Perrigo Company PLC (PRGO) 2011 Q3 法說會逐字稿

Good morning. My name is Tameka, and I will be your conference operator today. At this time I would like to welcome everyone to the Perrigo third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

Mr. Art Shannon, Vice President of Investor Relations, you may begin your conference.

Thank you very much, Tameka. Welcome to Perrigo's third quarter 2011 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. Also on our website is a slide presentation for this call.

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 the section 21 E 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 June 26, 2010. I would now like to turn the call over the Perrigo's Chairman and CEO, Joe Papa. Joe.

Thank you, Art and welcome, everyone, to Perrigo's third quarter fiscal 2011 earnings conference call. Joining me today is Judy Brown, Executive Vice-President and Chief Financial Officer. For our agenda today, I'll provide a brief perspective on the quarter. Next, Judy will walk through the detailed financials and our increased fiscal 2011 guidance. Then, I will give you an update on our new product launch of the generic version of Allegra, discuss the progress on closing the acquisition of Paddock Laboratories, and comment on the rest of our fiscal year. This will be followed by an opportunity for Q&A. Now, let's discuss the quarter.

We had another great quarter with the record third quarter net sales of $692 million up 29% over last year, plus adjusted operating income up 29% from last year also. In addition, our consolidated adjusted operating margin from continued operations was 19.6%, driven primarily by core business strength, new product sales of over $44 million, and operating execution improvements especially in our RX, API, and Nutritional segments. See slide number three for summary results.

Our Consumer Healthcare unit had another record third-quarter sales of $425 million, up 13% from last year's record third quarter. The performance was driven primarily by strong sales of existing products. The continued recalls of a national brand analgesics have helped our business. Our OTC business is performing well, but growth was limited by the steps we took to remediate the issues raised in the FDA warning letter at our Allegan, Michigan site, which limited our manufacturing through put. As we recently announced, the FDA has concluded its process with respect to the warning letter. This was my number one priority and I want to thank all of our employees and consultants who put in long hours and worked diligently through this process. I believe we are a better Company now having gone through it. It wasn't easy, but we spent the money and added necessary resources to get this done right the first time and resolve in less than one year. And, importantly, I want to thank the FDA Detroit district for making the re-inspection of our facility a priority and for working cooperatively with us to resolve the issues.

Looking at slide four, the overall OTC consumer market was up over 1% versus last year with national brands down nearly 4%. But, store brands gained nearly 15% on the strength of new product launches, national brand recalls, and increased market share. The analgesic category was obviously impacted by recalls at a branded OTC competitor; however, all, all of the individual store brand categories were up. Please note this data represents the last 52 weeks activity.

Our RX business segment had another very strong quarter as it continued to execute ahead of our expectations. RX net sales of $84 million increased 66%, and adjusted operating income grew 77% versus last year. The strength came from new product sales of $23 million led by generic Aldara, the generic version of Xyzal, and the generic version of Differin, along with increased sales in the RX-based business.

The Nutritional segment, which includes infant formula, vitamin and mineral supplements, and oral electrolyte solutions, exceeded our expectations due to strong performance in the infant formula business. Net sales in Nutritionals in the third quarter were $124 million with adjusted operating income of approximately $24 million. PBM sales continue to surpass the original expectation we estimated in the announcement of our acquisition in March of 2010. Our API segment continues to perform well also driven by strong European sales of Temozolomide during the quarter. API sales were $41 million during the quarter up 26% versus last year, but adjusted operating income was up 76% versus last year.

As a result of our strong year-to-date performance, we're raising our expected adjusted EPS guidance for fiscal 2011 to a range of $3.90 to $4. I'm sure you'll have plenty of questions, but first let me turn the call over to Judy to provide details on the quarter and guidance first. Judy.

Thanks, Joe. Good morning, everyone. As you just heard it was another strong quarter both operationally and with the benefit of a one-time tax adjustment. As a result, I'll be providing revised earnings guidance for the remaining year in a few minutes. But first I'll give a brief review of our fiscal 2011 third quarter results. As always, I'd like to remind you my comments are focused exclusively on results from continuing operations.

As you can see on slide five, we had a strong year over year revenue growth this quarter on a consolidated basis. The net sales strength was driven primarily by the acquisitions of PBM and Orion, which added approximately $88 million, consolidated new product sales of $44 million, and increased CAC and RX volumes. That growth was partially offset by decreases in sales in certain products which I'll explain in more detail over the next minutes.

On slide six, you'll see that we have excluded two items from our analysis of the adjusted operating basis financials for the third quarter of fiscal 2011 and four items from fiscal 2010. You may view the reconciliation from the recorded GAAP numbers to our adjusted non-GAAP numbers in the appendices to this slide presentation and in our press release.

Now, I'll take you through the rest of the analysis based on adjusted results from continuing operations. On slide seven, you can see as that as we were able to expand the top line 29%, we were also able to grow consolidated adjusted gross profit year-over-year the same amount, driven primarily by the contribution of the PBM acquisition, the new product sales in RX and API, and the strong sales of analgesics in our consumer health care business.

Additionally, we benefited this quarter from the impact of a one-time tax adjustment related to the change in the future Israeli statutory tax rates. As I had indicated in our last call on February 1, the Israel government enacted new tax legislation in January which is applicable to specific qualifying entities. Therefore, US GAAP required to us revalue those deferred tax positions on the balance sheet which related to certain of our Israel legal entities. Based upon our expected adoption date of the new law, we recorded a one-time adjustment of approximately $9 million which benefited the income tax expense line, reducing this quarter's adjusted effective tax rate to 20.2%. So, all in, our performance this quarter translated into a record $1.07 adjusted diluted earnings per share from continuing operations, which includes approximately $0.09 related to the tax rate reduction I just noted.

