King Pharmaceuticals sells brand-name prescription pharmaceuticals, most notably Altace®. This ACE inhibitor, which is used to treat patients with cardiovascular risks, accounts for about 1/3 of King's net sales.
King experienced some difficulties in the early years of this decade, including Medicaid overcharge allegations, inventory management challenges, and a proposed merger with Mylan Labs that fell apart after Carl Icahn raised objections. King stock plunged 84 percent from $46.05 per share in July 2001 to $7.55 in April 2005, before rebounding to about $20. King has dealt with these problems. But, it now faces a challenge that could be more difficult to surmount: the looming loss of patent protection on Altace and other key products.
When we analyzed King after the March quarter, the Overall score was an excellent 59 points. Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 19 points. Profitability and Value were weakest at 13 points each. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]
Now, with the available data from the June 2007 quarter, our gauges display the following scores:
- Cash Management: 16 of 25
- Growth: 19 of 25
- Profitability: 16 of 25
- Value: 7 of 25
- Overall: 50 of 100
Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.
| ($ M) | June 2007 (actual) | June 2007 (predicted) | June 2006 (actual) | |
| Revenue | 543 | 535 | 500 | |
| Op expenses | ||||
| CGS (1) | (126) | (123) | (107) | |
| Depreciation (2) | (40) | (37) | (39) | |
| R&D | (37) | (37) | (35) | |
| SG&A (3) | (173) | (187) | (154) | |
| Other (4) | (78) | (20) | (0) | |
| Operating Income | 88 | 130 | 165 | |
| Other income | ||||
| Investments | 0 | 0 | 0 | |
| Interest, etc. | 7 | 7 | 5 | |
| Pretax income | 95 | 137 | 170 | |
| Income tax | (30) | (45) | (59) | |
| Net Income | 65 | 92 | 111 | |
| $0.27/sh | 0.37/sh | 0.46/sh | ||
2. Includes $1.5 million for "accelerated depreciation"
3. Includes co-promotion, legal, and professional fees.
4. Mostly asset impairment charges; also in-process R&D upon acquisition, restructuring charges
Revenue was 1.5 percent above our estimate. We expected Revenue to be 7 percent greater than in the year-earlier quarter, and the actual increase was 8.6 percent. In addition, we thought the Cost of Goods Sold (CGS) would be 23 percent of Revenue, and the actual value was 23.2 percent.
Depreciation was 7.4 percent of Revenue, compared to our estimate of 7 percent. Research and Development (R&D) expenses were 6.8 percent of Revenue, a shade less than our 7 percent estimate. Sales, General, and Administrative (SG&A) expenses were 31.9 percent of Revenue, compared to our forecast of 35 percent.
What through the quarter out of kilter was a $74.8 million asset impairment charge. The charge resulted from a decision to sell a manufacturing plant and to drop development of a new product formulation.
The net effect was Operating Income 32 percent below the forecast value.
The Income Tax Rate was 31.6 percent, instead of the predicted 33 percent. As a result, Net Income fell below our prediction by 29 percent.
Cash Management. This gauge decreased from 19 points in March to 17 points now.
The measures that helped the gauge were:
- LTD/Equity = 16.1%; manageable, down from 18.6 percent a year ago
- Inventory/CGS = 156 days, compared to 177 and 214 days 3 and 12 months ago, respectively
- Cash Conversion Cycle Time (CCCT) = 144 days, down from 188 days, for this measure of efficiency
- Debt/CFO = 0.7 years, compared to 0.7 and 1.1 years 3 and 12 months ago, respectively
- Working Capital/Market Capitalization = 20 percent, up from 18 percent
The measures that hurt the gauge were:
- Days of Sales Outstanding (DSO) = 46 days, greater than the 43-day level one year earlier
- Current Ratio = 3.6; too much of a good thing, it was 2.3 in June 2006
Finished Goods/Inventory was not reported, it was 28 and 31 percent 3 and 12 months ago, respectively
Growth. This gauge decreased from 16 points in March to 12 points now.
The measures that helped the gauge were:
- CFO growth = 47 percent, up from -34 percent in a year
- Net Income growth = 62 percent, down from 91 percent in a year
- Revenue/Assets = 61.1 percent, up from 60.6 percent in a year
Net income benefited from a change in the income tax rate from 34.7 to 31.4 percent
The measures that hurt the gauge were:
- Revenue growth = 7 percent, down from 23 percent in a year
Profitability. This gauge increased from 13 points in March to 14 points now.
The measures that helped the gauge were:
- FCF/Equity = 20.1 percent, up from 14.9 percent in a year
- Accrual Ratio = -5.7 percent, down from -4.1 percent in a year
- ROIC = 13.9 percent, down from 16.5 percent in a year
The decreasing Accrual Ratio tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in non-operational Balance Sheet accruals.
The measures that hurt the gauge were:
- Operating Expenses/Revenue = 72.1 percent, up from 66.7 percent in a year
The increase in operating expenses was the result of a decrease in Gross Margin and an increase in special charges.
Value. King's stock price rose over the course of the quarter from $19.67 to $20.46. The Value gauge, based on the latter price, held steady at 13 points from three months ago.
The measures that helped the gauge were:
- P/E = 16.3, about half its average
- P/E to S&P 500 average P/E = 2 percent discount, much lower than its five-year median of a 60 percent premium
- Price/Revenue ratio = 2.4, a little higher than its five-year median of 2.3
- Enterprise Value/Cash Flow = 8.2, down a little from its average
The average P/E for the Biotechnology and Drugs industry is 28. The average Price/Revenue for the industry is 8.
Now at very good 55 out of 100 possible points, the Overall gauge has been strong for eight of the last nine quarters. To some extent, the strength reflects a rebound from very tough conditions in previous years. We would feel much better about King if special operating charges weren't such a regular occurrence. We also have to worry about patent expirations.
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