Eli Lilly and Company (LLY) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Vice President, Investor Relations, Phil Johnson. Please go ahead.

Good morning. Thank you for joining us for Eli Lilly & Co.'s Second Quarter 2012 Earnings Conference Call. I'm Phil Johnson, Vice President of Investor Relations. Joining me are John Lechleiter, our Chairman, President and CEO; Derica Rice, our Chief Financial Officer; Dr. Jan Lundberg, our President of Lilly Research Laboratories; Dave Ricks, President of our Lilly Bio-Medicines business; Enrique Conterno, President of our Diabetes business; and Ilissa Rassner and Travis Coy from the Investor Relations team. During this conference call, we anticipate making projections and forward-looking statements that are based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on Slide 3 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. We're very pleased with our performance in the second quarter 2012. In the face of significant reductions in revenue and earnings due to the Zyprexa patent expiration, Lilly employees around the world continue to focus on execution. They delivered results that position us to raise our 2012 financial guidance, and it places us on track to meet or exceed our financial minimum goals through 2014. Let's begin today's call with a review of events that have taken place since our last earnings call. First, 2 important decisions from Washington. In a much-anticipated ruling, the Supreme Court upheld most aspects of the Affordable Care Act, and the FDA Safety and Improvement Act was signed into law, which included the reauthorization of the Prescription Drug User Fee Act or PDUFA. From a commercial perspective, Cymbalta received pediatric exclusivity from the U.S.…

Thanks, Phil. As you can see on Slide 10, the total revenue decline of 10% for the quarter was driven by a negative volume impact of 9% and a negative foreign exchange impact of 2%, partially offset by a favorable price impact of 1%. By geography, you'll notice that U.S. volume decreased 20%. This was entirely due to Zyprexa sales erosion. Excluding olanzapine from both 2011 and 2012, volume in the rest of our U.S. business was up about 1.5%. Similarly, in Europe, the volume decline of 12% was entirely due to the Zyprexa patent expiration. Excluding Zyprexa from both 2011 and 2012, volume growth for the rest of our European products was 6%. The year-on-year European price change of negative 8% was also heavily influenced by Zyprexa. Excluding Zyprexa, European price declined 3%. Historically, we've experienced a 1% to 2% price decline in Europe. So this 3% decline confirms that we've not seen significant new austerity measures that impact our products. Staying in Europe, accounts receivable, particularly in Southern Europe, has been a hot topic lately. And thinking about our exposure, keep in mind that the majority of our European sales are to private sector wholesalers. Payments by these customers have remained timely throughout the European crisis. A smaller portion of our sales are to government entities, particularly sales to hospitals. Receivables from these customers have been and continue to be immaterial to our financial position. Currently, our European receivables and the percent of receivables that are overdue are lower than they've been for many years. Given the economic situation, we will continue to closely monitor and manage our European receivables. Turning to Japan, robust volume growth of 18% was driven primarily by Forteo, Alimta and Zyprexa, while the negative 5% price impact reflects a full quarter of the…

Thanks, Ilissa. As I've have done in the past, I'll start with the progress update on key events we've highlighted for 2012. The green check marks show what we've achieved so far this year, including regulatory approval of Amyvid and of new indications or line extensions for Trajenta and Erbitux, as well as important data disclosures for Alimta, dulaglutide, ixekizumab and our novel basal insulin analog. In the remainder of 2012, we anticipate an FDA decision on Alimta as continuation maintenance therapy for patients with non-squamous, non-small cell lung cancer. We also could begin Phase III trials for evacetrapib, our CETP inhibitor, as well as for baricitinib, our oral JAK1/JAK2 inhibitor for rheumatoid arthritis in partnership with Incyte. In addition, we expect to compete and disclose data from a number of important Phase III trials, including the EXPEDITION studies with solanezumab for Alzheimer's disease; the TRILOGY study with Effient and ACS medically managed patients; and the POINTBREAK study with Alimta, a non-squamous, non-small cell lung cancer. We will also complete a number of the Phase III trials for dulaglutide, and in collaboration with Boehringer Ingelheim, for empagliflozin. We expect to disclose results from some of these trials at the ADA in 2013. And we plan to disclose 24-week data from the Phase IIb trial of baricitinib at a medical meeting later this year. As outlined in our press release, we've updated our 2012 financial guidance. This update takes into account the impact of weaker foreign currencies, strong sales performance for Cymbalta, Cialis Evista, Forteo, Alimta and Elanco and the expectation that OUS [ph] Rights for exenatide transfer in 2013 and not in 2012. Our guidance does not assume accelerated repayment of Amylin's revenue-sharing obligation. In terms of the individual line items, we still project revenue to be between $21.8 billion…

