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Eli Lilly and Company (NYSE:LLY)

Q2 2009 Earnings Call

July 22, 2009 9:00 am ET

Executives

Philip Johnson – Vice President of Investor Relations

Derica W. Rice – Senior Vice President and Chief Financial Officer

Nicholas Lemen – Manager, Corporate Business Development Group

Steven M. Paul – Executive Vice President, Science and Technology, President, Lilly Research Laboratories

J. Anthony Ware – Vice President Cardiovascular Research and Clinical Investigation

Javan Collins – Vice President of Lilly's U.S. Cardiovascular Business

Analysts

John Boris – Citi

Eric Low – Banc of America/Merrill Lynch

David Moskowitz – Caris & Company

Jami Rubin – Goldman Sachs

David Risinger – Morgan Stanley

Tony Butler – Barclays Capital

Robert Hazlett – BMO Capital Markets

Operator

Ladies and gentlemen thank you for standing by and welcome to the Eli Lilly and Company Q2 2009 earnings call. At this time all participants are in a listen-only mode. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the conference over to our host Vice President of Investor Relations, Phil Johnson. Please go ahead. One moment please for Mr. Johnson.

Unidentified Company Representative

Robert.

Operator

Yes, yes sir.

Unidentified Company Representative

Are you getting this right, now?

Operator

I am getting you, but I am not getting Mr. Johnson.

Philip Johnson

Will be available on our website through August 21, 2009. In the second quarter, we again generated strong financial results including volume driven revenue growth, leverage between revenue growth and total expense growth, robust EPS growth and strong operating cash flow. As you will see our operating leverage and robust earnings growth was not due to foreign exchange as we did in the first quarter we again delivered leverage and robust earnings growth on a performance basis. This 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 Q2 results. I will quickly run through some of the key events since our last earnings call. Our top priority is advancing the pipeline and while we had a number of achievements in this regard none was bigger than the U.S. FDA approval of Effient for the reduction of thrombotic cardiovascular events including stent thrombosis in patients with acute coronary syndromes, who are managed with an artery-opening procedure known as percutaneous coronary intervention.

Later in the call, Steve will discuss prasugrel in more detail as well as provide you with a pipeline update. Staying with regulatory approvals, the FDA approved Alimta as a maintenance therapy for locally advanced or metastatic non-small cell lung cancer, specifically for patients with a nonsquamous histology whose disease has not progressed after four cycles of platinum-based first-line chemotherapy.

The European Commission granted approval for the use of Alimta as a monotherapy for maintenance treatment of patients with other than predominantly squamous cell histology in locally-advanced or metastatic non-small cell lung cancer, whose disease has not progressed immediately following platinum-based chemotherapy. And Alimta received regulatory approval in Japan as a first and second-line treatment of non-small cell lung cancer.

In terms of regulatory submission along with Amylin and Alkermes we submitted a new drug application to the FDA for exenatide once weekly, and this application was accepted for review. We remain excited about the opportunity for this molecule and we are very pleased with the top line data just announced from the DURATION-3 head-to-head superiority study versus insulin glargine. In DURATION-3, exenatide once weekly produced superior reduction in HbA1C and weight as well as less hypoglycemia. We also resubmitted the supplemental New Drug Application for Cymbalta for the management of chronic pain.

In clinical trial news we began enrolling patients in two separate, but identical Phase III clinical trials of Solanezumab, an anti-amyloid beta monoclonal antibody being investigated as a potential treatment to delay the progression of mild to moderate Alzheimer's disease. The trials will each include a treatment period that lasts 18 months and are expected to enroll a total of 2,000 patients age 55 and over from 16 countries.

On the legal front, the U.S. District Court for the Southern District of Indiana issued a preliminary injunction to prevent the launch of a generic version of Evista by Teva Pharmaceuticals, until the Court renders its final ruling. We anticipate that a final ruling could come sometime this year or early next year. We significantly advanced discussions with the attorneys general for several states that were not part of the Eastern District of Pennsylvania settlement. Seeking to resolve their Zyprexa-related claims.

As a result in the second quarter, we incurred a special pretax charge of $105 million, representing the currently probable and estimable exposures in connection with the states' claims. Discussions are ongoing and it is possible that additional charges may occur in the future.

Now, let me turn the call over to Derica.

Derica W. Rice

Thanks, Philip. As I have done on previous call, I will focus my comments on the pro forma non-GAAP results, which we believe provides insight into the underlying trends in the business. This view as soon as we owned ImClone as of January 1, 2008, and it excludes certain items such as restructuring charges, asset impairments, and other special charges.

Moving to slide eight. Let's take a look at our Q2 income statement before discussing the impact of foreign exchange on our Q2 results. On a pro forma non-GAAP basis you can see that we generated leverage between revenue and total expenses. As second quarter revenue grew 1%, while operating income grew a robust 20%. Leverage between revenue and total expenses was driven by a 4.6 percentage point expansion in our gross margin percent and by operating expense defined as a sum of R&D and SG&A growing inline with revenue. The increase in the gross margin percent from 77.5% to 82.1% is primarily due to the favorable impact on cost of sales due to the impact of changes in the value of the U.S. dollar on international inventories sold in the period.

Specifically changes in the foreign currency value of the U.S. dollar resulted in a substantial addition to the cost of sales in Q2 2008, while producing a small reduction to cost of sales in Q2 of 2009. Breaking operating expense into its component parts, operating expense growth of 1% is comprised of a 5% increase in R&D expense reflecting increased activity as we continue to build and advance our pipeline and a 2% decrease in SG&A expense.

