Eli Lilly and Company (LLY) Q3 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. Your host and speaker, Vice President of Investor Relations, Phil Johnson. Please go ahead, sir.

Good morning. And thanks for joining us for Eli Lilly & Co.'s Third Quarter 2011 Earnings Conference Call. I'm Phil Johnson, Vice President Of Investor Relations. Joining me today are John Lechleiter, our Chief Executive Officer; Derica Rice, our Chief Financial Officer; Dr. Jan Lundberg, our Chief Scientific Officer; Dave Ricks, who's currently President of our U.S. affiliate, and as announced last week, Dave will assume the role of President of our Biomedicine business upon Bryce Carmee's [ph] retirement at the end of the year; and we have Ronika Pletcher and Elisa Razner [ph] for 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 on latest forms 10-K and 10-Q filed for Securities and Exchange Commission. The information we provide about our product and pipeline is for the benefit of investment community. It is not intended to be promotional and is not sufficient for prescribing decisions. Let's begin with a recap of events since our Q2 earnings call. We had multiple developments on the regulatory front. The European Commission granted final approval for Trajenta for adults with type 2 diabetes. EU launches have begun, starting with the U.K. Launches in other European countries are expected over the balance of 2011 and the first half of 2012. Despite initial impasse, we hope to reach an agreement with local authorities that allows Trajenta to be made available to German patients. The FDA approved Cialis for once-daily use for the treatment of men who have signs and symptoms of benign prostatic hyperplasia or BPH, and men who have both erectile dysfunction and signs and symptoms of BPH. Cialis is the only medication approved by the FDA to treat both ED and BPH. Just last night, the FDA approved BYETTA for use with insulin glargine. Europe's CHMP issued a positive opinion for use of ALIMTA as a continuation maintenance therapy in patients with nonsquamous non-small-cell lung cancer after initial treatment with ALIMTA plus cisplatin. We expect EC approval during Q4. Along with Amylin and Alkermes, we submitted our reply to the FDA's Complete Response Letter for Bydureon, and the FDA assigned a PDUFA goal date of January 28, 2012. We also submitted our reply to the FDA's Complete Response Letter for Amyvid, a PET imaging agent under investigation for the detection of beta-amyloid plaque in the brains of living patients. And finally, we submitted the sBLA for ERBITUX in first-line metastatic colorectal cancer. On the business development front, we entered into 2 different agreements to bolster our diabetes presence in India. First, we entered into collaboration with Lupin Limited, under which Lupin will promote Humulin in India and Nepal. And we expanded our collaboration with Boehringer Ingelheim to include co-promotion Linagliptin by Lilly and copromotion of Humalog by Boehringer Ingelheim. Also, in an earlier stage of this development initiative, we launched a new platform, called Open Innovation Drug Discovery, to both build our own pipeline, and identify molecules that may be useful in the treatment of multiple-drug resistant tuberculosis. On the legal front, the Court of Appeals for the Federal Circuit ruled in Lilly's favor in the Strattera patent case, overturning a prior ruling by the U.S. District Court in New Jersey and upholding the Strattera method-of-use patent, which will expire in May 2017. The defendants filed a motion for rehearing en banc, and earlier this week, the court denied their request. Lastly, in important news for our industry and for Lilly. The America Invents Act was signed into law. Not only will this new law align U.S. patent laws more closely to those of other countries, but we believe, it will improve U.S. competitiveness by: reducing the backlog of patent applications, enhancing the quality of issued patents; and providing greater certainty for those that invest in innovation. Now with background, Ronika will discuss our Q3 financial results and provide our pipeline update. And then Derica will cover our financial guidance for 2011 and key events for the remainder of 2011 and 2012. Ronika?

