Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Adam Rodriguez – Vice President of Business Development & Investor Relations

Catherine M. Burzik – President & Chief Executive Officer

Martin J. Landon – Senior Vice President & Chief Financial Officer

Michael J. DelVacchio, Jr. – Senior Vice President, U.S. VAC® Therapy Sales & Marketing

Stephen D. Seidel – Senior Vice President, General Counsel, & Secretary

Analysts

Seth Damergy – Deutsche Bank Securities

Jayson Bedford – Raymond James

Matt Miksic – Piper Jaffray

Taylor Harris – JPMorgan

Kinetic Concepts, Inc. (KCI) Q2 2009 Earnings Call July 21, 2009 8:30 AM ET

Operator

Good morning. My name is Nikisha and I will be your conference operator. At this time I would like to welcome everyone to the KCI second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). I would now turn the conference over to Mr. Adam Rodriguez, Vice President of Business Development and Investor Relations. Sir, you may begin your conference.

Adam Rodriguez

Thank you and welcome to the KCI’s second quarter 2009 earnings conference call. Today we will review the results that were announced in our press release earlier this morning. Today’s conference call will include prepared remarks by Catherine Burzik, our President and Chief Executive Officer; and Marty Landon, our Chief Financial Officer. We will also be joined by other selected members of our senior leadership team.

If you have not received a copy of KCI’s earnings release, it is currently available on the company website at www.kci1.com. Today’s call is being webcast live over the Internet. A replay of the call will be made available on KCI’s corporate website shortly after the conclusion of today’s call.

Our conference call this morning will include forward-looking statements about our business, including guidance on future plans, revenues, and earnings. These statements are based on our current expectations and are subject to a number of risks and uncertainties, which could cause actual results to differ from our expectations. More information about potential risk factors may be found in our filings with the SEC.

Also, quarterly results discussed on this call may reflect adjustments for expenses related to the LifeCell acquisition and other significant costs incurred during the quarter. Please refer to the non-GAAP reconciliation of these metrics contained in our earnings release issued this morning.

Finally, due to scheduling conflicts and as a matter of convenience for you given the busy September calendar we are rescheduling our Annual Analyst Day event from September 14 to November 9. Management will be on hand at the event to review strategic initiatives and performance objectives.

We will communicate with you as we get closer to the event and look forward to seeing you there. I would now like to turn the call over to Catherine Burzik, President and Chief Executive Officer of Kinetic Concepts.

Catherine M. Burzik

Thank you, Adam and good morning everyone. Today's call will begin with my general comments and highlights from our second quarter 2009. Including remarks regarding the earnings release, which we posted this morning. I will then update you each on each of our core businesses before handling the call over to Marty, who will review financial results for the quarter in more detail. Thereafter, we will open the call for questions.

First, let me start by saying that I am very proud of the resilience of KCI's businesses and of its talented people in light of sustained global economic uncertainty and increased competitive pressures on our Wound Therapy, Therapeutic Support Services, and Regenerative Medicine businesses. We are delivering on our goals in terms of innovation, global expansion, diversification, and operational efficiency. And our business fundamentals remain solid.

Late in the quarter, in the U.S. and Europe we introduced our negative pressure based ABThera System and off-the-shelf solution for the operating room that allows surgeons to manage and treat the acute open abdomen in patients where fascial closing is impossible or undesirable. There are over 250,000 such instances annually. Typically the results are traumatic surgery or sever conditions such as Abdominal Compartment Syndrome or Sepsis. In the most serious of these cases, we anticipate that surgeons will also incorporate our Strattice or AlloDerm, acellular dermal matrix post the application of ABThera, to achieve wound closure.

We are very enthused to bring to market the types of combination negative pressure Regenerative Medicine therapy as envisioned with our acquisition of LifeCell in May of 2008. Our ABThera System represents the first of our operating room based negative pressure platform products and will be followed by the launch our surgical incision wound management system Prevena later this year. During this quarter we also made significant progress in our plans for the launch of V.A.C Therapy in the large and unpenetrated Japanese markets.

We believe we are on track for regulatory approval in Q3 and reimbursement in April of 2010. We anticipate placing beta V.A.C. site in Japan later this year. As we have grown we have recognized the need to bring in a key executive to lead our expanding Wound Therapy division and I'm very pleased that Mike Genau, formerly of General Electric and an executive that I have known for over 10 years joined KCI last week as our Global President, Wound Therapy. Over the next several months we will build out our Wound Therapy division under Mike's leadership to include all aspects of our negative pressure business globally including our signature V.A.C Therapy product, which has improved a lot of over 3 million patients in the last decade. And importantly we look forward with confidence to the rest of the year. I will now go into more specifics about our operating results.

Consolidated revenues for the second quarter were $491 million, up 6% on an as reported basis. Assuming constant currency, our revenue increased 3% on a pro forma basis taking into account the LifeCell transaction. Wound healing revenues increased to $349 million, up approximately 3% on a constant currency basis. Our Regenerative Medicine business posted revenues of $71 million, up 22% over what LifeCell reported in the same period last year. Our Therapeutic Support Systems business decreased to approximately $71 million, which represented a 7% decrease on a constant currency basis. We reported GAAP net earnings of approximately $58 million or $0.82 per diluted share, compared to a loss of $5 million or $0.07 per diluted share during the prior year period.

As expected our U.S. V.A.C. business was stable, units in use increased nearly 6% year-over-year tampered by mix shift and modest anticipated pricing pressure in line with expectations. We are particularly proud of the fact that this unit growth is consistent with what we saw in Q1 and highlights that despite competitive actions and depressed hospital consensus metrics, KCI's Wound Therapy business is growing. We continue to educate professionals on the full clinical and economy benefits of our V.A.C. Therapy that uniquely provides for other claim, but cannot prove. Our customer programs like Ready Care and Customer Plus and economic tools such as our budget impact model together with our new products like Simplace, Bride and ABThera have been very well received by our customers and consistent with prior periods we saw minimal pricing declines outside of Medicare Part B.

