Lilly Takes Another Shot to Foot

Eli Lilly's(LLY - Cramer's Take - Stockpickr) shareholders got a scare Wednesday when the drugmaker said the FDA is intensifying scrutiny of its quality-control procedures. But although the probe is serious, analysts said it is unlikely to explode like the one afflicting Schering-Plough(SGP - Cramer's Take - Stockpickr).

Lilly said Wednesday that the FDA had listed 50 quality-control issues at its manufacturing plants that would need to be resolved before final marketing approval is granted on new products. The issues mainly involve the company's computer systems, process reviews and data handling, and correcting them could delay the launch of some drugs.

Lilly said the approval dates for two drugs originally expected to be launched in early 2002, an injectable form of antipsychotic Zyprexa and the osteoperosis drug Forteo, are now "uncertain" and "dependent on resolution of all manufacturing issues to the agency's satisfaction."

Other drugs slated for release in 2002 and 2003, including Cialis, for erectile dysfunction; Atomoxetine, for attention deficit disorder; Xigris, for sepsis; and Duloxetine, for depression, also could be affected, according to company spokeswoman Terra Fox. Eli Lilly plans to launch about a half-dozen new products in 2002.

Though the FDA's inquiry won't interfere with already approved drugs, the company is planning to upgrade all of its manufacturing facilities, old and new, to meet the FDA standards. To address the upgrades, Eli Lilly has "substantially increased capital spending" planned for 2002, redeployed several hundred employees and hired about 350 more, according to Fox. The increased spending is not expected to eat into profits, Fox said.

Stepping Up

The development is the latest blow to Lilly, which recently lost patent protection for its blockbuster antidepressant Prozac, and in November saw FDA approval for sepsis treatment Xigris limited to patients with a high risk of death, at least until more tests are conducted. On the other hand, the company is considered to have one of the most promising drug pipelines in the industry.

Over the past three years, the FDA has extended extensive inquiries into quality control at Schering-Plough(SGP - Cramer's Take - Stockpickr). One of the most serious of the problems was occasional failure to fill its Proventil asthma-inhaler cans with medicine.

Some estimate that resolving the slip-ups, plus bad publicity, shaved almost 5% from Schering's earnings for January through July. Schering-Plough's stock is now 36% below its 12-month high, at $36.86.

But Eli Lilly didn't change its earnings guidance for 2002 and still expects high-teen per-share earnings growth in 2003, "assuming timely new product launches," said Fox. Despite potential delays, the company continues to plan for the release of Atomoxetine in late 2002. In October the company cut its earnings forecasts after a sharp fall in sales of Prozac, which went off patent this year. Prozac sales dropped 34 percent in the third quarter, the biggest sales falloff ever for a branded medicine.

Shares of Eli Lilly fell slightly on the news this morning and closed off $1.04, to $81.60. Schering Plough also fell in early trading and closed down 20 cents, to $36.86. Merck(MRK - Cramer's Take - Stockpickr) rose 83 cents, to $59.33, and Bristol-Myers Squibb(BMY - Cramer's Take - Stockpickr) gained 53 cents, to $51.71.

2003 the Key

One analyst said the reaction wasn't more pronounced because the quality- control issues Lilly faces are fairly easily resolved, and anyway, investors care more about drugs slated for 2003, which are less likely to face delays.

"These are more blocking and tackling issues than they are major revamp issues," said Jeffrey Kraws, analyst for Gruntal & Co. "The company has a significant pipeline ahead of them carrying the valuation. Forteo and Zyprexa are not huge products that investors are expecting to carry the company along. High hopes are based on 2003, with Xigris and Duloxene."

The FDA's most recent move may send a message to other drug companies to get their factories in top shape, said Kraws.

"Between now [the Lilly probe] and Schering-Plough, if I were a drug company, I would immediately be talking to people about product compliance. This certainly alerts pharmaceutical companies that they need to make sure all of their processes are in compliance, and possibly take closer looks at the way they manufacture," he said.