Bausch Health Companies Inc (BHC) 2002 Q2 法說會逐字稿

Please stand by. Good day, everyone, and welcome to the ICN pharmaceutical second-quarter 2002 earnings results conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would now like to turn the conference over to Mr. Greg Keever, executive vice president, general counsel, and corporate secretary for ICN. Please go ahead, sir.

Thank you. I would like to welcome everyone to today's call. Before we begin the call, I would like to read to you the safe harbor statement under the Private Securities Litigation Reform Act of 1995.

This presentation contains forward-looking statements that involve risks and uncertainties, including, but not limited to, projections of future sales, operating income, returns on invested assets, regulatory approval processes, competition from generic products, marketplace acceptance of the company's products, and other risks detailed from time to time in the company's Securities and Exchange Commission filings.

Joining us on the call today are Robert W. O'Leary, ICN's chairman and CEO, Adam Jerney, president, John Giordani, chief financial officer, Mark Taylor, head of North American operations, Phil [Loberg], treasurer, and Winnie Wu, controller. All of whom will be available to answer questions during the Q and A session. And now I will turn over the call to Mr. O'Leary.

Thank you, Greg. Welcome to all of you joining us on the call this morning. Our aim this morning is to share with you more detail about the second quarter's results, as well as the status of our strategic review, more than we were able to share when we announced our earnings shortfalls last month.

While there are clearly issues in the quarter that we will touch on in a minute, it is important to note that ICN had areas of strong performance in the second quarter to display some of the depth of our operations and helped convince us that the long-term prospects of this business is, indeed, sound.

And another important take-away that you hope you have this morning, as you will see from the results that we will announce, the second quarter includes onetime charges that address past events but do not really reflect our ongoing operations.

North America and Russia were clearly soft, but these regions are getting back on track and our strategic review will help accelerate that process. In spite of this softness, the fundamentals of the business are good and that will give us a solid base upon which to reshape this company in the future.

There are three main areas that we want to address this morning with respect to the earnings. First, we're going to talk about our results from operations that exclude nonrecurring and extraordinary items. These results represent the ongoing operations of ICN Americas, ICN international, and Ribapharm.

Second, we will talk about the details of the significant amount of nonrecurring charges that are flowing through the quarter. The charges must be recorded as a component of operating income, but don't reflect our ongoing operations.

Third, we'll talk about the extraordinary and unusual items that are below the operating line. These items include the gain on the sale of Ribapharm stock, an extraordinary loss from a debt repurchase, and our application of FSAS 142 with respect to the impairment of goodwill that we adopted on schedule and as planned, and that impacted our six-months results.

Let me move to ongoing operations.

Let's first address the results of our ongoing operations. As you can see in the release, we reported revenues of 237 million, operating income of 40.7 million, and net income of 16.3 million or 19 cents per diluted share in the second quarter.

Again, these results exclude nonrecurring and extraordinary items, and they are in line with the earnings guidance we gave last month.

ICN's results were driven largely by Ribapharm, which had a strong contribution to revenues and profits. As you recall, our partner, Schering-Plough, launched its PEG-Intron and Ribavirin combination therapy in October of 2001 and has seen strong sales as a result. These sales in turn resulted in 66 million in royalty revenue for Ribapharm in the second quarter.

In addition, many of you will recall that last year's sales of Ribavirin were somewhat constrained by the warehousing of FC patients ahead of Schering's PEG-Intron Rebetol launch. Ribapharm also has continued to expand upon its research and development efforts in the antiviral and anticancer therapeutic categories.

Now, Ribapharm will discuss its results in far greater detail in its earnings release and conference call with analysts and investors tomorrow morning.

Results for the specialty pharmaceutical business, which includes ICN Americas and ICN international, were not as impressive as we discussed in our previous earnings guidance. However, as I mentioned earlier, there are areas of strength in that business that continue to perform well, and I will point those out in a moment.

Revenues for the specialty pharma business overall were down 2 million, or 1% in the quarter. But reflect different results in different parts of the globe.

Operating income in the quarter for this business was down substantially, 30.3 million, compared to a year ago. The lower operating income principally reflects the decline in sales as well as higher selling expenses and overhead costs.

