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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, 2001
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 333-56135
RIVER HOLDING CORP.
(Exact name of registrant as specified in its charter)
Delaware 95-1867330
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
599 Lexington Avenue, 18/th/ floor 10022
New York, New York (Zip Code)
(Address of Principal Executive Offices)
(212) 758-2555
(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 May 31, 2002, the number of shares of Common Stock, $.01 par
value, outstanding (the only class of common stock of the registrant
outstanding) was 9,144,293. 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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River Holding Corp.
Fiscal Year Ended December 31, 2001
TABLE OF CONTENTS
Page
----
PART I ................................................................................................... 1
Item 1. Business ............................................................................... 1
Item 2. Properties ............................................................................. 7
Item 3. Legal Proceedings ...................................................................... 9
Item 4. Submissions of Matters to a Vote of Security Holders ................................... 9
PART II .................................................................................................. 10
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .................. 10
Item 6. Selected Financial Data ................................................................ 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation ... 14
Item 7A. Quantitative and Qualitative Disclosure About Market Risk .............................. 31
Item 8. Financial Statements ................................................................... 32
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............ 32
PART III ................................................................................................. 35
Item 10. Directors and Executive Officers of the Registrant ..................................... 35
Item 11. Executive Compensation ................................................................. 37
Item 12. Security Ownership of Certain Beneficial Owners and Management ......................... 41
Item 13. Certain Relationships and Related Transactions ......................................... 43
PART IV .................................................................................................. 45
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........................ 45
SIGNATURES ............................................................................................... S-1
ii
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 River Holding Corp. 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." River Holding Corp. 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
River Holding Corp. ("Holding" or River") conducts all of its business
through its majority-owned subsidiary, Hudson Respiratory Care Inc. and its
subsidiaries (collectively, "Hudson RCI" or the "Company"). Consequently, the
following discussion relates primarily to the Company. 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 7,000 distributors and alternate site service providers
throughout the United States and in more than 90 countries worldwide. The
Company has supplied the disposable respiratory care market for over 55 years
and enjoys strong brand name recognition and leading market positions.
The Company manufactures and markets approximately 2,000 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 in the United States 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 two
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.
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 four 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 under the Gibeck
brand. Hudson RCI's principal executive offices are located at 27711 Diaz Road,
P.O. Box 9020, Temecula, California 92589, and its
1
telephone number is (909) 676-5611. Holding's principal executive offices are
located at 599 Lexington Drive, 18/th/ floor, New York, New York, and its
telephone number is (212) 758-2555.
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 or 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 clinically
desirable to humidify or medicate the gas prior to delivery to the patient. 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 clinical and economic 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 and infection control 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 reliable manufacturers with large,
high quality 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 contracted 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 four clinical categories: (i)
oxygen therapy; (ii) aerosol therapy; (iii) humidification and filtration; and
(iv) airway management. Although the Company's sales efforts differ depending on
the clinical use of its products, management focuses on geographical segments
for strategic decision making.
Category/Products Description
- ------------------------------------------------ ----------------------------
Oxygen Therapy: oxygen masks, cannulae, oxygen Used to transport, regulate, deliver and analyze
catheters, oxygen tubing, prefilled and therapeutic, supplemental oxygen to a patient.
refillable humidifiers, oxygen regulators, Cylinder carts and bases are used to transport and
cylinder carts and bases, oxygen stabilize oxygen cylinders. Regulators control the
analyzers/monitors, oxygen sensors, and adaptors pressure and flow of oxygen from the primary gas
and connectors. Sales for this category as a source to the patient. Oxygen masksand nasal
percentage of total Company sales were 32.6%, cannulae cover the nose and mouth or fit inside the
34.6% and 40.0% for fiscal years 2001, 2000 and nostrils and are connected to an oxygen source via
1999, respectively. small diameter tubing through which oxygen flows.
Oxygen analyzers, monitors and sensors are utilized to
measure and monitor the oxygen concentration being
delivered to the patient. 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.
Aerosol Therapy: aerosol masks, prefilled and Used to create and deliver aerosolized particles of
refillable large volume nebulizers, aerosol liquid water, sodium chloride or medication solutions
tubing, unit dose solutions, small volume to the patient's airways to dilute and mobilize
nebulizers, peak flow meters, spacers/changers. secretions and/or dilate constricted breathing
Sales for this category as a percentage of total passages. The peak flow meter is used to monitor the
Company sales were 16.5%, 17.2% and 21.0% for patient's respiratory status before and after an
fiscal years 2001, 2000 and 1999, respectively. aerosolized medication treatment. Spacers/Chambers
are used as an adjunct to metered dose inhaler therapy to
facilitate optimal treatment effectiveness.
Humidification and Filtration: ConchaTherm Heated humidification systems actively heat and
heated humidifiers and accessories, Humid-Heat humidify oxygen/air mixtures or anesthetic gases
and accessories, AquaTherm and ThermaGard provided by a mechanical ventilator or anesthesia gas
nebulizer heaters; Concha water, Concha Pak, machine or other gas source. Heat Moisture Exchangers
Aqua+ and Humid-Vent HME's, and filters for (HMEs) passively conserve the heat and humidity in the
critical care, anesthesia and pulmonary function. patient's exhaled breath for use during inspiration.
Sales for this category as a percentage of total Breathing filters are used to protect patients,
Company sales were 21.6%, 27.3% and 21.5% for caregivers and medical equipment from
fiscal years 2001, 2000 and 1999, respectively. cross-contamination with bacteria and viruses.
Airway Management: oral mairways, Sheridan(R) Used to secure and maintain an open airway and
endotracheal tubes, incentive breathing unobstructed breathing passage; convey an oxygen/air
exercisers
3
Category/Products Description
- ------------------------------------------------- ----------------------------
(IBEs), disposable and re-useable mixture and/or anesthetic gas from a mechanical
resuscitation bags, hyperinflation bags, ventilator, anesthesia gas machine to a patient; and
breathing bags, air cushion masks, anesthesia artificially support ventilation during resuscitative
circuits, heated-wire and conventional ventilator efforts. The infant CPAP system provides non-invasive
circuits, gas sampling lines and filters, respiratory support to premature infants with
catheter mounts and infant CPAP. Sales for this under-developed, immature lungs.
category as a percentage of total Company sales
were 29.2%, 20.9% and 17.5% for fiscal years 2001
2000 and 1999, respectively.
Sales, Marketing and Distribution
The Company's main focus for operational management and strategic
decisions is based on geographical segments. These are defined as the Domestic
and European operations, each having their own, distinct management team.
The Company has sales offices in Temecula, Sweden, Germany, France and
the United Kingdom and two distribution facilities in the United States and one
in Europe. The Company also employs sales representatives in Thailand, China and
Australia. 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 10 to "Item 8. Financial Statements" for information with
respect to international sales. The Company's U.S. sales personnel currently
call on approximately 5,900 hospitals and surgery centers, over 50 hospital
distributors and over 3,000 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.
