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Kinetic Concepts Inc. (NYSE:KCI)

Q4 2007 Earnings Call

January 29, 2008 8:30 am ET

Executives

David Holmes - Investor Relations

Catherine Burzik - President and CEO

Marty Landon - CFO

Lynne Sly - Global President

Steve Seidel - SVP, General Counsel

Analysts

Mark Richter - Jefferies & Company

Seth- Deutsche Bank

Taylor Harris - J.P. Morgan

Vincent Ricci - Wachovia

John Colter - Piper Jaffray

Larry Keusch - Goldman Sachs

Spencer Nam - Summer Street Research Partners

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Kinetic Concepts, Earnings Call. My name is Carol, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. David Holmes, Director of Investor Relations. Please proceed, sir.

David Holmes - Investor Relations

Thank you, Carol, and good morning to all of you joining us to review our financial results for the fourth quarter and full year 2007, which we released 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 are also joined by other selected members of our senior leadership team. Following our prepared remarks, we will open the call for questions.

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 these potential risk factors may be found in our filings with the SEC. I would now like to turn the call over to Catherine Burzik, President and Chief Executive Officer of Kinetic Concepts.

Catherine Burzik

Thank you, David, and good morning to all of you joining us to review our results for the fourth quarter and a full year 2007. Today, we reported a strong quarter for KCI, in terms of both revenue and earnings, to close out a full year of solid performance.

Total revenue for the quarter was $434 million, which is an increase of $62 million or 17% over the same period last year, V.A.C. revenue continues to lead our growth, increasing $52 million or 18% over the same period in 2006. Our surfaces business posted strong growth for the quarter as well, with total revenue increasing $10 million or 13% over the prior year quarter.

Net earnings for the fourth quarter were $66 million, which is an increase of 30% compared to the same period a year ago. Diluted earnings per share were also strong at $0.92 for the quarter, up 26% over the same period last year. In addition to our strong financial performance for the year, 2007 was an important period of positioning KCI for the future. Steps were taken to prepare for continued growth, and to address the changing competitive landscape.

During 2007, we made further progress in the rollout of our third generation V.A.C. therapy technology InfoV.A.C. and ActiV.A.C. In the US, InfoV.A.C. now accounts for over 32% of our acute care placement and ActiV.A.C. accounts for 26% of our homecare placements.

Adoption continues to be driven by strong caregiver response to the new systems' enhanced features and functionality, which are easier to use and support improved patient compliance.

Internationally, we have initiated launches in the United Kingdom, the Netherlands, Germany, and Austria. Further launches are currently scheduled for the first quarter of 2008.

In 2007, we made progress in repositioning our Therapeutic Surfaces business, and we close the year with another quarter of solid revenue performance. Our plans for 2008, call for improvement and the profitability of our surfaces business, which may include rationalization of both products and contracts. We remained open to opportunities to expand this business beyond therapeutic surfaces to include other therapeutic support system. Lynne Sly will lead these efforts. Lynne had previously served as head of KCI's US Surfaces Business, as well as most recently Interim President of KCI's International Operations. She will now serve as Global President of this business.

Earlier this month, we also announced that we will be creating a dedicated US sales force to service our V.A.C. and Therapeutic Surfaces businesses. It is our belief that this move will better position these businesses for profitable growth in the longer term.

During 2007, we also made significant investments in streamlining our processes globally, and in effort to capture growth opportunity, improved scalability and create efficiency to ensure that KCI operates as a globally aligned organization. The implementation of these efforts will continue into 2008, and they've already begun to pay dividends in the form of improved communication, reduced cost and process consistencies across the organization.

Today's press release included guidance on our outlook for 2008, and I now want to share with you several perspectives and our plans for the coming year. We remained confident in our ability to execute our growth plans for 2008, as we continued to make long-term investments in the business. Our guidance reflects mid-teens growth in revenues for V.A.C. therapy franchise, as we implement our sales force redeployment and a further penetration of the V.A.C. market. We remained highly confident in our business fundamentals and our ability to compete effectively in the market.

I've just recently come from a US sales meeting, and I am truly impressed by the size, the debt and the enthusiasm of our sales organization.

KCI's clinical sales force is a unique competitive advantage, and as I mentioned earlier they are implementing plans to create dedicated sales teams for both our V.A.C. and Therapeutics Surfaces business. This new sales force structure allows us to focus more closely on leveraging the physician call points that are unique to each product line, while developing new caregiver relationship.

Our positioning of the V.A.C. side of the sales force reflects our belief that the market opportunity for V.A.C. therapy remains largely underserved, and our new structure and design to better position KCI for changing competitive dynamics, as well as an enhanced focus on execution.

Our new V.A.C. sales force was specialized in acute and post acute sale, and the incentives are structured in a manner to streamline and transition the patients of healthcare study. We believe this structure will strengthen our ability to capture and maintain patients, as they move from acute to the extended and homecare studying, where a large growth opportunity remains.

Importantly, this new structure will allow us to seamlessly bring new products to the marketplace. Our growth plans also call for further geographic expansion of our business, and I am pleased to report that our efforts to obtain regulatory approval of V.A.C. therapy in Japan are ahead of schedule. We have completed the clinical trials that were underway there, and in leading acute care facilities, and we are in the process now of compiling the dossier material to be submitted to the Ministry of Health.

Japan offers significant promise as the second largest medical device market in the world and our plans will first address the estimated 200,000 V.A.C. appropriate wounds currently treated in the acute care setting. We will continue in our efforts to accelerate the launch process, which is currently anticipated for late 2009.

