24 September 2009

KG: Look Ahead to September 2009 Quarterly Results

The GCFR Overall Gauge of King Pharmaceuticals (NYSE: KG) dropped from 28 to 18 of the 100 possible points in the second quarter of 2009.  Our income statement and financial gauge analysis reports explained this result in some detail.

Reported Revenue in the June 2009 quarter was 12 percent more than in the second quarter 2008.  However, the recent period included sales of products King acquired when it purchased Alpharma and the 2008 period did not.  This Alpharma deal was timely because some of King's best-selling branded pharmaceuticals have come under pressure.  Altace® sales dropped 82 percent because of the loss of patent protection and the availability of generic substitutes.  Sales of Thrombin-JMI®, Avinza® and Levoxyl® declined 17 to 24 percent each.

Second-quarter earnings fell from $0.17 last year to $0.15 per share.  Non-GAAP earnings per share slipped from $0.35 to $0.32.

We have now modeled King's Income Statement for the third quarter, which will conclude on 30 September.  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 November.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

Given the Alpharma acquisition, some substantial challenges, and the uncertain possibilities of new products, our model's range of uncertainty is especially wide.  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, among other products, pharmaceuticals for animal health.

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 $39 million in the second quarter, is a nonsteroidal anti-inflammatory drug

King has several pain-killing medications under development with features that deter abuse.  As is the case for all new drugs, many obstacles have to be surmounted before the necessary regulatory approvals can be gained.

Days ago, King announced that EMBEDA™ had become available commercially for the first time.  EMBEDA™ is the first "long-acting opioid designed to reduce drug liking and euphoria when tampered with by crushing or chewing" approved by the U.S. Food and Drug Administration.

Earlier this month, King and Acura Pharmaceuticals (NASDAQ: ACUR) jointly announced that an Advisory Committee of the FDA would "consider the evidence to support the potential opioid abuse deterrent effects of Acurox® Tablets."  However, the "Companies do not expect the meeting to be convened before the end of this year."

King plans to resubmit a new drug application for abuse-resistant painkiller Remoxy® in the middle of 2010.  In the mean time, "King plans to conduct a likeability study and a pharmacokinetic trial in volunteers."

In January 2009, a U.S. District Court acted to invalidate two of King's 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.

The press release announcing second quarter earnings did not any guidance pertaining to future results.  However, management's expectations were discussed during the post-announcement conference call on 6 August 2009 with financial analysts.  The transcript is available at SeekingAlpha.com.

Revenue in the third quarter should benefit only modestly from the Embeda launch and inventory adjustments.  However, sales of older branded pharmaceuticals will remain under pressure.  With these factors in mind, we are setting our Revenue target at $450 million.   This amount is 1 percent more than Revenue in the June quarter.

The Gross Margin was 69.8 percent in the first quarter of 2009 and 68.5 in the second.  For the third quarter, we are splitting the difference and looking for 69.0 percent.  Given our Revenue estimate, the Cost of Goods Sold (CGS) should be about (1 - 0.69) * $450 million = $140 million.

Depreciation and Intangible Amortization expenses were about $53 million in each of the first two quarters of 2009. We are looking for the same amount in the third quarter.

Research and Development expenses were cut from $27 million in the first quarter to $21 million in the second.  Given this, we are assuming $24 million in third quarter R&D. 

In August, King lowered it guidance for annual Sales, General, and Administrative expenses to between $540 and $560 million.  Given the year-to-date figures, we are setting our third-quarter target at $135 million.

King often records non-recurring operating charges, but we have no basis by which to forecast them. 

The estimates above would lead to Operating Income for the quarter of $99 million, which would be 20 percent less than the equivalent (but non-Alpharma) figure in the third quarter of 2008.

Net interest payments are expected to be about $18 million per quarter, and the predicted Income Tax Rate is 37 percent.  These figures bring Net Income down to $51 million ($0.20 per share), compared to $85 million ($0.34 per share) in the September 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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