Shares of Salix Pharmaceuticals fell 34 percent Friday after the Raleigh company disclosed that it had been under-reporting the inventory levels of several of its drugs.
The massive sell-off reflected the shock waves that the company’s announcement sent through the analyst and investor community, which had previously driven Salix shares to record highs. The disclosure was compounded by the company’s conference call with analysts late Thursday, which left many analysts with more questions than answers.
Before Thursday, Salix had been reporting inventory levels for several of its drugs as being between 10 and 12 weeks. The revised levels showed that Salix’s best-selling drug Xifaxan and its drug Apriso both had a nine-month supply while Glumetza had a seven-month supply and Uceris had a five-month supply.
The changes meant that Salix had been selling more drugs to wholesalers than they were able to sell to pharmacies. For investors, it raised questions both about the true demand for Salix’s products and whether the company will be able to maintain the growth rate that has made it such an attractive company. It also meant that Salix’s revenue would take a hit as wholesalers worked their way through their excess inventory.
The revised inventory levels were a sign that the company’s past financial results were somewhat exaggerated, said Roth Capital Partners analyst Scott Henry in a research note. Henry lowered its rating on Salix shares from buy to neutral and put a revised price target of $95 on the stock. Salix shares closed Friday at $91.47, down $47.08
It remains to be seen whether Salix will need to restate previous earnings or whether the issue will only affect future revenue expectations. Salix’s board of directors has hired outside counsel and formed an audit committee to review the way the company had earlier characterized inventory levels.
Salix executives said Thursday that the company’s independent auditor stands by the wholesaler revenue that Salix has reported.
Shibani Malhotra, an analyst with Sterne Agee, said she felt “incrementally more comfortable” after a follow-up conversation with Salix executives on Friday. She said they confirmed that the company’s fourth-quarter revenue forecast includes the expected hit that will occur as inventory levels are drawn down.
She also got more clarity on how the buildup occurred. Salix does not have negotiated agreements with its wholesalers, and has been offering them rebates of as much of 25 percent to entice them to buy. Such rebates, while common among drugmakers who don’t have negotiated agreements, clearly got out of hand at some point, Malhotra said.
Salix is now moving to establish agreements with its wholesalers, which Malhotra said should reduce volatility in its drug pricing and ultimately benefit Salix because it will lower the rebates it offers.
Malhotra maintains a buy rating on Salix stock, saying that Friday’s sell-off – which shaved $3.1 billion off the company’s market value – was excessive. She noted that demand for the company’s products remains strong, as does its pipeline of new drug applications. She noted that if federal regulators approve Xifaxan to treat irritable bowel syndrome, the seven-month supply of the drug will likely go quickly.
“All that value is still very much there. That has not gone,” Malhotra said. “So for us to watch and see a $50 reaction, we can tell that a huge chunk of it is just emotion. And our job is to be a bit more calm and take a more factual approach.”
Still, it’s clear Salix’s management will need to regain the trust of investors and the analyst community. Adam Derbyshire, who had been with the company for 14 years, abruptly resigned Thursday as chief financial officer. On a second quarter conference call with analysts in August, Derbyshire reassured them that the company’s inventory levels would return to normal in the fourth quarter.
“We built in some softening of inventory levels into our third quarter guidance and obviously we’re sticking with our full year guidance of $1.6 billion,” Derbyshire said at the time.
On Thursday, Salix lowered its full-year revenue guidance from $1.6 billion to $1.4 billion. Malhotra said Derbyshire’s assurances in August made Thursday’s disclosure all the more devastating.
“That was a shock for everybody. People were just horrified,” she said. “And they didn’t explain things well at all. People kept asking the same question again and again.”
As for why the company’s excess inventory came to light now, that may have something to do with the discussions Salix has reportedly had with several companies about being acquired. The Wall Street Journal, citing people familiar with the talks, reported Thursday that concerns with Salix’s inventory levels were an obstacle to Botox-maker Allergan reaching a deal to buy the company.