Penwest Pharmaceuticals Co. (PPCO)

Q3 2008 Earnings Call Transcript

November 4, 2008, 11:00 am ET

Executives

Jennifer Good – President and CEO

Ben Palleiko – SVP, Corporate Development and CFO

Analysts

Ken Trbovich – RBC Capital Markets

Larry Neibor – Robert W. Baird

Corey Davis – Natixis

Wayne Rothbaum

Scott Henry – Roth Capital

Angela Larson – Susquehanna International Group

Arthur Freedman [ph]

Bert Hazlett – BMO Capital Markets

Tim Chiang – FTN Midwest Securities

Presentation

Operator

Good morning. My name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2008 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Ms. Good, you may begin your conference.

Jennifer Good

Good morning, everyone. Welcome to our review and discussion of Penwest results for the third quarter and nine months ended September 30, 2008. Joining me on the call today is Ben Palleiko, Penwest’s Senior Vice President of Corporate Development and Chief Financial Officer.

I' will provide an update on our business as well as the priorities for the remainder of the year. And then Ben will discuss the financial results for the quarter and nine-month period. After our prepared remarks, we will open up the call to answer any questions you may have. We have been busy on three primary fronts; advancing the drug we have under development, actively working on multiple licensing efforts, and finally, aggressively controlling our expenses and related burn within the company. I will touch on each of these areas.

But first, let me provide an update on Opana ER. The third quarter was an important one for us on the Opana front as we recorded our first revenues from the product. We completed the royalty holiday period provided for in the contract during the quarter and will now begin receiving 50% of the royalties due to us while we work off the $28 million of development costs incurred by Endo on our behalf during the development program. When Endo released its earnings late last week, it reported an increase in sales for the Opana franchise of 73% to $41.5 million compared to $24 million in the same period a year ago. Endo also reported a prescription volume for the franchise increase 80% in the third quarter of 2008 versus the comparable 2007 period.

For the nine months ended September 30, 2008, net sales for the Opana franchise increased 64% to $128 million compared to $78 million in the same period a year ago. As a reminder, we are involved with Endo on the extended release product in this franchise, which according to recent IMS numbers represents about 82% of the underlying prescription demand.

Endo discussed on its call last week that this increase in sales reflects strong prescription demand as well as a success of its physician targeting program. Endo has also had success with managed care conversions. During the quarter, they signed an additional five new managed care contracts. We are pleased with the continued growth of this product and the priority it has within the Endo sales force.

Turning now to the areas that have been keeping us busy. We made important progress during the quarter on the two products that we have under development and advanced two additional drugs we are developing under drug delivery collaboration deals. In July, we announced that we had begun dosing in Phase Ia clinical trial of A0001, a molecule that we are developing for the treatment on certain mitochondrial diseases.

The clinical trial was designed to evaluate the safety and tolerability of A0001 at various doses and to collect pharmacokinetic data. As we announced this morning in our press release, this trial is complete and the results from the trial support our advancing to the next phase of development. There were no drug-related serious adverse events in the study and a pharmacokinetic range was achieved in dosing. Penwest is proceeding with plans to initiate a Phase Ib multiple ascending dose trial to assess safety and tolerability following repeating dosing in healthy subjects. If all goes well, we would then advance the product to a Phase IIa trial in patients.

In July, we also began dosing of Phase I clinical trial for PW4153, an extended release formulation of carbidopa/levodopa that Penwest was developing for the treatment of symptoms of Parkinson's disease. The goal of this formulation was to extend the dosing and level of the drug while minimizing the peak to trough ratio. We believe it could enhance the efficacy tolerability and convenience of the drug for Parkinson’s patients. As we announced this morning, we did not meet the targeted profile. And a result, the company has terminated this program.

Our pharmacokinetic profile did match the currently marketed ER version on the product, Sinemet CR. But we believe that because of the absorption window and variability of the drug, we were not able to improve upon this profile and therefore it did not want our continued development. We continue to believe that dosing carbidopa/levodopa in a more sustained manner could have important benefits for patients. However, we have convinced ourselves that it is not technically achievable through the oral delivery route.

Next, our development team has been busy working on the two collaborations we signed with Otsuka and Cobalt that utilize our drug delivery technology. During the quarter, we completed work on the Otsuka compound and will now wait for the result of this clinical trial. The work on the Cobalt compound will continue on to the first part of next year. As these are not our compounds, I will not be providing any additional information or guidance on them until we either achieve a successful contractual milestone or the program is terminated.

Completing business development deals for the company is important to increasing our cash position as well as advancing programs that are not core to our strategy. We have three primary assets available for license; nalbuphine ER, Opana ex-US, and collaborations utilizing our drug delivery technology.

I’ll now give you a brief update on each of these assets. Nalbuphine ER is a drug we have been developing for moderate chronic pain that completed a Phase IIa trial in chronic pain in the first quarter of this year. We have largely completed the design of a Phase IIb trial for this drug candidate. However, because pain is not core to Penwest’s strategy and the cost involved in conducting a Phase IIb trial are significant, we are actively seeking a partner to co-develop this drug. We are still active in that process.

We have discussed in the past that Endo was in discussions to out-license Opana ER in Europe. Based on BD priorities at Endo around in-licensing, Endo has transferred the lead on efforts to license this drug in ex-US territories to Penwest. We are currently evaluating the opportunities for this product in various territories outside of the US. We do not currently believe a deal can be signed by the end of this year. But we will be spending efforts to realize value on this product outside of the US opportunity. Finally, on the drug delivery front, we are in discussions regarding several potential collaborations and believe we will find one additional deal by year-end.

