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ENDP > SEC Filings for ENDP > Form 10-Q on 1-May-2012All Recent SEC Filings

Show all filings for ENDO PHARMACEUTICALS HOLDINGS INC

Form 10-Q for ENDO PHARMACEUTICALS HOLDINGS INC


1-May-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations describes the principal factors affecting the results of operations, liquidity and capital resources, and critical accounting estimates of Endo. This discussion should be read in conjunction with the accompanying quarterly unaudited Condensed Consolidated Financial Statements and our Annual Report on Form 10-K, for the year ended December 31, 2011 (Annual Report). Our Annual Report includes additional information about our significant accounting policies, practices and the transactions that underlie our financial results, as well as a detailed discussion of the most significant risks and uncertainties associated with our financial and operating results. Except for the historical information contained in this Report, this Report, including the following discussion, contains forward-looking statements that involve risks and uncertainties. See "Forward-Looking Statements" beginning on page i of this Report.

EXECUTIVE SUMMARY

About the Company

Endo Pharmaceuticals Holdings Inc., which we refer to as "Endo", "we", "us", or the "Company", is a U.S. based, specialty healthcare solutions company with a diversified business model, operating in four key business segments-Branded Pharmaceuticals, Generics, Devices and Services. These segments reflect a 2011 reassessment of our reporting structure, whereby management is better able to assess its prospects and future cash flow potential to ultimately make more informed operating decisions about resource allocation and the enterprise as a whole. We deliver an innovative suite of complementary branded and generic drugs, devices, services and clinical data to meet the needs of patients in areas such as pain management, urology, endocrinology and oncology. We believe that recent healthcare reform in the U.S. places a premium on providing cost-effective healthcare solutions, like those we offer. Over the past two years, we have invested in and reshaped our company through a combination of organic and strategic growth initiatives, creating a company that we believe is positioned to address the changing economics that are driving the transformation of the U.S. healthcare environment.

We believe our diversified business model enables us to strengthen our partnerships with providers, payers and patients by offering multiple products and platforms to deliver healthcare solutions. We have a portfolio of branded pharmaceuticals that includes established brand names such as Lidoderm®, Opana ® ER, Voltaren® Gel, Percocet®, Frova ®, Supprelin® LA, Vantas®, Valstar ® and Fortesta® Gel. Branded products comprised approximately 53% of our revenues in the three months ended March 31, 2012 and 67% of our revenues in the three months ended March 31, 2011, with 30% of our revenues coming from Lidoderm® for the three months ended March 31, 2012 and 34% for the three months ended March 31, 2011. Our non-branded generic portfolio, which accounted for 21% of revenues in the three months ended March 31, 2012 and 24% of our revenues in the three months ended March 31, 2011, currently consists of products primarily focused on pain management. We generally focus on selective generics that have one or more barriers to market entry, such as complex formulation, regulatory or legal challenges or difficulty in raw material sourcing. Device revenue accounted for 19% of total revenues in for the three months ended March 31, 2012 and our Services segment accounted for the remaining revenue for the three months ended March 31, 2012 and March 31, 2011.

We have a dedicated pharmaceutical products sales forces in the United States, consisting of 488 Endo pharmaceutical sales representatives and 228 sales contracted representatives focusing primarily on pain products, 83 Endo sales representatives focusing primarily on bladder and prostate cancer products, 36 Endo medical center representatives focusing on the treatment of central precocious puberty and 25 Endo account executives focusing on managed markets customers. We also have 334 sales representatives focusing primarily on devices and 68 on services. We market our products and services to primary care physicians and specialty physicians, including those specializing in pain management, orthopedics, neurology, rheumatology, surgery, anesthesiology, urology and pediatric endocrinology. Our sales force also targets retail pharmacies and other healthcare professionals throughout the United States.

