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Big Pharma's Report Card

The third quarter of 2004 hasn't been kind to the major U.S.-based pharmaceutical companies. In a period in which several of the players are already struggling with a dearth of new product launches, declining sales of key products, and looming patent expirations, Merck's (MRK) surprise market withdrawal of Vioxx , its COX-2 inhibitor pain medication, was the biggest blow. The withdrawal meant not only the vaporization of $2.5 billion in annual sales, but also the beginning of a long product-litigation nightmare for the company.

Meanwhile, Bristol-Myers Squibb (BMY) and Schering-Plough (SGP) experienced slight sales declines, as weakness in their key franchises -- Bristol-Myers' in its cholesterol-lowering statin Pravachol and Schering-Plough's in its hepatitis C treatment PEG-Intron -- offset gains by younger products. Eli Lilly (LLY) continued to suffer declines in U.S. sales of its antipsychotic drug Zyprexa.

All four outfits experienced gross margin declines. And some companies, such as Bristol-Myers and Lilly, are shedding sales staff. Restructuring will be a consistent theme for the next several quarters as several of the major pharmaceutical companies pare R&D, manufacturing, and sales infrastructures to adapt to the harsher reality the industry is now facing. Even 'AAA'-rated Pfizer (PFE) warned that results in 2005 will be affected by generic competition to four major products -- Diflucan, Neurontin, Accupril, and Zithromax -- which collectively accounted for $5 billion in annual sales. Not the best of times for Big Pharma.

However, not all the news was bad. Lilly and Wyeth (WYE) both posted double-digit sales increases in the third quarter because of continued strong sales growth of their key products. Merck and Schering-Plough jointly launched the high-sales-potential cholesterol-lowering treatment Vytorin, and Lilly launched its antidepressant Cymbalta. Furthermore, the passage of the American Jobs Creation Act provides pharmaceutical companies with a major opportunity. Major industry players haven't yet disclosed publicly any plans on repatriating funds from abroad.

Where do the big drug outfits stand in the wake of these recent developments? Here are Standard & Poor's Ratings Services' views on the credit ratings and outlook for major U.S.-based pharmaceutical companies:

Bristol-Myers Squibb (Rating: A-/CreditWatch: Negative)

Despite strong sales growth of Plavix and Avapro, Bristol-Myers faced a 2% overall decline in U.S. third-quarter sales and essentially flat worldwide sales as its drugs Paraplatin and Glucophage came under fire from increased generic competition.

Meanwhile, Pravachol fell prey to branded competition, its total sales dropping 24%, to $598 million, as it faced continued pressure from Pfizer's Lipitor, the market leader, and from a newly launched rival, Vytorin, from Merck and Schering-Plough. Pravachol doesn't lose patent protection until early 2006, but sales are expected to continue sliding, a decrease that may accelerate. Standard & Poor's expects Plavix and Avapro to continue generating strong growth in the intermediate term.

Developments to watch:

Bristol-Myers is expected to file for U.S. Food & Drug Administration (FDA) approval on three drug prospects over the next year.

Patent litigation on Plavix is set to go to trial in early 2005.

Standard & Poor's will also watch the rate of decline in the sales of Pravachol.

The bottom line: Management has made progress in resolving several of the company's issues, and has begun to shrink infrastructure. (It recently reduced its sales force by 500.) However, Bristol-Myers needs additional new products now. A gradual decline in Pravachol sales over the next year and a half, after which its patent expires, is incorporated in the ratings. However, an adverse litigation development on Plavix isn't. The loss of Plavix sales would likely result in a downgrade. The magnitude of such a downgrade depends a great deal on the success of newer products.

Eli Lilly (Rating: AA/CreditWatch: Stable)

Lilly's eight newer franchises, including the key products Cymbalta, Strattera, and Cialis, contributed 12% of total company sales, up from 6% last year. Standard & Poor's expects these newer drugs to continue to contribute a greater portion of Lilly's revenues and earnings. However, these new products are being counted on heavily to offset possible continued declines in some key franchises.

Increasing competitive pressures in the U.S. have hurt the sales of two key franchises. Sales of Lilly's all-important Zyprexa dropped 9% in the third quarter on a 22% decline in the U.S. The domestic retreat followed wholesaler destocking, which possibly reflects less U.S. demand. Zyprexa fared better internationally, as sales grew 12%. Sales are expected to grow worldwide for the full year, but the recent declines are troubling. Evista sales also declined in the third quarter as a result of competition in the U.S. market. Competitive pressures also led to a slight decline in the diabetes franchise.

