Eli Lilly and Company

December 13, 2002

Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549

Re: Proposed Rule: File No. S7-43-02. Conditions for Use of Non-GAAP Financial Measures

Dear Mr. Katz:

Eli Lilly and Company appreciates the opportunity to respond to the Proposed Rule: File No. S7-43-02, Conditions for Use of Non-GAAP Financial Measures (referred to as the "Proposed Rule").

Overall, we support the Commission's initiatives in establishing a framework for transparent disclosures of non-GAAP financial measures and we support most elements of the Proposed Rule. However, we wish to provide suggestions that we believe will provide practicality to the Proposed Rule, while maintaining the intent.

Section 401(b) of the Sarbanes-Oxley Act, states the following:

(b) Commission Rules on Pro Forma Figures - Not later than 180 days after the date of enactment of the Sarbanes-Oxley Act of 2002, the Commission shall issue final rules providing that pro forma financial information included in any periodic or other report filed with the Commission pursuant to the securities laws, or in any public disclosure or press release or other release, shall be presented in a manner that-

    (1) does not contain an untrue statement of a material fact or omit to state a material fact necessary in order to make the pro forma financial information, in light of the circumstances under which it is presented, not misleading; and

    (2) reconciles it with the financial condition and results of operations of the issuer under generally accepted accounting principles.

We believe that the Proposed Rule has gone further than the intent of the Sarbanes-Oxley Act and will ultimately provide less information to investors.

In April 2001, Financial Executive International (FEI) and National Investors Relations Institute (NIRI) issued "FEI/NIRI Earnings Press Release Guidelines." In the Commission's, "Cautionary Advice Regarding the Use of "Pro Forma" Financial Information in Earnings Releases" issued in December 2001, the Commission stated the following:

"Pro forma" financial information can serve useful purposes. Public companies may quite appropriately wish to focus investors' attention on critical components of quarterly or annual financial results in order to provide a meaningful comparison to results for the same period of prior years or to emphasize the results of core operations. To a large extent, this has been the intended function of disclosures in a company's Management's Discussion and Analysis section of its reports. There is no prohibition preventing public companies from publishing interpretations of their results, or publishing summaries of GAAP financial statements.

The Commission went on to state in the "Cautionary Advice Regarding the Use of "Pro Forma" Financial Information in Earnings Releases":

Fourth, we commend the earning press release guidelines jointly developed by the Financial Executives International and the National Investors Relations Institute and we encourage public companies to consider and follow those recommendations before determining whether to issues "pro forma" results, and before deciding how to structure a proposed "pro forma" statement. A presentation of financial results that is addressed to a limited feature of financial results or that sets forth calculations of financial results on a basis other than GAAP generally will not be deemed to be misleading merely due to its deviation from GAAP if the company in the same public statement discloses in plain English how it has deviated from GAAP and the amounts of each of those deviations.

We support the Guidelines developed by the FEI/NIRI and are concerned that the Proposed Rule will inhibit the flow of information that is useful to the investment community and was supported by the FEI/NIRI guidelines.

Below is a brief summary of each of our suggestions, while the remainder of this letter addresses each of our suggestions in more detail.

  • We are concerned with the prohibition established in the Proposed Rule on "adjusting a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur." The Proposed Rule does not define "reasonably likely to recur," so we are unclear as to when this prohibition would apply. A registrant may have unusual events occur on a non-routine basis that should be separately identified and eliminated in providing a measure of "recurring" earnings to the investment community.

  • We oppose the elimination of "presenting a non-GAAP per-share measure." The implementation of not providing non-GAAP per-share information will provide less information to investors, not more. This does not appear to be within the letter or spirit of the Sarbanes-Oxley Act.

  • We oppose the concept of requiring a reconciliation of non-GAAP financial measure to a GAAP financial measure for forward-looking information. A registrant is not able to predict with certainty unusual or infrequent events that may occur in the future. A registrant, however, is able to predict with some degree of certainty its normal expected earnings. The Proposed Rule, as drafted, may deter registrants from providing forward-looking information because of the difficulties in reconciling unknown events to GAAP financial measures, as the GAAP financial measures are far less certain. Consider for example, an unexpected legal liability or a natural disaster to a facility used for manufacturing.

The remainder of our letter discusses our suggestions in more detail.

Non-recurring, Infrequent or Unusual Events

We are concerned with the language of the Proposed Rule that prohibits adjusting for non-recurring, infrequent, or unusual events that are "reasonably likely to recur." The intent of eliminating certain information in "non-GAAP" financial information is to provide the readers with information that will be reflective of a company's base operations. We are concerned that the restriction on providing certain "non-GAAP" financial measures could lead to a lack of transparency.

The definition of "reasonably likely to recur" is unclear because it is completely unlimited as to time. We agree with a concept of limiting seasonal fluctuations or other events that will occur with regularity; however, certain events may occur from time to time over a period of years that we believe should be excluded from normal recurring earnings as provided to the investment community. We agree that occasional abuses and inconsistencies have resulted from the determinations by certain registrants as to what events should be singled out for adjustment; however, we believe that existing MD&A rules and anti-fraud laws should be sufficient to deter abuses.

