General

Total net revenues decreased to $821.1 million for the three months ended June 30, 2012 as compared to $1.15 billion for the same period last year primarily due to a decrease in Lexapro® sales resulting from the expiration of its market exclusivity in March, partially offset by increases in sales of our currently promoted products. Our next generation products, Bystolic®, Savella®, Teflaro®, Daliresp® and Viibryd®, totaled $200 million in sales for the current quarter, representing growth of 63% over the year ago period. Lexapro's market exclusivity expired in March 2012 and Lexapro now faces generic competition which, as expected, has resulted in a significant reduction in sales as compared with the same period last year. Net income decreased 78.6% in the current quarter as compared to the same period last year primarily due to the expiration of Lexapro's market exclusivity as well as the impact in the current quarter of post-launch promotional spending for Daliresp and Viibryd and pre-approval commercial costs associated with aclidinium (Tudorza™ Pressair™) and linaclotide.

On July 23, 2012 we along with our licensing partner Almirall, S.A. (Almirall), received marketing approval from the U.S. Food and Drug Administration (FDA) for Tudorza Pressair (aclidinium bromide inhalation powder) for the long-term maintenance treatment of bronchospasm associated with chronic obstructive pulmonary disease (COPD), including chronic bronchitis and emphysema. We expect Tudorza Pressair to be available to wholesalers in the fourth quarter of calendar 2012.

In May 2012, we entered into an agreement with Nabriva Therapeutics (Nabriva) for the development of Nabriva's novel antibacterial agent, BC-3781. Pursuant to the agreement, upon the expiration of the Hart-Scott waiting period in July 2012, we provided Nabriva an upfront fee of $25 million and will fund and conduct, in collaboration with Nabriva, certain development activities related to BC-3781 over the next 12 months. During the 12-month period we have the exclusive right to acquire Nabriva. Our decision to acquire Nabriva will be dependent upon certain contingencies.

Financial Condition and Liquidity

Net current assets increased by $52.6 million from March 31, 2012. Cash and cash equivalents and marketable securities and investments increased by $71.8 million primarily due to cash generated by operating activities of $90.5 million offset by capital expenditures of $18.5 million.

Of our total cash and cash equivalents and marketable securities position at June 30, 2012, 11%, or approximately $345 million, was domiciled domestically with the remainder held by our international subsidiaries. Approximately $2.9 billion is held in low tax jurisdictions and is attributable to earnings that are expected to be indefinitely reinvested offshore. Cash repatriations are subject to restrictions in certain jurisdictions and may be subject to withholding and other taxes. We continue to actively seek opportunities to further develop foreign operations through strategic alliances, business acquisitions, collaboration agreements, and other investing activities including working capital and capital expenditures. We expect cash generated by our U.S. operations, together with existing cash, cash equivalents, marketable securities, our $500 million revolving credit facility and access to capital markets to be sufficient to cover cash needs for our U.S. operations including common stock repurchases, strategic alliances and acquisitions, milestone payments, working capital and capital expenditures. We invest funds in variable rate demand notes that have major bank liquidity agreements, municipal bonds and notes, government agency bonds, commercial paper, corporate bonds, certificates of deposit, auction rate securities and floating rate notes.

Trade accounts receivable decreased $52.0 million primarily due to lower sales as a result of the expiration of Lexapro's market exclusivity. Net inventories decreased $8.8 million as we continue to manage our inventory at levels appropriate to support our products' current life cycles. In anticipation of the expiry of Lexapro's market exclusivity, the Company designed and executed over the past few years, a plan to manage Lexapro inventory balances to levels necessary to support post-expiry sales levels. We believe that current inventory levels are adequate to support the growth of our ongoing business. Other current assets decreased primarily due to a reduction in our current tax asset account that resulted from accruing the current period tax expense against tax overpayments made in prior periods. Accounts payable and accrued expenses decreased primarily due to significant declines in royalties payable and accrued rebates related to Lexapro. The decline in accrued rebates was net of a $12 million change in estimate for obligations pursuant to the Healthcare Reform Bill.

