Endo International plc
Q1 2015 Earnings Call Transcript

Published: 11 May 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Endo International first quarter 2015 earnings conference call. As a reminder, this conference call is being recorded. I would now like your host for today's conference, Ms. Keri Mattox, Senior Vice President of Investor Relations and Corporate Affairs. Ma'am, please go ahead.

[Keri P. Mattox:]

Thank you. Good morning and thank you for joining us to discuss our first quarter financial results. With me on today's call are Rajiv De Silva, President and CEO of Endo; and Suke Upadhyay, Chief Financial Officer. We have prepared a slide presentation to accompany today's webcast, and that presentation is posted online in the Investors section at www.endo.com. I would like to remind you that any forward-looking statements by management are covered under the Private Securities Litigation Reform Act of 1995 and Canadian Securities Litigation Act, and are subject to the changes, risks, and uncertainties described in today's press release and in our U.S. and Canadian securities filings. In addition, during the course of this call we may refer to non-GAAP financial measures that are not prepared in accordance with the accounting principles generally accepted in the United States and that may be different from non-GAAP financial measures used by other companies. Investors are encouraged to review Endo's current report on Form 8-K furnished with the SEC for Endo's reasons for including those non-GAAP financial measures in today's earnings announcement. The reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is contained in our earnings press release issued prior to today's call. With that, I would now like to turn the call over to Rajiv.

[Rajiv De Silva:]

