Eli Lilly and Company — Q1 2010 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2010; comparative figures are for the three months ended March 31, 2009. Lilly operates primarily in human pharmaceuticals; animal health is included in the reported pharmaceutical segment. The filing was signed April 30, 2010.
Financial results and liquidity
| Metric | Q1 2010 | Q1 2009 / comparison |
|---|---|---|
| Revenue | $5,485.5 million | $5,047.0 million; up 9% |
| Gross margin | 79.5% | 83.8%; down 4.3 percentage points |
| Income before income taxes | $1,707.8 million | $1,683.4 million |
| Net income | $1,248.1 million | $1,313.1 million; down 5% |
| Diluted earnings per share | $1.13 | $1.20; down 6% |
| Operating cash flow | $958.0 million | $87.9 million |
| Cash and cash equivalents | $4,725.2 million at March 31 | $4,462.9 million at December 31, 2009 |
| Total debt | $6.68 billion at March 31 | Up $19.3 million from December 31, 2009 |
| Current assets / current liabilities | $12,252.4 million / $5,657.6 million | At March 31, 2010 |
Revenue growth reflected 4% higher worldwide volume, a 3% favorable foreign-exchange effect, and a 1% increase in selling prices. Growth was led by Alimta (+57%), Cymbalta (+13%), Humalog (+12%), and Cialis (+14%). Gemzar revenue fell 22%, largely reflecting generic competition outside the U.S. R&D expense rose 10% to $1,039.1 million; marketing, selling, and administrative expense rose 6% to $1,614.4 million.
The gross-margin decline was attributed mainly to currency effects on international inventories sold. Operating cash flow was much higher than the prior-year quarter, when $1,063.1 million of marketing-investigation charges were paid. Investing cash flow was a $52.6 million use, financing cash flow was a $547.0 million use, and dividends paid were $539.2 million. The quarterly dividend was $0.49 per share. Approximately 97% of debt was fixed-rate; ratings were AA at S&P and A1 at Moody’s.
Material changes and unusual items
- U.S. health-care reform reduced Q1 revenue by $62.4 million through higher rebates and led to a one-time, noncash $85.1 million tax charge. Together these reduced Q1 EPS by about $0.12.
- A $50.0 million acquired in-process R&D charge followed the Acrux license for Axiron, a testosterone treatment candidate under FDA review.
- Asset impairment, restructuring, and other special charges were $26.2 million, mainly severance and exit costs.
- Other-net income was $74.5 million, versus expense of $70.7 million a year earlier. The 2010 result primarily included damages recovered following German Zyprexa patent litigation and a gain on disposition of investment securities acquired in the ImClone transaction.
- Effective tax rate was 26.9%, versus 22.0%, reflecting the retiree-drug-subsidy tax charge and expiration of the R&D tax credit.
- Lilly terminated its duloxetine collaboration with Boehringer Ingelheim and reacquired rights outside the U.S. and Japan, paying approximately $400 million and agreeing to royalties through 2012.
Outlook, management commentary, and risks
Lilly revised 2010 diluted EPS guidance to $4.35–$4.50, excluding potential future restructuring charges. Management estimated health-care reform would reduce 2010 EPS by about $0.35, including the Q1 tax charge and higher rebates expected to reduce 2010 revenue by $350–$400 million. For 2011, it estimated a $600–$700 million revenue impact from reform.
Management expected mid-single-digit volume-driven revenue growth, gross margin flat to declining, low-to-mid-single-digit growth in marketing and administrative expense, and low-double-digit R&D expense growth. Other-net was expected to be a $50–$100 million expense. Cash flow was expected to cover approximately $1.0 billion of capital expenditures, business-development activity, and dividends. The company stated that operating cash, available cash, and credit access should fund normal 2010 needs; it had $1.24 billion of unused committed bank facilities.
- Patent and exclusivity exposure: Lilly identified upcoming Zyprexa exclusivity losses in Europe and the U.S. in 2011, Humalog in major European markets in 2010, and existing Gemzar generic competition. It warned that generic entry could rapidly and materially reduce product revenue. Key patent disputes also involve Cymbalta, Gemzar, Alimta, Evista, and Strattera.
- Regulatory and product pipeline: Bydureon received an FDA complete response letter; Lilly and partners submitted a response in April. FDA action on Cymbalta for chronic pain remained pending, with an advisory committee expected in the second half of 2010. Effient was newly marketed, with worldwide Q1 sales of $8.8 million.
- Litigation and contingencies: Remaining Zyprexa product-liability and related claims could materially affect results, liquidity, or financial position; Lilly said outcomes and additional claims could not be determined. It was substantially self-insured for future product-liability losses. Gemzar and other patent outcomes could accelerate generic competition; environmental matters may require a fine, which the company did not expect to be material.
- Other business risks: Management cited health-care price and rebate pressure, government cost containment, foreign-exchange and macroeconomic conditions, regulatory approvals, competition, tax changes, and wholesaler inventory shifts. Lilly set a goal to reduce its cost structure by $1 billion by end-2011 and lower global headcount to 35,000, excluding specified strategic additions.
Important facts for investors to verify
- Whether revenue growth and product demand can offset the gross-margin decline, rising R&D costs, and anticipated health-care reform rebates.
- Progress and outcomes in Gemzar, Cymbalta, Strattera, Alimta, Evista, and Zyprexa patent cases, and the timing and effect of generic launches.
- FDA and other regulatory developments for Bydureon, Axiron, and Cymbalta chronic-pain use.
- Exposure from unresolved Zyprexa and other product-liability claims, including the adequacy of recorded contingencies and the impact of self-insurance.
- Execution of the $1 billion cost-reduction plan, the approximately $400 million duloxetine rights payment, and the stated 2010 EPS and cash-flow outlook.