Consolidation in the generic drug industry has been the trend for 2006, thanks to the low-margin and increasingly competitive nature of the business. Mergers and acquisitions give the generic drug manufacturers the opportunities to achieve a degree of scale in the operations, which will be necessary going forward, as margins continue to decrease for all the companies in this industry. As Dr. Reddy's Laboratories (NYSE:RDY) showed in its Q2 2007 earnings release on Friday, it is possible to scale up operating income at a higher rate, even in the face of declining gross margins.

For the quarter, revenues were up 245% to $436 million, but gross margins declined to 41% from the year-ago level of 52%, because most of the sales growth occurred in the relatively lower-margin generic drugs divisions. Even so, sales expanded rapidly across all three of the company's major divisions:


Y-O-Y Growth

Generic Drugs



Branded Drugs



Active Pharmaceutical Ingredients



*All sales in millions, using an exchange rate of $1 to 45.95 Rs.

Excluding the amortization of acquired research and development expenses, net income came in at $70 million, about 230% higher for the quarter, and operating margins were up to 21% compared to the 12% level last year.

Reddy's is actively growing its sales and geographic reach through its recent acquisitions, and its German and Mexican operations contributed 20% to the top-line results compared to the year ago period. As Reddy's further integrates these two acquisitions (both less than a year old) into its operations, revenue growth should remain strong and margins may improve.

I've always liked the mid-cap international pharmaceutical companies, as they are generally more shareholder-friendly; they often pay a dividend, they don't hand out options like they are Halloween candy, and even making their websites easier to read than their U.S.-based counterparts. Reddy's is no different, and it's worth a look for investors who want a fast-growing pharmaceutical company specializing in selling generic drugs.

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Fool contributor Brian Lawler does not own shares of any company mentioned in this article. The Fool has a disclosure policy.