Our international operations reported an increase in revenues in the quarter of 9.3 million, or 11% over the last year. The revenue improvement for international was led by our operations in western and Central Europe. These regions experienced strength in several products, such as Calcitron for osteoporosis and [inaudible] for cough, as well as active ingredients such as morphine and Nystatin.

Eastern European revenues in the second quarter were lower than last year, reflecting our decision to stop production in Russia of certain low-margin products and focus on those with higher margins. In addition, we closed down our direct retail distribution channels in favor of existing national wholesalers. We believe these actions were the right strategic steps to take and have already seen significant increases in sales of our top 10 products in Russia as a result.

As these steps gain momentum, as we move into the last half of the year, we expect to see revenues from Russia return to planned levels by the end of the year.

Operating income for international was substantially lower than last year because of the reduced sales in eastern Europe and because of the increased overhead cost for ICN international, due to the establishment of the division's new headquarters in Basel, Switzerland, which added 5.9 million to operating expenses in the quarter.

So overall, international revenue performed well because of strength in western and Central Europe, but operating income was off because of temporary difficulties in eastern Europe, particularly Russia, and Basel overhead costs.

Revenues for ICN Americas declined 11.2 million or 13% in the second quarter primarily due to lower product sales in North America. Operating income was off 52% in the quarter, reflecting the lower sales, as well as increased operating expenses in the photonics business.

The decline in North America's revenues, in part, reflects reduced shipments of Mestinon in the quarter to reduce inventory levels in anticipation of the possibility of generic competition.

To address this issue, we've developed several marketing programs to stem any potential erosion of our franchise. These programs will be targeted toward key market segments, which include physicians, pharmacies and patients, and have as their focus patient safety.

In addition, it is our practice to develop improved delivery forms for certain products that face generic competition, and those plans are in the works for Mestinon.

In addition, the decline in revenues reflects the decision on the part of the company to reduce inventories at wholesalers to a level that moves us closer to industry norms in the second quarter. The company began a program to reduce inventories - excuse me - at its U.S. wholesalers. The company managed production, inventory, and wholesale distribution levels in accordance with customer demand. Inventory levels at wholesalers have historically been held at levels that would ensure availability of product while undergoing a series of manufacturing issues and site changes that require the company to operate with higher inventory levels.

The level of inventory supply at wholesalers at the end of June approximated the average level in 2001. We expect to significantly reduce those inventories to a level by the end of this year that this company has not seen since 2000. This action is expected to reduce quarterly revenues by 10 to 12 million per quarter, and we expect smaller reductions in the new year in quarterly revenues in 2003, when wholesaler inventories will move much closer to the norms.

Also, as we have mentioned in our earnings guidance call, our North American operations were negatively impacted by lower than expected revenue from our photonics business which decreased by 2.6 million in the quarter. In addition, operating expenses for this business were 3.8 million higher in the second quarter, which negatively impacted operating income.

Another positive, in addition to western and Central Europe, is our operations in Latin America, where we posted strong results in the quarter, with revenues up 3 million, or 10% over last year, and operating income up nearly 30%. This, in spite of currency devaluation of 11% in the region. Latin America benefitted from strong product sales in the quarter, particularly our vitamin B injectables, which generated sales growth of 18%.

Our Americas business clearly experienced weakness in the U.S. due to our desire to bring wholesaler inventories down, and because of the weakness in the photonics business, but the product portfolio remains strong, generating revenue and cash flow, and Latin America is clearly a strong region for us.

The company's gross margin was off in the quarter, dropping from 59% last year to 56% in the current quarter. The decline is primarily due to the reduction in sales of higher-margin products in North America, which put pressure on the gross margin.

General and administrative expenses were higher in the second quarter versus last year, and primarily reflect the costs of our international headquarters facility in Basel, as well as higher corporate expenses, mainly associated with various overseas M and A and tax issues, as well as severance costs.

Overhead, I should add, is an area of intense focus of the new management and our advisors. While we can't share with you any specific actions until we complete that review, we do believe that there is considerable room for improvement in ICN's overhead and expect to evaluate this area very, very closely and then take decisive action.

Let's take a step away now for a moment from the ongoing operations of the company and talk about the nonrecurring and extraordinary items in the second quarter.