Thank you, Keri, and good morning, everyone. I would like to start by taking a moment to thank our retiring Chief Legal Officer, Caroline Manogue, for her exemplary leadership and contributions during her nearly 15-year tenure at Endo. Caroline has made many profound contributions to the transformation of our company over her time here and has truly helped shape Endo into the global specialty pharmaceutical company that it is today. Throughout this time, she has always set the standard for acting in the best interests of our employees, customers, patients, and shareholders. We wish Caroline continued happiness in the next chapter of her life. I would also like to welcome our newly appointed Chief Legal Officer, Matthew Maletta, who joined Endo last week. Matt brings to Endo nearly two decades of legal experience in the specialty pharmaceutical industry and with private law firms, including extensive experience in M&A, corporate, securities, finance, commercial, and employment law. Matt joins our team at Endo after most recently serving as Vice President, Associate General Counsel, and Corporate Secretary of Allergan. His broad industry experience, significant expertise in M&A and corporate law, and respected leadership skills will be a great addition to our executive leadership team. With that, let me turn to our first quarter earnings presentation. Thank you for joining us today. I hope that you have all had the chance to review the company's earnings press release that we issued earlier this morning. On slide two, you will see our agenda for today's call. We will start with a review of our recent accomplishments, including our announced acquisition of a portfolio of products from Aspen Holdings to support our international business in South Africa, and follow that with the highlights of our first quarter 2015 financial results. We will then focus on our full-year 2015 outlook and financial guidance. After our prepared remarks, we look forward to taking your questions. Moving on to slide three, we continue to make good progress in addressing our near-term strategic priorities that we believe will support our objective of becoming a leading global specialty pharmaceutical company. First, we are enhancing our operational focus in order to help drive organic growth. During the first quarter, we largely completed the integration of Auxilium into our U.S. Branded Pharmaceuticals business. The efficient manner of capturing the great majority of the $175 million in synergies that we previously identified is expected to support a focused reinvestment for growth for the remainder of 2015. U.S. Generic Pharmaceuticals delivered strong underlying growth in first quarter 2015. Generic VALCYTE was a highlight among new products and contributed to double-digit volume growth from the base business. Second, we continued to sharpen our R&D focus on near-term opportunities. We received a Day 74 letter from the FDA regarding our BELBUCA NDA during first quarter and continue to be encouraged as we move forward with the agency's review. The FDA has set an action date of October 23, 2015. More immediately, XIAFLEX has an action date later this week on May 15 for a potential enhancement to the product label that would add an indication for the retreatment of recurrent contractures for Dupuytren's contracture patients. Recurrence affects between 20% to 60% of all Dupuytren's contracture patients. So like multi-cord, this could be an important potential expansion of the product's label. And on the late-stage development front for XIAFLEX, we continue to expect to initiate additional studies for the treatment of cellulite and adhesive capsulitis or frozen shoulder syndrome by the end of 2015. Third, we remain focused on delivering strong and sustainable financial performance. We had a solid first quarter and are raising our guidance for full-year 2015 adjusted diluted EPS from continuing operations. First quarter revenues were collectively in line with expectations, and we are maintaining our full-year 2015 financial guidance for revenue. The relative strength of revenues from our U.S. Generics Pharmaceuticals business in the first quarter was a highlight of the value of our increasingly diversified business. Moving on to slide four, this morning we also announced the acquisition of a portfolio of products in South Africa from Aspen Holdings. This acquisition supports our aspiration to support our international business in attractive emerging markets. This acquisition increases our international revenues through the addition of approximately 60 branded and generic products in South Africa. This portfolio is focused on pain, anti-infectives, cardiovascular, and other specialty therapeutic areas. This acquisition also provides expected future organic growth drivers through the addition of approximately 70 R&D pipeline programs. With respect to the terms, we are acquiring this portfolio for $130 million in cash, and expect the transaction to close in the third quarter of 2015. This transaction is transformational for our Litha business in South Africa. Upon completion, it will add 60% in incremental revenues to Litha's pharmaceutical business. The transaction also meets our rigorous financial M&A criteria. We believe the transaction multiple will be less than 10 times EBITDA based on the expected 2015 portfolio performance and operating synergies that we will be able to deliver within the Litha Group. Moving to slide six, you will see that we are reporting $714 million in revenues for the first quarter, up 52% versus prior year, and $1.17 in adjusted diluted earnings per share from continuing operations. Suke will provide more details about our first quarter results in just a few minutes. While acquisitions contributed to the growth of our revenues, organic growth was also an important contributor. On the next few slides, I will focus on the organic growth drivers in each of our core businesses that we believe demonstrate the underlying strength of our company. Moving to slide seven, core products in U.S. Branded Pharmaceuticals delivered underlying sales growth of 11% in first quarter of 2015 as compared to the fourth quarter of 2014. The underlying growth rate that we would like to focus on in 2015 for U.S. Branded Pharmaceuticals includes Auxilium results on a pro-forma basis and includes 2014 acquisitions once annualized. And similar to last year, we exclude sales of LIDODERM and royalties received from Actavis for its generic lidocaine patch for comparison purposes. One of our expected key long-term growth drivers, XIAFLEX, continues to perform well and in line with our expectations. I will provide a more in-depth review of XIAFLEX on the next slide. We continue our robust efforts to protect the OPANA ER franchise, including the promotion and development of the product as well as the vigorous assertion of its intellectual property. We have a meeting scheduled with FDA in June to discuss the next steps in development and labeling. In addition, we recently concluded a Paragraph IV patent infringement trial in federal district court in the Southern District of New York. A decision is expected in the near term. The outcome of this lawsuit, however, will not impact the ongoing litigation we initiated in late 2014 in the District of Delaware against these generic competitors with respect to newly issued patents covering the product. Across our broader portfolio, we are focused on building momentum for AVEED and successfully launching NATESTO. The efficiency of our integration of Auxilium has provided the flexibility to invest in our broader portfolio efforts and to relaunch STENDRA. We believe the opportunity to build momentum for STENDRA following the addition of the 15-minute onset indication was not fully captured while our acquisition of Auxilium was still pending. And so following the deeper dive into XIAFLEX performance, I will focus on our plans for relaunching STENDRA and providing the market support to drive its growth. Moving to slide eight, XIAFLEX had a solid first quarter and remains on track with internal expectations. On a pro forma basis, revenues grew 120% compared to first quarter 2014 in Peyronie's disease and Dupuytren's contracture. We reported sales for the first two months in the first quarter that followed the close of the Auxilium transaction. However, to help with comparisons to data disclosed by Auxilium in 2014, approximately 12,200 vials of XIAFLEX were shipped from January 1 through March 31, 2015. That is an increase of 114% compared to the same period prior year. Most of that growth is attributable to the launch in Peyronie's disease, which accounted for 6,300 demand vials. Demand growth in Dupuytren's contracture was attractive as well and increased at a lower double-digit growth rate, with 5,900 demand vials in first quarter 2015. Building on the successful launch date in Peyronie's disease, there was continued traction with new patients and certified physicians. Through the end of March, there were approximately 1,900 certified physicians and 8,100 patients enrolled in our reimbursement program. In Dupuytren's contracture, we believe that the multi-cord indication will continue to support growth in 2015. And, as referenced earlier, we have the near-term potential for a label update that could add an indication for the retreatment of recurrent contractures. Moving to slide nine, we are investing to relaunch STENDRA starting in late second quarter. We have engaged a new contract sales organization and recently completed training of those associates. And we plan to launch a targeted DTC campaign to build patient and physician awareness. We will seek to restore demand growth for STENDRA to our expectations through these efforts. These efforts will be important in reducing wholesale inventory levels over time to bring STENDRA in line with the inventory management agreements. At the wholesale level, our partners typically carry about a month of inventory. Auxilium's initial launched stocking has resulted in higher wholesale inventory levels, which were at approximately two months of wholesale inventory for STENDRA in the channel at the end of first quarter 2015. Moving to slide 10, our U.S. Generics business continued to deliver impressive results in the first quarter, with sales of $357 million, delivering 68% growth versus the prior year. First quarter results benefited from the acquisition of DAVA Pharmaceuticals that closed in August 2014 and the partial quarter contribution of Boca Pharmacal, which was acquired in February 2014. Sales of LIDODERM AG were a strong source of new growth as well. While growth from these strategic initiatives is attractive, even more impressive was the robust underlying growth of 39% in our U.S. Generics business this quarter. Underlying growth was a product of both volume and price, and we are confident in the double-digit growth rate we expect for this business for the full year. Following the strong start to the year in U.S. Generics, we expect to increase prices on selected products during the second quarter. We expect these actions to support improved performance in late 2015 and into 2016, following near-term price penalty and shelf stock adjustments that we will have to recognize in the second quarter. Organic growth drivers are important for each of our businesses. In U.S. Generics, we are on track to meet our objective to file six ANDAs in 2015. Our focus on quality is producing very good results as well. Our Charlotte tablets facility was inspected by FDA in April, and the result of the inspection was a clean outcome. Moving to slide 11, we believe that we have a strong set of organic growth drivers in our Generics business. LIDODERM AG continued to be a strong source of new sales for Qualitest, and our AG has approximately 29% share of the overall lidocaine patch market. Late last year we launched the first generic version of VALCYTE available in the U.S. While a second generic is now available, we have approximately 41% share of this market, and generic VALCYTE is performing in line with our expectations as a strong contributor to organic growth. Hydrocodone-acetaminophen combination products are a leading source of revenue for our Generics business. Our portfolio of combination products with 325 milligrams of acetaminophen made a solid contribution to underlying growth. And in the 300-milligram line, we continue to be the exclusive generic of VICODIN and enjoy a market share of approximately 66% of prescriptions. Across all strengths, the impact of revenues of the DEA's rescheduling of hydrocodone from Class III to Class II has been in line with our expectations. Moving to slide 12, our International Pharmaceuticals business performed well and met our expectations. 2015 remains a transition year for International Pharmaceuticals. From a pro forma perspective, first quarter sales were lower compared to first quarter 2014 sales, primarily due to foreign exchange rates and the loss of a few products in the Paladin portfolio due to change in control provisions triggered by the acquisition by Endo. These results are in line with our expectations, and we remain focused on optimizing the base business and expanding our strategic options. The base Paladin business delivered a solid performance, and Paladin's business developments efforts are progressing at a similar pace to historical levels. Paladin is also preparing to submit BELBUCA to Health Canada during the third quarter 2015 for potential approval and use in Canada. Somar, our Mexican business, is now fully integrated into Endo and is delivering results in line with expectations. Efforts to qualify Somar as a source of lower-cost manufacturing for the U.S. Generics business is also currently progressing and on track. Products have been identified for tech transfer, and we expect to progress towards an eventual FDA inspection of the Somar facility to complete the qualification process. Finally, we have a portfolio review underway at Litha to support business optimization in South Africa. We will continue to focus on the core pharmaceuticals business, as evidenced by today's announcement related to the acquisition of a portfolio of products from Aspen as well as the recent licensing of ZORVOLEX from Iroko Pharmaceuticals by Litha. However, we do continue to remain open to all our options for all of Litha's business unit. With that, let me turn the call over to Suke to provide some more details of our financial performance for the quarter. Suke?

