Perrigo Company (NYSE:PRGO)
F2Q13 Earnings Call
February 1, 2013 10:00 a.m. ET
Arthur Shannon - VP, IR & Communication
Joe Papa - Chairman, CEO and President
Judy Brown – CFO & EVP
David Risinger - Morgan Stanley
Ariel Herman - Goldman Sachs
Linda Bolton Weiser - B. Riley Caris
Ami Fadia – UBS
Elliot Wilbur - Needham & Company
Louise Chen - Guggenheim Securities
Annabel Samimy - Stifel, Nicolaus
Greg Gilbert - BofA Merrill Lynch
David Steinberg - Deutsche Bank
David Buck - Buckingham Research
Shibani Malhotra - RBC Capital Markets
Randall Stanicky - Canaccord Genuity
John Anderson - William Blair
Good morning. My name is Don, and I will be your conference operator today. At this time, I would like to welcome everyone to the Perrigo's Fiscal 2013 Second Quarter Earnings Results Conference Call. (Operator Instructions) Thank you Mr, Art Shannon, Vice President of Investor Relations & Corporate Communication, you may begin your conference sir.
Thank you very much, Don. Welcome to Perrigo's second quarter 2013 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 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 1 of the company's Form 10-K for the year ended June 30, 2012.
I would now like to turn the call over to Perrigo's Chairman and CEO, Joe Papa. Joe?
Thank you, Art and welcome everyone to Perrigo’s second quarter fiscal 2013 earnings conference call. Also joining me today is Judy Brown, Perrigo’s Executive Vice President and Chief Financial Officer.
For our agenda today, I will discuss the discussion we announced earlier this morning. Then I will provide a brief perspective on the quarter and the continued stress in our store brand market share growth. Next, Judy will go through the details of the quarter and our fiscal 2013 earnings guidance. Then I will provide an update on the transition to plastic containers in our instant formula business and our plans for new product launches plus an overview of our expectations for the rest of the year. Finally, this will be followed by an opportunity for Q&A.
First, earlier today we announced the acquisition of Velcera for $160 million in all-cash transaction as you can see on slide number three. This acquisition follows our move into pet care with the Sergeant's acquisition in last October. Velcera is best known for PetArmor. It is a (inaudible) based flea and tick treatment comparable to Frontline top spot. The complete Frontline franchise has annual branded sales of $1 billion.
In calendar 2012, Velcera had annual sales of approximately $60 million. Velcera is expected to add a great new product pipeline and be $0.11 accretive to adjusted earnings in its first full year and ROIC accretive in our fiscal 2015. This transaction combines an existing store brand player with our manufacturing capabilities enabling us to deliver the strongest flea and tick market offering. These are expensive products that can truly benefit from the addition of quality affordable store brand.
Now let’s discuss the quarter. On slide five, you can see we had all-time record quarterly net sales of $883 million with record adjusted net income of 14% from last year on a 5% net sales growth. We had all-time high second quarter adjusted gross and operating margin. Consolidated adjusted operating margin was 22% driven by strong operational performance.
Our operations in the consumer healthcare business are producing higher volumes and are operating more efficiently than at any time in our history. The lean sigma process changes that we began to embed a few years ago are now really paying dividend for us. The Perrigo quality and supply chain teams are doing great work. Along these record earnings and earnings per share, cash flow from operations was a fiscal second quarter record $185 million.
Turning to slide six, you can see the business segment breakdown. Judy will walk you through the details but I wanted to touch on a few of the items. First, our consumer healthcare segment has all-time record second quarter sales up 14% versus last year. If we normalize the days versus last year, CHC growth would have been 23%. The performance was driven by continued execution of our CHC strategies, operational excellence, store brand market share growth and innovative new product international growth and continued expansion in adjacent categories.
Sales in our nutrition segment were down from last year as we spent the majority of the quarter ramping up our retailers by the retailer launch of the plastic containers in the instant formula business. This launch is underway and retailers have begun to heavily promote store brand instant formula. Both gross and operating margins in the segment improved as a result of the increased pricing and improved product mix. Judy will discuss our guidance for this segment shortly.
With the record adjusted second quarter gross and operating margin, our Rx business had a good quarter. Although net sales decreased 8% compared to a record second quarter last year and adjusted operating income was down 6% as a result of increased competition of certain based products, on a normalized basis, considering the extra week last year, net sales were relatively flat to last year. The Rx business has our best pipeline in Perrigo’s history.
Looking at slide seven, the mega trend shift from national brand to store brand continues. The overall OTC consumer market was up more than 2% versus last year. National brands were down almost 2% but store brand gained 9.7% on the strength of new product launches, national brand recalls and increased store brand acceptance and nearly every category store brands drove the growth.
The diabetes category experienced tremendous store brand’s growth of more than 14%. In the gastrointestinal market, the category was flat while store brands grew 12.2%. Store brands continued to drive growth in the marketplace.
Now let me turn the call over to Judy.
Thank you. Good morning everyone. As you just heard, we delivered another high-quality quarter with record second-quarter revenue, adjusted earnings and cash flow. We’re already busy working in what should (ph) be a strong second half of fiscal 2013 which I will discuss in a few minutes.
But first let me review the fiscal second quarter results by business segment. As you may recall in this time last year the second quarter of fiscal 2012 included 14 weeks of activity versus the 13 weeks in the second quarter of fiscal 2013 which we’re reviewing today.
