Eli Lilly

(LLY) - Get Report

enters the third quarter trying to impress investors with strategies for expanding its diabetes franchise and protecting its position in neuroscience.

A successful offense and defense will determine how well the Indianapolis-based company can inject life into its stock, which trails an index of large drugmakers as well as the

S&P 500

. In the past 12 months, Lilly's stock is off 13%, the Amex Pharmaceutical Index is up 3.4%, and the S&P 500 has gained 11.5%.

On the diabetes front, Lilly starts the quarter with a new product, Byetta, on the market, a new licensing deal with Japan's


for an experimental drug, some hopeful signs from the laboratory and decent reviews coming from last month's American Diabetes Association scientific conference.

As for neuroscience, Lilly is breathing a bit easier now that a

patent challenge to its schizophrenia drug Zyprexa has been defeated (although the challengers plan to appeal). But Lilly is still coping with weakening U.S. sales of Zyprexa, its best-selling drug, and with disappointing sales of Strattera, a treatment for attention deficit hyperactivity disorder.

The pushing and pulling of good news, bad news and uncertain news means many analysts are sitting on the fence.

"In spite of overall positive views on Lilly's fundamentals, our neutral rating reflects our view of uncertainty stemming from the Zyprexa patent decision and, regardless of the patent dispute outcome, Zyprexa performance," says Chris Shibutani of J.P. Morgan in a recent research report.

Side Effects

Shibutani and 13 other analysts are neutral on the stock, according to Thomson First Call. There are nine buy ratings and two sell ratings.

Zyprexa's sales have been hurt since 2004 by newer drugs from

Bristol-Myers Squibb

(BMY) - Get Report



(AZN) - Get Report

that cause fewer side effects, such as weight gain, Shibutani says.

Worldwide Zyprexa sales for the first half of 2005 should reach $1.08 billion, down 11% from the same period last year, he says. Foreign sales for the second quarter should be up 10%, but U.S. sales will probably be down 26%. The analyst doesn't own shares, but his firm has had an investment banking relationship with Lilly.

The company will report its latest financial results Thursday, and Wall Street analysts, on average, expect Lilly to earn 67 cents a share in the second quarter and $2.82 for the year. The revenue estimates are $3.69 billion for the quarter and $14.8 billion for 2005.

For the quarter ended June 30, 2004, Lilly had a profit of 60 cents a share and sales of $3.56 billion.

To move Shibutani out of neutral, Lilly would have to produce better-than-expected sales for Zyprexa and Strattera and enjoy "earlier-than-expected progress" among key experimental drugs.

Robert Hazlett, of SunTrust Robinson Humphrey, takes the same information on Zyprexa and other drugs, but he comes up with a buy rating. Yes, Zyprexa has troublesome side effects, Hazlett tells investors in a July 6 research report, but "we continue to maintain that Zyprexa's full range of benefits and risks will continue to drive prescription growth."

He says Zyprexa is still the most effective drug among its peers, and "it is this efficacy, along with a moderate side effect profile, that we believe will continue to result in prescription growth for the drug," he adds.

Hazlett says the chance of a generic competitor overturning

a federal judge's ruling in mid-April is "small." An adverse appeals court ruling would wreck the stock, but he doesn't expect a ruling until late 2006. He expects any appeals court decision to be appealed, too, thus extending the legal saga for several more years.

"With Lilly's excellent late-stage pipeline now coming on line, and with even more potential blockbusters in the wings ... we remain convinced Lilly has the potential for sustained midteens EPS growth over the long term," says Hazlett, who doesn't own shares and whose firm has had a noninvestment banking relationship with the company.

Diabetes Drugs

Diabetes products accounted for about 20% of corporate sales last year, and much of the encouraging news for Lilly is related to drugs now in clinical trials or new to the marketplace.

Hazlett says the deal with Taisho enabled Lilly to license a drug, in early stage clinical trials, for helping the body produce natural insulin in response to rising levels of blood sugar. This compound belongs to a class of drugs called DPP-IV inhibitors, and many of the world's pharmaceutical giants are trying to develop this next-generation treatment.

Another experimental drug -- "a potential blockbuster," he says -- being examined is a treatment for a host of ailments linked to diabetes, such as nerve pain, eye damage and kidney damage. Lilly may submit an application to the FDA by the end of the year.

Gilalilly Monster
When nature's fury is friend, not foe.

On Tuesday, Lilly and its partner


(ALKS) - Get Report

said they had started a late-stage trial of an inhaled insulin. The product is about two years behind the leading inhaled insulin candidate, Exubera, which is being reviewed by the FDA. Exubera is made by


(PFE) - Get Report



(SNY) - Get Report


Nektar Therapeutics

(NKTR) - Get Report


Lilly and another partner,

Amylin Pharmaceuticals

( AMLN), recently began marketing Byetta, which helps patients manage their blood-sugar levels. Lilly says most patients in long-term clinical trials lost weight while taking Byetta, which was originally isolated from the saliva of the Gila monster. The drug must be injected twice a day.

Byetta is the first marketed drug in the class called incretin mimetics. "First in class Byetta emerged as one of the stars of the

American Diabetes Association conference," says a recent report from Sagient Research Systems, of San Diego, whose BioMedTracker report follows the research and investment prospects of biotechnology companies.

"While the number of doctors we spoke with at the ADA conference were initially hesitant about Byetta -- citing they would rather just start insulin -- minds were changed as physicians learned more about the possible benefits," the Sagent report says.

Noting that "physician education will be important," Sagient says the big question for patients, and for Byetta sales, will be their willingness to be injected.