Forest Beats, Ups View

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Forest Laboratories, Inc. (NYSE:FRX - News) reported earnings per share of $1.04 in the third quarter of fiscal 2012, beating the Zacks Consensus Estimate of $1.00. Third quarter fiscal 2012 earnings, however, came in below the year-earlier earnings of $1.34. Despite an increase in revenues, higher costs led to the year-over-year decline in earnings.

Third quarter revenues increased 7.4% to $1.21 billion, with net sales increasing 9.2% to $1.16 billion. Total revenues topped the Zacks Consensus Estimate of $1.17 billion.

The Quarter in Detail

Third quarter product revenues increased 9.2% to $1.16 billion. While Lexapro revenues increased 1.1% to $593 million, Namenda, which is approved for the treatment of moderate and severe Alzheimer’s disease, delivered revenues of $340.4 million, recording year-over-year growth of 6.4%.

Bystolic, Forest Labs’ beta-blocker for the treatment of hypertension, posted revenues of $90.6 million, up 33%. Savella, which is approved for the management of fibromyalgia, posted revenues of $26.3 million, up 6.9% from the year-ago period. Revenues improved on a sequential basis as well.

Forest Labs’ new product, Teflaro, posted revenues of $6.5 million, up from $5.3 million in the second quarter of fiscal 2012. The FDA granted approval to Teflaro for the treatment of patients suffering from acute bacterial skin and skin structure infection and community acquired bacterial pneumonia in October 2010. Forest Labs launched the product in March 2011.

The company is targeting 2,200 key hospitals and hospital systems. The Center for Medicaid and Medicare Services (NYSE:CMS - News) has added Teflaro to the Specifications Manual for National Hospital Inpatient Quality Measures as a recommended initial antibiotic (applicable to hospital discharges on or after January 1, 2012). This should increase the use of Teflaro as a first-line agent, particularly in community-acquired bacterial pneumonia.

Two other new products, Daliresp and Viibryd, were launched in August 2011. While Daliresp, which is approved for the treatment of chronic obstructive pulmonary disease (:COPD), recorded revenues of $8.4 million (up from $1.2 million in the second quarter), Viibryd (vilazodone HCl), approved for the treatment of major depressive disorder (NYSEArca:MDD - News) recorded revenues of $18.9 (up from $5.3 million in the second quarter).

Contract revenue came in at $34.1 million, down from $46.8 million in the year-ago period. Benicar co-promotion income dropped 26.6% year-over-year to $31.4 million. Under its agreement with Daiichi Sankyo, Forest Labs is now receiving a gradually declining royalty rate on Benicar until the end of March 2014. Benicar earnings are expected to decline in fiscal 2012.

Adjusted SG&A expense increased 38.6% to $396.1 million in the reported quarter. Forest Labs continues to focus on promoting its new products. Adjusted R&D spend increased 42% during the quarter.

Ups Guidance

Forest Labs increased its earnings guidance for fiscal 2012 by five cents. The company now expects earnings in the range of $3.65 - $3.75 per share, up from the earlier guidance of $3.60 to $3.70. The Zacks Consensus Estimate for fiscal 2012 currently stands at the lower end of the guidance range at $3.65 per share. With the company delivering above expectations and increasing its guidance, we expect upward revisions in earnings estimates.

Pipeline Update

The company provided an update on its pipeline and expects to have two new products (linaclotide and aclidinium) in its marketed product portfolio in calendar 2012.

Forest Labs and  its partner, Ironwood Pharmaceuticals, Inc. (NasdaqGS:IRWD - News) filed a new drug application (:NDA) for linaclotide. The companies are seeking approval for the use of linaclotide for the treatment of irritable bowel syndrome with constipation (IBS-C) and chronic constipation (:CC). A response from the FDA should be out in June 2012.

Another candidate, aclidinium, is currently under regulatory review. Forest Labs and its partner Almirall are looking to gain approval for aclidinium for the treatment of COPD. Aclidinum’s approval would be a major boost for Forest Labs with the COPD market representing huge commercial potential.

The company could be in a position to file for approval of two more candidates in calendar 2012. Forest Labs intends to report data on phase III candidate, cariprazine, for two indications -- schizophrenia and acute mania associated with bipolar I disorder -- in the first quarter of calendar 2012.

The company will also be reporting top-line results from an ongoing phase III study for levomilnacipran for the treatment of major depressive disorder. Positive results from all these studies would allow Forest Labs to file for both candidates in the second half of calendar 2012.

Neutral on Forest Labs

We currently have a Neutral recommendation on Forest Labs, which carries a Zacks #3 Rank (short-term Hold rating). The company is facing a major patent cliff in March 2012 when lead product Lexapro is slated to lose exclusivity. Moreover, Namenda will face generic competition in early 2015 putting another $1+ billion at risk.

In such a scenario, the company is dependent on new products to make up for a part of the loss of revenues that will take place with the genericization of Lexapro. We were pleased to see an improvement in new product sales in the reported quarter. We are also encouraged by the company’s efforts to grow its pipeline through in-licensing and acquisition activities.

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