Monday, December 28, 2015

Friday On My Mind

The iconic 60s Australian rock-star - Steve Wright - has died.

And I can't help but hum cheery Easybeats songs - which is I think the way it should be.

For those that did not know him - here is Friday On My Mind:





I suspect many more people know the David Bowie cover...




Less well known is Bruce Springsteen's penchant for covering the Easybeats, however The Boss makes it an angry song and it shouldn't be like that.





John

Thursday, December 17, 2015

Valeant: cash EPS, GAAP EPS and various covenants

Today Valeant guided down its so-called cash EPS. You can find the press release at this link.

Lets just take the 3Q guidance as published:

Q4 2015 Revised Guidance 
  • Total Revenues previously $3.25 - $3.45 billion now $2.7 - $2.8 billion
  • Adjusted EPS* previously $4.00 - $4.20 now $2.55 -$2.65
  • Adjusted Cash Flow from Operations* previously greater than $1.0 billion, now greater than $600 million

At the low end of this range we have reduced quarterly revenue from $3.25 billion to $2.8 billion dollars. This is $425 million. [The high-end of the reduction is $750 million.]

The reduction is - at this end - $425 million on $3.25 billion of sales. The low end is thus a 13 percent revenue reduction.

Here is what Valeant said about Philidor on the October 26 call.



To quote: In Q3 2015, Philidor represented 6.8% of total Valeant revenue.

The reduction in revenue is about twice the revenue running through Philidor.

Observation 1: The revenue drop is more than just Philidor. Something else is going on. 

The bull argument to date is that Philidor is a small percentage of sales some of which will be caught elsewhere and thus can be ignored. However the drop in sales is twice Philidor (or more than twice Philidor for most points in the range). 

Second - the "adjusted EPS* drops from $4.00 - $4.20 to $2.55 -$2.65. This is a drop at the minimum end of $4.00 to $2.65 0r $1.35 per share.

There were - according to the last 10Q - 343,101,797 shares outstanding as of October 19, 2015.

So so-called cash EPS will fall by roughly $463 million at a minimum.

The fall in cash-EPS is more than double the entire revenue of Philidor.

Again something other than Philidor has been broken here.

GAAP numbers and debt covenants

Valeant tells the market about "cash EPS" - a measure that differs considerably from GAAP EPS.

The cash EPS numbers are not audited. The differences are differences you must trust the management to honestly report.

However they are not the numbers as reported in the 10-Q nor are they the numbers that are contained in the debt covenants. [See just one debt indenture at this link.]

Here is the P&L statement for the last quarter and nine months from the 10-Q.

VALEANT PHARMACEUTICALS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(All dollar amounts expressed in millions of U.S. dollars, except per share data)
(Unaudited)
Three Months Ended
September 30,
Nine Months Ended
September 30,
2015
2014
2015
2014
Revenues
Product sales
$
2,748.2

$
2,022.9

$
7,590.1

$
5,868.1

Other revenues
38.6

33.3

120.0

115.4

2,786.8

2,056.2

7,710.1

5,983.5

Expenses
Cost of goods sold (exclusive of amortization and impairments of
finite-lived intangible assets shown separately below)
634.6

545.8

1,864.9

1,619.5

Cost of other revenues
13.6

15.0

43.1

45.3

Selling, general and administrative
697.6

504.1

1,956.9

1,501.8

Research and development
101.6

59.1

238.5

186.9

Amortization and impairments of finite-lived intangible assets
679.2

393.1

1,629.8

1,113.9

Restructuring, integration and other costs
75.6

61.7

274.0

337.4

In-process research and development impairments and other charges
95.8

19.9

108.1

40.3

Acquisition-related costs
7.0

1.6

26.3

3.7

Acquisition-related contingent consideration
3.8

4.0

22.6

14.8

Other expense (income)
30.2

(232.0
)
213.2

(275.7
)
2,339.0

1,372.3

6,377.4

4,587.9

Operating income
447.8

683.9

1,332.7

1,395.6

Interest income
0.7

0.8

2.5

3.8

Interest expense
(420.2
)
(258.4
)
(1,130.7
)
(746.1
)
Loss on extinguishment of debt


(20.0
)
(93.7
)
Foreign exchange and other
(34.0
)
(53.0
)
(99.5
)
(63.0
)
Gain on investments, net

3.4


5.9

(Loss) income before (recovery of) provision for income taxes
(5.7
)
376.7

85.0

502.5

(Recovery of) provision for income taxes
(57.4
)
100.3

10.4

124.4

Net income
51.7

276.4

74.6


378.1

Less: Net income (loss) attributable to noncontrolling interest
2.2

1.0

4.4

(0.5
)
Net income attributable to Valeant Pharmaceuticals International, Inc.
$
49.5

$
275.4

$
70.2

$
378.6

Earnings per share attributable to Valeant Pharmaceuticals International, Inc.:
Basic
$
0.14

$
0.82

$
0.21

$
1.13

Diluted
$
0.14

$
0.81

$
0.20

$
1.11

Weighted-average common shares (in millions)
Basic
344.9

335.4

340.8

335.2

Diluted
351.0

341.3

347.2

341.4



Note that operating income (earnings before interest and tax) for the third quarter was $447.8 million and for the nine months was $1332.7 million.

Note that the minimum fall in so-called "cash eps" in the fourth quarter is larger than the entirety of operating income in the third quarter. This should provide some scale.

Here is the cash flow statement from the last 10-Q.

VALEANT PHARMACEUTICALS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(All dollar amounts expressed in millions of U.S. dollars)
(Unaudited)
Three Months Ended
September 30,
Nine Months Ended
September 30,
2015
2014
2015
2014
Cash Flows From Operating Activities
Net income
$
51.7

$
276.4

$
74.6

$
378.1

Adjustments to reconcile net loss (income) to net cash provided by operating activities:
Depreciation and amortization, including impairments of finite-lived intangible assets
726.4

439.3

1,768.4

1,248.1

Amortization and write-off of debt discounts and debt issuance costs
20.5

34.6

123.7

58.1

In-process research and development impairments
95.8

19.9

108.1

20.3

Acquisition accounting adjustment on inventory sold
27.2

12.4

97.7

21.9

Loss (gain) on disposal of assets, net
5.3

(254.5
)
9.2

(254.5
)
Acquisition-related contingent consideration
3.8

4.0

22.6

14.8

Allowances for losses on accounts receivable and inventories
19.6

12.0

46.4

47.6

Deferred income taxes
(91.4
)
74.6

(79.0
)
63.2

Additions (reductions) to accrued legal settlements
25.6

(0.9
)
31.9

(48.2
)
Payments of accrued legal settlements
(26.2
)
(0.2
)
(32.1
)
(1.2
)
Share-based compensation
50.5

20.2

111.4

60.6

Excess tax expense (benefits) from share-based compensation
3.9

(15.9
)
(21.7
)
(17.1
)
Foreign exchange loss
31.0

55.1

96.6

62.4

Loss on extinguishment of debt


20.0

93.7

Payment of accreted interest on contingent consideration
(7.7
)
(1.3
)
(19.8
)
(9.5
)
Other
0.2

9.7

(13.7
)
15.8

Changes in operating assets and liabilities:
Trade receivables
(347.2
)
(121.4
)
(656.0
)
(205.2
)
Inventories
(45.6
)
(41.5
)
(132.4
)
(122.8
)
Prepaid expenses and other current assets
(88.5
)
5.5

(252.0
)
34.5

Accounts payable, accrued and other liabilities
281.6

90.7

334.1

18.4

Net cash provided by operating activities
736.5

618.7

1,638.0

1,479.0

Cash Flows From Investing Activities
Acquisition of businesses, net of cash acquired
(115.8
)
(606.8
)
(14,001.7
)
(981.1
)
Acquisition of intangible assets and other assets
(0.1
)
(74.3
)
(58.1
)
(105.8
)
Purchases of property, plant and equipment
(51.1
)
(39.6
)
(163.7
)
(211.2
)
Proceeds from sales and maturities of short-term investments
32.5


