KINETIC CONCEPTS INC /TX/ - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2003

Commission file number 001-09913

KINETIC CONCEPTS, INC.

(Exact name of registrant as specified in its charter)

Texas	74-1891727
(State of Incorporation)	(I.R.S. Employer Identification No.)

8023 Vantage Drive
San Antonio, Texas 78230
Telephone Number: (210) 524-9000
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _ No _X

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes _ No _X

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common Stock: 71,028,040 shares as of May 12, 2003

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

Condensed Consolidated Statements of Earnings

Condensed Consolidated Statements of Cash Flows

Notes to Condensed Consolidated Financial Statements

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 4. CONTROLS AND PROCEDURES

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

SIGNATURES

CERTIFICATIONS

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KINETIC CONCEPTS, INC.

INDEX

		Page No.
PART I.	FINANCIAL INFORMATION		4
	Item 1.	Financial Statements	4
		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Earnings	5
		Condensed Consolidated Statements of Cash Flows	6
		Notes to Condensed Consolidated Financial Statements	7
		Parent Company Balance Sheet, March 31, 2003	14
		Parent Company Balance Sheet, December 31, 2002	15
		Parent Company Statement of Earnings, three months ended March 31, 2003	16
		Parent Company Statement of Earnings, three months ended March 31, 2002	17
		Parent Company Statement of Cash Flows, three months ended March 31, 2003	18
		Parent Company Statement of Cash Flows, three months ended March 31, 2002	19
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	21
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	35
	Item 4.	Controls and Procedures	35
PART II.	OTHER INFORMATION		36
	Item 1.	Legal Proceedings	36
	Item 6.	Exhibits and Reports on Form 8-K	36
	SIGNATURES		37
	CERTIFICATIONS		38

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

KINETIC CONCEPTS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands)

	March 31,	December 31,
	2003	2002
	(unaudited)
Assets:
Current assets:
Cash and cash equivalents	$ 137,191	$ 54,485
Accounts receivable, net	157,959	152,896
Accounts receivable - other	-	175,000
Inventories, net	34,857	37,934
Prepaid expenses and other current assets	13,302	9,760
	_______	_______
Total current assets	343,309	430,075
	_______	_______

Net property, plant and equipment	114,241	105,549
Loan issuance cost, less accumulated amortization
of $12,528 in 2003 and $11,949 in 2002	5,332	5,911
Goodwill	46,357	46,357
Other assets, less accumulated amortization of
$6,974 in 2003 and $6,840 in 2002	30,356	30,167
	_______	_______
	$ 539,595	$ 618,059
	_____	_____
Liabilities and Shareholders' Deficit:
Current liabilities:
Accounts payable	$ 12,643	$ 11,156
Accrued expenses	64,641	61,556
Current installments of long-term obligations	19,901	30,550
Current installments of capital lease obligations	159	157
Derivative financial instruments	1,691	1,341
Income taxes payable	86,222	14,615
Current deferred income taxes	-	66,838
	_______	_______
Total current liabilities	185,257	186,213
	_______	_______

Long-term obligations, net of current installments	394,949	491,300
Capital lease obligations, net of
current installments	52	95
Deferred income taxes, net	8,701	9,501
Deferred gain, sale of headquarters facility	9,764	10,023
Other noncurrent liabilities	2,617	1,363
	_______	_______
	601,340	698,495
Shareholders' deficit:	_______	_______
Common stock; issued and outstanding 71,028
in 2003 and 70,928 in 2002	71	71
Retained deficit	(58,626)	(76,216)
Accumulated other comprehensive loss	(3,190)	(4,291)
	_______	_______
	(61,745)	(80,436)
	_______	_______
	$ 539,595	$ 618,059
	_____	_____
See accompanying notes to condensed consolidated financial statements.

