Eli Lilly & Co reported higher-than-expected quarterly profit on Monday as it controlled costs and revalued overseas inventory because of the stronger dollar.

The results far exceeded Wall Street forecasts, due to a sharp expansion in profit margins from the inventory adjustments. Company shares initially rose 4 percent, but were down 1.7 percent at midday after Lilly cautioned that margins would likely retreat in coming months.

We do believe that the first quarter represents a peak in terms of the gross margin improvement, Lilly Chief Financial Officer Derica Rice said in a conference call. We do not anticipate that we'll be able to sustain that level of gross margin for the remaining three quarters of the year.

Sales of Lilly's biggest product, schizophrenia treatment Zyprexa, were flat, but several of its other big medicines posted strong gains, including depression drug Cymbalta, which jumped 17 percent to $709 million.

The stronger dollar, by lowering the value of overseas inventories, improved the cost of goods sold -- boosting profit margins 6.9 percentage points to 83.8 percent.

Earnings increased to $1.31 billion, or $1.20 per share, from $1.06 billion, or 97 cents per share, in the year-earlier period, when results benefited from the resolution of a tax audit.

Analysts on average expected 99 cents per share, according to Reuters Estimates.

Despite what he termed solid quarterly results, JP Morgan analyst Chris Schott said investors are more focused on whether enough new Lilly drugs will be approved in the next few years to offset looming generic competition for Zyprexa, Cymbalta and other top-selling brands.

We continue to believe Lilly's pipeline remains too early-stage to convince us of its ability to meaningfully offset the loss of core franchises, Schott said in a research note.

One of Lilly's biggest hopes is prasugrel, a blood clot preventer that is awaiting U.S. approval after a number of previous regulatory delays.

Lilly's quarterly revenue rose 5 percent to $5.05 billion, matching the Reuters Estimates forecast. The company said the stronger dollar crimped sales by six percentage points, yet helped profit margins because of the inventory situation.

The Indianapolis drugmaker said it still expected full-year earnings of $4 to $4.25 per share.

ICAHN SEEKS AMYLIN SALE TO LILLY

Lilly's global share of revenue from Byetta, a diabetes drug it sells in partnership with Amylin Pharmaceuticals Inc , rose 18 percent in the quarter to $98 million thanks to growing overseas sales. But U.S. sales of the drug, given by injection twice daily, were flat.

Lilly and Amylin plan to seek U.S. marketing approval in the first half of the year for a once-weekly form of Byetta. They hope its greater convenience will draw more patients and fend off future competitors.

Billionaire investor Carl Icahn, who is in a proxy fight with Amylin, is pressuring the biotechnology company to sell itself to Lilly, according to a regulatory filing issued on Monday by Amylin.

Sales of Zyprexa were hurt by generic competition in Germany and Canada and concerns the pill causes weight gains that can increase the risk of diabetes.

Gemzar, a treatment for a variety of cancers, was also hurt by overseas generic competition, with sales falling 14 percent to $368 million. And osteoporosis treatment Evista fell 2 percent to $257 million.

Sales of Lilly's Humalog brand of insulin jumped 11 percent to $450 million, and sales of lung cancer treatment Alimta soared 36 percent to $335 million. Revenue from anti-impotence pill Cialis rose 6 percent to $359 million.

Lilly shares fell 59 cents to $33.16 on the New York Stock Exchange, amid big declines for the drug group and broad stock market.

(Additional reporting by Lewis Krauskopf; Editing by Lisa Von Ahn and John Wallace)

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