Forest Laboratories


may have removed the suspense of its upcoming fourth-quarter earnings report, it hasn't removed the distress of many analysts who await official results on April 19.

On April 7, Forest said earnings per share would be 40 cents, which is well below its previous guidance as well as the Wall Street consensus estimate of 52 cents for the three months ended March 31.

But this isn't the first time Forest has changed its outlook. On Jan. 4, it preannounced third-quarter earnings, saying analysts' estimates were too low. On Nov. 1, it cut fiscal-year estimates due to faster-than-expected government approval of generic competitors for a major drug. And on Oct. 5, it preannounced second-quarter results, saying Wall Street's estimates were not high enough.

Needless to say, analysts aren't thrilled with Forest's penchant for preannouncements.

"Forest Labs continues to try our patience," says Marc Goodman of Morgan Stanley in a recent report to clients. He is keeping his overweight rating on the stock because he believes Forest could stage a comeback in the second half of its current fiscal year.

Forest "reminds us, again, that we like health care for its simple beauty and rising earnings, not for erratic growth and shameless hype," says

columnist James J. Cramer in a recent commentary. "Remember, it was just a few months ago that Forest was telling everyone how


business was, to the point of preannouncing better-than-expected earnings." (Cramer doesn't own shares.)

"This could get worse," warns David W. Maris of Banc of America Securities in a recent report in which he maintains his sell rating. "How low will

fiscal 2006 go?"

Upcoming Challenges

Although Forest's bulls say angry investors ignore future prospects, an overwhelming majority of Forest followers say the company faces serious challenges.

The Thomson First Call consensus says Forest will do worse in the current fiscal year than in the previous year. The consensus call is earnings per share of $2.45 for the year ending March 31, 2006, or 6 cents lower than the just-completed fiscal year with its newly stripped-down guidance.

Key future issues include ferocious generic competition for its depression drug Celexa; slower-than-expected growth from its leading product, the antidepressant Lexapro; an upcoming Lexapro patent challenge trial; and questions about the growth rate of the Alzheimer's disease drug Namenda.

If you add several recent setbacks in clinical trials of drugs for hypertension and Alzheimer's and inject some failed efforts

to extend the uses of Lexapro, you have a prescription for difficult times ahead. That's why 18 analysts are sitting on the fence with neutral ratings; eight recommend buying shares and two advocate selling the stock.

"Our original investment thesis on Forest was built on a belief that depression market growth would normalize against adverse growth comparisons moving into this year," says Ken Kulju of Credit Suisse First Boston in a recent report, as he cut his rating to neutral from outperform. "This forecast has failed to materialize."

Forest is under pressure because the antidepressant market is under pressure, thanks to the Oct. 15 decision by the Food and Drug Administration to order strict 'black box' warnings on a wide range of antidepressants.

The new labels cover the use of these drugs in children and adolescents, warning that these drugs "increase the risk of suicidal thinking and behavior for patients suffering from major depressive disorder and other psychiatric problems."

Virtually all of these drugs, including Lexapro and Celexa, aren't approved for children. However, federal law permits doctors to prescribe a drug for any use or any person once the drug has been approved by the FDA for a single disease or condition. Such "off-label" use is common with antidepressants.

Clearly, the FDA warning played a role in suppressing the number of prescriptions for antidepressants. Kulju notes that U.S. growth rates for both total and new prescriptions for the depression market are "still anemic." That's why he is cutting his 2006 fiscal-year prediction of Lexapro sales to $1.72 billion -- up 7% from the just-ended fiscal year.

His original prediction for fiscal 2006 was $1.87 billion, and that revision caused him to reduce fiscal 2006 earnings per share by 18 cents to $2.47. Kulju doesn't own shares; his firm, CSFB, says it expects to seek or receive investment banking fees from Forest in the next three months.

The generic-drug impact on Celexa, which lost patent protection in October 2004, was stronger and faster than the company and Wall Street had expected. Forest said Celexa will produce only $6 million in sales for the fourth quarter, well below analysts' predictions.

How Good Is Guidance?

"Despite the company's assurances that it could transition the difficult time of generic Celexa, we questioned this confidence given we had seen almost no companies manage this type of transition well," says Maris of Banc of America Securities.

Maris says Forest's lack of clear guidance in the past raises questions about its confidence in winning a patent challenge lawsuit against Lexapro. The trial starts May 9.

"Misplaced confidence in a company's guidance is obviously dangerous, and this reminder comes at a particularly bad time," says Maris, who doesn't own shares and whose firm says it plans to seek or receive investment banking-related compensation in the next three months.

Noting that Forest has convinced some Wall Street stock-pickers that it will win the case, Maris warns: "We think that one cannot predict the outcome of a patent case with any accuracy, and as such, should carry a healthy dose of skepticism." If Forest loses, it would fall into the red "without massive restructuring steps," he says.

Even a Forest bull like Morgan Stanley's Goodman inserts notes of caution in his evaluation. He has lowered his price target, reduced his assumptions about prescription growth in the antidepressant market and trimmed his fiscal 2006 prediction to $2.37 a share from $2.65.

"Forest remains a good second-half story," he says. "We assume the company will put out very conservative numbers for the upcoming year." Goodman doesn't own shares; and Morgan Stanley has had an investment banking relationship with Forest.