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
Corporate Name Change
At the Company's Annual Meeting of Stockholders on May 23, 2012, the Company's
stockholders approved the proposal to amend and restate the Company's Amended
and Restated Certificate of Incorporation to change the name of the Company from
Endo Pharmaceuticals Holdings Inc. to Endo Health Solutions Inc. This change
became effective on May 23, 2012. Concurrently with this change, the Company
also changed the names of its business segments. Effective May 23, 2012, the
names of our business segments are Endo Pharmaceuticals (formerly Branded
Pharmaceuticals), Qualitest (formerly Generics), AMS (formerly Devices) and
HealthTronics (formerly Services).
About the Company
Endo Health Solutions 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-Endo
Pharmaceuticals, Qualitest, AMS and HealthTronics. Our Endo Pharmaceuticals and
Qualitest segments offer a variety of branded and generic pharmaceutical
products in multiple therapeutic areas. AMS provides providing technology
solutions to physicians treating men's and women's pelvic health conditions.
Finally, HealthTronics provides urological services, products and support
systems to urologists, hospitals, surgery centers and clinics. As a combined
entity, we deliver comprehensive healthcare solutions across our diversified
businesses in key therapeutic areas, including pain and urology, and believe we
are positioned to address the changing economics that are driving the continued
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. Endo Pharmaceuticals comprised approximately 56% and 55% of our
revenues for the three and six months ended June 30, 2012, respectively,
compared to 66% in the comparable 2011 periods. Lidoderm® comprised
approximately 29% and 30% of our revenues for the three and six months ended
June 30, 2012, respectively, compared to 32% and 33%, respectively, for the
three and six months ended June 30, 2011. Our non-branded Qualitest portfolio,
which accounted for 20% and 21%, respectively, of revenues for the three and six
months ended June 30, 2012 and 22% and 23%, respectively, of our revenues for
the three and six months ended June 30, 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. AMS
accounted for 16% and 18% of our revenues for the three and six months ended
June 30, 2012, respectively, compared to 4% and 2%, respectively, for the three
and six months ended June 30, 2011. HealthTronics accounted for the remaining
revenue for the three and six months ended June 30, 2012 and 2011.
We have a dedicated pharmaceutical products sales forces in the United States,
consisting of 457 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, 35
Endo medical center representatives focusing on the treatment of central
precocious puberty and 27 Endo account executives focusing on managed markets
customers. We also have 363 sales representatives focusing primarily on devices
and 56 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.
Watson Litigation Settlement
On May 28, 2012, Endo Pharmaceuticals Inc. (EPI) entered into a Settlement and
License Agreement (the Watson Settlement Agreement) among EPI and Teikoku, on
the one hand and Watson, on the other hand. The Watson Settlement Agreement
settles all ongoing patent litigation among the parties relating to Watson's
generic version of Lidoderm®. Under the terms of the Watson Settlement
Agreement, the parties dismissed their respective claims and counterclaims
without prejudice. As part of the settlement, Watson agreed not to challenge the
validity or enforceability of Endo's and Teikoku's patents relating to Lidoderm®
with respect to
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Watson's generic version of Lidoderm®. Watson also agreed not to sell its
generic version of Lidoderm® until it receives FDA approval and, in any event,
no sooner than September 15, 2013, except in limited specific circumstances
(such date being the Start Date). Endo and Teikoku agreed to grant Watson a
license permitting the sale of generic Lidoderm® upon the Start Date in the
United States. The license to Watson is exclusive as to Endo's launch of an
authorized generic version of Lidoderm® until the earlier of 1) the introduction
of a generic version of Lidoderm® by a company other than Watson or 2) seven and
a half months after Watson launches its generic version of Lidoderm®. Endo will
receive an at market royalty equal to 25% of the gross profit generated on
Watson's sales of its generic version of Lidoderm® during Watson's period of
exclusivity.
Additionally, the Watson Settlement Agreement provides that Endo and Teikoku
will provide, at no cost, to Watson's wholesaler affiliate branded Lidoderm®
product for Watson's wholesaler affiliate's distribution, subject to certain
terms and conditions. Endo will be responsible for the payment of all gross to
net adjustments arising from Watson's sale of the branded Lidoderm® product. In
contemplation of the Watson Settlement Agreement, Teikoku has agreed to provide
a rebate to Endo equal to 50% of the cost of branded Lidoderm® product that is
required to be provided to Watson's wholesaler affiliate pursuant to the Watson
Settlement Agreement.
