TEVA PHARMACEUTICAL INDUSTRIES LTD quarterly report, Q2 FY2020

Business Context and Reporting Period

Teva Pharmaceutical Industries Limited filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2020. Teva is a global pharmaceutical company focused on generic medicines, specialty medicines and biopharmaceuticals, operating through North America, Europe and International Markets. Prior-period revenue and cost-of-sales amounts were revised to present certain Israeli distribution revenues on a net basis; gross profit, operating income, earnings per share, balance sheet and cash flow were unaffected.

Key Financial Metrics

U.S. dollars in millions, except per-share data	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Net revenues	$3,870	$4,177	$8,227	$8,326
Gross profit	$1,763	$1,893	$3,826	$3,749
Gross margin	45.5%	45.3%	46.5%	45.0%
Operating income (loss)	$173	$(644)	$364	$(510)
Income (loss) before taxes	$(51)	$(850)	$(84)	$(934)
Net income (loss) attributable to Teva	$140	$(689)	$209	$(794)
Diluted EPS	$0.13	$(0.63)	$0.19	$(0.73)
Net cash from operating activities	$273	$(227)	$578	$(115)

Q2 operating income margin was 4.5%, compared with negative 15.4% in the prior-year quarter. Six-month operating margin was approximately 4.4%, compared with negative 6.1% in 2019. Q2 free cash flow, as defined by Teva, was $582 million, compared with $168 million in Q2 2019.

Segment revenue and profit: North America revenue was $2,047 million and segment profit was $573 million; Europe revenue was $1,001 million and segment profit was $244 million; International Markets revenue was $488 million and segment profit was $97 million.
Product trends: Q2 North America revenue included AUSTEDO of $161 million, up 67%; AJOVY of $34 million, up 50%; COPAXONE of $238 million, down 13%; and BENDEKA/TREANDA of $103 million, down 18%.
Cash and liquidity: Cash and cash equivalents were $2,402 million at June 30, 2020. Cash, short-term and long-term investments totaled $2,431 million. The $2.3 billion revolving credit facility had no borrowings at June 30, 2020; €200 million was outstanding as of the filing date.
Debt: Total debt was $26,266 million at June 30, 2020, including $1,649 million of short-term debt and $24,616 million of long-term senior notes and loans. Debt was effectively denominated 64% in U.S. dollars, 33% in euros and 3% in Swiss francs. Teva reported approximately 6.1 years of average debt maturity and 64% financial leverage.
Balance sheet: Total assets were $54,991 million, total liabilities were $40,167 million and total equity was $14,824 million. Identifiable intangible assets were $9,940 million and goodwill was $24,616 million.

Material Changes Versus the Prior Comparable Period

Q2 revenue declined 7% in U.S. dollars and 5% in local-currency terms, primarily because of lower generic, OTC and COPAXONE revenue, lower QVAR and BENDEKA/TREANDA sales, COVID-19-related purchasing changes and currency effects. Exchange-rate movements, net of hedging, reduced Q2 revenue by $79 million and operating income by $35 million.
North America revenue declined 1%, but profit increased 14% to $573 million due to product mix, particularly AUSTEDO and AJOVY, and lower expenses. Europe revenue and profit declined 15% and 23%, respectively, while International Markets revenue and profit declined 16% and 29%, respectively.
Gross margin improved modestly in Q2 to 45.5%, despite lower revenue, principally from improved North America product mix. Six-month gross margin increased to 46.5% from 45.0%.
Operating results benefited from lower intangible-asset impairment charges and substantially lower legal-settlement charges. Q2 intangible impairments were $120 million versus $561 million, while legal settlements and loss contingencies were $13 million versus $646 million.
These benefits were partly offset by $381 million of other asset impairments, restructuring and other items, compared with $101 million in Q2 2019. The increase primarily reflected a $261 million impairment associated with assets of the Teva-Takeda Japanese venture classified as held for sale.
Six-month results also included $768 million of intangible impairments, including $211 million related to AUSTEDO pediatric Tourette syndrome assets after clinical trials failed to meet primary endpoints.
Operating cash flow improved to $578 million for the six months from a use of $115 million, mainly due to customer collections. Financing cash outflows increased to $703 million, including $700 million of debt repayment.

