Perrigo Company PLC (PRGO) 2004 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Perrigo second quarter results conference call. (OPERATOR INSTRUCTIONS) Thank you. I would now like to turn the conference over to Doug Schrank, Chief Financial Officer. Please go ahead, sir.

I would like to welcome all of you on the conference call. We are delighted to have you join us and thank each of you for your interest in wanting to learn more about Perrigo. I can only say I hope your weather is a little bit better than ours, warmer and not snowy.

First, let me dispense with the SEC Safe Harbor language. These conferences include our views of where the business is going. We will make forward-looking statements we believe to be reasonable, but can give no assurance that those statements will prove to be correct. We have prepared a detailed discussion of the many factors we believe may have a material effect on our business on an ongoing basis, and have included this discussion on Pages 25 to 30 on our Form 10-K for the year ended June 28, 2003.

Additionally, at certain times we will use non-GAAP financial measures that we believe better describe the ongoing financial results and trends of the business. The required reconciliation of these measures to GAAP measures is included in our press release, which has been filed on a Form 8-K that may be accessed on our website at www.perrigo.com.

In today's call, Dave and I will focus our comments on results from operations, excluding the impact of a onetime tax benefit of $13.1 million that was recorded in the second quarter.

With these formalities completed, I will now turn the call over to David Gibbons, Perrigo's Chairman, President and Chief Executive Officer.

Thanks and good morning everybody. It is a pleasure for me to report the record results we had in the second quarter, as well as for the six months ended December 27, 2003.

In the quarter our sales were up eight percent as the anticipated seasonal business did flow in. There was strong demand in the cough, cold and analgesia categories, the result of the early and severe cough, cold and flu season this year. And the month of December was particularly strong as the season peaked early. Our Loratadine D24 product also continued to sell well. There was a little softness in the GI category -- gastrointestinal category, continuing weakness in the vitamin category, and flat sales outside the US. But it was more than countered with the positives from the rest of our businesses. All together, our increased volume, favorable product mix, new product sales, and continuing operational efficiencies and productivity gains helped to lift gross profits and operating income to double-digit gains.

And I will now turn it back over to Doug to review the specifics of the great quarter that we did have.

Before reviewing the key financial components in our second quarter and first six months, I've got a couple of overview comments.

First of all, the Peter Black acquisition was completed on December 29th for $13.4 million. This is reflected in the appropriate working capital and fixed assets on the balance sheet. And there was no goodwill with this transaction. There was also no impact on the second quarter income statement, as foreign results are reported on a one month lag basis.

Secondly, the acquisition of Peter Black required a realignment of our reported segments. Starting with this quarter we will report the following segments -- consumer health care, which includes our US operations; pharmaceuticals, which we have referred to in the past as our new generic business; Perrigo UK, the combination of Wrafton and Peter Black; and Perrigo Mexico, which is our Mexican, often referred to as our Quifa business.

And then third, as you've seen in our press release last week, the Internal Revenue Service concluded a routine federal tax examination of our tax years 1998, '99 and 2000. As a result of the examination, the Company recorded a onetime income tax benefit of $13.1 million or 18 cents per share in the second quarter of fiscal 2004. This will cause some confusion, but I will try to identify net income and earnings per share both before and after this onetime tax benefit.

So let's look at the second quarter. We had a great quarter due to the early onset and widespread nature of influenza this year and the sale of our Loratadine D new product. The topline growth was leveraged throughout the income statement with sales of plus 8 percent, gross margin at plus 15, and operating income at plus 47. I only wish every quarter worked this way.

As Dave noted, second quarter sales of 245 million increased 18 million or 8 percent from a year ago's 228 million. The consumer health care segment accounted for most of that increase as its sales increased 9 percent from 205 million to 232 million.

We recorded volume gains in dollar sales in our cough, cold, analgesia, feminine hygiene and diet aid categories, and experienced declines in the vitamin categories and products related to the gelatin coating process.