The Company has concluded that the Watson Settlement Agreement is a
multiple-element arrangement and has recognized a liability and corresponding
charge of $131.4 million in Patent litigation settlement expense in the second
quarter of 2012 representing the estimated fair value of the settlement
component. Fair value of the settlement component was estimated using the
probability adjusted expected value of branded Lidoderm® product to be provided
to Watson at the anticipated wholesaler acquisition cost (WAC) expected to be in
place at the time of shipment, less a reasonable estimate of Watson's selling
costs. The resultant probability-weighted values were then discounted using a
discount rate of 5.1%. The Company presently believes that the level and timing
of branded Lidoderm® product to be shipped, discount rate, and probabilities
used in the model appropriately reflect market participant assumptions. Because
the liability is recorded at fair value using WAC, the charge recognized in 2012
is comprised of several elements, including our cost of product to be shipped,
estimated gross-to-net deductions to be paid by the Company and the estimated
product profit margin. We believe this is the most appropriate measure of fair
value as these components combined, represent the value accruing to Watson. As a
result of using a fair value measurement, the second quarter 2012 charge will be
greater than the actual cost to the Company. As such, relief of the liability in
subsequent periods through shipments of branded Lidoderm® product will result in
income, which we expect to record as a component of Other expense (income), net
in the Company's Condensed Consolidated Statements of Operations. We intend to
reclassify the portion of the settlement liability related to the gross-to-net
component into our gross-to-net reserves as product is shipped to Watson, the
effect of which will be to offset a portion of the income that will be
recognized into Other expense (income), net in the Company's Condensed
Consolidated Statements of Operations, as the settlement liability is relieved.
The rebate arrangement with Teikoku will also be accounted for prospectively as
product purchased from Teikoku will be recorded into inventory at the discounted
purchase price and relieved as shipments are made to Watson. The benefit
associated with this rebate will be recorded as a component of Other expense
(income), net in the Company's Condensed Consolidated Statements of Operations.
Changes, if any, resulting from revisions to the timing or the amount of the
original estimate will be recognized as an increase or a decrease in the
carrying amount of the litigation settlement liability and the related Patent
litigation settlement expense during the period of change. Changes in estimates
to the settlement liability could have a material impact on our results of
operations.
Impax
Pursuant to the June 2010 Settlement and License Agreement (the Impax Settlement
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 Settlement 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.
Accordingly, the Company recognized a liability under the Impax Settlement
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 was recorded in our Condensed
Consolidated Financial Statements as a charge to Cost of revenues in March 2012.
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
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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 paid this amount in the second quarter of 2012.
Recent Business Activity
As a result of market and potential regulatory changes affecting the commercial
potential in the United States for one of the AMS IPR&D assets, the Company
determined that the asset's carrying value was no longer fully recoverable.
Accordingly, in the second quarter of 2012, we recorded a pre-tax non-cash
impairment charge of $3.0 million, which was assigned to our AMS segment and was
recorded in the Asset impairment charges line of our Condensed Consolidated
Statements of Operations. The fair value of this asset was determined using a
probability-weighted discounted cash flow model, or income approach. This fair
value measurement technique is based on significant inputs not observable in the
market and thus represents a Level 3 measurement within the fair value
hierarchy. Changes in any of the assumptions used in determining the fair value
of this asset may result in a further reduction to its estimated fair value and
could result in additional and potentially full future impairment charges of up
to $1.0 million.
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. The Company appealed this
ruling, and subsequently in June 2012, our appeal was dismissed. As part of our
first quarter 2012 Form 10-Q filing, despite the Company's intent to appeal the
District Court's ruling, 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 transitioned to the
crush-resistant formulation in March 2012 upon successfully accelerating
production of the new formulation.
Changes in Directors & Officers and Other Related Matters
On July 18, 2012, Endo announced the appointment of Camille Farhat as President
of American Medical Systems, a wholly owned subsidiary of Endo Health Solutions
Inc. Prior to joining AMS, Mr. Farhat served in a variety of senior leadership
positions within the healthcare industry; most recently as General Manager
of Baxter Pharmaceuticals and Technologies. As General Manager, Mr. Farhat
significantly enhanced the performance and improved the operating efficiency of
the business while focusing on the needs of patients. During his time at Baxter,
he also held the role of General Manager for Baxter Global Infusion
Systems. Before that, Mr. Farhat provided executive leadership at Medtronic,
including roles in Business Development, as well as Global General Manager,
Gastroenterology and Urology. In addition, he held a variety of positions at GE
Healthcare, including roles as a Global General Manager of the Computed
Tomography Business. He also held leadership positions in strategic planning and
global sourcing at General Electric.
