Perrigo Company PLC (PRGO) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen. My name is Lawrence, and I will be your conference facilitator today. (OPERATOR INSTRUCTIONS) Thank you. It is now my pleasure to turn the floor over to your host, Mr. Doug Schrank, Chief Financial Officer. Sir, you may begin your conference.

Thank you, Lawrence. I would like to welcome all of you on this conference call. We are delighted to have you join us, and thank each of you for your continued interest in wanting to learn more about Perrigo. We especially want to thank those in Israel, who are joining us late in the afternoon.

It's a pleasure for me today on this fall day in Michigan to welcome a couple of additional participants to the meeting. With me today, besides Dave, are Mori Arkin, our Vice Chairman, who has responsibilities for our generic and API business, and John Hendrickson, Executive Vice President with responsibilities for the Consumer Healthcare Business. Both John and Mori will help us with Q&A when we get to the question-and-answer session. So, 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 business, and have included this discussion on pages 33 to 44 of our form 10-K for the year ended June 25, 2005. 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 from our website at www.perrigo.com. With these formalities completed, I will now turn the call over to Mr. David Gibbons, our Chairman, President, and CEO. Dave?

Thanks, Doug. Good morning, everybody. As we had indicated in September, what had appeared to be coming together as a very good year in fiscal 2006, has been impacted by the pseudoephedrine issue. While we can't control the external factors impacting our business, we're doing all we can to adjust to the new legislation and to retailers' actions, and we believe that we'll recover most of the lost pseudoephedrine sales volume as we have our portfolio of phenylephrine replacement products available for fiscal 2007. This morning, Doug and I will review the quarter and also discuss the pseudoephedrine impact in more detail.

Starting with the first quarter. On a consolidated basis, sales were up 40%, or $92 million, reflecting the addition of the Agis results. In consumer healthcare, sales were flat. We did see new sales from the topical OTC products acquired in the Agis transaction, as well as sales of recently introduced products, primarily smoking cessation; however, our sales of pseudoephedrine-based cough/cold products declined $23 million from a year ago. Reported net income for the quarter was $12.9 million, or $0.14 per share, compared with $17.6 million, or $0.24 per share last year.

Excluding the acquisition-related inventory step-up charge of $3.7 million, or $0.04 per share, net income was $16.6 million, or $0.18 per share. Results included the financial impact of the recall of the prescription mesalamine suspension product, and a consumer healthcare product, both related to packaging concerns. The cost associated with the recalls was $3.3 million after tax, or $0.03 per share. And now I'll turn it over to Doug for his more detailed financial review of the quarter. Doug?

Thanks, Dave. Thank goodness, this quarter's financial results should be less complex than the last two reports. Other than normal operating fluctuations, there are only two adjustments worth noting. The first is the last of the inventory step-up charge of $4.8 million pre-tax, which reduced gross margins in the consumer healthcare business by about $400,000, in the API segment by $1.7 million, and in the other category, $2.7 million. In total, a pre-tax charge of $4.8 million, which translated into after-tax of 3.7, or earnings per share, as Dave said, of $0.04 per share. The Rx pharmaceutical results included $2.8 million pre-tax charge, which is 2.7 after tax, or $0.03 a share for the recall of the mesalamine product as a result of leaky caps.

Now let me turn to the first quarter results. On a consolidated basis, sales were $320 million, compared to $228 million last year, an increase of $92 million, or 40%. Increased fiscal 2006 sales included approximate 110 million from Agis businesses. Gross profit was 87 million, an increase of 22 million compared to a year ago. The gross profit percentage was 27.2%, compared to 28.4% last year, and the only non-recurring charge to affect gross profit was the inventory step-up charge, which reduced it by 4.8 million. Excluding this charge, gross margin would have been 28.7%, up slightly from last year. The impact on gross margin is a result of the cost of product recalls, reduced gross margin by about 1 percentage point.

Taxes are a little different now that we have Agis. The acquisition with its foreign income taxed at different rates than the U.S. rates and its enterprise zone tax holidays result in tax rate fluctuations quarter-to-quarter. In essence, as the percentage of income in lower tax jurisdiction increases, the tax rate falls. The tax rate in the first quarter was 28%, resulting from the higher percentage of Israel income because of the shortfall in consumer healthcare pseudoephedrine sales and income.

The tax rate will increase in the next three quarters, and it is still estimated to be between 33 and 34% for the entire fiscal year. The reported consolidated net income was 12.9 million, or $0.14 a share. Excluding the nonrecurring charge for inventory step-up, net income would have been 16.6 million, or $0.18 per share. The impact on net income as the result of the charges for the product recall was $3.3 million after tax, or $0.03 per share.

