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Teva Pharmaceutical Industries Ltd. (TEVA)

Q4 2006 Earnings Call

February 13, 2007 8:45 am ET

Executives

Kevin Mannix - North American Director of IR

Israel Makov - President and CEO

Dan Suesskind - CFO

George Barrett - President and CEO of Teva North America

Bill Marth - President and CEO of Teva USA

Analysts

Greg Gilbert - Merrill Lynch

Richard Silver - Lehman Brothers

Tim Chang - FTN Midwest Securities

Michael Tong - Wachovia Securities

Elliot Wilbur - CIBC World Markets

Ron Miguel - Bernstein

Randall Stanicky- Goldman Sachs

Louise Chen - Morgan Stanley

Robert Bonte - Citigroup

Marc Goodman - Credit Suisse

Will Sawyer - Leerink Swann

Ken Cacciatore - Cowen & Company

Ben Josef - Mezdi Capital

John Smart - JAS Securities

Presentation

Operator

Greetings ladies and gentlemen and welcome to the Teva Pharmaceutical Industries Ltd., Fourth Quarter 2006 Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Kevin Mannix, North American Director of Investor Relations. Thank you, Mr. Mannix you may begin.

Kevin Mannix

Thank you, Claudia. Good morning and good afternoon everyone. Welcome to Teva's fourth quarter and full year 2006 Earnings Call. We hope you’ve all had a chance to review our press release which we issued earlier this morning. A copy of the press release is available on our website at www.tevapharm.com. Additionally, we are conducting a live webcast of this call which is also available on our website.

Today, we are joined by Israel Makov, President and CEO; Dan Suesskind, Chief Financial Officer; George Barrett, President and CEO of Teva North America; Bill Marth, President & CEO of Teva USA; and Moshe Manor, Vice President of Global Products.

Israel and Dan will begin by providing an overview of our results. We will then open up the call for a question-and-answer period. Before we proceed with the call I'd like to remind everyone that the Safe Harbor language contained in today's press release also pertains to this conference call and the webcast. I would now like to turn the call over to Teva's president and CEO Israel Makov. Israel.

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Israel Makov

Thank you, Kevin. Welcome everyone and thank you for joining us today as we review Teva's results for the fourth quarter and full year 2006. 2006 was an extraordinary year. It was a record breaking year across the board for sales, net income and cash flow and of course profit margins. This was also an exceptional year in terms of strategic achievements. Before I describe the year in greater detail, let me briefly review the fourth quarter.

Our sales of approximately $2.3 billion in Q4, matched the record we achieved in Q3. We had strong sales across Europe and our international geographies where we achieved new sales records as we did in our API, respiratory, and Copaxone market sales.

Our US generic business, once again demonstrated its strength. While we enjoyed successful launch of bupropion XL and launches of a number of other smaller products in Q4, we also had to absorb the loss of exclusivities from simvastatin and pravastatin including the associated significant shelf-stock adjustment. It is worth noting here that our US market share of simvastatin today is a bit higher than it was during the exclusivity period, quite a rare phenomenon.

Although retaining this significant market share required that we take a larger than anticipated shelf-stock adjustment in Q4, we are pleased that our key customers will continue to source this important vertically integrated product from Teva, and welcome the additional ongoing value from these important products.

Global sales of Copaxone continue to be robust. In-market sales in US increased by 9% and non-US sales by 35% quarter-over-quarter. And in our international region, which includes all our geographies outside North America and Western Europe, sales of Copaxone nearly doubled.

Our recently launch of Azilect also did very well in Q4, with in-market sales of $19 million, reflecting the positive reception the product has received in the 24 countries where it is already marketed.

And now one of the highlight of Q4, the tremendous increase in respiratory sales in US across our entire portfolio. The conversion of our Albuterol MDI market from CFC to HFA is now well underway. And now ProAir HFA now holds more than 60% market share of this fast growing market.

All of this together with the required contributions from the businesses that I'll not review here today resulted in adjusted net income of $433 million for the period and adjusted EPS of $0.53, consistent with our guidance.

Now let's turn to the full year of 2006, a year in which our sales increased by 60% to reach $8.4 billion. Our adjusted net income rose 74% to approximately $1.9 billion. Our cash flow from operations crossed the $2 billion mark.

The major strategic event of 2006 was of course the acquisition of Ivax, and the major challenge of the year was the Ivax integration. I'm pleased to report this was a challenge we met with great success. We were able to extract the highest possible value from the acquisition during the year, and the integration of the company was so successful, which we are already operating effectively as one unified.

Our cost synergies of $113 million exceeded our ambitious goal of $100 million in the first year. And we achieved sales synergies of many hundreds of millions of dollars at the high end of our initial estimates.

These sales synergies include the tremendously successful launches of simvastatin and sertraline, launches from which neither Ivax nor Teva could have extracted so much value independently.

Most importantly though, we acquired similar new engines for growth from Ivax; one especially exciting engine is though its respiratory line, which I mentioned earlier. We managed to increase respiratory sales in the very first year of operations by 90% in US and by 38% globally to reach total global sales of $500 million. We are very enthusiastic about the growth prospects for our respiratory line.

Another exciting growth engine is Latin America. Our sales this year reached $514 million, a 15% increase over the two companies combined sales in 2005.

