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Executives

Patty Eisenhaur - VP IR and Corporate Communications

Paul M. Bisaro - President, Chief Executive Officer, Director

R. Todd Joyce CPA - Chief Financial Officer, Senior Vice President

Albert Paonessa III - Executive Vice President; Chief Operating Officer of Anda, Inc

G. Frederick Wilkinson - Executive Vice President - Global Brands

Analysts

Tim Chiang – FTN Equity

Mark Goodman - UBS

Rich Silver – Barclays Capital

Adam Greene – RBC Capital Markets

Louise Chen – Collins Stewart

Greg Gilbert – Banc of America

Michael Tong – Wells Fargo Securities

Randall Stanicky – Goldman Sachs

John Boris – Citi

David Buck - Research Group

Ken Cacciatore – Cowen and Company

Elliot Wilbur - Needham & Company

Presentation

Watson Pharmaceuticals, Inc. (WPI) Q3 2009 Earnings Call November 4, 2009 8:30 AM ET

Operator

Good morning and thank you for joining the Watson Pharmaceuticals third quarter 2009 earnings conference call. (Operator's Instructions) At this time I would like to turn the conference call over to Watson's Vice President of Investor Relations and Corporate Communications, Patty Eisenhaur. Please go ahead.

Patty Eisenhaur

Thank you and good morning, everyone. I'd like to welcome you to Watson's third quarter 2009 earnings conference call. Earlier this morning Watson issued a press release reporting its earnings for the third 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 forecast. Additionally we are conducting a live webcast 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 who will provide an overall perspective of the third quarter, including highlights on the performance of our three business segments. Todd Joyce, our Chief Financial Officer will then provide some additional details of our financial results for the quarter. Paul will then conclude our presentation with our outlook for the remainder of 2009. We'll then open the call for questions and answers.

Also present and available during the Q&A portion of the call are Tom Russillo, President of our Generics Division, Fred Wilkinson, Executive VP of Global Brands, Al Paonessa, Chief Operating Officer of our Anda Distribution Division, and David Buchen our General Counsel.

Please note that today's call is copyrighted material of Watson Pharmaceuticals, Inc. and cannot be rebroadcast 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' 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 the Watson business. These factors are detailed in our periodic public filings with the Securities and Exchange Commission including, but not limited to, the Watson Form 10-Q for the period ended June 30, 2009.

With that I’ll turn the call over to Paul.

Paul M. Bisaro

Thanks, Patty and good morning, everyone, and thanks for joining us today. I'm pleased to report that our third quarter finished in line with our expectations with strong net income and record adjusted EBITDA. GAAP net income as $63 million or $0.55 per diluted share and net revenue of $662 million which increased $21 million when compared to the third quarter of last year.

Adjusted net income for the quarter was $76 million, an increase of $22 million or 41% compared to adjusted net income for the same period last year. This 41% increase in adjusted net income was driven by sustainable margin improvements resulting from operating efficiencies delivered by our global supply chain initiative as well as the contribution of new products.

We realized approximately $20 million in savings from the global supply chain initiative last year and we anticipate we will significantly exceed these savings this year.

Adjusted EBITDA for the quarter was a record $178 million and our cash flow from operations was $74 million.

In our generics business we reported net revenue of $398 million versus $364 for the third quarter last year, reflecting the launches of the 25 and 50 mg strengths of metoprolol ER, Next Choice, our generic version of PLAN B, and Azurette, our generic version of Mircette.

Adjusted gross profit climbed nearly $45 million for the quarter to $201 million. As I highlighted earlier a significant portion of this increase comes from our global supply chain initiatives. We have increased manufacturing volumes out of Florida and continued the planned reductions at our Carmel, New York plant. Additionally, our India sites continue to remap up volume, contributing to lower overall manufacturing costs. We look forward to additional benefits from these supply chain and operational programs into 2010.

On generic R&D we increased investment to $37 million during the quarter, which is consistent with our continued emphasis on aggressively filing new ANDAs. We received five product approval during the quarter, most sigifnciatly of course was the 25 and 50 mg metoprolol ER, Next Choice OTC, and two-faded nicotine gum products. We also announced our patent challenge on Sanctura XR. So all in all, a very productive quarter for our generic business.

Moving to the brand division, the rent launches of RAPAFLO and Genius helped drive net revenue to $113 million compared to $106 million in the same period last year. Co promotion revenue from AndroGel and Femring also contributed to the growth, as did the resumption of shipments of INFeD on a sequential basis.

As you may recall, INFeD had been out of stock in the second quarter due to issues with our raw materials supplier. We have been successful with INFeD in reestablishing that product into the institutional and oncology accounts.

As expected, we continue to see declines in the sales of Ferrlecit due to customers switching to a competitor's product. As we announced last quarter, we will be promoting Ferrlecit through the end of the year when we anticipate the depletion of our inventory. As you know, we also signed a license agreement for a generic version of Ferrlecit from GeneraMedix during the third quarter, and that application is currently pending with the FDA.

During the quarter we responded to FDA's complete response letter regarding our six month formulation of TRELSTAR. That submission is under active review and we now anticipate launching a six-month product in the first half of 2010. Accordingly we have taken certain launch expenses and revenues out of our 2009 forecast for this ix month product.