Moving down the income statement, you'll see that a slight improvement in other income and deductions was offset by modestly higher effective tax rate. As a result growth in net income and EPS was 20% and 19% respectively. Slide nine shows our reported income statement, while slide 10 provides a reconciliation between reported and pro forma non-GAAP EPS. Additional details about our reported earnings are available in today's earnings press release.

Now let's talk about how foreign exchange affected our Q2 results. Let me give you the punch line first. Excluding the impact of exchange rate movement, we grew revenues faster than both cost of goods sold and operating expenses, driving significant leverage and strong 16% operating income and EPS growth. Let's walk through what's going on one step at a time starting with revenue.

As you can see on slide 11, total revenue growth of 1% on a pro forma non-GAAP basis includes a negative impact from foreign exchange of 6%. Absent the negative impact of foreign exchange, revenue grew 7% in performance terms. This revenue growth was driven by volume growth of 4% followed by price growth of 3%.

Slide 12 presents the price, rate, volume analysis on a reported basis. Now let's look at the rest of the income statement. The table on slide 13 shows the year-on-year growth of select line items on our pro forma non-GAAP income statement with and without the impact of foreign exchange rate. The numbers in the first column are straight from our pro forma non-GAAP income statement. I will focus my comment on the second column of numbers, which strips out the impact of foreign exchange rate on our pro forma non-GAAP results.

First, you'll see the 7% revenue growth I mentioned earlier. Next you'll see that after the impact of FX, cost of sales increased only 3% as a result of our cost containment efforts as well as strong production volume output. In total, operating expenses grew 5% in performance terms, below our 7% revenue growth, performance growth in operating expenses were driven by an increase of 4% in marketing, selling and administrative expenses and an increase of 7% in R&D expenses. Thus excluding the impact of foreign exchange, we drove improvement in the gross margin percent as well as operating leverage with revenue growth outpacing operating expense growth.

Robust performance growth in revenue and control of total expenses allowed us to leverage 7% revenue growth into 16% operating income growth. You may recall that in Q1 we drove 19% operating income growth excluding the impact of FX. Comparing the increases in operating income and EPS with and without the impact of the FX highlights that a vast majority of the growth over Q2 2008 was driven by performance. In fact rate contributed approximately $0.03 per share to our Q2 EPS growth, while the other $0.15 came from pure performance.

Now, hopefully this analysis provides you with a better understanding of the impact foreign exchange had on our Q2 results and underscores the strong underlying financial performance we generated in the quarter. Slide 14 shows the year-on-year growth of select line items of our reported income statement, both with and without the impact of foreign exchange rate. Now what do our Q2 financial results mean for the remainder of 2009 and therefore for our 2009 financial guidance.

Moving to slide 15, let’s first discuss the impact of foreign exchange rates. If exchange rates remain at current levels for the rest of 2009 the fluctuation exchange rates in Q3 and Q4 of 2008 would negatively impact the year-on-year comparisons for international revenue and margin in Q3 of 2009, while the impact in Q4 of 2009 would be small.

The substantial benefit from FX related to international inventories sold that was seen in the first half of the year would not be repeated in the second half as any addition or reduction to the cost of goods sold would be minimal. Year-on-year comparisons would however be impacted by the additional cost book in Q3 of 2008 and the significant reduction in cost book in Q4 of 2008.

In terms of operational performance, first we expect to see continued volume driven revenue growth. However, we may see more significant erosion of Gemzar sales as generics penetrate international markets. Second, we expect to see upward pressure on our operating expense growth in the second half due to various factors including the ramp up of U.S. and international prasugrel launches. Anticipated higher DTC spend, the advancement of our pipeline into later and more expensive stages of development and potential milestone payments. And third, in addition shutdowns at our manufacturing plants are more heavily weighted to the second half of the year.

With this context, let's move to slide 16 and I will summarize our 2009 guidance. Given the strong performance in the first half of the year we are raising our 2009 earning per share guidance to a range of $4.20 to $4.30 per share on a pro forma non-GAAP basis. This corresponds to a range of $4.14 to $4.24 on a reported basis. We also reconfirm our line item guidance on a both a pro forma non-GAAP and reported basis. We continue to 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 for the year is expected to increase, driven by beneficial impact of foreign exchange in the first half of 2009, compared to the first half of 2008. For the second half of 2009, we expect a decrease in gross margin as a percent of revenue.

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. We expect other income for 2009 to be a net deduction 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 Nick for our product review. Nick?

Nicholas Lemen

Thanks Derica. This quarter we've changed the format for the product review. For those of you looking for the prior information, you will find the qualitative price, rate, volume, and product discussion in our earnings press release and you will find the product sale slides at the end of this presentation. What we will do instead is highlight a few products in our portfolio, focusing on what we feel are some of the more important trends.

As you can see on slight 18 and as mentioned earlier in Q2 we again posted volume driven sales growth. This is a trend we've seen for nearly the entire decade. In the lower chart, you will see the contribution made by select products to our worldwide volume growth of 4%. Alimta and Cymbalta were the biggest contributors with Humalog, Zyprexa, Animal Health, and Byetta also contributing nicely. Decline in Gemzar's volume as a result of generic competition in Europe. While the decline in Evista is due to the out licensing of the product to Daiichi Sankyo in most European markets. Now, let’s look to the underlying prescription and share market trends for Cymbalta, Alimta, Cialis and Byetta.

