Eli Lilly 2005 Annual Report Download - page 28

FI NA NCI A L S
26
to the consolidated financial statements for additional
information regarding our retirement benefits.
Periodically, we evaluate the discount rate and the
expected return on plan assets in our defined benefit
pension and retiree health benefit plans. In evaluating
these assumptions, we consider many factors, includ-
ing an evaluation of the discount rates, expected return
on plan assets and the health-care-cost trend rates of
other companies; our historical assumptions compared
with actual results; an analysis of current market con-
ditions and asset allocations (approximately 85 percent
to 95 percent of which are growth investments); and the
views of leading financial advisers and economists. We
use an actuarially-determined, company-specific yield
curve for purposes of determination of the discount
rate. In evaluating our expected retirement age as-
sumption, we consider the retirement ages of our past
employees eligible for pension and medical benefits to-
gether with our expectations of future retirement ages.
We believe our pension and retiree medical plan as-
sumptions are appropriate based upon the above factors.
If the health-care-cost trend rates were to be increased
by one percentage point each future year, the aggregate
of the service cost and interest cost components of the
2005 annual expense would increase by approximately
$26 million. A one-percentage-point decrease would
decrease the aggregate of the 2005 service cost and
interest cost by approximately $22 million. If the discount
rate for 2005 were to be changed by a quarter percent-
age point, income before income taxes and cumulative
effect of change in accounting principle would change by
approximately $27 million. If the expected return on plan
assets for 2005 were to be changed by a quarter percent-
age point, income before income taxes and cumulative
effect of change in accounting principle would change
by approximately $13 million. If our assumption regard-
ing the expected age of future retirees for 2005 were
adjusted by one year, our income before income taxes
and cumulative effect of change in accounting principle
would be affected by approximately $22 million.
Income Taxes
We prepare and file tax returns based on our interpre-
tation of tax laws and regulations and record estimates
based on these judgments and interpretations. In the
normal course of business, our tax returns are subject
to examination by various taxing authorities, which may
result in future tax and interest assessments by these
authorities. Inherent uncertainties exist in estimates
of tax contingencies due to changes in tax law result-
ing from legislation, regulation and/or as concluded
through the various jurisdictions’ tax court systems. We
record a liability for tax contingencies when we believe
it is probable that we will be assessed and the amount
of the contingency can be reasonably estimated. The
tax contingency reserve is adjusted for changes in facts
and circumstances, and additional uncertainties. For
example, adjustments could result from significant
amendments to existing tax law and the issuance of reg-
ulations or interpretations by the taxing authorities, new
information obtained during a tax examination, or resolu-
tion of an examination. We believe that our estimates for
tax contingency reserves are appropriate and sufficient
to pay assessments that may result from examinations of
our tax returns.
We have recorded valuation allowances against
certain of our deferred tax assets, primarily those that
have been generated from net operating losses in certain
taxing jurisdictions. In evaluating whether we would more
likely than not recover these deferred tax assets, we have
not assumed any future taxable income or tax planning
strategies in the jurisdictions associated with these carry-
forwards where history does not support such an assump-
tion. Implementation of tax planning strategies to recover
these deferred tax assets or future income generation in
these jurisdictions could lead to the reversal of these valu-
ation allowances and a reduction of income tax expense.
We believe that our estimates for the valuation al-
lowances reserved against the deferred tax assets are
appropriate based on current facts and circumstances.
A 5 percent change in the valuation allowance would result
in a change in net income of approximately $23 million.
FINANCIAL EXPECTATIONS FOR 2006
For the full year of 2006, we expect earnings per share to
be in the range of $3.10 to $3.20. We expect sales to grow
7 to 9 percent and gross margins as a percent of sales to
improve modestly compared with 2005. In addition, we
expect operating expenses to grow in the mid-single dig-
its in the aggregate, with marketing and administrative
expenses accelerating while research and development
expense growth moderates somewhat. However, we will
continue to be among the industry leaders in terms of
research and development investment as a percent of
sales. We also expect other income, net of interest ex-
pense, to contribute approximately $175 million to $275
million; this ongoing net contribution is expected to be
driven primarily by net interest income, Lilly ICOS joint
venture after-tax profit, and partnering and out-licensing
of molecules. We also anticipate the effective tax rate to
be approximately 21 percent.
Actual results could differ materially and will depend
on, among other things, the continuing growth of our cur-
rently marketed products; developments with competitive
products; the timing and scope of regulatory approvals
and the success of our new product launches; asset im-
pairments, restructurings, and acquisitions of compounds
under development resulting in acquired in-process
research and development charges; foreign exchange
rates; wholesaler inventory changes; other regulatory
developments, litigation, and government investigations;
the outcome of the Zyprexa patent appeal; and the impact
of governmental actions regarding pricing, importation,
and reimbursement for pharmaceuticals. We undertake
no duty to update these forward-looking statements.