Growth Strategies

Pfizer Defiant

How David Shedlarz challenges the analysts.
Stephen BarrJuly 1, 1999

Perched on the third-floor landing of Boston’s Marriott Copley Place, a tense analyst lies in wait for the trio of Pfizer executives ascending the escalator. “Looks like Celebrex is gonna be a blockbuster,” the analyst ventures, referring to a new arthritis drug that has been selling like hotcakes since its January launch.

The statement is really a question. Maybe even two. From this chance encounter at a health care­industry confab, the analyst is desperately seeking some acknowledgement–any acknowledgement–that Celebrex is doing as well as recent reports have indicated. More important, he wants to gauge the impact the new drug will have on Pfizer’s 1999 earnings, which are uncertain to top last year’s Viagra- induced record. Like many of the analysts who cover Pfizer, he wants much more information than the closemouthed executive vice president and CFO, David Shedlarz, is ready to give.

Shedlarz, predictably, refuses to take the bait. Instead, he offers a noncommittal mumble and a shrug. But the analyst is unrelenting. “You sure are spending a lot,” he ventures, referring to the fact that the New York pharmaceutical giant has a larger sales force and puts more into research and development (R&D)–$2.2 billion in 1998 alone– than any of its competitors, and lavishly pours in more at the expense, as some see it, of higher earnings.

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“We call it ‘investments,’” Shedlarz fires back as he evaporates into the crowd.

Balancing Act

Shedlarz had helicoptered to Boston that March morning to deliver, in a choreographed, 30- minute presentation, much the same message he had delivered in that impromptu tango. It’s the message he has been delivering for much of the past year–that despite Pfizer’s recent stellar performance, and the oft-stated ambition of chairman and CEO William C. Steere Jr. to be the world’s leading pharmaceuticals company by June 2001, when he retires–the company is committed to “striking the right balance between growth and investment.”

“What I was telling him,” Shedlarz explains, “was that we see lots of opportunities, and that Pfizer is committed to investing substantial sums to support them. If that means not enhancing profitability in the short term, then he knows what we are going to do.”

But this is an industry well known for its smooth earnings. “Pfizer’s in an industry where you have to invest for the long term, but that’s also known for stable near-term performance,” says PaineWebber Inc. drug analyst Jeffrey Chaffkin. “The fact that they decide to spend even more on R&D [than their peers] doesn’t change the fundamentals of the company,” he adds. “But it is very difficult to convince investors to own the company, when they get negative earnings values against future investments.”

Clearly, the sell-side analysts are unhappy that Pfizer, and Shedlarz, are refusing to conform to convention. The company maintains a reputation for being hard to read, and its practice of not holding a conference call on the day earnings are released irks many analysts.

Things came to a head in mid-April, when Pfizer announced robust, Celebrex-fueled first- quarter results and provided rare guidance on the rest of the year. Surprising many, the company projected earnings growth in the “single-digit range” for the second quarter–meaning they won’t match up to last year’s windfall–and said it was comfortable with estimates in the $2.40-to-$2.50-a-share range. The analyst consensus had been $2.49, with one as high as $2.60.

In response, 13 of 23 analysts lowered their expectations for the full year, and Pfizer’s share price had fallen below $100 by press time. Moreover, several analysts have begun to grouse about what they see as Pfizer’s attempt to manage earnings downward. Morgan Stanley Dean Witter & Co.’s Jami Rubin, for example, recently bellyached that the company’s “high spending levels suggest that [it] continues to have more earnings potential than it is allowing to drop to its bottom line,” while David Lippman, of Prudential Securities Inc. finds it “somewhat troubling” that “huge increases in investment spending never seem to moderate.”

Such accusations don’t trouble Shedlarz. In January, he went so far as to tell Forbes magazine that, unlike most CFOs, he doesn’t worry that earnings won’t be high enough; his concern is that they will grow too high. “It’s a sign we’re doing something wrong,” he cautioned.

Intense and cerebral, Shedlarz is hardly the first CFO in America to assert, “We manage the business, not the numbers.” But these days, sacrificing short-term profitability for investment may be viewed as a contrarian–even bold–strategy, even at a company as successful as Pfizer. Shedlarz isn’t afraid to say that it is not his job to maximize profits- -and seems willing to pay the short-term price, certain in his belief that Pfizer will ultimately have the last laugh.

