Bausch Health Companies Inc.
Q3 2013 Earnings Call Transcript

Published: 31 Oct 2013

[Operator:]

Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Valeant Pharmaceuticals Financial Conference Call. [Operator Instructions] Thank you. Mrs. Little, you may begin your conference.

[Laurie Little:]

Thanks, Julie. Good morning, everyone, and welcome to Valeant's Third Quarter 2013 Financial Results Conference Call. Presenting on the call today are J. Michael Pearson, Chairman and Chief Executive Officer; and Howard Schiller, Chief Financial Officer. In addition to a live webcast, a copy of today's slide presentation can be found on our website under the Investor Relations section. Certain statements in this presentation may constitute forward-looking statements. Please see Slide 1 for important information regarding these forward-looking statements and associated risks and uncertainties. Readers are cautioned not to place undue reliance on any of these forward-looking statements. The company undertakes no obligation to update any of these forward-looking statements to reflect events or circumstances after the date of this presentation or to reflect actual outcome. In addition, this presentation contains non-GAAP financial measures. For more information about these non-GAAP financial measures... [Technical Difficulty]

[Laurie Little:]

I apologize, everyone. We seem to have had some technical difficulties. Hopefully, everyone can hear us. You missed my exciting, forward-looking statements but with that, I'm going to turn the call back over to Mike Pearson.

[J. Michael Pearson:]

Thank you, Laurie. We're not sure where we got cut off, so I'm going to start from the beginning. Good morning, everyone, and thank you for joining us. As you've read in our press release, we followed up our solid performance in the first half of 2013 with another quarter of strong operating results. On today's call, I will review our third quarter results and performance, provide an update on Valeant's business and then provide my early perspectives on our Bausch + Lomb acquisition. Howard will then provide an update on the Bausch + Lomb integration and discuss the business going forward. After our remarks, Howard and I will be available for Q&A. This morning, we reported Valeant's third quarter results for 2013, which were driven by strong sales growth and profitability across all of our operations, including strong performance from Bausch + Lomb since the August 5 close. Total revenue in the quarter was $1.54 billion, as compared to $884 million in the third quarter of 2012. Our third quarter cash EPS was $1.43 per share. As a reminder, we closed the Bausch + Lomb financing before we closed the deal. The pre-closing interest expense and the pre-closing impact of our additional shares cost us $0.09 per share this quarter. If you exclude this cost, our cash EPS increased 31% this quarter. In addition, foreign exchange movement negatively impacted us by $0.03 in the quarter and an unexpected early generic launch of Retin-A Micro that occurred right after our last earning call in August, had a negative $0.04 impact on the third quarter results. All of these negatives are included in the $1.43 cash EPS. Adjusted cash flow from operations was $408 million for the quarter, an increase of 69% over the prior year. I would like to make -- take a moment to touch on several onetime items that were also recorded during the quarter. First, we took a total impairment charge of $645 million for the retigabine, ezagobine franchise. This charge was necessitated by the decision by GSK to cease marketing and sales support for the immediate release formulation in the United States. In addition, we announced earlier this week that we have settled all outstanding claims by Anacor Pharmaceuticals regarding Jublia and all other disputes with Anacor for $142.5 million. Finally, we recorded $305 million in restructuring and integration charges, primarily related to the Bausch + Lomb acquisition. As we mentioned in August, post the Bausch + Lomb acquisition, we have a very diversified portfolio of Rx, device, OTC and branded generics businesses. We will continue our strategy of focusing on long lift durable products, cash-pay businesses and growth geographies. We do not want to limit ourselves to 1 or 2 therapeutic areas, but rather, we look for durable products that could be actively promoted [Audio Gap]

[Operator:]

Ladies and gentlemen, this is the operator, I do apologize but there will be a slight delay in today's conference call. Please hold and the conference will resume momentarily. Thank you for your patience. [Technical Difficulty]

[Laurie Little:]

And so we apologize for the issues that we're having this morning. We're going to go ahead and go back a little bit. And Mike's going to start probably at the top, so we'll probably be repeating a bit that -- what we just said but we're not sure exactly where we dropped off. So I apologize for the delay and I'll turn it back over to Mike.

[J. Michael Pearson:]

