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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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?)
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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