Valeant Pharmaceuticals International Q2 2008 Earnings Call Transcript

| About: Valeant Pharmaceuticals (VRX)

Valeant Pharmaceuticals International (NYSE:VRX)

Q2 2008 Earnings Call Transcript

August 11, 2008 11:00 am ET


Laurie Little – Vice President, IR

Mike Pearson – Chairman and CEO

Peter Blott – EVP and CFO


Greg Gilbert – Merrill Lynch

Michael Tong – Wachovia Capital


Good morning. My name is Leslie, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Valeant second quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Ms. Little, you may begin your conference.

Laurie Little

Thank you, Leslie. Good morning, everyone, and welcome to Valeant’s 2008 second quarter financial results conference call. Joining us on the call today, are Mike Pearson, Chairman and Chief Executive Officer, and Peter Blott, Chief Financial Officer.

Before we begin, I would like to call your attention to the fact that this presentation may contain forward-looking statements, including, but not limited to, expectations and plans relating to Retigabine our Taribavirin and the ability to partner our products in development. These statements are based upon current expectations and beliefs of management, and are subject to certain risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements.

These risks and uncertainties include, but are not limited to, risks and uncertainties related to the ability to partner our products in development, our ability to close the sale of our European operations, and other risks and uncertainties discussed in the company's filings with the SEC. These risks are among the factors that could cause the actual results to differ materially from the expectations described. An undue reliance should not be placed on any of these forward-looking statements. Valeant undertakes no obligation to update any of these forward-looking statements to reflect events or circumstances after the date of this call or to reflect actual outcome.

Certain figures discussed in today's presentation will be based on adjusted or non-GAAP information. A reconciliation of historical GAAP to non-GAAP results can be found in the tables to the company's press release issued earlier today and on Valeant's Web site at

And now, I’d like to turn the call over to Mike.

Mike Pearson

Thank you, Laurie. Good morning, everyone, and thank you for joining us. Today, I would like to update you on the progress we have made on our six key initiatives and to discuss a few other business items. And then have Peter discuss our financial results and further detail.

Our first initiative was to sell/IPO Europe. Last week, we announced that we have signed a deal to divest our operations in Western and Eastern Europe, the Middle East, and Africa to Meda AB, a specialty pharma company located in Sweden. Before we went into this process, we conducted a thorough analysis of all of our options, and had a good idea as to the value of this business and which strategic buyers will be most interested. In parallel with the option process being run by Goldman, I reached up to Meda who was on the top of the list. Meda has a strong presence in the European market and was looking to strengthen certain geographies and add more products to its portfolio.

Valeant’s European Prague portfolio and its infrastructure is a perfect fit with Meda’s current operations. While we had many companies express interest in these operations through their first round bids in the option process, none equaled Meda’s offer. Working directly with Meda also allowed us to move more quickly than sticking to the original option timing.

By selling what we affectionately have come to call WEMEA [ph], we will reduce Valeant’s geographic footprint from operating in over 80 countries, to operating in less than 20. In addition, we will go from over 80 suppliers to roughly 40 suppliers, and from over 1,800 SKUs to less than 1,000 SKUs. This is a dramatic and critical step in reducing complexity of the company.

As you heard in the press release, Meda will pay Valeant $392 million in cash. I believe we received an appropriate amount for these operations, which collectively had a revenue base of approximately $180 million in 2007, and an operating margin of approximately 14%. This compares to 2007 Prague sales in our Central European region, which we are keeping, of $120 million, and an operating margin of approximately 35%. We hope to close the deal by late third quarter to early fourth quarter, which I mentioned is much sooner than we had planned. It also ends the period of uncertainty for our European WEMEA employees, and allows us to move forward on further reductions in and simplification of our corporate infrastructure.

We are still considering a possible IPO of our Central European operations where our revenues are largely driven by our Polish branded-generic business. Although, given current market conditions that will probably not happen this year. This business, the Central European business, continues to impress me with its strong management team, its robust sales growth, and positive cash flow. For the past two years, this business has delivered double-digit sales growth. And I believe that we can expect this to continue. The Central European business grew over 21% in 2007, and is up 32% in the second quarter of this year.

