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Executives

Phil Johnson – VP IR

Derica Rice - CFO

Ronika Pletcher - IR Department

Nick Lumon - IR Department

Steven Paul – EVP Science & Technology

Analysts

Catherine Arnold - Credit Suisse

John Boris - Citigroup

Steve Scala - Cowen And Company

Robert Hazlett – BMO Capital Markets

David Risinger – Morgan Stanley

Seamus Fernandez - Leerink Swann

Chris Schott - JPMorgan

David Moskowitz - Caris & Company

Roopesh Patel - UBS

Tim Anderson – Sandford Bernstein

Jami Rubin - Goldman Sachs

Eli Lilly and Company (LLY) Q1 2009 Earnings Call April 20, 2009 9:00 AM ET

Operator

Welcome to the Q1 2009 earnings call. (Operator Instructions) I would like to turn the conference over to our host to Vice President of Investor Relations, Mr. Phil Johnson; please go ahead.

Phil Johnson

Thanks for joining us for Eli Lilly and Company's first quarter 2009 earnings conference call. I'm Phil Johnson, Vice President of Investor Relations. I'm joined today by our Chief Financial Officer, Derica Rice, by our President of Lilly Research Laboratories, Dr. Steven Paul, and by Ronika Pletcher and Nick Lumon from the IR department.

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 various factors including those listed on slide two and those outlined in our latest 10-K filed with the Securities & Exchange Commission.

The information we provide about our products and pipeline are for the benefit of the investment community. It is not intended to be promotional and is not sufficient for prescribing decisions. You can access the earnings press release and supporting materials, a live webcast and internet based replay and a podcast of this conference call at www.lilly.com. The replay, the supporting materials, and the podcast will be available on our website through May 20, 2009.

We’re off to a strong start in 2009. In the first quarter we continued to generate volume driven revenue growth, leverage between growth and revenue and operating expense, and increasing gross margin percent and strong operating cash flow.

This type of financial performance provides the resources necessary to build a robust pipeline to drive future growth, to effectively deal with the patent expirations coming in the next decade, and to respond from a position of strength to an increasingly challenging healthcare environment.

Before turning the call over to Derica, to kick off our discussion of our Q1 results, I will quickly run through some of the key events of the past three months.

On the legal front, a bench trail was held in the US District Court for the Southern District of Indiana regarding patent litigation for Evista. A temporary restraining order currently prohibits the launch of a generic version of Evista by Teva Pharmaceuticals. We expect a ruling on our request for a preliminary injunction by April 23, 2009. If granted, the preliminary injunction would enjoin Teva from launching prior to a final ruling.

The Court of Appeals for the Federal Circuit in Washington, DC overturned a lower court decision and ruled in our favor in the case of Ariad Pharmaceuticals v. Eli Lilly and Company, holding that Ariad's patent claims purporting to cover Evista and Xigris are invalid.

In terms of data releases, along with [amblin] and [alcameze] we released top line data from the DURATION-2 study of exenatide once weekly. In this study patients taking exenatide once weekly showed a greater reduction in HbA1c and a greater reduction in weight then patients taking either sitagliptin or pioglitazone.

We also announced that a meta-analysis of primary cardiovascular events across controlled clinical trials of three months or more showed no increased risk of cardiovascular events associated with exenatide use.

For our top priority of advancing the pipeline the European Commission granted marketing authorization for prasugrel for the prevention of atherothrombotic events in patients with ACS undergoing PCI. The product has now been launched in both Germany and the United Kingdom.

We also launched Zypadhera in the European Union. The FDA approved two new indications for Zyprexa for the acute treatment of treatment resistant depression or TRD in adults. The FDA also approved two new combination indications for Zyprexa and fluoxetine in adults for the acute treatment of bipolar depression and for TRD.

Zyprexa remains under review for use in adolescents age 13 to 17, for the acute treatment of schizophrenia and acute mixed or manic episodes associated with bipolar 1 disorder. Lilly has been asked by the FDA to review our data at a psychopharmacologic drugs advisory committee meeting scheduled in June.

We submitted our reply to the FDA regarding the agency’s complete response letter for Zyprexa long acting injection. The agency has designated a six months review period. We received a complete response letter from the FDA for the first line squamous cell carcinoma of the head and neck sBLA for Erbitux.

And finally the FDA Cardiovascular and Renal Drugs Advisory Committee voted nine to zero that prasugrel should be approved for the treatment of patients with ACS undergoing PCI. Later in the call Steven will share with you a more detailed review of our pipeline as well as key upcoming clinical and regulatory events.

Now let me turn the call over to Derica.

Derica Rice

Thanks Phil, as I have done on previous calls, I will focus my comments on pro forma non-GAAP results which we believe provide insight into the underlying trends in the business. This view assumes we owned ImClone as of January 1st, 2008, and it excludes certain items. We had no such items this quarter but we did in Q1 of last year.

Slide seven shows that first quarter revenue grew 3% while operating expense, defined as the sum of SG&A and R&D, was flat. Again we delivered positive operating leverage. I am sure you’ve noticed in our press release that the cost of sales decreased 29% compared to Q1 2008. This decrease is due to the impact on international inventories, of the strengthening of the US dollar, principally versus the euro, resulting in a substantial benefit to the cost of sales.

