Attached files
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EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - KINETIC CONCEPTS INC | exhibit-31_2.htm |
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - KINETIC CONCEPTS INC | exhibit-31_1.htm |
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - KINETIC CONCEPTS INC | exhibit-32_1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
|
SECURITIES
EXCHANGE ACT OF 1934
|
For
the quarterly period ended September 30, 2009
|
Commission
File Number: 001-09913
|
KINETIC
CONCEPTS, INC.
(Exact
name of registrant as specified in its charter)
Texas
|
74-1891727
|
|
(State
of Incorporation)
|
(I.R.S.
Employer Identification No.)
|
|
8023
Vantage Drive
San
Antonio,
Texas
|
78230
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code: (210) 524-9000
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No ____
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
Yes ____ No ____
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large
accelerated filer
|
X
|
Accelerated
filer
|
||
Non-accelerated
filer
|
(Do
not check if a smaller reporting company)
|
Smaller
reporting company
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes ____ No X
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
Common
Stock: 71,225,194 shares as of October 30, 2009
KINETIC
CONCEPTS, INC.
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No.
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2
The
following trademarks are proprietary to KCI Licensing, Inc. and/or LifeCell
Corporation, their affiliates and/or licensors and may be used in this
report: ABThera, ActiV.A.C., AirMaxxis, AlloDerm, AlloDerm GBR,
AlloDura, AtmosAir, AtmosAir with SAT, BariAir, BariKare, BariMaxx,
BioDyne, Changing the Standard of Healing, Conexa, Cymetra, DeltaTherm,
Dri-Flo, DynaPulse, Extremity Pump, EZ Lift, FirstStep Advantage,
First Step, First Step All in One, FirstStep Plus, FirstStep Select, FluidAir,
FluidAir Elite, GranuFoam, InfoV.A.C., InterCell, Innova Basic, Innova Extra,
Innova Premium, InstaFlate, Instillation Therapy, KCI, KCI Express, KCI The
Clinical Advantage, KCI USA, Kinetic Concepts, Kinetic Therapy,
KinAir, KinAir MedSurg, KinAir MedSurg Pulse, KinAirX, LifeCell, LifeTent,
MaxxAir ETS, Maxxis, Micronized AlloDerm, ParaDyne, PediDyne, PlexiPulse,
Prevena, ReliefZone, Repliform, RIK, RotoProne, RotoRest, RotoRest Delta, Seal
Check, SensaT.R.A.C., Strattice, T.R.A.C., TheraKair, TheraKair Visio,
TheraPulse, TheraPulse ATP, TheraRest, TheraRest SMS, TheraTex,
TriaDyne, TriaDyne Proventa, TriCell, V.A.C., V.A.C. ATS, V.A.C. Freedom, V.A.C.
GranuFoam Silver, V.A.C. Instill, V.A.C. Ready Care, V.A.C. Simplace,
V.A.C. WhiteFoam, V.A.C. WRN, Vacuum Assisted Closure, WoundMD. All
other trademarks appearing in this report are the property of their
holders. The absence of a trademark or service mark or logo from this
list does not constitute a waiver of trademark or other intellectual property
rights of KCI Licensing, Inc. and/or LifeCell Corporation.
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
Quarterly Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, which are covered by the "safe harbor" created
by those sections. The forward-looking statements are based on our
current expectations and projections about future events. Discussions containing
forward-looking statements may be found in "Management's Discussion and Analysis
of Financial Condition and Results of Operations," “Risk Factors” and elsewhere
in this report. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "could," "predicts,"
"projects," "potential," "continue," "expects," "anticipates," "future,"
"intends," "plans," "believes," "estimates," or the negative of these terms and
other comparable terminology, including, but not limited to, statements
regarding the following:
·
|
the
benefits that can be achieved with the LifeCell
acquisition;
|
·
|
competition
in our markets;
|
·
|
our
ability to enforce and protect our intellectual property rights and the
effects of intellectual property litigation on our
business;
|
·
|
our
ability to introduce competitive new products and services and enhance
existing products and services on a timely, cost-effective
basis;
|
·
|
risks
of operating LifeCell operations from one
facility;
|
·
|
expectations
for third-party and governmental audits, investigations, claims, product
approvals and reimbursement;
|
·
|
expectations
for the outcomes of our clinical
trials;
|
·
|
material
changes or shortages in the sources of our
supplies;
|
·
|
our
ability to attract and retain key
employees;
|
·
|
our
ability to manage the risk associated with our exposure to foreign
currency exchange rate
fluctuations;
|
·
|
compliance
with government regulations and
laws;
|
·
|
projections
of revenues, expenditures, earnings, or other financial
items;
|
·
|
our
ability to expand the use of our products into additional geographic
markets;
|
·
|
changes
in domestic and global economic conditions or disruptions of credit
markets;
|
·
|
the
plans, strategies and objectives of management for future
operations;
|
·
|
risks
inherent in the use of medical devices and the potential for patient
claims;
|
·
|
risks
of negative publicity relating to our
products;
|
·
|
risks
related to our indebtedness;
|
·
|
restrictive
covenants in our senior credit facility;
and
|
·
|
any
statements of assumptions underlying any of the
foregoing.
|
These
forward-looking statements are only predictions, not historical facts, and
involve certain risks and uncertainties, as well as
assumptions. Actual results, levels of activity, performance,
achievements and events could differ materially from those stated, anticipated
or implied by such forward-looking statements. The factors that could
contribute to such differences include those discussed under the caption "Risk
Factors." You should consider each of the risk factors and uncertainties under
the caption "Risk Factors" among other things, in evaluating our prospects and
future financial performance. The occurrence of the events described in the risk
factors could harm our business, results of operations and financial condition.
These forward-looking statements are made as of the date of this
report. We disclaim any obligation to update or alter these
forward-looking statements, whether as a result of new information, future
events or otherwise.
KINETIC
CONCEPTS, INC. AND SUBSIDIARIES
|
||||||||
(in
thousands)
|
||||||||
(unaudited)
|
||||||||
September
30,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Assets:
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 270,054 | $ | 247,767 | ||||
Accounts
receivable, net
|
410,738 | 406,007 | ||||||
Inventories,
net
|
111,615 | 109,097 | ||||||
Deferred
income taxes
|
23,921 | 19,972 | ||||||
Prepaid
expenses and other
|
36,684 | 34,793 | ||||||
Total
current assets
|
853,012 | 817,636 | ||||||
Net
property, plant and equipment
|
290,272 | 303,799 | ||||||
Debt
issuance costs, less accumulated amortization of $19,391 at 2009 and
$7,896 at 2008
|
38,800 | 50,295 | ||||||
Deferred
income taxes
|
10,924 | 8,635 | ||||||
Goodwill
|
1,328,881 | 1,337,810 | ||||||
Identifiable
intangible assets, net
|
458,586 | 472,547 | ||||||
Other
non-current assets
|
13,140 | 12,730 | ||||||
$ | 2,993,615 | $ | 3,003,452 | |||||
Liabilities
and Shareholders' Equity:
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable
|
$ | 72,349 | $ | 53,765 | ||||
Accrued
expenses and other
|
214,687 | 258,666 | ||||||
Current
installments of long-term debt
|
114,286 | 100,000 | ||||||
Income
taxes payable
|
616 | - | ||||||
Total
current liabilities
|
401,938 | 412,431 | ||||||
Long-term
debt, net of current installments
|
1,236,802 | 1,415,443 | ||||||
Non-current
tax liabilities
|
30,268 | 26,205 | ||||||
Deferred
income taxes
|
224,319 | 239,621 | ||||||
Other
non-current liabilities
|
5,390 | 6,382 | ||||||
Total
liabilities
|
1,898,717 | 2,100,082 | ||||||
Shareholders'
equity:
|
||||||||
Common
stock; authorized 225,000 at 2009 and 2008, issued and outstanding 71,088
at 2009 and 70,524 at 2008
|
71 | 71 | ||||||
Preferred
stock; authorized 50,000 at 2009 and 2008; issued and outstanding 0 at
2009 and 2008
|
- | - | ||||||
Additional
paid-in capital
|
793,093 | 765,645 | ||||||
Retained
earnings
|
291,019 | 128,648 | ||||||
Accumulated
other comprehensive income, net
|
10,715 | 9,006 | ||||||
Shareholders'
equity
|
1,094,898 | 903,370 | ||||||
$ | 2,993,615 | $ | 3,003,452 | |||||
See
accompanying notes to condensed consolidated financial
statements.
|
KINETIC
CONCEPTS, INC. AND SUBSIDIARIES
|
|||||||||||||||
(in
thousands, except per share data)
|
|||||||||||||||
(unaudited)
|
|||||||||||||||
Three
months ended
|
Nine
months ended
|
||||||||||||||
September
30,
|
September
30,
|
||||||||||||||
2009
|
2008
|
2009
|
2008
|
||||||||||||
Revenue:
|
|||||||||||||||
Rental
|
$ | 298,577 | $ | 305,205 | $ | 872,955 | $ | 906,393 | |||||||
Sales
|
205,820 | 198,094 | 592,872 | 479,046 | |||||||||||
Total
revenue
|
504,397 | 503,299 | 1,465,827 | 1,385,439 | |||||||||||
Rental
expenses
|
169,555 | 182,392 | 505,264 | 538,669 | |||||||||||
Cost
of sales
|
59,940 | 66,542 | 177,745 | 152,220 | |||||||||||
Gross
profit
|
274,902 | 254,365 | 782,818 | 694,550 | |||||||||||
Selling,
general and administrative expenses
|
125,838 | 109,420 | 365,045 | 309,814 | |||||||||||
Research
and development expenses
|
24,669 | 21,884 | 68,071 | 53,279 | |||||||||||
Acquired
intangible asset amortization
|
10,160 | 10,189 | 30,476 | 14,843 | |||||||||||
In-process
research and development
|
- | - | - | 61,571 | |||||||||||
Operating
earnings
|
114,235 | 112,872 | 319,226 | 255,043 | |||||||||||
Interest
income and other
|
158 | 835 | 646 | 4,997 | |||||||||||
Interest
expense
|
(25,728 | ) | (29,943 | ) | (80,449 | ) | (49,062 | ) | |||||||
Foreign
currency gain (loss)
|
3,183 | (3,253 | ) | (3,896 | ) | (2,740 | ) | ||||||||
Earnings
before income taxes
|
91,848 | 80,511 | 235,527 | 208,238 | |||||||||||
Income
taxes
|
27,279 | 26,600 | 73,156 | 91,185 | |||||||||||
Net
earnings
|
$ | 64,569 | $ | 53,911 | $ | 162,371 | $ | 117,053 | |||||||
Net
earnings per share:
|
|||||||||||||||
Basic
|
$ | 0.92 | $ | 0.75 | $ | 2.32 | $ | 1.63 | |||||||
Diluted
|
$ | 0.91 | $ | 0.75 | $ | 2.31 | $ | 1.62 | |||||||
Weighted
average shares outstanding:
|
|||||||||||||||
Basic
|
70,150 | 71,831 | 70,035 | 71,756 | |||||||||||
Diluted
|
70,666 | 72,130 | 70,425 | 72,110 | |||||||||||
See
accompanying notes to condensed consolidated financial
statements.
|
KINETIC
CONCEPTS, INC. AND SUBSIDIARIES
|
||||||||
(in
thousands)
|
||||||||
(unaudited)
|
||||||||
Nine
months ended
|
||||||||
September
30,
|
||||||||
2009
|
2008
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
earnings
|
$ | 162,371 | $ | 117,053 | ||||
Adjustments
to reconcile net earnings to net cash provided by operating
activities:
|
||||||||
Depreciation,
amortization and other
|
114,672 | 86,649 | ||||||
Provision
for bad debt
|
7,602 | 5,986 | ||||||
Amortization
of deferred gain on sale of headquarters facility
|
(803 | ) | (803 | ) | ||||
Amortization
of convertible debt discount
|
14,645 | 8,081 | ||||||
Write-off
of deferred debt issuance costs
|
2,348 | 860 | ||||||
Share-based
compensation expense
|
22,977 | 19,678 | ||||||
Excess
tax benefit from share-based payment arrangements
|
(515 | ) | (258 | ) | ||||
Write-off
of in-process research and development
|
- | 61,571 | ||||||
Change
in assets and liabilities, net of business acquired:
|
||||||||
Increase
in accounts receivable, net
|
(14,419 | ) | (19,879 | ) | ||||
Increase
in inventories, net
|
(2,725 | ) | (8,297 | ) | ||||
Increase
in prepaid expenses and other
|
(1,505 | ) | (9,712 | ) | ||||
Increase
(decrease) in deferred income taxes, net
|
(5,212 | ) | 68,105 | |||||
Increase
(decrease) in accounts payable
|
18,484 | (8,230 | ) | |||||
Decrease
in accrued expenses and other
|
(46,415 | ) | (49,603 | ) | ||||
Increase
in tax liabilities, net
|
978 | 554 | ||||||
Net
cash provided by operating activities
|
272,483 | 271,755 | ||||||
Cash
flows from investing activities:
|
||||||||
Additions
to property, plant and equipment
|
(66,019 | ) | (83,748 | ) | ||||
Decrease
(increase) in inventory to be converted into equipment for short-term
rental
|
1,969 | (12,100 | ) | |||||
Dispositions
of property, plant and equipment
|
4,298 | 4,638 | ||||||
Business
acquired in purchase transaction, net of cash acquired
|
(173 | ) | (1,745,522 | ) | ||||
Increase
in identifiable intangible assets and other non-current
assets
|
(18,206 | ) | (3,753 | ) | ||||
Net
cash used by investing activities
|
(78,131 | ) | (1,840,485 | ) | ||||
Cash
flows from financing activities:
|
||||||||
Proceeds
from revolving credit facility
|
20,000 | 75,000 | ||||||
Repayments
of long-term debt, revolving credit facility and capital lease
obligations
|
(198,990 | ) | (25,193 | ) | ||||
Excess
tax benefit from share-based payment arrangements
|
515 | 258 | ||||||
Proceeds
from exercise of stock options
|
784 | 2,431 | ||||||
Purchase
of immature shares for minimum tax withholdings
|
(242 | ) | (886 | ) | ||||
Proceeds
from the purchase of stock in ESPP and other
|
3,336 | 2,346 | ||||||
Acquisition
financing:
|
||||||||
Proceeds
from senior credit facility
|
- | 1,000,000 | ||||||
Proceeds
from convertible senior notes
|
- | 690,000 | ||||||
Repayment
of long-term debt
|
- | (68,000 | ) | |||||
Proceeds
from convertible debt warrants
|
- | 102,458 | ||||||
Purchase
of convertible debt hedge
|
- | (151,110 | ) | |||||
Payments
of debt issuance costs
|
- | (60,704 | ) | |||||
Net
cash provided (used) by financing activities
|
(174,597 | ) | 1,566,600 | |||||
Effect
of exchange rate changes on cash and cash equivalents
|
2,532 | (18,627 | ) | |||||
Net
increase (decrease) in cash and cash equivalents
|
22,287 | (20,757 | ) | |||||
Cash
and cash equivalents, beginning of period
|
247,767 | 265,993 | ||||||
Cash
and cash equivalents, end of period
|
$ | 270,054 | $ | 245,236 | ||||
Cash
paid during the nine months for:
|
||||||||
Interest,
including cash paid for interest rate swap agreements
|
$ | 48,577 | $ | 25,602 | ||||
Income
taxes, net of refunds
|
$ | 68,168 | $ | 39,288 | ||||
See
accompanying notes to condensed consolidated financial
statements.
|
KINETIC
CONCEPTS, INC. AND SUBSIDIARIES
(unaudited)
NOTE
1. Summary of Significant Accounting
Policies
(a) Basis of
Presentation
The
unaudited condensed consolidated financial statements presented herein include
the accounts of Kinetic Concepts, Inc., together with its consolidated
subsidiaries (“KCI”). The unaudited condensed consolidated financial
statements appearing in this quarterly report on Form 10-Q should be read in
conjunction with the financial statements and notes thereto included in KCI's
latest Annual Report on Form 10-K for the fiscal year ended December 31, 2008
and our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31,
2009 and June 30, 2009. The accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information
necessary for a fair presentation of results of operations, financial position
and cash flows in conformity with U.S. generally accepted accounting
principles. Operating results from interim periods are not
necessarily indicative of results that may be expected for the fiscal year as a
whole. The unaudited condensed consolidated financial statements
reflect all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation of our results for the interim periods
presented. Certain prior-period amounts have been reclassified to
conform to the current period presentation.
During
the first quarter of 2009, we redefined our operating segments to correspond
with our current management structure. We have three reportable
operating segments: (i) V.A.C. Therapy, (ii) Regenerative Medicine and (iii)
Therapeutic Support Systems (“TSS”). The geographic reporting
structure continues to consist of (i) North America, which is comprised of the
U.S., Canada and Puerto Rico; and (ii) EMEA/APAC, which is comprised principally
of Europe, the Middle East, Africa and the Asia Pacific region.
(b) Income
Taxes
We
compute our quarterly effective income tax rate based on our annual estimated
effective income tax rate plus the impact of any discrete items that occur in
the quarter. The effective income tax rates for the third quarter and
the first nine months of 2009 were 29.7% and 31.1%, respectively, compared to
33.0% and 43.8% for the corresponding periods in 2008. The high
effective income tax rate for the first nine months of 2008 resulted from the
impact of non-deductible costs associated with our LifeCell
acquisition. The decrease in the effective income tax rate for the
third quarter and first nine months of 2009 was due primarily to the favorable
resolution of certain tax contingencies during the quarter.
(c) Interest Rate Protection
Agreements
We use
derivative financial instruments to manage the economic impact of fluctuations
in interest rates. Periodically, we enter into interest rate
protection agreements to modify the interest characteristics of our outstanding
debt. Each interest rate swap is designated as a hedge of interest
payments associated with specific principal balances and terms of our debt
obligations. These agreements involve the exchange of amounts based
on variable interest rates, for amounts based on fixed interest rates over the
life of the agreement, without an exchange of the notional amount upon which the
payments are based. The differential to be paid or received, as
interest rates change, is accrued and recognized as an adjustment to interest
expense related to the debt. The value of our contracts at September
30, 2009 was determined based on inputs that are readily available in public
markets or can be derived from information available in publicly quoted markets.
(See Notes 5 and 6.)
(d) Foreign Exchange Protection
Contracts
We use
derivative financial instruments to manage the economic impact of fluctuations
in currency exchange rates on our intercompany balances and corresponding cash
flows. We enter into forward currency exchange contracts to manage
these economic risks. As required, KCI recognizes all derivative
instruments on the balance sheet at fair value. Gains and losses
resulting from the foreign currency fluctuations impact to transactional
exposures are included in foreign currency gain (loss) in our condensed
consolidated statements of earnings. (See Notes 5 and
6.)
(e) Concentration of Credit
Risk
KCI has a
concentration of credit risk with financial institutions related to its
derivative instruments and the Note Hedge described in Notes 4 and
5. As of September 30, 2009, Bank of America and JP Morgan Chase
collectively held equity hedges related to our Note Hedge as described in Note 4
in notional amounts totaling $352.9 million. Bank of America was also
the counterparty on some of our interest rate protection agreements and our
foreign currency exchange contracts in notional amounts totaling $65.7 million
and $8.6 million, respectively. Additionally, JP Morgan Chase was a
counterparty on some of our foreign currency exchange contracts in notional
amounts totaling $6.8 million. We use master netting agreements with
our derivative counterparties to reduce our risk and use multiple counterparties
to reduce our concentration of credit risk.
(f) Other Significant Accounting
Policies
For
further information on our significant accounting policies, see Note 1 of the
Notes to the Consolidated Financial Statements included in KCI's Annual Report
on Form 10-K for the fiscal year ended December 31, 2008.
(g) Recently Adopted Accounting
Principles
In June
2009, the Financial Accounting Standards Board ("FASB") issued a new
pronouncement which establishes the single source of authoritative U.S.
generally accepted accounting principles (“GAAP” or “the
Codification”). Rules and interpretive releases of the Securities and
Exchange Commission (“SEC”) under authority of federal securities laws are also
sources of authoritative GAAP for SEC registrants. The Codification
superseded all previously-existing non-grandfathered non-SEC accounting and
reporting standards. The Codification reorganizes all GAAP into
approximately 90 accounting topics and displays them using a consistent
structure, and includes relevant SEC guidance organized using the same topical
structure in separate sections. This statement was effective for KCI beginning
September 30, 2009. This pronouncement does not change GAAP; therefore, our
adoption of this pronouncement did not have an impact on our results of
operations, financial condition or cash flows.
On
June 30, 2009, KCI adopted changes issued by the FASB related to
disclosures about fair value of financial instruments. These changes
require an entity to provide disclosures about fair value of financial
instruments in its summarized financial information for interim reporting
periods. Under the changes, a publicly traded company shall include
disclosures about the fair value of its financial instruments whenever it issues
summarized financial information for interim reporting periods. In addition,
entities must disclose, in the body or in the accompanying notes of its
summarized financial information for interim reporting periods and in its
financial statements for annual reporting periods, the fair value of all
financial instruments for which it is practicable to estimate that value. The
adoption of the changes did not have a significant impact on our results of
operations or our financial position.
On
June 30, 2009, KCI adopted changes issued by the FASB related to subsequent
events. These changes established standards for accounting for and
disclosing subsequent events (events which occur after the balance sheet date
but before financial statements are issued or are available to be issued). The
changes require an entity to disclose the date subsequent events were evaluated
and whether that evaluation took place on the date financial statements were
issued or were available to be issued. The adoption of the changes did not have
a material impact on our results of operations or our financial
position.
