Perrigo Company PLC (PRGO) 2007 Q2 法說會逐字稿

Good morning. My name is Sharita and I will be your conference operator today. At this time, I would like to welcome everyone to the Perrigo Fiscal Year 2007 Second Quarter Earnings Results Conference Call. [Operator Instructions.] It is now my pleasure to turn the floor over to your host, Mr. Art Shannon. Sir, you may begin your conference.

Thank you very much, Sharita. Welcome to Perrigo's Second Quarter 2007 Earnings Conference Call. I hope you all had a chance to review our press release, which we issued earlier this morning. A copy of the press release is available on our website at www.perrigo.com.

Before we proceed with the call, I'd like to remind everyone that the Safe Harbor language contained in today's press release also pertains to this conference call. Certain statements in this call are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the Safe Harbor created thereby. Please see the cautionary note regarding forward-looking statements on page one of the Company's Form 10-K for the year-ended July 1, 2006.

I would now like to turn the call over to Perrigo's President and CEO, Joe Papa. Joe?

Thank you, Art. Welcome to Perrigo's Second Quarter 2007 Earnings Conference Call. Joining me today are Judy Brown, Executive Vice President and Chief Financial Officer, John Hendrickson, Executive Vice President and General Manager of Consumer Healthcare, and Moshe Arkin, our Vice Chairman and General Manager of Perrigo Global Generics and API.

We have a straightforward call planned for today. First, I will provide a broad overview of the quarter's performance; next, Judy will walk through the detailed financials and talk about our outlook for the year; and then, we'll have a brief discussion of our new products and approvals. This will be followed by a Q&A session.

Overall, the second quarter can best be characterized by several positive developments, especially with new products, but also some one-time challenging issues, such as our acetaminophen recall. Consolidated second quarter sales of $371 million increased $11 million, or 3% from a year ago. Consolidated six month sales of $711 million increased 31 million, or 5%, from a year ago.

Net income for the quarter was $21.1 million, or $0.23 per share, compared with $25.4 million or $0.27 per share last year. Year-to-date, net income was $38 million, or $0.41 per share, compared with $38.3 million, or $0.41 per share last year. Judy will walk through the details of our quarter. But to be clear, our success in new products and a lower global tax rate was offset by lower seasonal cough/cold volumes and several one-time issues.

In our consumer healthcare segment, quarter two consolidated revenue was $275.9 million, up $5.7 million this quarter, led by the launch of our store brand coated nicotine mint gum. Consumer healthcare's margins benefit from the introductions of new higher margin products. However, this positive was offset by the additional quarter two costs of $5 million and $6 million year-to-date for the acetaminophen recall, an unfavorable product mix and production costs, especially in our liquid cough/cold business, and overall lower consumer healthcare volumes due to a late start of the cough/cold/flu season.

Our Rx and API business performed well in a difficult competitive environment, reaching combined quarter two sales of $56.9 million. Rx pharmaceutical sales were flat, compared to a record year last year, and API sales grew 6%. As we told you last quarter, this is going to be a tough year for the Rx and API segments. But we are pleased that these businesses are performing as expected.

Now, let me turn the call over to Judy for a more detailed financial review of the quarter.

Thanks, Joe. As Joe mentioned a few minutes ago, consolidated second quarter sales of $371 million increased $11 million, or 3%, from a year ago. Consolidated second quarter gross profit of $98 million was a decline of $7 million from last year, and the gross margin percentage was 26.5% of net sales, compared with 29.3% last year.

Consolidated second quarter net income was $21 million this year, including costs for a product recall of $3 million after tax. Last year, reported second quarter net income was $25 million. There was, however, one non-GAAP item in the second quarter of this year and one last year that I would like to note now, and then leave behind us for the rest of the quarterly financial analysis.

In the current quarter, there was a restructuring charge related to the previously announced closing of manufacturing facilities in Montague and Holland, Michigan. In the second quarter, we successfully sold one of the plants to another manufacturer, allowing us to offset $2 million of our employee-related and plant shutdown restructuring costs with a gain of more than $1 million on this asset sale. After tax, this net charge was $417,000, or less than $0.01 per share. Because of this second quarter sale, we now expect our total net restructuring charges for the year will be less than $1 million after tax.

Last year's second quarter included a gain on the sale of the Company's interest in a Canadian distribution company of $3 million after tax, or $0.03 per share. Reported second quarter earnings were $0.23 per share this year, versus $0.27 per share last year. Excluding the impact of the non-GAAP items I just noted, adjusted earnings per share in the second quarter were $0.23 this year, versus $0.24 last year.

Now, I'll exclude the impact of these adjustments and focus on the core year-over-year operating results. First, I'd like to move you through a more detailed review of our business segments on an operating basis. Understanding the progress in each part of the portfolio will give you a better picture of the consolidated results. And I'll start with a brief update of the market activity in the past quarter for the consumer healthcare business.