Guidance, Outlook, Risks and Unusual Items

Management stated that supply chains and essential-medicine production remained largely uninterrupted, with adequate inventory and redundancy plans. It did not anticipate a material negative impact on 2020 financial results from COVID-19 at the filing date, but acknowledged substantial uncertainty.
COVID-19 caused lower Q2 demand following elevated Q1 purchasing, fewer doctor visits and prescriptions in Europe, and immaterial delays in clinical trials, regulatory approvals and pre-commercial activities. Longer or more severe disruption could affect manufacturing, supply chains, demand, liquidity and cash resources.
Management expected a 2020 non-GAAP tax rate of 17% to 18%, compared with 18% in 2019. No full-year GAAP revenue or earnings guidance was provided in the filing text.
Teva expects sufficient cash resources to meet debt service and other obligations for at least one year from issuance of the financial statements and expects to remain within revolving-credit financial covenants. The net debt-to-EBITDA covenant limit was 6.0x in Q1 and Q2 2020 and declines to 5.75x in Q3 and Q4 2020.
Teva has substantial litigation exposure, including opioid, generic-pricing and antitrust, product-liability, intellectual-property, regulatory and FCPA-related matters. The legal settlements and loss-contingency provision was $1,588 million at June 30, 2020.
The opioid nationwide settlement framework contemplated up to approximately $23 billion of medication supplied over ten years and up to $250 million of cash payments. Teva stated that the framework was not finalized and that an upper end of potential losses could not be determined if it was not finalized in its current form.
The Davie, Florida manufacturing facility remained classified by the FDA as “official action indicated.” Teva expected approximately $161 million of 2020 revenue from the site, assuming no unscheduled slowdown or stoppage, but identified possible approval delays, remediation costs, impairments and enforcement actions.
Operations at certain Goa, India facilities were temporarily suspended because of a water-supply issue. The Q2 financial impact was immaterial, with remediation expected in Q3 2020; prolonged remediation could cause lost sales, penalties or asset impairments.
Teva and Takeda agreed to sell most generic and operational assets of their Japanese venture, with closing expected by early 2021. The transaction was not considered a strategic shift or discontinued operation.
Subsequent to quarter-end, Teva entered into an exclusive U.S. commercialization partnership with Alvotech for five biosimilar candidates. The agreement includes an upfront payment and future milestones, but the filing text does not provide the payment amounts.
In July 2020, Teva repaid €1,010 million of senior notes at maturity. Teva has not paid dividends since December 2017 and stated that its accumulated deficit currently prevents dividends and share repurchases.

Investor Verification Checklist

Verify the sustainability of improved operating cash flow and free cash flow, including the contribution from securitized accounts receivable and customer collections.
Monitor debt maturities, covenant headroom, refinancing needs and the effect of the July 2020 euro-denominated debt repayment.
Assess the durability of AUSTEDO and AJOVY growth against continued COPAXONE erosion, generic price competition and specialty-product competition.
Track COVID-19 effects on prescription demand, manufacturing, supply chains, clinical trials and regulatory approvals.
Review developments in opioid, generic price-fixing and antitrust litigation, including whether the proposed opioid framework is finalized and whether existing provisions remain adequate.
Evaluate potential additional impairments to goodwill, intangible assets and assets held for sale, particularly if litigation outcomes, product forecasts, competition or COVID-19 assumptions deteriorate.
Follow FDA remediation at the Davie facility and the Goa, India water-supply issue.
Reconcile management’s non-GAAP results with GAAP results; Q2 2020 non-GAAP diluted EPS was $0.55 versus GAAP diluted EPS of $0.13.