In the current U.S. hospital 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 three of its major
GPOs, Novation LLC, Consorta and HealthTrust Corporation. The Company's most
significant GPO relationships are with AmeriNet Inc., Broadlane, Consorta,
Health Services Corporation of America, HealthTrust Corporation and Novation
LLC.
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 and web site 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, 2001 placed at service provider
locations under this program.
4
The Company utilizes a network of over 50 hospital distributors, as
well as over 3,000 alternate site distributors and end-users, 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 $30.4 million or
approximately 19.4% of total fiscal 2001 net sales, $32.2 Million or 20.2% of
total fiscal 2000 net sales and $24.5 million or 19.0% of total fiscal 1999 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's international
distributors outside of the European Union ("EU"), Middle East and Africa place
their orders directly with dedicated international customer service
representatives. Customer orders are shipped from one of three warehouse
locations. Sales strategies and marketing plans are tailored to each clinical
product group 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 120 international distributors, typically on an exclusive basis
within each market. Customers within Europe, the Middle East and Africa are
serviced by the Company's Sweden office.
Manufacturing and Assembly
The Company operates three manufacturing 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. During the past several years, many of the
machines have been replaced with more efficient models, which have increased
capacity. Tubing is produced on 11 extrusion lines: 6 corrugated, 4 vinyl and 1
repellitizer/regrinder. The Temecula facility uses approximately 19 million
pounds of over 30 different kinds of resin annually; the most prominent are PVC,
polyethylene, polypropylene and polystyrene. 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. The SHERIDAN(R) 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. During 2001, the Company made the decision to
relocate the Argyle production facility to Tecate, Mexico, beginning in 2002 and
anticipates completing the move by October, 2003.
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 monitors the quality of its products at its manufacturing
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 and Sweden facilities are certified as ISO 9001
compliant.
5
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 2001 were
tubing grade PVC, clear PVC, LDPE-EVA, polypropylene, pre-cut elastic, mask
grade PVC, acrylic resin, hose-end grade PVC, manual resuscitator assembly, and
breathing bag assembly. The Company believes that it is able to purchase
materials at a cost no higher than its competitors. 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 20
people, including 14 engineers. The Company's engineering 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. Significant products introduced in the last
five years include the line of heat-moisture exchangers, the SHERIDAN(R) brand
of endotracheal tubes, CONCHATHERM(R) IV heated humidification system, expansion
of the Company's ventilator circuit and nebulizer line, a demand oxygen
regulator and CONCHATHERM(R) 2000. CONCHATHERM(R) 2000 is a heated
humidification system for the sleep apnea market. The Company constantly works
to reduce costs through continuous process improvements. The Company incurred
research and development expenses of approximately $2.0 million, $2.4 million
and $2.0 million in fiscal 2001, 2000 and 1999, respectively.
Competition
The U.S. medical supply industry is characterized by intense
competition. The Company's primary competitor in the respiratory care sector is
Allegiance Healthcare (a subsidiary of Cardinal Health, Inc.) 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 design and quality, breadth of
product line, service and price.
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 personnel. The Company has 27 patents
in the United States. Many of the U.S. patents have corresponding patents issued
in Canada, Europe and various other countries.
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
6
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 pertinent sections of the Code
of Federal Regulations, 21CFR GMP/QSR, 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 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 contract sterilization
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. 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 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 May 31, 2002, the Company employed approximately 2,342 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. In August 2001, the Company made a decision to close the Atlanta
distribution center. 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, 2005, respectively. The Company
leases a 33,260 square foot facility in Kuala Lumpur, Malaysia, under a lease
that expires in July 2002. This facility primarily assembles finished products
for the HME and filter product lines. The Company is currently in discussions
with the owners of the Swedish and Malaysia properties and expects the leases to
be renewed on a favorable basis. 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. During 2001, the Company made a decision to relocate the
endotracheal product line from its manufacturing plant in Argyle, New York to
Tecate, Mexico. The Company has acquired an approximately 99,000 square foot
facility in Tecate, under a lease that expires in March 2005.
7
The Company believes that its current facilities are adequate for its
present level of operations.
8
Item 3. Legal Proceedings.
The Company is not a party to any material lawsuits or other
proceedings, including suits relating to product liability and patent
infringement. While the results of the Company's existing 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.
9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
There is no established public trading market for Holding's Common
Stock. As of June 21, 2001, Holding has 18 record holders of its Common Stock.
Holding has not paid cash dividends on its Common Stock in the past two
years, and does not intend to pay cash dividends on its Common Stock 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 Holding's ability to pay cash dividends on
its Common Stock.
Item 6. Selected Financial Data.
The selected fiscal year end historical financial data has been derived
from the audited financial statements of the Holding and Hudson. The information
contained in this table as of December 31, 2000 and 2001, and for each of the
three years in the period ended December 31, 2001 should be read in conjunction
with Hudson's and Holding's audited consolidated financial statements and notes
thereto included elsewhere in this Report.