As we managed our NPWT placements across care settings, so we are cognizant of the difficult economic environment our customers face and we offer flexible programs to help them manage cost. Despite a nearly 10% price cut from CMS that took effect in January, we have experienced only minimal spill over with MCOs, who understand that our clinical evidence and economic data consistently support that utilization of V.A.C. Therapy saves lives, limbs, and costs. We note that we have experienced a shift in patient mix, which has also lowered our average realized pricing to some extent. Our Wound Therapy business continues to grow outside the U.S. is demonstrated with record volumes in several important countries including Germany, Canada, and Australia.

Germany delivered incremental volume despite significant open competition from both gauze and foam-based products. Well pricing is an area of concern, given the aggressive tactics of competitive we are holding contracting price study by demonstrating the economic value associated with using V.A.C. therapy as well as working to mitigate impacts of new technology adoptions and premium price disposables. We are seeing some rationalization of utility and programs, which affects average price realization. We were especially pleased with the results from Canada. Our Country Manager there, General Manager there, John Simmons is doing outstanding job there in his very first year.

In summary, regarding our Wound Therapy business, we are successfully meeting the challenges of aggressive competitive advances in a difficult economic environment, while continuing to penetrate the market. And with a sustained uptake of a new product like Simplace, Bridge and ABThera we are demonstrating KCI's firm results to not only protect our core, but to deliver additional solutions into new markets that make it different for our customers, restore well-being in patients and promote our global market leadership in NPWT.

Now turning to LifeCell, our Regenerative Medicine business, AlloDerm and Strattice are performing well up 27% year-over-year on a pro forma basis in our core applications of challenging hernia repair and breast reconstruction postmastectomy. Overall, our Regenerative Medicine business grew 22% on a pro forma basis it now represents approximately 15% of KCI's revenue. With the successful handling characteristics, significant clinical experience and strong data, AlloDerm has developed a dedicated filing among surgeons, especially those performing breast reconstructions. And thus we see stronger than expected demand.

Once again we were impressed with the adoption rate of Strattice, now over 30% of Regenerative Medicine revenue in the quarter. And we observed strong clinical acceptance especially in challenging hernia repair where the availability of larger product sheet and excellent biomechanical properties are driving clinical utility. Although, we are significantly increasing our production output, demand continues to outpace our ability to supply. Outside the U.S. we are making strong progress with Strattice in the U.K., where uptake especially in breast reconstruction is ahead of plan. The adoption rate in Germany however is going slower than planned. We continue to build out our capabilities and are formulating tactical approaches in Germany and expect to be in full-scale implementation by the end of the year.

Additionally, as planned we are initiating a trial in the European Union for abdominal wall repair in the second half of the year. We anticipate that study results will provide us clinical outcomes data for reimbursement and commercial activities for use in further international expansions. Now, with regard to other new Regenerative Medicine products and initiatives, we are pleased with Tornier's growth and performance in rotator cuff and foot and ankle applications. We remain excited about the breast plastic surgery business as well and continue to receive positive feedback from surgeons on how Strattice can be a highly valuable tool to address complex problems following breast augmentation.

Development of our tissue matrices configured for chronic wounds [Audio Disturbance] and we expect to have early patient experience in the first quarter of 2010. This will be a strong demonstration of leverage across business units with this especially designed LifeCell product being sold to surgeons by the V.A.C. sales organization. We are also witnessing increased use of AlloDerm and Strattice in conjunction with our negative pressure products to drive superior critical outcomes. Much of this efficiency has resulted from plant collaborative efforts between the LifeCell and V.A.C. commercial organizations to raise utilization of such combination solutions when and where appropriate as well as to share local relationships among the two sales forces to better serve surgeons.

Turning now to our TSS business. As expected hospitals remain impacted by the challenging economic environment, which in turn continues to impact the business though we did see more stability in EMEA. Offsetting some of the declines from lower hospital census and spending in many product lines our life saving RotoProne Therapy is progressing well, demonstrating an ability to impact the recovery of patients in the most seriously compromised situations. As a result of strong demand, we are expanding access to this product across the United States. Our strategic alliance with Carroll Hospital Group announced last quarter has launched with very encouraging early feedback from use of this best-in-class Spirit Select low bed. We are dedicated to enhancing the margin profile of this business to gaining profitable contracts, prudent manufacturing investments, and approving operating efficiencies especially in service and delivery activities.

Now let me come back to an area that I am very personally passion about, innovation. KCI remains committed to the development of important therapies that restore well being in patients and lower overall healthcare costs. We have invested significant resources in our innovation pipeline and we are very proud of the caliber of products reaching the markets. Specifically, we are eager to officially launch ABThera in Q3 as this is our first differentiated product from V.A.C. utilizing negative pressure and focused in the OR suite as previously mentioned. The comments from clinicians involved in the limited launch had been very positive and we are excited about bringing in innovative solution to such a challenging clinical problem.

In addition, this is an area where our portfolio of acute care products including our acellular dermal matrixes has a role in the management of the sick and complex patients. Another new platform offering again focused in the operating room is the Prevena system for surgical incision management, which should reach the market in Q4. This exciting product combines our deep knowledge of negative pressure and material interfaces to provide a novel tool to manage surgical incision in high-risk patients, who may develop postoperative complications.

Additionally, we have several incremental growth drivers entering the later stages of development including Strattice-based inguinal and parastomal hernia repair application. On the heels of these launches will be our next generation negative pressure technology platform products, which will open up entirely new wound acuity levels for KCI to penetrate in 2010 and beyond. 2009 and 2010 are important transformative years for KCI as we introduced new products would allow us to open new markets. We believe these innovations will enable us to drive meaningful growth and assure the long-term success of our company.

