KG: Financial Analysis through December 2008 (Update)

The press release announcing the results of King Pharmaceuticals (NYSE: KG) during the fourth quarter of 2008 did not include some detailed information, such as a Cash Flow statement.  When we analyzed the initial announcement and computed gauge scores, we estimated data that had not yet been disclosed.

The omissions from the press release were not unusual in any way.  Many companies report certain financial details only in their more formal SEC filings.

Just a few days after the earnings announcement, King filed the formal and more complete 10-K report for 2008.  We used the 10-K to update our analysis, and this post identifies the revisions.

The 10-K did not change our examination of the fourth-quarter Income Statement.

http://sheet.zoho.com/public/ncarvin/kg-income-statement?mode=html



King Pharmaceuticals, Inc. manufactures and sells various brand-name prescription pharmaceuticals.  Headquartered in Bristol, TN, King now focuses on specialty products for the neuroscience, hospital and acute care markets.  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.

In early 2009, the U.S. District Court for the Eastern District of New York invalidated two U.S. patents relating to SKELAXIN® (metaxalone).  Although King plans to appeal the Court's order, it is important to realize that this muscle relaxant is currently King's best selling branded pharmaceutical product.  SKELAXIN accounted for $446 million (28.5 percent) of King's sales in 2008.

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.


Although the previously undisclosed data in the 10-K changed some of the financial metrics that determine the gauge scores , the scores reported in the original analysis report were unaffected.

• 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)

Figures that were changed by the 10-K are shown in red text below:

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	68.4%	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 expect King is taking action to refinance a big chunk of short-term debt to long-term paper when market conditions allow. 

From 30 September to 31 December 2008, Inventory rose $92 million to $258 million.  The Finished Goods component of Inventory rose from $59 million to $177 million.  The 10-K does not provide a full explanation for these massive increases.  With respect to Inventory, the 10-K provides more information 2007's changes to the Altace inventory and the situation with the Flector ^® Patch product acquired with Alpharma.  Perhaps the company intentionally inflated its inventory in preparation for new product launches, but we are concerned in signals weaker sales ahead.

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	-26.9%	0.0%	44.5%
Net Income growth	N/A	45.5%	-36.5%
Gauge Score (0 to 25)	0	8	4

Growth rates are trailing four quarters compared to four previous quarters.


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 this 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	18.5%	20.7%	26.0%
Accrual Ratio	-15.7%	-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.