The top and bottom lines of Teva Pharmaceuticals' (NYSE:TEVA) profit-loss statement told the story of the main drivers for the second quarter. Revenue was down 2% year over year, but adjusted net income was 15% higher than the year-ago quarter. There are only two things that can cause revenue to decrease while income goes in the opposite direction: expanding margins, and currency changes.
Teva used both, although they're somewhat related because Teva reports earnings in U.S. dollars, but has much of its expenses in other currencies. As the dollar strengthens, the company's expenses decrease when reported in dollars, which, in turn, increases margins.
Currency changes decreased revenue by $341 million, but when you factor in the lower expenses and the currency hedging by Teva, adjusted operating income was only reduced by $4 million due to currency changes. And when you factor in one-time items, the currency changes actually increased GAAP operating income by $17 million.
Gross margins jumped to 58.4% in the second quarter, up from 52.7% in the year-ago quarter. In addition to the aforementioned decrease in costs when translated back to dollars, the gross margin increased due to a 12% jump in sales of Copaxone, which sports a gross margin of just below 90%.
Selling and marketing expenses fell from 18.1% of revenue in the year-ago quarter to 17% of revenue in the recently completed quarter. General and administrative expenses actually increased slightly as a percentage of revenue, but the small jump -- just 40 basis points -- didn't hurt operating margins that much.
With slightly more shares outstanding, adjusted earnings per share grew slower than the aforementioned 15% increase in net income; but who's going to complain about a 14% year-over-year increase in adjusted earnings per share?
It gets better if you look beyond the profit-loss statement altogether. Teva's free cash flow increased a whopping 51% year over year, to $1.3 billion during the second quarter.
With the strong quarter in the book, Teva raised adjusted earnings per share guidance for 2015 to between $5.15 and $5.40 from a previous range of $5.05 to $5.35.
The 2015 earnings guidance doesn't include any sales from the acquisition of Allergan's global generics business that Teva announced earlier this week. The deal isn't expected to close until the first quarter of next year.
Teva is paying $40.5 billion for Allergan's global generics business in a mix of $33.75 billion in cash and $6.75 billion in Teva stock. Teva only had $2.8 billion on hand at the end of the second quarter, so it will need to sell shares through a secondary offering and/or take on debt to raise funds to pay for the cash portion of the transaction.
Despite the dilution and likely increase in interest expenses, Teva thinks the addition of Allergan's generic drugs will result in a double-digit increase in adjusted EPS in 2016, and 20% increase in the second and third full years following the close of the transaction.
Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Teva Pharmaceutical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.