Eli Lilly encountered an increasingly challenging environment for its pharma business in the third quarter, with the ongoing generic erosion of Gemzar, higher overseas inventory costs with the weak US dollar, and a jump in marketing and development expenses from the Boehringer Ingelheim diabetes alliance. Higher rebates associated with healthcare reform in the US market also provided a drag on growth in the quarter. Overall, these headwinds contributed to margin erosion and negative year-over-year (YoY) comparisons on both the operating and net income lines. Similarly, Lilly's adjusted (non-GAAP) earnings dropped 7% YoY to $1.13 a share, excluding a $25 million (2-cents per share) severance charge related to its latest restructuring program. This was consistent with consensus market forecasts for the quarter. The company's earnings benefited from a YoY decline on the tax line, which was the result of a favorable IRS settlement of a prior audit that led to a $45 million tax benefit in the quarter.

The majority of Lilly's key brands delivered healthy growth in the quarter though, with double-digit YoY sales gains for Cymbalta, Humalog, Forteo, Strattera, Cialis and Alimta. Volume growth and currency gains equally contributed to the 9% top-line growth in the quarter, with no net benefit from pricing. The company's top-line performance was driven by its international business, with a 15% gain overall, and even faster growth in the Chinese and Japanese markets, with continued momentum from several recent product launches in those regions. Management believes that its ability to leverage its existing portfolio and pipeline in Japan, China and other emerging markets will help support its pharma business through its upcoming patent expiry challenges in the developed US and European markets.

Although Lilly has shown consistent top-line growth in recent quarters, the nearing generic erosion of its largest product line, Zyprexa, will dampen its revenue growth and profitability beginning in the fourth quarter of 2011. As a result, management expects only mid-single digit revenue growth for the full-year and non-GAAP earnings in a $4.30 to $4.35 range in 2011. This quarter, management moved its earnings guidance 5-cents a share higher on the low-end of its prior range, but this still represents a significant downturn on a YoY basis, at an 8% to 9% pace.

In order to manage through this period following the Zyprexa patent expiration, Lilly continues to progress its in-house pipeline and expand its new product opportunities through business development deals. The company now has 66 NMEs in clinical development and reached its R&D goal with 10 projects in Phase III development by the end of 2011. This is expected to allow the company to upgrade its new product launch schedule to two projects a year by 2013. In the near-term, Lilly expects regulatory decisions on Erbitux in its first-line head and neck cancer indication and its Bydureon diabetes treatment in the US, but longer-term the company is under pressure to add even more new product opportunities and accelerate its geographic expansion in order to revive the growth of its business.

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