Business Context and Reporting Period
Teva Pharmaceutical Industries Limited filed its Form 10-K for the fiscal year ended December 31, 2017, prepared under U.S. GAAP. Teva is a global pharmaceutical company focused on generic medicines, specialty medicines, over-the-counter products, active pharmaceutical ingredients and distribution. The filing reports 2017 results under the former Generic Medicines and Specialty Medicines segments; management announced a new regional commercial structure in late 2017.
The fourth quarter was materially affected by a $10.4 billion goodwill impairment, primarily relating to the U.S. generics reporting unit. Teva reported a quarterly net loss attributable to ordinary shareholders of $11.6 billion on revenue of $5.46 billion.
Financial Performance and Key Metrics
| U.S. dollars in millions, except per-share data | 2017 | 2016 | Change |
|---|---|---|---|
| Net revenues | $22,385 | $21,903 | +2% |
| Gross profit | $10,825 | $11,859 | -9% |
| Gross margin | 48.4% | 54.1% | -5.7 points |
| Operating income (loss) | $(17,484) | $2,154 | Turned to loss |
| Net income (loss) attributable to Teva | $(16,265) | $329 | Turned to loss |
| Net loss attributable to ordinary shareholders | $(16,525) | $68 | Turned to loss |
| Diluted loss per share | $(16.26) | $0.07 | Turned to loss |
| Cash flow from operating activities | $3,507 | $5,225 | -33% |
| Capital expenditures | $874 | $901 | -3% |
| Operating cash flow less capital expenditures | $2,633 | $4,324 | -39% |
Reported operating results included $17.1 billion of goodwill impairments, $3.8 billion of long-lived-asset impairments, $535 million of restructuring expense, a $396 million Venezuela deconsolidation charge and $500 million of legal settlements and loss contingencies. Other income was $1.2 billion, primarily reflecting divestiture gains.
Management reported non-GAAP operating income of $6.1 billion, or 27% of revenue, and non-GAAP net income attributable to ordinary shareholders of $4.1 billion, or $4.01 per diluted share. These measures exclude substantial impairment, restructuring, amortization, legal, acquisition-related and other items and should not replace GAAP results.
Segment Results
| U.S. dollars in millions | 2017 Revenue | 2016 Revenue | 2017 Segment Profit | 2016 Segment Profit |
|---|---|---|---|---|
| Generic Medicines | $12,257 | $11,990 | $2,829 | $3,310 |
| Specialty Medicines | $7,914 | $8,674 | $4,333 | $4,661 |
| Other activities | $2,214 | $1,239 | $86 | $68 |
- Generic Medicines revenue increased 2%, helped by a full year of Actavis Generics contribution, but segment profit declined 15%. Gross margin fell to 41.7% from 47.5%, mainly because of U.S. price erosion, higher production costs and weaker ROW performance.
- Specialty Medicines revenue declined 9% and segment profit declined 7%. COPAXONE revenue fell 10% to $3.80 billion; AZILECT revenue fell 59% and NUVIGIL revenue fell 70% following generic competition.
- Other activity revenue increased 79%, primarily from the Anda distribution business acquired in late 2016.
Liquidity, Debt and Balance Sheet
| U.S. dollars in millions | December 31, 2017 | December 31, 2016 |
|---|---|---|
| Cash, cash equivalents and investments | $1,060 | $1,949 |
| Total debt | $32,475 | $35,800 |
| Short-term debt | $3,646 | $3,276 |
| Long-term debt | $28,829 | $32,524 |
| Total equity | $18,745 | $34,993 |
| Working capital | $(384) | $303 |
- Teva repaid approximately $4.4 billion of net debt during 2017. Debt declined by $3.3 billion year over year, partly offset by $1.1 billion of foreign-exchange effects.
- The $3.0 billion syndicated revolving credit facility was undrawn at year-end. Approximately $3.7 billion of debt was subject to financial covenants, and Teva stated that it was in compliance as of December 31, 2017.
- Contractual obligations totaled approximately $40.9 billion, including $38.5 billion of long-term debt obligations with estimated interest, $591 million of operating leases and $1.8 billion of purchase obligations.
- Credit ratings were downgraded to non-investment grade by Fitch, Moody’s and Standard & Poor’s during late 2017 and early 2018, increasing refinancing costs and limiting financial flexibility.
Material Changes Versus the Prior Comparable Period
- Revenue increased modestly, but gross margin contracted sharply and GAAP operating results moved from income of $2.2 billion to a $17.5 billion operating loss.
- Net loss attributable to ordinary shareholders was $16.5 billion compared with net income of $68 million in 2016, primarily because of goodwill and long-lived-asset impairments.
