LivaNova PLC: Q2 2016 Form 10-Q Summary
Business context and reporting period
LivaNova is a London-based global medical-device company operating in Cardiac Surgery, Cardiac Rhythm Management and Neuromodulation. The October 2015 Cyberonics-Sorin merger created the combined company. Cyberonics is the accounting predecessor, so reported comparisons are not fully comparable: the current period includes both Cyberonics and Sorin, while the prior period primarily reflects historical Cyberonics.
The filing covers the three and six months ended June 30, 2016. Comparative periods are the thirteen and twenty-six weeks ended July 24, 2015. All amounts below are in U.S. dollars unless otherwise noted.
Financial performance and key metrics
| Metric | Q2 2016 | Six months 2016 |
|---|---|---|
| Net sales | $321.0 million | $608.0 million |
| Gross profit | $190.4 million | $353.8 million |
| Gross margin | 59.3% | 58.2% |
| Operating income (loss) | $22.0 million | $(14.2) million |
| Operating margin | 6.8% | (2.3)% |
| Net income (loss) | $9.0 million | $(31.4) million |
| Diluted EPS | $0.18 | $(0.64) |
| Cash flow from operations | Not separately provided for the quarter | $12.6 million |
- Q2 sales included Cardiac Surgery of $161.1 million, Cardiac Rhythm Management of $69.6 million and Neuromodulation of $90.0 million. Neuromodulation sales increased 11.1% versus the comparable historical Cyberonics period.
- Six-month sales were $608.0 million versus $155.1 million in the historical Cyberonics comparison, primarily because the current period includes Sorin operations. On a supplemental pro forma basis, prior-period combined sales were $606.4 million and pro forma net loss was $34.9 million.
- Q2 selling, general and administrative expense was $120.2 million, research and development expense was $30.2 million, merger and integration expense was $6.2 million, restructuring expense was $4.2 million, amortization was $6.3 million and litigation-related expense was $1.3 million.
- Six-month results included $35.0 million of amortization of the merger-related inventory fair-value step-up, $32.8 million of restructuring expense, $22.2 million of acquired-intangible amortization and $6.3 million of equity-method investment losses.
Balance sheet, liquidity and cash flow
- Cash and cash equivalents were $63.9 million at June 30, 2016, down from $112.6 million at December 31, 2015. Short-term investments were $7.0 million.
- Total debt was $152.1 million, consisting of $68.9 million of current debt and $83.3 million of long-term debt, down from $174.3 million at December 31, 2015. Management stated that debt represented 8.3% of total equity.
- Net cash used in the first six months was $48.7 million. Operating cash flow of $12.6 million and investing cash outflows of $16.0 million were more than offset by $46.2 million of financing outflows, primarily debt repayments of approximately $52.7 million, including repayment of trade-receivable advances.
- Accounts receivable increased to $299.6 million. The company increased its bad-debt allowance by $6.0 million, primarily for potentially uncollectible receivables in Greece.
- Management believes existing cash, investments and expected operating cash generation will fund operating needs, working capital, research and development, capital expenditures and debt service over the next twelve months.
Material changes versus the prior comparable period
- Reported sales and expenses increased substantially because the current period includes Sorin's Cardiac Surgery and Cardiac Rhythm Management businesses, whereas the historical comparison primarily represents Cyberonics.
- Q2 operating income was $22.0 million versus $21.3 million in the prior historical comparison. Six-month operating results declined to a $14.2 million loss from $38.0 million of operating income, reflecting acquired-business costs, inventory step-up amortization, restructuring, acquired-intangible amortization and litigation expense.
- Q2 net income declined to $9.0 million from $12.4 million. Six-month net income declined to a $31.4 million loss from $22.9 million of net income.
- Reported cost of sales increased to 40.7% of sales in Q2 and 41.8% for the first six months, versus 11.6% and 11.0% in the historical Cyberonics comparisons, mainly because of the inclusion of Sorin and merger-related inventory step-up amortization.
- SG&A and R&D declined as percentages of sales, to 37.4% and 9.4% in Q2, respectively, reflecting integration synergies, project completion and portfolio prioritization. A $4.7 million Italian government grant reduced SG&A in Q2.
- The company recorded a $25.3 million reduction to goodwill from measurement-period adjustments related primarily to deferred taxes. The merger purchase-price allocation remained provisional through the June quarter, with finalization expected by October 19, 2016.
Guidance, outlook, unusual items and risks
- No specific revenue or earnings guidance is provided in the filing. Management stated that current liquidity is expected to be sufficient for the next twelve months.
- Restructuring plans are expected to reduce the workforce by approximately 184 employees; 79 reductions had occurred by June 30, 2016. The plans include closing the Meylan, France R&D facility and consolidating activities in Clamart.
- The FDA Warning Letter concerning the Munich and Arvada facilities restricts U.S. importation of 3T Heater Cooler devices. Existing U.S. customers may be served under a certificate-of-medical-necessity process. Management estimated that less than 1% of fiscal 2016 consolidated sales would be affected and stated that the Q2 financial impact was not material.
- Multiple lawsuits allege risks associated with 3T Heater Cooler devices and bacterial exposure. The principal class action had not been certified, but additional related cases had been filed. Potential losses could not be estimated and could materially affect results, financial condition or liquidity.
- SNIA environmental litigation and related appeals concern potential liability for historical contamination in Italy. LivaNova had not accrued for the matter because material loss was considered not probable and the potential amount was not estimable.
- An Italian tax audit covering 2014 and 2015 was ongoing, and the company maintained a $19.2 million provision related to separate Italian tax litigation. Tax outcomes remain uncertain, including the risk that U.S. authorities could treat LivaNova as a U.S. corporation for federal tax purposes.
- Brexit increased currency, capital-market, trade, tax and regulatory uncertainty. Management stated that the immediate impact had been minimal but that the full effect remained uncertain.
- On August 1, 2016, the board authorized repurchases of up to $30 million through December 31, 2016 and up to $150 million in aggregate through December 31, 2018. No repurchases had been made as of August 5, 2016.
- Subsequent events included $8.0 million of new Italian term loans and a $7.5 million investment in Caisson Interventional LLC in July 2016.
Most important facts for investors to verify
- Whether post-merger integration and restructuring produce the expected cost synergies and margin improvement.
- The sustainability of operating cash generation given the June 30 cash balance, ongoing capital expenditures and debt service.
- The final purchase-price allocation and any further goodwill, deferred-tax or amortization adjustments before October 19, 2016.
- The commercial and financial consequences of the FDA 3T Heater Cooler restrictions and related litigation.
- The outcome and potential exposure from SNIA environmental claims, Italian tax proceedings and the ongoing Italian tax audit.
- The effect of foreign exchange, Brexit-related volatility and U.S. tax rules on the company’s international structure and future acquisitions.
- Whether Neuromodulation growth and newly approved products, including Perceval and CROWN PRT, offset pressure in Cardiac Rhythm Management and international markets.