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Executives

Art Shannon - VP Investor Relations and Communications

Joe Papa - President and CEO

Judy Brown - EVP and CFO

Analysts

Scott Harsh - Credit Suisse

Linda Bolton Weiser - Caris

Derek Leckow - Barrington Research

Greg Gilbert - Merrill Lynch

Randall Stanicky - Goldman Sachs

Perrigo Co. (PRGO) F3Q08 (Qtr End 3/29/08) Earnings Call May 6, 2008 10:00 AM ET

Operator

Good morning. My name is Sandra and I will be your conference operator today. At this time I would like to welcome everyone to the Perrigo’s third quarter earnings result conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer period. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Art Shannon, Vice President of Investor Relations. Sir, you may begin your conference.

Art Shannon

Thank you very much, Sandra. Welcome to Perrigo’s third quarter 2008 Earnings Call. I hope you 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.perrigo.com. 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. Certain statements in this call are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended and are subject to the Safe Harbor created thereby. Please see the cautionary note regarding forward-looking statements on page 1 of the company’s form 10-K for the year ended June 30, 2007.

I would now like to turn the call over to Perrigo’s Chairman and CEO, Joe Papa.

Joe Papa

Thank you, Art, and welcome everyone to Perrigo’s fiscal 2008 third quarter earnings conference call. Joining me today is Judy Brown, Executive Vice President and Chief Financial Officer. For our agenda today, first I will provide a brief perspective on the quarter. Next, Judy will walk through the detailed financials and then I will discuss our very successful new product launches for Omeprazole and Cetirizine plus an update on some other pipeline products. This will be followed by an opportunity for Q&A.

My overall comment on the quarter is we continue to execute on our plan with a strong focus on our five pillars of quality, customer service, new products, our efforts to reduce our cost structure and people development. Once again, all our business segments performed very well on high volumes. We had record sales of more than $0.5 billion in the quarter with double-digit sales growth in each of our business segments, plus record operating income, up more than 140% from last year on a 390 basis point improvement in gross margin.

As an example of executing on our plan, we realized quality improvements that help to drive these margins. Our quality prevention expenses are actually up 10% and our quality appraisal investments are up more than 15% versus a year ago, but our total cost to quality are down because we reduced quality variations by more than $10 million versus last year. The investments in quality over the past two years are coming to fruition.

Our Consumer Healthcare unit had an all time record sales quarter. The team was able to execute two of the largest product launches in our history within a month of each other. They were also integrating our UK acquisition Galpharm Healthcare, which we closed during the quarter. As a remainder, Galpharm is a leading supplier of over-the-counter store brand pharmaceutical products sold by super markets, drug stores and pharmacies in the UK.

In addition to making Perrigo the leader of store brand products in UK, the Galpharm acquisition also strengthens our footprint for future expansion into Western Europe. The acquisition is expected to add more than $55 million in sales annually and be accretive to the earnings in the first year. I would like to welcome the Galpharm team to Perrigo and congratulate them for winning the Tesco supplier of the year which was just announced last week. This type of acquisition is similar to the Glades acquisition in our Rx business last year. These are ROIC-driven acquisitions that add to our product lines and capitalize on existing customer relationships.

One of the important items we track for dashboard is performance of the OTC market, store brand performance and Perrigo’s growth. I am happy to share with you that the overall OTC consumer market was up 6.4% in the quarter versus last year but store brands gained 11.3% versus last year and Perrigo gained 72% on the strength of new product launches versus last year.

Within OTC the overall cough/cold market in the quarter is up nearly 10% from last year despite a late start this season predominantly due to the launch of Cetirizine. Store brands during this time period gained 18% while Perrigo sales in the cough/cold area were up 59%. I will get into more depth in these numbers in moment but let me just say we feel very good about the performance of our products in the store brand category.

Another important metric for our dashboard is customer service. Customer service levels remain higher in FY07 but with the increase in sales we are still working very hard to improve our service levels. The Rx business continues to benefit from the Glades acquisition and the Clobetasol foam launch. Sales were up 45% in the quarter over last year and the API business had sales up more than 20% over last year.

I am sure you will have plenty of questions surrounding Omeprazole and Cetirizine launches, so I will get into that detail shortly, but before I turn the call over to Judy for more detailed financial review of the quarter, let me publicly thank the 6000 Perrigo employees around the world for another strong quarter with dedication to our customers and our goal of quality affordable healthcare.

Let me turn the call now over to Judy.

Judy Brown

Thanks, Joe. I can’t help but repeat what you just heard from Joe, this was a great quarter. On a GAAP basis, we had record sales of at least 20% in every segment. Gross profit increased 59% and the gross profit margin increased 390 basis points. Consolidated net income was up $23 million to a record $40 million or $0.42 a share.

After reviewing the earnings press release in this morning, you will see that there were three items this year and two last year which we have excluded from our analysis for the quarterly financials on an adjusted operating basis. I will summarize these briefly for your understanding here.

On January 9th, 2008, we completed the acquisition of Galpharm Healthcare as Joe noted a few moments ago. The Galpharm balance sheet and operating results are included in our consolidated results beginning in the third quarter. So, in the third quarter this year we recorded a charge to cost of sales of $2 million after tax or $0.02 per share related to the step up of inventory acquired in this acquisition. Additionally, this quarter we recorded a charge of $2 million after tax or $0.02 per share for the write-off of the Galpharm’s in-process research and development. And finally, this quarter we made the decision to close our West Coast based distribution center. As a result, we incurred restructuring expenses, impairment, and termination benefits of $219,000 after tax or less than $0.01 per share.