We have a significant presence in five countries in Latin America and we are extremely well positioned to benefit from the rapid growth of the pharmaceutical market in this region. We have a similar growth in another region, which is CE, which we also obtained from Ivax.

Teva’s global supply chain is one of our most important sources of competitive advantage and in 2006 the convergence of many key events truly put this system to the test. To begin with, there was the integration of Ivax, and that company plant rationalization plan, which included the transfer of 160 products from (inaudible) and at the same time, we launched 37 products in North America, 144 products in Europe and many others elsewhere in our network and as you know, two of these products were amongst the largest launches in the history of the US generics. And we manage all of these without the benefit of either our Cidra plant in Puerto Rico -- with full benefit of our Cidra plant in Puerto Rico or our new state of the (inaudible) inspection was delayed.

Nevertheless by the end of 2006 we've produced 37 billion tablets, 71% more than Teva standalone in 2005, which I believe is quite an accomplishment. 2006 was also a year in which we significantly enhanced our marketing capabilities. With acquisition of Ivax, we entered into more branded and more branded generic markets around, reorganized and repositioned our global respiratory business and expanded our presence in neurology as we launched Azilect in US for the treatment of Parkinson's disease.

We both recruited new talents and built up from existing talents to create a strong commercial platform, one we will continue to leverage as our business evolves.

Our generic R&D engine was equally busy bringing the total number of NDAs in our US pipeline to 162, representing total brand value of [$92 billion]. We believe we were first to final 42 of these, representing a brand value of $36 million. And today, this robust R&D engine is supporting many more markets, becoming even more efficient as it is able to leverage its efforts over more geographies.

In summary, in 2006 we demonstrated once again our industry leadership, our unparallel global supply chain and R&D operations, our unique integration capabilities and above all our ability to successfully manage so many moving parts to capture the maximum value for the company.

As you all know, I will be concluding my term as President and CEO of Teva at the end of this month. I would like to take this opportunity to say how very proud I am of this company. In recent years, Teva has evolved into a truly unique company, not just in generics company but in the pharmaceutical industry. Teva is the only company that has successfully integrated and managed under one roof, generics, API, innovative, branded generics as well as other specialty product lines like respiratory products.

Leveraging the interconnection between all of these businesses and activities in a large number of markets has allowed us not only to generate additional revenue, but also to balance our business model and thus achieve consistent profitable growth year-over-year.

We all know that the healthcare industry is facing major challenges. The demand for prescription drugs is rising, while the resources to pay for them lag far behind.

As the population ages, and the need to bring more people into the healthcare system increases, the industry is struggling to find cost effective solutions. It's a case, not only in the US, but in Europe and other regions as well. These factors happen with the growth of emerging economies, shrink significantly and continuously increase the market generics far into the foreseeable future.

I believe that the -- as of the leader of the generic industry, Teva is in an excellent position to meet the demands of the evolving healthcare industry and to benefit from the opportunities that lie ahead. For me personally, one of the best things about being a CEO of this exceptional company has been through the chance to see my wildest dreams for Teva come true.

When I joined the company 12 years ago, I could only dream that Teva would reach the leadership position with the scale and size it has. Teva was then a company having $700 million in sales and profit under $100 million. When I took over the position of CEO five years ago, sales were already at $2 billion and profit was around $300 million.

At the end of this month, I will step down as a CEO of the company that made a major leap forward in scale with annual sales of over $8 billion and over $1.8 billion in net profit.

I take pride in passing the leadership of a company that has turned into a true global leader, with an exceptional workforce and with an exceptionally strong and talented management team, a team that I could not be more proud of. I warmly welcome my successor, Shlomo Yanai. I am sure Shlomo will lead this team to new heights and I wish him every possible success. He knows, he can rely on my support in every way.

Before I close, I would like to thank the entire Teva family around the world, this extraordinary group has made my years at Teva more exciting and more fulfilling than I ever could have imagined. Thank you all very much and now I will turn the call over to Dan.

Dan Suesskind

Thank you very much Israel and good day to all of our friends around the world. I hope you have had the chance to review our excellent quarterly and annual figures we released this morning.

First, let me start by reminding all of you that the comparison between the two quarters and the two years is not an apple-to-apple comparison, because the results of Ivax were not included in '05. The acquisition is also reflected in the items that we have taken out of the P&L and realizing it our as adjusted figures. These were items that were recorded mainly in Q1 and Q4 of '06. There were no such items in '05.

We strongly believe that the as adjusted results, which are the results used by management and our Board provide a better indication of Teva's operations and trends. So, my analysis on this call speaks to the as adjusted numbers excluding these items, which are primarily acquisition related. I will mention the major items throughout the call.

Let me give you a synopsis of our figures. As compared to Q4 of '05, sales are up 63% to $2.3 billion, adjusted net income is up 42% to $433 million, and adjusted EPS is up 18% to $0.53. We again generated very significant cash from operations amounting to $765 million for the quarter, while free cash flow amounted in the quarter to $576 million. And as to the annual '06 figures, sale exceeded $8.4 billion, up 60%. Adjusted net income is up with 74% to $1.9 million, and adjusted EPS has increased 45% to $2.30 per share. Cash flow from operations for the year amounted to $2.1 billion and free cash flow to almost $1.5 billion. At yearend our total cash balances and other liquid assets reached $2.3 billion.