On
January 1, 2009, KCI adopted changes issued by the FASB related to the
accounting for convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement). These changes specify
that issuers of such instruments account separately for the liability and equity
components of convertible debt instruments in a manner that reflects an issuer’s
estimated non-convertible debt borrowing rate. The impact associated
with our adoption of these changes is disclosed in this report. (See Note
4.)
On
January 1, 2009, KCI adopted changes issued by the FASB revising the
accounting for business combinations. The revisions establish
principles and requirements for how the acquirer of a business recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the
acquiree. These revisions also provide guidance for recognizing and
measuring any goodwill acquired in the business combination and specify what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. The
impact that the adoption of the revisions will have on our consolidated
financial statements is dependent on the nature, terms and size of any
prospective business combinations.
On
January 1, 2009, KCI adopted changes issued by the FASB which enhance the
required disclosures regarding derivatives and hedging
activities. The adoption of the changes did not have a material
impact on our results of operations or our financial position. (See
Note 5.)
On
January 1, 2009, KCI adopted changes issued by the FASB related to the
determination of the useful life of intangible assets. These changes
amend the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible
asset. The changes are intended to improve the consistency between
the useful life of an intangible asset and the period of expected cash flows
used to measure the fair value of the asset. The adoption of the changes did not
have a material impact on our results of operations or our financial
position.
On
January 1, 2009, KCI adopted changes issued by the Emerging Issues Task
Force (“EITF”) and ratified by the FASB related to determining whether an
instrument (or an embedded feature) is indexed to an entity’s own
stock. The determination of whether an instrument (or an embedded
feature) is indexed to an entity’s own stock is taken into consideration in
evaluating the applicability of other provisions within the Codification related
to accounting for derivative instruments and hedging activities. The
adoption of the changes did not have a material impact on our results of
operations or our financial position.
On
January 1, 2009, KCI adopted changes issued by the FASB related to
determining whether instruments granted in share-based payment transactions are
participating securities. The changes state that unvested share-based payment
awards that contain nonforfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class method. The
adoption of the changes did not have a material impact on our results of
operations.
NOTE
2. Acquisition
On May
27, 2008, we completed the acquisition of all the outstanding capital stock of
LifeCell Corporation (“LifeCell”) for an aggregate purchase price of
approximately $1.8 billion. The purchase price consisted of $1.7
billion of cash paid to acquire the outstanding common stock of LifeCell, at a
price of $51.00 per share, $83.0 million in fair value of assumed vested stock
options, restricted stock awards and restricted stock units, and $20.7 million
of acquisition related transaction costs, which primarily consisted of fees
incurred for financial advisory and legal services.
The
LifeCell acquisition was accounted for as a business combination using the
purchase method and, accordingly, the fair value of the net assets acquired and
the results of operations for LifeCell have been included in KCI’s consolidated
financial statements from the acquisition date forward. The
preliminary allocation of the total purchase price to LifeCell’s net tangible
and identifiable intangible assets was based on their estimated fair values as
of the acquisition date. Adjustments to these estimates have been
included in the final allocation of the purchase price of
LifeCell. The excess of the purchase price over the identifiable
intangible and net tangible assets, in the amount of $1.3 billion, was allocated
to goodwill.
The
following table represents the final allocation of the purchase price as of the
acquisition date (dollars in thousands):
June
30, 2008
|
Adjustments
|
May
27, 2009
|
||||||||||
Goodwill
|
$ | 1,286,508 | $ | (6,524 | ) | $ | 1,279,984 | |||||
Identifiable
intangible assets
|
486,653 | 486,653 | ||||||||||
In-process
research and development
|
61,571 | 61,571 | ||||||||||
Tangible
assets acquired and liabilities assumed:
|
||||||||||||
Cash
and cash equivalents
|
96,269 | 96,269 | ||||||||||
Accounts
receivable
|
27,053 | 27,053 | ||||||||||
Inventories
|
66,298 | 66,298 | ||||||||||
Other
current assets
|
6,031 | 1,101 | 7,132 | |||||||||
Property
and equipment
|
37,331 | 37,331 | ||||||||||
Current
liabilities
|
(48,546 | ) | (4,377 | ) | (52,923 | ) | ||||||
Noncurrent
tax liabilities
|
(5,101 | ) | (4,295 | ) | (9,396 | ) | ||||||
Net
deferred income tax liability
|
(171,829 | ) | 14,042 | (157,787 | ) | |||||||
Total purchase
price
|
$ | 1,842,238 | $ | (53 | ) | $ | 1,842,185 |
Purchase
accounting rules require that as certain pre-merger issues are identified,
modified or resolved, resulting increases or decreases to the preliminary value
of assets and liabilities are offset by a change in
goodwill. Modifications to goodwill reflected in the “Adjustments”
column above were primarily the result of a transaction cost analysis resulting
in the identification of additional tax deductions and severance costs
associated with the transaction, net of the related tax effects.
The
following sets forth the sources and uses of funds in connection with the
acquisition of LifeCell (dollars in thousands):
Amount
|
||||
Source
of funds:
|
||||
Borrowings
under the senior credit facility
|
$ | 1,000,000 | ||
Gross
proceeds from the sale of the 3.25% convertible senior
notes
|
690,000 | |||
Gross
proceeds from convertible debt warrants
|
102,458 | |||
Cash
on hand
|
329,534 | |||
Total
|
$ | 2,121,992 | ||
Use
of funds:
|
||||
Purchase
of LifeCell common stock and net settlement of options
|
$ | 1,821,496 | ||
Repayment
of debt under previous senior credit facility
|
68,000 | |||
Purchase
of convertible debt hedge
|
151,110 | |||
Transaction
fees and expenses for the Acquisition Financing (1)
|
60,697 | |||
Transaction
fees and expenses for the LifeCell acquisition
|
20,689 | |||
Total
|
$ | 2,121,992 | ||
|
||||
(1)
Transaction fees and expenses for the senior credit facility and the 3.25%
convertible senior notes have been deferred and will be amortized over the
life of the debt instruments.
|
The
results of LifeCell’s operations since the acquisition date have been included
in our condensed consolidated financial statements. The following
table reflects the unaudited pro forma condensed consolidated results of
operations, as though the acquisition of LifeCell had occurred as of the
beginning of the period presented (dollars in thousands, except per share
data):
Nine
months ended
|
||||
September
30, 2008
|
||||
Pro
forma revenue
|
$ | 1,470,433 | ||
Pro
forma net earnings
|
$ | 162,230 | ||
Pro
forma net earnings per share:
|
||||
Basic
|
$ | 2.26 | ||
Diluted
|
$ | 2.25 |
Only
items with a continuing effect may be presented as adjustments when preparing
the pro forma income statement. As a result, the unaudited pro forma
results exclude the effects of the increased valuation of inventory and related
costs of goods sold and the in-process research and development expense recorded
in connection with the LifeCell acquisition as these represented non-recurring
expenses. The unaudited pro forma financial results presented above
are for illustrative purposes only and are not necessarily indicative of what
actually would have occurred had the acquisition been in effect for the period
presented, nor are they indicative of future operating results.
NOTE
3. Supplemental Balance Sheet
Data
(a) Accounts Receivable,
net
Accounts
receivable consist of the following (dollars in thousands):
September
30,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Gross
trade accounts receivable:
|
||||||||
North
America:
|
||||||||
Acute
and extended care organizations
|
$ | 124,396 | $ | 122,373 | ||||
Medicare
/ Medicaid
|
56,671 | 58,662 | ||||||
Managed
care, insurance and other
|
184,995 | 184,172 | ||||||
North
America - trade accounts receivable
|
366,062 | 365,207 | ||||||
EMEA/APAC
- trade accounts receivable
|
112,057 | 98,500 | ||||||
LifeCell
– trade accounts receivable
|
32,347 | 33,521 | ||||||
Total
trade accounts receivable
|
510,466 | 497,228 | ||||||
Less: Allowance
for revenue adjustments
|
(101,435 | ) | (94,516 | ) | ||||
Gross
trade accounts receivable
|
409,031 | 402,712 | ||||||
Less: Allowance
for bad debt
|
(8,981 | ) | (9,469 | ) | ||||
Net
trade accounts receivable
|
400,050 | 393,243 | ||||||
Other
receivables
|
10,688 | 12,764 | ||||||
$ | 410,738 | $ | 406,007 |
Domestic
trade accounts receivable consist of amounts due directly from acute and
extended care organizations, third-party payers, or TPP, both governmental and
non-governmental, and patient pay accounts. Included within the TPP
accounts receivable balances are amounts that have been or will be billed to
patients once the primary payer portion of the claim has been settled by the
TPP. EMEA/APAC and LifeCell trade accounts receivable consist of
amounts due primarily from acute care organizations.
The
domestic TPP reimbursement process requires extensive documentation, which has
had the effect of slowing both the billing and cash collection cycles relative
to the rest of the business, and therefore, increasing total accounts
receivable. Because of the extensive documentation required and the
requirement to settle a claim with the primary payer prior to billing the
secondary and/or patient portion of the claim, the collection period for a claim
in our homecare business may, in some cases, extend beyond one year prior to
full settlement of the claim.
We
utilize a combination of factors in evaluating the collectibility of our
accounts receivable. For unbilled receivables, we establish reserves
against revenue to allow for expected denied or uncollectible
items. In addition, items that remain unbilled for more than a
specified period of time, or beyond an established billing window, are reserved
against revenue. For billed receivables, we generally establish
reserves against revenue and bad debt using a combination of factors including
historic adjustment rates for credit memos and cancelled transactions,
historical collection experience, and the length of time receivables have been
outstanding. The reserve rates vary by payer group. In
addition, we record specific reserves for bad debt when we become aware of a
customer's inability or refusal to satisfy its debt obligations, such as in the
event of a bankruptcy filing.
(b) Inventories,
net
Inventories
are stated at the lower of cost (first-in, first-out) or market (net realizable
value). Inventories consist of the following (dollars in
thousands):
September
30,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Finished
goods and tissue available for distribution
|
$ | 70,531 | $ | 68,837 | ||||
Goods
and tissue in-process
|
13,046 | 9,892 | ||||||
Raw
materials, supplies, parts and unprocessed tissue
|
61,455 | 64,242 | ||||||
145,032 | 142,971 | |||||||
Less:
Amounts expected to be converted into equipment for
|
||||||||
short-term
rental
|
(25,031 | ) | (27,000 | ) | ||||
Reserve
for excess and obsolete inventory
|
(8,386 | ) | (6,874 | ) | ||||
$ | 111,615 | $ | 109,097 |
(c) Identifiable intangible
assets, net
Identifiable
intangible assets include the following (dollars in thousands):
September
30,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Developed
technology
|
$ | 238,391 | $ | 238,391 | ||||
Customer
relationships
|
192,204 | 192,204 | ||||||
Tradenames
and patents
|
95,879 | 78,725 | ||||||
Identifiable
intangible assets
|
526,474 | 509,320 | ||||||
Accumulated
amortization
|
(67,888 | ) | (36,773 | ) | ||||
$ | 458,586 | $ | 472,547 |
During
the first nine months of 2009, we recorded approximately $30.5 million of
amortization expense associated with the purchased identifiable intangible
assets. The amortization of identifiable product-related intangible
assets associated with our LifeCell acquisition is included in “acquired
intangible asset amortization” expense and, as a result, is excluded from cost
of sales and the determination of product margins.
NOTE
4. Long-Term Debt and Derivative
Financial Instruments
Long-term
debt consists of the following (dollars in thousands):
September
30,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Senior
Credit Facility – due 2013
|
$ | 800,000 | $ | 950,000 | ||||
Senior
Revolving Credit Facility – due 2013
|
- | 29,000 | ||||||
3.25%
Convertible Senior Notes due 2015
|
690,000 | 690,000 | ||||||
Less:
Convertible Notes Discount, net of accretion
|
(138,912 | ) | (153,557 | ) | ||||
1,351,088 | 1,515,443 | |||||||
Less: current
installments
|
(114,286 | ) | (100,000 | ) | ||||
$ | 1,236,802 | $ | 1,415,443 |
Senior
Credit Facility
On May
19, 2008, we entered into a $1.3 billion senior secured credit facility due May
2013.
Loans. The senior credit
facility consists of a $1.0 billion term loan facility and a $300.0 million
revolving credit facility. Up to $75.0 million of the revolving
credit facility is available for letters of credit and up to $25.0 million of
the revolving credit facility is available for swing-line
loans. Amounts available under the revolving credit facility are
available for borrowing and reborrowing until maturity. At September
30, 2009, $800.0 million was outstanding under the term loan facility and we had
no revolving loans outstanding. We had outstanding letters of credit
in the aggregate amount of $11.4 million. The resulting availability
under the revolving credit facility was $288.6 million at September 30,
2009.
Interest. Amounts outstanding
under the senior credit facility bear interest at a rate equal to the base rate
(defined as the higher of Bank of America's prime rate or 50 basis points above
the federal funds rate) or the Eurocurrency rate (the LIBOR rate), in each case
plus an applicable margin. The applicable margin varies in reference
to our consolidated leverage ratio and ranges from 1.75% to 3.50% in the case of
loans based on the Eurocurrency rate and 0.75% to 2.50% in the case of loans
based on the base rate. As of September 30, 2009, our average nominal
interest rate on borrowings under the senior credit facility was
3.039%.
We may
choose base rate or Eurocurrency pricing and may elect interest periods of 1, 2,
3 or 6 months for the Eurocurrency borrowings. Interest on base rate borrowings
is payable quarterly in arrears. Interest on Eurocurrency borrowings
is payable at the end of each applicable interest period or every three months
in the case of interest periods in excess of three months. Interest
on all past due amounts will accrue at 2.00% over the applicable
rate.
Covenants. For further
information on our long-term debt covenants, see Note 6 of the Notes to the
Consolidated Financial Statements included in KCI's Annual Report on Form 10-K
for the fiscal year ended December 31, 2008. As of September 30,
2009, we were in compliance with all covenants under the senior credit
agreement.
Events of Default. The senior
credit facility contains events of default including, but not limited to,
failure to pay principal or interest, breaches of representations and
warranties, violations of affirmative or negative covenants, cross-defaults to
other indebtedness, a bankruptcy or similar proceeding being instituted by or
against us, rendering of certain monetary judgments against us, impairments of
loan documentation or security, changes of ownership or operating control,
defaults with respect to certain ERISA obligations and termination of the
license agreement with Wake Forest University Health Sciences relating to our
negative pressure wound therapy line of products.
3.25%
Convertible Senior Notes
On April
21, 2008, we closed our offering of $600 million aggregate principal amount of
3.25% convertible senior notes due 2015 (the “Convertible Notes”). On
May 1, 2008, we issued an additional $90.0 million aggregate principal amount of
notes to cover over-allotments. The notes are governed by the terms
of an indenture dated as of April 21, 2008 (the “Indenture”).
Principal Amount. At
September 30, 2009, $690.0 million in aggregate principal amount of the notes
was outstanding.
Interest. The coupon on the
notes is 3.25% per year on the principal amount. Interest accrued from April 21,
2008, and is payable semi-annually in arrears on April 15 and October 15 of each
year.
Covenants. For further
information on our long-term debt covenants, see Note 6 of the Notes to the
Consolidated Financial Statements included in KCI's Annual Report on Form 10-K
for the fiscal year ended December 31, 2008. As of September 30,
2009, we were in compliance with all covenants under the Indenture for the
Convertible Notes.
Recently adopted accounting
principle. On January 1, 2009, KCI adopted accounting standards
issued by the FASB related to the accounting for convertible debt instruments
that may be settled in cash upon conversion (including partial cash
settlement). Upon adoption of these changes, we allocated the
proceeds received from the issuance of the Convertible Notes between a liability
component and equity component by determining the fair value of the liability
component using our estimated non-convertible debt borrowing
rate. The difference between the proceeds of the notes and the fair
value of the liability component was recorded as a discount on the debt with a
corresponding offset to paid-in-capital (the equity component), net of
applicable deferred income taxes and the portion of debt issuance costs
allocated to the equity component. The resulting debt discount will
be accreted by recording additional non-cash interest expense over the expected
life of the Convertible Notes using the effective interest rate
method. The accounting changes were effective for periods subsequent
to December 15, 2008 and were applied retroactively. Due to the
required retrospective application, the notes reflect a lower principal balance
and additional non-cash interest expense has been recorded based on our
estimated non-convertible borrowing rate. For the three months and
nine months ended September 30, 2009, we recorded $5.6 million and $16.8
million, respectively, of interest related to the contractual interest coupon
rate. Additionally, based on our estimated non-convertible borrowing
rate of 7.78%, the adoption of the accounting changes resulted in approximately
$5.0 million and $14.6 million of additional non-cash interest expense for the
three months and nine months ended September 30, 2009,
respectively. The adoption of the accounting changes also resulted in
additional non-cash interest expense for the three months and nine months ended
September 30, 2008 of approximately $4.6 million and $8.1 million, respectively,
resulting in a reduction of net earnings of $2.8 million and $5.0 million, or
$0.03 and $0.07 per diluted share, respectively.
The
initial conversion price of the Convertible Notes is approximately $51.34 per
share of common stock. Upon conversion, holders will receive cash up
to the aggregate principal amount of the notes being converted. For
any conversion obligation in excess of the aggregate principal amount of the
notes being converted, holders will receive shares of our common
stock. The conversion rate and the conversion price are subject to
adjustment upon the occurrence of certain events, such as distributions of
dividends or stock splits.
Events of Default. The
Indenture contains events of default including, but not limited to, failure to
pay the principal amount of any note when due or upon required repurchase,
failure to convert the notes into cash or shares of common stock, as applicable
and as required upon the occurrence of triggering events as detailed above,
failure to pay any interest amounts on any note when due if such failure
continues for 30 days, failure to provide timely notice of a fundamental change,
failure to comply with certain obligations upon certain consolidation, merger,
or sale of assets transactions, failure to pay any indebtedness for money
borrowed by us or any of our subsidiaries in excess of a specified amount,
(except in certain instances) if the guarantee of the Convertible Notes by the
Subsidiary Guarantor is held to be unenforceable, failure to comply with other
terms and covenants contained in the notes after a specified notice period and
certain events of bankruptcy, insolvency or reorganization of us or any of our
significant subsidiaries.
Note
Hedge and Warrants
Concurrently
with the issuance of the Convertible Notes, we entered into convertible note
hedge (the “Note Hedge”) and warrant transactions (the “Warrants”) with
affiliates of the initial purchasers of the notes. These consist of
purchased and written call options on KCI common stock. The Note
Hedge and Warrants are structured to reduce the potential future economic
dilution associated with conversion of the notes and to effectively increase the
initial conversion price to $60.41 per share, which was approximately 50% higher
than the closing price of KCI’s common stock on April 15, 2008. The
net cost of the Note Hedge and Warrants was $48.7 million.
The Note
Hedge consists of 690,000 purchased call options, representing the number of
$1,000 face value Convertible Notes and approximately 13.4 million shares of KCI
common stock based on the initial conversion ratio of 19.4764
shares. The strike price is $51.34, which corresponds to the initial
conversion price of the Convertible Notes and is similarly subject to customary
adjustments. The Note Hedge expires on April 15, 2015, the maturity
date of the Convertible Notes. Upon exercise of the Note Hedge, KCI
would receive from its counterparties, a number of shares generally based on the
amount by which the market value per share of our common stock exceeds the
strike price of the convertible note hedge as measured during the relevant
valuation period under the terms of the Note Hedge. The Note Hedge is
recorded in equity as a component of additional paid-in capital. The
Note Hedge is anti-dilutive and therefore will have no impact on net earnings
per share, or EPS.
The
Warrants consist of written call options on 13.4 million shares of KCI common
stock, subject to customary anti-dilution adjustments. Upon exercise,
the holder is entitled to purchase one share of KCI common stock for the strike
price of approximately $60.41 per share, which was approximately 50% higher than
the closing price of KCI’s common stock on April 15, 2008. KCI at its
option may elect to settle the Warrant in net shares or cash representing a net
share settlement. The Warrants were issued to reduce the net cost of
the Note Hedge to KCI. The Warrants are scheduled to expire during
the third and fourth quarters of 2015. The Warrants are recorded in
equity as a component of additional paid-in capital. The Warrants
will have no impact on EPS until our share price exceeds the $60.41 exercise
price. Prior to exercise, if our share price exceeds the $60.41
exercise price, we will include the effect of additional shares that may be
issued using the treasury stock method in our diluted EPS
calculations.
NOTE
5. Derivative Financial
Instruments
Interest
Rate Protection
All
derivative instruments are recorded on the balance sheet at fair
value. We designated our interest rate swap agreements as cash flow
hedge instruments. The swap agreements are used to manage exposure to
interest rate movements by effectively changing the variable interest rate to a
fixed rate. We do not use financial instruments for speculative or
trading purposes. We estimate the effectiveness of our interest rate
swap agreements utilizing the hypothetical derivative method. Under
this method, the fair value of the actual interest rate swap agreement is
compared to the fair value of a hypothetical swap agreement that has the same
critical terms as the portion of the loan being hedged. Changes in
the effective portion of the fair value of the remaining interest rate swap
agreement will be recognized in other comprehensive income, net of tax effects,
until the hedged item is recognized into earnings. The differential
to be paid or received, as interest rates change, is accrued and recognized as
an adjustment to interest expense related to the debt.
