禮來公司 (LLY) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by, and welcome to the Q3 2009 earnings conference call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

(Operator Instructions).

I would now like to turn the conference over to executive director of investor relations, Phil Johnson.

Please go ahead.

Good morning and thanks for joining us for Eli Lilly and Company's third quarter 2009 earnings conference call.

I'm Phil Johnson, Vice President of investor relations.

Joining me are our President, CEO and Chairman; John Lechleiter; our Chief Financial Officer, Derica Rice; our President of Lilly Research Laboratories, Dr.

Steve Paul; and Ronika Pletcher and Nick Lemen from investor relations.

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 3 and those outlined in our latest 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.

You can access the earnings press release, supporting materials, a live webcast, an internet-based replay and a podcast of this conference call at Lilly.com.

The supporting materials, the replay and the podcast will be available on our website through November 20, 2009.

In the third quarter we again generated strong financial results, including volume-driven revenue growth, leverage between revenue growth and operating income growth, robust EPS growth, and strong operating cash flow.

This financial performance gives us the resources we need to strengthen our pipeline, to deal with the patent expirations coming in the next decade and to respond to our challenging healthcare environment.

Now I'll turn the call over to John for a review of key events since our last earnings call.

Thanks, Phil.

During the third quarter we took bold steps to reshape our operations.

We unveiled a new corporate operating model, as well as a series of changes designed to speed medicines to patients, to deliver greater value and to lower our costs.

I'll have more to say about these changes in a minute.

Now aligned with these plans we offered a voluntary exit program in select areas of our US sales force.

We're implementing a new commercial approach in 2010 that's designed to deliver more value to our customers and to be more efficient.

We agreed to sell our Tippecanoe Laboratories manufacturing sites to an affiliate of Evonik Industries.

This deal provides a continuous reliable supply of human and animal health products to Lilly.

It preserved high-quality manufacturing jobs for the Indiana economy and enables us to lower our costs over time.

In regulatory news FDA approved Forteo for the treatment of osteoporosis associated with sustained systemic glucocorticoid therapy in men and women at high risk of fracture and we submitted Byetta in Japan for the treatment of type II diabetes in adults.

In clinical trial news, based upon the outcome of the Phase III GENERATIONS trial, we announced that we will not submit Arzoxifene for regulatory review.

While the study met its primary efficacy endpoints it did not meet key secondary efficacy and safety endpoints.

As a result, we did not feel arzoxifene would offer a competitive value proposition.

This decision led to a charge to earnings of approximately $45 million in the third quarter, most of which was booked in R&D expense.

Along with BioMS we announced the results of the two-year MAESTRO-01 Phase III trial, which showed that dirucotide did not meet the primary endpoint of delaying disease progression in patients with secondary progressive Multiple Sclerosis.

The companies announced that we're stopping clinical trials.

On a more positive note we completed enrollment ahead of schedule for our IDENTITY 1 trial, the first of two Phase III trials of semagacestat for Alzheimer's disease.

On the legal front, the US District Court for the southern district of Indiana upheld the Company's method-of-use patents on Evista.

These patents run through March of 2014.

The US District Court for the eastern district of Michigan granted a partial summary judgment motion invalidating the Company's method-of-use patent on Gemzar, which had been set to expire in May of 2013.

We continue to believe that our Gemzar method-of-use patent is valid and will be upheld by the court.

We intend to pursue an appeal of this decision with the court of appeals for the federal circuit.

The Canadian Federal Court ruled that Lilly's Canadian compound patent for Zyprexa is invalid.

We believe this decision is deeply flawed and that it is inconsistent the evidence that was presented at trial and with applicable law.

We intend to appeal this decision and protect Lilly's intellectual property rights regarding the validity of the Zyprexa patent in Canada through April 2011.

Finally, we reached settlement with the Attorneys General of West Virginia, Connecticut, South Carolina, and Idaho,resolving their Zyprexa-related claims.

In addition, we're in advanced discussions with eight other state attorneys general.

As a result, in the third quarter we incurred a special pretax charge of $125 million to adequately reserve for the currently probable and estimable exposures in connection with the state's claim.

Now I'd like to share a few of my thoughts about the changes we announced in mid-September, which are the most sweeping in Lilly's history.

We're reorganizing the development function within Lilly Research Laboratories.

Now a Development Center of Excellence will employ a variety of tools to speed molecules to patients.

We're reorganizing our global operations around five business units and we're streamlining and aligning our corporate services and general and administrative functions.

On top of that we aim to reduce our cost base by $1 billion and lower our headcount to 35,000 by the end of 2011, excluding strategic sales force additions in high-growing emerging markets and Japan.

There's been considerable coverage of these changes in the media and on Wall Street, much of it focused on the cost savings and the headcount reductions.

In fact, our key objective is to fulfill our strategy of creating value by accelerating the flow of innovative new medicines that provide improved outcome for individual patients.

Our commitment to innovation will not waiver.

These organizational changes are primarily intended to reduce the time it takes to get medicines to patients, to establish a clear line of sight to our customers, and to reduce our operating cost structure, thereby freeing up the resources necessary to fund the innovation that will drive our future growth.

Let's start with the changes in R&D.

