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Teva's US generic business hit hard by buyer negotiations; shares drop

Teva Pharmaceutical Industries Ltd. is the latest generic-drug maker to be hit by U.S. pricing pressure in the second quarter.

Teva did not anticipate the pressure that consolidated buyers of U.S. generic drugs would exert this year, executives said on the company's second-quarter earnings call.

The world's biggest generic-drug maker reported an 18% drop in earnings, plagued by increased competition in the U.S. generic business that led to 6% price erosion in the quarter. Novartis AG had also cited pricing pressure on its generics unit, Sandoz, when the Swiss drugmaker reported its second-quarter earnings July 18.

Teva's stock price had dropped 20.6% on the NYSE by 11:39 am ET on Aug. 3. Mylan NV another company with a significant generics business, saw its stock fall 4.6% by the same time. Mylan reports its second-quarter earnings Aug. 9.

The most notable challenge for Teva has been U.S. customer consolidation and their ability to negotiate prices, interim CEO, President and Director Yitzhak Peterburg said.

"We are ready to make significant business decisions that were not easy to make," Peterburg said. "But they are decisions that are critical to supporting the business and Teva's future."

The plan includes slashing 7,000 jobs throughout the year and streamlining the business after the acquisition of Allergan's generics unit, Actavis, which was a bright spot in second-quarter revenue. By the end of 2017, the company plans to reduce costs by $1.6 billion.

Whether that can help with debt reduction remains to be seen — if lower cash flow continues, there is a possibility that the company will have to renegotiate the terms of some debt contracts, interim CFO Michael McClellan said. Meeting the company's debt covenants for the year will require a net-debt-to-EBITDA ratio of 4.25, he noted.

Though the U.S. generics erosion will continue through this year and potentially into next, Peterburg believes it will eventually stabilize as contracts with the group purchasing organizations, or GPOs, equalize on price.

According to Peterburg, 80% of Teva's generics purchases are concentrated in four GPOs, the middlemen that negotiate generic drug buys for hospitals and providers. Pressure from those companies stepped up over the past nine months or so, he said, noting that a request for proposals, or RFP, from a combination of group purchaser McKesson Corp. and retail giant Wal-Mart Stores Inc. made an impact, as did an RFP earlier in the year from another customer, Econdisc. In May, Econdisc announced an agreement linking up drug sourcing information between the GPO, pharmacy benefit manager Express Scripts Holding Co. and pharmacy chain Walgreens Boots Alliance Inc.

These contract negotiations have been incorporated in the company's outlook for the rest of 2017, which assumes high single-digit generic price erosion in the second half of the year.

Looking long-term, Teva is buckling down on generics.

Peterburg said they see greater value coming from more complex products, such as respiratory and injectable medicines.

"They are difficult to make, they are difficult to get regulatory approval, and we believe that the value that we will see out of these products will be far more durable than some of the blockbusters that we have seen in the past," he said.

"We understand that significant change is required and we all have a sense of urgency," Chairman Sol Barer said.