The main adjustments that we have made in the fourth quarter are acquisitions of in-process R&D in relation with Ivax acquisition of $29 million, the impairment and restructuring expenses of $16 million, acquisition of R&D in-process, which is not related to the Ivax acquisition of $19 million and litigation settlement of $50 million. We also released, from prior year tax provisions, which I'll relate to later.

These are in addition to the adjustments made in the first quarter results which were mainly related to the Ivax acquisition. These add up annually to $1.3 billion.

And with the annual figures out of the way, I will now focus mainly on the quarterly figures and take you through our quarterly results line-by-line beginning with sales. As I mentioned, sales reached $2.28 billion, an increase of $876 million year-over-year with only 2% of positive currency effect. This quarter, the most significant impact on global sales when compared to prior quarter for '05, was the consolidation of Ivax, both in the US and ex-US. In the US, sales benefited this quarter from 18 new products that were not sold in the comparable quarter of '05 and most significant being the exclusive launch of bupropion XL during the first quarter of '06, as well as the products launched in previous quarters of '06, such as venlafaxine.

The expiration of the 180-day exclusivity for simvastatin on December 23, '06 and sertraline on February 6, '07 made the fourth quarter in the US more of a normal quarter after two great quarters. And as US generics' is Teva's largest business, it impacted the breakdown of global sales and the margins including the bottom line.

Sales in Western Europe, including Hungary, grew by 40%, mainly through the consolidation of Ivax to an all-time high of $557 million and represented 24% of global sales. International sales by which we mean sales outside of the US, Canada and Western Europe benefited most from the Ivax acquisition, going from $138 million in the comparable quarter to $384 million in the reported quarter.

Ivax as well-established markets in Latin America and the CE countries, and these were the main contributors to the growth in the international sales, which amounted to 17% of global sales in the quarter as compared to 10% in the comparable quarter.

Global in-market sales of Copaxone amounted to $378 million. This is a 17% increase over the comparable quarter. Sales in the US, a much more mature market, increased 9% from $238 million and non-US sales, mainly Europe and Canada, increased to a much higher -- at a much higher pace of 35% to $139 million. Non-US sales now accounts for 37% of our total global in-market sales.

Talking about Copaxone; in March '08, Teva expects to take over the distribution responsibilities from Sanofi-Aventis in the US and Canada. According to agreement, we will book all in-market sales as of the second quarter of '08, net of 25% payment due to Sanofi-Aventis for additional two years.

Teva's SG&A will also increase by roughly the same amount as Sanofi-Aventis will cease to participate in Teva Neuroscience marketing expenses. Although the exercise of the option would thus increase Teva's net sales and SG&A expenses, this will have a minimum impact on the bottom line until the second quarter of 2010 when we cease paying to Sanofi-Aventis.

Starting in this quarter, second quarter of 2010, with the cease of paying the 25% consideration, we would increase North America Copaxone -- this will increase the North America Copaxone contribution by 25% and which will flow all the way to the bottom line. The European agreement with Sanofi-Aventis, which will end in February 2012, is in exchange for significantly lower payment.

As to Teva's API third-party business this quarter, it amounted to $151 million, up 7%. In addition, the API business sold $129 million worth of raw materials internally to Teva's pharmaceutical operations, a decrease of 16% over '05 compared in the quarter as well as the past quarter as we supported Teva's major US generic launches.

Stepping down one line in the P&L to gross profit, gross profit margin reached 48.4% in this quarter, essentially no change from the comparable quarter. And this gross margin falls within the higher band of 47% to 50% we have indicated last quarter as Teva's limited gross margin going forward. The gross margin this quarter declined from the exceptionally high gross margins of the second and the third quarter of '06, which were attributable to the high sales of newly launched products of exclusivity. In addition to the anticipated loss of exclusivities on simvastatin, pravastatin and finasteride that occurred during the quarter, the company absorbed nearly $50 million more on shelf stock adjustment for simvastatin than had been expected due to the retention of the much larger-than-expected market share of simvastatin following the end of the exclusivity period.

And from gross margin to R&D, net R&D increased 40% in the quarter to $137 million. This record number represents the importance that Teva is giving to its R&D activities and demonstrates the combined R&D efforts following the Ivax integration on generics, innovative R&D and API. On an annual basis we invested $0.5 million in R&D.

SG&A, which reached $478 million in the quarter, represents 21% of sales. To a large extent, this increase reflects the consolidation of Ivax's significant branded business and operations in many branded generic markets, with its usually higher gross margins on one side, but which also requires a substantially higher selling and marketing expenses on the other side.

In addition, Teva's successful introduction of Azilect in the US and non-US markets generated higher sales and marketing costs. SG&A also included profit sharing with some of our partners as part of federal agreement on this new product.

Option expensing, which was introduced in '06, accounted for approximately $12 million in the quarter, $50 million for the year and is mostly included in SG&A. We do not extract these expenses in our adjusted numbers.

Operating profit this quarter amounted to $488 million or 21% of sales, lower than in the previous quarters, reflecting all the above. As to financial expenses, they were actually in the black this quarter. We recorded $4 million of financial income. This deserves some explanation. Our normal or usual interest expense in a quarter is about $40 million, the majority of which is servicing our $4.6 billion of long-term debt.

