Eli Lilly (LLY) reported third quarter earnings per share of $1.21, easily surpassing the Zacks Consensus Estimate of $1.15 and a penny above the year-earlier earnings of $1.20. Although revenues increased 2% to $5.66 billion from the year-earlier period, they were slightly below the Zacks Consensus Revenue Estimate of $5.79 billion.

Revenues increased mainly due to a 3% price increase, which was offset by unfavorable foreign exchange fluctuations (1%). Volume growth remained flat.

US revenues remained flat mainly due to lower volume that was attributed to wholesaler buying patterns. Ex-US revenues increased 4% mainly due to higher demand that was partially offset by unfavorable foreign exchange fluctuations and lower prices.

Eli Lilly reported strong performance in Japan which contributed 27% to revenue growth. Other markets that performed well included China.

Revenue by Major Products

During the third quarter, Eli Lilly’s lead product Zyprexa recorded a 1% decline in revenues which came in at $1.2 billion. While US revenues increased 6%, international markets revenues declined 7%, mainly due to unfavorable foreign exchange fluctuations and lower prices.

Products contributing to third quarter growth included Cymbalta (4% growth to $825.3 million), Humulin (7% growth to $278 million), Alimta (21% growth to $560.3 million) and Cialis (2% growth to $406.5 million). Continued strong growth for the non-small cell lung cancer indication in Japan helped boost Alimta revenues. Meanwhile, Humulin revenues benefited from price increases and volume growth thanks to Eli Lilly’s new partnership deal with Wal-Mart (WMT).

Eli Lilly’s Animal Health segment contributed $353.2 million (up 12%) to revenues. Higher demand helped boost Animal Health revenues.

Meanwhile, Gemzar recorded a 2% decline in revenues to $324.6 million due to the entry of generics in major international markets. Newly launched Effient posted revenues of $36.3 million with US revenues coming in at $28.1 million.

Expenses

On the operational front, expenses increased 3% during the quarter. R&D expenses were 9% higher, mainly due to increased late-stage clinical trial costs and costs associated with the termination of the semagacestat development program. Apart from this, marketing, selling and administrative expenses remained flat at $1.7 billion mainly due to the company’s cost-control efforts.

EPS Guidance Raised Again

For the second time this year, Eli Lilly raised its EPS guidance for fiscal 2010. Guidance was increased based on the year-to-date performance and lower estimates of the impact of the US health care reform. Eli Lilly said that US health care reform impacted third-quarter revenues by only $25 million instead of the anticipated $65 million. The company now expects earnings in the range of $4.65 – $4.75, up from the earlier guidance of $4.50 – $4.65 per share.

Eli Lilly raised its revenue guidance and now expects volume-driven revenue growth in the mid-single digit range. The company was previously expecting 2010 revenue growth in the low-to-mid single digit range. Growth will be driven primarily by Alimta, Cymbalta, Humalog, Cialis and Effient. The company expects health care reform to impact 2010 revenues by $225 – $275 million.

 

Eli Lilly, however, maintained certain other components of its guidance. The company expects gross margin as a percentage of revenue to be flat to increasing. Meanwhile, marketing, selling and administrative expenses are expected to increase in the low single digits, and research and development expenses are still slated to grow in the low-double digits. Eli Lilly expects cash flows to be sufficient for funding capital expenditures of about $700 million, acquisitions and dividend.

 

Neutral on Eli Lilly

 

We currently have a Neutral recommendation on Eli Lilly, which is supported by a Zacks #3 Rank (short-term “Hold” rating). Strong sales from key products such as Cymbalta, Cialis and Alimta will be fundamental to revenue growth in 2010. The addition of ImClone will add incremental revenue growth.

 

Longer-term, we are unconvinced that ImClone will be the catalyst that Lilly needs to grow revenue and earnings following Zyprexa’s US patent expiration in 2011. We expect the top-and bottom-line to remain under pressure from late 2011 as the contraction in Zyprexa sales more than offsets growth in Cymbalta, diabetes and new product sales.

 

Barring significant cost-cutting efforts or additional revenue catalysts, 2013 will be the beginning of a very challenging period with Cymbalta losing US patent protection during the year.

 

We are also concerned about Eli Lilly’s lack of success with its pipeline. The company faced several development and regulatory setbacks recently including the delay in the approval of type II diabetes candidate, Bydureon. With two key products facing patent expiration in the next few years, pipeline setbacks will weigh heavily on the shares.

 
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