This pushed gross margin as a percent of revenue to nearly 84%. As a result of the large increase in gross margin percent as well as revenue growth outpacing operating expense growth, we reported earnings of per share of $1.20, an increase of 36% on a pro forma non-GAAP basis.

Now, let me take a moment to explain our operational performance versus the impact of foreign exchange. Clearly the 36% growth rate in EPS benefited from the favorable impact of foreign exchange rates on cost of sales. One would typically expect weakening foreign currencies to decrease the US dollar value of margins earned internationally.

We did see a negative impact in the first quarter of foreign exchange on the US dollar value of margins earned overseas. However, as we’ve discussed in the past, the accounting for our international inventories provides a natural hedge of sorts, particularly when the exchange rates move substantially as they have since mid 2008.

I want to make sure you understand that excluding the impact of foreign exchange rates on both our international earnings and on our international inventories, we still registered strong underlying performance growth in revenue and EPS in Q1.

Let’s walk through what’s going on one step at a time starting with revenue, as shown in the price/rate/volume table in slide eight, we saw volume growth in total revenue of 5% on a pro forma basis. The graph on the right illustrates that this continues a trend of strong volume growth we’ve seen since 2003.

Returning to the table on the left, you will notice that our underlying performance growth in revenue of 8% is currently being masked by the significant 5% negative impact of weaker foreign currencies. This effect is pronounced in nearly all international markets, with the one notable exception of Japan. Now let’s look at the rest of the income statement.

The table on slide nine shows the year on year growth of select line items of our income statement, both with and without the impact of foreign exchange rates. The numbers in the middle column are straight from our pro forma non-GAAP income statement we just reviewed. The third column of numbers strips out the impact of foreign exchange rates. Walking through this column you can see the 8% revenue growth I mentioned earlier.

Absent the impact of FX cost of sales increased but at a slower rate then revenue. Removing FX from operating expenses shows underlying performance growth of about 3%, well below our 8% revenue growth. So, on a performance basis, we generated 19% growth in operating income driven primarily by leverage between revenue and operating expenses and to a lesser extent due to operational improvements in the gross margin percent.

Hopefully, this provides you with a better understanding of the impact foreign exchange had on our Q1 results. I also hope that it underscores the strong underlying operating and financial performance we generated in the quarter. Now, what do our Q1 financial results mean for the rest of 2009 and therefore for our 2009 financial guidance?

Moving to slide 10 let’s first discuss the impact of foreign exchange rates, going forward if exchange rates remain at current levels, the negative impact we saw in Q1 on the international revenue and margins is likely to persist for Q2 and Q3 and moderate in Q4.

The substantial benefit seen in Q1 from FX related to international inventories will not sustain itself through the remaining three quarters of 2009. In terms of operational performance, we expect to see continued volume driven revenue growth. However we may see more significant erosion of Gemzar sales as generics penetrate international markets.

Similar to Q1 growth of cost of products sold may be relatively close to revenue growth. We expect to see an impact on our operating expense growth due to the ramp up of international prasugrel launches and the advancement of our pipeline. With this context, let’s move to slide 11 and I will summarize our 2009 guidance.

The operative word here is unchanged. Given the dynamics I described, we reconfirm our previously issued 2009 earnings per share guidance range of $4.00 to $4.25. We also reconfirm our line item guidance on both a pro forma non-GAAP and reported basis. We expect volume growth in revenue driven by Cymbalta, Alimta, Cialis, Humalog, and the launches of prasugrel, as well as by the Elanco Animal Health division.

However, the negative impact of weaker foreign currencies and the impact of generic competition in certain markets for Gemzar, are anticipated to partially offset these positive impacts. As a result, we expect low single-digit revenue growth on a pro forma non-GAAP basis, and mid single-digit revenue growth on a reported basis.

Gross margin as a percent of revenue is expected to increase, driven by the strengthening dollar. This increase is expected to be more pronounced in the first half of 2009. Marketing, selling, and administrative expenses are projected to show flat to low single-digit growth. Research and development expenses are projected to grow in the high single-digit on a pro forma non-GAAP basis, and in the low double-digit on a reported basis due primarily to higher interest expense and lower interest income as a result of the ImClone acquisition, we expect other income for 2009 to be a net loss of between $200 million and $250 million.

And the effective tax rate is expected to be approximately 22%. Capital expenditures are expected to be approximately $1.1 billion and we expect continued strong operating cash flow. Now let me turn the call over to Ronika and Nick for a more detailed review of our financial results, starting with a review of sales performance by key products.

Nick Lumon

Thanks Derica, slide 13 shows worldwide Zyprexa sales totaled $1.123 billion in Q1, which was essentially flat compared with the first quarter of 2008. Sales in the US increased 7% to $535 million, driven by higher prices and the favorable impact of wholesaler buying patterns, partially offset by lower demand. International sales were down 5% to $588 million, driven by the unfavorable impact of foreign exchange rates partially offset by increased volume. Demand outside the US was favorably impacted by the withdrawal of generic competition in Germany.

Moving to slide 14, Cymbalta sales in the first quarter were $709 million, up 17% compared with the first quarter 2008. US sales increased 17% to $597 million, driven by higher demand, increased prices, and the favorable impact of wholesaler buying patterns. International sales totaled $112 million, an increase of 19% driven primarily by higher demand, partially offset by the unfavorable impact of foreign exchange rates.

