EXHIBIT 13. ANNUAL REPORT TO SHAREHOLDERS FOR THE YEAR
ENDED DECEMBER 31, 1999
REVIEW OF OPERATIONS
SALE OF PCS HEALTH-CARE-MANAGEMENT BUSINESS
In November 1998, the company signed a definitive agreement to sell to Rite Aid
Corporation the company's PCS health-care-management subsidiary for $1.60
billion in cash. The sale, which was completed in January 1999, is allowing the
company to further focus on pharmaceutical innovation and the realization of
optimal demand for company products in the marketplace. As a consequence of the
divestiture, the operating results of PCS have been reflected as "discontinued
operations" in the company's financial statements for all periods and have been
excluded from consolidated sales and expenses reflected therein. The company
recognized a gain on disposal of $174.3 million, net of $8.7 million tax
benefit, which increased earnings per share by approximately $.16, net of tax,
in the first quarter of 1999.
OPERATING RESULTS FROM CONTINUING OPERATIONS - 1999
SUMMARY
- -------
Income from continuing operations was $2.55 billion, or $2.30 per share, in 1999
and $2.10 billion, or $1.87 per share, in 1998 (before the 1998 extraordinary
charge of $7.2 million, or $.01 per share). Comparisons between 1999 and 1998
are made difficult by the impact of several unusual items that are reflected in
the company's operating results for both years. Excluding these unusual items,
which are discussed further below, income from continuing operations before
extraordinary item for 1999 and 1998 would have been $2.52 billion, or $2.28 per
share, and $2.17 billion, or $1.94 per share, respectively. This represents an
increase in earnings and earnings per share of 16 percent and 18 percent,
respectively. The 1999 increases are attributed to increased sales, improved
gross margin, and increases in operating expenses at a rate less than sales
growth. Earnings per share also benefited from a decrease in the number of
shares outstanding as a result of the share repurchase plan.
UNUSUAL ITEMS
- -------------
As noted above, several unusual transactions are reflected in the company's
operating results for 1999 and 1998. These transactions are summarized as
follows (see Note 3, Note 4, and Note 12 to the consolidated financial
statements for additional information):
- - The company realized approximately $90 million in additional product sales as
a result of year-2000-related wholesaler buying, which increased earnings per
share by approximately $.06 in the fourth quarter of 1999.
- - The company recognized a pretax gain of $110.0 million in settlement of
litigation with Biochimica Opos S.p.A., which increased earnings per share by
approximately $.06 in the fourth quarter of 1999.
- - The company recognized a pretax charge of $26.0 million associated with the
decommissioning of manufacturing facilities and other site charges, which
decreased earnings per share by approximately $.02 in the fourth quarter of
1999.
- - The company recognized a pretax gain of $67.8 million on the sale of Lorabid
marketing rights, which increased earnings per share by approximately $.05 in
the third quarter of 1999.
- - The company recognized a pretax charge of $150.0 million as the result of a
contribution to Eli Lilly and Company Foundation, which decreased earnings
per share by approximately $.09 in the first quarter of 1999.
Page 1
- - The company recognized a pretax charge of $61.4 million associated with the
impairment of certain manufacturing assets, which decreased earnings per
share by approximately $.04 in the first quarter of 1999.
- - The company recognized a pretax charge of $127.5 million for acquired in-
process technology associated with a collaboration with ICOS Corporation,
which reduced earnings per share by approximately $.07 in 1998.
SALES
- -----
The company's worldwide sales for 1999 increased 8 percent, to $10.0 billion.
Approximately $90 million of worldwide sales were related to year 2000
wholesaler buying. Sales growth was led by Zyprexa, a treatment for
schizophrenia and related psychoses; the osteoporosis treatment and prevention
agent Evista; the oncolytic product Gemzar; diabetes care products; and the
cardiovascular agent ReoPro. Sales in the U.S. were $6.23 billion, a 7 percent
increase, while sales outside the U.S. were $3.77 billion, an 11 percent
increase. Worldwide sales reflected volume growth of 9 percent and a 1 percent
increase in prices, partially offset by a 2 percent decrease in exchange rates.
Worldwide sales of the antidepressant Prozac in 1999 were $2.61 billion,
representing a decrease of 7 percent. Approximately $12 million of worldwide
Prozac sales were related to year 2000 wholesaler buying. Prozac sales in the
U.S. decreased 8 percent, to $2.09 billion. Sales of Prozac outside the U.S.
decreased 3 percent, to $525.1 million. The decline in U.S. sales was largely
caused by wholesaler stocking that occurred during 1998, creating a significant
adverse impact on sales comparisons in 1999. Prozac sales in the U.S. were also
adversely affected by increased competition from new antidepressants. The
company expects slight declines in worldwide Prozac sales in 2000 compared with
1999 primarily due to increased generic competition outside the U.S. Actual
sales levels will depend on the effectiveness of the company's marketing efforts
in offsetting increased competition, the rate of growth of the antidepressant
market, and the stocking patterns of wholesalers, retailers, and consumers.
Zyprexa posted worldwide sales of $1.89 billion in 1999, representing an
increase of 31 percent. Approximately $17 million of worldwide Zyprexa sales
were related to year 2000 wholesaler buying. U.S. sales of Zyprexa increased 22
percent, to $1.37 billion. Sales outside the U.S. increased 62 percent, to
$513.9 million. During the fourth quarter of 1999, the U.S. Food and Drug
Administration (FDA) issued an approvable letter for Zyprexa for the treatment
of acute mania associated with bipolar disorder. The company expects continued
strong sales growth for Zyprexa in 2000 due, in part, to the anticipated new
indication.
Worldwide Gemzar sales of $455.8 million in 1999 reflected an increase of 49
percent. Sales in the U.S. increased 57 percent, to $264.2 million, and sales
outside the U.S. increased 38 percent, to $191.6 million. The company
anticipates strong sales growth for Gemzar in 2000.
Worldwide ReoPro sales of $447.3 million in 1999 reflected an increase of 22
percent. U.S. sales of ReoPro increased 18 percent, to $357.5 million. ReoPro
sales outside the U.S. increased 43 percent, to $89.8 million. The company
anticipates strong sales growth for ReoPro in 2000.
Worldwide diabetes care revenues, composed of Humulin, the company's
biosynthetic human insulin; Humalog, the company's insulin analog; the animal
source insulin Iletin; and Actos, an oral diabetes agent introduced in the U.S.
in 1999, increased 19 percent, to $1.38 billion, in 1999. Approximately $23
million of worldwide diabetes care revenues were related to year 2000 wholesaler
buying. Diabetes care revenue in the U.S. increased 18 percent, to $827.7
million. Diabetes care revenue outside the U.S. increased 21 percent, to $547.5
million. Worldwide Humulin sales increased 13 percent, to $1.09 billion. U.S.
Humulin sales increased 12 percent and Humulin sales outside the U.S. increased
15 percent. Worldwide Humalog sales were $224.5 million, representing an
increase of 73 percent. The company anticipates moderate growth in sales of
diabetes care products, excluding Actos, in 2000. Actos, an oral agent for the
treatment
Page 2
of type 2 diabetes, was introduced to the U.S. diabetes market in the third
quarter of 1999. Actos is manufactured and sold in the U.S. by Takeda Chemical
Industries, Ltd., and is copromoted by the company. The company received service
revenues of $37.9 million in 1999 relating to Actos sales. The company
anticipates very strong growth in Actos revenues in 2000.
Worldwide sales of anti-infectives decreased 12 percent in 1999, to $1.02
billion, as a result of continuing competitive pressures. U.S. and international
anti-infectives sales declined 22 percent and 8 percent, respectively. Cefaclor
and Lorabid accounted for the majority of the decline in anti-infectives sales,
offsetting growth in Vancocin outside the U.S. The company expects a continued
decline in anti-infectives sales in 2000.
Evista sales increased $182.0 million, or 126 percent, to $326.1 million in
1999. Evista was launched in the first quarter of 1998 in the U.S. for the
prevention of osteoporosis in postmenopausal women. During 1999, the company
received approval from the FDA to promote Evista for the treatment of
postmenopausal osteoporosis. While most of the sales dollar growth for Evista
occurred in the U.S., international Evista sales reflected strong percentage
growth. The company anticipates strong growth in worldwide Evista sales in
2000.
Worldwide sales of animal health products of $627.8 million in 1999 reflected a
2 percent increase. Sales were flat in the U.S. and increased 4 percent outside
the U.S. The worldwide sales growth was driven primarily by Surmax, a
performance enhancer for poultry and swine, and Micotil, an antibiotic for
bovine respiratory disease, offset, in part, by decreases in worldwide sales of
Tylan, a performance enhancer for poultry, swine, and cattle. In January 2000,
the company received approval for Paylean, a new swine lean-meat enhancer, from
the FDA's Center for Veterinary Medicine.
The company's payments under federally mandated Medicaid rebate programs reduced
1999 sales by approximately $352.5 million compared with approximately $278.6
million in 1998. The company anticipates that Medicaid rebates will increase in
2000 due, in part, to the continuing growth of Zyprexa sales.
GROSS MARGIN, COSTS, AND EXPENSES
- ---------------------------------
The 1999 gross margin improved to 79.0 percent of sales compared with 78.2
percent for 1998. This increase was attributed primarily to production
efficiencies and, to a lesser extent, favorable changes in product mix, as well
as the expiration of Humulin and Humalog royalties in August 1998. The company
anticipates a slight improvement in gross margin in 2000.
Operating expenses (the aggregate of research and development and marketing and
administrative expenses) increased 3 percent in 1999. Research and development
investments increased 3 percent, to $1.78 billion, in 1999 as the company
continued to build internal and external capabilities. Reduced incentive
compensation significantly offset the expense growth. In addition, Phase III
clinical trials for certain compounds were discontinued in the first half of
1999, which contributed to the reduction in the growth rate. Marketing and
administrative expenses increased 4 percent. The increases were due to
increased spending to support new product launches around the world and
enhancements in the company's global information technology systems, including
year 2000 readiness efforts. However, the impact of these increases was
mitigated by expense management initiatives and reduced incentive compensation.
For 2000, the company expects operating expenses will return to a more typical
growth rate of low double-digit to mid-teen increases. The actual 2000 increase
will vary depending upon a number of factors, particularly the level of research
collaboration activity.
Excluding the gains from the litigation settlement, the sale of Lorabid
marketing rights, and the charge for the contribution to Eli Lilly and Company
Foundation, net other income for 1999 was $125.1 million, which represents a
decrease of $24.2 million. Other income in 1998 benefited from gains generated
from the sale of investments.
Page 3
The company's effective tax rate for 1999 was 21.5 percent compared with 21.3
percent for 1998. Excluding the unusual items discussed previously, the
effective tax rates for 1999 and 1998 were 22.0 percent and 22.2 percent,
respectively. The company expects that a comparable tax rate will be
sustainable under present law for the near term. See Note 10 to the
consolidated financial statements for additional information.
OPERATING RESULTS FROM CONTINUING OPERATIONS -- 1998
SUMMARY
- -------
Income from continuing operations (before the 1998 extraordinary charge of $7.2
million, or $.01 per share) was $2.10 billion, or $1.87 per share, in 1998 and
$2.02 billion, or $1.78 per share, in 1997. Comparisons between 1998 and 1997
are made difficult by the impact of several unusual transactions that are
reflected in the company's operating results for both years. Excluding these
unusual items, which are discussed further below, income from continuing
operations before extraordinary item for 1998 and 1997 would have been $2.17
billion, or $1.94 per share, and $1.83 billion, or $1.62 per share,
respectively. This represents an increase in earnings and earnings per share of
19 percent and 20 percent, respectively. The 1998 increases are attributed to
increased sales, improved gross margin, reduced interest expense, and a lower
effective tax rate, partially offset by increases in operating expenses.
UNUSUAL ITEMS
- -------------
During 1998, the company announced a collaboration with ICOS Corporation to
jointly develop and globally commercialize a phosphodiesterase type 5 (PDE5)
inhibitor as an oral therapeutic agent for the treatment of male erectile
dysfunction and female sexual dysfunction. The company's payments to acquire
rights to this compound were required to be charged as an expense of $127.5
million, which reduced earnings per share by approximately $.07 net of tax. The
company's reported tax rate was also affected by this item. See Note 4 to the
consolidated financial statements for additional information.
