Make no mistake about it: Eli Lilly (NYSE:LLY) reported solid third-quarter results.

Earnings of $1.20 billion, or $1.11 per share, handily beat analysts' expectations of $1.04 per share. Sales were up by 6% year over year to $5.78 billion, also exceeding analysts' projections -- although only narrowly.  Lilly even raised its full-year earnings guidance from a range of $4.05-$4.15 per share to a range of $4.10-$4.15 per share.

All is bright and sunny, right? Not necessarily. A detailed look at Lilly's earnings reveals some potential problems ahead. Here are three dark clouds in the big drugmaker's third-quarter silver lining.

1. Cost-cutting only works for a while
Slashing costs helped Lilly's bottom line considerably. The company reported marketing, selling, and administrative costs of $1.652 billion, down 6% year over year. This reduced spending amounted to more than $0.09 per share -- more than the amount by which Lilly beat Wall Street's earnings estimate.

Lilly, however, did increase research and development spending by $34.6 million compared to the third quarter of 2012. This higher R&D spending added another $0.03 per share in costs.

The cost-cutting moves made by Lilly appear to have been smart and have paid off. The problem, though, is that costs can only be cut to a point before they're more harmful than helpful. Don't count on continued cost reductions to keep delivering earnings beats in the future. 

2. Price increases can only help to a limited extent
Lilly's year-over-year revenue gains of 6% look solid. There's no question that bringing in another $329 million during the quarter as compared to the prior year is a good thing. But let's take a look at why revenue was higher.

The company reported 3% higher sales volume in the last quarter versus the same period in 2012. However, those gains were largely offset by a 2% decrease due to unfavorable currency fluctuations. How did Lilly manage to still increase total revenue? It bumped up prices of its drugs by 5%.

Price increases are a fact of life in the pharmaceutical industry, and Lilly will no doubt continue raising prices in the future on many of its drugs. However, there is a limit on how much the company can make such moves before risking a customer backlash. Lilly probably can't depend on future price increases to deliver well-received earnings results down the road, especially with the diminishing returns from further cost cuts.

3. The top-selling drug is already slipping
While Lilly's total sales volume was up 3%, that wasn't the case for its top-selling drug, Cymbalta. The drug continued to rock along with sales of $1.376 billion during the third quarter. That number is up 11% year over year, but the volume for Cymbalta was actually down. The higher sales figure came from price increases.

Lilly attributed the lower volume to a reduction in inventory levels in the wholesale and retail channels. However, the decline foreshadows the stark reality facing the company: Lilly's biggest current blockbuster loses patent exclusivity in a little more than a month. 

Unfortunately, the damage won't be limited to Cymbalta. Key patents for Zyprexa and Humalog have already expired. Evista goes off-patent in early 2014. That's four out of the top 10 drugs for Lilly that have either lost or soon will lose patent protection.

Bright spots
Despite these real challenges, Lilly certainly has several bright spots. One of the brightest is type 2 diabetes drug dulaglutide, which is awaiting regulatory review in both the U.S. and Europe. The drug bested Merck's (NYSE:MRK) Januvia and Bristol-Myers Squibb's (NYSE:BMY) Byetta in controlling blood glucose levels in late-stage clinical studies.

If dulaglutide performs along the lines of Byetta, it will only be a so-so win for Lilly. Byetta has generated $295 million in sales for Bristol so far this year. However, if Lilly's drug is even close to the same league as Januvia commercially, that's a different story altogether. Merck is on track to rack up $4 billion or more in sales for Januvia this year.

Lilly also claims several other drugs in its pipeline that could emerge as big winners. Cancer drugs ramucirumab and necitumumab stand out among the pack.

The most significant problem for Lilly, though, is that these bright spots might not shine quickly enough to make up for the impending revenue loss from drugs going off-patent. 2013 is looking sunny, but the weather forecast for Lilly looks potentially stormy over the next year or two.


Fool contributor Keith Speights has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.