Document/ExhibitDescriptionPagesSize 1: 10-K Annual Report -- kci10k2007 HTML 1.85M
3: EX-10.22 2008 Compensation Policy for Outside Directors HTML 22K
4: EX-10.25 Executive Retention Agreement HTML 33K
5: EX-10.26 Executive Retention Agreement HTML 33K
6: EX-10.32 Contract of Employment HTML 37K
7: EX-10.33 Executive Retention Agreement HTML 34K
8: EX-10.34 2003 Non-Employee Directors Stock Plan HTML 79K
9: EX-10.35 2004 Equity Plan International Stock Option HTML 60K
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10: EX-10.36 2004 Equity Plan Restricted Stock Unit Award HTML 38K
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11: EX-10.37 2004 Equity Plan International Restricted Stock HTML 56K
Unit Award Agreement
12: EX-10.38 2004 Equity Plan Nonqualified Stock Option HTML 41K
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13: EX-10.39 2004 Equity Plan Restricted Stock Award Agreement HTML 40K
2: EX-10.6 Toll Manufacturing Agreement HTML 130K
14: EX-21.1 Subsidiaries of Registrant HTML 24K
15: EX-23.1 Exhibit 23.1 - Consent of Independent Auditor HTML 10K
16: EX-31.1 Exhibit 31.1 - 302 Certification of CEO HTML 14K
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(Exact
name of registrant as specified in its charter)
Texas
74-1891727
(State
of Incorporation)
(I.R.S.
Employer Identification No.)
8023
Vantage Drive
San
Antonio,
Texas
78230
(Address
of principal executive offices)
(Zip
Code)
Registrant’s
telephone number, including area code: (210) 524-9000
Securities
registered pursuant to Section 12(b) of the Act:
Title
of each
class
Name of each exchange
on which registered
Common
stock, par value $0.001
New
York Stock Exchange
Securities
registered pursuant to section 12(g) of the Act: NONE
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes X No ____
Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act.
Yes ____ No X
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.
Yes X No ____
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large
accelerated filer X Accelerated
filer ____ Non-accelerated
filer ____
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes ____ No X
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates as of June 30, 2007 was $2,738,522,771 based upon the closing
sales price for the registrant's common stock on the New York Stock
Exchange.
Documents
Incorporated by Reference: Certain information called for by Part III
of this Form 10-K is incorporated by reference to the definitive Proxy Statement
for the 2007 Annual Meeting of Shareholders, which will be filed not later than
120 days after the close of the Company's fiscal year.
The
following terms are our trademarks and may be used in this
report: ActiV.A.C.®,
AirMaxxis®,
AtmosAir®,
AtmosAir® with
SATÔ, BariAir®,
BariatricSupportÔ,
BariKare®,
BariMaxx® II,
BioDyne®,
Dri-Flo®,
DynaPulse®, EZ
LiftÔ, FirstStep®,
FirstStep®
AdvantageÔ, First Step
All in One®,
FirstStep®
PlusÔ, FirstStep
Select®,
FirstStep Select® Heavy
DutyÔ, FluidAir®,
FluidAir Elite®,
GranuFoam®,
InterCell®,
InfoV.A.C.®,
InstaFlate®,
KCI®, KCI The
Clinical Advantage®,
KinAir® IV,
KinAir MedSurg®, KinAir
MedSurg®
PulseÔ, KCI
Express®, Kinetic
Concepts®, Kinetic
TherapyÔ, MaxxAir
ETS®,
Maxxis® 400,
ParaDyne®,
PediDyne®,
PlexiPulse®,
RIK®,
RotoProne®,
RotoRest®,
RotoRest® Delta,
Seal Check®,
SensaT.R.A.C.Ô,
T.R.A.C.®,
TheraKair®,
TheraKair Visio®,
TheraPulse® ATPÔ, TheraRest®,
TheraRest SMS®,
TriaDyne® II,
TriaDyne Proventa®,
TriCell®,
V.A.C.®, V.A.C.
ATS®, V.A.C.
Freedom®,
V.A.C.® Therapy,
The V.A.C.® System,
V.A.C. GranuFoam Silver®, V.A.C.
Instill®,
V.A.C.®
WhiteFoam, and V.A.C. ® WRNÔ. All other
trademarks appearing in this report are the property of their
holders.
SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, which are covered by the "safe harbor" created
by those sections. The forward-looking statements are based on our current
expectations and projections about future events. Discussions containing
forward-looking statements may be found in "Management's Discussion and Analysis
of Financial Condition and Results of Operations,""Risk Factors," and elsewhere
in this report. In some cases, you can identify forward-looking statements by
terminology such as "may,""will,""should,""could,""predicts,""projects,""potential,""continue,""expects,""anticipates,""future,""intends,""plans,""believes,""estimates," or the negative of these terms and other comparable
terminology, including, but not limited to, statements regarding the
following:
·
projections
of revenues, expenditures, earnings, or other financial
items;
·
expectations
for third-party and governmental audits, investigations, claims, product
approvals and reimbursement;
·
the
plans, strategies and objectives of management for future
operations;
·
expectation
of market size and market acceptance or penetration of the products and
services we offer;
·
the
effects of any patent litigation on our
business;
·
dependence
on new technology;
·
expectations
for the outcomes of our clinical
trials;
·
attracting
and retaining customers;
·
competition
in our markets;
·
inherent
risks associated with our international business
operations;
·
material
changes or shortages in the sources of our
supplies;
·
the
timing and amount of future equity compensation
expenses;
·
productivity
of our sales force;
·
future
economic conditions or performance, including
seasonality;
·
fluctuations
in foreign currency exchange rates;
·
changes
in effective tax rates or tax
audits;
·
changes
in patient demographics;
·
estimated
charges for compensation or otherwise;
and
·
any
statements of assumptions underlying any of the
foregoing.
These
forward-looking statements are only predictions, not historical facts, and
involve certain risks and uncertainties, as well as assumptions. Actual results,
levels of activity, performance, achievements and events could differ materially
from those stated, anticipated or implied by such forward-looking statements.
The factors that could contribute to such differences include those discussed
under the caption "Risk Factors." You should consider each of the risk factors
and uncertainties under the caption "Risk Factors" among other things, in
evaluating our prospects and future financial performance. The occurrence of the
events described in the risk factors could harm our business, results of
operations and financial condition. These forward-looking statements are made as
of the date of this report. We disclaim any obligation to update or alter these
forward-looking statements, whether as a result of new information, future
events or otherwise.
Kinetic
Concepts, Inc. is a global medical technology company with leadership positions
in advanced wound care and therapeutic support systems. 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 has been demonstrated clinically to promote
wound healing through unique mechanisms of action and can help reduce the cost
of treating patients with serious wounds. Our therapeutic support
systems, including specialty hospital beds, mattress replacement systems and
overlays, are designed to address pulmonary complications associated with
immobility, to reduce skin breakdown and assist caregivers in the safe and
dignified handling of obese patients. We have an infrastructure
designed to meet the specific needs of medical professionals and patients across
all health care settings, including acute care hospitals, extended care
organizations and patients’ homes, both in the United States and
abroad. Our strategy is to maximize global penetration of our
existing V.A.C. and therapeutic support systems product lines, accelerate the
development of new business opportunities through focused research and
development activities, and expand our product portfolio through acquisition and
licensing opportunities.
KCI was
founded in 1976 and is incorporated in Texas. Our principal executive
offices are located at 8023 Vantage Drive, San Antonio, Texas78230. 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 and therapeutic support systems address four
principal clinical applications: advanced wound healing and tissue repair,
pulmonary complications in the intensive care unit, 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 clinical and cost effectiveness. Given the high
cost and infection risk associated with treating these patients in health care
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, reducing infection risk, 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.
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 United States 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 doubled from 11.6% in 1990 to approximately
24.4% in 2006. In addition, obesity is now the second leading cause
of preventable death in the U.S. According to statistics published by
the Centers for Disease Control and Prevention, medical expenditures
attributable to obesity were estimated at 5.7% of total medical spending based
on data covering 1998 to 2000. Obese patients are often unable to fit
into standard-sized beds and wheelchairs and pose an increased risk to
caregivers. KCI's BariatricSupport, a comprehensive offering of
therapy-driven, safety-focused products, education and training, provides obese
patients with the surface therapies, accessories and support they need. In
addition, our bariatric products 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 from 300 to 600 pounds, most are
expandable and can accommodate patients weighing from 850 to 1,000
pounds. Our most sophisticated bariatric products can serve as a
chair, weight scale, and x-ray table; and they provide therapies like those in
our wound treatment and prevention systems. Moreover, treating obese patients is
a significant staffing issue for many health care 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 health care personnel.
Our products and accessories assist organizations in complying with any
applicable "no lift" policy and enable health care personnel to treat these
patients in a manner that is safer for health care personnel and safer 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.
We offer
a wide range of products in each clinical application to meet the specific needs
of different subsets of the market, 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:
·
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.
·
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.
·
The
V.A.C. Instill System was introduced in 2003 to add 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.
·
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.
·
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.
The
V.A.C. GranuFoam Silver Dressing was introduced into the wound care market in
August 2005. Designed specifically for the V.A.C. Therapy system,
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.
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 467 journal articles (405
peer-reviewed), 470 abstracts, 51 case studies and 61 textbook
citations. Of these, the research for 66 articles, 98 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.
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, 68 journal articles (56 peer-reviewed articles), 44
abstracts, 19 case studies and four textbook citations. Of these, the research
for 17 articles, 32 abstracts and 19 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 these patients
in a safe and dignified manner. The most advanced product in this line is the
BariAir Therapy System, which can serve as a bed, cardiac chair or x-ray table.
The BariAir, first introduced in 1996, provides low-air-loss pressure relief,
continuous turn assist, percussion and step-down features designed for both
patient comfort and nurse assistance. This product can be used for patients who
weigh up to 850 pounds. We believe that the BariAir is the most advanced product
of its type available today and is indicated for the treatment of the most
complex bariatric patient, typically found in the ICU. In addition to therapy,
the BariAir provides a risk management platform for patients weighing up to 850
pounds. It is a front-exit bed with the ability to convert to a cardiac chair
position. In 1996, we also introduced the FirstStep Select Heavy Duty overlay,
which provides pressure-relieving low-air-loss therapy when placed on a BariKare
bed. Our AirMaxxis product provides a therapeutic air surface for the home
environment for patients weighing up to 650 pounds. The Maxxis 300 and Maxxis
400 provide a homecare bariatric bed frame for patients weighing up to 600
pounds and 1,000 pounds, respectively.
The
BariMaxx II bed provides a basic risk management platform for patients weighing
up to 1,000 pounds for those customers looking for a set of features including
built-in scales and an expandable frame at a lower cost. 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 that also includes rotational therapy of
up to 30 degrees on each side. In 2006, we launched a powered
transport option that enables caregivers to safely and more easily transport
patients on the BariMaxx II.
All of
our bariatric beds can be combined with our EZ Lift patient transfer system, an
Air Pal air assisted lateral transfer system, a Carechair combination chair /
stretcher, and other accessories such as wheelchairs, walkers and commodes to
create a complete bariatric suite offering. This complete suite offering helps
caregivers in the day-to-day care of the bariatric patient and also assists with
compliance to "no lift" policies being implemented in health care
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 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.
In 2006,
we launched the next generation platform of mattress replacement systems, the
FirstStep All in One. 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.
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 to advance our understanding
of the science of wound healing and the physical and biologic processes that can
be influenced to treat a variety of wounds. Through such efforts, 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. Recent innovations
include the launch of the next-generation InfoV.A.C. and ActiV.A.C. therapy
systems.
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 adds to KCI's significant body of clinical data that clearly shows that
our V.A.C. Therapy system, including its unique foam dressing, provides clinical
advantage for treatment of diabetic foot ulcers, including limb
salvage.
KCI also
continues to successfully distinguish its products from competitive offerings
through unique FDA-approved 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, new claims were approved by the Food and Drug Administration, or
FDA, in 2007 which now specify the use of V.A.C. systems in all care settings,
including in the home. These newly-issued claims are unique to KCI’s
V.A.C. systems in the field of NPWT.
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 health care settings. We have
relationships with approximately 9,000 acute care hospitals
worldwide. In the United States, we have relationships with
approximately 9,200 extended care organizations and over 10,500 home health care
agencies and wound care clinics, in addition to numerous clinicians in these
facilities with whom we have long-established relationships.
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 375 contracts with some of the largest private insurance payers in the
U.S.
Extensive service center
network. With a network of 141 U.S. and 67 international
service centers, we are able to rapidly deliver our products to major hospitals
in the United States, 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.
We have a
broad reach across all health care settings. We have relationships with
approximately 9,000 acute care hospitals worldwide. In the United
States, we have relationships with approximately 9,200 extended care
organizations and over 10,500 home health care agencies and wound care clinics.
As of December 31, 2007, we served over 2,700 medium-to-large hospitals in the
United States. Through our network of 141 U.S. and 67 international service
centers, we are able to rapidly deliver our products to major hospitals in the
United States, 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, 2007, 2006 and 2005, accounted for $193.6 million, or
12.0% of total revenue, $179.2 million, or 13.1% of total revenue, and $159.6
million, or 13.2% of total revenue, respectively. Medicare, which
reimburses KCI for placement of our products and therapies with Medicare
participants, accounted for $181.5 million, or 11.3% of total revenue, $165.4
million, or 12.1% of total revenue, and $148.6 million, or 12.3% of total
revenue for the years ended December 31, 2007, 2006 and 2005,
respectively. No other individual customer or payer accounted for 10%
or more of total revenues for the years ended December 31, 2007, 2006 and 2005,
respectively.
Our
customers typically prefer to rent our V.A.C. Therapy systems and therapeutic
support systems and purchase the related disposable products, 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.
Billing
and Reimbursement
We have
extensive contractual relationships and reimbursement coverage for our products
in the United States. We have contracts with nearly all major acute care
hospital organizations and most major extended care organizations. Generally,
these acute and extended care organizations pay us directly for our products and
services. In the homecare market, we provide our products and services directly
to patients and bill third-party payers, including Medicare, Medicaid and
private insurance. We currently have V.A.C. contracts with private and
governmental payer organizations covering over 200 million member lives in
the United States as of December 31, 2007. This represents more than 10 times
the number of member lives we had under contract as of mid-2000.
The
following table sets forth, for the periods indicated, the percentage of revenue
derived from different types of payers:
2007
2006
2005
Acute
and extended care organizations
67.4
%
67.9
%
66.9
%
Third-party
payers
32.6
%
32.1
%
33.1
%
Employees
As of
January 31, 2008, we had approximately 6,400 employees. Our
corporate, manufacturing, finance, research and development and administrative
functions are performed by approximately 1,000 employees who are located in San
Antonio, Texas. Our USA division had approximately 3,500 employees, including
approximately 1,300 employees located in San Antonio who perform functions
associated with customer service and sales administration. As of December 31,2007, we had approximately 2,000 employees in our International division.
Approximately 85 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.
Our
business has two geographical operating segments: USA and
International.
With
approximately 3,500 employees as of December 31, 2007, our USA division serves
the domestic acute care, extended care and homecare markets with the full range
of our products and services. The domestic division distributes our medical
devices and therapeutic support systems to over 4,600 acute care hospitals and
approximately 9,200 extended care organizations and also directly serves the
homecare market through our service center network. Our USA division accounted
for approximately 71.4%, 72.5% and 73.3% of our total revenue in the years ended
December 31, 2007, 2006 and 2005, respectively.
As of
December 31, 2007, our International division 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. The
International division distributes our medical devices and therapeutic support
systems through a network of 67 service centers to approximately 4,400 acute
care hospitals. Our international corporate office is located in Amsterdam, the
Netherlands. We have international manufacturing and engineering operations
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 International division consists of approximately
2,000 employees who are responsible for all sales, service and
administrative functions within the various countries we serve. Our
International division accounted for approximately 28.6%, 27.5% and 26.7% of our
total revenue in the years ended December 31, 2007, 2006 and 2005,
respectively.
Sales
and Marketing Organization
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 600 clinical consultants, all of whom are health care
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 200 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
domestic sales organization includes approximately 1,300
employees. Effective February 2008, our domestic 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.
Selling,
marketing and advertising expenses in each of the periods below were as follows
(dollars in thousands):
Our USA
division has a national 24-hour, seven day-a-week customer service
communications system, which allows us to quickly and efficiently respond to our
customers' needs. 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 USA division distributes our medical
devices and therapeutic support systems through a network of 141 service
centers. Our USA division's network gives us the ability to deliver
our products to any major Level I domestic trauma center within
hours. Our International division distributes our medical devices and
therapeutic support systems through a network of 67 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 145,000 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 United States and 600 employees
internationally.
Research
and Development
We have a
successful track record of pioneering advanced wound care 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. 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. More recently, we have developed a broad
portfolio of bariatric surface products to improve the care of obese patients
and have introduced two new sophisticated critical care
therapies. 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 200 employees worldwide.
Our
primary focus for innovation is to introduce new technologies that expand our
current product portfolio into different clinical settings, explore novel
opportunities across the entire spectrum of wound care, and evaluate
opportunities that leverage our expertise in critical care and in a variety of
other clinical disciplines to expand product offerings beyond wound care 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 operational efficiency. Significant investments in our 2007
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 V.A.C. Therapy technology and enhanced therapeutic
effectiveness through improved understanding of the V.A.C. Therapy
systems' various mechanisms of action;
and
·
initiation,
execution or support of a number of well-designed randomized-controlled
clinical trials, registries, development studies, and investigator
initiated trials.
Expenditures
for research and development, including clinical trials, in each of the periods
below, were as follows (dollars in thousands):
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 United States 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 135 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 70 trademarks and
service marks registered with the United States 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 50 issued U.S. patents (including
14 design patents) and approximately 90 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 approximately 400 issued patents and more than 300
pending patent applications, including protection in Europe, Canada, Australia,
Japan and the United States. 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.