Property, plant and equipment before accumulated depreciation increased from March 31, 2012 as we continue to invest in our technology and facilities.

On May 18, 2010, the Board of Directors authorized the 2010 Repurchase Program for up to 50 million shares of our common stock. The authorization was effective immediately and has no set expiration date. Since the beginning of fiscal 2011, we have entered into three separate agreements with Morgan Stanley & Co. LLC (MSCO) to repurchase a cumulative total of $1.35 billion of our common stock utilizing accelerated share repurchase transactions (ASRs): a $500 million ASR entered into in June 2010, a $500 million ASR entered into in June 2011 and a $350 million ASR entered into in August 2011. Pursuant to these transactions, we paid MSCO the applicable purchase price upon entering each ASR and as of June 30, 2012, MSCO delivered to us a total of 38.4 million shares: 16.9 million shares during fiscal 2011 (5.7 million shares purchased under the 2007 Repurchase Program and 11.2 million shares purchased under the 2010 Repurchase Program) and 21.5 million shares during fiscal 2012 (all under the 2010 Repurchase Program). In July 2012, the Company received an additional 1.7 million shares (for a total of 13.5 million shares at an average price $37.04) and 1.2 million shares (for a total of 10.9 million shares at an average price of $32.07) upon final settlement of the June 2011 ASR and August 2011 ASR, respectively. As of August 8, 2012 we had the authority to repurchase an additional 14.4 million shares under the 2010 Repurchase Program.

Results of Operations

Net sales for the three-month period ended June 30, 2012 decreased $352.4 million or 31.9% as compared with the same period last year primarily due to a decrease in Lexapro sales of $475.7 million resulting from the expiration of its market exclusivity in March, partially offset by increases in our promoted products Namenda®, Bystolic, Teflaro, Viibryd and Daliresp.

Sales of Namenda (memantine HCl), a N-methyl-D-aspartate (NMDA) receptor antagonist for the treatment of moderate and severe Alzheimer's disease increased $48.5 million or 15.2% to $368.4 million for the quarter ended June 30, 2012 as compared with the June 30, 2011 quarter of which $55.1 million was due to price increases offset by volume decreases of $6.6 million. Namenda's patent is set to expire in April 2015.

Bystolic (nebivolol), a beta-blocker indicated for the treatment of hypertension, grew 38.2%, achieving sales of $107.8 million in the current quarter, an increase of $29.8 million as compared to $78.0 million for the quarter ended June 30, 2011 of which $18.7 million was due to increased sales volume and $11.1 million was due to price increases.

Sales of Savella (milnacipran HCl), a selective serotonin and norepinephrine reuptake inhibitor (SNRI) for the management of fibromyalgia increased 3.5% to $26.7 million as compared to $25.8 million for the same period last year due to price increases totaling $3.2 million offset by volume decreases of $2.3 million.

Teflaro (ceftaroline fosamil), a broad-spectrum hospital-based injectable cephalosporin antibiotic for the treatment of adults with community-acquired bacterial pneumonia and with acute bacterial skin and skin structure infections, launched in March 2011, achieved sales of $9.4 million for the quarter ended June 30, 2012.

Viibryd and Daliresp, two of our newest products became available to patients during the June 2011 quarter and were formally launched in late August 2011.

Viibryd (vilazodone HCl), our selective serotonin reuptake inhibitor (SSRI) and a 5-HT1A receptor partial agonist for the treatment of adults with major depressive disorder (MDD) recorded sales of $37.4 million for the quarter ended June 30, 2012.

Daliresp (roflumilast), our selective phosphodiesterase 4 (PDE4) enzyme inhibitor, achieved sales of $17.8 million for the current three-month period. Daliresp is indicated for the treatment to reduce the risk of exacerbations in patients with severe COPD associated with chronic bronchitis and a history of exacerbations.

Sales of Lexapro (escitalopram oxalate), an SSRI indicated for the initial and maintenance treatment of MDD in adults and adolescents and generalized anxiety disorder in adults, decreased 81.2% to $110.0 million for the quarter as compared with $585.7 million for the same period last year due to the loss of market exclusivity in March 2012. Lexapro now faces generic competition which has significantly eroded sales.