At Perrigo we utilize IRI point-of-sale data for key product categories. This represents consumer sales while our sales are to retailers. Also, remember that the data we review excludes Wal-Mart, Dollar, and Club Store sales.

So, for the first--the 13 weeks ended December 24, the overall cough/cold market was up 5%. The growth in the category is reflective of the changing environment since the withdrawal of pseudoephedrine from over-the-counter products. The brand has taken a very strong position in the cough/cold category this season, launching more than 50 new products for pseudoephedrine reformulations supported by increased promotions, especially for unique branded items, like Mucinex, Selsun, and [Zychem].

Neither store brands nor Perrigo have kept pace with this national brand growth. Store brand dollar erosion has been almost 10% and we have also seen erosion. The market for analgesic products was up 6% this quarter, again reflecting increased brand promotion levels, and store brands were up 7%. We experienced weakness in acetaminophen product sales following the November recall, but believe any impact will be short-term.

The gastrointestinal market for antacid and laxative products was up 7%, with continued heavy promotion of branded Prilosec OTC and Pepcid products. In the antacid segment, we benefited from the recent launch of Famotidine Extra Strength, Maximum Strength Pepcid, and in the laxative segment, sales were impacted by our exit from the fiber/laxative product category.

The vitamin market overall was up 2%, while store brand was down. We continue to see good sales gains in new products at existing accounts, however, staying steady for the quarter and outpacing the market over the last 52 weeks.

Now, I'll move on to specific operating results in the second quarter. Sales growth in our consumer healthcare segment was all organic with an increase of $6 million, or 2%, to $276 million. We recorded $20 million of new product sales in the quarter, which included Famotidine 20 milligram tablets and our first shipments of coated nicotine gum.

Our international operations in the U.K. and Mexico also performed very well in the quarter, posting a sales increase of $7 million, or 22% on both favorable currency of $2 million and positive volume mix on existing products.

Sales of pseudoephedrine-containing products declined $32 million from last year, offset by sales of new phenylephrine reformulations in the quarter, resulting in $20 million of additional cough/cold sales.

On an operating basis, consumer healthcare gross profit was down $10 million, or 15% from last year. This includes $5 million of costs in the quarter related to our November recall of 500 milligram acetaminophen caplets. Our gross margin was 21.5% of sales, versus last year's 25.8%. The gross margin benefited from the launch of new products this quarter, but these gains were offset by several factors - $5 million of acetaminophen recall expenses, pseudoephedrine to phenylephrine formulation and conversion costs, an unfavorable product mix on existing products, and higher production and quality spending.

Let me share with you a little more about the acetaminophen recall. On November 9, we announced a retail level recall of certain batches of 500-milligram acetaminophen caplets. At that time, we approximated the cost for retail sales returns and refunds, disposition of returns, and existing inventory to be approximately $3 million. Subsequent to this announcement, we received numerous consumer inquiries and voluntarily initiated a consumer level return program as well.

We have updated our estimate of the total cost of this recall to be $6 million in total, which includes the additional cost to handle end consumers' questions, manage a consumer level returns process, and dispose of additional inventory. As noted earlier, $5 million of this total $6 million was recorded in the second quarter. Discussions continue with the raw material suppliers to determine the expense at which the recall related materials costs may still be recoverable.

Operating expenses in consumer healthcare increased $3 million in the quarter due to higher variable, promotional, and selling expenses on new product launches, as well as higher employee related recruitment, relocation, and training expense. The lower margin contribution and higher operating expenses contributed to a decline in operating income of $13 million, or 43% in the quarter.

In the Rx pharmaceutical segment, net sales decreased to $28 million from $29 million, and included $6 million of service and royalty revenues. New products, defined as those which have entered the market in the last 12 months, contributed $2 million of revenue this quarter.

I'd like to point out that the second quarter Rx sales and gross margins include charges totaling $5 million related to our accruals for customer programs. Such programs are common in the generic pharmaceutical industry and include such items as rebates and chargebacks. The determination of the liability for these programs involve a significant amount of estimation. We've been monitoring our methodology and made material improvements to certain of these estimates in the second quarter of fiscal 2007 that led to the current quarter charges.

The changes to the estimates are intended to further enhance the accuracy and reliability of the accrual calculation, and to reduce the risk of incremental charges for customer programs beyond the current quarter charge. Gross margins in Rx were $11 million, or 40.3% of sales, and include the $5 million adjustments I just mentioned. These margins are down slightly from $12 million, or 40.5% of sales last year.

Operating expenses increased $1 million from last year as we increased our investment in research and development by 64% from last year. Operating income declined to $4 million from $5 million last year, due mainly to the planned increase in R&D spend I just mentioned.

Now, let's review API. API sales increased 7% to $29 million, from $27 million last year, and include $1 million in new product sales for the quarter. Gross profit increased from $13 million, or 47.6% of sales in the second quarter last year, to $14 million, or 49.2% of sales in the current quarter. R&D outlays were up more than 75% from the second quarter last year as we continue to invest in the future of this business. Operating profit in API was $6 million, down from $7 million last year.

