31 December 2009

KG: Look Ahead to December 2009 Quarterly Results

King Pharmaceuticals, Inc. (NYSE: KG) earned $0.17 per share in the third quarter of 2009, which ended 30 September, down from $0.34 in the same quarter of last year.  Earnings fell from $0.39 to $0.29 per share on a non-GAAP ("pro forma" or "ex-items") basis, which excludes items such as amortization of intangible assets.

In November, we examined King's Income Statement for the September quarter and compared the entries on each line to our "look-ahead" estimates.  We later performed a financial gauge analysis of King, which determined that the GCFR Overall gauge slipped negligibly from 18 to 17 of the 100 possible points.

We have now modeled King Pharmaceuticals' Income Statement for the quarter that will end on 31 December 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce in February 2010.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about King and the business environment in which it is currently operating.

King Pharmaceuticals, Inc. (NYSE: KG), headquartered in Bristol, TN, manufactures and sells various brand-name prescription pharmaceuticalsAnimal health products were added when King spent $1.6 billion to acquire Alpharma, in a deal completed on 29 December 2008.

Medications for treating acute and chronic pain have become important elements of King's product line.  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 $40 million in the third quarter, is a nonsteroidal anti-inflammatory drug

King has several pain-killing medications under development with features that deter abuse.  The U.S. Food and Drug Administration, reported Health News, directed all makers of opioid drugs to produce Risk Evaluation and Mitigation Strategy "to curb the abuse of prescription painkillers and insure the benefits of the drugs continue to outweigh the risk."  

In September, 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 FDA.

In that same 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 specifically at the current quarter.

Projecting King's performance has been a daunting task all year because of the Alpharma merger, substantial challenges to existing products, and the unpredictable possibilities of promising new products.  For the fourth quarter of 2009, our uncertainty is increased because we missed the company's conference call on 5 November 2009 with analysts.

SeekingAlpha, an outstanding source of affordable (i.e., free) transcripts, doesn't have this particular one.  Therefore, we will rely on information made available earlier in the year.

In each of the first three quarters of 2009, King reported more Revenue than in the preceding quarter.  Since the fourth quarter will be the first full period with sales of Embeda, we are assuming the growth trend will continue.  However, we suspect the pace of growth will slow.

With these factors in mind, we are setting our Revenue target at $472 million.  This amount is only 2 percent more than in the September quarter.  However, it is 36 percent greater than Revenue in the extremely weak fourth quarter of 2008.

The Gross Margin in the first three quarters of the year was 69.8 percent, 68.5 percent, and 65.4 percent, in that order.  We suspect the more recent figure was depressed by one-time costs.  Therefore, we gave greater weight to the earlier margins when coming up with an estimate of 68 percent for the fourth quarter.  Given our Revenue estimate, the Cost of Goods Sold (CGS) would be about (1 - 0.68) * $472 million = $151 million.

Depreciation and Intangible Amortization expenses have been $53 million per quarter in 2009.  We are looking for the same amount in the fourth quarter.

Research and Development expenses were cut from $27 million in the first quarter to $21-$22 million in the next two quarters.  Given this, we are assuming $23 million for the fourth quarter's R&D. 

In August, King lowered it guidance for annual Sales, General, and Administrative expenses to between $540 and $560 million.  The year-to-date figures suggest the final number will be close to the bottom of this range.  We are setting our fourth-quarter target at $142 million.

King often reports non-recurring operating charges, and the fourth-quarter of 2008 included a whopper.  King recorded asset impairment, restructuring, and other operating charges of $610 million, the lion's share of which was $593 million for in-process R&D associated with the Alpharma acquisition. 

The estimates above would lead to Operating Income for the quarter of $103 million.

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 $54 million ($0.22 per share), compared to a loss of $548 million ($2.25 per share) in the December 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.

Note: Yahoo Finance is the source of the historical share price data.

Full disclosure: Long KG at the time of writing. No position held in any other firms mentioned in this article.

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