NVDA: Look Ahead to July 2009 Quarterly Results

NVIDIA (NASDAQ: NVDA) lost $201 million ($0.37 per share) in the three months that ended on 26 April 2009.  The GCFR Overall Gauge for NVIDIA fell from 31 of the 100 possible points to 20, a very weak score.

Our initial and updated analysis reports examined the April quarter, which was the first quarter of the company's fiscal 2010, in some detail.  In summary, a large chunk of the loss was due a $140 million charge related to the company's purchase of underwater employee stock options.  The quarter would not, however, have been profitable if the charge had been excluded. 

While Revenue was 42 percent less than in the April 2008 quarter, it was encouraging that sales recovered substantially from the disastrous levels of late 2008.  PC makers replenishing their inventories once the IT market showed sign of stabilizing earlier this year might have boosted the rise.


We have now modeled NVIDIA's Income Statement for fiscal 2010's second quarter, which will end on 26 July 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce in 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 NVIDIA and the business environment in which it is currently operating.  Readers that keep close tabs on the company are invited to skip ahead.


NVIDIA Corporation designs powerful Graphics Processing Units that rapidly perform the intensive calculations required to produce hyper-realistic images for computers and video games.  Hewlett Packard (NYSE: HPQ), Dell (NASDAQ: DELL), and Apple, Inc., (NASDAQ: AAPL) are among the various manufacturers that use NVIDIA GPUs in their products.  [The status of relations between Apple and NVIDIA has recently been the subject of rumors.]

Advanced Micro Devices (NYSE: AMD) bought ATI Technologies in 2006 and became NVIDIA's most direct rival in the marketplace for high-end GPUs on video cards.  Intel (NASDAQ: INTC) also makes numerous chips that perform graphical processing. 

Sales of semiconductors, which include GPUs, are down sharply because financially strapped consumers and businesses are spending less on information technology.  Sales of semiconductors were less in 2008 than 2007, which was the first yearly drop since 2001.  The SIA forecasts an even steeper decline in 2009.  However, a ChangeWave survey in May determined that "U.S. corporate IT spending in the process of rapidly stabilizing."

NVIDIA is zealously promoting "GPU computing" as an alternative to general-purpose microprocessors for some tasks.  The company has developed technology making it easier to take advantage of the GPU's parallel-processing design.  NVIDIA has even discussed designing its own general-purpose x86 microprocessor.  Intel might have had this rivalry in mind when they sued NVIDIA in February 2009 over licensing.  With Larrabee, expected in 2010, Intel will have its own potent entry in the competition for general-purpose GPUs.

The market for handheld devices has not escaped NVIDIA's notice.  Reports indicate that the company's Tegra "computer on a chip" will power the Zune HD from Microsoft (NASDAQ: MSFT).  Other reports indicate the Tegra will soon be found in smart phones.

In 2008, NVIDIA recorded a $196 million charge to cover warranty, replacement, and other costs related to faults in certain products for notebook computers.  The faults were said to result from "a weak die/packaging material set" that is no longer used.  PCWorld reported in April that owners of Hewlett Packard laptops "continue to complain about defective Nvidia graphics cards that could cause laptops to fail" due to over-heating.


We are now ready to look ahead.

Our starting point was the transcript at SeekingAlpha from NVIDIA's conference call with financial analysts on 7 May 2009.  The following is a summary of the guidance the company offered for the current quarter.

"... we expect revenue to be up quarter over quarter in the range of 5%. As for gross margin, while we are not expecting any near-term improvement in demand in the workstation market, we do believe cost reduction efforts will allow us to improve margins. Accordingly, we expect our GAAP margins to be in the range of 32% to 34%.

"We expect GAAP operating expenses to be in the range of $280 million.

"We estimate stock-based compensation expense in the second quarter to be $25 million, and deprecation and amortization and capital expenditures to be approximately flat when compared to the first quarter. Basic shares for the second quarter are expected to be about 548 million."

Similar, but less quantitative, statements were included in NVIDIA's 10-Q for the April quarter.