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, specifically ISO 13485:2003, and the United States Food and
Drug Administration’s Quality System Regulation, 21 CFR 820.
We
contract for the manufacture of V.A.C. disposable supplies through Avail Medical
Products, Inc., a leading contract manufacturer of sterile medical
products. Effective November 30, 2007, we entered into a three-year
Toll Manufacturing Agreement with Avail through November 2010, which is
renewable annually for an additional twelve-month period in November of each
year, unless either party gives notice to the contrary. The Agreement
replaces the Amended and Restated Manufacturing Agreement between KCI and Avail,
dated December 18, 2002. Under the new agreement, we will have title
to the raw materials used to manufacture our disposable supplies and will retain
title of all disposables inventory throughout the manufacturing
process. Under the previous agreement, title to the raw materials and
work-in-process inventory was retained by Avail during the manufacturing
process. Approximately 24.1% of our total revenue for the year ended
December 31, 2007 was generated from the sale of these disposable
supplies. 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 maintain an inventory of disposables
sufficient to support our business for approximately seven weeks in the United
States and nine weeks in Europe. However, in the event that we are
unable to replace a shortfall in supply, our revenue could be negatively
impacted in the short term.
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 health care 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.
In
addition to direct competition from companies in the advanced wound care market,
health care 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 health care 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.
Reimbursement
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. We believe that government and private insurance efforts to
contain or reduce health care costs are likely to continue. These trends may
lead third-party payers to deny or limit reimbursement for our products, which
could negatively impact the pricing and profitability of, or demand for, our
products.
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 diagnosis-related group, or DRG. Every DRG is assigned a
payment rate based upon the estimated intensity of hospital resources necessary
to treat the average patient with that particular diagnosis. The DRG
payment rates are based upon historic national average costs and do not consider
the actual costs incurred by a hospital in providing care. 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 DRG 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, 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 health care 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. For example, in August 2006, CMS finalized new provisions
for the hospital 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 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. On August 1, 2007, CMS issued a final rule
revising Medicare payment and policy under the hospital IPPS for federal fiscal
year 2008. These changes, which were first proposed in April 2007,
will restructure the inpatient DRGs to account more fully for the severity of
patient illness. Specifically, the final rule creates 745 new
severity-adjusted DRGs to replace the current 538 DRGs. 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 place
downward pressure on prices paid by acute care hospitals to KCI and adversely
affect the demand for our products used for inpatient services.
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 health care costs.
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 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 health care programs, raises additional potential
liabilities. See “Government
Regulation –Fraud and
Abuse Laws.”
Our
V.A.C. Therapy Systems received Medicare Part B reimbursement coverage in
2000. Since that time, usage of V.A.C. Therapy Systems in the home
has greatly increased as 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, 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. Under the MMA, the reimbursement
amounts for DME, including V.A.C. Therapy systems, will no longer be increased
on an annual basis through 2008. In the MMA, Congress also 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 will be required to be successful bidders and meet certain program
standards in order to supply selected DMEPOS items to Medicare beneficiaries in
certain designated geographic areas. Competitive bidding is being
phased in both by geographical area and by product category. In 2008,
CMS will operate competitive bidding areas, or CBAs, within 10 of the nation’s
largest metropolitan areas, excluding New York, Los Angeles, and
Chicago. CMS has included Negative Pressure Wound Therapy, or NPWT,
as one of the product categories in the first phase of competitive
bidding. Suppliers that bid to furnish a particular product category
in a CBA must submit a bid for each item within the product
category. All bids submitted must be at or below the fee schedule
amount for the item at the time the bid is made, thereby ensuring that the
competitive bidding program will result in lower Medicare reimbursement levels
for DMEPOS items furnished within the CBAs. Once CMS selects the
contract suppliers for a particular product category, CMS will establish single
payment amounts for each item within the product category. The single
payment amount is based on the median of the winning suppliers’ bids for each of
the selected items in the CBA. Therefore, a winning supplier is not
guaranteed reimbursement at its actual bid amount for an item; rather,
approximately half of the winning suppliers who opt to become contract suppliers
will be reimbursed at a lower rate than their bid to furnish a particular item,
while the other half will receive reimbursement in excess of their bid
amount. Those bidders which are awarded contracts and agree to become
contract suppliers must accept reimbursement from CMS at 80% of the item’s
single payment amount for the CBA in which the beneficiary maintains a permanent
residence; the beneficiary is responsible for the 20% copayment. It
is possible, however, that CMS will not award any contracts for certain product
categories in one or more of the CBAs. In such case, those products
would continue to be reimbursed by Medicare at the current fee schedule
pricing.
Recently,
CMS announced the 70 metropolitan areas included in the second phase of the
competitive bidding process. CMS has included NPWT as a product
category in this second phase of competitive bidding. In the second
phase of the program, CMS has indicated that new single payment amounts would be
established and paid to winning bidders that opt to become contract suppliers
beginning in mid-2009 in the designated metropolitan
areas. Non-winning bidders generally would be unable to furnish
Medicare-covered NPWT in a CBA, except in limited circumstances. The
Medicare DMEPOS competitive bidding program could have a negative impact on our
Medicare reimbursement levels, and could result in increased price pressure from
other third-party payers. The competitive bidding program could also
limit customer access to KCI’s homecare products in the designated
CBAs. We estimate the V.A.C. rentals and sales to Medicare
beneficiaries in the ten designated metropolitan areas included in phase one of
the program represented approximately $16.6 million, or 1.5% of our total U.S.
V.A.C. revenue, or 1.0% of KCI’s total revenue for the year ended December 31,2007. We estimate the V.A.C. rentals and sales to Medicare
beneficiaries in the 80 designated metropolitan areas represented less than 7%
of our total U.S. V.A.C. revenue, or less than 5% of KCI’s total revenue for the
year ended December 31, 2007.
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 health care 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 United
States-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
United States, health care reform legislation will most likely remain focused on
reducing the cost of health care. 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 health care system continue. Current methods
to contain health care 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. NPWT has been designated as a product category for the first
two phases of the competitive bidding program.
The
reimbursement of our products is also subject to review by government
contractors that administer payments under federal health care 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
health care reform initiatives in the United States have caused health care
providers to examine their cost structures and reassess the manner in which they
provide health care services. This review, in turn, has led many health care
providers to merge or consolidate with other members of their industry in an
effort to reduce costs or achieve operating synergies. A substantial number of
our customers, including proprietary hospital groups, GPOs, hospitals, national
nursing home companies and national home health care 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 health care providers often results
in the re-negotiation of contracts and the granting of price concessions.
Finally, as GPOs and integrated health care systems increase in size, each
contract represents a greater concentration of market share and the adverse
consequences of losing a particular contract increases.
Government
Regulation
United
States
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
United States, medical devices are classified into one of three classes
(Class I, II or III) on the basis of the controls deemed necessary by the
FDA to reasonably ensure their safety and effectiveness. 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 United States 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
Health Care 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.
Fraud
and Abuse Laws
There are
numerous rules and requirements governing the submission of claims for payment
to federal health care 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
United States 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
United States 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 health care 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 health care
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
health care companies to have to defend false claim actions, pay fines or be
excluded from the Medicare, Medicaid or other federal or state health care
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 health care 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 health care
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 health care 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
health care program, or is convicted of a felony relating to health care fraud,
the secretary of the United States Department of Health and Human Services is
required to bar the party from participation in federal health care programs and
to notify the appropriate state agencies to bar the individual from
participation in state health care 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 health care 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 health care 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) health care fraud and
(ii) false statements relating to health care matters. The health care
fraud statute prohibits knowingly and willfully executing or attempting to
execute a scheme or artifice to defraud any health care 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 health care 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 health care
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 health care delivery and
payment.
The most
recent publication of the OIG’s Work Plan for 2008 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.
Several
states also have referral, fee splitting and other similar laws that may
restrict the payment or receipt of remuneration in connection with the purchase
or rental of medical equipment and supplies. State laws vary in scope and have
been infrequently interpreted by courts and regulatory agencies, but may apply
to all health care 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
The
industry in which we operate is generally characterized by long collection
cycles for accounts receivable due to complex and time-consuming documentation
requirements for obtaining reimbursement from private and governmental
third-party payers. Such protracted collection cycles can lead to delays in
obtaining reimbursement. Moreover, regional Medicare contractors periodically
conduct pre-payment and post-payment reviews and other audits of paid claims,
which can further lengthen the collection cycle. Medicare and
Medicaid contractors are under increasing pressure to scrutinize health care
claims more closely. Reviews and/or similar audits or investigations of our
claims and related documentation could result in denials of claims for payment
submitted by us.
We are
subject to periodic technology assessments and claims audits by governmental
third-party payers in the U.S. and internationally. In the U.S., the
OIG has initiated various studies and technology assessments on NPWT efficacy
and billing practices during 2006, 2007 and 2008. The OIG regularly
evaluates effectiveness and efficiency of a wide range of programs of DHHS
pursuant to an annual work plan. We routinely cooperate with requests
for information from the OIG and other governmental agencies by supplying
billing records and other relevant information. In the event we are
unable to satisfy inquiries by governmental payers in the U.S. or
internationally in connection with ongoing or future assessments and studies,
our billings could be subject to claims audits and recoupment actions, and the
results of such studies could factor into future coverage and reimbursement
determinations for our products by U.S. and international governmental
payers.
In June
2007, the Medicare Region D contractor notified KCI of a post-payment audit of
claims paid during 2006. The DMAC requested information on 250 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. The DMAC subsequently made a minor recoupment for the
exceptions noted during its review.
We are
currently responding to requests from a Medicare Region A Recovery Audit
Contractor (“RAC”) covering claims submitted between 2004 and
2005. The RAC audits are part of a pilot program under the CMS
Medicare Integrity Program, currently being conducted in California, Florida and
New York. At this time, we are awaiting additional information and it
is not possible for KCI to determine the outcome of these requests.
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. In the event that a post-payment 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 provided in the audit.
We also
routinely receive pre-payment reviews of claims we submit for Medicare
reimbursement. In December 2007, the Medicare Region B DMAC initiated
a pre-payment review of all second and third cycle NPWT claims submitted by all
providers, including KCI. While we are actively responding to these
ongoing requests, if a determination is made that our records or the patients’
medical records are insufficient to meet medical necessity or Medicare
reimbursement requirements, we could be subject to denial, recoupment or refund
demands for claims submitted for Medicare reimbursement. The
results of this or any pre-payment audit could also result in subsequent
post-payment audits for claims previously paid by Medicare. 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 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. Going forward, it is
likely that we will be subject to periodic inspections, assessments and audits
of our billing and collections practices.
HIPAA
covers a variety of provisions which impact our business, including the privacy
of patient health care 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 health care
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 UK 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.
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
We are
subject to numerous federal, state and local laws and regulations relating to
such matters as safe working conditions, manufacturing practices and fire hazard
control.
International
Sales of
medical devices outside of the United States 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.
We
operate in multiple tax jurisdictions both inside and outside the United States.
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.
We
face significant and increasing competition, which could adversely affect our
operating results.
We face
significant and increasing competition in our advanced wound care and
therapeutic support systems businesses. Our advanced wound care
business primarily competes with Convatec, Johnson & Johnson, Molnycke,
RecoverCare/Sten+Barr, Smith & Nephew, and 3M Company, in addition to
several smaller companies that have introduced medical devices designed to
compete with our V.A.C. Therapy Systems. Our Therapeutic Support
Systems business primarily competes with the Hill-Rom Company, Gaymar
Industries, and Sizewise Rentals and in Europe with Huntleigh
Healthcare/Gettinge.
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,
health care 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 health care 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.
We also
face the risk that innovation by our competitors in our markets may render our
products less desirable or obsolete. Additionally, 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 GPO agreements
come up for bid, it is likely that contract awards will result in dual or
multi-source agreements with GPOs in the advanced wound care and therapeutic
support systems categories, which could result in increased competition in the
acute and extended care settings for all of our product
offerings. Additionally, renewals of agreements could result in no
award to KCI.
We
may not be able to enforce or protect our intellectual property rights, which
may harm our ability to compete and adversely affect our business. If
we are unsuccessful in protecting and maintaining our intellectual property,
particularly our rights under the Wake Forest patents, 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 they 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. Our patents may not prevent other companies from
developing functionally equivalent products or from challenging the validity or
enforceability of our patents. 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. In 2007, requests for ex-parte reexamination of
five patents owned and licensed by KCI were granted by the U.S. Patent and
Trademark Office, including the base V.A.C. Therapy patents licensed from Wake
Forest. If we are unable to enforce our intellectual property rights,
or patent claims related to V.A.C. Therapy are altered or cancelled through
reexamination, our competitive position would be harmed.
We have
agreements with third parties pursuant to which we license patented or
proprietary technologies, including our exclusive license of the base V.A.C.
patents from Wake Forest. These agreements commonly include
royalty-bearing licenses. If we lose the right to license
technologies essential to our business, or our costs to license these
technologies materially increase, our business would suffer.
KCI and
its affiliates are involved in multiple patent litigation suits in the U.S. and
Europe involving 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 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 $950.1 million in revenue, or 59.0% of
total revenue for the year ended December 31, 2007 and $808.3 million in
revenue, or 58.9% of total revenue for the year ended December 31, 2006 from our
domestic V.A.C. Therapy products relating to the U.S. patents at
issue. In continental Europe, we derived $199.5 million in revenue,
or 12.4% of total revenue for the year ended December 31, 2007 and $158.9
million, or 11.6% of total revenue for the year ended December 31, 2006 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 or therapeutic support systems
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:
·
pay
material damages for third-party infringement
claims;
·
discontinue
manufacturing, using or selling the infringing products, technology or
processes;
·
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
·
license
technology from the third-party claiming infringement for which the
license may not be available on commercially reasonable terms or at
all.
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 V.A.C. Therapy and therapeutic
support systems 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 V.A.C. Therapy and therapeutic support systems
products is required for us to grow and compete effectively. Over
time, our existing foreign and domestic patent protection in both the V.A.C.
Therapy and Therapeutic Support Systems businesses 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 and therapeutic support systems
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.
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 health care 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.
In the
U.S., the reimbursement of our products by Medicare is subject to review by
government contractors that administer payments under federal health care
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 Medicare DME regions. 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 regional
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. We currently have
approximately $21.5 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.
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.
CMS
formally launched the DMEPOS competitive bidding program through publication of
a final rule in April 2007, under which suppliers will be required to be
successful bidders and meet certain program standards in order to supply
selected DMEPOS items to Medicare beneficiaries in certain designated geographic
areas. Competitive bidding is being phased in both by geographical area and by
product category. In 2008, CMS will operate competitive bidding areas, or CBAs,
within 10 of the nation’s largest metropolitan areas, excluding New York, Los
Angeles, and Chicago. CMS has included Negative Pressure Wound
Therapy, or NPWT, as one of the product categories in the first phase of
competitive bidding. Suppliers that bid to furnish a particular
product category in a CBA must submit a bid for each item within the product
category. All bids submitted must be at or below the fee schedule
amount for the item at the time the bid is made, thereby ensuring that the
competitive bidding program will result in lower Medicare reimbursement levels
for DMEPOS items furnished within the CBAs. Once CMS selects the
contract suppliers for a particular product category, CMS will establish single
payment amounts for each item within the product category. The single
payment amount is based on the median of the winning suppliers’ bids for each of
the selected items in the CBA. Therefore, a winning supplier is not
guaranteed reimbursement at its actual bid amount for an item; rather,
approximately half of the winning suppliers who opt to become contract suppliers
will be reimbursed at a lower rate than their bid to furnish a particular item,
while the other half will receive reimbursement in excess of their bid
amount. Those bidders which are awarded contracts and agree to become
contract suppliers must accept reimbursement from CMS at 80% of the item’s
single payment amount for the CBA in which the beneficiary maintains a permanent
residence; the beneficiary is responsible for the 20% copayment. It
is possible, however, that CMS will not award any contracts for certain product
categories in one or more of the CBAs. In such case, those products
would continue to be reimbursed by Medicare at the current fee schedule
pricing. Recently, CMS announced the 70 metropolitan areas included
in the second phase of the competitive bidding process. CMS has
included NPWT as a product category in this second phase of competitive
bidding. In the second phase of the program, CMS has indicated that
new single payment amounts would be established and paid to winning bidders that
opt to become contract suppliers beginning in mid-2009 in the designated
metropolitan areas. Non-winning bidders generally would be unable to
furnish Medicare-covered NPWT in a CBA, except in limited
circumstances.
The
Medicare DMEPOS competitive bidding program could have a negative impact on our
Medicare reimbursement levels, and could result in increased price pressure from
other third-party payers. The competitive bidding process could also
limit customer access to KCI’s homecare products in the CBAs. If
KCI’s products are no longer available in certain metropolitan areas, the
physician prescribing patterns for non-Medicare patients in these areas may also
be negatively impacted. We estimate the V.A.C. rentals and sales to
Medicare beneficiaries in the ten designated metropolitan areas included in
phase one of the DMEPOS competitive bidding program represented approximately
$16.6 million, or 1.5% of our total U.S. V.A.C. revenue, or 1.0% of KCI’s total
revenue for the year ended December 31, 2007. We estimate the V.A.C.
rentals and sales to Medicare beneficiaries in the 80 designated metropolitan
areas represented less than 7% of our total U.S. V.A.C. revenue, or less than 5%
of KCI’s total revenue for the year ended December 31, 2007. We
cannot predict the outcome of the Medicare competitive bidding program on our
business nor the Medicare payment rates that will be in effect in 2008 and
beyond for the items subject to competitive bidding.
