05 April 2010

KG: Look Ahead to March 2009 Quarterly Results

This post describes our model of King Pharmaceuticals' (NYSE: KG) Income Statement for the first quarter of 2010, which ended on 31 March.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about King and the business environment in which it is currently operating.

King Pharmaceuticals, headquartered in Bristol, TN, manufactures and sells various brand-name prescription pharmaceuticals and other products.  The acquisition of Alpharma, in a $1.6 billion deal completed in December 2008, added new painkilling medicines with significant sales potential and animal health products.

King earned $92 million on Revenue of almost $1.8 billion in 2009.  The company recorded a $342 million loss in the previous year, which included acquisition-related charges totaling $600 million.

The company's current market capitalization is nearly $3 billion.

The business is divided for reporting purposes into four segments: Branded prescription pharmaceuticals, Animal health, Meridian Auto-Injector, and Royalties and other.   Branded prescription pharmaceuticals, the largest segment, was responsible for 62.7 percent of Revenue and 76.6 percent of Assets in 2009.

Neuroscience products make up the bulk of the Branded prescription pharmaceuticals, and this category is dominated by medications for treating acute and chronic pain.  The products include Skelaxin® (metaxalone), Flector® Patch, Avinza® and EMBEDA™.

Skelaxin®, a muscle relaxant, brought in the most Revenue, but sales slipped to $401 million in 2009 from $446 million in 2008.  In January 2009, a U.S. District Court acted to invalidate two of King's U.S. patents relating to Skelaxin®.  Although King is appealing this judgment, the company has scaled back its promotional efforts.

The Flector® Patch, which was developed by Alpharma, is a "prescription topical treatment for acute (short-term) pain due to minor strains, sprains, and contusions (bruises)."  Sales of this product were $138.6 million in 2009.

King has several pain-killing medications under development with features that deter abuse.  EMBEDA™, which also came to King from Alpharma, became available commercially in September 2009.  Zacks Investment Research opined

" ... we view the approval and launch of Embeda as a major milestone for the company. Embeda represents significant growth potential and could help King gain a leadership position in the abuse-deterrent opioid market."

Animal health products, which also came from Alpharma, contributed Revenue of $359 million, 20 percent of the total.  Reuters reported in January that King is evaluating the value of this business.

To resolve allegations that Alpharma, prior to its acquisition, engaged in improper sales and marketing practices involving the Kadian® painkiller, King in March 2010 entered into a settlement agreement with the U.S. government.  The agreement requires King to pay $42.5 million plus interest.  King divested Kadian® in conjunction with the Alpharma acquisition.

We are now ready to look specifically at the March 2010 quarter.

During the conference call (thanks SeekingAlpha for the transcript!) after the release of fourth-quarter 2009 results, King provided some financial guidance for 2010:

For the full year, we expect that our gross margin rate will be between 67% and 68%. With respect to SG&A, we estimate that our 2010 investments will range between $560 million and $575 million excluding the Altace co-promotion fee. We anticipate that depreciation expense will approximate $16 million and amortization will be $115 million [ph]. With respect to R&D, we anticipate that our 2010 investments will range between $100 million and $110 million. We expect to incur net interest expense excluding the imputed interest on our $400 million convertible bonds of approximately $10 million. We forecast our tax rate will remain at approximately 38%. Finally, we anticipate cash flow from operations to be in a range of $300 million to $350 million this year.

King provides neither Revenue, nor earnings, guidance.

In 2009, King's Revenue per quarter was between $429 million and $463 million, a relatively narrow range.  Revenue increased early in the year, but it fell back in the fourth quarter.  At this point, we just don't know whether new products will provide enough sales growth to offset the declines of older products. 

Given the lack of a trend, we are setting our Revenue target for the first quarter of 2010 at $444 million.  This amount is the average Revenue per quarter in 2009.

The company's Gross Margin guidance for the year is 67 percent to 68 percent.  As an estimate for the first quarter, we are using the midpoint, 67.5 percent.  Given our Revenue estimate, we are looking for a Cost of Goods Sold (CGS) of (1 - 0.675) * $444 million = $144 million.

The guidance for Depreciation and Amortization expenses was $16 million + $115 million = $131 million.  If split equally over the year, the amount per quarter would be $32.75 million.  Although this seems low, given that the charge was over $50 million per quarter in 2009, we will use the smaller number and learn from the reported results if we have misinterpreted the guidance. 

Similarly, we will look for 25 percent of the guided Research and Development and Sales, General, and Administrative expenses in the first quarter.

As for non-recurring, "special" operating expenses, we don't believe it is necessary to account for the $42.5 million settlement charge (other than, perhaps, interest) because King made a provision for this expense in 2009.  However, since non-recurring operating expenses are fairly common, we will include a $10 million placeholder in the first quarter model.

The estimates above would lead to Operating Income for the quarter of $90 million.

For non-operating items, we estimate a net expense of $15 million.

With the predicted Income Tax Rate of 38 percent, Net Income would be $46 million ($0.18 per share), compared to a loss of $11 million ($0.04 per share) in the March 2009 quarter.  If we exclude the $10 million guess for special operating charges, Net Income would be $52 million ($0.21 per share)

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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