[Operator Instructions] So our first question will come from the line of Tony Butler with Barclays.

Two questions. Derica, you did make a comment about implementation and standardization for insulins and devices that would actually double capacity for insulin. I wonder if you could flush that out more. And does that actually imply or does that also include that the basal insulin needs to be on the market in order for gross margins to improve? And then my second question, which is totally separate, is you had previously given guidance that Elanco profit would double in YZ. And I wondered if you could actually flush that out a little bit. What -- I mean, I understand the word double, but can you give us some idea of the magnitude of -- in absolute numbers?

Tony, this is Phil. Since we do have Enrique Conterno with us, we'll actually have him address your first question on the insulin manufacturing agenda and then come back to Derica for the Elanco profit expansion.

Tony, yes, it does include the full range of insulin. So as we think about our manufacturing plant, they will have the capability of being able to make the full range of insulin that we have available today and the ones that we plan to make available in the future. As you can appreciate, this provides significant flexibility for us. And as Derica said, we will be able to support twice the current demand that we have with the same manufacturing footprint that we have today.

Tony, this is Derica. In regards to Elanco, yes, we still expect to double the size of our Elanco business over this YZ time period, this 4- to 5-year period. And at the same time, we're also expanding margins. So if you were to look, we have gone from about 18% to about 25% profit margins in our Elanco business over this time frame as well. So they're performing quite well.

From ISI, we'll go to the line of Mark Schanberg (sic) [Schoenebaum].

It's Mark Schoenebaum. I had one question perhaps for Derica, and that is I think a question on a lot of people's minds. The guidance is predicated on both revenue growth post 2014 as well as expense management, and so I guess the question on everyone's mind, including mine, is what if your revenue doesn't grow or certainly doesn't grow very much? Should the investor community still expect that you'll be able to honor your new R&D and SG&A expense guidance? And then sort of the partner question I suppose is, is it realistic to expect that you could, if needed, reduce R&D and SG&A dollars, not just the percent of sales? And then finally just a quick one, you've said that you expect your Phase III pipeline to -- the probability of success to be in near industry averages. I was wondering what your data show the industry average probability of success is?

Okay, Mark, this is Derica. Let me try to answer at least 2 of your first 3 questions. First of all, in regards to our expense management and our margin expansion, we are absolutely committed to prudently managing our business. And definitely, obviously, today we're factoring in revenue growth coming out of the 2014 time period, as well as continued prudent expense management. One could argue that if we are in a scenario where our pipeline is not successful, then that will call for even more prudent management of our expenses. So we're still committed to the longer-term outlook that we shared with you all here today, and we believe it is absolutely achievable. In regards to your question around are we able to reduce SG&A or R&D spend in absolute dollars, I think that will be one thing that we'll have to see how it plays out. Obviously, as we go through and see how the pipeline matures, especially given some of the therapy areas we're in, based upon where we have success and where we have failure will be a key determinant in terms of what our commercial footprint looks like. So if we find that, for example, neuroscience, if we're not successful there, then one could argue, do we still need the neuroscience footprint that we have today? So we'll have to see how this plays out. But obviously, we're prepared to be nimble and agile and respond to the outcomes of our pipeline. I'm not sure I understand your last question, to be honest, in regards to the probability of success of the pipeline versus industry averages. I think when we were talking about returning the industry averages in our call text, we were talking about returning for SG&A to more be in line with industry averages. And for our R&D spend as a percent of revenue, we said we'll return back closer to our levels of historical averages of the 18% to 20% range.