The company's reported results from continuing operations for 1997 include the
following unusual transactions: a pretax gain of $631.8 million from the sale of
the company's interest in the DowElanco joint venture, a $97.8 million noncash
charge for an asset impairment, a charge for the settlement of a significant
portion of the company's remaining retail pharmacy pricing litigation, and a
$24.1 million charge for the discontinuance of the research collaboration with
Somatogen, Inc. The company's reported tax rate for 1997 was also affected by
these transactions.
SALES
- -----
The company's sales for 1998 increased 16 percent, to $9.24 billion. Sales
growth was led by four of the company's newer products: Zyprexa, ReoPro,
Gemzar, and Evista, as well as Prozac. Sales in the U.S. were $5.84 billion, a
20 percent increase, while sales outside the U.S. were $3.40 billion, a 9
percent increase. Worldwide sales reflected volume growth of 15.3 percent and a
2.1 percent increase in selling prices, which were partially offset by an
unfavorable exchange rate impact of 1.8 percent.
Worldwide sales of Prozac in 1998 were $2.81 billion, representing an increase
of 10 percent. Prozac sales in the U.S. increased 13 percent, to $2.27
billion, due, in part, to wholesaler stocking in advance of a 1999 price
increase. Sales of Prozac outside the U.S. were substantially the same as 1997.
Continued competitive pressures affected sales outside the U.S.
Zyprexa posted worldwide sales of $1.44 billion in 1998, representing an
increase of 98 percent. U.S. sales of Zyprexa increased 91 percent, to $1.12
billion. Sales outside the U.S. increased 127
Page 4
percent, to $317.9 million. Sales comparisons for Zyprexa benefited to some
extent from U.S wholesaler stocking in the fourth quarter of 1998.
Worldwide diabetes care revenue, composed of Humulin, Humalog, and Iletin,
increased 8 percent, to $1.15 billion, in 1998. Insulin sales in the U.S.
increased 4 percent, to $701.5 million. Insulin sales outside the U.S.
increased 14 percent, to $453.4 million. Worldwide Humulin sales increased 3
percent, to $959.3 million. Worldwide Humalog sales were $129.6 million,
representing an increase of 91 percent, or $61.9 million, over 1997. Iletin
sales were essentially flat compared with 1997.
Worldwide sales of anti-infectives decreased 9 percent, to $1.16 billion. U.S.
and international anti-infectives sales declined 20 percent and 4 percent,
respectively. These declines were due, in part, to continued generic
competition in certain markets and the impact of unfavorable exchange rates.
Cefaclor, Lorabid, and Vancocin accounted for the majority of the decline in
anti-infectives sales with declines of 10 percent, 14 percent, and 5 percent,
respectively.
Worldwide Axid sales decreased 20 percent, to $418.0 million, due to continuing
competition from other branded and generic antiulcer agents.
As mentioned above, the newer products ReoPro, Gemzar, and Evista contributed
significantly to worldwide sales growth. Worldwide ReoPro sales of $365.4
million reflected an increase of 44 percent. Worldwide Gemzar sales increased 76
percent, to $306.8 million. Evista, introduced in the first quarter of 1998, had
worldwide sales of $144.1 million. Sales of Evista benefited somewhat from U.S.
wholesaler stocking in the fourth quarter of 1998.
Worldwide sales of animal health products increased 4 percent, to $614.4
million. Sales increased 7 percent in the U.S. and 2 percent outside the U.S.
The worldwide sales growth was driven primarily by Micotil, Tylan, and Surmax.
Weakness in the general economic condition of the Asia-Pacific region negatively
affected sales of animal health products outside the U.S. These products have a
greater sensitivity to adverse economic conditions in the Asia-Pacific region
than pharmaceutical products.
The company's payments under federally mandated Medicaid rebate programs reduced
1998 sales by approximately $278.6 million compared with approximately $199.1
million in 1997.
GROSS MARGIN, COSTS, AND EXPENSES
- ---------------------------------
The gross margin improved to 78.2 percent of sales compared with 75.6 percent
for 1997. This increase was due primarily to favorable changes in product mix
and, to a lesser extent, to productivity improvements.
Operating expenses (the aggregate of research and development and marketing and
administrative expenses) for 1998, excluding the effect of the expenses for
acquired in-process technology related to the ICOS collaboration, increased 22
percent. The increase reflects a 27 percent growth rate in research and
development, to $1.74 billion. This growth was the result of greater
investments in both internal research efforts and external research
collaborations. Marketing and administrative expenses increased 19 percent, to
$2.66 billion. This increase was driven by increased expenditures to support
continued new product launches around the world, including the U.S. launch of
Evista and direct-to-consumer advertising campaigns in the U.S. In addition to
the above, operating expenses were also affected by investments in the company's
global information technology capabilities, which include expenditures relating
to the company's year 2000 computer initiatives and increased compensation due
to the company's performance-based bonus programs.
Interest expense in 1998 decreased $51.4 million, or 22 percent, due largely to
declines in the company's borrowings.
Page 5
Net other income for 1998 was $149.3 million, a decrease of $12.1 million from
1997. Net other income in 1998 benefited from gains on the sale of certain
investments and increased interest income. Also, in comparison with 1997, 1998
benefited from the inclusion in the 1997 amount of the charges associated with
the discontinuance of a collaboration with Somatogen, Inc. These increases were
more than offset by the absence of both DowElanco joint venture income and
certain license fee income in 1998.
The company's effective tax rate for 1998 was 21.3 percent compared with 30.5
percent for 1997. The company's 1997 effective tax rate was distorted by the
gain from the sale of DowElanco and the asset impairment charge. The company's
tax rate for 1997, excluding the impact of these items, was 24.1 percent.
Excluding the ICOS transaction discussed previously, the company's effective tax
rate for 1998 was 22.2 percent. The lower 1998 rate is primarily the result of
changes in the mix of earnings between jurisdictions with lower tax rates and
those with higher rates.
The company refinanced an ESOP debenture during 1998. An extraordinary charge
of $7.2 million, net of a $4.8 million income tax benefit, was recorded as a
result of this refinancing.
DISCONTINUED OPERATIONS
Discontinued operations consists of the company's PCS health-care-management
business. In November 1998, the company entered into an agreement to sell PCS
for $1.60 billion in cash. The sale was closed in January 1999 and the
resulting net gain on disposal was recognized in the first quarter of 1999. See
Note 3 to the consolidated financial statements for further information.
In the second quarter of 1997, the company recognized an asset impairment (a
noncash charge) of approximately $2.30 billion to adjust the carrying value of
PCS's long-lived assets, primarily goodwill, to their fair value of
approximately $1.50 billion. The company determined that PCS's estimated future
undiscounted cash flows were below the carrying value of PCS's long-lived
assets. As a consequence, the carrying value was adjusted to the estimated fair
value based on anticipated future cash flows, discounted at a rate commensurate
with the risk involved.
FINANCIAL CONDITION
As of December 31, 1999, cash, cash equivalents, and short-term investments
totaled approximately $3.84 billion compared with $1.60 billion at December 31,
1998. Total debt at December 31, 1999, was $3.05 billion, an increase of $686.5
million. The increase in cash was due to the sale of PCS in January 1999, the
issuance of debt in August 1999, and cash flows generated from operations.
Substantially all the decreases in accounts receivable ($524.7 million) and
accounts payable ($740.5 million) during 1999 were also a result of the sale of
PCS. The company has completed its previously announced $1.50 billion share
repurchase, acquiring approximately 19.1 million shares in 1999. The company
believes that cash generated from operations, along with available cash and cash
equivalents, will be sufficient to fund essentially all the company's operating
needs, including debt service, capital expenditures, and dividends in 2000.
The company believes that amounts available through existing commercial paper
programs should be adequate to fund maturities of short-term borrowings. The
company's commercial paper program is also backed by $2.05 billion of committed
bank credit facilities.
In the normal course of business, operations of the company are exposed to
fluctuations in currency values and interest rates. These fluctuations can vary
the costs of financing, investing, and operating. The company addresses a
portion of these risks through a controlled program of risk management that
includes the use of derivative financial instruments. The objective of
controlling these risks is to limit the impact on earnings of fluctuations in
interest and currency exchange rates. All derivative activities are for
purposes other than trading.
Page 6
The company's primary interest rate risk exposure results from changes in short-
term U.S. dollar interest rates. In an effort to manage interest rate
exposures, the company strives to achieve an acceptable balance between fixed
and floating rate debt positions and may enter into interest rate swaps to help
maintain that balance. Based on the company's overall interest rate exposure at
December 31, 1999, including derivatives and other interest rate risk sensitive
instruments, a hypothetical 10 percent change in interest rates applied to the
fair value of the instruments as of December 31, 1999, would have no material
impact on earnings, cash flows, or fair values of interest rate risk sensitive
instruments over a one-year period. Similarly, a hypothetical 10 percent change
in interest rates from 1998 applied to the fair value of the instruments as of
December 31, 1998, would have had no material impact on earnings, cash flows, or
fair values of interest rate risk sensitive instruments during 1999.
The company's foreign currency risk exposure results from fluctuating currency
exchange rates, primarily the strengthening of the U.S. dollar against the
Japanese yen and the euro. The company faces transactional currency exposures
that arise when its foreign subsidiaries (or the company itself) enter into
transactions, generally on an intercompany basis, denominated in currencies
other than their local currency. The company also faces currency exposure that
arises from translating the results of its global operations to the U.S. dollar
at exchange rates that have fluctuated from the beginning of the period. The
company uses forward contracts and purchased options to manage its foreign
currency exposures. Company policy outlines the minimum and maximum hedge
coverage of such exposures. Gains and losses on these derivative positions
offset, in part, the impact of currency fluctuations on the existing assets,
liabilities, commitments, and anticipated revenues. Considering the company's
derivative financial instruments outstanding at December 31, 1999, a
hypothetical 10 percent weakening in the exchange rates (primarily against the
U.S. dollar) over a one-year period would increase pretax earnings by $70.0
million, while a 10 percent strengthening in the exchange rates would decrease
pretax earnings by $49.1 million. Comparatively, considering the company's
derivative financial instruments outstanding at December 31, 1998, a
hypothetical 10 percent weakening in the exchange rate (primarily against the
U.S. dollar) over a one-year period would have increased pretax earnings by
$45.9 million, while a 10 percent strengthening in the exchange rates would have
decreased pretax earnings by $26.1 million. This calculation does not reflect
the impact of exchange gains/losses on the underlying positions that would be
offset, in part, by the results of the derivative instruments.
Capital expenditures of $528.3 million during 1999 were $108.4 million more than
in 1998 as the company continued to invest in manufacturing and research and
development initiatives and related infrastructure. The company expects near-
term capital expenditures to increase from 1999 levels. Sufficient cash flows
exist to meet these near-term requirements.
Dividends of $.92 per share were paid in 1999, an increase of 15 percent from
the $.80 per share paid in 1998. In the fourth quarter of 1999, effective for
the first-quarter dividend in 2000, the quarterly dividend was increased to $.26
per share (13 percent), resulting in an indicated annual rate for 2000 of $1.04
per share. The year 1999 was the 115th consecutive year in which the company
made dividend payments and the 32nd consecutive year in which dividends have
been increased.
Page 7
YEAR 2000 READINESS DISCLOSURE
Many of the company's global information technology (IT) systems and non-IT
systems, including laboratory and process automation devices, required
modification or replacement in order to render the systems ready for the year
2000. In late 1996, the company initiated a comprehensive program to reduce the
likelihood of a material impact of the year 2000 on the business.
The company's inventory of IT systems, including software applications, was
divided into various categories. Those most critical to the company's global
operations were generally assessed and renovated, when necessary, first. The
company completed renovation of substantially all its applications that needed
some form of renovation.
The most important non-IT systems were various laboratory and process automation
devices. The company completed a global assessment of all devices. Based on
this assessment, only a small percentage (15 percent) of all automation devices
appeared to require upgrade or replacement. The company completed remediation
of the critical devices.
