HAEMONETICS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with both our interim consolidated financial statements and notes thereto which appear elsewhere in this Quarterly Report on Form 10-Q and our annual consolidated financial statements, notes thereto and the MD&A contained in our fiscal year 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on May 22, 2012. The following discussion may contain forward-looking statements and should be read in conjunction with the "Cautionary Statement Regarding Forward-Looking Information." Our Business Haemonetics is a blood management solutions company. Anchored by our medical device systems, we also provide information technology platforms and value added services to provide customers with business solutions which support improved clinical outcomes for patients and efficiency in the blood supply chain. On August 1, 2012 we completed the acquisition of the business assets of the blood collection, filtration and processing product lines of Pall Corporation. At the closing of the transaction, we paid $535.1 million in cash consideration subject to typical post-closing adjustments to reflect certain cost allocations, assets and liabilities. The acquisition was funded utilizing $475.0 million of loans and the remainder from cash on hand. The blood processing systems and equipment acquired are for use in transfusion medicine and include Pall's manufacturing facilities in Covina, California; Tijuana, Mexico; Ascoli, Italy and a portion of Pall's assets in Fajardo, Puerto Rico. Approximately 1,300 employees transferred to Haemonetics. We anticipate paying an additional $15.0 million upon the replication and delivery of certain manufacturing assets of Pall's filter media business to Haemonetics by 2016. Until that time, Pall will manufacture and sell filter media to Haemonetics under a supply agreement. We refer to this newly acquired business as the whole blood business.

In April 2012, we announced the planned acquisition of the business assets of Hemerus Medical, LLC, a Minnesota-based company that develops innovative technologies for the collection of whole blood and processing and storage of blood components. Under the terms of the agreement, we paid $1.0 million and we will pay up to $26.0 million contingent on certain regulatory approvals.

Additionally, royalty payments on Hemerus products will apply for the next 10 years or until a maximum cumulative royalty amount of $14.0 million has been paid. We currently expect the required regulatory approvals in the first quarter of fiscal 2014. Because our acquisition agreement expires on April 30, 2013, accordingly, negotiations of an extension to the agreement may be required.

Our medical device systems provide both automated and manual collection and processing of donated blood, assess likelihood for blood loss, salvage and process blood from surgery patients, and dispense and track blood inventory in the hospital. These systems include devices and single-use, proprietary disposable sets ("disposables") some of which only operate with our specialized devices. Specifically, our plasma and blood center systems allow users to collect and process only the blood component(s) they target - plasma, platelets, or red blood cells - increasing donor and patient safety as well as collection efficiencies. Our blood diagnostics system assesses hemostasis (a patient's clotting ability) to aid clinicians in assessing the cause of bleeding, resulting in overall reductions in blood product usage. Our surgical blood salvage systems allow surgeons to collect the blood lost by a patient in surgery, cleanse the blood, and make it available for transfusion back to the patient. Our blood tracking systems automate the distribution of blood products in the hospital. Our manual blood collection and filtration systems enable the manual collection of all blood components while detecting bacteria, thus reducing the risks of infection through transfusion.

When placed devices remain our property, the customer has the right to use these for a period of time as long as the customer meets certain conditions we have established, which, among other things, generally include one or more of the following: 19-------------------------------------------------------------------------------- Table of Contents • Purchase and consumption of a minimum level of disposables products; • Payment of monthly rental fees; and • An asset utilization performance metric, such as performing a minimum level of procedures per month per device.

Our disposables revenue stream includes the sales of manual collection and filtration systems, device disposables and fees for the use of our equipment, which accounted for approximately 84.7% and 82.2% of our total revenues for the nine months ended December 29, 2012 and December 31, 2011, respectively.

