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Executive Summary

Warner-Lambert has twice been a winner at FDA advisory committees in recent months with approval recommendations for two new neuroscience drugs, but the stock market likes the company's prospects primarily for its strength in consumer products and confectionaries. Eking out a one-point (1.4%) gain for the first three months of 1993, Warner-Lambert was one of only six stocks on the 30-firm pharmaceutical component of the "F-D-C" Index of NYSE and AMEX issues to post a gain for the quarter. The issue closed March 31 at 70-1/8. The company's sagging drug business received a strong boost from separate advisory committee approval recommendations for its anti-epilepsy product Neurontin and its Alzheimer's drug Cognex. However, the key to the company's first quarter market performance appeared to be its nonpharmaceutical interests. Following the March 18 review of Cognex by FDA's Peripheral & CNS Drugs Advisory Committee, Alex. Brown analyst Barbara Ryan estimated that a June approval of Cognex could add 10 cents per share to 1993 earnings. "We continue to rate the Warner-Lambert shares 'buy,' primarily on the basis of the company's substantial consumer franchise values in OTC medicines and gums and mints," she concluded. The stability offered to Warner-Lambert by its nonprescription businesses was also implied in another analyst recommendation late in the quarter. On March 23, S.G. Warburg's Kristine Bryan picked Warner-Lambert and Lilly as two drug stocks that could show the highest returns as companies "which are likely to survive" the trauma of health care reform, but are in "critical" condition. Bryan said the two companies are "valuable takeover or turnaround candidates." Warner-Lambert's strength in consumer products and confectionaries helped the company counter the continued flight of investors from drug stocks as the nervous market fretted about the president's health care reform effort. Other drug stocks staying close to even for the quarter were those perceived to have the least exposure in the prescription drug market: Rhone-Poulenc Rorer (up 1/8 to 46-3/4), American Home Products (down 1-3/8 to 66-1/8) and Schering-Plough (down 3-5/8 to 60). In contrast, fully half of the stocks on the pharmaceutical component lost 15% or more of their market value during the quarter. While drug stocks were out of favor for most of 1992, the early actions of the Clinton Administration have met and exceeded investors worst fears, driving stocks even lower in 1993. The administration rhetoric has openly targeted industry profitability as one area of potential health care savings, and concrete proposals like cuts in Sec. 936 tax credits and consolidated vaccine purchases have been taken as signs of worse to come when the Clinton health reform task force makes its proposal next month. The careful Washington watch has reached such a peak that several expressions of distaste for price controls by top White House aide Ira Magaziner at the end of March led to a small rally among the pharmaceutical stocks. Ironically, two days after Magaziner's comments, HHS Secretary Shalala held a press conference to announce a single purchaser -- i.e. price control -- plan for vaccines. In their market misery, the pharmaceutical companies may have found a source of political strength. The "F-D-C" Index pharmaceutical component dropped 17.6% in the first quarter of 1993, the equivalent of $47 bil. in valuation of the 30 drug companies. Since Jan. 1, 1992, the pharmaceutical component is down nearly 33%, the equivalent of over $100 bil. in valuation. Industry executives have not been reticent about citing such figures. In fact, they have actively been courting media attention to dramatize the potential financial consequences if the administration's health reform package lives up to the anti- industry rhetoric surrounding the reform debate. After years of delivering the industry message primarily to the financial community, senior drug company executives are now talking to politicians and the general public. With the change in audience has come a new image: the prescription drug industry is now describing itself as "fragile." At an April 1 press briefing organized by the Rx Partners media campaign, for example, Hoffmann-La Roche Chairman Irwin Lerner cited estimates that the drug manufacturers have lost over $150 bil. in market valuation since 1992. He reminded the reporters that the entire U.S. drug industry, with sales of about $60 bil., is smaller than single companies like General Motors and Exxon. "We are a very fragile industry," he said. The perception of fragility was heightened by Merck's March 23 announcement that the firm did not believe it would meet Street earnings estimates for the year and would reduce employment by 1,000. The Merck announcement helped drive the "F-D-C" Index still lower, sending the pharmaceutical component below its 1990 close. The broader "F-D-C" Index of 54 drug, diversified, wholesaler and chains closed at its lowest point since early 1991 and down 13.9% so far this year. Merck itself was down 18.4% to 35-3/8 for the quarter. After restructurings and/or disappointing earnings forecasts from Syntex (down 17.9%), Upjohn (down 7.4%), Bristol-Myers Squibb (down 12.2%), Lilly (down 19.8%), Marion Merrell Dow (down 25%) and Searle/Monsanto (down 13.7%) in previous months, the Merck announcement was taken as evidence that no drug company would be able to continue historical growth rates in the new cost-conscious health care environment. While the cutbacks and reduced earnings have created a short term market disaster for drug stocks, by clearing the books of bad news drug firms may be positioning themselves for a long term recovery and producing a political dividend by mollifying their Capitol Hill critics. The market's reaction to the Cognex approval recommendation typifies the newly reduced expectations. Hailed as a potential billion dollar drug while still in development, Cognex is being greeted with conservative sales estimates now that it is all but certain to be the first Alzheimer's therapy approved in the U.S. The dampened forecasts for Cognex are largely the result of the chastening experience of two advisory committee rejections coupled with the need for weekly blood monitoring -- a stumbling block in the past for other products such as Sandoz' Clozaril and Syntex' Ticlid. However, a new factor has entered into forecasting: cost/benefit. The treatment IND price of about $1,000 per year has been widely cited as the main drawback to trying Cognex, given the limited efficacy of the drug. The net result of a more skeptical investment community may be positive for Warner-Lambert. While Cognex would clearly have been hard pressed to meet projections cited for it two years ago, analyst estimates of $100 mil. in 1994 sales seem achievable, and Cognex may even exceed expectations. Warner-Lambert has done its part to downplay expectations from its prescription drug business. In a March 23 press release, the company said that continuing compliance problems at the firm's Puerto Rico manufacturing plant coupled with new pharmaceutical regulations in Germany "contributed to an overall first-quarter sales performance which is ahead only modestly." The firm's top- seller, Lopid, is also open to generic competition. Warner-Lambert took advantage of the soft-results release to say that it is ready to jettison the Novon biodegradable packaging subsidiary begun during the end of the term of the former chairman, Joseph Williams. The first quarter drug sell-off included generic companies who benefited greatly in 1992 from the perception that cost- containment would be good for their business. Mylan (down 2-1/2 to 29) and Biocraft (down 5-1/2 to 19) fell victim to profit taking and concerns that even generic firms would not be untouched by some Clinton proposals, such as reduction in 936 tax credits. Halsey (down 6-1/2 to 4-3/8) collapsed when it reported that it had halted production of certain products due to ANDA discrepancies uncovered as part of an ongoing FDA/Justice Department investigation. Two generic firms posted gains. Pharmaceutical Resources was up 3/4 to 10-1/8. Barr, whose court case with FDA ended in February, benefited from a licensing deal with ICI for a generic tamoxifen (Nolvadex) as a settlement of patent litigation.

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