06 August 2009

KG: Income Statement Analysis for the June 2009 Quarter

King Pharmaceuticals, Inc. (NYSE: KG) earned $0.15 per share in the three months that ended on 30 June 2009, down from $0.17 per share in the second quarter of last year. 

On a non-GAAP ("pro forma" or "ex-items") basis, King's earnings slipped from $0.35 to $0.32 per share.  The difference between GAAP and non-GAAP Net Income was $42 million in the latest quarter.  The most substantial item excluded from the non-GAAP results is amortization of intangible assets.

This post examines the GAAP-compliant Income Statement for the quarter and compares it to our "look-ahead" estimates, which were published on 29 June.  Our target for King's Net Income in the latest quarter was $0.15 per share.

In a second article, we will report King's scores as measured by the GCFR Financial Gauges.  The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Our principal sources were the earnings announcement and the 10-Q for the quarter.  Some background information about King Pharmaceuticals and the business environment in which it is currently operating can be found in the look-ahead.

King completed a $1.6 billion acquisition of Alpharma on 29 December 2008.  The June quarter was, therefore, King's second with Alpharma as a wholly owned subsidiary.  When comparing the June 2008 and June 2009 quarters, it is very important to realize that the recent period includes the results of the King-Alpharma combination and the earlier period only includes King's results.  Alpharma's results as a separate company in 2008 have not been integrated into King's financial baseline.  For those willing to dig a little, some limited pro forma data is included in Note 7 of the financial statements in the 10-Q.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Revenue in the second quarter was 12.1 percent more than in the June 2008 period.  The reported figure exceeded our Revenue estimate by only 1.1 percent.

According to the 10-Q, sales of branded prescription pharmaceuticals fell $40.6 million (12.9 percent) in the quarter.  However, sales of existing products actually dropped $79.2 million because King gained $38.6 million from sales of the Flector® Patch,which was brought to the company by Alpharma.

Altace® sales fell the most, $36.4 million or 82 percent.  Sales of Thrombin-JMI®, Avinza® and Levoxyl® declined 17 to 24 percent each.

Sales of Skelaxin®, the company's most important current product, were down only (?) 4.7 percent.

Animal Health products, which came to King from Alpharma, contributed Revenue of $82.8 million, 18.6 percent of the total. 

The Cost of Goods Sold (CGS) -- Cost of Revenues on King's Income Statement, but not including "Acquisition related inventory step-up" costs -- was 31.5 percent of Revenue in the quarter, which translates into a Gross Margin of 68.5 percent.  The actual margin beat our 68-percent target by 0.5 percent.

In the June 2008 quarter, the Gross Margin was a more lucrative 74.3 percent.

Depreciation and Amortization expenses in the second quarter were 5.4 percent less than our estimate, which was derived from King's guidance for 2009.

Research and Development expenses dropped considerably and were 22 percent less than our estimate.  R&D spending was only 4.8 percent of Revenue, whereas we thought 6 percent of Revenue was more likely.  

Sales, General, and Administrative (SG&A) expenses were also below expectations, 11 percent less than our target value.  SG&A spending was 27.8 percent of Revenue, and We were looking for 31.8 percent.

We should have realized that Altace co-promotion fees, which are part of SG&A would drop to almost nothing.

Although King often announces "special" non-recurring operating charges, we failed to anticipate a $16 million charge for "Acquisition related inventory step-up" costs and a $1.5 million charge for restructuring.

As a result of the Revenue gained in the Alpharma acquisition and some lower costs, King's Operating Income rose 31 percent relative to the same period last year.  Operating Income also surpassed our estimate by 18 percent, helped by lower-than-anticipated R&D and SG&A costs.  Unexpected special charges kept the Operating Income from beating our target by an even greater amount.

Net Non-Operating (primarily interest) expenses were about $4 million more than we had forecast. 

The Income Tax Rate was 43.6 percent, much higher than our 37-percent target.  King reported that the effective rate was greater than the statutory rate of 35 percent "primarily due to losses from foreign subsidiaries with no tax benefit, taxes related to stock compensation and state taxes."

The higher-than expected interest expense and income tax ate up Operating Income's surplus over our target and brought Net Income down to our original target of $0.15 per share.  Net income was down 7 percent from last year and EPS was down 8 percent.

Six months have now passed since King Pharmaceuticals acquired Alpharma. Although reported Revenuein the second quarter was 12.1 percent more than in the June 2008 period, readers need to remember that the recent period includes sales of products acquired with Alpharma and the earlier period did not.  Revenue from some formerly best-selling branded pharmaceuticals is down sharply because of competition and loss of patent protection.

Full disclosure: Long KG at time of writing.

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