"We expect revenue to increase slightly during the second quarter of fiscal year 2010 as compared to the first quarter of fiscal year 2010. [...]

"we expect gross margin to increase during the second quarter of fiscal year 2010 as compared to the first quarter of fiscal year 2010. [...]

"We expect operating expenses to decrease in the second quarter of fiscal year 2010 compared to the first quarter of fiscal year 2010."

Because NVIDIA's Revenue in the April 2009 quarter was $664 million, the first part of the guidance implies an expectation of Revenue in the July 2009 quarter of about 1.05 * $664 million = $697.2 million.  We will round this up to $700 million and call it our target.

For the Gross Margin, we will use the midpoint of the guidance range, 33 percent, as our target for the July quarter.  In other words, we expect to see the Cost of Goods Sold (CGS) of (1 - 0.33) * $700 million, which is $469 million.

NVIDIA said they would reduce the quarter's Operating Expenses, by which they mean Research and Development and Sales, General, and Administrative costs, to about $280 million.  This seems achievable.  We have allocated the expense as $200 million for R&D and the remaining $80 million for SG&A.

If there will be neither restructuring, nor asset impairment charges, Operating Income would be negative $49 million in the July 2009 quarter.  Operating income was negative $155 million one year earlier, after the $196 million warranty, etc., charge.

For Interest and other non-operating income, our estimate is $5 million.  This figure is consistent with the results of the previous few quarters.  It brings the pretax loss to $44 million.

If the tax benefit, on a percentage basis, mirrors that of the April quarter, Net Income will be -$39 million (minus $0.07 per share), compared to -$121 million (minus $0.22 per share) in the July 2008 quarter.



Please click here to see a full-sized, normalized depiction of the projected results next to NVIDIA'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:  Long NVDA, INTC, and MSFT at time of writing.  No position in any other security mentioned

CSCO: Look Ahead to July 2009 Quarterly Results

Earnings at Cisco Systems (NASDAQ: CSCO) fell from $0.29 to $0.23 per share in the April quarter.  This result contributed to a decline in Cisco's GCFR Overall Gauge score from 71 to 54 points.

Our initial and updated analysis reports examined the April quarter, which was the third quarter of the company's fiscal year, in some detail.  In summary, total Revenue was 16.6 percent less in April 2009 than April 2008.  Revenue from products dropped 22 percent, with router sales down 32 percent.  The 10-Q attributed the sales decline to the effect of "the global macroeconomic downturn across our geographic theaters" and the consequent "cautious spending by customers in [all] markets." Double-digit sales declines were experienced in each of the five defined "geographic theaters."

The bright spot was services, where Revenue increased 9 percent.  We also gave Cisco credit for carefully managing its costs and inventory.  The Gross Margin was down just 0.3 percent from April 2008.

Despite the weak economy, or, perhaps because the worst financial fears were not realized, the price of Cisco shares rallied 29 percent from $14.97 on 31 January to $19.32 on 30 April.  The contrarian Value gauge responded by falling 8 points, which is why the Overall gauge lost as many points as it did.  The combination of a surging share price and much lower earnings could not have any other result. 


We have now modeled Cisco's Income Statement for the quarter that will end 25 July 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company is scheduled to announce on 5 August 2009.  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 Cisco and the business environment in which it is currently operating.  Readers that keep close tabs on the company are invited to skip ahead.


Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a dominant position in the market for enterprise networking products and services, such as routers.  Juniper Systems (NASDAQ: JNPR) is usually considered Cisco's most direct competitor in this market.

The company also sells devices intended for home use.

In a major shift, Cisco is preparing to sell computer servers, equipped with virtualization software, for large data centers.  While it would appear that this puts Cisco into competition with heavyweights such as Hewlett-Packard (NYSE: HPQ) and IBM (NYSE: IBM), Cisco claims to be creating a new, specialized market called Unified Computing. 