Good morning, everyone for the third time. Hopefully, third time's a charm. We'll start from the beginning. As you've read in our press release, we followed up our solid performance in the first half of 2013 with another quarter of strong operating results. On today's call, I will review our third quarter results and performance, provide an update on Valeant's business and then provide my open perspectives in Bausch + Lomb. Howard will then provide an update on the Bausch + Lomb integration and discuss the business going forward. After our remarks, Howard and I will be available for Q&A. This morning, we reported Valeant's third quarter results for 2013, which were driven by strong sales growth and profitability across all of our businesses, including strong performance from Bausch + Lomb since the August 5 close. Total revenue in the quarter was $1.54 billion as compared to $884 million in the third quarter of 2012. Our third quarter cash EPS was $1.43 per share. As a reminder, we closed the Bausch + Lomb financing before we closed the deal. The pre-closing interest expense and the pre-closing impact of our additional shares cost us $0.09 per share. If you exclude this cost, our cash EPS increased 31% this quarter. In addition, foreign exchange movement negatively impacted us by $0.03 in the quarter and an unexpected early generic launch of Retin-A Micro that occurred right after our last earnings call in August, had a negative $0.04 impact on the third quarter results. All these negatives are included in the $1.43 cash EPS. Adjusted cash flow from operations was $408 million for the quarter, an increase of 69% over the prior year. I would like to take a moment to touch on several onetime items that were also recorded during the quarter. First, we took a total impairment charge of $645 million for the retigabine and ezogabine franchise. This charge was necessitated by the decision by GSK to cease marketing and sales support for the IR foreign relation in the U.S.. In addition, we announced earlier this week that we have settled all outstanding claims by Anacor Pharmaceuticals regarding Jublia and all other disputes with Anacor for $142.5 million. Finally, we recorded $305 million of restructuring and integration charges, primarily related to the Bausch + Lomb acquisition. As we mentioned in August, post the Bausch + Lomb acquisition, we have a very diversified portfolio of Rx, device, OTC and brand generics businesses. We will continue our strategy of focusing on long-lived durable products, cash pay businesses and growth geographies. We do not want to limit ourselves to 1 or 2 therapeutic areas but rather, we look for durable products that could be actively promoted to a small set of physicians or health care professionals to drive strong organic growth. As you can see from the chart, branded prescription drugs now represent 41% of our total pro forma 2013 revenues. Of this revenue slice, only 24% of the brand prescriptions sales, or 10% of our total revenue, are subject to a patent cliff. We believe our strategy has positioned us with the most durable set of assets in the industry. This dynamic is further demonstrated by the patent chart that we shared with you last quarter. Looking forward over the next 4 years, you can see that 2013 is, by far, our toughest year, as we were impacted by generic competition for Zovirax, Retin-A Micro and a number of other brands. The year-on-year impact and lost revenues will be $300 million in 2013. A significant impact on our total revenue base of approximately $6 billion. We will also expect patent expiry on Vanos in the U.S. and Wellbutrin in Canada during the fourth quarter. With our most recent acquisitions, including Bausch + Lomb, and other promoted brands coupled with the significant increase in third-party promotion of many of our neuro and other products, our U.S. business mix has changed significantly. Today, 80% of our U.S. products are now actively promoted through sales forces, directed physician marketing and other targeted selling activities. Going forward, our percentage of promoted products in the U.S. will only increase given the number of new product launches we have planned for 2014 and beyond. Therefore, it no longer makes sense to split the U.S. market into promoted and non-promoted products for the purpose of reporting organic growth. I would also like to note that with the addition of Bausch + Lomb, coupled with the acquisition of Obagi and the significant growth of our aesthetics businesses, our U.S. business is even more diversified. For example, our prescription dermatology business in the U.S. now only represents 20% of our U.S. revenues, a dramatic shift from just a year ago. Given the impact of generics on the Zovirax franchise, Retin-A Micro, and BenzaClin. We thought it would be more useful to our investors to show organic growth excluding these products to demonstrate the growth of the underlying business. The decline of revenue of the above-mentioned products was approximately $100 million for the quarter, and the details are included in table 6 of our press release for your information. As we move forward, we will continue to show organic growth without the impact of significant generics, and also to disclose the quarterly revenue impact of products excluded from the calculation. We believe that this presentation will facilitate investors in modeling their revenues going forward. Excluding these products, our U.S. business continues to exhibit solid organic growth of 5%, driven by many of our dermatology prescription brands, our aesthetics and oral health portfolios and our Orphan drug products and Xenazine. Our emerging market segment delivered the same-store organic growth rate of 14% in the quarter, continuing the exceptional strong progress seen so far this year. Almost all the legacy Valeant U.S. business reported strong performance this quarter. While the overall U.S. Dermatology market continues to realize greater generic penetration, most of our brands have continued to maintain or growing market share including Elidel, Acanya, Atralin, Carac and CeraVe, just to name a few. Solodyn, while seeing some erosion this year, appears to have stabilized at roughly $200 million on an annualized level. Our aesthetics franchise continues to perform extremely well. Dysport continues to increase its market share and Obagi had another great quarter. We attribute this continued progress to our commitment to the specialty, our continued development of relationships with many doctors and our broad portfolio. Our MVP Program has been very well received, as we continue to pay benefits. We are very excited about the future of this business. OraPharma continues its strong performance track record, once again, with double-digit revenue growth. We will introduce a new product to support bone regeneration post-tooth removal in Q4 which should further boost growth going forward. Finally, our neuro and other portfolio saw a double-digit growth in our Orphan drug portfolio and we are pleased to say that Wellbutrin XL continued to be stable at approximately $150 million annually. The legacy generic products that are partnered with Teva and Forest continued their decline, but now represent only about $50 million a year. As we noted on the organic growth chart, our Emerging Markets continue to deliver strong growth. Our operations in Central and Eastern Europe remained robust growing at a healthy 15% rate with both Russia and Poland significantly outpacing their respective markets. We are now a top 10 player in Poland and we have well north of $400 million in revenue in Russia. Our operations in Southeast Asia and South Africa also remained very strong with same-store sales nearing 20% organic growth. We are excited to have entered Vietnam and with the close of the Euvipharm acquisition and we are looking to establish a local presence in Indonesia within the next 12 months. Latin America also recorded double-digit growth in the quarter with both our Mexican and Brazilian businesses continuing their track record of strong growth. Finally, a few reflections on the Bausch + Lomb acquisition. Since the transaction closed in August, I've spent a significant amount of time getting to know our operations and people around the world. I've been to Germany, France, the U.K., Sweden, Eastern Europe, China, Japan, Mexico, Canada and all of our locations in the U.S. multiple times. Probably, the best word I can use to sum of these travels is, excited. I'm excited about our new colleagues and I'm very pleased with the continued strong performance of the business during the integration process. I'm excited about the opportunity to streamline costs and to trim the fat without touching the muscle. The global and regional Bausch + Lomb infrastructure was inappropriate given the size of the business. In fact, we should be able to exceed our synergy targets. I'm excited about our decentralized launch feed that has been embraced across the organization. I am convinced that better decisions will be made by people closer to the customers. And I'm most excited about the opportunity to adopt local business strategies and foresee local business development activities. I am convinced that we will accelerate our growth, by giving our country teams more say in how products are positioned and priced, and how they can be complemented by new products such as lower-cost surgical equipment, to meet local needs. Finally, I am excited about the continued productivity of the Bausch + Lomb development team. Since we announced the deal, we have had 8 new product approvals and many more are on the way. As expected, our R&D spend will be higher in the first half of 2014 as multiple Phase III pharmaceutical programs will be reaching completion. We did not include any of these development programs in our deal model. We would hope some will succeed, so we can deliver more upside to all of you. With that, I will turn the call over to over to Howard.

