01—Abstract
Summary
Summary of the 10-K filed March 8, 2005. Cited figures are marked; the original filing is the authoritative source.
Eli Lilly's 10-K for fiscal 2004 shows a year of solid top-line growth overshadowed by large one-time charges.
Worldwide net sales rose 10% to $13.86 billiona (U.S. +6% to $7.67 billion; outside the U.S. +15% to $6.19 billion), driven by new launches such as Strattera, Cymbalta, Alimta and Forteo, plus continued growth in Gemzar, Humalog and Evista. However, net income fell 29% to $1.81 billion ($1.66 per diluted share) from $2.56 billion, as the company absorbed a $465 million tax charge tied to planned repatriation of $8.00 billion of foreign earnings under the American Jobs Creation Act, $494 million of Q4 restructuring and impairment charges, a $36 million provision for the Evista marketing investigation, and $362 million of acquired in-process R&D from the Applied Molecular Evolution acquisition. The effective tax rate rose to 38.5% from 21.5%.
The biggest investor concern is concentration and patent risk around Zyprexa, the company's largest product at $4.42 billionb in 2004. U.S. Zyprexa sales fell 8%, management expects a slight decline in worldwide Zyprexa sales in 2005, and a pending generic patent challenge (compound patent expiring 2011) could materially accelerate that erosion if the trial court rules against Lilly. Lilly also faces product liability suits over Zyprexa (about 140 cases involving about 360 claimants, plus more than 3,050 tolled claims), an ongoing U.S. Attorney civil investigation into marketing practices for Zyprexa, Prozac and Prozac Weekly, and a potential Evista-related resolution.
Management guided 2005 EPS to $2.80 to $2.90c, including about $0.25 per share of new stock-option expense, with sales growth of 8% to 10%. Balance sheet and cash flow remain strong. Cash, equivalents and short-term investments rose $3.75 billion to $7.46 billion, operating cash flow was $2.87 billion, and the dividend was raised 7% to an indicated $1.52 annual rate, extending a 37-year streak of increases.
Total debt rose to $6.51 billiond, with the company's ratings at AA (S&P) and Aa3 (Moody's). Investors should weigh the strong franchise and dividend against the near-term earnings pressure, the Zyprexa patent and litigation exposure, and the costs of restructuring and pipeline spending.
02—Key points
Key Highlights
- Net sales grew 10% to $13.86 billion in 2004, with U.S. sales up 6% to $7.67 billion and international sales up 15% to $6.19 billion; volume rose 5%, price 2%, and currency 3%.
- Net income fell 29% to $1.81 billion ($1.66 diluted EPS) versus $2.56 billion ($2.37) in 2003, driven by the AJCA repatriation tax charge ($465.0 million), Q4 asset impairments and restructuring ($494.1 million), and acquired IPR&D ($392.2 million in total).
- Zyprexa, the top product at $4.42 billion (32% of sales), faces a U.S. patent challenge (compound patent expiring 2011), U.S. sales declined 8% in 2004, and management expects a slight decline in 2005 worldwide Zyprexa sales.
- Newly launched products roughly doubled to $1.5 billion in sales, led by Strattera ($667 million, +80%), Forteo ($239 million), Alimta ($143 million), Cymbalta ($94 million) and Cialis (joint venture sales of $552 million).
- 2005 guidance calls for EPS of $2.80 to $2.90 (including about $0.25 per share of stock-option expense), sales growth of 8% to 10%, and an effective tax rate of about 22%.
- Significant legal and regulatory exposure: Zyprexa product liability suits, a U.S. Attorney civil investigation into marketing practices (Zyprexa, Prozac), an Evista marketing probe with a $36.0 million provision, and pricing pressure from Medicare Part D beginning January 2006.
- Strong liquidity and shareholder returns: cash and short-term investments of $7.46 billion, operating cash flow of $2.87 billion, total debt of $6.51 billion, dividends of $1.42 per share paid in 2004, and a 7% dividend increase to an indicated $1.52 annual rate.
03—Questions
Frequently Asked Questions
Why did Lilly's net income fall 29% in 2004 even though sales grew 10%?
Several one-time items weighed on results. Lilly recorded a $465.0 million tax charge tied to its plan to repatriate $8.00 billion of foreign earnings in 2005 under the American Jobs Creation Act. It also took $494.1 million in Q4 restructuring and impairment charges, a $108.9 million Q2 impairment, $362.3 million of acquired in-process R&D from the AME acquisition, and a $29.9 million IPR&D charge. The effective tax rate rose to 38.5% from 21.5%, and gross margin fell to 76.7% from 78.7% because of manufacturing investment and currency effects.
How much does Lilly depend on Zyprexa, and what is the main risk to it?
Zyprexa is the largest product, with 2004 sales of $4.42 billion, about 32% of total net sales. U.S. sales fell 8% in 2004 on competitive pressure, and management expects a slight decline in worldwide Zyprexa sales in 2005. The main risk is a patent challenge by generic makers Zenith, Dr. Reddy's and Teva. Lilly's compound patent runs to 2011, and the trial court decision is pending. If the decision is unfavorable and generics launch before appeals are resolved, management says financial results would be very negatively affected.
What legal and regulatory issues could materially affect Lilly's future results?
The filing describes several. Zyprexa product liability suits (about 140 U.S. cases involving about 360 claimants, plus over 3,050 tolled claims) allege diabetes and blood-glucose side effects, and Louisiana and Canadian suits were added. A civil investigation by the U.S. Attorney in Pennsylvania covers marketing of Zyprexa, Prozac and Prozac Weekly, and the company has a $36.0 million provision for the Evista marketing probe. Other matters include an SEC investigation into Polish subsidiaries under the FCPA, Evista and Cialis patent litigation, and Medicaid pricing suits. Management says most matters are not expected to have a material adverse effect on financial position, but some could be material to results in a given period.
What is Lilly's 2005 outlook and how does the dividend look?
For 2005, Lilly expects EPS of $2.80 to $2.90, including about $0.25 per share from expensing stock options and compensation changes. It expects sales to rise 8% to 10%, with acceleration in the second half, gross margin to fall 50 to 75 basis points, marketing and administrative expenses to grow in the low single digits, R&D to grow in the mid-single digits, and an effective tax rate near 22%. The quarterly dividend was raised 7% to $0.38 per share, an indicated annual rate of $1.52, continuing a 37-year record of annual increases.
How strong is Lilly's balance sheet and cash position?
Lilly ended 2004 with cash, cash equivalents and short-term investments of $7.46 billion, up $3.75 billion, helped by $2.88 billion from selling long-term investments in preparation for the AJCA repatriation. Operating cash flow was $2.87 billion and capital expenditures were $1.90 billion. Total debt rose to $6.51 billion, mainly from commercial paper, and the company holds $1.25 billion of unused committed credit lines. Credit ratings are AA from S&P and Aa3 from Moody's. Shareholders' equity was $10.92 billion, and return on equity fell to 17.5% from 28.4%.
04—Continue