06 May 2010

KG: Income Statement Analysis for the March 2010 Quarter

King Pharmaceuticals, Inc. (NYSE: KG) earned $0.02 per diluted share on a GAAP basis in the first quarter of 2010, which ended 31 March.  In the year-earlier quarter, various restructuring charges related to the Alpharma acquisition contributed to King losing $0.04 per share.

Non-GAAP "adjusted" earnings fell from $0.26 to $0.14 per share. A $41 million pretax charge for the amortization of intangible assets was the most substantial item excluded from the adjusted results in the latest quarter.

This post examines King's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Our $0.18 per share earnings projection was $0.16 more than the reported amount, and it was $0.04 greater than Adjusted earnings.

The principal sources for this income statement analysis were the earnings announcement, the conference call transcript (made available by Seeking Alpha), and the formal 10-Q report.

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, 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.  Additional background information about King and the business environment in which it is currently operating can be found in the look-ahead.

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 of $381 million in the first quarter of 2010 was 11 percent less than Revenue of $429 million in the same quarter of last year.  Total Revenue was 14 percent less than the $444 million we had expected. 

Sales of branded prescription pharmaceuticals, the company's largest business, fell 13 percent from the first quarter of 2009.  Only the Animal Health business, of King's four reporting business segments, achieved a Revenue increase in the latest quarter when compared to the same quarter of 2009. King recently decided to retain this business, which came with Alpharma.

Business Segment Revenue ($M)1Q-20101Q-2009Change
Branded prescription pharmaceuticals $241.5 $277.7   -13%
Animal Health 81.3 79.8   +2%
Meridian Auto-Injector 49.8 56.6   -12%
Royalties and other 8.6 16.1   -46%
Eliminations (0.5) (1.2) NA
Total Revenue
$380.9 $429.1   -11%

Revenue is also reported separately for each of King's major Branded prescription pharmaceutical products, as listed below.

Sales of Skelaxin®, the company's biggest product, are expected to "decrease significantly" in the remainder of 2010 because generic versions from Sandoz (part of Novartis) and CorePharma recently became available. //Update//On 7 May 2010, the Associated Press reported that King had received a preliminary injunction that would limit or delay the availability of generic versions of Skelaxin®.  We have not seen a formal statement from King on the significance of the injunction."//  Thrombin-JMI®, another important product, is losing ground to competitors.

Branded Prescription Pharma Revenue ($M) 1Q-2010  1Q-2009  Change 
Skelaxin® $90.9 $100.6 -10%
Thrombin-JMI® 36.9 47.3 -22%
Flector® Patch 33.5 16.8 +100%
Avinza® 23.2 39.0 -40%
Embeda® 9.1 0NA
Levoxyl® 15.4 19.6 -22%
Other 32.5 54.4 -40%
Total Segment Revenue $241.5 $277.7 -13%

King is optimistic about EMBEDA™, which it began selling in September 2009.  This opioid is for management of moderate to severe pain under certain conditions.  King reported Embeda is achieving volume and market share growth.  The FDA had objected to claims made in some of the marketing information used in conjuction with the product's launch.  King revised its marketing materials and implemented other corrective actions that apparently satisfied the FDS.

The doubling of Flector® Patch revenue is partially due to depressed sales in the earlier period when wholesale inventories were adjusted after the Alpharma acquisition.  King expressed some disappointment with Flector's sales, which it attributed to time spent on Embeda marketing.

The Cost of Goods Sold (CGS) -- "Cost of Revenues" on King's Income Statement -- was $127 million, or 33.4 of Revenue.  This equates to a Gross Margin of 66.6 percent, which is 320 basis points less profitable than the 69.8-percent margin last year.  The decline in the Gross Margin might be due to lower Revenue, changes in the product mix, competitive pressures, Embeda launch costs, and increased royalty payments related to Skelaxin.

The latest Gross Margin was 90 basis points less than our 67.5-percent target for the quarter.

The Depreciation (including Intangible Amortization, and Accelerated Depreciation) expense of $57 million was 7 percent more than last year's $53 million.  As a percentage of Revenue, this expense increased from 12.4 percent to 15.0 percent.

The latest Depreciation expense was $24 million more than our $33 million estimate, which was based on the company's guidance for the year.

Research and Development expenses were relatively unchanged, rising from $27 million to $28 million. We had estimated $26 million.

Sales, General, and Administrative expenses, exclusive of special charges, were also nearly unchanged at $140 million.  We expected $142 million, 1 percent more than the actual amount.

The SGA& expense increased from 32.3 percent to 36.9 percent of Revenue.

King often records "special" non-recurring operating charges, but the amounts in the latest quarter were immaterial.  The year-earlier quarter included acquisition-related and restructuring charges totaling $70 million.

Subtracting the various operating expenses from Revenue yields Operating Income of $27 million, compared to only $7 million in the year-earlier quarter.  Non-GAAP Operating Income fell from $119.7 million to $70.8 million.  Both figures for Operating Income were substantially less than our $89 million target, primarily because of lower-than-expected Revenue and higher-than-expected Depreciation.

A net Non-Operating expense of $9 million was down considerably from last year's $24 million.  The latest amount was also less than the $15 million we had estimated.  Interest Expense was the item in the Non-Operating category that changed the most, from $23 million to less than $9 million.

The effective Income Tax Rate was an extraordinary 75 percent, adding insult to injury.  We had expected a 38 percent tax rate. 

King stated that the tax rate was higher than normal because of "losses on foreign subsidiaries with no tax benefit, stock compensation and state taxes."

Bottom-line Net Income flipped from an $11 million ($0.04 per share) loss in 2009's first quarter to a tiny $4 million ($0.02 per share) gain in the latest quarter.  On a non-GAAP basis, Net Income declined from $64 million ($0.26 per share) to $35.7 million ($0.15 per share).

Neither formulation of Net Income reached our target of $46 million ($0.18 per share).

Full disclosure: Long KG at time of writing.

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