Bausch Health Companies Inc (BHC) 2003 Q4 法說會逐字稿

Good morning. My name is Sylvia and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Valeant Pharmaceuticals International fourth quarter and the year end 2003 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Jeff Misakian, Vice President of Investor Relations. Please go ahead sir.

Thank you. Good morning everyone. Welcome to Valeant's fourth quarter and year end 2003 earnings call. Before we begin, I would like to call your attention to the fact that this presentation may contain (technical difficulty) forward-looking statements that may involve risks and uncertainties including, but not limited to, projections of future sales, royalty income, operating income, returns on invested assets, regulatory approval processes, competition from generic products, marketplace and acceptance of the company's products, success of the company's strategic repositioning initiatives, and the ability of management to execute them, cost cutting measures, acceptance of the company's strategic plan and the ability to achieve financial targets and cost reduction (technical difficulty) goals and other risks detailed from time to time in Valeant's SEC filings.

These statements are based on management's current expectations and involve risks and uncertainties that include Valeant's ability to (technical difficulty) employees and reduce costs, general economic factors and business and capital market conditions, general industry trends and changes in tax law requirements and government regulation. Valeant wishes to caution the listener that these factors as well as other factors described in Valeant's SEC filings are among the factors that could cause actual results to differ materially from the expectations described in the forward looking statements.

Joining us on the call today are Robert W. O'Leary, Valeant's Chairman and Chief Executive Officer; Timothy C. Tyson, President and Chief Operating Officer; and Bary G. Bailey, Executive Vice President and Chief Financial Officer; Dr. Kim Lamon, President R&D and Chief Scientific Officer; Wes Wheeler, President, North America and Global Marketing and Business Development; (indiscernible), Controller; and Phil Loberg, Treasurer, are also here and available to answer questions during the Q&A session. Now I would like to turn the call over to Mr. O'Leary.

Good morning everyone. Thank you for joining us today. This morning we announced another solid quarter of performance for our specialty pharmaceuticals business. We ended the year with sales improvement in nearly every region, while continuing to hold the line on expenses. This past year has been one of consistent execution of our strategic plan, a year in which we have kept our promises. Our fourth quarter and year end results reflect this execution. Our specialty pharmaceuticals business turned in a 26 percent improvement in product sales in the fourth quarter when compared to the same period a year-ago, while operating income continued to be strong. Tim Tyson will give you more detail on our core business in just a few minutes.

Royalty revenues from the sales of ribavirin continued to decline in the fourth quarter, consistent with the decrease in sales of Rebetol reported by Schering-Plough. As you know, the timing of generic competition to ribavirin in the United States continues to be an uncertainty. We are pleased that the FDA appears to be carefully reviewing the issues raised in our citizens petition filed six months ago. Nevertheless, it's important to remember that generic competition could enter the U.S. market at any time. As promised, the company makes strategic investments in the business in the fourth quarter, which impacted our cost of goods sold and research and development expenses.

We kicked off our global manufacturing and supply chain initiatives in the third quarter, and our teams are well underway in executing these plans. We also initiated Phase III trials of Viramidine in the fourth quarter, and just recently told you of our plans to accelerate those trials in 2004. We continue to hold the line on overhead costs reducing our general and administrative expenses by 29 percent in the fourth quarter, compared to a year ago. All of these activities lead to an improved earnings performance in the 2003 fourth quarter compared to last year.

Excluding the impact of the early extinguishment of debt in the fourth quarter, we reported income from continuing operations of 10.8 million or 13 cents per diluted share, a penny ahead the income from continuing operations, adjusted for nonrecurring items reported last year, and this in spite of the 63 percent decline in royalty revenue. This improvement demonstrates the magnitude of the progress we have made in our core business. I have given you the highlights of our quarterly performance. Bary Bailey will cover our detailed financial results shortly, but now I would like to turn the call over to Tim Tyson for a discussion of our business.

Thank you, Rob, and good morning everyone. As Rob mentioned, sales were up in nearly all regions of our specialty pharmaceutical business in the fourth quarter while operating profit increased substantially over the same period last year. Once again, North America turned in solid performance with a 138 percent increase in sales to $28.2 million in the fourth quarter of 2003. In the region, operating income was $11.9 million in the fourth quarter, versus an operating loss a year ago. Our efforts to focus on our global brands continue to bear fruit.

We experienced year-over-year increases in our core dermatology products, Efudex, Kinerase and Oxsoralen. In addition, Mestinon continued to be an important contributor in North America in the fourth quarter in spite of the generic challenge. We believe that market share declines for Mestinon in the United States have slowed and leveled off at about 50 percent according to IMS data due to the strength of this important brand. Sales in Europe were 22 percent higher in the fourth quarter totaling $62.6 million, compared to the same period last year. European sales were aided by the strength of foreign currencies in the fourth quarter which contributed $6.3 million of the sales increase over the prior-year. However, we also incurred manufacturing costs in local currencies which somewhat mitigated this impact on the operating income line.

