Lilly Touts Its R&D Reorganization And Pipeline Prospects, But A Looming Patent Cliff And Risky Bets Take Center Stage

John Lechleiter faced a tough crowd on Dec. 10: three months after announcing a reorganization of Eli Lilly's R&D apparatus and global cutbacks, the drug maker's CEO came to New York to explain to Wall Street analysts how he planned to cope with a massive loss of revenue due to begin in just two years as patents expire on several best-selling medicines.

"We're well aware that you have some important questions about our plans going forward," Lechleiter said in his opening remarks at the Equitable Center in Manhattan. "Will we engage in large-scale M&A? Do we have the ability to fund our emerging pipeline? We want you to leave today's meeting sharing our confidence in Lilly's future prospects."

For the next three-plus hours, Lechleiter and his team trotted out slide after slide to buttress their contention that drugs under development - such as a handful of late-stage cancer and Alzheimer's molecules and new indications for existing drugs - notably using the Cymbalta (duloxetine) antidepressant to treat chronic pain - can help patch over what, admittedly, will be a difficult stretch.

Moreover, they used the meeting to talk up their R&D reorganization, which involved carving out several stand-alone units that will now focus exclusively on oncology and diabetes drugs, as well as emerging and established markets. And they created a so-called Developmental Center of Excellence, which is supposed to refine and accelerate the time-consuming process of running late-stage clinical trials.

A notable portion of the R&D discussion was also devoted to Lilly's closely watched Chorus experiment, an autonomous unit of about two dozen specialists from across the R&D organization whose goal is to move compounds to proof-of-concept faster and cheaper than the traditional internal research group (¹ (Also see "Lilly Sings A New Tune: Chorus Unit Brings High Efficiency Note To Early R&D" - Pink Sheet, 26 Feb, 2007.)).

To date, five new chemical entities made it through proof of concept and were transferred back to Lilly's research labs for further development. And overall, the seven-year-old pilot program has saved an estimated $100 million in research costs. Lilly execs say they are so pleased with the results that a second Chorus unit is being created.

This means that roughly half of the 60 compounds in Lilly's pipeline - by most measures, a more-than reasonable number of prospects - will be part of the Chorus experiment. The drug maker is also expanding the concept by actively courting investors to finance clinical projects in order to lower the risk inherent in discovery and development, and is also looking at using the Chorus units to work on compounds obtained elsewhere.

"We are applying creative approaches to every point in the R&D chain to develop more medicines more quickly at a lower cost," said Steve Paul, executive vice president of science and technology, and president of Lilly Research Laboratories, who is retiring in February after 17 years with the drug maker and will be replaced by Jan Lundberg, executive vice president and head of global discovery research at AstraZeneca.

It remains unclear what, if any, changes Lundberg may institute once he arrives; he has kept a low profile since his hiring was announced last month. At AstraZeneca, he was known for emphasizing a strategy to hasten discovery efforts and using licensing deals to unlock the value of compounds housed in the pipeline.

Paul, however, maintained that the reorganization and various programs that he has put in place to speed discovery and research will mean that Lilly should have at least 10 molecules in Phase III by the end of 2011. This would allow the drug maker to start launching at least two new medicines by 2013.

The emphasis on being aggressive cropped up just a day before the presentation. Lilly ended a five-year collaboration with Isis Pharmaceuticals for LY2275796, a second-generation compound targeting eukaryotic initiation factor 4E, which recently completed Phase I oncology trials (² (Also see "Deals Of The Week: GSK/Intercell, Novo Nordisk/ZymoGenetics, Lilly/Isis ..." - Pink Sheet, 14 Dec, 2009.)). Isis is paying an undisclosed amount to reclaim the product and explained that it was being overlooked in the wake of Lilly's $6.5 billion acquisition last year of ImClone Systems, which involved several cancer compounds.

But data for the compound has been sparse, leading Leerink Swann analyst Joseph Schwartz to speculate that Lilly returned the drug due to a lack of cancer-fighting activity, or perhaps toxicity. Whatever the reason, the move suggests that Lilly is, indeed, more concerned with devoting resources to late-stage assets rather than riskier, early-stage products.

