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Executives

Michael Freeman - Executive Director of IR

Carolyn Logan - President and CEO

Adam Derbyshire - SVP and CFO

Analysts

Scott Hirsch - Credit Suisse

Michael Tong - Wachovia Securities

Angela Larson - SIG

Yamila Donna - Thomas Weisel

Salix Pharmaceuticals Ltd. (SLXP) Q4 2007 Earnings Call March 4, 2008 5:00 PM ET

Operator

Good day, everyone, and welcome to the Salix Pharmaceuticals Fourth Quarter 2007 Earnings Release Conference Call. Today's call is being recorded.

And at this time, I would like to turn the call over to Mr. Michael Freeman, Executive Director of Investor Relations. Mr. Freeman, please go ahead.

Michael Freeman

Thank you. Good afternoon. Thank you for joining us today. I am Mike Freeman, Executive Director of Investor Relations and Corporate Communications for Salix Pharmaceuticals. With me today are Carolyn Logan, our President and Chief Executive Officer, and Adam Derbyshire, our Senior Vice President and Chief Financial Officer.

Adam will begin the presentation with a review of the financial results for the fourth quarter and full year, 2008. Carolyn will then review operations to complete the formal segment of today's call. At the conclusion of these comments, the management will respond to appropriate questions.

Various remarks that management might make during this conference call about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995.

Actual results might differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our press releases and SEC filings, including our Form 10-K for 2006. Specifically, the information in this conference call related to projections, development plans, and other forward-looking statements is subject to this safe harbor.

In addition, in this conference call we will use some non-GAAP financial measures. Today total product revenue, earnings per share, and gross margin excluding the effect with the launch of generic Balsalazide, are non-GAAP measures that should not be considered superior to or a substitute for the related GAAP measures of total product revenue, earnings per share, and gross margin.

However, we believe that in this instance, these non-GAAP measures might provide investors additional relevant information in par for purposes of historical comparison. In addition, we use these non-GAAP measures to analyze our performance in mortgage sales with better historical comparability since there were not comparable events in 2006.

A reconciliation of these non-GAAP measures to the related GAAP measures is included in the financial table included as part of our fourth quarter earnings press release, which also is available on our corporate website at www.salix.com.

I now will turn the call over to Adam Derbyshire, our Chief Financial Officer.

Adam Derbyshire

Mike, thank you. Including the effects of the December 28, 2007 approval of three generic Balsalazide products, total product revenue was $39.1 million for the fourth quarter of 2007 and $232.9 million for the full year of 2007, compared to $62.6 million and $208.5 million for the same period in 2006. The company reported net loss of $19 million or $0.40 per share, fully diluted for the fourth quarter of 2007, compared to the fourth quarter of 2006 net income of $13.9 million and earnings per share of $0.29 fully diluted.

For the full year of 2007, the company reported net income of $8.2 million, or $0.17 per share, fully diluted, compared to net income of $31.5 million or $0.65 per share, fully diluted for the full year of 2006. The introduction of generic competitors to COLOZAL or to Salix’s COLAZAL required a $34.6 million non-cash charge to be taken during the fourth quarter of 2007. This charge reflects an estimate of potential returns and in-house inventory write-off, due to an anticipated decrease of future prescription demand. Full year and fourth quarter revenue also includes $2.2 million from sales of our authorized generic version of COLAZAL by our authorized generic distributor, Watson Pharmaceuticals

Non-GAAP total product revenue, excluding the non-cash charge and authorized generic revenue described above, was $71.5 million for the fourth quarter of 2007, a year-over-year of 14%, compared to $62.6 million for the fourth quarter of 2006. Non-GAAP total product revenue excluding these items was $265 million for 2007, a year-over-year increase of 27% compared to $208.5 million for 2006.

Non-GAAP net income for the full year of 2007 excluding these items was $43 million, or $0.88 per share, fully diluted for the full year. This non-GAAP net income of $0.88 per share represents a 52% increase over 2006 net income per share, on a fully taxed, fully diluted basis. This level of performance is in line with the company's 2007 guidance of approximately $262 million in product revenue and $0.88 in earnings per share.

Cash, cash investments, and cash equivalents were $111 million or $111.3 million as of December 31, 2007, compared to $76.5 million as of December 31, 2006. Cash, cash and investments, and cash equivalents were approximately $128 million as of February 29, 2008.

XIFAXAN revenue for the fourth quarter of 2007 was $17 million, compared to $18.7 million for the fourth quarter of 2006. XIFAXAN revenue for the fourth quarter of 2006 reflects an impact of 5% price increase in the related product buy-in that occurred during the period. XIFAXAN revenue for 2007 was 64.3 million, a 25% increase compared to 2006.

