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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from_______________ to ________________
Commission file number 1-9913
KINETIC CONCEPTS, INC.
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(Exact name of registrant as specified in its charter)
Texas 74-1891727
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(State of incorporation) (I.R.S. Employer Identification No.)
8023 Vantage Drive
San Antonio, TX 78230 (210) 524-9000
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(Address of principal executive (Registrant's telephone number)
offices and zip code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
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 X No _____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-K or any amendments to this Form 10-K. [ ]
As of March 1, 1998, there were 17,713,152 shares of the Registrant's
Common Stock outstanding, 17,613,152 of which were held by affiliates.
FORM 10-K TABLE OF CONTENTS
PART I PAGE
Item 1. Business........................................... 4
Item 2. Properties......................................... 18
Item 3. Legal Proceedings.................................. 18
Item 4. Submission of Matters to a Vote of Security
Holders............................................ 20
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................ 20
Item 6. Selected Financial Data............................ 22
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations...... 24
Item 8. Financial Statements and Supplementary Data........ 37
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............. 78
PART III
Item 10. Directors and Executive Officers of the Registrant.. 79
Item 11. Executive Compensation.............................. 81
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......................................... 84
Item 13. Certain Relationships and Related Transactions...... 85
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K......................................... 86
Signatures................................................... 90
TriaDyner, BariKarer, The V.A.C.r, PlexiPulser, PlexiPulse All-in-
1 System TM, KinAirr III, First Stepr, FirstStepr Plus,
FirstStepr Select, FirstStepr MRS, TheraPulser, BioDyner,
BioDyner II, FluidAirr Plus, FluidAirr Elite, RotoRestr, Q2
Plusr, HomeKairr DMS, DynaPulser, FirstStepr TriCell,
Impressionr, RotoRestr Delta, PediDyner, BariAirer, FirstStepr
Select Heavy Duty, TriCellr, RIKr and AirWorksr Plus, are
trademarks of the Company used in this Report. Kinetic Therapy
SM, The Clinical Advantage SM, Genesis SM and Odyssey SM are
service marks of the Company used in this Report.
CAUTINARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Private Securities Litigation Reform Act of 1995
provides a "safe harbor" for certain forward-looking statements.
The forward-looking statements made in "Business", "Legal
Proceedings" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations," which reflect
management's best judgment based on market and other factors
currently known, involve risks and uncertainties. When used in
this Report, the words "estimate," "project," "anticipate,"
"expect," "intend," "believe" and similar expressions are
intended to identify forward-looking statements. All of these
forward-looking statements are based on estimates and assumptions
made by management of the Company, which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance
should not be placed upon such estimates and statements. No
assurance can be given that any of such statements or estimates
will be realized and actual results will differ from those
contemplated by such forward-looking statements.
PART I
Item 1. Business
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General
Kinetic Concepts, Inc. (the "Company" or "KCI") is a worldwide
leader in innovative therapeutic systems which prevent and treat
the complications of immobility that can result from disease,
trauma, surgery or obesity. The Company's clinically effective
therapeutic systems include specialty hospital beds, specialty
mattress overlays and non-invasive medical devices combined with
on-site patient care consultation by the Company's
clinically-trained staff. The complications of immobility include
pressure sores, pneumonia and circulatory problems which can
increase patient treatment costs by as much as $75,000 and, if left
untreated, can result in death. The Company's therapeutic systems
can significantly improve clinical outcomes while reducing the cost
of patient care by preventing these complications or accelerating
the healing process, as well as by providing labor savings. The
Company has also been successful in applying its therapeutic
expertise to bring to market innovative medical devices that treat
chronic wounds and help prevent blood clots.
The Company designs, manufactures, markets and services its
products, many of which are proprietary. KCI's therapeutic systems
are used to treat patients across all health care settings
including acute care hospitals, extended care facilities and
patients' homes. Health care providers generally prefer to rent
rather than purchase the Company's products in order to avoid the
ongoing service, storage and maintenance requirements and the high
initial capital outlay associated with purchasing such products, as
well as to receive the Company's high-quality clinical support.
The Company can deliver its therapeutic systems to any major
domestic trauma center within two hours of notice through its
network of service centers.
Founded by James R. Leininger, M.D., an emergency room
physician, to provide better care for his patients, the Company was
incorporated in Texas in 1976. The Company's principal offices are
located at 8023 Vantage Drive, San Antonio, Texas 78230 and its
telephone number is (210) 524-9000.
On November 5, 1997, a substantial interest in the Company was
acquired by certain affiliates of Fremont Partners L.P. ("Fremont")
and Richard C. Blum & Associates, L.P. ("RCBA") (collectively, the
"Investors") pursuant to the terms of a Transaction Agreement dated
October 2, 1997, as amended by a letter agreement dated November 5,
1997 (as so amended, the "Transaction Agreement"). Under the terms
of the Transaction Agreement, the Investors purchased approximately
7.8 million newly-issued shares of the Company's common stock. The
proceeds of the stock purchase, together with proceeds from certain
financings were used to purchase approximately 31.0 million shares
of the Company's common stock from the selling shareholders and pay
all related fees and expenses. The entities controlled by the
Investors were subsequently merged with and into the Company, with
the Company as the surviving corporation. Following the merger,
Fremont, RCBA, Dr. James Leininger and Dr. Peter Leininger own
approximately 7.0 million, 4.6 million, 5.9 million and 0.1 million
common shares, respectively, representing 39.7%, 26.2%, 33.5% and
0.6% of the total shares outstanding. There are currently no other
shareholders, however, members of management have retained, and
have been granted, additional options to purchase shares.
Therapies
The Company's therapeutic systems deliver one or a combination
of the following therapies:
Pressure Relief/Pressure Reduction. The Company's pressure
relief and pressure reduction surfaces provide effective skin care
therapy in the treatment of pressure sores, burns, skin grafts and
other skin conditions and help prevent the formation of pressure
sores which develop in certain immobile individuals. The Company's
beds and mattress overlays reduce the amount of pressure at any
point on a patient's skin by using surfaces supported by air,
silicon beads, or a viscous fluid. Some of the products further
promote healing through pulsation.
Pulmonary Care. The Company's pulmonary care systems provide
Kinetic Therapy to help prevent and treat acute respiratory
problems, such as pneumonia, by reducing the build-up of fluid in
the lungs. The United States Centers for Disease Control (the
"CDC") defines Kinetic Therapy as the lateral rotation of a patient
by at least 40 degrees to each side (a continuous 80 degree arc).
Some of the Company's products combine Kinetic Therapy with
additional therapies such as percussion and pulsation which help
loosen mucous buildup and promote circulation.
Bariatric Care. The Company offers a line of bariatric care
products which are designed to accommodate obese individuals. These
products are used generally for patients weighing from 300 to 600
pounds, but can accommodate patients weighing nearly 1,000 pounds.
These individuals are often unable to fit into standard-sized beds
and wheelchairs. The Company's most sophisticated bariatric care
product can serve as a bed, chair, scale and x-ray table, helps
patients enter and exit the bed, and contains other features which
permit patients to be treated safely and with dignity. Moreover,
treating obese patients is a significant staffing issue for many
health care facilities because moving and handling these patients
increases the risk of worker's compensation claims by such
personnel. Management believes that these products enable health
care personnel to treat these patients in a manner which is safer
to hospital personnel than traditional methods, which can help
reduce worker's compensation claims. Some of the bariatric products
also address complications of immobility and obesity such as
pressure sores.
Closure of Chronic Wounds. The Company is the provider of a
patented, non-invasive device which uses negative pressure to
promote the healing of chronic wounds. The negative pressure is
applied through a proprietary foam dressing which draws the tissue
together, stimulates blood flow, reduces swelling and decreases
bacterial growth. The device heals wounds more quickly than
traditional methods and has been effective at closing chronic
wounds which have, in some cases, been open for years.
Circulatory Improvement. The Company offers a non-invasive
device which improves blood circulation, decreases swelling in the
lower extremities and reduces the incidence of blood clots. The
therapy is accomplished by wrapping inflatable cuffs around a foot
or leg and then automatically inflating and deflating them at
prescribed intervals. The products are often used by individuals
who have had hip or knee surgeries, diabetes, or other conditions
which reduce circulation.
Corporate Organization
In 1997, the Company was organized into four operating
divisions: KCI Therapeutic Services, Inc. ("KCI Therapeutic
Services" or "KCTS"), KCI Home Care, KCI International, Inc. ("KCI
International") and KCI New Technologies, Inc. ("NuTech"). At the
beginning of 1998, the Company combined the operations of KCTS and
KCI Home Care into a single business unit.
KCI Therapeutic Services
KCI Therapeutic Services provides a broad line of therapeutic
specialty support surfaces to patients in acute and sub-acute
facilities as well as extended care settings. This division
consists of approximately 1,100 personnel, many of whom have a
medical or clinical background. Sales are generated by a sales
force of approximately 350 individuals who are responsible for new
accounts in addition to the management and expansion of existing
accounts. A portion of this sales force is focused exclusively on
either the extended care market or the acute care market although
the majority of the sales force is responsible for sales across
both settings.
KCI Therapeutic Services has a national 24-hour, seven
days-a-week customer service communications system which allows it
to quickly and efficiently respond to its customers' needs. The
Company distributes its specialty patient support surfaces to acute
and extended care facilities through a network of 143 domestic
service centers. The KCTS service centers are organized as profit
centers and the general managers who supervise the service centers
are responsible for both sales and service operations. Each center
has an inventory of specialty beds and overlays which are delivered
to the individual hospitals or extended care facilities on an
as-needed basis.
The KCTS sales and support staff is comprised of approximately
250 employees with medical or clinical backgrounds. The principal
responsibility of approximately 125 of these clinicians is making
product rounds and participating in treatment protocols. These
clinicians educate the hospital or long-term facility staff on
issues related to patient treatment and assist in the establishment
of protocols. The clinical staff makes approximately 200,000
patient rounds annually. KCTS accounted for approximately 65%, 64%
and 61%, respectively, of the Company's total revenue in the years
ended December 31, 1997, 1996 and 1995.
KCI Home Care
KCI has developed a continuum of products that address the
unique demands of the home health care market. In January 1995, KCI
Home Care started a transition from a combined direct/dealer
distribution system to distributing its products through home
medical equipment ("HME") dealers. The Company believes that
selling products through the home care provider network gives it
access to a larger patient population and improves the overall
contribution from this business segment despite a reduction in per
patient revenue. Subsequent to 1997, the Company has combined the
operations of KCTS and KCI Home Care into a single business unit.