The company completed a comprehensive risk management analysis of the
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the company and certain third
parties to complete efforts necessary to achieve year 2000 compliance on a
timely basis or from abnormal wholesaler or consumer buying in anticipation of
the year 2000. Contingency plans were developed for the company and its
critical vendors, customers, and suppliers to address the flow of products to
the consumer. The company increased inventories of certain key products in
order to have additional finished stock in the event excessive consumer
purchasing occurred in late 1999. Business continuity plans were developed to
address the company's approach for dealing with extended disruptions.
The company currently estimates it will spend between $160 million and $165
million over the life of the program and that approximately 98 percent of the
anticipated costs were incurred by December 31, 1999. Expenses associated with
addressing year 2000 issues are being recognized as incurred.
The company went through the year 2000 rollover with minimal disruptions to its
business. There were no failures of IT systems or automation devices deemed
critical or essential. All incidents reported were corrected and resulted in no
material impact on the business. While the company continues to be cautious
about the impact of similar issues that could possibly occur around February 29,
2000, it does not expect a material impact on the business. Plans have been put
into place to monitor issues around the leap year rollover.
EURO CONVERSION
On January 1, 1999, 11 European nations adopted a common currency, the euro, and
formed the European Economic and Monetary Union (EMU). For a three-year
transition period, both the euro and individual participants' currencies will
remain in circulation. After July 1, 2002, at the latest, the euro will be the
sole legal tender for EMU countries. The adoption of the euro will affect a
multitude of financial systems and business applications as the commerce of
these nations will be transacted in the euro and the existing national currency.
The company has created the capability to transact in both the euro and the
legacy currency and will continue to address euro-related issues and their
impact on information systems, currency exchange rate risk, taxation, contracts,
competition, and pricing. Action plans currently being implemented are expected
to result in compliance with all laws and regulations; however, there can be no
certainty that such plans will be successfully implemented or that external
factors will not have an adverse effect on the company's operations. Any costs
of compliance associated with the adoption of the euro will be expensed as
incurred and the company does not expect these costs to be material to its
results of operations, financial condition, or liquidity.
Page 8
LEGAL AND ENVIRONMENTAL MATTERS
Barr Laboratories, Inc. (Barr), and Geneva Pharmaceuticals, Inc. (Geneva), have
each submitted an Abbreviated New Drug Application (ANDA) seeking FDA approval
to market generic forms of Prozac before the expiration of the company's
patents. The ANDAs assert that two U.S. patents held by Lilly covering Prozac
are invalid and unenforceable. The company filed suit against Barr and Geneva
in federal court in Indianapolis seeking a ruling that Barr's challenge to
Lilly's patents is without merit. On January 12, 1999, the trial court granted
summary judgment in favor of Lilly on two of the four claims raised by Barr and
Geneva against Lilly's patents. That decision has been appealed. On January
25, 1999, Barr and Geneva dismissed their other two claims in exchange for a $4
million payment, which Barr and Geneva will share with a third defendant. In
late 1998, three additional generic pharmaceutical companies, Zenith Goldline
Pharmaceuticals, Inc.; Teva Pharmaceuticals USA; and Cheminor Drugs, Ltd.,
together with one of its subsidiaries, filed ANDAs for generic forms of Prozac,
asserting that the later of the two patents (expiring in December 2003) is
invalid and unenforceable. In early 1999, Novex Pharma, a division of Apotex,
Inc., changed its previously filed ANDA to assert that both the 2001 and 2003
patents are invalid and unenforceable. Lilly has filed suits against the four
companies in federal court in Indianapolis. In November 1999, Lilly filed a
lawsuit against Cheminor Drugs and Schein Pharmaceuticals, Inc., based on their
ANDA filing for an additional dosage form. A trial date of October 30, 2000,
has now been set for these cases. While the company believes that the claims of
the seven generic companies are without merit, there can be no assurance that
the company will prevail. An unfavorable outcome of this litigation could have
a material adverse effect on the company's consolidated financial position,
liquidity, and results of operations.
In addition, the company is a defendant in numerous product liability suits
involving primarily two products, diethylstilbestrol (DES) and Prozac. See Note
12 to the consolidated financial statements for further information on those
matters.
The company's worldwide operations are subject to complex and changing
environmental and health and safety laws and regulations, which will continue to
require capital investment and operational expenses. The company has also been
designated a potentially responsible party with respect to fewer than 10 sites
under the federal environmental law commonly known as Superfund. For more
information on those matters, see Note 12 to the consolidated financial
statements.
While it is not possible to predict or determine the outcome of the patent,
product liability, or other legal actions brought against the company or the
ultimate cost of environmental matters, the company believes that, except as
noted above, the costs associated with all such matters will not have a material
adverse effect on its consolidated financial position or liquidity but could
possibly be material to the consolidated results of operations in any one
accounting period.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 --
A CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
Under the safe harbor provisions of the Private Securities Litigation Reform Act
of 1995, the company cautions investors that any forward-looking statements or
projections made by the company, including those made in this document, are
based on management's expectations at the time they are made, but they are
subject to risks and uncertainties that may cause actual results to differ
materially from those projected. Economic, competitive, governmental,
technological, and other factors that may affect the company's operations and
prospects are discussed in Exhibit 99 to the company's most recent report on
Forms 10-Q and 10-K filed with the Securities and Exchange Commission.
Page 9
Consolidated Statements of Income
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions, except per-share data)
Year Ended December 31 1999 1998 1997
- -------------------------------------------------------------------------------------------------
Net sales......................................... $10,002.9 $9,236.8 $ 7,987.7
Cost of sales..................................... 2,098.0 2,015.1 1,946.0
Research and development.......................... 1,783.6 1,738.9 1,370.2
Marketing and administrative...................... 2,757.6 2,658.3 2,233.1
Acquired in-process technology (Note 4)........... - 127.5 -
Asset impairment and other site
charges (Note 3)................................ 87.4 - 97.8
Gain on sale of DowElanco (Note 4)................ - - (631.8)
Interest expense.................................. 183.8 181.3 232.7
Other income--net................................. (152.9) (149.3) (161.4)
--------------------------------------------
6,757.5 6,571.8 5,086.6
--------------------------------------------
Income from continuing operations before
income taxes and extraordinary item............. 3,245.4 2,665.0 2,901.1
Income taxes (Note 10)............................ 698.7 568.7 885.2
--------------------------------------------
Income from continuing operations before
extraordinary item.............................. 2,546.7 2,096.3 2,015.9
Income (loss) from discontinued operations,
net of tax (Note 3)............................. 174.3 8.8 (2,401.0)
Extraordinary item, net of tax (Note 6)........... - (7.2) -
--------------------------------------------
Net income (loss)................................. $ 2,721.0 $2,097.9 $ (385.1)
============================================
Earnings (loss) per share - basic (Note 9):
Income from continuing operations
before extraordinary item..................... $ 2.34 $ 1.91 $ 1.83
Income (loss) from discontinued operations...... .16 .01 (2.18)
Extraordinary item.............................. - (.01) -
--------------------------------------------
Net income (loss)............................... $ 2.50 $ 1.91 $ (.35)
============================================
Earnings (loss) per share - diluted (Note 9):
Income from continuing operations
before extraordinary item..................... $ 2.30 $ 1.87 $ 1.78
Income (loss) from discontinued operations...... .16 .01 (2.12)
Extraordinary item.............................. - (.01) -
--------------------------------------------
Net income (loss)............................... $ 2.46 $ 1.87 $ (.34)
============================================
See notes to consolidated financial statements.
Page 10
Consolidated Balance Sheets
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions)
December 31 1999 1998
- --------------------------------------------------------------------------------------
Assets
Current Assets
Cash and cash equivalents.......................... $ 3,700.4 $ 1,495.7
Short-term investments............................. 135.6 101.4
Accounts receivable, net of allowances of
$79.9 (1999) and $64.3 (1998)................... 1,443.2 1,967.9
Other receivables.................................. 399.6 275.8
Inventories........................................ 899.6 999.9
Deferred income taxes (Note 10).................... 240.3 332.7
Prepaid expenses................................... 236.8 233.4
------------------------------
Total current assets............................ 7,055.5 5,406.8
Other Assets
Prepaid retirement (Note 11)....................... 741.1 612.3
Investments........................................ 180.3 204.0
Goodwill and other intangibles, net of
allowances for amortization of $107.6 (1999)
and $171.4 (1998)............................... 118.6 1,517.9
Sundry............................................. 748.2 758.2
------------------------------
1,788.2 3,092.4
Property and Equipment............................. 3,981.5 4,096.3
------------------------------
$12,825.2 $12,595.5
==============================
Page 11
Consolidated Balance Sheets
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions) - Con't.
December 31 1999 1998
- ------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current Liabilities
Short-term borrowings (Note 6)....................... $ 241.5 $ 181.4
Accounts payable..................................... 445.5 1,186.0
Employee compensation................................ 489.3 704.0
Dividends payable.................................... 283.0 252.9
Income taxes payable (Note 10)....................... 1,445.3 1,290.2
Other liabilities.................................... 1,030.8 992.7
--------------------------------
Total current liabilities......................... 3,935.4 4,607.2
Other Liabilities
Long-term debt (Note 6).............................. 2,811.9 2,185.5
Deferred income taxes (Note 10)...................... 137.0 247.9
Retiree medical benefit obligation (Note 11)......... 115.7 114.7
Other noncurrent liabilities......................... 812.2 1,010.6
--------------------------------
3,876.8 3,558.7
Commitments and contingencies (Note 12).............. - -
Shareholders' Equity (Notes 7 and 8)
Common stock - no par value
Authorized shares: 3,200,000,000
Issued shares: 1,091,226,806 (1999)
and 1,098,396,306 (1998)........................ 682.0 686.5
Retained earnings.................................... 4,985.6 4,228.8
Deferred costs - ESOP................................ (139.9) (146.9)
Accumulated other comprehensive income (Note 13)..... (406.4) (229.8)
--------------------------------
5,121.3 4,538.6
Less cost of common stock in treasury:
1999 - 988,902 shares
1998 - 995,492 shares............................ 108.3 109.0
--------------------------------
5,013.0 4,429.6
--------------------------------
$12,825.2 $12,595.5
================================
See notes to consolidated financial statements.
Page 12
Consolidated Statements of Cash Flows
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions)
Year Ended December 31 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income (loss).......................................... $ 2,721.0 $ 2,097.9 $ (385.1)
Adjustments To Reconcile Net Income (Loss) to
Cash Flows From Operating Activities
Depreciation and amortization............................ 439.7 490.4 509.8
Change in deferred taxes................................. 27.1 25.4 (293.0)
Gain on sale of PCS, net of tax.......................... (174.3) - -
Gain on sale of DowElanco, net of tax.................... - - (303.5)
Asset impairment and other site charges, net of tax...... 58.1 - 2,429.6
Other noncash income--net................................ (26.1) (93.0) (37.8)
----------------------------------------------
3,045.5 2,520.7 1,920.0
Changes in operating assets and liabilities:
Receivables - increase................................ (179.0) (403.6) (4.7)
Inventories - (increase) decrease..................... 16.9 (55.6) (65.8)
Other assets - increase............................... (88.8) (81.1) (22.2)
Accounts payable and other
liabilities - increase (decrease)................... (174.9) 649.4 573.1
----------------------------------------------
(425.8) 109.1 480.4
----------------------------------------------
Net Cash From Operating Activities......................... 2,619.7 2,629.8 2,400.4
Cash Flows From Investing Activities
Additions to property and equipment........................ (528.3) (419.9) (366.3)
Disposals of property and equipment........................ 78.3 30.6 11.5
Net additions to other assets.............................. (116.6) (120.1) (34.2)
Reductions of investments.................................. 216.1 273.1 365.7
Additions to investments................................... (162.8) (57.6) (388.5)
Proceeds from sale of DowElanco............................ - - 1,221.5
Proceeds from sale of PCS.................................. 1,600.0 - -
----------------------------------------------
Net Cash From (Used for) Investing Activities.............. 1,086.7 (293.9) 809.7
Cash Flows From Financing Activities
Dividends paid............................................. (1,000.5) (877.7) (818.0)
Purchases of common stock and other
capital transactions.................................... (1,453.0) (1,999.8) (351.3)
Issuances under stock plans................................ 310.2 414.0 205.4
Issuance (redemption) of subsidiary stock.................. - (172.8) 160.0
Decrease in short-term borrowings.......................... (139.4) (170.0) (1,146.0)
Additions to long-term debt................................ 843.5 23.8 2.8
Reductions of long-term debt............................... (13.5) (30.2) (7.5)
----------------------------------------------
Net Cash Used for Financing Activities..................... (1,452.7) (2,812.7) (1,954.6)
Effect of exchange rate changes on cash.................... (49.0) 25.0 (121.7)
----------------------------------------------
Net increase (decrease) in cash and
cash equivalents........................................ 2,204.7 (451.8) 1,133.8
Cash and cash equivalents at beginning of year............. 1,495.7 1,947.5 813.7
----------------------------------------------
Cash and cash equivalents at end of year................... $ 3,700.4 $ 1,495.7 $ 1,947.5
==============================================
See notes to consolidated financial statements.
