Perrigo Company PLC (PRGO) 2007 Q3 法說會逐字稿

Good morning. My name is Barbara and I will be your conference operator today. At this time, I would like welcome everyone to the Perrigo Fiscal Year 2007 Third Quarter Earnings Results Conference Call. [Operator Instructions]

It is now my pleasure to turn the quarter over to your host, Mr. Art Shannon, Vice President of Investor Relations. Sir, you may begin your conference.

Thank you very much, Barbara. Welcome to Perrigo's third 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 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 the 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.

Thank you, Art, and welcome, everyone, to Perrigo's FY '07 third quarter earnings conference call. Joining me today is Judy Brown, Executive Vice President and Chief Financial Officer.

We have a straightforward agenda today. First, I will discuss a few of the important achievements in the third quarter and 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. Then I will discuss our new products, our acquisitions and an update on our OTC business. This will be followed by an opportunity for Q&A.

Overall, Perrigo continues to make progress consistent with our expectations and we had a few important achievements during the third quarter. Let me highlight those.

First, we had record third quarter revenue this year. Second, we executed two strategic acquisitions representing future annual sales revenue of over $30 million. Third, we significantly improved our cash flow during the quarter, while improving customer service and increasing our sales of new products.

Fourth, we made progress on our portfolio review and completed the closing of two manufacturing sites and began the rationalization of our lower margin products. Finally, we significantly increased our R&D expenditures in Q3. It was up 33% or a $7.0 million increase over last year.

With that quick review of our recent achievements, let's move to our third quarter performance. Consolidated third quarter sales were $362 million, increasing $30 million or 9.0% from a year ago. Consolidated nine-month sales of $1.0 billion 73 million increased $61 million or 6.0% from a year ago.

Net income for the quarter was $17 million, or $0.18 per share, including a write-off of acquired IP R&D and a restructuring charge. Excluding these charges, adjusted net income was $22 million or $0.24 per share compared with $21 million or $0.22 per share last year.

YTD, adjusted net income was $60.5 million or $0.65 per share, compared with $60 million or $0.64 per share last year, excluding onetime charges. Judy will walk through the details of our quarter in just a moment.

In our Consumer Healthcare segment, quarter three consolidated revenue was $262 million, up $24 million this quarter, led by our Smoking Cessation products, Analgesics and Nutrition categories and strong gains from operations in Mexico and the UK. Our local management in Mexico and the UK have been capitalizing on opportunities to broaden our product portfolios and grow store brand share locally and we are clearly seeing the results.

Gross margins benefited from the introduction of new higher margin products. However, this positive was offset by higher production costs, especially in our Liquid Cough/Cold business. Our Rx and API business performed well in a difficult, competitive environment, reaching combined third quarter sales of $64 million, up $4.0 million from last year.

API sales were flat with last year. As we told you last quarter, this is going to be a tough year for these segments, but we are pleased how these businesses are performing in their environment.

Now I will turn the call over to Judy for a more detailed financial review of the quarter.

Thank you, Joe.

As Joe mentioned a few minutes ago, consolidated third quarter sales of $362 million increased $30 million or 9.0% from a year ago. The consolidated third quarter gross profit of $100 million was an increase of $3.0 million from last year and the gross margin percentage was 27.7% of net sales, compared with 29.3% last year.

Consolidated third quarter reported net income was $17 million this year versus $21 million last year. There were, however, two non-GAAP items in the third quarter of this year, outlined in Table 2 of our earnings press release, that I would like to note now and then leave behind for the rest of the quarterly financial analysis.

First, there were restructuring expenses related to the previously announced closing of two manufacturing facilities in Michigan. After tax, this net charge was $199,000 or less than $0.01 per share. We now expect that our total net restructuring charges for the year will be less than $1.0 million after tax.

Second, on March 26, 2007, as Joe mentioned, we completed the acquisition of nine products and four pipeline products from Glades Pharmaceuticals, Inc. Our March 31, 2007 balance sheet reflects this transaction. You'll begin to see operating results from this acquisition in the fourth quarter P&L.

However, in the fiscal third quarter there is a charge for the write-off of in-process R&D related to this acquisition. U.S. GAAP accounting requires the write-off of the net present value of future cash flows for products in development, which have not yet reached technological feasibility. This charge totaled approximately $5.0 million after tax or $0.05 per share.

Reported third quarter EPS were $0.18 this year versus $0.22 last year. Excluding the impact of the non-GAAP items I just noted, however, adjusted EPS in the third quarter were $0.24 this year, up from $0.22 last year.