Major product contributors to sales in the fourth quarter were Mestinon throughout Europe and Calcitonin in Spain. Dermatix, which we introduced this year, was an important contributor to the region's performance and provides an early indication of the continued success we expect to see in 2004. Operating income in Europe in the fourth quarter improved to $5 million from a loss of $1.8 million a year-ago. The issues in the European marketplace, however, have not changed with German health care reform, reference pricing legislation in Spain and Italian price controls all creating a challenging environment.

In spite of these challenges, our European region has continued to perform strongly. Because of this improvement, we were able to absorb the $2.3 million in severance costs as we took initial steps to rationalize our manufacturing. In Latin America, sales were essentially flat compared to the year-ago period, while operating income declined 10 percent. The region continued to be impacted negatively by foreign currency translation which reduced sales by $1.9 million. This was partially offset by higher volume and price increases in the quarter. We have strengthened our leadership in this region by appointing Martin Mercer to oversee our operations in Latin America. Mr. Mercer's broad general management background includes market development, competitive positioning, and new product launches for pharmaceutical companies in Latin America.

Prior to joining Valeant, Mr. Mercer was with GlaxoSmithKline for over 20 years holding positions of increasing responsibility in sales, marketing and general management. Mr. Mercer has extensive experience in Latin America having worked in the region for well over 25 years. His proven leadership abilities, extensive contacts in the region and knowledge of the pharmaceutical market will make a significant contribution to Valeant. Our triple-A region performed well in the fourth quarter with a 22 percent increase in sales of $13.4 million and an operating profit of $1.4 million in the quarter.

The region benefited from increased sales of Nyal, Mestinon, and Librax. Thanks to the efforts of our new leadership in the region, Reptilase (ph), a key product, contributed to fourth quarter performance. As we told you last quarter, we brought in David Kwo to strengthen our triple A region. His thirty years of experience, knowledge of the critical Asian markets and contacts have already been a tremendous asset to the company. We have focused a lot of attention on our global brand this past year through several initiatives, such as the acquisition of international rights to Kinerase, the relaunch of our Efudex solution, our Kinerase direct to consumer campaign, and our international focus on Mestinon, we have been able to grow our global products by 27 percent in 2003 to $117.8 million.

Our global products sales comprised 23 percent of total sales in 2003. On the research side of the business, our R&D teams continue to be very active and as you know have recently stepped up their pace even more. Our Phase III testing of Viramidine, which we're developing an oral form for the treatment of hepatitis C in combination with a pegylated interferon, has begun in earnest due to our accelerated initiation of the Phase III clinical trials. As a result, R&D expenses were 11 percent higher in the fourth quarter and as we previously told you, we expect the investment to increase in 2004.

We're looking forward to sharing the 24 week data from Phase II studies of Viramidine at the EASL conference in Berlin in April and additional data at the DDW conference in New Orleans in May. Ribavirin (ph) which we formally refer to as Hepavire B continues to progress well. We expect to move into Phase II testing in this hepatitis B candidate in mid 2004. We're also working on a number of preclinical projects that we think show a lot of promise in the areas of HIV, hepatitis C, hepatitis B, immunology and oncology. We plan to share more with you on these projects in the near future. On the acquisition front, we recently completed our purchase of Amarin Pharmaceutical PLC's U.S. subsidiary, Amarin Pharmaceuticals, Inc. and its U.S. products. The Amarin purchase is a solid strategic fit for us which will add immediately to our revenue base while strengthening our neurology platform.

We expect Amarin products to add nearly $20 million in annual revenues. The acquisition will be neutral to earnings in 2004, excluding the write-off of in-process R&D of approximately $10 million. In the transaction, we also obtained the rights to Zelapar, a late stage candidate for the treatment of Parkinson's disease which has an approvable letter from the FDA. We're working with Amarin to complete the safety studies required by the FDA for Zelapar this year and we hope to launch this product into the marketplace in 2005. Our business development teams are actively considering other opportunities and we hope to have more to share with you on these activities in the near future. We continue to advance several lifecycle expansion projects including our recently launched Kinerase eye cream line extension. We also have line extensions in development for Mestinon and Efudex.

We remain confident that our specialty pharmaceuticals business can achieve industry level growth of 5 to 10 percent not including acquisitions. Turning to our operations, we began implementation of our global manufacturing and supply chain initiative in 2003, which is designed to execute our manufacturing rationalization plan. In the past year, these efforts have reduced the number of plants from 33 to 15 and the number of employees from more than 7,000 to less than 2,000 at the end of 2003. We remain confident that our manufacturing initiative will lead to cumulative cost savings of $150 to $200 million over the next five years and that it will reduce the company's manufacturing headcount to approximately 1,300 to 1,400 employees.

Naturally, as Rob discussed, this requires an investment in our operations, which as you saw resulted in an increase in cost of goods sold in the fourth quarter. However, these investments will pay off in the long run with a vastly more efficient network. The company's goal is to reduce inefficiencies and create a new supply network that can operate five best in class manufacturing facilities to improve our competitive position and meet our changing production requirements as our business evolves. This will reduce our cost of goods sold to between 20 and 25 percent as we have previously communicated. This effort is not just limited to our manufacturing operations.