On slide 15, Humalog sales grew 11% to $451 million. US sales increased 20% to $286 million driven by increased prices and increased demand. Sales outside the US decreased 3% to $164 million driven by the unfavorable impact of foreign exchange rates, partially offset by increased demand.

Slide 16 shows Cialis sales were up 6% in the quarter reaching $359 million. Sales in the US were up 21% to $149 million driven by higher prices, increased demand, and the favorable impact of wholesaler buying patterns. Sales outside of the US decreased 2% to $210 million driven primarily by the unfavorable impact of foreign exchange rates, partially offset by increased demand and higher prices.

Moving to slide 17, Alimta sales in the first quarter continue to be strong coming in at $335 million, an increase of 36% over Q1 2008. US sales increased 42% to $173 million due to increased demand. Sales outside the US were up 30% to $162 million due to increased demand, partially offset by the unfavorable impact of foreign exchange rates.

On slide 18, Humulin sales for the quarter were down 7% to $241 million. US sales increased 6% to $99 million due to primarily to higher net effective selling prices. International sales decreased 14% to $142 million driven by the unfavorable impact of foreign exchange rates and to a lesser extent lower prices.

Slide 19 shows quarterly Forteo sales of $187 million, up 1% over Q1 of last year. US sales increased 3% to $122 million driven by increased net effective selling prices, partially offset by lower demands. International sales of Forteo decreased by 1% to $66 million due to the unfavorable impact of foreign exchange rates partially offset by higher demand.

Slide 20 shows worldwide Byetta sales for the quarter were $181 million, a 7% increase. US Byetta sales were essentially flat at $158 million while OUS Byetta sales were $24 million compared to $10 million in Q1 2008. Lilly reports half of the gross margin for US sales for Byetta plus sales of pens to Amylin and 100% of international sales. Total Byetta revenue recognized in Lilly’s income statement was $98 million, an 18% increase.

Ronika Pletcher

Before looking at the rest of the income statement, let’s look at slide 21 which shows the impact of price, exchange rates, and volume on revenue presented on a pro forma, non-GAAP basis as if we owned ImClone for all of 2008. Please note that beginning with this quarter we are adopting a new accounting pronouncement to break out total revenue into two distinct elements; product sales and collaboration and other revenues.

Product sales will consist of sales of pharmaceutical and animal health products, as well as third party sales of manufactured product such as sales of Erbitux through Bristol-Myers Squibb, and of Byetta pens to Amylin. Collaboration and other revenue includes payments from our partners such as royalties and profit sharing arrangements.

The largest component included in this classification are the Byetta gross margin share in the US and the Erbitux net royalty received from our collaboration partners. As Derica mentioned earlier in Q1 our 3% increase in total revenue was driven by a 5% increase in volumes and a 3% increase in net effective selling prices, partially offset by the negative foreign exchange impact of 5%. Q1 volume growth in Japan was impacted by last year’s April 1st price decrease while in Europe we begin to see the positive impact of reclaiming exclusive [inaudible] Zyprexa in Germany.

Animal Health year on year volume benefited from the inclusion of the US Posilac sales acquired from Monsanto in Q4 last year. The reduction in collaboration and other revenue was driven primarily by the step down in the residual royalty from [inaudible] for US [inaudible] and to a lesser extent by lower net Erbitux royalties.

Slide 22 presents the price, rate, volume analysis on a reported basis. Slide 23 shows the income statement for Q1 2009. Worldwide pro forma total revenue for the first quarter of 2009 was $5.047 billion, an increase of 3% compared with the first quarter of 2008. Gross margin as a percentage of total revenues increased by 7.3 percentage points to 83.8%.

This increase was due to the impact of the decline in foreign exchange currencies compared to the US dollar resulting in a benefit to cost of sales. Marketing, selling, and administrative expenses decreased 3% to $1.529 billion. The decrease was due to the impact of foreign exchange rates and a reduction in expenses related to US marketing programs partially offset by the increased prasugrel prelaunch activities.

Research and development expenses were $947 million or 19% of sales compared with the first quarter of 2008 research and development expenses grew by 4% due to increase late stage clinical trial and discovery research costs partially offset by the impact of foreign exchange rates.

You can see that the expansion of our gross margin percentage drove a robust 38% increase in operating income. The adjusted effective tax rate on a pro forma non-GAAP basis was 22% for the quarter. Net income in fully diluted earnings per share showed growth of 37% and 36% respectively.

Slide 24 shows first quarter and other income and deductions which decreased by $25 million to $71 million of net expense primarily due to lower business development income.

Slide 25 shows our reported EPS as well as significant items effecting net income and earnings per share. There were no significant items effecting net income for the first quarter of 2009 however the reported earnings per share for the first quarter of 2008 were favorably effected by significant items netting to $0.05 per share.

To reflect the impact of ImClone acquisition as if the acquisition occurred on January 1st, 2008, first quarter 2008 pro forma non-GAAP earnings per share have been reduced by $0.04. For additional information we have provided a reported earnings statement on slide 26. Details about our reported earnings are available on our earnings press release dated today, April 20, 2009.

Now let me turn the call over to Steven to update you on our pipeline and key events for the rest of 2009.

