Perrigo Company plc — Q3 2017 Form 10-Q
Business context and period: Global healthcare products company selling OTC, infant formula, branded consumer healthcare, and generic prescription products, primarily in North America and Europe. This unaudited filing covers the three and nine months ended September 30, 2017; comparisons are to the three and nine months ended October 1, 2016.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,231.3 million | $1,261.6 million | $3,663.1 million | $3,949.3 million |
| Gross profit | $497.8 million | $484.5 million | $1,466.7 million | $1,564.1 million |
| Gross margin | 40.4% | 38.4% | 40.0% | 39.6% |
| Operating income (loss) | $162.4 million | $(1,468.3) million | $439.6 million | $(1,515.1) million |
| Net income (loss) | $44.5 million | $(1,590.2) million | $46.4 million | $(2,653.7) million |
| Diluted EPS | $0.31 | $(11.10) | $0.32 | $(18.53) |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $482.0 million | $448.7 million |
Balance sheet and liquidity: At September 30, 2017, cash and cash equivalents were $775.9 million, total assets $11.84 billion, and total liabilities $5.80 billion. Total borrowings were $3.69 billion, including $417.1 million current debt; cash less borrowings implies net debt of approximately $2.92 billion. The $1.0 billion revolving credit facility had no borrowings outstanding, and Perrigo reported compliance with debt covenants. Management said cash, operating cash flow, and available credit were expected to cover known and foreseeable liquidity and capital needs, while noting lenders’ ability or willingness to lend could change.
Material changes versus comparable periods
- Sales fell 2% in Q3 and 7% for the first nine months. Lower sales reflected divested businesses, cancelled distribution agreements, discontinued products, Entocort declines, and pricing pressure; new product sales and, in Q3, currency benefits partly offset these reductions.
- Reported operating results improved sharply from 2016, principally because the prior-year periods included approximately $1.6 billion of Q3 and $2.0 billion of year-to-date impairment charges. The improvement should not be read as equivalent growth in underlying sales or earnings.
- Q3 gross margin improved to 40.4%, driven by mix and operating efficiencies. Nine-month gross margin rose to 40.0%, while segment performance varied: CHCA and CHCI margins improved, but RX gross margin declined amid Entocort weakness and pricing pressure.
- Nine-month interest expense declined to $133.1 million from $163.2 million following debt repayments. However, Perrigo recorded a $135.2 million loss on extinguishment of debt, including $116.1 million of early-retirement premiums and related costs.
- Cash rose to $775.9 million from $622.3 million at year-end 2016. Operating cash flow was $482.0 million; investing cash flow was $2.27 billion, including $2.2 billion proceeds from the Tysabri asset sale; financing used $2.62 billion, including $2.24 billion of debt payments and $191.5 million of share repurchases.
Outlook, management commentary, and unusual items
- Pricing and segments: Management expects continued pricing pressure in CHCA and RX. It forecast a high-single-digit RX pricing decline for 2017 and said 2017 RX sales would be reduced by approximately $67 million due to increased competition for Entocort.
- Cost actions: A workforce plan targets approximately 750 fewer employees, about 14% of global non-production staff. Estimated total pretax restructuring charges are $55–$65 million; $54.7 million was recognized in the first nine months. The cost-optimization plan is expected to generate approximately $130 million in annual savings by mid-2018.
- Asset sales: Perrigo sold its Tysabri royalty asset to Royalty Pharma for $2.2 billion cash and potential milestone payments of up to $250 million in 2018 and $400 million in 2020, subject to sales thresholds. The milestone asset was valued at $143.2 million at quarter-end; its fair value declined amid expected competition from Ocrevus. Perrigo also agreed to sell its Israel API business for $110 million cash, with closing expected within three months of the filing, and completed sales of its India API and Russian businesses.
- Taxes and legal matters: The nine-month effective tax rate was 68.7%, affected by non-deductible debt-cancellation fees, discrete tax items, and additional deferred-tax valuation allowances. Uncertain tax positions totaled $454.9 million. Perrigo is seeking $163.6 million in federal tax refunds and disclosed an IRS draft transfer-pricing adjustment relating to an acquired subsidiary that could be material but was not quantifiable. Litigation includes securities, generic-drug pricing, antitrust, Eltroxin, Tysabri product-liability, and Omega acquisition arbitration matters; outcomes and potential losses are uncertain.
- Controls and leadership: Disclosure controls were ineffective at September 30, 2017 because of material weaknesses in internal control. Weaknesses involving Tysabri accounting and impairment testing were reported as remediated; income-tax control weaknesses remained under remediation. The company was searching for a successor CEO and, subsequently, a permanent CFO; the acting CFO remained in place.
- Accounting outlook: Perrigo planned to adopt the revenue recognition standard on January 1, 2018 using the modified retrospective method. Its initial assessment indicated some contract manufacturing and private-label arrangements could qualify for over-time revenue recognition; the final impact had not yet been quantified.
Most important facts for investors to verify
- Whether sales and operating performance stabilize after divestitures, cancelled contracts, product discontinuations, and ongoing pricing pressure—especially in RX and CHCI.
- Whether the expected $130 million annual cost savings are achieved by mid-2018, and the final restructuring costs and timing.
- Debt reduction, cash deployment, and the extent to which Tysabri milestone payments are earned as Ocrevus competition develops.
- Progress in remediating the remaining income-tax control weaknesses and maintaining effective financial reporting controls.
- Outcomes of significant IRS disputes, uncertain tax positions, securities and pricing litigation, and other disclosed contingencies.
- Completion and proceeds of the proposed Israel API sale, and whether management and finance leadership transitions proceed without disruption.