Kinetic Concepts fourth quarter net earnings increase 12% to $74.0 million

Feb 1 2011

Kinetic Concepts, Inc. (NYSE: KCI) today reported fourth quarter and full year 2010 total revenue of $527.5 million and $2.02 billion, respectively, compared to $526.8 million and $1.99 billion in the corresponding periods of the prior year. Foreign currency exchange movements unfavorably impacted total revenue for the fourth quarter of 2010 by 1% while having no significant impact on revenue for the full year of 2010 compared to the corresponding periods of the prior year.

“Management's Discussion and Analysis of Financial Condition and Results of Operations.”

Net earnings for the fourth quarter of 2010 were $74.0 million, or $1.03 per diluted share, compared to $66.3 million, or $0.93 per diluted share, for the fourth quarter of 2009, representing increases of 12% and 11%, respectively, from the prior-year period. For the full year of 2010, net earnings were $256.1 million, or $3.57 per diluted share, compared to $228.7 million, or $3.24 per diluted share for 2009, representing increases of 12% and 10%, respectively, from the prior year. Net earnings per diluted share on a comparable, non-GAAP basis were $1.17 and $4.29 for the fourth quarter and full year of 2010, respectively, up 6% and 8% from the same corresponding periods of the prior year.

"We were very pleased with our fourth quarter results, particularly the outstanding performance of our LifeCell division and the stability of the U.S. AHS business," said Catherine M. Burzik, President and Chief Executive Officer of KCI. "KCI continues to execute to its strategy. With the introduction of several new products and therapies, for example our new VAC Via Therapy, our geographic expansion and our demonstrated operating discipline, KCI is well positioned to deliver unparalleled value to its patients, caregivers, payers, and investors."

Revenue Recap - Fourth Quarter and Full Year of 2010

Worldwide revenue from AHS products was $367.1 million for the fourth quarter of 2010 and $1.41 billion for the full year of 2010, which was essentially flat compared to the same corresponding periods of 2009. Compared to the prior-year periods, foreign currency exchange movements unfavorably impacted worldwide AHS revenue by 1% in the fourth quarter of 2010 while having no significant impact on worldwide AHS revenue for the full year of 2010. On a non-GAAP, constant currency basis, the growth in fourth quarter 2010 AHS revenue was attributable primarily to increased sales volumes.

North American AHS revenue of $279.4 million for the fourth quarter increased 2% from the prior-year quarter due primarily to improved rental and sales volumes. For the full year of 2010, North American AHS revenue was $1.07 billion, which was comparable to the prior year. Fourth quarter AHS revenue in the U.S. increased 1% over the prior-year quarter due largely to rental and sales volume growth.

EMEA/APAC AHS revenue decreased 6% to $87.7 million for the fourth quarter of 2010 and decreased 2% to $334.8 million for the full year of 2010, respectively, compared to the same corresponding periods of 2009. On a constant currency basis, EMEA/APAC AHS revenue decreased by 2% compared to the fourth quarter of the prior year while being comparable to the full year of 2009. The fourth quarter revenue decrease was due primarily to lower pricing and sales volumes in price sensitive and highly-competitive markets driven largely by governmental austerity measures in response to a challenging economic environment. The lower AHS revenue in EMEA was partially offset by volume growth related to new products and new geographies, particularly in Japan.

Total revenue from our LifeCell division was $93.7 million for the fourth quarter of 2010 and $341.4 million for the full year of 2010. Regenerative Medicine revenue increased 22% and 19% for the fourth quarter and full year of 2010, respectively, as compared to the same periods one year ago. Direct sales of Strattice™, our porcine-based reconstructive tissue matrix, generated $40.0 million of revenue in the quarter, or 43% of total Regenerative Medicine revenue for the period. Direct sales of Strattice in the fourth quarter of 2010 increased $12.9 million, or 48%, from the same period one year ago. The EMEA region contributed approximately 180 and 170 basis points of the Regenerative Medicine overall revenue growth rate for the fourth quarter and full year of 2010, respectively, as we continued to penetrate the European markets. We have now introduced our Regenerative Medicine products into eleven European countries.

Worldwide TSS revenue was $66.6 million for the fourth quarter and $270.2 million for the full year of 2010 compared to $82.7 million and $300.2 million, respectively, for the same corresponding periods of the prior year. North American revenue from TSS was $43.2 million for the fourth quarter of 2010, a 21% decrease from the prior-year period, due primarily to decreased demand in our critical care business stemming from a much less severe flu season than in 2009. North American TSS revenue for the full year of 2010 was $178.0 million, down 9% from the prior year revenue of $196.4 million. EMEA/APAC TSS revenue of $23.4 million and $92.2 million for the fourth quarter and full year of 2010, decreased 17% and 11%, respectively, compared to the corresponding periods of 2009. Excluding foreign currency exchange rate movements, EMEA/APAC TSS revenue decreased 10% and 8%, respectively, for the fourth quarter and the full year of 2010 compared to the same periods in the prior year due primarily to decreased rental volume and average rental pricing.