[Howard Bradley Schiller:]

Thank you, Mike. I am pleased to report that our integration activities continued to yield positive results and we have now identified greater than $850 million in synergies from the Bausch + Lomb transaction with the run rate of greater than $500 million exiting 2013. At this point, we have integrated the 3 Bausch + Lomb global businesses into our decentralized structure, and have synergized the global, corporate, regional and back-office functions to streamline the operations and place responsibility and accountability into the hands of the country managers and the business leaders in the United States. We have also begun to review and rationalize the Bausch + Lomb and the legacy Valeant R&D portfolios. The cost to achieve these synergies will be approximately half of a full year synergy, and we have spent close to $128 million to date. The accounting rules required us to accrued for all identified severances, whether paid or not, which is why the restructuring charge of $305 million is significantly above the cash spent to date. Finally, we also expect to be on track to complete the B+L IP integration by January 1, 2014. I know that all of you would like some update as the performance of the Bausch + Lomb trend operations, so we've provided this chart as a look in to the strength of the business since we have closed the acquisition. In the U.S., the operations delivered 15% organic growth, driven by strong growth in pharmaceuticals and OTC sales, while the rest of the world developed markets delivered 3% growth bringing the total developed markets growth rate to 9%. Emerging Markets businesses delivered double-digit growth of 14%, as almost all of the Emerging Market businesses exhibited strong growth, driven largely by sales of contact lens and OTC products, including lens solutions. Overall, B+L's organic growth rate was 10% in the quarter. We are very pleased with this accomplishment so far and hope to continue this trend in the future. As Mike mentioned, we have visited most of the Bausch + Lomb regions and businesses. And with this world tour now complete, we have a better view of the opportunities and challenges facing each of the businesses. As we currently look at the B+L businesses, we divided them in to 3 categories listed on the slide. A number of the businesses are performing extremely well. These include the U.S., Russia, China, Turkey, the Middle East and Germany, among others. And we would expect to continue to invest in these franchises and accelerate their growth. There's a second group of businesses including Japan, Mexico, Brazil, Southeast Asia and Canada that are doing well, but we believe they will benefit from our decentralized structure and will develop local strategies including local business development to drive improved growth. Lastly, there are also a few countries where we will need to rethink the way we were operating the business and turn around the performance. We're in the middle of our 2014 budget process and so far, we have ample reasons to be excited about the improved profitability and growth prospects of B+L businesses in 2014. Turning now to a summary of our financial performance. We delivered strong results again this quarter. Looking at the ratios and margins, that expected our cost of good sold increased with the Bausch + Lomb acquisition from 23% last quarter to 27% in the third quarter. On a standalone basis, B+L had gross margins in the 53% range prior to the acquisition. In addition, both SG&A and R&D expenses as a percentage of revenue both ticked up in the quarter. This led to an operating margin that dipped below 50%. We would expect these ratios to improve over time and trend towards historical levels, as we have realized cost synergies and implement the Valeant in business model. While we are very pleased with our strong performance in Q3, we did face a number of headwinds in addition to the genericization of Zovirax, Retin-A Micro and BenzaClin. During the quarter, the dollar significantly strengthened versus a number of our currencies. Compared to FX rates in Q3 a year ago, and compared to FX rates we used when we updated 2013 guidance in August, this movement in currencies cost us approximately $20 million in revenue and $0.03 a share to the bottom line. As you can see from the chart, we now have significant exposures to additional currencies including the euro, the yen and a number of emerging market currencies. As mentioned in our Q2 call, we did not back out of our Q3 cash EPS to pre-close cost of B+L financing. The fact that we closed the financing for Bausch + Lomb acquisition before the deal closed cost us about $0.09 per share. Finally, when we provided guidance on our last call, we were expecting generic competition for Retin-A Micro to occur in early 2014. Unfortunately, a generic launch occurred just a few days after our last investor call. This event negatively impacted our third quarter results by approximately $0.04 and we expect an impact of $0.06 on the fourth quarter of 2014. We are pleased that we were able to absorb these headwinds and still deliver cash EPS above consensus. Today, we have updated our annual 2013 revenue guidance to $5.7 billion to $5.9 billion, which is a slight reduction from August, but in line with current analyst consensus. Since August, the reduction has been primarily triggered by the unexpected early launch of the Retin-A Micro generic, foreign exchange headwinds and slower sales of the B+L surgical equipment, which has a much lower gross margin. In addition, we have divested several small products in the U.S. and Australia. We discontinued the sales of active ingredients to third parties from our Probiotica business in Brazil, and expect some softness in our contract manufacturing operations. These items are all -- are also low margin businesses, so the impact to our bottom line will be less than to our top line. We are tightening up the range of our previous cash EPS guidance to $6.11 to $6.16 for 2013, reflecting the strength of our underlying businesses. Finally, our adjusted cash flow from operations should be greater than $1.8 billion for the year. In closing, we are pleased with our progress this quarter as we integrated Bausch + Lomb and we delivered a very strong quarter. We are nearing completion of our normal budget process and we are excited and confident our ability to deliver strong operating results in 2014. We plan on discussing our 2014 expectations with investors in early January. With that, I will turn it over to Laurie.