Net of income of our invested cash and other liquid assets, this would result in the net interest expense of $15 million to $20 million. But this quarter, we recorded a $22 million income benefit on our hedging activities. As we hedge only against underlying assets, most of the income recorded here is recorded as an expense in other line items and had a slightly negative impact on those margins.

Going forward, we still expect the typical net financial expenses, net of currencies and hedging activities to fluctuate between the quarters and the net financial income to be in the range of $15 million to $20 million.

As to the provision for income tax, the provision this quarter on a US GAAP basis showed actually an income of $77 million. This includes crediting the provisions for taxes, with $141 million due mainly to closure of tax settlements and the expiration of tax statute of limitations in various jurisdictions.

As for the regular quarterly provision for taxes, we have adjusted slightly the annual rates to 15% resulting in a 13% rate for the quarter, compared with 12.5% in the previous quarter, which was also significantly lower than the tax rate for the entire year. All that leads us to a net income of $433 million, up 42% from last year.

EPS based on this income from to about $6 million were added back related to the converts, works out at $0.53 on the larger share base.

Cash flow from operations amounted in this quarter to a record $765 million, bringing our annual generation of cash from operations to $2.1 billion, 50% higher than the $1.4 billion generated just last year. Our free cash flow after CapEx and dividends amounted in '06 almost to $1.5 billion, of which $576 million were generated in the fourth quarter. Part of this cash flow was used for our share repurchase plan. You may recall that last November, a $600 million share repurchase plan was approved. Through the end of fiscal '06, 234 million were repurchased. Since then we repurchased another $112 million worth of stock. In total about 10 million shares have been brought so far at an average price of $32.5. In addition $4 million of converts were also repurchased.

Our working capital decreased sequentially by approximately $93 million and at year's end amounted to $3.6 billion, and from here to some working capital items. First, day sales outstanding receivables, these decreased from 63 days in September '06 to 58 days in December of '06. We have calculated this after netting out from the receivables, the sales, reserves and allowances, the so called SR&A. As you know, we record receivables on a gross basis and record the SR&A under current liabilities. But in order to facilitate a more meaningful comparison with some of our peers, who record it differently, we record -- we use the receivables net for these calculations.

Total SR&A at December 31, '06, amounted to almost $1.6 billion, an increase of $128 million from September 30. Over 90% of the total reserves are from the US, up $102 million from September of '06. The largest swing is in the share price adjustment provision that relates to the expiration of simvastatin and sertraline exclusivity.

Inventories remained at a $1.9 million level, with day sales of inventory down from 162 to 145 days sequentially.

This quarter, CapEx amounted to $130 million, bringing the total for the year to $390 million, an increase of 26% over '05. In '06, we further invested in Teva's new state-of-the-art pharmaceutical facility in Jerusalem. We expanded Teva's state-of-the-art API facility in the southern part of Israel, as well as our API plant in Hungary.

As to our debt, $4.6 billion or 86% of our total interest-bearing debt as of December 31 is long-term, $2.5 billion in converts and $2.1 billion in straight, fixed, and floating interest rates. The leverage measured as debt to debt plus equity spends on this date on 0.32.

Shareholders' equity at December 31 reached $11.1 billion and from here to some figures on our shares. For the convenience of our audience, I would again to mention three figures relating to our share count so that we are all on the same page. For the fourth quarter of '06, our average share count for purpose of calculating fully diluted EPS was 832 million shares, 822 million shares for fiscal -- and for calculating market cap, it was approximately 765 million shares.

Now, I would like to turn to the subject of our outlook for '07 and beyond. Following an exceptionally strong '06, we have now entered the first year of our three-year plan, '07 to '09. A three-year period in which we expect to achieve substantial profitable growth based on our detailed bottom-up risk-adjusted three-year work plan. We feel very strong with this plan including the good year '07, the first year of this plan. As you know, launch exclusivity in the US in '06 provided an unusual concentration of very large opportunity, while we expect to have 30 to 40 generic launches in US in '07 and many other launches throughout our other global markets, none of these is likely to have the impact of the major products of '06.

One has to remember, that the tough comparisons relate in '07 only to our US generics -- actually only to the US generics, but Teva with its balanced business model, enjoys support from so many other businesses including even in the US, the respiratory businesses. But despite this fact, in '07 we foresee achieving record sales exceeding $9 billion. We expect full year '07 EPS to be in the range of $2.07 to $2.19 with a return to our more normalized net income margins of around 20% of sales.

We then expect to be ending '07 with strong momentum in all of our businesses so that in '08, a year in which we could again anticipate some large generic product launches in the US, as well as positive developments in our other businesses, we would expect to exceed the $10 billion mark in sales with EPS of nicely exceeding $2.50. And we expect to maintain this momentum from '08 into '09, and anticipate achieving a similar or even higher growth trajectory in '09 with EPS again nicely exceeding the $3 mark.

Coming next to '07, we anticipate that '07 will be a backend loaded year. We expect the first quarter to remind us of the first quarter of '06 where we reported EPS of $0.37. However, as the year progresses we should see accelerating earnings growth as the products in our pipeline come to market with the second half of the year performance exceeding substantially the first half. Where we end up within our guidance range will depend on the timing of these products introductions. So, that's why we are providing a range of outcomes.

