26 September 2010

WPI: Look Ahead to September 2010 Quarterly Results

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

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, down from $238 million in 2009.  Revenue increased from $2.5 billion to $2.8 billion.

The company's market value is currently about $5.5 billion.

The Arrow Group acquisition in December 2009 augmented Watson's portfolio of generic drugs and expanded the company's access to international markets.  Arrow was not Watson's first large acquisition: it purchased Andrx in late 2006.  The company also obtained 15 drugs in 2008 from Teva Pharmaceutical (NASDAQ: TEVA).

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.  In 2010, Global Brand revenue has benefited from sales of products launched in 2009, most notably RAPAFLO and Gelnique.  New sales have helped offset revenue lost due to the termination last December of a supply and distribution agreement with Sanofi-Aventis (NYSE: SNY) involving Ferrlecit.  (Watson stated in their 2009 10-K that Ferrlecit was responsible for approximately 12 percent of the company's "gross profit" in 2009.)

The Distribution segment generated 23.8 percent of Revenue and 5.2 percent of operating income in 2009.

Watson Pharmaceuticals earned $0.57 per diluted share on a GAAP basis in 2010's second quarter, which ended 30 June.  Earnings per share were 28 percent more than the $0.45 Watson made in the same quarter of 2009.

Adjusted, non-GAAP earnings rose from $0.73 to $0.83 per share, up 22 percent from the June 2009 quarter.  The adjustments exclude non-cash items, such as amortization and asset impairments.

Readers wanting to take another look at Watson's June 2010 quarter might wish to review our Income Statement and Financial Gauge analyses.

We are now ready to look specifically at the September 2010 quarter.

When Watson in August announced its second-quarter results, it also updated its sales and earnings forecasts for fiscal 2010.

2010 Financial Outlook
Watson’s estimates are based on actual results for the second 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 $3.5 billion.
  • Total Global Generics segment revenue between $2.25 and $2.35 billion
  • Total Global Brands segment revenue between $440 and $460 million
  • Total Distribution segment revenue between $760 and $800 million
  • Adjusted EBITDA between $820 million and $850 million
  • Cash earnings per share between $3.30 and $3.45
The forecast for total revenue changed from $3.55 billion to $3.5 billion.  The ranges narrowed for some other estimates.

Additional guidance emerged during the second-quarter conference call (transcript available from Seeking Alpha).

For the full year 2010, we expect total R&D spending on a GAAP basis to be in the range of $260 million to $275 million.

For 2010, we expect our SG&A spending on a GAAP basis to be in the range of $620 million to $650 million.

For 2010, we expect amortization expense to be approximately $175 million.

For 2010, we now expect the GAAP effective tax rate to be in the range of 32% to 34%. On an adjusted cash basis, we continue to expect our 2010 effective tax rate to be in the range of 36% to 38%.

Revenue in the first half of 2010 was $1.732 billion, which translates into 49.5 percent of the company's $3.5 billion guidance for the full year.  We are assuming revenue in the third quarter will equal 25.25 percent of the guidance, or $884 million.  This estimate is 33.5 percent more than revenue in 2009's third quarter, which was prior to the Arrow acquisition.

The company's Gross Margin in the first half of 2010 was 42.1 percent.  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 third-quarter target for the Cost of Goods Sold of (1 - 0.44) * $884 million = $495 million.

Watson expects its Amortization expense in 2010, which is excluded from the company's Cash EPS guidance, to be around $175 million.  The company reported $82 million of Amortization, 47 percent of the projected total, in the first half.  This suggests the expense will increase modestly above the current $41 million per quarter rate.   We expect the third quarter expense will increase to $44 million. 

Annual Research and Development expenses are forecast to be between $260 million and $275 million.  The actual R&D expense in the first half was only $121.3 million, which suggests the expense should be higher in the final two quarters of 2010.  Our R&D estimate for the third quarter is $65 million.

This year's Sales, General, and Administrative expense is projected to be between $620 and $650 million.  The first half SG&A expense was a below-track $308.6 million.  Our third-quarter estimate is $160 million.

These estimates would result in Operating Income of $120 million, some 5 percent more than last year's $114 million.

We are assuming a net non-operating expense of $10 million.

With a 33 percent predicted income tax rateNet Income for the third quarter would be $73.7 million ($0.59/share).  This compares to $63 million ($0.54 per share) in September 2009. 

Ignoring amortization to approximate (roughly) cash earnings, which is the type of earnings on which many analysts focus, our projection for the September 2010 quarter rises $103 million ($0.83 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