KCI International
KCI International offers the Company's therapies and services
in 12 foreign countries including Germany, Austria, the
United Kingdom, Canada, France, the Netherlands, Switzerland,
Australia, Italy, Denmark, Sweden and Ireland. The Denmark
office has recently been expanded to service all of Scandinavia. In
addition, relationships with 75 independent distributors in Latin
America, the Middle East, Asia and Eastern Europe allow KCI
International to service the demands of a growing global market.
KCI International accounted for approximately 23%, 25% and 25%,
respectively, of the Company's total revenue in the years ended
December 31, 1997, 1996 and 1995. See Note 13 of Notes to
Consolidated Financial Statements for information on foreign and
domestic operations.
NuTech
NuTech manufactures and markets the PlexiPulse and PlexiPulse
All-in-l System. The products are sold through a direct sales force
and a limited number of independent distributors and rented through
an alliance with MEDIQ/PRN, a national medical device rental
company with a strong portfolio of national accounts. NuTech
accounted for approximately 6% of the Company's total revenue in
1997.
Products
The Company's "Continuum of Care" is focused on treating wound
care patients, pulmonary patients, large or obese patients and
patients with circulatory problems by providing innovative, outcome
driven therapies across multiple care settings. The Company's
therapies include Pressure Relief/Pressure Reduction, Pulmonary
Care, Bariatric Care, Closure of Chronic Wounds and Circulatory
Improvement.
Pressure Relief/Pressure Reduction
The Company's pressure relief products include a variety of
framed beds and overlays such as the KinAir III, TheraPulse,
FluidAir Elite, HomeKair, First Step TriCell, DynaPulse, First Step
Plus, First Step Select, AirWorks Plus, Impression, RIK mattress,
and RIK overlay. The KinAir III has been shown to provide effective
skin care therapy in the treatment of pressure sores, burns and
post operative skin grafts and flaps, and to help prevent the
formation of pressure sores and certain other complications of
immobility. The TheraPulse provides a more aggressive form of
treatment through continuous pulsating action which gently massages
the skin to help promote capillary and lymphatic circulation in
patients suffering from severe pressure sores, burns, skin grafts
or flaps, swelling or circulation problems. The FluidAir Elite
supports the patient on a low-pressure surface of air-fluidized
silicon beads providing pressure relief for skin grafts or flaps,
burns and pressure sores and also has built in scales. The HomeKair
bed and TriCell overlay are low-cost pressure relief products
designed to be easily transportable directly to a patient's home.
The DynaPulse is a pulsating mattress replacement system that helps
prevent pressure ulcers in patients at high risk for skin breakdown
and can also be used to treat existing pressure ulcers. The First
Step family of overlays is designed to provide pressure relief and
help prevent pressure sores. AirWorks Plus is a low-cost overlay
which has air chambers which assist in redistributing pressure for
better skin care. Impression is a self-contained for-sale product
for the prevention of pressure sores which is intended to replace
standard hospital mattresses. The RIK mattress and the RIK overlay
are non-powered products that provide pressure relief utilizing a
patented viscous fluid and an anti-shear layer.
Pulmonary Care
The CDC defines Kinetic Therapy as lateral rotation of a
patient by at least 40 degrees on each side (a continuous 80 degree
arc). The Company believes Kinetic Therapy is essential to the
prevention or effective treatment of pneumonia and other pulmonary
complications in immobile patients. The Company's Kinetic Therapy
products include the TriaDyne, RotoRest, RotoRest Delta, PediDyne,
BioDyne II and Q2 Plus. The TriaDyne, introduced in mid-1995,
provides patients in acute care settings with three distinct
therapies on an air suspension surface. The TriaDyne applies
Kinetic Therapy by rotating the patient up to 40 degrees to each
side and provides an industry-first feature of simultaneously
turning the patient's torso and lower body in opposite directions
while keeping the patient positioned in the middle of the bed. The
TriaDyne can also provide percussion therapy to the patient's chest
to loosen mucous buildup in the lungs and pulsating therapy to
promote capillary circulation. The TriaDyne is built on Stryker
Corporation's critical care frame, which is well suited to an ICU
environment. The TriaDyne offers several other novel features not
available on other products. The RotoRest Delta is a specialty bed
which can rotate a patient up to a 62 degree angle on each side for
the treatment of pulmonary complications and prevention of
pneumonia. The RotoRest has been shown to improve the care of
patients suffering from multiple trauma, spinal cord injury, severe
pulmonary complications, respiratory failure and deep vein
thrombosis. The PediDyne, introduced in 1997, provides many of the
benefits found in the TriaDyne to pediatric patients. The BioDyne
II combines many of the therapeutic benefits of the KinAir III and
the RotoRest and is used by patients suffering from pneumonia,
coma, stroke and chronic neurological disorders.
Bariatric Care
The Company markets a line of therapeutic support surfaces and
aids for patients suffering from obesity, a market that had
previously been underserved. These products not only provide the
proper support needed by obese patients, but also enable nurses to
care for these patients in a dignified manner. Moreover, treating
obese patients is a significant staffing issue for many health care
facilities because moving and handling these patients increases the
risk of worker's compensation claims by nurses. The use of the
Company's bariatric products enables hospital staff to treat and
move obese patients in a manner which is safer to hospital
personnel while utilizing fewer hospital personnel. The most
advanced product in this line is the BariKare, which can serve as a
bed, chair, scale and x-ray table. This product is used generally
for patients weighing from 300 to 600 pounds but can be used for
patients who weigh up to nearly 1,000 pounds. The Company believes
that the BariKare is the most advanced product of its type
available today. In 1996, the Company also introduced the FirstStep
Select Heavy Duty overlay which incorporates pressure-relieving
therapy in a design that supports patients weighing up to 650
pounds. The Company recently introduced a new therapy-driven
bariatric product, the BariAire. The BariAire provides pressure
relief, patient turn assistance and step-down features designed for
both patient comfort and nurse assistance.
Closure of Chronic Wounds
The Company manufactures and markets the Vacuum Assisted
Closure device (the "V.A.C."), a non-invasive, active wound closure
therapy that utilizes negative pressure. The V.A.C. promotes
healing in wounds, pressure ulcers and grafts that frequently do
not respond to traditional methods of treatment. Treatment prot-
ocols with the V.A.C. call for a proprietary foam material to be
fitted and placed in or on top of a wound and covered with an
airtight, occlusive dressing. The foam is attached to a separate
vacuum pump. When activated, the vacuum pump creates a negative
pressure in the wound that draws the tissue together. This vacuum
action also stimulates blood flow on the surface of the wound,
reduces edema and decreases bacterial colonization, all of which
stimulate healing. The dressing material is replaced every 48 hours
and fitted to accommodate the decreasing size of the wound over
time. This is a significant improvement over the traditional method
for treating wounds which requires the nursing staff to clean and
dress a serious wound every 8 to 12 hours.
Circulatory Improvement
The PlexiPulse and PlexiPulse All-in-1 System are non-invasive
vascular assistance devices that aid venous return by pumping blood
from the lower extremities to help prevent deep vein thrombosis
("DVT") and re-establish microcirculation. The pumping action is
created by compressing specific parts of the foot or calf with
specially designed inflatable cuffs that are connected to a
separate pump unit. The cuffs are wrapped around the foot and/or
calf and are inflated in timed increments by the pump. The
intermittent inflation compresses a group of veins in the lower
limbs and boosts the velocity of blood flowing back toward the
heart. This increased velocity has been proven to significantly
decrease formation of DVT in non-ambulatory post-surgical and
post-trauma patients. The PlexiPulse is effective in preventing
DVT, reducing edema and improving lower limb blood circulation.
Competition
The Company believes that the principal competitive factors
within its markets are product efficacy, clinical outcomes, service
and cost of care. Furthermore, the Company believes that a national
presence with full distribution capabilities is important to serve
large, sophisticated national and regional health care group
purchasing organizations ("GPOs") and providers.
The Company contracts with both proprietary hospital groups
and voluntary GPOs. Proprietary groups own all of the hospitals
which they represent and, as a result, can ensure compliance with a
national agreement. Voluntary GPOs negotiate contracts on behalf of
member hospital organizations but cannot ensure that their members
will comply with the terms of a national agreement. Approximately
47% of the Company's total revenue during 1997 was generated under
national agreements with proprietary groups and voluntary GPOs in
the acute and extended care settings.
The Company competes on a national level with Hill-Rom,
Kendall and Invacare and on a regional and local level with
numerous other companies. The Company competes principally with
Invacare in the home care segment. NuTech competes primarily with
Kendall International in the foot and leg compression market. In
the U.S. specialty surface market and certain international
markets, the Company competes principally with Hill-Rom.
Market Outlook
The Company believes that it is well positioned to address the
following factors affecting the market for health care products and
services:
Uncertainty of Health Care Reform
There are widespread efforts to control health care costs in
the United States and abroad. As an example, the Balanced Budget
Act of 1997 (the "BBA") significantly reduces federal spending on
Medicare and Medicaid over the next five years by reducing annual
payment updates to acute care hospitals, changing payment systems
for both skilled nursing facilities and home health care services
from cost-based to prospective payment systems, eliminating annual
payment updates for durable medical equipment("DME"), and allowing
states greater flexibility in controlling Medicaid costs at the state
level. Until the Health Care Financing Administration ("HCFA") issues
regulations implementing this legislation in 1998, the Company
cannot reliably predict the timing of or the exact effect which these
initiatives could have on the pricing and profitability of, or
demand for, the Company's products. However, certain of the pro-
visions of the BBA, such as the changes in the manner Medicare
Part A reimburses skilled nursing facilities, may change the manner
in which the Company's customers make renting and purchasing
decisions and could have a material adverse effect on the Company.
The Company also believes it is likely that efforts by governmental
and private payors to contain costs through managed care and other
efforts and to reform health systems will continue in the future.
Consolidation of Purchasing Entities
One of the most tangible results of the health care reform
debate in the United States has been to cause health care providers
to examine their cost structures and reassess the manner in which
they provide health care services. This review, in turn, has led
many health care providers to merge or consolidate with other
members of their industry in an effort to reduce costs or achieve
operating synergies. A substantial number of the Company's
customers, including proprietary hospital groups, group purchasing
organizations, hospitals, national nursing home companies and
national home health care agencies, have been affected by this
consolidation. An extensive service distribution network and broad
product line is key to servicing the needs of these larger provider
networks. In addition, the consolidation of health care providers
often results in the renegotiation of contracts and in the granting
of price concessions. Finally, as group purchasing organizations
and integrated health care systems increase in size, each contract
represents a greater concentration of market share and the adverse
consequences of losing a particular contract increases
considerably.
