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Executives

Philip Johnson – Vice President-Investor Relations

Ilissa Rassner – Director-Investor Relations

Derica W. Rice – Executive Vice President, Global Services and Chief Financial Officer

John C. Lechleiter – Chairman, President and Chief Executive Officer

Enrique Conterno – Senior Vice President and President-Lilly Diabetes

Jan M. Lundberg – Executive Vice President, Science and Technology and President-Lilly Research Laboratories

Analysts

Tony Butler – Barclays Capital, Inc.

Gregg Gilbert – Bank of America Merrill Lynch

Timothy Anderso – Sanford C. Bernstein & Co. LLC

Mark Schoenebaum – ISI Group

Jami Rubin – Goldman Sachs & Co.

Steve Scala – Cowen and Company

Chris Schott – JPMorgan

Marc Goodman – UBS

David Risinger – Morgan Stanley

John T. Boris – SunTrust Robinson Humphrey

Damien Conover – Morningstar

Eli Lilly & Co. (LLY) Q2 2013 Earnings Conference Call July 24, 2013 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 Earnings Call 2013. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) And as a reminder this conference is being recorded.

I’ll now turn the conference over to Phil Johnson, Vice President of Investor Relations. Please go ahead, sir.

Philip Johnson

Good morning and thank you for joining us for Eli Lilly and Company’s second quarter 2013 earnings conference call. I’m Phil Johnson, Vice President of Investor Relations. Joining me today are John Lechleiter, our Chairman, President, and CEO; Derica Rice, our Chief Financial Officer; Dr. Jan Lundberg, President of Lilly Research Laboratories; Enrique Conterno, President of our Diabetes Business; as well as Ilissa Rassner and Travis Coy from the Investor Relations team.

During this conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on slide three and those outlined in our latest Forms 10-K and 10-Q filed with the Securities and Exchange Commission. The information we provide about our products and pipeline is for the benefit of the investment community. It is not intended to be promotional and is not sufficient for prescribing decisions.

We’re very pleased with the solid financial results we delivered in the second quarter of 2013. Strong performance of key products and ongoing cost containment efforts have allowed us to raise our full-year financial guidance and continued to place us on track to meet or exceed our financial minimum goals through 2014.

Let me begin today’s call to review key events that have taken place since our last earnings call. In clinical news, I’ll start by reviewing some of the highlights from recent medical conferences. At the American Diabetes Association Scientific sessions, we present a detailed data from the initial Phase 3 trials for both dulaglutide, and in collaboration with Boehringer Ingelheim, for empagliflozin. Along with Incyte, at the European League Against Rheumatism’s Annual European Congress of Rheumatology, we presented 52-week efficacy and safety data from the Phase 2b trial of baricitinib in patients with rheumatoid arthritis. And at the meeting of the American Society of Clinical Oncology, we announced that the PRONOUNCE study, comparing an Alimta/carboplatin doublet regimen to a paclitaxel/carboplatin/bevacizumab triplet regimen did not achieved its endpoint of improved progression-free survival without grade four adverse events.

In other clinical news, we announced that the Phase 3 trial for enzastaurin, did not meet its primary endpoint for improved disease-free survival in patients with diffuse large B-cell lymphoma, who are high risk for relapse, and we stop the Phase 2 study for our BACE inhibitor being investigated as a once-daily treatment to slow the progression of Alzheimer's disease.

On the regulatory front, the marketing authorization application for our new insulin glargine product was accepted for review by the European Medicines Agency, and we received approval in the EU for Strattera for the treatment of adults with ADHD. Strattera is the first product indicated for adults with ADHD across the EU regions.

And from a commercial perspective, we’re disappointed with the Centers for Medicare & Medicaid Services draft decision that proposed Coverage with Evidence Development for the use of beta-amyloid Positron Emission Tomography imaging agents, which includes our approved product Amyvid. We believe that insufficient Medicare coverage would be a significant set back for patients and the Alzheimer's disease community.

Now let’s turn to our financial performance. First, I’ll provide some brief comments about our GAAP results and then discuss a few non-GAAP measures, which we believe provides insights into the underlying trends in our business.

As you can see on slide 6, worldwide revenue increased 6% as growth in key products including Cymbalta, Cialis, Tradjenta, Animal Health, Axiron, Effient, Insulin and Forteo, more than offset lower Zyprexa revenue following patent expirations and for exenatide revenue following the transition of commercial rights to Amylin.

Excluding Zyprexa outside of Japan and exenatide the rest of our worldwide revenue grew 8.5%. Gross margins percent of revenue increased 80 basis points from 79.5% to 80.3%. The increase in gross margin percent was driven by higher prices and production volumes partially offset by the impact of foreign exchange rates on international inventories sold.

Excluding the FX effect on international inventories sold from both 2012 and 2013, gross margin as a percent of revenue increased 2 percentage point from 77.9% in Q2 of 2012 to 79.9% in Q2 of 2013. As in past quarters, we’ve included a supplementary slide providing our gross margin percent for the last 10 quarters with and without this FX effect.

Now, let’s move onto the non-GAAP measures provided on slide 7. This quarters’ total operating expense, defined as the sum of R&D and SG&A declined 2%. Within operating expenses, marketing, selling and administrative expenses fell 3% while R&D expenses grew 1%. The reduction in marketing selling and administrative expenses reflects our ongoing cost containment efforts, which were partially offset by higher litigation costs.

Other income and deductions provided income of $11.9 million in the second quarter of 2013 compared to an expense of $16.5 million in the second quarter of 2012. This difference is primarily due to a gain on the sale of the Lilly Asian Ventures investment.