During 2008, we plan to continue our geographic expansion plan. We recently announced the creation of two key leadership positions that will focus primarily on our Asian and European regions. First, we've been joined by Patrick Loh, who assumed the role of President of KCI's Asia Pacific operations. Patrick who will be based in Shanghai joins KCI from Thermo Fisher Scientific, a world leader in life sciences, where he was Vice President of Asia Pacific. Prior to that, Patrick was General Manager of Greater China for Fisher Scientific International. Patrick brings extensive and proven Asia Pacific leadership capability to the team, and he will lead our efforts as we target growth in this important region.

We also announced the appointment TLV Kumar to lead our efforts in Europe, the Middle East and Africa. TLV comes to us with more than 30 years of proven leadership experience in international role. Most recently, he was head of Applied Biosystems' Asia Pacific operation, where he oversaw operations in 17 countries. Prior to that TLV was at Philips Medical Systems, where he was Chief Operation Officer for the Asia Pacific business. In this role he is responsibilities included over sight of marketing, product management, customer service and supply chain. Both Patrick and TLV are uniquely qualified to lead KCI's international expansion efforts.

The development of diversified revenue opportunities remains a key focus as we enter into 2008 and important steps have now been taken to ensure our success in this regard.

Our level of R&D spending during 2007 was 3.1% of revenue, which was up from 2.7% in the prior year, and reflects our continued investment in the science of wound healing, and our negative pressure technology platform. It is our belief that these investments forte ongoing dividends, as we continue our heritage of bringing to market innovative therapies, targeted at unmet medical needs that ultimately change the practice of medicine.

We have implemented a best-practices approach in the Management of our international development, our internal development efforts that will ensure both a robust and efficient internal development pipeline. At our Analyst Day event in September, we outlined plans for the expansion of presence within the field of advance wound care across two important dimensions. And these efforts will further accelerate in 2008. Today, V.A.C. therapy is effective in the areas of exudate management, edema reduction, and in the formulation of granulation tissue.

Our plans call for the expansion of our product lines across the wound healing continuum to include the areas of cleaning and debridement, disinfection, and wound closure. Products that utilize our negative pressure technology platform to treat surgical wounds, lower severity wounds as aid in the area of hard tissue regeneration, are actively progressing through our development pipeline.

Our strategy for sustained growth and diversification also calls for the continued evaluation of new licensing and acquisition opportunities. These development efforts are headed by Rohit Kashyap, Senior Vice President of Corporate Development who has assembled a dedicated team, tackling, execution of strategic opportunities.

During 2007, we continued to take important steps to support our M&A efforts. Our balance sheet remains strong as evidenced by our net cash position. We believe that this coupled with our notable cash generation capability to provide significant flexibility to pursue and execute on our pipeline of strategic opportunities.

Our plans to respond to the ever changing dynamics of healthcare reimbursement are also reflected in our guidance for 2008. Assuming that KCI does not participate in round one of the CMS competitive bidding process, the total 2008 potential revenue impact represents approximately 1.5 of 1% of KCI's total estimated revenue for 2008, or approximately $9 million. CMS also announced that NPWT would be included in the next round of competitive bidding, which will include an additional 70 competitive bidding areas, or CBAs, and pricing from the next round is scheduled to be effective in mid 2009. Again, assuming that KCI does not participate in the program the total potential 2009 revenue impact would represent less than 5% of KCI's total revenue.

KCI has maintained a highly competitive pricing structure for CMS, and we believe that the overall value proposition provided by the V.A.C. therapy has resulted in significantly improved outcome for Medicare patients, as well as favorable economic benefits for CMS. While we thought it was appropriate to participate in the bidding process, it is our continued belief that negative pressure wound therapy is not suitable for the competitive bidding process due to the lack of clinical equivalency of product offerings in the category, and the lack of proven DME suppliers in the NPWT category.

Support for this position is growing. Last month bipartisan legislation was introduced in the US House of Representatives, entitled the Medicare Wound Therapy Patient Protection Act of 2007, which calls for the exclusion of NPWT from the competitive bidding process until clinical equivalency products in the category can be demonstrated. We believe that KCI will be joined in support of this legislation by numerous wound healing societies and key opinion leaders.

We will continue to be actively involved in matters related to reimbursement and anticipate that this will be a continued focus in 2008. It has been our experience that the growing acceptance of V.A.C therapy under product prescribers, often results in natural points of resistance, as the annual amount spent on the therapy increases. We have been successful in demonstrating the value proposition to payers, based on a lowering of the overall cost of care for patients, as a result of shorter treatment time and reduced complication rates. In 2008 we'll further draw on the use of use of our proprietary budget impact model that enables us to accurately measure the economic benefits of V.A.C. therapy that are specific to a particular institution.

Our plans for 2008 also call for the continued protection of our technology and intellectual property as evidenced by recent court filings announce earlier this month. While we do not comment on the specific details or strategies related to litigation we remain committed to enforcing and protecting our intellectual property rights.

And finally, I am often asked to comment on our strategy to deal with the changing competitive landscape. And I want to reiterate our response as we look forward to 2008. First, competition has been a part of the operating climate in every business that I've run. KCI has maintained strong growth momentum despite the introduction of less effective therapies by competitors over the last several years. I am convinced that we are well prepared to effectively compete going forward.

And secondly, we will always focus on patient outcome. It has been consistently demonstrated that prescribers and care givers will continue to opt for therapies that allow for faster wound closure times and reduce complication rates, leading to a reduction in the overall cost of care.