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 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. In
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the following months, the Court considered the constitutionality of the
individual mandate, as well as whether the overall health care law could still
stand even if the individual mandate was ruled unconstitutional. On June 28,
2012, the Supreme Court upheld the individual mandate. By virtue of ruling that
the individual mandate is constitutional, the entire law remains constitutional.
In its ruling, the Court did address the expansion of Medicaid required under
the law, a provision that requires states to expand Medicaid to approximately 17
million additional low-income individuals up to 133 percent of the federal
poverty level. Under the law, the federal government would pay the additional
costs for the expansion of Medicaid for the years 2014 to 2016 and then the
federal share would phase down to 90 percent by 2020. The law provided that if a
state did not expand its Medicaid program eligibility to 133 percent, they would
risk losing the federal share for all its Medicaid funding and not just the
funding for the expansion. On this matter, the Supreme Court upheld the
constitutionality of the Medicaid expansion but ruled that the punitive aspects
of the provision are unconstitutional meaning that the federal government does
not have the authority to terminate existing federal funding for Medicaid if the
states do not expand Medicaid. This aspect of the ruling may cause some states
to refuse to expand its Medicaid eligibility thereby limiting the number of
individuals with access to health insurance.
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 trillion 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.
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.
Consolidated Results Review
Revenues. Revenues for the three and six months ended June 30, 2012 increased
29% to $785.2 million and 26% to $1,475.8 million, respectively, from the
comparable 2011 periods. These increases in revenues are primarily driven by our
acquisition of AMS during the second quarter of 2011, from which we derived
$128.1 million and $258.3 million in revenue for the three and six months ended
June 30, 2012, respectively, compared to $26.8 million during the three and six
months ended June 30, 2011 as well as continued growth in our Endo
Pharmaceuticals, Qualitest and HealthTronics segments.
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The following table displays our revenues by category and as a percentage of
total revenues for the three and six months ended June 30, 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 June 30, Six Months Ended June 30,
2012 2011 2012 2011
$ % $ % $ % $ %
Lidoderm® $ 228,006 29 $ 195,840 32 $ 438,020 30 $ 385,565 33
Opana® ER 93,413 12 92,853 15 174,499 12 177,468 15
Voltaren® Gel 43,690 6 36,655 6 43,690 3 67,953 6
Percocet® 25,824 3 27,675 5 49,204 3 54,635 5
Frova® 14,002 2 14,163 2 29,646 2 27,371 2
Supprelin® LA 14,797 2 12,515 2 28,243 2 23,737 2
Other brands 23,054 3 18,566 3 43,058 3 37,052 3
Total Endo Pharmaceuticals* 442,786 56 398,267 66 806,360 55 773,781 66
Qualitest 159,895 20 133,047 22 305,240 21 267,456 23
AMS 128,131 16 26,812 4 258,297 18 26,812 2
HealthTronics 54,376 7 49,485 8 105,924 7 99,588 9
Total revenues* $ 785,188 100 $ 607,611 100 $
1,475,821 100 $ 1,167,637 100
_____________
* - Percentages may not add due to rounding.
Lidoderm®. Net sales of Lidoderm® for the three and six months ended June 30,
2012 increased 16% to $228.0 million and 14% to $438.0 million, respectively,
from the comparable 2011 periods. 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 $21.2
million and $42.1 million higher during the three and six months ended June 30,
2012, respectively, compared to the same periods in 2011. Lidoderm® had solid
performance this year, reflected by its double-digit growth and increase in
scripts from the comparable 2011 periods, 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 June 30, 2012
increased 1% to $93.4 million, while net sales for the six months ended June 30,
2012, decreased 2% to $174.5 million. Revenues during the three months ended
June 30, 2012 increased, primarily due to sales of our new formulation of
Opana® ER, designed to be crush-resistant, which we began selling in March 2012.
The decrease during the six months ended June 30, 2012 resulted primarily from
the first quarter 2012 Opana® ER supply disruptions associated with the
temporary shutdown of Novartis's Lincoln, Nebraska manufacturing facility.
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, production of Voltaren® Gel resumed at an alternative
Novartis manufacturing site. Sales of Voltaren® Gel totaled $43.7 million for
the three months ended June 30, 2012. This represents a 19% or $7.0 million
increase from the comparable 2011 period. We believe the continued growth of
Voltaren® Gel is driven by the product's proven clinical efficacy combined with
our sustained promotional activities aimed at increasing product awareness in
the target audience.
Percocet®. Net sales of Percocet® for the three and six months ended June 30,
2012 decreased 7% to $25.8 million and 10% to $49.2 million, respectively, from
the comparable 2011 periods. These decreases were primarily attributable to
reduced volumes.