Marty will be providing an update on the global business transformation project for cost efficiencies, but I would like to highlight that we made very good progress in the second quarter and are on our way to our goal of $100 million in annualized savings by the end of 2011. We also continue to work on the Branchburg Manufacturing ramp-up. We initiated expansion of our plant in Ireland, which will eventually bring most cost efficient manufacturing under our direct control. And finally we made notable progress with realigning the service center infrastructure. We look forward to 2010 for meaningful gains in margins as these items are fully implemented and begin to have an impact.

Also no call this earnings season would be complete without at least a few comments on health reform in the U.S. While the ultimate form of legislation that exits Congress is yet to be determined. We're working diligently through AdvaMed to ensure that our industry receives fair and balanced treatment. We remained committed to the ultimate goal of achieving broad-based reform that offers every American access to healthcare. To that end, we are maintaining an open line of communication and again through AdvaMed are working constructively with the White House and leaders on Capitol Hill. We have been engaged in continuing discussions with all interested parties on methods for improving the quality and efficiency of the healthcare system in the U.S., including comparative effectiveness research, value-based purchasing, coordination of care and encouraging innovation, and appropriate utilization.

In closing, when I reflect on the important work we are doing at KCI I firmly believe in our ability to sustain the leadership positions we have earned for several key reasons. First, outcome, our therapies result in unparalleled patient outcomes and customers continue to have confidence and preference for the proven clinical results of our therapies. And secondly, customer trust, our infrastructure with its high caliber, sales, service, and 24/7 customer and patient support backed up by unmatched compelling clinical evidence has resulted in exceptionally strong and broad customer relationships globally. Our customers trust us, what we say, what we do, and what we deliver, and it is difficult to imagine that any other company could or would bear the high cost and time investments required to replicate this competency.

And thirdly, cost effectiveness, our therapies yield compelling quantitative economic value for our customers and patients. And fourthly, know-how, experience matters, know-how matters, and we have developed this knowledge base over a decade. We innovate others can only try to imitate us. Fifth, our commitment to innovation, our R&D pipeline is robust and transformational. No windows of science of negative pressure and Regenerative Medicine mechanisms of actions, better than KCI. You have seen this for over a decade from us, you see it currently from Simplace, Bridge, ABThera, AlloDerm and Strattice and you will see it going forward with the launch of many new products in markets over the next several quarters.

And sixth reason is our strategic vision. Only KCI will be able to bring together best-in-class negative pressure and Regenerative Medicine products. The gold standards in the respective applications that will enable surgeons to treat people with very serious complications to regenerate lost tissue, to restore well-being, and to enable recovery. This was the vision that we had when we acquired LifeCell last year. And then finally people, it's always all about people and leadership and willingness to win. Our people are passionate about patients it is a distinctly unique characteristic and indeed the brand of KCI people globally. And with this I would now like to turn the call over to Marty Landon, our CFO.

Martin J. Landon

Thanks Cathy and good morning everyone. As Cathy said we had solid financial performance in the quarter, we continue to deliver growth against a backdrop of increasing competition in the weakened global economy for several important reasons. First, we see steady demand backed by customer trust that only comes with offering best-in-class products, service excellence and strong infrastructure all of which Cathy touched on earlier.

Secondly, despite headwinds in the macro environment, we have shown a sustained ability to execute in part because of our large clinical sales force and the caliber of patient and economic outcomes that continue to differentiate us. And lastly, we're running the business in a disciplined way, driving further operating efficiencies, which in turn enable us to sustain KCI's rich heritage of providing innovation to the market including combination therapies such as our ABThera System and acellular tissue matrices.

Let me now walk through the details of the quarter. For the second quarter of 2009, we reported total revenue of $491.3 million, a 6% increase from the same period one-year ago. The increase in revenue was substantially driven by our Regenerative Medicine division, which contributed $71 million in revenue for the period. We completed our acquisition of LifeCell in May of last year and I am pleased to report that the acquisition was cash EPS accretive for the first half of the year, ahead of our initial plan.

On a pro forma basis, assuming LifeCell was acquired on January 1, 2008 our second quarter 2009 revenue was essentially flat versus the prior year, as higher unit demand for our Biologic and Wound Therapy products was substantially offset by lower revenue from our Therapeutic Support Systems, unfavorable foreign currency exchange rate variances and lower realized pricing in V.A.C. Therapy, due to a CMS price reduction and patient mix shift.

As with many other global companies, foreign currency exchange rate movements continue to be a significant headwind for us in the period. We are using both consolidated revenue growth and V.A.C revenue growth by 4% as compared to the year ago quarter and reducing TSS revenue growth by 6% compared to the second quarter of last year. On a constant currency basis, consolidated revenue growth was 10% period-to-period while on a comparable pro forma basis revenue growth was approximately 3% assuming full LifeCell revenue for the 2008-second quarter.

On a sequential basis, we delivered revenue growth of $21 million or 4.5% up from the first three months of the year. Worldwide V.A.C revenue for the second quarter of 2009 was $349.4 million, a 1% decline from a year ago due primarily to unfavorable foreign currency exchange rate variances. On a constant currency basis worldwide V.A.C revenue increased approximately $10 million or 3% year-on-year due to continuing strong demand for our products.

North America V.A.C rental unit growth of 6% demonstrated the durability and progress of this business due, we believe to our clinically differentiated outcomes. North American V.A.C revenue growth was around 2% resulting from lower realized pricing due to a number of factors including the 9.5% Medicare price reduction that was effective at the beginning of the year and a movement towards more flexible pricing arrangements resulting from hospital budgetary constraints and then a higher mix of patients covered by Medicaid. All combined North American V.A.C. revenue for the second quarter increased almost 2% to $266.3 million. On a constant currency basis, second quarter North American V.A.C. revenue was up a little over 2% showing remarkable resilience due to the clinical, economic, and services advantages of our offerings.