Our tax rate was 20.5% this quarter, a decrease of 1.6 percentage points from Q2 2012. The decrease in the effective tax rate reflects the reinstatement of the R&D tax credit in the U.S. that went into effect in January of 2013. At the bottom line, our non-GAAP EPS increased a robust 40% to $1.16.

Slide 8 provides the same information on a year-to-date basis, while slide 9 provides a reconciliation between reported and non-GAAP EPS. Additional details about our reported earnings are available in today’s earnings press release.

Now, I will turn the call over to Ilissa.

Ilissa Rassner

Thanks Phil. As you can see on slide 10, the total revenue increase of 6% for the quarter was driven by a favorable price impact of 6% and a 2% increase in volume, partially offset by a negative foreign exchange impact of 2%.

By geography, you all noticed that U.S. Pharma sales increased by 14%, driven by price as volume was essentially flat. In Europe, the volume decline of 4% was due to the Zyprexa patent expiration and a transfer of exenatide commercial rights outside of the U.S. to Amylin Pharmaceuticals. Excluding Zyprexa and exenatide from both 2012 and 2013, volumes for the rest of our European products was up almost 3%.

Turning to Japan, our revenues were once again significantly impacted by the weakening of the Yen. The 18% decline form foreign exchange and 3% price declines were partially offset by strong double-digit volume growth of 10%. Volume growth was primarily driven by Forteo, Strattera, Tradjenta, and Evista.

As for emerging markets, which is embedded in rest of the world, revenue grew 5% this quarter or 7% excluding the impact of foreign exchange. Within emerging markets China continue to register double-digit revenue growth up 18% driven by volume growth of 17%.

Elanco Animal Health sales grew 6% this quarter. In the U.S sales grew 5%, due primarily to increased demand of Trifexis. Out side the U.S sales increased 7% also driven by increased sales of companion animal products. We continue to expect that Elanco will deliver robust growth for 2013 and in the coming years.

Finally, the 17% increase in collaboration and other revenue is due to Tradjenta growth.

Slide 11, illustrates the effect of changes in foreign exchange on our 2013 results. At the bottom line, changes in foreign exchange rates reduced our EPS growth by 12 percentage points. Excluding FX, revenue grew 8%, while cost of sales and operating expenses either decrease or grew slower than revenue leading to Q2 reported and non-GAAP EPS growth of 46% and 52% respectively.

Next, I’ll provide a brief pipeline update before turning the call over to Derica.

Slide 12, shows our pipeline as of July 15. Changes since our last earnings call are highlighted, with green arrow showing progression and red arrow showing attrition.

As Phil mentioned earlier, in collaboration with Boehringer Ingelheim, we announced that our new insulin glargine product was accepted for review by the European Medicines Agency. We filed the application to the EMA's biosimilar pathway and are excited by the potentials of our basal insulin for the treatment of patients of type 1 and type 2 diabetes.

We also announced plans to stop development of enzastaurin, which was being studied as monotherapy in the prevention of relapse in patients with diffuse large B-cell lymphoma. With respect to earlier stages of the pipeline, you’ll see that we began Phase II testing as two small molecules; one for osteoarthritis pain and one for cancer, and one biologic, a PCSK9 monoclonal antibody for cardiovascular disease. We also began Phase I testing basically biologics; two for diabetes and one for Alzheimer’s disease. In addition, we terminated development of a Phase II diabetes molecule.

We continue to expect four submissions this year. In addition to already filing Empagliflozin and our new insulin glargine product, built in collaboration with Boehringer Ingelheim, we remain on track to complete the already initiated rolling submissions around for ramucirumab, as a single agent biologics therapy in patients with advanced gastric cancer following progression on prior chemotherapy. As well as the U.S. and European submission for dulaglutide, our GLP-1 receptor agonist for the treatment of type 2 diabetes. We are encouraged by our progress and believe this pipeline positions us for growth post 2014.

Now, I’ll turn the call over to Derica to cover some of the remaining key events for 2013, our financial guidance and some closing comments before we open the call for Q&A. Derica?

Derica W. Rice

Thanks, Ilissa. I’ll begin my remarks with slide 13. 2013 is an important year for Lilly. As you can see from the check marks on this slide, we are making progress on our goals.

Let me give you a quick reminder of the potential key events for the remainder of this year, as we continue to advance our pipeline, and share clinical data that will help you better gauge our growth potential post 2014.

In oncology, later this year we hope to present detailed data from the Phase 3 trial of ramucirumab in first-line breast cancer. Now recall that the data we expect to receive in 2013 will be the final progression-free survival data, and the interim overall survival data.

There are also several Phase 3 trials that we expect to produce data in 2013, although presentation of detailed data at medical meetings would likely occur in 2014 or later. These include the initial Phase 3 trials of our novel basal insulin analogue for both type 1 and type 2 diabetes. The pivotal trials for our new insulin glargine product, ramucirumab as combination therapy for second line gastric cancer. Our Phase 3 trial for necitumumab in combination with gemcitabine and Cisplatin for first line squamous non-small cell lung cancer, and the initial trials of edivoxetine as adjunctive therapy for major depressive disorder.

As Ilissa mentioned earlier, in addition to the two Phase III assets empagliflozin and the new insulin glargine products already submitted to regulatory authorities this year. We expect to have two more regulatory submissions. Dulaglutide our once-weekly GLP-1 agonist for the treatment of type 2 diabetes, and ramucirumab as a single agent biologic therapy in patients with advanced gastric cancer following progression on prior chemotherapy for which we’ve already submitted two of the three modules as part of the rolling submission.