We have introduced the lean six sigma process to Valeant to build a passion for improving efficiencies and financial performance into the fabric of our entire operation going forward. This initiative, similar to the six sigma process at General Electric, has already been enthusiastically embraced in addition to our manufacturing operation worldwide in R&D and throughout every region of the world. We have seen significant early cost savings and expect additional benefits as we develop a positively charged company culture that is focused on efficiencies and value creation throughout every level of our organization. We will have more to report on this in the future. Now, I will turn the call over to Bary Bailey.

Thank you Tim. As Tim has already discussed, our topline sales results for the fourth quarter were quite strong with an increase of $29.8 million or a 26 percent increase over the prior-year. Excluding the impact of foreign currency products sales were still up 20 percent over last year. Royalty revenues declined 63 percent in the fourth quarter to $30.7 million reflecting lower Rebetol sales by Schering-Plough due to their continued inventory reduction challenges which were exacerbated by the competitive challenges from Roche to their hepatitis C franchise.

We also receive royalties from Roche on sales of Copegus but at a lower rate than that paid by Schering. Approximately three quarters of the total royalties in the fourth quarter were from sales of oral ribavirin outside the U.S. As Rob mentioned, we continue to expect generic competition in the critical U.S. market soon but cannot predict when that may occur. Thus it is difficult to predict the level of royalty revenues we will receive in 2004. Our gross margin increased to 63 percent in the fourth quarter from 62 percent in the same period last year.

The increase was primarily due to a combined change in product and geographic mix with more sales of high margin products and increased contributions from North America. The margin is somewhat lower than in the third quarter reflecting the timing of certain efforts related to our manufacturing rationalization. As Tim mentioned, we continue to make investments in our operations to drive efficiencies which increased cost of goods sold. Specifically we incurred $2.3 million in severance costs in the planned divestiture of our manufacturing facility in Spain and accelerated depreciation expense of $1.6 million in the fourth quarter.

We expect accelerated depreciation associated with the global manufacturing initiative to add $6.4 million in incremental expense in 2004. In spite of this investment, we continue to expect our gross margin in 2004 to be in the range of 64 to 66 percent. Selling expenses were only marginally higher on an absolute basis in the fourth quarter, in spite of the 26 percent increase in product sales. General and administrative expenses were down almost 30 percent in the fourth quarter compared to a year ago reflecting our continued efforts to keep costs under control, especially in the areas of legal and consulting expenses.

Selling expenses declined to 32 percent of sales of the fourth quarter compared to 39 percent in the same period last year while G&A expense declined to 18 percent compared to 33 percent last year. Overall, SG&A was 51 percent of sales in the fourth quarter compared to 71 percent a year ago. These are significant improvements in our key metrics. The reduction in G&A in the fourth quarter reflects our continued effort to hold overhead down. But, on a prospective basis, we continue to anticipate G&A expense for 2004 in the range of 20 to 21 percent of sales.

Now with respect to selling expenses, we expect to see early investments in 2004, with selling and advertising expenses be higher in the first half of the year as a percentage of sales than in the last half of the year. However, we continue to be confident with our previous communications for the full year 2004 at between 30 and 32 percent. Amortization expense was 73 percent higher in the fourth quarter due principally to the increased amortization from the Ribapharm acquisition as we previously disclosed. We expect to see additional amortization expense from our recent acquisition of Amarin and are currently looking at amortization expense in 2004 to be in the range of $50 to $55 million.

The company's effective tax rate for continuing operations in the fourth quarter and for the year was 38 percent. We continue to expect an effective rate in 2004 of between 36 and 37 percent. As you know, we took steps in the fourth quarter to restructure our debt obligation adding two tranches of convertible subordinated notes with $240 million principal amount in each tranche, along with $300 million in Senior Notes. In total we issued $780 million in new debt in the quarter. The notes provide us with a better maturity structure, lower our overall interest rates and provide us with cash for potential acquisitions.

We repurchased $140 million of Valeant's existing 6.5 percent convertible notes in the fourth quarter at a pre-tax loss of $12.8 million. As previously disclosed, we intend to purchase the remaining $326 million of the 6.5 percent convertible notes on or prior to the first redemption date in July of 2004. Based on the July date redemption price of 103.7, this would result in a pre-tax loss of $19 million in 2004. In January 2004, the company entered into an interest rate swap agreement on 150 million of Valeant's new Senior Notes to (indiscernible) our effective rate interest rate on these instruments.

We exchanged fixed-rate interest payments at 7 percent for a floating-rate payment at 2.409 percent over LIBOR resulting in a current rate of approximately 3.6 percent. Overall, we expect net interest expense in 2004 to be approximately $40 million assuming a July 2004 redemption of a 6.5 percent convertible note. We ended the year with a total long-term debt balance of $1.1 billion, a significant increase over the $482 million at the end of 2002. Our cash at December 31, 2003, was significantly higher as well totaling $872 million. Excluding potential acquisitions, we expect cash to be in the range of $500 to $550 million after the redemption or repurchase of the remaining 6.5 percent convertible note.

