Eli Lilly and Company — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Comparisons are with the corresponding 2015 periods unless noted. Amounts are in U.S. dollars.
Financial results and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $5.405 billion | $4.979 billion | $10.270 billion | $9.623 billion |
| Gross margin | $3.940 billion; 72.9% of revenue | $3.760 billion; 75.5% | $7.482 billion; 72.9% | $7.212 billion; 74.9% |
| Operating expenses (R&D and marketing, selling, administrative) | $2.959 billion | $2.805 billion | $5.653 billion | $5.368 billion |
| Net income | $747.7 million | $600.8 million | $1.188 billion | $1.130 billion |
| Diluted EPS | $0.71 | $0.56 | $1.12 | $1.06 |
| Operating cash flow | Not separately stated for the quarter | $1.075 billion | $863.8 million |
- Q2 revenue rose 9%; six-month revenue rose 7%. Growth reflected volume, especially in the U.S.; six-month revenue outside the U.S. declined 1%, including a 3% adverse foreign-exchange effect.
- Q2 diluted EPS increased 27%, and six-month EPS increased 6%. Six-month net income rose 5%. Comparisons were affected by prior-year acquired in-process R&D and debt-repurchase charges, among other items.
- Gross margin percentage declined 2.6 percentage points in Q2 and 2.0 points for the first half, mainly because of a smaller foreign-exchange benefit on international inventory and the Erbitux rights transfer; prior-year Novartis inventory step-up costs partly offset the declines.
- R&D expense increased 14% in Q2 and 16% for the first half, including a $100 million BACE-inhibitor milestone in Q2 and a $55 million baricitinib milestone in Q1. Marketing, selling, and administrative expense decreased 1% and 2%, respectively.
- Six-month operating cash flow increased year over year, but was reduced by a $1.400 billion net use from changes in operating assets and liabilities. Investing activities used $1.166 billion; financing activities used $237 million, including $1.080 billion of dividends and $300 million of share repurchases.
- At June 30, cash and cash equivalents were $3.238 billion, short-term investments $697 million, and total investments $5.15 billion. Total debt was $9.331 billion, up from $7.979 billion at year-end 2015, primarily following a $1.21 billion Swiss-franc note issuance. About $1.2 billion remained available under the corporate credit facility.
- Current assets were $12.977 billion and current liabilities $8.401 billion. The filing states management expects operating cash generation and available cash to fund normal operating needs, including dividends, repurchases, and capital spending.
Business developments and material changes
- Human pharmaceutical revenue increased 10% in Q2; animal health revenue increased 2%. Trulicity revenue reached $201 million in Q2 versus $44 million a year earlier. Cyramza, Trajenta, and Erbitux also grew; Erbitux’s increase primarily reflects Lilly taking over North American commercialization in October 2015.
- Alimta revenue declined 9% in Q2 and 5% for the first half, amid competitive pressure and generic-entry exposure. Cymbalta and Zyprexa also declined, reflecting loss of exclusivity; generic Zyprexa launched in Japan in June.
- For the first half, U.S. revenue increased 15%, while revenue outside the U.S. decreased 1%. Product-level results also reflected pricing, wholesaler buying patterns, and currency movements.
- Lilly reported approximately 45 potential new drugs in human testing or regulatory review. Baricitinib and olaratumab were submitted for regulatory review; the BACE inhibitor advanced to Phase III. Taltz was launched in the U.S. and Europe during 2016.
- David A. Ricks was announced as incoming CEO effective January 1, 2017, succeeding John C. Lechleiter, who planned to retire at year-end 2016.
Outlook, risks, and unusual items
- Lilly reaffirmed 2016 guidance: revenue of $20.6–$21.1 billion; diluted EPS of $2.68–$2.78; gross margin of approximately 73%; R&D expense of $4.9–$5.1 billion; marketing, selling, and administrative expense of $6.1–$6.3 billion; other-net expense of $125–$200 million; tax rate of approximately 21%; and capital expenditures of approximately $1.1 billion.
- Longer-term expectations include at least 5% average annual revenue growth through the remainder of the decade, on a constant-currency basis, increasing gross margin on that basis, resuming annual dividend increases, and an operating expense-to-revenue ratio of 50% or less in 2018.
- A $203.9 million first-quarter charge reflected the Venezuelan financial crisis and bolívar deterioration. Lilly expected Venezuelan revenue for the remainder of 2016 to be minimal and said further charges were possible, though not expected to materially affect future results.
- First-half special charges were $189.4 million, including impairment and other charges associated with closing an animal-health manufacturing plant in Ireland and Novartis AH integration. Lilly also recorded $41.6 million of investment impairment losses in the first half.
- Patent challenges and potential generic competition pose significant risks, particularly for Alimta; the filing warns that loss of exclusivity could cause a rapid, severe revenue decline. It also identifies upcoming or recent exclusivity losses for products including Cymbalta, Zyprexa, Strattera, and Cialis.
- Other disclosed exposures include Actos product-liability litigation (with Takeda expected to indemnify Lilly, but full recovery is not assured), Byetta and other product claims, and Brazil employee litigation. A Brazilian court estimated potential impact at approximately 1.0 billion reais plus interest; Lilly appealed and disputes the ruling. Lilly is self-insured for product-liability losses on marketed products.
- The filing also describes U.S. pricing and reimbursement pressure, foreign-exchange volatility, regulatory and tax uncertainty, and an ongoing U.S. investigation concerning contracts, services, and payments involving pharmacy benefit managers. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether 2016 guidance remains achievable as gross-margin pressure, pricing, foreign exchange, and product mix evolve.
- Progress and outcomes in Alimta patent proceedings and the timing and market impact of generic competition; also monitor other product exclusivity expirations.
- Whether growth in newer products, particularly Trulicity and pipeline candidates, can offset declines in mature products.
- Cash-flow quality and working-capital movements, alongside higher debt, dividends, repurchases, and planned capital spending.
- Developments in the Brazil litigation, Actos indemnification, the pharmacy-benefit-manager investigation, and any additional Venezuela-related charges.