Yes, if I can go ahead and add, and this is Phil. We have had some comments in the past where we cited some of the industry benchmarking data that indicate that in past years you would have seen something like 70% to 80% probably as a more likely success rate for Phase III compounds. That maybe I think what [indiscernible] was referring to.

We'll go to the line of Tim Anderson with Sanford Bernstein. Tim Anderson - Sanford C. Bernstein & Co., LLC., Research Division: On your long-term guidance, on the spend element post 2014, to give those aspirational percentages you obviously have to have a revenue forecast. And any chance you would be willing to bracket your assumptions for revenue growth in that post-2014 period? Also what's embedded in that guidance for Alimta exclusivity? And then on solanezumab and upcoming data release, if you see hints of efficacy that support the beta-amyloid hypothesis, but those data are not good enough for approval, can you say whether you'd likely push solanezumab into the next round of clinical trials or whether you'd more likely move on to other approaches like BACE inhibition?

Tim, this is Derica. Let me take your first question regarding post 2014 in revenue. We're not prepared to share our revenue forecast at this time frame. Obviously, as we continue to work through YZ, we'll have an opportunity to reengage in that particular specific aspect of our business going forward. But I did want to get out there today in terms of what the profile of Lilly should look like in terms of our business longer term. That should begin to hopefully give you guys greater insight as to how we look to manage our business.

Tim, on the Alimta exclusivity, currently we have a compound patent that with the pediatric exclusivity and other provisions would expire in January of 2017. We believe we have valid IP that we intend to pursue and uphold for the method-of-use patent that would expire in 2022. So really any outcome that would be negative on that method of use patent really wouldn't come into play until that 2017 time frame. And then in terms of the strategy for solanezumab data, obviously, if we do, as you're mentioning, fall short of hitting the primary endpoints, clearly we'll look to see if there are any strong signals and subpopulations. There's been some talk about this in prior investment meetings we've had. Obviously, we'd want to discuss that with the agency if we would see such results. At this point it would be premature to speculate on whether or not that would require or whether or not we would pursue additional clinical studies with solanezumab. As you mentioned, we do have a BACE compound that just started Phase II, very encouraged by the data we've seen today with that compound and excited to take that forward into development.

From Leerink Swann, we'll go to the line of Seamus Fernandez.

So just a couple of quick questions. The performance in the diabetes portfolio this quarter, can you just kind of comment on again the sort of slowing script trends. Is that entirely due to Caremark in your view, or is there some other contributing feature in that regard? And then how would that trajectory, how do you see that trajectory changing with a basal insulin? And then separately, I think just following up on one of the earlier questions, I think Tony's earlier question -- historically, you've kind of in some meetings characterized the value of having the expanded manufacturing capability as contributing the value of a blockbuster from an operational perspective. Can you help us think about that? Should we be thinking about that as kind of a $350 million number relative to a blockbuster in terms of cost avoidance?

Thanks, Seamus. We'll have Enrique respond.

Yes. So when we look at the performance in U.S. for diabetes, which is what I think you are referring to, because when we look outside of the U.S., it is pretty clear that when we look at our mealtime [ph] share performance, we have shared trends that are positive, whether it's in Europe, Japan or emerging markets. In the U.S. we specifically lost very -- we -- Humalog got removed from a very large formulary. And the impact that we see is basically very specific to that. Of course, there's always some spillover effect that we see. But 80% of the share loss can be directly attributed to basically lines [ph] That are covered by the large formulary. If we were to look outside of that specific segment, for example, we've talked in the past about our hospital share. Our hospital share continues to go up and continues to increase with the introduction of the [indiscernible]. The dynamics of our performance outside of this one event continue to be very consistent. I think it's important to emphasize that we are very much looking at protecting the gross margin that we have when it comes to our insulin business. Clearly, we are concerned about single-source type deals and this dynamic that is happening in the marketplace. But we're monitoring this very, very closely. At the end of the day, we need to make sure that patients are going to be in Lilly insulin products. Clearly, when we look at the future portfolio, additional critical mass and starting patients on basal insulin, will make us more competitive. We know that patients start insulin on a basal product. So to the extent that that is Lilly insulin, that will make us even more competitive when we're able to have that. As far as the impact, the financial impact from manufacturing, we have characterized this. We should be thinking about a gross margin expansion of several percentage points whenever we look at our overall insulin business. So this is very significant, but it's going to take time for this to materialize.

