Exact quotes...
FQ4 2013
Mario Vincent Corso - Mizuho Securities USA Inc., Research Division
On XIFAXAN, anything going on in the quarter inventory-wise, which would prevent quarter-over-quarter growth into the first quarter? And I know the weather and other issues might be a factor as well. Also wondering what you can say about HE penetration there and how far you think you have to go. And then on the financial side of things, anything in the quarterly R&D or SG&A trends over the course of this year that would make things particularly lumpy? Or would you expect things to be relatively linear?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. I would expect the R&D to be spread pretty evenly throughout the year, maybe slowly ramping but no real extreme lumpiness in that. And in terms of inventory levels on XIFAXAN, based on the latest run rate or data -- run rate data, we were right in line with demands and no changes with XIFAXAN. And was there a third part to that question? I'm sorry, Mario.
FQ1 2014
And now the blame game starts...blaming Santarus inventory levels with X550. Didn't make sense on May 4th, and doesn't make sense now...basically he is implying that X550 and Apriso sales declined (or flat) because Santarus keep lower inventory levels with wholesalers. Because of these low levels and wholesalers wanting to increase them to our levels we had stronger than anticipated revenue growth for Santarus products.
"Relative to the prior year period, first quarter 2014 revenue for XIFAXAN declined 25% while APRISO revenue was flat, despite strong year-over-year prescription growth of 19% and 58%, respectively. This was due to wholesalers and drug change which have had very thin inventories for Santarus products, focusing on securing additional product during the quarter to establish adequate inventories in accordance with our preferred inventory levels. This resulted in strong revenue growth for Santarus products in the first quarter."
Of course David from Piper Jaffray was thinking the same thing I was and asked a question...
David Amsellem - Piper Jaffray Companies, Research Division
Just a couple of questions. So first, I just want to make sure I understand the inventory dynamics here. Why would the addition of the Santarus assets necessarily impact your inventory patterns on your existing products like XIFAXAN? And then, secondly, to be clear, would -- should we expect the Santarus sales to be down sequentially in 2Q? And then, the second question is sort of a more general question on XIFAXAN. If the TARGET 3 study were to fail, how do you think about pricing power given that the label would be in essentially an orphan indication in HE?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Sure, David. I'll handle your first question. I don't know -- you may or may not be aware that Santarus did have inventory management agreements in place. And so shortly after the acquisition closed, we terminated those agreements, which I think caused a little angst with wholesalers with respect to their products. So they were focused and we were focused on wanting to make sure those inventory levels got to the level that we're comfortable with, which is typically in that 10 to 12 weeks. We didn't quite achieve that. We're probably more in the 2- to 3-month range with the Santarus products. So again, they were focused on getting there. We were focused on that as well. And they had existing inventories at the legacy Salix products, which they were comfortable with. So what we expect in second quarter is that XIFAXAN 550 will rebound and more than likely exceed demand. And then, we would expect the Santarus products to come in line with demand for the remainder of the year and then all products to come in line with demand for the second half of the year. And then, in terms of TARGET 3 study...
Isn’t 10-12 weeks basically 2-3 months? And I like the redirect from Adam to the Target 3 study...
But yet more questions- This one from Andrew from Susquehanna Financial group
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
And maybe you can clarify the comment about the inventory levels. You said 10 to 12 weeks and 3 months for -- if you can just clarify for each of your products and the Santarus products where it stood at the end of the year and where it stood -- stands now since the difference between the run rates you gave and the 1Q sales for some of these products indicate a swing of several months' worth of demand trends. And then, on a different note, just about the spending progression throughout the year, how you're thinking about SG&A and R&D relative to your previous guidance and sort of the progression as we go throughout the year?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. So we would expect by the end of second quarter that in -- ideally, all of our inventories for all of our products would be in that 10- to 12-week range. Clearly, we'd be in a 2- to 3-month range, so we would fully expect that. Keep in mind that the shipments, especially the Santarus products, were happening very early in the quarter -- in first quarter and so here we are in May. And so inventories are, again, at that 2- to 3-month timeframe. We would like for it to be 10 to 12 weeks and we expect it to be there by the end of second quarter. In terms of...