And finally we'll continue to leverage and invest in our infrastructure, our relationships and our core competencies that have been developed over the last decade, which include our unique clinical sales force, our deep understanding of the science of wound healing, our expertise in the area of billing and collection and our customer support infrastructure.

These competencies are essential to succeed in this space. They cannot be readily duplicated by new market entrant, and will continue to position KCI as the market leader in the field of advanced wound care. Simply stated KCI's business fundamentals are strong, and we remain confident in our continued ability to compete successfully in the market. At this time I will turn the call over Marty Landon who will brief you on our financial results.

Marty Landon

Thank you, Cathy and good morning everyone. Looking at our 2007 results, total revenue for the fourth quarter set another new high for the company at $433.6 million, which was up $62.1 million or 17% over the same period in 2006. Foreign currency exchange movements favorably impacted fourth quarter revenue by approximately $14 million or 4% compared to the prior year period. On a sequential basis, total revenue for the fourth quarter was up $22.7 million or 6% from the third quarter 2007 levels, driven primarily by continued demand for V.A.C therapy worldwide and strong growth in our Therapeutic Services Business.

Net earnings for the fourth quarter were $66.5 million, up $15.2 million or 30% over the same period last year. Net earnings per diluted share increased to $0.92, up 26% over the fourth quarter of the prior year. Net earnings growth for the fourth quarter outpaced our revenue growth, consistent with our expectations, as we continue to create leverage in the business model while investing in key growth areas such as R&D.

Domestic revenue for the fourth quarter was $303.6 million, an increase of $35.3 million or 13% over the fourth quarter last year. International revenue of $130 million for the fourth quarter was up $26.8 million or 26% over the year-ago period.

Looking at our revenue by product lines, global V.A.C. revenue growth continues to lead the way, increasing to $344.9 million for the quarter, up 18% over the same period last year. Our growth in the quarter was driven by the continued demand for our V.A.C. therapy system, both in the US and abroad. US V.A.C. revenue for the period was $250.9 million, an increase of $31.4 million or 14% over the same period last year.

Fourth quarter US V.A.C. revenue growth was primarily unit driven and rental volume increased across the broad. As expected, growth rates in the Home Care setting continued to exceed growth rates in the Institutional settings and prices across all care settings remained stable.

The rate of V.A.C revenue growth slowed in the fourth quarter of 2007 as we initiated work on the redeployment of our domestic sales force which caused some disruption in selling activities and we faced a slightly tougher year-on-year comp due to the strong finish 2006.

International V.A.C. revenue for the fourth quarter grew to $93.9 million, an increase of $20.2 million or 27% over the year ago period. Higher V.A.C. revenue from increased rental volumes accounted for about half of the period-over-period increase, and favorable foreign currency exchange rate movements accounted for the remainder.

Internationally, we continue to see increased competitive selling efforts related to NPWT, mostly in the form of free trials and evaluations.

Worldwide revenue from our Therapeutic Services Business, reflected impressive growth for the fourth quarter and totaled $88.7 million for the period, up $10.4 million or 13% over the same period last year. Domestic services revenue for the fourth quarter was $52.6 million, up $3.9 million or 8% over the same period last year, due primarily to higher rental volumes.

International services revenue increased to $36 million for the fourth quarter, up $6.6 million or 22% over the same period in 2007. Again, favorable currency exchange rate variances accounted for approximately $4.2 million of the year-over-year increase.

Gross profit for the fourth quarter was $213.9 million, an increase of $36.8 million or 21% over the fourth quarter last year. Gross margin was strong at 49.3% improving by 160 basis points over the prior-year period. Revenue growth and slower sales force expansion contributed to our strong margin performance in the quarter.

Below the gross profit line, we increased our R&D spending for the quarter by $6.7 million or 58% year-on-year. Our total R&D investment was $18.3 million for the quarter, representing 4.2% of total revenue. Our planned increases in R&D spending reflect our goal of continuing to broaden and leverage our knowledge of the science of wound healing to drag further innovation in negative pressure technology platform applications.

Operating profit for the quarter was $100.2 million and reflected benefits received from our globalization and process efficiency efforts. Our operating margin was 23.1% for the quarter, up 70 basis points from a year ago and exceeding $100 million for the first time in KCI's history.

Below the operating line, our results for the quarter reflects progress that has been made in increasing liquidity and reducing leverage. Interest income increased to $2.6 million in the fourth quarter, up from approximately $1 million a year ago. Interest expense again declined for the period due to active de-leveraging. Total debt outstanding at year-end was $68 million.

Our effective tax rate was 34% for the quarter, down from 34.7% in the prior year period and 33.8% on a full year basis, which is up slightly from the 2006 full year tax rate of 33.1% due to the favorable resolution of certain tax matters in the first half of last year.

Free cash flow for the year was strong at $247 million, up a $111 million or 81% from the prior year. Increases in free cash flow versus the same period last year resulted primarily from higher net earnings and strong working capital management.

Our balance sheet continues to reflect high liquidity and operating flexibility. Our cash balance of $266 million at year-end is up considerably for the period due to favorable collection patterns during the quarter as well as the timing of licensing fee payments to Wake Forest University which takes place in the first and third quarters of each year.

Our year-end net accounts receivable balance of $357 million remained flat to the preceding quarter, despite continued revenue growth, reflecting the benefits of our order to cash process improvement efforts.

Our fourth quarter results showed continued progress in our efforts to actively manage payer relationships, and leverage process efficiencies. Total days revenue outstanding for the period declined by just under 5 days from the same period in 2006. US receivable days outstanding decreased 4% from 75 days at the end of 2006 to 72 days at the end of 2007. International days outstanding improved 14%, following from 90 days in the prior year period to 79 days for the current period.