Outside North America, weak global economic conditions and increasing competitive activities resulted in a slowing of EMEA/APAC V.A.C. revenue growth. On a reported basis EMEA/APAC V.A.C. revenue was $83.1 million, down 9% from the second quarter of 2008. While on a constant currency basis, V.A.C. revenue from the EMEA/APAC regions increased almost 5%. The weak global economy contributed to lower revenue growth in the quarter, as hospitals continued to operate under budgetary constraints. Other factors in the quarter included sustained competitive trialing in the presence of additional competitive offerings. Demand for KCI’s V.A.C. remains solid in the period and overall contracted pricing in the region was stable.

Regenerative Medicine revenue for the second quarter was up 22%, on a comparable pro forma basis to $71.1 million. We continue to experience increased demand for Strattice, our porcine-based regenerative tissue matrix launched in early 2008, which now represents over 30% of the total Regenerative Medicine business. Our growth in Regenerative Medicine revenue was again driven primarily from challenging hernia repair and breast reconstruction procedures.

Second quarter revenue from our Therapeutic Support Systems or TSS business was $70.8 million, a 13% decrease compared to the same quarter a year ago. On a constant currency basis, TSS revenue declined approximately 7% period-to-period, demonstrating the notable impact of foreign currency rate fluctuations on performance. Reduced U.S. hospital census, credit availability, and budgetary constraints contributed to the second quarter revenue decline.

Gross profit for the second quarter was strong at $263.8 million, an increase of 15.2% over last year's second quarter. Gross profit margins increased approximately 410 basis points to 53.7%, compared to the same period of 2008. As expected the increased gross margin was due primarily to a combination of higher gross margins associated with our Regenerative Medicine products and increased service productivity within our core business.

Is notable I think that the second quarter gross profit increased almost $20 million from the first quarter of this year, nearly the same level as our sequential revenue increased. This performance is a reflection of ongoing efforts to enhance service levels and efficiency throughout our manufacturing and operations activities in optimizing the productivity of our sales organizations. As we announced last quarter over the next two and half years, we are targeting additional cost and effectiveness improvements in our global service operations as part of our global business transformation or shared services initiative. We see ourselves is well in our way to achieving our $100 million in targeted savings exiting 2011.

SG&A expense for the second quarter was a $119 million, compared to a $102.9 million in the same period of 2008. Of this increase $12 million was attributable to our acquisition of LifeCell last year. From an operating perspective, we recorded higher expenses in a few areas during the second quarter including provisions for costs associated with the consolidation of domestic service centres in addition to recording high legal fees from ongoing litigation matters.

We continue to make progress in reducing transaction related costs and implementing improved and standardized processes throughout the organization. As announced at the end of March, we formed a Global Shared Services Team for the purpose of optimizing our organizational structure, business process, design, and technology assistance across KCIs infrastructure. We have much more work to do here and some of this work comes at a cost in the short-term, but overall we expect to at least maintain if not improve operating margins in the second half of the year.

As part of our sustained commitment to innovation and as previously disclosed, we continued to expand our research and development investment in the period. For the second quarter, total R&D expense was $21.3 million, an increase of 27.5% over the prior year period due partly to the addition of LifeCell as well as augmented spending to advance our robust R&D pipeline towards commercialization. As a percent of total revenue, R&D was 4.3% up 70 basis points from the same period in 2008.

Interest expense was $26.2 million in the second quarter related to the LifeCell acquisition financing completed during the second quarter of last year. On a sequential basis, interest expense decreased approximately $2.3 million due to our continuing and accelerated debt repayment levels, the second quarter interest expense also includes non-cash cost of approximately $4.8 million associated with our adoption of FASB Staff Position APB 14-1 related to our convertible notes.

Transactional impacts from foreign currency fluctuations resulted in additional expense of $1.9 million in the second quarter, essentially flat versus the prior year, but an improvement over the first quarter due to more effective hedging strategies. We have once again provided within the earnings press release a reconciliation of our GAAP earnings per share to our adjusted EPS excluding certain non-cash acquisition related expenses, for example, our acquired intangibles amortization and our non-cash interest expense associated with our adoption of Staff Position APB 14-1.

We reported our GAAP EPS for the period, which was $0.82 compared to a net loss of $0.07 per diluted share for the second quarter of 2008, due primarily to cost recorded in conjunction with the 2008 acquisition of LifeCell. On an adjusted basis, we generated diluted EPS of $0.98 for the second quarter, up approximately 9% from the comparable period of the prior year and up from $0.83 or 18% from what we reported in the first three months of this year.

Our improved earnings were the results of continued revenue growth and improvements in our overall cost structure. We generated operating cash flow of $160.6 million for the first six months of 2009, an increase of approximately 25% from the year ago period and our net capital expenditures were $35.1 million, down from $61.6 million a year ago. We made a scheduled debt repayment of $25 million in the second quarter on our senior debt facilities, bringing our total repayment for the year to approximately a $129 million net of revolving credit borrowings.

Consistent with our stated objectives, we continued to use free cash flow after first funding our initiatives in global expansion and innovation to further reduce our leverage level. Our leverage level is now approximately 2.5 times our trailing EBITDA versus 3.2 times leverage a year ago and our revolving credit facility is undrawn. Our financial position remains liquid and stable with total worldwide cash of over $200 million and a substantially unencumbered $300 million revolving credit line.

As indicated in our press release this morning, we have reaffirmed revenue and earnings per share guidance for the full year of 2009. With the continued market preference for our best-in-class products and services combined with further manufacturing improvements, operations, and delivery efficiencies and the work underway on our global business transformation initiative, we expect to sustain expanded margins and resulting higher earnings over the reminder of the year.

Further, we expect continued capital constraints in the hospital setting during the second half and we expect additional competitive and economic headwinds in our Wound Therapy business outside the U.S. Again included in our press release this morning, we have provided you a reconciliation to this adjusted earnings per share number to assist you with your modelling and to provide a consistent basis of comparison. And at this time, we will open up the lines for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from the line of Tao Levy with Deutsche Bank.

