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Executives

Patty Eisenhaur – Executive Director IR

Paul Bisaro – President and CEO

David Buchen – SVP, General Counsel and Secretary

Todd Joyce – VP and Corporate Controller

Al Paonessa – EVP and COO of ANDA Distribution Division

Analysts

Bob [ph] – Goldman Sachs

Tim Chiang – FTN Equity

Greg Gilbert – Banc of America

Rich Silver – Barclays Capital

John Boris – Citi

Chris Yu – JP Morgan

Louise Chen – Collins Stewart

Corey Davis – Natixis

Adam Greene – RBC Capital Markets

David Risinger – Morgan Stanley

Ken Cacciatore – Cowen and Company

Michael Tong – Wells Fargo Securities

Watson Pharmaceuticals, Inc. (WPI) Q2 2009 Earnings Call Transcript July 29, 2009 8:30 AM ET

Operator

Good morning. My name is Lindsey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Watson Second Quarter 2009 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

Thank you, Lindsey, and good morning everyone. I would like to welcome you to Watson's second quarter 2009 earnings conference call. Earlier this morning, Watson issued a press release reporting its earnings for the second quarter 2009. The press release is available on our website at www.watson.com, and includes a reconciliation of our GAAP and adjusted financial results and forecasts. Additionally, we are conducting a live web cast of this call, which will also be available on our website after the call's conclusion.

With us on today's call are Paul Bisaro, President and CEO of Watson, and Todd Joyce, Vice President and Corporate Controller. Also present and available during the Q&A portion of the call are Tom Russillo, President of our Generic 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 second quarter, including highlights on the performance of our three business segments. Todd will then provide some additional details of our results for the quarter. Paul will conclude our presentation with a strategic outlook for the company and our outlook for the remainder of 2009. We will then open up the call for questions and answers.

Please note that today's call is copyrighted material of Watson Pharmaceuticals, Inc. and cannot be rebroadcast without the company's expressed written content.

I would 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 is important to note that such statements about estimated or anticipated Watson results, prospects, or other non-historical facts are 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, 2008.

With that, I will turn the call over to Paul.

Paul Bisaro

Thank you Patty and good morning everyone, and thank you for joining us today. This morning, I will briefly review our financial results and provide an update for each of our three business segments as well as an update on our pending acquisition of the Arrow Group. Todd will then provide further details on our financial results.

As all of you know by now Mark Durand, our CFO, has taken leave of absence to address a health related matter, and of course we wish him all the best and a speedy return.

Taking a look at this morning's earnings report, we are pleased to report that our consolidated revenue for the second quarter was a record $678 million, an increase of $55 million or 9%. As a result of these strong revenues, second quarter adjusted net income was $70 million, resulting in adjusted earnings of $0.61 per share for the quarter.

Adjusted EBITDA for the quarter was a record $164 million and cash flow from operations for the second quarter was $92 million.

It was truly an extraordinary quarter for us, one that was highlighted by the strong financial performance I just described, as well as featuring the launch of two new brand products, Rapaflo and Gelnique. In addition, in June we took the strategic step to expand our global footprint and leverage our assets across numerous new markets around the world through the proposed acquisition of the Arrow Group. With Arrow group, we have enhanced our long-term growth profile.

No turning back to the quarter results, let me discuss highlights of each of our divisions. First our generic business. The generic business continued to perform very well, increased product sales and strong gross profits contributed to a 19% or $20 million increase in generics contribution quarter-over-quarter. Potassium chloride or generic Micro-K was again one of the strongest performing products for us in the quarter. As you know, we fully supplied the market for the entire quarter.

We also continued to realize the benefits from the products acquired as a result of the Teva-Barr merger. Transdermal fentanyl continues to be a strong performer. Market share has remained steady at around 18%, although we did see some pricing pressure on this during the quarter.

On the production side, increased manufacturing volume coming out of our Florida site is enhancing our absorption of overhead and it is contributing to the overall health of our global supply chain, and of course, gross profit. Product transfers from our Carmel, New York, facility to our other sites continues as planned, and we still anticipate full closure of the Carmel facility by the end of next year.

As an update on our India manufacturing facility, we now have 20 product families coming out of Goa, and we are on track to produce over 2 billion units in that facility this year. And our Florida site continues to prepare for the anticipated launches of generic Toprol XL and Cardizem LA.

A quick update on our generics R&D pipeline, in the quarter we received approval for Next Choice, the generic Rx version of Plan B, and in July our cinnamon and fruit coated nicotine gums were approved. These launches are well under way.

We also had a number of notable ANDA submissions, including the filings for generic versions of Mucinex, Mucinex D, Mucinex DM, and generic Enablex, and most recently generic Sanctura XR. All of these filings are paragraph IV patent challenges, and we believe that on least three of the five filings we may be first to file.

With the recent approvals and filings, we continue to have approximately 60 ANDAs pending with approximately 15 first to file opportunities. As you can see, our generic division continues to be a key contributor to our success.

Moving now to the Brand Division, obviously the biggest events in the Brand Division during the second quarter were the launches of Rapaflo and Gelnique. Both products represent significant advances for patients from an efficacy, safety and convenience standpoint.