MOVIPREP, OSMOPREP, and VISICOL, which comprised our bowel cleansing product line, generated revenue of $13.1 million for the fourth quarter of 2007, compared to $11.5 million for the fourth quarter of 2006. Our bowel cleansing product line contributed $47.7 million in product revenue for 2007, compared to $45.5 million for 2006.

Our other products category generated revenue of $8.9 million and $28.5 million for the fourth quarter and full year 2007, respectively; compared to $2 million and $7.9 million for the corresponding periods of 2006. The year-over-year increase in other products revenue for the fourth quarter and full year of 2007 primarily reflects the contribution of PEPCID OS, which we acquired in February 2007.

Total cost of products sold was $16.9 million for the fourth quarter and $55 million for 2007. Gross margin on total product revenue was 56.7% for the fourth quarter of 2007 and 76.4% for the full year 2007.

Excluding the impact of generic Balsalazide, non-GAAP gross margin was 79.1% fourth quarter of 2007 and 80% for the full year 2007. Gross margin was 80.4% for the fourth quarter of 2006, and 80.1% for the full year 2006.

Research and development expenses were $15.1 million for the fourth quarter 2007, compared to $15.8 million for the prior year period. Research and development expenses were $71.9 million for 2007 compared to $47.9 million for 2006. Selling, general and administrative expenses were $22.4 million for the fourth quarter of 2007 and $86.5 million for 2007 compared to $19.1 million and $82.6 million respectively for the corresponding periods of 2006. The increase in 2007 selling, general and administrative expenses was primarily related to pre-launch activities for Balsalazide Tablet and Granulated Mesalamine, and a small one-time write-off associated with COLAZAL samples.

During 2007, the company succeeded in supporting its current operations, acquiring new products, funding the development of Rifaximin, Balsalazide Tablets, and Granulated Mesalamine, and at the same time growing its cash reserves to $34.8 million.

Combined product revenue from our bowel cleansing products, XIFAXAN, and our other products achieved year-over-year growth of 34% for 2007. We anticipate these products to continue to generate increasing revenue and serve as the core of our business as the company continues its strategy to expand its revenue base primarily by means of a development of new indications for Rifaximin in product acquisition.

We believe, based on our current projections, that our revenue generation capability combined with our cash reserve should be sufficient for the company to execute its business plan and return to profitability without the need to raise additional funds.

The current annualized run rates for XIFAXAN, our bowel cleansing products, and other products, are approximately $71 million, $61 million, and $28 million respectively. We believe total company product revenue for 2008 will be approximately $180 million. During 2008, the company intends to focus its research and development investment of approximately $88 million for 2008 on projects with the greatest commercial potential, namely the Phase 3 Rifaximin trials in non-constipation predominant irritable bowel syndrome, hepatic encephalopathy and other priority projects.

The company is planning to invest approximately $105 million in selling, general and administrative activities during 2008, in anticipation of the launch of one product and pre-launch of two products during the year, as well as costs related to protecting our COLAZAL business.

As a result of the decision to continue to invest in promising development projects and prepare for the launch of new products, the company anticipates generating a loss of approximately $1.12 per share fully dilutive for the full year ending December 31, 2008. Based on the information currently available, we expect to report a loss of approximately $0.50 per share for the first quarter of 2008.

Product revenue should be back-end loaded for the year. We estimate first quarter revenue will account for approximately 20% of revenue for the full year. Research and development expense should be front-end loaded for the year and we estimate first quarter R&D expense will count for approximately 30% of R&D expense for the full year.

Based on current information and projections, in 2009 the company expects to approach profitability and to be cash flow positive. In 2010, the company expects to return to the level of revenue and earnings per share that the company was projected to generate in 2007, absent the genericization of COLAZAL. In 2011 and beyond, assuming the approval of Rifaximin for IBS and hepatic encephalopathy, addressing a combined market of approximately $2.8 billion, the company anticipates generating significant growth in revenue and earnings per share.

I now will turn the call over to Carolyn Logan, our President and Chief Executive Officer.

Carolyn Logan

Thank you, Adam. Salix continues to grow and expand its business. Highlights of 2007 were the submission of New Drug Application for Balsalazide Tablet and for Granulated Mesalamine, the successful completion and outcome of our Phase 2b trial of Rifaximin in the treatment of diarrhea-associated irritable bowel syndrome, and the acquisitions of PEPCID OS and metoclopramide-ZYDIS. These successes were tempered by the unexpected year-end approval of three generic Balsalazide products by the Office of Generic Drugs. The company responded decisively and rapidly to this challenge.