50.2


Net settlement of assumed derivative contracts (Note 3)


184.6


Settlement of foreign currency forward exchange contracts


(26.3
)

Purchases of marketable securities
(24.2
)

(24.5
)

Purchase of equity method investment



(75.9
)
Proceeds from sale of assets and businesses, net of costs to sell
2.5

1,477.0

2.8

1,479.8

Decrease (increase) in restricted cash and cash equivalents


(5.2
)

Net cash (used in) provided by investing activities
(156.2
)
756.3

(14,041.9
)
105.8

Cash Flows From Financing Activities
Issuance of long-term debt, net of discount

555.0

16,925.8

963.4

Repayments of long-term debt
(29.0
)
(1,629.8
)
(1,387.2
)
(2,184.0
)
Repayments of convertible notes assumed


(3,122.8
)

Issuance of common stock, net


1,433.7


Repurchases of common shares


(50.0
)

Proceeds from exercise of stock options
7.0

3.8

29.1

10.9

Excess tax benefits from share-based compensation
(3.9
)
15.9

21.7

17.1

Payment of employee withholding tax upon vesting of share-based awards
(24.3
)
(2.0
)
(85.8
)
(38.5
)
Payments of contingent consideration
(48.4
)
(14.4
)
(129.4
)
(96.6
)
Payments of financing costs

(10.2
)
(101.7
)
(18.8
)
Other
(9.9
)
(0.4
)
(10.2
)
(14.9
)
Net cash (used in) provided by financing activities
(108.5
)
(1,082.1
)
13,523.2

(1,361.4
)
Effect of exchange rate changes on cash and cash equivalents
(9.8
)
(15.3
)
(21.9
)
(14.9
)
Net increase in cash and cash equivalents
462.0

277.6

1,097.4

208.5

Cash and cash equivalents, beginning of period
958.0

531.2

322.6

600.3

Cash and cash equivalents, end of period
$
1,420.0

$
808.8

$
1,420.0

$
808.8

Non-Cash Investing and Financing Activities
Acquisition of businesses, contingent and deferred consideration obligations at fair value
$
(108.7
)
$
(16.0
)
$
(783.3
)
$
(65.1
)
Acquisition of businesses, debt assumed
(6.1
)
(4.5
)
(3,129.2
)
(8.5
)


Depreciation and amortization, including impairments of finite-lived intangible assets was $726.4 million in the third quarter and $1,768.4 for the nine months.

In the third quarter EBITDA (defined as earnings before interest and tax and adding in depreciation and amortisation) was $447.8 + $726.4 million = $1174 million.

So so-called cash EPS will fall by roughly $463 million at a minimum.

This means that the run-rate GAAP EBITDA is $711 million or less.

Debt restrictions

Here is a debt indenture. This debt indenture places restrictions on Valeant if the debt to EBITDA ratio exceed 3.5 times. These do not cause an "event of default" but do limit Valeant's flexibility to buy back shares (they can't), incur most indebtedness or to make other investments.

Given that debt is about $30 billion and EBITDA run-rate is about $700 million per quarter there can be little question that Valeant is operating under strict loan-covenant based restrictions.

In Pearson we trust

Mike Pearson did not tell us about Philidor.

Originally Valeant stated that they did not disclose Philidor because their alternative fulfilment was a "competitive advantage". Later they declared that Philidor was not unusual - other companies used specialty pharmacies (p. 8).

Then Mike Pearson told us that the issues related to Philidor and Philidor was 6.8 percent of revenue.

Then he guided down revenue by approximately double the sales of Philidor.

Then he neglected to tell the market he was operating under covenants that restrict many of his actions. In October Bill Ackman thought that Valeant might buy-back stock at these low prices. That is not possible.

Still despite these things it is clear that most the market believes something akin to Valeant's so-called cash EPS.

The market trusts Mr Pearson for the moment.

I am a gnarly fellow however: I note the revenue fall is roughly twice Philidor - so I know that I don't know what is going on and I don't believe what I am told.

What you believe dear readers however is up to you.




John

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.