Frova®. Net sales of Frova® for the three months ended June 30, 2012 decreased
1% to $14.0 million from the comparable 2011 period, while sales for the six
months ended June 30, 2012 increased 8% to $29.6 million from the comparable
2011 period. During the three months ended June 30, 2012, price increases were
more than offset by the impact of decreased volumes. The increase during the six
months ended June 30, 2012 was primarily attributable to price increases.
Supprelin® LA. Net sales of Supprelin® LA for the three and six months ended
June 30, 2012 increased 18% to $14.8 million and 19% to $28.2 million,
respectively, from the comparable 2011. These increases were driven by volume
growth, 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.
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Other brands. Net sales of our other branded products for the three and six
months ended June 30, 2012 increased 24% to $23.1 million and 16% to $43.1
million, respectively, from the comparable 2011 periods. These increases were
largely attributable to increased revenues from Fortesta® Gel, Vantas® and
Valstar®, partially offset by decreased revenue from Opana® as demand continues
to shift to Opana® ER.
Qualitest. Net sales of our generic products for the three and six months ended
June 30, 2012 increased 20% to $159.9 million and 14% to $305.2 million,
respectively, from the comparable 2011 periods. These increases were primarily
driven by strong demand for Qualitest's diversified product portfolio and
favorable pricing, resulting in gross profit of approximately 40%. Sales of
hydrocodone and acetaminophen increased $15.4 million and $23.2 million,
respectively, during the three and six months ended June 30, 2012 and sales of
methylprednisolone, increased $9.3 million and $17.7 million, respectively,
during the three and six months ended June 30, 2012.
AMS. Revenues from our AMS segment for the three and six months ended June 30,
2012 were $128.1 million and $258.3 million, respectively, and were attributable
to sales of products from our AMS subsidiary, which we acquired on June 17,
2011. These amounts compare to $26.8 million from June 18, 2011 through June 30,
2011.
HealthTronics. Revenues from our HealthTronics segment for the three and six
months ended June 30, 2012 increased 10% to $54.4 million and 6% to $105.9
million, respectively, from the comparable 2011 periods. These increases were
primarily attributable to the revenues from the electronic medical records
software companies, Intuitive Medical Software, LLC and meridianEMR, Inc. which
we acquired in the second half of 2011, partially offset by the loss of sales
from our IGRT business, which was sold in August 2011.
Gross Margin, Costs and Expenses. The following table sets forth costs and
expenses for the three and six months ended June 30, 2012 and 2011 (dollars in
thousands):
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
$ % of Revenues $ % of Revenues $ % of Revenues $ % of Revenues
Cost of revenues $ 294,570 38 $ 236,697 39 $ 659,390 45 $ 468,255 40
Selling, general and
administrative 233,622 30 178,133 29 488,076 33 337,519 29
Research and
development 45,427 6 40,840 7 134,115 9 82,970 7
Patent litigation
settlement expense 131,361 17 - - 131,361 9 - -
Asset impairment
charges 3,000 - - - 43,000 3 - -
Acquisition-related and
integration items, net 7,055 1 17,626 3 10,804 1 23,699 2
Total costs and
expenses* $ 715,035 91 $ 473,296 78 $ 1,466,746 99 $ 912,443 78
_____________
* - Percentages may not add due to rounding.
Cost of Revenues and Gross Margin. Cost of revenues for the three and six months
ended June 30, 2012 increased 24% to $294.6 million and 41% to $659.4 million,
respectively, from the comparable 2011 periods. These increases were primarily
driven by our June 2011 acquisition of AMS, which contributed approximately
$39.5 million and $81.1 million to our Cost of revenues during the three and six
months ended June 30, 2012, respectively, compared to $11.5 million during the
three and six months ended June 30, 2011. Our first quarter 2012 Cost of
revenues was also impacted by the charge of $110.0 million related to the
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 and six months ended
June 30, 2012 were 62% and 55%, respectively, compared to 61% and 60%,
respectively, during the three and six months ended June 30, 2011. The increase
in gross profit margins for the three months ended June 30, 2012 was primarily
due to changes in our revenue mix resulting from the timing of our acquisition
of AMS in June 2011. The decrease in gross profit margins for the six months
ended June 30, 2012 was primarily due to the Impax accrual.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three and six months ended June 30, 2012
increased 31% to $233.6 million and 45% to $488.1 million, respectively, from
the comparable 2011 periods. These increases are primarily attributable to the
inclusion, during the three and six months ended June 30, 2012, of $67.3 million
and $145.3 million, respectively, of AMS expense as well as $2.9 million and
$14.1 million, respectively, 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.