We also announced last week, in a separate deal, that we have agreed to form joint ventures with Meda in Australia, Canada, and Mexico to develop and market, and commercialize certain current and future Meda products. The joint ventures will be majority owned by Meda, and Valeant will own a minority interest. Valeant management and infrastructure will be used to operate the JVs in each of these three countries. The joint ventures will pursue the regulatory filings and manage the commercialization of the products. And Valeant will participate in a 50-50 profit split. The joint ventures will initially include products such as Sublinox, which is a treatment for insomnia, and flupirtine, which is a pain treatment, with the option to include additional products in the future.

I believe this deal is a positive one for Valeant. We have strong operations in both Canada and Australia, and we are putting in place a strong team in Mexico. All three countries are in need of new products to increase their market presence and sales opportunity. The joint venture should provide us with new growth potential with nominal risk and expense. I believe that Meda will be a strong partner with Valeant as we move forward, as we are both aligned in building solid, profitable businesses.

Our second initiative was to fix Mexico. Mexico remains a very important operation for Valeant. And I feel positive about the positive about the progress that has been made in the business operations since we implemented significant management changes in April. I have made seven trips to Mexico since joining the company, and I’m working closely with Dr. Revalo [ph] on executing the turnaround plan.

In addition to headcount reduction and other G&A restructuring that has taken place, we have recently hired an additional 150 sales reps in Mexico, which brings our total sales force in Mexico to approximately 353 representatives. Our reductions and overhead spend in Mexico more than offset the cost of these new sales representatives. These new reps began calling on customers in Jul when the first changes that we made was to require our reps to once again call on the retail channel, a practice that was discontinued under previous management. Pharmacists in Mexico play an important part in the healthcare system. And we learned to our detriment what happens when they no longer have interaction with our sales reps. The majority of our reps are now calling on retail pharmacies in the morning when doctors are traditionally in the hospital, and then the physicians themselves in the afternoon when they’re back in their offices. In addition, we have 50 reps completely dedicated to the retail channel.

We have also changed the compensation structure for these reps. The compensation is now heavily skewed towards a variable program versus a much more fixed compensation program that had been put in place by prior management. We have also come a long way to repairing our relationships with Nagro and Saba [ph], the two major distributors in Mexico. And we have begun to see our financial arrangements, for example, inventory levels, payment terms, et cetera, return to normal. We have also began selling to a large number of smaller distributors that in total represent a third of the Mexican market that, again, we mistakenly stopped selling to in 2007.

Three weeks ago, during my most recent visit to Mexico, Dr. Revalo and I met again with Wal-Mart, and we were delighted to see that our recent sales through this important channel had improved significantly since my prior visit to Wal-Mart in March. While these changes are significant steps towards turning this business around, we still have a ways to go before we fully repair this business. That said, we would hope to begin to improve to deliver on approved financial results in Mexico before the end of 2008.

Our third initiative was to partner our pipeline assets. One of my top priorities since joining Valeant has been to find a strong global partner to collaborate with us on Retigabine and maximize the potential of this compound. We are in ongoing discussions with some potential partners and hope to formalize a deal in the third quarter. Our goal is to get a partnership in place by the time we file our NDA application.

Valeant has many capable and experienced people in-house that are leading the Retigabine project. And the addition of a partner knowledgeable in neurology, and epilepsy in particular, with suppliers with variable guidance as we move towards – move forwards – move forward with the FDA and our commercialization plans.

On Taribavirin, we are taking a longer term horizon to partner than with Retigabine given its earlier stage in its development program. However, given the right partner and the right terms, we could end up partnering the product this year.

We announced our 12-week data in April, and expect to present our 24-week data at AASLD in October. We believe it is important to further our dialogue with potential scientific leaders and to generate enthusiasm for the additional development of Tarivabirin. And we will share our data with you at the appropriate time. We continue to believe the weight-based dosing of Taribavirin is a key component of a successful development program.

