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 advanced wound care, regenerative medicine and
therapeutic support system 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 biological soft tissue repair products made from human
(“allograft”) and animal (“xenograft”) tissue for use in reconstructive,
orthopedic and urogynecologic surgical procedures to repair soft tissue
defects. Our Therapeutic Support Systems, or TSS, business includes
specialty hospital beds, mattress replacement systems and overlays, which are
designed to address pulmonary complications associated with 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.
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. LifeCell develops, processes and markets
biological soft tissue repair products made from both allograft and xenograft
tissue. This acquisition enhances our product platform and provides significant
future growth opportunities.
KCI was
founded in 1976 and is incorporated in Texas. Our principal executive
offices are located at 8023 Vantage Drive, San Antonio, Texas
78230. Our telephone number is (210) 524-9000. Our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports filed or furnished pursuant to Section 13
or 15(d) of the Securities Exchange Act, as amended, are available free of
charge on our website at www.kci1.com,
as soon as reasonably practicable after we file or furnish such information with
the SEC. Information contained on our website is not incorporated by
reference to this report.
Clinical
Applications
Our
advanced wound care systems, regenerative medicine products and therapeutic
support systems address five principal clinical applications: advanced wound
healing and tissue repair, pulmonary complications in the intensive care unit,
regenerative medicine, bariatric care and wound treatment and
prevention.
Advanced
Wound Healing and Tissue Repair
In the
acute care setting, serious trauma wounds, failed surgical closures, amputations
(especially those resulting from complications of diabetes) and serious pressure
ulcers present special challenges to the physician and to the patient. These are
often complex and/or large wounds that are prone to serious infection and
further complications due to the extent of tissue damage or the compromised
state of the patient's health. These wounds are often difficult or in the worst
cases, impossible to treat quickly and successfully with traditional treatments.
Physicians and hospitals need a therapy that addresses the special needs of
these wounds with high levels of both clinical and cost effectiveness. Given the
high cost and infection risk associated with treating these patients in
healthcare organizations, the ability to create healthy wound beds and reduce
bacterial levels in the wound is particularly important. Our InfoV.A.C. and
V.A.C. ATS Therapy systems are designed to meet these needs by promoting the
reduction in local edema, managing exudate, removing infectious material, and
stimulating the growth of healthy, vascularized granulation tissue.
In the
extended care and homecare settings, different types of wounds, with different
treatment implications, present the most significant challenges to physicians
and nurses. Although a large number of acute wounds require post-discharge
treatment, a majority of the challenging wounds in the homecare setting are
non-healing chronic wounds. These wounds often involve physiologic and metabolic
complications such as reduced blood supply, compromised lymphatic system or
immune deficiencies that interfere with the body's normal wound healing
processes. In addition, diabetic ulcers and pressure ulcers are often
slow-to-heal wounds. These wounds often develop due to a patient's impaired
vascular and tissue repair capabilities. These conditions can also inhibit a
patient's healing process, and wounds such as these often fail to heal for many
months, and sometimes for several years. Difficult-to-treat wounds do not always
respond to traditional therapies, which include hydrocolloids, hydrogels and
alginates.
Physicians
and nurses look for therapies that can accelerate the healing process and
overcome the obstacles of patients' compromised conditions. They also prefer
therapies that are easy to administer, especially in the homecare setting, where
full-time skilled care is generally not available. In addition, because many of
these patients are not confined to bed, they want therapies that are minimally
disruptive to the patient's or the caregiver’s typical daily routines. Our
ActiV.A.C. and V.A.C. Freedom Therapy systems are designed to allow patients
mobility to conduct normal lives while their wounds heal.
Regenerative
Medicine
Soft
tissue, such as dermis, heart valves, blood vessels and nerve connective tissue,
contains a complex, three-dimensional structure consisting of multiple forms of
collagen, elastin, proteoglycans, other proteins and blood vessels (the “tissue
matrix”). As part of the body’s natural regenerative process, cells
within a tissue continuously degrade and, in the process, replace the tissue
matrix. However, in the event that a large portion of the tissue
matrix is destroyed or lost because of trauma or surgery, the body cannot
regenerate the damaged portion, resulting in scar formation. In such
situations, surgeons face a number of treatment options for restoring structure,
function and physiology, including the use of implant materials. Alternatives
include transplants from one part of the patient’s body to another
(“autograft”), processed allograft tissue, processed xenograft tissue and
synthetic products.
We
believe the use of autograft tissue is disadvantageous due to the creation of a
separate donor site wound and the associated pain, morbidity and scarring from
this additional wound. We also believe there are disadvantages of
using synthetic materials and certain biologic materials including their
susceptibility to infection, resorption, encapsulation, movement away from the
transplanted area, and erosion through the skin. Some biologic
materials may include bovine collagen, which requires patient sensitivity
testing.
We
believe that our LifeCell allograft and xenograft products may provide surgeons
with benefits over other implant materials. Our tissue matrices
undergo non-damaging proprietary processing, resulting in intact acellular
matrices that are strong and support tissue regeneration by way of rapid
revascularization. Our proprietary tissue processes remove cells from
biologic tissues to minimize the potential for specific rejection of the
transplanted tissue. Our tissue matrix products also offer ease of
use and minimize risk of some complications, including adhesions to the
implant.
Pulmonary
Complications in the Intensive Care Unit
The most
critically ill patient population is generally cared for in the intensive care
unit, or ICU, of a hospital, where they can receive the most intense medical
treatment and attention. Patients treated in the ICU usually suffer from serious
acute or chronic diseases or severe traumatic injuries. These patients often
have, or develop, pulmonary complications, such as Acute Respiratory Distress
Syndrome, or ARDS, resulting directly from their conditions or stemming from
their impaired mobility. Some ICU patients are in such acute distress
that their organ systems are at risk of failure and many are on some type of
life-support. For the fiscal year 2007, there were an estimated 1.4 million ICU
patients in the U.S. with, or at risk of developing, pulmonary
complications.
Treating
pulmonary complications requires special equipment and treatment methods.
Because of the aggressive and specialized treatments required to address these
life-threatening conditions, daily patient-care costs in the ICU are high. Our
critical care therapies consist of Kinetic Therapy, Prone Therapy and Kinetic
Prone Therapy to provide mobility to patients who cannot mobilize themselves.
Kinetic Therapy involves the side-to-side rotation of a patient to an angle of
at least 40 degrees per side and has been shown in independent clinical
studies to reduce the incidence of certain pulmonary complications and length of
stay in the ICU. Prone Therapy involves turning a patient from the supine to
prone position (180 degrees) and often is done manually by nurses in the ICU.
Independent clinical studies have demonstrated that proning an ICU patient
improves oxygenation in ARDS patients and reduces ventilator time and ICU length
of stay, with more recent studies suggesting overall improved mortality
rates. Kinetic Prone Therapy involves delivering Kinetic Therapy in
the prone position.
Bariatric
Care
In the
U.S., the prevalence of obesity has more than doubled from 11.6% in 1990 to
approximately 26.3% in 2007. In addition, obesity is now the second
leading cause of preventable death in the U.S. Obese patients are
often unable to fit into standard-sized beds and wheelchairs and pose an
increased risk to patients and caregivers. KCI's BariatricSupport, a
comprehensive offering of safety-focused and therapy-driven products, education
and training enable caregivers to care for obese patients in a safe and
dignified manner in all care settings. While our bariatric products
are generally used for patients weighing between 300 and 600 pounds, our
products can accommodate patients weighing from 850 to 1,000 pounds. Our most
sophisticated bariatric product can serve as a cardiac chair, weight scale, and
x-ray table; and many of our products provide therapies like those in our wound
treatment and prevention products. Moreover, treating obese patients is a
significant safety issue for many healthcare organizations, causing several
states and many organizations to adopt a "no lift" policy, because moving and
handling obese patients increases the risk of injury to healthcare personnel.
Our products and accessories assist organizations in complying with any
applicable "no lift" policy and enable healthcare personnel to treat obese
patients in a manner that is safe for healthcare personnel as well as safe and
more dignified for the patient.
Wound
Treatment and Prevention
Our
pressure relieving therapeutic support systems provide therapy for the treatment
of pressure sores, burns, ulcers, skin grafts, and other skin conditions. They
also help prevent the formation of pressure sores that can develop in immobile
individuals. Our therapeutic support systems reduce the amount of pressure on a
patient's intact skin surface (prevention) or an existing wound site (treatment)
by redistributing forces away from the skin or wound site through immersion of
the patient into a medium such as air, foam, silicon beads, or viscous fluid.
Our products also help to reduce shear, a major factor in the development of
pressure ulcers, by reducing the amount of friction between the skin surface and
the surface of the bed. Many of our products also provide moisture control, a
major cause of maceration of the skin, by flowing air through the support
surface to the skin, keeping the skin dry and moisture free. In addition to
providing pressure-relieving therapy, some of our products also provide for
pulsing of air into the surface cushions, known as Pulsation Therapy, which
helps improve blood and lymphatic flow to the skin. Some of our products further
promote healing and reduce nursing time by providing an automated "wound care"
turn of at least 20 degrees per side. Our therapeutic wound care surfaces
are utilized by patients in hospitals, residents in nursing homes and
individuals in the home.
Products
We offer
a wide range of products in each clinical application to meet the specific needs
of different subsets of the markets we serve, providing innovative, cost
effective, outcome-driven therapies across multiple care settings.
Advanced
Wound Healing and Tissue Repair Products
Our wound
healing and tissue repair systems incorporate our proprietary V.A.C. Therapy
technology. The V.A.C. Therapy system consists of a therapy unit and
four types of disposables: a foam dressing, an occlusive drape, a tubing system
connecting the dressing to the therapy unit and a specialized
canister. The therapy unit consists of a pump that generates
controlled negative pressure and sophisticated internal software that controls
and monitors the application of the therapy. The therapy can be
programmed for individualized use. Additionally, all of our V.A.C.
Therapy units include safety alarms that respond in real time to signal users of
any tubing blockage, dressing leakage or other condition which may interfere
with appropriate therapy delivery. The systems have a number of on
screen user-assist features such as treatment guidelines.
Our
negative pressure wound healing therapy is delivered to the wound bed through a
proprietary foam dressing which can be customized to fit the size and shape of
the wound. The dressing is connected to the therapy unit through
tubing which both delivers the negative pressure and measures the pressure
delivered to the wound surface, providing continuous feedback. An occlusive
drape covers the dressing and secures the foam, thereby allowing negative
pressure to be maintained at the wound site. Negative pressure can also be
applied continuously or intermittently to the wound site. We believe
intermittent therapy further accelerates granulation tissue growth. The canister
collects the fluids, or exudates, helps reduce odors through the use of special
filters and provides for safe disposal of medical waste. V.A.C. dressings are
typically changed every 48 hours for non-infected wounds, versus
traditional dressings which often require dressing changes one or more times per
day. Our V.A.C. dressings are specially designed to address the unique physical
characteristics of different wound types, such as large open wounds, surgical
wounds, diabetic foot ulcers and open abdominal wounds, among
others.
Our wound
healing and tissue repair systems are targeted to meet the needs of specific
care settings and wound or patient requirements, and consist of the following
V.A.C. wound therapy systems:
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The
InfoV.A.C. System was introduced at the end of the second quarter of 2007
to further meet acute care customer requirements. This therapy
unit is 50% smaller and lighter than the V.A.C. ATS. It
provides a new digital wound imaging feature that allows caregivers to
monitor and document wound healing progress. Digital images can
be reviewed on-screen or transferred electronically to help document
patient progress, allowing for convenient sharing of wound information
among caregivers and payers who require evidence of wound
healing. Advancements also include SensaT.R.A.C. Technology and
Seal Check that simplify the application, monitoring and documentation of
wound therapy.
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The
ActiV.A.C. System was introduced in the third quarter of 2007 in the home
care market. It addresses the demand for a simpler, lighter, and lower
profile design that enhances patient comfort and mobility. The ActiV.A.C.
Therapy System features newly-developed technology that automatically
documents the patient's therapy history and treatment times. Reports are
electronically stored in the system and can be reviewed on-screen or
downloaded to a computer. The ActiV.A.C. System incorporates
SensaT.R.A.C. Technology and Seal Check that simplify the application,
monitoring and documentation of wound
therapy.
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The
V.A.C. Instill System adds additional therapeutic capability to the V.A.C.
Therapy system. The V.A.C. Instill combines the ability to instill fluids
into the wound with V.A.C. Therapy. Fluids prescribed by physicians for
topical use—including antibiotics, antiseptics and anesthetics—can be
instilled, making the system particularly well suited for infected and
painful wounds. Future uses could include cytokines, growth factors, or
other agents to stimulate wound healing. Because the V.A.C. Instill is
based on the V.A.C. ATS system, it also includes all the capabilities and
features of the V.A.C. ATS.
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The
V.A.C. ATS System was introduced in 2002 and incorporates our proprietary
T.R.A.C. technology, which enables the system to monitor pressure at the
wound site and automatically adjust system operation to maintain the
desired therapy protocol. As the InfoV.A.C. Therapy system, with
SensaT.R.A.C. dressings, is introduced to the acute care market, the
V.A.C. ATS will be transitioned solely into the long-term care market
segment.
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The
V.A.C. Freedom System was introduced in 2002 to meet the requirements for
a lightweight product suitable for ambulatory patients. The V.A.C. Freedom
system also utilizes T.R.A.C. technology and T.R.A.C.
dressings. As with the InfoV.A.C. system, as the ActiV.A.C.
system is introduced to the post-acute market, the V.A.C. Freedom will be
transitioned solely into the long-term care market. In
addition, our V.A.C. Freedom System has achieved Joint Airworthiness
Certification (“JAC”) status by the U.S. Military, following an extensive
evaluation process testing the device's safety for use on military
aeromedical evacuation aircraft. The certification program is a shared
U.S. Air Force-Army initiative and applies to specific U.S. Air Force
aircraft and U.S. Army helicopters. The certification enables military
caregivers to continue providing effective and uninterrupted treatment for
injured military personnel being transported long distances from theatre
hospitals to continental U.S.
hospitals.
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In
addition to our GranuFoam dressing kits that are marketed with the V.A.C. wound
therapy systems, we commercialize specialized dressings designed to enhance
ease-of-use and effectiveness for the treatment of certain conditions, including
the following:
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In
December 2008, we introduced the V.A.C. Simplace Dressing which features
both a newly designed GranuFoam dressing and a 3M Tegaderm dressing
designed exclusively for use with KCI's proprietary V.A.C. Therapy
system. The unique features of the V.A.C. Simplace Dressing kit
are designed to simplify the V.A.C. Therapy dressing application process
allowing a broader user-base to become comfortable using the technology
with less training. The new spiral shaped V.A.C. GranuFoam
Dressing is pre-scored, reducing the need to cut the foam making it easier
to place in the wound site. The 3M Tegaderm Dressing conforms to the body
and flexes with the skin to help ensure that there is an optimal
environment established for wound healing. The V.A.C. Simplace Dressings
are now available in the U.S. and will be introduced in additional
countries in 2009.
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The
V.A.C. GranuFoam Silver Dressing combines the proven benefits of negative
pressure wound therapy, or NPWT, with the antimicrobial attributes of
silver. The V.A.C. GranuFoam Silver Dressing is the only silver
dressing that allows the GranuFoam dressing pores to come in direct
contact with the wound, eliminating the need for additional silver
dressing layers that may inhibit negative pressure and
granulation. Micro-bonded metallic silver is uniformly
distributed throughout the dressing, providing continuous delivery of
silver even after dressing sizing. A single application of
V.A.C. GranuFoam Silver Dressing eliminates the need for adjunct silver
dressings. The dressing offers a protective barrier to reduce
certain infection-producing bacteria, yeast and fungi, and may help reduce
infections in the wound.
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The
superior clinical efficacy of our V.A.C. Therapy wound healing and tissue repair
systems is supported by an extensive collection of published clinical studies.
V.A.C. Therapy systems have been reviewed in at least 580 journal articles (479
peer-reviewed), 587 abstracts, 51 case studies and 62 textbook
citations. Of these, the research for 72 articles, 122 abstracts and
all case studies were funded by research grants from KCI. NPWT, as
delivered by the V.A.C. Therapy system, has been granted a seal of approval by
the American Podiatric Medical Association, the German Wound Healing Society and
the Austrian Wound Healing Society. In addition, independent
consensus conferences have issued guidelines for the use of NPWT for diabetic
foot wounds, pressure ulcers, complex chest wounds, hospital-treated wounds and
open abdominal wounds.
We are
currently sponsoring multiple prospective, randomized and controlled
multi-center clinical studies specifically designed to provide further evidence
of V.A.C. Therapy's clinical efficacy for treating various targeted wound
types. Our research and development team has also initiated pilot
studies to evaluate the effect of V.A.C. Therapy at the cellular and molecular
levels.
Regenerative
Medicine Products
Our
regenerative medicine products include biological soft tissue repair products
made from human (“allograft”) and animal (“xenograft”) tissue for use in
reconstructive, orthopedic and urogynecologic surgical procedures to repair soft
tissue defects. AlloDerm regenerative tissue matrix is donated
allograft human dermis that has been processed with our non-damaging proprietary
processing resulting in an intact acellular tissue matrix. AlloDerm
supports the repair of damaged tissue by providing a foundation for regeneration
of normal human soft tissue. Following transplant, AlloDerm is
revascularized and repopulated with the patient’s own cells becoming engrafted
into the patient. AlloDerm is a versatile scaffold and has multiple surgical
applications. AlloDerm is marketed to plastic reconstructive and
general surgeons as an “off-the-shelf” superior alternative to other implant
materials. AlloDerm is predominately used in plastic reconstructive,
general surgical, burn and periodontal procedures:
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as
an implant for soft tissue reconstruction or tissue deficit
correction;
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as
a graft for tissue coverage or closure;
and
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as
a sling to provide support to tissue following nerve or muscle
damage.
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AlloDerm
was first used in 1994 for the treatment of third-degree and deep second-degree
burns requiring skin grafting to replace lost dermis. The use of
AlloDerm in burn grafting has clinically-shown performance equivalent to
autograft in reducing the occurrence and effects of scar contracture, the
progressive tightening of scar tissue that can cause joint immobility, while
significantly reducing donor site trauma. We believe that AlloDerm
provides significant therapeutic value when used in burn grafting over a
patient’s mobile joints.
Today,
AlloDerm is predominately used as a subcutaneous implant for the replacement of
soft tissue in reconstructive surgical procedures in various areas of the
body. For example, in surgical repair of abdominal wall defects,
AlloDerm is used to repair defects resulting from trauma, previous surgery,
hernia repair, infection, tumor resection or general failure of the
musculofascial tissue. We believe that AlloDerm provides an
alternative to other implant materials because of its functional, biomechanical
and regenerative properties. AlloDerm is also used in cancer reconstruction
procedures, including breast reconstruction following mastectomy
procedures.
Periodontal
surgeons use AlloDerm to increase the amount of attached gum tissue supporting
the teeth as an alternative to autologous connective tissue grafts excised from
the roof of the patient’s mouth and then transplanted to the
gum. BioHorizons Implant Systems, Inc. is our exclusive distributor
of AlloDerm for use in periodontal applications in the U.S. and certain
international markets.
In June
2007, LifeCell received clearance from the Food and Drug Administration, or FDA,
for a new xenograft product, Strattice reconstructive tissue
matrix. Strattice is porcine dermis that has been processed with our
non-damaging proprietary processing that removes cells and significantly reduces
a component believed to play a major role in the xenogeneic rejection
response. Strattice supports the repair of damaged tissue by allowing
rapid revascularization and cell repopulation required for tissue
regeneration. In pre-clinical studies, Strattice demonstrated rapid
revascularization and cell repopulation and strong healing. LifeCell
commenced marketing Strattice during the first quarter of 2008 to plastic
reconstructive and general surgeons as an implant to reinforce soft tissue where
weakness exists and for the surgical repair of damaged or ruptured soft tissue
membranes. In October 2008, our LifeCell Tissue Matrix for the
management of wounds utilizing our proprietary Strattice technology received
510(k) clearance from the FDA. Additionally, we achieved CE marking
and are now on the market in Germany and the UK. The Strattice
technology provides an environment that supports wound healing and can be used
in the management of a wide range of wound types, including pressure ulcers,
diabetic ulcers, venous ulcers, chronic vascular ulcers, surgical wounds, trauma
wounds and other acute wounds.
Conexa
reconstructive tissue matrix is the trade name for our porcine dermis product
that has been processed with our non-damaging proprietary process and is used
for soft tissue reinforcement in surgical procedures intended to repair rotator
cuff tissue. Tornier is our exclusive distributor for Conexa in the U.S.
and certain international markets.
GraftJacket
regenerative tissue matrix is the trade name for our proprietary human allograft
tissue products intended for use in repairing damaged or inadequate integumental
tissue in orthopedic surgical procedures, such as for rotator cuff tendon
reinforcement. GraftJacket is also used by podiatrists for the
treatment of lower extremity wounds. Wright Medical Group, Inc. is
our exclusive distributor for GraftJacket in the U.S. and certain international
markets.
AlloCraftDBM
is a proprietary human allograft bone-grafting product that combines
demineralized bone and micronized acellular human dermal matrix to form a
putty-like material. AlloCraftDBM is intended for use as a bone void
filler in various orthopedic surgical procedures. Stryker Corporation
is our exclusive distributor for AlloCraftDBM in the United States.
Repliform
regenerative tissue matrix is the trade name for our proprietary human allograft
tissue matrix product intended for use in repairing damaged or inadequate
integumental tissue in urogynecologic surgical procedures. Since
1997, surgeons have used Repliform in urogynecologic procedures as a bladder
sling in the treatment of stress urinary incontinence and for the repair of
pelvic floor defects.
Currently,
materials used for slings and pelvic floor repair surgeries include autologous
tissue, synthetic materials, biologic materials and cadaveric
fascia. The autologous tissue often is taken from the patient’s thigh
or abdomen resulting in a painful donor site. We believe that
Repliform used as a sling for urinary incontinence or pelvic floor repair
provides a safe and effective alternative that eliminates the need for a donor
site and will repopulate as the patient’s own tissue. Boston
Scientific Corporation is our exclusive worldwide sales and marketing
representative for Repliform.
Products
Treating Pulmonary Complications in the Intensive Care Unit
Our
pulmonary care therapies include both Kinetic Therapy products and Prone Therapy
products. In late 2004, we introduced the RotoProne Therapy System, an advanced
patient-care system for the treatment and prevention of pulmonary complications
associated with immobility. Providing Kinetic Therapy, Prone Therapy and Kinetic
Prone Therapy, the RotoProne Therapy System enables caregivers to automatically
rotate immobile patients with respiratory complications from the supine to the
prone position and to also rotate them from side to side up to 62 degrees
in both the supine and prone positions. The Rotoprone Therapy System can help
improve patient outcomes by providing caregivers an easier way to deliver
multiple intervals of Prone or Kinetic Prone Therapy over an extended period of
time. It also has the capability of delivering Kinetic Therapy in the
supine position. The RotoProne Therapy System features include programmable
rotation, up to 62 degrees in either the prone or supine position, with an
acclimation mode as well as pause and hold functions to suspend the patient in a
side-lying position for ease of nursing care. Other features of the RotoProne
Therapy System include a proprietary tube management system, electronically
monitored buckles, an ergonomically-designed head positioning system and
40-second or less return to supine from the prone position for delivery of
CPR.
Our other
Kinetic Therapy products include the TriaDyne Proventa, TriaDyne II, RotoRest
Delta, and PediDyne. The TriaDyne Therapy System is used primarily in acute care
settings and provides patients with four distinct therapies on an air suspension
surface. The TriaDyne Therapy System applies Kinetic Therapy by rotating the
patient up to 45 degrees on each side. There are three different modes of
rotation: upper body only, full body rotation, and counter rotation,
simultaneously rotating the patient's torso and lower body in opposite
directions to keep the patient centered on the patient surface. The TriaDyne
Therapy System also provides percussion therapy to loosen mucous buildup in the
lungs and pulsation therapy to promote capillary and lymphatic flow. The
RotoRest Delta is a specialty bed that can rotate a patient up to 62 degrees on
each side for the treatment of severe pulmonary complications and respiratory
failure. The RotoRest Delta is also designed, and has been shown, to improve the
care of patients suffering from multiple trauma and spinal cord
injury. Kinetic Therapy has been clinically studied in at least 17
randomized clinical trials, 84 journal articles (69 peer-reviewed articles), 46
abstracts, 19 case studies and four textbook citations. Of these, the research
for 18 articles, 33 abstracts and all case studies was funded by research grants
from KCI.
Bariatric
Care Products
Our
bariatric products provide a range of therapy options and the proper support
needed by obese patients that enable nurses to properly care for obese patients
in a safe and dignified manner. The most advanced product in this
line is the BariAir Therapy System, a front-exit bed, which can serve as a
critical care bed, cardiac chair or x-ray table for patients weighing up to 850
lbs. The BariAir, first introduced in 1996, provides low-air-loss
pressure relief with a Gore Medical fabric cover, continuous turn assist,
percussion, pulsation and step-down features designed for both patient comfort
and nurse assistance. Designed for the most complex bariatric
patient, we believe the BariAir is the only bariatric product available on the
market that provides five therapies integrated into one system.
The
FirstStep Select Heavy Duty overlay provides pressure-relieving low-air-loss
therapy when placed on a BariKare bed. The Maxxis 400 provides a
homecare bariatric bed frame for patients weighing up to 1,000
pounds. Our AirMaxxis product, to be used on the Maxxis 400 frame, is
a mattress replacement system which provides a therapeutic air surface for the
home environment for patients weighing up to 650 pounds.
The
BariMaxx II bariatric therapy system is a modular bed that allows the clinician
to choose the appropriate accessories for their environment and patient’s
needs. This platform, which comes standard with a foam mattress is
built for patients weighing up to 1,000 pounds, and provides customers with many
features including built-in scales, Trendelenburg and Reverse Trendelenburg
positioning and an expandable frame. The BariMaxx II side-exit
feature allows the caregiver to assist patients in a more traditional exit of
the bed. This is an important factor in a patient's rehabilitation and prepares
them for facility discharge. The MaxxAir ETS (Expandable Turning
Surface) mattress replacement system is a low-air-loss, pressure relieving
surface option for the BariMaxx II therapy system. The MaxxAir
ETS provides clinicians with rotational therapy of up to 30 degrees on each
side, instant CPR deflation and a Gore Medical Fabric cover to assist in skin
integrity. Additionally, we offer a powered transport option that
enables a single caregiver to safely and more easily transport patients on the
BariMaxx II therapy system.
Recognizing
the importance of safety in handling patients, all of our bariatric beds can be
rented or sold with safety and mobility products such as the EZ Lift patient
transfer system, an AirPal air assisted lateral transfer system, and other
accessories such as wheelchairs, walkers and commodes to create a complete
bariatric suite offering. The flexibility of options is just one of
the ways KCI helps caregivers in the day-to-day care of the bariatric patient
and also assists them with compliance to "no lift" policies being implemented in
healthcare organizations.
Wound
Treatment and Prevention Products
We offer
a wide variety of therapeutic support systems for wound treatment and
prevention, providing pressure reduction, pressure relief, pulsation,
alternating pressure, and a continuous turn of a minimum of 20 degrees. Most of
our therapy beds and surfaces incorporate the exclusive use of Gore Medical
Fabric in the patient contact areas to provide an ideal microclimate for skin
protection and moisture control. Our pressure relief products include framed
beds and overlays such as the KinAir MedSurg and KinAir IV framed beds; the
FluidAir Elite and FluidAir II bead beds; the FirstStep, FirstStep Plus,
FirstStep Select, FirstStep Advantage, TheraKair, TheraKair Visio and TriCell
overlays, the AtmosAir family of non-powered, dynamic mattress replacement and
seating surfaces; and the RIK fluid mattress and overlay. Our pulsation products
include the KinAir MedSurg Pulse and TheraPulse ATP framed beds and the
DynaPulse mattress replacement system. Our alternating pressure or
air cycling products include a powered model of the AtmosAir and the InterCell.
Our turn assist products include the KinAir IV, Therapulse ATP and a powered
AtmosAir model. During 2007, we obtained the rights from Hill-Rom
Company to produce a mattress compatible with their VersaCare bed and launched
the AtmosAir V series mattress. Internationally, the TheraKair Visio
represents the next generation of our strong TheraKair brand, providing
low-air-loss pressure relief with Pulsation Therapy.
The
KinAir MedSurg and KinAir IV have been shown to provide effective skin care
therapy in the treatment of pressure sores, burns and post-operative skin grafts
and flaps and to help prevent the formation of pressure sores and certain other
complications of immobility. The FluidAir Elite and FluidAir II support patients
on a low-pressure surface of air-fluidized beads providing pressure relief and
shear relief for skin grafts or flaps, burns and pressure sores. The TheraKair,
TheraKair Visio, and FirstStep family of overlays and mattress replacement
systems are designed to provide pressure relief and help prevent and treat
pressure sores. The FirstStep All in One is the only mattress replacement system
that combines multiple therapy levels (low-air-loss, pulsation, and rotation) at
different price points with a higher weight capacity to allow maximum
flexibility to help organizations in optimizing patient care and nursing
efficiency. The AtmosAir family consists primarily of for-sale mattress
replacement products that have been shown to be effective for the prevention and
treatment of pressure sores in a series of hospital-based case studies. The
proprietary AtmosAir with Self Adjusting Technology (“SAT”) utilizes atmospheric
pressure and gravity to deliver non-powered dynamic pressure
relief.
The
KinAir MedSurg Pulse and TheraPulse ATP framed beds and the DynaPulse overlay
provide a more aggressive form of treatment through a continuous pulsating
action which gently massages the skin to help improve capillary and lymphatic
circulation in patients suffering from severe pressure sores, burns, skin grafts
or flaps, swelling or circulatory problems.
The
KinAir IV, Therapulse ATP and a powered AtmosAir model all provide turn assist
of a minimum of 20 degrees to each side. Turn assist helps the caregiver
reposition and/or turn a patient in order to provide patient care and pressure
relief.
Competitive
Strengths
We
believe we have the following competitive strengths:
Innovation and
commercialization. KCI has a successful track record spanning
over 30 years in commercializing novel technologies in advanced wound care and
therapeutic support systems. We leverage our competencies in
innovation, product development and commercialization to bring solutions to the
market that address the critical unmet needs of clinicians and their patients
and can help reduce the overall cost of patient care. We continue to
support an active research and development program in wound care and advanced
biologics. We seek to provide novel, clinically efficacious,
therapeutic solutions and treatment alternatives that increase patient
compliance, enhance clinician ease of use and ultimately improve healthcare
outcomes. In May 2008, we completed our acquisition of LifeCell, an
innovative leader in the regenerative medicine market with a proven ability to
develop and commercialize advanced biological products made from human and
animal tissue.
Product differentiation and superior
clinical efficacy. We differentiate our portfolio of products
by providing effective therapies, supported by a clinically-focused and
highly-trained sales and service organization, which combine to produce
clinically-proven superior outcomes. The superior clinical efficacy of our
V.A.C. Therapy systems and our therapeutic support systems is supported by an
extensive collection of published clinical studies, peer-reviewed journal
articles and textbook citations, which aid adoption by clinicians. In
February 2008, we announced the final efficacy results of a large, multi-center
randomized controlled clinical trial utilizing V.A.C. Therapy compared to
advanced moist wound therapy, or AMWT, in the treatment of diabetic foot ulcers,
which resulted in the following statistically significant results:
|
·
|
a
greater proportion of foot ulcers achieved complete ulcer closure with
V.A.C. Therapy versus AMWT;
|
|
·
|
time
to wound closure was less with V.A.C. Therapy than with AMWT;
and
|
|
·
|
patients
on V.A.C. Therapy experienced significantly fewer amputations than with
AMWT.
|
This
study was later published in Diabetes Care, a peer-reviewed scientific
publication, in April 2008.
In June
2008, we announced the results of a clinical study conducted in Japan utilizing
V.A.C. Therapy compared to standard moist wound therapy for the treatment
of acute wounds. The results of this study showed a significant
treatment difference in median time to wound closure of 15 days for V.A.C.
Therapy versus 41 days for standard moist wound therapy. The study also
confirmed that V.A.C. Therapy could be used safely and effectively for the
treatment of acute wounds.
These
recent publications add to KCI's significant body of clinical evidence that
clearly shows that our V.A.C. Therapy system, including its unique foam
dressing, provides a clinical advantage for treatment of wounds, including limb
salvage in patients with diabetic foot ulcers.
We
continue to successfully distinguish our V.A.C. Therapy products from
competitive offerings through unique FDA-cleared marketing and labeling claims
such as the V.A.C. Therapy system is intended to create an environment that
promotes wound healing by preparing the wound bed for closure, reducing edema
and promoting granulation tissue formation and perfusion. Following a
review of requested clinical data, additional claims were cleared by the FDA in
2007 which now specify the use of V.A.C. systems in all care settings, including
in the home. These claims are unique to KCI’s V.A.C. systems in the
field of NPWT.
Within
our regenerative medicine business, we also believe our allograft and xenograft
tissue regeneration products provide surgeons with benefits over alternative
products for soft tissue defects. Our products offer surgeons and
patients intact acellular matrices that are strong and which support tissue
regeneration and the rapid restoration of blood supply. Our
proprietary tissue processes remove cells from biological tissues to minimize
the potential for specific rejection of the transplanted
tissue. Our tissue matrix products also offer ease of use and
minimize risk of some complications, including adhesions to the
implant. The benefits of using LifeCell’s AlloDerm and Strattice
products over the use of autografts and other processed and synthetic products
include reduced patient discomfort from autograft procedures and reduced
susceptibility to infection, resorption, encapsulation, movement away from the
transplanted area, and erosion through the skin.
Broad reach and customer
relationships. Our worldwide sales team, consisting of
approximately 2,000 team members, has fostered strong relationships with our
prescribers, payers and caregivers over the past three decades by providing a
high degree of clinical support and consultation along with our extensive
education and training programs. Because our products address the critical needs
of patients who may seek treatment in various care settings, we have built a
broad and diverse reach across all healthcare settings. We have key
relationships with an extensive list of acute care hospitals worldwide and
long-term care facilities, skilled nursing facilities, home healthcare agencies
and wound care clinics in the U.S. Additionally, our LifeCell sales
representatives interact with plastic surgeons, general surgeons, ear, nose and
throat surgeons, burn surgeons and trauma/acute care surgeons regarding the use
and potential benefits of our reconstructive tissue products. We
believe synergies will be realized through LifeCell’s leveraging of our
extensive list of acute customers, prescribers and caregivers and our ability to
promote the use of multiple KCI products and therapies for complex wounds and
defects.
Reimbursement
expertise. A significant portion of our V.A.C. revenue is
derived from home placements, which are reimbursed by third-party payers such as
private insurance, managed care and governmental payers. We have dedicated
significant time and resources to develop a core competency in third-party
reimbursement, which enables us to efficiently manage our collections and
accounts receivable with third-party payers. We have over 400
contracts with most of the largest private insurance payers in the
U.S.
Extensive service center
network. With a network of 135 U.S. and 59 international
service centers, we are able to rapidly deliver our products to major hospitals
in the U.S., Canada, Australia, Singapore, South Africa, and most major European
countries. Our network gives us the ability to deliver our products to any major
Level I domestic trauma center within hours. This extensive network is critical
to securing contracts with national group purchasing organizations, or GPOs, and
the network allows us to efficiently serve the homecare market directly. Our
network also provides a platform for the introduction of additional products in
one or more care settings.
Customers
We have a
broad and diverse reach across all healthcare settings. We have key
relationships with an extensive list of acute care hospitals worldwide and
long-term care facilities, skilled nursing facilities, home healthcare agencies
and wound care clinics in the U.S. Additionally, our LifeCell sales
representatives interact with plastic surgeons, general surgeons, ear, nose and
throat surgeons, burn surgeons and trauma/acute care surgeons regarding the use
and potential benefits of our reconstructive tissue products. We
believe synergies will be realized through LifeCell’s leveraging of our
extensive list of acute customers, prescribers and caregivers and our ability to
promote the use of multiple KCI products and therapies for complex wounds and
defects.
Through
our network of 135 U.S. and 59 international service centers, we are able to
rapidly deliver our products to major hospitals in the U.S., Canada, Australia,
New Zealand, Singapore, South Africa and most major European countries. This
extensive network is critical to securing national contracts with GPOs, and
allows us to efficiently serve the homecare market directly. Our network also
provides a platform for the introduction of additional products. Our
International division also serves the demands of a growing global market
through relationships with independent distributors in Latin America, the Middle
East, Eastern Europe and Asia. Additionally, operations have been
established in Japan and we are actively pursuing the regulatory approvals
required to enter the Japanese market.
Our
agreements with GPOs, reimbursement under Medicare Part B, and our contractual
relationships with third-party private payers account for a significant portion
of our revenues. We have agreements with numerous GPOs which
negotiate rental and purchase terms on behalf of large groups of acute care and
extended care organizations. Our largest GPO relationship is with
Novation, LLC. Under our agreements with Novation, we provide
products and therapies to over 1,800 acute care and extended care
organizations. Rentals and sales to Novation participants in the
years ended December 31, 2008, 2007 and 2006, accounted for $198.3 million, or
10.6% of total revenue, $193.6 million, or 12.0% of total revenue, and $179.2
million, or 13.1% of total revenue, respectively. Medicare, which
reimburses KCI for placement of our products and therapies with Medicare
participants, accounted for $170.4 million, or 9.1% of total revenue, $181.5
million, or 11.3% of total revenue, and $165.4 million, or 12.1% of total
revenue for the years ended December 31, 2008, 2007 and 2006,
respectively. No other individual customer or payer accounted for 10%
or more of total revenues for the years ended December 31, 2008, 2007 and 2006,
respectively.
Our
customers typically rent our V.A.C. Therapy systems and therapeutic support
systems, while they purchase our allograft and xenograft products and disposable
products related to our advanced wound healing systems, such as V.A.C.
dressings. We believe that some of our customers, who tend to be our larger
customers, desire alternatives to rental for at least some of their business. We
expect this trend may continue as V.A.C. penetration increases, and we are
evaluating and developing alternative models that will meet our customers' needs
now and into the future.
Employees
As of
January 31, 2009, we had approximately 6,900 employees. Our
corporate, finance, administrative and V.A.C. and TSS research and development
functions are performed by approximately 1,000 employees who are located in San
Antonio, Texas. Our U.S. operations had approximately 3,400
employees, including approximately 1,200 employees located in San Antonio who
perform functions associated with customer service and sales
administration. As of December 31, 2008, we employed approximately
2,000 employees internationally, including approximately 1,700 employees located
in our EMEA/APAC operations, which is primarily composed of our European
operations and 300 located in Canada. LifeCell, acquired in May 2008,
has approximately 460 employees, of which approximately 350 are located in
Branchburg, New Jersey. Approximately 90 employees in our France
subsidiary are represented by a workers' council, pursuant to applicable
industrial relations laws. Our employees are not otherwise
represented by labor unions or workers' councils and we consider our employee
relations to be good.
Corporate
Organization
We are
principally engaged in the rental and sale of advanced wound care systems,
therapeutic support systems and regenerative tissue products throughout the U.S.
and in 18 primary countries internationally. As of December 31, 2008,
we had direct operations in 18 foreign countries including Germany, Austria, the
United Kingdom, Canada, France, the Netherlands, Switzerland, Australia, Italy,
Denmark, Sweden, Norway, Ireland, Belgium, Spain, New Zealand, Singapore and
South Africa. On May 27, 2008, we completed the acquisition of all
the outstanding capital stock of LifeCell, a leader in innovative regenerative
medicine products sold primarily throughout the U.S. In the first
quarter of 2009, we expanded the distribution of our regenerative products to
the United Kingdom and Germany.
During
the first quarter of 2008, we completed the realignment of our geographic
reporting structure to correspond with our current management
structure. For 2008, we are reporting financial results for our
V.A.C. Therapy and Therapeutic Support Systems product lines consistent with
this new structure, including the reclassification of prior period amounts to
conform to this current reporting structure. Under our current
management structure, LifeCell is excluded from the geographic reporting
structure and is reported as its own operating segment. The results
of LifeCell’s operations have been included in our consolidated financial
statements since the acquisition date.
We have
three reportable operating segments: (i) North America – V.A.C. and Therapeutic
Support Systems, which is comprised principally of the U.S. and includes Canada
and Puerto Rico; (ii) EMEA/APAC – V.A.C. and Therapeutic Support Systems, which
is comprised principally of Europe and includes the Middle East, Africa and the
Asia Pacific region; and (iii) LifeCell.
With
approximately 3,700 employees as of December 31, 2008, our North America
division serves the acute care, extended care and homecare markets in the U.S.,
Canada and Puerto Rico with the full range of our products and services. In the
U.S., we distribute our medical devices and therapeutic support systems to acute
care hospitals and extended care organizations and also directly serve the
homecare market through our service center network. Our North America division
accounted for approximately 67.7%, 76.0% and 77.2% of our total revenue in the
years ended December 31, 2008, 2007 and 2006, respectively.
Our
EMEA/APAC division distributes our medical devices and therapeutic support
systems through a network of 45 service centers and has key relationships with
an extensive list of acute care hospitals. Our international corporate office is
located in Amsterdam, the Netherlands. During 2008, our international
manufacturing and engineering operations were based in the United Kingdom,
Ireland and Belgium. We also have research and development personnel
in Japan who oversee our clinical studies and developments in that
country. In addition, our international division serves the demands
of a growing global market through relationships with approximately 40
independent distributors in Latin America, the Middle East, Eastern Europe and
Asia. The EMEA/APAC division consists of approximately 1,700 employees who
are responsible for all sales, service and administrative functions within the
various countries we serve. Our EMEA/APAC division accounted for approximately
24.0%, 24.0% and 22.8% of our total revenue in the years ended December 31,
2008, 2007 and 2006, respectively.
Our
LifeCell division develops, processes and markets biological soft tissue repair
products made from human and animal tissue. LifeCell currently
markets AlloDerm in the U.S. for plastic reconstructive, general surgical and
burn applications through our direct sales and marketing
organization. During the first quarter of 2008, LifeCell also
commenced marketing Strattice through its direct sales and marketing
organization. As of December 31, 2008, our LifeCell division had a
sales, marketing and customer service staff of approximately 130 employees,
including approximately 100 in our domestic sales
organization. LifeCell accounted for approximately 8.3% of our
total revenue for the year ended December 31, 2008.
Sales
and Marketing Organization
Total
selling, marketing and advertising expenses in each of the periods below were as
follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
|
$ |
322,498 |
|
|
$ |
273,127 |
|
|
$ |
237,440 |
|
|
Percentage
of total revenue
|
|
17.2 |
% |
|
|
17.0 |
% |
|
|
17.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing
|
$ |
67,973 |
|
|
$ |
57,297 |
|
|
$ |
58,938 |
|
|
Percentage
of total revenue
|
|
3.6 |
% |
|
|
3.6 |
% |
|
|
4.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advertising
|
$ |
9,646 |
|
|
$ |
8,090 |
|
|
$ |
7,406 |
|
|
Percentage
of total revenue
|
|
0.5 |
% |
|
|
0.5 |
% |
|
|
0.5 |
% |
V.A.C.
and TSS Operations
Our
worldwide sales organization consists of approximately 2,000 individuals
and is organized by care setting. Since physicians and nurses are critical to
the adoption and use of advanced medical systems, a major element of the sales
force's responsibility is to educate and train these medical practitioners in
the application of our products, including the specific knowledge necessary for
optimal clinical outcomes and reducing the cost of patient care. We have
approximately 630 clinical consultants, all of whom are healthcare
professionals, whose principal responsibilities are to make product rounds,
consult on complex cases and assist organizations and home health agencies in
developing their patient-care protocols. Our clinicians educate the hospital,
long-term care organization or home health agency staff on the use of our
products. In addition, we employ approximately 160 specialists who consult with
our customers regarding the often demanding and complex paperwork required by
Medicare and private insurance companies. In fulfilling the paperwork
requirements, these specialists enhance the overall productivity of our sales
force.
Our U.S.
sales organization includes approximately 1,200 employees. Effective
February 2008, our U.S. sales organization was realigned to provide for a
dedicated sales force for our therapeutic support systems separate from our
V.A.C. Therapy products. Our international sales organization
includes approximately 700 employees in 18 foreign countries. In each foreign
market where we have a presence, we sell our products through our direct sales
force or through local distributors with local expertise.
LifeCell
Operations
LifeCell
currently markets AlloDerm in the U.S. for plastic reconstructive, general
surgical and burn applications through its direct sales and marketing
organization. During the first quarter of 2008, LifeCell also
commenced marketing Strattice through its direct sales and marketing
organization. As of December 31, 2008, LifeCell had a sales,
marketing and customer service staff of approximately 130 employees, including
100 in the U.S. sales organization. LifeCell sales representatives
are responsible for interacting with plastic surgeons; general surgeons; ear,
nose and throat surgeons; and burn surgeons to educate them regarding the use
and potential benefits of LifeCell’s reconstructive tissue
products. LifeCell also participates in numerous national fellowship
programs, national and international conferences and trade shows, and sponsor
medical education symposia.
