Business context and reporting period
Eli Lilly and Company’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2013. Lilly operates human pharmaceutical and animal health businesses. Unless noted, amounts are U.S. dollars.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $5.93 billion | $5.60 billion | $11.53 billion | $11.20 billion |
| Net income | $1.21 billion | $0.92 billion | $2.75 billion | $1.93 billion |
| Diluted EPS | $1.11 | $0.83 | $2.53 | $1.73 |
| Gross margin as % of revenue | 80.3% | 79.5% | 79.9% | 79.1% |
| Operating cash flow | Not separately reported for the quarter | $2.02 billion | $2.16 billion |
Q2 revenue rose 6%, net income 31%, and diluted EPS 34% year over year. For the first half, revenue rose 3%, net income 42%, and diluted EPS 46%. Revenue growth reflected higher prices and product growth, partly offset by foreign exchange, Zyprexa generic competition, and the exenatide rights transfer. Q2 growth in earnings also benefited from lower marketing and administrative expense and a lower effective tax rate.
Q2 research and development expense was $1.33 billion, up 1%; marketing, selling, and administrative expense was $1.87 billion, down 3%. First-half R&D expense increased 8% to $2.68 billion, while marketing, selling, and administrative expense decreased 7% to $3.52 billion. First-half special charges were $85.2 million, including $63.5 million in Q2, primarily for a planned German facility closure and workforce cost reductions. The first-half effective tax rate was 20.5%, versus 23.3% in 2012, reflecting reinstatement of the U.S. R&D tax credit and a one-time prior-year credit.
Financial position and cash flow
At June 30, cash and cash equivalents were $3.79 billion, short-term investments $0.92 billion, and current assets $12.64 billion. Current liabilities were $8.41 billion. Total debt, including current maturities, was $5.31 billion, compared with $5.53 billion at year-end 2012; the filing attributes the decrease primarily to the fair-value change in hedged debt. Lilly reported $1.36 billion of unused committed bank credit facilities, including $1.20 billion supporting its commercial paper program.
First-half operating cash flow was $2.02 billion. Investing activities provided $103 million, while financing activities used $2.26 billion, including $1.06 billion in dividends and $1.20 billion in share repurchases. Cash decreased $232 million from year-end. Management stated that operating cash generation and available cash should fund normal needs, including dividends and capital spending.
Material changes and unusual items
- First-half results included $495.4 million pretax income ($0.29 per share) from transferring exenatide commercial rights outside the U.S. to Amylin. This nonrecurring item materially boosted first-half earnings and other income.
- Q2 and first-half revenue increased, but performance varied by product: Q2 Cymbalta revenue rose 22%, Cialis 13%, and Effient 24%; Zyprexa fell 25%. First-half Zyprexa revenue declined 40% as generic competition continued.
- First-half other-net income was $541.1 million, primarily reflecting the exenatide transfer. Q2 other-net income was $11.9 million, with the filing citing an investment-sale gain.
- Lilly completed the remaining $1.10 billion of its announced $1.50 billion share-repurchase program in Q1; there were no repurchases in Q2. The quarterly dividend remained $0.49 per share.
Outlook, risks, and contingencies
For full-year 2013, Lilly revised diluted EPS guidance to $4.28–$4.38 and maintained revenue guidance of $22.6–$23.4 billion. It expected gross margin of approximately 79%, marketing and administrative expense of $7.0–$7.2 billion, R&D expense of $5.3–$5.5 billion, and other-net income of $440–$590 million. Capital spending was expected to be approximately $900 million. Management cited growth across several products and emerging markets, while noting that a weaker yen could dampen Japan growth.
Key commercial risks include expected U.S. loss of Cymbalta exclusivity in December 2013 and Evista exclusivity in March 2014, each expected to cause rapid and severe sales declines. Lilly also identified pricing and reimbursement pressure, health-care policy and tax changes, foreign exchange exposure, and the inherent uncertainty of drug development. Pipeline updates included regulatory submissions for empagliflozin and a new insulin glargine product; the company stopped enzastaurin development after negative Phase III results and discontinued tabalumab’s rheumatoid arthritis program for lack of efficacy.
Alimta patent challenges are a significant contingency: an unfavorable outcome could materially affect results, liquidity, and financial position, and Lilly warned that loss of exclusivity could sharply reduce sales. The filing also describes Byetta, DES, Prozac, Darvon, Actos, and other product-liability matters, as well as Brazil employee litigation and other legal proceedings. Management said outcomes and maximum exposure could not be reasonably estimated; substantially all currently marketed products are self-insured for product liability. Lilly stated that, except for the Alimta patent challenges, resolution of the described matters was not expected to materially affect consolidated financial position or liquidity, though results in an individual period could be affected.
Important facts for investors to verify
- How much reported first-half earnings growth depended on the $495.4 million exenatide transfer gain, and how underlying earnings compare without it.
- The pace and financial impact of generic entry for Cymbalta and Evista, and continuing Zyprexa erosion.
- Progress and commercial prospects for late-stage pipeline candidates, including empagliflozin, dulaglutide, and the new insulin glargine product.
- Developments in Alimta patent litigation and the potential financial exposure from product-liability and other legal matters.
- Whether cash flow, debt, and investment resources remain adequate amid dividends, R&D spending, and expected patent-related revenue declines.