Inventory fiasco hurts Salix Pharma stock; CFO is let go and company's possible merger plans upset

A reprise of the 'channel stuffing' days?

There’s a lot of after-the-fact speculating about merger talks involving Salix Pharmaceuticals and Allergan (which is in turn looped into the ongoing Allergan-Valeant acquisition battle); but what is clear is that Salix had to come clean on excessive inventory in distribution channels when it reported Q3 results on Nov. 6. The company statement notes that inventory levels of several of its key products had soared to seven to nine months (previously, it had indicated that it wanted to maintain inventories at wholesalers at around 60 days). The company CFO, Adam Derbyshire, has resigned (Timothy Creech, SVP finance, takes over as acting CFO), and the company’s stock dropped by nearly a third on the news.

Salix’ sales (mostly in gastrointestinal products) had been reported to show double-digit growth in the past year, as nine-month revenue in 2014 grew to $1.1 billion from $676 million in the prior year’s nine-month period. A company statement says that “while current wholesaler inventory levels are appropriate,” it is overhauling its entire arrangements with wholesalers. “Salix believes its lack of distribution services arrangements with wholesalers has contributed to the Company’s difficulty in forecasting revenue,” and that it is “currently negotiating with its principal wholesalers to enter into distribution services agreements [that] will improve its visibility into wholesaler inventory levels … enable the Company to better forecast revenue and expenses … [and] enhance the Company’s profitability over the long term.”

According to the HDMA 2014-15 Factbook, member wholesalers averaged 27.5 (median) days’ sales in inventory in 2011, the latest year for which data are available. The same report noted that 83% of its suppliers had inventory management agreements (IMAs) in place in that year. Over the past decade, most large wholesalers have converted their prior sales agreements, which enabled them to buy excess inventory and earn revenue as product prices rose, to fee-for-service agreements that enables manufacturers to set inventory levels and pricing in a more collaborative fashion. Financial scandals in the early 2000s in which manufacturers “stuffed” their channels to inflate apparent sales became, it is supposed, a thing of the past.

A WSJ report (subscription required) on the Salix announcements cite sources that the poorly controlled inventory system torpedoed a potential acquisition of Salix by Allergan back in September; for its part, Allergan is still engaged in a hostile-takeover battle with Valeant. Actavis Pharma is being cited as a potential white horse merger candidate with Allergan.