Our domestic and international days revenue outstanding directly benefited from efforts to improve the efficiencies of our order to cash process.

We continued work during the quarter on Medicare claims audits covering prior years. Work was completed on the Region B audit, while we've reported 94% of KCIs reviewed claims were found to be without exception, resulting in a nominal recruitment amount.

We'll continue to work proactively with CMS as we further improve and refine our billing and collection competency.

As I mentioned previously, our long term debt balance at quarter end was less then $70 million and significantly less then our trailing 12 month EBITDA which is now approximately $464 million.

We made no open market share repurchases during the quarter under our previously announced share buyback plan.

In summary, 2007 was an important year for KCI where substantial investments were made in positioning the company for future growth. During the year, we made organizational and leadership changes that have positioned KCI well for continued global growth. These efforts included investing in process efficiencies, systems and senior leadership resources.

In our 2007 operations, we also funded new V.A.C product launches, increased spending in our R&D pipeline, made further investments in our information and compliance systems, as well as our new manufacturing facility in Ireland. As a team, we feel good about our 2007 results, and we were well aligned as we begin to execute our growth plans going forward.

Turning now to 2008, this morning's press release included financial guidance, was cause for revenue of $1.77 to $1.82 billion, and earnings per diluted share of $3.85 and $3.95 per share. Our 2008 guidance reflects further penetration of the global V.A.C market, which remains largely underserved, while recognizing the short-term disruptive effects of the sales force redeployment and the potential market distractions associated with the additional competitive entrance and Medicare reimbursement changes.

Our plans call for continued growth in V.A.C revenue, both domestically and internationally. Our plans also call for a strict discipline around improved profitability for our therapeutic surfaces business, where our goal would be we want a profitable market share gain. We believe it is reasonable to expect relatively flat revenue from surfaces in the short-term.

Our guidance also reflects improved earning in margins, as we continue to drive process improvements and efficiencies within the business.

We look forward to 2008 with great anticipation and a clear bias for action. And finally, we expect to file our annual report on Form 10-K with the SEC in late February.

This concludes our prepared remarks and at this time, we will turn the call back over to the operator to begin our question and answer session.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions)

And your first question comes from the line of Mark Richter with Jefferies & Company. Please proceed.

Mark Richter - Jefferies & Company

Hi, good morning guys and congratulations on a good quarter.

Catherine Burzik

Thanks, Mark

Marty Landon

Thanks, Mark.

Mark Richter - Jefferies & Company

So, first question is the legislation that you guys discussed to potentially remove Negative Pressure Wound Therapy from the competitive bidding process, can you sort of talk about where you stand in the legislative process? And how you see this playing out especially if you're choosing not to be involved in the competitive bidding process?

Catherine Burzik

So, Mark, this is Cathy. And I am happy to give you some perspective on that. This bill that is in front of the house, as I mentioned, is a bipartisan bill sponsored by several physicians within the house. It has the backing of major medical associations. For example, the American Association for the Advancement of Wound Care and numerous other podiatrists, etcetera. It will work its way through. We don’t yet have a bill on the Senate side and obviously we will have to get a bill going offline to Senate side and we are actively working on that.

Clearly, what we are trying to do here, is signal strongly alignment with the physician community against the whole competitive bidding process for Negative Pressure Wound Therapy, until clinical equivalents can be proven, which we think is a very fair approach.

As we talked about at the JPM Conference, KCI has submitted all bids for the first date of competitive bidding and as far as we know at this point, there has been no feedback relative to about that bidding process. Does that answer your question?

Mark Richter - Jefferies & Company

Yeah, I know that's perfect. And then sort of switching gears for a second, just on the competitive front, can you just talk about ITI, BlueSky, Medela sort of what you've seen if anything from them in the marketplace? And I guess most investors at this point are mostly concerned with ITI, so if you can comment on that and then obviously the ensuing litigation that would be helpful?

Catherine Burzik

I'll start and then Steve may like to make a few comments. We continued to see that the company that you mentioned within the United States market and internationally we see a number of other companies that are coming into the market which what I'll call lower priced, non-effective or less effective therapy. And I just want to bring, Mark, you back to what we have continued to talk about here is the fact that it is all about clinical outcomes and the body of evidence that KCI has with our clinical trials. And with all of the peer review of general article, continue to set KCI apart from the competition.

And we fully expect and we've seen people come in, they get free trials, they try to get people to try product and then the physician and caregivers come back to KCI because it's really the only proven therapy and that has repeated itself over and over and over again both in the US and internationally over that past year and even before that.

So that's kind of the state that what we see in the overall competitive space and what we expect certainly going into 2008. So, we are not blind to this. We are obviously ready for it, but again it's really all about the proven outcome that V.A.C has. And I would turn it over to Steve for maybe a brief comment on the company that you mentioned.

Steve Seidel

Yeah on the ITI, I mean the piece that we haven't seen in the marketplace a lot, as far as the intelligence that we have gathered on our end, we did see them in the marketplace in a hospital in North Carolina, and that led to the filing of a lawsuit that we have at North Carolina, which is a patent litigation.

We also have -- it's kind of completely unrelated. It's litigation in Texas that’s more of the state court claims that relates to breach of contract, breach of confidentiality and agreement on part of one of the business there to transfer any technology they developed back at KCI. So, again those are two separate lawsuits kind of going at the same product. Again to date, the activity in the market place we have seen has been fairly limited.