Impax

Pursuant to the June 2010 Settlement and License Agreement (the Impax Agreement), with Impax Laboratories Inc. (Impax), the Company agreed to provide a payment to Impax should Prescription Sales of Opana® ER, as defined in the Impax Agreement, fall below a predetermined contractual threshold in the quarter immediately prior to Impax launching a generic version of Opana® ER. During the first quarter of 2012, the Novartis shut-down of its Lincoln, Nebraska manufacturing facility and resulting lack of 2012 oxymorphone active pharmaceutical ingredient (API) quota granted by the Drug Enforcement Agency (DEA) caused the Company to attempt an accelerated launch of the crush-resistant formulation of Opana® ER. While significant uncertainties existed throughout the first quarter of 2012 about our ability to rapidly ramp up production of the new formulation and produce finished goods at a new, untested manufacturing facility in a very short period of time, we were able to do so in March 2012. The Company recognized a liability under the Impax Agreement upon the Company's sale of the new formulation, which occurred in March 2012. As a result, we believe it is probable that Prescription Sales of the original formulation of Opana® ER in the quarter prior to the expected generic launch by Impax (which is expected during the first quarter 2013), will be less than the predetermined contractual threshold, thus triggering a liability to Impax of approximately $110.0 million, to be paid in 2013 if certain conditions are met. This amount has been recorded in our Condensed Consolidated Financial Statements as a charge to Cost of revenues during the quarter ended March 31, 2012.

Healthcare Reform

On March 23, 2010, President Obama signed into law H.R. 3590, the Patient Protection and Affordable Care Act (PPACA), which will make major changes to the U.S. healthcare system. On March 30, 2010, the President signed H.R. 4872, the Health Care and Education Reconciliation Act of 2010 (Reconciliation Act), which included a package of changes to the PPACA, as well as additional elements to reform health care in the U.S.

While some provisions of the new healthcare reform law have already taken effect, most of the provisions to expand access to health care coverage will not be implemented until 2014 and beyond. Since implementation is incremental to the enactment date of the law, there are still many challenges and uncertainties ahead. Such a comprehensive reform measure will require expanded implementation efforts on the part of federal and state agencies embarking on rule-making to develop the specific components of their


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new authority. The Company will monitor closely the implementation and any attempts to repeal, replace, or remove funding of the new health care reform law. This effort will primarily take place on two fronts: 1) in Congress through attempts to pass legislation to overturn all or specific sections of the law and
2) in the Courts through attempts to have the law declared unconstitutional.

In March 2012, the U.S. Supreme Court heard oral arguments challenging the constitutionality of the health care reform law. The Court will consider the constitutionality of the individual mandate, as well as whether the overall health care law can still stand even if the individual mandate is ruled unconstitutional. The Court's decision could significantly impact on the number of Americans who would be afforded access to health care services under the Patient Protection and Affordable Care Act.

Barring a Supreme Court ruling that the Patient Protection and Affordable Care Act is unconstitutional, the passage of the PPACA and the Reconciliation Act will result in a transformation of the delivery and payment for health care services in the U.S. The combination of these measures will expand health insurance coverage to an estimated 32 million Americans. In addition, there are significant health insurance reforms that are expected to improve patients' ability to obtain and maintain health insurance. Such measures include: the elimination of lifetime caps; no rescission of policies; and no denial of coverage due to preexisting conditions. The expansion of healthcare insurance and these additional market reforms should result in greater access to the Company's products.

Our estimate of the overall impact of healthcare reform reflects a number of uncertainties. However, we believe that the impact to our business will be largely attributable to changes in the Medicare Part D Coverage Gap, the imposition of an annual fee on branded prescription pharmaceutical manufacturers, and increased rebates in the Medicaid Fee-For-Service Program and Medicaid Managed Care plans. There are a number of other provisions in the legislation that collectively are expected to have a small impact, including originator average manufacturers' price (AMP) for new formulations, and the expansion of 340B pricing to new entities. Certain elements of healthcare reform reduced total revenues by approximately $40 million in 2011 and will continue to have a similar impact in future years.

In the U.S., the Medicare Prescription Drug Improvement and Modernization Act of 2003 continues to provide an effective prescription drug benefit to seniors and individuals with disabilities in the Medicare program (Medicare Part D). Uncertainty will continue to exist due to Congressional proposals that have the potential to impose new costs and increase pricing pressures on the pharmaceutical industry.

In response to the U.S. debt-ceiling crisis, Congress passed the Budget Control Act of 2011 on August 2, 2011. Within the Act, Congress created the Joint Select Committee on Deficit Reduction (JSC), which was charged with issuing a formal recommendation on how to reduce the federal deficit by $1.2 to $1.5 trillion over the next ten years. The Budget Control Act provided that if Congress failed to pass a deficit reduction plan by December 23, 2011, a process of sequestration would occur on January 1, 2013 which will result in across-the-board spending cuts to certain government programs, including Medicare, in order to meet the deficit reduction goal. Since the JSC failed to put forth a proposal and Congress ultimately failed to pass a deficit reduction plan, the sequestration process is scheduled to be triggered in 2013. The automatic spending cuts that would occur as a result of the sequestration process are unpalatable for many lawmakers and Congress may use the 2012 session to consider repealing the cuts by finding savings in other programs, such as Medicaid.