Over the past few years we've significantly improved productivity and research, leading to an unprecedented number of Phase I starts; 15 in 2007, 17 in 2008, and 13 so far this year.

Internal research has been and will continue to be the primary driver for our long-term viability and must remain intact.

As a result, there are no significant changes occurring in our basic research area, but we're reorganizing development to ensure we move these molecules quickly and get the most out of them.

We're creating the Development Center of Excellence, or COE, to address a drug development process that is increasingly complex, slow and expensive, not just at Lilly, but across the industry.

Now, what makes the development COE different is that we will use one common operating system, one common set of priorities, and a singular focus to streamline the development of new medicines.

The common operating system will provide our scientists with a simpler way to organize and get work done, common priorities will help each function in the COE know where to focus their resources and their efforts, and the singular focus means that we'll now have one single point where decisions will be made.

Again, the ultimate goal of the Development Center of Excellence is to accelerate the development and launch of Lilly molecules over the next decade and bring innovative medicines to patients sooner.

Next, in addition to our existing Animal Health business unit we're organizing our Human Health business around four distinct business units; one for oncology, one for diabetes, a business unit for established markets, and one for emerging markets.

Each business unit will be charged with creating a competitive, sustainable business.

In addition to commercial responsibilities, they will all reach back into development and partner with research to bring forward valuable, innovative molecules for their customers.

The business unit heads will report directly to me and I expect the structure to drive more accountability, to establish clear authority and ultimately to provide our customers with greater value.

These changes, the Development Center of Excellence and the new business unit will be in place on January 1, 2010.

We will also streamline corporate and general and administrative functions to support the business through improved quality, better customer service, and reduced costs.

We anticipate that the streamlined function would be in place by mid next year.

Now, Derica will discuss our third-quarter financial results.

Thanks, John.

As I've done on previous calls, today I'll focus my comments on the pro forma non-GAAP results, which we believe provides insights into the underlying trends in the business.

Now this view assumes we owned ImClone as of January 1, 2008 and it excludes certain items, such as restructuring charges, asset impairment, and other special charges.

Now, let's start on Slide 12 with a quick look at our Q3 income statement before reviewing the effect of foreign exchange.

On a pro forma non-GAAP basis, you can see that we generated leverage between revenue and operating income, as third-quarter revenue grew 5%, while operating income grew a robust 17%.

The leverage between revenue and operating income was driven by 3.7 percentage point expansion in our gross margin percent.

The increase in the gross margin percent from 77.4% to 81.1% is due to the favorable effect on cost of sales arising from the effect of changes in the value of the US dollar on international inventories that we've sold during the period.

Specifically changes in the foreign currency value of the US dollar added to the cost of sales in Q3 of 2008, while lowering costs in Q3 of 2009.

In addition, this quarter, operating expenses, which we've defined as the sum of R&D and SG&A, grew slightly faster than sales.

Within operating expenses, marketing, selling, and administrative expenses grew only 2%, while R&D expense grew 13% due to the increased late stage clinical trial costs, as well as the costs from terminating the development of Arzoxifene.

Moving down in the income statement you also see a slight improvement in other income due to lower net interest expense.

In addition, our tax rate improved by about two percentage points due to a projected change in the mix of income among tax jurisdictions and also the final resolution of our 2001 to 2004 IRS audit.

As a result of these modest improvements in other income and the effective tax rate, net income and EPS both grew faster than operating income of 22% compared to 17%.

Now let's move to Slide 13, which shows our reported income statement while Slide 14 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 look at how foreign exchange affected our Q3 results, starting with revenue.

As you can see on Slide 15, total revenue grew 5% on a pro forma basis, which includes a negative 3% impact from foreign exchange.

Absent that impact total revenue grew 8%, driven by a robust 6% volume growth.

This volume growth was consistent across all major geographies.

Japan's volume growth was largely driven by Alimta, which was approved earlier this year for both first line and second line non small-cell lung cancer.

Also, Animal Health volume growth benefited from the inclusion of US Posilac sales after our acquisition of Monsanto's dairy business in Q4 of last year.

As you'll see on Slide 16 we provided the price, rate and volume analysis on a reported basis.

Now let's look at the rest of the income statement.

Slide 17 shows the year-on-year growth of select line items of our pro forma non-GAAP income statement, both with and without the effective changes in foreign exchange rates.

The numbers in the first column are the same as those you saw earlier on our pro forma non-GAAP income statement.

I'll focus my comments on the second column of numbers, which strips out the impact of foreign exchange rates on our pro forma non-GAAP results.

Now first you'll see the 8% revenue growth I mentioned previously.

Below that, you'll see that cost of sales and operating expenses grew in line with revenues this quarter.

The 8% performance growth in operating expenses was driven by an increase of 5% in marketing, selling and administrative expenses, and an increase of 14% in R&D.

Our 8% performance growth in revenue translated into 8% performance growth also in operating income.

EPS grew slightly faster at 11%, due to year-on-year favorability in other income and the effective tax rate.

Finally, you'll see in the last column that year to date we've grown revenue faster than both cost of sales, as well as operating expenses, which has led to a 14% performance growth in operating income and EPS.

Now for your information, on Slide 18 we provided the year-on-year growth of select line items of our reported income statement, both with and without the effect of foreign exchange rates.

