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Warner Chilcott Limited (NASDAQ:WCRX)

Q2 2008 Earnings Call

August 8, 2008 8:00 am ET

Executives

Paul Herendeen - EVP and CFO

Roger Boissonneault - President and CEO

Analysts

Edmund Kim - JPMorgan

Michael Tong - Wachovia Capital Markets

Ken Trbovich - RBC Capital Markets

David Buck - Buckingham Research

Dave Windley - Jeffries & Company

John Borzilleri - GRT capital

Greg Gilbert - Merrill Lynch

Operator

Good day, everyone. My name is Rufus, and I will be your conference operator today. At this time, I would like to welcome everyone to Warner Chilcott's operating results for the second quarter ended June 30, 2008 conference call. (Operator Instructions) As a reminder, today's call is being recorded.

I would now like to turn the call over to Mr. Paul Herendeen, Executive Vice President and Chief Financial Officer of Warner Chilcott. Mr. Herendeen, please go ahead, sir.

Paul Herendeen

Thank you, Rufus, and good morning everyone, and thank you for joining our call. Earlier this morning, we issued a press release that provides the details of our second quarter results, which I hope you've all had a chance to review. Copies of that press release are available on our company's website. Roger and I would like to take a few moments to provide some additional comments with regard to our second quarter results, which will be followed by a Q&A period.

Before doing that, let me point out that on this call we will include certain forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause the company's actual results to differ materially from such statements. These risks and uncertainties are discussed in our 2007 annual report on Form 10-K which is available on the SEC's website.

The forward-looking statements made during this call are made only as of the date of this call and the company undertakes no obligation to update such statements to reflect subsequent events or circumstances.

In addition, we may make certain references during this call to non-GAAP financial measures as defined by SEC regulations. In accordance with these regulations, we have provided reconciliations of these measures in our press release issued this morning to what we believe are the most directly comparable GAAP measures.

With that, let me turn things over to Roger Boissonneault, our President and Chief Executive Officer.

Roger Boissonneault

Thanks, Paul. Good morning, everyone, I'll give you a brief overview of our performance for the second quarter and provide an update on development activities before turning the presentation back to Paul for additional details. Our second quarter revenue was $234.2 million, an increase of 3.2% compared to the second quarter of '07. The increase was led by the sales of our key promoted products, LOESTRIN 24, FEMCON, TACLONEX and DORYX.

LOESTRIN 24 generated revenue of $50.2 million in the second quarter of '08, a 44.7% increase versus the year quarter. LOESTRIN 24 has continued to achieve revenue growth and market share gains. Although its share gains continue to come at a slower pace than we thing is possible.

Over the past few quarters, we have focused our efforts on ensuring that we have the right sales force configuration, staffed with effective sales representatives. We currently have approximately 150 territories in women's health field force, whose primary focus is LOESTRIN 24.

In addition, we have two other sales forces combined OC and PSR, which have a total of approximately 90 territories and sales representatives that focus their efforts on LOESTRIN 24, as well as other promoted products.

LOESTRIN 24 is the top promotional priority within the company, and we will continue to implement specific initiatives focused on improving the sales force effectiveness in driving market share gains.

FEMCON generated sales of $10.7 million in the second quarter of '08, compared to $6.4 million in the prior year quarter. FEMCON continue to be the primary focus of our Chilcott field force, consists of nearly 150 territories. FEMCON is currently the only 30 or 35-microgram gram oral contraceptive being actively promoted and sampled to the Ob/Gyn.

Revenue from DOVONEX, TACLONEX franchise, which now includes Taclonex Scalp, totaled $72.3 million in the second quarter of '08. We have already received positive feedback from opinion leaders and the psoriasis segment regarding Taclonex Scalp which was launched in early June.

We continue our efforts to promote the use of TACLONEX and Taclonex Scalp as a first line treatment option for patients with mild-to-moderate psoriasis. For those patients looking for a non-steroidal treatment option, for those patients we continue promote DOVONEX Cream.

Also in dermatology, sales of DORYX were $31.7 million in the second quarter of '08 representing a 12.1% increase, compared to the prior year quarter. Total prescriptions for DORYX increased 8% in the second quarter of '08, compared to the prior year quarter.

In June, we announced the FDA approval 150-milligram strength for DORYX. Which gives physicians additional dosing flexibility when prescribing DORYX. DORYX remains a high priority for us within dermatology.

Before turning things over to Paul, let me provide a progress report on our product development activities. With regards to new product development, the clinical trials for two new oral contraceptives continue to be on track.

The clinical trial for the first product, which we refer to as the low-dose OC completed enrollment in the third quarter of '07. If all goes well, we could be in a position to file an NDA for that product in the first half of '09.

The second trial is for a new oral contraceptive, the characteristics of which we have not fully disclosed. The trial completed enrollment in December of '07, and is progressing on a time line that is approximately six months behind low-dose OC trial.

Let me now turn things over to Paul to take you through the financials.

Paul Herendeen

Thanks, Roger. And I'll get into a deeper dive on the financial results. As Roger mentioned, revenue for the second quarter increased $7.2 million, or roughly 3% to $234 million versus the prior year quarter. The revenue growth for the quarter was driven by net sales of LOESTRIN 24, FEMCON, TACLONEX and DORYX.

As we said when discussing our outlook for 2008, 2008 is a challenging year for us for revenue growth perspective, due to the onset of generic competition for several of our products, particularly ESTROSTEP, which declined $13.7 million in the quarter, compared with Q2 of '07.