Financial Summary Three Months Ended Nine Months Ended (in thousands, except per share December 29, December 31, % Increase/ December 29, December 31, % Increase/ data) 2012 2011 (Decrease) 2012 2011 (Decrease) Net revenues $ 247,395 $ 191,160 29.4 % $ 642,048 $ 541,174 18.6 % Gross profit $ 113,115 $ 95,931 17.9 % $ 304,990 $ 274,629 11.1 % % of net revenues 45.7 % 50.2 % 47.5 % 50.7 % Operating expenses $ 97,368 $ 70,608 37.9 % $ 266,261 $ 206,831 28.7 % Operating income $ 15,747 $ 25,323 (37.8 )% $ 38,729 $ 67,798 (42.9 )% % of net revenues 6.4 % 13.2 % 6.0 % 12.5 % Other income (expense), net $ (2,542 ) $ 140 $ (3,518 ) $ 370 Income before taxes $ 13,205 $ 25,463 (48.1 )% $ 35,211 $ 68,168 (48.3 )% Provision for income tax $ 3,301 $ 7,211 (54.2 )% $ 8,972 $ 19,088 (53.0 )% % of pre-tax income 25.0 % 28.3 % 25.5 % 28.0 % Net income $ 9,904 $ 18,252 (45.7 )% $ 26,239 $ 49,080 (46.5 )% % of net revenues 4.0 % 9.5 % 4.1 % 9.1 % Earnings per share-diluted $ 0.19 $ 0.36 (47.2 )% $ 0.50 $ 0.95 (47.4 )% Net revenues increased 29.4% and 18.6% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012.

Without the effects of foreign exchange, net revenues increased 28.7% and 17.8% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. This increase includes sales from the recently acquired whole blood business of $54.9 million and $83.5 million for the three and nine months ended December 29, 2012, respectively. The remaining increase for the three months ended December 29, 2012 is primarily due to revenue growth from our surgical and diagnostics businesses. The increase for the nine months ended December 29, 2012 also included growth in our plasma business. Fiscal 2012 revenue benefited from purchases by the Japan Red Cross ("JRC") in March 2012 to avoid future supply disruptions in anticipation of an internal business system conversion, negatively impacting the nine months ended December 29, 2012.

Operating income decreased 37.8% and 42.9% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012.

Without the effects of foreign exchange, operating income decreased 34.2% and 51.9% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012 as increased gross profit due to revenue growth was more than offset by higher costs of goods sold due to a $2.8 million and $11.1 million acquisition-related step-up in the value of acquired inventory respectively, higher operating expenses including significant acquisition and integration costs totaling $11.7 million and $29.1 million, respectively and a $6.1 million inventory reserve for a quality matter with a component of our whole blood disposable inventory which occurred in the three months ended December 29, 2012. This matter is discussed in the gross profit section below.

Net income decreased 45.7% and 46.5% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012.

Without the effects of foreign exchange, net income decreased 43.5% and 56.1% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. The decrease in net income was attributable to the decrease in operating income described above and additional interest expense.

20-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Net Revenues by Geography Three Months Ended Nine Months Ended December 29, December 31, % Increase/ December 29, December 31, % Increase/ (in thousands) 2012 2011 (Decrease) 2012 2011 (Decrease) United States $ 125,362 $ 92,123 36.1 % $ 324,755 $ 264,857 22.6 % International 122,033 99,037 23.2 % 317,293 276,317 14.8 % Net revenues $ 247,395 $ 191,160 29.4 % $ 642,048 $ 541,174 18.6 % International Operations and the Impact of Foreign Exchange Our principal operations are in the U.S., Europe, Japan and other parts of Asia.

Our products are marketed in more than 97 countries around the world through a combination of our direct sales force and independent distributors and agents.

Our revenues generated outside the U.S. approximated 49.4% and 51.1% of total net revenues for the nine months ended December 29, 2012 and December 31, 2011, respectively. International sales are generally conducted in local currencies, primarily the Japanese Yen and the Euro. Our revenues are impacted by changes in the value of the Yen and the Euro relative to the U.S. Dollar.

Please see section entitled "Foreign Exchange" in this discussion for a more complete explanation of how foreign currency affects our business and our strategy for managing this exposure.

