Perrigo Company PLC (PRGO) 2005 Q1 法說會逐字稿

Good morning and welcome to your Perrigo first quarter Results Conference Call. At this time all parties have been placed on a listen only mode followed by a question and answer session after today's presentation. Now without further ado, your host, Doug Schrank, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Mark. 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 actually wish you were all here in Allegan, because we're having a very fine late summer day.

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 assurances 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 27 to 23, of our Form 10-K, for the year ended June 26, 2004.

With these formalities completed, I will now turn the call over to Dave Gibbons, Perrigo's Chairman, President and CEO. Dave?

Hello, everybody. And thanks, Doug. We are pleased to announce our first quarter results, and to talk about the preparations we have in place for the cough, cold and flu season.

Overall, we think we're off to a good start to fiscal 2005. Sales were up 8%, or $16 million, to $228 million. The Loratadine family of allergy, sinus products continued to sell well. Vitamin sales were up double digits for the third consecutive strong quarter. UK sales were up with the Peter Black vitamin business adding $9 million to sales, although profits were disappointing. Net income for the quarter was $17.6 million, or $0.24 per share, compared with $16.5 million or $0.23 per share last year.

Now, I'll turn it over to Doug for his financial review for the quarter in more detail, and then I'll be back.

Thanks, Dave. It was another good quarter for Perrigo. The increase in earnings was due to a strong performance in the consumer health care segment. As Dave noted, consolidated first quarter sales of 228 million, increased 16 million, or 8%, from a year ago. These consolidated sales included approximately 9 million from the Peter Black acquisition, and approximately 1 million from currency translation.

Consolidated gross profit of 64.7 million, was an increase of 4.7 million, compared with last year, and the gross margin percentage was 28.4% of net sales, compared with 28.3% last year. Consolidated net income was 17.6 million this year, compared to 16.5 million in fiscal '04, and earnings per share was $0.24 versus $0.23 a year ago.

Now, I'm going to take you through a detailed review of our four business segments. Understanding the progress in each segment will give you a better picture of the consolidated results. But first let me review the IRI point of sale data for key product categories for the 12 weeks ending October 3rd, and remember that does not include the Wal-Mart information.

The cough/cold market was down 2%. Store brand was up 6% and Perrigo was up 21%. Perrigo sales were strong due to good loratadine sales volumes from D24, loratadine syrup, loratadine quick dissolve and the 10-milligram tablet, and the cough/cold seasonal sell-in. As a note, it is too early to gauge the effect of the flu vaccine shortage.

The analgesic market was down 4%, store brand was down 6%, and Perrigo was down 4%. There were no significant new product introductions in the quarter, and little seasonal sell-in as analgesics more closely follow flu symptoms and generally trail the onset of colds.

In addition, we have yet -- we have not yet seen any effect of the discontinuation of Vioxx sales. We expect this could have a positive effect on Ibuprofen and acetaminophen sales.

The gastrointestinal market was up 7%, store brand was down 7%, and Perrigo was down 6%. The lower dollar sales for Perrigo reflect the loss of some antacid business and very competitive price pressures in the H2s, due to Prilosec OTC.

The vitamin market was down 2%, store brand was down 1%, and Perrigo was up 14%. This quarter, like last, we experienced double-digit gains in the core vitamin product categories. Additional volume is from innovative new products at existing accounts, which are positioned as better than the advertised brand.

Now, let me move to the consumer health care segment. Sales of the consumer health care segment increased $7 million, or 4% from 193 million to 200 million. The increase was due to the strong sales of the loratadine family of allergy medications, the sell-in of cough/cold products and higher unit sales of vitamin products, which were partially offset by a decline in the antacids, allergies and diet aid categories.

The 4% sales increase was achieved despite a retail environment that experienced soft sales due to the hurricane disruptions along the eastern seaboard and consumer spending reductions attributable to higher gas prices. I think many of you have seen this softness reflected in our key retailer results this quarter.

The consumer health care gross profit increased from 56 million to 60 million, up 7%, and as a percent of sales, gross margin increased from 29.3% to 30.3%, an increase of 100 basis points in the quarter, as ongoing purchasing initiatives and manufacturing productivity projects continue to pay off.

Operating expenses increased 3%, or $1 million, from 31.6 million to 32.6 million, and remain relatively constant as a percent of sales at 16.4%. All in all, the consumer health care segment had an excellent first quarter with a 4% sales gain, a 7% increase in gross margin, and operating income up 12%.