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 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 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. On August 1, 2007, CMS issued a final rule revising Medicare
payment and policy under the hospital IPPS for federal fiscal year
2008. These changes, which were first proposed in April 2007, will
restructure the inpatient DRGs to account more fully for the severity of patient
illness. Specifically, the final rule creates 745 new
severity-adjusted DRGs to replace the current 538 DRGs. 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
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 health care 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. For example, we were informed in
November 2004 that CMS intended to evaluate the clinical efficacy, functionality
and relative cost of the V.A.C. Therapy system. 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 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 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 2008 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. 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
health care 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 spurred by recommendations made by
government agencies, such as those in the June 2007 OIG report.
We are
currently responding to requests from a Medicare Region A Recovery Audit
Contractor (“RAC”) covering claims submitted between 2004 and
2005. The RAC audits are part of a pilot program under the CMS
Medicare Integrity Program, currently being conducted in California, Florida and
New York. At this time, we are awaiting additional information and it
is not possible for KCI to determine the outcome of these
requests.
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. In the event that a post-payment 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 provided in the audit which could have a material adverse
effect on our financial condition and results of operations.
We also
routinely receive pre-payment reviews of claims we submit for Medicare
reimbursement. In December 2007, the Medicare Region B DMAC initiated
a pre-payment review of all second and third cycle NPWT claims submitted by all
providers, including KCI. While we are actively responding to these
ongoing requests, if a determination is made that our records or the patients’
medical records are insufficient to meet medical necessity or Medicare
reimbursement requirements, we could be subject to denial, recoupment or refund
demands for claims submitted for Medicare reimbursement. In
addition, Medicare or its contractors could place KCI on extended pre-payment
review, which could slow our collections process for these
claims. The results of this or any pre-payment audit could also
result in subsequent post-payment audits for claims previously paid by
Medicare. 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 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. Going forward, it is likely that we will be
subject to periodic inspections, assessments and audits of our billing and
collections practices which could also have a material adverse effect on our
financial condition and results of operations.
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 health
care program beneficiaries.
There are
numerous rules and requirements governing the submission of claims for payment
to federal and state health care 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.
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 health care
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 health care 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 health
care 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. Governmental authorities could attempt to take the
position that one or more of these arrangements, or the payments or other
remuneration provided thereunder, violates the Anti-Kickback Statute, the Stark
Law or similar state 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 health
care 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 health care 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 V.A.C. Therapy's clinical efficacy may reduce
physician usage or put pricing pressures on V.A.C. and cause our V.A.C. Therapy
revenue to decline.
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. A successful clinical trial program is necessary to maintain
and increase rentals and sales of V.A.C. Therapy products, in addition to
supporting and maintaining third-party reimbursement of these products in the
United States 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 V.A.C. Therapy, physicians may
elect not to use V.A.C. Therapy as a treatment in general, or for the type of
wound in question. Furthermore, in the event of an adverse clinical
trial outcome, V.A.C. Therapy may not achieve “standard-of-care” designations
for the wound types in question, which could deter the adoption of V.A.C.
Therapy in those wound types or others. 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 V.A.C. Therapy, limit the manner in which they cover V.A.C. Therapy, or
reduce the price they are willing to pay or reimburse for V.A.C.
Therapy.
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 of surfaces
products and rental and sales of V.A.C. Therapy systems and related
disposables.
We obtain
some of our finished products and components from a limited group of
suppliers. In particular, we have an exclusive supply agreement with
Avail Medical Products, Inc., a subsidiary of Flextronics International Ltd. for
the manufacture and packaging of our 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 79.5% of our total revenue
for the year ended December 31, 2007, of which sales of V.A.C. disposables
represented approximately 24.1% 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.
In
November 2007, we entered into a new three-year supply agreement with Avail
through November 2010, which is renewable annually for an additional
twelve-month period in November of each year, unless either party gives notice
to the contrary. 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. 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 United States 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. In the event that Foamex or
Noble experiences manufacturing interruptions, our supply of foam or silver
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 December
2007. We estimate that our current inventory levels will provide
sufficient frames for the next 2-3 years. Management is currently
exploring various supply alternatives to address our future supply
requirements.
Our
international business operations are subject to risks that could adversely
affect our operating results.
Our
operations outside the United States, which represented approximately $459.7
million, or 28.6%, of our total revenue for the year ended December 31, 2007,
$377.9 million, or 27.5%, of our total revenue for the year ended December 31,2006 and $322.4 million, or 26.7%, of our total revenue for the year ended
December 31, 2005, are subject to certain legal, regulatory, social, political,
and economic risks inherent in international business operations, including, but
not limited to:
·
less
stringent protection of intellectual property in some countries outside
the U.S.;
·
trade
protection measures and import and export licensing
requirements;
·
changes
in foreign regulatory requirements and tax
laws;
·
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;
·
changes
in foreign medical reimbursement programs and policies, and other health
care reforms;
·
political
and economic instability;
·
complex
tax and cash management issues;
·
potential
tax costs associated with repatriating cash from our non-U.S.
subsidiaries; and
·
longer-term
receivables than are typical in the U.S., and greater difficulty of
collecting receivables in certain foreign
jurisdictions.
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 United States, 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:
·
billing
practices;
·
product
pricing and price reporting;
·
quality
of medical equipment and services and qualifications of
personnel;
·
confidentiality,
maintenance and security of patient medical
records;
·
marketing
and advertising, and related fees and expenses paid;
and
·
business
arrangements with other providers and suppliers of health care
services.
In this
regard, HIPAA 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 health care
programs. Further, 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. 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 Food and Drug Administration, or 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 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 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.
We
may be unable to consummate acquisitions or divestitures in accordance with our
plans or as necessary to meet our objectives.
KCI’s
growth is dependent upon our ability to enhance our existing products and to
introduce new products on a timely basis. KCI has decided to pursue
new products through acquisitions of other companies and
technologies. Acquisitions involve numerous risks, including the
following:
·
inability
to identify acquisition
opportunities;
·
inability
to complete an acquisition at commercially acceptable
terms;
·
difficulties
in integrating the operations, technologies, products and personnel of the
acquired businesses;
·
diversion
of management’s attention from normal daily operations of the
business;
·
difficulties
in entering markets in which KCI has no or limited direct prior experience
and where competitors in such markets have stronger market
positions;
·
an
acquisition may not further our business strategy as we expected, or we
may pay more than the acquired company or assets are
worth;
·
our
relationship with current and new employees, customers, partners and
distributors could be impaired; and
·
inadequate
internal control procedures and disclosure controls to comply with the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or poor
integration of a target company’s or businesses’ procedures and
controls.
issue
common stock that would dilute KCI’s current shareholders’ percentage
ownership or earnings per share;
·
incur
additional debt, including senior debt, which may impact KCI’s ability to
service its debt;
·
assume
liabilities, some of which may be unknown at the time of such
acquisitions;
·
record
goodwill and non-amortizable intangible assets that will be subject to
impairment testing and potential periodic impairment
charges;
·
incur
amortization expenses related to certain intangible
assets;
·
incur
large and immediate write-offs of in-process research and development
costs; or
·
become
subject to litigation.
Mergers
and acquisitions of medical technology companies inherently entail significant
risk. Any acquisition we pursue may not be successful or may have a
material adverse affect on our business and operating
results. Similar issues may arise in connection with any disposition
we may elect to pursue.
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:
·
the
level of acceptance of our V.A.C. Therapy systems by customers and
physicians;
·
the
type of indications that are appropriate for V.A.C. Therapy and the
percentages of wounds that are considered good candidates for V.A.C.
Therapy;
·
third-party
government or private reimbursement policies with respect to V.A.C.
Therapy and competing products;
·
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.;
·
changes
in the status of GPO contracts or national tenders for our therapeutic
support systems;
·
developments
or any adverse determination in litigation;
and
·
new
or enhanced competition in our primary
markets.
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. 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. In the short term, we do not have the
ability to adjust spending in a time-effective manner to compensate for any
unexpected revenue shortfall, which also could cause a significant decline in
the trading price of our stock.
Restrictive
covenants in the senior credit agreement may restrict our ability to pursue our
business strategies.
The
senior credit agreement limits 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;
·
make
investments;
·
grant
liens;
·
enter
into transactions with our shareholders and
affiliates;
·
sell
assets; and
·
acquire
the assets of, or merge or consolidate with, other
companies.
The
senior credit agreement contains financial covenants requiring us to meet
certain leverage and interest coverage ratios.
We may
not be able to maintain these ratios. Covenants in the senior credit agreement
may also 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
default under the senior credit agreement, the lenders under this facility could
require immediate repayment of the entire principal. If those lenders require
immediate repayment, we may not be able to repay them. If we are unable to
generate sufficient cash flow or otherwise obtain funds necessary to make
required payments under the senior credit facility, or if we are unable to
maintain the financial ratios under the senior credit facility, we will be in
default under the credit agreement, which could, in turn, cause a default under
any other debt obligations that we may incur from time to time.
Despite
our existing debt, we may incur additional indebtedness, including senior debt,
which would increase the risks described above.
We may be
able to incur additional debt, including senior debt, in the future which may
impact KCI’s ability to service its debt. As of December 31, 2007, we
had $423.3 million (net of outstanding letters of credit of $8.7 million) of
total availability for potential borrowing under our revolving credit facility,
subject to our compliance with the financial and other covenants included in our
revolving credit facility.
Our
articles of incorporation, our by-laws and Texas law contain provisions that
could discourage, delay or prevent a change in control or
management.
Our
articles of incorporation and by-laws and Texas law contain provisions which
could discourage, delay or prevent a third-party from acquiring shares of our
common stock or replacing members of our Board of Directors. These provisions
include:
·
authorization
of the issuance of preferred stock, the terms of which may be determined
at the sole discretion of the Board of
Directors;
·
establishment
of a classified Board of Directors with staggered, three-year
terms;
·
provisions
giving the Board of Directors sole power to set the number of
directors;
·
limitations
on the ability of shareholders to remove
directors;
·
requirements
for the approval of the holders of at least two-thirds of our outstanding
common stock to amend our articles of
incorporation;
·
authorization
for our Board of Directors to adopt, amend or repeal our
by-laws;
·
limitations
on the ability of shareholders to call special meetings of shareholders;
and
·
establishment
of advance notice requirements for presentation of new business and
nominations for election to the Board of Directors at shareholder
meetings.
In
addition, under Texas law and our articles of incorporation and our by-laws,
action may not be taken by less than unanimous written consent of our
shareholders unless the Board of Directors has recommended that the shareholders
approve such action. The limitation on the ability of shareholders to
call a special meeting, to act by written consent and to remove directors may
make it difficult for shareholders to remove or replace the Board of Directors
should they desire to do so. These provisions could also delay or
prevent a third-party from acquiring us, which could cause the market price of
our common stock to decline.
We lease
approximately 156,400 square feet at our corporate headquarters building in San
Antonio, Texas, the majority of which is leased under a 10-year lease that
expires in 2012. We also lease approximately 35,900 square feet in
adjacent buildings that are used for general corporate purposes, and
approximately 88,500 square feet of office space in San Antonio for our customer
service center. In addition, in February 2004 and February 2005, we
entered into 99-month leases for approximately 80,400 and 80,200 square feet of
office space in San Antonio to be used as our research and development and
medical facility and for general corporate purposes, respectively. In
2007, we entered into a lease agreement expiring in 2018 for 58,200 square feet
of space with a projected construction completion and occupancy to occur in
March 2008. The space will be used as general office space for
Information Technology personnel and training.
We
conduct domestic manufacturing, shipping, receiving, engineering and storage
activities in a 171,100 square foot facility in San Antonio, Texas, which we
purchased in January 1988, and an adjacent 32,600 square foot facility
purchased in 1993. During 2007, our operations were conducted with
approximately 75% cumulative utilization of plant and equipment. We also lease
two storage facilities in San Antonio. We lease approximately 141
domestic service centers, including each of our five regional
headquarters.
Internationally,
we lease 67 service centers. Our international corporate office is located in
Amsterdam, the Netherlands. International manufacturing and
engineering operations are based in the United Kingdom, Ireland and
Belgium. The United Kingdom, Ireland and Belgium plants are
approximately 24,800, 55,000 and 19,600 square feet,
respectively. During 2007, the plants in the United Kingdom and
Belgium operated with 100% cumulative utilization of plant and
equipment. The plant in Ireland will manufacture our V.A.C. Therapy
units for our global markets which had previously been manufactured in our San
Antonio, Texas and United Kingdom plants. In addition, the Ireland
plant will manage the third party manufacturers, global purchasing, supplier
agreements and distribution of our V.A.C. products.
We
believe that our current facilities will be adequate to meet our needs for
2008.
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. The 2003 case filed against
BlueSky Medical Group, Inc., Medela, Inc. and Medela AG is currently on appeal
before the Federal Circuit Court of Appeals in Washington, D.C. In
2006, the 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 device marketed by BlueSky. In 2007, BlueSky
Medical was acquired by Smith & Nephew plc, which is now a party to the
appeal. Initial appellate briefs have been filed by all parties to
the appeal. As a result of the appeal, the District Court’s final
judgment could be modified, set aside or reversed, or the case could be remanded
to District Court for retrial.
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 negative pressure devices which we
believe infringe a Wake Forest continuation patent issued in 2007 relating to
our V.A.C. technology. Also, 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
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.
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 recently introduced by ITI infringes three Wake Forest patents which are
exclusively licensed to KCI. We are seeking damages and injunctive
relief in the case. Also in January 2008, in a separate action, KCI and its
affiliates filed suit in state District Court in Bexar County, Texas, against
ITI and three of its principals, all of whom were former employees of KCI. The
claims in the suit include breach of confidentiality agreements, conversion of
KCI technology, theft of trade secrets and conspiracy. We are seeking damages
and injunctive relief in the case.
Although
it is not possible to reliably predict the outcome of the lawsuits 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 $950.1 million in revenue, or
59.0% of total revenue for the year ended December 31, 2007 and $808.3 million
in revenue, or 58.9% of total revenue for the year ended December 31, 2006 from
our domestic V.A.C. Therapy products relating to the U.S. patents at
issue. In continental Europe, we derived $199.5 million in revenue,
or 12.4% of total revenue for the year ended December 31, 2007 and $158.9
million, or 11.6% of total revenue for the year ended December 31, 2006 in
V.A.C. revenue relating to the patents at issue in the ongoing German
litigation.
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.
ITEM 4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM
5. MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
(a) Our
common stock has traded on the New York Stock Exchange under the symbol "KCI"
since February 24, 2004, the date of our initial public offering. The
following table sets forth, for the periods indicated, the high and low sales
prices for our common stock as reported by the New York Stock
Exchange:
2007
High
Low
First
Quarter
$
52.55
$
39.13
Second
Quarter
$
56.23
$
44.90
Third
Quarter
$
66.77
$
51.19
Fourth
Quarter
$
65.23
$
47.18
2006
High
Low
First
Quarter
$
43.10
$
35.14
Second
Quarter
$
44.74
$
38.29
Third
Quarter
$
49.10
$
22.50
Fourth
Quarter
$
41.22
$
30.80
On
February 21, 2008, the last reported sale price of our common stock on the New
York Stock Exchange was $51.11 per share. As of February 21, 2008,
there were approximately 146 shareholders of record of our common
stock.
We do not
currently pay cash dividends on our common stock. Any future payment of cash
dividends on our common stock will be at the discretion of our Board of
Directors and will depend upon our results of operations, earnings, capital
requirements, contractual restrictions and other factors deemed relevant by our
board. Our Board of Directors currently intends to retain any future
earnings to support our operations and to finance the growth and development of
our business and does not intend to declare or pay cash dividends on our common
stock for the foreseeable future. In addition, our senior credit
agreement limits our ability to declare or pay dividends on, or repurchase or
redeem, any of our outstanding equity securities. For
more information regarding the restrictions under our Senior Credit Agreement,
see "Management’s Discussion & Analysis of Financial Condition and Results
of Operations—Liquidity and Capital Resources—Debt Service."
(1) During the
fourth quarter of 2007, KCI purchased and retired approximately 1,570
shares in connection with the withholding of shares to satisfy the minimum
tax withholdings on the vesting of restricted stock.
(2)
In August 2006, KCI’s Board of Directors authorized a share repurchase
program for the repurchase of up to $200 million in market value of common
stock through the third quarter of 2007. In August 2007, KCI's Board
of Directors authorized a one-year extension to this program. During
2007, KCI repurchased shares for minimum tax withholdings and
exercise price of employee stock option exercises and minimum tax
withholdings on the vesting of restricted stock. No open-market
repurchases were made under this program during 2007. As of December31, 2007, the remaining authorized amount for share repurchases under
this program was $87.4 million.
The
following graph shows the change in our cumulative total shareholder return
since our common stock began trading on the New York Stock Exchange on
February 24, 2004 based upon the market price of our common stock, compared
with: (a) the cumulative total return on the Standard & Poor’s 500
Large Cap Index and (b) the Standard & Poor’s Healthcare Equipment
Index. The graph assumes a total initial investment of $100 as of
February 24, 2004, and shows a "Total Return" that assumes reinvestment of
dividends, if any, and is based on market capitalization at the beginning of
each period. The performance on the following graph is not necessarily
indicative of future stock price performance.
The
following tables summarize our consolidated financial data for the periods
presented. You should read the following financial information together with the
information under "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and the
notes to those consolidated financial statements appearing elsewhere in this
report. The selected consolidated balance sheet data for fiscal years 2007 and
2006 and the selected consolidated statement of earnings data for fiscal years
2007, 2006 and 2005 are derived from our audited consolidated financial
statements included elsewhere in this report. The selected consolidated
statement of earnings data for fiscal years 2004 and 2003 and the selected
consolidated balance sheet data for fiscal years 2005, 2004 and 2003 are derived
from our audited consolidated financial statements not included in this
report. Reclassifications have been made to our results from prior
years to conform to our current presentation (in thousands, except per share
data).