Comparisons of 2009 to 2008 operating income and EPS are not meaningful due to charges taken in 2008.

Now let me wrap up my comments with an update of our 2009 financial guidance.

If you take a look at Slide 19, let's discuss a few high-level trends for the remainder of the year.

In terms of operating performance, we expect continued volume-driven revenue growth.

We also expect revenue growth to exceed growth in operating expenses, and regularly-scheduled maintenance shutdowns at our manufacturing site should put upward pressure on our cost of goods sold.

In terms of the impact of foreign exchange, at current rate FX should have a modest positive impact on international revenue and income.

However, we do not expect the substantial cost of sales benefit from FX related to international inventories sold in the first nine months of the year to be repeated in Q4.

At current FX rates we could see a significant addition to cost of sales in the fourth quarter.

In addition, year-on-year comparisons will be affected by the significant reduction to cost of sales booked in the fourth quarter of 2008.

With this context, let's move to Slide 20 to summarize our 2009 guidance.

Given the strong performance in the first nine months of the year we are raising our previously-issued 2009 earnings per share guidance range of $4.20 to $4.30 to a new range of $4.30 to $4.40 on a pro forma non-GAAP basis.

This corresponds to a range of $3.90 to $4 on a reported basis.

In terms of line item guidance we expect total revenue to grow low to mid single digits on a pro forma basis and mid single digits on a reported basis.

Gross margin, as a percent of revenue for the year, is expected to increase on both a pro forma non-GAAP and reported basis.

In the fourth quarter we expect a significant 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 digits on a pro forma non-GAAP basis and low double digits on a reported basis.

Our other income for the year is still expected to be a net deduction of between $200 million and $250 million, as well as the effective tax rate for the full year should now be approximately 21% on a pro forma non-GAAP basis and 20% on a reported basis.

Finally, we expect capital expenditures to be less than $1 billion for the year.

Now, let me turn the call over to Nick or Ronika for a product review and pipeline update.

Nick?

Thanks, Derica.

As you can see on Slide 22, and as mentioned earlier, in Q3 we again posted volume-driven revenue growth, continuing a trend we've seen for most of this decade.

In the lower chart you will see the contribution made by select products to our worldwide volume growth of 6%.

Alimta, Cymbalta, Zyprexa and Humalog were the principal drivers.

Gemzar's international volume fell 30% compared to Q3 2008 because of generic competition, which cut volume growth of total revenue by [25%].

Last quarter we discussed underlying prescription and share of market trends Cymbalta, Alimta, Cialis and Byetta.

This quarter, we'll take a look at Humalog and provide an update on the launch of Effient.

We've seen an encouraging trend in the mealtime insulin for the market during Q3.

Humalog had been losing share to Novolog for over a year, especially in the primary care physician segment.

Over the last three months Humalog's new to brand share gains have been impressive in both the endocrinologist and primary care settings.

We achieved these results by applying our increased understanding of the mealtime insulin experience for both patients and healthcare professionals, which has enabled our sales force to have more valuable customer interactions and dedicate more focus to the Humalog brand.

The Humalog quick pen, which we believe is best-in-class in the mealtime insulin market continues its strong sales performance.

Now let's turn to Effient, our new treatment for the reduction of thrombotic cardiovascular events in patients with acute coronary syndromes, who are undergoing percutaneous coronary intervention, or PCI.

We receive FDA approval for Effient in mid July.

We launched in the US in early August and were diligently executing our launch plan.Obtaining hospital formulary status is critical to the uptake of a hospital-based product like Effient.

As we've said in the past, gaining wide-spread hospital formulary status will take roughly six months.

To date we're on track to achieve our hospital formulary goals.

As we move forward, in addition to working to gain formulary status, we'll be focused on communicating formulary availability to physicians and seeking initiation of appropriate ACS/PCI patients, particularly those under 75 years of age and those over 132 pounds of body weight who have not had a TIA or stroke.

Payer access is also meeting our expectations of interim formulary status of Tier 3 unrestricted.

We're especially pleased that as of October 1st Effient has Tier 2 unrestricted access with Express Scripts in both commercial managed care and Medicare Part D.

In Europe, despite receiving regulatory approval in late February this year, we're still early in the process of gaining pricing and reimbursement access at the individual country and hospital level.

For example, we received a positive nice recommendation for England and Wales in September; however, this recommendation will only become final later this month and then individual hospitals will have up to 90 days to implement this approval.

We've also received positive reimbursement and access decisions in a number of countries, including Argentina, Australia, Denmark, Greece, New Zealand, and most recently, Switzerland.

France also has recommended reimbursement of Effient, although it will be some time before pricing discussions conclude.

We hope to fully launch the products in France, Italy and Spain during 2010.

As in the US, we're making good progress and expect Effient prescription volumes to build over time.

Now, Ronika will provide a brief update on our pipeline.

As we communicated in earlier press releases, we're disappointed about the losses of Arzoxifene and dirucotide.

Our decision not to submit Arzoxifene for regulatory review was based on overall clinical profile of the compound in light of currently-available treatment, including our own Evista.

And in the Phase III MAESTRO-01 pivotal trial dirucotide did not meet the primary objective of delaying disease progression in patients with secondary progressive Multiple Sclerosis.

