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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
Commission file number 333-56097
HUDSON RESPIRATORY CARE INC.
(Exact name of registrant as specified in its charter)
California 95-1867330
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
27711 Diaz Road, P.O. Box 9020 92589
Temecula, California (Zip Code)
(Address of Principal Executive Offices)
(909) 676-5611
(Registrant's telephone number, including area 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 [_] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) 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 amendment to this Form 10-K.
[_] Not Applicable.
As of August 15, 2001, the number of shares of Common Stock, $.01 par
value, outstanding (the only class of common stock of the registrant
outstanding) was 10,391,435. The registrant's Common Stock is not traded in a
public market.
Aggregate market value of the registrant's voting and nonvoting Common Stock:
Not Applicable.
Documents Incorporated by Reference: None
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HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
Fiscal Year Ended December 31, 2000
TABLE OF CONTENTS
Page
----
PART I..................................................................................................... 1
Item 1. Business................................................................................ 1
Item 2. Properties.............................................................................. 8
Item 3. Legal Proceedings....................................................................... 8
Item 4. Submissions of Matters to a Vote of Security Holders.................................... 8
PART II.................................................................................................... 9
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................... 9
Item 6. Selected Financial Data................................................................. 9
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.... 11
Item 7A. Quantitative and Qualitative Disclosure About Market Risk............................... 23
Item 8. Financial Statements.................................................................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.... 24
PART III................................................................................................... 25
Item 10. Directors and Executive Officers of the Registrant...................................... 25
Item 11. Executive Compensation.................................................................. 27
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 29
Item 13. Certain Relationships and Related Transactions.......................................... 30
PART IV.................................................................................................... 31
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 31
SIGNATURES................................................................................................. S-1
PART I
Item 1. Business.
This Annual Report on Form 10-K contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These statements
include without limitation the words "believes," "anticipates," "estimates,"
"intends," "expects," and words of similar import. All statements other than
statements of historical fact included under "Item 1. Business," "Item 2.
Properties," "Item 3. Legal Proceedings" and "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" include forward-
looking information and may reflect certain judgements by management. Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
Hudson Respiratory Care Inc. or the respiratory care and anesthesia products
industries to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. These
potential risks, uncertainties and other factors include, but are not limited
to, those identified in the "Risk Factors" section of this Form 10-K located at
the end of "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations." The Company disclaims any obligation to update any
such factors or to publicly announce the results of any revisions to any of the
forward-looking statements contained herein to reflect future events or
developments.
General
Hudson Respiratory Care Inc. ("Hudson RCI" or the "Company") is a leading
manufacturer and marketer of disposable medical products utilized in the
respiratory care and anesthesia segments of the domestic and international
health care markets. The Company offers one of the broadest respiratory care and
anesthesia product lines in the industry, including such products as oxygen
masks, humidification systems, nebulizers, cannulae and tubing. In the United
States, the Company markets its products to a variety of health care providers,
including hospitals and alternate site service providers such as outpatient
surgery centers, long-term care facilities, physician offices and home health
care agencies. Internationally, the Company sells its products to distributors
that market to hospitals and other health care providers. The Company's products
are sold to over 3,000 distributors and alternate site service providers
throughout the United States and in more than 75 countries worldwide. The
Company has supplied the disposable respiratory care market for over 50 years
and enjoys strong brand name recognition and leading market positions.
The Company manufactures and markets over 2,500 respiratory care and
anesthesia products. The Company believes that its broad product offering
represents a competitive advantage over suppliers with more limited product
offerings, as health care providers seek to reduce medical supply costs and
concentrate purchases among fewer vendors. The Company also benefits
competitively from its extensive relationships with leading group purchasing
organizations (GPOs), as large purchasing organizations play an increasingly
important role in hospitals' purchasing decisions.
The Company maintains three manufacturing facilities and three distribution
facilities in the United States, assembly operations in Mexico and Malaysia and
sales and marketing offices in the United States, Sweden, the United Kingdom,
France and Germany. The Company has reduced its manufacturing and assembly costs
through cost reduction programs, process improvements, equipment automation and
upgrades and increased utilization of its Ensenada, Mexico and Kuala Lumpur,
Malaysia facilities for labor-intensive operations.
Hudson Oxygen Therapy Sales Company ("Hudson Oxygen"), Hudson RCI's
predecessor, was founded in 1945. In 1988, Hudson Oxygen formed Industrias
Hudson, a subsidiary that oversees the Company's assembly operation in Mexico.
In 1989, Hudson Oxygen merged with Respiratory Care Inc. to form Hudson RCI. In
April 1998, the Company consummated a recapitalization, pursuant to which it
became a majority-owned subsidiary of River Holding Corp. ("Holding"). In the
past three years, the Company has completed a number of strategic acquisitions
in order to expand its product line and geographic penetration, most
significantly with the July 1999 acquisition of Hudson RCI AB (formerly Louis
Gibeck AB), a Swedish company that manufactures and markets medical devices.
Hudson RCI's principal executive offices are located at 27711 Diaz Road, P.O.
Box 9020, Temecula, California 92589, and its telephone number is (909) 676-
5611.
1
Industry Overview
The worldwide market for disposable respiratory care and anesthesia
products consists of the domestic hospital market, the alternate site market and
the international market. Respiratory care and anesthesia principally involve
the delivery of oxygen and anesthesia from a gas source, such as a mechanical
ventilator or respirator, to the patient's pulmonary system. The gas is
typically delivered to the patient through specialized tubing connecting to a
cannula, mask or endotracheal tube. In addition, it is often necessary to
humidify or medicate the gas. The market for respiratory care and anesthesia
products, including disposable products, is expected to be positively impacted
by demographic trends, both domestically and internationally. In the United
States, changes in demographics, including an aging population, increased
incidence and awareness of respiratory illnesses and heightened focus on cost-
efficient treatment, have had a positive impact on the domestic respiratory care
and anesthesia markets. There has been an increasing incidence of respiratory
illnesses (such as asthma and emphysema), due in part to an increasingly
susceptible aging population, environmental pollution, smoking-related illnesses
and communicable diseases with significant respiratory impact, such as
tuberculosis, HIV and influenza. The Company believes that the international
respiratory care and anesthesia markets will experience many of the trends
currently affecting domestic markets. In addition, many international markets
have high incidences of communicable respiratory diseases and are becoming
increasingly aware of the value of single-use, disposable products.
The market for respiratory care and anesthesia products is also affected by
trends involving the health care market generally. In particular, the overall
trend towards cost containment has increased the desirability of disposable
products relative to reusable products, and has influenced pricing, distribution
channels, purchasing decisions and health care delivery methods.
Efforts to contain rising health care costs have increased the preference
for disposable medical products that improve the productivity of health care
professionals and reduce overall provider costs. Health care organizations are
evaluating modes of treatment that are less labor and/or technology intensive as
a means of decreasing the cost of care, which can often result in increased
disposable usage. In particular, increased utilization of disposable products
can decrease labor and other costs associated with sterilizing reusable
products. In addition, the risks of transmission of infectious diseases such as
HIV, hepatitis and tuberculosis, and related concerns about the occupational
safety of health care professionals, have also contributed to an increased
preference for disposable single-use medical products.
Cost containment has caused consolidation throughout the health care
product supply channel, which has favored manufacturers with large product
offerings and competitive pricing. In an effort to contain costs, service
providers have consolidated to form GPOs, which take advantage of group buying
power to obtain lower supply prices. This, in turn, has led to consolidation
among distributors, who seek to provide "one-stop shopping" for these large
buying groups. Distributors have also sought to concentrate purchases among
fewer vendors in an effort to reduce supply costs. Since selection as a GPO
provider and strong relationships with distributors are critical to many health
care manufacturers, they have responded to these trends by providing a broad
range of integrated products, combined with reliable delivery and strong after-
sales support.
Cost containment has also caused a migration of the decision making
function with respect to supply acquisition from the clinician to the
administrator. As clinicians lose influence and purchasing agents, materials
managers and upper level management become more involved in the purchasing
decision, a greater emphasis is placed on price relative to product features and
clinical benefits.
As a result of cost containment, health care is increasingly provided
outside of traditional hospital settings through alternate health care sites,
such as outpatient surgery centers, long-term care facilities, physician offices
and patients' homes. Growth of the alternate site market is also attributable to
advances in technology that have facilitated the delivery of care outside of the
hospital, an increased number of illnesses and diseases considered to be
treatable outside of the hospital and increased acceptance by the medical
community of, and patient preference for, non-hospital treatment.
2
Products
The Company manufactures and markets products for use in respiratory care
and anesthesia. The products for each market are similar and often overlap, as
do the distribution channels.
The Company groups its products into nine categories: (i) oxygen delivery;
(ii) aerosol therapy; (iii) active and passive humidification; (iv) ventilatory
support; (v) adaptors, connectors and filters; (vi) resuscitation; (vii) airway
management; (viii) electronic monitoring; and (ix) durable equipment.
Category/Products
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Oxygen Delivery: Oxygen Masks, Oxygen Cannulae, Oxygen Tubing
Aerosol Therapy: AQUAPAK(R) Large Volume, Prefilled Nebulizers; Non-Prefilled
Large Volume Nebulizer; UPDRAFT(R), UPDRAFT II(R), AVA-NEB(R) and MICRO MIST(R)
Small Volume, Medication Nebulizers; Aerosol Tubing; AQUATHERM(R) and
THERMAGARD(R) Nebulizer Heaters; AQUAPAK Prefilled Ultrasonic Cups; ADDIPAK(R)
Prefilled Unit Dose Solutions; POCKETPEAK(R) Peak Flow Meter
Active and Passive Humidification:
CONCHATHERM(R) Heated Humidifiers, AQUA+(R) Hygroscopic Condenser Humidifiers,
AQUAPAK Prefilled Humidifiers, Non-Prefilled, Reusable Humidifier, Non-Prefilled
Disposable Humidifier, HUMID-HEAT(R) Heat-Moisture Exchangers
Ventilatory Support: Conventional Ventilator Circuits, Heated-Wire Ventilator
Circuits, Anesthesia Breathing Circuits, Air Cushion Anesthesia Masks, Infant
CPAP Systems
Adaptors, Connectors and Filters: A wide variety of adaptors and connectors;
Main Flow Bacterial/Viral Filters; Pulmonary Function Filter
Description
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Used to deliver therapeutic, supplemental oxygen to a patient. Oxygen masks
cover the nose and mouth. Nasal cannulae fit inside the nostrils. Both masks and
cannulae are connected to an oxygen source via small diameter tubing through
which oxygen flows.