This compares to $9.8 million of AMS expense and $0.5 million and $4.0 million,
respectively, of integration costs and separation benefits in the comparable
2011 periods.
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Research and Development Expenses. Research and development expenses for the
three and six months ended June 30, 2012 increased 11% to $45.4 million and 62%
to $134.1 million, respectively, from the comparable 2011 periods. These
increases are primarily attributable to the addition of AMS's research and
development portfolio upon our June 2011 acquisition of AMS. Due to the timing
of our AMS acquisition, AMS incurred Research and development expenses during
the entire three and six month periods ended June 30, 2012, as compared to a
partial period's expense during the three and six months ended June 30, 2011.
Research and development expenses were also impacted by 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.
During the three and six months ended June 30, 2012 we incurred $2.8 million and
$49.8 million, respectively, in expense related to milestones classified as
Research and development expense compared to $5.0 million and $16.0 million,
respectively, in the comparable 2011 periods.
Patent Litigation Settlement Expense. On May 28, 2012, Endo Pharmaceuticals Inc.
(EPI) entered into a Settlement and License Agreement (the Watson Settlement
Agreement) among EPI and Teikoku, on the one hand and Watson, on the other hand.
The Watson Settlement Agreement settles all ongoing patent litigation among the
parties relating to Watson's generic version of Lidoderm®. Under the terms of
the Watson Settlement Agreement, the parties dismissed their respective claims
and counterclaims without prejudice. As part of the settlement, Watson agreed
not to challenge the validity or enforceability of Endo's and Teikoku's patents
relating to Lidoderm® with respect to Watson's generic version of Lidoderm®.
Watson also agreed not to sell its generic version of Lidoderm® until it
receives FDA approval and, in any event, no sooner than September 15, 2013,
except in limited specific circumstances (such date being the Start Date). Endo
and Teikoku agreed to grant Watson a license permitting the sale of generic
Lidoderm® upon the Start Date in the United States. The license to Watson is
exclusive as to Endo's launch of an authorized generic version of Lidoderm®
until the earlier of 1) the introduction of a generic version of Lidoderm® by a
company other than Watson or 2) seven and a half months after Watson launches
its generic version of Lidoderm®. Endo will receive an at market royalty equal
to 25% of the gross profit generated on Watson's sales of its generic version of
Lidoderm® during Watson's period of exclusivity.
Additionally, the Watson Settlement Agreement provides that Endo and Teikoku
will provide, at no cost, to Watson's wholesaler affiliate branded Lidoderm®
product for Watson's wholesaler affiliate's distribution, subject to certain
terms and conditions as follows:
• Beginning on January 1, 2013 through August 1, 2013, Endo and Teikoku
will provide branded Lidoderm® of value totaling $12.0 million each
month ($96.0 million in total for 2013) (valued at the then-prevailing
wholesale acquisition cost). The obligation of Endo and Teikoku to
provide this branded product at no cost terminates immediately upon the
launch of a third party's generic version of Lidoderm® in the United
States, including its territories, possessions and the Commonwealth of
Puerto Rico (the Territory).
• In the event Watson does not receive final FDA approval of its generic
version of Lidoderm® by January 1, 2014, then beginning on January 1,
2014 through December 1, 2014, Endo and Teikoku will provide branded
Lidoderm® product of value totaling $6.7 million each month ($80.0
million in total for 2014) (valued at the then-prevailing wholesale
acquisition cost). The obligation of Endo and Teikoku to provide this
branded product at no cost terminates immediately upon the earlier of (a) the final FDA approval of Watson's generic version of Lidoderm® or
(b) the launch of a third party's generic version of Lidoderm® in the
Territory.
• In the event Watson does not receive final FDA approval of its generic
version of Lidoderm® by January 1, 2015, then beginning on January 1,
2015 through September 1, 2015, Endo and Teikoku will provide branded
Lidoderm® product of value totaling $7.1 million each month ($64.0
million in total for 2015) (valued at the then-prevailing wholesale
acquisition cost). The obligation of Endo and Teikoku to provide this
branded product at no cost terminates immediately upon the earlier of (a) the final FDA approval of Watson's generic version of Lidoderm® or
(b) the launch of a third party's generic version of Lidoderm® in the
Territory.
Endo will be responsible for the payment of all gross to net adjustments arising
from Watson's sale of the branded Lidoderm® product.
In contemplation of the Watson Settlement Agreement, Teikoku has agreed to
provide a rebate to Endo equal to 50% of the cost of branded Lidoderm® product
that is required to be provided to Watson's wholesaler affiliate pursuant to
Section 3(b), 3(c) and 3(d) of the Watson Settlement Agreement.