Moving to the pharmaceutical business. Operating expenses were 1.3 million, compared with $300,000 last year, as we continue to fund the start-up of our greenfield generic prescription drug business. We continue to expect annual operating losses of this segment in the $10 to $12 million range.

Moving to the UK. In the Perrigo UK, sales increased 10.6 million to $23.2 million. The Peter Black acquisition accounted for approximately 8.6 million of the gain, and currency translation another 1.3 million. Operating profit in the business was 200,000, down from 400,000 last year. We have implemented the second stage of the Wrafton Peter Black merger integration plan, which reduces ongoing operating costs of the combined business and will reduce the overall break-even point. This will result in a significant year-over-year improvement in operating income, which will be evident in the last three quarters of this fiscal year.

Turning to Mexico. Sales decreased 1.5 million, to $5 million due to lower government and distribution sales. The operating loss was $100,000, compared to an income of $300,000 last year. As you know, we are changing the Mexico business model to become more dependent on store brand sales, and less dependent on government sales. This change continues at a good pace as store brand sales grew 30% in the quarter, and now represent one-third of our sales in Mexico.

Looking at the consolidated operating income. In summary, consolidated operating income in the quarter was 26.6 million, versus 25.3 million last year, up 5%. Operating income was driven by the 12% increase in consumer health care, which was partially offset by continued investment spending in pharmaceutical and decreases in income in both the UK and Mexico.

The effective tax rate for the quarter was 36%, the same as last year, and consolidated net income was 17.6 million, compared with 12 -- or compared with 16.5 million last year. Diluted earnings per share was $0.24 compared with $0.23, and excluding the $1 million increase in spending in our pharmaceutical business, net income was up 10%.

Now some comments on the balance sheet. Working capital, excluding cash at quarter end, was 165 million, versus 135 -- 134 million last year an increase of $31 million. Our cash balance declined from 172 million at yearend, to 142 million. This was due to higher seasonal accounts receivable and our decision to build inventory earlier this year. Accounts receivable were 113 million, compared with 99 million a year ago, reflecting seasonal sell-in, which was higher this year in mid to late September, than it was a year ago.

Inventories were 182 million, an increase of 8 million from yearend, and an increase of 32 million from a year ago. This reflects our strategy to better meet customer delivery requirements during peak demand of cough/cold/flu season and to support more aggressive sales and promotional programs for store brands this season. Both initiatives should result in higher store brand share throughout the cough/cold and flu season, which will translate to higher sales for Perrigo and our customers.

Accounts payable were 84 million, compared with 68 million a year ago. This 16 million increase offset the $32 million increase in inventories and mitigates the cash used from the inventory buildup. Cash from operations for the year was 23 million -- I'm sorry, cash used for operations for the year was 23 million, compared with cash provided by operations of 8 million in the first quarter last year. The high use of cash funded the 14 million accounts receivable increase, and the 16 million inventory increase, that's a 32 million increase net of the 16 million increase in accounts payable, to improve customer service and to increase seasonal promotional programs.

Cash flow will be positive through the first two quarters, as inventories fall, and receivables are collected through the cough/cold season, and this reflects a reasonable approximation of our normal pattern. Capital expenditures during the quarter were 2 million, and we anticipate spending 25 to 30 million for the year.

In summary, it was another good quarter for Perrigo. We have a strong balance sheet and are in position to take advantage of store brand share gains during the upcoming cough/cold/flu season.

Now let me turn it back over to Dave.

Thanks, Doug. I'd like to start, as we look forward here, to discussing a couple of recent ANDA approvals that we've had. On October 5, Perrigo announced the final approval for two new products that was granted through FDA's ANDA process.

The first in the OTC area was our nicotine gum where we received approval for the OTC nicotine gum in both 2-milligram and 4 milligram doses in three different flavors each, orange, regular and mint. These products are the generic over-the-counter equivalent of Nicorette. We will begin shipping in early calendar year 2005. Those early sales will not be too meaningful, as we will be the third store brand offering out in the marketplace. But it's still going to be a nice product for us.

The second ANDA approval is the Ibuprofen oral suspension. We received approval for prescription-strength Ibuprofen oral suspension, the generic equivalent to Motrin. We will begin shipping that again in early calendar year 2005, and while this is a small product, with an overall market of only $10 million, it is a milestone for Perrigo as our first generic prescription drug approval.

