27 September 2010

KG: Look Ahead to September 2010 Quarterly Results

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

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 now approximately $2.4 billion, down from $5 billion as recently as 2007 and $3 billion earlier this year.

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.  King is placing special emphasis on pain-management medications with features that deter abuse.

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.  Branded Skelaxin sales plunged 95 percent in the June 2010 quarter after generic versions became available from Sandoz (part of Novartis) and CorePharma.

King announced that it had recently taken actions with its staff to improve the marketing of EMBEDA® and Flector® Patch, becoming more aggressive in some areas, moving away from others, and changing organizational relationships.  EMBEDA® is a promising opioid, which became available commercially in September 2009, for management of moderate-to-severe pain under certain conditions.  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)." 

King is developing the 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.

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.

King Pharmaceuticals 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, which exclude certain items, were also down substantially, falling from $0.32 to $0.17 per diluted share.

Readers wanting to take another look at King's June 2010 quarter might wish to review our Income Statement and Financial Gauge analyses.

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

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

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

In August, when discussing second-quarter results, King's forward-looking financial comments were more focused on balance sheet contributions to cash flow from operations:

We anticipate that working capital will have a positive impact on operating cash flow in the last six months of the year by approximately $90 million as follows

Accounts receivable will generate approximately $40 million ...

In addition, lower inventory levels ...  will provide approximately $20 million of operating cash flow; and other components of working capital will provide approximately $30 million of operating cash flow in the second half of 2010. Therefore, our forecast for full-year cash flow from operations remains at approximately $300 million.

To estimate King's Revenue in the September quarter, we start with the sales data for the June period and make a couple of adjustments.  As shown in the table below, King has been experiencing declining sales with several of its branded prescription pharmaceutical products, with the overall decline moderated partially by new sales of Embeda®. 

Branded Prescription Pharma Revenue ($M) 2Q-2010 1Q-2010  4Q-20092Q-2009 
Skelaxin®$5.3 $90.9 $96.1 $102.2
Thrombin-JMI®$37.0 36.9 44.1 48.6
Flector® Patch 35.3 33.5 42.9 38.6
Avinza®24.7 23.232.5 28.9
Embeda®14.6 9.15.6 -
Levoxyl®16.1 15.418.9 15.3
Other 29.2 32.536.6 41.6
Total Segment Revenue $162.2 $241.5 $276.8 $275.1

First, assume sales of branded Skelaxin and Thrombin-JMI® will continue to fall.  Second, we assume sales of Embeda and Flector patch will respond positively to increased marketing emphasis.  Third, we assume the fee CorePharma will pay to King for the license to sell an authorized generic version of Skelaxin will be less than the second quarter's $25.6 million.  Fourth, we expect modest sales growth from the Animal health and Meridian Auto-Injector businesses.

These assumptions lead us to a Revenue estimate of $360 million.

The company's Gross Margin guidance for 2010 was 67 percent to 68 percent, and the actual margin in the first half of the year was about 67.3 percent.  Our target for the third quarter is 67.5 percent.  Therefore, given our Revenue estimate, we are looking for a Cost of Goods Sold of (1 - 0.675) * $360 million = $117 million.

The guidance for Depreciation and Amortization expenses for the full year was $60 million + $115 million = $175 million.  If we subtract the first half's $111 million expense, we're left with $64 million for the remaining two quarters or about $32 million per quarter.

Similarly, the midpoint of the annual Research and Development guidance, $115 million, less the first half's $61 million, leaves $27 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 $124 million.

We are assuming a minor $5 million in the quarter for non-recurring, "special" operating expenses.

The estimates above would lead to Operating Income for the quarter of $55 million, 37 percent less than September 2009's $87 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 $28 million ($0.11 per share), compared to income of $43 million ($0.17 per share) in the September 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.

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