Discontinued operations at December 31, reflect the company's API business in Chek and Hungary with a total -- net book value of approximately $10 million. We continue to actively market this business and expect to complete this sale this year. The loss from discontinued operations in the fourth quarter was due to losses from operation in the quarter. The loss in 2002 was primarily due to a write-down of the discontinued operations. Now, I would like turn it back over to Rob for closing comments.

Thank you Bary. As we have said before, 2004 will be a year of investment in the business as we drive efficiencies in our manufacturing operations and accelerate our research and development activities. We remain confident that that we will manage within the metrics that we have previously disclosed for 2004, and that we will achieve the 2008 target that we presented in September in our strategic plan. Let me ask you now to take a moment and pause and reflect with me on what has been a truly amazing 12 months for the company we now call Valeant. The company this management team inherited in 2002 was complex and unfocused and with very little transparency. It was centered on Eastern Europe and Russia, in numerous unrelated and for the most part unprofitable businesses, with an unnatural emphasis on topline growth at the expense of earnings and an over dependence on royalties.

The company, the company's management team and board were more focused on self-fulfillment rather than shareholder value creation and as ludicrous as it sounds, for a pharmaceutical organization, the company had little or no control or influence over its own research and development capabilities. In marked contrast, Valeant today as a result of our highly successful divestment program is a far less complex and more transparent company that is devoid of unrelated businesses and focused solely on specialty pharma, nine global products in ten key markets.

The former ICN bloated and inefficient manufacturing capability has been dramatically rationalized from 33 plants to 15 with more to come. Valeant today has only 42 percent of the employee headcount we had just one year ago. Our balance sheet has been dramatically upgraded. We have spread out our maturities and now we have some real acquisition muscle. The new management team which has been built in record time I regard as potentially be best in this industry and there has been a substantive and complete change in our governance profile. What was before an embarrassment is increasingly being recognized as a model of best practices in this new governance environment, but it is in research and development where there has been the most dramatic transformation.

We have competent new leadership and have built significantly on our great scientific drug discovery and preclinical development capabilities with the addition of expertise in clinical, regulatory, biometrics and project management, competent people have all done it before and have been immensely successful. This has resulted in our unprecedented early entry into Phase III in Viramidine and management's unbridled enthusiasm for increased and accelerated investments in our research and development capability. The bottom line on all of this is that Valeant today has a significantly different strategic platform upon which to grow the company and dramatically increase shareholder value. I want to thank you for your time and we will be pleased to take your questions at this time.

(OPERATOR INSTRUCTIONS). Michael Tong with Wachovia Securities.

Good morning. Just a couple of quick questions. Number one is, could you give us an idea of in the Phase III for Viramidine how many patients have been enrolled and how many are actually on treatment right now? Bary, I might have missed this when you said the gross margin expectation for '04 of 64 to 66 percent. Does that include or exclude the accelerated depreciation?

Bary is going to answer that question first and then Dr. Lamon will take the Viramidine question.

That includes the accelerated appreciation.

I want to let you know that the Phase III program that we started is going very, very well and we are very happy with the progress, but it is still early. We're still in the ramp-up phase, but we are very happy with what has occurred over the last couple of months.

Great. Thank you. I will jump back into queue.

Robert Uhl with Wells Fargo Securities.

Thank you. Can you just go over some of the specific programs you have put in place to revitalize if you call it the U.S. business. Which products are you focusing on, what are the salespeople out selling? What is the marketing thrust at this point?

As we have indicated, we're focusing on the core areas of our business and in the United States we're focusing on dermatology, and we have focused on Kinerase, Efudex, and Glyquin. We also have had some activity around Mestinon to ensure that we are able to retain as much business as possible. There has been significant activity by Wes Wheeler to restructure the salesforce, provide new marketing tools and messages, talk about the direct to consumer advertisement campaign on Kinerase; basically a whole revitalization of the focus for targeting for the salesforce and for new marketing tools for our U.S. operation. I want to also remind you that we have focused on and resolved early the inventory issues that existed in the U.S. business.

If one looks at IMS data, all of those products you named are still highly negative prescription results when you look at year-over-year comparisons. So, at some point that should turn. Why haven't we seen evidence of that yet?

In terms of Efudex, we have actually grown the IMS market share from about 49 percent a year ago to, we're currently holding about 52 percent of that market. The market is more or less mature, it is growing slightly. But our market share has actually grown year on year for Efudex. On Mestinon, the reason why the market share has gone down and the volume has gone down is because we've had three generics enter the market in the last 12 months and we have actually held onto a major part of that business because of our patient loyalty.

I guess I'm looking at prescriptions and not share. So prescriptions are down 19 percent in January for the company overall. That is barely an improvement from the 25 percent decline that was reported a year ago.

