On 29 December 2008, King completed the $1.6 billion acquisition of Alpharma, Inc. (NYSE: ALO), and Alpharma became a wholly owned subsidiary. A $600 million charge due to the purchase resulted in King reporting substantial net losses for the fourth quarter and full year.
The press release announcing these results did not include complete financial statements and notes. We will reevaluate our analysis when the information becomes available in the company's 10-K filing.
To gain Federal Trade Commission approval of the Alpharma acquisition, 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.
King reported on 21 January 2009 that the U.S. District Court for the Eastern District of New York invalidated two U.S. patents relating to SKELAXIN® (metaxalone), a muscle relaxant. King plans to appeal the Court's order. In the first nine months of 2008, King's SKELAXIN sales were $333 million, which was 29 percent of the company's Net Sales during this period.
Given the Alpharma acquisition and the SKELAXIN decision, it is not terribly surprising that King announced cost-cutting workforce reductions affecting about 22 percent of its employees.
King must have been bitterly disappointed when, last December, the U.S. FDA asked for additional non-clinical data on the abuse-resistant painkiller REMOXY King is developing with Pain Therapeutics, Inc. (NASDAQ: PTIE).
These recent setbacks came not long after King suffered its greatest reversal. In 2007, the U.S. Court of Appeals invalidated King's patent for Altace® (Ramipril). This ACE inhibitor, used to treat patients with cardiovascular risks, had accounted for roughly 1/3 of King's net sales. The Court's decision resulted in King recognizing asset impairment charges (covering intangible assets and inventory) totaling $250 million and King laying off 20 percent of its staff.
Three months ago, the GCFR Overall Gauge of King Pharmaceuticals increased from 50 to 74 of the 100 possible points. Our analysis report on the September quarter explained the results in some detail. (Note that the scores are not exactly as reported originally because of some changes to our algorithms.) Despite Revenue in the third quarter falling almost 30 percent, the score rose primarily because the sinking price per share made the valuation appear more attractive. In addition, our gauges reacted positively to decreasing operating expenses as a percentage of Revenue.
Now, with the data from the December quarter, our gauges are displaying the following scores:
- Cash Management: 3 of 25 (down from 13 in September)
- Growth: 0 of 25 (down from 8)
- Profitability: 12 of 25 (down from 20)
- Value: 5 of 25 (down from 22)
- Overall: 25 of 100 (down from 74)
Before we examine the factors that affected each gauge, we will review the latest quarterly Income Statement and compare it to our previously communicated expectations.
Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
http://sheet.zoho.com/public/ncarvin/kg-income-statement?mode=html
Revenue in the fourth quarter was 34.8 percent below that in the December 2007 period, and it fell below our estimate by 6.7 percent. Sales of Altace in the fourth quarter dropped from $166 million to $14 million.
Full-year Revenue plunged 27 percent from 2007 to 2008.
The Cost of Goods Sold (CGS) -- Cost of Revenues on King's Income Statement -- in the quarter was 26.9 percent of Revenue, which translates into a Gross Margin of 73.1 percent. Our target for the margin, based on guidance provided earlier by company management, was 74 percent.
Depreciation and Amortization expenses were consistent with the earlier guidance. These expenses were 8.5 percent of Revenue
Research and Development expenses were 9.1 percent of Revenue, and they were a substantial $7 million less than the $39 million we anticipated. Our target was based on management's guidance this past November that R&D expenses in 2008 would be about $150 million.
Sales, General, and Administrative (SG&A) expenses were 30.2 percent of Revenue. Our target had been 28 percent. However, since Revenue was less than we expected, actual SG&A expenses equaled the amount we projected. Co-promotion fees for Altace dropped from $37 million to $3 million.
In the December 2008 quarter, King recorded asset impairment, restructuring, and other operating charges of $610 million. The lion's share of this amount was $593 million for in-process R&D associated with the Alpharma acquisition. Not having any data to forecast this charge, we had anticipated special charges of (only!) $44 million.
The huge charges dropped Operating Income, which is total sales less all operating expenses, to a $522 million loss. However, if special items are excluded, Operating Income was $87 million. This figure is better than we expected, and better than in the December 2007 quarter.
Net Non-Operating (primarily interest) Income was a few million less than forecast, but there was also an unanticipated $7.5 million investment loss.
Given the pre-tax loss, the income tax rate is immaterial. However, when special items are excluded, the income tax rate was 33 percent. The guidance was 34.0 percent.