Cisco has long been a serial acquirer, insatiably gobbling up companies of all sizes.  Recent acquisitions include Tidal Software, which writes programs for data centers, for $105 million, and Pure Digital Technologies for $590 million.  The latter firm has sold more than two million Flip Video camcorders in the last two years.

The company certainly has the financial resources for further acquisitions.  Cisco added $4.0 billion of long-term debt in the April quarter, most of which went (loosely speaking) into the company's bank account.  Cisco had over $33 billion in cash and short-term investments on 25 April.

Cisco's executives often express confidence, with appropriate caveats, that the company can expand its Revenue over the long term at a rate between 12 and 17 percent.  However, the "historic collapse," as ChangeWave described it, in information technology spending has derailed this objective for the time being.


We're now ready to look ahead.

Our starting point was the guidance in Cisco management's prepared remarks when they presented April's results.  A transcript of this 6 May 2009 event is available at SeekingAlpha.com.  For our purposes, the following are the key points:

[W]e anticipate total revenue for the fourth quarter to be down approximately 17% to 20% year-over-year.  [...]

we believe total gross margin in Q4 to be in the range of 63% to 64%, reflecting the revenue guidance [...]

We believe Q4 operating expenses will be approximately 39 to 40% of revenue. [...]

We expect interest and other income to be approximately $30 million in the fourth quarter.  Our tax provision rate for Q4 is expected to be approximately 22%.  [...]  We are modeling share count to be flat quarter-over-quarter in weighted average shares outstanding for EPS purposes.  [...]

For our Q4 FY ‘09 GAAP earnings, we anticipate that Q4 GAAP EPS will be $0.05 to $0.07 per share lower than the non-GAAP EPS, primarily due to acquisition charges and stock compensation expense. 

The guidance statements were made with appropriate caveats, which we have not reproduced here, about the difficulty in looking ahead in the current environment.


Since Revenue in the July 2008 quarter was $10.4 billion, the guidance range for the current quarter is $8.3 to $8.6 billion.  We have selected $8.5 billion as our Revenue target.

We are using the lower end, 63 percent, of management's guidance for Gross Margin.  In other words, our forecast for Cost of Goods Sold (CGS) is (1 - 0.63) * $8.5 billion, which is a bit over $3.1 billion.

Operating Expenses between 39 and 40 percent of Revenue are expected.  If we apply the 40 percent figure to the Revenue target, we get $3.4 billion to apportion between Research and Development and Sales, General, and Administrative costs.  [On GCFR Income Statements, CGS is also listed as an Operating Expense.]

Cisco always reports various other operating charges, including payroll tax on stock options, amortization of deferred compensation, amortization of purchased intangible assets, and the mysterious in-process research and development.  The average value for these charges in the last 10 quarters, discarding the highest and lowest values, is $122 million.

These figures would result in Operating Income, as we define it, of $1.83 billion.  This result is 27.5 percent below the comparable year-earlier value.

Cisco indicated that Interest and Other Income would be about $30 million in the July quarter.  This is much less than in July 2008.

Management forecasts a 22 percent Income Tax Rate, which would lead to Provisions for Income Taxes of $410 million.

Given all of the following, it should be clear why we're looking to see GAAP Net Income in the quarter equal to $1.45 billion (about $0.25 per share), which is 25 percent below earnings of the year-earlier quarter.


Please click here to see a full-sized, normalized depiction of the projected results next to Cisco'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: Long CSCO at time of writing.  No position in any other security mentioned.

EIX: Look Ahead to June 2009 Quarterly Results

Edison International (NYSE: EIX) reported that earnings in the first quarter fell from $0.91 per share to $0.76.  This result kept the GCFR Overall Gauge of Edison in the low-30's, a weak score but better than it had been.

Our analysis report reviewed the first quarter in some detail.  In summary, lower energy prices, especially for natural gas, reduced Edison's costs for fuel, purchased power, etc., by 13.5 percent.  Revenue fell only 9.7 percent, however, and this gap had the beneficial effect of increasing Gross Margin profitability by a substantial 3 percent, from 29.6 percent to 32.6 percent.