Now, let's move on to the business segments. Looking to slide eight in our Consumer Healthcare segment, net sales growth was driven by a $36 million increase in existing product sales primarily in analgesics and cough/cold as well as $9 million in new product sales and $7 million from the acquisition of Orion. That growth was offset by $5 million year-over-year decline in existing product sales primarily in the feminine hygiene and contract manufacturing categories. However, overall, our core base business is performing well, despite the through put pressures in manufacturing, and we continue to experience record demand for our products. The decline in adjusted gross margin was due largely to increased investments in spending related to quality control, assurance and supervision, variable incentive compensation, as well as some inventory rework.

At the same time, Consumer Healthcare continued to experience somewhat lower manufacturing efficiencies due to the production process redesign activities continuing in this quarter. This, combined with higher investments in R&D, resulted in the year-over-year decline in adjusted operating margin you see here. On slide nine, you can see that our new Nutritional segment had a very solid quarter, benefiting from strong retail demand for our infant nutrition products and some residual upside from challenges at a competitor in infant formula. The new PBM business was the main driver of the net sales increase, adding $81 million to the segment in the quarter. The new sales were partially offset by a year-over-year decrease in net sales of vitamin, mineral, and dietary supplement products, as we continue our efforts around skew rationalization. The adjusted growth in operating margin improvements were driven by the acquisition of PBM.

On slide 10, you can see that our RX business continues along the strong growth trajectory we have seen over the last several quarters. Net sales growth was driven by $23 million in new product sales, primarily the generic versions of Aldara, Xyzal and Differin. Adjusted gross profit for the quarter was strong compared to last year due to the success in new product sales as well as improvements in pricing. You will notice, however, a relative decrease in the adjusted gross margin attributable mainly to the financial structure of our ongoing authorized generic partnership with Graceway Pharmaceuticals for Imiquimod. However, please note that we did have our own vertically integrated version of the drug on the market throughout the third quarter of fiscal 2011, and, as such, the adjusted gross margins have improved on a sequential basis.

Next, looking at the API segment on slide 11, the 26% net sales growth was driven by new product sales of Temozolomide in Europe which were enhanced due to a product recall at the only other generic supplier for this product. This product's sales were also the main driver of the expansion in adjusted gross margin. This higher adjusted gross margin, combined with decreased expenses following the sale of our former German operations, helped drive the relative increase in adjusted operating margin, which was slightly offset by decreased sales of dossier agreements as compared to this quarter last year.

Now, some quick highlights on our balance sheet. Excluding cash and current investments, working capital from continuing operations was $471 million at the end of the quarter, up from $375 million at this time last year. The increase was primarily related to the acquisitions of PBM and Orion, timing and business unit mix of sales in the quarter, and inventory supplies on hand. Cash flow from operations for the third quarter was a strong $106 million. As of March 26, 2011, total current and long-term debt on the face of the balance sheet was $892 million. This is down from $1.3 billion at the end of fiscal 2010, primarily as a result of the closeout of the $400 million back-to-back loan which had been in place since 2005. Excluding cash and cash equivalents, our net debt to total capital at the end of the third quarter was -- of fiscal 2011 was 31.9%. This quarter we also paid $6.5 million in dividends, or $0.07 per share.

And, now, I'd like to discuss our updated earnings outlook for fiscal 2011. As a reminder, our earnings outlook is based on adjusted financials from continuing operations which exclude deal-related amortization as well as certain acquisition-related charges.

First, looking to our consolidated projections on slide 12. As Joe shared with you earlier, we are updating our estimate of fiscal year adjusted diluted earnings per share from continuing operations to rise to be between $3.90 and $4, an increase of 29% to 32% compared to fiscal 2010's $3.03. As I noted a few moments ago, we recorded a one-time benefit this quarter related to the change in the Israel income tax law of approximately $9 million, or $0.09 diluted earnings per share. We expect this benefit to carry forward for the remainder of the fiscal year.

In addition, our business segments contributed to this raised guidance. Let's start first with CHC. We continue to anticipate strong demand for our products in our Consumer Healthcare segment. However, given the throughput pressure we experienced in the first nine months of the fiscal year which limited our ability to fully service our full demand, we expect revenue growth to be at the low end of the 7% to 9% range we had projected in February. This now includes the contribution from the launch of Fexofenadine, the generic version of Allegra, but no longer includes the potential launch of the generic version of Mucinex, which we believe will not be before fiscal 2012. This growth rate includes an assumption that the competitive dynamics created by challenges faced by a large branded competitor continues through the rest of our fiscal year. That said, we expect the mid point of the ranges for full year fiscal 2011 adjusted growth and operating margins in Consumer Healthcare to be approximately 32% and 18% respectively.

In our new Nutritional segment we reiterate our previous guidance and expect sales to be nearly double that of fiscal 2010 full-year sales and expect the midpoint of the ranges for fiscal 2011 adjusted growth and operating margin of approximately 34% and 18.5% respectively. In RX, we are now expecting top-line growth of over 40% compared to fiscal 2010, driven primarily by strong new products. We now expect RX adjusted gross margin to be in a range of 48% to 50% and adjusted operating margin to be in a range of 35% to 38%.