In addition, in August we'll have the U.S. District Court trial for the Alimta method-of-use patents. In Q3, we’ll initiate EXPEDITION3, a pivotal trial for solanezumab in patients with mild Alzheimer's disease. During a recent investor call, we released the details of this trial design. And in December, we’ll lose U.S. exclusivity for Cymbalta.

Now turning to our 2013 guidance, our solid financial performance has allowed us to raise our full year expectations. In terms of the individual line items, we still project revenue to be between $22.6 billion and $23.4 billion. Gross margin as a percent of revenue is now projected to be approximately 79%. As a result of our continued cost containment efforts, we’ve narrowed and lowered the forecast for marketing, selling and administrative expenses to now be between $7 billion and $7.2 billion.

We have also lowered the high-end of the range of R&D expenses by $100 million, which is now forecasted to be between $5.3 billion and $5.5 billion. OID continues to be in the range of a net deduction of $50 million to a net income of $100 million. The tax rate is still expected to be approximately 19%, driven primarily by strong growth margin performance as well as by lower total operating expenses. Our non-GAAP EPS is now expected to be in the range of $4.05 to $4.15 per share.

Finally, we still expect capital expenditures to be roughly $900 million. Slide 15 provides a reconciliation between reported and non-GAAP EPS for 2013 and the associated growth rates from these numbers to our 2013 guidance.

In closing, we are pleased with our financial performance this quarter. We delivered solid financial results including top line revenue growth and continued cost containment efforts which resulted in strong earnings growth. We remain committed to our innovation strategy and we believe it will drive growth and expand margins post-2014.

We will diligently execute our strategy by continuing to replenish and advance our pipeline, continuing to drive growth in our on-patent brands and in Elanco, Japan and emerging markets, continuing to drive productivity gains across all areas of our business as demonstrated by our year-to-date financial performance. And of course, we are now preparing to launch a number of new medicines.

The progress we’ve made positions us to meet or exceed our mid-term financial projections through 2014; minimum annual revenue of at least $20 billion, net income of at least $3 billion and operating cash flow of at least $4 billion.

We continue to disseminate important data that will help investors and analysts better gauge our long-term growth potential with more to come over the remainder of 2013 and 2014. And we’ll keep you updated on our continued progress. We’re confident in our strategy and in our ability to successfully navigate our patent expiration and to emerge with even greater strength and capacity to drive growth.

This concludes our prepared remarks and now we’ll take your questions. Operator, first caller please?

Question-and-Answer Session

Operator

Thank you. Our first caller is Tony Butler with Barclays Capital. Go ahead, please.

Tony Butler – Barclays Capital, Inc.

Yes, thanks very much. First of all, welcome back, John, and two questions really for Dr. Lundberg, if possible. One is, could you discuss your filing strategy for the insulin glargine in the U.S. and have you chosen a route that includes BLA? And then second, there has been some commentary clearly out of ASCO and even before around VEGF inhibitors and their ability to demonstrate good PFS, but very little OS. You’ve seen this in glioblastoma, just [2.1] example, and while our recognized ramu is a VEGF-2, can you mechanistically help us understand the difference and why PFS and OS may correlate this time or in fact may not? Thanks very much.

John C. Lechleiter

Great, Tony, thank you for questions. Since we do have Enrique here who heads up our Diabetes business, we’ll have him take the first question on the filing strategy for insulin glargine here in the U.S., our insulin glargine product, I should say, in the U.S. And then, Jan will give the (inaudible) question.

Enrique Conterno

Sure. Tony, we are not discussing our regulatory strategy for our insulin glargine product. As you are aware, we have filed in Europe and this has been filed through the EMA by the similar pathway. That’s what we can share at this time.

John C. Lechleiter

Jan?

Jan M. Lundberg

Yeah. In relation to VEGF, our inhibitors and ramu more specifically, we did see a correlation for ramu between PFS and overall survival in the monotherapy for second-line gastric cancer and now we need to wait and see if we can repeat that for the other indications. Thank you.

Philip Johnson

Kathy, next caller please?

Operator

Thank you. That will be Gregg Gilbert with Bank of America. Please go ahead.

Gregg Gilbert – Bank of America Merrill Lynch

Thank you. Just have a quick few. First, for Enrique, I think the uptick of exenatide in the U.S. has been pretty robust as well as down in certain European countries. Has your outlook changed in terms of detailed potential for AMPA? And then for Jan, it looks like your CDK 4/6 inhibitor has interesting activity for the data at ASCO, but also high rates of diarrhea. Could you provide some context around that and next step? And Derica, a few quarters ago you commented that 2014 EPS consensus was too low. Do you have any updated comments ready on that given that you said that in press by commenting them? Thanks.

John C. Lechleiter

All right, Gregg, great. Thanks for the questions. Enrique, you want to start this off?

Enrique Conterno

Sure. So we won’t comment on competitive products, but what I can say is as we look at the uptick of these new classes, I think it’s early, but so far it is encouraging in terms of what we see, in terms of adoption by physicians of this product that has been launched both in the U.S. and Europe.

Gregg Gilbert – Bank of America Merrill Lynch

Okay.

Jan M. Lundberg

In relation to our CDK 4/6 inhibitor, we are very encouraged by the initial data we have seen and now we are doing a variety of tumor expansions. One advantage of our compound could be that actually it has a safety profile that enables continuous dosing without introduction, which the other competitor compounds don’t seem to be able to do. So, even if there maybe some side effects, I think we need to see this in comparison to the other agency in the same class.