The Company has concluded that the Watson Settlement Agreement is a
multiple-element arrangement and has recognized a liability and corresponding
charge of $131.4 million in Patent litigation settlement expense in the second
quarter of 2012 representing the estimated fair value of the settlement
component. Fair value of the settlement component was estimated using the
probability adjusted expected value of branded Lidoderm® product to be provided
to Watson at the anticipated wholesaler acquisition cost (WAC) expected to be in
place at the time of shipment, less a reasonable estimate of Watson's selling
costs. The resultant probability-weighted values were then discounted using a
discount rate of 5.1%. The Company presently believes that the level and timing
of branded Lidoderm® product to be shipped, discount rate, and probabilities
used in the model appropriately reflect market participant assumptions. Because
the liability is recorded at fair value using WAC, the charge recognized in 2012
is comprised of several elements, including our cost of product to be shipped,
estimated gross-to-net deductions to be paid by the Company and the estimated
product profit margin. We believe this is the most appropriate measure of fair
value as these components combined, represent the value accruing to Watson. As a
result of using a fair value measurement, the second quarter 2012 charge will be
greater than the actual
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cost to the Company. As such, relief of the liability in subsequent periods
through shipments of branded Lidoderm® product will result in income, which we
expect to record as a component of Other expense (income), net in the Company's
Condensed Consolidated Statements of Operations. We intend to reclassify the
portion of the settlement liability related to the gross-to-net component into
our gross-to-net reserves as product is shipped to Watson, the effect of which
will be to offset a portion of the income that will be recognized into Other
expense (income), net in the Company's Condensed Consolidated Statements of
Operations, as the settlement liability is relieved. The rebate arrangement with
Teikoku will also be accounted for prospectively as product purchased from
Teikoku will be recorded into inventory at the discounted purchase price and
relieved as shipments are made to Watson. The benefit associated with this
rebate will be recorded as a component of Other expense (income), net in the
Company's Condensed Consolidated Statements of Operations. Changes, if any,
resulting from revisions to the timing or the amount of the original estimate
will be recognized as an increase or a decrease in the carrying amount of the
litigation settlement liability and the related Patent litigation settlement
expense during the period of change. Changes in estimates to the settlement
liability could have a material impact on our results of operations.
Asset Impairment Charges. As a result of market and potential regulatory changes
affecting the commercial potential in the United States for one of the AMS IPR&D
assets, the Company determined that the asset's carrying value was no longer
fully recoverable. Accordingly, in the second quarter of 2012, we recorded a
pre-tax non-cash impairment charge of $3.0 million, which was assigned to our
AMS segment and was recorded in the Asset impairment charges line of our
Condensed Consolidated Statements of Operations. The fair value of this asset
was determined using a probability-weighted discounted cash flow model, or
income approach. This fair value measurement technique is based on significant
inputs not observable in the market and thus represents a Level 3 measurement
within the fair value hierarchy. Changes in any of the assumptions used in
determining the fair value of this asset may result in a further reduction to
its estimated fair value and could result in additional and potentially full
future impairment charges of up to $1.0 million.
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®.
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. The Company appealed this ruling, and
subsequently in June 2012, our appeal was dismissed. Watson's application with
the FDA for a generic version is currently pending.
As part of our first quarter 2012 Form 10-Q filing, despite the Company's intent
to appeal the District Court's ruling, the Company concluded that an impairment
assessment was required to evaluate the recoverability of the indefinite-lived
intangible asset. 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 in March 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 and Integration Items, net. Acquisition-related and
integration items, net for the three and six months ended June 30, 2012 were
$7.1 million in expense and $10.8 million in expense, respectively, compared to
$17.6 million in expense and $23.7 million in expense, respectively, in the
comparable 2011 periods. Acquisition-related and integration items, net for the
three and six months ended June 30, 2012 and 2011 primarily consisted of
transaction fees including legal, separation, integration, and other expenses
for our acquisitions.