Mark Richter - Jefferies & Company

Okay, perfect thanks. And then the last question, V.A.C. revenues grew up nicely, international growth was strong, you talked about launching in the first quarter in some additional countries or US, can you just talk about what those countries are?

Catherine Burzik

You are talking about Instill V.A.C and ActiV.A.C, right?

Mark Richter - Jefferies & Company

Yes exactly.

Catherine Burzik

I actually have Lynne Sly here. Lynne most recently came from running Europe prior to TLV and maybe, Lynne, you can provide a little color on those [SWMS] plan.

Lynne Sly

Sure as mentioned on the call, we've already began our launches in Germany, in Austria for example, and we'll continue to roll out in the UK and later on into some of the smaller markets and lot of products like, Switzerland and France and so forth. So, you can expect taking the full year to continue to roll out into these markets as we prepare selling organization and our service organizations to deliver these new products.

Mark Richter - Jefferies & Company

Sorry. And one last question, since I have you. And then just in terms of your launch timeline or plans for the SWMS product as well?

Catherine Burzik

Mark, Cathy again here. We are actively developing, but we are actively in development for our SWMS platforms. For those who are on the phone that are familiar with that, this is the our surgical wound management system. This is a product that would serve in the surgical suite. We're very excited about this product. The product continues under development. Carb, do you want to add any couple of words of color?

Mark Carbeau

Like Cathy said, we are just looking to put our resources towards the development of products in that negative-pressure technology platform that we introduced you at the Analyst Day, and we're looking to bring this to the market in the most timely fashion that we can.

Catherine Burzik

Okay, thank you Carb. And thank you, Mark.

Mark Richter - Jefferies & Company

Thanks.

Operator

And your next question comes from the line of Tao Levy with Deutsche Bank. Please proceed.

Catherine Burzik

Hi, Tao. How are you?

Seth - Deutsche Bank

Good, this is actually [Seth], Cathy.

Catherine Burzik

Hi, Seth.

Seth - Deutsche Bank

Congrats on a great quarter.

Catherine Burzik

Thank you.

Seth - Deutsche Bank

I have a bunch of questions, but I am trying to limit them. First, we recently saw the NeutroPhase. I think it was approved as a 5-K to 10-K for NovaBay, so I was just kind of wondering when we should expect to see the launch of NeutroPhase with V.A.C. Instill?

Catherine Burzik

It's a very good question. For those of you on the call who aren't familiar with this, we have under development a next generation V.A.C. instill-therapy product that we're excited to bring to the market. Obliviously all of our products will need 5-K to 10-K approval. NeutroPhase has been approved just kind of a stand-alone product, and we're now in the process of really testing it out with our overall instill product. So, depending on how the testing goes -- and this, as you can imagine, is a very complex kind of trial that we need to do here to make sure that the product works accurately and works as expected. So, I think that you should expect this to take some time before we would introduce it, probably near to the end of this year or early in '09.

Seth - Deutsche Bank

Okay, great. And you mentioned that the Japanese trial has been completed in your working on the dossier. Any update as to when we might see some data from the trial?

Catherine Burzik

The trial itself was highly successful in Japan, and I'll be heading over to Japan in just a couple of weeks to make sure that everything is on track. But we will now actively be submitting this and interacting with the Ministry of Health. We have to go through the regulatory approval, and that's somewhat parallel to the reimbursement approval. I am not sure if the trial results become public information. Do you know, Todd, if they do?

Todd Fruchterman

Not by virtue of the dossier. It does not become public information. But again, we saw very positive results for V.A.C. in the acute-care settings similar to the results that we have seen in the United States. Again, this is just demonstrating the effectiveness of V.A.C. across different wound types in the acute care setting.

Seth - Deutsche Bank

Okay.

Catherine Burzik

Alright.

Seth - Deutsche Bank

Yeah, that's great. Also, in the last call, you mentioned that there were some health-technology assessments in Europe. Maybe Lynne or Cathy can comment on any updates there?

Catherine Burzik

We are working on that. This will take some time and take some energy. Definitely, it's not going to be an instant care here. But I was very encouraged by both our organization stepping up and the resistivity of the U.K. organization, the National Institute for Clinical Effectiveness (NASDAQ:NICE), as well as the (inaudible) in Germany, where I think we've established very good ongoing dialogue with both of those entities. So, while we can't get clear success at this point, the good news is that we are talking -- in particular, in the U.K., where we have not had a really good dynamic. I think that is changing. So, we'll see as 2008 rolls on, but I am encouraged by where we are.

Seth - Deutsche Bank

Okay. And one last one, if you don't mind?

Catherine Burzik

Okay.

Seth - Deutsche Bank

Just for modeling purposes: So R&D was little bit heavier, I guess, what we expected in this current quarter. Is this something we should expect to carry into 2008 and also on the margin line for Q1 '08? Should we expect a margin similar to the past couple of quarters, or something more in line with first quarter '07, which was little bit lighter? Thank you.

Marty Landon

Basically, we expect to. As I said in my prepared remarks, we expect to continue to expand our spending on the R&D line. It was fairly heavy in the fourth quarter. I think that you are going to see measured expansion, as we've talked about. That will be funded internally. I think, from a margin standpoint, we'll do that by managing other costs within the business. So, I would expect that we do have the sales-force deployment going on, and that will continue through the February time period at least. So, you might see a little bit of a squeeze in terms of margins early in the year, expanding later in the year, but I think it would be done generally along the lines of what we've talked about. If you think about the year overall, you are going to see an expansion of margins anywhere from 50 to 100 basis points, kind of the same thing that we've talked about. I don't think that you'll see quite as low as maybe what we saw in the first quarter of 2007 because we are operating pretty well in terms of some of the globalization efforts and some of the process efficiencies.

