Valeant Part XIII: channeling Jeff Skilling - or trying to reconstruct Valeant's balance sheet

There was a very famous conference call once where Highfields Capital analyst Richard Grubman asked for a balance sheet with Enron's earnings statement. Jeff Skilling's response is a key part of the Enron legend.

Grubman: You’re the only financial institution that can’t produce a balance sheet or cash flow statement with their earnings. 

Skilling: You…you…you. Well, uh…thank you very much. We appreciate it. Asshole.

The "asshole" quip disappeared from the conference call transcript but everyone remembered it.

Well today Valeant produced a earnings result with only cursory balance sheet data and no balance sheet. Linked here is the SEC release.  And here is all they say about balance sheet.

Valeant Pharmaceuticals International, Inc.

Table 5

Consolidated Balance Sheet and Other Data

(In millions)

5.1 Cash

		As of				As of
		September 30,				December 31,
		2014				2013
Cash and cash equivalents		$	808.8			$	600.3
Marketable securities			—				—
Total cash and marketable securities		$	808.8			$	600.3
Debt
Series A-1 Tranche A Term Loan Facility		$	182.3			$	259.0
Series A-2 Tranche A Term Loan Facility			166.3				228.1
Series A-3 Tranche A Term Loan Facility			1,813.9				1,935.7
Series D-2 Tranche B Term Loan Facility			1,088.6				1,256.7
Series C-2 Tranche B Term Loan Facility			837.5				966.8
Series E-1 Tranche B Term Loan Facility			2,544.8				3,090.5
Senior Notes			9,629.5				9,618.9
Other			12.0				12.0
			16,274.9				17,367.7
Less: current portion			(191.7	)			(204.8	)
Total long-term debt		$	16,083.2			$	17,162.9

Okay - net debt was $15,466.1 million (being $16,274.9 minus 808.8).

Lets go back a quarter ago. Here is the balance sheet from the 10Q:

VALEANT PHARMACEUTICALS INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

(All dollar amounts expressed in millions of U.S. dollars)

(Unaudited)

	As of June 30,  2014				As of December 31,  2013
Assets
Current assets:
Cash and cash equivalents	$	531.2			$	600.3
Trade receivables, net	1,770.7				1,676.4
Inventories, net	942.5				883.0
Prepaid expenses and other current assets	452.6				343.4
Assets held for sale	1,156.9				15.9
Deferred tax assets, net	309.8				366.9
Total current assets	5,163.7				3,885.9
Property, plant and equipment, net	1,319.6				1,234.2
Intangible assets, net	11,751.4				12,848.2
Goodwill	9,436.3				9,752.1
Deferred tax assets, net	18.3				54.9
Other long-term assets, net	206.3				195.5
Total assets	$	27,895.6			$	27,970.8
Liabilities
Current liabilities:
Accounts payable	$	327.7			$	327.0
Accrued and other current liabilities	1,774.9				1,800.2
Acquisition-related contingent consideration	88.9				114.5
Current portion of long-term debt	266.7				204.8
Liability held for sale	27.1				—
Deferred tax liabilities, net	11.0				66.0
Total current liabilities	2,496.3				2,512.5
Acquisition-related contingent consideration	238.1				241.3
Long-term debt	17,058.8				17,162.9
Pension and other benefit liabilities	165.5				172.0
Liabilities for uncertain tax positions	115.8				169.1
Deferred tax liabilities, net	2,238.8				2,319.2
Other long-term liabilities	215.0				160.5
Total liabilities	22,528.3				22,737.5
Commitments and contingencies (note 17)
Equity
Common shares, no par value, unlimited shares authorized, 333,777,181 and
333,036,637 issued and outstanding at June 30, 2014 and December 31, 2013, respectively	8,325.9				8,301.2
Additional paid-in capital	212.2				228.8
Accumulated deficit	(3,175.3		)		(3,278.5		)
Accumulated other comprehensive loss	(104.7		)		(132.8		)
Total Valeant Pharmaceuticals International, Inc. shareholders’ equity	5,258.1				5,118.7
Noncontrolling interest	109.2				114.6
Total equity	5,367.3				5,233.3
Total liabilities and equity	$	27,895.6			$	27,970.8

Cash and equivalents was $531 million. Long term debt was $17058 million. Current debt was $266.7 million.