The
following chart summarizes interest rate hedge transactions effective as of
September 30, 2009 (dollars in thousands):
Original | |||||||||||
Notional |
Notional
Amount at
|
Fixed
|
|||||||||
Accounting
Method
|
Effective
Dates
|
Amount |
September
30, 2009
|
Interest
Rate
|
Status
|
||||||
Hypothetical
|
06/30/08-06/30/11
|
$ | 100,000 | $ 67,000 | 3.895 % |
Outstanding
|
|||||
Hypothetical
|
06/30/08-06/30/11
|
$ | 50,000 | $ 33,500 | 3.895 % |
Outstanding
|
|||||
Hypothetical
|
06/30/08-06/30/11
|
$ | 50,000 | $ 33,500 | 3.895 % |
Outstanding
|
|||||
Hypothetical
|
09/30/08-03/31/11
|
$ | 40,000 | $ 29,400 | 3.399 % |
Outstanding
|
|||||
Hypothetical
|
09/30/08-03/31/11
|
$ | 30,000 | $ 22,050 | 3.399 % |
Outstanding
|
|||||
Hypothetical
|
09/30/08-03/31/11
|
$ | 30,000 | $ 22,050 | 3.399 % |
Outstanding
|
|||||
Hypothetical
|
12/31/08-12/31/10
|
$ | 40,000 | $ 32,200 | 3.030 % |
Outstanding
|
|||||
Hypothetical
|
12/31/08-12/31/10
|
$ | 30,000 | $ 24,150 | 3.030 % |
Outstanding
|
|||||
Hypothetical
|
12/31/08-12/31/10
|
$ | 30,000 | $ 24,150 | 3.030 % |
Outstanding
|
|||||
Hypothetical
|
09/30/09-09/30/10
|
$ | 50,000 | $ 50,000 | 1.055 % |
Outstanding
|
|||||
Hypothetical
|
06/30/09-06/30/10
|
$ | 60,000 | $ 60,000 | 1.260 % |
Outstanding
|
|||||
Hypothetical
|
06/30/09-06/30/10
|
$ | 40,000 | $ 40,000 | 1.260 % |
Outstanding
|
|||||
Hypothetical
|
03/31/09-03/31/10
|
$ | 60,000 | $ 60,000 | 1.110 % |
Outstanding
|
|||||
Hypothetical
|
03/31/09-03/31/10
|
$ | 40,000 | $ 40,000 | 1.110 % |
Outstanding
|
|||||
Hypothetical
|
12/31/08-12/31/09
|
$ | 60,000 | $ 60,000 | 2.520 % |
Outstanding
|
|||||
Hypothetical
|
12/31/08-12/31/09
|
$ | 40,000 | $ 40,000 | 2.520 % |
Outstanding
|
At
September 30, 2009, we had sixteen interest rate swap agreements in effect
pursuant to which we have fixed the rate on an aggregate $638.0 million notional
amount of our outstanding variable rate debt at a weighted average interest rate
of 2.441%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the
senior credit agreement. The aggregate notional amount decreases
quarterly by amounts ranging from $26.0 million to $47.0 million until
maturity.
In
addition to the swaps in effect at September 30, 2009, we have entered into
three additional interest rate swap agreements to convert $150.0 million of our
variable-rate debt to a fixed rate basis, which become effective on December 31,
2009. These agreements have been designated as cash flow hedge
instruments. The following chart summarizes these new agreements
(dollars in thousands):
Original
|
||||||
Notional
|
Fixed
|
|||||
Accounting
Method
|
Effective
Dates
|
Amount
|
Interest
Rate
|
|||
Hypothetical
|
12/31/09-12/31/10
|
$ 50,000 | 1.290 % | |||
Hypothetical
|
12/31/09-12/31/10
|
$ 50,000 | 0.955 % | |||
Hypothetical
|
12/31/09-12/31/10
|
$ 50,000 | 0.950 % |
We are
required under the Credit Agreement to enter into interest rate swaps to attain
a fixed interest rate on at least 50% of our aggregate outstanding indebtedness
through February 2011. As a result
of the interest rate swap agreements currently in effect as of September 30,
2009, approximately 89.1% of our long-term debt outstanding, including the
Convertible Notes, has a fixed interest rate.
The
interest rate swap agreements have quarterly interest payments, based on three
month LIBOR, due on the last day of March, June, September and
December. The fair value of the swap agreements was zero at
inception. At September 30, 2009, the aggregate fair value of our
interest rate swap agreements was negative and was recorded as a liability of
approximately $10.3 million. This aggregate fair value was based on
inputs that are readily available in public markets or can be derived from
information available in publicly quoted markets. This amount was
also recorded in other comprehensive income, net of tax effects. No
asset derivatives were held as of September 30, 2009 related to our interest
rate swap agreements. The ineffective portion of these interest rate
swaps was not significant for the three months or nine months ended September
30, 2009. As of September 30, 2009, the amount of hedge gain or loss
to be reclassified from Accumulated Other Comprehensive Income over the next 12
months is $9.1 million.
We are
exposed to credit loss in the event of nonperformance by counterparties to the
extent of the fair values of the outstanding interest rate swap agreements, but
do not anticipate nonperformance by any of the counterparties. If our
interest rate protection agreements were not in place, interest expense would
have been approximately $3.1 million and $7.6 million lower for the three months
and nine months ended September 30, 2009, respectively. If our
interest rate protection agreements were not in place, interest expense would
have been approximately $556,000 and $562,000 lower for the three months and
nine months ended September 30, 2008, respectively.
Foreign
Currency Exchange Rate Protection
We also
use derivative instruments to manage our transactional currency exposures when
our foreign subsidiaries enter into transactions denominated in currencies other
than their local currency. These nonfunctional currency exposures
relate primarily to existing and forecasted intercompany receivables and
payables arising from intercompany purchases of manufactured
products. KCI enters into forward currency exchange contracts to
mitigate the impact of currency fluctuations on transactions denominated in
nonfunctional currencies, thereby limiting risk that would otherwise result from
changes in exchange rates. These contracts are not designated as
hedges; as such, we recognize the fair value of these instruments as an asset or
liability with income or expense recognized in the current
period. The periods of the forward currency exchange contracts
correspond to the periods of the exposed transactions, generally not to exceed
one year.
The
location and fair value amounts of derivative instruments, as defined by the
Derivatives and Hedges topic of the Codification, reported as of September 30,
2009 in the balance sheet are as follows (dollars in thousands):
Asset
Derivatives
|
|||||
Balance
Sheet Location
|
Fair
Value
|
||||
Derivatives
not designated as hedging instruments
|
|||||
Foreign currency exchange contracts
|
Prepaid
expenses and other
|
$ | 385 | ||
Total
derivatives
|
$ | 385 |
Liability
Derivatives
|
|||||
Balance
Sheet Location
|
Fair
Value
|
||||
Derivatives
designated as hedging instruments
|
|||||
Interest
rate swap agreements
|
Accrued
expenses and other
|
$ | 10,341 | ||
Derivatives
not designated as hedging instruments
|
|||||
Foreign
currency exchange contracts
|
Accrued
expenses and other
|
$ | 5,333 | ||
Total
derivatives
|
$ | 15,674 |
The
location and net amounts reported in the Statements of Earnings or in
Accumulated Other Comprehensive Income (“OCI”) for derivatives designated as
cash flow hedging instruments under the Derivatives and Hedges topic of the
Codification for the three months and nine months ended September 30, 2009 are
as follows (dollars in thousands):
Effective
portion
|
||||||||
Amount
of gain
|
Location
of gain (loss)
|
Amount
of gain (loss)
|
||||||
(loss)
recognized
|
reclassified
from
|
reclassified
from
|
||||||
in
OCI on
|
accumulated
OCI
|
accumulated
OCI
|
||||||
derivative
|
into
income
|
into
income
|
||||||
Three
months ended September 30, 2009
|
||||||||
Interest rate swap agreements
|
$ | (1,588 | ) |
Interest
expense
|
$ | 2,044 | ||
Nine
months ended September 30, 2009
|
||||||||
Interest rate swap agreements
|
$ | (3,081 | ) |
Interest
expense
|
$ | 4,965 |
The
location and net amounts reported in the Statements of Earnings for derivatives
not designated as hedging instruments under the Derivatives and Hedges topic of
the Codification for the three months and nine months ended September 30, 2009
are as follows (dollars in thousands):
Location
of gain (loss)
|
Amount
of gain (loss)
|
||||
recognized
in income on
|
recognized
in income
|
||||
derivative
|
on
derivative
|
||||
Three
months ended September 30, 2009
|
|||||
Foreign
currency exchange contracts
|
Foreign
currency gain (loss)
|
$ | (4,938 | ) | |
Nine
months ended September 30, 2009
|
|||||
Foreign
currency exchange contracts
|
Foreign
currency gain (loss)
|
$ | (10,662 | ) |
Certain
of the Company’s derivative instruments contain provisions that require
compliance with the restrictive covenants of our credit
facilities. (See Note 4.)
If we
default under our credit facilities, the lenders could require immediate
repayment of the entire principal. If those lenders require immediate
repayment, we may not be able to repay them which could result in the
foreclosure of substantially all of our assets. In these
circumstances, the counterparties to the derivative instruments could request
immediate payment or full collateralization on derivative instruments in net
liability positions. All of our derivative counterparties are also
parties to our credit facilities.
No
collateral has been posted by the Company in the normal course of
business. If the credit-risk-related contingent features underlying
these agreements were triggered on September 30, 2009, the Company could be
required to settle or post the full amount as collateral to its
counterparties.
NOTE
6. Fair Value
Measurements
The
Codification defines fair value as the exit
price that would be received to sell an asset or paid to transfer a
liability. The Fair Value Measurements and Disclosure topic of the
Codification establishes a three-tier fair value hierarchy, which prioritizes
the inputs used in measuring fair value. These tiers include: Level
1, defined as observable inputs such as quoted prices in active markets; Level
2, defined as inputs other than quoted prices in active markets that are either
directly or indirectly observable; and Level 3, defined as unobservable inputs
in which little or no market data exists, therefore requiring an entity to
develop its own assumptions.
At
September 30, 2009, we had sixteen interest rate swap agreements designated as
cash flow hedge instruments and foreign currency exchange contracts to sell
approximately $99.6 million of various currencies. The fair values of
these interest rate swap agreements and foreign currency exchange contracts are
determined based on inputs that are readily available in public markets or can
be derived from information available in publicly-quoted markets. The
following table sets forth the aggregate fair value of all derivative
instruments with credit-risk-related contingent features as of September 30,
2009 (dollars in thousands):
Fair
Value Measurements at Reporting
|
|||||||||||||
Fair
Value at
|
Date
Using Inputs Considered as
|
||||||||||||
September
30, 2009
|
Level
1
|
Level
2
|
Level
3
|
||||||||||
Assets:
|
|||||||||||||
Foreign
currency exchange contracts
|
$ | 385 | $ | - | $ | 385 | $ | - | |||||
Liabilities:
|
|||||||||||||
Foreign
currency exchange contracts
|
$ | 5,333 | $ | - | $ | 5,333 | $ | - | |||||
Interest
rate swap agreements
|
$ | 10,341 | $ | - | $ | 10,341 | $ | - |
We did
not have any measurements of financial assets or financial liabilities at fair
value on a nonrecurring basis at September 30, 2009.
NOTE
7. Earnings Per
Share
Net
earnings per share was calculated using the weighted average number of shares
outstanding during the respective periods. The following table sets
forth the reconciliation from basic to diluted weighted average shares
outstanding and the calculations of net earnings per share (in thousands, except
per share data):
Three
months ended
|
Nine
months ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Net
earnings
|
$ | 64,569 | $ | 53,911 | $ | 162,371 | $ | 117,053 | ||||||||
Weighted
average shares outstanding:
|
||||||||||||||||
Basic
|
70,150 | 71,831 | 70,035 | 71,756 | ||||||||||||
Dilutive
potential common shares from stock
|
||||||||||||||||
options
and restricted stock (1)
|
516 | 299 | 390 | 354 | ||||||||||||
Diluted
|
70,666 | 72,130 | 70,425 | 72,110 | ||||||||||||
Basic
net earnings per share
|
$ | 0.92 | $ | 0.75 | $ | 2.32 | $ | 1.63 | ||||||||
Diluted
net earnings per share
|
$ | 0.91 | $ | 0.75 | $ | 2.31 | $ | 1.62 | ||||||||
|
||||||||||||||||
(1)
Potentially dilutive stock options and restricted stock totaling 5,254
shares and 4,727 shares for the three months ended September 30, 2009 and
2008, respectively, and 5,803 shares and 4,396 shares for the nine months
ended September 30, 2009 and 2008, respectively, were excluded from the
computation of diluted weighted average shares outstanding due to their
antidilutive effect.
|
Holders
of our Convertible Notes may, under certain circumstances, convert the
Convertible Notes into cash, and if applicable, shares of our common stock at
the applicable conversion rate, at any time on or prior to
maturity. (See Note 4.) The Convertible Notes will have no
impact on diluted earnings per share unless the price of our common stock
exceeds the conversion price (initially $51.34 per share) because the principal
amount of the Convertible Notes will be settled in cash upon
conversion. Prior to conversion we will use the treasury stock method
to include the effect of the additional shares that may be issued if our common
stock price exceeds the conversion price. The convertible note hedge
purchased in connection with the issuance of our Convertible Notes is excluded
from the calculation of diluted earnings per share as its impact is always
anti-dilutive. The warrant transactions associated with the issuance
of our Convertible Notes will have no impact on EPS unless our share price
exceeds the $60.41 exercise price.
NOTE
8. Incentive Compensation
Plans
Share-based
compensation expense was recognized in the condensed consolidated statements of
earnings as follows (dollars in thousands, except per share data):
Three
months ended
|
Nine
months ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Rental
expenses
|
$ | 1,547 | $ | 1,259 | $ | 3,649 | $ | 4,122 | ||||||||
Cost
of sales
|
192 | 245 | 673 | 513 | ||||||||||||
Selling,
general and administrative expenses
|
7,284 | 5,545 | 18,655 | 13,273 | ||||||||||||
Pre-tax
share-based compensation expense
|
9,023 | 7,049 | 22,977 | 17,908 | ||||||||||||
Less: Income
tax benefit
|
(3,008 | ) | (2,280 | ) | (7,641 | ) | (5,120 | ) | ||||||||
Total
share-based compensation expense, net of tax
|
$ | 6,015 | $ | 4,769 | $ | 15,336 | $ | 12,788 | ||||||||
Diluted
net earnings per share impact
|
$ | 0.09 | $ | 0.07 | $ | 0.22 | $ | 0.18 |
During
the first nine months of 2009 and 2008, KCI granted approximately 1,671,000 and
1,826,000 options, respectively, to purchase shares of common stock under the
equity plans. Included in the 2009 stock option grants were
approximately 205,000 performance stock options issued to certain
executives. If certain company performance targets are met, these
options will vest over a three-year period, or earlier, and any options not
vested by the end of three years will be forfeited. The
weighted-average estimated fair value of stock options granted during the
nine-month periods ended September 30, 2009 and 2008 was $11.38 and $19.95 per
share, respectively, using the Black-Scholes option pricing model.
A summary
of our stock option activity, and related information, for the nine months ended
September 30, 2009 is set forth in the table below:
Weighted
|
||||||||||||
Average
|
||||||||||||
Weighted
|
Remaining
|
Aggregate
|
||||||||||
Average
|
Contractual
|
Intrinsic
|
||||||||||
Options
|
Exercise
|
Term
|
Value
|
|||||||||
(in
thousands)
|
Price
|
(years)
|
(in
thousands)
|
|||||||||
Options
outstanding – January 1, 2009
|
4,366 | $ | 43.15 | |||||||||
Granted
|
1,671 | $ | 25.07 | |||||||||
Exercised
|
(90 | ) | $ | 8.74 | ||||||||
Forfeited/Expired
|
(392 | ) | $ | 44.89 | ||||||||
Options
outstanding – September 30, 2009
|
5,555 | $ | 38.14 | 7.73 | $ | 26,383 | ||||||
Exercisable
as of September 30, 2009
|
2,029 | $ | 43.16 | 6.08 | $ | 5,031 |
During
each of the first nine months of 2009 and 2008, we issued approximately 442,000
shares of restricted stock and restricted stock units under our equity plans at
a weighted average estimated fair value of $25.09 and $45.78,
respectively. The following table summarizes restricted stock
activity for the nine months ended September 30, 2009:
Number
of
|
Weighted
|
||||||
Shares
|
Average
Grant
|
||||||
(in
thousands)
|
Date
Fair Value
|
||||||
Unvested
shares – January 1, 2009
|
771 | $ | 45.21 | ||||
Granted
|
442 | $ | 25.09 | ||||
Vested
and distributed
|
(47 | ) | $ | 40.80 | |||
Forfeited
|
(71 | ) | $ | 41.82 | |||
Unvested
shares – September 30, 2009
|
1,095 | $ | 37.49 |
KCI has a
policy of issuing new shares to satisfy stock option exercises and restricted
stock award issuances. In addition, KCI may purchase shares in
connection with the net share settlement exercise of employee stock options for
minimum tax withholdings and exercise price and the withholding of shares to
satisfy the minimum tax withholdings on the vesting of restricted
stock.
NOTE
9. Share Repurchase
Program
In
October 2008, our Board of Directors authorized a share repurchase program (the
“2008 Repurchase Program”) for the repurchase of up to $100.0 million in market
value of common stock, which expired September 30, 2009. Under the
2008 Repurchase Program, 2.1 million shares of common stock were repurchased at
an average price of $24.11 per share for an aggregate purchase price of $50.3
million. These repurchases include $50.0 million of common stock
repurchases made in open-market transactions. The remainder resulted
from the purchase and retirement of shares in connection with the withholding of
shares to satisfy the minimum tax withholdings on the vesting of restricted
stock.
The
purchase price for shares of KCI's stock repurchased under the 2008 Repurchase
Program was reflected as a reduction to shareholder's equity. In
accordance with the Equity topic of the Codification, we are required to
allocate the purchase price of the repurchased shares as a reduction to common
stock, additional paid-in capital and retained earnings. The share
repurchases since the inception of this program are summarized in the table
below (in thousands):
Common
Stock
|
Total
|
||||||||||||||
Shares
of
|
and
Additional
|
Retained
|
Shareholders’
|
||||||||||||
Common
Stock
|
Paid-in
Capital
|
Earnings
|
Equity
|
||||||||||||
Repurchase
of common stock
|
2,088 | $ | 19,728 | $ | 30,615 | $ | 50,343 |
NOTE
10. Other Comprehensive
Income
KCI
follows the Comprehensive Income topic of the Codification in accounting for
other comprehensive income and its components. The components of
total comprehensive income are as follows (dollars in thousands):
Three
months ended
September
30,
|
Nine
months ended
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Net
earnings
|
$ | 64,569 | $ | 53,911 | $ | 162,371 | $ | 117,053 | ||||||||
Foreign
currency translation adjustment, net of taxes
|
(679 | ) | (14,681 | ) | (177 | ) | (8,136 | ) | ||||||||
Net
derivative loss, net of taxes
|
(1,588 | ) | (377 | ) | (3,081 | ) | (1,154 | ) | ||||||||
Amount
of gain (loss) reclassified from accumulated OCI into income, net of
taxes
|
2,044 | 361 | 4,965 | 365 | ||||||||||||
Total
comprehensive income
|
$ | 64,346 | $ | 39,214 | $ | 164,078 | $ | 108,128 | ||||||||
NOTE
11. Commitments and
Contingencies
Patent
Litigation
Although
it is not possible to reliably predict the outcome of U.S. and foreign patent
litigation described below, we believe that each of the patents involved in
litigation are valid and enforceable, and that our patent infringement claims
are meritorious. However, if any of our key patent claims were
narrowed in scope or found to be invalid or unenforceable, or we otherwise do
not prevail, our share of the advanced wound care market for our V.A.C. Therapy
systems could be significantly reduced in the U.S. or Europe, due to increased
competition, and pricing of V.A.C. Therapy systems could decline significantly,
either of which would materially and adversely affect our financial condition
and results of operations. We derived approximately 52% of total
revenue for the nine months ended September 30, 2009 and 53% of total revenue
for the year ended December 31, 2008 from our domestic V.A.C. Therapy products
relating to the U.S. patents at issue. In continental Europe, we
derived approximately 12% of total revenue for the nine months ended September
30, 2009 and 13% of total revenue for the year ended December 31, 2008 in V.A.C.
revenue relating to the patents at issue in the ongoing litigation in Germany,
France and the United Kingdom.
U.S.
V.A.C. Patent Litigation
KCI and
its affiliates, together with Wake Forest University Health Sciences (“Wake
Forest”), are involved in multiple patent infringement suits involving patents
licensed exclusively to KCI by Wake Forest. In 2006, a U.S. Federal
District Court jury found that the Wake Forest patents involved in the
litigation were valid and enforceable, but that the patent claims at issue were
not infringed by the gauze-based device marketed by BlueSky Medical, which was
acquired by Smith & Nephew plc in 2007. The parties appealed the
judgment entered by the District Court. On February 2, 2009, the U.S.
Court of Appeals for the Federal Circuit affirmed the decision of the District
Court. Specifically, the Federal Circuit upheld the validity of the
patents at issue, but also upheld the finding that the BlueSky gauze-based
device did not infringe these patents. Medela has filed a petition
for certiorari with the
U.S. Supreme Court challenging the Federal Circuit’s ruling. KCI
recently filed its brief opposing Medela’s petition.
In May
2007, KCI, its affiliates and Wake Forest filed two related patent infringement
suits: one case against Smith & Nephew and BlueSky and a second case against
Medela, for the manufacture, use and sale of gauze-based negative pressure
devices which we believe infringe a Wake Forest continuation patent issued in
2007 relating to our V.A.C. technology. These cases are being heard
in the Federal District Court for the Western District of Texas. In
December 2008, we amended our claims in the case to assert additional patents
and patent claims against Smith & Nephew following its announcement that it
would begin commercializing foam dressing kits for use in negative pressure
wound therapy, or NPWT. In addition, in February 2009, we filed a
motion for preliminary injunction against Smith & Nephew and requested an
expedited hearing on this motion, which was heard in June 2009. A
ruling on the preliminary injunction has not yet been issued by the
Court. These cases are currently set for trial in February
2010.