Also during the quarter, Fred Wilkinson joined Watson as Executive Vice President of Global Brands. Fred will lead all aspects of Watsons's global brand business including brand product development, global sales, and business development cavities. In addition, Fred will also oversee Watson's biologic development efforts. With Fred on board we look forward to the continued growth of our brand business.

Turning now to our distribution business, Anda reported declines in both revenues and margins during the quarter due to relatively few third party new generic product launches and racing and volume declines for generics products launched since the third quarter of 2008. It is important to remember that the Anda numbers do not include sales of Watson products, only third-party distributed products.

Finally a few comments on the acquisition of Arrow. We continue to expect the deal to close relatively soon. As you know we complied our bond offering this quarter on very favorable terms and we stand ready to close as soon as our FTC clearance is received.

To the extent that we can, prior to the close of the transaction, we continue to evaluate potential near-term synergies such as the ability to eliminate Arrow's US sales and marketing expenses and perhaps some modest tax savings. We also anticipate that some synergies may result from the rationalization of the combined generic development pipelines.

We've also begun to analyze how the favorable cost structure of Arrow's Malta facility can be maximized. With longer term synergies will come from APA sourcing and generic product development. We can vertically integrate Arrow's portfolio and pipeline and hopefully win some tax savings. Also, we are already exploring potential generic and brand product filings in some of Arrow's markets; nicotine gum and our Genius precut are just two examples of that.

We're also reviewing ways to review the commercial infrastructure beyond what Arrow has established to date we remain extremely excited about this deal which marks the first step in Watson establishing a global marketing preens while enhancing Watson's long-term growth profile.

In summary, it was another solid quarter for Watson. We saw modest overall net revenue growth, a 41% increase in adjusted net income, and record gross profit. Overall, the generic product sales increased by 11% driven in part by new products and brand sales also increased for the quarter reflecting contributions from our newt’s brands, RAPAFLO and Genius.

Our global supply chain initiative is paying sound dividends as we had promised and we continue to prepare to maximize the potential of the acquisition of Arrow. In short, it has been a very busy and productive quarter of the company.

Now I would like to introduce Todd Joyce. As you are already aware, we announced Todd's appointment last week as CFO, succeeding Mark Durand. I want to take this opportunity to thank Mark for his service to the company. I also wanted to note that Todd has been with Watson's finance department for over 12 years. I've had the pleasure of working closely with him for over two years. He's held a variety of senior financial positions in the company and he also has extensive international experience. I am fully confident in the ability of Todd and his team to meet the financial and reporting needs of our company and to support our global growth.

With that I’ll now turn the call over to our new CFO, Todd Joyce.

R. Todd Joyce

Thanks, Paul, and good morning. I will now review our third quarter financial performance on a consolidated and visual basis. For the third quarter of 2009 consolidated net revenue was $662 million, an increase of 3% from the prior year period. Net revenue for our generic division was $398 million, up 9% on a year over year basis. The increase was primarily due to the launch of metoprolol ER during the quarter and strong sales of potassium chloride.

We also launched two oral contraceptives during the quarter, our next Choice emergency contraceptive OTC product, and Azurette, our generic version of Mircette. Oral contraceptive sales were 93 million during the quarter, a 16% increase forms ales of 80 million during the third quarter of 2008.

The adjusted gross margin for the generic division was 50.4%, up 6.7 percentage points on a sequential quarter basis and up 7.6 percentage points on a year over year basis. The increase in adjusted gorses margins reflects lower unit manufacturing costs as a result or our global supply chain initiative and higher margins from new products.

Moving to the brand division, net revenue was $113 million, up 6% from the prior year period. Specialty product sales were $62 million, up from $54 million in the year period due to our recent RAPAFLO and Genius launches and strong sales of Androgen. Nephrology sales were $34 million, down $6 million compared to the prior year period due to lower Ferrlecit sales. Brand other revenue as $17 million for the quarter, an increase of approximately $5 million on a year over year basis due to higher promotional revenue from Femring and AndroGel.

Brand adjusted gross margin was 81.6%, up slightly from the second quarter of this year and up 10 percentage points on a year over year basis. The prior year period was negatively impacted by a $7.7 million inventory charge related to our inset iron product.

Finally, net revenue from our distribution segment was $151 million, down 11% or $20 million from the prior year period. Due to a decline in third party product launches and lower pricing of volume on products launched in the prior year period. This was partially offset by an increase of brand product sales during the current year quarter. Distribution segment gross margin for the quarter was 14.9%, slightly down from last year.

Turning now to operating expenses, consolidated R&D spending for the third quarter was $52 million which is up appriomxatley $7 million or 15% compared to the prior year period as we saw higher R&D spending in our generics division. For the year on a standalone basis we expect total R&D spending in the range of $180-$190 million.

On a GAAP basis, SG&A for the third quarter was $120 million which is an increase of $19 million over the prior year period. The current year quarter includes acquisition expenses, higher litigation costs, and a legal settlement. The prior year period was favorably impacted by settlements of a tax-related liability. For the year we expect SG&A to be approximately $500 million.

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

Adjusted EPS for the quarter was $0.66 and this excludes $7 million in costs associated with our global supply chain initiative, a $3.5 million asset impairment charge, a $3.5 million legal settlement, and $2.9 million in acquisition and licensing related charges. GAAP EPS for the quarter was $0.55. Details on the adjustments can be found in the reconciliation table of our press release.