Page 13
Consolidated Statements of Comprehensive Income
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions)
Year Ended December 31 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
Net income (loss)...................................... $2,721.0 $2,097.9 $(385.1)
Other comprehensive income (loss):
Foreign currency translation
adjustments........................................ (177.7) 69.2 (209.3)
Net unrealized gains (losses) on
securities (Note 13)............................... 27.8 (2.6) (13.4)
Minimum pension liability adjustment................. (26.7) (30.8) (16.8)
-----------------------------------------------------
Other comprehensive income (loss) before
income taxes......................................... (176.6) 35.8 (239.5)
Provision for income taxes related to
other comprehensive income items..................... - 15.6 5.4
-----------------------------------------------------
Other comprehensive income (loss)...................... (176.6) 51.4 (234.1)
-----------------------------------------------------
Comprehensive income (loss)............................ $2,544.4 $2,149.3 $(619.2)
=====================================================
See notes to consolidated financial statements.
Page 14
Segment Information
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions)
The company operates in one significant business segment - pharmaceutical
products. Operations of the animal health business segment are not material and
share many of the same economic and operating characteristics as pharmaceutical
products. Therefore, they are included with pharmaceutical products for
purposes of segment reporting.
Year Ended December 31 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
Net sales - to unaffiliated customers
Neurosciences........................................ $ 4,729.3 $4,487.8 $3,515.3
Endocrinology........................................ 2,075.5 1,626.6 1,381.8
Anti-infectives...................................... 1,022.3 1,160.9 1,272.5
Cardiovascular....................................... 637.6 536.9 421.0
Animal health........................................ 627.8 614.4 589.8
Oncology............................................. 486.1 339.2 210.6
Gastrointestinal..................................... 354.7 418.0 525.4
Other pharmaceutical................................. 69.6 53.0 71.3
--------------------------------------------------
Net sales.................................................. $10,002.9 $9,236.8 $7,987.7
==================================================
Geographic Information
Net sales - to unaffiliated customers/1/:
United States.......................................... $ 6,226.4 $5,836.2 $4,881.8
Western Europe......................................... 1,888.0 1,692.3 1,462.9
Other foreign countries................................ 1,888.5 1,708.3 1,643.0
--------------------------------------------------
$10,002.9 $9,236.8 $7,987.7
==================================================
Long-lived assets:
United States.......................................... $ 3,416.8 $3,363.5 $3,281.8
Western Europe......................................... 568.4 642.6 595.5
Other foreign countries................................ 646.1 625.1 638.0
--------------------------------------------------
$ 4,631.3 $4,631.2 $4,515.3
==================================================
/1/ Net sales are attributed to the countries based on the location of the
subsidiary making the sale.
The largest category of products is the neurosciences group, which includes
Prozac, Zyprexa, Permax, and Darvon. Endocrinology products consist
primarily of Humulin, Evista, Humatrope, Humalog, Actos, and Iletin. Anti-
infectives include primarily Ceclor, Vancocin, Keflex, Lorabid, Nebcin,
and Tazidime. Cardiovascular products consist primarily of ReoPro and
Dobutrex. The gastrointestinal group is entirely composed of Axid.
Oncology products consist primarily of Gemzar. Animal health products include
Tylan, Micotil, Surmax, Rumensin, Coban, and other products for livestock
and poultry. The other pharmaceutical product group includes other
miscellaneous pharmaceutical products and services.
Most of the pharmaceutical products are distributed through wholesalers that
serve physicians and other health care professionals, pharmacies, and hospitals.
In 1999, the company's three largest wholesalers each accounted for between 13
percent and 18 percent of consolidated net sales. Animal health products are
sold primarily to wholesale distributors.
The company's business segments are distinguished by the ultimate end user of
the product: humans or animals. Performance is evaluated based on profit or
loss from operations before income taxes. The accounting policies of the
individual segments are substantially the same as those described in the summary
of significant accounting policies in Note 1. Income before taxes
Page 15
for the animal health business was approximately $165.0 million, $141.0 million,
and $142.0 million in 1999, 1998, and 1997, respectively. The assets of the
animal health business are intermixed with those of the pharmaceutical products
business and are not separately determinable.
Total assets on the consolidated balance sheet include amounts from the
discontinued operations of PCS for 1998 (see Note 3). Total assets from
continuing operations for both 1998 and 1997 were $10.6 billion. Long-lived
assets disclosed above consist of property and equipment and certain sundry
assets of the continuing operations.
The company is exposed to the risk of changes in social, political, and economic
conditions inherent in foreign operations, and the company's results of
operations and the value of its foreign assets are affected by fluctuations in
foreign currency exchange rates.
Page 16
Selected Quarterly Data (unaudited)
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions, except per-share data)
1999 Fourth Third Second First
- -----------------------------------------------------------------------------------------------------------------------
Net sales.................................... $2,820.5 $2,585.2 $2,341.6 $2,255.6
Cost of sales................................ 565.2 548.2 491.1 493.5
Operating expenses........................... 1,285.8 1,139.3 1,110.1 1,006.0
Asset impairment and other
site charges............................... 26.0 - - 61.4
Other (income) expense - net................. (80.2) (41.5) 1.4 151.2
Income from continuing operations
before income taxes........................ 1,023.7 939.2 739.0 543.5
Income from:
Continuing operations...................... 786.3 732.6 576.4 451.4
Discontinued operations.................... - - - 174.3
Net income................................. 786.3 732.6 576.4 625.7
Earnings per share - basic:
Continuing operations...................... .73 .68 .53 .41
Discontinued operations.................... - - - .16
Net income................................. .73 .68 .53 .57
Earnings per share - diluted:
Continuing operations...................... .71 .67 .52 .40
Discontinued operations.................... - - - .16
Net income................................. .71 .67 .52 .56
Dividends paid per share..................... .23 .23 .23 .23
Common stock prices:
High...................................... 77.38 77.19 90.25 97.44
Low....................................... 64.13 61.50 65.19 76.19
1998 Fourth Third Second First/1/
- -----------------------------------------------------------------------------------------------------------------------
Net sales.................................... $2,635.4 $2,359.4 $2,155.0 $2,087.0
Cost of sales................................ 583.5 495.7 478.6 457.3
Operating expenses........................... 1,329.2 1,107.5 1,054.1 906.4
Acquired in-process technology............... - 127.5 - -
Other (income) expense - net................. 7.4 29.6 (25.0) 20.0
Income from continuing operations
before income taxes and
extraordinary item......................... 715.3 599.1 647.3 703.3
Income (loss) from:
Continuing operations and
before extraordinary item.................. 561.6 512.2 490.9 531.6
Discontinued operations.................... 5.7 6.0 0.4 (3.3)
Net income................................. 567.3 518.2 491.3 521.1
Earnings per share - basic:
Continuing operations before
extraordinary item......................... .51 .47 .45 .48
Discontinued operations.................... .01 - - -
Net income................................. .52 .47 .45 .47
Earnings per share - diluted:
Page 17
Continuing operations before
extraordinary item........................... .50 .46 .44 .47
Discontinued operations...................... .01 - - -
Net income................................... .51 .46 .44 .46
Dividends paid per share....................... .20 .20 .20 .20
Common stock prices:
High........................................ 91.31 81.63 73.75 72.38
Low......................................... 68.00 62.56 57.88 57.69
/1/Reflects the impact of an extraordinary item (see Note 6).
The company's common stock is listed on the New York, London, Tokyo, and other
stock exchanges.
Page 18
Selected Financial Data (unaudited)
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions, except per-share data)
1999 1998 1997 1996 1995
-----------------------------------------------------------------------------------------
Operations
Net sales......................... $ 10,002.9 $ 9,236.8 $ 7,987.7 $ 6,998.3 $ 6,508.8
Research and development.......... 1,783.6 1,738.9 1,370.2 1,189.5 1,042.3
Other costs and expenses.......... 4,973.9 4,832.9 4,348.2 3,677.5 3,599.9
Gain on sale of DowElanco......... - - (631.8) - -
Income from continuing
operations before taxes
and extraordinary item........... 3,245.4 2,665.0 2,901.1 2,131.3 1,866.6
Income taxes...................... 698.7 568.7 885.2 505.6 457.6
Income (loss)from:
Continuing operations
before extraordinary
item............................ 2,546.7 2,096.3 2,015.9 1,625.7 1,409.0
Discontinued operations.......... 174.3 8.8 (2,401.0) (102.2) 881.9
Net income (loss)................ 2,721.0 2,097.9/2/ (385.1) 1,523.5 2,290.9
Income from continuing
operations before
extraordinary item as a
percent of sales................. 25.5% 22.7% 25.2% 23.2% 21.6%
Per-share data - diluted:
Income (loss) from:
Continuing operations
before extraordinary
item........................... $ 2.30 $ 1.87 $ 1.78 $ 1.45 $ 1.22
Discontinued operations......... .16 .01 (2.12) (.09) .77
Net income (loss)............... 2.46 1.87/2/ (.34) 1.36 1.99
Dividends declared per share...... .95 .83 .76 .694 .665
Weighted-average number of
shares outstanding -
diluted (thousands).............. 1,106,055 1,121,486 1,130,579 1,117,110 1,152,016
=========================================================================================
Financial Position
Current assets.................... $ 7,055.5 $ 5,406.8 $ 5,320.7 $ 3,891.3 $ 4,138.6
Current liabilities............... 3,935.4 4,607.2 4,191.6 4,222.2 4,967.0
Property and equipment - net...... 3,981.5 4,096.3 4,101.7 4,307.0 4,239.3
Total assets...................... 12,825.2 12,595.5 12,577.4 14,307.2 14,412.5
Long-term debt.................... 2,811.9 2,185.5 2,326.1 2,516.5 2,592.9
Shareholders' equity.............. 5,013.0 4,429.6 4,645.6 6,100.1 5,432.6
=========================================================================================
Supplementary Data/1/
Return on shareholders'
equity........................... 53.9% 46.2% 37.5% 28.2% 26.1%
Return on assets.................. 21.3% 17.0% 15.4% 11.4% 9.6%
Capital expenditures.............. $ 528.3 $ 419.9 $ 366.3 $ 443.9 $ 551.3
Depreciation and
amortization..................... 439.7 490.4 509.8 543.5 553.7
Effective tax rate................ 21.5% 21.3% 30.5%/3/ 23.7% 24.5%
Number of employees............... 31,300 29,800 28,900 27,400 26,800
Number of shareholders of
record........................... 62,300 62,300 58,200 54,500 52,600
=========================================================================================
Page 19
/1/ All supplementary financial data have been computed using income from
continuing operations except for capital expenditures and depreciation and
amortization, which include amounts from discontinued operations. The number of
employees reflects continuing operations, including controlled joint ventures.
/2/ Reflects the impact of an extraordinary item (see Note 6).
/3/ Excluding the impacts of the unusual transactions reflected in 1997, the
effective tax rate would have been 24.1 percent.
Page 20
Notes to Consolidated Financial Statements
ELI LILLY AND COMPANY AND SUBSIDIARIES
(Dollars in millions, except per-share data)
Note 1: Summary of Significant Accounting Policies
Basis of presentation: The accounts of all wholly owned and majority-owned
subsidiaries are included in the consolidated financial statements. All
intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues, expenses, and
related disclosures at the date of the financial statements and during the
reporting period. Actual results could differ from those estimates.