Despite the drop in ESTROSTEP sales, net sales of our oral contraceptive portfolio increased 12%, or $7.8 million in the second quarter of '08 compared with the prior year. We continue to deliver year-over-year growth in our promoted products, LOESTRIN 24 and FEMCON.

LOESTRIN 24 contributed $50.2 million of net sales in the second quarter, a 44.7% increase versus the prior year quarter and that was primarily related to an increase in filled prescriptions of 31.5%. Sequentially, LOESTRIN 24 sales increased 7% in Q2, compared with Q1 of '08.

We introduced FEMCON in the second half of 2006 and began actively promoting the product in April of 20007. FEMCON generated net sales of $10.7 million in the second quarter of 2008, a 67% increase over the same period in 2007. Primarily that's related to an increase in filled prescriptions of 73.4%.

FEMCON continues to gain share at a steady pace. The 30 to 35 microgram segment represents a significant and attractive portion, the overall OC market. And FEMCON is the only branded product in this segment being actively promoted actively promoted to Ob/Gyns is well-positioned to capture an increasing share in this space.

Offsetting the growth delivered by LOESTRIN 24 and FEMCON was the impact of generic competition on our OC portfolio. As I said earlier, sales of generic versions of ESTROSTEP began in late October 2007 and contributed to a decrease in sales of $13.7 million, or nearly 70% compared to the prior year quarter. Our revenue from Watson sales of Tilia, the authorized generic version of ESTROSTEP offset a portion of the decline in our revenue from ESTROSTEP.

Turning to our dermatology portfolio, sales of our dermatology products increased $7.2 million, or 7.4% in the second quarter of 2008 when compared with the prior year quarter. The growth in this segment was led by increased sales of TACLONEX and initial sales of Taclonex Scalp, which was launched at the beginning of June. Combined, the TACLONEX family contributed $38.8 million of sales in the quarter, a 10.9%, almost 11% increase as compared to the second quarter of 2007.

The increase was due to increased demand as well as higher average selling prices. Sales of DOVONEX were flat in the second quarter of 2008, compared to the prior year quarter due to a reduction in filled prescriptions offset by higher average selling prices.

Net sales of DORYX increased $3.4 million, or 12% to $31.7 million in the second quarter of 2008 compared to Q2 '07. And that was due to increased demand as well as higher average selling prices for the product.

As Roger mentioned, towards the end of June, we received FDA approval for 150 milligram strength of DORYX, which augments the 75 milligram and 100 milligram dosage strengths that we were promoting before that. Sales of our hormone therapy products were flat in Q2 compared to the prior year quarter.

Sales of ESTRACE Cream increased $2.2 million, mainly due to higher selling prices, as unit demand for the product was essentially flat. Net sales FEMHRT decreased just under $1 million dollars in the second quarter of '08, as a 14.5% decline in FEMHRT filled prescriptions was nearly offset by the impact of higher average selling prices in the quarter. Our gross profit margin as a percentage of total revenue was 78.2% in the second quarter, down from 79.6% in the prior year quarter. The primary factors that impacted our gross profit margin are product mix and a general increase in costs compared to the prior year.

Reported SG&A expenses for the quarter were $47.1 million, a decrease of $23.1 million or 32%, almost 33% compared with Q2 of '07. There are three types of expenses that roll up into our SG&A. Selling and distribution costs which are the costs of our field forces, advertising and promotion costs and general and administrative expenses. Selling and distribution expenses increased $0.7 million or 3.1% in the second quarter of '08, compared to the prior year quarter and this was primarily the result of normal inflationary increases. We had approximately the same head counts in each period.

Advertising and promotion expenses decreased $12.1 million or 54% in the quarter, compared to the prior year quarter, due mainly to our reduction in the use of direct to consumer advertising in 2008, compared with 2007. DTC played an important role in the launch of LOESTRIN 24 in 2006 and carrying forward into 2007. And we continue to run some network TV adds for LOESTRIN 24 through the first part of 2008. But as we go forward, we expect to make much more limited use of DTC in support of our existing brands, relying instead on execution at the sales rep level to drive market share gains.

General administrative expenses decreased by $11.7 million or 45.8% in the second quarter of 2008 as compared to the prior year quarter. Note that in the prior year quarter G&A expense included a $10 million settlement of the Ovcon 35 litigation. Adjusting for the legal settlement in the prior year quarter, G&A expenses decreased $1.7 million, primarily as a result of a reduction in external legal expenses associated with ongoing litigation. At this point, most of our ongoing external legal expenses are associated with the paragraph 4 filings against LOESTRIN 24 and FEMCON.

R&D expense in the quarter was $12.5 million, an increase of $1.3 million when compared to the prior year quarter. The higher expense is attributable to the ongoing clinical trials for the two oral contraceptives, which Roger mentioned, at the tail end of his remarks, as well as other ongoing development projects. Amortization in the quarter totaled $53.1 million, as we've noted in the past in computing cash net income per share, we add back the after tax impact of amortization of intangible assets. Our forecast for our aggregate scheduled amortization for 2008 based on current assumptions is $208 million, reducing to $184 million in 2009 and $150 million in 2010. Net interest expense for the second quarter was $24.6 million, which includes $1.1 million of write-off of deferred loan costs associated with the optional prepayment of $70 million of debt on June 30 of 2008.

As of the end of the second quarter, our debt balance, net of cash on hand was approximately $1.1 billion. Our net debt to trailing 12 month EBITDA, using the bank and bond definition, was 2.25 times as of June 30. Our reported GAAP net income in the second quarter 2008 was $33.6 million. In arriving at cash net income, we add back the after tax impact of both book amortization of intangibles and the amortization of deferred financing fees. We add these items back at the marginal tax rate specific to each item in each period. For Q2 '08 the marginal tax rate for amortization of intangibles was 9% and the rate for deferred financing fees was 12.2%. Cash net income for the quarter was $84.3 million or $0.34 per share based on $250.5 million fully diluted Class A shares outstanding.