So on slide eight, you can see net sales in consumer healthcare grew 14% year-over-year driven by an increase in sales of existing products of $38 million in the contracts, analgesics and smoking cessation category, $34 million attributable to the Sergeant and CanAm acquisitions and new product sales of $12 million primarily in the cough/cold, dermatologic and gastrointestinal categories.
Specifically sales in the analgesics category were up more than 8% year-over-year led by sales in children and infants liquid analgesic products in a period where a specific branded competitor has not fully returned to the market. Additionally, sales of our OTC products outside the U.S. increased 9% as the team continues its concerted effort to grow store brand market share internationally. These increases were partially offset by a year-over-year decline of $13 million in sales of various existing allergy and gastrointestinal products and approximately $5 million dollars of discontinued products.
The increase in adjusted gross margin was due primarily to product mix and increased production efficiencies. Our operating expenses remained flat as a percent of net sales as R&D spend was down slightly due to project timing while the SG&A expenses increased with the expansion into our new animal health and diabetes care categories.
On slide nine, you can see that net sales within the nutritional segment declined 5% year-over-year. The 14-week impact previously discussed accounted for even more than this amount but was offset by $3 million of new product sales. Growth rates in the U.S. are still down 2% year-over-year and national brands continue to coupon (ph) as part of their marketing strategy to gain market share in instant formula.
We began shipping the new SmarTub plastic container in mid-December. As of today, February 1, we’ve launched the customer to represent a little more than 60% of our U.S. volume. Feedback on the plastic containers has been favourable and notably Walmart and Sam’s Club have featured this new packaging directly next to the national brand in a number of nationwide circulars.
Adjusted gross margin in the nutritionals segment increased 280 basis points to 27.2% as price increases which we initiated following the continued rise in raw material prices were fully visible this quarter, and product mix was favorable as a greater percentage of sales were from infant formula versus relatively lower margin toddler foods. The adjusted operating margin increased 320 basis points due to lower employee related expenses as a result of our back office consolidation activity along with the absence of operating expenses related to the company’s Florida location, which was closed in the fourth quarter of fiscal 2012.
On slide 10, net sales in our Rx business decreased 8% as existing product sales were lower year-over-year by $11 million due to the expected competition on certain products. These decreases were partially offset by new product sales of $9 million. Most of the decline in second-quarter net sales was attributable to the extra week of operations. Adjusted gross and operating margin increased due to favorable product mix versus last year, as well as higher margins on new product sales.
Next on slide 11, net sales in the API segment decreased 4% due to a decrease in existing product sales of approximately $5 million as a result of increased competition, partially offset by $4 million related to the continued strong performance of a customer’s product. Growth in operating margins was positively impacted by the product launch I just referred to along with favorable mix of existing product sales within our API segment.
Now some quick highlights on our balance sheet. Excluding cash and current investments, working capital was $680 million at the end of the quarter, up from $536 million at this time last year, reflecting primarily the impact of our acquisition of Sergeant’s Pet Care and CanAm Care, organic growth and timing of tax related liabilities compared to the previous year.
As of December 29, 2012 total current and long-term debt on the face of the balance sheet was $1.4 billion, flat sequentially from last quarter. Excluding cash and cash equivalents, our net debt to total capital at the end of our second quarter fiscal 2013 was 30.2%. Cash flow from operations of $185 million was a second quarter record due to strong earnings and the positive impact from improvements in the company’s working capital during the quarter. Year-to-date net cash flow from operations was $230 million, $10 million more than last year based on strong earnings growth offset by timing of certain tax payments as compared to the prior year.
Now, I’d like to discuss our earnings outlook for the full year fiscal 2013. On slide 12, you will see that we are upgrading guidance for the nutritional segment based upon lower than expected results during the first half of the year. As we stated previously, retailers have been in the process of phasing out the older package metal cans in anticipation of their recently launched new plastic containers. Although this process has been going a bit slower than we had initially planned, we continue to expect store brand penetration to increase as the new plastic containers gain consumer acceptance. Given the timing on this phase-out phase-in, the highly competitive sales environment among national brands in the infant formula category, and a larger than expected revenue shortfall in the first half of the fiscal year from our original plan in VMS, we now estimate nutritionals revenue to grow between 1% and 5% year-over-year with adjusted gross margin of between 26% and 30% and adjusted operating margin of between 10% and 14%.
On slide 13, you will notice that we are not making any adjustments to our consolidated guidance for the fiscal year at this time. However we are lowering our probability wait on the launches of certain new partner products, including the broader (inaudible) family of products and Loratadine-D 12 (ph). Due to the limited visibility we have on the launches of these partner products, it is more difficult to precisely forecast their exact launch date. Incorporating this factor into our risk adjusted model we now expect fiscal 2013 consolidated new products revenue to be approximately $150 million. Please note that these numbers still include our 600 milligram extended release Guaifenesin version, we are still currently expecting to launch within the fiscal year.
The cough/cold flu season is off to a solid start and sales within our overall base consumer healthcare and Rx businesses are strong. We assume these factors will mitigate a portion of the updated nutritional guidance and new product revenue impact I just spoke about and therefore we now expect consolidated fiscal year 2013 revenue near the mid to lower end of the stated guidance range.
Once again, the team demonstrated its commitments in manufacturing and operating excellence this quarter as evidenced by producing the largest volumes in our 125 year history. Lean sigma continuous improvement initiatives implemented since 2010 helped to facilitate the strong operational performance which translated into consistent margin expansion. While he believe there is always more to do we remain focused on solid execution as the basis for continued growth, both internally and as we further cultivate our business development pipeline.
Now let me turn it back to Joe.