Net Revenues by Product Type Three Months Ended Nine Months Ended December 29, December 31, % Increase/ December 29, December 31, % Increase/ (in thousands) 2012 2011 (Decrease) 2012 2011 (Decrease) Disposables $ 212,638 $ 156,354 36.0 % $ 543,925 $ 444,810 22.3 % Software solutions 16,008 15,849 1.0 % 51,354 51,208 0.3 % Equipment & other 18,749 18,957 (1.1 )% 46,769 45,156 3.6 % Net revenues $ 247,395 $ 191,160 29.4 % $ 642,048 $ 541,174 18.6 % Disposable Revenues by Product Type Three Months Ended Nine Months Ended December 29, December 31, % Increase/ December 29, December 31, % Increase/ (in thousands) 2012 2011 (Decrease) 2012 2011 (Decrease) Plasma disposables $ 68,102 $ 69,040 (1.4 )% $ 200,657 $ 196,206 2.3 % Blood center disposables Platelet 45,139 44,383 1.7 % 125,579 123,888 1.4 % Red cell 11,752 12,162 (3.4 )% 35,738 35,676 0.2 % Whole blood 54,894 - 100.0 % 83,514 - 100.0 % $ 111,785 $ 56,545 97.7 % $ 244,831 $ 159,564 53.4 % Hospital disposables Surgical 18,900 17,333 9.0 % 55,965 49,281 13.6 % OrthoPAT 7,090 7,755 (8.6 )% 22,276 22,804 (2.3 )% Diagnostics 6,761 5,681 19.0 % 20,196 16,955 19.1 % $ 32,751 $ 30,769 6.4 % $ 98,437 $ 89,040 10.6 % Total disposables revenue $ 212,638 $ 156,354 36.0 % $ 543,925 $ 444,810 22.3 % Disposables Disposables revenue increased 36.0% and 22.3% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, disposables revenue increased 35.2% and 21.2% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012, 21-------------------------------------------------------------------------------- Table of Contents driven primarily by revenue from the acquired whole blood business and growth in sales in the surgical and diagnostics businesses as discussed below.

Plasma Plasma disposables revenue decreased 1.4% and increased 2.3% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, plasma revenue decreased 1.1% and increased 2.3% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Plasma revenue increased for the nine months ended December 29, 2012 due primarily to higher revenue from commercial fractionation customers in North America, with increased collections more than offsetting price reductions in contract renewals completed in fiscal 2012. Plasma revenue declined for the three months ended December 29, 2012 as collection growth did not fully offset price reductions as collections in the prior fiscal year were more highly skewed to the third quarter.

Blood Center Blood center consists of disposables used to collect blood components platelets, red cells and whole blood. Platelet disposables revenue increased 1.7% and 1.4% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, platelet disposable revenue increased 1.8% and 0.4% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012 resulting from continued growth in emerging markets which more than offset declines in mature markets. Revenue in Japan was lower due to benefits from quality issues experienced with a competitor's device in the prior year, and for the nine months ended December 29, 2012 due to the negative impact of the JRC's purchases in March 2012 to avoid future supply disruptions in anticipation of internal system conversion.

Red cell disposables revenue decreased 3.4% in the three months and increased 0.2% in the nine months ended December 29, 2012 respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, red cell disposables revenue decreased 2.8% and increased 0.6% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012, due to reductions in surgical procedures and improved blood management. Recent data suggests improved blood management procedures in hospitals are reducing demand for red cells.

Whole blood disposables revenue was $54.9 million and $83.5 million for the three and nine months ended December 29, 2012, representing sales of products from the Pall acquisition completed on August 1, 2012.

Hospital Hospital consists of Surgical, OrthoPAT, and Diagnostics products. Surgical disposables revenue consists principally of the Cell Saver and CardioPAT products. Revenues from our surgical disposables increased 9.0% and 13.6% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, surgical disposables revenue increased 7.8% and 10.5% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012, due to continued growth from market acceptance of Cell Saver Elite in the U.S., Europe and Japan. Surgical revenue also benefited from market share gains due to limited product availability from our primary competitor during the majority of the nine months ended December 29, 2012 due to a now resolved supply chain disruption associated with a natural disaster in Europe.

Revenues from our OrthoPAT disposables decreased 8.6% and 2.3% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, OrthoPAT disposables revenue decreased by 9.4% and 3.5% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012 primarily due to lower sales in the U.S. as device utilization by smaller hospitals has declined following the voluntary recall of the OrthoPAT device in fiscal 2012.