(1) Amounts
for fiscal years 2007 and 2006 include share-based compensation expense
recorded as a result of the adoption of Statement of Financial Accounting
Standards No. 123 Revised. See Note 1(q) to our consolidated
financial statements.
(2) Amounts for
fiscal year 2003 include the second and final payment of
$75.0 million as part of an anti-trust settlement. Amounts for 2005
include the litigation settlement with Novamedix Limited of $72.0 million,
net of recorded reserves of $3.0 million. See Note 13 to our
consolidated financial statements.
(3) Amounts for fiscal year 2004 include bonuses paid of $19.3
million, including related payroll taxes, and approximately $562,000 of
professional fees and other miscellaneous expenses in connection with our
initial public offering.
(4) Amounts for fiscal year 2004 include $2.2 million of
professional fees and other miscellaneous expenses in connection with our
secondary offering.
(5) Recapitalization expenses include non-interest related
expenses incurred in connection with our 2003
recapitalization.
(6) Amounts for fiscal year 2003 include an aggregate of
$16.3 million in expense for the redemption premium and consent fee
paid in connection with the redemption of our previously-existing 9 5/8%
senior subordinated notes combined with the write off of unamortized debt
issuance costs associated with the previously-existing senior credit
facility. Amounts for fiscal year 2004 include an aggregate of
$11.7 million in expense incurred in connection with our offerings,
including bond call premiums totaling $7.7 million incurred in
connection with the redemption of $107.2 million of our
previously-existing senior subordinated notes and $4.0 million of
debt issuance costs that we wrote off related to the retirement of
debt. Amounts for fiscal year 2007 include an aggregate of
$7.6 million in expense for the redemption premium paid in connection
with the redemption of our previously-existing 7 ⅜% senior subordinated
notes combined with the write off of unamortized debt issuance costs
associated with the previously-existing senior credit
facility.
(7) Amounts for fiscal year 2004 include cumulative preferred
dividends paid-in-kind through December 31, 2005 and beneficial conversion
feature in connection with our initial public offering. Amounts for
fiscal year 2003 include dividends-in-kind.
(8) Potentially dilutive stock options and restricted stock totaling
1,779 shares, 3,241 shares, 595 shares, 72 shares and 117 shares for
fiscal years 2007, 2006, 2005, 2004 and 2003, respectively, were excluded
from the computation of diluted weighted average shares outstanding due to
their antidilutive effect.
(9) Due to their antidilutive effect, 2,990 and 7,522 dilutive
potential common shares from the preferred stock conversion were excluded
from the diluted weighted average shares calculation for the years ended
December 31, 2004 and 2003, respectively.
(10)
Total debt equals current and long-term debt and capital lease
obligations.
ITEM
7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
Kinetic
Concepts, Inc. is a global medical technology company with leadership positions
in advanced wound care and therapeutic support systems. 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 has been demonstrated clinically to promote
wound healing through unique mechanisms of action and can help reduce the cost
of treating patients with serious wounds. Our therapeutic support
systems, including specialty hospital beds, mattress replacement systems and
overlays, are designed to address pulmonary complications associated with
immobility, to reduce skin breakdown and assist caregivers in the safe and
dignified handling of obese patients. We have an infrastructure
designed to meet the specific needs of medical professionals and patients across
all health care settings, including acute care hospitals, extended care
organizations and patients’ homes, both in the United States and
abroad.
We have
direct operations in the United States, 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 two geographical
segments: the United States, or domestic, and
International. Operations in the United States accounted for
approximately 71.4%, 72.5% and 73.3% of our total revenue for the years ended
December 31, 2007, 2006 and 2005, respectively.
For the
last several years, our growth has been driven primarily by increased revenue
from V.A.C. Therapy systems and related supplies, which accounted for
approximately 79.5% of total revenue for the year ended December 31, 2007, up
from 77.9% and 75.1% for the same periods in 2006 and 2005,
respectively. We derive our revenue from both the rental and sale of
our products. In the U.S. acute care and extended care settings,
which accounted for more than half of our U.S. revenue for the year ended
December 31, 2007, we bill our customers directly, such as hospitals and
extended care organizations. In the U.S. homecare setting, where our
revenue comes predominantly from V.A.C. Therapy systems, we provide products and
services directly to patients and bill third-party payers directly, such as
Medicare and private insurance. Internationally, most of our revenue
is generated in the acute care setting on a direct billing basis.
Historically,
we have experienced a seasonal slowing of domestic V.A.C. unit growth beginning
in the fourth quarter and continuing into the first quarter, which we believe
has been caused by year-end clinical treatment patterns, such as the
postponement of elective surgeries and increased discharges of individuals from
the acute care setting around the winter holidays. Although we do not
know if our historical experience will prove to be indicative of future periods,
a similar slow-down may occur in subsequent periods.
We
believe the growth in our domestic V.A.C. Therapy revenue has substantially
benefited from the availability of Medicare reimbursement for our products in
the home. Beginning in 2005, an increasing number of devices being
marketed to compete with V.A.C. Therapy systems have obtained similar
reimbursement codes. Also, in April 2007, the Centers for Medicare
and Medicaid Services, or CMS, released final rules on competitive bidding for
certain Medicare covered durable medical equipment, including negative pressure
wound therapy, or NPWT, which establish procedures to set competitively-bid
reimbursement amounts for such items in ten designated metropolitan
areas. In the first phase of the program, new competitively-bid
reimbursement amounts would be paid to winning bidders beginning in July 2008 in
the designated metropolitan areas. Recently, CMS announced the 70
metropolitan areas included in the second phase of the competitive bidding
process. CMS has included NPWT as a product category in this second
phase of competitive bidding. In the second phase of the program, CMS
has indicated that new single payment amounts would be established and paid to
winning bidders that opt to become contract suppliers beginning in mid-2009 in
the designated metropolitan areas. Non-winning bidders generally
would be unable to furnish Medicare-covered NPWT in a CBA, except in limited
circumstances. The Medicare DMEPOS competitive bidding program could
have a negative impact on our Medicare reimbursement levels, and could result in
increased price pressure from other third-party payers. The
competitive bidding program could also limit customer access to KCI’s homecare
products in the designated CBAs. We estimate the V.A.C. rentals and
sales to Medicare beneficiaries in the ten designated metropolitan areas
included in phase one of the program represented approximately $16.6 million, or
1.5% of our total U.S. V.A.C. revenue, or 1.0% of KCI’s total revenue for the
year ended December 31, 2007. We estimate the V.A.C. rentals and
sales to Medicare beneficiaries in the 80 designated metropolitan areas
represented less than 7% of our total U.S. V.A.C. revenue, or less than 5% of
KCI’s total revenue for the year ended December 31, 2007.
As a
health care supplier, we are subject to extensive government regulation directed
at ascertaining the appropriateness of reimbursement and preventing fraud and
abuse under various government programs. Periodically, we receive
inquiries from various government agencies requesting customer records and other
documents. In June 2007, the U.S. Department of Health and Human
Services Office of the Inspector General, or OIG, issued a report on a study it
conducted with regard to NPWT claims submitted to CMS for reimbursement during
2004. The OIG report made a number of 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
CMS, its regional contractors and other third-party payers for refunds or
recoupments of amounts previously paid to us. We are currently
participating in a post-payment claims audit by a CMS regional contractor.
If a determination were made that our records or the patients’ medical records
are insufficient to meet medical necessity or Medicare reimbursement
requirements, we could be subject to denial, recoupment or refund demands for
claims submitted for Medicare reimbursement. In addition, CMS or its
contractors could place KCI on extended pre-payment review, which could slow our
collections process and increase our administrative costs for providing V.A.C.
Therapy. If CMS 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 would be materially and adversely
affected. Going forward, it is likely that we will be subject to
periodic inspections, assessments and audits of our billing and collections
practices, which could also adversely affect our business and operating
results.
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 to advance our understanding
of the science of wound healing and the physical and biologic processes that can
be influenced to treat a variety of wounds. Through such efforts, 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. Recent innovations
include the launch of the next-generation InfoV.A.C. and ActiV.A.C. therapy
systems.
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 adds to KCI's significant body of clinical data that clearly shows that
our V.A.C. Therapy system, including its unique foam dressing, provides clinical
advantage for treatment of diabetic foot ulcers, including limb
salvage.
KCI also
continues to successfully distinguish its products from competitive offerings
through unique FDA-approved 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, new claims were approved by the Food and Drug Administration, or
FDA, in 2007 which now specify the use of V.A.C. systems in all care settings,
including in the home. These newly-issued claims are unique to KCI’s
V.A.C. systems in the field of NPWT.
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 health care settings. We have
relationships with approximately 9,000 acute care hospitals
worldwide. In the United States, we have relationships with
approximately 9,200 extended care organizations and over 10,500 home health care
agencies and wound care clinics, in addition to numerous clinicians in these
facilities with whom we have long-established relationships.
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 375 contracts with some of the largest private insurance payers in the
U.S.
We
believe that the key factors underlying V.A.C. Therapy growth over the past year
have been:
·
increasing
V.A.C. Therapy awareness and adoption among customers and physicians by
increasing the number of regular users and prescribers and the extent of
use by each customer or physician;
·
market
expansion by identifying new wound type indications for V.A.C. Therapy and
increasing the percentage of wounds that are considered good candidates
for V.A.C. Therapy; and
·
strengthening
our contractual relationships with third-party
payers.
Extensive service center
network. With a network of 141 U.S. and 67 international
service centers, we are able to rapidly deliver our products to major hospitals
in the United States, 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.
We
continue to focus our marketing and selling efforts on increasing physician
awareness and adoption of the benefits of V.A.C. Therapy. These
efforts are targeted at physician specialties that provide care to the majority
of patients with wounds in our target categories. Within these
specialties, we focus on those clinicians who serve the largest number of wound
care patients. Our ongoing clinical experience and studies have
increased the market acceptance of V.A.C. Therapy and expanded the range of
wounds considered to be good candidates for V.A.C. Therapy. We
believe this growing base of data and clinical experience has driven the trend
toward use of V.A.C. Therapy on a routine basis for appropriate
wounds. We recently obtained FDA clearance for expanded indications
for use of V.A.C. Therapy systems, which permit KCI to market and label the
unique mechanisms of action of V.A.C. Therapy. The new FDA clearance
further substantiates the unique mechanisms of action of V.A.C. Therapy while
clearly differentiating V.A.C. Therapy from other offerings in wound
care. We will continue to seek additional indications for use as the
body of evidence supporting V.A.C. Therapy grows.
Our
intellectual property is very important to maintaining our competitive
position. With respect to our V.A.C. Therapy business, we rely on our
rights under the Wake Forest patents licensed to us and a number of KCI patents
in the U.S. and internationally. Continuous enhancements in our
product portfolio and positioning are also important to our continued growth and
market penetration. We believe superior outcomes derived from the use
of our advanced V.A.C. Therapy systems have increased customer acceptance and
the perceived value of V.A.C. Therapy. We have benefited from the
introduction of specialized dressing systems designed to improve ease-of-use and
effectiveness in treating a variety of wounds.
The
following table sets forth, for the periods indicated, rental and sales revenue
by geographical segment, as well as the percentage change in each
line item, comparing 2007 to 2006 (dollars in thousands):
Year
ended December 31,
%
2007
2006
Change
Domestic
Revenue:
Rental
$
878,259
$
760,232
15.5
%
Sales
271,951
233,540
16.4
Total
- USA Revenue
1,150,210
993,772
15.7
International
Revenue:
Rental
268,285
219,437
22.3
Sales
191,449
158,427
20.8
Total
- International Revenue
459,734
377,864
21.7
Total
rental revenue
1,146,544
979,669
17.0
Total
sales revenue
463,400
391,967
18.2
Total
Revenue
$
1,609,944
$
1,371,636
17.4
%
Revenue
by Product Line
The
following table sets forth, for the periods indicated, 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
$
872,769
$
732,308
19.2
%
Sales
406,854
336,781
20.8
Total
V.A.C.
$
1,279,623
$
1,069,089
19.7
%
Therapeutic
Support Systems Revenue:
Rental
273,775
247,361
10.7
%
Sales
56,546
55,186
2.5
Total
Therapeutic Support Systems
$
330,321
$
302,547
9.2
%
Total
Revenue
$
1,609,944
$
1,371,636
17.4
%
The
growth in total revenue over the prior-year period was due primarily to
increased rental and sales volumes for V.A.C. Therapy systems and related
disposables and increased rental volumes of therapeutic support
systems. Foreign currency exchange rate movements favorably impacted
total revenue by 2.5% compared to the prior year.
For
additional discussion on segment and geographical information, see Note 16 to
our consolidated financial statements.
The
following table sets forth, for the periods indicated, the percentage
relationship of each item to total revenue in the period, as well as the changes
in each line item, comparing 2007 to 2006:
The
following table sets forth, for the periods indicated, domestic 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
$
707,755
$
603,558
17.3
%
Sales
242,341
204,703
18.4
Total
V.A.C.
950,096
808,261
17.5
Therapeutic
Support Systems Revenue:
Rental
170,504
156,674
8.8
Sales
29,610
28,837
2.7
Total
Therapeutic Support Systems
200,114
185,511
7.9
Total
rental revenue
878,259
760,232
15.5
Total
sales revenue
271,951
233,540
16.4
Total
Domestic Revenue
$
1,150,210
$
993,772
15.7
%
The
growth in domestic revenue over the prior year was due primarily to increased
rental and sales volumes for V.A.C. Therapy systems and related
disposables.
Total
domestic V.A.C. revenue increased over the prior year primarily due to higher
rental and sales unit volume, resulting from increased market
penetration. Growth in rental unit volume was reported across all
care settings. The increase in domestic V.A.C. rental revenue was
primarily due to a 17.8% increase in rental unit volume compared to the
prior-year period. The increase in domestic V.A.C. sales revenue over
the prior year was due primarily to higher sales volumes for V.A.C. disposables
associated with the increase in V.A.C. rental unit volume.
Domestic
Therapeutic Support Systems revenue increased over the prior year primarily due
to a 7.8% increase in rental unit volume.
The
following table sets forth, for the periods indicated, international 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
$
165,014
$
128,750
28.2
%
Sales
164,513
132,078
24.6
Total
V.A.C.
329,527
260,828
26.3
Therapeutic
Support Systems Revenue:
Rental
103,271
90,687
13.9
Sales
26,936
26,349
2.2
Total
Therapeutic Support Systems
130,207
117,036
11.3
Total
rental revenue
268,285
219,437
22.3
Total
sales revenue
191,449
158,427
20.8
Total
International Revenue
$
459,734
$
377,864
21.7
%
Growth in
total international revenue is 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 9.2% of the increase in total international revenue in
2007 compared to the prior year.
The
increase in international 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 international V.A.C revenue by 9.5% in 2007 compared to the
prior year. The growth in international V.A.C. rental revenue over
the prior year was due primarily to a 23.2% increase in rental unit
volume. Higher international unit volume was partially offset by
lower realized pricing due primarily to lower contracted
pricing. Foreign currency exchange rate movements favorably impacted
international V.A.C. rental revenue by 9.7% in 2007 compared to the prior
year. The increase in international 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 international V.A.C. sales
revenue by 9.3% in 2007 compared to the prior year.
The
increase in international Therapeutic Support Systems revenue over the prior
year was primarily due to a 3.9% increase in rental unit volume and foreign
currency exchange rate movements which favorably impacted international
Therapeutic Support Systems revenue by 8.6% 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):
Rental,
or field, expenses are comprised of both fixed and variable
costs. This 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 includes manufacturing
costs, product costs and royalties associated with our “for sale”
products. The decreased sales margin was due primarily to a volume
purchase discount received in 2006 relating to a large purchase of V.A.C.
disposables which was fully recognized in that year.
Gross Profit Margin
The following table presents the gross
profit margin comparing 2007 to 2006:
The increase in gross profit margin is
due primarily to increased market penetration, improved revenue realization
levels, increased sales force and service productivity and lower marketing
expenditures during 2007 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):
Selling, general and administrative
expenses include administrative labor, incentive and sales commission
compensation costs, insurance costs, professional fees, depreciation, bad debt
expense and information systems costs. The increase in selling,
general and administrative expenses, as a percent of total revenue, is 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 therapeutic support
systems 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):
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):
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 Therapeutic Support Systems
business.
Operating Margin
The following table presents the
operating margin comparing 2007 to 2006:
The increase in operating margin is 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 therapeutic support systems
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 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.
The following table sets forth, for the
periods indicated, rental and sales revenue by geographical segment, as well
as the percentage change in each line item, comparing 2006 to 2005
(dollars in thousands):
Year
ended December 31,
%
2006
2005
Change
Domestic
Revenue:
Rental
$
760,232
$
671,864
13.2
%
Sales
233,540
214,329
9.0
Total
- USA Revenue
993,772
886,193
12.1
International
Revenue:
Rental
219,437
186,234
17.8
Sales
158,427
136,129
16.4
Total
- International Revenue
377,864
322,363
17.2
Total
rental revenue
979,669
858,098
14.2
Total
sales revenue
391,967
350,458
11.8
Total
Revenue
$
1,371,636
$
1,208,556
13.5
%
Revenue by Product Line
The following table sets forth, for the
periods indicated, rental and sales revenue by product line, as well as the
percentage change in each line item, comparing 2006 to 2005 (dollars in
thousands):
Year
ended December 31,
%
2006
2005
Change
V.A.C.
Revenue:
Rental
$
732,308
$
615,579
19.0
%
Sales
336,781
291,964
15.4
Total
V.A.C.
