This post provides the GCFR analysis for the period. The first quarter of 2009 was King's first with Alpharma as a wholly owned subsidiary. King Pharmaceuticals completed the $1.6 billion acquisition of Alpharma on 29 December 2008.
First, we present some background information.
King Pharmaceuticals, Inc. (NYSE: KG), headquartered in Bristol, TN, manufactures and sells various brand-name prescription pharmaceuticals for neuroscience and other markets. The Alpharma acquisition added animal health products to the business.
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. Skelaxin sales were $446 million in 2008, according to King's 10-K. This amount was 28.5 percent of the company's total Revenues.
After the Alpharma acquisition and the Skelaxin decision, King announced workforce reductions affecting about 22 percent of its employees.
King received disappointing news last December when the U.S. FDA responded it would require additional non-clinical data before it would consider approving the abuse-resistant painkiller Remoxy®, which King had been developing with Pain Therapeutics, Inc. (NASDAQ: PTIE). King has now "assumed full control" of all activities related to Remoxy development. King hopes to respond to the FDA in July 2009.
These recent setbacks followed closely on the heels of King's 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 dismissing 20 percent of its staff.
Looking back to the fourth quarter of 2008, we are reminded that King's Revenue fell 34.8 percent from the same period in the previous year. The decline was due, in large part, to sales of Altace sinking from $166 million to $14 million. In addition, King recorded asset impairment, restructuring, and other operating charges of $610 million, the lion's share of which was $593 million for in-process R&D associated with the Alpharma acquisition. The net result was a loss on a GAAP basis of $548 million ($2.25/share).
The Overall Gauge plunged from 74 to 25 of the 100 possible points when the fourth-quarter results were evaluated. Each GCFR gauge score declined, but the double-weighted and contrarian Value gauge sank like a stone. This gauge reacted behaved the way it did because the weak operating performance was combined with a rising share price.
Now, with the data from the March quarter, our gauges are displaying the following scores:
- Cash Management: 7 of 25 (down from 4 in December)
- Growth: 0 of 25 (unchanged)
- Profitability: 5 of 25 (down from 10)
- Value: 9 of 25 (up from 4)
- Overall: 26 of 100 (up from 23)
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-2009q1?mode=html
Revenue in the first quarter was 1 percent below that in the March 2008 period. According to the 10-Q, sales of branded prescription pharmaceuticals fell $92 million (25 percent!) in the quarter. Altace® sales, down $70 million, were responsible for most of the decline; however, sales of Skelaxin® (-13 percent) and Thrombin-JMI® (-29.5 percent) were also down substantially. Other the hand, sales of Avinza® and Levoxyl® were up more than 20 percent each.
The overall Revenue decline was not more severe because King gained $80 million in sales of Animal Health products and $17 million sales of the Flector® Patch in the acquisition of Alpharma.
Our Revenue estimate was too optimistic by 7.2 percent. Assessing a company after a big merger is never easy, but the divestitures, inventory normalization, regulatory actions, and legal uncertainty at King/Alpharma adds to the uncertainty.
The Cost of Goods Sold (CGS) -- Cost of Revenues on King's Income Statement, but excluding acquisition costs -- was 30.2 percent of Revenue in the quarter, which translates into a Gross Margin of 69.8 percent. In the year-earlier quarter, the Gross Margin was a much more lucrative 78.8 percent. Our target for the margin, based on guidance provided earlier by company management, was 68 percent.
Depreciation and Amortization expenses in the first quarter were just slightly less than one might expect given the full-year guidance of D&A expenses between $220 and $225 million.
Research and Development expenses were 6.4 percent of Revenue, which is consistent with management's guidance that R&D in 2009 would be between $100 and $110 million. Our target for these expenses in the first quarter had been $25 million.
Sales, General, and Administrative (SG&A) expenses were 32.3 percent of Revenue. Our target had been 31.5 percent. The actual amount is consistent with the company's guidance that these expenses would be $560 to $580 million, plus Altace co-promotion fees, over the course of the year.
Although King often announces non-recurring operating charges, we failed to anticipate the more than $73 million in acquisition and restructuring charges that were recorded in the first quarter.
As a result of a lower Gross Margin and the aforementioned non-recurring special charges, Operating Income fell 94 percent relative to the same period last year. However, if special items are excluded, Operating Income fell by a less severe 34 percent. Our estimate of Operating Income was too optimistic because we had not expected the special charges.
Net Non-Operating (primarily interest) expenses were 25 percent more than we had forecast. The actual Income Tax Rate was 36.1 percent, but it was calculated with a negative value for pretax income. Our target for the tax rate was 37 percent.
Net Income fell to negative $11 million for a loss of $0.04 per-share, compared to earnings of $88 million or $0.36 per share in the same period last year.
If special items were excluded, adjusted earnings would be $64 million ($0.26 per share).
We had expected earnings of $44 million ($0.17 per share).
