A previous article examined King's Income Statement for the June quarter in some detail. Reported GAAP earnings were $0.02 less than the $0.09 per share we had forecast.
We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value. This post reports on the metrics for King Pharmaceuticals and the associated financial gauge scores. The metrics were calculated using data from King's current and historical financial statements, including those in the latest 10-Q report.
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 an important January 2009 decision, two King 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.
Mergers and acquisitions, such as King's purchase of Alpharma, pose a challenge to us at GCFR because a major deal can lead to both temporary and longer term changes to the company's financial results. Comparisons with the past, a key element of our approach, can be misleading. Temporary changes include unusual revenue growth and large restructuring expenses. In addition, it's not unusual for one transaction to be followed by others, such as asset divestitures that don't conform to the new organization's priorities.
For these and other reasons, extra caution has to be taken when evaluating a company in the immediate aftermath of a merger or acquisition. It is often prudent to "let the dust settle" before drawing any far-reaching conclusions.
With this caveat in mind, King's latest quarterly results produced the following changes to the gauge scores:
- Cash Management: 13 of 25 (down from 15 in March)
- Growth: 9 of 25 (down from 15)
- Profitability: 8 of 25 (unchanged)
- Value: 7 of 25 (up from 0)
- Overall: 34 of 100 (up from 28)
The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary. Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.
|Cash Management||30 Jun 2010||31 Mar 2010||30 Jun 2009||5-Yr Avg|
|LTD to Equity||14.3%||14.2%||25.7%||18.2%|
|Days of Sales Outstanding (days)||46.9||45.7||46.2||45.2|
|Cash Conversion Cycle Time (days)||122.2||116.9||135.6||140.4|
|Gauge Score (0 to 25)||13||15||6||14|
The Cash Management gauge score gave back a couple of points it had recently acquired, but it is still much better than it was last year at this time.
King's Long-term Debt increased from $400 million to $878 million when acquired Alpharma at the end of 2008. In the following year, the company used its cash, earnings, and funds from asset sales to slash the debt level by 60 percent. Now listed at $342 million, Long-term Debt is below what it was before the acquisition. And, the ratio of Long-term Debt to Shareholders' Equity is a scant 14 percent.
Paying down the debt did not impair the company's liquidity, as far as we can tell. King has $573 million in Cash and equivalents, which exceeds its $306 million in Current Liabilities. The Current Ratio is a (too?) hefty 3.6, and Working Capital -- the difference between Current Assets and Current Liabilities -- increased from $656 million to $804 million in the last 12 months.
One modest liquidity concern might be that King held, as of 30 June 2010, tax-exempt auction rate securities having a par value of $213 million, down from $282 million six months earlier. Poorly functioning credit markets have led to failed auctions that make it difficult for security owners to recover the full value of their investments, although interest payments usually continue without interruption. During the first quarter of 2010, King sold auction rate securities associated with student loans with a par value of $8 million for $7.36 million.
King's Inventory expanded last year to include the products it acquired from Alpharma and new products. The company has since been working with its customers to normalize the inventory levels across the product base, and the inventory level (as measured by days of Cost of Goods Sold) has recently decreased. The Finished Goods ratio has recently bounced back up, which could become a concern.
|Growth||30 Jun 2010||31 Mar 2010||30 Jun 2009||5-Yr Avg|
|Operating Profit Growth||-30.5%||-24.6%||-13.5%||-22.6%|
|Net Income Growth||N/A||N/A||N/A||0.4%|
|Gauge Score (0 to 25)||9||15||0||11|
Weak operating results, reflecting the loss of Skelaxin exclusivity and diminished sales of some other branded pharmaceutical products, have cut deeply into the Growth gauge score. The fading of the short-term boost that resulted from the Alpharma acquisition has also taken its toll on the gauge score.
The results from the June 2010 quarter reduced the trailing-year Revenue and Cash Flow growth rates. Second-quarter Revenue decreased 17 percent, and quarterly Cash Flow was cut in half.
The trailing-year Net Income growth rates isn't applicable because Net Income was negative in the four quarters that ended June 2009.
A year-to-year increase in the ratio of trailing-year Revenue to total Assets added some support to the Growth gauge.
|Profitability||30 Jun 2010||31 Mar 2010||30 Jun 2009||5-Yr Avg|
|Free Cash Flow/Invested Capital||13.8%||15.5%||14.9%||21.3%|
|Gauge Score (0 to 25)||8||8||6||13|
The Profitability gauge managed to remain unchanged because the Accrual Ratio is low, which we use as measure of earnings quality, and the ROIC and Free Cash Flow ratios have stayed positive.
King's Operating Margin has suffered: operating expenses are taking a bigger bite out of each Revenue dollar. The declining margin is due in large measure to lower sales of high-margin branded pharmaceutical products and the addition of low-margin Animal Health products. In addition, special charges have also increased overall operating expenses.
Although Cash Flow from Operations was under $50 million in the first half of 2010, it was still $362 million in the last four quarters. Reduced capital spending gives a small boost to Free Cash Flow.
|Value||30 Jun 2010||31 Mar 2010||30 Jun 2009||5-Yr Avg|
|P/E vs. S&P 500 P/E||1.4||1.6||N/A||1.2|
|Enterprise Value/Cash Flow (EV/CFO)||4.6||6.7||7.1||6.5|
|Gauge Score (0 to 25)||7||0||3||10|
|Share Price ($)||$7.59||$11.76||$9.63||-|
A 35-percent drop in King's share price during the second quarter helped get the Value gauge above last quarter's zero-point score. The price decline made the EV/CFO and Price/Sales ratios attractive compared to their averages, based on trailing year results.
The share price has since rebounded to $9.37. At this price, the trailing-year P/E rises to 27, Price/Sales increases to 1.4, and the EV/CFO ratio becomes 5.8. The Value gauge score would be 3 points.
|Overall||30 Jun 2010||31 Mar 2010||30 Jun 2009||5-Yr Avg|
|Gauge Score (0 to 100)||34||28||18||48|
This quarter's increase in the Overall gauge score was mostly the result of the Value gauge's rise, which is double-weighted in the calculations. The Value gauge rose as the share price took another tumble. However, as mentioned above, a post-quarter small rebound in the share price would erase several points from the score.
Because some of King's legacy branded pharmaceutical products are not able to generate the sales and profits they once did, King is counting on new products to succeed and make up the shortfall. King's share price may fluctuate with regulatory and market expectations for these new products.
Full disclosure: Long KG at time of writing.