- Operating cash flow fell $1.7 billion to $3.5 billion, mainly because of working-capital effects. The filing notes that receivables securitization proceeds are included in operating cash flow; adoption of new cash-flow guidance was expected to reclassify approximately $1.3 billion for 2017.
- Generic Medicines performance deteriorated in the United States because of customer consolidation, accelerated FDA approvals, increased competition, price erosion and delayed launches.
- Specialty Medicines faced generic competition to COPAXONE, AZILECT and NUVIGIL. At least one generic COPAXONE 40 mg/mL product launched in the United States before final resolution of patent litigation.
- Cash dividends on ordinary shares and ADSs were suspended in December 2017, and dividends on mandatory convertible preferred shares were suspended in the fourth quarter because of the accumulated deficit.
Guidance, Outlook, Commentary and Unusual Items
- Teva announced a two-year restructuring plan intended to reduce its cost base by $3 billion by the end of 2019, with more than half expected by the end of 2018. The plan includes product discontinuations, manufacturing and R&D site closures or divestitures, reduced R&D programs and approximately 14,000 job reductions by the end of 2019.
- The filing does not provide a clear numerical 2018 revenue or earnings guidance figure. Management identifies continued COPAXONE erosion, U.S. generic pricing pressure, high debt, non-investment-grade ratings, currency fluctuations, specialty-product competition and potential asset divestitures as major 2018 drivers.
- Management expects additional restructuring charges in 2018 and 2019 and acknowledges execution, labor, supply-chain, regulatory and divestiture risks.
- Teva recorded a $1.9 billion tax benefit in 2017, including a provisional benefit from U.S. tax reform and benefits associated with utilization of historical losses. The company stated that its accounting for U.S. tax reform remained provisional.
- Teva deconsolidated its Venezuelan subsidiaries effective November 30, 2017 and recorded a $396 million charge because of hyperinflation, currency restrictions and loss of control.
- In November 2017, Teva sold PARAGARD for $1.1 billion and PLAN B ONE-STEP and related brands for $675 million. It completed an additional $703 million sale of women’s health and other specialty products on January 31, 2018.
- Pipeline developments included the 2017 U.S. launch of AUSTEDO and FDA submission of fremanezumab. Phase 3 and phase 2 studies for certain candidates, including laquinimod and TV-45070, did not meet specified endpoints.
Risks, Contingencies and Litigation
- Further deterioration in U.S., European or ROW generics markets could cause additional goodwill or intangible-asset impairments. European and ROW generics reporting units had relatively narrow valuation cushions at year-end.
- Teva remains highly dependent on generic medicines and on COPAXONE, which represented approximately 17% of 2017 revenue and a disproportionately higher share of profit and operating cash flow.
- Approximately 47% of revenue was denominated in currencies other than the U.S. dollar; currency movements reduced 2017 revenue by $914 million and operating income by $290 million versus 2016.
- Material legal matters include patent litigation, antitrust claims involving generic pricing and patent settlements, product-liability claims, opioid-related litigation, government investigations, Medicaid pricing matters and the GSK carvedilol litigation. Accrued legal settlements and loss contingencies totaled approximately $1.2 billion at year-end.
- Teva remained subject to a three-year deferred prosecution agreement and independent compliance monitoring following its $519 million FCPA resolution. In January 2018, it agreed to pay Israeli authorities approximately $22 million related to the same underlying conduct.
- Manufacturing and regulatory risks include prior FDA concerns involving an API facility in China, potential supply disruptions, site-specific approvals and the impact of planned plant closures.
- The company had approximately $1.0 billion of gross unrecognized tax benefits and contingent milestone payments of up to approximately $407 million, assuming applicable regulatory and sales targets are achieved.
Most Important Facts for Investors to Verify
- Whether the restructuring plan achieves the targeted $3 billion of cost reductions without disrupting product supply, regulatory approvals, R&D productivity or employee retention.
- The pace and depth of COPAXONE revenue and margin erosion following generic launches and the outcome of related U.S. and European patent litigation.
- U.S. generic pricing, customer concentration, FDA approval trends, launch timing and the sustainability of generic segment margins.
- Debt covenant headroom, refinancing requirements, maturity timing, interest costs and the availability of asset-sale proceeds to reduce leverage.
- Potential additional goodwill and intangible-asset impairments, particularly for U.S., European and ROW generics reporting units.
- The conversion of reported operating cash flow into recurring free cash flow, including the effects of receivables securitization and working-capital management.
- Exposure from antitrust, opioid, product-liability, government-investigation and other legal matters not fully quantified in the filing.
- Whether pipeline products, including fremanezumab, AUSTEDO and biosimilar candidates, can offset losses from mature specialty products and generic price erosion.