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Executives

Laurie Little - VP IR

Mike Pearson, Chairman and CEO

Peter Blott - EVP, CFO

Analysts

Michael Tong - Wachovia Capital

John Boris - Bear Stearns

Hank Rauch - Liberty Mutual

Greg Gilbert - Merrill Lynch

Rajeev Jashnani - Civic

Valeant Pharmaceuticals International (VRX) Q1 2008 Earnings Call May 7, 2008 10:00 AM ET

Operator

At this time, I would like to welcome everyone to the Valeant first quarter earnings call. (Operator Instructions)

Thank you, Ms. Little. You may begin your call.

Laurie Little

Thank you, Christine. Good morning, everyone, and welcome to Valeant's 2008 first quarter financial results conference call. Joining us on the call today are Mike Pearson, Chairman and Chief Executive Officer; Peter Blott, Chief Financial Officer; and Dr. Janet Hammond, Vice President, Global Medical Affairs and Chief Medical Officer. In addition, Phil Loberg, Group Financial Controller; and Grace Lin, Treasurer are also here and available to answer questions during the Q&A session.

Before we begin, I would like to call your attention to the fact that this presentation may contain forward-looking statements, including, but not limited to, expectations and plans relating to retigabine our taribavirin and the and the ability to partner our products in development. These statements are based upon current expectations and beliefs of management and are subject to certain risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statement. These risks and uncertainties include, but are not limited to, risks and uncertainties related to RESTORE 1 results that are not necessarily predictive of RESTORE 2 results and that adverse events are not always immediately apparent even in well-defined clinical trials, the ability to partner our products in development, our ability to divest our European operations in the current credit environment and other risks and uncertainties discussed in the company's filings with the SEC. These factors are among the factors that could cause actual results to differ materially from the expectations described in the forward-looking statements. Undue reliance should not be placed on any of these forward-looking statements which speak only as of the date of this call. Valeant undertakes no obligation to update any of these forward-looking statements to reflect events or circumstances after the date of this call or to reflect actual outcome.

Certain figures discussed in today's call will be based on adjusted or non-GAAP information. A reconciliation of historical GAAP to non-GAAP results can be found in the tables in the company's press release issued earlier today and on Valeant's website at www.valeant.com. Valeant has not provided the reconciliation of forward-looking non-GAAP financial measures due to the difficulty of forecasting and quantifying certain excluded items.

And now, I'd like to turn the call over to Mike.

Mike Pearson

Thank you, Laurie. Good morning to everyone and thank you for joining us.

Since our last call on March 27th, I've had the opportunity to meet with many of our shareholders, and many of you have asked me about the upcoming milestones and what are the key events that Valeant should be measured on. I would like to quickly summarize these.

The next 12 months, Valeant will be focused on six key initiatives. The first is to sell or IPO Europe. As we've talked about our European operations, our key driver of complexity in this company and while we operate in many countries and in many different businesses, a wide range of products, this has caused a lot of additional cost and complexity.

The second priority is to fix Mexico. Operation in Mexico has had very disappointing results in 2007 and the first quarter of 2008. And this is because of a series of very poor management decisions that have had a negative impact on our sales and market share. The third initiative is to partner our pipeline assets, retigabine and taribavirin to maximize both these compounds.

The fourth initiative is to file the NDA for retigabine. The fifth is to restructure the organization. This company needs to significantly downsize its G&A spending, needs to redirect its promotional spend and needs to rationalize its R&D programs. Finally, the sixth initiative, as we move through all these objectives, we plan on strengthening our balance sheet.

Now, let me update you on progress against these six initiatives. First, the sale or IPO of Europe. We have made significant steps forward on our plan to divest or IPO our European operations. Goldman Sachs has had many interested parties step forward, and we plan on issuing an offering memorandum in the second quarter. We have also put in place financial incentives for our key employees to ensure the business continues to perform well throughout the sale process.