Our adjusted EBITDA for the third quartet was $178 million, up 30% compared with the rigor year period and 9% from the second quarter of 2009, reflecting higher contribution from our generics division. Cash flow from operations for the third quarter was $74 million and capital expenditures for the third quarter were $17 million.

Our tax rate in the third quarter was 38.4%. The higher rate reflects nondeductible acquisition related costs and the tax effect of the impairment charge taken in the quarter. Our current debt position is just under $1 billion.

During the third week of August we completed our offering of $185 million in senior notes and used a portion of the proceeds to pay down $100 million of our term loan and redeemed $575 million of convertible debt. Interest expense for the third quarter reflects a partial quarter with the new debt. The annual interest cost of the new debt will be approximately $50 million. However, going forward, our weighted average share count will be reduced by 14.4 million shares.

At the end of the quarter we had $826 million in cash and marketable securities and $500 million indrawn on our revolving credit facility. Cash consideration for the Arrow acquisition is $1.05 billion. We will be funding the Arrow acquisition using cash on hand and borrowings under our revolver. We will also issue 16.9 million shares of commonest dock and 200 million of zero-coupon non convertible preferred shares which mature in 2012. As a reminder, these shares will be treated as debt for accounting purposes.

With that I will turn the call back over to Paul for an update on our 2009 forecast (inaudible).

Paul M. Bisaro

Thanks, Todd. There are a number of factors, of course, that will influence our forecast for the remainder of the year. As always, some of these factors we can influence through solid execution, but others are out of our direct control. So first I'll go through a few assumptions and then provide the current forecast. I want to start by reminding you that our acquisition of Arrow is not included in the guidance. We'll be providing guidance for 2010 that will include Arrow's operations early next year. Also, we anticipate moving to cash EPS in 2010 which will exclude all of our amortization.

So, based on the actual results for the first nine months of 2009, we continue to estimate the full year net revenues of approximately $2.7 billion. We are tightening our generic revenue forecast from $1.55 and $1.65 billion to between $1.6 and $1.65 billion. Regarding generic Cardizem LA, we anticipate the approval and launch of this product before the end of the year and we expect it to contribute to the fourth quarter results.

As for generic Toprol XL 100 mg and 200 mg, we also expect approval of this product before the end of the year, however, we anticipate that customers will need to wind down their existing inventory and as such, have a minimal contribution for these two strengths of metropolis in 2009.

Finally, we have not included anything for new patent challenges.

On the brand side of the business we continue to forecast net revenue between $450-$465 million for the year. With the Anda distribution business we have adjusted our expectations downward somewhat and now anticipate revenue between $620-$640 million due to low visibility of significant third-party new generic drug approvals through the end of Th year. For adjusted EPS we affirm our previous forecast of between $2.50-$2.58. Accordingly, adjusted EBITDA is still expected to be between $668 and $685 million. But for both measures we expect to be closer to the higher end of the range.

For Watson, 2009 is shaping up to be a very strong year. We exceeded our expectations and we anticipate carrying this positive momentum into 2010. With that I'll turn it back to Patty for questions.

Patty Inhaul

Thanks, Paul. At times time we're happy to take any questions you might have. Again as are reminder, in the interest of time and consideration to others, please limit yourself to one question and one followup question. Operator, I'll turn it back over to you to get the Q&A under way.

Question-and-Answer Session

Operator

(Operator's Instructions) Our first question comes from the line of Tim Chiang with FTN Equity.

Tim Chiang - FTN Equity

Thanks, Paul. Good morning. I wanted to ask you about the metoprolol launch. How has that gone? Did you have significant revenues in the third quarter or do you expect that to benefit your fourth quarter results? I wanted to get your thoughts also on where you expect your share to be two-three quarters from now.

Paul M. Bisaro

Yeah. We were very pleased of the launch of the 25 and 50 mg metoprolol. I think the market has begun to settle out. There was a fair amount of stock in the trade in the third quarter that had to be worked through, although we did get some significant product out in the third quarter. We do expect to do about the same amount in the fourth quarter that we did in the third quarter and as to market share, we're pretty comfortable with where things are settling out and it's basically a two player market. We ended up in a good solid position. Of course market share is always a balance between price and market share so I think we're very pleased with where we ended up.

Tim Chiang - FTN Equity

Can you comment a little bit on where the prices settled for you guys relative to the other players?

Paul M. Bisaro

Well, I think the prices settled as it would in a two player market. It has settled nicely and we don't see a lot of continued pricing pressure on the product at the moment. I wouldn't anticipate any unit there's another sort of event that might occur, new entrant, that sort of thing. So I think it'll be fairly stable going forward.

Tim Chiang - FTN Equity

Would you say that the same thing’s happening in Micro-K as well, Paul?

Paul M. Bisaro

Well, Micro-K is a different situation. We're the only player in Micro-K so it is a significantly different situation for us. We had a very solid quarter with Micro-K. We expect that to continue through the end of the year. We don’t expect any new competition on Micro-K through the end of the year now or any significant competition I should say, but that is a one player market so our pricing is accordingly. The product is accordingly priced, I should say.

Tim Chiang - FTN Equity

Okay great. Thanks.

