Eli Lilly and Company — Q1 2015 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2015, compared with Q1 2014. Lilly operates human pharmaceutical and animal health businesses. The quarter included Novartis Animal Health (AH), acquired January 1 for approximately $5.29 billion; Lilly sold certain U.S. Sentinel rights to Virbac for approximately $410 million.
Key financial results
Amounts in USD millions, except per-share data and percentages.
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $4,644.7 | $4,683.1 | Down 1% |
| Gross margin as percentage of revenue | 74.3% | Approximately 73.9% | Up 0.4 percentage points |
| Research and development expense | $1,039.3 | $1,109.3 | Down 6% |
| Marketing, selling, and administrative expense | $1,523.5 | $1,484.9 | Up 3% |
| Income before taxes | $617.9 | $890.8 | Down 31% |
| Net income | $529.5 | $727.9 | Down 27% |
| Diluted EPS | $0.50 | $0.68 | Down 26% |
| Operating cash flow | $(84.8) | $272.3 | Down $357.1 |
| Capital expenditures | $188.6 | $202.0 | Down $13.4 |
Management attributed the revenue decline mainly to foreign exchange and continued erosion in Cymbalta and Evista, offset by Novartis AH, higher U.S. prices, wholesaler buying patterns, and volume growth in several products. U.S. revenue rose 6% to $2.21 billion; revenue outside the U.S. fell 6% to $2.43 billion. Currency reduced worldwide revenue by 6 percentage points, while price and volume each contributed 3 percentage points of growth.
Reported earnings included $256.0 million of acquired in-process R&D expense, $108.0 million of impairment, restructuring, and other special charges, and $63.5 million of Novartis AH acquired-inventory fair-value expense. Other-net income was $92.7 million, reflecting a favorable legal judgment and net investment gains. The effective tax rate was 14.3%, versus 18.3%.
Financial position and liquidity
- At March 31, cash and cash equivalents were $3.06 billion, short-term investments $1.08 billion, and noncurrent investments $4.58 billion. Cash and investments totaled approximately $8.72 billion.
- Total debt was approximately $8.22 billion, up from $8.06 billion at year-end 2014. Lilly issued $2.20 billion of fixed-rate notes, primarily to repay commercial paper used for the Novartis AH acquisition. Approximately $3.2 billion remained available under credit facilities.
- Current assets were $11.74 billion and current liabilities $8.34 billion. Cash declined by $806.8 million during the quarter.
- Operating cash flow was negative, including a $206.3 million payment to terminate interest-rate swaps and substantial net changes in operating assets and liabilities. Investing cash flow was positive $160.8 million, including acquisition-related restricted cash release and acquisition spending; financing cash flow was negative $701.2 million.
Material changes and business developments
- Animal health revenue rose 42% to $749.8 million, primarily reflecting Novartis AH. Human pharmaceutical revenue fell to $3.89 billion from $4.16 billion.
- Product revenue declines included Cymbalta, down 40% overall; Evista, down 55%; and Zyprexa, down 22%. Lilly cited generic competition and foreign exchange among the drivers. Animal health revenue growth included acquired sales; on a pro forma basis, management reported animal health declines of 3% in the U.S. and 4% outside the U.S.
- In March, the FDA lifted a partial clinical hold on tanezumab; Lilly paid Pfizer $200 million, recorded as acquired IPR&D. Lilly also recorded a $56 million Innovent collaboration charge. The filing says tanezumab Phase III studies were expected to resume in 2015.
- Lilly reported approximately 60 potential new drugs in human testing or regulatory review. Ixekizumab was submitted for U.S. review; the company reported positive top-line results for a baricitinib rheumatoid arthritis trial.
Guidance, risks, and contingencies
- 2015 guidance: revenue of $19.5–$20.0 billion; diluted EPS of $2.21–$2.31; 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; other-net income of $75–$125 million; tax rate of approximately 16.5%; and capital expenditures of approximately $1.3 billion. Some estimates were revised, including EPS, margin, selling and administrative costs, and tax rate. Guidance remained subject to final acquisition accounting adjustments.
- Patent exposure is significant. Lilly warned that generic entry for Cymbalta, Alimta, and other products could sharply reduce revenue; Zyprexa exclusivity in Japan was due to expire in December 2015. Alimta patent challenges remained unresolved, and an unfavorable outcome could materially affect results, liquidity, and financial position.
- Actos litigation involved approximately 5,700 U.S. cases. In April 2015, Takeda announced a proposed settlement of approximately $2.4 billion, conditional on at least 95% of current litigants opting in. Lilly disputed liability and said indemnification from Takeda was not assured. Other disclosed matters include Byetta and Prozac product-liability claims, Effient patent litigation, and Brazilian employee litigation; the latter had a trial-court ruling estimated at approximately 1.0 billion Brazilian reais plus interest, which Lilly appealed.
- Other risks include foreign-exchange volatility, pharmaceutical pricing and reimbursement pressure, regulatory and clinical-development uncertainty, tax-law changes, and the possibility of adverse legal outcomes. Lilly stated that its disclosed risk factors had not materially changed from its 2014 Form 10-K.
Important facts for investors to verify
- Whether acquisition integration and final purchase accounting alter Novartis AH-related expenses, assets, or 2015 guidance.
- Whether currency movements and further generic competition affect revenue and earnings, particularly for Cymbalta, Alimta, and Zyprexa.
- Progress and regulatory outcomes for the late-stage pipeline, including tanezumab, baricitinib, and basal insulin peglispro; the filing notes peglispro submission was delayed pending additional liver-fat data.
- Whether the Actos settlement conditions are met and how litigation, indemnification, and other contingencies are ultimately resolved.
- Cash generation, debt levels, and the ability to fund dividends, repurchases, capital spending, and planned pension contributions.