As you can see in the release, these items were significant, and I want to describe some of the larger items for you.

First, the company repurchased 61 million of employee stock options following what was deemed to be a change in control of the company in the stock option agreements. The second largest nonrecurring item was the cash bonus of approximately 48 million paid to ICN executives and board members in connection with the Ribapharm IPO. In addition, the company paid 13 million in investment banking fees related to the Ribapharm transaction, and wrote off previously capitalized IPO costs for ICN international of 18.3 million.

The latter were costs the company wrote off because of the substantial passage of time since they were initially incurred and was a step the company was advised to take by our auditors, regardless of whether or not we proceed with the spinoff of international operations.

The company also incurred non-cash expenses related to certain incentive compensation costs based on the change of control provisions in the contracts of several senior executives, which totaled 12 million in the quarter.

Finally, the company incurred expenses of 6.3 million related to the recent proxy contest.

Now, all - I want to yeah size all - of the actions I have just described were taken and executed prior to the seating of the new board and the appointment of the new chairman and CEO on June 19th. The items I outlined for you were the largest components of the nonrecurring charges. The remainder of the charges were for the write-off of in-process R and D related to a recent acquisition, other asset write-offs, and severance costs.

While these items are not part of our ongoing operations, we are required to include them in operating income. As a result, our operating profit of 40.7 million from operations was reduced by those charges to a loss of 148.5 million in the quarter.

Going below the operating line, you will see that we have also recorded a onetime gain in the quarter for the proceeds from the Ribapharm IPO that totaled 263 million before taxes. In addition, we recorded, on an after-tax extraordinary loss of 26.8 million, or 27 cents per diluted share for the repurchase of debt in the quarter, related to the Ribapharm IPO. As a result of these onetime and extraordinary items, the company reported a net profit for the second quarter of 32.4 million, or 38 cents per diluted share.

The last of our unusual items was the application of a recent accounting rule in which we reviewed our goodwill and other intangible assets for impairment. The rule applies to all companies and we adopted it on schedule.

As a result of that review, we wrote down these assets by 25.3 million in the quarter, which we were required to do to reflect - required to reflect in our year-to-date results.

Now, let me step back with you and talk just a bit about the strategic review process.

As we previously announced, we've initiated a strategic review of the company's operation and business plans going forward. I want to give you an update on where we are with that review.

We expect to move quickly and decisively through the process, and expect to have more details to share with you within 90 days. Until that time, we are limited on what we can say to you on the expected outcome.

However, we would like to share with you components of the process we are undertaking as we go through the review, so that you can see that we are moving forward Swiftly and how we are proceeding along that path.

We announced recently that ICN retained Goldman Sachs and a leading management consulting firm with significant global pharmaceutical experience to assist us in the process, and their input is proving extremely valuable.

As we have said, what remains is a 90-day process and we are still in the early stages, but in the first phase of the process, we are assessing profitability and value creation potential across all regions and product assets, and conducting competitive scans in all our key geographic areas, eastern Europe, Argentina, et cetera. And across each product area, dermatological products versus others, et cetera. To assess the likely future value of assets.

We are also conducting internal benchmarking to determine improvement opportunities in our operations. In the next phase, we expect to develop a set of strategic asset configuration options that are balanced against risks and feasibility analysis, along with specific strategies and operating models for key assets and business units.

As we approach the final phase, we'll make determinations on the key action steps needed and develop recommendations to the board for an optimal structure for the company in the future.

As we said before, everything is on the table as we go through this process, including the previously planned spinoff of Ribapharm and spinoff of our international operations. We have made no decisions yet, and don't intend to send any signals at this point. However, we feel that it's important that we be as clear and transparent on the process as we possibly can be.

As material developments occur, we will share them with you.

Let me move now to talk about certain balance sheet components.

First, cash at the end of June totaled 290 million, which was a slight decline from the balance at the end of 2001, and a decline of 90 million during the quarter.

Cash inflows in June quarter included the IPO proceeds and royalty receipts. They were more than offset, however, by outflows that primarily included payment for the bond repurchases, bonuses to management for the Ribapharm IPO, stock option purchases, share repurchases, strategic investments, and taxes.