[Laurie Little:]

Thank you, Howard. [Operator Instructions] Operator, with that, we'll open it up for questions.

[Operator:]

. [Operator Instructions] Your first question comes from the line of Douglas Miehm from RBC Capital Markets.

[Douglas Miehm:]

Since I'm limited to one question, I guess, what I'm curious about is just, Mike, with respect to what you're seeing on the acquisition and merger front, is anything changing given the way different companies are now approaching their businesses in terms of costs and et cetera, et cetera? Are you seeing pricing changing for opportunities? Or do you think there are a number of opportunities that have fallen away or do you see as much opportunity as you've ever seen?

[J. Michael Pearson:]

Actually, probably the opportunities that's increased. I think, part of the increases is we're more well known and most companies include us in their list that they're going to call before they either divest assets or put them up for sale. And I don't see any fundamental differences. I think some other companies have taken out some costs but I think as we see with Bausch + Lomb, there are -- we believe there's an additional, quite a bit of opportunity if we adapt our business model. So I don't think sort of a -- probably the least of our concerns in terms of our strategy is sort of the number of opportunities out there. What we have to do is remain very, very disciplined on price and focus on getting durable assets and growing geographies.

[Douglas Miehm:]

And have you seen any changes in pricing?

[J. Michael Pearson:]

No.

[Operator:]

Your next question comes from the line of Andrew Finkelstein with Financial Group.

[Andrew Finkelstein:]

I was hoping that maybe you'd be able to talk a little bit about some of the drivers in the Emerging Markets for your business, you know, where you're seeing the most opportunities for growth? And then in terms of the U.S., are you thinking any differently as you combine and aren't making the distinction being promoted and non-promoted, are you approaching your sales force promotion any differently in particular to how you're marketing the dermatology products?

[J. Michael Pearson:]

Sure. In terms of the emerging markets, we have been changing our mix to more and more branded generic and OTC products, which tend to be increasingly cash paid. So we are trying to avoid sort of the government-reimbursed products. And in a sense, branded generics that are not government reimbursed are very similar to OTCs in that doctors will make the recommendations or pharmacists will make the recommendations, but the patient will pay it out of their pocket. And it makes us more susceptible to economic cycles but obviously, less susceptible to government intervention. I have to say, our teams have been doing a terrific job, double-digit organic growth in all of our regions. As I look forward, as far as the budget process that Howard mentioned, we visited all these locations, have seen preliminary budgets. And we're very, very optimistic about the continued performance in the Emerging Markets. In terms of the U.S., in terms of sales force differences in dermatology, I guess, 2 comments. One is we are increasingly focusing on physician-dispensed products with all -- the Obagi acquisition, and we are adding a number of products under the Obagi umbrella. So that, again, these are protected because they go directly through the physician channels. And the injectable business or the aesthetics business, it's really a great business. We're seeing very strong growth and we'll be investing heavily in that area looking forward. I think the other thing we are doing is, we have a very creative team running our neuro and other business and we have a number of our products now there being promoted primarily through partners. And we've seen a significant uptick in growth in that business as well as very few of our products at this point have no promotional activity.

[Operator:]

Your next question comes from the line of Chris Schott.