Operator

Your next question comes room the line of Mark Goodman with UBS.

Mark Goodman - UBS

Paul, can you talk about your thoughts on increasing the SG&A for the brands, how much we should be expecting? And just given the launches so far, how do you think those launches have gone and just your commitment throughout the next year continuing to put money behind those brands?

Paul M. Bisaro

Yeah. I'm very pleased with the way the launch has gone. I think the team has worked real hard to overcome some pretty significant challenges. I think it's clear that if you look at new launches across the board, whether they're ours or any other company's product, everybody's facing new challenges with managed care controlling so much of the marketplace it is difficult to get these things moving. But, I think our team has come up with some very creative ways to break through and we're seeing a lot of new gains in the managed care marketplace which is being now reflected in scripts.

We are fully committed and we remain fully committed to our brand division. We will become and we are currently a very strong urology company. We continue to look for urology opportunities and continue to add new ones to our pipeline everyday. We'll continue to focus also on female health care. It's a great crossover opportunity; urology and female health fit nicely together and we'll continue to grow the teams.

Regarding continuing spending, as the brands ramp up as we're able to spend more we probably will.

Mark Goodman - UBS

(Inaudible) like you're spending more in the fourth quarter for, so I was just wondering what is the spend?

Paul M. Bisaro

The fourth quarter is just slightly up. The fourth quarter spend does not include any new head count or any new particular DTC campaigns. It's just probably additional fort around the managed care area. We're probably doing a bit more sampling, we're doing a bit more coupon work, so that's probably where that's coming from.

Mark Goodman - UBS

And can you just give a sense of — I mean, are both these products, I mean, Genius (inaudible) before ether launch, are they on a lot of formularies already? Can you just give us a sense of how they're doing?

Paul M. Bisaro

Well, I think we're probably in about half of the formularies that we want to be on and we're continuing to work through the other half. A lot of it is timing. New formulary committees meet usually at the beginning of a quarter or twice a year so we're expecting another big push in the first quarter of 2010 to get onto more formularies.

So I think we're doing as well as anybody can with these products and I do expect to see continued growth from both of them. I think from an internal basis on our internal forecast we're pretty much right on target with RAPAFLO. The combination of Genius and Extol is on target. I think as I had mentioned in the past what I think we didn't anticipate was Oxytrol — we expected Genius to take more of the Oxytrol business and in fact it didn't and so as combination we're well on track for that combination for our internal forecast purposes.

Mark Goodman - UBS

So should we expect as you move into '10 there will be increased DTC spending or more sales reps or what are you thinking about that?

Paul M. Bisaro

I don't think we'll see DTC spending in the near term from us. As to new sales reps I think that will come with new products. As you know we've got a new oral contraceptive that we're working on and we've got a number of other opportunities, but until some of those things hit we probably won’t be increasing our sales force.

Mark Goodman - UBS

And just one other question just a different line, but the gross margin in the generics business seems to be really picking up, can you just give us a flavor for how sustainable that is? How much of that is really just metoprolol, Mice-K, just your product-mix shift? How much is behind the scenes of this whole little supply initiatives since we know what's variable versus your two key new products and what's sustainable?

Paul M. Bisaro

Sure. Well, as I mentioned in my prepared remakes, we're very pleased with the results of our global supply chain initiatives and it's starting to pay dividends for us. Of the roughly 6%-7% increase in that generic margin, I would say about half of that is sustainable, comes from the global supply chain. The other half is probably related, as you point out, to product mix he new product launches, as well as moving away from authorized generic revenue and moving more toward revenue generated by products of higher margin.

So, about half of it is sustainable. We do expect to continue to get benefit from the global supply chain initiative. As we had said in the past, we did $20 million of improvement in cost reduction in 2008. We do expect to do substantially more in 2009. 2010 on a standalone basis we would do even more. 2010 will be a little bit different as we bring in the three manufacturing plants from Arrow, but we do expect to continue to reap benefits from our global supply chain initiative.

Mark Goodman - UBS

Thank you.

Operator

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

Rich Silver – Barclays Capital

Good morning, Paul. Just looking at the generics business and the, at least relative to our estimate quarter to quarter, with the OCs being a bit stronger than we expected and with the launch of Toprol XL and Generic PLAN B, it looks like there's some flatness there. Can you talk about the base generics business and where pricing has been and volume trends on a quarter-to-quarter basis?

Paul M. Bisaro

Yeah. Quarter-to-quarter trends in the generic revenue lines are always difficult to explain because there's movements of buying patterns and all kinds of — what's in the inventory, whets in our control, what's out of our control, but on a general matter I think I’m very pleased with the results for the quarter. We had, obviously, very strong continued sales of OCs. A lot of that was related to new launches of course, but still we continue to see strong OC sales across our entire line.

Metoprolol, as I mentioned earlier, has done very well, and then you asked about pricing and I'll sort of echo what I said in the past; I think pricing remains a bit more stable than we had originally anticipated for the year. We are seeing less volatility and that is reflected in the profitability of the company. I expect that that stability in pricing will continue for some time. A lot of factors contribute to that stability, but I don't see any major change imp racing over the next few quarters, and in fact as we look into 2010 we would anticipate using very similar numbers that we have this year and to next year for erosion rates.

Rich Silver – Barclays Capital

So there's nothing that you can really point to account for the flat revenues considering that you did have the benefit of these generic launches?