$
1,069,089
$
907,543
17.8
%
Therapeutic
Support Systems Revenue:
Rental
$
247,361
$
242,519
2.0
%
Sales
55,186
58,494
(5.7
)
Total
Therapeutic Support Systems
$
302,547
$
301,013
0.5
%
Total
Revenue
$
1,371,636
$
1,208,556
13.5
%
The
growth in total revenue over the prior year was due primarily to increased
rental and sales volumes for V.A.C. Therapy systems and related disposables,
partially offset by lower domestic realized pricing. Domestic V.A.C.
pricing for 2006 was unfavorably impacted by a number of factors including lower
canister reimbursement under Medicare Part B, lower contracted prices, payer mix
changes and reductions in cash realization estimates. Foreign
currency exchange movements accounted for 0.9% of the increase in total revenue
in 2006 compared to the prior year.
For additional discussion on segment
and geographical information, see Note 16 to our consolidated financial
statements.
The following table sets forth, for the
periods indicated, the percentage relationship of each item to total revenue in
the period, as well as the changes in each line item, comparing 2006 to
2005:
The
following table sets forth, for the periods indicated, domestic rental and sales
revenue by product line, as well as the percentage change in each line item,
comparing 2006 to 2005 (dollars in thousands):
Year
ended December 31,
%
2006
2005
Change
V.A.C.
Revenue:
Rental
$
603,558
$
519,570
16.2
%
Sales
204,703
186,476
9.8
Total
V.A.C.
808,261
706,046
14.5
Therapeutic
Support Systems Revenue:
Rental
156,674
152,294
2.9
Sales
28,837
27,853
3.5
Total
Therapeutic Support Systems
185,511
180,147
3.0
Total
rental revenue
760,232
671,864
13.2
Total
sales revenue
233,540
214,329
9.0
Total
Domestic Revenue
$
993,772
$
886,193
12.1
%
The
growth in domestic revenue over the prior year was due primarily to increased
rental and sales volumes for V.A.C. Therapy systems and related
disposables.
Total
domestic V.A.C. revenue increased over the prior year due primarily to higher
rental unit volumes across all care settings, partly offset by lower realized
pricing. The increase in domestic V.A.C. rental revenue was due
primarily to a 21.9% increase in unit volume compared to the prior
year. For 2006, higher domestic rental unit volume was partially
offset by lower realized pricing due to a number of factors including lower
contracted prices, payer mix changes and reductions in cash realization
estimates. The increase in domestic V.A.C. sales revenue over the
prior year was due primarily to higher sales volumes for V.A.C. disposables
associated with the increase in V.A.C. rental unit volume, partially offset by
lower canister reimbursement.
Domestic
Therapeutic Support Systems revenue increased over the prior year primarily due
to an increase in rental unit volume, partially offset by lower pricing, which
resulted from competitive pressures in certain markets.
International
Revenue
The
following table sets forth, for the periods indicated, international rental and
sales revenue by product line, as well as the percentage change in
each line item, comparing 2006 to 2005 (dollars in thousands):
Year
ended December 31,
%
2006
2005
Change
V.A.C.
Revenue:
Rental
$
128,750
$
96,009
34.1
%
Sales
132,078
105,488
25.2
Total
V.A.C.
260,828
201,497
29.4
Therapeutic
Support Systems Revenue:
Rental
90,687
90,225
0.5
Sales
26,349
30,641
(14.0
)
Total
Therapeutic Support Systems
117,036
120,866
(3.2
)
Total
rental revenue
219,437
186,234
17.8
Total
sales revenue
158,427
136,129
16.4
Total
International Revenue
$
377,864
$
322,363
17.2
%
The
growth in total international revenue is due primarily to increased rental
volumes for V.A.C. Therapy systems and related disposables and favorable foreign
currency exchange rate variances. Foreign currency exchange rate
movements accounted for 3.5% of the increase in total international revenue in
2006 compared to the prior year.
The
increase in total international V.A.C. revenue over the prior year was due to
higher V.A.C. rental unit volume and favorable foreign currency exchange
variances. Foreign currency exchange rate movements accounted for
4.5% of the increase in international V.A.C. revenue in 2006 compared to the
prior year. The growth in international V.A.C. rental revenue over
the prior year was due primarily to a 30.1% increase in rental unit
volume. The average rental price for 2006 was comparable to the prior
year period. Foreign currency exchange rate movements accounted for
5.2% of the increase in international V.A.C. rental revenue in 2006 compared to
the prior year. The increase in international 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. During 2005, we completed a $2.6 million V.A.C. sale to the
Canadian government, which unfavorably impacted international V.A.C. sales
revenue growth by 3.2% for 2006 compared to the prior year. Foreign
currency exchange rate movements accounted for 3.9% of the increase in
international V.A.C. sales revenue in 2006 compared to the prior
year.
International
Therapeutic Support Systems revenue decreased from the prior
year. During the first quarter of 2005, we completed a significant
$5.1 million sale of therapeutic support systems to the Canadian government,
which unfavorably impacted revenue growth by 4.3% for 2006. Foreign
currency exchange rate movements favorably impacted international Therapeutic
Support Systems revenue by 1.7% for 2006 compared to the prior
year.
Rental,
or field, expenses are comprised of both fixed and variable
costs. The expense associated with our sales headcount increase in
2006 slightly outpaced our rental revenue growth for the same period compared to
the prior year due to lower price realization of our V.A.C. rentals, as
discussed above. Additionally, 2006 included an increase in
share-based compensation expense of $4.3 million, before taxes, resulting from
the January 1, 2006 adoption of SFAS 123R compared to the prior
year. Our sales and service headcount increased to 3,520 at December31, 2006 from approximately 3,160 at December 31, 2005.
Cost
of Sales
The following table presents cost of
sales and the sales margin comparing 2006 to 2005 (dollars in
thousands):
Cost of sales includes manufacturing
costs, product costs and royalties associated with our “for sale”
products. The increased margin was due to continued cost reductions
resulting from our global supply contract for V.A.C. disposables, including a
volume purchase discount received in the second quarter of 2006 relating to a
large purchase of V.A.C. disposables which was fully recognized in
2006.
Gross Profit Margin
The following table presents the gross
profit margin comparing 2006 to 2005:
Increased revenue combined with
productivity improvements in our service operations and continued cost
reductions from our global supply contract for V.A.C. disposables contributed to
the margin expansion for 2006, partially offset by the impact of our January 1,2006 adoption of SFAS 123R.
Selling,
General and Administrative Expenses
The following table presents selling,
general and administrative expenses and the percentage relationship to total
revenue comparing 2006 to 2005 (dollars in thousands):
Selling, general and administrative
expenses include administrative labor, incentive and sales commission
compensation costs, insurance costs, professional fees, depreciation, bad debt
expense and information systems costs. In 2006, we recorded
share-based compensation expenses of approximately $12.3 million, before income
taxes, compared to $1.9 million recorded in the prior year. Selling,
general and administrative expenses for 2006 also include an additional $3.7
million expense over the prior year related to the patent litigation case, $2.7
million in CEO transition costs and $3.0 million related to the reduction of the
carrying value of our assets subject to leveraged lease.
The following table presents research
and development expenses and the percentage relationship to total revenue
comparing 2006 to 2005 (dollars in thousands):
Research and development expenses
relate to our investments in clinical studies and the development of new
advanced wound healing systems and dressings, new technologies in wound healing
and tissue repair, new applications of V.A.C. Therapy technology and upgrading
and expanding our surface technologies.
Litigation
Settlement Expense
On September 30, 2005, we reached an
agreement to settle our litigation with Novamedix Limited, a subsidiary of
Orthofix International NV. Under the terms of the settlement, we paid
Novamedix $75.0 million. The settlement payment resulted in a charge
of $72.0 million, net of recorded reserves of $3.0 million, in
2005.
Operating Margin
The following table presents the
operating margin comparing 2006 to 2005:
Share-based compensation recorded under
SFAS 123R unfavorably impacted our operating margin by 1.3% in 2006 compared to
0.2% in the prior year. Prior to January 1, 2006, we accounted for
share-based compensation under Accounting Principles Board, or APB, Opinion No.
25, or APB 25, “Accounting for
Stock Issued to Employees.” The prior-year litigation
settlement unfavorably impacted our operating margins for 2005 by
6.0%.
Interest Expense
Interest expense was $20.3 million in
2006 compared to $25.2 million in the prior year. Interest expense in
2006 and 2005 includes write-offs of capitalized debt issuance costs totaling
$1.5 million and $2.9 million, respectively, and open-market premium payments of
$490,000 and $510,000, respectively, related to the purchase 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 from the prior year.
Net Earnings
Net
earnings for 2006 were $195.5 million compared to $122.2 million in the prior
year, an increase of 60.0%. Net earnings for 2005 were unfavorably
impacted by the litigation settlement of $47.4 million, net of
taxes. The effective income tax rate for 2006 was 33.1% compared to
34.0% for the prior year. The income tax reduction was primarily
attributable to the favorable resolution of certain tax contingencies in
2006.
Net Earnings per Diluted
Share
Net
earnings per diluted share for 2006 were $2.69 compared to net earnings per
diluted share of $1.67 in the prior year. The litigation settlement
charge unfavorably impacted the prior year by $0.65 per share. The
open-market repurchases of common stock in 2006 favorably impacted reported
earnings per share by $0.03 per share.
We
require capital principally for capital expenditures, systems infrastructure,
debt service, interest payments and working capital. Our capital expenditures
consist primarily of manufactured rental assets, computer hardware and software
and expenditures related to the need for additional office space for our
expanding workforce. 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 2007, 2006
and 2005, 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, 2007, 2006 and 2005 (dollars in thousands):
Effect
of exchange rates changes on cash and cash equivalents
9,253
3,700
(4,895
)
Net
increase (decrease) in cash and cash equivalents
$
158,847
$
(16,237
)
$
(983
)
(1) 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 new revolving credit facility.
(2)
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.
(3)
This amount for 2005 is reduced by the litigation settlement charge of
$72.0 million, which impacted net earnings by $47.4 million, net of the
related tax benefit of $24.6 million.
(4)
This amount for 2005 includes debt prepayments and regularly scheduled
payments totaling $137.7 million on our previous senior credit facility
and $13.4 million on our previously-existing senior subordinated
notes.
At
December 31, 2007, our principal sources of liquidity consisted of approximately
$266.0 million of cash and cash equivalents and $423.3 million available
under our revolving credit facility. The revolving credit facility
makes available to us up to $500.0 million over a five-year
period. This limit may be increased at any time up to $650.0 million
upon satisfaction of certain conditions. At December 31, 2007, there
were $68.0 million of borrowings and $8.7 million in undrawn letters of credit
under our revolving credit facility.
Working
Capital
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”).
At
December 31, 2006, we had current assets of $531.8 million, including $43.5
million in inventory, and current liabilities of $250.8 million resulting
in a working capital surplus of approximately $280.9 million, compared to a
surplus of $242.1 million at December 31, 2005. The
increase in our working capital surplus of $38.8 million was due primarily to
increases in cash from operations and increased cash and accounts receivable
associated with revenue growth in the current year, partially offset by debt
prepayments, capital expenditures and the repurchase of KCI common stock through
our share repurchase program.
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. As of December 31, 2007, we had
$357.0 million of receivables outstanding, net of realization reserves of
$96.8 million. During 2007, domestic receivables were
outstanding for an average of 72 days, a decline from 75 days in
2006. International receivable days were down from 90 days in 2006 to
79 days in 2007. The decrease in receivable days for domestic and
international were due to efforts aimed at improving the efficiency of our
order-to-cash process.
Capital
Expenditures
During
2007, 2006 and 2005, we made capital expenditures of $95.8 million,
$92.2 million and $94.2 million, respectively, due primarily to
expanding the rental fleet and information technology purchases.
Debt
Service
As of
December 31, 2007, we had $68.0 million in debt outstanding under our senior
revolving credit facility due July 2012. To the extent that we have
excess cash, we may use it to reduce our outstanding debt
obligations.
Senior
Credit Facility
Our
senior credit facility consists of a $500.0 million revolving credit
facility due July 2012. The following table sets forth the amount owed under the
revolving credit facility, the effective interest rate on such outstanding
amount, and amount available for additional borrowing thereunder, as of December31, 2007 (dollars in thousands):
Senior
Credit Facility
Maturity
Date
Effective
Interest Rate
Amount
Outstanding
Amount
Available For Additional Borrowing
Revolving
credit facility
July
2012
5.84
%
$
68,000
$
423,286
(1)
Total
$
68,000
$
423,286
(1)
At December 31, 2007, amount available under the revolving portion of our
credit facility reflected a reduction of $8.7 million for letters of
credit issued on our behalf, none of which have been drawn upon by the
beneficiaries thereunder.
Our
senior credit facility contains affirmative and negative covenants customary for
similar facilities and transactions including, but not limited to, quarterly and
annual financial reporting requirements and limitations on other debt, other
liens or guarantees, mergers or consolidations, 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.
We are
permitted to effect unlimited repurchases of our capital stock when our leverage
ratio is less than or equal to 3.0 to 1.0 and there is no default under the
senior credit agreement. In the event the leverage ratio is greater
than 3.0 to 1.0, open-market repurchases of our common stock are limited to
$300.0 million until such time as the leverage ratio has been
restored. In addition, we have the unlimited ability to pay dividends
on our capital stock if our pro forma leverage ratio, as defined in the senior
credit agreement, is less than 3.0 to 1.0. As of December 31, 2007,
our leverage ratio was 0.2 to 1.0.
Our
senior credit facility contains financial covenants requiring us to meet certain
leverage and interest 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 4.0
to 1.0, or
·
as
of the last day of any fiscal quarter, our ratio of EBITDA to consolidated
cash interest expense, as defined in the senior credit agreement, to be
less than 2.5 to 1.0.
As of
December 31, 2007, we were in compliance with all covenants under the senior
credit agreement.
At
December 31, 2007, we did not have any interest rate protection agreements in
place. As of December 31, 2006, the fair value of our interest rate
protection agreement was negative and recorded as a liability of approximately
$54,000. As of December 31, 2005, the fair value of our interest
rate swap agreements was positive in the aggregate and was recorded as an asset
of approximately $1.8 million. If our previously-existing interest
rate protection agreements were not in place, interest expense would have been
approximately $51,000 lower for the year ended December 31, 2007, while $2.0
million and $1.3 million higher for the years ended December 31, 2006 and 2005,
respectively.
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, 2007 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
$
-
$
-
$
68,000
$
-
$
68,000
Interest
on Long-Term Debt Obligations (2)
3,972
7,944
6,289
-
18,205
Capital
Lease Obligations
318
361
48
-
727
Operating
Lease Obligations
34,502
56,386
34,158
30,561
155,607
Purchase
Obligations
39,860
-
-
-
39,860
Total
$
78,652
$
64,691
$
108,495
$
30,561
$
282,399
(1)
This excludes our liability of $31.3 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 30, 2007, we entered into a three-year Toll Manufacturing Agreement
(the "Agreement") with Avail Medical Products, Inc. ("Avail") for our V.A.C.
related disposable supplies. The Agreement replaces the Amended and
Restated Manufacturing Agreement between KCI and Avail, dated December 18,2002. The Agreement retains the material provisions of the prior
agreement, including an initial thirty-six month term, through November 2010,
with automatic extension thereafter for additional twelve-month periods unless
either party gives notice to the contrary (the "Exclusivity
Period"). Pursuant to the Agreement, Avail will continue as KCI's
exclusive supplier for sterile disposable products for use with KCI's V.A.C.
Therapy systems throughout the Exclusivity Period. The Agreement also
provides that during the Exclusivity Period and thereafter for an additional
thirty-six months, Avail will not manufacture or sell similar products for or to
any customer other than KCI. In the event of termination, we would
have been committed to purchase from Avail approximately $13.7 million of
inventory as of December 31, 2007, 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. See
Note 1 to our consolidated financial statements.
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, 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. In
addition, 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.
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 claim
in our homecare business may, in some cases, extend beyond one year prior to
full settlement of the claim.
We
utilize a combination of factors in evaluating the collectibility of our
accounts receivable. For unbilled receivables, we establish reserves against
revenue to allow for expected denied or uncollectible items. In
addition, items that remain unbilled for more than a specified period of time,
or beyond an established billing window, are reserved against
revenue. For billed receivables, we generally establish reserves
against revenue and bad debt using a combination of factors including historic
adjustment rates for credit memos and cancelled transactions, historical
collection experience, and the length of time receivables have been
outstanding. The reserve rates vary by payer group. In
addition, we record specific reserves for bad debt when we become aware of a
customer's inability or refusal to satisfy its debt obligations, such as in the
event of a bankruptcy filing. If circumstances change, such as higher
than expected claims denials, post-payment claim recoupments, a material change
in the interpretation of reimbursement criteria by a major customer or payer, or
payment defaults or an unexpected material adverse change in a major customer's
or payer's ability to meet its obligations, our estimates of the realizability
of trade receivables could be reduced by a material amount. A
hypothetical 1% change in the collectibility of our billed receivables at
December 31, 2007 would impact pre-tax earnings by an estimated $7.6
million.
Inventory
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 the
last twelve months demand 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.
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 determined that there was no
impairment. The most recent annual test completed in the fourth
quarter of 2007 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, 2007, deferred tax assets recorded by KCI increased from 2006. We
have established a valuation allowance to reduce deferred tax assets associated
with foreign NOLs, 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.
Income
taxes increased $24.2 million, or 25.1%, in 2007, $33.7 million, or 53.5%, in
2006 and $9.8 million, or 18.5%, in 2005. The increases in income
taxes in these years were due primarily to increases in income before income
tax. Our effective tax rate in 2007 was 33.8% compared to 33.1% and
34.0% in 2006 and 2005, respectively. The
income tax rate was lower in 2006 primarily due to the favorable resolution of
certain tax contingencies.
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.