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Pipeline Developments

In January 2012, the Company signed a worldwide license and development agreement with BioDelivery Sciences International, Inc. (BioDelivery) for the exclusive rights to develop and commercialize BEMA® Buprenorphine, a transmucosal form of buprenorphine which incorporates a bioerodible mucoadhesive (BEMA®) technology and is currently in phase III trials for the treatment of moderate to severe chronic pain. At this time, the Company made an upfront payment to BioDelivery for $30.0 million, which was expensed as Research and development in the first quarter of 2012. An additional $15.0 million payment related to the achievement of certain regulatory milestones was triggered and recorded as Research and development expense during the first quarter of 2012. We expect to pay this amount in the second quarter of 2012.

Branded Business Activity

In April 2012, the U.S. District Court for the District of Delaware ruled that five patents covering Allergan USA, Inc.'s (Allergan's) Sanctura XR® (trospium chloride) extended-release capsules were invalid. We intend to appeal the District Court's ruling. However, because we receive royalties based on net sales of Sanctura XR® made by Allergan, we concluded that an impairment assessment was required to evaluate the recoverability of the indefinite-lived intangible asset in light of the District Court's ruling. As a result of this assessment, we determined the fair value of the Sanctura XR ® intangible asset was $21.6 million at March 31, 2012. Accordingly, the Company recorded a pre-tax non-cash impairment charge of $40.0 million for the three months ended March 31, 2012, representing the difference between the carrying value of the intangible asset and its estimated fair value. The impairment charge was recognized in earnings and is included in the Asset impairment charges line item in the Condensed Consolidated Statements of Operations. Changes in any assumptions may result in a further reduction to the estimated fair value of the Sanctura XR ® intangible asset and could potentially result in additional future impairment charges.

In December 2011, the FDA approved a new formulation of Opana® ER designed to be crush-resistant, which will continue to be called Opana® ER with the same dosage strengths, color and packaging and similar tablet size. Endo began transitioning to the crush-resistant formulation in March 2012 upon successfully accelerating production of the new formulation.

RESULTS OF OPERATIONS

Our quarterly results have fluctuated in the past, and may continue to fluctuate. These fluctuations are primarily due to (1) the timing of mergers, acquisitions and other business development activity, (2) the timing of new product launches, (3) purchasing patterns of our customers, (4) market acceptance of our products, (5) the impact of competitive products and products we recently acquired and (6) pricing. These fluctuations are also attributable to charges incurred for compensation related to stock compensation, amortization of intangible assets, asset impairment charges, and certain upfront, milestone and certain other payments made or accrued pursuant to acquisition or licensing agreements.


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Consolidated Results Review

Revenues. Revenues for the three months ended March 31, 2012 increased 23% to $690.6 million from $560.0 million in the comparable 2011 period. This increase in revenues is primarily driven by our recent acquisition of AMS, from which we derived $130.2 million in revenue. This increase was partially offset by first quarter 2012 supply disruptions, primarily with respect to Voltaren® Gel and Opana® ER, resulting from the temporary shutdown of Novartis's Lincoln, Nebraska manufacturing facility.

The following table displays our revenues by category and as a percentage of total revenues for the three months ended March 31, 2012 and 2011 (dollars in thousands). We have retrospectively revised the segment presentation for all periods presented reflecting a change from three to four reportable segments:

                                                 Three Months Ended March 31,
                                                 2012                    2011
                                              $           %           $           %
         Lidoderm®                        $ 210,014        30     $ 189,725        34
         Opana®ER                            81,086        12        84,615        15
         Voltaren®Gel                            -         -         31,298         6
         Percocet®                           23,380         3        26,960         5
         Frova®                              15,644         2        13,208         2
         Supprelin®LA                        13,446         2        11,222         2
         Other brands                        20,004         3        18,486         3

         Total Branded Pharmaceuticals*     363,574        53       375,514        67
         Total Generics                     145,345        21       134,409        24
         Total Devices revenue              130,166        19            -         -
         Total Services revenue              51,548         7        50,103         9

         Total revenues                   $ 690,633       100     $ 560,026       100

* - Percentages may not add due to rounding.