Paul M. Bisaro

No, not particularly.

Rich Silver – Barclays Capital

Okay. And I guess similar question on the brand or the specialty side, any kind of insights you can provide on, again, the sequential trend which was down?

Paul M. Bisaro

Well, that was related more towards Ferrlecit declines. As we've mentioned in the past, remember Venofer as the major competitor of Ferrlecit is now owned by FMC and FMC was a major customer of Watson and our Ferrlecit business. And as more and more of those FMC clinics convert to Venofer as you would epact they would, our sales will decline. So it has been as struggle to maintain the business that weaves. Our team has done a terrific job at maintaining that business, but it's also recognition than those sales are on the decline. So as they decline we have to replace them with new things and that's where RAPAFLO and Genius and hopefully TRELSTAR six months early in 2010.

Rich Silver – Barclays Capital

Sorry, the question was on specialty, not nephrology, just the ex nephrology.

Paul M. Bisaro

Oh, that would just be buying patterns.

Rich Silver – Barclays Capital

Thank you.

Operator

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

Adam Greene – RBC Capital Markets

Thanks, good morning. Actually following up on Rich's question, you've lost virtually all of your Cartia XT sales over the last six months. I think it's down 90%. So how much does this contribute to the sequential decline? And I mean this is obviously a high-margin product as well also you can you just explain the impact there from loss of Cartia XT?

Paul M. Bisaro

That was minimal. I mean, I guess you guys are talking about a $3 million sequential decline in revenue on the generic side. It is pretty small. I would say those are — I mean, it's very hard to point to one specific thing on a $400 million revenue line and say there's decline. I think the revenues are pretty flat quarter over quarter and a lot of that is reflective of buying patterns. We don't always control when (inaudible) or A, B, or C are going to place an order and in one quarter they can place it at the end of the quarter or at the beginning of the quarter and it can move the numbers fairly significantly on the revenue line. So I wouldn’t read too much into that in that fluctuation.

Adam Greene – RBC Capital Markets

So is it fair to assume that metropolis XL is a fairly small contribution to the quarter? I mean, probably less than 5% of generics?

Paul M. Bisaro

I would say it's slightly higher than that.

Adam Greene – RBC Capital Markets

Okay. And is there any update on Concerta at this point?

Paul M. Bisaro

No. We continue to litigate and we're continuing to work to get our final approval.

Adam Greene – RBC Capital Markets

Okay, thank you.

Operator

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

Louise Chen – Collins Stewart

Hi. I just had a question on your OTC products with respect to the launches of your nicotine gum and then your Next Choice product, can you talk about what kind of market shares you have for those products and then where do you expect to be over the next several months or so?

Paul M. Bisaro

Well, on the nicotine gum it's a two player market. Paragon and Watson have the nicotine gum products. Certainly the addition of the new flavors has been very helpful for our product line and we would anticipate that our market share will remain consistent with kind of where it's been historically. We might see some improvement as we get the new flavors and get those out there and we'll get a bit more market share, but I would say we're real pleased with the way nicotine gum is going, but I wouldn't expect to see substantial increases in market share on that.

Regarding the PLAN B OTC, our Next Choice product, that has done very well for us. We are the only generic version of the product and as such we've taken what you would expect only generic would take out of that current marketplace. What we don't know is how it will play through the OTC market. It's still a little early to tell. We are pleased with the uptake we've gotten so far. We've gotten a lot of interest in the product from CVS and Walgreens and Wal-Mart and the like, and we'll have to see how it does play out in the fourth quarter, but so far it's been going pretty good.

Louise Chen – Collins Stewart

And then just one followup question on your launches of RAPAFLO and Genius, can you give ore color on how those are progressing and could you even give us any revenues that you have achieved for those products?

Paul M. Bisaro

Yeah. We've sort of shied away from giving revenue projections for the year. We'll probably be looking to give you more color early in 2010 for those products. Again, they're consistent with our internal estimates. We are working very hard to, as I said, overcome the challenges.

If you stack up let's say Genius’s launch against Tobias’s launch, you can see that we're almost script for script with them in growth and they have maybe 300 more reps and they’ve used DTC and have all these things, and I think that just shows you that unit you've broken into the managed care marketplace, until you've resolved those issues, you’re going to struggle a bit in the early quarters and I think we're seeing that across all the products that are launching.

And so I think what it really means for all of us as we contemplate brand product launches, we have to anticipate that it's going to be the early quarters which are going to be a struggle to get out there until you can establish yourself in managed care.

Louise Chen – Collins Stewart

Thank you.

Operator

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

Greg Gilbert – Banc of America

Thank you. Good morning, guys. Following up on a bunch of the questions, it sounds like people assume that inventory levels are the same at all times as they assess shrinkage of old products and addition of new products. So Paul, can you flush out a bit sort of how much visibility you have on trade inventory levels whether you have Incas on the generic side and perhaps what levels were end of 2Q and end of 3Q?

Paul M. Bisaro

We do have a fair amount of visibility into the inventory levels. I think I sort of hinted at this before, but maybe I'll be more explicit about it, with metoprolol there was a lot of product in the trade when we launched metoprolol 25 and 50. That was a result of a number of factors. I think certainly our customers were concerned about supply of that product as you may remember there, two companies sort of lost the ability to supply and that often sends customers out frantically looking for inventory because they don't ever want to be short of generic products.