Turning to liquidity, in the second quarter we generated $122.8 million of cash from operating activities. During the quarter, we utilized $40 million of our operating cash flow to pay the required milestone payment to LEO Pharma upon the FDA approval of TACLONEX for the scalp. We also prepaid $70 million under our senior secured credit facility. We ended the quarter with a balance in cash and cash equivalents of $21.2 million.

In the absence of compelling opportunities to invest our free cash flow in strategic initiatives such as in licensing, acquisitions or other internal product development activities, we expect to continue to utilize available excess cash flow for de-levering purposes, at least through the balance of 2008. For those debt holders on the call, we included a reconciliation of net income to adjusted EBITDA in our press release. Adjusted EBITDA using the bank bond definition for Q2 '08 was $128.9 million.

Before turning to Q&A, let me update you on our financial guidance for the full year 2008. Based on the first half of the year, actual results and the current outlook for the remainder of 2008, we continue to expect total revenue to be in the range, previously communicated which is $935 million to $945 million. Gross profit margin, as a percentage of total revenue, is currently expected to be at the lower end of the 80% to 81% range we had previously communicated. We now expect that total SG&A for the year will be in the range of $208 million to $217 million. The $15 million decrease relates primarily to a reduction in our expected spending for general and administrative expenses due to a significant decrease in the expected legal expenses as a result of slower than originally estimated progress of our paragraph 4 patent challenges for FEMCON and LOESTRIN 24.

I know that I've said this in the past, let me say it again. Legal expenses are a significant portion of our total G&A spend and it can be difficult to forecast both the level and the timing of those expenses into the future. R&D expense is now anticipated to be in the range of $64 million to $67 million, an increase of $7 million which reflects our current spending trajectory and the potential for up to $12.5 million of milestone payments in the second half of 2008. We now anticipate that our income tax provision for 2008 will be in the range of 7.5% to 8.5% of earnings before taxes and book amortization of intangibles or EBTA.

Our tax rate can be volatile when looking at it on an interim basis, as small changes in the forecast of pretax income by tax jurisdictions for full year can move the rate around. Add to that, the impact on our tax rate of our having reached settlements with respect to both federal and state income tax audits of prior years and the rate can fluctuate even more. The increase in our tax rate guidance reflects our most recent forecast of 2008 pretax earnings by tax jurisdiction and the impact on our current tax provision of the settlements of audits of prior years. We continue to enjoy a very attractive cash tax rate.

The result of these revisions to our outlook is neutral to both GAAP net income which is still expected to be in the range of $129 million to $142 million, and cash net income which is still expected to be in the range of $326 million to $339 million. Using $251 million Class A common shares, the company expects cash net income per share to continue to be in the range of $30 to $35 for the full year 2008.

Let me be clear about the assumptions included in the updated guidance. The guidance does not include the impact to reported earnings of any new licensing agreements with third parties which could be included in our reported R&D expense. Also, only estimated R&D milestones under our existing agreements are included in our guidance at this time. So in summary, when thinking about the first half of the year, in the year-to-date period revenue was up 4% or $18 million despite a $31 million drop in revenue from Estrostep.

Our EBITDA, using the bank bond definition was up 20% from the year-to-date period. And our cash net income was up 26% in the year-to-date period. LOESTRIN 24, FEMCON, DORYX and the TACLONEX franchise, all gained share and continue to gain share. We had two products approved by the FDA, Taclonex Scalp and DORYX 150. We advanced the clinical trials for the two OCs in our pipeline and if all goes well we could be in a position to file the so called low dose in the first half of '09 and the other OC six months later.

Below the operating line, since the beginning of the year we reached an agreement with the IRS to reduce the perceived risks around our attractive tax structure and we settled the shareholder litigation without creating a blip. On the liquidity front, we prepaid another $70 million of term debt and settled out a number of accrued tax liabilities from older periods. I'd say we're doing pretty well and we can continue to do better. And with that, I'll ask Rufus if you could open up the lines to take Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And for our first question we go to Edmund Kim with JPMorgan.

Edmund Kim - JPMorgan

Great. Thanks for taking the questions. I've got two. How does the entry of more competitors in the OC market affect you now and going forward in terms of how you think about your promotional efforts? Similarly, in your prepared remarks you talked about just kind of focusing on the sales force initiative to drive LOESTRIN 24 growth. Could you just elaborate that? Also along the same lines, how much as Yasmin going generic affected your share voice out there now? Thank you.

Roger Boissonneault

Okay. That actually was three questions.

Edmund Kim - JPMorgan

Sorry.

Roger Boissonneault

Well, I guess there's not more brand competitors. The big issue is generic competitors as I guess we get a sense that Teva is taking over Barr. That's a zero sum because that competitor stays the same. It looks like Novartis might be coming in. And it looks like Mylan may be coming in. But none of those guys are coming in on the branded side. So when we look at competition, we look at purely as branded competition and we don't think that having other generic competitors is certainly not going to change our game much.

As far as sales force initiatives, I keep on telling people this is like you just chip away at this. It's not like we're going to add a new sales force or take away a sales force, but you've got to become more effective and have at least the psychological power on the part of the sales representative that they're going to be successful and they're not in there just to maintain share. We have to grow share.

