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What: Shares of Salix Pharmaceuticals (NASDAQ:SLXP), a biopharmaceutical company that develops and acquires drugs designed to treat gastrointestinal diseases, was clobbered in November and fell by 29%, based on data from S&P Capital IQ, after the company reported considerably worse-than-expected third-quarter earnings results.

So what: Some earnings reports are just bad; Salix's was just disastrous. On the surface things might look OK with net sales up 49% to $354.7 million and its adjusted earnings per share rising 72% year-over-year to $1.53. Unfortunately, Wall Street was expecting $392.9 million in sales and $1.55 in adjusted EPS. Even worse, the company's fourth-quarter guidance called for revenue in the neighborhood of $325 million and approximately $1.16 in EPS. By comparison, the Street's consensus was $436.9 million in sales and $1.96 in EPS.

Why the enormous miss? Salix's management team blames the shortfall on a lack of adequate distribution service arrangements for its key pipeline products which led to a sizable inventory buildup for drugs like Xifaxan, Apriso, Glumetza and Uceris. These inventory buildups can cause wild quarter-to-quarter fluctuations in revenue as we're seeing now. 

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Salix's management has reduced 2014 sales estimates since this latest presentation. Source: Salix Pharmaceuticals.

As icing on the cake, Salix's chief financial officer announced his resignation, and the board of directors' audit committee announced that it's probing Salix's handling of its inventory levels. With Wall Street led to believe one figure in terms of expected inventory levels from select drugs and the actual figure being far off, there's concern of possible wrongdoing within Salix's management team. The resignation of the CFO certainly doesn't help matters. 

Now what: Prior to these audit issues and the third quarter I'd have probably declared Salix a good shot to run to $200 per share or to be bought out given its rapid growth rate, high margins, and strong profitability. However, the monkey wrench of high inventory levels and a possible violation of management's fiduciary responsibilities should all but wipe Salix off your near-term radars.

Don't get me wrong, Salix's product portfolio is going to continue to generate profits and its gastrointestinal product portfolio could be a great dangling carrot for a bigger pharmaceutical company looking to generate growth by acquisition. But, when push comes to shove I can't in good faith even consider investing my money into a company facing an internal audit as well as a mountain of potential investor lawsuits over what should be simple inventory accountability.

To top things off, Salix's recent acquisition of Santarus is wreaking havoc on Salix's GAAP-based bottom-line (which includes non-recurring costs and benefits). It's possible this could just blow over a few months from now, but I'd rather play it safe than sorry and stick to the sidelines until investors feel as if they can trust the management team here once again.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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