Our fourth initiative was to file the NDA for Retigabine. Significant effort is being made to file our NDA for Retigabine by the end of third quarter ’08. And while we remain on track with that objective, we are being realistic in allowing that this goal may slip into the fourth quarter as pursuing a partner for Retigabine to enhance the product’s potential for success has complicated this endeavor. In setting a third quarter filing for the NDA, previous management did not anticipate partnering the product. What matters more than the submission date is submitting a high quality file, which will allow regulators to move quickly on assessing the compound. It is also clear that any partner we choose will want to have input on both content and timing into the submission, which may delay the filings for Retigabine.

Currently, all necessary and required clinical testing for Retigabine has been completed. We continue to have a meaningful dialogue with the FDA regarding our submission and we feel confident that we are in good shape. I do caution that the NDA approval process has its inherent risks, but we feel very strongly that Retigabine has a good risk reward profile and look forward to the next step in the approval process. As a side note, we have been accepted to present our data on the Retigabine clinical program at the Eight Annual European Congress on Epilepsy, which is being held in Berlin in September.

Our fifth initiative was to restructure our organization. We announced our first $20 million savings in G&A in the first quarter, and an additional $20 million savings with headcount reduction savings in Mexico and the US in May. Since these announcements, we have implemented several internal committees to target external spend and streamline our internal processes. Given our reduced headcount, we hope to sublease our headquarters and move to a more modest space. This move should provide us with significant savings and send a clear message to our employees and stakeholders.

As we mentioned on our last quarterly call, during the second quarter, we implemented planned changes to our inventory, our wholesaler inventory levels, to bring them in line with industry standards. In the US, this quarter, we went from eight weeks of inventory of the wholesalers to three weeks. In Canada, we went from six weeks to three weeks. And in Mexico, we went from more than eight weeks to approximately one month. The impact of this change was approximately $20 million in lost sales in the second quarter across our entities. In terms on its impact on sales, that breaks down to $15 million in the US $2 million in Canada, and approximately $3 million in Mexico.

Finally, we have decided to seize the soft promoting Cesamet in the United States with our oncology sales force. We were simply not getting the growth we needed to economically justify the expense. In early August, we severed our six-person sales force and management in this area. I believe that these changes were overdue, and will place Valeant into a better position as we move out of our restructuring phase.

Our sixth and final initiative was strengthening our balance sheet. In early July, we announced an increase in the amount authorized under share repurchase program from $200 million to $300 million. We repurchased roughly $100 million as of the end of 2007, and we have purchased an additional$41 million or 2.4 million shares this year since we’ve began buying shares in mid July. That leaves roughly $160 million left in the program that runs through mid 2009. We plan to be quite active in the market on an ongoing basis in the months to come, and we’ll update you on our progress each other.

We also announced that we would be redeeming our $300 million in senior notes, which we have completed on July 21st. Peter will provide more insight into this transaction later in the call.

Finally, a quick update on Efudex, In May, the courts denied our request for preliminary injunction, and Spears Pharmaceuticals was able to enter the market. So far, the market for generic Efudex has been as rational as can be expected. Pricing is down about 30% on the generic side and we continue to sell our branded product as well. Valeant currently holds roughly 70% of the total Efudex market, with Spears holding the remaining 30%. The court case is still pending and we have not yet made the decision to withdraw or to let the court case proceed.

Now, let me turn the call over to Peter Blott to discuss our financial performance in more detail.

Peter Blott

Thank you, Mike. Our results in the second quarter 2008 reflect the impact of a number of changes arising from our revised strategy announced in March, which made comparison of this quarter difficult. In particular, these include changes in income tax, the effects of our previously announced industry draw-down program and additional inventory reserves, which were required following changes to our commercial strategy on some products. I will talk about each of these, but let me start by discussing sales.

Product sales from continuing operations decreased 5% in the 2008 second quarter compared to the same period last year. As Mike mentioned, we made planned changes to our wholesales inventory levels to bring them to standard industry terms of less than month. Previously, they were a little over two months. We completed this program in the US and Canada within the second quarter. It’s had the impact of reducing North American sales by $17.4 million approximately. If you were to exclude this, our North American product sales grew by 5% versus the same quarter last year.

