Kinetic Concepts' CEO Discusses Q4 2010 Results - Earnings Call Transcript

Feb. 1.11 | About: Kinetic Concepts, (KCI)

Kinetic Concepts (NYSE:KCI)

Q4 2010 Earnings Call

February 01, 2011 8:30 am ET

Executives

Stephen Seidel -

Michael Genau - Global President of Active Healing Solutions

Martin Landon - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Cathy Burzik - Chief Executive Officer, President, Executive Director and Chairman of Technology Committee

Todd Wyatt - Vice President of Investor Relations

Analysts

Matthew Miksic - Piper Jaffray Companies

Michael Weinstein - JP Morgan Chase & Co

Christopher Cooley - Stephens Inc.

Tao Levy - Collins Stewart LLC

Lennox Ketner - BofA Merrill Lynch

Operator

Good morning. My name is Christie and I will be your conference operator today. At this time, I would like to welcome everyone to the KCI Fourth Quarter Year End 2010 Earnings Call. [Operator Instructions] Thank you. I will now turn the conference over to Mr. Todd Wyatt, Vice President of Investor Relations.

Todd Wyatt

Thank you, Christie. And welcome to the KCI Fourth Quarter and Fiscal Year 2010 Earnings Conference Call. Today, we will review the results that were announced in our press release earlier this morning. Today's webcast and conference call will include prepared remarks by Cathy Burzik, our President and Chief Executive Officer; and Marty Landon, our Chief Financial Officer. We are also 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 our corporate website at www.kci1.com. A replay of this webcast will be made available on our website shortly after the conclusion of the 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 and full year results discussed on this call may reflect various GAPP and non-GAAP financial measures. A reconciliation between the two is contained in our earnings release issued this morning. [Operator Instructions]

I would now like to turn the call over to Cathy Burzik, President and Chief Executive Officer of Kinetic Concepts.

Cathy Burzik

Thank you, Todd, and good morning, everyone. We appreciate your joining us to discuss our fourth quarter and fiscal year 2010 results. On today's call, I will review highlights of the fourth quarter and the fiscal year, and then review the performance of our three businesses, including an update on new products and strategic initiatives. Marty Landon will review financial results and provide our fiscal 2011 guidance. We will conclude with the question-and-answer session.

I'm pleased to report that we ended the year on a positive note, with our U.S. AHS business demonstrating continued resilience and our Regenerative Medicine business continuing to deliver exceptionally strong growth. Our focus on investments in our key strategic initiative has been instrumental and positions us well for 2011 and beyond. For example, in our AHS business, the launch of V.A.C. Therapy in Japan continues to ramp up, and our new product introductions are gaining momentum throughout North America and Europe. Likewise, in our Regenerative Medicine business, investments in commercial initiatives, prospective clinical studies and the launch of new applications in new geographies are showing tangible results.

In the fourth quarter, total worldwide revenue of approximately $527 million was comparable to Q4 '09 on an as-reported basis and grew approximately 1% on a constant currency basis. Net earnings per diluted share on a fully reported or GAAP basis were $1.03 per share for the quarter compared to the $0.93 per share in the same period last year, an increase of 11%. EPS on an adjusted non-GAAP basis was $1.17, an increase of approximately 6% versus the prior-year quarter.

Fiscal year 2010 revenues totaled $2.02 billion, up 1% compared to revenues of $1.99 billion in the prior year. Diluted EPS on a GAAP basis was $3.50 per share, reflecting an increase of 10% over fiscal 2009 results. EPS on an adjusted non-GAAP basis was $4.29, reflecting growth of 8% versus fiscal 2009.

I will now speak briefly about some of the key highlights since our last call. Our Regenerative Medicine business, LifeCell, accelerated growth to 22% in Q4, driven mainly by strong performance from our core applications of challenging hernia repair and breast reconstruction. At the American College of Surgeons, we released 12-month data from our R.I.C.H study, a prospective multicenter study of challenging hernias, and our R.I.C.H. study had very favorable results.

We saw continued resilience in the U.S. Active Healing Solutions business, with strong order growth across the business. We recorded a 2% increase in North America revenues. Our AHS business in Japan exceeded our budget for the year as the market there is embracing V.A.C. Therapy. We completed our customer preference trial for V.A.C.VIA and are very excited to announce that we began our global launch of VIA today. And in TSS, we announced the acquisition of TechniMotion Medical's innovative patient handling system, which will be an important addition to our TSS portfolio.

Let me turn now to a review of our fourth quarter performance by business segment. All revenue growth rates will be stated in terms of constant currency figures, unless otherwise noted. In our AHS business, global revenue grew 1% year-over-year and 2% sequentially in Q4. In North America, AHS revenue, which includes the U.S., Canada and Latin America, improved 2% compared to last year's quarter. In the U.S. business, revenues increased 1% year-over-year. Pricing was down approximately 1%, and this was offset entirely by improved volume. Importantly, we met our objective of hiring over 100 new sales and support professionals for our AHS U.S. business by end of 2010, positioning us well for 2011.

In the EMEA/APAC AHS market, revenue was down approximately 2%, driven entirely by continued weakness in the EMEA region. In EMEA, AHS revenue declined 7% year-over-year. The decline was due equally to continued pricing pressure and a decline in disposable volume. Most European countries are facing healthcare budget constraints resulting from austerity measures. These financial constraints, coupled with competitive pressures, negatively impacted our EMEA results. We expect these headwinds to continue through 2011.