Related
to the Smith & Nephew litigation, the U.S. Patent and Trademark Office
(“USPTO”) recently issued office actions confirming the validity of three
separate patents licensed to KCI by Wake Forest University Health Sciences in
re-examination proceedings. The patents associated with this decision
include U.S. Patent Nos. 5,636,643 (“the ‘643 Patent”), 5,645,081 (“the ‘081
Patent”), and 7,216,651 (“the ‘651 Patent”), which all relate to KCI’s negative
pressure wound therapy technologies. The USPTO recently issued certificates of
re-examination affirming the validity of key claims in the ‘643 Patent and the
‘081 Patent. The USPTO also issued a formal Office action confirming the
validity of all claims in the ‘651 Patent.
In
September 2007, KCI and two affiliates were named in a declaratory judgment
action filed in the Federal District Court for the District of Delaware by
Innovative Therapies, Inc. (“ITI”). In that case, the plaintiff has
alleged the invalidity or unenforceability of four patents licensed to KCI by
Wake Forest and one patent owned by KCI relating to V.A.C. Therapy, and has
requested a finding that products made by the plaintiff do not infringe the
patents at issue. On November 5, 2008, the District Court dismissed
ITI’s suit based on a lack of subject matter jurisdiction. ITI has
appealed the dismissal of the suit.
In
January 2008, KCI, its affiliates and Wake Forest filed a patent infringement
lawsuit against ITI in the U.S. District Court for the Middle District of North
Carolina. The federal complaint alleges that a negative pressure
wound therapy device introduced by ITI in 2007 infringes three Wake Forest
patents which are exclusively licensed to KCI. We are seeking damages
and injunctive relief in the case. Also in January and June of 2008,
KCI and its affiliates filed separate suits in state District Court in Bexar
County, Texas, against ITI and several of its principals, all of whom are former
employees of KCI. The claims in the state court suits include breach
of confidentiality agreements, conversion of KCI technology, theft of trade
secrets and conspiracy. We are seeking damages and injunctive relief
in the state court cases.
In
December 2008, KCI, its affiliates and Wake Forest filed a patent infringement
lawsuit against Boehringer Wound Systems, LLC, Boehringer Technologies, LP, and
Convatec, Inc. in the U.S. District Court for the Middle District of North
Carolina. The federal complaint alleges that a negative pressure
wound therapy device manufactured by Boehringer and commercialized by Convatec
infringes Wake Forest patents which are exclusively licensed to
KCI. In February 2009, the Defendants filed their answer, which
includes affirmative defenses and counterclaims alleging non-infringement and
invalidity of the Wake Forest patents.
International
V.A.C. Patent Litigation
In June
2007, Medela filed patent nullity suits in the German Federal Patent Court
against two of Wake Forest’s German patents licensed to KCI. These
patents were originally issued by the German Patent Office in 1998 and 2000 upon
granting of the corresponding European patents. The European patents
were upheld as amended and corrected during Opposition Proceedings before the
European Patent Office in 2003. In March 2008 and February 2009,
Mölnlycke Health Care AB and Smith & Nephew, respectively, joined the
nullity suit against Wake Forest’s German patent corresponding to European
Patent No. EP0620720 (“the ‘720 Patent”). A hearing on the validity
of the ‘720 Patent was held on March 17, 2009, at which time the German Federal
Patent Court ruled the ‘720 Patent invalid. The patent remains valid
and enforceable until a final ruling on appeal, which KCI and Wake Forest are
pursuing. In March 2008, Mölnlycke Health Care AB filed suit in the
United Kingdom alleging invalidity of the ‘720 Patent. Following a
trial in July 2009 on this matter and a previous ruling by the Court of Appeal
that the claims of the ‘720 patent were invalid, the trial court also ruled the
‘720 patent invalid. A hearing on the validity of Wake Forest’s
German patent corresponding to European Patent No. EP0688189 (“the ‘189 Patent”)
was held on May 5, 2009, at which time the German Federal Patent Court ruled the
‘189 Patent valid and fully maintained as granted.
In
December 2008, KCI and its affiliates filed a patent infringement lawsuit
against Smith & Nephew in the United Kingdom requesting preliminary and
interim injunctive relief. A trial on infringement and validity of
the patent in the United Kingdom was held in March 2009. In May 2009,
a judgment was issued by the Court in which it determined that certain claims of
the ‘720 Patent covering the use of foam dressing kits with NPWT systems were
valid and infringed by Smith & Nephew's foam-based NPWT dressing
kits. The court held that other claims under the patent were
invalid. The Court’s judgment extended the previously-issued
injunction. Smith & Nephew appealed the ruling and in July 2009,
the Court of Appeal heard arguments from both parties and thereafter ruled the
claims at issue invalid and lifted the injunction in the United
Kingdom. KCI may be required to pay damages for the period of
injunction. KCI was denied permission to appeal by the Court of
Appeal and is now seeking permission to appeal from the Supreme Court (formerly
House of Lords).
In March
2009, KCI and its affiliates filed a patent infringement lawsuit against Smith
& Nephew in the Federal Court of Australia, requesting preliminary
injunctive relief to prohibit the commercialization of a Smith & Nephew
negative pressure wound therapy dressing kit. The Federal Court
issued a temporary injunction in the case, which was recently overturned by an
Australian Court of Appeals. A full trial on validity and
infringement of the Wake Forest patent involved in the case is expected in the
summer of 2010.
In March
2009, KCI's German subsidiary filed a request for a preliminary injunction with
the German District Court of Düsseldorf to prevent commercialization of a Smith
& Nephew negative pressure wound therapy system that KCI believes infringes
the German counterpart of its European Patent No. EP0777504 (“the ‘504
Patent”). Following a hearing in July 2009 on this matter, the Court
denied KCI’s request. Also, in April 2009, KCI's German subsidiary
and its affiliates filed a patent infringement lawsuit against Smith &
Nephew, GmbH Germany in the German District Court of Mannheim. The
lawsuit alleges that the negative pressure wound therapy systems commercialized
by Smith & Nephew infringe the ‘504 Patent and another German patent owned
by KCI corresponding to European Patent No. EP0853950 (“the ‘950
Patent”). A trial was held in October 2009 on the ‘504 patent claims,
after which the Court dismissed KCI’s claims. A trial on KCI’s ‘950
patent claims was temporarily adjourned and is scheduled to resume in March,
2010 after additional briefing by the parties.
In July
2009, KCI and its affiliates filed a request for a preliminary injunction with
the Paris District Court in France to prevent commercialization of Smith &
Nephew’s NPWT system that KCI believes infringes the French counterpart of the
‘504 Patent. A hearing on KCI’s request for preliminary injunction
was heard in October 2009 in France and a ruling is expected in
November. A trial on the matter is expected in 2010. Also
in July 2009, KCI and its affiliates filed patent infringement lawsuits against
Smith & Nephew in the United Kingdom and its affiliates in France alleging
infringement of the ‘504 Patent and the ‘950 Patent in those
countries. KCI has withdrawn its request for a preliminary injunction
in the United Kingdom based on the ‘504 Patent and the ‘950 Patent, and is
proceeding to trial in March 2010.
Regenerative
Medicine Litigation
In
September 2005, LifeCell recalled certain human-tissue based products because
the organization that recovered the tissue, Biomedical Tissue Services, Ltd.
(“BTS”), may not have followed Food and Drug Administration (“FDA”) requirements
for donor consent and/or screening to determine if risk factors for communicable
diseases existed. LifeCell promptly notified the FDA and all relevant
hospitals and medical professionals. LifeCell did not receive any
donor tissue from BTS after September 2005. LifeCell has been named,
along with BTS and many other defendants, in lawsuits relating to the BTS donor
irregularities. These lawsuits generally fall within three
categories, (1) recipients of BTS tissue who claim actual injury, (2) suits
filed by recipients of BTS tissue seeking medical monitoring and/or damages for
emotional distress (categories (1) and (2) are collectively referred to herein
as “recipient cases”), (3) suits filed by family members of tissue donors who
did not authorize BTS to donate tissue (“family cases”).
In the
first category, LifeCell has been named in three cases filed in the State Court
of New Jersey, and approximately seven cases in New Jersey Federal Court in
which the plaintiffs allege to have contracted a disease from BTS’s
tissue. The seven cases in the Federal Court were administratively
stayed pending an appeal filed by plaintiffs in other recipient cases that were
dismissed. The State Court cases are in discovery.
In the
second category, LifeCell has been named in more than twenty suits in which the
plaintiffs do not allege that they have contracted a disease or suffered
physical injury, but instead seek medical monitoring and/or damages for
emotional distress. Seventeen of those cases which were consolidated
in New Jersey Federal District Court as part of a Multi-District Litigation
(“MDL”) were dismissed on December 10, 2008, and are now the subject of an
appeal by plaintiffs. The balance of those were filed in State Court
in New Jersey. On April 3, 2009, six of the State Court cases were
dismissed. On June 12, 2009, the remaining five State Court cases
were dismissed. All 11 cases are now on appeal.
In the
third category, approximately twenty suits have been filed by family members of
tissue donors seeking damages for emotional distress. Three of those
are in the MDL. The other family cases have been filed in state
courts in New Jersey and Pennsylvania. Many of these cases improperly
name LifeCell as the Company did not receive any tissue from the decedent
donor. Voluntary dismissals have been obtained in many of those
cases. The balance of the family cases are in discovery.
Although
it is not possible to reliably predict the outcome of the BTS-related
litigation, we believe that our defenses to the claims are meritorious and will
defend them vigorously. LifeCell insurance policies covering the
BTS-related claims, which were assumed in our acquisition of LifeCell, should
cover the majority of litigation expenses, settlement costs and damage awards,
if any, in the recipient cases.
We are
party to several additional lawsuits arising in the ordinary course of our
business. Additionally, the manufacturing and marketing of medical
products necessarily entails an inherent risk of product liability
claims.
Other
Commitments and Contingencies
As a
healthcare supplier, we are subject to extensive government regulation,
including laws and regulations directed at ascertaining the appropriateness of
reimbursement, preventing fraud and abuse and otherwise regulating reimbursement
under various government programs. The marketing, billing,
documenting and other practices are all subject to government
scrutiny. To ensure compliance with Medicare and other regulations,
regional carriers often conduct audits and request patient records and other
documents to support claims submitted by KCI for payment of services rendered to
customers.
From time
to time, we receive inquiries from various government agencies requesting
customer records and other documents. It has been our policy to
cooperate with all such requests for information. In 2005, the U.S.
Department of Health and Human Services Office of Inspector General, or OIG,
initiated a study on NPWT. As part of the 2005 study, KCI provided
the OIG with requested copies of our billing records for Medicare V.A.C.
placements. In June 2007, the OIG issued a report on the NPWT study
including a number of findings and recommendations to CMS. The OIG
determined that substantially all V.A.C. claims met supplier documentation
requirements; however, they were unable to conclude that the underlying patient
medical records fully supported the supplier documentation in 44% of the claims,
which resulted in an OIG estimate that approximately $27 million in improper
payments may have been made on NPWT claims in 2004. The purpose of
the OIG report is to make recommendations for potential Medicare program savings
to CMS, but it does not constitute a formal recoupment action. This
report may result in increased audits and/or demands by Medicare, its regional
contractors and other third-party payers for refunds or recoupments of amounts
previously paid to us.
We also
are subject to routine pre-payment and post-payment audits of reimbursement
claims submitted to Medicare. These audits typically involve a
review, by Medicare or its designated contractors and representatives, of
documentation supporting the medical necessity of the therapy provided by
KCI. While Medicare requires us to obtain a comprehensive physician
order prior to providing products and services, we are not required to, and do
not as a matter of practice require, or subsequently obtain the underlying
medical records supporting the information included in such
certificate. Following a Medicare request for supporting
documentation, we are obligated to procure and submit the underlying medical
records retained by various medical facilities and
physicians. Obtaining these medical records in connection with a
claims audit may be difficult or impossible and, in any event, all of these
records are subject to further examination and dispute by an auditing
authority. Under standard Medicare procedures, KCI is entitled to
demonstrate the sufficiency of documentation and the establishment of medical
necessity, and KCI has the right to appeal any adverse
determinations. If a determination is made that KCI’s records or the
patients’ medical records are insufficient to meet medical necessity or Medicare
reimbursement requirements for the claims subject to a pre-payment or
post-payment audit, KCI could be subject to denial, recoupment or refund demands
for claims submitted for Medicare reimbursement. In the event that an
audit results in discrepancies in the records provided, Medicare may be entitled
to extrapolate the results of the audit to make recoupment demands based on a
wider population of claims than those examined in the audit. In
addition, Medicare or its contractors could place KCI on extended pre-payment
review, which could slow our collections process for submitted
claims. If Medicare were to deny a significant number of claims in
any pre-payment audit, or make any recoupment demands based on any post-payment
audit, our business and operating results could be materially and adversely
affected. In addition, violations of federal and state regulations
regarding Medicare reimbursement could result in severe criminal, civil and
administrative penalties and sanctions, including disqualification from Medicare
and other reimbursement programs. Going forward, it is likely that we
will be subject to periodic inspections, assessments and audits of our billing
and collections practices.
In July
2008, the Durable Medical Equipment Medicare Administrative Contractors (“DMAC”)
for Region B notified KCI of a post-payment audit of claims paid during the
third quarter of 2008. The DMAC requested information on 98 NPWT
claims for patients treated with KCI’s V.A.C. Therapy. In addition to
KCI’s records, the DMAC requested relevant medical records supporting the
medical necessity of the V.A.C. and related supplies and quantities being
billed. We submitted all of the requested documentation in a timely
manner and have received an initial report indicating that approximately 41% of
the claims subject to this audit were inappropriately paid, which may result in
future recoupments by Medicare. We have disputed these initial audit
findings and as is customary with activities of this type, we will exhaust all
administrative remedies and appeals to support the claims billed.
In
February 2009, we received a subpoena from the OIG seeking records regarding our
billing practices under the local coverage policies of the four regional
DMACs. We are in discussions with the government regarding the scope
of the subpoena and have produced substantial documentation to the OIG in
response to their requests in a timely manner. We intend to cooperate
with the OIG’s inquiry. The review is in its initial stages and we
cannot predict the time frame in which it will be resolved nor the impact the
findings will have on our results of operations or our financial
position.
In June
and July of 2009, the Medicare Region B DMAC conducted a pre-payment review of
25 claims from nine suppliers. This review resulted in KCI receiving
a 100% approval rate.
In April
2009, the Medicare Region A DMAC initiated a pre-payment review and sent
documentation request letters to KCI for NPWT claims related to various cycles
of treatment. We received documentation request letters related to 64
claims. We cooperated with the government’s review and received
payment on 100% of our reviewed claims.
As of
September 30, 2009, our commitments for the purchase of new product inventory
were $34.5 million, including approximately $13.0 million of disposable products
from our main disposable supplier, $3.7 million from our provider of low height
medical-surgical beds and $2.7 million from our major electronic board and touch
panel suppliers. Other than commitments for new product inventory, we
have no material long-term purchase commitments.
NOTE
12. Segment and Geographic
Information
We are
principally engaged in the rental and sale of advanced wound care systems and
therapeutic support systems throughout the United States and in 20 primary
countries internationally and the sale of regenerative medicine products
primarily throughout the United States.
During
the first quarter of 2009, we changed our operating unit reporting structure to
correspond with our current management structure, including the reclassification
of prior-period amounts to conform to this current reporting
structure. Under our current management structure, we manage our
business by product line.
We have
three reportable operating segments which correspond to our primary product
lines: (i) V.A.C. Therapy; (ii) Regenerative Medicine; and (iii) Therapeutic
Support Systems. We have two primary geographic regions: North
America, which is comprised principally of the U.S. and includes Canada and
Puerto Rico; and EMEA/APAC, which is comprised principally of Europe and
includes the Middle East, Africa and the Asia Pacific
region. Revenues for each of our geographic regions in which we
operate are disclosed for each of our product line operating
segments. In most countries where we operate, our product lines are
marketed and serviced by the same infrastructure and, as such, we have allocated
these costs to the various product line operating segments based on allocation
methods including rental and sales events, headcount, revenue and other methods
as deemed appropriate. We measure segment profit as operating
earnings, which is defined as income before interest and other income, interest
expense, foreign currency gains and losses, and income taxes. All
intercompany transactions are eliminated in computing revenue and operating
earnings.
Information
on segments and a reconciliation of consolidated totals are as follows (dollars
in thousands):
Three
months ended
|
Nine
months ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Revenue:
|
||||||||||||||||
V.A.C.
|
||||||||||||||||
North
America
|
$ | 270,848 | $ | 269,965 | $ | 791,837 | $ | 781,884 | ||||||||
EMEA/APAC
|
89,732 | 90,324 | 247,490 | 264,613 | ||||||||||||
Subtotal
– V.A.C.
|
360,580 | 360,289 | 1,039,327 | 1,046,497 | ||||||||||||
Regenerative
Medicine
|
||||||||||||||||
North
America
|
71,248 | 61,233 | 208,132 | 88,836 | ||||||||||||
EMEA/APAC
|
519 | - | 913 | - | ||||||||||||
Subtotal
– Regenerative Medicine
|
71,767 | 61,233 | 209,045 | 88,836 | ||||||||||||
Therapeutic
Support Systems
|
||||||||||||||||
North
America
|
46,542 | 55,082 | 141,817 | 167,705 | ||||||||||||
EMEA/APAC
|
25,508 | 26,695 | 75,638 | 82,401 | ||||||||||||
Subtotal
– Therapeutic Support Systems
|
72,050 | 81,777 | 217,455 | 250,106 | ||||||||||||
Total
revenue
|
$ | 504,397 | $ | 503,299 | $ | 1,465,827 | $ | 1,385,439 |
Three
months ended
|
Nine
months ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Operating
earnings:
|
||||||||||||||||
V.A.C.
|
$ | 113,408 | $ | 109,955 | $ | 318,283 | $ | 319,265 | ||||||||
Regenerative
Medicine
|
20,817 | 19,230 | 62,666 | 27,983 | ||||||||||||
Therapeutic
Support Systems
|
7,158 | 13,669 | 20,250 | 40,223 | ||||||||||||
Other
(1):
|
||||||||||||||||
Executive
|
(7,428 | ) | (4,722 | ) | (26,903 | ) | (23,416 | ) | ||||||||
Share-based
Compensation
|
(9,023 | ) | (7,049 | ) | (22,977 | ) | (19,678 | ) | ||||||||
Acquired
intangible asset amortization
|
(10,160 | ) | (10,189 | ) | (30,476 | ) | (14,843 | ) | ||||||||
Purchase
transactions (2)
|
(537 | ) | (8,022 | ) | (1,617 | ) | (74,491 | ) | ||||||||
Total
other
|
(27,148 | ) | (29,982 | ) | (81,973 | ) | (132,428 | ) | ||||||||
Total
operating earnings
|
$ | 114,235 | $ | 112,872 | $ | 319,226 | $ | 255,043 | ||||||||
|
||||||||||||||||
(1)
Includes general headquarter expenses, including severance costs
associated with workforce restructuring and share-based
compensation expense, which are not allocated to the individual
segments. Additionally, “Other” includes expenses related to our
LifeCell acquisition in May 2008.
(2)
Purchase transactions are related to our LifeCell acquisition and include
the inventory mark-up on acquired inventories, integration-related costs,
professional fees and costs associated with retaining key LifeCell
employees and the write-off of in-process research and
development.
|
A number
of factors contributed to the year-to-year reduction in V.A.C. operating
earnings for the nine months ended September 30, 2009 including unfavorable
foreign currency exchange rate movements, additional legal expenses associated
with patent litigation and an increase in bad debt expense associated with an
increase in customer bankruptcies. The reduction in TSS operating
earnings was primarily attributable to lower revenue as a result of a weak
economic environment and hospital capital constraints.
NOTE
13. Subsequent Events
In
addition to the swaps in effect at September 30, 2009, we have entered into
three additional interest rate swap agreements to convert $150.0 million of our
variable-rate debt to a fixed rate basis which become effective on December 31,
2009. (See Note 5.)
Subsequent
to September 30, 2009, we borrowed a net of $70.0 million on our senior
revolving credit facility for working capital purposes. On November
3, 2009, we made a voluntary repayment of $25.0 million on our senior credit
facility. As of November 5, 2009, $775.0 million and $70.0 million
were outstanding on our senior credit facility and revolving credit facility,
respectively. We expect the balance of our senior revolving credit
facility to be repaid in December 2009. As of November 5, 2009, total
long-term debt outstanding was $1.396 billion, with $218.6 million available
under our senior revolving credit facility.
Subsequent
events have been evaluated through November 5, 2009, the date these condensed
consolidated financial statements were issued.
The
following discussion should be read in conjunction with the condensed
consolidated financial statements and accompanying notes included in this
report. The following discussion contains forward-looking statements
that reflect our plans, estimates and beliefs. Our actual results
could differ materially from those discussed in the forward-looking
statements. Factors that could cause or contribute to these
differences include, but are not limited to, those discussed in our “Risk
Factors,” (Part I, Item 1A.), including those previously disseminated in KCI's
Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and each
of the Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31,
2009 and June 30, 2009.