Carolyn J. Logan - Chief Executive Officer, President and Director
And I think our wholesalers and drug chains view us as being a more aggressive marketing company than Santarus. And we're putting a lot of people on these products. And I think they expected us to grow at a faster rate than Santarus.
More blame on Santarus. Interestingly they implied but never gave a clear answer on exactly where our inventory levels stood...
Still more questions as the call goes on...this one from Goldman Sachs
Roger Kumar - Goldman Sachs Group Inc., Research Division
This is Roger Kumar stepping in for Gary. Just had a couple ones here. First, I was wondering if you guys could maybe quantify on a dollar basis how much inventory contributed to maybe UCERIS and how much drawdown contributed to XIFAXAN? And also just wondering if you guys could comment on where you guys are with the integration of the sales force. And how long should we expect to see an impact to XIFAXAN in HE and primary care and also with UCERIS with the Salix sales force?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, so I'll handle your first question. So if you look at the run rate as a surrogate for that and you do the math, what you'll come up with on the Santarus products that upon shipment, it was roughly 4 months of inventory. And then, obviously, that's been working down ever since. So again, at the end of second quarter, we would expect to be in that 2- to 3-month range. And then, if you look at the run rate for XIFAXAN and apply it to what was shipped, so the run rate would be about $175 million and we shipped $114 million. So that would imply that 1.5 months or so of inventory was -- came down.
Still no direct answer from Adam on where the inventory stood- but does say that it is down 1.5 months from what it was at... but if wholesales in November of 2014 are at 9 months of inventory of X550 it makes you wonder what this number was at this time!
Now we move on to August and our Fq2 2014 earnings call...
Adam opens up..
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Thank you, Mike. I will start with the financial results for second quarter ended June 30, 2014. As a reminder, prior period results do not reflect the Santarus acquisition. Total net product revenue was $382 million for the second quarter of 2014 compared to $235.4 million for the second quarter of 2013. Demand for our key products remained very strong in the quarter, with XIFAXAN and APRISO prescriptions growing 23% and 25%, respectively, from the second quarter of last year.
However, product revenue for XIFAXAN and APRISO was impacted by some inventory destocking in the wholesale channel during the second quarter of 2014, although less than the first quarter of 2014. Currently, we expect destocking may continue to a lesser degree in the third quarter and normalize in the fourth quarter.
Gross margin, excluding $54.9 million in amortization of product rights and intangible assets, a $16.2 million step-up in value of Santarus inventory in connection with the acquisition,
Basically saying that X550 and Apriso revenue lower because wholesalers were destocking our products and not ordering....interesting since we now know they have 9 months of inventory- what were these levels at this time???
First question...
Michael Eric Faerm - Wells Fargo Securities, LLC, Research Division
First question is on the inventory movements this quarter. Could you talk a little bit more about what's causing that and what the expectations are going forward for next quarter and beyond? What might start to normalize that and when? And then I have one follow-up.
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, sure. Frankly, we really don't know what's causing it other than wholesalers are wanting to lower their overall inventories, but what we did is we built into our guidance for third quarter continued softening, to a lesser degree, of inventory levels and that normalizing in fourth quarter.
Michael Eric Faerm - Wells Fargo Securities, LLC, Research Division
And so do you expect the revenues that did not happen in 2Q, do you expect those to sort of come back? Or those -- are those gone because inventory levels are normalized at the new level?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, again, we built in some softening of inventory levels into our third quarter guidance. And obviously, we're sticking with our full year guidance of $1.6 billion.
Adam saying we have built into our 3rd quarter guidance that wholesalers will continue to destock some X550...but still looking good for the year. BTW- of course wholesalers want to destock X550 inventory at this point they probably had a year supply!
Next question...from Andrew- who is probably left scratching his head by this response- who are these amateurs running this company!
We go next to Andrew Finkelstein with Susquehanna Financial Group.
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
If I could follow up on the inventory a little bit more. I know some of these things are difficult to predict, but maybe you could share a little bit more perspective on what investigation you've done with your customers and where things stand relative to IMA levels. I think we discussed, last quarter, you tried to keep these products in a pretty tight range of 10 to 12 weeks. And looking over last quarter and this quarter, it seems that some of these products have come down relative to their run rates quite significantly. I think 7 weeks or so for XIFAXAN, many weeks for the purgatives and then up dramatically for GLUMETZA, maybe by as much as 6 months' worth of inventory. So I was hoping you could share a little bit more color on what -- on a product-by-product basis. Some of them seem to be at very high inventory levels and some quite low. Where they individually stand, particularly with 3Q for GLUMETZA? What you're thinking happens there whether that comes down a lot?
