Eli Lilly and Company — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results. Lilly operates human pharmaceutical and animal health businesses.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $5.192 billion | $4.960 billion | $15.462 billion | $14.583 billion |
| Gross margin | $3.791 billion; 73.0% | $3.723 billion; 75.1% | $11.273 billion; 72.9% | $10.935 billion; 75.0% |
| Net income | $778 million | $800 million | $1.966 billion | $1.930 billion |
| Diluted EPS | $0.73 | $0.75 | $1.85 | $1.81 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $2.734 billion | $1.969 billion |
Quarterly revenue increased 5%, while net income and diluted EPS declined 3%. For the first nine months, revenue rose 6%, net income 2%, and diluted EPS 2%. Revenue growth was led by U.S. sales, up 12% for Q3 and 14% year to date; outside-U.S. revenue declined 3% and 2%, respectively. Human pharmaceutical revenue was $4.486 billion in Q3; animal health revenue was $706 million.
Research and development expense rose 8% in Q3 to $1.236 billion and 13% year to date to $3.793 billion, mainly on higher late-stage development costs. Marketing, selling, and administrative expense fell 1% in Q3 to $1.565 billion and 2% year to date to $4.662 billion. The company reported no acquired in-process R&D charge in 2016, versus $336 million in the first nine months of 2015.
Cash, debt, and liquidity
At September 30, 2016, cash and equivalents were $3.489 billion, short-term investments $738 million, and noncurrent investments $5.027 billion. Total debt was $9.349 billion, up from $7.979 billion at year-end 2015, primarily following $1.207 billion of Swiss-franc-denominated note issuance. Current assets were $13.386 billion and current liabilities $8.273 billion. Lilly had approximately $1.2 billion available under its corporate credit facility.
Nine-month operating cash flow was $2.734 billion; investing activities used $1.961 billion and financing activities used $835 million. Capital expenditure was $627 million, dividends paid were $1.617 billion, and share repurchases were $300 million. Cash declined $177 million from year-end 2015.
Material changes and notable items
- Q3 gross margin percentage fell 2.1 percentage points, primarily due to a smaller favorable foreign-exchange effect on international inventories and, to a lesser extent, the North American Erbitux rights transfer. Year-to-date margin also benefited comparatively from 2015 Novartis inventory step-up costs.
- Trulicity revenue grew to $244 million in Q3 from $74 million; Cyramza rose 43% to $159 million. Erbitux revenue increased to $185 million from $86 million, largely reflecting Lilly’s assumption of North American commercialization rights in October 2015.
- Alimta revenue declined 9% in Q3 amid competitive pressure and loss of exclusivity in several markets. Zyprexa declined 37%, with Japanese generic entry contributing. Cymbalta’s reported Q3 revenue increased, but included an approximately $145 million reduction to the U.S. product-return reserve; the nine-month adjustment was approximately $175 million.
- Other-net included a $203.9 million charge in Q1 related to Venezuela’s currency and economic crisis. The filing says Venezuelan revenue for the remainder of 2016 was expected to be de minimis.
- Asset impairment, restructuring, and special charges were $45.5 million in Q3 and $234.9 million year to date, primarily related to Novartis Animal Health integration; year-to-date charges also included the Ireland animal-health plant closure.
- In October 2016, Lilly announced a proposed $885 million all-cash acquisition of a Boehringer Ingelheim U.S. animal-health vaccine portfolio, expected to close by early 2017 subject to approvals. Lilly anticipated issuing debt to fund it.
Outlook and management commentary
Lilly revised its 2016 outlook to revenue of $20.8–$21.2 billion and diluted EPS of $2.66–$2.76. It expected gross margin of approximately 73%, R&D expense of $4.9–$5.1 billion, marketing, selling, and administrative expense of $6.2–$6.4 billion, other-net expense of $100–$150 million, a tax rate of approximately 21%, and capital expenditures of approximately $1.0 billion. Management expected growth from several established and newer products, partly offset by lower Alimta revenue from competition.
The late-stage pipeline included baricitinib, submitted for regulatory review in the U.S., Europe, and Japan; Phase III programs including abemaciclib, solanezumab, galcanezumab, and tanezumab; and the BACE inhibitor program, which entered Phase III in 2016. Management highlighted patent challenges and impending loss of exclusivity as material risks. U.S. protection for Strattera, Cialis, and Effient was expected to expire in 2017; Alimta’s effective protection was being contested. Lilly warned that generic entry can cause rapid and severe product revenue declines.
Risks, contingencies, and other disclosures
- Alimta patent litigation and administrative proceedings could materially affect future results, liquidity, and financial position if resolved unfavorably. The filing also describes U.S. Effient patent challenges; the USPTO had found method-of-use patents invalid, with appeals pending.
- Lilly reported numerous product-liability matters, including Byetta, Cymbalta, Actos, Axiron, and Cialis cases. Lilly is self-insured for product liability. It believes it is entitled to indemnification from Takeda for covered Actos claims, but cannot assure full recovery.
- In Brazilian employee litigation, a court estimated potential impact at approximately 1.0 billion Brazilian real (about $310 million at September 30, 2016) plus interest. Lilly appealed, disputes the ruling, and could not estimate the reasonably possible loss range.
- Lilly was cooperating with a U.S. investigation into contracts and payments involving pharmacy benefit managers and a Chinese investigation of distributor pricing practices.
- Pricing and reimbursement pressure, foreign-exchange movements, tax-law changes, patent challenges, and regulatory and development uncertainty were identified as risks. Management stated disclosure controls were effective and reported no material third-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether 2016 revenue and EPS guidance was achieved, and the assumptions behind the revised outlook.
- How much of reported Cymbalta growth reflected the reserve adjustment rather than underlying demand, and whether the reserve estimate remains appropriate.
- Progress and outcomes in Alimta and Effient patent proceedings, and the timing and revenue effects of expected generic competition.
- Whether gross-margin pressure, rising R&D spending, and the Venezuela-related charge persist or change.
- Funding, approvals, closing conditions, and integration costs for the proposed $885 million animal-health acquisition.
- Developments in significant legal matters, particularly the Brazil employee case, and any changes to accrued or potential exposures.