GENERAL
Kinetic
Concepts, Inc. is a leading global medical technology company devoted to the
discovery, development, manufacture and marketing of innovative, high-technology
therapies and products for the wound care, tissue regeneration and therapeutic
support systems markets. We design, manufacture, market and service a
wide range of proprietary products that can improve clinical outcomes and can
help reduce the overall cost of patient care. Our advanced wound care
systems incorporate our proprietary V.A.C. Therapy technology, which is
clinically-proven to promote wound healing through unique mechanisms of action,
and to speed recovery times while reducing the overall cost of treating patients
with complex wounds. Our regenerative medicine products include
tissue-based products for use in reconstructive, orthopedic and urogynecologic
surgical procedures to repair soft tissue defects. Our Therapeutic
Support Systems (“TSS”) business includes specialty hospital beds, mattress
replacement systems and overlays, which are designed to address pulmonary
complications associated with influenza, acute respiratory distress syndrome
(ARDS) and immobility, to reduce or treat skin breakdown and assist caregivers
in the safe and dignified handling of patients of size. We have an
infrastructure designed to meet the specific needs of medical professionals and
patients across all healthcare settings, including acute care hospitals,
extended care organizations and patients’ homes, both in the U.S. and
abroad.
We have
direct operations in the U.S., Canada, Western Europe, Australia, New Zealand,
Singapore, Hong Kong and South Africa, and we conduct additional business
through distributors in Latin America, the Middle East, Eastern Europe and
Asia. We manage our business in three reportable operating segments
which correspond to our primary product lines (i) V.A.C Therapy (“V.A.C.”); (ii)
Regenerative Medicine; and (iii) TSS. We have operations in two
primary geographic regions: North America, which is comprised principally of the
U.S. and includes Canada and Puerto Rico; and EMEA/APAC, which is comprised
principally of Europe and includes the Middle East, Africa, and the Asia Pacific
region.
Operations
for our North America geographic region accounted for approximately 77.9% and
75.0% of our total revenue for the nine-month periods ended September 30, 2009
and 2008, respectively. In the U.S. acute care setting, which
accounted for approximately half of our North American revenue for the nine
months ended September 30, 2009, we bill our customers directly for the rental
and sale of our products. In the U.S. homecare setting, where our
revenue comes predominantly from V.A.C. Therapy systems, we provide products and
services to patients in the home and bill third-party payers directly, such as
Medicare and private insurance. In the EMEA/APAC geographic region,
most of our V.A.C. and TSS revenue is generated in the acute care setting on a
direct billing basis.
In May
2008, we completed the acquisition of all the outstanding capital stock of
LifeCell for an aggregate purchase price of approximately $1.8
billion. LifeCell represents our Regenerative Medicine business unit
and develops, processes and markets biological soft tissue repair products made
from both human (“allograft”) and animal (“xenograft”) tissue. These
products are used by surgeons to restore structure, function and physiology in a
variety of reconstructive, orthopedic and urogynecologic surgical
procedures. The LifeCell acquisition enhances our product platform
and provides significant future growth opportunities for our
company.
Regenerative
Medicine revenue is generated primarily in the U.S. in the acute care setting on
a direct billing basis. We market our AlloDerm product, made from
allograft or human tissue, and Strattice product, made from xenograft or animal
tissue, for plastic reconstructive, general surgical and burn applications
primarily to hospitals for use by general and plastic surgeons. These
products are marketed through our direct sales and marketing
organization. Our sales representatives are responsible for
interacting with plastic surgeons, general surgeons, ear, nose and throat
surgeons, burn surgeons and trauma/acute care surgeons to educate them on the
use and potential benefits of our reconstructive tissue products. We
also participate in numerous national fellowship programs, national and
international conferences and trade shows, and sponsor medical education
symposiums. Our products for orthopedic and urogynecologic procedures
are marketed through independent sales agents and distributors. These
products include GraftJacket, for orthopedic applications and lower extremity
wounds; AlloCraftDBM, for bone grafting procedures; Repliform, for
urogynecologic surgical procedures; and Conexa, for rotator cuff tissue
repairs.
A
significant majority of our revenue is generated by our V.A.C. Therapy systems
and related supplies, which accounted for approximately 70.9% of total revenue
for the nine months ended September 30, 2009, compared to 75.5% for the same
period in 2008. We derive our revenue primarily from the rental of
our therapy systems and the sale of related disposables. The sale of
our regenerative medicine products accounted for approximately 14.3% and 6.4% of
our total revenue for the nine months ended September 30, 2009 and 2008,
respectively. Our TSS business accounted for approximately 14.8% and
18.1% of our total revenue for the nine months ended September 30, 2009 and
2008, respectively.
Historically,
we have experienced a seasonal slowing of domestic V.A.C. unit growth beginning
in the fourth quarter and continuing into the first quarter, which we believe
has been caused by year-end clinical treatment patterns, such as the
postponement of elective surgeries and increased discharges of individuals from
the acute care setting around the winter holidays. Regenerative
Medicine has also historically experienced a similar seasonal slowing of sales
in the third quarter of each year. Although we do not know if our
historical experience will prove to be indicative of future periods, similar
slow-downs may occur in subsequent periods.
RECENT
DEVELOPMENTS
In
addition to the swaps in effect at September 30, 2009, we have entered into
three additional interest rate swap agreements to convert $150.0 million of our
variable-rate debt to a fixed rate basis which become effective on December 31,
2009. These agreements have been designated as cash flow hedge
instruments. The following chart summarizes these new agreements
(dollars in thousands):
Original
|
||||||
Notional
|
Fixed
|
|||||
Accounting
Method
|
Effective
Dates
|
Amount
|
Interest
Rate
|
|||
Hypothetical
|
12/31/09-12/31/10
|
$ 50,000 | 1.290 % | |||
Hypothetical
|
12/31/09-12/31/10
|
$ 50,000 | 0.955 % | |||
Hypothetical
|
12/31/09-12/31/10
|
$ 50,000 | 0.950 % |
Subsequent
to September 30, 2009, we borrowed a net of $70.0 million on our senior
revolving credit facility for working capital purposes. On November
3, 2009, we made a voluntary repayment of $25.0 million on our senior credit
facility. As of November 5, 2009, $775.0 million and $70.0 million
were outstanding on our senior credit facility and revolving credit facility,
respectively. We expect the balance of our senior revolving credit
facility to be repaid in December 2009. As of November 5, 2009, total
long-term debt outstanding was $1.396 billion, with $218.6 million available
under our senior revolving credit facility.
In an
effort to reduce U.S. healthcare costs, there have been and continue to be
proposals by legislators, regulators, and governmental payers to reduce these
costs. Certain legislative proposals, if passed, may impose
additional taxes on certain healthcare companies, limitations on the prices we
will be able to charge for our products or the amounts of reimbursement
available for our products from governmental agencies or third-party
payers. In particular, President Obama and members of the U.S.
Congress have proposed significant reforms to the U.S. healthcare
system. The Obama administration's fiscal year 2010 budget included
proposals to limit Medicare payments, reduce drug spending and increase
taxes. In addition, members of Congress have proposed a single-payer
healthcare system, a government health insurance option to compete with private
plans and other expanded public healthcare measures. Various
healthcare reform proposals have also emerged at the state level. We
cannot predict what healthcare initiatives, if any, will be implemented at the
federal or state level, or the effect any future legislation or regulation will
have on us. However, an expansion in the government’s role in the
U.S. healthcare industry is likely and may lower reimbursements for our
products, reduce medical procedure volumes and increase taxes certain healthcare
companies are required to pay. While our products have been
demonstrated clinically to reduce the overall cost of care due to unique
mechanisms of action resulting in shorter treatment periods, these proposed
changes could adversely affect our business.
We continue to see signs of weakness in the U.S. and global
economies. We believe the economic downturn may generally decrease
hospital census and the demand for elective surgeries, which could negatively
impact the demand for certain of our products. Also, the global
financial crisis, increasing unemployment and general economic uncertainties
have made it more difficult and more expensive for hospitals and health systems
to obtain credit, and may contribute to pressures on their operating
margins. We believe that rising unemployment reduces the number of
individuals covered by private insurance, which has resulted in a noticeable
increase in our charity-care placements and may increase the cost of
uncompensated care for hospitals. Rising unemployment may also result
in a shift in reimbursement patterns as unemployed individuals switch from
private plans to public plans such as Medicaid or Medicare. If the
economic downturn persists and unemployment remains high or increases, any
significant shift in coverage for the unemployed may have an unfavorable impact
on our reimbursement mix and may result in a decrease in our overall average
unit prices.
RESULTS
OF OPERATIONS
During
the first quarter of 2009, we changed our operating segment reporting structure
to correspond with our current management structure. For the third
quarter and first nine months of 2009, we are reporting financial results
consistent with this new structure. We have three reportable
operating segments which correspond to our primary product lines: (i) V.A.C.;
(ii) Regenerative Medicine and (iii) Therapeutic Support Systems. We
have two primary geographic regions: North America, which is comprised of the
U.S., Canada and Puerto Rico; and EMEA/APAC, which is comprised principally of
Europe and includes the Middle East, Africa and the Asia Pacific
region. Revenues for each of our geographic regions in which we
operate are disclosed for each of our product line operating
segments. The results of our Regenerative Medicine operating segment
have been included in our condensed consolidated financial statements since the
LifeCell acquisition date.
Revenue
by Operating Segment
The
following table sets forth, for the periods indicated, product line revenue by
geographic region, as well as the percentage change in each line item, comparing
the third quarter of 2009 to the third quarter of 2008 and the first nine months
of 2009 to the first nine months of 2008 (dollars in thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
%
|
%
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
V.A.C.
revenue:
|
||||||||||||||||||||||
North
America
|
$ | 270,848 | $ | 269,965 | 0.3 | % | $ | 791,837 | $ | 781,884 | 1.3 | % | ||||||||||
EMEA/APAC
|
89,732 | 90,324 | (0.7 | ) | 247,490 | 264,613 | (6.5 | ) | ||||||||||||||
Total
– V.A.C.
|
360,580 | 360,289 | 0.1 | 1,039,327 | 1,046,497 | (0.7 | ) | |||||||||||||||
Regenerative
Medicine revenue:
|
||||||||||||||||||||||
North
America
|
71,248 | 61,233 | 16.4 | 208,132 | 88,836 | 134.3 | ||||||||||||||||
EMEA/APAC
|
519 | - | - | 913 | - | - | ||||||||||||||||
Total
– Regenerative Medicine
|
71,767 | 61,233 | 17.2 | 209,045 | 88,836 | 135.3 | ||||||||||||||||
TSS
revenue:
|
||||||||||||||||||||||
North
America
|
46,542 | 55,082 | (15.5 | ) | 141,817 | 167,705 | (15.4 | ) | ||||||||||||||
EMEA/APAC
|
25,508 | 26,695 | (4.4 | ) | 75,638 | 82,401 | (8.2 | ) | ||||||||||||||
Total
– TSS
|
72,050 | 81,777 | (11.9 | ) | 217,455 | 250,106 | (13.1 | ) | ||||||||||||||
Total
revenue
|
$ | 504,397 | $ | 503,299 | 0.2 | % | $ | 1,465,827 | $ | 1,385,439 | 5.8 | % |
For
additional discussion on segment and operation information, see Note 12 to our
accompanying condensed consolidated financial statements.
Revenue
by Geography
The
following table sets forth, for the periods indicated, rental and sales revenue
by geography, as well as the percentage change in each line item, comparing the
third quarter of 2009 to the third quarter of 2008 and the first nine months of
2009 to the first nine months of 2008 (dollars in thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
%
|
%
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
North
America revenue:
|
||||||||||||||||||||||
Rental
|
$ | 234,662 | $ | 239,260 | (1.9 | )% | $ | 692,102 | $ | 707,766 | (2.2 | )% | ||||||||||
Sales
|
153,976 | 147,020 | 4.7 | 449,684 | 330,659 | 36.0 | ||||||||||||||||
Total
– North America
|
388,638 | 386,280 | 0.6 | 1,141,786 | 1,038,425 | 10.0 | ||||||||||||||||
EMEA/APAC
revenue:
|
||||||||||||||||||||||
Rental
|
63,915 | 65,945 | (3.1 | ) | 180,853 | 198,627 | (8.9 | ) | ||||||||||||||
Sales
|
51,844 | 51,074 | 1.5 | 143,188 | 148,387 | (3.5 | ) | |||||||||||||||
Total
– EMEA/APAC
|
115,759 | 117,019 | (1.1 | ) | 324,041 | 347,014 | (6.6 | ) | ||||||||||||||
Total
rental revenue
|
298,577 | 305,205 | (2.2 | ) | 872,955 | 906,393 | (3.7 | ) | ||||||||||||||
Total
sales revenue
|
205,820 | 198,094 | 3.9 | 592,872 | 479,046 | 23.8 | ||||||||||||||||
Total
revenue
|
$ | 504,397 | $ | 503,299 | 0.2 | % | $ | 1,465,827 | $ | 1,385,439 | 5.8 | % |
The
growth in total revenue over the prior-year periods was due primarily to
revenues associated with our acquisition of LifeCell in May 2008 and increased
rental and sales volumes for V.A.C. Therapy systems and related
disposables. Foreign currency exchange rate movements negatively
impacted total revenue and EMEA/APAC revenue by 1.4% and 5.1%, respectively, in
the third quarter of 2009 and 3.3% and 11.3%, respectively, for the first nine
months of 2009 compared to the prior-year periods.
Revenue
Relationship
The
following table sets forth, for the periods indicated, the percentage
relationship of each item to total revenue in the period, as well as the changes
in each line item, comparing the third quarter of 2009 to the third quarter of
2008 and the first nine months of 2009 to the first nine months of
2008:
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||
Total
revenue:
|
||||||||||||||
V.A.C.
revenue
|
71.5 | % | 71.6 | % |
(10
bps)
|
70.9 | % | 75.5 | % |
(460
bps)
|
||||
Regenerative
Medicine revenue
|
14.2 | 12.2 |
200
bps
|
14.3 | 6.4 |
790
bps
|
||||||||
TSS
revenue
|
14.3 | 16.2 |
(190
bps)
|
14.8 | 18.1 |
(330
bps)
|
||||||||
Total
revenue
|
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
North
America revenue
|
77.1 | % | 76.8 | % |
30
bps
|
77.9 | % | 75.0 | % |
290
bps
|
||||
EMEA/APAC
revenue
|
22.9 | 23.2 |
(30
bps)
|
22.1 | 25.0 |
(290
bps)
|
||||||||
Total
revenue
|
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
Rental
revenue
|
59.2 | % | 60.6 | % |
(140
bps)
|
59.6 | % | 65.4 | % |
(580
bps)
|
||||
Sales
revenue
|
40.8 | 39.4 |
140
bps
|
40.4 | 34.6 |
580
bps
|
||||||||
Total
revenue
|
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
V.A.C.
Revenue
The
following table sets forth, for the periods indicated, V.A.C. rental and sales
revenue by geography, as well as the percentage change in each line item,
comparing the third quarter of 2009 to the third quarter of 2008 and the first
nine months of 2009 to the first nine months of 2008 (dollars in
thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
%
|
%
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
North
America revenue:
|
||||||||||||||||||||||
Rental
|
$ | 193,337 | $ | 192,799 | 0.3 | % | $ | 566,274 | $ | 562,982 | 0.6 | % | ||||||||||
Sales
|
77,511 | 77,166 | 0.4 | 225,563 | 218,902 | 3.0 | ||||||||||||||||
Total
North America revenue
|
270,848 | 269,965 | 0.3 | 791,837 | 781,884 | 1.3 | ||||||||||||||||
EMEA/APAC
revenue:
|
||||||||||||||||||||||
Rental
|
43,214 | 44,588 | (3.1 | ) | 120,472 | 130,966 | (8.0 | ) | ||||||||||||||
Sales
|
46,518 | 45,736 | 1.7 | 127,018 | 133,647 | (5.0 | ) | |||||||||||||||
Total
EMEA/APAC revenue
|
89,732 | 90,324 | (0.7 | ) | 247,490 | 264,613 | (6.5 | ) | ||||||||||||||
Total
rental revenue
|
236,551 | 237,387 | (0.4 | ) | 686,746 | 693,948 | (1.0 | ) | ||||||||||||||
Total
sales revenue
|
124,029 | 122,902 | 0.9 | 352,581 | 352,549 | - | ||||||||||||||||
Total
V.A.C. revenue
|
$ | 360,580 | $ | 360,289 | 0.1 | % | $ | 1,039,327 | $ | 1,046,497 | (0.7 | )% |
The
growth in North America V.A.C. revenue over the prior-year periods was due
primarily to increased rental and sales volumes for V.A.C. Therapy systems and
related disposables due to continued market penetration. Average
North America rental unit volume during the third quarter and first nine months
of 2009 increased 4.1% and 5.3%, respectively, over the corresponding periods of
2008, partly offset by reduced treatment periods and lower realized pricing due
to unfavorable payer mix and lower Medicare pricing.
Foreign
currency exchange rate movements unfavorably impacted EMEA/APAC V.A.C. revenue
by 5.1% and 11.6% for the third quarter and first nine months of 2009,
respectively, compared to the prior-year periods. EMEA/APAC V.A.C.
Therapy revenue, excluding the impact of foreign currency exchange rate
movements, increased due primarily to rental unit volumes which increased 14.0%
and 14.8% for the third quarter and first nine months of 2009, respectively, and
an overall increase in V.A.C. disposable sales associated with the increase in
V.A.C. rental unit volumes. Higher EMEA/APAC unit volume was
partially offset by lower realized pricing compared to the prior-year period due
primarily to lower contracted pricing resulting from an increase in long-term
rental contracts, GPO pricing pressures, continued economic weakness and
increased competition.
Regenerative
Medicine Revenue
LifeCell’s
revenue since the acquisition date has been included in our condensed
consolidated financial statements. The following table reflects
Regenerative Medicine revenue by product included in our condensed consolidated
statements of earnings during the third quarter of 2009 and 2008, the nine
months ended September 30, 2009, and the unaudited pro forma revenue as though
the acquisition of LifeCell had occurred as of the beginning of the comparable
prior-year period (dollars in thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
%
|
Pro
Forma
|
%
|
||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
AlloDerm
|
42,231 | 45,812 | (7.8 | ) | 129,880 | 139,400 | (6.8 | ) | ||||||||||||||
Strattice
|
23,921 | 9,423 | 153.9 | 62,101 | 16,348 | 279.9 | ||||||||||||||||
Orthopedic,
urogynecologic and other products
|
5,615 | 5,998 | (6.4 | ) | 17,064 | 18,081 | (5.6 | ) | ||||||||||||||
Total
revenue
|
$ | 71,767 | $ | 61,233 | 17.2 | % | $ | 209,045 | $ | 173,829 | 20.3 | % |
Regenerative
Medicine revenue generated from the use of AlloDerm, Strattice and other tissue
products in reconstructive surgical procedures, including challenging hernia
repair and breast reconstruction, accounted for 92.2% and 91.8% of total
Regenerative Medicine revenue for the third quarter and first nine months of
2009, respectively. Revenue from Strattice accounted for 33.3% and
29.7% of total Regenerative Medicine revenue for the third quarter and first
nine months of 2009, respectively. Sales generated outside of the
U.S. increased from the second quarter of 2009, but were not material for the
third quarter of 2009.
The
growth in Regenerative Medicine revenue over the prior-year periods was due
primarily to increased demand for our regenerative tissue matrix products due to
continued market penetration. We believe the third quarter 2009
Regenerative Medicine revenue growth rate was negatively impacted by
approximately 3% to 4% due to AlloDerm and Strattice supply constraints compared
to the prior-year period.
TSS
Revenue
The
following table sets forth, for the periods indicated, TSS rental and sales
revenue by geography, as well as the percentage change in each line item,
comparing the third quarter of 2009 to the third quarter of 2008 and the first
nine months of 2009 to the first nine months of 2008 (dollars in
thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
%
|
%
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
North
America revenue:
|
||||||||||||||||||||||
Rental
|
$ | 41,325 | $ | 46,461 | (11.1 | )% | $ | 125,828 | $ | 144,784 | (13.1 | )% | ||||||||||
Sales
|
5,217 | 8,621 | (39.5 | ) | 15,989 | 22,921 | (30.2 | ) | ||||||||||||||
Total
North America revenue
|
46,542 | 55,082 | (15.5 | ) | 141,817 | 167,705 | (15.4 | ) | ||||||||||||||
EMEA/APAC
revenue:
|
||||||||||||||||||||||
Rental
|
20,701 | 21,357 | (3.1 | ) | 60,381 | 67,661 | (10.8 | ) | ||||||||||||||
Sales
|
4,807 | 5,338 | (9.9 | ) | 15,257 | 14,740 | 3.5 | |||||||||||||||
Total
EMEA/APAC revenue
|
25,508 | 26,695 | (4.4 | ) | 75,638 | 82,401 | (8.2 | ) | ||||||||||||||
Total
rental revenue
|
62,026 | 67,818 | (8.5 | ) | 186,209 | 212,445 | (12.3 | ) | ||||||||||||||
Total
sales revenue
|
10,024 | 13,959 | (28.2 | ) | 31,246 | 37,661 | (17.0 | ) | ||||||||||||||
Total
TSS revenue
|
$ | 72,050 | $ | 81,777 | (11.9 | )% | $ | 217,455 | $ | 250,106 | (13.1 | )% |
Worldwide
TSS revenue decreased from the prior-year periods due primarily to lower rental
and sales volumes in the U.S. resulting from the economic downturn and capital
constraints on acute care facilities combined with unfavorable foreign currency
exchange rate movements. Foreign currency exchange rate movements
unfavorably impacted worldwide TSS revenue by 2.2% and 4.6% for the third
quarter and first nine months of 2009, respectively, compared to the same
periods one year ago. North America TSS revenue decreased from the
prior-year periods due primarily to lower hospital census and customer capital
constraints. EMEA/APAC TSS revenue decreased from the same periods a
year ago due primarily to foreign currency exchange rate movements, which
unfavorably impacted total EMEA/APAC TSS revenue by 5.0% and 10.5% for the third
quarter and first nine months of 2009, respectively, as compared to the
prior-year periods.