Accounts receivable at June 30 totaled 256 million, down 11 million from the balance at December 31. Inventory at June 30 was down as well, totaling 158 million. Stockholders' equity increased by 58 million in the year to 869 million at the end of June.

Now, I know that a number of you will be looking for us to give you some guidance on what to expect for our results for the rest of 2002.

I must tell you that our strategic review complicates the guidance process to the extent that the outcome of that review affects, of course, the structure of the business going forward.

But I can tell you that based on the information we have today in our core businesses, that we are not uncomfortable with the consensus estimates that are on the street today for 2002.

I will forewarn you, however, that our strategic review could significantly alter the assumptions we are using today, which could impact those estimates.

In addition, the outcome of the strategic review could result in the need for the company to record additional nonrecurring charges in the latter half of 2002 that would not be a part of our ongoing operations.

I know this has been a challenging quarter for everyone. You can imagine what a welcome it was for me, after only 33 days on the job. While we have experienced weakness in some of our business units, I am now more convinced than ever that our business is fundamentally solid and that our long-term prospects are good. This was clearly evident in our product portfolio and in the business units that performed well, such as western and Central Europe and Latin America.

Issues that were a part of the second quarter are being actively addressed by management. We've already taken steps to stem potential erosion from generic competition and to reduce wholesaler inventories to a level that moves us closer to the industry norms. The levels of overhead at corporate and international headquarters are areas that we will focus on intently in the weeks ahead, and we expect to move decisively to make corrections.

We believe that ICN has a solid platform upon which to build and shape this company through our strategic review, and we expect to have much more to say about that in the coming weeks.

With that, I would like to open the call to questions. Please limit your questions to one per person, to allow as many as possible on the call to participate. As we mentioned earlier, several of our officers are here with me or on the phone and will be able to answer your questions. Phil, would you be kind enough to take the first question, please? 00:22:42

Thank you, Mr. O'Leary. Our question and answer session will be conducted electronically. If you would like to ask a question for our panel of speakers, please firmly press the star key followed by the digit 1 on your touch-tone telephone. We will take the questions as you have signaled us, and take as many questions as time permits. Once again, that is star 1 to ask your question. And we'll pause for just a moment to assemble our roster.

And our first question comes from Michael Tong with Wachovia Securities.

Hi. Good morning. Actually, I have a question concerning the international headquarters. A couple of things. One, if I recall correctly, there used to be an international headquarters in Moscow. Have you written that investment down? Is it still there? And two, as it relates to the international headquarters, outside of that extraordinary cost, is there any other things that's in the SG and A line that might be onetime related so we can look forward to what the - what the ongoing SG and A would be like in the next several quarters? Thank you.

Phil?

Yes. This is Phil [Loberg]. Thank you for the question. The expenses for headquarters are primarily related to Basel. While there's a regional headquarters in Moscow, bosses you will is where the significant activity occurs.

With regards to other charges sitting in the G and A, we've attempted to break out the significant items in the nonrecurring. For those that are not classified as nonrecurring, they are in continuing operations and we'll provide more visibility to those when we release the 10-Q.

Thank you.

Thank you, Michael.

And our next question comes from Larry Smith with Gerard Klauer.

Hi. Could you quantify the impact on revenues and cost of goods sold in the second quarter from the inventory situation in the U.S.?

And also, could you comment on what you think, at steady state after the inventory situation has run its course, what the gross margins on your business might be?

And as a - also, what you think a normal SG and A margin might be.

There's a lot of questions in there, Larry. You sure got your nickel's worth. Let's see which of those we can get to and then there may be some of them we'll want to get back to you off-line on. Phil?

Yeah, this is Phil [Loberg]. In the quarter just ended, the reduction in inventory was approximately 15 million, and as we indicated, a significant portion of that was related to the effect of a generic entry or potential generic entry, and as it affected our inventory levels in our wholesaler chain.

With regards to the remaining quarters of the year, we estimate the range of that impact to be approximately around the $10 million level on the revenue line. And a lesser amount going into next year.

With regard to margins, North America has significantly - or has higher margins than the other enter - than the international regions, and as a result, that shortfall in North America has negatively impacted margins, but we expect, as we work off that inventory situation, the margins will continue to restore themselves back to normal levels.

