09 November 2010

KG: Income Statement Analysis for the September 2010 Quarter

King Pharmaceuticals (NYSE: KG) earned $0.16 per diluted share on a GAAP basis in the September-ending third quarter of 2010, down 8.6 percent from $0.19 in the same three months of last year. 

After the quarter ended, King agreed to be acquired by Pfizer (NYSE: PFE).

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 $0.05 more than the $0.11 per share we had forecast.

The principal source for this income statement analysis was the 10-Q report filed by King on 5 November 2010.

King Pharmaceuticals, headquartered in Bristol, TN, manufactures and sells various brand-name prescription pharmaceuticals and other products.  Background information about King can be found in the look-ahead.

Because of the acquisition, we won't bother to calculate King's scores as measured by the GCFR financial gauges

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 September quarter decreased 19 percent, from $463 million last year to $375 million in the most recent three months.

Reported revenue exceeded our $360 million estimate by $15 million or 4.2 percent.  We did not anticipate royalties growing from $11.9 million in the September 2009 quarter to $34.3 million.  King recognized royalty revenue of $25.3 million in the latest quarter as a share of gross profit earned by CorePharma from selling an authorized generic version of Skelaxin®.

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)3Q-20103Q-2009Change
Branded prescription pharmaceuticals $160.8 $283.4   -43.3%
Animal Health 92.795.8   -3.3%
Meridian Auto-Injector 83.671.8   16.4%
Royalties and other 38.513.0  196%
Eliminations (0.9) (0.7) NA
Total Revenue
$374.6 $463.3   -19.2%

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

Branded Prescription Pharma Revenue ($M) 3Q-2010  3Q-2009  Change 
Skelaxin® $6.8 $102.1 -93%
Thrombin-JMI®32.243.4 -26%
Flector® Patch 42.440.4 5.0%
Avinza®27.330.8 -11.4%
Embeda®10.2 11.2-9.0%
Levoxyl®15.517.0 -8.9%
Other 26.438.5 -32%
Total Segment Revenue $160.8 $283.4 -43.3%

Sales of Skelaxin® plunged because generic versions from Sandoz (part of Novartis) and CorePharma became available in the second quarter of 2010.

The  Cost of Goods Sold -- "Cost of Revenues" on King's Income Statement -- was $133 million, or 35.4 of Revenue.  This equates to a Gross Margin of 64.6 percent, which is about 80 basis points less profitable than the margin in last year's third quarter.  The decline in the Gross Margin is probably due to lower Revenue, changes in the product mix, and competitive pressures.

The latest Gross Margin was nearly 300 basis points less profitable 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 $32.7 million was just slightly higher than our $32 million estimate, which was derived from the company's guidance.  The latest Depreciation expense was much less than last year's $53 million because King had "completely amortized" its Skelaxin assets in the second quarter of 2010.

Research and Development expenses increased 14 percent, rising from $22 million to $26 million. We had estimated $27 million.  King attributed the rise to "the timing of costs incurred" on R&D projects.

Sales, General, and Administrative expenses fell 16 percent, from $136 million to $114 million.  We expected $124 million.  SG&A expenses last year were boosted by marketing costs associated with the launch of Embeda®.

The SG&A expense increased from 29.3 percent to 30.5 percent of Revenue.

Other operating charges included $1.15 million for merger and acquisition-related costs, $15 thousand for restructuring, and a $0.7 million gain on an asset held for sale.  We had set aside $5 million for miscellaneous operating items, but this figure proved to be too high.

Subtracting the various operating expenses mentioned above from Revenue yields Operating Income of $69 million, down 21 percent from $87 million in the year-earlier quarter.  Operating income surpassed our $55 million estimate because Revenue, SG&A expenses, and other expenses were better than we expected, and these items outweighed the weaker-than-expected Gross Margin.

As for non-operating items, King recorded a $7 million interest expense.  A $2 million gain on investments balanced a $2 million entry for other expenses.  These figures were not far off from our expectations.

The effective Income Tax Rate was 36.3 percent, which was slightly less burdensome than the 38 percent tax rate we expected. 

Bottom-line Net Income fell from $43 million ($0.17 per share) in 2009's third quarter to $39 million ($0.16 per share) in the latest quarter.  

In summary, in King's last quarter before being acquired, the company reported results that were weaker than in the same quarter of 2009 but were better than we anticipated.  Better-than-expected royalty revenue and lower-than-expected SG&A costs accounted for most of the difference between the actual results and our targets.

Note: Product names are registered trademarks of King Pharmaceuticals.

Full disclosure: No position in any security mentioned at the time of writing.

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