No Comparison

Pfizer’s problem, if you want to call it that, is one many companies would enjoy: The company has been more successful than anticipated. In 1998, after all, it recorded $3.4 billion in profits (up 27 percent) on $13.5 billion in revenues (up 23 percent), and saw its stock rise 67 percent, to $125, before climbing to $150 on April 12 of this year.

Nineteen ninety-eight also marked Pfizer’s transformation from a diversified health-care concern to a nearly pure pharmaceuticals play. Since 1991, under Steere’s stewardship, the company has shifted from 50 percent drug sales to 87 percent.

As for spending, in 1998 Pfizer upped the totals for both research and marketing/sales by 26 percent, making it the industry leader in R&D spending. What perplexes many analysts is the size of the lead. While Pfizer leads Johnson & Johnson by only $3 million, it outspends Glaxo Wellcome Inc. and Merck & Co., two larger peers, by an estimated $700 million in R&D and an estimated $1 billion in SG&A.

Shedlarz counters that such comparisons are misguided. Some of Pfizer’s peers, he argues, “are leveraging the business” in order to retain double-digit earnings growth on single-digit revenue growth. Some, like Abbott Laboratories and American Home Products Corp., have actually cut back on R&D, while others, like Merck, are in more-diversified businesses. Merck spent only 12 percent of pharmaceutical sales on R&D, compared with 18 percent for Pfizer. “I’m not saying what’s right for us is right for everybody,” Shedlarz expands, “but our sharp focus on pharmaceuticals, coupled with a large number of current opportunities, compel us to make a large number of investments.”

Cutting back on investments to improve earnings is dangerous, says Rick Hoddeson, Pfizer’s vice president of operations planning and analysis and one of Shedlarz’s chief lieutenants. “The life cycles are so long on these types of products,” he says, “that if you don’t grow your research process, it won’t bite you for 8 to 10 years.” But, he insists, it will eventually bite you. “We know that unless you continue to feed [the pipeline], there’s ultimately a day of reckoning.”

Besides, Shedlarz points out, R&D shouldn’t be the main indicator of competitive strength. For a truer peer comparison, he says, look at profitability. On that score, Pfizer’s strategic initiatives have increased margins from 16.5 percent in 1991 to 27.7 percent today, even while spending has grown at a faster rate than sales. “We had one of the lowest levels [of profitability] in our peer group, and now we have one of the highest,” Shedlarz boasts.

Show Time

In a makeshift office in the Marriott Copley Place, Shedlarz has his game-face on. It’s just minutes till show time. He has finished prepping with George Milne, president of Pfizer Central Research, and investor- relations director Ron Aldridge, and he broods silently as he skims through his slides.

Asked what he hopes to accomplish in his talk at the SG Cowen Securities Corp.­sponsored conference, Shedlarz spells out three objectives. One–no surprise here–is to stress the “validity,” as he calls it, of balancing growth and investment. Another is to “mitigate the intense focus on Viagra sales” by emphasizing Pfizer’s broad portfolio of products. Finally, he anticipates that the analysts’ questions “will give me a read on what’s important to investors.”

“This company is under a microscope,” Shedlarz adds, “and we want to frame and reinforce the Pfizer narrative.”

But why, he is asked, does he look so uncomfortable? That question elicits a sheepish grin. “This is the intellectual equivalent of facing a hanging,” he says. “This is a sophisticated, well-educated audience of people who make major judgments about your stock. Doing this gets your brain sharpened. You need to be at the top of your game.”

Fast Track

Since his promotion from vice president of finance to CFO in July 1995, the 51-year-old Shedlarz has clearly had to work hard to get comfortable with the “game.” But when it comes to the other demands of his job, he has always been in top form.

Shedlarz joined Pfizer in 1976, a freshly minted MBA from New York University, starting as a financial analyst in the company’s original manufacturing facility in Brooklyn. Almost from the start, his career paralleled Steere’s. He rotated with the future CEO through several assignments before following him to headquarters in 1992 with a mandate to shake things up. “Finance was way overstaffed and much more complicated than it needed to be,” says Rick Stover, an analyst at Arnhold & S. Bleichroeder who follows Pfizer and worked at the company in the late 1970s and early 1980s.