Peregrine UK sales increased from 13 to $15 million and Perrigo Mexico sales declined from 9 million to $7 million. Each was influenced by currency exchange as the British pound strengthened and the Mexican peso weakened year-over-year. The net effect of the currency changes was a positive $300,000.

Let's move to the IRI point-of-sale data. And you will remember, this is excluding Wal-Mart. And this data is for the 12 weeks ending December 28th for store brand sales dollars and indicates the following. First, the cough/cold market was up 21 percent, store brand was up 21 percent, Perrigo was up 29 percent. The slow start in retail orders in the first quarter -- and some of you will remember we discussed that at last quarter's call -- plus the very strong cough, cold, flu season and Loratadine new product sales were more than enough to offset the sales decline in the gelatin film sealed tablets and caplets.

The analgesia market was up five percent, store brand was up four percent, and Perrigo was up eight percent. Perrigo analgesic sales were strong as core products, particularly aspirin, more than offset the losses in the gelatin film sealed gel tabs and gel caps business.

Gastrointestinal, which includes antacids and laxatives, the total market was up five percent, store brand was up three percent, and Perrigo was down seven percent. The lower dollar sales for Perrigo reflects the loss of some antacid tablet business and very competitive price pressures in H2s and a loperamide product.

The vitamin market was up five percent, store brand was up four percent, and Perrigo was down seventeen percent. A number of items affected the vitamin business. We lost business on price at some key accounts, and overall sales decline and a major customer reduction in that customer store counts. We're working hard to reverse this trend, and have won new business in a couple of accounts during the last quarter.

Moving on to gross profit, gross profit of 73.9 million was an increase of 9.6 million compared to last year and was 30.2 percent of net sales compared with 28.3 percent in the second quarter last year. The increase in gross margin percentage was due to the continued success of a number of supply chain initiatives and overall efficiency improvements in our manufacturing operations, combined with the higher volume through our manufacturing facilities. In essence, we had more output per hour due to much longer runs.

Looking at operating expenses, in total they declined $3 million in the quarter and as a percent of sales were 14.3 percent versus 16.7 percent for the same period last year.

R&D expenses increased $900,000, due mainly to pharmaceutical RX spending. And selling and administration expenses declined $3 million due to lower bad debt expenses and cost savings measures implemented in our Mexican operation as a result of moving the small, independent retailers from a direct sell to independent distributors.

The effective tax rate for the quarter after the onetime adjustment was 2.6 percent. Excluding this adjustment it would have been 36 percent.

Net income on an operating basis was up 49 percent to $25.1 million compared with 16.8 million last year.

Diluted earnings per share was 35 cents compared with 24 cents last year. And after the onetime tax adjustment, earnings was 38.2 million and earnings per share was 53 cents.

Now, moving on to the six months, sales for the six months were $455 million, up 3 percent compared with sales of 441 million last year. The consumer health care segment accounted for all of the increase, as it increased 3 percent from 400 to $414 million. Almost all of the sales gain were volume increases. Sales gains were achieved and cough, cold and flu, diet aids and most other product categories, but were reduced by declines in vitamins and antacids.

Perrigo UK sales increased 10 percent from 25 million to 27 million and Perrigo Mexico sales decline 9 percent from 15 to 14 million. As in the quarter, each was influenced by currency exchange. For the six months the net currency effect was a $500,000 increase.

Gross profit of 132 million was an increase of 6 million or 5 percent. As a percentage of sales, this was 29 percent compared with 28.6 percent last year or an increase of 40 basis points. The increase in this gross margin percentage was due to success in a number of our supply chain initiatives and overall improved manufacturing efficiencies.

The major differences in year-to-date operating expenses were in -- R&D, which was 11.9 million compared with 10.8 million last year and this was due mainly to pharmaceutical RX spending; selling and administrative expenses declined 6 million or 10 percent in the first half, reflecting lower bad debt expense; the decline in SG&A as a result of the Quifa restructuring discussed already; and good overall spending control.

I would remind you that we recorded $3.1 million in vitamin litigation settlement income in the first quarter of fiscal 2003 last year.