But the audience was largely unimpressed. A key issue confronting Lilly is that its near-stage pipeline consists of a half dozen compounds, and three are targeting oncology and Alzheimer's disease, which are known for high attrition rates. As Tim Anderson, an analyst at Sanford Bernstein & Co., commented in an investor note: "None is a slam dunk." And teplizumab, one of the molecules that is in Phase III testing for treating Type I diabetes, was almost entirely discounted by another analyst, who described it as an extremely high-risk compound that wasn't worth factoring into long-run sales projections.

"Lilly's pipeline remains anemic and cost cutting may not go as deeply as we expected," wrote Jon LeCroy, an analyst at Hapoalim Securities, in an investor note that referred to Lechleiter's plan to cut $1 billion in expenses and some 5,500 jobs - or 13 percent of the global workforce by 2011. "Things may be worse than we thought."

There is no secret, though, about the source of problems that Lilly is about to confront. A parade of medicines will soon lose patent protection and encounter lower-cost competition, beginning late next year with Gemzar (gemcitabine), a $1.8 billion seller oncologic. The really big loss, though, will occur in 2011, when the atypical antipsychotic Zyprexa (olanzapine) goes off patent. At that point, Lilly will quickly start losing a huge amount of money - the widely prescribed pill generated $4.7 billion in revenue in 2008.

Just one year later, another $1 billion seller - the osteoporosis drug Evista (raloxifene) - loses patent protection. And in 2013, the patent expires on Cymbalta, which generated $2.7 billion in sales last year, or 13 percent of all 2008 revenue.

All totaled, this is an overwhelming loss of revenue. Two years ago, for instance, Lilly was replacing every $1 in sales of declining drugs with $6.64 in sales from newer products, defined as drugs launched during the previous five years. By 2012, this replacement ratio is expected to plummet to just 22 cents, according to AVOS Life Sciences, a consulting firm.

Looked at another way, the drugs scheduled to fall off the patent cliff accounted for a whopping 57 percent of Lilly's recent third-quarter revenue, according to Fitch Ratings.

Meanwhile, Lilly's newest drugs face uncertain prospects. A key example is Effient (prasugrel), the blood thinner launched this past summer after a lengthy delay (³ (Also see "Effient Review Delayed More By Management Issues Than Clinical Disputes" - Pink Sheet, 9 Nov, 2009.)). Once considered to be a potential blockbuster that could rival Plavix (clopidogrel), Lilly/Daiichi Sankyo's antiplatelet agent is off to a slow start on formularies. And with competition from generic Plavix and AstraZeneca's coming Brilinta , analysts have lowered their expectations. Hapoalim's LeCroy, for instance, forecasts Effient sales will hit only $360 million by 2014.

There is also mixed enthusiasm for another drug expected to receive FDA approval in 2010 - Byetta LAR (exenatide), a long-acting, once-weekly version of Lilly's existing Byetta Type 2 diabetes drug, which was licensed in a 2002 deal and has been linked to cases of pancreatitis.

The potential of the new version, which Lilly is developing with Alkermes and Amylin, is unclear. David Kliff of Diabetic Investor believes that doctors and patients will embrace the convenience of once-a-weekly administration, but Wall Street estimates Lilly won't receive more than $600 million in royalties and foreign sales by 2015, which is not nearly enough to compensate for the patent cliff.

Further complicating matters is that Lilly has only about $4 billion in cash and securities, insufficient for scooping up a rival. This makes it easier for Lechleiter to forsake the possibility of doing a big deal, a prospect that he maintains is not worth pursuing, despite ongoing Wall Street speculation that Lilly should consider a merger of equals with Bristol-Myers Squibb.

"We see a divergence of strategies among our peers to deal" with the challenges facing Lilly and most of its rivals, he told the crowd at the Dec. 10 business review. Large-scale "M&A is not the way to go. ... Our strategy is to create value by accelerating the flow of innovation." Whether Lilly can accelerate that flow fast enough is the open question.

- Ed Silverman ( ⁴ [email protected] )