In our API segment, we now expect net sales of growth of approximately 7% compared to fiscal 2010, due primarily to strong European sales of Temozolomide and our expectations for how this should continue for the rest of the year. Because of this product's strong showing, we now expect API adjusted gross margin to be in the range of 45% to 47%, and, due to productivity improvements, now expect adjusted operating margin to be in a range of 25% to 28%.

So, summing everything up, back at the consolidated P&L level on slide 13, we continue to estimate that consolidated net sales growth will be in a range of 20% to 23% over fiscal 2010. We anticipate this increase will be driven by acquisition, new product sales of over $180 million, and growth in our base business. We continue to estimate adjusted consolidated gross margin to be between 35% and 36% and adjusted consolidated operating margin of between 19% and 20%. Lastly, note that we are now assuming an effective worldwide tax rate from continuing operations of approximately 26%, down from our previous expectations due to the impact of the fiscal third quarter one-time benefit recorded related to the Israel tax rate change.

This consolidated guidance continues to assume that we will be in a position to close the Paddock acquisition before mid-June. As we noted in our second-quarter earnings call, the timing of this transaction's closing is dependent upon finalization of regulatory approval. While the review process is progressing along according to plan, we have modeled our expectations prudently and assume Paddock's results will contribute only minimally to adjusted operating earnings in fiscal 2011. In total, this brings us to an estimate of adjusted diluted earnings from continuing operations of between $3.90 and $4 per share. We continue to expect fiscal 2011 cash flow from operations to be between $350 million and $300 million. However, based upon the relative timing of our larger projects underway in Michigan, Israel, and India, we have decreased our expectations on internal capital expenditures are now anticipating spending between $60 million and $80 million for the full fiscal year on CapEx.

We are focused on execution the rest of this year and are now well under way with our planning processes for fiscal 2012. At the same time, the team is busy preparing for a successful close and integration of the Paddock acquisition. As always, the team is quite busy running multiple projects to further solidify our foundation for continued growth. And, now, let me turn it back to Joe.

Thanks, Judy. Now, Judy has given you all the details from the quarter, I'd like to talk about our future. First, let me talk about the Fexofenadine or store brand Allegra launch this past month. Our partner received final approval on April 13, and we began shipping immediately, and our product is on the retailer shelves. In comparison to our store brand Cetirizine launch, we do not directly control the manufacturing of Fexofenadine active ingredient and/or final dosage form, and we have an aggressive competitor in the market. But, but we do believe that we will get the majority of the business.

Why do we believe this? Look at slide No. 14. There is more to a successful launch than just shipping product. We give the retailer a turn-key, new product launch program. This slide shows just some of what we do for the retailer. Next, as we wind down to the end of the fiscal year, we look forward to closing our acquisition of Paddock Labs. As you can see on slide No. 15, we continue to be very excited about this transaction. The acquisition of Paddock Labs meets all of our deal criteria. First, we expect it to be accretive to return on invested capital in 2013, our second full year of ownership. Additionally, we expect it to be accretive to both GAAP and adjusted operating earnings in the first full fiscal year, 2012. We have more to say about this business as the deal closes.

We are excited about our future. We are working together with our retailers to meet the demand from consumers for all of our products. Perrigo is the right Company at the right time, at the right place to meet the world's growing need for quality, affordable health care products. Operator, let's now open it up for any questions.

(Operator Instructions) Your first question comes from the line of Amy Fadia of UBS.

Good morning. I have a couple of questions. Focusing on Allegra, could you give us a sense of the amount of stocking that occurred during the launch. Secondly, could you tell us how many retailers you've launched at so far, and if you could characterize the amount of discounting you've offered to the retailers as opposed to some of the previous launches such as Zyrtec, etc. And I'll come back with the additional questions later.

Just before we start, Allegra is a Q4 event. It's not in our Q3 numbers, just to be clear for everybody. This is a Q4 event.

On the question of stocking and sales and where we are, let me say, we don't ever specifically give -- with one exception on omeprazole, when we launched omeprazole, we don't ever talk about an individual product. I will simply say that we are very excited about Allegra. We think it's a great store brand opportunity, and we are very happy with where we are relative to launching the product. As you probably know, we are out there with one other competitor, an aggressive competitor, admittedly, but we are excited about what we see in terms of the opportunity.

Relative to -- I think part of your question is just relative to the price points on the product. The branded product is -- appears to be doing very well. It's very early in the launch of the brand. However, right now, admittedly in the midst of an allergy season, the brand looks to be poised to reach somewhere in a $500 million to $600 million pace, although admittedly, this is very early in the launch, so I don't want anyone to get too far ahead of ourselves on that one.

Relative to the discount versus the branded product, very consistent with past, where we're somewhere around a 25% to 30% discount the store brand is priced versus the national brand.

Thanks. A follow-up question on the Consumer Health side. How should we think about the impact on operating margins going forward? I mean, you've given us some color on the guidance for the rest of the year, but beyond that, how should we expect the gross and operating margins to evolve into next year?

Sure. There's a lot of input to that. I'll start, but Judy, you may want to add something to this. First of all, let me talk about the manufacturing output and pace of where we are as a Company. I'm glad to say that in the third quarter of our fiscal 2011, our manufacturing output versus the previous year was up -- in the tablet side was up approximately 15%, so we are gaining additional capacity. However, some of our input costs, as Judy had talked about, and that's just in terms of people, resources, labor, other incremental quality inspections that we put into the process, have increased our cost, and as Judy said, it's somewhere in that approximate $6 million range, $5 million, $6 million range in terms of our cost. That will be with us. The only variable we will quickly add is we believe there's opportunities through continuous improvement processes, for example, improving our cleaning validation throughput to continually improve the operating margin of our Consumer Healthcare business. Judy, anything you want to add to that?

