LILLY NON-DRUG BUSINESSES MAY BE DIVESTITURE TARGETS

Executive Summary

LILLY NON-DRUG BUSINESSES MAY BE DIVESTITURE TARGETS, Lilly Chief Executive Officer Randall Tobias indicated in a July 20 presentation before the New York Society of Security Analysts. Lilly "must consider some tough decisions about our portfolio of businesses," Tobias said. "Our traditional pharmaceutical business will clearly provide the engine that will drive the corporation into the future. The question is this: what other businesses do we need in our portfolio to enhance our opportunities for success in this changing industry?" In addition to pharmaceuticals, Lilly has medical device and animal health businesses. "There will be no sacred cows," Tobias vowed. "We are looking at absolutely anything and everything...I think that's one of the opportunities of this kind of change" in management. "A changing marketplace always dictates changing business relationships, structures and alliances," Tobias continued. "We have a number of options to consider. We'll be focused and thoughtful, but we won't be timid or indecisive." Tobias' appearance before NYSSA came on day 16 of his tenure as Lilly chairman, CEO and president. Formerly the president of AT&T International, Tobias replaced Vaughn Bryson in the Lilly top spot June 25 ("The Gray Sheet" June 28, p. 18). Bryson had moved to the Lilly CEO post from the device side, and there has been recent speculation that Lilly may be considering device business divestitures. Lilly's device units include Cardiac Pacemakers, Inc.; Advanced Cardiovascular Systems, Inc. and Devices for Vascular Intervention, Inc., which manufacture vascular access products; Physio-Control, which produces external defibrillators; infusion pump manufacturer IVAC; and diagnostics manufacturers Hybritech and Pacific Biotech. The firm recently has faced regulatory problems with a number of the device businesses, the most damaging being good manufacturing practices and medical device reporting violations at Physio-Control that led the unit to cease operations and distribution of its three products in 1992. Operations at Physio-Control resumed in May after the subsidiary obtained 510(k) clearance for design changes to one product, the Lifepak 10 external defibrillator/monitor ("The Gray Sheet" May 24, I&W-4). Asked about the regulatory compliance problems that led Physio-Control to cease distribution of its devices in May 1992, Tobias said: "I cannot and will not promise you that we are never going to have those kinds of problems. I will promise you that we are going to be certain that we have in place everything that is humanly possible to assure that those kinds of things won't occur because nothing less than our reputation is at stake...Our reputation is one of the most important things that we have." Medical Devices and Diagnostics Division President Ron Donnel commented that Lilly has "absolutely internalized that issue to say if we had compliance issues taken care of at Physio-Control when we should have, we would not have had this outcome." He added: "Given that very expensive lesson that we had during the 12 months from [the] middle of May '92 to [the] middle of May '93, we have said we will absolutely go to school on that. We have very specific programs to transfer that learning to every one of our device and diagnostic companies as well as making sure that we have transferred that learning also into the pharmaceutical business." In addition to discussing potential changes in Lilly's business mix, Tobias emphasized that Lilly needs a "greater sense of urgency" in cost-cutting and realigning operations. "This is a company that is doing a lot of things very, very well," Tobias said. "I think we need to do them faster. I think we need to do them with more intensity." He added: "In these early days...I believe I can contribute most by bringing a greater sense of urgency -- an intense sense of urgency -- to Lilly regarding shareholder value, both in the near term and the long term...We must determine how we can move even more quickly -- and dig more deeply -- to streamline our operations and to reduce expenses." Lilly's decision to turn outside the company for leadership marked a significant change in management philosophy for a company that has prided itself on a tradition of home- grown management. Tobias' remarks to NYSSA suggested several rationales for the move, including an outsider's presumably more objective eye to cost-cutting decisions. "This is an industry that has suffered perhaps from...doing its benchmarking against itself," Tobias said. "Lilly has always run a tight ship by pharmaceutical industry standards, but those standards are changing." Tobias did not elaborate on what sort of cutbacks are planned. He maintained that streamlining could be accomplished without layoffs or a significant restructuring charge. In the third quarter of 1992, Lilly posted a loss based in part on nonrecurring expenses including "a redefinition of site missions and a streamlining of several manufacturing operations." Results for the quarter were also hurt by regulatory problems at both Physio-Control and Advanced Cardiovascular Systems, which suspended sales of the ACS Rx Streak .014 rapid-exchange angioplasty catheter for two months in 1992 ("The Gray Sheet" Oct. 26, 1992, p. 11). However, the company has not joined the growing list of pharmaceutical firms announcing major cutbacks. One alternative to layoffs used by Lilly has been employee retraining, Tobias said. He noted that the company has retrained 700 people in the last eight months, in many cases using them to replace outside contractors. "I believe it is a failure of leadership if you get yourself into the situation where the only alternative you can find to downsize your force is to lay off," Tobias declared. "That means that you have been denying reality for too long a time." "One of the most precious assets that we have at Lilly is the feeling that exists between Lilly employees and the institution," Tobias continued. "Once you lose that it is a very expensive asset to reacquire." Tobias, however, added that Lilly will not hesitate to turn to layoffs if they prove necessary. He reminded the analysts that "I was involved in eliminating 125,000 jobs at AT&T. Believe me, I understand job elimination." He added that Lilly has laid off workers in the past but "I do not expect that to be the case now." Concrete financial steps under way within the company include a plan to "reallocate $1 bil. of corporate resources over the next three years into areas where they can better support our leveraging and speed-to-market priorities," Tobias said. "We're already at approximately the $250 mil. mark." The company also is reducing its capital expenditures, Tobias said. After $913 mil. in capital expenses during 1992, the company expects to spend about $800 mil. this year and $700 mil. in 1994. The Lilly CEO, however, pointedly deflated any expectations for a quick turnaround in Lilly's earnings performance. After reviewing the company's preliminary financial projections, Tobias declared: "We believe that the company's full-year earnings this year are likely to be in the neighborhood of the lower end of the estimates we've recently seen." For 1994, "it will be a challenge for us to stay even with our 1993 results." Tobias reassured analysts that the annual dividend is secure. In addition to cost-cutting, Tobias listed four other "priorities" he sees for Lilly. First, he said, Lilly "must transcend our traditional focus on selling products to our customers" and instead "our customers must come to view us as the world's leading partner in the provision of clinically and economically optimal therapeutic outcomes." Second, Tobias continued, "we must increase our global presence." Approximately 60% of Lilly's sales are in the domestic market, Tobias said, and a failure to "bring into better balance" the global sales effort "would make it virtually impossible for us to fulfill our corporate potential." Tobias added that he intends "to be very active on this front." Third, Tobias said, "we must increase the focus, effectiveness, and resources associated with our R&D commitment." Finally, Tobias concluded, "we must approach the global public policy arena proactively." Critics "have done a real job on the pharmaceutical industry," Tobias said. The criticism "has...distorted some of the most basic assumptions involved in discussions of health care reform, and perhaps we have been too willing to sit back and watch as this has happened. I believe that Lilly must take a leadership role in public policy debates, wherever they unfold." Tobias indicated that he also believes Lilly must do a better job of selling itself to the financial community. The NYSSA meeting marked Lilly's first appearance before the financial community in more than two years; Bryson never held such a meeting during his short tenure as CEO. Tobias said that scheduling the July 20 meeting was "one of my first decisions after accepting this job." Tobias promised "frequent and regular meetings between this management team and the investment community." He suggested that the company "has been hiding its light under a bushel."