Going back to last year’s third fiscal quarter, we excluded two items from our analysis of adjusted operating results. First, we recorded a charge of $5 million after tax or $0.05 per share related to the write-off of in-process research and development on our Glades acquisition. And second, we recorded restructuring expenses of $199,000 after tax or less than $0.01 per share relating to the closing of manufacturing facilities in Michigan. Please note that you can view the reconciliation from the reported GAAP net income and EPS to these adjusted non-GAAP numbers in table two of the appendix to our press release.

With that behind us, I will take you through the financial analysis of our fiscal third quarter based on adjusted operating results, that is, the reported GAAP figures excluding these charges I just mentioned.

Consolidated third quarter net sales were at an all-time record $504 million, an increase of $141 million or 39% from a year ago. New product launches, acquisitions and growth in existing categories all contributed to this achievement. Adjusted gross profit of $161 million was up $61 million from a year ago led by the strong contribution of consumer healthcare. Adjusted consolidated gross margin was 31.9%, up a full 440 basis points from last year.

Adjusted operating income was $66 million, up 98% or $32 million from last year. Our adjusted operating income margin this quarter was 13%, up from 9.2% of net sales last year. The adjusted consolidated net income was $44 million, compared with $22 million last year, and adjusted earnings per share were $0.47, up from $0.24 last year.

Now, I will take you to review of the business segment, focusing first as always on consumer healthcare. Consumer healthcare sales of $373 million represent an increase of $111 million or 42% from last year. Growth surged on launches of Omeprazole, Cetirizine, and new smoking cessation product. Additionally, the acquisition of Galpharm in the UK contributed new sales volume of $8 million in the quarter.

We also recorded higher sales of existing products in the cough/cold, analgesic, and smoking cessation categories due in part due the discontinuance of a key competitor in the OTC market toward the end of the third quarter last year. Adjusted gross profit of $111 million was up $51 million from last year's $60 million. Adjusted gross margin of 29.7% reflects a 700 basis point increase over last year.

We are seeing quantifiable improvement in gross margins resulting from our investments in quality systems, production process realignment and higher volume through our factory. We have a stronger foundation now to handle the headwind of increasing raw material costs that we are seeing in today's market.

Adjusted operating expenses increased $18 million compared with the third quarter last year for several reasons. First, distribution costs in the quarter were up 9% on a 42% increase in sales. As I was just discussing with respect to gross margin, the supply chain team is also continuing its focus on efficiencies in logistics processes, including full-load shipping and the closure of our remote distribution center in our network. This focus on cost and process has allowed us to leverage our spend in distribution better this quarter, even with the higher than normal volume being shipped.

Second, the January acquisition of Galpharm inorganically added over $2 million in operating expenses in the quarter.

Third, R&D activities in our Consumer Healthcare business were up this quarter 5% versus the same time last year, in line with our expectations.

Selling, general and administrative expenses rose this quarter in both percent of sales and dollar term as a bolus of approximately $10 million of promotional activities, market research, variable incentive personnel costs and increased accounts receivable reserves were incurred this quarter along with two of the largest launches in Perrigo’s history.

To give you an order of magnitude, we created more than 175,000 promotional kits, brochures, PR packs, etcetera, in the last four months to successfully launch Omeprazole and Cetirizine. While our business model is predicated on the continuous creation of these kinds of material, it is absolutely unprecedented to have so many at any one time. In all, consumer healthcare had adjusted operating income of $55 million for the third quarter compared with $22 million last year. The adjusted operating income margin was 14.7% of net sales, up from 8.5% last year.

Looking at Rx Pharmaceuticals, net sales in Rx were $49 million, up $15 million or 45% compared with $34 million last year. This increase is a result of new product sales including Clobetasol Foam of $9 million, $5 million in sales of Glades products and $9 million payment for an early termination of licensing agreement. These increases were offset by continuous pricing pressure on existing products as well as the decrease in service revenue of $3 million compared with last year’s third quarter.

As we have noted in earlier calls, we have a developmental collaboration agreement; a portion of which is coming to term. Non-product service revenue related to this portion of the agreement is expected to decline in the fourth quarter fiscal 2008 and beyond.

Gross profit was $22 million, up $5 million from last year. Gross margin was 44.3% of sales, a decrease from 47.9% a year ago reflecting pricing pressure and the impact of lower service and royalty revenue in the quarter. The licensing termination, I mentioned a moment ago, added $5 million to the gross margin line this quarter. That is the $9 million upfront payment offset by a write-off of the remaining underlying intangible on the books.

Operating expenses in Rx were $10 million, up from $9 million a year ago due to additional spending in research and development for clinical trial. Distribution, selling, general and administrative expenses were flat in dollar terms and down 410 basis points on percent of sales terms. Operating income was $11 million compared with $8 million last year and included the $5 million contribution from the termination of the licensing agreement I mentioned a moment ago.

Now looking at API. API sales in the third quarter was $38 million, up $8 million or 26% from last year's $30 million, due in part to a one-time accrual reversal of $5 million related to a longstanding customer contract negotiation. Gross profit of $15 million was up from $11 million a year ago, in large part due to the $5 million reversal I just noted.

Higher production cost versus this time last year challenged margin in the third quarter. Operating expenses were $9 million, up $1 million from last year due to an increase in R&D expense, changes in the exchange rates and variable employee related cost.

Operating income was $6 million compared with $4 million last year. In the other category which is our Israel based consumer products and pharmaceutical and diagnostic businesses, sales were $44 million, up $8 million or 22% due primarily to favorable changes in the foreign exchange rate and favorable sales mix of products.

