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, 2015. It operated a global specialty pharmaceutical and medical-device business. The April 1, 2015 Salix acquisition substantially expanded the company and its gastrointestinal product portfolio; reported results therefore include acquired businesses for only part of the comparison period.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $2.787 billion | $2.056 billion | $7.710 billion | $5.984 billion |
| Operating income | $448 million | $684 million | $1.333 billion | $1.396 billion |
| Net income attributable to Valeant | $50 million | $275 million | $70 million | $379 million |
| Diluted EPS | $0.14 | $0.81 | $0.20 | $1.11 |
| Operating cash flow | $737 million | $619 million | $1.638 billion | $1.479 billion |
- Revenue rose 36% in Q3 and 29% year to date, but acquisitions were the main driver. Management attributed $647 million of Q3 revenue growth and $1.43 billion of nine-month growth to acquisitions. Excluding acquisitions, foreign exchange, divestitures and discontinuations, existing-business product sales increased $253 million and $891 million, respectively.
- Operating margin was approximately 16% in Q3, down from 33% a year earlier. Higher amortization, SG&A, other expense and interest costs outweighed increased product contribution. Net income attributable to Valeant fell 82% in Q3 and 81% for the nine-month period. The Q3 bottom line included a $57 million income-tax benefit despite a pretax loss.
- Cost of goods sold was 23% of revenue in Q3 versus 27% a year earlier. However, sales deductions increased: provisions were 41% of gross product sales in Q3 versus 32% in 2014, reflecting product mix, rebates, chargebacks and assistance programs.
- Cash and equivalents were $1.420 billion at September 30, 2015, versus $322.6 million at year-end 2014. Current assets were $6.996 billion and current liabilities $4.651 billion. Operating cash flow increased, while working capital absorbed cash, particularly through receivables.
- Total debt carrying value was approximately $30.88 billion, including $707 million classified as current, compared with $15.23 billion at year-end 2014. Interest expense was $420 million in Q3 and $1.131 billion year to date. The company reported compliance with debt covenants and said cash and operating cash generation should cover current needs and maturities.
- Nine-month investing cash outflow was $14.04 billion, principally reflecting acquisitions; financing provided $13.52 billion, largely from debt and equity raised to fund Salix. Capital expenditures were $164 million year to date.
Material changes versus prior period
- Salix and other acquisitions drove much of the revenue, asset and debt expansion. Total assets rose to $48.45 billion from $26.33 billion; goodwill increased to $17.37 billion from $9.35 billion, and net intangible assets to $22.38 billion from $11.26 billion.
- Developed Markets revenue increased 54% in Q3 and 43% year to date, substantially reflecting acquired products. Emerging Markets revenue declined 15% and 12%, respectively, with foreign-exchange pressure a major factor. The U.S. dollar’s strength reduced existing-business revenue by $168 million in Q3 and $472 million year to date.
- Q3 2014 included a $324 million gain from selling aesthetic filler and toxin assets; Q3 2015 instead included, among other items, a $25 million AntiGrippin litigation charge. This comparison contributed to the decline in operating and net income.
- Salix-related amortization, acquired inventory accounting adjustments, integration costs and higher interest expense weighed on reported earnings. The company recorded a $90 million write-off for a terminated Rifaximin SSD development program and a $26 million Zelapar impairment in Q3.
Outlook, commentary, risks and contingencies
- Management identified approximately $530 million in annual run-rate Salix cost synergies, expected substantially by year-end 2015, and estimated approximately $300 million of related integration and rationalization costs, with work expected substantially complete by mid-2016. It reported more than $900 million of annual run-rate Bausch & Lomb synergies substantially achieved by the end of 2014. The filing did not provide numeric revenue or earnings guidance.
- Management said liquidity sources were expected to meet current needs, while warning that acquisitions could require further debt, equity issuance or asset sales. Moody’s rating was Ba3 and S&P’s BB-; the filing highlighted downgrade and floating-rate borrowing risks. A 100-basis-point increase in rates was estimated to raise annual pretax interest expense by approximately $81 million on current variable-rate debt.
- Philidor-related scrutiny was a significant emerging risk. The network represented 7% of consolidated net revenue in Q3 and 6% year to date. After allegations surfaced, the board established an ad hoc committee to review the relationship; management stated the audit committee and board had reviewed and confirmed the accounting treatment through October 26, 2015. Two U.S. Attorney’s Offices had subpoenaed the company regarding, among other topics, patient assistance, distribution, information provided to CMS and pricing. The company said it intended to cooperate; outcomes and potential losses were uncertain.
- Other disclosed legal and regulatory matters included investigations concerning pricing and promotional practices, Salix-related investigations and litigation, an FTC information request regarding Paragon, and shareholder suits. The company cautioned that adverse outcomes in some matters could materially affect results; many losses could not be reasonably estimated.
- Foreign-exchange exposure, generic competition, reimbursement and pricing restrictions, acquisition integration, product safety, intellectual-property challenges, tax uncertainty and potential intangible-asset impairments were identified risks. Salix purchase-accounting valuations remained provisional.
- Subsequent to quarter-end, the company acquired Sprout for approximately $1 billion plus potential future profit-based consideration, acquired Amoun for approximately $838 million plus contingent payments, and licensed brodalumab, including a $100 million upfront payment and potential additional milestones.
Most important facts for investors to verify
- How much of reported growth and cash generation is sustainable organic performance versus acquired revenue, working-capital timing and currency effects.
- Whether the higher rebates and other sales deductions persist, and how gross-to-net estimates and returns reserves develop.
- Philidor’s revenue recognition, collectability, channel inventory and the findings or consequences of the independent review and government investigations.
- Debt repayment capacity, refinancing needs, covenant headroom and sensitivity to floating interest rates, given approximately $30.9 billion of debt.
- Realization and timing of Salix synergies, remaining integration costs, and any further acquired-asset impairments or legal contingencies.