Rental
Expenses
The
following table presents rental expenses and the percentage relationship to
total V.A.C. and TSS revenue comparing the third quarter of 2009 to the third
quarter of 2008 and the first nine months of 2009 to the first nine months of
2008 (dollars in thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
Rental
expenses
|
$ | 169,555 | $ | 182,392 | (7.0 | )% | $ | 505,264 | $ | 538,669 | (6.2 | )% | ||||||||||
As
a percent of total V.A.C. and TSS revenue
|
39.2 | % | 41.3 | % |
(210
|
bps) | 40.2 | % | 41.5 | % |
(130
|
bps) |
Rental,
or field, expenses are comprised of both fixed and variable
costs. Rental expenses as a percent of total V.A.C. and TSS revenue
during the third quarter and first nine months of 2009 decreased from the
prior-year periods due primarily to service center rationalization
efforts. These rationalization efforts have resulted in the
consolidation of over 20 service centers as of September 30, 2009 compared to
prior-year levels.
Cost
of Sales
The
following table presents cost of sales and the sales margin (calculated as sales
revenue less cost of sales divided by sales revenue for the periods indicated)
comparing the third quarter of 2009 to the third quarter of 2008 and the first
nine months of 2009 to the first nine months of 2008 (dollars in
thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
V.A.C.
and TSS:
|
||||||||||||||||||||||
Cost
of sales
|
$ | 38,166 | $ | 40,569 | (5.9 | )% | $ | 114,297 | $ | 114,899 | (0.5 | )% | ||||||||||
Sales
margin
|
71.5 | % | 70.4 | % |
110
|
bps | 70.2 | % | 70.6 | % |
(40
|
) bps | ||||||||||
Regenerative
Medicine:
|
||||||||||||||||||||||
Cost
of sales
|
$ | 21,774 | $ | 25,973 | (16.2 | )% | $ | 63,448 | $ | 37,321 | 70.0 | % | ||||||||||
Sales
margin
|
69.7 | % | 57.6 | % |
1,210
|
bps | 69.6 | % | 58.0 | % |
1,160
|
bps | ||||||||||
Total:
|
||||||||||||||||||||||
Cost
of sales
|
$ | 59,940 | $ | 66,542 | (9.9 | )% | $ | 177,745 | $ | 152,220 | 16.8 | % | ||||||||||
Sales
margin
|
70.9 | % | 66.4 | % |
450
|
bps | 70.0 | % | 68.2 | % |
180
|
bps |
Cost of
sales includes manufacturing costs, product costs and royalties associated with
our “for sale” products. Higher sales margins associated with the
Regenerative Medicine business segment for the first nine months of 2009 were
partially offset by lower sales margins for V.A.C. and TSS due to unfavorable
changes in our product mix as compared to the prior-year periods. During the
third quarter of 2009, margins for V.A.C., TSS and Regenerative Medicine
improved over the prior-year period. LifeCell’s cost of sales
includes $7.0 million for the third quarter and $10.2 million for the first nine
months of 2008 related to LifeCell purchase accounting adjustments associated
with our inventory step-up to fair value, which unfavorably impacted the
LifeCell sales margin by 11.4% for the prior-year periods.
Gross
Profit Margin
The
following table presents the gross profit margin (calculated as gross profit
divided by total revenue for the periods indicated) comparing the third quarter
of 2009 to the third quarter of 2008 and the first nine months of 2009 to the
first nine months of 2008:
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||
Gross
profit margin
|
54.5 | % | 50.5 | % |
400
bps
|
53.4 | % | 50.1 | % |
330
bps
|
Higher
gross profit margins associated with the Regenerative Medicine business segment
and increased service productivity comprised the majority of the increase in
gross profit margin in the third quarter and first nine months of 2009 compared
to the prior-year periods.
Selling,
General and Administrative Expenses
The
following table presents selling, general and administrative expenses and the
percentage relationship to total revenue comparing the third quarter of 2009 to
the third quarter of 2008 and the first nine months of 2009 to the first nine
months of 2008 (dollars in thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
Selling,
general and administrative expenses
|
$ | 125,838 | $ | 109,420 | 15.0 | % | $ | 365,045 | $ | 309,814 | 17.8 | % | ||||||||||
As
a percent of total revenue
|
24.9 | % | 21.7 | % |
320
|
bps | 24.9 | % | 22.4 | % |
250
|
bps |
Selling,
general and administrative expenses include administrative labor, incentive and
sales compensation costs, insurance costs, professional fees, depreciation, bad
debt expense and information systems costs. Severance associated with
the Company’s workforce restructuring and other pre-tax charges accounted for
approximately $9.4 million of the increase for the nine months ended September
30, 2009 compared to the prior-year period. Additionally, increased
legal fees associated with pending litigation matters, higher share-based
compensation expense and costs associated with our upcoming market entry in
Japan, global business transformation activities and our service center
rationalization efforts contributed to the increase in selling, general and
administrative expenses during the third quarter and first nine months of
2009. Other selling, general and administrative expenses included
selling costs associated with the LifeCell Regenerative Medicine business
segment since its May 2008 acquisition. Selling, general and
administrative expenses related to our Regenerative Medicine business during the
third quarter of 2009 and 2008 totaled $19.3 million and $16.1 million,
respectively, and were $57.4 million and $24.1 million for the first nine months
of 2009 and 2008, respectively.
Share-Based
Compensation Expense
Share-based
compensation expense was recognized in the condensed consolidated statements of
earnings for the three months and nine months ended September 30, 2009 and 2008,
respectively, as follows (dollars in thousands, except per share
data):
Three
months ended
|
Nine
months ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Rental
expenses
|
$ | 1,547 | $ | 1,259 | $ | 3,649 | $ | 4,122 | ||||||||
Cost
of sales
|
192 | 245 | 673 | 513 | ||||||||||||
Selling,
general and administrative expenses
|
7,284 | 5,545 | 18,655 | 13,273 | ||||||||||||
Pre-tax
share-based compensation expense
|
9,023 | 7,049 | 22,977 | 17,908 | ||||||||||||
Less: Income
tax benefit
|
(3,008 | ) | (2,280 | ) | (7,641 | ) | (5,120 | ) | ||||||||
Total
share-based compensation expense, net of tax
|
$ | 6,015 | $ | 4,769 | $ | 15,336 | $ | 12,788 | ||||||||
Diluted
net earnings per share impact
|
$ | 0.09 | $ | 0.07 | $ | 0.22 | $ | 0.18 |
Research
and Development Expenses
The
following table presents research and development expenses and the percentage
relationship to total revenue comparing the third quarter of 2009 to the third
quarter of 2008 and the first nine months of 2009 to the first nine months of
2008 (dollars in thousands):
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||||||||||
Research
and development expenses
|
$ | 24,669 | $ | 21,884 | 12.7 | % | $ | 68,071 | $ | 53,279 | 27.8 | % | ||||||||||
As
a percent of total revenue
|
4.9 | % | 4.3 | % |
60
|
bps | 4.6 | % | 3.8 | % |
80
|
bps |
Research
and development expenses relate to our investments in clinical studies and the
development of new advanced wound healing systems, products and
dressings. This includes the development of new and synergistic
technologies across the continuum of wound care, including tissue regeneration,
preservation and repair, new applications of negative pressure technology, as
well as upgrading and expanding our surface technologies in our Therapeutic
Support Systems business. The increase in research and development
expense during the third quarter and first nine months of 2009 is primarily
related to increased activity in the development of our next generation of
advanced wound care and tissue regeneration products. Research and
development expenses related to our Regenerative Medicine business during the
third quarter of 2009 and 2008 totaled $7.4 million and $5.9 million,
respectively, and were $18.8 million and $8.6 million for the first nine months
of 2009 and 2008, respectively.
Acquired
Intangible Asset Amortization
In
connection with the LifeCell acquisition, we recorded $486.7 million of
identifiable intangible assets during the third quarter of
2008. During the third quarter and first nine months of 2009, we
recorded approximately $10.2 million and $30.5 million, respectively, of
amortization expense associated with these acquired identifiable intangible
assets. During the third quarter and first nine months of 2008, we
recorded approximately $10.2 million and $14.8 million, respectively, of
amortization expense associated with these acquired identifiable intangible
assets.
Operating
Margin
The
following table presents the operating margin, defined as operating earnings as
a percentage of total revenue, comparing the third quarter of 2009 to the third
quarter of 2008 and the first nine months of 2009 to the first nine months of
2008:
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||
2009
|
2008
|
Change
|
2009
|
2008
|
Change
|
|||||||||
Operating
margin
|
22.6 | % | 22.4 | % |
20
bps
|
21.8 | % | 18.4 | % |
340
bps
|
The
increase in operating margin is due primarily to higher gross profit combined
with operating efficiencies and process improvements and Regenerative Medicine’s
contributed operating profit. The first nine months of 2008 were
negatively impacted by the $61.6 million write-off of in-process research and
development and $10.2 million related to the step-up of LifeCell inventory to
fair value associated with our LifeCell acquisition in May 2008.
Interest
Expense
Interest
expense was $25.7 million in the third quarter and $80.4 million for the first
nine months of 2009 compared to $29.9 million and $49.1 million, respectively,
in the same periods of the prior year. Third quarter 2009 interest
expense decreased due to scheduled and voluntary debt payments made over the
last twelve months. The increase in interest expense for the nine months ended
September 30, 2009 is due to our debt financing that was only outstanding for a
portion of the prior-year period. At September 30, 2009, we had
$800.0 million outstanding under our term loan
facility. Additionally, we had $690.0 million aggregate principal
amount of convertible senior notes outstanding. On January 1,
2009, KCI adopted changes issued by the FASB related to the accounting for
convertible debt instruments that may be settled in cash upon conversion
(including partial cash settlement). As a result of the adoption of
these changes, we recorded $5.6 million in the third quarter and $16.8 million
for the first nine months of 2009 of additional non-cash interest expense
related to amortization of the discount on our convertible senior
notes. The adoption of the accounting changes also resulted in
additional non-cash interest expense for the third quarter and first nine months
ended September 30, 2008 of approximately $4.6 million and $8.1 million,
respectively. Additionally, interest expense for the third quarter
and first nine months of 2009 includes write-offs of $720,000 and $2.3 million,
respectively, for unamortized deferred debt issuance costs associated with
optional prepayments on our senior credit facility totaling $27.1 million and
$79.8 million, respectively. Interest expense for the nine months
ended September 30, 2008 also includes write-offs of $860,000 recorded in the
second quarter of 2008 for unamortized deferred debt issuance costs on our
previous debt facility upon the refinancing of our credit facility and long-term
debt.
Foreign
Currency Gain (Loss)
Foreign
currency exchange rate movements unfavorably impacted pre-tax income by $1.2
million for the first nine months of 2009 compared to the prior-year
period. We recognized a foreign currency exchange gain of $3.2
million in the third quarter and a loss of $3.9 million for the first nine
months of 2009 compared to a loss of $3.3 million and $2.7 million,
respectively, in the same periods of the prior year. The losses
incurred during the first half of 2009 due to significant fluctuations in
exchange rates were partially offset by the expansion of our foreign currency
hedging program, reduced exposures and the conversion of a larger portion of
foreign currency cash balances to U.S. dollars.
Net
Earnings
For the
third quarter of 2009, we reported net earnings of $64.6 million, an increase of
19.8%, compared to $53.9 million in the prior-year period. For the
first nine months of 2009, net earnings were $162.4 million, an increase of
38.7%, compared to $117.1 million in the prior-year period. Net earnings for the
first nine months of 2008 were negatively impacted by the write-off of
in-process research and development of $61.6 million associated with our
LifeCell acquisition. Additionally, for the first nine months of
2009, expenses associated with KCI’s restructuring reduced net earnings by $6.3
million and foreign currency exchange rate movements unfavorably impacted
pre-tax income by $1.2 million compared to the same period one year
ago.
Net
Earnings per Diluted Share
Net
earnings per diluted share for the third quarter of 2009 were $0.91, as compared
to net earnings per diluted share of $0.75 in the prior-year
period. For the first nine months of 2009, net earnings per diluted
share were $2.31 compared to net earnings per diluted share of $1.62 in the
prior-year period. Net earnings per diluted share for the first nine
months of 2008 were negatively impacted by $0.85 per share as a result of the
write-off of in-process research and development associated with our LifeCell
acquisition. Additionally, for the first nine months of 2009,
expenses associated with KCI’s restructuring reduced net earnings by $6.3
million, or $0.09 per diluted share.
LIQUIDITY
AND CAPITAL RESOURCES
General
We
require capital principally for capital expenditures, systems infrastructure,
debt service, interest payments and working capital. Our capital expenditures
consist primarily of manufactured rental assets, manufacturing equipment,
computer hardware and software and expenditures related to leasehold
improvements. Working capital is required principally to finance
accounts receivable and inventory. Our working capital requirements
vary from period-to-period depending on manufacturing volumes, the timing of
shipments and the payment cycles of our customers and payers.
Sources
of Capital
Based
upon the current level of operations we believe our existing cash resources, as
well as cash flows from operating activities and availability under our
revolving credit facility will be adequate to meet our anticipated cash
requirements for at least the next twelve months. During the first
nine months of 2009 and 2008, our primary sources of capital were cash from
operating activities. The following table summarizes the net cash
provided and used by operating, investing and financing activities for the nine
months ended September 30, 2009 and 2008 (dollars in thousands):
Nine
months ended
|
||||||||
September
30,
|
||||||||
2009
|
2008
|
|||||||
Net
cash provided by operating activities
|
$ | 272,483 | $ | 271,755 | ||||
Net
cash used by investing activities
|
(78,131 | ) | (1,840,485 | ) | ||||
Net
cash provided (used) by financing activities
|
(174,597 | ) | 1,566,600 | |||||
Effect
of exchange rates changes on cash and cash equivalents
|
2,532 | (18,627 | ) | |||||
Net
increase (decrease) in cash and cash equivalents
|
$ | 22,287 | $ | (20,757 | ) |
At
September 30, 2009, our principal sources of liquidity consisted of
approximately $270.1 million of cash and cash equivalents and $288.6 million
available under our revolving credit facility, net of $11.4 million in undrawn
letters of credit. During the first nine months of 2009, we made
scheduled and voluntary senior credit facility net repayments totaling $179.0
million from cash-on-hand.
Working
Capital
At
September 30, 2009, we had current assets of $853.0 million, including $410.7
million in net accounts receivable and $111.6 million in inventory, and current
liabilities of $401.9 million resulting in a working capital surplus of $451.1
million compared to a surplus of $405.2 million at December 31,
2008.
As of
September 30, 2009, we had $410.7 million of receivables outstanding, net of
realization reserves of $110.4 million. North America receivables,
net of realization reserves, were outstanding for an average of 69 days at
September 30, 2009, down from 71 days at December 31, 2008. EMEA/APAC
net receivable days increased from 84 days at December 31, 2008 to 85 days at
September 30, 2009.
Capital
Expenditures
During
the first nine months of 2009 and 2008, we made net capital expenditures of
$64.1 million and $95.8 million, respectively, due primarily to expanding the
rental fleet, information technology purchases and leasehold improvements for
the expansion of our LifeCell manufacturing facility. Net capital
expenditures were higher in 2008 as a result of the global deployment of our
newly-introduced InfoV.A.C. and ActiV.A.C. units.
Senior
Credit Facility
On May
19, 2008, we entered into a senior credit facility, consisting of a $1.0 billion
term loan facility and a $300.0 million revolving credit facility due May
2013. The following table sets forth the amounts owed under the term
loan and revolving credit facility, the effective interest rates on such
outstanding amounts, and amounts available for additional borrowing thereunder,
as of September 30, 2009 (dollars in thousands):
Effective
|
Amount
Available
|
|||||||||||
Maturity
|
Interest
|
Amount
|
for
Additional
|
|||||||||
Senior
Credit Facility
|
Date
|
Rate
|
Outstanding
|
Borrowing
|
||||||||
Revolving
credit facility
|
May
2013
|
- | $ | - | $ | 288,615 | (1) | |||||
Term
loan facility
|
May
2013
|
4.756 | % (2) | 800,000 | - | |||||||
Total
|
$ | 800,000 | $ | 288,615 | ||||||||
|
||||||||||||
(1)
At September 30, 2009, the amount available under the revolving portion of
our credit facility reflected a reduction of $11.4 million for letters of
credit issued on our behalf, none of which have been drawn upon by the
beneficiaries thereunder.
|
||||||||||||
(2)
The effective interest rate includes the effect of interest rate hedging
arrangements. Excluding the interest rate hedging arrangements, our
average nominal interest rate as of September 30, 2009 was
3.039%.
|
Amounts
outstanding under the senior credit facility bear interest at a rate equal to
the base rate (defined as the higher of Bank of America's prime rate or 50 basis
points above the federal funds rate) or the Eurocurrency rate (the LIBOR rate),
in each case plus an applicable margin. The applicable margin varies
in reference to our consolidated leverage ratio and ranges from 1.75% to 3.50%
in the case of loans based on the Eurocurrency rate and 0.75% to 2.50% in the
case of loans based on the base rate.
We may
choose base rate or Eurocurrency pricing and may elect interest periods of 1, 2,
3 or 6 months for the Eurocurrency borrowings. We have generally
elected to use Eurocurrency pricing with a duration of 3
months. Interest on base rate borrowings is payable quarterly in
arrears. Interest on Eurocurrency borrowings is payable at the end of
each applicable interest period or every three months in the case of interest
periods in excess of three months. Interest on all past due amounts
will accrue at 2.00% over the applicable rate.
Our
senior credit facility contains affirmative and negative covenants customary for
similar facilities and transactions including, but not limited to, quarterly and
annual financial reporting requirements and limitations on other debt, other
liens or guarantees, mergers or consolidations, capital expenditures, asset
sales, certain investments, distributions to shareholders or share repurchases,
early retirement of subordinated debt, changes in the nature of the business,
changes in organizational documents and documents evidencing or related to
indebtedness that are materially adverse to the interests of the lenders under
the senior credit facility and changes in accounting policies or reporting
practices. For further information on our covenants and obligations
under the senior credit agreement, see Note 6 of the Notes to the Consolidated
Financial Statements included in KCI's Annual Report on Form 10-K for the fiscal
year ended December 31, 2008. As of September 30, 2009, we were in
compliance with all covenants under the senior credit agreement.
Convertible
Senior Notes
On April
21, 2008, we closed our offering of $600.0 million aggregate principal amount of
3.25% convertible senior notes due 2015 (the “Convertible Notes”). On
May 1, 2008, we issued an additional $90.0 million aggregate principal amount of
notes to cover over-allotments. The notes are governed by the terms
of an indenture dated as of April 21, 2008. Interest on the notes
accrues at a rate of 3.25% per annum and is payable semi-annually in arrears on
April 15 and October 15. For further information on our convertible
notes and the related note hedge and warrant transactions, see Note 6 of the
Notes to the Consolidated Financial Statements included in KCI's Annual Report
on Form 10-K for the fiscal year ended December 31, 2008.
On
January 1, 2009, KCI adopted changes issued by the FASB related to the
accounting for convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement). The changes specify
that issuers of such instruments account separately for the liability and equity
components of convertible debt instruments in a manner that reflects an issuer’s
estimated non-convertible debt borrowing rate. Upon adoption of these
changes, we allocated the proceeds received from the issuance of the convertible
notes between a liability component and equity component by determining the fair
value of the liability component using our estimated non-convertible debt
borrowing rate. The difference between the proceeds of the notes and
the fair value of the liability component was recorded as a discount on the debt
with a corresponding offset to paid-in-capital (the equity component), net of
applicable deferred income taxes and the portion of debt issuance costs
allocated to the equity component. The resulting debt discount will
be accreted by recording additional non-cash interest expense over the expected
life of the convertible notes using the effective interest rate method. The
accounting changes were effective for periods subsequent to December 15, 2008
and were applied retroactively. Due to the required retrospective
application, the notes reflect a lower principal balance and additional non-cash
interest expense has been recorded based on our estimated non-convertible
borrowing rate. For the three months and nine months ended September
30, 2009, we recorded $5.6 million and $16.8 million, respectively, of interest
related to the contractual interest coupon rate. Additionally, based
on our estimated non-convertible borrowing rate of 7.78%, the adoption of the
accounting changes resulted in approximately $5.0 million and $14.6 million of
additional non-cash interest expense for the three months and nine months ended
September 30, 2009, respectively. The adoption of the accounting
changes also resulted in additional non-cash interest expense for the three
months and nine months ended September 30, 2008 of approximately $4.6 million
and $8.1 million, respectively, resulting in a reduction of net earnings of $2.8
million and $5.0 million, or $0.03 and $0.07 per diluted share,
respectively.
Interest
Rate Protection
At
September 30, 2009, we had sixteen interest rate swap agreements in effect
pursuant to which we have fixed the rate on $638.0 million notional amount of
our outstanding variable rate debt at an average interest rate of 2.441%,
exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit
agreement. As of September 30, 2009, the aggregate fair value of our
swap agreements was negative and recorded as a liability of $10.3
million. If our interest rate protection agreements were not in
place, interest expense would have been approximately $3.1 million and $7.6
million lower for the three months and nine months ended September 30, 2009,
respectively. As of September 30, 2008, the aggregate fair value of
our swap agreements was negative and recorded as a liability of $1.2
million. If our interest rate protection agreements were not in
place, interest expense would have been approximately $556,000 and $562,000
lower for the three months and nine months ended September 30, 2008,
respectively.