Now, I'll exclude the impact of these items and focus on the core year-over-year operating results. As usual, I'll start by walking you through each of our business segments on an operating business, starting with a brief update of the market activity in the past quarter for the Consumer Healthcare business.

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

For the 13 weeks ended March 18th, the overall Cough/Cold market was up 9.0%. The growth in the category is reflective of the changing environment since the withdrawal of pseudoephedrine from most OTC products. National brands have taken a strong position in the Cough/Cold category this season, launching many new products and reformulations, supported by increased promotions, especially for exclusive branded items like Mucinex and Delsym.

Perrigo's 5.0% growth is outpacing overall store brand category, which declined 1.0%. Perrigo's strengths came from nasal sprays, some liquids and loratadine. The market brand Analgesic Products was up 6.0% this quarter, again reflecting increased national brand promotion levels. Store brands were up 6.0% and we were up 15%. We experienced sales gains at key customers and a rebound in acetaminophen product sales following the November recall.

The gastrointestinal market for Antacid and Laxative products was us 5.0%, with continued heavy promotion of branded Prilosec OTC and Pepcid products, as well as new product line extensions. In the Antacid segment, we benefited from the recent launch of famotidine extra strength and we grew our share.

However, our position in the overall GI category was impacted by the Laxative segment, where sales declined followed our exit from the fiber laxative product category this year.

The Vitamin markets overall was up 5.0%, while store brand was down. We continue to see good sales gains in new products in the Bone/Joint, Calcium Supplement and Heart Health product categories. We're performing better than store brands overall and are outpacing the market for the last 52 weeks.

Now I'll move on to segment operating results in the third quarter. Sales growth in our Consumer Healthcare segment was all organic, with an increase of $24 million or 10% to $262 million. We recorded $17 million in new product sales in the quarter, which included Smoking Cessation products, famotidine 20-mg tablets and Nutritional products.

Our initial operations in the UK and Mexico also performed very well in the quarter, posting a sales increase of $9.0 million or 30% on both positive volume and mix on existing products, and $3.0 million of favorable currency.

Third quarter sales of pseudoephedrine-containing products declined $10 million from last year, offset by $8.0 million of sales of new phenylephrine reformulations introduced during the year.

On an operating basis, Consumer Healthcare gross profit was $59 million, down about $1.0 million from last year. Our gross margin was 22.6% versus last year's 25.2%. Although the gross margin benefited from the contribution of new product sales again this quarter, Consumer Healthcare margins struggled to regain ground as we continued to incur higher-than-planned costs for quality assurance and production.

Operating expenses in Consumer Healthcare decreased $2.0 million in the quarter, largely due to lower employment-related expenses, offset by a $1.0 million increase in R&D project spending. Increased sales volume and lower operating expenses contributed to an increase in operating income of $1.0 million or 7.0% in the quarter.

In the Rx Pharmaceutical segment, net sales increased to $34 million from $30 million and included $6.0 million of service and royalty revenue. New products, defined as those which have entered the market in the last 12 months, comprised $2.0 million of revenue this quarter.

Gross profit was $16 million or 47.4% of sales, up from $12 million or 38.2% of sales last year, driven by new products and the increased service and royalty revenues.

Operating expenses increased $1.0 million from last year, as we increased our investment in R&D by 50%. Operating income rose to $7.0 million from $4.0 million last year, due to the higher volume and margin contribution.

Next we'll turn to API. API sales were flat versus last year, at $30 million. Remember, however, that the third quarter last year included a onetime $4.0 million sale of intellectual property. This reduction in revenue was offset by an increase in sales in new products as well as strong sales of existing products.

Gross profit of $12 million, or 41.5% of sales, declined from $14 million or 47.3% of sales last year. This decrease is primarily due to the absence of the sale of intellectual property, partially offset by increased volume attributable to new products and a change in customer and product mix.

R&D outlays were up nearly 80% from the third quarter of last year, as we continued to invest in the future of this business. Operating profit in API was $4.0 million, down from $8.0 million last year.

In the other category, which represents our Israeli-based Consumer Products and Pharma Distribution businesses, third quarter sales increased 8.0% to $36 million, up from $33 million last year. The product mix in our Consumer Products business has improved, moving overall gross margins up to 34.4% this year from 33.9% last year.

Operating income was $1.0 million, up from $700,000 last year, driven by both sales and margin growth. Unallocated corporate expenses for the quarter were $2.0 million, down from $3.0 million last year.

