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Watson Pharmaceuticals, Inc. (WPI)

Q4 2008 Earnings Call Transcript

February 19, 2009 8:30 am ET

Executives

Patty Eisenhaur – Executive Director, IR

Paul Bisaro – President & CEO

Mark Durand – SVP & CFO

Analysts

Greg Gilbert – Bank of America

Corey Davis – Natexis

Tim Chiang – FTN Equity Capital

Rich Silver – Barclays Capital

Ronnie Gavin [ph] – Bernstein [ph]

Elliot Wilbur – Needham

Randall Stanicky – Goldman Sachs

Graef Crystal – Morgan Stanley

Michael Tong – Wachovia Capital

John Bourse [ph] – Citi

Operator

Good morning. My name is Erika, and I will be your conference operator today. At this time, I would like to welcome everyone to the Watson Pharmaceuticals fourth quarter and full year 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) Thank you. Ms. Eisenhaur, you may begin your conference.

Patty Eisenhaur

Great. Thank you, Erika, and good morning, everyone. I’d like to welcome you to Watson's fourth quarter and full year 2008 earnings conference call. Earlier this morning, Watson issued a press release reporting its earnings for the fourth quarter and full year 2008. The press release is available on our Web site at www.watson.com, and includes the reconciliation of our GAAP and adjusted financial results and forecast. Additionally, we are conducting a live webcast of this call, which will also be available in our Web site after the call's conclusion.

With us on today's call are Paul Bisaro, President and CEO of Watson; and, Mark Durand, our Chief Financial Officer. Also present and available during the Q&A portion of the call are Tom Russillo, President of our Generics Division; Ed Heimers, President of our Brand Division; Al Paonessa, Chief Operating Officer of our Anda Distribution Division; and, David Buchen, our General Counsel.

During the formal portion of today's call, Paul will share highlights of the fourth quarter, including highlights on the performance of our three business segments. Mark will then provide some additional details of our results for the quarter and the year. Paul will conclude our presentation with the strategic outlook for the company and our outlook for 2009. We will then open up the call for questions and answers.

Please note that today's call is copyrighted material of Watson Pharmaceutical Inc. and cannot be re-broadcast without the company's expressed written consent. I’d also like to remind you that during the course of this call, management will make projections or other forward-looking remarks regarding future events or the future financial performance of the company. It’s important to note that such statements about estimated or anticipated Watson results, prospects, or other non-historical facts, or forward-looking statements, and reflect our current perspective of existing trends and information as of today's date. Watson disclaims any intent or obligation to update these forward-looking statements except as expressly required by law.

Actual results may differ materially from current expectations and projections depending on a number of factors affecting Watson's business. These factors are detailed in our periodic public filings with the Securities and Exchange Commission, including, but not limited to, Watson's Form 10-K for the year ended December 31, 2007.

With that, I'll turn the call over to Paul.

Paul Bisaro

Thanks, Patty. And good morning, everyone, and thank you for joining us today. We are pleased to be able to share with you our results for the fourth quarter and the year. And I’m extremely proud of our accomplishments for 2008 and the fourth quarter capped off what has been a very successful year for Watson.

2008 was a year of focus, execution, and momentum building for us. A year in which we set goals and met each of them, and a year in which we made significant progress in our product pipelines and our strategic initiatives. It was also a year in which we continued to make investments in the future. I believe that we now have the foundation, which will carry us into what will be a very exciting 2009 and beyond.

This morning, I’ll briefly review our financial results and provide an update on each of the three business segments. Mark will then provide further details on our results, discuss how we view our capital structure, and how we are preparing for new growth opportunities that we see.

Taking a look at this morning's earnings report, we are pleased to announce that our fourth quarter and full year finished strong and ahead of expectations. Our consolidated revenue for the fourth quarter was $645 million, and revenue for the full year was $2.5 billion. We posted strong fourth quarter adjusted earnings of $0.53 per share, and adjusted EPS of $2.03 for the full year. Adjusted EBITDA for the quarter was a $143 million, and for the full year $567 million. Cash flow from operations for 2008 was a strong $417 million.

Turning to our generics business, we continue to make progress both operationally and on the R&D front in our generics division. We launched 11 new generic products during 2008, and we have already launched another two in 2009.

While we have had our share of high profile commodity product launches such as alendronate sodium, we have realized an important overall shift in our product mix towards higher margin products. Products such as clarithromycin Extended-Release, Galantamin Extended-Release, and transdermal fentanyl contributed significantly to our generics product sales and profitability this past year. And we expect to see continued strong contributions from these products throughout 2009.

A major operational success came in April last year with the OAI status being lifted from our Davie, Florida site. This allowed us to get additional and important new product approvals and launches from that facility, products such as omeprazole 40 mg Delayed-Release, on which we had 180 days of exclusivity, and potassium chloride or generic Micro-K. This facility is now performing well, and is preparing to meet the challenges for generic Micro-K as well as for generic Toprol XL, products which I will discuss in detail shortly.

We continue to make good progress on our Global Supply Chain Initiative and Operational Excellence programs. Product transfers from our Carmel, New York facility; to our Davie, Florida; Corona California; and, Delhi, India sites is ongoing. and we continue to meet or exceed all of our milestones. With the build out of our Goa facility near completion, product transfers to that site will increase in 2009. And we will begin to realize additional savings as each transfer is completed.

Also, our Operational Excellence Initiative has been implemented and continues to be rolled out across our US facilities. Last year, we've realized approximately $20 million in sustainable cost reductions from Global – from the Global Supply Chain and Operational Excellence Initiatives, with more to be achieved in 2009.

On the R&D front, we made significant efforts in 2008 to realize – to rationalize our generics pipeline in order to create a stronger, more focused, and more profitable product portfolio. Today, we have approximately 60 ANDAs pending.