Steven Paul

Thanks Ronica, during the past few years we have substantially increased the number of new chemical entities and new biologic entities in clinical development. Owing both to the increased productivity of our own labs and to acquisitions, the current list of compounds in some stage of human testing at Lilly is larger and more exciting then at any time in the history of the company.

Our clinical stage portfolio now stands at 61 distinct NMEs, double the number we had at the end of 2006 including a record 26 compounds in Phase 2 and Phase 3 and we continue to build a robust biotech portfolio. In fact biotech molecules represent almost half of our late stage Phase 2 and Phase 3 assets and now represent over 40% of our overall clinical portfolio.

As we’ve discussed in the past we are squarely focused on advancing our pipeline. As you can see reflected by the arrows on slide 27 since our last formal portfolio update in New York this past December, we’ve received approval for and launched prasugrel in the European Union.

We’ve moved four more compounds into Phase 2 testing and we’ve moved four more compounds into Phase 1 testing. We are implementing a strategy and making the investments to build Lilly’s position as a biotech and oncology powerhouse. We are also increasing the productivity of our small molecule research and are strengthening our therapeutic presence in neuroscience and diabetes as well as musculoskeletal and osteoporosis.

We’re building a pipeline that we believe will meet the challenges of the next decade providing a continuous flow, two launches per year, of high value medicines by 2013. To this end, we now estimate that of the 61 new chemical entities and new biologic entities in clinical development, 15 to 20 may reach the market as either best in class or first in class medicines over the next five to 10 years.

On slide 28 I have listed compounds that could launch during the year’s [YZ]. Of course while a number of these may undoubtedly not make it to market, we are optimistic given the number and quality that sustaining two good launched per year by 2013 is well within our grasp.

Now let me turn to slide 29 to highlight upcoming regulatory and clinical milestones. As we know you do we eagerly await FDA action on the prasugrel [NVA]. FDA action is also pending on the Byetta monotherapy indication and on Byetta labeling.

We recently submitted our reply to the complete response letter we received from the FDA on Zyprexa LAI late last year and have received a six-month review.

Earlier this year the FDA raised concerns about [pharmacal kinetic] comparability data in our sBLAs for Erbitux in first line squamous cell carcinoma of the head and neck and in first line non-small cell lung cancer. We anticipate resubmitting the non-small cell lung cancer sBLA and responding to the head and neck cancer complete response letter in the second half of this year.

Other potential milestones this year include; submission to the FDA for exenatide once weekly, and resubmission of Cymbalta for chronic pain in the US both in this quarter, submitting arzoxifene to the FDA and presenting data from our large Phase 3 GENERATIONS trial, reporting Phase 3 results for dirucotide in secondary progressive multiple sclerosis, reporting Phase 3 results from the DURATION-3 head to head superiority study of exenatide once weekly versus insulin [inaudible], initiating Phase 3 trials for our A-beta antibody for antibody for Alzheimer’s disease, ,moving into the Phase 3 portion of our Phase 23 seamless, adaptive trial for GLP-1 and presenting results from a separate Phase 2 study of the drug, and Initiation of Phase 3 trials for ImClone’s 11F8 and A12 for cancer.

The year 2009 is shaping up to be an eventful year and one we are particularly excited about in the Lilly Research Laboratories and across our company. This concludes our prepared remarks and now we are ready for the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Catherine Arnold - Credit Suisse

Catherine Arnold - Credit Suisse

I was wondering if you could give us an update on the Byetta LAR filing, post [prasugrel] type panel. If you could about if the FDA has requested any incremental data or studies, if your filing is still on for the second quarter and assuming that’s the case, when will your meeting be with the FDA in terms of finalizing that filing and then I also wanted to just follow-up on the mGlu program and if you could talk about if you have a backup to 023, if that might be advancing at the same time as your plans to sort of do another Phase 2 program for 023.

Steven Paul

In response to your first question on Byetta LAR, we have every intention of filing on track. We are not in any way we believe impacted at this point by the [lower] glutide advisory committee meeting. These drugs need to be thought of separately. They are different. We will base our case on our clinical data as well as our preclinical tox data as that [FNDA] becomes adjudicated.

So we don’t see anything there. Obviously we can’t anticipate what the FDA is thinking at this point and clearly there may be an impact but at this point we don’t anticipate one, so we’re on track there.

With respect to and again I point your attention to the robustness of the clinical data, the safety package that we’re accumulated with Byetta itself as well as the safety package on LAR.

Catherine Arnold - Credit Suisse

But you were not asked to do anything further on carcinogenicity before the panel nor have you been asked since the panel has concluded.

Steven Paul

No, the carcinogenicity studies on drugs are pretty pro forma. You do your tox studies etc. and we’re on track. With respect to mGlu R we certainly have a very robust backup program in this area. This is a platform. But I just remind you we haven’t given up by any means on the first molecule that’s in clinical development. We did have a busted trial, we could not interpret the results because our positive comparator in this case a very good drug called Zyprexa, did not separate adequately.

This happens, not infrequently in neuroscience trials. I’d be glad to tell you why if you want to talk offline. We still believe in this molecule. Its very unique. Its hard to reconcile our initial Phase 2 data with the fact that this compound would not work. It does seem to be efficacious and obviously we need to gather more data on both efficacy and safety. So we’re still very enthusiastic about this molecule and need to come back and do a good study.