Gross profit increased $1 million to 11% primarily due to changes in Forex. Operating expenses were $13 million, up $2 million from last year, again due to changes in the foreign exchange rate. As a percent of sales, OPEX were flat. Operating income of $1 million was down approximately $700,000 from last year.

Adjusted unallocated corporate expenses for the quarter were $7 million compared with $2 million in the third quarter of last year. This increase reflects higher variable wage and benefit expenses and incentive plans recorded this quarter.

The GAAP basis or reported effective tax rate for the quarter was 28.1%, up from 21.6% in the third quarter a year ago. Last year foreign source income, which is generally taxed at a lower rate than that in the US, represented 79% of total income compared with only 45% this year.

Now, let's review the nine months year-to-date result on a GAAP basis. Consolidated nine months net sales of $1.322 billion increased $249 million or 23% from a year ago, with sales up in all segments.

Phenomenal new product launches have contributed $134 million or more than half of this growth. Consolidated gross profit was $406 million, up 41% from last year. The gross margin was 30.7% of net sales, up 380 basis points from last year’s 26.9%.

Consolidated GAAP operating income was $156 million, up 102% from last year. Operating margins rose 450 basis points to 11.8% of sales. Consolidated GAAP net income year-to-date was $108 million or $1.14 per share, compared with $55 million or $0.59 per share last year.

The effective GAAP tax rate for the year-to-date is 24.9%, up from 19.4% last year. So, let me discuss the factors that contributed to this year-over-year increase. First, as you've heard me say many times, our blended tax rate moves up and down based on the geographic mix of income generation. This year-to-date that mix changed quite dramatically. Approximately 55% of pre-tax income was generated in the US this year, up from 21% last year.

In addition to the overall mix changes in earnings before tax, the Galpharm IPR&D charge is not deductible for tax purposes, thereby raising the rate this year. Also, a tax credit related to Michigan tax bar change was reclassified into operating income. And lastly, Congress did not renew the R&D credit this year. Given the impact of all of these dynamics, we believe that our overall tax rate for the year will now be increased to between 23% and 27%.

Now, let's look at our balance sheet. First, let me say that the phenomenal growth in the earnings this quarter and year-to-date were driven in part by new product launches, a few of which were near the end of the fiscal quarter. As a result of the timing of these launches, dollar balances of working capital have increased as well.

Working capital excluding cash investments was $375 million at the end of the third quarter versus $280 million last year, an increase of $95 million. The increase was due to higher inventory levels and accounts receivables associated with the higher sales volume.

Going into more depth on working capital, accounts receivable were $373 million, up from $247 million a year ago reflecting the higher fiscal 2008 sales volume and new product launches in March. In fact, approximately two-thirds of this dollar increase is attributable to just new launches.

DSO meanwhile has remained constant versus this time last year. I would like to also note that collections of these new product launch receivable were well underway in the month of April bringing the balance of accounts receivable down subsequent to quarter end to more normal levels in dollar terms.

Inventories were $357 million, up 15% from $310 million at this time last year. A few factors are at play here. First and most importantly, we are in the midst of our Omeprazole and Cetirizine launches. New products ready for delivery and in process accounted for more than half of the year-over-year increase.

Second, we have a concerted effort to reduce excess and PRG-15 0:44 (inaudible) inventory in our supply chain. As the result while inventory reserves are essentially flat in dollar terms, they have decreased as a percent of sale. As the bolus of our new product launches moves through the supply chain, we expect balances to return to more normal levels.

Accounts payable were $230 million, up $71 million from $158 million a year ago. Again, driven by the material purchasing activity tied to this quarter’s new product launches. This increase over last year more than compensated for the dollar rise in inventory at quarter end. Year-to-date cash provided by operations was $135 million compared with $74 million last year.

Despite the prolong working capital required to launch important new products in the last four weeks of the quarter, we generated $40 million of operating cash flow in the third quarter alone. Capital expenditures to date were $26 million and we still anticipate spending between $40 million and $50 million for the full year.

Debt-to-total capital decreased 430 basis points from last year’s 31.7 to 27.4% this year. I am pleased with this finish given the fact that we executed an acquisition and had significant working capital utilization this quarter. Subsequent to quarter end, we completed the execution of $125 million term loan. These funds were used to pay down our revolver during the month of April creating more cash management flexibility.

In the third quarter we repurchased 707,000 shares for $24 million under our 10b5-1 stock repurchase plan. Year-to-date we have repurchased 2 million shares for $59 million. We paid cash dividends of $13.6 million or $14.5 per share for the nine months of fiscal 2008.

Now let me take you on to our guidance for the remainder of fiscal 2008. As I just noted, the company generated $40 million in operating cash this quarter and is on track to meet our full year cash guidance of approximately $180 million to $200 million. As always, we continue to focus on working capital. Although our outstanding working capital increased this quarter as a result of two of the largest new product launches in our history, cash collection subsequent to quarter end are already normalizing on our balance sheet.

Even with the ongoing launch activity though, we are still looking for continued improvement in our inventory management along with operational efficiencies for the remainder of fiscal 2008 and beyond. As the picture of our competitive landscape and new product launch timing has become clear over the course of the year, we have raised earnings guidance three times. On our last call on February 5th , we guided to $1.50 to $1.60 per share for the full year excluding any acquisition related write-offs for restructuring charges. With only one quarter remaining in this fiscal year, we are tightening this range and moving to the top end of it, while at the same time increasing the underlying effective tax rate.