We are off to a quick start in 2009 in the generics business. We were able to leverage our financial strength to buy a series of products from Teva that were divested because of – because of their recent merger with Barr. Distribution of these products began in January. We launched Azurette, our generic version of Mircette in early January bolstering our strong generic oral contraceptive portfolio. We also have the launch of Mint Coated Nicotine Gum underway, and we expect to see more flavors of Gum approved as we progress through the year. So we’re starting out the year with continued momentum and with plenty of opportunities in front of us.

Moving now to the brand business. 2008 was a very rewarding year for us as we continue to establish our presence in three therapeutic areas, neurology, gynecology, and nephrology, while also significantly expanding our brand portfolio.

I am proud to say that our brand R&D and regulatory teams delivered exactly what we asked them to in 2008. Their challenge was to file three new drug applications in 2008. And not only did these NDAs get filed, but we received first cycle approval on Rapaflo, our alpha-blocker for BPH in only 10 months, which is particularly impressive for a new chemical entity, and which speaks volumes about the high quality and efficiency of our R&D, clinical, and regulatory groups. With the rapid and sustained – with rapid and sustained efficacy and exceptional safety profile, we believe that Rapaflo provides us with excellent long term opportunity and will help strengthen the foundation for future growth within our urology specialty area.

We are actively working on launch preparations for this new brand. And pharmacy stocking will get underway in late March. And our urology sales force will begin detailing to positions in early April.

In January this year, we also received first cycle approval of our second NDA filing, our oxybutynin gel product Gelnique. This product is a unique formulation of oxbutynin. It is the first and only topical gel for the treatment of overactive bladder, currently a $1.8 billion market. Our specialty sales force will be actively marketing Gelnique to gynecologists and urologists. And we anticipate that the product will be made available to patients in late April.

Our third NDA, for a six-month formulation of Trelstar, was accepted for filing by FDA in November of last year. And we anticipate FDA will take action on our application in the third quarter of this year. So it is conceivable that Watson will be in the unique position of introducing three new brand products this year that treat the top three conditions in urology. This is certainly impressive for any company.

We have also been busy on the business development front. In January, we announced an agreement with Warner Chilcott to co-promote Femring to gynecologists. The specialty field force will begin promoting Femring this quarter. As a reminder, we do receive fee based compensation for promoting this product and a royalty on a portion of sales above an agreed upon level.

Additionally, we have licensed the late stage oral contraceptive product from Warner Chilcott. The pivotal trial is complete, and Warner Chilcott anticipates filing the NDA in the second half of 2009. This product is anticipated to be launched in late 2010, early 2011, and will provide a good foundation to our growing Ob/Gyn franchise.

That’s the quick update on Ferrlecit. As a reminder we have enough Ferrlecit inventory on hand to carry us through the year. The arbitration hearing regarding the agreement with Sanofi-Aventis is scheduled for April, and the arbitration panel has confirmed they expect to deliver a decision in May. We do feel confident that the arbitration panel will agree with us that our distribution agreement with Sanofi terminates at the calendar year-end 2009. We also continue to dialogue with Sanofi, but as of now we have no updates to provide.

Finally, we continue to develop contingency plans in the event we are unable to reach agreement with Sanofi or in the event we do not prevail in the arbitration. Due to the sensitive state of discussions with Sanofi, we are not going to discuss the specifics of our contingency plans, but know that we are working to ensure a smooth transition for our nephrology franchise.

Turning now to our distribution business, this segment was also very productive in 2008. This past year, ANDA was instrumentally involved in some significant product launches, including generic versions of Prosperidol [ph], Protonix, and Magil [ph], which certainly contributed to ANDA's success in 2008. Additionally, ANDA expanded its business model to include both generics and selected brands, becoming the main secondary wholesaler for an expanded group of customers. Lastly, ANDA's margins were strengthened throughout the year primarily a result of purchasing initiatives that we were able to implement.

As you can see, we accomplished much of what we set out for ourselves in 2008, and we are well positioned to seize new opportunities that are presenting themselves in 2009. We also continue to post solid financial results, generate good cash flow, and are making continued investments in our R&D to grow the business further.

With that, I'll hand the call over to Mark who will give you some details on our financials for the quarter, the full year, and our current financial position. Mark?

Mark Durand

Thanks, Paul, and good morning to all. I’d like to now provide highlights of our fourth quarter financial results on a consolidated and divisional basis. We have provided segment details for you on our press release. So rather than review the entire P&L, I’ll go through the highlights and discuss the major moving parts.

Fourth quarter of 2008 net revenue with $645 million, an increase of 3% from the prior year period. 57% in net revenue is from generics, 18% from brands, and 25% from ANDA distribution.

On a GAAP basis, overall gross profit for the quarter increased 6% from the prior year period and includes $6 million in costs related to our Global Supply Chain Initiative. Excluding these costs, fourth quarter gross profit increased 8% to $159 million or 43.3% of revenue. The increase in gross margin was due to a favorable product mix and higher margins on new products. Improvements in gross margins are also beginning to reflect the benefits and cost efficiencies that we are realizing from our Global Supply Chain Initiative.

Let me provide a few highlights related to our divisional performance. Generics fourth quarter net revenue was $357 million. This is relatively even with fourth quarter of the prior year and up slightly from the third quarter of 2008. However, there are a few factors that should be mentioned. Generic product sales increased 6% or $21 million from last year's fourth quarter due primarily to additions of omeprazole 40 mg and ternazenol [ph], which were launched in the third quarter as well as growth from transdermal fentanyl.

Our generic other revenue declined $28 million, due primarily to reduced royalties on (inaudible) of sales of generic Toprol XL.