One of the more common questions we have received recently is regarding the impact of the economy in our business. Most notably for Cymbalta in the antidepressants and pain marketplace. Many believe that the downturn in the economy has led to an increase in the usage of generic antidepressants. Slide 19 shows that while the use of generics is increasing, the trend is not accelerated as the economy is suffered.

Slide 20 shows the status of competition amongst the branded selective norepinephrine reuptake inhibitors in the antidepressant and pain marketplace. Wyeth's Effexor XR and Pristiq and Lilly Cymbalta. The red line shows that Cymbalta has surpassed the combined new prescription market share of Effexor XR and Pristiq, a notable achievement for the product in the competitive U.S. market.

Now on to the Oncology marketplace, where Lilly continues to make great strives towards establishing itself as a powerhouse. Slide 21 shows market share trends for the first line setting of non-small cell lung cancer. The red line represents Alimta continued growth in this setting up to a 21% market share as of May on the strength of our first line approval last September in locally advanced or metastatic nonsquamous non-small cell lung cancer. Alimta's performance continues to provide us with the confidence that we are on the right track by focusing on targeted therapies. Alimta continues to grow impressively even as use in the squamous population falls to near zero. One other note in the slide is the performance of Gemzar, which continues to hold relatively stable with an 11% market share in the first-line non-small cell lung cancer market.

Moving on now to Cialis, our product for the treatment of erectile dysfunction. Slide 22, shows U.S. new prescription share of market by specialty in the ED marketplace. Cialis continues to make progress on closing the market share gap from Pfizer's Viagra in the primary care physician's office represented by the graph on the top of the slide. In addition, Cialis has surpassed Viagra in the new prescription share in urologist office. We are also pleased with the progress Cialis has made in the European market. As you can see on slide 23, Cialis passed Viagra in dollar share of market in Q4 last year aided by introduction of the once daily formulation Cialis has begun to pull away from the long time market leader.

Next let's go to an update on Byetta, the injectable type 2 diabetes product we promote with Amylin. In August of last year, the FDA provided a safety update on Byetta concerning pancreatitis. As you can see from slide 24, this update coincided with a drop in Byetta's total prescriptions in a growing diabetes market. After addressing the pancreatitis concern with our customers late in 2008 in early this year, we’ve been able to refocus our efforts on the efficacy of the product, in which patients are best suited for its use. As you can see on the top chart these efforts have resulted in a TRx trend that more closely matches the broader diabetes market. Encouragingly, the bottom chart shows that we have recently returned to share growth in NRx.

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

Steven M. Paul

Well thanks Nick. Let me start with a few comments on the FDA approval of Effient. First and foremost, we are excited to offer this important new option for patients with acute coronary syndromes who are being managed with PCI. Effient is now approved in the U.S. and Europe as well as Australia and with a very good label. We feel that the positive benefit risk profile prasugrel offers a large percentage of ACS/PCI patients will be readily recognized by interventional cardiologists and that pairs with the compelling health economics value proposition.

The boxed warning for bleeding risk may necessitate a more in-depth discussion of prasugrel benefits and risks with some physicians, particularly in the primary care setting so that they appropriately weigh the benefits with the risk as opposed to focusing solely on the risk. As we engage in these discussions, we are armed with convincing data from the TRITON-TIMI 38, a head-to-head superiority trial versus the established standard-of-care Clopidogrel. The data generated in the TRITON-TIMI 38 trial provided compelling evidence for patients, physicians and payers that prasugrel significantly reduce the combined risk of cardiovascular death, heart attack or stroke, when compared to Clopidogrel, the current standard of care and did so for a wide range of patient types.

Prasugrel generated a reduction in these events of 18% in patients with unstable angina and non-ST elevation miocardial infarction, 20% in more severely ill patients with ST elevation MI and 30% in diabetic patients. Prasugrel also produced a 34% reduction in urgent target vessel revascularization, a 35% reduction in subsequent occurrences of the primary composite endpoint of CV death, non-fatal MI or non-fatal stroke recall that our primary composite endpoint only captured the first occurrence of these events and a 50% reduction in stent thrombosis. All of these reductions were statistically significant and we believe clinically very meaningful.

In addition, the conversion of Prasugrel into its active metabolite enhance the ability of a patient to benefit from its antiplatelet effect does not seem to be influenced by CYP2C19 genotype. This is in contrast to the pharmacokinetics of Clopidogrel's active metabolite, which is affected by genetic variations in CYP2C19. As reported in the Plavix label, somewhere between 28% and 64% of patients depending on ethnic background may not expensively metabolize Clopidogrel. Patients with impaired metabolism of Clopidogrel may face an increase risk of death, myocardial infarction and stroke.

Now in terms of safety, prasugrel was associated with a significantly higher risk of serious bleeding event compared to Clopidogrel. Specifically, the TRITON-TIMI 38 clinical study, the risk of non-CABG TIMI major bleeding including life-threatening and fatal bleeding was higher in patients treated with Effient plus aspirin 2.2% compared with Plavix plus aspirin 1.7%. The risk of bleeding was highest in Effient-treated patients, who were either 75 years of age or older, weight less than 60 kilograms or who had a prior history of transient ischemic attacks or stroke. In the U.S. Effient is contraindicated in patients with a history of prior TIA or stroke or with active pathological bleeding.