Despite these disappointments, we still have a robust pipeline in both quantity and quality.

Our clinical phase portfolio is now (inaudible) at Our -- 61 distinct NMEs, including 23 compounds in Phase II and Phase III.

We continue to develop a robust biotech portfolio.

Biotech molecules represent over half of our late stage Phase II and Phase III assets and over a third of our overall clinical portfolio.

Our focus has not changed.

Advancing our pipeline is our number one priority.

As reflected by the arrows on Slide 25, since our last formal portfolio update during the second quarter earnings call, we've initiated Phase II clinical trials on A-beta antibody for the treatment for Type II diabetes and we've moved three more compounds in the Phase I testing; two for diabetes and one for depression.

As is the nature of our business, we also terminated development of eight other assets; two in Phase II and six in Phase I.

You may recall that in Q1 and Q2 we only had one Phase I and one Phase II termination.

Running the right experiments to enable early go/no-go decisions and knowing when to stop development is just as important as advancing assets, allowing us to refocus our time and money on more promising molecules.

Now, let me turn to Slide 26 to highlight select milestones between now and mid 2010.

In regulatory actions we could have FDA action on Byetta monotherapy and Zyprexa LAI this year and on Exenatide once weekly and Cymbalta for chronic pain in the first half of 2010.

Earlier this year the FDA raised concerns about the pharmacokinetic comparability data in our FDLAs for Erbitux in first-line point of cell carcinoma of the head and neck and first-line non small-cell lung cancer.

Later this year we will meet with the FDA to discuss our path forward.

Pending the outcome of this discussion we hope to resubmit the non small-cell lung cancer FDLA and respond to the head and neck cancer with a response letter by late this year or early next year.

And we expect to initiate a number of Phase III trials in oncology late this year or early next year, including ImClone 11F 8 and A12 and our own tasisulam.

In addition, early next year we hope to begin stand-alone Phase III clinical trials on GLP-Fc and diabetes.

This concludes our prepared remarks and we will now open the call for the Q&A session.

Operator, first caller, please?

Thank you.

(Operator Instructions).

Our first question comes from John Boris with Citi.

Thanks for taking the question and congratulations on the quarter.

First question just has to do with the revised guidance, if I just take the midpoint of that range and assign a 10% or a 15% growth rate to that, I'm coming up with an earnings estimate that could be in the $4.79 to $5 range.

I guess not looking for specific guidance -- I know you'll deliver that in December -- but can you help us understand what some of the pushes and pulls are going into 2010 that we should be thinking about from a modeling standpoint?

The second question just has to do with formulary uptake on Effient, both on the hospital side and PBM side, any color you can give there?

And then just -- last question just has to do with IDENTITY 1, can you provide an update also on IDENTITY 2 and when do you think you'll have data available for presentation in how we communicate the results from the IDENTITY Alzheimer's program with your (inaudible)?

Thanks.

Good questions, John.

We'll go ahead and have Derica respond to your guidance question and I'll probably take your formulary hospital question with Effient, and then Nick will respond for you on the IDENTITY 2 trial.

Derica?

Good morning, John.

John, first of all, in regards to 2010 we'll provide more color on that at our December 10th analyst meeting, but let me at least provide some insight in terms of our outlook for the remainder of the year.

As you have seen and stated, we've revised our guidance on a pro forma non-GAAP basis to $4.30 to $4.40.

Now in that we still expect to continue the solid volume-driven growth -- revenue growth that we've seen for the first nine months of this year and that's the sustainable part of our business.

So that's where we focus, because with that we get great leverage through the remainder of our operations, both in our manufacturing facilities in terms of full absorption, as well as getting the full return on our marketing and sales investment.

With that, you also heard me speak about the effect of FX on our operating performance in terms of our financials and given where current FX rates are I anticipate having a very significant cost impact to our cost of sales in the fourth quarter of 2009.

And as I stated, this time last year, we had a significant benefit to cost of sales in the fourth quarter because the rates were going the other way.

If you were to go back and look at history, you can basically track the impact of FX on our cost of goods sold line for the last three years.

So in the Q4 of 2007 was when we had a significant cost of sales due to FX in our gross margin.

Last year we had a significant benefit and now that rates are going the other way again we're having another significant cost -- we anticipate another significant cost.

And you pretty much track the dramatic movement and rates when you look at the dollar devaluation in '07, appreciation in Q4 of '08, and then devaluation again and now in Q4 of '09, we anticipate.

So that would be our outlook for the remainder of the year.

I want to -- this is John Lechleiter, John.

I want to just add that we've also got some planned manufacturing plant shutdowns in the fourth quarter.

We're also going to be continuing robust investment in late-stage clinical trials for a number of assets in our pipeline.

So these are things that also will factor into those fourth quarter results and are factored into the guidance adjustment we made today.

And, John, Effient formulary access, we had a plan essentially that stretched over the first six months or so after approval for us to meet with the various hospitals, have their committees take their decisions, and then grant the access that we expect that we will get.

We are executing to that plan and things are proceeding according to plan.

As I mentioned earlier, we're very pleased to add Express Scripts in both the managed care commercial business and also in the Part D plans.

So, again, we're executing to our plan.

things are proceeding according to plan, but this is a process that will take a few months to play out.

Nick?

