23 June 2010

WPI: Look Ahead to June 2010 Quarterly Results

This post describes our model of Watson Pharmaceuticals' (NYSE: WPI) Income Statement for the second quarter of 2010, which will end on 30 June.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about Watson and the business environment in which it is currently operating.

Watson Pharmaceuticals, Inc., produces and distributes generic and, to a lesser extent, branded pharmaceuticals. 

Watson earned $222 million in 2009 on revenue of $2.8 billion.  The corresponding figures for 2008 were $238 million and $2.5 billion.

The company's current market capitalization is approximately $5.5 billion.

The acquisition of Arrow Group, which closed in December 2009, augmented Watson's portfolio of generic drugs and strengthened its international connections.  The Arrow purchase followed Watson's acquisition of Andrx in late 2006 and the 2008 purchase of 15 drugs that Teva Pharmaceutical (NASDAQ: TEVA) had to divest after it acquired Barr Pharmaceuticals.
As a result of these deals, Watson should now be better postured to compete against generic giants Teva and Mylan (NYSE: MYL). 

Watson's business is divided for financial reporting purposes into three segments: Global Generics, Global Brands and Distribution.  With 170 different products, Global Generics contributed 59.7 percent of Revenue in 2009 and 71.6 percent of allocable operating income. 

Global Brands had 30 pharmaceutical products in 2009, with several in Women's Health and Urology markets.  This business yielded 16.5 percent of Watson's Revenue and 23.1 percent of operating income in 2009.  The Distribution segment generated 23.8 percent of Revenue and 5.2 percent of operating income.

in the first quarter of 2010, which ended 31 March, Watson earned $0.57 per share.  This result was 36 percent more profitable than the $0.42 it earned per share in the same quarter of 2009.  The quarter included a $23.4 million ($0.19 per share) gain on the sale of an investment in Scinopharm Taiwan Ltd.

Adjusted, non-GAAP earnings, which exclude non-cash items, increased from $0.69 to $0.81 per share in the first quarter. 

We're now ready to look specifically at the June 2010 quarter.

In the earnings announcement released in May 2010, Watson updated its sales and earnings forecasts for fiscal 2010.

2010 Financial Outlook
Watson’s estimates are based on actual results for the first quarter 2010 and management’s current belief about prescription trends, pricing levels, inventory levels and the anticipated timing of future product launches and events.
— Watson estimates total net revenue for the full year ended December 31, 2010 at approximately $3.55 billion.
— Total Global Generics segment revenue between $2.25 and $2.40 billion, with international product sales between $500 and $550 million
— Total Global Brands segment revenue between $440 and $480 million
— Total Distribution segment revenue between $730 and $780 million
— Adjusted EBITDA between $800 million and $850 million
— Cash earnings per share between $3.25 and $3.45
Additional guidance emerged during the first quarter conference call (transcript available from Seeking Alpha).

We expect Generic gross margins to remain strong for the remainder of the year, given the recent launch of two new strengths of metoprolol and ongoing cost savings from our Global Supply Chain Initiative.

For the full year 2010, we continue to expect total R&D spending in the range of $240 million to $260 million. We are currently trending toward the higher end of this range.

For 2010, we still expect our SG&A to be in the range of $630 million to $680 million. However, we now expect to be at the lower end of this range.

For 2010, we expect amortization expense to be roughly $170 million.

For 2010, we expect the GAAP effective tax rate to be roughly 39%.

The first quarter's Revenue of $856.5 million was 24.1 percent of the company's $3.55 billion guidance for the full year.  We are assuming revenue in the second quarter will inch up to $870 million, 24.5 percent of the projected annual total.  This estimate is 28 percent more than revenue in 2009's second quarter, but it still leaves some room for additional revenue growth in the last two quarters of the year.

The Gross Margin in the first quarter was 41.1 percent.  However, it was held down by the low-margin Distribution segment's greater-than-normal contribution to total Revenue.  The margin should increase to about 44 percent if each segment performs in accordance with the company's guidance for the year.  Combining our estimates for Revenue and Gross Margin produces a second-quarter target for the Cost of Goods Sold of (1 - 0.44) * $870 million = $487 million.

Watson expects its Amortization expense in 2010 to be around $170 million.  The company reported $39 million of Amortization, 23 percent of the projected total, in the first quarter.  We expect the second quarter expense will increase to 24 percent of $170 million, or $41 million. 

The Amortization expense is excluded from the company's Cash EPS guidance.

Watson forecast that annual Research and Development expenses would be between $240 million and $260 million, with the upper end of range more likely than the lower.  The actual R&D expense in the first quarter was $60 million, which suggests that modestly higher amounts per quarter are expected in the remainder of 2010.  Our R&D estimate for the second quarter is $63 million.

This year's Sales, General, and Administrative expense is projected to be between $630 and $680 million, with lower end of the range considered more likely.  The first quarter SG&A expense was $152 million.  Our second quarter estimate is $160 million.

These estimates would result in Operating Income of $119 million, some 26 percent more than in last year's second quarter.

We are assuming a net non-operating expense of $10 million.  We are not expecting a repeat of the first quarter's $23 million gain on the sale of equity interests.

With a 39 percent Income Tax Rate, Net Income for the second quarter would be $66 million ($0.54/share).  This compares to $53 million ($0.45 per share) in June 2009. 

Ignoring amortization to approximate (roughly) cash earnings, our estimate for the June 2010 quarter rises $108 million ($0.87 per share).

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

No comments:

Post a Comment