Business context and reporting period
Valeant Pharmaceuticals International, Inc. (now Bausch Health Companies Inc.) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company develops and sells branded and generic pharmaceuticals, OTC products, and medical devices in more than 100 countries. It reorganized reporting into Bausch + Lomb / International, Branded Rx, and U.S. Diversified Products. Comparatives for the nine months ended September 30, 2015 are restated.
Financial performance and position
| Metric | Q3 2016 | Nine months 2016 | Comparable 2015 |
|---|---|---|---|
| Revenue | $2.480 billion | $7.271 billion | $2.787 billion / $7.689 billion |
| Operating income (loss) | $(863) million | $(716) million | $448 million / $1.360 billion |
| Net income (loss) attributable to Valeant | $(1.218) billion | $(1.894) billion | $49.5 million / $94.2 million |
| Diluted earnings (loss) per share | $(3.49) | $(5.47) | $0.14 / $0.27 |
| Operating cash flow | Not provided for quarter | $1.575 billion | $1.660 billion |
- Revenue declined 11% in Q3 and 5% year to date. Existing-business sales weakness, especially in Branded Rx and U.S. Diversified Products, outweighed acquired-business contributions.
- Cost of goods sold was 26% of revenue in Q3 and for the nine-month period, versus 23% and 24%, respectively, in 2015. Total segment profit was $1.244 billion in Q3 and $3.377 billion year to date, down 17% and 16%; segment profit margin fell to 50% and 46% from 54% and 52%.
- Operating results included a $1.049 billion goodwill impairment in Q3 and $2.389 billion of amortization and impairments of finite-lived intangibles year to date. These charges materially contributed to reported losses.
- At September 30, cash was $658.5 million, current assets $5.674 billion, and current liabilities $3.897 billion. Long-term debt, including current portion, was $30.445 billion; shareholders’ equity was $4.167 billion. The filing reports no current ratio.
- Year-to-date debt repayments were $1.917 billion, partly offset by $1.220 billion of new borrowings, principally under the revolver. Cash increased $61 million during the period. Contractual long-term debt obligations including interest totaled $39.928 billion.
- Interest expense was $470 million in Q3 and $1.369 billion year to date, up 12% and 21%. The company estimated that a 100-basis-point rise in rates would add about $113 million to annual pretax interest expense on variable-rate debt.
Material changes versus prior comparable periods
- Branded Rx revenue fell 23% in Q3 and 10% year to date; U.S. Diversified Products fell 17% and 10%. Bausch + Lomb / International rose 4% in Q3 and was approximately flat year to date.
- Management attributed declines to lower realized prices and rebates, changes to the Walgreens fulfillment model, generic competition, lower price-appreciation credits, foreign exchange, and discontinued or divested products. Revenue provisions rose to 40% of gross product sales in both 2016 periods, versus 36% in Q3 2015 and 32% year to date.
- The 2015 comparative statements were restated primarily for Philidor revenue-recognition errors. For the nine months ended September 30, 2015, restated revenue was $20.8 million lower and attributable net income was $24 million higher than previously reported; cash-flow totals were unchanged.
- Goodwill declined from $18.553 billion at December 31, 2015 to $17.450 billion at September 30, 2016. In addition to the $1.049 billion goodwill impairment, the company recorded write-downs associated with Ruconest and businesses held for sale.
Outlook, commentary, risks and unusual items
- Management said it expected cash and operating cash generation to meet liquidity needs for the next 12 months and beyond, and expected to remain covenant-compliant based on its forecast. However, it disclosed limited headroom under the 2.50-to-1 secured leverage covenant and warned that further underperformance without debt reduction could cause a breach, acceleration, and refinancing difficulty.
- The company’s stated priorities included reducing debt, improving profitability and resource allocation, growing key therapeutic areas, and pursuing product launches. It expected acquisitions to be minimal in 2016 and the foreseeable future, partly due to debt-reduction priorities and credit-agreement restrictions. No numeric revenue or earnings guidance is provided in the supplied filing text.
- Credit amendments lowered the interest-coverage covenant threshold to 2.00-to-1 for quarters beginning September 30, 2016, while increasing borrowing costs. Moody’s had downgraded the corporate rating to B3 on November 8, 2016 and the outlook was negative; S&P’s rating was B with a stable outlook.
- Management concluded disclosure controls were ineffective as of September 30, 2016 because of material weaknesses involving tone at the top and non-standard revenue transactions. Remediation was underway; effectiveness had not yet been demonstrated.
- Significant legal and regulatory exposure included investigations and inquiries concerning Philidor, pricing, distribution, accounting and product marketing, as well as U.S. and Canadian securities and other class actions. The company generally said outcomes and potential losses could not be reliably predicted. It disclosed a $20 million Texas demand that it disputed and a Salix-related settlement of approximately $54 million plus interest and fees, largely paid in 2016.
- Other notable items included the voluntary PeroxiClear product recall, a $199 million Ruconest impairment and $88 million of impairments for businesses classified as held for sale. The FDA delayed its brodalumab decision date to February 16, 2017; latanoprostene bunod received a Complete Response Letter related to manufacturing inspection deficiencies, not identified efficacy or safety concerns.
Most important facts for investors to verify
- Debt repayment capacity, covenant headroom, required asset-sale proceeds, and refinancing options in light of approximately $30.4 billion of debt and higher interest costs.
- Whether revenue trends, rebate and chargeback rates, and Walgreens-related pricing effects stabilize, particularly in dermatology and Salix products.
- Progress and independent validation of internal-control remediation, and any further accounting revisions or delayed filings.
- Final goodwill impairment testing, including Salix valuation assumptions, and any additional impairments involving Addyi or other products.
- Developments and potential financial consequences from Philidor-related investigations, securities litigation, pricing inquiries, and other disclosed proceedings.
- Regulatory outcomes and commercial performance for brodalumab, latanoprostene bunod, Oral Relistor, and Addyi, including the contractual Addyi spending obligation.