09 August 2010

KG: Income Statement Analysis for the June 2010 Quarter

King Pharmaceuticals, Inc., (NYSE: KG) earned $0.07 per diluted share on a GAAP basis in 2010's second quarter, which ended 30 June.  Earnings per share were less than half the $0.15 King made in the same quarter of 2009.

Non-GAAP adjusted earnings were also down substantially, falling from $0.32 to $0.17 per diluted share.  The non-GAAP results for the most recent quarter exclude items totaling $25.1 million, net, including a $38.2 million pretax charge for intangible assets amortization and a $12.5 million gain on a divested product.

This post examines King's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported GAAP earnings were $0.02 less than the $0.09 per share we had forecast.

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.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

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 and animal health products.

In a January 2009 decision greatly detrimental to King and its shareholders, two patents related to the muscle relaxant Skelaxin® (metaxalone) were invalidated by a U.S. District Court.  Skelaxin was one of the company's best-selling products at the time.  Generic versions of Skelaxin became available in the April 2010, and sales of King's branded product tumbled.

Pain-killing medications with features that deter abuse may be King's best hope for the future.  The company seems especially optimistic about EMBEDA®, which first became available commercially in September 2009.  King reported prescription growth of 15 percent for Embeda, an opioid for management of moderate to severe pain under certain conditions, during the month of June 2010.

King is also developing Acurox® product with Acura Pharmaceuticals (NASDAQ: ACUR), Remoxy® with Pain Therapeutics, Inc. (NASDAQ: PTIE), and the ALO-02 oxycodone/naltrexone product started by Alpharma.  King management expressed optimism that non-clinical data seen to date will support a Remoxy NDA resubmission by the end of this year.

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 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 June quarter decreased 17 percent, from $445 million last year to $371 million in the most recent three months.

Reported revenue exceeded our $340 million estimate by $31.4 million or 9.25 percent.  The difference is in large part explained by the $26 million in royalty revenue King received from CorePharma for selling an authorized generic version of SKELAXIN®.  We had not anticipated this payment. 

Sales of branded prescription pharmaceuticals, the company's largest business, declined 41 percent from the second quarter of 2009.  The Meridian Auto-Injector business recorded the most robust growth.

Business Segment Revenue ($M)2Q-20102Q-2009Change
Branded prescription pharmaceuticals $162.2 $275.1   -41%
Animal Health 84.782.8   2.2%
Meridian Auto-Injector 82.772.1   14.7%
Royalties and other 42.415.7  169 %
Eliminations (1.1) (0.8) NA
Total Revenue
$370.9 $445.0   -16.6%

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

Branded Prescription Pharma Revenue ($M) 2Q-2010  2Q-2009  Change 
Skelaxin® $5.3 $102.2 -95%
Thrombin-JMI®37.048.6 -24%
Flector® Patch 35.338.6 -8.7%
Avinza®24.728.9 -14%
Embeda®14.6 -NA
Levoxyl®16.115.3 5.4%
Other 29.241.6 -30%
Total Segment Revenue $162.2 $275.1 -41%

Sales of Skelaxin® fell 95 percent (an even steeper plunge than we expected) because generic versions from Sandoz (part of Novartis) and CorePharma became available.

King announced that it had recently taken actions with its staff to improve the marketing of Embeda and Flector, becoming more aggressive in some areas, moving away from others, and changing organizational relationships.  Sales data for June were deemed encouraging.

The  Cost of Goods Sold -- "Cost of Revenues" on King's Income Statement -- was $119 million, or 32.1 of Revenue.  This equates to a Gross Margin of 67.9 percent, which is 60 basis points less profitable than the 68.5-percent margin last year.  The decline in the Gross Margin might be due to lower Revenue, changes in the product mix, competitive pressures, and Embeda launch costs.

The latest Gross Margin was 40 basis points higher than our 67.5-percent target for the quarter.  Our figure was based on the company's full-year guidance of a Gross Margin between 67 an 68 percent.

The Depreciation (including Intangible Amortization, and Accelerated Depreciation) expense of $54 million was just slightly higher than last year's $53 million.  As a percentage of Revenue, this expense rose from 11.9 percent to 14.5 percent.

The latest Depreciation expense was $29 million more than our $25 million estimate.  The error was the result of a miscalculation.

Research and Development expenses increased 56 percent, rising from $21 million to $33 million. We had estimated $29 million.

Sales, General, and Administrative expenses rose 6.7 percent, from $124 million to $132 million.  We expected $127 million.

The SG&A expense increased from 27.8 percent to 35.5 percent of Revenue.

The only other operating charge was $4.85 million charge for restructuring.  We didn't make a provision for restructuring expenses because we had no basis for an estimate.  Fortunately, the amount was minor.

Subtracting the various operating expenses mentioned above from Revenue yields Operating Income of $28.1 million, down 69 percent from $90 million in the year-earlier quarter.  Although King had more Revenue than we expected, the additional amortization amount and slightly higher-than-expected R&D and SG&A expenses resulted in actual Operating Income much less than our $48.2 million target.

Non-GAAP Operating Income, which excludes special items, fell from $148.7 million to $73.0 million.

As for non-operating items, King recorded a $12.5 million gain on Kadian.  To obtain Federal Trade Commission approval of the purchase of of Alpharma, Inc., King sold the KADIAN drug for $127.5 million to Iceland's Actavis.  KADIAN, which was responsible for 23 percent of Alpharma's total revenues in 2007, is used for the treatment of moderate to severe chronic pain.

We hadn't anticipated this gain, but the other non-operating items were consistent with our estimates.

The effective Income Tax Rate was 39.8 percent. We had expected a 38 percent tax rate. 

Bottom-line Net Income fell from $38 million ($0.15 per share) in 2009's second quarter to $18 million ($0.07 per share) gain in the latest quarter.  On a non-GAAP basis, Net Income declined from $79.9 million ($0.32 per share) to $43.1 million ($0.17 per share).

GAAP Net Income fell short of our $23.7 million ($0.09 per share) target.  Revenue was greater than we expected and the Kadian gain was a pleasant surprise, but higher-than-expected expenses and a slightly more burdensome tax rate resulted in Net Income $0.02 per share lower than we had estimated.

Note: Product names are registered trademarks of King Pharmaceuticals.

Full disclosure: Long KG at time of writing.

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