Reimbursement of Health Care Costs
The Company's products are rented and sold principally to
hospitals, skilled nursing facilities and DME suppliers who receive
reimbursement for the products and services they provide from
various public and private third party payors, including Medicare,
Medicaid and private insurance programs. The Company also acts as a
Durable Medical Equipment Supplier under 42 U.S.C. 1395 et seq. and
as such furnishes its products directly to customers and bills
payors. As a result, the demand for the Company's products in any
specific care setting is dependent in part on the reimbursement
policies of the various payors in that setting. In order to be
reimbursed, the products generally must be found to be reasonable
and necessary for the treatment of medical conditions and must
otherwise fall within the payor's list of covered services. For
example, the Company is seeking to establish coverage and payment by
Medicare Part A and Medicare Part B for the V.A.C., its chronic
wound treatment product. Although clinical acceptance of this
product has continued to increase, it has not been officially
classified as a covered item by either Part A or Part B. In light
of increased controls on Medicare spending, there can be no assur-
ance on the outcome of future coverage or payment decisions for any
of the Company's products by governmental or private payors. If
providers, suppliers and other users of the Company's products
and services are unable to obtain sufficient reimbursement for the
provision of KCI products, a material adverse impact on the Company's
business, financial condition or operations could result.
Fraud and Abuse Laws
The Company is subject to various federal and state laws
pertaining to health care fraud and abuse including prohibitions on
the submission of false claims and the payment or acceptance of
kickbacks or other remuneration in return for the purchase or lease
of Company products. The United States Department of Justice and
the Office of the Inspector General of the United States Department
of Health and Human Services launched an enforcement initiative
which specifically targets the long term care, home health and DME
industries. Sanctions for violating these laws include criminal
penalties and civil sanctions, including fines and penalties, and
possible exclusion from the Medicare, Medicaid and other federal
health care programs. Although the Company believes its business
arrangements comply with federal and state fraud and abuse laws,
there can be no assurance that the Company's practices will not be
challenged under these laws in the future or that such a challenge
would not have a material adverse effect on the Company's business,
financial condition or results of operations.
Patient demographics
U.S. Census Bureau statistics indicate that the 65-and over
age group is the fastest growing population segment and is expected
to exceed 75 million by the year 2010. Management of wounds and
circulatory problems is crucial for elderly patients. These
patients frequently suffer from deteriorating physical conditions
and their wound problems are often exacerbated by incontinence and
poor nutrition.
Obesity is increasingly being recognized as a serious medical
complication. In 1994, approximately 650,000 patients in U.S.
hospitals had a principal or secondary diagnosis of obesity. Obese
patients tend to have limited mobility and thus are at risk for
circulatory problems and skin breakdown. Treating obese patients
is also a significant staffing issue for many health care
facilities and a cause of worker's compensation claims among
nurses.
Research and Development
The focus of the Company's research and development program
has been to develop new products and make technological
improvements to existing products. Since January 1994, the Company
has introduced a number of new products including: the TriaDyne,
the BariKare, the TriCell, the First Step Select Heavy
Duty, the FluidAir Elite, the PlexiPulse All-in-1 System, the
BariAire, the PediDyne and The V.A.C., a product developed from
technology licensed to the Company. Expenditures for research and
development represented approximately 2% of the Company's total
expenditures in 1997. The Company intends to continue its research
and development efforts.
Manufacturing
The Company's manufacturing processes for its specialty beds,
mattress overlays, and medical devices include the manufacture of
certain components, the purchase of certain other components from
suppliers and the assembly of these components into a completed
product. Mechanical components such as blower units, electrical
displays and air flow controls consist of a variety of customized
subassemblies which are purchased from suppliers and assembled by
the Company. The Company believes it has an adequate source of
supply for each of the components used to manufacture its products.
Patents and Trademarks
The Company seeks patent protection in the United States and
abroad. As of December 31, 1997, the Company had 59 issued U.S.
patents relating to its specialized beds, mattresses and related
products. The Company also has 32 pending U.S. Patent applications.
Many of the Company's specialized beds, products and services are
offered under trademarks and service marks. The Company has 28
registered trademarks and service marks in the United States Patent
and Trademark Office.
Employees
As of December 31, 1997, the Company had approximately 2,100
employees. The Company's employees are not represented by labor
unions and the Company considers its employee relations to be good.
Government Regulation
United States. The Company's products are subject to
regulation by numerous governmental authorities, principally the
United States Food and Drug Administration ("FDA") and
corresponding state and foreign regulatory agencies. Pursuant to
the Federal Food, Drug, and Cosmetic Act, and the regulations
promulgated thereunder, the FDA regulates the clinical testing,
manufacture, labeling, distribution and promotion of medical
devices. Noncompliance with applicable requirements can result in,
among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production,
failure of the government to grant premarket clearance or premarket
approval for devices, withdrawal of marketing clearances or
approvals, and criminal prosecution. The FDA also has the authority
to request repair, replacement or refund of the cost of any device
manufactured or distributed by the Company that violates statutory
or regulatory requirements.
In the United States, medical devices are classified into one
of three classes (Class I, II or III) on the basis of the controls
deemed necessary by the FDA to reasonably ensure their safety and
effectiveness. Class I devices are subject to general controls
(e.g., labeling, premarket notification, and adherence to Quality
System Regulations) although many Class I devices are exempt from
certain FDA requirements. Class II devices are subject to
general and special controls (e.g., performance standards,
postmarket surveillance, patient registries, and FDA guidelines).
Generally, Class III devices are high risk devices that receive
greater FDA scrutiny to ensure their safety and effectiveness
(e.g., life-sustaining, life-supporting and implantable devices, or
new devices which have been found not to be substantially
equivalent to legally marketed devices). Before a new medical
device can be introduced in the market, the manufacturer must
generally obtain FDA clearance ("510(k) Clearance") or Premarket
Approval ("PMA"). All of the Company's current products have been
classified as Class I or Class II devices, which typically are
legally marketed based upon 510(k) Clearance. The FDA has announced
plans to evaluate its classification system and reclassify or
exempt many devices that are currently classified as Class I
devices. 510(k) Clearance will generally be granted if the
submitted information establishes that the proposed device is
"substantially equivalent" to a legally marketed medical device.
The FDA recently has been requiring a more rigorous demonstration
of substantial equivalence than in the past.
All devices manufactured or distributed by the Company are
subject to pervasive and continuing regulation by the FDA and
certain state agencies, including record keeping requirements and
mandatory reporting of certain adverse experiences resulting from
use of the devices. Labeling and promotional activities are
subject to regulation by the FDA and, in certain circumstances, by
the Federal Trade Commission. Current FDA enforcement policy
prohibits the marketing of approved medical devices for unapproved
uses and the FDA scrutinizes the advertising of medical devices to
ensure that unapproved uses of medical devices are not promoted.
Manufacturers of medical devices for marketing in the United
States are required to adhere to applicable regulations setting
forth detailed Quality System Regulation ("QSR") (formerly Good
Manufacturing Practices) requirements, which include design,
testing, control and documentation requirements. Manufacturers must
also comply with MDR requirements that a company report certain
device-related incidents to the FDA. The Company is subject to
routine inspection by the FDA and certain state agencies for
compliance with QSR requirements, MDR requirements and other
applicable regulations. The Company is also subject to numerous
federal, state and local laws relating to such matters as safe
working conditions, manufacturing practices, environmental
protection, fire hazard control and disposal of hazardous or
potentially hazardous substances. Changes in existing requirements
or adoption of new requirements could have a material adverse
effect on the Company's business, financial condition, and results
of operations. There can be no assurance that the Company will not
incur significant costs to comply with laws and regulations in the
future or that laws and regulations will not have a material
adverse effect upon the Company's business, financial condition or
results of operations.
Fraud and Abuse Laws. The Company is subject to federal and
state laws pertaining to health care fraud and abuse. In
particular, certain federal and state laws prohibit manufacturers,
suppliers, and providers from offering or giving or receiving
kickbacks or other remuneration in connection with the ordering or
recommending purchase or rental, of health care items and
services. The federal anti-kickback statute provides both civil and
criminal penalties for, among other things, offering or paying any
remuneration to induce someone to refer patients to, or to
purchase, lease, or order (or arrange for or recommend the
purchase, lease, or order of), any item or service for which
payment may be made by Medicare or certain federally-funded
state health care programs (e.g., Medicaid). This statute also
prohibits soliciting or receiving any remuneration in exchange
for engaging in any of these activities. The prohibition
applies whether the remuneration is provided directly or indirectly,
overtly or covertly, in cash or in kind. Violations of the law can
result in numerous sanctions, including criminal fines, imprison-
ment, and exclusion from participation in the Medicare and Medicaid
programs.
These provisions have been broadly interpreted to apply to
certain relationships between manufacturers and suppliers, such as
the Company, and hospitals, skilled nursing facilities ("SNFs"),
and other potential purchasers or sources of referral. Under
current law, courts and the Office of Inspector General ("OIG") of
the United States Department of Health and Human Services ("HHS")
have stated, among other things, that the law is violated where
even one purpose (as opposed to a primary or sole purpose) of a
particular arrangement is to induce purchases or patient referrals.
The OIG has taken certain actions which suggest that
arrangements between manufacturers/suppliers of durable medical
equipment or medical supplies and SNFs (or other providers) may be
under continued scrutiny. An OIG enforcement initiative, Operation
Restore Trust ("ORT"), has targeted an investigation of fraud and
abuse in a number of states (i.e., California, Florida, Illinois,
New York, and Texas), focusing specifically on the long-term care,
home health, and DME industries. ORT's funding has officially ended
and the Inspector General has announced plans to implement an
"ORT-Plus" program in other states in conjunction with other
federal law enforcement bodies. Furthermore, in August 1995, the
OIG issued a Special Fraud Alert describing certain relationships
between SNFs and suppliers that the OIG viewed as abusive under the
statute. These initiatives create an environment in the industry in
which the Company operates in which there will continue to be
significant scrutiny for compliance with federal and state fraud
and abuse laws.
Several states also have referral, fee splitting and other
similar laws that may restrict the payment or receipt of
remuneration in connection with the purchase or rental of medical
equipment and supplies. State laws vary in scope and have been
infrequently interpreted by courts and regulatory agencies, but may
apply to all health care items or services, regardless of whether
Medicaid or Medicaid funds are involved.
