LivaNova plc 2019 Q2 Form 10-Q Summary
Business context and reporting period
LivaNova is a global medical-device company organized in England and Wales, with two reportable segments: Cardiovascular and Neuromodulation. The filing reports unaudited U.S. GAAP results for the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
On June 12, 2019, LivaNova acquired the minimally invasive cardiac surgery instruments business of Miami Instruments for up to $17.0 million, including $10.8 million paid at closing and up to $6.0 million of contingent consideration.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $277.2 million | $287.5 million | $528.0 million | $537.9 million |
| Operating income (loss) | $(29.9) million | $21.6 million | $(50.7) million | $34.1 million |
| Net income (loss) | $(29.2) million | $15.1 million | $(44.1) million | $28.3 million |
| Diluted EPS | $(0.60) | $0.31 | $(0.91) | $0.58 |
| Cash flow from operations | Not separately provided for the quarter | $(17.4) million | $48.5 million |
Revenue declined 3.6% in the quarter and 1.8% year to date. Cardiovascular revenue declined 2.4% in Q2 and 1.5% year to date, while Neuromodulation revenue declined 5.8% and 2.7%, respectively. Advanced Circulatory Support growth partly offset weakness in Cardiopulmonary and Heart Valves. Neuromodulation weakness was concentrated in the U.S., reflecting competitive dynamics and sales-force turnover.
Cost of sales excluding amortization was 27.0% of sales in Q2 versus 32.0% in the prior-year quarter, and 30.2% versus 32.8% for the six-month periods. Reported operating margin was approximately negative 10.8% in Q2 and negative 9.6% year to date, compared with positive 7.5% and 6.3% in the comparable 2018 periods. Reported net margin was approximately negative 10.5% in Q2 and negative 8.3% year to date, compared with positive 5.2% and 5.3%.
At June 30, 2019, cash and cash equivalents were $44.5 million, compared with $47.2 million at December 31, 2018. Current assets were $568.4 million and current liabilities were $595.9 million. Total assets were $2.62 billion and total liabilities were $1.14 billion.
Debt obligations included $37.7 million of current debt and $174.4 million of long-term debt on the balance sheet. The company also reported $7.9 million of short-term revolving borrowings. Long-term debt facilities had $204.2 million of principal outstanding. LivaNova entered into a 2019 debt facility with an aggregate commitment of $350 million; $50.6 million was outstanding at June 30, 2019. The company stated that it was in compliance with all debt covenants.
Material changes versus the prior comparable period
- Operating results shifted from profit to loss, primarily because of a $50.3 million impairment of the ImThera obstructive sleep apnea in-process research and development asset, higher litigation-related costs, increased commercial and research spending, and lower revenue.
- Net sales decreased despite growth in Advanced Circulatory Support. Cardiopulmonary sales were affected by the January 2019 exit from a Canadian distribution agreement and unfavorable foreign currency movements. Heart Valves sales declined, particularly in the United States and Europe.
- Neuromodulation segment income fell to $0.6 million in Q2 from $57.2 million in the prior-year quarter and to $22.3 million for the six-month period from $95.9 million. The 2018 comparison included a $50.3 million impairment charge in 2019 and a $11.5 million acquisition gain in 2018.
- Operating cash flow declined from $48.5 million provided in the first half of 2018 to $17.4 million used in the first half of 2019, primarily reflecting working-capital changes, including inventory, taxes, and accrued liabilities.
- Investing cash use improved to $22.5 million from $93.2 million, as the prior-year period included significant acquisitions. Financing cash provided increased to $37.1 million, principally from new long-term borrowing.
- LivaNova adopted ASC 842 lease accounting on January 1, 2019, recognizing approximately $60 million of right-of-use assets and lease liabilities at adoption. At June 30, total operating lease liabilities were $58.3 million.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide clear numerical revenue, earnings, or cash-flow guidance. Management stated that existing cash, expected operating cash generation, and available borrowing capacity should fund operating needs, working capital, research and development, capital expenditures, and debt service for at least the next 12 months.
Management expects the LifeSPARC advanced circulatory support system to be commercially released by the end of 2019. The company also reported CMS coverage developments for VNS Therapy in treatment-resistant depression and continued development of products in heart failure, obstructive sleep apnea, and other therapeutic areas.
The most significant contingency is litigation related to the 3T Heater-Cooler device. LivaNova recorded a $293.3 million litigation provision at June 30, 2019. A settlement framework provides for payments of up to $225 million for specified claims; $135 million was paid into a qualified settlement fund in July 2019 and the remainder was expected in January 2020. Approximately 215 filed and unfiled claims were identified worldwide as of July 30, 2019. The company also expected $33.8 million of insurance recoveries, which had not been recorded at June 30.
The 3T product remediation liability was $10.5 million at June 30, 2019, and remediation expenses were $8.1 million in the first half. The company remains subject to an FDA Warning Letter and related regulatory restrictions concerning certain 3T devices.
Other risks include additional impairment from delays in obstructive sleep apnea commercialization, regulatory approval and reimbursement risk, product liability, unresolved Italian environmental and tax proceedings, foreign-exchange exposure, Brexit-related uncertainty, supplier dependence, cybersecurity, competition, and volatility in medical-device demand.
Management concluded that disclosure controls and procedures were not effective as of June 30, 2019 because of material weaknesses in internal control over financial reporting previously disclosed in the 2018 Form 10-K. Remediation efforts were ongoing, with completion expected before the end of 2019; the weaknesses had not yet been deemed remediated.
Most important facts for an investor to verify
- Whether the $293.3 million 3T litigation provision and the $225 million settlement framework are sufficient as remaining claims and non-U.S. proceedings develop.
- The timing and amount of the expected $33.8 million insurance recovery and the effect of the July 2019 and January 2020 settlement payments on liquidity.
- Whether U.S. Neuromodulation sales stabilize and whether the obstructive sleep apnea commercialization delay leads to further impairment.
- Progress toward remediation of the material weaknesses in internal control over financial reporting.
- Compliance with debt covenants and access to borrowing capacity given cash of only $44.5 million and current liabilities exceeding current assets.
- Regulatory progress and commercial adoption of LifeSPARC, 3T remediation programs, VNS Therapy, and other pipeline products.
- Potential exposure from Italian environmental litigation, tax proceedings, patent litigation, and other unrecorded contingencies for which the filing states that losses are not currently probable or reasonably estimable.