[Suketu P. Upadhyay:]

Thanks, Rajiv, and good morning to those joining us for today's presentation. We are pleased with the performance that Endo delivered in the first quarter of 2015. We believe the strength of our increasingly diversified portfolio, the efficiency of our integration of Auxilium Pharmaceuticals, and our favorable corporate structure have us well positioned to support our key organic growth drivers and to access the capital we need to pursue value-creating M&A opportunities. Starting with slide 14, I'll walk you through some of the financial details for first quarter 2015. I won't cover revenues in detail, as Rajiv has already addressed that earlier in the presentation. Revenues increased 52% versus the first quarter of 2014. Underlying that, we had organic growth of approximately 21%. For clarity, underlying growth for Endo includes Auxilium results on a pro forma basis and includes 2014 acquisitions once annualized, and we exclude all sales and royalties related to LIDODERM for comparison purposes. For the full year 2015, we believe that our underlying growth rate will approximate our longer-term aspirations for sustainable high single-digit to low double-digit organic growth. As Rajiv discussed earlier, these results were driven by low double-digit underlying growth in our Branded Pharmaceuticals business and strong double-digit underlying growth in our Generics business. And while the International business was unfavorably impacted by a strengthening dollar, the underlying performance of the business was in line with our expectations. We continue to focus on organic drivers of the business, and the addition of Auxilium is the most recent example of how we expect to use acquisitions to support near-term performance while also providing durable revenue growth. Moving to slide 15, adjusted gross margin increased in the quarter when compared to the first quarter of 2014, primarily as a result of improved margins within our U.S. Generics business and offset by unfavorable trends in segment mix. Our adjusted operating expenses were less than 21% of revenues or more than 500 basis points improved versus the prior year. We were very efficient in capturing synergies from the Auxilium transaction, and we are well positioned to support organic growth drivers for the remainder of the year. In addition to our positive operating expense performance, we have an improving adjusted effective tax rate as a result of the Paladin transaction. We posted a first quarter 2015 adjusted effective tax rate of 16%, which is over a 500 basis point improvement compared to the first quarter of 2014. The improvements in our cost structure and adjusted tax rate led to first quarter adjusted income growth at a rate that was significantly faster than our revenue growth. First quarter adjusted EPS from continuing operations of $1.17 outpaced our revenue growth rate as well despite the increased share count related to the Auxilium transaction. For additional details on our first quarter 2015 financial results, please review today's earnings press release. Moving to slide 17, I will summarize our full-year 2015 financial guidance that we announced earlier this morning. First quarter performance gives us the confidence to affirm our top line guidance range and increase adjusted EPS guidance while tightening and improving some of the details in between. We are holding our revenue guidance and raising EPS despite FX headwinds and a slower than expected start to the year for STENDRA. The continued diversification of our portfolio should enable continued growth for the company in 2015 and beyond. We expect full-year 2015 revenues of between $2.9 billion and $3 billion. On an adjusted basis, we now expect our full-year 2015 gross margin to be between 64% and 65%. On an adjusted basis, we expect operating expenses as a percentage of revenues for full-year 2015 to be in the range of 23% to 24%. On average, that implies approximately $30 million of incremental operating expense each quarter based on our first quarter expenses. We believe those incremental expenses represent investments with good potential returns from a combination of commercial and development projects. Moving on with guidance, we expect adjusted interest expense in 2015 of approximately $310 million. We now anticipate an adjusted effective tax rate of approximately 13% to 14% in 2015. This rate is expected to be lumpy due to the mix of earnings and impact of discrete items throughout the year. Our strategic tax planning in a number of areas, including intellectual property planning and improved supply chain management, gives us confidence that we will be more efficient in our conversion of operating income to cash flow from operations when compared to 2014. We have increased our estimated adjusted diluted earnings per share from continuing operations, and now expect that to be in a range of $4.40 to $4.60 for 2015. And we project reported or GAAP diluted earnings per share from continuing operations for the year to be within the range of $1.70 to $1.90. Reported GAAP diluted earnings per share from continuing operations will fluctuate through the year as we continue to finalize purchase price allocation for Auxilium and as we incur the remainder of integration and acquisition costs related to the transaction. Our fully diluted per share estimates assume, among other items contained in today's earnings press release, a weighted average number of common shares outstanding of approximately 180 million shares. Before closing, I would like to provide some comments regarding the earnings cadence for the remainder of 2015. We had a strong first quarter in a number of areas, and we believe that we can use that strength to set up an improved performance in late 2015 and into 2016. As mentioned earlier, we expect to increase prices on selected products in our U.S. Generics business. As Rajiv mentioned, while these price increases benefit our financial profile in future periods, the immediate impact of pricing penalties such as shelf stock adjustments will temporarily negatively impact sales and gross margin in the Generics segment in the second quarter. This is expected to lead to overall Endo revenues in the second quarter that are broadly in line to slightly above first quarter sales. The combination of improved price and volume performance in Generics and increased promotional investments in U.S. Branded Pharmaceuticals along with the additional month of Auxilium sales in the second half of 2015 gives us confidence in achieving our full-year guidance for revenues. The impact of the second quarter price increase in Generics along with stepped-up OpEx will lead to lumpier quarterly results than originally expected. Using the top end of our earnings per share guidance range, we would expect approximately 52% to 53% of our EPS to be realized in the second half of 2015. That implies a sequential step-down in second quarter earnings per share results, but we are confident in our increased expectations for full-year 2015. Overall, I am pleased with the fundamentals of the business that led to the beat and great start to 2015. Likewise, I'm excited by the opportunities that we have to continue with the transformation of Endo into a leading global specialty pharmaceutical company. Now, let me turn it back to Rajiv to close out.