Before turning the call over to Ben, I want to comment on our steps to control expenses and the related burn within the company. We are continuing to manage this company so that we will not have to raise capital in 2009. We have managed our cash throughout the year by downsizing our workforce, cutting or renegotiating all non-essential overhead expenses, and expending significant efforts to license assets that are not core to Penwest mission.

Tightly controlling our cash burn continues to be a high priority for Ben, for me, and for our Board. This quarter you can see a reduction in our operating expenses, both in SG&A and R&D, as well as a reduction in the cash burn. We will continue with these efforts as we try to build value in the company without raising additional capital to do so.

In closing, it is a very tumultuous time both in the macro economy and for small cap stocks in the biotech/spec pharma space. Our staff is obviously no exception. Like other than our industry we feel this pressure and are acutely focused on trying to build incremental value inside the company while ensuring that we will not need to access the capital markets next year. We are focused one executing a strategy of licensing the available assets we have to fund the development of select programs that we believe are meaningful and can generate value for Penwest shareholders.

We, as a management team and Board, believe this is both an achievable and manageable strategy. I understand the risks of trying to develop a pharmaceutical product. But we are following a path with definable checkpoints and that can be course corrected if necessary. I believe we demonstrated this in the termination of our carbidopa/levodopa program and the advancement of A0001.

I have a strong conviction that we are taking the right step to build this company for the long-term based on the fundamental financial principle of the business, increasing revenues by leveraging and developing assets that have real value. I also believe it is important to do that in the least dilutive way to our shareholders, which will likely require some pacing of our investments. Although this pacing comes with the price of time, I believe it is necessary in these difficult and uncertain financial times. These are the principles in which we are building Penwest today. I think we demonstrated progress during the quarter on all the fronts under our control and we will continue to try to make the most out of what we have.

I appreciate your patience and look forward to things improving, as I know you all do as well. I will now turn it over to Ben to discuss the financial results for the quarter and nine months.

Ben Palleiko

Thank you, Jennifer, and good morning. The net loss for the third quarter of 2008 was $7.3 million or $0.23 per share compared with the net loss of $9.3 million or $0.40 per share in the third quarter of last year. For the nine months ended September 30, 2008, our loss was $24.5 million or $0.83 per share compared to $25.2 million or $1.08 per share for the comparable period in 2007. The decrease in the loss for both of these periods primarily reflects lower operating expenses and higher revenues. These were partially offset by decreases in investment income due to the lower interest rates and average balances on our cash and securities balances.

As Jennifer mentioned, we completed our $41 million royalty holiday on Opana ER royalties in the third quarter and recognized revenues of $577,000. Our total revenues for the quarter were $1.4 million compared with $882,000 in the third quarter of 2007. Besides royalties from Endo, our other revenues in the third quarter were derived primarily from our continuing royalties on sales by Mylan Pharmaceuticals of Pfizer’s 30 milligram generic version of Procardia XL, although we also recognized $209,000 in revenue related to our ongoing drug delivery collaborations.

For the nine months ended September 30, 2008, our total revenues were $3.4 million compared to $2.4 million for the comparable period in 2007. This increase is due largely to the Endo royalties and drug delivery collaborations revenues, partially offset by a continuing decline in royalty revenues from Mylan.

Selling, general and administrative expenses in the third quarter were $2.2 million compared to $3.4 million in last year’s third quarter. This decrease is due primarily to a $470,000 reimbursement from Endo recognized in the third quarter related to the legal expenses associated with our generic litigation as well as lower stock-based compensation, facility related costs, and other operating expenses.

SG&A expenses for the nine months ended September 30, 2008 were $9.6 million, a decrease of $1.2 million from $10.8 million from the third quarter of 2007. The nine-month expenses include a $1 million charge recorded in the first quarter related to a $1 million loan made to Edison as part of our agreement, offset by the previously mentioned reimbursement from Endo and lower expenses.

Research and development spending for the third quarter was $5.9 million compared to $6.6 million in the third quarter last year. This decrease was due to lower contractual payments to Edison, overall lower program spending, primarily due to lower spending on nalbuphine ER and lower operating expenses, partially due to headcount reductions and other expense controls implemented in the first quarter. Partially offsetting these reductions was $490,000 patent impairment charge we recorded on patent costs related to certain programs and other patents that we decided not to maintain for various reasons. Our last full sponsored research payment to Edison under the terms of the collaboration agreement was made earlier this month and our last partial sponsored research payment will be made in January.

For the nine months ended September 30, 2008, our R&D expense was $16.8 million, a decrease of $254,000 from $17.1 million in the comparable nine months of 2007. This decrease is primarily due to overall slightly higher development expenses offset by the patent impairment charge previously mentioned. In addition, headcount reductions and allocations of costs to the ongoing drug delivery collaborations contributed to the overall decrease in R&D expense.

As promised earlier this year, we have placed great emphasize on reducing our operating costs and managing our cash balance closely. Our overall operating expenses as of the end of the third quarter are 19% lower than the comparable period of 2007 and 5% lower year-to-date, despite the fact that the majority of the cost reductions were not fully implemented until the second quarter.

As of September 30, 2008, we had cash and investments of $23 million compared to $23 million at December 31, 2007, and $28.7 million at the end of the second quarter of 2008. As a result of our cost controls and development plans for the rest of 2008, we anticipate that our cash and investments balance at the end of the year will be towards the higher end of the $14 million to $16 million range we’ve previously provided. We believe that this cash level combined with the royalty payments we anticipate receiving from Endo and other sources will be sufficient to fund our operations into at least the first quarter of 2010.

In closing, I want to emphasize that we continue to be as conservative as possible in our financial assumptions, given the current economic environment. We are currently in the budgeting process and are constructing our plans for 2009 with high control of overhead expenses and staged program spending to enable us to operate through at least next year and potentially beyond without requiring the company to access the capital markets.

