Teva Pharmaceutical Industries Ltd. — Q2 2018 Form 10-Q Summary
Business context and reporting period
Teva is a global pharmaceutical company focused on generic medicines, specialty products, active pharmaceutical ingredients and distribution. The unaudited report covers the three and six months ended June 30, 2018. Teva reported under three segments: North America, Europe and International Markets.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net revenues | $4.701 billion | $5.720 billion | $9.766 billion | $11.370 billion |
| Gross profit / margin | $2.061 billion / 43.8% | $2.855 billion / 49.9% | $4.409 billion / 45.1% | $5.694 billion / 50.1% |
| Operating income (loss) | $(14) million | $(5.740) billion | $1.511 billion | $(4.845) billion |
| Net income (loss) attributable to Teva | $(176) million | $(5.970) billion | $944 million | $(5.325) billion |
| Net income (loss) attributable to ordinary shareholders | $(241) million | $(6.035) billion | $814 million | $(5.455) billion |
| Diluted EPS | $(0.24) | $(5.94) | $0.80 | $(5.37) |
| Cash flow from operating activities | $162 million | $435 million | $1.658 billion | $571 million |
Q2 revenue declined 18% year over year, or 19% in local currency. Six-month revenue declined 14%, or 17% in local currency. Foreign exchange movements increased Q2 revenue by $92 million and six-month revenue by $332 million compared with the prior-year periods.
- Q2 segment revenue and profit: North America $2.263 billion and $722 million; Europe $1.328 billion and $346 million; International Markets $789 million and $139 million.
- North America was pressured by COPAXONE competition and U.S. generic price erosion. COPAXONE revenue in North America fell 46% to $464 million.
- Q2 R&D expense was $290 million, or 6.2% of revenue, versus $469 million, or 8.2%, in the prior year. Selling and marketing expense was $710 million, or 15.1% of revenue.
- Cash and cash equivalents were $1.861 billion at June 30, 2018, compared with $963 million at December 31, 2017. Cash and short- and long-term investments totaled approximately $1.9 billion at quarter-end.
- Total debt was approximately $30.2 billion at June 30, 2018, including $1.272 billion of short-term debt and $28.965 billion of long-term debt. The $3 billion revolving credit facility was undrawn.
- Total assets were $67.030 billion and total equity was $19.368 billion at June 30, 2018.
Material changes versus the prior comparable periods
- Revenue and gross margin declined primarily because of generic competition to COPAXONE, continuing U.S. generic price erosion, product divestitures and discontinued activities.
- North America revenue fell 29% in Q2 and segment profit fell 42%; Europe revenue rose 3% and profit rose 58%; International Markets revenue fell 11% while profit rose 15%.
- Q2 results included $715 million of other asset impairments, restructuring and other items, including $520 million of intangible-asset impairments, $107 million of restructuring expense and $41 million of valsartan recall and inventory reserves.
- Teva recorded a $120 million goodwill impairment in Q2 related to the Mexico reporting unit. Six-month goodwill impairment was $300 million.
- The prior-year periods included a $6.1 billion goodwill impairment, making the year-over-year improvement in operating income and net income less representative of underlying operating trends.
- Six-month 2018 results benefited from $1.3 billion of legal settlement income, primarily related to the Allergan working-capital settlement, the Rimsa settlement and reversal of a prior carvedilol litigation reserve.
- Teva prepaid approximately $2.3 billion of U.S. term loans and JPY-denominated term loans in the first quarter, issued approximately $4.4 billion of new senior notes and redeemed certain 2018 and 2019 maturities.
Guidance, outlook, commentary and risks
- Management expects a 15% annual non-GAAP tax rate for 2018, revised lower because of the expected geographic mix of income.
- The two-year restructuring plan is intended to reduce the cost base by $3 billion by the end of 2019. Teva reported approximately 8,300 full-time-equivalent headcount reductions since the plan was announced.
- Management stated that available resources are sufficient to meet ordinary-course obligations for at least twelve months. However, leverage remains high and the revolving-credit facility includes a net-debt-to-EBITDA covenant and other restrictions.
- Teva suspended ordinary-share dividends and suspended cash dividends on mandatory convertible preferred shares in Q2 because of its accumulated deficit.
- Key operating risks include additional COPAXONE and generic competition, generic price erosion, loss of intellectual-property protection, execution of the restructuring plan, impairment of goodwill and intangible assets, manufacturing and quality issues, foreign-exchange exposure and substantial indebtedness.
- After a July 2018 FDA inspection of the Davie, Florida facility, Teva received a Form FDA-483. Management stated that the Q2 financial impact was immaterial, but further consequences could include approval delays, lost revenue, inventory write-offs, penalties and remediation costs.
- Teva voluntarily recalled valsartan and certain combination products after an impurity was detected in API supplied by a third party. The Q2 charge was $41 million, with potential for additional losses, penalties or litigation costs.
- Teva disclosed a material weakness in internal control over financial reporting related to allocation of businesses between the International Markets and Rimsa reporting units for interim goodwill impairment testing. Disclosure controls were therefore considered ineffective as of June 30, 2018, although management concluded the financial statements were fairly presented.
- Material legal and regulatory exposures include generic pricing and antitrust investigations, opioid litigation, patent litigation, Medicaid and pricing-reporting claims, product liability matters and ongoing FCPA-related compliance obligations. The filing does not provide a clear aggregate maximum exposure for these matters.
Most important facts for investors to verify
- Whether revenue stabilization is achievable as COPAXONE erosion and U.S. generic price pressure continue.
- The pace and cash costs of the restructuring plan and whether the targeted $3 billion cost-base reduction is achieved.
- Debt repayment capacity, refinancing requirements, covenant compliance and the effect of elevated interest expense.
- Potential additional goodwill and intangible-asset impairments, particularly following changes in discount rates, product forecasts or reporting-unit assumptions.
- The financial and regulatory consequences of the Davie FDA observations and valsartan recall.
- Developments and ultimate exposure in generic pricing, antitrust, opioid, patent, product-liability and other legal proceedings.
- Remediation of the material internal-control weakness and the results of subsequent goodwill impairment testing.