Our second initiative, fixing Mexico, we have implemented a five-step program to fix Mexico. First, as previously announced, we have replaced management. Second, we have now aligned our sales force activities to call both on physicians and on the retail segment and to rebuild our important relationships with the pharmacists.

Third, we are repairing our relationships with our wholesalers. We now have full-time Valeant employees at the wholesalers who are working with these wholesalers to align our demand forecast with our manufacturing schedules and to ensure consistent payment on the parts that we sell to our wholesalers.

Fourth, we are dismantling our international regional organization in Mexico and making significant inroads to reduce our infrastructure in Mexico. Fifth, we have taken additional reserves against aged inventory and accounts receivable to more appropriately balance these accounts against current sales volumes.

Although the first quarter results in Mexico were poor, this is the last quarter under the previous management team. Dr. [Revollo], our new head of Mexico, has been in charge for one month and is taking decisive action. In terms of our third initiative, partnering our pipeline assets, again, we plan to partner both retigabine and taribavirin. And as we previously announced, we will announce the results for results for RESTORE 2 in the second quarter of this year.

In terms of taribavirin, we do not plan to directly fund a large scale Phase 3 trail. We are looking to partner this compound both for a major Phase 3 trial as well as the trial in the co-infected HIV patients. We will be willing to fund smaller clinical trails to evaluate taribavirin in patient population that cannot tolerate anemia such as dialysis patients and patients with disorders of the hemoglobin.

We were selected as a late breaker at the European Association for the Study of the Lever, EASL, and we presented on April 26th. I was over in Italy and was very pleased with the response from the various medical professionals I met and their renewed excitement in this molecule.

The next initiative is to file an NDA for retigabine. With the positive results from the RESTORE 1 in-house and the pending results from RESTORE 2 anticipated shortly, we are working diligently to be in a position to file an NDA with the FDA before the end of 2008. Our target remains in the third quarter of 2008. We are also targeting an MAA submission for Europe for retigabine before the end of 2008.

The next initiative is to restructure and right-size the organization. We have taken the first step to resize our organization to accurately reflect the size we will be after the sale of our assets. We recently announced headcount reductions of 130 physicians, primarily in the U.S. and our corporate operations. Cost savings associated with this action is approximately $20 million on an annualized basis. This is in addition to the $20 million that we previously announced, which is tied to the divestiture of our European operations.

We have redirected our selling and marketing dollars against those products that we believe will be more promotionally sensitive, products such as Kinerase and Diastat, and we have taken promotional dollars away from Tasmar and Zelapar. We will also be addressing our R&D spend, which will be reduced significantly as we move through the completion of our Phase 3 retigabine program.

Finally, we will strengthen our balance sheet by deploying our cash in appropriate ways. We will discuss this in greater detail at our next quarter earnings call.

I'd also like to just take few minutes to address two other relevant issues, Efudex and trade inventories. First, on Efudex. As you know Spear Pharmaceuticals received regulatory approval of their ANDA for our Efudex Cream on April 11 and reportedly began selling their products shortly thereafter.

On April 25th, Valeant filed an application for temporary restraining order, a TRO, in the federal court against the FDA, seeking to suspend the FDA's approval of Spear's ANDA. On May 1st, the federal court entered a stay of all proceedings through May 14th.

Spear has committed to the court that it will or has suspended sales and shipments of the product during the duration of the court ordered stay. We will update you on subsequent events as they unfold, and in the meantime, we continue to provide Efudex to our patients.

We filed this lawsuit, because we feel the approval of Spear's product by the FDA without requiring appropriate clinical testing of its efficacy in the treatment of basal cell carcinoma represents an inappropriate risk to patients. Allowing another company to launch an AB-rated product that has only been clinically tested on sun damaged skin, but which will be labeled and used to treat superficial basal cell carcinoma, a form of skin cancer, is not in the best interest of our patients. And we thought it was prudent to pursue this course of action.

