Bausch Health Companies Inc. annual report, FY2017

Business context and reporting period

This is Valeant Pharmaceuticals International, Inc.’s Form 10-K for the fiscal year ended December 31, 2017, filed February 28, 2018. The company, now identified in the request as Bausch Health Companies Inc., reported three segments: Bausch + Lomb/International, Branded Rx, and U.S. Diversified Products. Its strategy shifted toward eye health, gastrointestinal and dermatology businesses, with divestitures of non-core assets to reduce debt.

Financial performance and liquidity

Revenue declined 10%; reported net income principally reflected a $4.145 billion income tax benefit, including provisional tax-reform effects and benefits from internal restructuring. It should not be read as a measure of recurring operating profitability. Operating income included $312 million of goodwill impairment, $714 million of asset impairments, and $580 million of net gains on asset sales. Interest expense was $1.840 billion.

For Q4 2017, revenue was $2.163 billion, operating loss was $322 million, net income attributable to Valeant was $513 million, and operating cash flow was $578 million. The supplied filing gives these quarterly figures but does not provide a clear standalone Q4 explanation for the net income.

Cost of goods sold was 29% of revenue, versus 27% in 2016, implying a 71% versus 73% margin before amortization and intangible impairments. Segment revenue and profit were: Bausch + Lomb/International $4.871 billion and $1.440 billion (30% margin); Branded Rx $2.475 billion and $1.361 billion (55%); U.S. Diversified Products $1.378 billion and $994 million (72%). Total segment profit was $3.795 billion, down 16%.

At year-end, cash and cash equivalents were $720 million; restricted cash was $77 million. Working capital was $478 million, down from $1.468 billion. Debt was $25.444 billion net of discounts and issuance costs ($25.752 billion principal), compared with $29.846 billion net at year-end 2016. Total assets were $37.497 billion and shareholders’ equity was $5.849 billion. The revolving facility had $1.156 billion of availability. Scheduled principal maturities included $209 million in 2018, none in 2019, $2.690 billion in 2020, $3.175 billion in 2021 and $5.115 billion in 2022. Approximately 85% of debt was fixed-rate.

Material changes versus the prior comparable period

• Revenue fell $950 million: $459 million was attributed to divestitures and discontinuations, $403 million primarily to lower volumes and loss of exclusivity, and $78 million to unfavorable foreign exchange.
• Segment revenue decreased 1% in Bausch + Lomb/International, 12% in Branded Rx and 28% in U.S. Diversified Products. Bausch + Lomb/International organic revenue grew 6%, while Branded Rx declined 6% and U.S. Diversified Products declined 27%.
• Operating results improved from a $566 million loss to $102 million income, helped by lower goodwill impairment and expenses and gains on divestitures. Asset impairment charges increased to $714 million from $422 million.
• Operating cash flow rose $203 million. Management attributed more than $800 million of cash generation to working-capital changes, including inventory and supply-chain actions; it did not expect similar material working-capital cash generation in 2018.
• The company received over $3.2 billion in net cash proceeds from 2017 divestitures, including skincare brands, Dendreon, iNova and Obagi; Sprout was sold for a 6% royalty on Addyi sales beginning June 2019. It repaid $4.641 billion of debt principal during 2017 and refinanced maturities, lowering required principal repayments through 2020.

Outlook, risks and unusual items

• Management anticipated 2018 R&D expense above 4% of revenue and expected to submit over 60% of 71 U.S. core-business pipeline projects for FDA approval in 2018–2019. It described the Significant Seven products’ 2017 revenue as less than $100 million and expected substantial potential over five years; this is forward-looking, not a guarantee.
• Management expected to remain compliant with debt covenants and meet debt obligations for the next 12 months based on its forecast. It cited cost reductions, asset sales or refinancing as possible responses if performance weakened. Acquisition activity was expected to remain low while debt reduction remained a priority.
• Major risks include substantial debt and interest costs, covenant compliance and refinancing, generic competition and loss of exclusivity, pricing and reimbursement pressure, product launches and regulatory approvals, foreign exchange, and dependence on third-party and single-source supply.
• Ongoing legal and regulatory matters included investigations relating to pricing, marketing, distribution, accounting and the former Philidor relationship, as well as securities, RICO, antitrust and product-liability litigation. Certain settlements were agreed or proposed, including $96 million as Valeant’s share of the Allergan settlement, subject to court approval, and a $58 million Solodyn antitrust settlement, also subject to approval. Ultimate losses for other matters were not reliably estimable.
• The $4.145 billion tax benefit included $975 million of provisional net benefits from the U.S. Tax Act; management said final tax accounting could differ materially. The company also disputed an Australian tax assessment of $117 million, including penalties and interest.
• Goodwill and intangible assets remained significant. Salix’s October 2017 reporting-unit fair value was $10.660 billion against a carrying value of $13.404 billion; no related goodwill impairment was recorded in the annual test, but management identified sensitivity to assumptions and future impairment risk. Auditors gave an unqualified opinion on the financial statements and internal controls; management also reported effective controls at year-end.

Most important facts for investors to verify

1. How much of reported earnings and future cash generation is recurring, given the large tax benefit, divestiture gains, impairments and financing costs?
2. Whether operating performance can stabilize and debt continue to decline without relying on further asset sales or working-capital releases; verify actual maturities, interest expense and covenant headroom.
3. Whether core-segment revenue, margins and product launches can offset ongoing declines from generic competition, divestitures and pricing or reimbursement pressure.
4. Progress and potential financial exposure from the Philidor-related investigations, securities and RICO claims, antitrust matters, Allergan settlement, Australian tax assessment and other contingencies.
5. Whether provisional tax accounting and the Salix goodwill valuation withstand final tax guidance and changes in forecasts, discount rates or product exclusivity assumptions.