So there was probably a higher than normal level of inventory on the metoprolol at the beginning of the third quarter when we launched into that, and then it became a question of burning through that inventory that these guys held and then get to our product and then we get to restock after that's done. So we won't fully appreciate the full market share position that we've got until sometime late in the fourth quarter.

Greg Gilbert – Banc of America

Other than metoprolol, any significant changes Q2 to Q3 for overall trade levels in the number of weeks?

Paul M. Bisaro

No. I don't think there was any significant — I mean, I can't think of any significant changes. Tom doesn't know of any either. I think it's just really buying patterns.

Greg Gilbert – Banc of America

Okay. And then my followup question is an Anda question perhaps for Al, how crowded do you expect the generic Prevacid market to be upon formation next week and are you looking for any other significant launches between now and year end into the Anda business? Thanks.

Albert Paonessa III

Yeah, Greg. Prevacid has kind of been confusing to us. We thought there'd be multiple players and right now we're thinking that there might only be three at the launch. So that's all we've been able to figure out so far, very confusing. As to other significant launches, the reintroduction of placard (ph) will be good for us towards the end of the quarter. Allegra D just came out this week and that's about all that we see in the fourth quarter right now.

Greg Gilbert – Banc of America

Thank you.

Operator

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

Michael Tong – Wells Fargo Securities

Hey, good morning. Paul, just want to followup on the generic margin improvement question. You talk about half of it being sustainable from your global supply chain initiative and the other from product mix. Based on what you're seeing in terms of your visibility to product launches over the next two to three quarters, is there any reason why the gross margin for the generics wouldn’t toy up there at about 50%?

Paul M. Bisaro

I think that's probably a reasonable assumption, maybe a little lighter than that, but it really sort of depends on the timing of the launch of the Cardizem LA and the metoprolol 100 and 200, but we would expect to see a little bit of erosion not on metoprolol of course, or even potassium, but ones omen of Theo there products there will be some slight erosion. So unless we get those other launches and they're able to overcome the existing erosion, we would expect them to be in the high 40s or around 50.

Michael Tong – Wells Fargo Securities

Okay, great. And then secondly maybe a question for Fred, as you sits now, what's your thought process behind Watson's generic biologic strategy?

G. Frederick Wilkinson

I think that the primary driver of our biologic strategy will be the foundation work that we've done developing discussions with partners and ideas that we might go into as far as some our partnering opportunities, and then second, what will be established out of the Arrow acquisition. There's a good foundation within Arrow. They have a position within a third party and we have visited many times there and are starting to establish our strategy.

There are multiple products that are available for us to be participating in and we just look forward to driving the strategy of biologics, whether that is bio better or bio similar.

Michael Tong – Wells Fargo Securities

And do you think you need the Washington pathway to open up for you where you can get to a particular strategy?

G. Frederick Wilkinson

I think we will probably play on both sides. I think we would expect the Washington pathway to, at some point, open up, but I think we're prepared to participate on both sides.

Michael Tong – Wells Fargo Securities

Great, thank you.

Operator

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

Randall Stanicky – Goldman Sachs

Great. Thanks for the question. Paul, just piecing together several of the other questions, can you give us some directional color or guidance or expectations around standalone growth for Watson for next year? I know you talked about a 10% target perviously; maybe can you give us some thoughts around where you think EBITDA can go?

Paul M. Bisaro

Well, I think on a standalone basis we would expect to grow year over year. The extent of that growth will be dependent on a couple of factors, some of which are in our control, some of high care not. I've said in the past at some point we will have to include contributions from patent challenges in our forecasts. Until we do that it's going to be difficult to give you the specific percentage growth rates because products like Concerta of course, if they do contribute in 2010, would have a significant impact and I know some of our competitors are now including at least some weighted contributed for patent challenges and I think we'll have to think about doing that for 2010.

Our current plan, Randall, is to close the Arrow acquisition and look to provide specific guidance on the combined basis in early 2010, probably sometime in January, to give you some color on what we think 2010 will look like on a combined basis. As I sit here now both knowing what we know about Arrow and what I know about Watson, I do expect 2010 to be age old year for the combined entity.

Randall Stanicky – Goldman Sachs

Okay. But assuming no new major product launches, and then assuming Toprol XL and Micro-K's stable market, you think you can grow standalone next year?

Paul M. Bisaro

I do think we can do that, yes.

Randall Stanicky – Goldman Sachs

Okay, great. And then one final question, I'm sorry if I missed it, but did you talk about fentanyl and any changes that you're seeing in that marketplace?

Paul M. Bisaro

I did not talk about it, but I’m happy to. The fentanyl marketplace remains relatively stable. There's been some erosion in price. As you may remember there is a new product that was — there' as new brand version of the product out there. We still have a reservoir product and we continue to sell our reservoir product. We don't expect to have to stop selling that product so we continue to make it, we don't have any supply issues, and our market share remains pretty stable.

Again, we've seen a little bit of erosion on that product in the pricing arena on fentanyl Th ought.

Randall Stanicky – Goldman Sachs

And that's in the last quarter?

Paul M. Bisaro

Yeah. I mean remember, there have been new entrants and every time there's a new entrant there is some jockeying for position which causes price erosion.