We're not sure what date you're looking at, Michael, but what Wes indicated to you is the facts that we have and of course you can see the financial performance Robert of the market place. So, I think that any detailed information on market share or prescription data we would be glad to talk with you, but we don't have all of the data in front of us. But, we're very confident of the performance and our focus in the U.S. marketplace.

Michael Stansky (ph) from Tutor Investments.

Tim, you talked about an accelerated manufacturing spend that impacted gross margins in the fourth quarter. Bary gave us severance and accelerated depreciation impact. Can you tell us roughly how much that hit the gross margins in the fourth quarter and more importantly how you see that unwinding or impacting '04?

I will give you a couple of comments and Bary can talk about how it impacts directly gross margins in the fourth quarter. But we are in the middle of detailed implementation just as we have indicated. There are a lot of moving parts and the manufacturing costs have come down from the information, and as this management has begun the responsibility back in mid 2002, from a 41.5 percent to the end of the year at 36 percent. There are going to be some quarterly fluctuations, but right now we have some significant activity going on to reduce the number of people and to move products from sites that we have to sites that we are going to keep.

All of that is taking investment to prepare ourselves by writing regulatory dossiers so that we can submit them to regulatory authorities so that we are able to affect the move to reduce the number of sites that we have by selling them off to get to the five sites that we have discussed. So, that is what is going on, that is what you're seeing, and all of these are part of an aggressive implementation of our manufacturing master plan.

The amounts that we have specifically identified though as events if you will are the accelerated depreciation which we have communicated, and we have moved up on the severance by reduction in force in Spain predominately. We are starting to take those steps to move that process along and those are the only two items that we see as, if you will, almost specific in nature.

To sort of give you a high-level overview, I'm sure you sense it, but just to remind everyone that within what we call the manufacturing rationalization plan there are actually too -- many things going on but two major thrusts. One, the efforts to do everything we need to do to move from approximately ten plus plants into a concentrated five plants, so that involves as Tim said, new dossiers and all of that stuff. But at the same time and in parallel, we are making major efforts through our lean six sigma program to dramatically improve the operations throughout the manufacturing environment.

That of course requires investment in education, training. We've now got an impressive number of what they called black belts and green belts in the lean six sigma program and people have been taking off the line, some of our best people, and then put through this intensive training so that we can come -- what we want to do is come out of this with not just a reduction to five plants, but a reduction to five highly efficient plants and that is requiring the additional investment as we move through these early stages of the manufacturing plan.

That should be something that basically takes place through all of '04?

Actually it takes place through all of '04 and '05 but the benefits, the cost investment is particularly in the lean six sigma activities, is primarily on the front end and the benefits of course will start to be realized in 2005 and beyond. But there is a bubble here, somewhat of a bubble at the beginning on the investment and while we wait to have some of this flow through to the improvements we expect.

One other quick question, if Kim is on. You mentioned an internal pipeline of HIV, hep C and hep B. Is there anything close enough to discuss those products, those efforts?

I think those are really a bit early to comment on. You may know that we have both nucleoside and non-nucleoside libraries, so each of those programs if you will, is duplicated. So an HIV in both nucleoside and non-nucleoside, it is really too early to communicate more than that to you.

Thank you.

Todd Krasear (ph) with Bear Stearns.

I was just wondering if on the gross margin front, just a little more color on what you're doing in terms of the supply chain initiatives? And then if you could also just indicate that given the severance costs that were there in the fourth quarter and it sounds like are expected to continue on through 2004, that is all baked into your expectations of a 64 percent to 66 percent gross margin?

It is absolutely baked into our expectations that we have communicated.

You were at the bottom, I guess the bottom. If you exclude -- well I guess excluding this severance expense you would've been at about 64 percent but you think with the severance expense in there, you could still be at 64 percent or better in 2004?

We have expected in all of our cases, we're looking and we see opportunities for selling the facilities with the majority of the employees in place. What we have done is we have looked at the staffing levels in the facilities and saw opportunities for efficiencies that frankly the buying parties would not want to pick up anyway. So we have addressed that upfront and tried to resolve it in advance. We don't see a substantial amount of that on a prospective basis.

But in terms of the severance expense, you don't anticipate say in the first half of '04 that you might continue to be below your guidance range for the year?

We will meet the guidance range by the end of the year. We have some significant investments going on in the early part of the year that will effect the gross margin or cost of goods sold. So yes, we do expect it to continue. It probably will not be based on letting people go or severance costs because as Bary said we expect to sell the facilities that we have with the majority of the people in the facilities.

Could you on the supply chain initiatives, could you just give a little more color around what you are doing there?

Certainly. The supply chain initiative is focused on a few things. Most of the cost and manufacturing come from headcount and from the number of sites that we have. As we have communicated, we have a plan to go from 33 sites to 5 sites, to take the headcount from more than 7,000 to around 1,300 to 1,400, and to reduce the cost of goods from 20 to 25 percent. That includes the manufacturing rationalization that I just discussed, it also includes some implementation in benefit from lean six sigma as Rob had indicated, it also includes the application of global procurement activities so that we will gain some benefit from our global buying power.