BioHorizons
Implant Systems, Inc., is an exclusive distributor in the U.S. and certain
international markets of AlloDerm for use in periodontal
applications. Wright Medical Group is an exclusive distributor in the
U.S. and certain international markets for GraftJacket. Stryker
Corporation is an exclusive distributor in the U.S. for AlloCraft DBM. Boston
Scientific Corporation is an exclusive worldwide sales and marketing agent for
Repliform for use in urogynecology. Tornier is an exclusive
distributor for Conexa in the U.S. and certain international
markets.
Service
Organization
Our U.S.
operations have a national 24-hour, seven day-a-week customer service
communications system, which allows us to quickly and efficiently respond to our
customers' needs. Additionally, our U.S. operations have approximately 1,200
employees located in San Antonio who perform functions associated with customer
service and sales administration. In 2005, we launched KCI Express, our secure
and encrypted website allowing customers in acute care, extended care and
homecare to transact business with KCI directly on the web. Our
website, www.kciexpress.com,
provides KCI’s customers self-service applications designed to meet the specific
needs in their care setting. Our North America division distributes
our medical devices and therapeutic support systems through a network of 135
service centers. Our U.S. division's network gives us the ability to
deliver our products to any major Level I domestic trauma center within
hours. Our international operations distribute our medical devices
and therapeutic support systems through a network of 59 service
centers. These international service centers are strategically
located within the regions and countries where we market our products and
provide services similar to those provided in the U.S. market, but vary by
country to ensure we meet the unique needs of our international
customers.
In
addition to delivery, pick-up and technical support services, our service
organization cleans, disinfects and reconditions products between
rentals. To ensure availability when products are needed, the service
organization manages our rental fleet of approximately 170,000 units,
deploying units to meet individual service center demand patterns while
maintaining high levels of rental asset utilization. Services are
provided by approximately 1,000 employees in the U.S. and 600 employees
internationally.
Research
and Development
In 2008,
we continued our successful track record of pioneering advanced wound care,
regenerative medicine and therapeutic support system technologies through new
product introductions and significant enhancements to existing products. Our
development and commercialization of V.A.C. Therapy systems, including
proprietary disposable dressings, has established KCI as a leader in advanced
wound care. With the recent acquisition of LifeCell, we now offer a portfolio of
regenerative medicine products that are used in a variety of surgical procedures
including: breast reconstruction, abdominal wall reconstruction, orthopedic
repair, and burn management. From LifeCell, we also gained valuable
biological matrix knowledge and technologies to complement our product
development efforts. Our therapeutic support systems technology
originated with the introduction of the RotoRest bed over 30 years ago.
Since that time, we have continued to develop and commercialize a broad spectrum
of therapeutic support systems which have significantly enhanced patient
care. Additionally, we continue to strengthen our medical
capabilities and commitments to clinical research that continues to demonstrate
the benefits of our technologies. Our research and development
activities are managed by approximately 240 employees worldwide.
One of
our primary focuses for innovation is to gain greater insights into areas of
high clinical needs, where we can bring new product solutions with novel
technologies to help clinicians address these problems. We aim to
expand our product offerings beyond wound care, to areas that address
significant unmet needs of our customers and their patients. In
addition, we strive to improve the value proposition of our products by
increasing their clinical and economic benefits and by improving their ease of
use. Significant investments in our 2008 research and development
included:
|
·
|
new,
advanced wound healing systems and dressings tailored to the needs of
different wound types and care
settings;
|
|
·
|
new
technologies in wound healing and tissue
repair;
|
|
·
|
new
applications of negative pressure technology for other therapeutic
modalities;
|
|
·
|
initiation,
execution or support of a number of clinical trials, registries,
development studies, and investigator initiated
trials;
|
|
·
|
development
of new surgical applications for
Strattice;
|
|
·
|
development
of programs designed to expand our product line in the rapidly growing
biosurgery market.
|
Expenditures
for research and development, including clinical trials, in each of the periods
below, were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development spending
|
$ |
75,839 |
|
|
$ |
50,532 |
|
|
$ |
36,694 |
|
|
Percentage
of total revenue
|
|
4.0 |
% |
|
|
3.1 |
% |
|
|
2.7 |
% |
Our
regenerative medicine research activities are funded by current operations, as
well as research grants obtained through external organizations, including the
National Institutes of Health and the Department of Defense. Research
grant revenues of $291,000 were recognized in 2008, subsequent to the LifeCell
acquisition.
Patents,
Trademarks and Licenses
To
protect our proprietary rights in our products, new developments, improvements
and inventions, we rely on a combination of patents, copyrights, trademarks,
trade secrets and other laws, and contractual restrictions on disclosure,
copying and transfer of title, including confidentiality agreements with
vendors, strategic partners, co-developers, employees, consultants and other
third parties. We seek patent protection in the U.S. and
abroad. We have approximately 175 issued U.S. patents relating to our
existing and prospective lines of therapeutic medical devices. We
also have approximately 200 pending U.S. patent applications. Many of
our specialized beds, medical devices and services are offered under proprietary
trademarks and service marks. We have approximately 85 trademarks and
service marks registered with the U.S. Patent and Trademark
Office. We also have agreements with third parties that provide for
the licensing of patented and proprietary technology.
We have
patents relating to our current V.A.C. Therapy products, in the form of owned
and licensed patents, including approximately 60 issued U.S. patents (including
17 design patents) and approximately 145 U.S. patent applications
pending. Our worldwide patent portfolio (including owned and licensed
patent assets) relating to current and prospective technologies in the field of
V.A.C. Therapy includes more than 700 issued patents and approximately 660
pending patent applications, including protection in Europe, Canada, Australia,
Japan and the U.S. Most of the V.A.C. patents in our patent portfolio
have a term of 20 years from their date of priority. The V.A.C.
Therapy utility patents, which relate to our basic V.A.C. Therapy, extend
through late 2012 in certain international markets and through the middle of
2014 in the U.S. We also have multiple longer-term patent filings
directed to cover unique central systems, dressings and other improvements of
the V.A.C. Therapy system.
On October 6,
1993, we entered into a license agreement with Wake Forest University on which
we rely in connection with our V.A.C. Therapy business. Under this
agreement, Wake Forest University has licensed to us on a worldwide, exclusive
basis, the right to use, lease, sell and sublicense its rights to certain
patents that are integral to the technology that we incorporate in our V.A.C.
Therapy products. The term of the agreement continues for as long as
the underlying patents are in effect, subject to Wake Forest University's right
to terminate earlier if we fail to make required royalty payments or are
otherwise in material breach or default of the agreement.
There are
certain primary patents and patent applications that we rely upon to protect our
regenerative medicine technology. Three issued U.S. patents cover
methods of producing our tissue-based products and products made by some of
these methods. Seven additional U.S. patents and thirteen pending U.S. patent
applications supplement these patents and cover methods and apparatus for using,
preparing, preserving and freeze-drying tissue-based
products. Additionally, we license rights to additional technologies,
some of which are protected by patents owned by others. We also have
applied for patent protection in several foreign countries. Because
of the differences in patent laws and laws concerning proprietary rights, the
extent of protection provided by U.S. patents or proprietary rights owned by or
licensed to us may differ from that of their foreign counterparts.
We have
federal trademark or service mark registrations that we currently use for
LifeCell, which concern processing and preserving tissue samples; for AlloDerm,
which concerns our human allograft tissue matrix products; for Strattice, our
xenograft tissue matrix product; and for Repliform, the version of AlloDerm for
urology and gynecology. GraftJacket is a registered trademark of
Wright Medical Group. AlloCraftDBM is a registered trademark of
Stryker Corporation.
We are
subject to legal proceedings involving our patents that are significant to our
business. These proceedings are discussed subsequently in "Item 3:
Legal Proceedings."
Manufacturing
Our
manufacturing processes for V.A.C. Therapy systems and therapeutic support
systems, including mattress replacement systems and overlays, involve producing
final assemblies in accordance with a master production plan. Assembly of our
products is accomplished using (1) metal parts that are fabricated,
machined, and finished internally, (2) fabric that is cut and sewn
internally and externally, and (3) plastics, electronics and other
component parts that are purchased from outside suppliers. Component parts and
materials are obtained from industrial distributors, original equipment
manufacturers and contract manufacturers. The majority of parts and materials
are readily available in the open market (steel, aluminum, plastics, fabric,
etc.) for which price volatility is low. The manufacturing process and quality
system are in compliance with the International Organization for
Standardization, or ISO, specifically ISO 13485:2003, and the U.S. Food and Drug
Administration’s Quality System Regulation, 21 CFR 820.
Effective
November 2007, we entered into a supply agreement with Avail Medical Products,
Inc., a subsidiary of Flextronics International Ltd., which was subsequently
amended as of July 31, 2008. The agreement has a term of five years
through November 2012 and is renewable annually for an additional twelve-month
period in November of each year, unless either party gives notice to the
contrary three-months or more prior to the expiration of the then-current
term. Under this agreement, we have title to the raw materials used
to manufacture our disposable supplies and retain title of all disposables
inventory throughout the manufacturing process. The terms of the
supply agreement provide that key indicators be provided to us that would alert
us to Avail's inability to perform under the agreement. We currently
maintain an inventory of disposables sufficient to support our business for
approximately seven weeks in the U.S. and nine weeks in Europe. Our
manufacturing plant in Ireland currently manufactures our V.A.C. Therapy units
for our global markets which had previously been manufactured in our San
Antonio, Texas and United Kingdom plants. Additionally, beginning in
2009, the Ireland plant will start manufacturing certain disposable supplies
which are currently supplied by Avail Medical. Approximately 24.0% and 24.1% of
our total revenue for the years ended December 31, 2008 and 2007, respectively,
was generated from the sale of these disposable supplies. In
the event that we are unable to replace a shortfall in supply, our revenue could
be negatively impacted in the short term.
We
conduct our regenerative medicine manufacturing operations, including tissue
processing, warehousing and distribution at a single location in Branchburg, New
Jersey. We maintain a comprehensive quality assurance and quality
control program, which includes documentation of all material specifications,
operating procedures, equipment maintenance, and quality control test methods
intended to comply with appropriate FDA and ISO requirements. During
2008, our regenerative medicine operations operated with 85-90% cumulative
utilization of plant and equipment. We are currently validating a new
manufacturing suite in our existing facility that will be operational by the end
of the first quarter of 2009. With the addition of this new
manufacturing facility, we believe that we will have sufficient manufacturing
capacity for anticipated growth in the near term.
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 a recent FDA inspection of our manufacturing facility that led to the
issuance of a Form 483, in which the FDA identified 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 Form 483
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 the 483 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 we plan to
prevent GMP violations from occurring in the future, and that we supply
documentation of corrective actions taken. 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. We are
currently in dialogue with the FDA regarding the corrective
actions. While we believe that this matter 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 our business. While the warning letter did not cite any of the GTP
observations relating to AlloDerm, we have not received notice that the FDA’s
observations with regards to AlloDerm have been resolved.
Working
Capital Management
We
maintain inventory parts, supplies and V.A.C. disposables to support customer
needs in our service centers, manufacturing facilities and supplier distribution
warehouses. We also maintain inventory for conversion to our surface and V.A.C.
rental fleet in our manufacturing facilities. Our V.A.C. rental equipment cannot
be used without the disposables that support the V.A.C. Therapy systems. As
such, we generally ship disposable inventory directly from our supplier to the
customer.
Our
payment terms with acute care and extended care organizations are consistent
with industry standards and generally provide for payment within 30 days of
invoice. Our payment terms with third-party payers, including
Medicare and private insurance, are consistent with industry standards and are
regulated by contract and state statute and generally vary from 30 to 45
days. A portion of our receivables relate to unbilled revenues
arising in the normal course of business. A portion of our revenues
remain unbilled for a period of time due to monthly billing cycles requested by
our acute care or extended care organization customers or due to our internal
paperwork processing and compliance procedures regarding billing third-party
payers.
Competition
We
believe that the principal competitive factors within our markets are clinical
efficacy, clinical outcomes, cost of care and service. Furthermore, we believe
that a national presence with full distribution capabilities is important to
serve large, national and regional healthcare GPOs. We have contracts with most
major hospital GPOs and most major extended care GPOs for V.A.C. Therapy
systems. The medical device industry is highly competitive and is characterized
by rapid product development and technological change. In order to remain
competitive with other companies in our industry, we must continue to develop
new cost-effective products and technologies that result in superior clinical
outcomes.
Historically,
our V.A.C. Therapy systems have competed primarily with traditional wound care
dressings, other advanced wound care dressings (hydrogels, hydrocolloids,
alginates), skin substitutes, products containing growth factors and other
medical devices used for wound care. Many of these methods can be
used to compete with V.A.C. Therapy or as adjunctive therapies which may
complement V.A.C. Therapy. For example, caregivers may use one of our
V.A.C. Therapy systems in order to reduce the wound size and create a healthy
wound bed, and then use a skin substitute to manage the wound to final
closure.
We
believe our V.A.C. Therapy system is well-positioned to compete effectively in
advanced wound care, based on the clinical efficacy and superior outcomes of
V.A.C. Therapy, as supported by the large body of evidence we have collected,
our breadth and scope of customer relationships and our extensive sales and
service infrastructure. As a result of the success of our V.A.C.
Therapy systems, a number of companies have announced or introduced products
similar to or designed to mimic our V.A.C. Therapy systems and others may do so
in the future. If competitors are able to successfully develop
technologies that do not infringe our intellectual property rights and obtain
FDA clearance and reimbursement, we could face increasing competition in the
advanced wound care business. Over time, as our patents in the
V.A.C. field begin to expire, we expect increased competition with products
adopting the basic V.A.C. technologies.
Our
advanced wound care business primarily competes with Smith & Nephew,
Huntleigh Healthcare/Gettinge, Talley and RecoverCare/Sten+Barr, in addition to
several smaller companies that have introduced medical devices designed to
compete with our V.A.C. Therapy systems. In addition to direct
competition from companies in the advanced wound care market, healthcare
organizations may from time to time attempt to assemble NPWT devices from
standard hospital supplies. While we believe that many possible NPWT
device configurations by competitors or healthcare organizations would infringe
our intellectual property rights, we may be unable to enforce our rights against
the sale or use of such potentially competing products, which could harm our
ability to compete and could adversely affect our business.
With
respect to therapeutic support systems for treatment of pulmonary complications
in the ICU, wound treatment and prevention, our primary competitors are Hill-Rom
Company, Huntleigh Healthcare and Stryker Corporation. In the bariatric market,
our primary competitors are Hill-Rom Company, Sizewise Rentals, Stryker
Corporation and Huntleigh Healthcare. We also compete on a regional, local and
market segment level with a number of other companies.
Our
regenerative medicine products compete with autologous tissue and various
commercially available products made from synthetic materials or biologic
materials of human or animal tissue origin. Our tissue matrix
products compete with synthetic surgical mesh products marketed by such large
medical device companies as Johnson & Johnson; C.R. Bard; W.L. Gore &
Associates; and Integra Life Sciences Holdings Corporation. They also
compete with animal-derived products marketed by companies such as C.R. Bard;
Cook, Inc.; and Tissue Science Laboratories, plc. Two tissue
processors, Musculoskeletal Transplant Foundation (“MTF”) and RTI BioLogics,
distribute human tissue-based products that compete with our
products. MTF distributes its products through a direct sales force
and through Synthes, Inc. and Johnson & Johnson. RTI BioLogics
distributes its products through C.R. Bard and Mentor
Corporation. Our AlloCraftDBM product competes with other similar
bone repair products produced by companies such as RTI BioLogics.; Osteotech,
Inc.; AlloSource; Wright Medical Group; Isotis Orthobiologics; and
MTF.
Reimbursement
We have
extensive contractual relationships and reimbursement coverage for our products
in the U.S. We have contracts with nearly all major acute care
hospital organizations and most major extended care organizations. As
of December 31, 2008, we have V.A.C. contracts with private and governmental
payer organizations covering over 200 million member lives in the U.S.,
which represents more than 10 times the number of member lives we had under
contract as of mid-2000. Our products are rented and sold principally
to hospitals, extended care organizations and directly to patients in the home
who receive payment coverage for the products and services they utilize from
various public and private third-party payers, including government-funded
programs, such as the Medicare and Medicaid programs in the U.S. and other
publicly-funded health plans in foreign jurisdictions. As a result,
the demand and payment for our products are dependent, in part, on the
reimbursement policies of these payers. The manner in which
reimbursement is sought and obtained for any of our products varies based upon
the type of payer involved and the setting to which the product is furnished and
in which it is utilized by patients. Generally, acute and extended
care organizations pay us directly for our products and services; however, in
the homecare market, we provide our products and services directly to patients
and bill third-party payers. We believe that government and
private insurance efforts to contain or reduce healthcare costs are likely to
continue. These trends may lead third-party payers to deny or limit
coverage and reimbursement for our products, which could negatively impact the
pricing and profitability of, or demand for, our products.
The
following table sets forth, for the periods indicated, the percentage of revenue
derived from different types of payers:
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Acute
and extended care organizations
|
|
70.3% |
|
|
|
67.4% |
|
|
|
67.9% |
|
|
Third-party
payers
|
|
29.7% |
|
|
|
32.6% |
|
|
|
32.1% |
|
Hospital
Setting
Acute
care hospitals in the U.S. and in most of the countries where we conduct
business are generally reimbursed for the treatment of patients by governmental
healthcare programs or private insurance. In the U.S., Medicare
reimburses acute care hospitals for inpatient operating costs based upon
prospectively determined rates. Under the inpatient prospective
payment system, or IPPS, acute care hospitals receive a predetermined payment
rate for each hospital discharge. The fixed payment amount is based
upon each patient’s Medicare Severity Diagnosis Related Group, or
MSDRG. Every MSDRG is assigned a payment rate based upon the
estimated intensity of hospital resources necessary to treat the average patient
with that particular diagnosis. The MSDRG payment rates are based
upon historic national average costs and do not consider the actual costs
incurred by a hospital in providing care to an individual
patient. Certain additional or "outlier" payments may be made to a
hospital for cases involving unusually high costs or lengths of
stay. Accordingly, U.S. acute care hospitals generally do not receive
direct Medicare reimbursement under the IPPS for the distinct costs incurred in
purchasing or renting our products. Rather, reimbursement for these
costs must come from within the MSDRG payments made to hospitals for the
treatment of Medicare-eligible inpatients who utilize the
products. U.S. long-term care and rehabilitation organizations are
now also paid under a prospective payment system, or PPS, rate that does not
directly account for all actual services rendered. Because PPS
payments are based on predetermined rates, and may be less than a facility’s
actual costs in furnishing care, organizations have incentives to lower their
inpatient operating costs by utilizing equipment and supplies, such as our
products, that will reduce the length of inpatient stays, reduce avoidable
procedures, decrease labor or otherwise lower their costs. Such
facilities are also incentivized to pay as little as possible to procure such
beneficial equipment and supplies. In the hospital setting, we
generally contract directly with healthcare facilities, or group purchasing
organizations representing such facilities, for the rental or sale of our
products at rates which are negotiated independently of the reimbursement
amounts the facilities receive for the treatment of patients using our
products.
From time
to time, U.S. and foreign governmental payers make changes to the way they
reimburse hospitals and other facilities for the treatment of
patients. The change in fiscal year 2008 to restructure the inpatient
MSDRGs to account more fully for the severity of patient illness reclassified
the 538 Diagnosis Related Groups, or DRGs, into 745 new severity-adjusted
MSDRGs. As a result, payments are expected to increase for hospitals
serving more severely ill patients and decrease for those serving patients who
are less severely ill. These changes will be phased in over two
years. These changes or others that may be adopted in the U.S. or
internationally could ease or increase pressure on prices paid by acute care
hospitals to KCI depending on hospital case mix and alter the demand for our
products based on hospital case mix.
Skilled
Nursing Facility Setting
We
provide products to patients in skilled nursing facilities and long term care
centers in the U.S. and in most of the countries where we conduct
business. In this care setting, KCI generally receives payment either
directly from the facility pursuant to a negotiated agreement, from a patient’s
private insurance carrier, or directly from the patient. In many
cases, these facilities are reimbursed directly by governmental healthcare
programs or private insurance similar to acute care facilities, as described
above. In the U.S., Medicare reimbursement for skilled nursing
facilities is conducted under a prospective payment system, where Medicare
patients are assigned categories upon admission based upon the medical services
and functional support the patient is expected to require. The
facility then receives a prospectively determined daily payment based upon the
category assigned to each Medicare patient. These payments are intended
generally to cover all inpatient services for Medicare patients, including
routine nursing care, capital-related costs associated with the inpatient stay
and ancillary services. Many U.S. state Medicaid programs reimburse
skilled nursing facilities in a similar manner, while some Medicaid programs may
provide additional reimbursement to facilities based on the actual care provided
to patients. Because many skilled nursing facilities and other long
term care centers receive fixed reimbursement amounts based on assigned patient
categories, rather than the actual cost of care, these facilities face
increasing cost pressures due to rising healthcare costs.
Home
Setting
In the
home care setting, we generally provide products directly to patients and
receive direct reimbursement from governmental healthcare programs, private
insurance, or the patient. The demand for our products in the home is
highly dependent upon the coverage and reimbursement determinations of
governmental and private insurance payers. In the U.S., we provide
products to Medicare beneficiaries under the Part B program, which
reimburses beneficiaries, or suppliers accepting an assignment of the
beneficiary's Part B benefit, for the purchase or rental of Durable Medical
Equipment (“DME”) for use in the beneficiary's home or a home for the
aged. As long as we continue to provide our products to Medicare
beneficiaries for use in the homecare setting and the Medicare Part B
coverage criteria are met, our homecare products are reimbursed under the
Medicare DME benefit. Pursuant to the fee schedule payment
methodology for this category, Medicare pays a monthly rental fee equal to 80%
of the established allowable charge for the item. The patient (or his
or her supplemental insurer) is responsible for the remaining 20%. In
contrast to the hospital and skilled nursing facility settings where we bill and
collect from the inpatient facilities, KCI generally bills the Medicare program
and other insurers directly, on an assignment basis, for the covered homecare
items we furnish. This direct billing, including billing to federal
healthcare programs, raises additional potential liabilities. See
“Government Regulation
– Fraud and Abuse
Laws.”
In the
U.S., our V.A.C. Therapy Systems are subject to Medicare Part B reimbursement in
the home. Many U.S. insurers have adopted coverage criteria similar to Medicare
standards. We have received governmental home care reimbursement in a
number of countries outside the U.S. where we conduct business and we are
actively seeking reimbursement and coverage in other
countries. Receiving and increasing reimbursement levels for our
products is essential to maintain demand for our products. Any
adverse determinations or reductions in governmental reimbursement for our
products in the U.S. or internationally could negatively affect the demand for
our products.
In
addition, governmental programs frequently adopt new reimbursement rules and
practices that may affect our business. In 2003, the Centers for
Medicare and Medicaid Services (“CMS”) issued a final rule implementing an
"inherent reasonableness" authority, which allows CMS and its administrative
contractors to adjust reimbursement amounts for durable medical equipment
covered under Medicare Part B by up to 15% per year when the existing fee
schedule payment amount for an item or service is determined to be grossly
excessive or grossly deficient. The regulation lists factors that may
be used by CMS and the administrative contractors to determine whether an
existing reimbursement rate is grossly excessive or grossly deficient and to
determine what is a realistic and equitable payment amount. CMS may
make a larger adjustment each year if they undertake prescribed procedures for
determining the appropriate payment amount for a particular
service. Using this authority, CMS and the administrative contractors
could reduce KCI’s reimbursement levels for its home care products covered by
Medicare Part B.
The
Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA,
provides for revisions to the manner in which payment amounts are to be
calculated over the next five years (and thereafter). The MMA
contains revisions to payment methodologies and other standards for items of
DME. These revisions could have a direct impact on our
business. In the MMA, Congress directed CMS to establish a
competitive bidding program to pay for certain items of durable medical
equipment, prosthetics, orthotics and supply, or DMEPOS, beginning in
2007.
CMS
formally launched the DMEPOS competitive bidding program through publication of
a final rule in April 2007, under which suppliers were required to bid and meet
certain program standards in order to supply selected DMEPOS items to Medicare
beneficiaries in certain designated geographic areas. In 2008, CMS
operated competitive bidding areas, or CBAs, for NPWT within 8 large
metropolitan areas before Congress enacted the Medicare Improvements for
Patients and Providers Act of 2008 (“MIPPA”) on July 15,
2008. Several key provisions of MIPPA include the exemption of NPWT
from the first round of competitive bidding, termination of all durable medical
equipment supplier contracts previously awarded by CMS in the first round of
competitive bidding, delay of the implementation of the first round of
competitive bidding until at least January 2010 and of the second round of
competitive bidding until at least January 2011. The law also defers
competitive bidding for NPWT until at least January 2011 and imposes a 9.5%
price reduction for all U.S. Medicare placements of equipment as of January
2009. The 9.5% reduction in reimbursement will result 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
Medicare reimbursement reduction will negatively impact our 2009 revenue by
approximately 1.0%, compared to pre-2009 reimbursement levels.
Additionally,
MIPPA directed CMS to evaluate the NPWT codes for the consideration of coding
changes after the evaluation of all relevant studies and
information. On December 30, 2008, KCI received notice that CMS had
contracted with the Agency for Healthcare Research and Quality (“AHRQ”) and
their subcontractor, the ECRI Institute, and have begun the NPWT Technology
Assessment as directed by Congress in the MIPPA. After AHRQ releases
their NPWT Technology Assessment, CMS will make preliminary coding
recommendations for this category in April, with a final coding decision
released in the fourth quarter of 2009. Any changes in coding to this
category will be effective January 1, 2010. U.S. Medicare Part B
revenue was approximately 17.0% of our total U.S. V.A.C. Therapy revenue, or
9.1% of KCI’s total revenue for the year ended December 31, 2008. The
future impact for KCI will vary based on whether CMS differentiates the NPWT
codes based on the published clinical and scientific evidence or maintains
current coding. KCI feels well positioned for the NPWT Technology
Assessment and coding review given our substantial body of clinical and
scientific evidence, including 16 Randomized Clinical Trials and over 470 peer
reviewed studies; numerous published clinical guidelines; and outstanding
support of the clinical community.
International
(OUS) Coverage and Reimbursement
In order
for KCI to meet its business objectives, it is important that with regard to our
products the company achieve increasing market penetration in countries outside
the U.S., or OUS. In most OUS markets, KCI’s V.A.C. Therapy System is
covered and reimbursed in the inpatient hospital setting and to some extent,
depending on the country, in post acute or community based care settings.
However, in certain countries important to KCI’s growth, such as Germany, United
Kingdom, France and Spain, post acute care coverage and reimbursement are
largely provided on a case by case basis and multiple efforts are underway with
certain countries to secure consistent coverage and reimbursement policies in
community based (outpatient) care settings. In targeted countries, KCI is
utilizing accepted “coverage with evidence” mechanisms in close cooperation with
local esteemed clinicians and clinical centers, government health ministry
officials, and in some cases, private payers to obtain the necessary evidence to
support adequate coverage and reimbursement. Strattice, KCI’s newest tissue
regeneration product from LifeCell has achieved regulatory clearance in European
Union countries, which enables KCI to pursue the evidence requirements for
coverage and reimbursement. It can be expected that this process is more complex
and by definition lengthier due to the biotech category in which they
reside.
In the
Asia/Pacific Region (“APAC”), major coverage and reimbursement efforts for our
V.A.C. Therapy Systems are underway. In Japan, we are currently
seeking reimbursement to facilitate commercialization of our V.A.C. Therapy
System in the acute care setting. Related to our reimbursement
efforts in Japan, we have reported successful results from our V.A.C. clinical
trials. We have submitted the required dossiers for regulatory
approval and are currently in the process of responding to questions from the
Pharmaceutical and Medical Devices Agency, which serves as the regulatory
authority in Japan. In Australia, where acute care reimbursement for
the V.A.C. Therapy System has been approved for many years, the company is
seeking reimbursement approval for V.A.C. in the post acute or community based
settings. In this regard, negotiations are underway with the
Australian health ministry, as well as that country’s largest private payers.
Other APAC countries that are important to KCI’s growth are China, India, South
Korea, Taiwan and Singapore, but these for the present are secondary targets
with regard to the allocation of KCI health economic and reimbursement
resources.
Overall,
the prospects of KCI achieving its world-wide coverage and reimbursement goals
for its products in both acute and post acute settings are dependent upon the
controls applied by governments and private payers with regard to rising
healthcare costs balanced by the significant and growing evidence that KCI wound
healing products have demonstrated the ability to prepare wounds for closure
while reducing the costs associated with them. KCI believes that its plans to
achieve positive coverage and reimbursement decisions for its products in OUS
countries are sound, based on a growing need for clinical and economic evidence
of their necessity and that the company is prioritizing these country by country
efforts appropriately.
LifeCell
Regenerative Tissue Matrices
LifeCell
regenerative tissue matrices, AlloDerm and Strattice, are used primarily by
plastic and reconstruction surgeons and general surgeons treating patients with
complex abdominal wall/hernia repair and breast reconstruction postmastectomy.
Hospitals are the primary purchasers of the matrices, and these surgical
procedures are handled primarily in the hospital inpatient care setting with
reimbursement associated with the appropriate MSDRG. Surgeons are
reimbursed based on the appropriate Current Procedural Terminology reflecting
the services provided. The majority of patients treated with AlloDerm
or Strattice are non-Medicare patients.
LifeCell
is paid directly by hospitals, who seek reimbursement for surgical procedures
from both private and public insurers. As of 2007, the majority of
private and public insurers did not provide coverage or payment for the use of
AlloDerm in connection with a surgical procedure, and AlloDerm was considered to
be experimental, investigational and not medically necessary. Often,
this would result in hospitals and doctors not being reimbursed for procedures
using AlloDerm. LifeCell made significant efforts in 2008 to inform
and educate private insurers about AlloDerm and the value it brings to the
patient in terms of improved clinical outcomes. By the end of 2008,
several major national and regional insurers have revised their policies to
provide coverage for the use AlloDerm in connection with surgical procedures,
which is now available to more than 90 million lives in the U.S.
At the
end of 2008, CMS changed the Healthcare Common Procedure Coding System (“HCPCS”)
coding for all tissue/skin substitute biologicals from J codes to Q codes.
During the transition change to Q codes, effective January 1, 2009, the agency
inadvertently did not assign a distinct Q code for AlloDerm. LifeCell
Corporation is currently working with the agency to correct this
discrepancy. HCPCS codes are important to facilities for appropriate
payment for AlloDerm when procedures are able to be conducted in a Hospital
Outpatient setting or in an Ambulatory Surgery Center. A favorable
resolution is anticipated by the third quarter of 2009.
With the
launch of Strattice in the first quarter of 2008, efforts to secure insurance
coverage will be initiated with the support of published clinical
data. Initial private insurance coverage has been
favorable. On December 23, 2008, LifeCell submitted to CMS a HCPCS
Coding Modification Recommendation requesting an appropriate HCPCS code for
Strattice. This submission will be reviewed by the
agency. A preliminary decision is expected in the first quarter of
2009, with the opportunity to comment on the preliminary decision in late spring
or early summer 2009, with a final determination made in late October or early
November 2009. A successful determination will provide Strattice a
new HCPCS code effective January 1, 2010.
Human
Tissue Procurement
In 2008,
we obtained all of our donated human cadaveric tissue from tissue banks and
organ procurement organizations in the U.S. These tissue banks and
organ procurement organizations are subject to Federal and state
regulations. In addition, we require supplying tissue banks and organ
procurement organizations to comply with voluntary procedural guidelines
outlined by the American Association of Tissue Banks (“AATB”). The
AATB is recognized for the development of industry standards and its program of
inspection and accreditation. The AATB provides a standards-setting
function and has procedures for accreditation similar to the ISO
standards. We are accredited by the AATB.
We
believe that we have established adequate sources of donated human tissue to
satisfy the expected demand for our allograft tissue based products in the
foreseeable future. To date, we have not experienced any material
difficulty in procuring adequate donated cadaveric tissue.
Market
Outlook
Reimbursement
of Healthcare Costs and Healthcare Reform
The
demand for our products is highly dependent on the policies of third-party
payers such as Medicare, Medicaid, private insurance and managed care
organizations that reimburse us for the sale and rental of our
products. If coverage or payment policies of these third-party payers
are revised in light of increased efforts to control healthcare spending or
otherwise, the amount we may be reimbursed or the demand for our products may
decrease.
The
importance of payer coverage policies has been demonstrated by our experience
with our V.A.C. technology in the homecare setting. On October 1, 2000, a
Medicare Part B policy was approved, which provided for reimbursement
codes, an associated coverage policy and allowable rates for the V.A.C. Therapy
systems and V.A.C. disposable products in the homecare setting. The
policy facilitated claims processing, permitted electronic claims submissions
and created a more uniform claims review process. Because many payers
look to Medicare for guidance in coverage, a specific Medicare policy is often
relied upon by other payers. In contrast with this U.S.-based
experience, coverage in several European countries has been limited to
case-by-case approvals until the appropriate approvals have been granted by the
government-sponsored approval body. Switzerland approved homecare
reimbursement in 2004, which has opened the market for broad use in the
home. In February 2008, the German Ministry of Health approved a
clinical study, including paid placements, which will allow selected patients to
receive V.A.C. Therapy in the home. During the study period, KCI will
receive reimbursement from German health insurance funds for patients
participating in this study. In other countries, such as Austria and
the Netherlands, coverage by insurance companies is widespread, even without
formal government approval.
A
significant portion of our wound healing systems revenue is derived from home
placements, which are reimbursed by both governmental and non-governmental
third-party payers. The reimbursement process for homecare placements
requires extensive documentation, which has slowed the cash receipts cycle
relative to the rest of our business.
In the
U.S., healthcare reform legislation will most likely remain focused on reducing
the cost of healthcare. We believe that efforts by private payers to contain
costs through managed care and other methods will continue in the future as
efforts to reform the healthcare system continue. Current methods to
contain healthcare costs include the MMA revisions that cease increases to DME
fee schedule reimbursement through 2008 and the forthcoming Medicare DMEPOS
competitive bidding program, each of which could impact reimbursement of our
homecare products.
From time
to time, CMS publishes reimbursement policies and rates that may unfavorably
affect the reimbursement and market for our products. In the past,
our V.A.C. Therapy systems and disposables were the only devices assigned to the
CMS reimbursement codes for NPWT. Beginning in 2005, CMS assigned the
same NPWT reimbursement codes to other devices marketed to compete with V.A.C.
Therapy systems. Also, CMS may reduce reimbursement rates on NPWT or
its various components, which would reduce revenue. As a result of
recent CMS decisions, there has been an increase in the development of products
designed to compete with V.A.C. Therapy systems and inquiries from other
third-party payers regarding reimbursement levels. Both increased
competition and/or reduced reimbursement could materially and adversely affect
our operating results.
The
assignment of CMS reimbursement codes to competing products also increases the
likelihood of the NPWT product category being included in future rounds of the
DMEPOS Medicare competitive bidding program, which could negatively impact KCI’s
revenue from products that are reimbursed by Medicare in the homecare
setting. Although NPWT’s participation in the competitive bidding
program has been delayed, we anticipate that NPWT will be included in the
competitive bidding process beginning in January 2011.
The
reimbursement of our products is also subject to review by government
contractors that administer payments under federal healthcare programs,
including Durable Medical Equipment Medicare Administrative Contractors, or
DMACs, and Program Safeguard Contractors, or PSCs. The DMACs have the
authority to make local or regional determinations and policies for coverage and
payment of DME used in the home. The local coverage determinations
published by the DMACs define coverage criteria, payment rules and documentation
that will be applied to DMEPOS claims processed by the DMACs. Adverse
interpretation or application of DMAC coverage policies, adverse administrative
coverage determinations or changes in coverage policies can lead to denials of
our claims for payment and/or requests to recoup alleged overpayments made to us
for our products. Such adverse determinations and changes can often
be challenged only through an administrative appeals process.
Consolidation
of Purchasing Entities
The many
healthcare reform initiatives in the U.S. have caused healthcare providers to
examine their cost structures and reassess the manner in which they provide
healthcare services. This review, in turn, has led many healthcare
providers to merge or consolidate with other members of their industry in an
effort to reduce costs or achieve operating synergies. A substantial
number of our customers, including proprietary hospital groups, GPOs, hospitals,
national nursing home companies and national home healthcare agencies, have been
affected by this consolidation. An extensive service and distribution
network and a broad product line are key to servicing the needs of these larger
provider networks. In addition, the consolidation of healthcare providers often
results in the re-negotiation of contracts and the granting of price
concessions. Finally, as GPOs and integrated healthcare systems
increase in size, each contract represents a greater concentration of market
share and the adverse consequences of losing a particular contract
increases.
Government
Regulation
Overviews
Our
products are subject to regulation by numerous governmental authorities,
including the FDA, and corresponding state and foreign regulatory
agencies. Under the Federal Food, Drug, and Cosmetic Act, the FDA
regulates the design, clinical testing, manufacture, labeling, distribution,
sale and promotion of medical devices. Noncompliance with applicable
requirements can result in fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant pre-market clearance or pre-market approval for devices,
withdrawal of marketing clearances or approvals and criminal
prosecution. The FDA also has the authority to demand the repair,
replacement or refund of the cost of any device that we manufacture or
distribute that violates regulatory requirements.
In the
U.S., medical devices are classified into one of three classes (Class I, II
or III) on the basis of the controls deemed necessary by the FDA to reasonably
ensure their safety and effectiveness. Although many Class I devices are
exempt from certain FDA requirements, Class I devices are subject to
general controls (for example, labeling, pre-market notification and adherence
to the Quality System Regulation). Class II devices are subject
to general and special controls (for example, performance standards, post-market
surveillance, patient registries and FDA guidelines). Generally,
Class III devices are high-risk devices that receive significantly greater
FDA scrutiny to ensure their safety and effectiveness (for example,
life-sustaining, life-supporting and implantable devices, or new devices which
have been found not to be substantially equivalent to legally marketed
Class I or Class II devices). Before a new medical device
can be introduced in the market, the manufacturer must generally obtain FDA
clearance (510(k) clearance) or pre-market application, or PMA,
approval. All of our current products have been classified as
Class I or Class II devices, which typically are marketed based upon
510(k) clearance or related exemptions. A 510(k) clearance will
generally be granted if the submitted information establishes that the proposed
device is "substantially equivalent" in intended use and technological
characteristics to a legally marketed Class I or Class II medical
device or to a Class III device on the market since May 28, 1976, for
which PMA approval has not been required. A PMA approval requires proof to the
FDA's satisfaction of the safety and effectiveness of a Class III device. A
clinical study is generally required to support a PMA application and is
sometimes required for a 510(k) pre-market notification. For
"significant risk" devices, such clinical studies generally require submission
of an application for an Investigational Device Exemption. The FDA's 510(k)
clearance process usually takes from four to twelve months, but may take
longer. The PMA approval process is much more costly, lengthy and
uncertain. The process generally takes from one to three years; but it may take
even longer.
Devices
that we manufacture or distribute are subject to pervasive and continuing
regulation by the FDA and certain state agencies, including record-keeping
requirements and mandatory reporting of certain adverse experiences associated
with use of the devices. Labeling and promotional activities are
subject to regulation by the FDA and, in certain circumstances, by the Federal
Trade Commission. Current FDA enforcement policy prohibits the
marketing of approved medical devices for unapproved uses and the FDA
scrutinizes the labeling and advertising of medical devices to ensure that
unapproved uses of medical devices are not promoted.
Manufacturers
of medical devices for marketing in the U.S. are required to adhere to
applicable regulations, including the Quality System Regulation, or QSR,
(formerly the Good Manufacturing Practice regulation), which imposes design,
testing, control and documentation requirements. Manufacturers must
also comply with the Medical Device Reporting, or MDR, regulation, which
generally requires that manufacturers report to the FDA if their device may have
caused or contributed to a death or serious injury or malfunctioned in a way
that would likely cause or contribute to a death or serious injury if it were to
recur. We are subject to routine inspection by the FDA and certain
state agencies for compliance with QSR requirements, MDR requirements and other
applicable regulations. Recently, CMS announced that all DMEPOS
suppliers need to be accredited by a nationally recognized accreditation body by
September 30, 2009 in order to maintain Medicare billing
privileges. In December 2005, KCI received accreditation from the
Joint Commission on Accreditation of Healthcare Organizations, or Joint
Commission. Under this accreditation process, KCI will be reevaluated
every three years and is subject to routine unannounced inspections by the Joint
Commission to ensure
continued compliance with standards. KCI completed its
reaccreditation survey with the Joint Commission in December 2008.
FDA
Classification of LifeCell Products
We
believe that AlloDerm, GraftJacket and Repliform satisfy FDA requirements to be
considered human cells, tissues, or cellular and tissue-based products, or
HCT/P, eligible for regulation solely as human tissue and therefore, we have not
obtained prior FDA clearance or approval for commercial distribution of these
products. AlloCraftDBM is regulated as an HCT/P and medical device
and received 510(k) clearance from the FDA in December 2005.
Strattice
is regulated as a medical device and received 510(k) clearance from the FDA in
June 2007 for use as a soft tissue patch to reinforce soft tissue where weakness
exists and for the surgical repair of damaged or ruptured soft tissue membranes,
including the repair of hernias and/or body wall defects which require the use
of a reinforcing or bridging material. In October 2007 and April 2008, we
received additional 510(k) clearances for Conexa allowing its use for
reinforcement of soft tissue repaired by sutures or suture anchors during tendon
repair surgery including reinforcement of rotator cuff, patellar, achilles,
biceps, quadriceps, or other tendons.
FDA
Human Tissue Regulation
FDA
regulatory requirements for human allografts are complex and constantly
evolving. In 2001, the FDA issued a final rule requiring
manufacturers of human cellular and tissue-based products to register their
establishments and list their products with the FDA. The 2001 final
rule sets forth the FDA’s test for determining whether an HCT/P is eligible for
tissue regulation (as opposed to medical device or biologic
regulation). A product containing human tissue may be regulated
solely as a human cellular and tissue-based product or it may also be subject to
regulation as a medical device or biologic. The FDA will apply human
tissue regulation to an HCT/P that is: (i) minimally manipulated; (ii) intended
for homologous use; (iii) is not combined with a device, drug or biologic (with
limited exceptions); and (iv) does not have a systemic effect and is not
dependent upon metabolic activity for its primary function (with certain
exceptions). HCT/Ps generally may be commercially distributed without
prior FDA clearance or approval.
The FDA
has also issued regulations that require tissue donors to be screened and tested
for relevant communicable diseases and require manufacturers of HCT/Ps to follow
good tissue practice (“GTP”) in their recovery, processing, storage, labeling,
packaging and distribution of HCT/Ps in order to prevent the introduction,
transmission or spread of communicable diseases. Moreover, the FDA
has the authority to inspect our facilities and to detain, recall or destroy our
products and order us to cease manufacturing if we fail to comply with these
requirements. The new regulations also require us to report adverse
reactions and deviations from donor screening and other applicable
requirements.
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 a recent FDA inspection of our manufacturing facility that led to the
issuance of a Form 483, in which the FDA identified 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 Form 483
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 the 483 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 we plan to
prevent GMP violations from occurring in the future, and that we supply
documentation of corrective actions taken. 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. We are
currently in dialogue with the FDA regarding the corrective
actions. While we believe that this matter 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 our business. While the warning letter did not cite any of the GTP
observations relating to AlloDerm, we have not received notice that the FDA’s
observations with regards to AlloDerm have been resolved.
National
Organ Transplant Act
Procurement
of certain human organs and tissue for transplantation is subject to the
restrictions of the National Organ Transplant Act (“NOTA”), which prohibits the
acquisition of certain human organs, including skin and related tissue for
valuable consideration, but permits the reasonable payment of costs associated
with the removal, transportation, implantation, processing, preservation,
quality control and storage of human tissue and skin. We reimburse
tissue banks and organ procurement organizations for their expenses associated
with the recovery, storage and transportation of donated human skin that they
provide to us for processing. We include in our pricing structure the
fees paid to tissue banks to reimburse them for their expenses associated with
the recovery and transportation of the tissue, in addition to certain costs
associated with processing, preservation, quality control and storage of the
tissue, marketing and medical education expenses, and costs associated with
development of tissue processing technologies. NOTA does not apply to
xenograft tissue products.
Fraud
and Abuse Laws
There are
numerous rules and requirements governing the submission of claims for payment
to federal healthcare programs. If we fail to adhere to these
requirements, the government could allege that claims we have submitted for
payment violate the federal False Claims Act, or FCA. The FCA generally
prohibits the known filing of a false or fraudulent claim for payment to the
U.S. government or the known use of a false record or statement to obtain
payment on a false or fraudulent claim paid by conspiring to defraud the U.S.
government by getting a false or fraudulent claim allowed or paid. There are
both civil and criminal provisions of the FCA. Violation of the criminal FCA can
result in imprisonment of up to five years, a fine of up to $250,000 for an
individual or $500,000 for an organization, up to three times the amount of the
improper payment and/or exclusion from participating in federal and state
healthcare programs.