One of the things, Seamus, that I'd have you consider on the overall financial benefit of this manufacturing technical agenda -- as Enrique mentioned, we expect to expand margins by several percentage points. To put that into the context we had a $3.5 billion insulins business last year, and we see that business expanding pretty considerably over time. And the other thing that contributes very favorably to the overall financial impact is significant capital avoidance. When we were talking about this having the essential value of a blockbuster, it was the combination of the 2 things -- the reduced costs over time and then significant capital avoidance. Just to put that into perspective, to put in a new insulin plant you're talking multiple hundreds of millions of dollars for that similar kinds of investment, somewhat smaller on the fill-finish side.

To the line of Catherine Arnold from Crédit Suisse. Catherine J. Arnold - Crédit Suisse AG, Research Division: I have a question about Alzheimer's and then I wanted to talk to you about evacetrapib. On Alzheimer's, could you just share if you know the percentage of patients in EXPEDITION that were ApoE4 carriers, and is it in line with the generally quoted sort of incidence of 60%? And does the [indiscernible] study change your probability of success in any way? And then on the evacetrapib, is there a possibility of partnership for this molecule given the large-scale work and expense? And is that a gating factor before starting Phase III? How does it impact your R&D guidance for the longer term?

Great, Catherine, this is Phil. I'll take your first one on Alzheimer's and I'll have Dave Ricks take your second question on evacetrapib. So we have not had any kind of a presentation or publication of baseline characteristics of the patients in the solanezumab studies. The one piece that we have commented on over time is that in the general population there would be roughly about 1/3 mild, 1/3 moderate, 1/3 severe. If you recall, our trials are just in the mild-to-moderate patient population, and we have said that there is a larger percentage of the mild patients as opposed to moderate. But we've not presented other baseline characteristics to date, including the percentage of ApoE4 carrier versus non-carrier. And then, Dave, on the evacetrapib question?

Sure. Catherine, we remain very excited about this program based on the data we released at AHA last year which shows a compelling benefit on both HDL and LDL. As mentioned earlier, we are hoping to start this program very soon. Without commenting specifically on evacetrapib, I can say broadly we always look at our options to maximize the molecule, share risk and bring them forward through the Phase III process with partners or without. And I think that's certainly an option on this program, as well as others, but we have made no specific determinations at this time.

From Cowen, we'll go to the line of Steve Scala.

Two questions. First, apologies if I misunderstood, but the post-2014 guidance, to what years does it apply? It sounds like it does not contemplate what happens in 2017 when Alimta's substance patent expires. And the second question is back on Alzheimer's disease, Merck has said its beta-secretase inhibitor lowers CSF Abeta by more than 90% than a once-daily oral formulation based on a very early study. Can you characterize how yours might compare?

Steve, we'll have Derica take the financial question and then Jan respond on the base inhibitor.

Steve, this is Derica. In regards to the post 2014, we haven't given a specific time frame, but you got to think that we're talking about in that '15, '16, '17 time frame as being in the range of years when we should be able to move back into those levels of profitability. Jan?

Yes, we recently communicated, as you heard, that our new beta-secretase oral inhibitor has entered Phase II. Some data were recently communicated about the effects of this agent on healthy volunteers. And the reduction we reported at the 35-milligram dose was around 60% reduction in the cerebrospinal fluid A-beta. It's not really known currently how much you need to reduce A-beta to have a significant potential effect. In the paper about the mutation in APP at the close to the beta cleavage side, which then has protective components against Alzheimer, dementia and also other aging dementia, the tentative reduction that this mutation caused was around 40% reduction. That had then the protective effect. Then realizing of course that that is present during the whole lifetime while we then are trying to influence this process by treating people later in life. So our molecule is very potent and we are very encouraged of what we have seen so far.

We'll go to the line of Marc Goodman with UBS.

