Eli Lilly and Company (LLY) Earnings Call Transcript & Summary

So good afternoon everyone. Thank you so much for joining us for this session with Eli Lilly. It's very much my pleasure to welcome Josh Smiley, the company's CFO. So I just need to start with the standard disclaimer, so I need to read that quickly. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. It's not for members of the press. If you're a member the press, please disconnect and reach out separately. For important disclosures, please see www.morganstanley.com/researchdisclosures. If you have any questions, reach out to your sales representative. So with us, we have Josh Smiley, as I mentioned. He's been with Lilly since 1995 and has held a number of different roles in the commercial, finance and operational excellence teams; and also Sara Smith from Investor Relations is joining us as well.

And I figured we would just sort of jump right into it. So Josh, maybe we could just start out with your take on the prescription market recovery and whether Lilly is on track for the updated guidance it provided when it reported 2Q results.

Yes. Yes. Thanks, Dave, and thanks for the time. I appreciate the opportunity. I think at the end of the second quarter, we talked about we were seeing good pickup in health care utilization. We were seeing a trend of improvement in -- starting in the U.S., starting in late May going through June and July. We said that we'd expect by Q4 to see prescription trends get back to pre-pandemic levels in this -- is particularly in the new prescription segment. We're seeing that. I think what we've seen since July is in our therapeutic areas, we're seeing utilization trends back up 90-plus percent relative to February or the rolling averages before the lockdown started. And that trend continues, I think, even when we start to drill down into hotspots or segments around the country. I think even when we're seeing sort of a resurgence, I think physicians and patients have figured out ways to get to the doctors safely even if there's concern about the virus. So I think we're on track, at least for the trends around health care utilization. I think our -- we're starting to see the new-to-brand prescriptions also sort of follow that utilization trend. So we feel pretty good about the volume opportunities we're seeing, I think, for our brands overall. From a competitive perspective, we sort of -- nothing changed during the pandemic, so it's really a matter of getting the overall patient volumes back up and we're seeing that happen.

Excellent. Great. And so let's -- actually, before we turn to some of the detailed questions that I have, I'd actually love to get your perspective on the evolution of the ROI and R&D. And I asked that because I was looking at your background here, and you were obviously in charge of finance and the R&D organization many years ago.

Yes.

So you've seen the evolution of R&D productivity and the financial assessment of R&D productivity. So it'd be great to just hear from you any thoughts on that evolution and how you now measure it at Lilly and what you're striving for.

Yes. I think, first, and as you said, Dave, I've had a long history. The products we're launching today or started to launch, things like Trulicity, I was part of the finance team when they were just project ideas, so it's very gratifying to be on the back end here. But things have changed a lot. I think what we're really proud of in our R&D organization is the increase in speed of development that we've seen over the last few years. We moved from probably, in the middle of the last decade, being probably among the worst when we would just look at apples-to-apples comparison of development time lines and -- to one of the best. And that's, I think, the biggest change that we see is we now have the ability to look at a project entering Phase I and can see -- and it obviously depends on the therapeutic area and the development plan. But in general, we're seeing years that we've been able to take out of our historical development time lines. That's got tremendous benefits. Of course, you're getting better therapies to patients quicker. But from a financial perspective, the opportunity to launch 2 or 3 years earlier brings with it competitive benefits. It obviously brings with it sales on the back end. So I think our -- now when we're making assessments around early-stage investments, they look a lot more attractive than they did 5 or 6 years ago because we've got a time value of money and longer to sell the product in a better competitive position. So I think that's the thing that's probably most interesting to us. I think though, we've learned a lot also about how to assess and progress projects. And I think one of the things that we saw from prior portfolio iterations is if you don't have good Phase II data that can inform things like dose and patient population for Phase III, your chance of success in Phase III is pretty low. It becomes more like a crapshoot, 50% or less. Our success rates in Phase III over the last 3 to 4 years have improved considerably as well. So we've got -- we're moving faster and with more certainty or less risk on where we come out on the back end. So you put all of that together and I think our ROI on R&D investment in these last few cycles looks really good. We use like EvaluatePharma, which takes your forecast, everybody else's and puts them together. And when we look at that, I think, and compared to other companies, we feel like we've got a very productive R&D organization. So if you just look at amount of spend over any reasonable time period relative to the inherent value that's captured in the portfolio, we tend to look really good. And I think it's for those reasons, speed, better probabilities of success and of course, we tend to now focus -- we used to be, when I started doing R&D, finance, we were in 10 -- 10 or 11 sort of areas that we focused on. We've really narrowed it down to the places where we have really good scientific expertise. We're in 5 therapeutic areas now. I think we know what the science is. We know what patients need. We know what physicians want. I think that helps us as well.