Great. One other thing then I'll get back in queue. In terms of selling expense, could you repeat what you said the guidance would be for '04? Is it 30 to 32 or did you say it was 32 to 33?

We said 30 to 32.

Okay. Thanks very much. I will get back into queue.

Diana Monteith (ph) from Loomis Sayles.

My questions have been answered.

Dave Groober with Meisenbach Capital.

Royalties declined 21 percent in the second quarter, 43 in the third and now 63 percent. Phar (ph) Pharmaceuticals has received an approvable letter for ribavirin. So assuming shared exclusivity, what are your expectations for ribavirin royalties in '04 given the accelerated mix change between Schering and Roche and the pending launch of a generic ribavirin, and if you could use '03 royalties of 168 million (technical difficulty)? Could you help us out there please?

The impact that we have on royalties is affected by many things. Firstly, it will be affected as a generic comes into the marketplace, but as you know there has not been a generic in the marketplace. It's affected mostly by two things. Number one the competition, and the market share between Schering and Roche, and also by the fact that there was some significant inventory that Schering had. So those dynamics are what have affected our royalty revenues and you have heard some of those things as you have heard both Roche and Schering's discussion on earnings.

Can we make an assumption -- I guess maybe premature. How does the decline in the ribavirin loyalties affect profitability? If you back out the royalty number to some degree, the base business profitability is minimal, even a loss in that regard. Could you walk us through that? I am just trying to better understand. There are lots of investments that have to be had, at the same time your key driver will be cut next year or this year?

With respect to the royalties, what we have said for our analysis, we look at specialty pharma excluding the royalties and the R&D operation. We have done that going back to when Ribapharm was a separate entity from the current company and we have continued to believe that the royalties will fund, will be adequate to fund our R&D effort. Certainly if you took royalties away, took them down to zero, we would not want to stop our R&D efforts and that would obviously have a bottom-line impact to the total company as you have outlined.

Great. Thank you.

Andrew Sidoti from Wm. Smith & Co.

Good morning gentlemen. Just a couple of questions. On the royalty revenue, again what is the split between domestic and international?

About three-quarters of the royalty revenues in the fourth quarter came from -- out of the U.S.

How long are the patent protections on that royalty stream?

Actually we rely on data exclusivity, predominately in Europe, and that takes us through 2008, and then the rest of the world is 2009 -- I'm sorry, I'm getting the two flipped around. On the rest of the world, it's around 2010 or is it --?

That is correct.

With focus on the euro.

Was there year-over-year growth in that component, international component, of the royalty revenues?

It has been fairly stable from a sale standpoint. There has been some impact from Roche entering. It obviously has not impacted the sales from that standpoint, but our royalties with Roche are lower than the Schering royalties in those markets. So that would have impacted our royalties to some degree.

I will say that if you look at the worldwide Midas (ph) data from IMS, you will see a year on year growth in most of the rest of the world markets by significant margin.

Last question was just on the acquisition front, what your criteria is and I know you can't comment on specifics, but I just wanted to know how, get a feel for how robust the acquisition pipeline is?

We're certainly continuing to look at and have looked at a lot of opportunities and we continue to focus and expect to provide some -- to be successful and to provide some information when we are. The way that we're looking at them I would just like to ask Bary to comment on that.

We have said in the past, we don't specifically comment on hurdle rates or anything like that, other than to say that if you look at the acquisition we did of the buyback of Ribapharm, that should give you some indication of the hurdle rates. They obviously vary based on what we perceive to be the relative risk of the products or businesses that we had acquired. We are focused on our three therapeutic areas, and as evidenced by Wes heading up that business development area, we also have an emphasis on the U.S. opportunity, not ignoring international but an emphasis on the U.S. opportunity.

Thank you very much.

I just wanted to highlight, we are evaluating approximately 25 deals currently.

Okay. Thank you.

Franz Tudor with Variant Research.

A couple of quick questions. First on the operating margins of the base business. I know you explained why the margins fell in Europe but can you also talk about Asia? Sequentially we went from 14.5 percent down to 11, U.S. operating margins went from 43.75 back down to 42. What is going on with those trends?

Thanks for the question. I think it is tough to parcel out all of the different regions and look at them specifically. There are a lot of moving parts. Just as we're accelerating our overall manufacturing plan and strategy, there is a lot of activity going on to establish the dossier, that as I mentioned, we got a lot of investment going on around the world, getting the activities in place ready to relocate products so we can remove the excess capacity. Also, as Bary indicated, there has been some accelerated depreciation that has hit a number of parts of our operation. So, I think it is very difficult to take a particular quarter and look at it. If you look at the overall activity, and the trends, you will see that there has been some reduction, there has been some investment and will continue to be in this year to lead to some significant improvement in 2005 and after, as Rob had indicated.