One consequence of this development was the mutual agreement by Salix and Eisai to terminate the co-promotion agreement relating to Balsalazide that the companies entered into in September of 2007. We continue to be focused on executing our long-term strategy to build our revenue by expanding the indications for our current products and securing additional products, and then leveraging our industry-leading sales force to sell these patent-protected products to our targeted universe of high-prescribing physicians.

We achieved an unprecedented level of success during the year in our product development efforts. In June of 2007, we submitted a New Drug Application seeking approval to market an 1100 mg tablet formulation of Balsalazide Disodium. We believe Balsalazide Tablets, if approved, should provide added convenience with twice-a-day dosing and fewer pills per day, providing a therapy that will better serve the needs of gastrointerologists and their patients.

In December, we submitted a New Drug Application seeking approval to market Granulated Mesalamine. We believe this once-a-day, delayed and extended release formulation, if approved, should provide reliable and effective delivery of Mesalamine, or 5-ASA, beginning in the small bowel and continuing throughout the colon. Wilmington Pharmaceuticals, which licensed Metoclopramide-ZYDIS to us, is moving forward in seeking FDA approval to market this fast-dissolving formulation. At this time, Wilmington is targeting a fourth quarter 2008 approval. We believe that our specialized sales force is positioned to effectively commercialize this patient-friendly formulation of this widely-prescribed agent.

We expect the product development success we achieved during 2007 should be followed by commercial success during 2008, as we anticipate receiving responses from the Food and Drug Administration during 2008 regarding Balsalazide Tablet, Granulated Mesalamine and Metoclopramide-ZYDIS. At this time we are planning for a May 2008 approval and July 2008 launch for Balsalazide Tablet, and for fourth quarter 2008 approvals and early 2009 launches for Metoclopramide-ZYDIS and Granulated Mesalamine. Based on these anticipated actions, Balsalazide should contribute to second half of 2008 revenue and Granulated Mesalamine and Metoclopramide-ZYDIS should contribute to 2009 revenue beginning early in the year.

Our development activities will be focused primarily on Rifaximin during 2008. In September 2007, we announced the successful completion and outcome of our 680-patient multi-center Phase 2b trial to assess the efficacy and safety of Rifaximin in the treatment of patients with diarrhea-associated irritable bowel syndrome. This 14-day course of Rifaximin dosed 550 mg twice-a-day, provided statistically significant improvement in both adequate relief of diarrhea-associated IBS symptoms, as well as adequate relief of IBS-related bloating, compared to placebo.

Lead investigators from this study conducted in the United States have submitted several abstracts discussing results of the trial for presentation at Digestive Disease Week 2008, which will be held May 17 through the 22. We met with the FDA in December 2007 to discuss the trial results and the next steps in the pursuit of marketing approval. Currently we anticipate initiating patient enrollment in two large Phase 3 trials by the end of June, 2008. Based on the results of the Phase 2b trial and subsequent discussions with the FDA, the Phase 3 trials will evaluate a broader patient population that only excludes the subset of IBS patients with constipation-predominant IBS. We anticipate, based on current timelines, completing these trials and submitting a New Drug Application in mid-2010.

Last week we completed patient enrollment in the Phase 3 trial of Rifaximin to assess the efficacy and safety of Rifaximin, dosed 550 mg twice-a-day, in the prevention of recurrence of hepatic encephalopathy in patients with liver disease. Patients in this trial are dosed for six months; therefore, patient dosing should be completed during the third quarter of this year. Provided the results of the trial support a submission, we anticipate submitting the NDA late in the fourth quarter of 2008 or early in the first quarter of 2009. The application has the potential for a six-month review based upon the current unmet medical need in treating this serious medical condition. The decision to accelerate the review cycle will be made by the FDA at the time of submission.

COLAZAL performed admirably in a very competitive market during 2007. We were successful in growing prescriptions to more than 475,000, a year-over-year increase of about 1%, during a year in which the first quarter launch of a competitive product created a challenging environment. We believe this commendable performance speaks to not only the efficacy of this azo-bonded product, but also demonstrates the effectiveness of our specialty sales and marketing effort.

We are very pleased with the performance of our bowel cleansing products, OSMOPREP and MOVIPREP. These two proprietary products have been gaining market share in the growing bowel cleansing market since their launch in 2006. The prescription bowel cleansing market experienced 18% prescription growth for 2007 compared to 2006. OSMOPREP, MOVIPREP and VISICOL prescriptions grew 68% increasing from approximately 202,000 prescriptions in fourth quarter of 2006 to approximately 340,000 prescriptions in fourth quarter of 2007. Our bowel cleansing franchise exited 2007 with a 25% share of the prescription bowel cleansing market.