The Company is also subject to federal and state laws
prohibiting the presentation (or the causing to be presented) of
claims for payment (by Medicare, Medicaid, or other third party
payors) that are determined to be false, fraudulent, or for an item
or service that was not provided as claimed. In one case, a major
DME manufacturer paid more than $4 million to settle allegations
that it had "caused to be presented" false Medicare claims through
advice that its sales force allegedly gave to customers concerning
the appropriate reimbursement coding for its products.
ISO Certification. Due to the harmonization efforts of a
variety of regulatory bodies worldwide, certification of compliance
with the ISO 9000 series of International Standards ("ISO
Certification") has become particularly
advantageous and, in certain circumstances necessary for many
companies in recent years. Beginning in June of 1998, ISO
Certification is expected to be required for all manufacturers
selling and distributing products within the European Economic
Community. The Company received ISO Certification in the fourth
quarter of 1997.
Other Laws. The Company owns and leases property that is
subject to environmental laws and regulations. The Company also is
subject to numerous federal, state and local laws and regulations
relating to such matters as safe working conditions, manufacturing
practices, fire hazard control and the handling and disposal of
hazardous or potentially hazardous substances.
International Sales of medical devices outside of the United
States are subject to regulatory requirements that vary widely from
country to country. Premarket clearance or approval of medical
devices is required by certain countries. The time required to
obtain clearance or approval for sale in a foreign country may be
longer or shorter than that required for clearance or approval by
the FDA and the requirements may vary. Failure to comply with
applicable regulatory requirements can result in loss of previously
received approvals and other sanctions and could have a material
adverse effect on the Company's business, financial condition or
results of operations.
Reimbursement
The Company's products are rented and sold principally to
hospitals, extended care facilities and HME providers who receive
reimbursement for the products and services they provide from
various public and private third-party payors, including the
Medicare and Medicaid programs and private insurance plans. The
Company also directly bills third party payors, including Medicare
and Medicaid, and receives reimbursement from these payors. In such
cases, Medicare beneficiaries are billed twenty percent for
coinsurance. As a result, demand and payment for the Company's
products is dependent in part on the reimbursement policies of
these payors. The manner in which reimbursement is sought and
obtained for any of the Company's products varies based upon the
type of payor involved and the setting in which the product is
furnished and utilized by patients.
Medicare. Medicare is a federally-funded program that
reimburses the costs of health care furnished primarily to the
elderly and disabled. Medicare is composed of two parts: Part A and
Part B. The Medicare program has established guidelines for the
coverage and reimbursement of certain equipment, supplies and
support services. In general, in order to be reimbursed by
Medicare, a health care item or service furnished to a Medicare
beneficiary must be reasonable and necessary for the diagnosis or
treatment of an illness or injury or to improve the functioning of
a malformed body part. This has been interpreted to mean that the
item or service must be safe and effective, not experimental or
investigational (except under certain limited circumstances
involving devices furnished pursuant to an FDA-approved clinical
trial), and appropriate. Specific Medicare guidelines have not
currently been established addressing under what circumstances, if
any, Medicare coverage would be provided for the use of the
PlexiPulse or the V.A C.
The methodology for determining the amount of Medicare
reimbursement of the Company's products varies based upon, among
other things, the setting in which a Medicare beneficiary receives
health care items and services. The recently enacted BBA will
significantly impact the manner in which Medicare reimbursement is
funded over the next five years. Most of the Company's products are
furnished in a hospital, skilled nursing facility or the
beneficiary's home.
Hospital Setting. With the establishment of the prospective
payment system in 1983, acute care hospitals are now generally
reimbursed by Medicare for inpatient operating costs based upon
prospectively determined rates. Under the prospective payment
system ("PPS"), acute care hospitals receive a predetermined
payment rate based upon the Diagnosis-Related Group ("DRG") into
which each Medicare beneficiary is assigned, regardless of the
actual cost of the services provided. Certain additional or
"outlier" payments may be made to a hospital for cases involving
unusually long lengths of stay or high costs. However, outlier
payments based upon length of stay are gradually being phased out
and will be eliminated effective with fiscal year 1998.
Furthermore, pursuant to regulations issued in 1991, and subject to
a ten-year transition period, the capital costs of acute care
hospitals (such as the cost of purchasing or renting the Company's
specialty beds) are also reimbursed by Medicare pursuant to an
add-on to the DRG-based payment amount. Accordingly, acute care
hospitals generally do not receive direct Medicare reimbursement
under PPS for the distinct costs incurred in purchasing or renting
the Company's products. Rather, reimbursement for these costs is
deemed to be included within the DRG-based payments made to
hospitals for the treatment of Medicare-eligible inpatients who
utilize the products. Since PPS rates are predetermined, and
generally paid irrespective of a hospital's actual costs in
furnishing care, acute care hospitals have incentives to lower
their inpatient operating costs by utilizing equipment and supplies
that will reduce the length of inpatient stays, decrease labor, or
otherwise lower their costs.
The principal manner in which the BBA impacts Medicare Part A
in the acute care setting is that it has reduced the annual DRG
payment updates to be paid over the next five years by more than
$40.0 billion. In addition, the BBA authorizes HCFA to enact
regulations which are designed to restrain certain hospital
reimbursement activities which are perceived to be abusive or
fraudulent.
Certain specialty hospitals (e.g., long-term care,
rehabilitation and children hospitals) also use the Company's
products. Such specialty hospitals currently are exempt from the
PPS and, subject to certain cost ceilings, are reimbursed by
Medicare on a reasonable cost basis for inpatient operating and
capital costs incurred in treating Medicare beneficiaries.
Consequently, long-term care hospitals may receive separate
Medicare reimbursement for reasonable costs incurred in purchasing
or renting the Company's products; however, Medicare reimbursement
for such hospitals is expected to be reduced by $3.5 billion over
the next five years. There can be no assurance that a prospective
payment system will not be instituted for such hospitals in future
legislation.
Skilled Nursing Facility Setting. Skilled Nursing Facilities
("SNFs") which purchase or rent the Company's products may be
reimbursed directly under Medicare Part A for some portion of their
incurred costs. Generally speaking, only the costs of treatment
during the first 100 days of a qualifying spell of illness are
subject to Medicare reimbursement. The costs incurred by SNFs in
furnishing care to Medicare beneficiaries are categorized as either
routine costs or ancillary costs. Routine costs are those costs
which are incurred for items and services routinely furnished to
all patients (e.g., general nursing services, items stocked in
gross supply). Ancillary costs are considered those costs which are
incurred for items or services ordered to treat a condition of a
specific patient and which are not generally furnished to most
patients. Ancillary costs are not subject to the routine
cost limits. Given the current routine cost limits, SNFs may be more
inclined to purchase or rent products which are reimbursed by
Medicare as ancillary items or services than if these products were
reimbursed as routine items or services. At present, the Company's
specialty beds are classified under Medicare Part A as ancillary
items. HCFA currently interprets the definition of ancillary items
to include certain support surfaces such as low air loss mattress
replacements, bed overlay systems and air fluidized therapy. Neither
The V.A.C. nor the PlexiPulse have yet been classified as ancillary
items when furnished in a SNF setting.
On July 1, 1998, the manner in which SNFs are reimbursed under
Medicare Part A will change dramatically. On that date,
reimbursement for SNFs under Medicare Part A will change from a
cost-based system to a prospective payment system. The new payment
system will be based on resource utilization groups ("RUGs"). Under
the RUGs system, a SNF Medicare patient will be assigned to a RUGs
category upon admission to the SNF. The RUGs category to which the
patient will be assigned will depend upon the level of care and
resources the patient requires. The SNF will receive a fixed per
diem payment based upon the RUGs category assigned to each Medicare
patient. The per diem payments made to the SNFs will be based upon
a blend of their actual costs and a national average cost (which is
subject to local wage-based adjustments). Initially, 75% of a SNF's
per diem will be based on its costs and 25% of the per diem will be
based on national average cost. At the end of a four-year phase-in
period, all per diem payments will be based on the national average
cost. Because the RUG's system provides SNFs with fixed cost
reimbursement, SNFs may be less inclined than they have in the past
to use products which had previously been reimbursed as ancillary
costs. Because the Company believes its products are both cost
effective and efficacious, the Company believes that it will be
able to rent and sell its products effectively under the RUGs
system.
Home Setting. The Company's products are also provided to
Medicare beneficiaries in home care settings. Medicare reimburses
beneficiaries, or suppliers accepting assignment, for the purchase
or rental of DME for use in the beneficiary's home or a home for
the aged (as opposed to use in a hospital or skilled nursing
facility setting). So long as the Medicare Part B coverage criteria
are met, certain of the Company's products, including air fluidized
beds, air-powered floatation beds and alternating air mattresses,
are reimbursed in the home setting under the DME category known as
"Capped Rental Items." Pursuant to the fee schedule payment
methodology for this category, Medicare pays a monthly rental fee
(for a period not to exceed fifteen months) equal to 80% of the
established allowable charge for the item. Guidelines concerning
under what circumstances, if any, The V.A.C. or the PlexiPulse will
be covered and reimbursed by DME have not been established. Under
the BBA, there will be a five-year freeze on consumer price index
updates for Medicare Part B Services in the home care setting.
Medicaid. The Medicaid program is a cooperative federal/state
program that provides medical assistance benefits to qualifying low
income and medically-needy persons. State participation in Medicaid
is optional and each state is given discretion in developing and
administering its own Medicaid program, subject to certain federal
requirements pertaining to payment levels, eligibility criteria and
minimum categories of services. The Medicaid program finances
approximately 50% of all care provided in skilled nursing
facilities nationwide. The Company sells or rents its products to
SNFs for use in furnishing care to Medicaid recipients. SNFs, or
the Company, may seek and receive Medicaid reimbursement directly
from states for the incurred costs. However, the method and level
of reimbursement, which generally reflects regionalized average
cost structures and other factors, varies from state to state.
Private Payors. Many private payors, including indemnity
insurers, employer group health insurance programs and managed care
plans, presently provide coverage for the purchase and rental of
the Company's products. The scope of coverage and payment policies
varies among private payors. Furthermore, many such payors are
investigating or implementing methods for reducing health care
costs, such as the establishment of capitated or prospective
payment systems.
The Company believes that government and private efforts to
contain or reduce health care costs are likely to continue. These
trends may lead third-party payors to deny or limit reimbursement
for the Company's products, which could negatively impact the
pricing and profitability of, or demand for, the Company's
products.
Item 2. Properties
- ------ ----------
The Company's corporate headquarters are currently located in
a 170,000 square foot building in San Antonio, Texas which was
purchased by the Company in January 1992. The Company utilizes
89,000 square feet of the building with the remaining space being
leased to unrelated entities.