[Christopher T. Schott:]

From JPMorgan. I guess my question is with several of the major pharma companies having become more vocal about exploring ways to manage their legacy or established brands, some potentially separate entities, it seems like these type of businesses would be right for a Valeant like approach to cost management. Are those potentially opportunities that you could look at? Or do those type of assets not fit your criteria of being durable assets with limited payer exposure, et cetera? I'm just trying to understand as we're hearing this, is that something you would look at as a piece of the Valeant portfolio over time?

[J. Michael Pearson:]

Thanks, Chris. Those certainly are some assets that we're beginning to explore. And it kind of depends on the mix of the established products. We obviously love the Emerging Market establish products businesses to date, tend to be brands that have lost patents already, so understands that brand are generics. They just have the originator name on them. Obviously, in the U.S. tail products are -- there's less you can do with them. But certainly, from a cost management approach applying our business model would make sense, so certainly on our list of possibilities.

[Christopher T. Schott:]

Can I just follow-up to that. I guess, as you're looking out as the company becomes larger and you're looking at potentially larger acquisitions, they just kind of playing out that answer, would you entertain deals that can have a portion of assets that might be, for instance, brand generic assets in the Emerging Markets that you like but come with -- to get those assets, you might have to buy portfolios that have Western European exposure or U.S. exposure. Is that -- are you willing to flex that criteria a little bit if you'd get a good chunk of assets that are attractive to you or is that just going to be too hard to pull off?

[J. Michael Pearson:]

No, I think Bausch + Lomb is an example. We weren't thrilled initially by the fact that we would have Western European businesses. It's an area we've avoided. Now it turns out in Bausch + Lomb, that almost all of the Western European assets are cash pay businesses. So very, very low government reimbursement. Their whole pharma business is OTC. And contact lenses is all direct-to-consumer. So I think that's just an example of a company that we bought where most of the assets are in higher growth markets but we can't be completely selective as we look at larger acquisitions or we're not going to find any opportunities.

[Operator:]

Your next question comes from the line of Greg Gilbert from Bank of America.

[Gregory B. Gilbert:]

For Howard, I was wondering if you could confirm that same-store organic growth, if you did not adjust anything out, was it more like down 20 for U.S. and down 9 or 10 for total company. And on Solodyn, you talked about $200 million for stabilization level earlier in they year. I think you got into high 200s or mid to high 200s. Is there still some price flexibility there, or there other things you're doing to still achieve that given that, that may be the most important asset that came with Medicis?

[Howard Bradley Schiller:]

Yes. In terms of the organic growth, obviously, if you include those generics, it's negative. And your calculation are roughly correct. And again, we gave you the pieces on just the one we got. Remember, we gave everyone the pieces of the puzzles to pull that calculation together in Table 6. This relates to Solodyn, I believe we said originally it would be about $250 million. We're clearly seeing some erosion. We believe it's been stabilized. We're exploring opportunities to continue to grow that. I would point out while it's the largest asset, there were also a number of upsize we've seen in -- since Medicis, including luliconazole, which we hope to get approved at the end of this year, which we did not value the extension of Ziana, Zyclara patents. And also point out the aesthetics business in our mind was actually, overall, the most valuable asset. And there were also a portfolio of orphan assets, which we didn't know about, that have been quite profitable. Then lastly, I'd point out that we actually able to realize higher synergies. So Solodyn, it has been a disappointment, but overall, there's more good things than bad happening as it relates to the Medicis acquisition.

[Operator:]

Your next question comes from the line of Tim Chiang from CRT Capital.

[Timothy Chiang:]

Mike, could you talk a little bit more about just some of these antifungal products you have in the pipeline? What's your confidence that you get the positive FDA decision in the near term?

[J. Michael Pearson:]

So efinaconazole is obviously our fungal -- most important antifungal product. I think we were pleased with the Canadian approval. And I think that bodes well for compound. I think on our last call, we mentioned Howard and I were both down at the FDA when -- in the last meeting we have with them. They made it pretty clear to us this is a question of when, not whether, we got approval. We'll hopefully be addressing most of their concerns and resubmitting at the end of this year. And then we believe we'll get approval sometime next year. In terms of luliconazole, we've had positive interactions with the FDA and so we would hope we'd also get an approval on that one. And that would be the end of this year, beginning of next year.

[Timothy Chiang:]

Just quick follow-up. You've already -- you already have the marketing infrastructure to sell these products, right. You don't need to build anymore on the sales side, do you?

[J. Michael Pearson:]

No. No. We have -- we believe our current resources will be enough, depending on the success of the product. If more sales reps make sense, but for the launch and I think we have the capacity in terms of our sales and marketing infrastructure as we speak. We also bought Pedinol last year, which is probably the strongest company name among the podiatrists and we think that will help as well.

[Operator:]

Your next question comes from the line of David Amsellem from Piper Jaffray.

[David Amsellem:]

Just a question on M&A developments and strategy. I mean, given the cost of debt related to the Bausch deal, should we assume that the next large transaction is essentially going to be a stock deal and -- or do you think you can take on additional debt in an acceptable cost? How should we think about that? And speaking of large deals, I mean, what's your appetite for acquiring your -- acquiring a presence in the U.S. generic space?