At this point everyone thinks Salix legacy products have low wholesaler inventory and Santarus inventory levels are increasing despite lower demand..
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, sure. I would expect that the GLUMETZA and UCERIS will come down in third quarter. And then, as you can see, both with APRISO and XIFAXAN, they did come more in line with demand. They didn't quite get there, but we would expect that to continue to become more in line with demand in third quarter and then to normalize in fourth quarter.
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
Well, I mean, specifically, where -- what's your sense of how much inventory is in the channel at this point? Is it within your contractual ranges or not?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Well, we don't have IMAs. We don't have any contracts.
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
Okay. So you have nothing -- so your 10 to 12 weeks are noncontractual? It's just your goal?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Correct.
Notice the analyst keep saying 8 weeks X550 but no one is giving a straight answer. This is misleading IMO.
Annabel Samimy - Stifel, Nicolaus & Company, Incorporated, Research Division
I promise this is going to be the last inventory question. Can you just define what normalizing means? Is that a new level that you're targeting now, not 10 to 12 weeks, but something else? Can you just help us understand that?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. I mean, I think from an overall portfolio standpoint, I would say that's in the 8-week or minus a little bit range for the entire channel.
You think its the last question....but yet they rightfully continue
Mario Vincent Corso - Mizuho Securities USA Inc., Research Division
I hate to keep harping on the inventory situation, but so -- just trying to make sure if I understand this correctly. So on the third quarter, we should be expecting to see XIFAXAN reported below demand. And for the Santarus products, is it still coming in above demand? And I'm wondering -- so is your assumption that the price increases that were taken in the quarter, there was some buying ahead of those in the absence of agreements? And then, again -- so is this a portfolio issue like you thought it was last quarter, whereas they're buying more the Santarus products? They're destocking XIFAXAN? Or is this specifically purposeful destocking of XIFAXAN? And on the 8 weeks for XIFAXAN, is that kind of a guess? Or is that something that's been communicated to you?
William P. Forbes - Chief Development Officer, Chief Medical Officer and Executive Vice President of Research & Development
Sure. No, I just think it's a -- again, with the Santarus products, we would expect them not to remain at this level. So we put a lot of effort behind getting, as Carolyn said earlier, in distribution, especially at the pharmacy level. So I would expect them to come down to maybe even be slightly in line with demand or slightly below. And when I say the Santarus products, I'm really just referring to GLUMETZA and UCERIS. And then, we would expect the legacy Salix products to come further in line with demand, whether it actually gets there in third quarter, we're not sure. So we built that into our guidance for the quarter, but we would expect that to come in line in fourth quarter.
One thing our senior management is consistent with is- blaming Santarus.
Gregory B. Gilbert - Deutsche Bank AG, Research Division
I'm sorry if I missed this. I don't think I heard your estimate for where you think inventory levels actually are at the end of the second quarter for XIFAXAN and APRISO. And perhaps, a naïve question, but how do you actually know with specificity without IMAs? My other question is about gross margin guidance. Is the lower guidance tied to higher GLUMETZA sales?
Haha great question- mainly because no one has yet answered where the inventory levels actually are!!! But fear not- Adam will continue to dance around the question
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Correct. So that's why there's some pressure on margins based on our 80% guidance in [indiscernible]and now we're guiding it 78%. So we do expect -- I mean, we have visibility in inventories because we know what we shipped, we know what pulls through, we know what returns are, so we have an idea -- a visibility into inventory levels. So again, we would be hopeful, because we are not under IMAs, that when things do normalize that we can normalize around that 8-week or a little less level, and that would be true for both XIFAXAN and for APRISO.
Shibani Malhotra - Sterne Agee & Leach Inc., Research Division
I've got one for Adam and then some follow-ups for Carolyn. Adam, just conceptually, I know you've been asked a lot of inventory questions, but can you explain to us, conceptually, why wholesalers would be reducing inventory of your products because the Santarus -- because the increasing inventory of Santarus products. Just -- I'm just struggling to understand that. And then, I have my Carolyn follow-up.
