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Actavis’s Expanding Gross and Operating Margins

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Gross margins

Actavis’s (ACT) gross margins continue to improve from 44% in 2011 to 52% in 2014. This is due to improved gross margins for the North American Generics and International segments, up by 400 basis points from the prior year.

This improvement was led by new product launches, as well as increased international revenues from Forest Laboratories–acquired branded products that have higher margins than unbranded generics. Another significant factor is the decline in the cost of sales. As a percent of revenue, it declined to 47% in 2014 from 52% in 2013. This is primarily due to cost savings resulting from global supply chain initiatives and divestitures in Western Europe, which had a reduction of $133.3 million YoY.

However, the gross margin adjusted for non-recurring expenses was 61.3% in 2014, up from 50% in 2013. Teva’s (TEVA) gross margins improved to 55% in 2014 from 52% in 2012. Mylan’s (MYL) gross margins were up by 180 basis points to 51% in 2014.

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Operating margins

Actavis’s adjusted EBITDA (or earnings before interest, tax, depreciation, and amortization) margin improved to 34% in 2014 from 26% in 2013. The adjusted EBITDA reflects the adjustments made for non-recurring items such as legal settlements, non-recurring gains/losses, acquisition charges, and restructuring charges. The improvement was a trickle-down effect of an increase in revenues and a decline in the cost of sales. However, this was partially offset by an increase in SG&A expense.

Actavis’s SG&A expenses increased to 28% in 2014 as a percentage of sales from 24% in 2013, up by 400 basis points from the prior year. This was primarily due to an increase in selling and marketing expenses, particularly after the acquisition of Forest Laboratories.

Among its peers in 2014, Teva (TEVA) and Mylan (MYL) incurred SG&A (or selling, general, and administrative) expenses of 25% and 21.1% as a percentage of sales, respectively.

Pharmaceutical ETFs such as the First Trust Health Care AlphaDEX Fund (FXH) and the iShares US Healthcare ETF (IYH) are capitalizing on the profitability of these companies.

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