Operator

Your next question comes from the line of John Boris - Citigroup

John Boris - Citigroup

Just on [FEN] I think you mentioned a couple of times prelaunch expenses and prelaunch plans, first off on the US can you just comment as to whether the US sales force has been fully trained and are you ready to launch it at any time and can we just get an update on where you’re at on enrollment in TRILOGY and timing for TRILOGY and then just on the EU with FEN can you just comment on the rollout and then any kind of pricing benefit or premium pricing that you might have been able to attain in Germany and the UK market, and then since we do have Steven on the line, can you just provide some commentary on your own human GLP-1, the long acting GLP-1, and tox data on that I think it was commented earlier that some of the carcinogenicity data that has been seen with other compounds have not been seen with its own compound. Can you just comment maybe more specifically about your own fully humanized compound.

Phil Johnson

Okay I’m go to have Derica address your FEN questions, both for the US and for the EU and then we’ll have Ronika respond to your TRILOGY and then either Steven or I on your GLP-1 question.

Derica Rice

In regards to our preparation for launch in the US, yes as soon as we receive approval we are prepared to launch this product. The sales force has been fully trained. In regards to the EU, as you know we’ve received approval there. We have launched in Germany and the UK but its still early to really comment on that in terms of results.

Ronika Pletcher

With regards to your TRILOGY question we have no plans nor do we are we prepared to give updates with regards to the TRILOGY trail in terms of enrollment largely due to competitive reasons. We choose not to give updates with regards to that trial.

Steven Paul

On GLP Fc, let me just make a couple of comments, first while we’re not prepared to discuss our toxicology profile on that molecule but I want to make one comment that relates both to it and kind of tied to LAR and that is when you do a two year toxicology study, you do it at multiple, multiple doses and you usually try to get doses that are far in excess of what you would anticipate in human testing or human clinical use.

That’s to figure out exactly what your margin of safety is. You very carefully have to then look at the exposures. Remember two years in a rat or a mouse is equivalent to about three-quarters of the lifetime of a human being. And then extrapolate on the exposures, blood levels, etc. to what your margin of safety might be.

So until you see that data and this would apply for LAR, etc. as I’ve indicated earlier and any of our GLP follow-up molecules, you really don’t know exactly what you have but so far GLP Fc and our GLP programs are on track. The clinical data is, we’re accumulating clinical data, and we’re still very optimistic about this platform.

Phil Johnson

On your question on pricing in the EU, we definitely feel like the [Tritan] trial gave us a very strong package to have discussions with payers on the value that prasugrel can offer compared to current standard of care particularly from the savings that would accrue from having fewer heart attacks and things like the [inaudible] thrombosis.

So I think you’re aware we have launched at a premium in both the UK and Germany to the Plavix price. I think what you’re going to find is that we have future launches overseas, there’s a huge disparity in actual Plavix pricing, market by market. So you’re likely to see that you’re going to have different percent premiums at which we launch prasugrel.

Much of this is due to changes in exchange rates for example between the pound and the euro over the last couple of years, also things like the [PPRS] system in the UK where companies essentially provide monies back to the government through price decreases on products they select. So you may actually see in this case, I don’t have the numbers with me for exact numbers, but the actual price if you convert at current euro pound exchange rates, is actually higher in Germany then it is in the UK for prasugrel but the premium to Plavix is actually less in that market.

Operator

Your next question comes from the line of Steve Scala - Cowen And Company

Steve Scala - Cowen And Company

Are there any upcoming events regarding the Congressional investigation of prasugrel’s FDA panel. Do you anticipate a formal hearing and do you have evidence that FDA intends to act without resolution of this investigation.

Phil Johnson

There’s nothing upcoming that we’re aware of. We’re responded fully to the questions that we received from the sub committee. There is no anticipation that we have for any kind of a formal hearing and we do not anticipate based on our discussions with FDA that these two particular processes are linked. It would appear that FDA is moving along with its evaluation independent of the Congressional requests that both the agency and Lilly had received.

Operator

Your next question comes from the line of Robert Hazlett – BMO Capital Markets

Robert Hazlett – BMO Capital Markets

Just a little bit more on the GLP-1 in the wake of [inaudible], have you assessed [calcitonin] status or base line [calcitonin] levels and then with the addition long acting GLP-1 programs, and if you have could you share with us that data, and secondly how much was Humalog, the international revenue impacted by foreign exchange specifically and then just a quick one on the pipeline chart, you have, I noticed that these, with the green arrows that the compounds have achieved milestones. Does that mean that we should be expecting a phase movement with those particular compounds in the not too distant future.

Phil Johnson

My understanding is for our GLP-1 program that we’ll be building in some of these measurements into the trials that we conduct but I don’t believe we have any data at this point in time to report out with [calcitonin] levels for our GLP-1 Fc, the lead GLP that we have.

The Humalog FX impact, I can’t provide that by specific product but certainly I can say that if you look at the 5% negative FX impact that we had corporately, essentially that’s all coming obviously from overseas and a little less then half our sales overseas, so the actual overseas impact you can assume it at a little more then double the 5%. That would be up or down depending on specific products whether there’s slightly more international sales, but roughly you’re looking at that sort of low double-digit negative impact we’d have had on the vast majority of our products.

Steven Paul

The green arrows for the eight compounds, four moving into Phase 2, four moving into Phase 1, indicate that we’ve initiated those Phase 2 and Phase 1 studies for those compounds.