Our guiding principle is to make responsible investments in our programs, pursuing the best opportunity in achieving what we can while acknowledging that not everything is possible in the current climate.

With that, Jennifer and I would now like to open up the call for any questions that you may have. Jennifer?

Question-and-Answer Session

Operator

(Operator instructions) We have a question from Ken Trbovich.

Ken Trbovich – RBC Capital Markets

Thanks for taking the question. I guess just really quickly, Ben, if you could go back on that patent impairment charge, was it $490,000 or $440,000?

Ben Palleiko

$490,000.

Ken Trbovich – RBC Capital Markets

$490,000? And was that related to the program you terminated or is that related to any products that are currently available on the market?

Ben Palleiko

Partially, primarily it’s related to actually a bunch of patents that are in other geographies and other programs that we terminated a while ago. So it’s not related to actually anything that’s currently marketed on ER.

Ken Trbovich – RBC Capital Markets

Okay. And then just with regard to the payment that you referred to on the reimbursement of legal fees, is that a catch-up payment for expenses incurred in prior quarters or is this just the amount that happened to fall into the quarter?

Ben Palleiko

No, that was essentially payment for all the expenses we incurred prior to the revision that we and Endo signed in July where they agreed to pay for all the costs going forward. There was a lump sum repayment.

Ken Trbovich – RBC Capital Markets

Okay. And then for Jennifer, I guess you mentioned taking over the efforts to try to find a licensing partner for Opana ER in Europe. Do you see this as starting from ground zero with this effort now? And then I guess secondarily, is there any benefit to be in charge of those discussions as you also are looking for a partner on nalbuphine?

Jennifer Good

Good question, Ken. First of all, I think I want to be clear. So we’re taking over licensing effort sort of ex-US. So I think the first thing I’d say is all territories where pain drugs make sense will sort of to be fair territory. It’s definitely not ground zero in Europe. Endo did a lot of effort there. We sort of know-who showed an interest at one point in time. So we’re not starting from the ground. And as far as being able to leverage nalbuphine, I don’t know – I mean it’s certainly something we’ll try to do, but most of our nalbuphine efforts really have centered here around the US and we are sort of ways down that path. Our efforts on Opana really are going to be ex-US. So, of course, we’ll think about that along the way. But to be fair, I’m not sure there’s going to be a whole lot of overlap, because we’re talking to folks about marketed products and that’s sort of back to development stage.

Ken Trbovich – RBC Capital Markets

Okay. Thank you.

Operator

You have a question from Larry Neibor.

Larry Neibor – Robert W. Baird

Thank you. Good morning.

Ben Palleiko

Hi, Larry.

Larry Neibor – Robert W. Baird

Could you give some idea of what your royalty payment for Opana ER would have been? Had the holiday been completed at the end of the second quarter?

Ben Palleiko

Yes. Ex the $28 million recoupment, it would have been right around $5.9 million.

Larry Neibor – Robert W. Baird

$5.9 million. And what remaining sales need to occur –?

Ben Palleiko

I’m sorry, Larry. Larry, I’m sorry, I’m just reading the sheet here, let me take that back. That would actually have been the exclusion amount. The gross royalty would have been around $7 million.

Larry Neibor – Robert W. Baird

$7 million. Thank you. And what are the remaining sales to full royalty payment?

Ben Palleiko

I don’t actually have that calculation handy. It’s $28 million less the $600,000 we recognized, divided roughly $0.1 million. So –

Larry Neibor – Robert W. Baird

Right. Okay. And you don’t intend to access the capital markets going forward. Do you have credit lines available from anywhere?

Ben Palleiko

No, we do not.

Larry Neibor – Robert W. Baird

Okay, thank you.

Operator

You have a question from Corey Davis.

Corey Davis – Natixis

Hi, thanks very much. I’m with Natixis. I know it’s kind of old news, but given the upcoming headcount for both (inaudible) it may be topical, so maybe could you remind us of two things. One, how susceptible is Opana ER to abuse and diversion, things like crushing and dissolving in alcohol? What types of studies have you done? And secondly, I know it’s probably more an Endo’s camp, but any comments you want to make about how strong the current risk mitigation program is? And do you think there is a chance that if the FDA does approve these new abuse deterrent systems that they ask you to step up the REMS [ph] program on Opana ER?

Jennifer Good

Thank you, Corey. I’ll do sort of the best I can. You’re right. These are better sort of Endo questions. With regard to Opana ER, although the TIMERx technology has, I think, features that reduce abuse and we’ve actually got patents filed in that area, Endo chose not to try to pursue that in the label at all. And that was really sort of due to the climate at that time. They felt like that was sort of a hot potato. I think that’s sort of cleared up somewhat at this point. So the current label for Opana ER does not allow Endo in any way to market that around sort of being less abuse resistance I guess. They clearly have their own thoughts around sort of pursuing this area and you may see some follow on in that space. As far as the risk mitigation plan, when Endo got Opana approved, they set a very high bar around risk mitigation. There was a lot of focus on that area at that time. We got very good feedback or Endo got very good feedback from FDA about what they were proposing. And so I would not anticipate having anything else come out of it because I think they have already got a high bar around that. We have not had a lot of issues with diversion of Opana. So I’m not worried about that risk. I haven’t heard Endo worrying about that risk, but again that’s a good Endo question.

Corey Davis – Natixis

And just back to the patents that have been filed regarding some sort of testing that you’ve done, have those patents been published?

Jennifer Good

The patents around abuse resistance?

Corey Davis – Natixis

Yes. Abuse –

Jennifer Good

Yes. We have some patents on abuse resistance. I don’t have the numbers right in front of me, but if you want to call back and talk with Ben and myself, they are published.

Corey Davis – Natixis

Sure. And I was just getting at whether or not some of the data that you’ve generated is in the public domain. It sounds like yes.

