Hoosier firms find cutting costs no substitute for growth

July 31, 2010

Many Hoosier firms are reporting sharply higher second-quarter earnings—figures that top the expectations of analysts and bolster investor confidence the economic recovery is in full swing.

The reality, however, is a lot less reassuring.

Sure, some companies are posting eye-popping results built on real growth. For example, Carmel-based ITT Educational Services Inc., the for-profit school operator, said a 21-percent increase in enrollment helped push earnings up 35 percent, to $96 million.

But that business, which is thriving partly because underemployed adults are flocking to upgrade their skills, is the exception.

More typical is Evansville-based Old National Bancorp, the largest Indiana-based banking company. Profit rose 9 percent, to $10.5 million—in part because of expense controls. Salaries and benefits declined 3 percent, or $1.3 million, from the same period a year earlier.

Old National, which has a major Indianapolis presence, eked out increases in business checking accounts and in commercial loans. But in a conference call with analysts, CEO Bob Jones offered no more than “cautious optimism.”

In the second quarter, “employment and economic growth remained stagnant, and in conversations with our clients there still remains a tepid view toward the economy,” he said.

“At the same time, there is an acknowledgement that businesses have potentially held out as long as they can without expanding inventory or making capital investments.”

National patterns are similar. Seventy-eight percent of firms have beaten analysts’ expectations this earnings season, according to New York-based Bespoke Investment Group, well ahead of the 62-percent average since 1998.

The gains amid economic malaise are impressive, but also unsustainable. Companies can’t continue to grow earnings forever based on cost-cutting.

No one knows that better than the management team at Eli Lilly and Co., which is preparing for a torrent of patent expirations in the next few years.

Lilly last September said it planned to cut 5,500 jobs as part of an effort to eliminate $1 billion in expenses by the end of 2011. The drug firm already has identified more than 2,000 positions to chop.

The reductions already may be paying off. Lilly and other drugmakers that face a slew of patent expirations “likely will continue to surprise on the upside as they continue to chop more and more costs” in advance of generic competition, Tim Anderson, an analyst with Bernstein Research in New York, said in a report.

But most analysts are paying little attention to Lilly’s thriftiness. Instead, they’re focused on the company’s R&D pipeline, which must pump out breakthrough drugs if Lilly is to avoid sharp declines in annual sales in the middle of this decade.

For now, Lilly is posting impressive results. Second-quarter profit surged 16 percent, to $1.3 billion. Driving much of the increase was real growth—sales climbed 9 percent, to $5.7 billion.

But many analysts question whether numbers like that are sustainable.

“The company’s large pipeline includes a number of interesting but very high-risk shots on goal,” Morgan Stanley analyst David Risinger wrote in a report.

Vera Bradley enlists locals

Unfortunately, Vera Bradley Inc., the handbag-maker that filed for an initial public offering last month, is based two hours up the road in Fort Wayne rather than here. But that doesn’t mean local professional-services firms will miss out as the company accelerates its growth.

Papers that Vera Bradley filed with the Securities and Exchange Commission in connection with plans for its $175 million IPO show the Indianapolis office of PricewaterhouseCoopers serves as the company’s outside auditing firm. And among the law firms handling work for the firm is Baker & Daniels in Indianapolis.

Vera Bradley already is a substantial business, with revenue of $289 million and profit of $43 million in its latest fiscal year. But management aspires to much more.

The company sells online as well as through 3,300 independent retailers and 28 of its own full-price stores.

The first full-price store opened just three years ago. Vera Bradley says in the SEC filing that it believes the United States can support more than 300.

Appraisers get house arrest

A pair of central Indiana appraisers who valued hundreds of homes that ended up in foreclosure each will spend six months in home detention after pleading guilty to filing false tax returns.

Federal investigators said 44-year-old Susan Ruhana of Greenwood and 71-year-old Frederick Bauter of Indianapolis failed to disclose appraisal-related income they received in 2004 and 2005 stemming from a massive mortgage fraud orchestrated by Robert Penn.

Penn was sentenced in January to seven years in prison after he pleaded guilty to wire fraud and other felony charges. Authorities say he duped lenders into providing mortgage loans for amounts far exceeding the value of homes being acquired. The sellers ended up receiving only the market value, and straw buyers ended up on the hook for inflated loans.

Many homes were in the Windsor Village neighborhood near Arlington Avenue and 21st Street on the east side.•


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