Our contraceptive sales in the fourth quarter were $80 million, down from $90 million last year. This is in line with our expectations, reflecting slightly lower units and pricing across our portfolio overseas.

Moving on to the brand division, net revenue was $116 million, up 6% or $6 million from the fourth quarter last year. Brand product sales consisted of $59 million in specialty product sales and $43 million in nephrology. Brand gross margin in the third quarter was 78.5%, which is an increase on both the year-over-year and sequential quarter basis. As a reminder, third quarter brand margins were affected by an inventory charge we took related to our input product.

Finally, net revenue from the ANDA distribution division was a $162 million, up 13% or $18 million from the prior year, due primarily to new product launches. Distribution gross margin was 15.6% consistent with levels we have seen through 2008, but up from 14.4% in the fourth quarter last year as a result of recent initiatives to enhance efficiencies in the business.

Turning now to operating expenses, R&D spending for the fourth quarter was $48 million, which is up about $12 million or 33% compared to the prior year period. The increased investment in R&D was heavily weighted towards the generics division and reflects acceleration activity following the rationalization of our generics development portfolio. SG&A for the fourth quarter was a $111 million, which is a slight increase over SG&A of $108 million in the year ago period.

Amortization for the fourth quarter was $20 million, a decrease of $24 million from the fourth quarter of the prior year reflecting the full amortization of Ferrlecit product rights.

Adjusted EPS for the quarter was $0.53 per share, and excludes $6.5 million in costs associated with our Global Supply Chain Initiative. Adjusted EPS is up $0.18 per share year-over-year, nearly all of which is due to the change in amortization expense. GAAP EPS for the quarter was $0.50 per share. Details on all the adjustments can be found in the reconciliation table in our press release.

Our adjusted EBITDA for the fourth quarter was $143 million, up slightly from last year and the third quarter. Cash flow from operations for the fourth quarter was $176 million, an increase from third quarter levels of $74 million primarily due to quarter-to-quarter working capital swings.

During the quarter, we chose to draw out $50 million from our $500 million revolver in part to pay for the Teva-Barr domestic products.

Capital expenditures for the fourth quarter were $21 million and $64 million for full year of 2008.

For the full year of 2008, we had total cash flow from operations of $417 million, with cash and marketable securities of $521 million at year-end, up from $216 million at beginning of the calendar year. Our consistent ability to generate cash flows and our strong balance sheet signifies the financial health of the business. Additionally, our management of expenses and financial discipline allows for an appropriately prudent and effective cost structure. Together, this provides Watson flexibility to move full speed ahead on our strategic growth initiatives and to invest in our future.

Our capital structure remains very strong. Current debt position is at $878 million, consisting of a $575 million convertible at 1.75% interest, a $250 million term loan, and the $50 million revolver at LIBOR plus 75 basis points.

Our debt-to-capital ratio continues to be below 30% at 29.4%, and our debt-to-EBITDA ratio was 1.5. At the end of the quarter, we had $521 million in cash and marketable securities and $450 million remaining available on our revolver.

As a result, we believe we have significant resources available to us to be opportunistic on the M&A front.

With that, I will turn it back to Paul to provide details on our 2009 forecast and concluding remarks.

Paul Bisaro

Thanks Mark. The forecast we are providing today is based on our base growth assumptions, and includes only a modest contribution from sales of generic Micro-K and generic Toprol XL. And then, I’ll discuss the possible additional impact on our projected results from these two products.

So for our core forecast, we estimate full year net revenues at approximately $2.65 billion or approximately 5% growth over 2008. Our bottom line is expected to grow at approximately 10%, with our adjusted EPS forecast between $2.18 and $2.28.

Let me provide a bit more detail on what is going into these estimates. We expect generic revenues to be one – between $1.45 billion and $1.55 billion. While we are seeing a moderating of price erosion on base generics business, we have continued to factor in an annual generic price erosion of approximately 10%.

On the brand side, we have significant opportunities in 2009 with the launch of three exciting new products. Revenue from the launch of Rapaflo, Gelnique, and the six-month formulation of Trelstar is expected to essentially offset the revenue decline we have modeled for Ferrlecit as well as some other brand products. So brand segment net revenue is forecast at between $445 million and $470 million for the year. As a note, we have forecasted a full year Ferrlecit contribution, but at a reduced revenue level due to the market dynamics in the IV iron space.

With the ANDA distribution business, we anticipate revenue growth to be 10% or higher, with revenue forecast between $660 million and $710 million. This increase in revenue will come from the continued broadening of our brand product offerings as well as our expansion into alternative care in the institutional markets.

Adjusted EBITDA as expected to be between $600 million and $620 million, reflecting strong improvements in our overall gross profit as a result of cost savings associated with our Global Supply Chain and Operational Excellence programs, and enhanced overhead absorption in our manufacturing sites. Again, the forecast we have just provided is considered our core growth forecast, and only factors in modest contribution from generic Micro-K and generic Toprol XL.

Now, let’s talk about those two opportunities. First, on Micro-K, we estimate the current market to be more than $100 million. With KB’s [ph] current inability to supply both their brand and generic products, we are now the only supplier of Micro-K for the market. We have the capacity and our foresight to meet the full market demand. And we are currently scaling up production, and expect to fully supply the market by March. Obviously, this product could provide upside.

Likewise, generic Tropol XL could be another upside opportunity. Unlike Micro-K, we are still awaiting approval from the FDA for our Tropol XL. The timing of our launch and the competitive landscape at that time will ultimately determine the amount of upside we have in this product. Nevertheless, it is important for you to understand that our adjusted EPS forecast of $2.18 and $2.28 could be significantly exceeded based on one or both of these opportunities.