Thank you, Judy. We had a solid quarter but now I want to focus on the future. Let’s start with consumer healthcare. This year the cough/cold flu season has become an epidemic in some regions of the country starting in mid-December. We are realizing strong sales in our cough/cold and analgesic categories. The key for our sales in the cough/cold flu area is the duration of the season and so far it is above our expectation but we will have to continue to monitor the season.
Now let me turn your attention to slide number 14. In January we launched the store brand version of Nicorette Mini Lozenges with approximately $30 million in branded sales continuing our leadership position in the smoking cessation category. Additionally we are preparing for the launch of the store brand version of Mucinex 600 milligram with annual branded sales of approximately $135 million. As of today we currently expect to launch this product in our fiscal year 2013 and specifically March 2013. As previously stated before we will issue a press release the date launches.
In our nutritionals business highlighted on slide 15 we are excited about the upgrade to what we believe is a better than the national brand style packaging. As you have seen in other products when we closely match the packaging to the national brand, we gain market share. Last month Perrigo received clearance to manufacture three Codex compliant infant formulas for international market which underscores high-quality standard of Perrigho’s opening up more international opportunities.
Turning to slide 16, first I would like to welcome Doug Boothe, our executive vice president of our Rx pharmaceutical groups to the team. Dough brings a wealth of experience and knowledge about the pharmaceutical industry from his many years working at companies such as at (inaudible). Welcome to the Perrigo family, Doug.
The generic Rx is well-positioned for growth. In fact, this morning we launched clobetasol emulsion form, the generic version of Olux® -E Foam, with branded prescription sales of approximately $38 million. This is our second launch from the Cobrek family of products since the recent acquisition in December 2012. To date we have launched six new foam based products into the market and all these products Perrigo is the sole generic player in the market.
As highlighted on slide 17 we are poised for strong new product launches in the second half of the year with the recently announced launch of generic versions of Acetadote, (inaudible) form plus other undisclosed products of more than $500 million in branded sales. We expect to have a strong second half of the year ahead for Rx team. The Perrigo team has done a great business development pipeline and continues to evaluate opportunities in new categories, technology and geographies.
In summary, on slide 18 Perrigo is poised for continued growth. The market continues to shift to store brand offerings, and our OTC switches are expected to continue with $10 billion in branded Rx sales likely to switch in the next five years with $5 billion of that expected in the next three years. Our nutritionals business conversion to the new plastic tub is being received positively, and our Rx business continues to perform well. We expect to grow adjusted earnings 9% to 13% over the last year’s record performance as we continue to execute on our mission of making quality healthcare more affordable for our customers.
Operator, let’s open up the call for any questions.
(Operator Instructions) Your first question comes from the line of David Risinger with Morgan Stanley.
David Risinger - Morgan Stanley
I have a bunch of questions but I don’t want to take too much time. I guess I will just start with a few things. First of all, with respect to Mucinex, can you provide some more detailed comments on exactly where things stand, level of confidence et cetera, obviously it’s taken longer than expected and it’s a matter of timing but just wanted to better understand exactly what we should know about Mucinex? And then second, with respect to the flu benefit, could you talk about the benefit in the December quarter and what we should expect for the March quarter, is there any way to quantify that? And then I guess a final question is with respect to competitors could you just talk about competitor manufacturing resolutions, what’s happening at J&J, what’s happening at Novartis, what’s happening Novartis’ flea and tick recall et cetera, just so that we understand what's happening in the competitive landscape?
Okay, I will be happy to answer your one question, Dave but – going to Mucinex, first of all, as everyone knows we've originally launched Mucinex to our customers starting in April 2012, that was a select number of customers, limited amount of quantity as we are getting ready for the full scale launch to our OTC customers. We noticed a change in the characteristics of one of the excipients in our products that force us to go back into revalidate our product with this new excipient characteristics, we have done that. As I sit here today, we expect to be able to launch our Mucinex 600 milligram in March of 2013, and as I've noted that – the day we launch it we will send out a press release to everybody to alert them the fact that we have launched it.
The only other thing I will say about Mucinex is that we all launch practices that are necessary for this product launch have either been completed or in process as we speak today. So March 2013 is our best estimate at this time. On the second question on the flu benefit in the March quarter, I would say that at this point the majority of the increase in incidents of flu really happened in about mid December, so it wasn’t a major contributor to our second-quarter. But certainly there was some come contribution in the second quarter. I think the only other thing I want to say on the third quarter, fourth quarter is really the comments that Judy said is we are really – we put that into our guidance, the real question though is we cannot predict exactly the duration of the cough/cold flu season. At this time we really try to track what I'd call is the area under the curve of the incidents of cough cold flue. And right now as I sit here today it’s up about 20% from last year, that’s the specific number as we sit here today. Don’t know that duration will continue at this rate and that's really what we try to put into our probability waiting for the remainder of the year which Judy highlighted.
On the question of the competitors and where they are, J&J continues to resolve their questions, the latest information that I’ve heard have been that they will continue to bring product to back into 2013 and expect to have the majority their products back at the end of – by the end of 2013, and we’ve attempted to factor that into our guidance really – as we said we always try to bring that in one quarter at a time, not try to get ahead of ourselves on that guidance question. On the other individual company you mentioned Novartis -- Novartis has reentered the product categories the calendar fourth quarter. They began reentering products into the categories and that is our expectation is that they will continue to reenter products as we speak.
Dave, I think you mentioned also the flea and tick category, that’s a channel products. So it’s not overlapping with our focus on the retail consumption of flea and tick.