Yesterday, the Board approved an increased fourth quarter dividend amounting to approximately $72 million. On a per share basis, our dividend was increased from 0.34 shekels to 0.40 shekels, and based on the current rate of exchange of the shekel to the dollar, amounts to approximately $0.094 per share. The average dividend per share in the first three quarters of the '06 was $0.072 per share.

Thank you all for your time and attention today. And, we will now be glad to take your questions. Thank you very much.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time we will be conducting a question-and-answer session. (Operator Instructions). Our first question is coming from Greg Gilbert with Merrill Lynch. Please proceed.

Greg Gilbert - Merrill Lynch

Thanks Dan, if I could, one or two part financial question. Could you clarify your guidance for the total financial income? Like you're looking for going forward and estimate your tax rate for '07 and beyond?

Dan Suesskind

As to the financial expenses, I may have said wrongly, but we will go forward to have financial income. As to the financial net income, net of any hedging or currency impact, it should be 15. The financial expense will be at the range of $15 million to $20 million, we expect in '07.

Greg Gilbert - Merrill Lynch

Tax rate?

Dan Suesskind

Obviously by quarter. Our tax rate, we model it currently at about 17%. As you may know, our tax rate is subject to the rate of our different territories, it depends a lot on our product mix and territory mix but I think the best approximation for our '07 should be 17%.

Greg Gilbert - Merrill Lynch

And for Copaxone, what gross margin should we be using, starting in second quarter '08? And is the 25% payment to Sanofi based on sales or gross profits? Thanks, that's it.

Dan Suesskind

It should be the -- whatever your estimated gross margin before, adding 20% to 25% to the sales in market rates. No, the revenues -- no the gross margin, the gross margins.

Operator

Thank you. Our next question is coming from Richard Silver with Lehman Brothers. Please proceed with your question.

Richard Silver - Lehman Brothers

Okay. Dan, just on the SG&A outlook you did say on your last call that SG&A as a percentage of revenues would rise, obviously it was much higher this quarter than the third quarter. Can you give us some sense of what the range will be in the coming quarters as a percentage of revenue and what -- what's behind that, besides the fact that there is Ivax brand business included and these partnered products, which include some contribution?

Dan Suesskind

I am sorry, but you -- being cutoff and I didn't understand the second part of your question.

Richard Silver - Lehman Brothers

Just on SG&A, you did say last quarter that this figure would rise as a percentage of revenues, which should obviously have third quarter to fourth quarter -- And just if you can give us some idea of what we should expect going forward in terms of a range and what's driving that number besides what you mentioned today, which was the Ivax brand business as well as some impact from partnered products?

Dan Suesskind

I will say it should be below 20% -- to which, how much below 20% is mainly related -- actually related with the partner that you mentioned in the last part of your question. This is the -- I think the largest swing on a quarterly basis on this line item. And the competition of this line item is, as I said, including also efforts or expenses that we have in relation with our innovative products, mainly Copaxone and Azilect. And as we mentioned, the branded business in operations were branded markets of Ivax.

Richard Silver - Lehman Brothers

And just one, if I can sneak one more in, which is on the respiratory business. Can you give us some sense as at some point will you be providing sales of ProAir on a standalone basis as we also see with Copaxone and at what point might you do that?

Dan Suesskind

We will consider this going forward. We started this time by giving an overall sales figure for our global respiratory business, which we said was $0.5 billion. Going into more detail in the future, we will see how it works out.

Richard Silver - Lehman Brothers

Thank you.

Operator

Our next question is coming from Mr. Tim Chang with FTN Midwest Securities. Please proceed with your question.

Tim Chang - FTN Midwest Securities

Thanks. Hi Dan,, I wanted to get your thoughts on the potential M&A outlook in terms of what companies you're focusing in and on, or what geographies at this point, you have given some targets for '08, and they look pretty positive. But again, I think all investors are wondering, does that include another potential purchase, your thoughts, Dan?

Dan Suesskind

It does not include any major condition. As I mentioned, it includes a change in the agreement with Sanofi-Aventis?

Tim Chang - FTN Midwest Securities

Okay. Great, thanks.

Operator

Our next question is coming from Michael Tong with Wachovia Securities.

Michael Tong - Wachovia Securities

Hi, I am just wondering if, Dan, you can clarify. As far as, once you take over the Copaxone agreement, the extra 25% is that in cost of goods or will that reflect in SG&A?

Dan Suesskind

The increase on top-line and increase in SG&A.

Michael Tong - Wachovia Securities

But the 25

Dan Suesskind

Which more or less -- which more or less was.

Michael Tong - Wachovia Securities

Right, but the 25% is on the SG&A line or SG&A -- the cost of goods line or SG&A?

Dan Suesskind

No, the SG&A line.

Michael Tong - Wachovia Securities

Okay. Great. Thank you.

Operator

Our next question is coming from Elliot Wilbur with CIBC World Markets.

Elliot Wilbur - CIBC World Markets

Thank you. I have a two-part question on your North American generic business, but first I want to say thank you for sharing with us your longer-term expectations and providing greater clarity into the Copaxone transition. So my question with respect to the North American generics is, number one, if you look at the industry data, it seems like we've reached a point where volume gains are now offsetting the rate of pricing erosion and if I look at your commentary from the last couple of quarters, you seem to suggesting that in fact it was true, at least with respect to your base business in the US. So, outside of exclusivity launches as we go through the course of '07, do you think that the volume gains likely to see in your business will more than offset the normalized rate of pricing erosion in '07? And then number two, a lot of momentum on capital hail for various items that could significantly alter the competitive landscape in the generic industry. And I guess if you look at all these different initiatives, are there any there that you think have the potential to materially impact the performance of the US generic business in the latter part of '07 or headed into 2008? Thanks.