All per-share amounts, unless otherwise noted in the footnotes, are presented on
a diluted basis, that is, based on the weighted-average number of outstanding
common shares and the effect of all potentially dilutive common shares
(primarily unexercised stock options).
Cash equivalents: The company considers all highly liquid investments, generally
with a maturity of three months or less, to be cash equivalents. The cost of
these investments approximates fair value.
Inventories: The company states all its inventories at the lower of cost or
market. The company uses the last-in, first-out (LIFO) method for substantially
all its inventories located in the continental United States, or approximately
50 percent of its total inventories. Other inventories are valued by the first-
in, first-out (FIFO) method. Inventories at December 31 consisted of the
following:
1999 1998
--------------------------------------------------
Finished products.............................. $295.1 $325.1
Work in process................................ 372.7 435.8
Raw materials and supplies..................... 224.7 236.3
--------------------------------------------------
892.5 997.2
Increase to LIFO cost.......................... 7.1 2.7
--------------------------------------------------
$899.6 $999.9
==================================================
Investments: All short-term debt securities are classified as held-to-maturity
because the company has the positive intent and ability to hold the securities
to maturity. Held-to-maturity securities are stated at amortized cost, adjusted
for amortization of premiums and accretion of discounts to maturity.
Substantially all long-term debt and marketable equity securities are classified
as available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, net of tax, reported in other
comprehensive income. The company owns no investments that are considered to be
trading securities.
Derivative financial instruments: The company's derivative activities, all of
which are for purposes other than trading, are initiated within the guidelines
of documented corporate risk-management policies and do not create additional
risk because gains and losses on derivative contracts offset losses and gains on
the assets, liabilities, and transactions being hedged. As derivative contracts
are initiated, the company designates the instruments individually as hedges of
underlying financial instruments or anticipated transactions (i.e., underlying
exposures). Management reviews the correlation and effectiveness of its
derivatives on a periodic basis. Derivative contracts that do not qualify for
deferral hedge accounting are marked to market.
Page 21
For terminations of derivatives receiving deferral accounting, gains and losses
are deferred when the related underlying exposures remain outstanding and are
included in the measurement of the related transaction or balance. In addition,
upon termination of the underlying exposures, the derivative is marked to market
and the resulting gain or loss is included with the gain or loss on the related
transaction. The company may redesignate the remaining derivative instruments
as hedges of other underlying exposures.
The company enters into foreign currency forward and option contracts to reduce
the effect of fluctuating currency exchange rates (principally the Japanese yen
and the euro). Generally, foreign currency derivatives used for hedging are put
in place using the same or like currencies and duration as the underlying
exposures. Forward contracts are principally used to manage exposures arising
from affiliate foreign currency balances. These contracts are marked to market
with gains and losses recognized currently in income to offset the respective
losses and gains recognized on the underlying exposures. The company also
enters into purchased option contracts to hedge anticipated foreign currency
transactions, primarily intercompany inventory activities expected to occur
within the next year, and foreign currency forward contracts and currency swaps
to hedge firm commitments. The contracts are designated and effective as hedges
of those future transactions. Gains and losses on these contracts that qualify
as hedges are deferred and recognized as an adjustment of the subsequent
transaction when it occurs. Forward and option contracts generally have
maturities not exceeding 12 months.
The company also enters into interest rate swaps to manage interest rate
exposures. The company designates the interest rate swaps as hedges of the
underlying debt. Interest expense on the debt is adjusted to include the
payments made or received under the swap agreements.
Goodwill and other intangibles: Goodwill and other intangibles arising from
acquisitions and research alliances are amortized over their estimated useful
lives, ranging from 5-25 years, using the straight-line method. Goodwill and
other intangibles are reviewed to assess recoverability when impairment
indicators are present. Assets are considered to be impaired and are written
down to fair value if expected future operating cash flows of the related assets
are less than their carrying amounts. Fair value is the present value of the
expected future cash flows of the related assets using a discount rate
commensurate with the risk involved. Assets are grouped at the lowest level for
which there are identifiable cash flows for purposes of impairment testing.
Property and equipment: Property and equipment is stated on the basis of cost.
Provisions for depreciation of buildings and equipment are computed generally by
the straight-line method at rates based on their estimated useful lives
(generally 12 to 50 years for buildings and 5 to 18 years for equipment). At
December 31, property and equipment consisted of the following:
1999 1998
----------------------------------------------
Land.............................................. $ 104.6 $ 141.1
Buildings......................................... 2,255.8 2,178.5
Equipment......................................... 4,458.9 4,556.6
Construction in progress.......................... 528.0 398.3
----------------------------------------------
7,347.3 7,274.5
Less allowances for depreciation.................. 3,365.8 3,178.2
----------------------------------------------
$3,981.5 $4,096.3
==============================================
Depreciation expense related to continuing operations for 1999, 1998, and 1997
was $406.7 million, $393.4 million, and $382.3 million, respectively.
Approximately $29.0 million, $17.0 million, and $20.4 million of interest costs
were capitalized as part of property and equipment in 1999, 1998, and 1997,
respectively. Total rental expense for all leases related to continuing
operations, including contingent rentals (not material), amounted to
approximately $154.9
Page 22
million for 1999, $134.8 million for 1998, and $111.8 million for 1997. Capital
leases included in property and equipment in the consolidated balance sheets and
future minimum rental commitments are not material. However, the company entered
into capital lease obligations aggregating $10.2 million in 1999 and $13.3
million in 1998.
Revenue recognition: Revenue from sales of products is recognized at the time
products are shipped to the customer. Revenue from copromotion services is
recognized at the time the co-promotion partner records sales.
Income taxes: Deferred taxes are recognized for the future tax effects of
temporary differences between financial and income tax reporting based on
enacted tax laws and rates. Federal income taxes are provided on the portion of
the income of foreign subsidiaries that is expected to be remitted to the United
States and be taxable.
Earnings (loss) per share: Basic earnings (loss) per share are calculated based
on the weighted-average number of outstanding common shares and incremental
shares. Diluted earnings (loss) per share are calculated based on the weighted-
average number of outstanding common shares plus the effect of dilutive stock
options and other incremental shares.
Note 2: Implementation of New Financial Accounting Pronouncements
In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities," was issued.
Statement 133 was amended in June 1999 and is now required to be adopted in
years beginning after June 15, 2000. The statement permits early adoption as of
the beginning of any fiscal quarter after its issuance. The company will adopt
Statement 133 on January 1, 2001. The statement will require the company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. Hedge
ineffectiveness, the amount by which the change in the value of a hedge does not
exactly offset the change in the value of the hedged item, will be immediately
recognized in earnings. The company has determined that adopting Statement 133
and applying it to the company's interest rate derivatives will not have a
material effect on the earnings and financial position of the company based on
the interest rate derivatives owned by the company at December 31, 1999. The
effect of applying Statement 133 to the company's foreign currency derivative
instruments cannot be determined at this time as the company's foreign currency
derivative instruments have durations of less than a year.
Note 3: Discontinued Operations and Asset Impairment and Other Site Charges
The company recognized two separate asset impairments and other site charges
totaling $87.4 million in 1999 ($61.4 million and $26.0 million in the first and
fourth quarters, respectively). The impairment charges were necessary to adjust
the carrying value of certain manufacturing assets to fair value. The major
portion of the charges ($75.0 million) related to the decommissioning of
manufacturing buildings and the related equipment, which resulted from the
consolidation of certain manufacturing processes. The company plans to continue
ownership of the vacated buildings although no planned future uses have been
identified. The fair values of the facilities were estimated based upon
anticipated future cash flows, discounted at a rate commensurate with the risk
involved.
In November 1998, the company signed a definitive agreement for Rite Aid
Corporation to acquire PCS, the company's health-care-management subsidiary for
$1.6 billion in cash. The transaction closed on January 22, 1999, and generated
a gain of $174.3 million ($.16 per share) net of $8.7 million tax benefit, in
the first quarter of 1999.
Page 23
The results of operations of PCS have been classified as discontinued operations
in the consolidated statements of income. Selected income statement information
for PCS follows:
1998 1997
-------------------------------
Revenues................................................... $814.5 $ 529.9
Income tax expense......................................... 32.2 10.1
Income (loss) from discontinued
operations............................................... 8.8 (2,401.0)
In the second quarter of 1997, concurrent with PCS's annual planning process,
the company determined that PCS's estimated future undiscounted cash flows were
below the carrying value of PCS's long-lived assets. Accordingly, during the
second quarter of 1997, the company adjusted the carrying value of PCS's long-
lived assets, primarily goodwill, to their estimated fair value of approximately
$1.5 billion, resulting in a noncash impairment loss of approximately $2.3
billion ($2.07 per share), which is included in discontinued operations. The
estimated fair value was based on anticipated future cash flows, discounted at a
rate commensurate with the risk involved.
The consolidated balance sheet and consolidated statements of cash flows include
PCS for periods prior to its sale. Selected balances, excluding intercompany
amounts, as of December 31, 1998, were as follows:
Current assets............................................. $ 528.7
Goodwill................................................... 1,397.4
Total assets............................................... 2,026.5
Current liabilities........................................ 886.3
An asset impairment charge related to continuing operations was also identified
in the second quarter of 1997, concurrent with the annual planning process. The
primary component of the $97.8 million noncash asset impairment charge was an
adjustment to the carrying value of certain long-lived assets, which were
subsequently disposed of by the company. Similar to the impairment of PCS's
long-lived assets discussed above, the company determined that the estimated
future undiscounted cash flows were below the carrying value of the related
long-lived assets. Accordingly, the carrying value was adjusted to estimated
fair value based on anticipated future cash flows, discounted at a rate
commensurate with the risk involved.
Note 4: Collaboration and Dispositions
During 1999, the company recognized a pretax gain of $67.8 million on the sale
of the U.S. and Puerto Rican marketing rights of Lorabid, an antibiotic used in
the treatment of bacterial infections, to King Pharmaceuticals, Inc. The gain
has been included in other income in the consolidated statements of income. The
company will manufacture Lorabid for King and has an opportunity to receive
additional payments if certain sales performance milestones are achieved.
In December 1999, the company signed an agreement to sell its interest in
Kinetra LLC. The sale closed in January 2000 and will generate a gain in the
first quarter of 2000.
During 1998, the company announced a collaboration with ICOS Corporation to
jointly develop and globally commercialize a phosphodiesterase type 5 (PDE5)
inhibitor as an oral therapeutic agent for the treatment of male erectile
dysfunction and female sexual dysfunction. The compound was in the development
phase (Phase II clinical trials) and no alternative future uses were identified.
As with many Phase II compounds, launch of the product, if successful, was not
expected in the near term. The company's payments to acquire rights to this
compound were required to be charged as an expense of $127.5 million.
Page 24
On June 30, 1997, The Dow Chemical Company acquired the company's 40 percent
interest in the DowElanco joint venture. The cash purchase price was $1.2
billion, resulting in a gain of $631.8 million ($303.5 million aftertax).
Note 5: Financial Instruments
Risk-Management Instruments and Off-Balance-Sheet Risk
In the normal course of business, operations of the company are exposed to
fluctuations in currency values and interest rates. These fluctuations can vary
the costs of financing, investing, and operating. The company addresses a
portion of these risks through a controlled program of risk management that
includes the use of derivative financial instruments.
The notional amounts of derivatives summarized in the following paragraphs do
not represent amounts exchanged by the parties and thus are not a measure of the
exposure of the company through its use of derivatives. The company is exposed
to credit-related losses in the event of nonperformance by counterparties to
financial instruments, but it does not expect any counterparties to fail to meet
their obligations given their high credit ratings.
At December 31, the stated, or notional, amounts of the company's outstanding
derivative financial instruments were as follows:
1999 1998
------------------------------------
Forward exchange contracts....................................... $608.7 $448.3
Foreign currency options - purchased............................. 756.0 606.0
Interest rate swaps.............................................. 295.0 -
Financial instruments that potentially subject the company to credit risk
consist principally of trade receivables and interest-bearing investments.
Wholesale distributors of life-sciences products and managed care organizations
account for a substantial portion of trade receivables; collateral is generally
not required. The risk associated with this concentration is mitigated by the
company's ongoing credit review procedures. The company places substantially
all its interest-bearing investments with major financial institutions, in U.S.
government securities, or with top-rated corporate issuers. In accordance with
documented corporate policies, the company limits the amount of credit exposure
to any one financial institution.