The only thing I'd add as we go into the planning cycle right now for fiscal 2012, it's a balance between keeping very sensitive to the ongoing dynamics in the procurement sector and watching input pricing, obviously to Joe's point watching external unit pricing, and also we want to make sure we are still continuing to make the investments in R&D and what we feel are a lot of important opportunities. And if you look year over year, it's within operating expenses, but our year-to-date spend in R&D within the Consumer Healthcare segment is up fairly dramatically year over year at this point, and we want to make sure that we continue to refill the pipeline on some of the opportunities we see going forward. So expansion opportunities are there, and we're going to be going through the planning process to make the balance to make sure that we're continuing to reinvest at the same time.

Thanks. And one last question on the tax rate, and then I'll jump back in the queue, how should we think about the tax rate going forward? And if you could clarify, you mentioned the benefit from the Israeli tax change continue for the rest of the year, so should we see additional benefit in the fourth quarter?

Okay. Let me help you -- walk you through the rate dynamics for the year. Let me step way back and help everyone understand what's going on this year. At the beginning of the year, the original guidance for the year was 29%. And the new guidance that I just provided for the full year rate is 26%. And the evolution of that is, there are a couple pieces. The actual rate and mix changes around the globe have actually been negative for us this year, so they would have raised the rates. However, we did have the benefit of the US passing the R&D tax credit, and we saw that come through in the second quarter. This quarter, the third fiscal quarter, we had the benefit of the Israel law change that the one-time event, what I meant by it carries forward, we get $0.09 good guys third quarter and that $0.09 doesn't go away, it stays in the year to date numbers, so it's part of the rate for the full year, and that actually contributed to about a 150-basis point decline in the rate. Again, another reason the rate is coming down from our original expectations. That will -- that's a one-time only event , and we will not see that $0.09 repeat in future quarters. So it's between tax rate planning, the Israel statutory rate change, the R&D tax credit. We're now looking at a full-year rate of approximately 26%.

Looking forward, however, those one-time events we do not expect to repeat, so we'll most likely be starting the planning process for fiscal 2012 with a rate more similar to where we started this year, that is approximately 28%, 29%, and of course, I'll provide more guidance on exact expectations there in August once we see the business unit and legal entity mix dynamics that go into the

Thank you.

Operator, next question?

Your next question comes from the line of Linda Weiser with Caris.

Hi, how are you doing? Can you more a little bit on the store brand Allegra, we saw at retail a couple of price discounts on the brand after it was launched of fairly significant magnitude. Do you have any idea why that would be strategically? Were they just trying to adjust price prior to the store brand entry or what that would be? Because it kind of signifies that the sales were not strong initially. So yes, that's my first question.

Well, so I can't ever speak about any individual retailer and what they're trying to do relative to the overall market. However, to date, the data we see, Linda, suggested, has been a very strong launch. We think the folks at Chattem Sanofi have done a very good job of getting the product off the ground. Although, I have to add, it's very early in their launch, and they're doing it in the midst of a strong -- or an Allergy season right at the peak of hitting in the Allergy season right now, so it's hard to really do the exact direction of where sales are going with it.

Second comment I wanted to make is that usually when the brand makes any price move or retailer makes any price move, it really is done from the point of view of their direct competitor. So in the retail setting, it's usually as a result of competition with another retailer, and/or on the -- if it's across the board, it's usually based on competition from, in the case of Allegra with the Zyrtec product or the Claritin product, the branded products is really the major competitive threat. There's very -- usually very little discounting that is really directed towards a launch of a new store brand at this point, because they know we have -- we launch at usually a 25%, 30% savings for the consumer, but obviously there's some flexibility on that. So I would say most of the data, although early, suggests that the Allegra product is on trajectory to be something similar to what we had seen with the Zyrtec branded launch, which by our estimation was a very good launch.

Okay. And then just on the infant formula business. When you acquired it, you talked about the opportunities to improve the packaging and merchandising and even pricing, and with the brands going to a rectangular plastic tub for the powder and you guys still being in a round tin, the packaging doesn't look like a lot like the national brand. Are you moving forward on packaging changes? And also, what about plans for further international expansion of the infant formula business?

Okay, two great questions, Linda. As we have launched the PBM business and have -- we have worked a lot on trying to continue to improve the packaging and design of the product, a lot of that work has happened, and we've introduced some larger sized products. We've also made some additional just label design improvements in the packaging, so a lot of that's already happened. Do we think there's still more to go there? The answer is absolutely yes. We believe that when a company needs to be national brand equivalent or similar, we will continue to seek to try to get ourselves as close to the national brand as possible, so we will always continue to look at packaging design opportunities, and we are very aware of what both the MeadJohnson and Abbott product have done on the plastic tubs. We're aware of it; we will continue to look at it; we will continue to try to move towards store brand -- move the store brand closer to the national brand.

On the question of the international side, I think as I said in previous meetings, of all the opportunities we thought about PBM, one of the most exciting, we believe, is the international opportunity, so we're clearly trying to expand that international opportunity. We've got a lot of work that's being done by the team, in our PBM team to continue to try to improve that. And I do feel that, for example, the Asia opportunity with the number of births going on in Asia and with the team really dedicated towards that opportunity, we will continue to try to grow that business outside of the United States, as well as gain store brand share in the United States as evidenced by my chart where it shows infant formula significantly -- store brand infant formula significantly outpacing the national brands.