Diagnostics product revenue consists principally of the consumable reagents used with the TEG analyzer. Revenues from our diagnostics products increased 19.0% and 19.1% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, diagnostics product revenues increased 17.3% and 17.5% for the three and nine months ended December 29, 2012 respectively, as compared to the same periods of fiscal 2012. The revenue increase is due to continued adoption of our TEG analyzer, principally in the U.S. and China.

Software Solutions Our software solutions revenues include sales of our information technology software platforms and consulting services. Software revenues increased 1.0% and 0.3% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, software revenues increased 1.8% and 1.7% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. The increases were primarily due to hospital software sales and installed base growth, offset by declines in plasma software revenue.

22-------------------------------------------------------------------------------- Table of Contents Equipment & Other Our equipment and other revenues include revenue from equipment sales, repairs performed under preventive maintenance contracts or emergency service visits, spare part sales, and various service and training programs. These revenues are primarily composed of equipment sales, which tend to vary from period to period more than our disposable business due to the timing of order patterns, particularly in our distribution markets. Equipment and other revenues decreased 1.1% and increased 3.6% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, equipment and other revenues decreased 0.9% and increased 3.6% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Year-to-date growth is primarily due to higher surgical equipment sales. The decline in revenue for the three months ended December 29, 2012 is due primarily to timing of tender awards in our distribution markets.

Gross Profit Three Months Ended Nine Months Ended December 29, December 31, % Increase/ December 29, December 31, % Increase/ (in thousands) 2012 2011 (Decrease) 2012 2011 (Decrease) Gross profit $ 113,115 $ 95,931 17.9 % $ 304,990 $ 274,629 11.1 % % of net revenues 45.7 % 50.2 % 47.5 % 50.7 % Gross profit amounts increased 17.9% and 11.1% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Without the effect of foreign exchange, gross profit increased 16.6% and 8.6% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. Our gross profit margin decreased by 446 and 324 basis points for the three and nine month periods ending December 29, 2012, respectively, as compared to the same periods of fiscal 2012.

The decrease in gross profit margin for the three and nine month periods includes approximately $2.8 million and $11.1 million respectively of costs of goods sold related to the increase in fair value of acquisition-related whole blood inventory acquired from Pall as well as a $6.1 million inventory reserve recorded. This reserve related to the removal of affected whole blood collection sets from inventory for destruction or rework based on a quality matter detected during the third quarter of fiscal 2013. We issued a field action letter to blood center customers requesting visual inspection of a component of certain whole blood collection sets, due to the potential for a leak to occur at a very low frequency. The component, referred to as a Y connector, was supplied by a contract manufacturer. We will pursue all available means of financial recovery related to this inventory loss. However, no salvage or recovery value from these efforts was recorded as we cannot currently conclude whether a favorable outcome will result.

Additionally, the decrease in gross profit margin included the mix impact of whole blood disposable sales, as whole blood gross margins are lower than average gross margins for our complete product line. This was partially offset by reduced equipment depreciation expense as a result of a change in estimated useful lives implemented during the three months ended June 30, 2012. We expect this change in estimate will reduce fiscal year 2013 depreciation expense by approximately $4.5 million and increase income net of tax by approximately $3.3 million.

Operating Expenses Three Months Ended Nine Months Ended December 29, December 31, % Increase/ December 29, December 31, % Increase/ (in thousands) 2012 2011 (Decrease) 2012 2011 (Decrease) Research and development $ 10,588 $ 9,232 14.7 % $ 30,823 $ 28,190 9.3 % % of net revenues 4.3 % 4.8 % 4.8 % 5.2 % Selling, general and administrative $ 86,780 $ 61,376 41.4 % $ 235,438 $ 180,221 30.6 % % of net revenues 35.1 % 32.1 % 36.7 % 33.3 % Contingent consideration $ - $ - 100.0 % $ - $ (1,580 ) (100.0 )% % of net revenues - % - % - % (0.3 )% Total operating expenses $ 97,368 $ 70,608 37.9 % $ 266,261 $ 206,831 28.7 % % of net revenues 39.4 % 36.9 % 41.5 % 38.2 % 23-------------------------------------------------------------------------------- Table of Contents Research and Development Research and development expenses increased 14.7% and 9.3% for the three and nine months ended December 29, 2012, respectively, as compared to the same periods of fiscal 2012. These increases are primarily due to additional staff and program spending related to the whole blood acquisition and related product initiatives, as well as a general increase in development programs to support long-term product plans.