Turning to the Consumer Healthcare segment. Sales were $229 million versus $228 million last year, up only slightly. New products related to the Agis acquisition accounted for approximately $19 million of the increase, and this $19 million addition was offset by the decline in the ongoing cough/cold/flu category, where pseudoephedrine was $23 million lower than in the first quarter of last year. Sales of new products particularly smoking cessation helped make up the remaining shortfall. Gross profit was 52.8 million, a decrease of 11.9 million from last year of 64.7 million. Gross profit as a percent of sales declined from 28.4% to 23.2%, down 5.2 percentage points.

Inventory obsolescence was higher this year and included a charge of $2.4 million for additional obsolete pseudoephedrine inventory on-hand that became evident in the first quarter, and this obsolescence expense was generally offset by lower production costs as we brought those costs down in anticipation. Most of the shortfall in gross margin percentage was caused by an unfavorable mix of products sold and the lower volume of pseudoephedrine-containing products, which were typically sold at a margin higher than the average in the segment.

Operating expenses were 40 million in fiscal 2006, up 3 million from 2005, primarily due to the expenses for operating the new Agis facility in New York, and the amortization of intangible assets related to the acquisition. These costs total $1.4 million. Operating income was 13 million versus 28 million last year.

Moving to the Rx Pharmaceutical segment, sales were $29 million. Gross profit was 11.6 million, or 40% of sales, and includes a charge of 2.8 million for the mesalamine product recall. Operating expenses were 7.8 million versus 1.3 million in the prior year, and approximately three-fourths of the increase resulted from the acquisition of the Agis business. Including spending by Agis, R&D was 4.8 million, an increase of 4.2 million year-over-year.

Operating income was 3.9 million versus a $1.3 million loss last year, and if you remember last year, we were in the start-up phase of the Greenfield Rx pharma business, and most of that was R&D costs. Operating income in fiscal 2006 was reduced 2.8 million for the product recall, and operating income included a charge for the amortization of intangibles of 1.6 million.

Looking at the API business, net sales were 26.8 million, gross margin was 12 million, or 44.8% of net sales, and includes a charge of 1.7 million for the write-off of the inventory step-up. Excluding this charge, gross profit as a percent of sales would be 51.3%. Operating expenses were 5.4 million, and the operating income was 6.6 million including the inventory step-up charge. Without that charge, operating income would have been 8.3 million.

The other category -- basically, the other segment includes the Israel businesses for consumer, pharmaceutical and diagnostic products. Net sales were 35 million, gross profit was 10.5 million, or almost 30% of sales, and includes a charge of 2.7 million for the write-off of the inventory step-up. Excluding this charge, gross profit would have been about 37.5%. Operating expenses were 11.2 million, and operating income for the quarter excluding the inventory step-up charge would have approximated $2 million. Unallocated corporate expenses were 2.2 million and include 600,000 for the one-time acquisition cost.

Cash flow was strong in the quarter. Operating cash flow was $18 million versus the use of $23 million last year. The contribution of operating cash flow from the Agis businesses offset the reduction in income of the Consumer Healthcare segment relating to the pseudoephedrine issue. Cash flow was also influenced by good inventory control in both businesses, and by lower accounts receivable in Consumer Healthcare due to lower pseudoephedrine sales and lower bonus payments versus the prior year.

We purchased 496,000 shares in the quarter for almost $7 million as we executed against our 10b5-1 plan throughout the quarter.

In summary, this was a difficult quarter. The Consumer Healthcare business was affected by a $23 million reduction in pseudoephedrine product sales; however, the Rx Pharmaceutical and API businesses performed very well. If the change in the OTC marketplace because of legislative and political activity surrounding the pseudoephedrine product issue had not occurred in the last three months, this would have been a much different quarter.

We are operating with the cards we've been dealt. The Consumer Healthcare business has adjusted inventory and production levels during the quarter to meet the pseudoephedrine changes. It is well positioned to manage through this short-term issue and is ready for the start of the cough/cold season. With that, let me turn it back to Dave.

Thanks, Doug, and we'll stick to the pseudoephedrine issue. I know we talked a lot about it, but we do want to make sure that we do keep you informed on where we are with pseudoephedrine.

Last quarter we discussed the industry's challenges relating to pseudoephedrine and methamphetamine use. As you will remember, pseudoephedrine is an active ingredient that can be illegally converted to methamphetamine. For this reason, state legislatures have moved rapidly to remove pseudoephedrine-based products from the retail shelves and move them to behind the pharmacy. Since June, the retailer responses to these legislative initiatives have created broad changes in the cough/cold category landscape, changes that have reduced our expectations for the year as we have previously discussed.

