Susan Mesco - Pacira Pharmaceuticals, Inc. David M. Stack - Pacira Pharmaceuticals, Inc. Richard E. Scranton - Pacira Pharmaceuticals, Inc. Charles A. Reinhart III - Pacira Pharmaceuticals, Inc..

Randall S. Stanicky - RBC Capital Markets LLC David A. Amsellem - Piper Jaffray & Co. David Michael Steinberg - Jefferies LLC Dana Flanders - Goldman Sachs & Co. LLC Serge Belanger - Needham & Co. LLC Ami Fadia - Leerink Partners LLC Gary Nachman - BMO Capital Markets (United States) Boris Peaker - Cowen & Co. LLC.

Good day, ladies and gentlemen and welcome to the Third Quarter 2018 Pacira Pharmaceuticals Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Susan Mesco, Head of Investor Relations. Ma'am, you may begin..

Thank you, Heather and good morning everyone. Welcome to today's conference call to discuss our third quarter financial results. Joining me on today's call are Dave Stack, Chairman and Chief Executive Officer; Dr. Richard Scranton, our Chief Medical Officer; and Charlie Reinhart, our Chief Financial Officer.

Before we start, let me remind you that today's call will include forward-looking statements based on current expectations. Such statements represent our judgment as of today and may involve risks and uncertainties.

Please refer to our filings with the SEC which are available from the SEC or our website for information concerning the risk factors that could affect the company. With that, I will now turn the call over to Dave Stack..

First, providing clinical data and Enhanced Recovery After Surgery protocols to expand the use of EXPAREL in key surgical settings; second, driving education and awareness around the need for improving access to opioid-sparing solutions within and outside of the operating room; and third, partnering with those who share our commitment to reducing or eliminating opioids in the post-surgical setting.

I'll start by sharing an update on the nerve block launch where we continue to gain traction. Since introduction, EXPAREL as a brachial plexus block in early April, we've seen 115% increase in the average weekly sales of the 10 mL vial compared to a 13-week pre-launch benchmark.

We continue to hear success stories from anesthesiologists around the country who are now regularly using EXPAREL as an integral part of their suite of post-surgical pain management solutions. At the October Meeting of the American Society of Anesthesiologists, the enthusiasm around EXPAREL was palpable.

As you know, anesthesiologists are typically key gatekeepers of pain management strategies, as well as influential voice on P&T committees and hospital and ambulatory surgery decision-making. ASA attendees expressed a high level of interest in simplifying their pain management approach by turning to targeted non-opioid pain relief with EXPAREL.

They noted the benefits of EXPAREL offered by eliminating the cost and time associated with continuous administration of large doses of bupivacaine through cumbersome pumps and catheters.

Physicians are also reporting consistent results with three days of pain control with many patients not taking any opioid, following very painful shoulder procedures. Beyond nerve block, our clinical, regulatory and medical affairs teams are advancing initiatives to broaden the use of EXPAREL.

Key highlights include completing enrollment of our C-section study, where EXPAREL was administered as a transverse abdominis plane or TAP block, and rolling out a follow-on study for opioid-free C-section surgery; launching a registration study for pediatric patients, a population in critical need of innovative opioid-free options for postsurgical pain; kicking off our Phase 4 studies in spine and hip fracture; advancing regulatory activities for key markets outside of the U.S.

with emphasis on China, Canada and the European Union; and continued expansion of EXPAREL-based Enhanced Recovery After Surgery or ERAS protocols across a wide range of surgical procedures. Dr. Rich Scranton will provide further details on these initiatives shortly.

Now I'd like to turn to the second pillar of our strategy; education, awareness and expanding access. I'll start with a summary of where we stand with CMS in some of our commercial payer initiatives. In terms of Medicare, we expect an EXPAREL-specific J code imminently.

CMS's decision to unbundle EXPAREL and reimburse ambulatory centers at average selling price plus 6% is a significant victory for patients and providers. We believe the removal of this reimbursement hurdle will accelerate the transition of certain procedures to the ambulatory setting.

This will not only drive patient and provider satisfaction, but also reduce the overall cost to the healthcare system. Our partner, Aetna, continues to encourage access to non-opioids, with a recently launched pilot program designed to incentivize the use of EXPAREL through expanded coverage at select ambulatory centers in Florida and New Jersey.

We expect to advance additional initiatives with commercial payers as we prepare for the full rollout of the J code on January 1. We also now have a focused team of field outpatient account managers, who are working with them ambulatory centers and commercial payers to facilitate EXPAREL reimbursement.

Once the final CMS rule and J code take effect on January 1, we will expect smoother reimbursement to begin to unfold for both Medicare and commercial payers, as the market standardizes around the Medicare reimbursement J code.

In addition to the ambulatory setting, our outpatient account managers are successfully engaging with oral surgery and plastic surgery customers, who are interested in highlighting their use of EXPAREL as a means of differentiating their practice.

We see an expanding role for EXPAREL in oral surgery field, where an overwhelming majority of patients would prefer a non-opioid option for managing pain. Many of these younger patients are exposed to opioids for the first time, following common procedures like wisdom tooth extractions.