Net debt was thus $16793 million.

Net debt thus dropped $1327 million in the quarter. That looks pretty good.

Except that they sold the Aesthetics business during the quarter.

Slide 165 of this presentation (reproduced below) indicates net proceeds of $1240 million.

Net of this they generated only $88 million of cash in the quarter.

Which given they had $2 billion of sales and everyone thinks their cash margin is about 50 percent does not seem to compute.

We could of course work it out with a balance sheet and cash flow statement. It is probably all sweet and innocent.

So at the risk of being called an "asshole" please Mr Pearson will you give me a balance sheet and a cash flow statement with your earnings?





John

Nu Skin's capital structure makeover

Yesterday Nu Skin announced that they had a new loan to replace the old loan. This was essential because the old loan was about to breach its covenants and an event of default would not be a good thing for Nu Skin shareholders or their management.

So prima-facie the new loan was good news.

The stock however dropped almost 10 percent (and was briefly down more).

The loan terms are onerous and complicated and there are some bizarre disclosures in the attachments to the loan document.

The first bizarre thing about the loan is the disclosure as to how much is drawn immediately. Here it is:

The Credit Agreement provides for a $127,500,000 term loan facility, a ¥6,593,406,594 term loan facility and a $187,500,000 revolving credit facility, each with a term of five years.  The term loan facilities were drawn in full on October 10, 2014, and $112,500,000 of the revolving credit facility was also drawn on October 10, 2014.

They immediately drew $127.5 million dollars of term loan, ¥6.59 billion and a further $112.5 million on the revolver.  That is $309.4 million USD.

This is way more debt than they had at the end of the previous quarter. Here is the balance sheet from the last 10-Q.

NU SKIN ENTERPRISES, INC.

Consolidated Balance Sheets (Unaudited)

(U.S. dollars in thousands)

---

	June 30, 2014			December 31, 2013
ASSETS
Current assets:
Cash and cash equivalents	$	219,501		$	525,153
Current investments		14,227			21,974
Accounts receivable		41,712			68,652
Inventories, net		389,650			339,669
Prepaid expenses and other		180,957			162,886
		846,047			1,118,334
Property and equipment, net		429,332			396,042
Goodwill		112,446			112,446
Other intangible assets, net		79,258			83,168
Other assets		136,531			111,072
Total assets	$	1,603,614		$	1,821,062
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	35,836		$	82,684
Accrued expenses		383,012			626,284
Current portion of debt		99,828			67,824
		518,676			776,792
Long-term debt		111,621			113,852
Other liabilities		81,559			71,799
Total liabilities		711,856			962,443
Commitments and contingencies (Note 9)
Stockholders' equity:
Class A common stock – 500 million shares authorized, $.001 par value, 90.6 million  shares issued		91			91
Additional paid-in capital		410,440			397,383
Treasury stock, at cost – 31.3 million and 31.6 million shares, respectively		(844,615)			(826,904)
Accumulated other comprehensive loss		(42,284)			(46,228)
Retained earnings		1,368,126			1,334,277
		891,758			858,619
Total liabilities and stockholders' equity	$	1,603,614		$	1,821,062

In the last quarter they had $219.5 million in cash and another $14.2 million in current investments. Against this they had $99.8 million in current debt and another $111.6 million in long term debt.

Total debt was $211.4 and net debt was zero.

Despite this they drew $302 million at moderately high interest rates.

But it is worse than that... the old debt numbers included some debt in Japan and Korea. Some of that is being left in place as per the loan covenant. In quantity:

Indebtedness

Debt
	Borrower	Lender	Currency	Amount
	Nu Skin Japan Co., Ltd.	Mizuho Bank	Japan Yen	1,000,000,000
	NSE Korea Ltd.	Shinhan Bank	US Dollar	20,000,000

That is another $30.5 million of debt.

So now - suddenly - the company has $339.9 million in debt - way more than the $211.4 they used to have. The rise is inexplicable because their last accounts showed net cash.

The company has rapidly - and at what was to them a penal interest rate - borrowed a huge amount of money they didn't seem to need a quarter ago and when they had net cash.

And it can't be for an acquisition because the loan covenants prohibit that.