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KINETIC CONCEPTS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Earnings (in thousands, except per share data) (unaudited)




	Three months ended March 31,
	2003	2002
Revenue:
Rental and service	$ 129,442	$ 101,415
Sales and other	37,142	25,726
	_______	_______
Total revenue	166,584	127,141
	_______	_______

Rental expenses	78,960	61,790
Cost of goods sold	13,645	9,605
	_______	_______
	92,605	71,395
	_______	_______
Gross profit	73,979	55,746

Selling, general and administrative expenses	40,906	31,192
	_______	_______
Operating earnings	33,073	24,554

Interest income	400	10
Interest expense	(8,178)	(10,308)
Foreign currency gain (loss)	1,788	(544)
	_______	_______
Earnings before income taxes	27,083	13,712

Income taxes	10,156	5,279
	_______	_______
Net earnings	$ 16,927	$ 8,433
	_____	_____

Basic earnings per common share	$ 0.24	$ 0.12
	_____	_____
Diluted earnings per common share	$ 0.21	$ 0.11
	_____	_____
Average common shares:
Basic (weighted average
outstanding shares)	70,995	70,925
	_____	_____
Diluted (weighted average
outstanding shares)	79,861	77,721
	_____	_____

See accompanying notes to condensed consolidated financial statements.

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KINETIC CONCEPTS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
	Three months ended March 31,

	2003	2002
Cash flows from operating activities:
Net earnings	$ 16,927	$ 8,433
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation	9,952	7,537
Amortization	713	1,475
Provision for uncollectible accounts receivable	1,749	2,514
Amortization of deferred gain on sale/leaseback of
headquarters facility	(259)	-
Change in assets and liabilities net of effects from
purchase of subsidiaries and unusual items:
Increase in accounts receivable, net	(6,983)	(13,655)
Decrease in other accounts receivable	175,000	-
Decrease (increase) in inventories	2,992	(499)
Increase in prepaid expenses and other current assets	(3,541)	(5,129)
Increase in accounts payable	1,455	324
Increase (decrease) in accrued expenses	3,025	(3,521)
Increase in income taxes payable	71,606	2,956
Decrease in current deferred income taxes	(66,838)	-
Increase (decrease) in deferred income taxes, net	(677)	340
	______	______
Net cash provided by operating activities	205,121	775
	______	______
Cash flows from investing activities:
Additions to property, plant and equipment	(17,678)	(16,269)
Increase in inventory to be converted into
equipment for short-term rental	(200)	(200)
Dispositions of property, plant and equipment	404	842
Business acquisitions, net of cash acquired	-	(3,736)
Increase in other assets	(323)	(1,229)
	______	______
Net cash used by investing activities	(17,797)	(20,592)
	______	______
Cash flows from financing activities:
Proceeds from (repayment of) notes payable, long-term,
capital lease and other obligations	(105,787)	22,005
Proceeds from the exercise of stock options	663	-
	______	______
Net cash provided (used) by financing activities	(105,124)	22,005
	______	______
Effect of exchange rate changes on cash and cash equivalents	506	(104)
	______	______
Net increase in cash and cash equivalents	82,706	2,084
Cash and cash equivalents, beginning of period	54,485	199
	______	______
Cash and cash equivalents, end of period	$ 137,191	$ 2,283
	_____	____
Supplemental disclosure of cash flow information:
Cash paid during the first three months for:
Interest	$ 2,730	$ 4,924
Income taxes	$ 5,508	$ 1,839
See accompanying notes to condensed consolidated financial statements.

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KINETIC CONCEPTS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation

The financial statements presented herein include the accounts of Kinetic Concepts, Inc., together with our consolidated subsidiaries ("KCI"). The unaudited condensed consolidated financial statements appearing in this quarterly report on Form 10-Q should be read in conjunction with the financial statements and notes thereto included in KCI's latest annual report on Form 10-K. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial position and cash flows in conformity with accounting principles generally accepted in the United States. Operating results from interim periods are not necessarily indicative of res ults that may be expected for the fiscal year as a whole. In our opinion, the consolidated financial statements reflect all adjustments considered necessary for a fair presentation of our results for the periods presented. Certain reclassifications of amounts related to the prior year have been made to conform with the 2003 presentation.