We now project the range of adjusted earnings per share again excluding charges for acquired inventory step-up, IT, R&D and restructuring to be between $1.55 to $1.60 per share and within this range again, we expect the tax rate to be between 23% and 27%, up from the previous guidance of 21% to 24%. We will give our fiscal year 2009 EPS estimates first in August when we release the fourth quarter earnings.

And with that, let me turn it back to Joe.

Joe Papa

Thanks, Judy. Now, as Judy has given you all of the financial details of our third quarter, I would like to talk about our new product launches. Overall, we are cautiously optimistic about our launch of Cetirizine and Omeprazole. Cetirizine was launched in January ahead of the national brand Zyrtec.

Despite six competitive Cetirizine approvals at market formation, we have been able to capture more than 80% of the store brand Cetirizine. The Cetirizine launch represents an important milestone for Perrigo, as Cetirizine will also be Perrigo's first vertically integrated consumer healthcare product.

We have created value for our customers through 55,000 customized Cetirizine marketing programs with off-shelf displays, print ads, pharmacy introduction kits, on-shelf signage, and more. We believe no other store brand marker can offer these value added programs to the retailers which is why we are able to capture this level of Cetirizine store brand. As Judy explained, there is a significant launch expense in the quarter for Cetirizine and Omeprazole. Fortunately, the outstanding execution in our manufacturing and quality groups provides us with the operating efficiencies in cash to invest in these important new product launches.

We expect this launch expense to be an important investment in differentiating Perrigo as the store brand market leader for today and the future.

The national brand has done an excellent job promoting the Zyrtec product. Market estimates have the brand sales for the family of Zyrtec products annually at $650 million, far exceeding pre-launch estimates. When a brand creates this kind of increased product awareness, this really helps the store brand product launch as well. In fact, we believe these are some of the reasons why the Cetirizine launch store brand have captured more than 35% of the market in volume share already, much higher than the traditional 20% to 25% average.

Next, let me review Omeprazole, our largest product launch in our 120-year history and which we started in the first week of March. Initial sales have gone very well. Very early indications have store brands capturing more than 27% of the latest week data in only the first seven weeks. As we told you earlier, we expect Omeprazole to add $150 million to $200 million in annual sales and the initial launch did nothing to change our view.

I just returned from the [NATDS] meeting and the retailer receptivity to these launches, both Omeprazole and Cetirizine has been great. We are encouraged by the early consumer sales data we are receiving and the store brand market share gains we are already seeing.

I would caution us, however, that it is early to draw conclusions of what store brand sales and market share percentages will be attained with only a few weeks of data available since these products have been launched. What we do know is that our retailer, customers are excited about the value they are able to reinforce to their consumers with these two significant new products and are committed to growing their store brand shares. We will continue to work closely with them to maximize this great opportunity that these new products represent.

Moving on to addition of new products and the pipeline in March, our partner Teva received final FDA approval for over-the-counter Cetirizine Hydrochloride with Pseudoephedrine Hydrochloride extended-release tablets comparable to McNeil's Zyrtec-D extended-release tablets. It is indicated for 12-hour relief of indoor and outdoor allergy symptoms and nasal congestion.

According to Walter [Schuler] data brand sales for the original prescription strip version of this product for the 12 month ending December 2007 were approximately $190 million. We are currently launching this product. Also last month we announced final FDA approval for the OTC Children's Cetirizine Oral Solution. It began shipping immediately utilizing our own active pharmaceutical ingredient in the formulation.

Famotidine Complete represents another positive development for our new product pipeline during the quarter. In February we received final FDA approval for OTC Famotidine Complete Chewable Tablets. This product will be marketed under store brand labels and is comparable to the J&J product Pepcid Complete, an acid reducer plus antacid medication indicated for the relief of heartburn associated with acid indigested and sour stomach.

Annual retail sales for Pepcid Complete Chewable Tablets are estimated to approximately $95 million. Perrigo was the first applicant to complete an ANDA with the paragraph 4 certification and we will have 180 days of marketing exclusivity. In April, the court of appeals affirms the trial court’s decision in favor of Perrigo and our Famotidine Complete. We expect to begin shipping the product in the third quarter of calendar 2008.

In the Rx segment, we launched Clobetasol Foam, the generic version of Olux. This product is a topical corticosteroid indicated for the treatment of moderate-to-severe dermatosis of the scalp. Annual sales for the brand were approximately up $85 million. As the first filer, this commenced our 180 days of generic exclusivity, which we launched at risk, which is a first for Perrigo.

Cumulatively, we have an opportunity of approximately $1 billion of branded new products that Perrigo has the exclusive store brand offering and we expect that exclusivity to last for over 12 months with many of these products.

New products represent an important pillar for Perrigo and we will continue to build our pipeline and believe there are more opportunities in consumer healthcare store brands with Rx to OTC Switches and new ANDA that will be worth over $10 billion of branded opportunities that we could experience in the next five to six years.

In FY 2008, we are also planning to file more than 10 ANDAs with more than half of them being paragraph 4 filings. We have increased funding of R&D in all of our business units versus last year just to maintain this pace to ensure that this important growth engine is sustainable.

Overall, our bottom-line results have exceeded our expectations. Since last year, my team and I have been focused on improving our execution in each of our business unit. We continue to meet weekly, focusing on the metrics in the dashboards to help up manage inventories, improve working capital and just improve our overall business processes.

In these volatile market conditions, I like the fact that we have positioned the company to have the ability to generate cash on a solid foundation. We are well on our way to meeting our goal of $180 million to $200 million in cash for the year. Our guidance for EPS of the $1.55 to $1.60 represents an increase of 75% to 80% above last year’s adjusted earnings.

Early returns from the retail data for our new products are encouraging and we are cautiously optimistic about the future of Omeprazole and Cetirizine.