[Howard Bradley Schiller:]

Okay. As we stated post the B+L acquisition, we took our leverage up because we thought it was absolutely the right acquisition. We continue to believe that being a BB is the right general credit rating for us to be at, to ensure low-cost access to capital over cycles. And we're committed to getting our leverage down to below 4x. So that means that in the near term, we're likely to do smaller cash deals, tuck-in deals, many of which are not only MPV positive but also credit enhancing. And with a possibility of larger deals which could be for stock. In terms of generics, we're now -- we now have a $300 million or so generic business in the U.S., which has very attractive margins and we're excited about some of the opportunities that are in the pipeline and we'll continue to grow and invest in that business. So it's something we're excited about.

[Operator:]

Your next question comes from the line of Alex Arfaei.

[Alex Arfaei:]

Alex Arfaei, BMO Capital Markets. Mike, a follow-up question on the opportunities available to you. I appreciate your earlier comments on the branded generics in Emerging Market. But what about looking at something like Mercks consumer chair business to complement your OTC business? Is your preference on the pharmaceutical side as opposed consumer products or will it really depend on the opportunity?

[J. Michael Pearson:]

Thanks. It really depends on the opportunity. We don't think about -- I talk about therapeutic areas. We don't think about growing or not growing in a specific asset type. Again, what we're looking for is durable assets once where we could believe we can achieve significant synergies and then maintain or accelerate growth in the assets that we purchased. So those are our criteria and we have made consumer acquisitions in the past. We bought Afexa up in Canada a couple of years ago. We bought some J&J consumer brands and -- about a year ago. And so, I think, as I mentioned on the last call, about 25% of our overall business is consumer products at this point. We picked up some very nice consumer products with Bausch + Lomb, both the solutions business but also the vitamins and the allergy products that are growing very, very nicely. And then we have a lot of skills, we believe, in the consumer at this point.

[Operator:]

Your next question comes from the line of Marc Goodman with UBS.

[Marc Harold Goodman:]

Howard, you had mentioned when you were talking about the changes to the revenue guidance, you talked about now surgical FX, generics domestic products and things. Can you go through each of those and help quantify what changed and help us with some of the numbers? How much revenues are we losing with divested products kind of on an annualized basis? And you mentioned contract manufacturing, you mentioned ATI, Brazil, Probiotica. Can you go through those slowly and help us?

[Howard Bradley Schiller:]

Sure. I don't have each of those individual components in my fingertips but -- and, Mark, a number of them are small but they add up to a number, which led us to take it down slightly. And so Retin-A Micro, we said will cost us about $0.08 a share, so you can reverse engineer that, and it was very high margin product. So it was $25-plus million or so in revenue. The foreign exchange, now that will move around a lot. I mentioned in Q3, versus the FX rates we used when we gave you guidance in August, it cost us a little over $20 million in revenue. Just since those were sort of end of July rates we used. So that falls off, that will likely be another 20 -- that will be $20 million plus because our revenue will grow. So you're roughly half of that number to begin with right there with those 2 items. The Bausch + Lomb surgical equipment business, there has been some slow down in some of the big ticket on surgical equipment, but that's a very low margin. As you recall on the surgical side, you make your money by selling the consumables in oracular lenses, not the capital equipment. And then a bunch of little things. The divestitures in Australia and U.S., they're not large. I mean, in total for the quarter, they're probably in the $5 million -- $5 million to $10 million range. There's 1 under that's new, which is we in Probiotica in Brazil, we were selling ingredients to third parties, we were buying ingredients for ourselves and also selling some to the third party, hoping to get a better price by buying more of the wave protein. But we really weren't and it became a bit of a distraction, so we stopped that. That's probably another 5 or so, so there's lot of little ones. And the contract manufacturing, we do out of our Laval plant in Canada, we do a lot of contract manufacturing. And that's probably up to a $10 million softness. But again, if you know, the margin on contract manufacturing is quite small. So hopefully, that keeps you close enough to that number. The point is though that there is a thing -- the Retin-A Micro and FX obviously hurts. The other items have very low margin and we can absorb that elsewhere.

[Operator:]

Your next question comes from the line of Louise Chen from Guggenheim.

[Louise Alesandra Chen:]

Back onto the, I guess, the debt portion of the M&A side. If interest rates were derived meaningfully, would there be any risk to your roll-up strategy? Or does that not really concern you for the foreseeable future?

[Howard Bradley Schiller:]

I mean, in theory, as interest rates rise, asset values should come down. And again, when you think about the way we price our transactions, I'm like sort of maybe a traditional buyer. We're not looking at where this breaks even. We're now looking at arbitrage low interest rates for high -- for accretion to EPS. In fact, it's not even an analysis we really do -- we're very IRR focused and we're pay back focused. So obviously, if we have to pay more, it will impact the cash flows coming, and we'll have to adjust our valuations accordingly. But I don't see any reasonable increase in interest rates isn't going to change our opportunity set. Certainly, won't change how we approach things and we'll continue to be able to allocate capital. The key, as Mike said, is that we remain discipline as to how we allocate capital.

[Operator:]

Your next question comes from the line of Annabel Samimy with Stifel.