XIFAXAN also demonstrated strong growth during 2007 as prescriptions grew 37% during the year. The company and independent investigators continue to evaluate the potential of this broad spectrum, minimally absorbed antibiotic in a range of disease states. To date approximately 400 publications are available and Rifaximin was the topic of 22 abstracts presented at Digestive Disease Week and the American College of Gastroenterology meetings in 2007.

As stated earlier, the company is focusing its development activities and financial investment on the IBS and HE trials. Presently we are assessing the current status of enrollment in the C. Difficile-Associated Diarrhea, or CDAD, trial. At this time, the study remains open and patient enrollment continues.

However, during 2008, we will continue to redirect funds previously allocated to patient recruitment in the C. Difficile trial to fund other initiatives. In January 2006 we announced the results of our first of two Phase 3 trials to evaluate Rifaximin in the prevention of travelers' diarrhea in travelers to Mexico. The results of the trial were highly statistically significant with a p value of less than 0.0001 with 84% of Rifaximin-treated travelers remaining free from travelers' diarrhea versus 50% of placebo-treated travelers.

As previously disclosed in our second Phase 3 trial to evaluate Rifaximin in the prevention of travelers' diarrhea in travelers to Thailand, the incident rate at which international travelers to southern Thailand acquired bacterial diarrhea was lower than the historical incident rate. Consequently, due to the low incidence of travelers' diarrhea, the study was unable to determine the utility of Rifaximin in this particular study population. The company has a strong database of information from other travelers' diarrhea prophylaxis trials, and we intend to meet with the FDA to discuss these data and potential next steps.

The company is vigorously pursuing its goal to become the leading specialty pharmaceutical company in gastrointerology. Our success in securing the approval of four new drug applications over the past eight years has served a crucial role in our ability to build a strong portfolio of commercial products. We anticipate expanding our portfolio during 2008 and beyond with additional products and indication approval as well as business developmental activity.

As I stated earlier, we have submitted NDAs for our Balsalazide Tablets and for Granulated Mesalamine, and Wilmington Pharmaceuticals have submitted an NDA for Metoclopramide-ZYDIS. We expect to receive a response from the FDA on the three applications this year.

Results of the clinical investigation of Balsalazide Tablet will be presented at Digestive Disease Week in May, and results of the clinical investigation of Granulated Mesalamine will be presented this October at the Annual Meeting of the American College of Gastroenterology.

We are targeting to submit the NDA for Rifaximin in the treatment of the hepatic encephalopathy during the fourth quarter of this year or first quarter of 2009 and to submit the NDA for Rifaximin in the treatment of non-constipation predominant IBS in mid-2010. We plan to release results of the clinical investigations associated with these programs, close to the time we submit these applications. We project receiving a response from the FDA regarding hepatic encephalopathy during the third quarter of 2009 and regarding IBS in mid 2011.

These development activities have been and will continue to be complemented by our ongoing business development activities, as the company pursues opportunities to in-license additional late stage and marketed products. In February 2007, the company purchased the US prescriptions pharmaceutical product rights to PEPCID Oral Suspension and DIURIL Oral Suspension from Merck & Co. As expected, PEPCID sales are generating immediate revenue while requiring minimal promotional expense.

In September 2007, Salix acquired the exclusive worldwide right to Metoclopramide-ZYDIS. We believe the availability of the Metoclopramide-ZYDIS, if approved, should serve the increased patient compliance and, in some instances, provide an economical alternative to emergency room visits and/or intravenous infusion by patients suffering from nausea and gastric distress.

This completes my comments. Thank you for participation in today's call. And now I will turn the call over to the operator to begin the question-and-answer.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question today will come from [Scott Hirsch] with Credit Suisse.

Scott Hirsch - Credit Suisse

Yeah, hi there.

Carolyn Logan

All right.

Scott Hirsch - Credit Suisse

So a few questions for you; one, with respect to the guidance, how much inventory are you guys putting into guidance for the 1100 milligram? And then secondly, with respect to the money you guys have on the books now, I think you said you are at 128. How much of that cash, if any, is in auction-rate securities?

Adam Derbyshire

None of it's in auction rate securities.

Scott Hirsch - Credit Suisse

None of it?

Adam Derbyshire

Right. And then in terms of (inaudible) tablet, again, we plan on launching that in July, and we will do our typical distribution. We will probably try and distribute approximately 40,000 bottles.

Scott Hirsch - Credit Suisse

And with respect to taxes moving forward, I know you've spoken about that before. In the outer years, particularly '010 when you would like to be profitable again, what can we expect for a tax rate at that point?