For six months the effective tax rate was 15.9 percent after the onetime adjustment versus 37.3 percent last year. Excluding this adjustment, the fiscal '04 year-to-date rate would have been 36 percent.

Net income for the six months was 41.6 million compared with 35.6 million last year.

Earnings per share were 58 cents compared with 50 cents last year. And including the onetime tax adjustments, earnings were 54.7 million and earnings per share was 76 cents.

Now some comments on a very strong balance sheet. Working capital, excluding cash at quarter end, was 132 million versus 134 million last quarter and 127 million a year ago, an increase from last year of $5 million, including in addition of $8 million for Peter Black. Working capital as a percent of sales declined to 12.1 percent from 13.9 percent last year. And our cash balance was 111 million, up from $94 million at year-end.

Accounts receivable were 124 million and includes 6 million from Peter Black compared with 103 million a year ago, reflecting the strong sales at the end of the second quarter. And this caused an increase in DSO to 46 days from 40 days a year ago. Inventories were 143 million, an increase of -- a decrease. I'm sorry, let me say that again. Inventories were 143 million, a decrease of 18 million from year-end and a decrease of 11 million from a year ago, despite the addition of $8 million for Peter Black. Days in inventory dropped from 91 days a year ago to 80 days this year.

Cash flow from operations for the past six months was $60 million versus $37 million last year. And free cash flow was 46 million versus 24 million a year ago. We continue to believe operating cash flow for the full year will meet our expectations of 70 to $75 million. Capital expenditures for the first six months were 13 million, and we anticipate spending 25 to 30 million for the year.

In summary, we're pleased with the first half results.

Now let me turn it back to Dave.

I will pick up with a few comments on the first half, which, as I said, were the best six months ever for Perrigo, including the best quarter ever with the second quarter. That was a result of our seasonal business -- very much the result of our seasonal business picking up in October, and then we really saw point-of-sale jump up as well in December. And we've worked hard to put ourselves in a position to benefit from the volume growth, and it certainly paid off in the quarter and in the half in the strong operating leverage that we got. These past efforts to improve productivity, drive costs down and control our working capital are paying dividends today.

As you know, in December we acquired Peter Black Pharmaceuticals, the largest supplier of store brand vitamins and nutritional products in the UK. That business is not material to Perrigo today, but is an important strategic decision. We now have Wrafton with a good position in OTC, Peter Black with a good position in nutrition. Combined they are now one of the UK's largest OTC and nutritional suppliers to retailers for their store brands. We will continue to work to build that store brand business, move away from the contract business where it makes sense in both those companies and then use our leadership position to better serve our retail customers in the UK.

In the prescription drug area we have now hired two key people for our developing generic prescription business, a VP of scientific affairs and R&D and a VP of sales. Those people will be starting next week and we will have an announcement on who those people are at the beginning of next week as we do bring them on board and they start working with Perrigo.

Looking forward, we're still looking for the year for a three to five percent topline growth. And in addition to that, we will add on approximately $15 million coming from Peter Black in the UK.

We don't anticipate seeing any topline benefit from the balance of the cough, cold and flu season, which is now clearly past its peak. And you see the cough, cold and flu indications having dropped dramatically over the past four to five weeks. Despite that precipitous drop, we do believe that the strong seasonal business in the second quarter will largely be incremental for the full year, and now look at somewhere between 80 to 83 cents per share for the fiscal year on an operating basis.

Also in the second half we will have some new products, not huge blockbusters, and no individual product having the impact that D24 is having, but we will have an ibuprofen pseudoephedrine suspension equivalent to Motrin Cold; we will have heat therapy back wraps equivalent to Therma Care; we will have the ovulation test kits; Miconazole three combo pack; as well as the Loratadine quick dissolve product that is now shipping and Loratadine syrup which we would anticipate shipping by the end of February.

I would also comment on the other Loratadine products that are not out yet -- the 10 mg product which accounts for almost half of the overall market, as well as the D12 -- and we are not anticipating any volume from those products in this fiscal year. We do anticipate those products starting to make a contribution sometime in the first half of fiscal '05.