We had to look elsewhere to explain the drop in earnings.  One factor was a $10 million increase in capitalized software amortization costs.  In addition, "cross-border leveraged leases" had to be terminated as part of a federal tax settlement at a cost of $21 million.


We have now modeled Edison International's Income Statement for the June 2009 quarter.   The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce in 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 Edison International and the business environment in which it is currently operating.  Readers that keep close tabs on the company are invited to skip ahead.


Edison International is the parent of Southern California Edison and Edison Mission Group.  SCE, which traces its roots back to 1886, is one of the largest investor-owned, regulated electric utilities in the U.S.  Edison Mission Group owns, or has interests in, power-generation facilities across the U.S., plus the Doga Energy power plant in the Esenyurt, Turkey.

As another indication of Edison's far-flung interests, we note that the company led an international consortium that bid to develop the Akkas natural gas field in Iraq.

Already a leader in renewable energy sources, SCE signed agreements in June with suppliers for an additional 960 megawatts of wind and solar power, beginning in 2013 and 2014.  Edison International claims to deliver more energy from these sources to consumers than any other U.S. utility and to have "delivered 65 percent of the nation’s solar energy to its customers in 2008."

The Renewables Portfolio Standard originally set 2017 as the year by which regulated utilities in California had to obtain 20 percent of their energy from renewable sources.  In 2006, the deadline was legally advanced to 2010.  In 2008, Governor Schwarzenegger signed an Executive Order requiring that 33 percent of energy sold in 2020 be created from renewable sources.  Edison's CEO, in a Bloomberg interview, has indicated there are limits to the growth of renewable energy sources.


We're now ready to look ahead.

Our starting points were (1) the transcript at SeekingAlpha.com from Edison's conference call with financial analysts on 8 May 2009 and (2) the Business Update presented by the company. 

The presentation includes guidance to expect "Core" earnings in 2009 between $2.90 and $3.20 per share.  Guidance for GAAP earnings per share is $1.98 to $2.51.  The Core figures exclude the lease termination and other charges associated with the tax settlement. 

Note that the non-core expenses for the year are now expected between $0.69 and $0.92 per share, which dwarfs the $0.04 charge in the first quarter.  The per-share range is equivalent to Net Income charges between $225 million and $300 million.  On a pre-tax basis, the charges could be as high as $450 million.  The transcript indicates that this charge, less the $21 million taken in the first quarter, will be recorded in the second quarter.


Edison's Revenue varies with customer demand for power, the rates it is authorized to charge, and energy prices.  Demand is dependent on factors such as the economy, population growth, and weather.  The third quarter of the year is responsible, on average, for 31 percent of the year's total Revenue.

Because the first quarter is almost always the period with the least Revenue, we can reasonably expect Revenue in the June 2009 quarter to be higher than the $2.8 billion in the March 2009 quarter.  An increase of 10 to 12 percent would not be unusual.  However, given the weak economy and mild Spring, we consider a 7 to 8 percent March-to-June increase to be more likely.  Therefore, our estimate for the second quarter is 1.075* $2.8 billion = $3.0 billion.

For convenience, we group the Fuel, Purchased Power, and Other Operation and Maintenance operating expenses reported by Edison and call the subtotal Cost of Goods Sold.  On this basis, Edison's Gross Margin averaged 27.2 percent in 2008, with a wide variation from quarter to quarter.

In the first quarter of 2009, the Gross Margin soared to 32.6 percent, which was unusually high (because of the retroactive rate increase?).   We, therefore, expect it to be lower, down to 28 percent, in the second quarter.  Given this assumption and our Revenue estimate, our target for the CGS is (1 - 0.28) * $3.0 billion = $2.2 billion.

Expenses for Depreciation, Decommissioning, and Amortization were about $340 million in the last two quarters, and we will assume a similar amount for the June quarter.

We're now at the point where we need to add a provision for the pre-tax special charges discussed above.  Based on what little we know, we have chosen $300 million as our estimate.  There is much uncertainty about this value.