Rapaflo, which was launched in early April, is a fast acting, uniquely selective alpha blocker for BPH. Our urology field force of approximately 100 representatives is currently promoting Rapaflo to urologists and we are seeing good uptake on our called-on targets. Physicians are coming to appreciate Rapaflo’s attributes and interestingly about half of our Rxs are coming from switches from other BPH products. As a reminder, BPH is the number one condition treated by urologists and is also a category that sees high sampling.

Gelnique launched in mid-May is fast drying, odorless and clear gel to treat overactive bladder. For active women experiencing OAB, Gelnique represents a new alternative treatment that has a favorable side-effect profile without sacrificing efficacy. Initial reactions to this new form from physicians and patients has been very positive. Remember our specialty team of approximately 120 representatives is promoting this product to urologists and select gynecologists, and similar to Rapaflo, sampling levels are very competitive in the OAB market.

For both products, managed care acceptance represents both a significant opportunity and challenge. And we recognize that we will have to earn our position within managed care. We are working to solidify our position by demonstrating Rapaflo and Gelnique’s unique attributes, especially with the Medicare population.

In our nephrology franchise, we recently announced that as of July 10, we had resumed shipments of INFeD, which had been out of stock due to issues faced by our raw material supplier. We are pleased that we were able to get the product back on the market earlier than expected, and as a result have added this product back into our full-year forecast, and we are actively re-establishing the product in institutional and oncology accounts.

Turning to Ferrlecit, as you know we were successful in our arbitration with Sanofi Aventis, and we will continue to promote Ferrlecit and provide appropriate support to the nephrology community through the end of the year. As you also know, we have been planning for when our distribution agreement for Ferrlecit will end. As part of that planning, we announced late yesterday that we have entered into an exclusive license and marketing agreement with GeneraMedix for a generic version of Ferrlecit.

GeneraMedix’s application is under expedited review with the FDA and upon approval Watson will begin marketing that product. In addition, in late July we began to expand the efforts of our nephrology team. Together with their continued promotion of Ferrlecit in nephrology, they began promoting TRELSTAR, in institutional and oncology accounts that were using INFeD, and will assist the urology team in promoting that product to select urology accounts.

On the Brand R&D front, we received a complete response from FDA on the six-month formulation of TRELSTAR, which we had licensed in from Debiopharm. FDA asked for further explanation on the clinical studies conducted by Debiopharm, and requested additional information related to the manufacturing of that product. We’ve already provided much of the information to FDA based on earlier discussions with them, and we're working very quickly to address the new questions that they have.

Once we formally respond to the lettering and get their feedback, we will provide an update on timing.

Turning now to our distribution business, once again, ANDA showed a strong performance this quarter with new product sales coming from the launches of generic Adderall XR and Depakote ER. In addition, we continue to see higher brand sales, an area where we are putting increased focus on this year.

Second-quarter margins tended towards historical levels and we expect margins to continue to trend down as ANDA distributes more brand products.

Finally, I would like to spend a few minutes discussing a significant strategic achievement during the quarter that is of course, the proposed acquisition of the Arrow Group. This acquisition represents a significant opportunity for Watson to expand our global footprint, and enhance our ability to leverage Watson’s assets in new markets.

The Arrow acquisition also is financially attractive and we believe significantly enhances our long-term growth profile. We have submitted our HSR application to the FTC in early July, and the FTC has 30 days to decide whether to issue a second request. We are in dialogue with the FTC now and things are progressing. We continue to expect this deal to close during the second half of 2009. We have begun planning the integration and as we said before the lack of overlap in our businesses makes for a very manageable integration and we expect this process to go smoothly.

Arrow’s management team and employees bring with them a great deal of experience in managing their own respective businesses, and we will work with them to ensure that they are able to continue to build upon past successes as we quickly integrate this organization into Watson.

With that, I will turn it over to Todd. He can give you some more details on the financials. Todd.

Todd Joyce

Thanks Paul and good morning. I will now review our second-quarter financial performance on a consolidated and divisional basis.

For the second quarter of 2009, net revenue was $678 million, an increase of 9% from the prior year period.

Second quarter net revenue for our Generic Division was $401 million. This is a 7% increase over the second quarter last year. Generic product sales increased 14% or $49 million from last year's second quarter, due primarily to strong sales of potassium chloride and transdermal fentanyl.

Generic other revenue was $25 million lower than the prior year period as we had a $15 million one-time payment from Barr related to Cenestin in last year's second quarter.

Oral contraceptive sales in the second quarter were $86 million, relatively flat $87 million last year.

Moving on to the Brand Division, net revenue was $115 million, down 2% from the prior year period. Brand product sales of $98 million consisted of $67 million in specialty product sales and $31 million in nephrology sales.

In the specialty business, we launched both Rapaflo and Gelnique during the quarter, which accounted for roughly half of the year-over-year increase in specialty product sales. Our specialty product sales in the prior year period were $58 million. As for nephrology trends, revenue is down due to supply issues with INFeD in the quarter, however, we resumed shipping INFeD in mid-July. Additionally, we saw modest declines in Ferrlecit sales due to stocking patterns and decreased unit sales.

Brand other revenue was $18 million for the quarter, and increased primarily as a result of higher co-promotional revenue related to Femring and Androgel.