Improving access to opioid-free solutions like EXPAREL is critical in this vulnerable population.

The good news here is that the – at the request of the American Association of Oral and Maxillofacial Surgeons or AAOMS, the American Dental Association has issued a new dental billing code, D9613, that can be used for EXPAREL, specifically for infiltration of sustained-release pharmacologic agent for long-acting surgical site pain control.

This strong national support from two prestigious dental societies validates the clear need for non-opioid approaches within the dental community. We expect the D code to facilitate reimbursement and drive uptake as more and more oral surgeons begin to offer EXPAREL to their patients.

In fact, our partner, Aetna, is already notifying their network providers that they're covering the new D code for impacted wisdom tooth extractions and reimbursing the 10 mL vial.

And we are actively working with other commercial dental payers who will offer non-opioid options like EXPAREL as a means of differentiating themselves, especially self-insured plans. On the education front, we continue to advance our robust public relations campaign to raise awareness around the need for opioid-sparing pain management strategies.

Last month, new research was published representing the most current analysis of national trends in opioid prescribing. The report titled, Exposing a Silent gateway to Persistent Opioid Use, is based on an analysis of 2017 claims data and a 2018 nationwide survey of surgical patients and surgeons.

Key findings include patients received 100 to 200 opioid pills to help manage the pain from common surgical procedures. 25% of orthopedic patients – surgery patients were prescribed the daily dose of opioids that was so potent, the CDC designates it as a high risk of overdose. Trends were especially concerning among millennials aged 18 to 34.

Persistent use increased 17% for millennial women over last year and 18% of millennial men and women reported becoming addicted or dependent after surgery. Nearly one in five patients refilled their opioid prescription even though they no longer had pain.

And 90% of patients with leftover pills reported they did not dispose of them properly, leaving them in their homes or sharing them with family or friends. We have launched a broad initiative to disseminate these compelling data.

We're working together with Partnership for Drug-Free Kids, shatterproof.org, and key opinion leaders to help patients and physicians create personalized opioid-sparing pain management strategies.

Moving to our third and final strategic pillar, partnerships, I'll start with J&J, which has continued to exceed our expectations through a shared commitment to providing an opioid alternative to as many patients as possible.

J&J continues to invest in making EXPAREL a success through their talent and financial resources as well as their organizational expertise.

Now that EXPAREL is being integrated into each of J&J's orthopedic sales verticals and educational materials, the team is focusing on total non-opioid solution strategies for key procedures such as rotator cuff, spine and hip fractures.

A key example here is the new initiative featuring EXPAREL and the DePuy Synthes' recently launched DYNACORD Suture, which is part of the DPS-Mitek sports medicine portfolio. The campaign is featuring both brands as a differentiated and opioid-sparing solution for rotator cuff repairs.

We're also pleased to further extend our relationship to include co-promotional efforts with TYLENOL. The marketing campaign includes co-branded materials to motivate patients to speak to their doctors about opioid-free postsurgical pain relief. It features both agents as improved tools for a non-opioid approach.

This will include a digital initiative, driving patients to a co-branded micro site as well as EXPAREL.com. We continue to remain very optimistic about the near-term and long-term opportunities fostered by this very successful J&J collaboration.

Another key highlight from our partnership network is our innovation with MEDNAX to address the ongoing use of opioids during and after cesarean surgery, through a series of educational workshops around enhanced recovery after C-section surgery programs.

We are working with their team of maternal-fetal specialists, anesthesiologists, obstetricians and perioperative nurses to create a new innovative platform for cesarean sections that features EXPAREL as a TAP block for targeted long-lasting opioid-free pain management. The last line item I will quickly touch on is our product pipeline.

Here we are focused on becoming the premier provider of innovative non-opioid pain management and regenerative health solutions through a three-pronged approach.

First, given the excellent safety profile and flexibility of our DepoFoam platform, we are advancing a development plan for intrathecal delivery of non-opioid analgesics for acute and chronic pain. This program is underway with EXPAREL as well as other local anesthetic and novel API products.

Second, we have several DepoFoam-based products in preclinical development. Following data readouts from animal and other feasibility studies for these candidates, we will determine the best programs to advance into the clinic. We expect to announce these additional DepoFoam assets over the next couple of quarters.

And third, business development where Pacira is solidified as a partner of choice given our financial strength, our clinical and commercial expertise in hospital and ambulatory markets and our significant partnership network.

Our team is selectively evaluating opportunities in orthopedic surgery, osteoarthritis, and additional products and technologies of interest to surgeons and anesthesiologists.

We also remain very excited about our investment in TELA Bio and their OviTex platform, which we believe is highly differentiated and positioned to emerge as a leading bioscaffold solution to replace traditional surgical mesh. With that overview, I would like to turn the call over to Dr.

Rich Scranton to provide some additional color on our clinical and regulatory activities.

Rich?.

Thanks, Dave and good morning to all joining today's call. Since we last spoke, we have continued to make great progress, executing on our clinical and regulatory strategies. EXPAREL has been used in more than 4.5 million patients since approval. Given its excellent safety profile, we are focused on broadening the use of EXPAREL within key procedures.