And that certainly is a mindset that we're trying to get through to representatives. Obviously we have an excellent product and we continue to work at that and I think Carl Reichel, who is ultimately in charge of the sales force is certainly enthusiastic about getting some better results. We've made some active changes in that organization.

The last piece as far as Yasmin going away, in the competitive milieu, Yasmin hasn't been promoted for the last year. They haven't dropped samples of Yasmin. So on the branded front, it really has been obviously their execution, switch the Yasmin business to Yaz. Any further questions, Mr. Kim?

Edmund Kim - JPMorgan

Sure, if I could just sneak in one more. So do you think branded innovation in OCs will precipitously drop down over the next couple years or do you see…?

Roger Boissonneault

The question out there is, you know, why haven’t introduced the product in quite a while and what's going to happen to your Ortho franchise. I'm sure the Bayer people are working on new oral contraceptives and I can tell you that we are actively engaged in working on new oral contraceptives. It just seems like the competitive milieu from the generic side that apparently has become more competitive. But I do think the people are going to add innovation or new products into this category will probably be Bayer, I would assume has active R&D and working on new products. Certainly we are working on new products.

So I guess the traditional market leaders and when I grew up throughout this business were always Ortho and Wyeth. It appears there's a change of focus there.

Edmund Kim - JPMorgan

Thank you.

Operator

We'll go next to Michael Tong with Wachovia Capital Markets.

Michael Tong - Wachovia Capital Markets

Thanks. Good morning. I'll try to stick with three questions. First one is actually for Paul. You talk about the gross margin expectation for the rest of the year. And just wanted to get a little bit more clarity as to what drives the margins back up in the second half of '08 to bring the overall margin up to the level that you're guiding.

And then second question had to do with DORYX. Maybe still early in the launch phase of the 150-milligram strength, but how would you see the market share among the three strengths play out let's say, call it 12 months from now.

And then the third question is actually a follow-up from Edmund's question. Regarding new OC development, based on what you're seeing from market research standpoint, what do consumers want in a new product? Because it looks like there are a whole bunch of different characteristic out there, which is really key to drive the success of a new product.

Paul Herendeen

Yeah, thanks. Michael, I'll take the first one, as you laid it out for me. The gross margin similarly to taxes can move around in any interim period. The thing that affects it the most by far is the mix of products sold during the quarter. The second factors are what I'll call specials that occur during the quarter where you might have a write-off of some product and whatever.

So, we're looking at the second half of the year and expecting our margin to continue to be in the range that we set out when we provided our guidance back at the early part of the year. It just on an interim basis, it can go up and down but we remain confident that it will be in that range of 80% to 81%.

Roger Boissonneault

On the DORYX front, as far as predicting 150's share, we think it's going to be a significant product but as you say, we only have two weeks of data. So I think the first week we had about 21 Rxs and the second week we had 250 Rxs. So, if you're a finance guy like Paul, you connected those two lines and developed a slope, it looks like it's going to be a tremendous product.

We need a few more weeks of data to see where it's going to be. It's actually a good time to be launching the product as kids are going to be preparing to go back to school and actually it's kind of interesting, end of August and the beginning of September, are big days for our doxycycline and our acne franchise to make sure that the product is in position. But we do have high hopes for this product and anecdotally it looks like it's getting off to an excellent start.

You also asked as far as OC development and what do customers want and that milieu, what does the physician want? What does the patient want? And I think what we've seen overtime is less is better. We've seen the migration of the oral contraceptive to lower and lower dose products and certainly the acceptance of lower dose products. And how do you get there? I think that's one of the avenues. The other piece is the side effect profile. What do we give up to get to lower doses and generally that's measured in cycle control, breakthrough bleeding perhaps amenorrhea and can we still continue to go to lower doses without compromising efficacy and have a favorable side effect profile. That's I believe what the future looks for and that's the track at least we're going down.

Michael Tong - Wachovia Capital Markets

Great. That's helpful. Thanks.

Operator

And we go next to Ken Trbovich with RBC Capital Markets.

Ken Trbovich - RBC Capital Markets

Thanks for taking the question. I guess I'd like to start with follow-up on the DORYX questions. Could you give us a sense for whether the launch of the 150 led you to intentionally reduce channel inventory or this was just a normal cycle as a result of the second quarter being relatively low on the Rx line?

Roger Boissonneault

Paul, why don't you grab that?

Paul Herendeen

Yeah, I'll take that. We didn't do anything intentional to work the pipeline one way or the other. I think with DORYX 150, we're ready to launch the product but we launched the product, actually started to sell the product in here after quarter closed. So the things that you see going on with DORYX from the financial results perspective is all just normal DORYX.

Ken Trbovich - RBC Capital Markets

Okay. And then, with regard to SARAFEM, I guess I was somewhat surprised that the revenues were as high as they were during the quarter. Could you comment on that?

Paul Herendeen

I'll take that as well. As you may recall, we did switch out the dosage form of SARAFEM and leading into that we did significantly work down the inventory levels of the old product and then started to ramp up on the sales of the new product. We talked about this; I think might have been perhaps in the last call, certainly in some the conferences.

This was something where we had the opportunity to protect a bit of that franchise. We were able to in short order affect the change out of the dosage form and we've been able to sustain a bit of that franchise and it's worked for us, but I would submit for everyone. Yes, it's a little bit on the favorable side. Maybe better than people were expecting, but this is not a core franchise for us.

Ken Trbovich - RBC Capital Markets

Okay. And then on the clinical trial side, I guess in the R&D section there was some mention of initiation of new programs upping the OC efforts towards the end of '07 and early '08. Could you give us a sense as to whether or not these are the programs that are in development with LEO or if perhaps these are some of the earlier stage programs you folks have in place.

