Strong 3Q for Kinetic

Kinetic Concepts Inc. (KCI) reported third quarter 2011 EPS of $1.16, up 9% from the year-ago quarter. However, adjusted EPS (excluding acquisition-related expenses related to LifeCell purchase in 2008 and expenses associated with the proposed merger during the quarter) came in at $1.35, surpassing the Zacks Consensus Estimate of $1.31 and 12.5% higher than the year-ago quarter.

Revenues of $531.4 million increased 5% year over year and also exceeded the Zacks Consensus Estimate of $525 million. Reported revenues witnessed a favorable foreign currency exchange movement of 2% during the quarter.

Rental income (52.5% of revenues) during the quarter declined 3.4% to $279.1 million. Revenue derived from the North American market increased 3.2% to $413.4 million while EMEA/APAC revenues jumped 11.1% to $117.9 million.

The company’s product segments, namely,  Active Healing Solutions (AHS), Regenerative Medicine (LifeCell) and Therapeutic Support Systems (TSS) reported sales of $372.1 million (up 1.4% at CER), $97.4 million (up 14.4%) and $61.8 million (down 6.4%), respectively.

Within the AHS segment, favorable foreign currency movement, higher volumes from new markets, capital sales and recent product launches were partially offset by lower rental revenue in established markets. Foreign exchange movements favorably impacted worldwide AHS revenues by 2%.The AHS Americas revenues increased 2% year over year due to a combination of increased sales volumes of V.A.C. Therapy units and increased revenue from the adoption of newly-launched negative pressure-based therapies in the US, partially offset by a decrease in rental volumes and realized pricing on V.A.C.Therapy rental units.

Sales in the EMEA region declined 5% at CER due to continued pricing pressures on V.A.C. Therapy rental units and a decline in rental and sales volumes, partially offset by higher sales volume of V.A.C.Via, ABThera and V.A.C. Therapy units. However, AHS revenues from APAC surged 32% at CER primarily due to higher rental and sales volumes in Japan.

The company’s LifeCell business witnessed strong growth mainly on the back of increased penetration into EMEA markets. During the quarter, the company reported EMEA sales of $2.9 million compared with $1.7 million in the prior-year quarter based on the successful introduction of LifeCell products across new geographical regions.

The TSS division reported revenues of $37.7 million in Americas, down 9.8% while sales from EMEA/APAC increased 12.1% to $24.1 million. The overall TSS revenue declined as the rental business during the quarter experienced increased competitive pressure and modest share loss.

Kinetic’s gross margin expanded 530 basis points (bps) to 62% during the reported quarter. This was driven by lower royalty expense associated with Kinetic’s license agreement with Wake Forest University, relating to patent disputes with Smith & Nephew (SNN - Snapshot Report) since 2008. Further, higher gross margins associated with LifeCell business unit, lower rental fleet depreciation and favorable product mix favorably impacted the gross margin.

Adjusted operating margin for the third quarter expanded 320 bps to 28.7% due to lower royalty expense, favorable foreign currency movements and year-ago charges relating to TSS portfolio rationalization and Global Business Transformation, partially offset by higher costs associated with the proposed acquisition of Kinetic.

Outlook

With regards to Kinetic’s pending merger with the Apax consortium and related recapitalization, Kinetic has suspended its fiscal 2011 outlook.

Earlier in July, Apax Partners along with two Canadian pension funds decided to acquire Kinetic. The deal, including Kinetic's outstanding debt, is valued at approximately $6.3 billion. As per the terms of the agreement, Kinetic’s shareholders will receive $68.50 in cash for each share of the company. The company expects this transaction to close in November 2011.

However, following the announcement, some of the company’s shareholders initiated legal actions challenging the merger. However, in order to resolve the problem, Kinetic has called for a shareholders meet on October 28.

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