Operator, we're hearing a lot of feedback on the line, are you hearing that as well?

I am.

Anything we can do about that? Is there anything we can do about that?

It sounds very staticky at times. Are you moving the mike?

No. Let's just keep going, sorry.

Great. Are you ready for your next question?

Yes, please.

Your next question questions comes from the line of Frank Pinkerton with SunTrust.

Thanks for taking my question. Can you hear me?

We can hear you, Frank.

Just two sets of questions, and the first on is, can you give us a specific timing or range of date to close on the Paddock acquisition? And since you've had a little time there, possibility for any additional color on that, specifically around the pipeline?

I'll start, and Judy, you may want to add something. Going back to the comments, we expect Paddock will close during the current fiscal quarter 4. We expect it to close in that June time frame relative to where we are with it. As we've had time to spend with the Paddock team, we continue to be very impressed with the work that the Paddock team that done. And also, we feel that the opportunity there for the 25 ANDAs pending approval will look to us to be a great opportunity for new product launches in our generic RX space. So everything continues as planned. We're excited, and we think, as we said before, it fits all of our deal criteria in terms of accreted to adjusted EPS, ROIC accretive in fiscal year 2013.

Okay. Great. And Judy, a question for you, and this one may be a little far-fetched, but from the standpoint where you source your raw material and other needs for the products, has the weakening dollar plus inflation been putting any pressure on margins? And are there any kind of leverage points or trigger points we need to think about going forward if some of those trends continue, where we should think about ultimately some negative impact? Thank you.

Great question. On a consolidated basis right now, we are not seeing pressure to the margins, so the consolidated numbers that you're looking at on a net-net basis don't really have much in terms of impact because of that, because of the way our consolidated business rolls up. Certainly, however, on a line-by-line basis, on a business unit by business unit basis, certain areas of ordering are seeing some of that, and so we have hedging programs in place to address specific currency positions, and in areas where we can forecast buying, we are absolutely engaging in forward contracts to try to address that. On a go-forward basis, we'll continue to be active in that vein. Again, because of the very broad diversity of our footprint and the broad diversity of our purchasing activities, we're not really overly exposed in any one area except for the shekel, but we're, again engaged in hedging to reflect that. So for the moment, not a tremendous concern, but we're monitoring it closely, and to the extent it would become something material enough to start being visible on a consolidated basis, we would certainly be talking about that more and helping you be able to model it better in your own numbers.

I'm disappointed I didn't hear anything on potential price increases. I know some branded products have been taking either price increases and/or same price for smaller, lower amounts. Is that possible in the store brand side as long as you keep the ratio of discount approximate to help offset any potential margin problems?

Yes. I think the answer to that is absolutely yes, Frank. We have talked about this in the past. In the store brand world, we have been effectively able to -- some places get price increases, some places for competitive reasons we have to take decreases, but across our total book of business, we think we've been able to keep our prices flat. Flat, I would probably say right now. Flat is probably the best if you're modeling it. But there are definitely places where we are getting some price increases in our business. The answer to that is definitely true.

Thank you.

Your next question comes from the line of Louise Chen with Collins Stewart.

Hi, how are you. Just a few questions. First one just a follow up on an earlier question with respect to the Chinese JV opportunity for PBM or Asia opportunity. We've gotten a lot of questions on how to size this market opportunity and the mechanics behind how you would set something up. Is there any way you can give us color on this?

It is an enormous opportunity, let's be clear, relative to the number of births in China versus the US. The number of births in China relative to the US is three to four times the US rate so the clear increase in the number of births and the opportunity there. The second comment I offer is that we are continuing to talk to a number of potential partners. There is a high interest in putting together some type of a joint venture. By no means have we concluded anything at this time. However, we clearly have a lot of interest in the joint ventures. But the market opportunity is very significant, certainly based on the absolute number of births and rising number of births that are being seen not only in China but across Asia. We are working very hard in that. We do recognize it as being one of our top priorities for the infant formula business, both -- growing store brand share in the United States is clearly part of it, but the Asia opportunity is the part other part of it. I don't want to give you any more specifics on exactly what the JV would be until we get that solidified, but it is the highest priority in terms of the international expansion is the Asia opportunity.

Maybe if I could just ask one more question on that, could it be as large as what you're seeing sort of in the North America market in terms of what you see now for PBM or subset of that size?

You know, not immediately. I don't anyone to think that immediately, but the number of births -- if you think about the numbers in the United States for store brand infant formula, store brand infant formula has a single percentage point market share in the United States, and yet we do, ballpark, $200 million of formula and food in the United States. Clearly, it is a big opportunity with only a single digit market share. If we can get similar market shares in china, it would be significantly higher, but I don't want anyone to think that's going to happen overnight. There's a lot of work that still needs to be done.

My second question is now that you've got this warning letter behind you, what kind of operating efficiencies have you put in place in trying to resolve that and letter, and will be there any sort of positive earnings impact over time from this maybe as early as fiscal 2012, or is it going to take longer to get that?

