10 April 2009

KG: Look Ahead to March 2009 Quarterly Results

The GCFR Overall Gauge of King Pharmaceuticals (NYSE: KG) plunged from 74 to 25 of the 100 possible points in the fourth quarter of 2008, which ended on 31 December.  Our initial and updated analysis reports explained this result in some detail.

Recent tweaks to the GCFR gauges trimmed two more points from the latest score, which now stands at 23.

We have now modeled King's Income Statement for the March 2009 quarter, which will be the first period in which King's results include those of recent acquisition Alpharma.   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 in early May.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

Given the Alpharma deal and new challenges to King's products, our model's range of uncertainty is greater than normal.  We will alter the assumptions on which the model is based as more information becomes available.

First, we present some background information.

King Pharmaceuticals, Inc. 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. 

On 29 December 2008, King completed the $1.6 billion acquisition of Alpharma, Inc., and Alpharma became a wholly owned subsidiary.  To gain Federal Trade Commission approval of the purchase, King sold the KADIAN drug for $127.5 million to Iceland's Actavis.  KADIAN, which was responsible for 23 percent of Alpharma's total revenues in 2007, is used for the treatment of moderate to severe chronic pain.

In early 2009, the U.S. District Court for the Eastern District of New York invalidated two U.S. patents relating to SKELAXIN® (metaxalone), a muscle relaxant.  King plans to appeal this decision involving its best-selling, branded pharmaceutical product.  SKELAXIN accounted for $446 million (28.5 percent) of King's sales in 2008.

After the Alpharma acquisition and the SKELAXIN decision, King announced cost-cutting workforce reductions affecting about 22 percent of its employees.

King must have been quite disappointed when, last December, 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).

King suffered its most significant setback in 2007 when 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 in King reducing its staff by 20 percent.

Revenue in the fourth quarter of 2008 was 34.8 percent less than that in the December 2007 period.  Sales of Altace dropped from $166 million to $14 million.  King recorded asset impairment, restructuring, and other operating charges of $610 million in the latest quarter. The lion's share of this amount was $593 million for in-process R&D associated with the Alpharma acquisition.  These charges resulted in negative Net Income on a GAAP basis of $548 million ($2.25/share).   On a non-GAAP basis, King earned $49 million ($0.24/share).

From 30 September to 31 December 2008, Inventory rose $92 million to $258 million. The Finished Goods component of Inventory rose from $59 million to $177 million.  Perhaps the company intentionally inflated its inventory in preparation for new product launches, but we are concerned the higher inventory signals weaker sales ahead.

The fourth-quarter results caused each GCFR gauge of King Pharmaceutical to drop.  The double-weighted and contrarian Value gauge sank like a stone because the weak operating performance was combined with a share price that surprisingly rose during the turbulent last three months of 2008.

Readers are advised to read the transcript at SeekingAlpha.com from King's conference call with financial analysts on 26 February 2009.  King announced that synergies will allow the combined company to cut operating expenses, primarily SG&A and R&D, by $60 million over 2009.  In addition, King will reduce its expenses by another $90 million in 2009 by trimming the size of its workforce reduction and cost-cutting efforts.

Predicting King's Revenue for the first quarter of 2009 is a daunting task.  Revenue in the December 2008 quarter, which does not include any contributions from Alpharma, fell to $348 million from $533 million in December 2007.  We haven't been able to find Alpharma's results for the December 2008 quarter, but Revenue in the September 2008 quarter was $176 million.  Approximately $50 million of this amount, as best we can determine, was due to the now-divested KADIAN product.  We also understand that Flector sales should be down about $15 million due to excess wholesale inventory in December 2008. 

This suggests to us that first-quarter Revenue will be around $460 million (348+176-50-15).  Obviously, this is nothing more than a rough guess.

The Gross Margin guidance from management for 2009 is 68 percent.  We suspect the margin might be a little less early in the year because there hasn't been enough time to exploit merger-related synergies.  However, we will stick with the guidance value, since we don't have any data to justify an adjustment.  Given our Revenue estimate, the Cost of Goods Sold (CGS) should be about (1 - 0.68) * $460 million = $147 million.

The company expects Depreciation and Amortization expenses for the full year between $220 and $225 million.  We will assume $56 million for the first quarter.

Similarly, management indicated that Research and Development expenses in 2009 will be between $100 and $110 million.  We'll allocate $25 million to the first quarter.  There might be additional charges paid to partners. 

The guidance for annual Sales, General, and Administrative expenses is $560 to $580 million, plus Altace co-promotion fees.  We will set our target at $145 million.

King often announces non-recurring operating charges.   We don't have sufficient insights to forecast these charges, which can greatly influence overall GAAP earnings, with any confidence. 

The estimates above would lead to an Operating Income for the quarter of $87 million.

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 $44 million

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.


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