In the Other category, which represents our Israeli-based consumer product and pharma distribution businesses, second quarter sales increased 11% to $38 million, up from $34 million last year. The product mix in our consumer product business has improved, moving gross margins to 35.7% this year from 33.7% last year. Operating income was $3 million, up from $1 million last year, driven by both the sales and margin growth.

Unallocated corporate expenses for the quarter were $4 million, compared with $5 million last year. The second quarter last year included acquisition integration costs of more than $1 million. The reported GAAP effective tax rate for the quarter was 16.8%, down from 36.6% last year. Several factors contributed to this significant year-over-year decline. First, as I have mentioned in previous calls, our blended tax rate will move higher or lower based on the geographic mix of where the income is generated. In the current quarter, approximately 80% of pre-tax income was generated internationally in countries where our tax rates are lower than U.S. rates.

Additionally, earlier than expected, we benefited from several of our tax planning programs, which we believe will allow us to have lower effective rates, not only in this quarter, but which will also be sustainable over the longer term, similar to other international pharmaceutical companies. Finally, at calendar year-end, Congress renewed retroactive to January 1, the R&D tax credit, which benefits all U.S.-based companies with significant R&D activities.

Now, let's move on to a recap of the six-month year-to-date reported results. Consolidated six-month sales of $711 million increased $31 million, or 5% from a year ago. Consolidated gross profit was $193 million, flat to last year, and the gross margin percentage was 27.1% of net sales, compared with 28.3% a year ago. Consolidated operating income was $52 million, including $6 million of recall expenses, down from $60 million last year. Consolidated GAAP net income was $38 million, flat to last year.

As noted earlier, there was a restructuring charge in the first half of this year of less than $0.01 per share. The first six months of last year included a gain on the Company's interest--on the sale of the Company's interest in a Canadian distribution company, of $3 million after tax, or $0.03 per share, and a write-off in the step-up of the value of acquired inventory of $4 million, or $0.04 per share. Reported earnings per share for the first six months of fiscal 2007 were $0.41 this year versus $0.41 per share last year. Excluding the impact of the non-GAAP items noted above, adjusted earnings per share in the first six months was $0.41 this year versus $0.41 last year.

The year-to-date fiscal 2007 tax rate was 18.4%, down from 33.9% last year, for the same reasons I just noted a moment ago.

Now, let's walk through the year-to-date operating results by segment, excluding the non-GAAP items I just mentioned, first starting with consumer healthcare. Consumer healthcare sales were $518 million versus $497 million last year, up 4%. Sales related to new products contributed $27 million and sales of new phenylephrine reformulations were $38 million. These were offset by a year-over-year decline in the sale of pseudoephedrine products of $51 million. We now expect combined pseudoephedrine/phenylephrine sales of $90 to $100 million for the year, down from the earlier estimate of $110 million to $120 million.

Gross profit of $116 million, which includes a $6 million charge for the acetaminophen recall, declined $7 million from $122 million last year. Gross profit as a percent of sales declined to 22.3% from 24.6% last year. Year-to-date operating expenses for fiscal 2007 were $81 million, compared with $78 million last year. And operating expenses as a percent of sales were 15.6%, unchanged versus last year. Operating income was $35 million in the first six months, versus $45 million in fiscal 2006.

Rx pharmaceutical sales were $60 million versus $58 million last year, an increase of 3%. New products have contributed $4 million in new sales year-to-date. Gross profit was $25 million, or 42.2% of sales, compared with $23 million, or 40.2% of sales a year ago. Operating expenses were $15 million compared with $14 million a year ago with the increase largely due to higher R&D funding. Operating income was $9 million, flat with last year.

API sales were $58 million, a 9% increase from last year's sales of $54 million. New products were $2 million of this total year-to-date. Gross profit was $26 million, down from $27 million last year. Operating expenses were $15 million, up from $12 million last year, due in large part to the 65% increase in R&D spending year-over-year in this segment.

Net sales in the Other category were $75 million, up 6% over last year. Gross profit was $26 million, up 6%, from $25 million a year ago. Operating income was $6 million, up from $3 million last year. Margin growth and expense control were the key drivers of this increase.

Now, some comments on the balance sheet. Working capital, excluding cash and investments, was $292 million at the end of the second quarter versus $228 million last year, an increase of $64 million. Accounts receivable were $247 million, compared with $236 million a year ago, reflecting higher fiscal 2007 sales. Inventories were $323 million, an increase of $60 million from a year ago.

Consumer healthcare inventory quantity levels are usually higher at this point in the year. This year's levels in dollar terms are higher than they have been in the recent past, as we have more relative complexity with many more new products and reformulations moving through our supply chain than we have had in the past. Consumer healthcare balances are down, however, from the end of the first quarter.