River Holding Corp. (consolidated)
Fiscal Year
---------------------------------------------------
2001 2000 1999(a) 1998 (b)
-------- -------- --------- --------
Operating Data: (amounts in thousands)
Net sales .................................. $157,112 $159,278 $128,803 $ 76,232
Cost of sales .............................. 110,314 87,183 77,678 44,662
-------- -------- ------- --------
Gross profit ............................... 46,798 72,095 51,125 31,570
Operating expenses:
Selling expenses ........................... 19,496 18,262 13,122 8,032
Distribution expenses ...................... 11,429 10,109 4,647 2,471
General and administrative expenses ........ 26,833 (c) 24,022 14,732 10,914
Impairment of goodwill ..................... 161,591 (d) -- -- --
Impairment of fixed assets ................. 4,712 (e) -- -- --
Amortization of Goodwill ................... 8,570 8,400 5,080
Research and development expenses .......... 2,043 2,388 2,038 726
-------- -------- ------- --------
Operating income (loss) .................... (187,876) 8,914 11,513 9,427
-------- -------- ------- --------
Other (income) and expenses: ............... -- -- --
Interest expense ........................... 20,542 21,089 17,263 11,100
Other (income) expense ..................... 1,563 1,159 1,332 (99)
-------- -------- ------- ---------
Total other expense ........................ 22,105 22,248 18,595 11,001
-------- -------- ------- --------
Income (loss) before provision for income
taxes ................................... (209,981) (13,334) (7,082) (1,574)
Provision for income taxes ................. 12,252 (f) 3,203 (1,508) (614)
-------- -------- -------- ---------
of debt) ................................ -- -- -- --
-------- -------- ------- --------
Net income (loss) .......................... $(222,233) $(16,537) $ (5,574) $ (960)
========= ======== ======= ========
10
Hudson Respiratory Care Inc. and Subsidiaries
Fiscal Year
--------------------------------------------------------------
2001 2000 1999(a) 1998 1997
--------- --------- --------- --------- ---------
Operating Data: (amounts in thousands)
Net sales ............................................. $ 157,112 $ 159,278 $ 128,803 $ 100,498 $ 99,509
Cost of sales ......................................... 108,054 84,923 75,418 56,802 54,575
--------- --------- --------- --------- ---------
Gross profit .......................................... 49,058 74,355 53,385 43,696 44,934
Operating expenses:
Selling expenses ...................................... 19,496 18,262 13,122 10,350 9,643
Distribution expenses ................................. 11,429 10,109 4,647 3,336 3,170
General and administrative expenses ................... 30,205 (j) 27,343 14,732 10,284 11,456
Impairment of goodwill ................................ 33,128 (d) -- -- -- --
Impairment of fixed assets ............................ 4,469 (e) -- -- -- --
Research and development expenses ..................... 2,043 2,387 2,031 976 1,072
Provision for equity participation plan ............... -- -- -- 63,939 (g) 6,954
Provision for retention payments ...................... -- -- -- 4,754 (h) --
--------- --------- --------- --------- ---------
Operating income (loss) ............................... (51,712) 16,254 18,853 (49,943) 12,639
--------- --------- --------- --------- ---------
Other (income) and expenses: .......................... -- -- --
Interest expense ...................................... 20,542 21,089 17,263 11,327 1,834
Other (income) expense ................................ 1,563 1,159 1,232 406 (638)
--------- --------- --------- --------- ---------
Total other expense ................................... 22,105 22,248 18,495 11,733 1,196
--------- --------- --------- --------- ---------
Income (loss) before provision for income taxes ....... (73,817) (5,994) 358 (61,676) 11,443
Provision for income taxes ............................ 69,854 (k) 3,203 1,586 8,405 150
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item ............... (143,671) (9,197) (1,228) (70,081) 11,293
Extraordinary item (loss on extinguishment of debt) ... -- -- -- 104 (i) --
--------- --------- --------- --------- ---------
Net income (loss) ..................................... $(143,671) $ (9,197) $ (1,228) $ (70,185) $ 11,293
========= ========= ========= ========= =========
continued on following page
11
River Holding Corp. (consolidated)
Fiscal Year
------------------------------------------------------------
2001 2000 1999(a) 1998
--------- --------- ---------- ---------
Balance Sheet Data: (amounts in thousands)
Total assets ................................................ $ 144,105 $ 361,036 $ 344,961 $ 262,709
Total debt .................................................. 226,147 221,914 211,694 159,000
Mandatorily-redeemable preferred stock ...................... 44,989 40,061 35,421 31,513
Shareholders' equity (deficit) .............................. (160,681) 62,927 78,393 59,653
Working capital ............................................. (288) 29,972 36,204 29,865
Other Financial Data:
Net cash provided by (used in) operating activities ......... $ 5,564 $ 11,624 $ 7,097 $ 3,854
Net cash used in investing activities ....................... (9,017) (26,942) (75,818) (254,472)
Net cash provided by (used in) financing
activities ............................................... 7,330 16,220 71,529 251,125
Operating margin before EPP and Retention Payments (l) ...... (119.6)% 5.6% 8.9% 12.4%
Depreciation and amortization ............................... $ 21,239 $ 20,051 $ 15,655 $ 8,507
Capital expenditures ........................................ 9,029 11,329 10,973 3,120
Ratio of earnings to fixed charges (m) ...................... -- x -- --x -- x
Deficiency of earnings to cover fixed charges ............... $(209,981) $ (13,334) $ (7,082) $ (1,574)
Ratio of earnings to fixed charges and preferred stock
dividends (n) ............................................ -- x -- x -- x -- x
Deficiency of earnings to cover fixed charges and preferred
stock dividends .......................................... $(218,194) $ (21,067) $ (13,597) $ (5,761)
Hudson Respiratory Care Inc. and Subsidiaries
Fiscal Year
---------------------------------------------------------------------
2001 2000 1999(a) 1998 1997
--------- --------- ---------- --------- ---------
Balance Sheet Data: (dollar amounts in thousands)
Total assets ........................................... $ 137,055 $ 275,234 $ 251,819 $ 165,321 $ 77,554
Total debt ............................................. 226,147 221,914 211,694 159,000 20,250
Mandatorily-redeemable preferred stock ................. 44,989 40,061 35,421 31,513 --
Shareholders' equity (deficit) ......................... (167,821) (22,775) (14,649) (37,735) 22,515
Working capital ........................................ (160) 29,559 35,971 29,533 6,430
Other Financial Data:
Net cash provided by (used in) operating activities .... $ 5,564 $ 10,379 $ 7,097 $ (83,024) $ 19,269
Net cash used in investing activities .................. (9,017) (26,941) (75,818) (6,444) (3,673)
Net cash provided by (used in) financing activities .... 7,330 17,464 71,529 89,624 (16,398)
Operating margin before EPP and Retention
Payments (l) ........................................ (32.9)% 10.2% 14.6% 18.7% 19.7%
Depreciation and amortization .......................... $ 12,224 $ 11,719 $ 8,315 $ 6,101 $ 5,847
Capital expenditures ................................... 9,029 11,329 10,973 3,111 4,659
Ratio of earnings to fixed charges (m) ................. -- x 0.7 x 1.0 x -- x 6.0 x
Deficiency of earnings to cover fixed charges .......... $ (73,817) $ -- $ -- $ (61,676) $ --
Ratio of earnings to fixed charges and preferred stock
dividends (n) ....................................... -- x 0.8 x -- x -- x 6.0 x
Deficiency of earnings to cover fixed charges
and preferred stock dividends ....................... $ (73,817) $ -- $ (6,160) $ (65,863) $ --
____________________
(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) VOLDYNE(R), since certain of its assets were
acquired in November 1999.
(b) Holding was formed to effect the recapitalization. Accordingly, operating
data for 1998 presented for Holding is for the period April 7, 1998 to
December 25, 1998. Holding accounted for the acquisition of the Company
using the purchase method of accounting, which was not pushed down to the
accounts of the Company. Accordingly, the carrying amounts of certain
assets and liabilities of Holding differ substantially when compared to
those of the Company. All financial covenants have been calculated using
the Company's accounts, and, accordingly, no comparative amounts for
Holding are presented.
(c) Consists of (i) general and administrative expenses of $24,007 and (ii)
provision for bad debts of $2,826.
12
(d) Reflects impairment of goodwill based on management's analysis described in
the "Fourth Quarter Charges" section of "Item 7 - Results of Operations"
(e) Reflects write-off of certain assets management has determined have no
value as described in the "Fourth Quarter Charges" section of "Item 7 -
Results of Operations"
(f) Includes the write-off of deferred taxes of $11,273 as described in the
Fourth Quarter Charges section of the Results of Operations.