We have to be the laughing stock of “big pharma” in terms of management teams. These analysts must think Salix has some of the biggest idiots leading the company
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
I think it's a function of where the Santarus products were when we acquired the company. And again, as we talked about this in the first quarter, how their products were razor-thin and they didn't have the distribution we wanted to have at the retail level. So we wanted to get that in order. So that's the only explanation I have for that.
Again no one understands why we continue to blame Santarus about X550 inventory levels...
Shibani Malhotra - Sterne Agee & Leach Inc., Research Division
I guess, what has that got to do with the Salix legacy products? That's my key question.
Begging them please explain your thought process behind your answers because it makes no sense!!!!
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. I mean, I think, what we talked about on the first quarter call, we really don't know is the answer. But I think our customers are very comfortable with the Salix legacy products. And so I think they feel comfortable bringing those inventory levels down, and they've told us they want to bring those inventory levels down. And I think -- that's why we say we think in the fourth quarter that things will normalize.
Of course in November you (well Adam you will be gone…but your replacement) will be saying that things will normalize in 2016...
FQ3 “Doomsday call”
Starts out with our CEO
Carolyn J. Logan - Chief Executive Officer, President and Director
We also announced in our earnings press release that we are currently negotiating with our principal wholesalers to enter into distribution services agreements, sometimes referred to as DSAs, for each of our products. We believe these agreements will improve our visibility into wholesaler inventory levels and our inventory management and planning. We believe they will provide valuable inventory and sales data and ensure proper service levels to pharmacies and other indirect customers and enable us to better forecast revenue and expenses. In addition, we believe entering into distribution service agreements will enhance our profitability over the long term because service fees under the agreements are expected to be less in the aggregate than the aggregate discounts given to wholesalers in recent periods. We also expect that these agreements, when finalized, will enable us to achieve our objective of predictably and deliberately reducing wholesaler inventory levels of XIFAXAN 550, APRISO and UCERIS to approximately 3 months at or before the end of 2016, depending on future demand for these products. We believe this is an appropriate level of inventory for our key products under a distribution services agreement structure, given the prescription growth rates of our products and the expected service levels that will be required of the wholesalers under the agreement. We expect these distribution services agreements to be finalized and become effective in the first quarter of 2015.
Then the questions start….I love the first one. This guy was pretty mad…I won’t even copy and paste the rest of the questions of comments because this guy hits the nail in the head!
David A. Amsellem - Piper Jaffray Companies, Research Division
So you've said historically that there were 10 to 12 weeks of XIFAXAN inventory on hand. Now we're being told 9 months on hand. So how do you square that? And I guess the other way of asking that, given your comments on inventory on the last couple of calls, how can we now say that those comments were not misleading?
Carolyn J. Logan - Chief Executive Officer, President and Director
David, unfortunately, we really can't comment on that, as I mentioned earlier. The Audit Committee has retained outside counsel, and they are conducting a review of this. And to preserve the integrity of that process, it's just not appropriate for me to comment. However, I do want to say, and I think I said it in the script, but management believes that the company's accounting in relation to sales to wholesalers has been appropriate, and that any questions related to that have all been vetted. Our auditor, Ernst & Young, has conducted its quarterly reviews for each of the 3 quarters. They've also informed us that they stand by their unqualified opinion in respect to their 2013 audited financial statements. So we do not think there are any issues there.
Timothy J. Creech -
And let me tell you why we think -- why do have confidence in the numbers we have given you today. As we disclosed, we began the process of negotiating DSAs, and we have gotten some inventory data from our major wholesalers and compared that to our estimate, which was based on our total inventory estimates based on our internal shipments. And those numbers are consistent with that numbers we received from the wholesalers.
David A. Amsellem - Piper Jaffray Companies, Research Division
Okay. And I guess the comment is, I don't know how you square 10 to 12 weeks which is what you've said historically versus what we're being told today of 9 months. But I guess, I'll just jump back in the queue.