Under
separate statutes, submission of claims for payment or causing such claims to be
submitted that are "not provided as claimed" may lead to civil monetary
penalties, criminal fines and imprisonment, and/or exclusion from participation
in Medicare, Medicaid and other federally funded state health
programs. These false claims statutes include, but are not limited
to, the federal FCA. When an entity is determined to have violated
the civil FCA, it must pay three times the actual damages sustained by the
government, plus mandatory civil penalties of between $5,500 and $11,000 for
each separate false claim. A private party may file a suit on behalf
of the government under the Civil FCA, known as a “qui tam” or “whistle blower”
lawsuit. The ability of private individuals to collect damages under
these lawsuits significantly increase the possibility that a healthcare provider
may be challenged under the Civil FCA. In addition, recently passed
Federal legislation provides incentives for states to enact their own false
claims statutes or strengthen their existing false claims statutes. A
significant number of states have enacted their own false claims statutes and
several states have false claims legislation pending.
Qui tam
actions have increased significantly in recent years causing greater numbers of
healthcare companies to have to defend false claim actions, pay fines or be
excluded from the Medicare, Medicaid or other federal or state healthcare
programs as a result of an investigation arising out of such
action. Because we directly submit claims for payment for certain of
our products to federal and state healthcare programs, we are subject to these
false claims statutes, and, therefore, could become subject to "qui tam" or
other false claims actions. Imposition of such penalties or
exclusions would result in a significant loss of reimbursement and could have a
material adverse effect on our financial condition.
Recently,
the federal government has significantly increased investigations of medical
device manufacturers with regard to alleged kickbacks to physicians who use and
prescribe their products. The federal Anti-Kickback Statute is a
criminal statute that prohibits the offering, payment, solicitation or receipt
of remuneration (including any kickback, bribe or rebate), directly or
indirectly, overtly or covertly, in cash or in kind, for (1) the referral of
patients or arranging for the referral of patients to receive services for which
payment may be made in whole or in part under a federal or state healthcare
program; or (2) the purchase, lease, order, or arranging for the purchase, lease
or order of any good, facility, service or item for which payment may be made
under a federal or state healthcare program. Generally, courts have taken a
broad interpretation of the scope of the Anti-Kickback Statute. The criminal
sanctions for a conviction under the Anti-Kickback Statute are imprisonment for
not more than five years, a fine of not more than $25,000 or both, for each
incident or offense, although the fine may be increased to $250,000 for
individuals and $500,000 for organizations. If a party is convicted of a
criminal offense related to participation in the Medicare program or any state
healthcare program, or is convicted of a felony relating to healthcare fraud,
the secretary of the U.S. Department of Health and Human Services is required to
bar the party from participation in federal healthcare programs and to notify
the appropriate state agencies to bar the individual from participation in state
healthcare programs. Imposition of such penalties or exclusions would result in
a significant loss of reimbursement and could have a material adverse effect on
our financial condition and results of operations.
Federal
authorities have also increased enforcement with regard to the federal physician
self-referral and payment prohibitions, commonly referred to as the Stark Law.
The Stark Law generally forbids, absent qualifying for one of a few named
exceptions, a physician from making referrals for the furnishing of any
"designated health services," for which payment may be made under the Medicare
or Medicaid programs, to any "entity" with which the physician (or an immediate
family member) has a "financial relationship." DME items, including our homecare
products, are designated health services. Our arrangements with physicians who
prescribe our products, including arrangements whereby physicians serve as
speakers and consultants for KCI, our training programs and our sales and
marketing events (including meals, travel and accommodations associated
therewith), could be deemed to create a "financial relationship" under the Stark
Law, in which case, unless an applicable exception is met, the physician may not
order Medicare or Medicaid covered DME from us, and we may not present a claim
for Medicare or Medicaid payment for such items. Penalties for Stark Law
violations include denial of payment, civil monetary penalties of up to $15,000
for each illegal referral and up to $100,000 for any scheme designed to
circumvent the Stark Law requirements. Prosecution under the Stark Law could
have a material adverse impact on our financial condition and results of
operations.
In some
cases, Anti-Kickback Statute or Stark Law violations may also be prosecuted
under the FCA, which increases potential liability. In these cases, federal
authorities and whistleblowers have alleged that items and services that were
furnished in furtherance of an Anti-Kickback Statute or Stark Law violation are
not billable to federal or state healthcare programs and that, to the extent
that such claims for payment are submitted, they are false claims within the
meaning of the FCA. Even the assertion of a violation under any of these
provisions could have a material adverse effect on our financial condition and
results of operations.
Recent
federal cuts to state administered healthcare programs, particularly Medicaid,
have also increased enforcement activity at the state level under both federal
and state laws. In July 2006, CMS released its initial comprehensive
Medicaid Integrity Plan, a national strategy to detect and prevent Medicaid
fraud and abuse. This new program will work to identify, recover and
prevent inappropriate Medicaid payments through increased review of suppliers of
Medicaid services. KCI could be subjected to such reviews in any
number of states. Such reviews could result in demands for refunds or
assessments of penalties against KCI, which could have a material adverse impact
on our financial condition and results of operations.
In
addition, the Health Insurance Portability and Accountability Act of 1996, or
HIPAA, defined two new federal crimes: (i) healthcare fraud and
(ii) false statements relating to healthcare matters. The healthcare fraud
statute prohibits knowingly and willfully executing or attempting to execute a
scheme or artifice to defraud any healthcare benefit program, including private
payers. The false statements statute prohibits knowingly and willfully
falsifying, concealing or covering up a material fact or making any materially
false, fictitious or fraudulent statement or representation in connection with
the delivery of or payment for healthcare benefits, items or services. This
statute applies to any health benefit plan, not just Medicare and
Medicaid. Violations of these statutes may result in fines,
imprisonment, or exclusion from government healthcare
programs. Additionally, HIPAA granted expanded enforcement authority
to the U.S. Department of Health and Human Services, or DHHS, and the U.S.
Department of Justice, or DOJ, and provided enhanced resources to support the
activities and responsibilities of the DHHS's Office of the Inspector General,
or OIG, and the DOJ by authorizing large increases in funding for investigating
fraud and abuse violations relating to healthcare delivery and
payment.
The most
recent publication of the OIG’s Work Plan for 2009 includes several projects
that could affect our business. Specifically, the OIG indicated its initiation
of a plan to compare acquisition prices for NPWT pumps and supplies by suppliers
against the amount Medicare reimburses such suppliers for those
items. OIG has also reiterated that it plans to continue to review
DME suppliers’ use of certain claims modifiers to determine whether the
underlying claims made appropriate use of such modifiers when billing to
Medicare. Under the Medicare program, a DME supplier may use these modifiers to
indicate that it has the appropriate documentation on file to support its claim
for payment. Upon request, the supplier may be required to provide this
documentation; however, recent reviews by Medicare regional contractors have
indicated that some suppliers have been unable to furnish this information. The
OIG intends to continue its work to determine the appropriateness of Medicare
payments for certain DME items, including wound care equipment, by assessing
whether the suppliers’ documentation supports the claim, whether the item was
medically necessary, and/or whether the beneficiary actually received the
item. The OIG also plans to review DME that is furnished to patients
who are receiving home health services to determine whether the DME is properly
billed separately from the home health agency’s reimbursement. In the
event that these initiatives result in any assessments respecting KCI claims, we
could be subject to material refunds, recoupments or penalties. Such
initiatives could also lead to further changes to reimbursement or documentation
requirements for our products, which could be costly to administer.
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 the timing of our response. We intend to cooperate with the government's
review. The review is in its initial stages and we cannot predict the time frame
in which it will be resolved. For a description of risks relating to
governmental review and investigation of our businesses, see each of the risk
factors entitled “The
initiation by U.S. and foreign healthcare, safety and reimbursement agencies of
periodic inspections, assessments or studies of the products, services and
billing practices we provide could lead to reduced public reimbursement or the
inability to obtain reimbursement and could result in reduced demand for our
products;” “We may be
subject to claims audits that could harm our business and financial
results;” and “We could
be subject to governmental investigations under the Anti-Kickback Statute, the
Stark Law, the federal False Claims Act or similar state laws with respect to
our business arrangements with prescribing physicians and other healthcare
professionals.”
Several
states also have referral, fee splitting and other similar laws that may
restrict the payment or receipt of remuneration in connection with the purchase
or rental of medical equipment and supplies. State laws vary in scope and have
been infrequently interpreted by courts and regulatory agencies, but may apply
to all healthcare products or services, regardless of whether Medicaid or
Medicare funds are involved.
We are
also subject to the U.S. Foreign Corrupt Practices Act, or FCPA, which prohibits
corporations and individuals from engaging in certain activities to obtain or
retain business or to influence a person working in an official capacity. It is
illegal to pay, offer to pay, or authorize the payment of anything of value to
any foreign government official, government staff member, political party, or
political candidate in an attempt to obtain or retain business or to otherwise
influence a person working in an official capacity. Violations of the
FCPA may result in significant fines and penalties.
Claims
Audits
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. The U.S. Department of Health
and Human Services Office of Inspector General, or OIG, initiated a study on
negative pressure wound therapy, or NPWT, in 2005. 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
respecting 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 August
2007, KCI received requests for medical records in support of our claims from a
Medicare Region A Recovery Audit Contractor (‘‘RAC’’) covering 180
previously-paid claims submitted between 2004 and 2005, which KCI responded to
in a timely manner. The RAC audit initial findings were that approximately 29%
of the claims subject to this audit were not covered under Medicare and thus,
resulted in an overpayment. Amounts paid were recouped but we have
disputed the findings through the administrative appeal process. To
date, the RAC findings have been reversed in approximately half of the disputed
claims and we have received payment on those. The remaining claims
subject to the audit are still in the appeals process.
In
December 2007, the Medicare Region B DMAC initiated a pre-payment review of all
NPWT claims for the second and third months of treatment submitted by all
providers, including KCI. The pre-payment review was suspended by the
Medicare Region B DMAC in the first quarter of 2008. For every
monthly period of treatment beyond 30 days, we are required to
demonstrate/document progress towards wound healing. KCI has
responded to these claim review requests and has received reimbursement for many
of the claims subject to review. The remaining claims subject to the
audit are still in the appeals process.
In July
2008, the DMAC for Region B notified KCI of a post-payment audit of claims paid
during the second 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.
Medical
Record Confidentiality and Privacy Laws
HIPAA
covers a variety of provisions which impact our business, including the privacy
of patient healthcare information, the security of that information and the
standardization of electronic data transactions for billing. Sanctions for
violating HIPAA include criminal penalties and civil sanctions. HIPAA’s privacy
regulations restrict the use and disclosure of certain individually identifiable
protected health information, or PHI. The HIPAA security standards
require us to implement certain measures to protect the security and integrity
of electronic PHI. HIPAA regulations regarding standardization of electronic
data billing transactions also impact our business. We continue to work with all
of our business associates with whom we share PHI and who process standardized
transactions covered by the regulations in order to make the transition to
standardized billing codes as smooth as possible. However, the healthcare
industry’s continued transition to standardized billing codes may create billing
difficulties or business interruptions for us.
ISO
Certification
Due to
the harmonization efforts of a variety of regulatory bodies worldwide,
certification of compliance with International Quality System Standards (e.g.,
those issued by the ISO) has become particularly advantageous and, in certain
circumstances, necessary for many companies in recent years. We
originally received ISO 9001 and EN 46001 certification in 1997, followed by
certification in 2002 to ISO 13485:1996, a medical device-specific version of
ISO 9001. In 2005, we obtained certification to ISO 13485:2003, the
latest version of that standard. We are registered in the United
Kingdom with the Medicines and Healthcare Products Regulatory Agency and our
products are CE marked through AMTAC (notified body number
0473.) Since 2002, we have obtained medical device licenses from
Health Canada for our products.
LifeCell’s
quality management system meets the requirements of the standards ISO 13485:2003
and ISO 9001: 2000. The certifications were granted by the Netherlands-based
notified body, KEMA, in May 2008. Certification to ISO 13485 was a major
milestone for LifeCell in the strategy to attain CE Mark approval for its
Strattice Reconstructive Tissue Matrix. The CE Mark, granted in November
2008, allowed KCI to begin marketing Strattice in all 27 European Union member
(“EU”) states.
Environmental
Laws
We are
subject to various environmental laws and regulations that govern our operations
in the U.S. and internationally, including the handling and disposal of
non-hazardous and hazardous substances and wastes, and emissions and discharges
into the environment. Failure to comply with such laws and regulations could
result in costs for corrective action, penalties or the imposition of other
liabilities. We also are subject to laws and regulations that impose liability
and cleanup responsibility for releases of hazardous substances into the
environment. Under certain of these laws and regulations, such liabilities can
be imposed for cleanup of previously owned or operated properties, or properties
to which substances or wastes were sent from current or former operations at our
facilities. From time to time, we have incurred costs and obligations for
correcting environmental noncompliance matters and for cleanup of certain of our
properties and third-party sites.
Other
Laws
A few,
but increasing number of states including Florida, California, Oklahoma,
Illinois, New York and Maryland impose their own regulatory requirements on
establishments involved in the processing, handling, storage and distribution of
human tissue. Noncompliance with state requirements may include some
or all of the risks associated with noncompliance with FDA regulation, as well
as other risks.
We are
also subject to various federal, state and local laws, regulations and
requirements relating to such matters as safe working conditions, laboratory and
manufacturing practices, and the use, handling and disposal of hazardous or
potentially hazardous substances used and produced in connection with our
research and development work.
International
Sales of
medical devices outside of the U.S. are subject to regulatory requirements that
vary widely from country to country. Pre-market clearance or approval of medical
devices is required by certain countries. The time required to obtain clearance
or approval for sale in a foreign country may be longer or shorter than that
required for clearance or approval by the FDA and the requirements vary. Failure
to comply with applicable regulatory requirements can result in loss of
previously received approvals and other sanctions and could have a material
adverse effect on our business, financial condition or results of
operations.
The
regulation of our human tissue products outside the U.S. varies by country and
is complex and constantly evolving. A limited amount of our human
tissue products are currently distributed in several countries
internationally. Certain countries regulate our human tissue products
as pharmaceutical products, requiring us to make extensive filings and obtain
regulatory approvals before selling our product. Certain countries
classify our products as human tissue for transplantation, but may restrict its
import or sale. Certain foreign countries have laws similar to
NOTA. These laws may restrict the amount that we can charge for our
products and may restrict our ability to export or distribute our products to
licensed not-for-profit organizations in those countries. Other countries have
no applicable regulations regarding the import or sale of human tissue products
similar to our products, creating uncertainty as to what standards we may be
required to meet.
Recently,
we achieved CE marking for Strattice and are now on the market in Germany and
the United Kingdom. Additionally, we may pursue clearance to
distribute other products in certain other countries in the
future. The uncertainty of the regulations in each country may delay
or impede the marketing of our products in the future or impede our ability to
negotiate distribution arrangements on favorable terms. Noncompliance
with foreign country requirements may include some or all of the risks
associated with noncompliance with FDA regulation as well as other
risks.
We
operate in multiple tax jurisdictions both inside and outside the U.S. In the
normal course of our business, we will undergo reviews by taxing authorities
regarding the tariff classifications of our products and the amount of tariffs
we pay on the importation and exportation of these products.
Risks
Related to the LifeCell Acquisition
We
may fail to realize all of the anticipated benefits of the acquisition of
LifeCell.
In May
2008, we completed our acquisition of LifeCell. The success of our acquisition
of LifeCell will depend, in part, on our ability to achieve the anticipated
revenue synergies and other strategic benefits from combining the businesses of
KCI and LifeCell. The combined growth of KCI’s V.A.C. Therapy systems and
LifeCell’s biological soft tissue repair products are essential to our
assumptions for revenue synergies. Any unanticipated decline in the growth rates
of these products could reduce the expected benefits of the acquisition. We also
expect to benefit from opportunities to leverage adjacent technologies and
global infrastructure to drive revenue synergies, and expect a reduction of
certain general and administrative expenses. However, to realize these
anticipated benefits, we must successfully combine the businesses of KCI and
LifeCell. If we are not able to achieve these objectives, the anticipated
synergies and other strategic benefits of the acquisition may not be realized
fully, or at all, or may take longer to realize than expected. We may fail to
realize some, or all, of the anticipated benefits of the transaction in the
amounts and times projected for a number of reasons, including that the
integration may take longer than anticipated, be more costly than anticipated or
have unanticipated adverse results relating to KCI’s or LifeCell’s existing
businesses.
The
integration of the businesses and operations of KCI and LifeCell involves risks,
and the failure to integrate the businesses and operations successfully in the
expected time frame may adversely affect our future results.
Prior to
the completion of the acquisition, KCI and LifeCell historically operated as
independent companies. Since the completion of the acquisition, LifeCell
operates as a new global regenerative medicine division within KCI. Our
management may face significant challenges in integrating KCI’s and LifeCell’s
technologies, organizations, procedures, policies and operations, as well as
addressing differences in the business cultures of KCI and LifeCell and
retaining key personnel. The integration process and other disruptions resulting
from the acquisition may disrupt KCI’s and LifeCell’s ongoing businesses or
cause inconsistencies in standards, controls, procedures and policies that
adversely affect our relationships with customers, suppliers, employees,
regulators and others with whom we have business or other
dealings. If we are unable to successfully integrate the businesses
and operations, the combined company’s future results could be adversely
affected.
Charges
to earnings resulting from our LifeCell acquisition and integration costs may
materially adversely affect our operating results.
In
accordance with U.S. GAAP, we have accounted for the completion of the
acquisition using the purchase method of accounting. We have
allocated the total purchase price to LifeCell’s net tangible assets,
identifiable intangible assets and non-amortized intangibles, and based on their
fair values as of the date of completion of the acquisition, we have recorded
the excess of the purchase price over those fair values as
goodwill. Our financial results, including earnings per share, could
be adversely affected by a number of financial adjustments required by U.S. GAAP
including the following:
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we
will incur additional amortization expense over the estimated useful lives
of certain of the identifiable intangible assets acquired in connection
with the acquisition;
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to
the extent the value of goodwill or identifiable intangible assets with
indefinite lives becomes impaired, we may be required to incur material
charges relating to the impairment of those assets;
and
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any
further adjustments to the fair value of assets acquired and liabilities
assumed based on our final purchase price
allocation.
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We have
incurred significant costs associated with the acquisition and related
transactions, including financial advisors’ fees and legal and accounting fees,
and we will continue to incur additional cost in connection with the integration
of the business. These costs may be substantial and may also include those
related to severance and other exit costs. We face potential costs related to
employee retention and deployment of physical capital and other integration
costs. We have not yet determined the full extent of these costs. We account for
costs directly related to the acquisition and related transactions, including
financial advisors’ fees and legal and accounting fees, as purchase price
adjustments when the expenses are incurred, as prescribed under U.S. GAAP. These
items reduce cash balances for the periods in which those costs are paid. Other
costs that are not directly related to the acquisition and related transactions,
including retention and integration costs, are recorded as incurred and
negatively impact earnings, which could have a material adverse effect on our
operating results.
Risks
Related to Our Business
We
face significant and increasing competition, which could adversely affect our
operating results.
We face
significant and increasing competition in each of our businesses. Our
advanced wound care business primarily competes with Smith & Nephew,
Huntleigh Healthcare/Gettinge, Talley and RecoverCare/Sten+Barr, in addition to
several smaller companies that have introduced medical devices designed to
compete with our V.A.C. Therapy systems. Our LifeCell regenerative
tissue business competes with products marketed by Johnson & Johnson, C.R.
Bard, W.L. Gore & Associates, Integra LifeSciences Holdings Corporation,
Tissue Science Laboratories, plc., the Musculoskeletal Transplant Foundation,
RTI Biologics, Inc., AlloSource and Wright Medical Group. Our
Therapeutic Support Systems, or TSS, business primarily competes with the
Hill-Rom Company, Gaymar Industries, Sizewise Rentals and Huntleigh
Healthcare/Gettinge. We also face the risk that innovation by
competitors in our markets may render our products less desirable or
obsolete.
Several
competitors have obtained regulatory and/or reimbursement approvals for negative
pressure wound therapy, or NPWT, products in the U.S. and
internationally. We expect competition to increase over time as
competitors introduce additional products competitive with V.A.C. Therapy
systems in the advanced wound care market. Additionally, as our
patents in the field of NPWT start to expire beginning in 2012, we expect
increased competition with products adopting basic NPWT
technologies. Our advanced wound care systems also compete with
traditional wound care dressings, other advanced wound care dressings, skin
substitutes, products containing growth factors and other medical devices used
for wound care in the U.S. and internationally.
In
addition to direct competition from companies in the advanced wound care market,
healthcare organizations may from time to time attempt to assemble drainage
and/or negative pressure devices from standard hospital
supplies. While we believe that many possible device configurations
by competitors or healthcare organizations would infringe our intellectual
property rights, we may be unsuccessful in asserting our rights against the sale
or use of any such products, which could harm our ability to compete and could
adversely affect our business.
Our
V.A.C. Therapy and therapeutic support systems can be contracted under national
tenders or with larger hospital group purchasing organizations, or
GPOs. In prior years, many GPO contracts were awarded as sole-source
or dual-source agreements. GPOs have come under public pressure to
modify their membership requirements and contracting practices, including the
award of multi-source contracts or the conversion of sole-source and dual-source
agreements to agreements with multiple suppliers. As national tenders
and GPO agreements come up for bid, it is likely that contract awards will
result in dual or multi-source agreements with GPOs in the product categories
where we compete, which could result in increased competition in the acute and
extended care settings for our advanced wound care and TSS product
offerings. Additionally, renewals of agreements could result in no
award to KCI.
If
we are unsuccessful in protecting and maintaining our intellectual property,
particularly our rights under our exclusive licenses of the base V.A.C. patents
from Wake Forest University our competitive position would be
harmed.
Our
ability to enforce our patents and those licensed to us, together with our other
intellectual property is subject to general litigation risks, as well as
uncertainty as to the enforceability of our intellectual property rights in
various countries. We have numerous patents on our existing products and
processes, and we file applications as appropriate for patents covering new
technologies as such technologies are developed. However, the patents we own, or
in which we have rights, may not be sufficiently broad to protect our technology
position against competitors, or may not otherwise provide us with competitive
advantages. We often retain certain knowledge that we consider
proprietary as confidential and elect to protect such information as trade
secrets, as business confidential information or as know-how. In
these cases, we rely upon trade secrets, know-how and continuing technological
innovation to maintain our competitive position. Our intellectual
property rights may not prevent other companies from developing functionally
equivalent products, developing substantially similar proprietary processes, or
otherwise gaining access to our confidential know-how or trade
secrets.
When we
seek to enforce our rights, we may be subject to claims that the intellectual
property right is invalid, is otherwise not enforceable or is licensed to the
party against whom we are asserting a claim. When we assert our intellectual
property rights, it is likely that the other party will seek to assert alleged
intellectual property rights of its own against us, which may adversely impact
our business as discussed in the following risk factor. All patents are subject
to requests for reexamination by third parties. When such requests for
reexamination are granted, some or all claims may require amendment or
cancellation. Since 2007, multiple requests for reexamination of five patents
owned or licensed by KCI were granted by the U.S. Patent and Trademark Office
(“USPTO”), including the Wake Forest Patents. In July 2008, the USPTO issued a
final office action in one of the reexaminations of Patent No. 5,636,643 (“the
‘643 patent”) owned by Wake Forest, in which it ruled all but one of the claims
patentable and/or confirmed valid. In response, Wake Forest cancelled
claim 13 of the ‘643 patent and requested issuance of a Certificate of
Reexamination. A second reexamination of the ‘643 patent remains
pending and could result in a delay in the issuance of a Certificate of
Reexamination or another office action. In December 2008, the USPTO
issued a Certificate of Reexamination for Patent No. 7,198,046 in which all
claims under reexamination were confirmed valid. In February 2009,
office actions, that included claim rejections, were issued in a second pending
reexamination of the ‘643 patent, and in pending reexamination proceedings of
Patent Nos. 5,645,081 and 7,216,651. Each of these patents are
licensed to KCI from Wake Forest. All other reexaminations remain
pending. If we are unable to enforce our intellectual property rights, or patent
claims related to V.A.C. Therapy are altered or cancelled through litigation or
reexamination, our competitive position would be harmed.
We have
agreements with third parties pursuant to which we license patented or
proprietary technologies, including the Wake Forest Patents. These agreements
commonly include royalty-bearing licenses. If we lose the right to license
technologies essential to our businesses, or the costs to license these
technologies materially increase, our businesses would suffer.
KCI and
its affiliates are involved in multiple patent litigation suits in the U.S. and
Europe involving the Wake Forest Patents as well as other patents owned or
licensed by KCI, as described in Item 3: ‘‘Legal Proceedings.” 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
KCI’s 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 53% and 59%, respectively, of total revenue for the years ended
December 31, 2008 and 2007 from our domestic V.A.C. Therapy products
relating to the U.S. patents at issue. In continental Europe, we derived
approximately 13% and 12%, respectively, of total revenue for the year ended
December 31, 2008 and 2007 in V.A.C. revenue relating to the patents at issue in
the ongoing German litigation.
We
may be subject to claims of infringement of third-party intellectual property
rights, which could adversely affect our business.
From time
to time, third parties may assert against us or our customers alleged patent or
other intellectual property rights to technologies that are important to our
business. We may be subject to intellectual property infringement
claims from individuals and companies who have acquired or developed patent
portfolios in the fields of advanced wound care, therapeutic support systems or
regenerative medicine for the purpose of developing competing products, or for
the sole purpose of asserting claims against us. Any claims that our
products or processes infringe the intellectual property rights of others,
regardless of the merit or resolution of such claims, could cause us to incur
significant costs in responding to, defending and resolving such claims, and may
divert the efforts and attention of our management and technical personnel away
from our business. As a result of any such intellectual property
infringement claims, we could be required to:
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pay
material damages for third-party infringement
claims;
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discontinue
manufacturing, using or selling the infringing products, technology or
processes;
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develop
non-infringing technology or modify infringing technology so that it is
non-infringing, which could be time consuming and costly or may not be
possible; or
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license
technology from the third-party claiming infringement for which the
license may not be available on commercially reasonable terms or at
all.
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The
occurrence of any of the foregoing could result in unexpected expenses or
require us to recognize an impairment of our assets, which would reduce the
value of our assets and increase expenses. In addition, if we alter
or discontinue our production of affected items, our revenue could be negatively
impacted.
If
we are unable to develop new generations of products and enhancements to
existing products, we may lose market share as our existing patent rights begin
to expire over time.
Our
success is dependent upon the successful development, introduction and
commercialization of new generations of products and enhancements to existing
products. Innovation in developing new product lines and in
developing enhancements to our existing products is required for us to grow and
compete effectively. Over time, our existing foreign and domestic
patent protection will begin to expire, which could allow competitors to adopt
our older unprotected technology into competing product lines. Most
of the V.A.C. patents in our patent portfolio have a term of 20 years from
their date of priority. The V.A.C. Therapy utility patents, which relate to our
basic V.A.C. Therapy, extend through late 2012 in certain international markets
and through the middle of 2014 in the U.S. We also have multiple
longer-term patent filings directed to cover unique features and improvements of
V.A.C. Therapy systems and related dressings. If we are unable to
continue developing proprietary product enhancements to V.A.C. Therapy systems,
therapeutic support systems and LifeCell products that effectively make older
products obsolete, we may lose market share in our existing lines of
business. Also, any failure to obtain regulatory clearances for such
new products or enhancements could limit our ability to market new generations
of products. Innovation through enhancements and new products
requires significant capital commitments and investments on our part, which we
may be unable to recover.
Increasing
our revenues and profitability in the future may depend on our ability to
develop and commercialize new products.
Product
development is subject to risks and uncertainties. We may be required to
undertake time-consuming and costly development activities and seek regulatory
clearance or approval for new clinical applications for current products and new
products. The completion of development of any new products, including obtaining
regulatory approval, remains subject to all the risks associated with the
commercialization of new products based on innovative technologies, including:
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unanticipated
technical problems;
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obtaining
regulatory approval of such products, if
required;
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manufacturing
difficulties;
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the
possibility of significantly higher development costs than anticipated;
and
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gaining
customer acceptance.
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Healthcare
payers’ approval of reimbursement for new products in development may be an
important factor in establishing market acceptance. If we are unable to
successfully develop and commercialize new products, including enhancements to
V.A.C. Therapy systems, our future revenues and profitability could be
materially and adversely affected.
In June
2007, LifeCell received 510(k) clearance from the Food and Drug Administration,
or FDA, for Strattice, a new xenograft tissue product developed by LifeCell. In
pre-clinical studies, Strattice demonstrated rapid revascularization and cell
repopulation and strong healing. A significant amount of LifeCell’s research and
development initiatives in 2008 included clinical programs designed to support
the marketing of Strattice in current clinical applications and to potentially
extend its use into new surgical applications. The results of these pre-clinical
and clinical studies may not be sufficient to gain surgeon customer acceptance
of this new product. LifeCell commenced marketing Strattice in the first quarter
of 2008, is currently manufacturing Strattice in pilot facilities and is in the
process of expanding its production capabilities. We cannot assure that
Strattice will achieve commercial acceptance, or that we will be able to satisfy
demand that develops. If we are unable to successfully develop and commercialize
new products, including Strattice and enhancements to V.A.C. Therapy Systems,
our future revenues and profitability could be materially and adversely
affected.
Any
shortfall in our ability to 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 launch
in European markets in 2009. We currently expect the sales of
Strattice, and to a lesser degree, Alloderm, to be constrained by our ability to
manufacture sufficient quantities to meet demand during the first quarter of
2009. The manufacture of both products is conducted exclusively at
our sole manufacturing facility in Branchburg, New Jersey. We are
currently validating a new manufacturing suite in our existing facility that
will be operational by the end of the first quarter of 2009. In
the event that our manufacturing expansion plans are insufficient to meet
expanding demand for our products, our revenue growth could be negatively
impacted. Also, 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.
All of
LifeCell’s operations are currently conducted at our New Jersey location. 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.
Changes
in U.S. and international reimbursement regulations, policies and rules, or
their interpretation, could reduce the reimbursement we receive for and
adversely affect the demand for our products.
The
demand for our products is highly dependent on the regulations, policies and
rules of third-party payers in the U.S. and internationally, including the U.S.
Medicare and Medicaid programs, as well as private insurance and managed care
organizations that reimburse us for the sale and rental of our
products. If coverage or payment regulations, policies or rules of
existing third-party payers are revised in any material way in light of
increased efforts to control healthcare spending or otherwise, the amount we may
be reimbursed or the demand for our products may decrease, or the costs of
furnishing or renting our products could increase. One example of
such a change is the new Medicare competitive bidding program discussed
below.
In the
U.S., the reimbursement of our products by Medicare is subject to review by
government contractors that administer payments under federal healthcare
programs. These contractors are delegated certain authority to make
local or regional determinations and policies for coverage and payment of
durable medical equipment, or DME, and related supplies in the
home. Adverse interpretation or application of Medicare contractor
coverage policies, adverse administrative coverage determinations or changes in
coverage policies can lead to denials of our claims for payment and/or requests
to recoup alleged overpayments made to us for our products. Such adverse
determinations and changes can often be challenged only through an
administrative appeals process.
From time
to time, we have been engaged in dialogue with the medical directors of the
various Medicare contractors in order to clarify the local coverage policy for
NPWT which has been adopted in each of the four Medicare DME jurisdictions. In
some instances the medical directors have indicated that their interpretation of
the NPWT coverage policy differs from ours. Although we have informed the
contractors and medical directors of our positions and billing practices, our
dialogue has yet to resolve all open issues. In the event that our
interpretations of NPWT coverage policies in effect at any given time do not
prevail, we could be subject to recoupment or refund of all or a portion of any
disputed amounts as well as penalties, which could exceed our related revenue
realization reserves, and could negatively impact our V.A.C. Medicare
revenue.
In
addition, the current Medicare NPWT coverage policy instructs the Medicare
contractors to initially deny payment for any V.A.C. placements that have
extended beyond four months in the home; however, the policy allows for us to
appeal such non-payment on a claim-by-claim basis. As of December 31,
2008, we had approximately $15.0 million in outstanding receivables from the
Centers for Medicare and Medicaid Services, or CMS, relating to Medicare V.A.C.
placements that have extended beyond four months in the home, including both
unbilled items and claims where coverage or payment was initially denied. We are
in the process of submitting all unbilled claims for payment and appealing the
remaining claims through the appropriate administrative appeals processes
necessary to obtain payment. We may not be successful in collecting these
amounts. Further changes in policy or adverse determinations may result in
increases in denied claims and outstanding receivables. In addition, if our
appeals are unsuccessful and/or there are further policy changes, we may be
unable to continue to provide the same types of services that are represented by
these disputed types of claims in the future.
If
we are unable to obtain expanded reimbursement for V.A.C. Therapy systems in
foreign jurisdictions, our international expansion plans could be delayed and
our plans for growth could be negatively impacted.
We
are continuing our efforts to obtain reimbursement for V.A.C. Therapy systems
and related disposables in foreign jurisdictions. These efforts have
resulted in varying levels of reimbursement from private and public payers in
Germany, Austria, the Netherlands, Switzerland, Canada, South Africa, Australia
and the UK, mainly in the acute care setting. 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. If
we are unable to obtain expanded reimbursement, our international expansion
plans could be delayed and our plans for growth could be negatively
impacted.
In
Japan, obtaining regulatory and reimbursement approvals from the Japanese
governmental authorities are important to a successful broad-based launch of
V.A.C. Therapy systems in Japan. We have reported results from our
Japanese V.A.C. clinical trials and, in 2008, we submitted the required dossiers
for regulatory approval. Based on our discussions with the Japanese
regulatory authorities, we expect to receive initial regulatory approval for
V.A.C. Therapy systems in 2009. We will submit applications to the
Japanese Ministry of Health and Welfare (MHLW) for acute care reimbursement of
V.A.C. Therapy, contingent on timely regulatory approval. Our plans
for commercialization in Japan contemplate obtaining acute care reimbursement in
2010. In the event that we are unable to obtain regulatory and/or
reimbursement approvals in 2009 and 2010, respectively, it is likely that we
would not be able to obtain acute care reimbursement of the V.A.C. Therapy
system in Japan until at least 2012, which would significantly delay our launch
plans and our overall international expansion.
In
Germany, we now receive reimbursement for the V.A.C. Therapy systems in the
acute care setting. We are currently seeking expanded homecare
reimbursement as part of our growth plans in Germany. We are working
with the German government and several German insurance agencies to design two
clinical trials and a registry for the purposes of assessing payment and
coverage for V.A.C. Therapy. Initial patient enrollment is expected
in the third quarter of 2009 with all studies concluding in 2011. Our
goal is to achieve broad-based homecare reimbursement in Germany by
2012. However, if our clinical trials are unsuccessful or are only
marginally successful, it is possible that V.A.C. Therapy systems could receive
limited reimbursement or none at all in the home care setting. If we
are unable to obtain expanded homecare reimbursement in Germany, our growth
plans in Germany could be substantially limited.
U.S.
Medicare reimbursement of competitive products and the implementation of the
Medicare competitive bidding program could reduce the reimbursement we receive
and could adversely affect the demand for our V.A.C. Therapy systems in the
U.S.
From time
to time, Medicare publishes reimbursement policies and rates that may
unfavorably affect the reimbursement and market for our
products. Since 2005, Medicare has assigned NPWT reimbursement codes
to several devices being marketed to compete with V.A.C. Therapy
systems. Due to the introduction of new competitive products, CMS and
other third-party payers could attempt to reduce reimbursement rates on NPWT or
its various components, which may reduce our revenue. Increased competition and
any resulting reduction in reimbursement could materially and adversely affect
our business and operating results.
Beginning
in July 2007, a Medicare competitive bidding program affecting our V.A.C.
Therapy homecare business was delayed and significantly modified by the Medicare
Improvements for Patients and Providers Act of 2008 (“MIPPA”), enacted by
Congress on July 15, 2008. MIPPA exempted NPWT from the first round
of competitive bidding, terminated all supplier contracts for NPWT previously
awarded by CMS in the first round of competitive bidding, delayed implementation
of the first round of competitive bidding until at least January 2010 and
of the second round of competitive bidding until at least January
2011. The law also defers competitive bidding for NPWT until at least
January 2011 and imposes a 9.5% price reduction for all U.S. Medicare placements
of equipment as of January 2009. The 9.5% reduction in reimbursement
will result 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 Medicare reimbursement reduction will negatively
impact our 2009 revenue by approximately 1.0%, compared to pre-2009
reimbursement levels.
U.S.
Medicare reimbursement changes applicable to facilities that use our products,
such as hospitals and skilled nursing facilities, could reduce the reimbursement
we receive for and adversely affect the demand for our products.
In August
2006, CMS finalized new provisions for the hospital inpatient prospective
payment system, or IPPS, for the 2007 federal fiscal year, which included a
significant change in the manner in which it determines the underlying relative
weights used to calculate the diagnosis-related group, or DRG, payment
amount. For federal fiscal year 2007, CMS began to phase-in the use
of hospital costs rather than hospital charges for the DRG relative weight
determination. This change is to phase-in ratably over three years
with the full phase-in to be completed in federal fiscal year
2009. We expect that these and other changes to the DRG reimbursement
system will restructure the inpatient DRGs to account more fully for the
severity of patient illness. As a result, payments are expected to
increase for hospitals serving more severely ill patients and decrease for those
serving patients who are less severely ill. These changes will be
phased in over two years. The fiscal year 2009 IPPS final rule,
issued in 2008, announced the completion of the transition to the
severity-adjusted DRGs. The changes to IPPS reimbursement procedures
could place downward pressure on prices paid by acute care hospitals to KCI and
adversely affect the demand for our products used for inpatient
services.
The
initiation by U.S. and foreign healthcare, safety and reimbursement agencies of
periodic inspections, assessments or studies of the products, services and
billing practices we provide could lead to reduced public reimbursement or the
inability to obtain reimbursement and could result in reduced demand for our
products.
Due to
the increased scrutiny and publicity of rising healthcare costs, we may be
subject to future assessments or studies by U.S. and foreign healthcare, safety
and reimbursement agencies, which could lead to changes in reimbursement
policies that adversely affect our business. We are also currently subject to
multiple technology assessments related to our V.A.C. Therapy systems in foreign
countries where we conduct business. Any unfavorable results from
these evaluations or technology assessments could result in reduced
reimbursement or prevent us from obtaining reimbursement from third-party payers
and could reduce the demand or acceptance of our V.A.C. Therapy
systems.
The U.S.
Department of Health and Human Services Office of Inspector General, or OIG,
initiated a study on NPWT in 2005. 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 did 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 which could have a material adverse effect on our
financial condition and results of operations.
The most
recent publication of the OIG’s Work Plan for 2009 includes several projects
that could affect our business. Specifically, the OIG indicated it plans to
assess the range of acquisition prices for NPWT pumps and supplies by suppliers
and compare the median supplier purchase price against the amount Medicare
reimburses such suppliers for those items. It is possible that the
OIG could use pricing data received by CMS from NPWT suppliers as part of the
competitive bidding application process, to ascertain the range of supplier
purchase prices for the pump. If the OIG finds that Medicare
reimbursement for the pump significantly exceeds the median supplier purchase
price, CMS could use this data to lower Medicare reimbursement for the pump
through the agency's inherent reasonableness authority.
The OIG
has also reiterated that it plans to continue to review DME suppliers’ use of
certain claims modifiers to determine whether the underlying claims made
appropriate use of such modifiers when billing to Medicare. Under the Medicare
program, a DME supplier may use these modifiers to indicate that it has the
appropriate documentation on file to support its claim for payment. Upon
request, the supplier may be required to provide this documentation; however,
recent reviews by Medicare regional contractors have indicated that some
suppliers have been unable to furnish this information. The OIG intends to
continue its work to determine the appropriateness of Medicare payments for
certain DME items, including wound care equipment, by assessing whether the
suppliers’ documentation supports the claim, whether the item was medically
necessary, and/or whether the beneficiary actually received the
item. The OIG also plans to review DME that is furnished to patients
who are receiving home health services to determine whether the DME is properly
billed separately from the home health agency’s reimbursement. In the
event that these initiatives result in any assessments respecting KCI claims, we
could be subject to material refunds, recoupments or penalties. Such
initiatives could also lead to further changes to reimbursement or documentation
requirements for our products, which could be costly to administer. The results
of U.S. or foreign government agency studies could factor into governmental or
private reimbursement or coverage determinations for our products, and could
result in changes to coverage or reimbursement rules which could reduce the
amounts we collect for our products and have a material adverse effect on our
business.
We
may be subject to claims audits that could harm our business and financial
results.
As a
healthcare supplier, we are subject to claims audits by government regulators,
contractors and private payers. We are subject to extensive
government regulation, including laws regulating reimbursement under various
government programs. Our documentation, billing and other practices
are subject to scrutiny by regulators, including claims audits. To
ensure compliance with U.S. reimbursement regulations, the Medicare regional
contractors and other government contractors periodically conduct audits of
billing practices and request medical records and other documents to support
claims submitted by us for payment of services rendered to our
customers. Such audits may also be initiated as a result of
recommendations made by government agencies, such as those in the June 2007 OIG
report.
In August
2007, KCI received requests from a Medicare Region A Recovery Audit Contractor,
or RAC, covering 180 previously-paid claims submitted between 2004 and 2005,
which KCI responded to in a timely manner. The RAC audit initial findings were
that approximately 29% of the claims subject to this audit were inappropriately
paid resulting in a recoupment of these previously-paid claims by
Medicare. We have disputed and appealed these results and have
subsequently received payment on approximately half of the disputed
claims. The remaining claims subject to the audit are still in the
appeals process.
In
December 2007, the Medicare Region B DMAC initiated a pre-payment review of all
NPWT claims for the second and third months of treatment submitted by all
providers, including KCI. The pre-payment review was suspended by the
Medicare Region B DMAC in the first quarter of 2008. KCI has
responded to these claim review requests and has received reimbursement for many
of the claims subject to review. The remaining claims subject to the
audit are still in the appeals process.
In July
2008, the DMAC for Region B notified KCI of a post-payment audit of claims paid
during the second 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 plan to
dispute these 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
addition, our agreements with private payers commonly provide that payers may
conduct claims audits to ensure that our billing practices comply with their
policies. These audits can result in delays in obtaining reimbursement, denials
of claims, or demands for significant refunds or recoupments of amounts
previously paid to us.
We
could be subject to governmental investigations regarding the submission of
claims for payment for items and services furnished to federal and state
healthcare program beneficiaries.
There are
numerous rules and requirements governing the submission of claims for payment
to federal and state healthcare programs. In many cases, these rules
and regulations are not very clear and have not been interpreted on any official
basis by government authorities. If we fail to adhere to these
requirements, the government could allege we are not entitled to payment for
certain claims, and may seek to recoup past payments
made. Governmental authorities could also take the position that
claims we have submitted for payment violate the federal False Claims
Act. The recoupment of alleged overpayments and/or the imposition of
penalties or exclusions under the federal False Claims Act or similar state
provisions could result in a significant loss of reimbursement and/or the
payment of significant fines and may have a material adverse effect on our
operating results. Even if we were ultimately to prevail, an
investigation by governmental authorities of the submission of widespread claims
in non-compliance with applicable rules and requirements could have a material
adverse impact on our business as the costs of addressing such investigations
could be significant.
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 the timing of our response. We intend to cooperate with the government's
review. The review is in its initial stages and we cannot predict the time frame
in which it will be resolved. For a description of other risks
relating to governmental review and investigation of our businesses, see each of
the risk factors entitled “The
initiation by U.S. and foreign healthcare, safety and reimbursement agencies of
periodic inspections, assessments or studies of the products, services and
billing practices we provide could lead to reduced public reimbursement or the
inability to obtain reimbursement and could result in reduced demand for our
products;” “We may be
subject to claims audits that could harm our business and financial
results;” and “We could
be subject to governmental investigations under the Anti-Kickback Statute, the
Stark Law, the federal False Claims Act or similar state laws with respect to
our business arrangements with prescribing physicians and other healthcare
professionals.”
We
could be subject to governmental investigations under the Anti-Kickback Statute,
the Stark Law, the federal False Claims Act or similar state laws with respect
to our business arrangements with prescribing physicians and other healthcare
professionals.
The U.S.
federal government has significantly increased investigations of medical device
manufacturers with regard to alleged kickbacks and other forms of remuneration
to healthcare professionals who use and prescribe their
products. Such investigations often arise based on allegations of
violations of the federal Anti-Kickback Statute, which prohibits the offer,
payment solicitation or receipt of remuneration of any kind if even one purpose
of such remuneration is to induce the recipient to use, order, refer, or
recommend or arrange for the use, order or referral of any items or services for
which payment may be made in whole or in part under a federal or state
healthcare program. A number of states have passed similar laws, some
of which apply even more broadly than the federal Anti-Kickback Statute because
they are not limited to federal or state reimbursed items or services and apply
to items and services that may be reimbursed by any payer.