The expected reported consolidated tax rate for the quarter was 21.6%, down from 30.9% last year. As I commented on throughout the quarter, throughout the year, our blended tax rate will move higher or lower based on the geographic mix of where income is generated.

In the current quarter, approximately 80% of pretax income was generated internationally, in countries where our tax rates are lower than U.S. rates. This quarter we benefited again from several of our tax planning programs, which we believe will allow us to have lower effective rates, sustainable over the long-term, similar to other international pharmaceutical companies.

Now let's move on to a recap of the nine-month YTD results. Consolidated nine-month sales of $1.0 billion 73 million increased $61 million or 6.0% from a year ago. Consolidated reported gross profit was $293 million, up 1.0% from last year, and the gross margin was 27.3% of net sales, compared with 28.6% a year ago.

Consolidated reported operating income was $76 million, down from $90 million a year ago. Consolidated GAAP net income was $55 million, down from $59 million last year.

Let's begin a review of the non-GAAP items for the nine-months, both this year and last year.

In the current year, the restructuring charges related to the closing of manufacturing facilities were $600,000 after tax, or $0.01 per share. The write-off of IP R&D from the Glades acquisition was $5.0 million after tax, or $0.05 per share.

In the nine months last year, the two non-GAAP adjustments included a gain on the sale of a Canadian distribution company of $3.0 million after tax, or $0.03 per share. And we also recorded a write-off in the step-up of the value of acquired inventory of $4.0 million or $0.04 per share.

Reported EPS for the first nine months of 2007 were $0.59 this year versus $0.63 last year. Excluding the impact of the non-GAAP items I just noted, adjusted EPS for the first nine months were $0.65 this year, up from $0.64 last year. The YTD fiscal 2007 tax rate was 19.4%, down from 32.9% last year for the same reasons I noted a few moments ago.

Now, let walk through the YTD operating results by segment, excluding the non-GAAP items I just mentioned, first starting with Consumer Healthcare.

Sales were $780 million versus $736 million last year, up 6.0%. Sales related to new products contributed $44 million and sales of new phenylephrine reformulations were $41 million. These were offset by a year-over-year decline in the sale pf pseudoephedrine products of $61 million. We expect combined pseudoephedrine and phenylephrine sales of approximately $85 to $95 million for the full year.

Gross profit of $175 million declined $8.0 million from $183 million last year. This year's gross profit includes a $6.0 million charge for the acetaminophen recall. Gross margin declined from 24.8% to 22.4% this year. This decrease was due to the impact related to the recall just mentioned, as well as higher costs for production and quality assurance. These decreases were partially offset by the positive gross margin impact of new products and increased international sales volume.

YTD operating expenses for FY '07 were $118 million compared $117 million last year and operating expense as a percent of sales were 15.1% versus 15.9% last year. Our overall spending in R&D and Consumer Healthcare has increased $1.0 million or 5.0% YTD, as we invest in our new product pipeline.

Operating income was $57 million in the nine months versus $66 million in FY '06.

Moving on to the Rx Pharmaceuticals business, YTD sales were $94 million in this segment versus $88 million last year, an increase of 7.0%. New products have contributed $6.0 million in new sales and service and royalty revenues have contributed $16 million in incremental sales YTD.

Gross profit was $41 million, or 44.1% of sales, compared with $35 million or 39.5% of sales a year ago. The increase is mainly due to the increase in service and royalty revenue, partially offset by pricing pressure on existing products and the increased expense for customer programs noted in the second quarter.

Operating income were $24 million, compared with $21 million a year ago, with the increase largely due to the 26% increase in R&D funding. Operating income was $17 million, up from $13 million last year.

Next, API.

YTD API sales were $89 million, a 5.0% increase in last year's sales of $84 million. This increase was due to $2.0 million in new product sales, as well as favorable customer and product mix changes, partially offset by the absence this year of the $4.0 million sale of intellectual property.

Gross profit was $38 million, down from $41 million last year, due to the absence this year of the sale of intellectual property. Offsetting this was improved gross profit on increased volume attributable to new products and changes in customer and product mix.

Operating expenses were $24 million, up from $18 million last year, due in large part to the 70% increase in R&D spending year-over-year. Operating income was $15 million, compared with $23 million last year.

In the other category, net sales were $111 million, up 7.0% over last year. Gross profit was $39 million, up 7.0% from $36 million a year ago and gross margins have remained stable at approximately 34.8%.

Operating income was $7.0 million, up from $4.0 million last year. Gross profit growth and expense control were the key drivers of this increase.

