28 July 2007

WPI: Look Ahead to 2Q Results

Watson Pharmaceuticals (WPI) will report its results for second quarter of the year on 2 August 2007.

This company
develops, manufactures, and sells generic and, to a lesser extent, branded pharmaceutical products. Watson had been expanding beyond its roots a generic drug manufacturer into higher-margin branded pharmaceuticals. However, the $1.9 billion acquisition of Andrx Corporation increased Watson's concentration in generics, which are now responsible for over 75 percent of revenues.

Back in February, Watson issued guidance for 2007 that fell below Wall Street expectations at that time. Nevertheless, generic drug manufacturers became more attractive to investors, who realized that large numbers of pharmaceutical products will be losing their patent protection over the next several years. Watson stock hit a series of 52-week highs within the last two weeks, before giving some of the gain back in the recent market downturn.

Watson stated that they expect Revenue for 2007 to be between $2.5 and $2.6 billion. Since this announcement coincided with the report that first quarter revenues were $672 million, which would scale to $2.688 billion, Watson was signaling that the average revenue in the three final quarters would be somewhat less than $650 million. For our purposes, we will assume that Revenue in the second quarter will equal $650 million, and we will worry later about the September and December quarters.

The increased proportion of generics in the product mix, as a result of the Andrx acquisition, has lowered Watson's Gross Margin below its historic levels. We'll assume the gross margin in the second quarter, as a percentage of revenue, will match the 35.5 percent average of the two preceding quarters. Therefore, the estimate for the Cost of Goods Sold (CGS) is 64.5 percent of $650 million, or a little over $419 million.

We will also use recent results and company forecasts to estimate the Depreciation expense at 7 percent of revenue ($45.5 million), and the Research and Development (R&D) expense, which is usually a little less, at 6 percent of revenue ($39 million).

In the last year, Watson has reduced Sales, General, and Administrative (SG&A) expenses to 16 percent of revenue, which we'll use as our estimate. This works out to be $104 million.

These estimates would result in an Operating Income of $42 million.

Watson's non-operating income and expenses are not typically significant. We'll assume a $5 million expense.

With a 37 percent Income Tax Rate, Net Income would be $23 million.

($ M)

June 2007
June 2006

Op expenses

CGS (419)


R&D (39)

SG&A (104) (71)

Operating Income
Other income


Interest, etc.
Pretax income

Income tax

Net Income


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