As I stated in my comments, resolving the warning letter was absolutely my first priority for this current fiscal year. It really was critical. As I've stated on these calls from the first day I joined Perrigo, I believe quality is the most important priority for any pharmaceutical company, and getting the warning letter resolved in less than one year and getting it resolved the first time through the FDA re-inspection we feel was a great achievement and we're delighted with it. Having said that, there's still more that we need to do. Part of it is really based on the continuous improvement process that we are executing on and that goes to things like cleaning validation. How do we continually improve cleaning validation? The FDA has looked at how we do cleaning. They certainly believe it's acceptable. And now we've got to continue to validate the number of times -- batches we can run between when we do cleaning validation, so the whole series of continuous improvement. I use cleaning as simply a singular example, but there's a whole series of continuous improvement programs we are working on to ensure that we will continue to improve our efficiency, especially in the Allegan site. I think Judy mentioned that also in her comments. We're continuing to work on it. It's only been a couple weeks now since we got this resolved, but we will certainly make that a very important priority for us in the future.

One last quick question. You had mentioned, I think, Dr. Reddy's being in the market with Allegra, being very aggressive. I don't think you mentioned them by name, but I'm assuming that's who you were mentioning. And how does that compare relative to Zyrtec and Prilosec which I think they were also on the market as well. Is it a similar dynamics where you keep majority share, or is it something different this time?

I don't want to ever want to talk about any individual company. In the case, though, of Zyrtec, we had, I think it was six additional competitors, or six competitors plus ourselves, and the Fexofenadine or Allegra market, there was one other competitor, albeit an aggressive competitor. I don't know how I can give you more color on that. It's really something that we're continuing to look at. We like what we see in terms of our ability to put together a turn-key program for the retailers. That's certainly very important. I think as you may know, the one other competitor at this time is -- has a legal court case under way, the status of which is unclear to us. We don't have any visibility to that. But I do know that court case could change the market dynamics if, for example, they were excluded from the market in the future. I can't say which direction that's going to go, and I don't want to make anyone believe I know anything there. It really is unclear at to how that court case will play out. But we're excited. You know, the important -- other point I have to say is I don't control the manufacturing of the tablet or the API, which is different than Cetirizine where I did control that, so I had more capability to influence that. In this case, I'm working with very good partner, but I don't control it. But at the end of the day we still believe we will get the majority share.

Thank you.

Your next question comes from the line of Randall Stanicky with Goldman Sachs.

Thanks, good morning Joe and Judy. Just a couple of follow ups. I heard you talk a lot about the Paddock acquisition. Did you also talk about the accretion and if there's been any change to your expectations on that front?

No, Randall, we did not talk about any changes in the accretion of Paddock Labs. We still feel very good about it. We think the -- they're making -- continue to make good progress in the time period since we announced the transaction on gaining new product approval, but we've made no changes relative to the accretion of adjusted EPS or the GAAP EPS or the ROIC. We continue to feel they meet all those criteria but have to the changed any numbers.

Okay, great. And just two follow ups on the consumer business. One's mechanical. There's been a lot of questions on Allegra this morning. Can you just talk about how that's going to be recognized? Is it going to be you booking all top line and paying out a royalty of gross profit, just so we understand how it flows through the P&L?

Sure. And in this particular product, the mechanics are fairly straightforward. We are not as complicated of a delay, a lag cycle as we have been in the past on some RX products where we have to wait to get back the flow-through on customer program accruals, so it is set up more similar to what you would be calling like a royalty agreement. So in the fourth quarter, if sales are made to our third party retailers, we have a fairly straightforward calculation with our partner on getting to the net profitability and will be recording that right in the fourth quarter, so you won't have a 90-day lag as is the case in some instances with RX products.

But Judy, just to be clear, relative to the top line for the sales of that product, is that falling through Perrigo?

Sales for that product are Perrigo sales, yes, that's correct.

We book sales, yes.

We book sales, and we will then pay to our partner their share of a portion of profitability, so gross profit will reflect our sharing of the profits with our partner.

Okay. Perfect. And then Joe, is it fair to say that relative to some of the gains you've been picking up from J&J, that that's been fairly consistent this quarter with what we've seen the last couple?

Yes, I would say that is consistent. As we stated going back now almost a year, the opportunity that we saw in the J&J challenges was approximately a $100 million opportunity, and we did not have sufficient capacity to ship all of that, so we've been saying somewhere in the range if -- we can ship approximately half of that, so somewhere in the range on an annual basis of approximately $50 million or about $12.5 million per quarter. That is continuing to be the expectation. As to when J&J will return, I think that's still open for -- as an open question. We, from our point of view, tend to be conservative. We'll pick it up approximately one quarter at a time relatively to our expectations of when J&J will return to the market.

That's helpful. My last question, something that's been a huge earnings driver for you guys has been your ability to find deals and specifically accretive deals. How are you thinking right now, and I know we talked about this last quarter and in between, but how are you thinking about the deal landscape right now and specifically your appetite? And then perhaps are there any specific areas where you're more focused right now? Thanks.

Good question. First and foremost, let me back up a little bit on your question. I feel very good about Perrigo's ability to find accretive opportunities, accretive to ROIC, which is our hurdle that we rook at. However, the best part of the situation is we do not feel we need to do deals in terms of growth rate. We feel we've got a strong organic growth rate to which if we find an appropriate deal, it will simply just supplement the opportunities for our shareholders. So we feel we're coming at it from a position of strength.

