Kinetic Concepts second-quarter global revenue increases 1% to $497.8 million

Jul 27 2010

Second Quarter Highlights

“Importantly, our U.S. V.A.C. business was stable despite challenges related to increasing competition and the economy.”

- Worldwide revenue of $497.8 million, up 1% from the prior-year period as reported and up 2% on a constant currency basis

- Worldwide Active Healing Solutions ("AHS") revenue of $347.7 million, equivalent to the prior-year period

• United States AHS revenue of $254.0 million increased 6% compared to the first quarter of 2010

- Worldwide Regenerative Medicine revenue of $83.7 million, up 18% from the prior-year period

- Worldwide Therapeutic Support Systems ("TSS") revenue of $66.3 million, down 6% from the prior-year period

- Diluted net earnings per share of $0.75, down 9% from the prior-year period, including $0.11 per diluted share of previously-communicated restructuring and business transformation charges

- Diluted net earnings per share up 3% on an adjusted non-GAAP basis from the prior-year period

Kinetic Concepts, Inc. (NYSE: KCI) today reported second quarter 2010 total revenue of $497.8 million, an increase of 1% from the second quarter of 2009 and up 2% from the first quarter of 2010. Total revenue for the first half of 2010 was $983.6 million, a 2% increase from the prior-year period. Unfavorable foreign currency exchange movements reduced total revenue for the second quarter of 2010 by less than 1%, while favorably impacting total revenue for the first six months of 2010 by 1% compared to the corresponding periods of the prior year.

Net earnings for the second quarter of 2010 were $53.6 million, or $0.75 per diluted share on a GAAP basis compared to a $58.1 million, or $0.82 per diluted share, for the same period of 2009. During the second quarter of 2010, the company recorded approximately $12.7 million before income taxes, or $0.11 per diluted share, in expenses related to our TSS portfolio rationalization and employee separation costs related primarily to our Global Business Transformation project. Net earnings per diluted share on a non-GAAP basis, excluding costs associated with the TSS inventory rationalization, employee separation costs and non-cash acquisition-related items were $1.01 for the second quarter of 2010, up 3% from the prior-year period on a comparable, non-GAAP basis.

"During the second quarter, we successfully launched our innovative V.A.C. Therapy system in Japan, received FDA approval on two of our new AHS platform technology products and continued expanding the reach of our best-in-class Strattice regenerative tissue matrix in Europe," said Catherine Burzik, President and Chief Executive Officer of KCI. "Importantly, our U.S. V.A.C. business was stable despite challenges related to increasing competition and the economy."

Revenue Recap - Second Quarter and First Half of 2010

Worldwide revenue from AHS products was $347.7 million for the second quarter of 2010 and $680.7 million for the first half of 2010, compared to $349.4 million and $678.7 million, respectively, for the corresponding periods of 2009. On a constant currency basis, worldwide AHS revenue in the second quarter of 2010 was comparable to the prior-year period and decreased 1% for the first six months of 2010, compared to the prior-year period. Higher global sales volumes in the second quarter were offset by unfavorable foreign currency exchange rate movements and lower realized pricing.

North American AHS revenue of $266.7 million for the second quarter was comparable to the prior-year period, while revenue of $516.5 million for the first half of 2010 represented a decrease of 1% compared to the same period of the prior year. Second quarter 2010 AHS revenue from the United States was $254.0 million, which was flat to the same period one year ago and increased 6% compared to the first quarter of 2010. Rental revenue declined 1% from the prior-year period resulting from a combination of factors including (i) reductions in chronic wounds treated outside the hospital, (ii) unfavorable changes to wound and payer mix and (iii) increased usage of lower-priced advanced wound care therapies. Foreign currency exchange movements favorably impacted second quarter and first half North American AHS revenue by 1% compared to the prior-year periods.

EMEA/APAC AHS revenue was $81.0 million for the second quarter of 2010 compared to $83.1 million in the prior-year period due primarily to foreign currency exchange movements, which unfavorably impacted second quarter EMEA/APAC AHS revenue by 3% compared to the prior-year period. On a constant currency basis, second quarter EMEA/APAC AHS revenue increased 1% compared to the same period one year ago due largely to the successful launch of V.A.C. in Japan. Increased rental and sales volumes in EMEA were offset by lower realized pricing associated with an increasingly competitive environment in Europe and our offering of longer-term, lower-priced rental arrangements. For the first six months of 2010, AHS revenue in the EMEA/APAC region was $164.2 million, up 4% compared to the first half of 2009. Foreign currency exchange movements favorably impacted first half EMEA/APAC AHS revenue by 2% compared to the prior year.

The Company began direct sales operations in Japan during April 2010. While Japan still represents a small percentage of our AHS business, the accelerated growth experienced in the quarter and the wide physician acceptance of this therapy is encouraging. KCI estimates that the annual market potential for V.A.C. Therapy in Japan approximates $500 million.

Total revenue from our Regenerative Medicine division, or LifeCell, was $83.7 million and $162.8 million for the second quarter and first six months of 2010, respectively, up 18% and 19% from the prior year periods. Sales of Strattice, our porcine-based regenerative tissue matrix were $33.2 million in the quarter, or approximately 40% of total Regenerative Medicine revenue for the period, up from 31% in the comparable prior-year period. The EMEA region contributed 2% to Regenerative Medicine revenue growth as we continue to penetrate the U.K. and German markets while introducing our Regenerative Medicine products into additional European countries.