On the question of SG and A, Larry, let me just say this: Without pointing to a specific number of benchmark, that's exactly some of the work that we're doing with our consultants now. Suffice to say that our numbers are sufficiently over any benchmark that we might come up with. We've got work to do in this area, and we'll be much more transparent about what we think the benchmark ought to be and the distance we need to travel in future calls, but I think you're right on with the question. I'd like to not be pinned down on a number just yet, but we'll be prepared to be very specific on this next time around.

Okay. Thank you.

Yeah.

We will now hear from Matt Duffy with black diamond research.

Yes. Good morning. Thank you very much for taking my question. Just wanted to try and get a little clarity on the inventory situation. I think on your last call, you had expected inventory reductions to move into the middle of next year, and today you're just saying that you expect some - some effect through 2003.

Can you talk about how far into 2003 you might expect the impact and you see it's less than 10 to 12 million per quarter, but any sense of how low it's going to go?

Matt, you - you listen well. Let me - let me say, in fact, that we think we'll - we're going to make the most significant improvement as we get through the rest of this year. And then we will cut down the pace of improvement as we get into 2003. We are planning at the present time to spread that effect throughout 2003, but it will be nowhere as dramatic on a per-quarter basis as it is in 2002. Meaning the second, third, and fourth quarters. If that helps you at all.

What I want to do is see where we are at the end of 2002 and then reevaluate the program, but in general, our view is that rather than taking it out in bigger - in the same size chunks in the first quarter or second quarter of 2003, we would be better advised to spread it throughout the year, and that's - that's basically our game plan at this point.

Okay. Thank you very much.

We will now hear from Bill [Pechar] with Aristia capital.

Hi, guys. Just a couple questions on the cash flow side. What was capex, and license and product acquisition cash expenditures for the quarter?

On the capex, I think that was approximately 10, 15 million. And with regards to acquisition activity, it was approximately 20 - 20, 25 million for the year-to-date and I think it was about 12 million for the quarter.

Great. Thanks.

Okay, Bill, thank you.

We will now hear from Rick Stover with Arnold financial.

Good morning.

Good morning, Rick.

Could you comment on the status of the CEO search and if you've got any sense of what sort of timing is involved there?

I can't give you any - any notion on timing, and - but I can tell you that the - Korn/Ferry is doing the search and they seem to be making good progress and have reported to the - to the search committee that they have begun to vet a pool of attractive candidates and I would imagine we'll be moving into the second phase of that search in the - in the next several weeks.

Understandably, while I'm a member of the search committee, that hasn't been my primary focus right now. I've left that to the other members of the committee and the search consultant.

Classically, in these searches, the first - the first period of time is the research side done by the firm, their ability to talk with and attract candidates, and I will say to you that the feedback we're getting is that there is no - no difficulty interesting candidates in this company because of the - the belief that there's some strong fundamentals and nice up side in the company.

Thanks.

[inaudible] with [Kober] management has our next question.

Hello. Do you have any plans to purchase your outstanding debt in the open market?

I'm sorry, I could barely hear you.

Do you have any plans to make any open-market purchases of the outstanding debt?

Phil?

Yeah. Thank you for your question. We're always considering the optimal use of our capital, and that activity and others is currently under consideration at the present time.

Thank you.

We will now hear from Mark [Schoenbaum] with CIBC World Markets.

Yes, Mark.

Hi, everybody. Thanks very much for taking my question. Really appreciate it. Can you just comment, we understand you haven't made a decision yet regarding the Ribapharm spinoff but can you kind of take us through what kinds of arguments on both sides you're considering? What would be some reasons for spinning it off, what would be some reasons for not spinning it off and kind of set the stage for maybe the debate that may be going on internally? Thanks very much.

Mark, I got to admit, that's a nice try. I'm not going to comment or speculate about the strategic review or where we're going, and I'm not smart enough to talk you through the answer to those questions without suggesting, even inadvertently, some sort of a bias, so I'm going to take a pass on your question, Mark.

I understand. And - that's fair. And in terms of the timing for news on that, could we expect - you mentioned that you would have clarity from the - from the firms - you would finish this process in roughly 90 days. Could we expect clarity as to the spinoff plans in 90 days as well?