Derica W. Rice

Gregg, in January when I made that comment, this is when we were able to, as we look at the analysts estimates, they were well below our $3 billion guidance that we have put out here. It’s the minimum that we thought we could achieve through this period. Now it’s moved up somewhat, but we are absolutely still committed, as I even said here today that we have to believe we can exceed those minimums that we put out here. So, if you look at our performance here, through the first half of 2013, we actually believe we’re on track to at least meet or exceed those goals.

Gregg Gilbert – Bank of America Merrill Lynch

Thanks so much.

Philip Johnson

Great, Cath. If we could have the next caller, please?

Operator

Certainly. We have Tim Anderson with Sanford Bernstein. Go ahead please.

Timothy Anderso – Sanford C. Bernstein & Co. LLC

Thank you. I have a couple of questions. On slide 13, you talked about potential regulatory submissions in 2013. Shouldn’t ramucirumab for breast-cancer potentially be on there assuming that the data ends up being positive? And then the second question on Alimta, the trial date for the patent challenge drawing closure. Can you comment on whether settlement with your generic challengers remains a realistic possibility, because usually these sorts of things get hammered out ahead of a trial’s start date?

John C. Lechleiter

Great, Tim. Thanks for the questions. In terms of over the ramucirumab breast-cancer, it would be very difficult to go ahead and have a following package is ready for submission this year. Clearly, if we have positive data that can be very focused on moving as quickly as possible, but would not want the expectation that would lead to a filing in 2013 at this point. Then for the litigations ongoing, as we’ve commented in the past, we do not have a history of settlement with companies. You can observe that from past expirations we had with products.

We’ve not commented specifically on our strategy other than to say that we believe that that valid intellectual property that we intent to pursue the whole. So we’ll keep you posted as that trial progresses obviously through August, talks here in Indianapolis on August 19. So, thanks for the question, Tim. If we can go to next caller, Cathy?

Operator

Thank you. We have Mark Schoenebaum with ISI Group. Go ahead, please.

Mark Schoenebaum – ISI Group

Thank you for taking my question. First of all, I’d just like to say it’s great to see John back on the saddle. Congratulations on a speed recovery. We’re all happy to have you back. And my questions are, number one, since we have Enrique on the phone, Enrique, could you maybe bring us up the speed and as much detail as you’re willing to at least on the DPT-4 situation.

There’s been a lot of at least Wall Street chatter about big discounting going on, driven by Lilly. Can you update us on that and also maybe a broader overview what you’re seeing in the DPT-4 market right now in terms of share for your own drug, collaboration with BI as well as overall rate of market growth, whether or not that has changed in the last few quarters?

Number two, I think it’s been Lilly’s position, and please correct me if I’m wrong, which is why I’m asking the question that for ram in breast that it’s been your position and overall survival benefit is not needed for FDA approval, assuming that PFS benefit is clinically meaningful. I’d like to just get your thoughts and I want to make sure I’m not wrong. And more of a general question is my third. At this point, now that we’re closing in on Obamacare implementation, do you expect any material impact your business in 2014, and then applying 2014 guidance specifically, but just in general conceptually any shifts there? Thank you very much.

Derica W. Rice

Great, Mark. Thanks for the questions. Enrique will start off. Then I’ll take the ram breast cancer, and then we’ll have John talk about the healthcare reforms as we move forward into 2014, additional implementation of some of the aspects of that law.

Enrique Conterno

Sure. So, on the DPT-4 market we have seen a slowdown when we look at this market. I think it’s important to look at the history and when we look at what’s driving some of that growth, it was coming at the expense of both TCDs and to a lesser extent it’s use. Now the TCD opportunity is really drained out. So we basically see this as a change in the dynamics of why the DPT-4 markets has slowdown in the U.S. We still see fairly good growth outside of the U.S.

When it comes to our share, I think we are pretty pleased in terms of our performance. We are gaining share on a consistent basis in most markets, including the U.S. and Japan. Notably we got the add-on indication in Japan earlier this year, which has made us much more competitive in that market and we have seen significant uptick as a result of that. But we are pleased with our share performance everywhere, where we look.

When it comes to rebates, I think it’s important to know that as we look at [the agenda], specifically in the U.S., our Tier 2 access in commercial is 65%. So that’s not a level of access that I would classify as trying to really compete on pricing. When we look at our composite access, it’s still below that of when we look at both commercial, but it’s still below that of when we look at both commercial, and it is still below that of some of the leaders in this class. So we are gaining share despite the fact that we still have opportunities for increased access at the tier 2 level.

Derica W. Rice

Yeah, one quick comment in terms of share, I know some of you Mark and others on the sell side, do follow not only total prescriptions and new prescriptions but also new to brand. And I think you will see that during this year we’ve actually passed Onglyza on the new to brand. Share of market that may be a leading indicator of where NRx, and then TRx may have in the future, so Enrique said we are very pleased with the performance.

In terms of ramucirumab for breast cancer and what's necessary for filing. There are definitely differences among regulatory bodies in the European Union essentially the main driver will be the progression-free survival data not necessarily the overall survival data. In the U.S. as you are alluding to, it’s a bit more of holistic equation looking at both the magnitude and significance of the PFS benefit, and then what’s being seen in terms of the trend for OS.