Also in the Rx, API, and Other Business segments, we tactically added safety stock inventory at the end of the second quarter to ensure customer service before and after the cutoff to our new ERP system in Israel.

Accounts payable were $173 million, compared with $150 million a year ago. This $23 million increase partially mitigates the cash used for the year-over-year inventory build I just mentioned. Cash provided by operations turned positive in the second quarter and was $18 million for the first six months, compared with cash provided by operations of $55 million in the six months last year.

Capital expenditures to date were $20 million. We still anticipate spending between $40 and $50 million for the year. We purchased 251,000 shares of our stock in the quarter for $4 million, according to our 10b5-1 Stock Repurchase Plan. Year-to-date, we have repurchased 961,000 shares for $16 million. We paid quarterly dividends of $8 million, or nearly $0.09 per share, for the first half of fiscal 2007, a 6% increase from last year.

Our Rx, API, and Other Businesses are performing well, and we expect that they will finish this year in line with our previous projections. Consumer healthcare has had a challenging first half. While we expect CHC to return to our plan levels in the second half, we don't expect that consumer healthcare will be able to fully compensate for the first half's weakness. With the positive impact of international tax planning and our updated expectations of the worldwide income mix for the full year, our full year tax rate is expected to be in the range of 20 to 23%, down from our prior estimate of 30 to 32%.

So all told, we are confirming that our earnings guidance for the full year continues to be within the previously announced range of $0.86 to $0.91 per share, excluding $0.01 per share of restructuring costs.

Now, let me turn it back to Joe.

Thanks, Judy. Now that Judy has given you all of the details of our second quarter, I'd like to discuss some of the things that happened during the quarter. Once again, new product launches were a key driver for the quarter and year-to-date. In fact, over the last 18 months, new products accounted for revenue of more than $100 million. We are well on our way to meet our goal of adding more than $50 million of new product revenue in FY07 in consumer healthcare alone.

New products will continue to be a primary focus for us and we are increasing our funding of R&D to keep on this pace to ensure that this important growth engine is sustainable. A little later I'll go through all of the new products in the quarter and some of the news about our future as well.

In reformulations, all of our planned launches of phenylephrine are in the market for this year, and we have more planned for 2008. We have launched more than three dozen new formulations - 36 new formulations over the past year. To put this in perspective, there has been an unprecedented change in the cough/cold market, a category that has been our heritage. It took us over 20 years to build this category, and yet it has gone through major transformation during the last 18 months due to the pseudoephedrine to phenylephrine conversion.

Name brands are also innovating fast - faster than ever - creating $90 million in new products or reformulations just in the second quarter on a quarter to market of $700 million. Name brands are clearly innovating faster. Our expertise is to be a fast follower. We picked certain products for fiscal '07 and they are in the market. We don't have store brand equivalents for every national brand product on the shelf today, but we will have more out next year. We like strong brands and we like to be on the shelf right next to the strong brands.

Let me now move to the three key issues impacting this quarter. The acetaminophen recall will cost the Company $6 million year-to-date, 5 million in quarter two. We believe any negative impact to our acetaminophen sales will be short-term as consumers have shown loyalty to their store brands. The shelves are restocked and we are seeing positive results over the past few weeks in acetaminophen sales.

The second important issue for us is quality. We have invested in quality to ensure that recalls of this magnitude are part of our past. During the quarter, we spent $8 million on our cost of quality, which includes investments in staff, audits of our supply chain, and the scrapping of products which did not meet our high quality standards. We have identified our needs and addressed them quickly.

We are delighted that [Dr. Lewis Hugh] recently joined us after working more than 15 years in the brand and generic pharmaceutical industry. Dr. Hugh has already been actively working with the quality team in identifying leading and lagging indicators and the new process to measure them. The Company doesn't expect the need for this kind of quarterly quality investment to continue, but we will not hesitate to invest in quality as it's warranted.

The third key issue is our results in consumer healthcare. We are seeing good results in some products, but other higher margin products, such as the liquid forms, have struggled during this season's pseudoephedrine and phenylephrine transition. We are the largest producer of store brand liquid, and thus, our results have been dampened by the seasonal marketplace. We expect demand for cough/cold/flu products will increase, and we don't expect the consumer healthcare margin pressure to continue long-term.

We know that just as Perrigo has transformed its top line across new product categories, like generic topical prescriptions, API business, and smoking cessation, we also need to transform our global supply chain to ensure a high level of efficiency, quality, and reliability over an evolving production platform. This is my highest priority in the coming months.

My final item to review is our new product approvals. On the Rx side, we had several approvals in the quarter. First, in October, we received tentative approval for Ciclopirox topical solution known as Penlac Nail Lacquer. Final approval is subject to the exploration of patent protection for Penlac. The [Adventis] pharmaceutical patent will expire on September 18, 2000. Penlac is indicated for the treatment of mild to moderate fungal infection of fingernails and toenails and has annual brand sales of approximately $125 million.