In June
2006, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 06-3
(“EITF 06-3”), “How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be
Presented in the Income Statement (That Is, Gross versus Net
Presentation).” The scope of EITF 06-3 includes any tax
assessed by a governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer. This
Issue provides that a company may adopt a policy of presenting taxes within
revenue either on a gross basis or on a net basis. If taxes subject
to this Issue are significant, a company is required to disclose its accounting
policy for presenting taxes and the amount of such taxes that are recognized on
a gross basis. EITF 06-3 was effective for KCI beginning
January 1, 2007, and the adoption of EITF 06-3 did not have an impact on
our consolidated financial statements. We present sales tax on a net
basis in our consolidated financial statements.
In July
2006, the FASB issued FIN 48, “Accounting for Uncertainty in
Income Taxes,” which clarifies the accounting for uncertainty in income
taxes recognized in the financial statements in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income
Taxes.” FIN 48 provides guidance on the financial statement
recognition and measurement of a tax position taken, or expected to be taken, in
a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosures, and transition and is effective for fiscal years beginning after
December 15, 2006. We adopted FIN 48 as of January 1,2007. The adoption of this standard did not have an impact on our
results of operations or our financial position, but did impact the balance
sheet classification of certain tax liabilities.
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 is effective for fiscal years beginning
after November 15, 2007. The adoption of this standard on January 1,2008, 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 is effective for fiscal years beginning after
November 15, 2007. The adoption of this standard on January 1, 2008,
did not have a material impact on our results of operations or our financial
position.
In May
2007, the FASB issued FASB Staff Position FIN 48-1 (“FSP FIN 48-1”), “Definition of Settlement in FASB
Interpretation No. 48.” FSP FIN 48-1 provides guidance on how
to determine whether a tax position is effectively settled for the purpose of
recognizing previously unrecognized tax benefits. FSP FIN 48-1 is
effective retroactively to January 1, 2007. The adoption of this
standard did not have an 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. This Issue 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. EITF 07-3 is effective for fiscal
years beginning after December 15, 2007. Earlier application is not
permitted. Companies should report the effects of applying this Issue
prospectively for new contracts entered into on or after the effective date of
this Issue. The adoption of this standard on January 1, 2008, did not
have a material impact on our results of operations or our financial
position.
ITEM
7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 and 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. Through the second quarter of 2007, we managed our interest rate
risk on our borrowings through an interest rate swap agreement which effectively
converted a portion of our variable-rate borrowings to a fixed rate basis
through June 29, 2007, thus reducing the impact of changes in interest rates on
interest expenses. Based on our debt balance and our evaluation of
the interest rate risk associated with the debt, we did not enter into any
interest rate swap agreements during the third and fourth quarters of
2007. We do not use financial instruments for speculative or trading
purposes.
The
tables below provide information about our long-term debt and interest rate
swaps, both of which are sensitive to changes in interest rates, as of December31, 2007 and 2006. 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):
(1)
The weighted average interest rates for future periods were based on the
nominal interest rates as of the specified date.
(2)
Interest rate swaps relate to the variable rate debt under long-term
debt. The fair value of our interest rate swap agreement was negative
and was recorded as a liability at December 31, 2006.
Foreign
Currency and Market Risk
We have
direct operations in the United States, 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
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, 2007 we had outstanding forward currency exchange contracts to sell
approximately $27.2 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 $67.3 million for the year ended
December 31, 2007. We estimate that a 10% fluctuation in the value of
the U.S. dollar relative to these foreign currencies at December 31, 2007 would
change our net earnings for the year ended December 31, 2007 by approximately
$3.0 million. Our analysis does not consider 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 these foreign entities.
ITEM
8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
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, 2007 and 2006, and the
related consolidated statements of earnings, shareholders’ equity, and cash
flows for each of the three years in the period ended December 31, 2007. Our
audits also included the financial statement schedule listed in the index at
Item 15(a)2. These financial statements and the 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, and 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, 2007 and 2006, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2007, 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, and in 2006, changed
its method of accounting for share-based compensation.
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, 2007, 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 22, 2008
expressed an unqualified opinion thereon.
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 2007
presentation.
(b) Nature of
Operations and Customer Concentration
Kinetic
Concepts, Inc. is a global medical technology company with leadership positions
in advanced wound care and therapeutic support systems. 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 has been demonstrated clinically to promote
wound healing through unique mechanisms of action and can help reduce the cost
of treating patients with serious wounds. Our therapeutic support
systems, including specialty hospital beds, mattress replacement systems and
overlays, are designed to address pulmonary complications associated with
immobility, to reduce skin breakdown and assist caregivers in the safe and
dignified handling of obese patients. We have an infrastructure
designed to meet the specific needs of medical professionals and patients across
all health care settings, including acute care hospitals, extended care
organizations and patients’ homes, both in the United States and
abroad.
We have
direct operations in the United States, 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 two geographical
segments: the United States, or domestic, and
International. Operations in the United States accounted for
approximately 71.4%, 72.5% and 73.3% of our total revenue for the years ended
December 31, 2007, 2006 and 2005, respectively.
We derive
our revenue from both the rental and sale of our products. In the
U.S. acute care and extended care settings, which accounted for more than half
of our U.S. revenue in 2007, we directly bill our customers, such as hospitals
and extended care organizations. 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
complete 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 36.9%, 37.6% and 37.4% of our total revenue
during 2007, 2006 and 2005, respectively, was generated under national
agreements with GPOs. During 2007, 2006 and 2005, we recorded
approximately $193.6 million, $179.2 million and $159.6 million,
respectively, in V.A.C. and Therapeutic Support Systems 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 directly to patients and we directly
bill third-party payers, such as Medicare and private
insurance. During 2007, 2006 and 2005, we submitted claims for
approximately $181.5 million, $165.4 million and $148.6 million,
respectively, to Medicare. Internationally, most of our revenue is
generated from the acute care setting.
(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.
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. In addition, 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
previously-existing 7 ⅜% Senior Subordinated Notes
due 2013, or the Notes, approximates fair value. We estimate the fair value of
long-term obligations, excluding the Notes, by discounting the future cash flows
of the respective instrument, using our incremental rate of borrowing for a
similar instrument. The fair value of the Notes is estimated based
upon open-market trades at or near year-end. The carrying value of
the Notes as of December 31, 2006 was $68.1 million, with a corresponding fair
value of approximately $69.5 million. During 2007, we redeemed the
remaining notes using proceeds from our debt refinancing. (See Note
2)
(g) Accounts
Receivable
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.
Significant
concentrations of accounts receivable include:
2007
2006
Acute
and extended care organizations
50%
50%
Managed
care, insurance and other
34%
33%
Medicare/Medicaid
15%
16%
Other
1%
1%
The
domestic TPP reimbursement process requires extensive documentation, which has
had the effect of slowing both the billing and cash collection cycles relative
to the rest of the business, and therefore, increasing total accounts
receivable. Because of the extensive documentation required and the
requirement to settle a claim with the primary payer prior to billing the
secondary and/or patient portion of the claim, the collection period for a claim
in our homecare business may, in some cases, extend beyond one year prior to
full settlement of the claim.
We
utilize a combination of factors in evaluating the collectibility of our
accounts receivable. For unbilled receivables, we establish reserves against
revenue to allow for expected denied or uncollectible items. In
addition, items that remain unbilled for more than a specified period of time,
or beyond an established billing window, are reserved against
revenue. For billed receivables, we generally establish reserves
against revenue and bad debt using a combination of factors including historic
adjustment rates for credit memos and cancelled transactions, historical
collection experience, and the length of time receivables have been
outstanding. The reserve rates vary by payer group. In
addition, we record specific reserves for bad debt when we become aware of a
customer's inability or refusal to satisfy its debt obligations, such as in the
event of a bankruptcy filing. If circumstances change, such as higher
than expected claims denials, post-payment claim recoupments, payment
defaults, a material change in the interpretation of reimbursement criteria by a
major customer or payer, 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.
(h) 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 30, 2007, we entered into a three-year Toll Manufacturing Agreement
(the "Agreement") with Avail Medical Products, Inc. ("Avail") to continue
supplying the majority of our inventory which generates V.A.C. sales
revenue. The Agreement replaces the Amended and Restated
Manufacturing Agreement between KCI and Avail, dated December 18, 2002, and has
a term through November 2010, which is renewable annually for an additional
twelve-month period in November of each year, unless either party gives notice
to the contrary. We maintain an inventory of disposables sufficient
to support our business for approximately seven weeks in the United States and
nine weeks in our international locations.
(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 as of December 31, 2007, include
costs incurred in connection with the issuance of debt under our 2007 senior
revolving credit facility, net of amounts written off related to our 2007, 2006
and 2005 redemptions and purchases of our subordinated notes and repayment of
our previously-existing senior credit facility. The costs associated with our
senior credit facility are amortized on a straight line basis over the
respective term of debt to which they relate. Costs associated with
our previous debt were amortized over the respective term of the debt using the
effective interest method. 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 2007, 2006 and 2005 was $84.4 million, $78.8 million
and $66.7 million, respectively.
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 16: USA and International. Goodwill and other indefinite lived
intangible assets were tested for impairment during the fourth quarter of 2007
and we determined no impairment write down was required.
(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.
During
2007, our effective income tax rate is lower than our statutory rate due to the
impact of the domestic production deduction, research and development credit and
earnings in lower-tax foreign jurisdictions. In addition, the lower
effective income tax rate for the prior year resulted from the favorable
resolution of tax contingencies.
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.
KCI has
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. An increase to net income would occur if we were to
determine that we were able to utilize more of these deferred tax assets than
currently expected.
(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.
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 both specific and aggregate 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 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(t))
(q) Stock
Options
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123 Revised (“SFAS 123R”), "Share-Based Payment," which
is effective for fiscal years beginning after June 15, 2005. SFAS
123R eliminated the alternative to account for share-based compensation using
the intrinsic-value method prescribed under APB 25, "Accounting for Stock Issued to
Employees," and required such transactions be recognized, based on their
fair values on the date of grant, as compensation expense in the statement of
earnings, with the compensation expense recognized on a straight-line basis over
the period in which an employee is required to provide service in exchange for
the entire stock award. We adopted SFAS 123R on January 1, 2006 using
the modified prospective transition method. As such, the compensation
expense recognition provisions of SFAS 123R apply to new awards and to any
awards modified, repurchased or cancelled after the adoption
date. Additionally, for any unvested awards outstanding at the
adoption date, we are recognizing compensation expense over the remaining
vesting period. Also, prior to the adoption of SFAS 123R, we
presented all benefits of income tax deductions resulting from the exercise of
stock options as operating cash flows in the statement of cash flows, as
required. In accordance with SFAS 123R, we now present cash flows
related to the tax benefit resulting from exercises of share-based payment
arrangements in excess of the tax benefit recorded on compensation cost
recognized for those options (excess tax benefit) as financing cash
flows.
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.
During
2007 and 2006, we recorded share-based compensation expense under SFAS 123R
which reduced net earnings by approximately $16.8 million and $12.0 million,
respectively, or $0.23 and $0.17 per diluted share,
respectively. Additionally, for the years ended 2007 and 2006, we
recorded an actual tax benefit from share-based payment arrangements of $18.4
million and $45.8 million, respectively, of which $14.3 million and $43.2
million, respectively, is reflected as a financing cash inflow, representing the
excess tax benefit from share-based payment arrangements, as required under SFAS
123R. Prior to the adoption of SFAS 123R, these amounts would have
been classified as an operating cash inflow.
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 2007, 2006
and 2005 was $24.30, $17.63 and $21.04, respectively, using the Black-Scholes
option pricing model with the following weighted average assumptions (annualized
percentages):
2007
2006
2005
Expected
stock volatility
39.6%
39.2%
35.0%
Expected
dividend yield
-
-
-
Risk-free
interest rate
4.5%
4.8%
4.2%
Expected
life (years)
6.2
6.2
5.0
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.
Share-based
compensation expense was recognized in the consolidated statements of earnings
as follows (dollars in thousands):
Prior to
2006, as permitted by SFAS No. 123 (“SFAS 123”), "Accounting for Stock-Based
Compensation," we used the intrinsic-value method to account for our
share-based compensation plans. In 2005, compensation costs of approximately
$1.2 million, net of estimated taxes, have been recognized in the financial
statements related to our plans. The 2005 expense relates to restricted stock
awards, which are expensed on a straight-line basis over the vesting
period. If the compensation cost for our share-based employee
compensation plans had been determined based upon a fair value method consistent
with SFAS 123, our net earnings and net earnings per share would have been
adjusted to the pro forma amounts indicated below. For 2005, the impact of
adopting SFAS 123R approximates the SFAS 123 disclosure of pro-forma net
earnings and net earnings per share as follows (dollars in thousands, except per
share data):
Compensation
expense under intrinsic method, after tax
1,237
Compensation
expense under fair value method, after tax
(6,707
)
Pro
forma net earnings
$
116,685
Net
earnings per share, as reported:
Basic
$
1.76
Diluted
$
1.67
Pro
forma net earnings per share:
Basic
$
1.68
Diluted
$
1.60
(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, including
tissue healing, preservation and repair, new applications of negative pressure
technology, as well as upgrading and expanding our surface technologies in our
Therapeutic Support Systems business. The 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
KCI
follows the provisions of SFAS No. 133 (“SFAS 133”), "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137 (“SFAS
137”), “Accounting for Derivative
Instruments and Hedging Activities – Deferral of the Effective Date of FASB
Statement No. 133 – An Amendment of FASB Statement No. 133” and SFAS No.
138 (“SFAS 138”), “Accounting for Certain Derivative
Instruments and Certain Hedging Activities – An Amendment of FASB Statement No.
133” in accounting for our derivative financial
instruments. 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. At December31, 2007, we did not have any interest rate protection agreements in
place. The value of our contracts at December 31, 2006 was determined
using quoted prices in active markets for equivalent contracts. (See
Note 5)
In late
2005, we began using 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 statements of
earnings. (See Note 5)
(u) 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 $2.8 million, $2.1 million and $2.0 million for the
years ended December 31, 2007, 2006 and 2005, respectively, are included in
sales revenue for these periods.
(v) 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.
(w) Advertising
Expenses
Advertising
costs are expensed as incurred. Advertising expenses were $7.9
million, $7.4 million and $9.6 million for the years ended December 31, 2007,
2006 and 2005, respectively.
(x) Seasonality
For the
last several years, our growth has been driven primarily by increased revenue
from V.A.C. Therapy systems and related supplies, which accounted for
approximately 79.5% of total revenue for the year ended December 31, 2007, up
from 77.9% and 75.1% for the same periods in 2006 and 2005,
respectively. 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.
(y) Other Recently
Adopted Accounting Pronouncements
In June
2006, the FASB ratified EITF Issue No. 06-3 (“EITF 06-3”), “How Taxes Collected from Customers
and Remitted to Governmental Authorities Should Be Presented in the Income
Statement (That Is, Gross versus Net Presentation).” The scope
of EITF 06-3 includes any tax assessed by a governmental authority that is
directly imposed on a revenue-producing transaction between a seller and a
customer. This Issue provides that a company may adopt a policy of
presenting taxes within revenue either on a gross basis or on a net
basis. If taxes subject to this Issue are significant, a company is
required to disclose its accounting policy for presenting taxes and the amount
of such taxes that are recognized on a gross basis. EITF 06-3 was
effective for KCI beginning January 1, 2007, and the adoption of EITF 06-3
did not have an impact on our consolidated financial statements. We
present sales tax on a net basis in our consolidated financial
statements.
In July
2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in
Income Taxes,” which clarifies the accounting for uncertainty in income
taxes recognized in the financial statements in accordance with SFAS No. 109,
“Accounting for Income
Taxes.” FIN 48 provides guidance on the financial statement
recognition and measurement of a tax position taken, or expected to be taken, in
a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosures, and transition and is effective for fiscal years beginning after
December 15, 2006. We adopted FIN 48 as of January 1,2007. The adoption of this standard did not have an impact on our
results of operations or our financial position, but did impact the balance
sheet classification of certain tax liabilities. (See Note
7)
In May
2007, the FASB issued Staff Position FIN 48-1 (“FSP FIN 48-1”), “Definition of Settlement in FASB
Interpretation No. 48.” FSP FIN 48-1 provides guidance on how
to determine whether a tax position is effectively settled for the purpose of
recognizing previously unrecognized tax benefits. FSP FIN 48-1 is
effective retroactively to January 1, 2007. The adoption of this
standard did not have an impact on our results of operations or our financial
position.
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 is effective for fiscal years beginning
after November 15, 2007. The adoption of this standard on January 1,2008, 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 is effective
for fiscal years beginning after November 15, 2007. The adoption of
this standard on January 1, 2008, 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. This Issue 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. EITF 07-3 is effective for fiscal
years beginning after December 15, 2007. Earlier application is not
permitted. Companies should report the effects of applying this Issue
prospectively for new contracts entered into on or after the effective date of
this Issue. The adoption of this standard on January 1, 2008, did not
have a material impact on our results of operations or our financial
position.
NOTE
2. Refinancing
Senior Credit Facility.
On July 31, 2007, we entered into a new $500.0 million senior secured
revolving credit facility due July 30, 2012, with Citibank, N.A. as
administrative agent for the lenders thereunder. We used proceeds from
borrowings under the new credit facility primarily to repay the remaining
outstanding balance of $114.1 million under our previously-existing senior
credit facility due 2010 and to redeem the remaining $68.1 million outstanding
on our 7 ⅜% Senior Subordinated Notes due 2013. 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 foreign subsidiaries.
(See Note 5)
Redemption of 7 ⅜% Senior Subordinated Notes.
As of August 1, 2007, we had $68.1 million outstanding in 7 ⅜% Senior
Subordinated Notes due 2013. On that date, we notified the holders of
these notes that, pursuant to their terms, we would redeem all such outstanding
notes for a purchase price of 100.0% of their principal amount plus accrued but
unpaid interest to the date of redemption plus an early redemption premium based
on a reference treasury yield chosen in accordance with the senior credit
agreement plus 0.5%. The redemption was completed on August 31,2007. The total early redemption premium paid was $3.6 million and is
included within interest expense on our consolidated statement of
earnings.