I think strictly speaking, it doesn’t necessarily need to have a large statistically significant OS benefit if other attributes of the molecule are very strong like the progression-free survival benefit, the safety profile et cetera. So again obviously the best case scenario is, you’ve got stats figure result on your survival and it’s not an issue, but clearly it doesn’t seem to be a prerequisite, and we look rather overall features of the molecule, determine the best filing strategy and indicate to you, that you should look at the overall safety and efficacy profile to try to gauge likelihood of approval, employ the commercial uptake as well.

Johnny will comment on the Affordable Care Act or ‘14.

John C. Lechleiter

Sure Mark. Thank you and thanks to Tony for your kind comments. I am back. I am very happy to be back and I’m going full-bore. With respect to Obamacare, I think despite some of the recent changes and challenges that we all know about, in terms of implementing that, our outlook relative to 2014 has not changed based on from what we have been planning all along, and I don’t think right now the implementation of the law is going to have any material impact on our business next year.

Mark Schoenebaum – ISI Group

Okay.

John C. Lechleiter

Kathy next caller please.

Operator

Thank you. Next will be Jami Rubin with Goldman Sachs. Please go ahead.

Jami Rubin – Goldman Sachs & Co.

Thank you. And John, I let go sentiments already discussed on the call that really great to have you back and thank goodness everything turned out okay. A question for you and a question for Derica. Derica, can you, I mean, obviously you guys are doing a great job executing on your goals to leverage SG&A, can you give us a sense for how far you are in your overall restructuring plans, where you are with U.S. restructuring, and how much further you can go, and where that stands globally outside the U.S., because year-on-year we will see about $500 million decline in SG&A following about $350 million decline the year before.

So obviously, to hit the $3 billion number, we need to see continued aggressive cuts in SG&A, I’m just wondering sort of big picture, where you are in the magnitude of that change?

And then John, if you could talk about BD activity, just curious to know what your appetite, we’re starting to see BD picking up across the sector here and there, and just wondering given what you face over the next couple of years, what your appetite is? Thanks very much.

Derica W. Rice

Good morning, Jamie. This is Derica. As you recall in April, we announced further steps in the restructuring of our U.S. commercial operations, where we essentially reduced the size of our U.S. sales force by about 30%. And we indicated at that time, that the savings on a full year annual rate should be somewhere between $200 million to $250 million.

Now we’ve just – that’s now complete. So some of that may show up in the second half of the year, but we’ll get the full year impact starting in 2014. We will continue to look for opportunities to further refine and streamline our business operations.

As you also saw from our results, we got really good leverage at the gross margin line and some of that was priced, but all of those – some of it was driven by the efficiency of our manufacturing operations, our plans are running all out in terms of full growth in as well as doing very good job of expense management.

When we think about 2014, also bear in mind that not just on the SG&A line, but also in terms of the R&D line, we are in the midst of completing some very large and expensive trials. As those roll of between 2013 and 2014, that gives us some relief on our R&D line as well.

So this is why we are extremely confident that we can achieve those minimum goals that we put out there for 2014 in terms of Eli’s achieving $33 billion in net income. And very much the performance we’ve seen year-to-date says that we’re absolutely on track to get there.

Jami Rubin – Goldman Sachs & Co.

Thanks, Derica.

John C. Lechleiter

Jamie, this is John. Again thank you for your kind wishes there. With respect to business development, let me put it in a couple of buckets. I think first of all, we’ve probably been most active in the Animal Health space, where since about the middle of the last decade, we sort of have done a deal a year to sort of add to an augment, our core Animal Health business in addition to getting good strong organic growth.

So I think you should expect that we’re going to continue to be aggressive with respect to business development at a still a fairly modest scope and scale to help a $2 billion business today get to $3 billion and $4 billion beyond that. We think that, that’s a great opportunity for our company.

With respect to the Pharma part of the business, we continue to be vigilant obviously, and on the lookout for technology that we think could supplement or augment what we currently have coming out of our own pipeline. I think our greatest challenge in next few years is to make sure that, despite the headwinds we face in patent expirations, we’re able to adequately fund the completion of these Phase III trials, and make sure we have good launches, it’s what we hope will be a number of products as we come to the end of this patent expiration period.

I think if there’s a wish list of sorts, it would be in my mind a license deal or a smaller kind of acquisition that could give us access to sales revenue in our Bio-Medicines business between now and say 2017. Obviously, that was so hard to come by, but we continue to be quite active in looking at these things. We’re still not interested in large scale, M&A and our investors should not expect that.

Philip Johnson

Thanks, John. Kathy, next caller please?

Operator

Thank you. Next we have Steve Scala with Cowen. Go ahead, please?

Steve Scala – Cowen and Company

Oh, thank you. I have several questions. First on Cymbalta, what was the magnitude of this favorable wholesaler buying patterns, and does it really expect returns to commence before the patent expiration? So why is the company allowing wholesalers to buy extra stock now, that’s the first question.

Secondly for Dr. Lundberg, so Lilly stopped development of its base inhibitor given molecule specific toxicity, would you share with us what aspect or feature of the molecule led to the toxicity. And then lastly, what products steal the 15% contribution from price in the U.S. in the second quarter? Thank you.

John C. Lechleiter

Great. Thanks, Steve. I think, I’ll answer your first question, I’ll move to Jan for the second, and then Derica for the last. On Cymbalta, sort of those two questions being related. In the variations that we saw in wholesale inventory levels from Q1 of last year, Q2 of this year were within the normal ranges, happened to be slightly favorable at this quarter, but was not a significant driver of the growth.

Wholesalers on average are keeping a couple to a few weeks of inventory, Steve it’s not a large amount of inventory. So actually we wouldn’t expect that they would begin to ramp down purchases for example until you get into the fourth quarter given that the patent expires December 11, I believe it, as of this year. Jan?