Now, let’s take your questions.

Question-and-Answer-Session

Operator

(Operator Instructions)

Your first question comes from Randall Stanicky of Goldman Sachs.

Randall Stanicky - Goldman Sachs

Thanks guys very much for the question, just a couple. First, Judy, on the tax rate, can you maybe just help us feel down a little bit on some of the moving parts there that cause it to increase? And I am thinking that we would have obviously known that we are going to have some increased contribution in the US from the launch. So, as we think about the tax credit and other things that you talked about, maybe -- is it possible to give us a little bit of relative impact there and then is this the rate as we think about F'09 in going forward that would be I guess our best estimate at this point?

Judy Brown

Sure and great question. Obviously the tax rate over the last several years has been very dynamic and I am trying to provide color on a very regular basis to keep you up-to-date as things develop with our overall tax planning strategies and obviously the most critical piece of the tax rate being the mix.

As we have given color over the course of the year on the range of the tax rate, we were focusing on that source of income and our expectations of the blended rate between domestic and international components of our tax rate. The biggest piece again, if you look at the swing of drivers between last year, 55% of our income this year is domestic versus 21% last year, that's the big driver year-over-year. Last year's rate had a couple of one-time credit that I've talked about last year. This year's rate, if you try to quantify, a few percentage points attributable to the items I mentioned during the earlier discussion related to Michigan tax law change, the change in the R&D tax credit positioning have all added to a few percentage point increase overall.

So, as I am looking at moving the rate up to 23% to 27% for the remainder of the year, there were few percentage points on those changes as well as a few percentage points just cumulatively as we continue to get better information on that exact source of revenue or earnings before tax for the full year.

To think about the future, this middle around 25%-27% full year would be a reasonable expectations, but again, we are going to give more color as we really have a deeper understanding of earnings before tax. But as we've guided in earlier analyst meetings as well our goal in a world where we are doing a significant portion of business in the US with the corporate tax rate of approximately 32% to be able to get down into the mid or just about mid-20s range still a very important project for us and continuing to work and adding value by being able to keep the tax rate in the mid-20s going forward.

Randall Stanicky - Goldman Sachs

Great. And then just a question on the consumer health business. Can you give us the organic rate and maybe I just want to make sure what things look profitable? If we look at the $373 million and take out the $97 million in new launch, it implies roughly $14 million increase from last year and clearly there are some moving parts, some acquisition revenue in there, and I just want to make sure we are thinking about the growth of the core part of that business properly.

Judy Brown

Certainly, consumer health care specifically 42% growth in the quarter, organic -- of which organic was 38%. We have talked about Galpharm adding $8 million this quarter. There was just a little bit of foreign exchange in there. It's just a minimal amount and also a small portion of income related to the Qualis acquisition.

In terms of growth in our core, the core is still growing a few percentage points year-over-year and in line with what we had expected for the full year as we are looking at the opportunity in our existing categories as well as our sales as our competitor without of the market place this quarter.

Randall Stanicky - Goldman Sachs

So with that $97 million, is it possible to characterize how much that is in perhaps initial stock (inaudible) amount, maybe without exactly or approximately the sources of that?

Judy Brown

That's another outstanding question, Randall and for competitive reasons we are not going to be giving exact dollars on specific product launches. As you know, we talk about new products as a general term to help everyone understand growth driven by new products but now as we are going forward we will not be giving specific dollars on any specific product as we have not done in the past, but obviously, it's going to be important.

In the past we gave you an idea of how much Omeprazole, for example, was going to contribute in total dollar revenues, in terms of total EPS impact and that was because it was just -- it's such a material and important product launch for us, we felt that it was important to give you some color on the size of that, so we can help everyone understand the impact of the bottom line but going forward it will be challenging for us competitively to just give a specific number. But we had continuing launches in new products this quarter on the smoking cessation category. We had continuing launches in our nutrition category, some cough/cold products as well as obviously Omeprazole.

Randall Stanicky - Goldman Sachs

Right, and so do you still….

Joe Papa

If I may, the only thing I would just say is that nothing has changed our expectations. We still believe that as we look at the initial uptake of Omeprazole, we still feel very comfortable with our $150 million and $200 million that we have given previously as per Judy’s comment. So just to confirm that $150 million to $200 million on Omeprazole is still something that on an annual basis we feel very optimistic about that opportunity.

Randall Stanicky - Goldman Sachs

And Joe, the bottom-line the $0.20 to $0.25 that would be the same as we are implying roughly a profitability profile that you had initially anticipated?

Joe Papa

Yeah, but just to review the $0.20 to $0.25 was for the fiscal year 2008, just as a reminder. Fiscal year 2008, that was the $0.20 to $0.25.

Randall Stanicky - Goldman Sachs

But the profitability profile is in line with your initial expectations.

Joe Papa

Profitability profile is in line with our initial expectations. The only thing maybe I would say is that we did, as you can look at our SG&A, spend a significant amount in, as Judy outlined, in the launch expense for all the displays and other activities, which were associated with the launch, simply because we looked at that as an important investment for our future and candidly as I mentioned we had great operational performance on manufacturing and quality. It allowed us to have some flexibility to increase our expenditures in the launch so that we could maximize the opportunity to be successful with Omeprazole and Cetirizine for that manner.

Randall Stanicky - Goldman Sachs

Okay. I will jump up. Thanks all for the color.

Operator

Thank you. Your next question comes from Greg Gilbert of Merrill Lynch.