In parallel, we're pursuing new indications where non-opioid solutions are greatly needed and where we believe our DepoFoam technology would be the most physiologically appropriate drug delivery technology, given its safe profile and flexibility. Pediatrics is an area in urgent need of opioid-free alternatives and I'll start here.

Last month, as Dave noted, the team attended the ASA meeting and the inbound interest at our booth around pediatrics was extraordinarily high. At the ASA meeting, investigators from Cleveland Clinic presented data from a retrospective cohort analysis, which described the safety profile of EXPAREL in the pediatric population.

A total of 924 surgical cases were included in the analysis. 356 pediatric patients received EXPAREL and these patients were matched to 568 patients who had received bupivacaine. The primary outcome, which was two or more postoperative complications possibly related to local anesthetics did not occur in any patient.

The authors concluded that local infiltration with EXPAREL was found to be safe in these pediatric surgical patients. Pediatric patients have few options other than opioids to manage severe postsurgical pain.

So the high level of interest among anesthesiologists is not surprising, with clinicians very eager for pediatric patients to be included in the EXPAREL label. To that end, we are preparing to launch an expended PK and safety study in children aged 6 to 17 undergoing cardiovascular or spine surgeries.

These painful procedures are ideal for EXPAREL, which will provide analgesia via a long-lasting field block and reduce the need for opioids. Site selection is now underway and we expect to begin the study before the end of the year.

Next, let's move to our C-section study, where we continue to see great interest from both patients and healthcare providers.

There are approximately 100,000 C-sections performed each month in United States and there is a significant need for a non-opioid pain regimen to help eliminate the negative side effects and allow new mothers the ability to recover faster and spend more time with their babies.

This study is approaching full enrollment with top line results expected near the end of this year. In addition, there continue to be great deal of enthusiasm around our follow-on C-section study known as the Choice study.

Choice will launch later this year and will utilize patient reported outcomes to measure the benefits of reducing or eliminating the need for opioids administered via an epidural. Linking opioid reduction to patient benefits will help define clinical meaningfulness in support of an opioid-sparing claim.

We believe that linking opioid reductions to improvements in patient-reported outcomes are the critical elements of an opioid-sparing therapy.

Based on private discussions by academic and government bodies on the need to define what constitutes an opioid-sparing claim, we believe our work in this area will provide the necessary evidence to discuss these outcomes with healthcare providers, payers and regulators.

As for our other programs, site selection is now underway for our Phase 4 spine study and our Phase 4 hip fracture study. The spine study will be an observational design that will collect patient-reported outcomes for today's opioid-based standard of care versus an EXPAREL-based multi-model regimen.

In our hip fracture study, we are targeting a small number of leading clinicians who are already experiencing very positive real-world results using EXPAREL administrated as of fascial iliaca field block for hip fractures that present in the emergency room.

The EXPAREL field block is a simple 5-minute procedure that will be compared to a continuous bupivacaine infusion through a catheter.

The primary endpoint will focus on the ease of use and compare the time required to perform the block procedure and technique-related complications such as, block failure rate, catheter displacement and pumps malfunction.

We along with our J&J colleagues are very excited about this trial as we believe hip fractures represents a significant opportunity to improve patient outcomes. Hip fracture is a major burden on the geriatric population, and as the elder population in the United States grows, this burden will continue to increase.

Hip fractures are also associated with a high rate of mortality and can significantly impair quality of life. With EXPAREL, physicians are able to deliver a opioid-free pain relief beginning in the emergency room and better prepare patients for surgery.

This is a key advantage as the literature indicates that performing hip fracture surgery within 24 hours of injury is associated with better functional outcomes, along with lower complications and mortality. Turning to Europe, our marketing authorization application remains on track for first quarter of 2019.

We will be seeking approval of EXPAREL for local and regional analgesia in the acute pain setting for adults. Our recently approved Pediatric Investigation Program or PIP will be part of the European filing and includes studies in peripheral nerve blocks.

And finally China, we have requested a meeting with regulators to discuss the regulatory path and clinical trial requirements along with our partners at Nuance Biotech. With that, I'll turn the call over to Charlie to walk through our financial results.

Charlie?.

Thank you, Rich and good morning everyone. Before I review our third quarter financial results, I'd like to remind you that we will be discussing non-GAAP financial measures this morning. A description of these metrics, along with our reconciliation to GAAP can be found in this morning's press release.

The third quarter of 2018 was another strong quarter for EXPAREL and our company. Net EXPAREL sales were $82.2 million, representing a 23% increase over the third quarter of 2017.

With multiple EXPAREL growth drivers now bearing fruit, we are very pleased to once again be in the position to raise our full-year EXPAREL sales guidance to $325 million to $330 million from our prior range of $320 million to $325 million. Our non-GAAP gross margin for the third quarter of 2018 was 79% versus 75% for the third quarter of last year.

Our third quarter 2018 gross margin was favorably impacted by increased facility utilization which lowered our cost per vial. Non-GAAP research and development expenses increased to $13.8 million for the third quarter of 2018 versus $11 million for the third quarter of last year.