The Company conducts its manufacturing, shipping, receiving
and storage activities in a 153,000 square foot facility in San
Antonio, Texas, which was purchased by the Company in January 1988.
In 1989, the Company completed the construction of a 17,000 square
foot addition to the facility which is utilized as office space.
The Company also owns a 37,000 square foot building in San Antonio,
Texas which houses the Company's engineering center and currently
serves as the NuTech division headquarters. In 1992, the Company
purchased a 35,000 square foot facility in San Antonio, Texas which
is used for storage. The Company maintains additional storage at
two leased facilities in San Antonio, Texas. In 1994, the Company
purchased a facility in San Antonio, Texas which has been provided
to a charitable organization to provide housing for families of
cancer patients. The facility is built on 6.7 acres and consists of
a 15,000 square foot building and a 2,500 square foot house. In
June 1997, the Company acquired a 2.8 acre tract of land adjacent
to its corporate headquarters. There are three buildings on the
land which contain an aggregate of 40,000 square feet.
The Company leases approximately 143 domestic distribution
centers, including each of its seven regional headquarters, which
range in size from 1,500 to 18,000 square feet.
Item 3. Legal Proceedings
- ------- -----------------
On February 21, 1992, Novamedix Limited ("Novamedix") filed a
lawsuit against the Company in the United States District Court for
the Western District of Texas. Novamedix manufactures the principal
product which directly competes with the PlexiPulse. The suit
alleges that the PlexiPulse infringes several patents held by
Novamedix, that the Company breached a confidential relationship
with Novamedix and a variety of ancillary claims. Novamedix seeks
injunctive relief and monetary damages. Initial discovery
in this case has been substantially completed. Although it is
not possible to reliably predict the outcome of this litigation
or the damages which could be awarded, the Company believes that
its defenses to these claims are meritorious and that the litigation
will not have a material adverse effect on the Company's business,
financial condition or results of operations.
On August 16, 1995, the Company filed a civil antitrust
lawsuit against Hillenbrand Industries, Inc. and one of its
subsidiaries, Hill-Rom. The suit was filed in the United States
District Court for the Western District of Texas. The suit alleges
that Hill-Rom used its monopoly power in the standard hospital bed
business to gain an unfair advantage in the specialty hospital bed
business. Specifically, the allegations set forth in the suit
include a claim that Hill-Rom required hospitals and purchasing
groups to agree to exclusively rent specialty beds in order to
receive substantial discounts on products over which they have
monopoly power - hospital beds and head wall units. The suit
further alleges that Hill-Rom engaged in activities which
constitute predatory pricing and refusals to deal. Hill-Rom has
filed an answer denying the allegations in the suit. Although
discovery has not been completed and it is not possible to reliably
predict the outcome of this litigation or the damages which might
be awarded, the Company believes that its claims are meritorious.
On October 31, 1996, the Company received a counterclaim which
had been filed by Hillenbrand Industries, Inc. in the antitrust
lawsuit which the Company filed in 1995. The counterclaim alleges
that the Company's antitrust lawsuit and other actions were
designed to enable KCI to monopolize the specialty therapeutic
surface market. Although it is not possible to reliably predict the
outcome of this litigation, the Company believes that the
counterclaim is without merit.
On December 26, 1996, Hill-Rom, a subsidiary of Hillenbrand
Industries, Inc., filed a lawsuit against the Company alleging that
the Company's TriaDyne bed infringes a patent issued to Hill-Rom.
This suit was filed in the United States District Court for the
District of South Carolina. Based upon its preliminary
investigation, the Company does not believe that the TriaDyne bed
infringes any valid claims of the Hill-Rom patent or that this
lawsuit will have a material adverse impact on the Company's
business.
The Company is a party to several lawsuits arising in the
ordinary course of its business, including three other lawsuits
alleging patent infringement by the Company, and the Company is
contesting adjustments proposed by the Internal Revenue Service to
prior years' tax returns in Tax Court. Provisions have been made in
the Company's financial statements for estimated exposures related
to these lawsuits and adjustments. In the opinion of management,
the disposition of these matters will not have a material adverse
effect on the Company's business, financial condition or results of
operations.
The manufacturing and marketing of medical products
necessarily entails an inherent risk of product liability claims.
The Company currently has certain product liability claims pending
for which provision has been made in the Company's financial
statements. Management believes that resolution of these claims
will not have a material adverse effect on the Company's business,
financial condition or results of operations. The Company has not
experienced any significant losses due to product liability claims
and management believes that the Company currently maintains
adequate liability insurance coverage.
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
A special meeting of the shareholders of the Company was held
on January 5, 1998 for the purpose of approving the Transaction
Agreement. A total of 19,518,595 shares of the Company's Common
Stock were entitled to vote at the meeting; 14,897,892 shares of
common stock were voted in favor of approval of the Transaction
Agreement and no shares of common stock were voted against
approval.
PART II
Item 5. Market for Registrant's Common Equity and Related
- ------- -------------------------------------------------
Stockholder Matters
-------------------
The Company's common stock ("Common Stock") traded on The
Nasdaq Stock Market under the symbol: KNCI until November 19, 1997,
which was the date on which the Company delisted its common stock.
The range of the high and low bid prices of the Common Stock for
each of the quarters during the 1997 and 1996 fiscal years is
presented below, through the last date that the Company's common
stock was traded on a national exchange.
MARKET PRICES OF COMMON STOCK
1997 1996
---------------------- -----------------------
High Low High Low
First Quarter $15.750 $11.375 $13.875 $10.438
Second Quarter 18.375 13.500 17.375 13.125
Third Quarter 19.938 16.875 16.063 13.500
Fourth Quarter 19.500 18.125 15.000 11.875
The Company's Board of Directors declared quarterly cash
dividends on the Common Stock in 1997 and 1996. The cash dividends
totaled $0.1125 and $0.15 per common share in each of 1997 and
1996, respectively. The Company's credit agreements contain
certain covenants which currently restrict the Company's ability to
declare and pay cash dividends.
As of March 1, 1998, there were 4 holders of record of the
Company's Common Stock. There is currently no established public
trading market for the Company's Common Stock.
Item 6. Selected Financial Data
- ------- -----------------------
KINETIC CONCEPTS, INC. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
Year Ended December 31,
1997 1996 1995 1994 1993
-------- -------- ------- -------- -------
Consolidated Statements of
Earnings Data:
Revenue:
Rental and service...... $247,890 $225,450 $206,653 $228,832 $232,250
Sales and other......... 59,026 44,431 36,790 40,814 36,622
------- ------- ------- ------- -------
Total revenue......... 306,916 269,881 243,443 269,646 268,872
------- ------- ------- ------- -------
Rental expenses........... 156,179 146,205 137,420 159,235 169,687
Cost of goods sold........ 23,673 16,315 13,729 19,388 18,666
------- ------- ------- ------- -------
Gross profit.......... 127,064 107,361 92,294 91,023 80,519
Selling, general and
administrative expenses. 62,654 52,007 48,502 51,813 53,279
Unusual items (1)......... -- -- -- (84,868) 6,705
Recapitalization expense (2) 34,361 -- -- -- --
------- ------- ------- ------- -------
Operating earnings.... 30,049 55,354 43,792 124,078 20,535
Interest income........... 2,263 9,332 5,063 1,318 2,911
Interest expense.......... (10,173) (245) (509) (5,846) (8,819)
Foreign currency loss..... (1,106) -- -- -- --
------ ------ ------ ------- ------
Earnings before income
taxes, minority
interest, extraord-
inary item and
cumulative effect of
changes in account-
ing principles...... 21,033 64,441 48,346 119,550 14,627
Income taxes.............. 8,403 25,454 19,905 55,949 7,175
------ ------ ------ ------- ------
Earnings before minority
interest, extraordinary
item and cumulative
effects of changes in
accounting principles 12,630 38,987 28,441 63,601 7,452
Minority interest in
subsidiary loss (gain).. (25) -- -- 40 560
Extraordinary item - debt
extinguishment, net..... -- -- -- -- (400)
Cumulative effect of change
in accounting for
inventory (3)........... -- -- -- 742 --
Cumulative effect of change
in accounting for income
taxes (4)............... -- -- -- -- 450
------- ------- ------- ------ ------
Net earnings.......... $ 12,605 $ 38,987 $ 28,441 $ 64,383 $ 8,062
======= ======= ======= ======= ======
Earnings per common
share (5)........... $ 0.33 $ 0.89 $ 0.64 $ 1.47 $ 0.18
======= ======= ======= ======= ======
Earnings per common
share -- assuming
dilution (5)........ $ 0.32 $ 0.86 $ 0.63 $ 1.46 $ 0.18
======= ======= ======= ======= ======
Average common shares:
Basic (weighted average
common shares)........ 38,591 43,958 44,163 43,913 44,249
======= ======= ======= ======= ======
Diluted (weighted average
out-standing shares).. 39,910 45,489 45,457 44,143 44,627
======= ======= ======= ======= ======
Cash flow provided by
operations.............. $ 9,336 $ 62,167 $ 56,782 $ 96,451 $56,538
======= ======= ======= ======= ======
Cash dividends paid to
common shareholders..... $ 6,388 $ 6,607 $ 6,631 $ 6,588 $ 6,638
======= ======= ======= ======= ======
Cash dividends per share
paid to common share-
holders................. $ .11 $ .15 $ .15 $ .15 $ .15
======= ======= ======= ======= ======
Consolidated Balance Sheet
Data:
Working capital......... $ 96,365 $107,334 $109,413 $ 90,731 $ 60,907
Total assets............ $351,151 $253,393 $243,726 $232,731 $284,573
Long-term obligations --
noncurrent (6)........ $530,213 $ -- $ -- $ 2,755 $101,889
Minority interest....... $ -- $ -- $ -- $ -- $ 40
Other shareholders'
equity (2)............ $(275,698) $211,078 $210,324 $185,423 $125,707
(1) Includes $81.6 million gain, net of legal expense, from the
settlement of a patent infringement lawsuit. In addition, a $10.1
million pre-tax gain from the sale of the Company's Medical
Services Division was recognized. The Company also recorded
certain other unusual items related to planned dispositions of
under-utilized rental assets and over-stocked inventories of $6.8
million.
(2) See Note 2 of Notes to Consolidated Financial Statements for
information on the Company's recapitalization .
(3) On January 1, 1994, the Company changed its method of applying
overhead to inventory. Historically, a single labor overhead
rate and a single materials overhead rate were used in valuing
ending inventory. Labor overhead was applied as labor was
incurred while materials overhead was applied at the time of
shipping. This change resulted in a cumulative earnings effect
of $742,000.
