Forest Laboratories, Inc. ( FRX - Analyst Report ) recently slashed its outlook for fiscal 2013 mainly due to lower expectations from Lexapro. Forest Labs’ shares fell about 3.5% on the news.

Reason for the Downward Revision

Lexapro, which was a key revenue generator at Forest Labs, lost exclusivity in March 2012. With the entry of generic competition, Lexapro sales fell significantly (down 40.2% to $355.8 million in the fourth quarter of fiscal 2012).

Forest Labs, which had been previously expecting branded Lexapro sales of $250 million, now expects sales of $215 million. The company said that it had to cut its estimate due to the higher-than-expected discounting in the market. Forest Labs is currently expecting a generic substitution rate of 88% instead of 84%. Pharmacy demand for the branded product lagged expectations while a higher number of units are being sold at lower prices through government healthcare programs.

Another factor that is expected to affect sales is lower than expected royalty income. Forest Labs receives royalty income from Mylan ( MYL - Analyst Report ) on sales of its authorized generic version of Lexapro. The company, which was previously expecting $115 million, is now expecting $60 million. The downward revision reflects a change in the company’s assumption regarding the brand price discount rate and the authorized generic distributor’s market share especially during the six-month exclusivity period.

Besides Mylan’s authorized generic version, Teva Pharmaceutical Industries Ltd.’s ( TEVA - Analyst Report ) generic version of Lexapro is available in the market. Teva will enjoy six months of marketing exclusivity as it was the first generic company to have filed an Abbreviated New Drug Application (ANDA) for Lexapro with a paragraph IV challenge.

Forest Labs had assumed that the generics would be sold at a 30% discount to the branded price. However, generic Lexapro has been priced at a 60-65% discount to the branded product. Besides this, Forest Labs was expecting the authorized generic to maintain a 44% share of the market through September 12, 2012. However, the company said that the authorized generic’s market share is about 40%.

Another reason for the guidance cut is the discontinuation of shipping of Levothroid. Forest Labs, which has a distribution agreement for Levothroid, was informed that the manufacturer has stopped producing and shipping the product from its facility due to some regulatory and quality concerns voiced by the FDA regarding the manufacturing facility.

Due to the manufacturing disruption, Forest Labs said that it currently does not have any visibility on when supply will resume. Prolonged disruption in supply could affect full year earnings by about 3 cents.

New Guidance

Based on the above factors, Forest Labs cut its fiscal 2013 guidance by 25 cents to $0.95 - $1.10. The Zacks Consensus Estimate of 96 cents is towards the lower end of this new guidance range.

Our Take

The guidance revision is disappointing – Forest Labs had initially provided a $1.20 floor for fiscal 2013 which was subsequently reduced. However, we point out that the impact of the guidance cut is near term and will primarily affect first half fiscal 2013 results. Once the six month exclusivity period expires, additional generics will enter the market and by that time investor focus will have shifted from Lexapro to the other products in Forest Labs’ portfolio, especially its pipeline candidates. We currently have a Neutral recommendation on Forest Labs, which carries a Zacks #3 Rank (short-term ‘Hold’ rating).