Jan M. Lundberg

Yeah, in relation to our base inhibitor, what we saw was elevation of liver and lungs that came with time, and which caused those accident to stop this program. We believe, it’s likely to be molecule specific based on the totality or base biology, which has been published for humans and animal studies. It remains to be seen however, what happens with other base molecules.

John C. Lechleiter

Derica?

Derica W. Rice

Steve, in regards to the U.S. price benefit seen in this quarter, and at the product level the two biggest drivers of that will be Cymbalta and Evista. Obviously it’s very good for us in the quarter and for the year, but we know that will come to an end as we endure the patent expiries of those two products beginning in December and then Q1 for Evista in 2014.

Philip Johnson

Thanks, Derica. Kathy, next caller please?

Operator

Thank you. We have Chris Schott with JPMorgan. Please go ahead?

Chris Schott – JPMorgan

Hi, great. Thanks very much, and first of all, maybe just I could obviously say it’s great John to have you back and hope everything went smoothly with the recovery. Two questions, first, maybe for Derica, can you just elaborate on the guidance update? I guess, my question is, is the move to lower end of the expense ranges here driven by deeper and expected cost cutting, I mean are you finding more to cut than you expected? Or is this more of a timing issues and that you’re achieving targeted cost reductions faster than you expected? I guess, just want to read this – is this just a matter of maximizing your pre-patent expiration earnings or should it be thinking about just implying more confidence in 2014 and beyond?

The second question was, last year on this call, you’ve provided a longer-term view of the company that called for margins to normalize overtime. I guess, some sort of given the pipeline updates you’ve had over the past year, could you just update both your comfort in that longer-term view, and perhaps maybe talk a little bit more about the time horizon with which – about to kind of get margins back to a more normalized level once we kind of get through 2014? Thanks very much.

Derica W. Rice

Okay, sure. Chris this is Derica. In regard to the guidance update it really is, the organization honestly is doing an outstanding job of just deriving productivity gains that we think are sustainable across the business. So these are not one-time effects, and so that absolutely gives us even greater confidence in our ability to meet those minimums I talked about for 2014, especially the $3 billion in net income. And so we believe we are very much on track to get to those goals.

In regards to the long-term view, as you recall, you’re correct this time last year, we talked on our Q2 earnings call for 2012. We’ve talked about the opportunity for Lilly to begin to expand margins coming out in the 2014 trough, and we still always see that as being an opportunity before us.

The two elements that will drive us expanding those margins is obviously we’re planning on returning to revenue growth coming out of the losses involved in Evista, and that’s a net 2015, 2016, 2017 timeframe, while at the same time being able to get greater leverage from both our commercial and our manufacturing footprint. And not having to grow those to cost base or expense base is at the same rate as our revenue growth. And that’s what’s really going to drive that expansion.

Obviously, one of the questions we get often is, Derica if we do not achieve the pipeline output that you’re hoping for, do you believe that you can still expand margins? We still believe we can expand margins coming out, obviously how we get there will differ, and it would depend upon which assets from the pipeline emerge or don’t emerge. So that’s why we’re not able to be more specific at this stage, because we have to see how the pipeline itself specifically plays out.

Philip Johnson

Thanks, Derica. Kathy, next caller please?

Operator

Thank you. We have Marc Goodman with UBS. Please go ahead?

Marc Goodman – UBS

Yes, good morning. A couple of questions, first PCSK9, obviously there is a few others that are ahead, so I was curious how you think your product could differentiate in that market?

And second can you give us little more color on the Animal Health business? Last quarter, we talked about the supply/demand getting a little bit out of awkward in the quarter, and I was wondering if that’s got better and if you can talk a little more there? And then also, third question is, is Europe, can you talk about pricing in Europe? Have there been any major changes that you’ve seen, any countries talking about major changes that we need to be watching for? Thanks.

John C. Lechleiter

As we to PCSK9 first, the cardiovascular area is a keen interest to Lilly for instance than the connection to diabetics, which has a very high risk for cardiovascular disease. And as you know, we have an oral CETP inhibitor, approved in place to rate them for cardiovascular prevention, which then gives a very large HDL elevation. So I think it’s a good strategic fit then to have a molecule which gives also very powerful LDL lowering.

And our molecule what we have seen then in our early clinical trials is, it could be a best in class molecule with a very powerful LDL lowering with very long duration and of great magnitude.

Marc Goodman – UBS

Great. Thanks John. Derica?

Derica W. Rice

Marc, in regards to Animal Health, we did see a very solid bounce back in our Animal Health business in the second quarter with 6% growth. As you saw from Melissa’s comments earlier that, it was really driven by good strong growth in our combined animal business both in U.S. and outside of the U.S. And also the good news is, we saw a further stabilization in our food animal business versus the drag that we were experiencing in Q1. As we report, we still expect that, we should be able to drive good growth in our Animal Health business both in the second half of 2013, but as well as we think about 2014 as future years.

We are seeing some stabilization at the producer level in terms of both the sizes of herds as well as beginning to see some monetary improvement in some of the segments.

Marc Goodman – UBS

Great. And then in terms of European price mark, that a quarter of the European price impact was minus 1% at the lower end of our historical average of minus 1% to minus 3% in part due to the fact that in the UK the current PPRS scheme actually calls for very modest, but slight price increase in 2013.

In terms of developments moving forward, the French government has talked about potential measures on some of the hospital products that those who go through, those could impact particularly Alimta could happen yet this year or in 2014, that’s unclear at this point in time.