Thanks, Phil. As we've done on previous calls, we'll focus our comments on non-GAAP results, which we believe provide insight into the underlying trends in our business. This view excludes certain items such as restructuring charges, asset impairments and other special charges. We'll also provide commentary on our Q3 results, excluding the effect of headwinds that were highlighted in previous discussions of both our quarterly performance and our 2011 guidance. I'll start on Slide 6 with a quick look at our Q3 income statement. On a non-GAAP basis, you can see that we generated robust revenue growth in this quarter, excluding Gemzar outside of Japan and the effect of U.S. healthcare reform, revenue would have grown 15%. Compared to Q3 2010, gross margin as a percentage of revenue decreased 4.3 percentage points to 78.2%. This decrease is primarily due to the effective changes in foreign exchange rates on international inventories sold and to a lesser extent, a negative mix effect. Operating expense defined as the sum of R&D and SG&A grew 10% this quarter. This increase was driven primarily by SG&A, which increased 13%, while the increase in R&D was 5%. Drivers of increase in operating expenses included: costs related to our diabetes alliance with Boehringer Ingelheim, including late-stage clinical trial expense; the effect of changes in foreign exchange rates, as well as the pharmaceutical manufacturing fee associated with U.S. healthcare reform, which was roughly $45 million. Excluding the effect of U.S. healthcare reform and the Boehringer Ingelheim alliance, operating expenses would have grown 3%, with this amount entirely driven by foreign exchange. Other income and deductions was a net expense of $83.4 million this quarter, which was higher than last year. The higher net expense was due to a partial write-down and the IPR&D value of Amyvid, due to a revised assumption for the timing of a potential regulatory approval and sales uptake. Our tax rate was 17.9% this quarter or 4.6 percentage points lower than Q3 2010. The largest item driving this reduction is the recognition of a discrete tax benefit of $45.4 million, primarily as a result of a resolution of the company's 2007 IRS tax audit. At the bottom line, our non-GAAP EPS decreased 7% from $1.21 to $1.13. Consistent with the 2011 guidance we provided in January, we saw robust EPS growth in our business in Q3, excluding U.S. healthcare reform, the effect of Gemzar patent expiration outside of Japan, and investments related to the Boehringer Ingelheim diabetes alliance. Excluding these items, EPS would have grown in the mid-20% range. Slide 7 shows our reported income statement, while Slide 8 provides a reconciliation between reported and 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 revenue. As you can see on Slide 9, total revenue growth of 9% was again driven by solid volume growth of 4%. This quarter, foreign exchange was -- also contributed 4%, while price had a negligible impact on worldwide revenue growth. We continue to see strong volume growth from our 3 countercyclical engines: Japan, animal health and emerging market. In total, these businesses delivered 15% volume growth in the quarter. Volume growth continued to be strong in Japan at 20%, driven by recent launches of both Cymbalta and Forteo. Elanco Animal Health volume grew 22% in Q3, driven primarily by organic growth, including increased demand for our food animal products and the continued expansion of our companion animal business. The launch of Trifexis in the U.S. has been particularly robust. To a lesser extent, this volume growth was driven by the acquisition of certain Hanson[ph] and Pfizer animal health assets in Europe. Finally, embedded within the rest of world line, our emerging markets revenue grew 7% in volume and 5% overall. Although the growth in emerging markets moderated relative to previous quarters, particularly noteworthy was China's revenue growth of 22% in volume and 31% overall. This quarter, FX had a significant effect on EPS. Slide 10 shows the year-on-year growth of our select line item of our non-GAAP income statement, both with and without the effects of changes in foreign exchange rate. The numbers in the first column are the same as those you saw on the last column on Page 6. Let's focus on the second column of numbers, which strip out the effect of foreign exchange. First, you'll see that the 4% growth in revenue I mentioned earlier. Below that, you'll see that cost of sales and gross margin grew 8% and 3%, respectively. This is consistent with the statement that the reduction in gross margin as a percentage of revenue was primarily due to the effect of foreign exchange on international inventories sold. In total, operating expense grew 7%, excluding FX. As mentioned earlier, the increase was driven entirely by the Boehringer Ingelheim deal and the pharmaceutical industry fees. Continuing on, you'll see that excluding FX, operating income declined 2% and EPS declined 1%. So you can clearly see that FX had a significant negative effect on EPS this quarter, lowering EPS growth by 6 percentage points to negative 7%. In other words, a favorable effect of FX on our foreign operating income was more than offset by the negative effect of FX on inventories sold. Excluding U.S. health care reform, the effect of Gemzar patent expiration outside of Japan and the investments related to the BI diabetes alliance, EPS would have grown in the mid-20s. On Slide 11, you'll find year-on-year growth of the same items of our income statement on a reported basis, both with and without FX. Now before turning the call over to Derica, let me provide a brief update on our pipeline. On Slide 12, you'll find a view of our new molecular entities in clinical development as of October 10, inclusive of changes since our July update. Our clinical stage portfolio now stands at 66 distinct NMEs, including 34 compounds in Phase II and Phase III. Biotechnology represents half of our Phase II and Phase III assets, as well as nearly half of our overall clinical portfolio. We continue to make progress in advancing our pipeline. Since July, we began Phase III testing of our new insulin glargine products, and we now have 10 distinct compounds in Phase III testing, with 2 more likely to begin before year end. We advanced 3 assets in the Phase II testing, including our Myostatin monoclonal antibody that Jan Lundberg discussed at our June investment community meeting. We advanced 2 assets in the Phase I testing, and we terminated or suspended development of 6 assets across our Phase I and Phase II portfolio. In summary, we have already achieved our goal of having 10 NMEs in Phase III by year end. With Phase III starts expected this quarter for our innovative basal analog insulin and for Anti-IL-17 monoclonal antibody for psoriasis, we could finish this year with 12 NMEs in Phase III testing. We're pleased with our progress we've made, building a robust, high-quality, mid- to late-stage pipeline, with many potential opportunities to advance patient care in diseases with large unmet need, as well as significant commercial opportunity. As outlined at our Investment Community Meeting in June, we believe our current pipeline provides the foundation for Lilly to return to growth post-2014. Derica?