We currently await approval on two additional generic drug filings that were submitted in fiscal 2004, and we anticipate the filing of 8 to 10 new generic drug ANDAs during fiscal 2005.

In terms of looking ahead, we'll first look at our US consumer health care business. We think we are better prepared to take advantage of seasonal business opportunities this year than we've been in a long time. We have the promotional plans, the inventories and the resources in place and are ready to take full advantage of the season. We also believe our supply chain initiatives and operating efficiencies can provide the leverage to drive more of those sales down to the bottom line this year.

In the UK, the integration of our OTC and nutritional businesses is progressing, and despite poor quarter one results, we're confident that we will see improved operating results over the next three quarters. We feel good about where we're headed in this business. We will continue the investment and development of our start-up generic drug business.

In summary, it's a good start to the year for Perrigo. Our consumer healthcare business in the US is ready to meet the seasonal challenges ahead. I'd remind you that it's not unusual that the results for our first quarter don't provide a clear indication of the results for the full year. At this point, early in the cough/cold and flu season, there really is no obvious pattern that has developed. There's positive signs, there's not so positive signs. It's hard to tell where it's going to go.

We do remain confident that we have sound operating plans in place and for the full year we continue to have every expectation of revenue growth of 4 to 5% and earnings growth of 3 to 5%, consistent with the way we felt as we entered the fiscal year. We're also very positive about our generic pharmaceutical initiative as we continue to invest for growth and develop this new business for Perrigo.

At this point, Doug and I would now be happy to take your questions. We'd ask that you limit your inquiries to one question and a possible follow-up to that question, if needed, in the initial round, so that everyone has a chance to participate. After all questions -- after everyone has had a chance for questions, we'll then go back and open it up for additional questions from anyone of you. Questions for either Doug or me.

Thank you. The floor is now open for questions. If you have a question, please press "star" "one" on your touch-tone phone. Once again, that's "star" "one" to pose a question. Please hold while we poll for questions. Thank you.

Our first question comes from Joe Norton from Bank of America. Please go ahead, sir.

Yes, thanks, good morning.

Good morning Joe.

Good morning.

Gee, I'm so limited, I have to figure out which question I want to ask here. So -- I guess I wanted to ask about the -- can you quantify in the quarter or in September, whichever, I guess it would be September, what was the dollar impact of the earlier sell-in this year?

Joe, this is Doug. You have to understand two things. And I'll give you that you number, it's probably in the $5 million to $6 million range. But the real issue is when the sales happened. Whether they happen late in the period or late in the month before causes the receivable balances to change. So it really -- it's really more of a pattern of how the shipments went out than it is what happens up or down in the sales volume.

OK. And -- I guess my follow-up to that is both in terms of the timing and the magnitude, was it about what you expected?

It was actually a little bit less. We had expected that having talked to all of our retailers, that the sell-in would have been stronger in the first quarter, and when we'd sit back and talk to the retailers across the board -- well, not completely across the board, but over a fair bit of it, they had a slower first quarter business than they expected.

I mean if you talk to those that have big presence on the East Coast, I mean, the hurricanes obviously had significant impact. If you talk to retailers who -- a part of their sales are to lower income individuals, they'll tell you they were affected by the gas price increases that we've seen quarter-over-quarter. So as it relates to all of that, we think -- we had really expected first quarter sales and sell-in to be a little bit higher.

So then we could conclude also that the inventories are probably a little bit higher than you guys thought they'd be at the end of the quarter?

Absolutely. But the one thing I'll tell you is that all of our retailers are excited about the in-season promotions that really start to hit when the season hits. It's a little bit flexible. You would think that they will hit in the second quarter or third quarter. Despite the slow start, they're very excited and they're counting on doing those promotions to really try to drive store brand share as a percent of the total share during that peak season. Remember, we talked about that share falling last year during the peak season, and we've partnered with our store brand customers to really make that go the other way.

And since you mentioned that on this topic, is the promotional programs, is that essentially what drove the S&A up so much in the first quarter?

Actually, if you look at S&A in the first quarter there's a couple of drivers of it. You'll see it in the pharma business as we built the staff of pharma, and you'll also see it in the Peter Black business that really was not in the S&A in the first quarter of last year. If you look at the consumer products business, which is really equal year-over-year, your build is really probably in the 3% range. You'll see that in the Q, and that's about what we would have expected. So it's really the consolidated S&A is up because of pharma and Peter Black. Consumer health care is well in line.