Turning now to Asia. Japan remains a large growth opportunity for our business, and we exceeded our revenue budget for the year. We remain focused on building our commercial operations and hiring additional sales reps in Japan. The expansion of our sales force remains a gating factor in our ability to reach the increasing number of accounts and geographies that are voicing a strong interest in using KCI's V.A.C. Therapy. We expect that Japan revenue will be in excess of $20 million in 2011.

Our efforts to expand operations in both China and India continued in the fourth quarter. While it is still early in both these countries, we are committed to offer V.A.C. Therapy in these two clearly substantial and growing markets.

Now let me provide an update on our new AHS products. I'm going to start with V.A.C.VIA, our single-patient use, negative pressure wound therapy product that we launched today. VIA is the only NPWT product of its kind that is built with our proprietary boarded [ph] pump technology, which enables its miniaturization and virtually silent operation. I continue to believe that V.A.C.VIA is the most revolutionary product in NPWT since the initial introduction of V.A.C. Therapy in the mid-1990s.

In the fourth quarter, we completed customer preference trials on over 100 patients in four key countries. The intent of these trials is to help us learn more about the way doctors and facilities view V.A.C.VIA compared to traditional V.A.C. Therapy, including but not limited to the length of use, applicable wounds and outcome. And I'm pleased to report the clinician test consistently reported very positive outcome with V.A.C.VIA.

Finally, our negative pressure surgical management, NPSM product group. Another exciting growth opportunity for our business performed well in Q4 with revenue on an annualized run rate of over $25 million. Our NPSM group is represented by ABThera, our system for the active management of open abdominal wounds, and Prevena, our novel negative-pressure based technology designed to reduce infection and dehiscence in surgical incisions.

Let me turn now to our Regenerative Medicine business, LifeCell. Our LifeCell business reported an acceleration in the year-over-year growth rate from the third quarter. With record fourth quarter revenues of $94 million, this reflects an increase of 22% versus the prior-year quarter. Strattice grew an impressive 48% over Q4 '09 and now comprises 43% of revenue. Strattice is now on an annual run rate of $160 million in revenue and is the clear biologic of choice for challenging hernia repair due to its superb clinical performance.

In North America, AlloDerm and Strattice delivered a combined increase of 21% over last year, driven by continued growth of both breast reconstruction and challenging hernia repair application. The sales force expansion in January 2010 and the recent release of the favorable R.I.C.H study clinical data helped bolster fourth quarter performance. Our new applications of Strattice, namely stoma reinforcement and breast plastic surgery contributed to the strong quarterly performance. As surgeons see the value of Strattice in these applications, we expect the utilization will continue to increase, driving revenue growth.

In Europe, our LifeCell business achieved strong revenue growth as demand for Strattice for breast reconstruction and challenging hernia repair improved sequentially, even as the economy there remains challenged. Overall, Europe contributed approximately 2% of the overall LifeCell revenue growth for Q4. We were pleased with the ramp of LifeCell in the U.K. and Germany where Strattice acceptance is growing. And we're making steady progress in other European countries and expect to see momentum strengthen in 2011 as the productivity of our European sales force improves and gains traction in these newer markets.

From a LifeCell new product perspective, we look forward to launches of new applications of Strattice, for example, hiatal and inguinal hernia in 2011. And importantly, we have the guidance to pilot a new formulation of AlloDerm that is ready to use. We anticipate that this product will be well received by the market, and we are planning a full launch in 2012.

I'm very enthusiastic about the potential of our recent sales and marketing agreement for the distribution of Novadaq Technologies' SPY System. The system specifically designed for plastic surgeons, mainly the SPY Elite [ph] tissue perfusion assessment system, has been well received by surgeons, and was launched at our sales meeting two weeks ago. This SPY Elite [ph] system enables surgeons to see blood perfusion in tissue during surgical procedures, allowing them to adjust their surgical approach realtime before the patient leaves the operating room.

Now turning to our TSS business. In the fourth quarter, TSS had a difficult comparison to the prior-year period, which saw a substantial H1N1 flu outbreak that resulted in unprecedented use of RotoProne therapy. This trend did not repeat in Q4 of 2010, which saw a weaker flu season. Additionally, lower hospital intensive trends negatively affected TSS as rental revenue and existing accounts decreased year-over-year.

In the fourth quarter, we redeployed our North American TSS sales force in order to gain focus on key markets and key accounts. The redeployment will allow us to more effectively support our existing accounts and give us the infrastructure needed to support the introduction of new product. And from a TSS new product perspective, we are making improvements in several parts of our portfolio. In Q4, we launched the Skin IQ Microclimate Manager. Skin IQ is a brand new therapeutic surface approach for the prevention and management of pressure ulcers.

Also, we recently announced the acquisition of assets and intellectual property of TechniMotion Medical related to an innovative and ergonomic patient handling system for use in the acute and post-acute care settings. These products, which will start launching in mid-2011, will be an important addition to our portfolio. And finally, we continue to evaluate our current products for opportunities to improve our offerings for our customers. During 2011, we plan to launch additional products within our TSS wound care and bariatric segments.

I will now turn the call over to Marty Landon to review our financial performance for the quarter and to speak to 2011 guidance. Marty?