In addition, the drug is generally not recommended in patients 75 years of age or older except for patients in high-risk situations such as those with diabetes or a history of prior heart attack. Patients with a prior history of TIA or stroke were 4% of the patient population in TRITON and patients 75 years of age or older that were non-diabetic and did not have a history of prior heart attack TIA or stroke were about 7% of the TRITON patient population. Thus we feel that the U.S. label contraindicates or generally recommends against the use of prasugrel in a relatively small percentage of ACS/PCI patients.

The label does suggest consideration of the 5-milligram maintenance dose for patients weighing under 60 kilograms to manage the risk of bleeding. In addition, the label encourages physicians to manage bleeding without discontinuing prasugrel as stop in treatment can increase the risk of subsequent cardiovascular events. You undoubtedly have many questions about prasugrel, which I will be happy to answer during the Q&A. We will also be joined by Dr. Tony Ware, Head of our Global Diabetes and Cardiovascular teams and by Javan Collins, who is responsible for prasugrel sales and marketing in the United States.

Now, let me provide a brief update on our pipeline. In the second quarter, we continued to increase the number of new chemical entities and new biologic entities in clinical development. As I mentioned last quarter, the current list of compounds in some stage of human testing at Lilly is larger and more exciting than at any time in the history of the company. Our clinical stage portfolio now stands at 66 distinct entities, including 26 compounds in Phase II and Phase III. And we continue to build a robust biotech portfolio.

In fact, biotech molecules represent half of our late stage Phase II and Phase III assets and almost 40% of our overall clinical portfolio. As we have made abundantly clear we are squarely focused on advancing our pipeline reflected by the arrows on slide 26, since our last formal portfolio update during the first quarter earnings call. We have initiated two Phase III clinical trials on Solanezumab, our anti beta antibody for the treatment of Alzheimer's disease. We moved once cancer compound into Phase II testing and we moved six more compounds into Phase I test. We did terminate development of one Phase II compound being studied for hot flashes.

We are building a pipeline that we believe will meet the challenges of the next decade providing a continuos flow of two launches per year of high value medicines by 2013. To this end, we continue to estimate that of the 66 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 5 to 10 years.

Now let me turn to slide 27 to highlight upcoming potential regulatory and clinical milestones. FDA action is also pending on the Byetta monotherapy indication and on Byetta labeling. We await the response to our reply to the complete response letter we received from the FDA on Zyprexa LAI. Earlier this year the FDA raised concerns about pharmacokinetic 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. Pending the outcome of the PK study we hope to resubmit the non-small cell lung cancer sBLA and respond to the head and neck cancer complete response letter in the second half of this year.

Other potential milestones this year include submitting our arzoxifene to the FDA and presenting data from our large Phase III GENERATIONS trial. Reporting Phase III results for dirucotide in secondary progressive multiple sclerosis, initiation of Phase III trials for ImClone’s 11F8 and A12 for cancer, and initiation of Phase III trials for tasisulam also for cancer. The second half of 2009 should continue to be eventful in Lilly Research Laboratories and across the company. As we continue to advance our pipeline and transform our company to compete and win in the coming years.

Now this concludes our prepared remarks and now we will open up the call for the Q&A session. Operator, first call please.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of John Boris from Citi. Please go ahead.

John Boris – Citi

Thanks for taking the questions. First question just has to do with the EPS increase of about $0.05 on your guidance range. It seems as though you did the consensus pretty handily in the quarter by $0.10 and then first quarter was about a $0.20 beat. So if you could possibly take us through your thought process here on the $0.05 raise relative to the magnitude of the beat in the initial quarters. And then second question just has to do with Effient, it appeared trade at an 18% premium can you just comment on how you plan on or what your targets are for meeting drug store stocking and hospital stocking? Are there certain percentages of those stores that have been stocked since you put the product into the channel? Can you give us any commentary on formulary access and then just on length of therapy? Can you remind us what the length of therapy was at the TRITON trial? How long patients stayed on average Effient therapy and in clinical practice obviously, I believe Plavix has a much lower rate relative to what they have been in TRITON, but how you plan on driving length of therapy with Effient therapy? Thanks.

Philip Johnson

Derica will take your EPS and guidance question, we will Javan and Tony answer the questions you got lined on Effient?

Derica W. Rice

Hi John, this is Derica. John we had good strong underlying performance in the first half of the year. We still expect that to continue into the second half, but we still expect a volume driven growth in the second half. Some of the things that is impacting us in the second half that wasn't there in the first half as I mentioned earlier on the call was one we are going, you're going to see us ramping up our operating expense spend for the to support the launch of Effient in the U.S. as well as other OUS markets. We will also see I anticipate a higher DTC spend, we worked on the AIR fully in the first half of the year. And then also as you've heard Steve's comment, we are expecting also to see an increase in our R&D expense associated with the advancement of our pipeline to both the later stages, which happen also be the more expensive stages of development. And embedded in there are also some milestone payments. Some of the things that you saw in the first half such as the FX benefit in our gross margin, we expect to mitigate and basically be neutral in the second half of the year. And then likewise the headwind that we’ve seen on the international performance both in sales and our international operating margins, we expect to still be present, but somewhat more muted or dissipated in second half. So that's really what's impacting our outlook for the year, but all in all we still expect strong underlying business performance in the second half of the year.

