It's little secret that pharmaceutical giant Eli Lilly (NYSE:LLY) faces drug patent expirations on its top-selling drugs over the next few years. The question is the extent to which this is already reflected in the share price and whether the company can find a way to put billions in cash flow to good use and find a way out of its predicament.
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First-Quarter Highlights
Total sales advanced a healthy 9% to $5.5 billion as LLY's four highest-grossing drugs - Zyprexa, Cymbalta, Alimta, and Humalog - all reported strong top-line trends. Zyprexa, which is used primarily for the treatment of schizophrenia and bipolar disorders, accounts for 22.1% of sales and saw an 8% boost while the rest of the top four experienced double-digit increases.

Reported net income fell 5% to $1.25 billion, or 23.6% of sales, as cost of sales and income taxes rose by more than 30%. Higher shares outstanding sent earnings down 2% to $1.18 per diluted share. However, the company's definition of operating earnings resulted in 8% growth and didn't include charges related to expected health care reform costs in coming years and a number of other small non-recurring expenses.

Health care reform costs also resulted in the lowering of company full-year earnings guidance to between $4.35 and $4.50 per share. Management expects 35 cents in charges from the reforms and mid-single digit sales growth on volume increases on most of its top-selling drugs as well as Cialis and Effiant. (Learn about the controversies surrounding companies commenting on their forward-looking expectations in Can Earnings Guidance Accurately Predict The Future?)

Bottom Line
Lilly's quarterly profits came in ahead of analyst expectations and based off earnings guidance the company is trading at a seemingly bargain-basement forward P/E multiple of under nine. However, 2011-2013 will see close to have of sales fall victim to generic competition from the likes of TEVA Pharmaceuticals (Nasdaq:TEVA) and Mylan (NYSE:MYL) and includes patent expiration of Zyprexa and Cymbalta, Lilly's two top sellers.

Lilly, along with Forest Labs (NYSE:FRX), has so far chosen to go it alone in developing new drugs to replace those with expiring patents. This is in contrast to other industry leaders, including Merck (NYSE:MRK) that has chosen to also pursue mergers to diversify away from drugs losing patent protection. The go-it-alone bias is risky, but the low earnings multiple offers a good degree of downside protection. And in the case of Lilly it will have more than $5 billion in annual free cash flow over the next few years to try and stem its top-line predicament.

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