Finally, over the coming quarters we would expect to have further, more detailed comments in the generic RX area as our organizational structure takes shape. And hopefully we can start to comment maybe two quarters or so by now on some of the product development projects as they take shape as well. And as I mentioned, we will have some specific announcements to make on the people that we're adding. And I would say we're very pleased with the quality of those people that we're adding to our generic prescription process and we will comment on those next week.

Thank you all, and Doug Schrank and I would now welcome any of your questions.

(OPERATOR INSTRUCTIONS) Chuck Cerankosky, McDonald Investments.

Great quarter. A quick question on the tax benefit. Doug, was that all cash? Is that essentially a cash inflow item?

No, that really was on the balance sheet as a payable and that payable is eliminated. It really would have been future cash that we don't have to spend, but it's not past cash.

It was carried as an Accounts Payable?

Yes -- income taxes payable, basically, which is no longer payable.

Good.

So it is really a future cash savings.

Excellent. In looking at the selling and administrative expense line, you detailed some of that was reduced bad debt, but it looks like an awfully good performance given the better than normal sales increase. Can you get into a little more detail about what's going on there?

When you look at the big items, and as I said, there was strong or just good expense control throughout the quarter everywhere and throughout the first half. But the biggest item -- lots of pluses and minus, but the only item that really stands out is the bad debt expense. You can see that distribution, despite the sales growth, continues to be a smaller percent of total sales. So that item is really tied into good productivity as we get product out the door. R&D is driven by the generic RX piece; otherwise it's fairly flat. And the selling and administration is driven -- the biggest item is bad debt. There are a number of other items -- the consultants on the outside, some salaries and wages were lower -- but in general the only thing of consequence was bad debt.

What was the swing factor in that item in the quarter?

If you look at your balance sheet, you'll see that the balance for bad debt dropped about 2.6 million. It's on the bottom of page 5. So that's really what came in with bad debts.

Are you guys seeing any impact from the prolonged work stoppage among the retailers in Southern California?

No, we're not seeing a material impact, but certainly sales are somewhat down right in that region. You can see regional POS information, which say that sales are overall a little bit down. But there's nothing material to Perrigo.

Are you sort of making it up as customers shifted their purchases? Is that a factor?

I think it's a small enough impact that it's hard to tell whether the impact in that particular area -- what the different factors are. I would say that that certainly -- we would see a negative factor, certainly, from the accounts that are most impacted, but it is not a substantial factor.

Thank you.

Derek Leckow, Barrington Research.

Congratulations on a nice quarter here. I just had a question for you on the guidance that you gave. It sounds like you are indicating that you think the earnings that you were able to achieve on an incremental basis in the quarter, that that is actually incremental for the full year but not the volume. I assume that's just a function of the leverage that you got.

Yes, I would say that that really is it. We anticipate continuing productivity gains and gains from our operational efficiencies, and I think those gains will continue whether sales volume increases continue or not. And as sales volume would come in in any particular quarter, you'll just see a quarter that will have terrific leverage from those continuing productivity and operational gains.

So we should probably assume that these margin rates come down next quarter and use a more normalized rate of gross margin and operating margin?

No question. If you go back in history for Perrigo, you'll find that the highest margin point usually is in the second or third quarter, depending on how the season is. Definitely, it's in the first half of the year versus the second half. For example, last year our gross margin first half to second half actually dropped almost 100 basis points. That's pretty normal for our business.

Just looking at the guidance for next year, you haven't given any at all. I'm looking at 2005 from the standpoint of you're going to have the five key products in Loratadine coming together, I guess, by the middle of the year. Can you give us any sense for what that means in terms of your ability to gain market share and maybe some additional growth from that set of products?

We're still in the middle of this fiscal year, and we're not ready to give any guidance towards next year. Certainly looking at Loratadine, it will be a continuing nice impact as we add new products in there, but none of them will mean as much to us as the D24 has meant to us by being out there early and first, etc. Something nice to look forward to, but it's hard to say today what the impact will be on fiscal '05, and we are not ready at all at this point in the middle of this season to put any guidance out there for fiscal '05.