Martin Landon

Thank you, Cathy, and good morning, everyone. Total revenue for the fourth quarter of 2010 was $527.5 million, up slightly from the $526.8 million reported for the same quarter one year ago but with varying dynamics, as Cathy has just described. Excluding the effects of foreign currency exchange rate movements, fourth quarter 2010 revenue increased approximately 1% year-to-year as foreign currency exchange represented a slight headwind for us in the quarter.

Fourth quarter 2010 net earnings per diluted share on a fully reported or GAAP basis were $1.03 per share compared to $0.93 per share we reported for the same quarter last year, an increase of 11%. Our EPS growth in the quarter reflected stable operating metrics to what was a strong 2009 fourth quarter, consistent metrics to the third quarter of this year and improving financial leverage within the business. Our adjusted non-GAAP earnings per share were $1.17 per share, up from $1.10 reported for the same period of 2009, an increase of $0.07 or 6%.

For your convenience, we have provided a reconciliation of GAAP to adjusted non-GAAP earnings per share in today's release. For the full year, revenues of $2.02 billion rose 1.3% on both a reported and constant currency basis. Full year 2010 GAAP diluted earnings per share totaled $3.57 versus $3.24 in 2009, representing a 10% improvement while non-GAAP adjusted EPS of $4.29 improved 8% from $3.99 in the prior year.

Returning to the quarter, in our AHS business segment, fourth quarter revenue of $367.1 million was essentially flat from the prior-year period on a reported basis while up approximately 1% on a constant currency basis. Worldwide AHS revenue improved over 2% from the third quarter of 2010, continuing the improvement from weaker trends we experienced in the first half of 2010. This improvement was largely fueled by increases in our North American region, including the U.S., Canada and Latin America as fourth quarter revenue in the region rose 2% over the prior year on higher volumes, offset partially by approximately 1% decrease in prices.

In the EMEA/APAC region, Asia's revenue was $87.7 million, a decrease of 6% on a reported basis and a decline of 2% on a constant currency basis. As Cathy mentioned, this fourth quarter decline in EMEA/APAC AHS revenue was fully attributable to the EMEA region as continued pricing pressure and lower volumes resulted from increased healthcare austerity spending measures and continued competition across Europe. The decrease in EMEA was partly offset by strong demand in unit growth in Asia-Pacific, particularly in Japan, driven by our early success in introducing V.A.C. Therapy to this new and important market.

Regenerative Medicine had another record quarter, with revenue for the three months ended December 2010 reaching $93.7 million. This represents a 22% increase from the same period last year on both a reported and constant currency basis and a robust 10% improvement sequentially. This increase was driven by continued penetration into the core applications, challenging hernia repair and breast reconstruction, new applications and continued penetration in the European market. As Cathy mentioned, the compelling study result from our infected hernia clinical trial have bolstered our sales efforts.

Offsetting this revenue growth, we experienced a 19% decrease in TSS revenue for the fourth quarter of 2010 compared to the year-ago period. As of last quarter, the decline resulted largely from lower rental volumes globally, driven by lower influenza rates in 2010 versus the prior year, namely H1N1 and reduced rental revenue in existing accounts. Gross profit for the quarter was $301.3 million, resulting in a gross margin of 57.1% for the second straight quarter. Gross margins were in line with our expectations, given the underlying expenses associated with the expansion of our AHS sales force. Our Q4 gross margin was approximately 80 basis points lower than the year ago quarter due primarily due to higher selling costs, higher royalty rates and lower critical care rental volume in TSS, partially offset by a higher gross margins associated with the LifeCell business.

The higher royalty rates resulted from our lower V.A.C. legal costs, which are shared with Wake Forest and are netted against our overall licensing fee payments. SG&A expenses for the fourth quarter were $146.1 million, representing a slight decrease from $147.5 million for the same period of 2009. SG&A costs continue to reflect our investments in the expansion of V.A.C. into the Japanese market and LifeCell growth in the U.S. and its expansion into EMEA, offset by lower spending in shared service functions.

Research and development expense of $22.9 million was down 5% from the prior year but up 10% sequentially, consistent with our plans. The majority of this decrease over the prior year period was due to the timing of certain programs and activities, and therefore, was temporary in nature. For the full year, our R&D spending is approximated 4 1/2% of revenue, and we would expect R&D spending to increase in 2011.

Operating profit for the fourth quarter of 2010 was $123.5 million versus $123.3 million in the same period last year. Despite the year-over-year decline in gross margin, our Q4 operating margin of 23.4% was comparable to last year's as we continue to drive operational improvements while still investing in our strategic initiatives. Below the operating line, we again delivered strong financial leverage in the quarter, with interest expense of $19.7 million down 20% or $4.8 million versus last year's fourth quarter due to our accelerated debt repayment program and lower interest rates. During fiscal 2010, we repaid almost $225 million of our debt in both scheduled and voluntary debt repayments.

The fourth quarter effective tax rate was 28% compared to 32.9% in the prior-year period. The lower effective tax rate relative to last year was a function of a higher percentage of taxable income being generated in lower tax jurisdictions and the benefit associated with the extension of the U.S. R&D tax credit provision. Regarding our balance sheet, our financial position was strong with year-end cash balance at $316.6 million, a 20% increase over last year. We made scheduled debt payments on our term A bank facility totaling $38 million in the quarter. At the end of 2010, our total debt on an economic instrument basis was $1.2 billion or approximately 1.9x our trailing 12 months EBITDA, which is down from leverage of around 3x EBITDA at the time of our LifeCell acquisition in 2008.