OK. Good, thank you very much. That's helpful.

Yep.

Thank you. Our next question comes from Doug Lane from Avondale Partners.

Hi, Doug.

Hi. Good morning, everybody. Let's stay on the cough and cold here for a minute, Doug and Dave. Can you give us a recap of last year? Because we had that huge spike early in the season and then it really fell off the table after the first of the year. So, how are you able to respond to that sort of sudden and dramatic increase in demand and say, you know, late November, early December, or throughout the month of December, last year, and really were you able to respond to the demand?

Yes, last year we were moving along just pretty much -- this is Dave Gibbons. We were moving along pretty much as expected, Doug, until right around the 1st of December, and that's when that huge peak hit. And we were not able to respond as effectively as we would have liked to or as our retailers would have liked us to. And we ended up scrambling all through December, all through January, without ever really catching up until the season was turning down.

We've determined this year that we don't want to let that opportunity for sales fall by the wayside and when you look at last year, we got clobbered -- we lost sales because of that early peak, but the season as a whole was a normal season. Overall sales were actually by the end of the year slightly by a couple percentage points, down over the average year. So the peak actually cost us sales, because we could have responded if it was a normal bell curve kind of season. We weren't able to respond as effectively with the peak season.

This year, we really feel that we can respond to either a peak season or a more normal bell-shaped curve season, and that's why we have built the inventory that we built, especially -- Doug and I both feel more comfortable with it, especially because we have the aggressive promotional programs for this year that we've put in, that are different than we've had in the past.

And we have noticed the falloff we've had in other seasons when the store -- when the national brands do all their advertising and promoting, our share drops below what our normal share should be, and this year we're going to be out there promoting our store brand cough/cold products and we're hoping to pick up a couple of points in store brand share. And so whether it's a peak season or a bell curve season, the timing of when our sales come in maybe -- may change, depending on the type of season. But overall we think we're going to get those sales.

So, just -- and just to follow-up. There's three things going on differently, then. One is a more aggressive inventory build to make sure product is on the shelf from the get-go. Secondly, you're working a more rigorous promotional program to counter the national brand promotions that typically run on a. seasonal basis that you didn't really have of this magnitude last year. And then thirdly, you're actually better equipped in Allegan to respond to customer reorders, so just structurally you're more nimble on customer reorders when they come in as the season progresses.

Correct, I think all three of those are exactly the take-away.

OK, thank you.

Thank you. Our next question comes from Russell Morrison (ph) from RJM Investment Incorporated.

Good morning.

Good morning.

I hear some reference to reporting excluding Wal-Mart. And that may account for the fact that I have a sense of disconnect between the figures and the adjectives, describing your business. Are you getting beaten up on price there, or quantities, or is that a plus/minus?

Russell, this is Doug. The reference to excluding. Wal-Mart in the US, the IRI data, which is the marketplace data, that is collected, and if it were Neilson, it would be the same thing. That data, Wal-Mart does not contribute to that data. So the only reference to Wal-Mart being excluded is in the market data that I gave early on.

And that's consistent with the way any companies have to report since Wal-Mart made the decision a couple years ago to not supply their data to IRI or Neilson.

But you'd have a feeling how things are going over at Wal-Mart.

We certainly do. We have very good pulse for where our business is with Wal-Mart.

So how is it doing?

It's doing fine, it's doing consistent with historical patterns, and if you look at Wal-Mart's overall business for the quarter, it will give you a pretty good indication of where our business with Wal-Mart was for the quarter.

And your margins are not going up or down particularly?

They're staying pretty steady, yes.

Thank you.

Thank you. Our next question comes from Keith Markey from Value Line. Please go ahead.

Good morning. Of the $10 million to $12 million you expect to spend on your generic drug segment this year, how much of that is going to be going to selling and administrative purposes and how much for R&D?

Keith, this is Doug. The vast majority of it will be in R&D. The selling and administrative is probably in the range of a couple million dollars. But the vast majority of that is in R&D for bio-studies it's for the ramp-up of the R&D employees, you know, it's for depreciation of lab equipment; it's for all those things.

Right. Thanks. Will you be adding many sales people, then?