Page 25
Fair Value of Financial Instruments
A summary of the company's outstanding financial instruments at December 31
follows. As summarized, "cost" relates to investments while "carrying amount"
relates to long-term debt.
1999 1998
----------------------------------------------------------------
Cost/ Cost/
Carrying Carrying
Amount Fair Value Amount Fair Value
----------------------------------------------------------------
Short-term investments:
Debt securities........................ $ 135.6 $ 136.0 $ 101.4 $ 102.7
Noncurrent investments:
Marketable equity...................... 63.9 96.8 66.5 70.4
Debt securities........................ 35.6 35.6 38.6 38.6
Nonmarketable equity................... 14.9 14.9 26.1 26.1
Long-term debt, including
current portion......................... 3,026.7 2,990.6 2,337.7 2,629.7
The company determines fair values based on quoted market values where available
or discounted cash flow analyses (principally long-term debt). The fair values
of nonmarketable equity securities, which represent either equity investments in
start-up technology companies or partnerships that invest in start-up technology
companies, are estimated based on the fair value information provided by these
ventures. The fair value and carrying amount of risk-management instruments
were not material at December 31, 1999 and 1998.
At December 31, 1999 and 1998, the gross unrealized holding gains on available-
for-sale securities were $42.5 million and $22.7 million, respectively, and the
gross unrealized holding losses were $12.6 million and $20.6 million,
respectively. Substantially all these gains and losses are associated with the
marketable equity securities. The proceeds from sales of available-for-sale
securities totaled $56.2 million, $36.3 million, and $39.7 million in 1999,
1998, and 1997, respectively. Realized gains on sales of available-for-sale
securities were $25.0 million, $20.6 million, and $6.6 million in 1999, 1998,
and 1997, respectively. Realized losses on sales of available-for-sale
securities were negligible, $2.5 million, and $25.3 million in 1999, 1998, and
1997, respectively. The net adjustment to unrealized gains and losses on
available-for-sale securities increased other comprehensive income by $18.6
million in 1999 and decreased other comprehensive income by $1.7 million in
1998.
Page 26
Note 6: Borrowings
Long-term debt at December 31 consisted of the following:
1999 1998
----------------------------------
6.57 to 7.13 percent notes (due 2016-2036)...................... $1,000.0 $1,000.0
6.25 to 8.38 percent notes (due 2001-2006)...................... 650.0 750.0
Floating rate capital securities (due 2029)..................... 525.0 -
8.13 to 8.38 percent eurodollar bonds
(due 2000-2005).............................................. 350.0 350.0
Resettable coupon capital securities (due 2029)................. 300.0 -
7.10 percent medium-term notes.................................. - 36.5
6.55 percent ESOP debentures (due 2017)......................... 98.6 99.6
Other, including capitalized leases............................. 103.1 101.6
----------------------------------
3,026.7 2,337.7
Less current portion............................................ 214.8 152.2
----------------------------------
$2,811.9 $2,185.5
==================================
On August 5, 1999, the company issued $525.0 million floating rate capital
securities and $300.0 million adjustable rate capital securities. These capital
securities are subordinated to the notes, bonds, and debentures, listed above.
The floating rate capital securities pay cumulative interest at an annual rate
equal to LIBOR plus a predetermined spread, reset quarterly. The rate at
December 31, 1999, is 7.355 percent. The securities may be redeemed any time on
or after August 5, 2004, for a defined redemption price. The resettable coupon
capital securities pay cumulative interest at an annual rate of 7.717 percent
until August 1, 2004. At this date and every fifth anniversary thereafter, the
interest rate will be reset equal to the weekly average interest rate of U.S.
treasury securities having an index maturity of five years for the week
immediately preceding the reset date plus a predetermined spread. The
securities may be redeemed on August 1, 2004, and anytime thereafter for a
defined redemption price.
The 6.55 percent Employee Stock Ownership Plan (ESOP) debentures are obligations
of the ESOP but are shown on the consolidated balance sheet because they are
guaranteed by the company. The principal and interest on the debt are funded by
contributions from the company and by dividends received on certain shares held
by the ESOP. Because of the amortizing feature of the ESOP debt, bondholders
will receive both interest and principal payments each quarter. These
debentures replaced other ESOP debentures pursuant to a refinancing in March
1998. An extraordinary charge of $7.2 million, net of a $4.8 million income tax
benefit, was recorded as a result of this refinancing.
The aggregate amounts of maturities on long-term debt for the next five years
are as follows: 2000, $214.8 million; 2001, $166.1 million; 2002, $13.9 million;
2003, $211.8 million; and 2004, $9.6 million.
At December 31, 1999 and 1998, short-term borrowings included $26.7 million and
$29.2 million, respectively, of notes payable to banks. At December 31, 1999,
unused committed lines of credit totaled approximately $2.05 billion.
Compensating balances and commitment fees are not material, and there are no
conditions that are probable of occurring under which the lines may be
withdrawn.
Cash payments of interest on borrowings totaled $170.6 million, $188.2 million,
and $243.9 million in 1999, 1998, and 1997, respectively.
Page 27
Note 7: Stock Plans
Stock options are granted to employees at exercise prices equal to the fair
market value of the company's stock at the dates of grant. Generally, options
vest 100 percent three years from the grant date and have a term of 10 years.
Performance awards are granted to officers and key employees and are payable in
shares of the company's common stock. The number of performance award shares
actually issued varies depending upon the achievement of certain earnings
targets. In general, performance awards vest 100 percent at the end of the
second fiscal year following the grant date.
In July 1999, the company issued its third grant under the GlobalShares program.
Essentially all employees were given an option to buy 100 shares of the
company's stock at a price equal to the fair market value of the company's stock
on the date of the grant. Options to purchase approximately 2.8 million shares
were granted as part of the program. Individual grants generally become
exercisable on or after the third anniversary of the grant date and have a term
of 10 years.
The company has elected to follow Accounting Principles Board Opinion (APB) No.
25, "Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock options and performance awards. Under APB No. 25,
because the exercise price of the company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized. Total compensation expense for stock-based performance
awards reflected in income on a pretax basis was $117.1 million, $257.8 million,
and $242.1 million in 1999, 1998, and 1997, respectively. However, SFAS No.
123, "Accounting for Stock-Based Compensation," requires presentation of pro
forma information as if the company had accounted for its employee stock options
and performance awards granted subsequent to December 31, 1994, under the fair
value method of that statement. For purposes of pro forma disclosure, the
estimated fair value of the options and performance awards at the date of the
grant is amortized to expense over the vesting period. Under the fair value
method, the company's net income (loss) and earnings (loss) per share would have
been as follows:
1999 1998 1997
---------------------------------------------
Net income (loss).......................................... $2,639.6 $2,120.9 $(339.5)
Earnings (loss) per share - diluted........................ 2.39 1.89 (.30)
Because SFAS No. 123 is applicable only to options and performance awards
granted subsequent to December 31, 1994, and the options and performance awards
have three-year and two-year vesting periods, respectively, the pro forma
effect was not fully reflected until 1998.
The weighted-average per-share fair value of the individual options and
performance awards granted during 1999, 1998, and 1997 were as follows on the
date of grant:
1999 1998 1997
---------------------------------------------
Employee stock options..................................... $20.27 $16.64 $15.55
Performance awards......................................... 66.50 88.88 69.63
The fair values of the options were determined using a Black-Scholes option-
pricing model with the following assumptions:
1999 1998 1997
------------------------------------------------------------
Dividend yield............................. 2.73% 2.96% 3.14%
Volatility................................. 25.2% 23.5% 21.5%
Risk-free interest rate.................... 6.15% 4.29% 6.18%
Forfeiture rate............................ 0 0 0
Expected life.............................. 7 years 7 years 7 years
Stock option activity during 1997-1999 is summarized below:
Page 28
Shares of
Common Stock Weighted-Average
Attributable to Exercise
Options Price of Options
---------------------------------------------------
Unexercised at January 1, 1997................ 65,909,876 $18.86
Granted....................................... 5,854,408 64.73
Exercised..................................... (10,072,728) 13.88
Forfeited..................................... (797,912) 22.30
-------------------------
Unexercised at December 31, 1997.............. 60,893,644 24.05
Granted....................................... 6,803,350 74.18
Exercised..................................... (13,696,906) 16.88
Forfeited..................................... (1,047,023) 24.29
-------------------------
Unexercised at December 31, 1998.............. 52,953,065 32.35
Granted....................................... 12,493,848 68.22
Exercised..................................... (10,848,573) 19.04
Forfeited..................................... (875,253) 50.46
-------------------------
Unexercised at December 31, 1999.............. 53,723,087 43.08
=========================
The following table summarizes information concerning outstanding and
exercisable options at December 31, 1999 (shares in millions, contractual life
in years):
Options Outstanding Options Exercisable
------------------------------------------------------ --------------------------------
Weighted-
Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ---------------- ------------------------------------------------------ --------------------------------
$10 - $20 12.37 3.64 13.82 12.37 13.82
$20 - $65 22.33 6.32 36.10 17.14 27.69
$65 - $90 19.02 9.41 70.30 .42 74.21
Shares exercisable at December 31, 1999, were 29.9 million (1998 - 35.8 million
shares, 1997 - 29.6 million shares).
As noted above, the number of shares ultimately issued pursuant to the
performance award program is dependent upon the earnings achieved during the
vesting period. Pursuant to this plan, approximately 2.2 million shares, 1.5
million shares, and 1.1 million shares were issued in 1999, 1998, and 1997,
respectively. At December 31, 1999, plan participants had the right to receive
up to 5.2 million additional shares (reduced to the extent necessary to satisfy
payroll tax withholdings), contingent upon earnings achieved.
At December 31, 1999, additional options, performance awards, or restricted
stock grants may be granted under the 1998 Lilly Stock Plan for not more than
35.6 million shares.
Page 29
Note 8: Shareholders' Equity
Changes in certain components of shareholders' equity were as follows:
Additional Deferred Common Stock in
Paid-in Retained Costs - Treasury
Capital Earnings ESOP Shares Amount
-------------------------------------------------------------------------------
Balance at
January 1, 1997.............. $ 67.4 $ 7,197.0 $(176.9) 16,079,323 $ 1,295.9
Net loss....................... (385.1)
Cash dividends
declared per
share: $.76.................. (840.9)
Stock dividend
declared..................... (346.5)
Retirement of
treasury shares.............. (1,134.5) (14,223,272) (1,143.4)
Purchase for
treasury..................... 3,400,000 355.3
Issuance of stock
under employee stock
plans........................ (99.7) (4,247,216) (397.4)
ESOP transactions.............. 39.6 21.2
Other.......................... (0.3) 0.3 (8,835) (0.9)
Reclassification............... 1,127.5 (1,127.5)
-------------------------------------------------------------------------------
Balance at
December 31, 1997............ - 4,497.3 (155.7) 1,000,000 109.5
Net income..................... 2,097.9
Cash dividends
declared per share:
$.83......................... (908.9)
Retirement of treasury
shares....................... (2,035.2) (29,009,799) (2,053.3)
Purchase for treasury.......... 28,349,900 2,005.8
Issuance of stock under
employee stock plans......... 558.7 659,899 47.5
ESOP transactions.............. 23.6 8.8
Other.......................... 5.4 (10.0) (4,508) (0.5)
Reclassification............... 1,447.5 (1,447.5)
-------------------------------------------------------------------------------
Balance at
December 31, 1998............ - 4,228.8 (146.9) 995,492 109.0
Net income..................... 2,721.0
Cash dividends
declared per share:
$.95......................... (1,030.5)
Retirement of treasury
shares....................... (1,488.4) (19,688,522) (1,500.8)
Purchase for treasury.......... 19,147,000 1,455.1
Issuance of stock under
employee stock plans......... 530.6 541,522 45.7
ESOP transactions.............. 20.8 7.0
Other.......................... 3.3 (6,590) (0.7)
Reclassification............... 933.7 (933.7)
-------------------------------------------------------------------------------
Balance at
December 31, 1999............ $ - $ 4,985.6 $(139.9) 988,902 $ 108.3
===============================================================================
Page 30
As shown above, the company has completed its 1999 $1.5 billion and 1998 $2.0
billion share repurchase programs, acquiring approximately 19.1 million and 28.3
million shares in 1999 and 1998, respectively.