Phil Johnson

Typically you’ll see that consistently that we will not go ahead and show those as having moved to the next phase until the actual work for that phase has been completed. There are some that could be upcoming yet this year that we’re hopeful for but we won’t represent those as movements until they’ve actually started the work for that particular phase.

Operator

Your next question comes from the line of David Risinger – Morgan Stanley

David Risinger – Morgan Stanley

My questions relate to foreign exchange, I was hoping that you could talk in a little bit more detail about the gross margin benefit in the quarter and how we should think about gross margin progressing over the next couple of quarters sequentially. Should be assume that the gross margin declined sequentially from the peak in the first quarter of 2009 because the benefit from FX will diminish as the inventory is sold through, so that’s I guess my first question. And then separately in terms of calculating the benefit to EPS, was basically half of the year over year EPS gain due to FX and how should we think about FX next quarter. Should we be expecting a gain or a loss from FX on the earnings per share line in the second quarter of 2009.

Derica Rice

In regards to the FX impact and gross margin, let me just remind you that even without FX, at constant rates, we still had gross margin improvement, gross margin expansion. Now it was further accelerated due to the benefit of FX in terms of our reevaluation of inventories. If you’re trying to project out to the remainder of the year, we do believe that Q1 represents a peak in terms of the gross margin improvement.

We do not anticipate that we’ll be able to sustain that level of gross margin for the remaining three quarters of the year. Now in regards to trying to project forward on a quarter by quarter basis, as you are aware remember we’ve moved away from giving quarterly guidance and so we are not prepared to break it down on a Q2 versus the remainder of the year.

What I can say also to your question about if you look at the Q1 results I think your question was about did FX drive about half of the EPS improvement year over year, that’s about, you’re in the ballpark there. We did highlight however on the slide that if you look at our business at constant rates, we had operating income growth of 19% in the quarter based off of 8% revenue growth at constant rates.

Operator

Your next question comes from the line of Seamus Fernandez - Leerink Swann

Seamus Fernandez - Leerink Swann

Just to follow-up on Dave’s question, is specifically with regard to the sequence, you didn’t raise the guidance obviously, I guess the implied spending increases would be fairly dramatic relative to those changes so again even if half of the spend was coming from the gross margin or the improvement came from the gross margin it seems to me that only the upper end of that guidance could be achieved so I guess the question is why wouldn’t you have at least raised the lower end of your guidance for the $4.00. To get to $4.00 it would almost imply you would have to do a major acquisition in order to drive that kind of a change. Also just separately related to corporate tax rate changes and some of the rumblings that we’re getting out of Washington, I’m just wondering if you can comment on the impact or basically the potential impact on Lilly that changes to foreign tax deferrals and foreign tax structure in terms of the, where the, where profits are domiciled. If you can comment on that. I know that there’s a Bill upcoming that may be introduced by representative Rangel and obviously the Administration has sort of suggested some guidelines to Congress. Just wondering how you see that progressing.

Derica Rice

Coming back to your follow-up question around FX and how to look at our guidance for the year, we still feel very good about the $4.00 to $4.25 guidance range that we provided and we still believe its relevant for our business at this time. As you heard from our call text that we reiterated earlier, if you look going forward some events that we expect to happen in the last nine months of the year is one, we do not believe that the FX benefit that we saw in gross margin in Q1 will sustain itself for the remaining nine months.

Secondly, we also have the generic Gemzar erosion that we’re anticipating for key markets outside of the US. The generic primarily came on the market in Europe on March 9th so you didn’t see the full effect of that in Q1. Then yes, we also are planning for the continual launches of prasugrel both in the US if we receive approval, as well as within Europe and key international markets.

And as Steven talked about we’ve got 61 medicines in clinical stage of development and we’re still planning on progressing those medicines through our development cycle so all of that added up says that we believe we’ll be somewhere in the range that we provided.

In regards to your second question in terms of corporate tax rates, yes, we’re very aware of the discussions that are being had around the outlook and everything that we’ve heard, at least up to this date, is that it looks like its less of a possibility in 2009 but maybe more of a possibility of some type of tax reform in 2010.

That being said the current proposal that’s on the table, if deferrals was repealed and removed, yes it would have a detrimental impact on both the cash flows and the bottom line of Lilly. But that would also be true for all US multinationals that are operating on a global basis so we are actively discussing this and providing our input where we can on what we think is, that would be the proper tax [reforms].

Phil Johnson

A couple of comments as well on Gemzar both in Europe as well as internationally, as Derica mentioned we did lose our patent exclusivity on the 6th of March. Generics came into some of the European markets on the 9th. So right now its not clear to us exactly how much of volume the generics have in total to be able to penetrate the European market let alone the international market. So we’re monitoring that situation pretty closely as you would imagine.

We have seen more significant price erosion then we would have anticipated in the markets where the generics have come in. So again, its very early days both in Europe and internationally but to give you an idea of what we have at stake to a certain extent, you had about $600 million in European sales last year of Gemzar and about $1 billion internationally.

Operator

Your next question comes from the line of Chris Schott - JPMorgan

Chris Schott - JPMorgan

On the wholesaler impact in the quarter I think for a number of products you mentioned a favorable benefit, can you just talk about the net impact on the wholesaler moves in the quarter and maybe more importantly heading out to next quarter. Is there stuff we expect to come out next quarter or are we at normal levels at this point and then on animal health, about the economic sensitivity of that business ex US, I know currency was a factor there, but it seems like you’re seeing limited organic growth for that business, and just any color there might be great.

