Eli Lilly & Co. (LLY) Q3 2013 Earnings Call October 23, 2013 9:00 AM ET
Phil Johnson - Vice President of Investor Relations
Derica Rice - Chief Financial Officer, Executive Vice President - Global Services
Jan Lundberg - President of Lilly Research Laboratories
Ilissa Rassner - Director, Investor Relations
Travis Coy - Director, Investor Relations
Mark Schoenebaum - ISI Group
Bruce Badner - Sanford Bernstein
Jay Olson - Goldman Sachs
Chris Schott - JPMorgan
Vamil Divan - Credit Suisse
Tony Butler - Barclays
Gregg Gilbert - Bank of America
Marc Goodman - UBS
Damien Conover - Morningstar
Alex Arfaei - BMO Capital Markets
John Boris - SunTrust
Ladies and gentlemen, thank you for standing by and welcome to Eli Lilly & Company. Q3 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a questions-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded.
I would now like to turn the conference over to our host, Mr. Phil Johnson, Vice President of Investor Relations. Please go ahead, sir.
Good morning. Thank you for joining us for Eli Lilly & Company's third quarter 2013 earnings conference call. I am Phil Johnson, Vice President of Investor Relations. Joining me today are Derica Rice, our Chief Financial Officer, Dr. Jan Lundberg, our President of Lilly Research Laboratories and Ilissa Rassner and Travis Coy from the Investor Relations team.
During this conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on slide three and those outlined in our latest forms 10-K and 10-Q filed with the Securities and Exchange Commission. The information we provide about our products and pipeline is for the benefit of the investment community. It is not intended to be promotional and is not sufficient for prescribing decisions.
Q3 marked another quarter of strong operational execution, both in terms of financial results and pipeline advancements. Solid topline revenue growth and expense controls produced a 41% increase in non-GAAP earnings per share. And in the last eight months, we have completed eight U.S., European and Japanese regulatory submission for four potential new medicines. Empagliflozinm, our insulin glargine product in collaboration with Boehringer Ingelheim, dulaglutide and ramucirumab.
In the coming quarters, our financial results will reflect the U.S. patent expirations for Cymbalta and Evista. We are ready for this challenging financial period and remain well positioned to invest in R&D, recapitalize our asset base and gauge an optimistic business development and return substantial cash to shareholders by paying our dividend at least at this current level in 2014 and beyond and by repurchasing shares under our recently authorized $5 billion program.
In 2014, we will also see more Phase 3 data readouts and could have additional regulatory submissions as well as multiple product launches. This is an exciting time and we remain focused on continued execution of our innovation based strategy to bring value patients, physicians payers and shareholders.
Before covering our financial results, let's review events that have taken place since our last earnings call. We had a number of clinical data readouts, including positive readouts for SQUIRE, a Phase 3 study investigating necitumumab as first-line treatment for squamous non-small cell lung cancer and for RAINBOW, a Phase 3 study of ramucirumab as combination therapy in patients with advanced gastric cancer. In both studies, we saw increased overall survival.
Also for ramucirumab, the Phase 3 RA study in first-line breast cancer failed to meet its primary endpoint of increased progression free survival. We also made substantial progress on the regulatory front as we completed the rolling DLA submission in the U.S. for ramucirumab as a single agent for advanced gastric cancer and completed the E.U. submission for the same indication.
As you saw this morning, we are pleased with the FDA granted Priority Review designation. We also submitted dulaglutide for Type II diabetes in both, the U.S. and Europe and along with Boehringer Ingelheim, submitted empagliflozin for Type II diabetes in Japan.
Disappointingly, we received the final decision for the centers for Medicare and Medicaid services that provide coverage with evidence development for the use of beta-amyloid Positron Emission tomography imaging agents, including our approved product Amyvid.
We believe this decision is a significant setback for patients and for the Alzheimer's disease community. Finally, Lilly's board of directors authorized a new 5 billion share repurchase program, which the company intends to complete over a multi-year period.
Now let's turn to discuss our financial performance. First, I will provide comments about our GAAP results and then Travis will discuss a few non-measures, which we believe provide insights into the underlying trends in our business.
Turning to Slide 6, you will see that just as I did in Q2, worldwide revenue increased 6% driven by growth in key products, including Cymbalta, Alimta, Cialis, Tradjenta, Humalog, Strattera, Humulin and Animal Health.
