Perrigo Company plc — 2016 Form 10-K
Reporting period: Year ended December 31, 2016. The filing also reports fourth-quarter results. Perrigo changed its fiscal year to the calendar year, so periods shown are not all directly comparable; management’s calendar-2015 comparison combines audited and unaudited periods.
Business context and financial results
Perrigo sells consumer healthcare products, store-brand infant nutrition, generic prescription drugs and active pharmaceutical ingredients, principally in North America and Europe. Its reporting segments are Consumer Healthcare Americas (CHCA), Consumer Healthcare International (CHCI), Prescription Pharmaceuticals (RX), Specialty Sciences and Other.
| Metric | 2016 | Comparable information / context |
|---|---|---|
| Net sales | $5.281 billion | Management’s calendar-2015 comparison: $5.015 billion; increase of about 5.3%. |
| Gross profit / margin | $2.052 billion / 38.9% | Calendar-2015 comparison: $2.049 billion / 40.9%. |
| Operating income (loss) | $(2.000) billion | Includes $2.631 billion of impairment charges. |
| Net income (loss) / diluted EPS | $(4.013) billion / $(28.01) | Includes the large non-cash reduction in the Tysabri royalty asset’s fair value. |
| Operating cash flow | $654.9 million | Down $109.4 million from the reported six-month comparison cited in the cash-flow discussion; periods differ in length. |
| Investing / financing cash flow | $(175.0) million / $(268.7) million | Investing included acquisitions and $353.7 million of Tysabri royalty receipts; financing included debt repayment. |
| Cash and debt at year-end | $622.3 million cash; $5.797 billion total borrowings | Current indebtedness was $572.8 million; long-term debt, net of current portion, was $5.225 billion. |
Fourth quarter: Net sales were $1.331 billion, gross profit was $487.7 million, net loss was $1.359 billion and diluted loss per share was $9.48. The quarter included $378.6 million of intangible-asset impairment and $224.1 million of goodwill impairment; the Tysabri royalty asset’s fair value fell by $1.116 billion.
Material changes versus prior periods
- CHCA sales declined about 2% to $2.507 billion; operating income fell about 9% to $399.8 million amid pricing pressure, a milder cough-and-cold season and the VMS divestiture.
- CHCI sales rose to $1.652 billion, partly because 2016 included a full year of Omega operations versus a partial year in 2015. The segment recorded a $2.042 billion operating loss, primarily from impairments of Omega-related goodwill and intangible assets.
- RX sales increased about 4% to $1.043 billion, but operating income fell from $377.8 million to approximately break-even. Competitive pressure, lower pricing and a $342.2 million Entocort impairment were major factors.
- Gross margin fell 2.0 percentage points year over year on management’s calendarized comparison. Company-wide impairment charges totaled $2.631 billion.
- The filing restated prior financial statements. The Tysabri royalty stream was reclassified from an intangible asset to a Level 3 financial asset measured at fair value; receipts moved from operating to investing cash flows, and fair-value changes moved to non-operating results. The restatement also corrected Omega-related deferred-tax accounting and other items.
Outlook, management commentary and risks
- Management forecast a 9%–11% RX pricing decline in 2017. It expected the cancellation of the unprofitable Belgian EuroGenerics agreement and other distribution exits to reduce CHCI 2017 sales by about $200 million.
- A company-wide workforce plan announced in February 2017 targeted approximately 750 positions, about 14% of global non-production staff. Perrigo estimated $70–$80 million of pre-tax restructuring costs, mostly in 2017, and approximately $130 million of annual savings by mid-2018; these savings are not assured.
- In March 2017 Perrigo completed the sale of its Tysabri royalty rights for $2.2 billion cash plus potential milestone payments of $250 million and $400 million, dependent on sales thresholds. Management said it intended to use proceeds and residual free cash flow to reduce debt. The sale followed a 2016 fair-value reduction and competition concerns, including the expected impact of Ocrevus.
- Management expected 2017 net sales to be reduced by approximately $72 million because of increased Entocort competition. The RX business was undergoing a strategic review. Perrigo also completed the sale of its India API business in April 2017 and was exploring strategic alternatives for its Israel API operations.
- Reporting and controls: Management and the auditor concluded internal control over financial reporting was ineffective at December 31, 2016 due to material weaknesses involving acquisition accounting, Tysabri financial-asset accounting, income taxes and impairment testing. The auditor gave an adverse opinion on internal controls, while issuing an unqualified opinion on the financial statements. Remediation was ongoing.
- Filing and debt risk: The 10-K states Perrigo was not current with SEC reporting obligations and had not filed its April 1, 2017 Form 10-Q. Credit agreements were amended and waivers obtained; the company said it was covenant-compliant as of the 10-K filing date, but warned further reporting delays could threaten compliance.
- Legal, regulatory and tax exposures: Perrigo disclosed securities litigation, Tysabri product-liability cases, generic-drug price-fixing lawsuits, an Omega acquisition arbitration and IRS disputes. Search warrants were executed at Perrigo facilities in May 2017 as part of a government drug-pricing investigation; the filing said no charges had been brought against Perrigo at that time. The company reported $398 million of uncertain-tax-position liabilities and disputed IRS assessments, including an approximately $74.2 million assessment for 2011–2012.
Important facts for investors to verify
- Review the restated statements and notes, including the Tysabri fair-value assumptions and the reconciliation of the unusually large 2016 loss.
- Check whether Perrigo filed subsequent reports on time, remediated the identified control weaknesses and maintained compliance with debt covenants.
- Track debt reduction from Tysabri sale proceeds, the timing and conditions of potential milestone receipts, and refinancing or rating developments.
- Assess whether RX pricing erosion, CHCI distribution exits and the Entocort competition impact matched management’s 2017 expectations.
- Monitor impairment risk in remaining goodwill and intangible assets, and the progress and realized costs and savings of restructuring.
- Follow developments in the antitrust investigation, securities and product-liability litigation, Omega arbitration and IRS disputes.