(b) Stock Options

We use the intrinsic value method in accounting for our stock option plan. In the first quarter of 2003 and 2002, compensation costs of approximately $660,000 and $85,000, respectively, net of estimated taxes, have been recognized in the financial statements related to this plan. If the compensation cost for our stock-based employee compensation plan had been determined based upon a fair value method consistent with Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," our net earnings and earnings per share would have been decreased to the pro forma amounts indicated below. For purposes of pro forma disclosures, the estimated fair value of the options is recognized as an expense over the options' respective vesting periods. Our pro forma calculations are as follows (dollars in thousands, except for earnings per share information):

	Three months ended
	March 31,
	2003	2002

Net earnings as reported	$ 16,927	$ 8,433
Pro forma net earnings	$ 16,553	$ 8,070

Earnings per share as reported
Basic earnings per common share	$ 0.24	$ 0.12
Diluted earnings per common share	$ 0.21	$ 0.11

Pro forma earnings per share
Basic earnings per common share	$ 0.23	$ 0.11
Diluted earnings per common share	$ 0.21	$ 0.10

We are not required to apply, and have not applied, the method of accounting prescribed by SFAS 123 to stock options granted prior to January 1, 1995. Moreover, the pro forma compensation cost reflected above may not be representative of future expense.

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(c) Other New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued SFAS 143, "Accounting for Asset Retirement Obligations," effective for fiscal years beginning after June 15, 2002. This standard addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard requires us to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and to adjust its present value in each subsequent period. In addition, we must capitalize an amount equal to the adjustment by increasing the carrying amount of the related long-lived asset, which is depreciated over the remaining useful life of the related asset. We adopted SFAS 143 during the first quarter of 2003 and it did not have a significant effect on our financial position or results of operations.

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities," effective for fiscal years or interim periods beginning after June 15, 2003. FIN 46 addresses accounting for, and disclosure of, variable interest entities. FIN 46 requires the disclosure of the nature, purpose and exposure of any loss related to our involvement with variable interest entities. We have adopted FIN 46 during the first quarter of 2003 and it did not have a significant effect on our financial position or results of operations.

(d) Other Significant Accounting Policies

For further information, see Note 1 to the consolidated financial statements included in KCI's Annual Report on Form 10-K for the year ended December 31, 2002.

(2) ACCOUNTS RECEIVABLE COMPONENTS

Accounts receivable consist of the following (dollars in thousands):

	March 31,	December 31,
	2003	2002

Trade accounts receivable:
Facilities / dealers	$ 96,395	$ 91,756

Third party payers:
Medicare / Medicaid	33,878	31,721
Managed care, insurance and other	53,914	53,229
	_______	_______
	184,187	176,706
Medicare V.A.C. receivables prior to
October 1, 2000	14,191	14,351
Employee and other receivables	2,874	2,410
	_______	_______
	201,252	193,467
Less: Allowance for doubtful accounts	(29,102)	(26,220)
Allowance for Medicare V.A.C. receivables
prior to October 1, 2000	(14,191)	(14,351)
	_______	_______
	$ 157,959	$ 152,896
	_____	_____

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(3) INVENTORY COMPONENTS

Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). Inventories are comprised of the following (dollars in thousands):

	March 31,	December 31,
	2003	2002

Finished goods	$ 15,050	$ 16,411
Work in process	2,612	2,411
Raw materials, supplies and parts	30,987	31,825
	______	______
	48,649	50,647

Less: Amounts expected to be converted
into equipment for short-term rental	(11,300)	(11,100)
Reserve for excess and obsolete
inventory	(2,492)	(1,613)
	______	______
	$ 34,857	$ 37,934
	_____	_____

(4) LONG-TERM OBLIGATIONS AND DERIVATIVE FINANCIAL INSTRUMENTS

Long-term obligations consist of the following (dollars in thousands):