Federal
authorities have also increased enforcement with regard to the federal physician
self-referral and payment prohibitions, commonly referred to as the Stark
Law. If any of our business arrangements with physicians who
prescribe our DME homecare products for Medicare or Medicaid beneficiaries are
found not to comply with the Stark Law, the physician is prohibited from
ordering Medicare or Medicaid covered DME from us, and we may not present a
claim for Medicare or Medicaid payment for such items. Reimbursement
for past orders from such a physician could also be subject to
recoupment.
We have
numerous business arrangements with physicians and other potential referral
sources, including but not limited to arrangements whereby physicians provide
clinical research services to KCI, serve as consultants to KCI, or serve as
speakers for training, educational and marketing programs provided by
KCI. Many of these arrangements involve payment for services or
coverage of, or reimbursement for, common business expenses (such as meals,
travel and accommodations) associated with the arrangement. Although
we believe these arrangements or the remuneration provided thereunder, in no way
violate the Anti-Kickback Statute, the Stark Law or similar state laws,
governmental authorities could attempt to take the position that one or more of
these arrangements, or the payments or other remuneration provided thereunder,
violates these statutes or laws. In addition, if any of our
arrangements were found to violate such laws, federal authorities or
whistleblowers could take the position that our submission of claims for payment
to a federal healthcare program for items or services realized as a result of
such violations also violate the federal False Claims Act. Imposition
of penalties or exclusions for violations of the Anti-Kickback Statute, the
Stark Law or similar state laws could result in a significant loss of
reimbursement and may have a material adverse effect on our financial condition
and results of operations. Even the assertion of a violation under
any of these provisions could have a material adverse effect on our financial
condition and results of operations.
We
could be subject to increased scrutiny in states where we furnish items and
services to Medicaid beneficiaries that may result in refunds or
penalties.
Recent
federal cuts to state administered healthcare programs, particularly Medicaid,
have also increased enforcement activity at the state level under both federal
and state laws. In 2006, CMS released its initial comprehensive
Medicaid Integrity Plan, a national strategy to detect and prevent Medicaid
fraud and abuse. This new program will work to identify, recover and
prevent inappropriate Medicaid payments through increased review of suppliers of
Medicaid services. KCI could be subjected to such reviews in any
number of states. Such reviews could result in demands for refunds or
assessments of penalties against KCI, which could have a material adverse impact
on our financial condition and results of operations.
Failure
of any of our randomized and controlled studies or a third-party study or
assessment to demonstrate the clinical efficacy of our products may reduce
physician usage or result in pricing pressures which could have a negative
impact on business performance.
For the
past several years, we have been conducting a number of clinical studies
designed to test the efficacy of V.A.C. Therapy across targeted wound
types. We expect additional clinical studies related to our V.A.C.
Therapy and our regenerative tissue products in the future. A
successful clinical trial program is necessary to maintain and increase revenue
from our products, in addition to supporting and maintaining third-party
reimbursement of these products in the U.S. and abroad, particularly in Europe
and Canada. If, as a result of poor design, implementation or
otherwise, a clinical trial conducted by us or others fails to demonstrate
statistically significant results supporting the efficacy or cost effectiveness
of our products, physicians may elect not to use our products as a treatment for
medical conditions that may benefit from our products. Furthermore,
in the event of an adverse clinical trial outcome, our products may not achieve
“standard-of-care” designations for the conditions in question, which could
deter the adoption of our products. If we are unable to develop a
body of statistically significant evidence from our clinical trial program,
whether due to adverse results or the inability to complete properly designed
studies, domestic and international public and private payers could refuse to
cover our products, limit the manner in which they cover our products, or reduce
the price they are willing to pay or reimburse for our products.
Because
we depend upon a limited group of suppliers and, in some cases, exclusive
suppliers for products essential to our business, we may incur significant
product development costs and experience material delivery delays if we lose any
significant supplier, which could materially impact our rental and sales of
V.A.C. Therapy systems, related disposables, therapeutic support systems
products and regenerative medicine products.
We obtain
some of our finished products and components from a limited group of
suppliers. In particular, Avail Medical Products, Inc., a subsidiary
of Flextronics International Ltd. is our sole third-party supplier of packaged
V.A.C. disposables. V.A.C. Therapy cannot be administered without the
appropriate use of our V.A.C. units in conjunction with the related V.A.C.
disposables. Total V.A.C. rental and sales revenue represented
approximately 74.2% of our total revenue for the year ended December 31, 2008,
of which sales of V.A.C. disposables represented approximately 24.0% of total
revenue for the same period. While we have the flexibility under our
agreement with Avail to manufacture and package V.A.C. disposables internally,
any disruption in Avail’s supply of V.A.C. disposables resulting in a shortage
of disposables would inevitably cause our revenue to decline and, if material or
continued, a shortage may also reduce our market position.
Effective
November 2007, we entered into a supply agreement with Avail, which was
subsequently amended as of July 31, 2008. The agreement has a term of
five years through November 2012 and is renewable annually for an additional
twelve-month period in November of each year, unless either party gives notice
to the contrary three-months or more prior to the expiration of the then-current
term. We require Avail to maintain duplicate manufacturing
facilities, tooling and raw material resources for the production of our
disposables in different locations to decrease the risk of supply interruptions
from any single Avail manufacturing facility. However, should Avail
or Avail’s suppliers fail to perform in accordance with their agreements and our
expectations, our supply of V.A.C. disposables could be jeopardized, which could
negatively impact our V.A.C. revenue. The terms of the supply
agreement provide that key indicators be provided to us that would alert us to
Avail's inability to perform under the agreement. Should Avail have any
difficulty performing under the agreement, we have increased flexibility to
manufacture and package V.A.C. disposables. Our manufacturing plant
in Ireland currently manufactures our V.A.C. Therapy units for our global
markets which had previously been manufactured in our San Antonio, Texas and
United Kingdom plants. Additionally, beginning in 2009, the Ireland
plant will start manufacturing our disposable supplies which were previously
supplied by Avail Medical. However, any down time between
manufacturing cycles could cause a shortfall in supply. We maintain
an inventory of disposables sufficient to support our business for approximately
seven weeks in the U.S. and nine weeks in Europe. In the event that
we are unable to replace a shortfall in supply, our revenue could be negatively
impacted in the short term.
Avail
relies exclusively on Foamex International, Inc. for the supply of foam used in
the V.A.C. disposable dressings. We also contract exclusively with
Noble Fiber Technologies, LLC for the supply of specialized silver-coated foam
for use in our line of silver dressings and with Dielectrics, Inc. for the
supply of specialized bridge dressings for use in our line of specialized
dressings for diabetic foot ulcers. In the event that Foamex, Noble
or Dielectrics experiences manufacturing interruptions, our supply of
specialized V.A.C. dressings could be jeopardized. If we are required
but unable to timely procure alternate sources for these components at an
appropriate cost, our ability to obtain the raw material resources required for
our V.A.C. disposables could be compromised, which would have a material adverse
effect on our entire V.A.C. Therapy business.
In prior
years, Stryker Medical was our sole supplier of frames used to manufacture our
KinAir IV, TheraPulse and TriaDyne Proventa framed surface
products. Stryker Medical ceased supplying frames to us in
2007. We estimate that our current inventory levels will provide
sufficient frames for the next 1-2 years. Management is currently
exploring specific supply alternatives to address our future supply
requirements.
Our
biologic soft tissue repair product business is dependent on the availability of
donated human cadaveric tissue. We currently receive human tissue
from 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 met such demand and have established
what we believe to be adequate sources of donated human tissue to satisfy the
expected demand for human tissue products in the foreseeable future, 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.
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.
Any
significant interruption in the availability of human cadaveric tissue or
porcine tissue or in our ability to process this tissue would likely cause us to
slow down the distribution of 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.
We
may not be able to maintain our competitive advantages if we are not able to
attract and retain key personnel.
Our
future success depends to a significant extent on our ability to attract and
retain key members of our executive, technical, sales, marketing and engineering
staff. While we have taken steps to retain such key personnel, there
can be no assurance that we will be able to retain the services of individuals
whose knowledge and skills are important to our businesses. Our
success also depends on our ability to prospectively attract, expand, integrate,
train and retain qualified management, technical, sales, marketing and
engineering personnel. Because the competition for qualified
personnel is intense, costs related to compensation and retention could increase
significantly in the future.
Our
international business operations are subject to risks that could adversely
affect our operating results.
Our
operations outside the U.S., which represented approximately $525.2 million, or
28.0%, of our total revenue for the year ended December 31, 2008 and $459.7
million, or 28.6%, of our total revenue for the year ended December 31, 2007,
are subject to certain legal, regulatory, social, political, and economic risks
inherent in international business operations, including, but not limited
to:
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less
stringent protection of intellectual property in some countries outside
the U.S.;
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trade
protection measures and import and export licensing
requirements;
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changes
in foreign regulatory requirements and tax
laws;
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violations
of the Foreign Corrupt Practices Act of 1977, and similar local commercial
bribery and anti-corruption laws in the foreign jurisdictions in which we
do business;
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changes
in foreign medical reimbursement programs and policies, and other
healthcare reforms;
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political
and economic instability;
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complex
tax and cash management issues;
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potential
tax costs associated with repatriating cash from our non-U.S.
subsidiaries; and
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longer-term
receivables than are typical in the U.S., and greater difficulty of
collecting receivables in certain foreign
jurisdictions.
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We
are exposed to fluctuations in currency exchange rates that could negatively
affect our operating results.
Because a
significant portion of our business is conducted outside the U.S., we face
exposure to adverse movements in foreign currency exchange rates related to the
value of the U.S. dollar. While we enter into foreign exchange forward contracts
designed to reduce the short-term impact of foreign currency fluctuations, we
cannot eliminate the risk, which may adversely affect our expected
results.
Changes
in effective tax rates or tax audits could adversely affect our
results.
Our
effective tax rates could be adversely affected by earnings being lower than
anticipated in countries where we have lower statutory rates and higher than
anticipated in countries where we have higher statutory rates, by changes in the
valuation of our deferred tax assets and liabilities, or by changes in tax laws,
regulations, accounting principles or interpretations thereof. In
addition, we are subject to the routine examination of our income tax returns by
the Internal Revenue Service and other tax authorities, which, if adversely
determined could negatively impact our operating results.
If
we fail to comply with the extensive array of laws and regulations that apply to
our business, we could suffer civil or criminal penalties or be required to make
significant changes to our operations that could reduce our revenue and
profitability.
We are
required to comply with extensive and complex laws and regulations at the
federal, state and local government levels relating to among other
things:
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product
pricing and price reporting;
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quality
of medical equipment and services and qualifications of
personnel;
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confidentiality,
maintenance and security of patient medical
records;
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marketing
and advertising, and related fees and expenses paid;
and
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business
arrangements with other providers and suppliers of healthcare
services.
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For
example, the Health Insurance, Portability and Accountability Act of 1996
defines two new federal crimes: (i) healthcare fraud and (ii) false statements
relating to healthcare matters, the violation of which may result in fines,
imprisonment, or exclusion from government healthcare
programs. Further, under separate statutes, any improper submission
of claims for payment, causing any claims to be submitted that are “not provided
as claimed,” or improper price reporting for products, may lead to civil
monetary penalties, criminal fines and imprisonment, and/or exclusion from
participation in Medicare, Medicaid and other federally funded state health
programs. We are subject to numerous other laws and regulations, the
application of which could have a material adverse impact on our operating
results.
We
are subject to regulation by the FDA and its foreign counterparts that could
materially reduce the demand for and limit our ability to distribute our
products and could cause us to incur significant compliance costs.
The
production and marketing of substantially all of our products and our ongoing
research and development activities are subject to regulation by the FDA and its
foreign counterparts. Complying with FDA requirements and other
applicable regulations imposes significant costs on our
operations. If we fail to comply with applicable regulations or if
postmarket safety issues arise, we could be subject to enforcement sanctions,
our promotional practices may be restricted, and our marketed products could be
subject to recall or otherwise impacted. Each of these potential
actions could result in a material adverse effect on our operating
results.
In July
2008, KCI initiated a voluntary device recall on InfoV.A.C. canisters in order
to correct a tubing connection occlusion occurring in specified
lots. We notified the FDA of the voluntary recall and have provided
customers with the replacement of affected canisters. As our main
V.A.C. canister supplier will reimburse us for the majority of the costs to
replace these recalled canisters, we do not expect the recall to materially
impact our revenue or cost of sales. Any defects that warrant
material or widespread product recalls in the future could have a material
adverse effect on our operating results.
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 a recent FDA inspection of our manufacturing facility that led to the
issuance of a Form 483, in which the FDA identified 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 Form 483
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 the 483 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 we plan to
prevent GMP violations from occurring in the future, and that we supply
documentation of corrective actions taken. 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. We are
currently in dialogue with the FDA regarding the corrective
actions. While we believe that this matter 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 our business. While the warning letter did not cite any of the GTP
observations relating to AlloDerm, we have not received notice that the FDA’s
observations with regards to AlloDerm have been resolved.
In
addition, new FDA guidance and new and amended regulations that regulate the way
we do business may occasionally result in increased compliance
costs. In 2006, the FDA published notice of its intent to implement
new dimensional requirements for hospital bed side rails that may require us to
change the size of openings in new side rails for some of our surface
products. Over time, related market demands might also require us to
retrofit products in our existing rental fleet, and more extensive product
modifications might be required if the FDA decides to eliminate certain
exemptions in their proposed guidelines. In 2007, standardization
agencies in Europe and Canada adopted the revised standard, IEC 60601, requiring
labeling and electro-magnetic compatibility modifications to several product
lines in order for them to remain state-of-the-art. Listing bodies in
the U.S. are expected to adopt similar revised standards in
2010. Each of these revised standards will entail increased costs
relating to compliance with the new mandatory requirements that could adversely
affect our operating results.
If
our future operating results do not meet our expectations or those of our
investors or the equity research analysts covering us, the trading price of our
common stock could fall dramatically.
We have
experienced and expect to continue to experience fluctuations in revenue and
earnings for a number of reasons, including:
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the
level of acceptance of our V.A.C. Therapy systems and regenerative
medicine products by customers and
physicians;
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the
type of indications that are appropriate for regenerative medicine
products or V.A.C. Therapy and the percentages of wounds that are
considered good candidates for V.A.C.
Therapy;
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our
ability to expand the use of our products into additional geographic
markets;
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third-party
government or private reimbursement policies with respect to V.A.C.
Therapy and competing products;
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clinical
studies that may be published regarding the efficacy of V.A.C. Therapy,
including studies published by our competitors in an effort to challenge
the efficacy of the V.A.C.;
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changes
in the status of GPO contracts or national tenders for our therapeutic
support systems;
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our
ability to successfully combine the LifeCell and KCI businesses and
achieve estimated synergies;
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developments
or any adverse determination in
litigation;
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new
or enhanced competition in our primary markets;
and
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our
ability to adjust spending in a time-effective manner to compensate for
any unexpected revenue shortfall.
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We
believe that the trading price of our common stock is based, among other
factors, on our expected rates of growth in revenue and earnings per share. If
we are unable to realize growth rates consistent with our expectations or those
of our investors or the analysts covering us, we would expect to realize a
decline in the trading price of our stock. Historically, domestic V.A.C. unit
growth has been somewhat seasonal with a slowdown in V.A.C. rentals beginning in
the fourth quarter and continuing into the first quarter, which we believe is
caused by year-end clinical treatment patterns. LifeCell has also
historically experienced a similar seasonal slowing of sales in the third
quarter of each year. The adverse effects on our business arising
from seasonality may become more pronounced in future periods as the market for
V.A.C. Therapy systems matures and V.A.C. Therapy growth rates
decrease.
Because
our staffing and operating expenses are based on anticipated revenue levels, and
because a high percentage of our costs are fixed, decreases in revenue or delays
in the recognition of revenue could cause significant variations in our
operating results from quarter to quarter. This could also cause a
significant decline in the trading price of our stock.
Adverse
changes in general domestic and global economic conditions and instability and
disruption of credit markets could adversely affect our operating results,
financial condition or liquidity.
We are
subject to risks arising from adverse changes in general domestic and global
economic conditions, including recession or economic slowdown and disruption of
credit markets. The credit and capital markets have recently experienced extreme
volatility and disruption. The strength of the U.S. and global economy has
become increasingly uncertain, and the prospects for a period of prolonged
recession or slower growth appear strong. We believe that the
turbulence in the financial markets, liquidity crisis 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 operating
margin, resulting from rising supply costs, reduced investment income and
philanthropic giving, reimbursement pressure, reduced elective
healthcare spending and uncompensated care. In addition, the general economic
uncertainties may decrease the demand for elective surgeries, and consequently,
the demand for our products, which are partly dependent upon hospital census, or
the number of patients being treated in hospitals, whether due to elective or
non-elective procedures.
The
disruption in the credit markets could impede our access to capital, which could
be further adversely affected if we are unable to maintain our current credit
ratings. Should we have limited access to additional financing sources, we may
need to defer capital expenditures or seek other sources of liquidity, which may
not be available to us on acceptable terms if at all.
All of
these factors related to the global economic situation, which are beyond our
control, could negatively impact our business, results of operations, financial
condition and liquidity.
We
are exposed to product liability claims for which product liability insurance
may be inadequate and therefore could materially and adversely affect our
revenues and results of operations.
Our
businesses expose us to product liability risks inherent in the testing,
manufacturing, marketing and use of medical products. LifeCell is currently
named as a defendant in a number of lawsuits that are related to the
distribution of its products, including multiple lawsuits relating to certain
human-tissue based products because the organization that recovered the tissue,
Biomedical Tissue Services, Ltd., may not have followed FDA requirements for
donor consent and/or screening to determine if risk factors for communicable
diseases existed. Although LifeCell has stated it intends to vigorously defend
against these actions, and KCI intends to continue vigorously defending against
these actions, there can be no assurance that we will prevail. We maintain
product liability insurance; however, we cannot be certain that:
|
·
|
the
level of insurance will provide adequate coverage against potential
liabilities;
|
|
·
|
the
type of claim will be covered by the terms of the insurance
coverage;
|
|
·
|
adequate
product liability insurance will continue to be available in the future;
or
|
|
·
|
the
insurance can be maintained on acceptable
terms.
|
The legal
expenses associated with defending against product liability claims and the
obligation to pay a product liability claim in excess of available insurance
coverage would increase operating expenses and could materially and adversely
affect our results of operations and financial position.
The
FDA could disagree with our conclusion that AlloDerm, GraftJacket and Repliform
products satisfy FDA requirements for regulation solely as human tissue. If the
FDA were to impose medical device or biologic regulation on one or more of these
products, it would adversely affect our marketing and therefore our financial
condition and results of operations could be materially and adversely
affected.
We
believe that the AlloDerm, GraftJacket and Repliform products satisfy FDA
requirements to be considered Human Cellular and Tissue-based Products (HCT/P)
eligible for regulation solely as human tissue, and therefore, we have not
obtained prior FDA clearance or approval for commercial distribution of these
products. If the FDA were to disagree with our determination as to
any of these products, or were to prospectively alter the requirements for HCT/P
eligibility, the agency could prohibit the marketing of these products until we
met stringent medical device or biologic premarket clearance or approval
requirements, which could include obtaining extensive supporting clinical
data. In that event, our financial condition and results of
operations and cash flows could be materially and adversely
affected.
We
may not be able to obtain required premarket clearance or approval of our
products for new intended uses, resulting in an adverse impact on our financial
condition and results of operations.
Our
determination that AlloDerm, GraftJacket and Repliform products are eligible for
regulation as HCT/P’s is limited to their current intended uses. In
the future, we may wish to market AlloDerm, GraftJacket and Repliform for new
intended uses. Based on such new uses, our products may also be
regulated as medical devices or biologics, requiring premarket clearance or
approval and adherence to FDA medical device or biologic
regulations. Additionally, the FDA could prohibit distribution of
existing products for new uses until clearance or approval is
obtained. We cannot assure that clearance or approval for new uses of
existing products, or new products could be obtained in a timely fashion, or at
all. Such clearance or approval process could include a requirement
to provide extensive supporting clinical data.
Even if a
device receives 510(k) clearance, such as our Strattice product, any
modification we may wish to make that could significantly affect its safety or
effectiveness or that would constitute a major change in the intended use of the
device will require a new 510(k) submission or, possibly, a pre-market approval
application. The FDA could prohibit distribution of the modified
product until clearance or approval is obtained. We do not know if
clearance or approval could be obtained in a timely fashion, or at
all. Such clearance or approval process could include a requirement
to provide extensive supporting clinical data.
Our
financial condition and results of operations and cash flows could be materially
and adversely affected by a change in the regulatory classification of our
products resulting in a disruption in our ability to market such products and
the expense associated with providing extensive clinical data, if required by
the FDA.
The
National Organ Transplant Act (“NOTA”) could be interpreted in a way that could
reduce our revenues and income in the future.
Procurement
of certain human organs and tissue for transplantation is subject to the
restrictions of NOTA, which prohibits the acquisition of certain human organs,
including skin and related tissue for valuable consideration, but permits the
reasonable payment of costs associated with the removal, transportation,
implantation, processing, preservation, quality control and storage of human
tissue, including skin. We reimburse tissue banks for expenses
incurred that are associated with the recovery and transportation of donated
cadaveric human skin that the tissue bank processes and
distributes. In addition to amounts paid to tissue banks to reimburse
them for their expenses associated with the procurement and transportation of
human skin, we include in our pricing structure certain costs associated
with:
|
·
|
quality
control and storage of the tissue;
and
|
|
·
|
marketing
and medical education expenses.
|
NOTA
payment allowances may be interpreted to limit the amount of costs and expenses
that we may recover in our pricing for our products, thereby negatively
impacting our future revenues and profitability. If we are found to
have violated NOTA’s prohibition on the sale of human tissue, we also are
potentially subject to criminal enforcement sanctions which may materially and
adversely affect our results of operations.
Certain
of our products contain donated human cadaveric tissue and therefore have the
potential for disease transmission which may result in patient
claims.
AlloDerm,
GraftJacket, AlloCraftDBM and Repliform contain donated human cadaveric tissue.
The implantation of tissue products derived from donated cadaveric tissue
creates the potential for transmission of communicable disease. Although we
comply with federal and state regulations and voluntary AATB guidelines intended
to prevent communicable disease transmission, and our tissue suppliers are also
required to comply with such regulations, there can be no assurance
that:
|
·
|
our
tissue suppliers will comply with such regulations intended to prevent
communicable disease transmission;
|
|
·
|
even
if such compliance is achieved, that our products have not been or will
not be associated with transmission of disease;
or
|
|
·
|
a
patient otherwise infected with disease would not erroneously assert a
claim that the use of our products resulted in disease
transmission.
|
Any
actual or alleged transmission of communicable disease could result in patient
claims, litigation, distraction of management’s attention and potentially
increased expenses. As a result, such actions or claims could potentially harm
our reputation with our customers and disrupt our ability to market our
products, which may materially and adversely affect our results of operations
and financial condition.
Negative
publicity concerning the use of donated human tissue in medical procedures could
reduce the demand for our products and negatively impact the supply of available
donor tissue.
Negative
publicity concerning the use and method of obtaining donated human tissue that
is used in medical procedures could reduce the demand for our products or
negatively impact the willingness of families of potential donors to agree to
donate tissue, or tissue banks to provide tissue to us. In such event, we might
not be able to obtain adequate tissue to meet the needs of our customers and our
results of operations and our relationships with customers could be materially
and adversely affected.
Risks
Related to Our Capital Structure
Our
indebtedness will limit our financial flexibility.
Our
indebtedness as of December 31, 2008 was approximately $1.7 billion. The term
loan portion of our credit facilities has a required scheduled amortization,
with the percentage to be amortized increasing over the term of the loan, as
well as a requirement to use a portion of excess cash, as defined, to pay down
the debt. Our leverage is higher than KCI’s and LifeCell’s combined
previously-existing leverage. As a result of the increase in debt, demands on
our cash resources for debt service have increased, which could have the effect
of: reducing funds available to us for our operations and general corporate
purposes or for capital expenditures as a result of the dedication of a
substantial portion of our consolidated cash flow from operations to the payment
of principal and interest on our indebtedness; increasing our vulnerability to a
general economic downturn or a significant reduction in the prices paid for the
our products caused by the coverage or reimbursement decisions of third-party
payers such as Medicare and private insurance. The increased debt service
obligations may place us at a competitive disadvantage compared to our
competitors with less debt; affecting our ability to obtain additional financing
in the future for refinancing indebtedness, acquisitions, working capital,
capital expenditures or other purposes; and subjecting us to the risks of higher
interest rates.
Restrictive
covenants in our credit facilities may restrict our ability to pursue our
business strategies.
Our
credit facilities contain limitations on our ability, among other things,
to:
|
·
|
incur
additional indebtedness or contingent
obligations;
|
|
·
|
pay
dividends or make distributions to our
shareholders;
|
|
·
|
repurchase
or redeem our stock;
|
|
·
|
repurchase
our Convertible Senior Notes;
|
|
·
|
enter
into transactions with our shareholders and
affiliates;
|
|
·
|
acquire
the assets of, or merge or consolidate with, other
companies.
|
Our
credit facilities contain financial covenants requiring us to meet certain
leverage and interest coverage ratios. We may not be able to maintain these
ratios.
Our
credit facilities may impair our ability to finance future operations or capital
needs, or to enter into acquisitions or joint ventures or engage in other
favorable business activities.
If we are
unable to generate sufficient cash flow or otherwise obtain funds necessary to
make required payments under our new credit facilities or if we are unable to
maintain the financial ratios or otherwise fail to comply with the terms under
our new credit facilities, we will be in default under the agreements, which
could, in turn, cause a default under any other debt obligations that we may
incur from time to time. If we default under our new 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.
Our
3.25% convertible senior notes due 2015 (the “Convertible Notes”) and
corresponding warrant transactions may result in a dilution in our
earnings per share and the conversion of these Convertible Notes and the
exercise of the related warrant transactions may, under certain circumstances,
dilute the ownership interest of existing shareholders.
During
the second quarter of 2008, we closed our offering of $690 million aggregate
principal amount of the Convertible Notes. 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. If the price of our common stock
exceeds the conversion price, initially $51.34 per share, the Convertible Notes
will cause a dilution in our reported earnings per share. A
conversion of some or all of the Convertible Notes will also dilute the
ownership interests of existing shareholders. In addition, the
anticipated conversion of the notes into shares of our common stock could
depress the price of our common stock.
Concurrently
with the issuance of the Convertible Notes we entered into warrant
transactions with affiliates of the initial purchasers of the
notes. 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. These warrant transactions could separately have a
dilutive effect on our earnings per share to the extent that the market price
per share of our common stock exceeds the strike price of the
warrants. Upon the exercise of the warrants, if we elect to settle in
net shares this will also dilute the ownership interests of existing
shareholders.
None.
The
following table sets forth, for the periods indicated, EMEA/APAC V.A.C. and TSS
rental and sales revenue by product line, as well as the percentage
change in each line item, comparing 2007 to 2006 (dollars in
thousands):
|
|
|
Year
ended December 31,
|
|
|
|
|
|
|
|
|
|
|
%
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Change
|
|
|
V.A.C.
revenue:
|
|
|
|
|
|
|
|
|
|
|
Rental
|
|
$ |
142,602 |
|
|
$ |
109,773 |
|
|
|
29.9 |
% |
|
Sales
|
|
|
143,981 |
|
|
|
114,779 |
|
|
|
25.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
V.A.C.
|
|
|
286,583 |
|
|
|
224,552 |
|
|
|
27.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TSS
revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
|
|
|
79,207 |
|
|
|
67,833 |
|
|
|
16.8 |
|
|
Sales
|
|
|
20,524 |
|
|
|
19,971 |
|
|
|
2.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
TSS
|
|
|
99,731 |
|
|
|
87,804 |
|
|
|
13.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
rental revenue
|
|
|
221,809 |
|
|
|
177,606 |
|
|
|
24.9 |
|
|
Total
sales revenue
|
|
|
164,505 |
|
|
|
134,750 |
|
|
|
22.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
$ |
386,314 |
|
|
$ |
312,356 |
|
|
|
23.7 |
% |
The 2007
growth in total EMEA/APAC revenue was due primarily to increased rental and
sales volumes for V.A.C. Therapy systems and related disposables and favorable
foreign currency exchange rate variances. Foreign currency exchange
rate movements accounted for 12.3% of the increase in total EMEA/APAC revenue in
2007 compared to the prior year.
The
increase in EMEA/APAC V.A.C. revenue over the prior year was primarily due to
higher V.A.C. rental and sales unit volume and favorable foreign currency
exchange variances. Foreign currency exchange rate movements
favorably impacted EMEA/APAC V.A.C revenue by 11.6% in 2007 compared to the
prior year. The growth in EMEA/APAC V.A.C. rental revenue over the
prior year was due primarily to a 24.7% increase in rental unit
volume. Higher EMEA/APAC unit volume was partially offset by lower
realized pricing due primarily to lower contracted pricing. Foreign
currency exchange rate movements favorably impacted EMEA/APAC V.A.C. rental
revenue by 12.1% in 2007 compared to the prior year. The increase in
EMEA/APAC V.A.C. sales revenue over the prior year was primarily due to overall
increased sales of V.A.C. disposables associated with the increase in V.A.C.
rental unit volume. Foreign currency exchange rate movements
favorably impacted EMEA/APAC V.A.C. sales revenue by 11.3% in 2007 compared to
the prior year.
The
increase in EMEA/APAC TSS revenue over the prior year was due primarily to
foreign currency exchange rate movements which favorably impacted EMEA/APAC TSS
revenue by 13.9% for 2007 compared to the prior year.
Rental
Expenses
The
following table presents rental expenses and the percentage relationship to
total revenue comparing 2007 to 2006 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
expenses
|
|
$ |
684,935 |
|
|
$ |
607,132 |
|
|
|
12.8 |
% |
|
As
a percent of total V.A.C. and TSS revenue
|
|
|
42.5 |
% |
|
|
44.3 |
% |
|
(180
|
bps) |
Rental,
or field, expenses are comprised of both fixed and variable
costs. The decrease in rental expenses as a percent of total revenue
was primarily due to increased sales force and service productivity and lower
marketing expenditures during 2007 compared to the prior year. Our
sales and service headcount increased to approximately 3,560 at December 31,
2007 from 3,520 at December 31, 2006, which resulted in a slower growth rate in
expenses associated with our sales and service headcount than the rate of
revenue growth.
Cost of Sales
The following
table presents cost of sales and the sales margin for the periods indicated,
comparing 2007 to 2006 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
$ |
145,611 |
|
|
$ |
120,492 |
|
|
|
20.8 |
% |
|
Sales
margin
|
|
|
68.6 |
% |
|
|
69.3 |
% |
|
(70
|
bps) |
Cost of sales
includes manufacturing costs, product costs and royalties associated with our
“for sale” products. The decreased sales margin for 2007 was due
primarily to a volume purchase discount received in 2006 relating to a large
opportunistic purchase of V.A.C. disposables which was fully recognized in
2006.
Gross
Profit Margin
The following
table presents the gross profit margin comparing 2007 to 2006:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit margin
|
|
|
48.4 |
% |
|
|
47.0 |
% |
140
|
bps
|
The increase
in gross profit margin for 2007 was due primarily to increased market
penetration, improved revenue realization levels, increased sales force and
service productivity and lower marketing expenditures compared to the prior
year.
Selling,
General and Administrative Expenses
The following
table presents selling, general and administrative expenses and the percentage
relationship to total revenue comparing 2007 to 2006 (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
$ |
356,560 |
|
|
$ |
298,076 |
|
|
|
19.6 |
% |
|
As
a percent of total revenue
|
|
|
22.1 |
% |
|
|
21.7 |
% |
|
40
|
bps |
The increase
in 2007 selling, general and administrative expenses, as a percent of total
revenue, was due primarily to increased management transition costs, costs
associated with our global alignment efforts, share-based compensation and
reserve provisions associated with the portfolio rationalization of selected TSS
inventory and rental assets compared to the prior year.
Share-Based
Compensation Expense
KCI
recognizes share-based compensation expense under the provisions of Statement of
Financial Accounting Standards (“SFAS”) No. 123 Revised (“SFAS 123R”), “Share-Based Payment,” which
was adopted on January 1, 2006 and requires the measurement and recognition of
compensation expense over the estimated service period for all share-based
payment awards, including stock options, restricted stock awards and restricted
stock units based on estimated fair values on the date of grant.
As SFAS
123R requires the expensing of equity awards over the estimated service period,
we have experienced an increase in share-based compensation expense as
additional equity grants are made, compared to the prior
year. Share-based compensation expense was recognized in the
consolidated statements of earnings as follows (dollars in thousands, except per
share data):
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
Rental
expenses
|
|
$ |
5,322 |
|
|
$ |
4,285 |
|
|
Cost
of sales
|
|
|
623 |
|
|
|
487 |
|
|
Selling,
general and administrative expenses
|
|
|
17,769 |
|
|
|
12,335 |
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax
share-based compensation expense
|
|
|
23,714 |
|
|
|
17,107 |
|
|
Less: Income
tax benefit
|
|
|
(6,933 |
) |
|
|
(5,071 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total
share-based compensation expense, net of tax
|
|
$ |
16,781 |
|
|
$ |
12,036 |
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
net earnings per share impact
|
|
$ |
0.23 |
|
|
$ |
0.17 |
|
Research
and Development Expenses
The following
table presents research and development expenses and the percentage relationship
to total revenue comparing 2007 to 2006 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development expenses
|
|
$ |
50,532 |
|
|
$ |
36,694 |
|
|
|
37.7 |
% |
|
As
a percent of total revenue
|
|
|
3.1 |
% |
|
|
2.7 |
% |
|
40
|
bps |
Research and
development expenses relate to our investments in clinical studies and the
development of new advanced wound healing systems and dressings, new and
synergistic technologies across the continuum of wound care, including tissue
healing, preservation and repair, new applications of negative pressure
technology, as well as upgrading and expanding our surface technologies in our
TSS business.
Operating
Margin
The following
table presents the operating margin comparing 2007 to 2006:
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
margin
|
|
|
23.1 |
% |
|
|
22.5 |
% |
60
|
bps
|
The increase
in operating margin was due primarily to increased market penetration, improved
revenue realization levels and increased sales force and service productivity,
partially offset by increased management transition costs, costs associated with
our global alignment efforts, share-based compensation and reserve provisions
associated with the portfolio rationalization of selected TSS inventory and
rental assets compared to the prior year. Share-based compensation
expense under SFAS 123R unfavorably impacted our operating margin by 1.5% in
2007 compared to 1.3% in the prior year.
Interest
Expense
Interest
expense was $19.9 million in 2007 compared to $20.3 million in the prior
year. Interest expense in 2007 and 2006 includes write-offs of
capitalized debt issuance costs totaling $3.9 million and $1.5 million,
respectively. During 2007 and 2006, early-redemption premium payments
of approximately $3.6 million and $490,000, respectively, were recorded as
interest expense related to the redemption of our previously-existing senior
subordinated notes. The remaining decrease in interest expense from
the prior year is due to a reduction in our outstanding debt balance and a lower
interest rate compared to the prior year.
Net
Earnings
Net
earnings for 2007 were $237.1 million compared to $195.5 million in the prior
year, an increase of 21.3%. The effective income tax rate for 2007
was 33.8% compared to 33.1% for the prior year. The lower effective
income tax rate in 2006 resulted from the favorable resolution of certain tax
contingencies in that year.
Net
Earnings per Diluted Share
Net
earnings per diluted share for 2007 were $3.31 compared to net earnings per
diluted share of $2.69 in the prior year. This increase resulted from
higher net earnings in 2007 and the favorable impact of our open-market
repurchases of common stock made during the second half of 2006.
LIQUIDITY
AND CAPITAL RESOURCES
General
We
require capital principally for capital expenditures, systems infrastructure,
debt service, interest payments, working capital and our share repurchase
program. 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 2008, our
primary source of capital was cash from operations and proceeds from our
acquisition financing. During 2007 and 2006, our primary source of
capital was cash from operations. The following table summarizes the
net cash provided and used by operating activities, investing activities and
financing activities for the years ended December 31, 2008, 2007 and 2006
(dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
$ |
427,131 |
|
|
$ |
348,938 |
|
|
$ |
236,263 |
|
|
|
Net
cash used by investing activities
|
|
|
(1,887,235 |
) |
(1)
|
|
(101,685 |
) |
|
|
(99,775 |
) |
|
|
Net
cash provided (used) by financing activities
|
|
|
1,449,209 |
|
(2)
|
|
(97,659 |
) |
(3)
|
|
(156,425 |
) |
(4) |
|
Effect
of exchange rates changes on cash and cash equivalents
|
|
|
(7,331 |
) |
|
|
9,253 |
|
|
|
3,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
$ |
(18,226 |
) |
|
$ |
158,847 |
|
|
$ |
(16,237 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Includes
the LifeCell acquisition, net of cash acquired, of $1.7 billion utilizing
funds received from our new senior credit facility and convertible senior
notes.
|
|
|
(2) Includes
proceeds of $1.7 billion on our new senior credit facility and convertible
senior notes and $114.0 million on our revolving facility, partially
offset by the repayment of our previous revolving credit facility of $68.0
million, regularly scheduled debt payments totaling $50.0 million on our
new senior credit facility, payments totaling $85.0 million on our
revolving facility and a net cash payment of $48.7 million for our
convertible note hedge and warrant transactions.
|
|
|
(3) This
amount for 2007 includes debt prepayments and regularly scheduled debt
payments totaling $120.0 million on our revolving credit facility, $139.5
million on our previous senior credit facility and $68.1 million for
redemption of our subordinated notes, partially offset by proceeds of
$188.0 million from our previously-existing revolving credit
facility.
|
|
|
(4) This
amount for 2006 includes debt prepayments and regularly scheduled debt
payments totaling $70.4 million on our previous senior credit facility and
$16.3 million for the repurchase of our previously-existing subordinated
notes. In addition, the amount for 2006 includes $109.8 million
related to the repurchase and retirement of 3.5 million shares of KCI
common stock.
|
|
At
December 31, 2008, our principal sources of liquidity consisted of
$247.8 million of cash and cash equivalents and $262.4 million available
under our revolving credit facility. The revolving credit facility
makes available to us up to $300.0 million until May 2013. At
December 31, 2008, there were $29.0 million of borrowings and $8.6 million in
undrawn letters of credit under our revolving credit
facility. Subsequent to December 31, 2008, we made voluntary
prepayments of $50.0 million on our senior credit facility and $29.0 million on
our revolving credit facility.
Working
Capital
At
December 31, 2008, we had current assets of $817.6 million, including
$406.0 million in net accounts receivable and $109.1 million in inventory, and
current liabilities of $412.4 million resulting in a working capital surplus of
$405.2 million compared to a surplus of $482.3 million at December 31,
2007. The decrease in working capital is primarily due to current
installments of our long-term debt under our senior credit
facility.
As of
December 31, 2008, we had $406.0 million of receivables outstanding, net of
realization reserves of $104.0 million. North
America receivables, net of realization reserves, were outstanding for an
average of 77 days at December 31, 2008, up from 72 days at December 31,
2007. The increase in North American days revenue outstanding during
2008 is primarily attributable higher levels of growth in our homecare business
which has a longer collection cycle. EMEA/APAC net receivable days
increased from 81 days at December 31, 2007 to 84 days at December 31,
2008. LifeCell receivables were outstanding for an average of 43 days
at December 31, 2008.
At
December 31, 2007, we had current assets of $746.0 million, including
$357.0 million in net accounts receivable and $50.3 million in inventory, and
current liabilities of $263.7 million resulting in a working capital surplus of
$482.3 million compared to a surplus of $280.9 million at December 31,
2006. The increase in our working capital surplus of $201.4 million
was primarily due to increased cash from operations associated with revenue
growth in 2007, partially offset by capital expenditures and the debt repayments
made during the current year. The increase in working capital is
also attributable to a reclassification of tax liabilities totaling $31.3
million to long-term in the current year resulting from our January 1, 2007
adoption of Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income
Taxes,” which was issued by the Financial Accounting Standards Board
(“FASB”).
If rental
and sales volumes for V.A.C. Therapy systems and related disposables continue to
increase, we believe that a significant portion of this increase could occur in
the homecare market, which could have the effect of increasing accounts
receivable due to the extended payment cycles we experience with most
third-party payers. We have adopted a number of policies and procedures to
reduce these extended payment cycles.
Capital
Expenditures
During
2008, 2007 and 2006, we made capital expenditures of $131.3 million,
$95.8 million and $92.2 million, respectively, due primarily to
expanding the rental fleet, information technology purchases and leasehold
improvements for the expansion of our LifeCell manufacturing
facility.
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 December 31, 2008 (dollars in thousands):
|
|
|
|
|
Effective
|
|
|
|
|
|
Amount
Available
|
|
|
|
|
Maturity
|
|
Interest
|
|
|
Amount
|
|
|
for
Additional
|
|
|
Senior
Credit Facility
|
|
Date
|
|
Rate
|
|
|
Outstanding
|
|
|
Borrowing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving
credit facility
|
|
May
2013
|
|
4.62 |
% |
|
$ |
29,000 |
|
|
$ |
262,411 |
(1) |
|
Term
loan facility
|
|
May
2013
|
|
5.67 |
% |
(2)
|
|
950,000 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
$ |
979,000 |
|
|
$ |
262,411 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
At December 31, 2008, amount available under the revolving portion of our
credit facility reflected a reduction of $8.6 million for letters of
credit issued on our behalf, none of which have been drawn upon by the
beneficiaries thereunder. Subsequent to December 31, 2008, we made
voluntary prepayments of $50.0 million on our senior credit facility and
$29.0 million on our revolving credit facility.
|
|
(2)
The effective interest rate includes the effect of interest rate hedging
arrangements. Excluding the interest rate hedging arrangements, our
nominal interest rate as of December 31, 2008 was 4.75%.
|
|
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. 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 additional
indebtedness, 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.
Our
senior credit facility contains financial covenants requiring us to meet certain
leverage and fixed charge coverage ratios. It will be an event of
default if we permit any of the following:
|
·
|
as
of the last day of any fiscal quarter, our leverage ratio of debt to
EBITDA, as defined in the senior credit agreement, to be greater than a
maximum leverage ratio, initially set at 3.50 to 1.00 and stepped down
periodically until the fiscal quarter ending December 31, 2009, upon which
date, and thereafter, the maximum leverage ratio will be 3.00 to 1.00;
and
|
|
·
|
as
of the last day of any fiscal quarter, our ratio of EBITDA (with certain
deductions) to fixed charges to be less than a minimum fixed charge
coverage ratio, initially set at 1.10 to 1.00 and stepped up for the
fiscal quarter ending December 31, 2008, and thereafter, to a minimum
coverage ratio of 1.15 to 1.00.
|
As of
December 31, 2008, we were in compliance with all covenants under the senior
credit agreement and our leverage ratio of debt to EBITDA, as defined, was 2.7
to 1.0.
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. We granted an option to the
initial purchasers of the notes to purchase up to an additional $90.0 million
aggregate principal amount of notes to cover over-allotments, which was
exercised on May 1, 2008 for the entire $90.0 million aggregate principal
amount. 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,
beginning on October 15, 2008.
The notes
are senior unsecured obligations, and rank (i) senior to any of our future
indebtedness that is expressly subordinated to the notes; (ii) equally to
any future senior subordinated debt; and (iii) effectively junior to any
secured indebtedness to the extent of the value of the assets securing such
indebtedness. In addition, the notes are structurally junior to (i) all
existing and future indebtedness and other liabilities incurred by our
subsidiaries and (ii) preferred stock issued by our subsidiaries, except
that in the case of the guarantee of the principal and interest on the notes by
the Subsidiary Guarantor, such guarantee will be (a) effectively
subordinated to all of the Subsidiary Guarantor’s secured debt to the extent of
the value of the assets securing such debt, (b) contractually subordinated
to its secured guarantee of our new credit facility and any credit facilities we
enter into in the future, (c) pari passu with all of its other senior
indebtedness, and (d) senior to all of its indebtedness that is expressly
subordinated in right of payment to the subsidiary guarantee and all of its
preferred stock outstanding.
Holders
of the notes may convert their notes at their option on any day prior to the
close of business on the business day immediately preceding October 15, 2014
only if one or more of the following conditions is satisfied:
|
(1)
|
during
any fiscal quarter commencing after June 30, 2008, if the last reported
sale price of our common stock for at least 20 trading days in the period
of 30 consecutive trading days ending on the last trading day of the
preceding fiscal quarter is greater than or equal to 130% of the
conversion price of the notes in effect on each applicable trading
day;
|
|
(2)
|
during
the five business day period following any five consecutive trading day
period in which the trading price for the notes (per $1,000 principal
amount of the notes) for each such trading day was less than 98% of the
last reported sale price of our common stock on such date multiplied by
the applicable conversion rate; or
|
|
(3)
|
if
we make certain significant distributions to holders of our common stock
or enter into specified corporate transactions. The notes are convertible,
regardless of whether any of the foregoing conditions has been satisfied,
on or after October 15, 2014 at any time prior to the close of
business on the third scheduled trading day immediately preceding the
stated maturity date.
|
Upon
conversion, holders will receive cash up to the aggregate principal amount of
the notes being converted and shares of our common stock in respect of the
remainder, if any, of our conversion obligation in excess of the aggregate
principal amount of the notes being converted. The initial conversion
rate for the notes is 19.4764 shares of our common stock per $1,000 principal
amount of notes, which is equivalent to an initial conversion price of
approximately $51.34 per share of common stock and represents a 27.5% conversion
premium over the last reported sale price of our common stock on April 15, 2008,
which was $40.27 per share. 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. The entire principal
amount of the Convertible Notes is recorded as debt as prescribed under APB
14, “Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants.”