Seth - Deutsche Bank

Great, thanks Marty, and congrats again.

Catherine Burzik

Thank you, Seth.

Operator

And your next question comes from the line of Mike Weinstein with J.P. Morgan. Please proceed.

Taylor Harris - J.P. Morgan

Thanks a lot. It's actually Taylor Harris here for Mike. So, first question is on the sales force. Cathy, you guys announced that you are splitting the sales forces. Can you maybe just let us know, are you planning on increasing the overall size of the V.A.C. sales force, or is it more just a specialization effort for '08? And then, along those lines, what have seen recently in terms of sales force productivity? What are the trends look like there?

Catherine Burzik

Okay, Taylor. Thanks for the question. This sales force redeployment that we are going through right now, it's a pretty exciting initiative for KCI. Just to kind of give a little bit of flavor on this: As we look at the latter part of last year with my first year coming into the company, and then with Woody Staub also joining the company, we both started after sales. How do you increase the penetration rate of V.A.C. over time. And, given the overall size that we are now with the business, given a need to provide focus and also what we see is a longer term opportunity for surfaces, we decided now it's the time to separate the sales force. We actually bit the bullet on that in Q4 and accelerated our plans to do that.

Also from just a little more detail on the V.A.C. side of the business, we've actually had three areas of focus in V.A.C.. We've had home, extended and acute, and what we're doing now there is really going to have an acute post acute. We think this is going to streamline the physician call-point, so that you don't have one person saying keep the patient in the hospital and another one saying, send them home. We're going to make the transition ownership really with the acute sales force. So, it really is more of a reconfiguration of our current organization, where I think there was a natural split between people who have a best part of surfaces, who really love selling surfaces, and who have kind of moved there. Then we have another set of folks who are moving into the V.A.C. sales force. So net-net, we will continue to expand both of those sales forces in a measured way going forward, as we've talked about, but the sales force reorganization itself has not yet met very many people. Does that help answer the question?

Taylor Harris - J.P Morgan

It does. How about the productivity side of the selling organization -- have you seen increases or has that plateaued?

Catherine Burzik

I looked at this overall sales force -- and you are talking about large additions now on an annual basis that we are trying to make to the top line of the company -- I just think that you are going to have more effective sales force and more productivity if you have a sales force that is very focused on one customer call-point, so I am expecting to see increase productivity from the sales force going forward with this new structure.

Marty Landon

Taylor, this is Marty. As we've moved through the year, we have seen slight increases in productivity, and that’s part of what’s been helping to drive the gross profit margins that we are seeing.

Taylor Harris - J.P Morgan

Okay. Great, and then a second question: You mentioned points of resistance along the way as you get to certain scale levels with, say, commercial payers or institutions. Can you just spell that out a little bit? How does that play out practically at institutional level? Did they set caps on usage or just pushback more on increased utilization?

Catherine Burzik

It’s a great question, Taylor, and it is really more of the later than the former. You get to a certain size in these hospitals -- I saw this happening both domestically and internationally during the course of last year -- where the individual doctor no longer can just make the decision for the back therapy. He get's certain level of bend within the hospital. And I think that the overall administration within the hospital, yet to certain levels, and they say what is this thing called back therapy, and then all of a sudden your officer is not in the overall clinical mode, not until you are in the administration mode, where people are coming to Dallas and looking at the bend.

So, what we are really doing now is rolling out. I talked a bit about this at the JP Morgan Conference. We developed a proprietary tool in Europe that has been very effective for the budget impact model. And what this has is proprietary information that is that really -- we developed over a period of time and that shows the effectiveness of V.A.C. from a value proposition and saving an individual institution money while getting better patient outcome. We've had good success with this within Europe. We wanted to tailor this now for the U.S. marketplace, and we will be rolling this out during the first and second quarter of this year into our sales force.

I also think having a sales force now that's specifically just ties to the V.A.C. part of the business, should provide a lot of bandwidth within that organization, for uptick on this model and an opportunity to sit and work through with these various administrators, what are these hurdles and how we get though them, because it’s a very effective and compelling story. And I said in the past that (inaudible) has a lot of documented evidence that V.A.C. actually healed wounds 35% faster and reduces costs 25% compared to conventional therapy. So, all of that is baked into this model.

Taylor Harris - J.P Morgan

Do you think you'll be using that tool proactively even if you don't get resistance from an institution?

Catherine Burzik

Most definitely, it's going to go onto selling. That's what we were talking about our sales force last week. The thinking here is to roll this out as a tool. When I was at J&J working diagnostics, I had this tool, the same kind of tool for all of my previous firms to try to help them sell the value proposition of your business. So, we are pretty excited about this.

Taylor Harris - J.P Morgan

Okay, great. And then one last question, Marty. You talked about the Medicare claims process in Region B in the 94% favorable outcome. What happened with the other 6%? Are those still in dispute or what happened there?

Marty Landon

There were like 250 claims -- 241 I think was the actual number -- but there were 19 claims that are under dispute, and so you go back and you look at each of those and then you have the chance to appeal those and then at some point of time you either reach a resolution. You either get paid more they recoup the money.

Taylor Harris - J.P Morgan

Okay. Thank you, guys.

Catherine Burzik

Thank you.

Operator

And you next question comes from the line of Vincent Ricci with Wachovia. Please proceed.

Vincent Ricci - Wachovia

Hi, thanks for taking my questions. Gross margins kind of looked good this quarter, and we were just wondering: How much opportunity is there for gross-margin expansion? There seems to be a lot of investor concerns over competitions, like competitive bidding and whatnot.

