13 December 2008

KG: Look Ahead to December 2008 Quarterly Results

The GCFR Overall Gauge of King Pharmaceuticals (NYSE: KG) increased from 54 to 68 of the 100 possible points in the third quarter of 2008, which ended on 30 September. Our analysis report explained this score in some detail.

Despite Revenue in the third quarter falling almost 30 percent, the score rose because operating expenses were slashed by a greater amount. The sinking price per share also made the valuation appear more attractive.

To look ahead, we've modeled King's Income Statement for the December 2008 quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that the company will announce on, or about, 6 February 2009. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

King Pharmaceuticals, Inc. (NYSE: KG) manufactures and sells various brand-name prescription pharmaceuticals. Headquartered in Bristol, TN, King now focuses on specialty products for the neuroscience, hospital and acute care markets.

Last month, Alpharma, Inc. (NYSE: ALO) accepted King's tender offer to purchase all Alpharma common shares for $37 per share in cash -- about $1.6 billion in total. Alpharma will become a wholly owned subsidiary of King. Alpharma's KADIAN and FLECTOR products for treating acute pain appealed to King, which is looking to increase its share of the pain-care market.

King must have been bitterly disappointed when, earlier this month, the U.S. FDA asked for additional non-clinical data on the abuse-resistant painkiller REMOXY King is developing with Pain Therapeutics, Inc. (NASDAQ: PTIE).

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 laying off 20 percent of its staff.

During the first few quarters after the Altace decision, before its negative consequences really took hold, the GCFR gauges of King's performance went haywire and misleadingly indicated that King shares were significantly undervalued. It was during this period that the Overall gauge soared to 75 points, normally a superlative score. It took until the second quarter of 2008, when generic Ramipril became available from firms other than Cobalt Laboratories, for our gauges to move towards a more realistic assessment of King.

Readers are advised to read the transcript at SeekingAlpha.com from King's conference call with financial analysts on 6 November 2008.

We expect Revenue in the fourth quarter to be down 30 percent from that in the December 2007 quarter. Given that Revenue in the earlier period was $533 million, this sets our target for the current quarter at $373 million.

Management reiterated last month that they expect the Gross Margin for the year to be 75 percent. Since the margin in the first three quarters of 2008 was 75.8 percent, we assume it might be a little less than the guidance value in the fourth quarter. If we set the fourth-quarter target at 74 percent, and apply our Revenue estimate, the Cost of Goods Sold (CGS) should be about (1 - 0.74) * $373 million = $101 million.

The company was clear in May that it expects quarterly expenses for Depreciation and Amortization to be about $31 million.

In November, management indicated that Research and Development expenses in 2008 will match 2007's $150 million value. If we subtract the $111 million of R&D during the first nine months of the current year, we get an R&D estimate for the December quarter of $39 million.

In 2008 to date, Sales, General, and Administrative expenses have been about 28 percent of Revenue, which ought to be a good estimate for the fourth quarter. Given our $373 million Revenue projection, our SG&A target for the fourth quarter is $105 million.

King often announces non-recurring operating charges. Costs associated with the Alpharma acquisition would fall into this category. We don't have sufficient insights to forecast these charges, which can greatly influence overall GAAP earnings, with any confidence. Our $44 million fourth-quarter estimate is the average charge for the last 10 quarters, ignoring the highest and lowest values.

The estimates above would lead to an Operating Income for the quarter of $58 million, which is 18 percent more than the comparable value in 2007's fourth quarter.

Net Non-Operating Income or (Expense) is usually around $5 to $10 million per quarter. We chose to use the lower value of this range for the fourth quarter estimate.

If the Income Tax Rate matches the 34 percent rate during the first three quarters of the year, Net Income will be $41 million ($0.17 per share). This is about 3 percent less than in the year-earlier quarter.

Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)

December 2008
December 2007

Op expenses

CGS (97)


R&D (39)

SG&A (105) (164)

Operating Income
Other income


Interest, etc.
Pretax income

Income tax

Net Income

Shares outstanding


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