Business context and reporting period
Eli Lilly and Company’s Form 10-K covers the fiscal year ended December 31, 2015; unaudited quarterly data include the fourth quarter. Lilly discovers, develops, manufactures, and sells human pharmaceuticals and animal-health products worldwide. Financial statements are prepared under U.S. GAAP and received an unqualified audit opinion.
On January 1, 2015, Lilly acquired Novartis Animal Health for $5.28 billion in cash, expanding Elanco’s products, pipeline, facilities, and global presence. Lilly divested certain U.S. Sentinel-related assets for approximately $410 million.
Financial performance and condition
| Metric | 2015 | 2014 |
|---|---|---|
| Revenue | $19.96 billion | $19.62 billion |
| Gross margin | $14.92 billion; 74.8% of revenue | $14.68 billion; 74.9% of revenue |
| Net income | $2.41 billion | $2.39 billion |
| Diluted EPS | $2.26 | $2.23 |
| Operating cash flow | $2.77 billion | $4.37 billion |
| Capital expenditures | $1.07 billion | $1.16 billion |
| Cash and cash equivalents | $3.67 billion | $3.87 billion |
| Total debt | $7.98 billion | $8.02 billion |
Current assets were $12.57 billion and current liabilities $8.23 billion. Cash, cash equivalents, and investments totaled approximately $8.10 billion. Lilly also reported $1.30 billion of unused committed credit facilities. Long-term debt was $7.97 billion. Cash flow from operations fell about 36% year over year, while capital expenditures declined modestly.
Revenue rose 2% overall: U.S. revenue increased 11%, while revenue outside the U.S. declined 6%, including a 13% unfavorable foreign-exchange impact. Animal-health revenue grew 36% as reported, primarily due to the Novartis acquisition; on a pro forma basis, total company volume grew 2%. Human-pharmaceutical segment revenue was $16.78 billion and animal-health revenue was $3.18 billion.
Fourth-quarter revenue was $5.38 billion and net income was $478.4 million, compared with $5.12 billion and $428.5 million, respectively, in fourth-quarter 2014.
Material changes versus prior period
- Net income and diluted EPS edged up 1%, while revenue increased 2% and gross margin percentage was essentially flat.
- Revenue growth from new and expanding products and the Novartis AH acquisition was partly offset by loss of exclusivity and generic competition. Cymbalta revenue fell 36% for the year; Evista fell 43%; Alimta fell 11%.
- Animal-health revenue included $1.02 billion from Novartis AH. Integration, inventory fair-value adjustments, and acquired intangible amortization affected results.
- Acquired in-process R&D charges rose to $535.0 million from $200.2 million, principally reflecting collaboration payments and the acquisition of intranasal glucagon rights. Restructuring and special charges were $367.7 million, down from $468.7 million.
- Operating cash flow declined, in part reflecting increased investment in inventory and other working-capital movements. Lilly issued $4.45 billion of debt and repaid or redeemed debt, ending the year with debt slightly lower than in 2014.
Outlook, risks, and unusual items
For 2016, management forecast revenue of $20.2–$20.7 billion and diluted EPS of $2.83–$2.93. Expected gross margin was approximately 74%; R&D expense $4.8–$5.0 billion; marketing, selling, and administrative expense $6.0–$6.2 billion; and an effective tax rate of approximately 21%. Capital expenditures were expected to be about $1.1 billion. Management anticipated growth from several established and newer products, partly offset by lower Alimta revenue from increased competition.
Key risks include generic and biosimilar competition, approaching patent expirations, pricing and reimbursement pressure, foreign-exchange volatility, product safety or efficacy issues, regulatory and manufacturing compliance, supply disruptions, and the uncertain success of the development pipeline. Management discontinued development of evacetrapib and basal insulin peglispro in 2015. It also approved a plan to close an animal-health manufacturing plant in Ireland, expecting approximately $100 million of first-quarter 2016 charges.
Material legal and contingency matters include Alimta and Effient patent challenges; product-liability claims involving Actos, Byetta, Cymbalta, Prozac, and Axiron; and Brazil employee litigation. Lilly said it could not reasonably estimate maximum exposure or possible loss beyond accruals for certain matters. A Brazil court ruling was estimated by the judge to have a financial impact of approximately 1.0 billion Brazilian real, or about $255 million at year-end 2015, plus interest; Lilly appealed. Lilly is self-insured for product-liability losses.
Other items to note: Lilly recorded a $166.7 million pretax debt-extinguishment loss in 2015, partly offset by related gains; an inquiry by the U.S. Department of Justice concerning wholesaler distribution-service agreements and Medicaid average manufacturer price reporting was ongoing; and Lilly voluntarily disclosed that certain Iran-bound shipments handled by a logistics provider had used Iran Air. Lilly reported no direct payments to Iran Air and no attributable gross revenue or net profit.
Important facts for investors to verify
- Whether 2016 revenue and EPS guidance was achieved, particularly assumptions for product uptake, Alimta competition, pricing, and foreign exchange.
- The timing and commercial impact of generic entry for Alimta, Effient, and other products facing patent or data-protection challenges.
- Whether launches and pipeline submissions—including Basaglar, Trulicity, Cyramza, ixekizumab, and baricitinib—deliver anticipated growth, and the clinical and regulatory status of late-stage candidates.
- Cash-flow conversion, inventory levels, acquisition integration costs, debt and liquidity, and the sustainability of dividends and repurchases.
- Developments in the DOJ inquiry, product-liability and patent cases, Brazil litigation, and the Iran-related voluntary disclosure.
- That management’s internal-control assessment excluded Novartis AH operations acquired in 2015, which represented about 3% of year-end assets and 5% of annual net sales.