These figures would result in Operating Income of $206 million.  If the special charges were excluded, Operating income would be $506 million, up from $450 million in the June 2008 quarter.

Edison also reports a plethora of non-operating income and expense items, which we partition into three categories.  The first category is Investment gains and losses.  The second Non-operating category is gains on asset sales.  The final category is for interest expenses and a plethora of miscellaneous items.  We are assuming these figures will be similar to those reported in the first quarter.

These figures would result in pretax income of $36 million ($336 million with charges excluded).  If we assume an effective tax rate of 31 percent, the tax provision would be $11 million.  We also need to subtract values for Minority Interests and Dividends on Preferred Shares.  With these adjustments made, we end up with a minuscule (but positive!) $5 million (about $0.02 per share) estimate for Net Income.  If we exclude the uncertain $300 million special charge, Net Income would be $212 million ($0.65 per share).



Please click here to see a full-sized, normalized depiction of the projected results next to Edison'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: Long EIX at time of writing.

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

KG: Look Ahead to June 2009 Quarterly Results

[This is the 500th article to be posted on the Gauging Corporate Financial Results web site.  Since the first article was posted on 22 October 2006, there has been an average of one new article every other day.]

The GCFR Overall Gauge of King Pharmaceuticals (NYSE: KG) edged up from 23 to 26 of the 100 possible points in the first quarter of 2009, which ended on 31 March.  Our analysis report explained this result in some detail.

The March quarter was King's first with Alpharma as a wholly owned subsidiary.  King Pharmaceuticals completed a $1.6 billion acquisition of Alpharma on 29 December 2008.


Revenue in the quarter was just slightly less than King's Revenue in the same period of 2008.  However, this was not an apples-to-apples comparison.  The recent quarter included revenues from Alpharma products and the earlier quarter did not.  The new acquisition-gained revenues masked the sharp drop in sales of some of King's other products.  According to the 10-Q, sales of branded prescription pharmaceuticals fell $92 million (25 percent!) in the quarter.

The first quarter of 2009 included more than $73 million in acquisition and restructuring charges.  Net Income fell to negative $11 million (minus $0.04 per share), compared to earnings of $88 million ($0.36 per share) in the first quarter of 2008.   Earnings in the March 2009 quarter would have been $64 million ($0.26 per share) if there had been no special items.


We have now modeled King's Income Statement for the second quarter, which will conclude on Tuesday.   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.

Given the Alpharma integration, some substantial challenges, and the uncertain possibilities of new products, our model's range of uncertainty is much wider than normal.  If new information comes to light that reduces the uncertainty, we will revise our estimates as expeditiously as possible.


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

King Pharmaceuticals, Inc. (NYSE: KG), headquartered in Bristol, TN, manufactures and sells various brand-name prescription pharmaceuticals.  The Alpharma acquisition added animal health products to the business.

Medications for treating acute and chronic pain are becoming more and more important to King.  With Alpharma, King got the Flector® Patch "prescription topical treatment for acute (short-term) pain due to minor strains, sprains, and contusions (bruises)."  The active ingredient in Flector, which had sales of $17 million in the first quarter, is a nonsteroidal anti-inflammatory drug.  We suspect King also hoped to keep Alpharma's Kadian® drug for the treatment of moderate to severe chronic pain; however, to maintain the competition with King's Avinza product, the Federal Trade Commission required the divestiture of Kadian.  Iceland's Actavis purchased it for $127.5 million.

King has several high-tech, pain-killing medications under development that require regulatory approval.  Many obstacles have to be surmounted before each new product can be launched.  Just a few days ago, King announced that it no longer expects to obtain fast-track U.S. FDA approval for the Acurox® Tablets, an opioid analgesic (oxycodone hydrochloride and niacin) product it is developing with Acura Pharmaceuticals (NASDAQ: ACUR).

The Acurox situation seems to echo the disappointment last December when the U.S. FDA responded it would require additional non-clinical data before it would consider approving the abuse-resistant painkiller Remoxy®, which King had been developing with Pain Therapeutics, Inc. (NASDAQ: PTIE).  King has now "assumed full control" of all activities related to Remoxy development.  King hopes to respond to the FDA in July 2009.