Thanks, Ronika. Before providing our updated guidance, I would like to talk through how the Zyprexa patent expiration will affect our income statement. This may be particularly helpful as you update your models. Now clearly, this patent expiration, which is essentially a U.S. and European phenomenon, will negatively affect our revenue and income, causing our fourth quarter results to differ substantially from those we posted September year-to-date. We lost the Zyprexa patent in most European countries last month. This coming Sunday, October 23, we'll lose patent protection for Zyprexa here in the U.S. Now as you might expect, during Q3, we saw the initial impact of the Zyprexa patent expiration. Specifically, we saw some reduction in wholesaler purchases in anticipation of reduced future sales of branded Zyprexa. In addition, we also made accruals to account for the potential future return of products that were sold to wholesalers during the third quarter. In European markets, we've already seen multiple generic companies enter the various markets, offering very large discounts. For example, in Germany, there are about 20 generic players, and the initial generic pricing came in at about a 75% discount to Zyprexa's pre-patent expiry price. Now here in the U.S., while we expect rapid and significant erosion of the branded Zyprexa sale, the competitive dynamic will be a bit different, as we will have a single generic company marketing each presentation of olanzapine for the first 6 months, post patent expiration. Also, as part of our late life-cycle planning, we've entered into an authorized generic agreement here in the U.S. with Prasco to allow them to market a generic version of olanzapine. Now upon the expiration of the 6-month exclusivity period in late April of 2012, we would expect additional companies to market their own generic olanzapine, leading to further sales erosion of Zyprexa. In summary, on the revenue line, we expect to see a significant negative impact in Q4. This is reflected in the fact that our worldwide revenue has grown 8% September year-to-date, while our full year guidance for 2011 is for revenue growth in the mid-single digits. As you think about the impact of the Zyprexa patent expiration on other line items of our income statement, you should keep in mind a few items. We do not expect Zyprexa-related manufacturing expenses to decrease at the same rate as sales. While there will be some savings of variable production costs, other fixed costs that had been absorbed by the production of Zyprexa will remain. As a result, the expected decline of Zyprexa sales will put downward pressure on our gross margin as a percent of revenue. This is why we forecast gross margin as a percent of revenue for the full year 2011 to be between 78% and 79%, despite the fact that it is at 79.5% for the first 9 months of the year. Now in terms of marketing and selling expenses, we currently have very little variable marketing spend behind Zyprexa during this late stage of its life cycle. Consequently, there will be minimal marketing savings post patent expiration. The major spend behind Zyprexa has been the sales force. Now, you should not expect to see a significant reduction in sales force expense as a result of the Zyprexa patent expiration for 2 main reasons. First, beginning in late 2009, we restructured our U.S. and then our European neuroscience sales forces. Among other factors, this restructuring took into account the CNS sales footprint needed post Zyprexa patent expiration. Second, keep in mind that Cymbalta's sold by these same sales forces, and we remain committed to providing a competitive detailing effort behind this very important brand. In a nutshell, our strategy for managing costs, leading up to the Zyprexa patent expiration, has been to act early and not wait until the event itself was upon us. Since 2004, we've been reducing headcount and driving productivity improvements across all areas of our business. And since 2009, we've upped the pace of rightsizing our organization for the post-Zyprexa period, significantly restructuring everything from our senior management layers to our back-office operation to our sales and marketing organization. As a result of these efforts, we fully expect to meet our goal of reducing our expenses by $1 billion by the end of this year. This will essentially complete our restructuring effort. While we will continue to drive incremental productivity, we have no plans for a major restructuring. Hopefully, this additional color commentary on the impact of the Zyprexa patent expiration is helpful as you update your models. Now let's review our updated 2011 financial guidance. At a high level, our updated guidance is very consistent with the guidance we issued on our July earnings call. It reflects continued strong underlying performance of our business. It also includes the discrete tax benefit and the additional charges recorded in Q3. In total, these changes result in an increase and narrowing of our EPS guidance. On a non-GAAP basis, we now expect 2011 EPS of between $4.30 and $4.35. Our 2011 reported EPS guidance range of $3.89 to $3.94 reflects the $0.23 IPR&D charge for the Boehringer Ingelheim alliance and $0.18 in restructuring recharges in the first 9 months of the year. Our guidance on individual line items is largely unchanged. Revenue is still expected to grow in the mid-single digits, and the gross margin as a percent of revenue it is still expected to decline by 2 to 3 percentage points when compared to the full year of 2010. SG&A growth is still expected to be in high-single digits, and R&D growth is still expected to be in the low-single digits. Our guidance for other income is now forecast to be a net loss in the range of $175 million to $225 million, reflecting the partial impairment of the acquired in-process R&D asset related to Amyvid. As a result of the discrete tax benefit recognized this quarter, we now expect our 2011 effective tax rate to be approximately 20% on a non-GAAP basis, and approximately 19.5% on a reported basis. And we now expect capital expenditures to be approximately $700 million. Now Slide 15 provides a reconciliation between reported and non-GAAP EPS for 2010, and the associated growth rates from these numbers to our revised 2011 guidance. In terms of key future events, highlights for the balance of 2011 include: potential FDA approval of ERBITUX for first-line head and neck cancer; the anticipated European Commission approval of ALIMTA as continuation maintenance therapy in non-squamous, non-small-cell lung cancer; expected Phase III starts for our innovative basal analog insulin and our anti-IL-17 monoclonal antibody in psoriasis. This would bring our Phase III portfolio to 12 new molecular entities, exceeding our goal of 10. We also expect to present key Phase II data on our CETP inhibitor at the American Heart Association meeting in November, as well as for our anti-IL-17 and RA at the ACR meeting, also in November. And in psoriasis at the Jane D. Clinic [ph] meeting in London in December. Now in the interest of time, I will not recite the full list of potential events for 2012. But as you can see, we have made a significant number of -- we have a significant number of potential regulatory actions, Phase III trial completions and potential data disclosures. We are clearly excited about the year ahead and are pleased with the progress we continue to make in advancing our pipeline. This will remain our #1 priority. Now as I mentioned on our July earnings call, 2011 is playing out largely as we had expected. We're delivering solid financial results, as we head into the Zyprexa patent expiration, and importantly, we are making progress in advancing our pipeline. As expected, in Q3 we saw the impact of known headwinds, including: patent expirations that are lowering sales of Gemzar outside of Japan, U.S. health care reform, which is exacting a higher cost in 2011 than it did in 2010, and near term dilution from expenses associated with our strategic diabetes alliance with Boehringer Ingelheim. Now, while these headwinds negatively affected our Q3 results, we again deliver strong underlying growth in the rest of our business. Excluding these items, on a non-GAAP basis, we posted revenue growth of 15%, operating expense growth of 3% and mid-20s percent EPS growth. As you think about our future revenue, you'll clearly need to factor in the patent expiration of Zyprexa in the U.S. and Europe. But I also like to highlight that in Q3, our countercyclical growth engines of Japan, emerging markets and animal health collectively grew 19%. And we had a number of key brands that posted double-digit worldwide revenue growth, including: Cymbalta, Humalog, Strattera, Forteo, Cialis and ALIMTA. We've already achieved our goal of having 10 molecules in Phase III development by the end of the year. And we expect to begin Phase III testing of our innovative basal analog insulin and our anti-IL-17 monoclonal antibody in psoriasis before year end. We firmly believe that our current pipeline serves as the foundation for Lilly to return to growth post-Years YZ. Moving forward, we will continue to focus on executing our 3-part strategy as we stated in June. Replenishing and advancing our pipeline, and for innovation-based biopharmaceutical company, this is our future. Second, investing to drive growth in our countercyclical growth engines and key currently marketed brands, particularly those that do not lose patent protection in the YZ period. And third, continue to drive productivity gains across our business that allow us to fund R&D necessary to fuel our future growth, recapitalize our physical assets and maintain our dividend. Now this concludes our prepared remarks, and we'll now open the call for the Q&A session. Operator, first caller please.

