Eli Lilly: Life after Prozac patent expires — (Bloomberg BusinessWeek Magazine)

Thanks to Prozac, Sidney Taurel has had it pretty easy. No, he doesn’t take it himself. But until recently, the chief executive of Eli Lilly & Co. (LLY) could depend on the antidepressant to give a steady lift to his company’s numbers. Prozac, with 40 million users, accounted for a quarter of Lilly’s $10.8 billion in sales and more than a third of its $3 billion profit last year. With Prozac’s U.S. patent set to expire on Aug. 3, however, Lilly will no longer be protected from cheaper generics. Within weeks, the company could see two-thirds of its global market for Prozac–and much of its profit–vanish.

That would indeed be a bitter pill to swallow. But foreseeing the end of the Prozac monopoly, Taurel, a 30-year Lilly veteran (and a director of the McGraw-Hill Companies, corporate parent of BusinessWeek), furiously ramped up new-drug development after becoming CEO and chairman in 1998. He increased the research and development budget about 30%, to more than $2.2 billion, hired 700 scientists in the last year alone, and in a search for the next blockbuster, ordered Lilly’s 6,900 researchers not to bother with any drug unlikely to top $500 million in annual sales. The payoff: Lilly now has a medicine cabinet stocked full of promising new drugs, including treatments for schizophrenia and for sepsis–a potentially fatal form of bacterial infection. Provided that management is able to handle some significant challenges from regulators and competitors, those new products could more than offset Prozac’s loss in just 12 months.

POTENTIAL HITS. Taurel, 52, vows that’s only the beginning. He is determined not to be painted into a corner again. “The situation we had in the mid-1990s, of having 35% of our sales dependent on Prozac, won’t repeat itself,” he says. Indianapolis-based Lilly has scheduled the rollout of 10 products, each a potential hit, over the next three years. Add in drugs introduced in the past five years, and Lilly could have 15 potential megasellers with long-lived patents and Prozac-size gross profit margins of 90% by 2004. And in Lilly’s labs, scientists are working on enough other drugs to keep the company’s string of high-impact product launches going through the rest of the decade. Says August M. Watanabe, Lilly’s executive vice-president for science and technology: “It’s not just one big bang and that’s it.”

Only a year ago, analysts and investors were skeptical that Lilly could plug the Prozac hole. Acting on a lawsuit by generic drugmakers, a U.S. Court of Appeals ruled last Aug. 9 that Lilly would have to cede its Prozac patent in 12 months, rather than in late 2003, as Lilly had hoped. Lilly’s stock plunged by almost a third in one day, to $75 a share, wiping out $36.8 billion in equity. The stock bottomed out at $66 the next month. But Lilly’s R&D machine has changed minds on Wall Street. Now, Morgan Stanley Dean Witter & Co. analyst Jami Rubin estimates that beginning in 2003, as profits from the new drugs kick in, annual earnings at Lilly should jump 17%. That will follow two years of single-digit profit growth. In 2001, Lilly is expected to net $3 billion, up 4%, as sales rise 5%, to $11.5 billion.

Lilly shares meanwhile have rebounded to about $76, and with a price-earnings ratio of 27.6, the company trades at a higher multiple than rivals Merck, Bristol-Myers Squibb, and Schering-Plough. “They’re doing all the right things,” says James Fenger, lead portfolio manager of the Scudder Health Care Fund, which held 75,000 Lilly shares as of Mar. 31.

Lilly’s suddenly rosy prospects also have validated Taurel’s determined go-it-alone strategy. Unlike the competition, Lilly has spurned acquisitions as a way to come up with new products, preferring to create them in its own labs or form marketing pacts with biotech companies whose compounds fill out Lilly’s sales catalog. Taurel says he has analyzed data on drug industry deals over the last 30 years and found that growth rates at companies engaged in takeovers lag behind the rates at companies that kept to themselves. He believes the merged companies suffered as cost-cutting and culture clashes traumatized their research efforts. “There is no correlation between innovation and size,” the CEO insists, while acknowledging that unlike smaller rivals, Lilly has the financial muscle to pay the $1 billion it can take to bring out a new drug. Lilly also has an 11,500-member sales force to push new pharmaceuticals. And it usually doesn’t require major national ad campaigns, since many of its products, such as the diabetes drugs Humulin and Humalog, are aimed at smaller patient groups.FICKLE. Still, with Lilly’s fortunes tied so closely to the notoriously fickle–and highly regulated–market for new drugs, Taurel will have to deftly juggle several daunting challenges to his Prozac replacements. For instance, the company had planned to begin selling Xigris, a first-of-its-kind treatment for sepsis, by October, its first drug launch after Prozac goes off-patent. But the Food & Drug Administration recently pushed that date back by at least two months. Taurel concedes that the FDA has raised quality-control questions about a subcontractor Lilly has hired to help make Xigris. But he says the real hang-up is that the agency needs the extra time to review the drug’s 81,414-page application.

Add to that the competition Lilly suddenly faces for Zyprexa, a schizophrenia drug that has surpassed Prozac as the company’s top seller, with expected 2001 sales of $2.8 billion. In the spring, Pfizer Inc. launched Geodon, which is considered to have an edge over Zyprexa because it does not cause weight gain. Taurel claims that based on early sales results and feedback from doctors, Geodon won’t be a threat because Zyprexa has advantages of its own. Zyprexa needs to be taken only once daily, vs. a twice-a-day regimen for Geodon. And Lilly says that patients can mitigate their weight gain if they take Zyprexa with another Lilly drug, Axid, which is formulated to treat ulcers. Still, analysts warn that Geodon could eventually eat into Zyprexa’s dominance. “We’ll know in the next three months whether Geodon will be a problem,” says Steven C. Tighe, a drug-industry analyst at Merrill Lynch & Co.

Analysts point out that new-drug markets are inherently unpredictable. Says Mara Goldstein, an analyst with CIBC World Markets: “Sometimes products look good on paper, but they don’t turn out that way in reality.” In 1998, for instance, the company launched Evista–which can prevent and reverse osteoporosis in older women–in the hopes that it would become an overnight success. But first-year sales came to a less-than-spectacular $144 million. Why? Taurel says it was harder than expected to convince women to buy the drug before they have symptoms of the degenerative bone disease. But after Lilly tweaked its marketing effort, the drug took off, with sales expected to top $700 million this year. It is a blockbuster after all.

Even with its carefully nurtured new products and some early successes, Lilly executives know that their work is cut out for them in replacing their franchise drug. “I’ve been told no one has survived this type of patent expiration,” confesses Richard D. DiMarchi, group vice-president for research and development. There’s a first time for everything, however. And Taurel is determined to prove to investors that they don’t need Prozac to be happy.  By Michael Arndt in Indianapolis