In 1993, Shedlarz avidly embraced reengineering. By 1996, every corner of Pfizer finance was transformed. Among other innovations, a global chart of accounts and a worldwide information system were installed and a single shared-services center for transaction processing was opened. When Shedlarz encountered resistance from those who complained that Pfizer was amply profitable, he relied on the force of his personality to see that his demands were executed. “When David tells you, ‘Be bold,’ you believe dramatic things are possible,” corporate accountant Claude Christiano told CFO in 1993. “David doesn’t believe in taking small steps,” Greg Vahle, vice president of employee resources and services, corporate finance, now adds. “He’s got a big plan, and he wants to get where he’s going very quickly.”

Shedlarz, in turn, credits the entire finance organization for being bold, citing a tax rate that’s flat at a time when it should be rising and nearly $400 million in additional annual resources available to invest from consolidated treasury practices.

Sustained Performance

The Marriott’s Salon C is filled to capacity with more than 200 analysts. There’s not a free patch of carpet to stand on. “You can’t even get in to Pfizer,” a woman complains as she heads for the Merck presentation in Salon B.

The Pfizer talk is informative but uneventful, and most of the questions afterward are directed at Milne. This is a rare chance for analysts to quiz Pfizer’s chief researcher about products in the pipeline. Still, one attendee does ask Shedlarz what he thinks of the Street’s consensus earnings for 1999.

“I was expecting someone to ask that,” Shedlarz cracks. His comment is meant to be more disarming than funny. It allows him to avoid giving an immediate answer. He refers to his final slide, which shows that balancing growth and investment leads to “strong, sustained performance.” Only then does he return to the question, to which he says, “It’s too early to comment.”

True enough, although Shedlarz has already concluded that the consensus was too high. As the session breaks up, several analysts look for a gesture or a whispered tidbit from the CFO. They get none.

A Different Drummer

The first time Shedlarz articulated the notion of balancing growth and investment was in 1997, as Pfizer enjoyed blockbuster sales of Lipitor, a new cholesterol-lowering pill co- marketed with Warner-Lambert Co. “We thought framing the issue in those terms was an effective way to put forward the strategy of the company,” he says.

Such talk had become part of Shedlarz’s regular patter with the Street by the time Pfizer reported that second-quarter 1998 earnings had soared 37 percent, thanks to Viagra. But the very next quarter the company reported profits up “only” 13 percent, 6 cents below consensus per-share estimates. In a press release, Shedlarz explained that Pfizer made a “very deliberate decision” to increase the sales force for the Celebrex launch (a co-marketing venture with the G.D. Searle & Co. division of Monsanto Co.), despite the dampening effect on results.

With the worldwide rollout of Viagra and the approaching launch of Celebrex, Pfizer’s shares climbed higher in late 1998 and into 1999. But with the stock holding the highest price-earnings ratio in the drug sector, and with the comparison to 1998’s second quarter looming, Shedlarz could see analyst uncertainty ahead. In January, he noted that more than half the analysts who follow the company had not filled in estimates for the second quarter, and that some who had were projecting growth of as much as 25 percent.

“We saw that the analysts were waiting for guidance,” Shedlarz says. “It was clear they hadn’t concluded whether the balance theme would prevail, or that more smoothing of earnings would be seen.”

So in mid-February, Steere, Shedlarz, and seven other executives on the corporate management committee gathered to consider what earnings would be for the upcoming quarters, and what Pfizer should say about them, if anything. At the meeting, Rick Hoddeson made the case that the unprecedented surge in Viagra sales in the second quarter of 1998 had left many Pfizer stock watchers uncertain about year-over-year comparisons. And unless Pfizer were willing to back off its commitment to pour more into marketing and R&D, it would be unable to show the smooth quarterly progression in earnings growth that the Street likes to see.

