AMLN Amylin Pharmaceuticals, Inc. (MM)

Eli Lilly & Company (LLY) reported second quarter adjusted earnings per share of $1.18, a penny below the Zacks Consensus Estimate and 6 cents below the year-ago earnings of $1.24.

Earnings were hurt by higher operating expenses, which more than offset the rise in revenues.

Second quarter revenues increased 9% to $6.3 billion, above the Zacks Consensus Revenue Estimate of $6.0 billion. Revenues were boosted by increased demand for Eli Lilly’s major products. Exchange rates also favorably impacted revenues during the quarter.

Reported earnings (including special items), declined 12% to $1.07. Reported earnings included $132.3 million of restructuring costs.

Quarterly Details

Second quarter revenues increased mainly due to a 5% volume growth and 4% foreign exchange fluctuation. Price increases did not have a major impact on revenue growth. Healthcare reform impacted revenues by $110 million.

US revenues increased 3% to $3.35 billion, mainly due to higher volumes. Higher prices also contributed to the increase in US revenues. Ex-US revenues increased 17% to $2.91 billion, mainly due to higher demand and favorable foreign exchange fluctuations.

During the second quarter, Eli Lilly’s lead product Zyprexa recorded a 12% increase in revenues, which came in at $1.41 billion. While US revenues increased 11%, international market revenues increased 12%, mainly due to favorable foreign exchange fluctuations.

Products contributing to second quarter growth included Cymbalta (16% growth to $1 billion), Humulin (18% growth to $311.8 million), Alimta (11% growth to $613.4 million) and Cialis (14% growth to $477.2 million). Alimta continued to perform well in ex-US markets due to increased demand. Meanwhile, Humulin revenues benefited from increased demand thanks to Eli Lilly’s partnership with Wal-Mart (WMT) for Humulin ReliOn.

Eli Lilly’s Animal Health segment contributed $389.5 million (up 20%) to revenues. Higher demand and the impact of the acquisition of certain Pfizer animal health products helped boost Animal Health revenues.

Meanwhile, Gemzar revenues continued to decline with second quarter sales falling 62% to $112.4 million. Sales were impacted by the entry of generics in the US in November 2010. The product is also facing generic competition in major international markets. Effient posted revenues of $71.7 million with US revenues coming in at $52 million.

Expenses

On the operational front, expenses increased 12% during the quarter. Research and development (R&D) expenses were 6% higher, mainly due to costs associated with late-stage clinical activities. Apart from this, marketing, selling and administrative expenses increased 16% to $2 billion.

2011 Projection

Eli Lilly increased its 2011 earnings per share guidance range to $4.25-$4.35 from $4.15 - $4.30 per share. The Zacks Consensus Estimate for 2011 is $4.28, well within the guidance range provided by the company.

Revenue growth is now expected in mid-single digits as opposed to the previous expectation for 2011 revenues growing in low single digits. Eli Lilly still expects the US health care reform to impact 2011 revenues by $400 - $500 million.

2011 will be a challenging year for Eli Lilly with the company losing patent exclusivity on Zyprexa. Zyprexa sales should erode rapidly from October 2011 with the entry of generics. Moreover, we expect continued erosion of Gemzar sales due to generics.

The company expects gross margin as a percentage of revenue to decline in the range of 2-3 percentage points. Meanwhile, marketing, selling and administrative expenses are expected to increase in high-single digits, with research and development expenses expected to increase in low-single digits. Eli Lilly expects cash flows to be sufficient for funding capital expenditures of $700 - $800 million, acquisitions and dividend.

Neutral on Eli Lilly

We currently have a Neutral recommendation on Eli Lilly. The stock carries a Zacks #3 Rank (Hold rating) in the short run. Even though we are concerned about the generic threat to key products and the lack of a significantly strong pipeline to offset key patent expirations at Eli Lilly, a strong performance of the diabetes business should offer some downside support.

The primary pipeline candidate at Eli Lilly’s diabetes pipeline is Bydureon. Eli Lilly has co-developed the candidate with Alkermes, Inc. (ALKS) and Amylin Pharmaceuticals, Inc. (AMLN). Bydureon is approved in the European Union and a response to the US Food and Drug Administration’s complete response letter is slated for the third quarter of 2011.

The other diabetes candidates at Eli Lilly include empagliflozin (launch potential in 2014), dulaglutide (regulatory submission potentially in 2013) and basal insulins (phase III studies scheduled to commence in the second half of 2011).

The ramp of blood thinner Effient, upside from the ImClone deal and Eli Lilly’s focus on emerging markets should provide a boost to revenues. We are also pleased to see Lilly pursuing small acquisitions and in-licensing deals to boost its pipeline.

 
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