Lilly under gun to replace aging blockbuster Zyprexa

There's a $2 billion hole in Eli Lilly and Co.'s future. That's roughly how much pretax profit Lilly derives
each year from its best-seller, Zyprexa, according to calculations by IBJ. And it's how much black ink will start
running off Lilly's books once Zyprexa's U.S. and European patents expire in 2011.

Between now and then, Lilly's scientists need to pull another blockbuster or two out of their lab coats to replace the
aging Zyprexa, an antipsychotic pill first sold in 1996. Zyprexa produced 28 percent of Lilly's sales last year, but nearly
50 percent of its profits, according to IBJ's estimate.

Lilly hopes it already has a new blockbuster, a blood thinner called prasugrel. Lilly scheduled to release results Nov. 4
from a massive clinical trial that pitted prasugrel head-to-head against Plavix, an established blood thinner that racked
up $6 billion in sales last year.

The trial at first excited analysts and investors, but they have grown skeptical of prasugrel since Oct. 24, when Lilly halted
two smaller clinical trials of the drug to re-examine dosing.

If prasugrel succeeds, Lilly can keep funding research on new compounds for future years, employing thousands of scientists
at its Indianapolis headquarters. If it doesn't–and Lilly can't come up with other blockbusters–the company could
be forced to cut its work force and may even become a takeover target.

Lilly isn't alone in its predicament. Other large pharmaceutical companies such as Bristol-Myers Squibb Co., Merck &
Co. Inc., Pfizer Inc. and Wyeth all face patent expirations on their star drugs. And so far their pipelines don't show
enough pizzazz to make up the difference.

But no other company's pipeline rests so heavily on one drug as does Lilly's, analysts said.

"Prasugrel represents over 60 percent of our total estimate of Lilly's late-stage pipeline," wrote Moody's
Investors Service analyst Michael Levesque. "Among the peer group, there are no other pipeline products representing
this high a proportion of the total."

Morgan Stanley analyst Jami Rubin gave Lilly just a 10-percent chance that prasugrel would prove more effective than Plavix
and cause only minor side effects, according to an Oct. 25 research note. She gave higher odds, 35 percent, to the worst-case
scenario–that Lilly and its development partner, Daiichi Sankyo Co. Ltd. of Japan, never bring prasugrel to market.

Most likely, she said, is that prasugrel comes to market but safety concerns limit its sales.

"We believe that any restriction on prasugrel's use will be a significant advantage for Plavix from a marketing
perspective and will limit prasugrel's commercial opportunity," Rubin wrote.

After the Oct. 24 prasugrel announcement, Rubin downgraded Lilly's stock to "underweight" and the shares fell
7 percent. The stock now trades for about $53 a share, down 13 percent from its 52-week high.

Anything less than prasugrel's full success against Plavix is bad news for Lilly, said Les Funtleyder, an analyst at
Miller Tabak & Co. in New York. Otherwise, Lilly's stock price will fall further and make Lilly attractively priced
for an acquisition.

"Then I think it's a takeout candidate," Funtleyder said.

In response, Lilly spokesman Phil Belt provided Lilly's long-held resistance to mergers.

"We believe that pursuing an innovation-driven growth strategy as an independent entity is the best way to deliver value
to all of our stakeholders," he wrote in an e-mail, adding, "This position on consolidation will not be altered
by prasugrel results, whatever they may be."

Daunting challenge

The top brass at Lilly's world headquarters just south of downtown are well aware of their challenge. Replacing Zyprexa's
revenue is a topic that's been discussed for years by Lilly's corporate strategy group, the team of officers that
handles strategic planning for the whole company.

Lilly faces a different situation now than it did in the late 1990s, when it planned for the loss of Prozac's patent
protection. The antidepressant was then Lilly's top seller. Lilly lost a patent challenge in court to a generic drugmaker,
which ended Prozac's patent two years earlier than expected.

But with Zyprexa, Lilly won a court challenge and an appeal. That makes Zyprexa's patent expiration no less inevitable,
Belt said, but it does make it more predictable.

"When the Zyprexa patent expires, it will be an issue that affects our financial performance," Belt said. But,
he added, "The unknown that we faced with Prozac isn't there with Zyprexa."

Patent expiration in general is an issue that reaches to every part of Lilly's operations. After a patent expiration,
makers of generic versions of brand-name drugs move quickly to capture market share. Analysts expect Lilly to lose as much
as 90 percent of Zyprexa's sales, which totaled nearly $4.4 billion last year.

Zyprexa's patents were invalidated this year by courts in Canada and Germany. However, Lilly officials have predicted
slight impact from generic competition in those small markets.

Preparation for coming patent expirations on several Lilly drugs, Belt said, "has been something that's been considered
and addressed throughout the company."

That's typical for major pharmaceutical companies. They rely on sales of current drugs, particularly blockbusters like
Zyprexa, to bring in stratospheric profits in order to pay to research and launch the next generation of drugs.

Lilly's annual cost to manufacture Zyprexa or any similar chemical compound is no more than 10 percent of the drug's
total sales, according to former consultants and executives for the company. That means producing Zyprexa likely costs less
than $500 million a year.

The company also has to pay sales and marketing and R&D costs for Zyprexa–including an effort to win approval for a
new version patients would take by injection every few weeks, rather than ingesting pills daily. Lilly doesn't break out
such costs by drug, only companywide.