Selling, General and Administrative During the three and nine months ended December 29, 2012, selling, general and administrative expenses increased 41.4% and 30.6%, respectively, as compared to the same periods of fiscal 2012. These increases include acquisition and integration expenses associated with the whole blood acquisition of $11.7 million and $29.1 million for the three and nine months ended December 29, 2012, respectively. We also incurred approximately $13.6 million and $22.0 million of incremental expense related to the whole blood business during the three and nine months ended December 29, 2012, respectively, following the August 1, 2012 acquisition. We also incurred higher incentive compensation this fiscal year as financial performance versus established financial targets improved as compared to fiscal 2012.

Contingent Consideration Income Under the accounting rules for business combinations (specifically, ASC Topic 805, Business Combinations), we established a liability for payments that we might make in the future to former shareholders of Neoteric that are tied to the performance of the Blood Track business for the first three years post acquisition, beginning with fiscal 2010. During fiscal 2012, we reviewed the expected performance versus the necessary thresholds of performance for the former shareholders to receive additional performance payments and we recorded an adjustment to the fair value of the contingent consideration as contingent consideration income of $1.6 million and $1.9 million for the nine months ended December 31, 2011 and January 1, 2011, respectively.

In September 2011, we entered into an agreement which released the Company from the contingent consideration due to the former shareholders of Neoteric. Under the terms of the agreement, the former shareholders of Neoteric received $0.7 million in exchange for releasing the Company from any future claims for contingent consideration. The Company paid the $0.7 million settlement amount during September 2011 and recorded the associated expense in the selling, general and administrative line item in the accompanying consolidated statements of income for the nine months ended December 31, 2011.

Other Expense, Net Other expense, net, increased for the three and nine months ended December 29, 2012 as compared to the same periods of fiscal 2012, primarily due to interest expense from the $475.0 million term loan.

Income Taxes Three Months Ended Nine Months Ended December 29, December 31, % Increase/ December 29, December 31, % Increase/ 2012 2011 (Decrease) 2012 2011 (Decrease) Reported income tax rate 25.0 % 28.3 % (3.3 )% 25.5 % 28.0 % (2.5 )% The Company's reported tax rate was 25.0% and 25.5% for the three and nine months ended December 29, 2012, respectively. Our reported tax rate is lower than the federal statutory tax rate in both periods reported primarily due to lower foreign tax rates, including tax benefits associated with our operations in Switzerland and since the acquisition of the whole blood business, Puerto Rico.

Liquidity and Capital Resources The following table contains certain key performance indicators we believe depict our liquidity and cash flow position: December 29, March 31, (dollars in thousands) 2012 2012 Cash & cash equivalents $ 193,181 $ 228,861 Working capital $ 421,272 $ 396,385 Current ratio 3.4 4.0 Net (debt)/cash position (1) $ (289,266 ) $ 225,090 Days sales outstanding (DSO) 61 66 Disposable finished goods inventory turnover 4.4 5.7 24-------------------------------------------------------------------------------- Table of Contents (1) Net (debt)/cash position is the sum of cash and cash equivalents less total debt.

Our primary sources of liquidity are cash and cash equivalents, internally generated cash flow from operations and option exercises. On August 1, 2012, we entered into a loan agreement for $475.0 million which was used to finance the acquisition of certain assets of the blood collection, filtration and processing business of Pall Corporation. We also entered into a $50.0 million revolving loan on August 1, 2012 which we have not yet drawn down on. On December 21, 2012 we entered into an interest rate swap arrangement to minimize our exposure to changes in the benchmark rate, LIBOR. This swap agreement requires that we pay fixed sums of interest and in exchange receive variable amounts based on LIBOR.

We believe these sources are sufficient to fund our cash requirements over the next twelve months, which are primarily capital expenditures, cash payments under the loan agreement, share repurchases under programs authorized by the Board of Directors at its discretion and investments including the contingent purchase of Hemerus described previously and other acquisitions.

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