Perrigo Company plc — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 29, 2018. Figures are in U.S. dollars; financial statements are unaudited. Perrigo sells consumer healthcare products and prescription pharmaceuticals through Consumer Healthcare Americas (CHCA), Consumer Healthcare International (CHCI), and Prescription Pharmaceuticals (RX).
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $1,133.1m | $1,231.3m | $3,536.5m | $3,663.1m |
| Gross profit / margin | $424.8m / 37.5% | $497.8m / 40.4% | $1,388.5m / 39.3% | $1,466.7m / 40.0% |
| Operating income (loss) | $(122.0)m | $162.4m | $129.0m | $439.6m |
| Net income (loss) | $(67.5)m | $44.5m | $49.6m | $46.4m |
| Diluted EPS | $(0.49) | $0.31 | $0.36 | $0.32 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $398.7m | $482.0m |
Q3 sales declined 8%, chiefly from competitive pricing and lower volumes in CHCA and RX; nine-month sales declined 3%. Q3 operating results included $221.8m of impairment charges, primarily related to animal-health goodwill and intangible assets. Q3 also included a $74.9m increase in the fair value of contingent Tysabri milestone payments, recorded as a gain, partly offsetting other pressures. Nine-month operating income fell 71%, principally due to impairment charges.
- Segment trends: Q3 CHCA sales were $596.2m, nearly flat year over year, but the segment recorded a $123.9m operating loss, including impairment charges. CHCI sales fell 2% to $357.6m and operating loss was $2.0m. RX sales fell 29% to $179.3m and operating income fell 56% to $36.0m, reflecting pricing pressure, product mix, and lower volumes.
- Cash and liquidity: Cash was $444.2m at September 29, down from $678.7m at year-end 2017. Nine-month operating cash flow was $398.7m; capital expenditures were $56.8m. Cash used in investing was $80.7m and cash used in financing was $537.6m.
- Debt: Total borrowings were $3,265.2m, including $194.2m current debt; cash less total borrowings was approximately $2,821m. The $1.0bn revolving credit facility had no borrowings outstanding. Perrigo reported compliance with debt covenants.
- Capital returns: Perrigo repurchased $400.0m of shares and paid $78.7m in dividends during the first nine months. The board authorized a new share repurchase program of up to $1.0bn in October 2018.
Material changes and comparability
- Q3 gross margin contracted 290 basis points; management attributed the decline mainly to RX product mix. Nine-month gross margin fell 70 basis points.
- RX continued to face substantial competition-driven pricing declines. Nine-month RX sales were down 15%, while operating income declined 35%.
- CHCI nine-month sales rose 2% and operating income increased to $18.4m from $8.7m, supported by new products, favorable currency, improved mix, and manufacturing insourcing.
- ASC 606 revenue recognition was adopted in 2018; 2017 comparatives use the prior standard. Adoption increased reported 2018 net sales by $9.7m in Q3 and $8.4m year to date versus the former method, with corresponding cost-of-sales effects.
- Nine-month interest expense declined to $95.2m from $133.1m, largely reflecting prior debt repayments. The 2017 comparison included a $135.2m debt-extinguishment loss; 2018 recorded $0.5m.
Outlook, commentary, risks, and unusual items
- Management forecast an 11%–14% RX pricing decline for full-year 2018 and expected pricing softness to persist for the foreseeable future. No consolidated earnings or revenue guidance is provided in the filing.
- Perrigo announced plans to separate RX, potentially through a sale, spin-off, merger, or other structure, targeting the second half of 2019. Estimated preparation costs are $45m–$80m, excluding restructuring and transaction costs. The form, timing, completion, and benefits are uncertain.
- Management described a growth-focused review of business opportunities and portfolio priorities. In October 2018, Perrigo appointed Murray Kessler as CEO following Uwe Roehrhoff’s resignation.
- Animal-health weakness prompted $136.7m of goodwill impairment and additional intangible impairments; management said the final goodwill valuation could change the estimate. Customer/channel changes, lower forecasts, pricing pressure, RX competition, commodity costs, and operational inefficiencies are notable business risks.
- The company’s disclosure controls and internal control over financial reporting were deemed ineffective because of an unremediated material weakness in income-tax accounting controls. Management was implementing remediation but had not yet demonstrated sustained operating effectiveness.
- Tax matters include a $163.6m refund claim under IRS litigation and other U.S. and Irish tax disputes. Perrigo said potential outcomes of certain audits could be material but were not quantifiable. An Irish Revenue audit finding letter concerning the historical Tysabri asset sale was received October 31, 2018, after quarter-end.
- Generic-drug price-fixing litigation and multiple securities lawsuits remain ongoing; Perrigo said outcomes could not be reasonably predicted. An Israeli Eltroxin class settlement remained subject to court and Attorney General review.
- The $200.4m fair value of potential Royalty Pharma milestone payments depends on Tysabri global sales thresholds. Failure to meet the 2018 or 2020 threshold could require write-offs; meeting them could produce additional income. These valuation changes contributed to earnings volatility.
Investor verification priorities
- Track RX pricing, volumes, and customer service, and assess whether the 11%–14% full-year pricing decline estimate was borne out.
- Review the animal-health impairment valuation and subsequent segment performance for evidence of further impairment or recovery.
- Monitor operating cash flow, inventory levels, debt repayment, and the use of the new repurchase authorization relative to liquidity needs.
- Confirm progress, costs, financing and tax implications, and any change in timing or structure of the proposed RX separation.
- Follow remediation and testing of income-tax controls, and developments in IRS and Irish Revenue disputes, price-fixing and securities litigation.
- Verify actual Tysabri milestone outcomes against the disclosed sales thresholds and related fair-value assumptions.