Brand adjusted gross margins in the second quarter were 80.9%, up slightly on a sequential quarter and year-over-year basis.

Finally, net revenue from the ANDA Distribution Division was $161 million, up 26%, or $33 million from the prior year due primarily to new product launches, specifically the launches of generic Adderall XR and Depakote ER. ANDA gross margin for the quarter was 15.1%, slightly below last year.

Turning now to our operating expenses, R&D spending for the second quarter was $43 million, which is up about $3 million, or 9% compared to the prior year period as we saw higher R&D spending in our Brand Division.

SG&A for the second quarter was $128 million, which is an increase of $24 million over the prior year period. The increase is the result of launch cost for Rapaflo and Gelnique and transaction costs associated with the pending acquisition of Arrow. Excluding any operating results for the Arrow business going forward, SG&A is expected to be between $480 million and $500 million for the year.

Amortization for the second quarter was $22 million, an increase of $2 million from the second quarter last year due to the acquisition of products from Teva.

Adjusted EPS for the quarter was $0.61 and excluded $11.9 million in costs associated with the Arrow acquisition and $8.6 million in costs associated with our global supply chain initiative. GAAP EPS for the quarter was $0.46 per share. Details on the adjustments can be found in the reconciliation table in our press release.

Our adjusted EBITDA for the second quarter was $164 million, up 19% compared with the prior year period, and 4% from the first quarter of 2009.

Cash flow from operations for the second quarter was $92 million. Capital expenditures for the second quarter were $11 million and are expected to be approximately $50 million for the full year.

Our tax rate in the second quarter was 41.5%, and the higher rate reflects the non-deductible cost related to the Arrow acquisition. Our current debt position remains at $876 million, consisting of $575 million convertible debt, the $250 million term loan, and the $50 million outstanding on our revolving credit facility.

At the end of the quarter, we had $651 million in cash and marketable securities, as well as an additional $450 million available on our revolver. We expect to announce our financing plan for the Arrow acquisition within the next couple of weeks.

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

Paul Bisaro

Thanks Todd. As always, there are a number of factors that will influence our forecast for the remainder of the year. Some of these forecasts that were unclear in the first half of the year are now starting to crystallize a bit. So first, I will go through these assumptions and then provide the current forecast.

I want to start by reminding you the Arrow’s results of operations are not included in our forecast, and we expect that we will continue to provide our forecast for the reminder of the year on a stand-alone basis. The forecast we provided you in April included only a modest contribution from generic Toprol XL. Given what we know today, we expect to be receiving approval shortly and anticipate immediately launching the 25 mg and 50 mg strains of Toprol XL. Accordingly, we have included a greater contribution for this product in 2009.

As for generic Cardizem LA, we also expect approval of this product shortly, and haven't changed our expectations for it to be a contributor in 2009. Finally, we have not included any contribution from new patent challenges.

Based on these assumptions as well as the strength of our underlying base businesses, we have increased our estimate for full-year net revenues to approximately $2.7 billion. Generic revenue expectations have increased and are now expected to be between $1.55 billion and $1.65 billion.

On the brand side of the business, we continue to forecast net revenues between $445 million and $470 million for the year. Brand revenue estimates reflect the resumed sales of INFED as we stated before.

With the ANDA Distribution business, because of fewer than expected new generic launches across the industry, we now anticipate revenue for ANDA will be lower than originally forecast and be between $630 million and $660 million.

Turning to adjusted EPS, we are moving from $2.40 to $2.52 to a new forecast of between $2.50 and $2.58 per share. Accordingly, adjusted EBITDA is now expected to be between $668 million and $685 million.

I believe the reminder of 2009 will be as exciting as the first part of the year, and we look forward to the integration efforts with Arrow, as we begin to build an even stronger combined company.

I would also like to and end by again thanking our employees for all of their efforts so far this year, and I know they are strongly committed to Watson’s success as ever.

With that, I will turn the call back to Patty and we can open it up for questions.

Patty Eisenhaur

Thanks Paul. And Lindsey, we can open up the conference call for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Randall Stanicky from Goldman Sachs.

Bob - Goldman Sachs

Hi, good morning guys. This is actually Bob [ph] on for Randall this morning. Paul just quickly on the guidance, I guess could you may be help us understand, what gives you more confidence today to include more Toprol XL in the guidance for this year?

Paul Bisaro

Sure, conversations with the FDA.

Bob - Goldman Sachs

So we should expect that very near-term over the next quarter, how should we think about that?

Paul Bisaro

We expect the approval in the near term.

Bob - Goldman Sachs

Okay, great. Then just on the announcement on the license agreement for generic Ferrlecit, just a couple of questions, is there any risk from Sanofi trying to prevent you from selling this product? Is there any non-compete clause that we should think about?

Paul Bisaro

No, no that is no provisions like that.

Bob - Goldman Sachs

And then any update on the CPs for Ferrlecit?

Paul Bisaro

Well, the CPs are still pending at the FDA, and since they are still pending we are not prepared to discuss them at this time. What I will say is we have done extensive due diligence on the GeneraMedix product, and we are comfortable with it.

Bob - Goldman Sachs

So this expedited ANDA process doesn't have anything to do with the CPs?

Paul Bisaro

They are completely -- those two things are completely separate.