The FDA did signal that new opioid pain-killing drugs could eventually be approved.

Pain medications are becoming more important to King because existing products are now facing, or will soon face, generic competition.  In January 2009, a U.S. District Court acted to invalidate two U.S. patents relating to Skelaxin® (metaxalone), a muscle relaxant.  Skelaxin sales were $446 million in 2008, according to King's 10-K.  This amount was 28.5 percent of the company's total Revenues.

In 2007, the U.S. Court of Appeals invalidated King's patent for Altace® (Ramipril).  This ACE inhibitor, used to treat patients with cardiovascular risks, had accounted for roughly 1/3 of King's net sales.  The Court's decision resulted in King recognizing asset impairment charges (covering intangible assets and inventory) totaling $250 million and King dismissing 20 percent of its staff.


We are now ready to look forward.

We started by rereading the transcript at SeekingAlpha.com from King's conference call with financial analysts on 11 May 2009.  This is a good place to learn about corporate management's expectations.

When compared to the first quarter of 2009, Revenue in the June quarter should benefit from the end of a Flector inventory adjustment that reduced sales by about $15 million.  Other things remaining the same (they won't), then Revenue in the June quarter might be about $429 million + $15 million = $444 million.  However, we wouldn't be surprised to see a further decline in the sales of branded prescription pharmaceuticals, although we're not sure of the magnitude.  In recognition of this concern, we will round down the Revenue estimate to $440 million.

We hope it is clear that this figure is intended to be a rough guess.

The Gross Margin guidance from management for 2009 is 68 percent.  It was closer to 70 percent in the first quarter, so it might be a little less in the remainder of the year.  For the second quarter, we will stick to the guidance value and see if a readjustment is needed later.  Given our Revenue estimate, the Cost of Goods Sold (CGS) should be about (1 - 0.68) * $440 million = $141 million.

The company expects Depreciation and Amortization expenses for all of 2009 between $220 and $225 million.  Taking into account the actual figure recorded in the first quarter, we come up with an estimate of $56 million for the second quarter.

Similarly, management indicated that Research and Development expenses in 2009 would be between $100 and $110 million.  Given this, it seems reasonable to assume that R&D in the second quarter will match the $27 million of the first quarter. 

Management reiterated their guidance that annual Sales, General, and Administrative expenses would be between $560 and $580 million.  With the delay in marketing campaigns for new product launches, we will set our second-quarter target at $140 million.

We wouldn't be surprised to see a non-recurring operating charge, but we have no information to justify any particular figure. 

The estimates above would lead to Operating Income for the quarter of $76 million, which would be 32 percent than the equivalent (but non-Alpharma) figure in the second quarter of 2008.

Net interest payments are expected to be about $17.5 million per quarter, and the predicted Income Tax Rate is 37 percent.  These figures bring Net Income down to $37 million ($0.15 per share), compared to $43 million ($0.18 per share) in the June 2008 quarter.


Please click here to see a full-sized, normalized depiction of the projected results next to King'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: Long KG at the time of writing. No position held in any other firms mentioned in this article.

Documenting Changes to Our Gauges

During the two-year-plus life of this blog -- this is post #499 -- we have made frequent small adjustments to our gauges of corporate financial performance and value.  It isn't unusual for us to tinker with some factor multiple times until we get comfortable with it.

The following are the types of changes that we have made (and are likely to make again):

• Add or delete a financial metric from a category gauge
• Alter the relative weights of the various metrics used to compute one of the category gauge scores
• Alter the relative weights of the category gauges when determining the Overall Gauge score.

The changes have been intended to make our analyses more accurate, complete, and insightful and, if possible, make the gauges better indicators. 

The catalyst for a change might be a belated realization that we had not been giving some aspect of a company's finances sufficient attention.  Or, we might have discovered that a financial ratio we relied on produces misleading results under certain circumstances.  It might also be recognition that a certain factor provides a better or worse indication of future results that we had first thought.