Jennifer Good

Yes, they are. And I think, Corey, too some of the alcohol resistance with the alcohol dose dumping stuff, that’s been published as well. You could get at some of that.

Corey Davis – Natixis

Okay. Thanks, Jennifer.

Jennifer Good

You bet.

Operator

You have a question from Wayne Rothbaum.

Wayne Rothbaum

Hi, guys. Thanks for taking my question. Two quick questions. One is around nalbuphine. Can you just walk us through – maybe I missed it, but I’m here – the timelines for a corporate partnership of when do you think – and at one point we were talking year-end, it seems like that’s probably being pushed out a little bit. But when could we expect or when do you expect to try to execute a deal? Do you expect to try to execute a deal?

Jennifer Good

Okay. You have a second question, Wayne? You said two.

Wayne Rothbaum

Yes. The second question is, I want to talk a little bit about the generic – the thread of generic entries and about incoming royalty streams. And have you given thought to any type of dividend where you give back to shareholders some percent or some piece of that cash or that royalty cash flow?

Jennifer Good

Okay.

Wayne Rothbaum

In other words, is that on the table? Is this a strategic option?

Jennifer Good

Yes, I understand. Okay. So first of all, with regard to nalbuphine, we have had a lot of efforts underway in this area all year, as you know. We actually were in pretty heavy discussions around a lot of the pain, spec pharma pain companies. For various reasons, a lot of those companies are sort of in motion right now, which a lot of you are aware, which I think has sort of made some of our process a little bit lower. When we recognized the lot of that was going on, we have branched out and have started pursuing sort of I think the strategic partners but not necessarily right in that pain space. So, to your point, Wayne, you’re right. We had set as a corporate goal trying to get a deal done by year-end. I cannot – sitting where I do today, I can’t tell you with assurance that’s likely to happen. We are not giving up on that internally, obviously. But I’m not close enough to a deal sitting here today that I can tell you with some assurance that will happen. I can’t tell you that there is enough interest that we are clearly still in active licensing discussions around the product. So that’s probably the best update I can give you. With regard to your generic entry and royalty streams, I understand the question. We’ve discussed this in the past. I think overall the fundamental concern is there is a pretty good royalty stream that’s going to be coming into the company certainly through the next couple years, and Endo and Penwest are going to do everything they can to make that go much longer. And it becomes the whole moral hazard question of just blowing through that royalty dream. I want to give some assurance to our shareholders that that is not the intent. I think during [ph] 2009 where we are in this repayment period and the company is not in a position to be meaningfully profitable. My belief and the Board’s belief is there are incremental investments that can be made and tightly controlled to try and drive value. But there is a point in time that this company can become meaningfully profitable. We recognize that we need to do that. And we also need to be considering mechanism by then to get some of that royalty stream back in shareholders' hands. And, Wayne, we’ll need to think through whether that’s dividending or share buyback or what the right structure for that is. But my feeling is that of 2010 sort of decision for us. But it is definitely something discussed at a Board level and something that’s very much alive inside the company.

Wayne Rothbaum

Okay. Maybe we can talk about that more offline because I want to walk through the financials with you as well regarding how that all play out. Okay, thank you.

Jennifer Good

Well then, that’s have to be that.

Wayne Rothbaum

Yes.

Operator

You have a question from Scott Henry.

Scott Henry – Roth Capital

Thank you. And this is a question for Jennifer, and it’s a bit on the strategy side, and I want to push you a little bit because I think it’s necessary. My question is, has the world changed a little bit for Penwest? And I really question whether the company is a viable entity for early stage drug development? I mean, $30 million a year in SG&A and R&D – $30 million to $40 million, might not be viable. So my question is, has the Board considered other options such as selling the assets, becoming an Opana royalty stream company, and running the company kind of for the shareholders? What is the Board doing to consider this option?

Jennifer Good

Okay. First of all, I think your numbers are high, Scott. I mean, our net loss – our SG&A investment through nine months is roughly – the bottom line is roughly $25 million. So –

Scott Henry – Roth Capital

It was $38 million in ’07.

Jennifer Good

What’s that?

Scott Henry – Roth Capital

It was $38 million in ’07, $23.5 million and $14 million. And I’ve got $36 million in ’08. Now there are shareholder – I mean, there are options in there, but that doesn’t give me any more comfort.

Jennifer Good

The number is coming down. I think to your point, the burn this quarter was roughly $6 million. So I mean, we can sort of start from that premise. I think it doesn’t obviate your question, which is, is it a better strategy to just take the Opana royalty stream and try to dividend it out to shareholders. I think the problem is – and yes, that has been discussed at a Board level multiple times, not only among our own team, we’ve brought in outside advisors to have this conversation I think to bring sort of a sanity perspective on this. We’ve looked at comparable companies who have tried to do similar paths. I think the challenge around the Opana asset right now is some of the uncertainty around the IP, so trying to either sell the royalty stream and monetize it and distribute it to shareholders becomes challenging because you can’t find the IP landscape. And if you just shut down the company and try and distribute out over time, your stock is certainly not going to trade off any kind of multiple that’s interesting. We’ve done for comparable valuations. And quite frankly, it doesn’t bring much to shareholders. So, the view from the Board is, if we can control our expenses, we do believe there are assets in the drug delivery technology that’s leverageable. We have signed in the last nine months and we are sort of – but we will sign one again in the next few quarters. Although those are small, I think it’s an asset that’s leverageable. I think the A0001 programs in some of our mitochondrial work we think there's real value. And it's definable milestones again that we can control. There is licensing programs that we can out-license and drive value. So the problem with shutting things down and just running it for the royalty stream as you essentially cap the upside. And when you net present value that out and look at the stock today, it really does not drive the stock increase for the shareholders. What it does is essentially put a cash flow under the stock. But it’s pretty low cash flow based on the uncertainty around the IP today. So that’s largely the logic by the Board.