Concurrently
with the issuance of the convertible senior 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 Notes and is similarly subject to customary
adjustments. The Note Hedge expires on April 15, 2015, the maturity
date of the 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, we will include the effect of additional
shares that may be issued using the treasury stock method in our diluted EPS
calculations.
In May
2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position
No. APB 14-1 (“FSP APB 14-1”), “Accounting for Convertible Debt
Instruments that May be Settled in Cash Upon Conversion.” FSP
APB 14-1 requires that the liability and equity components of convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement) be separately accounted for in a manner that reflects an issuer’s
non-convertible debt borrowing rate. Upon adoption of FSP APB 14-1 on
January 1, 2009, 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 an estimated
non-convertible debt borrowing rate for similar types of
instruments. 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 taxes and the portion of issuance costs allocated to the
equity component. The resulting 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. FSP APB
14-1 is effective for financial statements issued for fiscal years and interim
periods beginning after December 15, 2008. Retrospective application
to all prior periods presented is required. Due to the retrospective
application, the notes will reflect a lower principal balance and additional
non-cash interest expense based on our non-convertible debt borrowing
rate. Based on our estimated non-convertible borrowing rate of 7.8%,
the adoption of FSP APB 14-1 will result in approximately $12.4 million and
$18.8 million, or $0.11 and $0.16 per diluted share of additional non-cash
interest expense for 2008 and 2009, respectively, assuming diluted weighted
average shares outstanding of approximately 71.8 million. This amount
will increase in subsequent reporting periods as the debt accretes to its par
value over the remaining life of the notes.
Interest
Rate Protection
At
December 31, 2008, we had eleven interest rate swap agreements pursuant to which
we have fixed the rate on $467.5 million notional amount of our outstanding
variable rate debt at an average interest rate of 3.317%, exclusive of the
Eurocurrency Rate Loan Spread as disclosed in the senior credit
agreement. As of December 31, 2008, the aggregate fair value of our
swap agreements was negative and recorded as a liability of $13.3
million. If our interest rate protection agreements were not in
place, interest expense would have been approximately $492,000 and $51,000 lower
for 2008 and 2007, respectively, but $2.0 million higher in 2006.
In
January, 2009, we entered into additional interest rate swap agreements to
convert an additional $100 million of our variable-rate debt to a fixed rate
basis. These interest rate swap agreements are effective beginning on
March 31, 2009 and expire on March 31, 2010 with a fixed interest rate of
1.110%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the
senior credit agreement. These have been designated as cash flow
hedge instruments under SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities”.
Contractual
Obligations
We are
committed to making cash payments in the future on long-term debt, capital
leases, operating leases and purchase commitments. We have not guaranteed the
debt of any other party. The following table summarizes our
contractual cash obligations as of December 31, 2008 for each of the periods
indicated (dollars in thousands):
|
|
|
Less
Than
|
|
|
1
- 3 |
|
|
4
- 5 |
|
|
After
5
|
|
|
|
|
|
|
|
1
Year
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Total
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-Term
Debt Obligations
|
|
$ |
100,000 |
|
|
$ |
375,000 |
|
|
$ |
504,000 |
|
|
$ |
690,000 |
|
|
$ |
1,669,000 |
|
|
Interest
on Long-Term Debt Obligations (2)
|
|
|
75,201 |
|
|
|
120,635 |
|
|
|
67,788 |
|
|
|
28,903 |
|
|
|
292,527 |
|
|
Capital
Lease Obligations
|
|
|
191 |
|
|
|
187 |
|
|
|
13 |
|
|
|
- |
|
|
|
391 |
|
|
Operating
Lease Obligations
|
|
|
36,370 |
|
|
|
52,383 |
|
|
|
27,342 |
|
|
|
22,966 |
|
|
|
139,061 |
|
|
Purchase
Obligations
|
|
|
27,616 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
27,616 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
239,378 |
|
|
$ |
548,205 |
|
|
$ |
599,143 |
|
|
$ |
741,869 |
|
|
$ |
2,128,595 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) This
excludes our liability of $26.2 million for unrecognized tax benefits.
We cannot make a reasonably reliable estimate of the amount and
period of related future payments for such liability.
|
|
|
(2) Amounts
and timing may be different from our estimated interest payments due to
potential voluntary prepayments, borrowings and interest rate
fluctuations.
|
|
Effective
November 2007, we entered into a supply agreement with Avail Medical Products,
Inc., a subsidiary of Flextronics International Ltd., which was subsequently
amended as of July 31, 2008. The agreement has a term of five years
through November 2012 and is renewable annually for an additional twelve-month
period in November of each year, unless either party gives notice to the
contrary three-months or more prior to the expiration of the then-current
term. Under this agreement, we have title to the raw materials used
to manufacture our disposable supplies and retain title of all disposables
inventory throughout the manufacturing process. In the event of
termination, we would have been committed to purchase from Avail approximately
$7.7 million of inventory as of December 31, 2008, which is included within
Purchase Obligations in the table above.
Critical
Accounting Estimates
The SEC
defines critical accounting estimates as those that are, in management's
opinion, very important to the portrayal of our financial condition and results
of operations and require our management's most difficult, subjective or complex
judgments. In preparing our financial statements in accordance with
U.S. generally accepted accounting principles, we must often make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
expenses and related disclosures at the date of the financial statements and
during the reporting period. Some of those judgments can be
subjective and complex. Consequently, actual results could differ
from our estimates. The accounting policies that are most subject to
important estimates or assumptions are described below. Also, see
Note 1 to our consolidated financial statements.
Revenue
Recognition and Accounts Receivable Realization
We
recognize revenue in accordance with Staff Accounting Bulletin
No. 104,“Revenue
Recognition,” when each of the following four criteria are
met:
|
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. International 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 full
settlement of a claim in our homecare business may, in some cases, extend beyond
one year.
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
December 31, 2008 would impact pre-tax earnings by an estimated $3.1
million.
Inventory
V.A.C.
and TSS inventories
Inventories
are stated at the lower of cost (first-in, first-out) or market (net realizable
value). Costs include material, labor and manufacturing overhead costs.
Inventory expected to be converted into equipment for short-term rental is
reclassified to property, plant and equipment. We review our inventory balances
monthly for excess sale products or obsolete inventory levels. Except where firm
orders are on-hand, inventory quantities of sale-only products in excess of
demand over the preceding twelve months are considered excess and are reserved
at 50% of cost. For rental products, we review both product usage and product
life cycle to classify inventory as active, discontinued or obsolete.
Obsolescence reserve balances are established on an increasing basis from 0% for
active, high-demand products to 100% for obsolete products. The inventory
reserve balance is reviewed, and if necessary, adjustments are made on a monthly
basis. We rely on historical information and production planning forecasts to
support our reserve and utilize management's business judgment for "high risk"
items, such as products that have a fixed shelf life. Once the inventory is
written down, we do not adjust the reserve balance until the inventory is sold
or otherwise disposed.
LifeCell
inventories
Inventories
are stated at the lower of cost or market, with cost being determined on a
first-in, first-out basis. Inventories on hand include the cost of
materials, freight, direct labor and manufacturing overhead. The
Company records a provision for excess and obsolete inventory based primarily on
inventory quantities on hand, the historical product sales and estimated
forecast of future product demand and production requirements. In
addition, the Company records a provision for tissue that will not meet tissue
standards based on historic rejection rates.
Long-Lived
Assets
Property,
plant and equipment are stated at cost. Betterments, which extend the useful
life of the equipment, are capitalized. Depreciation on property, plant and
equipment is calculated on the straight-line method over the estimated useful
lives (20 to 30 years for buildings and between three and seven years for
most of our other property and equipment) of the assets. If an event
were to occur that indicates the carrying value of long lived assets might not
be recoverable, we would review property, plant and equipment for impairment
using an undiscounted cash flow analysis and if an impairment had occurred on an
undiscounted basis, we would compute the fair market value of the applicable
assets on a discounted cash flow basis and adjust the carrying value
accordingly.
Goodwill
and Other Intangible Assets
Goodwill
represents the excess purchase price over the fair value of net assets acquired.
Effective January 1, 2002, we applied the provisions of SFAS No. 142
(“SFAS 142”), "Goodwill
and Other Intangible Assets," in our accounting for
goodwill. SFAS 142 requires that goodwill and other intangible
assets that have indefinite lives not be amortized but instead be tested at
least annually, by reporting unit, for impairment, or more frequently when
events or changes in circumstances indicate that the asset might be
impaired. For indefinite lived intangible assets, impairment is
tested by comparing the carrying value of the asset to the fair value of the
reporting unit, which is the same as the segment to which they are
assigned.
Goodwill
and other indefinite lived intangible assets were initially tested for
impairment during 2002, and we determined that there was no
impairment. The most recent annual test completed in the fourth
quarter of 2008 reconfirmed the lack of impairment. The goodwill of a
reporting unit will be tested annually or if an event occurs or circumstances
change that would likely reduce the fair value of a reporting unit below its
carrying amount. Examples of such events or circumstances include,
but are not limited to, a significant adverse change in legal or business
climate, an adverse regulatory action or unanticipated competition.
Income
Taxes
Deferred
income taxes are accounted for in accordance with SFAS No. 109 (“SFAS 109”),
“Accounting for Income
Taxes,” as
amended. SFAS 109 requires the asset and liability method, whereby
deferred tax assets and liabilities are recognized based on the tax effects of
temporary differences between the financial statements and the tax bases of
assets and liabilities, as measured by current enacted tax
rates. When appropriate, in accordance with SFAS 109, we evaluate the
need for a valuation allowance to reduce our deferred tax assets.
We
account for uncertain tax positions in accordance with the FASB issued
Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in
Income Taxes.” Accordingly, a
liability is recorded for unrecognized tax benefits resulting from uncertain tax
positions taken or expected to be taken in a tax return. We recognize
interest and penalties, if any, related to unrecognized tax benefits in income
tax expense.
At
December 31, 2008, deferred tax assets recorded by KCI decreased from 2007 as a
result of the LifeCell transaction and the recording of deferred tax liabilities
associated with the acquisition. We have established a valuation
allowance to reduce deferred tax assets associated with foreign net operating
losses, certain foreign deferred tax assets and state research and development
credits to an amount whose realization is more likely than not. We
anticipate that the reversal of existing taxable temporary differences and
future income will provide sufficient taxable income to realize the tax benefit
of the remaining deferred tax assets; therefore we have not provided a valuation
allowance.
The
effective income tax rate for the full year of 2008 was 39.5% compared to 33.8%
in 2007. For 2008, the increase in the effective income tax rate was
due primarily to the non-deductibility of the $61.6 million write-off of
IPR&D associated with the LifeCell acquisition.
Share-based
Compensation
KCI
recognizes share-based compensation expense under the provisions of SFAS No.
123(R) (“SFAS 123R”), “Share-Based Payment,” which
requires the measurement and recognition of compensation expense over the
estimated service period for all share-based payment awards, including stock
options, restricted stock awards and restricted stock units based on estimated
fair values on the date of grant.
KCI has
elected to use the Black-Scholes model to estimate the fair value of option
grants under SFAS 123R. We believe that the use of the Black-Scholes
model meets the fair value measurement objective of SFAS 123R and reflects all
substantive characteristics of the instruments being
valued. Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by employees who receive
share-based compensation awards, and subsequent events will not affect the
original estimates of fair value made by us under SFAS 123R.
As
prescribed by SFAS 123R, KCI estimates forfeitures when recognizing compensation
costs. We will adjust our estimate of forfeitures as actual
forfeitures differ from our estimates, resulting in the recognition of
compensation cost only for those awards that actually vest. Prior to
the adoption of SFAS 123R, we recorded forfeitures of share-based compensation
awards as they occurred. As a result of this change, we recorded a
cumulative effect of a change in accounting principle of approximately $114,000
as a reduction in share-based compensation expense in our condensed consolidated
statement of earnings in the first quarter of 2006.
The
weighted-average estimated fair value of stock options granted during 2008, 2007
and 2006 was $19.52, $24.30 and $17.63, respectively, using the Black-Scholes
option pricing model with the following weighted average assumptions (annualized
percentages):
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected
stock volatility
|
|
|
39.4 |
% |
|
|
39.6 |
% |
|
|
39.2 |
% |
|
Expected
dividend yield
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Risk-free
interest rate
|
|
|
3.2 |
% |
|
|
4.5 |
% |
|
|
4.8 |
% |
|
Expected
life (years)
|
|
|
6.3 |
|
|
|
6.2 |
|
|
|
6.2 |
|
The
expected stock volatility is based on historical volatilities of KCI and other
similar entities. The expected dividend yield is 0% as we have
historically not paid cash dividends on our common stock. The
risk-free interest rates for periods within the contractual life of the option
are based on the U.S. Treasury yield curve in effect at the time of
grant. We have chosen to estimate expected life using the simplified
method as defined in Staff Accounting Bulletin No. 107, “Share-Based Payment,” rather
than using our own historical expected life as there has not been sufficient
history since we completed our initial public offering to allow us to better
estimate this variable.
Legal
Proceedings and Other Loss Contingencies
We are
subject to various legal proceedings, many involving routine litigation
incidental to our business. The outcome of any legal proceeding is
not within our complete control, is often difficult to predict and is resolved
over very long periods of time. Estimating probable losses associated
with any legal proceedings or other loss contingencies is very complex and
requires the analysis of many factors including assumptions about potential
actions by third parties. Loss contingencies are disclosed when there
is at least a reasonable possibility that a loss has been incurred and are
recorded as liabilities in the consolidated financial statements when it is both
(1) probable or known that a liability has been incurred and (2) the
amount of the loss is reasonably estimable, in accordance with SFAS No. 5,
"Accounting for
Contingencies." If the reasonable estimate of the loss is a
range and no amount within the range is a better estimate, the minimum amount of
the range is recorded as a liability. If a loss contingency is not
probable or cannot be reasonably estimated, a liability is not recorded in the
consolidated financial statements.
New
Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 157 (“SFAS 157”), “Fair Value
Measurements,”
which defines fair value, establishes guidelines for measuring fair value and
expands disclosures regarding fair value measurements. SFAS 157 does
not require any new fair value measurements, but rather eliminates
inconsistencies in guidance found in various prior accounting
pronouncements. SFAS 157 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. On February 12,
2008, the FASB issued Staff Position No. FAS 157-2 (“FSP 157-2”), which delays
the effective date of SFAS 157 for one year for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis. We elected a
partial deferral of SFAS 157 under the provisions of FSP 157-2 related to
the nonfinancial assets and nonfinancial liabilities associated with our
LifeCell acquisition which were measured and recorded at fair value as of the
acquisition date. We adopted SFAS 157 for our financial assets and
financial liabilities beginning January 1, 2008 and beginning January 1,
2009, we have adopted the provision of SFAS 157 previously deferred by FSP
157-2. The adoption of SFAS 157 did not have a material impact on our
results of operations or our financial position.
At
December 31, 2008, we had eleven interest rate swap agreements designated as
cash flow hedge instruments and foreign currency exchange contracts to sell
approximately $87.6 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 information by level for financial assets and
financial liabilities that are measured at fair value, as defined by SFAS 157,
on a recurring basis (dollars in thousands):
|
|
|
|
|
|
Fair
Value Measurements at Reporting
|
|
|
|
|
Fair
Value at
|
|
|
Date
Using Inputs Considered as
|
|
|
|
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,964 |
|
|
$ |
- |
|
|
$ |
1,964 |
|
|
$ |
- |
|
|
Interest
rate swap agreements
|
|
$ |
13,240 |
|
|
$ |
- |
|
|
$ |
13,240 |
|
|
$ |
- |
|
We did
not have any measurements of financial assets or financial liabilities at fair
value on a nonrecurring basis at December 31, 2008.
In
February 2007, the FASB issued SFAS No. 159 (“SFAS 159”), “The Fair Value of Financial Assets
and Financial Liabilities,” which permits entities to
elect to measure many financial instruments and certain other items at fair
value that are not currently required to be measured at fair
value. This election is irrevocable. SFAS 159 was
effective for KCI beginning January 1, 2008, and the adoption of SFAS 159
did not have a material impact on our results of operations or our financial
position.
In June
2007, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-3
(“EITF 07-3”), “Accounting for
Nonrefundable Advance Payments for Goods or Services to Be Used in Future
Research and Development Activities.” The scope of EITF 07-3
is limited to nonrefundable advance payments for goods and services to be used
or rendered in future research and development activities pursuant to an
executory contractual arrangement. EITF 07-3 provides that
nonrefundable advance payments for goods or services that will be used or
rendered for future research and development activities should be deferred and
capitalized. Such amounts should be recognized as an expense as the
related goods are delivered or the related services are
performed. Companies should report the effects of applying EITF 07-3
prospectively for new contracts entered into on or after the effective date of
this Issue. EITF 07-3 was effective for KCI beginning January 1,
2008, and the adoption of EITF 07-3 did not have a material impact on our
results of operations or our financial position.
In
December 2007, the FASB issued SFAS No. 141 Revised (“SFAS 141R”), “Business Combinations,” which establishes
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. SFAS 141R also provides guidance for recognizing and
measuring the goodwill acquired in the business combination and specifies what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. SFAS
141R applies prospectively to business combinations and is effective for fiscal
years beginning after December 15, 2008. The impact that the adoption of SFAS
141R will have on our consolidated financial statements is dependent on the
nature, terms and size of business combinations that occur after the effective
date.
In March
2008, the FASB issued SFAS No. 161 (“SFAS 161”), “Disclosures about Derivative
Instruments and Hedging Activities – An Amendment of FASB Statement No.
133,” which
enhances the required disclosures regarding derivatives and hedging
activities. SFAS 161 is effective for fiscal years and interim
periods beginning after November 15, 2008. SFAS 161 was effective for
KCI beginning January 1, 2009, and the adoption of SFAS 161 did not have a
material impact on our results of operations or our financial
position.
In April
2008, the FASB issued Staff Position No. FAS 142-3 (“FSP 142-3”), “Determination of the Useful Life of
Intangible Assets” which amends the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset under SFAS 142, “Goodwill and Other Intangible
Assets.” FSP 142-3 is intended to improve the consistency
between the useful life of an intangible asset determined under SFAS 142 and the
period of expected cash flows used to measure the fair value of the asset under
SFAS 141R and other U.S. generally accepted accounting principles. FSP 142-3 is
effective for fiscal years and interim periods beginning after December 15,
2008. FSP 142-3 was effective for KCI beginning January 1,
2009, and the adoption of FSP 142-3 did not have a material impact on our
results of operations or our financial position.
In May
2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position
No. APB 14-1 (“FSP APB 14-1”), “Accounting for Convertible Debt
Instruments that May be Settled in Cash Upon Conversion.” FSP
APB 14-1 requires that the liability and equity components of convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement) be separately accounted for in a manner that reflects an issuer’s
non-convertible debt borrowing rate. Upon adoption of FSP APB 14-1 on
January 1, 2009, 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 an estimated
non-convertible debt borrowing rate for similar types of
instruments. 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 taxes and the portion of issuance costs allocated to the
equity component. The resulting 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. FSP APB
14-1 is effective for financial statements issued for fiscal years and interim
periods beginning after December 15, 2008. Retrospective application
to all prior periods presented is required. Due to the retrospective
application, the notes will reflect a lower principal balance and additional
non-cash interest expense based on our non-convertible debt borrowing
rate. Based on our estimated non-convertible borrowing rate of 7.8%,
the adoption of FSP APB 14-1 will result in approximately $12.4 million and
$18.8 million, or $0.11 and $0.16 per diluted share of additional non-cash
interest expense for 2008 and 2009, respectively, assuming diluted weighted
average shares outstanding of approximately 71.8 million. This amount
will increase in subsequent reporting periods as the debt accretes to its par
value over the remaining life of the notes.
In June
2008, the FASB ratified EITF Issue No. 07-5 (“EITF 07-5”), “Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own
Stock.” EITF 07-5 addresses the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock which is
taken into consideration in evaluating the applicability of SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” and EITF Issue No. 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.”
EITF 07-5 is effective for fiscal years and interim periods
beginning after December 15, 2008. Early adoption is not
permitted. EITF 07-5 was effective for KCI beginning January 1,
2009, and the adoption of EITF 07-5 did not have a material impact on our
results of operations or our financial position.
In
October 2008, FASB issued Staff Position No. FAS 157-3 (“FSP 157-3”), “Determining the Fair Value of a
Financial Asset When the Market for that Asset is not Active,” which clarifies the
application of SFAS 157 in a market that is not active and provides an example
to illustrate key considerations in determining the fair value of a financial
asset when the market for that financial asset is not active. FSP
157-3 was effective October 10, 2008 and for prior periods for which financial
statements have not been issued. The adoption of FSP 157-3 did not
have a material impact on our results of operations or our financial
position.
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.
We are
required under the senior credit facility to enter into interest rate swaps to
attain a fixed interest rate on at least 50% of our aggregate outstanding
indebtedness, for a period of at least 30 months thereafter. As a result
of the swap agreements currently in effect as of December 31, 2008,
approximately 69.4% of our long-term debt outstanding, including the convertible
senior notes, has a fixed interest rate.
At
December 31, 2008, we had eleven interest rate swap agreements pursuant to which
we have fixed the rate on an aggregate $467.5 million notional amount of our
outstanding variable-rate debt at a weighted average interest rate of 3.317%,
exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit
agreement, as follows:
|
·
|
3.895%
per annum on $87.0 million of our variable rate debt through June 30,
2011;
|
|
·
|
3.895%
per annum on $43.5 million of our variable rate debt through June 30,
2011;
|
|
·
|
3.895%
per annum on $43.5 million of our variable rate debt through June 30,
2011;
|
|
·
|
3.399%
per annum on $37.4 million of our variable rate debt through March
31, 2011;
|
|
·
|
3.399%
per annum on $28.1 million of our variable rate debt through March
31, 2011;
|
|
·
|
3.399%
per annum on $28.1 million of our variable rate debt through March
31, 2011;
|
|
·
|
3.030%
per annum on $40.0 million of our variable rate debt through December
31, 2010;
|
|
·
|
3.030%
per annum on $30.0 million of our variable rate debt through December
31, 2010;
|
|
·
|
3.030%
per annum on $30.0 million of our variable rate debt through December
31, 2010;
|
|
·
|
2.520%
per annum on $60.0 million of our variable rate debt through December
31, 2009; and
|
|
·
|
2.520%
per annum on $40.0 million of our variable rate debt through December
31, 2009.
|
The
aggregate notional amount decreases quarterly by amounts ranging from $26.0
million to $47.0 million until maturity.
In
January, 2009, we entered into additional interest rate swap agreements to
convert an additional $100 million of our variable-rate debt to a fixed rate
basis. These interest rate swap agreements are effective beginning on
March 31, 2009 and expire on March 31, 2010 with a fixed interest rate of
1.110%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the
senior credit agreement. These have been designated as cash flow
hedge instruments under SFAS 133.
The
tables below provide information as of December 31, 2008 and 2007 about our
long-term debt and interest rate swaps, both of which are sensitive to changes
in interest rates. 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):
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
Thereafter
|
|
|
Total
|
|
|
Fair
Value
|
|
|
Long-term
debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
rate
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
690,000 |
|
|
$ |
690,000 |
|
|
$ |
392,955 |
(1) |
|
Average
interest rate
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3.250 |
% |
|
|
3.250 |
% |
|
|
|
|
|
Variable
rate
|
|
$ |
100,000 |
|
|
$ |
150,000 |
|
|
$ |
225,000 |
|
|
$ |
300,000 |
|
|
$ |
204,000 |
|
|
$ |
979,000 |
|
|
$ |
881,100 |
|
|
Weighted
average interest rate(2)
|
|
|
4.748 |
% |
|
|
4.748 |
% |
|
|
4.748 |
% |
|
|
4.748 |
% |
|
|
4.748 |
% |
|
|
4.748 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable
to fixed-notional amount
|
|
$ |
205,500 |
|
|
$ |
192,500 |
|
|
$ |
69,500 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
467,500 |
|
|
$ |
(13,272 |
) |
|
Average
pay rate
|
|
|
3.293 |
% |
|
|
3.511 |
% |
|
|
3.797 |
% |
|
|
— |
|
|
|
— |
|
|
|
3.380 |
% |
|
|
|
|
|
Average
receive rate(4)
|
|
|
1.460 |
% |
|
|
1.460 |
% |
|
|
1.460 |
% |
|
|
— |
|
|
|
— |
|
|
|
1.460 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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
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 December 31, 2008.
|
|
|
(4) The
average receive rates for future periods are based on the current period
average receive rates. These rates reset quarterly.
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
Thereafter
|
|
|
Total
|
|
|
Fair
Value
|
|
|
Long-term
debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable
rate
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
68,000 |
|
|
$ |
68,000 |
|
|
$ |
68,000 |
|
|
Weighted
average interest rate(1)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
5.84 |
% |
|
|
5.84 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) The
weighted average interest rates for future periods were based on the
nominal interest rates as of the specified date.
|
|
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
December 31, 2008, we had outstanding forward currency exchange contracts to
sell approximately $87.6 million of various currencies. Based on our
overall transactional currency rate exposure, 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 profit of $136.2 million for the year ended
December 31, 2008. We estimate that a 10% fluctuation in the value of
the U.S. dollar relative to these foreign currencies as of and for the year
ended December 31, 2008 would change our net earnings for the year ended
December 31, 2008 by approximately $13.0 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.
Report
of Independent Registered Public Accounting Firm
The Board
of Directors and Shareholders of Kinetic Concepts, Inc.
We have
audited the accompanying consolidated balance sheets of Kinetic Concepts, Inc.
and subsidiaries “the Company” as of December 31, 2008 and 2007, and the related
consolidated statements of earnings, shareholders’ equity, and cash flows for
each of the three years in the period ended December 31, 2008. Our audits also
included the financial statement schedule listed in the index at Item
15(a). These financial statements and schedule are the responsibility
of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Kinetic Concepts, Inc.
and subsidiaries at December 31, 2008 and 2007, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2008, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
As
discussed in Note 1 to the consolidated financial statements, in 2007, the
Company changed its method of accounting for income taxes.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s internal control over financial
reporting as of December 31, 2008, based on criteria established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated February 23, 2009
expressed an unqualified opinion thereon.
|
/s/
ERNST & YOUNG LLP
|
|
ERNST
& YOUNG
LLP
|
San
Antonio, Texas
|
|
|
|
Consolidated
Balance Sheets
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
Assets:
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
247,767 |
|
|
$ |
265,993 |
|
|
Accounts
receivable, net
|
|
|
406,007 |
|
|
|
356,965 |
|
|
Inventories,
net
|
|
|
109,097 |
|
|
|
50,341 |
|
|
Deferred
income taxes
|
|
|
19,972 |
|
|
|
41,504 |
|
|
Prepaid
expenses and other
|
|
|
34,793 |
|
|
|
31,176 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
817,636 |
|
|
|
745,979 |
|
|
|
|
|
|
|
|
|
|
|
|
Net
property, plant and equipment
|
|
|
303,799 |
|
|
|
228,471 |
|
|
Debt
issuance costs, less accumulated amortization of $9,625 at 2008 and $218
at 2007
|
|
|
53,528 |
|
|
|
2,456 |
|
|
Deferred
income taxes
|
|
|
8,635 |
|
|
|
8,743 |
|
|
Goodwill
|
|
|
1,337,810 |
|
|
|
48,897 |
|
|
Identifiable
intangible assets, less accumulated amortization of $36,773 at 2008 and
$10,678 at 2007
|
|
|
472,547 |
|
|
|
7,196 |
|
|
Other
non-current assets
|
|
|
12,730 |
|
|
|
15,843 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
3,006,685 |
|
|
$ |
1,057,585 |
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity:
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
53,765 |
|
|
$ |
50,804 |
|
|
Accrued
expenses and other
|
|
|
258,666 |
|
|
|
212,874 |
|
|
Current
installments of long-term debt
|
|
|
100,000 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
412,431 |
|
|
|
263,678 |
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt, net of current installments
|
|
|
1,569,000 |
|
|
|
68,000 |
|
|
Non-current
tax liabilities
|
|
|
26,205 |
|
|
|
31,313 |
|
|
Deferred
income taxes
|
|
|
181,745 |
|
|
|
9,921 |
|
|
Other
non-current liabilities
|
|
|
6,382 |
|
|
|
7,653 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
2,195,763 |
|
|
|
380,565 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders'
equity:
|
|
|
|
|
|
|
|
|
|
Common
stock; authorized 225,000 at 2008 and 2007, issued and outstanding 70,524
at 2008 and 72,153 at 2007
|
|
|
71 |
|
|
|
72 |
|
|
Preferred
stock; authorized 50,000 at 2008 and 2007; issued and outstanding 0 at
2008 and 2007
|
|
|
- |
|
|
|
- |
|
|
Additional
paid-in capital
|
|
|
665,746 |
|
|
|
644,347 |
|
|
Retained
earnings (deficit)
|
|
|
136,099 |
|
|
|
(7,181 |
) |
|
Accumulated
other comprehensive income
|
|
|
9,006 |
|
|
|
39,782 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders'
equity
|
|
|
810,922 |
|
|
|
677,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
3,006,685 |
|
|
$ |
1,057,585 |
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
|
|
|
|
|
|
Consolidated
Statements of Earnings
|
|
|
(in
thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
Rental
|
|
$ |
1,199,778 |
|
|
$ |
1,146,544 |
|
|
$ |
979,669 |
|
|
Sales
|
|
|
678,131 |
|
|
|
463,400 |
|
|
|
391,967 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
|
1,877,909 |
|
|
|
1,609,944 |
|
|
|
1,371,636 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
expenses
|
|
|
724,970 |
|
|
|
684,935 |
|
|
|
607,132 |
|
|
Cost
of sales
|
|
|
218,503 |
|
|
|
145,611 |
|
|
|
120,492 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
934,436 |
|
|
|
779,398 |
|
|
|
644,012 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
423,513 |
|
|
|
356,560 |
|
|
|
298,076 |
|
|
Research
and development expenses
|
|
|
75,839 |
|
|
|
50,532 |
|
|
|
36,694 |
|
|
Acquired
intangible asset amortization
|
|
|
25,001 |
|
|
|
- |
|
|
|
- |
|
|
In-process
research and development
|
|
|
61,571 |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
earnings
|
|
|
348,512 |
|
|
|
372,306 |
|
|
|
309,242 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income and other
|
|
|
6,101 |
|
|
|
6,154 |
|
|
|
4,717 |
|
|
Interest
expense
|
|
|
(68,639 |
) |
|
|
(19,883 |
) |
|
|
(20,333 |
) |
|
Foreign
currency gain (loss)
|
|
|
1,308 |
|
|
|
(624 |
) |
|
|
(1,580 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
before income taxes
|
|
|
287,282 |
|
|
|
357,953 |
|
|
|
292,046 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
|
113,387 |
|
|
|
120,809 |
|
|
|
96,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
|
$ |
173,895 |
|
|
$ |
237,144 |
|
|
$ |
195,468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
2.43 |
|
|
$ |
3.34 |
|
|
$ |
2.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$ |
2.42 |
|
|
$ |
3.31 |
|
|
$ |
2.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
71,464 |
|
|
|
70,975 |
|
|
|
70,732 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
71,785 |
|
|
|
71,674 |
|
|
|
72,652 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
|
|
|
|
|
|
Consolidated
Statements of Shareholders' Equity
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Additional
Paid-in
|
|
|
Deferred
|
|
|
Retained
Earnings
|
|
|
Accumulated
Other Comprehensive
|
|
|
Total
Shareholders’
|
|
|
|
Shares
|
|
|
Par
|
|
|
Capital
|
|
|
Compensation
|
|
|
(Deficit)
|
|
|
Income
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
70,307 |
|
|
$ |
70 |
|
|
$ |
557,468 |
|
|
$ |
(6,880 |
) |
|
$ |
(365,916 |
) |
|
$ |
6,724 |
|
|
$ |
191,466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
195,468 |
|
|
|
- |
|
|
|
195,468 |
|
|
Foreign
currency translation adjustment, net of taxes of $880
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
19,431 |
|
|
|
19,431 |
|
|
Net
derivative gain, net of taxes of $41
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
75 |
|
|
|
75 |
|
|
Reclassification
adjustment for gains included in income, net of taxes of
$(701)
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(1,301 |
) |
|
|
(1,301 |
) |
|
Repurchase
of common stock in open-market transactions
|
|
(3,254 |
) |
|
|
(3 |
) |
|
|
(26,120 |
) |
|
|
- |
|
|
|
(73,877 |
) |
|
|
- |
|
|
|
(100,000 |
) |
|
Exercise
of stock options and other
|
|
2,951 |
|
|
|
3 |
|
|
|
30,134 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
30,137 |
|
|
Shares
purchased under ESPP
|
|
124 |
|
|
|
- |
|
|
|
3,830 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
3,830 |
|
|
Restricted
stock issued, net of forfeitures
|
|
333 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Share-based
compensation expense
|
|
- |
|
|
|
- |
|
|
|
17,107 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
17,107 |
|
|
Reclassification
as a result of SFAS 123R adoption
|
|
- |
|
|
|
- |
|
|
|
(6,880 |
) |
|
|
6,880 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
70,461 |
|
|
$ |
70 |
|
|
$ |
575,539 |
|
|
$ |
- |
|
|
$ |
(244,325 |
) |
|
$ |
24,929 |
|
|
$ |
356,213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
237,144 |
|
|
|
- |
|
|
|
237,144 |
|
|
Foreign
currency translation adjustment, net of taxes of $353
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
14,819 |
|
|
|
14,819 |
|
|
Net
derivative gain, net of taxes of $1
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1 |
|
|
|
1 |
|
|
Reclassification
adjustment for losses included in income, net of taxes of
$18
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
33 |
|
|
|
33 |
|
|
Exercise
of stock options and other
|
|
1,459 |
|
|
|
2 |
|
|
|
42,738 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
42,740 |
|
|
Shares
purchased under ESPP
|
|
119 |
|
|
|
- |
|
|
|
4,083 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
4,083 |
|
|
Restricted
stock issued, net of forfeitures and shares withheld for minimum tax
withholdings
|
|
114 |
|
|
|
- |
|
|
|
(1,097 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(1,097 |
) |
|
Share-based
compensation expense
|
|
- |
|
|
|
- |
|
|
|
23,084 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
23,084 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
72,153 |
|
|
$ |
72 |
|
|
$ |
644,347 |
|
|
$ |
- |
|
|
$ |
(7,181 |
) |
|
$ |
39,782 |
|
|
$ |
677,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
173,895 |
|
|
|
- |
|
|
|
173,895 |
|
|
Foreign
currency translation adjustment, net of taxes of $565
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(22,170 |
) |
|
|
(22,170 |
) |
|
Net
derivative loss, net of taxes of $(4,806)
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(8,926 |
) |
|
|
(8,926 |
) |
|
Reclassification
adjustment for losses included in income, net of taxes of
$172
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
320 |
|
|
|
320 |
|
|
Repurchase
of common stock in open-market transactions
|
|
(2,073 |
) |
|
|
(1 |
) |
|
|
(19,384 |
) |
|
|
- |
|
|
|
(30,615 |
) |
|
|
- |
|
|
|
(50,000 |
) |
|
Exercise
of stock options and other
|
|
94 |
|
|
|
- |
|
|
|
1,495 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,495 |
|
|
Shares
purchased under ESPP
|
|
172 |
|
|
|
- |
|
|
|
4,457 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
4,457 |
|
|
Restricted
stock issued, net of forfeitures and shares withheld for minimum tax
withholdings
|
|
178 |
|
|
|
- |
|
|
|
(1,010 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(1,010 |
) |
|
Share-based
compensation expense
|
|
- |
|
|
|
- |
|
|
|
26,315 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
26,315 |
|
|
Convertible
bond note hedge, net of taxes of ($58,178), and
warrants
|
|
- |
|
|
|
- |
|
|
|
9,526 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
9,526 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
70,524 |
|
|
$ |
71 |
|
|
$ |
665,746 |
|
|
$ |
- |
|
|
$ |
136,099 |
|
|
$ |
9,006 |
|
|
$ |
810,922 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
|
|
|
|
|
|
Consolidated
Statements of Cash Flows
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
|
$ |
173,895 |
|
|
$ |
237,144 |
|
|
$ |
195,468 |
|
|
Adjustments
to reconcile net earnings to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation,
amortization and other
|
|
|
135,372 |
|
|
|
93,823 |
|
|
|
83,407 |
|
|
Provision
for bad debt
|
|
|
10,605 |
|
|
|
7,567 |
|
|
|
13,744 |
|
|
Amortization
of deferred gain on sale of headquarters facility
|
|
|
(1,070 |
) |
|
|
(1,070 |
) |
|
|
(1,070 |
) |
|
Write-off
of deferred debt issuance costs
|
|
|
860 |
|
|
|
3,922 |
|
|
|
1,515 |
|
|
Share-based
compensation expense
|
|
|
26,315 |
|
|
|
23,714 |
|
|
|
17,107 |
|
|
Excess
tax benefit from share-based payment arrangements
|
|
|
(1,917 |
) |
|
|
(14,318 |
) |
|
|
(43,152 |
) |
|
Write-off
of in-process research and development
|
|
|
61,571 |
|
|
|
- |
|
|
|
- |
|
|
Change
in assets and liabilities, net of business acquired:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
in accounts receivable, net
|
|
|
(39,884 |
) |
|
|
(33,534 |
) |
|
|
(55,986 |
) |
|
Decrease
(increase) in inventories, net
|
|
|
5,632 |
|
|
|
(8,731 |
) |
|
|
(14,505 |
) |
|
Decrease
(increase) in prepaid expenses and other
|
|
|
2,528 |
|
|
|
(5,592 |
) |
|
|
(2,527 |
) |
|
Decrease
(increase) in deferred income taxes, net
|
|
|
84,771 |
|
|
|
(16,091 |
) |
|
|
(20,875 |
) |
|
Increase
(decrease) in accounts payable
|
|
|
(15,618 |
) |
|
|
12,793 |
|
|
|
(4,850 |
) |
|
Increase
(decrease) in accrued expenses and other
|
|
|
(6,085 |
) |
|
|
23,409 |
|
|
|
19,769 |
|
|
Increase
(decrease) in tax liabilities, net
|
|
|
(9,844 |
) |
|
|
25,902 |
|
|
|
48,218 |
|
|
Net
cash provided by operating activities
|
|
|
427,131 |
|
|
|
348,938 |
|
|
|
236,263 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
to property, plant and equipment
|
|
|
(131,283 |
) |
|
|
(95,847 |
) |
|
|
(92,178 |
) |
|
Increase
in inventory to be converted into equipment for short-term
rental
|
|
|
(11,200 |
) |
|
|
(5,000 |
) |
|
|
(4,000 |
) |
|
Dispositions
of property, plant and equipment
|
|
|
5,998 |
|
|
|
2,528 |
|
|
|
1,894 |
|
|
Business
acquired in purchase transaction, net of cash acquired
|
|
|
(1,745,743 |
) |
|
|
- |
|
|
|
- |
|
|
Purchase
of investments
|
|
|
- |
|
|
|
(36,425 |
) |
|
|
- |
|
|
Maturities
of investments
|
|
|
- |
|
|
|
36,425 |
|
|
|
- |
|
|
Increase
in identifiable intangible assets and other non-current
assets
|
|
|
(5,007 |
) |
|
|
(3,366 |
) |
|
|
(5,491 |
) |
|
Net
cash used by investing activities
|
|
|
(1,887,235 |
) |
|
|
(101,685 |
) |
|
|
(99,775 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from revolving credit facility
|
|
|
114,000 |
|
|
|
188,000 |
|
|
|
- |
|
|
Repayments
of long-term debt, capital lease and other obligations
|
|
|
(135,260 |
) |
|
|
(327,659 |
) |
|
|
(87,684 |
) |
|
Payments
of debt issuance costs
|
|
|
- |
|
|
|
(2,359 |
) |
|
|
- |
|
|
Repurchase
of common stock in open-market transactions
|
|
|
(50,000 |
) |
|
|
- |
|
|
|
(100,000 |
) |
|
Excess
tax benefit from share-based payment arrangements
|
|
|
1,917 |
|
|
|
14,318 |
|
|
|
43,152 |
|
|
Proceeds
from exercise of stock options
|
|
|
2,454 |
|
|
|
28,372 |
|
|
|
11,937 |
|
|
Purchase
of immature shares for minimum tax withholdings
|
|
|
(1,010 |
) |
|
|
(2,414 |
) |
|
|
(27,660 |
) |
|
Proceeds
from purchase of stock in ESPP and other
|
|
|
4,457 |
|
|
|
4,083 |
|
|
|
3,830 |
|
|
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 |
) |
|
|
- |
|
|
|
- |
|
|
Payment
of debt issuance costs
|
|
|
(60,697 |
) |
|
|
- |
|
|
|
- |
|
|
Net
cash provided (used) by financing activities
|
|
|
1,449,209 |
|
|
|
(97,659 |
) |
|
|
(156,425 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
(7,331 |
) |
|
|
9,253 |
|
|
|
3,700 |
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
(18,226 |
) |
|
|
158,847 |
|
|
|
(16,237 |
) |
|
Cash
and cash equivalents, beginning of year
|
|
|
265,993 |
|
|
|
107,146 |
|
|
|
123,383 |
|
|
Cash
and cash equivalents, end of year
|
|
$ |
247,767 |
|
|
$ |
265,993 |
|
|
$ |
107,146 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
|
|
Notes
to Consolidated Financial Statements
NOTE 1.
Summary of Significant Accounting
Policies
(a) Principles of
Consolidation
The
consolidated financial statements presented herein include the accounts of
Kinetic Concepts, Inc., together with its consolidated subsidiaries. All
inter-company balances and transactions have been eliminated in consolidation.
The consolidated entity is referred to herein as "KCI." Certain prior
period amounts have been reclassified to conform to the 2008
presentation.
During
the first quarter of 2008, we completed the realignment of our geographic
reporting structure to correspond with our current management
structure. For 2008, we are reporting financial results for our
V.A.C. Therapy and Therapeutic Support Systems (“TSS”) product line revenues
consistent with this new structure, including the reclassification of prior
period amounts to conform to this current reporting structure. On May
27, 2008, we completed the acquisition of all the outstanding capital stock of
LifeCell Corporation (“LifeCell”), a leader in innovative tissue regeneration
products sold primarily throughout the United States (“the
U.S.”). Under our current management structure, LifeCell is excluded
from the geographic reporting structure and is reported as its own operating
segment. The results of LifeCell’s operations have been included in
our consolidated financial statements beginning on May 20, 2008, the date on
which we achieved a majority ownership position and control of the LifeCell
operations.
(b) Nature of
Operations and Customer Concentration
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 advanced wound care, regenerative medicine and
therapeutic support system 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 TSS business includes specialty hospital beds, mattress
replacement systems and overlays, which are designed to address pulmonary
complications associated with 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 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:
(i) North America – V.A.C. and TSS, which is comprised principally of the U.S.
and includes Canada and Puerto Rico; (ii) EMEA/APAC – V.A.C. and TSS, which is
comprised principally of Europe and includes the Middle East, Africa and the
Asia Pacific region; and (iii) LifeCell.
Operations
for North America V.A.C. and TSS accounted for approximately 67.7%, 76.0%
and 77.2% of our total revenue for 2008, 2007 and 2006, respectively. In
the U.S. acute care settings, which accounted for approximately half of our
North American V.A.C. and TSS revenue for 2008, we bill our customers
directly for the rental and sale of our products. Also in the U.S.
acute and extended care settings, we contract with both proprietary hospital
groups and voluntary group purchasing organizations, or
GPOs. Proprietary hospital groups own all of the hospitals which they
represent and, as a result, can ensure compliance with an executed national
agreement. Voluntary GPOs negotiate contracts on behalf of member
hospital organizations, but cannot ensure that their members will comply with
the terms of an executed national agreement. Approximately 32.6%,
36.9% and 37.6% of our total revenue during 2008, 2007 and 2006, respectively,
was generated under national agreements with GPOs. During 2008, 2007
and 2006, we recorded approximately $198.3 million, $193.6 million and
$179.2 million, respectively, in V.A.C. and TSS revenues under contracts
with Novation, LLC, our largest single GPO relationship.
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. During 2008, 2007 and 2006, we recorded revenue related to
Medicare claims of approximately $170.4 million, $181.5 million and
$165.4 million, respectively.
To date,
LifeCell regenerative medicine revenue has been 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; and Repliform, for urogynecologic surgical procedures.
Outside
of the U.S., most of revenue is generated in the acute care setting on a direct
billing basis.
