Eli Lilly Q3 2013 Earnings Results

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, Eli Lilly has completed eight U.S., European and Japanese regulatory submission for four potential new medicines; Empagliflozinm, insulin glargine product in collaboration with Boehringer Ingelheim, dulaglutide and ramucirumab.

The company 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, Eli Lilly 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. The company also made substantial progress on the regulatory front as it 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.

This morning, the FDA granted Priority Review designation. Eli Lilly 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, the company 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 its approved product Amyvid.

Eli Lilly Board of Directors authorized a new $5 billion share repurchase program, which the company intends to complete over a multi-year period.

Worldwide revenue increased 6% driven by growth in key products, including Cymbalta, Alimta, Cialis, Tradjenta, Humalog, Strattera, Humulin and Animal Health. Gross margin 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 the company’s 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, Eli Lilly recognized $788 million of income related to early payment of Amylin's financial obligations related to exenatide. The company had no such income this year, and other income and deductions was a net deduction of $31 million in the quarter.

Eli Lilly’s 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, the company’s 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.

Now let's turn to Eli Lilly’s updated 2013 financial guidance. The company have revised two line items. First, Eli Lilly raised the bottom end of EPS guidance by $0.05. This brings the company’s full year non-GAAP EPS guidance range to $4.10 to $4.15 per share. Second, the company is now forecasting capital expenditures to be approximately $1 billion.

Eli Lilly did not raise the top end of its full year EPS guidance range despite beating Q3 EPS consensus by $0.07. 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 the company’s 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.

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.

Eli Lilly’s expectation is that U.S. Cymbalta sales will come in well below current consensus. First, the company expects minimal wholesaler repurchases after the patent expires on December 11. Second, it expects 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.

In Q4, Eli Lilly will also take a substantial reserve for expected future returns. As a result, the company anticipates that U.S. Cymbalta sales in Q4 will be closer to $500 million or half its recent quarterly run rate as opposed to the nearly $800 million that is reflected in sell side consensus.

In the coming quarters, Eli Lilly’s financial results will reflect the U.S. patent expirations for Cymbalta and Evista. The company is ready for this challenging financial period and remains well positioned to invest in R&D, recapitalize its asset base and gauge an optimistic business development and return substantial cash to shareholders by paying dividend at least at this current level in 2014 and beyond and by repurchasing shares under the company’s recently authorized $5 billion program.

In 2014, Eli Lilly 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 the company remains focused on continued execution of its innovation based strategy to bring value patients, physicians, payers and shareholders.