Scott Henry – Roth Capital

Jennifer, I mean, if I could just put the other argument, the stocks at $1, and you’re talking about multiples. The problem isn’t the Opana uncertainty. The problem is the $30 million to $40 million in overhead that gets spent a year. Investors can deal with the uncertainty. The question in my mind is, you can run this company with fewer people. I mean, it’s inevitable that something has to give at some point.

Jennifer Good

Well, Scott, on the people side, that is something that’s always up for discussion, really based around sort of what the activity is going on in the company. I mean, we did cut heads earlier this year. We cut 14, 15 folks out. That’s something that will consistently need to be reevaluated based on what’s going on within the business. So I’m not telling you overhead won’t be reevaluated. It’s just a matter – I think fundamentally the discussion is, are you just going to be an Opana royalty stream company? Are you going to try to create value-add of the other remain assets in the business? You got believe there is other assets here. You got to believe that this team can do it. And I think that’s what a Board of Directors is really paid to evaluate. So to me, the cost overhead structure will constantly be reevaluated based on what’s going on in that side of the equation. But that’s the calculus.

Scott Henry – Roth Capital

Okay. Well, I appreciate your feedback, Jennifer. And I think it’s an appropriate issue. And I think the Board has to consider the viability of the funding for the long-term for early stage R&D, but you guys are in charge.

Jennifer Good

No, Scott, it’s a fair point. And you’re not the only person raising this. And it’s something we do debate probably almost at every Board meeting based on current facts and circumstances, and we’ll continue to do that.

Scott Henry – Roth Capital

Okay. My suggestion would be to get the overhead under $20 million at a minimum, but that’s just my suggestion.

Jennifer Good

Okay.

Operator

You have a question from Angela Larson.

Angela Larson – Susquehanna International Group

Good morning, and thank you for taking all the questions. On the mitochondrial program, could you give us a little bit of color of how – I know the A0001 is going forward, but how many other identified compounds there might be and the nature of how quickly this program could move forward, and if there is any specifics about which specific diseases you are looking at?

Jennifer Good

Sure, Angela. It’s good to hear from you, by the way. The mitochondrial program, so we have rights to another NCE from Edison behind A0001. We’ve also done some work inside our own shop to identify other compounds we believe are accessible that could be developed in this space. The reality is sort of based on the prior conversation with Scott. We’re going to need to pace those investments along as much as I’d love to have forth our development efforts going in the space, because I believe the market opportunities there and I actually think this is a solvable equation with some kind of drug development strategy. We’re going to have to pick our one or two best bets and sort of play them even though in a perfect world that’s not what I would do. As far as diseases we’re looking at, we are looking at a lot of these orphan pediatric diseases that currently don’t have therapies. The mitochondrial respiratory chain diseases are things like Friedreich's Ataxia, which Santhera is working on now; a disease called Milof [ph], which Seratres is also dosing in a Phase I study, Leber's hereditary optic neuropathy and some (inaudible) deficiencies. We’re going after this from a little different angle than, for instance, Seratres is going out of (inaudible) perspective. We are really taking the anti-oxidant channel. We also believe this compound, as we prove it out I think in the space we’re focused on, could have applications in a lot broader areas. I think these are bigger disease states that we probably wouldn’t pursue. But there may be options for us to find partners who actually develop them in these bigger spaces. So I think there are leverageable points in this program. Clearly, you got to get past the safety hurdle and then I think you can start exploring where this drug might work from an efficacy perspective.

Angela Larson – Susquehanna International Group

That’s helpful. Thank you.

Operator

You have a question from Arthur Freedman [ph].

Arthur Freedman

Yes. Hi, Jennifer and Ben. I have a question, I want to understand now that the royalty holiday of $41 million is completed, so exactly how is the revenue stream going to work going forward? So, for example, if you had $1,000 worth of sales of Opana ER, how much is Penwest going to get? I really want to clearly understand it now.

Ben Palleiko

Okay. So we have a – we get a royalty from Endo based on annual net sales of the product. And that royalty range rate is between 22% and 30%, a total of six tiers, and then escalate throughout the year as the product sales cross during [ph] threshold. Most of those thresholds haven’t been disclosed, but it has been disclosed that the royalty rate goes from 20% to 25% at $150 million in net sales. So in theory for your – whatever – your $1,000 in net sales number, they give at last 22% of that, so $220. But offsetting that is the fact that as probably that agreement we made with them that transform this into a royalty agreement, we agreed that Endo had the right to recoup $28 million that they spent on our behalf during the development of Opana ER. And the way we do that is by keeping half of the calculated royalty until the half that they retained adds up to the $28 million. So that $220 for the time being, they would only have to pay us $110. And that’s what you saw the numbers I talked about here in the third quarter, which is Endo booked a gross amount of Opana ER sales that hasn’t been disclosed. And on the net of that, they calculated the royalty. There was – in the third quarter, there was a little bit of a royalty, excluding the amount that was left over, that was about $5.9 million that have been previously disclosed by us. And so they owed us basically 11% of what was left after the exclusion of the amount came out, which is what got us to the 5.77 for the quarter.

Arthur Freedman

All right. So, in other words, basically going forward though, we should expect to see a lot more income coming in for the company, no?

Ben Palleiko

Well, right. What you will see hopefully is the product sales continue to grow. We’ll be booking more royalties. We’ll book more royalties in the fourth quarter simply because of the fact that $41 million now has completely gone. So what we will get next quarter will be exactly half of the calculated royalties. So next quarter – in the fourth quarter, royalties should be substantially high than the third quarter anyway. And then through our next year they will grow with Opana sales. And then once the $28 million has been recouped, you should see the royalty effectively double in one quarter as we move into the period where there is no withholds at all.

Arthur Freedman

Right. Okay. I just want to make sure – I and everyone else on the call was clear on that, because to me that’s positive. But I want to make sure I understood it. The last question that I have today, I just want to understand – I was surprised to hear that Endo had turned over to you the whole licensing in Europe. And did that surprise you guys, or can you tell us why that occurred?

Jennifer Good

Yes, Arthur. It’s not really – Dave Holveck, the new CEO there, he is clearly aggressively trying to build Endo in a direction in a vision that he has, which involves a lot of in-licensing activities. He has got that organization hustling. I have to say he has been terrific to deal with from our perspective. He knows that it’s important to us to try and realize value-added. So essentially I think he is a good collaborator. He said, look, we don’t have the bandwidth. I’m running tight. If you want to take this asset, we’ll support your effort from a diligence perspective and sort of closing that, you guys go look. And so I appreciate that. I think it’s – again I think the relationship there has been good. And I think he is trying to support what we are trying to do here.

Arthur Freedman

Okay, great. Well, thank you very much.

Jennifer Good

You bet.

Operator

You have a question from Bert Hazlett.

Bert Hazlett – BMO Capital Markets

Thanks. Good morning. Couple questions, Jennifer. First on – you mentioned previously about the abusability discussion with Endo. And you characterized that as a – with Opana, you are of course. You had characterized that situation as kind of a hot potato at that point. But the situation appears to be changing. And the question is, is there anything to be ferreted out or teased out of Opana ER given that abusability is now something that’s certainly wanted necessary etcetera, etcetera? Is there anything you can do surrounding that at this point? And I have another one to ask.

Jennifer Good

All right, Bert. Yes. I mean, I think the views at Endo have changed around sort of where tamper resistance fits in the marketplace. I think before they didn’t want to get into that, I do believe those views have changed. Clearly I see (inaudible) in this space. And we sort of have an ability to do that. So I don’t want to get into Endo’s lifecycle management strategy, but I do believe that I guess the views around sort of tamper resistance and its value in the marketplace have evolved there.

Bert Hazlett – BMO Capital Markets

I would suggest that we would likely to get in to Endo’s lifecycle strategy and some discussion about this franchise. Again, that’s the critical aspect of your business at this point I think. Can you share any additional color there?

Jennifer Good

Not at the risk of having Endo strangle me. So, no. They don’t talk about it publicly and it’s not appropriate for me to get ahead of what they want to say, Bert. So I understand – I mean, it would be great for our shareholders, I just can’t get ahead of our marketing partner and sort of their plans on lifecycle management for competitive reasons.

Bert Hazlett – BMO Capital Markets

Okay, thank you. I appreciate that. But there is something going on there. And there are more efforts being contemplated given the fluidity of the situation there.

Jennifer Good

Yes. I mean, Endo is up. Dave Holveck himself was publicly saying that they are working on lifecycle management on all of their products. And so, yes, I can confirm there’s stuff going on there.

Bert Hazlett – BMO Capital Markets

Okay, great. And then back to kind of an earlier comment or question, certainly expenses are a concern and we can appreciate that. But really the fundamental issue is the fact that how long life an asset is Opana ER and how much – how long the royalty streams you have out of this? So, we’ve had a lot of discussion on patents previously, but with the 192 final rejection, could you talk about just in brief terms maybe over the – for the next 18 months, what are your expectations for additional patent protection for Opana ER? And if you can say, kind of specifically, maybe a road map [ph] just in general terms what are the incremental efforts that are going on that will be critical for protecting the franchise, and certainly efforts that are potentially orange book listable?

Jennifer Good

Yes. So I think, Bert, fundamentally we’ve pretty much shot up the formulation. I think fundamentally from here there is really two types of patents or buckets of patents. One is clearly these clinical patents that Endo has been prosecuting. I think the most visible and the most broad is 192. You are right that it did get a final rejection in September. Endo now needs to make a decision that it will either go to appeals with that patent or trend, work its way back to the examiner. I don’t believe they have made that public what their decision is. So I don’t want to get ahead of that. But I think it’s fair to say shareholders will have visibility on that over the next couple months where they are taking that whole scenario. Endo is acutely aware they need to get these patents issued in 2009. So they are clearly on the strategy to do that. They are also prosecuting three additional patents. And they are quite frankly at similar decision points with all three of those patents. So I think, Bert, on this Endo clinical side, you will be able to see sort of their strategy around these patents over the next couple months, as that will be available on the PTO website. On our formulation side, we are also working through some of these abuse resistance and alcohol resistant patents. We actually had made good progress on getting those patents allowed. And then with the generic filing for litigation, they have to go back to review at the PTO. We do expect to hear decisions on those over the upcoming, say, six months or so. And I think all these patents provide incremental coverage. So there is a lot of activity going on in that front. And suffice it to say there is a plan, an aggressive plan in place to get incremental patents issued through ’09.

Bert Hazlett – BMO Capital Markets

Thanks. I appreciate the color.

Jennifer Good

You bet, Bert.

Operator

You have a question from Tim Chiang.

Tim Chiang – FTN Midwest Securities

Hi, thanks. I wanted to – have a question on the finances. I think you said $14 million to $16 million of cash that you will finish the year at. Does that figure include the cash that you likely will get from Endo in the fourth quarter on the Opana royalty?

Ben Palleiko

So what I’ve done before was got that to $14 million to $16 million to year-end cash. And what we think we said today, what I meant to say today (inaudible) clearly was that we expect to end at the higher end of that range. The way our Endo royalties work is that we record it in the quarter what Endo does, but the check actually comes 60 days after the end of the quarter. So at the end of this year, we will have received the check from the revenues recognized in the third quarter, but obviously the money for the fourth quarter royalties won’t come until Q1 of 2009, which is sort of a long way [ph] of saying we will have part of the royalties recognized – part of royalties in the bank at year-end, but a bigger chunk of them are out.