Second, we received a final FDA approval for Ciclopirox topical solution--suspension known as Loprox in December. An antifungal medication indicated for the topical treatment of skin infections, it has annual brand sales of approximately $42 million and shipments are already underway.

And third, we received final FDA approval for [Civistat] tablets, also known as [Logore]. A lipid lowering agent with multiple cardiovascular indications, annual brand sales of approximately 5 billion. To be clear, this was a highly competitive launch and we don't see material earnings in the foreseeable future for [Civistat].

On the OTC side, our partner, Dexel, received an approvable letter from the letter for OTC [Imeprosole] new drug application for imeprosole delayed relief tables. This is one of several intermediate steps in the FDA review process of new products. But is an important milestone on the path to receive FDA approval. As you may know, it is indicated for the treatment of frequent heartburn, and we are very excited about the prospects of this new product as we believe we are the only filer to date. As a reminder, the annual branded sales of Prilosec OTC are approximately $600 million and are growing approximately 20% per year.

This quarter we also began shipping coated nicotine mint gum. This is the store brand equivalent to Nicorette Fresh Mint coated gum, which has estimated retail sales of more than $100 million. This exclusive new product is the latest growth driver in our smoking cessation category and we are very pleased with the early results. As of January, Perrigo is now the store leaders--the leader in store brand oral nicotine products with uncoated gum, coated gum, and a nicotine lozenge.

Lastly, I want to give you some thoughts as I complete my first three months at Perrigo. Overall, while year-to-date results are explainable, I want to assure you that [1] we are committed to continue the growth in new products; [2] we are striving to return our base business to historical gross margin levels; and [3] we are focusing on decreasing the problems associated with one-time effects, like the acetaminophen recall.

Overall, we have reason to be optimistic in our future based on the great advantages in our markets. Our ability to market products to our customers utilizing mass customization is unique in the industry. We manufacture, package, and distribute over 10,000 SKUs. We have the critical mass in each of our segments to be competitive in any market environment. We manufacture, package, and distribute 25 billion tablets and capsules annually. Besides our position in finished dosage forms, we have one of the top 10 API businesses in the world and a niche topical generic business that continues to search for opportunities to launch exclusive or semi-exclusive generic topical products. Perrigo's strategy will remain focused on growing our consumer healthcare, generic topical Rx, and API businesses.

Thank you for your attention, and now let me open up the microphone for questions. Operator, will you please open up for questions?

[Operator Instructions.] Our first question is coming from Greg Gilbert with Merrill Lynch.

Thanks. Good morning. I have a couple. First, Judy, I may have missed this, but I think your previous guidance for consumer operating income was 98 to 104. Did you offer new guidance, or if not, can you? And are there any changes other than the recall costs and the reduction in phenylephrine product sales in that new guidance?

We're not breaking out guidance for the remainder of the year specifically by the business units. But you can expect Rx, API, and Other to be within the range preliminarily provided. And we're expecting to be within run rates that were built into guidance for the second half of the year in the consumer healthcare business.

So conceptually, no real changes beyond the phenylephrine and the recall issue?

That's reasonable. Yes.

Okay. And then, on the tax rate, pretty big deal here. Are you saying your new longer term guidance is 20 to 23%?

Our guidance for the remainder of this fiscal year is 20 to 23%. As we look forward and talk about fiscal '08 as we approach closer to the end of this year, I'll be able to refine some better numbers for '08, '09 and beyond. But definitely, with some of the tax planning strategies that we've been able to get in place earlier than planned, we do expect that our longer term tax rates are going to be coming into the 20s more quickly than we had anticipated.

I'm not saying 20 to 23% is the rate you would expect in '08, but certainly, moving out of the 30s and into the upper 20s in a longer term basis. And I'll be more specific about that as we get closer to next year. But obviously, we'll have to be looking at our planning process knowing that the balance of income around our international income basket is the key driver in that tax rate in the long term.

Greg, the only thing I would add to what Judy said is I just want to compliment the team here who's done a lot of good work in moving forward with our tax planning. Also, I think, obviously, this is one of the benefits of our international acquisition of the [Aegis] business. And I think you're just starting to see some of the benefits show up in this. And I--one thing I know, it's great work by the team here who's spending a lot of effort to try to look at this issue.

Sure. And it sounds like you think structurally operating margins for consumer will get back to where they were. So the net change is great on those two issues combined. And then, lastly, for Joe or John. I realize recalls are pretty common in the industry. But do you think the most recent one has affected your relationships or shelf space at important customers at all?

Yes. I'll start with--John, you can just join in. I think we've been very good in dealing with this issue. I think we took some proactive steps to deal with the issue. And in fact, it did cost us a little bit more than perhaps it would have if we took a harder line. But we very much regard our customer relations as key. And we took the steps that were required, extending it to some additional consumer level activities that were not required, but we proactively took that stand because customer relations are so important to us.