Got it. On Peter Black, you mention it's not material today, but any kind of growth you're expecting of that division now that you have Peter Black in there as well? Is that something we should think about?

I'm not ready, again, to comment again on that. We're in the early stages of what we would look to be a three-month integration plan being developed and starting to be implemented. I think we will have a better idea then.

Peter Black does bring us some good positioning with the retailers in the vitamin/mineral/supplement area and some sales. They do not really generate much of a profit today. When we put the two together I would certainly anticipate that we would see some improvement in the overall business versus the two individual parts. But it is really hard to say today what the impact would be in '05.

Outside of any impact from any prescription drug revenue or any kind of a joint venture that you might get involved with next year, the other thing is, the gelatin coating products, that's obviously a negative comparison this year. Can you talk about the status of your ability to compete in that market again?

We intend to be a player in that market. We actually continue to be a significant player in that market, but we certainly are suffering negative comparisons where we are today. We do anticipate in fiscal '05, though, that that would be turning around. Certainly it would not be a negative drain as we are in fiscal '05. Our goal, and it continues to be, to be a good player in that business and have that be a good contributor to us.

Are those lines -- have you completed your manufacturing on those now? Is that still ongoing?

That is still ongoing, and we're making good progress. We're in the midst of that program and it is not completed yet.

Thanks very much and good luck.

Andrea Bise (ph), Schroeder’s Management (ph).

Congratulations. Just a quick question on your cash flow statement. I just want to make sure -- it's kind of a follow-up to Chuck's question -- that the tax refund, did that show up in your cash flow statement as a reversal of maybe accrued taxes or anything like that?

That's exactly where (multiple speakers) Andrea. It just makes that number different. But it also shows up in net income, so when you get to the operating cash flow it nets out to zero. So in essence, net income went up 13.1 million and the effect of the income tax when down -- the tax payable went down 13.1, but the operating cash flow in 2004 stays the same. So (multiple speakers)

So the net cash from operating activity then of almost 60 million --?

Does not change.

There was no impact on that from the tax?

That's correct. That's real cash.

Doug Lane, Avondale Partners.

Just to clarify, on the sales forecast for the full year you guys said up three to five percent -- no change -- and then we add incrementally the 15 million or so from the acquisition?

Yes.

The acquisition was not considered in your original three to five percent estimate when you gave that out last time or whatever?

We did not have that specific acquisition in there. Our goal has been to grow our core business in that three to five percent range and that acquisitions would be additive to that. And we feel that somewhere in that range is where we will end up this year.

And with the good quarter here you're on track, right, through six months, so --?

Yes, that is our feeling, even though the incidents of flu indications are dramatically down in January. There was certainly some carryover in filling the pipeline in into early January. So we think we will hold on to at least a good chunk of the second quarter's gains.

Did the 10 mg Loratadine move out of '04 into '05, so that can we view the better revenues in the second quarter from the season -- the flu season -- as being partially offset by the Loratadine introduction of at least the 10 mg, if not the D12, being pushed off out of the second half of '04 into '05?

I'm not sure that I'm catching your question there.

Last summer where you were talking about three to five percent growth, were you thinking that you would be rolling out a 10 mg --?

Yes, we were. We expected that by the back half of the year that there would be contribution coming from all five Loratadine products; at some point by the end of the year we would have had all five of them, that they would have been contributing. So what we are saying today is we're going to hit our growth targets despite not having all of the Loratadine products.

Right and one key reason is the better flu season, the cough and cold products, right?

That absolutely is one reason and the other reason would be the strong sales of D24.

So D24 is really doing better than you expected?

Yes.

That's good to hear. Just to wrap this up -- because Andrx announced that the D12 was approved last week -- why couldn't you be introducing that sooner than fiscal '05, I guess would be the question?