John, on (inaudible) our small molecule for Alzheimer's, as we mentioned IDENTITY 1, the first Phase III trial has completed enrollment on that.

IDENTITY 2, we have enrolled over half of that study to date of about 1,100 subjects.

We expect that study to report out in mid 2012, but keep in mind that this is one -- it's a 21-month study, so 21 months after completion of enrollment is when we expect that study to report.

John, this is Steve Paul.

Just quickly, we're reassured by the periodic safety updates, this compound looks to be -- it's behaving very well -- very well tolerated, so that's all very encouraging about this trial.

Great.

Operator, next caller, please?

Yes, our next question comes from Catherine Arnold, Credit Suisse.

Thanks very much, and good morning.

I was wondering, John, if you could speak to your -- to two things.

One is your recently-announced cost savings program and your changes in development.

Should we be thinking about the $1 billion in saving as a starting point given the significant reduction in cost structure for the industry overall and Lilly obviously playing a role in that, and also the outlook for the Company in terms of some of the products that are going off patent?

Could you just frame how we should be thinking about that initial announcement?

And then you had made some pretty dramatic comments about the organizational changes in the Development Center of Excellence.

I wondered, guys, we're sitting in your analyst meeting and we're talking to you over the course of the next year, what kind of metrics will you be sharing with us in terms of us knowing whether or not that was a successful initiative and how that's progressing over time?

Thanks, Catherine.

I think right now all we have to say on our plans for cost cutting is what we said on September 14th, that we aim to take $1 billion out by the end of '11 and we expect that, in concert with this, we'll need to reduce the number of positions at Lilly from a little over 40,000 today down to 35,000, excluding significant sale -- strategic sales additions in certain emerging markets and in Japan.

Obviously, Catherine, we're going to be guided by events as they unfold.

As we bring molecules forward through Phase III in anticipation of launches in those out years, we're going to want to make sure we have the right investment behind those products.

So I think this is going to be an unfolding story as we, as we move along.

With respect to changes in development, I think there's a couple things you should expect.

I think you should expect that we can more or less consistently adhere to timelines and target dates.

Obviously this is a business with a lot of risks.

There are acts of men and acts of God and sometimes the acts of God set you back, but you still got to figure out how to recover from those and I think we've done that historically.

I think you should also expect to see accelerated timelines.

I've got my 30th anniversary with Lilly in two weeks time and it's still a ten to 15-year journey just like it was in the late 1970's to move a molecule from a lab to a patients.

We don't believe that has to be accepted as gospel.

We believe that we can apply new tools and new technologies in a more robust fashion and a more consistent fashion in order to reduce that cycle time and also to reduce hopefully cost and risk along the way.

We're looking at tailoring strategies even before we enter the clinic.

The opportunity therefore to study early sta -- drugs in early stage development in population groups that may be more enriched with people who are more likely to respond.

You've seen the benefit of tailoring with our Alimta sales this month -- or this quarter, 47% increase, and actually the Alimta target population today is smaller in terms of the broad lung cancer population than it was when we launched because we're only indicated today for treatment of other than squamous cell type lung cancer.

But that data that we have, the benefit for patients in that population is, is so clear that it is obviously prompting physicians to choose Alimta for those patients who stand to benefit the most.

So those are some thoughts on that.

You can expect that we will be quite up front with the kinds of metrics that we think will be and should be indicative of progress.

Catherine, Steve Paul here.

Let me just elaborate just briefly and we will spend more time on this in December at the analyst meeting, but there are three pillars to this Development Center of Excellence.

One is a new operating system that we call critical chain, which, as John indicates, now has us operating on time with virtually every project where we've adapted the critical chain methodology and we'll be talking about that and we want to increase that to 100% of our projects.

John mentioned tailored therapies and the stratification piece, which is so important for our oncology pipeline.

And then the third one is something we call advanced analytics, which includes clinical trial stimulation modeling, which has really helped us not have to repeat trials, which is a major source of timeline delays, as well as adaptive seamless designs like we've done with (inaudible) where you can literally prevent having any downtime between either Phase I and II or in many cases, Phase II and Phase III, and those are going to speed innovation to patients.

Thanks, Catherine.

Next caller, please?

Thank you.

Our next question comes from Steve Scala with Cowen.

Thank you.

I have two questions, first on Effient.

On the second quarter call Lilly stated that you expected rapid formulary access across the board, that you expected things to move very quickly and that you expected Effient to perform extremely well where indicated, and now you're saying you expect it to build over time.

Six months was mentioned.

It seems like there's been a change, although you're saying it's performing according to plan, so I wonder if you could reconcile that those groups of statements?

And secondly, Lilly only periodically updates its 2007 through '11 EPS guidance of low double digit on the earnings line.

Is that guidance intact at this time, and given the very strong performance thus far in 2009 is there any reason for us not to assume it will be reiterated or even increased at the December analyst meeting?

Thank you.

Sure, Steve, thanks for the questions.

In terms of Effient, as I mentioned before, we are tracking to the plans that we have for having the scheduled meetings with the various hospitals and with the decisions that today have been favorable on granting that formulary access.

For the 2007 to 2011 guidance, you're right, that is something that we do update typically once a year at the December analyst meeting, and if we made one exception recently that was when we had the ImClone acquisition that was significant enough we decided to update that guidance off cycle.