The increase in R&D was largely driven by the scale up of our manufacturing capacity in Swindon. We are now in the final stages of the regulatory process for the first stage of our capacity expansion and expect to begin commercial production within the next few months.

Our non-GAAP selling, general, and administrative expenses increased to $38.4 million in the third quarter of 2018 compared to $34.3 million for the third quarter of last year, primarily due to our expanded public affairs campaign focused on improving access to non-opioid options like EXPAREL; increased sales and promotional activities, including our new team of outpatient account managers who are engaging with ambulatory centers as well as oral and plastic surgery specialists; higher internal incentive compensation and J&J commissions, both of which are directly linked to incremental sales; and expenses related to the launch of EXPAREL for brachial plexus nerve block.

All of this resulted in non-GAAP net income of $12.8 million or $0.31 per basic and diluted share for the third quarter of 2018, compared to non-GAAP net income of $4.4 million or $0.11 per basic and diluted share for the third quarter of last year.

Finally, our cash position remains strong, as we ended the quarter with approximately $386 million in cash and investments. Looking ahead to our full-year financial guidance. In addition to increasing our EXPAREL sales guidance, today, we're also improving our non-GAAP gross margin guidance to 74% to 75% from our previously guided range of 72% to 74%.

The remainder of 2018 full-year financial guidance remains the same. Non-GAAP R&D expense of $50 million to $60 million, non-GAAP SG&A expense of $150 million to $160 million, noting that we expect to be in the high end of this range, and stock-based compensation expense of $30 million to $35 million.

With that, I will now turn the call over to the operator to begin our Q&A session.

Operator?.

Thank you. Your first question comes from Randall Stanicky with RBC. Your line is open..

Great, thanks guys. Dave or Charlie, maybe just to start-off, I have a couple of questions. But – in the past you've talked about monthly growth trends and those trends have been accelerating in recent months.

Can you perhaps give us some color in terms of how September, and I don't know if you have October, looked? Just to get a sense, are we still seeing those monthly trends track in the upper teens? Is that acceleration still continuing?.

So I would say, we reported obviously revenue growth of 23%. That was reasonably consistent throughout the period frankly..

Okay. So when we look at the fourth quarter guidance, I think it's implying, if my math is correct, bolted to 19%. We should be thinking about that as a conservative bar. I mean, you've raised guidance – you've beaten and raised guidance for the last two quarters in a row.

There's no growth slowdown in your guys' confidence in that growth and that acceleration or at least that level of growth continuing remains high given all of the things you have going on, is that fair?.

So, Randall, we remain very excited about what we're seeing in our business and are very optimistic. I think the comment about it being conservative is probably an accurate statement. The only other thing to consider is that our sales trajectory changed last year in the fourth quarter.

So just to remind you, we had roughly 7% growth for Q1 through Q3 and it increased to 10% for the fourth quarter. So the denominator in fourth quarter growth percent is a little stronger than it has been in the other quarters. That's all..

Got it. And then on the J&J side, I know, Dave you talked about this relationship continuing to expand and it sounds like with TYLENOL, you've continued to integrate yourself into the J&J relationships, so new initiatives there.

What's the next step there? I mean, are there additional opportunities to further closing that relationship going forward? And if so what would those be?.

The answer is – well, thanks for the question first, Randall. Yes, I mean, now we're being driven by the marketplace more than any strategic intent that's developed in somebody's office. And the interest in the passionate J&J around opioid-sparing is really driving many of the decisions that we've got.

So as we look forward, we're working with customers and working with different groups within J&J, who have regular discussions with their customers about the need for opioid-sparing solutions.

The best example would be the bariatrics pilot in that regard where the opportunity to not have patients with nausea and vomiting and all of the other issues that you have with an opioid are palpable in the marketplace and pretty easy for folks to understand.

So I think where we've entered a new phase in a relationship is where we're able to marry where they're going and where we're going. We referenced DYNACORD during the call.

There's a number of other development initiatives and strategic developments at Johnson & Johnson that marry very well with the customer bases that we're talking to, who are the primary focus of our opioid-sparing efforts. And DYNACORD is one, there's a number of others.

And as Rich mentioned, both with the spine and with the hip fracture, a lot of what's being done between the two organizations is being driven by their input on which customers they have and which clinical development and the device development programs they have, that would benefit a lot from an opioid-sparing solution.

So I would tell you that some of the movement here actually was never anticipated when we put this together and I think it speaks to the personal relationships we have with the J&J folks as well as the opportunity around the product..

That's great. Dave, thanks..

Thanks, Randall..

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

Hey, thanks. Just had a few. So, I wanted to look forward to 2019 and get your sense on the extent to which commercial insurers are going to follow the lead of CMS regarding the unbundling. I know you had the announcement regarding the Aetna pilot program.

But can you talk to that, and talk qualitatively about how impactful in a positive way that could be? So that's number one.

And then number two, as you think about – as we think about continued growth of the product, do you have a better sense of how of the extent to which the unbundling could benefit brachial plexus and shoulder? Maybe the better way of asking it is how much of those procedures are done in ambulatory surgical centers? And if that's a big part of the mix, should we think about the unbundling as being particularly impactful to brachial plexus? Thanks..