Hi, this is Dave Gibbons, we just recently added two additional sales people. So we will now have three sales people for immediate needs, and we will add additional sales people as needed, as we bring more products to the market.

OK, thank you.

Thank you, our next question comes from Derek Leckow from Barrington Research.

Hi, Derek, good morning.

Hi Derek.

Thanks. Good morning. How you guys doing?

Great. Good.

Just want to ask my question here on the generic drug start-up. I realized it's somewhat strategic right now but can you talk a little about the categories that these medications might fall into, and then as a follow-up to that how would you characterize the opportunities out there to maybe accelerate that process with acquisitions or joint ventures right now?

We do not have specific categories at this point in time to delineate. What we're doing is looking at opportunities to get us a product line in the marketplace sooner rather than later, and product lines that will allow us to leverage our existing strengths. So, the early products that we're working on Derek, are aimed at getting us out in the marketplace, what can we do to get a foundation built. At some point in the future we will look at what therapeutic indications we want to focus on, but in the early stages, we have not committed to a particular therapeutic area that we're going to put our emphasis on.

In terms of acquisitions, we continue to be very, very interested in doing the right acquisition. It is an area that we're putting a lot of effort on, a lot of emphasis on, but it's an area where we will not do an acquisition unless we really feel it is getting us the foundation that we need to really jumpstart us in this business. So again, you may not -- you're certainly not going to hear anything about what we're doing and looking at potential acquisitions, but I can assure you that it remains a key interest of ours, but we won't do anything if we are not sure it's the right thing to do.

OK. I guess the takeaway there is you're not shifting your strategy in any way away from the acquisition front, and the acquisition opportunities that are out there. I guess pricing was a concern previously, but I just wanted to make sure of that. And then, if I could ask one follow-up, the statins category, obviously, is a big category. Can you guys talk about what you're doing there that area specifically?

Yes, this is Dave again. We are looking at developing products in the statin area. We think that statins have a good chance of going OTC. Sales for store brand, if it does go OTC, are still years out, but we've got to start work on those products earlier rather than later, and we certainly are keyed in on the statin area as a good opportunity for Perrigo. In fact, what's a great opportunity for Perrigo in statins is, with our generic initiative, we could put work on those products and we can have sales opportunity whether they're generic prescription or whether they go OTC. So, we actually have a nice advantage in the statin area over a lot of other companies.

OK. Thanks very much.

Thank you. Our next question comes from Linda Bolton Weiser from Oppenheimer.

Thanks. Forgive me if somebody already asked this, but can you just clarify again the losses in the generic Rx business, I think you said it would be 10 to 12 million annually, and so there was a $1 million loss in the first quarter. That will ramp up as the year progresses, is that correct?

Yes, it will. We'll be adding more people as the year goes on. We'll also be spending more on bio-studies, and some of the types of things that tend to snowball as you go along. So we still -- we looked at the $1.3 million in spending in the first quarter, we re-looked at our 10 to $12 million estimate for the year, and we came away saying yes, that's still what we think we'll be spending in the 10 to $12 million, as we look at when that spending will occur.

And how much of the R&D expenditure for the whole company was related to generic Rx in the quarter?

In the quarter -- it's relatively small in the quarter. On an annual basis, I guess, we probably spend about 35 million in R&D overall, and 10 to 12 million of that will be in generics. And I'm -- off the top of my head, round numbers, maybe, but I think that's in the ballpark, Linda -- on an annual basis. I just don't remember what we did in OTC R&D in the first quarter exactly.

So just, just so I'm straight. The operating loss in the generic Rx segment is expected to be 10 to 12 million for the full year?

Correct.

OK. And just one follow-up, on loratadine, can you clarify how the competitive landscape is going on loratadine? How many competitors you have, and also just update on the status of the 10-milligram?

I'll start with the status of the 10-milligram. We did begin shipping the 10-milligram in September, but as you noted, there are more competitors out in the marketplace today. So we -- we're get something business on 10-milligram, but we don't expect it to be the kind of impact item that the earlier products were.

In regard to the products that we've had out on the marketplace, we're continuing to see good sales coming in from those products, but you are absolutely also correct, there are increasing numbers of competitors out there that does impact margins. What we're seeing today is some margin erosion, but it's right in line with what we had in the plan for the year. There's nothing happening out there that is surprising us or is of any greater impact than what we had expected at this point in the product life cycle.

OK. Thanks a lot.

