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Allergan’s Third­ Quarter Gross Margins and Tax Rate Lead to EPS Upside

Friday morning Allergan announced third‐quarter results with revenue of $1.414 billion, up 9.4% year over year in constant currency, shy of consensus of $1.427 billion and our estimate of $1.424 billion estimate. Non‐GAAP earnings of $1.06, up 15% year‐over‐year, were above consensus of $1.04 and our estimate of $1.03. The shortfall in revenue was primarily attributed to Botox, while growth approximated 11.7% on constant‐currency basis foreign‐exchange headwinds represented a drag on growth by 2.7%. The company’s medical device business also came in below expectations, posting product sales of $213 million during the quarter below our estimate of $221 million and consensus of $225 million.

Within the medical device unit, the obesity intervention product segment (Lap Band) continues to be weak, with revenue of $37 million, down 25% year‐over‐year. Given continued difficulties at the unit, which only represented 2.6% of total revenue during the quarter, management announced the decision to seek a strategic or financial buyer of the profitable unit, which has become a drag on growth. Although profitability of the business has not been broken out sales of Lap Band product are annualizing at an approximate $150 million run‐ rate, although sales are declining quarterly. Device assets have recently received multiples ranging between 2 to 6 times forward‐year revenue estimates.

Given the negative growth profile of the product and litigation overhang related to the unit, we would assume a sale in the low end of that range, which could suggest $300 million to $450 million in a transaction. With use of funds from any transaction potentially being incorporated into a share buyback, we exclude all obesity intervention sales from our estimates beyond the fourth quarter and incorporated a $400 million share buyback into our 2015 estimates.

Restasis continues its strong growth with sales of $198 million above our estimate of $180 million and consensus of $186 million. With continued outperformance of the product Restasis is now the second‐largest ophthalmic product worldwide behind Roche’s Lucentis. The Lumigan franchise continues the transition from the 0.03% formulation to the 0.01% formulation, which now represents 70% of all prescription volume, with a complete transition expected by year‐end. We see significant value in this conversion as Lumigan 0.03% is currently patent protected through 2014, while the 0.01% formulation, which exhibits similar efficacy and a much‐improved tolerability profile is patent protected until 2027

Gross margin of 86.4% was 30 basis points above consensus of 86.1% and 60 basis points our estimate of 85.8%. This strength was driven by favorable product and geographic mix, which we assume, based on commentary, includes the ramp‐up of Botox Therapeutic domestically. R&D spending of $231 million (up 4% year‐over‐ year) was ahead of consensus of $225 million and our estimate of $222 million, while SG&A of $537million was roughly in line with our and consensus estimates. The non‐GAAP tax rate of 25.0%, versus our and the consensus estimate of 28.7% was also a driver of upside in the quarter, however management continues to believe the effective non‐GAAP tax rate will approximate between 27% and 28% for the year.

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