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Interest Expense, net. The components of interest expense, net for the three and
six months ended June 30, 2012 and 2011 are as follows (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Interest expense $ 46,078 $ 25,731 $ 93,086 $ 44,648
Interest income (93 ) (171 ) (205 ) (298 )Interest expense, net $ 45,985 $ 25,560 $ 92,881
$ 44,350
Interest expense during the three and six months ended June 30, 2012 was $46.1
million and $93.1 million, respectively, compared with $25.7 million and $44.6
million, respectively, in the comparable 2011 periods. These increases were
primarily attributable to increases in our average total indebtedness. During
the three and six months ended June 30, 2012, we incurred $23.8 million and
$47.6 million, respectively, of interest expense on our $1.3 billion of senior
notes, of which $400.0 million originated in November 2010 and the remaining
$900.0 million in June 2011. This compares to $11.3 million and $18.6 million,
respectively, of senior note interest in the comparable 2011 periods. During the
three and six months ended June 30, 2012, we incurred $14.1 million and $31.3
million of interest expense, respectively, related to our credit facilities
compared to $6.8 million and $10.9 million, respectively, in the comparable 2011
periods. These increases were primarily attributable to the 2011 Credit Facility
entered into in June 2011, which initially provided $2.2 billion of term loan
indebtedness, of which $1.7 billion remains at June 30, 2012, compared to $395.0
million of term loan indebtedness prior to our June 2011 term loan borrowings.
Loss on Extinguishment of Debt. In February 2012, we made a prepayment of $205.0
million on our Term Loan B Facility. Approximately $5.4 million of the remaining
unamortized financing costs associated with this facility were written off in
connection with our February 2012 prepayment and included in the Condensed
Consolidated Statements of Operations as a Loss on extinguishment of debt.
Other Expense (Income), net. Other expense (income), net for the three and six
months ended June 30, 2012 was $0.3 million in expense and $0.7 million in
expense, respectively, which compares to $0.1 million in income and $0.2 million
in expense, respectively, in the comparable 2011 periods.
Income Tax. The effective income tax rate on earnings from continuing operations
before income taxes was 7.4% and 41.7% for the three and six months ended
June 30, 2012, respectively, compared to 32.7% and 32.8% for the three and six
months ended June 30, 2011, respectively.
Income tax expense for the three months ended June 30, 2012 decreased 95% from
the three months ended June 30, 2011. For the six months ended June 30, 2012 an
income tax benefit of $37.6 million was recorded as compared to tax expense of
$66.2 million for the six months ended June 30, 2011. These fluctuations are due
to decreases in income before income tax and the recording of a $6.3 million
benefit for a prior period adjustment during the three months ended June 30,
2012 related to the reversal of a 2010 capital loss valuation allowance recorded
in connection with our acquisition of HealthTronics, Inc. The valuation
allowance was reversed because of a 2011 transaction that resulted in a realized
ordinary loss for income tax purposes.
2012 Outlook. We estimate that our 2012 total revenues will be between $3.05
billion and $3.175 billion. Our estimate is based on the continued growth of
both our Qualitest and Endo Pharmaceuticals portfolios-driven by ongoing
prescription demand for our key inline products, including Lidoderm®, Opana® ER,
and Voltaren® Gel-and the full-year effect of the AMS acquisition. Cost of
revenues as a percent of total revenues is expected to increase when compared to
2011. This increase is expected due to a full year of amortization expense
associated with the intangible assets acquired with AMS as well as growth in
lower margin generic and branded pharmaceutical products in 2012, partially
offset by a full year's revenues from the AMS acquisition. Selling, general and
administrative expenses as a percentage of revenues are expected to decline in
2012 relative to 2011, reflecting new approaches to customer segmentation and
marketing, annualized effects of the prior year's cost reduction efforts,
forecasted synergies associated with our AMS acquisition, as well as 2012
operating efficiency improvements and redeployment of flexible spending. The
total amount of selling, general and administrative expenses will increase year
over year, however, reflecting the full year effects of our acquisitions.
Research and development expenses are expected to increase due to the addition
of AMS's research and development portfolio to our existing programs, the
progress of our branded pharmaceutical portfolio's development, as well as the
expansion of our efforts in the pharmaceutical discovery and device research and
development areas. Of course, there can be no assurance that the Company will
achieve these results.
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Business Segment Results Review
In the fourth quarter of 2011, as a result of our strategic planning process,
the Company's executive leadership team reorganized the manner in which it views
our various business activities. Management's intention was to enhance its level
of understanding of the entity's performance, better assess its prospects and
future cash flow potential and ultimately make more informed operating decisions
about resource allocation and the enterprise as a whole. Based on this change,
we reassessed our reporting structure under the applicable accounting guidance
and determined that the Company now has four reportable segments: (1) Endo
Pharmaceuticals, (2) Qualitest, (3) AMS and (4) HealthTronics. We have
retrospectively revised the segment presentation for all periods presented
reflecting the change from three to four reportable segments. Additionally,
consistent with the Company's May 2012 enterprise-wide rebranding initiative and
corporate name change, the Company changed the names of its reportable segments
to better align with these efforts. These changes to our segments have no impact
on the Company's Condensed Consolidated Financial Statements for all periods
presented. Each segment derives revenue from the sales or licensing of their
respective products or services and is discussed below.