(4) The Company adopted Statement of Financial Accounting
Standards No. 109 "Accounting for Income Taxes" as of January 1,
1993 resulting in a cumulative earnings effect of $450,000.
(5) See Note 11 of Notes to Consolidated Financial Statements for
information concerning the Company's reconciliation from basic to
diluted average common shares and the calculations of net income
per common share.
(6) See Notes 5 and 6 of Notes to Consolidated Financial
Statements for information concerning the Company's borrowing
arrangements and lease obligations.
Item 7. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations
-------------------------
General
The ongoing health care debate continues to create pressure on
health care providers to control costs, provide cost effective
therapies and improve patient outcomes. Industry trends resulting
from these pressures include the accelerating migration of patients
from acute care facilities into extended care (e.g., skilled
nursing facilities and rehabilitation centers) and home care
settings, and the consolidation of health care providers and
national and regional group purchasing organizations. In August
1997, in an effort to reduce the federal deficit and lower overall
federal healthcare expenditures, Congress passed the Balanced
Budget Act, (the "BBA"). The BBA contains a number of provisions
which will impact the federal reimbursement of health care costs
and reduce projected payments under the Medicare system by $115
billion over the next five years. The majority of the savings are
scheduled for the fourth and fifth years of this plan. The
provisions include: (i) a reduction exceeding $30 billion in the
level of payments made to acute care hospitals under Medicare Part
A over the next five years (which will be funded primarily through
a reduction in future consumer price index increases); (ii) a
change, beginning July 1, 1998, in the manner in which skilled
nursing facilities ("SNFs") are reimbursed from a cost based system
to a prospective payment system whereby SNFs will receive an all
inclusive, case-mix adjusted per diem payment for each of their
Medicare patients; and (iii) a five-year freeze on consumer price
index updates for Medicare Part B services in the home and the
implementation of competitive bidding trials for five categories of
home care products.
Less than 10% of the Company's revenues are received directly
from the Medicare system. However, many of the health care
providers who pay the Company for its products are reimbursed,
either directly or indirectly, by the federal government under the
Medicare system for the use of those products. The Company does not
believe that the changes introduced by the BBA will have a
substantial impact on its hospital customers or the dealers who
distribute the Company's products in the home health care market.
However, changes introduced by the BBA may have an impact on the
manner in which the Company's extended care customers make
purchasing and rental decisions. Under a fixed payment system,
decisions on selecting the products and services used in patient
care are generally based on clinical and cost-effectiveness.
Industry trends including pricing pressures, the consolidation
of health care providers and national and regional group purchasing
organizations and a shift in market demand toward lower-priced
products such as mattress overlays have had the impact of reducing
the Company's overall average daily rental rates on its individual
products. These industry trends, together with the increasing
migration of patients from acute care to extended and home care
settings, have had the effect of reducing overall acute care market
growth.
Expansion of the Company's national distribution network has
allowed KCI to leverage a relatively fixed field cost structure
across a broad range of patients and care settings which has
resulted in improved operating margins. In addition, increasing
demand for the Company's products in the extended and home care
settings has increased utilization of certain of the Company's
products which were originally developed for acute care settings.
Because of cost pressures within the health care industry, patients
are leaving the acute care setting sooner, thereby increasing the
demand for the Company's products in the extended and home care
settings.
Generally, the Company's customers prefer to rent rather than
purchase the Company's products in order to avoid the ongoing
service, storage and maintenance requirements and the high initial
capital outlays associated with purchasing such products, as well
as to receive the Company's high-quality clinical support. As a
result, rental revenues are a high percentage of the Company's
overall revenues. More recently, sales have increased as a portion
of the Company's revenues. The Company believes this trend will
continue because certain U.S. health care providers are purchasing
products that are less expensive and easier to maintain such as
medical devices, mattress overlays and mattress replacement
systems. In addition, international health care providers tend to
purchase therapeutic surfaces more often than U.S. health care
providers.
Results of Operations
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
- ---------------------------------------------------------------------
The following table sets forth, for the periods indicated, the
percentage relationship of each item to total revenue as well as
the change in each line item as compared to the prior year ($ in
thousands):
Year Ended December 31,
---------------------------
Revenue Increase
Relationship (Decrease)
------------- -----------
1997 1996 $ Pct
---- ---- ---- ----
Revenue:
Rental and service......... 81% 84% $ 22,440 10%
Sales and other............ 19 16 14,595 33
--- --- -------
100% 100% 37,035 14
Rental expenses.............. 51 54 9,974 7
Cost of goods sold........... 8 6 7,358 45
--- --- -------
Gross profit............. 41 40 19,703 18
Selling, general and
administrative expenses...... 20 19 10,647 20
Recapitalization costs....... 11 -- 34,361 N/A
--- --- -------
Operating earnings....... 10 21 (25,305) (46)
Interest income.............. -- 3 (7,069) (76)
Interest expense............. (3) -- (9,928) N/A
Foreign currency loss........ -- -- (1,106) N/A
--- --- -------
Earnings before income
taxes and minority
interest............... 7 24 (43,408) (67)
Income taxes................. 3 10 17,051 67
Minority interest............ -- -- (25) N/A
--- --- -------
Net earnings............. 4% 14% $(26,382) (68)%
=== === =======
The Company's revenue is derived from three primary markets.
The following table sets forth, for the periods indicated, the
amount of revenue derived from each of these markets ($ in
millions):
Year Ended December 31,
-----------------------
1997 1996
-------- --------
Domestic specialty surfaces.... $198.7 $181.3
International surfaces......... 66.7 67.6
Medical devices................ 39.2 20.4
Other.......................... 2.3 0.6
----- ------
Total revenue $306.9 $269.9
===== =====
Total Revenue: Total revenue in 1997 was $306.9 million, an
increase of $37.0 million, or 13.7%, from $269.9 million in 1996.
This increase was primarily attributable to growth in both the
Company's domestic specialty surface and medical devices
businesses. Domestic specialty surface revenue includes revenue
from acute and extended care facilities as well as revenue from the
home care setting. Revenue from the Company's domestic specialty
surface business was $198.7 million, up $17.4 million, or 9.6%,
from $181.3 million in the prior year due to therapy day growth in
each of the wound care, pulmonary and bariatric markets combined
with an overall increase in the average daily rental price of its
products. Revenue from the Company's international surface business
was $66.7 million compared to $67.6 million in the prior year,
despite adverse foreign currency exchange fluctuations of
approximately $6.4 million. Revenue from the Company's medical
devices business of $39.2 million increased $18.8 million, or
92.2%, up from $20.4 million in the prior year, due substantially
to growth in V.A.C. rentals in the United States.
Rental Expenses: Rental expenses consist largely of field
personnel costs, depreciation of the Company's rental equipment
and related facility costs. Rental expenses for 1997 totaled
$156.2 million, an increase of $10.0 million, or 6.8%, from $146.2
million in the prior year. The addition of extended care sales
representatives, new marketing programs and product costs
associated with new and acquired therapies and technologies
accounted for the majority of this increase. As a percentage of
total revenue, 1997 rental expenses were 50.9%, down from 54.2% in
the prior period. This decrease is primarily attributable to the
increase in rental revenue, as the majority of the Company's
rental or field expenses are relatively fixed.
Gross Profit: Gross profit in 1997 was $127.1 million, an
increase of $19.7 million, or 18.4%, from $107.4 million in the
year-ago period due substantially to higher revenue, combined with
relatively fixed field expenses and improved sales volumes. Gross
profit margin for 1997, as a percentage of total revenue, was
41.4%, up from 39.8% for the prior year. Rental margins improved
to 37.0%, up 1.9 percentage points from 1996, while sales margins
declined to 59.9%, from 63.3%, as the product mix shifted toward
lower-margin overlays, particularly in the international home care
setting.
Selling, General and Administrative Expenses: Selling, general and
administrative (SG&A) expenses for 1997 were $62.7 million, an
increase of $10.6 million, or 20.5%, from 1996. Key investments
in marketing programs and information systems as well as higher
legal and professional fees and provisions for uncollectible accounts
receivable made up the majority of this increase. As a percentage
of total revenue, SG&A expenses in 1997 were 20.4%, up slightly
from 19.3% in the year-ago period.
Recapitalization: During 1997, the Company recognized $34.4
million in fees and expenses resulting from the transactions
associated with the Transaction Agreement (the
"Recapitalization"). Recapitalization expenses consisted of
compensation expense associated with employee stock option
exercises and other incentives, commitment fees on unused credit
facilities, legal and professional fees and other miscellaneous
costs and expenses.
Operating Earnings: Operating earnings for 1997 were $30.0
million, a decrease of $25.3 million, or 45.7%, from 1996, due
substantially to Recapitalization expenses of $34.4 million in
1997. Excluding the Recapitalization expenses, operating earnings
for 1997 were $64.4 million, an increase of $9.1 million, or
16.4%, from $55.4 million in 1996. As a percentage of total
revenue, the Company's operating margin, excluding the
recapitalization expenses, improved to 21.0%, up from 20.5% in
1996.
Interest Income: Interest income earned during 1997 was $2.3
million, a $7.1 million decrease from 1996. The prior year
interest income included $5.2 million of non-recurring interest
income from the early repayment of all remaining notes receivables
from the 1994 disposition of the Medical Services Division. The
remainder of the variance is due to lower invested cash balances
in 1997 as the Company funded five acquisitions during the year
from existing cash reserves.
Interest Expense: Interest expense for the year was $10.2
million, an increase of $9.9 million from 1996. The majority of
this increase was due to interest accrued on approximately $535.0
million of debt outstanding after completion of the
Recapitalization.
Income Taxes: The Company's effective income tax rate for 1997
was 40.0% compared to 39.5% in 1996.