(c) Use of
Estimates
The
preparation of financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
(d) Revenue
Recognition
We
recognize revenue in accordance with Staff Accounting Bulletin
No. 104, “Revenue
Recognition,” when each of the following four criteria are
met:
|
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 or organization, at the contracted rental rate for contracted customers
and generally, retail price for non-contracted customers. Sales
revenue is recognized when products are shipped and title has transferred.
We establish realization reserves against revenue to provide for adjustments
including capitation agreements, credit memos, volume discounts, pricing
adjustments, utilization adjustments, product returns, cancellations, estimated
uncollectible amounts and payer adjustments based on historical
experience.
(e) Cash and Cash
Equivalents
We
consider all highly liquid investments with an original maturity of ninety days
or less to be cash equivalents. We maintain cash and cash equivalents
with several financial institutions. Deposits held with banks may
exceed the amount of insurance provided on such deposits. Generally,
these deposits may be redeemed upon demand and are maintained at financial
institutions of reputable credit and therefore bear minimal credit
risk.
(f) Fair Value of
Financial Instruments
The
carrying amount reported in the balance sheet for cash and cash equivalents,
accounts receivable, accounts payable and long-term obligations, excluding our
senior credit facility and 3.25% Convertible Senior Notes, or the Notes,
approximates fair value. The fair value of our senior credit facility and the
Notes is estimated based upon open-market trades at or near
year-end. The carrying value of our senior credit facility and the
Notes as of December 31, 2008 was $979.0 million and $690.0 million,
respectively, with a corresponding fair value of approximately $881.1 million
and $393.0 million.
(g) Accounts
Receivable
Trade
accounts receivable in North America 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. Both EMEA/APAC and LifeCell trade accounts
receivable consist of amounts due primarily from acute care
organizations.
Significant
concentrations of accounts receivable include:
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Acute
and extended care organizations
|
|
|
50%
|
|
|
|
50%
|
|
|
Managed
care, insurance and other
|
|
|
36%
|
|
|
|
34%
|
|
|
Medicare/Medicaid
|
|
|
12%
|
|
|
|
15%
|
|
|
Other
|
|
|
2%
|
|
|
|
1%
|
|
The TPP
reimbursement process in the U.S. 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.
(h) Inventories
V.A.C. and
TSS inventories
Inventories
are stated at the lower of cost (first-in, first-out) or market (net realizable
value). Costs include material, labor and manufacturing overhead costs.
Inventory expected to be converted into equipment for short-term rental is
reclassified to property, plant and equipment. We review our inventory balances
monthly for excess sale products or obsolete inventory levels. Except where firm
orders are on-hand, inventory quantities of sale-only products in excess of
demand over the preceding twelve months are considered excess and are reserved
at 50% of cost. For rental products, we review both product usage and product
life cycle to classify inventory as active, discontinued or obsolete.
Obsolescence reserve balances are established on an increasing basis from 0% for
active, high-demand products to 100% for obsolete products. The reserve is
reviewed, and if necessary, adjustments are made on a monthly basis. We rely on
historical information and production planning forecasts to support our reserve
and utilize management's business judgment for "high risk" items, such as
products that have a fixed shelf life. Once the inventory is written down, we do
not adjust the reserve balance until the inventory is sold or otherwise
disposed.
Effective
November 2007, we entered into a supply agreement with Avail Medical Products,
Inc., a subsidiary of Flextronics International Ltd., which was subsequently
amended as of July 31, 2008. The agreement has a term of five years
through November 2012 and is renewable annually for an additional twelve-month
period in November of each year, unless either party gives notice to the
contrary three-months or more prior to the expiration of the then-current
term. Under this agreement, we have title to the raw materials used
to manufacture our disposable supplies and retain title of all disposables
inventory throughout the manufacturing process. We maintain a finished goods
inventory of disposables sufficient to support our business for approximately
seven weeks in the U.S. and nine weeks in our international
locations.
LifeCell
inventories
Inventories
are stated at the lower of cost or market, with cost being determined on a
first-in, first-out basis. Inventories on hand include the cost of
materials, freight, direct labor and manufacturing overhead. We
record a provision for excess and obsolete inventory based primarily on
inventory quantities on hand, the historical product sales and estimated
forecast of future product demand and production requirements. In
addition, we record a provision for tissue that will not meet tissue standards
based on historic rejection rates.
(i) Vendor
Rebates
We may
receive consideration from vendors in the normal course of business in the form
of rebates of purchase price paid. Our policy for accounting for
these funds is in accordance with Emerging Issues Task Force (“EITF”) Issue
No. 02-16, “Accounting by
a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor.” The funds are
recognized as a reduction of cost of sales and inventory if the funds are a
reduction of the price of the vendor’s products.
(j) Long-Lived
Assets
Property,
plant and equipment are stated at cost. Betterments, which extend the useful
life of the equipment, are capitalized. Software development costs for internal
use are capitalized pursuant to Statement of Position No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal
Use." Debt issuance costs at December 31, 2008 represent fees
and other direct costs incurred in connection with our borrowings. These amounts
are capitalized and amortized using the effective interest method over the
contractual term of the borrowing. During 2008, we capitalized $60.7
million related to the completion of our acquisition financing. (See
Note 3.) Other assets consist principally of patents,
trademarks, long-term investments and our investment in assets subject to
leveraged leases. Patents and trademarks are amortized over the estimated useful
life of the respective asset using the straight-line method. Patent
and trademark costs associated with products for which we are no longer pursuing
development are written-off to expense.
Depreciation
on property, plant and equipment is calculated on the straight-line method over
the estimated useful lives (20 to 30 years for buildings and between three
and seven years for most of our other property and equipment) of the assets.
Amortization for leasehold improvements is taken over the shorter of the
estimated useful life of the asset or over the remaining lease term.
Depreciation expense for 2008, 2007 and 2006 was $97.1 million, $84.4 million
and $78.8 million, respectively.
(k) Goodwill and
Other Intangible Assets
Goodwill
represents the excess purchase price over the fair value of net assets acquired.
Effective January 1, 2002, we have applied the provisions of Statement of
Financial Accounting Standards (“SFAS”) No. 142 (“SFAS 142”),
"Goodwill and Other Intangible Assets," in our accounting for goodwill.
SFAS 142 requires that goodwill and other intangible assets that have
indefinite lives not be amortized but instead be tested at least annually by
reporting unit for impairment, or more frequently when events or changes in
circumstances indicate that the asset might be impaired. For indefinite lived
intangible assets, impairment is tested by comparing the carrying value of the
asset to the fair value of the reporting unit. KCI defines its reporting units
at the same level as our segments disclosed in Note 17: North America, EMEA/APAC
and LifeCell. Goodwill and other indefinite lived intangible assets were tested
for impairment during the fourth quarter of 2008 and we determined no impairment
write down was required.
The fair
value of each reporting unit was determined using discounted cash flow models.
Significant assumptions included risk-based discount rates ranging from 12% to
15.5%, estimated growth rates based on KCI’s long-range planning model and
terminal values of each reporting unit based on a growth rate of 3.5% after the
10th year. Goodwill arising from the LifeCell purchase was allocated to the
applicable reporting units based on the discounted projected benefit received by
that reporting unit. (See Note 5.)
Identifiable
intangible assets include developed technology, customer relationships,
trademarks and patents. The increase in identifiable intangible
assets is due primarily to the $486.7 million of identifiable intangible assets
purchased in connection with the LifeCell acquisition. We amortize
our identifiable intangible assets over 5 to 17 years, depending on the
estimated economic or contractual life of the individual asset.
(l) Income
Taxes
Deferred
income taxes are accounted for in accordance with SFAS No. 109 (“SFAS 109”),
“Accounting for Income
Taxes,” as
amended. SFAS 109 requires the asset and liability method, whereby
deferred tax assets and liabilities are recognized based on the tax effects of
temporary differences between the financial statements and the tax bases of
assets and liabilities, as measured by current enacted tax
rates. When appropriate, in accordance with SFAS 109, we evaluate the
need for a valuation allowance to reduce our deferred tax assets.
We
account for uncertain tax positions in accordance with the Financial Accounting
Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in
Income Taxes.” Accordingly, a
liability is recorded for unrecognized tax benefits resulting from uncertain tax
positions taken or expected to be taken in a tax return. We recognize
interest and penalties, if any, related to unrecognized tax benefits in income
tax expense.
At
December 31, 2008, deferred tax assts recorded by KCI decreased from 2007 as a
result of the LifeCell transaction and the recording of deferred tax liabilities
associated with the acquisition. We have established a valuation
allowance to reduce deferred tax assets associated with foreign net operating
losses, certain foreign deferred tax assets and state research and development
credits to an amount whose realization is more likely than not. We
anticipate that the reversal of existing taxable temporary difference and future
income will provide sufficient taxable income to realize the tax benefit of the
remaining deferred tax assets; therefore we have not provided a valuation
allowance.
The
effective income tax rate for 2008 was 39.5% compared to 33.8% in
2007. The increase in the effective income tax rate was due primarily
to the non-deductibility of the $61.6 million write-off of in-process research
and development (“IPR&D”) associated with the LifeCell
acquisition.
(m) Net Earnings Per
Share
Basic net
earnings per share, or EPS, is computed by dividing net earnings by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in our earnings when
dilutive.
(n) Royalties
We pay
royalties for the right to market our medical devices. Royalties are
based on applicable revenue and recognized in the period that the related
revenue is earned. Royalties related to rental revenue are included
in rental expense. Royalties on sales revenue are included in cost of
sales.
(o) Self-Insurance
We
self-insure certain employee benefit and casualty insurance
risks. Our group medical plan for U.S. employees is a qualified
self-insured plan subject to specific stop loss insurance coverage. Our
short-term disability plan for U.S. based employees is self-insured. The Texas
Employee Injury Benefit Plan is self-insured subject to a $500,000 per
occurrence deductible. Our general and product liability insurance coverage is
subject to a $750,000 per occurrence self-insured retention. Our
workers’ compensation and auto liability insurance coverages are subject to
$750,000 per occurrence deductibles. Our group life and accidental
death and dismemberment plan along with our long-term disability plan are all
fully insured. We fully accrue our self-insurance liabilities, including claims
incurred but not reported. These liabilities are not discounted.
(p) Foreign Currency
Translation and Transaction Gains and Losses
The
functional currency for the majority of our foreign operations is the applicable
local currency. The translation of the applicable foreign currencies into U.S.
dollars is performed for balance sheet accounts using the exchange rates in
effect at the balance sheet date and for revenue and expense accounts using a
weighted average exchange rate during the period. Gains and losses resulting
from the foreign currency translations are included in accumulated other
comprehensive income. Transaction gains and losses, such as those
resulting from the settlement of nonfunctional currency receivables or payables,
including intercompany balances, are included in foreign currency gain (loss) in
our consolidated statements of earnings. Additionally, payable and
receivable balances denominated in nonfunctional currencies are marked-to-market
at month-end, and the gain or loss is recognized in our consolidated statements
of earnings. (See Note 1(u).)
(q) Share-based
Compensation
KCI
recognizes share-based compensation expense under the provisions of SFAS No.
123(R) (“SFAS 123R”), “Share-Based Payment,” which
requires the measurement and recognition of compensation expense over the
estimated service period for all share-based payment awards, including stock
options, restricted stock awards and restricted stock units based on estimated
fair values on the date of grant.
KCI has
elected to use the Black-Scholes model to estimate the fair value of option
grants under SFAS 123R. We believe that the use of the Black-Scholes
model meets the fair value measurement objective of SFAS 123R and reflects all
substantive characteristics of the instruments being
valued. Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by employees who receive
share-based compensation awards, and subsequent events will not affect the
original estimates of fair value made by us under SFAS 123R.
Share-based
compensation expense was recognized in the consolidated statements of earnings
as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
expenses
|
|
$ |
4,955 |
|
|
$ |
5,322 |
|
|
$ |
4,285 |
|
|
Cost
of sales
|
|
|
559 |
|
|
|
623 |
|
|
|
487 |
|
|
Selling,
general and administrative expenses
|
|
|
20,801 |
|
|
|
17,769 |
|
|
|
12,335 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax
share-based compensation expense
|
|
|
26,315 |
|
|
|
23,714 |
|
|
|
17,107 |
|
|
Less: Income
tax benefit
|
|
|
(8,310 |
) |
|
|
(6,933 |
) |
|
|
(5,071 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
share-based compensation expense, net of tax
|
|
$ |
18,005 |
|
|
$ |
16,781 |
|
|
$ |
12,036 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
net earnings per share impact
|
|
$ |
0.25 |
|
|
$ |
0.23 |
|
|
$ |
0.17 |
|
As
prescribed by SFAS 123R, KCI estimates forfeitures when recognizing compensation
costs. We will adjust our estimate of forfeitures as actual
forfeitures differ from our estimates, resulting in the recognition of
compensation cost only for those awards that actually vest. Prior to
the adoption of SFAS 123R, we recorded forfeitures of share-based compensation
awards as they occurred. As a result of this change, we recorded a
cumulative effect of a change in accounting principle of approximately $114,000
as a reduction in share-based compensation expense in our condensed consolidated
statement of earnings in the first quarter of 2006.
The
weighted-average estimated fair value of stock options granted during 2008, 2007
and 2006 was $19.52, $24.30 and $17.63, respectively, using the Black-Scholes
option pricing model with the following weighted average assumptions (annualized
percentages):
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected
stock volatility
|
|
39.4 |
% |
|
39.6 |
% |
|
39.2 |
% |
|
Expected
dividend yield
|
|
- |
|
|
- |
|
|
- |
|
|
Risk-free
interest rate
|
|
3.2 |
% |
|
4.5 |
% |
|
4.8 |
% |
|
Expected
life (years)
|
|
6.3 |
|
|
6.2 |
|
|
6.2 |
|
The
expected stock volatility is based on historical volatilities of KCI and other
similar entities. The expected dividend yield is 0% as we have
historically not paid cash dividends on our common stock. The
risk-free interest rates for periods within the contractual life of the option
are based on the U.S. Treasury yield curve in effect at the time of
grant. We have chosen to estimate expected life using the simplified
method as defined in Staff Accounting Bulletin No. 107, “Share-Based Payment,” rather
than using our own historical expected life as there has not been sufficient
history since we completed our initial public offering to allow us to better
estimate this variable.
(r) Research and
Development
The focus
of our research and development program has been to invest in clinical studies
and the development of new advanced wound healing systems and dressings, new and
synergistic technologies across the entire continuum of wound
care. Our focus includes the healing, preservation and repair of
tissue, the development of new applications of negative pressure technology, the
upgrading and expanding of our surface technologies in our TSS business and the
leveraging of our core understanding of biological tissues in order to develop
biosurgery products in our regenerative medicine business. The types
of costs classified as research and development expense include salaries of
technical staff, consultant costs, facilities and utilities costs related to
offices occupied by technical staff, depreciation on equipment and facilities
used by technical staff, supplies and materials for research and development and
outside services such as prototype development and testing and third-party
research and development costs. Expenditures for research and development,
including expenses related to clinical studies, are expensed as
incurred.
(s) 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 December
31, 2008 was determined based on inputs that are readily available in public
markets or can be derived from information available in publicly quoted
markets. (See Note 6.)
(t)
Convertible Instruments
We
evaluate and account for conversion options embedded in convertible instruments
in accordance with SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (“SFAS 133”), EITF 00-19, “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock” (“EITF 00-19”) and other related guidance.
We use
derivative financial instruments to manage the economic impact of fluctuations
in currency exchange rates on our intercompany balances. 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 consolidated statements of earnings. (See
Note 6.)
(v) Shipping and
Handling
We
include shipping and handling costs in rental expense and cost of sales, as
appropriate. Shipping and handling costs on sales products recovered
from customers of $4.2 million, $2.8 million and $2.1 million for the
years ended December 31, 2008, 2007 and 2006, respectively, are included in
sales revenue for these periods.
(w) Taxes Collected
from Customers and Remitted to Governmental Units
Taxes
assessed by a government authority that are directly imposed on a revenue
producing transaction between KCI and its customers, including but not limited
to sales taxes, use taxes and value added taxes, are accounted for on a net
(excluded from revenues and costs) basis.
(x) Advertising
Expenses
Advertising
costs are expensed as incurred. Advertising expenses were $9.6
million, $8.1 million and $7.4 million for the years ended December 31, 2008,
2007 and 2006, respectively.
(y) Seasonality
For the
last several years, our growth has been driven primarily by increased revenue
from V.A.C. Therapy systems and related supplies. Revenue from V.A.C.
Therapy systems accounted for approximately 74.2%, 79.5% and 77.9%,
respectively, of total revenue for the years ended December 31, 2008, 2007 and
2006. Historically, we have experienced a seasonal slowing of V.A.C.
revenue growth beginning late 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. LifeCell has also historically experienced a similar
seasonal slowing of sales in the third quarter of each year.
(z) Recently Adopted
Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157 (“SFAS 157”), “Fair Value
Measurements,”
which defines fair value, establishes guidelines for measuring fair value and
expands disclosures regarding fair value measurements. SFAS 157 does
not require any new fair value measurements, but rather eliminates
inconsistencies in guidance found in various prior accounting
pronouncements. SFAS 157 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. On February 12,
2008, the FASB issued Staff Position No. FAS 157-2 (“FSP 157-2”), which delays
the effective date of SFAS 157 for one year for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis. We elected a
partial deferral of SFAS 157 under the provisions of FSP 157-2 related to
the nonfinancial assets and nonfinancial liabilities associated with our
LifeCell acquisition which were measured and recorded at fair value as of the
acquisition date. We adopted SFAS 157 for our financial assets and
financial liabilities beginning January 1, 2008 and beginning January 1,
2009, we have adopted the provision of SFAS 157 previously deferred by FSP
157-2. The adoption of SFAS 157 did not have a material impact on our
results of operations or our financial position.
In
February 2007, the FASB issued SFAS No. 159 (“SFAS 159”), “The Fair Value of Financial Assets
and Financial Liabilities,” which permits entities to
elect to measure many financial instruments and certain other items at fair
value that are not currently required to be measured at fair
value. This election is irrevocable. SFAS 159 was
effective for KCI beginning January 1, 2008, and the adoption of SFAS 159
did not have a material impact on our results of operations or our financial
position.
In June
2007, the FASB ratified EITF Issue No. 07-3 (“EITF 07-3”), “Accounting for Nonrefundable
Advance Payments for Goods or Services to Be Used in Future Research and
Development Activities.” The scope of EITF 07-3 is limited to
nonrefundable advance payments for goods and services to be used or rendered in
future research and development activities pursuant to an executory contractual
arrangement. EITF 07-3 provides that nonrefundable advance payments
for goods or services that will be used or rendered for future research and
development activities should be deferred and capitalized. Such
amounts should be recognized as an expense as the related goods are delivered or
the related services are performed. Companies should report the
effects of applying EITF 07-3 prospectively for new contracts entered into on or
after the effective date of this Issue. EITF 07-3 was effective for
KCI beginning January 1, 2008, and the adoption of EITF 07-3 did not have a
material impact on our results of operations or our financial
position.
In
October 2008, FASB issued Staff Position No. FAS 157-3 (“FSP 157-3”), “Determining the Fair Value of a
Financial Asset When the Market for that Asset is not Active,” which clarifies the
application of SFAS 157 in a market that is not active and provides an example
to illustrate key considerations in determining the fair value of a financial
asset when the market for that financial asset is not active. FSP
157-3 was effective October 10, 2008 and for prior periods for which financial
statements have not been issued. The adoption of FSP 157-3 did not
have a material impact on our results of operations or our financial
position.
(aa) Recently Issued
Accounting Pronouncements
In
December 2007, the FASB issued SFAS No. 141 Revised (“SFAS 141R”), “Business Combinations,” which establishes
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. SFAS 141R also provides guidance for recognizing and
measuring the goodwill acquired in the business combination and specifies what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. SFAS
141R applies prospectively to business combinations and is effective for fiscal
years beginning after December 15, 2008. The impact that the adoption of SFAS
141R will have on our consolidated financial statements is dependent on the
nature, terms and size of business combinations that occur after the effective
date.
In March
2008, the FASB issued SFAS No. 161 (“SFAS 161”), “Disclosures about Derivative
Instruments and Hedging Activities – An Amendment of FASB Statement No.
133,” which
enhances the required disclosures regarding derivatives and hedging
activities. SFAS 161 is effective for fiscal years and interim
periods beginning after November 15, 2008. SFAS 161 was effective for
KCI beginning January 1, 2009, and the adoption of SFAS 161 did not have a
material impact on our results of operations or our financial
position.
In April
2008, the FASB issued Staff Position No. FAS 142-3 (“FSP 142-3”), “Determination of the Useful Life of
Intangible Assets” which amends the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset under SFAS 142, “Goodwill and Other Intangible
Assets.” FSP 142-3 is intended to improve the consistency
between the useful life of an intangible asset determined under SFAS 142 and the
period of expected cash flows used to measure the fair value of the asset under
SFAS 141R and other U.S. generally accepted accounting principles. FSP 142-3 is
effective for fiscal years and interim periods beginning after December 15,
2008. FSP 142-3 was effective for KCI beginning January 1,
2009, and the adoption of FSP 142-3 did not have a material impact on our
results of operations or our financial position.
In May
2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position
No. APB 14-1 (“FSP APB 14-1”), “Accounting for Convertible Debt
Instruments that May be Settled in Cash Upon Conversion.” FSP
APB 14-1 requires that the liability and equity components of convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement) be separately accounted for in a manner that reflects an issuer’s
non-convertible debt borrowing rate. Upon adoption of FSP APB 14-1 on
January 1, 2009, 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 an estimated
non-convertible debt borrowing rate for similar types of
instruments. 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 taxes and the portion of issuance costs allocated to the
equity component. The resulting 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. FSP APB
14-1 is effective for financial statements issued for fiscal years and interim
periods beginning after December 15, 2008. Retrospective application
to all prior periods presented is required. Due to the retrospective
application, the notes will reflect a lower principal balance and additional
non-cash interest expense based on our non-convertible debt borrowing
rate. Based on our estimated non-convertible borrowing rate of 7.8%,
the adoption of FSP APB 14-1 will result in approximately $12.4 million and
$18.8 million, or $0.11 and $0.16 per diluted share of additional non-cash
interest expense for 2008 and 2009, respectively, assuming diluted weighted
average shares outstanding of approximately 71.8 million. This amount
will increase in subsequent reporting periods as the debt accretes to its par
value over the remaining life of the notes.
In June
2008, the FASB ratified EITF Issue No. 07-5 (“EITF 07-5”), “Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own
Stock.” EITF 07-5 addresses the determination of whether an
instrument (or an embedded feature) is indexed to an entity’s own stock which is
taken into consideration in evaluating the applicability of SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” and EITF Issue No. 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.”
EITF 07-5 is effective for fiscal years and interim periods
beginning after December 15, 2008. Early adoption is not
permitted. EITF 07-5 was effective for KCI beginning January 1,
2009, and the adoption of EITF 07-5 did not have a material impact on our
results of operations or our financial position.
NOTE
2. Acquisition
On May
27, 2008, we completed the acquisition of all the outstanding capital stock of
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 $20.5 million of
acquisition-related transaction costs, which primarily consisted of fees
incurred for financial advisory and legal services.
The
purchase price was arrived at through negotiations between KCI and LifeCell and
was based on a number of factors, including but not limited to the market price
of LifeCell’s common stock, our ability to leverage our infrastructure together
with LifeCell’s products to further diversify our revenue stream and expand
LifeCell’s reach into the global marketplace, the ability to expand our presence
in the operating room and Acute care setting, and the prospects of the combined
research and development capabilities of KCI and LifeCell.
LifeCell
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. This acquisition enhances our product platform and
provides significant future growth opportunities.
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. The purchase price allocation is
preliminary, pending the final determination of the fair value of certain
assumed assets and liabilities. We have 12 months from the closing of
the acquisition to finalize our valuations. As these issues are identified,
modified or resolved, resulting increases or decreases to the preliminary value
of assets and liabilities are offset by a change to goodwill, which may be
material. Adjustments to these estimates will be 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, which is not deductible for
tax purposes.
The
following table represents the preliminary allocation of the purchase price as
of the acquisition date (dollars in thousands):
|
|
|
|
|
Adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
$ |
1,286,508 |
|
|
$ |
2,405 |
|
|
$ |
1,288,913 |
|
|
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 |
|
|
|
|
|
|
|
6,031 |
|
|
Property
and equipment
|
|
37,331 |
|
|
|
|
|
|
|
37,331 |
|
|
Current
liabilities
|
|
(48,546 |
) |
|
|
(4,280 |
) |
|
|
(52,826 |
) |
|
Noncurrent
tax liabilities
|
|
(5,101 |
) |
|
|
|
|
|
|
(5,101 |
) |
|
Net
deferred income tax liability
|
|
(171,829 |
) |
|
|
1,649 |
|
|
|
(170,180 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total purchase
price
|
$ |
1,842,238 |
|
|
$ |
(226 |
) |
|
$ |
1,842,012 |
|
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. During the second
half of 2008, modifications to goodwill reflected in the “Adjustments” column
above were primarily the result of severance costs associated with the
transaction, net of the related tax effects, established under EITF Issue No.
95-3, “Recognition of
Liabilities in Connection with a Purchase Business
Combination.”
In
connection with the preliminary purchase price allocation, we recorded a charge
of $61.6 million for the write-off of IPR&D. We allocated values
to the IPR&D based on an independent evaluation and appraisal of LifeCell’s
research and development projects. Such evaluation consisted of a
specific review of the efforts, including the overall objectives of the project,
progress toward the objectives and the uniqueness of the developments of these
objectives. Further, each IPR&D project was reviewed to determine
if technological feasibility had been achieved. The value of the
IPR&D was calculated using cash flow projections discounted for the risk
inherent in such projects. The discount rate was 13%. The
acquired IPR&D was confined to new products/technologies under
development. No routine efforts to incrementally refine or enhance
existing products or production activities were included in the acquired
IPR&D write-off.
Based on
the independent appraisal, the IPR&D was identified with three projects
including laparoscopic hernia, inguinal hernia and hybrid ACL repair
technologies. Laparoscopic hernia repair represents approximately
51.2% of the IPR&D and is a sterile medical device constructed for a fully
biological repair, is intended for ventral hernia repairs primarily for
laparoscopic repairs, but can be utilized for open repairs. Inguinal
hernia repair represents approximately 25.0% of the IPR&D and is a tissue
matrix for use in reinforcement and repair of inguinal hernia in order to reduce
chronic pain and discomfort. Hybrid ACL repair represents
approximately 23.8% of the IPR&D and is an anterior cruciate ligament
replacement device, comprised of composite construct of tissue matrix and
absorbable polymer fiber reinforcement and is compatible with current surgical
methods and equipment.
The
deferred tax liability relates primarily to the tax impact of future
amortization associated with the identification of intangible assets acquired,
which are not deductible for tax purposes.
We
estimated the fair value of acquired identifiable intangible assets using the
income approach. Acquired identifiable intangible assets will be
amortized on a straight-line basis over their estimated useful lives, which we
believe is the most appropriate amortization method. The amortization
of identifiable product-related intangible assets is included in “Acquired
intangible asset amortization” expense and, as a result, is excluded from cost
of sales and the determination of product margins.
The
following table represents the preliminary fair value of the components of
acquired identifiable intangible assets and their estimated useful lives at the
acquisition date (dollars in thousands):
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
|
Useful
|
|
|
|
|
Fair
Value
|
|
|
Life (years)
|
|
|
Acquired
identifiable intangible assets:
|
|
|
|
|
|
|
|
Developed
technology
|
|
$ |
238,391 |
|
|
|
14.0 |
|
|
Customer
relationships
|
|
|
192,204 |
|
|
|
10.1 |
|
|
Tradenames
and patents
|
|
|
56,058 |
|
|
|
11.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
486,653 |
|
|
|
|
|
The
results of LifeCell’s operations since the acquisition date have been included
in our 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
periods being presented (dollars in thousands, except per share
data):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
Pro
forma revenue
|
|
$ |
1,962,903 |
|
|
$ |
1,800,462 |
|
|
|
|
|
|
|
|
|
|
|
|
Pro
forma net earnings
|
|
$ |
225,176 |
|
|
$ |
171,888 |
|
|
|
|
|
|
|
|
|
|
|
|
Pro
forma net earnings per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
3.15 |
|
|
$ |
2.42 |
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$ |
3.14 |
|
|
$ |
2.40 |
|
Only
items with a continuing effect may be presented as adjustments when preparing
the pro forma income statement. As a result, for all periods
presented above, the unaudited pro forma results exclude the effects of the
increased valuation of inventory related to the LifeCell acquisition as this
represents a non-recurring expense. Additionally, for 2008, the unaudited pro
forma results above exclude the IPR&D expense recorded in connection with
the LifeCell acquisition as well as the write-off of unamortized debt issuance
costs on our previously-existing debt facility which resulted from our
refinancing associated with the LifeCell acquisition. 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 periods presented, nor are they indicative of
future operating results.
NOTE
3. Acquisition Financing
New Senior Credit Facility. On May
19, 2008, we entered into a new five-year senior secured credit facility with
Bank of America, N.A. as an administrative agent for the lenders
thereunder. The senior credit facility consists of a $1.0 billion
term loan facility and a $300.0 million revolving credit facility, both of which
mature in May 2013. We borrowed $1.0 billion under the new term loan
facility. We used the proceeds from the borrowing to fund a portion
of the purchase price of the LifeCell acquisition, to pay related fees and
expenses in connection with the LifeCell acquisition, to pay fees and expenses
associated with our acquisition financing, to repay all amounts then outstanding
under our previously-existing senior credit facility due 2012, and for general
corporate purposes. Borrowings under the new senior credit facility are
secured by a first priority security interest in substantially all of our
existing and hereafter acquired assets, including substantially all of the
capital stock or membership interests of all of our subsidiaries that are
guarantors under the new credit facility and 65% of the capital stock or
membership interests of certain of our other subsidiaries. (See Note
6.)
Issuance of 3.25% 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. We granted an
option to the initial purchasers of the notes to purchase up to an additional
$90.0 million aggregate principal amount of notes to cover over-allotments,
which was exercised on May 1, 2008 for the entire additional $90.0 million
aggregate principal amount. In connection with the offering and
over-allotment exercise, we entered into convertible note hedge and warrant
transactions with affiliates of the initial purchasers of the
notes. Proceeds of the notes were used to pay the net cost of the
convertible note hedge transactions, to fund a portion of the purchase price of
the LifeCell acquisition, to repay certain indebtedness, to provide ongoing
working capital and for other general corporate purposes. (See Note
6.)
The
funding of the LifeCell acquisition using proceeds from the issuance of the
3.25% convertible senior notes due 2015, borrowing under the new senior credit
facility, and the repayment of our previously-existing senior credit facility
are referred to herein collectively as the “Acquisition
Financing”. In addition, we wrote off unamortized deferred debt
issuance costs on our previous debt facility upon the refinancing of our credit
facility and repayment of our previous debt totaling $860,000 in the second
quarter of 2008. The write-off of the unamortized deferred debt
issuance costs is included within interest expense on our consolidated
statements of earnings.
The
following sets forth the sources and uses of funds in connection with the
Acquisition Financing (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
|
|
|
329,361 |
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,121,819 |
|
|
|
|
|
|
|
|
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
|
|
|
20,516 |
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,121,819 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Transaction
fees and expenses for the Acquisition Financing have been deferred and
will be amortized over the life of the debt
instruments.
|
|
NOTE
4. Supplemental Balance Sheet
Data
(a) Accounts
Receivable
Accounts
receivable consist of the following (dollars in thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
Gross
trade accounts receivable:
|
|
|
|
|
|
|
|
North
America:
|
|
|
|
|
|
|
|
Acute
and extended care organizations
|
|
$ |
122,373 |
|
|
$ |
123,643 |
|
|
Medicare
/ Medicaid
|
|
|
58,662 |
|
|
|
66,922 |
|
|
Managed
care, insurance and other
|
|
|
184,172 |
|
|
|
153,612 |
|
|
|
|
|
|
|
|
|
|
|
|
North
America - trade accounts receivable
|
|
|
365,207 |
|
|
|
344,177 |
|
|
|
|
|
|
|
|
|
|
|
|
EMEA/APAC
- trade accounts receivable
|
|
|
98,500 |
|
|
|
102,682 |
|
|
|
|
|
|
|
|
|
|
|
|
LifeCell
– trade accounts receivable
|
|
|
33,521 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
Total
trade accounts receivable
|
|
|
497,228 |
|
|
|
446,859 |
|
|
|
|
|
|
|
|
|
|
|
|
Less: Allowance
for revenue adjustments
|
|
|
(94,516 |
) |
|
|
(90,095 |
) |
|
|
|
|
|
|
|
|
|
|
|
Gross
trade accounts receivable
|
|
|
402,712 |
|
|
|
356,764 |
|
|
|
|
|
|
|
|
|
|
|
|
Less: Allowance
for bad debt
|
|
|
(9,469 |
) |
|
|
(6,695 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net
trade accounts receivable
|
|
|
393,243 |
|
|
|
350,069 |
|
|
|
|
|
|
|
|
|
|
|
|
Employee
and other receivables
|
|
|
12,764 |
|
|
|
6,896 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
406,007 |
|
|
$ |
356,965 |
|
(b) Inventories
Inventories
consist of the following (dollars in thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Finished
goods and tissue available for distribution
|
|
$ |
68,837 |
|
|
$ |
34,647 |
|
|
Goods
and tissue in-process
|
|
|
9,892 |
|
|
|
1,341 |
|
|
Raw
materials, supplies, parts and unprocessed tissue
|
|
|
64,242 |
|
|
|
34,551 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
142,971 |
|
|
|
70,539 |
|
|
|
|
|
|
|
|
|
|
|
|
Less:
Amounts expected to be converted into equipment for
|
|
|
|
|
|
|
|
|
|
short-term
rental
|
|
|
(27,000 |
) |
|
|
(15,800 |
) |
|
Reserve
for excess and obsolete inventory
|
|
|
(6,874 |
) |
|
|
(4,398 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
109,097 |
|
|
$ |
50,341 |
|
Inventories
at December 31, 2008 included $40.0 million of LifeCell inventory, net of
reserves. In addition, the increase in raw materials and amounts
expected to be converted into equipment for short-term rental is primarily
related to the increase in V.A.C. unit raw materials necessary to support our
V.A.C. products.
(c) Net
property, plant and equipment
Net
property, plant and equipment consists of the following (dollars in
thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
$ |
599 |
|
|
$ |
599 |
|
|
Buildings
|
|
|
16,501 |
|
|
|
15,753 |
|
|
Equipment
for short-term rental
|
|
|
363,743 |
|
|
|
340,634 |
|
|
Machinery,
equipment and furniture (1)
|
|
|
275,288 |
|
|
|
214,692 |
|
|
Leasehold
improvements
|
|
|
68,561 |
|
|
|
31,614 |
|
|
Inventory
to be converted to equipment
|
|
|
27,000 |
|
|
|
15,800 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
751,692 |
|
|
|
619,092 |
|
|
Less
accumulated depreciation (1)
|
|
|
(447,893 |
) |
|
|
(390,621 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
303,799 |
|
|
$ |
228,471 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Net
property, plant and equipment as of December 31, 2008 and 2007 includes
approximately $1.2 million and $1.5 million, respectively, in machinery,
equipment and furniture under various capital
leases.
|
|
(d) Accrued
expenses and other
Accrued
expenses and other consist of the following (dollars in thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Payroll,
benefits, commissions, bonuses and related taxes
|
|
$ |
81,221 |
|
|
$ |
79,346 |
|
|
Royalty
accrual
|
|
|
63,870 |
|
|
|
61,661 |
|
|
Derivative
liability
|
|
|
13,240 |
|
|
|
- |
|
|
Deferred
compensation
|
|
|
- |
|
|
|
7,129 |
|
|
Insurance
accruals
|
|
|
5,915 |
|
|
|
7,239 |
|
|
Other
accrued expenses
|
|
|
94,420 |
|
|
|
57,499 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
258,666 |
|
|
$ |
212,874 |
|
NOTE
5. Accounting for Goodwill and Other
Non-current Assets
(a) Goodwill
The
components of goodwill by reporting segment are listed below (dollars in
thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
187,081 |
|
|
$ |
25,303 |
|
|
EMEA/APAC
|
|
|
23,594 |
|
|
|
23,594 |
|
|
LifeCell
|
|
|
1,127,135 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,337,810 |
|
|
$ |
48,897 |
|
The
increase in goodwill is related to our acquisition of LifeCell in May
2008. As of December 31, 2008, we allocated $161.8 million of
goodwill related to the LifeCell acquisition to our North America – V.A.C. and
TSS reporting unit based on the discounted projected benefit to be received by
this reporting unit.
(b) Identifiable intangible
assets
Identifiable
intangible assets include the following (dollars in thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Developed
technology
|
|
$ |
238,391 |
|
|
$ |
- |
|
|
Customer
relationships
|
|
|
192,204 |
|
|
|
- |
|
|
Tradenames
and patents
|
|
|
78,725 |
|
|
|
17,874 |
|
|
|
|
|
|
|
|
|
|
|
|
Identifiable
intangible assets
|
|
|
509,320 |
|
|
|
17,874 |
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
amortization
|
|
|
(36,773 |
) |
|
|
(10,678 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
472,547 |
|
|
$ |
7,196 |
|
The
increase in identifiable intangible assets is due primarily to the $486.7
million of identifiable intangible assets purchased in connection with the
LifeCell acquisition. During 2008, we recorded approximately $25.0
million of amortization expense associated with the purchased identifiable
intangible assets.
Amortization
expense, related to definite-lived intangibles, was approximately $26.0 million,
$1.3 million and $415,000 for 2008, 2007 and 2006, respectively. We
amortize these intangible assets over 5 to 17 years, depending on the
estimated economic or contractual life of the individual asset. The
following table shows the estimated amortization expense, in total, to be
incurred over the next five years for all definite-lived intangible assets as of
December 31, 2008 (dollars in thousands):
|
|
|
Estimated
|
|
|
Year
ending
|
|
Amortization
|
|
|
December
31,
|
|
Expense
|
|
|
|
|
|
|
|
2009
|
|
$ |
41,576 |
|
|
2010
|
|
$ |
41,583 |
|
|
2011
|
|
$ |
41,487 |
|
|
2012
|
|
$ |
41,448 |
|
|
2013
|
|
$ |
41,385 |
|
(c) Other
non-current assets
Other
non-current assets include the following (dollars in thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Investment
in assets subject to leveraged leases
|
|
$ |
7,400 |
|
|
$ |
11,200 |
|
|
Deposits
and other
|
|
|
5,330 |
|
|
|
4,643 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
12,730 |
|
|
$ |
15,843 |
|
|
|
|
|
|
|
|
|
|
|
We
acquired beneficial ownership of two Grantor Trusts in December 1996 and
December 1994. The assets held by each Trust consist of a
McDonnell Douglas DC-10 aircraft and three engines. In connection with the
acquisitions, KCI paid cash equity of $7.2 million and $7.6 million,
respectively. At the date of the acquisition, the Trusts held debt of
$48.4 million and $51.8 million, respectively, which is non-recourse
to KCI. The aircraft are leased to the FedEx Corporation, or FedEx,
through June 2012 and January 2012, respectively. FedEx
pays monthly rent to a third-party, who in turn, pays the entire amount to the
holders of the non-recourse indebtedness, which is secured by the
aircraft. The holder's recourse in the event of a default is limited
to the Trusts’ assets.
We
evaluate the potential for impairment annually or more frequently when events or
changes in circumstances indicate an asset might be impaired. The
current market analysis of these assets includes the commercial airline
industry, which has suffered diminished market values. During 2008,
2007 and 2006, based on our analysis of the current market conditions, we
decreased our net investment in these aircraft by $3.8 million, $2.3 million and
$3.0 million, respectively, which was expensed to selling, general and
administrative expenses. These assets are under long-term lease to
FedEx. If FedEx were to terminate the existing leases prior to
expiration, the lease agreement would require FedEx to make a stated termination
payment. At December 31, 2008, the termination payment would cover
the remaining debt and the residual value recorded by KCI. We believe
the current asset balance represents the residual value we expect to realize
upon lease expiration.
(d) Debt
issuance costs
As of
December 31, 2008, unamortized debt issuance costs related to our current senior
credit facility and convertible senior notes were $53.5
million. Unamortized debt issuance costs related to our
previously-existing senior revolving credit facility was $2.5 million as of
December 31, 2007. Amortization of debt issuance costs recorded for
the years ended December 31, 2008, 2007 and 2006 were $9.6 million, $4.8 million
and $2.7 million, respectively. The amortization for 2008, 2007 and
2006 includes approximately $860,000, $3.9 million and $1.5 million,
respectively, of debt issuance costs written off in connection with our
redemptions of our subordinated notes and prepayments on our previously-existing
senior revolving credit facility. The remaining costs for the current
senior credit facility and convertible notes are amortized on a straight-line
basis or using the effective interest method, as appropriate, over the
respective term of debt to which they specifically relate.
NOTE 6. Long-Term Debt and Derivative
Financial Instruments
Long-term
debt consists of the following (dollars in thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Senior
Credit Facility – due 2013
|
|
$ |
950,000 |
|
|
$ |
- |
|
|
3.25%
Convertible Senior Notes due 2015
|
|
|
690,000 |
|
|
|
- |
|
|
Senior
Revolving Credit Facility – due 2013
|
|
|
29,000 |
|
|
|
- |
|
|
Senior
Revolving Credit Facility – due 2012 (1)
|
|
|
- |
|
|
|
68,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,669,000 |
|
|
|
68,000 |
|
|
Less: current
installments
|
|
|
(100,000 |
) |
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,569,000 |
|
|
$ |
68,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) All
outstanding amounts were repaid in connection with Acquisition Financing
completed in the second quarter of 2008.
|
|
Senior
Credit Facility
On May
19, 2008, we entered into a new $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 December
31, 2008, $950.0 million and $29.0 million were outstanding under the term loan
facility and revolving credit facility, respectively. We had
outstanding letters of credit in the aggregate amount of $8.6
million. The resulting availability under the revolving credit
facility was $262.4 million at December 31, 2008.
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 December 31 2008, our nominal interest
rate on borrowings under the senior credit facility was 4.748%.
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.
Collateral. The senior credit
facility is secured by a first priority lien and security interest in (a)
substantially all shares of capital stock and intercompany debt of each of our
present and future subsidiaries (limited in the case of certain subsidiaries to
65% of the voting stock of such entity) and (b) substantially all of our present
and future real property (with a value in excess of $10 million individually),
and the present and future assets of our subsidiaries that are and will be
guarantors under the senior credit facility. The security interest is
subject to some exceptions and permitted liens.
Guarantors. Our obligations
under the senior credit facility are guaranteed by each of our direct and
indirect 100% owned subsidiaries, other than foreign subsidiaries or
subsidiaries whose only assets are investments in foreign
subsidiaries.
Maturity. The senior credit
facility matures on May 19, 2013.
Voluntary Prepayments. We may
prepay, in full or in part, borrowings under the senior credit facility without
premium or penalty, subject to minimum prepayment amount and increment
limitations.
Mandatory Repayments. We must
make periodic prepayments of an aggregate principal amount of the term loans
equal to (i) 100% of the net cash proceeds of certain dispositions of property,
(ii) 100% of the net cash proceeds of the issuance or incurrence of certain
indebtedness, (iii) 50% of the net cash proceeds received from certain equity
issuances, and (iv) 50% (or a reduced percentage determined in reference to our
consolidated leverage ratio) of our domestic excess cash flow.
Representations. The senior
credit facility contains representations generally customary for similar
facilities and transactions.
Covenants. The senior credit
facility contains affirmative and negative convents customary for similar
facilities and transactions. The material covenants and other restrictive
covenants in the senior credit agreement are summarized as follows:
|
·
|
quarterly
and annual financial reporting
requirements;
|
|
·
|
limitations
on other debt, with baskets for, among other things, the convertible
senior notes, debt used to acquire fixed or capital assets, debt of
foreign subsidiaries, certain intercompany debt, debt of newly-acquired
subsidiaries, debt under certain nonspeculative interest rate and foreign
currency swaps and up to $50 million of additional
debt;
|
|
·
|
limitations
on other liens, with baskets for certain ordinary-course liens and liens
securing certain permitted
debt above;
|
|
·
|
limitations
on mergers or consolidations and on sales of assets with baskets for
certain ordinary course asset sales and certain asset sales for fair
market value;
|
|
·
|
limitations
on investments, with baskets for certain ordinary-course extensions of
trade credit, investments in cash equivalents, certain intercompany
investments, interest rate and foreign currency swaps otherwise permitted,
investments constituting certain permitted debt and certain
acquisitions;
|
|
·
|
limitations
on early retirement of subordinated debt with a basket for certain
prepayments using excess cash not required to be applied to mandatory
prepayment of the term loan;
|
|
·
|
limitations
on changes in the nature of the business, on changes in our fiscal year,
and on changes in organizational
documents;
|
|
·
|
limitations
on changes in accounting policies or reporting practices;
and
|
|
·
|
limitations
on capital expenditures.
|
We are
permitted to pay dividends on our capital stock or effect unlimited repurchases
of our capital stock when our pro forma leverage ratio, as defined in the senior
credit agreement, is less than or equal to 1.75 to 1.00 and there is no default
under the senior credit agreement. In the event the leverage ratio is
greater than 1.75 to 1.00, open-market repurchases of our common stock are
limited to $100.0 million until such time as the leverage ratio has been
restored.