Contract revenue for the current quarter was $65.8 million compared to $40.6 million in the same period last year. Benicar® (olmesartan medoxomil) co-promotion income totaled $35.4 million, a decrease of $1.3 million compared to $36.7 million in last year's first quarter. Contract revenue in the current quarter also included $29.4 million of income from a distribution agreement with Mylan, Inc. (Mylan) pursuant to which Mylan is authorized to sell a generic version of Lexapro and we retain a portion of the profits from those sales.

Cost of sales as a percentage of net sales was 22.4% for the June 2012 quarter, as compared with 23.0% in the same period last year. Cost of sales includes royalties in respect of our products. In the case of our principal products, Lexapro and Namenda, the royalties are in the range of 15 to 25% of sales.

Selling, general and administrative expense increased to $382.3 million for the current quarter as compared to $358.1 million for the same period last year. The current level of spending reflects the resources and activities we believe are required to support our currently marketed products, particularly our newest products Teflaro, Daliresp and Viibryd and pre-approval commercial costs associated with Tudorza Pressair and linaclotide.

Research and development (R&D) expense totaled $195.2 million in the current quarter as compared to $194.4 million in the same period last year. The June 2011 quarter included a $40 million upfront payment to Blue Ash Therapeutics, LLC (Blue Ash) for rights to azimilide. Excluding this charge, R&D expense would have increased by 26.4% in the current quarter as compared to the same period last year. Neither period included product development milestone expenses.

Research and development expense is comprised of third party development costs, internal and other development costs and milestone and upfront charges. The following table presents research and development expense by category.

(In thousands)
                                             Three Months Ended June 30,
Category                                           2012                 2011
Third party development costs            $      106,019       $       80,736
Internal and other development costs             89,147               73,707
Milestone and upfront payments                                        40,000
Total research and development expense   $      195,166       $      194,443

Third party development costs are incurred for clinical trials performed by third parties on our behalf with respect to products in various stages of development. For the quarter ended June 30, 2012, these costs were largely related to clinical trials for nebivolol, aclidinium/formoterol, vilazodone and roflumilast. Internal and other development costs are primarily associated with activities performed by internal research personnel. Milestone and upfront charges are incurred upon consummation of new licensing agreements and achievement of certain development milestones.

Research and development expense reflects the following:

· In December 2009, we entered into an agreement with AstraZeneca AB (AstraZeneca) to acquire additional rights to avibactam (the International Nonproprietary Name for NXL104 as approved by the World Health Organization) and amended the Company's prior agreement with Novexel S.A. Pursuant to this amended agreement, the Company acquired full worldwide rights to the ceftaroline/avibactam combination while simultaneously out-licensing rights to this combination outside the United States, Canada and Japan to AstraZeneca. We also acquired co-development and exclusive commercialization rights in the United States and Canada to all other products containing avibactam including the ceftazidime/avibactam combination. Avibactam is a novel broad-spectrum beta-lactamase inhibitor designed to be co-administered intravenously with select antibiotics to enhance their spectrum of activity by overcoming beta-lactamase-related antibacterial resistance. Avibactam is currently being developed in combination with ceftaroline (Teflaro) and ceftazidime. Ceftazidime is a cephalosporin antibiotic having a different spectrum of activity compared to ceftaroline. The ceftaroline/avibactam combination is currently being studied in Phase II clinical trials conducted by Forest. Data from two Phase II trials for ceftazidime/avibactam in patients with complicated intra-abdominal infections (cIAI) and complicated urinary tract infections (cUTI) demonstrated that ceftazidime/avibactam achieved high clinical cure rates and was well tolerated in patients with cIAI and cUTI. Based on the results of these studies, we and AstraZeneca initiated Phase III studies for ceftazidime/avibactam in patients with cIAI in December 2011 and in patients with cUTI in July 2012.