[Rajiv De Silva:]

Thank you, Suke. Before we start the question-and-answer period, I would like to close with a few brief thoughts. Moving to slide 18, first, we continue to increase organizational focus on our core pharmaceuticals businesses. The expected completion of the divestiture of AMS's Men's Health and Prostate Health businesses remains on track for third quarter 2015, and we continue to evaluate strategic options for the AMS Women's Health business. Proceeds from the divestiture of AMS are expected to provide balance sheet flexibility to support objectives of future value-creating M&A. Second, we are investing to support current and future organic growth, as we have detailed in today's presentation. Third, we are focused on deploying capital to accretive value-creating transactions, and we believe our objective to complete two to three value-creating deals in 2015 is achievable. We continue to evaluate a robust set of small to medium-sized transactions across all of our businesses, and we continue to be willing to opportunistically pursue larger transformative deals. What is important to emphasize is that financial discipline remains the key in all of our transactions. That concludes our prepared remarks. Let me now turn the call back over to Keri to manage our question-and-answer period. Keri?

[Keri P. Mattox:]

Thank you, Rajiv. That concludes our prepared remarks, and we'd like now to open the lines for your questions. In the interest of time, if you could limit your initial questions to allow us to get in as many as possible, we would appreciate it. Operator, may we have the first question?

[Operator:]

Thank you. Our first question comes from the line of Marc Goodman from UBS. Your line is open.

[Marc Goodman:]

Yes, morning. First question is on the incremental spending that you talked about. I was curious if you were taking advantage of just the rest of the business being strong, a lower tax rate or something, so that you're still able to make numbers but you can increase spending. Or was the plan all along to increase spending in this manner? And just in the generics, you mentioned the plan for the price increases, and obviously you get the step down before you get the step up. I thought you had already done a big one of these last year. So can you talk about what occurred last year in that dynamic and what's differently this time? Thanks.

[Rajiv De Silva:]

So thanks, Marc. On the spending question, let me just give you a couple of thoughts, and Suke can add to it. It was always our intention to put the incremental spending behind STENDRA. But certainly, I think what we have been able to do going into the second quarter is benefit from the increased performance in the rest of the business as well as better performance in areas like tax as well as our better than expected performance in terms of capturing the synergies from the Auxilium transaction. All of those things do help us to put perhaps more than we had originally anticipated behind STENDRA. Suke, anything to add to that?

[Suketu P. Upadhyay:]

No, I think that's it. There was a little bit of timing of expenses coming out of Q1 into Q2 and beyond, but largely it's due to the strength of the business.

[Rajiv De Silva:]

And then on the generic price increases, so you're right, we did take a price increase towards the back end of last year. But those were largely speaking on the hydrocodone products, and these were tied to the rescheduling of those products. So the price increase that we now expect to take in the second quarter relate to different products. We are not going to talk about which ones they are, but they are different ones from the ones that we adjusted last year.

[Keri P. Mattox:]

Operator, can we move on to the next question?

[Operator:]

Yes, our next question comes from the line of Chris Schott from JPMorgan. Your line is open.

[Christopher T. Schott:]

Great, thanks very much, just two quick ones here. First, just coming back to the generic pricing dynamics, is it possible to quantify how much of an impact that you're expecting in 2Q from some of these moves? And I guess just put another way, how much growth would you otherwise be seeing in your sequential top line this quarter as you get the full Auxilium quarter, et cetera? My second question was post the Salix bid in March. Can you just elaborate a little more on the M&A priorities, particularly the opportunity for larger deals? I guess how unique was the Salix asset to you, or should we think about there being multiple opportunities for Endo to pursue transformational acquisitions? Thanks very much.

[Rajiv De Silva:]

Sure. Chris, let me have Suke touch on the first question, and then I'll get to your question on M&A.

[Suketu P. Upadhyay:]

Yes so Chris, on the generics price increases and thinking about how to size that, the way we look at that is in the second quarter, we expect that to have about an 8 percentage point to 10 percentage point unfavorable impact on gross margins in that business. So that will help you size what's the size or what's the magnitude or quantum of the price impact or the penalties.

[Christopher T. Schott:]

Now just quickly on that, is there a payback period we think about typically when you see those type of moves? Is that something within a quarter or two you recoup that, or does it take a longer period of time?

[Suketu P. Upadhyay:]

Generally, we see that to be accretive within the year. So breakeven tends to be within about a quarter give or take a month. And then clearly, by the end of 2015 it's NPV-positive.

[Rajiv De Silva:]

And then, Chris, with respect to the question on Salix and M&A, as we have continually said, even on the backdrop of ending the pursuit of Salix, our bread-and-butter transactions are the small to medium-size transactions. So we continue to look at a whole range of them across all three of our segments, Branded, Generics, as well as International. That being said, we are open to larger, more transformational deals. And I think what we found attractive about Salix was the opportunity for double-digit growth, organic growth in addition to the growth that our business currently sustains. So we certainly remain open for transactions of that nature. But the larger ones obviously very opportunistic, and there's no predicting which ones or timing of those types of transactions.

[Christopher T. Schott:]

Thank you.

[Operator:]

Thank you. Our next question comes from Annabel Samimy from Stifel. Your line is open.

[Annabel E. Samimy:]

Hi, thanks for taking my question. I wanted to talk a little bit about Auxilium now that it's been in-house for three to four months. Can you talk about some of the things that you're seeing? For example, you had some overcapacity in urology that you're going to sell. But now you've got a CSO for STENDRA. We've noticed that TESTOPEL, which is a relatively large product, is dropping off into the other brands. So can you talk about some of the priorities within Auxilium and how that's changed, as you've had it in your hands for a few months?

