NEW YORK (Reuters) - Merck & Co. (MRK) on Thursday reported a 28 percent drop in quarterly profit and said 2004 earnings will fall as much as 11 percent due to last month's recall of its Vioxx arthritis drug.

Vioxx had annual sales of $2.5 billion before the recall, accounting for over 10 percent of Merck's annual revenues.

The recall cost the Whitehouse Station, New Jersey-based drugmaker $553 million in earnings, including customer returns and write-offs of inventory. The medicine was withdrawn on Sept. 30 after being linked to heart attacks and strokes.

Third-quarter earnings fell to $1.33 billion, or 60 cents per share, from $1.86 billion, or 83 cents, a year earlier. Wall Street analysts expected 71 cents a share.

The company's stock was off 0.9 percent in afternoon trading.

"Merck has become really scary; its earnings were even lower than I expected, even with the Vioxx debacle," said Bijal Shah, an analyst with 1838 Investment Advisors.

Shah said Merck's earnings prospects will remain dim because it is developing few important drugs and the patent on its biggest product, $5 billion-a-year cholesterol fighter Zocor, will lapse in 2006 and leave the blockbuster prey to competition from cheaper generics.

Global company sales totaled $5.54 billion for the third quarter, compared with $5.76 billion a year earlier as it wrote down its inventories of now-useless Vioxx.

Merck expects fourth-quarter earnings of 48 cents to 53 cents per share, including about $700 million to $750 million in lost sales of Vioxx and other recall costs. The company posted earnings of 62 cents per share in the fourth quarter of 2003.

Consequently, Merck said it expects full-year 2004 earnings of $2.59 to $2.64 per share, a decline of 9.5 percent to 11 percent from last year. Before the recall, Merck had expected earnings to grow almost 9 percent.

"Merck didn't give a lot of clues on what its earnings picture will be in 2005; that's still a big question," said Scott Henry, an analyst for Oppenheimer & Co.

The drugmaker is facing 300 lawsuits filed by former users of Vioxx who allege that the drug caused them gastrointestinal bleeding, heart attacks and kidney damage.

Merck said it was unclear whether insurance will adequately cover its potential liability to Vioxx users, including 20 million Americans who have taken the drug since it was launched in 1999. It said it has product liability insurance for claims brought in Vioxx lawsuits of up to approximately $630 million.

In contrast, rival drugmaker Wyeth (WYE) has taken over $16 billion in charges to cover liability to 6 million Americans who took its two "fen-phen" diet drugs that were recalled in 1997 after being linked to heart valve damage.

"Merck's eventual Vioxx liability will be less than fen-phen, but it could approach $5 billion to $10 billion and leave investors in uncomfortable suspense," said Henry.

Shah said he has doubts whether Merck can remain an independent company in its wounded state. "Some foreign company could buy it to sell their products."

Quarterly sales of Merck's osteoporosis treatment Fosamax rose 13 percent to $778 million, while sales of hypertension drugs Cozaar and Hyzaar jumped 14 percent to $706 million.

But sales of Zocor shrank 13 percent to $1.2 billion, in part because of generic competition outside the United States.

Asthma drug Singulair saw revenue edge up 2 percent to $626 million from the year-ago quarter, when wholesalers stocked up on the popular medicine.

Shares of Merck were down 27 cents to $31.13 on the New York Stock Exchange. The shares have lost a third of their value since the Vioxx recall.