Randall Stanicky – Goldman Sachs

Okay fair enough. Thanks, Paul.

Operator

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

John Boris – Citi

Thanks for taking the question. Good mooring, Paul. First question just has to do with Toprol XL and Micro-K, just any color on what your assumption is for additional come option on those assets and then have after Arrow.

Paul M. Bisaro

Okay. On Micro-K we don't anticipate any substantial competition on that product through 2009. As we look into 2010 we'll have to sort of reevaluate that. On metropolis we also don’t expect any competition through the end of the year. Again, 2010 will be a different story, but right now as we see the world we don't expect anything for either one of those two products in 2009.

John Boris – Citi

But when you say it's a different story ink 2010, you are assuming some competition in '10 from other son those assets?

Paul M. Bisaro

I do expect competition on metoprolol to hit additional competition on metropolis in 2010.

John Boris – Citi

Would that be front half, back half?

Paul M. Bisaro

Probably too early to tell. Given the information that we have, and it's only kind of what everybody else has, I would anticipate mid year.

John Boris – Citi

Mid year, okay. And then on Arrow on your refinement of your strategies on the acquisition to ensure a smooth and efficient integration of the asset, you indicated there could be some tax savings, but as you've laid out some assuming for Arrow, and I know you're going to do that in January, but as we're thinking about the integration of this asset, any other things that may have changed or altered your opinions from when you first announced the acquisition on revenues or synergies or tax or integration of Cobalt? I mean you've given some comment on the integration on the R&D side there, but any other thoughts that you might have as you're refining those?

Paul M. Bisaro

Well, as we look more and more into the asset we're of course limited somewhat still with what we can do, but as we learn more and more and more about the company, I think we continue to be very bullish on some of the major markets in which they operate. We're very pleased in what we see Arrow's doing or Cobalt is doing up in Canada. We're real pleased with market performance in France and Australia. Those key markets for Arrow are looking like they’re going to achieve what they are expected to achieve in 2009 and then we have high hopes for what they can achieve in 2010.

As we've said in the past, one of the reasons Arrow was so attractive to us is many of their products that were pending are expected to launch over the next 12-18 months in many of these key markets and that should drive growth. And also frankly, as we haven't talked about this yet, but there have been disruptions in the marketplaces around the world. There have been disruptions here in the US with companies having manufacturing issues, but there are also disruptions in other key countries and as those disruptions hit, Arrow and the Arrow teams in those countries have been able to take advantage and achieve additional growth.

So I mean, everyday we take a look at this asset we're real pleased with what we see and I just can't wait to get started on putting it all together and driving the business.

John Boris – Citi

Thanks.

Operator

Your next question comes from the line of David Buck with Research Group.

David Buck - Research Group

Hi, good morning. Thanks for taking the question .A c couple on generics; can you talk a little bit about — you mentioned market share for generic Toprol XL, I think you said, settling out. Right now it's about 16% roughly in terms of scripts, do you expect that to be the number for the current strengths? And just in terms of additional opportunities, generic Acted is one you've been selling. I know it's a lower rating product, but what's the situation there with supply potentially being limited for one of your competitors and another competitor coming in? And do you have any Lovenox visibility at all? And then just one for Fred, when should we expect RAPAFLO and Genius to become profitable? Thanks.

Paul M. Bisaro

Okay. Well, I'll start and then Fred, you can answer the hard question. On Actiq we have the same visibility everyone else has. We saw that Covidien got an approval. They've also said they don't expect to launch until some time early next year I think is what they said. We also understand that Teva is no longer getting the product, but they also have significant inventory. So unless Teva gets approval on a new product I would expect that we'll have at least a two player market for some time. We don't expect any major uptake on our side. We continue to get the product and we continue to sell the product. So, not a big change either ray on Actiq.

Regarding Lovenox, I think we don't have any more visibility than I guess we had last quarter. Our partner continues to try to work through issues with the FDA and get the product approved, but we don't have anything for Love ox as far as contribution info or 2009.

And then your question on metoprolol was market share, certainly the 16% market share that is currently being shown is too low. We will be substantially higher than that. Again in a two player marker you would anticipate to be closer to 50% than 16% so I think you can look for us to be moving up toward that number and like I said, three’s a balance that you try to keep between price and quantity, and we'll see market share go up, as I mentioned, as this inventory sort of works its wee through the chain and our customers start using our products as opposed to old inventory that they had.

G. Frederick Wilkinson

I think regarding the profitability of the two launch products, we tend to have a nice opportunity here because of the franchise business that we've developed in urology. Essentially we're able to launch these two products without expansion of the fixed asset which is your sales force, by speeding the use of the sales representatives that used to be on Oxytrol and TRELSTAR exclusively. So now being on Oxytrol, Genius, RAPAFLO, as a combination all going to urologists and some primary care. So the incremental spend is essentially on the marketing side of things.

With most launch products, I think you're expected to be profitable somewhere between 12-24 months into the launches and we look at the two of them differently. RAPAFLO is a pure launch into a new category. Genius is a launch into a franchise category which is the oxybutynin category. So Genius and Extol most likely are profitable now. RAPAFLO will become profitable probably in that 18-24 months timeframe.