Roger Boissonneault

Ken, it's Roger. These are programs that are internal programs, be they in the area of dermatology and those would primarily be acne and contraception and hormone development. So yes, the chart is pretty full, but we don't add color until we get significantly down the path.

Ken Trbovich - RBC Capital Markets

Sure and could you tie in the potential milestones that you've included in the guidance to specific programs or sort of major milestones that relates to or these completion of regulatory trials that enable the programs to advance or perhaps to see some form of registration?

Roger Boissonneault

The milestones that we talk about and we have talked about as how the study's enrolling, have we completed enrollment, when we're going to file an NDA. I guess generally the NDA is accepted sometimes, people go out there and say, well the NDA has been accepted and then the approval. So we keep you informed that there are big [trend] like currently the number one project we have is fully enrolled and we will file an NDA in the first half of '09. And those are, we will continue to report those milestones, but generally when we get into Phase III that we get notable milestones.

Paul Herendeen

And Ken, this is Paul. Just to buttress that is the milestones that we talked about that we're including in our guidance in the back half of this year, $12.5 million, just to be very clear, we would only include milestones from our existing agreements. We currently have agreements with LEO, Paratek and with NexMed.

The difficult part from a financial perspective, as you know, when we have a milestone payment that hits it under GAAP, it hits the R&D line and by definition reduces both our net income and our cash net income that people are looking for out there and milestones are binary. If it occurs on December 30, the milestone is earned, it would be in our Q4 results and if it happens January 3rd, it would be in Q1 of next year. As we sit here right now, we have included in our guidance $12.5 million of potential milestone payments under our existing agreements that could occur in the second half of the year.

Ken Trbovich - RBC Capital Markets

Okay. Thank you.

Operator

Our next question comes from David Buck with Buckingham Research.

David Buck - Buckingham Research

Yes, good morning. Thanks for taking the questions. First, can you give us a recap of any price increase activity that we've seen so far this quarter and just review the last quarter? And for Roger, how should we think about LOESTRIN 24 as we enter 2009, obviously you mentioned it's your first priority promotionally, but can you give us some insight into any contingencies perhaps around the 30 month waiting period expiring in July. Thanks.

Roger Boissonneault

On the price increase front, I mean, were you talking about just in the quarter, David?

David Buck - Buckingham Research

Well, in the quarter and then thereafter.

Roger Boissonneault

Yes, the price on DORYX, both the 75 and the 100 remain the same throughout the quarter. There was not a price increase within the quarter. DOVONEX remained the same, just on the significant products. We did have a price increase on FEMCON, 4.5% and hold on. LOESTRIN 24, 4.5%, and TACLONEX remained the same.

David Buck - Buckingham Research

Okay and nothing so far in August?

Roger Boissonneault

Nothing, no.

David Buck - Buckingham Research

Okay.

Paul Herendeen

On the LOESTRIN 24 front, I guess there are what we fully believe is that we have strong intellectual property. As far as the sales force and marketing group is concerned, it's full ahead. We don't see any change in emphasis through '08 and '09. It will continue to be the primary product that we will be promoting, at least in the (inaudible) office. So yes, no, we believe strongly in our case, in our intellectual property and as far as contingencies are moving away from LOESTRIN 24 or switching it around, we have no plans at this time. I think we're standing behind the product and we believe we will continue to have market exclusivity.

David Buck - Buckingham Research

Or I guess and how do you handicap the potential for an at-risk launch?

Roger Boissonneault

It's not my choice. It's not my decision. I mean, some companies I guess generic companies do at-risk launch, but that's some of the policies and how they feel are or how their case is and at this point we still haven't seen an ANDA approval for LOESTRIN 24, so the point is moot.

David Buck - Buckingham Research

Okay, thanks.

Operator

(Operator Instructions). We go next to Dave Windley with Jeffries & Company.

Dave Windley - Jeffries & Company

Hi, thanks for taking the questions. I wanted to follow up on one of the earlier questions on gross margin. Paul, you mentioned mix and you said general factors are increasing, could you give more color on what some of those other factors were?

Paul Herendeen

Yes when I said the general part, I was referring to what we saw in the quarter. We've had general increases in our manufacturing costs in our facility, in Fajardo as I suspect some of our competitors have as well in this environment. That was a smaller, but material part of the change in the quarter. I think the more weighty parts of the change in the gross profit margin in the quarter were around mix and again, those specials that I talked about. You could have product that you just ended up having to destruct et cetera.

Dave Windley - Jeffries & Company

Okay, thank you. You also mentioned on the tax rate, you said that the settlement could actually contribute to the volatility of the tax rate. And I guess that was counter intuitive to me and I thought I would ask you to explain that, please.

Paul Herendeen

No. Thanks for bringing that up because I wouldn't want to leave anybody with the impression that a settlement increased volatility. I was more thinking back to where we were when we had our first quarter call and how we were forecasting our tax rate for the balance of the year and then we had these settlements which precipitated some of the change in the tax rate that we were expecting from when we were at the end of Q1 to what we're expecting now as of the end of Q2.

So it's really not increasing volatility on a go forward basis, it's that it changed our outlook for 2008, for the tax rate for 2008. And again, I know for anybody who cares, but the way that all of those payments that we made and all the settlements that we reached were well within the reserves that we had on our balance sheet.