Now, the inventories. We have also made the decision to reduce our inventory levels at our wholesalers to industry standard levels. Specifically, over the next quarter, we will reduce our U.S. inventories from 1.8 months to 3 weeks. In Canada, we will reduce from 6 weeks to less than a month. And we will make a similar reduction in Mexico. This will obviously reduce our reported sales over the next quarter, but over the long-term, will improve our financial and help our P&L.

Now, let me turn the call over to Peter Blott to discuss our financial performance for the quarter.

Peter Blott

Thank you, Mike. Earnings from continuing operations adjusted to non-GAAP items was a loss of $0.04 per diluted share in the first quarter of 2008 compared to a net income of $0.21 per diluted share in the same period last year. Last year, our first quarter results benefited from a one-time milestone income of $19.2 million received from Schering-Plough related to pradefovir.

Product sales from continuing operations increased 8% in the 2008 first quarter compared to the same period last year. This increase was primarily due to currency gains in Europe with increased sales of Efudex, Cesamet and Bisocard, offset by a further decline in sales in Mexico. Quarter-over-quarter comparisons of product sales are also impacted by divestments since last year.

Ribavirin royalties were $12.8 million in the 2008 first quarter compared to $17.3 million in the same period last year, reflecting Schering-Plough's reduced sales of ribavirin and the discontinuation of Roche royalties we've discussed earlier from June 2007.

Our gross margin in 2008 first quarter was 70%, down from 72% recorded in the comparable period last year, driven by the impact of increased inventory reserves in Latin America in the quarter.

On May the 2nd, we announced headcount reductions of 130 in the U.S. and Mexico as Mike mentioned. The annual impact of these impacts is a further $20 million, but these do not impacts the G&A costs until later in the year and have no impact upon the first quarter results.

Research and development expense was $29.4 million in the first quarter of 2008, an increase of 40% over the previous year. This increase was due to the external clinical development spending on retigabine on the RESTORE trials.

Cash and marketable securities increased $158 million in the 2008 first quarter to over $0.5 billion, actually $519 million. This reflects $71 million we received from the sale of Infergen, $38 million that we received from the sale of Asia-Pacific and working capital improvements and cash generated from operations. Cash provided by continuing operating activities for the 2008 first quarter was $54 million. This reflects the continued strength in our base business to generate steady cash flow.

On a non-GAAP basis, EBITDA was $25.3 million in the first quarter. Restructuring recorded in the first quarter was a net gain of $12.7 million. This included $36.9 million net gain on the sale of our Asia-Pacific business, offset by other charges of $24.2 million, which included an impairment of $7.9 million relating to Argentinean sale, $4.8 million of professional and legal fees and $11.5 million employee severance costs. The severance costs are mainly attributed to six executives, including Tim Tyson, our former CEO.

Now, I will turn the call back to Mike for closing remarks.

Mike Pearson

Thank you, Peter. Over the next 12 months, we will be streamlining and simplifying this company and creating a profitable operating base from which to grow in 2009 and beyond. We will not be providing financial guidance or metrics for the foreseeable future, but we will be updating you on our six key initiatives over the next several quarters.

2008 will be a year in which we will do whatever it takes to put this company on track to be successful. And I believe that we have made solid progress towards this goal so far. Thank you for your attendance this morning. We will now take any question you have.

Questions-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Michael Tong from Wachovia Capital. Your line is open sir.

Michael Tong - Wachovia Capital

Hi. Good morning. Just one quick question. I was wondering whether I can get some idea as to how much of Efudex use is in basal cell carcinoma?

Mike Pearson

Want to go ahead, Peter?

Peter Blott

Essentially, we don't necessarily get good data from IMS on the prescriptions. So, I am not sure we have any published data on that or anything we have discussed.

Michael Tong - Wachovia Capital

Any ballpark or just give me an idea on that?

Mike Pearson

It's probably less than a third.

Michael Tong - Wachovia Capital

Okay, great. Thanks.