Profit Margins Stable

Gross profit for the fourth quarter and the full year of 2010 was $301.3 million and $1.14 billion, respectively, compared to $304.9 million and $1.11 billion, respectively, in the corresponding periods of the prior year. Gross profit margin was approximately 57% for the fourth quarter of 2010, down slightly from 58% in the prior-year period due primarily to additional investment in our AHS sales force during the second half of 2010, higher royalty expense, and lower TSS critical care rentals, partially offset by favorable margins in our Regenerative Medicine business.

Research and development expenses for the fourth quarter of 2010 decreased 5% from the prior-year period to $22.9 million. The majority of this decrease was due to the commercialization of new products in the second half of 2010 which were previously under development. Total research and development expenses represented approximately 4.5% of revenue for the full year of 2010.

Selling, general and administrative ("SG&A") expenses for the fourth quarter were $146.1 million, a decrease of approximately 1% from the fourth quarter of the prior year. The lower SG&A spend was due to lower spending in shared services functions partially offset by continuing investment in the LifeCell sales force and our Japanese infrastructure.

Other Income/Expense Reflects Continued Deleveraging

Fourth quarter 2010 interest expense was $19.7 million compared to $24.5 million in the same period of the prior year due to a combination of scheduled and voluntary debt payments made over the last twelve months and lower interest rates. Long-term debt outstanding as of December 31, 2010 consisted of a senior secured term loan of $527.3 million due 2013 and 3.25% senior convertible notes of $690.0 million due 2015.

Foreign currency transaction losses were $1.4 million in the fourth quarter of 2010 compared to $108,000 in the prior-year period due primarily to continued volatility in currency exchange rates.

Income Tax Rate

The effective income tax rate for both the fourth quarter and full year of 2010 was 28.0% compared to 32.9% and 31.6%, respectively, for the corresponding periods of the prior year. The decrease in the effective income tax rate for the fourth quarter and full year 2010 resulted from a higher percentage of taxable income being generated in lower tax foreign jurisdictions and the favorable resolution of certain tax contingencies during 2010. The fourth quarter tax rate also benefited from the extension of the U.S. research and development credit.

Financial Position Provides Flexibility and Strength

Total cash at year-end was $316.6 million, an increase of $53.4 million from year-end 2009. During the fourth quarter and year ended December 31, 2010, the Company made scheduled and voluntary senior credit facility repayments totaling $37.7 million and $222.7 million, respectively, from cash-on-hand. Operating cash flow less net capital expenditures for the full year of 2010 was $275.4 million. Total long-term debt outstanding at December 31, 2010 was $1.11 billion on a GAAP-basis, including the discount associated with our adoption of required accounting standards, and $1.22 billion on an economic, or debt-instrument, basis.

Subsequent Event

Our liquidity and financial flexibility were enhanced in January 2011 when we entered into a new credit agreement which was used to refinance our existing senior credit facility and will also be used for strategic and general corporate purposes. The new credit agreement provides for (i) a $550.0 million term A facility that matures in January 2016, and (ii) a $650.0 million revolving credit facility that matures in January 2016, which represents a $350.0 million increase from our previous revolving credit facility. The Company also has the right at any time to increase its borrowings under the new credit agreement by an aggregate additional amount up to $500.0 million.

2011 Outlook

The following guidance is based on current information and expectations as of February 1, 2011 (in millions, except per share data):

The revenue guidance reflects our expectation of (i) flat to low-single digit growth in AHS resulting from emerging market penetration and new product introductions, partially offset by lower realized pricing and competitive share loss, (ii) mid-to-upper teens growth in Regenerative Medicine revenue and (iii) low-to-mid single digit contraction in TSS revenue. Our 2011 outlook also assumes foreign currency exchange rates are comparable to 2010 and assumes the seasonal slowing of AHS revenue growth which we have historically seen beginning late in the fourth quarter and continuing into the first quarter. We believe this seasonal pattern is generally caused by year-end clinical treatment patterns, such as the postponement of elective surgeries and increased discharges of individuals from the acute care setting around the winter holidays. Historically, approximately 23% to 24% of our total annual revenue is realized during the first three months of the year.

The 2011 earnings guidance does not consider any potential impact to our royalty obligations resulting from ongoing patent litigation. KCI and its affiliates, together with Wake Forest University Health Sciences ("Wake Forest") are involved in multiple patent infringement suits against companies including Smith & Nephew, all of whom are challenging the validity of the Wake Forest patents. In October 2010, the Federal District Court for the Western District of Texas entered an order in the Smith & Nephew case invalidating the patent claims involved in the lawsuit. In light of the ruling, KCI believes that continued payment of the royalties scheduled under the Wake Forest license is inappropriate and the Company is pursuing various alternatives.

While we expect 2011 to be an investment year in terms of expanding our presence in the Japanese market and continuing with our global business transformation efforts, earnings leverage is expected to be realized through favorable product mix, operating efficiencies and continued financial leverage. In addition, during the first half of 2011, the Company expects to incur certain charges associated with its global business transformation and other business unit initiatives.