Lidoderm®. Net sales of Lidoderm ® for the three months ended March 31, 2012 increased by $20.3 million, or 11%, from the comparable 2011 period. We were required to pay Hind royalties based on net sales of Lidoderm® until this obligation expired on November 23, 2011. Hind royalties were recorded as a reduction to net sales due to the nature of the license agreement and the characteristics of the license involvement by Hind in Lidoderm®. Due to the expiration of the Hind royalty, net sales were $20.8 million higher during the three months ended March 31, 2012 compared to the same period in 2011. Lidoderm® had solid performance this year and continues to generate strong cash flow that we can use to invest in our business to continue to further diversify our revenue base.

Opana® ER. Net Sales of Opana® ER for the three months ended March 31, 2012 decreased by $3.5 million, or 4% from the comparable 2011 period. The decrease in net sales is primarily attributable to first quarter 2012 Opana® ER supply disruptions associated with the temporary shutdown of Novartis's Lincoln, Nebraska manufacturing facility. However, the impact of these supply disruptions was partially offset by revenues from our new formulation of Opana® ER designed to be crush-resistant, which we began selling in March 2012.

Voltaren® Gel. Due to short-term Voltaren® Gel supply constraints resulting from the temporary shutdown of Novartis's Lincoln, Nebraska manufacturing facility, there were no sales of Voltaren® Gel during the three months ended March 31, 2012. In April 2012, we began producing Voltaren® Gel at an alternative Novartis manufacturing site. Accordingly, sales of Voltaren® Gel resumed in April 2012.

Percocet®. Net sales of Percocet®for the three months ended March 31, 2012 decreased by $3.6 million, or 13% from the comparable 2011 period. The decrease is primarily attributable to reduced volumes during the first quarter of 2012 as compared to 2011.

Frova®. Net sales of Frova® for the quarter ended March 31, 2012 increased by $2.4 million or 18% from the comparable 2011 period. The increase is primarily attributable to increased prices during the first quarter of 2012 as compared to 2011.

Supprelin® LA. Net sales of Supprelin® LA for the three months ended March 31, 2012 increased by $2.2 million or 20% from the comparable 2011 period. This increase was driven by volume growth during the first quarter of 2012, resulting primarily from an increase in new patient starts and a growing base of continued care patients. We believe this growth is largely due to a strong base of national opinion leader support and ongoing efforts to streamline the treatment initiation process.

Other brands. Net sales of our other branded products for the three months ended March 31, 2012 increased by $1.5 million or 8% from the comparable 2011 period. This increase is largely attributable to increased revenues from Fortesta® Gel and Valstar ®, partially offset by decreased revenue from Opana® as demand continues to shift to Opana® ER.


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Generics. Net sales of our generic products for the three months ended March 31, 2012 increased by $10.9 million, or 8% from the comparable 2011 period. This increase was largely attributable to our ability to capitalize on opportunities in the marketplace, particularly as it relates to revenues from 1) hydrocodone and acetaminophen, which increased $7.9 million in the first quarter of 2012 compared to first quarter 2011 and 2) oxycodone and acetaminophen, which increased $3.0 million in the first quarter of 2012 compared to first quarter 2011.

Devices. Revenues from our Devices segment for the three months ended March 31, 2012 were $130.2 million and were attributable to sales of products from our AMS subsidiary, which we acquired in June 2011.

Services. Revenues from our Services segment for the three months ended March 31, 2012 increased by $1.4 million to $51.5 million from $50.1 million from the comparable 2011 period. This increase was largely attributable to the revenues from our electronic medical records software companies, Intuitive Medical Software, LLC and meridianEMR, Inc. which we acquired in the second half of 2011.

Gross Margin, Costs and Expenses. The following table sets forth costs and expenses for the three months ended March 31, 2012 and 2011:

                                                                  Three Months Ended
                                                                      March 31,
                                                     2012                                   2011
                                            $            % of revenues             $            % of revenues
Cost of revenues                        $ 364,820                    53 %      $ 231,558                    41 %
Selling, general and administrative       254,454                    37 %        159,386                    28 %
Research and development                   88,688                    13 %         42,130                     8 %
Asset impairment charges                   40,000                     6 %             -                     -
Acquisition related costs                   3,749                     1 %          6,073                     1 %

Total costs and expenses*               $ 751,711                   109 %      $ 439,147                    78 %

* - Percentages may not add due to rounding.