Now some comments on the consolidated balance sheet.

Working capital, excluding cash and investments, was $280 million at the end of the third quarter, versus $209 million last year, an increase of $71 million.

AR were $247 million, compared with $220 million a year ago, reflecting higher FY '07 sales. We have seen an improvement in a number of outstanding days during the quarter compared to last year.

Inventories were $310 million, an increase of $37 million from a year ago, but down $13 million from last quarter. Consumer Healthcare inventories are back down this quarter, in line with historical levels. Rx inventories are higher than at this time last year, reflecting the purchase of inventory acquired from Glades.

Accounts payable were $158 million, compared with $153 million a year ago, reflecting the reduction of inventory in the quarter.

Cash provided by operations was $74 million YTD, of which $57 million was generated in the third quarter, compared with cash provided by operations of $111 million in the nine months last year. Capital expenditures YTD were $30 million. We still anticipate spending between $40 and $45 million for the full year.

We purchased 316,000 shares in the quarter for $5.0 million under our 10b-51 stock repurchase program. YTD we've repurchased approximately 1.3 million shares for $21 million. We paid quarterly dividends of $12 million or $0.13 per share for the first nine month of FY '07, a 5.0% increase from last year.

In summary, a few take-aways on the broader picture of FY '07 YTD.

We expected our new product sales in Consumer Healthcare to exceed $50 million this year. YTD we've already reached $44 million and are on track to close the year between $60 and $70 million in new product sales, with another $10 million for the full year coming in from Rx and API.

Third quarter Consumer Healthcare gross margins are, admittedly, not yet back to our recently historical levels. We were, however, up 90 BP from our second quarter and the operational focus continues on a weekly basis to drive process efficiencies and productions and Joe will comment on this further in a few moments.

Our working tax planning and the income mix YTD have allowed us, and our shareholders, to benefit from the effective tax rate of 19.4%. We're still on track to have an effective tax rate of between 20 and 23% for the full year.

Our focused efforts around working capital have paid off, with $57 million of cash generated in this quarter alone. We continue this focus weekly and we're still looking for continuous improvements in the inventory cycle and operational efficiencies to deliver more cash flow.

All said, we're on track to meet our full year operating cash flow guidance of between $100 and $120 million. We announced two acquisitions this quarter while maintaining a net debt ratio of approximately 22%, consistent with last year's levels.

We continue to project full year earnings of between $0.86 and $0.91 per share on an operating basis, that is excluding the write-off of IP R&D and restructuring. We'll give you our full FY '08 EPS estimates when we release fourth quarter earnings in August.

Now let me turn it back to Joe.

Thanks, Judy. Now that Judy has given us a comprehensive review of all the details for our third quarter, I'd like to discuss three key drivers for this quarter.

First, you may remember, last quarter, I talked about our investments in quality. In the second quarter of '07, we spent $8.0 million, approximately half of which was a onetime expense with the rest ongoing in nature. This was a timely investment. Industry events have proven that a company can never sacrifice its commitment to quality. Our team is focused on meeting quality goals, while continuing to challenge our cost structure.

Generic products, whether behind or in front of the counter, are subject to the same FDA guidance as name brands. Perrigo's objective is to continually raise the standard and be ahead of those guidelines to produce high quality, affordable healthcare products.

Second, once again new product sales were a key driver for us. As Judy mentioned, we added nearly $17 million in new products in Consumer Healthcare alone in this quarter. In the Smoking Cessation category, we continue to gain share. This is a great example of the power of Perrigo's marketing and distribution system.

Just three years ago we were not in the smoking cessation market. Now we are the store brand market leader with uncoated nicotine gum, coated nicotine gum and nicotine lozenge. New products will continue to be a primary focus for us and we are increasing our funding of R&D in all of our business units to keep on this pace to ensure that this important growth engine is sustainable.

Third, this quarter we made two strategic investments. In Consumer Healthcare, we acquired pediculicide products for $12 million in cash. These products compare to Rix and Nix. They are niche products that fit well with our current portfolio and will broaden our offering to our customers. We'll begin manufacturing these products in our New York facility after the deal is closed on or around June 30,2007.

Similarly, on the Generic Rx side, we acquired nine generic prescription dermatologic products and four pipeline products from Glades Pharmaceutical for $57 million in cash plus $2.5 million in other considerations for future R&D collaborations. We expect to add $20 million in sales of these products.

These kinds of niche acquisitions are very attractive to us. We were able to add products to our portfolio without adding brick and mortar assets. We will continue to look for more of these types of acquisitions in the future.

