycontin business has priced very modestly.

There's only the 80 mg strength available.

And that competitor has taken pretty much as much as they want of the Oxy business with very modest price cuts.

Should the other products enter, and they would have a six-month exclusivity period on the other three strengths, 24 and 60.

I'm sorry 10, 20, and I think 40.

Anyway, the other three strengths.

And they would be alone for six months.

So depending upon when they entered, I would expect them to be reasonably cautious with price cuts as well.

That after that period of time, it is going to be by and large other competitors entering.

And the price competition as we move through '05 will become more intense.

I still do not believe it will be like the non-opioid markets' generic competition where kind of no holds barred price slashing.

Because in this category there are a limited number of competitors, but one or two others will enter.

And so there will be more rapid price cuts As they move through '05.

We don't see that environment in '05 with price cuts that are probably going to be in the 30 percent plus range to be anything that we would bump our head against because of the big difference between Avinza cost per prescription and Oxycontin cost per prescription.

We have about a 60 to 70 percent difference at the minimum.

And so generics won't close that gap.

So in 2005 we don't see an impact on our pricing.

Going into 2006, we will watch and monitor how that generic competition impacts and rolls forward.

And we would have to be cautious about the rate of future increases beginning in '06 based on whatever happens with that ceiling above Avinza between the Oxy -- the Oxy generics and Avinza on a cost per day basis.

At this point do you expect the 2006 Avinza sales will be higher than in 2005?

Yes.

Stephen Warren.

Just wanted to check with you a little bit on the stocking for the quarter.

You have given those numbers in the past, I was wondering if you clear some confusion?

By stocking what do you mean?

Specifically on Avinza, I'm sorry, avinza, how much of the Avinza.

Was it a net stocking into the channels and then destocking from the channels?

Is there more out there in the trades than there was last quarter?

I think I can answer that pretty clearly.

We did, and probably you haven't caught up with the press release, it is in the press release.

We did not -- we have done our estimations.

We've got gotten our data in from the wholesalers.

And we don't estimate any significant overall expansion or reduction of wholesaler chain inventories during the quarter.

That is pretty much been our game plan for the year, and that is pretty much held true through third quarter of this year.

Then would it be correct in thinking that the difference between what IMS is reporting potentially is simply a difference in the net effective price that we should be going forward with the modeling and obviously --?

That is a great question.

What I would say is there are several things.

If you're referring to the NSP data, that need to be taken into account.

NSP works on wholesaler to the outlet invoiced price.

Now here that is hospitals they try to approximate the hospital prices.

Where it is retail they look at what went out from them, and so they do their estimates with a mix of prices.

It is not wac (ph).

It is not even a perfect proxy for wac.

It is an IMS set of formulas.

So there will always be some mix of prices in there that account for some variances in IMS estimates.

So that is number one.

Number two, if you look at the IMS, NSP data, taking third quarter at 38 million, it is constant from quarter to quarter, and that is the good news.

You can see the dynamics of the business.

But it doesn't incorporate all of the business in a balanced way.

Examples.

You have in IMS not a very good proxy to estimate things like Kaiser, Wal-Mart, fairly substantial movers of product.

They don't have a good estimate for them in how they estimate here.

So depending upon how strong a given product's business might be in that, the estimates won't capture that well from quarter to quarter.

Same thing goes for, if you do business directly with Walgreens, as opposed to Walgreens buying from the wholesale channels, IMS can be in the the NSP data fairly substantially off in estimating a given product's sales.

So those are things which quite frankly even we don't have a good way of having a perfect handle on.

We are collecting now through the DSA agreements better and better wholesaler information about out movement, and we're trying to piece all that together.

But I think that as IMS projects it you need to be aware that there are both price differences, channel and sales mix differences that their estimates will simply not give on a quarter to quarter basis.

And I probably haven't been helpful to you.

I've confused your modeling attempts, but I think it is really important to appreciate those differences.

Thank you.

That's not confusing.

Then just one final question.

I was wondering if you could give us the percent of total revenues you expect Avinza to comprise?

Yes, we're trying to keep overall products sales guidance between -- to a gross level.

I think we have been watching Avinza and oncology kind of split approximately two-thirds and one-third throughout the year.

That can vary a little bit from quarter to quarter, but I think we can't fine tune it better than that.

Michael Higgins.

I was hoping if you could clarify for us, as you did in the second quarter, the difference between the, in this case, the 38 million to the 28?

I know it has been brought up a little bit, but if you are able to quantify what those items are in between the 38 and the 28?

The items -- I apologize, I don't have an exact reconciliation here for you. (technical difficulty) there are the usual category of deducts which range from charge backs and rebates to the cash discounts to whatever allowances in a quarter were paid to the wholesalers, to the distribution service agreements, to the cost of coupons that we do on Avinza.

Pretty much that range back and the discounts to PDMs, GPOs and HMOs.

So that is always what goes into the difference between our reported gross sales and net sales, keeping in mind that IMS is not a perfect proxy for our gross sales.

If you're trying to look at the 38 to 28, that is what goes into those line items.

And I think that that rate that we saw in third quarter -- I don't know whether you were on the call for some of the comments I made about dynamics going forward, but we certainly saw that gap between our gross and our net, not necessarily IMS estimates of the overall gross.

We certainly saw that gap stabilize in the third quarter.

We did not have any additional surprises on Medicaid rebates or on returns, so those components in there are pretty much stabilized.

I don't know whether that was helpful to you?

Yes.

Is there -- was there any one time hits from the expanded access through PDMs and so forth?

We would say not one times in the sense of adjustments.

What we would say is we saw the sales mix grow in the direction as we expected of increased PDM, GPO and HMO business.

And we would say that we would expect that to grow further.

We view that as positive because it is much less discounted business than our Medicaid business.

And that is the area we need to grow as our primary care sales forces promote where that business, that retail business is going to come, is from the managed care contracts that we have in place.

And that will be a favorable (technical difficulty) overall mix effect even if that segment grows faster because it is much less discounted business than the Medicaid business.

David Mena (ph).

Just one follow-up question on the expense side.

Can you clarify the guidance for the fourth quarter operating expenses?

Yes, the operating expenses for the full year would be between 166 and 170, so that translates to between 44 and 48 for the fourth quarter.

And again, operating expenses is defined as R&D expense, SG&A expense and the copromotion expense for this purpose, and it does not include the cost of products sold.

There are no further questions. (OPERATOR INSTRUCTIONS).

I think that we have probably over stayed our welcome on the call, so we thank you very much for participation today.

And as always in the future we will be available for calls off-line, if something else comes up.

Thank you again.