As you probably know, early this year, we put in place a new larger credit facility that positions us well to execute on our strategic plan going forward. Specifically, we refinanced our term A debt at favorable rates that will be anywhere from 50 to 125 basis points lower than our prior facility depending on leverage levels. In addition, we substantially increased our revolver to $650 million from $300 million previously and provided for an additional accordion feature of $500 million. All in, we now have access to about $1.2 billion in available borrowing capacity, which will be used for strategic and general corporate purposes.

Turning to our cash flows. Operating cash flow less net capital expenditures was $275.4 million for the 12 months ended December 2010 versus $292.7 million in fiscal 2009, a contraction of approximately $17 million, principally due to our previously announced efforts to increase inventory of our biologic products in order to meet the growing demand for our AlloDerm and Strattice tissue matrices. We also paid higher cash taxes in 2010 due to various timing issues. These working capital increases were partially offset by higher net earnings, improved cash collections and reduced capital expenditures. Accounts receivable days outstanding improved 3% from the prior-year period as we continue to work hard at improving our billing and customer-service operations.

Regarding our cash balance and in light of our recent refinancing, our priorities for cash remain focused on supporting the growth initiatives within our existing businesses and particularly supporting business development activities underway in each business to further diversify our sources of revenue and earnings growth, paying down our debt over time and, to the extent we have excess free cash, repurchasing shares opportunistically.

Now turning forward. In today's release, we announced our fiscal 2011 financial guidance. For the full year, we expect our revenue to be in the range of $2.05 billion to $2.09 billion, implying reported growth of 2% to 4%. Our revenue guidance reflects the business dynamics we've been discussing over the past few quarters, including considerations of economic challenges, particularly in Europe and competitive factors mainly resulting in modest pricing pressure in AHS. Within AHS, these negative factors will be offset by growth from geographic expansion and new product introductions leading to a flat to low single-digit growth rate.

Revenue from our Regenerative Medicine segment is expected to continue growing in the mid to high teens range, which will favorably impact our gross margins. Also we have assumed average currency rates compared to 2010. Our guidance for reported or GAAP diluted earnings per share is $3.82 to $3.96, implying growth of approximately 7% to 11%. Non-GAAP earnings per share is forecast at $4.45 to $4.61, or growth of approximately 47%. The non-GAAP EPS guidance includes, among other things, restructuring and other charges related to the loan issuance write off associated with the new credit facility and employee separation costs related to our global business transformation project.

Continued business mix improvements in operating efficiencies will allow us to fund our organic growth investments while expanding full-year margin slightly. This, combined with continue deleveraging, should result in higher net earnings. To assist you with your modeling and provide a consistent basis of comparison, we've included a reconciliation to the adjusted earnings per share in this morning's press release.

While we do not provide quarterly guidance, I would like to remind you that we would expect to repeat the historical pattern of a sequential dip in first quarter revenues from the preceding fourth quarter. Over the past two years, first quarter revenues have generally accounted for approximately 23% to 24% of the fiscal year total revenues, and we expect Q1 2011 to follow a similar pattern.

Despite the sequential decline in first quarter revenues, we expect spending on rental or field expenses to remain roughly comparable to the 2010 fourth quarter, particularly as we normally incur a higher level of operating expenses in the first quarter as a percent of revenue due largely to our investment in the sales force and continued investments in strategic initiatives such as Japan and the EMEA expansion for LifeCell.

And with that, I'll turn the call back to Cathy for concluding comments. Cathy?

Cathy Burzik

Thanks, Marty. And before opening the lines for questions, let me leave you with a few comments on 2011. In 2011, we plan to accelerate our revenue growth by growing in the 2% to 4% range as Marty just described. Regarding our global Active Healing Solutions business, in the U.S., we see clear signs that revenue growth in AHS has returned, albeit modestly. In Europe, we expect economic pressures will continue at the current level. While the global V.A.C. market remains competitive, we continue to differentiate ourselves with flexible customer programs and superior customer support, coupled with a differentiated and expanding product portfolio. And we are very excited about the potential we see for the V.A.C.VIA platform to broaden access to V.A.C. Therapy. We anticipate our investments in the development of Japan and other markets, plus continued uptake of new products, will contribute to modest growth in 2011. I fully believe that the peak-leading [ph] TSS is moving in the right direction. And as we move through 2011, we expect the TSS business performance to improve.

Our expectations for our Regenerative Medicine LifeCell business remain robust, and we are confident in our ability to achieve mid to high teens growth through continued strength in the core business, our launch of new products and applications and increasing penetration in Europe.

And finally, let me make a statement with regards to Wake Forest patent. In light of the most recent court ruling, as well as the rulings outside the U.S., KCI believes the continued payment of the royalty schedule under the original Wake Forest license agreement is inappropriate, and we are pursuing various alternatives related to this situation.

As we said, we have been and are in discussions with the University. There are many and various issues related to these discussions, some of which are patent related and some of which are contract related. And therefore, we think it best to not comment at this time.

And now with that, I will ask the operator to open the call for questions. Thanks, Christie.

Question-and-Answer Session

Operator

[Operator Instructions] Your next question comes from the line of Lennox Ketner of Bank of America.