Our
senior credit facility contains financial covenants requiring us to meet certain
leverage and fixed charge coverage ratios. It will be an event of default if we
permit any of the following:
|
·
|
as
of the last day of any fiscal quarter, our leverage ratio of debt to
EBITDA, as defined in the senior credit agreement, to be greater than a
maximum leverage ratio, initially set at 3.50 to 1.00 and stepped down
periodically until the fiscal quarter ending December 31, 2009, upon which
date, and thereafter, the maximum leverage ratio will be 3.00 to 1.00;
and
|
|
·
|
as
of the last day of any fiscal quarter, our ratio of EBITDA (with certain
deductions) to fixed charges to be less than a minimum fixed charge
coverage ratio, initially set at 1.10 to 1.00 and stepped up for the
fiscal quarter ended December 31, 2008, and thereafter, to a minimum
coverage ratio of 1.15 to 1.00.
|
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.
As of
December 31, 2008, we were in compliance with all covenants under the senior
credit agreement.
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 December
31, 2008, $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 accrues from April 21,
2008, and is payable semi-annually in arrears on April 15 and October 15 of each
year, beginning October 15, 2008.
Recently issued accounting
pronouncement. Upon adoption of FSP APB 14-1 on January 1, 2009, 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 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 taxes and the portion of issuance costs allocated to the
equity component. The resulting 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. FSP APB
14-1 is effective for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those fiscal
years. Retrospective application to all prior periods presented is
required. Due to the retrospective application, the notes will
reflect a lower principal balance and additional non-cash interest expense based
on our non-convertible debt borrowing rate. Based on our
non-convertible borrowing rate of 7.8%, the adoption of FSP APB 14-1 will result
in approximately $12.4 million and $18.8 million, or $0.11 and $0.16 per diluted
share of additional non-cash interest expense for 2008 and 2009, respectively,
assuming diluted weighted average shares outstanding of approximately 71.8
million. This amount will increase in subsequent reporting periods as
the debt accretes to its par value over the remaining life of the
notes.
Guarantor. Our wholly-owned
subsidiary, KCI USA, Inc. (the “Subsidiary Guarantor”), has
guaranteed the principal and interest payable under the notes on a contractually
subordinated basis to its secured guarantee of our new credit facility and any
credit facilities we enter into in the future.
Ranking. The notes are senior
unsecured obligations, and rank (i) senior to any of our future
indebtedness that is expressly subordinated to the notes; (ii) equally to
any future senior subordinated debt; and (iii) effectively junior to any
secured indebtedness to the extent of the value of the assets securing such
indebtedness. In addition, the notes are structurally junior to (i) all
existing and future indebtedness and other liabilities incurred by our
subsidiaries and (ii) preferred stock issued by our subsidiaries, except
that in the case of the guarantee of the principal and interest on the notes by
the Subsidiary Guarantor, such guarantee will be (a) effectively
subordinated to all of the Subsidiary Guarantor’s secured debt to the extent of
the value of the assets securing such debt, (b) contractually subordinated
to its secured guarantee of our new credit facility and any credit facilities we
enter into in the future, (c) pari passu with all of its other senior
indebtedness, and (d) senior to all of its indebtedness that is expressly
subordinated in right of payment to the subsidiary guarantee and all of its
preferred stock outstanding.
Maturity. The notes will
mature on April 15, 2015, unless previously converted or repurchased in
accordance with their terms prior to such date. As of December 31,
2008, the notes are classified as a non-current liability.
Redemption. The notes are not
redeemable by us prior to the maturity date, but the holders may require us to
repurchase the notes at 100% of the principal amount of the notes, plus accrued
and unpaid interest, following a “fundamental change” (as defined in the
Indenture).
Conversion. Holders of the
notes may convert their notes at their option on any day prior to the close of
business on the business day immediately preceding October 15, 2014 only if one
or more of the following conditions is satisfied:
|
(1)
|
during
any fiscal quarter commencing after June 30, 2008, if the last reported
sale price of our common stock for at least 20 trading days in the period
of 30 consecutive trading days ending on the last trading day of the
preceding fiscal quarter is greater than or equal to 130% of the
conversion price of the notes in effect on each applicable trading
day;
|
|
(2)
|
during
the five business day period following any five consecutive trading day
period in which the trading price for the notes (per $1,000 principal
amount of the notes) for each such trading day was less than 98% of the
last reported sale price of our common stock on such date multiplied by
the applicable conversion rate; or
|
|
(3)
|
if
we make certain significant distributions to holders of our common stock
or enter into specified corporate transactions. The notes are convertible,
regardless of whether any of the foregoing conditions has been satisfied,
on or after October 15, 2014 at any time prior to the close of
business on the third scheduled trading day immediately preceding the
stated maturity date.
|
Upon
conversion, holders will receive cash up to the aggregate principal amount of
the notes being converted and shares of our common stock in respect of the
remainder, if any, of our conversion obligation in excess of the aggregate
principal amount of the notes being converted. The initial conversion
rate for the notes is 19.4764 shares of our common stock per $1,000 principal
amount of notes, which is equivalent to an initial conversion price of
approximately $51.34 per share of common stock and represents a 27.5% conversion
premium over the last reported sale price of our common stock on April 15, 2008,
which was $40.27 per share. 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. The entire principal
amount of the Convertible Notes is recorded as debt as prescribed under APB
14, “Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants.”
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 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 senior 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 Notes and is similarly subject to customary
adjustments. The Note Hedge expires on April 15, 2015, the maturity
date of the 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, we will include the effect of additional
shares that may be issued using the treasury stock method in our diluted EPS
calculations.
Interest
Rate Protection
We follow
SFAS 133 and its amendments, SFAS 137, “Accounting for Derivative
Instruments and Hedging Activities – Deferral of the Effective Date of FASB
Statement No. 133,” and SFAS 138, “Accounting for Certain Derivative
Instruments and Certain Hedging Activities,” in accounting for our
derivative financial instruments. SFAS 133 requires that all
derivative instruments be 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
following chart summarizes interest rate hedge transactions effective during
2008 (dollars in thousands):
|
|
|
|
|
Original
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional
|
|
|
Notional
Amount at
|
|
|
Fixed
|
|
|
|
Accounting
Method
|
|
Effective
Dates
|
|
Amount
|
|
|
|
|
|
Interest
Rate
|
|
Status
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hypothetical
|
|
06/30/08-06/30/11
|
|
$ |
100,000
|
|
|
$ |
87,000
|
|
|
|
3.895%
|
|
Outstanding
|
|
Hypothetical
|
|
06/30/08-06/30/11
|
|
$ |
50,000
|
|
|
$ |
43,500
|
|
|
|
3.895%
|
|
Outstanding
|
|
Hypothetical
|
|
06/30/08-06/30/11
|
|
$ |
50,000
|
|
|
$ |
43,500
|
|
|
|
3.895%
|
|
Outstanding
|
|
Hypothetical
|
|
09/30/08-03/31/11
|
|
$ |
40,000
|
|
|
$ |
37,400
|
|
|
|
3.399%
|
|
Outstanding
|
|
Hypothetical
|
|
09/30/08-03/31/11
|
|
$ |
30,000
|
|
|
$ |
28,050
|
|
|
|
3.399%
|
|
Outstanding
|
|
Hypothetical
|
|
09/30/08-03/31/11
|
|
$ |
30,000
|
|
|
$ |
28,050
|
|
|
|
3.399%
|
|
Outstanding
|
|
Hypothetical
|
|
12/31/08-12/31/10
|
|
$ |
40,000
|
|
|
$ |
40,000
|
|
|
|
3.030%
|
|
Outstanding
|
|
Hypothetical
|
|
12/31/08-12/31/10
|
|
$ |
30,000
|
|
|
$ |
30,000
|
|
|
|
3.030%
|
|
Outstanding
|
|
Hypothetical
|
|
12/31/08-12/31/10
|
|
$ |
30,000
|
|
|
$ |
30,000
|
|
|
|
3.030%
|
|
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
December 31, 2008, we had eleven interest rate swap agreements pursuant to which
we have fixed the rate on an aggregate $467.5 million notional amount of our
outstanding variable rate debt at a weighted average interest rate of 3.317%,
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.
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,
for a period of at least 30 months thereafter. As a result
of the swap agreements currently in effect as of December 31, 2008,
approximately 69.4% of our long-term debt outstanding, including the convertible
senior 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 December 31, 2008, the aggregate fair value of our
interest rate swap agreements was negative and was recorded as a liability of
approximately $13.3 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
ineffective portion was recorded in our consolidated statements of earnings
for 2006, 2007 or 2008.
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 $492,000 and $51,000 lower for 2008 and 2007,
respectively, but $2.0 million higher in 2006.
In
January, 2009, we entered into additional interest rate swap agreements to
convert an additional $100.0 million of our variable-rate debt to a fixed rate
basis. These interest rate swap agreements are effective beginning on
March 31, 2009 and expire on March 31, 2010 with a fixed interest rate of
1.110%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the
senior credit agreement. These have been designated as cash flow
hedge instruments under SFAS 133.
Foreign
Currency Exchange Fluctuation Protection
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. All forward
currency exchange contracts are marked-to-market each period and resulting gains
or losses are included in foreign currency loss in the consolidated statements
of earnings. Additionally, payable and receivable balances
denominated in nonfunctional currencies are marked-to-market at month-end, and
the gain or loss is recognized in our consolidated statements of
earnings. (See Note 1(u).)
At
December 31, 2008 and 2007, we had outstanding forward currency exchange
contracts to sell approximately $87.6 million and $27.2 million, respectively,
of various currencies. 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. We have designated our forward currency exchange
contracts as cash flow hedge instruments.
Interest
and Future Maturities
Interest
paid, net of cash received from interest rate swap agreements, during 2008, 2007
and 2006 was $54.7 million, $15.6 million and $17.6 million,
respectively. These amounts include any early redemption premium
payments associated with the purchase or redemption of our senior subordinated
notes.
Future
maturities of long-term debt at December 31, 2008 were (dollars in
thousands):
|
Year
|
|
Amount
|
|
|
2009
|
|
$ |
100,000 |
|
|
2010
|
|
$ |
150,000 |
|
|
2011
|
|
$ |
225,000 |
|
|
2012
|
|
$ |
300,000 |
|
|
2013
|
|
$ |
204,000 |
|
|
Thereafter
|
|
$ |
690,000 |
|
NOTE
7. Fair Value
Measurements
On
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” for
our financial assets and financial liabilities. We elected a partial
deferral of SFAS 157 under the provisions of FSP 157-2 related to
the nonfinancial assets and nonfinancial liabilities associated with our
LifeCell acquisition which were measured and recorded at fair value as of the
acquisition date. Under SFAS 157, fair value is defined as the exit
price that would be received to sell an asset or paid to transfer a
liability. SFAS 157 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
December 31, 2008, we had eleven interest rate swap agreements designated as
cash flow hedge instruments and foreign currency exchange contracts to sell
approximately $87.6 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 information by level for financial assets and
financial liabilities that are measured at fair value, as defined by SFAS 157,
on a recurring basis (dollars in thousands):
|
|
|
|
|
|
Fair
Value Measurements at Reporting
|
|
|
|
|
Fair
Value at
|
|
|
Date
Using Inputs Considered as
|
|
|
|
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,964 |
|
|
$ |
- |
|
|
$ |
1,964 |
|
|
$ |
- |
|
|
Interest
rate swap agreements
|
|
$ |
13,240 |
|
|
$ |
- |
|
|
$ |
13,240 |
|
|
$ |
- |
|
We did
not have any measurements of financial assets or financial liabilities at fair
value on a nonrecurring basis at December 31, 2008.
NOTE
8. Leasing
Obligations
We are
obligated for equipment under various capital leases, which expire at various
dates during the next four years. At December 31, 2008 and 2007, the gross
amount of equipment under capital leases totaled $2.5 million and
$2.6 million and related accumulated depreciation was approximately $1.3
million and $1.1 million, respectively.
In
August 2002, we sold our corporate headquarters facility and adjacent land
and buildings under a 10-year sale-leaseback arrangement. The
properties were sold for $17.9 million, net of selling costs, resulting in
a deferred gain of approximately $10.7 million. The deferred
gain is being amortized over the term of the lease. In 2008, 2007 and
2006, approximately $1.1 million of gain was recognized annually as a
reduction of selling, general and administrative expenses. The
initial lease term is 10 years, expiring in 2012. We have two
consecutive options to renew the lease for a term of three or five years each at
our option. If we exercise either renewal option, the terms of the
renewal lease will be on prevailing market rental terms, including the lease
rate and any improvement allowance or other inducements available to renewing
tenants on prevailing market terms. In order to exercise our renewal
options, we must give notice at least six months prior to the expiration of the
then-existing term. Rental expense for our corporate headquarters
totaled $4.6 million, $4.2 million and $4.1 million for the years ended 2008,
2007 and 2006, respectively. The following table indicates the
estimated future cash lease payments of our corporate headquarters, inclusive of
executory costs, for the years set forth below (dollars in
thousands):
|
Year
ending
|
|
Estimated
Cash
|
|
|
December
31,
|
|
Lease
Payments
|
|
|
|
|
|
|
|
2009
|
|
$ |
4,210 |
|
|
2010
|
|
|
3,865 |
|
|
2011
|
|
|
3,900 |
|
|
2012
|
|
|
2,330 |
|
|
Thereafter
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
$ |
14,305 |
|
In
addition to leasing our headquarters facility, we lease computer and
telecommunications equipment, service vehicles, office space, various storage
spaces and manufacturing facilities under non-cancelable operating leases, which
expire at various dates over the next nine years. Total rental expense for
operating leases, including our headquarters facility, was $37.7 million,
$35.8 million and $32.4 million for the years ended December 31, 2008,
2007 and 2006, respectively.
Future
minimum lease payments under capital and non-cancelable operating leases,
including our headquarters facility (with initial or remaining lease terms in
excess of one year) as of December 31, 2008 are as follows (dollars in
thousands):
|
|
|
Capital
|
|
|
Operating
|
|
|
|
|
Leases
|
|
|
Leases
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
$ |
191 |
|
|
$ |
36,370 |
|
|
2010
|
|
|
132 |
|
|
|
29,845 |
|
|
2011
|
|
|
55 |
|
|
|
22,538 |
|
|
2012
|
|
|
8 |
|
|
|
16,722 |
|
|
2013
|
|
|
5 |
|
|
|
10,620 |
|
|
Thereafter
|
|
|
- |
|
|
|
22,966 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
minimum lease payments
|
|
$ |
391 |
|
|
$ |
139,061 |
|
|
|
|
|
|
|
|
|
|
|
|
Less
amount representing interest
|
|
|
(58 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Present
value of net minimum capital lease payments
|
|
|
333 |
|
|
|
|
|
|
Less
current portion
|
|
|
(191 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations
under capital leases, excluding current installments
|
|
$ |
142 |
|
|
|
|
|
NOTE
9. Income Taxes
The
following table summarizes earnings before income taxes of U.S. and foreign
operations (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$ |
199,136 |
|
|
$ |
288,796 |
|
|
$ |
233,391 |
|
|
Foreign
|
|
|
88,146 |
|
|
|
69,157 |
|
|
|
58,655 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
287,282 |
|
|
$ |
357,953 |
|
|
$ |
292,046 |
|
The
following table summarizes the composition of income taxes (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$ |
9,502 |
|
|
$ |
106,541 |
|
|
$ |
92,315 |
|
|
State
|
|
|
15,943 |
|
|
|
14,279 |
|
|
|
14,778 |
|
|
International
|
|
|
12,357 |
|
|
|
11,799 |
|
|
|
11,010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
current expense
|
|
|
37,802 |
|
|
|
132,619 |
|
|
|
118,103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
78,821 |
|
|
|
(9,462 |
) |
|
|
(17,620 |
) |
|
State
|
|
|
417 |
|
|
|
(1,181 |
) |
|
|
(1,623 |
) |
|
International
|
|
|
(3,653 |
) |
|
|
(1,167 |
) |
|
|
(2,282 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
deferred tax expense (benefit)
|
|
|
75,585 |
|
|
|
(11,810 |
) |
|
|
(21,525 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
$ |
113,387 |
|
|
$ |
120,809 |
|
|
$ |
96,578 |
|
The
reconciliation of the U.S. federal statutory rate to the consolidated effective
tax rate is as follows:
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Computed
"expected" tax expense
|
|
35.0 |
% |
|
35.0 |
% |
|
35.0 |
% |
|
State
income taxes, net of federal benefit
|
|
2.8 |
|
|
2.8 |
|
|
2.9 |
|
|
Non-deductible
in-process research & development
|
|
7.5 |
|
|
-
|
|
|
-
|
|
|
Nondeductible
meals and entertainment
|
|
0.6 |
|
|
0.3 |
|
|
0.4 |
|
|
Foreign
income taxed at other than U.S. rates
|
|
(6.5 |
) |
|
(3.1 |
) |
|
(3.9 |
) |
|
Foreign
tax refund
|
|
-
|
|
|
(0.3 |
) |
|
(0.9 |
) |
|
Section
199 production deduction
|
|
(0.5 |
) |
|
(0.9 |
) |
|
(0.3 |
) |
|
Research
and development credit
|
|
(0.5 |
) |
|
(0.5 |
) |
|
(0.3 |
) |
|
Non-deductible
Stock Options
|
|
0.5 |
|
|
0.5 |
|
|
-
|
|
|
Other,
net
|
|
0.6 |
|
|
-
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
39.5 |
% |
|
33.8 |
% |
|
33.1 |
% |
The tax
effects of temporary differences which give rise to significant portions of the
deferred tax assets and liabilities consist of the following (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
Deferred
Tax Assets:
|
|
|
|
|
|
|
|
Accounts
receivable, principally due to allowance for doubtful
accounts
|
|
$ |
5,706 |
|
|
$ |
29,783 |
|
|
Foreign
net operating loss carry forwards
|
|
|
9,983 |
|
|
|
12,448 |
|
|
Domestic
net operating loss
|
|
|
1,071 |
|
|
|
- |
|
|
Deferred
state tax asset
|
|
|
- |
|
|
|
4,553 |
|
|
Convertible
note hedge
|
|
|
48,737 |
|
|
|
- |
|
|
Tax
credits, primarily research and development
|
|
|
1,203 |
|
|
|
1,576 |
|
|
Accrued
liabilities
|
|
|
9,737 |
|
|
|
6,528 |
|
|
Compensation
|
|
|
- |
|
|
|
2,220 |
|
|
Deferred
foreign tax asset
|
|
|
11,222 |
|
|
|
11,559 |
|
|
Deferred
gain on sale of headquarters facility
|
|
|
1,342 |
|
|
|
1,717 |
|
|
Inventories,
principally due to additional costs capitalized for tax purposes pursuant
to the Tax Reform Act of 1986
|
|
|
3,606 |
|
|
|
1,691 |
|
|
Intangible
assets, deducted for book purposes but capitalized and amortized for tax
purposes
|
|
|
293 |
|
|
|
288 |
|
|
Share-based
compensation as a result of adoption of SFAS 123R
|
|
|
13,636 |
|
|
|
8,216 |
|
|
Accrued
Interest
|
|
|
1,262 |
|
|
|
1,933 |
|
|
Derivatives
|
|
|
4,634 |
|
|
|
- |
|
|
Other
|
|
|
2,613 |
|
|
|
3,973 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
gross deferred tax assets
|
|
|
115,045 |
|
|
|
86,485 |
|
|
Less:
valuation allowances
|
|
|
(11,821 |
) |
|
|
(14,673 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax assets
|
|
|
103,224 |
|
|
|
71,812 |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
Tax Liabilities:
|
|
|
|
|
|
|
|
|
|
Intangibles
amortized for book not tax
|
|
|
(160,771 |
) |
|
|
- |
|
|
Deferred
state tax liability
|
|
|
(17,512 |
) |
|
|
- |
|
|
Plant
and equipment, principally due to differences in depreciation and
basis
|
|
|
(68,117 |
) |
|
|
(22,072 |
) |
|
Net
intangible assets, deducted for book purposes over a longer life than for
tax purposes
|
|
|
(7,625 |
) |
|
|
(6,833 |
) |
|
Other
|
|
|
(2,337 |
) |
|
|
(2,581 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total
gross deferred tax liabilities
|
|
|
(256,362 |
) |
|
|
(31,486 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net
deferred tax asset (liability)
|
|
|
(153,138 |
) |
|
|
40,326 |
|
|
Less:
current deferred tax asset
|
|
|
(19,972 |
) |
|
|
(41,504 |
) |
|
Less:
non-current deferred tax asset
|
|
|
(8,635 |
) |
|
|
(8,743 |
) |
|
|
|
|
|
|
|
|
|
|
|
Non-current
deferred tax liability
|
|
$ |
(181,745 |
) |
|
$ |
(9,921 |
) |
The
change in the balance sheet deferred tax accounts reflect deferred income tax
expense, the deferred tax impact of other comprehensive income items and
purchase accounting adjustments for the LifeCell acquisition.
At
December 31, 2008, $1.2 million of state research and development credits and
$10.0 million of foreign tax losses were available for
carryforward. The losses and credits generally expire within a period
of 3 to 20 years, with some foreign losses available indefinitely. We
have valuation allowances of $1.2 million associated with our state research and
development credit carryforwards, $10.0 million associated with foreign loss
carryforwards, and approximately $600,000 associated with certain foreign
deferred tax assets due to uncertainties regarding their
realizability. The net valuation allowance decreased by $2.9 million
and $199,000 for the years ended December 31, 2008 and 2007,
respectively. For the year ended December 31, 2006, the net valuation
allowance increased by $3.3 million due primarily to increased foreign net
operating losses. We believe that the remaining deferred income tax
assets will be realized based upon historical pre-tax earnings, adjusted for
reversals of existing taxable temporary differences. Certain tax
planning or other strategies will be implemented, if necessary, to supplement
income from operations to fully realize these remaining deferred tax
assets. Accordingly, we believe that no additional valuation
allowances are necessary.
KCI
operates in multiple tax jurisdictions with varying rates, both inside and
outside the U.S. and is routinely under audit by federal, state and foreign tax
authorities. These reviews can involve complex matters that may
require an extended period of time for resolution. KCI's U.S. Federal
income tax returns have been examined and settled through fiscal year
2004. However, KCI has filed amended returns for increased Research
and Development Credits for 2003 and 2004 that are being reviewed by the
Internal Revenue Service. In addition, KCI has ongoing audits in
various state and local jurisdictions, as well as audits in various foreign
jurisdictions. We provide tax reserves for federal, state, local and
international uncertain tax positions. The development of these tax
positions requires subjective, critical estimates and judgments about tax
matters, potential outcomes and timing. Although the outcome of open
tax examinations is uncertain, in management's opinion, adequate provisions for
income taxes have been made for potential liabilities emanating from these
reviews. If actual outcomes differ materially from these estimates,
they could have a material impact on our financial condition and results of
operations. Differences between actual results and assumptions, or changes in
assumptions in future periods, are recorded in the period they become
known. To the extent additional information becomes available prior
to resolution, such accruals are adjusted to reflect probable
outcomes.
At
December 31, 2008 and 2007, we had $26.2 million and $31.3 million,
respectively, of unrecognized tax benefits that were classified as long-term
liabilities, of which $22.4 million and $26.9 million, would favorably impact
our effective tax rate, if recognized. The reconciliation of the
allowance for uncertain tax positions is as follows (dollars in
thousands):
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of year
|
|
$ |
31,313 |
|
|
$ |
28,732 |
|
|
Net
additions & reductions for tax positions of prior
years
|
|
|
(1,297 |
) |
|
|
1,929 |
|
|
Net
additions & reductions based on positions related to the current
year
|
|
|
4,889 |
|
|
|
2,665 |
|
|
Settlements
|
|
|
(286 |
) |
|
|
- |
|
|
Reductions
resulting from a lapse of the applicable statute of
limitation
|
|
|
(8,414 |
) |
|
|
(2,013 |
) |
|
|
|
|
|
|
|
|
|
|
|
Balance
at end of year
|
|
$ |
26,205 |
|
|
$ |
31,313 |
|
KCI’s
continuing practice is to recognize interest and penalties related to income tax
matters in income tax expense. KCI recognized approximately $415,000
and $1.9 million, respectively, of interest and penalties expense in the
consolidated statement of earnings for the years ended December 31, 2008 and
2007. Additionally, $6.9 million and $7.6 million, respectively, of
interest and penalties were recorded in the consolidated balance sheets as of
December 31, 2008 and 2007.
KCI is
subject to U.S. federal income tax, multiple state taxes, and foreign income
tax. In general, the tax years 2005 through 2008 remain open in the
major taxing jurisdictions, with some state and foreign jurisdictions remaining
open longer, as the result of net operating losses and longer
statutes.
KCI is
periodically under examination in multiple tax jurisdictions. It is
reasonably possible that these examinations or statutes could close at various
times within the next twelve months. As a result, between $3.0
million and $6.0 million of our unrecognized tax benefit could be reduced within
the next twelve months.
The
cumulative undistributed earnings of our foreign subsidiaries were approximately
$592.8 million, $267.4 million and $187.2 million at December 31, 2008, 2007 and
2006, respectively. These earnings are considered to be permanently
reinvested in foreign operations and, accordingly, no provision for U.S. federal
or state income taxes has been provided thereon. Upon distribution of
those earnings in the form of dividends or otherwise, we would be subject to
both U.S. income taxes (subject to an adjustment for foreign tax credits) and
withholding taxes payable to various foreign countries. Determination
of the amount of unrecognized deferred U.S. income tax liability is not
practicable because of the complexities associated with its hypothetical
calculation.
The Tax
Extenders and Alternative Minimum Tax Relief Act of 2008, which is contained in
H.R. 1424, was signed into law on October 3, 2008. This reinstated
the federal Research and Development Credit for 2008. Accordingly, we
recognized a benefit in the fourth quarter of 2008.
Income
taxes paid were $44.9 million, $113.9 million and $72.1 million for the years
ended 2008, 2007 and 2006, respectively.
NOTE
10. Shareholders'
Equity
On
February 9, 2004, in connection with the initial public offering, KCI’s
shareholders amended our Articles of Incorporation to increase the number of
shares of stock authorized to be issued by KCI to 225,000,000 shares of common
stock, $0.001 par value (the "Common Stock") and authorized KCI to issue up to
50,000,000 shares of preferred stock, $0.001 par value. The number of
shares of Common Stock issued and outstanding as of December 31, 2008 and 2007
was 70,523,895 and 72,153,231, respectively. During the years ended
December 31, 2008 and 2007, there were no preferred stock shares issued or
outstanding.
NOTE
11. Share Repurchase
Program
In August
2006, KCI's Board of Directors authorized a share repurchase program (the “2006
Repurchase Program”) for the repurchase of up to $200.0 million in market value
of common stock. In August 2007, the Board authorized a one-year
extension of this share repurchase program through September 30,
2008. Pursuant to the share repurchase program, we entered into a
pre-arranged purchase plan under Rule 10b5-1 of the Exchange Act authorizing
repurchases of up to $87.0 million of KCI common stock if our stock price is
below certain levels. Since the inception of the share repurchase
program, 3.6 million shares of common stock have been repurchased and recorded
as a reduction to shareholders’ equity totaling $113.4
million. Effective April 7, 2008, KCI terminated the share repurchase
program and the pre-arranged purchase plan under Rule 10b5-1 as a result of the
merger agreement with LifeCell.
The stock
repurchased under the 2006 Repurchase Program during 2008 and 2007 resulted from
the purchase and retirement of shares in connection with (i) the net share
settlement exercise of employee stock options for required minimum tax
withholdings and exercise price and (ii) the withholding of shares to satisfy
the minimum tax withholdings on the vesting of restricted stock. No
open-market repurchases were made under the 2006 Repurchase Program during 2008
or 2007.
In
October 2008, KCI’s 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 through the third quarter of
2009. During 2008, we repurchased and retired 2.1 million shares of
KCI common stock under the 2008 Repurchase Program at an average price of $24.12
per share for an aggregate purchase price of $50.1 million. During
2008, $50.0 million of our common stock repurchases were 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. As of December
31, 2008, the remaining authorized amount for share repurchases under the 2008
Repurchase Program was $49.9 million. KCI will evaluate making
opportunistic repurchases of additional shares of common stock under the share
repurchase program in open-market transactions or in negotiated transactions off
the market.
The
purchase price for shares of KCI's stock repurchased under the program was
reflected as a reduction to shareholder's equity. In accordance with
APB Opinion No. 6, "Status of
Accounting Research Bulletins," we are required to allocate the purchase
price of the repurchased shares as a reduction to common stock and additional
paid-in capital and an increase to 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
|
|
|
2,076 |
|
|
$ |
19,484 |
|
|
$ |
30,615 |
|
|
$ |
50,099 |
|
NOTE
12. Employee Benefit
Plans
Investment
Plan
We have
an Investment Plan intended to qualify as a deferred compensation plan under
Section 401(k) of the Internal Revenue Code of 1986. The
Investment Plan is available to all domestic employees and we match employee
contributions up to a specified limit. In 2008, 2007 and 2006,
matching contributions charged to expense were approximately $8.0 million,
$7.4 million and $6.5 million, respectively.
Deferred
Compensation Plan
In
December 2006, management decided to discontinue the Kinetic Concepts, Inc.
Executive Deferred Compensation Plan (the “Plan”) effective January 1,
2007. All balances as of December 31, 2006 remained with the Plan
throughout 2007 unless the participant had a previously-scheduled
distribution. All undistributed balances in the Plan, totaling $7.1
million as of December 31, 2007, were distributed during the first quarter of
2008. In addition, KCI liquidated the Plan assets totaling $7.4
million, which were used by KCI in the first quarter of 2008 to fund participant
distributions.
Stock
Option Plans
In
December 1997, the Board of Directors approved the 1997 Management Equity Plan
(the “Management Equity Plan”). In January of 2004, the Board of
Directors determined that no new equity grants would be made under the
Management Equity Plan. The maximum aggregate number of shares of
common stock that could be issued in connection with grants under the Management
Equity Plan, as amended, was approximately 13.9 million shares, subject to
adjustment as provided for in the plan. Outstanding grants under the
Management Equity Plan are administered by the Compensation Committee of the
Board of Directors. The exercise price and term of options granted
under the Management Equity Plan have been determined by the Compensation
Committee or the entire Board of Directors. However, in no event has
the term of any option granted under the Management Equity Plan exceeded ten
years.
The 2003
Non-Employee Directors Stock Plan (the “Directors Stock Plan”) became effective
on May 28, 2003, and was amended and restated on November 9, 2004, November 15,
2005, November 28, 2006, and December 4, 2007. In May of 2008, upon
approval of the Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan, the
Board of Directors determined that no new equity grants would be made under the
Directors Stock Plan. The maximum aggregate number of shares of
common stock that could be issued in connection with grants under the Directors
Stock Plan was 400,000 shares, subject to adjustment as provided for in the
plan. The exercise price of options granted under this plan was
determined as the fair market value of the shares of our common stock, which was
equal to the closing price of our common stock on the date that such option was
granted. The options granted vest and become exercisable
incrementally over a period of three years. The right to exercise an
option terminates seven years after the grant date, unless sooner as provided
for in the Directors Stock Plan. Outstanding grants under the
Directors Stock Plan are administered by the Compensation Committee of the Board
of Directors. During 2008, no options to purchase shares of common
stock or restricted stock were granted under this plan. During 2007
and 2006, we issued approximately 44,000 and 41,000 options, respectively to
purchase shares of common stock. Additionally, during 2007 and 2006,
we issued approximately 18,000 and 14,000 shares of restricted stock,
respectively, under this plan.
On
February 9, 2004, KCI’s shareholders approved the 2004 Equity Plan (the “2004
Equity Plan”) and the 2004 Employee Stock Purchase Plan (the
“ESPP”). In May of 2008, upon approval of the Kinetic Concepts, Inc.
2008 Omnibus Stock Incentive Plan, the Board of Directors determined that no new
equity grants would be made under the 2004 Equity Plan. The 2004
Equity Plan was effective on February 27, 2004 and reserved for issuance a
maximum of 7,000,000 shares of common stock to be awarded as stock options,
stock appreciation rights, restricted stock and/or restricted stock
units. Of the 7,000,000 shares, 20% could be issued in the form of
restricted stock, restricted stock units or a combination of the
two. The exercise price of options granted under the 2004 Equity Plan
was equal to KCI’s closing stock price on the date that such option was
granted. The options granted vest and become exercisable
incrementally over a period of four years unless otherwise provided in the
option award agreement. The right to exercise an option terminates
ten years after the grant date, unless sooner as provided for in the
plan. Restricted stock and restricted stock units granted under the
2004 Equity Plan generally vest over a period of three to six years unless
otherwise provided in the award agreement. The fair value of the
restricted stock and restricted stock units was determined on the grant date
based on KCI’s closing stock price. The likelihood of meeting the
performance criteria was considered when determining the vesting period on a
periodic basis. Restricted stock and restricted stock units granted
are classified primarily as equity awards. During 2008, 2007 and
2006, we granted approximately 1,676,000, 972,000 and 1,596,000 options,
respectively, to purchase shares of common stock under the 2004 Equity
Plan. Additionally, during 2008, 2007 and 2006, we issued
approximately 408,000, 270,000 and 385,000 shares, respectively, of restricted
stock and restricted stock units under the 2004 Equity Plan at a weighted
average estimated fair value of $46.32, $53.03 and $35.71,
respectively.
The 2006
restricted stock grants included 50,000 shares of restricted stock (“Awards”)
granted on April 1, 2006 to KCI’s former President and Chief Executive Officer
who retired effective December 31, 2006. The lapsing of restrictions
for these Awards were based on performance milestones set forth by the
Compensation Committee of the Board of Directors. The compensation
cost associated with these Awards was recognized over the estimated performance
period for all restrictions probable of lapsing. Based on the
retirement of said Chief Executive Officer, we recognized, in the fourth quarter
of 2006, compensation cost for awards with restrictions probable of
lapsing. The additional expense associated with the acceleration of
vesting for these awards was $450,000. In 2007, 25,000 of these
Awards were forfeited as the target associated with this award was not
attained. In addition, 12,500 of these Awards vested during 2007 and
the remaining 12,500 Awards vested in 2008.
The 2006
stock grants include options granted on November 6, 2006, to KCI’s current
President and Chief Executive Officer to purchase 332,000 shares of KCI’s common
stock, which will vest over four years, and a restricted stock grant of 88,200
shares, whose restrictions will lapse at the end of three years. Both
grants are subject to continual employment with KCI and may become fully vested
in the event of a change in control of KCI or termination of employment for any
reason other than "Cause," or she terminates for "Good Reason," as
defined.
The ESPP
became effective in the second quarter of 2004. The maximum number of
shares of common stock reserved for issuance under the ESPP is 2,500,000
shares. Under the ESPP, each eligible employee is permitted to
purchase shares of our common stock through regular payroll deductions in an
amount between 1% and 10% of the employee's compensation for each payroll
period, not to exceed $25,000 per year. The ESPP provides for
six-month offering periods. Each six-month offering period will be
composed of an identical six-month purchase period. Participating
employees are able to purchase shares of common stock with payroll deductions at
a purchase price equal to 85% of the fair market value of the common stock at
either the beginning of each offering period or the end of each respective
purchase period, whichever price is lower. During 2008, 2007 and
2006, there were approximately 172,000, 119,000 and 124,000 shares of common
stock purchased, respectively, under the ESPP.
On
May 20, 2008, the shareholders of the Company approved the Kinetic
Concepts, Inc. 2008 Omnibus Stock Incentive Plan (the “2008 Plan”), which
provides for the reservation of 6,125,000 shares of the Company’s common stock,
plus any and all shares of common stock that would have been returned to the
Directors Stock Plan and the 2004 Equity Plan by reason of expiration of its
term or cancellation upon termination of employment or service. No
additional grants will be made under either the Directors Stock Plan or the 2004
Equity Plan. The 2008 Plan is administered by the Compensation
Committee of the KCI Board of Directors, and provides for the grant of stock
options, stock appreciation rights, restricted stock, restricted stock units,
performance shares, stock bonuses, cash awards, or any combination of the
foregoing. The exercise price per share of stock purchasable under
the 2008 Plan shall be determined by the administrator in its sole discretion at
the time of grant but shall not be less than 100% of the fair market value of
the stock on such date. The term of each stock option shall be
fixed by the administrator, but no stock option shall be exercisable more than
ten years after the date such stock option is granted. During 2008,
we granted approximately 227,000 options to purchase shares of common stock
under the 2008 Plan. Additionally, during 2008, we issued
approximately 46,000 shares of restricted stock and restricted stock units under
the 2008 Plan at a weighted average estimated fair value of $34.78.
The
following table summarizes the number of common shares reserved for future
issuance under our stock option plans, excluding shares issuable upon exercise
of outstanding options and restricted stock units, as of December 31,
2008:
|
2004
Employee Stock Purchase Plan
|
|
1,935,658 |
|
|
2008
Omnibus Stock Incentive Plan
|
|
6,496,593 |
|
|
|
|
|
|
|
|
|
8,432,251 |
|
A summary
of our stock option activity, and related information, for the year ended
December 31, 2008 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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,212 |
|
|
$ |
42.69 |
|
|
|
|
|
|
|
|
Granted
|
|
1,903 |
|
|
$ |
44.47 |
|
|
|
|
|
|
|
|
Exercised
|
|
(94 |
) |
|
$ |
26.16 |
|
|
|
|
|
|
|
|
Forfeited/Expired
|
|
(655 |
) |
|
$ |
47.19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,366 |
|
|
$ |
43.15 |
|
|
7.63 |
|
|
$ |
2,368 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,555 |
|
|
$ |
39.94 |
|
|
5.76 |
|
|
$ |
2,362 |
|
The
intrinsic value for stock options is defined as the difference between the
current market value and the grant price. The total intrinsic value
of stock options exercised during 2008, 2007 and 2006 was $1.9 million, $50.5
million and $120.7 million, respectively. Cash received from stock
options exercised during 2008, 2007 and 2006 was $2.5 million, $28.4 million and
$11.9 million, respectively, and the actual tax benefit from share-based payment
arrangements totaled $2.0 million, $18.4 million and $45.8 million,
respectively.
The fair
value of stock options granted during 2008, 2007 and 2006 was $19.52, $24.30 and
$17.63, respectively. As of December 31, 2008, there was $37.7
million of total unrecognized compensation cost, net of estimated forfeitures,
related to non-vested stock options granted under our various
plans. This unrecognized compensation cost is expected to be
recognized over a weighted average period of 2.7 years.
During
2008, 2007 and 2006, we issued approximately 454,000, 289,000 and 399,000 shares
of restricted stock and restricted stock units under our equity plans,
respectively. The following table summarizes restricted stock
activity for the year ended December 31, 2008:
|
|
|
Number
of
|
|
|
Weighted
|
|
|
|
|
Shares
|
|
|
Average
Grant
|
|
|
|
|
(in
thousands)
|
|
|
Date
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
602 |
|
|
$ |
45.88 |
|
|
Granted
|
|
|
454 |
|
|
$ |
45.14 |
|
|
Vested
and Distributed
|
|
|
(97 |
) |
|
$ |
45.29 |
|
|
Forfeited
|
|
|
(188 |
) |
|
$ |
46.98 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
771 |
|
|
$ |
45.21 |
|
The
weighted average grant date fair value of restricted stock granted during 2008,
2007 and 2006 was $45.14, $52.79 and $35.84, respectively. The total
fair value of restricted stock which vested during 2008, 2007 and 2006 was
approximately $4.4 million, $4.3 million and $400,000,
respectively. As of December 31, 2008, there was $15.1 million of
total unrecognized compensation cost related to non-vested restricted stock
granted under our plans. This unrecognized compensation cost is
expected to be recognized over a weighted average period of 2.0
years.
The 2008
restricted stock awards include 87,300 shares of performance based restricted
stock granted to certain executives. The lapsing of restrictions for
these awards is based on revenue performance milestones set forth by the
Compensation Committee of the Board of Directors. As of December 31,
2008, it has been determined that it is not probable that the performance
milestones will be met. As such, at December 31, 2008, no
compensation cost has been recorded on these awards. If it becomes
probable in the future that the performance milestones will be met, a cumulative
catch-up adjustment will be made to retroactively record compensation
expense.
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
13. Other Comprehensive
Income
KCI
follows SFAS No. 130, "Reporting Comprehensive Income,"
in accounting for comprehensive income and its components. The
components of other comprehensive income are as follows (dollars in
thousands):
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
$ |
173,895 |
|
|
$ |
237,144 |
|
|
$ |
195,468 |
|
|
Foreign
currency translation adjustment, net of taxes of $565 in 2008, $353 in
2007 and $880 in 2006
|
|
(22,170 |
) |
|
|
14,819 |
|
|
|
19,431 |
|
|
Net
derivative gain (loss), net of taxes of $(4,806) in 2008, $1 in 2007 and
$41 in 2006
|
|
(8,926 |
) |
|
|
1 |
|
|
|
75 |
|
|
Reclassification
adjustment for losses (gains) included in income, net of taxes of $172 in
2008, $18 in 2007 and $(701) in 2006
|
|
320 |
|
|
|
33 |
|
|
|
(1,301 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income
|
$ |
143,119 |
|
|
$ |
251,997 |
|
|
$ |
213,673 |
|
The
components of accumulated other comprehensive income are as follows (dollars in
thousands):
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
Foreign
|
|
|
Accumulated
|
|
|
Accumulated
|
|
|
|
|
Currency
|
|
|
Derivative
|
|
|
Other
|
|
|
|
|
Translation
|
|
|
Gains
|
|
|
Comprehensive
|
|
|
|
|
Adjustment
|
|
|
(Losses)
|
|
|
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,532 |
|
|
$ |
1,192 |
|
|
$ |
6,724 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment, net of taxes of $880
|
|
|
19,431 |
|
|
|
- |
|
|
|
19,431 |
|
|
Net
derivative gain, net of taxes of $41
|
|
|
- |
|
|
|
75 |
|
|
|
75 |
|
|
Reclassification
adjustment for gains included in income, net of taxes of
$(701)
|
|
|
- |
|
|
|
(1,301 |
) |
|
|
(1,301 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
24,963 |
|
|
$ |
(34 |
) |
|
$ |
24,929 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment, net of taxes of $353
|
|
|
14,819 |
|
|
|
- |
|
|
|
14,819 |
|
|
Net
derivative gain, net of taxes of $1
|
|
|
- |
|
|
|
1 |
|
|
|
1 |
|
|
Reclassification
adjustment for losses included in income, net of taxes of
$18
|
|
|
- |
|
|
|
33 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
39,782 |
|
|
$ |
- |
|
|
$ |
39,782 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment, net of taxes of $565
|
|
|
(22,170 |
) |
|
|
- |
|
|
|
(22,170 |
) |
|
Net
derivative loss, net of taxes of $(4,806)
|
|
|
- |
|
|
|
(8,926 |
) |
|
|
(8,926 |
) |
|
Reclassification
adjustment for losses included in income, net of taxes of
$172
|
|
|
- |
|
|
|
320 |
|
|
|
320 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
17,612 |
|
|
$ |
(8,606 |
) |
|
$ |
9,006 |
|
NOTE
14. Earnings Per
Share
Net
earnings per share were calculated using the weighted average number of common
shares outstanding. (See Note 1(m).) 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):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings
|
|
$ |
173,895 |
|
|
$ |
237,144 |
|
|
$ |
195,468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
71,464 |
|
|
|
70,975 |
|
|
|
70,732 |
|
|
Dilutive
potential common shares from stock options and restricted stock
(1)
|
|
|
321 |
|
|
|
699 |
|
|
|
1,920 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
71,785 |
|
|
|
71,674 |
|
|
|
72,652 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
net earnings per share
|
|
$ |
2.43 |
|
|
$ |
3.34 |
|
|
$ |
2.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
net earnings per share
|
|
$ |
2.42 |
|
|
$ |
3.31 |
|
|
$ |
2.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Potentially
dilutive stock options and restricted stock totaling 4,977 shares, 1,779
shares and 3,241 shares for 2008, 2007 and 2006, 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 6.) 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
15. Commitments and
Contingencies
KCI and
its affiliates, together with Wake Forest University Health Sciences, are
involved in multiple patent infringement suits involving patents licensed
exclusively to KCI by Wake Forest. In 2006, a 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, which was acquired
by Smith & Nephew plc in 2007. The parties appealed the judgment
entered by the District Court. Appellate briefs were filed by all
parties to the appeal and oral arguments were heard on October 8,
2008. On February 2, 2009, the U.S. Court of Appeals for the
Federal Circuit issued its opinion in the case, which 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 NPWT devise did not infringe these patents.
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. In December 2008, KCI, its
affiliates and Wake Forest amended their claims in this suit to assert
additional patents and patent claims against Smith & Nephew following its
announcement that it would begin commercializing foam dressing kits for use in
NPWT. In addition, in February 2009, KCI, its affiliates and Wake
Forest filed a motion for preliminary injunction against Smith & Nephew and
requested an expedited hearing on this motion. These cases are
currently set for trial in February 2010.