[Operator Instructions] First question's from the line of Steve Scala, Cowen.

I have 2 questions, both of which are on solanezumab. Does the delay in the futility look allow for a view of the data, reflecting a longer duration of treatment such as, say, 15 months as opposed to, had the look occurred in the current quarter, when perhaps it would've been more like 12 months, or regardless of when the look was taken is the duration of treatment the same? That's the first question. And then the second question is for Dr. Lechleiter. Do you view the final solanezumab Phase III result in the second quarter of 12 as just another Phase III readout? Or is this perhaps the most important data point for Lilly in years, and will dictate where you lead the business? And perhaps asked differently, is your current course viable, if solanezumab should fail?

I'll go ahead and take your first question, have John answer the second. The futility analysis had been originally scheduled for December and for purely logistical reasons, the DMC rescheduled that to January. So there is no particular change in the number of months, number of patients type data that they would be reviewing at that particular review. It was simply a logistical change that led to the movement from this year to next year. John?

Steve, with respect to your second question, obviously, we're very interested in those results, and we're very interested, frankly, in anything we can do to advance the cause of developing new therapies to treat Alzheimer's. I will mention, we have other molecules as well in various stages of development in our portfolio, looking at the beta-amyloid and other mechanisms associated with Alzheimer's disease. While this is a very important readout for us next year, it's not something -- whether it's positive or negative is going to change our strategy or change the basic underlying assumptions that we're carrying forward as we go through YZ. Our future does not depend on any single molecule including solanezumab, there are soon to be 11 other molecules in Phase III. And we'll go where the data takes us and proceed accordingly, but we're really interested in prosecuting and moving forward that entire portfolio.

Steve, this is Phil. Before we go to the next caller, as you're thinking about solanezumab, also in relation to the financial projections that we had discussed in Derica's section of the Investment Community Meeting in June, we have said all along this is a high-risk program. It's very interesting science. We're very hopeful of the potential outcome, but we have recognized that it's high risk. Essentially, for the financial modeling, what that means is it's a sign of relatively low probability of actually hitting, if you will. So that means for our financial projections, if that low probability goes to 0, it really does not take them down very much. If on the other hand, it were to go ahead and go from that low probability to 1, it would have a substantial potential upside to those numbers. Hope that's helpful.

Next question is from the line of Seamus Fernandez, Leerink Swann.

Another pipeline question. As we think about the prospects for the spend, as you move through and into some of these new trials, I do see that you have a potential move forward of the CETP inhibitor into Phase III. Maybe, John, can you just talk a little bit strategically about your interest in the CETP inhibitor? And perhaps even -- there are many, many CETP inhibitors in development across the industry, would there be any interest in basically saying, "Okay, let's look across the different CETP inhibitors, take the data and perhaps partner with someone else who has this and share the development cost, given the risk profile associated with this still untested mechanism?"