We evaluate segment performance based on each segment's adjusted income (loss)
before income tax, a financial measure not determined in accordance with GAAP.
We define adjusted income (loss) before income tax as income (loss) before
income tax before certain upfront and milestone payments to partners,
acquisition-related and integration items, net, cost reduction and
integration-related initiatives, asset impairment charges , amortization of
intangible assets related to marketed products and customer relationships,
inventory step-up recorded as part of our acquisitions, non-cash interest
expense, and certain other items that the Company believes do not reflect its
core operating performance.
Certain corporate general and administrative expenses are not allocated and are
therefore included within Corporate unallocated. We calculate consolidated
adjusted income (loss) before income tax by adding the adjusted income (loss)
before income tax of each of our reportable segments to corporate unallocated
adjusted income (loss) before income tax.
We refer to adjusted income (loss) before income tax in making operating
decisions because we believe it provides meaningful supplemental information
regarding the Company's operational performance. For instance, we believe that
this measure facilitates its internal comparisons to its historical operating
results and comparisons to competitors' results. The Company believes this
measure is useful to investors in allowing for greater transparency related to
supplemental information used by us in our financial and operational
decision-making. In addition, we have historically reported similar financial
measures to our investors and believe that the inclusion of comparative numbers
provides consistency in our financial reporting at this time. Further, we
believe that adjusted income (loss) before income tax may be useful to investors
as we are aware that certain of our significant stockholders utilize adjusted
income (loss) before income tax to evaluate our financial performance. Finally,
adjusted income (loss) before income tax is utilized in the calculation of
adjusted diluted net income per share, which is used by the Compensation
Committee of Endo's Board of Directors in assessing the performance and
compensation of substantially all of our employees, including our executive
officers.
There are limitations to using financial measures such as adjusted income (loss)
before income tax. Other companies in our industry may define adjusted income
(loss) before income tax differently than we do. As a result, it may be
difficult to use adjusted income (loss) before income tax or similarly named
adjusted financial measures that other companies may use to compare the
performance of those companies to our performance. Because of these limitations,
adjusted income (loss) before income tax should not be considered as a measure
of the income generated by our business or discretionary cash available to us to
invest in the growth of our business. The Company compensates for these
limitations by providing reconciliations of our consolidated adjusted income
(loss) before income tax to our consolidated income before income tax, which is
determined in accordance with U.S. GAAP and included in our Condensed
Consolidated Statements of Operations
Endo Pharmaceuticals
The Endo Pharmaceuticals segment includes a variety of branded prescription
products related to treating and managing pain as well as our urology,
endocrinology and oncology products. The marketed products that are included in
this segment include Lidoderm®, Opana® ER, Percocet®, Voltaren® Gel, Frova®,
Supprelin® LA, Vantas®, Valstar® and Fortesta® Gel.
Qualitest
The Qualitest segment is comprised of our legacy Endo non-branded generics
portfolio and the portfolio from our recently acquired Qualitest Pharmaceuticals
business. Our generics business has historically focused on selective generics
related to pain that have one or more barriers to market entry, such as complex
formulation, regulatory or legal challenges or difficulty in raw material
sourcing. With the addition of Qualitest Pharmaceuticals, the segment's product
offerings now include products in the pain management, urology, central nervous
system (CNS) disorders, immunosuppression, oncology, women's health and
hypertension markets, among others.
AMS
The AMS segment currently focuses on providing technology solutions to
physicians treating men's and women's pelvic health conditions and operates in
the following business lines: men's health, women's health, and BPH therapy.
These business lines are
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discussed in greater detail within Note 5. Acquisitions in the Condensed
Consolidated Financial Statements. We distribute devices through our direct
sales force and independent sales representatives in the U.S., Canada,
Australia, and Western Europe. Additionally, we distribute devices through
foreign independent distributors, primarily in Europe, Asia, and South America,
who then sell the products to medical institutions. None of our devices
customers or distributors accounted for ten percent or more of our total
revenues during the three or six months ended June 30, 2012 or 2011. Foreign
subsidiary sales are predominantly to customers in Canada, Australia and Western
Europe.
HealthTronics
The HealthTronics segment provides urological services, products and support
systems to urologists, hospitals, surgery centers and clinics across the U.S.
These services are sold through the following business lines: lithotripsy
services, prostate treatment services, anatomical pathology services, medical
products manufacturing, sales and maintenance and electronic medical records
services.
Revenues. The following table displays our revenue by reportable segment for the
three and six months ended June 30, 2012 and 2011 (dollars in thousands):