Bob - Goldman Sachs

Okay, and then last question just on Plan B, can you remind us when we should expect the OTC version of that product, and then how should we think about the market considering obviously the Plan B One-Step that is coming and obviously the branded product that is already on the market?

Paul Bisaro

What a question there.

Bob - Goldman Sachs

(inaudible).

Paul Bisaro

I believe the OTC exclusivity for Plan B expires near the end of this year, I think it is October. I think it would be fair -- I am sorry, August. I think it is fair to say that we would expect to be a participant in that market post the exclusivity expiring. As to the new products you spoke about that really will depend on the efforts that Duramed puts behind it, and how they intend to position the product. We expect to be able to participate in the market as we would with any other OTC generic version like our nicotine gum and our nicotine patch products. So we have a lot of experience in this area and I think we will be well positioned to be able to deal with what comes along.

Bob - Goldman Sachs

Thanks for the questions.

Paul Bisaro

Okay.

Operator

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

Paul Bisaro

Hi Tim.

Tim Chiang - FTN Equity

Hi Paul. You know, you mentioned the 25 mg and 50 mg strengths in Toprol XL potentially getting approved in the near term, can you comment about the 100 and 200 mg strength you have also filed and how do you sort of look at this competitive landscape? Do you expect other generics to also get approval in the near term on Toprol?

Paul Bisaro

Well, on the 100 and 200 we do expect approval on those, but we expect those to occur later, well obviously past the 25 and 50, but sometime later this year, it is probably more likely for those products. The competitive landscape is sort of what we hear and what we know about is that I mean Sandoz [ph] is working on certainly bringing their product back, and I'm certain KV is working on bringing their product back, but we have no particular intelligence as to the timing of that and we have not at this time heard of any new applications pending or anyone speaking in the marketplace about new competitors in that arena.

Tim Chiang - FTN Equity

And I guess given the fact that Toprol XL has got a very attractive price right now in the marketplace given the shortages on the generic side, how does this sort of launch impact your margins, you know, I would imagine it will probably have a positive impact, but is there any reason to sort of give us a little bit more detail as to where your gross margins might actually go in the second half of this year?

Paul Bisaro

Well Tim, I think it is fair to say that has to look at a marketplace like this one is we would do our best to maximize both the penetration as well as the profitability of the product. So you can look for us to be judicious in how we approach the marketplace.

You are right, there have been some shortages so that presents some opportunities, and of course, we will be able to build stock and we will be able to hopefully meet as much demand as we can create in a very short order. I guess overall I suspect there would be a positive impact on overall margins though for the remainder of the year.

Tim Chiang - FTN Equity

And just one last follow up, I mean what about Micro-K, I mean certainly that product has done extremely for you, any real change on our thoughts on potential new entrants coming in later this year, at the end of the year, what are you hearing?

Paul Bisaro

Well, right now we assume -- for our guidance purposes we have assumed really no competition for the reminder of the year for Micro-K. We have not heard of any new competitors, again I would assume KV continues to work to resolve its issues and try to bring the product back. But at this time, our best information would be that we should be there alone for the rest of the year.

Tim Chiang - FTN Equity

Okay, great. Thanks Paul.

Operator

The next question comes from the line of Greg Gilbert of Banc of America.

Greg Gilbert - Banc of America

Thank you, good morning.

Paul Bisaro

Hi Greg.

Greg Gilbert - Banc of America

Paul, do you expect an AB rating on the GeneraMedix product, and what do you expect a competitive landscape to be? Are you suggesting they are in a unique position having done more -- come through more hoops [ph] with the agency than others. Can you just frame that for us?

Paul Bisaro

Well, we do expect that there it will be an A-rated product I believe injectables AP rated, sort of AB rated. So we do expect that. It would be not quite clear how the competitive landscape around Ferrlecit will look with say additional generic competitors. We are not aware of a large number of people working on Ferrlecit. We've obviously looked at what was available, and we are comfortable that GeneraMedix is obviously in a good position, but right now we don't have any specific intelligence regarding other competitors in that arena.

Greg Gilbert - Banc of America

Would you be allowed to launch before year-end if the approval came?

Paul Bisaro

Well, Greg right now we do not have any contribution from generic Ferrlecit in 2009.

Greg Gilbert - Banc of America

Separately it looks like Teva settled with Pfizer on Lipitor. Can you frame that opportunity for Watson? Are you expecting a three player generic market or is Pfizer able to settle with anyone who comes along between now and then relative to your deal, Arrow’s deal?

Paul Bisaro

Well, I have to be a bit careful about this because I don't have all the specifics of all the deals and of course we are waiting for the closure and once the closing happens be able to be a bit more specific about it, but I don't think there is any impact on the period of time in which Arrow and I guess Ranbaxy would be alone with Lipitor in the US.

Greg Gilbert - Banc of America

Okay, and then last one on distribution for you Paul or Al, are you expecting fewer generic launches in the second half than expected or is that comment for first half and second half and longer-term do you see a role for ANDA in the long-acting opioid category in new REMS world, thanks.

Al Paonessa

Greg, I think that there will be the third quarter will be quite late on the new launches for the rest of the quarter. We do see some other products coming out in the fourth quarter but it will be towards the end of the fourth quarter. So overall, it's quite behind what we saw last year same time in launches.