Thanks, David. One of the real strategic opportunities for us frankly as it relates to the CMS approval is that it will standardize the reimbursement. Let me take it in the opposite direction, David, and if I describe the problem that's being solved, it'll be easier to understand why this is a solution.

So many of the big payers would tell you that they believe that they pay for EXPAREL today. The problem is that because we don't have a J code and the SOP for how the providers are billing the payers is to use the general use of the J code for their road map and how they get paid.

The absence of a road map for EXPAREL has been a real issue for us and has led to individual payers coming up with their own set of numbers and their own reimbursement protocols, some by mills, some by a milliliter, some by a milligram, some by bundling EXPAREL into a procedure code et cetera.

So we believe that this is really important to us in terms of making it relatively easy for the local providers to standardize their ability to bill for EXPAREL across the continuum way more than Medicare.

So in terms of a qualitative impact of that change, there are procedures where it is commonplace to have them done in an ambulatory surgery center already and a brachial plexus block would actually be a marquee if that was our working hypothesis.

But I think it's also important to know that in many of these scenarios, the profit margins are quite thin.

And so, we think that having the ability to bill for EXPAREL even in an environment where it is currently the standard of care is going to really accelerate the opportunity to move from places that they're already using brachial plexus block to other scenarios where they may not be.

And so, things like hernia repair and a number of abdominal surgeries, we have some pretty good intelligence that it is highly likely that the joints will be paid for by CMS next year in an outpatient environment, but also remember that many of the initiatives we have with the commercial payers are encouraging total joint procedures to be done in an ambulatory setting now.

And so that J code will make that possible. The J code is not specific to procedures or to specific areas of care, it is a broad J code for reimbursement. So it'll provide all kinds of opportunities for us to move forward. I mean, just give you one very specific example.

We've got one ASC provider that believes that there is a very specific opportunity to move hysterectomies to the ambulatory care setting. And we are working with them in order to achieve that. So you start to see people thinking about how can I use a J code to improve patient care.

And then of course a big motivator for the national payers is that the cost environment in an ambulatory care setting is quite favorable from a cost of care perspective..

Okay. That's helpful. Thank you..

Thanks, David..

Thank you. Your next question comes from David Steinberg with Jefferies. Your line is open..

Thanks very much and good morning. Couple of questions. You touched upfront on some of the changes with Aetna and AAMOS and how things were going in the oral surgery market. I know it's an area that gets sort of back-burnered, because it's a smaller area and the mL vials are smaller and less profitable.

Could you talk about what sort of momentum you're seeing in the oral surgery market? Do you have the right critical mass in place in terms of sales force? And I know you mentioned that the 10 mL vial size increased 115% this quarter.

Was part of that in the oral surgery setting? And can you even break out any sales you have in that setting? And the second question is, I know that Symphony Health for a long time kind of correlated with EXPAREL and then it stopped. And then more recently, there's been a very tight correlation.

But this quarter, Symphony Health way underestimated the actual sales number. I was wondering what your view of the most recent Symphony data and whether that will better correlate over time? Thanks..

Thanks, David. I'll answer your first question. I think what you're seeing from Aetna and other commercial payers is probably the best predictor of the future for us.

There is great strategic interest in those – in the commercial payers paying for EXPAREL to avoid that first exposure of opioids being for these folks that are having third molar extraction, and so I think it's an important strategic tool for them.

And so I think we have every reason to believe that when you marry that with a D code, that we will see oral surgery increase and prominence as a way to provide an opioid-sparing solution to patients. We do see continued momentum in oral surgery and on a per patient basis, it's actually quite important to us. As you point out, it is a 10 mL vial.

It is 5 mL for each tooth. But we see – we can't define exactly how the product is being used, because most of these procedures are done in an ambulatory environment.

But we can see the momentum, because there are a number of orders on a daily basis that are going specifically to oral surgery practices, and especially, the national oral surgery groups who order on a regular basis.

And so, part of the reason we put the 24 folks out there was specifically to allow folks that have a retail focus and plastic surgery and oral surgery are the basis of that beyond the ambulatory care setting. So, yes, I think I would be – and I know you've been on this for a while now, David, when we have our discussions.

I didn't fully appreciate the value of oral surgery to EXPAREL and the marketplaces proved me wrong and it is quite an important growth driver. Symphony data, I just don't know what to tell you. I have no idea how they do what they do.

It's very difficult to sit here and try to analyze their data on a month-to-month and quarter-to-quarter basis and try to figure out what the gaps might be. So I'm just going to have to admit the feed on that one..

Fair enough. Next question. So, in July, CMS proposed upgrading EXPAREL reimbursement in the ASC setting. And they put a very detailed document outlining the rationale for changing certain rules governing CMS's packaging policy for certain drugs to be consistent with the goals of the present commission and combating drug addiction in the opioid crisis.

And doing so, in the document, the agency found that total units of EXPAREL use in ASC setting declined sharply from a peak of around 330,000 units a year in calendar 2014 to about 74,000 units per year in calendar year 2017.

So that's a 258,000 total annual decline in that setting over those three-year period, which represent a potential lost sales of around $80 million if you use the current $315 List/WAC price.