David Buck - Research Group

Great. And just to followup, from a disclosure standpoint, should we be expecting as these become more important to you in 2010 to hear either guidance or at least disclosure of the key branded products?

Paul M. Bisaro

I guess we'll take that under advisement. I do think we'll probably give more color in January around our whole brand franchise. Our plan is to have some sort of analyst meeting sometime hopefully in January or early February where we can lay out for you all our view of the combined company and what we expect for 2010 and beyond and he’ll focus obviously as significant amount of that effort on the branded vision because it is a key growth driver for us going forward.

David Buck - Research Group

Thank you.

Operator

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

Ken Cacciatore – Cowen and Company

Good morning, guys. Paul, you're talking about maybe are you trying to include some of the challenges next year like Concerta, and so I’m raying to understand what's different over the last six years with the FDA or maybe your product. Are there different people at the agency? Is your formulation somehow changed? What has happened over the six years that would give you more or less confidence? And then maybe discuss the OC completive landscape as you see it, how might it change over the next 12-24 months? Is that something we should be thinking about as well?

Paul M. Bisaro

Sure. On Concerta, I think what's changed is we of course won the district court decision against Johnson & Johnson so we've got a pretty strong position moving onto appeal. That gives us one set of — it takes one hurdle away that you have to get over. The second thing is we of course have resolved the manufacturing issues in Florida. Florida has been working very hard on metoprolol and on Cardizem LA and as they get more and more capacity online and we get more ability to work on more products, Concerta is a natural continuation of that growth out of Florida.

Ken Cacciatore – Cowen and Company

So Paul, wasn't there a point in time this late listed patent and pre manufacturing issues, I think it was probably two years where they could have approved the drug and they chose not to?

Paul M. Bisaro

No. Remember, IMPAX is sitting with potential first to file on Concerta and is arguably blocking our ability to get a final approval. So that was one of the reasons. And the second reason was while the Florida facility was under OAI; they were not getting approvals for anything.

Ken Cacciatore – Cowen and Company

And you're talking IMPAX, you believe, had exclusivity all the way back in March of 2004.

Paul M. Bisaro

They claim to have the first to file position and we're working with the FDA to try to understand why they still have it.

Ken Cacciatore – Cowen and Company

Okay. And then on the OCs?

Paul M. Bisaro

On the OC front we are starting to see a new competition hitting on some of the OCs. That will, of course, affect the overall profitability of the franchise, but I don't expect to see any sort of broad competitor in 12-24 months. I mean, the next logical competitor is probably Qualities with the products that they acquired from Teva on Tea’s divestiture of the products that Watson originally had through its acquisition of André. Those 12-14 products we do anticipate will appear at some point over the next 12-24 months, but somebody with a franchise of 25 different oral contraceptives including PLAN B OTC and new follow-on products coming everyday, I don't see somebody with that kind of magnitude and I expect that Teva and Watson will continue to be dominant in that category.

Ken Cacciatore – Cowen and Company

Great, thank you.

Patty Eisenhaur

Operator, we'll have to take our last question just due to time restraints.

Operator

Okay. And your last question comes from the line of Elliot Wilbur with Needham & Company.

Elliot Wilbur - Needham & Company

Hey, Paul. Thanks, good morning. Just coming back to your commentary around Cardizem LA, is your prognostication there similar to what we saw with Toprol where you're sort of in the final stages of discussions with the FDA? Just trying to get a sense of your degree of confidence that you're going to, in fact, get approval for your Anda there.

Paul M. Bisaro

Yeah. I think it's fair to say it's similar to my thoughts around the 25 and 50 when we last spoke.

Elliot Wilbur - Needham & Company

Okay. And then just last question on distribution segment, just want to confirm that the modest reduction in revenue expectation there is entirely due to shift in some of the P4 opportunities and not in any sort of change in the underlying rate of pricing erosion industry wide? And then just sort of curious given that those are all third party sales, guess when you guys build your revenue forecast you're sort of making your own probability adjusted assumptions on some of these potential laud inch events to just include sort of a single bucket for new product opportunities and discount that. Imp just kind of curious as to how you get insight tin some of the individual opportunities?

Paul M. Bisaro

Well let me just go first and then I'll let Al answer the question on pricing. I think the reason why we keep making sure people understand that Anda doesn't include Watson sales is for example, when we launch Cardizem LA and we're the only product in the marketplace, Al get son credit for that. So you don't see revenue for him and profitability for his sales of those products. We capture all of that in the Watson line. Same thing with potassium. So his numbers are not really reflective of his true distribution dollars. That's important to remember and that's what I want people to focus on. But the overall business is pretty strong and Al, I'll let you fill in the rest on the racing and the strength of the business.

Albert Paonessa III

Yeah, our overall base has been very consistent. Customer base is strong quarter over quarter. Pricing really has been effected by a couple 180 day products, the Risperdal and (inaudible) from last year. Those have really eroded. But the base business that we have quarter over quarter of the commodity products have been ratty consistent and we haven't seen a lot of erosion which you normally would when you don't see a lot of new products come out. You see those products erode, but we haven’t seen that.

Patty Eisenhaur

Okay. Well, thank you everyone for joining toddy’s call and we'll be sure to follow up with you soon. Take care.

Operator

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

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Source: Watson Pharmaceuticals Q3 2009 Earnings Call Transcript
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