Excellent. That's very helpful. So maybe we could transition to the diabetes portfolio, which obviously has tremendous long-term growth potential. Could you just characterize the penetration of the classes with momentum that matter a lot to Lilly, including the GLP-1s and SGLT2s just to give us a sense for the runway that you see in the portfolio?

Sure. First in GLPs, the thing we've looked at is, as patients progress from orals to injectables, we look at that first injection as a meaningful marker. And right now, in new prescriptions or new-to-therapy starts, GLPs are getting about 50% of injections versus basal getting the other 50%. I think the data is very compelling that, that should be almost 100% GLPs first before you go on to basal. So I'd say just from that standpoint, there's a big opportunity. Of course, if you translate that into -- it's been growing. So if you look at total prescriptions, it's still only 1/3 of total prescriptions in that injection space. First injection space are GLPs versus basal. So you've got more than double the opportunity just from the patient sort of population that we focus on today for GLPs. So certainly, you can project out for many years significant double digit, 20% type of growth and feel good. We see the bigger opportunities coming so not just that population today, but can you keep patients on -- can you get the benefit of a GLP longer? We just got approval for higher doses of Trulicity. We think that will help. Can you start earlier in treatment? We think that with the next-generation GLPs, like tirzepatide coming, I think there's a compelling reason to think about getting patients onto a product like tirzepatide because of the weight loss benefit and the profound ability to reduce HbA1c. We think we can further expand that pie. So a long way of saying there's a lot of room to run in the GLP space. I think in the SGLT2s, if we look at sort of total prescriptions there, I think it's only about 15% of diabetes prescriptions are SGLT2s. And if you look at the data on cardiovascular benefits, heart failure, it's pretty compelling. So again, I think we would look for Jardiance and -- as the market leader, but SGLT2s overall to continue to grow at pretty significant rates. There -- again, there's -- you can make a case that, that number should be triple or more of where we see SGLT2 utilization today.

Very helpful. And with respect to 2021, so just pivoting here and the revenue prospects, I think you mentioned recently that over 90% of your formulary contracts were set as of this summer. So could you just frame for us your visibility for 2021 at this point and how we should think about volume and net pricing components?

Yes, sure. For the U.S., there are 3 major commercial payers. They make their formulary decisions as we negotiate with them. We tend to defer to them in terms of their announcements. But we are pretty close to being sort of finalized for 2021 and we feel really good about the access that we'll add. So what we've said is we have -- if you look across our portfolio today, with the exception of Taltz, really, if you look at our diabetes portfolio, our migraine portfolio, we've got like 90-plus percent availability today. So we've got really good commercial and Part D availability. We feel like that's going to persist into 2021. And we'll have Taltz where we have not had as good access. We do have an announced major change or win at ESI, so Taltz will be the preferred IL-17 agent there. So that's incrementally good. I think when we put all of that together in -- across all of our segments, our expectation is probably, on an apples-to-apples basis, our net pricing will decline in the low single digits. So to maintain the access and in some cases, upgrade the access that we have today, in total, that's what we see. Then the second factor there is what does the segment mix look like? And I think there, we do anticipate we'll see a little bit more Medicaid utilization in 2021 than we see in 2020. That's a function of the economy in the U.S. So we think that will be a little bit of a headwind. We talked about that on the Q2 call. So that if we quantify it today, we're making estimates based on what the economy looks like and everything else. So we think that's probably an incremental $100 million to $200 million headwind in '21 or something like maybe 1 point. Then I think the wildcard, of course, is what happens with legislative changes or administrative changes to government programs. I think we always anticipate -- we build some buffer into our thinking and anticipate something is going to happen that has happened almost every year since I've been in this job. But right now, most of the things that we see as potential changes tend to be in that 1- or 2-point impact. So I think it's -- we haven't given specific guidance for 2021 yet, but I think it's in that low to mid-single-digit net declines across the portfolio or across segments is probably a fair place to be thinking about it now. And that feels very manageable to us because to your second part of your question, we see certainly double-digit volume opportunities in the U.S. We continue to grow the core brands and core franchise as well. And then we'll add on to that full year of Retevmo next year, early adjuvant for Verzenio, we'd expect an approval there. So I think we've got some good additional growth opportunities in 2021. So we're quite optimistic, I think, about the opportunity in the U.S. and around the world.