The political pressure has led many retailers to accelerate the move of pseudoephedrine to behind the pharmacy counter. Our largest customer, for example, is dropping most of their pseudoephedrine tablets, leaving only liquids out on the shelf.

But this is a constantly changing environment. Just recently we've seen some retailers move some liquid products back out to the shelf from behind the counter in states that allow it, even as other retailers respond to state-by-state legislation and continue to move product behind the counter. We continue to see a steep year-over-year decline in sales of pseudoephedrine products, down approximate $60 to $70 million, or 35%. Pseudoephedrine sales in the quarter, as we've said, already have come down $23 million.

We've adjusted our business appropriately in light of these changes. The Consumer Healthcare team has adjusted inventory and production levels to meet this situation. Inventory levels did not balloon and production costs were down year-over-year. As you would expect, the lower volume of pseudoephedrine products, which carry a higher than average gross margin certainly did reduce our results.

As we said in September, we're in the middle of pack in the formulation and validation of the new phenylephrine products. Despite pressure to bring the phenylephrine products to market as quickly as possible, we absolutely will not compromise our quality and compliance processes. We will ensure that the new products are stable, safe and effective, and that all the appropriate regulatory requirements have been met before we bring those products to market.

As we accelerate the conversions to non-pseudoephedrine formulas, we're also working with retailers on consumer education and merchandising programs to help support behind-the-counter purchases. We're encouraging retailers to continue to support the merchandising of the liquid products that are not moving behind the counter, and we are aggressively managing production costs and we're aggressively managing our inventories.

Product recalls. We did have two voluntary product recalls in the quarter, both related to packaging. It's always been our goal to maintain the highest quality standards, whether it's product or packaging. We have increased our focus on design, on components, and on packaging recently. Specifically, some other things we've done in the area of quality and compliance recently are increased management oversight through the formation of an Executive Quality Counsel that meets twice a month. We revised our consumer complaint investigation process including adding additional staffing, and we've improved our process for investigation of deviations, again, including increased staffing.

Looking at new products and approvals in Consumer Healthcare, we saw new sales from topical over-the-counter products, and from new products, primarily nicotine gum. In the quarter we received a tentative approval for famotidine 20 mg tablets. We expect final approval about a year from now, when the brand's exclusivity expires in September 2006.

In the Prescription Pharmaceutical area, we received final approval and recently began shipping glimepiride, a treatment for diabetes. Sales of one of our recent product launches, mometasone lotion continues to go well, as do several other core Rx products.

Last quarter we noted the paragraph 4 filing for clobetasol foam, the generic version of Olux from Kinetics. Following receipt of acceptance of the filing, we notified Kinetics and we were subsequently sued. As I think you are aware, a patent infringement of this nature is rather normal and allows the patent holder time to assert its patent rights in court before a generic competitor can enter the market and finally NDA approval can be delayed up to 30 months in this case.

To wrap up, we are now six weeks in to tracking the severity of the 2005 and 2006 cough/cold/flu season and no definitive patterns have yet developed. It's still very early. We would expect a clearer picture to emerge by December. At least at this early stage, we're seeing a historically normal cough, cold and flu season developing. As this past quarter has proven, the pseudoephedrine sales decline is a tough challenge for our Consumer Healthcare operations. We're responding with cost reductions and we're on track with the development and replacement products for the pseudoephedrine products.

Finally, while we're dealing with a dynamic operating environment at this point in time, we see no reason to change our earnings guidance for the full year, which is earnings per share of $0.74 to $0.78 per share before the inventory step-up of $0.04 per share. Thank you all, and we'll open it up for questions now.

(OPERATOR INSTRUCTIONS) Thank you. Our first question is coming from Derek Leckow of Barrington Research.

Thank you. Good morning. Got a question about the potential consolidation that's happening in your customer base. Albertson's looks like it's going to be sold here soon. Is there any impact that you're anticipating among your -- in your cough/cold business?

I do not see any impact for this season. The consolidation is just an example of the ongoing consolidation that's been happening for many years from now. We have good relationships with all the players involved, and we would anticipate to continue those relationships as we go forward.

Okay. So really no inventory impact, perhaps. You're pretty much -- you're already planning for that, so --

Yes. I really think we're fine in that, Derek

Thank you. Second question is, on the synergies, I wondered if you could talk about execution there, and what are some of the key cost saving synergies you've already been able to gain and, as well, what are some of the revenue synergies we should be seeing in terms of growth this year?