And I think we can see from the data, at least over the preliminary data that we've seen over the last several weeks, that indeed our acetaminophen sales are as expected and we do not see this as affecting our relationship with our large customers. John, anything else you'd like to add?

No--good response.

Thank you. I'll get back in line.

Thank you. Your next question is coming from Linda Bolton Weiser with Oppenheimer and Company.

Thanks. I guess I'm just kind of wondering in terms of the guidance for the year. I mean, on sort of an operating basis, excluding the tax rate change, you kind of missed consensus by about $0.08 for the quarter. And for the year, then, it seems like you're essentially reducing operating earnings guidance by about $0.13. So I'm wondering if you're being conservative enough for the next couple of quarters, given that you have a lot of stuff that's going on that you're dealing with here. I guess that's my first question.

And then, on pseudoephedrine sales, I had thought that sales in the prior year were about 33 million. So if you're saying it was down 32 million, it looks like it was nearly zero. And I guess I was thinking it would be a little higher than that. So maybe you could comment on that.

And then, thirdly, on a longer term, bigger picture kind of thing. Can you--just for us non-drug analysts here, can you give a little bit of discussion about how your thoughts would go about launching the Prilosec OTC store brand at risk, if there were no litigation settlement when your period of--when the 30 months or so is up? What would be the issue surrounding your decision to launch at risk?

Okay. Yes--several different questions here. Judy, you want to first take the question on the guidance one here for us?

It's just that the mechanics of the guidance, Linda, and the way you're looking at it, we are very pleased that we've had the benefit of positive tax rate mix or income mix that's helped our tax rate as well as the benefit of key tax planning strategies. So you're certainly right. But if you back out the effect of the previously provided tax rate guidance that the income is a different number than was projected.

And that is what we were talking about in terms of some of the operating one-time events that Joe and the team are going to be focusing on driving in the second half of the year. We believe that we're being appropriately reasonable in terms of the second half of the year operating results. And we believe that Rx, API, and Other are going to continue to deliver strong volumes in the second half of the year as we originally guided.

The second--her second question was about pseudoephedrine and the sales in the 33--we had a little bit different number there. Maybe we can clarify the pseudoephedrine sales for Linda.

Certainly. And I'm just looking here--what's quoted in the script as well. Pseudoephedrine--we still expect the pseudoephedrine for the full year to be between $30 and $35 million for the full year. And in the first half of the year, those sales declined $51 million net. We're at about the halfway point for the year in sales of pseudo. Those are going to be much more level loaded products on a go forward basis because they're not only cough/cold driven, they're very allergy and sinus driven as well, those behind the counter products.

With [PE] in the first half of the year picking up 33 million, so total category also at about the halfway point for the year--with a year--full year guidance on PSE combined with phenylephrine of approximately 90 to 100 million.

And the last question was on Prilosec OCT. The question is would we launch at risk? I think it's early for us to call that. I guess maybe I'll just remind people of a couple of facts. First of all, as we file this, and we already have an approvable--or our partner, Dexel, already has an approvable, we think we're making great progress in this. And I think it reflects FDAs desire to get products to the market--first filers of any new generic to the market as quickly as possible. So we're making good progress with the FDA.

On the question of the litigation, obviously, that's ongoing. We--it would be hard for us to make a judgment on the specifics of the case at this point. As a general rule though, reflecting that the November 2008 would be the end of the 30-month stay, I think we have to make a judgment as we get closer to that November 2008 timeframe.

I would remind you that in a separate jurisdiction outside of the U.S., our partner did win the patent litigation with this product. However, it's obviously a different--it's a different--was a different country. And it would be inappropriate to comment as to whether the situation is similar or not in the U.S.

Anything--anybody else want to add on the--?

--No.

Yes. Maybe I would add one sentence regarding imeprosole. Considering the fact that a key patent of Astra Zeneca is going to expire in 2007--a key formulation patent, we feel very comfortable about our patent situation in 2008 with this product.

Okay. Thanks. Can I just ask one more follow-up? In terms of--can you give some color on--in the industry, is it common for products to launch at risk? What percentage of Paragraph Four filings launch at risk? Or do you normally wait in the industry until there's a court settlement?

Usually--Linda, usually people wait for a court settlement.

Okay.

Or a--at a district court level rather than launching at risk. There are examples though where products have been launched at risk, to be clear.

Okay. Thanks very much.

Thank you.

Thank you. Your next question is coming from Derek Leckow with Barrington Research.

Thank you. Good morning, everybody.

Good morning, Derek.

Good morning, Derek.

A question. Help me understand what's happening on your consumer healthcare gross margin here. I've been having trouble reconciling the recent removal of low margin products, the huge amount of new price revenue that's coming in here. Can you maybe categorize the gross margin impact by product category just so we can see a little bit better what's happening there?