Greg Gilbert - Merrill Lynch

Thanks, good morning. Let me start with the general financial question for Judy, which I guess could have several questions within it. But just big picture, other than tax rate, what factors would cause next quarter's earnings per share number to be lower than this past quarter? Is it primarily function of working through new product shipments or could you walk us through some of those factors?

Judy Brown

Certainly. A couple of factors are at play if we look at Q3 to Q4. You have a normal seasonality flow underlying in the ongoing business, thus if you look at the run rate on Perrigo, it's the normal flow. Fourth quarter is normally the slower. Second is all, as I have commented on both in this quarter's Rx discussion as well as in earlier guidance provided for the full year, the impact of collaborative R&D works that was being done in Rx will continue to decrease in the fourth quarter and that will have a direct impact quarter-over-quarter if you look at consequent quarters. That will be an impact to the fourth quarter.

We will also be continuing our new product activity. We had obviously launch quantity going through in the third quarter. And there are also continuing activities ongoing in sales and marketing and moving through promotional and sales activities in that area in the fourth quarter as well. So there are several pieces at play, all of which we looked at are full year when we gave the color guidance on $1.50 to $1.60 for the full year on February 5th. We were able to see pieces that were coming through in Q3 and Q4.

As you know we don't give quarterly guidance, but there were several items that came through in this quarter. For example, the resolution of a royalty arrangement in the third quarter that happened this quarter that will not be a recurring activity in the fourth quarter that also changes -- again, when you line up the quarters, Q3 to Q4.

So, again items that were considered as part of our full year view, but we knew timing wise were going to be prevalent in Q3 but not present in Q4.

Joe Papa

I would add to Judy's comment, which was a very good answer. I also would add, I think as we look at the-- what's happening out in the external world, we see some economic uncertainty which may or may not help store brand depending on how value conscious the consumers gets to be. We clearly also see higher commodity cost out there in the marketplace and obviously, as I said, we are very excited about Omeprazole and Cetirizine, but it's very early data.

So, while we have significantly increased our earnings from a year ago $0.89 adjusted earnings to $1.55 to $1.60 and we also beyond the tax rate increased R&D by 17%. We just felt at this point it's prudent to just take a look at what's happening out with these new products because they can be such an important driver for us.

Greg Gilbert - Merrill Lynch

So, let me just go on to the selling and admin a little more. With $10 million sequentially, it sounds like a lot of that was launch related, but it also sounds like a lot of that is not going away and in fact may go up next quarter. Is that the right way to think about that line?

Judy Brown

Definitely, R&D is going to go up next quarter in dollar terms. There are some pieces still related to the selling and marketing activities that will continue in the fourth quarter but certainly not go up, so that $10 million really is the main bolus. It will not all go back to last year’s dollar spend but let me be clear, I am still expecting that for the full year distribution, selling, general, and admin as a percent of sales will be down for the full year and is going to come down as a percent of sales also next quarter. So, there are certainly pieces there that are driving the sales activity right now.

There are pieces in our selling, general, and admin that are variable, we've talked about, it's a small percentage compared to a branded company by far but certainly there is some variability there when you are going through the size of product launches that we are looking at. So, it will not be flat as the last year in dollar spends but it will be down in this quarter.

Greg Gilbert - Merrill Lynch

Thanks. And one more before I get back in line for Joe. It was nice to see Wal-Mart include a bunch of OTC products in their $4 program and I assume that Perrigo is participating there and it sounds like a good volume story for sure, but have you noticed any changes with that customer in terms of their demand for better pricing or do you see that as a risk or is it all good news from your perspective? Thanks.

Joe Papa

Good question, Greg. I think maybe bottom-line when the world's largest retailer gets behind and increases promotion on store brands, we think that's clearly good for store brands, clearly good for consumers and we also believe it'd be very good for Perrigo. We expect to see increase volume as we are a significant supplier to Wal-Mart for their store brand products.

I really do think that the expectations on their unit volume will go up, certainly as they have been promoting it -- just based on what we had seen in the previous iterations of the $4 pharmacy programs. So, we expect to see increased volume and we think that's going to be good for consumers, good for store brand, and certainly good for Perrigo in terms of the volume increases and obviously Wal-Mart feels very happy with their early result in the first phases of their $4 program.

So, relative, we haven’t -- no specific adjustment in pricing, so we think this will be good news.

Greg Gilbert - Merrill Lynch

Great.

Judy Brown

Greg. I'd like to just add. I'll be remiss if I didn’t take this as a follow-up -- as a follow-up to your follow-up. I will add that the one important piece that we can't forget also in our cost structure is that we have gone through an acquisition. We have acquired Galpharm in the UK and with that acquisition we have also acquired SG&A, that’s even net of the activities that we are doing to integrate that business and that is going well and is well underway. And just excluding -- just looking at that one particular line in our P&L in isolation, obviously we've got foreign exchange impact going through that right now.

So, between inorganic growth and foreign exchange, we've had an increase of over 10% just down last year right after that on those two items. So, those are pieces that will also be prevalent I'm sure in the fourth quarter as currencies are staying around as same as they were in the third quarter. So just to expect that piece is part of a run rate change that we are going to be seeing going forward.

Greg Gilbert - Merrill Lynch

Is Galpharm's growth and operating margins similar to Perrigo's standalone consumer margins? You gave us the sales impact and that it would be accretive, but should we think about the margin structure as being similar to…

Judy Brown

Their margin structure is similar. We will have accretion on our 12-month basis from the time of the acquisition. We also have about a month and a half worth of sales in this quarter versus it's full three months. So, I'd say right now, sales are in line with our expectations, gross margins are going to be similar to the margins that we have in the UK and we'll add bottom-line operating income value overall.