Seamus, I can't speak specifically to the CETP inhibitor, because we really need to wait and see the data as we share that in November. But I think as we look at our pipeline, obviously, we're making decisions and looking at different things all the time that say, "Should we alone with this, or should we partner that one." Obviously, we got a huge benefit, I think, from the deal we struck with BI earlier this year, where we, in essence got our 4 potential assets. One of which is now launched, Linagliptin, shared between the 2 companies on a global basis. And as we move new molecules into Phase III, other programs begin to wind down. So we're looking at this all the time, and obviously, we'll do what we think is in the best interest of the company and the shareholders, as we make these decisions.

Next question from the line of Marc Goodman, UBS.

First, can you give us a little more color on the emerging markets, maybe just talk about why it slowed a little bit, maybe talk about a couple other countries. And then second of all, maybe you can talk about some of the products that moved into Phase III a little bit. Is there any color you can give us -- mechanism of action? And maybe just a little bit more color there.

Deric, you want to handle the first question? Maybe Jan can have the second, please?

Sure, Phil. Marc, this is Derica. We still are very pleased with our performance in the emerging markets. And as I stated, it's really playing out as we had expected. What we saw in the third quarter is the beginning effects of Zyprexa patent erosion in the emerging markets, and specifically, in Brazil. In markets like China, where we haven't seen that, that's why you saw the 22% volume growth there and the 31% growth overall. So the growth that you saw in the third quarter is according to the expectations that we had laid out.

Jan?

In relation to the new Phase III starts, as you see on the pipelines slide, we have a new insulin glargine opportunity that we have moved into Phase III. This will fit very well into our diabetes portfolio overall and then help actually the choice for the physicians then to different patients. We believe we have a very good agent, and we are comparing this to Lantus statin in two Phase III trials, both then in type 1 and type 2 diabetes for non-inferiority. Furthermore, with our expertise and in manufacturing and advanced devices, we think we can be really competitive in this area.

Marc, anything that you will see are some new names for what was previously on the chart as mGlu2/3 and NERI. So you've got pomaglumotab methyanol [ph] which is mGlu2/3, so new name, but same molecule, and then edovoxotin [ph] which is NERI.

Next question's from the line of Chris Schott, JPMorgan. Christopher Schott - JP Morgan Chase & Co, Research Division: First question was if you just elaborate a little bit more on the European pricing environment, and how it's trending relative to your expectations. I think most importantly, kind of as we go forward, how are you seeing 2012 and 2013 shaping up from a pricing perspective relative to 2011? Second question was on the insulin business. Can you talk about the competitive response you've seen in the market? You're obviously doing very well with volume trends here. Can you just talk about -- again, are you seeing any different competitive response as you've regained some share? And then finally, just color on Trajenta and how you see the EU opportunity for this product, given some of the challenges that you highlighted in Germany?

Deric, go handle your first question, I'll take a shot at the second too, Chris.

Okay. Chris, regards to the current pricing situation in Europe, it's actually playing fairly consistent with what we've seen historically. If you look at our Q3 results, you can see price was down about 1%. Historically, we typically see about a 1 to 2 percentage point erosion on an annual basis, year-on-year, so very much aligned. Now, obviously, each government is acting at different points in time, but we continue to be able to manage our way through that. As I think about 2012 and 2013, at least in Europe, we still see things playing out more or less along those lines. Probably the biggest question from a pricing standpoint still remains in the U.S., and what emerges from the discussion around the super budget committee and if there's any change as it relates to healthcare reform and dual eligibiles or so forth -- increases in rebate. That's probably the biggest unknown from a pricing standpoint facing the industry at this stage.

Also, on European pricing, Chris, probably since our last call, the one thing that would've changed that would be the largest impact was in Spain, where they instituted a couple of new measures, one for those products that have been on the market for more than 10 years, and for which there is no generic reference pricing group, because there's no generic competition. They had asked for a 15% rebate essentially on those products, that compares to the 7.5% that they had been requesting prior. And then probably and more materially for us here, they went ahead and said that innovative formulations, even if they are protected by patent protection would still be subject to reference pricing. So specifically for us, Velatab [ph], the rapid dissolving form of Zyprexa, while it will not have generic competition in Spain, it probably has now been pegged to the reference pricing for the generic olanzapine group broadly. For the insulin competition, this is a sector that we've dedicated a lot more focus to over the last couple of years, in particular, I'd say, with the formation of our diabetes business in early 2010. And we intend to maintain that focus on that business. And we have said before, we are seeing -- it is more competitive, I think, Nolos [ph] is now seeing a more competitive Lilly. And as we would expect, they're going to react. And I would say though, while the insulin business is one that is extremely important, it's going to be a very large part of the overall diabetes treatment market, one that we intend to go ahead and be very competitive in. Our goal of regaining leadership over time in diabetes is not predicated solely on insulin. It really does encompass the GLP space as well as orals. So our focus on building that broad-based portfolio and leveraging that is intact, and we'll continue to execute that very diligently. Trajenta is really very early days. You may have been also referring to the decision made in Germany, where there were some very difficult comparables being applied to what the government was espousing it would like to reimburse the product at, that did not make it appropriate for Boehringer Ingelheim or Lilly to move forward at this time. We definitely do anticipate we'll be able to reach some agreement with the government that provides this product to patients and also recognizes innovation, the benefits that it brings and the appropriate compensates Boehringer Ingelheim and Lilly. So we remain very optimistic about this class and about this product. Again, very early days in Europe on this particular front.