Derek, let me try and help you understand a bit of the dynamics going on in the gross margin. If I just look at year-over-year, year-to-date evolution--so we have 22.3% gross margin in the first half of this year, down from 24.6% last year. Obviously, new products contributing heavily to growth at the top line, but also within gross margin, of approximately 125 basis points being driven by smoking cessation. Recalls, obviously, a negative impact. But thinking about those really as one-off that we want to obviously isolate and not see as recurring taking away of about 80, 90 basis points in gross margin in the quarter.

And the impact, albeit much smaller this year in the year-over-year decline impact of the pseudoephedrine/phenylephrine conversion, still a drag on gross margins and contributing 75 to 100 basis drag also. Again, remember that the mix of those products was significantly higher than our average gross margins in the past. And while the gross margin impact is a much different story than it was last year with the conversion process being mostly complete, that still does have a negative impact in the margin.

And the last piece in the gross margins is these investments in quality and ongoing supply chain improvements that Joe was talking about. Making continuing investments there and feeling that we have a better run rate on a go forward basis to get back to historical gross margin levels. So you're definitely seeing the impact, both of recall and investments in quality, partially mitigated then by the obvious improvement with the new product launches.

Well, I guess I understand that the quality investment seems to be one-time in nature. I mean, those are typically done and you reap the benefits in future periods. So what's the opportunity here? I mean, what do you see gross margin climbing to by year-end, or what are you using in your guidance for your assumptions? And then, what's the ultimate goal for that? I mean, where can we see gross margins for the consumer healthcare business ending up for next year, let's say?

Oh, go ahead. Think about the second half of the year. When we talk about consumer healthcare run rate, new products continuing to flow through in the second half of the year, a good portion of those quality investments that Joe mentioned being more one-time in nature, and a lot of process improvement work going on to avoid any kind of additional scrapping or rework costs that might be necessary. And focusing on those improvements in the second half, looking at more mid-20s in the second half of the year.

So a balanced rate for the year that certainly is lower than our original expectations for the full year because of the nature of some of these one-time events that have occurred already in the first half of the year. Not necessarily going to make up for that in the back half of the year, but a definitive improvement in gross margins due to these process improvements and focus on quality that John and his team have been doing.

But I think--.

But there--. Okay, sorry. Go ahead.

Oh, go ahead.

Well, the question was that's for consumer healthcare, mid 20s. And then, consolidated - something closer to the upper 20s, then, right?

Yes.

Okay. And then, just another question here on acquisitions and your seriousness about them. I mean, I see you buying back stock at reasonable valuations, which is a good thing for shareholders. But looking out there at the acquisition landscape, there are plenty of companies for sale and think they're also trading at much lower valuations than they had two, three, five years ago. And specifically, look at Taro Pharmaceuticals. They've got some product lines there that would certainly match what you're trying to do.

Can you give me a sense for where the acquisition activity is? I mean, is there a sense of urgency here inside the Company to get some accretive growth from acquisitions?

Yes--let me take that question. I--this is Joe. I think the way I would characterize our comments on acquisitions, first, we can't obviously comment on any specific opportunity. What I would say is we will look at acquisitions. But we feel fortunate that we do not feel that we need to make acquisitions to drive growth in this business. We see that the new products opportunity that we have, we have the ability to improve our supply chain to drive the bottom line for our organization.

As I said, with over $100 million of new products over the last 18 months we feel that's going to be a very important driver for our business. We will look at opportunities as they present themselves, but we don't feel it's something we absolutely need to do. We'll only make acquisitions if we indeed think it will help us in our long-term strategy with this business.

But Joe, don't you agree that there are opportunities out there, and certainly the growth rates we've been seeing over the last couple of years have been--at least as far as EPS is concerned have been below your long-term targets. And I'm just kind of getting--trying to get a sense for are we going to see more share repurchases and more internally focused investment, or are we going to see a blend of the two, which leads to higher ultimate EPS growth in the out years?

Yes--I think I just would maybe repeat, I look at it as that there is opportunities out there. We will look at those as they present themselves. But the reality is, we think we've got a number of real significant product opportunities in front of us - things like the OTC imeprosole that will really help to drive our business in the near term, supplemented with what we're doing in the Rx business and the API business.

So we see good potential for growth. Is there--if there's a chance to look at a company, we certainly will look. We think it's in the benefit of our shareholders. But we do not feel compelled to make that investment. In the absence of an external opportunity, we certainly continue to look at share repurchase within our business as one of the issues that we'll talk to our Board about.

Okay. Thanks, Joe. And just, I guess you're seeing a lot of opportunity then within the current pipeline that you acquired from Aegis. So I guess that's really the focus I guess for the near term. Right?

Absolutely. That plus the opportunities within the OTC business for our coated gum, for the nicotine lozenge, for the imeprosole - those are really important drivers for our future.

Okay. Thanks very much.

Thank you.

Thank you. Your next question is coming from Randall Stanicky with Goldman Sachs.