Long-Term
Commitments
The
following table summarizes our long-term debt obligations, excluding the
convertible debt discount, as of September 30, 2009, for each of the periods
indicated (dollars in thousands):
Long-Term
Debt Obligations
|
||||||||||||||||||||||
Year
Payment Due
|
2009
|
2010
|
2011
|
2012
|
2013
|
Thereafter
|
Total
|
|||||||||||||||
Long-term
debt
|
$ | 22,857 | $ | 137,143 | $ | 205,714 | $ | 274,286 | $ | 160,000 | $ | 690,000 | $ | 1,490,000 |
OTHER
MATTERS
A
Medicare competitive bidding program that was initiated in 2007 was delayed and
significantly modified by the Medicare Improvements for Patients and Providers
Act of 2008, or MIPPA, enacted by Congress on July 15, 2008. Several
key provisions of the MIPPA include the following:
·
|
the
exemption of negative pressure wound therapy, or NPWT, from the first
round of competitive bidding;
|
·
|
the
termination of all durable medical equipment supplier contracts previously
awarded by Centers for Medicare and Medicaid Services, or CMS, in the
first round of competitive bidding;
|
·
|
the
delay of the implementation of the first and second rounds of competitive
bidding until January 2010 and January 2011, respectively;
and
|
·
|
an
imposed reduction of NPWT pricing by 9.5% for all U.S. Medicare V.A.C.
placements in the home, effective January
2009.
|
MIPPA
effectively delays competitive bidding for NPWT until January
2011. CMS recently announced, following a meeting of the DMEPOS
Competitive Bidding Oversight Committee, that the tentative schedule would delay
final implementation of the first round of competitive bidding until January
2011. CMS has not yet provided tentative implementation dates for the
second round of competitive bidding. This recent announcement
regarding potential delays in the competitive bidding program is subject to
change. The 9.5% reduction in NPWT pricing has resulted in lower
Medicare reimbursement levels for our products in 2009 and beyond. We
estimate the V.A.C. rentals and sales to Medicare beneficiaries subject to the
9.5% price reduction will negatively impact our total consolidated revenue by
approximately 1.0% in 2009, compared to 2008 reimbursement levels.
We are
continuing our efforts to obtain reimbursement for V.A.C. Therapy systems and
related disposables in the homecare setting in foreign
jurisdictions. These efforts have resulted in varying levels of
reimbursement from private and public payers in Germany, Austria, France, the
Netherlands, Switzerland, Canada, South Africa, Australia, Taiwan and the
UK. In these jurisdictions and others outside the U.S., we continue
to seek expanded homecare reimbursement, which we believe is important in order
to increase the demand for V.A.C. Therapy systems and related disposables in
these markets. In Germany, statutory insurance companies are
establishing a tender offer process for the study and ultimately the supply of
NPWT in post acute care settings and for the German home healthcare
market. If KCI is successful in the tender offer and the study
results are positive, it is expected that the insurance companies would provide
coverage and reimbursement for V.A.C. Therapy in these care
settings.
With regard to our efforts to obtain reimbursement for V.A.C. Therapy systems in
Japan, we have reported successful results from our V.A.C. clinical
trials. In November 2009, we were informed by the Ministry of Health,
Labor and Welfare (“MHLW”) in Japan that KCI has been granted final regulatory
approval to market and sell our innovative V.A.C. Therapy
product. Reimbursement applications have been submitted following
regulatory approval, and we anticipate reimbursement approval in the first half
of 2010. Once reimbursement approval is obtained, we will begin
commercializing V.A.C. Therapy in Japan.
In March
2009, the OIG published a report entitled “Comparison of Prices for Negative
Pressure Wound Therapy Pumps” in which the OIG compared supplier costs of a
number of gauze-based wound drainage pumps. The findings in the OIG
study point to a disparity in average prices paid by selected suppliers of NPWT
pumps and the prices paid by Medicare for such pumps. We believe the
OIG’s methodology was flawed for a number of reasons, primarily because the
comparison of pump prices does not take into account the significant
technological differences between KCI’s products and other products in the same
NPWT reimbursement codes. The report also did not consider any other
costs involved in attaining a positive clinical outcome, such as the substantial
investments KCI has made in professional medical education and training, our
comprehensive service organization and offering, our clinical support and
administrative staff which help maintain compliance with one of the most complex
reimbursement coverage policies covering DME today. The report does
not give any indication that the OIG considered the value of clinical efficacy
or the substantial investments KCI has made in research and
development. While we disagree with a number of aspects of the OIG
report, it is possible that CMS may use the findings in the OIG report as a
basis for lowering Medicare reimbursement for V.A.C. Therapy Systems through the
agency's inherent reasonableness authority or through other means, including
future rounds of the Medicare competitive bidding process.
In June
2009, the Agency for Healthcare Research and Quality (“AHRQ”) issued a report on
its NPWT technology assessment, which was required under the
MIPPA. AHRQ conducted the study through its subcontractor the ECRI
institute. While affirming in its report that KCI is the only NPWT
provider with any clinical evidence involving a comparator, AHRQ concluded that
it was unable to identify therapeutic distinctions between different NPWT
systems because of a lack of published studies comparing one NPWT system to
another. Following its own defined research protocol, the AHRQ report
included 38 NPWT clinical studies, all of which were studies comparing KCI's
V.A.C. Therapy System to control groups treated with advanced wound care
therapies. None of the control groups utilized any other NPWT system
or product. Case studies on other NPWT products were included in the
report to answer a question about occurrences of
complications. Notably, the AHRQ’s recent report did not conclude
that the NPWT systems they evaluated were similar in function or
efficacy. KCI has stated its belief that grouping together KCI’s
clinically proven V.A.C. Therapy System with unproven products in a single
reimbursement category disregards or compromises the standards of evidence-based
medicine. Any decisions based on the AHRQ study which do not
differentiate the reimbursement of products based on efficacy are likely to
sacrifice quality and ultimately lead to higher healthcare
costs. While we have taken issue with a number of other aspects of
the AHRQ report, it is possible that CMS may use the report as a basis for
future coding and reimbursement decisions relating to NPWT, which may be
unfavorable to KCI.
In June
2009, based on the findings of the AHRQ report, CMS released its preliminary
decision not to change the current Health Care Procedural Coding System
(“HCPCS”) coding for NPWT pumps, dressings, or canisters. On July 9, 2009, CMS
held a public hearing to allow public comment on its preliminary HCPCS coding
decision for NPWT pumps, dressings, and canisters. KCI testified in opposition
to the preliminary coding decision on the grounds that no other product in the
current HCPCS code has published clinical evidence of efficacy. CMS
will make a final decision on this matter in the fourth quarter of 2009 with any
changes to current HCPCS coding becoming effective on January 1,
2010.
In
October 2008, LifeCell received a warning letter from the FDA identifying
certain non-compliance with Good Manufacturing Practice (“GMP”) in the
manufacture of our Strattice/LTM product. This warning letter arose
from an inspection of LifeCell’s manufacturing facility which led to
observations by the FDA identifying certain observed non-compliance with GMP in
the manufacture of Strattice/LTM and non-compliance with Good Tissue Practice
(“GTP”), in the processing of AlloDerm. LifeCell provided a written
response to the observations describing proposed corrective actions to address
the observations, which was followed by the warning letter from the
FDA. The warning letter indicated that LifeCell’s proposed corrective
actions in its initial response did not adequately resolve all of the issues
identified by the FDA related to Strattice/LTM, and states that failure to
comply may result in regulatory action such as seizure, injunction, and/or civil
money penalties without further notice. The warning letter requested
explanation of how LifeCell plans to prevent GMP violations from occurring in
the future, and that LifeCell supply documentation of corrective actions
taken. While the October 2008 warning letter did not cite any of the
GTP observations relating to AlloDerm, the FDA has requested that LifeCell
provide an update on corrective actions taken with respect to these observations
as well. LifeCell provided the FDA with a written response to the
warning letter in November 2008 detailing corrective actions taken, and
proposing additional corrective actions. Since that time, LifeCell
has provided periodic updates to the FDA on our implementation of the corrective
action plan. In June 2009, LifeCell received an initial written
response from the FDA requesting additional clarification of LifeCell’s
corrective action plans and quality system features. LifeCell
submitted a written response to the correspondence in September 2009 and
subsequently attended a meeting with FDA staff to review open
issues. In November 2009, the FDA initiated a follow-up inspection
which is currently underway. While we believe that the issues raised
by the warning letter can be resolved in the course of discussions with the FDA,
we cannot give assurance that the FDA will not take regulatory action or that
the warning letter will not have a material impact on the LifeCell Regenerative
Medicine business.
In the
first quarter of 2009, LifeCell was notified by one of its human tissue
suppliers that certain donor information was improperly collected by the
supplier relating to ten distributed lots of LifeCell’s human tissue-based
regenerative medicine products. Five of these lots were marketed by
two of LifeCell’s distributors. LifeCell filed a Biological Deviation
Report with the FDA and notified the distributors of the protocol deviations and
requested that the distributors place a hold on the remaining inventory units
from the affected lots, [which still remained in the distributor
inventories]. Following corrective actions taken by LifeCell’s tissue
supplier, it was determined that there were no health or safety concerns with
the affected product lots and LifeCell instructed the distributors that they
were permitted to remove the product hold. In recent correspondence
with LifeCell, the FDA notified LifeCell that the hold placed on the affected
lots during the first quarter of 2009 met the FDA’s definition of a Class III
recall, which has been reported in the FDA’s weekly enforcement
report. LifeCell is not required to undertake additional actions
relating the FDA’s recall determination and did not incur any incremental cost
related to the matter.
In
October 2009, we became aware of an investigation being conducted by the FDA
into the safety of certain power cords supplied to medical device manufacturers,
including KCI, by Electri-cord Manufacturing Company. Due to the potential
safety risks associated with the 110 volt AC power cords supplied by
Electri-cord, we have determined to initiate a voluntary correction of KCI
for-sale products in order to inspect and replace the affected power
cords. Affected products include V.A.C. therapy units and TSS
products. With respect to KCI’s V.A.C. and TSS rental fleets, the power
cord replacements will occur during normal service cycles. We expect that
the FDA may publish our voluntary correction as a recall in its periodic
enforcement report following our submission of the required documentation.
The replacement of the affected power cords likely will take place during the
remainder of 2009 and into 2010, which we do not expect to have a material
impact on our results of operations.
CRITICAL
ACCOUNTING ESTIMATES
Revenue
Recognition and Accounts Receivable Realization
We
recognize revenue in accordance with the Revenue Recognition topic of the
Codification when each of the following four criteria are met:
1)
|
a
contract or sales arrangement
exists;
|
2)
|
products
have been shipped and title has transferred or services have been
rendered;
|
3)
|
the
price of the products or services is fixed or determinable;
and
|
4)
|
collectibility
is reasonably assured.
|
We
recognize rental revenue based on the number of days a product is used by the
patient/organization, (i) at the contracted rental rate for contracted customers
and (ii) generally, retail price for non-contracted customers. Sales
revenue is recognized when products are shipped and title has
transferred. In addition, we establish realization reserves against
revenue to provide for adjustments including capitation agreements, estimated
credit memos, volume discounts, pricing adjustments, utilization adjustments,
product returns, cancellations, estimated uncollectible amounts and payer
adjustments based on historical experience.
Domestic
trade accounts receivable consist of amounts due directly from acute and
extended care organizations, third-party payers, or TPP, both governmental and
non-governmental, and patient pay accounts. Included within the TPP
accounts receivable balances are amounts that have been or will be billed to
patients once the primary payer portion of the claim has been settled by the
TPP. EMEA/APAC and LifeCell trade accounts receivable consist of
amounts due primarily from acute care organizations.
The
domestic TPP reimbursement process requires extensive documentation, which has
had the effect of slowing both the billing and cash collection cycles relative
to the rest of the business, and therefore, increasing total accounts
receivable. Because of the extensive documentation required and the
requirement to settle a claim with the primary payer prior to billing the
secondary and/or patient portion of the claim, the collection period for a claim
in our homecare business may, in some cases, extend beyond one year prior to
full settlement of the claim.
We
utilize a combination of factors in evaluating the collectibility of our
accounts receivable. For unbilled receivables, we establish reserves
against revenue to allow for expected denied or uncollectible
items. In addition, items that remain unbilled for more than a
specified period of time, or beyond an established billing window, are reserved
against revenue. For billed receivables, we generally establish
reserves against revenue and bad debt using a combination of factors including
historic adjustment rates for credit memos and cancelled transactions,
historical collection experience, and the length of time receivables have been
outstanding. The reserve rates vary by payer group. In
addition, we record specific reserves for bad debt when we become aware of a
customer's inability or refusal to satisfy its debt obligations, such as in the
event of a bankruptcy filing. If circumstances change, such as higher
than expected claims denials, post-payment claim recoupments, a material change
in the interpretation of reimbursement criteria by a major customer or payer, or
payment defaults or an unexpected material adverse change in a major customer's
or payer's ability to meet its obligations, our estimates of the realizability
of trade receivables could be reduced by a material amount. A
hypothetical 1% change in the collectibility of our billed receivables at
September 30, 2009 would impact pre-tax earnings by an estimated $2.7
million.
For a
description of our other critical accounting estimates, please see our Annual
Report on Form 10-K for the fiscal year ended December 31, 2008 under the
heading Part II, Item 7. “Management's Discussion and Analysis of Financial
Condition and Results of Operations – Critical Accounting
Estimates.”
Recently
Adopted Accounting Principles
In June
2009, the Financial Accounting Standards Board ("FASB") issued a new
pronouncement which establishes the single source of authoritative U.S.
generally accepted accounting principles (“GAAP” or “the
Codification”). Rules and interpretive releases of the Securities and
Exchange Commission (“SEC”) under authority of federal securities laws are also
sources of authoritative GAAP for SEC registrants. The Codification
superseded all previously-existing non-grandfathered non-SEC accounting and
reporting standards. The Codification reorganizes all GAAP into
approximately 90 accounting topics and displays them using a consistent
structure, and includes relevant SEC guidance organized using the same topical
structure in separate sections. This statement was effective for KCI beginning
September 30, 2009. This pronouncement does not change GAAP; therefore, our
adoption of this pronouncement did not have an impact on our results of
operations, financial condition or cash flows.
On
June 30, 2009, KCI adopted changes issued by the FASB related to
disclosures about fair value of financial instruments. These changes
require an entity to provide disclosures about fair value of financial
instruments in its summarized financial information for interim reporting
periods. Under the changes, a publicly traded company shall include
disclosures about the fair value of its financial instruments whenever it issues
summarized financial information for interim reporting periods. In addition,
entities must disclose, in the body or in the accompanying notes of its
summarized financial information for interim reporting periods and in its
financial statements for annual reporting periods, the fair value of all
financial instruments for which it is practicable to estimate that value. The
adoption of the changes did not have a significant impact on our results of
operations or our financial position.
On
June 30, 2009, KCI adopted changes issued by the FASB related to subsequent
events. These changes established standards for accounting for and
disclosing subsequent events (events which occur after the balance sheet date
but before financial statements are issued or are available to be issued). The
changes require an entity to disclose the date subsequent events were evaluated
and whether that evaluation took place on the date financial statements were
issued or were available to be issued. The adoption of the changes did not have
a material impact on our results of operations or our financial
position.
On
January 1, 2009, KCI adopted changes issued by the FASB related to the
accounting for convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement). These changes specify
that issuers of such instruments account separately for the liability and equity
components of convertible debt instruments in a manner that reflects an issuer’s
estimated non-convertible debt borrowing rate. The impact associated
with our adoption of these changes is disclosed in this report. (See Note
4.)
On
January 1, 2009, KCI adopted changes issued by the FASB revising the
accounting for business combinations. The revisions establish
principles and requirements for how the acquirer of a business recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the
acquiree. These revisions also provide guidance for recognizing and
measuring any goodwill acquired in the business combination and specify what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. The
impact that the adoption of the revisions will have on our consolidated
financial statements is dependent on the nature, terms and size of any
prospective business combinations.
On
January 1, 2009, KCI adopted changes issued by the FASB which enhance the
required disclosures regarding derivatives and hedging
activities. The adoption of the changes did not have a material
impact on our results of operations or our financial position. (See
Note 5.)
On
January 1, 2009, KCI adopted changes issued by the FASB related to the
determination of the useful life of intangible assets. These changes
amend the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible
asset. The changes are intended to improve the consistency between
the useful life of an intangible asset and the period of expected cash flows
used to measure the fair value of the asset. The adoption of the changes did not
have a material impact on our results of operations or our financial
position.
On
January 1, 2009, KCI adopted changes issued by the Emerging Issues Task
Force (“EITF”) and ratified by the FASB related to determining whether an
instrument (or an embedded feature) is indexed to an entity’s own
stock. The determination of whether an instrument (or an embedded
feature) is indexed to an entity’s own stock is taken into consideration in
evaluating the applicability of other provisions within the Codification related
to accounting for derivative instruments and hedging activities. The
adoption of the changes did not have a material impact on our results of
operations or our financial position.
On
January 1, 2009, KCI adopted changes issued by the FASB related to
determining whether instruments granted in share-based payment transactions are
participating securities. The changes state that unvested share-based payment
awards that contain nonforfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class method. The
adoption of the changes did not have a material impact on our results of
operations.
We are
exposed to various market risks, including fluctuations in interest rates and
variability in currency exchange rates. We have established policies,
procedures and internal processes governing our management of market risk and
the use of financial instruments to manage our exposure to such
risk.
Interest
Rate Risk
We have
variable interest rate debt and other financial instruments, which are subject
to interest rate risk that could have a negative impact on our business if not
managed properly. We have a risk management policy which is designed
to reduce the potential negative earnings effect arising from the impact of
fluctuating interest rates. We manage our interest rate risk on our
borrowings through interest rate swap agreements which effectively convert a
portion of our variable-rate borrowings to a fixed rate basis through June 2011,
thus reducing the impact of changes in interest rates on future interest
expenses. We do not use financial instruments for speculative or
trading purposes.
At
September 30, 2009, we had sixteen interest rate swap agreements in effect
pursuant to which we have fixed the rate on an aggregate $638.0 million notional
amount of our outstanding variable rate debt at a weighted average interest rate
of 2.441%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the
senior credit agreement. The aggregate notional amount decreases
quarterly by amounts ranging from $26.0 million to $47.0 million until
maturity. In
addition to the swaps in effect at September 30, 2009, we have entered into
three additional interest rate swap agreements to convert $150.0 million of our
variable-rate debt to a fixed rate basis which become effective on December 31,
2009. These agreements have been designated as cash flow hedge
instruments. (See Note 5 to our accompanying condensed consolidated
financial statements.)
The table
below provides information about our long-term debt and interest rate swaps,
both of which are sensitive to changes in interest rates, as of September 30,
2009. For long-term debt, the table presents principal cash flows and
related weighted average interest rates by expected maturity
dates. For interest rate swaps, the table presents notional amounts
and weighted average interest rates by expected (contractual) maturity
dates. Notional amounts are used to calculate the contractual
payments to be exchanged under the contract. Weighted average
variable rates are based on implied forward rates in the yield curve at the
reporting date (dollars in thousands):
Expected
Maturity Date as of September 30, 2009
|
||||||||||||||||||||||||||||
2009
|
2010
|
2011
|
2012
|
Thereafter
|
Total
|
Fair
Value
|
||||||||||||||||||||||
Long-term
debt
|
||||||||||||||||||||||||||||
Fixed
rate
|
$ | — | $ | — | $ | — | $ | — | $ | 690,000 | $ | 690,000 | $ | 668,540 | (1) | |||||||||||||
Average
interest rate
|
— | — | — | — | 3.250 | % | 3.250 | % | ||||||||||||||||||||
Variable
rate
|
$ | 22,857 | $ | 137,143 | $ | 205,714 | $ | 274,286 | $ | 160,000 | $ | 800,000 | $ | 788,000 | ||||||||||||||
Weighted
average interest rate(2)
|
3.039 | % | 3.039 | % | 3.039 | % | 3.039 | % | 3.039 | % | 3.039 | % | ||||||||||||||||
Interest rate swaps(3)
|
||||||||||||||||||||||||||||
Variable to fixed-notional amount
|
$ | 126,000 | $ | 442,500 | $ | 69,500 | $ | — | $ | — | $ | 638,000 | $ | (10,341 | ) | |||||||||||||
Average
pay rate
|
2.521 | % | 2.469 | % | 3.797 | % | — | — | 2.450 | % | ||||||||||||||||||
Average
receive rate(4)
|
0.290 | % | 0.290 | % | 0.290 | % | — | — | 0.290 | % | ||||||||||||||||||
|
||||||||||||||||||||||||||||
(1)
The
fair value of our 3.25% Convertible Senior Notes due 2015 is based on a
limited number of trades and does not necessarily represent the purchase
price of the entire convertible note portfolio.
(2)
The
weighted average interest rates for future periods were based on the
average nominal interest rates as of the specified date.
(3)
Interest
rate swaps relate to the variable rate debt under long-term debt. The
aggregate fair value of our interest rate swap agreements was negative and
was recorded as a liability at September 30, 2009.
(4)
The
average receive rates for future periods are based on the current period
average receive rates. These rates reset quarterly.
|
Foreign
Currency and Market Risk
We have
direct operations in the U.S., Canada, Western Europe, Australia, New Zealand,
Singapore and South Africa, and we conduct additional business through
distributors in Latin America, the Middle East, Eastern Europe and Asia. Our
foreign operations are measured in their applicable local
currencies. As a result, our financial results could be affected by
factors such as changes in foreign currency exchange rates or weak economic
conditions in the foreign markets in which we have
operations. Exposure to these fluctuations is managed primarily
through the use of natural hedges, whereby funding obligations and assets are
both managed in the applicable local currency.
KCI faces
transactional currency exposures when its foreign subsidiaries enter into
transactions denominated in currencies other than their local
currency. These nonfunctional currency exposures relate primarily to
existing and forecasted intercompany receivables and payables arising from
intercompany purchases of manufactured products. KCI enters into
forward currency exchange contracts to mitigate the impact of currency
fluctuations on transactions denominated in nonfunctional currencies, thereby
limiting risk that would otherwise result from changes in exchange
rates. The periods of the forward currency exchange contracts
correspond to the periods of the exposed transactions.