Also in
December 2008, KCI, its affiliates and Wake Forest filed patent infringement
lawsuits against Smith & Nephew in the United Kingdom and Germany,
requesting preliminary and interim injunctive relief. On January 13,
2009, the Specialist Patents Court in the High Court of Justice of England and
Wales granted KCI’s request for a temporary injunction. The temporary
injunction prohibits Smith & Nephew from commercializing foam dressing kits
for negative pressure wound therapy in the United Kingdom, until such time as
the court can rule on the patent infringement action that KCI has brought
against Smith & Nephew. A trial date on infringement and validity
of the patent in the United Kingdom has been set for March 23,
2009. A hearing on KCI’s request for interim injunctive relief in
Germany is expected to be set for March 2009.
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 February 2009, Smith & Nephew
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 is set for March 17, 2009.
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 University Health Sciences 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 March
2008, Mölnlycke Health Care AB filed a patent nullity suit in Germany against
one of Wake Forest’s German patents licensed to KCI. This suit has
been joined with the nullity suit previously brought by Medela. A
hearing has been set for March 17, 2009 on this matter. Also in March
2008, Mölnlycke filed suit in the United Kingdom to have a related Wake Forest
patent revoked. A hearing has been set for July 2009 on this
matter. These patents were originally issued in 1998 by the German
Patent Office and the United Kingdom Patent Office upon granting of the
corresponding European patents. The corresponding European patents
were upheld as amended and corrected during Opposition Proceedings before the
European Patent Office in 2003.
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.
Although
it is not possible to reliably predict the outcome of the legal proceedings
described above, 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 53% and 59%,
respectively, of total revenue for the years ended December 31, 2008 and 2007
from our domestic V.A.C. Therapy products relating to the U.S. patents at
issue. In continental Europe, we derived approximately 13% and 12%,
respectively, of total revenue for the years ended December 31, 2008 and 2007 in
V.A.C. revenue relating to the patents at issue in the ongoing German
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.
In the
first category, LifeCell has been named in approximately five cases filed in the
State Court of New Jersey, and approximately five cases in New Jersey Federal
Court in which the plaintiffs allege to have contracted a disease from BTS’s
tissue. The cases in the Federal Court were dismissed on December 10,
2008, but are the subject of a motion to reconsider filed by the
plaintiffs.
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. Most of the cases have been consolidated in New
Jersey Federal District Court as part of a Multi-District Litigation (“MDL”),
while several cases still remain in state court in New
Jersey. Related to these cases, the FDA recommended those patients
receive appropriate testing. On December 10, 2008, the Federal District Judge
entered an order dismissing over 400 cases in the MDL, including all of the
Recipient Cases against LifeCell. The Plaintiffs are appealing this
dismissal.
In the
third category, approximately twenty suits have been filed by family members of
tissue donors seeking damages for emotional distress. Approximately
three of these are in the MDL. The other cases have been filed in
state courts in New Jersey and Pennsylvania.
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 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.
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. The U.S. Department of Health
and Human Services Office of Inspector General, or OIG, initiated a study on
negative pressure wound therapy, or NPWT, in 2005. 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
respecting 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 August
2007, KCI received requests from a Medicare Region A Recovery Audit Contractor
(‘‘RAC’’) covering 180 previously-paid claims submitted between 2004 and 2005,
which KCI responded to in a timely manner. The RAC audit initial findings were
that approximately 29% of the claims subject to this audit were inappropriately
paid resulting in a recoupment of these previously-paid claims by
Medicare. We have disputed and appealed these results and have
subsequently received payment on approximately half of the disputed
claims. The remaining claims subject to the audit are still in the
appeals process.
In
December 2007, the Medicare Region B DMAC initiated a pre-payment review of all
NPWT claims for the second and third months of treatment submitted by all
providers, including KCI. The pre-payment review was suspended by the
Medicare Region B DMAC in the first quarter of 2008. For every
monthly period of treatment beyond 30 days, we are required to
demonstrate/document progress towards wound healing. KCI has
responded to these claim review requests and has received reimbursement for many
of the claims subject to review. The remaining claims subject to the
audit are still in the appeals process.
In July
2008, the DMAC for Region B notified KCI of a post-payment audit of claims paid
during the second 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 the timing of our response. We intend to cooperate with the government's
review. The review is in its initial stages and we cannot predict the time frame
in which it will be resolved.
As of
December 31, 2008, our commitments for the purchase of new product inventory
were $27.6 million, including approximately $7.7 million of disposable products
from our main disposable supplier and $8.0 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.
See
discussion of our self-insurance program at Note 1(o) and leases at
Note 8.
NOTE
16. Related Party
Transactions
A member
of our Board of Directors, David J. Simpson, was an officer of Stryker
Corporation through December 31, 2007, with which we conduct business on a
limited basis. During 2007 and 2006, we purchased approximately
$3.1 million and $4.3 million, respectively, in hospital bed frames
from Stryker.
A member
of our Board of Directors, Harry R. Jacobson, M.D., is the Vice Chancellor for
Health Affairs of Vanderbilt University, with which we conduct business on a
limited basis. During fiscal years 2008, 2007 and 2006, we recorded
revenue of approximately $1.3 million, $1.5 million and $1.1 million,
respectively, for V.A.C. products and TSS billed to Vanderbilt University.
In addition, following our acquisition of LifeCell in May 2008, we recorded
revenue of approximately $1.2 million for sales of LifeCell products to
Vanderbilt University.
NOTE
17. Segment and Geographic
Information
We are
principally engaged in the rental and sale of advanced wound care systems and
TSS throughout the U.S. and in 18 primary countries
internationally. Revenues are attributed to individual countries
based on the location of the customer. On May 27, 2008, we completed
the acquisition of all the outstanding capital stock of LifeCell, a leader in
innovative regenerative medicine products sold primarily throughout the
U.S.
During
the first quarter of 2008, we completed the realignment of our geographic
reporting structure to correspond with our current management
structure. For 2008, we are reporting financial results for our
V.A.C. Therapy and TSS product lines consistent with this new structure,
including the reclassification of prior period amounts to conform to this
current reporting structure. Under our current management structure,
LifeCell is excluded from the geographic reporting structure and is reported as
its own operating segment. The results of LifeCell’s operations have
been included in our consolidated financial statements since the acquisition
date.
We have
three reportable operating segments: (i) North America – V.A.C. and TSS, which
is comprised principally of the U.S. and includes Canada and Puerto Rico; (ii)
EMEA/APAC – V.A.C. and TSS, which is comprised principally of Europe and
includes the Middle East, Africa and the Asia Pacific region; and (iii)
LifeCell. We have three primary product lines: V.A.C. Therapy, TSS
and LifeCell, which includes regenerative medicine products. Revenues
for each of our product lines are disclosed for our operating
segments. Other than revenue, no discrete financial information is
available for our V.A.C. Therapy and TSS product lines. In most
countries where we operate, our V.A.C. Therapy and TSS product lines are
marketed and serviced by the same infrastructure and, as such, we do not manage
these businesses by product line, but rather by geographical
segments. 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):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
North
America:
|
|
|
|
|
|
|
|
|
|
|
V.A.C
|
|
$ |
1,049,215 |
|
|
$ |
993,040 |
|
|
$ |
844,537 |
|
|
Therapeutic
Support Systems
|
|
|
221,684 |
|
|
|
230,590 |
|
|
|
214,743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
–North America
|
|
|
1,270,899 |
|
|
|
1,223,630 |
|
|
|
1,059,280 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EMEA/APAC:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
V.A.C
|
|
|
344,735 |
|
|
|
286,583 |
|
|
|
224,552 |
|
|
Therapeutic
Support Systems
|
|
|
105,438 |
|
|
|
99,731 |
|
|
|
87,804 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
– EMEA/APAC
|
|
|
450,173 |
|
|
|
386,314 |
|
|
|
312,356 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LifeCell
|
|
|
156,837 |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
$ |
1,877,909 |
|
|
$ |
1,609,944 |
|
|
$ |
1,371,636 |
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Operating
earnings:
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
509,672 |
|
|
$ |
493,334 |
|
|
$ |
426,569 |
|
|
EMEA/APAC
|
|
|
73,366 |
|
|
|
36,393 |
|
|
|
16,474 |
|
|
LifeCell
|
|
|
51,790 |
|
|
|
- |
|
|
|
- |
|
|
Other
(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive
(2)
|
|
|
(54,126 |
) |
|
|
(48,195 |
) |
|
|
(30,279 |
) |
|
Finance
and Information Technology
|
|
|
(53,467 |
) |
|
|
(47,005 |
) |
|
|
(41,531 |
) |
|
Manufacturing/Engineering
|
|
|
(26,159 |
) |
|
|
(15,888 |
) |
|
|
(12,012 |
) |
|
Administration
|
|
|
(47,569 |
) |
|
|
(46,333 |
) |
|
|
(49,979 |
) |
|
In-process
research and development
|
|
|
(61,571 |
) |
|
|
- |
|
|
|
- |
|
|
Acquired
intangible asset amortization
|
|
|
(25,001 |
) |
|
|
- |
|
|
|
- |
|
|
Purchase
transactions (3)
|
|
|
(18,423 |
) |
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other
|
|
|
(286,316 |
) |
|
|
(157,421 |
) |
|
|
(133,801 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating
earnings
|
|
$ |
348,512 |
|
|
$ |
372,306 |
|
|
$ |
309,242 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Includes
general headquarter expenses which are not allocated to the individual
segments and are included in selling, general and administrative expenses
within our consolidated statements of earnings. Additionally, “Other”
includes expenses related to our LifeCell acquisition in May
2008.
(2) Includes
all share-based compensation expense and all U.S. incentive compensation
expense which totaled approximately $41.9 million, $41.5 million and $28.0
million for the years ended December 31, 2008, 2007 and 2006,
respectively.
(3) 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Depreciation,
amortization and other:
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
48,631 |
|
|
$ |
43,027 |
|
|
$ |
38,394 |
|
|
EMEA/APAC
|
|
|
26,507 |
|
|
|
30,414 |
|
|
|
23,226 |
|
|
LifeCell
|
|
|
3,414 |
|
|
|
- |
|
|
|
- |
|
|
Other
(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive
|
|
|
8,780 |
|
|
|
1,360 |
|
|
|
408 |
|
|
Finance
and Information Technology
|
|
|
13,431 |
|
|
|
11,400 |
|
|
|
11,156 |
|
|
Manufacturing/Engineering
|
|
|
3,243 |
|
|
|
2,563 |
|
|
|
2,401 |
|
|
Administration
|
|
|
6,365 |
|
|
|
5,059 |
|
|
|
7,822 |
|
|
Acquired
intangible asset amortization
|
|
|
25,001 |
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other
|
|
|
56,820 |
|
|
|
20,382 |
|
|
|
21,787 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total depreciation,
amortization and other
|
|
$ |
135,372 |
|
|
$ |
93,823 |
|
|
$ |
83,407 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Includes
general headquarter expenses which are not allocated to the individual
segments and are included in selling, general and administrative expenses
within our consolidated statements of earnings. Additionally, “Other”
includes expenses related to our LifeCell acquisition in May
2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Total
assets:
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
655,730 |
|
|
$ |
657,122 |
|
|
$ |
504,223 |
|
|
EMEA/APAC
|
|
|
480,620 |
|
|
|
303,422 |
|
|
|
242,795 |
|
|
LifeCell
|
|
|
1,723,109 |
|
|
|
- |
|
|
|
- |
|
|
Other:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive
|
|
|
722 |
|
|
|
8,562 |
|
|
|
9,047 |
|
|
Finance
and Information Technology
|
|
|
28,565 |
|
|
|
25,150 |
|
|
|
23,799 |
|
|
Manufacturing/Engineering
|
|
|
29,304 |
|
|
|
25,818 |
|
|
|
19,582 |
|
|
Administration
|
|
|
88,635 |
|
|
|
37,511 |
|
|
|
42,996 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other
|
|
|
147,226 |
|
|
|
97,041 |
|
|
|
95,424 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$ |
3,006,685 |
|
|
$ |
1,057,585 |
|
|
$ |
842,442 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Gross
capital expenditures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
48,620 |
|
|
$ |
53,487 |
|
|
$ |
42,674 |
|
|
EMEA/APAC
|
|
|
32,959 |
|
|
|
20,958 |
|
|
|
23,496 |
|
|
LifeCell
|
|
|
12,227 |
|
|
|
- |
|
|
|
- |
|
|
Other:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance
and Information Technology
|
|
|
32,179 |
|
|
|
18,923 |
|
|
|
17,922 |
|
|
Manufacturing/Engineering
|
|
|
5,298 |
|
|
|
2,479 |
|
|
|
8,086 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other
|
|
|
37,477 |
|
|
|
21,402 |
|
|
|
26,008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross capital
expenditures
|
|
$ |
131,283 |
|
|
$ |
95,847 |
|
|
$ |
92,178 |
|
The
following is other selected geographic financial information of KCI (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Geographic
location of revenue:
|
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$ |
1,352,727 |
|
|
$ |
1,150,210 |
|
|
$ |
993,772 |
|
|
Foreign
|
|
|
525,182 |
|
|
|
459,734 |
|
|
|
377,864 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
revenue
|
|
$ |
1,877,909 |
|
|
$ |
1,609,944 |
|
|
$ |
1,371,636 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December
31,
|
|
|
Geographic
location of long-lived assets:
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Domestic
|
|
$ |
2,090,467 |
|
|
$ |
228,549 |
|
|
$ |
223,884 |
|
|
Foreign
|
|
|
98,582 |
|
|
|
83,057 |
|
|
|
86,770 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
long-lived assets
|
|
$ |
2,189,049 |
|
|
$ |
311,606 |
|
|
$ |
310,654 |
|
NOTE
18. Quarterly Financial Data
(unaudited)
The
unaudited consolidated results of operations by quarter are summarized below (in
thousands, except per share data):
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
420,016 |
|
|
$ |
462,124 |
|
|
$ |
503,299 |
|
|
$ |
492,470 |
|
|
Gross
profit
|
|
$ |
208,986 |
|
|
$ |
226,883 |
|
|
$ |
251,621 |
|
|
$ |
246,946 |
|
|
Operating
earnings
|
|
$ |
98,924 |
|
|
$ |
43,247 |
|
|
$ |
112,872 |
|
|
$ |
93,469 |
|
|
Net
earnings
|
|
$ |
67,955 |
|
|
$ |
(2,711 |
) |
|
$ |
56,552 |
|
|
$ |
52,099 |
|
|
Net
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.95 |
|
|
$ |
(0.04 |
) |
|
$ |
0.79 |
|
|
$ |
0.74 |
|
|
Diluted
|
|
$ |
0.94 |
|
|
$ |
(0.04 |
) |
|
$ |
0.78 |
|
|
$ |
0.74 |
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
71,665 |
|
|
|
71,771 |
|
|
|
71,831 |
|
|
|
70,594 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
72,162 |
|
|
|
71,771 |
|
|
|
72,130 |
|
|
|
70,845 |
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
368,816 |
|
|
$ |
396,652 |
|
|
$ |
410,880 |
|
|
$ |
433,596 |
|
|
Gross
profit
|
|
$ |
171,185 |
|
|
$ |
190,131 |
|
|
$ |
204,221 |
|
|
$ |
213,861 |
|
|
Operating
earnings
|
|
$ |
83,165 |
|
|
$ |
90,113 |
|
|
$ |
98,876 |
|
|
$ |
100,152 |
|
|
Net
earnings
|
|
$ |
53,556 |
|
|
$ |
58,072 |
|
|
$ |
59,025 |
|
|
$ |
66,491 |
|
|
Net
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.76 |
|
|
$ |
0.82 |
|
|
$ |
0.83 |
|
|
$ |
0.93 |
|
|
Diluted
|
|
$ |
0.75 |
|
|
$ |
0.81 |
|
|
$ |
0.82 |
|
|
$ |
0.92 |
|
|
Weighted
average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
70,347 |
|
|
|
70,802 |
|
|
|
71,214 |
|
|
|
71,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
71,079 |
|
|
|
71,427 |
|
|
|
71,929 |
|
|
|
72,190 |
|
Schedule II
|
Kinetic
Concepts, Inc.
|
|
|
Valuation
and Qualifying Accounts
|
|
|
|
|
|
(in
thousands)
|
|
| |
|
| |
|
|
Description
|
|
|
|
Additions
Charged to Costs and Expenses
|
|
Acquired
LifeCell Reserves
|
|
Additions
Charged to Other Accounts
|
|
Deductions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable realization reserves
|
|
$ |
78,730 |
|
$ |
13,744 |
|
$ |
- |
|
$ |
45,509 |
(1) |
$ |
49,495 |
|
$ |
88,488 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
reserve
|
|
$ |
3,708 |
|
$ |
714 |
|
$ |
- |
|
$ |
- |
|
$ |
1,333 |
|
$ |
3,089 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax asset valuation allowance
|
|
$ |
11,548 |
|
$ |
3,324 |
|
$ |
- |
|
$ |
- |
|
$ |
- |
|
$ |
14,872 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
|
|
|
Additions
Charged to Costs and Expenses
|
|
Acquired
LifeCell Reserves
|
|
Additions
Charged to Other Accounts
|
|
Deductions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable realization reserves
|
|
$ |
88,488 |
|
$ |
7,567 |
|
$ |
- |
|
$ |
41,262 |
(1) |
$ |
40,527 |
|
$ |
96,790 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
reserve
|
|
$ |
3,089 |
|
$ |
3,412 |
|
$ |
- |
|
$ |
- |
|
$ |
2,103 |
|
$ |
4,398 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax asset valuation allowance
|
|
$ |
14,872 |
|
$ |
- |
|
$ |
- |
|
$ |
- |
|
$ |
199 |
|
$ |
14,673 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
|
|
|
Additions
Charged to Costs and Expenses
|
|
Acquired
LifeCell Reserves
|
|
Additions
Charged to Other Accounts
|
|
Deductions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable realization reserves
|
|
$ |
96,790 |
|
$ |
10,605 |
|
$ |
279 |
|
$ |
43,321 |
(1) |
$ |
47,010 |
|
$ |
103,985 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
reserve
|
|
$ |
4,398 |
|
$ |
4,745 |
|
$ |
2,198 |
|
$ |
- |
|
$ |
4,467 |
|
$ |
6,874 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax asset valuation allowance
|
|
$ |
14,673 |
|
$ |
- |
|
$ |
- |
|
$ |
- |
|
$ |
2,852 |
|
$ |
11,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Additions
to the accounts receivable realization reserves charged to other accounts
reflect the net increase in revenue reserves to allow for expected credit
memos, cancelled transactions and uncollectible items where collectibility
is not reasonably assured in accordance with the provisions of Staff
Accounting Bulletin No. 104.
|
|
FINANCIAL
DISCLOSURE
None.
Disclosure Controls and
Procedures. KCI’s management, with the participation of KCI’s
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 fourth fiscal quarter of
2008 that have materially affected, or are reasonably likely to materially
affect, KCI’s internal control over financial reporting.
Report
of Management on Internal Control Over Financial Reporting
The
management of Kinetic Concepts, Inc. (the "Company") is responsible for
establishing and maintaining adequate internal control over financial reporting,
as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of
1934.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
The
Company’s management assessed the effectiveness of its internal control over
financial reporting as of December 31, 2008. In making this assessment, the
Company’s management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated
Framework. Based on our assessment, we believe that, as of December 31, 2008,
the Company’s internal control over financial reporting is effective based on
those criteria.
Ernst
& Young LLP, the Company’s independent registered public accounting firm,
has audited the Company's internal control over financial reporting as of
December 31, 2008 as stated in their report, included herein.
|
/s/
Catherine M. Burzik
|
|
Catherine
M. Burzik
|
|
President
and Chief Executive Officer
|
|
|
|
|
|
/s/
Martin J. Landon
|
|
Martin
J. Landon
|
|
Executive
Vice President and Chief Financial Officer
|
|
|
The
Board of Directors and Shareholders
Kinetic
Concepts, Inc.
We have
audited Kinetic Concepts, Inc.’s internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Kinetic Concepts, Inc.’s management is
responsible for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Report of Management on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the
company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, Kinetic Concepts, Inc. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on the
COSO criteria.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Kinetic
Concepts, Inc. and subsidiaries as of December 31, 2008 and 2007, and the
related consolidated statements of earnings, shareholders’ equity and cash flows
for each of the three years in the period ended December 31, 2008 of Kinetic
Concepts, Inc. and subsidiaries and our report dated February 23, 2009 expressed
an unqualified opinion thereon.
|
/s/
ERNST & YOUNG LLP
|
|
ERNST
& YOUNG
LLP
|
San
Antonio, Texas
None.
Incorporated
in this Item 10, by reference, are those portions of the Company’s definitive
Proxy Statement for its 2008 Annual Meeting of Shareholders to be filed with the
SEC within 120 days after the close of the fiscal year ended December 31, 2008
appearing under the caption "Directors and Executive Officers" and "Section
16(a) Beneficial Ownership Reporting Compliance."
Our Code
of Ethics for Chief Executive and Senior Financial Officers, along with our
Directors' Code of Business Conduct and Ethics, and our KCI Code of Conduct can
be found on our website at www.kci1.com
under the tab entitled "Corporate Governance – Codes of Conduct" on the Investor
Relations page. We intend to satisfy the disclosure requirements
under Item 5.05 of Form 8-K regarding amendment to, or waiver from, a provision
of the Code of Ethics for Chief Executive and Senior Financial Officers by
posting such information on our website, at the address and location specified
above.
Information
about our board committees, including our Audit and Compliance Committee,
Compensation Committee and Director Affairs Committee, as well as the respective
charters for our board committees, can also be found on our website under the
tab entitled "Corporate Governance – Committee Composition and Charters" on the
Investor Relations page. Shareholders may request a copy of the above
referenced codes and charters, at no cost, from Investor Relations, Kinetic
Concepts, Inc., 8023 Vantage Drive, San Antonio, Texas 78230.
Furthermore,
because our common stock is listed on the NYSE, our Chief Executive Officer is
required to make a CEO's Annual Certification to the NYSE in accordance with
Section 303A.12 of the NYSE Listed Company Manual regarding the Company’s
compliance with the NYSE corporate governance listing standards. The
Annual Certification was made on June 12, 2008. In addition, the
certifications of the Company’s Chief Executive Officer and Chief Financial
Officer required under Section 302 of the Sarbanes-Oxley Act of 2002, regarding
the quality of the Company’s disclosures in this Annual Report on Form 10-K, are
filed as exhibits 31.1 and 31.2 hereto.
Incorporated
in this Item 11, by reference, is that portion of the Company’s definitive Proxy
Statement appearing under the caption "Executive Compensation."
The
following chart gives aggregate information regarding grants under all of our
equity compensation plans through December 31, 2008:
|
Plan
category
|
|
Number
of securities to be issued upon exercise of outstanding
options
|
|
|
Weighted-average
exercise price of outstanding options
|
|
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
|
|
|
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans approved by security holders
|
|
4,499,237 |
(1) |
|
$ |
43.15 |
(2) |
|
8,432,251 |
(3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans not approved by security holders
|
|
- |
|
|
|
- |
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
4,499,237 |
|
|
$ |
43.15 |
|
|
8,432,251 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) This
amount includes 133,443 shares of common stock that are subject to
outstanding restricted stock unit awards. This amount does not
include 637,361 shares of common stock issued and outstanding pursuant to
unvested restricted stock awards.
(2) This
amount is calculated exclusive of outstanding restricted stock unit
awards.
(3) This
amount includes 6,496,593 shares available for future issuance under the
2008 Omnibus Stock Incentive Plan, which provides for grants of restricted
stock, options and other awards. This amount also includes 1,935,658
shares available for future issuance under the ESPP, which makes stock
available for purchase by employees at specified
times.
|
|
Incorporated
in this Item 12, by reference, is that portion of the Company’s definitive Proxy
Statement appearing under the caption "Security Ownership of Certain Beneficial
Owners and Management."
INDEPENDENCE
Incorporated
in this Item 13, by reference, is that portion of the Company’s definitive Proxy
Statement appearing under the caption "Certain Relationships and Related
Transactions."
Incorporated
in this Item 14, by reference, is that portion of the Company’s definitive Proxy
Statement appearing under the caption "Principal Accounting Fees and
Services."
|
(a) The
following documents are filed as part of this Annual
Report:
|
|
|
1. Financial
Statements
|
|
|
The
following consolidated financial statements are filed as a part of this
report:
|
|
|
Report
of Independent Registered Public Accounting Firm
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes
to Consolidated Financial Statements
|
|
|
2. Financial
Statement Schedules
|
|
|
The
following consolidated financial statement schedule for each of the three
years ended December 31, 2008 is filed as part of this Annual
Report:
|
|
|
|
|
|
All
other schedules have been omitted as the required information is not
present or is not present in amounts sufficient to require submission of
the schedule, or because the information required is included in the
financial statements and notes thereto.
|
|
(b) Exhibits
|
|
|
|
EXHIBITS
|
Exhibits
|
|
Description
|
| |
|
|
| 2.1 |
|
Agreement
and Plan of Merger, dated as of April 7, 2008, between Kinetic Concepts,
Inc., Leopard Acquisition Sub, Inc., and LifeCell Corporation (filed as
Exhibit 2.1 to our Form 8-K filed on April 7, 2008).
|
| 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 From 8-K filed on February 24,
2009).
|
| 4.1 |
|
Specimen
Common Stock Certificate (filed as Exhibit 4.3 to Amendment No. 1 to our
Registration Statement on Form S-1, filed on February 2, 2004, as
thereafter amended).
|
| 4.2 |
|
Form
of 3.25% Convertible Senior Note due 2015, dated as of April 21, 2008,
(included in Exhibit 4.1 to our Form 8-K filed on April 22,
2008).
|
| 4.3 |
|
Indenture,
dated as of April 21, 2008 between Kinetic Concepts, Inc., KCI USA, Inc.
and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to
our Form 8-K filed on April 22, 2008).
|
| 10.1 |
|
|
| 10.2 |
|
|
| **10.3 |
|
|
| **10.4 |
|
Form
of Option Instrument with respect to the Kinetic Concepts, Inc.
Management Equity Plan (filed as Exhibit 10.14 to our Annual Report
on Form 10-K for the year ended December 31, 2000, filed on
March 30, 2001).
|
| 10.5 |
|
Standard
Office Building Lease Agreement, dated July 31, 2002 between CKW San
Antonio, L.P. d/b/a San Antonio CKW, L.P. and Kinetic Concepts, Inc. for
the lease of approximately 138,231 square feet of space in the building
located at 8023 Vantage Drive, San Antonio, Bexar County, Texas 78230
(filed as Exhibit 10.27 on Form S-4, filed on September 29,
2003).
|
| †10.6 |
|
Toll
Manufacturing Agreement, by and between KCI Manufacturing and Avail
Medical Products, Inc. dated December 14, 2007.
|
| †10.7 |
|
Amendment
to Toll Manufacturing Agreement, by and between KCI Manufacturing and
Avail Medical Products, Inc. dated July 31, 2008 (filed as Exhibit 10.14
to our Quarterly Report on Form 10-Q for the quarter ended September 30,
2008, filed on November 5, 2008).
|
| †10.8 |
|
License
Agreement, dated as of October 6, 1993, between Wake Forest
University and Kinetic Concepts, Inc., as amended by that certain
Amendment to License Agreement, dated as of July 1, 2000 (filed as
Exhibit 10.29 to Amendment No. 4 to our Registration Statement
on Form S-1, filed on February 23, 2004).
|
| **10.9 |
|
Form
of Director Indemnity Agreement (filed as Exhibit 10.31 to Amendment No. 1
to Registration Statement on Form S-1, filed on February 2, 2004, as
amended).
|
| **10.10 |
|
2004
Equity Plan (filed as Exhibit 10.32 to Amendment No. 1 to Registration
Statement on Form S-1, filed on February 2, 2004, as
amended).
|
| **10.11 |
|
2004
Employee Stock Purchase Plan (filed as Exhibit 10.33 to Amendment No. 1 to
Form S-1, filed on February 2, 2004, as amended).
|
| **10.12 |
|
Form
of Stock Option Agreement under Amended and Restated 2003 Non-Employee
Directors Stock Plan (filed as Exhibit 10.2 to our Current Report on
Form 8-K filed on November 15, 2004).
|
| **10.13 |
|
Form
of Restricted Stock Award Agreement under Amended and Restated 2003
Non-Employee Directors Stock Plan (filed as Exhibit 10.3 to our
Current Report on Form 8-K filed on November 15,
2004).
|
| **10.14 |
|
Executive
Deferred Compensation Plan (filed as Exhibit 10.1 to our Quarterly Report
on Form 10-Q for the quarter ended March 31, 2006, filed on May 9,
2006).
|
| **10.15 |
|
Form
of KCI 2004 Equity Plan Restricted Stock Award Agreement (filed as Exhibit
10.1 to our Quarterly Report on Form 10-Q for the quarter ended September
30, 2006, filed on August 9, 2006).
|
| **10.16 |
|
Form
of KCI 2004 Equity Plan Nonqualified Stock Option Agreement (filed as
Exhibit 10.2 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, filed on August 9, 2006).
|
| **10.17 |
|
Form
of KCI 2004 Equity Plan Restricted Stock Unit Award Agreement (filed as
Exhibit 10.3 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, filed on August 9, 2006).
|
| **10.18 |
|
Form
of KCI 2004 Equity Plan International Restricted Stock Unit Award
Agreement (filed as Exhibit 10.4 to our Quarterly Report on Form 10-Q for
the quarter ended September 30, 2006, filed on August 9,
2006).
|
| **10.19 |
|
Form
of KCI 2004 Equity Plan International Stock Option Agreement (filed as
Exhibit 10.5 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, filed on August 9, 2006).
|
| **10.20 |
|
Letter,
dated October 16, 2006, from Kinetic Concepts, Inc. to Catherine M. Burzik
outlining the terms of her employment (filed as Exhibit 10.1 to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2006,
filed on November 3, 2006).
|
| **10.21 |
|
2004
Equity Plan Nonqualified Stock Option Agreement between Kinetic Concepts,
Inc. and Catherine M. Burzik, dated November 6, 2006 (filed as
Exhibit 10.28 to our Annual Report on Form 10-K for the year
ended December 31, 2006, filed on February 23,
2007).
|
| **10.22 |
|
2004
Equity Plan Restricted Stock Award Agreement between Kinetic Concepts,
Inc. and Catherine M. Burzik, dated November 6, 2006 (filed as
Exhibit 10.29 to our Annual Report on Form 10-K for the year
ended December 31, 2006, filed on February 23,
2007).
|
| **10.23 |
|
|
| **10.24 |
|
|
| **10.25 |
|
|
| **10.26 |
|
|
| **10.27 |
|
|
| **10.28 |
|
|
| **10.29 |
|
|
| **10.30 |
|
|
| **10.31 |
|
|
| **10.32 |
|
|
| **10.33 |
|
Form
of Kinetic Concepts, Inc. 2004 Equity Plan International Restricted Stock
Unit Award Agreement, as amended on February 19, 2008 (filed as Exhibit
10.37 to our Annual Report on Form 10-K for the year ended December 31,
2008, filed on February 22, 2008).
|
| **10.34 |
|
|
| **10.35 |
|
|
| **10.36 |
|
Credit
Agreement, dated as of May 19, 2008 among Kinetic Concepts, Inc., the
lenders party thereto, and Banc of America, N.A. as administrative agent
for the lenders (filed as Exhibit 10.1 to our Form 8-K filed on May 23,
2008).
|
| **10.37 |
|
Purchase
Agreement, dated as of April 15, 2008, among Kinetic Concepts, Inc., J.P.
Morgan Securities Inc. and Banc of America Securities LLC, as
representatives of the several Initial Purchasers (filed as Exhibit 1.1 to
our Form 8-K filed on April 22, 2008).
|
| **10.38 |
|
Kinetic
Concepts, Inc. 2008 Omnibus Stock Incentive Plan (filed as Exhibit 10.2 to
our Form 8-K filed on May 23, 2008).
|
| **10.39 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Non-Employee
Director Nonqualified Stock Option Agreement (filed as Exhibit 10.7 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| 10.40 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Non-Employee
Director Restricted Stock Award Agreement (filed as Exhibit 10.8 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| 10.41 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Nonqualified
Stock Option Agreement (filed as Exhibit 10.9 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.42 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Restricted
Stock Award Agreement (filed as Exhibit 10.10 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.43 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Restricted
Stock Unit Award Agreement (filed as Exhibit 10.11 to our Quarterly Report
on Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.44 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Cashless
International Stock Option Agreement (filed as Exhibit 10.12 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| **10.45 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan International
Stock Option Agreement (filed as Exhibit 10.13 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.46 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan International
Restricted Stock Unit Award Agreement (filed as Exhibit 10.14 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| *21.1 |
|
|
| *23.1 |
|
Consent
of Independent Registered Public Accounting Firm, from Ernst & Young
LLP.
|
| *31.1 |
|
Certification
of the Chief Executive Officer Pursuant to section 302 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2009.
|
| *31.2 |
|
Certification
of the Chief Financial Officer Pursuant to section 302 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2009.
|
| *32.1 |
|
Certification
of the Chief Executive Officer and Chief Financial Officer Pursuant to
section 18 U.S.C. section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2009.
|
| |
|
|
| |
|
* Exhibit filed
herewith.
|
| |
|
** Compensatory
arrangements for director(s) and/or executive
officer(s).
|
| |
|
† Confidential
treatment granted on certain portions of this exhibit. An
unredacted version of this exhibit has been filed separately with the
Securities and Exchange
Commission.
|
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) 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, in the City of San Antonio, State
of Texas on February 26, 2009.
|
|
KINETIC
CONCEPTS, INC.
|
|
|
|
|
|
|
By:
|
/s/
Ronald W. Dollens
|
|
|
|
Ronald
W. Dollens
|
|
|
|
Chairman
of the Board of Directors
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
|
Signatures
|
|
Title
|
|
Date
|
|
|
|
|
|
|
|
/s/
Ronald W. Dollens
|
|
Chairman
of the Board of Directors
|
|
|
|
RONALD
W. DOLLENS
|
|
|
|
|
|
|
|
|
|
|
|
/s/
Catherine M. Burzik
|
|
Director,
President and Chief Executive Officer
|
|
|
|
CATHERINE
M. BURZIK
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
|
|
|
/s/
Martin J. Landon
|
|
Executive
Vice President and Chief Financial Officer
|
|
|
|
MARTIN
J. LANDON
|
|
(Principal
Financial and Principal Accounting Officer)
|
|
|
|
|
|
|
|
|
|
/s/
James R. Leininger, M.D.
|
|
Director,
Chairman Emeritus
|
|
|
|
JAMES
R. LEININGER, M.D.
|
|
|
|
|
|
|
|
|
|
|
|
/s/
John P. Byrnes
|
|
Director
|
|
|
|
JOHN
P. BYRNES
|
|
|
|
|
|
|
|
|
|
|
|
/s/
Craig R. Callen
|
|
Director
|
|
|
|
CRAIG
R. CALLEN
|
|
|
|
|
|
|
|
|
|
|
|
/s/
Woodrin Grossman
|
|
Director
|
|
|
|
WOODRIN
GROSSMAN
|
|
|
|
|
|
|
|
|
|
|
|
/s/
Harry R. Jacobson
|
|
Director
|
|
|
|
HARRY
R. JACOBSON
|
|
|
|
|
|
|
|
|
|
|
|
/s/
Carl F. Kohrt
|
|
Director
|
|
|
|
CARL
F. KOHRT
|
|
|
|
|
|
|
|
|
|
|
|
/s/
David J. Simpson
|
|
Director
|
|
|
|
DAVID
J. SIMPSON
|
|
|
|
|
|
|
|
|
|
|
|
/s/
C. Thomas Smith
|
|
Director
|
|
|
|
C.
THOMAS SMITH
|
|
|
|
|
|
|
|
|
|
|
|
/s/
Donald E. Steen
|
|
Director
|
|
|
|
DONALD
E. STEEN
|
|
|
|
|
|
|
|
|
|
|
|
Exhibits
|
|
Description
|
| |
|
|
| 2.1 |
|
Agreement
and Plan of Merger, dated as of April 7, 2008, between Kinetic Concepts,
Inc., Leopard Acquisition Sub, Inc., and LifeCell Corporation (filed as
Exhibit 2.1 to our Form 8-K filed on April 7, 2008).
|
| 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 From 8-K filed on February 24,
2009).
|
| 4.1 |
|
Specimen
Common Stock Certificate (filed as Exhibit 4.3 to Amendment No. 1 to our
Registration Statement on Form S-1, filed on February 2, 2004, as
thereafter amended).
|
| 4.2 |
|
Form
of 3.25% Convertible Senior Note due 2015, dated as of April 21, 2008,
(included in Exhibit 4.1 to our Form 8-K filed on April 22,
2008).
|
| 4.3 |
|
Indenture,
dated as of April 21, 2008 between Kinetic Concepts, Inc., KCI USA, Inc.
and U.S. Bank National Association, as trustee (filed as Exhibit 4.1 to
our Form 8-K filed on April 22, 2008).
|
| 10.1 |
|
|
| 10.2 |
|
|
| **10.3 |
|
|
| **10.4 |
|
Form
of Option Instrument with respect to the Kinetic Concepts, Inc.
Management Equity Plan (filed as Exhibit 10.14 to our Annual Report
on Form 10-K for the year ended December 31, 2000, filed on
March 30, 2001).
|
| 10.5 |
|
Standard
Office Building Lease Agreement, dated July 31, 2002 between CKW San
Antonio, L.P. d/b/a San Antonio CKW, L.P. and Kinetic Concepts, Inc. for
the lease of approximately 138,231 square feet of space in the building
located at 8023 Vantage Drive, San Antonio, Bexar County, Texas 78230
(filed as Exhibit 10.27 on Form S-4, filed on September 29,
2003).
|
| †10.6 |
|
Toll
Manufacturing Agreement, by and between KCI Manufacturing and Avail
Medical Products, Inc. dated December 14, 2007.
|
| †10.7 |
|
Amendment
to Toll Manufacturing Agreement, by and between KCI Manufacturing and
Avail Medical Products, Inc. dated July 31, 2008 (filed as Exhibit 10.14
to our Quarterly Report on Form 10-Q for the quarter ended September 30,
2008, filed on November 5, 2008).
|
| †10.8 |
|
License
Agreement, dated as of October 6, 1993, between Wake Forest
University and Kinetic Concepts, Inc., as amended by that certain
Amendment to License Agreement, dated as of July 1, 2000 (filed as
Exhibit 10.29 to Amendment No. 4 to our Registration Statement
on Form S-1, filed on February 23, 2004).
|
| **10.9 |
|
Form
of Director Indemnity Agreement (filed as Exhibit 10.31 to Amendment No. 1
to Registration Statement on Form S-1, filed on February 2, 2004, as
amended).
|
| **10.10 |
|
2004
Equity Plan (filed as Exhibit 10.32 to Amendment No. 1 to Registration
Statement on Form S-1, filed on February 2, 2004, as
amended).
|
| **10.11 |
|
2004
Employee Stock Purchase Plan (filed as Exhibit 10.33 to Amendment No. 1 to
Form S-1, filed on February 2, 2004, as amended).
|
| **10.12 |
|
Form
of Stock Option Agreement under Amended and Restated 2003 Non-Employee
Directors Stock Plan (filed as Exhibit 10.2 to our Current Report on
Form 8-K filed on November 15, 2004).
|
| **10.13 |
|
Form
of Restricted Stock Award Agreement under Amended and Restated 2003
Non-Employee Directors Stock Plan (filed as Exhibit 10.3 to our
Current Report on Form 8-K filed on November 15,
2004).
|
| **10.14 |
|
Executive
Deferred Compensation Plan (filed as Exhibit 10.1 to our Quarterly Report
on Form 10-Q for the quarter ended March 31, 2006, filed on May 9,
2006).
|
| **10.15 |
|
Form
of KCI 2004 Equity Plan Restricted Stock Award Agreement (filed as Exhibit
10.1 to our Quarterly Report on Form 10-Q for the quarter ended September
30, 2006, filed on August 9, 2006).
|
| **10.16 |
|
Form
of KCI 2004 Equity Plan Nonqualified Stock Option Agreement (filed as
Exhibit 10.2 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, filed on August 9, 2006).
|
| **10.17 |
|
Form
of KCI 2004 Equity Plan Restricted Stock Unit Award Agreement (filed as
Exhibit 10.3 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, filed on August 9, 2006).
|
| **10.18 |
|
Form
of KCI 2004 Equity Plan International Restricted Stock Unit Award
Agreement (filed as Exhibit 10.4 to our Quarterly Report on Form 10-Q for
the quarter ended September 30, 2006, filed on August 9,
2006).
|
| **10.19 |
|
Form
of KCI 2004 Equity Plan International Stock Option Agreement (filed as
Exhibit 10.5 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2006, filed on August 9, 2006).
|
| **10.20 |
|
Letter,
dated October 16, 2006, from Kinetic Concepts, Inc. to Catherine M. Burzik
outlining the terms of her employment (filed as Exhibit 10.1 to our
Quarterly Report on Form 10-Q for the quarter ended September 30, 2006,
filed on November 3, 2006).
|
| **10.21 |
|
2004
Equity Plan Nonqualified Stock Option Agreement between Kinetic Concepts,
Inc. and Catherine M. Burzik, dated November 6, 2006 (filed as
Exhibit 10.28 to our Annual Report on Form 10-K for the year
ended December 31, 2006, filed on February 23,
2007).
|
| **10.22 |
|
2004
Equity Plan Restricted Stock Award Agreement between Kinetic Concepts,
Inc. and Catherine M. Burzik, dated November 6, 2006 (filed as
Exhibit 10.29 to our Annual Report on Form 10-K for the year
ended December 31, 2006, filed on February 23,
2007).
|
| **10.23 |
|
|
| **10.24 |
|
|
| **10.25 |
|
|
| **10.26 |
|
|
| **10.27 |
|
|
| **10.28 |
|
|
| **10.29 |
|
|
| **10.30 |
|
|
| **10.31 |
|
|
| **10.32 |
|
|
| **10.33 |
|
Form
of Kinetic Concepts, Inc. 2004 Equity Plan International Restricted Stock
Unit Award Agreement, as amended on February 19, 2008 (filed as Exhibit
10.37 to our Annual Report on Form 10-K for the year ended December 31,
2008, filed on February 22, 2008).
|
| **10.34 |
|
|
| **10.35 |
|
|
| **10.36 |
|
Credit
Agreement, dated as of May 19, 2008 among Kinetic Concepts, Inc., the
lenders party thereto, and Banc of America, N.A. as administrative agent
for the lenders (filed as Exhibit 10.1 to our Form 8-K filed on May 23,
2008).
|
| **10.37 |
|
Purchase
Agreement, dated as of April 15, 2008, among Kinetic Concepts, Inc., J.P.
Morgan Securities Inc. and Banc of America Securities LLC, as
representatives of the several Initial Purchasers (filed as Exhibit 1.1 to
our Form 8-K filed on April 22, 2008).
|
| **10.38 |
|
Kinetic
Concepts, Inc. 2008 Omnibus Stock Incentive Plan (filed as Exhibit 10.2 to
our Form 8-K filed on May 23, 2008).
|
| **10.39 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Non-Employee
Director Nonqualified Stock Option Agreement (filed as Exhibit 10.7 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| 10.40 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Non-Employee
Director Restricted Stock Award Agreement (filed as Exhibit 10.8 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| 10.41 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Nonqualified
Stock Option Agreement (filed as Exhibit 10.9 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.42 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Restricted
Stock Award Agreement (filed as Exhibit 10.10 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.43 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Restricted
Stock Unit Award Agreement (filed as Exhibit 10.11 to our Quarterly Report
on Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.44 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan Cashless
International Stock Option Agreement (filed as Exhibit 10.12 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| **10.45 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan International
Stock Option Agreement (filed as Exhibit 10.13 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2008, filed on August 7,
2008).
|
| **10.46 |
|
Form
of Kinetic Concepts, Inc. 2008 Omnibus Stock Incentive Plan International
Restricted Stock Unit Award Agreement (filed as Exhibit 10.14 to our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, filed
on August 7, 2008).
|
| *21.1 |
|
|
| *23.1 |
|
Consent
of Independent Registered Public Accounting Firm, from Ernst & Young
LLP.
|
| *31.1 |
|
Certification
of the Chief Executive Officer Pursuant to section 302 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2009.
|
| *31.2 |
|
Certification
of the Chief Financial Officer Pursuant to section 302 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2009.
|
| *32.1 |
|
Certification
of the Chief Executive Officer and Chief Financial Officer Pursuant to
section 18 U.S.C. section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2009.
|
| |
|
|
| |
|
* Exhibit filed
herewith.
|
| |
|
** Compensatory
arrangements for director(s) and/or executive
officer(s).
|
| |
|
† Confidential
treatment granted on certain portions of this exhibit. An
unredacted version of this exhibit has been filed separately with the
Securities and Exchange
Commission.
|