Greg Gilbert - Banc of America

Okay, and opioids and any opportunities for ANDA there longer-term on the brand side?

Al Paonessa

Sure. Go ahead Paul.

Paul Bisaro

I would say as Greg as you know, we have spent a lot of time and effort on the ANDA side of the business to build the capability to be a full line supplier, a wholesaler of C2 narcotics. We have expanded ANDA’s capability in that area. We cover now both generics and brands across the board, and of course with their unique technology they are able to provide products to pharmacies faster than the normal distributing channel. So I think that is one of the key areas for us, has been a targeted area for us and it will continue to be a targeted area for us going forward.

Greg Gilbert - Banc of America

Thank you guys

Operator

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

Rich Silver - Barclays Capital

Hi Paul.

Paul Bisaro

Hi Rich.

Rich Silver - Barclays Capital

Besides the increased assumption or the increased contribution in your raised guidance from Toprol-XL, what other factors would be attributable to the increased guidance?

Paul Bisaro

Well, there are sort of a number of factors, sort of the strength in the underlying business is one of those factors, the transdermal fentanyl patch we talked about, our continued contribution of oral contraceptives to the line. I think as we have talked about over the last few quarters, we have seen slightly less price erosion than we had originally anticipated. So all of those things are contributing to the overall strength of the business.

You know, I think on the brand side of course we are seeing, you know, having INFeD back has been certainly positive. We are able to -- we were able to get it out in July that meant that the time they are out of the market was considerably shorter than we originally anticipated, and our representatives -- our nephrology representatives are working very hard to sort of re-establish that back in the market, and we think that's going to be a positive contributor also for the remainder of the year, and of course even beyond.

So there are a number of contributing factors. I guess I should say and finally of course we worked very hard to as you know, control our cost. Well, supply-chain initiative hasn’t been something that has been top priority for us and we are now starting to see the benefits of that as higher gross margins and gross profit rolls through the numbers. So the overall business is performing well. We are taking out the cost we need to take out and we are preparing for you know, sort of continued success through 2009 and then certainly into 2010.

Rich Silver - Barclays Capital

And are you still assuming a contribution from Cardizem LA and is that a probability weighted contribution?

Paul Bisaro

No, we are expecting -- we are not probability weighting it, we are expecting a contribution from Cardizem LA. We expect to get approval in very short order.

Rich Silver - Barclays Capital

So that would be, maybe in the same time frame as the two initial strengths of Toprol-XL.

Paul Bisaro

They could be close together.

Rich Silver - Barclays Capital

Okay, and then just on R&D at least relative to ours, it look like light. Can you give us some sense of whether what the full-year number is and whether we should see an increase in the second half?

Paul Bisaro

Well, to the extent that there has been -- we might be a little off it would only be about timing. I think our R&D estimates sort of remain in the pretty much where we started the year at which was $180 million to $190 million range. That's what we expect to do there you know, obviously the issue with R&D both generic and brand is timing. You have expectations to be able to spend money on certain time frames and you will if you can, but sometimes other things intervene. So I do expect that we will be in that $180 million to $190 million range.

Rich Silver - Barclays Capital

And then similarly on SG&A with $480 million to $500 million guidance number for the year, what is behind the increase in the second half?

Paul Bisaro

Well, it is not really as much an increase in the second half. We've had some higher spending included in that is the transaction cost associated with Arrow as well as the litigation settlement in the first quarter. So the guidance that we have given is GAAP guidance, which includes that litigation settlement and the transaction cost.

Rich Silver - Barclays Capital

And Paul just lastly on the price erosion, what are you seeing now?

Paul Bisaro

Well, we've seen --

Rich Silver - Barclays Capital

Year-over-year?

Paul Bisaro

I'm sorry.

Rich Silver - Barclays Capital

In terms of year-over-year trends?

Paul Bisaro

On the year-over-year number, we still haven't changed from our normal 10%, and I suspect we carry that over into 2010. We probably are coming in a little bit below that on an actual basis, but from, you know, sort of guidance purposes and forecasting purposes that's what we have been using.

You know, as you think about pricing of course, it is event driven. So, usually prices are affected by new entrants coming into the market or new competitive landscape occurring or you know somebody attempting to take product away from you with the competitor. So as long as those things remain manageable, I think pricing will remain stable. As you know, things heat up in that arena we will see pricing be affected by that. But so far this year you know, as I mentioned we did see some pricing pressure on fentanyl patch. We think that is probably behind us now, but you know we will -- if it is not we will deal with it, but you know, at the moment we are pretty comfortable where we are at.

Rich Silver - Barclays Capital

Okay, thanks very much.

Operator

The next question comes from the line of John Boris with Citi.

John Boris - Citi

Thanks for taking the questions and good morning. First question for Paul. I think in 2008 you had indicated in terms of supply-chain costs, you were able to remove about $20 million to $30 million and with you being halfway through the year in '09 can you give any color on the magnitude of cost that you might be able to take out in '09, and I think you've also indicated you might be able to do even better in 2010. So any thoughts there Paul?

