Jazz Pharmaceuticals Plc quarterly report, Q2 FY2012

Jazz Pharmaceuticals plc — Q2 2012 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2012. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.

Business context and comparability

Jazz is a specialty biopharmaceutical company. The January 18, 2012 Azur Pharma merger was accounted for as a reverse acquisition, and EUSA Pharma was acquired on June 12, 2012. Accordingly, 2012 results include Azur only from January 18 and EUSA only from June 12, while prior-year reported results reflect Jazz Pharmaceuticals, Inc. alone. Reported year-over-year growth therefore is not a like-for-like measure of underlying growth.

Financial performance

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Total revenue	$129.5	$64.6	$238.0	$115.4
Operating income	$35.5	$33.9	$68.6	$56.5
Net income	$27.1	$33.2	$54.8	$55.0
Diluted EPS	$0.45	$0.71	$0.92	$1.19
Operating cash flow	Not separately stated for the quarter	$101.3	$61.9

• Q2 product sales were $128.3 million, up 102%; first-half product sales were $235.6 million, up 108%. Xyrem sales were $89.1 million in Q2 and $162.5 million for the half, increases of 59% and 64%, respectively. Management attributed Xyrem growth mainly to price increases and, to a lesser extent, 11% volume growth in both periods.
• Reported gross margin on product sales was 88.0% in Q2 and 88.9% for the first half, versus 94.7% and 94.5% a year earlier. Management expected the margin percentage to decline in 2012, partly due to the acquired businesses and acquisition-related inventory valuation adjustments.
• SG&A was $60.6 million in Q2 and $107.6 million for the half; increases reflected acquired operations, higher staffing and commercial costs, and transaction and integration costs. Intangible amortization rose to $15.8 million and $29.3 million, respectively, following the acquisitions.
• GAAP net income declined in Q2 and was nearly flat for the first half. The 2012 periods included income tax expense ($6.6 million Q2; $12.1 million first half), while the comparable 2011 periods had none. Diluted share counts also increased. Company-defined adjusted net income was $66.2 million for Q2 and $119.2 million for the first half, versus $38.4 million and $65.1 million; this non-GAAP measure excludes specified acquisition, amortization, share-based compensation and other items.

Balance sheet, cash and debt

• At June 30, cash and cash equivalents were $154.5 million, versus $82.1 million at year-end 2011; there were no marketable securities at quarter-end. Current assets were $300.4 million and current liabilities $192.3 million.
• First-half operating cash flow was $101.3 million. Investing cash outflow was $478.7 million, principally reflecting the EUSA acquisition; financing inflow was $450.4 million, mainly term-loan proceeds. Cash increased by $72.5 million over the half.
• The June credit agreement provided a $475 million six-year term loan and a $100 million five-year revolving facility. The term loan was used partly to finance EUSA; its June 30 interest rate was 5.25% and effective rate 6.7%. No revolver borrowings were outstanding. Term-loan principal repayments begin in September 2012, and a maximum secured leverage covenant begins with the September 2012 quarter. The debt is secured by substantially all assets of the borrowers and guarantors.
• Management said cash, expected operating cash flow and available revolver capacity should fund operations and existing obligations for the foreseeable future, while noting that this depends on assumptions including product sales and expenses.
• Goodwill was $446.2 million and net intangible assets $927.4 million at June 30, largely reflecting the acquisitions. A $185.7 million deferred tax liability primarily related to acquired EUSA intangibles and in-process R&D.

Material developments, outlook and risks

• EUSA was acquired for an upfront cash payment of $678.4 million. Jazz also recorded contingent consideration initially valued at $35.1 million for a possible $50 million payment if Erwinaze U.S. net sales reach $124.5 million in 2013. EUSA contributed $8.0 million revenue and a $1.6 million net loss from the acquisition date through quarter-end. Purchase-price allocations for both acquisitions remained preliminary.
• Management expected 2012 total product sales to increase versus 2011, driven by Xyrem and Luvox CR growth and the expanded portfolio. It expected higher SG&A, amortization, interest expense and R&D expense than in 2011; royalty and contract revenue was expected to decrease slightly. No specific numerical full-year earnings or revenue guidance is provided in the text summarized here. Management did not expect significant operating-cost synergies from the acquisitions and planned to focus on integration.
• Xyrem remained highly significant, comprising 69% of net product sales in both the quarter and first half. Roxane’s generic-Xyrem patent litigation continued; the 30-month FDA approval stay was described as ending April 18, 2013 unless earlier displaced by a court decision. Jazz filed FDA citizen petitions regarding generic bioequivalence and risk-management requirements and said their timing and effect were uncertain.
• FDA oversight of Xyrem was a material risk: the company had received an October 2011 warning letter and a May 2012 Form FDA 483 concerning adverse-event reporting and safety procedures. Jazz reported fewer than 80 previously unreported serious adverse events identified in its review, about half classified as serious and unexpected, including a small number of deaths; it said expedited reports were submitted in July and the remainder was planned for a September safety report. Management said it believed corrective actions were substantially complete or near completion, but could not predict FDA conclusions or further requirements.
• Other notable risks include reliance on Xyrem, possible generic competition, dependence on sole-source manufacturers and distributors, customer concentration, reimbursement and pricing pressure, acquisition integration, regulatory and clinical-development uncertainty, and foreign-exchange exposure. Express Scripts accounted for 69% of Q2 revenue and 46% of gross receivables at June 30; five customers represented 71% of gross receivables.
• Other product and legal developments include the FazaClo LD Teva sublicense taking effect in July 2012 and the possibility of an authorized generic launch; Luvox CR sublicenses generally scheduled to begin in April 2014 or earlier upon specified events; and a Cutler dispute alleging a contingent payment of either $10.5 million or $25 million plus unspecified damages. The arbitration was dismissed July 25, 2012 because the dispute was found outside the arbitration clause; the filing gives no final resolution of the underlying dispute.
• Management reported disclosure controls were effective as of June 30, while integration of the acquired companies’ internal controls was ongoing. The company reported no off-balance-sheet arrangements.

Investor verification priorities

• Separate organic product growth from the effects and timing of the Azur merger and EUSA acquisition; review the unaudited pro forma results alongside reported figures.
• Track Xyrem sales, generic-litigation and FDA-petition developments, and the FDA’s response to the adverse-event reporting findings and remediation.
• Verify the Erwinaze sales trajectory against the $124.5 million 2013 threshold for the potential $50 million contingent payment, and monitor supply reliability and post-marketing obligations.
• Assess debt service, covenant compliance and liquidity after scheduled term-loan amortization begins; confirm actual cash generation and acquisition-integration costs.
• Review customer and supplier concentration, product reimbursement and pricing, and the outcome or exposure from the Cutler matter and other disclosed legal proceedings.