(g) Reflects payments made under the equity participation plan ("EPP"), which
was terminated upon consummation of the recapitalization in April 1998.
(h) 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.
(i) Reflects the write-off of deferred financing fees related to the payoff of
outstanding debt under the Company's previous credit agreement.
(j) Consist of (i) general and administrative expense of $23,889, (ii)
amortization of goodwill of $3,490 and (iii) provision for bad debts of
$2,826.
(k) Includes the write-off of deferred taxes of $68,881 as described in the
Fourth Quarter Charges section of the Results of Operations.
(l) Represents ratio of operating income before EPP and retention payments to
net sales.
(m) 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.
(n) 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
have been "grossed up" to a pre-income tax basis to provide comparability
to other components of the ratio.
13
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Because Holding is a holding company with no operations, discussion
throughout this section primarily relates to the Company. This 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. Balances and
amounts unique to Holding are as follows:
Holding's acquisition of a majority of the Company's stock was
accounted for as a purchase. As a result of Holding's acquisition of the
Company, Holding recorded property, plant and equipment at fair value.
Additional expenses relating to amortization of goodwill of $5.0 million in 2001
and 2000, and additional depreciation related to the allocation of purchase
price at fair value to depreciable assets of $2.2 million were recorded in 2001
and 2000. As of December 31, 2001 the remaining value of the step-up in basis to
fair value was approximately $7.3 million.
Goodwill resulting from the acquisition of the Company was recorded on
the books of River and not pushed down to the Company, resulting in an
additional 128.4 million of goodwill recorded at Holding. As a result of
significant losses, both Holding and the Company recorded a goodwill impairment
of $161.6 million and $33.1 million, respectively.
Holding also has deferred tax assets stemming from the purchase of the
Company. Holding recognized an $11.2 valuation allowance against those assets in
2001.
As a result of an analysis of product lines during the fourth quarter
of 2001, Holding and the Company concluded that it would no longer support a
certain number of individual products, resulting in the related inventories of
those products no longer having value. Holding and the Company recorded charges
of $4.8 million and $4.6 million, respectively, related to the destruction of
obsolete inventory resulting from this strategic decision.
There are no other material differences between Holding consolidated
and the Company.
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
During 2001, management implemented several initiatives designed to
improve the Company's proficiency with its new management information system, to
decrease the Company's ongoing operating expenses, improve collections and
administration of accounts receivables, and to reduce inventory levels. While
the Company continues to experience some of the issues associated with the
implementation of the new system, management believes customer service levels
and relationships have improved since the business disruption resulting from
difficulties in the implementation of the system in 2000.
In the fourth quarter of 2001, River and the Company incurred charges
of $186.2 million and $115.1 million, respectively, as described more completely
in the "Fourth Quarter Charges" section of this item.
As of December 31, 2001, based on the Company's financial results, the
Company was not in compliance with certain financial covenants under its Credit
Facility. As a result of this non-compliance and resulting defaults, on March
30, 2002, the Company did not make a scheduled term loan payment to the lenders
as required under the Credit Facility and, as a result, the Company was
prevented from making a scheduled interest payment to its Subordinated Note
holders on April 15, 2002.
14
As of December 31, 2001, the Company's wholly-owned Swedish subsidiary,
Hudson RCI AB, was not in compliance with certain financial covenants of the
Hudson RCI AB bank facility. The Company and Hudson RCI AB are currently in
discussions with the lender and expect to receive a waiver curing all defaults
(see the "Liquidity and Capital Resources" section of this Item). Due to the
uncertainty of receiving this waiver from the lenders, the Company has
classified the entire Hudson RCI AB bank facility as a current liability on the
consolidated balance sheet. The Credit Facility and Senior Subordinated notes
are not cross-defaulted to the Hudson RCI AB bank facility.
On May 14, 2002, the Company amended and restated the Credit Facility
to (i) waive all existing events of default; (ii) extend the final maturity of
the term and revolving facilities under the Credit Facility to June 30, 2004;
(iii) amend existing term loan and acquisition facility amortization to $3.8
million in 2002, $9.3 million in 2003 and $37.0 million in 2004; and (iv) amend
financial covenants. to include only a limitation on capital expenditures and a
minimum EBITDA test. In connection with this amendment, the Company and HRC
Holding, its wholly-owned subsidiary, issued a total of $20.0 million in senior
unsecured notes to affiliates of Holding's majority stockholder. These notes
bear interest at 12%, with interest and principal due upon maturity on December
31, 2004.
During 2001, the Company made the decision to close the Argyle, New
York facility and move its operations to a new facility located in Tecate,
Mexico, beginning in 2002. It is anticipated that this move will cost
approximately $4.6 million, of which $0.9 million relating to severance costs
was recorded in 2001.
Critical Accounting Policies
Accounts Receivable: Management performs various analyses to evaluate
accounts receivable balances to ensure that recorded amounts reflect estimated
net realizable value. Management applies specified percentages to the accounts
receivable aging to estimate the amount that will ultimately be uncollectible
and, therefore, should be reserved. The percentages are increased as the
accounts age.
Management establishes and monitors these percentages through extensive
analyses of historical realization data, accounts receivable aging trends, other
operating trends, and the extent of contracted business and business
combinations. Also considered are relevant business conditions, including
general economic factors as they relate to the company's international
customers. If indicated by such analyses, management may periodically adjust the
uncollectible estimate and corresponding percentages. Further, focused reviews
of certain large and/or problematic payors are performed to determine if
additional reserves are required.
In the fourth quarter of fiscal year 2001, management decided to not
pursue certain aged accounts receivable for collection and to allocate resources
to other customer receivables and collection activities. As a result, River and
the Company provided for such identified accounts receivables totaling $2.2
million.
Inventory: Inventories are stated at the lower of cost (first-in,
first-out ("FIFO") method) or market. Management utilizes various analyses based
on forecasts, historical sales and inventory levels to ensure that the current
carrying value of inventory accurately reflects the current and expected
requirements of the Company within a reasonable timeframe. During the fourth
quarter of 2001, management embarked upon a new strategic initiative to
eliminate certain products that were either unprofitable or marginally
profitable. In addition, management initiated a similar strategic initiative to
eliminate inventory on hand which exceeded more than a reasonable level of
projected future demand. As a result of the above actions, River and the Company
recorded a charge of $4.6 million in the fourth quarter related to the write-off
and disposal of obsolete and excess inventory.
Revenue Recognition: River recognizes revenue when product is shipped
and title passes to customer, as the earnings process is substantially complete.