Dan Suesskind

George, will you take the two questions?

George Barrett

Sure, I'd be glad to. Good morning Elliot. As it relates to the offset between volume and price, it’s a little bit tough to assure that math. I think directionally you're observing the right trends, which is that volume growth is occurring. There is no doubt that Medicare Part D is helping to fuel that growth. I think, we can say as it relates to price, we saw during this recent quarter for the first time and sometime that the rate of the erosion of our base was somewhat lower in Q4 than we have seen in while. As you know that rate of erosion has been holding pretty study for a couple of years. Again, I would hate to -- certainly hesitate to suggest that one data point here makes a trend, but certainly it's good news on the price. To say that it's an offset is probably too much of a leap simply because we have fluctuation from period-to-period. For example, you have seasonal swings on volume, as we did this year that can affect that dynamic. But I think the general direction, they describe is positive.

As it relates to the activities in Washington as your well aware it's been a very busy couple of weeks and there are a lot of issues that are being discussed. I think certainly generic biologics is one that I think long-term has significant potential for our industry and frankly for broader products of the industry including some other biotech companies that may seek to bring products to market. And I think, there is a lot of support right now. To do something in generic biologics, obviously, we believe that process of empowering the FDA to move this forward coming from congress is the right direction. And we really believe that we are going to see significant motion there.

You have seen that the -- our generic sale is getting probably greater legs than we would guessed six months ago. And again, I think, that's good news and it's a right thing against the caution, obviously the stakes are very high and innovators fight in a lot of different ways, but probably also good news. And, of course, we are all watching very carefully the discussion is on settlements and I think you probably know our view on that. And we've talked about that pretty consistently that we'd certainly be concerned with legislation that too broadly restrict the terms of settlement because we think that settlements can be very, very pro-competitive. In fact, we've done some calculations and if we look at the settlements that we've been engaged in, we've taken more than 50 years of patent rights of products. So, we just want to make sure that we don't make it hard to bring generic products to market by creating a law that's too restrictive, but those are covered in most active things right now.

Operator

Thank you. Our next question is coming from Ron Miguel with Bernstein.

Ron Miguel - Bernstein

Hi, good afternoon folks. Two questions, first on ProAir. You boasted under -- well in the fourth quarter, do you see ProAir able to maintain its current market share or well from here pushback a little bit? And second, about the marketing of ProAir, roughly what should we be modeling, is it more around the $20 or the $15 to the $25 per script?

George Barrett

Hi Ronnie, it's George.

Ron Miguel - Bernstein

Hi George.

George Barrett

Hi. So let me just give you a just a very quick sense of where things are. I think one of the things that we did fairly early and you heard us talk about this in the last two quarters was to recognize that supply issue is what might really be driving the convergence. And we moved quickly to try to ramp up our capacity, our ability to respond to this demand. We also tried to approach this market in somewhat integrated way to see if would could actually lead the conversion, and so we relaunched our drug as ProAir as you know. And then we reached out to physicians, but also to pharmacists and managed care and interested groups like the American Lung Association helped move this process forward. But I think this has been effective, as you acknowledge and where our share is very high right now, it's in excess of 60%. I think we should expect some jostling as we go forward. The ramp-up is occurring very quickly. We've probably got another advantage, the most recent data which I think just came out yesterday Ronny, said that about 47% of new Rxs are HFA. So that's converting very fast, and so I think the issue of supply and the response at the right time is going to be important. So I would expect there will still be some jostling for share and that our share might moderate a bit, 50% is obviously very high.

As it relates to price I can't give you a specific pricing, except to say that of course it is at a higher price than the generic, it's a branded product. There is some discounting going on and we should also note that our net realized price is influenced by some of our programs designed to help patients cope with the transition, including couponing programs and others. So I think you should assume that there is some discounting going on, but we are really pleased with where we are right now.

Ron Miguel - Bernstein

Great. And last one is for Dan on share count. I think you note that it's going to be 832 million share count for '07, but just looking at 832 million share count average for the fourth quarter, and you've apparently purchased 3.5 million or so shares in the first quarter. Roughly what number of shares you will be thinking about for '07?

Dan Suesskind

First of all the end of the share count is also 832 and that is actually a few account adjustments to be made, one is, relating to the options and one is relating to the share count. But we have at our disposal now another $260 million or so, which we have to decide what the average price we think we would able to buy, that gives you the number of shares that we can be able to buy, which will be probably somewhere in the order of 6 million to 8 million shares.

Ron Miguel - Bernstein

Okay, thank you.

Operator

Our next question is coming from Randall Stanicky with Goldman Sachs. Please proceed with your question.

Randall Stanicky- Goldman Sachs

Great, thanks for the question. I just wanted to clarify the $2.50 and $3 numbers which are applied by my math of June, 20%. Those are organic numbers, any M&A would be upside and then the contribution from Copaxone during that time would be minimal and then I have a follow-up?

Dan Suesskind

It would be minimal in this period, it will -- well as I said, it will show up only in the second quarter of 2010.