Relative to the areas that we have stated we are interested in, it continues to be to add adjacent categories to the Consumer Healthcare store brand business that by far and away is our biggest business. It continues to be looking at geographic expansion of our Consumer Healthcare store brand business because we believe the need for quality, affordable health care products is not only a US event but a worldwide event, and we want to continue to look for international growth opportunities. And as appropriate, if we find an opportunity within the generic RX base like the Paddock acquisition, we feel that could also help us. But once again, we're not trying to compete and be a generic company in the multi-source products of oral solids. We really are focusing on what we call extended topicals or niche products in the generic space. So those really continue to be our specific category areas of high interest to us.

Got it. Thanks, guys.

Your next question comes from the line of Elliot Wilbur with Needham & Company.

Thanks, Joe. As a corollary to that question and your response, perhaps a little bit further down the road in terms of thinking about additional growth avenues for the company, I guess maybe given in light of the recent announced sale by Glaxo of some older established brands, would it be, do you think anyway sort of maybe too far outside of Perrigo's power alley to consider moving into some older, established store brand products where you don't necessarily need a lot of dollars spent in terms of building brand identity?

You're referring to the branded Glaxo?

Correct.

I would say that is something that we constantly re-evaluate with our board. We always look at, you know, where are the next good opportunities from a strategic investment point of view. At this time, we have not chosen to go into the branded space, either on the pharmaceutical space or the OTC space. However, it's something we will continue to look at and evaluate. If there's an opportunity there, we clearly believe -- if I pick up on your comments specific to Consumer Healthcare, we clearly believe we have the great relationships with the retailers that one would need to be successful. We clearly believe that we know how to put together programs to launch products and/or increase promotions on products. We would need some expertise to supplement on the marketing side, but we clearly think we have many of the important criteria for being successful, but at this point, to be clear, we have not made the strategic decision to go into brands, but it is something we will continue to evaluate especially in the Consumer Healthcare side, because we do think there's some interesting opportunities there, especially with the portfolio of formulations we have that essentially cover from A to Z all of the over the counter drugs that are in the marketplace. So we're continuing to look. But at this time it's not something we've made a decision to going in that branded space.

Then I have a question for Judy as well with respect to some of the quantitative metrics, specifically on the Nutritional segments. It looks like you raised your gross margin guidance by roughly -- excuse me, lowered gross margin guidance by roughly 100 basis points but kept operating margin guidance unchanged. I'm wondering what the offset is. Is it something you're doing more offensively to address the margin compression or is it just perhaps a more of a mix issue? And then as follow-up to that, you talked about skew rationalization and the non-PBM Nutritional business and usually that's something that's done sort of sacrificing revenue for additional margin, and that doesn't seem to be the dynamic that's currently taking place, and I'm just wondering if you could comment on that?

I'll take the second half of your question first. It's fresh in my mind. Specific to the vitamins, minerals, and supplements business that's part of the Nutrition segment, if you were to look at -- and go back the last two quarters, you'd see that year to date, the business has been effective in rationalizing the skews and improving overall margins. So this particular quarter, the mix dynamic was such that the gross margins saw a bit of compression year over year, but year to date, there's a market change on both the gross and operating side for the -- that product category. So as we've been saying, trying to focus on overall improvement, if we're going to be in the business, we may take a top line hit but we want to see the bottom line improvement, and we have seen that year to date and we expect that to continue for the full year numbers on VMS as well.

If you step back and look at the PBM specific, infant formula business and the slight decrease in overall margins that I guided for the full year, it's planning for some specific production activity that's going to be going on in the fourth quarter, some transformation work that's going to be happening that we're planning for and is built into our expectations, and knowing that and planning for it appropriately, being able to manage operating expenses overall to still be able to be consistent with our operating margins and being able to deliver the bottom line number we had planned to for the full year. As Joe has talked about for all of our categories, continuing to keep an eye on the commodity and raw material horizon, and that's -- being able to build that into our overall pricing strategies, as well as some of the pricing opportunities that still exist within infant formula as we bring new products to the market which are in fact planned for the next 12 to 18 months rolling forward. We're not looking right now at some dramatic change in our margin expectations going forward. Obviously we'll be talking about more detailed business segment by business segment in August, but that is not some specific harbinger of a change or a shift in the wind to infant formula at all.

Final question for either or both of you. In the Company, obviously, this year has enjoyed incredibly strong top line momentum and sequential bottom line momentum, and thinking about the fourth quarter, you have the benefit of Paddock for some period, launch of Allegra, arguably a lower tax rate at least relative to the numbers in the first half of the year. Trying to figure out what has to not go right so that -- seems like the low end of earnings per share guidance is very unlikely to be attained, and I can't figure out what, you know, we may be missing that would suggest that numbers would come anywhere close to the low end implied in your revised full-year expectations?

Elliot, I understand your question. How do we look at it? We feel very comfortable with our numbers and have confidence. Why? If you look at what's happening in the business, number one, OTC store brand gains continue to go forward as evidenced by the chart in terms of where OTC store brand utilization is. Number two, we have resolved our warning letter, so we feel very good about resolution of the warning letter, and I think getting it resolved in one year or less than one year was a very significant achievement. I thank the team that did it. Number three, new products, both in this year, but also over the next five years, we expect there to be $10 billion plus products that will come into the store brand world, predominantly the proton pump inhibiters, but also you are seeing some great numbers on the RX and API side. We had Paddock, we increased capacity this summer, so we feel very good about our future. We're very excited about it. I don't want to talk about any specific quarter, but as we look to the future, we feel very confident in our ability to grow this business.

Thank you for taking the questions.

Your next question comes from the line of Sumant Kulkarni with Bank of America. Your line is open.