FQ4 2013
Mario Vincent Corso - Mizuho Securities USA Inc., Research Division
On XIFAXAN, anything going on in the quarter inventory-wise, which would prevent quarter-over-quarter growth into the first quarter? And I know the weather and other issues might be a factor as well. Also wondering what you can say about HE penetration there and how far you think you have to go. And then on the financial side of things, anything in the quarterly R&D or SG&A trends over the course of this year that would make things particularly lumpy? Or would you expect things to be relatively linear?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. I would expect the R&D to be spread pretty evenly throughout the year, maybe slowly ramping but no real extreme lumpiness in that. And in terms of inventory levels on XIFAXAN, based on the latest run rate or data -- run rate data, we were right in line with demands and no changes with XIFAXAN. And was there a third part to that question? I'm sorry, Mario.
FQ1 2014
And now the blame game starts...blaming Santarus inventory levels with X550. Didn't make sense on May 4th, and doesn't make sense now...basically he is implying that X550 and Apriso sales declined (or flat) because Santarus keep lower inventory levels with wholesalers. Because of these low levels and wholesalers wanting to increase them to our levels we had stronger than anticipated revenue growth for Santarus products.
"Relative to the prior year period, first quarter 2014 revenue for XIFAXAN declined 25% while APRISO revenue was flat, despite strong year-over-year prescription growth of 19% and 58%, respectively. This was due to wholesalers and drug change which have had very thin inventories for Santarus products, focusing on securing additional product during the quarter to establish adequate inventories in accordance with our preferred inventory levels. This resulted in strong revenue growth for Santarus products in the first quarter."
Of course David from Piper Jaffray was thinking the same thing I was and asked a question...
David Amsellem - Piper Jaffray Companies, Research Division
Just a couple of questions. So first, I just want to make sure I understand the inventory dynamics here. Why would the addition of the Santarus assets necessarily impact your inventory patterns on your existing products like XIFAXAN? And then, secondly, to be clear, would -- should we expect the Santarus sales to be down sequentially in 2Q? And then, the second question is sort of a more general question on XIFAXAN. If the TARGET 3 study were to fail, how do you think about pricing power given that the label would be in essentially an orphan indication in HE?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Sure, David. I'll handle your first question. I don't know -- you may or may not be aware that Santarus did have inventory management agreements in place. And so shortly after the acquisition closed, we terminated those agreements, which I think caused a little angst with wholesalers with respect to their products. So they were focused and we were focused on wanting to make sure those inventory levels got to the level that we're comfortable with, which is typically in that 10 to 12 weeks. We didn't quite achieve that. We're probably more in the 2- to 3-month range with the Santarus products. So again, they were focused on getting there. We were focused on that as well. And they had existing inventories at the legacy Salix products, which they were comfortable with. So what we expect in second quarter is that XIFAXAN 550 will rebound and more than likely exceed demand. And then, we would expect the Santarus products to come in line with demand for the remainder of the year and then all products to come in line with demand for the second half of the year. And then, in terms of TARGET 3 study...
Isn’t 10-12 weeks basically 2-3 months? And I like the redirect from Adam to the Target 3 study...
But yet more questions- This one from Andrew from Susquehanna Financial group
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
And maybe you can clarify the comment about the inventory levels. You said 10 to 12 weeks and 3 months for -- if you can just clarify for each of your products and the Santarus products where it stood at the end of the year and where it stood -- stands now since the difference between the run rates you gave and the 1Q sales for some of these products indicate a swing of several months' worth of demand trends. And then, on a different note, just about the spending progression throughout the year, how you're thinking about SG&A and R&D relative to your previous guidance and sort of the progression as we go throughout the year?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. So we would expect by the end of second quarter that in -- ideally, all of our inventories for all of our products would be in that 10- to 12-week range. Clearly, we'd be in a 2- to 3-month range, so we would fully expect that. Keep in mind that the shipments, especially the Santarus products, were happening very early in the quarter -- in first quarter and so here we are in May. And so inventories are, again, at that 2- to 3-month timeframe. We would like for it to be 10 to 12 weeks and we expect it to be there by the end of second quarter. In terms of...
Carolyn J. Logan - Chief Executive Officer, President and Director
And I think our wholesalers and drug chains view us as being a more aggressive marketing company than Santarus. And we're putting a lot of people on these products. And I think they expected us to grow at a faster rate than Santarus.