Next question is from the line of Catherine Arnold, Crédit Suisse. Catherine J. Arnold - Crédit Suisse AG, Research Division: I wanted to ask you guys about the insulin diabetes market. And first of all, more broadly, now that you have this broader portfolio, some assets homegrown, some assets are, obviously, from other innovators. Are you in a position that you can actually use that portfolio for contracting purposes either to government, particularly, outside the United States or from the standpoint of private payers? If you could just comment on what you're able to do as you approach the customer on payment. And then I wanted to ask you on your insulin glargine aspirations, have you considered doing a combination with BYETTA and would you need a separate contract with Amylin to move forward on that idea?

Okay. Catherine, I'll go ahead and take a shot at the first two, and if anyone wants to chime in feel free to. So I don't necessarily believe that we're able to go ahead and leverage this in terms of the bundling, if you will, or the -- using different products to go ahead and gain leverage with payers that way. I think that one of the main things that we have been focused on is the ability to approach the physician and talk about what their patients' needs are, and those patients do have different needs over the course of their disease. So this clearly positions us to offer products that go from earlier stages with the oral treatments into the injectable phases with GLP initially, and then, obviously, you've got people who eventually will progress to, and will need insulin therapy, and obviously, we have very strong offerings, which we hope to expand in the future with the 2 basals that we're developing. In terms of the combo, to my knowledge there have not been any active discussions. I'm not familiar, Catherine, enough with the contract. I would think if you introduced another molecule into that collaboration, we would need to probably have some discussions to figure out how that would work, as the current collaboration really is focused on the exenatide molecule whether that's BYETTA, Bydureon or subsequent formulation.

Next question Tim Anderson, Sanford Bernstein. Tim Anderson - Sanford C. Bernstein & Co., LLC., Research Division: You talked about having already pulled much of the sales and marketing spend from Zyprexa. On the variable spending unrelated to the sales force, can you give us some idea of when you started to make these cuts in earnest? Can you quantify how much these spend savings annualize to compared to when you fully resourced the brand? And then looking forward to maybe the end of 2013 when Cymbalta looks like it's going to go away, that seems like it's going to have an impact on Lilly that's about the same as what Zyprexa's likely to have in the current year. Can you just confirm that the Cymbalta impact will be about the same as Zyprexa's a few years from now?:p id="E05" name="Philip Johnson" type="E" /> How about Dave comment on the Zyprexa dual marketing spend. And if you don't mind, maybe, Dave, talking about how you're thinking of -- not necessarily the comment on the sales decline, but just the management of sales operations, as we go off Cymbalta and we'll come to Derica for the financial piece.

Great. So with Zyprexa, this is a brand that for many years has had a very entrenched positioning in the minds of physicians. And we've been able to begin taking down expenses as early as 2007 in the U.S. on the variable side of the equation. In the last calendar year, we can just say that they were a fraction of that peak level already in 2010, in 2011 or even lower, per Derica's earlier comment. Cymbalta will see a very different picture in the U.S. This is a brand in a very competitive, highly genericized market, with less clinical differentiation in the minds of physicians. We do plan on having a robust sales and marketing effort, much closer to the loss of exclusivity, and therefore, as you think about modeling after LOE, there will be a more significant expense impact post LOE with Cymbalta.

Tim, when you think about the financial impact of -- so how do the numbers play out. Some of that is still also going to be predicated on how our pipeline emerges. So remember in our late stage pipeline, we have 3 new key neuroscience assets, solanezumab for Alzheimer's disease, mGlu2/3 or -- still pronounce the new name, I won't try it, but for schizophrenia, as well as NERI stil for depression. So as those play out, we may see a re-purposing of some of those Cymbalta assets and resources to these new brands as we anticipate gearing up for their launches, assuming that we're successful in bringing those through the regulatory process. So this is how we're trying to manage our way through this period and seize the opportunities as they emerge.

Next question is David Risinger, Morgan Stanley.

I have 3 questions for Derica, and then one for Enrique if he's on the online. So with respect to animal health, Derica, can you comment on what the organic growth was in the quarter? And then second, I was just hoping that you could rephrase or maybe add a little bit more color on your comment about Zyprexa product returns and what investors should expect in terms of fourth quarter U.S. Zyprexa sales. And then third, with respect to SG&A, obviously, spending continues to rise as you build businesses, and that's clearly working to drive the top line. But maybe you can just comment on the outlook for SG&A spending growth in coming years should we expect SG&A to continue to rise post Zyprexa going generic? And then if Enrique's on the line, or maybe somebody else can comment, I'm just wondering if you can provide any more color on the diabetes formulary pressure going into 2012 and your ability to offset the loss of CVS Caremark as a partner.

