04 May 2008

WPI: Financial Analysis through March 2008 (Update)

A few days ago, we posted an analysis of Watson Pharmaceuticals' preliminary financial results for the quarter that ended 31 March 2008. The company's press release included a condensed Balance Sheet, which omitted details characterizing inventories, current liabilities, and stockholder's equity.

Watson Pharmaceuticals, Inc. (WPI) subsequently filed a 10-Q quarterly report that included a full set of financial statements. The additional Balance Sheet detail resulted in the following changes to Watson's gauge scores.

Of all the information in the 10-Q, we considered the most interesting item to be the Inventory composition data. We had previously calculated that the Inventory level had risen to 127 days, as measured by the Cost of Goods Sold, from 122 days in December and 102 days in March 2007. The 10-Q revealed that 70.0 percent of the current Inventory is Finished Goods, up slightly from 69.7 percent three months ago and up more significantly from 62.2 percent 12 months ago.

The Cash Management gauge score will drop, as it did in this case, when the Inventory level increases. The score reduction will be greater when the Inventory increase is in the Finished Goods component. Growing Inventory could hint that the company's products are selling slower than expected. The company might have to cut production or take back unsold goods from wholesalers. A large Inventory might not be the best use of the company's Working Capital. Companies in extreme cases have had to write down the value of their Inventory, which can lead to a big loss.

In Watson's case, we can't be sure whether the Inventory increase indicates a difficulty or if it was deliberate. The 10-Q states that Inventory includes items (more than $10 million currently) that are pending FDA approval or new products that haven't been launched for contractual reasons.

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