Lilly(Eli) & Company (LLY) — Q1 2016 Earnings Call Transcript

Good morning everyone, and thanks for joining us for Eli Lilly's & Co. first quarter 2016 earnings call. I'm John Lechleiter, Lilly's Chairman, President and CEO. Joining me on today's call, and some from remote locations, are Derica Rice, our CFO; Dr. Jan Lundberg, President of Lilly Research Labs; Dr. Sue Mahony, President of Lilly Oncology; Enrique Conterno, President of Lilly Diabetes; Dave Ricks, who is President of Lilly Bio-Medicines; Chito Zulueta, President of Emerging Markets; Jeff Simmons, President of Elanco Animal Health; and Ilissa Rassner, Brad Robling and Phil Johnson of 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 SEC. 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 it's not sufficient for prescribing decisions. Successful execution of our innovation-based strategy has put Lilly on a positive trajectory that became most evident in 2014 and 2015, particularly with regard to sustaining the flow of innovation. Building on that positive momentum, 2016 is off to a good start. Let me begin our call today by recapping progress we've made on our strategic objectives since our last earnings call in January. Slide four should be familiar to you, depicting the four strategic objectives for our post-patent expiration period that we first laid out in January of 2015. On our first strategic objective, grow revenue, in the first quarter we grew revenue 8% on a constant currency for-performance basis. Nearly all of this performance growth was driven by volume. And in total, our new products, Trulicity, Cyramza, Jardiance, Basaglar and Portrazza drove five percentage points of this volume growth. Starting with today's call, we'll include in our earnings calls an update on the performance of new products for their first three years on the market. In addition, you'll see that we've included additional product information in our supplementary slides. Of course, we welcome your feedback on this approach. Turning to our next strategic objective, expand margins, our non-GAAP OpEx as a percent of revenue was up slightly compared to the first quarter 2015 due to the baricitinib milestone payments paid to Incyte, which totaled $55 million in the quarter. Excluding these payments, our OpEx percent was flat. We're on track to achieve our full-year guidance, which, at the midpoint of our ranges, implies an improvement of 200 to 250 basis points in OpEx as a percent of revenue, even including the baricitinib milestones. Under the heading of sustaining the flow of innovation, I've highlighted a few examples of the continued success we're experiencing. Along with AstraZeneca, we announced that our BACE inhibitor advanced into the Phase 3 portion of the AMARANTH study in early Alzheimer's disease. Taltz, discovered here at Lilly, was approved in the U.S. for moderate to severe plaque psoriasis, and initial shipments left our warehouse earlier this month. And just yesterday we received European approval. Also, olaratumab, a monoclonal antibody from our ImClone acquisition, has now been submitted to U.S. and European regulatory authorities for soft-tissue sarcoma. During this call, we'll provide a more complete list of the pipeline progress we've achieved over the last three months. Finally, on our strategic objective, deploy capital to create value, during the quarter we returned over $800 million to shareholders through our quarterly dividend and ongoing share repurchase plan. On the business development front, we completed a number of smaller deals including the Aratana deal, to bolster our companion animal business, and we continue to actively pursue external opportunities to enhance our future growth projects. In summary, I'm confident that we're on track to achieve each of our strategic objectives and assure you that their achievement remains a top priority of our entire management team. Now, let's move on to a review of the key events that occurred since our last earnings call. On the commercial front, in Europe following European Commission approval in late January, we launched Cyramza for second line, non-small-cell lung cancer and for second line metastatic colorectal cancer. We also received European Commission approval for, and earlier this month launched, Portrazza for first-line EGFR expressing squamous non-small-cell lung cancer. As I just mentioned, earlier this month we launched Taltz in the U.S. for the treatment of moderate to severe plaque psoriasis following FDA approval in the first quarter. And also here in the U.S., we launched the Humulin Regular U-500 KwikPen. It was a busy three months on the regulatory front as well. In addition to the U.S. and European approvals of Taltz and the European approval of Portrazza, in Japan we submitted baricitinib for the treatment of moderately to severely active rheumatoid arthritis. This represents an outstanding achievement, as regulatory submissions in the U.S., Europe and Japan occurred within a span of less than 40 working days. This also demonstrates that our focus on development execution is paying off. As an update to the submission announcement we made with Incyte, here in the U.S., the FDA has now accepted our submission for baricitinib, and we look forward to regulatory action in early 2017. As I mentioned earlier in both the U.S. and Europe, we submitted olaratumab for the treatment of soft tissue sarcoma. In collaboration with Boehringer Ingelheim, we submitted the once-daily combination tablet of empagliflozin and metformin XR to the FDA. And on the Animal Health front we received U.S. approval for Imrestor, a non-antibiotic Animal Health product for reduction of the incidents of clinical mastitis in dairy cows. Imrestor is a protein and a first-of-its-kind therapy that helps support the natural function of a dairy cow's immune system during the critical time around calving, when the risk for mastitis is heightened. On the clinical front, we announced a change to the EXPEDITION3 trial, solanezumab, in patients with mild Alzheimer's disease, making the ADAS-Cog14 cognitive scale the sole primary endpoint. Functional outcomes will be evaluated as key secondary endpoints. Along with AstraZeneca, we announced that AMARANTH, a Phase 2/3 study of AZD3293, an oral beta secretase cleaving enzyme or BACE inhibitor, currently in development as a potential treatment for early Alzheimer's disease, will move into the Phase 3 portion of this Phase 2/3 seamless trial. This movement into Phase 3 triggers a milestone payment from Lilly to AstraZeneca which will result in a second quarter pre-tax charge of $100 million to Lilly's GAAP and non-GAAP research and development expense. As mentioned at our December 8 Investment Community Meeting, the transition of AMARANTH into Phase 3 will also trigger the start of a second Phase 3 study with AZD3293. That study, called DAYBREAK, will focus on patients with mild Alzheimer's disease and is scheduled to begin enrolling patients in the third quarter this year. Similar to the EXPEDITION3 trial of solanezumab, also in patients with mild Alzheimer's disease, DAYBREAK will use a single cognitive primary endpoint. In this case, ADAS-Cog13. Further, the AMARANTH trial in patients with early Alzheimer's disease will also be changed to use ADAS-Cog13 as a single primary endpoint. So we're consistently moving to a single cognitive primary endpoint across our trials in the early stages of Alzheimer's disease. And following the successful results of the EMPA-REG OUTCOME trial along with Boehringer Ingelheim, we announced plans to conduct two outcome trials investigating Jardiance for the treatment of people with chronic heart failure. The trials are expected to begin within the next 12 months and are planned to enroll people with chronic heart failure both with and without type 2 diabetes. On the business development front, we modified our existing baricitinib agreement to provide Incyte with the right to develop ruxolitinib or Jakafi for graft versus host disease. We retain rights to develop baricitinib for this indication. As part of this deal, Lilly will receive a $35 million upfront payment that will be recognized as other income in the second quarter both in our GAAP and non-GAAP results. On the Animal Health side of the business, yesterday we announced that we licensed rights to Aratana's Galliprant, an FDA approved therapeutic for the control of pain and inflammation associated with osteoarthritis in dogs. This deal includes an upfront payment of $45 million plus additional milestone and royalty payments upon meeting certain development, regulatory and sales milestones. Galliprant will support the growth of our companion animal therapeutic segment, one of the key growth engines for our Animal Health business. In other news, the UK High Court decided the Alimta vitamin regimen patent would not presently be infringed by Actavis marketing pemetrexed trometamol in the UK, France, Italy and Spain with instructions to dilute the product only with dextrose solution. We plan to appeal this decision to the UK Court of Appeal. Finally, in the first quarter, we repurchased $300 million of stock, leaving $2.65 billion remaining on our $5 billion plan. During the quarter, we also distributed over $500 million to shareholders via our dividend. We remain committed to providing a robust dividend and to returning excess cash to shareholders. And now, I'll turn the call over to Phil for a discussion of our financial performance for the quarter.