Well, we would like to, but as you noted we are purchasing this product and partnering with Andrx on this product. And there's still some work to be doing in terms of validation and production planning. And at this point it's not fully in our hands; we want to work with Andrx in getting the product ready to go to the market and we're just not able to do that today as quickly as we would have anticipated.

Okay. You realigned the divisions; you have the new generic pharmaceutical. You didn't talk it in the second quarter, so I assume there were no revenues in the second quarter for that effort. Will we see revenues in the third quarter, fourth quarter?

No, we don't anticipate seeing any revenues. I think we've been pretty consistent in that. So I would repeat what we expect, and of course things could change because it's like to start a business and there's a lot of things that we're trying to make happen, and it's hard to say when some of these things will happen. But our anticipation would be no revenues in '04, very minimal revenues in '05, and maybe even a little ramp up in spending in '05 without significant revenues and then '06 is where we really do expect to see some good revenue hits. And as we report on results in '05, I would think you would hear of product approvals and things, or licensing agreements, etc., that you would then see specifics of the groundwork being laid for what we would hope to be some good contribution and good revenues in '06. But they would not be material -- the revenue side will be virtually nothing, we would expect, in '04 and very minimal in '05, and only really becoming material in '06.

You mentioned the spend, and we did see R&D jump up a little bit -- 5.7 in the first quarter to 6.2 in the second quarter. Any feel for how that should continue? Should we just incrementally add $1 million a quarter for lack of any other direction? How do you see that unfolding?

We now have some people hired to start to get the -- we've hired a number of people, but some really key hires -- the Vice President of Research and Development and the Vice President of Sales. So I would say you will see a ramp up in the third and fourth quarter. Probably for the full year we would be more coming towards the low end of that 5 to $7 million that we said we would spend this year. And I think you could then take the spending rate in the second half of this year and project that as an ongoing rate for fiscal '05, and probably be pretty close, at least to the best we could estimate at this point. And as we give guidance for fiscal '05 at the end of this fiscal year, we will definitely be able to clarify that better. It's just hard to say at this point in time in what's really an early stage start a business for us.

I understand. Thank you.

(OPERATOR INSTRUCTIONS) Chuck Cerankosky, McDonald Investments.

Dave, could you comment please on what you are seeing in terms of, call it, cannibalization among the old antihistamines like clemastine and the benadryl compound and others as a result of Loratadine now that we've got twelve months behind us?

Yes. It's no real surprise that there is some cannibalization. If we look at the overall allergy segment, the total segment was maybe somewhere close to $600 million. With the addition of Claritin you've got the segment up to about $1 billion category. And there are -- so the category overall has grown, but Claritin has taken away business from other parts of that segment -- or Loratadine, I should say, has taking business away from some of the other products. And I really can't comment on the specifics. I don't have -- I look at those, but I don't remember off the top of my head what ones are being hurt more than others.

But you're saying the net is a benefit to you?

The net is a benefit to us, yes.

One of the things that you see when you've got a blockbuster brand in the marketplace is that typically the products that get hurt worst are sort of the weakest national brands. The store brands are hurt less than that. But it's really the weakest national brands that get hurt by this kind of a blockbuster advertised brand. It's interesting because what you see happening with Prilosec being launched is that the category has grown and everybody else has been hurt because it is a new brand and there are no new store brands out. So the GI category has grown, but basically everybody except Prilosec has taken a hit.

Again in that case, store brand has not taken as a great hit as some of the weaker national brands.

What looking ahead, what is your read now with some the FDA's recent commentary on the statin switching OTC?

It really hasn't changed. We still look at the statins as an opportunity for us, but not a near-term opportunity. I do think that there is movement towards more of this happening, but I also really don't believe that it's going to happen precipitously. I think it's going to be done with a lot of care and a lot of thought on the part of the FDA and the industry. So while I do think the statins are an excellent opportunity for a switch, I don't see it in the very near immediate term.

Thank you very much.

At this time there are no further questions.

Thank you all very much and thanks to the Perrigo team for a good quarter.

Thank you for participating in today's Perrigo second quarter results conference call. You may now disconnect.