Derica Rice

The wholesaler inventory stocking that we referenced in our call text was pretty much for the most part immaterial in the quarter so its not really driving the 5% volume growth or the 3% overall pro forma sales growth so I don’t anticipate there being a shift in the remaining quarters of the year. We have seen even going back to 2008 at least in the US, the wholesalers working to carry lower levels of inventories.

Secondly in regards to your question regarding animal health and any sensitivity to the current economic conditions, we still feel very good about the growth we’re getting out of animal health and our companion animal business is doing very well. We also have seen good growth at our food animal business but from an economic standpoint that’s where we’re tending to see the bigger impact.

And that impact has been seen more by the producers reducing the size of their herds and so therefore in some cases, filling the need to use less product in terms of productivity enhance our products, but for the most part its been managed more at this stage.

Ronika Pletcher

Just to add a bit more to Derica’s commentary, with regards to our OUS side, we did start to see a bit of a downturn relative to the global downturn in our sales there and also regards to our US sales, we actually saw impacts from the Q4 buy ahead. We had mentioned last call that we had a Q3 benefit, buy ahead benefit and we saw a downturn in Q4. Not all products were allowed to buy ahead in that Q3 timeframe, some were bought ahead in Q4. That then negatively impacted our Q1 2009 numbers as well.

Operator

Your next question comes from the line of David Moskowitz - Caris & Company

David Moskowitz - Caris & Company

A couple of product specific questions if I may, so Gemzar was also off in the US in this single-digit range, can you explain why that product may be declining and on the wholesaler buying patterns you mentioned it in relation to Cialis, but that product is showing 21% US growth. Given that that’s a real consumer sensitive product, could you talk about how much Cialis was related to wholesaler buying and how much was related to actual underlying demand. And just a quick follow-up on the cost of goods, I think about the base of COGS somewhere around a billion dollars, it looked like you had about a $200 million benefit in the quarter, again that’s based off of my assumptions, that’s 20%. So you talked about improvement in the cost of goods despite favorable foreign exchange, can you piece that out a little bit for us, can you talk about how much of the benefit and whether or not my baseline $200 million assumption is about correct. How much of that benefit was actual cost of goods improvement versus foreign exchange.

Derica Rice

I’ll start with the COGS and I’ll work my way back the other way. In regards to the COGS, if you look at a constant FX view that we’ve provided in the slides where we had 8% revenue growth, COGS grew about 7%. So you can do the calculation there in terms of trying to weed out the net FX benefit there.

Secondly if you look at Gemzar and your question about Gemzar performance in the US, Gemzar we actually saw the effect the other way. We actually saw a destocking for Gemzar in the US and that’s deflated the growth for Gemzar sales in the US in Q1.

For Cialis, in regards to the underlying trends there it really wasn’t driven by wholesaler buying patterns. If you look at Cialis over the last 12 months, we’ve gained in the US about 2.3 percentage points of market share improvement versus our competitors. And so we’ve had really good strong underlying demand and we continue to gain share against our competitors.

Steven Paul

One additional comment on Gemzar, actually in the first line non-small cell lung cancer population, Gemzar has stayed flat at about a 12% market share and that’s even in the face of the Alimta launch for the non-squamous [inaudible] population for non-small cell lung cancer where we’ve actually seen growth.

Operator

Your next question comes from the line of Roopesh Patel - UBS

Roopesh Patel - UBS

I have a couple of questions on foreign exchange as well, firstly if currency stays constant from here on, when will the FX benefit seen this quarter turn into a drag. Secondly, overall for the year at current exchange rates, do you expect to end up with a benefit or a drag to earnings related to foreign exchange and then thirdly and based on the details provided on slide nine, by my calculations the FX related EPS benefit this quarter was about $0.17, is that accurate.

Derica Rice

Once again, we’re not providing quarterly guidance but if you look at our guidance for the total year, what we’ve stated is that even on a total year basis, we still expect expanding [our] improving gross margins and that outlook has not changed.

We do not believe once again that the benefit seen in Q1 will last for the remaining nine months. Part of this is also trying to predict what FX rates are for the last nine months and who, I don’t have that crystal ball here today.

In regards to your last question around the bottom line impact, what we’ve stated is that if you look on the slides, at constant rate we had 19% improvement in operating income and I think there was a previous question and we said, if you look at the total growth at the bottom line about half of that you could attribute to FX benefit. I’d say that puts you somewhere in the right ballpark.

Phil Johnson

Another way to think of FX, if in fact as you suggest when a scenario of rates stay where they are, essentially you would never have a negative impact coming from the foreign inventory, those international inventories. What you would see is the benefit that we had to cost of sales this quarter would go down rather quickly and then essentially stay at zero.

The other piece then is the FX impact on our international income or margins, that piece as you would expect as you would have seen also in the top line results is actually negative in Q1 and based on current rates if we were to stay here, you’d probably have a relatively similar impact in Qs 2 and 3 before it would moderate pretty substantially in Q4 based on how quickly rates moved in the last part of last year.