Marty Landon

Vince, this is Marty. As we've talked in the past, we did think there was a little bit of leverage in the model. We think that this sales-force redeployment helps with that. I mean, you are talking about a large market opportunity here that remains underserved. And so we think that by providing that focus and providing the seamless transitional amongst the care settings, we will continue to be able to drive productivity improvements.

And so, we think there is leverage in the model. I would again caution about getting too excited about it. We'll do it in a very measured fashion because we are also going to invest in the sales force and invest in areas as we grow internationally. So, it will be a measured improvement. As we've said in the past, somewhere between 50 basis points and a 100 basis points. Where it tops out? Yet to be seen, but we are working hard at improving processes and making the customer experience better, so we hope it gets better overtime.

Vincent Ricci - Wachovia

Okay, great. And then, obviously, the discussion point on the increasing R&D expenditure. And then also acquisition strategy. I know you talked about this at your Analyst Day, or you'll be plugging the whole mix of acquisition, adding a new platform which is kind of filling in between. Where are your R&D, do you think there is an external knowledge base that you would rather bring in then develop internally?

Catherine Burzik

So, Vince, these are all good questions. Let me just give you a little bit of perspective on the way that I see this. Todd Fruchterman has build an absolutely outstanding R&D organization, and I am really, really pleased by the pipeline of products. We shared some of that at the Analyst Day, and there is a lot more that we haven't shared, and I am excited about it.

That said, my experience here is that I think it's good to have more growth platforms rather than just the two growth platforms that we have today, our back and surfaces. So, we are accurately [guessing] from an M&A perspective and we've talked about this before. We have a pretty strict and robust process here, and we are actively spending time on what is the right platform that leverages the historical capabilities of the company. That makes sense going forward that we could build on for the future, and I kind of think of this as platform for the next decade of KCI. And so, we are actively going to process -- and as that process plays out during the course of 2008, we'll definitely inform the community. I am sure you understand that we can't say too much about it right now.

Vincent Ricci - Wachovia

Okay. That's great. And then just a last quick question: We heard you guys might be looking for a new headquarters. What would be the cost implications there?

Catherine Burzik

I tell you that the comments about our new headquarters are interesting. We continue to figure out -- try to figure out -- where is the best place for KCI in the long-term. We would certainly not be leaving San Antonio. There is a finite time to the leases that we have on building here, and I think its natural for us to ask ourselves, does it make sense to stay where we are, or does it make it sense to go somewhere else here in San Antonio? I can assure you, as I look at Marty here, that this will be done in a very physically responsible manner in the event if we were to decide to do that.

Martin Landon

Like any company, Ben, you got look out to the long-term and say, what if and what could happen here and there -- you go through that work? But as Cathy says, it's going to be a fairly tight boundary within which we operate as we think about those things because we are going to remain physically responsible.

Vincent Ricci - Wachovia

Okay, great. Thanks for taking my questions.

Operator

And your next question comes from the line [John Colter with Piper Jaffray] please proceed.

John Colter - Piper Jaffray

Hi this is John on for Mark Mullikin. Just a quick question, I am not sure if you'd covered this already but, do you have any updates on the two lawsuits with ITI of this point or like what the timing is on those?

Steve Seidel

This Steve Seidel. From a timing standpoint, all are in the early stages. So I would say that in the state court filing here in San Antonio, you will run into answer days where the opposing part will start answering in early February. I think it is probably a similar timeline, or a little bit later in February for the North Carolina filing. And you’ve got procedural motions back and forth in Delaware. So at some point, it is going to be sorted out whether the patent litigation will be in Delaware or in North Carolina. I expect that to play out kind of later in the spring time for a final decision maybe an April or May timeframe.

John Colter - Piper Jaffray

Okay, great. And then one additional question: On the sales force, are there any plans for sales force expansion with this new split, or is it kind of (inaudible)?

Catherine Burzik

So, John, just to repeat something I said earlier in the call. We really try to be thoughtful in the way to we have done this, and I think that the fact that there's been kind of a natural movement of certain people who are more suited for the therapeutic surface is it is an obviously more suited for V.A.C. That said, the point in [and of] itself does not cause a significant expansion at all on the sales force. But as time has gone and if it makes sense for us to continue to expand, we will continue to expand both domestically and internationally.

John Colter - Piper Jaffray

Okay. Great, thank you.

Catherine Burzik

You're welcome.

Operator

And your next question comes from the line of Larry Keusch with Goldman Sachs. Please proceed.

Larry Keusch - Goldman Sachs

Hi, good morning. Can you just help me to understand: Why was the gross margin in the fourth quarter sequentially down from the third quarter? Was that again just some of the inefficiencies that you're having as you kind of looked at the sales force sort of splitting up moves, those sorts of things?

Marty Landon

We got to the point where we looked into the fourth quarter and said, when is the right time to really kick these things off? We decided that it is best for us to get going on it and to get it done. So we started, and we wanted to have it in place as we went to our global sales meetings. So we started that process in the fourth quarter. And any time you do something like that, people have some questions around, what's their role, et cetera. So we saw some of that. And there is also some cost associated with doing that, right? I mean, not everybody finds the right place or the right home for them, and so you have cost associated with that. And so you got some bumps along or whatever as you do any activity such as that, but again not of significance.

Larry Keusch - Goldman Sachs

But are you saying that there were costs associated with the redeployment of the sales force in the COGS line?

Marty Landon

Remember that the cost of our field organization is all above in the line, so it's more in the rental expenses or the field expenses.

