Lilly Slashes Revenue Forecasts For 2010 And 2011 Due To Health Care Reform

The drug maker blames changes to various government programs for revenue that will drop by hundreds of millions of dollars.

Citing the impact of health care reform, Eli Lilly slashed its revenue forecasts for both 2010 and 2011 by hundreds of millions of dollars, a move that offered the first glimpse of what some drug makers say is the legislation's impact on their business.

In an earnings conference call on April 19, Lilly executives estimated that health care reform will diminish 2010 revenue by $350 million to $400 million, and that 2011 revenue will be reduced by $600 million to $700 million. They pointed to such changes as a combination of higher rebates for Medicaid, discounts that will fill the Medicare Part D donut hole, and annual fees to be paid by brand-name drug makers, otherwise known as excise taxes (Also see "Strategies To Ease Short-Term Earnings Pain From Health Reform Include Cost-Cutting, Diversification" - Pink Sheet, 12 Apr, 2010.).

The extent of the revised forecasts surprised some analysts. "This is larger than we would have guessed, but it has been difficult to calculate the precise financial exposure (in the industry) on a name-by-name basis, given uncertainty about each company's 'base' rebate levels (and) market share of federal channels," Sanford Bernstein analyst Tim Anderson wrote in an investor note.

He added that, however, that Lilly has more exposure to the impact of health care reform that most other large drug makers because of its "higher concentration" in the US, its lower level of revenue diversification, and its unique product mix, which includes drugs that have a substantial share of the Medicaid market, such as the antipsychotic Zyprexa (olanzapine). As a result of new health care reform dicates, Lilly will have to offer sizeable rebates, although its exposure should lessen dramatically after the Zyprexa patent expires in 2011.

Analysts may rejigger their estimates before other drug makers report earnings in coming days, although it remains unclear whether other pharmaceutical companies will similarly lower guidance as Lilly has done. Lilly, meanwhile, is working feverishly to buy time as patents are set to expire on some of its biggest sellers over the next few years. Beyond Zyprexa, which generated $1.2 billion in sales in the first quarter, other top sellers facing generic competition include Gemzar (gemcitabine) cancer treatment and the Evista (raloxifene) osteoporosis medication

To cope, the drug maker is wringing approximately $1 billion in costs out of its operation and simultaneously revamping R&D by expanding a closely watched experiment called Chorus, designed to move drugs through development faster and more cheaply (Also see "Lilly Tries to Buy Time" - In Vivo, 1 Dec, 2009.). Meanwhile, though, Lilly's newest drug, the blood thinner Effient (prasugrel), is so far an anemic seller, chalking up just $8.8 million in worldwide sales in the first quarter.

"They just don't have much of a cushion," Deutsche Bank analyst Barbara Ryan told "The Pink Sheet" DAILY. "Their portfolio is mature and not really growing...I bet in their wildest dreams they wouldn't have thought Effient would only do $4.5 million (in the U.S.) in the first quarter. If other things were going well, they wouldn't have to cut the guidance as much as they did from health care reform."

Rising Medicaid fees, closing the donut hole hurt Lilly profits

In discussing the effect health care reform will have on revenue, Lilly executives pointed to a pair of changes that are retroactive to Jan. 1, 2010. One includes an increase in rebates from 15.1 percent to 23.1 percent in the Medicaid fee-for-service program, and a limitation on the maximum rebate to 100 percent of a medicine's price.

In an investor note, Leerink Swann analyst Seamus Fernandez pointed out that the "substantial majority" of Lilly's Medicaid business is managed Medicaid, which wasn't previously subject to mandatory minimum discounts. Consequently, the hit on 2010 revenue stems from the different discounts for Medicaid fee-for-service, in which the minimum discount rises from 15 percent to 23 percent, and managed Medicaid, where minimum discounts are rising from zero, in some cases, to 23 percent.

"On a gross basis, both Medicaid fee-for-service and managed Medicaid combined, account for just over 10 percent of our total U.S. business," said Bart Peterson, Lilly's senior vice president, corporate affairs, "on a net basis just slightly under 10 percent, so roughly 10 percent of our U.S. business is exposed to Medicaid."

The legislation also expanded the number of hospitals in the 340B program to include children's hospitals, freestanding cancer and critical access hospitals, rural referral centers and sole community hospitals, which means drug makers will be offering additional discounts.

This year's results will also be hit by what Lilly called channel accruals. Since government purchases correspond to sales in prior periods, Lilly needs to update its books to reflect future government discounts and rebates.

Another knock on 2010 results is an $85.1 million charge for the subsidy paid by the federal government to employers who provide retirees with a drug benefit equivalent to what is offered in Medicare Part D. Although the tax on the subsidy doesn't begin until 2013, the present value is calculated as a future tax liability and so a one-time charge is being taken.

The changes prompted Lilly to adjust earnings guidance to between $4.40 and $4.55 a share, compared with anticipated profit of $4.65 to $4.85 a share that was previously forecast.

As for the impact on 2011 revenue, Lilly executives pointed to the 50 percent discount that brand-name drug makers will provide to some Medicare Part D participants who enter the donut hole. On the flip side, they also agree that there will be added business if more Part D participates are induced to maintain treatment thanks to the added economic incentive.

But whether this will translate into a big boost for Lilly remains unclear. As an example, Phil Johnson, Lilly's vice president of investor relations, cited the Forteo (teriparatide) osteoporsis treatment, which in 2009 generated $816.7 million. Only about 15 percent to 30 percent of patients stop treatment when they reach the donut hole, he said, suggesting there isn't a huge amount of added business to be gained.

Lilly executives also pointed to a "multi-billion-dollar annual fee" that will be paid to the government, although Derrica Rice, Lilly's senior vice president and chief financial officer, declined to specify what Lilly's share might look like. But when adding the impact of the changes that begin this year, he said the collective hit on 2011 revenue should reach $600 million to $700 million.

Separately, Amylin Pharmaceuticals, Lilly's partner for the once-weekly diabetes medication Byetta LAR, on April 19 said it plans to respond this week to a recent FDA request for more information about the drug, which now has the proposed name of Bydureon .

The FDA on March 12 issued a complete response letter for the adult onset type 2 diabetes drug, which is a version of Amylin's Byetta (exenatide), a GLP-1. The agency wanted to clarify labeling and a Risk Evaluation and Mitigation Strategy, or REMS (Also see "FDA's "Complete Response" Letter For Byetta LAR Isn't Too Onerous, Amylin Says" - Pink Sheet, 15 Mar, 2010.).

-Ed Silverman ([email protected])