The company has an ESOP as a funding vehicle for the existing employee savings
plan. The ESOP used the proceeds of a loan from the company to purchase shares
of common stock from the treasury. The ESOP issued $200 million of third-party
debt, repayment of which was guaranteed by the company (see Note 6). The
proceeds were used to purchase shares of the company's common stock on the open
market. Shares of common stock held by the ESOP will be allocated to
participating employees annually through 2017 as part of the company's savings
plan contribution. The fair value of shares allocated each period is recognized
as compensation expense.
Under a Shareholder Rights Plan adopted by the company's board of directors in
1998, all shareholders receive along with each common share owned a preferred
stock purchase right entitling them to purchase from the company one one-
thousandth of a share of Series B Junior Participating Preferred Stock (the
"Preferred Stock") at a price of $325. The rights are not exercisable until
after the "Distribution Date," which is generally the 10th business day after
the date of a public announcement that a person (the "Acquiring Person") has
acquired ownership of 15 percent or more of the company's common stock. The
company may redeem the rights for $.005 per right up to and including the
Distribution Date. The rights will expire on July 28, 2008, unless redeemed
earlier by the company.
The plan provides that, if an Acquiring Person acquires 15 percent or more of
the outstanding common stock of the company and the company's redemption right
has expired, generally each holder of a right (other than the Acquiring Person)
will have the right to purchase at the exercise price the number of shares of
common stock of the company as have a value of two times the exercise price.
Alternatively, if, in a transaction not approved by the board of directors, the
company is acquired in a business combination transaction or sells 50 percent or
more of its assets or earning power after a Distribution Date, generally each
holder of a right (other than the Acquiring Person) will have the right to
purchase at the exercise price the number of shares of common stock of the
acquiring company as have a value of two times the exercise price.
At any time after an Acquiring Person has acquired 15 percent or more but less
than 50 percent of the company's outstanding common stock, the board of
directors may exchange the rights (other than those owned by the Acquiring
Person) for company common stock or Preferred Stock at an exchange ratio of one
common share (or one one-thousandth of a share of Preferred Stock) per right.
Page 31
Note 9: Earnings per Share
The following is a reconciliation of the numerators and denominators used in
computing earnings per share from continuing operations before extraordinary
item:
1999 1998 1997
----------------------------------------------------------
(Shares in thousands)
Income from continuing operations before
extraordinary item available to
common shareholders:
Income from continuing operations
before extraordinary item.......................... $ 2,546.7 $ 2,096.3 $ 2,015.9
Preferred stock dividends.......................... (.1) (1.7) (2.6)
----------------------------------------------------------
Income from continuing operations
before extraordinary item available
to common shareholders............................. $ 2,546.6 $ 2,094.6 $ 2,013.3
==========================================================
Basic earnings per share:
Weighted-average number of common
shares outstanding, including
incremental shares................................ 1,087,652 1,095,834 1,101,513
==========================================================
Basic earnings per share from
continuing operations before
extraordinary item................................ $ 2.34 $ 1.91 $ 1.83
==========================================================
Diluted earnings per share:
Weighted-average number of common
shares outstanding................................ 1,087,368 1,095,537 1,101,099
Stock options and other incremental
shares............................................ 18,687 25,949 29,480
----------------------------------------------------------
Weighted-average number of common
shares outstanding - diluted...................... 1,106,055 1,121,486 1,130,579
==========================================================
Diluted earnings per share from
continuing operations before
extraordinary item................................ $ 2.30 $ 1.87 $ 1.78
==========================================================
Page 32
Note 10: Income Taxes
Following is the composition of income taxes attributable to continuing
operations before extraordinary item:
1999 1998 1997
------------------------------------------------------
Current:
Federal......................................... $ 439.2 $ 322.1 $ 766.1
Foreign......................................... 260.4 238.9 392.3
State........................................... (4.9) (8.9) 51.5
------------------------------------------------------
694.7 552.1 1,209.9
Deferred:
Federal......................................... 104.0 36.3 (284.5)
Foreign......................................... 22.4 9.4 9.6
State........................................... 2.7 9.6 (49.8)
------------------------------------------------------
129.1 55.3 (324.7)
Utilization of capital loss carryforwards.......... (125.1) (38.7) 0.0
------------------------------------------------------
Income taxes....................................... $ 698.7 $ 568.7 $ 885.2
======================================================
Significant components of the company's deferred tax assets and liabilities as
of December 31 are as follows:
1999 1998
-----------------------------------------------
Deferred tax assets:
Capital loss carryforward.............................. $ 561.7 $ 703.7
Tax credit carryforwards and
carrybacks........................................... 496.0 589.9
Other carryforwards.................................... 243.9 223.2
Compensation and benefits.............................. 188.8 183.1
Inventory.............................................. 172.9 251.0
Other.................................................. 376.9 322.7
-----------------------------------------------
2,040.2 2,273.6
Valuation allowances................................... (703.4) (810.0)
-----------------------------------------------
Total deferred tax assets........................... 1,336.8 1,463.6
Deferred tax liabilities:
Property and equipment................................. (527.2) (540.4)
Unremitted earnings.................................... (381.9) (512.8)
Prepaid employee benefits.............................. (257.4) (238.3)
Other.................................................. (65.1) (54.7)
-----------------------------------------------
Total deferred tax liabilities...................... (1,231.6) (1,346.2)
-----------------------------------------------
Deferred tax assets - net................................. $ 105.2 $ 117.4
===============================================
At December 31, 1999, the company had operating and capital loss carryforwards
for income tax purposes of $1,608.2 million: $1,513.1 million will expire within
five years and $74.5 million thereafter; $20.6 million of the carryforwards will
never expire. The company also has tax credit carryforwards of $496.0 million
available to reduce future income taxes: $303.6 million will expire within five
years and $116.8 million thereafter; $75.6 million of the tax credit
carryforwards will never expire.
Page 33
As discussed in Note 3, the company sold its PCS health-care-management
subsidiary in January 1999. As a consequence of the sale, the company recorded
a deferred tax asset of $655.3 million for the tax capital loss that resulted
from this transaction. This loss can be carried forward five years. A
valuation allowance was established for this asset due to the uncertain
realization of the benefit.
Domestic and Puerto Rican companies contributed approximately 56 percent, 60
percent, and 73 percent in 1999, 1998, and 1997, respectively, to consolidated
income from continuing operations before income taxes and extraordinary item.
Unremitted earnings of foreign subsidiaries that have been, or are intended to
be, permanently reinvested for continued use in foreign operations and that, if
distributed, would result in taxes at approximately the U.S. statutory rate
aggregated $2.61 billion at December 31, 1999 ($1.01 billion at December 31,
1998). Cash payments of income taxes totaled $252 million, $273 million, and
$542 million in 1999, 1998, and 1997, respectively.
Following is a reconciliation of the effective income tax rate applicable to
income from continuing operations:
1999 1998 1997
--------------------------------------------------
United States federal statutory tax..................... 35.0% 35.0% 35.0%
Add (deduct):
International operations, including
Puerto Rico.......................................... (7.5) (10.5) (1.3)
General business credits............................... (1.6) (2.4) (2.2)
Valuation allowance reversal........................... (3.9) (1.5) -
Sale of investments.................................... - - (1.7)
Sundry................................................. (0.5) 0.7 0.7
--------------------------------------------------
Effective income tax.................................... 21.5% 21.3% 30.5%
==================================================
Excluding the impact of the gain on the sale of DowElanco and asset impairment,
the effective income tax rate applicable to continuing operations for 1997 would
have been 24.1 percent.
Note 11: Retirement Benefits
The change in benefit obligation, change in plan assets, funded status, and
amounts recognized in the consolidated balance sheets at December 31 for the
company's defined benefit pension and retiree health benefit plans were as
follows:
Defined Benefit
Pension Plans Retiree Health Benefits
1999 1998 1999 1998
-------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation at
beginning of year........................ $2,898.8 $2,550.9 $ 621.5 $ 477.5
Service cost.............................. 127.7 115.5 16.8 13.3
Interest cost............................. 193.7 185.8 41.5 34.5
Actuarial loss............................ 16.5 229.8 60.5 139.2
Benefits paid............................. (175.0) (170.3) (48.5) (43.3)
Foreign currency exchange rate
changes and other adjustments........... (57.3) (12.9) (4.2) 0.3
-------------------------------------------------------------------
Benefit obligation at end of
year..................................... 3,004.4 2,898.8 687.6 621.5
Change in plan assets:
Fair value of plan assets at
Page 34
beginning of year........................ 3,069.6 2,923.2 252.5 228.1
Actual return on plan assets.............. 543.6 286.4 80.4 33.8
Employer contribution..................... 122.1 28.1 47.7 33.9
Benefits paid............................. (175.0) (170.3) (48.5) (43.3)
Foreign currency exchange rate
changes and other adjustments............ (28.3) 2.2 - -
-------------------------------------------------------------------
Fair value of plan assets at
end of year.............................. 3,532.0 3,069.6 332.1 252.5
-------------------------------------------------------------------
Funded status............................. 527.6 170.8 (355.5) (369.0)
Unrecognized net actuarial (gain) loss.... (36.0) 202.7 240.9 254.9
Unrecognized prior service cost
(benefit)................................ 119.3 130.5 (1.1) (0.6)
Unrecognized net obligation at
January 1, 1986.......................... 2.0 2.6 - -
-------------------------------------------------------------------
Net amount recognized..................... $ 612.9 $ 506.6 $(115.7) $(114.7)
===================================================================
Amounts recognized in the
consolidated balance sheet
consisted of:
Prepaid benefit cost.................... $ 741.1 $ 612.3 $ - $ -
Accrued benefit liability............... (237.6) (192.3) (115.7) (114.7)
Intangible asset........................ 34.0 37.9 - -
Accumulated other
comprehensive income before
income taxes......................... 75.4 48.7 - -
-------------------------------------------------------------------
Net amount recognized................... $ 612.9 $ 506.6 $(115.7) $(114.7)
===================================================================
Defined Benefit Retiree Health
Pension Plans Benefits
1999 1998 1999 1998
----------------------------------------------------------------
(Percents)
Weighted-average assumptions
as of December 31:
Discount rate............................. 7.4 6.9 7.5 7.0
Expected return on plan assets............ 10.5 10.5 10.5 10.5
Rate of compensation increase............. 3.5-8.0 4.0-8.0 - -
Health-care-cost trend rates were assumed to increase at an annual rate of 7
percent in 2000 for participants under age 65, decreasing one-half percent per
year to 6.0 percent in 2002 and thereafter. For participants over age 65, the
rate was assumed to increase 6.0 percent in 2000 and thereafter. The discount
rate increase at December 31, 1999, decreased the projected benefit obligation
for the defined benefit plans and the retiree health benefits plans by
approximately $171.8 million and $35.3 million, respectively.
The projected benefit obligation, accumulated benefit obligation, and fair value
of the plan assets for the defined benefit pension plans with projected benefit
obligations in excess of plan assets were $637.1 million, $539.0 million, and
$364.5 million, respectively, as of December 31, 1999, and $586.6 million,
$502.3 million, and $349.7 million, respectively, as of December 31, 1998.
Net pension and retiree health benefit expense included the following components
related to continuing operations:
Page 35
Defined Benefit Retiree Health
Pension Plans Benefits
1999 1998 1997 1999 1998 1997
--------------------------------------------------------------------------------------
Components of net periodic
benefit cost:
Service cost........................ $ 127.7 $ 112.9 $ 86.3 $ 16.8 $ 12.8 $ 10.9
Interest cost....................... 193.7 184.2 178.0 41.5 34.3 31.5
Expected return on plan
assets............................ (295.1) (277.1) (252.2) (24.2) (23.0) (21.1)
Amortization of prior
service cost (benefit)............ 11.5 9.7 9.2 - (3.3) (7.9)
Recognized actuarial
loss.............................. 3.7 3.4 0.3 17.6 7.3 4.0
--------------------------------------------------------------------------------------
Net periodic benefit
cost.............................. $ 41.5 $ 33.1 $ 21.6 $ 51.7 $ 28.1 $ 17.4
======================================================================================
The assumed health-care-cost trend rates have a significant effect on the
amounts reported. If these trend rates were to be increased by one percentage
point each future year, the December 31, 1999, accumulated postretirement
benefit obligation would increase by 11 percent and the aggregate of the service
cost and interest cost components of 1999 annual expense would increase by 32
percent. A one-percentage-point decrease in these rates would decrease the
December 31, 1999, accumulated postretirement benefit obligation by 10 percent
and the aggregate of the 1999 service cost and interest cost by 1 percent.