Great. Thanks, guys. I just have two questions. The first for Judy. I just wanted to follow-up on Greg's question on the tax rate. Historically, your rates have been in the mid-30% range. And I think the discussion you had back in early '05 was your projected Israeli statutory rates were in the mid to high 20% range. So essentially for the next couple of years is a blend of those two from a broad perspective how we should be thinking about that? And then, I have a follow-up for Joe.

Certainly. The number that--prior to the acquisition of Aegis Industries, Perrigo's tax rate was primarily all U.S., and with a bit of income coming from the U.K. and Mexico. So if we looked at historical rates and taxations, those are becoming more irrelevant as we become a more global organization. So the historical Israeli rates--statutory rate is certainly lower than the U.S.

But also, as we talked about, one of the wonderful benefits of the Aegis acquisition was the fact that there were also opportunities for approved enterprise zone locations with single-digit tax rates and the opportunity to continue to make investments in Israel and be able to continue to get the leverage from those great tax opportunities out of Israel as well.

So just adding back the historical rates in those countries, not necessarily reflective of the tax planning strategies we have going forward. [And similar] large pharmaceutical companies with diversified asset bases around the world are moving more to that model and we can really leverage R&D and development work going on across the world as well as procurement processes going on around the world to leverage that rate.

So we talked earlier about rates in the low 30s and moving point-by-point over the years into the mid-20s. That process has been moving along more quickly than we anticipated because of some great work by the tax group and their tax planning processes. So again, thinking about rates more in the mid-20s as we look forward. Again, I'll be able to be more specific about that as we move into the '08 planning process.

That's helpful. But [ticking] up to a low 30% range for the next year is probably the way to think about it?

Again, I'll be able to be more specific as we get towards the end of the year. But we were saying already 30 to 32%.

Yes.

For this year. Clearly, 30% is going to be too high for this year. But thinking more high 20s to 30 being your ceiling on a go forward.

Got it. Okay. And then, for Joe. Just given what we've seen in the retail channels and the consolidation and changes from that front--from your customer front, how do you look at that? And then, are there pockets of opportunity for you guys as you think about both the generics and the OTC business?

Sure. Well, I think, clearly, we'll get--there are tremendous pockets of opportunities for us. As some of the retailers and mass merchandisers consolidate and grow and get bigger, it gives us an even more significant opportunity for our business. Because as we look at it, they're going to grow their store brand. And as they grow their store brand, we're going to grow with it, recognizing the fact that where we compete we have approximately a 65% market share of our product.

So we feel very good in terms of the consolidation that's going out there. We feel very good that we're in a great spot because affordable healthcare is going to be a major issue, certainly in the United States, and around the world. And as we provide customers with a lower priced alternative product, and we position ourselves right near the store brand, we think that gives just great opportunity for us to grow this business.

Right now, the store brands are in the low 20s as a percentage of the total business. We see opportunities in the future to increase that. And we're going to put together our strategic plans because we believe that we're delivering affordable healthcare with opportunities for our customers to make good returns on it. And that's really what's going to drive the value for that.

What--just to sort of--what categories do you think you're going--the store brands are going to penetrate or increase their penetration the quickest over the next call it two to three years?

Well, I think what you'll see is mostly in the area of the more expensive products is where you'll see the highest penetration. So, for example, in nicotine replacement therapy--oral nicotine replacement therapy we're seeing very high store brand penetration. We expect to see that continue as we go out--rollout the lozenge and the coated gum.

I think the other area that we clearly believe will be significant will be the proton pump inhibitors. They are an expensive item in the store. In the national brands they are an expensive item. And clearly, as we come forward with an imeprosole delayed release product into that marketplace, we expect that that would be also a very significant opportunity. And as I said before, based on our intelligence at this point, we believe we're the only player that has filed for that product with our partner, Dexel.

That's great. Thanks a lot, guys.

Joe, I think we only have time for one more question.

Okay. We have time, Operator, for one more question. Is there another one?

Okay. Your final question is coming from [Yalv Bergin] with Leader Capital Markets.

Hi. Actually, I think all of my questions have already been answered. Just two short bookkeeping questions. What's the current number of shares outstanding basic?

[Indiscernible] from the balance sheet, income statement 93,500,000 diluted. Basic shares are 91,836,000.

Okay. And what's the current number of outstanding options?

I don't have that off the top of my head. But obviously, we can do a follow-up.

Okay, great. Thank you.

Thank you, everyone. We thank you for your interest in our quarter. As I said, we think there's a couple of things we need to work on. But all in all, we've had some growth in our business and we clearly look to continue to grow our consumer healthcare business, continue to grow our Rx business and our API business. And we believe we've got good position in the marketplace to help our customers generate dollars, and therefore, help us to grow our business.

So thank you very much for your attention today.

Thank you. This does conclude today's teleconference. You may now disconnect. And have a wonderful day.