Teva Beat Analysts’ Consensus, But Its Big Battles Are Still Up Ahead

Teva Pharmaceutical Industries had so little good news to offer Wednesday that CEO Kåre Schultz had to throw in some reassurance of his own in response to the analysts’ questions, promising he will see his five-year contract to its end and stay on longer if needed. While at first glance Teva’s second-quarter reports, published Wednesday, seemed better than expected, having beaten the analyst consensus on several fronts, a deeper look reveals Teva’s woes are far from over.

Teva’s old burden, the multi-billion debt it accrued as a result of its $40.5 billion acquisition of Actavis in 2016, still exists, but now the company has to contend with multiple lawsuits related to the opioid abuse crisis in the U.S. Teva also faces a civil lawsuit, along with 19 other generic drugmakers, for allegedly conspiring together to create a drug-fixing cartel. The company’s new growth engines have yet to hit their stride, and on Wednesday, shareholders received another hit in the form of the abrupt resignation of chief financial officer Michael McClellan.

Teva CEO Kåre Schultz. Photo: Sivan Farage

McClellan’s resignation at the current timing—though Schultz stressed that he is the only member of senior management to resign—is a serious blow for Teva. Due to the skepticism that surrounded the initial, brief announcement, Schultz was forced to disclose that one of McClellan’s family members is very ill, leading him to step down. Though he assured the analysts that McClellan will stay on until the company’s third-quarter reports are published to ensure a smooth transition and that Teva is already looking for his replacement, a company of Teva’s caliber should have at least announced a temporary replacement so as to not give shareholders the feeling that management is slipping.

What worries Teva’s shareholders most, and rightly so, is that the company is nearing the point where it will have no “organic” revenue sources to pay its debt, meaning its cash and cash flow will not be enough for repaying the billions it owes in 2021 and 2023. Copaxone revenues continue to fall, and the sales of migraine-treatment drug Ajovy showed minuscule growth, $23 million for the second quarter compared to $20 million in the first, leading Schultz to admit Teva will probably not meet its full-year target of $150 million. A silver lining can be found in Austedo, for treating Huntington's disease and tardive dyskinesia, which according to Schultz stands to surpass the $350 million target the company set for 2019.

The company knows that in 2021 and 2023 it will need more cash than it will have on hand, and when the time is right it will need to consider its options, McClellan said during the call.

In a Wednesday interview with Calcalist, McClellan said that currently, the company is not under much pressure despite the high yield of its bonds, which pushes them into junk bonds territory. Things are complicated, he added. Both shareholders and bondholders are worried about the unknown factors, even more so recently, but no one wants to make things harder for the company, he said.

In its second-quarter reports, Teva revealed its cash flow used in operating activities is now negative, a critical issue as Teva’s financial survival depends on a positive flow of $2 billion to $3 billion to enable it to repurchase its debt.

Teva will need to refinance that sum in the next few years, a process that will start in the fall due to the market’s low interest rates, but it will have to be some form of debt financing, McClellan told Calcalist, adding that shareholders will not be diluted. One of the issues Teva will need to handle is the gap between the low interest rate under which it raised its original debt in 2015, when it was at its peak—3% at most—and the interest rate it will need to pay for new debt, expected to be in the range of 6%-9%.

The black cloud hanging over Teva was reflected in the behavior of the analysts, who did not take it easy on either Schultz or McClellan and focused less on operational questions and more on issues pertaining to the company’s survival. Alongside the debt, Teva’s biggest threat today is the opioid abuse lawsuits.

When asked about the new legal troubles, Schultz answered that when he took on the role in late 2017, he knew he would face a major struggle when it came to the company’s diminishing revenues and to creating new revenue sources, while also managing the company’s debt. Finding himself involved in two “legacy legal situations,” he said, was “especially annoying.” This is the first time Schultz has commented directly on Teva’s legal issues.

Due to Actavis’ main role in selling opioids in the U.S. market during 2006-2012, some estimates place the damages Teva could face as a result of the many lawsuits against it at as much as $4 billion. While Teva’s management broke its silence on the matter Wednesday, the main takeaway is that Teva itself is not yet really sure how hard the blow will be.

During Wednesday’s analyst call, McClellan said the company put aside $646 million as a provision for legal settlements. The company recently paid $85 million to settle opioid abuse-related charges in Oklahoma, catching the market by surprise, as Schultz previously said the case could go to the supreme court.

Asked by Wolfe Research senior analyst Akash Tewari about the small sum Teva put aside, as opioid distributions are proposing settlements in the billons, McClellan said that the company normalized the Oklahoma settlement as the first one, and used it to see what it could end up paying in future settlements. “We don't have enough information based on the current situation to know where this is going to go, you end up booking the low end of the range, and that's what we've done,” he said, adding that the numbers being thrown around are just speculation.

“We still don't see that we have a huge liability in this case in terms of causing this epidemic, but we do know that there is a lot of cases going on and there is a likelihood that some of these could settle in the future,” McClellan said. Earlier in the call, Schultz also opinionated that the opioid-abuse lawsuits are politically-driven, and that drug manufacturers are being scapegoated.

The decision to settle in Oklahoma, which did not see Teva admit any wrongdoing or responsibility, does not mean Teva will settle again, Schultz said. Other than Teva, only two other companies were charged (and only Johnson & Johnson chose to go on to trial), and the judge was a local, not federal judge, Schultz explained. The company decided to put its resources into the global battle, not the local one, he said, adding that ultimately, he does not see the opioid crisis in the U.S. as something that will be solved by litigation.

Regarding the company’s revenues and income, Schultz said, the operating margin is stabilizing around 23%, but the company’s long-term target is 27%. He repeated his previous statement that 2019 will be rock bottom for the company. He further said that the aggressive reorganization plan he launched at the end of 2017 is progressing as planned, having resulted in a $3 billion cut to the company’s annual expenses. Teva still paid out $240 million in bonuses to senior executives in the first half of 2019.

Schultz also dropped a bomb when he said that when Teva will publish its annual reports for 2019, once the restructuring program is fully executed, Teva will share its longer-term plans for optimizing its manufacturing. The statement is reminiscent of his words two years ago, when he said a company of Teva’s size needs no more than 12 manufacturing facilities, not the 80 it had at the end of 2016, many of which have since been shut down or sold as Teva laid off 25% of its global employee force.