Tim Chiang – FTN Midwest Securities

Okay. And then, Jennifer, my question to you is, how much discussions have you had with Mr. Holveck at Endo about, I don’t know, some sort of partnership such that maybe they could help fund some of your projects in return for a piece of the royalty stream on Opana. I mean, they certainly have a lot of cash. I mean, they seem to have a different problem. They don’t have a pipeline. They have a lot of cash. You guys get royalties, but are certainly the much smaller company here.

Jennifer Good

Yes. I mean, so the bank of Endo essentially is the question. I think, Tim, we’ve discussed through this. To be honest, I don’t think we’ve ever felt it was good for our shareholders to sell the Opana royalty stream in any form and sort of plow back into R&D. I mean, you can hear the pressure I’m getting even just on this call. And I hear consistently exactly I think what our shareholders don’t want us to do. It is always a solution. I don’t think it’s a good solution for our shareholders. And quite frankly, we don’t need cash. I mean, the only way I would need cash is that I really wanted to ramp up the R&D spend here and blow about four or five programs into the pipeline. Again, the strategy side of me would love to that. I think it ups your odds of success. I just think in this environment that that’s not the right thing to do, nor would it be tolerated. So to be honest with you, Tim, we don’t need the money. I don’t think it’s good for the shareholders to take that cash and put it back into R&D. So those discussions have not been had.

Tim Chiang – FTN Midwest Securities

Okay. And then just one last question for Ben. This 50% royalty that you get in terms of the last piece that Endo is sort of taking off the top, if you will, on the royalty stream, when do you think that will end? Do you think that you will ultimately get the full 22% of the net profit sometime like by the middle of next year?

Ben Palleiko

Right. So, Tim, I mean it obviously entirely depends upon how Endo sales ramp over the next year. And they have actually given us no official estimates for the 2009 sales on Opana ER. I think we’ve previously said that we would hope to have this done by the end of 2009 or early 2010, but I really can’t give you more clarity than that without official Endo’s sales estimates.

Tim Chiang – FTN Midwest Securities

Okay. Okay, great. Thanks a lot.

Jennifer Good

Thanks, Tim.

Operator

You have a follow-up question from Wayne Rothbaum.

Wayne Rothbaum

Thanks for taking my call again. This might be a little tough here. So I want to talk a little bit about the questions asked earlier by Scott. I’m kind of struggling with your answer, Jennifer, I mean with all due respect. But lots of your answers didn’t make a lot of sense. First, I guess you talked about a sanity check by the Board. I guess my first reaction is as your Board seeing because I understand that they are looking at the sanity check in the markets, but I got to believe that has to be considered in a serious manner given the state of the market and given the stock, real thought given to shutting the company down. I mean, you look at what’s going on and really just looking at your pipeline of products and looking at your burn, I’m struggling with kind of your answer because what we know is a few things. We know what your pipeline is currently. All right? We know that the L-dopa program failed. We know that nalbuphine is more difficult to partner away, even that’s going to get partnered away. We know that Endo has now turned over the partnering discussions for Europe back to you. So we have sort of this mitochondrial enzyme replacement or this is really early stage for risky technology. But other than that, there is really nothing in the pipeline. We also know that there is a finite amount of number of income you’re going to receive or royalty you’re going to receive. Even if generics come to market, we can assign a pretty healthy value to when we think that’s – a very near certain value of when we think that’s going to happen; in other words, whether it’s the end of 2010, 2011. So we can come up with a pretty decent estimate of the actual cash flow you’re going to receive from that royalty income. And while you talked about discounting it back and not being a lot, that’s a finite number and the risk for that is very low. So you can get to like plus $3 a share even, not including anything else in the company. While on the other hand what you – I guess what I’m struggling with is you didn’t talk about the discounting back for risk and other factors, your clinical programs and your pipeline. So when you talk about being capped, yes, when your stock is at $1, $3 or $4 a share, even over three years is not so bad when you look at your pipeline. And potentially the uncertainty of not knowing what you’re going to invest the rest of your money, the inflow that’s coming in into, then you have to discount that back as well, because you can’t just discount back your royalty stream and not discount back your pipeline or potential pipeline or potential out-licensing, which we don’t even know about or you may not even know about. And I bet you that’s going to have a significantly higher risk and higher discount value than your royalty stream. So what real I guess scenario could be is that in 2011, 2012, you basically wasted away or you reinvested away all of or most of your royalty income if your generics [ph] did come in 2011, 2012. And you have an uncertain pipeline that’s probably still in development and has a high degree of risk. And Ben, when you look at your numbers, I mean if you really go through the numbers, it’s pretty clear you’re going to have to finance in 2010. You’re going to be out of cash, because through 2009 you’re going to use that cash. It’s going to bleed down even though you’re getting income back from your royalty, it’s still not going to be enough to cover your burn. So you’re going to bleed through most of that cash. So when you look at the dilutive effects in 2010, $1 may look rich right now back – in 2010. That may be a great price versus $3, $4 and a dividend back to shareholders if the company is shut down. So I guess I implore you that your shareholders may know just as much as management does in terms of what’s best for them. But these are uncertain times and you can not discount back the risk to investors from an uncertain pipeline that’s very sparse right now, especially given your current state and we know for fact there is going to be $80 million, $90 million, $100 million-plus in royalties coming back to investors. That has value, at least $3 in value. I’d rather take that and discount that back over two, three years than the uncertainty of having virtually no pipeline and not knowing the risks in discounting that back. So I guess I’m kind of struggling with that analysis. I think the Board really needs to consider those risks. And I implore them if there is anyone listening on this call or after this call that they either call me or listen to this call because these are difficult times and things have changed. And I just – I’m struggling with your answer right now. I think you need to be a little bit more open-minded and not tell us what’s best for us when we are on the front line and we see what’s going on. So I’m sorry, I’m a little hard here, but I guess I’m just struggling with your last answer.