The
repayment of our previously-existing senior credit facility and the redemption
of our senior subordinated notes using proceeds from our current senior
revolving credit facility are referred to herein collectively as the
"Refinancing." We recorded Refinancing expenses associated with these
transactions of $4.5 million, net of income taxes, or $0.06 per diluted share,
in the third quarter of 2007. These expenses included the write-off
of capitalized debt issuance costs associated with the repayment of our previous
debt and the payment of an early redemption premium due to the holders of our
senior subordinated notes. These Refinancing expenses are included
within interest expense on our consolidated statement of
earnings.
The
following sets forth the sources and uses of funds in connection with the
Refinancing (dollars in thousands):
Amount
Source
of funds:
Borrowings
under new senior revolving credit facility
$
188,000
Cash
on hand
2,507
$
190,507
Use
of funds:
Repayment
of debt under previous senior credit facility
$
114,133
Redemption
of 7 ⅜% Senior
Subordinated Notes (1)
71,775
Payment
of accrued interest
2,241
Transaction
fees and expenses for the Refinancing (2)
2,358
$
190,507
(1)
Includes early redemption premium of 5.355% of the aggregate principal
amount of our 7 ⅜% Senior Subordinated Notes due 2013 pursuant to the
terms of our previously-existing credit agreement.
(2)
Transaction fees and expenses for the Refinancing have been deferred and
will be amortized over the life of the senior revolving credit
facility.
NOTE
3. Supplemental Balance Sheet
Data
(a) Accounts
Receivable
Accounts
receivable consist of the following (dollars in thousands):
(1) Net
property, plant and equipment as of December 31, 2007 and 2006
includes approximately $1.5 million and $1.3 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):
We have
recorded amortizable intangible assets in other non-current assets on our
consolidated balance sheets. Other non-current assets include the following
(dollars in thousands):
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 2007
and 2006, based on our analysis of the current market conditions, we decreased
our net investment in these aircraft by $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, 2007, 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.
Amortization
expense, related to definite-lived intangibles, was approximately $1.3 million,
$415,000 and $700,000 for 2007, 2006 and 2005, 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, 2007 (dollars in thousands):
Estimated
Year
ended
Amortization
December
31,
Expense
2008
$
675
2009
666
2010
633
2011
594
2012
561
As of
December 31, 2007, unamortized debt issuance costs related to our current senior
credit facility were $2.5 million and unamortized debt issuance costs related to
our previously-existing senior credit facility and subordinated notes were $2.7
million and $2.1 million, respectively, as of December 31,2006. Amortization of debt issuance costs recorded for the years
ended December 31, 2007, 2006 and 2005 were $4.8 million, $2.7 million and $4.4
million, respectively. The amortization for 2007, 2006 and 2005
includes approximately $3.9 million, $1.5 million and $2.9 million,
respectively, of debt issuance costs written off in connection with our
redemptions of our subordinated notes and prepayments on our previously-existing
senior credit facility. The remaining costs are being amortized on a
straight-line basis for the current senior credit facility and were amortized
using the effective interest method for the previously-existing debt over the
respective term of debt to which they specifically relate.
NOTE
5. Long-Term Debt and Derivative
Financial Instruments
Long-term
debt consists of the following (dollars in thousands):
Senior
Credit Facility – Term loan B2 due 2010 (1)
-
139,494
7
⅜% Senior Subordinated Notes due 2013 (1)
-
68,127
68,000
207,621
Less: current
installments
-
(1,446
)
$
68,000
$
206,175
(1)
Outstanding amounts were repaid in connection with the Refinancing
completed during the third quarter of 2007. (See Note
2)
Senior
Credit Facility
On July31, 2007, we entered into a new $500.0 million senior secured revolving credit
facility due July 30, 2012.
Loans. The senior credit
facility consists of a $500.0 million revolving credit facility increasable, at
any time, up to $650.0 million upon satisfaction of certain
conditions. Amounts available under the new senior credit facility
are available for borrowing and reborrowing until maturity and up to $60.0
million of the revolving credit facility is available for letters of
credit. At December 31, 2007, $68.0 million was outstanding under the
revolving credit facility. In addition, we had outstanding letters of
credit in the aggregate amount of $8.7 million, none of which have been drawn
upon by the beneficiaries thereunder. The resulting availability
under the revolving credit facility was $423.3 million at December 31,2007.
Interest. Amounts outstanding
under the senior credit facility bear interest at a rate equal to the Base Rate,
as defined in the senior credit agreement, or the Eurocurrency Rate (the LIBOR
rate), in each case plus an applicable margin. The applicable margin
varies in reference to Moody’s and Standard and Poor’s credit rating of the
senior credit facility and ranges from 0.40% to 1.25% in the case of loans based
on the Eurocurrency Rate and 0.0% to 0.25% in the case of loans based on the
Base Rate. The weighted average interest rate on amounts outstanding
under the revolving credit facility was 5.84% at December 31, 2007.
We may
choose Base Rate or Eurocurrency Rate 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 2.0% over the
applicable rate.
Collateral. The senior credit
facility is secured by a first-priority security interest in (a) substantially
all shares of capital stock and intercompany receivables of each of our present
and future subsidiaries (limited in the case of certain foreign subsidiaries to
65% of the capital stock or membership interests 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 or will be guarantors under the senior credit
facility. The security interest is subject to certain 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 July 30, 2012.
Prepayments. We may prepay,
in full or in part, borrowings under the senior credit facility without premium
or penalty, subject to a minimum prepayment amount and increment
limitations.
Representations. The senior
credit facility contains representations generally customary for similar
facilities and transactions.
Covenants. The senior credit
facility contains affirmative and negative covenants customary for similar
facilities and transactions. The material covenants and other
restrictive covenants in the senior credit agreement are summarized as
follows:
·
limitations
on other debt, with unlimited permission to incur unsecured indebtedness
and up to $60.0 million of secured indebtedness (subject to compliance
with financial covenants) and with baskets for, among other things, debt
used to acquire fixed or capital assets, debt of foreign subsidiaries for
working-capital purposes, certain intercompany debt, debt of
newly-acquired subsidiaries, debt under certain nonspeculative interest
rate and foreign currency swaps, certain ordinary-course debt, and certain
sale-leaseback transactions;
·
limitations
on other liens, with baskets for certain ordinary-course liens, liens
under allowed sale-leaseback transactions and liens securing debt that may
be allowed as described 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,
and certain acquisitions; and
·
limitations
on changes in the nature of the business, on changes in KCI’s fiscal year,
and on changes in organizational
documents.
We are
permitted to effect unlimited repurchases of our capital stock when our leverage
ratio is less than or equal to 3.0 to 1.0 and there is no default under the
senior credit agreement. In the event the leverage ratio is greater
than 3.0 to 1.0, open-market repurchases of our common stock are limited to
$300.0 million until such time as the leverage ratio has been
restored. In addition, we have the unlimited ability to pay dividends
on our capital stock if our pro forma leverage ratio, as defined in the senior
credit agreement, is less than 3.0 to 1.0. As of December 31, 2007,
our leverage ratio was 0.2 to 1.0.
The
senior credit facility contains financial covenants requiring us to meet certain
leverage and interest 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 4.0
to 1.0, or
·
as
of the last day of any fiscal quarter, our ratio of EBITDA to consolidated
cash interest expense, as defined in the senior credit agreement, to be
less than 2.5 to 1.0.
As of
December 31, 2007, we were in compliance with all covenants under the senior
credit agreement.
Events of Default. The senior
credit facility contains events of default including, but not limited to,
failure to pay principal or interest, breaches of representations and
warranties, violations of affirmative, negative or financial
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 Employee
Retirement Income Security Act (ERISA) obligations and termination of the
license agreement with Wake Forest University Health Sciences relating to our
negative pressure wound therapy, or NPWT, line of products.
Interest
Rate Protection
We follow
SFAS 133 and its amendments, SFAS 137 and SFAS 138, 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 were 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. The critical terms of
the interest rate swap agreements and the interest-bearing debt associated with
the swap agreements must be the same to qualify for the shortcut method of
accounting. 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
2007 (dollars in thousands):
Notional
Fixed
Accounting
Method
Effective Dates
Amount
Interest Rate
Status
Shortcut
08/21/06-06/29/07
$
60,000
5.550
%
Matured
06/29/07
At
December 31, 2007, we did not have any interest rate protection agreements in
place. As a result of the interest rate protection agreements that
were in place during 2007, 2006 and 2005, interest expense was approximately
$51,000 higher in 2007, but $2.0 million and $1.3 million lower in 2006 and
2005, respectively.
Foreign
Currency Exchange Fluctuation Protection
KCI
enters into forward currency exchange contracts to mitigate the impact of
currency fluctuations on transactions denominated in nonfunctional currencies,
thereby limiting risk that would otherwise result from changes in exchange
rates. These nonfunctional currency exposures relate primarily to
intercompany receivables and payables arising from intercompany purchases of
manufactured products. The periods of the forward currency exchange
contracts correspond to the periods of the exposed transactions, with realized
gains and losses included in the measurement and recording of transactions
denominated in the nonfunctional currencies. 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(t))
At
December 31, 2007 and 2006, we had outstanding forward currency exchange
contracts to sell approximately $27.2 million and $26.1 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
paid, net of cash received from interest rate swap agreements, during 2007, 2006
and 2005 was $15.6 million, $17.6 million and $21.0 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, 2007 were (dollars in
thousands):
Year
Amount
2008
$
-
2009
$
-
2010
$
-
2011
$
-
2012
$
68,000
Thereafter
$
-
NOTE
6. Leasing
Obligations
We are
obligated for equipment under various capital leases, which expire at various
dates during the next four years. At December 31, 2007 and 2006, the gross
amount of equipment under capital leases totaled $2.6 million and
$2.2 million and related accumulated depreciation was approximately $1.1
million and $900,000, 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 2007, 2006 and
2005, 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 $4.2 million, $4.1 million and $4.2 million for the years ended 2007,
2006 and 2005, 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
ended December 31,
Estimated
Cash Lease Payments
2008
$
4,138
2009
4,210
2010
3,865
2011
3,900
2012
2,330
Thereafter
-
$
18,443
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 $35.8 million,
$32.4 million and $29.4 million for the years ended December 31, 2007,
2006 and 2005, 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, 2007 are as follows (dollars in
thousands):
Capital
Operating
Leases
Leases
2008
$
318
$
34,502
2009
216
31,295
2010
145
25,091
2011
48
19,320
2012
-
14,838
Thereafter
-
30,561
Total
minimum lease payments
$
727
$
155,607
Less
amount representing interest
(135
)
Present
value of net minimum capital lease payments
592
Less
current portion
(259
)
Obligations
under capital leases, excluding current installments
$
333
NOTE
7. Income Taxes
The
following table summarizes earnings before income taxes of U.S. and foreign
operations (dollars in thousands):
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):
At
December 31, 2007, $1.6 million of state research and development credits and
$12.5 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 $1.6 million associated with our state research and
development credit carryforwards, $12.5 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 $199,000 for
the year ended December 31, 2007. For the years ended December 31,2006 and 2005, the net valuation allowance increased by $3.3 million and $4.7
million, respectively, 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 United States 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.
On
January 1, 2007, KCI adopted the provisions of FIN 48. We recognized
no change in the amount of our reported liability for unrecognized income tax
benefits as a result of the implementation of FIN 48. As of January1, 2007, we had $28.7 million of unrecognized tax benefits that were
reclassified as long-term liabilities, of which $24.4 million would favorably
impact our effective tax rate, if recognized. At December 31, 2007,
unrecognized tax benefits totaled $31.3 million of which $26.9 would favorably
impact our effective tax rate, if recognized.
The
reconciliation of the allowance for uncertain tax positions is as follows
(dollars in thousands):
KCI’s
continuing practice is to recognize interest and penalties related to income tax
matters in income tax expense. KCI recognized $1.9 million of
interest and penalties expense in the consolidated statement of earnings for the
year ended December 31, 2007, and $7.6 million in the consolidated balance sheet
as of December 31, 2007.
KCI is
subject to U.S. federal income tax, multiple state taxes, and foreign income
tax. In general, the tax years 2002 through 2007 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 $2.0
million and $5.0 million of our unrecognized tax benefit could be reduced within
the next twelve months.
The
cumulative undistributed earnings of our foreign subsidiaries were approximately
$267.4 million, $187.2 million and $124.2 million at December 31, 2007, 2006 and
2005, 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 2006
Tax Relief and Healthcare Act was signed into law on December 20,2006. This reinstated the federal Research and Development Credit for
2006 and 2007. Accordingly, we recognized a benefit in the fourth
quarter of 2006.
Income
taxes paid were $113.9 million, $72.1 million and $17.8 million for the years
ended 2007, 2006 and 2005, respectively.
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, 2007 and 2006
was 72,153,231 and 70,461,231, respectively. During the years ended
December 31, 2007, 2006 and 2005, there were no preferred stock shares
issued or outstanding.
NOTE
9. Share Repurchase
Program
In August
2006, KCI's Board of Directors authorized a share 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. As of
December 31, 2007, the authorized amount for share repurchases under this
program was $87.4 million. Pursuant to the share repurchase program,
we have 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.
During
the second half of 2006, $100.0 million of the authorized shares were
repurchased in open-market transactions through a pre-arranged purchase plan
pursuant to Rule 10b5-1 of the Exchange Act. During 2007, we
repurchased and retired approximately 54,900 shares of KCI common stock at an
average price of $50.90 per share for an aggregate purchase price of $2.8
million. During 2006, we repurchased and retired approximately 3.5
million shares of KCI common stock at an average price of $31.05 per share for
an aggregate purchase price of $109.8 million. The stock not
repurchased in open-market transactions during 2007 and 2006 resulted from the
purchase and retirement of shares in connection with the net share settlement
exercise of employee stock options for the minimum tax withholdings and exercise
price and the withholding of shares to satisfy the minimum tax withholdings on
the vesting of restricted stock. No open-market repurchases were made
under the share repurchase program during 2007.
The
purchase price for shares of KCI's common stock repurchased under the program
has been reflected as a reduction to shareholders’ equity. In
accordance with Accounting Principles Board 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 deficit. The share repurchases since the
inception of this program are summarized in the table below (amounts in
thousands):
Common
Stock
Total
Shares
of
and
Additional
Retained
Shareholders’
Common
Stock
Paid-in
Capital
Deficit
Equity
Repurchase
of common stock
3,590
$
38,684
$
73,877
$
112,561
NOTE
10. 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 2007, 2006 and 2005,
matching contributions charged to expense were approximately $7.4 million,
$6.5 million and $4.5 million, respectively.
Through
December 31, 2006, KCI offered a deferred compensation plan (the "Plan") for key
management personnel. The Plan offered the employee a rate of return
based on various investment opportunities. The employee was able to
receive distributions in a lump sum, or over five or ten years upon retirement
as defined, or at a date previously specified. Our obligation under this Plan
was that of an unsecured promise to pay in the future. In December
2006, management made the decision to discontinue the Plan effective January 1,2007. There were no salary deferrals made subsequent to December 31,2006. All balances as of December 31, 2006 remained with the Plan
throughout 2007 unless the participant had a previously-scheduled
distribution. Any undistributed balances as of December 31, 2007 will
be distributed during the first quarter of 2008. Amounts payable to a
participant shall be paid from the general assets of KCI,
exclusively. KCI established a Rabbi Trust to increase security for
the Plan benefits. At December 31, 2007, the assets in the Rabbi
Trust include approximately $7.8 million of cash surrender value under life
insurance policies for the participants and cash held by the
Trust. The liability of the Plan is approximately
$7.1 million. Both the assets and the liabilities of the Plan
have been reflected in our consolidated financial statements.
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. The maximum aggregate
number of shares of common stock that may be issued in connection with grants
under the Directors Stock Plan is 400,000 shares, subject to adjustment as
provided for in the plan. The exercise price of options granted under
this plan is determined as the fair market value of the shares of our common
stock, which is equal to the closing price of our common stock on the date that
such option is granted. The options granted will 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. The Compensation Committee
of the Board of Directors administers the Directors Stock
Plan. During 2007, 2006 and 2005, we granted approximately 44,000,
41,000 and 41,000 options, respectively, to purchase shares of common
stock. Additionally, during 2007, 2006 and 2005, we issued
approximately 18,000, 14,000 and 10,000 shares of restricted stock,
respectively, under this plan.
On
February 9, 2004, KCI’s shareholders approved the 2004 Equity Plan (the “Equity
Plan”) and the 2004 Employee Stock Purchase Plan (the “ESPP”). The
Equity Plan was effective on February 27, 2004 and reserves 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% may 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 Equity Plan is
equal to KCI’s closing stock price on the date that such option is
granted. The options granted will 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
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 is determined on the grant date based on KCI’s
closing stock price. The likelihood of meeting the performance
criteria is considered when determining the vesting period on a periodic
basis. Restricted stock and restricted stock units granted are
classified primarily as equity awards.
During
2007, 2006 and 2005, we granted approximately 972,000, 1,596,000 and 766,000
options, respectively, to purchase shares of common stock under the Equity
Plan. Additionally, during 2007, 2006 and 2005, we issued
approximately 270,000, 385,000 and 123,000 shares, respectively, of restricted
stock and restricted stock units under the Equity Plan at a weighted average
estimated fair value of $53.03, $35.71 and $57.83, 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 are scheduled to vest 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 2007, 2006 and
2005, there were approximately 119,000, 124,000 and 106,000 shares of common
stock purchased, respectively, under the ESPP.