Yes, hi. Sorry about that. You mentioned that the FDA process limited the out through put. Now that the process is behind you, how do you expect that to change your ability to capitalize on competitive issues going forward?

Really what's happened, I'll use an example where we -- in the past, the FDA asked us to improve our validation on cleaning, as an example, and we have stepped back and done cleaning more frequently in our process. And that's something that we have validated, and now we will continue to validate with expanding the amount of batches between cleanings, so as we can continue to improve or put continuous improvement projects together that help us be more efficient, that is part of what we will be see. To be clear, though, as Judy specified and I specified, we did increase the actual head counts of quality individuals, labor costs incrementally during the year as a result of trying to ensure that we have quality products each and every time, and that's something that will with us going into the future. But we do think there is significant continuous improvement projects that will help us to improve the efficiency of our organization and get greater output from mostly the Allegan, Michigan, site but really from really, for Perrigo around the world.

And on the prescription generic side, are there any major launches that you've accounted for in the guidance for this year? Specifically, when do you expect to launch generic Duac?

Duac we are not expecting in the current fiscal year. We do expect that we will get approval for the Duac sometime in the next, say, 6 to 12 months. However, it's not currently in our numbers for this quarter. The only other launch we expect is a June 15 launch of Nasacort, although because, as Judy specified how we deal with the RX programs, it is in at a very minimal first month launch in our current fiscal year ending June 30. So it's a very small number this quarter. The majority of it will be experienced in the next fiscal year.

Thank you.

Operator, we have time for one more question.

Your final question comes from the line of David Buck with Buckingham Research.

Thanks for taking the question. A couple of brief ones. First on PBM, could you give us what the year-over-year growth would have been in that segment, and how much was from international? Secondly, if I look at Consumer Health, Joe, you had a nice step-up from the prior quarter. Can you talk about how much of that might have been from the cough/cold season comparisons, and how much of the sales were held back by still the throughput issued you saw? And finally on the RX business, is there anything that led to the sequential drop in terms of pricing or competitors coming back to the market? Thanks.

A couple of different questions, different directions. Approximately 20% of the sales for PBM were from the international side, and that's been fairly consistent since the time we acquired the business, so approximately 20% is international sales. Really, as we look to the future, that's where we see some growth opportunities for PBM. Number one, the biggest opportunity we see is international, especially in Asia. And number two, is just driving store brand share and introducing new store brand products into the US market is the number two area. But international, approximately 20% on the business.

On the Consumer Healthcare side, indeed our throughput did go up both versus a year ago and sequentially. It went up approximately 15% versus a year ago. This is the tablet side, which is the major constraint we had, went up about 15%. We had some in liquid, but one's pretty much resolved. 15% on the tablet side. And it went up 10% versus quarter two, so gives you some sense of our output from -- that's predominantly focused on our Michigan location, which is the primary source of our tablets and liquids. So that was the question. It has gone up. How can we continue to improve it? That's just going to be continuous improvement process. What I always put -- as I look to any new budget is I put a new hurdle for the team to look at. Where are the continuous improvement projects? And how can we execute on continuous improvement to improve our efficiency and get greater throughput through our facilities to immediate the world's need for quality affordable products? That will be consistent with what we will do for our fiscal year '12.

Then on -- I think the final question was on the RX side, we feel very good about what's happening in the RX side as evidenced by the performance of that business. It clearly has done incredibly well when you're talking about looking at the RX business being up 66% on the sales line, up 77% on the operating income line versus a year ago, so continuing strong performance there. And Judy, you may want to add some other comments.

David, maybe the question was around there pressure on growth margin, I believe, was your inquiry, was sequentially actually the margins have improved year over year. The gross margin in this quarter and last quarter, there was gross margin pressure because of the relative mix of Aldara authorized generic, which carried with it a lower gross margin. But as we're selling now relatively more of our own vertically integrated imiquimod into the portfolio, you'll see sequentially the gross margins have improved from last quarter as more of that product is our own product.

Sure.

Otherwise, pricing has been good in that business unit. The mix has been stable. That's the main driver of the year-over-year change in gross margin in RX.

Actually the question was more on the sales drop sequentially. The question was whether you were seeing some of the competitors come back into the market who had been out of the market, the dip down in RX sequentially?

I think those are just -- probably just -- I don't think there's anything major there. I think it's just some timing questions or other things. I don't think it's anything major there, David.

Okay.

I'm not worried about that.

If I could sneak one in, the PBM year-over-year growth?

I'm sorry? Do you have that number?

(inaudible)

I'm sorry, I couldn't hear you, Judy.

There were no PBM sales in the third fiscal quarter of 2010. We closed on that acquisition of April 30 of last year.

I understand. What would it have been? What was the growth versus the prior ownership? $81 million compares to what?

I don't have the exact number, but it's got to be over 10% because I know we had forecasted a $300 million business was about 10% --

Right.

-- run rate and during the quarter did -- we did the $81 million of sales, so it's got to be probably in the -- I don't have the exact number, David, but it's got to be over 10% because it's exceeding our expectations there.

Okay, great. Thanks.

This concludes our question-and-answer session. I would like to turn the call back to Joe Papa for closing remarks.

Well, thank you, everyone. Thank you very much for joining us today. Thank you for your interest in Perrigo. We look forward to continuing to improve our organization, find operational efficiency, and continue to focus on quality, affordable health care products. Thank you very much for your attention and interest in Perrigo. Have a great day.

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