[Rajiv De Silva:]

Sure. Overall, we are quite pleased with the progress of Auxilium. As I said, from an integration standpoint, we completed the majority of it well within the time expectations that we had said. We're also pleased with the synergy capture. In terms of the products, clearly we continue to be very optimistic about XIAFLEX both in Dupuytren's contracture as well as Peyronie's. And on the R&D front, we continue to make good progress in terms of getting the next trial onboard for frozen shoulder adhesive capsulitis as well as cellulite. So the XIAFLEX franchise I would say is progressing very well. In terms of other priorities, the Low-T market is a big priority for us because with TESTOPEL, AVEED, and now NATESTO as well as some of our legacy brands like FORTESTA and TESTIM, we have the broadest range of products in the Low-T market. So clearly, it's an area of priority. So we do continue to focus on TESTOPEL, AVEED, and NATESTO. They are in different field forces, which allows us to continue our focus. In terms of STENDRA, clearly you can judge from our comments this morning that that has been a bit of a disappointment for us in terms of how the transition of that product worked from Auxilium to our hands. But that being said, nothing has changed about the profile of the product, and we continue to believe that the safety and efficacy profile puts it among the leaders in the PD files. And with the new 15-minute onset indication, it is the clear difference here. But obviously, for a brand like that, we need to put in more emphasis around promotion, other tactics like DTC, which is what we are rolling out. And just on the CSO for example, just to comment, the CSO concept was one that Auxilium themselves had begun to initiate. We just changed the concept with a different CSO with great emphasis. So all in all, I would say the Auxilium acquisition is progressing very well based on our expectations. And hopefully, by the back end of the year, we should be able to STENDRA back on track as well.

[Annabel E. Samimy:]

Okay, thanks.

[Operator:]

Thank you. Our next question comes from Gary Nachman from Goldman Sachs. Your line is open.

[Gary J. Nachman:]

Hi, good morning. Rajiv, on the Aspen deal, as you bulk up in South Africa, what other surrounding regions would you expect to extend into as well? And could you take some of those products and bring them into your U.S. business? And then on BELBUCA, how are you feeling about a timely approval? Any pre-launch activities you started on, and would you add reps for the launch of that product if you get it approved on time?

[Rajiv De Silva:]

Thanks, Gary. So with respect to Aspen, we've been very pleased with that transaction because, as we said in our comments, it is transformational for our Litha business. And as we stabilize the pharmaceutical base in South Africa, the expectation is that we ought to be able to expand into sub-Saharan Africa through more of a distributor and export business in South Africa, so that would be the next region of interest. And in the medium term, we do have an interest in expanding into Northern Africa and the Middle East, but that's not likely to happen in the very near term. And on your question around whether we can bring the products to the U.S., the answer is no. What we acquired are the rights for South Africa only. BELBUCA, so far so good is what I would say. We continue to dialogue with the FDA. I think we've already talked about the fact that the Day 74 letter was an encouraging one in that we didn't see anything in there that we saw was a major impediment to an on-time approval. That being said, the approval is uncertain, as you know, until the last minute and it's subject to discussion with the FDA. But we continue to be cautiously optimistic about the timeline there. In terms of the resourcing of BELBUCA, that's a question that we are still analyzing and debating. I think you also probably picked up from prior commentary that we made that we're becoming increasingly optimistic about what the market potential for this brand could be. So if that truly does pan out, we will likely need to add resources. But right now, our belief is that we can launch the brand with our existing field force. But if the facts as we get closer trend towards a more optimistic outcome, we would not be shy about adding resources for this brand.

[Gary J. Nachman:]

Okay, thanks.

[Rajiv De Silva:]

Okay.

[Operator:]

Thank you. And our next question comes from Jason Gerberry from Leerink Partners. Your line is open.

[Jason M. Gerberry:]

Good morning, thanks for taking the question. First, can you just talk a little bit about some of the biggest swing factors to your Generics outlook and what's embedded in the base case guidance? In terms of upside, is it continued lack of competition to the LIDODERM AG or the Boca product, or is it really pipeline? I'm just trying to get a sense of what are some of the bigger upside factors. And then on XIAFLEX, I just wanted to confirm. So the next step is a pivotal Phase III and it seems like you're done with frozen shoulder, but I just wanted to confirm that as well. Thanks.

[Rajiv De Silva:]

Thanks, Jason. So in terms of the swing factors on generics, our guidance for the year assumes additional generic competition for Boca as well as for valganciclovir as well as LIDODERM. So I think if any one of those events is either delayed or doesn't happen, there would be upside in the business. But also keep in mind that generics are a lumpy business and highly competitive, so there are competitive dynamics that could lead in the opposite direction as well. So our belief is that our business is very well balanced in terms of opportunities and the upsides and downsides in the business. On your question on XIAFLEX, I'm not sure I fully understood you, but let me just clarify where we are. So with cellulite, we are in discussions with the FDA with respect to the endpoint for our next trial. Now most likely, the next trial is going to be a Phase IIb trial and not a Phase III trial. However, as we get closer to the time and we've truly clarified the endpoint, we may choose to size the Phase IIb trial in a way that it could become a pivotal trial, but we have not come to that point yet. In terms of frozen shoulder and adhesive capsulitis, I'm not sure what you meant by we are done with it. Where we are is that our results, as we outlined earlier in one of our previous public disclosures, was that we had a mixed result due to unexpectedly high placebo effects. Since then, we've had a series of discussions with our product leaders and investigators on that trial, and we are looking at ways of recrafting that trial and most likely targeted towards recalcitrant patients. So we do believe that there is likely a path forward for frozen shoulder and adhesive capsulitis. But again, the next trial is unlikely to happen before the end of this year. And most likely, that will have to be another Phase IIb trial to prove out what we saw in the Phase IIa trial, which was much more positive last year. So I hope that's helpful.

[Jason M. Gerberry:]

No, great. Thank you very much.

[Rajiv De Silva:]

Yes.

[Operator:]

Thank you. Our next question comes from David Amsellem from Piper Jaffray. Your line is open.

[David A. Amsellem:]

Thanks, just a couple. So regarding STENDRA, maybe talk about, and I apologize if I missed this, maybe the level of spend we should think about regarding DTC and how many reps will be supporting the product via the CSO. And then secondly on BELBUCA, I guess the question here is, are you now even more bullish about the sales opportunity, given how hydrocodone volumes have behaved since the rescheduling? So maybe talk about how you're thinking now about the sales opportunity versus how you were thinking about if before the rescheduling and the subsequent behavior in volumes. Thanks.