Net Earnings: Net earnings for 1997 were $12.6 million, or $0.32
per share, compared to 1996 net earnings of $39.0 million, or
$0.86 per share. Excluding non-recurring items, net earnings for
1997 would have been $39.2 million, or $0.98 per share, compared
to 1996 net earnings of $35.9 million, an increase of $3.3
million, or 9.2%. Higher revenue combined with controlled
spending accounted for the earnings improvement.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
- ---------------------------------------------------------------------
The following table sets forth, for the periods indicated,
the percentage relationship of each item to total revenue as well
as the change in each line item as compared to the prior year ($
in thousands):
Year Ended December 31,
---------------------------
Revenue Increase
Relationship (Decrease)
------------- -----------
1996 1995 $ Pct
------ ------ ----- -----
Revenue:
Rental and service........... 84% 85% $18,797 9%
Sales and other.............. 16 15 7,641 21
100% 100% 26,438 11
Rental expenses................ 54 56 8,785 6
Cost of goods sold............. 6 6 2,586 19
--- --- ------
Gross profit............... 40 38 15,067 16
Selling, general and
administrative expenses...... 19 20 3,505 7
--- --- ------
Operating earnings......... 21 18 11,562 26
Interest income................ 3 2 4,269 84
Interest expense............... -- -- 264 52
--- --- ------
Earnings before income
taxes.................... 24 20 16,095 33
Income taxes................... 10 8 5,549 28
--- --- ------
Net earnings............... 14% 12% $10,546 37%
=== === ======
The Company's revenue is derived from three primary markets.
The following table sets forth, for the periods indicated, the
amount of revenue derived from each of these markets ($ in
millions):
Year Ended December 31,
-----------------------
1996 1995
------- -------
Domestic specialty surfaces.... $181.3 $163.0
International surfaces......... 67.6 60.7
Medical devices................ 20.4 17.1
Other.......................... 0.6 2.6
----- -----
Total revenue.... $269.9 $243.4
===== =====
Total Revenue: Total revenue in 1996 was $269.9 million, an
increase of $26.4 million or 10.9% from 1995. This increase was
primarily attributable to growth in the Company's domestic
specialty support surface business combined with international
expansion and penetration. Domestic support surface revenue
includes revenue from acute and extended care facilities as well as
revenue from the home care segment. Revenue from domestic surfaces
increased $18.3 million to $181.3 million in 1996, an increase of
11.2% compared to the prior year. The domestic revenue increase
was due in large part to the continued success of KCI's TriaDyne
TM, the Company's leading Kinetic Therapy product, combined with
growth in extended care patient days and the addition of various
new national accounts. Revenue from the Company's international
specialty surface business increased $6.9 million, or 11.4%, to
$67.6 million in 1996, despite adverse foreign currency exchange
fluctuations of approximately $2 million. Strong sales in mattress
overlay products accounted for more than half of this increase.
Revenue growth in the German home care market and further
penetration in various emerging markets, e.g., Switzerland and
Australia, also contributed to international revenue growth.Revenue
from the Company's two primary medical devices, PlexiPulse TM and
The V.A.C. TM, was $20.4 million, an increase of $3.3 million, or
19.3%, from 1995. This increase was substantially due to the intro-
duction of The V.A.C. TM in the United States as well as growth
in V.A.C. revenue overseas.
In November 1996, the Company announced that it had been
advised by Premier Purchasing Partners, L.P., that its bid to be
the primary supplier for the newly combined group had been awarded
to another vendor. Premier is a new voluntary group purchasing
organization which was formed as a result of the merger of three
separate group purchasing organizations. Revenue from hospitals
within Premier for 1996 accounted for approximately 10% of the
Company's total revenue. Because facilities within Premier are not
committed to do business with the group's primary vendor, it is
difficult to predict the ultimate effect of the new agreement on
revenue and operating profits. For 1997, a substantial portion of
the revenue from the Premier group was retained.
Rental Expenses: Rental expenses consist largely of field
personnel costs, depreciation of the Company's rental equipment
and related facility costs. Rental expenses for 1996 totaled
$146.2 million, an increase of $8.8 million, or 6.4%, from the
prior year. The addition of extended care sales representatives
and international market expansion accounted for a majority of the
increase. As a percentage of total revenue, 1996 rental expenses
were 54.2%, down from 56.4% in the prior period. This decrease is
due primarily to the 1996 revenue increase because most of the
Company's rental or field expenses are relatively fixed in nature.
Gross Profit: Gross profit in 1996 was $107.4 million, an
increase of $15.1 million, or 16.3%, from the year-ago period due
substantially to higher revenue, as discussed previously, combined
with relatively fixed field expenses. Gross profit margin for
1996, as a percentage of total revenue, was 39.8%, up from 37.9%
for the prior year. Rental margins improved to 35.1%, up 1.6
percentage points from 1995, while sales margins improved slightly
to 63.3%, from 62.7%, as the product mix continued to shift toward
higher margin overlays and disposable products.
Selling, General and Administrative Expenses: SG&A expenses for
1996 were $52.0 million, an increase of $3.5 million, or 7.2%,
from 1995. Total SG&A expenses for the prior year also included a
$2.9 million non-recurring loss from the sale of the Financial
Services Division in June 1995. Costs associated with
international market expansion, improved information systems and
marketing, legal and professional activities accounted for a
substantial part of this increase. As a percentage of total
revenue, SG&A expenses in 1996 were 19.3%, down slightly from
19.9% in the year-ago period.
Operating Earnings: Operating earnings for 1996 were $55.4
million, an increase of $11.6 million, or 26.4%, from 1995. The
increase was due primarily to the growth in revenue combined with
the implementation of various initiatives undertaken to improve
efficiencies, e.g., new information systems. As a percentage of
total revenue, the Company's operating margin improved to 20.5%,
up more than two percent from 1995.
Net Interest Income: Net interest income for 1996 was $9.1
million, which included $5.2 million from the early repayment of
all remaining notes receivable from the 1994 disposition of the
Medical Services Division. The notes had an aggregate face value
of $10 million and had been discounted to a carrying value of $3.2
million, excluding accrued interest. The notes were retired for
approximately $9 million.
Income Taxes: The Company's effective income tax rate for 1996
was 39.5% compared to 41.2% in 1995. This decrease was primarily
the result of implementing various tax planning initiatives both
domestically and overseas.
Net Earnings: Net earnings for 1996 were $39.0 million, or $0.86
per share, compared to 1995 net earnings of $28.4 million, or
$0.63 per share. Higher revenue and controlled spending, combined
with the one-time increase in interest income and a lower overall
tax rate accounted for the 37% earnings improvement. Average
common and common equivalent shares outstanding were substantially
unchanged year-to-year.
Financial Condition
Accounts receivable at December 31, 1997 were $81.2 million,
an increase of $23.0 million, or 39.5%, from the prior year end.
Approximately $5.4 million of this increase was due to receivables
associated with purchase transactions during the year. In
addition, VAC rentals and sales which will be paid through the
Medicare and other third party programs increased receivables by
$3.8 million as the Company continued its work towards
establishment of a Medicare VAC Reimbursement Code. The remainder
of this increase was due primarily to (i) revenue growth in
extended care and home care markets which tend to have customers
and payors who historically have paid over a longer cycle than
acute care customers and (ii) growth in international receivables.
Inventories at December 31, 1997 increased $1.5 million, or
7.5%, to $21.6 million from the end of 1996, due primarily to the
Ethos Medical Group, Ltd. and the RIK Medical L.L.C. acquisitions.
Prepaid expenses and other current assets at December 31,
1997 were $18.4 million, an increase of $11.6 million, or 169%,
compared to the prior year. The majority of this increase was due
to: (i) a current tax receivable of $6.2 million related to the
refund of all 1997 Federal tax payments made and (ii) $3.0 million
of assets to be sold to Dr. James Leininger in 1998.
Net property plant and equipment at December 31, 1997 was
$75.4 million, an increase of $10.2 million, or 15.7%, from the
prior year due, in part, to business acquisitions made during the
year. Net capital expenditures in 1997 were $27.9 million and
related primarily to new product additions to the Company's fleet
of rental frames and surfaces.
Goodwill associated with the excess purchase price of
acquisitions over net tangible and intangible assets acquired
increased $32.4 million, or 239%, from December 31, 1996 due to
the five acquisitions completed during 1997. The goodwill
associated with these acquisitions is being amortized over periods
ranging from 15 to 25 years. See Note 3 of Notes to Consolidated
Financial Statements for further discussion of the Company's
acquisition activities.
During 1997, KCI recorded loan issuance costs of $17.7
million associated with the Company's recapitalization. See Note
2 of Notes to Consolidated Financial Statements for further
discussion of this item.
Accounts payable and accrued expenses were $40.4 million and
$41.3 million, respectively, at December 31, 1997 compared to $4.0
million and $29.8 million, respectively, at the end of 1996. The
increased liabilities relate primarily to payments to be made for
shares of common stock not previously tendered as well as unpaid
costs and expenses associated with the Recapitalization.
Deferred income taxes at December 31, 1997 were $10.0
million, an increase of $4.9 million from year-end 1996. The
increase from the prior year is primarily due to accelerated tax
depreciation on the TriaDyne TM fleet, as well as depreciation on
assets subject to leveraged leases.
Income Taxes
The provision for deferred income taxes is based on the asset
and liability method and represents the change in the deferred
income tax accounts during the year. Under the asset and liability
method of FAS 109, deferred income taxes are recognized for the
future tax consequences attributable to the difference between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences
are expected to be recovered or settled.
At the end of 1997, the net impact of these timing issues
resulted in a net deferred tax liability comprised of deferred tax
liabilities totaling $23.6 million offset by deferred tax assets
totaling $13.5 million.
Legal Proceedings
A description of the Company's legal proceedings is set forth
under the caption "Item 3. Legal Proceedings".
Liquidity and Capital Resources
At December 31, 1997, the Company had current assets of $183.0
million and current liabilities of $86.6 million resulting in a
working capital surplus of $96.4 million, compared to a surplus of
$107.3 million at December 31, 1996.
In 1997, the Company made net capital expenditures of $27.9
million. The 1997 capital expenditures primarily relate to the
Company's TriaDyne TM, TriCell TM and FluidAir TM products, various
mattress overlay products and the design and development of new
information systems. The Company's current budget for capital
expenditures for 1998, other than acquisition expenditures, is
$30.5 million and consists primarily of rental product additions.
Other than commitments for new product inventory, including
disposable "for sale" products, of $11.4 million, the Company has
no material long-term capital commitments and can adjust the level
of capital expenditures as circumstances dictate.
The Company's principal sources of liquidity are expected to
be cash flow from operating activities and borrowings under the
Senior Credit Facilities. It is anticipated that the Company's
principal uses of liquidity will be to fund capital expenditures
related to the Company's rental products, provide needed working
capital, meet debt service requirements and finance the Company's
strategic plans.
The Senior Credit Facilities total $400.0 million and consist
of (i) a $50.0 million six-year Revolving Credit Facility, (ii) a
$50.0 million six-year Acquisition Facility, (iii) a $120.0 million
six-year amortizing Term Loan A, (iv) a $90.0 million seven-year
amortizing Term Loan B and (v) a $90.0 million eight-year
amortizing Term Loan C, (collectively, "the Term Loans"). The Term
Loans were fully drawn to finance a portion of the Tender Offer.
