Is There a Pill For That? Forest Labs’ Iffy Pipeline

Forest Labs (FRX) has launched several new products in the past two years – yet has demonstrated limited success in filling the earnings void created by the patent expiry for Lexapro, its erstwhile blockbuster antidepressant. Can a new generation of products turn the tide and float the drug maker back to profitability?

The Company reported a net loss for the twelve months ended March 31, 2013, of $32.1 million compared to net income of $979.1 million posted in the prior year, as net sales plummeted 33.9% to $2.9 billion due to the loss of marketing exclusivity of Lexipro (escitalopram oxalate) in March 2012. The company derived more than 55% of sales in fiscal 2011, or $2.23 billion, from its flagship antidepressant.

FRX Operating Income Quarterly Chart

FRX Operating Income Quarterly data by YCharts

Chairman and chief executive Howard Solomon also attributed the decline in operating profitability to the continued increase in expenses resultant from new product launches: Tudorza (aclidinium bromide inhaled powder) and Daliresp (roflumilast) for patients with chronic obstructive pulmonary disease (COPD); Linzess (linaclotide) used in the treatment of both irritable bowel syndrome with constipation and chronic idiopathic constipation; Teflaro (eftaroline osamil injection), a broad-spectrum antibiotic for the treatment of bacterial skin infections and community acquired bacterial pneumonia; and, Viibryd (vilazodone), an SSRI and a partial serotonergic 5-HT1A receptor agonist used for the treatment of major depression.

Management told analysts on its recent earning’s call that sales of these next-generation products could grow 48% over fiscal 2013, adding incremental revenue of $1.32 billion in 2014. This optimism is founded on recent sales momentum exhibited by these newer drugs, which posted year-on-year gains in the fourth quarter of 51.3% to $254.3 million.

“We must distinguish between speaking to deceive and being silent to be reserved,” said Voltaire, 18th century French philosopher.

Unfortunately, management has demonstrated an insouciant reticence when it comes to individual drug performance – as opposed to the aggregate: The antibiotic Teflaro, for example, launched back in March 2011, continues to underperform, recording anemic sales of just $13.1 million last quarter.

Additionally, Forest may have overpaid when it spent $1.2 billion in 2011 to secure the rights to Vibyrd. Already holding a reputation and presence in the psychiatric and primary care market with Celexa and then Lexapro, management believed the newer antidepressant could easily drive home more than $1 billion in peak annual sales. Such has not proved true. Vibyrd posted sales of just $163 million in fiscal 2013, down from $175 million in 2012.

Piper Jaffrays (PJC) analyst David Amsellem presciently observed in 2011 that spending heavily to purchase Vibyrd wasn’t realistic in a market with such heavy generic competition. “The days of the blockbuster antidepressant are largely behind us,” warned Amsellem, further opining that annual sales of Viibryd would likely peak at between $500 million and $700 million.

Given recent prescription trends, management’s guidance of Viibryd sales of approximately $220 million in 2014 could prove too optimistic.

Critical to a rebound in the operational performance of the company, however, remains the future fortunes of the Alzheimer’s treatment Namenda (memantine HCl), which generated sales of approximately $1.5 billion in fiscal 2013. Unfortunately, Namenda, which owns more than a 35% share of total Alzheimer prescriptions, could face generic challenges as early as 2015. Management expects to launch an extended-release version later this year. Its desire to convert 25% to 40% of existing patients to the XR version by 2015, however, will depend less on sales acumen and more on managed care brinkmanship – convincing pharmacy benefits managers that compliance advantages will more than offset higher cost of the drug compared to generic substitutes.

The company is also expecting a decision in second-half 2013 for its antipsychotic cariprazine (a new, second-generation drug targeting dopamine D3 receptors) being developed for the treatment of both schizophrenia and bipolar mania. Analytics outfit Datamonitor cogently noted in a research report, however, that although Forest's experience in the psychiatry market will be a distinct commercial advantage, the firm will still need to demonstrate clinical benefits associated with the drug’s novel mechanism of action.

CEO Solomon promulgated on the fourth-quarter conference call that Forest Labs would return to profitability for FY ending March 2014. The chief executive guided analysts to expect share-net in a range of $0.40 to $0.60, based on product sales of approximately $3.3 billion.

Contrary to Solomon’s optimism, given SG&A expenses are expected to rise 13.3% in FY 2014 to approximately $1.75 billion, as the company needs to increase promotional activities for new and recently launched products, operating margins will likely remain under pressure.

FRX Free Cash Flow Yield Chart

FRX Free Cash Flow Yield data by YCharts

Investors looking to purchase shares in manufacturers like Forest Labs – still struggling to climb back from the patent precipice – might consider focusing instead on companies that sell biologics: Public debate regarding safety and quality concerns on the manufacturing of generic biosimilars is still in its infancy, which will further delay the introduction of cheaper competitors to drugs like Johnson & Johnson’s (JNJ) Procrit (epoetin alfa) or Amgen’s (AMGN) Neupogen (filgrastim).

David J. Phillips, a contributing editor at YCharts, is a former equity analyst. His journalism has appeared in Bloomberg BusinessWeek, Forbes, and Kiplinger's Personal Finance. From 2008 to 2011, David was a reporter for CBS News Interactive. He can be reached at editor@ycharts.com.

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