Seth Damergy – Deutsche Bank Securities

Yeah. Hi Marty and Cathy. This is Seth for Tao. How are doing?

Catherine M. Burzik

Hi, Seth. How are you?

Martin J. Landon

Good morning, Seth.

Seth Damergy – Deutsche Bank Securities

Good, good. So first I wanted to just touch on the 6% unit growth for the V.A.C this quarter?

Catherine M. Burzik

Yes.

Seth Damergy – Deutsche Bank Securities

So specifically can you give us an idea of how much of that’s due to the new pump consignment program versus customers reengaging KCI and moving from competitive products?

Catherine M. Burzik

Well, I'll talk a little bit about that there is probably a lot of detail that we wouldn't release, but what I would say is that what I see the primary thing that's driving the 6% growth is really, really good execution on the part of Mike DelVacchio's organization in the United States. We've done, I think a very good job of launching these programs and Seth I talked a little bit about this last quarter, we talked about ready care and customer plus. And in general is being more flexible I think in the way that we do business with our customers, and I think that's all been helped by these new product launches of Simplace and Bridge that has given an opportunity, for our sales forces to go in and speak to wound care nurses and surgeons about these new products. That's really what I attribute the quarter growth to.

Seth Damergy – Deutsche Bank Securities

Okay. And – or Cathy is there any or is there any one particular channel that’s still being pressured or particularly strong for the V.A.C business?

Catherine M. Burzik

I would say that the pressure that we see continues to be more on the hospital side, where we continue to see the situation where the economy is affecting, unemployment is affecting the number of people in the hospital as well as the small amount of elective surgeries. I would say from a competitive situation as we talked about in the past you see the strongest competition in the skilled nursing segment and in the LTPAC segment and I have been particularly pleased by the growth that we've seen in the post-acute segment and the home care segment.

Martin J. Landon

And I think its fair to say, Seth that the relationships there are strong and good and its what allows us to work with the customers to try and find workable solutions for them and things that work for us. So from a relationship standpoint, I think the fact that we've been in there and providing them, best-in-class products that provide these exceptional outcomes has really helped over the time.

Seth Damergy – Deutsche Bank Securities

Okay. Thank you for that. And maybe if we turn over to the margin side, the strength in the margin was impressive and I wanted to just see if we could kind of hash out how much of that is do to increased utilization of Strattice or ballpark it and on the pricing pressure side on the V.A.C., did anymore significant this quarter than in previous quarters?

Catherine M. Burzik

I would say, and Marty talked about this a little bit in his release. We saw some amount of realized price reduction as a result of the mix of these programs and as a result of the overall mix in the payers, certainly modest, but some. What I think was particularly impressive in the gross margin is, we put together this global business transformational team last year, and I see that team gaining traction I see our service consolidation that we talked about in the marketplace, it's now kicking in and it’s now paying off and on the work we clearly done with manufacturing, being able to consolidate our manufacturing in Ireland. So I think a lot of the things that we talked about, you are now starting to see the benefits of that and Marty might want to make another comment to that.

Martin J. Landon

Yeah. I mean in terms of, breaking it down certainly a portion of it is owing to LifeCell acquisition as we have said. I think we are also we talked in prior calls about being in the early phases of some of this work around efficiencies and some of that is starting to bear fruit. And so, on an operating side of things, we are better but even on a sales expense, as a percent of revenue, we’re a little better. So it’s a number of things that that go into that Seth and as a result we see it as something that has some legs to it in terms of can you deliver going forward, there is always going to be bumps along the way as you institute the next level of change, but overall we’d like [Audio Disturbance].

Seth Damergy – Deutsche Bank Securities

Okay, Thanks, thanks for that Marty. And just one last one then I will jump back in the queue.

Catherine M. Burzik

Okay.

Seth Damergy – Deutsche Bank Securities

On the new products front, can you just talk maybe anecdotally about the ABThera System, your initial feedback from the field and can you also remind us if there are any other significant launches in the second half and I think, this rooms product was potentially slated for late 2009, but any clarity would be great? Thank you.

Catherine M. Burzik

Yeah. So first happy to talk about both. We launched ABThera back at the, we haven't officially launched, its kind of a pre-launch back about a month ago. Both in major conference here in the United States and then also in Dublin and in both of these conferences it was really standing remotely, it was like the abdominal conference here in the United States really, really pleased. I think there were like 700 surgeons. I mean it's just a wonderful example of how we can bring together negative pressure and Regenerative Medicine Technology. These patients are really, really sick patients. These patients are the patients where you see in my pictures where the guts of pretty much spilled out of the person and you have to find a way to put them back in and this can be as a result of sepsis or aortic aneurysm, abdominal aneurysms it can be from abdominal compartment syndrome. There is actually 250,000 of these cases a year and literally these people have had really no way to treat them. They've tried to use V.A.C. to some extent, but V.A.C. has just not worked, so we've learned, it works a part of the time, not all of the time and we knew we could do it better so the work that Todd has done in R&D with the special spider dressing and we gave you a taste of that at last year's analyst meeting. The work by having a brand new pump, a larger canister because the exudate is so much more for these patients and then I think importantly to have it on the shelf in the operating room, so the surgeons can just get familiar with using it, I think is really important. So we have great expectations for this and I will tell you that doctors and surgeons we've talked to that are using it now on patients are really telling us its making a difference on these extremely sick patients. So this is clearly, ABThera brought to you by the makers of V.A.C and it's just a wonderful product. And I don't know, I have Mike DelVacchio, Mike you might want to just comment on, early feedback you've gotten from some customers.

Michael J. DelVacchio, Jr.

Yes. So we launched this into several little trauma centers in the past month and we are continuing to hear very positive results from our physicians as they place this on very, very sick trauma patients. And we've begin a full launch later this week and are expecting very good things throughout the rest of the year.