Quarter-over-quarter comparisons of product sales were also impacted bye the divestments since last year. In total, revenue from the businesses in Asia Pacific and Argentina that have been sold was $9.4 million in the second quarter of 2007, as compared to $2.3 million in the second quarter of 2008. On the other side, our product sales in the quarter did benefit from currency movements of $16.8 million. If you were to exclude these three factors, the wholesaler draw-down, the divestments, and the currency effect, then underlying product sales are essentially flat compared with the second quarter last year.

Ribavirin royalties were $14.8 million in the second quarter of 2008, compared to $19 million in the same period last year. This continues the same pattern in previous quarters following the loss of patent in Europe last year.

Now, let me turn towards cost and earnings. Earnings from continuing operations adjusted from non-GAAP items were a loss of $0.06 per share in the second quarter of 2008, compared with a profit of $0.15 last year. As part of the revised strategy that we communicated on March 27th, 2008, we indicated that we’ll be revising product focus within our commercial operations. As a consequence of this, we have moved our focus away from some products and discontinued others. This has resulted in an inventory of (inaudible) within cost of goods in the second quarter of $15 million, namely on Kinerase, fluorouracil, olsaderm [ph], delmadorm [ph], and other products. This has significantly impacted our overall cost of goods in the quarter. We have not excluded this $15 million charge from non-GAAP earnings as presented.

We have also taken this opportunity to update the financial presentation of our gross margin to include amortization expense. The gross margin in the second quarter of 2008 including amortization expense was 56%, compared 64% in the same period last year. Excluding amortization, the gross margin was 64%, compared to 71% last year. The deterioration in margin is entirely a consequence of increased inventory of (inaudible) charges built within cost of goods.

G&A expenses in the quarter were impacted by a number of items, most notably, the settlement of the patent court case in Spain. While we were disappointed with the outcome of this investigation, it will be good to resolve this matter before completion of sale of WEMEA. We record an expense of $9 million in the quarter related to this matter. We also recorded a charge in the quarter of $3.2 million to reflect on other than temporary impairment in an investment we have held in a Swiss private equity fund for the past seven years, a charge of $3 million relating to reversal of a tax benefit previously taken in Mexico, and a credit of $2.8 million related to stock option forfeitures.

As Mike mentioned, we are going through significant restructuring efforts that will primarily impact our selling and G&A expenses. Our current headcount reductions are over 200, and we should see an additional headcount reduction of approximately 385 attributable to the sale of WEMEA. While we began to see an impact of this in the second quarter, much of this effect will only be seen – will only be seen later in the year. Restructuring expenses recorded in the second quarter was $17.6 million including severance costs, legal professional and other fees, the loss relating to the sale of the business in Argentina, and also adjustments in the overall gain related to the sale of business in Asia.

Research and Development expense was $22.7 in the second quarter of 2008, the same as the previous year. In the quarter, we spend $12.6 million in external costs on our Retigabine program.

I’d now like to make a few comments on taxation. Historically, Valeant has kept profits and by our foreign subsidiaries abroad such that we recorded income tax expense on these profits only at the foreign tax rate. As part of the implementation of our new business strategy, we have changed this. Since June, we have repatriated cash from our foreign subsidiaries. This was achieved with little tax leakage and without incurring cash income taxes because of the utilization of foreign tax credits as part of our historical US net operating loss. However, this change does require us to recognize an in income tax provision on profits with a US tax rate rather than the foreign tax rate we previously used.

Consequently, our non-GAAP effective tax rate has increased 30% reported in the first quarter to approximately 36%, which is broadly the US rate. Our GAAP effective tax rate – tax position is also impacted by the effects of devaluation allowances recorded in prior periods. Provision for income taxes in the 2008 second quarter was $46.9 million, as compared to our benefits of $7.5 million reported in the same period in 2007. We anticipate that after this year, our GAAP and non-GAAP effective tax rates will move more closely together. This change in approach towards our taxes gives us the flexibility to use our cash generation to support future business priorities, whether that is through internal investment, share repurchases, or acquisitions.

As you will have seen, we announced last week an agreement for the sale of our Western-Eastern Europe, Middle East, and Africa business to Meda for $392 million. A significant proportion of the gain on this transaction will be sheltered by foreign tax credits and our US net operating loss. As you can imagine, there are various complexities and restrictions in the utilization of NOL. So I’m not in the position to be specific about the tax impact of this transaction, but I can indicate that we most likely will have some cash taxes payable on this – from this transaction of approximately $50 million.