To sum up, this past year has been a tremendous one for Watson, and I’m very pleased with the progress we’ve made in 2008. I believe our continued focus on execution and leveraging the momentum we have built over the past year has us well positioned for strong growth in 2009 and beyond. With that, I’ll turn it back to Patty for the Q&A.

Patty Eisenhaur

Great. Erika, we are now ready to open up for question and answer.

Question-and-Answer Session

Operator

(Operator instructions) We’ll pause for just a moment to compile the Q&A roster. Your question comes from Greg Gilbert with Bank of America.

Paul Bisaro

Hey, Greg.

Greg Gilbert – Bank of America

Hey, thanks. Good morning. Paul, you slipped in a comment about pricing improving, given the importance to the industry and the fact that we haven’t heard that type of thing for a few years, can you put a little more meat on the bone as to what some of the factors are that may be stabilizing or at least improving the erosion rate for the industry, and for Watson particular, in ’09 versus ’08?

Paul Bisaro

Well, I think there are a number of factors, Greg. I think one factor is the industry consolidation, of course, that does affect the pricing stability. I would also say that there’s unfortunately a number of competitors of ours have faced some troubles with the FDA and had other troubles. That’s also led to stability. And I think, finally, the – I guess, perhaps, the way to describe it is a slowdown in the approval of that of the FDA due to their backlog and basically overworked and under-funded activities there has led to fewer approvals. So all those things lead to probably more stability than we’ve seen in the past.

Greg Gilbert – Bank of America

So you could probably – you might be able to do better than minus 10, but you’re being just conservative for now. Is that the message?

Paul Bisaro

Well, I think, we’d use 10% erosion for the last few years. We’ve been very comfortable with that. And we did that this year as well. And, yes, we may be a little conservative here, but it’s probably prudent.

Greg Gilbert – Bank of America

Okay. Secondly, if Ferrlecit goes generic, will you lose the contribution after this year? Can you grow earnings per share next year?

Paul Bisaro

I believe we can, Greg. We’ve got a lot of great opportunities in the pipeline on both the brand and the generic sides. And we haven’t even begun to put our cash to work yet in ways that we can. So I do think we will continue to grow earnings, and it’s certainly our – my expectation that we’ll grow earnings year-over-year. And it’s my target that we do that at a low double-digit rate like we did this year, 10%.

Greg Gilbert – Bank of America

One last. I’ll get back. On M&A, Paul, what’s your latest take on what Watson is interested in and not interested in at this point? Thanks.

Paul Bisaro

Well, I think we’re interested in everything and looking at everything. And we’re pretty prudent. We’re also reasonably conservative. So we’ll take a – we’ll take a hard look at the opportunities that are presented. And try to decide what makes sense for us and we’ve made no secret out of the fact that we would like to expand our marketing footprint outside of the US. So that’s a priority for us, but I guess the question is how, with whom, and how big do you try to go? And so, we’ll look at all of the factors that are presented and try to be prudent about how we do it. And, like I said, I think it’s a priority for us in 2009. And I can’t guarantee it’ll happen in 2009, but we’ll be looking.

Operator

Your next question comes from the line of Corey of Davis with Natexis.

Corey Davis – Natexis

Thanks very much. A couple of questions, the first is, with respect to your ’09 guidance. I understand why you’d be conservative with Tropol XL given that you don’t have approval yet, but why be conservative with Micro-K. It sounds like it’s unambiguous that you got the capacity and that you’ll be up to speed by March. Is there some other factor I’m not thinking about?

Paul Bisaro

Yes, Corey, Well, there is – there are – there are two factors that we’re thinking about. One is, we know we’ll be giving guidance again probably in about eight weeks when we go into the first quarter results. And I think we’ll know a lot more about the timing of KAB’s return to the market, or potential return to the market as well as whether there’ll be an additional competition this year. So that’s I think the reason for our reluctance to put too much into Micro-K right now. And as you point out appropriately, Tropol XL were not approved for yet, so it’s kind of hard to guess what’s going to happen there.

Corey Davis – Natexis

Okay. And secondly, now that you threw out an aspirational target of 10% growth for 2010. If Tropol XL comes and everything works in your favor, and there’s tons of excess to go around, would you show it in EPS? Or would you choose to spend it, perhaps, more on the brand side of the business so that you could continue a more smooth growth pattern into 2010?

Paul Bisaro

Well, I will say that we would spend – well, let me answer it this way. It is obviously possible and probably likely that if everything went very well for us and we were able to capture significant upside from both of these product opportunities, we would certainly use some of that money to fund, perhaps, even more aggressively the launches of Rapaflo and Gelnique as well as putting some that – those assets to work for future growth. Obviously though, a significant amount of that would also hit the bottom line. So we would put money to work. We will put the money to work. and continue to drive value for 2009, ‘10, ‘11, and ‘12.

Corey Davis – Natexis

Okay. Great. Thanks, Paul.

Operator

Your next question comes from the line of Tim Chiang with FTN Equity Capital.

Tim Chiang – FTN Equity Capital

Hey, Paul. I have a couple of questions. On Toprol, assuming that you do get an approval, do you have ample capacity to actually meet the demand in the marketplace on all four strengths? I mean, I would imagine it would take you some time to build that up.

Paul Bisaro

Well, yes, it will. But remember, there really isn’t a shortage right now. I believe the authorized generic is still out as well as the brand is still there. So there really isn’t a market shortage. We would have to build our capacity – well, we have plenty of capacity in Florida. That’s not the issue. The issue is building enough product and stock so we would – it would take us a little time to grow that stock and we are going to have to go out and get customers, of course. But we also know what the situation is going to be with (inaudible) and their timing. So yes, we have plenty of capacity and, yes, we’ll be able to meet what we perceive to be our market demand.