For example, consider a charge for acquired in-process research and development (IPR&D). Eli Lilly and Company spends approximately $2 billion in research and development yearly in an attempt to develop new and innovative pharmaceutical products. As successful as we have been in the development of our internal pharmaceutical portfolio, occasionally we in-license a late-stage product in development from a biotech company. Our significant in-licensing transactions usually involve a pharmaceutical compound that has been successfully proven through certain stages of testing, and usually involve a sizeable upfront fee that is properly expensed upon execution of the contract. These in-licensing activities are rather infrequent, not predictable, and vary in amounts and terms. We only exclude them from operations in a calculated non-GAAP measure if they represent a material one-time distortion (positive or negative) to our earnings. For illustration purposes, we entered into the following material in-licensing arrangements from 2000 through 2002:


Reported Compounds in-licensed

Material IPR&D expense

Q1 2000



Q2 2000



Q3 2000



Q4 2000



Q1 2001



Q2 2001



Q3 2001


$90.5 million

Q4 2001


$100.0 million

Q1 2002



Q2 2002



Q3 2002


$84.0 million

Q4 2002



As illustrated, in the last two quarters of 2001 and the four quarters of 2002, we in-licensed 4 compounds totaling $275 million. However, given the size of the upfront payments and the nature of the transaction, we would still characterize these events as unusual and infrequent. We do believe the in-license of compounds will occur in the future; however, we believe it would be misleading if we failed to identify these items as unusual and include them in a reconciliation from GAAP earnings per share to "normalized" earnings per share. The events are sporadic and unpredictable as to the timing and amount of the in-licensing opportunity. It is important to provide this transparency to help investors understand what otherwise might be perceived as unexpected volatility in earnings and to understand our true, base investment in research and development.

We would view a sizeable gain from the sale of an investment in a similar fashion. For example, we excluded from our operations a $214.4 million gain from the sale of our interest in Kinetra LLC to WebMD Corporation in 2000 and a $67.8 million gain from the sale of the rights to one of our products in 1999. For both gains, we separately identified the amount of the gain and the impact to earnings per share in our earnings release and Commission filings.

We believe the interests of investors are well served in excluding these unusual items from normal operations as long as the guidelines developed by the FEI/NIRI are followed.

Elimination of Non-GAAP Per-Share Measure

We are opposed to the elimination of non-GAAP per-share information in press releases and periodic filings with the Commission. We support the initiative of providing a reconciliation between GAAP amounts and those that are non-GAAP. We believe per-share information could be accomplished in the same manner. This reconciliation would provide the reader enough information as to the nature of the transaction and the estimated impact that the event had on earnings per share. In this era of providing as much information as possible to investors, we believe that the reconciliation increases transparency to the reader of the financial statements.

Based upon conversations with the certain members of the staff of the Commission, we understand that the Commission would allow the registrant to quantify the net income impact of the event in dollars and the number of shares outstanding. However, the Commission would be opposed to a registrant providing an earnings per share amount. This seems illogical; in effect, the registrant can give the reader the pertinent information but cannot "do the arithmetic" for the convenience of the reader. We believe that if an event warrants the transparency of being included in the reconciliation from GAAP earnings to the non-GAAP measure, the registrant should have the latitude to present the impact on earnings per share.

We believe that an approach of providing a reconciliation of "normalized" earnings per share with GAAP basis earnings per share should be considered a best practice during periods where unusual, infrequent and material events occur. The following example illustrates the reconciliation included in our 2002 third quarter Form 10-Q filed with the Commission:

  Three Months Ended

September 30,

Nine Months Ended

September 30,

  2002 2001 2002 2001
Diluted earnings per share (as reported) $.63 $.52 $1.82 $2.02
Add back one-time charges:        
In-process research and development .05 .05 .05 .05
Asset impairment and other site charges - .07 - .07
Early retirement of debt - .02 - .02
Diluted earnings per share (as adjusted) $.68 $.66 $1.87 $2.16

In addition to this reconciliation, we provided a discussion of each of the components identified as "one-time charges" that we considered unusual, infrequent and material to the results of operations for that respective period.

Forward-looking Information

It is difficult and legally risky for a registrant to provide forward-looking financial information on a GAAP basis without providing some kind of contingency for unknown, unplanned unusual events. For example, as noted above, we occasionally participate in the in-licensing or out-licensing of pharmaceutical compounds. The ability to execute and the timing of these events are extremely difficult to predict, and we do not believe we should be bound to a GAAP-calculated amount that doesn't exclude certain unusual events. It is impossible for us to provide an estimate of forward-looking information, without indicating that the estimate "excludes unusual items." Should the Proposed Rule be adopted, we are concerned it will reduce the number of registrants who are willing to provide any forward-looking information to investors, as registrants will be less likely to provide forward-looking information on a "GAAP-only" basis given the inability to predict these "unusual" events which the Proposed Rule may prohibit a registrant from excluding when determining the non-GAAP financial measure. Therefore, this portion of the Proposed Rule may have the unintended consequence of reducing the meaningful information that registrants are willing to provide to the investment community.

Consider an unexpected legal liability, a natural disaster to a manufacturing facility, or a substantial gain from the strategic investment in another company. All of these events we believe would likely be deducted when arriving at the non-GAAP earnings amounts; however, they all would be included in GAAP earnings calculations. In addition, consider the confidential nature of the disclosure of some infrequent events, such as the in-licensing of a pharmaceutical molecule, or a financial settlement with litigants or regulatory authority. This information would be damaging to the registrant and its investors if disclosed publicly prior to the completion of negotiations in an attempt to provide forward-looking information on a GAAP basis.

We believe it is also important to provide the investment community with information that is on a comparable basis. If the Proposed Rule eliminated the ability of registrants to exclude unusual, infrequent, and material items from actual results, the investment community would not have an appropriate comparison between actual results and forward-looking financial expectations, excluding unusual items.

We believe that it is acceptable that forward-looking information be provided on a non-GAAP basis without a reconciliation to GAAP financial results, as there is far less certainty relative to GAAP basis financial results in any particular period.

We appreciate the opportunity to express our views and concerns in regards to this Proposed Rule. If you have any questions regarding our response or would like to discuss our comments, please feel free to call me at (317) 276-2024.



Arnold C. Hanish
Executive Director, Finance and
Chief Accounting Officer