Used to create and deliver aerosolized particles of liquid water, sodium
chloride or medication to the patient's airways to dilute and mobilize
secretions and/or dilate constricted breathing passages. The peak flow meter is
used to monitor the patient's respiratory status before and after an aerosolized
medication treatment.
Heated humidification systems actively heat and humidify oxygen/air mixtures or
anesthetic gases provided by a mechanical ventilator or anesthesia gas machine.
Hygroscopic condenser humidifiers passively conserve the heat and humidity in
the patient's exhaled breath for use during inspiration. Prefilled and non-
prefilled humidifiers are used to add water vapor to oxygen being provided to a
patient via a mask or cannula.
Used to convey an oxygen/air mixture and/or anesthetic gas from a mechanical
ventilator or anesthesia gas machine to a patient during the temporary or long-
term support of ventilation. The infant CPAP system provides non-invasive
respiratory support to premature infants with under-developed, immature lungs.
The adaptors and connectors are frequently used in respiratory care and
anesthesia to add accessories, modify configurations, and/or customize other
related products to meet specific needs. Filters are used to protect patients,
3
Category/Products
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Resuscitation: LIFESAVER(R) Reusable and Disposable Resuscitation Bags,
Isolation Valves and Kits, LIFESAVER Tubes and Kits
Airway Management: SOFTECH(R) Cuffed and Uncuffed Endotracheal Tubes; CATH-
GUIDE(R), Color-Coded and DUAL-CHANNEL Oral Pharyngeal Airways; BITEGARDO(TM)
Oral Bite Block; CATH-GUIDE Closed Suction Catheters; VOLDYNE(R) and TRI-FLO(R)
Incentive Breathing Exercisers; SHERIDAN(R) Endotracheal Tubes
Electronic Monitoring: Replacement oxygen sensors, Oxygen Monitors and
Analyzers, VENTILARM II(R) Low-Pressure Alarms
Durable Equipment: Oxygen Regulators; Cylinder Carts, Trucks and Stands;
Portable Oxygen Units
Description
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Caregivers, and medical equipment from cross-contamination with bacteria and
viruses.
Used during cardiopulmonary resuscitation ("CPR") to adequately support and/or
maintain the patient's ventilatory function.
Assist in securing and maintaining an open airway and unobstructed breathing
passage. They also can assure that the patient's ventilation can be maintained
and that respiratory secretions can be adequately removed from the lungs.
The oxygen sensors, monitors and analyzers are used to analyze and monitor the
amount of oxygen being administered to a patient. The low-pressure alarm is used
to detect a patient disconnect or a leak in the breathing circuit during
mechanical ventilation.
Used to regulate oxygen flow from cylinders, stabilize or transport oxygen or
other gas cylinders, and provide a portable oxygen supply for emergency use.
Sales, Marketing and Distribution
The Company has sales offices in Temecula, Sweden, Germany, France and the
United Kingdom. While a majority of the Company's domestic hospital sales are
made to distributors, the Company's marketing efforts are focused on the health
care service provider. In the alternate site market, the Company both sells and
markets directly to the service provider. Internationally, the Company sells its
products to distributors that market to hospitals and other health care
providers. See Note 12 to "Item 8. Financial Statements" for information with
respect to international sales. The Company's sales personnel currently call on
approximately 2,800 health care providers, 50 hospital distributors and 1,500
alternate site customers. Due to consolidation and cost pressures among the
Company's customer base, the Company's target call point at the health care
provider has been moving away from the clinician to include a purchasing manager
or corporate executive. As of December 31, 2000, the Company had a sales backlog
of approximately $3.9 million.
In the current market environment, GPO relationships are an essential part
of access to the Company's target markets and the Company has entered into
preferred supplier arrangements with 14 national GPOs. The Company is typically
positioned as either a sole supplier of respiratory care disposables to the GPO,
or as one of two suppliers. While these arrangements set forth pricing and terms
for various levels of purchasing, they do not obligate either party to purchase
or sell a specific amount of product. In addition, GPO affiliated hospitals
often purchase products from other suppliers notwithstanding the existence of
sole or dual source GPO arrangements. Further, these arrangements are terminable
at any time, but in practice usually run for two to three years. The Company
enjoys longer terms with two
4
of its major GPOs, Novation LLC (which represents the 1998 consolidation of VHA,
Inc. and University HealthSystem Consortium) and HCA. The Company's most
significant GPO relationships are with AmeriNet Inc., HealthTrust Corporation,
Health Services Corporation of America, MHA, and Novation LLC. In 2000, the
Company entered into a new, exclusive relationship with Consorta, the merger of
the former DOC and SSM Catholic hospital organizations.
Health care providers have responded to pressures to reduce their costs by
merging with other members of their industry. The acquisition of a customer of
the Company often results in the renegotiation of contracts, the granting of
price concessions or in the loss of the customer. Alternatively, to the extent a
customer of the Company grows through acquisition activity, the Company may
benefit from increased sales to the larger entity.
The Company markets its products primarily through consultative dialogue
with health care providers, targeted print advertising, trade shows, selective
promotional arrangements with distributors and the Company's heater lease
program. To support sales of the entire line of humidification and ventilation
products, the Company leases heaters to domestic customers without charge. The
revenues from the sale of products used in connection with the operation of the
heaters covers the amortization of the heater cost under the leases. The Company
has heaters with a net book value of approximately $2.2 million as of
December 31, 2000 placed at service provider locations under this program.
The Company utilizes a network of over 3,000 hospital distributors, as well
as additional alternate site distributors, to reach its markets. A number of
these distributors carry competing product lines, but many are moving to select
single supply sources for particular product groups. The Company has been
selected as the FOCUS preferred vendor of respiratory disposables for Owens &
Minor Inc. Such status gives preference to the shipping of the Company's
products versus competing product lines. Owens & Minor Inc. is the Company's
largest distributor, accounting for approximately $32.2 million or approximately
20.2% of total fiscal 2000 net sales. The Company provides a price list to its
distributors which details base acquisition prices. Distributors receive orders
from the service providers and charge the contract pricing (which is determined
by their GPO affiliation or individual contract price) plus a service margin.
As is customary within the industry, the Company rebates the difference between
base acquisition price and the specific contract price to the distributor. The
Company offers select large health care providers a reward for purchasing a
broader selection of the Company's product lines. The program allows a rebate in
the form of merchandise credit for purchasing minimum volumes from a selected
group of products. The Company's international distributors outside of the EU,
Middle East and Africa place their orders directly with dedicated international
customer service representatives. Customer orders are shipped from one of two
warehouse locations. Sales strategies and marketing plans are tailored to each
market with involvement of the distributor. Region and territory sales managers
are responsible for the launch of products into their regions, including related
support and training. The Company utilizes a network of approximately 100
international distributors, typically on an exclusive basis within each market.
Manufacturing and Assembly
The Company operates three manufacturing facilities and three distribution
facilities in the United States and assembly facilities in Ensenada, Mexico and
Kuala Lumpur, Malaysia. While the Company believes that it is operating at a
high utilization rate, existing facilities could support increased capacity with
additional machinery and workers.
The Company's manufacturing facility in Temecula, California houses 77
injection molding machines, 67 of which are automated. During the past five
years, 31 out of the 76 machines have been replaced with more efficient models,
which has increased capacity. Tubing is produced on 11 extrusion lines: 6
corrugated, 4 oxygen or "spaghetti," and 1 repellitizer/regrinder. The Temecula
facility uses 12-14 million pounds of over 30 different kinds of resin annually;
the most prominent are PVC, polyethylene and polypropylene. Sterile prefilled
humidification and nebulization products are manufactured using 9 blow/fill/seal
machines in the Company's facility in Arlington Heights, Illinois.
The Company's Argyle, New York facility houses 4 extrusion lines , 4 blow
molding machines and 8 assembly lines designed to produce the SHERIDAN(R) brand
of endotracheal tubes. This product line was acquired in October, 2000 from Tyco
Healthcare Group LP ("Tyco"). The Company leases approximately fifty percent of
the Argyle facility from Tyco under a three year lease ending in October, 2003.
The Company expects to either renew the lease or relocate the production lines
to another Company facility.
5
The Company's facility located in Ensenada, Mexico is primarily used for
the assembly of certain products molded and/or extruded at the Temecula
facility. The facility is a maquiladora, and therefore there are minimal tariffs
associated with the transport of products and components across the United
States-Mexico border. The Company's facility located in Kuala Lumpur, Malaysia
assembles virtually all of the HME and filter products marketed by the Company.
The components assembled by the Malaysian operation are generally molded by
outside vendors in Malaysia.
The Company occasionally outsources production of certain products while it
establishes its ability to penetrate a target market. Having achieved an
acceptable level of penetration, the Company internalizes the manufacturing
function in order to increase margins and improve quality control.
The Company monitors the quality of its products at the Temecula, Arlington
Heights, Argyle, Ensenada and Kuala Lumpur facilities by statistical sampling
and visual and dimensional inspection. The Company also inspects incoming raw
materials for inconsistencies, rating its vendors on quality and delivery time.
The Company is routinely audited by the FDA and has received no significant
regulatory actions. The Company is in substantial compliance with the GMP/QSR
regulations of the FDA and the United States and Mexico operations have
qualified for an "advanced notification" program allowing the Company to be
informed of FDA inspections in advance. The Company utilizes outside facilities
for sterilization of products produced in Temecula, Argyle, Arlington Heights,
Kuala Lumpur and Ensenada. Certain Arlington Heights products are manufactured
in a sterile environment and are certified sterile as a result of the production
process. The Ensenada, Kuala Lumpur, Argyle and Arlington Heights facilities are
certified as ISO 9002 compliant and the Temecula facility is certified as ISO
9001 compliant.
Suppliers and Raw Materials
The Company's primary raw materials are various resins, which are formed
into the Company's products. The top 10 purchased products in 2000 were Tubing
Grade PVC, Clear PVC, LDPE-EVA, Polypropylene, Aluminum Cylinder, Pre-Cut
Elastic, Non-Tubing Grade PVC, Cannula Blanks, Acrylic Resin and Hose-End Grade
PVC. The Company believes that it is able to purchase materials at a cost no
higher than its competitors. The Company does not have long-term supply
contracts for any of its purchased raw materials. The Company believes that
sufficient availability exists for its raw materials, as they consist of mainly
readily available plastic resins.
