Shares of Alkermes (Cambridge, Massachusetts) dropped 9% Friday after the firm confirmed rumors in the market that its partner Eli Lilly (Indianapolis) plans to pull out of its deal to develop and commercialize AIR Inhaled Insulin, which currently is in Phase III development for diabetes.

When the market closed with shares of Alkermes down $1.14, to $11.26, Lilly released a statement confirming the news. While emphasizing that it had no safety concerns about the product, John Lechleiter, Lilly president/CEO, said the decision came after months of review. It would be “inappropriate,” he said, for Lilly to continue the program “Without the prospect of a new drug application.”

The company said it was in the process of contacting clinical investigators conducting the current AIR Insulin clinical trials to shut them down. Patients enrolled will be moved to other insulin therapies and in the U.S. Lilly will implement a patient assistance program to provide patients with financial support to fund their medications and diagnostic supplies through the end of 2008.

Lilly also said it will recognize a 1Q08 charge to earnings in the range of $90 million to $120 million.

“Clearly, the issuance of the press release indicates that Alkermes management believes the termination is likely,” analyst David Windley of Jefferies and Co. said in a research note.

The move by Lilly to drop the program follows Pfizer’s (New York) decision in October to abandon its inhaled insulin product Exubera (Medical Device Daily, Oct. 22, 2007), which it developed with Nektar Therapeutics (San Carlos, California) and Novo Nordisk’s (Bagsvaerd, Denmak) decision in January to end its partnership with Aradigm (Hayward, California) to develop AERx iDMS. (MDD, Jan. 17, 2008).

Alkermes noted in its statement that the inhaled insulin product successfully completed more than 10 Phase I and II clinical trials and is being evaluated in a broad multicenter, multinational Phase III program in thousands of patients with Types I and II diabetes.

The Phase III program, launched in 2006, was expected to be completed this year. Alkermes said that despite whatever decision Lilly makes, the biotech believes the Phase III trials should be completed.

“Data from these studies will provide patients, physicians and the scientific community with long-awaited and important data for the evaluation of new diabetes medications,” Alkermes said.

Alkermes’ announcement Friday, analyst Russell McAllister of Merriman Curhan Ford & Co. told Medical Device Daily’s sister publication BioWorld Today, should not have come as surprise to anyone, given what happened recently with the Pfizer-Nektar and Novo Nordisk-Aradigm deals.

Pfizer decided to no longer market Exubera, the first U.S. approved inhaled insulin to enter the market, after sales of the product were “well beyond disappointing” McAllister noted.

Pfizer had invested nearly $3 billion in the product and ended up paying Nektar $135 million in termination fees to get out of the deal.

“Pfizer’s experience with Exubera demonstrated that the product worked but that the commercial opportunity just wasn’t what everyone thought it was going to be,” McAllister said.

Novo Nordisk pulled out of its deal with Aradigm based on what it said was an analysis of “a vast amount of information,” which included market research involving patients who used and physicians who prescribed Exubera.

“So basically what we are seeing here is a straight business decision from the big pharma partners,” McAllister said. “All of these stories have been consistent to the extent that nothing is wrong with the product from a clinical perspective. They haven’t encountered anything in the trials that is substantially different from what they expected going in. It’s just that the commercial opportunity and reimbursement for these products didn’t materialize in the way that they expected it to.”

McAlllister noted that as with the Pfizer case, Lilly may be required to pay Alkermes a termination fee, which could ultimately be a huge advantage for the company.

“People didn’t recognize how beneficial that was for Nektar,” McAllister said. “Nektar is actually an excellent proxy for Alkermes in this case. Nektar wasn’t getting any meaningful royalties from Pfizer because sales were so small that a royalty off of those sales was effectively immaterial. So they got more money from the termination fee than they would have gotten in the next five plus years in royalties based on the way sales were ramping.”

In addition, he noted, Nektar regained all rights to Exubera.

The Pfizer Exubera experience, McAllister said, showed that a big pharma sales approach of direct-to-consumer advertising was perhaps not the most cost-effective way to market inhaled insulin.

“They weren’t getting the mainstream adoption that they were looking for,” he said. “Given that there is this clear need in the market for this type of product, a more specialty pharma sales approach might work very well. Maybe this isn’t a product that addresses 40% or 50% of the market, but there’s probably 5% to 10% of the market that is definitely interested in adopting this technology and is willing to pay that premium.”

Given the investment that Lilly has likely made in the AIR Insulin program thus far, it makes sense for Alkermes to complete the Phase III program, “if the resources are there,” McAllister said.

However, he added, payers have been reluctant to cover inhaled insulin and “the end market might not still be there.”

But McAllister said he believes inhaled insulin products still have a place in the U.S. market, despite Exubera’s sluggish experience of catching on with patients and prescribers.

“They provide a very important clinical advantage to people who need insulin, and that advantage is convenience, which unfortunately the payers are not currently willing to pay for,” he said. “But I sense that will change in the future.”

The greatest issue with diabetes treatments is one of compliance, McAllister noted.

“People miss doses of drugs and as a result they have adverse events, and it’s the adverse events that are so costly to the health care system,” he said. “By improving convenience, you improve compliance, and as a result, you save money.”

But, McAllister said, that long-term perspective is one that most healthcare payers currently are unwilling to adopt.

One of the strongest arguments for the inhaled insulin products, he said, is the difficulty with patients with Type II diabetes who have to progress from oral medications to short-acting insulin.

“It’s difficult to train someone who is 60 or 70 years old to do self-injections, and as a result, compliance tends to be bad,” McAllister maintained.

Inhaled insulin, he contended, can address the needs of those patients.

If Alkermes, Nektar and Aradigm decide to no longer pursue the inhaled insulin market, McAllister said, “it is going to be very interesting to see what happens” with MannKind (Valencia, California), which is in Phase III development of its inhaled insulin product.