01 July 2009

WPI: Look Ahead to June 2009 Quarterly Results

The GCFR Overall Gauge of Watson Pharmaceuticals, Inc. (NYSE: WPI) decreased from 56 to 41 of the 100 possible points in the first quarter of 2009.  Our analysis report explained this result in some detail.

Watson's Revenue in the March 2009 quarter was 6.5 percent more than in last year's comparable period.  Generic drugs were responsible for 60 percent of Revenue, up from 58.5 percent.  Despite the head start provided by rising revenue, an $18 million charge to settle patent litigation with Elan (NYSE: ELN) led to a small drop in Operating Income.   A $1.5 million gain on the sale of assets in India might have made up some of the lost ground, but a higher state income tax rate also came into play.  The bottom line was Net Income 3 percent less than in 2008.

Each of the four GCFR category gauges that determine the Overall score were at 10 or 11 of the 25 possible points.

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

First, we set the stage with some background information about Watson and the business environment in which it is currently operating.  Readers that keep close tabs on the company are invited to skip ahead.

Watson Pharmaceuticals, Inc., develops, manufactures, and sells generic and, to a lesser extent, branded pharmaceutical products

In June 2009, Watson reached an agreement to acquire international generic drug maker Arrow Group for $1.05 billion in cash, $500 million of Watson common stock, and $200 million in other securities.  A limited overview of Arrow can be found on the web site of Cobalt Pharmaceuticals, a subsidiary.

This acquisition will expand Watson's non-U.S. operations and help it compete with Teva Pharmaceutical (NASDAQ: TEVA) and Mylan (NYSE: MYL).  The latest deal follows Watson's acquisition of Andrx in late 2006 and the purchase of 15 drugs that were divested, to resolve antitrust concerns, after Teva acquired Barr Pharmaceuticals.

Healthcare information provider IMS Health (NYSE: RX), when announcing its initial 2009 forecast of the global pharmaceuticals market, predicted that sales of generic drugs would grow five to seven percent.  IMS noted that this growth rate would be "similar to 2008 and lower than the levels experienced in 2006 and 2007."  IMS Health later reduced its overall forecast for pharmaceutical sales by about 2 percent, in recognition of the weak economic conditions, but we did not see a specific update for generic sales.

Generic drug makers are eager to take advantage of the large number of branded pharmaceutical products that have, or will soon, lose their patent protection.

A U.S. District Court ruled on 31 March 2009 that Watson's generic version of Concerta® did not infringe on a patent held by ALZA and McNeil-PPC [both owned by Johnson & Johnson (NYSE: JNJ)] because the patent was invalid.  Concerta® is approved for the treatment of attention deficit hyperactivity disorder (ADHD).

The FDA recently approved Watson's application for levonorgestrel, which is the generic equivalent to Duramed Pharmaceuticals' PLAN B.  Duramed became a unit of Teva after the latter purchased Barr.

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.

We're now ready to look ahead.

Watson, when it announced first quarter results, adjusted its guidance for the year. 

Watson estimates total net revenue for the full year of 2009 at approximately $2.65 billion. Estimates for segment revenue are as follows:

-- Total Generic segment revenue between $1.50 billion and $1.60 billion.

-- Total Brand segment revenue between $445 million and $470 million.

-- Total Distribution segment revenue between $660 million and $710 million.

Watson has increased its estimates for GAAP earnings per diluted share to between $2.15 and $2.27, and 
[...] adjusted earnings per diluted share is now estimated to be between $2.40 and $2.52.

Excluding special items
[...], adjusted EBITDA is now estimated to be between $650 and $672 million.

[emphasis added]

The Revenue portion of the guidance did not change from three months earlier.  Since Revenue was $667 million in the first quarter, the company is estimating Revenue of $1.983 billion during the last nine months of the year.  We will assume 1/3 of this amount, or $661 million, will be realized in the June 2009 quarter.  This figure is 6.2 percent greater than Revenue in the June 2008 quarter.

The guidance didn't address Gross Margin.  We will assume that the margin will equal the 42 percent of Revenue achieved in the first quarter.  Therefore, our estimate for the Cost of Goods Sold in the second quarter is (1 - 0.42) * $661 million, which equals $383 million.

In its initial guidance for 2009, management stated that 2009's Amortization expense is expected to be $88 million.  The first quarter was on track with a $22 million expense, and we will assume the same value for the second quarter.

The company forecast Research and Development expenses for 2009 between $180 million and $190 million.  Our estimate for R&D in the second quarter is $45 million, which is a little more than the first quarter figure.

Watson also predicted this year's Sales, General, and Administrative expenses will be between $450 and $470 million.  This item was inflated to $135 million in the March quarter because of the unplanned legal settlement.  We will look for a more typical $115 million in the June quarter.

These estimates would result in Operating Income of $96 million, which is 3.5 percent less than in the June 2008 quarter.

Watson's non-operating income and expenses are typically minor.  We assume they will cancel each other out.

With a 35 percent Income Tax Rate, Net Income will be $62 million ($0.53/share) for the quarter.  Our estimate is 3 percent above Net Income in 2008's second quarter.

Please click here to see a full-sized, normalized depiction of the projected results next to Watson's 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.

Full disclosure: No position in WPI or any other firm mentioned in this post at the time of writing

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