If you have any good idea what the sink-hole that absorbed this much cash is let me know. However if this cash were needed during the last quarter the whole thing is diabolical. Bluntly if it were needed the company is presumably and somehow massively loss making. I simply do not know how. I am a bear on this stock but that is worse than I would have dared to guess.

Two hypotheses:

(a) the company is secretly massively cash consumptive and we do not know (in which case short) or
(b) the company is drawing a huge amount of debt for which it has no obvious use and which it is prohibited to use for an acquisition [that might include buy-backs as discussed below].

But remember this: Nu Skin drew the revolvers. And it drew them hard. Drawing the revolvers has precedent. It is seldom something that makes credit providers happy. There may be a good explanation (truly). The market has not been provided with it.

Dividend restrictions

The story from yesterday was that the debt covenants involved dividend restrictions. This came from slightly ambiguous wording in the press release.

The press release states:

The Credit Agreement requires the Company to maintain a consolidated leverage ratio not exceeding 2.25 to 1.00 and a consolidated interest coverage ratio of no less than 3.00 to 1.00. The Credit Agreement also includes other covenants, including covenants that, subject to certain exceptions, restrict the ability of the Company and its subsidiaries (i) to create, incur, assume or permit to exist any liens, (ii) to incur additional indebtedness, (iii) to make investments and acquisitions, (iv) to enter into mergers, consolidations or similar transactions, (v) to make certain dispositions of assets, (vi) to make dividends, distributions and prepayments of certain indebtedness, (vii) to change the nature of the Company's business, (viii) to enter into certain transactions with affiliates, (ix) to enter into certain burdensome agreements, (x) to make certain amendments to certain agreements and organizational documents and (xi) to make certain accounting changes.

The highlighted section makes it clear that the company may not pay dividends subject to certain exceptions, which means provided they meet these exceptions they may pay dividends.

Indeed the loan documents allow the following use of proceeds:

Section 6.11.   Use of Proceeds.  Use the proceeds of the Credit Extensions (i) for working capital, capital expenditures, and other lawful corporate purposes, including (without limitation) investments, acquisitions, stock repurchases and dividends not prohibited by the Loan Documents and (ii) to consummate the Refinancing

So they may buy back stock and pay dividends provided they meet a fairly burdensome list of possible events of default.

An event of default is disastrous under the new documents because it involves immediate acceleration. You do not want immediate acceleration ever.

That said - and it is a clear positive for Nu Skin - the default based on trailing operating cash flow has been removed. As indicated in past blog posts Nu Skin is peculiar - it generates substantial earnings and huge negative operating cash flows. Nu Skin breaches its cash flow based covenants - and these have been removed.

The only explanation (that is not truly nasty) that I have for drawing the revolvers is a deep desire to use the cash (whilst it is available) to buy back stock. However given the nasty taste that drawing revolvers gives to credit providers this is an aggressive thing to do. [But it is possible. I am not dismissing it.]

Receiveables from offshore entities

The disclosure that caused most amazement amongst Nu Skin watchers was a disclosure at the back of the credit agreement about how much money their offshore subsidiaries own them. This is a list:

Intercompany Receivables
	Nu Skin Enterprises United States, Inc.
		Nu Skin Canada, Inc.	146,199
	Nu Skin Enterprises, Inc.
		Nu Skin Enterprises New Zealand, Inc.	175,787
		Nu Skin Enterprises Hong Kong, LLC	7,675,959
		Nu Skin Japan Co., Ltd.	620,350
		NSE Korea Ltd.	5,824,767
		Nu Skin Enterprises Singapore, Pte. Ltd.	230,681
		Nu Skin Israel, Inc.	165,000
		Nu Skin Taiwan, LLC	1,363
		Jixi Nu Skin Vitameal Co., Ltd.	430,500
		Pharmanex (Huzhou) Health Products Co., Ltd.	5,432,400
		NSE Asia Products, Pte. Ltd.	8,035,931
	Nu Skin International, Inc.
		Nu Skin International Management Group, Inc.	44,301,819
		Nu Skin Mexico, S.A. de C.V	5,672,930
		Nu Skin Guatemala, S.A.	3,488,701
		Nu Skin El Salvador S. A. de C.V.	104,543
		Nu Skin Honduras, S.A.	131,853
		Nu Skin Costa Rica	377,841
		Nu Skin Venezuela, C.A.	6,421,303
		Nu Skin Colombia, Inc.	128,188
		Nu Skin Argentina, Inc.	759,321
		Nu Skin Enterprises New Zealand, Inc.	436,748
		Nu Skin Enterprises (Thailand) Limited	627,077
		Nu Skin Enterprises Philippines, LLC	159,190
		Nu Skin (Malaysia) Sdn. Bhd.	1,321,469
		Nu Skin Pharmanex (B) Sdn. Bhd.	30,366
		Nu Skin Israel, Inc.	2,725,815
		PT Nu Skin Distribution Indonesia	6,427,129
		PT Nu Selaras Indonesia	924,291
		Nu Skin Enterprises Viet Nam Limited Liability Company	520,580
		Nu Skin Enterprises RS, Ltd.	283,453
		Nu Skin Enterprises South Africa (Proprietary) Limited	1,163,340
		Nu Skin (China) Daily-Use & Health Products Co., Ltd.	2,207,202
		NSE Asia Products, Pte. Ltd.	53,477,483
	NSE Products, Inc.
		Nu Skin Netherlands, B.V.	86,794
		Nu Skin Germany, GmbH	101,827
		Nu Skin France, SARL	27,185
		Nu Skin Italy, Srl	177,788
		Nu Skin Enterprise SRL	12,164,682
		Nu Skin Eastern Europe Ltd.	74,974
		Nu Skin Enterprises Poland Sp. Z.o.o.	8,814
		Nu Skin Turkey Cilt Bakimi Ve Besleyici Uranleri Ticarel Limited Sirketi	597,032
		Nu Skin Islandi ehf.	849,996
		Nu Skin Czech Republic, S.r.o.	217,724
		Nu Skin Slovakia	98,394
		Nu Skin Israel, Inc.	599,956
		Nu Skin Enterprises South Africa (Proprietary) Limited	71,231
		Nu Skin International Management Group, Inc.	2,272,938
		Nu Skin Mexico, S.A. de C.V	969,970
		Nu Skin Guatemala, S.A.	960,774
		Nu Skin El Salvador S. A. de C.V.	265
		Nu Skin Costa Rica	2,194,916
		Nu Skin Canada, Inc.	4,446,848
		Nu Skin Venezuela, C.A.	23,896,815
		Nu Skin Colombia, Inc.	7,811,575
		Nu Skin Argentina, Inc.	414,677
		Nu Skin Enterprises New Zealand, Inc.	4,010,293
		Nu Skin Enterprises Australia, Inc.	1,316,560
		NSE Korea Ltd.	18,651,855
		Nu Skin Enterprises Philippines, LLC	319,735

		Nu Skin Enterprises Viet Nam Limited Liability Company	224,177
		Nu Skin Enterprises Ukraine, LLC	377,261
		Nu Skin Enterprises RS, Ltd.	4,998,951
		Nu Skin (China) Daily-Use & Health Products Co., Ltd.	133,465,866
		NSE Asia Products, Pte. Ltd.	23,849,660
	Total		405,689,111

The total is almost $406 million. This is large - about half the stockholders equity and the bulk of tangible stockholders equity.

If the foreign subsidiaries have the cash (and it is presumed they do) then they should - subject to payment restrictions - just pay it.

There is $24 million owed to head office by Venezuela. Good luck collecting that. But outside that the amounts should be collectable if the foreign subsidiaries are good for it. There is $133 million owed by China. This might be difficult to collect based on the amount of activity we have seen in China. However if they own the very large office complex we saw (see the post) they could collect some of it by selling up.

But the more pertinent question is why haven't all those subsidiaries been able to pay the money they owe to head office? Inquiring minds are asking. Especially as the company drew the revolvers.

--

Venezuela

The Venezuela amounts are irrelevant in Nu Skin (and Herbalife for that matter) but there is a contradiction between what the table above shows and the management says. According to recent presentation at the Wedbush conference they only had $10-15 million of sales in Venezuela.

It is hard to see how they are owed $24 million by a subsidiary that only has half that in sales. I can't square it. A clearer explanation of Venezuela exposure would be nice.






John