Javan Collins

John, its Javan Collins. Regarding your question on pharmacies, we are currently contracting with pharmacies across the distribution channel. We expect to have a majority of pharmacies stocked, when we launch Effient the first week in August. As we look at the other hospitals or managed care organizations, we've also began discussions with hospitals and managed care organizations. We do have contracts in place with the GPO and we expect a rapid formulary access across the board because of the value that we are providing with regards to the value proposition for the payers, but also too in the TRITON study, the TIMI 38 study there was a sub-study that was done and that data were published at AHA and that study basically show that Effient offsets the cost of other healthcare costs and as you can imagine, we lower the cost because we have lower MIs, we also lowered the cost because we have fewer recapitalization that Dr. Paul mentioned, but we also have higher cost because of increased bleed. And so even with the 80% price premium, we still have results in that savings for the healthcare system. Now, with regards to the length of therapy question. In the trial, the trial went to 15-month, the median was 14.5-month. Our plans and our focus is obviously the primary care physician who is going to be managing that patient over the long-term and really communicating through the patient as well as the physicians the benefit and the value that the patient gets over the 15-month. This is important because Effient provides lower events myocardial events, CV death and stroke not just in the early stage, but also out to 15 months. Again as Dr. Paul mentioned, the study only looks the first event it did not factor in the second event of very good and we've got a great plan in place. Now, you'll have to ask BMS and Sanofi events regarding their length of therapy, but we are confident and we will be working towards the 15-month that we have in our label.

John Boris – Citi

Okay.

Philip Johnson

Operator next caller, please.

Operator

Thank you. And we have a question now from the line of Eric Low from Banc of America/Merrill Lynch. Please go ahead.

Eric Low – Banc of America/Merrill Lynch

Good morning guys. On Effient, I wanted to get some clarity in terms of the OUS ramp that you guys have in the U.K. and Germany. What's the reason behind the slow sales ramp that we saw sequentially from Q1 to Q2 and second question is on cost savings, can you update us on what the year-to-date cost saving initiatives through the Six Sigma program have saved you guys?

Philip Johnson

Thanks Eric. We will have Tony Ware take your first question. And then Derica will answer your second question on the Six Sigma savings for the first part of the year.

J. Anthony Ware

Hi, this is Tony Ware. In terms of sales outside the U.S. remember that we were just approved earlier this year, we are still negotiating with the regulatory authorities to receive full approval at that point. So, this is still very early days for us to really look at those cost. We are specifically in the United Kingdom until we get a full opinion from the National Institute for Clinical Effectiveness, we don't expect to have significant sales.

Derica W. Rice

Okay. Regards to the Six Sigma savings, we have never quantified on a quarterly basis kind of the Six Sigma that are flowing through our results. What I can is the impact that you're seeing is pretty relevant I think both in our gross margin line and our operating expenses. So if I just focus you on the slide where I displayed operating performance absent FX and if you see that in that 7% performance growth for revenue, 4 percentage points of that was driven by volume, our cost of goods sold only increased 3%, so we are able to basically gain significant leverage out of gross margin line on a operating performance basis due to the productivity improvement that we are seeing from Six Sigma and other measures in both our manufacturing organization, but also when you look at our operating expenses the fact that they only grew 5% versus the 7% since they were getting it in the rest of the line items as well. So you're seeing the impact of not only Six Sigma, but a whole host of productivity improvement efforts that we have going on across the entirety of the organization.

Steven M. Paul

It's Steve Paul here, it's difficult to quantify, but we are also seeing a very nice impact with Six Sigma on reducing clinical development cycle times. We think this will help us get these products to market much faster.

Philip Johnson

Operator, next caller please.

Operator

Thank you. And we have a question from the line of David Moskowitz from Caris & Company. Please go ahead.

David Moskowitz – Caris & Company

Yes. Thanks and good morning. I have a few questions. Have you guys given a PDUFA date for Byetta LAR?

Steven M. Paul

Yes we have, its March the 5th of 2010 it's a standard review.

David Moskowitz – Caris & Company

Very good. And I just want to talk about the interest costs. They looked very low in the quarter. I would assume this is attributed to low financing costs of ImClone. Can you talk about what those are going to look like going forward?

Derica W. Rice

I'll take that. This is Derica. Well, first of all if you look at Q2 versus Q1 recall that as we moved through time we have retired some of the debt as well as we also do not have in the second quarter the bridging cost of debt that we had in the first quarter. So that is impacting the quarter-on-quarter. If you look at the debt that we turned out, which was about $2 billion between three-year and five-year. The blended rate was just south of 4%.

David Moskowitz – Caris & Company

So I should expect the cost to go up on a sequential basis from here?

Derica W. Rice

To go up, no.

David Moskowitz – Caris & Company

Well you said, there were not bridging expenses in this quarter?

Derica W. Rice

In this quarter, but….

David Moskowitz – Caris & Company

So that…

Derica W. Rice

We are out of the bridge. We did have bridging interest expense in the first quarter because we had not turned out to debt yet from and…

David Moskowitz – Caris & Company

Got it.

Derica W. Rice

That was not present in the second quarter and then obviously will not be present going forward.

David Moskowitz – Caris & Company

Okay.

Philip Johnson

David this is Philip. Well on the helping may trend over time with regard to interest expense, this is probably around 50% to 60% is my recollection of our debt that is variable rate. So, a good portion of that interest expense will move as rates move going forward.

David Moskowitz – Caris & Company

Yeah. Okay. Thanks that's helpful. And just on Effient, can you talk about how you are going to be thinking about the short half-lives as a differentiator of the product in the field?