Larry Keusch - Goldman Sachs

Right. Okay.

Marty Landon

And so we have those cost captures there.

Larry Keusch - Goldman Sachs

Got you. And then on the R&D, which obviously stepped up nicely in the quarter, again it's sort of $18ish million level, which is certainly substantially higher than it's been. Is the right way to think about that now that your run-rate is going to be up in this $17 million, $18 million range?

Marty Landon

I think the right way to think about it is, as you look forward into 2008 is that for the year, we were 3.1% and that will expand somewhere between 3% and 4% for the coming year. Those things can be a little lumpy as you start projects, particularly as you get what we had going on here with some clinical research work a good bit of it supporting the current products, and we'll have additional current research going on with the new product launches. But I think the way to think of it is, as I said, is that going to be a measured increase over time. So you'll see it goings somewhere between 3% and 4% for the year of 2008. There could be quarters virtually little higher could be quarters virtually little lower.

Larry Keusch - Goldman Sachs

Okay. And then I'll just add the next one, and then you can just answer them. If I heard correctly, it sounded like you did not do any share repurchases in the fourth quarter, and I wonder if you could just review the criteria for your share-repurchase activities. And then secondly, the 18% growth in V.A.C -- if you could just tell us what the unit growth associated with that revenue growth was? That would be terrific.

Marty Landon

Okay. So while I can't give you our grid, I can tell you, as we've disclosed before, we do have authorization under a plan. We have 10b5-1 in place, and our purchase activity is generally taking place under that 10b5-1. Could also tell you that in terms of the V.A.C growth, it was primarily unit-driven.

Larry Keusch - Goldman Sachs

Okay. So there was some modest price or was unit, was it basically just all unit?

Marty Landon

Price has been pretty stable over the period.

Larry Keusch - Goldman Sachs

Okay, great. Thanks very much.

Operator

(Operator Instructions). And your next question comes from the line of Spencer Nam with Summer Street Research Partners. Please proceed.

Spencer Nam - Summer Street Research Partners

Hello.

Catherine Burzik

Hi, Spencer.

Spencer Nam - Summer Street Research Partners

Hi, how are you? Thanks for taking my questions. So a couple of quick questions and then one a little more-involved question. What is your current daily reimbursement rate per pound for the average sales price or the rate that you charge the institutions at?

Martin Landon

Well, Spence, this Marty, and we don't disclose our price list. What we've done in the past is just talk about that historically to the Medicare pricing, as that is currently approximately $65 a day.

Spencer Nam - Summer Street Research Partners

Great, thanks very much. And then on the competitive bidding side, I just wanted to make sure that for the round one 2008 competitive bidding that you have submitted bids in 10 MSAs. Is that correct?

Catherine Burzik

That is correct, Spencer.

Spencer Nam - Summer Street Research Partners

So the follow-up question on that is: If it's going to be half of 1% revenue impact, what is the strategic rational behind submitting the bids and essentially open up the cost structures and all this different thing that could be accessed by your competitors or the Medicare could take additional look at?

Catherine Burzik

Well, we thought a lot of about what the right thing here is to do relative to starting bidding. I can tell you we thought a lot about it: Should we bid, should we not bid? We don't have much flexibility relative to price. As you know we have our lowest prices into Medicare already. I think when all is said and done here, we really felt that with better for KCI to at least experience the game here. I mean, I don't know how this is going to turn out, at all. I suspect there's going to be substantial dialog with CMS as we go into round one and into round two, and I made a decision here that it was not the right thing for KCI to be excluded from it. That said, I am not endorsing the competitive bidding process.

We absolutely believe there are going to be access issues, cost issues and quality issues. So, I mean the whole thing, from an NPWT perspective, does not make sense. I also just think from an overall perspective here of how people view KCI responsibly as a company, I did not want to be in a position where KCI itself withheld the technology. That said, I mean if we are offered to participate and the price is such that it doesn’t make sense for us to participate, we are not going to participate.

Spencer Nam - Summer Street Research Partners

I appreciate that, that’s very clear. Final question is, in terms of the outlook: Based on the way you described 2008, assuming that the bed business is flat, is part of your guidance, the implied growth in the V.A.C business would be in the mid-teens. Given the growth of the overall market, how do you expect that to be realized? Also considering that there are going to be more competition, what are some of the assumptions that you are using to get that level of implied growth here?

Catherine Burzik

So you really need to think [center] about the size of opportunity, and every time I sit back and (inaudible) the sale force, and you look at the data. I mean, fewer than 5% of all of the wounds are treated by V.A.C, and if you just look at what we consider the [V.A.C. able] opportunity, we are less than 20% penetrated. There is, for all intensive purposes, no substantial competition. So, this is our market to go get it. The market is absolutely underserved, and I think it just (inaudible) us to make sure that we have the right tool, the right structures, and the right people to go after and to really grow the business. So that’s the way I look at it, and as we said earlier in the call, we know the sale force and reorganization costs have [caused] a slight amount of disruption in Q1, but we fully expect as we go into the second half of the year to ramp.

Spencer Nam - Summer Street Research Partners

Appreciate your thoughts, Cathy. Thank you.

Catherine Burzik

You're welcome.

Operator

And there are no additional questions at this time. I'd now like to turn the call back over to management for closing remarks.

David Holmes

Thank you, Carol. This concludes our fourth-quarter conference call. We appreciate your questions and participation, and on behalf of the KCI team, thank you and have a great week.

Operator

Thank you for joining in today's conference. You may now disconnect. And have a great day.

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