Derica?

Sure.

Steve, this is Derica, let me say this.

We're not going to update our guidance out to 2011 to date.

In fact, I commented even on our '10 outlook and the fact that we will be sharing that at our December meeting on December 10th.

What I can say is that at least the commitment that we've made and how we perform up to this point in time, so if you look at our Q3 results we generated 22% bottom-line growth.

If you take out the effect of FX, we were at 11% growth.

Year to date without FX, we're at 14% growth.

So up until this point in time, which we are prepared to talk about, we are absolutely executing upon the expectations that we set, both internally in terms of our internal goals, and what we've shared externally with our investment community.

And so I feel very good about the performance of the Company, not only this quarter and this year, but actually how we performed over the last several years, which was when we began to talk about that double-digit outlook, bottom line.

One other thing I would highlight for you, Steve, is in the 2007 to 2011 guidance that we had issued we did mention in the past included in expectation, which we have continued to see, of pricing pressures globally.

It did not include, however, a specific estimate for any significant healthcare reform here in the US.

So there'd be a number of pushes and pulls that would pull that number up, pull it back down, that will go into our updated numbers that we'll likely discuss in December.

That is one I would flag for you that was not contemplated in the prior guidance that we clearly need to figure out how we best incorporate that going forward.

Operator, next caller, please?

Our next question comes from Tim Anderson with Sanford Bernstein.

Thank you, couple of questions.

Just going back to guidance, so going to 2011 basically takes you right up to the edge of the patent cliff and I think the Market is kind of showing you that they want to know what guidance is beyond 2011 and you have more and more companies that are starting to give guidance into that difficult period of patent expirations and I'm wondering when we can expect Lilly to give guidance beyond 2011?

Second question is, earlier this year, on several different occasions, Lilly has disavowed doing any big pharma mergers and I'm wondering if that's still the Company's view, or if that could be the fallback option if your pipeline doesn't pan out over the next couple of years and as you approach that period of heavy patent expiries?

Derica?

Tim, this is Derica again.

In regards to guidance, and clearly as we look to meet on December 10th, we will share more of our perspective on our outlook for that period and how we look to manage through that period.

And in terms of '11 through '14, which we call our YZ, which is the period of patent expiry for Zyprexa and Cymbalta.

As you look at some of the actions that we've already taken, starting with John's announcements back in September, those are all things that are consistent with our strategies and plans to navigate through that difficult period and for the Company, both in terms of the cost savings, both in terms of the headcount reductions, but more importantly, and most importantly, is our focus on speeding up the development of the molecules in our pipelines, okay.

In regards to your last question, which was around M&A, we are solely focused on our number one priority, which you heard Ronika state, which is progressing the assets in our pipeline.

We feel very good about the 60 assets we have today in clinical stage of development.

They may not be there in time to recover immediately from the Zyprexa and Cymbalta hit, but clearly it provides good growth prospects post those events and that's where our central focus is at this time and it's not on large scale M&A.

Operator, next caller, please?

Yes, and our next question comes from Tim Butler with Barclays Capital.

Thanks very much.

John, two questions, please.

You've alluded -- or you've made statements about the $1 billion cuts from total operating expenses and when Catherine Arnold alluded to her views around how you -- how committed you may be, the question really is, if 23 products are in Phase II, III today your R&D expenses are jumping quite heavily into that XY period.

Would you be committed to actually doing more than $1 billion, is that a plan that's on the back burner?

That's question one.

Then question two, and perhaps more for Steve and apologies for just picking out one program, but if we look at the GLP-1 program, the GLP-Fc , and we look back at the Phase II data and we see some issues with heart rate and we see some issues with diastolic pressure, I am just curious how you actually justify moving the product along and I'd be interested in your thoughts, especially when John alluded to there are failures due to acts of God and failures due to acts of man and I'm wondering, could this be a failure due to act of man?

Tony, I'll start off and talk about the cuts.

Clearly, we want to make -- take all the actions necessary to enable us to place the right resources and invest the right resources in the right places in R&D.

Part of the effort under way, since our announcement in mid-September, is a close look at everything that we have in development, with an eye to being very clear within the Company.

We talk about this single operating system, on which assets represent the most significant opportunities and therefore should be considered and invested in as the highest priorities.

We certainly have other channels and other venues, including partnerships of various sorts, that we can also use to share costs and risk associated with development of a set of molecules that we think, frankly, are the most exciting set of clinical assets we've ever had in our history.

Again, I think we're very resolute on achieving the $1 billion target.

At this point in time, I think if we were to go any deeper than that, that would have to be with all due consideration of all the other factors that weigh in, including our desire and the need to invest in this pipeline to make sure that we have a trajectory that augers well for strong growth as we come out of this period.

Tony, let me comment on GLP-Fc.

Just to begin, we're very, very excited about the GLP-1 mechanism for treating diabetes.

There's no class of drugs that show this kind of glycemic control, weight loss, lack of hypoglycemia overall and the clinical data on the efficacy has been -- has really been tremendous and I include in this Exenatide once weekly in our own GLP-Fc.

Now, with respect to cardiovascular liability, let me -- rest assured we are very knowledgeable about what we need to do with respect to cardiovascular liability.