Excellent. And with respect to that formulary change that you had mentioned for Taltz, could you educate us a little bit about when that impacts your gross to net? Meaning, do you take reserves in the third quarter of 2020 because of the price adjustment assumption or -- and/or how is that spread out over time?

Yes. So the change will be effective January 1, so that's when the new pricing for ESI will go into effect. And the way we do our accounting here is we do everything on a current basis. So when we ship product, we make an estimate on where that product is going to be and what the rebates will look like. So we wouldn't do -- I think, to your question, we wouldn't do any reserves beforehand. It really would be on January 1. We'll make a new estimate when we ship Taltz on what that ultimate end price will be. What you do see though is because we make the initial accounting entry when the product leaves our dock, we then get bill -- those -- that product is going to McKesson or Cardinal or ABC, then, of course, it goes downstream and so on. So we always are making after-the-fact adjustments when we get invoices in from ESI or California -- Medi-Cal or something. And that's what you see in our -- the lumpiness in our quarterly results are. We'll say we thought 8% of the Taltz that we shipped in January of 2021 was going to end up in ESI and it turns out it was 9%, so therefore, we have to make an adjustment there. So we don't do anything to try to smooth. Again, I think we follow what's correct accounting. And unfortunately, I think what that does sometimes is you see some lumpiness in our results, and we'll come back and say we've made a prior period adjustment. It's really just because we can only forecast where we think the product is going to go, and then we true it up on a quarterly basis as we get the invoices in. All of that being said, I think what you should expect for Taltz for that ESI book of business is we'll have a lower net price but -- volume that we believe more than compensates for that or we wouldn't have done the deal.

Okay. Very good. That's helpful. So then actually speaking about lumpiness, obviously, the other income was much stronger than expected in the 2Q, which will present comparison issues. How would you just characterize that? I mean, obviously, market investors should be looking through that, but it is a swing factor that people can't model and predict very easily and have to have footnotes in their models on -- to remember the anomalies in the prior periods, et cetera. So how would you tell us to think about that? And are you thinking about any changes in future guidance or anything like that along those lines?

Yes. I think, first, I would say that the change -- the accounting change was last year where equities that we hold -- public equities that we hold, we have the mark-to-market. It used to be that you would recognize the gain or loss when you sold or you hold them at book value and then recognize a gain or loss when you sold. Now we mark them to market every quarter. We try to be -- I think we try to have as few non-GAAP adjustments as possible, so we just went with that accounting change. What we saw this year, though, is it's, I guess, a good problem to have is the -- about $2 billion in equities we hold, which are mostly a function of venture capital investments that we make or equity stakes we take with biotech partners if we have a partnership with them, they appreciate it considerably and we recognized that in -- a little bit in Q1 and more in Q2. I think that is a little -- so we try to be transparent about that. Our guidance for the second half of the year just assumes we hold, not that we have continued gains or losses, which we could have, of course, either. So we try to call that out as much as possible. Yes, I think looking at this now, it probably makes sense. This could be something that we, in the future, we sort of exclude from our non-GAAP earnings so that you don't see those kind of moves. If we do that, of course, we'll be clear about that and we'll get back to an apples-to-apples comparison. But I think that -- in 2019, I always said, it's not that big of a deal. I think we're seeing now pretty big swings. Again, the good thing is they've been very favorable for us and that's real. Ultimately, if we choose to sell those, it's real money, but I think it does create some distortions in the income statement.