And I think you saw during Q1 we settled up a large number old tax accruals meaning items that had been accrued, how that affects your rate in a current period is that you have to actually then affect, go through and make the adjustments by tax jurisdiction and flow that through and then see how that impacts your full year corporate effective tax rate. Once we did that, we raised our expectations for the corporate effective tax rate for the full year and that's why we've increased our guidance on the rate for 2008.

Dave Windley - Jeffries & Company

Okay.

Paul Herendeen

I hope that answers it.

Dave Windley - Jeffries & Company

That does help. Thank you. Then my last question, just curious if there is, in relation to the oral contraceptive market, do you sense that there are any changes in the relative sensitivity of physicians to promotion and what I'm getting at is just maybe some out-of-pocket sensitivity to price that might cause that kind of propensity to prescribe a brand, a change.

Roger Boissonneault

It's Roger. Well, you've got to remember on an economic basis and when you look at that, there is some price disparity. OCs are not really high priced items compared to certainly some cardiovascular products. The other thing is that we sample pretty aggressively in these areas and it gives the physicians actually the opportunity to align the economics with the patient. There are no really limits on samples.

So, therefore, a physician sees there are economic needs for a particular patient, they will use more samples for their patient and the only samples they have are branded products. And I think in this category it's kind of you unique. And in fact I don't think outside economics are lowering the price of OCs at the retail level really as intense, because that can be adjusted at the physician level.

Dave Windley - Jeffries & Company

Right, so maybe a follow-up question to that, is your sampling activity increasing?

Roger Boissonneault

In sampling, it's kind of interesting increases as sales increase. In other words, it appears that as your sales increase, your sample activity increases. And really if you've ever been to an OB/Gyn's office, they're not going to be low in anyone's particular sample. And actually if your sampling activity goes up, that is an absolute positive signal, because its probably means that you have got new starts coming out the other side.

Dave Windley - Jeffries & Company

All right, okay. Thanks for the detail.

Operator

We go next to John Borzilleri with GRT capital.

John Borzilleri - GRT capital

Thanks for the question. I just wanted to make sure I understood when you guys put out the press release about the TACLONEX patent a few weeks ago. I'm not quite sure I understand what it means. I wanted to get a sense of that, narrowing it down to one claim.

And then could you give me just a little bit of sense about price increases last year in the second half, I'm just worried that maybe some of the comps might be hard as you get to the second half of the year.

Roger Boissonneault

Paul, why don't you do the price increase stuff and I'll talk a little bit about the patent. I think I can boil it down, it's pretty simple. They're not questioning that we have a patent for TACLONEX. The question is how broad the patent is?

So that's where the discussion is, so I think in a simplistic form is we will have intellectual property for TACLONEX into 2020, and there's a lot of argument that will continue and this will continue over a relatively long period of time.

What is the breadth of that patent, and that really also is in LEO's court and LEO is heading the efforts to maintain the broadest patent available. Paul?

John Borzilleri - GRT capital

Roger, are you comfortable that even with a narrower patent that people won't be able to formulate around it?

Roger Boissonneault

No. The patent that we have is a combination. It's not a formulation patent.

John Borzilleri - GRT capital

So any combination you'd be protected on?

Roger Boissonneault

Right, yeah. It's a specific use of calcipotriene with a corticosteroid.

John Borzilleri - GRT capital

Okay. Great.

Paul Herendeen

Yeah, on the price increase question, if you look at the OCs. In the back half of 2007, we did not take a price increase in the OCs in the back half of 2007. We took one in December, which was a 4% increase on both FEMCON and on LOESTRIN 24.

Turning to DORYX, we did take a price increase of approximately 6% on DORYX. I believe it was October 1 of '07, so about mid-way through the second half of 2007. And so you've got that.

And then lastly, TACLONEX, we did not take a price increase on that until basically December of '07. So you should not have an unfavorable comparison based on price increase.

John Borzilleri - GRT capital

Okay, thank you.

Operator

We go next to Greg Gilbert with Merrill Lynch.

Greg Gilbert - Merrill Lynch

Thanks, good morning. Paul, on taxes, can you get us up-to-date on what you have agreed to, with the relevant parties so far and what issues, if any, are still up for discussion? Sort of getting at how stable that rate should be going forward?

Paul Herendeen

Yes. That’s actually, at this stage, and this would not have been the case six months ago, that's a relatively easy question to answer. We have reached agreement on settlements with the IRS for all the years up to the date of the change of control transaction in the beginning of 2005. We've reached agreement to settle those out and, by and large, those settlements are what's driving some of, what I described as volatility, probably a poor choice of words, the change in the expectations for the tax rate for 2008. So think of up through the beginning of 2005, we're good. We're quite good.

We've also recently reached an agreement with respect to the State of New Jersey, which is the State of New Jersey can be a very aggressive state and we're pleased that we're able to reach an agreement with them through the same period. So we feel like we're in quite good shape through the date of the change of control transaction, if you're thinking about liabilities that are hanging back there.

Secondarily, with the advanced pricing agreement that we were able to achieve in February, I think that is or would be, if we didn't have the agreement, the whole transfer pricing question would be the big question and one that would give you some uncertainty around the sustainability and the magnitude of our tax rate. With that agreement in place, I think we have a reasonable degree of confidence that we can sustain what we view as a very attractive cash tax rate, really, for the foreseeable future. I think, and again, I'll use the word volatility, some of the volatility that you saw when we got to the end of the first quarter and we felt like we had a lower tax rate, we increased the guidance range for our tax rate for '08 by a couple hundred basis points on EBTA.

Not a lot of dollars on our overall cash net income. That number can move around, I should say the tax rate can move around, it can bump up and down. But we have a reasonable degree of confidence that it will stay in that very attractive range. I hope that answers it.

