King Pharmaceuticals, Inc. (NYSE: KG) sells various brand-name prescription pharmaceutical products. The company experienced a substantial setback last year when 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. As a result of the Court's action, King incurred asset impairment charges (covering intangible assets and inventory) totaling $250 million.
King, as explained on the Orange Book Blog, tried unsuccessfully to delay the availability of generic Ramipril from firms other than Cobalt Laboratories. Additional sources for this product became available in June 2008.
At about $10 each, the current price of King's common shares is about 75 percent below the all-time high set back in 2001.
When we analyzed King's first quarter results, the Overall Gauge score was 74 (after an adjustment), on a scale of 0 to 100. This superlative (and, alas, misleading) score highlighted a limitation of the GCFR methodology: by focusing on past performance, the approach will produce specious results when the business of the company being analyzed changes significantly and abruptly. The price of King shares plunged immediately after the Altace decision, but the company's sales and earnings were slower to suffer the effects of the patent invalidation. Our number-crunching gauges were blind to the weaker figures that are now emerging.
With the data from the June 2008 quarter, our gauges are displaying the following scores:
- Cash Management: 17 of 25 (down from 18 in March)
- Growth: 4 of 25 (up from 3)
- Profitability: 17 of 25 (down from 18)
- Value: 11 of 25 (down from 23)
- Overall: 53 of 100 (down from 74)
Before we examine the factors that affected each gauge, we will review the latest quarterly Income Statement and compare it to our previously communicated expectations.
Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($ M) | | June 2008 (actual) | June 2008 (predicted) | June 2007 (actual) |
| Revenue | | 397 | 407 | 543 |
| Op expenses | | | | |
| | CGS | (102) | (102) | (126) |
| Depreciation | (32) | (31) | (49) | |
| | R&D | (49) | (50) | (37) |
| | SG&A | (112) | (165) | (173) |
| Other | (44) | (0) | (78) | |
| Operating Income | | 58 | 59 | 88 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. | 7 | 10 | 7 |
| Pretax income | | 65 | 69 | 95 |
| Income tax | | (22) | (24) | (30) |
| Net Income | | 43 | 46 | 65 |
| | | $0.18/sh | $0.19/sh | $0.27/sh |
| Shares outstanding | | 245 | 245 | 245 |
2. Cost of revenues, exclusive of depreciation, amortization and some impairments.
3. Depreciation and amortization, plus accelerated depreciation
4. SG&A, plus special legal and professional fees, plus co-promotion fees.
5. Excess purchase commitment, plus Excess inventory reserve, plus Arbitration settlement, plus In-process R&D, Asset impairment charges, plus Restructuring charges.
Revenue in the recent quarter was 26.9 percent below that in the year-earlier period. We had expected Revenue to decline by 25 percent. Generic competition for Altace, some of which didn't become available until the end of the quarter, took a 72.8 percent bite out of sales. Revenue in the trailing four quarters was 7.6 percent less than in the previous four quarters.
We had expected, based on company-provided guidance, that King would achieve a 75 percent Gross Margin in the quarter. The actual margin was a still-remarkable 74.3 percent. This latter value translates into a Cost of Goods Sold (CGS) of 25.7 percent of Revenue.
Depreciation expenses were just $1 million more than company guidance suggested.
On the other hand, Research and Development (R&D) expenses were $1 million less than anticipated.
We over-estimated Sales, General, and Administrative (SG&A) expenses by a huge $53 million, but this miscalculation was almost canceled out by the $44 million of unanticipated special operating expenses. SG&A expenses decreased primarily due to a $37.5 million reduction in in co-promotion expenses related to Altace.
King's Operating Income, which rolls up all the sales and operating expense, just about matched our forecast.
Interest income was $3 million less than forecast. The income tax rate was 34.0 percent, equaling the guidance. As a result, Net Income was within $3 million of our projection. However, Net Income was 33.7 percent less than in the June 2007 quarter.
Cash Management. This gauge decreased from 18 points in March to 17 points now.
| June 2008 | 3 months ago | 12 months ago | |
| Current Ratio | 4.4 | 5.0 | 3.6 |
| LTD/Equity | 15.2% | 15.5% | 16.1% |
| Debt/CFO | 0.6 yrs | 0.6 yrs | 0.7 yrs |
| Inventory/CGS | 106 days | 111 days | 156 days |
| Finished Goods/Inventory | 63.8% | 62.4% | 35.4% |
| Days of Sales Outstanding (DSO) | 41.2 days | 40.0 days | 46.3 days |
| Working Capital/Market Capitalization | 41.8% | 58.6% | 20.2% |
| Cash Conversion Cycle Time | 88.2 days | 96.9 days | 143.9 days |
King had over $1 billion in Cash or equivalents on 30 June. The amount is far more than needed to meet current obligations. The company could be planning to reduce its debt or getting ready to make a large investment. However, it might also be due to the company holding $466 million in auction rate securities that the company cannot reasonably liquidate. The Current Ratio and Working Capital-to-Market Capitalization ratios are very high, but they have retreated from even greater values in the first quarter. The other ratios in this category indicate improved efficiency. The one exception involves the large proportion of Finished Goods in the Inventory. It's a potential indicator of slower than anticipated sales.
Growth. This gauge increased from 3 points in March to 4 points now.
| June 2008 | 3 months ago | 12 months ago | |
| Revenue growth | -7.6% | 1.6% | 7.2% |
| Revenue/Assets | 55.2% | 60.0% | 61.1% |
| CFO growth | 20.1% | 14.8% | 46.8% |
| Net Income growth | -56.8% | -56.2% | 61.9% |
With rapidly declining sales and earnings, Growth isn't a big part of the current landscape at King. However, the fact that Cash Flow from Operations in the last four quarters was 20 percent greater than the four previous quarters is very encouraging.
Profitability. This gauge decreased from 18 points in March to 17 points now.
| June 2008 | 3 months ago | 12 months ago | |
| Operating Expenses/Revenue | 75.4% | 74.1% | 69.9% |
| ROIC | 18.0% | 18.3% | 15.0% |
| FCF/Equity | 22.5% | 23.5% | 20.3% |
| Accrual Ratio | -26.3% | -17.7% | 8.3% |
The loss of Altace exclusivity has, to no one's surprise, cut into King's Gross Margin. Nevertheless, the ROIC and FCF/Equity values remain quite appealing. The oddly low Accrual Ratio is a result of strong Cash Flow in the face of declining Net Income.
Value. King's stock price rose over the course of the quarter from $8.70 to $10.47. This increase was one reason the Value gauge dropped from 23 points in March to 11 points now.
| June 2008 | 3 months ago | 12 months ago | |
| P/E | 19.3 | 13.8 | 16.3 |
| P/E to S&P 500 average P/E | 108.7% | 79.8% | 98.9% |
| Price/Revenue | 1.3 | 1.0 | 2.4 |
| Enterprise Value/Cash Flow (EV/CFO) | 2.7 | 1.7 | 8.2 |
The earnings-based metrics aren't presently appealing, but ones involving Cash Flow may attract the attention of value investors.
The full effects of the Altace patent situation are being realized. Our rearward-looking gauges painted a too rosy view of King Pharmaceuticals during the initial transition, but the Overall Gauge fell a dramatic 21 points in the second quarter. A further contraction may be on the horizon. Nevertheless, the situation isn't entirely bleak. The company appears to be well capitalized, with little debt, and strong cash flow.
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