Gross margins as a percent of revenue is 79.2%, an increase of a 130-basis point over Q3, last year. The increase in gross margin percent was driven by higher prices and lower manufacturing costs partially offset by a smaller benefit from the effect of foreign exchange on international inventory sold.
Total GAAP operating expense, the sum of R&D, SG&A and other special charges, decreased 4%. This decrease was driven by a 6% decline in SG&A expenses and by a $53 million asset impairment charge in last year's quarter with no similar charges this quarter. The decline in SG&A expense was driven by ongoing cost containment efforts, including the previously announced changes to our U.S. sales and marketing activities related to the upcoming loss of exclusivity for Cymbalta and Evista.
R&D expense increased to 3% this quarter driven by higher early stage research expenses. The growth in revenue, increasing gross margin percent and decrease in total operating expenses combined to produce a 42% increase in operating income.
You may recall that in Q3 last year, we recognized $788 million of income related to early payment of Amylin's financial obligations related to exenatide. We had no such income this year, and other income and deductions was a net deduction of $31 million in the quarter.
Our GAAP tax rate decreased by 8.7 percentage points, due to the taxes payable in the third quarter of 2012 on the payment received from Amylin, and to a lesser extent the reinstatement of the R&D tax credit in the U.S. effective January 01, 2013.
As a result, our Q3 GAAP net income declined 9%, while the decline in GAAP earnings per share was slightly less at 6%, reflecting the benefit of our share repurchases late last year and early this year. Travis?
Thanks, Phil. Let's move on to the non-GAAP measures provided on Slide 7. This quarter, there were no reconciling items, so our GAAP and non-GAAP results are the same. Last year however, we did have the two items Phil mentioned earlier that were excluded from our non-GAAP results. $788 million of income related to exenatide and a $53 million asset impairment charge. Also our non-GAAP tax rate decreased 1.16 percentage points due primarily to the reinstatement of the R&D tax credit. As a result, our non-GAAP net income and EPS growth were substantially higher than the corresponding GAAP numbers at 35% and 41% respectively.
Slide eight provides the same information on a year-to-date basis, while slide nine provides a reconciliation between recorded and non-GAAP EPS. Additional details about our reported earnings are available in today's earnings press release.
As you can see on slide 10, total revenue increased 6% in Q3, driven by a favorable price impact of 5% and a 3% increase in volume, partially offset by a negative foreign exchange impact of 2%. U.S. pharma revenue increased 11%, driven by price as volume was essentially flat. In Australia, Canada and Europe, or ACE, revenue grew 5% driven by volume increases across multiple products, including Alimta, Cialis, Cymbalta, Forteo and Humalog. The positive effect of FX offset the negative price effect.
Once again, Japan revenue was significantly impacted by the weakening of Yen. For the quarter, FX reduced our Japan revenue by 21%. On a constant currency basis, Japan revenue grew 9% with an 11% increase in volume, partially offset by a 2% price decline. Volume growth was primarily driven by Forteo, Strattera, Tradjenta, and Evista. As for emerging markets, which is no longer embedded in rest of the world, revenue declined 1% this quarter, with FX contributing negative 4%, price negative 2% and volume a positive 5%, led by Alimta, Cialis, Forteo, Humalog and Tradjenta. Within emerging markets, revenue growth in China moderated but continued at a double-digit pace, up 11% driven by 10% volume growth. Elanco Animal Health grew 11% this quarter, also driven by volume including a benefit from the U.S. withdrawal of a competitor's suite of animal product. Both U.S. and o U.S. animal health grew 11% supported by food animal growth of 10% and companion animal growth of 13%.
Slide 11 shows the effect of changes in foreign exchange rates on our 2013 results. For both Q3 and year-to-date, FX has had a modest negative effect on revenue growth. In terms of cost of goods sold, this year we have seen a smaller benefit from the FX effect on international inventory sold. As a result, foreign exchange has had a substantial effect on growth in operating income and earnings per share.
Next, I will provide a brief pipeline update before turning the call over to Derica. Slide 12 shows our pipeline as of October 16. Changes since our last earnings call are highlighted with green arrows showing progression and red arrows showing attrition. As Phil mentioned earlier, we recently submitted dulaglutide and ramucirumab in both the U.S. and EU. In addition, we formally terminated development of our Phase 2 base inhibitor. In phase I, three molecules began testing and three others were terminated.
