18 June 2010

KG: Look Ahead to the June 2010 Quarter

This post describes our model of King Pharmaceuticals' (NYSE: KG) Income Statement for the second quarter of 2010, which will end on 30 June.

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 lost $342 million in 2008, in large part because of acquisition-related charges.

The company's current market capitalization is down to $2 billion, from $5 billion as recently as 2007 and $3 billion six months ago.

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.

Many of King's Branded prescription pharmaceuticals are classified as Neuroscience products, which include medications for treating acute and chronic pain

In January 2009, a U.S. District Court invalidated two patents related to King's muscle relaxant Skelaxin® (metaxalone), which was one of the company's best-selling products at the time.  Generic versions of Skelaxin became available in the April 2010.  King sought an injunction stopping Sandoz (part of Novartis) from selling generic Skelaxin, but the request was not granted.  CorePharma appears to be selling generic Skelaxin as well, and we're not sure how this meshes with Sandoz's claim of 180-day exclusivity.  King continues to pursue legal claims involving Skelaxin patents.

Skelaxin sales had been declining prior to the launch of the generic versions.  Sales fell from $446 million in 2008 to $401 million in 2009, and sales were also down 10 percent in the first quarter of 2010.

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, or is developing, several pain-killing medications with features that deter abuse.  The company seems especially optimistic about EMBEDA®, an opioid for management of moderate to severe pain under certain conditions.  King reported Embeda, which first became available commercially in September 2009, is achieving volume and market share growth.

King has partnered with Pain Therapeutics, Inc. (NASDAQ: PTIE), which owns certain rights related to opioid formulations.  The collaboration agreement allows King to develop Remoxy® and other opioid painkillers.  Remoxy, which is intended for treatment of moderate to severe chronic pain, is based on oxycodone and has been designed to be resistant to abuse.  King has already had various interactions related to Remoxy with the FDA, and the company now plans to resubmit a new drug application for Remoxy in the fourth quarter of 2010.  

Animal health products, which also came from Alpharma, contributed Revenue of $359 million, 20 percent of 2009's total.  King recently decided to leave the animal health business unchanged.

In the first quarter of 2010, which ended 31 March, King earned $0.02 per diluted share on a GAAP basis versus a $0.04 loss in the year-earlier quarter.  Non-GAAP "adjusted" earnings, which exclude items such as amortization of intangible assets, fell from $0.26 to $0.14 per share.

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

King provides neither Revenue, nor earnings, guidance.  However, the company does share some pertinent information about its expectations.  In particular, during the conference call (thanks SeekingAlpha for the transcript!) after the release of first-quarter 2010 results, King made the following comments about 2010:

"Now I’d like to provide an update on our 2010 financial expectations. We still anticipate that our gross margin rate will range between 67 and 68%. With respect to SG&A we now estimate that our 2010 investments will range between $515 million and $525 million. We still anticipate depreciation expense will approximate $60 million and amortization will be approximately $115 million. With respect to R&D, we now anticipate that our 2010 investments will range between $110 and $120 million.

"Finally we now believe our cash flow from operations for 2010 will approximate $300 million which is at the lower end of our previously stated guidance of $300 million to $350 million. This guidance also takes into consideration an estimated $15 million impact of the recently enacted healthcare reform legislation."    ...

"We still however project a 38% tax rate for the full year."

To estimate King's Revenue in the June quarter, we first need to consider the impact of generic Skelaxin® becoming available early in the quarter.  Branded Skelaxin® sales are going to be down substantially.  We can't be sure of the severity of the decline, but the two following items help frame the situation:

First, when generic versions of King's Altace® became available a couple of years ago, sales of the original product fell roughly 50 percent per quarter (see chart). 

Second, King's last 10-Q stated the following:

According to IMS America, Ltd. weekly prescription data, for the week ending April 23, 2010, generic competitors have garnered just over 80% of the prescriptions in the metaxalone market.

We will assume that King's revenue from Skelaxin® in the June quarter will be 40 percent less than the $90.9 million it generated in the March 2010 quarter.  This, by itself, would reduce overall revenue in the quarter by $36.4 million.
As shown in the table below, King has been experiencing declining sales with several other of its branded prescription pharmaceutical products.  The decline should be moderated to some extent by growth from new products, most notably the very promising Embeda®.  However, it seems likely that total branded product sales will be down, unless Flector Patch can get back on track. 

Branded Prescription Pharma Revenue ($M) 1Q-2010  4Q-20091Q-2009 
Skelaxin® $90.9 $96.1 $100.6
Thrombin-JMI® 36.9 44.1 47.3
Flector® Patch 33.5 42.9 16.8
Avinza® 23.232.5 39.0
Embeda® 9.15.6 0
Levoxyl® 15.418.9 19.6
Other 32.536.6 54.4
Total Segment Revenue $241.5 $276.8 $277.7

Our estimate is that revenue from branded prescription pharmaceuticals other than Skelaxin® will decline by $10 million in the June quarter, relative to March's results.

Finally, we expect sales growth from the Animal health and Meridian Auto-Injector businesses will increase by $5 million.

Therefore, our Revenue estimate for the June quarter is $380.9 million - $36.4 million - $10 million + $5 million  = $339.5 million.  Obviously, there is a wide margin of uncertainty around this figure.

The company's Gross Margin guidance for the year is 67 percent to 68 percent.  As an estimate for the second 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) * $339.5 million = $110 million.

The guidance for Depreciation and Amortization expenses for the full year was $16 million + $115 million = $131 million.  If we subtract the first quarter's $57 million expense, we're left with $74 million for the remaining three quarters or about $25 million per quarter.

Similarly, the midpoint of the annual Research and Development guidance, $115 million, less the first quarter's $28 million, leaves $29 million per quarter for the remainder of the year.

To get to $520 million of Sales, General, and Administrative expenses over the year, the expense per remaining quarter must average $127 million.

We don't anticipate non-recurring, "special" operating expenses during the quarter.

The estimates above would lead to Operating Income for the quarter of $48 million, 46 percent less than June 2009's $90 million.

For non-operating items, we estimate a net expense of $10 million.

With the predicted Income Tax Rate of 38 percent, Net Income would be $24 million ($0.09 per share), compared to income of $38 million ($0.15 per share) in the June 2009 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: Product names are registered trademarks of King Pharmaceuticals.

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

The information on Remoxy was updated 30 June 2010.

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