However, because Zyprexa is mature, those costs would be below average, former consultants and executives say. IBJ estimated
that, after factoring other administrative costs, the drug accounted for $2 billion of Lilly's $4.4 billion in pretax
earnings last year–a profit margin of 46 percent.

"That's a big number they have to make up for between now and 2011," said George Farra, a principal at Woodley
Farra Manion Portfolio Management in Indianapolis. He added, "[Prasugrel] has the potential to be the kind of drug that
could make a difference."

'Patent cliff'

Lilly has other popular drugs beside Zyprexa, but that doesn't necessarily make its future brighter. Many of them face
looming patent expirations, too.

Lilly had four other drugs that topped $1 billion in sales last year: Humalog insulin; Gemzar, a cancer drug; Evista, an
osteoporosis therapy; and Cymbalta, an antidepressant, which is fast becoming Lilly's newest star. At its current pace,
its sales could hit $2 billion this year.

Combined with Zyprexa, those drugs account for 60 percent of Lilly's sales. And they all face patent expiration in 2013
or 2014.

Lilly risks falling off a "double patent cliff," wrote Morgan Stanley's Rubin.

The answer to this problem is to fill the pipeline with new drugs. And Lilly does have many other promising compounds.

Last month, Lilly's partner Amylin Pharmaceuticals reported positive test results on a once-a-week version of Byetta,
a popular diabetes medicine that has been shown to help some patients lose weight. Lilly derived $87 million in third-quarter
revenue from a daily version of Byetta, up 40 percent from a year ago.

Lilly also is developing enzastaurin to treat non-Hodgkin's lymphoma and arzoxifine to treat osteoporosis and to prevent
breast cancer.

"While prasugrel is important," Belt said, "we've got to have multiple shots on goal." He added,
"Just as our current business isn't based only on Zyprexa, so our pipeline isn't based only on prasugrel."

Moody's Investors Service ranks Lilly's pipeline third best in the industry. It evaluates pipelines by projecting
peak sales for all drugmakers' new and late-stage test compounds and then dividing that total by each company's annual
sales.

Moody's estimates that Lilly's pipeline could produce as much as 18.6 percent of its current sales, or about $3 billion.
Moody's assumes nearly $2 billion of those sales would come from prasugrel.

If that projection is correct, it wouldn't cover the loss of Zyprexa sales, let alone the loss of sales from other drugs.

Another problem for Lilly–and all its pharmaceutical peers–is that the U.S. Food and Drug Administration has been tougher
on drug approvals, meaning some promising compounds have failed to take off.

For example, the FDA in 2006 indicated it likely would approve Lilly's Arxxant to treat diabetic eye disease. But it
first required Lilly to perform an additional–and expensive–clinical trial. Lilly appealed that decision, but the FDA rejected
its plea in March.

New York-based Pfizer, the nation's largest drugmaker, has had even worse luck. It stopped clinical studies last year
on a highly touted heart medication, torcetrapib, when it found it heightened the risk of death. And just last month, it yanked
its inhaled insulin Exubera off the market. An FDA warning about Exubera's effect on lung function depressed total sales
of Exubera this year to just $12 million.

Industrywide problem

In July, Moody's began to assign negative outlooks on the corporate bonds of any drugmaker that faces a major patent
expiration in the next three years. Lilly could face such an assessment as early as next fall.

But it's not alone.

Wyeth faces the loss of patent protection on Effexor, a $3.7-billion-a-year antidepressant, in 2008. Pfizer faces the loss
of patent protection on Lipitor, its $12-billion-a-year cholesterol drug, as early as 2010.

For Bristol-Myers Squibb, it's Plavix, in 2011. And for Merck, it's Singulair, a $3.6-billion-a-year asthma drug,
in 2012, with patent expirations on other blockbusters even earlier.

"We're just taking the position that all of those companies are highly exposed," said Michael Levesque, the
Moody's analyst, in an interview. "It's a few years away. It gives companies time to prepare and revise their
strategies, maybe do more acquisitions."

It's an unprecedented time in the industry, analysts say, to have so many companies face blockbuster patent expirations
and have relatively thin pipelines to replace them.

That's why Levesque and Funtleyder expect mergers, which would allow pharmaceutical companies to use economies of scale
to overcome a lack of revenue.

Lilly has pursued a strategy of licensing molecules, more than buying companies. Byetta and prasugrel are both examples of
that. Also, Lilly co-developed its Cialis impotence pill with Icos Corp., then acquired the whole firm in January.

Lilly has made two other acquisitions this year. It bought Hypnion Inc., a maker of sleep medicines, and Ivy Animal Health
Inc. Lilly also continues to be active signing licensing deals for new drugs. In October alone, it signed two such deals.

But Lilly has proportionally fewer resources with which to do similar deals than most of its other peers. Moody's pegs
Lilly's cash-to-debt ratio as third lowest among the industry's 10 largest companies.

Lilly's other option is to become more efficient. Already, in the last three years, it has trimmed its work force by
3,000. More cuts would be bad news for Indianapolis, where Lilly employs 14,000. But it's better than the company's
being acquired.

"You need new product. Right now, the drugs they have out there are growing nicely, particularly Cymbalta," said
Farra, the Indianapolis portfolio manager. "Then, let's hope they control their expenses."