David Risinger - Morgan Stanley
Sorry, I jumped on late, so I didn’t follow the rule. My apologies.
Your next question comes from the line of Dulie Sammin (ph) with JP Morgan.
Just a follow on the Mucinex franchise, what’s really – for timing we understand March of 2013 for the 600 milligram dose, does the excipient issue crossover to the other potential formulations of Mucinex and can you comment on the timing of the launches of those other formulations as well?
Sure. First on the question the Mucinex 600 milligram products and our expected March 2013 question, and the excipient does not relate to the other products. So the excipient issue that we have experienced with our 600 milligram product does not relate to the other Mucinex family of products is the answer of that question.
Relative to the other products, as Judy stated very well what we simply we did is because of the difficulty in seeing complete visibility of those products, we simply at this time decided to lower the probability of those products launching in the current fiscal year which as Judy mentioned caused some of the decrease in our new product – for some of the partner products that we have identified in our new product launches.
So those other formulations, so do you think that could potentially be a 2014 event?
Really don’t want to make any comments specific to 2014 but be clear as we've delayed or we reduced the probability and then by definition delayed the product probability of coming into this year it does not suggest that they will not come to the market, simply delayed the timing.
Your next question comes from the line of Jami Rubin with Goldman Sachs.
Ariel Herman - Goldman Sachs
Hi this is Ariel Herman in for Jami. Just a question on the guidance, just maybe if you guys could give us some of the swing factor to year being that we are about halfway through the year and the guidance trend is tough. So why – just maybe a little bit of the swing factors and why the guidance hasn’t maybe been increased with the Cobrek acquisition and the flu season being so strong?
Sure. Well, let me be clear, there is – so as you stated – there is a wide range in our EPS guidance to be clear. So I don't know I’d say that the actual percentage of cents of guidance doesn’t include a Cobrek number. So let’s – there is a wide range there, we’re still in that range. However as we stated – and I think Judy may want to make some comments to this as well, we feel very strongly that right now we’re continuing to monitor the cough cold flu season. If that duration continues there will be upside but we do not want to bake in the upside at this time until we actually see it because we believe in being cautious in that sense there.
Number two, the Rx business continues to perform very well, we’ve got a number of new product launches as evidenced by the product Olux-E we launched today, Lux-E product that we launch in mid January and then we have about half a dozen additional launches that we have planned for the rest of the year. Assuming those products go well because we probability waited our launches, there may be some upside but I think we want to take them one day at a time as we go out with these products. And clearly the comment on Cobrek is we are delighted with that. We’ve already got these two launched with Cobrek and so we think it’s a great opportunity for us relative to our Rx business and we are going to continue to monitor it. But we would rather take one day at a time rather than -- in one quarter at a time rather than build everything into the guidance at this time. So I think those are probably the first – Judy, want to make any other comments?
I would say Ariel just to give you – the overview our guidance range of $0.20 is about 3%, if you look at kind of the midpoint of the range, in cent terms $0.20 but in percentage terms quite very small. When we moved guidance in the past, we moved the range, usually with a specific finite item and acquisition that moves us outside of the range, a tax settlement again that moves us out of the range. In this quarter there are a lot of moving pieces at Joe’s just comment just now and I think we’ve stuck with our consistent philosophy of managing moving parts decreasing new products offset by other things, and without any specific items that move us out of the range, we were going to adjust at this one (ph). That is consistency in the approach.
Your next question comes from the line of Linda Bolton Weiser with B. Riley Caris.
Linda Bolton Weiser - B. Riley Caris
So I know you don't want to get into like a big long-range projections right now. But maybe now that we have some additional things contributing to growth for FY 2014 in terms of the acquisition, can you give us some just really broad brush strokes on -- it seems to me that EPS growth rate next year FY 2014 could be quite high, assuming base business growth of 10% to 12% and then accretion from the deal, and then the generic Temodar API, which was like a spurt of earnings in FY 2014. So it comes to a pretty high EPS growth rate. So is the offset that it's not such a robust year for new products because there's nothing big? Or can you just, without giving the guidance, can you just give us a way of have to think about it for FY 2014?
Linda, you mentioned a couple of important items for us to be clear. The temozolomide is a big product launch for us, it’s a launch for us in August 12, 2013 at least we believe a six month exclusivity as to whether it will be a longer exclusivity I can’t comment on that right now. But certainly at least for the first six months and as you know Temodar U.S. sales are very significant, I think Merck reported somewhere in the $960 million global sales number for Temodar. So it’s a big product. You’re absolutely correct.
I think though on the question of 2014, I don’t think I could really comment any further on that other than just what we speak about what we've talked about in our long-term guidance and that’s really that we say we expect to see somewhere between 5% to 10% revenue growth for our business on any three-year term and then the corresponding earnings per share growth would be approximately double that or 10% to 20%. And really that’s all I think I can say about will 2014 at this time based on the fact that we’ll have more to say about 2014 I guess.
Your next question comes from the line of Ami Fadia with UBS.
Ami Fadia - UBS
I've got one or two quick questions and then maybe it's like a three-part question. Maybe just on nutritionals, could you tell us what would be the drivers to get you to your new guidance range over the next two quarters? And on the Rx side, what should we know about any new competitors or any change in the competitive landscape there? And then, just thirdly, on the acquisition in pet care announced this morning, maybe if you could give us a sense of growth expectations, margins for the business and a little bit about the pipeline. I know it's going to be a long question.