Research and Development
The Company's research and development department consists of 18 people,
including 11 engineers. The Company's research and development efforts are split
between developing new products and process improvements to its manufacturing
operations. The Company develops new products to expand its product line in
anticipation of changes in demand. The Company has invested heavily in the
anesthesia product line, as the Company continues to penetrate this market. The
Company makes several new product introductions every year. Significant products
introduced in the last five years include the line of heat-moisture exchangers,
POCKETPEAK peak flow meter, SOFTECH endotracheal tubes, MICRO MIST small volume
nebulizer and CONCHA IV heated humidification system. The Company constantly
works to reduce costs through continuous process improvements. The Company
incurred research and development expenses of approximately $1.0 million, $2.0
million and $2.4 million in fiscal 1998, 1999 and 2000, respectively.
Competition
The medical supply industry is characterized by intense competition. The
Company's primary competitor in the respiratory care sector is Allegiance
Healthcare and its primary competitors in the anesthesia sector include Tyco,
Smiths Industries Medical Systems, Inc. ("SIMS"), and Vital Signs, Inc. Many of
the products manufactured by the Company are available from several sources, and
many of the Company's customers tend to have relationships with several
manufacturers. The Company competes on the basis of brand name, product quality,
breadth of product line, service and price.
Patents and Trademarks
6
The Company has historically relied primarily on its technological and
engineering abilities and on its design and production capabilities to gain
competitive business advantages, rather than on patents or other intellectual
property rights. However, the Company does file patent applications on concepts
and processes developed by the Company's personnel. The Company has 24 patents
in the U.S. Many of the U.S. patents have corresponding patents issued in
Canada, Europe and various other countries. The Company's success will depend in
part on its ability to maintain its patents, add to them where appropriate, and
develop new products and applications without infringing the patent and other
proprietary rights of third parties and without breaching or otherwise losing
rights in technology licenses obtained by the Company for other products. There
can be no assurance that any patent owned by the Company will not be
circumvented or challenged, that the rights granted thereunder will provide
competitive advantages to the Company or that any of the Company's pending or
future patent applications will be issued with claims of the scope sought by the
Company, if at all. If challenged, there can be no assurance that the Company's
patents (or patents under which it licenses technology) will be held valid or
enforceable. In addition, there can be no assurance that the Company's products
or proprietary rights do not infringe the rights of third parties. If such
infringement were established, the Company could be required to pay damages,
enter into royalty or licensing agreements on onerous terms and/or be enjoined
from making, using or selling the infringing product. Any of the foregoing could
have a material adverse effect upon the Company's business, financial condition
or results of operations.
Government Regulation and Environmental Matters
The Company and its customers and suppliers are subject to extensive
Federal and state regulation in the United States, as well as regulation by
foreign governments, and the Company cannot predict the extent to which future
legislative and regulatory developments concerning its practices and products
for the health care industry may affect the Company. Most of the Company's
products are subject to government regulation in the United States and other
countries. In the United States, the FD&C Act and other statutes and
regulations govern or influence the testing, manufacture, safety, labeling,
storage, record keeping, marketing, advertising and promotion of such products.
Failure to comply with applicable requirements can result in fines, recall or
seizure of products, total or partial suspension of production, withdrawal of
existing product approvals or clearances, refusal to approve or clear new
applications or notices and criminal prosecution. Under the FD&C Act and similar
foreign laws, the Company, as a marketer, distributor and manufacturer of health
care products, is required to obtain the clearance or approval of Federal and
foreign governmental agencies, including the FDA, prior to marketing,
distributing and manufacturing certain of those products. The Company may also
need to obtain FDA clearance before modifying marketed products or making new
promotional claims. Delays in receipt of or failure to receive required
approvals or clearances, the loss of previously received approvals or
clearances, or failures to comply with existing or future regulatory
requirements in the United States or in foreign countries could have a material
adverse effect on the Company's business. Foreign sales are subject to similar
requirements.
The Company is required to comply with the FDA's GMP/QSR Regulations, which
set forth requirements for, among other things, the Company's manufacturing
process, design control and associated record keeping, including testing and
sterility. Further, the Company's plants and operations are subject to review
and inspection by local, state, Federal and foreign governmental entities. The
distribution of the Company's products may also be subject to state regulation.
The impact of FDA regulation on the Company has increased in recent years as the
Company has increased its manufacturing operations. The Company's suppliers,
including the sterilizer facilities, are also subject to similar governmental
requirements. There can be no assurance that changes to current regulations or
additional regulations imposed by the FDA will not have an adverse impact on the
Company's business and financial condition in the future. The FDA also has the
authority to issue special controls for devices manufactured by the Company,
which it has not done to date. In the event that such special controls were
issued, the Company's products would be required to conform, which could result
in significant additional expenditures for the Company.
The Company is also 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
infectious materials or substances and emissions of air pollutants. The Company
owns and leases properties which are subject to environmental laws and
regulations. There can be no assurance that the Company will not be required to
incur
7
significant costs to comply with such laws and regulations in the future or that
such laws or regulations will not have a material adverse effect upon the
Company's business, financial condition or results of operations. In addition,
the Company cannot predict the extent to which future legislative and regulatory
developments concerning its practices and products for the health care industry
may affect the Company.
Employees
As of August 15, 2001, the Company employed approximately 2,700 employees,
substantially all of whom were full-time employees. None of the Company's
employees are represented by unions and the Company considers its employee
relations to be good.
Item 2. Properties.
The Company owns approximately 30 acres of land in Temecula, California on
which its headquarters, one of three principal manufacturing centers and three
other buildings totaling approximately 245,000 square feet are located. Plastic
and vinyl components and corrugated tubing are manufactured in Temecula and
assembled into finished goods at a 77,000 square foot facility in Ensenada,
Mexico. The Company owns the Ensenada facility and the underlying land is held
in a 30-year trust that expires in 2019. The Company leases an 86,000 square
foot manufacturing facility in Arlington Heights, Illinois under a lease that
expires in 2005 with an option to extend an additional 5 years. Prefilled
sterile solutions and electronics are manufactured in Arlington Heights. The
Company leases a 73,000 square foot distribution warehouse in Elk Grove,
Illinois under a lease that expires in May, 2010, and a 25,375 square foot
distribution facility in Atlanta, Georgia under a lease that expires in February
2006. The company leases a 99,100 square foot distribution facility in Temecula,
California under a lease that expires in September 2005. The Company leases
sales and marketing offices in Stockholm, Sweden; Ashby de la Zouch, U.K.; Lyon,
France; and Lohmar, Germany under leases that expire in September 30, 2002,
April 25, 2006 and April, 2002, respectively. The Company leases a 33,260
square foot facility in Kuala Lumpur, Malaysia, under a lease that expires in
July, 2001. This facility primarily assembles finished products for the HME and
filter product lines. The Company also leases approximately fifty percent of an
80,218 square foot facility in Argyle, New York under a lease that expires in
October, 2003. This facility manufacturers the SHERIDAN(R) line of endotracheal
tubes.
The Company believes that its current facilities are adequate for its
present level of operations.
Item 3. Legal Proceedings.
The Company is party to lawsuits and other proceedings, including suits
relating to product liability and patent infringement. While the results of such
lawsuits and other proceedings cannot be predicted with certainty, management
does not expect that the ultimate liabilities, if any, will have a material
adverse effect on the financial position or results of operations of the
Company.
Item 4. Submissions of Matters to a Vote of Security Holders.
None.
8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
There is no established public trading market for the Company's Common
Stock. All of the Common Stock of the Company is held by Holding and the
shareholder of the Company prior to the Recapitalization, described below. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Recapitalization."
The Company has not paid cash dividends to Holding in the past two
years, and does not intend to pay cash dividends to Holding in the foreseeable
future. See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources" for a discussion of
restrictions on the Company's ability to pay cash dividends.
Item 6. Selected Financial Data.
The selected fiscal year end historical financial data has been
derived from the audited financial statements of the Company. The information
contained in this table should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto included elsewhere in this
Report.