This drug does not produce, at doses that are very therapeutic and very effective, increases in blood pressure, okay?

There are some small increases in heart rate, a couple of beats per minute.

By the way, this may be a class effect for all GLP-1like drugs, so we are very, very confident right now with the safety data we have.

Now, we need more safety data as we develop the drug but we're constantly monitoring all our GLPs in development and feel that this is going to be a very important standard of care eventually for treating Type II diabetes.

Tony, just to be precise, I think the data you may be mentioning was also mentioned post-ADA on a call by a physician.

Actually Phase I data that, as Steve mentioned, was supratherapeutic doses of 5 milligrams, for example, which is significantly higher than we had studied in the Phase II trial called GBCJ that we had presented this year at the ADA that, as Steve mentioned, showed no increases in blood pressure.

Operator, next caller, please?

Certainly.

Our next question comes from Burt Hazelett with BMO Capital Markets.

Thank you.

I have a question -- a couple of product-specific questions, pipeline questions.

I've spent the past couple days at the rhematology meeting and you (inaudible) --

Bert, we're having a very hard time hearing you.

It's breaking up as you're talking.

We can't make out your questions.

Oh, I'm sorry.

The question is -- I'll make it short and sweet -- what are you doing to move IL-17 and BAFF forward?

Those are interesting programs.

What can you do specifically to move those programs forward?

When do we hear anything on the Nary depression program?

And then given these comments, you're talking about restructuring, can you comment on the dividend stability?

Thank you.

Okay, that was clearer.

Bert, we'll have Steve handle your first two questions then, Derica, you're third.

Bert, you're absolutely right.

I think IL-17 -- the IL-17 antibody, the antiBAFF and bliss antibody, LA- 294, and our IL-23 -- selective IL-23 antibody are among the most exciting assets that we have in the pipeline.

As you know, we've established proof-of-concept with all of those molecule -- each of those molecules in the clinic and they're being pursued for multiple disease indications in the autoimmune area.

So we're moving them as quickly as we can.

They'll likely -- there'll be some launches likely in indications and it will be continued development.

As you know, there's a lot of disease -- there are a lot of diseases where those molecules could be effective.

And Nary's also continuing along.

I don't know exactly the date that we have on Nary in terms of when we will announce data --

[I'm not sure but I'm happy to follow up with that later].

-- on that.

Again, a validated mechanism for depression and augmentation, and again, one that we're very excited about.

Derica, for the dividend?

Sure.

Bert, in regards to the dividend, today as you can look at our stock price, our yield is around 5.7%, I think that's a very healthy yield but we've -- up to this point we've been able to sustain our dividend.

In fact, we've actually increased our dividend over the last 40 years.

So we understand that it's very important to a very large portion of our investor base and today we're generating the cash flows that -- in support of that.

So if you look at our payout ratio, it's also reasonable.

So I feel good about where the -- our dividend payout is at this moment.

I think our dividend yield is too high, but primarily because I think our stock price is too low and undervalued at this state.

Operator, next caller, please?

Certainly.

Your next question comes from Eric Lo with Banc of America.

Great, thanks, guys, a couple questions.

With regards to the dividend, would you consider cutting the dividend if you had the right acquisition in place?

And when it comes to M&A, is the priority to acquire additional late-stage pipeline assets, or maybe incremental sales to offset the panic cliff in YZ years?

And the second question is with regards to the gross margin, using the current FX rates you guys are talking about, what would you say is the year-over-year impact to gross margins resulting directly from currency?

Okay, let me try to take those three.

In regards to would we consider cutting the dividend, it's very difficult to sit here and speculate and play what if.

It really would depend on what's before us, but as I stated earlier today, we feel very good about the current operations of the business.

Our focus to date is on progressing our pipeline.

We know we're going to take a hit with the loss of -- pending loss of Zyprexa and Cymbalta in our future.

Those are known dates and events.

The uncertainty in our business is around our ability to [prosecute] and advance our pipeline, so that is our number one focus from an asset allocation standpoint.

Secondly -- and so we believe we can do that and still sustain our dividend.

In regards to what is the focus of our business development activity, also as I stated earlier, it's really not out going to do the mega merger.

We are very active in the space of looking at molecular-type acquisitions, molecules that we believe will compliment or enhance or add to our current pipeline, and to date we've been, I think, quite successful with some of the arrangements that we've been able to negotiate with partners that we work very well with, such as Amylin.

In regards to your third question around gross margin, if you look to date we had, I think, in the fourth -- excuse me, in the third quarter, our gross margin increased by three -- or expanded by 3.7 percentage points, okay?

The majority of that was driven by the movement in FX rate, but it's two different directions in two different periods.

In Q3 of '08, our gross margin benefited from FX -- excuse me, I said it wrong way.

In Q3 of '08 our gross margin was hurt by FX, in Q3 of 2009 it benefited, so that's what creates the full 3.7% expansion year on year.

Eric, just one last thing on that.

Essentially if you look at the FX impact on sales and on manufacturing expenses in the period, there really was not much of an impact.

So it really is related to this foreign exchange impact on inventories sold in the period that we've talked about for the last couple of quarters.

And that really drove essentially the full change of that 3.7% compared to last year.

Operator, next caller, please?

Certainly.