Derica, in the past you've talked about that extra $1 billion of cost savings that you guys were going to get out of the business. And I was curious, your comments about Europe, is this kind of wrapped up in it, or is this an additional type of effort to bring cost down because of European austerity that's really kind of kicked in so much over the past 6 to 12 months? And is there anyway you can help quantify like how much you're talking about taking out of Europe if it is additional? And will we see it in the 2013 numbers, or when will we start to see that kind of kick in? Second question is just from the tofacitinib panel, I was wondering if there was anything that happened or any learnings that you'll have that you can comment on relative to your product. And then in emerging markets, can you talk about any key launches that will occur, whether it's the rest of the year or over the next year in 2013 that will drive emerging markets once again?

Mark, we'll have Derica start off and then go over to Jan for the tofa question. And then we'll congregate here and see who can answer your question on the emerging markets piece. Derica?

Mark, in regards to Europe, just to remind everyone we said that we would take out the $1 billion by the end of '11. And we more than exceeded that goal. So the actions we're currently talking about in Europe are more in response to the evolving environment and portfolio as we've described it. So as we see the austerity measures in Europe and how that market is evolving, as well as when we look at our own portfolio and if it we'd be progressing more towards a specialty-focused portfolio rather than a broad primary care portfolio, we see the changes that Dave and his team have outlined as being essential and mitigating those kinds of risk and addressing those kinds of challenges. In regards to quantification, we haven't put any specific numbers out there at this time.

And real quick on that piece, the $1 billion that I think you may be referring to, Marc, you may be referring to a slide Derica presented last June. We talked about $1 billion of operating improvement. That was actually through '05 to '10. The other $1 billion that was talked about on the call today was the $1 billion that we had talked about removing from our 2011 cost structure, so this would not have been contemplated in that 2011 cost basis. This is an action now that we're talking about in '12 would impact by '13 and beyond. Jan?

We are very keen to apply the comments from the advisory committee for then the Pfizer JAK inhibitor, tofacitinib. The key learnings were, first of all, that the advisory committee felt that this could be a major advance as a class of drugs then as new oral disease-modifying antirheumatic drugs actually than the first one in 10 years. The second thing is that different JAK inhibitors may have different safety profiles in particular. And we know that the Pfizer molecule is more a pan-JAK inhibitor including JAK3, whilst our molecule is selective for JAK1/JAK2. And thirdly, we need now to design the right Phase III trials to then exploit these type of reasonings, both regarding efficacy and safety. And as communicated earlier we anticipate starting those trials before the end of this year or early next year.

And Marc, in terms of the emerging market launches, for sure we'll have continued rollouts of Trajenta. And then I'll follow up off-line with our Emerging Markets business to see if we're missing any major line extensions that can be rolled out during this time frame as well.

From JPMorgan, we'll go to the line of Chris Schott. Christopher Schott - JP Morgan Chase & Co, Research Division: First question, I guess, for Derica and then very much appreciate those long-term margin targets. On those targets though, what gives you the confidence in providing these updates versus just your prior floor estimates? Is this based on some of the pipeline data we've seen so far this year, or as you're thinking of all of done [ph] your expense base? And then the second question is shifting over to the insulin franchise, can you just elaborate a little bit more on the feedback you've had on the Caremark formulary change either from patients or employers using that Caremark formulary? Just I guess on some of the questions really, are you getting any sense that other plans are considering moving maybe to a single insulin for their formularies as well?

Great, Chris. We'll have Derica and Enrique respond, respectively.

Chris, this is Derica. It's a great question. What gives us the confidence is the performance the we're seeing to date. The goals that we outlined wasn't just those minimum financial performance, but we also talked as a part about the -- how we would progress our pipeline. We talked about how would we address our cost structures as we were managing through YZ. And I can sit here today and say along many of those elements, we are actually achieving the mileposts the we laid out. So we absolutely feel confident about staying above the $20 billion in revenue. We took out the additional $1 billion by the end of '11 in our cost structure. And if you look at our pipeline, we have 12 assets in Phase III. More importantly, we also have a Phase II pipeline that's positioned to sustain that same type of output going forward. So when we look at each of the elements of our business in aggregate, we're seeing the pieces of the puzzle come together. And that's also what gave us the confidence even when we talked about capital allocation that we felt comfortable, both management and the board, and beginning to return some of our excess capital back to shareholders through the resumption of our share repurchase program. So we feel very good about where we are. Enrique?