Fiscal Year
-------------------------------------------------------------
1996 1997 1998 1999(a) 2000
------- ------- -------- -------- ----------
Operating Data: (dollars in thousands)
Net sales............................................... $93,842 $99,509 $100,498 $128,803 $ 159,278
Cost of sales........................................... 52,189 54,575 56,802 75,418 84,923
------- ------- -------- -------- ----------
Gross profit............................................ 41,653 44,934 43,696 53,385 74,355
Operating expenses:
Selling expenses........................................ 8,961 9,643 10,350 13,122 18,262
Distribution expenses................................... 3,114 3,170 3,336 4,647 10,109
General and administrative expenses..................... 11,277 11,456 10,284 14,732 27,343
Research and development expenses....................... 1,184 1,072 976 2,031 2,387
Provision for equity participation plan................. 8,249 6,954 63,939 -- ---
Provision for retention payments........................ -- -- 4,754(b) -- ---
------- ------- -------- -------- ----------
Operating income (loss)................................. 8,868 12,639 (49,943) 18,853 16,254
Other (income) and expenses:
Interest expense........................................ 2,177 1,834 11,327 17,263 21,089
Other (income) expense.................................. (463) (638) 406 1,232 1,159
------- ------- -------- -------- ----------
Total other expense..................................... 1,714 1,196 11,733 18,495 22,248
------- ------- -------- -------- ----------
Income (loss) before provision for income taxes......... 7,154 11,443 (61,676) 358 (5,994)
Provision for income taxes.............................. 73 150 8,405 1,586 3,203
------- ------- -------- -------- ----------
Income (loss) before extraordinary item................. 7,081 11,293 (70,081) (1,228) (9,197)
Extraordinary item (loss on extinguishment of debt)..... -- -- 104(c) -- ---
------- ------- -------- -------- ----------
Net income (loss)....................................... $ 7,081 $11,293 $(70,185) $ (1,228) $ (9,197)
======== ======= ======== ======== ==========
continued on following page
9
Fiscal Year
------------------------------------------------------
1996 1997 1998 1999(a)
---------- ---------- ---------- ---------
Other Financial Data: (dollars in thousands)
Net cash provided by (used in) operating activities..................... $ 16,133 $ 19,269 $(83,024) $ 7,097
Net cash used in investing activities................................... $(11,354) $ (3,673) $ (6,444) $(75,818)
Net cash provided by (used in) financing activities..................... $ (3,668) $(16,398) $ 89,624 $ 71,529
Adjusted EBITDA(d)...................................................... $ 23,194 $ 25,440 $ 24,851 $ 29,993
Adjusted EBITDA margin(e)............................................... 24.7% 25.6% 24.7% 23.3%
Operating margin before EPP and Retention Payments(f)................... 18.2% 19.7% 18.7% 14.6%
Depreciation and amortization(g)........................................ $ 6,133 $ 5,847 $ 6,101 $ 8,315
Capital expenditures.................................................... $ 6,395 $ 4,659 $ 3,111 $ 10,973
Ratio of Adjusted EBITDA to cash interest expense....................... 10.7x 13.9x 2.3x 2.1x
Ratio of total debt to Adjusted EBITDA.................................. 1.2x 0.8x 6.4x 7.1x
Ratio of earnings to fixed charges(h)................................... 3.7x 6.0x -- 1.0
Deficiency of earnings to cover fixed charges........................... -- -- $(61,676) --
Ratio of earnings to fixed charges and preferred stock dividends(i)..... 3.7x 6.0x -- 1.0
Deficiency of earnings to cover fixed charges and preferred stock
dividends.............................................................. -- -- $(61,676) --
Balance Sheet Data:
Working capital......................................................... $ 24,188 $ 6,430 $ 29,533 $ 35,971
Working capital as adjusted(j).......................................... 26,768 29,960 32,026 39,727
Total assets............................................................ 76,910 77,554 165,321 251,819
Total debt.............................................................. 28,146 20,250 159,000 211,694
Shareholders' equity (deficit).......................................... 19,872 22,515 (37,735) (14,649)
2000
----------
Other Financial Data:
Net cash provided by (used in) operating activities..................... $ 10,502
Net cash used in investing activities................................... $(26,941)
Net cash provided by (used in) financing activities..................... $ 17,341
Adjusted EBITDA(d)...................................................... $ 29,172
Adjusted EBITDA margin(e)............................................... 18.3%
Operating margin before EPP and Retention Payments(f)................... 10.2%
Depreciation and amortization(g)........................................ $ 12,918
Capital expenditures.................................................... $ 11,329
Ratio of Adjusted EBITDA to cash interest expense....................... 1.65x
Ratio of total debt to Adjusted EBITDA.................................. 7.6x
Ratio of earnings to fixed charges(h)................................... --
Deficiency of earnings to cover fixed charges........................... $ (5,994)
Ratio of earnings to fixed charges and preferred stock dividends(i)..... --
Deficiency of earnings to cover fixed charges and preferred stock
dividends.............................................................. $(13,727)
Balance Sheet Data:
Working capital......................................................... $ 29,559
Working capital as adjusted(j).......................................... 38,715
Total assets............................................................ 275,234
Total debt.............................................................. 221,914
Shareholders' equity (deficit).......................................... (22,775)
- -------------------
(a) Includes results of operations for (i) Hudson RCI AB, since it was acquired
in July 1999, (ii) Medimex, since certain of its assets were acquired in
October 1999 and (iii) Tyco, since certain of its assets were acquired in
November 1999.
(b) Reflects retention payments made to substantially every employee of the
Company in connection with the Recapitalization. These payments were
intended to ensure the continued employment of all employees after the
Recapitalization and no future payments are anticipated.
(c) Reflects the write-off of deferred financing fees related to the payoff of
outstanding debt under the Company's previous credit agreement.
(d) Adjusted EBITDA represents income before depreciation and amortization,
interest expense, income tax expense, charges related to the Equity
Participation Plan, which was terminated upon consummation of the
Recapitalization, and recognition of the portion of purchase price
allocation related to acquired inventories. The Company has excluded
payments under the Equity Participation Plan to present comparable figures
for all historical periods presented. Adjusted EBITDA is not a measure of
performance under generally accepted accounting principles, and should not
be considered as a substitute for net income, cash flows from operating
activities and other income or cash flow statement data prepared in
accordance with generally accepted accounting principles, or as a measure
of profitability or liquidity. The Company has included information
concerning Adjusted EBITDA as one measure of an issuer's historical ability
to service debt. In addition, certain covenants in the Indenture are based
upon a calculation analogous to Adjusted EBITDA. Adjusted EBITDA should not
be considered as an alternative to, or more meaningful than, income from
operations or cash flow as an indication of the Hudson RCI's operating
performance. For purposes of compliance with the Indenture, the Company's
Consolidated Net Income and EBITDA will not be reduced by retention
payments, payments made pursuant to the Equity Participation Plan or by the
amount of any contingent payments made by the Company to former
participants in the Equity Participation Plan. See Item 13 "Certain
Relationships and Related Transactions."
(e) Represents ratio of Adjusted EBITDA to net sales.
(f) Represents ratio of operating income before EPP and retention payments to
net sales.
10
(g) Includes amortization of deferred financing fees of $0.1 million in 1995
and $0.1 million in 1996, which should be excluded from depreciation and
amortization in calculating Adjusted EBITDA since such fees are reflected
below the operating income line.
(h) For the purpose of determining the ratio of earnings to fixed charges,
earnings consist of earnings before income taxes and fixed charges. Fixed
charges consist of interest on indebtedness, the amortization of debt issue
costs and that portion of operating rental expense representative of the
interest factor.
(i) For the purpose of determining the ratio of earnings to fixed charges and
preferred stock dividends, earnings consist of earnings before income taxes
and fixed charges. Fixed charges consist of interest on indebtedness, the
amortization of debt issue costs and that portion of operating rental
expense representative of the interest factor. Preferred stock dividends,
consisting of amounts to be paid-in-kind, are also included in the pro
forma fixed charge amounts. Preferred stock dividends have been "grossed
up" to a pre-income tax basis to provide comparability to other components
of the ratio.
(j) Working capital as adjusted represents current assets, excluding cash, less
current liabilities, excluding the current portion of long-term debt.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion of the Company's consolidated historical results
of operations and financial condition should be read in conjunction with the
consolidated financial statements of the Company and the notes thereto included
elsewhere in this Form 10-K. The following discussion and analysis includes
periods before completion of the Recapitalization.
General
The Company's results of operations may fluctuate significantly from
quarter to quarter as a result of a number of factors, including, among others,
the buying patterns of the Company's distributors, GPOs and other purchasers of
the Company's products, forecasts regarding the severity of the annual cold and
flu season, announcements of new product introductions by the Company or its
competitors, changes in the Company's pricing of its products and the prices
offered by the Company's competitors, rate of overhead absorption due to
variability in production levels and variability in the number of shipping days
in a given quarter.
Recent Developments
Beginning in April 2000, the company experienced disruption to its
operations resulting from difficulties in the implementation of a new management
information system. Consequently, the Company's financial results for the year
ended December 31, 2000 reflect increased freight, distribution and general and
administrative expenses related to the system implementation. The Company also
experienced liquidity pressures beginning in the fourth quarter of 2000 due to
such expense increases, delays in collection of due receivables and unplanned
increases in inventory related to difficulties in implementation and a lack of
familiarity with the new system. Management has implemented a number of
initiatives in 2001 designed to improve the Company's proficiency with the new
management information system, decrease the Company's operating expenses,
improve receivables collections and reduce inventory levels. Despite the
disruption related to the system implementation, management believes it has
generally maintained strong customer service levels and relationships.
11
Results of Operations
The following tables set forth, for the periods indicated, certain income
and expense items expressed in dollars and as a percentage of the Company's net
sales.
Fiscal Year
------------------------------
1998 1999 2000
-------- -------- --------
(dollars in thousands)
Net sales............................................................ $100,498 $128,803 $159,278
Cost of sales........................................................ 56,802 75,418 84,923
-------- -------- --------
Gross profit....................................................... 43,696 53,385 74,355
-------- -------- --------
Selling expenses..................................................... 10,350 13,122 18,262
Distribution expenses................................................ 3,336 4,647 10,109
General and administrative expenses.................................. 10,125 13,269 24,023
Amortization of goodwill............................................. 159 1,463 3,320
Research and development expenses.................................... 976 2,031 2,387
Provision for equity participation plan.............................. 63,939 -- --
Provision for retention payments..................................... 4,754 -- --
-------- -------- --------
Total operating expenses............................................. 93,639 34,532 58,101
-------- -------- --------
Operating income (loss).............................................. (49,943) 18,853 16,254
Add back: Provision for equity participation plan.................... 63,939 -- --
Add back: Provision for retention payments........................... 4,754 -- --
-------- -------- --------
Operating income before provision for equity participation plan and
provision for retention payments.................................... $ 18,750 $ 18,853 $ 16,254
======== ======== ========
Fiscal Year
---------------------------
1998 1999 2000
----- ----- -----
Net sales............................................................... 100.0% 100.0% 100.0%
Cost of sales........................................................... 56.5 58.5 53.3
----- ----- -----
Gross profit.......................................................... 43.5 41.4 46.7
----- ----- -----
Selling expenses........................................................ 10.3 10.2 11.5
Distribution expenses................................................... 3.3 3.6 6.3
General and administrative expenses..................................... 10.2 10.3 15.1
Amortization of goodwill................................................ --- 1.1 2.1
Research and development expenses....................................... 1.0 1.6 1.5
Provision for equity participation plan................................. 63.6 -- --
Provision for retention payments........................................ 4.7 -- --
----- ----- -----
Total operating expenses................................................ 93.2 26.8 36.5
----- ----- -----
Operating income (loss)................................................. (49.7) 14.6 10.2
Add back: Provision for equity participation plan....................... 63.6 -- --
Add back: Provision for retention payments.............................. 4.7 -- --
----- ----- -----
Operating income before provision for equity participation plan and
provision for retention payments....................................... 18.7% 14.6% 10.2 %
12
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Net sales, reported net of rebates, were $159.3 million in 2000, an
increase of $30.5 million or 23.7% over 1999. Of the $30.5 million increase,
$9.2 million related to the Tyco incentive breathing exerciser product line
acquisition made in November 1999, and $3.2 million was the result of the
acquisition of the Tyco SHERIDAN(R) endotracheal tube product line in October of
2000. In addition, the Louis Gibeck AB (now Hudson RCI AB) acquisition,
completed in July 1999, accounted for an additional $5.4 million of sales in
2000. For the base Hudson RCI business, alternate site sales increased $1.5
million or 7.1% as a result of the continued focus on this important and growing
marketplace. Domestic hospital sales increased by $9.7 million or 13.0% as the
result of new GPO relationships as well as increased purchases from existing GPO
relationships. Sales to Europe declined by $2.2 million or 18.0%, driven
primarily by backorders and sales losses created during the implementation of a
new ERP computer system. Sales to Latin America increased by $0.4 million, while
sales to the Pacific rim increased by $2.6 million. OEM sales increased by $0.8
million or 18.6%, the result of new relationships with several customers.