At the 2007 year-end, we reported our US NOL and its net operating loss as $271 million. This has increased since then by approximately $100 million because of settlements of certain issues coming out of the 2002 to 2004 IRS exam and current year losses. Utilization of the NOL is dependent upon future transactions and further repatriations of foreign earnings. But we hope to be able to fully utilize the NOLs within the next few years.

Up until now, we have reported our financial results on both a GAAP and a non-GAAP basis, but that might change in 2009. Valeant’s 2008 financials will have many moving parts, and our tax accounting will be very complicated. Consequently, we continue to provide our investors with non-GAAP comparables at this stage. However, as we complete our restructuring, I believe the non-GAAP presentation will no longer be necessary. As we move into 2009, Valeant should be measured on our sales and GAAP profitability.

Now, let me turn to our balance sheet. Cash and (inaudible) securities increased $31 million in the 2008 second quarter to $550 million, which includes proceeds from the sale of our Argentina business. Cash flow from operations in the quarter was negatively impacted by the wholesaler inventory reduction program, but we’re still positive.

As announced in June, we redeemed the entire face amounts of $300 million 7% senior notes to $310.5 million on July 21st, 2008. Along with the redemption of the notes, we also terminated the related interest rate swap with respect to $150 million principal announced as our notes. The effect of the swap was to exchange a portion of the fixed rate payments, the floating rate payments.

On an annualized basis, the interest savings from the debt redemption and a termination of the interest rate swap is actually to be $19 million. Mike has already mentioned the results from our share buyback program. And that with the – that scheduled with the redemption of a significant proportion of our outstanding debt, I believe we have made substantial progress in improving our balance sheet. I believe our balance sheet is now better positioned to support the company’s future growth.

We’re making good progress on our six key initiatives. However, as we said on the previous earnings call, we will not be in a position financial guidance or metrics for the foreseeable future. A number of you have been asking for information on how completion of the six initiatives will impact our margins structure. Because of the number of moving parts, I am not in a position to comment on any overall, company-wide specifics.

But I thought it might be helpful to give you some information on the size of margin of WEMEA in the second quarter to help you assess the impact this will have. The WEMEA business we are selling to Meda, represented 58% of our EMEA business segment product sales in the second quarter of 2008, but represented 33% of its operating income, excluding restructuring charges and the expense related to the Spanish patent case I mentioned earlier.

The Central European business, which was excluded from the sale to Meda has shown consistent growth and stronger margins. In the second quarter, it represented 42% of the EMEA sector sales, but 67% of the EMEA operating profit. I’ll set out additional information on this in our press tables.

Now, I will turn the call back to Mike for closing remarks.

Mike Pearson

Thank you, Peter. Since we set out our six initiatives in March, the entire company has been making significant progress in achieving these objectives. We have aligned our management team and all of our employees to focus on the same thing, building a strong, sustainable, and profitable company, and delivering value to our shareholders, customers, and patients.

Thank you all for your attention this morning. We will now take any questions you have. Operator, may we have the first question please.

Question-and-Answer Session


Mr. Gregg Gilbert.

Greg Gilbert – Merrill Lynch

Thanks. Good morning. First, a few for Peter; Peter, did I hear you correctly that your best estimate for the tax bill on the $392 –?

Peter Blott

Sorry, Gregg. They cut out. Yes. I mentioned that my best estimate is that we would be around approximately $50 million on the transaction.


It looks like Mr. Gilbert’s line is disconnected. We’re going to try to reconnect him. In the meantime, Mr. Michael Tong from Wachovia Capital, you’re online.

Michael Tong – Wachovia Capital

Hi. Just a quick question, I understand there are a lot of moving parts in your PNL, but how should I think about income tax rates going forward? You mentioned that the GAAP and the non-GAAP rate will converge, but converge to around where and directionally? Can you give me some handle on how I should think about that for the years beyond?

Peter Blott

Yes, Michael. I think having changed that representation on the repatriation and the use of foreign earnings, I think it’s reasonable to assume that our future taxation in this immediate period will be equivalent to the US rate. So probably something around 35% or 36% is probably where we’ll end up going forward once we’ve completed the various initiatives and sort of settle down the position.