Lennox Ketner - BofA Merrill Lynch

I want to start on the 2011 guidance. There's a few areas where it looks like it might be conservative to me, and I just wanted to follow up and make sure I'm thinking about it right. First, it seems like you're not assuming that you do anything with your cash. Is that a fair assumption? Or are you assuming that you'd pay down debt? Or anything along those lines?

Martin Landon

I think, Lennox, at this point in time, with the number of initiatives we have going on internally, we don't have major movements of cash so that we are able to execute on actual business development items as they arise and/or investments in various parts of the core. So that's correct.

Lennox Ketner - BofA Merrill Lynch

So to the extent that you did pay down debt or buy back shares, that would be upside.

Martin Landon

Correct.

Lennox Ketner - BofA Merrill Lynch

And then just on the revenue side, if I use -- I have to use the low end of the ranges that you gave for each business segment to get to kind of the midpoint of your guidance. Are you just being conservative there and assuming the low end of the ranges? Or I'm not sure if I'm missing something.

Cathy Burzik

Lennox, just a little bit of color on this. As Marty and I talked about, there are certainly still headwinds that I think all of us face in medical device industry about a whole global economic recovery, particularly the situation that we see in Europe and the austerity measures there. Certainly competition coming into the marketplace. When you take a look at all of these factors, and then obviously, we're very excited about our new product launches, so this is always some of both of an art and a science in how you put together your guidance. So we've put guidance in that we feel good about being able to make for the year.

Lennox Ketner - BofA Merrill Lynch

And then my last question is just on the V.A.C.VIA, I know you said you launched that today. I'm wondering if you could just talk a little bit about kind of the patient population that you're targeting with the V.A.C.VIA. And also just looking forward, assuming the main concerns that people have had about the negative pressure market is the potential impact of competitive bidding. And I'm just wondering as you move forward, given that V.A.C.VIA's a disposable product, to the extent that you're able to move your business over to V.A.C.VIA or other disposable products, is it fair to assume that those products would actually be immune from competitive bidding since they're not durable medical equipment?

Cathy Burzik

First, I'm always delighted to talk about V.A.C.VIA, and I have continued to remind people that is the most revolutionary product since Negative Pressure Wound Therapy V.A.C. Therapy was invented in the mid-1990's. As you know, the whole question about Negative Pressure Wound Therapy, and about a V.A.C in particular, is always one of access. There are many, many more Negative Pressure Wound Therapy V.A.C.-able wounds than we're able to get back to today for a wide variety of reasons. And we see the user friendliness and accessibility of V.A.C.VIA as an opportunity to go places were V.A.C. has not gone. Now there will also be some amount of cannibalization of the current V.A.C. business, which we totally expect. And we've plan for that. But I'm very excited to think about the opportunity of how we now get increase the access of V.A.C. Therapy in places like the emergency room, the operating room, supply cabinets in various hospitals and wound care clinics and doctors' offices, places where it just has not been easy to get the rental units consigned into all these various locations. And there's always the issue of the cost of all of those rental units. And so this is a new way of doing business. It's a new product. It's a new business model. And your question about competitive bidding is also a good question. Right now, the competitive bidding environment that CMS is executing is one for durable medical equipment, DME. VIA is not a DME. V.A.C. Therapy is a DME. We obviously have some time here before we have to put our bid in as we think about -- and we don't even know for sure that Negative Pressure Wound Therapy will be part of competitive bidding. But if it is, right now, it would be a rental prospect. We have an opportunity with VIA and we have longer-life VIAs planned. The current VIA is seven; we have 14-day and 20-day VIAs under development. And these provide an opportunity for us to approach insurance companies with a new way of reimbursement. Now that is going to require clinical studies and it's going to require data, but KCI is well prepared and planning to execute these to go forward and see if we can get V.A.C. Therapy reimbursed in a different way.

Lennox Ketner - BofA Merrill Lynch

On the Wake Forest royalties, I know you said you don't really want to comment further on that, but I just want to clarify your comments on it. I know in the past, you've talked about potentially reducing those royalties, but it sounds like now your position is that you don't think you should be paying them at all. Is that a fair statement?

Cathy Burzik

I said I'm not going to comment too much on this, Lennox. We don't know not exactly where the discussions with Wake Forest are going to end up, and we see there being a whole range of options here. So I wouldn't assume one thing versus another.

Operator

Your next question comes from the line of Tao Levy of Collins Stewart.

Tao Levy - Collins Stewart LLC

I do want to touch just on the Wake Forest, one clarification. Since you're planning to renegotiate that or are in discussions with Wake Forest, does that mean you're not going to appeal the district court decision?

Cathy Burzik

So let me just give a little bit of commentary on that, Tao. We don't see the appeal and any discussions regarding royalty as mutually exclusive. We believe that should we choose to proceed with an appeal, we can do that at same time we can continue the discussions about the royalty rates.

Tao Levy - Collins Stewart LLC

So one doesn't sort of, even though the appeal might make several -- and then if you give us some color -- before, in the last few quarters, you provided some kind of color in terms of your expectations of how some of the new products would perform throughout the year. Do you have any sense on Prevena and ABThera for 2011? I know VIA is obviously still very early.

