Perrigo Company plc — Q2 2016 Form 10-Q
Business context and reporting period. Perrigo is a global OTC consumer healthcare and specialty pharmaceutical company, with operations in Consumer Healthcare (CHC), Branded Consumer Healthcare (BCH), Prescription Pharmaceuticals (Rx), Specialty Sciences and API. This unaudited report covers the three and six months ended July 2, 2016. Perrigo changed to a calendar fiscal year in 2016; the comparable 2015 six-month period included only three months of Omega operations, acquired in March 2015.
Financial performance and position
- Q2 revenue and margins: Net sales were $1.481 billion, down 3% from $1.532 billion. Gross profit was $567.2 million and gross margin was 38.3%, compared with $628.1 million and 41.0%. Operating income rose 5% to $238.3 million, or 16.1% of sales, from $226.9 million, or 14.8%.
- Q2 earnings: Net income was $194.3 million ($1.35 diluted EPS), versus $56.4 million ($0.38 diluted EPS). The current quarter included an income tax benefit of $42.7 million; results also reflected a $19.8 million operating-expense credit for impairment charges, including a $30.3 million reduction to a previously estimated BCH goodwill impairment.
- Six-month results: Sales increased 11% to $2.864 billion from $2.581 billion, largely reflecting acquisitions and the additional three months of Omega results. Gross margin fell to 38.1% from 39.0%. Perrigo reported an operating loss of $65.5 million and net loss of $140.3 million, versus operating income of $426.2 million and a net loss of $38.4 million in the prior period. The current-period operating loss included $447.2 million of impairment charges, including $436.7 million of BCH goodwill and intangible-asset impairments. Prior-year net results included a $259.8 million acquisition-hedge loss.
- Cash flow: Six-month operating cash flow was $399.6 million, down from $730.7 million. Investing cash outflow was $477.8 million, including $416.4 million for the Tretinoin portfolio acquisition; financing cash inflow was $305.5 million, principally reflecting new debt issuance. Cash increased $224.0 million to $641.8 million.
- Liquidity and debt: At July 2, cash was $641.8 million, current assets $3.033 billion and current liabilities $2.093 billion. Total borrowings were $6.411 billion, including $758.1 million current indebtedness and $5.653 billion long-term debt. Perrigo had no revolving-credit borrowings and was in compliance with debt covenants.
- Other metrics: Q2 interest expense was $57.4 million, up from $45.9 million, mainly due to the March 2016 note issuance. Six-month dividends declared were $0.29 per share; no shares were repurchased under the existing authorization.
Material changes and management commentary
- Q2 sales weakness reflected lower CHC cough/cold, analgesics and contract-manufacturing sales; Rx acquisition and new-product contributions partly offset declines. CHC operating income fell 22% year over year, while reported BCH operating income improved partly because of the impairment-charge reduction and lower promotional spending.
- Management cited continuing pricing pressure in U.S. businesses, particularly Rx, from competition, customer cost-reduction efforts, low raw-material prices, loss of exclusivity and customer consolidation. It expected the pressure to continue at least through the rest of 2016.
- BCH remained challenged by softness in lifestyle and natural health/vitamins categories, macroeconomic conditions, promotional timing and product restaging. The company was prioritizing brands and aligning advertising and promotional spending with expected returns.
- New-product sales expectations for 2016 remained below the level anticipated at December 2015; some launches were delayed by regulatory approvals or revised market-share and timing assumptions. Management said expectations were consistent with its first-quarter update; this filing does not provide a clear numerical full-year earnings-guidance target.
- Perrigo acquired generic Retin-A products for $416.4 million and exercised an option for two development-stage Rx products, with contingent milestone and royalty obligations. It also sold its U.S. VMS business for $58.6 million in cash on August 5, 2016, after quarter-end; the India API business remained held for sale.
Risks, contingencies and unusual items
- Impairment exposure: BCH recorded $273.4 million of indefinite-lived intangible impairments and $163.3 million of goodwill impairment in the six-month period. Certain remaining asset values were at or near estimated fair value, so further deterioration could result in additional charges.
- Internal controls: Disclosure controls were deemed ineffective at July 2 because of a material weakness in management review controls over interim income-tax accounting and disclosure. Remediation had begun but was still being tested; the weakness remained outstanding.
- Tax matters: The company reported $353.4 million of liabilities for uncertain tax positions. It disputes an IRS assessment of approximately $68.9 million, paid in 2015, and anticipated filing a refund claim in federal court in 2017. The filing notes ongoing U.S. and Belgian tax audits and uncertainty over outcomes.
- Legal matters: Perrigo faced U.S. and Israeli securities litigation alleging, among other matters, inadequate disclosure related to the Mylan takeover defense and Omega integration. It also disclosed Eltroxin class-action proceedings in Israel and Tysabri product-liability lawsuits; outcomes could not be predicted.
- Other business risks: A potential competing multiple-sclerosis product, Ocrevus, could materially affect Tysabri royalties. The filing also identified possible Brexit-related trade, regulatory and demand impacts, and risks from senior leadership transitions.
- Debt and rating: Perrigo issued $1.2 billion of senior notes in March 2016 to repay revolving borrowings. It subsequently gave notice to redeem $500 million of 1.300% notes in September 2016. After quarter-end, Moody’s affirmed its Baa3 rating but changed the outlook to negative.
- Unusual prior-period comparability: Six-month comparisons are affected by Omega’s partial-period inclusion in 2015 and the prior-year acquisition-related derivative loss. The 2016 results also include substantial impairment charges and higher amortization following acquisitions.
Important facts for investors to verify
- Whether pricing pressure, delayed launches and BCH market weakness persist through the remainder of 2016, and how they affect sales, margins and management’s updated guidance.
- The assumptions behind the BCH impairment tests and whether further goodwill or intangible-asset impairments are required.
- Progress and validation of remediation for the material weakness in interim income-tax controls.
- Cash generation, working-capital trends, debt repayment plans and the implications of Moody’s negative outlook.
- Developments in the IRS dispute, securities litigation, Eltroxin and Tysabri cases, and the competitive outlook for Tysabri royalties.
- Completion and proceeds of the VMS sale, and the timing and terms of any India API divestiture.