Jazz Pharmaceuticals Plc quarterly report, Q3 FY2012

Jazz Pharmaceuticals plc — Q3 2012 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2012. Unaudited results. The January 2012 Azur merger and June 2012 EUSA acquisition materially expanded the business; 2011 comparison periods include only the historical Jazz Pharmaceuticals, Inc. business and are therefore not directly comparable.

Financial performance

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Total revenue	$175.5 million	$73.3 million	$402.3 million	$188.7 million
Income from continuing operations	$33.6 million	$32.5 million	$94.9 million	$87.5 million
Net income	$33.2 million	$32.5 million	$88.0 million	$87.5 million
Diluted net income per share	$0.55	$0.69	$1.47	$1.88
Operating income	$55.3 million	$33.7 million	$130.5 million	$90.2 million

• Revenue rose 139% in Q3 and 113% year to date, reflecting the enlarged portfolio as well as growth in existing products. Product sales were $174.1 million in Q3 and $398.6 million year to date.
• Xyrem sales were $102.6 million in Q3 and $265.1 million year to date, up 64% in both comparisons. Management attributed growth primarily to price increases, with sales volume up 9% in Q3 and 10% year to date.
• Q3 sales also included Erwinaze/Erwinase of $31.7 million, Prialt of $5.4 million, Luvox CR of $11.6 million, and FazaClo LD and HD of $6.4 million and $3.1 million, respectively. EUSA results are included only from June 12.
• Product gross margin was 81.3% in Q3 and 86.8% year to date, versus 94.6% in both 2011 periods. Acquired product costs and purchase-accounting inventory step-up contributed to the decline.
• Operating expenses increased with the acquisitions: Q3 selling, general and administrative expense was $60.9 million, R&D was $6.9 million, and acquired-intangible amortization was $19.7 million. Q3 included $10.3 million of inventory fair-value step-up cost.
• GAAP net income was broadly flat year over year despite higher revenue, reflecting higher operating costs, amortization, interest and taxes. Non-GAAP adjusted net income was $78.6 million in Q3 and $196.4 million year to date, versus $44.3 million and $109.5 million. These company-defined measures exclude specified items, including amortization, share compensation, acquisition costs and inventory step-up.

Cash flow, debt and liquidity

• Cash and cash equivalents were $189.8 million at September 30, 2012, compared with $82.1 million at December 31, 2011; the company held no marketable securities at quarter-end.
• Nine-month operating cash flow was $145.4 million, versus $107.9 million in 2011. Investing cash use was $482.5 million, primarily related to acquisitions; financing provided $444.9 million, chiefly from the new term loan.
• Term-loan principal outstanding was $469.1 million; the carrying amount of long-term debt, including discount and classification, was reported as $462.4 million. The loan interest rate was 5.25% at quarter-end. The $100 million revolving facility was undrawn.
• Management stated existing cash, anticipated operating cash flow, revolver availability and proceeds from the subsequent women’s-health sale should fund operations and obligations for the foreseeable future. The company was in compliance with its secured-leverage covenant.
• Reported contractual obligations totaled $659.4 million, including principal and estimated interest on the term loan, purchase commitments and leases. The table excludes uncertain obligations, including the potential $50 million Erwinaze milestone.

Material changes and unusual items

• The Azur merger closed January 18, 2012; EUSA was acquired June 12 for an upfront cash payment of $678.4 million. EUSA added Erwinaze and other products, international operations and infrastructure. A potential additional $50 million payment is due if Erwinaze meets the specified 2013 U.S. sales threshold.
• In October, the company completed the sale of its women’s-health business to Meda for $97.6 million, including inventory. Expected net proceeds were $93–$94 million; management expected a non-recurring Q4 gain of approximately $34–$36 million. The business generated $8.1 million of Q3 revenue and a $0.4 million Q3 loss, and was classified as discontinued operations.
• Q3 and nine-month discontinued-operations losses were $0.4 million and $6.9 million. Acquisition-related amortization and purchase-accounting inventory charges materially affect comparisons with the prior year.
• A post-acquisition restructuring began in June. The company recorded $2.2 million in termination-benefit costs year to date and expected approximately $1 million more; the plan was expected to be completed by Q2 2013.

Outlook, commentary and key risks

• Management expected 2012 total product sales to exceed 2011, driven by Xyrem and Luvox CR growth and inclusion of products added through the mergers. It expected royalty and contract revenue to decline slightly, gross margin to fall, and SG&A, R&D, amortization and interest expense to rise versus 2011. No specific full-year earnings or revenue guidance was provided in the filing.
• Xyrem remained the principal concentration, representing 59% of Q3 and 67% of year-to-date net product sales. Generic applicant Roxane’s patent litigation was ongoing; the original 30-month stay ran to April 18, 2013 absent an earlier court decision. A new Xyrem formulation patent suit was filed October 26, 2012, and no trial date had been set. FDA responses to the company’s citizen petitions and regulatory matters remained uncertain.
• The company disclosed an FDA warning letter concerning Xyrem adverse-event reporting, a May 2012 Form FDA 483, and a separate September 2012 warning letter concerning FazaClo promotional materials. Further regulatory action or requirements could affect distribution, costs or sales.
• Teva launched an authorized generic FazaClo LD product in August 2012; the company expected a negative effect on LD sales and possible impact on HD. Erwinaze growth also depends on reliable sole-source supply from the U.K. Health Protection Agency.
• Other material risks include reliance on sole-source manufacturers, customer concentration, pricing and reimbursement pressure, integration of acquired businesses, foreign-exchange exposure, product-development uncertainty, and secured debt and covenant obligations. Express Scripts accounted for 58% of Q3 revenue and 50% of gross receivables at quarter-end; five customers represented 76% of gross receivables.

Investor verification priorities

• Track Xyrem sales, price-versus-volume contribution, generic litigation and FDA decisions on labeling, REMS and adverse-event reporting.
• Verify sustained Erwinaze supply and sales performance, including the 2013 milestone threshold that could trigger the $50 million payment.
• Assess post-acquisition margins and expenses, integration progress, and the eventual accounting impact of purchase-price allocation and amortization.
• Confirm final proceeds and gain from the women’s-health sale and whether any proceeds are applied to debt under the credit agreement.
• Monitor cash generation, term-loan amortization, interest-rate sensitivity, covenant headroom and customer concentration.