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Financial pressures stretching Lilly

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Eli Lilly and Co. executives are performing their rendition of the 1970s hit “The Rubberband Man.”

But Wall Street isn’t cheering.

In a series of presentations, Lilly executives stretched themselves in four directions at once to convince investors and stock analysts that the company will bend but not break next year, and then snap back stronger than ever in 2015.

However, since Lilly executives started talking Thursday morning, the company’s stock has fallen more than 5 percent to below $48 a share—its lowest since the start of the year.

Lilly brass acknowledged that the Indianapolis-based drugmaker will have a harder-than-expected time meeting a goal of $20 billion in sales next year. That’s because not only will Lilly lose patent protection on its bestseller Cymbalta in December, but it also faces difficulties as the growth of emerging markets has slowed and inflationary policies in Japan have lowered the value of the yen, and therefore of Lilly’s growing sales there.

Chief Financial Officer Derica Rice promised that Lilly would still meet its goals, although it might do so in different ways.

One way Lilly executives have been touting since July is cuts to overhead and research and development expenses. Rice said Lilly’s selling, general and administrative expenses declined $400 million last year and will fall another $300 million to $500 million this year.

“R&D spending will decline in 2014 as the number of Phase 3 assets declines from 13 to eight,” Rice said. Even after 2014, he added, Lilly expects R&D spending to grow slower than revenue, as the company tries to do a better job of advancing only the most promising drugs into the large-scale Phase 3 trials that determine if a drug reaches the market.

But in the next breath, Lilly executives promised they wouldn’t cut R&D too much, for fear of repeating the mistake the company made in 2001, when it lost patent protection on its then-bestseller, Prozac. Lilly cut back on R&D spending then, which contributed to a drought of new drugs the company has suffered since 2005.

“I’m confident we’ll not see another large gap like the one in our rearview mirror,” Rice said.

For the past decade, Lilly executives have been touting the company’s pipeline as the thing that would save the company from a loss of revenue during these lean years. Lilly ramped up the number of drugs in human testing from about 10 a decade ago to roughly 60 now.

But Lilly has suffered a bevy of late-stage failures, leaving it with no drugs with sales potential anywhere close to the $6 billion that Cymbalta will generate this year or the $5 billion a year Zyprexa was producing until its major patents expired in late 2011.

Lilly’s pipeline has certainly had successes—just none that have hit it big in the market. That reality forced Lilly executives Thursday to declare victory based on submissions of drugs to regulators, rather than products on the market.

Lilly has submitted four drugs for market approval this year and analysts expect that some of those, and perhaps all of them, will be approved.

“Today, we’re seeing our strategy bear fruit,” said CEO John Lechleiter.

But that fruit won’t actually bear revenue until well after Cymbalta’s revenue declines precipitously in December when patients switch en masse to cheaper generic versions of the medicine.

That’s why Lilly is talking more than ever about cutting costs. And why investors have cut Lilly’s stock price.

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  • The blame game
    It is true that Lilly had a one-year 3.8% decline in its R&D spending in 2002. But that spending returned to growth in 2003, and has since risen at an average annual rate of 9.4%. So, blaming that one-time decline 11 years ago for the drought of new drugs the company has suffered since 2005 seems bizarre. Since the onset of that drought, Lilly has spent $33 billion in R&D, plus another $7 billion in acquisitions that have never returned a dime. It is also surprising that this excuse only surfaces now, while for years Lilly has kept boasting about its pipeline and how it would bring to market two drugs per year starting in 2013. Rather than blaming ancient history, Lilly's leadership should look instead at its deficit of competence for having turned the second most innovative company in the industry into one of its least productive ones despite robust R&D spending and an R&D organization that is still regarded as one of the most respected in the industry. If Lilly, as is now feared, must go through another round of layoffs, perhaps it should use the opportunity to put some of its leaders at the top of that list. That would be called accountability.

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