The Company's gross profit for 2000 was $74.4 million, an increase of $21.0
million or 39.3% from 1999. As a percentage of net sales, the Company's gross
profit for 2000 was 46.7% as compared to 41.4% for 1999. This increase was
primarily due to increased sales of higher profit margin products such as the
acquired Louis Gibeck AB and Tyco incentive breathing exerciser product lines.
This was somewhat offset by increased freight costs required to service customer
needs during a period of shipping difficulties caused by problems associated
with the new system implementation.
Selling expenses were $18.3 million for 2000, a $5.1 million or 39.2%
increase over 1999. This increase was primarily driven by the inclusion of full
year results in 2000 of Hudson RCI AB as well as establishment of sales offices
in France and the United Kingdom during 2000. As a percentage of net sales,
selling expenses were 10.2% and 11.5% in 1999 and 2000, respectively.
Distribution expenses were $10.1 million in 2000, which represents a $5.5
million or 118% increase over 1999. This increase was caused by implementation
of a second shift at all domestic distribution centers, increased overtime and
the addition of a new distribution warehouse in Temecula. These increased costs
were driven by shipping issues caused by the new system implementation as well
as higher volumes of products shipped during 2000 as compared to 1999.
Additionally, freight for products shipped between distribution facilities
increased significantly in order to meet increased demand as well as to better
serve customers affected by shipping problems associated with the new system
implementation.
General and administrative expenses were $24.0 million for 2000, an
increase of $10.8 million or 81.0% over 1999. This increase resulted primarily
from increased staffing required to maintain acceptable customer service levels
and operate the business with the new computer system. Additionally, due to
increased aging of receivables resulting from lack of experience and visibility
within the new management information system, the company increased its reserves
for doubtful accounts. In addition, general & administrative expense increases
also resulted from the establishment of sales offices in France and the United
Kingdom as well as the full year effect of Hudson RCI AB.
Amortization of goodwill was $3.3 million in 2000, a $1.9 million or 127%
increase over 1999. This increase was driven primarily by the Hudson RCI AB and
Tyco incentive breathing exerciser acquisitions in 1999, as well as the Tyco
SHERIDAN(R) endotracheal tube product line acquisition in 2000.
Research and development expenses were $2.4 million in 2000 as compared to
$2.0 million in 1999. This increase is solely due to the inclusion of Hudson RCI
AB results for a full year in 2000.
Interest expense was $21.1 million in 2000, a $3.8 million or 22.2%
increase over 1999. This increase was primarily due to increased borrowings to
fund the Hudson RCI AB, Tyco incentive breathing exerciser and Tyco SHERIDAN(R)
acquisitions. In addition, borrowings were higher under the working capital
revolver due to increased
13
working capital requirements that resulted from growth in the Company as well as
from issues relating to the new computer system implementation.
Year Ended December 31, 1999 Compared to Year Ended December 25, 1998
Net sales, reported net of accrued rebates, were $128.8 million in 1999, an
increase of $28.3 million or 28.2% over 1998. Of the $28.3 million increase,
approximately $6.1 million related to the acquisition of Hudson RCI AB, $2.2
million related to the Tyco acquisition and $0.9 million related to the Medimex
acquisition. In addition, the full effect in 1999 of the Gibeck, Inc.
acquisition in September 1998 resulted in a sales increase of $7.6 million. For
the base Hudson RCI business, domestic hospital sales increased by $3.3 million
or 5.5%, due to increased demand at the hospital level, primarily the result of
increased sales through certain GPOs. Alternate site sales increased by $4.4
million or 26.5% as the Company continued to focus its efforts on this growing
market. International sales increased by $1.6 million or 9.1%, as growth in
sales continued in Japan and Europe. This growth was partially offset by
weakness in South America. Sales to customers in Southeast Asia have stabilized,
remaining virtually unchanged over 1998. Canadian sales increased by
approximately $0.3 million, due primarily to the efforts of a new distributor in
that country. Approximately 30% of the Company's 1999 total net sales were to
two distributors.
The Company's gross profit for 1999 was $53.4 million, an increase of $9.7
million or 22.2% from 1998. As a percentage of net sales, the Company's gross
profit was 41.4% for 1999 as compared to 43.5% for 1998. This decline was
primarily due to the recognition of inventory revalued as a result of the Hudson
RCI AB acquisition, increased shipping costs as a result of sales of acquired
Gibeck, Inc. products, and an unfavorable mix variance caused by increased sales
of products at lower gross margins. This trend is expected to continue in the
future if the preference for passive humidification products over higher margin
active humidification products continues. This trend was partially offset by
manufacturing cost reductions realized by the Company and higher gross margins
of sales at Hudson RCI AB.
Selling expenses were $13.1 million for 1999, an increase of $2.7 million
or 26.8% over 1998. This increase was due primarily to $1.2 million of costs
associated with Hudson RCI AB and $1.2 million as a result of the start-up of
the German sales operation. In addition, sales and marketing expenses at Hudson
RCI increased by approximately $0.3 million. As a percentage of net sales,
selling expenses decreased to 10.2% as compared to 10.3% in 1998.
Distribution expenses were $4.6 million for 1999, an increase of $1.3
million or 39.0% over 1998. As a percentage of sales, distribution expenses
increased to 3.6% as compared to 3.3% in 1998. The increase is primarily the
result of the increased cost of freight between the Company's distribution
facilities, the start up of a distribution facility in Atlanta and increased
headcount.
General and administrative expenses for 1999 were $13.3 million, an
increase of $3.1 million or 31.1% over 1998. Of this increase, $2.0 million
relates to expenses incurred at Hudson RCI AB and $0.2 million as a result of
the German operation. In addition, the company increased management bonuses and
incurred certain non-recurring consulting expenses. As a percentage of net
sales, general and administrative expenses were 11.4% in 1999 as compared to
10.2% in 1998.
Amortization of goodwill was $1.5 million in 1999, a $1.3 million or 820%
increase over 1998. This was solely driven by the Hudson RCI AB and Tyco
incentive breathing exerciser acquisitions.
Research and development expenses were $2.0 million in 1999, an increase of
$1.1 million or 108.2% over 1998. This increase was primarily due to the
addition of Hudson RCI AB research and development expenses of $0.7 million and
increases in the Hudson RCI engineering staff.
The provision for equity participation plan consists of accrued expenses
and payments made to executives under the Equity Participation Plan. The Equity
Participation Plan was terminated upon consummation of the Recapitalization and
replaced with an executive stock purchase plan. See "Item 11. Executive
Compensation--Stock Subscription Plans." No payments under the Equity
Participation Plan were made in 1999 that were not provided for in 1998. In
1998, the
14
provision for equity participation plan was $63.9 million, which included
approximately $1.3 million in employer taxes relating to the distribution made
under the Equity Participation Plan.
The provision for retention payments, including related employer payroll
taxes, was $4.8 million in 1998. These payments were made to substantially every
employee in the Company and were intended to ensure the continued employment of
all employees after the Recapitalization. No payments were made in 1999 and no
future retention payments are anticipated.
Interest expense was $17.3 million for 1999, an increase of $5.9 million
over 1998. The increase was due to higher debt levels during 1999 as a result of
the Hudson RCI AB and Tyco acquisitions.
Seasonality
The Company's results of operations exhibit some measure of seasonality.
Generally, the Company's sales and EBITDA are higher in the first and fourth
quarters and lower in the second and third quarters. This is due primarily to
the higher incidence of breathing ailments, such as colds and flu, during the
winter months, which results in increased hospitalization and respiratory care,
especially among higher-risk individuals, such as infants and the elderly.
Fourth quarter sales are generally the Company's highest, as distributors
increase inventory in anticipation of the cold and flu seasons. First quarter
results are generally affected by the length and severity of flu seasons.
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash flow from operations,
borrowings under its working capital bank facility and, historically,
investments from its shareholders. Cash provided by (used in) operations before
EPP payments and retention bonuses totaled $(57.3) million, $7.1 million and
$11.6 million in 1998, 1999 and 2000, respectively. The increase from 1999 to
2000 is attributable to decreased working capital, primarily increased trade
payables. Subsequent to year end, trade payables have been reduced
significantly. The Company had operating working capital, excluding cash and
short-term debt, of $39.7 million and $38.7 million as of the end of fiscal 1999
and 2000, respectively. Inventories were $24.0 million and $44.6 million as of
the end of fiscal 1999 and 2000, respectively. In 2000, inventories increased to
unplanned levels due to problems related to the implementation of the new
management information system as well as higher sales levels. The Company has
significantly reduced inventory levels in 2001, but over time, the Company
expects its level of inventories to increase as the Company's sales in the
international market increase. As of June 30, 2001, inventory levels were
approximately $33.8 million. Accounts receivable, net of allowances, were $30.4
million and $28.3 million at the end of fiscal 1999 and 2000, respectively. The
average number of days sales in accounts receivable outstanding was
approximately 67 days for 2000, compared to 80 days for 1999 and 86 days for
1998. The Company offers 30 day credit terms to its U.S. hospital distributors.
Alternate site and international customers typically receive 60 to 90 day terms
and, as a result, as the Company's alternate site and international sales have
increased, the amount and aging of its accounts receivable have increased. The
Company anticipates that the amount and aging of its accounts receivable will
continue to increase gradually over time as alternate site and international
markets become a larger percentage of the Company's overall sales. The Company
established a European distribution center (EDC) in the fourth quarter of 2000.
While this will have the effect of increasing the Company's investment in
inventories, management believes that it will also result in improved service to
international customers as well as in lower international accounts receivable
than would otherwise be the case because customers will receive products, and
consequently pay for them, more quickly.
Net cash used in investing activities was $6.4 million, $75.8 million and
$26.9 million in 1998, 1999 and 2000, respectively. These funds were primarily
used to finance the acquisition of the custom anesthesia circuit product line in
1998, Hudson RCI AB and the Tyco incentive breathing exerciser product line in
1999 and the Tyco SHERIDAN(R) endotracheal tube product line in 2000 and for
capital expenditures. Capital expenditures, consisting primarily of new
manufacturing equipment purchases, computer systems purchases and expansion of
the Ensenada facility, totaled $3.1 million, $11.0 million and $11.3 million in
1998, 1999 and 2000, respectively. The increase in 1999 and 2000 relates to the
acquisition and implementation of a new computer system. The Company currently
estimates that capital
15
expenditures will be approximately $8.0 million in each of 2001 and 2002,
consisting primarily of additional and replacement manufacturing equipment and
new heater placements.