Operator

Your next question comes from John Boris from Bear Stearns. Your line is open, sir.

John Boris - Bear Stearns

Thanks for taking the question. On the trade inventory that you are going to be taking down in the U.S., Canada and then also Mexico, can you just provide a little bit of clarity as far as absolute dollar amounts? In the U.S., I think you indicated it was 1.8 months. You want to take that it down to around three weeks.

And then second question just has to do with Efudex. I think Spear did put product into the channel. Can they continue to sell that through major wholesalers or wholesaler is prevented from being able to sell that further into pharmacies and ultimately to the consumer? Thanks.

Mike Pearson

Let me take the second one first, and then I'll let Peter give you the specific numbers on the inventories. The product that Spear has sold to wholesalers, wholesalers are allowed to sell that product. They are not allowed to sell anything more. We don't have 100% information on what's out there, but the information we've collected suggests that there is a minimal amount in the wholesalers at this point in time.

Peter Blott

And just talking about the wholesaler inventory, I think the easy way to look at it, if you go from 1.8 months down to under a month, a one month reduction is equivalent to one month's worth of sales, which would be about just under $20 million for the U.S. and maybe about $4 million for Canada. The information that we have on wholesaler inventory levels and all prescription date is not as precise for Mexico, but there clearly will be an impact.

John Boris - Bear Stearns

Just a follow-up. Can you give a ballpark for Mexico?

Peter Blott

I would prefer not to, because our relationships with the wholesalers we are repairing going through the process that we talked about previously in relation to Mexico. And I am not sure I necessarily would have information that I would have enough faith in quote on an earnings call.

John Boris - Bear Stearns

Okay. I will step back in the queue.

Operator

And your next question comes from Hank Rauch from Liberty Mutual. Your line is open sir.

Hank Rauch - Liberty Mutual

Yes. You talked about your six key initiatives, but the sixth one about strengthening your balance sheet, you've indicated you'll talk about it over the next quarter. Why bring it up if you can't provide any information surrounding that piece of the puzzle?

Mike Pearson

Just because I plan to consistently talk about all six for the next year. And so, if it wasn't helpful to bring it up, I apologize, but what we do plan to do next quarter is talk about how we plan to redeploy the cash that we already have on our balance sheet and the cash that we anticipate to get through the sale of Europe, the sale of Argentina and continued cash flow from operations.

Hank Rauch - Liberty Mutual

Right. So, you have a lot of cash. You have some debt maturities coming up in a couple of years. Those maturities trade at a discount. Why not go out and buy some of that paper up rather having to pay it off at par down the road?

Peter Blott

It's Peter Blott again here. I think as we talked about, there is many things that we will be changing around our balance sheet as we go forward with the new strategy. And we will be discussing that next quarter rather than getting into any details now.

Hank Rauch - Liberty Mutual

Okay. Looking forward to it. Thanks.

Operator

Your next question comes from Greg Gilbert with Merrill Lynch. Your line is open, sir.

Greg Gilbert - Merrill Lynch

Thanks. Good morning. I have a few back on Efudex. Mike, what is the best case there given that FDA has spoken on the issue by approving Spear? Are you hoping that Judge compels with the FDA to rethink the decision or just what's the mindset there?

Mike Pearson

Yeah, we decided to sue the FDA because we believe it's not in the long-term interest of patients to be able to get the generic that has not had adequate clinical trials for basal cell carcinoma. So, the best case is that the FDA withdraws their approval of this product.

Greg Gilbert - Merrill Lynch

But in your mind that would only occur if the Judge listens to your view and then compels the FDA to do that?

Mike Pearson

Yes.

Greg Gilbert - Merrill Lynch

Okay. Is settlement with Spear an option at this stage?

Mike Pearson

I'm sorry. Repeat the question.

Greg Gilbert - Merrill Lynch

Is the settlement with Spear a possibility or not until you play forward sort of the thesis about the safety issue you just raised?