What startled Hoddeson about the discussion that ensued was that no one said Pfizer should keep quiet. Internally, there’s a belief that despite analyst complaints, the company is more open than before. “A few years ago, we were much more insular,” Hoddeson remarks. “There would have been some arguing, ‘Let the analysts figure it out.’”

A Sector Rotation?

Needless to say, analysts were far from happy upon hearing that, along with robust first- quarter income of $815 million (up 18 percent) on revenues of $3.93 billion (up 29 percent), R&D had soared 36 percent from the previous year and SG&A had risen 31 percent. With earnings meeting expectations to the penny, many analysts suspected that Pfizer had gone out of its way to keep profits in check. “Basically Pfizer said, ‘We’re not going to smooth anything out, and because the year looks solid, we’re going to spend even more,’” notes PaineWebber’s Chaffkin, who lowered his full-year estimate 10 cents, to $2.45.

As for Shedlarz, he insists that the Wall Street community “got the message” that Pfizer would not alter its investment patterns in favor of higher growth, “whether they agreed with it or not.” And he’s willing to take the large drop in Pfizer’s share price in stride, arguing that a sector rotation to cyclical stocks was mainly to blame for the decline. He notes that no analysts changed their recommendations to investors.

Although he recoils at the implication that Pfizer deliberately manages its earnings downward, he reiterates his concern that earnings not grow too fast. In an interview after the first-quarter release, he said: “In this industry, you can easily leverage yourself and report high earnings that are not sustainable. We want high profitability and strong growth today and in the future, so we have to balance growth today with investment for the future.”

Acknowledging that Pfizer could deliver double- digit growth in the second-quarter if it wanted to, Shedlarz goes on to predict that the guidance in April should forestall “pressure to manage the numbers [for the full year], now that we’ve given a clear signal what we’re comfortable with.”

That may be so, but who doesn’t think that in the second week of July, when second-quarter results are released, Shedlarz will have something to say about balancing growth and investment?

(Chart omitted)

A Vested Interest

David Shedlarz isn’t just a proponent of Pfizer’s R&D pipeline; he’s also a beneficiary.

After an analyst presentation at a conference in Boston last March, Shedlarz, CFO and executive vice president, gets into a discussion with president of Pfizer Central Research George Milne and investor-relations director Ron Aldridge about the looming battle between Pfizer’s Celebrex and Merck’s own new arthritis drug, Vioxx, which hit the market in late May. He mentions an article he read in a medical journal that found that patients stay with certain drugs for 9 to 18 months before they consider changing.

“That’s not well understood by investors,” Shedlarz suggests. “They think there will be an immediate redistribution and Vioxx will steal Celebrex’s thunder. I think our presence in the marketplace for six months is an important advantage.”

As far as Shedlarz is concerned, Celebrex’s prospects are more than a competitive issue. He recently began to take the drug to help combat the near-constant pain he feels from a horrific accident he suffered in the summer of 1996.

Although reluctant to talk about it, and visibly emotional as he does, Shedlarz recalls that it happened two days into a rare two-week vacation. He was riding his bicycle when he was sideswiped by a minivan. His pelvis was broken in five places. His doctor said he’d never seen anyone with such bad breaks live.

As frightening as the accident was, Shedlarz wouldn’t let it slow him down. Within a month, while still convalescing at home, he put in as many hours as he could. Within two months, chairman and CEO William C. Steere Jr. called to say he wanted Shedlarz to add some operating experience to his résumé and run Pfizer’s then­$1.5 billion medical-technology group. “This is either a very wonderful thing or a cruel joke,” Shedlarz had quipped.

Running a business that makes medical devices for people who have suffered through traumatic accidents like his wasn’t a joke. And Shedlarz wasn’t joking when he came back a year later and advised Steere to sell the group. If the company was serious about its pharmaceuticals focus, then medical technology didn’t make sense.

The sale was completed in 11 months, because, he says, “it was the most humanistic way to deal with a tough decision.” Pfizer had sold many businesses in previous years, and intellectually, Shedlarz had always understood the impact of a divestiture–jobs lost, people with a long history at Pfizer forced to leave the fold. But this time it was different. This time he found the experience so “heart- wrenching” he surprised even himself. “My own feelings of empathy were heightened by the accident,” he acknowledges.