Bausch Health Companies Inc. quarterly report, Q2 FY2018

Bausch Health Companies Inc. — Q2 2018 Form 10-Q

Reporting period: Three and six months ended June 30, 2018. Unaudited; amounts in U.S. dollars unless noted. The company, formerly Valeant Pharmaceuticals International, changed its name to Bausch Health Companies Inc. effective July 13, 2018.

Business context

The company develops and sells branded, generic and OTC pharmaceuticals and medical devices, with a stated strategic focus on eye health, gastrointestinal (GI) products and dermatology. Beginning in Q2, it reported four segments: Bausch + Lomb/International, Salix, Ortho Dermatologics and Diversified Products.

Key financial metrics

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Revenue	$2.128bn	$2.233bn	$4.123bn	$4.342bn
Operating income (loss)	$(245)m	$175m	$(2.526)bn	$386m
Net income (loss) attributable to Bausch Health	$(873)m	$(38)m	$(3.454)bn	$590m
Basic and diluted EPS	$(2.49)	$(0.11)	$(9.84)	$1.69 basic; $1.68 diluted
Operating cash flow	Not separately presented	Not separately presented	$660m	$1.222bn

Q2 product sales were $2.100bn; other revenue was $28m. Cost of goods sold, excluding amortization and impairments, was $584m. Product gross margin on that basis was approximately 72%, versus 71% in Q2 2017.
Interest expense was $435m in Q2 and $851m for the first half. The company’s weighted-average stated debt rate was 6.28% at June 30, up from 6.07% at December 31, 2017.
At June 30, cash and cash equivalents were $838m; current assets were $4.639bn and current liabilities $4.074bn. Long-term debt, net of discounts and issuance costs, was $25.088bn; gross contractual principal was $25.429bn.
For the first half, investing activities used $139m and financing activities used $465m. Cash and cash equivalents increased $41m from the beginning of the period.
The company reported total segment profits of $959m in Q2, versus $973m, and $1.812bn for the first half, versus $1.896bn. These segment measures exclude specified costs, including amortization and impairments.

Material changes versus prior comparable periods

Revenue fell 5% year over year in both Q2 and the first half. For the first half, the filing attributes the decline mainly to 2017 divestitures and discontinuations and lower volume from loss of exclusivity; higher realized pricing and favorable foreign exchange partly offset the decline. Organic revenue, a non-GAAP measure, rose 3% in Q2 and 2% in the first half.
Salix was a relative strength: Q2 revenue increased 14% to $441m and first-half revenue increased 25% to $863m, driven largely by Xifaxan pricing and volume. Ortho Dermatologics revenue declined 12% in Q2 and 25% in the first half. Diversified Products revenue declined 27% in both periods, reflecting divestitures and generic competition.
First-half operating results included $2.213bn of goodwill impairment charges recorded upon early adoption of revised goodwill impairment guidance, relating to Salix ($1.970bn) and Ortho Dermatologics ($243m). There was no goodwill impairment in Q2; the Ortho Dermatologics reporting unit’s estimated fair value exceeded carrying value by approximately 5% at the test date.
Asset impairments were $301m in Q2 and $345m for the first half, primarily related to lower forecasts following generic competition. Amortization expense rose 19% in Q2 and 18% in the first half, partly due to revised useful-life estimates.
Operating cash flow declined $562m year over year in the first half, primarily due to less favorable changes in operating assets and liabilities; the prior-year comparison benefited from collections of receivables and timing of other receipts and payments.
The company refinanced debt in March and June. At June 30, it had $325m drawn and $731m of remaining availability under its 2023 revolving facility, after $169m of letters of credit. Gross debt decreased $323m from year-end, while maturities were extended and the weighted-average stated interest rate increased.

Outlook, commentary and risks

Management said available cash and expected operating cash generation should meet liquidity needs and debt service for the next 12 months, and expected covenant compliance over that period. It reported compliance with financial maintenance covenants at June 30. These are forward-looking statements, not guarantees.
Expected primary cash requirements for the remainder of 2018 included approximately $900m for debt service, $140m for capital expenditures, $25m for contingent consideration, $25m for restructuring and integration, and $10m for benefit obligations.
Management expected 2018 R&D expense to exceed 4% of revenue. It cited more than 175 pipeline projects and anticipated submitting about 60 for regulatory approval in 2018–2019. It described the “Significant Seven” product prospects over five years as substantial, while noting 2017 revenue from the group was below $100m. No specific consolidated revenue or EPS guidance is provided in the filing text.
The FDA issued a Complete Response Letter for Duobrii, citing questions regarding pharmacokinetic data. Management planned to submit additional data in Q3 2018 and expected a Class II review, usually six months. Approval and timing remain uncertain.
Generic competition is a material risk. A generic competitor launched for Uceris Tablet in July 2018; the company cited Uceris revenues of approximately $70m in the first half of 2018 and $134m in 2017. A patent review decision invalidated one Jublia patent; the company appealed on August 7, 2018. The outcome and revenue effects are uncertain.
Key risks include substantial debt and interest-rate exposure, covenant compliance, product and goodwill impairments, generic challenges and pricing pressure, pending investigations and litigation, regulatory approvals, reimbursement and formulary access, and the company’s ability to execute its pipeline and turnaround plans. The company also maintained a commitment to limit average annual branded prescription price increases to single digits and below the industry’s five-year weighted average.
Legal matters include ongoing U.S. and Canadian securities litigation and government investigations involving, among other matters, pricing, accounting, distribution and the former Philidor relationship. The company reported $54m of accrued current loss contingencies. The Allergan settlement received court approval in June; the company’s $96m share had been paid into escrow, with insurance recovery not assured. Solodyn antitrust settlements totaling $58m for class actions, plus additional opt-out consideration, had been paid.
The filing identifies a non-material error in Q1 2018 tax and foreign-currency translation reporting; management said June 30 reported amounts were unaffected and the Q1 information would be revised in future filings. Management concluded the misstatements were not material.

Most important facts for investors to verify

Whether operating cash generation and available revolver capacity are sufficient to meet debt service, required amortization and covenant tests, given approximately $25.4bn of gross debt.
Actual revenue and margin effects from Uceris and other generic entries, including the reconciliation of the filing’s Uceris-related impairment disclosures.
Progress and timing of Duobrii’s FDA resubmission and other pipeline approvals, and whether new launches produce the growth management anticipates.
Developments in securities, regulatory, pricing and other litigation matters, including the amount of any additional exposure and insurance recoveries.
Future impairment assumptions and results, particularly for Salix and Ortho Dermatologics; the latter’s estimated fair value exceeded carrying value by only about 5% in the June test.
Final tax accounting under the Tax Act and correction of the disclosed Q1 reporting error in subsequent filings.