[Rajiv De Silva:]

Sure, David. Let me take on the STENDRA question first. For competitive reasons, we are not going to dimensionalize the DTC spend. But what I would say is that our concept of DTC is not national broadcast TV. We don't think that's the right move for the product at this point. So we are going to take a more targeted approach to it. So it will be more creative in terms of how DTC works. But suffice it to say that we will put sufficient resources behind it to do the real start of relaunching. In terms of the number of reps, similarly for competitive reasons, we're not going to talk about exactly how many. But in terms of the contract sales organization that we are going to be now working with, it is a well established contract sales organization. And STENDRA will be promoted alongside one of the leading brands which is also in launch phase. And the number of representatives will more than double the number of reps internally that Endo is putting behind the brand. So it will be a reasonably substantial increase on what the efforts would have been otherwise. With BELBUCA, the short answer is yes, I think as you know, against the backdrop of the rescheduling of hydrocodone has been a reason for the sharp drop in hydrocodone volumes, which goes to show the more restrictive nature of prescribing for a Class II product. So under the presumption that BELBUCA will continue to be a Class III product, and again, there's no new information that would lead us to believe that would not be the case, we continue to be encouraged because we do think that as a Class III that we will have promotional levels that are open to us that a Class II doesn't, and therefore allow us to have a fairly unique positioning for this product as a Class III opioid with what we hope would be similar labeling to what the Class II products are, though I would hasten to add that forces of approval and review with the FDA is not done yet. And until we conclude that, we can't say this with certainty.

[David A. Amsellem:]

Thank you.

[Rajiv De Silva:]

Okay.

[Operator:]

Thank you. Our next question comes from David Risinger from Morgan Stanley. Your line is open.

[David R. Risinger:]

Yes, thanks very much. Rajiv, I was just hoping that you could provide a little bit more perspective on the OPANA ER outlook and what to watch. And then with respect to XIAFLEX, it think that you had hinted that there were some other potential pipeline indications that you might consider for Phase IIa, but I'm not sure about that. So I just wanted to understand if there are other pipeline indications that you might pursue besides cellulite and frozen shoulder.

[Rajiv De Silva:]

David, absolutely, let me hit at your question. So with OPANA, we continue to be very encouraged by how the brand is behaving. Even against the backdrop of the two generics, we hold roughly about 60% market share of the molecule. We continue to promote it. Our development efforts have gone well in terms of the insufflation study that we conducted. And as we also talked about earlier in the call, we now have a date with the FDA to discuss (46

[David R. Risinger:]

Thank you.

[Rajiv De Silva:]

Okay.

[Operator:]

Thank you. Our next question comes from the line of Gregg Gilbert from Deutsche Bank. Your line is open.

[Gregg Gilbert:]

Yes, I have a few. First, what are the drivers to the lower tax rate guidance, Suke? Secondly, Rajiv, is there anything new to share on your thoughts around the duration of the V-gel [Voltaren gel] cash flows? And my last question is for you, Rajiv, on Generics strategy. I know you're not trying to be a broad-based generic company, but you do already get a pretty large portion of your revenues from the U.S. generics market. So my question is, are you comfortable increasing your exposure to U.S. generics as a portion of your total revenues, or do you think you're about right when you consider how diverse you would like to be? Thanks.

[Rajiv De Silva:]

Suke, why don't you start?

[Suketu P. Upadhyay:]

Yes. Hi, Gregg. Good morning, it's Suke. First of all on the tax drivers, the reason for the better than expected performance so far and lower tax rate throughout the rest of the year is really coming from faster than expected realization of our supply chain planning that we're doing through ventures and other vehicles in our corporate structure. Secondly, we're also realizing some benefits from the Auxilium transaction, both from an intellectual property planning perspective, but also some of the one-time benefits that we're getting this year around net operating loss utilization. So it's really a combination of a number of factors that are driving us to a lower tax rate this year.

[Rajiv De Silva:]

Gregg, on your question on V-gel, so there's no new information. I think it reflects on what we said at the beginning of the year. We have continued promotional rights to this brand through mid-2016, though we are in discussions with the new owners of the product, which has transitioned from Novartis to the GSK-Novartis joint venture in consumer health about what the future might look like. We've also said that there's no certainty around a potential generic for this brand. But to be conservative, we are making an assumption that there could be a generic in the market sometime in the back half of this year. But that having been said, there's no new information that would validate that assumption. So obviously, if that generic does not show up, we will continue to have a positive momentum with V-gel throughout 2015. In terms of your question on generics, as I reflect on the last two years at Endo that I've been in and certainly even before that, Qualitest has been a continued sustained high performer with mid-teens organic growth. So in that regard, we would not be opposed to adding to our exposure to U.S. Generics. I think as we said, we are unlikely to want to become a broad-based provider of generics, but we do like special niches and more protected areas like controlled substances. So if we have an opportunity to add assets to Qualitest that add other niches, other high barrier to entry types of areas, we would certainly be open to it.

[Gregg Gilbert:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Corey Davis of Canaccord Genuity. Your line is open.

[Corey George Davis:]

Thanks very much. Can you tell us – I'm not sure you're willing to break it out – but within your generics division, what percentage of that is roughly the hydrocodones and also your generic AG on LIDODERM this quarter?

[Rajiv De Silva:]

Suke, you want to handle the generic LIDO? And we'll see if we can give you an answer on the hydrocodone.

[Suketu P. Upadhyay:]

Yes, so on generic LIDODERM, the AG, the way to think about that is it's approximately about a $45 million to $50 million revenue business. And then around our pain franchise, we don't specifically break out hydrocodone, but overall the pain franchise is approximately about 45% of the total generics business.

[Rajiv De Silva:]

So, Corey, the pain franchise is about 45% of hydrocodone, sorry of the pain, of controlled substance is about 45% of the Qualitest business. And without getting too specific, I would say the hydrocodones are a very meaningful proportion of that.