Randall Stanicky- Goldman Sachs

Okay. Great, and Dan as you are thinking about M&A hurdle rates for the last couple -- large deals you did, were accretive fairly quickly. Has that changed, how are you thinking about that? And then as the branded businesses continue to grow, are you looking at non-generic deals currently or are you still focused on filling in holes on the generic side?

Dan Suesskind

No, we actually are open now also to deals relating to products or projects in different stages and not confine ourselves only to generics.

Operator

And next question is coming from Louise Chen with Morgan Stanley, please proceed with your question.

Louise Chen - Morgan Stanley

My question was with respect to the guidance for '07, what is driving the EPS to be backend loaded and then also, what should we think about for R&D and CapEx for '07?

Dan Suesskind

Relating to R&D, you can include in your model, somewhere 6% or 6 plus percent of sales. In relation to CapEx we had a record expense this year, record investment this year and I don't think it will increase much next year. What else did you ask, please?

Louise Chen - Morgan Stanley

The EPS, why it's backend loaded?

Dan Suesskind

Because it is based on new products that we expect to get and according to the flow, as we see today it will be more in the second half than in the first half.

Louise Chen - Morgan Stanley

Thank you.

Operator

Our next question is coming from Robert Bonte with Citigroup. Please proceed with your question.

Robert Bonte - Citigroup

Hi, just one question and sub-questions a, b and c. First question on the shelf stock adjustment, could you give us an update if that shelf stock adjustment is made to sales booked in 3Q or sales booked early in 4Q? Question b, do you have -- as we are all watching the ProAir scripts compound up. Do you have enough capacity to meet the runaway demand, or when will additional capacity come online? And question 1c, on the R&D spending, can you give us anymore detail on the non-Ivax acquisitions of in-process R&D in the quarter, Dan?.

Dan Suesskind

One by one, relating to capacity of our -- in relation to business, as we have said we are lengthening our capacity, and as we see, that it will co-relate the increased demand in the market and hopefully the -- our capacity will not be a constraint on our sales. As it relates to the $50 million as we have mentioned on capacity, it relates to sales that we have done in this quarter. What was next?

Robert Bonte - Citigroup.

So just to be clear about that -- this is not sales related in 3Q but its sales early in 4Q at the end of 4Q you have to adjust again?

Dan Suesskind

That's right.

Robert Bonte - Citigroup.

Okay. And the last question was just a description of in-process R&D of what you acquired in 4Q?

Dan Suesskind

It was something minor that one of the investments that we are doing in our so-called start-ups that we are investing in.

Robert Bonte - Citigroup.

Can you be specific?

George Barrett

I think we are specific enough. But maybe one thing, the name in any case won't give you anything.

Operator

Thank you. Our next question is coming from Marc Goodman with Credit Suisse.

Marc Goodman - Credit Suisse

George, can you talk about the strategy on the Zocor in the quarter and the shelf stock adjustments in order to maintain share and whether that you've treated Zocor differently than all the other products. Did you do with -- this with Pravachol and Zoloft, and you didn't really didn't call anything out previously? Just how about the strategy on that and Wellbutrin XL, I mean, big products and whether this is just a different world altogether, when you just as -- really wanted to maintain your share and the extensive price? And then the second, if you could just repeat the comments on the profit sharing, someone put some numbers, but I couldn't hear them, they impacted the SG&A line?

Dan Suesskind

George, will you take it please?

George Barrett

Sure. I will start with the first part, Dan you are going to cover the second issue, and I am also going to let Bill jump in a little bit here on this -- on simva. But yeah, certainly, Marc, it has been an enormous product. And by and large, I am not sure that we approached things all that different expect the size of it dictated some very interesting market characteristics. Again, just a touch on with Dan and Israel mentioned earlier, we did retain significantly higher share than we would have expected and we are pleased about that. Yeah, we did take the additional shelf stock adjustment into Q4, but I think the lasting value from that is important. I would like to just ask Bill to comment a little bit on what that dynamic has been all about. And then, Dan maybe you can take the next question which was the financial part. Bill?

Bill Marth

Yeah Marc, I would just -- I would just try to clarify that when we did our models, we hadn't anticipated keeping as much shares as we did. And so when our customers came to us at the close of the exclusivity and other companies were not able to ramp up and take care of them, it was necessary for us to maintain the market and to be good to do the right things with our customers and our relationships to hold on to that share. So we've done so and we think it's going to have lasting value for Teva, and we can get the right thing to do especially on the vertically integrated product like this.

Marc Goodman - Credit Suisse

Are you implying that the competitors could not supply enough to meet the market demand?

Bill Marth

Yes, we found that to be - we found that to be a fact.

Marc Goodman - Credit Suisse

That's unbelievable with all those players?

Bill Marth

See -- look Marc, again, I don't know that we should -- I don't want to turn it into a forward projection, but I think at a point that customers are making decisions here I think, they probably had to look and see whether or not the product is large, it was time to make that risk-based decision. I think we found that a lot of folks wanted to continue to do business with us. So, again, it's not meant to be a predictive statement as much as a statement of what we experienced as we came close to the end of exclusivity.

Marc Goodman - Credit Suisse

And so Zocor was different, you didn't really do this type of thing with the other products, or you just didn't see this type of issue with the other products that there was?

Bill Marth

This was more or less an anomaly. This was an unusual product.