More blame on Santarus. Interestingly they implied but never gave a clear answer on exactly where our inventory levels stood...
Still more questions as the call goes on...this one from Goldman Sachs
Roger Kumar - Goldman Sachs Group Inc., Research Division
This is Roger Kumar stepping in for Gary. Just had a couple ones here. First, I was wondering if you guys could maybe quantify on a dollar basis how much inventory contributed to maybe UCERIS and how much drawdown contributed to XIFAXAN? And also just wondering if you guys could comment on where you guys are with the integration of the sales force. And how long should we expect to see an impact to XIFAXAN in HE and primary care and also with UCERIS with the Salix sales force?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, so I'll handle your first question. So if you look at the run rate as a surrogate for that and you do the math, what you'll come up with on the Santarus products that upon shipment, it was roughly 4 months of inventory. And then, obviously, that's been working down ever since. So again, at the end of second quarter, we would expect to be in that 2- to 3-month range. And then, if you look at the run rate for XIFAXAN and apply it to what was shipped, so the run rate would be about $175 million and we shipped $114 million. So that would imply that 1.5 months or so of inventory was -- came down.
Still no direct answer from Adam on where the inventory stood- but does say that it is down 1.5 months from what it was at... but if wholesales in November of 2014 are at 9 months of inventory of X550 it makes you wonder what this number was at this time!
Now we move on to August and our Fq2 2014 earnings call...
Adam opens up..
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Thank you, Mike. I will start with the financial results for second quarter ended June 30, 2014. As a reminder, prior period results do not reflect the Santarus acquisition. Total net product revenue was $382 million for the second quarter of 2014 compared to $235.4 million for the second quarter of 2013. Demand for our key products remained very strong in the quarter, with XIFAXAN and APRISO prescriptions growing 23% and 25%, respectively, from the second quarter of last year.
However, product revenue for XIFAXAN and APRISO was impacted by some inventory destocking in the wholesale channel during the second quarter of 2014, although less than the first quarter of 2014. Currently, we expect destocking may continue to a lesser degree in the third quarter and normalize in the fourth quarter.
Gross margin, excluding $54.9 million in amortization of product rights and intangible assets, a $16.2 million step-up in value of Santarus inventory in connection with the acquisition,
Basically saying that X550 and Apriso revenue lower because wholesalers were destocking our products and not ordering....interesting since we now know they have 9 months of inventory- what were these levels at this time???
First question...
Michael Eric Faerm - Wells Fargo Securities, LLC, Research Division
First question is on the inventory movements this quarter. Could you talk a little bit more about what's causing that and what the expectations are going forward for next quarter and beyond? What might start to normalize that and when? And then I have one follow-up.
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, sure. Frankly, we really don't know what's causing it other than wholesalers are wanting to lower their overall inventories, but what we did is we built into our guidance for third quarter continued softening, to a lesser degree, of inventory levels and that normalizing in fourth quarter.
Michael Eric Faerm - Wells Fargo Securities, LLC, Research Division
And so do you expect the revenues that did not happen in 2Q, do you expect those to sort of come back? Or those -- are those gone because inventory levels are normalized at the new level?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, again, we built in some softening of inventory levels into our third quarter guidance. And obviously, we're sticking with our full year guidance of $1.6 billion.
Adam saying we have built into our 3rd quarter guidance that wholesalers will continue to destock some X550...but still looking good for the year. BTW- of course wholesalers want to destock X550 inventory at this point they probably had a year supply!
Next question...from Andrew- who is probably left scratching his head by this response- who are these amateurs running this company!
We go next to Andrew Finkelstein with Susquehanna Financial Group.
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
If I could follow up on the inventory a little bit more. I know some of these things are difficult to predict, but maybe you could share a little bit more perspective on what investigation you've done with your customers and where things stand relative to IMA levels. I think we discussed, last quarter, you tried to keep these products in a pretty tight range of 10 to 12 weeks. And looking over last quarter and this quarter, it seems that some of these products have come down relative to their run rates quite significantly. I think 7 weeks or so for XIFAXAN, many weeks for the purgatives and then up dramatically for GLUMETZA, maybe by as much as 6 months' worth of inventory. So I was hoping you could share a little bit more color on what -- on a product-by-product basis. Some of them seem to be at very high inventory levels and some quite low. Where they individually stand, particularly with 3Q for GLUMETZA? What you're thinking happens there whether that comes down a lot?