Catherine M. Burzik

Thanks. And then Seth you asked about, yes of Prevena so what we've talked about in the past are surgical wound management system or you have heard us talk about negative pressure surgical management. Our next product in that vein will be our Prevena product; it goes by the name Prevena. We are on track to have that product launched at the end of the year. The first version of that will be for incisional types surgeries and again and there will be follow on versions of that for other type of surgeries area management et cetera, as we move forward later into 2010. So net-net we are pretty excited about these new products.

Seth Damergy – Deutsche Bank Securities

Well congrats on the execution, Cathy. Thank you.

Catherine M. Burzik

Thanks Seth.

Operator

The next question is from the line of Jayson Bedford with Raymond James.

Jayson Bedford – Raymond James

Hi, good morning. Thanks for taking the questions.

Martin J. Landon

Good morning, Jayson.

Catherine M. Burzik

Hi, Jayson. How are you?

Jayson Bedford – Raymond James

Doing well thanks.

Martin J. Landon

Okay.

Jayson Bedford – Raymond James

Just a couple of follow-ups there, just looking at the 400 basis point delta between the rental growth and the revenue growth in North American V.A.C. I'm just wondering how much of that is can be related to the more flexible pricing arrangements that you mentioned?

Martin J. Landon

Well, certainly when we enter into those agreements Jayson, so for example, where you go, we call a Customer Plus where we provide a number of units to the facility and they take care of some of the service operations there. It helps you on the total service cost, but you still have to go in and you still have to figure out how to manage that overall cost structure and the interesting thing about this is, we believe we've done it in a way where we have actually improved service levels overall while reducing cost. So, there is something owing to that and it certainly helped, we try and do those things to where they are at least margin neutral or in that neighborhood again sharing some of the risk with our customers, but overall have been very, very beneficial.

Jayson Bedford – Raymond James

I guess more to the point Marty, can you attribute 1%, 2%, 3% growth, lack of growth to the pricing arrangements?

Martin J. Landon

So in terms of basis points.

Jayson Bedford – Raymond James

Yeah.

Martin J. Landon

It would be a portion of if you think about that total change in the operational efficiencies, you were somewhere in the neighborhood between 1 and 200 basis points, and I would just say that some portion of that less than half would be attributable to those new offerings.

Jayson Bedford – Raymond James

Okay, that’s helpful. And just maybe anecdotally here, this is the first full quarter where you've had foam competition in the U.S. here? Have you seen the competitive intensity change at all from the first quarter?

Catherine M. Burzik

I mean that’s a good question Jayson and so we have very full foam, competition now both in EMEA and in the United States and then we are starting to see it even outside of EMEA and the United States. I would say, I get asked this question a lot, the overall level of competitive trialing is pretty stable, really expense stable for the last several quarters, I think the market is pretty much absorbing all of that it can and it has the same effect that we've seen, has the effect certainly its slowing down decision making, on the part of the hospitals. We fight very hard to retain the business, and many, many more times than not we are successful in doing that. So, we see, the foam competition is just being kind of more of the same kind of competition that we've seen over the course of the last year.

Jayson Bedford – Raymond James

Helpful. And then can you talk about the economics around ABThera is it a similar rental model and what is kind of the pricing structure and then from a sales force perspective who is selling the product?

Catherine M. Burzik

Well, I will disclose some of that, but we are not going to disclose all of the details, it is more of a long-term rental kind of program because these units have to be on the shelf in the operating room in order to be effective. And the dressings have to be also available in the operating room to be effective. So the business model is more of a long-term rental to get these units in the hospital. They are fairly easy to clean – they can be cleaned by the hospital and put back on the shelf in the operating room, so that’s the model and so there is a rental model for the unit and then there is a price that we have for the dressings and you can imagine this is a very, very highly priced product because of the complexity and the proprietary nature of the overall dressing. So that was part one and I forgot, what was the second part of your question?

Jayson Bedford – Raymond James

More is it the LifeCell sales force or is that…

Catherine M. Burzik

Yes and so right now the sales force it is done, that's a great question too. The sales force is on this right now is Mike DelVacchio’s sales force. And one of things that we are currently, in discussion with is, about it what is the best sales force structure going forward if we have more and more of these operating room products, but we felt for this particular product because the knowledge of negative pressure was very, very important in teaching the surgeons about this that have made the most sense to have Mike’s sales forced involved with this. And it is not everyone of these that needs a Regenerative Medicine product, its only the ones that can't be close, which is a percentage of these, then the surgeon will be suturing in Strattice or AlloDerm.

Jayson Bedford – Raymond James

Fair. And just last question I will jump back in queue. On the restructuring program have you seen some of that – or did you see any of the benefits of it in the June quarter and then I guess what’s left to be done and will most of these savings be reflected in the gross margin line?

Martin J. Landon

So, you will see savings in both gross margin as well as G&A has, particularly as you talk about eliminating transactional processing costs. And have some of the savings been realized in the second quarter the answer of that is yes, but I would tell you there is a lot more work to be done in terms of globalization of transactional processing cost. So you'll see those things as we talked about over the two and a half years and some of them are technology enabled so you will see those things more towards the back-half of 2010 and into the first part of 2011. So certainly we see more opportunity there looking forward.

Catherine M. Burzik

Did that answer your question Jayson?

Jayson Bedford – Raymond James

It did. Thank you.

Catherine M. Burzik

You're welcome.

Operator

Your next question is from the line of Matt Miksic with Piper Jaffray.

Catherine M. Burzik

Hi Matt.

Matt Miksic – Piper Jaffray

Hi good morning. Thanks for taking our questions.

Catherine M. Burzik

Certainly.

Matt Miksic – Piper Jaffray

So first question just for Marty, you talked a little bit about the improvement in gross margins on mix and also, the service productivity. I was trying to get a sense of how that split out in cost of goods and then going forward, if we are going to see any of these margin benefits in SG&A as well as cost of goods if you could help us understand maybe what to expect here heading into the back half of the year?