Michael Tong – Wachovia Capital

Thank you.


And your next question comes from the line of Mr. Gregg Gilbert of Merrill Lynch.

Greg Gilbert – Merrill Lynch

Peter, can you hear me okay?

Peter Blott


Greg Gilbert – Merrill Lynch

Can you give us a little more color on the cogs, SG&A, and R&D expenses that go away with WEMEA as well as the depreciation and amortization?

Peter Blott

Yes, certainly. For the cogs piece, and obviously, there was a – in the second quarter, the – some elements of the inventory provisions I mentioned. But I think I mentioned the operating income that we have retained that WEMEA represented 33% of the operating income in the segment. And that is essentially a pretty consistent level. So if you probably look to model it by taking what area EMEA overall segment has been and assume essentially that broadly sort of 58% of the product sales go with WEMEA, but 33% of the operating income goes with WEMEA. That’s probably a reasonable method.

Greg Gilbert – Merrill Lynch

What about D&A?

Peter Blott

The –?

Greg Gilbert – Merrill Lynch

D&A. I’m sorry. Depreciation and amortization.

Peter Blott

Depreciation and amortization.

Greg Gilbert – Merrill Lynch


Peter Blott

It’s about $23 million for WEMEA – $22 million to $23 million for WEMEA per annum.

Greg Gilbert – Merrill Lynch

Per annum. Okay. Moving on to gross margin, are you going to be providing restated quarterly gross margins to include the amortization? And will you be doing that by region as well?

Peter Blott

We have essentially made that change into our numbers in the 10-Q that was filed today.

Greg Gilbert – Merrill Lynch

With all the quarters as well?

Peter Blott

With the quarters that we are reporting.

Greg Gilbert – Merrill Lynch

Okay. So we’ll get that one quarter at a time going forward in comparison.

Peter Blott

I suppose in a similar way, we could quite easily put something on our Web site that states what those numbers are for all intervening causes if that helps with the model.

Greg Gilbert – Merrill Lynch

Yes. Thank you. And then more operationally, can you talk about what drove the sequential strength from Q2 over 1Q in the other neurology – in the other pharma lines in North America?

Mike Pearson

Yes. What we’ve done in North America is – and I think I mentioned this in previous calls is we’ve realigned our promotional efforts in North America, over in the United States specifically. And we’re now promoting the more promotionally sensitive products. So Zelapar used to be in our first line. That’s been to Diastat. And we’ve also taken some pricing increases.

Greg Gilbert – Merrill Lynch

Okay. Thanks. Let me get back in line.


(Operator instructions) We’ll pause for just another moment.

Mike Pearson

All right. Well, thanks so much. Do we have anyone else coming for one more?


We do have a follow-up from Mr. Gilbert.

Mike Pearson


Greg Gilbert – Merrill Lynch

Yes. I guess the bigger picture question on GAAP, non-GAAP, Peter, why are you excluding some one-time items, but including certain other ones like inventory on (inaudible), the legal settlement, the biotech fund write down? Can you walk us through what the – how you’re characterizing internally sort of one-timers from non-one-timers.

Peter Blott

What we’re doing is essentially trying to apply a perspective consistent rate. As you look back again to the past, it’s becoming difficult to say that some of the – which are the inventory (inaudible) provisions are one time. And we charge just part of normal ongoing business because we’ve experienced them in the past. What we’d like to do is to move away from a non-GAAP presentation, and just characterize things in the future on the basis of their merits. And essentially ask that we measured upon our GAAP profitability, our GAAP earnings. That’s difficult while we have the position with our income taxes at the moment, but that is the desire to go – going forward, plus probably, from 2009 onwards.

In the meantime, I didn’t want to open up any new categories of non-GAAP earnings. So we essentially were just leaving restructuring and income taxes on non-GAAP for this quarter.

Greg Gilbert – Merrill Lynch

Okay. Guys, thanks for the details.


At this time, there are no further questions.

Mike Pearson

Great. Well, thank you for all of you who listened in. And we look forward to talking to you in the near future.

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