At this point everyone thinks Salix legacy products have low wholesaler inventory and Santarus inventory levels are increasing despite lower demand..
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes, sure. I would expect that the GLUMETZA and UCERIS will come down in third quarter. And then, as you can see, both with APRISO and XIFAXAN, they did come more in line with demand. They didn't quite get there, but we would expect that to continue to become more in line with demand in third quarter and then to normalize in fourth quarter.
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
Well, I mean, specifically, where -- what's your sense of how much inventory is in the channel at this point? Is it within your contractual ranges or not?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Well, we don't have IMAs. We don't have any contracts.
Andrew Finkelstein - Susquehanna Financial Group, LLLP, Research Division
Okay. So you have nothing -- so your 10 to 12 weeks are noncontractual? It's just your goal?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Correct.
Notice the analyst keep saying 8 weeks X550 but no one is giving a straight answer. This is misleading IMO.
Annabel Samimy - Stifel, Nicolaus & Company, Incorporated, Research Division
I promise this is going to be the last inventory question. Can you just define what normalizing means? Is that a new level that you're targeting now, not 10 to 12 weeks, but something else? Can you just help us understand that?
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. I mean, I think from an overall portfolio standpoint, I would say that's in the 8-week or minus a little bit range for the entire channel.
You think its the last question....but yet they rightfully continue
Mario Vincent Corso - Mizuho Securities USA Inc., Research Division
I hate to keep harping on the inventory situation, but so -- just trying to make sure if I understand this correctly. So on the third quarter, we should be expecting to see XIFAXAN reported below demand. And for the Santarus products, is it still coming in above demand? And I'm wondering -- so is your assumption that the price increases that were taken in the quarter, there was some buying ahead of those in the absence of agreements? And then, again -- so is this a portfolio issue like you thought it was last quarter, whereas they're buying more the Santarus products? They're destocking XIFAXAN? Or is this specifically purposeful destocking of XIFAXAN? And on the 8 weeks for XIFAXAN, is that kind of a guess? Or is that something that's been communicated to you?
William P. Forbes - Chief Development Officer, Chief Medical Officer and Executive Vice President of Research & Development
Sure. No, I just think it's a -- again, with the Santarus products, we would expect them not to remain at this level. So we put a lot of effort behind getting, as Carolyn said earlier, in distribution, especially at the pharmacy level. So I would expect them to come down to maybe even be slightly in line with demand or slightly below. And when I say the Santarus products, I'm really just referring to GLUMETZA and UCERIS. And then, we would expect the legacy Salix products to come further in line with demand, whether it actually gets there in third quarter, we're not sure. So we built that into our guidance for the quarter, but we would expect that to come in line in fourth quarter.
One thing our senior management is consistent with is- blaming Santarus.
Gregory B. Gilbert - Deutsche Bank AG, Research Division
I'm sorry if I missed this. I don't think I heard your estimate for where you think inventory levels actually are at the end of the second quarter for XIFAXAN and APRISO. And perhaps, a naïve question, but how do you actually know with specificity without IMAs? My other question is about gross margin guidance. Is the lower guidance tied to higher GLUMETZA sales?
Haha great question- mainly because no one has yet answered where the inventory levels actually are!!! But fear not- Adam will continue to dance around the question
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Correct. So that's why there's some pressure on margins based on our 80% guidance in [indiscernible]and now we're guiding it 78%. So we do expect -- I mean, we have visibility in inventories because we know what we shipped, we know what pulls through, we know what returns are, so we have an idea -- a visibility into inventory levels. So again, we would be hopeful, because we are not under IMAs, that when things do normalize that we can normalize around that 8-week or a little less level, and that would be true for both XIFAXAN and for APRISO.
Shibani Malhotra - Sterne Agee & Leach Inc., Research Division
I've got one for Adam and then some follow-ups for Carolyn. Adam, just conceptually, I know you've been asked a lot of inventory questions, but can you explain to us, conceptually, why wholesalers would be reducing inventory of your products because the Santarus -- because the increasing inventory of Santarus products. Just -- I'm just struggling to understand that. And then, I have my Carolyn follow-up.