Cathy Burzik

So we talked about, Tao, that fact that we exited the year at a $25 million run rate as we exited December. So you can assume that we're going to improve on that run rate through this coming year. And I would also say, regarding VIA, I would like to be in a position and our plan is to stay in a position that by the end of 2011, about 10% of our acute revenue would be coming from VIA.

Tao Levy - Collins Stewart LLC

And then just lastly, you indicated that the HS in North America was up 1%. Is that growth exclusively coming from new products? And basically, what I'm trying to figure out is how did the core V.A.C. product perform in North America? Was that -- I assume that was flat to down a bit.

Cathy Burzik

I'll just give you a tiny bit of color. Marty's welcome, or Mike, to jump in. But if you look at acute, post-acute and you parse it out, we had volume growth in both acute and post-acute. And some of that was offset by some pricing pressure. So that's volume growth in the core V.A.C. business. And then on top of it, we obviously had strong placements of our Prevena product and our Thera product as moved through the quarter. Is that fair, Mike?

Michael Genau

Yes, I think that represents it well. We're seeing still very strong activity with our core business in spite of some of the length of therapy challenges and it's complemented as we expand in new markets with our negative pressure surgical management products like you pointed out with ABThera and Prevena.

Operator

Your next question comes from the line of Chris Cooley of Stephens Inc.

Christopher Cooley - Stephens Inc.

If I may, could you I guess just kind of help us a little bit in looking at the guidance, particularly as it pertains to AHS for 2011, maybe help us just think about how much of that growth, the 2% to 4%, comes from new product, geographic expansion and just traditional business and the growth in the core business? Just kind of looking back through this again, I guess much like Lennox, I'm having a little bit of difficulty just in terms of thinking about how it is limited to that range if you're already at $20 million in Japan. And then just as a follow up, could you maybe address just the TSS business? We've looked at two of your peers in that space here in the fourth calendar quarter. And help us think about with your higher rental concentration, greater growth in bariatrics, how that business structurally is still at such a disparity to two those peers. What I'm asking her is, can that business really get back to kind of a negative five, low single-digit type growth rate in this year or is that aggressive?

Cathy Burzik

Let me try to give a little bit of color on AHS. And it's always a balance here, and I think everyone in the phone is familiar with our AHS business. So as we look at our core business that we have today, we obviously have challenges on that core business. And we're offsetting those challenges through geographical growth. And as I talked about, we would expect Japan to contribute $20 million towards the growth of AHS, at least during 2011. And we expect the new products to contribute, and we expect VIA to contribute. And obviously, what we look for here is how do those new products offset some amount of modest contraction in the core business. And that's what we talked about on Analysts Day, and that's the way we continue to think about it. So we gave guidance here in the flat to low single-digit. We obviously hope to do better than that. But we thought that was the best balanced judgment that we have for Mike's business going into the year. And regarding TSS, I'm sorry, Chris, you're very kind of faint on this call. I tried to make it louder, but I wasn't sure exactly what you were asking around TSS.

Christopher Cooley - Stephens Inc.

I'm just asking if anything has to change structurally when we think about the TSS franchise. I mean, when you look at it comparatively versus your two largest peers in the quarter even though you have a higher rental business, you have higher growth in bariatrics, there's a pretty wide disparity there in terms of the performance. Help us think about what transitions in 2011 that enables you to get back to that kind of low single-digit decline on a year-over-year basis. Or is that too aggressive?

Cathy Burzik

So the way I think about this, Chris, is we see the first couple quarters continually challenging. We see the business for TSS improving in the second half of the year. What distinguishes KPI continuously is our high dependence on the rental business. And as you see Steve introduce things like the lift in the patient mobility systems that we'll get from TechniMotion Medical in the middle of this year and a continual shift in our platform to beds that can be not just rental beds but also capital beds, we think that we will have a structural change there to our product portfolio that is more attractive to customers. And Steve Seidel is on the phone from Italy where he's visiting customers. Steve, maybe you'd like to clarify a bit.

Stephen Seidel

Yes, I think it's the right question. I believe the main answer is portfolio. I think as we introduce new products over the course of the year, some of that will depend on the level of uptake on those new products. But again, we feel very good about Skin IQ. We feel that the TechniMotion portfolio, that again is in development stage, some were released in the middle of the year are very promising products. And again, some of the other products in our AtmosAir line and others that we're looking at will be available to be both rented and sold. So I think you'll see us improving our mix between what's rental and what's sale. And obviously, the new frame products in the future will be important to us.

Operator

Your next question comes from the line of Mike Weinstein of JP Morgan.

Michael Weinstein - JP Morgan Chase & Co

So if I understand your 2011 guidance, the assumption on the base V.A.C. business, does that contract, let's say, low single digits in the U.S., but you offset that with all of the various new product launches you were touching on earlier? A fair summary?

Cathy Burzik

So Mike, I'd be careful on that here. The big pressure we see on the core V.A.C. business right now is in Europe.

Michael Weinstein - JP Morgan Chase & Co

Yes, I understand that. But just trying to understand your...

Cathy Burzik

That increased this year. So I think you could see some modest amount of impact on the U.S. business. But the U.S. business is pretty stable. We see the growth obviously as we ramp up with Prevena and VIA and ABThera, and then you see also the growth we have in Japan, China and India. So you see that in the U.S., we have similar to what you saw this quarter, we have volume increase with some modest amount of price pressure built into the plan.