Relative to, for example North America, our gross margins actually marginally improved between the third and fourth quarters. The sales, there is a sales variation. We don't see that is any indication of a trend. It is just the variabilities between quarters. As far as operating margins and I think it reflects the fact that we're willing to invest in sales on a prospective basis and as I indicated in my comments, we are expecting to continue to do that into the first and second quarters, but see that as that goes through the year that we will see those benefits ongoing for sales. We see a return on those investments in sales (indiscernible).

On Viramidine, is there the intent to possibly take an interim look at the data once you have enrolled say 500, 700 patients, something of that nature? But also if you could sort of walk us through the timeline, what you're expecting in terms of filing for Viramidine?

Regarding interim analyses, both of the pivotal studies do have incorporated in them an interim analysis. Regarding filing, we do not provide guidance on that but let me walk you through a couple of facts. On the trials of this size, 900 to 1,000 patients, have historically taken 12 months or more to enroll. The treatment herein for (indiscernible) patients at 18 months, so it is not unreasonable to think that these studies could take two or three years.

Okay. At what point is the interim analysis potentially going to take place?

It would be when the patients have completed, have gotten -- half of the patients have gotten through their treatment period, whether it be 24 weeks plus a follow up of 48 weeks (indiscernible) follow-up.

Last question. On Efudex, Tera (ph) has already received generic approval for topical solution. Have you heard anything through the channel in terms of their getting the actual cream approval?

We have no information on any ANDAs that are submitted. We don't have any evidence or knowledge of any creams for them or any other company, but we again would not have visibility of that Franz, but the solution is less than 5 percent of our business.

Matt Tepalis (ph) from Quaker Capital Management.

Two questions. One, as it relates to foreign royalties, two questions related to that. One, are those dollar-denominated, and also do they reflect Schering's excess inventory positions? I guess my question is do they really reflect accurate run rate sales?

Let me answer the second question and Bary can answer the first. The second question is the wholesale inventory issue is a U.S. only issue, but doesn't affect the global activities.

As far as the way the royalties are calculated they are obviously sold in local currency, and then Schering translates those and pays us in U.S. dollars.

So they are ultimately going to be subject then to the fluctuation of the U.S. dollar indirectly, I guess?

Yes.

Secondly, you did speak a little bit about the recently consummated acquisition, but could you talk a little bit more about it, what really drove it since I guess it's earnings neutral in '04 and obviously not a great deal of size? What were you most interested in? What prompted the deal?

We are interested in three therapeutic areas which we have discussed. Central nervous system is one of those. This was a nice little opportunity to add a small neurology salesforce, add an approvable drug for Parkinson's disease and in-line drug for Parkinson's. So, a nice opportunity to add and strengthen a platform in the business and to add about $20 million of sales. And again the pipeline drug gave us an opportunity where the product is potentially close to marketplace.

In terms of the approvable drug, could you give any sense of what you view the opportunity for this drug in terms of -- roughly sizing it?

I'm going to ask Wes to just make a comment on that.

Zelapar is a new formulation of Selegilene which is already a well-established compound in the Parkinson's disease market. We're not going to give guidance on future forecasts of that product, but I think if you look at the IMS data for that disease area you will see that Selegilene has a large opportunity in the marketplace. It is a very, very elegant formulation of that product.

Could you just -- roughly what Selegilene's sales are?

Worldwide sales of Selegiline, I don't have that data at my fingertips. U.S. sales of Selegiline, really it is both the combination of generic Eldepryl and (indiscernible). Let's get back to you on that.

We'll look that up and give you a comment in a minute.

Neil Shaw (ph) from Frontier Capital.

Good morning. I was calling you on the -- two questions. On the base business, forgetting about Viramidine looking out a few years from now, what do you think the -- and I'm also stripping out sort of royalties. What do you think the operating margins should be and can be? So sort of realistic and maybe even be more optimistic looking out a few years and taking into account all that you are doing with regard to the manufacturing and restructuring and etc.? That is the first question?

We have considered that in our information we have provided already to the marketplace on the different margins, the cost of goods sold, and the selling expense. So you can look at what we have already communicated. This will be a high gross margin product because it's an oral dosage form and the majority of the business will come out of North America and Europe.

I'm talking about X-Viramidine and ex the royalties, just sort of the base business you've got today?

We will try to give you a sense of that, but just a little bit tongue and cheek. The (indiscernible) answer your question is a difficult thing for us to do. We're not very focused on talking about things excluding Viramidine because that is where we are obviously placing a lot of our investment in this company and a lot of activity in every division of the company to prepare for manufacturing and commercialization as well as accelerating the R&D activities. So we will get back to you in just a couple of minutes here on your question, but just for the record your predicate is not really one we accept.

I can just say that the cost of goods sold information that we have provided is not dependant upon Viramidine.

Right. And that is an accumulative number, that 150 to 200?

Yes.

Then the other thing is Japan and -- Schering and Roche have not entered Japan right?

Schering is in the marketplace, and Roche is going to enter.

Alright. Thank you.

Kathy Reece (ph) with CHR Research.