Martin J. Landon

Yeah. So in the back half of the year, you'll continue to see as we continue to work on our service productivity and particularly we have done a lot of work in the U.S. and as we broaden that to be more global you will start to see some improvements there as well as on the G&A side, like I said there has been a portion of the value that's been realized, a lot of that came out of our first quarter reduction where we reduced headcount going forward, but there are a lot of process changes yet to come that will yield result on the SG&A side and in the areas of finance, HR, etc. So you will start to see some of that come through the G&A line as well. The timing of that, there will be some this year, but again the stuff that is technology enabled, we are doing the process work now, you are going to get real bank for your buck when you bring in the technology behind that and that we kind of see into the 2010 year. And that’s why I say if you look towards the back half of 2010 and into 2011, you are going to see us driving some additional results there. But as we go quarter-by-quarter, I would tell you that Cathy and I are pretty focused on this area. Particularly given the economic environment we are in, and just making sure that we manage the business, responsibly and we continue to drive earnings. So you will see it quarter-to-quarter there will be bumps along the way, as I say, because when you make change there are often times cost to go with it like when you closedown a service centre, but hopefully on the whole you realize benefit.

Matt Miksic – Piper Jaffray

Okay. And so in terms of the mix, should we think about the year-over-year impact of that since you've annualized LifeCell, should we think about maybe the mixed component of that being less significant in the back half, but sort of continued sequential improvements in margins, is that a fair way to think about it?

Martin J. Landon

I think, I would think in terms of being able to maintain or improve slightly the margins that we have to this point in the year. You’re going to see some comparative increases, because remember last year we had the step up of LifeCell inventory. So that that got amortized over the back half of the year. So you'll see on the gross profit line you’ll continue to see expansion there as that worked itself off as you get to the fourth quarter that will drop a little bit, but in terms of just thinking about KCI's margins I think we feel pretty comfortable the margin levels that we've got are sustainable.

Matt Miksic – Piper Jaffray

Great, that's helpful. And I think you mentioned in your remarks a couple of times this, the consignment program or some flexibility in terms of working with your hospital customers, can you talk about what you are seeing from cost addition, what, in other words how is competition, I think we all know, that they are coming at least from a pricing angle, but what are you seeing and how you're responding to that and maybe, what are some of the advantages that you have in terms of this flexibility as you deal with your customers?

Catherine M. Burzik

So, Matt it is Cathy. And I tried to outline that, in a lot of the remarks that I made, but, KCI has a long standing relationship with our customers and our customers really trust us as the therapy of choice to be able to move patients seamlessly from the hospital to other care settings. And as I've worked here now with our commercial organization its been clear that we just need to have more flexible ways of doing business with our customers we actually started this even before the economic turndown, the economic turn down has made it even more important that we find way to work with our customers globally. So we at KCI for a long time had only one business model rental, we probably now have, 10 different types of business models and relationships, its all aimed at and it’s a competitive advantage of ours, which, we hold pretty close to the chest here, exactly how these programs work, but, they're all aimed at making sure that there is the maximum number of therapy units in the hospital that the customers need, so that they can put them on the patients when they need to put them on the patients. And then importantly when they need to release those patients to go home, that there are V.A.C. units right there on the shelf that as soon as we get the okay from the insurance company that unit goes with the patient and goes home. So I mean it’s a whole combination of both kind of program, which we have worked very, very hard to further strengthen the relationship with the customers.

Matt Miksic – Piper Jaffray

Okay. So, flexibility in terms of consignments sort of maybe working capital and I guess I certainly understand some of the long standing customer relationships you have and the advantages that they bring. I think I do, but focusing more just on how you can respond to, the price element or the cost element of some of these smaller companies, are you also seeing a demand, I understand the vast majority of your V.A.C. revenues come from rental revenues. Is there any change in hospital demand or the interest among your customers to purchase units or is there still very much a rental market or you have seen any change there at all.

Catherine M. Burzik

So its, there are lot of questions in here all right. First, kind of let me backup and talk about the fact that, what the customers see in KCI, is they see value. And we talked about our family, then we talked about our budget impact model, we talked about the fact that we can show quantitative hard dollars and cents to hospitals and managed care organizations how V.A.C. Therapy saves them, V.A.C. save them dollars and there is no other company out there that has any evidence that they can do that. So, people could imitate us, but they don’t have the data. So we have the actual data that can go in and help the hospital understand, how they save, how they can save money utilizing V.A.C. therapy.

Matt Miksic – Piper Jaffray

Okay, but no change in demand for…

Catherine M. Burzik

And regarding the whole question on, sale versus rental you would be surprised that the vast majority of customers are more interested in renting the therapy than buying the therapy and it’s a lot and there is a very complex reason for this. I mean we make it so easy for the customers as far as, we keep track of where they're on the patients. We keep track of everything for them, and for those very few hospitals and there has been a few pilots, where we have tried sales. Some of them come back to rent, because it’s a lot easier when we manage it so there is not a huge pent-up demand around buying therapy units.

Matt Miksic – Piper Jaffray

Okay. Then I think that's, that I think I understand. I was just trying to get a sense of whether there is any, you're sensing any change, but it doesn't sound like you are?

Catherine M. Burzik

No, we are not sensing any change in that mode.

Matt Miksic – Piper Jaffray

And then the last thing just on, you mentioned couple of times competition and you're more often than not able to win these accounts back after evaluation when you, I'm just trying to get a sense of when you win them back, is this a matter of all or nothing or is this a matter of, you are taking back the vast majority of the business or, is it a binary win or loss are you finding that some of these hospitals are winding up with a dual source arrangement maybe for some of their less complex ones? Any color you could provide would be helpful?