Greg Gilbert - Merrill Lynch

Thanks.

Operator

Thank you. Your next question is coming from Derek Leckow of Barrington Research.

Joe Papa

Derek?

Derek Leckow - Barrington Research

Can you hear me?

Joe Papa

Yeah, we couldn't hear the beginning.

Derek Leckow - Barrington Research

Okay. Hi, how are you doing? Just looking at the sales contribution from new products, can you characterize the profit contribution of that going into the next couple of years -- is it, I mean, out of the most profitable sales store (inaudible) most of those products given the large amount of profit share you have taken initially?

Joe Papa

I will start and then Judy may want to add to this. First of all, I think the most important thing is that as I mentioned we feel very optimistic, although it's very early with these new products, certainly Omeprazole and Cetirizine. Second point, I'd mention is that right now for approximately $1 billion of branded products sales, Perrigo has the exclusive either store brand or the generic Rx product of those products in the market place and we expect that exclusivity in many cases can last certainly one to two years potentially. So, we feel very optimistic about the longevity of these new products.

And even in places where we do not have exclusivity, such as Cetirizine, we are sitting with approximately 80% store brand market share in the face of six competitors. So, we do believe that we have got good longevity; however, I would just go back to the comment, it's early but we are very excited about the prospects for both Omeprazole and Cetirizine. Judy, anything else you want to add to that?

Judy Brown

Well, just to add color, Joe spoke specifically about new products, but if we look at the profitability improvements this quarter and year-to-date versus last year, we would be remiss if we did not mention the important contribution that has come from process and production improvements, lower scrap, more streamlining in the plant, higher volume rank to the plant have added more than half of that 700 basis point improvement in consumer healthcare. So, looking forward that foundation is critical not only to maintaining but also having the opportunity to continue to expand as we look at that continuing flow of new product as Joe just mentioned on a stronger base.

Derek Leckow - Barrington Research

Yes but it sounds like some of these changes in investments you have made are going to lead to permanent operating profit improvement. So, as we try to model out five years from now, Judy, can you help us a little bit with your goals on operating profit? Is that something that you see expanding by 50 basis points a year? Is that the way to think about it or are we going to see fluctuations here just based on how large these new products were this year? I assume next year you are going to have also some pretty fast growth in the generic drug business. I know you don't want to speak to that, but just this so I can understand the modeling on the operating margin. Should we continue to think that these operating margins of today are still low compared to the five-year number if you look out that far?

Joe Papa

It's a great question. Derek, I think probably the best way to answer is that we very strongly believe that some of the investments we are making today, both investments in the R&D dollars and the investments in the success of the new product launches for Omeprazole and Cetirizine, Cetirizine-D, Cetirizine Syrup are all important parts of our growth profile for the future, and our expectations just knowing how new products work and how new ANDA products work is that that will give us an ability to improve operating margins going into the future.

However, I don't want to go into 2009 and beyond, really this way because really -- we are not going to really talk about 2009 until August timeframe. But on just a general basis, we do feel that the investments that we are making in all the promotions help us to solidify our position at the store brand market leader and also the dollars reporting in to R&D help us to look at the $10 billion of branded sales that we expect, will switch from prescription to OTC status or allow us to enter into marketplace with exclusive store brand, such as our ability to guaifenesin extended release to Mucinex as an example. Those are such of things that we think will help us to improve our operating margins.

Derek Leckow - Barrington Research

Yes, I mean, looking at the Mucinex for example I mean, you brought up. The peak operating margin, I guess, this one I'm trying get to and with products like that as huge opportunities you are going to be seeing, what is your operating margin top out?

Judy Brown

So, I am just trying to think about some other things that we have discussed already on the call, as I look forward to '09, we have got, we are going to making decisions as a group of out the right balance of R&D spend, looking at the projects as Joe just mentioned that are going to support to focus on that $10 billion of products that we believe we are going to switch. So, we have got some R&D leverage to pull. We have got to make the right investments in SG&A.

I would tell you as I mentioned earlier on the call that we have to be pragmatic about the headwinds of raw material price increases that we're seeing, and that I am sure many other companies that you listen to and follow are seeing as well and being smart about that and levering the foundation we have of being smart about how to handle price increasing. What's the right number? Is there a target number that we have in our mind. I would say, wouldn't bigger a number but we certainly need to be talking about that in August of how far we see it moving in the next 12 to 18 months? I don't have a number in my head right now, Derek.

Derek Leckow - Barrington Research

Okay. Well congratulations and good luck.

Joe Papa

Thank you.

Operator

(Operator Instructions) Your next question comes from Linda Bolton Weiser of Caris.

Linda Bolton Weiser - Caris

Hi, how are you doing? Can you talk about in the slow growth that you saw in the consumer healthcare segment and the underlying growth? Can you talk about how they have breaks down between pricing and volume growth?

Joe Papa

Yeah, maybe I'll just use, talk a little bit about it, from the point of view of the metrics. So, I think that's an important part of it. The way we look at it, we try to track the overall market and the market growth was as I mentioned for OTC is 6.4% within that store brands grew 11% and we grew 72%. Judy outlined before a large part of that was the new products that clearly is a large part of the growth.

The second part was probably really thinking about the metrics there was the volume growth a significant volume growth and there was some pricing but unbalance it was a small contributor to the overall growth, predominantly was a volume and the new products.

Linda Bolton Weiser - Caris

So you are saying pricing is actually slightly positive?

Joe Papa

There actually was a -- proabaly best we call as the neutral to very, very slightly positive. Neutral to very slightly positive, way we have shredded.