Net Income on a GAAP basis was a $548 million ($2.25/share) loss. Non-GAAP income was $49 million ($0.24/share), which was $0.07 per share better than our projection.
| Cash Management | December 2008 | 3 months prior | 12 months prior |
| Current Ratio | 1.7 | 5.3 | 4.0 |
| LTD/Equity | 44.2% | 14.6% | 15.9% |
| Debt/CFO (*) | 2.9 years | 0.7 years | 0.6 years |
| Inventory/CGS | 173 days | 109 days | 109 days |
| Finished Goods/Inventory | N/A | 64.4% | 55.6% |
| Days of Sales Outstanding (DSO) | 50.0 days | 45.2 days | 38.4 days |
| Working Capital/Market Capitalization | 16.6% | 50.2% | 47.1% |
| Cash Conversion Cycle Time | 149.2 days | 86.9 days | 83.7 days |
| Gauge Score (0 to 25) | 3 | 13 | 18 |
During the fourth quarter, King's holdings of Cash were cut by $290 million, Short-term debt and the currently due portion of Long-term Debt went from 0 to $444 million, and the rest of Long-term Debt increased from $400 million to $963 million. These figures sum to $1.3 billion, so it is safe to say that the changes were, more or less, associated with the $1.55 billion spent to acquire Alpharma.
The acquisition, therefore, is the principal explanation for the big drop in the Current Ratio, the big increase in the Debt levels, and the reduced Working Capital. However, the new numbers are not especially alarming, and we would expect King to refinance a big chunk of short-term debt to long-term paper when market conditions allow.
The large rise in inventory may be in preparation for new product launches, but it might also signify the extent to which sales were less than management expected.
| Growth | December 2008 | 3 months prior | 12 months prior |
| Revenue growth | -26.8% | -17.3% | 7.5% |
| Revenue/Assets | 40.7% | 50.8% | 63.3% |
| CFO growth (*) | -27% | 0.0% | 44.5% |
| Net Income growth | N/A | 45.5% | -36.5% |
| Gauge Score (0 to 25) | 0 | 8 | 4 |
* calculated with estimated data for 2008-4Q
With rapidly declining sales and decelerated Cash Flow, Growth isn't a big part of the current landscape at King. Negative Net Income, as a result of special charges, makes growth rates for the measure irrelevant.
| Profitability | December 2008 | 3 months prior | 12 months prior |
| Operating Expenses/Revenue | 114% | 79.9% | 89.4% |
| ROIC | N/A% | 12.8% | 10.8% |
| FCF/Equity (*) | 18.4% | 20.7% | 26.0% |
| Accrual Ratio (*) | -37.2% | -27.1% | 8.4% |
| Gauge Score (0 to 25) | 12 | 20 | 11 |
Operating Expenses are distorted by the special charges. If these are ignored in all time periods, Operating Expenses decreased from 73 percent of Revenue in 2007 to 72 percent in 2008.
| Value | December 2008 | 3 months prior | 12 months prior |
| P/E | N/A | 9.1 | 13.7 |
| P/E to S&P 500 average P/E | N/A | 50.8% | 76.8% |
| Price/Revenue | 1.7 | 1.3 | 1.2 |
| Enterprise Value/Cash Flow (EV/CFO) (*) | 6.2 | 2.4 | 2.3 |
| Gauge Score (0 to 25) | 5 | 22 | 23 |
King's stock price rose over the course of the quarter from $9.58 to $10.62. The valuation ratios above can be compared with other Drug Manufacturers.
| Overall | December 2008 | 3 months prior | 12 months prior |
| Gauge Score (0 to 100) | 25 | 74 | 66 |
The big news of the fourth quarter for King Pharmaceutical was the closing of its acquisition of Alpharma. King used funds from its cash war chest and took on additional debt to pay the $1.5 billion price for this purchase. (Was it worth it given the forced Kadian divestiture?)
Almost 40 percent of the acquisition price was written off as an in-process R&D expense.
Over the longer term, the invalidation of two U.S. patents relating to SKELAXIN® (metaxalone)
might prove to be more important.
Revenue in the fourth quarter fell by 34.8 percent, and full-year Revenue plunged 27 percent from 2007 to 2008. Greatly reduced sales of Altace was the dominant reason sales dropped.
After the Altace decision, our rearward-looking gauges were painting a too rosy view of King Pharmaceuticals. However, the latest acquisition costs are having the opposite effect on the Overall Gauge. When we revisit King after it files a 10-K report, we will see if we can improve the realism of the scores.
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