Gregg Gilbert - Merrill Lynch

Yes, it does, thanks. Roger, any noticeable changes in the derm channel, given the consolidation that's occurred there over the past year or two?

Roger Boissonneault

Not really. Nothing that I've noticed that there is any lack of competitiveness. But it's generally been the same players. I guess, I don't know. You look at some of the players and perhaps less visibility. We haven't talked much about, you don't hear a lot of big things going on in derm outside of the psoriasis and the biologics. So its been more of just straight execution. But we like the space. We continue to execute and I think we see this as a strategic opportunity.

Gregg Gilbert - Merrill Lynch

And lastly, you mentioned the majority of cash flow will be applied to debt for '08. What are your priorities thereafter? Thanks.

Paul Herendeen

Yeah, it's Paul. I mean, we've said through the balance of 2008, I think that at that point we start to look at other ways we might deploy our cash and that could include a variety of things including, we see a share repurchase, consider a dividend, things like that. But that's not to say we will. That's something we certainly will consider. Make it triple clear, our preference would be to deploy that cash and payments out to in license additional products or to acquire additional products. That would be our preference. In the absence of those things, once we get our debt down do a certain level, we will certainly consider alternate uses.

Gregg Gilbert - Merrill Lynch

Thanks.

Operator

(Operator Instructions) And with a follow-up question, we return to Edmund Kim with JPMorgan.

Edmund Kim - JPMorgan

Great, thanks, I just have one follow-up. Can you just talk about the impact of the recent FDA's non-approval letter for the NexMed product dapoxetine.

Roger Boissonneault

We don't like to try to interpret that. It really is NexMed's asset and it's up to them to communicate to the investment community as their feelings about it. We're involved with them and we do think that it's an excellent product. But they have to communicate their strategies as to the status of that product with the investment community.

Operator

Also with a follow-up question, we return to David Buck with Buckingham Research.

David Buck - Buckingham Research

Yes, thanks. Just two quick ones. Paul, can you give a sense of what the stocking was on Taclonex Scalp during the quarter and if I recall correctly, there's been a period of time since we've seen some price increases in the hormone therapy business. Could you talk a little bit about the pricing environment there and whether there's still an opportunity possibly for yourselves but also for your competitors to take up price there. Thanks.

Paul Herendeen

Sure. Let me take those. The Taclonex Scalp sales in the quarter were about $2.1 million. And so obviously a good chunk of that was stocking in because we're still very early in the process there. I hope that answers that.

Looking at the hormone therapy products, we took large price increases going back into the beginning part of last year. And what we're doing there is following the market leader. If they take price increases, we're happy to follow along. We took a 16% price increase in April. I'm looking at femhrt as a proxy. 16% price increase in April of '07, didn't take another one until the end of '07 or roughly 5%. And then again in midway through the year, July 1, we took a 7% increase.

So with respect to those products, we're happy to follow as the price trends up. We've said in the last several quarterly calls in a row, the units there, when I'm thinking about femhrt are in decline. We've been fortunate that the pricing in the space has enabled us to keep that franchise relatively flat. ESTRACE CREAM is actually a little bit different. In the ESTRACE CREAM the units held up quite nicely. In fact, the ESTRACE CREAM, Rxs have been flat to plus a couple of percent, maybe down a couple of percent but generally stable. And same deal, we've been able to enjoy price increases there.

David Buck - Buckingham Research

You think the market is still increasing price in the high single-digits, not double-digit.

Paul Herendeen

Can't speculate well, how it will continue. But that's what it has been.

David Buck - Buckingham Research

Okay, great, thanks.

Operator

Also with a follow-up question we return to Ken Trbovich with RBC Capital Markets

Ken Trbovich - RBC Capital Markets

Thanks. I was wondering to what extent you could comment on the back half strength that typically occurs in acne, having perhaps a positive bias on the margins as well as any impact from the launch of the 150.

Paul Herendeen

I'll take that. We are coming into the strong season for acne. That's the good news from a margin perspective. The opposite news is that it's also the strong season for psoriasis and you may recall our overall gross profit margins on the DOVONEX and TACLONEX franchise is significantly less than on the balance of our portfolio.

So that can be a pick up from DORYX, but it also can be offset by the declines that you would expect from the DOVONEX and TACLONEX franchise providing greater percentage of and that's back to that mix comment?

Ken Trbovich - RBC Capital Markets

And specifically within the DORYX franchise, does the launch of the 150 give you better enhanced margins as we look forward?

Roger Boissonneault

Margins are similar across all three strengths.

Paul Herendeen

Well if it increases faster than the TACLONEX, obviously it enhances the margin.

Ken Trbovich - RBC Capital Markets

Right. Yes, that would help.

Paul Herendeen

And I think the escalation on the fact that there's a comfort on the part of the clinician that they can use a higher dose DORYX. DORYX versus generic doxycycline using a 150 milligrams of generic doxycycline, you're going to have problems with GI upset.

The fact is with 150 milligrams of DORYX, we're seeing minimal impact on GI system. So you indeed give the physician to enhance, to escalate the dose without having side effects which mitigates the use of higher doses of doxycycline.

Ken Trbovich - RBC Capital Markets

And is that messaging part of the focus that you hope to have come out of the study, comparing the 150 to 100 milligram doxycycline?

Roger Boissonneault

Absolutely, Ken. You know that.

Ken Trbovich - RBC Capital Markets

It is fun to watch.

