29 June 2009

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.

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