Lilly(Eli) & Company (LLY) — Q1 2018 Earnings Call Transcript

Good morning. Thank you for joining us for Eli Lilly and Company’s first quarter 2018 earnings call. I’m Dave Ricks, Lilly’s Chairman and CEO. Joining me on today’s call are Josh Smiley, our Chief Financial Officer; and Enrique Conterno, the President of Lilly Diabetes and Lilly USA; Dr. Sue Mahony, President of Lilly Oncology; Christi Shaw, President of Lilly Bio-Medicines; and Jeff Simmons, President of our Elanco Animal Health. We’re also joined by Kristina Wright, Jim Heaney, Kevin Hern and Phil Johnson of the Investor Relations team. We also joined for the first time by Dan Skovronsky, our incoming President of Lilly Research Laboratories. Dan is succeeding Dr. Jan Lundberg who retires at the end of May. Jan has been key to our success as we navigated the years and returned to growth for a series of successful products. We want to thank Jan for all his contributions to our company. 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 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 only. It is not intended to be promotional and is not sufficient for prescribing decisions. 2018 is off to a good start. With first quarter revenue growth of 9%, which we leveraged into a 29% non-GAAP operating income growth and 37% non-GAAP EPS growth. New pharmaceutical products continue to be the drivers of our worldwide revenue growth, led by Trulicity, Basaglar, Jardiance and Taltz, with growth in both US and international markets where launches continue to scale up. New product growth more than offset revenue declines resulting from loss of exclusivity on a number of established products. In addition, we continue to expand our margins this quarter. Excluding the effect of foreign exchange, our international inventory sold non-GAAP gross margin as a percent of revenue increased by nearly 70 basis points over Q1 of 2017. And non-GAAP operating income as a percent of revenue increased by 775 basis points to 30.4%. Pipeline progress this quarter also included approval and launch of an additional indication and first line metastatic breast cancer for Verzenio based on the MONARCH 3 data. Positive Phase 3 studies of Taltz for ankylosing spondylitis, the positive Phase 3 study for Cyramza at high AFP patients with second line liver cancer. And the initiation of a Phase 3 study for Trulicity in 3 mg and 4.5 mg doses. While we are pleased that the FDA Arthritis Advisory Committee supported the efficacy of both the 2-mg and 4-mg doses of baricitinib in RA, we are disappointed that the committee did not recommend approval of the 4-mg dose. We are confident in the benefit-risk profile of both baricitinib 2-mg and 4-mg for the treatment of patients with RA, supported by the clinical data generated to date, and by the experience in more than 40 countries in which both doses are approved and available. We'll continue to work with the FDA on this important application. In terms of capital deployment, we announced a strategic collaboration with Sigilon to develop encapsulated cell therapies for the treatment of type 1 diabetes. We purchased $1.1 billion of stock and returned nearly $600 million via the dividend. And we are making expected progress on Elanco's strategic review and still anticipate sharing our conclusions on our Q2 earnings call this July. Slide 5 contains more detail on key events since our January earnings call. Now I would like to turn the call over to Joshua to review our Q1 results and provide an update on our financial guidance for 2018.

Thanks Dave. Slide 6 summarizes our presentation of GAAP results and non-GAAP measures. While Slide 7 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-order GAAP results. Looking at the non-GAAP measures on slide 8, you'll see the revenue increase of 9% that Dave mentioned earlier. Gross margin as a percent of revenue decreased to 75.1%. This decrease was due to the effective foreign exchange rates on international inventory sold. Excluding this FX effect, gross margin as a percent of revenue actually increased roughly 70 basis points, driven by higher realized prices and manufacturing efficiencies, partially offset by product mix. Total operating expense decreased 5% with marketing, selling and administrative expense decreasing 4% and R&D expense decreasing 6%. Total operating expenses as a percent of revenue declined by 710 basis points compared to Q1, 2017. This significant improvement reflects our continued efforts to reduce our cost structure and increase our margins, accelerated by the restructuring actions we took late last year. Other income and expense with income of $67.5 million this quarter compared to income of $78.3 million in last year's quarter. Our tax rate was 15.9%, a decrease of 530 basis points compared with the same quarter last year, driven primarily by the impact of US tax reform. At the bottom line, net income increased 35%, while earnings per share increased slightly faster at 37% due to a reduction in shares outstanding from shares repurchase. We achieved significant earnings growth by delivering high single digits revenue growth while significantly reducing our operating expenses, creating positive leverage again this quarter. Slide 9 provides a reconciliation between reported and non-GAAP EPS. You'll find additional details on these adjustments on slide 20. So moving to Slide 10, let's take a look at the effective price rate and volume on revenue growth. This quarter the effective foreign exchange provided a four percentage point benefit, excluding this our worldwide revenue growth on a performance basis was 5%, driven by both price and volume. For a fifth straight quarter, our Human Pharma business drove volume growth in each major geography. US Pharma revenue increased 10% driven by price to a lesser extent volume. Our diabetes portfolio led by Trulicity, Basaglar, and Jardiance was the primary driver of volume growth with growth of 30%, offset by the losses of exclusivity for Strattera, Effient, and Axiron and by a decline in volume for Cialis due to the entry of generic erectile dysfunction products. For US Pharma, it's also worth noting that when excluding LOEs, the rest of our US products grew by approximately 20% in total. US price growth in the quarter was favorably impacted by an adjustment for rebates and discounts, primarily related to lower Medicaid utilization than anticipated across the portfolio. While Medicaid remains a significant segment of our US business, we estimate that the growth we experienced in this segment in the past several years has plateaued in recent months. Moving to Europe. We've been pleased with the overall performance of our new product portfolio across the region. Pharma revenue grew 2% excluding FX, driven entirely by volume despite the loss of exclusivity for Cialis. Excluding the impact of the Cialis LOE, volume grew nearly 17%. This volume growth was led by Trulicity, Olumiant, Taltz, Lartruvo, Jardiance and Basaglar. In Japan, pharma revenue increased 1% excluding FX, driven by volume of new products namely Trulicity, Taltz, and Jardiance, with a partial offset in price from the impact of the biannual price cuts. Our pharma revenue in the rest of the world increased 4% on a performance basis this quarter, led by volume growth of Trulicity, Humalog and Forteo. Turning to animal health. As we noted during our Q4 earnings call, we've been expecting to return to top-line growth in the second half of this year, and our Q1 results are on track with this expectation. Excluding FX, Elanco revenue declined 4% this quarter. I highlight, however, that revenue in Q1 actually increased 1% in performance terms when excluding the impact of products we've made the strategic decision to exit. These strategic exits are the contract manufacturing activity that came with the acquisition of BIUS vaccines, as well as two terminated legacy US distribution agreements and Posilac. You'll see that we provided a backup slide quantifying the drivers of our animal health revenue growth excluding those strategic exits. We're encouraged with the revenue trends we're seeing in our ongoing or core business. New products contributed $62 million in Q1, driven primarily by Credelio, INTERCEPTOR PLUS and Galliprant. These new products drove our core companion animal portfolio up 10% in the quarter. Our core food animal business decreased 4%, primarily due to the U.S. buying patterns in Q1 of 2017, as well as continued ractopamine competition. Importantly though, our poultry business continues to deliver strong growth. In Q1, poultry products grew 11%, well ahead of the market and we expect to see full-year growth for our overall core food animal portfolio. Lastly, I would point out this is our second consecutive quarter with overall price growth, which is a sign of solid foundations in the industry. We expect this price growth to continue through 2018. We are monitoring the trade situation closely and while we do not see immediate impacts to our animal health business, we are cautious about the broader economic impact if export activity declines. Hopefully, this provides you with useful insights into our animal health revenue growth and Jeff can address questions you may have in the Q&A session. So now let's take a look at the drivers of our worldwide volume growth on Slide 11.

Thanks, Joshua. Slide 15 shows select NME and NILEX as of April 20th. Movement since our last earnings call includes the approval of baricitinib for the first line treatment of metastatic breast cancer in the US. A Phase 3 starts for Trulicity in 3 mg and 4.5 mg doses. A Phase 1 starts for the IL-23 CGRP biospecific antibody for immunology. While we have attrition of the Phase 2 base inhibitor molecule as monotherapy, the trial in combination with the N3pG antibody continues, and we look forward to seeing results in this novel trial design. We also discontinued our abemaciclib pancreatic cancer study. You'll see we've combined our NME and NILEX pipeline into one view. In terms of NILEX, we have a robust set of lifecycle opportunities for recently launched products, which we expect will continue to bolster the growth prospects for important brands like Trulicity, Taltz, Verzenio, Olumiant, and Jardiance. These products are well positioned in some of the largest and fastest-growing categories in our areas of high unmet medical need. Key NILEX opportunities include AxSpA for Taltz, atopic dermatitis for Olumiant, adjuvant breast cancer for Verzenio, the 3 mg and 4.5 mg dose study for Trulicity, and heart failure for Jardiance, which is in collaboration with Boehringer Ingelheim. On Slide 16, we highlight expected key events for 2018. In addition to noting the US approval of Verzenio for first line metastatic breast cancer, we've indicated the data disclosure of the keynote 189 study at AACR which showed that Alimta, in combination with Keytruda plus platinum chemotherapy reduced the risk of death by half compared with chemotherapy alone as a first-line treatment in metastatic, non-squamous, non-small cell lung cancer patients. The overall survival benefit was robust regardless of PDL-1 expression status. We also announced last week that the Cyramza Phase 3 study in bladder cancer did not reach statistical significance in the secondary endpoint of overall survival. There are many events to look forward to in 2018, notably the expected regulatory action for US baricitinib, galcanezumab, Verzenio, and Alimta. We also look forward to the data readout of the second Phase 3 study of Taltz in ankylosing spondylitis and the initiation of several phase 3 studies including our anti IL-23 for ramucirumab for psoriasis and ulcerative colitis. Before we go to the Q&A session, let me briefly sum up the progress we've made this quarter.

Thank you, Dave. We would like to take questions from as many callers as possible during the Q&A session. So we do ask that you limit your questions to one or to a single two-part question. Lia, you can provide the instructions for the Q&A session and then we're ready for the first caller.

Thanks. Good morning, team. First, Dan, congrats to you in your new role. Dave, can you talk about the use of baricitinib outside the US in terms of the mix of strengths and any post-marketing safety data that you have to bolster your case with the FDA? And secondly on the subject of drug pricing in the US. What types of changes are you expecting the administration to put forth? You can be specific as you'd like but at least conceptually would love your opinion and how do you think Lilly is positioned relative to those potential changes? Thanks.

Great, thank you for the questions. We are actually going to have Christi Shaw, President of Lilly Bio-Medicines, take your question on the use of the two different doses outside the US and any outside US data that may be helpful as we present our case to the FDA. And then Dave, you'll have the question on drug pricing. Christi?

So outside the US, over 40 countries have both the 2 mg and 4 mg approved. The majority of use is in the 4 mg, with remarkable efficacy, really patients getting their lives back and the safety continues to hold up with no new signals that are different from what we submitted to the FDA. The ADCOM's unanimous vote on the efficacy of the 4 mg is important to patients in the US. So we want both the 2 and 4 mg approved in the US for those patients.

Yes. Thanks, Greg. Obviously, a big topic, drug pricing. I mean it's hard to speculate exactly what the administration will say or do, but I think I can comment on what pharma's position has been and Lilly's as well, which is as it relates to leading pain at the pharmacy counter and reducing the burden of list prices that consumers pay at the counter. We've long been proponents of rebate pass-through, both in commercial plans and Part D. I think the most important action that the administration could take would be to create either set of experiments or mandate a rebate pass-through for patients in the Part D program. This would immediately impact seniors' cash flow and pocketbook, as well as I think help to normalize the incentives on gross to net spread. So I would be personally surprised if that wasn't part of the commentary, and that's something we've long stood for. So that would be a positive development from our perspective. The HHS Secretary has commented on Part B and the lack of market mechanisms there. I would expect that to be a topic of discussion. And then we do see increased desire under this administration to approve waivers for Medicaid, giving states flexibility in a variety of forms to manage their own programs. I would expect to see more of that. Finally, we worked closely with this administration on the trade agenda to balance the incentives that foreign markets have to suppress drug pricing, which primarily come from exports from the US. We've had some early signs of success there with the Korea free trade agreement. We'll keep on that. I think long term, the US needs to use its trading power to help equalize the sharing of the R&D expense that it takes to create the new innovations, which are becoming even more frequent in the industry. So we watch that carefully and continue to advocate for pro-innovation and pro-patient choice, as well as policies that can make sure that this innovation, this industry can continue to innovate and prosper for years to come. All those topics are front of mind and will keep working out, Greg.