08 November 2009

KG: Income Statement Analysis for the September 2009 Quarter

King Pharmaceuticals, Inc. (NYSE: KG) earned $0.17 per share in the third quarter of 2009, down from $0.34 in the same quarter of last year.

On a non-GAAP ("pro forma" or "ex-items") basis, earnings fell from $0.39 to $0.29 per share.  The pretax difference between GAAP and non-GAAP Net Income was $46 million in the latest quarter.  The most substantial item excluded from the non-GAAP results is amortization of intangible assets.

This post examines the Income Statement for the quarter in the earnings announcement and the more detailed 10-Q and compares the entries on each line to our "look-ahead" estimates.  Our target for King's Net Income in the latest quarter was $0.20 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 various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

King Pharmaceuticals manufactures and sells various brand-name prescription pharmaceuticals.  Some background information about King 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 September quarter was, therefore, King's third with Alpharma as a wholly owned subsidiary.  When comparing the latest results to those from September 2008, 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 historic results.  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 third quarter was 19.3 percent more than in the September 2008 period.  The reported figure exceeded our Revenue estimate by 2.9 percent.

According to the 10-Q, sales of branded prescription pharmaceuticals fell $18.5 million (6.1 percent) in the quarter.  However, Revenue from the branded products King was selling last year dropped $70.1 million because King gained $40.4 million from sales of the Flector® Patch, which was brought to the company by Alpharma, and $11.2 million from the new Embeda long-acting opioid.

Altace® sales fell $19.8 million (66 percent), and sales of Thrombin-JMI® declined 35 percent. Sales of Skelaxin®, the company's biggest seller, were down 7.2 percent.

Animal Health products, which came from Alpharma, contributed Revenue of $95.8 million, 20.7 percent of King's total Revenue. 

The Cost of Goods Sold (CGS) -- Cost of Revenues on King's Income Statement, but not including "Acquisition related inventory step-up" costs -- was 34.6 percent of Revenue in the quarter, which translates into a Gross Margin of 65.4 percent.  The Gross Margin was a more lucrative 73.9 percent in the September 2008 quarter.

The Gross margin fell substantially short of our 69-percent target.  The addition of lower-margin Animal Health products brought the average down.

Depreciation and Amortization expenses in the third quarter were consistent with our estimate, which was based on the results of the first two quarters of the year.

Research and Development expenses dropped considerably relative to last year and were 6  percent less than our estimate.  R&D spending was only 4.8 percent of Revenue, down from 8.7 percent in September 2008.   Spending decreased because the company didn't accrue the same milestone payments to partners it did last year.

Sales, General, and Administrative (SG&A) expenses matched our expectations, or nearly so.  SG&A spending was 29.3 percent of Revenue.

King often records "special" non-recurring operating charges.  In third quarter, there were small charges, amounting to only $4 million for "Acquisition related inventory step-up" costs and restructuring.

Operating Income, which we define as the difference between Revenue and the operating expenses identified above, was 29 percent less than last year.  It was also about 12 percent less than our estimate.  Although the Alpharma acquisition significantly increased Revenue, operating costs were also much higher, squeezing profits.

Net Non-Operating (primarily interest) expenses was only about $1 million more than we had forecast. 

The Income Tax Rate was 37.4 percent, slightly 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."

Net Income was 50 percent less than last year and about 16 percent less than we had estimated.

We remind readers that the recent period included Revenues and costs of products acquired with Alpharma and the earlier period did not.  Sales of some formerly best-selling branded pharmaceuticals are down sharply, but new products are entering the mix

Full disclosure: Long KG at time of writing.

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