Next I want to say that during my first six months as President and CEO, I have met with most of our management employees worldwide. I have been impressed with the hard work, the dedication and the commitment of our people. This is a very complex organization. My objective is to focus the organization on our core purpose - to provide the right pulls and direction and most important, execute on our goals.

As you may recall from last quarter's earnings call, the global supply chain is one of my top priorities. I'm very focused on procurement, production and logistic processes. During the quarter, I announced two management changes.

First, John Hendrickson has been named to the newly created role of the Executive Vice President of Global Operations and Supply Chain. In this capacity, John will be responsible for the global manufacturing and supply chain functions for all of Perrigo's consumer healthcare and Rx products. He will oversee operations in the U.S., the UK, Mexico and Israel.

John brings more than 20 years of industry experience to his position. He will establish our manufacturing strategic direction and focus on maximizing the effectiveness of our entire supply chain, from materials procurement through production and finished goods inventory management. I'm looking to John to chart the course to return our gross margins to more historical levels.

Second, I also announced that Sharon Kochan was promoted to EVP of U.S. Generics. Sharon is responsible for expanding the generic business in the U.S. market and coordinating the business development activities of our global generic business. Sharon's understanding of the market place and product development will, I believe, help us tor grow this segment.

Our Company has grown to a truly global manufacturer of OTC and generic prescription pharmaceutical products. These organizational personnel changes reflect the need to capitalize on the position as a market leader in the store brand and topical generic pharmaceutical markets.

By coupling these changes with our ability to vertically integrate our expertise in active pharmaceutical ingredients across our entire business will enable us to continue launching new, profitable products for our customers.

Finally, I would be remiss if I didn't discuss the market conditions in the OTC store brand segment. One of our competitors in this sector has voluntarily halted production and initiated wholesale level recall. We do not know how long this situation will continue, but we are making extraordinary efforts to meet our customers' needs.

The supply interruption did not occur until late in the third quarter, so our current results do not reflect it. But here's what we know right now. First, we have focused on doing the right thing for our customers. Second, of the business that has been awarded to date, we have been able to capture our current market share or approximately 65% of the business.

We cannot predict that the interruption will last another three weeks, three months, or three years. But we are optimistic about the opportunity, but not yet certain of the full financial impact. We remain committed to working diligently to exceed our customers' expectations and earn their long-term business. This is a good opportunity for us to prove we are worthy of the trust.

Overall, we continue to make progress. Our YTD bottom line results have met our expectations. Going forward, I want to assure you that are committed to continue our growth through the introduction of new products, return our base Consumer Healthcare business to historical gross margin levels through production efficiencies and inventory management and also ramp up our production to increase market share and improve profitability.

Overall, we are optimistic about our future. We are well positioned to take advantage of the market conditions, invest in our future through R&D and be selective about strategic acquisition opportunities, which can help us deliver value to both our customers as well as our shareholders.

Now let's take your questions. Operator, could you please open the lines?

[Operator Instructions] Thank you. Our first question is coming from Greg Gilbert from Merrill Lynch. Sir, you may begin.

Thanks. Good morning. Joe, I wanted to follow on to your last comments about your competitor's issues. When you're awarded new business due to their issues, how can you ensure that it's not just a temporary win for Perrigo and how do those contracts work, just so we understand how temporary or permanent they tend to be?

Good question, Greg. Relative to the business that, based on our competitor's issues that have occurred, I think what we've tried to do first and foremost is focus on rescuing the customers from the situation. Our belief that if we do a good job in providing the customer with high quality products, we have good customer service with the products we've been awarded, then, indeed, we believe we will be able to keep the business go forward.

I cannot guarantee whether we'll be able to keep it, but, as I said before, for three weeks, three months, three years. I think, really, at this point, what we're trying to focus our efforts on right now, Greg, is to ensure that we have high quality products that we deliver to our customer, deliver to them on time and meet the expectations that have been guaranteed or that we are working to guarantee for our customers. But I can't say whether or not we'll be able to keep this business or what duration of time period.

And as a follow on to that, your guidance hasn't changed for the last quarter of the year. Should we read from that that most of the tangible benefits from that new business would occur going into the cough/cold season of next year?

Yes, the reason -- what we've done here is there's certainly a ramp up period that occurs doing the quarter, as we ensure that we increase the output of our bulk tablets, as we ensure that we have the right product sizes for the customer. So, for example, if we had, for example, on a 250-count but the customer is looking for a 500-twin pack, as an example, we have to staff up and get the right bottles available for the customers, make sure we have their right labels.