Paul Bisaro

Yes, we are still on track with that John. We expect to do better than what we did in 2008. We are on track to take out at least that much and more for 2009 and then 2010 when we really sort of feel the full impact of the -- in this particular -- in 2010 particularly the closure of the Carmel facility and the full impact of a fully loaded Goa facility, we should be able to take even more costs out of the system. So our efforts remain on track and the other piece is by the way included in there is as our API facility continues to ramp up and more and more products that we are able to backward integrate into our supply-chain, we will even see even greater impact from that going forward.

John Boris - Citi

Okay, on Toprol-XL and Cardizem LA do you have large quantities built and you feel pretty confident with the amount of stock that you have (inaudible) on both and would you launch immediately upon approval?

Paul Bisaro

Yes, and yes.

John Boris - Citi

All right, and then on the generic Ferrlecit product that is under expedited review, can you just help us understand maybe some of the requirements from the FDA for generic equivalent, is it just the bioequivalency study that's required on the manufacturing process. Is it validated and will the FDA require any kind of safety data meaning actual clinical experience for the product to be able to be granted in AB rating, thanks.

Paul Bisaro

Well John, I think I am going to have to say -- what I have to say about that is this application is not ours. It is held by GeneraMedix, and they are working with the agency. We have, as I mentioned have done significant amount of due diligence on the product and we are very comfortable with where they are right now. We don't want to compete -- discuss the specifics of the application, not to mention we can't due to confidentiality reasons, but from a competitive perspective, I would prefer not to do that as well.

So what I will -- I'll stick with what I said and that is that we have done significant amount of due diligence on the product. As you know, we have a lot of experience with this kind of product, and I feel -- I think we all feel very comfortable with the GeneraMedix product. So I leave it at that.

John Boris - Citi

It is just -- quickly a follow-up. If you are able to secure approval before the end of the year, is this something you would have also large quantities on to be able to launch before the end of this year or early next year?

Paul Bisaro

Yes John. I think it is best to think of it. As I said we are not including any contribution from this product in 2009.

John Boris - Citi

Okay, very good. Thank you.

Operator

The next question comes from the line of Chris Yu with JP Morgan.

Chris Yu - JP Morgan

Great, thank you. Can you talk a little bit more about your assumptions on generic Duragesic going forward. I guess specifically you are expecting a greater presence for Teva in the market as part of your guidance for this year, and what leads you to believe, I think earlier you made some comments, you are hoping price stabilize this year and just -- can you just elaborate a little bit more on that?

Paul Bisaro

Well, as I mentioned the price stabilization is really a question of how aggressive people become in trying to either get market share or new entrants coming into the market. We don't anticipate right now any new entrants into this category. You know, there are -- with an 18% share of the market. There are certainly opportunities for Teva to you know, get market share from a number of people. So I think we are comfortable that we will be able to sort of maintain our position and we -- you know, I can't guarantee it, but I hope that we have seen some stabilization in the pricing on that front.

Chris Yu - JP Morgan

And then as it relates to Ferrlecit and kind of your infrastructure with your nephrology sales force, when we look out to next year this INFeD and some of the expanded role that this sales force will have with TRELSTAR. Does that support your current investment level at this point or is there opportunity to take more cost out of that infrastructure as we kind of look out towards next year?

Paul Bisaro

Yes, I wouldn't look to cost, take out of that. You know, that's not the way we are looking at this. What we are looking at is reprioritizing in a sense, retasking the nephrology group to focus on other products that fit nicely within their wheelhouse. We think we can productively use the representatives we have just to provide support for not just the products we have in 2009, but the products we anticipate getting, brand products we anticipate getting in 2010. So I don't see a reduction in costs at all in that regard, but you know, probably think of it more as a retasking.

Chris Yu - JP Morgan

And just one final question, as we think about your future business development activities, I guess with the move for Arrow this year with the Ferrlecit deal expiring as we move to next year, it looks like your product mix is shifting to much greater extent towards the generic business. It is when we think future -- do we look at more activity on the branded side of your business over time to get that balance or is that something to be driven more by your internal pipeline or is to be looking at a business that's again more heavily shifted towards the generics going forward?

Paul Bisaro

Well, I think as we look out at the combined company, the combined Watson Arrow company, we will have competing priorities for business development dollars. Some of those dollars and we will continue to spend strategically and I would say aggressively on our brand business, particularly as we look to continue to grow our urology franchise as well as our women's healthcare franchise. We see those opportunities as terrific for us.

We've got a great footprint in both areas right now and we want to continue to expand those. So, but the areas -- the ideas we are looking at here continue to be late stage products we can license in, take through the clinic using our clinical teams in Salt Lake and, you know, sort of generate the value that way. On a going forward basis as I think about generic expansion or worldwide expansion we will start looking at sort of market by market basis outside of the US principally as how do we help grow those markets.

One way of course is to take the products that we have in the US under the Watson label and provide them to our new affiliates across the globe, and we will be doing that as quickly as we can. But in addition we can also look to spend strategically in those markets or in some of those markets to help grow their base business. So I think it'll be a mixture of both across brand and generic spending, and we will be appropriate and judicious in spending those dollars. I think there is a lot of opportunity for growth in both categories.

Chris Yu - JP Morgan

Great, thank you very much.

Operator

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

Louise Chen - Collins Stewart

Hi. Just a few questions. First question I may have missed this, but you give what your sales were for the OC business this quarter?