Thanks, John. Slide seven summarizes our presentation of GAAP results and non-GAAP measures, while slide eight provides a summary of our GAAP results. I'll focus my comments on our non-GAAP adjusted measures to provide insights into the underlying trends in our business, so please refer to today's earnings press release for a detailed description of the year-on-year changes in our first quarter GAAP results. Of note, you will see in our GAAP other income and expense we have recognized a pre-tax charge of $204 million equivalent to $0.19 per share related to the significant deterioration of the Venezuelan economy and its impact on the bolivar. This charge represents the effect of revaluing our bolivar-denominated assets and liabilities at a rate of 275. Moving to non-GAAP measures on slide nine, you can see that Q1 2016 revenue increased 5% compared to Q1 2015 reaching $4.865 billion. Foreign exchange rates continue to provide a top line headwind. Excluding FX, our Q1 revenue increased 8% driven by higher volume from Trulicity, Cyramza, Humalog, Jardiance, and Trajenta among others, as well as by the takeback of North American rights for Erbitux. The effective price was 1%. Gross margin as a percent of revenue decreased 1.9 percentage points to 76.3%. This decrease was primarily driven by the effect of foreign exchange rates on international inventory sold. This effect resulted in a benefit both this quarter and last year's quarter, but the benefit this quarter was substantially smaller than the benefit realized last year. Excluding this FX effect, our gross margin percent decreased by 40 basis points going from 75.3% in last year's quarter to 74.9% this quarter, driven primarily by product mix and the timing of production. Total operating expense, defined as the sum of R&D and SG&A, increased by 7% compared to Q1 of 2015. Breaking this into its component parts, marketing, selling and administrative expenses declined 1% while R&D increased 17%. The reduction in marketing, selling and administrative expenses was due to the favorable impact of foreign exchange rates and lower litigation expenses, partially offset by expenses to support new products. The increase in R&D expense was driven primarily by higher late-stage clinical development costs, including $55 million in milestone payments to Incyte triggered by regulatory submissions for baricitinib in the U.S. and Europe. These milestone payments added over 5 percentage points to R&D expense growth and over 2 percentage points to total operating expense growth. Excluding these milestone payments, total operating expenses increased about 4.5% which was slightly slower than revenue growth. Other income and expense was income of $55 million this quarter and this represents a reduction of $38 million compared to Q1 2015, primarily due to lower net gains on investments. Our tax rate was 17.9%, a decrease of 5 percentage points compared to the same quarter last year. This decrease is due to a net discrete tax benefit of roughly $50 million this quarter and the benefit of certain U.S. tax provisions including the R&D tax credit that were in force during this year's quarter but had lapsed during last year's quarter. This was partially offset by a higher percentage of earnings in higher-tax jurisdictions this year compared to last year. At the bottom line, net income decreased 4% and earnings per share decreased 5%. While I'll cover the FX effect on our income statement in a subsequent slide, I would highlight that when excluding the effect of FX, non-GAAP net income and EPS actually increased 5% this quarter. Slide 10 provides a reconciliation between reported and non-GAAP EPS and you'll find additional details on these adjustments on slide 23.