So a large part of that is an ongoing process and we will expect to see some results during our fiscal fourth quarter. However, clearly it's a process that, at this point, as we try to put an expectation on it, we're really trying to be cautious in how much we put into the forecast as we look to the future.

Thanks and then just one for Judy. You mentioned that costs in Consumer are running higher than planned, preventing you from getting back to that mid-20's gross margin. Can you provide some more color on what those costs are and to what extent that theme is temporary or permanent? Thanks.

Sure. Thanks, Greg, and that's building a bit off of what we talked about in the second quarter. Obviously the first quarter was clouded by the acetaminophen recall, but overall, we plan our year in the Consumer Healthcare business around an expectation of the timing of the cough/cold season. And we have planned levels of production built into our factories.

We work at being flexible in that process overall and when we look at the timing of the year, the way the season works, the unexpectedly lower volumes of liquids that were being sold this season. Joe commented on higher liquids production costs. The focus now for us, we've seen improvements this quarter. We expect to see continuing improvements. It's an operational focus for us at the moment.

We are still working at getting back to the mid-20's. That is absolutely a top priority here internally and Joe has commented on that already. If we look at the dynamic this year, new products have improved gross margins overall, with a bit of base business erosion due to ephedrine-phenylephrine combo offsetting that.

The real driver is how we offset production inefficiencies going forward, stream line our overall production processes and this process of having had so many changes in our product mix over the last 18 months. Making the investments in quality assurance that Joe has talked about and making sure that overall, in the long run, that the investments in quality are really returning also the highest return bottom line, while we deliver high quality products in the most efficient way possible.

And Joe, if you'd like to add to that?

No, maybe I'd just reiterate a couple of points. I think, despite what most of our competitors talked about as a weak cough/cold season, we still we're able to stay on track is certainly what Judy is saying. And at the same time, as I mentioned during the call, we made a significant increased investment in our R&D. We increased the R&D YTD by $7.0 million and we made an investment in quality and I think putting those investments forward will just obviously make us more optimistic about our future opportunity with or without the competitor issues that we have.

Thanks.

Randall Stanicky, Goldman Sachs.

Great. Thanks for taking the question and good morning, Joe and Judy. Just following up, as we think about some of the new business wins coming in and some of the costs around that. Can you just, maybe, Joe, dig down a little bit more in terms of how much incremental cost do you have to see before you start recognizing that revenue? And then maybe with some of that new business is on line, should we be thinking about this as a fairly uniform gross profitability structure in terms of your current business and with the majority of it dropping down?

Yes, let me take the pieces of that. I guess I'd back up a bit and just, I guess, remind people that really what we're doing right now is it's a dynamic time period. We are, first and foremost, making sure that we're getting prepared to understand our customer needs and therefore doing everything we can to staff up, purchase the raw materials, purchase the bottles, get the active ingredients onboard so that we can be ready to move forward as quickly as possible. And a lot of that 's happened in essentially the last four-to-five weeks.

Relative, though, the gross margin, the actual incremental cost is very limited. In other words, we currently have the capacity in our facility. We may need, if discontinued, we may need to purchase a new tableting press at some point in the future, but clearly we believe we have the capacity to respond to our customer needs in an expeditious timeframe and we are doing so right now.

There is a little bit of ramp-up cost, as I mentioned, just to bring on the incremental active ingredient inventory and labels, etc. But we clearly we believe that the gross margin numbers will continue just to drop to bottom line for us as an organization.

Judy, anything else you wanted to add to Randall's question?

No and I was going to add the point about perhaps limited capital expenditures, but that would not even be something that we would see immediately. If it continues to Joe's point, we would build that into our expectations for FY '08, both in the '08 P&L planning as well as our capital expenditures and capital planning.

And maybe just to ask you guys the question a different way, at what point do we get better visibility on the sustainability of some of this new business opportunity? Is that something that takes place over the next month or two? Is that something that you see sort of as you're contracting with some of the new customers? Or do we have to wait and see, essentially, in terms of when the competitor would come back on line?

Yes, I mean, I think it's a great question. It's a question we ask ourselves every day and really, I guess what we want to try to be is a little bit cautious in respect to this question. We clearly are doing everything we can to meet our customer needs and meet them as quickly as possible. We're making the incremental expenditures that are required for increasing the inventory of our active ingredients and trying to do all the right things.

I firmly believe that customers will make decisions as to how long they keep the business with us, whether it's for the short-term or if it's forever, based on our ability to provide them with quality products and based on our ability to deliver customer service.

