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Eli Lilly & Co. Earnings: Patent Pains Continue

By Seth Robey - Oct 23, 2014 at 11:59AM

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Eli Lilly has experienced one of the toughest patent loss challenges in the industry. Did they finally reach the bottom this quarter?

Nowadays it's hard to see past the headline numbers when drugmaker Eli Lilly & Co. (LLY 0.86%) reports quarterly earnings. Patent losses have crushed Lilly's top and bottom lines. On Thursday Lilly reported its fourth consecutive quarter of year-over-year revenue declines, and remains a story of deteriorating margins. 

Inside the numbers
The table below compares some of Eli Lilly's results with the year-ago period, and with analyst expectations where available.

Metric Q3 2013 Q3 2014 estimates Q3 2014 Growth
Revenue $5.77 billion $4.83 billion $4.87 billion (16%)
EPS $1.11 $0.67 $0.47 (58%)
non-GAAP EPS $1.11 - $0.66 (41%)
Operating expenses $3.03 billion - $2.92 bilion (4%)

The drop in revenue was driven largely by a 73% decline in Lilly's best selling drug, Cymbalta, and by further declines to sales of drugs Evista and Zyprexa. Sales of Cymbalta have fallen so fast that management dropped the high end of its 2014 revenue guidance by $200 million to $19.8 billion.

As the product mix shifts from these products to others, gross margins also took a hit and fell to 74% from 79.2% in the third quarter of 2013. That decline in sales was slightly offset by a 4% reduction in operating costs, but cost-cutting initiatives still haven't gotten Lilly to its target operating margins. In the last quarter, management committed to achieving operating expenses at 48%-50% of revenue, yet Q3 brought operating expenses to 60%. As margins continue to squeeze, the pressure is mounting for Lilly to deliver some meaningful clinical results to support lofty expectations about the future. So what does Lilly have coming up the pipeline?

Pipeline updates
In addition to financial information, Lilly also provided a summary of pipeline developments from the quarter, and there were a few encouraging points. Lilly received FDA approval for three new products in the quarter including Jardiance and Trulicity, two drugs with innovative new mechanisms of treating type 2 diabetes. These products could go a long way in asserting Lilly's stated goal of competing in the crowded market for diabetes drugs.

On the oncology front, Lilly launched Cyramza, a cancer drug which Lilly has high hopes for. Cyramza is currently approved for gastric cancer, but the quarter also brought positive Phase 3 results in colorectal cancer and an FDA submission for label expansion into the non-small cell lung cancer market. Like other oncology drugs, label expansion presents in important opportunity for higher margin growth. 

The most encouraging pipeline update, though, may have been a preclinical agreement made with Zymeworks to develop bi-specific antibodies. The explosion in immuno-oncology drugs-from which Lilly has largely been absent-has been driven by antibodies that bind to specific targets on cancer or immune cells. Bi-specific antibodies present an innovative next step in the science of immuno-oncology by enabling one drug to reach multiple targets simultaneously. This partnership, while still very young, may signal a renewed interest in innovation from a pipeline lacking compelling first-in-class drug candidates.

Moving forward
While the numbers are pretty ugly, the results from this quarter are more or less in line with expectations. Management has referred to 2014 as its most challenging year, and expects growth to return in 2015. With a handful of new approvals to plug some of the patent loss holes, I remain unimpressed by Lilly's longer-term growth prospects, and will likely watch from a distance until cash flows stabilize and a clearer picture of the future emerges.

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