You're welcome.

Thank you. Our next question comes from Chuck Cerankosky from Key McDonald.

Good morning, everyone.

Good morning, Chuck.

Looking at your UK business. Could you give us a sense of what you're doing there, what sort of the steps that will be taken to improve the profitability over the course of the year, and can you put any kind of magnitude on that?

This is Dave. If you were to look at the financials for the UK, you'll see that operating expenses are out of line with the sales growth, Peter Black operating expenses were certainly higher than we would like, and we have plans in place to drive those operating expenses down. In fact, we have reduced a number of positions over there at the very end of September that announcement was made. So there's a chunk of costs that were in there in the first quarter that are already on their way out, and will be reflected being out in the second quarter and beyond.

So, I think, if you look at the numbers and see, operating expenses were higher than what you would expect for the combined companies. That's simply the fact that we have not fully -- in the first quarter had not fully gotten the costs out that we know we had targeted as we made that acquisition. We are in line, in terms of our planning, in driving the costs out, as we had expected. We don't see anything that says, we will not have a lot of improvement over the final three quarters of this year.

Anything you could comment on, Dave, with regard to building the top-line and moving into more store brand business and out of the contract manufacturing business in the UK?

I would comment, Chuck, that it is happening, but it's happening at a -- you know, relatively slow pace because of the approval process that you have to go through. We have to build the product line and gradually move the business to a store brand model. That is happening, it's happening right along the path we would like. It's a little slower than we thought it would be when we started our initiative in the UK, what's it, three years ago or so going now. But it is starting to come about, it's happening, it's happening both in the UK and it's happening in Mexico.

It's just starting from a small base, moving steadily but slowly. The percentage increases in both countries; UK and Mexico, in the growth of our store brand business look terrific. The problem is the base today is still pretty small. But, 15 or 20 years ago, the base in the US was pretty small, and we got a lot of good growth as we built the store brand business in the US, and we think that same kind of thing is going to happen as we get our momentum going outside the US.

When you talk about improved operating results over the course of the year, in the UK, what dollar magnitude are we talking about, taking a full year perspective?

Chuck, this is Doug. When you look at the business -- let me just back up a bit. What you've got here are two businesses, two locations, two sales organizations, two finance functions, two inventory systems, et cetera. And we've only owned that business for a little over six months or, I guess, nine months. So the whole integration process is a matter of integrating those businesses, and you can go about as fast as you can go with the IS systems, to get those done.

So, what Dave described is really Phase II of a probably three significant -- three key steps to make it happen. I can't remember what the operating income for the UK was for the full year last year. So I'm a little bit of at a loss, and I guess, what I need to do is go look at an annual report and figure that out, and then I can come back and try to comment on this year. So I have got to get the annual report to do that and I don't have it with me. So let's take another question and I'll come back at it.

Doug, it was $55,000 last year.

Is that what it was?

Yes.

I think that you can look for a number that is in the low millions 2-ish range for the year.

OK. Now one last question. Looking at your promotional programs, with the retailers, new focus on the season. Can you review, is this something the retailer funds or are you giving discounts, and what are the dollars behind that?

This is not something -- the promotional programs that we do with the retailers are a little different than what was -- what national brand companies do in that a big chunk of the costs of doing the promotions are born by the retailers when you're talking a store brand product promotion. Because if you look at our margins, we don't build-in margins that can support a whole big chunk of promotional programs. So what we may incur some additional costs in terms of the extra displays and all that we put together. But we're not paying for discounts or things like that off our regular prices to the retailers in terms of the products that are being put up on those promotions for the most part.

OK. That's good to hear. Thank you.

Chuck, let me come back to that question now that I see the annual report. On the UK. As you look at the UK for the year, I think you'll see it north of the historical numbers in operating income. So, as you look at '02, '03, and '04, that business is going to turn around fairly substantial in the last half of the year.

Thank you.

Thank you. Our next question comes from Steve Aliqueti (ph) from Argus Partners.

Hi, thanks. I'm curious if you can just talk a little more about the nicotine gum opportunity for this fiscal year, and also maybe it's preliminary but any comments you might have on how you will price relative to competitors. I'm just curious too if the added gross margin on that product line will be above or below your current overall corporate gross margin?