I am delighted. I was recently at the NACDS - National Association of Chain Drug Stores - meeting just two weeks ago. I had meetings with all the major customers and had a chance to firsthand discuss with them this issue, this opportunity and across the board, all the customers were very complimentary towards Perrigo relative to our quick response in dealing with this issue for them.

Having said that, I just think we just continue to focus on quality. We continue to focus on customer service and obviously we've got great relationships out there in the market place that we'll continue to work towards keeping the business as long as possible.

Did some of those conversations include color around potential additional competitor, if Dr. Reddy was to come in as -- there's been some discussion about it. I mean, is that something you would think your customers are open to, sort of - I don't want to say unknown, but - maybe a new competitor that hasn't perhaps been directly in this space before? And then maybe as a follow-up to that, do you have any timing on that from any of your discussions with anybody, if it was to happen, when it would happen?

Sure. Well, let me just maybe comment a little bit on the nature of your question, because I just want to be clear.

Dr. Reddy has already been in this particular space, albeit they've been in this space working through liner, but they've made significant bulk tablets in the space for this OTC market. What they have not done is the important step of the actual packaging in the final dosage form for the individual customers with the right label, the right strip packs, etc. But Dr. Reddy has been in the space. So clearly that is something that we are aware of.

I think one of the things that when I think I saw, probably, the same announcement that you did relative to a filing by our competitor. I called Dr. Reddy and just spoke to them and just asked them about the opportunity for us to collaborate, because clearly they have very good manufacturing capabilities. Perhaps there's an opportunity to collaborate.

I think it's probably best to say, at this point, that those discussions are ongoing and we'll see whether or not there's an opportunity for us to collaborate with other parties on these issues. Because, most importantly, we've always got to make sure that we take care of our customers in the best possible way.

Perrigo clearly has great capacity when it comes to the packaging of the materials, getting the labels prepared, having making sure that that quality process occurs each and every time. So there may be opportunities here to collaborate, as well, with another party.

Great. That's helpful and then just maybe lastly, in terms of overlap with Dr. Reddy and some of that business, is there significant overlap there? Or is there a lot of opportunity for sort of, I think, expanded offering if there was a collaboration?

I think there's opportunities for most -- I mean, most -- there is some overlap, but I think there's opportunity for expanded opportunities when you collaborate with another party. So, but I don't want to suggest that that's a stated strategy. I really just think it's really an exploratory step at this point in time.

Okay, great. Thanks for the color, guys.

Thank you for the questions.

Greg Gilbert, Merrill Lynch.

Thanks, a couple follow-ups. On Prilosec OTC, Joe, what are the relevant developments, as you see them, over the next year or so?

Sure. Just maybe for everybody, Greg, Prilosec OTC represents the largest opportunity in Perrigo's history where, we have an omeprazole 20 mg tablet that has been filed in March of 2006, as relative to a product that compares with Prilosec OTC. Prilosec OTC $600 million-plus product grow and get 20% per year, we think it's a very significant opportunity for us.

Relative to the status at this point, we are in discovery with the litigation. Just a reminder, we were sued by AstraZeneca in May of 2006. We are in discovery at this time. The trial is set for late calender '07, so late calendar '07 is the trial set date at this time and we continue in discovery.

We're delighted. Our partner continues to make progress on the FDA side. We received an Approvable in December and we continue to make progress on getting this product approved. So we're excited by those prospects.

The only other thing I would add is that, to the best of our knowledge, no other company has been sued relative to a generic equivalent of the Prilosec OTC. So we think that gives us a great opportunity with our omeprazole 20-mg tablets into the market and be out there as an exclusive, at least for some time product.

Joe, is there a good rule of thumb for average discount levels for such a product in the OTC world? I suspect the discounting is less than you would see on the Rx side, but is there a good rule of thumb to use there relative to that $600 million in brand sales?

Greg, the question you're asking has been of great debate within our Company. There are people who view it different ways and I guess what we're trying to do is make sure we have an offering that make sense for the consumer and makes sense for our retail customers and it clearly makes sense for ourselves and our partner, Dexcel.

Classically, the retail price is discounted in that 20 to 30% range. So, if I just use a simple example, a $10 product would be discounted between $7.00 and $8.00 versus the national brand. If a $10 national brand product, the discount to the consumer would be the $7.00 to $8.00 right.

Okay and then one other, as it applies to Zyrtec, which I think everyone assumes goes OTC. Are you assuming that the product will have three years of exclusivity for the innovator or the new innovator? Thanks.

