Eli Lilly and Company — Q3 2009 Form 10-Q
Business context and reporting period
Unaudited results for the quarter and nine months ended September 30, 2009, compared with the same 2008 periods. Lilly operates primarily in human pharmaceuticals; animal health is included in the reported pharmaceutical segment. The filing was signed October 30, 2009.
Financial performance
| Metric | Q3 2009 | Nine months 2009 |
|---|---|---|
| Total revenue | $5.562 billion, up 7% | $15.902 billion, up 5% |
| Net product sales | $5.386 billion, up 6% | $15.391 billion, up 4% |
| Net income | $941.8 million; prior year loss $465.6 million | $3.413 billion, versus $1.558 billion |
| Diluted EPS | $0.86, versus $(0.43) | $3.11, versus $1.42 |
| Gross margin | 81.1%, up 3.3 percentage points | 82.3%, up 5.2 percentage points |
| Operating cash flow | Not presented by quarter in the supplied filing text | $2.317 billion, versus $4.915 billion |
Revenue gains reflected growth in Alimta, Cymbalta, and Humalog, as well as Erbitux revenue following the 2008 ImClone acquisition. For the quarter, worldwide volume increased 8% and pricing contributed 2%, partly offset by a 3% foreign-exchange headwind. For the nine months, volume increased 7% and pricing contributed 3%, partly offset by a 5% FX headwind. Product performance was mixed: Q3 Alimta sales rose 47%, Humalog 16%, and Cymbalta 10%; Gemzar fell 25%, largely amid generic competition.
Gross-margin improvement was attributed principally to lower foreign currencies reducing the cost of international inventories sold. R&D expense rose 18% in Q3 and 12% year to date, to $1.122 billion and $3.110 billion, respectively, reflecting ImClone, later-stage trials, and estimated arzoxifene trial-termination costs. Marketing, selling, and administrative expense increased 3% in Q3 and 1% year to date.
Financial position, cash flow, and liquidity
At September 30, 2009, cash, cash equivalents, and short-term investments totaled $3.929 billion, down from $5.926 billion at year-end 2008. Total debt was $7.392 billion, down $3.07 billion from year-end; short-term borrowings declined to $622.5 million from $5.846 billion, while long-term debt rose to $6.770 billion from $4.616 billion. The company issued $2.4 billion of long-term notes in March 2009. Approximately 88% of total debt was at fixed rates, with swaps converting about 56% of fixed-rate debt to floating rates.
Nine-month operating cash flow was $2.317 billion, including $1.39 billion paid in connection with the EDPA Zyprexa settlement. The filing also identifies substantial outflows from marketing-investigation charges and changes in operating assets and liabilities. Investing activities provided $397.1 million; financing used $4.405 billion, including $1.612 billion of dividends and repayment of short-term borrowings. Cash declined $1.649 billion during the period. Lilly reported $1.24 billion of unused committed bank facilities, including $1.20 billion backing its commercial-paper program, and said operating cash and available resources should cover normal needs, debt service, litigation costs, capital spending, and dividends in 2009.
Material changes and unusual items
- Q3 2009 asset impairment, restructuring, and other special charges were $549.8 million, versus $1.659 billion in Q3 2008. The 2009 total included $424.8 million primarily tied to the planned Tippecanoe site sale and U.S. sales-employee exit program, plus $125 million for probable and estimable state Zyprexa claims. Year-to-date charges were $654.8 million, versus $1.894 billion.
- The Tippecanoe sale was expected to close by year-end, subject to conditions; Lilly planned a nine-year supply-and-services arrangement with the buyer. The associated Q3 restructuring charge included $363.7 million of noncash impairments and other charges and $61.1 million of severance, substantially all expected to be paid by early 2010.
- The 2008 comparison included a $1.42 billion charge for the EDPA Zyprexa resolution and other large special charges, explaining much of the year-over-year improvement in earnings. Lilly paid substantially all of the EDPA settlement in 2009.
- The Q3 2009 effective tax rate was 11.9%; the nine-month rate was 19.1%, down from 23.3% a year earlier. The 2009 rate reflected restructuring-related tax benefits, a revised forecasted tax rate, and, to a lesser extent, settlement of an IRS appeals matter. The IRS settlement reduced Q3 tax expense by $54.4 million.
- In July, Lilly and BioMS discontinued Phase III dirucotide trials after the drug failed to show significant benefit. Lilly also decided not to seek approval for arzoxifene after reviewing efficacy and safety results. Conversely, Effient gained U.S. approval and launched in August; worldwide Q3 sales were $22.6 million.
Outlook, management commentary, and risks
Lilly revised full-year 2009 reported EPS guidance to $3.90–$4.00 and expected mid-single-digit revenue growth. It forecast higher full-year gross margin, but a significant Q4 gross-margin decline versus Q4 2008; flat-to-low-single-digit growth in marketing, selling, and administrative costs; low-double-digit R&D growth; net other expense of $200–$250 million; an approximately 20% effective tax rate; capital spending below $1 billion; and continued strong operating cash flow.
Management set a goal to reduce expected costs by $1 billion by the end of 2011 and lower global headcount to 35,000, excluding strategic sales-force additions in selected markets. Key uncertainties include generic-entry and patent litigation affecting major products, unresolved Zyprexa product-liability and state claims, potential self-insured product-liability exposure, and evolving U.S. and international pricing, reimbursement, and healthcare policies. The filing also cites competition, regulatory and clinical outcomes, FX, economic conditions, tax changes, and wholesaler inventory as risks to results.
Important facts for investors to verify
- Progress and final terms of the Tippecanoe sale, supply agreement, and cost-reduction plan.
- Cash use and remaining liabilities associated with Zyprexa settlements, state claims, and product-liability litigation.
- Patent-case developments and potential generic competition for Cymbalta, Gemzar, Alimta, Evista, Strattera, and Zyprexa.
- Whether product launches and pipeline progress support the 2009 revenue and EPS outlook, especially given the dirucotide and arzoxifene setbacks.
- Drivers of the decline in operating cash flow, future debt requirements, and the expected Q4 gross-margin reduction.