The company has defined contribution savings plans that cover its eligible
employees worldwide. The purpose of these defined contribution plans is
generally to provide additional financial security during retirement by
providing employees with an incentive to make regular savings. Company
contributions to the plan are based on employee contributions and the level of
company match. Expenses under the plans related to continuing operations
totaled $56.4 million, $50.3 million, and $43.5 million for the years 1999,
1998, and 1997, respectively.
The company provides certain other postemployment benefits primarily related to
disability benefits and accrues for the related cost over the service lives of
the employees. Expenses associated with these benefit plans in 1999, 1998, and
1997 were not significant.
Note 12: Contingencies
Barr Laboratories, Inc. (Barr), and Geneva Pharmaceuticals, Inc. (Geneva), have
each submitted an Abbreviated New Drug Application (ANDA) seeking FDA approval
to market generic forms of Prozac before the expiration of the company's
patents. The ANDAs assert that two U.S. patents held by Lilly covering Prozac
are invalid and unenforceable. The company filed suit against Barr and Geneva
in federal court in Indianapolis seeking a ruling that Barr's challenge to
Lilly's patents is without merit. On January 12, 1999, the trial court granted
summary judgment in favor of Lilly on two of the four claims raised by Barr and
Geneva against Lilly's patents. That decision has been appealed. On January 25,
1999, Barr and Geneva dismissed their other two claims in exchange for a $4
million payment, which Barr and Geneva will share with a third defendant. In
late 1998, three additional generic pharmaceutical companies, Zenith Goldline
Pharmaceuticals, Inc.; Teva Pharmaceuticals USA; and Cheminor Drugs, Ltd.,
together with one of its subsidiaries, filed ANDAs for generic forms of Prozac,
asserting that the later of the two patents (expiring in December 2003) is
invalid and unenforceable. In early 1999, Novex Pharma, a division of Apotex,
Inc., changed its previously-filed ANDA to assert that both the 2001 and 2003
patents are invalid and unenforceable. Lilly has filed suits against the four
companies in federal court in Indianapolis. In November 1999, Lilly filed a
lawsuit against Cheminor Drugs and Schein Pharmaceuticals, Inc., based on their
ANDA filing for an additional dosage form. A trial date of October 30, 2000, has
now been set for these cases. While the company believes that the claims of the
seven generic companies are without merit, there can be no assurance that the
company will prevail. An
Page 36
unfavorable outcome of this litigation could have a material adverse effect on
the company's consolidated financial position, liquidity, and results of
operations.
The company has been named as a defendant in numerous product liability lawsuits
involving primarily two products, diethylstilbestrol (DES) and Prozac. The
company has accrued for its estimated exposure with respect to all current
product liability claims. In addition, the company has accrued for claims
incurred, but not filed, to the extent the company can formulate a reasonable
estimate of their costs. The company's estimates of these expenses are based
primarily on historical claims experience and data regarding product usage. The
company expects the cash amounts related to the accruals to be paid out over the
next several years. The majority of costs associated with defending and
disposing of these suits are covered by insurance. The company's estimate of
insurance recoverables is based on existing deductibles, coverage limits, and
the existing and projected future level of insolvencies among its insurance
carriers.
Under the Comprehensive Environmental Response, Compensation, and Liability Act,
commonly known as Superfund, the company has been designated as one of several
potentially responsible parties with respect to less than 10 sites. Under
Superfund, each responsible party may be jointly and severally liable for the
entire amount of the cleanup. The company also continues remediation of certain
of its own sites. The company has accrued for estimated Superfund cleanup
costs, remediation, and certain other environmental matters, taking into
account, as applicable, available information regarding site conditions,
potential cleanup methods, estimated costs, and the extent to which other
parties can be expected to contribute to payment of those costs. The company
has reached a settlement with its primary liability insurance carrier providing
for coverage for certain environmental liabilities and has instituted litigation
seeking coverage from certain excess carriers.
The environmental liabilities and litigation accruals have been reflected in the
company's consolidated condensed balance sheet at the gross amount of
approximately $245.7 million at December 31, 1999. Estimated insurance
recoverables of approximately $142.9 million at December 31, 1999, have been
reflected as assets in the consolidated balance sheet.
The company recognized a pretax gain of $110.0 million as a result of a cash
payment received in settlement of litigation with Biochimica Opos S.p.A.
relating to the manufacture, sale, or distribution of cefaclor and certain other
products made by Biochimica Opos S.p.A. The gain, which was recorded in other
income, increased earnings per share by approximately $.06 in the fourth quarter
of 1999.
While it is not possible to predict or determine the outcome of the patent,
product liability, antitrust, or other legal actions brought against the company
or the ultimate cost of environmental matters, the company believes that, except
as noted above, the costs associated with all such matters will not have a
material adverse effect on its consolidated financial position or liquidity but
could possibly be material to the consolidated results of operations in any one
accounting period.
Page 37
Note 13: Other Comprehensive Income
The accumulated balances related to each component of other comprehensive income
were as follows:
Minimum Pension Accumulated Other
Foreign Currency Unrealized Gains Liability Comprehensive
Translation (Losses) on Adjustment Income
Securities
-------------------------------------------------------------------------------
Beginning balance at
January 1, 1999 $(197.8) $ 1.5 $(33.5) $(229.8)
Other comprehensive
income (loss) (177.8) 18.6 (17.4) (176.6)
-------------------------------------------------------------------------------
Balance at
December 31, 1999 $(375.6) $20.1 $(50.9) $(406.4)
===============================================================================
The amounts above are net of income taxes. The income taxes related to other
comprehensive income were not significant as income taxes were generally not
provided for foreign currency translation.
The unrealized gains (losses) on securities is net of reclassification
adjustments of $8.5 million and $4.8 million, net of tax, in 1999 and 1998,
respectively, for realized gains and losses on sales of securities included in
net income.
Generally, the assets and liabilities of foreign operations are translated into
U.S. dollars using the current exchange rate. For those operations, changes in
exchange rates generally do not affect cash flows; therefore, resulting
translation adjustments are made to shareholders' equity rather than to income.
Page 38
Responsibility for Financial Statements
Eli Lilly and Company and Subsidiaries
The consolidated financial statements and related notes have been prepared by
management, who are responsible for their integrity and objectivity. The
statements have been prepared in accordance with generally accepted accounting
principles and include amounts based on judgments and estimates by management.
The other financial information in this annual report is consistent with that in
the financial statements.
The company maintains internal accounting control systems that are designed to
provide reasonable assurance that assets are safeguarded, that transactions are
executed in accordance with management's authorization and are properly
recorded, and that accounting records are adequate for preparation of financial
statements and other financial information. The design, monitoring, and
revision of internal accounting control systems involve, among other things,
management's judgments with respect to the relative cost and expected benefits
of specific control measures. A staff of internal auditors regularly monitors,
on a worldwide basis, the adequacy and effectiveness of internal accounting
controls.
In addition to the system of internal accounting controls, the company maintains
guidelines of company policy emphasizing proper overall business conduct,
possible conflicts of interest, compliance with laws, and confidentiality of
proprietary information. The guidelines are reviewed on a periodic basis with
employees worldwide.
The financial statements have been audited by Ernst & Young LLP, independent
auditors. Their responsibility is to examine the company's financial statements
in accordance with generally accepted auditing standards and to express their
opinion with respect to the fairness of presentation of the statements.
The members of the audit committee of the board of directors, none of whom are
employees of the company, recommend independent auditors for appointment by the
board of directors, review the services performed by the independent auditors,
and receive and review the reports submitted by them. The audit committee meets
several times during the year with management, the internal auditors, and the
independent auditors to discuss audit activities, internal controls, and
financial reporting matters. The internal auditors and the independent auditors
have full and free access to the committee.
Sidney Taurel
Chairman of the Board,
President, and Chief Executive Officer
Charles E. Golden
Executive Vice President and
Chief Financial Officer
January 31, 2000
Page 39
Report of Independent Auditors
Board of Directors and Shareholders
Eli Lilly and Company
We have audited the accompanying consolidated balance sheets of Eli Lilly and
Company and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of income, cash flows, and comprehensive income for each
of the three years in the period ended December 31, 1999. These financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Eli Lilly and
Company and subsidiaries at December 31, 1999 and 1998, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States.
Ernst & Young LLP
Indianapolis, Indiana
January 31, 2000
Page 40
Appendix to Exhibit 13
Graphs in Annual Report to Shareholders
for the Year Ended December 31, 1999
Set forth below, converted to tabular format, are the graphs included in Exhibit
13 in the paper format of the Company's Annual Report to Shareholders.
Graph #1--Sales Outside the U.S.
($ millions)
Year Amount
- -----------------------------------
1990 $1,636.9
1991 1,807.0
1992 1,996.2
1993 2,097.5
1994 2,430.2
1995 2,950.9
1996 3,081.0
1997 3,105.9
1998 3,400.6
1999 3,776.0
International sales continued to increase due to strong growth of Zyprexa,
Gemzar, Humalog, and Evista in numerous affiliates. Strong volume growth of 14
percent and price increases of 1 percent were partially offset by an adverse
exchange rate impact of 4 percent, resulting in net sales growth outside the
U.S. of 11 percent in 1999. International sales now represent 38 percent of
total worldwide net sales compared with 37 percent of 1998.
Graph #2--Net Sales
($ millions, percentages represent changes from 1998)
Percent Change
Class Amount from 1998
- -----------------------------------------------------------------------
Prozac $2,613.4 (7)%
Zyprexa 1,885.0 31%
Diabetes Care 1,375.2 19%
Anti-Infectives 1,022.3 (12)%
Animal Health 627.8 2%
Gemzar 455.8 49%
ReoPro 447.3 22%
Axid 354.7 (15)%
Evista 326.1 126%
Humatrope 300.0 12%
In total, 16 products, spanning all therapeutic classes, had annual sales in
excess of $100 million.
Page 41
Graph #3--Research and Development
($ millions)
Year Amount
- -----------------------------
1995 $1,042.3
1996 1,189.5
1997 1,370.2
1998 1,738.9
1999 1,783.6
Worldwide research and development expenditures increased 3 percent in 1999 in
support of the company's strong pipeline, which includes 21 compounds in Phase
II or Phase III clinical trials. Excluding the impact of incentive compensation
adjustments, the underlying growth in R&D during 1999 was 8 percent.
Graph #4--Economic Value Added
($ millions)
Year Amount
- --------------------------
1995 $ 333
1996 460
1997 751
1998 1,429
1999 1,584
In 1999, Lilly's Economic Valued Added (EVA) was $1.6 billion, an increase of 11
percent, reflecting the company's commitment to delivering exceptional
shareholder value.
Graph #5--Capital Expenditures
($ millions)
Year Amount
- ------------------------------
1995 $551.3
1996 443.9
1997 366.3
1998 419.9
1999 528.3
Capital expenditures increased 26 percent from the 1998 level primarily due to
the increased support of various manufacturing and research initiatives and
related infrastructure. The company expects near-term capital expenditures to
increase from 1999 levels due to continuing investment in research and
manufacturing capabilities.
Page 42
Graph #6--Dividends Paid per Share
(dollars)
Year Amount
- --------------------------
1995 $0.655
1996 0.685
1997 0.740
1998 0.800
1999 0.920
Dividends paid during 1999 increased 15 percent over 1998. Nineteen ninety-nine
was the 32nd consecutive year in which dividends were increased. The continued
earnings growth in 1999 enabled the company to declare a first-quarter 2000
dividend of $.26 per share, a 13 percent increase over 1999. The increase
reflects the company's continued commitment to delivering shareholder value.
Page 43