It would be my strong hope that that would be what we could do. This is the first time we've given you a signal as to the time line here. We're being fairly aggressive with it, but having made a commitment to you, we will do everything humanly possible to meet that, and - and have answers for you on those questions by that time.

Okay. Thanks very much for taking my question.

Well, thank you, Mark.

Bye-bye.

We will now hear from Bob Dunn with SAM investments.

Thank you. I was wondering if you could just review - you mentioned most of the items but could you review the major sources and uses of cash during the quarter, and do you have any outlook for cash usage over the rest of the year?

Certainly. Here's Phil.

Yeah. Thank you for your question. The primary inflows for the quarter related, of course, to the IPO proceeds of some 260 million, as well as royalties in the 50s. The outflows for the period primarily special items included the bond repurchase, 230 plus million, the Ribapharm bonuses, approximately 48 million. We had the employee option put of cash out on those was approximately 40 million. We had some share repurchases during the quarter of 32 million. And other acquisitions and activity the remaining balance, bringing us to a balance of cash of 290 million for the quarter.

Okay. Thank you. And any outlook for the rest of the year?

I expect that the cash balances will hold, subject to strategic review and any impacts that that may have. We have some activities which would reduce, in normal course, that are anticipated, but what we don't have considered is any potential activities that would be required by any decisions made as a result of the strategic review.

Thank you.

And just as a reminder, if you'd like to ask a question, please press star 1.

Moving on, we'll hear from Matt [inaudible] with Quaker capital management.

Just a couple more balance sheet numbers. Wondering what, if any, short-term debt you have, what - of all the charges taken in the quarter, are there any remaining that represent a cash obligation, and lastly, do you have - what are your remaining sort of acquisition-related payout obligations.

With regards to our short-term debt, it's immaterial. In terms of the current portion.

With regards to the remaining cash flows related to extraordinary items, I'd say we're about 70% there.

And with regards to acquisition commitments still pending, it's a nominal amount. 10, 15 million.

Okay. And that's - so that remaining 30% is of what number?

Of the a hundred and - I think 189 million of special charges.

Okay. So roughly 55 to 60 million to go?

Actually, a little bit less than that.

Okay. And your Q will be filed, I guess, by the 15th?

That is correct.

Okay. Thank you.

And we do have a follow-up question from Michael Tong.

Hi. Thanks for taking the follow-up.

Could you re- - refresh my memory as to what your exposure in Mexico is, as far as product sales for the Mexican government?

Adam?

Yes. A very good question. As you probably remember, we have discussed the fact, in previous telephonic conferences that we have been concentrating most of our business in the private market sector in Mexico. Therefore, our present exposure, as far as the collection issues is concerned from the government is immaterial.

Thank you.

And once again, as a reminder, please press star 1 to ask a question.

And we do have one question, and that comes from Steven McIntyre with Q investments.

Yeah, guys. I just - most of my balance sheet questions have been answered. I just had one on the stock buyback. The Q showed 28 million. I just wanted to make sure, was that last 4 million before the CEO change?

That is correct.

Thanks.

Folks, I guess that concludes our questions. I appreciate - I appreciate them, and hope that this is the last time we sit before you and kind of talk about soft earnings and disappointments. We have talked a little bit about what to look forward in the third and fourth quarter and we will try to make sure we're consistent with - with those expectations. We'll get information to you on the strategic review as - at the earliest opportunity, and we will continue our efforts to improve the clarity, decrease the complexity, and improve the transparency of the company. But as I said earlier, I know that this has been a challenging quarter for everyone, but we believe that this business is fundamentally solid, and that our long-term prospects are good. That should be evident from our product portfolio and the business - and that the business units that have performed well.

The other thing I would note to you, that the areas that have been problematic in the quarter are the kinds of things that lend themselves quite well to management actions, so there's reasons for optimism about the up side in the future.

The new management team is actively addressing past issues, and we expect to take decisive action in the weeks ahead, as we complete our strategic review.

We believe that ICN has a solid platform on which to build and shape this company, and we look forward to speaking with you about that soon. Thank you all for your time and your questions. Good day.

Thank you. That does today's conference. Thank you for your participation.