Eli Lilly and Company — Q2 2015 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2015, compared with the same 2014 periods. Lilly operates human pharmaceuticals and animal health businesses. On January 1, 2015, it acquired Novartis Animal Health (Novartis AH) for approximately $5.29 billion, expanding its animal health business.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $4,978.7 million | $4,935.6 million | $9,623.4 million | $9,618.7 million |
| Gross margin | $3,760.3 million; 75.5% | $3,745.9 million; 75.9% | $7,212.3 million; 74.9% | $7,206.3 million; 74.9% |
| Operating expenses | $2,957.3 million | $2,859.3 million | $5,884.1 million | $5,484.9 million |
| Income before taxes | $679.7 million | $940.4 million | $1,297.6 million | $1,831.2 million |
| Net income | $600.8 million | $733.5 million | $1,130.3 million | $1,461.4 million |
| Diluted EPS | $0.56 | $0.68 | $1.06 | $1.36 |
| Operating cash flow | Not separately reported | Not separately reported | $863.8 million | $1,326.2 million |
Q2 revenue rose 1%, while first-half revenue was essentially flat. U.S. revenue increased 6% in both periods; outside-U.S. revenue fell 4% in Q2 and 5% year to date, primarily reflecting unfavorable foreign exchange. The effective tax rate was 11.6% in Q2 and 12.9% for the first half, versus 22.0% and 20.2%, respectively, in 2014.
At June 30, cash and cash equivalents were $3.32 billion, short-term investments $915.4 million, and noncurrent investments $4.10 billion. Current assets were $12.35 billion and current liabilities $8.23 billion. Total debt was approximately $8.00 billion, versus approximately $8.02 billion at year-end 2014. Capital expenditures were $412.5 million for the first half; dividends paid were $1.07 billion.
Material changes and drivers
- Net income declined 18% in Q2 and 23% for the first half; diluted EPS fell 18% and 22%, respectively. Lower results reflected debt-repurchase charges, acquired in-process R&D, and restructuring and impairment charges, partly offset by lower tax rates.
- Novartis AH contributed $268.1 million of Q2 revenue and $504.5 million for the first half. Animal health revenue increased 40% in Q2 and 41% for the first half, substantially due to the acquisition. Acquisition-related inventory fair-value charges were $68.4 million in Q2 and $131.9 million year to date.
- Q2 acquired IPR&D expense was $80.0 million; first-half expense was $336.0 million, including payments associated with tanezumab, Innovent, Hanmi, and BioNTech. First-half restructuring, impairment, and special charges totaled $180.4 million.
- A $152.7 million pretax net debt-repurchase charge reduced earnings. Lilly issued $4.45 billion of fixed-rate notes and repaid or redeemed debt, including $1.65 billion principal of notes.
- Product revenue remained pressured by patent expirations: first-half Cymbalta sales declined 36%, Evista 51%, and Alimta 8% from the prior year. First-half Cyramza revenue increased to $155.2 million from $13.7 million.
Outlook, risks, and contingencies
2015 guidance: Diluted EPS of $2.20–$2.30; revenue of $19.7–$20.0 billion; gross margin of approximately 74.5%; R&D expense of $4.7–$4.9 billion; marketing, selling, and administrative expense of $6.4–$6.7 billion; capital expenditures of approximately $1.3 billion; and an expected tax rate of approximately 14.5%. Other-net expense is forecast between $50 million of expense and zero income. Management said the revenue outlook reflected first-half performance and launch trajectories for Jardiance, Trulicity, and Cyramza. Guidance remains subject to final acquisition accounting adjustments.
- Management expected operating cash generation, available cash, and access to credit to fund normal needs, including dividends, repurchases, and capital expenditures. Approximately $3.2 billion was available under credit facilities.
- Patent and exclusivity risks include generic challenges to Alimta and Effient, anticipated loss of Zyprexa exclusivity in Japan in December 2015, and continuing Cymbalta generic erosion. Lilly warned that loss of Alimta exclusivity could cause a rapid, severe revenue decline.
- Basaglar had tentative U.S. approval, but patent litigation stayed final approval until June 2016, subject to possible earlier court action. Lilly expected Phase III tanezumab studies to resume after the FDA lifted a partial clinical hold; pipeline and regulatory outcomes remain uncertain.
- Foreign-exchange volatility, drug pricing and reimbursement pressure, and potential health-policy changes could weigh on results. The filing also cites product-liability, patent, employment, and other legal proceedings.
- Takeda proposed an approximately $2.4 billion settlement of most U.S. Actos product-liability cases, effective only if at least 95% of current litigants opt in. Lilly asserted indemnification rights but noted it could not guarantee full indemnification. A Brazil employee-litigation ruling was estimated by the judge at approximately 1.0 billion Brazilian real, plus interest; Lilly appealed.
- Lilly reported no material changes to previously disclosed risk factors and concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether 2015 revenue and EPS guidance is achieved, particularly given foreign-exchange exposure and the timing and performance of product launches.
- Underlying animal health growth excluding Novartis AH, and the eventual integration, purchase-accounting, and restructuring costs.
- Cash conversion and the sustainability of dividends and repurchases given lower first-half operating cash flow and ongoing investment needs.
- Progress and outcomes in Alimta and Effient patent disputes, Basaglar litigation, and the Actos settlement and indemnification process.
- Pipeline milestones and safety/regulatory developments, including basal insulin peglispro, tanezumab, and late-stage candidates.