Forest Laboratories ( FRX) is entering this quarterly earnings season with a dilemma common to its brand-name peers -- what to do about the threat of generic competition.

The difference is that the impact could be quite uncommon if Forest loses a patent fight for the antidepressant Lexapro, which accounted for $1.87 billion, or 63% of its corporate revenue, for the fiscal year ended March 31.

New York-based Forest is being challenged by Israel's Teva Pharmaceutical Industries ( TEVA), which wants to break Lexapro's U.S. patent. A trial was held in March, and a judge's decision is expected this summer, perhaps even this month.

There's plenty of nervousness because Lexapro's impact on Forest is far greater than what, for example, the cholesterol drug Lipitor provides to Pfizer ( PFE) or the antipsychotic Zyprexa contributes to Eli Lilly ( LLY).

Shares of those two companies were rattled when generic-drug companies tried to overturn their U.S. patents, but Big Pharma investors rejoiced when Lilly won a court fight in April 2005 and Pfizer prevailed last December.

"We believe the overhang of the Lexapro decision will continue to cap the share price," says Robert Uhl of Friedman Billings & Ramsey in a recent research report. Like a majority of analysts, he is neutral on Forest. He doesn't own shares, but his firm says it seeks to do business with companies covered in research reports.

Going to Court

Forest's stock has bounced around from the mid-$30s to the high-$50s, but the net effect over the last 12 months has been basically no change in the shares. The stock closed at $38.56 Wednesday.

The quarter that ended June 30 won't reveal anything about the Lexapro litigation when the results are presented next week, but analysts will certainly ask Forest officials about another event that could affect the drug's sales. Pfizer's antidepressant Zoloft lost U.S. patent protection on June 30, and analysts want to assess the impact of generic versions, especially if managed-care companies persuade their customers to use cheaper products.

June 30 was the end of Forest's first quarter, and the Wall Street consensus calls for a profit of 51 cents a share on revenue of $785.9 million, according to Thomson First Call. The estimate excludes items. For the same period last year, Forest earned 52 cents a share, excluding special items, on revenue of $711.8 million.

Forest's revenue and profit for the 2006 fiscal year declined from the previous year. One major reason was the dramatic erosion in sales of the antidepressant Celexa, a Lexapro predecessor. Forest knew Celexa would lose its patent, whereas the company is fighting Teva to keep Lexapro's U.S. patent for at least another four years. Forest licenses Lexapro from the Danish company H. Lundbeck, which has joined Forest in suing Teva.

Several brand-name drug companies have decided to settle with generic challengers, thus preventing an all-or-nothing outcome, but in this case, Forest is following the Pfizer and Lilly strategy of fighting in court.

Forest did settle a Lexapro patent challenge in October with the Australian generic-drug company Alphapharm. Analysts say the Teva litigation presents a greater problem than the Alphapharm dispute.

Pipeline Prospects

The possibility for a settlement with Teva "remains in the cards, particularly given the devastating downside should Forest Laboratories lose, though visibility here is low," says Elliott Wilbur of CIBC World Markets in a June 22 research report. Wilbur, who doesn't own shares, has a sector-perform rating on Forest. His firm says it seeks to do business with companies covered in its research reports.

"We strongly believe Forest will win the case," says Marc Goodman of Credit Suisse. He recently initiated coverage of Forest with an outperform rating. He tempered his enthusiasm by saying the risk-return on the stock "is not favorable" because a win could boost shares by 15% to 20%, while a loss could deflate the stock by 50%.

He doubts there will be a settlement, "considering that Forest had such a good case." Goodman's report was issued before Forest said on Tuesday that it was suing Caraco Pharmaceutical Laboratories, ( CPD) for infringing on Lexapro's patent.

Although analysts are fixated on the Lexapro litigation, Goodman says Forest, which specializes in licensing drugs, has some pipeline prospects that could raise its prospects in the next 12 months.

He is "modestly optimistic" about nebivolol, an experimental blood-pressure medication licensed in January from Mylan Laboratories ( MYL) for sale in the U.S. and Canada. He figures the drug could carve out a niche in a very crowded market for hypertension, while a significant gain would come if the drug could be approved for congestive heart failure.

Forest expects to seek approval from the Food and Drug Administration for nebivolol as a treatment for heart failure, but Goodman worries that the agency will demand more clinical trials. He isn't sure Forest will want to spend the time and money.

Mylan received the FDA's conditional approval for nebivolol as a blood-pressure treatment in May 2005, saying more tests would be needed before the drug could be cleared. That led Forest to suggest the drug could be approved in mid to late 2007.

Goodman also is "fairly bullish" on an experimental antibiotic, Orapem, that Forest licensed in February from Replidyne ( RDYN), a Louisville, Colo., company that just went public. Replidyne asked the FDA in December to approve the drug for treating several diseases, including acute bacterial sinusitis and certain skin infections in adults. The FDA is expected to comment in October.