Good morning. Going back to Viramidine, with the generics expected to be on the market for possibly four years by 2008, what are you anticipating will be the actual market size opportunity for Viramidine by 2008? Another just kind of a housekeeping question, I think you mentioned earlier that your R&D would be higher in the first part of 2004 and with a Phase III starting, another Phase III starting in the second half of 2004, I was just curious how that was happening? (indiscernible), that would be great.

Firstly on the second question, we're going to have a Phase II study starting, not another Phase III study unless you mean Pfizer (ph) II. So we have Pfizer II starting in the mid of the year and all of the guidance or information that we have given you included that information. So we have provided information that we believe our expenses for the year is going to the $85 to $95 million. That includes all of the investments in R&D that we have in our plan.

So broken down during the year though, a lot of that will still be during the first half?

It is more likely to be -- it is going to ramp up. As you know clinical programs take time to get started, so we're just -- we began as you well know in late November, early December, in the first part of the study and the second part will begin in the midpart of the year. So as we ramp up the expenditures will also start ramping up.

Let me just interject. In your original question and the follow-up, I'm detecting that you thought you heard us say that the R&D costs was front-end loaded. The only thing we said like that was in reference to the manufacturing costs. The R&D costs are not primarily in the front in the first half, they are -- on an annual basis they are across the year and they will if anything be moving upwards as the number of studies involved are engaged.

I just want to make one point of clarification Kathy regarding the studies. The Phase II program is still ongoing. We used the twelve week data to make a decision to go to Phase III. So that study with about 180 patients is still ongoing and the data from that (technical difficulty) of that study will be presented in mid-April at an EASL meeting. We do have two Phase III's in-process of Viramidine. One of those has started the end of last year and is in the enrollment phase, and we're going to kick off the second Phase III study, same size, about 1,000 patients in 80 to 100 sites. That will kick off in the back half of the year.

So then 2005 is going to be similar to 2004 expected (indiscernible)?

Everything really depends on enrollment in the study. It is very hard to answer because of the enrollment period. Certainly those studies, since they carry over two to three years, the expense will follow.

Let me say it another way, Kathy, and then we are going to have to move on to the final two questions. One, we have given you a specific number for R&D expense for this year and we don't expect it to go down in the following year.

Thank you.

I just want to make a comment about your first question which we didn't mention, and that is your question about the value of Viramidine in the marketplace with generics. The value proposition for Viramidine if the clinical studies prove what the early data shows, will be a significant reduction in the incidence of anemia which is a very difficult issue and the reason for most patients to drop out of therapy. So if the proposition proves true, there will be an extra value in Viramidine and we will have a huge impact on the marketplace, as well as, there are people that are suffering from anemia that receive about a $10,000 to $15,000 treatment. So there is a huge opportunity there.

Okay. Thanks.

Tony Fiorini (ph) from Sands Point Partners.

I had a question. You mentioned that headcount was down 42 percent year-over-year, yet I see SG&A down only 11 percent year-over-year in the quarter. I'm just trying to understand when we'll actually see some leverage on the SG&A line from these restructurings?

Let me first, if you'll forgive me, reclarify what I said. I didn't say headcount was down 42 percent. I said it was down to 42 percent of what it was, so it's actually down 58 percent. But remember, most of that is as a result of our divestiture program, some of it is from headquarter reductions as well and a lot of that is in manufacturing in Russia, etc. Tim perhaps will answer the rest of the question.

There have been some significant impacts already to SG&A. SG&A is down significantly. As Rob indicated, a lot of the headcount reduction were in our discontinued operations, and so have been taken out of our financials. As you look at information, you will see that there has been some impact to SG&A already, and the manufacturing impacts will mostly accrue to cost of goods sold.

Okay. Thank you.

Alan Sapolsky (ph) from Apothecary Capital.

My first question has been answered, but just as a quick follow-up. Are you going to begin disclosing the quarterly sales numbers on an ongoing basis for product sales -- for the specific products that you have been getting on an annual basis?

We will be providing information on the products that we have discussed and that we disclosed during this release. So you have information on our global products and our top ten products, if that is what you are talking about.

But will you begin to disclose those on a quarterly basis?

We haven't made a decision on that at this point.

Okay. Thank you.

There was one question, who is it? Neil Shaw had asked a question relative to the operating margins. We have historically indicated that we expect to see that over 20 percent and that is reflected from our 2008 margin indication. If you just add up our percentages from the presentations we have done, the amount would range between 21 percent and 35 percent excluding amortization.

I want to thank everyone for your questions and your patience today. Just in very quick summary, as we finished this really first significant transformation year, I would tell you that most of all the restructuring really is done. Clearly we are focused on our specialty pharmaceuticals business and are free of many of the distractions of the past.

We are on schedule or ahead of schedule in our manufacturing rationalization in R&D investments, and in fact while we continue to work hard on the specialty pharmaceutical business and have to deal with the uncertainty of the generic entry, we really are very, very comfortable with the midterm and longer term view of the platform that has been created here and what we can do with this company in the years ahead. Thank you all very much for your participation today. We look forward to talking to you again.

This concludes today's call. Thank you for your participation. At this time, you may now disconnect from the conference.