So I was assuming and thinking about the potential upside once this is instituted, would you say that if you run the number, is it around $80 million or even if you assume a 50% gross to net, that would be about $40 million in incremental annual EXPAREL contribution.

Is that a reasonable way of thinking about it?.

I think over time it's not unreasonable, David, but I think we are part of the reason for the pilots frankly and part of the reasons that we've got these ambulatory sales force out there now is many of these procedures are contracted between the ASC and the payer.

And because many of the providers didn't realize that the payers had EXPAREL as a covered benefit, they have not been – those rates have not been negotiated. So the J code gives us a very straight-line opportunity to have those discussions, but in many cases, they have to be had in the future.

So I think if you look out in time, well, I would have to ask you – I don't think that that $80 million number is appropriate for 2019. I think this will be a more gradual uptake in the marketplace than that. I think if you look out further than that, I would tell you that we would think that that number is quite conservative.

And the reason that I say that is, in our discussions with payers, they see their ability to move patients to the outpatient marketplace based on patient demand as well as physician demand to be quite a lot more than looking at the current market as a static market and then trying to figure out how much impact the J code would have.

So we won't get to $80 million next year, but I think that that's quite conservative going forward after that date.

Does that answer your question David?.

Yes, it does. Very helpful. Thank you, David..

Right. And Randall has helped me think through there's a couple of different ways as well.

And there are papers out there that are written by economists that suggest that if we take all the noise out of the marketplace, things like biopsies in places where you would never use a long-acting product for acute pain, something like 30% of the surgeries are done in an ambulatory environment today, which means 70% are done in an inpatient environment.

And the projections over the next eight to 10 years is that that's going to flip. If that's even close to being true, then you can understand why we would be investing heavily in ambulatory care, and why I would suggest that your $80 million number might be very conservative..

Great. Thanks..

Okay. Thanks..

Thank you. Your next question comes from Dana Flanders with Goldman Sachs. Your line is open..

Hi. Thanks for the questions.

My first is maybe you could just give us an update on the ease of access to EXPAREL just within the hospital channel? Is that changing at all? Can you maybe just give us a flavor of your latest discussion across key stakeholders, just given what we're seeing in the outpatient setting? And then my second one, Charlie, just the strength you're seeing across gross margins, why would you expect that to dip in the Q4 or next year? Is that Swindon coming online? Or should we expect gross margins to continue to strengthen over time? Thanks..

So, let me take the gross margin question, Dana first. And I think we had a really strong quarter. There are all kinds of factors that go into how total gross margin comes out, and we had a quarter where a lot of those were good. We had volume, we had good yield, et cetera.

We're guiding to 74% to 75% for the year, which is where we're more comfortable at this point.

As far as margins going forward, we said a number of times that as we expand our manufacturing capacities, that ultimately we expect to be in the mid-$85 million range, and that's still a couple of years out, and we'll provide more guidance on 2019 specifics in early 2019 when we provide guidance for the year..

And I'll take the first piece, Dana. So yes, we do see improving access. On the impatient side, it's quite interesting. So we priced EXPAREL 10 mL at $170, very specifically to provide an easy leverage point for the anesthesiology community to do brachial plexus blocks.

As you know well, there's been some controversy in the anesthesia marketplace about the efficacy of EXPAREL. And so, what we've created it was an opportunity for anesthesiologist to use this product. They see the profound efficacy. I mean, we're getting 4, 4.5 days for $170.

And then it's the conversation changes completely to who said this stuff doesn't work? And so, once you have given the anesthesiologist choose a really important and knowledgeable customer for us, the opportunity to use the drug and that kind of a way, then we see a move pretty rapidly to play through field blocks, the fascial iliaca, the PECs, the TAPs that we've referenced several times during this discussion.

And those are largely 20 mL procedures, and you see that the anesthesiologists then joins the group of people who are demanding the use of EXPAREL in the hospital environment.

So we see – we've had some very interesting discussions, some just in the last 24 hours with big ambulatory groups who want to start using EXPAREL very aggressively to drive there the momentum of their business around the fact that that will be reimbursed, and you see the halo of that, that people that have had success with EXPAREL in the ambulatory environment, especially people who are very vocal on P&T committees and have a lot of say about how pain is managed in the hospital market, to demand EXPAREL, and we are getting new formulary in-hospital wins everyday..

Great. Thank you..

Thanks, Dana..

Thank you. Your next question comes from Serge Belanger with Needham & Company. Your line is open..

Hi. Good morning. A couple of questions for me. First, on the unbundling that we're expecting for January. How confident are you in getting the J code in that time? And the unbundling seems set for the ambulatory surgery centers.

Have you heard of any movements for the hospital outpatient segment at this point?.

Good question, Serge. We're as confident as you could be. I mean, the comment period is not whether or not they're going to do it, it's to determine if there are some additional qualifiers that need to be put on use. And so we fully expect to receive a J code sometime in the next few days.

We don't have a good sense of what that payment will be and how they will fix ASP plus 6%, but we're sure enough that we're going to get a code, that we're hiring people and putting them out in the field.