Operator

Your next question comes from the line of Tim Anderson – Sandford Bernstein

Tim Anderson – Sandford Bernstein

Related to the big favorable foreign exchange impact on inventories, I’m presuming that you fully expected this to occur when you gave your 2009 guidance back in December, if you can confirm that please. And then and R&D question, on slide 28 you show 19 products that could launch between 2012 and 2015, we haven’t seen data on many of these compounds, so it would be very helpful if you could focus our attention on the two to three compounds that you’re most excited about or that you have the highest confidence in.

Derica Rice

In terms of the guidance that we provided at the beginning of the year, we did anticipate some benefit from FX and that was based upon where we saw rates emerging as we went through the fourth quarter. But we did not anticipate this magnitude because at that point in time the dollar wasn’t trading where it is today so the dollar has moved beyond what we initially had estimated back in November and December timeframe when we initially provided our guidance in New York.

Steven Paul

I’ll point your attention to a number of molecules. Let me remind you that we’ve established proof of concept in Phase 2 for the vast majority of our compounds whether you’ve seen it or not so we’re quite encouraged by the probabilities given that this is principally a game of attrition.

But you’ve seen data on the BAFF antibody, that’s LA-294, IL-17, both those look really good. We’re still very excited about the GLP platform, the once weekly GLP-1 type compounds including LAR and R next generation molecules. The IMC -1121B and 11F8, I think the [inaudible] FR2 compound is a very exciting molecule where we’ve seen hints of efficacy if you will that are quite encouraging.

I’m not at all discouraged by mGlu R2/3 even though we had a busted trial as I indicated earlier and again I’d point your attention to the two soon to be Phase 3 molecules in the area of Alzheimer’s disease, our [gammsequetase] inhibitor, and our A-Beta antibody. Others on there, look pretty interesting to us, hopefully we’ll be presenting some data soon on Tasisulam, iGluR5, and our sleep promoting agent, the [hipion] molecule.

So I’m pretty excited about most of them, and again the data will tell the story.

Operator

Your next question comes from the line of Jami Rubin - Goldman Sachs

Jami Rubin - Goldman Sachs

I’m just wondering if you could comment on the US price increases which were 7% overall this quarter compared to 45 overall for 2008 and if you can just sort of talk about strategically what’s going on. I’m just wondering if that is an offset to perhaps are you seeing significant changes at national plan level or PBMs with respect to biological and specialty drugs which you are highly exposed to, if you could talk about what’s going on there.

Derica Rice

Our price increases that you saw in the first quarter results in terms of list price, it’s pretty much consistent with what the level of price increases, the actual list price increases that you’ve seen over the last four quarters so there really was no change there.

The primary driver behind the 7% versus what you’ve seen historically is that as we have various plans with managed care as well as Medicaid and Medicare we’re constantly having to true up our accrual balances, our provisions on our balance sheet, for those ongoing liabilities and as we do that, sometimes if we have to adjust those accruals down, that results in terms of a benefit to pricing and that’s what you’re seeing in the 7% in Q1.

Phil Johnson

A couple of things to keep in mind, in Q4 of 2007, we began to have additional accruals for the impact of a final rule that came through on DRA. We quantified that as about a 1% of sales in the US impact. That would have been a negative drag essentially for Q4 2007 through Q3 of 2008. That’s now essentially come off with Q4 of 2008 and Q1 of this year. We also started in February of 2008 to have some accruals for additional rebates that we anticipated would need to be paid to [Tricare] beneficiaries as they have their prescriptions filled at off base essentially types of pharmacies, retail pharmacies.

That started in February of 2008. You’re beginning to see that come out essentially of the pricing deductions. So as Derica mentioned, not a fundamental shift at all in the underlying list prices that some of the other dynamics are actually letting a bit more of those list price increases come through in the first quarter of 2009.

Operator

Your final question is a follow-up from the line of Steve Scala - Cowen And Company

Steve Scala - Cowen And Company

Regarding the 2009 guidance range, among the factors to consider you did not mention at risk launches of either Evista and/or Gemzar in the US, is that a factor why you have not changed the range or would an at risk launch lead to a cut in the guidance.

Derica Rice

An at risk launch of Evista is not built into the guidance that we provided of $4.00 to $4.25 nor have we also built anything in for the pending Gemzar trial in the US as well.

With that being the final question, maybe let me try to close off the call here. I want to begin by first thanking you taking your time this morning for this update on Eli Lilly and Company. We appreciate your interest in our company. Now let me close by emphasizing a few key points. I believe we are off to a strong start for 2009.

For the quarter we delivered strong operating financial results with volume driven revenue growth, continued leverage between growth and revenue and operating expenses, and increasing gross margin percent, and strong operating cash flow.

We remain confident that this type of financial performance provides the resources necessary to build a robust pipeline to drive future growth, to effectively deal with the patent expirations coming in the next decade, and to respond to an increasingly challenging healthcare environment.

Clearly we have staked our future on innovation, leveraging our 2007 and 2008 pipeline progression with a strong 2009 start as we moved four compounds into Phase 2 testing and we moved four compounds into Phase 1 testing.

Looking forward, we at Lilly are excited about the remainder of 2009. It should be an eventful year with a number of significant milestones and decisions. We look forward to keeping you informed of our progress.

Thank you.

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Source: Eli Lilly and Company Q1 2009 Earnings Call Transcript
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