We would expect that the gross margins on the Nicotine Gum will be somewhat higher than what our typical margins are. You can also expect that as a third competitor in this case Perrigo, comes into the marketplace, overall margins might drop somewhat on the total market. That would be pretty typical as well. And I don't know that we see much different happening there.

But I would also say we're not coming in and saying that our overall gross margins are X and so therefore that's how we're going to price Nicotine Gum. So I wouldn't necessarily draw that conclusion. I think that this is a unique product, and I would expect it would contribute somewhat higher margins for us when we introduce it.

I'm not sure I'm remembering the other part of your question, the earlier question. I guess, OK, the overall market on nicotine gum at retail is probably somewhere around 500 million, maybe and if you break down to store brand, I guess, it's less than that. It's probably more like 350 to $400 million for the overall market. And then if you breakdown store brand, you might come to a store brand market opportunity at retail of about $100 million, so maybe you're in the 65 to $70 million range for store brand market opportunity at manufacturer's take on that.

OK. And do you have a market share goal within that, then, right now?

Well, we...

Besides the obvious 100%?

No. I was going to say the obvious one is to get to our normal 65% or so market share. But we would not expect to be able to get there out of the gate because we're the third one in. So, certainly I would say if we could do half of that, we'd be pretty happy, and I'm not sure we could even count right out of the gate on getting those kind of numbers. So being the third one coming in, I think you're going to see more of a build in market share than an immediate capture of a whole big pile of market share there.

OK. But this product was somewhat baked into your guidance for fiscal '05 already, I'm assuming, is that correct?

Yes. What has happened with the approval would not -- it's one of those pluses that go along with pluses and minuses in the year when you put your estimates for the year together.

OK. All right, thank you.

Thank you. Our next question comes from Boris Vujcich (ph) from Pennant Capital.

Good morning. Most of my questions have been answered. I just had one other one. I did see that the allowances for doubtful accounts and for inventory went down a bit. Is something fundamentally different from this year than last year that we should be aware of in the product mix, or in your customer base?

Boris, this is Doug Schrank. We look at that, we've looked at that consistently year-over-year, and what you'll find is that the older the inventory is on hand, the larger any allowance for obsolescence would be. And as we've built this inventory to ship out in this cough/cold/flu season, more of the inventory is newer than you would have seen it as a percent than a year ago. So that's the only difference, it really is the mix of old versus new, and as we've built the inventory, it's all newer.

Thank you. Our next question is from Joe Norton from Banc of America.

Thanks. I just wanted to come back to for a minute, it was kind of interesting the comments you were making about the flu season and whether it's a peak or a bell curve. How are you thinking about the gross margin sensitivity to that? And specifically, I guess, I'm referring to, you know, obviously there's a very difficult comp in the second quarter, and so -- and given that you're going into the second quarter now with somewhat higher than expected inventories, is this promotional program you're putting in place sort of meant to take any sensitivity out of the gross margin, or how would we think about that?

Joe that's a tough question because every quarter on an absorption basis is a little bit different. When you look at the high volume quarters, which are obviously the second and third quarter. Gross margin is really pretty unaffected by the over or under absorption. We're really running at very high rates, and the standard costs that are applied to those high rates are going to be pretty consistent this year versus last year.

The only time absorption -- starts to affect us is in really low volume quarters like the fourth quarter last year when you've got a mix of production levels. So as I look at the second quarter this year, or the third quarter this year, just like in any other years, the margins are fairly comparable.

Now, with the promotion programs that we've got going, you always work with the retailer to try to drive from their perspective and from your perspective, those products that really are in consumer demand. Some of those have higher margins; some of those have a little bit lower margins. You're really trying to drive them off the shelf and take traffic away from the national brands. As I think about that, I think that has some positive and some negative effect on margins, and I think overall margins should track fairly closely year-over-year. And the ups and downs in margins track fairly closely.

OK. So then, there's no -- so it's reasonable to think about margins being similar to year ago levels, despite what your production schedule is.

Yes, I think so.

OK.

And mix of products always has an impact on that once it actually happens, but we see no reason that the mix of products will change very dramatically.

OK. Good, thank you.

Thank you. Our next question comes from Linda Bolton Weiser from Oppenheimer.

Thanks. Just a quick little question on the cash flow statement. What's the $5 million use of cash for purchase of assets?

That's the purchase of the foot care business that we announced, I think in the first quarter of this year or at the end of the fourth quarter. That's basically the purchase of receivables and inventory...