Catherine M. Burzik

So, it is more of the kind of all or nothing. It becomes a issue of the total value, so, you typically would see this, where, comparing again, this is, we're asking a lot of questions here about the hospital environment, but, where a competitor will come in and replace one or two V.A.Cs where they would have gone on with the competitive product. The customers see that and then they have to try to understand, what can V.A.C. competitor offer them, we are beyond just a lower price standard therapy and then they come up with a situation where either the wound doesn't heal or the whole issue of meaning the transition the patient out into the home. So all those things that KCI has invested in, regarding the infrastructure is where we really, really shine I think and making it easy for the customers and I think Matt you know, I mean that's build-up over a decade that’s hundreds of millions of dollars worth of infrastructure and we have that. And so that is why, most customers switch back, I’m not going to say its 100%, there is certainly some customers out there that are using competitive product.

Matt Miksic – Piper Jaffray

Okay. No and I certainly I think everyone recognized that you have got the leadership in terms of developed, really creating this market, but is under some pressure. The last question; just on trends you did about 2% to 3% constant currency growth in North America here in V.A.C. in Q1, and then also again in Q2, do you feel like this you've sort of settled into a normalized sort of stable range or, how should we think about growth going forward, is this something you can improve on this year, is it something that maybe we improve on next year against this year's comps, any color you could provide?

Catherine M. Burzik

So we’ll talk Matt certainly about, our thinking strategically over the next several years at our Analyst Day in November. But I would say, from the line of sight, we have right now, for the last half of the year, we have tried to dial that into our estimates, we see the performance of the V.A.C business is being pretty stable at this point in time, and I look forward to upsides associated with the launch of these new products, which we expect to see the value from that come primarily beginning next year as this is really the year of the launch. So, I hope that that provides some color for you.

Matt Miksic – Piper Jaffray

It does. Thanks very much.

Catherine M. Burzik

You’re welcome.

Operator

And we have time for one more question. Your last question is from the line of Taylor Harris with JPMorgan.

Catherine M. Burzik

Hi, Taylor.

Taylor Harris – JPMorgan

Hey, Cathy. Thanks for fitting me in here. Just a few hopefully quick ones. Marty just to clarify on gross margin for the back half of the year, was your comment that it should be at the same level or above the second quarter gross margin or the blended first half of the year gross margin?

Martin J. Landon

So, again Taylor the conservative side of me would say certainly from the first half, just as we go through some of these changes there can be bumps along the way, but we feel pretty good about the margin that we achieved in the second quarter I guess around the second quarter the one comment I would make is there wasn't anything that I would say was unusual in that number so if that's helpful to you.

Taylor Harris – JPMorgan

Yeah, that's helpful. And then on the, you called out the Medicaid Payer Mix issue I guess just remind us how big of a percentage your home care business is Medicaid and what are you seeing the trend in that population being?

Catherine M. Burzik

So, when we talk about the mix its not just Medicaid, right it's Medicaid and it's Medicare and it is a movement to Medicare from Managed Care. So, there is Managed Medicare and then there is Medicaid right and so we see patients moving from Managed Medicare to Medicare and then we see, an absolute impact just in sheer end MPOs because of the unemployment situation. So as a whole blend of that, that ends up with the realized price being less that it has been. So, the Medicaid business is really relatively small, that we have ever disclosed, the Medicaid itself is not huge.

Martin J. Landon

On an overall basis its certainly smaller than Medicare, but when you take the government programs Medicare and Medicaid together you've got somewhere in the neighborhood of, particularly when you talk about pricing impacts, you get somewhere between 1% and 2% impact, 1% on a worldwide basis, 2% if you are thinking about domestic.

Taylor Harris – JPMorgan

Okay, great. And the impact of Strattice, Strattice is ramping very nicely can you just remind us how big of a gross margin premium do you realize on Strattice and then can you estimate for us how much do you think demand outstrips supply right now?

Catherine M. Burzik

We do, I don't know have we ever disclosed, this gross margins, I think we just indicated that our gross margins are higher associated with the porcine-based products and I think we've explained that that's due to the fact that we are able to process so many of the, heights together. So when you're talking about human based products its kind of one at a time, so we have a real efficiencies of scale in our new production facility. So the margins are definitely higher, when it comes to support the porcine-based products.

Martin J. Landon

And what was the last part of….

Catherine M. Burzik

Yeah. What was your second question Taylor?

Taylor Harris – JPMorgan

The second part was just any estimate on how much demand is outstripping supplier right now?

Catherine M. Burzik

That’s a very good question. I don't have Lisa here, but I would just tell you that generally the feeling is from the sales force that they can make, they can sell everything that the production organization can make and where the area of the biggest demand for, the very large sheaths and, the thing that LifeCell was able to accomplish, when we switch to the porcine-based where these large sheath, because you have so many of the huge challenging hernias, previously they had a suture individual pieces of AlloDerm together in order to work with, work to be able to close these large hernias. So, I would just say that the demand for large sheath is very robust.

Taylor Harris – JPMorgan

Okay. That’s great. And last question any sense of timing on when you'll hear about your request for a preliminary injunction against Smith & Nephew's foam product in the U.S.?

Stephen D. Seidel

Taylor, its Steve. I don't know if there is any way to predict that. Again the judge would ask for a couple of follow-up issues, he is I think looking for feedback from the patent office on kind of what were the re-exam stand and that’s working through we believe nicely, but again we don’t know how to predict when that would be, so I mean that could be later this summer into the fall when he rules and again he seems to be firm on the day, for the trial next February, which is obviously kind of the more important date that we are keeping our eyes on.

Taylor Harris – JPMorgan

Okay, very good. Thank you guys.

Martin J. Landon

Thanks.

Catherine M. Burzik

Thanks, thanks Taylor.

Operator

There are no more questions. Do you have any closing remarks?

Catherine M. Burzik

No, I just would like to thank everyone for joining our earnings call and have a nice day. Thank you.

Operator

This concludes today's conference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Kinetic Concepts, Inc. Q2 2009 Earnings Call Transcript
This Transcript
All Transcripts