Tim Chiang – FTN Equity Capital

What about pricing in the Micro-K market now that KAB’s out? Do you have actually the possibility to raise prices on Micro-K again?

Paul Bisaro

Again? Well, yes, we do. Actually, we have some flexibility there as the market – as the only product in the market. We, of course, have to be mindful of the fact that there’s (inaudible). So we have recognized that that opportunity, people could switch from Micro-K to KAB, and we have to be mindful of it. But we do have some pricing flexibility there.

Tim Chiang – FTN Equity Capital

Okay, and then just one last question. On your branded segment, you do get some income from, I guess, marketing (inaudible). Does that – will that change at all later this year for you?

Paul Bisaro

Well, I think, Tim, that stream hits the generic line. But we don’t anticipate any change in our (inaudible) for 2009.

Tim Chiang – FTN Equity Capital

Okay. Great. Thanks.

Operator

Your next question comes from the line of Rich Silver with Barclays Capital.

Paul Bisaro

Hi, Rich.

Rich Silver – Barclays Capital

Good morning, Paul. How are you?

Paul Bisaro

Good.

Rich Silver – Barclays Capital

Just on the gross margin, can you give us some sense of a range for 2009 as well as tax rate?

Paul Bisaro

Well, I think our tax rate will be roughly the 37% range that we generally have. We don’t expect to see much fluctuation on tax rate. On the margin front, I would sort of attack it this way, I think I said that we’ve achieved about $20 million savings last year. I reckon that’s a $20 million dollar savings due to our Global Supply Chain Initiative and Operational Excellence. We expect to achieve $20 million, actually more than $20 million in savings in 2009, and we must look to do even better in 2010. So we do expect to see some margin expansion on the generic side in 2009.

Rich Silver – Barclays Capital

Okay. And then just back to the M&A topic, have you seen any change in the last three to six months or I should say three months as far as asset prices and competitiveness in terms of bidding for assets?

Paul Bisaro

Well, I think the credit markets have certainly made the bidding process more difficult. And I also think that the assets that area available are starting to recognize that the multiples that were paid in the tax are probably not going to be paid in the future. So I have seen – I do think we’ll see some moderation in multiples, and if the credit markets loosen up a little bit, I think you’ll see more activity.

Rich Silver – Barclays Capital

Okay. But on the credit market side, wouldn’t that actually be, maybe an advantage for you relative to the competing bidders?

Paul Bisaro

Yes. We would have – we have a very strong balance sheet. We have the ability to take on additional debt, and probably increase cost compared to what it used to be. So that all has to be factored in as well.

Rich Silver – Barclays Capital

Okay. Thanks very much.

Operator

Your next question comes from the line of Ronnie Gavin [ph] with Bernstein [ph].

Ronnie Gavin – Bernstein

Good morning, Paul.

Paul Bisaro

Good morning. How are you?

Ronnie Gavin – Bernstein

Feeling well. Couple of questions for you. First, you must have modeled it, but any idea of what will be a revenue number that makes you comfortable you’ll be breakeven or making some money on Gelnique and Rapaflo. That is how far in the urology market those products have to go? If you were at a point where you are going, “Okay, those products are now net contributors.” And second, around the bio-similar issue, how does it connect to a mid-sized player like Watson thinks about participation in that market. Is that a viable option for you? Is there a strategy, differential strategy, to be taken there by a players like yourself?

Paul Bisaro

Well, I’ll answer the first question first because it’s actually pretty easy. I do think there’s a, there is a viable strategy for Watson, and we are actively pursuing a strategy for biologic. We anticipate – we expect to be and want to be a major player in the biologics market. We don’t anticipate really though products – significant products being available in the market until 2012-2013 time frame. We have evaluated the – every biologic opportunity we could find, and we have a number of them in various stages of discussion.

And we did everything from licensing it, opportunities to potentially acquiring similar opportunities. So we’ve evaluated the full spectrum. I think that, to remind everybody, one of the things about being a specialty company like us, is we also have the capability to run our own clinical studies, which have proven what we can do. So clinical studies have to be performed with (inaudible) people in place and resources in place to do that. We have a regulatory expertise to be able to bring these products to market. We have the legal expertise to get through the actual property hurdle. So we’ve got all of the fundamentals in place. We just need to get some bricks and mortar and some licensing opportunities. Those opportunities exist and I expect we’ll be in that space for sure.

On the brand side, we have not, and we’re going to decline to give specific guidance with respect to the products Gelnique and Rapaflo. what we can say is we do expect a slower uptake on Rapaflo than Gelnique so that consistently, we think that Rapaflo is a billed product that, given the market dynamics in the BPH space, with Flomax and uroxitrol, Flomax going off patent at 2010. We expect the build to be slower than the Gelnique build, where we think we’ve got real opportunities to differentiate ourselves from existing players and the opportunity to do something that I think no one else has done, and that is continued use of the product as opposed to a episodic use of the product. We’re excited about both of the opportunities, but we’re going to keep our cards a bit close to the best that we think is going to happen.

Ronnie Gavin – Bernstein

Okay. So if we qualify (inaudible) on bio-similars, if we’re going to think about the magnitude of investments over, let’s say a period of five to six years between ’10 and ’09 , ’10 and 2013, 2014. When you think about the magnitude of investment you need to participate in that kind of market, are we looking at below hundreds? Are we looking much higher than that? How do you guys think about how much money are you able to participate?

Paul Bisaro

I don’t think we’re talking about that kind of contribution – that kind of number. I think that a product like, a similar product, the price is going to be in the tens of millions of dollars to develop. It’ll be similar to a brand product, so I don’t think it will be hundreds of millions.

Ronnie Gavin – Bernstein

Okay. Thanks very much.