[Corey George Davis:]

Okay. And then lastly, the upcoming FDA June meeting on OPANA to talk about label changes, have you already submitted all your information? And how soon after that meeting do you think, if they're willing to change the label, that change could take place?

[Rajiv De Silva:]

We are in the process of completing the information, sorry, the dossier for that meeting. Corey, look, this has been as you know a multiyear ongoing dialogue with the FDA, so I'm not going to predict timing of when they might respond. A lot of it is going to depend on their view on how much epi data is required to make the case. So in our view, we have sufficient and robust enough data for their decision. Of course, they may take a different view, right. So that continues to be the answer. But that being said, we along with FDA continue to believe that some form of abuse-resistant version of pan-opiods is in the best interest of patients.

[Corey George Davis:]

Okay, great. Thanks. And then just lastly, I know it's pulling up patent material. But is the Aspen acquisition you just announced included in your newly raised guidance for 2015?

[Rajiv De Silva:]

No, no. So we don't include the acquisitions in guidance until the transaction is closed.

[Corey George Davis:]

Okay, that's all I had. Thanks very much.

[Rajiv De Silva:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Swati Kumar from Guggenheim. Your line is open.

[Swati Kumar:]

Hi, thanks for taking the question. So I was wondering if you can give us a breakdown for the margins for the Generic and International business. And also as it relates to the Aspen deal, what would the multiples be without synergy, since you said it was under 10 times EBITDA with it? Thank you.

[Rajiv De Silva:]

Just on Aspen, and then Suke will talk about the margins. So with respect to the Aspen transaction, given our agreement with Aspen, we are not going to talk about current EBITDA multiples. I think what made us comfortable with the transaction is that in our hands against the backdrop of restructuring within Litha that this will enable, we're very confident in getting below the 10 times EBITDA multiple for the transaction. But beyond that, we can't disclose anything else.

[Suketu P. Upadhyay:]

Yes, and hi, Swati. Regarding the margin profile of Generics and International, so starting with Generics, we closed out the year, exited the year in 2014 in Generics with gross margins in the high 40s and then operating margins in the low 30s. And the way we think about it for 2015 is that we expect to see gross margins in the mid 50s and operating margins migrating to the high 40s, so very nice step change in overall margin profile for the Generics business. And as it relates to international, we exited, again, in the high 40s on a gross margin basis and in the high 20s on EBIT. And relative to this year, we'd expect to see ourselves about in the same place. And one of the things with Aspen, if and when we close that transaction, we expect that to be at about the overall international average and well above the Litha average for that business.

[Swati Kumar:]

So one quick follow-up. For the mid 50s for the Generic, does that include the pricing penalty this quarter, next quarter?

[Suketu P. Upadhyay:]

It does.

[Swati Kumar:]

Okay, all right. Thank you.

[Suketu P. Upadhyay:]

Yes.

[Operator:]

Thank you. Our next question comes from the line Randall Stanicky from RBC Capital Markets. Your line is open.

[Randall S. Stanicky:]

Great, thanks. Rajiv, I just have two questions for you. The first one, how do you balance IRR and some of the financial metrics as you look at these transactions versus strategic opportunities for what may be a uniquely attractive asset with really nice growth but maybe less financially attractive initially out of the box? And then I have one follow-up after that.

[Rajiv De Silva:]

Sure. So, Randall, we are very rigorous in our financial assessment of transactions because it's very easy to get carried away with strategic assessments. So we do anchor on a set of financial criteria. What I would say is that IRR criteria is not one that we relax in our evaluations very much. There are other criteria, though, that we have that go along with IRR. We have IRR. We have a requirement that the transaction be accretive within the first 18 months. We have cash payback periods, which are typically between seven to nine years, and then also an expectation that as a portfolio transaction, that they would be accretive to organic growth and/or margin over time. So the things that sometimes get relaxed when you look at longer-term growth assets are things like cash payback period. So for longer-term growth assets, you would expect the cash payback period to be a little bit longer. In terms of accretion, we may take a little bit less near-term accretion for a transaction like that. But unless we think that IRR is well above our cost of capital, we would not be creating value for our shareholders. So that's something that we hold firm on.

[Randall S. Stanicky:]

Okay. And without getting into specific transactions, obviously, there has been a lot of discussion with some of the bigger generic companies around increasing its appetite for OTC. Now to be fair, most of that interest is branded OTC ex-U.S. You're building out your branded footprint. So I guess the specific question is, A), is OTC an attractive area for you to want to build out either in the U.S. or outside the U.S.? And then Aspen brought some injectables exposure. Should we be thinking about injectables as an area where inorganic additions over time makes sense for you?

[Rajiv De Silva:]

Sure. So first on your question on the consumer OTC-oriented products, the short answer on that one is that we do find the OTC arena an attractive one. And actually some of our ex-U.S. businesses already have small OTC components. Paladin has a small OTC business in Canada, as does our Mexican business, Somar, as well. We like the OTC assets because of the longer duration of those assets typically and the self-pay nature of them. That being said, those are fairly difficult businesses to grow organically with small starting points. So if we ever did venture into OTCs, it will be on the back of a meaningful transaction. In terms of your question on the injectables, certainly probably the most attractive part of the Aspen acquisition was the fact that we were able to acquire a very nice portfolio of injectable products for the South African market. And more broadly, we continue to believe that injectables are an attractive area. Again, that is likely to be something that we would enter through an acquisition versus something that is homegrown. But certainly, what we are able to do in South Africa is a great start.

[Randall S. Stanicky:]

That's helpful. Thanks, Rajiv.

[Rajiv De Silva:]

Sure.

[Operator:]

Thank you. Our next question comes from Michael Faerm from Wells Fargo. Your line is open.

[Michael Faerm:]

Good morning, thanks for taking the question. My question is on the 2015 guidance. Based on the reduction in tax rate, it would appear that that would potentially drive a greater increase in EPS than the amount your guidance increased, in particular considering that the revenues and expense ratios remained unchanged. Could you provide any color on what other moving parts there might be there? Thank you.