River establishes reserves for sales returns and other allowances based on
historical experience. River sells its products to its distributors without
right of return based on a listed price. Distributors charge the service
providers, or River's end customers, a contract price (which is determined by
their GPO affiliation or individual contract price) plus a service margin. As is
customary within the industry, River rebates the difference between the list
price and the specific contract price to the distributor. River records revenue
and
15
receivables net of rebatable amounts. In the event no rebate is payable, the
amount is reversed and recognized as revenue.
Deferred Taxes: River and the Company apply the asset and liability
method in recording income taxes, under which deferred income tax assets and
liabilities are determined based on the differences between the financial
reporting and tax bases of assets and liabilities and are measured using
currently enacted tax rates and laws. Additionally, deferred tax assets are
evaluated and a valuation allowance is established if it is more likely than not
that all or a portion of the deferred tax asset will not be realized. As a
result of significant losses in the fourth quarter and cumulative losses in
recent years, management reevaluated its ability to realize the future benefit
of its deferred tax assets in light of the historical operating results.
Accordingly, River and the Company recorded a full valuation allowance against
its deferred tax assets of approximately $11.3 and $68.9 million, respectively.
Impairment of Goodwill and Other Intangibles: River and the Company
periodically review the recoverability of the carrying value of goodwill,
intangibles and other long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. Recoverability of these assets is determined by analysis of the
asset's fair value by comparing the forecasted future net cash flows from the
operations to which the assets relate, based on management's best estimates
using the appropriate assumptions and projections at the time, to the carrying
amount of the assets. If the carrying value is determined not to be recoverable
from future operating cash flows, the asset is deemed impaired and an impairment
loss is recognized equal to the amount by which the carrying amount exceeds the
estimated fair value of the assets. In addition, goodwill is assessed for
recoverability at an entity level, based on fair value determined by estimated
future cash flows discounted at a rate commensurate with the risk involved. In
the fourth quarter of 2001, as a result of significant losses from operations,
River and the Company recorded a goodwill impairment charge of approximately
$161.6 million and $33.1 million, respectively.
Recent Accounting Pronouncements
Effective January 1, 2001, Holding adopted Statement of Financial
Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 137 and SFAS No. 138. SFAS No. 133, as
amended, 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 adoption of
this new standard did not have a material impact on Holding's consolidated
financial statements.
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.
Any acquisitions made by Holding after June 2001 will be accounted for in
accordance with SFAS 141.
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 will no longer be amortized but will be assessed
at least annually for impairment using a fair value methodology. River stopped
amortizing goodwill, effective January 1, 2002 and, as a result, an equivalent
charge for goodwill amortization will not be made in 2002. River is still
evaluating the impact of the standard on impairment, which is expected to be
completed by the end of the second quarter of 2002. The amortization of goodwill
for 2001 was $8.6 million.
Also in June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting
and reporting obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It requires entities to record
the fair value of a liability for an
16
asset retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing the
carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful live of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs gain or loss upon settlement. SFAS 143 is effective January 1, 2003.
Holding does not expect the adoption of SFAS 143 to have a material impact on
Holding's consolidated financial statements.
In August 2001, the FASB issued SFAS 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets." This statement addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. This
statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," and the accounting and
reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations
- - Reporting the Effects of a Disposal of a Segment of a Business and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business (as previously defined in that Opinion).
SFAS No. 144 was effective January 1, 2002. The adoption of SFAS 144 is not
expected to have a material impact on Holding's consolidated financial
statements.
17
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
--------------------------------------------------------
2001 2000 1999
--------- --------- ---------
(dollars in thousands)
Net sales .................................................... $ 157,112 $ 159,278 $ 128,803
Cost of sales ................................................ 108,054 84,923 75,418
--------- --------- ---------
Gross profit ............................................. 49,058 74,355 53,385
Selling expenses ............................................. 19,496 18,262 13,122
Distribution expenses ........................................ 11,429 10,109 4,647
General and administrative expenses .......................... 23,889 20,917 12,829
Amortization of goodwill ..................................... 3,490 3,320 1,463
Impairment of goodwill ....................................... 33,128 -- --
Impairment of fixed assets ................................... 4,469 -- --
Research and development expenses ............................ 2,043 2,387 2,031
Provision for bad debts ...................................... 2,826 3,106 440
--------- --------- ---------
Total operating expenses ..................................... 100,770 58,101 34,532
--------- --------- ---------
Operating income (loss) ...................................... $ (51,712) $ 16,254 $ 18,853
========= ========= =========
Fiscal Year
--------------------------------------------------------
2001 2000 1999
--------- --------- ---------
Net sales .................................................... 100.0 % 100.0% 100.0%
Cost of sales ................................................ 68.8 53.3 58.5
--------- --------- ---------
Gross profit ............................................. 31.2 46.7 41.5
Selling expenses ............................................. 12.4 11.5 10.2
Distribution expenses ........................................ 7.3 6.3 3.6
General and administrative expenses .......................... 15.2 13.1 10.0
Amortization of goodwill ..................................... 2.2 2.1 1.1
Impairment of goodwill ....................................... 21.1 -- --
Impairment of fixed assets ................................... 2.8 -- --
Research and development expenses ............................ 1.3 1.5 1.6
Provision for bad debts ...................................... 1.8 2.0 0.3
--------- --------- ---------
Total operating expenses ..................................... 64.1 36.5 26.8
--------- --------- ---------
Operating income (loss) ...................................... (32.9)% 10.2% 14.7%
========= ========= =========
18
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net sales, reported net of rebates, were $157.1 million in 2001, a
decrease of $2.2 million or 1.4% from 2001. On a consolidated basis, domestic
hospital sales decreased by $5.5 million during 2001, or 5.9% as compared to
2000. The decrease in net sales is attributable to the following: (i) reduced
seasonal demand worldwide for certain products due to mild levels of flu-related
illnesses and unusually warm weather in the fourth quarter of 2001; (ii) lower
than normal demand from U.S. hospitals following the September 11, 2001
terrorist attacks in New York and Washington as a result of reduced hospital
admissions and lower levels of elective surgeries; and (iii) a decision by the
Company in 2001 not to offer purchasing incentives at year end to distributors.
Alternate site sales increased by $2.0 million or 8.8% due to market growth and
lower prior year sales which were the result of shipping difficulties
encountered in 2000 relating to the implementation of the management information
system. Original Equipment Manufacturing ("OEM") sales decreased by $1.0 million
or 16.3% during 2001, primarily due to changes in purchasing patterns from some
of its OEM customers and their reduced demand as a result of the weak influenza
season. European sales increased slightly by $0.3 million or 1.5% as compared to
2000 as a result of incremental sales of the SHERIDAN(R) product line (acquired
in October 2000) as well as increased sales in certain European markets now
served on a direct basis through the Company's European distribution center
located in the Netherlands. Pacific Rim sales increased by $2.0 million or 21.5%
as compared to 2000 as a result of incremental sales of the SHERIDAN(R) product
line and continued growth in the use of the Company's products in this
marketplace.