Operator

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

Elliot Wilbur – Needham

Paul, just maybe a quick question around the full year EPS guidance. I guess, given what’s likely to be a front-end loaded expense pattern around some of the new launches, I mean, any color you want to give on EPS progression over the course of the year?

Paul Bisaro

Yes. I can give you a little bit of color. I actually think EPS progression will increase as we go through the year. We are obviously working hard to begin the marketing programs for both Rapaflo and Gelnique. But that expense is being offset by the current opportunities and we expect to see the current opportunities plus the revenue and profitability generated from the products in the later quarter. So probably, I’ll look to see the first quarter probably being the lowest of the quarters with it going up from there.

Elliot Wilbur – Needham

Okay. Then I have a question for you on your ANDA pipeline as well. I think you mentioned that press release had 60 ANDAs pending, and then there was some commentary about come rationalization activities. I’m wondering if that was related to development projects or if that actually impacted some products that have been on file? And I guess it’s fair to assume that ’09 guidance does not include any contribution, probability-adjusted or otherwise from Concerta and/or Lovenox?

Paul Bisaro

You’re right about the last point. The Concerta and Lovenox, we have no contribution modeled in for 2009 for either one of those opportunities. So they continue to be a short term goal. We have – you’re right – we took a hard look at our ANDA pipeline as well as our product development program and rationalized involved areas, and took products, projects out. Our filings were sort of skewed to the end of the year, as you would expect, because we started new projects and we’ll have to get through this system.

And we’ve created some projects that we didn’t feel made sense to continue with in the early part of the year. So we have done a pretty good pruning job of both the ANDAs that were filed, as well as the ones that were being worked on. I think we’ve retooled and refocused our generic R&D efforts around products that are (inaudible) for opportunities that are difficult to manufacture using some of our unique technologies, the patches, the gels, that sort of stuff, so I think we’ll continue to see hopefully interesting opportunities from us coming out.

Elliot Wilbur – Needham

Okay. Thanks, and just one last question, coming back to the Ferrlicit issue and again appreciate the situation here, but it still seems like the expectation is still fairly widely held, but that would be resolved favorably in respect to your position, meaning that there’ll still be some fairly significant positive economic contribution in 2010, so I guess, I’m just wondering, at this point, maybe, would it not be more prudent for us simply to assume that doesn’t happen and then whatever outcome maybe realized would, of course, be upside. It just seems, I guess, from my observation, based on Sanofi’s behavior to date that it seems increasingly likely they’re leaning towards taking back the product. So I’m wondering what you’re thinking, is it about taking a more conservative approach to 2010?

Paul Bisaro

Well, as I said all along, we had to – we really had to wean ourselves off of Ferrlicit. We knew there was a potential cleft. We’ve done – we’ve taken a lot of steps to prepare for that. I’ve mentioned the opportunities on the brand side, but we also have contingency plans in place to deal with the situation, should we not have Ferrlecit from Sanofi in 2010. I don’t think the contribution from the IV iron space would be zero for Watson in 2010. So whether we have an ongoing relationship with Sanofi or we have another relationship or some other kind of relationship – I think we'll have some contribution from the IV iron space in 2010.

Elliot Wilbur – Needham

Ok good. Thank you.

Operator

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

Randall Stanicky – Goldman Sachs

Paul, just a couple of follow ups on the M&A and then I have another one, but first how large of a deal could you do or are you looking to do from M&A perspective. And then secondly, just the biologic opportunity, it is a 2012 opportunity, at what point do you think you need to be positioned in that market to participate?

Paul Bisaro

Well, the M&A front I think our current leverage ratios are about 1.5 times, and I think we have the certain kind of capability to lever up a bit, we would want to be prudent about what that number looks like, but I think you can do the math and figure out how much we can afford, plus what we have on the balance sheet, plus what we think are cash flows look like.

So I think we have the flexibility to do a substantial deal. The question is do we want to do a substantial deal and is there an opportunity that gets presented that makes sense for us to do. And that’s the way we will approach it. We will look at it as I said from a very prudent perspective to make sure whatever transaction we take on we have a very high likelihood of success, we have the ability to make it accretive quickly, and our ability to pay off the debt will be something very much focused on.

I think your second question is about biologics, and I think we need to probably be looking in the next year, two years to have a foundation built for products and I think you can tell that’s an important priority for us as well. It's possible that any acquisition we might do or any merger we might do could provide us with some of that capacity. So, were also thinking about the kind of acquisition or merger we might do that would also help us on the biologics front.

Randall Stanicky – Goldman Sachs

And then just to be clear, the timing here is more related to you finding the right asset versus financing issues.

Paul Bisaro

Yes. Absolutely.

Randall Stanicky – Goldman Sachs

And then, finally, just on fentanyl, you talked about being (inaudible) last year, can you just give us an update on market trends there, and how you are thinking of that in terms of the P&L for 2009?

Paul Bisaro

I’m sorry, Randy, you said that – you asked about fentanyl?

Randall Stanicky – Goldman Sachs

Fentanyl, yes.

Paul Bisaro

It was a big contributor in 2008 and we expect it to be a big contributor in 2009. Our market share is roughly 18% to 19% range. We don’t really anticipate much additional movement there with the competitors we see. We also have some rational pricing in this space.

We expect it to be a four-year contributor without any disruption in production. And I think as you may remember, we had a few issues with supply trying to meet demand, the new demand and now we are able to meet that new demand so we are not anticipating any demand issues or any supply issues for ourselves in 2009. So it should be a big contributor for us in 2009.

Randall Stanicky – Goldman Sachs

And Tampa has not had any substantial impact on either pricing or share?

