01—Abstract
Summary
Summary of the 10-K filed March 15, 2004. Cited figures are marked; the original filing is the authoritative source.
Eli Lilly's 2003 annual report shows a company that grew sales strongly but absorbed a sharp earnings decline as it reinvested heavily in the business.
Worldwide net sales rose 14% to $12.58 billiona, led by Zyprexa ($4.28 billion, now the first Lilly product above $4 billion), diabetes care, Gemzar, Evista, and the launches of Strattera, Cialis, and Forteo. Net income fell 5% to $2.56 billion ($2.37 per diluted share), reflecting higher marketing and administrative spending (up 18%), R&D of $2.35 billion (about 19% of sales), a gross margin that slipped to 78.7% from 80.4%, and roughly $382 million in asset impairment and restructuring charges, including Isis-related losses. The most important risk for investors is the Zyprexa U.S. compound patent challenge by generic makers (Zenith, Dr. Reddy's, Teva).
Lilly says the patent runs to 2011 and that it expects to prevail, but a trial court ruling was expected in mid-2004 and an adverse outcome could sharply reduce earnings if generic olanzapine launched before appeals concluded. Other exposures include the Evista patent suit against Barr, Pfizer's challenge to Cialis, ongoing Department of Justice and other promotional-practice investigations, thimerosal and DES product liability suits, and the Medicare drug benefit and importation pressures on U.S. pricing. Balance sheet and cash flow remain strong.
Operating cash flow was $3.65 billionb, total debt was $4.88 billion, and the company held about $3.71 billion in cash and short-term investments. The company guided 2004 EPS to $2.80 to $2.85, low double-digit sales growth, and a dividend raised 6% to $.355 per quarter, while noting that a Zyprexa ruling could materially hurt results.
02—Key points
Key Highlights
- Net sales rose 14% to $12.58 billion in 2003, with U.S. sales up 10% to $7.17 billion and international sales up 19% to $5.41 billion.
- Net income fell 5% to $2.56 billion ($2.37 diluted EPS) as Lilly reinvested in sales and marketing, manufacturing, and R&D.
- Zyprexa became the first Lilly product above $4 billion in sales ($4.28 billion, up 16%), but its U.S. growth slowed to 4% amid competition.
- Gross margin fell to 78.7% from 80.4%, and R&D spending rose 9% to $2.35 billion (about 19% of sales).
- The Zyprexa compound patent challenge by generic makers is a major binary risk; a trial ruling was expected in 2004, with appeals to follow.
- Cash flow from operations was $3.65 billion, with about $3.71 billion in cash and short-term investments against $4.88 billion of total debt.
- 2004 guidance calls for EPS of $2.80 to $2.85 and the quarterly dividend was raised 6% to $.355.
03—Questions
Frequently Asked Questions
What is the biggest risk to Lilly's earnings after 2003?
The Zyprexa U.S. patent litigation. Generic manufacturers challenge the compound patent, which Lilly says expires in 2011. Lilly expects to win, but an unfavorable trial-court ruling expected in 2004, combined with a generic launch before appeals end, would significantly hurt results. Zyprexa was Lilly's largest product at $4.28 billion of 2003 sales.
Why did earnings decline even though sales grew 14%?
Lilly deliberately increased investment: marketing and administrative expenses rose 18%, R&D rose 9%, and manufacturing costs for quality upgrades pushed gross margin down 1.7 points. The company also recorded about $382 million in asset impairment and restructuring charges in 2003, including losses tied to its Isis Pharmaceuticals relationship.
How diversified is Lilly's product portfolio?
Sales are spread across several franchises: neuroscience (Zyprexa, Prozac, Strattera) at $5.55 billion, endocrinology (diabetes insulins, Actos, Evista, Forteo) at $3.93 billion, oncology (Gemzar) at $1.04 billion, and animal health at $727 million. Nine key growth products accounted for 66% of 2003 sales, so concentration in a few brands remains significant.
What are the main regulatory and legal exposures beyond patents?
The filing discloses a U.S. Department of Justice grand jury subpoena related to Evista marketing practices, an SEC investigation of Polish subsidiaries under the Foreign Corrupt Practices Act, and an FTC antitrust inquiry. It also describes product liability suits over DES and thimerosal, Pfizer's challenge to Cialis, and pending suits over average wholesale price reporting. Management says these matters could be material to results in a given period, even though it does not expect them to materially affect the balance sheet.
What does the company's 2004 outlook look like?
Management guided 2004 EPS to $2.80 to $2.85, low double-digit sales growth, flat gross margin, and R&D growth in the mid-teens. Guidance excludes a substantial one-time in-process R&D charge expected from the Applied Molecular Evolution acquisition, and it assumes continued domestic competitive pressure on Zyprexa. Lilly also expects capital spending to increase, and it plans to issue additional debt in 2004 to fund cash needs.
04—Continue