J. Anthony Ware

I think that the half life is not as relevant to how this works, importance of Effient is how it generates the active metabolite, the half life of the parent compound isn't is clinically relevant, the advantage that we see with Effient occurs in its very efficient metabolism and the fact that it doesn't require isn't as nearly as dependent on enzymes in the CYP system, such as the much discussed 2C19 that has been in a lot of the press lately. Because of this it makes the onset the point of metabolite interferes with platelet aggregation faster and it occurs at a higher rate meaning it causes a stronger interactions with the platelets and it also is much more consistent in that there were fewer non-responders.

Steven M. Paul

David I see the active metabolite is essentially an irreversible inhibitor of the receptor and so it really is the half-life of the platelet that you worry about. So, it’s a long acting medicine in that regard.

J. Anthony Ware

Yeah it's right.

Steven M. Paul

It covers very, very nicely.

David Moskowitz – Caris & Company

Okay, thanks very much. I appreciate it.

Philip Johnson

Thanks David. Operator next caller please?

Operator

Thank you. We have a question now from the line of Jami Rubin from Goldman Sachs. Please go ahead.

Jami Rubin – Goldman Sachs

Thank you. Two questions both related on Effient, if you can give us sort of a little bit of color on what you’d expect the launch curve to look like, one of the issues that we need to think about is the uptake by managed care and typically some P&T committees don't meet for six months. So, if you can give us a sense for what you expectations are for the launch curve and timing of formulary positioning. And then if I could switch gears a bit, Derica if you can help us to understand how much leverage you have with discretionary spending during the patent cliff years and, obviously you've got a very deep early stage pipeline, which presumably would require continued increases in R&D expenses, but as we look out 2011 and beyond with the significant revenue hole, how do we think about modelling those expenses going forward? Thanks.

Philip Johnson

Thanks Jami. We will have Javan answer your first question and Derica for the cost question.

Javan Collins

Jami, Javan Collins. As you know, we don’t provide projections for individual products however we expect to perform extremely well in our indicated population. Now, as we look at the payers Medicaid Part D we're focusing on as well as the managed care and also the big PBMs. Now, these institutions review new products at different time points. However, we have a plan in place to try to accelerate that, we do have specific goals we are not providing those. And we do expect as we look at Effient based upon the value that it provides to patients, the expected pull that we expect to have from cardiologists and also to the healthcare savings even with the premium, we expect things to move very quickly.

Derica W. Rice

Yeah, okay. Jami this is Derica. We haven't given a lot of detailed guidance in terms of our outlook for the YZ years or patent cliff years, but let me at least give you some color commentary here. One, clearly with the loss of Zyprexa and then subsequently Cymbalta, you will see upward pressure on our cost of goods sold percent. You will also see upward pressure on our tax rate, effective tax rate we lose the efficiency in terms of the production of Zyprexa and Cymbalta, our manufacturing operations as well as some of the tax benefit. What you should also expect to see is that to the benefit side obviously we will remove the direct cost associated with those products and likewise you will continue to see cross-organizational efficiencies that we will continue to strive for. Now, those cross-organizational efficiencies will not just wait until 2011. You're also seeing us doing that today, hence my earlier comment around the productive improvements we are seeing in manufacturing even today as well as also in the SG&A line. I do not believe we will have exhausted by, with the time we get to 2011 all of the efficiency opportunities within the organization. Even while we're still improving year-on-year.

Philip Johnson

Operator, next caller please.

Operator

Thank you. We have a question now from the line of David Risinger from Morgan Stanley. Please go ahead.

David Risinger – Morgan Stanley

Yes. Thanks very much. I have a number of questions. I guess first on Effient, can you provide a little bit more color on your expectations for future uptake of Effient. Second on Effient, could you just talk about whether or not the U.S. FDA approval delay impacted the TRILOGY study and tell us about the current status of the TRILOGY study and when you expect it to report out? And then in terms of FX, if you could just tell us the impact on EPS. And then finally on Cialis page 23 of your slideshow it seems like in the past five to six months the share gain versus Viagra has dramatically increased, could you just speak to whether there was something that happened, specifically to drive the Cialis franchise or whether its Pfizer just pulling back on resources that’s a material driver of the Viagra share loss? Thank you.

Philip Johnson

Sure. So, we will have Javan and Tony probably handle the first questions that you have asked on Effient. Derica to talk about the EPS and then Nick will update you on what's been going on with Cialis.

Javan Collins

David, Javan Collins. With regards to expeditious uptake for Effient, we've got strong expectations on what we expect the product to do and again we expect to perform extremely well in the indicated population. Also to as you look at the updates that the FDA did to our label as well to the label of Clopidogrel, you will see a number of things. One is that you will see the strong efficacy across a wide variety of patients, you'll also see the stent thrombosis at over 50%, you'll also see the fact that the pharmacogenetic sub-study that Effient does not have these type of interactions with the Cytochrome P-450 system and it's been updated in the clinical labels that they have some challenges there. So we think that across the board as we look at all of these elements that we are very confident about the uptake as well as the future for Effient.