Cost of Revenues and Gross Margin. Cost of revenues for the three months ended March 31, 2012 increased by $133.3 million or 58%, to $364.8 million from $231.6 million in the comparable 2011 period. This increase was primarily driven by our June 2011 acquisition of AMS, which contributed approximately $41.5 million to our Cost of revenues during the three months ended March 31, 2012 as well as the charge of $110.0 million related to the first quarter 2012 accrual resulting from the 2010 Impax Settlement Agreement. These increases were partially offset by decreased Cost of revenues associated with our products which were impacted by the temporary shutdown of Novartis's Lincoln, Nebraska manufacturing facility. Gross profit margins for the three months ended March 31, 2012 and 2011 were 47% and 59%, respectively. The reduction in gross profit margins is primarily due to the Impax accrual.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended March 31, 2012 increased to $254.5 million from $159.4 million in the comparable 2011 period. The increase in Selling, general and administrative expenses for the three months ended March 31, 2012 compared to 2011 is primarily attributable to the inclusion of $78.0 million of AMS expenses, as well as $11.1 million of certain integration costs and separation benefits incurred in connection with continued efforts to enhance the Company's operations that were classified as Selling, general and administrative expense.

Research and Development Expenses. Research and development expenses for the three months ended March 31, 2012 increased to $88.7 million from $42.1 million in the comparable 2011 period. This increase was primarily driven by the addition of AMS's research and development portfolio, the progress of our branded pharmaceutical portfolio's development and the expansion of our efforts in the pharmaceutical discovery and device research and development areas. Additionally, during the three months ended March 31, 2012 we incurred $47.0 million in expense related to milestones classified as Research and development expense compared to $11.0 million in the comparable 2011 period.

Asset Impairment Charges. Pursuant to the Sanctura XR® Amended and Restated License, Commercialization and Supply Agreement with Allergan USA, Inc. (Allergan), the Company receives royalties based on net sales of Sanctura XR® made by Allergan.

In March 2009, Watson Pharmaceutical Inc. (Watson) filed an Abbreviated New Drug Application (ANDA) seeking FDA approval to market generic versions of Sanctura XR® before the expiration of Allergan's patents listed in the Orange Book. Subsequent to Watson's ANDA filing, Sandoz Inc. and Paddock Laboratories, Inc., (acquired by Perrigo Company in August 2011) also filed ANDAs for a generic version of Sanctura XR®.


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In April 2012, the U.S. District Court for the District of Delaware ruled that five patents covering Allergan's Sanctura XR® (trospium chloride) extended-release capsules were invalid. Watson Pharmaceutical Inc.'s application with the Food and Drug Administration for a generic version is currently pending.

The Company intends to appeal the District Court's ruling. However, the Company concluded that an impairment assessment was required to evaluate the recoverability of the indefinite-lived intangible asset as of March 31, 2012.

To estimate fair value, we assessed the estimates of the amount and timing of future cash flows from royalties and milestones received from Allergan related to net sales of the product. To calculate the fair value of the Sanctura XR® intangible asset, the Company used an income approach using a discounted cash flow model considering management's current evaluation of the above mentioned factors. The Company utilized probability-weighted cash flow models using a present value discount factor commensurate with the overall risk associated with this particular product. The cash-flow models included our best estimates of future FDA approval of generic versions of the product and the probability of a successful appeals process. The Company presently believes that the level and timing of cash flows assumed, discount rate, and probabilities used in the model appropriately reflect market participant assumptions.

The fair value of the Sanctura XR ® intangible asset was determined to be $21.6 million. Accordingly, the Company recorded a pre-tax non-cash impairment charge of $40.0 million for the three months ended March 31, 2012, representing the difference between the carrying value of the intangible asset and its estimated fair value. The impairment charge was recognized in earnings and included in the Asset impairment charges line item in the Condensed Consolidated Statements of Operations. Changes in any of our assumptions may result in a further reduction to the estimated fair value of the Sanctura XR ® intangible asset and could result in additional and potentially full future impairment charges of up to $21.6 million.

Acquisition Related Items, net. Acquisition-related items, net for the three months ended March 31, 2012 were $3.7 million in expense compared to $6.1 million in expense in the comparable 2011 period. Acquisition-related items, net for the three months ended March 31, 2012 and 2011 primarily consisted of transaction fees including legal, separation, integration, and other expenses for our recent acquisitions.

Interest Expense, net. The components of interest expense (income), net at March 31, 2012 and 2011 are as follows (in thousands):

                                             2012          2011
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