Mike Pearson

Yes, at this point, we are just pushing forward the safety argument.

Greg Gilbert - Merrill Lynch

And lastly on Efudex, if in fact the market does become fully genericized, are there cost cutting opportunities specific to that asset?

Mike Pearson

As we restructure our business, which I started to talk about our first steps, we are making the assumption for that scenario that Efudex does go generic.

Greg Gilbert - Merrill Lynch

Right, okay. All right. Moving on to another issue on the inventory reduction is the U.S. in particular, there are new agreements with wholesalers that get you there and is there an ongoing gross margin change as a result?

Mike Pearson

Yes, we are in active conversations with our wholesalers today. And when we reduce our inventory, that will have a positive P&L impact. So, again, we are just planning to go to industry standards in terms of the levels of inventory at wholesalers and we would expect to get industry-standard terms from our wholesalers.

Greg Gilbert - Merrill Lynch

Just to hammer that home, though, these agreements cost something, right? So, once you've reduced the three-week level, your gross margins on your North American business will be somewhat lower than it has been in the past. Is that a fair way to think about it?

Peter Blott

So, maybe if I can say we do have inventory management arrangements, IMAs, with all, particularly the three key wholesalers in the U.S. Those are the agreements that Mike is talking about and they do have various elements of fee for service, which would change and essentially would reduce enabling us to reflect and improve the cost structure either through reductions in gross demands or in absolute costs.

Greg Gilbert - Merrill Lynch

Okay, great. And lastly, Mike, can we pin you down on a timeline for retigabine and taribavirin partnerships? Thanks.

Mike Pearson

We aim to have both partnerships in place this year.

Greg Gilbert - Merrill Lynch

Thank you.

Operator

Your next question comes from John Boris from Bear Stearns. Your line is open, sir.

John Boris - Bear Stearns

Thanks for taking the follow-up. Just a follow on to Greg's on retigabine. I guess if you look at the composition of matter patent, Mike, I believe it's January 2013, is it safe to say that you had requests for Hatch-Waxman add-back? And I guess the max you can get is five years. Can you just walk us through what the elements are that would entitle you to potentially getting five years of add-back?

Mike Pearson

Can you repeat the last part of your question?

John Boris - Bear Stearns

Sure. My assumption is composition of matter patent I believe is January of 2013 on the retigabine asset? My assumption would be that you would request for under Hatch-Waxman some add-back on that IP. I think the max you can get is five years. Can you just walk us through, is it five years, is it two years, is it one year that you might be entitled to getting add-back on?

Mike Pearson

Yes, we fully expect to get five years when we've worked through the formula. And obviously, we will also be taking other initiatives in terms of trying to add on to that patent life through other developmental efforts. But specifically, we fully expect this patent to be in place through 2018.

John Boris - Bear Stearns

Okay. Can you just walk through some of the metrics that give you confidence that you would be able to get five years?

Mike Pearson

There is an actually formulas that the government uses to figure out exactly how many years. I don't have that data sitting in front of me. But we have worked through that and we have had discussions with them. So, we are confident in terms of the five years.

John Boris - Bear Stearns

Okay.

Operator

Okay. Your next question comes from Michael Tong from Wachovia Capital. Your line is open, sir.

Michael Tong - Wachovia Capital

Hi. Just a follow up on the operating expense side. Can you give ma a little bit as to sort of the increase year-over-year on the selling expense side? And also, as I think about your R&D program with the RESTORE trials winding down and no intention to go at it alone with respect to taribavirin on a large-scale trial, directionally how should I think about R&D expenses?

Mike Pearson

Peter, why don't you take the first one? I will take the second.

Peter Blott

So, I think the overall selling expense was up about $5 million quarter-on-quarter as a percentage, but as a percentage, it was essentially the same. The increase, a significant proportion of that, was related to the currency changes that we had a benefit on the topline I referred to, but also it means that cost in particularly across Europe went up in dollar terms when they get consolidated.