Marc Goodman - Credit Suisse

Okay.

George Barrett

I mean if you think about its size, 4.4 billion, largest molecule that's been engineered sized yet, I think it's not unreasonable. And again Marc, just to clarify what George said and what I had said, we don't want anyone to think that it's not unusual to see a situation where others couldn't pick up the share right away because if you are in a company and you are making a bet on how much share you are going pick up, it's a pretty expensive bet?

Dan Suesskind

Marc as to your other question relating to the splitting of profits, you didn't miss any number that I said because I didn't mention any number. But what I can say is that the majority of the incremental SG&A in Q4 over Q3 carrying from that.

Marc Goodman - Credit Suisse

Okay. Thank you.

Operator

Our next question is coming from Will Sawyer with Leerink Swann.

Will Sawyer - Leerink Swann

Good morning, and thanks for taking the question. First question on the Jerusalem facility, could you supply enough data as the status of that facility and how the factors in the guidance that you gave for the out years as far as gross margin and tax rate? And then the second question is for George, do you think the prevalence patent litigation settlements in sectors like technology limits Congress's ability to effectively legislate against the branded and generic drug settlements? Thanks.

Dan Suesskind

Actually, Jerusalem plant I will take it first George. We got the approval from the FDA last month and we started manufacturing also for the US. We are gradually increasing our capacity there, parallel to that we are increasing already our capacity. We started with -- with a capacity of 4 billion tablets in year. We are now working to extend it to 8 billion tablets a year, and I think we will get there more or less by yearend. This is included obviously in our guidance and also as you have rightly said has an impact on our tax situation although we have also benefits in other places that we manufacture tablets. So it won't be a major impact, but it will have a positive impact on our average tax rates.

George Barrett

Well, as it relates to settlements, again there are probably attorneys out there better equipped to answer the question as to whether or not this legislature will be influenced or the attempt to do legislation on settlements to be influenced by things happening in other segments, I think we could say that, it's a very complex area and the right to settle litigation goes beyond the question of just the drug industry and for those of us who undertake litigation, which is at its nature, uncertain, we have felt strongly and we try to make sure we educate people on the fact that settlements are part of the -- in our view necessary part of the equation when you undertake a risky or uncertain patent cases. So, I think we may find that this discussion becomes a broader question about how one views settlement in the context of litigation generally, and you raised an interesting point, but I am not sure, I can give an answer to that [other than one point].

Will Sawyer - Leerink Swann

Thank you.

Operator

Our next question is comes from Ken Cacciatore with Cowen & Company.

Ken Cacciatore - Cowen & Company

Hi, thanks guys. Just going back to the '07 guidance, I believe it's a Q1 on $0.37, but that would imply about an average of $0.56 in the following three quarters. I am just wondering, are there other kind of agreements that potentially like Wellbutrin XL or Allegra that maybe we can't see that you all are thinking about that might pop in as well maybe -- are we just anticipating the continued good HFA. Give us a little bit more color on why the steep acceleration?

Dan Suesskind

George, do you want to take it?

George Barrett

Yeah. Good morning. The truth is that we often are selling -- the things that happen during the course of the year that we can't describe in advance and unfortunately we have this year a number of moving parts, many of which we can't really disclose. As I think mentioned by Dan or Israel in their comments, we plan on in the US market 30 to 40 generic launches, some of those or many of those are not in the public domain. So again, unfortunately again providing -- I'm really sorry, that it is not something I can do. Of course we do see continued good news from the HFA conversion, and as I look throughout our businesses on our neurology business on businesses outside the US, we have a lot of good motion. So I'm sorry that I can't provide more detail on specific products in the course of the year but I guess you are probably used to that.

Operator

Our next question is coming from Ben Josef with Mezdi Capital

Ben Josef - Mezdi Capital

Hi there. Thank you. (inaudible) on accounting, can you just go over one more point, are you going to be accounting for 100% of the in-market sales, and then stripping the market shares [lower down] can you just confirm please?

Dan Suesskind

I hope I understood the question that you are asking. In the first phase, which in the two year starting in Q2 of '08, we will book roughly 75% of the in-market sales compared to a 50% plus that we booked to date. In starting with the second quarter of 2010, we will book the 100% of the sales, as we will cease paying -- making the payments, that we have under the agreement for two years. We will cease paying them to Sanofi-Aventis, is that what you asked?

Ben Josef - Mezdi Capital

Yes. And when you will be booking roughly 25% of the sales within SG&A, is that correct as well?

Dan Suesskind

That's right.

Ben Josef - Mezdi Capital

Okay, thanks very much.

Dan Suesskind

Thank you. We will take one more question.

Operator

Our final question is coming from [John Smart with JAS Securities].

John Smart - JAS Securities

Hi, thanks. You already covered my questions.

Dan Suesskind

Okay. Kevin, you close the call.

Kevin Mannix

Yes, thank you everybody for joining us today, appreciate it. If you have any additional questions, feel free to contact us, we will be happy to answer them offline. And Claudia, if you wouldn't mind could you provide the replay information.

Operator

Certainly. To listen to a replay of this teleconference, you can dial 877-660-6853 or for international parties 201-612-7415 using accounts number 3055 and conference ID 229480. This concludes today's conference. We thank you for your participation.

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Source: Teva Pharmaceutical Q4 2006 Earnings Call Transcript
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