Linda Bolton Weiser - Caris

Okay. And when you mentioned the market shares at the store brand Cetirizine and Omeprazole has gained so far. Can you describe -- give reasons maybe why the Cetirizine share for store brand is higher initially. Is it the price discount versus brand or the length of time since the launch or, can you just talk about that?

Joe Papa

Yeah, right now, my belief is, it is only the length of time, Cetirizine, as you may recall was launch, right on January 15th there about, whereas Omeprazole was launched on or about the 1st of March. So really, the only -- my opinion at this point the only data difference really is the length of time but I would cautioned that both of them very early in their launch history knowing, we got date on one for three months and really essentially month and half for the other one.

Linda Bolton Weiser - Caris

Okay. And then may be you already talked about this, but did you try to explain how much or what quantify how much was pipeline still of the new product sales in the quarter, because I would assume that we should expect sequentially the sales to be down sequentially?

Joe Papa

Well, I think, probably we have not talked about any specific percentages I think, your assessment is correct, when you launch a new product one of the important part is to sale the pipeline and ensure that there is sufficient product distribution and additional product for the distribution centers of the major retailers. So that clearly was one of the activity is now what we track for a closely is the percentage of distribution into the retail outlets, which we are delighted that we have got good distribution into the retail outlets. And the other thing obviously is the consumer trial. We have got good number so far. Obviously, the brands both the Prilosec OTC and the Zyrtec brands are doing significant activities in the area of promotions but we are excited as I mentioned before we have taken the data we have.

Linda Bolton Weiser - Caris

And just following on that with Omeprazole, do you expect to achieve full retail distribution by the end of calendar '08, or do you think they will continue to get more distribution in calendar '09?

Joe Papa

I am sorry. I just couldn't hear the first part of it. Omeprazole the question was?

Linda Bolton Weiser - Caris

Yeah. Do you think you will achieve full retail distribution by the end of calendar '08, or do you think you will continue to gain some additional distribution in calendar '09?

Joe Papa

I think we will have full retail distribution in calendar '08, however, greater usage by consumers and the consumer usage in '08 and '09. So the actual distribution -- we will have most of the outlooks, majority of the outlooks were clearly the stock and in the distribution channel for our fiscal year 2008.

Linda Bolton Weiser - Caris

Okay. Thank you very much.

Joe Papa

I think we have time may be for one last question. Operator?

Operator

Thank you. Your last question is coming from Scott Harsh of Credit Suisse.

Scott Harsh - Credit Suisse

Can you hear me?

Joe Papa

Yes. Hi, Scott.

Scott Harsh - Credit Suisse

Hi, there. So just two questions real quickly, one, can you give us a sense of -- I know you spoke just a little bit Judy, but the variability from SG&A, like when you send out these promotional displays for Omeprazole, do you have to do this again and again or just a one-time initial launch, send out the cardboard displays, you know how to do it again?

Joe Papa

I will take that question Scott. The majority of the launch displays are associated with launch. They can be refilled, but to the majority of the expense are associated with launch.

We will still continue to do promotions but nowhere near the magnitude that Judy outlined in her comment. So, I think the bottom line comment is that, yes we did a significant number of promotions. The majority of those are associated with the launch. We will continue to do promotions but not nearly to the level that we have gone just for this start of the launch type area.

Scott Harsh - Credit Suisse

Okay. And then, Omeprazole for a second, can you may be talk a little bit to back to the liner capture a little bit and whether you have been seeing additional share gains in the vitamin segment and the other non-OTC share and any of that kind of color you can give us?

Joe Papa

Yes, I absolutely happy to discuss. Relative to line just a quick review for everybody, we had previously talked about acquiring approximately $90 to 100 million of annual business from that opportunity. I am delighted to say that that continues to be our number. So, we are realizing all of that sales that we have previously spoken about on the OTC side of the business.

Relative to vitamin and nutrition, we have been successful in receiving incremental vitamin and nutritional business, as customers have come to us requesting some additional products. So, we have done that, although, we are very early in this process, the only I would add to that comment is to say that I will remind to the people in nutritional business, it is not as profitable as our OTC business. So, although, we have picked up some additional business, I don't want to put it at the same margin. It's a lower margin business.

Scott Harsh - Credit Suisse

Given these two biggest launches, do you still have capacity to capture a share for the liner side?

Joe Papa

The answer to the question is that we have picked up incremental vitamin and nutritional business and we are satisfying or we are working very hard to satisfy that business today. We are at a point where we added some additional equipment, some additional packaging lines, tableting process, etc., to work through that. If we work at -- need to pick up significantly increase beyond the current business we require -- that would require additional investment but at this current time we have sufficient capital in terms of equipment and packaging materials to pick up that business.

Scott Harsh - Credit Suisse

All right, great, thanks.

Joe Papa

May be just let me make a quick closing comment. Once again, I would like to thank the 6,000 people from Perrigo around the world that have worked so hard on this quarter and delivered an outstanding result. I would remind people that at this current time we have increased the guidance to $1.55 to $1.60 from where we were a year ago $0.89, so it's about 75% to 80% increase and we are very optimistic about our Omeprazole and Cetirizine albeit on limited data at this point in time.

I would invite any of you that would like to come visit us, come out and visit us here in Michigan to see the facility, to see what we are doing and see the excitement of our team. By this time of the year the weather is nice and clear back in Michigan, so we -- absolute come out to see us. Thank you very much for your interest in Perrigo. Have a great day.

Operator

Thank you. This does conclude today's teleconference. You may now disconnect your lines at this time and have a wonderful day.

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Source: Perrigo Co. F3Q08 (Qtr End 3/29/08) Earnings Call Transcript
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