Derek, this is Doug. When you look at the cost savings side, it's consistent with what we've said in the past. The first things are really physical assets. We've consolidated a number of distribution centers in the U.S. as it relates to both Consumer Healthcare and the Rx, if you look at what was in New York and what was in Allegan. We have moved a little bit of manufacturing around, liquids and semi-solids. Obviously, our liquid capacity here is much greater than theirs in New York, and their semi-solids is much greater out there.

You saw in the fourth quarter some of the charges for the reduction in headcounts. Those have taken place and those savings roll through on a quarterly basis and continue to roll through, so all of that is really encapsulated in our forecast. I think you'll remember that we said that the savings would pretty much offset the one-time costs, and if you'll remember at the analysts' meeting, we talked about one-time costs this fiscal year of about $8 million, so you can anticipate that the savings are in that ballpark as we look at the year.

On the revenue side, John and his team in Consumer Healthcare have really looked at everything from cosmetics to semi-solids, working to move those products into customers where they weren't, because our distribution is just slightly better, and the Rx Greenfield business that we had has been consolidated and is now operating by the Rx folks from Agis. So all of those things have taken place. They've moved forward pretty much on schedule. A couple of items ahead of schedule and a couple of items behind, but we're very comfortable with the status of integration. It's gone quite smoothly and we would expect that to continue.

Okay. Any major Rx to OTC switches on the horizon here?

Not any major ones in the near term. John, do you want to comment on Rx/OTC switch area?

Yes. I think we continue to invest very heavily between both businesses to make sure we're positioned in that arena, and at this point there is nothing that we're ready to announce today or talk about what's on the horizon here in the near future.

It continues, certainly, to be a major area of focus, wherein, over the long haul, we do see continuing opportunities and we plan to be there on the major switch opportunities.

Okay, great. Thank you very much and good luck.

Thank you. Our next question is coming from Chuck Cerankosky from Key McDonald.

Good morning, everyone. Looking at this PSE issue once again, what is the first quarter pattern tell you about the rest of the year? It sounds like you said you expect a $60 to $70 million sales hit in the year, and we only saw about 23 in the first quarter, but how does that get offset by the phenylephrine ramp as you introduce new products? And I understand that I'm asking about very unfamiliar terrain at this point.

This is Dave. The 23 million is about on track to coordinate with the 60 to 70 million that we had said that would fall off. There's really nothing that we have seen since the last analyst conference call in early September that would indicate anything different than what we had talked about at that point in time.

It's a bit of a changing environment. We've seen some positives in terms of some product that had been moved behind the counter coming back out in front of the counter, but we also see state legislation continuing to creep up there. In certain states, some retailers have to pull product off the shelf and put it behind the counter. So it's still a changing situation. But, in general, I think it's moving along pretty much like we talked about earlier, and the 23 million is right in line, and I don't see a lot different there.

Phenylephrine is about where we told you it was in coming along last time. There are still very few national brands with product out there. They're kind of in the same ball park we are, and phenylephrine is a little bit less stable than pseudoephedrine, and so it takes time to formulate it properly due to validations and get everything lined up to go with it. So we are committed to the quality and compliance process as the national brands are, and we're going to have the products out there as soon as we can. There really is nothing different than the timetable that we see in doing that versus what we had told you earlier.

Dave, can you put sort of an offset on the PSE sales reduction caused by PE products offsetting it?

In this fiscal year, we do not anticipate the phenylephrine products having a major impact on the drop in pseudoephedrine products, because so many of the phenylephrine products are going to be coming out in the third quarter, which is at the tail end of the season. So by the time we get them out there and they're ready to go on the shelf, Chuck, they're just not going to have a big impact. What we are shooting for is to get everything done properly and have those products out there ready to ship for the next cough, cold and flu season to replace the pseudoephedrine products that are coming off the shelf and going behind the counter.

Dave, thanks. Good luck with that effort.

Thank you. Our next question is coming from Linda Bolton Weiser of Oppenheimer.

Thanks. Hi, guys. How are you doing? Can I just ask you about the cash flow. Doug, I know you had given a target before for the fiscal year for operating cash flow. Can you remind us what that was, and are you still thinking the same thing?

Yes. We talked to you about 80 to 90 million, and as we look at it, we're still thinking the same thing. I guess that realistically, I think there's a larger opportunity that we'll exceed that than about two or three months ago, but we're still looking at $80 to $100 million for the fiscal year on an operating cash flow basis.

So the larger opportunity might be in terms of maybe working capital, or something like that?

Exactly. Both businesses, if you look at the balance sheet at the end of the quarter, the inventory really was fairly flat with June 30, and typically we start to rise a little bit. So we have -- both businesses have taken out some inventory. We've got programs that take out more. I can only say that they've worked well so far, but the bigger benefits will come later in the year, and if those really come through, I think we might be able to exceed that number.