J. Anthony Ware

David, it's Tony Ware. Regarding TRILOGY, TRILOGY we've changed the primary completion date from March of 2011 to October of 2011 and that’s when we expect that to report out. So it’s a seven months delay. Well I don’t think that is related to the U.S. FDA delay that's of course difficult to assess. We think that the major cause for that delay was the slower than expected enrollment. We saw a lot of patients who had ACS and otherwise qualified for the study but they were being screened out based on the original inclusion, exclusion criteria so we have implemented a number of protocol amendments that we think will speed up enrollment for that and hopefully we will be able to bring that in and make up for this seven month delay.

Steven M. Paul

David, its Steve Paul here. I think part of the future success of Effient will depend in part on the implications of the fact that Clopidogrel may not be working well in a large sub-group of patients simply because they can’t metabolize the drug to the act to metabolize. So if you think of the pharmacogenomic study that have already been published, if you think about the update to their label and to our label, somewhere between 30% and 40% of patients may not be getting an adequate dose of Clopidogrel, of Plavix. Data that's been published not by Lilly necessarily, by others suggest that this has significant implications in terms of risk with cardiovascular disease, serious disease, MI, stroke things like that. I'm not exactly sure how this story will play out. There will obviously be the need for more data from others, but to me it has potentially some very profound implications down the road.

Nicholas Lemen

Yeah and I will just add to that to Dr. Paul because even at the last cardiovascular meeting, Medco presented data from their database looking at claims data around the interaction about that Dr. Paul referring to and so we know that the payers are extremely interested in this because they want to, as physicians, we all do want to ensure that patients are really getting the benefit from the drug such as Effient and so we are very confident about the future and I think to Dr. Paul's comment we do expect some more and more data to be released from the academic community regarding the differences.

Derica W. Rice

Okay. David in regard to your question around FX impact on the results, if you recall just one of the slides that we shared in the deck if you remove the impact of exchange rate out of our results we had 7% performance revenue growth comprised of volume and price. We were able to leverage that rev 7% to 16% operating income and EPS growth. So of the $1.12 pro forma results that we, EPS that we reported about three pennies or $0.03 of that was related to FX benefits in the quarter?

Philip Johnson

Yes. Jut to be precise, when you talk about the $0.18 that's the change from last year's Q2 2008 pro forma EPS up to the $1.12 we booked this quarter at $0.18 different only $0.03 of that Dave is from FX. The rest of the $0.15 is from operating performance.

Nicholas Lemen

And Dave this is Nick. With regards to your question on Cialis I can't comment specifically to Pfizer's actions promotionally, but what we have seen is continued share growth since the launch of our on-demand Cialis. In addition, we've seen a nice uptake from the once daily launch in U.S. in March of '08 and elsewhere around the world as well. We feel that the once daily in combination or in additions rather to the on-demand formulation provides important option for patients and physicians and provides the flexibility of dosing options that people really appreciate.

David Risinger – Morgan Stanley

Okay thanks.

Philip Johnson

Robert. We have the next caller please.

Operator

Yes. We have a question now from the line of Tony Butler from Barclays Capital. Please go ahead.

Tony Butler – Barclays Capital

Thanks very much. Three questions please, again on Effient. Dr. Paul you actually alluded to patients who maybe inadequately dosed even on Clopidogrel, but I'm curious given the label and despite the fact that TIMI-38 was done at 10 milligrams. As many interventionalist will now consider outside of the 4% of the population, which was specified or pre-specified in the label consider simply using 5 milligrams, is that going to be sufficient for those patients who are going to be put on prasugrel, its question one? Number two is do you know or do you have or are you aware of any additional publications on prasugrel that maybe coming out in the future maybe useful for the overall community at a time during the launch. And then the third question on Alimta clearly having some very important and to me at least surprising growth what do you think the maintenance therapy or how do you think oncologists will behave with utilizing this agent in maintenance therapy given there is no particular reason to move away from first-line cisplatin and or Alimta cisplatin when in fact you don't have a patient which is relapsed, how do you think they'll be motivated to use that agent under that guide? Thanks very much.

Philip Johnson

Javan and Tony go ahead and handle your first question for the Effient 5-milligram and the publications coming out for prasugrel and then probably Dr. Paul and ourselves will go ahead and answer your question on Alimta.

J. Anthony Ware

Tony, this is Tony Ware. And regarding the 5-milligram we received approval for the 5-milligram as you noted in the lower body weight patients that is those patients less than 60 kilograms. It is difficult to speculate about whether an interventionalist would choose to use a lower dose in some of their patients later on for that that obviously would be up to the discretion of the treating physician. We don't have a data to guide outcomes of course in that lower dose population. We do have some bioequivalence data in the Phase II we performed some pharmacokinetics studies and we can guide, those data are available for the physician to refer to regarding how much active metabolites is generated by the 5 milligrams versus the 10. As you may remember the 10-milligram dosage was selected for Phase III because this was the lowest dose in which there were no non-responders and that was the basis for that choice and why we have taken that through. Some additional information on 5-milligram will be available with TRILOGY. In that study, we are randomizing patients to receive who are less than 60 kilograms, 132-pound or those patients who are 75 years of age or older to receive the 5-milligram maintenance instead of 10. In terms of publications coming forward I know our academic colleagues are continuing to work on papers during that time this has been a very rich source of data material for the TIMI group and for their colleagues and I think it is fair to call it remarkable set of scientific publications that have occurred with this database thus far and there will be more to come.

Javan Collins

Yeah I will just add to that our market research would suggest that there will be very little 5-milligram utilization. I think the second thing is that with some of the things that we've discussed, these are very hot topics in the cardiology academic community. So, we actually expect there to be more publications that will be from the cardiology academic community you will be seeing from Lilly.