Worldwide TSS revenue was $66.3 million for the second quarter and $140.1 million for the first six months of 2010, compared to $70.8 million and $145.4 million for the same periods one year ago, due primarily to lower rental volumes globally, resulting from continued economic weakness and its impact on acute care facilities, partially offset by slightly higher levels of capital sales. Foreign currency exchange movements unfavorably impacted worldwide TSS revenue by 1% for the second quarter of 2010 while favorably impacting revenue by 2% for the first six months of 2010, compared to the corresponding prior-year periods.

North American revenue from TSS was $44.6 million for the second quarter of 2010, a 3% decrease from the prior-year period, due primarily to lower hospital therapy days and reduced hospital spending on higher cost therapies, partially offset by increased levels of wound care capital sales and favorable foreign currency exchange movements. Foreign currency exchange movements favorably impacted North American TSS revenue by 2% in the second quarter. North American TSS revenue for the first six months of 2010 was $93.0 million, down 2% from the prior-year period on a reported basis, and down 5% on a constant currency basis. On a constant currency basis, EMEA/APAC TSS revenue decreased 7% for the second quarter and 6% for the first six months of 2010, compared to the same periods in the prior year due primarily to the impact of prior-year contract losses, as well as utilization changes in select countries and accounts.

Profit Margins

Gross profit for the second quarter and first six months of 2010 was $279.8 million and $551.5 million, respectively, representing increases of 3% and 6%, respectively, from the same periods of the prior year. Gross profit margin was 56.2% for the second quarter of 2010, an increase of approximately 110 basis points from the same period one year ago. The gross profit margin increase was due primarily to lower product royalty expenses, increased productivity of our service operations, higher gross margins associated with the Regenerative Medicine business unit and reduced levels of marketing expenditures related to delays in new product launches resulting from a delayed regulatory approval process.

Second quarter selling, general and administrative ("SG&A") expenses increased $21.4 million, or 17%, over the second quarter of 2009. Second quarter SG&A expense included $12.7 million in costs and expenses related to our TSS portfolio rationalization and employee separation costs. Other SG&A increases in the period consisted of launch costs associated with our entry in Japan and increased selling costs associated with the increase in Regenerative Medicine revenue.

Research and development expenses for the second quarter of 2010 increased 2% from the prior-year period to $21.7 million. Total research and development expenses represented approximately 4.4% of revenue for the current quarter. During the second quarter, the Company received FDA approval for its Prevena Incision Management System and has now launched this product in the U.S.

Operating earnings for the second quarter were $101.4 million on a reported basis, representing a decrease of 11% from the prior-year quarter. On a non-GAAP basis, excluding the $12.7 million related to the TSS inventory write-off and employee separation costs and non-cash acquisition related costs, operating earnings for the second quarter of 2010 were comparable to the prior-year quarter.

Other Income/Expense Reflects Focus on Debt Service

Second quarter 2010 interest expense was $22.3 million, compared to $26.2 million in the same period of the prior year, due to scheduled and voluntary debt payments made over the last twelve months totaling $225.0 million and lower interest rates. Long-term debt outstanding as of June 30, 2010 consisted of a senior secured term loan of $625.0 million due 2013 and 3.25% senior convertible notes of $690.0 million due 2015. Realized losses from foreign currency transactions were $2.7 million in the second quarter of 2010 compared to $1.9 million in the prior-year period due primarily to continued volatility in currency exchange rates compared to the prior year.

Income Tax Rate

The effective income tax rate for both the second quarter and first six months of 2010 was 30.0%, compared to 32.0% and 31.9%, respectively, for the corresponding periods in 2009. The decrease in the effective income tax rate for the second quarter and first six months of 2010 was due primarily to a higher percentage of income earned in lower tax jurisdictions and the favorable resolution of certain tax contingencies.

Financial Position Demonstrates Liquidity and Strength

Total cash at quarter-end was $247.1 million, a decrease of $16.1 million from year-end 2009. During the second quarter, the Company made scheduled and voluntary senior credit facility repayments of $50.0 million from cash-on-hand. Operating cash flow less net capital expenditures for the first half of 2010 was $99.0 million, a decrease of $26.6 million, from the same period one year ago, due to significant increases in inventory levels of our Strattice and AlloDerm tissue matrices, increased income tax payments and higher capital expenditures, partially offset by improved cash collections and higher net earnings. Total long-term debt outstanding at June 30, 2010 was $1.192 billion on a GAAP basis and $1.315 billion on an economic, or debt-instrument, basis. The long-term debt balances in our condensed consolidated balance sheets reflect the discount associated with applying the estimated non-convertible borrowing rate upon the issuance of the notes. The total discount will accrete over the term of the notes. As of June 30, 2010 and December 31, 2009 these convertible notes had balances of $566.6 million and $556.2 million, respectively, within our condensed consolidated balance sheets.

Outlook

Given the volatility of foreign currency exchange rates and other relevant factors discussed below, the Company has adjusted its 2010 financial guidance, based on current information and expectations as of July 27, 2010 (in millions, except per share data):

The revenue guidance, relative to 2009, reflects our expectation of unfavorable foreign currency exchange rates, stable revenue in our AHS business, double-digit growth in Regenerative Medicine revenue and a mid-to-high single digit contraction in our TSS business.

Fiscal year 2010 is an investment year in terms of geographic expansion and continuing with our global business transformation efforts, offset by modest earnings leverage from favorable product mix, operating efficiencies and continued debt reduction activities.