GILEAD SCIENCES, INC. quarterly report, Q2 FY2016

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Gilead Sciences, Inc. — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016. Amounts are U.S. dollars; financial statement amounts are in millions unless stated otherwise.

Business context

Gilead is a research-based biopharmaceutical company focused primarily on HIV and liver diseases, including HCV and HBV. It reports one operating segment. Its HCV and HIV medicines account for most product sales.

Financial performance and liquidity

  • Q2 revenue: $7.776 billion, down 6% from $8.244 billion a year earlier. Product sales were $7.651 billion, down 6%.
  • Q2 earnings: Operating income was $4.538 billion, down 19%; net income attributable to Gilead was $3.497 billion, down 22%; diluted EPS was $2.58 versus $2.92. Product gross margin was 89%, compared with 88%.
  • First-half revenue and earnings: Revenue was $15.570 billion, down 2%; operating income was $9.189 billion versus $10.987 billion; net income attributable to Gilead was $7.063 billion versus $8.825 billion; diluted EPS was $5.11 versus $5.68. Product gross margin was 87%, compared with 88%.
  • Sales mix: Q2 HCV product sales were approximately $4.0 billion, down from $4.9 billion, chiefly reflecting lower Harvoni sales. HIV and other antiviral sales rose to $3.1 billion from $2.7 billion, supported by newer TAF-based products. For the first half, HCV sales were $8.3 billion versus $9.4 billion, while HIV and other antiviral sales rose to $6.0 billion from $5.2 billion.
  • Expenses: Q2 R&D expense increased 81% to $1.484 billion; SG&A rose 10% to $890 million. Q2 interest expense was $227 million versus $140 million. The effective tax rate was 20.5%, compared with 18.4%.
  • Cash flow: First-half operating cash flow was $8.853 billion, down from $11.359 billion. Investing activities used $5.393 billion and financing activities used $9.912 billion. Q2 operating cash flow was $4.9 billion.
  • Liquidity and debt: Cash, cash equivalents and marketable securities totaled $24.616 billion at June 30, 2016; working capital was $7.909 billion. Total debt was $22.127 billion, including $700 million current debt. The company had no borrowings under its new $2.5 billion revolving credit facility. Approximately $23.4 billion of cash, cash equivalents and marketable securities was generated abroad and intended for foreign operations.
  • Capital returns: First-half repurchases were $9.0 billion and dividends paid were $1.2 billion. The declared quarterly dividend was $0.47 per share.

Material changes and unusual items

  • Q2 Harvoni sales fell 29% year over year to $2.564 billion. Management attributed the broader HCV slowdown to fewer new treatment starts after the 2015 launch surge, lower net prices and shorter treatment durations. Sovaldi sales rose 5% in Q2; new TAF-based HIV products contributed to growth in HIV sales.
  • R&D spending rose sharply due to the Nimbus acquisition, a purchased FDA priority review voucher, the Galapagos collaboration and advancing clinical studies. First-half R&D also included a $114 million impairment charge for momelotinib.
  • In May, Gilead acquired Nimbus Apollo’s ACC inhibitor program for $400 million, expensed as R&D, with up to $800 million of contingent development and regulatory payments.
  • Gilead paid Galapagos a $300 million license fee and invested $425 million in its shares; the agreement also provides for potential development, regulatory and sales milestones and royalties.
  • A court ruling in Gilead’s favor on its unclean-hands defense led the company to reverse a $200 million Merck litigation reserve in Q2. Merck appealed; damages and potential royalties could remain at issue if the ruling is overturned.
  • Cash declined from $12.851 billion at year-end 2015 to $6.485 billion, largely alongside substantial share repurchases and other financing uses. Marketable securities increased; total cash and marketable securities decreased by $1.592 billion from year-end.

Outlook, commentary and risks

  • Management expected full-year 2016 net product sales to be lower than 2015 and anticipated lower stock repurchases in the second half than in the first half. It expected operating cash flow to decrease as rebate liabilities are paid and milestone payments are made.
  • Management cited continued HCV pricing pressure, payer mix shifting toward higher-rebate segments, shorter treatment courses, competition and possible market-share loss. It also noted Japan’s mandatory 32% price reduction for Sovaldi and Harvoni effective April 1, 2016.
  • HCV products represented approximately 54% of first-half product sales; HIV products represented approximately 39%. The filing warns that changes in reimbursement, demand, competition or product safety could materially affect results.
  • Material legal and intellectual-property uncertainties include disputes involving sofosbuvir products, Merck and AbbVie; European patent oppositions covering sofosbuvir, TAF and cobicistat; and generic challenges to several products. The company stated it could not reasonably estimate maximum potential exposure or a range of possible loss for its significant legal matters.
  • Other disclosed risks include possible generic competition for TDF-containing products in 2017, foreign-exchange exposure, customer and wholesaler concentration, and Southern European collection risk. Receivables in Greece, Italy, Portugal and Spain totaled approximately $630 million, including $171 million more than 120 days past due.
  • Epclusa received U.S. and European approval during the quarter as an all-oral, pan-genotypic HCV regimen. Management also reported progress on HIV products and pipeline candidates; outcomes and timing remain subject to clinical and regulatory risks.

Important facts for investors to verify

  • Whether HCV patient starts, Harvoni sales, net prices and treatment duration continue to decline, and how quickly newer products offset that pressure.
  • Whether rebate estimates and payments, including the $5.447 billion accrued government and other rebates balance, affect future revenue and operating cash flow.
  • The progress and financial consequences of the Merck appeal and other material patent, generic and government matters, including any subsequent developments after quarter-end.
  • Pipeline progress and regulatory outcomes, alongside the returns and potential milestone obligations from the Nimbus and Galapagos agreements.
  • The pace of share repurchases and dividends relative to cash generation, debt obligations and the substantial portion of liquidity held abroad.