We have to be the laughing stock of “big pharma” in terms of management teams. These analysts must think Salix has some of the biggest idiots leading the company
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
I think it's a function of where the Santarus products were when we acquired the company. And again, as we talked about this in the first quarter, how their products were razor-thin and they didn't have the distribution we wanted to have at the retail level. So we wanted to get that in order. So that's the only explanation I have for that.
Again no one understands why we continue to blame Santarus about X550 inventory levels...
Shibani Malhotra - Sterne Agee & Leach Inc., Research Division
I guess, what has that got to do with the Salix legacy products? That's my key question.
Begging them please explain your thought process behind your answers because it makes no sense!!!!
Adam C. Derbyshire - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance & Administration
Yes. I mean, I think, what we talked about on the first quarter call, we really don't know is the answer. But I think our customers are very comfortable with the Salix legacy products. And so I think they feel comfortable bringing those inventory levels down, and they've told us they want to bring those inventory levels down. And I think -- that's why we say we think in the fourth quarter that things will normalize.
Of course in November you (well Adam you will be gone…but your replacement) will be saying that things will normalize in 2016...
FQ3 “Doomsday call”
Starts out with our CEO
Carolyn J. Logan - Chief Executive Officer, President and Director
We also announced in our earnings press release that we are currently negotiating with our principal wholesalers to enter into distribution services agreements, sometimes referred to as DSAs, for each of our products. We believe these agreements will improve our visibility into wholesaler inventory levels and our inventory management and planning. We believe they will provide valuable inventory and sales data and ensure proper service levels to pharmacies and other indirect customers and enable us to better forecast revenue and expenses. In addition, we believe entering into distribution service agreements will enhance our profitability over the long term because service fees under the agreements are expected to be less in the aggregate than the aggregate discounts given to wholesalers in recent periods. We also expect that these agreements, when finalized, will enable us to achieve our objective of predictably and deliberately reducing wholesaler inventory levels of XIFAXAN 550, APRISO and UCERIS to approximately 3 months at or before the end of 2016, depending on future demand for these products. We believe this is an appropriate level of inventory for our key products under a distribution services agreement structure, given the prescription growth rates of our products and the expected service levels that will be required of the wholesalers under the agreement. We expect these distribution services agreements to be finalized and become effective in the first quarter of 2015.
Then the questions start….I love the first one. This guy was pretty mad…I won’t even copy and paste the rest of the questions of comments because this guy hits the nail in the head!
David A. Amsellem - Piper Jaffray Companies, Research Division
So you've said historically that there were 10 to 12 weeks of XIFAXAN inventory on hand. Now we're being told 9 months on hand. So how do you square that? And I guess the other way of asking that, given your comments on inventory on the last couple of calls, how can we now say that those comments were not misleading?
Carolyn J. Logan - Chief Executive Officer, President and Director
David, unfortunately, we really can't comment on that, as I mentioned earlier. The Audit Committee has retained outside counsel, and they are conducting a review of this. And to preserve the integrity of that process, it's just not appropriate for me to comment. However, I do want to say, and I think I said it in the script, but management believes that the company's accounting in relation to sales to wholesalers has been appropriate, and that any questions related to that have all been vetted. Our auditor, Ernst & Young, has conducted its quarterly reviews for each of the 3 quarters. They've also informed us that they stand by their unqualified opinion in respect to their 2013 audited financial statements. So we do not think there are any issues there.
Timothy J. Creech -
And let me tell you why we think -- why do have confidence in the numbers we have given you today. As we disclosed, we began the process of negotiating DSAs, and we have gotten some inventory data from our major wholesalers and compared that to our estimate, which was based on our total inventory estimates based on our internal shipments. And those numbers are consistent with that numbers we received from the wholesalers.
David A. Amsellem - Piper Jaffray Companies, Research Division
Okay. And I guess the comment is, I don't know how you square 10 to 12 weeks which is what you've said historically versus what we're being told today of 9 months. But I guess, I'll just jump back in the queue.
this is why some people will be going to jail...
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