Kinetic Concepts Inc. (KCI) reported first-quarter fiscal 2011 EPS of 94 cents, up 27% from 74 cents in the first quarter of 2010. However, adjusted EPS (excluding non-cash acquisition-related items and expenses associated to the debt refinancing during the quarter) was $1.11, beating both the Zacks Consensus Estimate of $1.02 and the year-ago quarter’s earnings of 91 cents.

Revenues of $501.2 million increased 3% year over year and exceeded the Zacks Consensus Estimate of $494 million.Earnings growth was attributable to a 10.7% increase in operating income, ($123.4 million, excluding intangible asset amortization),an 11.6% decrease in interest expenses ($20.8 million)and a 270 basis points reduction in the effective tax rate to 27.3%.

Kinetic derived 44.4% of revenue from rental income during the quarter, which declined marginally to $278.7 million. While revenue derived from the North American market increased 4.3% to $392.6 million, the EMEA/APAC revenue recorded a marginal 0.6% decline to $108.3 million.

Among the different product segments – Active Healing Solutions (AHS), Regenerative Medicine (LifeCell) and Therapeutic Support Systems (TSS)– Kinetic recorded sales of $340.5 million (up 1.8% year over year on a constant currency basis), $93.0 million (up 17.5%) and $67.6 million (down 8.6%).

Within the AHS segment, revenue from the North American market increased 3% driven by higher unit volumes, resulting from a combination of increased usage of traditional VAC Therapy products and the adoption of new negative pressure-based therapies which was introduced in the US.

However, sales in the region of EMEA/APAC edged down by 0.6% due to lower average rental pricingand lower disposables volumesin price-sensitive and highly-competitive markets, partially offset by an increase in rental and sales volumes as a result of successful product launch in new geographies, especially Japan. Foreign currency movement favourably impacted APAC AHS revenue by 13% compared to the prior-year period.

The strong growth of LifeCell business was influenced by strong sales based on increased penetration into EMEA markets. During the quarter, the company reported sales of $2.8 million compared to $1.0 million in the prior-year quarter based on the successful introduction of LifeCell products in the new geographies.

The TSS division’s revenue from North America came in at $44.6 million, down 7.8%. Moreover, sales from EMEA/APAC declined 8.0% to $23.4 million. The overall TSS revenue declined due to lower rental volume of wound care surfaces.

Kinetic’s gross profit in the first quarter increased 6.4% year over year to $288.9 million with a 170 basis points expansion in gross margin to 57.6%.

The margin expansion resulted from lower royalty expense associated with the company’s previous license agreement with Wake Forest University and higher gross margins associated with its LifeCell business unit and lower rental fleet depreciation. However this was partially offset by the additional investment in Kinetic’s AHS sales force during the latter half of 2010.

While there was a 6.6% increase in selling, general & administrative expenses for Kinetic, the significant 14.5% reduction in research & development expenses during the quarter pushed up the operating income. The company recorded higher research & development expenses in the year-ago quarter as it was preparing for the launches of its VAC Via and Prevena.

Outlook

Kinetic reaffirmed its revenue guidance and increases its adjusted EPS guidance for fiscal 2011. The company expects adjusted EPS of $4.96-$5.08 representing growth of 16%-18% (earlier guidance being $4.45-$4.61) on revenue of $2.05-$2.09 billion (2%-4%). While the Zacks Consensus Estimate of $4.65 EPS is lower than the range, revenue estimate of $2.1 billion is higher than the company’s outlook.

Recommendation

Kinetic witnessed growth momentum in the Regenerative business. Moreover, we are encouraged by the company’s efforts to penetrate Japan and Europe which should boost the top line gradually.

Also the AHS business given host of products launched under its VAC. therapy system is gradually streamlining its position globally.  However, Kinetic continues to face challenges in the form of economic uncertainty and pricing pressures.

Currently we remain Neutral’ on the stock.

 
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