Our next question comes from Jami Rubin with Goldman Sachs.

Thank you.

Just for further clarification on the gross margin, so the guidance for full-year 2009 would seem to imply a midpoint of fourth quarter earnings of $0.79 to $0.89, I believe the consensus is around $0.96, so that would imply a gross margin of around 77%.

And I'm just -- Derica, I don't want to focus on this too much, but after the second quarter the guidance was to assume that -- we were to assume that gross margins would go back to normalized level.

Can you help us to think about what a normalized gross margin is, because fourth quarter last year you benefited, you had a strong gross margin versus a weak gross margin in the third quarter and I'm just getting confused.

So if you could just help us to think about what a normalized gross margin should be as we revise our numbers for 2010?

Thanks.

Okay, Jami, this is Derica, I'll try to address this one more time, if I may.

It's difficult to say what's a normal gross margin because our ability to predict exchange rate -- foreign exchange rates is, as I think is indicated by the movement over the last two years, is impossible.

What we are providing in our guidance for the year and its implications for the fourth quarter is that, based upon where rates are today, we would anticipate having a significant detriment, or negative impact to our cost of goods sold in the fourth quarter driven by rate.

You'd have to go back -- and Jami, the guidance I would give you is to go back and look at the movement over time, okay, so you go back and look over the last probably mid 2007 and you'll see the swings, but you'll also see the periods of stabilization, as well, and I think you can get to what a reasonable range would be.

I'm walking a fine line here because we've never provided guidance around our gross margin in terms of an absolute.

What we have said is where we see the movement being year on year as we progress forward.

Jami, at the last quarter call we had mentioned that we did expect for the second-half gross margin to decrease compared to the second half of last year.

That's still the case.

We still expect for that to be true for the second half.

As you're mentioning, clearly that will be comprised of a significant benefit in terms of the gross margin percent in the third quarter and a reduction in the year-on-year gross margin percent in the fourth quarter.

Probably take one more caller and then pass it to John to wrap up the call for us.

Operator, next caller?

Yes, our next question is from Chris Schott from JPMorgan.

Great, thanks, just two quick questions.

First on Erbitux, would be interested in your thoughts on the CHMP-negative opinion on the flex data that we had early in July?

And then second, can you elaborate a little bit more on the divisions created with the restructuring.

Specifically given the Company's historic strength in neuroscience and two late-stage Alzheimer's assets, I was interested in why you opted not to have a neuroscience center of excellence?

Thanks.

Thanks, Chris.

I'll go ahead and take your first question and have John comment on the second one.

So with the CHMP opinion for the first-line non small-cell lung cancer, definitely understand that Merck KGA is intent on that appealing that decision.

They're really in the driver's seat with having the relationship and the discussions with the regulators there, so they're probably the best positioned to give you more color commentary on how they view that interaction.

Clearly from our observations or comments and discussions with them there's clearly a strong view that there is data that's supportive of reconsideration of the CHMP's initial recommendation and Merck KGA is intent on taking that out to make sure that we can have that heard fully and hopefully have that recommendation reversed to get approval of the product.

John?

Chris, let me make a comment on the way -- the choices we made around our business units.

Clearly, neuroscience is the single biggest component within our single biggest, largest business unit, which is our established markets business unit.

Our choices of the business unit formation around diabetes and oncology are really driven by our surmising that we're going to be in these two businesses for many years to come.

A third of our clinical stage portfolio today are molecules in the oncology area and with our insulin and GLP platforms I think it's a pretty safe bet that insulin is a long-term business opportunity for Lilly.

We hope and believe that neuroscience can also be that opportunity, but that clearly depends on us being able to bring through the next generation of innovative products, whether it's Nary-4, the MGLU-23 drug or either of the Alzheimer's assets.

So we have the flexibility to make different choices down the road.

We think the current arrangement is the best one.

Thanks for all of your questions.

We're going to be, Ronika, Nick and I.

available after the call to take additional questions that you may have.

Let me go ahead and now turn it over to John to close the call.

Yes, and I would like to thank all of you for taking time this morning for this update on our Company.

We appreciate your interest in Eli Lilly.

Let's me close by emphasizing a few key points.

Our strong financial performance continued again in the third quarter, as we delivered volume-driven revenue growth, operating income growth greater than revenue growth, robust EPS growth, and strong operating cash flow.

We remain confident that this type of financial performance provides the resources we need to strengthen our pipeline and drive future growth, to deal with the patent expirations coming in the next decade, and to respond to a challenging healthcare environment.

We took decisive action to reshape our operations, including announcing a new operating model that includes a Development Center of Excellence to accelerate clinical development, and to the reorganization of our pharmaceutical business into four business units.

We communicated our plan to reduce our cost structure by $1 billion and lower our headcount to 35,000 by the end of 2011.

We offered a voluntary exit program to select areas of our US sales force to facilitate implementation of a new commercial approach in 2010.

And more recently, agreed to sell our Tippecanoe Laboratories manufacturing site to an affiliate of Evonik industries.

We continue to stake our future on innovation, investing appropriately in R&D, making timely database decisions to advance or terminate our assets.

We look forward to keeping you informed of our progress and seeing many of you in New York on December 10 for our annual investment community update.

Have a great day.

Thank you.

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