Eli Lilly and Company — Form 10-Q, 2011 Q3
Reporting period: Quarter and nine months ended September 30, 2011. Figures are consolidated and, unless noted, in millions of dollars. Lilly operates primarily in human pharmaceuticals; animal health is included in its segment reporting.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $6,147.9 | $5,654.8 | $18,239.9 | $16,889.0 |
| Gross margin as % of revenue | 78.2% | 82.5% | 79.5% | 81.4% |
| Income before income taxes | $1,502.5 | $1,671.3 | $4,307.7 | $5,115.6 |
| Net income | $1,236.3 | $1,302.9 | $3,489.5 | $3,899.9 |
| Diluted earnings per share | $1.11 | $1.18 | $3.13 | $3.53 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $5,289.8 | $4,628.7 |
- Revenue rose 9% in Q3 and 8% for the first nine months. Growth reflected higher sales of Cymbalta, animal health products, Humalog, Alimta and Cialis; nine-month growth also included Zyprexa. Gemzar declined sharply following generic competition.
- Net income fell 5% in Q3 and 11% year to date; diluted EPS fell 6% and 11%, respectively. Higher revenue and lower effective tax rates were outweighed by lower gross margins, higher selling and administrative expenses, higher other expense, and 2011 charges.
- Gross margin declined 4.3 percentage points in Q3 and 1.9 points year to date, primarily due to foreign-exchange effects on inventory costs. Research and development expense rose 5% in Q3 and 6% year to date; marketing, selling and administrative expense rose 13% in both periods.
- Effective tax rates were 17.7% for Q3 and 19.0% year to date, versus 22.0% and 23.8% in 2010. Q3 benefited by about $45 million from tax examination resolutions.
Cash, liquidity and debt
- At September 30, cash and cash equivalents were $6,597.7; short-term investments were $186.6. Together, these totaled $6,784.3, compared with $6,727.0 at December 31, 2010.
- Nine-month operating cash flow was $5,289.8. Investing used $2,947.6, including $605.7 for product rights, $307.8 for an acquisition, $388.0 for acquired in-process R&D, and $416.1 in net property and equipment purchases. Financing used $1,719.0, including $1,636.2 in dividends.
- Total debt was $7,080.0 at September 30, compared with $6,926.5 at year-end, including $1,628.7 of short-term borrowings and $5,451.3 of long-term debt. Lilly reported ratings of AA- from Standard & Poor’s and A2 from Moody’s.
- Management said operating cash flow and available cash should fund normal operating needs, debt service, capital spending and dividends in 2011. It reported $1.24 billion of unused committed bank credit facilities, including $1.20 billion backing commercial paper.
Significant changes and unusual items
- Health care reform reduced revenue by $128.5 in Q3 and $328.8 year to date through higher rebates and subsidies. The non-deductible pharmaceutical manufacturers’ fee added $44.8 and $134.3 to selling and administrative expense, respectively.
- First-nine-month acquired in-process R&D expense was $388.0, relating to the Boehringer Ingelheim diabetes collaboration. Restructuring and special charges were $25.2 in Q3 and $233.8 year to date; Lilly anticipated further restructuring charges in the remainder of 2011.
- Other-net expense was $83.4 in Q3 and $152.2 year to date, versus Q3 expense of $21.7 and nine-month income of $34.4 in 2010. The 2011 expense primarily reflected partial impairments of Amyvid and, year to date, liprotamase; investment disposition gains partly offset the year-to-date expense.
- Lilly acquired Janssen’s animal health business for $307.8 in cash. It also made $478.7 in regulatory milestone payments for linagliptin, capitalized as intangible assets.
- In October, Lilly announced withdrawal of Xigris after a study failed to meet its primary endpoint. It estimated a fourth-quarter pre-tax charge of $75–$95, included in its revised 2011 EPS guidance; the exact charge was not yet determined.
Outlook, commentary and risks
- Revised 2011 EPS guidance was $3.84–$3.89, including the estimated Xigris charge but excluding potential further restructuring charges. Revenue growth was still expected in the mid-single digits.
- Management expected gross margin as a percentage of revenue to decline 2–3 percentage points; marketing, selling and administrative expense to grow at a high-single-digit rate; R&D expense to grow at a low-single-digit rate; and other-net expense of $175–$225. The company expected health care reform to reduce 2011 revenue by $400–$500 and planned about $700 in capital expenditures.
- Lilly expected rapid, severe Zyprexa sales erosion following loss of exclusivity in the U.S. and major European markets, and continued Gemzar erosion. It expected growth in Alimta, Cialis, Cymbalta, Effient, Humalog and animal health products to help offset these declines.
- Patent challenges to Alimta and Strattera could materially affect future results, liquidity and financial position if decided adversely. Lilly reported favorable rulings at that point but could not assure the outcome. It also cited Zyprexa and Byetta product-liability claims, and said it was effectively self-insured for substantially all currently marketed products.
- Other risks include pricing and rebate pressure, changes in health policy and reimbursement, international price controls, foreign exchange and macroeconomic volatility, clinical and regulatory setbacks, and future loss of product exclusivity. Lilly noted that Zyprexa’s generic entry had begun and that Cymbalta and Humalog were expected to lose U.S. exclusivity in 2013.
- Pipeline developments included Bydureon’s European authorization and an FDA action date of January 28, 2012; an FDA request for an additional liprotamase trial; and a safety-related halt to enrollment in one necitumumab Phase III study. Management described drug development as inherently uncertain, with no reliable project-level R&D cost or revenue estimates.
Most important facts for investors to verify
- Whether Zyprexa erosion after U.S. and European generic launches matches management’s expected pace and materially affects revenue and cash flow.
- Developments in Alimta and Strattera patent litigation, and the commercial impact if exclusivity is lost.
- Whether Lilly achieves its 2011 EPS and revenue guidance, including the estimated Xigris charge and any additional restructuring costs.
- Progress and regulatory outcomes for Bydureon, Amyvid, liprotamase, and the late-stage pipeline, including the necitumumab safety issue.
- Continued impact of health care reform, rebates, pricing pressure, and foreign exchange on revenue, gross margin and earnings.
- Updates to Byetta-related litigation and other contingencies; the filing stated that maximum exposure or a range of possible losses could not be reasonably estimated for these matters.