And another thing I’d flag is the UK, where the current PPRS scheme does expire at the end of this year, negotiations are still ongoing for a new PPRS agreement that would start next year, and that should also be the date that the UK would start with its new value based pricing scheme yet to be determined in terms of how it will be implemented for new products.

On the UK front, one thing I would mention that had come up on some other calls earlier this quarter, UK had talked about potential decreases of 10% to 20% on a certain bundle of products, and just to be clear that impact will be zero for Lilly, because that was the impact of only those products for the companies that do not participate in the PPRS scheme, Lilly does participate in the PPRS scheme, it would not be subject to any of those potential price declines.

Derica W. Rice

Hey, Marc this is Derica again. Also just one other comment on Animal Health, I felt to make it, do recall that the – as we look at the current projections for the Animal Health industry growth, it is still projected to be in the lower single digits, and we fully expect to exceed the industry growth rate that we have done historically.

Philip Johnson

Thanks, Derica. Kathy, next caller please?

Operator

Thank you. We have David Risinger with Morgan Stanley. Please go ahead?

David Risinger – Morgan Stanley

Thanks very much. And John, I wanted to add my congratulations not only on the financial upside, but your healthy return timing upside?

John C. Lechleiter

Thank you.

David Risinger – Morgan Stanley

So, my three questions are as follows: regarding Ramucirumab, should we be expecting the top line press release before San Antonio Breast Cancer Symposium or not, second could you provide some perspective on the Humalog net price decline that was mentioned in the press release, I’m guessing that’s due to bundling to help drive Tradjenta access, but that’s just a guess on my part. And then third, I’m hoping you could talk a little bit about potentially bringing atomoxetine to market for depression and what the implications might be for your planning for the Cymbalta sales force? Thank you.

John Lechleiter

Great, Dave. Thank you for the questions. So I think Jan, if you want to answer the Ram top line press release part of (inaudible) breast question. Enrique on Humalog, Jan as well, if you want me to comment on atomoxetine and then the last question Dave, Derica you want to comment on sort of the Cymbalta sales force expectations as we move forward.

Jan Lundberg

Okay. So over the Ramucirumab data for breast cancer are eminent and the plan is to have a top line press release before the San Antonio Breast Meeting, in the best of world, we could also present the data at that meeting.

John Lechleiter

Jan, comment there about Edivoxetine as well before moving on to Enrique?

Jan Lundberg

The Edivoxetine is the adjunct therapy then for depression and there is a difference of actually having onboard SSRI and adding on the treatment compare them to having Cymbalta, where you have the two mechanism at the same time.

John Lechleiter

Okay. Enrique?

Enrique Conterno

Sure. First just to clarify, there is no such bottling. This is really driven quarter to quarter by their durability that we see as we look at the research and update them based on the latest information that we basically have. I would add just a bit of color to our insulin franchise, because we are pleased in terms of where we are, when we look at our volume growth. In the U.S., aligned with the market right now and outside of the U.S. it’s slightly ahead in terms of where that relevant for Humalog is. So we would likely continue to see some of durability there. There are no new contracts when it comes to pricing that starting in Q2. It is typical for us to look at new contracts at the start of the year.

Jan Lundberg

Dave, real quick, if you are thinking about sort of first quarter, second quarter, you will see that Humalog was up 9% in the U.S. in the first quarter and relatively flat here in the second quarter. As Enrique eluded to, that really is due to some base period entities made in Q1 and Q2 of 2012 related to Medicare and Medicaid rebate true-up. We continue to have sort of low to mid-single digit volume growth in the U.S., with pricing relatively flat if you look over a couple of quarter period. So 9% and zero in terms of average, they were in that that 4% to 5% growth, it’s far more actual reflection of the current run rate. Derica?

Derica W. Rice

Dave, in regards to the Cymbalta sales force, again we announced the restructuring of our U.S. sales force. Back in April, we reduced the size of our U.S. footprint about 30%. Obviously this was with an anticipation of the impact of the patent accretive both Cymbalta as well as Evista. We do believe at the same time that this residual footprint that we have is sufficient to accommodate our pipeline going forward.

So we were planning also in terms of with a foresight to what we think may emerge and if we are successful with Edivoxetine in terms from a regulatory standpoint, we think we can fit it into our existing commercial footprint.

David Risinger – Morgan Stanley

Great. Thank you.

Philip Johnson

Kathy, next caller please.

Operator

We have John Boris with Suntrust. Please go ahead.

John T. Boris – SunTrust Robinson Humphrey

Thanks for taking the questions and again John, welcome back and glad to hear you are going full board. Just on life cycle management of products towards the end of the life cycles, most probably Cymbalta and Evista that you alluded to, are you managing those products a lot differently. In that it seems as though you need a lot less feed on the street, but you are still growing volumes and it seems as though you’re maximizing profitability on those assets, so any thoughts on that?

Question for Jan, on Phase II assets, what are the assets that you are most excited about, there is quite a few of them that you have in Phase II development, but can you point to couple that you are excited about?

And then for Derica on R&D and also for Jan, as we look at R&D certainly as a percent of sales, it’s very high, but just directionally going forward over the next couple of years as you realize and file quite a few of these assets, how should we be thinking about the leverage that you are going to be getting out of that line going forward? Thanks.