The Company's gross profit for 2001 was $49.1 million, a decrease of
$25.3 million or 34.0% from 2000. As a percentage of net sales, the Company's
gross profit for 2001 was 31.2% as compared to 46.7% for 2000. This decrease was
primarily due to the following: (i) sale of inventory recorded a higher net
realizable value rather than manufacturing cost as a result of the SHERIDAN(R)
acquisition; (ii) increased shipping costs as a result of shipping difficulties
caused by problems associated with the new management information system; (iii)
an unfavorable mix variance caused by higher sales of products with lower gross
margins; (iv) higher level of unabsorbed manufacturing costs resulting from
lower than expected demand and decreased inventories and (v) charges in the
fourth quarter of 2001 relating to an initiative put in place to discontinue and
dispose of less profitable products.
Selling expenses were $19.5 million for 2001, a $1.2 million or 6.8%
increase over 2000. This increase was primarily driven by additions to the sales
and marketing departments to support recently acquired product lines, as well as
an increase in fees associated with certain GPO's. As a percentage of sales,
selling expenses were 12.4% in 2001 as compared to 11.5% in 2000.
Distribution expenses were $11.4 million in 2001, which represents a
$1.3 million or 13.1% increase over 2000. As a percentage of sales, distribution
expenses were 7.3% in 2001 versus 6.3% in 2000. This increase was a result of
the establishment of the European distribution center in the first quarter of
2001.
General and administrative expenses were $23.9 million for 2001, an
increase of $3.0 million or 14.3% over 2000. This increase resulted primarily
from increased staffing levels required to maintain acceptable customer service
levels and operate the business with the new management information system,
expenses related to the closure of the Atlanta distribution center, higher
depreciation associated with the new management information system and other
professional fees and charges related to implementing the new management
information system.
Amortization of goodwill was $3.5 million in 2001, a $0.2 million or
5.1% increase over 2000. The increase was the result of a full year of
amortization related to the SHERIDAN(R) acquisition made during the fourth
quarter of 2000. As a result of significant losses in the fourth quarter, the
Company reassessed future cash flows and determined that goodwill was not
recoverable. Accordingly, the Company recorded a goodwill impairment charge of
approximately $33.1 million.
Research and development expenses were $2.0 million in 2001 as compared
to $2.4 million in 2000, the result of eliminating several positions in the
Company's facility operated by Hudson RCI AB, the Company's Swedish subsidiary,
during 2001.
19
Interest expense was $20.5 million in 2001, a $0.5 million or 2.6%
decrease from 2000. The decrease was primarily due to a general decrease in
interest rates.
Income tax provision was $69.8 million for 2001 as compared to $3.2
million in 2000. As a result of losses in the fourth quarter of 2001 and
cumulative losses in recent years, the Company recorded a full valuation
allowance of $68.9 million in 2001.
Additional Quarterly Financial Information
Summarized quarterly financial data for 2001 is as follows (amounts in
thousands):
Quarters Ended
----------------------------------------------------------
March 31 June 30 September 30 December 31
-------- --------- ------------ -----------
net sales ........................................ $ 37,805 $ 40,801 $ 45,095 $ 33,411
Gross profit ..................................... 9,210 15,276 20,224 2,088
Net income (loss) ................................ (14,698) (7,653) 118 (200,000)
Fourth Quarter Charges
The following is a summary of the charges incurred by Holding and the
Company in the fourth quarter of 2001 (amounts in thousands):
Hudson
Holding RCI
----------- ----------
Write-off of deferred tax asset ...................................... $ 11,293 $ 68,881
Goodwill impairment .................................................. 161,591 33,128
Impairment of fixed assets ........................................... 4,712 4,469
Destruction of obsolete inventory .................................... 4,582 4,582
Write-off of uncollectible accounts receivable ....................... 2,189 2,189
Distribution center closure .......................................... 930 930
Relocation of manufacturing facilities ............................... 900 900
----------- ----------
Total fourth quarter charges ......................................... $ 186,197 $ 115,079
=========== ==========
As a result of significant losses in the fourth quarter and cumulative
losses in recent years, Holding and the Company have reevaluated their ability
to realize the future benefit of its net deferred tax assets held in light of
the historical operating losses. Accordingly, Holding and the Company recorded a
full valuation allowance against its deferred tax assets of approximately $11.3
Million and $68.9 million, respectively.
As a result of significant losses in the fourth quarter, Holding and
the Company have reassessed future cash flows and determined that goodwill was
not recoverable. Accordingly, Holding and the Company recorded a goodwill
impairment charge of approximately $161.6 million and $33.1 million,
respectively.
As a result of Holding and the Company's analysis of fixed assets in
the fourth quarter, it was determined that certain machinery and equipment was
no longer needed to support current business operations and had no value.
Additionally, certain software development costs incurred in 2001 related to the
management information system failed to achieve their intended results and, as a
result, were determined to have no future value. As a result, Holding and the
Company recorded an impairment charge of approximately $4.7 million and $4.5
million, respectively.
As a result of an analysis of product lines during the fourth quarter
of 2001, the Company concluded that it
20
would no longer support a certain number of individual products, resulting in
the related inventories of those products no longer having value. The Company
recorded charges of $4.6 million related to the destruction of obsolete
inventory resulting from this strategic decision.
The Company made a decision in the fourth quarter of 2001 to not pursue
certain aged accounts receivable for collection and to allocate resources to
other customer receivables and collection activities. As a result, the Company
increased its provision for write-offs based on analysis of those aged customer
receivables.
The Company recorded a charge of approximately $0.9 million related to
the fourth quarter closure of its Atlanta distribution center. This charge
primarily consisted of future rent commitments.
During fiscal 2001, the Company made a decision to relocate from its
manufacturing operation in Argyle, New York to Tecate, Mexico. In addition, the
Company made a decision to move certain product manufacturing from Temecula,
California to Ensenada, Mexico. The Company recorded approximately $0.9 million
in severance costs related to the relocations.
During the fourth quarter of 2000, the Company embarked on a detailed
review of the accounts receivable. Upon completion of such analysis, the Company
recorded an additional $2.3 million of provision for bad debts to recognize
certain accounts receivable, which became uncollectible in the fourth quarter.
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 VOLDYNE(R) incentive breathing exerciser product
line acquisition made in November 1999, and $3.2 million was the result of the
acquisition of the 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 management information 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 VOLDYNE(R) 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 computer system installation.
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 117.5% 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,
California. 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.