Without commenting about any specific formulary. We do see significant disruption at the patient level. Clearly, diabetes is a complex disease. And while some may think that there is some sort of savings when it comes to the medicine that can be passed to employers, there are significant hidden costs -- and we're planning to study this very, very carefully -- that go beyond the medicine when it comes to the treatment of diabetes. So it is difficult to say where the trends will go. But long term, the more that these get studied, in particular when it comes to patients in late-stage diabetes utilizing insulin, we will see that the other costs completely overburden any type of savings that people believe they may have in the medicine.

From Bank of America, we'll go to the line of Greg Gilbert.

I have a few. First on Alimta. It was good to see the positive Markman ruling. But can you discuss the patent and exclusivity picture for Alimta in key non-U.S. markets and whether anything's changed there from a ruling standpoint? Second is on Effient. It seems that you clearly have a share of voice [ph] opportunity would with Plavix going generic. Can you comment on how access and cost of access is shaping up for next year? And lastly, for Derica, you touched on this in your prior answer. I wanted to know if you could talk about the board and management discussion around resuming the share repurchase and whether there's been a change in how you view that particular mechanism even beyond the current authorization that's left?

We'll have Ilissa handle your first question on the Alimta Markman hearing and then Dave Ricks for Effient and then to Derica for share repurchase. Ilissa?

Yes, Greg, as we mentioned earlier, in the U.S. we had the Markman hearing and had a positive ruling in Lilly's favor, and we are waiting for a trial date to be set. In Europe, a similar patent has been challenged and a ruling was also issued in Lilly's favor in the first instance. This ruling has been appealed, but no date has been set yet for the appeal. There was another company that submitted third-party observations in this pending appeal, but we're still in the very early stages of that.

And the patent date in Europe is slightly different in the U.S. That would go into 2020.

On Effient, Greg, as we see in the Q2 results, we reported very strong sales growth for this product, both in Europe and the U.S. I think your question is really referring to the Plavix exclusivity, and clearly Bristol and Sanofi pulling out of that. We don't see that as a trend changer, in any case for Effient. Effient is used in the cath labs with very sick patients. And the choice-making there really is driven by the clinical benefits. And as you know from the TRITON-TIMI 38 study, we've got a compelling advantage, we believe, over Plavix, generic or branded, in patients who -- particularly those with diabetes, with high-risk cardiovascular disease and in the STEMI population. That's where we're driving share and were seeing that convert into nice sales growth across the globe. Derica?

Greg, quite honestly our capital allocation strategy actually hasn't changed. We've always been very clear that in regards to utilization of our capital, our first protocol was making sure we were properly investing and resourcing the internal opportunities that we had, specifically the pipeline. Our second protocol was then to pursue opportunistic business development, opportunities that were out there that we felt could compliment our existing footprint. In this case, bring in revenue and cash generating opportunities or augment our pipeline. And then at the end of that if we had excess capital, we would look to return that to shareholders. We believe that we've -- we're accomplishing the first 2. We feel very good about where we are with R&D and our resourcing. As it relates to business development you've seen the type of deals we've been active in. We continue to look for in-licensing opportunities. We believe we can still continue to do that while, at the same time, beginning to return some of our excess capital back to shareholders being the resumption of the share repurchase program throughout the end of this year. And obviously, to going beyond this year, it will be a continual discussion we'll have with our board around the timing and the amount of any potential future share repurchase activity.

Since we are a couple of minutes past the top of the hour, we'll go ahead and close the call here. We do hope you found some of the additional commentary that was provided on the post-2014 time frame helpful. We do recognize there are a few of you still left in queue. The IR team will get back to you very shortly, and our team will remain available during the rest of the day for any other questions you may have post today's call. Thank you very much for your interest in Lilly and for spending time with us today. Have a great day.

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