Paul Bisaro

We haven't seen pricing impacts but again their product is a matrix product and I think, as we have mentioned in the past, there is somewhat a bifurcation in this market between a Reservoir patch and a Matrix patch. So I think to an extent we can tell appears seems to be more disruption on the matrix side that the reservoir side.

Randall Stanicky – Goldman Sachs

Thanks, Paul.

Operator

Your next question come from the line of Graef Crystal with Morgan Stanley.

Graef Crystal – Morgan Stanley

Morning guys. A couple of questions on guidance. First of all, your guidance appears in 2009 to include optimistic (inaudible) expectations. When you say product launches are likely to offset the lesser downside given that they’re two moving parts. Can you give us more color on ways that Ferrlicit is going in 2009? And (inaudible) actually on new product launches? And then on new product launches, can you give us an idea of how much you plan to spend on sales and marketing? I’ll come back with another question after that.

Paul Bisaro

Well, we're not going to give guidance on specific products. So I'll try to be general about the comments I made. What I said was the revenue generated from the three products, the Trelstar 6, Rapaflo, and Gelnique should offset any declines in revenue we see from Ferrlecit, and Oxytrol, and the Trelstart 1 and 3 months, because there will be cannibalization, of course, of Oxytrol from – by Gelnique. And there will be a certain cannibalization of Trelstar 1 and 3 months from the Trelstar 6 months. So we think we've done prudent and conservative in the way we've approached the revenue projections. And in fact we don’t see ,as you consult from the guidance, we haven't shown huge increases in revenue for the brand division.

So I think were being prudent with the way were approaching our product. And I think you asked about the sales and marketing spend for the new products, our current sales force are in place so our sales expense on a sales force is already built in to our numbers, if you will. We don’t expect to increase dramatically the size of either our urology group or our specialty group for the launches. So most of the spend here is on samples. And it is a reasonably significant spend because these are categories that are both sample driven. So we will be spending the vast majority of our increase and sales and marketing expense on sampling. In fact, most of the increase you see year-over-year in the sales and marketing or the SG&A guidance is really that spend for Rapaflo and Gelnique.

Graef Crystal – Morgan Stanley

And then, Paul, can you give me some more color on 2010 guidance. You sort of talked about this 10% gross number. Firstly is that organic growth or does that include to the backward visions and now your patterning in Concerta. And then, if you lose Ferrlecit and then market share continue to decline on fentanyl, and with (inaudible) most likely coming back in the market with Toprol XL by 2010, where's the actual growth coming from in 2010?

Paul Bisaro

I need to be clear, what I said was about 2010 is that we have – our internal projections and our internal objective is to grow year-over-year. And we like the 10% growth rate that we saw this year and that is our internal objective for next year. Obviously, there's a lot of moving parts in this year and it would be difficult to replicate a year if we have a blowout year with Micro-k and Toprol, your right, it would be very difficulty font us to potentially achieve another 10% growth but we don’t factor in acquisitions in that growth rate so that would have to be organic growth. But we do have additional opportunities in our 60 products that we have filed. We also expect to continue to see growth from Rapaflo and Gelnique. In fact, we expect to see even faster growth than the first year.

Particularly with Rapaflo, when that’s the year when Flomax goes off patent. There are opportunities within our pipeline and within the products we currently have that can show growth. We also anticipate the launch of an oral contraceptive in late 2010, so there is growth opportunities in the brand side that certainly will help. There are growth opportunities on the ANDA, distribution side that would help. And of course we have the paragraph 4 opportunities and the regular launch opportunities of generics business. So the combination of all those things we think will organically grow the company.

Graef Crystal – Morgan Stanley

That’s off your guidance for today.

Paul Bisaro

Excuse me?

Graef Crystal – Morgan Stanley

That’s off your guidance today. You expect your 10% from there? Okay. And then, Paul, you – can you explain why pencil [ph] market share such a holdup? Like when I look at the scripts, weekly scripts, it seems that your shares comedown from roughly sort of 18 to 10 until the end of last year to right about 60% now and heavily taking shape from the reservoir patches –

Paul Bisaro

I'm not sure I agree with that. I think our last, the last number I saw we were at 18 point something per cent so, I'm not sure where you're getting that number from but we have not seen an erosion , a general erosion, I mean there are certain eggs and flaws that goes with this things but are numbers look fairly constant.

Graef Crystal – Morgan Stanley

Okay. Thank you.

Operator

Your next question comes from the line of Michael Tong with Wachovia Capital.

Michael Tong – Wachovia Capital

One quick question, I was wondering if you will attempt to quantify the gross margin impact as you start to distribute branded products. I mean we've seen an improvement in 08 relative to 07 as it relates to 09 we ought to be thinking about the moderation in that – is that the right way to think about it? And would you even quantify it.

Paul Bisaro

well here you're talking about ANDA correct? As I mentioned in the last call, we do anticipate a reduction in gross margins because of the increased distribution of branded products. I would expect to see that decline be moderate and I would expect it to relatively slowly throughout the year. We are not going out and buying a bunch of branded products and then starting with this process we already have some branded products in that distribution mix today, reminds you we are a full line supplier of T2 narcotics so we do have branded products in that area, we also have other branded products that we currently distribute through ANDA, from other companies, and this is a slow process not an immediate one.

Michael Tong – Wachovia Capital

And a quick follow up to the SG&A question. How confident are you that the modest increase that you're projecting for 09 relative to 08 is going to be sufficient to launch three new brand products?

Paul Bisaro

I'm very confident actually. I think the spend that were doing now is targeted for the kind of opportunities that we have. The Trelstar 6 opportunity I don’t think is going to require a normal amount of sampling or effort because it is really an add on to the existing portfolio of Telstar prop. So it means it's just a better product or a long racking product. With regards to Rapaflo and Gelnique well have to obviously evaluate our spend as we go to make sure that we are doing the appropriate amount, maybe we need to spend more or spend less, maybe we need to spend more but given the size of our company and the opportunities here, we are also looking at creative ways to reach a broader audience. We're looking at everything from e-detailing to detailing, to everything. To reach a broader audience when the audience currently can reach.