Steven M. Paul

Tony just a few comments on Alimta maintenance therapy for non-small cell lung cancer. First off I think we are in a new era, new territory here I think this is pretty much the only drug that's ever been shown to be effective in maintenance therapy for this disease and as you know, the survival advantage was five months, which is really quite substantial. Again how this will play with and by the way that was in the nonsquamous group of patients where we have already shown that that is the sub-group that response well for this drug as opposed to the squamous cell mythology. As you well know non-small cell lung cancer is still a terrible disease, it’s a fundamentally a fatal disease. There are very few people that have cured from it really unless its kind of resected very early et cetera. So, I personally believe that patients will elect particularly if the treatment is effective to more aggressively treat and try to prolong survival in the maintenance mode rather than wait until the tumor recurs and then go for another round of chemotherapy, but of course this will need to be played out overtime, but we are thrilled with the data, thrilled with the results that we've seen in five months is a pretty big deal in this field.

Tony Butler – Barclays Capital

Great.

Philip Johnson

Robert, we'll take one last caller.

Operator

Thank you. We have a question now from the line of Bert Hazlett, BMO Capital Markets. Please go ahead.

Robert Hazlett – BMO Capital Markets

Thanks, I've got a couple. First off, I guess we are going to hear on the dirucotide a little bit, in a little bit, could you frame that opportunity for us in terms of the potential. And with regard to the data specifically, I believe they're called the MAESTRO studies are you able to file on if the MAESTRO-1 study is positive or do you need the second study as well. And when will the second study play out? And then a question on potential competition for Effient, you've got an AstraZeneca compound that’s going to be showing Phase III data relatively short order here. It appears to have decent platelet aggregation in addition, but also some side effects, some increase in uric acids and dyspnea and ventricular pauses seen in Phase II. How do you think Effient will stack up against that potential competitor ACD6140? Thanks.

Philip Johnson

Okay, thanks Bert. We'll have Dr. Paul work on the first question for you and then I will turn it over to Tony to talk about the extra compound, he is going to talk a little bit about the potential for this.

Steven M. Paul

Yeah I mean as you know this is a completely new approach to treating multiple sclerosis, we are in the clinic now in a very large Phase III study, which as we've said we will see the results, announce the results by the second half of this year. This is the MAESTRO-1 study for secondary progressive MS. As you probably know the only real treatments out there or treatments that really profoundly affect the immune system at the suppressants they themselves have other unfortunate adverse events associated with the treatment and this is a very, very specific approach to prevent the progression of these secondary progressive symptoms of MS. So, I am fairly confident that if we see robust results in this study that there will be great enthusiasm for bringing this drug to patients sooner obviously those would be discussions that we would have to subsequently have in.

Robert Hazlett – BMO Capital Markets

Steve I do believe that's, you assigned a fast track in the creation for the drug, is that correct…

Steven M. Paul

Correct.

Robert Hazlett – BMO Capital Markets

Also if you really did have outstanding data that would be especially seemed to be opened?

Steven M. Paul

People are enthusiastic about seeing results for this disease including the regulators. So, I think we will be in pretty good grounds obviously it will depend on the robustness of that data.

Philip Johnson

Tony?

J. Anthony Ware

Bert, its Tony Ware. Regarding the AstraZeneca compound it’s a little early to comment on it, since we haven’t seen the Phase III data yet, it differs fundamentally from Effient in a couple of ways Effient is a irreversible inhibitor meaning that it last – it inhibits the platelet for the lifetime of the platelet, whereas Astra inhibitor is reversible platelet inhibitor. It’s a twice a day drug, and as you point out in your question in Phase II there were several side effects, which include shortness of breath and about 12% of the patient in nausea and in ventricular pauses, but I think that we will have to see what the data shows us at the ESC for me to be able to comment a little bit more intelligently about that.

Philip Johnson

Derica?

Derica W. Rice

Okay. I want to thank you all for taking your time this morning for this update on Eli Lilly and Company. And we truly appreciate your interest in our company. Let me close by emphasizing just a few key points. We performed very well, I believe so far in 2009, for the quarter, we delivered strong operating finance results with volume driven revenue growth, continued leverage between growth and revenue and operating expenses, and increase in 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 ever increasingly challenging healthcare environment. Now, clearly we have staked our future on innovation building upon our 2007 and 2008 pipeline progression. With a strong 2009 as we build the robust pipeline of 66 distinct NMEs and we have advanced 10 compounds into Phase I testing.

We have advanced five compounds into Phase II testing. We have advanced one compound our A-beta antibody for Alzheimer’s disease into Phase III testing. And importantly we have achieved regulatory approval for prasugrel in both the U.S. and the EU. We are optimistic about the benefits that this drug can bring to the treatment of patient with ACS undergoing PCI. We do look forward to keeping you informed of our continued progress and we wish each of you a great day.

Operator

Thank you. Ladies and gentlemen this conference will be available for replay after 11:00 AM today through midnight on July 29. You may access the AT&T Teleconference replay system by dialing 1-800-475-6701 and entering the access code 105581. International participants can dial 320-365-3844 with access code 105581. Once again those numbers are 1-800-475-6701 and 320-365-3844 with the access code 105581. That does conclude our conference for today. Thank you for your participation and thank you for using AT&T Executive Teleconference service. You may now disconnect.

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Source: Eli Lilly and Company Q2 2009 Earnings Call Transcript
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