Once again, a good question. Our expectation is that the product, the cetirizine product will go OTC. Our expectation is it will be at the end of this year, at the expiration of the patent, which I believe is December 27th, if I'm not mistaken. So our expectation is we'll go at that time. It is unclear to us, at this time, what the situation will be for exclusivity. So, whether or not there would be a three-year exclusivity is still unclear at this time.

We are going to take appropriate steps. We've got a couple of different scenarios under development for us to enter that market as quickly as possible. But we certainly believe we will be in the first wave store brand products that are available, if not the first out there, but there's some questions there that we just don't know, in terms of exclusivity.

Thanks

Randall Stanicky, Goldman Sachs.

Hey, thanks for the follow-up. Just, Judy, I might have missed it, but did you talk about SG&A spending in the quarter and the variation there and how we should be thinking about modeling that going forward?

I did not comment specifically on SG&A, per se. On a corporate side, the corporate expenses, if you remember, those are unallocated costs. The executive team and the corporate global team, those have come down in this quarter from the same quarter last year-end and I would think, on that level, you can probably model out this quarter, going forward, would be a reasonable run rate for corporate expenses.

On the overall SG&A side, we have continuous focus in this year's planning process to be looking at SG&A and opportunities for savings, overall, globally. Part of the initiative that Joe has really gotten underway in his tenure so far here, tenure has been to look for opportunities to make the SG&A support functions global. And find leverage and best practice among those groups around the world and make sure that we're doing the right things to control or reduce the SG&A spending.

On a go forward basis, obviously we'll talk about it in more detail in the FY '08 plan, when we discussion that in more detail in august. But for right now, I'd say averaging out at our current SG&A run rate would be reasonable, on a go forward basis, until we're able to roll out to you in more detail any specific broader opportunities we see.

No, that's helpful and then just on that, Joe, we've talked about this before, but as you've continued to look at the business and the specific businesses that you're in, any update on the Israeli consumer business and how you guys are thinking about it?

Good question. What we always try to do is look on our return on investment (ROI) capital and try to make decisions based on that. As we've talked about during the call, there are two businesses that we did actually completely exit in this past quarter. I think, really, that business is part of a continuous portfolio review process that we have underway for individual products as well as businesses in manufacturing locations.

So I really think, at this point, we're going to continue to look at the metrics on ROI capital and I don't have any other update relative to that. Judy may want to add some additional comments.

Over time, we've talked about those businesses and how they fit into the larger overview of our strategic portfolio of businesses. And we have talked about ROI capital and in the meantime, as we pull those businesses, our priority would be to focus on getting the best return possible from those businesses while they're part of our portfolio.

And I think you'll see in the results this YTD that those two businesses have been performing better than in prior years. And while perhaps not at the same returns as the other businesses in the overall portfolio, the focus has been, while we have them, they are definitely without having to make large investments in those businesses and add to the ROI capital denominator. We want to make sure that we're working on the numerator and trying to drive as much value as possible.

Your structured formal internal review going on or is that in terms of a decision on some of those business or is this an ongoing type of process?

Well, I think the answer is it's a little bit of both. I mean, it clearly is an ongoing process, but what we've done is we've implemented a quarterly business review process that has specific metrics for all of our businesses. And where we take a look each quarter at how the business is performing, what are the metrics from a sales revenue point of view, what are the metrics from a profitability point of view, what is the use of capital and return on that capital.

So, clearly, what we're trying to put forward is a thorough process, on a quarterly basis, where we go through the businesses and review them and candidly, we have everything to weekly calls on individual tactical issues. But on a strategy issue, it's a quarterly basis.

Got it. Okay, let me leave you there. Thanks a lot.

Thank you.

Thank you.

There appear to be no questions at this time. I would like to turn the floor back to management for any closing comments.

This is Art Shannon. I just wanted to let everyone know that we're going to have an analyst conference this fall, actually September 18th, wanted you to save the date. We'll be sending out a notice shortly on that to give you some of the details, but wanted to give you a heads up that September 18th we will have an analyst conference in New York City.

And also, now that the weather has improved in Michigan, we welcome everyone to come visit our facilities. I think you'll be very impressed to see our capabilities and the complex nature of our manufacturing and labeling site and all you need to do is contact myself, Art Shannon, or Ernie Schenk and we'll make the arrangements and we thank you very much.

Thank you, everyone. Thank you very much for your interest in Perrigo. Have a great day.

Thank you. This concludes today's Perrigo conference call. You may now disconnect. 15