	March 31,	December 31,
	2003	2002
Senior Credit Facility:
Term loans:
Tranche A due 2003	$ 17,633	$ 27,500
Tranche B due 2004	57,283	85,500
Tranche C due 2005	57,283	85,500
Tranche D due 2006	62,699	93,575
Tranche E due 2005	19,952	29,775
Revolving bank credit facility	-	-
	_______	______
	214,850	321,850
9 5/8% Senior Subordinated
Notes due 2007	200,000	200,000
	_______	______
	414,850	521,850
Less current installments	(19,901)	(30,550)
	_______	______
	$ 394,949	$ 491,300
	______	______

In January 2003, we received $175 million pursuant to the settlement of our anti-trust lawsuit with Hillenbrand Industries (see Note 7 for additional discussion). The cash received was used to pay down $107 million of indebtedness on the senior credit facility. In addition, $66.8 million has been recorded as income taxes payable for estimated tax liabilities related to the gain.

As of March 31, 2003, we had no revolving loan outstanding. However, we had outstanding five letters of credit in the aggregate amount of $10.9 million. The resulting availability under the revolving credit facility was $39.1 million at the end of the quarter.

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Interest Rate Protection

We follow SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," and its amendments, SFAS 137 and 138 in accounting for our derivative instruments. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at fair value. We have designated our interest rate swap agreements as cash flow hedge instruments. The swap agreements are used to manage exposure to interest rate movement by effectively changing the variable interest rate to a fixed rate. The critical terms of the interest rate swap agreements and the interest-bearing debt associated with the swap agreements must be the same to qualify for the shortcut method of accounting. Changes in the effective portion of the fair value of the interest rate swap agreement will be recognized in other comprehensive income, net of tax effects, until the hedged item is recognized into earnings.

The following chart summarizes interest rate hedge transactions effective during the first quarter of 2003 (dollars in thousands):

		Nominal	Fixed
Accounting Method	Effective Dates	Amount	Interest Rate	Status

Shortcut	12/31/02 - 12/31/03	$ 80,000	$ 1.745%	Outstanding
Shortcut	12/31/02 - 12/31/04	$ 100,000	$ 2.375%	Outstanding

As of December 31, 2002, two $100 million interest rate swap agreements were in effect to take advantage of low interest rates. On January 31, 2003, we sold $20 million of our $100 million, 1.7450% interest rate swap effective March 31, 2003 which resulted in an expense of approximately $74,000 which was recorded in the first quarter of 2003. As of March 31, 2003, the current interest rate swap agreements effectively fix the base-borrowing rate on 84% of our variable rate debt. The fair value of these swaps at inception was zero. Due to subsequent movements in interest rates, as of March 31, 2003, the fair values of the $80 million and $100 million swap agreements were negative and were adjusted to reflect a liability of approximately $300,000 and $1.4 million, respectively. As a result of interest rate protection agreements in effect during the first quarter of 2003 and 2002, we recorded interest expense of approximately $400,000 and $660,000, resp ectively. (See Note 6.)

(5) EARNINGS PER SHARE

The following table sets forth the reconciliation from basic to diluted average common shares and the calculations of net earnings per common share. Net earnings for basic and diluted calculations do not differ (dollars in thousands, except per share data):

	Three months ended March 31,
	Three months ended March 31,
	2003	2002

Net earnings	$ 16,927	$ 8,433
	_____	_____
Average common shares:
Basic (weighted-average outstanding shares)	70,995	70,925
Dilutive potential common shares from stock
options	8,866	6,796
	_____	_____
Diluted (weighted-average outstanding
shares)	79,861	77,721
	_____	_____
Basic earnings per common share	$ 0.24	$ 0.12
	_____	_____
Diluted earnings per common share	$ 0.21	$ 0.11
	_____	_____

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(6) OTHER COMPREHENSIVE INCOME

The components of other comprehensive income are as follows (dollars in thousands):

	Three months ended March 31,
	Three months ended March 31,
	2003	2002

Net earnings	$ 16,927	$ 8,433
Foreign currency translation adjustment	1,329	(746)
Net derivative income (loss), net of
taxes of $264 in 2003 and $200 in 2002	(491)	371