The Acquisition Facility was partially drawn to, in effect, finance
the RIK Medical acquisition. The Acquisition Facility provides the
Company with financing to pursue strategic acquisition
opportunities. The Acquisition Facility will remain available to
the Company for a period of three years at which time will begin to
amortize over the remaining three years of the facility. The
Company has utilized and will utilize borrowings under the
Revolving Facility to help effect the Tender Offer, pay related
fees and expenses, fund capital expenditures and meet working
capital needs.
The Term Loans are payable in equal quarterly installments (1)
subject to an amortization schedule as follows:
Year Amount
---- ------------
1998............................ $ 4,800,000
1999............................ $ 8,800,000
2000............................ $16,800,000
2001............................ $31,800,000
2002............................ $31,800,000
2003............................ $36,800,000
2004............................ $85,500,000
2005............................ $83,700,000
(1) The first three quarterly principal installments for 2004
shall be $450,000 with the final installment for that year
equal to $84,150,000. For 2005, the first three installments
shall be equal to $225,000 and the final installment shall be
equal to $83,025,000.
The Term Loans and the Notes are subject to customary terms,
covenants and conditions which partially restrict the uses of
future cash flows by the Company. The Company does not expect that
these covenants and conditions will have a material adverse impact
on its operations. At December 31, 1997, the Revolving Credit
Facility and Acquisition Facility had balances of $24.5 million and
$10 million, respectively. Correspondingly, the aggregate
availability under these two facilities was $65.5 million.
Indebtedness under the Senior Credit Facilities, including the
Revolving Credit Facility (other than certain loans under the
Revolving Credit Facility designated in foreign currency), the Term
Loans and the Acquisition Facility initially bear interest at a
rate based upon (i) the Base Rate (defined as the higher
of (x) the rate of interest publicly announced by Bank of
America as its "reference rate" and (y) the federal funds effective
rate from time to time plus 0.50%), plus 1.25% in respect of the
Tranche A Term Loans, the loans under the Revolving Credit Facility
(the "Revolving Loans") and the loans under the Acquisition
Facility (the "Acquisition Loans"), 1.50% in respect of the Tranche
B Term Loans and 1.75% in respect of the Tranche C Term Loans, or
at the Company's option, (ii) the Eurodollar Rate (as defined in
the Senior Credit Facility Agreement) for one, two, three or six
months, in each case plus 2.25% in respect of Tranche A Term Loans,
Revolving Loans and Acquisition Loans, 2.50% in respect of Tranche
B Term Loans and 2.75% in respect of the Tranche C Term Loans.
Certain Revolving Loans designated in foreign currency will
initially bear interest at a rate based upon the cost of funds for
such loans, plus 2.25% or 2.50%, depending on the type of foreign
currency. Performance-based reductions of the interest rates under
the Term Loans, the Revolving Loans and the Acquisition Loans are
available. Subsequent to December 31, 1997, the Company entered
into a swap transaction whereby the interest rate on $150,000,000
of the term loans is fixed at 5.7575% through January 8, 2001.
Indebtedness of the Company under the Senior Credit Agreement
is guaranteed by certain of the subsidiaries of the Company and is
secured by (i) a first priority security interest in all, subject
to certain customary exceptions, of the tangible and intangible
assets of the Company and its domestic subsidiaries, including,
without limitation, intellectual property and real estate owned by
the Company and its subsidiaries, (ii) a first priority perfected
pledge of all capital stock of the Company's domestic subsidiaries
and (iii) a first priority perfected pledge of up to 65% of the
capital stock of foreign subsidiaries owned directly by the Company
or its domestic subsidiaries.
The Senior Credit Agreement requires the Company to meet
certain financial tests, including minimum levels of EBITDA (as
defined therein), minimum interest coverage, maximum leverage ratio
and capital expenditures. The Bank Credit Agreement also contains
covenants which, among other things, limit the incurrence of
additional indebtedness, investments, dividends, loans and
advances, capital expenditures, transactions with affiliates, asset
sales, acquisitions, mergers and consolidations, prepayments of
other indebtedness (including the Notes), liens and encumbrances
and other matters customarily restricted in such agreements. The
Company is in compliance with the applicable covenants at December
31, 1997.
The Senior Credit Agreement contains customary events of
default, including payment defaults, breach of representations and
warranties, covenant defaults, cross-defaults to certain other
indebtedness, certain events of bankruptcy and insolvency, failures
under ERISA plans, judgment defaults, failure of any guaranty,
security document security interest or subordination provision
supporting the Bank Credit Agreement to be in full force and effect
and change of control of the Company.
As part of the Recapitalization transactions, the Company
issued $200.0 million of Senior Subordinated Notes (the "Notes")
due 2007. The Notes are unsecured obligations of the Company,
ranking subordinate in right of payment to all senior debt of the
Company and will mature on November 1, 2007. Interest on the Notes
accrues at the rate of 9 5/8% per annum and is payable
semiannually in cash on each May 1 and November 1, commencing on
May 1, 1998, to the persons who are registered Holders at the close
of business on April 15 and October 15, respectively, immediately
preceding the applicable interest payment date. Interest on the
Notes accrues from and including the most recent date to which
interest has been paid or, if no interest has been paid, from and
including the date of issuance.
The Notes are not entitled to the benefit of any mandatory
sinking fund. The Notes will be redeemable, at the Company's
option, in whole at any time or in part from time to time, on and
after November 1, 2002, upon not less than 30 nor more than 60
days' notice, at the following redemption prices (expressed as
percentages of the principal amount thereof) if redeemed during the
twelve-month period commencing on November 1 of the year set forth
below, plus, in each case, accrued and unpaid interest thereon, if
any, to the date of redemption.
Year Percentage
---- ----------
2000.................................. 104.813%
2001.................................. 103.208%
2002.................................. 101.604%
2005 and thereafter................... 100.000%
At any time, or from time to time, the Company may acquire a
portion of the Notes through open-market purchases. Also, on or
prior to November 1, 2000, the Company may, at its option, on one
or more occasions use all or a portion of the net cash proceeds of
one or more Equity Offerings (as defined) to redeem the Notes
issued under the Indenture at a redemption price equal to 109.625%
of the principal amount thereof plus accrued and unpaid interest
thereon, if any, to the date of redemption; provided that at least
65% of the principal amount of Notes originally issued remains
outstanding immediately after any such redemption. In order to
effect the foregoing redemption with the proceeds of any Equity
Offering, the Company shall make such redemption not more than 120
days after the consummation of any such Equity Offering. As used
in this paragraph, "Equity Offering" means any offering of
Qualified Capital Stock of the Company.
As of December 31, 1997 the entire $200.0 million of Senior
Subordinated Notes was issued and outstanding.
During 1997, the Company generated $10.7 million in cash from
operating activities compared to $62.2 million in the prior year, a
decrease of $51.5 million. The decrease in operating cash flows
resulted substantially from $34.4 million in fees and expenses
associated with the Recapitalization, as well as an increase in
accounts receivable as discussed previously. Excluding the effects
of the Recapitalization, operating cash flows for 1997 would have
been $37.3 million. Investment activities for 1997 used $68.1
million, including net capital expenditures of $27.9 million and
$41.2 million used to fund the five business acquisitions completed
during 1997. Financing activities for 1997 provided $61.9 million
consisting primarily of proceeds from common stock issuance and
borrowings of notes payable and long-term obligations, partially
offset by recapitalization costs to purchase treasury stock,
finance stock option exercises and pay dividends. In 1997, the
Company repurchased and retired approximately 258,000 shares of
common stock under a program which authorized the Company to pur-
chase up to 3 million shares.
At December 31, 1997, cash and cash equivalents totaling $61.81
million were available for general corporate purposes. Based upon
the current level of operations, the Company believes that cash
flow from operations and the availability under its lines of credit
will be adequate to meet its anticipated requirements for debt
repayment, working capital and capital expenditures through 1998.
Impact of Year 2000
The Year 2000 issue results from computer programs being
written using two digits rather than four digits to define the date
field. Certain of the Company's existing computer programs that
have time-sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in system
failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process
transactions or engage in similar normal business activities.
Based on a recent assessment, the Company determined that it
would need to modify or replace key portions of its software so
that its computer systems will function properly with respect to
dates in the year 2000 and thereafter. The Company presently
believes that through its conversion to the Oracle applications
platform and with modifications to other existing software, the
Year 2000 issue will not pose significant operational problems for
its computer systems. However, if such modifications and
conversions are not made properly or are not completed timely, the
Year 2000 issue could have a material impact on the operations of
the Company.
The Company has initiated formal communications with all of
its significant suppliers and large customers to determine the
extent to which the Company's interface systems are vulnerable to
those third parties' failure to remediate their own Year 2000
issues. The Company's total Year 2000 project cost, and estimates
to complete, include the estimated costs and time associated with
the impact of third party Year 2000 issues based on presently
available information. However, there can be no guarantee that the
systems of other companies on which the Company's systems rely will
be timely converted and would not have an adverse effect on the
Company's systems. The Company has determined
it has no exposure to contingencies related to the Year 2000 issue
for the products it has sold.
The Company will utilize both internal and external resources
to reprogram, or replace, and test the software for Year 2000
modifications. The Company anticipates completing the Year 2000
project by no later than March 31, 1999, which is prior to any
anticipated impact on its operating systems. The total cost of the
Year 2000 project is estimated at $6.5 million and is being funded
through operating cash flows. Also, $5.5 million of this total
will be used to purchase new software that will be capitalized and
the remaining $1.0 million will be expensed as incurred. To date,
the Company has incurred approximately $5.4 million ($900,000
expensed and $4.5 million capitalized for new software), related to
the assessment of the Year 2000 issue, development of a
modification plan, preliminary software modifications and purchase
of new software, where necessary.
The costs of the project and the date on which the Company
believes it will complete the Year 2000 modifications are based on
management's best estimates, which were derived utilizing numerous
assumptions of future events, including the continued availability
of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates
will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material
differences include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and
correct all relevant computer codes and similar uncertainties.
Item 8. Financial Statements and Supplementary Data
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KINETIC CONCEPTS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands)
December 31,
--------------------
1997 1996
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ASSETS
Current assets:
Cash and cash equivalents............ $ 61,754 $ 59,045
Accounts receivable, net............. 81,238 58,241
Inventories.......................... 21,553 20,042
Prepaid expenses and other........... 18,446 6,860
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Total current assets......... 182,991 144,188