Okay. Let me try the first 3. In regards to the animal health organic growth, it was about 18% in the quarter. As we think about Q4 and the U.S. Zyprexa sales, as you know, we do not provide product-level projections or forecast. But what you can anticipate, when we think about just return, we probably took about 1/3 of the impact -- anticipating impact in the third quarter. And we would anticipate about another 60% impact of returns in the fourth quarter, clearly, as you have -- we go through the brunt of the erosion -- the initial phase of the U.S. erosion curve. In regards to SG&A expenses, if you look at the third quarter, it was really driven by 3 elements, if you look at our total OpEx growth. FX was about 3 percentage points. The remaining 2 items was the pharma fixed fee, okay? And the third was the expenses both in SG&A, as well as R&D behind our BI collaboration. If you exclude those 3 items, our expense growth in the quarter was essentially flat, so 0. In fact, it was slightly negative in real terms. So when you think, projecting forward, we're not at a stage of putting out guidance beyond this period from a line item standpoint. But what you can expect is we're going to be managing our SG&A very tightly, okay?

And just a little short commentary on that 7% non-FX OpEx growth. Derica mentioned these 2 factors, the BI, the Boehringer Ingelheim strategic diabetes alliance, as well as the pharmacy. You've got approximately 5% of total OpEx growth being driven by the Boehringer Ingelheim collaboration and about 1.5% or so is driven by the pharma fee. And then your last question, Dave, on the diabetes formularies access here in the U.S., each and every year, there are some contracts that are up, not all of them. And each and every year, we have seen a dynamic where we've maintained probably the majority -- vast majority of those we have had. We've gained some additional ones, and then we've lost a few. That dynamic we expect to continue. In terms of talking about specific contracts, often in agreement with the actual customers, we don't disclose the specific contracts that have been won or lost until they actually take effect. I can't provide specific commentary on ones that we may anticipate could come off in '12 or that we may be gaining in '12. We'll have that information probably for you in the January call with the Q4 results.

Next question Tony Butler, Barclays Capital.

Two brief questions. One is, Derica, the volume in Japan has been quite spectacular. Question is with price cuts assumed to come in the spring of next year, what do you currently anticipate those price cuts to be, that is, how are you modeling it? And then second, back to the Zyprexa returns, can you tell us what you're actually accruing for -- the amount that you're accruing for those returns?

Okay. Tony, in regards to Japan, we continue, once again, to be very pleased with our performance there and the launches of Cymbalta and Forteo continue to go very well. We're not in a position of providing our pricing projections for Japan for 2012. Clearly, on our call in January, we'll be in a position to provide overall guidance for our outlook for `12, which would include Japan and the potential pricing. So if we can, we can put that off until then. John?

Tony, this is John. One comment I would make is, although this is still being implemented in Japan on a trial basis, in the last year or 2, pricing has been liberalized there to better recognize true innovation. Now, how's that going to continue to play out and how will other products that don't fall in that category be affected remains to be seen. But actually, in contrast to some other parts of the world, we actually see in the last 2 years and going forward a more favorable pricing environment in Japan as the government there recognizes the need to call out innovation and to value innovation, and also continues with its intent to ensure that more medicines that are approved in Europe and the U.S. are approved and made available to Japanese patients in a contemporaneous way.

Tony, to your last question, the returns was a little bit less than $50 million charge in the third quarter.

Next question John Boris, Citi.

First question is for Dave Ricks. Dave, can you maybe help frame or characterize the opportunity for Cialis in BPH? What percent of the business have you already shifted to the once-daily size of the market opportunity and reimbursement going forward? Second question for Derica. You'd mentioned on the sequential growth for the emerging markets that it was largely attributed to Zyprexa. Can you maybe give some color of the 500 basis points sequential decline? What percent of Zyprexa sales accounted for that in rest of world. And then third question, just for John, very quickly. In the environment in Washington, what do you find, John, that the industry is winning on going forward? And what do you think some of the challenges are in Washington that the industry continues to face?

Dave?

In Cialis, we're excited about the recent approval of Cialis for use in men who suffer from BPH as well as men who suffer from both ED and BPH. We're now detailing to physicians and are looking forward to this launch. To your question about the once-daily formulation, which is specific to this indication, you need to take the medicine every day prior to the DPH launch. About 1 in 4 Cialis prescriptions in the U.S. were for the once-a-day form. We would anticipate with BPH uptake that to continue to grow, and we see the BPH opportunity as a nice growth driver over the main life of Cialis in the U.S.

John, in regards to emerging market sequential growth, I don't have the specific data with me at this stage, at this meeting. But we can follow up with you on that, if that's okay.

John?