[Annabel Samimy:]

If I know a lot of the focus has been B+L and Emerging Markets have been strong but, I mean, you've made a pretty good investment in the derm space last year. And it's a little bit disappointing to see the low growth, as well as the serious impact from some erosion of your product. So what type of investment do you think that you need to make to be able to take advantage and monetize on this critical mass that you've essentially invested in, in this derm business?

[J. Michael Pearson:]

Actually, if you think about the issue with the derm has largely been Zovirax, which had nothing to do with the investment we made last year in Durham. This goes back to the [indiscernible] acquisition and if you look at the returns we've made in Zovirax since we made that acquisition, it's more than paid for itself many times over. So if you look at the assets that we bought at Medicis, as Howard said, we're actually pleased with its performance. Its cash flows continued to exceed the model we have. Again, as Howard mentioned, that the aesthetics business, was the piece of it that we were most excited about, which is completely protected because it's a business that's growing in the U.S. We still have a relatively low share, which we think we can increase. And our interest are completely aligned with that of our customers because they make -- the more they do, the more money they make and the more money we make. Solodyn has really been the only real disappointment, so we may be have lost about $50 million top line for Solodyn, but we've made that up, more than made that up on orphan drugs. And luliconazole, which we hope will get approved, and the extension of the patent lives of Zirgan and ZYCLARA. From an investment standpoint in Medicis, we're very comfortable that we'll continue to deliver superior returns to our shareholders. So the biggest, in my mind, the biggest issues we've had to deal with this year was loss of our largest product. In terms of RAM and discipline, those were both figured in the models for Ortho and Dermiks. If you look at the prices, we paid for those 2 assets. They were very, very inexpensive, around 2x and one of them is even less than 2x sales. And we've already pulled the cash out of both those acquisitions with the Dermik one, we got Sculptra, which is part of the aesthetics business now and is growing very nicely and droves out a lot of cash. And there's a number of products from the Ortho business that we've continue to grow. So again, Solodyn is probably the biggest disappointment and it's probably where we thought we could stabilize it closer to the 250 level, it's 200. So in a sense, there's a $50 million miss. But if you add up all the acquisitions we've made, we've more than offset that by increasing other products.

[Operator:]

Your next question comes from the line of Gary Nachman from Goldman Sachs.

[Gary Nachman:]

Mike, on B+L, now that you've had it for few months, can you give us a little more on what are the parts of the business where you're most pleasantly surprised and where do you forsee the greatest challenges? You mentioned surgical was slow, but could you also address Pharma and Vision Care?

[J. Michael Pearson:]

Yes. So Asia is probably, it comes to mind first in terms of the opportunity set. I think the Bausch + Lomb still has very strong market share positions in terms of contact lenses. And, again, most of the Pharma businesses in Asia are more OTC. So both Pharma and Vision Care in Asia, we think we can really accelerate the growth. I think we talked a little bit about Bausch + Lomb when they operated sort of all decisions were made at were quick including new products and M&A and everything like that. And there is a lot of local opportunities. And they also -- for example, in terms of the launch of the new daily lenses, Asia was going to be the last market that got the lenses. We're now going to make that a priority market to get the lenses. So Asia is 1 area. I think the strong growth in Pharma in the U.S. is, as Howard mentioned, 15% growth. That was largely driven by Pharma and then the OTCs. And that's a great business. I also think in the lot of markets where there were some sub-scale, places like Mexico and Canada, where we have large businesses. Our presence in those markets will actually help them dramatically. For example, in Russia, they didn't have any sales force per se. They used to contract sales force. We have more than 600 reps that are calling on pharmacies. So we should be able to really accelerate the growth of their Pharma business, which is largely OTCs. So there's a lot of opportunities like that. Probably, the area that's been least most disappointing is in the Surgical equipment area, as Howard mentioned. Part of that is probably the overall market conditions, part of that was also, there was some technical problems in the TPV plant and the manufacturing area that there's been a backorder on some of those equipment, which should be worked out this quarter. So part of that was due to supply. So hopefully that gives you a bit of a feel for some of the ups and downs.

[Gary Nachman:]

Yes. Just a quick follow-up, on the 10% organic growth, when you think about sustainability, do you need new products in order to achieve that or do you think it could do it with the existing business?

[J. Michael Pearson:]

We think -- well, actually, they have a bunch of new products, which is the good news, so it's a bit of a theoretical question as they have 8 product approvals. There's a bunch of product approvals that we expect to get next year. As you know, as well as I do, it's much easier to get approvals in OTC and in devices that it is in pharmaceutical. So there's a number of -- we have the zeus opportunity of the silicone hydrogel lens that we're launching by the daily contact lenses that we're launching, Proxy Clear which is a new OTC product. So I think with the new products and the momentum, we would hope to, as Howard said, maintain sort of a roughly 10% growth rate for the foreseeable future with the Bausch + Lomb business.

[Operator:]

Your next question comes from the line of David Risinger.

[David Risinger:]

My question is on M&A and, I guess, it's 2 parts. Really, the first is Howard had commented positively on U.S. generics. But Mike, I think you would emphasize durable assets. So with respect to generics, do you see U.S. and Western European generics as durable? And then could you comment further on the potential for large equity swap deals? I think in the past, Mike, you have aspired to do a large merger of equals using equity. And could you talk about after having had discussions with our other large companies, what the potential is for such a large equity swap deal and what investors should expect on the front in the near-to-medium term?