Were trying to be creative , were trying to use our dollars as efficiently as we can.

Michael Tong – Wachovia Capital

Thank you.

Operator

Your next question comes from the line of John Bourse [ph] with Citi.

John Bourse – Citi

I just have three, three on separate topics on generics and Toprol XL. On the inventory bill are you thinking about going after the 50 or 100 because they account for a large per cent of the prescription or is it a strategy to go after 25 to 100 or lower strength ,any thoughts there? And secondly, has the FDA looked at your QAQC records or inspected any of your manufacturing on Toprol XL that would give you a signal that the process is moving forward? And then on pricing, when we look at wholesalers we see about a 60% to 70% discount for the generic versions, would you see pricing settling out with only 2 players in the market?

Paul Bisaro

I’ll start from the bottom going up. On the pricing, I think the – your pricing numbers are probably behind a little. I think our intelligence tells us that the market for Toprol, and that’s what you're talking about the Toprol 60% to 70% , it's probably not that anymore. It's probably been moved up a bit now that there's been shortages in the market and the like. I would expect that number when we enter to be a little bit higher than what you have in your thinking.

Regarding the FDA we know the FDA is actively reviewing our applications for Toprol, there's actually two or maybe three, I guess. It really depends on what order do we get to answer your questions depend on what order we get the approvals. And the applications cover the four strains. So they're not just one application for all four, it’s three applications covering, one covers the 25 and 50, 100, and the other one the 200. So it really depends on what order we get the approvals.

John Bourse – Citi

And on inventory bill currently?

Paul Bisaro

We’re working on – actively working on validation right now. And once the validation is complete depending on what we hear from the agency we'll start building inventory.

John Bourse – Citi

On the branded side and Rapaflo? How interested is major pharma in wanting to strike a deal with Rapaflo? And are you thinking more about a share gain with major pharma or how do you think of structuring a deal and why wait until 2010 when the exclusivity period runs out? Aren’t you going to be leaving some money on the table by not having a major pharma player or someone who has primary care experience helping you in the next six, eight months on Rapaflo?

Paul Bisaro

Yes. I think that as we looked at this opportunity, we made the decision that given where the dynamics exist for this product today, that is Flomax with full detail DTC activity still in high gear, it didn’t make a lot of sense to go out and take on the giant at this point. It probably makes more sense and we think it makes more sense to wait and go after the market, particularly in the PCP area later.

We also know that Rapaflo with its side effect and its advanced – I think improved safety profile needs to be – the story needs to be told to urologists so they understand that issue. And I think – and once they understand it, we’re going to do better in the primary care markets once we’ve shown the value of the product to urologists. And so we’re focusing our efforts now in the urology space. We also have – to give you some sense of this. This is a new chemical entity. So we have – we have five years of statutory exclusivity, plus a patent that goes on the – which is a new chemical entity patent that goes out until I believe 2019, or 2018, or 2019.

So just because we’re so good at the generic piece of this, we know that nobody can file an application for four years. So we have time here to build the brand. And that’s what we plan to do. And as I’ve also said, we’re looking at ways to improve the brand by potentially combining it with other products and looking at new ways to grow the franchise.

John Bourse – Citi

What level of interest for a major pharma – I know you’re thinking about share gain or–

Paul Bisaro

Well, I think major pharma is – I think is not interested at the moment because of the Flomax situation. And frankly, I don’t blame them. I think maybe the – they’re waiting to see what we do in the urology space, how the product grows, and then what happens after 2010. And as to structure, I don’t have a particular structure in mind. We’re open to discuss pretty much anything.

John Bourse – Cit

Okay. And then to just one last question on M&A, I think the 1.5 time leverage ratio you put out, would that imply somewhere between $1 billion, $1.5 billion type acquisition? And of any XUS acquisition that you look at, how important is bio-similars?

Paul Bisaro

Well, bio-similars on an XUS acquisition is a very nice-to-have, but it’s not absolutely critical. Really, every asset that we look at and every project that we look undertake, we try to see what are the – what are the sum of the upsides. But it would clearly be a nice-to-have an acquisition. I don’t think – and then coming back to your ratio question, I think we can – we can lever up, as I said, to obviously, $1 billion is not out of the question, of course. But we can even go higher. I think there’s room to go higher if we wanted to. And of course, we could also use equity as well. So there is some opportunity to go bigger if we found the right opportunity. I’m not suggesting we will. But if we found the right opportunity, we would certainly consider it.

John Bourse – Citi

And on bio-similars, Insmet [ph] was recently purchased. Did you look at the asset? What did you think of the asset? And if you did look at it, what interested you in the asset?

Paul Bisaro

Well, I mean we know about this. As I’ve said, we’ve looked at all – almost all the assets in the bio space. And so, you conclude, yes, we did look at that asset. For us at the time, we looked at it, it was not the right moment for us to acquire a company that wasn’t really generating any revenue. It would be hard for us to absorb that. And so, we decided to wait. I think it is a good asset. I certainly think Merck will do it’s best to capitalize on that asset. And they did have some interesting opportunities.

John Bourse – Citi

Thanks for taking the questions.

Patty Eisenhaur

Erika, we’ll have the conclude now. But thank you everyone for participating, and we’re, obviously, happy to follow up with you after the call if you have any additional questions. Thank you, everyone.

Operator

This concludes today’s conference call, you may now disconnect.

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Source: Watson Pharmaceuticals, Inc. Q4 2008 Earnings Call Transcript
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