ELI LILLY & Co quarterly report, Q2 FY2010

Eli Lilly and Company — Form 10-Q summary

Reporting period: Quarter and six months ended June 30, 2010; comparisons are with the corresponding 2009 periods unless otherwise stated. The company operates primarily in human pharmaceuticals, with animal health included in its pharmaceutical reporting.

Financial performance

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Revenue	$5.75 billion	$5.29 billion	$11.23 billion	$10.34 billion
Net income	$1.35 billion	$1.16 billion	$2.60 billion	$2.47 billion
Diluted EPS	$1.22	$1.06	$2.35	$2.25
Gross margin as a share of revenue	82.2%	Approximately 82.2%	80.9%	82.9%

Revenue and net income rose 9% and 16%, respectively, in Q2; for the first half they rose 9% and 5%. EPS increased 15% in Q2 and 4% for the first half.
Q2 revenue growth reflected worldwide volume growth of 5%, price increases of 2%, and a 1% favorable foreign-exchange effect. First-half growth also reflected 5% volume growth, 2% price increases, and a 2% favorable currency effect.
Key product growth included Alimta (Q2 +43%; first half +50%), Cymbalta (+17%; +15%), and Cialis (+15%; +14%). Gemzar declined 17% in Q2 and 19% for the first half, largely reflecting generic competition outside the U.S.
Research and development expense rose 14% in Q2 and 12% for the first half, mainly from late-stage trials and development milestones. Marketing, selling, and administrative expense rose 3% and 4%, respectively. First-half cost of sales increased faster than revenue, contributing to the lower gross margin.
Operating cash flow was $2.87 billion for the first half, versus $1.01 billion in 2009. The comparison benefited substantially from lower marketing-investigation settlement payments: $80.5 million in 2010 versus $1.39 billion in 2009.
Cash and cash equivalents were $5.16 billion at June 30, up from $4.46 billion at year-end; cash, equivalents, and short-term investments totaled $5.20 billion. Total debt was $6.89 billion, up $226.8 million from year-end. Current assets were $12.47 billion and current liabilities $6.32 billion.
First-half investing cash outflow was $806.8 million, including $400 million for duloxetine rights and $148.4 million for an acquisition; financing cash outflow was $1.08 billion, primarily dividends. Dividends paid were $1.08 billion for the half.

Material changes, outlook, and commentary

Management raised 2010 EPS guidance to $4.44–$4.59, excluding potential restructuring charges. It projected mid-single-digit, volume-driven revenue growth; gross margin flat to increasing; low-single-digit growth in marketing, selling, and administrative expense; and low-double-digit R&D growth.
Other-net expense was expected to be $50–$100 million. Capital expenditures were estimated at less than $900 million. Management expected cash flows to fund capital spending, business development, and dividends.
The company is pursuing $1 billion of cost reductions by the end of 2011, including a targeted reduction of 5,500 positions. It reported $53.5 million of restructuring and related charges in the first half of 2010, primarily severance.
U.S. health-care reform increased rebates and reduced revenue by approximately $70 million pretax in Q2 and $130 million for the first half. Lilly also recorded a one-time, noncash $85.1 million first-quarter tax charge relating to the future taxation of its retiree drug-benefit subsidy. Management cited continuing pricing and rebate pressure from public and private payers.
Late-stage pipeline developments included a complete response letter for Bydureon, with a new FDA action date of October 22, 2010; Axiron remained under FDA review. Lilly completed its acquisition of Alnara in July 2010, after the quarter, for an upfront $180 million subject to adjustment, with up to $200 million in potential milestone payments.
Patent expiry and generic entry are significant risks. Lilly expected U.S. generic Gemzar entry as soon as mid-November 2010 after compound-patent expiry, which it said could cause a rapid and severe sales decline. It also identified loss of exclusivity for Humalog in major European markets in 2010 and for Zyprexa in major European markets and the U.S. in 2011.

Risks, contingencies, and unusual items

Patent challenges involving Cymbalta, Alimta, Evista, and Strattera could affect future exclusivity. The Gemzar method-of-use patent invalidation was affirmed on appeal in July 2010. Strattera litigation remained pending, with generic entry possible following an adverse decision.
Ongoing Zyprexa product-liability, state, and third-party-payer litigation could materially affect results, liquidity, or financial position. Lilly noted that many claims had been settled but that remaining U.S. cases included trials scheduled for late 2010. It was self-insured for substantially all currently marketed products against future product-liability losses.
The filing also describes other product-liability and environmental proceedings. Management generally expected resolution of legal matters not to materially harm financial position or liquidity, while acknowledging possible material effects on results in an individual period.
Other notable first-half items included $50 million of acquired in-process R&D expense for the Axiron license and $56.1 million of other-net income, primarily from German Zyprexa patent damages and a gain on investment securities acquired with ImClone.
Management said cash from operations and available cash were expected to meet normal operating needs. Lilly reported $1.24 billion of unused committed bank facilities, including $1.20 billion supporting commercial paper and maturing in May 2011; its stated credit ratings were AA from S&P and A1 from Moody’s.

Investor verification priorities

Verify the durability of growth in Alimta, Cymbalta, and other products against Gemzar generic entry and upcoming Zyprexa and Humalog exclusivity losses.
Track actual 2010 results against the revised EPS, revenue, margin, expense, and capital-spending outlook, including the exclusion of potential restructuring charges from EPS guidance.
Assess the continuing financial effects of health-care reform rebates, pricing pressure, and the retiree-subsidy tax change.
Monitor outcomes and potential cash requirements from Zyprexa litigation and pending generic patent disputes, particularly Gemzar and Strattera.
Review whether operating cash flow remains strong after accounting for the unusually large 2009 settlement-payment comparison, acquisitions, dividends, and planned cost reductions.