[J. Michael Pearson:]

Sure. So I think U.S. generics and European generics. Certainly, U.S. generics are more attractive than Western European generics in our view. But not all generics are equal. I think that similar to our view of the world in terms of the U.S. marketplace, large primary care products are probably, from a generic standpoint, the least attractive. The resource specialty generics, they fall in some of same areas that we're in. If you look at topicals and if you look at injectables and some of the more specialized forms, you can actually make good money for long periods of time. I think that's what Howard was referring to when Bausch + Lomb had a number of ophthalmology drugs that have gone generic and in its a pretty good business. So we think portions of generics can be durable but sort of the high litigation sort of -- the high litigation strategies and that type of thing were probably less comfortable that we're good at that. In terms of the large equity swap, it's a very difficult question to answer. Clearly, it's something that we're interested in. We are not going to do it at a premium, so don't expect us to offer some big premium for a company using stock. We would want to more of a merger of equals. When we say mergers of equals, it's plus referencing the size of the company. It's more referencing that 2 companies can create shareholder value by, in a sense, doing a no premium deal, yet both sets of shareholders really get the benefit similar to what we did a few years ago with Biovail. And you can't predict when something like that will happen. Do I think it would happen at some point? Yes. In terms of timing, it's just impossible to say.

[Operator:]

Your next question comes from the line of David Krempa from Morningstar.

[David Krempa:]

Talking, going back to your China presence. Do you think your ophthalmology presence, you'll be able to leverage that into other products like derm and branded generics or would that require significant more reinvestment?

[Howard Bradley Schiller:]

No, we're having our team over there looking that right away. Now it takes a while to get products approved in China. It's one of the more difficult markets but we certainly have the infrastructure that -- so it's probably not going to have impact next year. But probably year after, we'll start seeing that. I think the other point to make about China is that we are very pleased that we sell very, very few products to hospitals there, which is the issue in China right now. Most of them are OTC direct-to-consumer contact lenses and OTCs. So what we don't have is a big sort of traditional pharmaceutical business and we don't have the large infrastructure of -- we don't have many other companies have thousands of reps running around in China, we do not have that. So it's probably going to be more in the OTC and the device area that we'd be bringing products in, less so in the pharmaceutical side.

[Operator:]

Your next question comes from the line of from Lou Chen from HS Capital.

[Louise Alesandra Chen:]

Regarding efinaconazole, do you expect it to be a drug superior to [indiscernible] in the nail fungus market?

[J. Michael Pearson:]

Yes, we do.

[Operator:]

And your last question comes from Lennox Gibbs.

[Lennox Gibbs:]

TD Securities. How would you characterize Bausch + Lomb? And I guess, by extension, how you think the competitive advantage -- sorry, in the global contact lens markets, particularly given how capital-intensive that business tends to be, as well as the typically high R&D requirements of that business?

[J. Michael Pearson:]

Our competitive advantage I think was Bausch + Lomb has had -- their various competitive advantage probably is the brand name and the heritage. They invented the category. So around the world, Bausch + Lomb, probably less so in United States, but certainly in the in Asia, as I think we've mentioned in China, contact -- disposable contact lenses are known as dausis[ph], so an excellent brand name. Bausch + Lomb have not introduced a new contact lens for almost a decade when we bought the company. But what they did do is recently reinvested quite a bit of money into the development. So earlier this year, they launched a daily -- disposable daily lens, which, we believe, is a very, very good lens. We announced the silicone hydrogel lens, which will be more of a bi-weekly or monthly lens, which is we think will be highly competitive. And then we recently launched a Pure Vision 2 multifocal, which is a redesigned multifocal lens, which is getting terrific reviews in the United States. And we need to roll that out around the world. So I think we have now have a set of products that are at least is good as, if not better than, what our competitors have and we have a brand-name. In terms of going forward, it is slightly -- one has to continue to invest in manufacturing and those types of things. And as long as we can grow that business and make it profitable, we will invest the necessary money to make it sustainable. Again, but just like other parts, we believe the approaches other companies have taken tho contact lenses, I think we've proven we can do things in a lower-cost way than our competitors in these industries. And I think we do believe we'll come up with lower-cost ways to sustaining the contact lens business than others in the industry. I think that's -- if we're good at anything, that's one thing we're probably pretty good at, so we're excited about that business.

[Lennox Gibbs:]

And then just a quick follow-up, when do you think you have a better view as to the CapEx that's going to be associated with the launch of Biotrue and Zeus or more so Zeus, I guess than, Biotrue?

[J. Michael Pearson:]

As you mentioned, we're going through the budget process right now, which includes figuring out demand where these new products around the world, which would obviously drive how much capacity we need and what capital is going to be required. So I would suspect that probably January -- certainly January when we have our guidance call, we'll be giving you a sense just to how much capital is going to be required for the business next year.

[J. Michael Pearson:]

With that, we're going to end the call. I want to apologize again for the technical difficulties and we wish everyone a good Halloween.

[Operator:]

This concludes today's conference call. You may now disconnect.