21
General and administrative expenses were $20.9 million for 2000, an
increase of $8.0 million or 62.0% 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 and 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
126.9% increase over 1999. This increase was driven primarily by the Hudson RCI
AB and VOLDYNE(R) incentive breathing exerciser acquisitions in 1999, as well as
the 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, VOLDYNE(R) incentive breathing exerciser and SHERIDAN(R)
acquisitions. In addition, borrowings were higher under the working capital
revolver due to increased working capital requirements that resulted from growth
in the Company, as well as from issues relating to the new computer system
implementation.
The Company experienced significant changes in the composition and
complexity of accounts receivable that were aggravated by the Company's
implementation of its new ERP system. During the fourth quarter of 2000, the
Company embarked on a detailed review of accounts receivable. Upon completion of
such analysis, the Company recorded an additional $2.3 million of provision for
bad debts to recognize certain accounts receivable, which became uncollectible
in the fourth quarter.
During 2000, the Company also experienced a shift in customer product
and product mix to a higher rebate percentage. Similar to the problems
associated with the allowance for doubtful accounts, the shift was obscured by
difficulties associated with the implementation of the Company's new ERP system,
which resulted in the Company's reevaluation of the amount of rebates
recognized.
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
As the result of a number of factors affecting Holding in fiscal 2000
and 2001 resulting from the implementation of Holding's new information system,
management undertook numerous actions during 2001 to improve the liquidity and
improve the operating performance of Holding. Such actions included: elimination
of a distribution warehouse, the elimination of non-essential management
personnel, a reduction in inventory levels, aggressive collection and write-off
of accounts receivable and other cost reduction measures as management deemed
necessary to fund the operations of Holding, meet anticipated capital
expenditures and make required payments of principal and interest on its debt.
In addition, existing shareholders and key management personnel contributed a
total of $10.1 million in new cash in the form of convertible subordinated debt
and equity in 2001, and as discussed above, in May 2002, affiliates of Holding's
majority stockholder partially invested an additional $20.0 million in senior
unsecured notes, $12.0 million of which was exchanged for bank term loans
previously acquired. Proceeds from these notes were used to pay interest due on
the
22
Subordinated Notes, pay for expenses associated with the amendment of the Credit
Facility and provide for ongoing working capital requirements. Based on these
actions, as well as anticipated improved operating performance, management
believes it will have sufficient sources of liquidity to meet its obligations
for the remainder of 2002. If Holding does not generate sufficient cash flow
from operations in line with its current forecasts, Holding would have to
initiate measures to raise cash through asset sales, additional debt or equity
issuances and/or curtail operations. Holding currently has no commitments for
additional debt or equity and no assurance can be given as to whether or, on
what terms, additional debt or equity investments could be secured if required.
Failure to achieve expected cash flows or, if necessary, to obtain additional
debt or equity investment would have a material adverse affect on Holding.
The Company's primary sources of liquidity are cash flow from
operations and borrowings under its working capital bank facility and,
historically, investments from its shareholders. Cash provided by operations
totaled $5.6 million, $10.4 million and $7.1 million in 2001, 2000 and 1999,
respectively. The decrease from 2000 to 2001 is attributable to lower
profitability and reduction in trade accounts payable offset in part by
decreases in inventories and accounts receivable. The Company had operating
working capital, excluding cash and short-term debt, of $13.3 million and $38.7
million as of the end of fiscal 2001 and 2000, respectively. Inventories were
$25.2 million and $44.6 million as of the end of fiscal 2001 and 2000,
respectively. In 2000, inventories increased to unplanned levels due to problems
related to the implementation of a new management information system, as well as
higher sales levels. The Company significantly reduced inventory levels in 2001,
to levels more consistent with the current operating requirements of the
Company, but over time, the Company expects its level of inventories to increase
as the Company's sales in the international market increase. Accounts
receivable, net of allowances, were $19.3 million and $28.3 million at the end
of fiscal 2001 and 2000, respectively. In 2001 and 2000, the Company recorded
bad debt expense of $2.8 million and $3.1 million, respectively. The average
days sales in accounts receivable outstanding was approximately 55 days for
2001, compared to 65 days for 2000 and 86 days for 1999. 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 increase
gradually over time as alternate site and international sales become a larger
percentage of the Company's total sales. The Company established a European
distribution center in the first quarter of 2001. While this has had the effect
of increasing inventory, the Company 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 $9.0 million, $26.9 million
and $75.8 million in 2001, 2000 and 1999, respectively. These funds were
primarily used to finance customary purchases of property, plant and equipment
in 2001, the SHERIDAN(R) endotracheal tube product line acquisition in 2000, and
Hudson RCI AB and the VOLDYNE(R) incentive breathing exerciser product line
acquisition in 1999, and for capital expenditures. Capital expenditures,
consisting primarily of new manufacturing equipment purchases, computer systems
purchases, production of heaters, and expansion of the Ensenada facility,
totaled $9.0 million, $11.3 million and $11.0 million in 2001, 2000 and 1999,
respectively. The higher levels of spending in 2000 and 1999 relate to the
acquisition and implementation of a new computer system. The Company currently
estimates that capital expenditures will be approximately $8.0 million in 2002,
consisting primarily of additional and replacement manufacturing equipment and
new heater placements.
Net cash provided by financing was $7.3 million in 2001, reflecting net
borrowings by the Company and the issuance of $3.0 million in Junior Preferred
Stock and $100,000 in common stock. Net cash provided by financing activities in
2000 of $17.4 million, reflecting net borrowings and the issuance of $6.0
million in common stock, was used primarily to finance the Tyco SHERIDAN(R)
endotracheal tube product line acquisition. 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,
Medimex and VOLDYNE(R) acquisitions.
As of December 31, 2001, the Company had outstanding $226.1 million of
indebtedness, consisting of $115.0 million of Subordinated Notes, borrowings of
$77.0 million under the Company's Credit Facility, $17.2 million in notes
payable to affiliates and $16.9 million in outstanding borrowings under the bank
facility of Hudson RCI AB, its Swedish subsidiary.
23
The following is a summary of the Company's consolidated contractual obligations
as of December 31, 2001:
(amounts in thousands) Payments Due by Period
-------------------------------------------------------------------
Less Than 1-3 4-5 After 5
Total 1 Year Years Years Years
---------- ------------ ------------ ------------ -----------
Long-term debt ................................ $ 226,147 $ 20,680 $ 88,201 $ 2,266 $ 115,000
Mandatorily redeemable preferred securities ... 44,989 -- -- -- 44,989
Leases and other commitments .................. 12,336 2,247 6,065 1,792 2,232
--------- --------- --------- --------- -----------
Total contractual obligations ............. $ 283,472 $ 22,927 $ 94,266 $ 4,058 $ 162,221
========= ========= ========= ========= ===========
The Credit Facility currently consists of a $40.0 million Term Loan
Facility 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 ("Acquisition Facility") 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 sub-limit
of $7.5 million. The Term Loan Facility and Acquisition Facility, amended as
discussed below, mature on June 30, 2004 and require quarterly principal
installments totaling $3.8 million in 2002, $9.3 million in 2003 and $37.0
million in 2004. The Revolving Loan Facility matures on June 30, 2004.