Adam Derbyshire

Well, I imagine we'll probably ease that into a full tax rate, so - I don't know the answer to that; I wouldn't anticipate it being a full tax rate.

Carolyn Logan

We'll just have to give update on that on because taxes will complicate it.

Adam Derbyshire

So I think the best thing to do is just to look at it from a full tax rate and then we will update you and see if that will change for 2010.

Scott Hirsch - Credit Suisse

Okay, Thanks

Operator

We will go to Wachovia's Michael Tong with the net question

Michael Tong - Wachovia Securities

Hi, good afternoon, just a few book-keeping questions. In your other revenue line reported for Q4, you have a $2.2 million of authorized generic COLAZAL revenue or does it appear somewhere else?

Adam Derbyshire

That’s in the actual COLAZAL line.

Michael Tong - Wachovia Securities

Okay. And as of year-end '07, do you still have any intangible carrying value for COLAZAL?

Adam Derbyshire

No

Michael Tong - Wachovia Securities

Sorry

Adam Derbyshire

No we do not we don't have any carrying value for COLAZAL intangibles or anything.

Michael Tong - Wachovia Securities

Okay. And then finally, I might have missed this, you mentioned something about SG&A progression, could you repeat that please, for the quarterly progression for '08?

Adam Derbyshire

I didn’t mention the quarterly progression, but you can expect - in 2008 we have a launch of the tablet in second quarter. In first quarter you can expect a pretty similar rate to fourth quarter, and then it gets ramping from there on out all throughout the year, but in just the second quarter you will have DDW plus some pre-launch activity. In the third quarter you will have the full launch of the tablet, and in the fourth quarter you'll have pre-launch of two products plus ACG.

Michael Tong - Wachovia Securities

Great thanks very much

Operator

We will move to Angela Larson with SIG

Angela Larson - SIG

I want to follow on Michael Tong's question on SG&A in '08. As you look at the costs that are associated with the launch in the products and preparing for the other launches, how much of it is going into sales force expansion versus material aids, versus sampling? When we look at this expansion, is all of it going into advertising conferences or is half a bit advertising and half a bit of sales marketing aids?

Adam Derbyshire

Actually, none of it will be going towards expense to sales force. It's all going to go towards marketing for launch expenses initiated with marketing.

Carolyn Logan

Distribution expense.

Adam Derbyshire

And distribution expense.

Carolyn Logan

For the new product.

Adam Derbyshire

For the new product.

Angela Larson - SIG

Okay. And I apologize if I missed that, did we have an update on [the same] there?

Carolyn Logan

We didn't have an official update on that because really there has not been much change. They are still in an open label, confirmatory trial, it's a 70 patient trial, and I believe they are a little better than 50 patients. So it is still just chugging along.

Angela Larson - SIG

Okay. Thank you.

Operator

And we have a question from Donald Ellis from Thomas Weisel.

Yamila Donna - Thomas Weisel

Hi. This is actually [Yamila Donna] for Donald. My question is about the COLAZAL tablet and I was wondering about what percent of patients you believe will switch back to COLAZAL after the tablet is launched?

Carolyn Logan

You are saying what percentage of patients do we believe will switch to that Balsalazide Tablet?

Yamila Donna - Thomas Weisel

Yes.

Carolyn Logan

From COLAZAL?

Yamila Donna - Thomas Weisel

From the generics?

Carolyn Logan

Well obviously right now, we are trying to maintain as many people on the brand as we can. We have a program of COLAZAL Co-Pay card. So we are covering a patient Co-Pay up to $100 that they will maintain on the brand. And it is on our website. There are several different programs that are involved in communicating that information to physicians and to patients. And then when we launch to physicians in July, the primary focus will be to get COLAZAL patients back on to the tablet. And so we have not really given guidance for Balsalazide Tablets for the remainder of the year.

But obviously we'll be trying to get any existing patients on COLAZAL, as well as bringing as many back as we can from the generic. And in our experience, not every physician, but a significant number of physicians would prefer to keep their patients on a branded product. The challenge we face right now is at pharmacy, because of course the drug chain just makes so much money on generics that they try to switch patients. So our efforts have been giving the physician and patients reasons and encouraging them to stay on the brand.

Yamila Donna - Thomas Weisel

Thank you.

Operator

And that concludes the question and answer session. Ms. Logan, I will turn the call back over to you for any additional or closing remarks.

Carolyn Logan

Thank you. I'd just like to thank our stockholders, our employees and other supporters for their continued confidence and I look forward to speaking with you in the future. Thank you.

Operator

Once again, thank you all very much for joining us today. That does conclude the presentation. Have a great afternoon.

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