· In January 2011, we reported positive results from two Phase II(b) dose-ranging studies comparing fixed-dose combinations of aclidinium (Tudorza), a novel long-acting muscarinic antagonist developed as an inhaled therapy for the treatment of COPD and the long-acting beta-agonist formoterol to aclidinium alone, formoterol alone and placebo administered BID (twice-daily) in patients with moderate to severe COPD. Both studies showed statistically significant differences for the fixed-dose combination on the primary endpoint versus placebo. The fixed-dose combinations also provided a numerically higher bronchodilation effect compared to aclidinium alone and formoterol alone. Phase III studies with the fixed-dose combination commenced in September 2011 and we anticipate top-line results from the trials during the first half of calendar 2013. We and our licensing partner Almirall received marketing approval for Tudorza Pressair for the long-term maintenance treatment of bronchospasm associated with COPD, including chronic bronchitis and emphysema in July 2012.

· In September 2007, we entered into a partnership with Ironwood Pharmaceuticals, Inc. to co-develop and co-market the proprietary compound linaclotide in North America. Linaclotide is an agonist of the guanylate cyclase type-C (GC-C) receptor being developed for the treatment of constipation-predominant irritable bowel syndrome (IBS-C) and chronic constipation (CC). Linaclotide increases fluid secretion leading to increased bowel movement frequency and modulates the activity of local nerves to reduce abdominal pain. Positive top-line data from two Phase III trials in CC and two Phase III trials in IBS-C showed clinically meaningful and statistically significant symptom improvement in linaclotide-treated patients compared to placebo on all four primary efficacy endpoints. Based upon these results, we filed a New Drug Application (NDA) with the FDA for both indications in August 2011. In April 2012, the FDA notified us that it will require a three-month extension to complete its review of the data supporting the NDA for both indications. FDA action is now expected by September 2012.

· In December 2008, we entered into an agreement with Pierre Fabre Médicament to develop and commercialize levomilnacipran (F2695) in the United States and Canada. Levomilnacipran is a proprietary selective norepinephrine and serotonin reuptake inhibitor that is being developed for the treatment of depression. In April 2012, we reported positive results from the third Phase III randomized, double-blind, placebo-controlled, fixed-dose clinical trial evaluating the efficacy, safety and tolerability of levomilnacipran compared to placebo in adult patients with MDD. Treatment with levomilnacipran significantly reduced depression symptoms in patients with MDD compared to placebo, as measured by Montgomery-Asberg Depression Rating Scale-Clinician Rated (MADRS-CR). Based on the overall success of the development program, we plan to file an NDA for levomilnacipran with the FDA in the third quarter of calendar 2012.

· In November 2004, we entered into an agreement with Gedeon Richter Ltd. (Richter) for the North American rights to cariprazine, an oral D2/D3 partial agonist, and related compounds, being developed as an atypical antipsychotic for the treatment of schizophrenia, acute mania associated with bipolar depression, bipolar depression and as an adjunct treatment for MDD. In October 2011 and February 2012, we reported preliminary top-line results from two Phase III studies of cariprazine in patients with acute mania associated with bipolar disorder. The data from both studies showed that cariprazine-treated patients with acute manic episodes experienced significant symptom improvement compared to placebo-treated patients. In February, we also reported the results of two Phase III studies of cariprazine in patients with schizophrenia showing that cariprazine-treated patients with schizophrenia experienced significant symptom improvement compared to placebo-treated patients. We expect to file an NDA for cariprazine for those two indications during the fourth calendar quarter of 2012. Cariprazine is in Phase II development for bipolar depression and as an adjunct treatment for MDD.

· We recently initiated a Phase III clinical trial to study a fixed-dose combination of Bystolic, our proprietary beta-blocker launched in January 2008, and the market's leading angiotensin II receptor blocker (ARB) valsartan for the treatment of patients with hypertension. In January 2012, we began a multicenter, randomized, double-blind, placebo-controlled study of approximately 3,750 patients to evaluate the safety and efficacy of Bystolic and valsartan patients with stage 1 or 2 essential hypertension. We expect to report preliminary top-line data from the study in mid-calendar 2013.