Our second-quarter 2009 analyses will include an additional Growth metric: the annual growth in Operating Profit after Taxes, when averaged over 4 years.  We have long wanted to add a multi-year assessment of company growth, but we've found Net Income to be too much affected by non-operating items as well non-recurring operating items.

We will also start, as part of an experiment, to compare Price/Earnings ratios to this Operating Profit growth rate to create a (better, we hope) variant of the well-known PEG ratio.

Although we've tried, we haven't done a good job at communicating these changes to readers.  We resolve to do better.  Too often, we have simply referred to "algorithm tweaks" to explain scoring changes.

As a first step, we have revised the descriptions of the GCFR dashboard and the Cash Management, Growth, Profitability, Value, and Overall gauges.  These posts were some of the first items published on this blog, and they had not been kept up with the changes we had made since.

BR: Look Ahead to June 2009 Quarterly Results

The GCFR Overall Gauge of Broadridge Financial (NYSE: BR) plummeted from 60 to 31 points in the March 2009 quarter.  Our analysis report for the third quarter of the company's fiscal 2009 explained this result in some detail. 

The large drop in the score was exaggerated by Broadridge's yo-yo share price movement and its limited 2-year existence as an independent company.  The GCFR gauges tend to be more volatile when the subject firm is less than, say, five years old.  Score volatility is also common when a major corporate merger or restructuring makes the financial history less relevant.

In the March 2009 quarter, earnings per share rose from $0.21 in 2008 to $0.29 in the current year.  More than half of this increase was, however, due to a non-recurring $7.3 million ($0.05 per share) state-tax credit.  The credit had the effect of reducing the effective income tax rate from about 38 percent to 24.3 percent.  Revenue in the March quarter fell by 3.5 percent relative to the year-earlier period.  In addition to the tax credit, lower Sales, General, and Administrative expenses were also a positive feature of the March quarter. 

When examined carefully, the results were not deemed by our gauges to be commensurate with the 48 percent rise in Broadridge's share price, from $12.54 to $18.61, during the first three months of calendar 2009.


We have now modeled Broadridge's Income Statement for the June 2009 quarter.  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 present some background information.


Broadridge Financial Solutions, Inc. (NYSE: BR) provides investor communication, securities processing, and clearing services to financial companies.  Automatic Data Processing, Inc. (NASDAQ: ADP) spun off Broadridge on 30 March 2007. 

Although not a household name, Broadridge received "Top Overall Honors" in the 2008 survey of brokerage process service providers.  According to its 10-K, Broadridge's Securities Processing business in fiscal 2008 handled fixed-income trades valued at approximately $3 trillion per day.  This business includes processing of transactions involving equity and fixed-income securities in the U.S and in various other markets.

In March 2009, Broadridge announced an alliance with Beacon Capital Strategies, Inc.  Beacon "operates a marketplace dedicated to providing liquidity and electronic trading in the less-liquid fixed-income market."  The alliance is intended to "help the firms' clients locate difficult-to-find securities."  The types of securities involved include mortgage-backed securities, asset-backed securities, and collateralized mortgage obligations.

The Investor Communication Solutions business segment was responsible for more than 70 percent of Broadridge's revenue in fiscal 2008, according to the 10-K, and an even greater share of pre-tax earnings.  The services provided by this segment include the distribution and processing of proxies for public companies and mutual funds.

As a result of the credit crisis, this is a challenging time for companies reliant on customers in the financial industry.  For example, Lehman Brothers was a Broadridge client.  Broadridge made the best of the situation by signing a three-year contract for clearing services with asset manager Neuberger Berman, an erstwhile Lehman subsidiary.

The company's success at handling current economic challenges was recognized in February by Standard & Poor's, which revised its ratings outlook on Broadridge from positive from stable.  S&P recognized "the company's focus on reducing debt and its stable profitability."

The share price fell a disheartening 44 percent in 2008, sinking as low as $9.72 in late November.  However, the shares have rebounded substantially in 2009.