In the meantime, Lilly announced a restructuring that will result in the elimination of nearly 1,000 positions, 575 of which are related to sales and marketing. The restructuring should be mostly completed by May 31, 2005, at an estimated cost of $320 million to $420 million. The charge will be taken in the fourth quarter of 2004.

Developments to watch:

Cymbalta is the most important of the recent launches. Standard & Poor's will watch to see how sales of the drug ramp up.

Zyprexa's U.S. sales decline is troubling, as the drug generates nearly half of Lilly's earnings.

There has been no news on the ongoing Zyprexa patent trial, but Standard & Poor's is keeping an eye on it.

The bottom line: The launch of Cymbalta was a key development for the company. There are no immediate concerns about the rating. However, in the longer term, the sales growth of newer products, such as Cymbalta, is critical if the company is to maintain its business profile.

Merck (Rating: AAA/CreditWatch: Negative)

Merck has had an eventful third quarter, to say the least. The surprise withdrawal of its COX-2 inhibitor Vioxx eliminated $2.5 billion in annual sales of a franchise that scored higher-than-average margins. Merck was counting on the drug to be a core product, as it was already facing the loss of its top product, the cholesterol treatment Zocor, in 2006. The withdrawal of Vioxx also caused a significant amount of collateral damage. (An estimated $200 million of inventory at wholesalers will be returned, while $93 million of inventory on hand will be destroyed.)

Furthermore, Merck could face a flood of Vioxx-related lawsuits. Whether or not these reap large settlements, the litigation would be a major distraction for management at a time when it's trying to revitalize its business.

Merck's second-generation COX-2 inhibitor, Arcoxia, has been delayed, and sales prospects are now uncertain at best. The steep drop in Merck's stock price also makes it less attractive to use stock as a currency for transactions. No litigation reserves have been taken.

The Vioxx implosion now makes Merck more reliant on its remaining core products. Cozaar/Hyzaar continues to do well, growing 15% year-to-date, and the franchise's market share remains steady in a growing angiotensin II receptor blocker market. Fosamax sales were up 13%, including the unfavorable effect of a wholesalers' advance buy-in of $10 million. Fosamax once-weekly had patent protection in the U.S. and Europe until 2007, but the European patent office has revoked it. Merck has appealed.

Singulair grew 2%, but that included an unfavorable comparison because of a wholesaler buy-in of $120 million last year. Zocor sales were down 13%, in part because of an unfavorable comparison to last year because of a $110 million buy-in, but also because of continued generic inroads in international markets where Zocor has lost patent protection.

Vytorin was approved by the FDA this past quarter, and net sales were $52 million. It's too early to determine how quick the sales ramp-up on Vytorin will be, but because the drug's earnings are shared by Merck and Schering-Plough, it would have to be rapid if Vytorin is to be a significant contributor to Merck's earnings and cash flows.

Developments to watch:

Merck can expect more Vioxx headaches in the form of lawsuits.

Restocking its pipeline is even more critical now, given the loss of Vioxx and the uncertain potential of Arcoxia. Progress of three vaccines through Phase III clinical trials is critical.

It's important to watch for the continued health of Merck's remaining core franchises.

The CEO will retire in 2006, and this could augur a change in company strategy.

The bottom line: Standard & Poor's plans to resolve the CreditWatch listing within the next three months (see BW Online, 11/1/04, "Merck on Watch for Debt Downgrade"). With so many strategic concerns and uncertainties, Standard & Poor's will have to determine whether Merck continues to warrant an AAA rating.

Pfizer (Rating: AAA/CreditWatch: Stable)

Pfizer's cholesterol-lowering treatment Lipitor posted double-digit gains in sales and new prescriptions in the third quarter. Meanwhile, sales of its Celebrex/Bextra pain-medication franchise will benefit from Vioxx's withdrawal. However, in the longer term, the sales growth prospects of the COX-2 franchise is uncertain, given the greater scrutiny on the category.