[Suketu P. Upadhyay:]

Sure. So we are increasing our overall EPS. As you know, tax rate is a driver of that. But as we've said, we do expect to ramp up our operating expenses for the rest of the year. And so while we're maintaining our overall OpEx size and range, we'll likely be trending towards the higher end of that as a percentage of sales, so it counters a little bit of the tax benefit. But overall, again, we're confident in our raise for the year.

[Michael Faerm:]

And just one follow-up. For this quarter, the first quarter, what were some of the factors contributing to the lower than the trend, R&D in particular and also SG&A?

[Rajiv De Silva:]

Sure. So on R&D, it's simply that our expected trial work on frozen shoulder as well as cellulite is delayed a little bit from our initial assumptions. And that's primarily because on cellulite we want to have the right dialogue with the FDA before we enter into a trial. In frozen shoulder, what we need to do is make sure we structure the next trial in a way that optimizes the chances of success. All of that being said, in terms of our ultimate expectation of commercial availability of those two indications in 2018 hasn't really changed. And so we'll be able to have a better view on that once we get to the next trial and see what the results look like. So that largely speaking explains some of the lower than expected spend in R&D. In SG&A, we just got into the integration of Auxilium. And sometimes when you go two or three steps of things, you do slow down spend. You want to make sure that you are fully integrated before you start spending in certain areas. So that essentially has moved some expenses into second quarter and the second half.

[Michael Faerm:]

Thank you.

[Rajiv De Silva:]

Okay.

[Operator:]

Thank you. Our next question comes from the line of Andrew Finkelstein from Susquehanna. Your line is open.

[Andrew J. Finkelstein:]

Thanks for taking the question. Could you address a little bit with the deal expanding your portfolio significantly in South Africa? That's been a market that has proven challenging for some of the international generics players, where others have used some differentiated strategies to gain a bigger foothold there. But how do you think about realizing the value of that pipeline in a way that's compliant from a U.S. and international perspectives? And then also for the base business of products it has, if you could, address the outlook for what those are going to do absent the pipeline. Thanks.

[Rajiv De Silva:]

So there are a few embedded questions and elements, if I can get to at least some of them. So with the South African market itself, South Africa being a challenging market doesn't bother us because we are a differentiated player, and frankly we'd rather be in areas where everyone else is running away versus going into areas where everyone is crowding into. I think one of the primary differences is that we don't view ourselves as an international player in South Africa. We view ourselves as being a local player in South Africa, which is why the Litha business will continue to operate as an autonomous business unit. It will continue to have the Litha name. The Endo name is really not well known, nor will it be well known in South Africa. And other than currency, which certainly has been a big headwind for the rand over the course of the last little while, there's no reason to worry about the underlying growth dynamics in the South African market. It continues to be the most robust market in Africa. And on a local currency basis, it is a market that we think, at least with the categories that we are going to focus on, is easily a high single-digit growth market. And furthermore, once we have a more robust base in South Africa, being able to export products into sub-Saharan Africa, all those markets are double-digit growth markets. Again, it's mostly because the markets have a very small starting point. But that being said, from a forward-looking basis, they can be quite attractive for us. And with respect to the Aspen portfolio and our own Litha pharmaceutical business, we are in the middle of restructuring that entire business. And what I would say is that from a medium-term perspective, we have high single to low double-digit growth expectations for that business. And the business that we acquired from Aspen along with the pipeline will be a very important contributor.

[Andrew J. Finkelstein:]

Thanks very much.

[Operator:]

Thank you. Our next question comes from the line of Liav Abraham from Citi. Your line is open.

[Liav Abraham:]

Good morning, just a quick question on AVEED. Correct me if I'm wrong, but the product is being promoted alongside XIAFLEX following the completion of the Auxilium acquisition. I'm just wondering if it's benefited from being positioned alongside XIAFLEX, and also the impact of the permanent J-code that you received earlier this year just in the performance of the product over the quarter and any physician feedback. Thank you.

[Rajiv De Silva:]

Sure. So the product is detailed by the same field force that details XIAFLEX for Peyronie's disease and testicle. That being said, it's not a product that's co-positioned with XIAFLEX. So it's not going to benefit from that regard. However, it does, it will benefit from the fact that the broader reimbursement support that's in place and is being optimized with XIAFLEX is one that covers AVEED as well. So from that standpoint, once the dust will settle on that part of the integration, that it will be a net benefit for. So far, we've seen good continued output momentum in AVEED with the permanent J-code. And as we've consistently said, with these kinds of (1

[Liav Abraham:]

Great, thanks.

[Rajiv De Silva:]

Sure.

[Keri P. Mattox:]

Operator, I think we have time for maybe one more question.

[Operator:]

Yes, ma'am. Our last question comes from the line of Gary Nachman from Goldman Sachs. Your line is open.

[Gary J. Nachman:]

Hi, thanks for the follow-up; Suke, a quick one on tax. If you're benefiting from some one-time benefits in NOL this year, what would the normalized tax rate be? What should we use beyond 2015? And then, Rajiv, one more on M&A, just update us on what types of specialty brands you think it would make sense for you to expand into. Specifically, would you consider having a bigger presence in the hospital space? Thanks.

[Suketu P. Upadhyay:]

Yes. On the tax rate question, we would expect our sustained longer-term effective tax rate to be in the mid-teens, Gary.

[Gary J. Nachman:]

Okay, thanks.

[Rajiv De Silva:]

And then in terms of your question on M&A, I think as we have said in the past, Gary, we are opportunistic in terms of new therapeutic areas. And as long as the financial criteria that we talked about on that, we could see ourselves in a range of different therapeutic areas. I think in general, what we told you to expect that we are unlikely to get into a very heavily primary care-oriented therapeutic area, unlikely to be in very science-heavy areas, like oncology, et cetera. But outside of that, I think we would be open to any specialty-oriented therapeutic area.

[Gary J. Nachman:]

Okay, great. Thanks, guys.

[Rajiv De Silva:]

Yes.

[Keri P. Mattox:]

Operator, I think we're all set, if you would like to wrap. Thank you everyone for joining the call.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now all disconnect. Everyone, have a great day.