John, I think the Washington environment remains very fluid. I think when you couple the ongoing healthcare reform with the debts of reduction focus in terms of wins, patent reform is a huge win. It should in the medium- to long-term restore a great deal of confidence for investors that our patents can be -- can remain valid, can be enforced and can be the basis for investor confidence in addition to clearing this huge backlog. I think there is still strong support for maintaining 12.5 years of data protection, for biologics, which is part of the Affordable Care Act, and we -- it's the law, and we want to keep it that way. And I think there's a general recognition, appreciation to the fact that this industry employs directly and indirectly between 3 and 4 million people in this country. And is the only way we're going to attack diseases like Alzheimer's and cancer, which not only cause immense suffering, but help drive up a lot of the healthcare cost today and in the future. I think the area of concern for us right now is Part D. We're fighting, and we're quite adamant in our opposition to imposing government price controls in Part D. This is a program that's working. Premiums for seniors have remained low. The overall cost of the program is stunningly lower than any one forecast 5 or 6 years ago. And most seniors in Part D today have access to medicines. In terms of deficit reduction, Part D is making a difference there too. A recent study published in Jamma [ph] show that for every person enrolled in Part D, they have $1,200 a year less costs in other parts of the medical delivery system. That's more than $10 billion a year in savings that I think we have to attribute to that program as it's currently structured. So we're going to continue to make sure that, that message gets heard and understood, as we go forward. We'll continue as well to express concerns we have about IPAB, the Independent Payment Advisory Board, as well as the way the 340 B program is being expanded, we believe, inappropriately.

Gregg Gilbert, Bank of America Merrill Lynch.

First, I was hoping you could attempt to quantify your dual eligible's exposure. And maybe, John, you can handicap that specific item, what will happen there? Secondly, for Jan, as we head into AHA, can you frame your latest thinking on how your CTP product stacks up against others in the category based on info that's been made public over time? And third, perhaps for Derica, or Dave, on Axiron, was there any abnormally high discounting or couponing in the quarter that will abate over time?

This is Phil. I'll actually take your first question. So in terms of the exposure on the dual-eligible, low-income subsidy, today we've not provided a specific quantification. I guess, one thing I would point you to, to consider as you're trying to bracket how large this could be, for the original healthcare reform that was to have been a $80 billion cost to the industry over a 10-year period, we'd actually estimate, it's probably closer to $115 billion cost over that 10-year period of the industry. And as we talked about earlier, we've estimated that this year, you're probably talking about a $600 million to $700 million cost to Lilly in 2011 from healthcare reform. Numbers I've seen from the CBO, I guess, who scored Medicare dual eligible low-income subsidy going to Medicaid pricing, I believe they scored this at around $105 billion, $110 billion over a 10-year period. So as far as order of magnitude, without getting into specific numbers, I'll have you consider that. Jan?

Right. Well, the main thing I can say is that listen to the presentation at the American Heart Association. And secondly, what I stated in June was that in the interim analysis of the current study, where we now have the final data, the Data Monitoring Committee said accelerate progression of this agent.

Dave for Axiron?

Axiron in the U.S., as you know, we launched the drug in Q2, in June in primary care against the entrenched competitor. Like any launch in the U.S., your main mission in early days is to drive trial and a good use experience for patients. We believe we're doing that very successfully today in the U.S., about 1 in 4 of new starts in the testosterone class are going on to Axiron just 6 months into the launch. Obviously co-pay cards, vouchers, samples, our key partners ensuring that positive early use experience. But through time, those dissipate as you get more refills. So we're tracking right according to our plans and pleased with the early uptick.

And that question is from Barbara Ryan, Deutsche Bank.

Question is really on China, where obviously, you've been very successful in showing very strong sales growth, although we read about various government initiated programs, the reduced price, et cetera. And I wonder if you could share with us what you're seeing there, what your outlook is and maybe some split between what is actually part of the reimbursement list and what percentage of your business is private pay?

Okay, John?

Okay. Barbara, I think that -- we think, for us to be successful in China in the long run, formulary status at the national level, the provincial level and the hospital level is going to be key to that. So we work very hard to ensure that our medicines are included in those formularies all the way down to the local level. I think that there are going to be, today and going forward, situations where we have price decrease in China. I think in some cases, there's a focus on classes that we don't participate in, and in some cases, they're likely to affect us. I think, as we look at our long-term model in China, we tried to account for that, obviously, not only as the delivery of healthcare changing China, but I think the way in which healthcare is managed by the government will continue to evolve. And under any circumstance, our enthusiasm for the opportunity we have there to reach more patients with our products and to grow our business profitably has not diminished.

Thank you very much. I'll go ahead, as we approach the top of the hour and turn it over to Derica to close the meeting.

Sure, thanks. Barbara, just to close out, one thing I would say to add to John's comment is if you think about the therapeutic areas in which we compete, where we have a strong competitive position: diabetes, oncology and neuroscience, those are also 3 of the fast-growing therapeutic areas in the China market. So today, this is a lot of what's driving the strong volume growth that you're seeing in that business, in spite of the pricing environment that's resonant there. Thanks for everyone spending your time with us here this morning. And I guess, in closing, I'd like to just maybe reiterate a few points. One, Q3 was another strong quarter of our underlying revenue growth and financial performance for Lilly. And it was punctuated by double-digit growth from our countercyclical growth engines from 6 of our key brands. As we head into the teeth of our patent expiration period, we have positioned the company to fund the R&D necessary to fuel our future growth, recapitalize our physical assets and maintain our dividend. Finally, we continue to make progress in advancing our pipeline, which is the foundation of our future growth. We look forward to keeping you informed as we execute our strategy. And we thank you for your interest in Eli Lilly & Co. Our team will be available to answer any additional questions you may have following this call. Have a great day.

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