30 July 2009

WPI: Income Statement Analysis for the June 2009 Quarter

Watson Pharmaceuticals, Inc. (NYSE: WPI) earned $0.46 per share during the three months that ended on 30 June 2009, down from $0.51 in last year's second quarter. 

This post examines the Income Statement for the quarter and compares it to our "look-ahead" estimates.  Our target for Watson's Net Income in the latest quarter was $0.53 per share.

Our principal sources were the earnings announcement and the conference call transcript at Seeking Alpha.  Some background information about Watson and the business environment in which it is currently operating can be found in the look-ahead.

In a second article, we will report Watson's scores as measured by the GCFR Financial Gauges. The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Watson's Revenue in the quarter was 8.9 percent more than in the year-earlier quarter.  Our target, which was based on the company's prior guidance that total Revenue in 2009 would be approximately $2.65 billion, proved to be too low by 2.5 percent.

Revenue at the business segment associated with generic drugs increased 6.5 percent relative to last year's second quarter.  Revenue directly tied to generic drug sales rose 14.4 percent, with newly launched products providing a boost.

The smaller Distribution segment did even better with Revenue advancing 26 percent.  Revenue fell 2.3 percent at the business segment responsible for branded pharmaceuticals; however, the company is optimistic about two new branded products launched during the second quarter.

The Cost of Goods Sold was 58.0 percent of Revenue, which translates into a Gross Margin of 42.0 percent.  On this measure, Watson matched our expectation exactly.  We assumed the margin would equal the 42 percent of Revenue achieved in the first quarter.

The charge for Depreciation and Amortization in the quarter also matched our expectation.  Now halfway through the year, management's earlier guidance to expect an $88 million Amortization expense in 2009 appears to be accurate.

Research and Development expenses were about 5 percent less than our $45 million target.  The reported figures for the first two quarters of 2009 are modestly below what one would expect given the company's forecast of 2009 R and D expenses between $180 million and $190 million.

Sales, General, and Administrative costs exceeded our target by 11 percent. Watson reported that they incurred additional costs when launching the RAPAFLO® (silodosin) and Gelnique (oxybutynin chloride) products and in taking steps to acquire Arrow Group.  Watson increased its guidance range for these expenses in 2009 to $480-$500 million, from $420-$430 million.

The March 2009 quarter included
an $18 million charge to SG and A related to a legal settlement with Elan (NYSE: ELN).

Operating Income, as we define it, was down 7.4 percent from the amount in the June 2008 quarter.  Despite better-than-anticipated Revenue, Operating Income fell short of our prediction by 4.5 percent.  The deficiency was primarily due to new product and acquisition-related expenses.

Non-Operating items were almost immaterial, as expected.

Our target for the Income Tax Rate was 35 percent, and the actual rate was a surprisingly high 41.5 percent.  Watson attributed the higher rate to non-deductible expenses related to the pending Arrow Group acquisition.

Net Income was 12.1 percent less than the result of the year-earlier quarter, and it was 14.5 percent less than our prediction.   The shortfall was the result of the higher SG and A expenses and the higher provision for income taxes.

In summary, Revenue in the second quarter rose at a healthier rate than we expected, and the Gross Margin hit our target.  However, non-recurring product and acquisition expense negatively affected earnings.

Full disclosure: No position in WPI at the time of writing

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