Roger Boissonneault

Yes it is. And I think it's one of those and people don't, there are lot of doxycycline prescribed in the United States. It's one of the top 50 products prescribed, not only in acne but in Lyme's disease and other situations and higher doses of, we are seeing the use of more DORYX used in Lyme’s disease simply because you've got to use 250 milligrams a day.

And you've got to also look at body weight and that can be a difficult dose for someone with lower body weight to tolerate. Yes, we see no problems in tolerating at least the 150 milligram strength. So it allows dose escalation in some very important disease states including Lyme disease.

Ken Trbovich - RBC Capital Markets

Yes, thank you.

Operator

And also with a follow-up question, we return to John Borzilleri with GRT capital.

John Borzilleri - GRT capital

I just realized I was looking at the mix of sales in the derm between TACLONEX and DOVONEX were different than I expected. DOVONEX was stronger and TACLONEX was weaker. And can you talk a little bit about the trends in the future? Because I didn't notice and it looks like TACLONEX's prescriptions have slowed down a lot. You said you're going to a seasonally stronger area. Can you talk about jobs going forward and whether generic DOVONEX has had an impact on TACLONEX and your outlook?

Roger Boissonneault

Okay the thing that Paul has done and Paul will explain to us you've got to weigh it by grams.

Paul Herendeen

Right.

Roger Boissonneault

So we've had the 100 gram tube come into the marketplace. Paul, why don't you explain how this works?

Paul Herendeen

I'm glad you brought the point up because people are looking at the raw total prescriptions for TACLONEX and reaching what I believe is the wrong conclusion regarding the continued growth of that franchise. We did introduce that 100 gram tube and as a result we've got now a reasonable portion of our RXs in the 100 gram tube and the average script size for TACLONEX. I'll spit out some data so that everybody can jot it down. In the second quarter of 2008, the average grams per prescription per raw TRx were 75.3.

In the year ago period it was 67.7. So the average size of an Rx is up 10%. If you fully weight that for the six-month period and just look at the grams of TACLONEX sold, in the six months '08 versus '07, actual grams prescribed is up about 20%, in the quarter it's up about 14%.

So there is a tendency to just look at the raw TRx and the gross of the franchise has slowed down, but that's not the whole story. And then secondarily, I think, you asked about you were surprised by the mix.

I point this out not just to you, but everybody who tries to model us. Despite our best efforts at trying to keep our pipeline flat at less than 30 days supplies out there in the wholesalers, there are ebbs and flows in pipeline.

We chart it, we look at it, we know when we get a little ahead and we know when we're going to have to have that pipeline contract and come back. Depending on when the quarter closes you could be on one side of that line or another. Our goal and our objective and what we strive for is to try and run that pipeline as lean as we can.

That said there are always ebbs and flows.

John Borzilleri - GRT capital

Yeah. Can you be a little bit more specific about where inventory stands at the end of channel at DOVONEX and TACLONEX and how I correlate this milligram thing to the price with the 100 gram tube?

Roger Boissonneault

The price on the 100-gram tube, it's the same price per gram.

John Borzilleri - GRT capital

Okay.

Roger Boissonneault

So there's no price differential when you start moving that way. You just have to give me a second to find my pipeline chart, so I don't misspeak. Here we are. Okay. And looking at the quarter, TACLONEX was actually very close to true demand. In other words, the pipeline impact on the second quarter '08 was nominal. With respect to DOVONEX, DOVONEX expanded a bit, and I mean a little bit.

John Borzilleri - GRT Capital Partners

So it's not way ahead.

Paul Herendeen

No.

John Borzilleri - GRT Capital Partners

There is always some catch-up. Okay. Thanks very much, Paul.

Paul Herendeen

You bet. I am sorry, before you get off that, just FYI, DORYX looks like it went down a bit, contracted a bit in the period. So that's why I say, you try and get too fine with this and it really depends on what you shipped the last day you recognize revenue in the quarter, where you might end up. Our goal is to have nominal, if we could do it, changes in pipeline inventory. But that's not 100% within our control.

John Borzilleri - GRT Capital Partners

Last thing, do you have any thoughts about how much of the TACLONEX franchise of scalp could eventually be?

Paul Herendeen

How much of the franchise? It's really hard to tell right now. Because we introduced the product and obviously, we had two things going on at one time. You are really not going to see the potential for Taclonex Scalp until we get into the fall and the winter and that's when we see the greater problems with psoriasis. So I hate to predict it. It looks like it's being well-accepted. But your trial period is not now. It's going to be certainly in the later fall and let's see how it does this winter. But we think it's going to be a significant product.

Roger Boissonneault

Yeah, I mean, just I'll give you a rough guidelines. I mean, going back in time, when DOVONEX, when there was three forms of DOVONEX out there, the scalp product amounted to about 15% of the overall franchise. You can draw your own conclusions, but if you want to go back and look at what weekly or monthly Rx's were for that DOVONEX solution and maybe that helps you get a vicinity around what TACLONEX for scalp might look like.

John Borzilleri - GRT Capital Partners

Thank you.

Operator

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Herendeen, I'll turn the conference back over to you for any closing remarks.

Paul Herendeen

Yes, great. Just in closing, thank you all for attending our call. Again, to reiterate, I think through the year-to-date period we had a good, strong first half of the year with a number of good things happening and we're looking forward to the back half of 2008. And with that, we'll wrap up our call for the Q2. Thank you.

Operator

And again, ladies and gentlemen, this does conclude today's Warner Chilcott operating results for the second quarter ended June 30, 2008 conference call. We do appreciate your participation and you may disconnect at this time.

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Source: Warner Chilcott Limited Q2 2008 Earnings Call Transcript
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