Michael Weinstein - JP Morgan Chase & Co

So make sure I'm understanding; but this quarter, if I looked at the North American V.A.C. business, if my math was right, was x the new product launches was down about 1%, right? And then your guidance for 2011 would seem to imply basically something very similar to what we saw this quarter, unless my math is wrong.

Martin Landon

So Mike, this is Marty. First of all, many of those new product launches are global, so they're in both the North American and the EMEA/APAC numbers. But secondarily, the U.S. business overall, a combination of those things was up during the period. As we said, that overall volumes were up about 2% and the net price decrease was about 1%. So that netted you out at about 1% in the U.S.

Michael Weinstein - JP Morgan Chase & Co

I'm just looking at your North American reported numbers.

Cathy Burzik

So North America includes Latin America, it includes Canada. The way the numbers roll up right now, it includes Latin America, Canada and the U.S. So Marty just gave you the color on the U.S. And we would be thinking about the U.S. performance similar to what we saw in the fourth quarter. We have strong order growth across all care settings, and some of that offset by -- so we have good volumes, but some of that offset by length of therapy.

Michael Weinstein - JP Morgan Chase & Co

But, Cathy, let me just follow up the question on the services business there. You're expecting that you'll get paths [ph] and you'll start to anniversary some of these comps and that growth won't look as bad as we go through the second half of the year. If that doesn't play out, if you continue to lose market share and the businesses is declining at an accelerated rate, what's plan B?

Cathy Burzik

So I think, Mike, we always have discussions about all of our business segments at the management level and at the board level. I remain confident that Steve and his team are going to execute. The number of changes we've made in TSS over the course of 2010 have been dramatic in terms of changing leadership in the sales organizations in the U.S. and Europe. Steve himself moving very strong people into the R&D organization as well as some restructuring in service. So I think -- and the acquisition, as you see, of TechniMotion. So I want to convey on the call here that we feel good about the TSS business. Obviously, like all businesses, we look for long-term sustainability. But right now, we like what we see.

Michael Weinstein - JP Morgan Chase & Co

Then I want to make sure I understand how you're thinking about M&A in 2011, and I think this may fit into the context of people's questions on Wake Forest and potential royalty reduction there. But also I saw in the, I think it was in the 8-K this morning, there was an announcement of your amended credit facility and the increase in the size of that facility. All this seems to be playing together, where it seems like maybe your appetite for acquisitions is increasing as you've pay down the debt from a couple years ago. And are we setting up for 2011, which is going to be very active on the acquisition front for KCI?

Cathy Burzik

Well, I think you're going to see, just as we announced yesterday, the deal with Wright Medical. You've seen us announce Novadaq; you've seen us announce the TechniMotion deal. So you're kind of seeing now all three of our business segments and the leadership there starting to really build M&A pipelines, which are going to incorporate things like these licensing agreements as well as acquisitions. And then clearly, Marty and I and Adam [Rodriguez] and the Business Development team are looking for other potential legs on the stool, so to speak, for the company. So yes, I have fully, as you know, I'm committed to diversification as one of the long-term strategies for the company. So we're not going to do anything silly here. But clearly, we're in a position where I feel the businesses are now on solid ground and people are trying to look at what kinds of diversifications makes sense.

Martin Landon

Yes, I think it's very consistent with the strategy that we've laid out for the business and we've been talking about, right. Innovation in the business to give you organic growth, geographic expansion to give you organic growth, but at the same time, recognizing that it makes sense to further diversify the sources of growth. And so it's been our strategy for the last few years. I mean Cathy brought that with her when she came to the company. I think it's very consistent with where we've been going. Of course, you've got to position yourself well to do those things and you got to do things in a certain order. So I think what we've done, best I can tell, is prepare ourselves to be opportunistic when the right opportunities come around.

Michael Weinstein - JP Morgan Chase & Co

So the increase in the credit facility, I think it was $300 million; you took it up to $650 million. Is that in anticipation of something?

Cathy Burzik

I think it's, as Marty talked about, a variety of corporate-related things as well as business unit-related things. So we think it's some dry powder that we hope to use as the year goes on.

Operator

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

Matthew Miksic - Piper Jaffray Companies

So I just want to follow up on some of the questions on V.A.C.VIA. I know, Cathy, it's your favorite subject. I just wanted see your comment on data and what's going to be required. If this is going to penetrate the acute setting as you described or is it really more of a transitional product to the home setting? I know the product itself, it seems to be set up to target lower acuity wounds. So maybe just, this is a two part question. The first on, what kind of data do you think you will need? Is the product that different that you needed a new set of data to get paid for it or get adoption moving? And then the second is maybe something about the size of this lower acuity segment.