Net cash provided by financing was $89.6 million in 1998, reflecting net
borrowings by the Company. Net cash provided by financing activities was $71.5
million in 1999, reflecting net borrowings and equity issuances by the Company,
which was used primarily to finance the Hudson RCI AB and Tyco acquisitions. Net
cash provided by financing activities in 2000 of $16.2 million, reflecting net
borrowings, was used primarily to finance the Tyco SHERIDAN(R) endotracheal tube
product line acquisition.
As of December 31, 2000, The Company had outstanding $221.9 million of
indebtedness, consisting of $115.0 million of Subordinated Notes, borrowings of
$82.5 million under the Company's Credit Facility, $10.3 million in notes
payable to affiliates and $14.1 million in outstanding borrowings under the bank
facility of Hudson RCI AB, its Swedish subsidiary.
The Credit Facility currently consists of a $40.0 million Term Loan
Facility (all of which was funded in connection with the Recapitalization) and a
$55.0 million Revolving Loan Facility of which up to $40.0 million (all of which
has been borrowed and is outstanding) may be used for permitted acquisitions and
up to $15 million (the "Working Capital Portion") may be used for general
corporate purposes (other than acquisitions). The Revolving Loan Facility has a
letter of credit sublimit of $7.5 million. As of January, 2001 the Company had
fully utilized the Working Capital Portion of the Revolving Loan Facility. The
Term Loan Facility matures on June 30, 2003 and, commencing June 30, 1999,
requires quarterly principal installments totaling $3.0 million in 1999, $5.5
million in 2000, $7.5 million in 2001, $9.5 million in 2002 and $14.5 million in
2003. The Revolving Loan Facility matures on June 30, 2003. The interest rate
under the Credit Facility is based, at the option of the Company, upon either a
Eurodollar rate or a base rate (as defined) plus a margin during the period and
for the applicable type of loan as follows:
Margin
-------------------------
Period and Loan Type Base Rate Eurodollar
-------------------- --------- ----------
Through June, 2002
Term and Working Capital 3.00% 4.00%
Acquisition 3.25% 4.25%
July, 2002 through March, 2003
Term and Working Capital 3.50% 4.50%
Acquisition 3.75% 4.75%
Thereafter
Term and Working Capital 4.00% 5.00%
Acquisition 4.25% 5.25%
For periods after June, 2002, the margins set forth above are subject to pricing
reductions depending on the Company's then existing leverage ratio.
Borrowings under the Credit Facility are required to be prepaid, subject to
certain exceptions, with (i) 75% (or 50% for years when the Company's ratio of
Debt to EBITDA (as defined) is less than 5:1) of Excess Cash Flow (as defined),
(ii) 50% of the net cash proceeds of an equity issuance by Holding or the
Company in connection with an initial public offering or 100% of the net cash
proceeds of an equity issuance by Holding or the Company other than in
connection with an initial public offering (subject in each case to certain
exceptions), (iii) 100% of the net cash proceeds of the sale or other
disposition of any properties or assets of Holding and its subsidiaries (subject
to certain exceptions), (iv) 100% of the net proceeds of certain issuances of
debt obligations of the Company and its subsidiaries and (v) 100% of the net
proceeds from insurance recoveries and condemnations. The Revolving Loan
Facility must be repaid upon payment in full of the Term Loan Facility.
16
The Credit Facility is guaranteed by Holding and certain of the Company's
subsidiaries. The Credit Facility is secured by a first priority lien in
substantially all of the properties and assets of the Company and the guarantors
now owned or acquired later, including a pledge of all of the capital stock of
the Company owned by Holding and all of the shares held by the Company of its
existing and future subsidiaries; provided, that such pledge is limited to 65%
of the shares of any foreign subsidiary to the extent a pledge of a greater
percentage would result in adverse tax consequences to the Company.
The Credit Facility contains covenants restricting the ability of Holding,
the Company and the Company's subsidiaries to, among others, (i) incur
additional debt, (ii) declare dividends or redeem or repurchase capital stock,
(iii) prepay, redeem or purchase debt, (iv) incur liens, (v) make loans and
investments, (vi) make capital expenditures, (vii) engage in mergers,
acquisitions and asset sales, and (viii) engage in transactions with affiliates.
Hudson RCI is also required to comply with financial covenants with respect to
(a) limits on annual aggregate capital expenditures (as defined), (b) a fixed
charge coverage ratio, (c) a maximum leverage ratio, (d) a minimum EBITDA test
and (e) an interest coverage ratio. As of December 31, 2000, the Company was
not in compliance with certain of these restrictive covenants. The Company has
obtained an amendment to the Credit Facility waiving all non-compliance.
The Subordinated Notes bear interest at the rate of 9-1/8%, payable
semiannually on each April 15 and October 15, and will require no principal
repayments until maturity. The Subordinated Notes are general unsecured
obligations of the Company. The Subordinated Notes contain covenants that place
limitations on, among other things, (i) the ability of the Company, any
subsidiary guarantors and other restricted subsidiaries to incur additional
debt, (ii) the making of certain restricted payments including investments,
(iii) the creation of certain liens, (iv) the issuance and sale of capital stock
of restricted subsidiaries, (v) asset sales, (vi) payment restrictions affecting
restricted subsidiaries, (vii) transactions with affiliates and (viii) the
ability of the Company and any subsidiary guarantor to incur layered debt, (ix)
the ability of Holding to engage in any business or activity other than those
relating to ownership of capital stock of the Company and (x) certain mergers,
consolidations and transfers of assets by or involving the Company.
As of December 31, 2000, the Company had $10.3 million outstanding pursuant
to unsecured promissory notes payable to affiliates of Freeman Spogli. The notes
bear interest at 12.0% per annum and 14.0% per annum, respectively and mature in
August 2006.
The Company, through its wholly-owned Swedish Subsidiary, Hudson RCI AB,
has incurred bank debt in Sweden (the "HRCI AB Facility") that totaled $14.1
million as of December 31, 2000. The HRCI AB Facility, which is denominated in
Swedish krona, bears interest at three-month STIBOR (the interest rate at or
about 11:00 a.m. Stockholm time, two banking days before a draw-down date or the
relevant interest period, quoted for deposits in krona) plus 0.75% to 1.75%
(4.884% to 5.884% at December 31, 2000), matures in December 2003, and is
guaranteed by Steamer Holding AB, Hudson RCI AB's parent, and is secured by the
common stock of Hudson RCI AB.
In connection with the Recapitalization, the Company issued to Holding
300,000 shares of its 11-1/2% Senior Exchangeable PIK Preferred Stock due 2010
with an aggregate liquidation preference of $30.0 million, which has terms and
provisions materially similar to those of the 11 1/2% Senior Exchangeable PIK
Preferred Stock due 2010 issued by Holding in connection with the
Recapitalization. At the election of the Company, dividends may be paid in kind
until April 15, 2003 and thereafter must be paid in cash.
As the result of a number of factors affecting the Company in fiscal 2000,
management has taken numerous actions during 2000 and 2001 including elimination
of a distribution warehouse, elimination of non-essential management personnel,
reduction in inventory levels, aggressive collection efforts of accounts
receivable and other cost reduction measures as management deemed necessary to
fund the operations of the Company, meet anticipated capital expenditures and
make required payments of principal and interest on its debt, including payments
due on the Subordinated Notes and obligations under the Credit Facility.
Management does not believe the restructuring charges referred to above will be
material to the Company. In addition, existing shareholders and key management
personnel contributed approximately $11.6 million in the form of convertible
subordinated debt and equity in April and May of 2001 and will contribute an
additional $3.5 million in convertible subordinated debt and $3.0 million in
mandatorily-redeemable preferred stock of Holding, which Holding will invest in
preferred stock of the Company in August of 2001 in order to improve the
Company's liquidity position. Based on these actions, as well as anticipated
improved operating performance, management believes it will have sufficient
sources
17
of liquidity to meet its obligations for a period of at least 18 months.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137 and SFAS No. 138, effective for fiscal years beginning after June
15, 2000. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments. The statement requires that every derivative instrument
be recorded in the balance sheet as either an asset or liability measured at its
fair value, and that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. The
impact of adoption was not material to the financial statements.
During the second quarter of fiscal year 2000, Emerging Issues Task Force
(EITF) No. 00-10 "Accounting for Shipping and Handling Fees and Costs" was
issued. EITF No. 00-10 clarifies the accounting treatment and classification of
the Company's delivery revenues and expenses. The adoption of this EITF only
affects the classification of certain revenues and costs related to delivery
services and does not affect the Company's net income (loss). Delivery costs
include direct and incremental costs incurred to warehouse and move product to
the Company's customers. Since the Company records freight costs associated with
delivery of product to customers as a component of cost of sales and warehousing
costs as distribution expenses, management believes they already comply with
this pronouncement.
During December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB
No. 101 summarizes certain of the SEC's views in applying generally accepted
accounting principles to revenue recognition in financial statements. Management
believes the Company is in compliance with this pronouncement.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141, "Business Combinations"
("SFAS 141"). This Statement addresses financial accounting and reporting for
business combinations and supersedes APB Opinion No. 16, "Business
Combinations," and FASB Statement No. 38, "Accounting for Preacquisition
Contingencies of Purchased Enterprises." All business combinations in the scope
of this Statement are to be accounted for using one method, the purchase method.
The Company will adopt SFAS 141 for all business combinations initiated after
June 30, 2001.
Also in June 2001, the FASB issued Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142
addresses financial accounting and reporting for acquired goodwill and other
intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This
pronouncement addresses, among other things, how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. Goodwill would no longer be amortized but would be
assessed at least annually for impairment using a fair value methodology. The
Company will adopt this statement for all goodwill and other intangible assets
acquired after June 30, 2001 and for all existing goodwill and other intangible
assets beginning January 1, 2002. Upon adoption of this standard on January 1,
2002 the Company will cease recording amortization of goodwill which would
increase net income in 2002 by approximately $2.8 million, net of income taxes.
Other than ceasing the amortization of goodwill, the Company does not anticipate
that the adoption of SFAS 142 will have a significant effect on our financial
position or the results of our operations as the Company does not currently
anticipate any impairment charges for existing goodwill.