Paul Bisaro

Yes, our OC sales for the quarter I think we are $85 million or $86 million, $86 million.

Louise Chen - Collins Stewart

Okay, and then secondly have you given any update on the marketing partner for Gelnique or Rapaflo or can you give any update there?

Paul Bisaro

Well, right now we continue to take the product on our own -- use the product on our own. We don't have any plans at the moment to partner those products with anyone. We will continue to discuss the opportunities with potential partners as they come along, but frankly we are pretty pleased with how things are going with Rapaflo and Gelnique. We do have some challenges we see facing the products as I mentioned in my prepared remarks about managed care, but I think we have plans in place to try to overcome those challenges and we see that now as an opportunity to continue to grow both of those franchises. So, but right now we have no plans for our partners on either one of those products.

Louise Chen - Collins Stewart

Okay, and then last question is just on the quarterly EPS progression. I was just wondering how we should think about that given that you are going to have eminent launches, potentially of Cardizem LA and also Toprol-XL. So, you know, will the third quarter be stronger than the fourth quarter or there are going to be other things that kind of even them out, how should we think about it?

Paul Bisaro

Well, I think there we probably see a slightly -- I mean I think it will be slightly weighted to the second -- to the fourth quarter.

Louise Chen - Collins Stewart

Okay, thank you.

Operator

And the next question comes from the line of Corey Davis with Natixis.

Corey Davis - Natixis

Hi thanks. Hi, I've only got 32 questions, but I'll start with one that I have asked about four times now, regarding 2010. Now that you have raised your '09 guidance and I am assuming that you are going to beat the next two quarters. Is it still valid to think about a 10% aspirational earnings growth target for 2010?

David Buchen

I knew -- we knew this question was coming. So we spent a lot of time thinking about how to respond to it and I -- what I would say is I am still very bullish on 2010. I think we all are -- we see the challenges that we face of course are the loss of the Ferrlecit product, that's not a surprise, but we knew that and we have known that for two years now, and we worked very hard to put ourselves in a position to be able to replace the revenue and hopefully the full profit generation from that product.

And as I look at the just the brand division, you think about the opportunities we presented with ourselves. Now we've got Gelnique and Rapaflo having then, we will now have a full year of opportunity or most of 2009 and then a full year of 2010. We expect to have the TRELSTAR six-month product available to us, and we have additional products women's healthcare products that we expect to get approval for in 2010 that could also help support that.

And then as we turn to the generics business for other growth drivers, we now think about potentially generic Ferrlecit. We think about other opportunities in there and you know, one opportunity we haven't discussed was Concerta. So, yes I do see opportunities for us to continue to grow year-over-year without and this is of course not including the Arrow Group. I think the Arrow Group adds to our ability to grow, not detract from it, and that's one of the reasons why that acquisition was so attractive for us. So, on a combined basis, I think we can clearly grow year-over-year, you know, as we get into 2010 after the close of the transaction, we'll be able to give more specific guidance around 2010, but I do expect it to be up.

Corey Davis - Natixis

Okay, great. And one last question just on Toprol-XL. In hindsight, I don't know if you want to say too much and jinx yourself on approval, but what would you say the holdup was due to, is it just the other companies problems, maybe FDA step back and be ultra cautious on this one, and if so is that specific to Toprol-XL or are there broader implications for how the FDA is going to approach other extended-release products?

Paul Bisaro

Well, I think certainly the first matter you raised was part of the reason for the delay, if you will, in getting this product approved for Watson. The agency certainly wanted to make certain that this product is going to meet all the requirements and it is going to be able to remain on the market and of course we wanted exactly the same thing.

As to sort of a broader implication of that I think the agency has become more conservative in their view on approvals. They would -- I would anticipate difficult approvals like extended-release products to continue to get increased scrutiny perhaps from what was done in the past, and now the onus falls to the manufacturers to provide sort of more data and more comfort to the agency, when they submit their application. So, you know, on a going forward basis, we know what we have to do to get products approved and we are going to provide all the support we can to the agency to help them make the right decision in getting these products approved, but I think it is fair to say that the world has changed a bit on -- from the FDA's perspective.

Corey Davis - Natixis

Great, thanks Paul.

Operator

The next question comes from the line of Adam Greene with RBC Capital Markets.

Adam Greene - RBC Capital Markets

Thanks. Good morning Paul. How was your summer?

Paul Bisaro

Good. How was yours?

Adam Greene - RBC Capital Markets

Good, good. That is actually my only question, I don’t have anything else.

Paul Bisaro

Well, I could do without the rain in New Jersey but other than that.

Adam Greene - RBC Capital Markets

Okay, actually one question on Ferrlecit since that hasn't been asked enough. Do you -- with the CP filed by you, I can't remember if this was actually you that filed it?

Paul Bisaro

Yes, Watson did file that.

Adam Greene - RBC Capital Markets

So, do you have the right to pull that or rescind whatever you do with the CP?

Paul Bisaro

Well, there is certainly you know, this issue is sort of pending before the agency. So I'm going to decline to answer kind of how -- what can happen all the possible permutations. You know, our view as I said is that the GeneraMedix product is a good product, and we have done extensive due diligence on it. As I mentioned we have unique, I'd say unique expertise with respect to the products of this type. So, you know, we feel comfortable and we think the agency can get comfortable.

