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Lilly braces for decline in Europe

July 30, 2012

Austerity and upheaval in Europe have not hurt Eli Lilly and Co.’s $4 billion-a-year drug business there, but the company is moving forward with plans to survive a coming swoon anyway.

The Indianapolis-based drugmaker reported July 25 that its European sales rose 3 percent during the three months ended June 30, excluding the loss of sales for Zyprexa, Lilly’s former blockbuster which saw its European patents expire last fall.

Prices for Lilly’s products fell 3 percent in the quarter in Europe, where most drug prices are set by government-run health plans. Governments in Ireland, Italy, Greece and Spain all have had to enact spending reductions to deal with massive debt costs even as their economic growth has stagnated or declined. The government pullback has further exacerbated economic growth, and many say Europe has fallen back into recession.

“Historically, we've experienced a 1-percent to 2-percent price decline in Europe, so this 3-percent decline confirms that we've not seen significant new austerity measures that impact our products,” said Ilissa Rassner, Lilly’s director of investor relations, during a July 25 conference call with investors. She added that the private wholesalers Lilly uses to distribute its drugs have not fallen behind in paying their bills.

Even so, officials still see dark clouds over the European market. Consumers there account for 20 percent of Lilly’s global drugs sales, and cash-strapped governments will make it more difficult for the company to get favorable pricing and access to drug formularies, said Chief Financial Officer Derica Rice. A plethora of cheap, generic drugs also will take a toll on Lilly.

“While Europe will continue to be an important market for Lilly, we expect it to decline in value, driven by the difficult macroeconomic environment, faster generic erosion than in the past, and excessive hurdles for reimbursement and access of new products,” Rice told investors during the July 25 conference call.

In response, Lilly intends to reduce its number of locations and costs to operate in Europe.

“Specifically, we're simplifying the organization from 12 to five geographic hubs, giving us critical mass and delivering efficiencies across markets. In addition, we'll organize marketing medical, and other commercial support functions into pan-European therapeutic communities,” Rice said. “These changes will create a more focused organization, one able to respond effectively to customer needs.”

Rice declined to quantify how much Lilly could save with these changes, other than to say they will produce “substantial savings in the coming years.” However, Rice delighted analysts by saying that Lilly would reduce its worldwide selling, general and administrative expenses to no more than 30 percent in the few years after 2014.

Overhead expenses have been running at nearly 34 percent of revenue recently as Lilly deals with declining revenue from Zyprexa at the same time it has ramped up marketing efforts to generate new sales. That strategy has worked better than many Wall Street analysts expected. Lilly’s second quarter earnings per share were six cents higher than analysts predicted, and the company raised its full-year profit forecast by 10 cents to 15 cents per share.

In response, most analysts raised their long-term profit forecasts for Lilly, but some wondered whether the cost cuts will actually materialize—especially if Lilly fails to launch new products before then.

“We believe that cutting costs will be easier than growing revenues, and we remain cautious about revenue growth beyond 2014,” Alex Arfaei, a drug analyst at BMO Capital Markets, wrote in a July 27 research note.

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