The
following table summarizes the number of common shares reserved for future
issuance under our stock option plans as of December 31, 2007:
2003
Non-Employee Directors Stock Plan
126,826
2004
Equity Plan
3,003,661
2004
Employee Stock Purchase Plan
2,107,836
5,238,323
A summary
of our stock option activity, and related information, for the year ended
December 31, 2007 is set forth in the table below:
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 2007, 2006 and 2005 was $50.5 million, $120.7
million and $77.7 million, respectively. Cash received from stock
options exercised during 2007 and 2006 was $28.4 million and $11.9 million,
respectively, and the actual tax benefit from share-based payment arrangements
totaled $18.4 million and $45.8 million, respectively.
The fair
value of stock options granted during 2007, 2006 and 2005 was $24.30, $17.63 and
$21.04, respectively. As of December 31, 2007, there was $44.0
million of total unrecognized compensation cost 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.
The
following table summarizes restricted stock activity for the year ended December31, 2007:
The
weighted average grant date fair value of restricted stock granted during 2007,
2006 and 2005 was $52.79, $35.84 and $57.95, respectively. The total
fair value of restricted stock which vested during 2007 and 2006 was
approximately $4.3 million and $400,000, respectively. No restricted
stock vested in 2005. As of December 31, 2007, there was $22.5
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 2.8
years.
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
11. 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):
Net
earnings per share were calculated using the weighted average number of common
shares outstanding. See Note 1(m) to our consolidated financial
statements. 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
2005
Net
earnings
$
237,144
$
195,468
$
122,155
Weighted
average shares outstanding:
Basic
70,975
70,732
69,404
Dilutive
potential common shares from stock options and restricted stock
(1)
699
1,920
3,620
Diluted
71,674
72,652
73,024
Basic
net earnings per share
$
3.34
$
2.76
$
1.76
Diluted
net earnings per share
$
3.31
$
2.69
$
1.67
(1)
Potentially dilutive stock options and restricted stock totaling 1,779
shares, 3,241 shares and 595 shares for 2007, 2006 and 2005, respectively,
were excluded from the computation of diluted weighted average shares
outstanding due to their antidilutive effect.
On
September 30, 2005, KCI reached an agreement to settle its litigation with
Novamedix Limited, a subsidiary of Orthofix International NV. Under
the terms of the settlement, KCI paid Novamedix $75.0 million. The
settlement payment resulted in a charge of $72.0 million, net of recorded
reserves of $3.0 million, or $47.4 million and $0.65 per diluted share, net of
taxes, during the third quarter of 2005. The settlement resolved and
settled all claims between the parties in the case and allows KCI to continue
selling the PlexiPulse line of products going forward under a royalty-free
license without further claim of infringement by Novamedix. Total
revenues for the PlexiPulse product line were $3.0 million, $3.8 million and
$4.7 million for 2007, 2006 and 2005, respectively. The Novamedix
settlement will not have a continuing impact on future operations or cash
flows.
NOTE
14. 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. The 2003 case filed against
BlueSky Medical Group, Inc., Medela, Inc. and Medela AG is currently on appeal
before the Federal Circuit Court of Appeals in Washington, D.C. In
2006, the 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 device marketed by BlueSky. In 2007, BlueSky
Medical was acquired by Smith & Nephew plc, which is now a party to the
appeal. Initial appellate briefs have been filed by all parties to
the appeal. As a result of the appeal, the District Court’s final
judgment could be modified, set aside or reversed, or the case could be remanded
to District Court for retrial.
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 negative pressure devices which we
believe infringe a Wake Forest continuation patent issued in 2007 relating to
our V.A.C. technology. Also, 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
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.
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 NPWT device recently introduced
by ITI infringes three Wake Forest patents which are exclusively licensed to
KCI. We are seeking damages and injunctive relief in the case. Also
in January 2008, in a separate action, KCI and its affiliates filed suit in
state District Court in Bexar County, Texas, against ITI and three of its
principals, all of whom were former employees of KCI. The claims in the suit
include breach of confidentiality agreements, conversion of KCI technology,
theft of trade secrets and conspiracy. We are seeking damages and injunctive
relief in the case.
Although
it is not possible to reliably predict the outcome of the lawsuits 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 $950.1 million in revenue, or
59.0% of total revenue for the year ended December 31, 2007 and $808.3 million
in revenue, or 58.9% of total revenue for the year ended December 31, 2006 from
our domestic V.A.C. Therapy products relating to the U.S. patents at
issue. In continental Europe, we derived $199.5 million in revenue,
or 12.4% of total revenue for the year ended December 31, 2007 and $158.9
million, or 11.6% of total revenue for the year ended December 31, 2006 in
V.A.C. revenue relating to the patents at issue in the ongoing German
litigation.
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
health care 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
NPWT in 2005. As part of the 2005 study, KCI provided 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.
In June
2007, the Medicare Region D contractor notified KCI of a post-payment audit of
claims paid during 2006. The DMAC requested information on 250 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. The DMAC subsequently made a minor recoupment for the
exceptions noted during its review.
We are
currently responding to requests from a Medicare Region A Recovery Audit
Contractor (“RAC”) covering claims submitted between 2004 and
2005. The RAC audits are part of a pilot program under the CMS
Medicare Integrity Program, currently being conducted in California, Florida and
New York. At this time, we are awaiting additional information and it
is not possible for KCI to determine the outcome of these requests.
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. In the event that a post-payment 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 provided in the audit.
We also
routinely receive pre-payment reviews of claims we submit for Medicare
reimbursement. In December 2007, the Medicare Region B DMAC initiated
a pre-payment review of all second and third cycle NPWT claims submitted by all
providers, including KCI. While we are actively responding to these
ongoing requests, if a determination is made that our records or the patients’
medical records are insufficient to meet medical necessity or Medicare
reimbursement requirements, we could be subject to denial, recoupment or refund
demands for claims submitted for Medicare reimbursement. The
results of this or any pre-payment audit could also result in subsequent
post-payment audits for claims previously paid by Medicare. 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 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. Going forward, it is
likely that we will be subject to periodic inspections, assessments and audits
of our billing and collections practices.
Violations
of federal and state regulations can result in severe criminal, civil and
administrative penalties and sanctions, including disqualification from Medicare
and other reimbursement programs.
As of
December 31, 2007, our commitments for the purchase of new product inventory
were $39.9 million, including approximately $13.7 million of disposable products
from our main disposable supplier and $10.9 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 6.
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, 2006 and 2005, we purchased approximately
$3.1 million, $4.3 million and $2.3 million in hospital bed
frames from Stryker, respectively. During 2005, we sold approximately
$77,000 of therapeutic support systems to Stryker. We made no sales
to Stryker in 2007 and 2006.
C. Thomas
Smith became a member of our Board of Directors in April 2003, after he had
retired as the Chief Executive Officer and President of VHA Inc.
VHA Inc. is affiliated with Novation, LLC, a group purchasing organization
with which we have had major supply contracts since the 1980s. During
fiscal years 2007, 2006 and 2005, we received approximately $193.6 million,
$179.2 million and $159.6 million, respectively, in V.A.C. and
Therapeutic Support Systems revenues under our Novation contracts.
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 2007, 2006 and 2005, we recorded
revenue of approximately $1.5 million, $1.1 million and $1.5 million,
respectively, for V.A.C. products and therapeutic support systems billed to
Vanderbilt University.
NOTE
16. Segment and Geographic
Information
We are
principally engaged in the rental and sale of advanced wound care systems and
therapeutic support systems throughout the United States and in 18 primary
countries internationally. Revenues are attributed to individual countries based
on the location of the customer.
We define
our business segments based on geographic management
responsibility. We have two reportable segments: the United States,
which includes Puerto Rico, and International, which includes operations for all
countries outside of the United States. We have two primary product lines:
V.A.C. Therapy and therapeutic support systems. Revenues
for each of our product lines are disclosed for our operating
segments. Other than revenue, no discrete financial information is
available for our product lines. Our product lines are marketed and
serviced by the same infrastructure and, as such, we do not manage our business
by product line, but rather by geographical segments. We measure
segment profit as operating earnings, which is defined as income before interest
income and other, 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):
(1)
Other
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.
The
following is other selected geographic financial information of KCI (dollars in
thousands):
Net
earnings per share for the full year differs from the total of the quarterly
earnings per share due to the repurchase of shares in our 2006 share repurchase
program.
(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.
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
2007 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, 2007. 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, 2007,
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, 2007 as stated in their report, included herein.
We have
audited Kinetic Concepts, Inc.’s internal control over financial reporting as of
December 31, 2007, 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, 2007, 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, 2007 and 2006, and the
related consolidated statements of earnings, shareholders’ equity, and cash
flows for each of the three years in the period ended December 31, 2007 of
Kinetic Concepts, Inc. and subsidiaries and our report dated February 22, 2008
expressed an unqualified opinion thereon.
ITEM
10. DIRECTORS,
EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE
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, 2007
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, Texas78230.
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 21, 2007. 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."
ITEM
12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANGEMENT AND RELATED
SHAREHOLDER MATTERS
The
following chart gives aggregate information regarding grants under all of our
equity compensation plans through December 31, 2007:
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
3,283,181
(1)
$
42.69
(2)
5,238,323
(3)
Equity
compensation plans not approved by security holders
-
-
-
Total
3,283,181
$
42.69
5,238,323
(1)
This amount includes 71,604 shares of common stock that are subject to
outstanding restricted stock unit awards. This amount does not
include 530,392 shares of common stock issued and outstanding pursuant to
unvested restricted stock awards.
(2)
Calculated exclusive of outstanding restricted stock unit
awards.
(3)
This amount includes 126,826 shares available for future issuance under
the Directors Stock Plan and 3,003,661 shares available for future
issuance under the 2004 Equity Plan, both of which provide for grants of
restricted stock, options and other awards. This amount also includes
2,107,836 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."
ITEM
13. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
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."
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.
Restated
Articles of Incorporation (with Amendments) of Kinetic Concepts, Inc.
(filed as Exhibit 3.4 to Amendment No. 1 to our Registration Statement on
Form S-1, filed on February 2, 2004, as thereafter
amended).
3.2
Third
Amended and Restated By-laws of Kinetic Concepts, Inc. (filed as
Exhibit 3.6 to our Registration Statement on Form S-1, filed on
May 28, 2004).
3.3
Amendment
to the Third Amended and Restated By-laws of Kinetic Concepts, Inc. (filed
as Exhibit 3.1 on Form 8-K, filed on December 28,2007).
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).
10.1
Amended
and Restated Agreement Among Shareholders, dated as of January 26, 2005
(filed as Exhibit 10.1 on Form 8-K, filed on January 27,2005).
10.2
KCI
Employee Benefits Trust Agreement (filed as Exhibit 10.21 to our Annual
Report on Form 10-K/A, dated December 31, 1994, filed on January 23,1996).
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, Texas78230
(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
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).
**10.8
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).
10.9
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).
10.10
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).
**10.11
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).
**10.12
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).
**10.13
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).
**10.14
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 September30, 2006, filed on August 9, 2006).
**10.15
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).
**10.16
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).
**10.17
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).
**10.18
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).
**10.19
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).
**10.20
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).
**10.21
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).
***10.22
Kinetic
Concepts, Inc. Compensation Policy for Outside Directors, as adopted on
December 4, 2007.
**10.23
Executive
Retention Agreement between Kinetic Concepts, Inc. and Martin J. Landon,
dated February 21, 2007 (filed as Exhibit 10.31 to our Annual Report
on Form 10-K for the year ended December 31, 2006, filed on
February 23, 2007).
Employment
Separation and Release Agreement, dated June 12, 2007, between Kinetic
Concepts, Inc. and Mark Carbeau (filed as Exhibit 10.1 to our Quarterly
Report on Form 10-Q for the quarter ended June 30, 2007, filed on July 27,2007).
**10.29
Settlement
Agreement, dated June 25, 2007, between KCI Europe Holding B.V. and Jörg
Menten (filed as Exhibit 10.2 to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2007, filed on July 27, 2007).
**10.30
Offer
letter, dated July 18, 2007, between Kinetic Concepts, Inc. and Linwood A.
Staub (filed as Exhibit 10.3 to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2007, filed on July 27, 2007).
**10.31
Executive
Retention Agreement, dated July 18, 2007, between Kinetic Concepts, Inc.
and Linwood A. Staub (filed as Exhibit 10.4 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2007, filed on July 27,2007).
***10.32
Contract
of Employment, effective December 3, 2007, between KCI UK Holdings Limited
and TLV Kumar.
***10.33
Executive
Retention Agreement between Kinetic Concepts, Inc. and T.L.V. Kumar, dated
December 3, 2007.
***10.34
2003
Non-Employee Directors Stock Plan, as Amended and Restated on December 4,2007.
***10.35
Form
of Kinetic Concepts, Inc. 2004 Equity Plan International Stock Option
Agreement, as amended on February 19, 2008.
***10.36
Form
of Kinetic Concepts, Inc. 2004 Equity Plan Restricted Stock Unit Award
Agreement, as amended on February 19, 2008.
***10.37
Form
of Kinetic Concepts, Inc. 2004 Equity Plan International Restricted Stock
Unit Award Agreement, as amended on February 19, 2008.
***10.38
Form
of Kinetic Concepts, Inc. 2004 Equity Plan Nonqualified Stock Option
Agreement, as amended on February 19, 2008.
***10.39
Form
of Kinetic Concepts, Inc. 2004 Equity Plan Restricted Stock Award
Agreement, as amended on February 19, 2008.
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, 2008.
*31.2
Certification
of the Chief Financial Officer Pursuant to section 302 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2008.
*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, 2008.
† Exhibit
filed herewith. Confidential treatment requested on certain
portions of this exhibit. An unredacted version of this exhibit has been
filed separately with the Securities and Exchange
Commission.
†† 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.
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 23, 2008.
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.
Restated
Articles of Incorporation (with Amendments) of Kinetic Concepts, Inc.
(filed as Exhibit 3.4 to Amendment No. 1 to our Registration Statement on
Form S-1, filed on February 2, 2004, as thereafter
amended).
3.2
Third
Amended and Restated By-laws of Kinetic Concepts, Inc. (filed as
Exhibit 3.6 to our Registration Statement on Form S-1, filed on
May 28, 2004).
3.3
Amendment
to the Third Amended and Restated By-laws of Kinetic Concepts, Inc. (filed
as Exhibit 3.1 on Form 8-K, filed on December 28,2007).
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).
10.1
Amended
and Restated Agreement Among Shareholders, dated as of January 26, 2005
(filed as Exhibit 10.1 on Form 8-K, filed on January 27,2005).
10.2
KCI
Employee Benefits Trust Agreement (filed as Exhibit 10.21 to our Annual
Report on Form 10-K/A, dated December 31, 1994, filed on January 23,1996).
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, Texas78230
(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
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).
**10.8
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).
10.9
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).
10.10
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).
**10.11
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).
**10.12
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).
**10.13
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).
**10.14
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 September30, 2006, filed on August 9, 2006).
**10.15
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).
**10.16
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).
**10.17
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).
**10.18
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).
**10.19
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).
**10.20
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).
**10.21
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).
***10.22
Kinetic
Concepts, Inc. Compensation Policy for Outside Directors, as adopted on
December 4, 2007.
**10.23
Executive
Retention Agreement between Kinetic Concepts, Inc. and Martin J. Landon,
dated February 21, 2007 (filed as Exhibit 10.31 to our Annual Report
on Form 10-K for the year ended December 31, 2006, filed on
February 23, 2007).
Employment
Separation and Release Agreement, dated June 12, 2007, between Kinetic
Concepts, Inc. and Mark Carbeau (filed as Exhibit 10.1 to our Quarterly
Report on Form 10-Q for the quarter ended June 30, 2007, filed on July 27,2007).
**10.29
Settlement
Agreement, dated June 25, 2007, between KCI Europe Holding B.V. and Jörg
Menten (filed as Exhibit 10.2 to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2007, filed on July 27, 2007).
**10.30
Offer
letter, dated July 18, 2007, between Kinetic Concepts, Inc. and Linwood A.
Staub (filed as Exhibit 10.3 to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2007, filed on July 27, 2007).
**10.31
Executive
Retention Agreement, dated July 18, 2007, between Kinetic Concepts, Inc.
and Linwood A. Staub (filed as Exhibit 10.4 to our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2007, filed on July 27,2007).
***10.32
Contract
of Employment, effective December 3, 2007, between KCI UK Holdings Limited
and TLV Kumar.
***10.33
Executive
Retention Agreement between Kinetic Concepts, Inc. and T.L.V. Kumar, dated
December 3, 2007.
***10.34
2003
Non-Employee Directors Stock Plan, as Amended and Restated on December 4,2007.
***10.35
Form
of Kinetic Concepts, Inc. 2004 Equity Plan International Stock Option
Agreement, as amended on February 19, 2008.
***10.36
Form
of Kinetic Concepts, Inc. 2004 Equity Plan Restricted Stock Unit Award
Agreement, as amended on February 19, 2008.
***10.37
Form
of Kinetic Concepts, Inc. 2004 Equity Plan International Restricted Stock
Unit Award Agreement, as amended on February 19, 2008.
***10.38
Form
of Kinetic Concepts, Inc. 2004 Equity Plan Nonqualified Stock Option
Agreement, as amended on February 19, 2008.
***10.39
Form
of Kinetic Concepts, Inc. 2004 Equity Plan Restricted Stock Award
Agreement, as amended on February 19, 2008.
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, 2008.
*31.2
Certification
of the Chief Financial Officer Pursuant to section 302 of the
Sarbanes-Oxley Act of 2002 dated February 26, 2008.
*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, 2008.
† Exhibit
filed herewith. Confidential treatment requested on certain
portions of this exhibit. An unredacted version of this exhibit has been
filed separately with the Securities and Exchange
Commission.
†† 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.
Dates Referenced Herein and Documents Incorporated by Reference