Total borrowings as of December 31, 2001 and 2000 were $55.0 million
and $53.0 million under the Revolving Loan Facility and Acquisition Facility and
$22.0 million and $29.5 million under the Term Loan Facility, respectively.
As of December 31, 2001, the Company had utilized all available credit
under the Revolving Credit Facility. No additional borrowing was available under
the Term Loan Facility at December 31, 2001.
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
24
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.
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 restricted subsidiaries, including its Mexican
subsidiaries; provided, that (except for the Mexican subsidiaries) 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) and (b) as
amended a minimum EBITDA test.
The Company was not in compliance with certain financial covenants of
the Credit Facility as of December 31, 2001 and did not make the scheduled March
31, 2002 amortization payment of the Term Loan Facility on its due date. As a
result, in early April, 2002, the lenders under the Credit Facility blocked the
Company from making either the April 15, 2002 interest payment required under
the Senior Subordinated Notes or the April 15, 2002 dividend payment required
under the 11-1/2% Senior Exchangeable PIK Preferred Stock due 2010. On May 14,
2002, the Company and banks amended and restated the Credit Facility to (i)
waive all existing events of default; (ii) extend the final maturity of the term
and revolving facilities under the Credit Facility to June 30, 2004; (iii) amend
existing Term Loan and Acquisition Facility amortization to $3.8 million in
2002, $9.3 million in 2003 and $37.0 million in 2004, and (iv) amend the
financial covenants to include only a limitation on capital expenditures and a
minimum EBITDA test. As a result of the amendment, the Company is currently in
compliance with the terms and provisions of the Credit Facility. As of May 31,
2002, there was approximately $3.5 million of availability on the revolving Loan
Facility under the Credit Facility.
The Senior 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 Senior Subordinated Notes are general
unsecured obligations of the Company and 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, (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 discussed
above, the Company was prevented from making the April 15, 2002 interest payment
to holders of the Senior Subordinated Notes pending the completion of the
amendment to the Credit Facility on May 14, 2002. Because the Company made the
interest payment due under the Senior Subordinated Notes within the 30-day grace
period, no event of default occurred by reason thereof. The Company is currently
in compliance with the terms and provisions of the Senior Subordinated Notes.
In connection with the acquisition of Hudson RCI AB during 1999, one of
the Company's subsidiaries borrowed $22.0 million under an unsecured 12% note
payable to Holding's majority stockholder. The note is due August 1, 2006.
During 1999, the Company paid approximately $14.5 million in principal on the
note. In April 2001 an additional $6.0 million in principal on the note was
repaid. Proceeds from the April 2001 repayment were then reinvested by Holding's
majority stockholder in new notes issues by the Company, as described below.
25
During 2000, the Company borrowed an additional $2.0 million from
Holding's majority stockholder under an unsecured 14% note payable due on
demand. In August of 2001, this note was exchanged for a new long-term note as
described below.
In August 2001, the Company issued approximately $15.0 million of new
unsecured senior subordinated convertible notes to affiliates for $7.0 million
in cash and an exchange of $8.0 million in existing short-term unsecured notes.
The new notes bear interest at 10% and are due in March 2005. The interest may
be paid or deferred to the due date at the option of the Company and the notes
are convertible to the Company's common stock at the demand of the holder. The
notes are subordinated to borrowings under the Credit Facility and the new
senior unsecured notes discussed below and rank pari-passu with the Senior
Subordinated Notes.
As of December 31, 2001 and May 31, 2002, the Company and its
subsidiaries had a total of $17.2 million and $29.2, million, respectively, in
notes outstanding due to affiliates.
As part of the May 2002 amendment and restatement of the Credit
Facility discussed above, the Company issued $12.0 million of the senior
unsecured notes in exchange for $12.0 million of bank term loans purchased by
affiliates of Holding's majority stockholder. Additionally, HRC Holding issued
$8.0 million of unsecured senior notes to affiliates of Holding's majority
stockholder. HRC Holding used the proceeds of the notes issued by it to acquire
certain intercompany receivables from the Company. These notes bear interest at
12% annually with interest and principal due upon maturity on December 31, 2004.
Proceeds from these transactions were used to pay the April 2002 interest due
under the Subordinated Notes, fund expenses associated with the Amended and
Restated Credit Facility and provide funds for ongoing general corporate
purposes
The Company, through its wholly-owned Swedish Subsidiary, Hudson RCI
AB, has incurred bank debt in Sweden (the "HRCI AB Facility") that totaled $16.9
million as of December 31, 2001. 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 1.25% to 1.85%
(5.14% to 5.74% at December 31, 2001), matures in September 2005, and is
guaranteed by Steamer Holding AB, Hudson RCI AB's parent, and is secured by the
common stock of Hudson RCI AB. As of December 31, 2001, Hudson RCI AB was not in
compliance with certain financial covenants under the HRCI AB Facility. The
Company and Hudson RCI AB are currently in negotiations with the lender
concerning an amendment curing these defaults and expects to receive from the
lender a waiver curing all past covenant violations, but no assurance can be
given that an agreement will be reached. Accordingly, the outstanding balance is
classified as a current liability at December 31, 2001. The Company's Credit
Facility and the Senior Subordinated Notes are not cross-defaulted to the Hudson
RCI AB facility. If a waiver of such default is not obtained, the lender may
pursue its remedies under the facility, including, among other things, immediate
acceleration of all borrowings of the facility. In addition, the default
entitles the lender to take control of all the common stock of Hudson RCI AB and
its European parent companies.
In April 1998, the Company issued to Holding 300,000 shares of the
Company's 11-1/2% Senior 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
("Holding Preferred Stock"). The Holding Preferred Stock has an aggregate
liquidation preference of $30.0 million and bears interest at 11 1/2% per annum
payable in kind until April 2003 and thereafter in cash. Under the terms of the
Holding Preferred Stock, at the election of Holding, dividends may be paid in
kind until April 15, 2003 and thereafter must be paid in cash. In August 2001,
the Company issued 3,000 shares of Junior Convertible cumulative preferred stock
(the "Hudson Junior Preferred Stock") to Holding for cash consideration of $3.0
million and Holding issued an aggregate of 3,000 shares of Junior Convertible
cumulative preferred stock (the "River Preferred Stock") to Holding's majority
stockholder and Helen Hudson Lovaas for cash consideration of $3.0 million.
26
RISK FACTORS
Because Holding's only operations are through the Company, there are no
risks other than those for the Company. As such, the following discussion
relates solely to the Company.
Substantial Leverage; Shareholders' Deficit
As of December 31, 2001, the Company had $226.1 million of outstanding
indebtedness and a shareholders' deficit of approximately $167.8 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 gene