Fitch Affirms Eli Lilly & Co.'s Ratings.

CHICAGO -- Fitch Ratings has affirmed Eli Lilly and Co.'s (Lilly) Issuer Default Rating (IDR), bank loan, and senior unsecured debt ratings of 'AA' and commercial paper rating of 'F1+'. The Outlook remains Stable. The ratings apply to approximately $6.32 billion of outstanding debt.

Lilly has refreshed its pharmaceutical product portfolio since the patent expiration of its once top-selling drug, Prozac in August 2001. The product offering includes the pharmaceuticals launched over the past four years, specifically Alimta, Byetta, Cialis, Cymbalta, Forteo, Strattera, Symbyax, Xigris, and Yentreve, which collectively generated $3.18 billion of sales for the LTM period ending June 30, 2006, (21.1% of total company revenues) and grew 58% over the same period in 2005. Sustained successful commercialization of new products eases revenue and earnings concentration with the Zyprexa franchise, currently representing 27.8% of total sales for the latest 12-month (LTM) period ending June 30, 2006, down from 34% at the end of 2003.

Lilly had reversed sequential margin compression in 2006 that had been present since the patent expiration of Prozac. EBITDA margin for the LTM period ending June 30, 2006, was 31.6% up from 29.9% at the end of 2005. Fitch anticipates that continued market uptake of new drug products and successful commercialization of the late-stage R&D pipeline together with Lilly's focus on productivity and efficiency initiatives will support stabilization of margins. Market uptake of new internally-developed products (Alimta, Strattera, and Forteo), continued strong revenue growth of Gemzar and Evista, along with the moderation of the Zyprexa sales decline and benefits of restructuring actions will also more or less offset a sustained high level of investment dedicated to advancing the R&D pipeline, and royalties given to marketing partners of newer in-licensed products, specifically Cymbalta and Byetta.

Lilly continues to dedicate significant investment in its research and development (R&D) program, spending $3.08 billion for the LTM period at the end of the second quarter of 2006 or 20.4% of total sales. The company expects to file a total of five new molecular entities (NMEs) with the FDA within the next four years, namely prasugrel for the treatment for heart-related chest pain, arzoxifene for osteoporosis treatment, enzastaurin for glioblastoma, and inhaled insulin for the treatment of Type 2 diabetes, and including the currently-registered Arxxant for the treatment of diabetic retinopathy. Lilly's intellectual property position is solid, as no significant patent expirations are expected in the intermediate-term notwithstanding successful legal challenges to Zyprexa, Gemzar and Evista patents.

Fitch's primary concerns centered on litigation risk with an emphasis on legal challenges to Zyprexa, Gemzar and Evista patents and exposure from a rapidly increasing number of Zyprexa liability claims outside of the master settlement agreement established in September 2005. Significant uncertainty surrounds the final outcome of the litigation pertaining to Paragraph IV challenges to the Zyprexa compound patent (presently in the appeals process), the Evista method-of-use and formulation patents, and the Gemzar compound and method-of-use patents. If the patents are not successfully defended, the subsequent loss of sales to generic competition would adversely impact the credit. Additional litigation exposure arises from the growing number of Zyprexa product liability claims not currently bound by the settlement agreement, which totaled 7,600 at the end of the second quarter of 2006 (from 465 at the end of 2005).

The lack of sustained free cash flow generation has Fitch concerned; however, Lilly's total capital needs have moderated in 2005 and year-to-date 2006 due to project completions. Lilly's cash flow from operations of $1.38 billion for the LTM period ending June 30, 2006 was completely utilized by the company's dividend payments of $1.70 billion and capital expenditures of $1.07 billion. Fitch believes that free cash flow generation will remain weak for the rating category in 2006, but improve annually through the long-term, including annual increases to the dividend.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site. The issuer did not participate in the rating process other than through the medium of its public disclosure.