...of the Aerosol, Lamisil.

All right. And the annual sales are really small, aren't they, how much are the annual sales?

Yes. The annual sales are really in the $5 million range.

And can I also just ask, I had thought that your Ibuprofen approval for a generic Rx, was actually of the same strength as the OTC product but it's just approved for the prescription market. Am I mistaken on that?

You're correct.

And how much sales opportunity do you think, there is for you to do the same thing with other products, where it's the exact same product, same strength and it's just a different approval process?

We're working on a number of those opportunities; they're -- the obvious first targets for us, as we go into the business. They're not going to be -- we're not looking at them as a substantial component of our sales in our generics business, as we go forward in the long-term. These are just low hanging fruit that we can go after, Linda. And so there's a few other ones we're working on, they're not going to be huge drivers of volume for us over the long-term.

But, Linda, as you look at them very few of them are the same strength. Take Ibuprofen. OTC is 200 milligrams. When you look at it in Rx, it's 4, 6 and 800 milligrams. So the Ibuprofen suspension is really an unusual -- it's fairly unusual in that it's the same strength. The only other one, I can really think about is Pepcid, which transferred at 10 milligrams to OTC, and it was 10 milligrams at Rx. That's the only other one, I can think of, off the top of my head.

So when you're referring to these 8 to 10 filings you're planning on doing this year, those would be sort of different things, different dosages?

Different dosages than existing OTC products. Yes, ma'am.

As well as some other new products, we would be getting in.

Right. That would be different than any product, we make today.

It'll be a mix.

OK. Thanks.

And we're about at the end of our time. We can take one more question and then we'll be available off line for others, who want to call in, but we're running a little late for everybody here. So one more question.

Unfortunately, our last question comes from Doug Lane from Avondale Partners. Please go ahead, sir.

Yes, I had a quick follow-up and more for my edification here. Can you explain, Dave or Doug, how the losses in the pharmaceuticals have actually declined sequentially? I'm sort of simplistically envisioning a steady build to get to that 10 to 12 million run rate and your losses of 1.3 million this quarter are down substantially from almost 2 million in the fourth quarter. And I don't understand, how you get it to work the other way?

Doug, it's a matter of how bio-studies come in. You've got -- when you look at the pharma business, you've got ongoing G&A selling and R&D costs. Those are the people costs and all of the costs related to that. When you contract to do a bio-study, and those can run anywhere from 500,000 on up, some of them particularly in Rx, can go substantially north of that. That's expensed, when you enter that obligation, because you have no guarantee that it's going to be successful or not, and you really have no benchmarks against it.

So in the fourth quarter, I can't remember, if it was two or three bio-studies - actually, I don't remember the number at all, at this point. But the reason the expense was higher in that quarter were because of the bio-studies. As you go forward, there's no just ramp-up other than the people, and we know that the costs for the year is going -- or the loss for the year is going to be 10 to 12 million. I can't -- it depends on what quarter that those fall in.

OK. So you can't really forecast on a quarter-by-quarter basis. You couldn't -- it's too simplistic to just have a steady build in there.

That's exactly right.

Well, I think once, we're a bigger business and then I think, it will be a steadier quarter-to-quarter look, even though you still have ups and downs, but boy in the early stages like, this what you're talking, such small dollars, the bio-study costs have an undue impact on a quarter-to-quarter basis. But we looked at what are our plans for this year and we still think, we'll spend at least $10 million this year.

OK. That's fair. And just sort of separately, can you - you've announced this - at 15 months ago the generic strategy, and an acquisition has been part of the strategy from the get-go. Can you characterize your activity on looking at acquisitions today versus 6 and 12 months ago?

Steadily focused. Same as, we were six to 12 months ago. We, as you know, had announced a possibility of an acquisition and that we entered due diligence. We did not go forward with that acquisition, therefore we moved very aggressively to continue to look for other acquisition opportunities. And that's where we are today.

We have not changed our focus at all. We are going to start down the path of building our own generic business internally, so that we don't lose any time, but at the same time we remain very, very focused on looking at making the right acquisition that will suddenly put us, as a much bigger player in generics. But as you know on an acquisition, you don't have anything to announce until you have something to announce. And we are just continuing to aggressively look for the right opportunity in this area.

OK. Thanks.

Thank you, all.

Thank you. This does conclude today's presentation. Please disconnect your lines at this time. And have a great day.