LivaNova plc — Q1 2020 Form 10-Q Summary
Business context and reporting period
LivaNova is a global medical-device company with two reportable segments: Cardiovascular and Neuromodulation. Cardiovascular includes cardiopulmonary, heart-valve and advanced circulatory-support products; Neuromodulation includes VNS therapy for epilepsy, depression and obstructive sleep apnea. The filing covers the three months ended March 31, 2020, with comparisons to the three months ended March 31, 2019. Amounts are presented in U.S. dollars under U.S. GAAP.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 | Change/comment |
|---|---|---|---|
| Net sales | $242.4 million | $250.8 million | Down 3.4% |
| Operating income from continuing operations | $0.6 million | $(20.8) million | Improved by $21.4 million |
| Operating margin | 0.3% | (8.3)% | Improved approximately 8.6 percentage points |
| Loss before tax from continuing operations | $(6.0) million | $(21.5) million | Improved by $15.5 million |
| Income tax benefit | $44.7 million | $6.6 million | Includes $41.3 million CARES Act benefit |
| Net income | $37.6 million | $(14.8) million | Includes $1.0 million loss from discontinued operations |
| Diluted earnings per share | $0.77 | $(0.31) | Tax benefit materially affected earnings |
| Cash flow from operating activities | $(106.0) million | $2.0 million | Primarily reflects $115.6 million litigation settlement payments |
| Capital expenditures | $8.6 million cash purchases; $12.4 million by segment disclosure | $5.7 million cash purchases; $4.9 million by segment disclosure | Filing presents differing capital-expenditure measures |
| Cash and cash equivalents | $125.8 million | $61.1 million at December 31, 2019 | Increased following financing activity |
| Total debt obligations | $538.9 million | $337.7 million at December 31, 2019 | Includes $223.3 million current and $315.6 million long-term debt |
Reported net margin was approximately 15.5%, but this measure is not representative of underlying operating performance because of the $41.3 million discrete CARES Act tax benefit and other tax effects. The effective tax rate from continuing operations was 744.4%, compared with 30.8% in the prior-year quarter.
Segment sales were $152.1 million for Cardiovascular, down 2.2%, and $89.7 million for Neuromodulation, down 5.3%. Segment income increased to $8.7 million for Cardiovascular from $1.0 million and to $33.9 million for Neuromodulation from $21.6 million, partly because of lower litigation and remediation costs and a $14.6 million reduction in the fair value of obstructive-sleep-apnea contingent consideration.
Material changes versus the prior comparable period
- Sales declined across the United States, Europe and Rest of World, with the most significant reported impact occurring in the final two weeks of the quarter as healthcare systems diverted resources toward COVID-19 and delayed elective procedures.
- Cost of sales declined to 28.4% of sales from 33.6%, primarily reflecting a favorable $14.8 million change in the fair value of sales-based contingent consideration.
- Research and development expense declined to 14.8% of sales from 17.4%, primarily reflecting an $11.9 million favorable change in milestone-based contingent consideration.
- Operating performance improved despite lower revenue, assisted by reduced 3T Heater-Cooler litigation and remediation costs, lower restructuring expense and lower selling, general and administrative and R&D spending.
- Operating cash flow deteriorated by $108.0 million year over year because of $115.6 million of payments related to the 3T litigation settlement. The company paid the final $90.0 million settlement installment in January 2020 and made a $16.4 million CRM-sale working-capital adjustment payment.
- Financing activities generated $183.1 million, including $162.9 million of long-term debt proceeds and $46.1 million of short-term borrowings, partially offset by settlement-related and other payments.
- Goodwill declined to $888.6 million from $915.8 million at year-end, primarily due to foreign-currency translation. Management concluded that an interim goodwill or indefinite-lived-intangible impairment test was not required as of March 31, 2020.
Guidance, outlook, commentary, risks and unusual items
- Management expected Q2 2020 sales and operating results to be materially adversely affected by COVID-19, with anticipated stabilization in Q3 and a global recovery in Q4 if elective surgeries were rescheduled as expected. The filing states that this outlook was highly uncertain and was not a guarantee.
- COVID-19 reduced elective procedures and Neuromodulation implants, delayed clinical-trial activity and created risks to customer demand, employees, suppliers, manufacturing and distribution. The RECOVER study was expected to have few new implants for approximately six months, with implants expected to resume in Q4 2020. Enrollment in the ANTHEM-HFrEF U.S. pivotal trial was temporarily paused.
- The company determined that projected Q2 sales reductions could cause covenant breaches at the end of Q2 and Q4 2020, creating substantial doubt about going-concern status. April 2020 debt amendments modified leverage and interest-coverage covenants, waived certain COVID-19-related defaults through December 31, 2020 and, according to management, alleviated the substantial doubt for the twelve-month period following issuance.
- Management implemented cost reductions, including reduced hiring, marketing, travel, capital expenditures and selected R&D activities. It believed cash, operating cash flow and available borrowing capacity would fund expected needs for the following twelve months, but warned that further deterioration could require additional financing, covenant waivers, factoring or more extensive cost reductions.
- 3T Heater-Cooler remediation remained an unusual regulatory and product-liability matter. The company received FDA 510(k) clearance on February 25, 2020 for updated 3T devices and related design changes. The product-remediation liability was $1.6 million at March 31, 2020, while the related litigation provision was $54.6 million.
- The company was aware of approximately 90 filed and unfiled 3T-related claims worldwide as of April 29, 2020. Additional environmental, patent, contract and tax matters remained unresolved; certain potential losses were not accrued because they were not considered probable or reasonably estimable.
- Brexit could create future regulatory, trade and tax uncertainty. The company also reported $0.5 million of gross revenue and $0.2 million of net profit from activities in Iran during the quarter.
Important facts for investors to verify
- Whether the amended debt covenants remain satisfied as COVID-19 affected revenue, EBITDA and elective-procedure volumes.
- The pace and durability of elective-surgery recovery and its effect on Cardiovascular and Neuromodulation sales.
- Whether operating cash flow normalizes after the 3T settlement payments and whether additional borrowing is required.
- The remaining exposure from 3T litigation, environmental claims, patent litigation, contract litigation and Italian tax matters.
- Potential future goodwill or indefinite-lived-intangible impairment, particularly for Cardiovascular, whose 2019 goodwill headroom was reported at 24%.
- The extent to which the CARES Act tax benefit and contingent-consideration fair-value changes distort reported earnings and margins.
- The filing’s differing capital-expenditure presentations and the underlying cash capital-spending amount.