Cathy Burzik

Okay, I'm happy to talk about that. And all of KCI's my favorite topic, not just V.A.C.VIA, but I do really like the idea of V.A.C.VIA. Your question about data in acute, the data that we wanted in acute was really these customer preference trials, which we've executed through. Mike's team's done a good job at this over the fourth quarter. They have, what, about 120, 130 -- over 150 what we call customer preference trials. And we wanted to just make sure that the unit performed as V.A.C. performed. And yes, it is targeted towards the lower exudating wounds. But I can tell you, these customer trials pushed the limits on that. So we continue to feel around 30% to 40% of the wounds in the hospital acute segment are going to be able to be treated with V.A.C.VIA. We also think that there is a large expansion opportunity here because as much as you'd like to believe that every hospital, every wound in every hospital gets a V.A.C. today, there are a lot of wounds in hospitals that for a wide variety of reasons, they never bother to get the V.A.C. out of consignment to put on the patient, and we think this whole accessibility issue gets solved with VIA. We're also finding both in the U.S. and in Europe, where in Europe, we don't have a big home business at all. This idea of transitioning out of the hospital and lowering the cost of the hospital stay, getting the patient into their own home, and then even having the patient come back to the hospital outpatient to get the dressing changed, is the model that we saw countries in Europe start to adopt. My comment here around data, the data that I'm talking about mostly is to get into the post-acute setting and what it's going to take us to work with Managed Care Organizations, as well as CMS, to collect the data here to make an argument that there is another way to do business rather than just the rental model. So that's what we'll start to work on now. But the first focus of VIA is to have it launched into the hospital segment.

Matthew Miksic - Piper Jaffray Companies

And then the clinicians' motivation for taking a traditional V.A.C. approach versus the V.A.C.VIA, how do you think about their decision I guess to use V.A.C.VIA or traditional V.A.C. in the hospital?

Cathy Burzik

Well, obviously, this is all going to take some time. I think ultimately, where the clinician's going to make their decision will be the convenience factor. I mean, if there's VIA sitting in an operating room, we think it's highly more likely that the doctor will say, "Who knows?", that V.A.C. could be utilized that they would grab, unless it's a super highly exudating wound, they'll grab a VIA and put it on the wound. Today, if it's a super exudating wound, they end up having to call a WOCN and have it released from consignment. So that's the way we think about it.

Matthew Miksic - Piper Jaffray Companies

So a little faster. And then the cost side is to the hospital and to you, I guess, the revenue side, do you care which way they go? How the pricing or the revenue is different?

Cathy Burzik

So the actual revenue itself, we see at a per day therapy as comparable. So the price the hospital would pay us is comparable to what we would get today on a per day basis. But the costs associated with the management of the V.A.C., the costs associated with missing in action V.A.C.s and keeping track of all these V.A.C.s from a rental perspective are really minimized with V.A.C.VIA. Regarding our own cost, obviously we have ramp up here. In Athlone, we have fully automated the production of VIA. So our costs per unit of VIA are higher right now. We expect that over time to come down and be comparable to our V.A.C. costs today as the overall infrastructure required to support VIA is lower.

Matthew Miksic - Piper Jaffray Companies

One follow up on some of the geographic expansion. Can you remind us, is there a difference as you grow a little faster in some of these new geographies and a little slower in the U.S. or Europe, wherever the pressure may be, is there a difference in the way these products are rented and distributed? Or is it Latin America, Canada, Japan, for example, set up the same way as, say, the U.S. and Europe in terms of consignment and leasing and so on?

Michael Genau

Yes, Matt, this is Mike Genau. We have different models in the geographies. Where we're direct, the rental model is preferred and is what we use. Where we're indirect, often times, we will consign or sell the units to our distributor partners. They provide the services and the placement as well as the replenishment of disposables. So we work with the local patient base, the local commissions to set up business models that make sense.

Matthew Miksic - Piper Jaffray Companies

And so in Japan, for example, is direct, if I'm not mistaken, right? So just like the U.S.?

Michael Genau

Yes.

Matthew Miksic - Piper Jaffray Companies

But Latin America may be a mixed bag. Is that fair to say?

Michael Genau

Yes, but we're direct in Japan, like the U.S. So the model is similar to the U.S. When you go indirect like in Latin America and parts of Southeast Asia, for example, we use different models. We're working with distributors. We will oftentimes sell the products to them and they will provide placement and replenishment of disposables.

Matthew Miksic - Piper Jaffray Companies

But given other kind of small, more fragmented markets, that's not a -- I would imagine that's a significant change if we look at your overall rental versus sold model. Is that fair from like a top down?

Michael Genau

Well, we see the opportunity in these indirect market as large. There are more patients potentially there that would benefit from V.A.C Therapy. So the reach question is important, but the economics are different as you point out. And without reimbursement, we have to come up with different models to meet those local needs.

Matthew Miksic - Piper Jaffray Companies

And then last one and I'll jump off, is, Cathy, you've talked about China and India a couple times now and 350,000 or so I think it was the number that you'd thrown out, potential wounds there in the near term, even though obviously those markets could be a lot larger. Could you put just in context, given the difference in ability to pay compared to Japan, maybe compare the opportunities there over the next three to five years, as you think about China and India three to five years out? Japan, you've talked about $500,000,000 I think was the number. How do you compare those two?

Cathy Burzik

So we still believe that the Japan opportunity is a $100 million opportunity four to five years out. But we have talked about, when you look collectively at all of the rest of the emerging markets outside of Japan, I think we had a number of about $100 million by 2014, 2015. So we see all of these emerging markets, again, as part of the strategy of innovation, globalization, diversification that we have. Hopefully $100 from Japan isn't $100 million for the rest of these markets. So you see the global mix of KCI changing over the course of the next four or five years.

I think it's 8:30, Todd. So I think we're got to have to end with that. I appreciated the insightful questions that everybody asked. And I appreciate you all joining us for our earnings call, and we'll talk to you on the next call. Have a good day, everybody.

Operator

This concludes today's conference call. 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!