· In December 2010, we entered into a license agreement with Grünenthal for the co-development and commercialization of GRT 6005 and its follow-on compound GRT 6006 small molecule analgesic compounds in development for the treatment of moderate to severe chronic pain. GRT 6005 and GRT 6006 are novel first-in-class compounds with unique pharmacological and pharmacokinetic profiles that may enhance their effect in certain pain conditions. The unique mode of action of these compounds builds on the ORL-1 receptor and, supported by the established mu opioid receptor, is particularly suitable for the treatment of moderate to severe chronic pain. GRT 6005 has successfully completed initial proof-of-concept studies in nociceptive and neuropathic pain with further Phase II studies planned prior to initiation of Phase III studies.

· In June 2010, we entered into a license agreement with TransTech Pharma, Inc. (TransTech) for the development and commercialization of TTP399, a functionally liver selective glucokinase activator discovered and being developed by TransTech for the treatment of Type II diabetes. Early Phase I testing suggests that pharmacological enhancement of glucokinase activity may lower blood glucose in diabetic patients. We recently initiated a Phase II clinical program.

· In April 2011, we entered into an agreement with Blue Ash for the worldwide rights to azimilide, a novel class III antiarrhythmic agent. Azimilide has been studied in over 5,300 patients to investigate its potential as an antiarrhythmic agent. Based on its mechanism of action and results of clinical trials, azimilide was determined to be best suited for use in patients with a history of life-threatening ventricular arrhythmias and who have an implantable cardioverter defibrillator. In 2006, following submission of data from the SHIELD 1 Phase III clinical study, the FDA, under its then operable review practices, issued an Approvable Letter requesting an additional clinical trial for azimilide. In 2010, the FDA agreed to one additional Phase III study to support a regulatory submission for azimilide in the U.S. The SHIELD 2 study was initiated in November 2011 and is being conducted under a Special Protocol Assessment with the FDA. We expect to report top-line results from this study in the second half of calendar 2014.

We along with our partner Richter also continue to support the development of the mGLuR1/5 compounds, which involve a series of novel compounds that target group 1 metabotropic glutamate receptors. Many of our agreements require us to participate in joint activities and committees, the purpose of which is to make decisions along with our partners in the development of products. In addition, we have entered into several arrangements to conduct pre-clinical drug discovery.

Our effective tax rate was 26.7% for the three-month period ended June 30, 2012, as compared to 25.3% for the same period last year. The increase compared to last year was primarily due to a decrease in Lexapro sales resulting from the expiration of its market exculusivity in March as well as other various tax matters.

We expect to continue our profitability in the current fiscal year with continued growth in our principal promoted products.

Inflation has not had a material effect on our operations for the periods presented.

Non-GAAP Income and Non-GAAP EPS

Forest provides non-GAAP income and EPS financial measures as alternative views of the Company's performance, which exclude certain items (including costs, expenses, gains/(losses) and other specific items) due to their significant and/or unusual individual nature and the impact they have on the analysis of underlying business performance and trends. Management reviews these items individually and believes excluding these items provides information that enhances investors' understanding of the Company's financial performance. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not in lieu of, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows:

(In millions, except earnings per share amounts)
                                                               Three Months Ended June 30,
                                                                    2012                  2011
Reported Net income:                                       $          55         $         258
Specified items net of tax:
Amortization arising from business combinations and
acquisitions of product rights
Recorded in Cost of sales                                              9                     5
Recorded in Selling, general and administrative                       11                     3
Licensing payment to Blue Ash for azimilide                            -                    40
Adjusted Non-GAAP earnings:                                $          75         $         306

                                                               Three Months Ended June 30,
                                                                    2012                  2011
Reported diluted earnings per share:                       $        0.21         $        0.90
Specified items net of tax:
Amortization arising from business combinations and
acquisitions of product rights
Recorded in Cost of sales                                           0.03                  0.02
Recorded in Selling, general and administrative                     0.04                  0.01
Licensing payment to Blue Ash for azimilide                            -                  0.14
Adjusted Non-GAAP earnings per share:                      $        0.28         $        1.07

Off-Balance Sheet Arrangements

At June 30, 2012, the Company had no off-balance sheet arrangements.

Critical Accounting Policies

. . .