John C. Lechleiter

Great John, thanks for the questions. I will take your first and then Jan, shall comment on the pipeline assets and then Derica on the R&D. So clearly we are managing Cymbalta differently as we reach the end of its life cycle particularly here in the U.S. We have talked about the fact that this would be a different sales force and marketing effort as we approach patent expiration compared to Zyprexa, but each product is unique and requires a different approach. You may recall John that we really ramped down and had no sales force efforts, our marketing efforts to speak up probably for a couple of years prior Zyprexa patent expiration.

In this case essentially the sales force announcement was made early this year, we basically have completed that out of this middle part of July and have minimal efforts in terms of providing samples or the materials responding to questions as we move into this last six months of the patent here in the U.S.

We also have talked about the fact that we would maintain marketing efforts both direct to consumer television as well as other media, up until much later in the life cycle for Cymbalta and that continues to be the case.

Obviously those have the gun to ramp down and we will ramp down as we reach the patent expiration, again leading to some of the year-on-year cost savings in addition to the sales force that we talked about earlier. Jan?

Jan Lundberg

Yeah, so let me start with one of the most recent molecules, the Prostaglandin Synthetase Inhibitor which has been a difficult to drug target that we now have a compound in Phase 2 ‘14 indication. And this is Prostacyclin sparing which could mean that it has a better safety profile than the current exenatide.

Elotuzumab, as you know is our antibody which recently reported intriguing data on increasing bone mineral density both in the spine and to some extent also in the hip region. The Glucago receptor antagonist is an oral molecule than for Diabetes Type II where we recently also reported promising data or blood glucose lowering without any weight gain or risk for hypoglycemia. We have our TGF-beta monoclonal antibody for chronic renal disease or chronic kidney disease which then we have in large Phase 2 trials.

In the oncology area, I would like to mention three that TGF-beta oral molecule, the CDK 4/6 which we also discussed and our cMET antibody then for a variety of tumors. And finally I think we already mentioned that PCSK9 antibody then for lipid lowering. So we have a number of agents in Phase II to talk about.

John C. Lechleiter

Thanks Jan. Derica?

Derica Rice

John, in regards to R&D cost, as I stated earlier this in terms of our overall offerings with this. As we look to complete or conclude some of the large Phase 3 studies that were currently underway, actually progressing towards submission, hopefully approval. That will give us some relief in terms of our R&D expense going forward. So we believe that we are kind of at a peak at the moment. So when I look forward to future period, you should see kind of a relief of pressure and that does obviously help us in terms of our achieving our goal of $3 billion, while not sacrificing the replenishment and the future progressing of our clinical development pipeline.

So we are trying to make sure that, we maintain a very good balance between both our current Phase 3 as well as the questions you just had for Jan and making sure that there was a cohort of opportunities that can follow that we can avoid hopefully in future drought as you’ve seen from Lilly over the number of years and our learning from our prodec scenario. So we feel very good about the late stage and the early stage balance that we are looking at today.

John C. Lechleiter

Okay, thanks Derica. Kathy, next caller?

Operator

Thank you. We have Damien Conover with Morningstar. Please go ahead.

Damien Conover – Morningstar

Okay. Good morning. Thanks for taking the questions. I just have a question on pricing power in the U.S., excluding this in Bolton Evista, can you talk a little bit about the pricing power in the U.S. and I think historically we look at pricing power in the U.S. and kind of the mid-single digit range. I was just wondering if you still think given the current environment kind of extrapolating that into the future makes sense.

And then just one quick follow up on the biosimilar refining of the glargine product in Europe. Just wanted to confirm that you are still looking at that launch as more of a branded launch even though you’re taking the biosimilar filing strategy there? Thank you.

John C. Lechleiter

Great. Damien, thanks for the question. Enrique you may switch it up on if you want to go ahead and answer the second question first, and then Derica or I’ll handle your first question Daniel. Enrique?

Enrique Conterno

Yes, absolutely as we have stated in the year back, I think our intent is to offer a second high quality glargine option for patients. We believe that competition is going to be driven by the experiences of those individual patients. We have to remember here in licensing the critical role, as well as the level of support and service that we provide both physicians and the staff. So yeah, we are thinking that the market dynamics are more closely going to assemble that over the branded market.

John C. Lechleiter

And Damien, on pricing in the U.S., as we go through the pre-patent expiration period, given some of the dynamics you are seeing and probably will see higher than average U.S. net price increases. We don’t expect those to be sustained after this period and we will go back to far more normal increases that you mentioned probably in that mid to upper single digit range depending on where we are in life cycle and new product launches.

We have seen over time that last five years, increasing pressure were a greater percentage of list price increases. It is essentially given back in the form of rebates and discounts and in other words leading us to realize that two thirds of list price increase has caused us half of list price increase on average. At this point I think we expect significant additional pressure on the U.S. pricing that we certainly don’t expect to see the pressure that has currently existed updating it all.

Kathy, if there are more callers we have time for one more.

Operator

We have no one else in queue.

John C. Lechleiter

Great, well thank you very much to all of you for joining us live or listening on the reply. We are very pleased with our first half results this year that have positioned us to raise our full year 2013 guidance and put us on track to meet or exceed our minimum financial goals through 2014.

We continue to progress the pipeline and are confident we’ll have four regulatory submissions of molecules this year, frankly an unprecedented number for a company of our size or probably of any size in the industry. We are very pleased with the progress we’ve made on the pipeline.

Just a quick reminder, that prior to our third quarter call, the next major event we have, that which we hope to see many of you, or hopefully you would dial in is our October third investment community meeting that we will be holding here in Indianapolis.

Once again, thank you for your interest in Eli Lilly & Company, we are very appreciative and hope you have a great day.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and choosing AT&T executive teleconference. You may now disconnect.

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