18
RISK FACTORS
Substantial Leverage; Shareholders' Deficit
As of December 31, 2000, the Company had $221.9 million of outstanding
indebtedness and a shareholders' deficit of approximately $22.8 million. This
level of indebtedness is substantially higher than the Company's historical debt
levels and may reduce the flexibility of the Company to respond to changing
business and economic conditions. In addition, subject to the restrictions in
the Credit Facility and the indenture governing the Subordinated Notes (the
"Indenture"), the Company may incur additional senior or other indebtedness from
time to time to finance acquisitions or capital expenditures or for other
general corporate purposes. See "--Liquidity and Capital Resources." The Credit
Facility and the Indenture restrict, but do not prohibit, the payment of
dividends by the Company to Holding to finance the payment of dividends on the
Holding Preferred Stock.
The Company's high degree of leverage may have significant consequences for
the Company, including: (i) the ability of the Company to obtain additional
financing for working capital, capital expenditures, acquisitions or other
purposes, if necessary, may be impaired; (ii) a substantial portion of the
Company's cash flow will be dedicated to the payment of interest and principal
on its indebtedness and will not be available to the Company for its operations
and future business opportunities; (iii) the covenants contained in the
indenture and the Credit Facility will limit the Company's ability to, among
other things, borrow additional funds, dispose of assets or make investments and
may affect the Company's flexibility in planning for, and reacting to, changes
in business conditions; (iv) indebtedness under the Credit Facility will be at
variable rates of interest, which will cause the Company to be vulnerable to
increases in interest rates; and (v) the Company's high degree of leverage may
make it more vulnerable to a downturn in its business or the economy generally
or limit its ability to withstand competitive pressures. If the Company is
unable to generate sufficient cash flow from operations in the future to service
its indebtedness, it may be required to refinance all or a portion of its
existing debt or to obtain additional financing. There can be no assurance that
any such actions could be effected on a timely basis or on satisfactory terms or
that these actions would enable the Company to continue to satisfy its capital
requirements. The Company's ability to meet its debt service obligations and to
reduce its total indebtedness will be dependent upon the Company's future
performance, which will be subject to general economic conditions and to
financial, business and other factors affecting the operations of the Company,
many of which are beyond its control. The terms of the Company's indebtedness,
including the Credit Facility and the Indenture, also may prohibit the Company
from taking such actions.
Medical Cost Containment
In recent years, widespread efforts have been made in both the public and
private sectors to control health care costs, including the prices of products
such as those sold by the Company, in the United States and abroad. Cost
containment measures have resulted in increased customer purchasing power,
particularly through the increased presence of GPOs in the marketplace and
increased consolidation of distributors. Health care organizations are
evaluating ways in which costs can be reduced by decreasing the frequency with
which a treatment, device or product is used. Cost containment has also caused a
shift in the decision-making function with respect to supply acquisition from
the clinician to the administrator, resulting in a greater emphasis being placed
on price, as opposed to features and clinical benefits. The Company has
encountered significant pricing pressure from customers and believes that it is
likely that efforts by governmental and private payers to contain costs through
managed care and other efforts and to reform health systems will continue and
that such efforts may have an adverse effect on the pricing and demand for the
Company's products. There can be no assurance that current or future reform
initiatives will not have a material adverse effect on the Company's business,
financial conditions or results of operations.
The Company's products are sold principally to a variety of health care
providers, including hospitals and alternate site providers, that receive
reimbursement for the products and services they provide from various public and
private third party payors, including Medicare, Medicaid and private insurance
programs. As a result, while the Company does not receive payments directly
from such third party payors, 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
19
conditions and must otherwise fall within the payer's list of covered services.
In light of increased controls on Medicare spending, there can be no assurance
on the outcome of future coverage or payment decisions for any of the Company's
products by governmental or private payers. If providers, suppliers and other
users of the Company's products are unable to obtain sufficient reimbursement, a
material adverse impact on the Company's business, financial condition or
operations may result.
The Company expects that the trend toward cost containment that has
impacted the domestic market will also be experienced in international health
care markets, impacting the Company's growth in foreign countries, particularly
where health care is socialized.
Industry Consolidation; Customer Concentration
Cost containment has resulted in significant consolidation within the
health care industry. A substantial number of the Company's customers, including
group purchasing organizations, hospitals, national nursing home companies and
national home health care agencies, have been affected by this consolidation.
The acquisition of any of the Company's significant customers could result in
the loss of such customers by the Company, thereby negatively impacting its
business, financial condition and results of operations. For example, in 1996,
three GPOs that accounted for aggregate sales of approximately $11.0 million
combined and, as a result of a decision of the combined entity to enter into a
sole distributorship arrangement in 1997 with one of the Company's competitors,
the Company has experienced some decrease in sales and may experience additional
sales decreases in the future. In addition, the consolidation of health care
providers often results in the renegotiation of terms and in the granting of
price concessions. The Company's customer relationships, including exclusive or
preferential provider relationships, are terminable at will by either party
without advance notice or penalty. Because larger purchasers or groups of
purchasers tend to have more leverage in negotiating prices, this trend has
caused the Company to reduce prices and could have a material adverse effect on
the Company's business, financial condition or results of operations. As GPOs
and integrated health care systems increase in size, each relationship
represents a greater concentration of market share and the adverse consequences
of losing a particular relationship increases considerably. For fiscal 2000, the
Company's ten largest group purchasing arrangements accounted for approximately
34% of the Company's total net sales. Distributors have also consolidated in
response to cost containment. For fiscal 2000, approximately 30.8% of the
Company's net sales were to two distributors, Owens & Minor Inc. and McKesson,
which accounted for 20.2% and 10.6%, respectively, of the Company's net sales.
The loss of the Company's relationship with these distributors would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Government Regulation
The Company and its customers and suppliers are subject to extensive
federal and state regulation in the United States, as well as regulation by
foreign governments. Most of the Company's products are subject to government
regulation in the United States and other countries. In the United States, the
Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and other
statutes and regulations govern or influence the testing, manufacture, safety,
labeling, storage, record keeping, marketing, advertising and promotion of such
products. Failure to comply with applicable requirements can result in fines,
recall or seizure of products, total or partial suspension of production,
withdrawal of existing product approvals or clearances, refusal to approve or
clear new applications or notices and criminal prosecution. Under the FDC Act
and similar foreign laws, the Company, as a marketer, distributor and
manufacturer of health care products, is required to obtain the approval of
federal and foreign governmental agencies, including the Food and Drug
Administration ("FDA"), prior to marketing, distributing and manufacturing
certain of those products, which can be time consuming and expensive. The
Company may also need to obtain FDA clearance before modifying marketed products
or making new promotional claims. Delays in receipt of or failure to receive
required approvals or clearances, the loss of previously received approvals or
clearances, or failures to comply with existing or future regulatory
requirements in the United States or in foreign countries could have a material
adverse effect on the Company's business. Foreign sales are subject to similar
requirements.
The Company is required to comply with the FDA's "Quality System
Regulations for Medical Devices," implementing "Good Manufacturing Practices"
("GMP/QSR Regulations"), which set forth requirements for, among
20
other things, the Company's manufacturing process, design control and associated
record keeping, including testing and sterility. Further, the Company's plants
and operations are subject to review and inspection by local, state, federal and
foreign governmental entities. The distribution of the Company's products may
also be subject to state regulation. The impact of FDA regulation on the Company
has increased in recent years as the Company has increased its manufacturing
operations. The Company's suppliers, including sterilizer facilities, are also
subject to similar governmental requirements. There can be no assurance that
changes to current regulations or additional regulations imposed by the FDA will
not have an adverse impact on the Company's business and financial condition in
the future. If the FDA believes that a company is not in compliance with
applicable regulations, it can institute proceedings to detain or seize
products, issue a recall, impose operating restrictions, enjoin future
violations and assess civil and criminal penalties against the company, its
officers or its employees and can recommend criminal prosecution to the
Department of Justice. Other regulatory agencies may have similar powers. In
addition, product approvals could be withdrawn due to the failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
marketing. The FDA also has the authority to issue special controls for devices
manufactured by the Company, which it has not done to date. In the event that
such special controls were issued, the Company's products would be required to
conform, which could result in significant additional expenditures for the
Company.
The Company 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
infectious materials or substances and emissions of air pollutants. The Company
owns and leases properties which are subject to environmental laws and
regulations. There can be no assurance that the Company will not be required to
incur significant costs to comply with such laws and regulations in the future
or that such laws or regulations will not have a material adverse effect upon
the Company's business, financial condition or results of operations. In
addition, the Company cannot predict the extent to which future legislative and
regulatory developments concerning its practices and products for the health
care industry may affect the Company.
Risks Related to International Sales; Foreign Operations
Sales made outside the United States represented approximately 19.7% of the
Company's 2000 net sales and the Company intends to increase international sales
as a percentage of total net sales. Foreign operations are subject to special
risks that can materially affect the sales, profits, cash flows and financial
position of the Company, including increased regulation, extended payment
periods, competition from firms with more local experience, currency exchange
rate fluctuations and import and export controls. The Company has sales
operations in Germany, Sweden, the United Kingdom, France and other countries
where sales are made in local currency. While the Company plans to hedge its
foreign currency exposures by attempting to purchase goods and services with the
proceeds from sales in local currencies where possible, and to purchase forward
contracts to hedge receivables denominated in foreign currency, there can be no
assurance that the Company's hedging strategies will allow the Company to
successfully mitigate its foreign exchange exposures. The Company's foreign
exchange exposure has historically not been significant, and was not considered
to be significant in fiscal 2000.
The Company also maintains a manufacturing and assembly facility in
Ensenada, Mexico and an assembly facility in Kuala Lumpur, Malaysia and, as a
result, is subject to operational risks such as changing labor trends and civil
unrest in those countries. In the event the Company were required to transfer
its foreign operations to the United States or were otherwise unable to benefit
from its lower cost foreign operations, its business, financial condition and
results of operations would be adversely affected.
21
Product Liability
The manufacturing and marketing of medical products entails an inherent
risk of product liability claims. Although the Company has not experienced any
significant losses due to product liability claims and currently maintains
umbrella liability insurance coverage, there can be no assurance that the amount
or scope of the coverage maintained by the Company will be adequate to protect
it in the event a significant product liability claim is successfully asserted
against the Company. In addition, the Company cannot predict the extent to which
future legislative and regulatory developments concerning its practices and
products for the health care industry may affect the Company.
Dependence on Key Personnel; Management of Expanding Operations
The Company's success will, to a large extent, depend upon the continued
services of its executive officers. The loss of services of any of these
executive officers could materially and adversely affect the Company.