In terms of other movement, there was additional inflation activity with a number of things in Central and Eastern Europe of going through launches of branded generic products. Other than that, the first quarter was not that significantly different in other areas of the business than previously, and the major changes that Mike has been talking about have not really hit through the P&L in the first quarter.

Mike Pearson

In terms of R&D, clearly we were spending at an unsustainable level for a company of our size. I think our spending last year was over $100 million in R&D. So, we will complete the RESTORE 2 this quarter. And as you mentioned, we will partner both of these products and there will be a significant reduction in R&D going forward, because we need to do that to be a profitable company. We're not going to provide specific guidance on what our R&D spend is next year at this point.

Michael Tong - Wachovia Capital

Okay. That's helpful. Thank you.

Operator

(Operator Instructions)

Our next question comes from Greg Gilbert from Merrill Lynch. Your line is open, sir.

Greg Gilbert - Merrill Lynch

Just one follow-up Mike. I am sorry if you've covered this. But in terms of your thinking on Europe, are you considering IPOing or selling the entire thing or just thinking of IPO for a particular region at this point?

Mike Pearson

Yes. Yes are thinking about an IPO for our Central European business, which is largely our Polish business, but also includes Hungary, Czech, Slovak, Bulgaria, Romania. So, it's a very different business. It's a branded generic business. And if we can maximize shareholder value by going the IPO route, that's what we will do. The rest of Europe, we're not contemplating IPOing. That is up for sale.

Greg Gilbert - Merrill Lynch

Thank you.

Operator

Your next question comes from Rajeev Jashnani from [Civic]. Your line is open, sir.

Rajeev Jashnani - Civic

Hi. Thanks for taking the question. Just with respect to the destock, was any of that reflected in the first quarter sales that you've just reported? And is any of that related to Efudex or is this just related to really across the product line destockings? Thanks

Mike Pearson

Yes. Nothing in our first quarter reflects any destocking. It's something that we are announcing today, and we will start tomorrow. And it's across the board, across all our products. So, clearly it includes Efudex, but it is completely independent of the Efudex situation that we're currently in.

Peter Blott

And I think I would characterize it as just the industry over a number of years has been moving to lower levels of inventory at the wholesalers, and we're just moving down with those. It wasn't that we were particularly excessive before, but we now just want to take the opportunity of moving down to what we consider to be the appropriate level.

Rajeev Jashnani - Civic

Thanks.

Operator

Your next question comes from the John Boris from Bear Stearns. Your line is open.

John Boris - Bear Stearns

Thanks for taking the follow-up. Just on the European business, EMEA, can you give nay color on what the level of inventory would be across your European business? And then just a follow up on Efudex. Just to be clear, your argument is on the basal cell carcinoma indication in clinical trials there, but it sounds like that Spear potentially could be able to sell in actinic keratosis, which would potentially give them access to two-thirds of the market. Am I just reading that the right way? Thanks.

Peter Blott

I'll take the first part about the European business. Essentially, because of the divestment, we are leaving that business operating on the same basis it is at the moment, but that varies by market and essentially by product to a certain extent as well. There is just normal levels of inventory in the channel in all the markets that we have. It's just with the sales process going through, we are making no changes to that at the moment. On Efudex, do you want to handle it, Mike?

Mike Pearson

Yeah, on the Efudex, a generic approval will require the compound to be approved for all indications, and there are no partial approvals. So, you cannot have a substitutable product unless approved for all indications. So, they either have to make the decision to approve it for all indications or not. Those are the only two choices.

John Boris - Bear Stearns

Thanks, Mike.

Operator

(Operator Instructions)

We have no more questions in queue.

Laurie Little

Okay. Thank you, everyone. We are pleased that everyone could join us this morning, and we look forward to discussing more with you for future events coming up. Have a great day. Thanks.

Operator

This concludes your conference call for today. You may now disconnect your lines.

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