In any industry facing long-term pressures on margins and increased competition, it makes sense for companies to merge, to gain some presence in economies of scale. This happened in the telecom industry several years ago, and it's currently occurring with the generic drug manufacturers today. But there's one difference with the generic manufacturers: They're in a rapidly growing industry where many pharmaceutical drugs are expected to go off-patent in the next several years.

Mylan Laboratories (NYSE:MYL) is at the heart of the generic drug industry, and today it announced its Q2 2007 results. Revenues were up 23% to $366.6 million, and operating income soared 132%, thanks to 28% lower operating expenses. This propelled earnings to $0.36 a share for the quarter, up from the $0.16 a share the company earned in the same period last year.

With gross margins rising nearly five percentage points to 53.5% of sales, Mylan is bucking the generics-industry trend of declining gross margins. It's still showing the scaling of operating margins, which is important, because pharmaceutical companies can sometimes go overboard on spending. Gross margins are increasing primarily because of higher sales of its transdermal patches, which don't face nearly the same level of competition (and thus the pricing pressures) as some of Mylan's other drugs.

Revenue Growth

Gross Margins

Operating Margins

Q2 2007

23%

54.8%

36.7%

Q1 2007

10.1%

52.8%

32.9%

Q4 2006

2.7%

49.5%

28.3%


Perhaps realizing that -- even with increasing gross margins -- it's still primarily a generic drug manufacturer, Mylan bought a controlling interest in Indian generic company Matrix Labs in August for about $700 million. The deal gives Mylan an entrance into lucrative European markets, and it should afford the company some nice economies of scale and scope, if Mylan can get Matrix's management to follow its plans for the company.

It would be nice to see Mylan trim some of its $687 million in long-term debt, considering that the company will be spending as much as $736 million in the fourth quarter when the Matrix deal closes.

With earning guidance for all of fiscal 2007 in the range of $1.35-$1.55 a share, and growth of at least 35% over 2006, paying off some of this debt should be no problem for Mylan. Hopefully Mylan does this sooner rather than later; even if it is no ordinary generic drug manufacturer right now, that doesn't mean future competition can't make it ordinary once again.

Looking for the next great pharma innovator? Our Motley Fool Rule Breakers newsletter can lead the way. And now you can take the swashbuckling newsletter dedicated to up-and-coming companies in emerging fields for a 30-day free spin .

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