Okay, I will try to get to all of them and Judy, please help. On the nutritional side, really the growth expectations for our nutritionals are going to be two areas. Number one is infant formula and number two is the VMS. Clearly because it’s easier, one, really the growth in the VMS is really related to upticking of two additional customers, one of which we’ve already shipped, the other one is starting to ship soon. But that’s going to drive some of the growth in our nutritional business from the VMS side.
But really the important part of the growth is going to be – and certainly the operating margin growth is going to be driven by what we can do with getting the new package product out to the marketplace, which we are underway right now. We started shipping in December and that is happening as we speak. More products will be shipped as we go into the next weeks ahead. That’s going to be the big driver. Beyond that the actual shipping of the package, more importantly is the incremental promotions we are getting from our retailers. Those incremental promotions we think will help us to drive the business and help -- importantly drive store brand share. As I mentioned in my commentary when we moved our packaging to be more closely aligned with the national brand packaging, we do better. We gain conditional market share as it invites the consumer to compare our product with be the national brand and that's why we're really excited about our new package design, because now our package looks much more closely to the leading national brands, the Similac, the Enfamil and the Nestle Gerber product. So that’s really the excitement we see in the nutritional side.
On the Rx part of the business, in terms of changing landscape really – there are individual companies and individual product competition that we face but no major shift in the change in our Rx business. In fact, I would say we’re sitting today as I mentioned with the best pipeline opportunities we’ve ever had in the history of Perrigo’s Rx business. We’ve got a great pipeline of products, we’ve already launched two products, both the Luxiq foam, the Olux-E foam and then we have about a half-dozen of additional products that we expect to launch in the next six-months or by the end of the current fiscal year, I should probably say the next five months. So we feel like we are in a great position relative to the Rx business. There is clearly going to be some competition on the product A or product B but the wealth and breadth of our portfolio of new product launches is really what’s going to drive the success in our Rx business. And we are excited that most of these products are products with limited number of competitors.
Final comment was on the acquisition today, when you take our Velcera business, you add it to the Seargent's acquisition we essentially required approximately $200 million of business and I think I would say our expectations for growth are in that high single digit growth rate, so relative to where we expect it to grow. Obviously as we launch products with this category that’s when we’ll see acceleration of growth in any given year and we look to have more to say about that in the future in terms of our ability to launch new product as a result of taking the Velcera team and putting it with the Seargent’s acquisition and then driving our operating and gross margin.
Only other comment I would say is when we made the first acquisition in Seargent’s one of the comments I made is we picked up manufacturing capabilities as we add to develop better product range, we think we will also drive the gross margin and operating margin of that business to allow us to have certainly better than our average corporate margin in both of those cases.
Your next question comes from the line of Elliot Wilbur with Needham.
Elliot Wilbur - Needham & Company
Thanks. Good morning and offer my graduations to Judy and Art for their placement in the Aye-Aye All-America executive team. Joe, I just congratulate you on being an all-around great guy. How's that?
So my question is with respect to the generic segment. You hit on this a couple of times, but again, just thinking about even the low end of guidance. I mean, that would basically imply that you are going to kind of be at a $190 million run rate per quarter for the second half of the year. And obviously, if you're going to have some contributions from some new products, I'm assuming Cobrek is more of a margin impact. But I'm just wondering now, have you gained more confidence in some pipeline assets that maybe you had heavily probability-adjusted previously? And now you -- maybe you've adjusted those probabilities upward? Just difficult, I guess, sort of given what we know about the pipeline to see how you are going to get to those sorts of levels.
As we look at it, or are just simply looking at the pipeline opportunities, for example, getting the launch of the Luxiq and the Olux-E form behind us, having those launches January 15 and then again today that really improves our probability waiting on products just as they happen. So it’s an important part of how we look at forecasting. In addition to that, the clear other important factors I mentioned just a minute ago as we have six plus product launches in our Rx business over the next five months. That’s really going to help drive our performance in the Rx segment of our business. So that’s – it’s really our – as we look at the number of product launch opportunities we have, as we look at what the new products do for driving both the gross margin and operating margin, that's really what is going to be a critical element for us for the next five-months, and that’s really why we have the confidence.
Many of these products are what I would call either a date certain launch or an end of expiration period. So we have a good cool as to when they are launched to be fair, a couple of them are not. A couple of them we have to wait for approval and then we can go but as we balance out the probability waiting those products that’s the reason why we have the confidence for the remaining half of the year for our Rx businesses.
Your next question comes from the line of Louise Chen with Guggenheim.
Louise Chen - Guggenheim Securities
So as we look at your business now, it looks like you've got several meaningful growth opportunities. You've got the animal health, international expansion, Rx to OTC switch environment, improving at the FDA, you've got the infant formula and diabetes care. So just curious, of these opportunities, which one are you most excited about and why?
Well, I think I’d say in general Perrigo will continue to focus our business on our consumer healthcare and nutritional business. We are a store brand private label player and as we look at what’s happening there, there is couple big drivers and those are the ones that you mentioned. We continue to see acceleration of the store brand usage and the movement from national brand to store brand. I think that’s got to be -- probably one of the most important drivers in that we see every quarter of store brand growing about 9% where national brands are flat to up slightly. That's really going to be one of the imported drivers and one of the things we continue to track for our future.
The second comment is just take the example of what happened in the past week, the fact that Oxytrol has moved from prescription to OTC, that’s an important product not just for that individual product but it’s a brand new category with overactive bladder. There are some big products in that category, Detrol, Detrol LA, Ditropan are all examples of products that are in that category, and when you move another category like overactive bladder specifically like Oxytrol, it puts up the overactive bladder question. I am not suggesting today all those will move but certainly it is another potential example of what we are expecting. Animal health brand-new but Judy may want to make some more comments there.
We never want to pick between your children, but animal health space for us is incredibly exciting because if you think about – Joe just talked about all the opportunities of products that are going from behind the counter to over the counter. Animal health creates an entire new opportunity to save consumers’ money by being able to procure products in the retail space. The retailers are excited about being able to have products available, having store brand offering available. These two acquisitions are going to create an entire new aisle of value for consumers and I think that’s really exciting, it’s basically OTC in the 1980s as there is a whole new quality affordable healthcare offering. So that’s pretty exciting for us just because we’re going to be at the forefront of creating a whole new space for consumers.
Your next question comes from the line of Annabel Samimy with Stifel, Nicolaus.
Annabel Samimy - Stifel, Nicolaus
I think all of them have been answered, but I can ask you a variation on all of them. So maybe we can go to Rx Pharma for a bit. I mean, you've talked a lot about how you are set up for the year. This quarter, I guess, you had the one less week and you had some increased competition. How much can the new product launches that you have offset some of the competition that you've seen this quarter? And maybe can you talk about how you are set up for the medium term? Are most of these products in new foam launches or are these product categories that you potentially see competition in the future?
Well, in general I think we are looking at our Rx portfolio, we clearly as Judy said see some significant growth opportunities with our Rx business. That’s why we continue to look at our guidance, we think revenue growth can grow 15% to 19% for our Rx business and that's why we are – but most of all we’re excited about the new product potential for the Rx business.
On the question of our pipeline as I stated before, it’s the best platform we’ve ever had in the history of our company in the Rx business. So we are really excited about what that could mean for the growth aspect. Importantly that as you know new products tend to drive not only the sales line but they also drive the operating margin and the gross margin of our business. So for those reasons I think that’s going to offset any of the potential question we have on any competitive challenges and allow us to continue to demonstrate a very significant both gross margin and operating margin of the business.
As it relates to new products, majority of these new products fall in what we call extended topical. My extended topic, if I remind you, we think certainly dermatology products absorbed topically through skin, respiratory products absorbed topically through the lungs, nasal products and absorbed topically through the nasal mucosa. Those are the things that we talked about and that’s where we continue to stay focused on our portfolio of products and that’s really what we would continue to look at for the Rx business. Obviously we’ve got some other examples, the metered dose inhalers and other places we go with the business such as the -- we've got the first to file on ProAir. And I think, many of you may have seen, we got our first testosterone product approved yesterday and hopefully more to come but we will have more to say about that for the future.
Your next question comes from the line of Greg Gilbert with BofA Merrill Lynch.
Greg Gilbert - BofA Merrill Lynch
I have two. First, for Judy, I think your EPS year to date is tracking a little better than cash flow from ops relative to the full year goals. Is that just the typical rhythm of cash flow realization or are there other factors to consider in the second half? And, for Joe, is there a way for the Nexium-like store brand opportunity to form before Pfizer has its three years on the real Nexium product? Thanks.
Greg, I will take your cash flow question first. I think you just like to listen to me say that cash flow is never linear. The strong second-quarter and the drivers in cash flow of course starts with net income and based on the guidance we provided and the color we’ve given around concerning the consolidated projections for the full year, you can probably model fairly well the cash flow on net income and then the moving pieces on working capital, lot of inventory movement around this time of year as we’re in the midst of launches and of course cough cold flu season and as we gear them into the summer, we usually have a pull down in inventory and pull through on the working capital side. So usually although it’s never linear Q2, Q4 the larger a cash flow quarter is, as we confirmed our full year cash flow guidance at the moment. So not linear but we’re cost back up on where we thought we’d be year-to-date and on track for the full year.
On the question of Nexium Greg, at this time we think it’d be unlikely that there'll be Nexium store brand or competitive opportunity in OTC space before Pfizer launches theirs. But I can never say never but I think it's unlikely I think we'll see the Pfizer product show up in approximately 2014 and with an expected three year exclusivity we obviously want to get ready for any situation but with an expected three year exclusivity that would bring us to about 2017.
Greg Gilbert - BofA Merrill Lynch
And could BenzaClin be one of your launches this year?
You know that we don’t ever comment about our products., of course unless there is litigation, Greg. So I apologize I can’t answer that question. You also know that we know a lot about clindamycin and benzoyl peroxide but we can’t really comment about any individual product.
Your next question comes from the line of David Steinberg with Deutsche Bank.
David Steinberg - Deutsche Bank
Two quick questions. First on tax rate, Judy, I think at the beginning of the fiscal year you discussed 29% to 31% range for the year. But there could be some conservatism given some statute expirations and audits, and I think you said it could be a $40 million benefit. So in the first quarter, tax rate was 26%; 28.5% this quarter. Are you still guiding for 29% to 30% or should we think about a lower number?
So a great question. Just to go back to your comments, you made a comment about 49 upside, I think it was closer to 15, or check in the Q it will be going out this afternoon. But specifically we confirmed the range for the full year. Obviously as you know we picked up Seargent’s into the portfolio, will have nine-months of Seargent’s operations in there, as a 98% U.S. company at a 37 plus percent tax rate. And that’s a drain on the overall rate. A good guide though is our friends in Congress have renewed the R&D tax credit and the renewal of that will flow through the full year rate and be a good guide. So hence we kind of come out to a rate – still in that range maybe near the lower end of the stated range at the moment and that’s excluding any additional tax audit settlements or any one-time items that may come through that are unforeseen at this moment but we’ll obviously give color if any of those one timers come around. But the blended rate -- jurisdictional rate blend taking into consideration the renewals of the R&D tax credit I would expect it to be more the lower end of the stated range.
David Steinberg - Deutsche Bank
And then Joe, quick question. I think you mentioned the next five years it might be $10 billion worth of Rx to OTC switches. I know recently you've been incrementally more positive on the outlook for statins to go over-the-counter. Are statins in that $10 billion or are they not?
Yes, I did mention 10 billion in the next five years. Statins are not in our numbers at this time. I do believe that statins are something like a 60:40 probability, that would be 60% positive, 40% negative, but because of the size of the stat category we do not include it in our numbers as we think about the future, just something we prepared ourselves for in the event that that occurs and we could not -- 60:40 probability that’s something we’ve built into the model at this time, it’s just too uncertain at this time.
Your next question comes from the line of David Buck with Buckingham Research.
David Buck - Buckingham Research
Just a couple of quick questions. First, on the animal health business, Joe, you mentioned is about $200 million if you combine Sergeant's and the acquisition today of Velcera. I guess, why wouldn't it be growing more than high single digits given that you are expecting to actually launch some of the store brand versions of Frontline? Secondly, for OTC switches, the Oxytrol launch later in the year, are you expecting that to have three-year exclusivity? And can you confirm that you have some type of opportunity in that category as well? And then, just finally, for Joe, the flu season, better than expected so far, I think you mentioned 20% higher versus a year ago. When will you get a sense of whether you'll see the reorders that would push it well above what you've been modeling? I mean, at what point do we need to see the duration of the flu?
David, you tracked pretty well with my comments, Velcera $200 million and equipped 140 million with the 60 million, basically that is the $200 million product category for us. We are excited about the growth opportunities as we bring out store brand products because once again we think it’s going to be able to move markets from the vet only channel into the mass-market retailers such as Walmart, target, CBS, Walgreens, et cetera, so that’s all important activity for us and ones that we are very excited about. However one of the things we have not even closed yet on Velcera, we closed in October for the Seargent’s business. I think we just don’t want to get ahead of ourselves in terms of the opportunity there. And if indeed, there is more upside for that we will have comments later but right now we look at it as a – as I mentioned high single digit growth rate for the category and we will continue to track it and if it gets better than that, we will be happy to share that.
On the Oxytrol, it is something that we have been tracking and certainly something that once again we’re very excited to introduce a new category of overactive bladder products into this Rx OTC switch category. I do expect that Oxytrol will get an exclusivity, it has to do with very large trial that would allow the FDA to understand the ability of the consumer to make use this product. So therefore I do think there will be an exclusivity period granted to this product, otherwise don’t have a definitive answer at this time. So we do think that there is a three year exclusivity, and I am not going to – I can’t obviously comment about products we have specifically in our category.
On the question of cough cold flu starting in mid-December as I mentioned the season did take off significantly really in many parts of the country reaching epidemic proportions. It is about a 20% increase over a year ago, at its high it was in the mid-20s percent increase over year ago, so it’s something we continue to track on a weekly basis. Thus the biggest question for us is going to be when does the season come to a conclusion. So for example I used the word area under the curve if you are mapping that and charting it out, think of the line being 20% above where it was last year, the question of does it stay above last year at the 20% rates or a month which you’re seeing already. Is it two months, is it three months or does it drop down precipitously and go below the line, I cannot predict that. So what we do is take one quarter at a time in terms of our expectations. I can simply say that the demand for our cough cold flu season during the month of January has been very strong and I will have to probably leave it at that at this time. Can’t tell you if that’s going to continue into February and March, it’s too early for me to make that comment.
Your next question comes from the line of Shibani Malhotra with RBC Capital.
Shibani Malhotra - RBC Capital Markets
Just on your long-term growth, I guess the biggest -- the number one question we get from investors is whether Perrigo has grown too fast, too quickly, and how the company is going to be able to sustain the growth rate. So if you could just comment on that on a broad level. But then specifically, I think, Joe, you've talked about your -- and the OTC opportunity there as being something that you're very interested in. And there have been some recent dynamics in the market which are probably favorable to you, like the Celesio company getting a Lloyd's brand across Europe. So can you just talk about how that marketplace is evolving and whether you are seeing competitors trying to get in, like Watson, and how you're thinking about that?
Really the long term growth starting with that part of the question first, I can simply say that the megatrends that we continue to follow support the continued long-term growth of this business and really when you go back to is as the consumer healthcare megatrend, the movement from national brand to store brand continues. As evidenced by what you're seeing in the weekly data that we – or the monthly data –quarterly data that we sent out. And the second megatrend is movement from Rx to OTC, that’s a trend that we continue to see as evidenced by what you saw last week with Oxytrol, what you saw by the acquisition by Pfizer of the Nexium product portfolio, of the Nexium and extending their portfolio and bring it out estimate from that result. I think that megatrend continues. Other than the commentary I already made on talking about a long-term organic growth rate of high 5 to 10% and double that on the bottom line, I really can’t make any additional comments on that. I will remind everybody that we'll have more to say about 2014 in our August call and then on October 1, we expect to have an analyst day where we will go through all the major drivers of the business on October 1 to share more.
But really if you get through the basics of what makes Perrrigo successful we really believe it’s making sure we have a quality product, make sure we have good customer service, make sure we get out with the new product innovation, being in that first wave and making sure we keep a low cost structure, and continue to develop the people of the organization to allow us to continue to grow. Those are really the five things that I keep my hand on all the time, and I think that’s a critical thing that will make us successful.
On the question on Europe, as you know we’ve got more than 15 products that we have submitted, or are in various stages of regulatory approval some of them are approved, some are approved by country. Those are the things that we continue to look for growth in Europe but to be absolutely clear for continental Europe, the market in continental Europe is more consistent with what I would call in the United States our independent pharmacist model, there is no large retailers like Walgreens, CVS, or Walmart in continental Europe. So we have taken a approach similar to what we do in the United States with independent pharmacists where we work with large distributors like the Cardinal Health, the McKessons, the AmerisourceBergen. And that's really where we are sitting today. There may be opportunities for other acquisitions in Europe or other partnerships in Europe but right now I think we’re looking at this more similar to the way we look at independent pharmacists in the United States and how we go to market there by working with distributors, you mentioned Celesio, you didn’t mention Alliance Foods but I think those are some of the examples of opportunities for us.
Your next question comes from the line of Randall Stanicky with Canaccord Genuity.
Randall Stanicky - Canaccord Genuity
Judy, on Temodar, it's obviously a big opportunity. Can you just remind us of the economics relative to your split with Teva and any tax benefits that we should be thinking about with respect to that profit wash? And then, Joe, just at what point does Mucinex miss the cough and cold window for this year?
I will jump in on the first question, as you know we are expecting to launch that product in August of this calendar year. That will fall into fiscal ’14, the profit sharing arrangement that we have we don’t disclose the specific terms of it. So suffice it to say in your modeling it’s probably easy to just go, assume a profit split for these calculations. We won’t specify any more details than that.
The last piece, additionally sometimes in these arrangements there is a delay in the revenue recognition because of the timing on visibility to final third-party sales, it happened to us in the past, if you remember a few years ago it was a different launch. I can’t say yes, I think that is going to be the case, we will have better visibility as we get right on top of the launch date and I will probably be able to provide specific color to that when the first sale will be realized, it will be Q1 fiscal quarter or Q2 but the date of the launch is still going to have in order.
Last point on the tax front, I would expect that this launch will have a lower than average tax rate applied to a – I am not giving specific yet at this point but I think it would be a benefit overall to the effective tax rate for the full fiscal year rather than address it.
And then on the question Randall, of the Mucinex launch, as we said our expectation is that we will launch that in the March 2-13 timeframe and as I said most of the batches are ready to complete at this time for the launch, or in process, so we feel very good about our capabilities there, all the product has been validated or the processes have been validated for Mucinex.
Relative to the question of whether we miss the season or not, we look at Mucinex as being certainly important for cough cold flu season but also obviously for the allergy season, so we will certainly feel the time for that. But before the bottom line is as we look at our revenue guidance for consumer healthcare for a 16 to 20% growth for the full year, we did that with the knowledge of how we will probably realize the launch of all of our products and certainly the Mucinex 600 milligram was front and center in what we were looking for that, 16 to 20% growth rate for consumer healthcare.
Your final question comes from the line of John Anderson with William Blair.
John Anderson - William Blair
I'll keep it brief. I just wanted to ask about the international business. I think you mentioned early that OTC outside the U.S. was up 9% in the quarter. Can you just talk a little bit about the dynamics there, where you're seeing strengths, in which markets, and what your expectations and efforts there are going forward?
Well, I will just make a general comment. Relative to our international business, they had a good quarter, both in terms of foreign exchange but also in terms of real revenue growth. So they were both positive from foreign exchange but also on revenue growth. The businesses did well for us, we are certainly – our Mexico business, our UK business did very well for us and importantly we look at Australia as a being a big driver for us for the future as really Australia is very much in its infancy of store brand growth. So as we build more capabilities in Australia we think that’s going to really pay important dividends for us for growth for the future, but to be clear UK and Mexico really exceeded our expectations during the quarter and helped us to drive our OTC business.
Just highlighting what you said, the store brand is maintaining and growing store brand share, the UK store brand penetration has always been quite high, it was in excess of the US for many years but the US has been able to catch up with the penetration rates than have been historically seen in the UK. But that team is able to bring new products out, so the strength is there. Mexico still has runway, Australia still has runway and we have seen some uptick in the last few quarters.
Maybe operator, if I just close quickly, first of all thank you very much for your interest in Perrigo, I would say special thanks to everyone on the Perrigo team. They just did another outstanding quarter, it was just a great quarter, of collaboration and working, a lot of hard work went into the quarter into the M&A activities to announce, that’s out there this morning and everyone just did an outstanding job within the Perrigo team.
I think if you're looking at some of the important milestones for Perrigo over the near future clearly in the consumer healthcare that will be the continued cough cold flu season, what’s happening there as well as our Mucinex launch as stated before, we will make sure we get a press release out on Mucinex on the day it launches. On the Rx side, it really is going to be continued acceleration of the new launches for us on the Rx side of the business and what’s happening with those new product launches, we will have more to say about those as we launch this individual product and then finally really excited about what team’s effort have been to bring Velcero’s team to Perrigo and allow us to have approximately $200 million pet care business that we believe will have high single digit growth rate and importantly make a meaningful difference in the ability to provide a quality flea and tick product offering into the marketplace with an affordable price, that we think is very exciting and very core to what we do at Perrigo in our mission. So thank you very much for your interest in Perrigo and have a great day everyone. Have a good day.
This concludes today’s conference call. You may now disconnect.
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