Thanks, Phil. While Phil quantified the contribution to our worldwide volume growth coming from new products, I'd like to share some color behind the numbers. While it's too early to say much about Portrazza, I will provide a brief update on the other four new products: Trulicity, Cyramza, Jardiance, and Basaglar. During the Q&A session, Sue and Enrique will be happy to provide more details. As you can see on the graph on slide 13, our new products generated $325 million in revenue this quarter, led by Trulicity and Cyramza. This represents about 7% of our total worldwide revenue. After limited access for Trulicity in 2015 following its approval in late 2014, sales have accelerated this year. Both commercial and Part D access are now in excess of 70%, and Trulicity's total prescription share of the GLP-1 class is now 17% and growing, making Trulicity the second most prescribed GLP-1 brand. During the quarter, the class continued to grow at over 30% and we see continued upside from here. For Cyramza, this product continues to grow, driven largely by increasing sales in Japan and Europe as sales growth in the U.S. has slowed due in part to the competition from the immuno-oncology agents. Japan now makes up nearly 30% of our Cyramza global sales. We've had a strong launch in gastric cancer and we look forward to regulatory action in Japan later this year on our submissions for non-small-cell lung cancer and metastatic colorectal cancer, while in Europe, we just launched those two indications during the first quarter. With Jardiance, we've seen a substantial increase in our new-to-brand share of market with both endocrinologists and primary care physicians. In total, our new-to-brand share approached 30% in Q1, nearly double what it was a year ago. The overall class continues to experience significant growth with class total prescription volume up about 45% in the first quarter. We continue to see regulatory approval of EMPA-REG OUTCOME data as a catalyst for growth for both the class and for Jardiance. The other catalyst for growth is inclusion of these data in treatment guidelines. In general, we expect guideline updates to come after regulators implement label updates and we are pleased with the first treatment guideline update issued in Canada during Q1. Basaglar is early in its global launch cycle and is now marketed in a number of European countries, Japan, and Canada. Early share of the total basal insulin market varies greatly by country. To provide an idea of the differences in rates of adoption, Basaglar's share of market is 17% in Slovakia, 11% in Japan and 2% in Germany. We look forward to launching Basaglar in the U.S. in mid-December this year. Finally, our newest product, Portrazza, launched in the U.S. in December and in Europe earlier this month.

