13 April 2009

WPI: Look Ahead to March 2009 Quarterly Results

The GCFR Overall Gauge of Watson Pharmaceuticals, Inc. (NYSE: WPI) increased from 47 of the 100 possible points to 56 in the fourth quarter of 2008.  Our initial and updated analysis reports explained this result in some detail.

We have now modeled Watson's Income Statement for the March 2009 quarter.   The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that the company will announce later this month or in early May.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

Watson Pharmaceuticals, Inc. (NYSE: WPI) develops, manufactures, and sells generic and, to a lesser extent, branded pharmaceutical products.  Sales of generic drugs accounted for 58 percent of Watson's total Revenue in 2008. 

The company became one of the top generic drug manufacturers, along with Teva Pharmaceutical (NASDAQ: TEVA) and Mylan (NYSE: MYL), when it acquired Andrx in late 2006.  This growth continued more recently when Watson purchased the rights to 15 drugs that were divested, to resolve antitrust concerns, when Teva acquired Barr Pharmaceuticals, Inc. (NYSE: BRL).

Generic drug makers are poised to take advantage of the large number of branded pharmaceutical products that have, or will soon, lose their patent protection.  In addition, Reuters reports that manufacturing problems at some smaller generic drug companies might work to the advantage of the larger firms, such as Watson, by reducing competition.  The FDA is reported to have stepped up its scrutiny of drug makers. 

Watson had its own, minor misstep.  The company voluntarily recalled "one lot of Propafenone HCL 225 mg Tablets sold in 100 count bottles ... because some tablets may contain slightly higher levels of the active ingredient than specified."

More positively for Watson, a U.S. District Court ruled on 31 March 2009 that the generic version of Concerta® marketed by Watson Pharmaceuticals did not infringe on a patent held by ALZA and McNeil-PPC [both firms are owned by Johnson & Johnson (NYSE: JNJ)] because the patent was invalid.  Concerta® (methylphenidate hydrochloride extended-release tablets) is approved for the treatment of attention deficit hyperactivity disorder (ADHD).

Watson announced on 7 April 2009 the availability by prescription for RAPAFLO® (silodosin).  This new product is part of the company's growing urology franchise.  Watson received FDA approval for RAPAFLO in October 2008.

Watson's Revenue in the fourth quarter of 2008 was 2.9 percent more than in the year-earlier quarter.  Operating Income was up 36.8 percent from the December 2007 quarter as the result of better-than-expected Revenue and Gross Margin, offset by higher-than-expected R&D expenses.

Of the four individual gauges that drive the composite score, the Value Gauge was strongest at 18 of the 25 possible points when the December 2008 results were considered.  This contrarian measure rose in response to Watson's strong operating performance and lower price per share.  The Growth Gauge also perked up from 2 to 11 points.

Watson management provided guidance for 2009 when the company announced its 2008 fourth-quarter results.

The company estimated that total Revenue in 2009 would be approximately $2.65 billion.  This figure translates into 4.5 percent growth over 2008.  We will set of a target of $650 million for the March 2009 quarter.  This figure is 3.7 percent greater than Revenue in the March 2008 quarter.

The company didn't provide a forecast for Gross Margin.  We will assume that the margin will equal the 41 percent achieved in 2008.  Therefore, our estimate for the Cost of Goods Sold (CGS) in the first quarter is (1 - 0.41) * $650 million, which equals $384 million.

Watson stated that 2009's Amortization expense is expected to be $88 million.  We will allocate 25 percent, $22 million, of this amount to the first quarter. 

The company forecast Research and Development expenses for 2009 between $180 million and $190 million.  We will look for $45 million of R&D in the first quarter.

Watson also predicted this year's Sales, General, and Administrative expenses will be between $450 to $470 million.  Our estimate for the March quarter is $115 million.

These estimates would result in Operating Income of $85 million, which is 3 percent more than in the March 2008 quarter.

Watson's non-operating income and expenses are typically minor.  Lacking specific guidance, we'll assume a $2 million net expense.  This would lead to Income before Taxes of $83 million.

With a 35 percent Income Tax Rate, Net Income will be $54 million ($0.45/share) for the quarter.  Our estimate is 6 percent above Net Income in 2008's first quarter.

Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.


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