Jennifer Good

Okay, Wayne. I mean, first of all – I mean, I am open minded. As you know, I routinely have these conversations. I take everything back to the Board. So it’s not that I’m close-minded and don’t discuss this openly. I think our Board is very sane. We’ve got a very credible Board and we’ve had multiple advisors come to and discuss this topic. So I understand and I – what I don’t want you to walk away with is we’re not open-minded, things change. I mean, your analogy is sort of net present valuing back. First of all, obviously you have to include the risk around the pipeline. So we’ve done that. That’s included. We’re not just taking the revenues and discounting it back not offsetting that with the burn and the risk around the pipeline. You got to remember though that is a manageable cost and there are termination points if they don’t work. I think to come right back, I mean you really hit on the topic, which was – the last time the Board discussed this topic was September. We literally talk about this at almost every Board meeting. And you yourself said there is sort of a finite price to put the floor under this of $3 to $4 a share. In September the stock was at $3 and change. So it was at $3 a share. So at that point in time, it didn’t make sense. I do think the fact that the stock is traded back to $1, it’s going to warrant revisiting this. I'm not saying the answer necessarily changes, but I think it’s got to be an open discussion around sort of where the stock is at today. I think, to Scott’s point, revisiting the burn based on current programs, we must do. So Wayne, this is something we’re open to. But sitting here in September when again we went through for probably the third time this year, stock was sitting at $3 a share –

Wayne Rothbaum

Jennifer, with all due respect, it was sitting at $3 a share on the expectation or anticipate of you successfully getting your patent or defending a patent, that would have changed – that may change the PK patent. So that didn’t happen. You got a final rejection on that. So it’s kind of not fair to bring that up because there was a specific binary or inflection point event that results in the stock going down. And I would consider it to be somewhat material to why the stock deteriorated. So yes, I hear what you are saying, and yes, there is a $3 to $4 or maybe it’s $5, depending you always have the upside though that if you do successfully defend your patents. If you can’t potentially cut a deal, let’s say, impacts or one of the patents gets issued, investors would still have – shareholders would still have all that upside of an extension on that royalty income. We’re talking worst case scenario here. So it really isn’t necessarily a cap, but I can assure you that if you take that royalty income over the next three years or you know you have a minimum of $3 to $4 and you reinvest it into an uncertain pipeline. And right now, Jennifer, (inaudible) you really don’t have a – you don’t have a pipeline. You have one drug you’re trying to out-license and you have an early stage program that has a significant amount of risk. And that’s really what we’re talking about right now. And so it’s going to take a lot of time and money to even get to a point that the shareholders or those who are like, I would say, learn it in the field can make an educated assessment of what the potential impact is or the benefit is of this program. So, as we said, these are different times and we are not $3. And we are not $3 I think for specific reason. I mean, even your burn, it’s gone up 30% I guess in the successful quarters. It’s not actually gone down. It looks like it’s going up. Is that wrong or –?

Jennifer Good

No, it hasn’t gone up.

Wayne Rothbaum

Okay. So I guess that’s what I’m struggling with, is that it’s not September, we didn’t get the PK patent at least right now, maybe on appeal we’ll get it. But again, that’s all upside for investors. So that $3, $4 price, they could become $5 or $6. I guess at the end of the day, what’s best for shareholders involve some return on their capital. And sitting at least in my seat I’m struggling to see right now how that’s going to happen, because I can certainly tell you there is nothing in the pipeline that I see that over the next two, three years that should turn I think the shareholder value back to $3, $4, $5, unless it involves Opana royalty and potentially that income flowing back to shareholders.

Jennifer Good

Wayne, look, I understand your point. I mean, certainly it's a discussion we'll have again at the Board level. These are really hard times for us. I’m in no way going to convince you I have a robust pipeline. I told you myself that’s probably the biggest frustration of trying to sort of build the company, but I get it. I do think we have assets here and I do think we can bring value out of them. I think it’s got be managed and sort of you got to be putting down an appropriate amount of risk in that against that. But you make very good points and it’s a conversation we constantly have and it’s a conversation we need to have again sort of post $3 stock price. I don’t disagree with you. So I just don’t want to get ahead of sort of any decisions around the Board. I mean, what I conveyed to shareholders today really is the decision around how we’re running the company. I think these are all valid points at hard times. I do think there's real assets here and I think we can sort of manage the decision points around them. But I’ll carry the message back. I understand it and I think it’s fair.

Wayne Rothbaum

Okay. Well, I appreciate it. Maybe we can talk about this offline some more, but thank you.

Jennifer Good

I look forward to that discussion.

Operator

You also have a follow-up question from Bert Hazlett.

Jennifer Good

Okay.

Bert Hazlett – BMO Capital Markets

My question was answered. Thanks. Thank you for your patience with everyone, Jennifer. I really appreciate it. Thank you.

Jennifer Good

No, you bet. These are hard times. And the stock is at a $1, trust me, we don’t like this either internally. Okay. I’m going to end it for now then. Ben and I, of course, are both here and happy to follow up on anything else. But we appreciate you joining us to discuss our results. Ben and I will be at the RBC Investor Conference in December and we look forward to seeing some of you there. And in the meantime, don’t hesitate to call with any concerns or discussions you want to have. Thank you.

Operator

This does conclude today’s conference call. You may now disconnect.

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