Moving to slide 14, you'll see the effect of changes in foreign exchange rates on our Q1 2016 results. As mentioned earlier, this quarter, FX was a top line headwind reducing revenues in U.S. dollars by over 3 percentage points. Excluding FX, revenue grew 8%. In performance terms, growth in non-GAAP cost of sales at 12% outpaced revenue growth due to the negative effect of product mix and to lower production volume. Excluding FX, non-GAAP operating expense growth also slightly outpaced revenue growth due to the baricitinib milestone payments. Excluding these payments, non-GAAP operating expenses grew more slowly than revenue. Excluding FX, non-GAAP operating income increased 1% while a lower tax rate led to a 5% increase in non-GAAP EPS.

Moving on to our pipeline update, slide 15 shows our pipeline as of April 19. Changes since our last earnings call are highlighted with green arrows showing progression and red arrows showing movement out of the portfolio. In terms of advancement, you'll see that Taltz was approved by the U.S. FDA and by the European commission for psoriasis. Olaratumab was submitted in the U.S. and Europe. The BACE inhibitor with AstraZeneca successfully passed its safety assessment and advanced into Phase 3. And two earlier-stage molecules advanced; our Notch inhibitor for cancer moved into Phase 2 and a dyslipidemia molecule moved into Phase 1. Since our last update, we also terminated development of three Phase 2 molecules and a Phase 1 molecule for diabetic nephropathy.

Slide 16 shows select new indications and line extensions. You'll see the advancement of the empagliflozin/metformin XR combination tablet into regulatory review as well as the initiation of Phase 2 work for baricitinib in both atopic dermatitis and lupus. Turning to slide 17, let's recap the progress we've made on the key events we projected for 2016. Since our last call, we've added green checkmarks for the transition of the BACE inhibitor for early Alzheimer's disease from phase 2 to Phase 3. A number of regulatory submissions including U.S. and European submissions of olaratumab, Japanese submission of baricitinib and U.S submission of Empa+Met XR, and regulatory approvals for Portrazza in Europe, and Taltz in the U.S. and Europe. We're off to a strong start this year and we look forward to sustaining this momentum throughout the remainder of the year and into the years to come.

Now turning to our 2016 financial guidance, the first thing you may notice on slide 18 is that there is a lot of yellow highlighting changes from our last call. For our non-GAAP guidance, what this really represents, however, is just two changes. First, we lowered our full-year non-GAAP tax rate and raised our non-GAAP EPS range by a nickel to reflect a discrete tax benefit recognized this quarter. Second, we've updated our line item guidance for revenue, gross margin percent, SG&A and R&D to reflect recent foreign exchange movements. At the bottom of the slide, you'll see the major foreign exchange rates used for our revised guidance. We've also updated our GAAP guidance for other income and EPS to reflect the Venezuela charge Phil mentioned earlier, as well as charges related to the closure of a manufacturing facility and Novartis Animal Health integration costs. It's important to point out that our outlook for the underlying fundamentals of our business in 2016 has not changed since our last update in late January. To illustrate this point, let's look at an updated version of a slide we showed you when we provided our initial 2016 guidance in early January. You may recall that the version of slide 19 we showed in early January highlighted our expectation for non-GAAP EPS growth of roughly 15%, excluding the effects of foreign exchange. As you can see, we continue to expect mid-teens non-GAAP EPS growth on this same basis. As I mentioned earlier, we continue to expect robust operational growth and non-GAAP EPS driven by positive leverage as revenue growth exceeds operating expense growth. This reflects our commitment to reduce operating expenses as a percent of revenue and expand margin.

In summary, we're off to a good start to the year. Excluding FX, we drove revenue growth of 8%, with growing contributions from our recently launched products, which this quarter drove 5 percentage points of our growth. We're pleased to add Taltz to this group beginning in the second quarter. We have strong momentum behind our innovation-based strategy. Yet again, in Q1 we made significant progress advancing our pipeline. Among many others, key milestones included the approval and launch of Taltz for psoriasis, the submission of olaratumab for soft tissue sarcoma, and the transition of our BACE inhibitor for early Alzheimer's disease into Phase 3 testing. And as John mentioned when he kicked off the call, we continue to make steady progress against each of our strategic objectives: thriving revenue growth, expanding margins, sustaining the flow of innovation and deploying capital to create value. Continued execution of this strategy should position us to make major contributions to medical progress and create value for shareholders. This concludes our prepared remarks. I'll now turn the call over to Phil to moderate the Q&A session.

Great, thanks, Derica. As we have on most recent calls, if you would do us a favor and your colleagues that are going to be asking questions after you, of limiting your questions to two, or a single two-part question, that would be very much appreciated. Dave, if you could give the instructions for the Q&A session and then go to the first caller please.