Adam Greene - RBC Capital Markets

Okay, and then just quickly on the brand sales in the quarter, was there any stocking for either of Gelnique or Rapaflo or anything meaningful there?

Paul Bisaro

Well, as you may recall the way we accounted for Rapaflo, we did not – we accounted for that on a TRx basis, so we are not booking revenue on the stocking of Rapaflo. On Gelnique, we took the opposite approach because we are comfortable with the marketplace because of the Oxytrol experience. So we have booked some revenue for the stocking of Gelnique.

Adam Greene - RBC Capital Markets

All right, thanks.

Operator

The next question comes from the line of David Risinger with Morgan Stanley.

David Risinger - Morgan Stanley

Thanks. My question has been answered.

Operator

The next question comes from the line of Ken Cacciatore with Cowen and Company.

Ken Cacciatore - Cowen and Company

Hi, good morning guys. I see you had a question on the guidance. Just looking at your generic line, you are annualizing right into the middle of your range. So I'm actually confused as to why your guidance isn't higher than this given what should be real significant product flow in the back half of the year, so maybe comment on is there something in the generic line that is -- we are anticipating is going to be doing a little bit weaker in the back half? Thank you.

Paul Bisaro

I don't think there is really anything that is going to be significantly lower in the back half. I'm not quite certain. I understand the math that you use, but what I would say if there is an area that we may see some competition in and what we have anticipated is some competition in the oral contraceptives line, as you may remember QualiTest, I believe is the company that acquired a significant number of oral contraceptive products as a result of Teva-Barr merger and we've sort of been anticipating their entry into the market, which would have affected our oral contraceptive contribution. So to the extent there is anything in the back half that would be lower, it would be the anticipation of that.

Ken Cacciatore - Cowen and Company

Well, I guess what you did 400, I believe you did 400 last quarter and then around 400 this quarter. So your run rate is about $1.6 billion if you just stayed consistent and you have what appeared to be tremendous new product flow coming. So I'm just trying to understand you know, if you just go ahead and keep on the same run rate with these new products coming in. Why it is not, you know, a fair bit higher?

Paul Bisaro

Well, I can't answer that. I think we are comfortable with what we have got in place. I think we've got the right numbers in for the products that we are anticipating. So --

Ken Cacciatore - Cowen and Company

Fair enough, and then on the Arrow transaction, I was wondering if doing that transaction in any way alters, now that obviously you are going to be focused not only in the US business, but in the international business. Does it alter the way you look at the ANDA business? Is this now something more of a candidate to be divested as you kind of move further national or are there some synergies with ANDA into all the businesses that we just don't fully appreciate?

Paul Bisaro

Well, I don't see ANDA is a candidate for divestiture. I think ANDA is a strong -- gives us a particularly unique advantage in the US market having our own distribution capability. I think ultimately companies, many companies will want to have a distribution capability at some point in the future, and I think from that perspective ANDA is a very strategic asset for us. As to ANDA’s ability to replicate its business model across other markets that's something we will look at as the Arrow acquisition closes and we start contemplating what the next steps are for all of the businesses, but now we see ANDA as a major contributor to us, and a major component to our success going forward.

Ken Cacciatore - Cowen and Company

Okay, thanks guys.

Patty Eisenhaur

Lindsey, we will take one more question, okay.

Operator

The next question comes from the line of Michael Tong with Wells Fargo Securities.

Michael Tong - Wells Fargo Securities

Hi Paul, good morning. One question on the GeneraMedix deal. At one point you had the option of possibly extending the Ferrlecit distribution agreement. Is it fair to assume now that that door is closed?

Paul Bisaro

Well, as you all know, we've tried I think and of course unsuccessfully to extend the agreement with Sanofi for the distribution of Ferrlecit, and once it became clear that that was not going to be an option, we began looking for other alternatives, and I think it is probably fair to say that that option of extending the agreement in any meaningful way with Sanofi is -- was probably dead a while ago.

Michael Tong - Wells Fargo Securities

And you've also mentioned that had you been able to extend that disagreement -- that agreement?

Paul Bisaro

We also had some disagreement with them too, but…

Michael Tong - Wells Fargo Securities

That's true. The margin of the extension would have been lower than what you are currently getting now. Can you directionally guide us as to how you would compare that hypothetical margin with the GeneraMedix deal?

Paul Bisaro

Well, I think it would be fair to say that both the GeneraMedix deal and any potential Sanofi extension would have been lower than the existing arrangement that we had on Ferrlecit. As you know that was a unique kind of arrangement and certainly worked to Watson’s benefit. So I would think that both are directionally lower.

Michael Tong - Wells Fargo Securities

Great. How about between the two of them?

Paul Bisaro

You know, that's hypothetical. It's really hard for me to say. I would probably think about them as being relatively equivalent.

Michael Tong - Wells Fargo Securities

Okay, thank you.

Patty Eisenhaur

Okay. Well, thank you everyone for joining us on today's call and we look forward to catching up with you shortly. Take care, everyone.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Watson Pharmaceuticals, Inc. Q2 2009 Earnings Call Transcript
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