Now I will turn the call over to Derica to cover some of the remaining key events for 2013, our financial guidance and some closing comments before we open the call for Q&A. Derica?
Thanks, Travis. Today, I will began my remarks with slide 13. A slide we have used from the last three years to help you chart our progress, primarily on our number one priority which has been advancing our pipeline. You can see there many more green checkmarks than red and we are pleased with the progress that we have made this year. Starting mid-last year, we entered an intense period of Phase 3 data readouts that extends into 2014. So far, we have seen positive Phase 3 results for five assets, ramucirumab, necitumumab, dulaglutide and empagliflozinm and our insulin glargine product. And we completed regulatory submissions for four of these assets, with the fifth, necitumumab slated for 2014.
Before the end of the year, we have internal data readouts on a number of Phase 3 trial for edivoxetine as well that initial Phase 3 data for our novel basal insulin with a topline press release for edivoxetine likely between late this year and early next year and for our novel basal insulin later in 2014.
In August, we had the District Court hearing in the Alimta method-of-use patent litigation. We are pleased with the arguments that were presented and anticipate a ruling to be handed down in the first half of next year. Finally, later this quarter, on December 11 to be exact, we will lose the U.S. Patent protection for Cymbalta. We are proud of the benefit this product has brought to patients and we are prepared to successfully traverse the financial challenge posed by its patent expiration.
Now as we discussed in the past, due to the patent expiration in the fourth quarter, we expect to see a reduction in wholesaler purchases and we will take a substantial reserve for the expected future product return. I will provide a bit more color on this in just a moment.
Now let's turn to our updated 2013 financial guidance. As you can see on Slide 14, most of our line item guidance remains unchanged. We have revised two line items. First, we have raised the bottom end of our EPS guidance by $0.05. This brings our full year non-GAAP EPS guidance range to $4.10 to $4.15 per share. Second, we are now forecasting capital expenditures to be approximately $1 billion.
Now some of you have already commented this morning on the fact that we did not raise the top end of our full year EPS guidance range despite beating Q3 EPS consensus by $0.07, and you correctly observed that. To make the math work, this means that consensus EPS for Q4 needs to come down by roughly $0.07. It appears that the difference between our expectations compared to the streets for the split of EPS across Q3 and Q4 falls down to the expected sales erosion for U.S. Cymbalta.
Let's dig into this a little bit deeper. U.S. Cymbalta sales by quarter, this year have been $1.1 billion, $1.2 billion and $1.1 billion for the first three quarters of this year. For Q4, the street average is just under $800 million, which represents two full months of sales at the recent run rate.
Our expectation is that U.S. Cymbalta sales will come in well below current consensus. First, we expect minimal wholesaler repurchases after the patent expires on December 11. Second, we expect minimal wholesaler purchases in the first two to three weeks leading up to the patent expiration as wholesalers work down their existing inventories to post-patent expirations levels.
As we have called out in the past, in Q4 we will also take a substantial reserve for expected future returns and we said this reserve will on the hundreds of millions of dollars. As a result, we anticipate that U.S. Cymbalta sales in Q4 will be closer to $500 million or half our recent quarterly run rate as opposed to the nearly $800 million that is reflected in sell side consensus.
Moving to slide 15, you will see a reconciliation between reported and non-GAAP EPS for 2013 and the associated growth rates from these numbers to our 2013 guidance. In closing, Q3 marks another quarter with solid financial performance.
Through top line revenue growth and continued cost containment efforts, we delivered 41% non-GAAP earnings per share growth. Going forward, we will continue to focus on the three strategic priorities that have guided our efforts thus far advancing our pipeline, driving strong performance of our marketed brands in key growth areas and increasing productivity and reducing our cost structure.
These strategic priorities will also allow us to return substantial cash to shareholders by paying our dividend at least at this current level 2014 and beyond and by repurchasing shares under our recently authorized $5 billion program. We remain committed to our innovation strategy and believe it will drive growth and expand margins post 2014.
The progress we have made to-date positions us well to meet the challenges ahead. In 2014, we will begin the launch of our next wave of innovation and we will continue to generate and disseminate important data that will help investors and analysts better gauge our longer term growth potential. We look forward to keeping you updated on our progress. This concludes our prepared remarks and we will now take your questions. Lola, first caller please?
Earnings Call Part 2: