Lilly(Eli) & Company (LLY) — Q2 2018 Earnings Call Transcript

Good morning. Thank you for joining us for Eli Lilly and Company’s Q2 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; Dr. Dan Skovronsky, President of Lilly Research Labs; Enrique Conterno, President of Lilly Diabetes and Lilly USA; Dr. Sue Mahony, President of Lilly Oncology; Jeff Simmons, President of Elanco Animal Health; and unfortunately, Christi Shaw, our President of Lilly Bio-Medicines, is ill and won’t be joining us today. This will be the last earnings call for Sue Mahony, President of Lilly Oncology, who will retire at the end of August. I want to thank Sue for her leadership over the past 18 years at the company and for her inspiring passion for helping patients. During this 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 SEC. We continue the strong start to 2018 with the second quarter revenue growth of 9%, non-GAAP operating income growth of 28%, and non-GAAP EPS growth of 35%. New pharmaceutical products continue to be the driver of our worldwide revenue growth, led by Trulicity, Basaglar, Taltz, and Verzenio. We continue to expand margins this quarter. Excluding the effect of FX on international inventories sold, non-GAAP gross margin as a percent of revenue increased by 130 basis points over Q2 2017, and non-GAAP operating income, as a percent of revenue increased by nearly 600 basis points to 30.6%. We made significant progress with the pipeline, including the approval and launch of Olumiant in the U.S., FDA and EMA submissions of Nasal Glucagon, as well as positive Phase 3 read-outs for galcanezumab and episodic cluster headache, Taltz and ankylosing spondylitis, also known as radiographic axSpA, and tanezumab in OA pain in collaboration with Pfizer. In terms of capital deployment, we completed the acquisition of ARMO BioSciences, which added pegilodecakin to our Phase 3 portfolio. We returned nearly $600 million via the dividend. And we repurchased $950 million of stock, which completed our previous $5 million share repurchase program. We authorized a new $8 billion share repurchase program. And as reflected in the press release we released this morning, we concluded the review of our strategic alternatives for our Elanco Animal business and intend to establish Elanco as an independent publicly traded company via an IPO and subsequent separation. Based on this review, we concluded that after-tax value for Lilly’s shareholders would be maximized by pursuing an IPO and subsequent separation of Elanco. We believe independence will allow Elanco to efficiently deploy its resources to those growth opportunities that best serve its customers. This will also allow Lilly even greater focus on the human pharmaceutical business to pursue our purpose of creating life-changing medicines for patients. Execution of the IPO is dependent upon and subject to a number of factors and uncertainties, including business and market conditions.

Thanks Dave. Slide 8 summarizes our presentation of GAAP results and non-GAAP measures. While Slide 9 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. Looking at the non-GAAP measures on Slide 10, you'll see the revenue increase of 9% that Dave mentioned earlier. Gross margin as a percent of revenue decreased to 76.1%. This decrease was due to the effective foreign exchange rates on international inventories sold. Excluding this FX effect, gross margin as a percent of revenue actually increased 130 basis points, primarily driven by manufacturing efficiencies, partially offset by the timing of manufacturing production. Total operating expense decreased 1% with marketing, selling, and administrative expense decreasing 4%, offset in part by an increase to R&D expense of 5%. Total operating income increased 28% compared to Q2 2017, which put our operating margin at 29.1% for the quarter. Our tax rate was 17%, a decrease of 470 basis points, compared with the same quarter last year, driven primarily by the impact of U.S. tax reform. At the bottom line, net income increased 31%, while earnings per share increased slightly faster at 35%, due to a reduction in shares outstanding from shares repurchased. We achieved significant earnings growth by delivering high-single-digit revenue growth, while reducing our operating expenses, significantly improving profitability again this quarter.

Moving on to Slide 6 and 7, you will see more details on key events since our April earnings call, but now let me turn it over to Josh to review our Q2 results and to provide an update on our financial guidance for 2018.

Moving to Slide 18, you will see that we’ve updated our guidance to reflect an increase of $300 million on the top line, driven by strong performance across our portfolio, particularly in diabetes and the continued uptake of our new launch brands, as well as higher collaborations revenue, partially offset by the impact of weaker foreign currencies. On a reported basis, earnings per share for 2018 is now expected to be in the range of $3.19 to $3.29, while our non-GAAP earnings per share is now expected to be between $5.40 and $5.50. At the mid-point of the range, this represents an increase of 27% over 2017. Our updated guidance implies second half non-GAAP EPS of between $2.57 and $2.67, which exceeds our consensus. However, it’s lower than our first half EPS, due to the expected U.S. generic competition for Cialis in September and higher second half R&D expenses to support additional late-stage investments, including mirikizumab, Olumiant, and Taltz NILEX.

Thanks Josh. Slide 19 shows select NME’s and NILEX as of July 17. In my summary of the quarter at the beginning of the call, I mentioned the positive movements for Nasal Glucagon and the Phase 3 addition of pegylated IL-10 from our acquisition of ARMO BioSciences. The ARMO acquisition also includes Phase II studies for pegilodecakin, which are now reflected in the pipeline. This was clearly a busy and productive quarter for the company, and there are still many events to look forward to in 2018.

Great, thank you Dave. We would like to take questions from as many callers as possible. Please provide the instructions for the Q&A session and then we are ready for the first caller.

Thanks for taking the questions and congratulations on the operating results in the quarter. Dave, first question just has to do with the blueprint proposed by HHS secretary and the White House administration, what do you view as the base case scenario potentially coming out for the industry? And then just any thoughts on this issue that’s rising on copay accumulators that are certainly blunting manufacturers' ability to use copay assistance against copay accumulators, it seems to be very detrimental to patients getting access to medicine, so any thoughts that you have around that? Second question just has to do with the emerging pain franchise, just to your optimism over that franchise, especially galcanezumab, which seems to have hit some decent data in cluster headache. Thank you.

Hi, John, thank for the questions. Dave if you want to go ahead and comment, and then Dan if you want anything on the pain franchise that would be great. Dave?

Okay, great. Thank you for the questions. Just on the policy side, of course, the blueprint was rolled out in May. I think we can comment on actions that have been initiated. Last week the administration sent to OMB a proposed rule change for the Anti-Kickback safe harbor, which relates to rebates. We don’t know the substance of that rule change, but this has been heavily commented on. I think that indicates where the administration might be going. Overall, we support that. As long as we can embrace a pro-innovation market-driven set of changes that embrace this choice, I think we’re going to be fine. On the copay accumulators, this is going in the opposite direction of everything I just said. This is shifting cost back to consumers by standing the time they spend in high deductible phase. We don’t think by itself it’s a good policy. For Lilly, it's had very limited impact on our performance. It is a concerning thing to watch as we see back and forth in commercial markets.

Yes, I will just reiterate that we’re pleased with the data we’re seeing with galcanezumab, and I think one important opportunity here for Lilly is with cluster headache. We’re pleased with the data that we have there, and we're excited about the potential of this therapy.

Thank you, Dan. Kevin, if we can go to the next caller please.

Great. Thanks very much for the questions. Just two here, maybe first on tanezumab, can you put this initial Phase 3 data into context as you think about your enthusiasm for the program, specifically on safety? My second question was on price increases; the tone across the industry seems to be a bit more restrained than the past on willingness to take increases. Is this a 2018 dynamic or do you see this trend continuing out into 2019 and beyond?

Great, Chris, thank you for the questions. Dan if you want to comment on tanezumab and then Dave feel free to complement that answer and then we would take the price increase question. Dan?

On tanezumab, we have a lot of confidence in this mechanism of action based on the wealth of data generated in the past. The challenge here is to discharge the safety risk. That study will come with data probably next year or late this year.

On price increases, it’s difficult to comment on others' actions or even what happens long term. We’ll evaluate our strategies after observing how the regulatory landscape develops.

Thanks Dave. Kevin, if we can go to the next caller please.

Thanks. First for Dave, I was hoping you could share with us how the Elanco transaction or transactions in the coming quarters shape your thinking about capital allocation priorities for Lilly? And then shifting gears to diabetes, given the strong profile for the current injectable GLP-1’s and the emerging oral GLP-1 can you put a little more meat on the bones in terms of that bar?

Great Greg. Thank you for the questions. So, Dave, if you comment on Lilly capital allocation moving forward. And then Dan and Enrique, if you'd like to add regarding the oral GLP-1 work? Dave?

Our strategy on capital allocation doesn't change as a result of this decision. We’ll first invest organically, look at business development, and then return capital to shareholders.

We actually have a high bar for any type of next-generation incretin. In each of these cases, we’re looking for what we consider to be breakthrough efficacy. We are excited to share more at EASD.

Thank you. Kevin you can go to the next caller please.

Thank you. Couple of topics. Just to zoom in on the first question around the blueprint, particularly on the proposal on rebates. Assuming that is the case, how do you envisage the world working if PBMs could meaningfully amend their structure of rebates or remove rebates altogether for federal plans? Is it conceivable that the commercial side of the business will remain as is? And finally, timing, we assume that nothing is going to happen just given the plan is until 2020 in the earliest.

So, Dave if you want to take the first question. I'm not sure as much we can say, but whatever we can see on the blueprint speculation and then Dan if you want to comment on tanezumab?

It is difficult to speculate on a proposed rule change when all we have is the title of the rule. We’ll have to monitor it closely, but it is potentially that it could expand more broadly beyond just the federal programs.

It's premature to speculate on the labeling of tanezumab, given that we don’t have the primary safety data yet.

Thank you, Dan. Kevin, next caller please.

Yes, thanks very much. I have a few questions. First, with respect to the strategic exits that you mentioned for Elanco, I just wanted to better understand when these strategic exits were completed that had a negative impact on revenue in the second quarter? Second and with respect to Jardiance and Trajenta, both of those products were flattish sequentially despite the prescription growth that we saw? And then my final question is with respect to your Alzheimer's candidates, can you just provide a framework for those two Phase 2 programs, including the timing?

Great Dave, thank you for the questions. So maybe Josh if you want to take the first questions on when we've completed some of the strategic exits. And then Enrique on the sequential growth patterns for Jardiance and Trajenta, and then over to Dan for the question for our Alzheimer's programs in Phase 2. Josh?

The most significant of the strategic exits would be our Posilac business in the Augusta manufacturing plant in Georgia, which we just completed in the course of this month. So, I think you’ll start to see this annualize in total revenue beginning in the second half of this year.

When it comes to Jardiance, we have observed a disconnect in net sales. Admelog is experiencing strong competitive dynamics, making it difficult to predict access and uptake.

So, on our Alzheimer's candidates, we have 3 neurodegeneration-targeted molecules in Phase 2 trials. We’re excited about the potential of combining therapies to enhance efficacy.

Great, thank you, Dan. Kevin, if we can go to the next caller.

Thank you. David, just want to go back to some of the questions around rebate structures. When you look at your own numbers and think about different scenarios, looking at Lilly’s gross to net it’s the widest in the industry, largely because of your diabetes franchise. Is there a change to those rebates, what would you expect to happen to volumes? Conversely, if rebates go away, how can this not be a net positive even if you take into consideration lower volumes and potentially lower risk price?

Great Jami, thank you for the questions. Dave?

The huge opening caveat here is, we don’t know right. We don’t know what this rule entails. It truly depends on various factors, including the current agreements and patient adherence.

Thanks, Jami. Kevin, if we can go to the next caller.

Hi guys, thanks for the question. On Olumiant, I would just want to ask you guys a little bit more detail about the strategy going forward for the 4 mg dose in RA. What are the options you are looking at? And then, Dave or Josh, with the Elanco spin-out, can you help us with is it fair to say BD is now a lower priority?

Great, Geoff, thank you for the questions. So, Dan, maybe if you can comment on strategies going forward for the 4 mg in RA. And then Dave, if you can comment on the business development priorities? Dan?

We are excited about the potential of baricitinib for patients. With regards to prioritization, there are great opportunities for baricitinib in RA, but also in some other indications.

I wouldn’t attribute capital allocation solely to the IPO decision; we are interested in acquiring assets that enhance our growth across therapeutic areas.

Kevin, if we can go to the next caller please.

Thanks for taking my questions. I guess just first question on Humalog. How comfortable are you that the biosimilar competitor won’t really represent a meaningful source of competitive pressure to the business? And then my second question, just on galcanezumab, the feedback from the Amgen launch seems to be pretty favorable. Do you think payers are going to cover multiple CGRP agents on par or parity or do you think that they will opt for exclusive contracts?

Jason, thank you for the questions. Enrique we’ll go to you for Humalog.

As it relates to Humalog, we did have a benefit in Q2 due to changes in the estimates for rebates and discounts. Looking ahead, it's very difficult for us to predict access and uptake in 2019.

We want to ensure broad access for this category. We believe that employers will be interested in covering this new class of therapies.

Great. Thank you. Kevin, next caller please.

Thank you, several questions. First, on Taltz. In Q1, inventory was down 33%, how much of the second quarter performance was restocking the trade versus underlying demand? Second, the filing of galcanezumab in episodic cluster headache is not in the events table, so why is it 2018 filings not likely? And lastly, do you have any early reading on 2019 formulary discussions?

Okay, Steve. We can follow up later if needed on the Taltz question. And then maybe Enrique if you would like to also comment on the 2019 formulary question.

Taltz performance is driven by strong demand growth. So, we feel encouraged about that. Regarding galcanezumab, we are pleased with the results in the Phase 3 studies and will discuss those with regulators.

Kevin, if we can go to the next caller please.

Hi, thanks so much for taking my questions. I had three if I may, Dave, first, someone brought it up earlier about rebates. When it comes to mealtime insulin, Lilly and Novo split the market. So, do you foresee any scenario on rebates where Sanofi becomes a more meaningful player? And my second question is on IL-10; in your ongoing Phase 2 trials of PD1 plus IL-10, any observation from that trial to date? Lastly, on tanezumab, do we know what the rate of conversion was from Type 1 to Type 2 RPOAs in your prior trials?

Sure, Enrique, maybe if you'd like to comment on the first question about Sanofi? And then Sue or Dan can comment on the IL-10 trial.

It’s difficult to speculate what the changes would be and what the competitive dynamic would be as a result of that change.

We have two Phase 2 studies with IL-10 currently enrolling, and we’re anticipating seeing response rate data next year.

I understand your interest in the conversion rates, but we’re not disclosing specific details at this point.

Kevin, if we can go to the next caller please.

Can you hear me okay?

Yes, we can.

Okay, great. On Slide 5, you're indicating a potential debt offering prior to the IPO. Do you expect this Elanco to be a levering up event for Lilly?

The debt offering will intend to do that before we launch the IPO. You should expect to see Lilly on a net basis be more levered over time.

We would lose a certain amount of EBITDA, but there would be a minimal change in terms of Lilly's leverage moving forward. Kevin, do we have any more callers in the queue?

That's very helpful. Thank you.

We appreciate your participation in today's earnings call and your interest in Eli Lilly and Company. Our strong first-half growth makes us increasingly confident in our ability to deliver 5% compound revenue growth from 2015 to 2020 and to achieve a 30% operating margin in 2020.