Zoloft suffered slight sales declines after the FDA voiced concerns about the use of such antidepressants. Norvasc sales were also slightly down after the drug lost its patent exclusivity in select foreign markets. Viagra sales fell primarily because of increased competition in the erectile-dysfunction category. Nevertheless, Pfizer posted a slight increase in total sales, and cost-cutting efforts helped bolster earnings.

Developments to watch:

Successful commercialization of new products is critical, as Pfizer is set to lose several major products to generic competition over the next couple of years.

A number of Pfizer's core products, such as Zoloft, Viagra, and Lipitor, face increasing competition.

Lipitor will account for an increasing portion of sales, especially as patents on a number of other products expire. Also, the launch of Vytorin and the expected launch of generic Zocor and Pravachol in early 2006 will hurt sales growth prospects for Lipitor.

It's unclear how the withdrawal of Vioxx will affect the long-term prospects of the Celebrex/Bextra COX-2 franchise.

The bottom line: Pfizer will be challenged over the next couple of years by a number of major patent expirations and increased competition to remaining franchises from both branded rivals and generics. The company, however, has several promising prospects and an exceptional financial profile, so Standard & Poor's isn't currently concerned about the rating.

Schering-Plough (Rating: A-/CreditWatch: Negative)

Schering-Plough has taken some major steps in the third quarter toward turning around its beleaguered pharmaceutical business, but management still has a lot of work ahead. It recently launched Vytorin, its high-profile cholesterol lowering drug. It has also entered into a strategic alliance with Bayer. Schering-Plough also boosted its liquidity with the issuance of $1.5 billion in preferred securities.

Still, it is too early to judge Vytorin's success. As a combination of the successful Zetia and Merck's Zocor, Vytorin should be a major success, but this depends on how quickly sales ramp up. The statin drug market faces generic competition in the first half of 2006, which may slow growth of the whole cholesterol-lowering category. Also, Schering-Plough shares in the earnings of Vytorin with Merck, and the launch of a cholesterol-lowering drug is very expensive. In the meantime, the drugmaker has yet to arrest the decline of PEG-Intron, and Clarinex appears to be a non-growth franchise. Furthermore, it's still contending with its manufacturing compliance issues. Remediation costs will continue through at least 2005.

Developments to watch:

Standard & Poor's will monitor the growth of the Vytorin/Zetia franchise.

Schering-Plough's pipeline is arguably one of the lightest in the industry. Standard & Poor's will monitor the company's efforts to restock.

The company must continue its efforts to resolve its manufacturing noncompliance issues.

The bottom line: The gradual deterioration in Schering-Plough's performance isn't a major concern at this point. However, we expect earnings to continue struggling over the next several quarters as PEG-Intron sales continue to decline and as the company incurs the costs of launching Vytorin. In the meantime, Vytorin must perform. In the first half of 2006, cheaper, generic versions of Zocor and Pravachol could slow the dollar growth of the overall market in cholesterol-lowering treatments.

Wyeth (Rating: A/CreditWatch: Negative)

The strong growth of the drugs Effexor, Prevnar, and Enbrel more than offset declines in Protonix and Premarin. Protonix competes against generic Prilosec, and in this very price-sensitive environment, sales will likely struggle in the future. The Premarin franchise, meanwhile, continues its sales slide. Both product developments, along with the strong growth of the remaining main drugs, are incorporated into the ratings and outlook on Wyeth.

On the 1999 class-action suit regarding the safety of its diet drugs, Wyeth is awaiting plaintiff response to its proposed amendment to its national settlement. This amendment would enable Wyeth to settle a number of Matrix 1- and Matrix 2-level claims (the least serious) for $1.275 billion. Implementation of the amendment would likely result in an additional charge. However, Standard & Poor's believes the implementation might actually be a positive development, as it would remove a major uncertainty facing Wyeth.

Developments to watch:

Because of diet-drug litigation, we wouldn't be surprised if Wyeth incurs another charge in the fourth quarter. The question is how large.

Continued growth of core products will be important as several key franchises face increasing competition -- Effexor vs. Cymbalta, Enbrel vs. Humira, and Protonix vs. generic Prilosec.

Amid pipeline maturation, Wyeth has some interesting prospects. The company needs to deliver them, as it confronts major patent expirations in 2008.

The bottom line: The negative outlook is less reflective of Wyeth's drug business, which is healthy and growing, than the uncertainty of the ongoing diet-drug litigation.

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