Okay. And just secondly, are you saying that -- in terms of your new reformulated products replacing the PSE products, are you saying that we will see some on the store shelves in the December quarter?

I'll let John Hendrickson -- do you want to answer that on the phenylephrine?

Yes. On the phenylephrine products, we clearly have some products out there today, where the brands are out there and we have products out there. The straight pseudoephedrine products, Sudafed, we've had out there for nine months now. So there are products that have been out there as the brands have reformulated.

We continue to work on those products and sort of launch those as we go, and as we find out for sure what the brands are doing. We want to make sure that what we put out there -- we want to take the position the brands are taking that have very good, strong, stable, robust formulas. And so we want to make sure that we do it in a way that is long-term right for the Company, not just to get any short-term sales. So we're taking that approach, and I think it's similar to what most brands are taking, that are taking that same approach. So they will continue to phase out there, Linda, but if you look at direct impact having all those formulations out there, Dave said effectively, is you'll start to see most of that in -- you know, as we get into the next cough/cold season.

Okay. There have been some examples on the shelf of some generic store brand products that have been reformulated without the branded products having been reformulated. Are you taking that approach where you may move ahead without waiting for the brand?

Yes, we're doing that in some instances, where we've got a pretty good feel for where the brand might go with their reformulation, and we've got a formula that is again robust and so forth. In others where we're not sure where the brand will head as far as the strength of the product, especially when you get into very much multiple ingredient products. We're trying to manage those as close as we can to make sure that we don't get a reformulation put out there and then have a product that's not equivalent to the brand. So we're trying to manage that as close as we can, but in some instances, we've got pretty good estimates of what they're going to be. We are going out there with those products, also.

Do you think it might be an opportunity for store brands to take share from branded products?

Yes. That's a good question, Linda. I don't know; that could be. Certainly, we hope that as people go to a pharmacy counter and ask for a product that the pharmacist gives them a store brand versus a branded product, because in general that's a trend that they're comfortable with. I think there's that potential, but, again, you don't want to gain the potential of that opportunity and then have a problem with the product that negates all of your gains. So, again, we want to be very cautious, steady, making sure we're in it for the long term.

Okay, great. And just one final question. Going back to the Rx to OTC switches, would you say that Prilosec OTC would be the next major opportunity?

It is certainly a big one as far as just big market size. I mean, you know, next to the Claritin switch, certainly Prilosec was the biggest market building kind of switch. It is probably the big market opportunity. There are a lot of other ones, but not probably that magnitude, and Prilosec is a great product protected by lots of patents, and so it is a complex one to make sure that you manage through and get out there to the market. It is a big opportunity.

Okay, great. Thanks very much.

Thank you. (OPERATOR INSTRUCTIONS) Our next question is coming from William Driscoll of Talon Asset Management.

Good morning, everyone. I was just wondering, if we're modeling the Company out Rx, API, obviously a lot of one-time charges and a lot of moving parts, what should we think about as far as ongoing or cleaned up operating margins for those two units?

Bill, this is Doug. I mean, you need to do two things. You need to take out those one-time charges, and the biggest one being the inventory step-up, and the second biggest being just the mesalamine recall. Beyond that, you need to look at operating income on a GAAP basis, which would include the intangibles, and then look at an operating income on a real cash and what I call shareholder value basis excluding those intangibles. And I think if you go back and look at the fourth quarter and the first quarter, you'll get a pretty good average run rate of those businesses.

Of course, in the Rx and the API businesses, unlike the consumer healthcare businesses, new products at higher margins, or new competitors which reduce margins can have a bigger influence on margin than maybe one product within consumer healthcare. But beyond that, I think that would give you a really solid base to understand it.

Okay. And in regards to the R&D within the Rx market, I think you said it was 4.6 million. Do you have a percent of sale target that you'd be looking at for that business? And, also, with the NDA process for the Olux foam, are you going to go at it more from that process, where you are fighting a patent infringement in court, and we should maybe be guided in the future for how much legal expenses you're going to have in that unit as well?

The R&D was slightly on the low side in this quarter, so we plan to step up R&D in the next quarter, next year, but in a manner that will not change significantly the whole stability of the operation. As part of our future planning, we are providing for legal expenditure connected with the Kinetics [inaudible], and with other [inaudible] that we will be doing in the future.

Okay. Thanks a lot, guys.

Thank you. Sir, there appear to be no further questions at this time.

Thank you all very much. Appreciate you taking part.

This concludes today's conference call. You may now disconnect your lines at this time.