The Company's plans to expand its business may place a significant strain
on the Company's operational and financial resources and systems. To manage its
expanding operations, the Company may be required to, among other things,
improve its operational, financial and management information systems. The
Company may also be required to attract, train and retain additional highly
qualified management, technical, sales and marketing and customer support
personnel. The process of locating such personnel with the combination of skills
and attributes required to implement the Company's strategy is often lengthy.
The inability to attract and retain additional qualified personnel could
materially and adversely affect the Company.
Competition
The medical supply industry is characterized by intense competition.
Certain of the Company's competitors have greater financial and other resources
than the Company and may succeed in utilizing these resources to obtain an
advantage over the Company. The general trend toward cost containment in the
health care industry has had the effect of increasing competition among
manufacturers, as health care providers and distributors consolidate and as GPOs
increase in size and importance. The Company competes on the basis of brand
name, product quality, breadth of product line, service and price.
Risks Generally Associated with Acquisitions
An element of the Company's business strategy is to pursue strategic
acquisitions that either expand or complement the Company's business.
Acquisitions involve a number of special risks, including the diversion of
management's attention to the assimilation of the operations and the
assimilation and retention of the personnel of the acquired companies, and
potential adverse effects on the Company's operating results. The Company may
require additional debt or equity financing for future acquisitions, which may
not be available on terms favorable to the Company, if at all. In addition, the
Credit Facility and the Indenture contain certain restrictions regarding
acquisitions. The Indenture restricts acquisitions to those companies in the
same line of business as the Company, and requires that all such acquired
companies be designated Restricted Subsidiaries (as defined therein). The Credit
Facility restricts all acquisitions with the exception of Permitted Acquisitions
(as defined therein), and limits, among other things, (i) the sum that may be
paid in connection with any single acquisition to $30.0 million, (ii) the total
amount outstanding of revolving credit indebtedness that can be incurred for
acquisition purposes to $45.0 million, and (iii) the line of business of the
acquired entity or assets. The inability of the Company to successfully
finance, complete and integrate strategic acquisitions in a timely manner could
have an adverse impact on the Company's ability to effect a portion of its
growth strategy.
Patents and Trademarks
The Company has historically relied primarily on its technological and
engineering abilities and on its design and production capabilities to gain
competitive business advantages, rather than on patents or other intellectual
property rights. However, the Company does file patent applications on concepts
and processes developed by the Company's
22
personnel. The Company has 25 patents in the U.S. Many of the U.S. patents have
corresponding patents issued in Canada, Europe and various Asian countries. The
Company's success will depend in part on its ability to maintain its patents,
add to them where appropriate, and to develop new products and applications
without infringing the patent and other proprietary rights of third parties and
without breaching or otherwise losing rights in technology licenses obtained by
the Company for other products. There can be no assurance that any patent owned
by the Company will not be circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to the Company or that any of the
Company's pending or future patent applications will be issued with claims of
the scope sought by the Company, if at all. If challenged, there can be no
assurance that the Company's patents (or patents under which it licenses
technology) will be held valid or enforceable. In addition, there can be no
assurance that the Company's products or proprietary rights do not infringe the
rights of third parties. If such infringement were established, the Company
could be required to pay damages, enter into royalty or licensing agreements on
onerous terms and/or be enjoined from making, using or selling the infringing
product. Any of the foregoing could have a material adverse effect upon the
Company's business, financial condition or results of operations.
S Corporation Status
The Company elected to be treated as an S corporation for federal and state
income tax purposes for its taxable years beginning on or after January 1, 1987.
Unlike a C corporation, an S corporation is generally not subject to income tax
at the corporate level; instead, the S corporation's income is taxed on the
personal income tax returns of its shareholders. The Company's status as an S
corporation terminated upon consummation of the Recapitalization. If S
corporation status were denied for any periods prior to such termination by
reason of a failure to satisfy the S corporation election or eligibility
requirements of the Internal Revenue Code of 1986, as amended, the Company would
be subject to tax on its income as if it were a C corporation for these periods.
Such an occurrence would have a material adverse effect on the Company's
results.
Energy Costs and Availability
Over the past year, there has been a shortfall of available electricity in
several areas of California. This shortage has resulted in increased energy
costs and temporary interruptions in electrical service in several geographic
areas of California, including the area in which the Company maintains its
headquarters and principal manufacturing center. During the past several months,
the cost of obtaining energy for the Company's California facilities has
increased and electrical service to those facilities has been temporarily
interrupted on several occasions. Furthermore, the Company participates in a
program with the utility that provides electricity to its California facilities
whereby the Company receives discounted service rates in exchange for its
consent to temporary interruptions in electrical service to the California
facilities during peak periods of electricity use. There is a likelihood that,
with the increased demand for electricity in California during the summer months
ahead, the cost of obtaining electricity for the Company's California facilities
will continue to increase and interruptions in electrical service could result
in decreased productivity at the Company's California facilities. The Company
has implemented at its California facilities a generator capable of operating
the administrative offices, including all computer systems, which are required
to effectively conduct business at all locations in the United States and
Mexico.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
Quantitative Disclosures. With the Hudson RCI AB acquisition, the Company
has greater foreign currency exposure with respect to its international
operations. In the past, the Company's only international exposure was its
manufacturing operation in Mexico. All sales were previously denominated in U.S.
dollars. Currently, the Company has operations in Germany, Sweden, Japan and
other countries where sales are made in local currency. The Company plans to
hedge its foreign currency exposures by attempting to purchase goods and
services with the proceeds from sales in local currencies where possible. The
Company may also purchase forward contracts to hedge receivables denominated in
foreign currency that are expected to be collected and converted into another
currency. However, there can be no assurance that the Company's hedging
strategies will allow the Company to successfully mitigate its foreign exchange
exposures.
23
The Company is exposed to certain market risks associated with interest
rate fluctuations on its debt. All debt arrangements are entered into for
purposes other than trading. The Company's exposure to interest rate risk arises
from financial instruments entered into in the normal course of business that,
in some cases, relate to the Company's acquisitions of related businesses.
Certain of the Company's financial instruments are fixed rate, short-term
investments which are held to maturity. The Company's fixed rate debt consists
primarily of outstanding balances on the Subordinated Notes and its variable
rate debt relates to borrowings under the Credit Facility (see "Item 7.
Management's Discussion and Analysis of financial condition and Results of
Operations--Liquidity and Capital Resources"). With respect to the Company's
fixed rate debt, changes in interest rates generally affect the fair value of
such debt, but do not have an impact on earnings or cash flows. Because the
Company generally cannot prepay its fixed rate debt prior to maturity, interest
rate risk and changes in fair value should not have a significant impact on this
debt until the Company is required to refinance. With respect to variable rate
debt, changes in interest rates affect earnings and cash flows, but do not
impact fair value. The impact on the Company's interest expense in the upcoming
year of a one-point interest rate change on the outstanding balance of the
Company's variable rate debt would be approximately $932,000.
The following table presents the future principal cash flows and weighted-
average interest rates expected on the Company's existing long-term debt
instruments. The fair value of the Company's fixed rate debt is estimated based
on quoted market prices.
Expected Maturity Date
(as of December 31, 2000)
Fiscal Fiscal Fiscal Fiscal Fiscal There- Fair
2001 2002 2003 2004 2005 after Total Value
------ ------ ------ ------ ------ ------ ------- -------
(Dollars in thousands)
Fixed Rate Debt........... $ 2,000 $ -- $ -- $ -- $ -- $123,266 $125,266 $ 79,266
Average Interest Rate.. 14.0% -- -- -- 9.5%
Variable Rate Debt........ $10,686 $11,444 $13,444 $55,944 $ 5,130 $ -- $ 96,648 $ 96,648
Average Interest Rate.. 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%
Qualitative Disclosures. The Company's primary exposure relates to (1)
interest rate risk on long-term and short-term borrowings, (2) the Company's
ability to pay or refinance long-term borrowings at maturity at market rates,
(3) the impact of interest rate movements on the Company's ability to meet
interest expense requirements and exceed financial covenants and (4) the impact
of interest rate movements on the Company's ability to obtain adequate financing
to fund future acquisitions. The Company manages interest rate risk on its
outstanding long-term and short-term debt through the use of fixed and variable
rate debt. While the Company can not predict or manage its ability to refinance
existing debt or the impact interest rate movements will have on its existing
debt, management evaluates the Company's financial position on an ongoing basis.
Item 8. Financial Statements.
See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K."
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
24
PART III
Item 10. Directors and Executive Officers of the Registrant.
The following individuals are the executive officers and directors of
Holding and Hudson RCI as of August 15, 2001:
Name Age Position
- ---------------------------- --- --------------------------------------------------
Richard W. Johansen............. 49 President, Chief Executive Officer and Director
Lougene Williams................ 56 Senior Vice President
Patrick G. Yount................ 41 Chief Financial Officer
Jay R. Ogram.................... 46 Chief Information Officer
Brian W. Morgan................. 61 Vice President, Human Resources
Ola G. Magnusson................ 52 Senior Vice President
Jeffery D. Brown................ 43 Vice president, Marketing and Sales
Helen Hudson Lovaas............. 62 Director
Jon D. Ralph.................... 37 Director
Charles P. Rullman.............. 52 Director
Ronald P. Spogli................ 53 Director
Sten Gibeck..................... 57 Director
Richard W. Johansen is President, Chief Executive Officer and Director of
the Company and assumed the same positions with Holding after consummation of
the Recapitalization. Mr. Johansen became President of the Company in 1993 and
assumed the additional responsibilities of Chief Executive Officer in May 1997.
From 1989 to 1993, he served as Vice President, Marketing and Sales for the
Company following the 1989 acquisition of Respiratory Care Inc. by Hudson RCI.
He held the same position with Respiratory Care Inc. as well as prior executive
positions in the area of business development with its parent company, The
Kendall Company.
Lougene Williams is a Senior Vice President of the Company responsible for
its product development, quality assurance and manufacturing operations, having
served in this capacity since 1996, and assumed the same position with Holding
after consummation of the Recapitalization. Prior to 1996, he was the Company's
Vice President, Manufacturing, having held a similar position with Respiratory
Care Inc. From 1976 to 1987, he held manufacturing management positions of
increasing responsibility at various manufacturing plants of The Kendall
Company.
Patrick G. Yount became the Company's Chief Financial Officer in March,
2001. Prior to joining the company, he held the