Thank you. First, regarding solanezumab, how would you describe your interaction with regulators concerning the decision to adjust the endpoint? Secondly, can you provide an update on abemaciclib, including what you expect to learn and the timeline for this year? Additionally, what are your updated thoughts on its positioning and differentiation? Thank you.

Sure. Yeah. As we said in the March press release, we have made this change and it's really a decision of the sponsor. We inform regulators but don't actively seek a formal approval step. That's really in the category of a pre-submission or submission meeting. FDA and other regulators have been consistent over the last four or five years that they would like to see co-primaries in these studies. However, I think Lilly's belief, and I don't think we're alone in the field, is that the field has moved, and that both detecting changes and function in these early patients, as well as maybe the utility of the scales we're using, is more questionable than before. However, cognition is clearly something that can be detected easily. As you know, we've moved cognition to the key secondary endpoint – or function, rather, so that we'll continue to measure this and if we hit statistical significance on that as a key secondary, we feel confident that this is not very different in the scientific sense from dual primaries. And I think it does allow us some additional degrees of freedom in submission to look at two different ways to measure function in early Alzheimer's patients.

And Jan here. I can add that we will give FDA a robust analysis of the overall solanezumab's effect on cognition as well as function, including also the analysis of caregiver burden and various biomarkers including imaging of amyloid and tau as well then as safety, the way the microhemorrhage and edema, then detection using MRI. So I think we will have a comprehensive program.

Okay. With regards to the question on abemaciclib, we continue to believe that we could have a best-in-class CDK4/6 inhibitor, based on the differential potency of CDK4 and CDK6 based on the ability to continuously dose this agent and on the robust single-agent activity that we have seen. We have submitted the interim data for MONARCH 1, which is the single-agent Phase 2 single-arm study. We've submitted that to ASCO and we have a presentation at ASCO on the Friday. That is based on the eighth-month interim analysis. We hope to have the final data before ASCO and to include that data in the presentation. Additionally, as you're aware, we have two Phase 3 trials ongoing, MONARCH 2 and MONARCH 3. The final data on those studies should be next year, although we do have interims planned for this year, and they are based on events.

Thanks.

Great, Gregg. Thank you for the questions. Dave, if you'll take the first question on regulatory interactions for solanezumab, and Jan, feel free to complement that answer if you'd like. And then Sue, if you'll give the update on what we expect for the rest of the year for abemaciclib and how we see this one fitting into the CDK4/CDK6 landscape. Dave?

Sure. Yeah. As we said in the March press release, we have made this change and it's really a decision of the sponsor. We inform regulators but don't actively seek a formal approval step. That's really in the category of a pre-submission or submission meeting. FDA and other regulators have been consistent over the last four or five years that they would like to see co-primaries in these studies. However, I think Lilly's belief, and I don't think we're alone in the field, is that the field has moved, and that both detecting changes and function in these early patients, as well as maybe the utility of the scales we're using, is more questionable than before. However, cognition is clearly something that can be detected easily. As you know, we've moved cognition to the key secondary endpoint – or function, rather, so that we'll continue to measure this and if we hit statistical significance on that as a key secondary, we feel confident that this is not very different in the scientific sense from dual primaries. And I think it does allow us some additional degrees of freedom in submission to look at two different ways to measure function in early Alzheimer's patients.

And Jan here. I can add that we will give FDA a robust analysis of the overall solanezumab's effect on cognition as well as function, including also the analysis of caregiver burden and various biomarkers including imaging of amyloid and tau as well then as safety, the way the microhemorrhage and edema, then detection using MRI. So I think we will have a comprehensive program.

Okay. With regards to the question on abemaciclib, we continue to believe that we could have a best-in-class CDK4/6 inhibitor, based on the differential potency of CDK4 and CDK6 based on the ability to continuously dose this agent and on the robust single-agent activity that we have seen. We have submitted the interim data for MONARCH 1, which is the single-agent Phase 2 single-arm study. We've submitted that to ASCO and we have a presentation at ASCO on the Friday. That is based on the eighth-month interim analysis. We hope to have the final data before ASCO and to include that data in the presentation. Additionally, as you're aware, we have two Phase 3 trials ongoing, MONARCH 2 and MONARCH 3. The final data on those studies should be next year, although we do have interims planned for this year, and they are based on events.

Thanks.

Great, Gregg. Thank you for the questions. Dave, if you'll take the first question on regulatory interactions for solanezumab, and Jan, feel free to complement that answer if you'd like. And then Sue, if you'll give the update on what we expect for the rest of the year for abemaciclib and how we see this one fitting in to the CDK4/CDK6 landscape. Dave?