Now for the gauges:
| Cash Management | March 2009 | 3 months prior | 12 months prior |
| Current Ratio | 2.6 | 1.7 | 5.0 |
| LTD/Equity | 37.8% | 44.2% | 15.5% |
| Debt/CFO | 2.2 years | 2.9 years | 0.6 years |
| Inventory/CGS | 157 days | 173 days | 111 days |
| Finished Goods/Inventory | 72.8% | 68.4% | 62.4% |
| Days of Sales Outstanding (DSO) | 48.4 days | 50.0 days | 40.0 days |
| Working Capital/Invested Capital | 27.9% | 25.1% | 94.3% |
| Cash Conversion Cycle Time | 155 days | 149 days | 97 days |
| Gauge Score (0 to 25) | 7 | 4 | 15 |
The closing of the Alpharma acquisition at the end of December reduced liquidity, but we can already see signs of improvement. Working Capital is back up to $742 million.
Inventory/CGS declined modestly from last quarter's excessive level, but we would like to see this ratio decrease further. We view the high proportion of Finished Goods in the Inventory as a negative factor; it hints that sales were slower more than expected.
The Days of Sales Outstanding, which is based on the Accounts Receivable, is also rather high compared to last year's levels. The increase might be due in part to the acquisition, but it's also possible that the company relaxed payment terms in the face of declining sales.
| Growth | March 2009 | 3 months prior | 12 months prior |
| Revenue growth | -23.9% | -26.8% | 1.6% |
| Revenue/Assets | 44.2% | 40.7% | 60.8% |
| CFO growth | -38.6% | -26.9% | 14.8% |
| Net Income growth | N/A | N/A | -56.2% |
| Gauge Score (0 to 25) | 0 | 0 | 3 |
If the March 2009 quarter had not included Revenue from the Alpharma businesses, the Revenue decline would have been much steeper. The fall in Cash Flow from Operations is also a significant concern. Negative Net Income, as a result of special charges, makes growth rates for this measure irrelevant.
| Profitability | March 2009 | 3 months prior | 12 months prior |
| Operating Expenses/Revenue | 74.7% | 72.1% | 74.1% |
| ROIC | 8.9% | 9.9% | 25.1% |
| Free Cash Flow/Invested Capital | 13.7% | 16.5% | 38.7% |
| Accrual Ratio | 2.6% | -15.7% | -17.7% |
| Gauge Score (0 to 25) | 5 | 10 | 18 |
With sales of its branded pharmaceutical products down dramatically, and numerous acquisition-related charges, Profitability has suffered. The rise in the Accrual Ratio, which is the opposite of what we like to see, reflects the substantial decline in Cash Flow relative to the modest level of earnings.
| Value | March 2009 | 3 months prior | 12 months prior |
| P/E | N/A | N/A | 13.8 |
| P/E vs. S&P 500 P/E | N/A | N/A | 78% |
| PEG | N/A | N/A | N/A |
| Price/Revenue | 1.1 | 1.7 | 1.0 |
| Enterprise Value/Cash Flow (EV/CFO) | 5.3 | 6.2 | 1.7 |
| Gauge Score (0 to 25) | 9 | 4 | 20 |
King's stock price fell during the first quarter from $10.62 to $7.07, which made the company's valuation seem more attractive if one looks at the two non-earnings metrics above. King's valuation can be compared with other Drug Manufacturers.
| Overall | March 2009 | 3 months prior | 12 months prior |
| Gauge Score (0 to 100) | 26 | 23 | 67 |
Three months have now passed since King Pharmaceuticals acquired Alpharma. Merging businesses is never easy, but this is not the only challenge faced by the combined company’s management.
The reported one-percent drop in Revenue in the March 2009 quarter hides the fact that the recent period includes sales of products acquired with Alpharma and the earlier period did not. Revenue from some formerly best-selling branded pharmaceuticals is down sharply because of competition and loss of patent protection.
The company does have promising products in the pipeline. When the first quarter results were announced, Chairman and CEO Brian A. Markison stated that the company made progress in towards its goal of U.S. FDA approval of a new drug application for Embeda™, an abuse-resistant morphine formulation. Markison also discussed Remoxy (see above) and Acurox® Tablets, product being developing with Acura Pharmaceuticals.
Our Overall Gauge of King Pharmaceuticals stands at a weak 26 of 100 possible points, but it did managed to eke out a small gain relative to December's results. The increase was mostly due to the contrarian Value gauge moving up in a seesaw fashion response to a 33 percent decline in the King's share price during the first quarter. However, the shares have rebounded somewhat in the second quarter to date, and it is likely that a new computation would trim a few points off the Value score.
The Cash Management gauge showed that some progress has been made in that arena, but we're far from thrilled by the Inventory level and other efficiency measures. We needn't say much more about the Growth gauge's zero-point score or a Profitability score that was sliced in half.
Full disclosure: Long KG at time of writing.
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