So I think that sort of shows we're speaking with our mouth, right? So in the marketplace, the other, the OPPD, we started those discussions with the CMS. And we expect that those discussions will continue.

There is I mean, we've had very productive and very patient-directed discussions with the FDA, as well with CMS and HHS about the need to the follow through on the ASC J code with an OPPD code. We'll continue to work on that the same way we did with CMS on the J code.

I can't tell you that I can handicap that, but I think that there's a strong strategic rationale for us to improve patient care by making outpatient use available for EXPAREL as well..

Okay.

Second question is about the (00:46:05), the pilot program by Aetna that was announced earlier this week, what are they evaluating in this pilot program and do you expect it could expand naturally in sometime in 2019?.

Yeah. The Aetna pilot, I mean, it's basically letting their ambulating centers know, well, so it's a bridge basically to the J code. So what it does is it lets these centers know that Aetna is paying for EXPAREL now and that people can start to use EXPAREL now in advance of the J code and Aetna is going to pay for it.

So it is a true pilot, right? We're working with the providers to determine which procedures they think are best, how much educational activity is required in order to make that happen? We've been out this week and with a number of places talking to them about, do you want ERAS protocols? What kind of activity is it going to require for us to support the rapid movement of this product? And so, it's a very real pilot in terms of getting ready for a national launch.

So this isn't intended to be a national program, it's not intended in any way to restrict the use of the product, right? Their idea and our idea are both that we'll learn enough so that this can move very quickly on a national basis.

And I should add that, Aetna has been a great partner and there are strong personal relationships that support that partnership as well. But we also have a number of discussions ongoing with other ambulatory providers, and we expect that we will have pilot programs with those folks going mimicking the Aetna experience here..

Thanks for taking the questions..

Thanks..

Thank you. Your next question comes from Ami Fadia with Leerink. Your line is open..

Good morning. Thanks for the question. And apologize if this was discussed previously.

What's the likelihood of CMS expanding the unbundling for EXPAREL to the hospital outpatient setting? And if that decision doesn't come now, do you think there's still a possibility of that happening in the future? And then related to that, what's the current mix of the ASC settings in the U.S.? I heard a comment about 30%, is that your stance on that? And what was that mix when EXPAREL had a separate J code a couple of years ago, and kind of the script data that was referenced in the CMS document talked about those scripts.

And did those scripts include hospital outpatient as well also? Thank you..

So first we didn't have a J, we had a C code. (00:49:04).

Yeah, sorry. C code..

No, that's okay. No, I'm not trying to – it is slightly different and just to point that out. So we've talked to CMS about the analysis that was done and about when we had the C code, it was new and it came during a launch phase.

And so folks that didn't have access to non-opioid treatment therapies or any long-acting local anesthetics, it's hard to really make full value of the technology during a launch phase when you're talking to folks about how to use the drug and generally it wouldn't run right to an outpatient environment.

So we've had I think a cordial discussion on the fact that a five-year average is probably not a great way to look at this, that if you looked at it in the context of the first three years when we had a C code and you got to a certain point, you would understand that the last year is very different than the first year.

And then when you take that away, you have a very different scenario. So if you looked at it over the last two years when there was no payment relative to the last year that there was a payment, you would see that – you would come to a very different conclusion than if you took a five-year moving average which is the way that CMS approached it.

So I think whether they're going to – I think our expectation is that we are going to get a J code for the ambulatory setting. We have had collaborative discussions and I think CMS is very interested in trying to meet the goals of the Opioid Commission. And they are also very much interested in patient care.

And I think they have been – they have clearly been moved by all of the letters and all of the testimonies that were sent in during the comment period. And so we expect that we will continue to have discussions around outpatient use. Honestly, again, as I said after the last set of discussion, how that's going to end up, I don't know.

We'll give it the same effort that we gave CMS, as it related to the ambulatory setting and we were successful there. So that gives us some confidence but nothing more than that..

Got it, thank you..

Thank you..

Thank you. Your next question comes from Gary Nachman with BMO. Your line is open..

Hi good morning. Dave, talk a little bit more about the new field managers who are working with the ACSs. How many are there? And how have they been laying the groundwork for when you get the J code? Just give us a better sense of expectations on that uptake next year..

Yes, thanks Gary. I mean, you've known us for a long time, Gary. So we cut the market and in order to get at 60-plus percent of the market, you need something in the mid-30s. But the ambulatory care market is very much concentrated.

So you have states where you have huge opportunity in ambulatory care, and you have states and in some cases whole regions where you have almost none.

And so, what we decided to do was to take the place where these folks would have the opportunity to have a very strong input by putting them in places where there was a very strong focus on ambulatory care that already existed.

And so, I mean, I would just tell you – I don't want to – I always have to be careful here, because so much of what we say on these calls shows up being the strategic plan for some of the people that think they're our competitors. So I'll be a little bit careful here. But I would tell you, there's 24 people and nine of them are in one state.

And so, it speaks to the concentrated effort here. And so, what they're doing is there's another internal team that you would expect, that is in charge of launching this product. And it includes reimbursement specialists and folks that have done this before for many small teams.