Broadridge had one unfortunate moment in the spotlight.  A Broadridge error caused Yahoo! Inc. (NASDAQ: YHOO) to under-report votes withheld from board members at its highly publicized shareholder meeting. 


We are now ready to look ahead. 

Broadridge updated its guidance for the remainder of fiscal 2009, which ends this month, when it reported results for the March 2009 quarter.

Fiscal Year 2009 Financial Guidance

We are increasing the fiscal year 2009 GAAP earnings per share guidance range to $1.52 to $1.62 from $1.49 to $1.59, and we are reaffirming our Non-GAAP earnings per share guidance range of $1.45 to $1.55, which excludes the one-time gain from the purchase of our Senior Notes and the state tax credit true-up benefit for the prior fiscal year. The earnings per share guidance is based on diluted weighted-average shares outstanding of approximately 142 million shares.

We are reaffirming our full year net revenues guidance of -3% to flat, and expect net revenue growth will be at the mid-point to lower end of the range, primarily as a result of lower event-driven mutual fund proxy revenues, a further reduction in distribution fees resulting from higher Notice and Access adoption rates, as well as continued decline in trade activity and margin balances. We anticipate earnings before interest and taxes margins in the range of 16.0% to 16.9%, which is slightly lower than our previously provided guidance of 16.2% to 17.1%, due to the decline in revenues somewhat offset by discretionary cost containment. Our effective annual tax rate will be approximately 38% as a result of the benefit from the recurring state tax credit.

Free cash flow is expected to be in the range of $230 million to $270 million, which is higher than our previously provided guidance of $210 million to $250 million, as a result of lower needs of cash for working capital and capital expenditures. We are anticipating closed sales for fiscal year 2009 to be in the range of $160 million to $180 million.

[emphasis added]

In fiscal 2008, Broadridge's Revenue was $2.208 billion.  Given the guidance of Revenue growth at the "mid-point to lower end" of the zero to -3 percent range, we will assume that fiscal 2009 Revenue will be 2 percent lower than 2008.  Therefore, the Revenue target for the current fiscal year is (1 - 0.02) * $2.208 billion = $2.164 billion.

Revenue was $1.413 billion in the nine months through Meach 2009.  This leaves Revenue of $751 million for the current quarter.  This estimate is 5 percent less than the June 2008 quarter's Revenue of $792 million.

Note that Broadridge's Revenue exhibits a seasonal pattern in which the June quarter is much stronger than any of the others.  Revenue in June quarters is 35 to 37 percent of the annual total.

In the June period of the three previous fiscal years, Broadridge's Gross Margin was about 31 percent of Revenue.  We will assume a similar proportion in the current quarter.  Given our Revenue estimate, the Cost of Goods Sold (CGS) -- called Cost of Net Revenues on Broadridge's Income Statement -- is estimated to be (1 - 0.31) * $751 million = $518 million.

Sales, General, and Administrative expenses averaged 8.3 percent in the last three June quarters.  We will round down to 8 percent for the current quarter because Broadridge has had some success cutting costs.  Therefore, our estimate for SG&A is 0.08 * $751 million = $60.0 million.

With these estimates, we get a projected Operating Income, as we define it, of $172.6 million.  This is 2.1 percent less than Operating Income in the June 2008 quarter.

Our estimate for the June quarter of non-operating income and expenses -- items that have been erratic at Broadridge --  is for a net gain of $4 million.  This would bring pretax income to $176.6 million.  If the Income Tax Rate is 38 percent, Net Income in the quarter would be $109.5 million ($0.77 per share), compared to $97.8 million ($0.69 per share) in the June 2008 quarter.

For the fiscal year, our estimates would result in Net Income of $216 million ($1.53 per share).  In fiscal 2008, Net Income was $192 million ($1.35 per share).  We're right at the bottom end of the company's guidance for GAAP earnings. 



Please click here to see a full-sized, normalized depiction of the projected results next to Broadridge'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: Long BR at time of writing.