Eli Lilly (LLY) reported first quarter earnings per share of $1.18, a couple of cents below the year-ago earnings of $1.20, but above the Zacks Consensus Estimate of $1.11. Results included a 12-cent impact due to the US health care reform. Excluding this impact, earnings would have increased 4% from the year ago period.

Revenues recorded a 9% year-over-year increase to $5.49 billion, driven by an increase in volume (4%), prices (1%) as well as a favorable impact of foreign exchange (3%).

Revenue by Major Products

During the first quarter, Lilly’s lead product Zyprexa recorded an 8% year-over-year growth to $1.2 billion. Sales of the drug in both US and international markets increased 9% and 7%, respectively. Withdrawal of generic competition in Germany in early 2009 led to an increase in international demand of the drug.

Several other products maintained their growth momentum – Cymbalta (13% growth to $803.2 million), Humalog (12% growth to $506.4 million), Alimta (57% growth to $527.4 million) and Cialis (14% growth to $408.3 million).

Meanwhile, Gemzar recorded a 22% decline in revenues to $287.8 million due to the entry of generics in major international markets.

Newly launched Effient posted sales of $8.8 million with US sales coming in at $4.5 million. Lilly is working with partner Daiichi Sankyo to gain reimbursement and formulary access for the product.

The US market accounted for approximately 55% of Eli Lilly’s total revenues during the reported quarter. Revenues from the US increased 6% to $3 billion due to higher prices and increased demand.

The growth momentum was maintained in the international market as well. Revenues increased 13% to $2.45 billion due to increased demand and the positive impact of foreign exchange rates. This was partially offset by lower prices.

Gross margin declined to 79.5% during the quarter. A 37% year-over-year increase in cost of sales, due to the impact of foreign currency on international inventories sold during the quarter, brought down the margin.


On the operational front, operating expenses increased 7% during the quarter. R&D expenses were 10% higher, mainly due to increased late-stage clinical trial costs. Apart from this, marketing, selling and administrative expenses increased 6% driven by higher expenses in the international market and the impact of foreign exchange rates. This was partially offset by lower litigation expense.

Guidance Revised to Reflect Impact of Health Care Reform

Based on the recent health care reform, Lilly updated its guidance for 2010 to include the impact of this reform. The company expects health care reform to reduce earnings by about 35 cents per share in 2010.

Of this, 8 cents relate to a one-time tax charge (taken in the first quarter of 2010) associated with the levy of tax on the prescription drug subsidy of the company’s retiree health plan. The balance relates to higher governmental rebates, which are slated to affect the top-line by $350 – $400 million. 2011 revenues will be impacted to the tune of $600-$700 million by health care reform.

Lilly now expects 2010 earnings in the range of $4.40 – $4.55. Earlier, the company was expecting earnings in the range of $4.65 – $4.85. The earlier guidance did not include the impact of health care reform.

The company expects volume-driven revenue growth in the mid-single digits, down from its earlier expectation of high-single digit growth. Growth will be driven primarily by Alimta, Cymbalta, Humalog, Cialis, Effient and the exenatide franchise.

We expect Lilly’s diabetes care franchise to benefit from the approval of a once-weekly formulation of exenatide (proposed trade name: Bydureon) for the treatment of type II diabetes. Bydureon, which is one of the biggest drugs in Lilly’s pipeline, looks like it may be the injectable of choice for many patients. We think Bydureon’s once-weekly dosing with efficacy and tolerability offers huge potential. Bydureon’s approval, potentially later this year, would be a major boost for Lilly’s diabetes franchise.

Lilly did not change other components of its guidance. Gross margin as a percent of revenue is expected to be flat to declining. Meanwhile, marketing, selling and administrative expenses are expected to increase in the low- to mid-single digits. Research and development expenses are slated to grow in the low-double digits. Lilly expects cash flows to be sufficient for funding capital expenditures of approximately $1 billion, acquisitions, and dividend.

Our Expectations

Strong sales from key products such as Cymbalta, Cialis and Alimta will be the fundamental strength to revenue growth in 2010. Longer-term, we remain concerned about top-and bottom-line growth at Lilly following Zyprexa’s US patent expiration in 2011.

We expect the top-and bottom-line to remain under pressure 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.

On the flip side, strong performance of Cymbalta and the diabetes business should offer some downside support. The ramp of Effient and upside from the ImClone deal could also result in a short-term boost to revenue. We currently have a Neutral recommendation on Lilly.
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