So they're working at the top level with the IDMs and with the ambulatory care groups and all of that. And then the reps are at the local level, sharing the information that are coming from the IDMs and saying, okay, they think that they pay for it. They want to pay for it. You don't think they pay for it.

What's missing, right? What's in that gap? And how much of that can we cover in the next 60 days, so that we can be ready to go on January 1? And the biggest single thing is that we don't want to tell people that something is possible and then have them bill for it and have all those bills rejected. That's what we're trying to avoid.

It's not a negative strategy, but I think you get it, right? So that's a lot of it is, given these folks some time out there to get to know these customers, we're having web access with these folks. We're having web access with the Aetna folks and some of the other big commercial payers.

And so, they are all slightly different in terms of how they got to where they are with EXPAREL. And so, we're learning how to address these folks individually as customers as well as a group of people who will have a reimbursement opportunity on January 1. I don't know if that's helpful or not, Gary, but that's what comes to....

Yeah. No, that color is very helpful. And then just a couple more.

With nerve block in place, have the overall number of accounts ordering EXPAREL been increasing it? Or is it now about further penetrating existing accounts in the hospital setting?.

No. I'm happy to tell you that the number of accounts is growing both actually. But the number of accounts on almost a daily basis is growing, on a weekly basis for sure..

Okay..

It's interesting Gary, because you sit here, you almost hope that when you have days that you don't have big orders, because it's really in our benefit to have, I'd much rather see several hundred people order two boxes, than have one person order 100 boxes, right?.

Right. I know you used to give us a number of accounts and then it seemed like it sort of flat-lined a little bit, but given some of these recent initiatives, it would seem like that could have accelerated in terms of penetrating some new accounts..

No doubt about it. And there's also a lot of excitement with the D codes. And that goes back to David Steinberg, and how many times he told me that we should be moving more in dental.

The dental – we've been at the dental meetings and the interest in dental providers commercial dental providers and putting EXPAREL in as part of their program is really interesting to us. And those are mostly new customers when you see them on a daily basis..

Okay. And then just last one for Charlie. How do expect spending levels to trend into next year? How much more might investments go up from 2018? It seems like you're getting a good return on that investment, but just directionally, how should we think about that? Thanks..

Gary, I don't really think we've made specific comments about 2019, except in generality to say that we don't think it'll be significantly different than where we are. I don't think there's going to be any major changes. And we will give you more specifics when we provide 2019 guidance..

Yeah. I think Gary, even beyond that, right, it's all about leverage now for us, and execution. With J&J and all of the resources that they bring to bear here, I mean – the lot of the costs associated with Swindon and the new manufacturing facilities has already been covered. So we have a lot of opportunity to manufacture.

I think we're putting some people into the 2019 plan, but very selectively around certain customer uses. And we're at a point now where we almost put somebody else there for a book of business, it's already been covered, but for somebody in the marketplace that doesn't have the time to cover it adequately rather than prospecting.

So I think for us this is all about leverage now and we see a very distinct disparity between the ability to grow revenue versus the requirement to grow expenses..

Okay. Great. Thanks..

Thanks, Gary..

Thank you. Your next question comes from Boris Peaker with Cowen. Your line is open..

Great. Thanks for taking my question.

I was just curious to know what you're seeing with regards to the bupivacaine shortage in the market? And how is that impacting you now or may impact EXPAREL in the future?.

Yeah, thanks for the question, Boris. Very difficult to tell, to be honest with you. I mean, what we see specifically is when we see directives from pharmacy not to use the available caines in general by the way, its not just bupivacaine, to fill up elastomeric pumps.

Right, so they telling folks, don't use 12 mg, 1600 mg to fill up a pump when we can use it selectively and treat a dozen patients with that same amount of bupivacaine. But at the same time, I would tell you that we can go into hospital that is, that tells us that they are short and they are looking for alternatives and we put programs in place.

We can go into a sister hospital, and in many cases, it's across the street and wonder if they want to do the same thing in response to the bupivacaine shortage and they look at us like we just dropped out of a spaceship.

So I can't tell you that if we can get a full grasp on exactly what the issue is and whether it's – it doesn't seem to be administered across the country in the same way.

I'll tell you what we are fairly comfortable with is that when clinicians go to a EXPAREL ERAS protocol because of the bupivacaine shortage, we don't see them going back to the bupivacaine once bupivacaine becomes available again. So we think that it is spotty, but it is important and another leverage point for us..

Got it.

And so your manufacturing of EXPAREL, would you make your own bupivacaine or do you source that from external sources? And if you're sourcing it, is there any potential concern about disruption?.

No. There's dozens of places where you can buy API bupivacaine. That is not the issue here at all. The issue is related to the regulatory process and the ability of the folks who are making parenteral products to be able to make that – right now there would settle to make it breakeven. They're losing money on every vile.

And so it's – but this is not an API issue, this is a manufacturing into parenteral problem..

Great. Thank you very much for taking my questions..

Okay. Thanks, Boris..

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back over to Dave Stack, Chairman and CEO for closing remarks..

Thank you, Heather. Thank you for your questions in time this morning. We look forward to providing additional updates in the future. Next up for us is that Jefferies Conference in London, followed by the Piper Conference in New York. We look forward to seeing you there..

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