At
September 30, 2009, we had outstanding forward currency exchange contracts to
sell approximately $99.6 million of various currencies. Based on our
overall transactional currency rate exposure, ordinary movements in the currency
rates will not materially affect our financial condition. We are
exposed to credit loss in the event of nonperformance by counterparties on their
outstanding forward currency exchange contracts, but do not anticipate
nonperformance by any of the counterparties.
International
operations reported operating earnings of $83.5 million for the nine months
ended September 30, 2009. We estimate that a 10% fluctuation in the
value of the U.S. dollar relative to these foreign currencies as of and for the
nine months ended September 30, 2009 would change our net earnings for the nine
months ended September 30, 2009 by approximately
$12.8 million. Our analysis does not consider the impact the
fluctuation would have on the value of our forward currency exchange contracts
or the implications that such fluctuations could have on the overall economic
activity that could exist in such an environment in the U.S. or the foreign
countries or on the results of operations of our foreign entities.
Disclosure Controls and
Procedures. KCI’s management, with the participation of our
Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of KCI’s disclosure controls and procedures (as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the “Exchange Act”)) as of the end of the period covered by
this report. Based on such evaluation, KCI’s Chief Executive Officer
and Chief Financial Officer have concluded that, as of the end of such period,
KCI’s disclosure controls and procedures are effective in recording, processing,
summarizing and reporting, on a timely basis, information required to be
disclosed by KCI in the reports that it files or submits under the Exchange Act
and are effective in ensuring that information required to be disclosed by KCI
in the reports that it files or submits under the Exchange Act is accumulated
and communicated to KCI’s management, including KCI’s Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.
Changes in Internal Control over
Financial Reporting. There have not been any changes in KCI’s
internal control over financial reporting (as such term is defined by paragraph
(d) of Rule 13a-15) under the Exchange Act, during the third fiscal quarter of
2009 that have materially affected, or are reasonably likely to materially
affect, KCI’s internal control over financial reporting.
Patent
Litigation
Although
it is not possible to reliably predict the outcome of U.S. and foreign patent
litigation described below, we believe that each of the patents involved in
litigation are valid and enforceable, and that our patent infringement claims
are meritorious. However, if any of our key patent claims were
narrowed in scope or found to be invalid or unenforceable, or we otherwise do
not prevail, our share of the advanced wound care market for our V.A.C. Therapy
systems could be significantly reduced in the U.S. or Europe, due to increased
competition, and pricing of V.A.C. Therapy systems could decline significantly,
either of which would materially and adversely affect our financial condition
and results of operations. We derived approximately 52% of total
revenue for the nine months ended September 30, 2009 and 53% of total revenue
for the year ended December 31, 2008 from our domestic V.A.C. Therapy products
relating to the U.S. patents at issue. In continental Europe, we
derived approximately 12% of total revenue for the nine months ended September
30, 2009 and 13% of total revenue for the year ended December 31, 2008 in V.A.C.
revenue relating to the patents at issue in the ongoing litigation in Germany,
France and the United Kingdom.
U.S.
V.A.C. Patent Litigation
KCI and
its affiliates, together with Wake Forest University Health Sciences (“Wake
Forest”), are involved in multiple patent infringement suits involving patents
licensed exclusively to KCI by Wake Forest. In 2006, a U.S. Federal
District Court jury found that the Wake Forest patents involved in the
litigation were valid and enforceable, but that the patent claims at issue were
not infringed by the gauze-based device marketed by BlueSky Medical, which was
acquired by Smith & Nephew plc in 2007. The parties appealed the
judgment entered by the District Court. On February 2, 2009, the U.S.
Court of Appeals for the Federal Circuit affirmed the decision of the District
Court. Specifically, the Federal Circuit upheld the validity of the
patents at issue, but also upheld the finding that the BlueSky gauze-based
device did not infringe these patents. Medela has filed a petition
for certiorari with the
U.S. Supreme Court challenging the Federal Circuit’s ruling. KCI
recently filed its brief opposing Medela’s petition.
In May
2007, KCI, its affiliates and Wake Forest filed two related patent infringement
suits: one case against Smith & Nephew and BlueSky and a second case against
Medela, for the manufacture, use and sale of gauze-based negative pressure
devices which we believe infringe a Wake Forest continuation patent issued in
2007 relating to our V.A.C. technology. These cases are being heard
in the Federal District Court for the Western District of Texas. In
December 2008, we amended our claims in the case to assert additional patents
and patent claims against Smith & Nephew following its announcement that it
would begin commercializing foam dressing kits for use in negative pressure
wound therapy, or NPWT. In addition, in February 2009, we filed a
motion for preliminary injunction against Smith & Nephew and requested an
expedited hearing on this motion, which was heard in June 2009. A
ruling on the preliminary injunction has not yet been issued by the
Court. These cases are currently set for trial in February
2010.
Related
to the Smith & Nephew litigation, the U.S. Patent and Trademark Office
(“USPTO”) recently issued office actions confirming the validity of three
separate patents licensed to KCI by Wake Forest University Health Sciences in
re-examination proceedings. The patents associated with this decision
include U.S. Patent Nos. 5,636,643 (“the ‘643 Patent”), 5,645,081 (“the ‘081
Patent”), and 7,216,651 (“the ‘651 Patent”), which all relate to KCI’s negative
pressure wound therapy technologies. The USPTO recently issued certificates of
re-examination affirming the validity of key claims in the ‘643 Patent and the
‘081 Patent. The USPTO also issued a formal Office action confirming the
validity of all claims in the ‘651 Patent.
In
September 2007, KCI and two affiliates were named in a declaratory judgment
action filed in the Federal District Court for the District of Delaware by
Innovative Therapies, Inc. (“ITI”). In that case, the plaintiff has
alleged the invalidity or unenforceability of four patents licensed to KCI by
Wake Forest and one patent owned by KCI relating to V.A.C. Therapy, and has
requested a finding that products made by the plaintiff do not infringe the
patents at issue. On November 5, 2008, the District Court dismissed
ITI’s suit based on a lack of subject matter jurisdiction. ITI has
appealed the dismissal of the suit.
In
January 2008, KCI, its affiliates and Wake Forest filed a patent infringement
lawsuit against ITI in the U.S. District Court for the Middle District of North
Carolina. The federal complaint alleges that a negative pressure
wound therapy device introduced by ITI in 2007 infringes three Wake Forest
patents which are exclusively licensed to KCI. We are seeking damages
and injunctive relief in the case. Also in January and June of 2008,
KCI and its affiliates filed separate suits in state District Court in Bexar
County, Texas, against ITI and several of its principals, all of whom are former
employees of KCI. The claims in the state court suits include breach
of confidentiality agreements, conversion of KCI technology, theft of trade
secrets and conspiracy. We are seeking damages and injunctive relief
in the state court cases.
In
December 2008, KCI, its affiliates and Wake Forest filed a patent infringement
lawsuit against Boehringer Wound Systems, LLC, Boehringer Technologies, LP, and
Convatec, Inc. in the U.S. District Court for the Middle District of North
Carolina. The federal complaint alleges that a negative pressure
wound therapy device manufactured by Boehringer and commercialized by Convatec
infringes Wake Forest patents which are exclusively licensed to
KCI. In February 2009, the Defendants filed their answer, which
includes affirmative defenses and counterclaims alleging non-infringement and
invalidity of the Wake Forest patents.
International
V.A.C. Patent Litigation
In June
2007, Medela filed patent nullity suits in the German Federal Patent Court
against two of Wake Forest’s German patents licensed to KCI. These
patents were originally issued by the German Patent Office in 1998 and 2000 upon
granting of the corresponding European patents. The European patents
were upheld as amended and corrected during Opposition Proceedings before the
European Patent Office in 2003. In March 2008 and February 2009,
Mölnlycke Health Care AB and Smith & Nephew, respectively, joined the
nullity suit against Wake Forest’s German patent corresponding to European
Patent No. EP0620720 (“the ‘720 Patent”). A hearing on the validity
of the ‘720 Patent was held on March 17, 2009, at which time the German Federal
Patent Court ruled the ‘720 Patent invalid. The patent remains valid
and enforceable until a final ruling on appeal, which KCI and Wake Forest are
pursuing. In March 2008, Mölnlycke Health Care AB filed suit in the
United Kingdom alleging invalidity of the ‘720 Patent. Following a
trial in July 2009 on this matter and a previous ruling by the Court of Appeal
that the claims of the ‘720 patent were invalid, the trial court also ruled the
‘720 patent invalid. A hearing on the validity of Wake Forest’s
German patent corresponding to European Patent No. EP0688189 (“the ‘189 Patent”)
was held on May 5, 2009, at which time the German Federal Patent Court ruled the
‘189 Patent valid and fully maintained as granted.
In
December 2008, KCI and its affiliates filed a patent infringement lawsuit
against Smith & Nephew in the United Kingdom requesting preliminary and
interim injunctive relief. A trial on infringement and validity of
the patent in the United Kingdom was held in March 2009. In May 2009, a judgment
was issued by the Court in which it determined that certain claims of the ‘720
Patent covering the use of foam dressing kits with NPWT systems were valid and
infringed by Smith & Nephew's foam-based NPWT dressing kits. The court held
that other claims under the patent were invalid. The Court’s judgment
extended the previously-issued injunction. Smith & Nephew
appealed the ruling and in July 2009, the Court of Appeal heard arguments from
both parties and thereafter ruled the claims at issue invalid and lifted the
injunction in the United Kingdom. KCI may be required to pay damages
for the period of injunction. KCI was denied permission to appeal by
the Court of Appeal and is now seeking permission to appeal from the Supreme
Court (formerly House of Lords).
In March
2009, KCI and its affiliates filed a patent infringement lawsuit against Smith
& Nephew in the Federal Court of Australia, requesting preliminary
injunctive relief to prohibit the commercialization of a Smith & Nephew
negative pressure wound therapy dressing kit. The Federal Court
issued a temporary injunction in the case, which was recently overturned by an
Australian Court of Appeals. A full trial on validity and
infringement of the Wake Forest patent involved in the case is expected in the
summer of 2010.
In March
2009, KCI's German subsidiary filed a request for a preliminary injunction with
the German District Court of Düsseldorf to prevent commercialization of a Smith
& Nephew negative pressure wound therapy system that KCI believes infringes
the German counterpart of its European Patent No. EP0777504 (“the ‘504
Patent”). Following a hearing in July 2009 on this matter, the Court
denied KCI’s request. Also, in April 2009, KCI's German subsidiary
and its affiliates filed a patent infringement lawsuit against Smith &
Nephew, GmbH Germany in the German District Court of Mannheim. The
lawsuit alleges that the negative pressure wound therapy systems commercialized
by Smith & Nephew infringe the ‘504 Patent and another German patent owned
by KCI corresponding to European Patent No. EP0853950 (“the ‘950
Patent”). A trial was held in October 2009 on the ‘504 patent claims,
after which the Court dismissed KCI’s claims. A trial on KCI’s ‘950
patent claims was temporarily adjourned and is scheduled to resume in March,
2010 after additional briefing by the parties.
In July
2009, KCI and its affiliates filed a request for a preliminary injunction with
the Paris District Court in France to prevent commercialization of Smith &
Nephew’s NPWT system that KCI believes infringes the French counterpart of the
‘504 Patent. A hearing on KCI’s request for preliminary injunction
was heard in October 2009 in France and a ruling is expected in
November. A trial on the matter is expected in 2010. Also
in July 2009, KCI and its affiliates filed patent infringement lawsuits against
Smith & Nephew in the United Kingdom and its affiliates in France alleging
infringement of the ‘504 Patent and the ‘950 Patent in those
countries. KCI has withdrawn its request for a preliminary injunction
in the United Kingdom based on the ‘504 Patent and the ‘950 Patent, and is
proceeding to trial in March 2010.
Regenerative
Medicine Litigation
In
September 2005, LifeCell recalled certain human-tissue based products because
the organization that recovered the tissue, Biomedical Tissue Services, Ltd.
(“BTS”), may not have followed Food and Drug Administration (“FDA”) requirements
for donor consent and/or screening to determine if risk factors for communicable
diseases existed. LifeCell promptly notified the FDA and all relevant
hospitals and medical professionals. LifeCell did not receive any
donor tissue from BTS after September 2005. LifeCell has been named,
along with BTS and many other defendants, in lawsuits relating to the BTS donor
irregularities. These lawsuits generally fall within three
categories, (1) recipients of BTS tissue who claim actual injury, (2) suits
filed by recipients of BTS tissue seeking medical monitoring and/or damages for
emotional distress (categories (1) and (2) are collectively referred to herein
as “recipient cases”), (3) suits filed by family members of tissue donors who
did not authorize BTS to donate tissue (“family cases”).
In the
first category, LifeCell has been named in three cases filed in the State Court
of New Jersey, and approximately seven cases in New Jersey Federal Court in
which the plaintiffs allege to have contracted a disease from BTS’s
tissue. The seven cases in the Federal Court were administratively
stayed pending an appeal filed by plaintiffs in other recipient cases that were
dismissed. The State Court cases are in discovery.
In the
second category, LifeCell has been named in more than twenty suits in which the
plaintiffs do not allege that they have contracted a disease or suffered
physical injury, but instead seek medical monitoring and/or damages for
emotional distress. Seventeen of those cases which were consolidated
in New Jersey Federal District Court as part of a Multi-District Litigation
(“MDL”) were dismissed on December 10, 2008, and are now the subject of an
appeal by plaintiffs. The balance of those were filed in State Court
in New Jersey. On April 3, 2009, six of the State Court cases were
dismissed. On June 12, 2009, the remaining five State Court cases
were dismissed. All 11 cases are now on appeal.
In the
third category, approximately twenty suits have been filed by family members of
tissue donors seeking damages for emotional distress. Three of those
are in the MDL. The other family cases have been filed in state
courts in New Jersey and Pennsylvania. Many of these cases improperly
name LifeCell as the Company did not receive any tissue from the decedent
donor. Voluntary dismissals have been obtained in many of those
cases. The balance of the family cases are in discovery.
Although
it is not possible to reliably predict the outcome of the BTS-related
litigation, we believe that our defenses to the claims are meritorious and will
defend them vigorously. LifeCell insurance policies covering the
BTS-related claims, which were assumed in our acquisition of LifeCell, should
cover the majority of litigation expenses, settlement costs and damage awards,
if any, in the recipient cases.
We are
party to several additional lawsuits arising in the ordinary course of our
business. Additionally, the manufacturing and marketing of medical
products necessarily entails an inherent risk of product liability
claims.
Except
with respect to the risk factor provided below, there have been no material
changes from the risk factors disclosed in the Company’s Annual report on Form
10-K for the fiscal year ended December 31, 2008 and the Quarterly Reports on
Form 10-Q for the quarterly periods ended March 31 and June 30,
2009.
Any
shortfall in our ability to procure unprocessed tissue or manufacture Strattice
and AlloDerm in sufficient quantities to meet market demand would negatively
impact our growth.
Demand
for our regenerative tissue products Strattice and AlloDerm is significant in
the U.S. and we are expanding our
manufacturing capabilities to meet this demand. We believe that
demand for Strattice is likely to increase further following our planned
expansion in European markets during 2009 and in the future. Also,
demand growth for AlloDerm continues to be strong in light of a demonstrated
physician preference for AlloDerm in breast reconstruction
applications. We expect the sales of Strattice and AlloDerm to be
constrained by our ability to manufacture sufficient quantities to meet
demand. We currently expect that inventory levels of Strattice will
normalize and be sufficient to meet demand by the end of 2009 and for AlloDerm
by the second quarter of 2010.
The
manufacture of all of our regenerative medicine products is conducted
exclusively at our sole manufacturing facility in Branchburg, New Jersey, where
we completed validation of a new manufacturing suite that became operational in
the first quarter of 2009. Any temporary or permanent facility
shut-down caused by casualty (property damage caused by fire or other perils),
regulatory action, or other unexpected interruptions could cause a significant
disruption in our ability to supply our regenerative tissue products, which
would impair our LifeCell revenue growth. We take precautions to
safeguard the facility, including security, health and safety protocols and
off-site backup and storage of electronic data. Additionally, we
maintain property insurance that includes coverage for business
interruption. However, a natural disaster such as a fire or flood
could affect our ability to maintain ongoing operations and cause us to incur
additional expenses. Insurance coverage may not be adequate to fully
cover losses in any particular case. Accordingly, damage to the
facility or other property due to fire, flood or other natural disaster or
casualty event could materially and adversely affect our revenues and results of
operations.
Our
regenerative medicine business is dependent on the availability of sufficient
quantities of raw materials, including donated human cadaveric tissue, porcine
tissue and other materials required for tissue processing. We
currently receive human tissue from multiple U.S. tissue banks and organ
procurement organizations. Over the past few years, demand for our
products has increased substantially and thus our requirements for donor tissue
have also increased substantially. Although we have numerous sources
of donated human tissue, we cannot be sure that donated human cadaveric tissue
will continue to be available at current levels or will be sufficient to meet
our future needs. If current sources can no longer supply human
cadaveric tissue or the requirements for human cadaveric tissue exceed their
current capacity, we may not be able to locate other sources on a timely basis,
or at all, which would negatively impact sales in our human tissue-based
products. Additionally, Midwest Research Swine
(“MRS”) is our sole supplier of porcine tissue. MRS is
supplied by three separate breeding herd farms that are isolated for
biosecurity. We are currently exploring additional supply
alternatives to address our future supply requirements and increase our supply
chain security. Any significant interruption in the availability of
porcine tissue or in our ability to process this tissue would likely cause us to
slow down the distribution of our porcine-based regenerative medicine products,
which could adversely affect our ability to supply the needs of our customers
and materially and adversely affect our results of operations. Also,
we obtain from a single supplier certain specialized solutions that are
essential to the processing of our porcine-based regenerative medicine
products. We are exploring additional supply alternatives to address
our future supply requirements and increase our supply chain
security. We are currently in the process of building inventory of
these solutions and are currently negotiating a long-term supply arrangement
with the supplier. Any interruption in our ability to procure these
specialized solutions on a timely and commercially reasonable basis from our
current supplier or a third party would limit our ability to produce
porcine-based products, which would materially and adversely affect our results
of operations. Additionally, our materials and tissue suppliers are
subject to extensive regulatory requirements applicable to their
operations. Any failure on their part to comply with these
regulations could jeopardize our supply of tissue necessary to meet growing
demand for our regenerative medicine products.
(a) None
(b) Not
applicable
(c) Purchases
of Equity Securities by KCI (dollars in thousands, except per share
amounts):
Period
|
Total
Number of Shares Purchased(1)
|
Average
Price Paid per Share
|
Total
Number of Shares Purchased as Part of Publicly Announced Program(2)
|
Approximate
Dollar Value of Shares That May Yet be Purchased Under the Program(2)
|
||||
July
1, 2009 to
|
||||||||
July
31, 2009
|
1,082
|
$ 25.85
|
1,082
|
$ 49,667
|
||||
August
1, 2009 to
|
||||||||
August
31, 2009
|
218
|
$ 32.49
|
218
|
$ 49,660
|
||||
September
1, 2009 to
|
||||||||
September
30, 2009
|
85
|
$ 36.29
|
85
|
-
|
||||
Total
|
1,385
|
$ 27.54
|
1,385
|
-
|
||||
|
||||||||
(1) During
the third quarter of 2009, KCI purchased and retired 1,385 shares in
connection with the withholding of shares to satisfy the minimum tax
withholdings on the vesting of restricted stock.
(2) In
October 2008, KCI’s Board of Directors authorized a share repurchase
program for the repurchase of up to $100.0 million in market value of
common stock, which expired September 30, 2009. During the
three months ended September 30, 2009, KCI repurchased shares for minimum
tax withholdings on the vesting of restricted
stock.
|
A list of
all exhibits filed or included as part of this quarterly report on form 10-Q is
as follows:
Exhibits
|
Description
|
|
3.1 |
Amended
and Restated Articles of Incorporation of Kinetic Concepts, Inc. (filed as
Exhibit 3.5 to Amendment No. 1 to our Registration Statement on Form S-1,
filed on February 2, 2004, as thereafter amended).
|
|
3.2 |
Fifth
Amended and Restated By-laws of Kinetic Concepts, Inc. (filed as
Exhibit 3.1 to our Form 8-K filed on February 24,
2009).
|
|
31.1 |
Certificate
of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 5, 2009.
|
|
31.2 |
Certificate
of the Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 5, 2009.
|
|
32.1 |
Certificate
of the Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 dated November 5,
2009.
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
KINETIC
CONCEPTS, INC.
|
|
(REGISTRANT)
|
|
Date: November
5, 2009
|
By: /s/
Catherine M. Burzik
|
Catherine
M. Burzik
|
|
President
and Chief Executive Officer
|
|
(Duly
Authorized Officer)
|
|
Date: November
5, 2009
|
By: /s/
Martin J. Landon
|
Martin
J. Landon
|
|
Executive
Vice President and Chief Financial Officer
|
|
(Principal
Financial and Accounting Officer)
|
INDEX
OF EXHIBITS
Exhibits
|
Description
|
|
3.1 |
Amended
and Restated Articles of Incorporation of Kinetic Concepts, Inc. (filed as
Exhibit 3.5 to Amendment No. 1 to our Registration Statement on Form S-1,
filed on February 2, 2004, as thereafter amended).
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3.2 |
Fifth
Amended and Restated By-laws of Kinetic Concepts, Inc. (filed as
Exhibit 3.1 to our Form 8-K filed on February 24,
2009).
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31.1 |
Certificate
of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 5, 2009.
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31.2 |
Certificate
of the Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 5, 2009.
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32.1 |
Certificate
of the Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 dated November 5,
2009.
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