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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
Commission file number 333-56135
RIVER HOLDING CORP.
(Exact name of registrant as specified in its charter)
Delaware 95-4674065
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
599 Lexington Avenue, 18th Floor 10022
New York, New York (Zip Code)
(Address of Principal Executive Offices)
(212) 958-2555
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [x] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [_] Not Applicable.
As of March 30, 2000, the number of shares of Common Stock, $.01 par value,
outstanding (the only class of common stock of the registrant outstanding) was
8,544,291. The registrant's Common Stock is not traded in a public market.
Aggregate market value of the registrant's voting and nonvoting Common
Stock: Not Applicable.
Documents Incorporated by Reference: None
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RIVER HOLDING CORP. AND SUBSIDIARIES
Fiscal Year Ended December 31, 1999
TABLE OF CONTENTS
Page
----
PART I............................................................................................. 1
Item 1. Business............................................................................ 1
Item 2. Properties.......................................................................... 8
Item 3. Legal Proceedings................................................................... 8
Item 4. Submissions of Matters to a Vote of Security Holders................................ 9
PART II............................................................................................ 10
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 10
Item 6. Selected Financial Data............................................................. 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 12
Item 7A. Quantitative and Qualitative Disclosure About Market Risk........................... 26
Item 8. Financial Statements................................................................ 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 27
PART III........................................................................................... 28
Item 10. Directors and Executive Officers of the Registrant.................................. 28
Item 11. Executive Compensation.............................................................. 29
Item 12. Security Ownership of Certain Beneficial Owners and Management...................... 32
Item 13. Certain Relationships and Related Transactions...................................... 33
PART IV............................................................................................ 35
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K..................... 35
SIGNATURES......................................................................................... S-1
PART I
Item 1. Business.
This Annual Report on Form 10-K contains "forward-looking statements"
within the meaning of Section 27-A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. These
statements include without limitation the words "believes," "anticipates,"
"estimates," "intends," "expects," and words of similar import. All statements
other than statements of historical fact included in statements under "Item 1.
Business," "Item 2. Properties," "Item 3. Legal Proceedings" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation" include forward-looking information and may reflect certain
judgements by management. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of River Holding Corp. and Hudson
Respiratory Care Inc. or the respiratory care and anesthesia products industries
to be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. These potential risks,
uncertainties include, but are not limited to, those identified in the "Risk
Factors" section of this Form 10-K located at the end of "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
Company disclaims any obligation to update any such factors or to publicly
announce the results of any revisions to any of the forward-looking statements
contained herein to reflect future events or developments.
General
River Holding Corp. ("Holding") conducts all of its operations through
its majority-owned subsidiary, Hudson Respiratory Care Inc. ("Hudson RCI" or the
"Company"). The Company is a leading manufacturer and marketer of disposable
medical products utilized in the respiratory care and anesthesia segments of the
domestic and international health care markets. The Company offers one of the
broadest respiratory care and anesthesia product lines in the industry,
including such products as oxygen masks, humidification systems, nebulizers,
cannulae and tubing. In the United States, the Company markets its products to a
variety of health care providers, including hospitals and alternate site service
providers such as outpatient surgery centers, long-term care facilities,
physician offices and home health care agencies. Internationally, the Company
sells its products to distributors that market to hospitals and other health
care providers. The Company's products are sold to over 3,000 distributors and
alternate site service providers throughout the United States and in more than
75 countries worldwide. The Company has supplied the disposable respiratory care
market for over 50 years and enjoys strong brand name recognition and leading
market positions.
The Company manufactures and markets over 2,300 respiratory care and
anesthesia products. The Company believes that its broad product offering
represents a competitive advantage over suppliers with more limited product
offerings, as health care providers seek to reduce medical supply costs and
concentrate purchases among fewer vendors. The Company also benefits
competitively from its extensive relationships with leading group purchasing
organizations or GPOs, as large purchasing organizations play an increasingly
important role in hospitals' purchasing decisions.
The Company maintains two manufacturing facilities and two distribution
facilities in the United States, assembly operations in Mexico and Malaysia and
sales and marketing offices in the United States, Sweden and Germany. The
Company has reduced its manufacturing and assembly costs through cost reduction
programs, process improvement, equipment automation and upgrades and increased
utilization of its Ensenada, Mexico facility for labor-intensive operations.
Hudson Oxygen Therapy Sales Company ("Hudson Oxygen"), Hudson RCI's
predecessor, was founded in 1945. In 1988, Hudson Oxygen formed Industrias
Hudson, a subsidiary that oversees the Company's assembly operation in Mexico.
In 1989, Hudson Oxygen merged with Respiratory Care Inc. to form Hudson RCI. In
April 1998, the Company consummated a recapitalization, pursuant to which it
became a majority-owned subsidiary of Holding. In the past five years, the
Company has pursued a number of strategic acquisitions in order to expand its
product line and geographic penetration, most significantly with the July 1999
acquisition of Louis Gibeck AB ("LGAB"), a Swedish company that manufactures and
markets medical devices. Hudson RCI's principal executive offices are located
at 27711
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Diaz Road, P.O. Box 9020, Temecula, California 92589, and its telephone
number is (909) 676-5611. Holding was incorporated in Delaware in January 1998.
Holding's principal executive offices are located at 599 Lexington Avenue, 18th
Floor, New York, New York 10022, and its telephone number is (212) 758-2555.
Industry Overview
The worldwide market for disposable respiratory care and anesthesia
products consists of the domestic hospital market, the alternate site market and
the international market. Respiratory care and anesthesia principally involve
the delivery of oxygen and anesthesia from a gas source, such as a mechanical
ventilator or respirator, to the patient's pulmonary system. The gas is
typically delivered to the patient through specialized tubing connecting to a
cannula, mask or endotracheal tube. In addition, it is often necessary to
humidify or medicate the gas. The market for respiratory care and anesthesia
products, including disposable products, is expected to be positively impacted
by demographic trends, both domestically and internationally. In the United
States, changes in demographics, including an aging population, increased
incidence and awareness of respiratory illnesses and heightened focus on cost-
efficient treatment, have had a positive impact on the domestic respiratory care
and anesthesia markets. There has been an increasing incidence of respiratory
illnesses (such as asthma and emphysema), due in part to an increasingly
susceptible aging population, environmental pollution, smoking-related illnesses
and communicable diseases with significant respiratory impact, such as
tuberculosis, HIV and influenza. The Company believes that the international
respiratory care and anesthesia markets will experience many of the trends
currently affecting domestic markets. In addition, many international markets
have high incidences of communicable respiratory diseases and are becoming
increasingly aware of the value of single-use, disposable products.
The market for respiratory care and anesthesia products is also
affected by trends involving the health care market generally. In particular,
the overall trend towards cost containment has increased the desirability of
disposable products relative to reusable products, and has influenced pricing,
distribution channels, purchasing decisions and health care delivery methods.
Efforts to contain rising health care costs have increased the
preference for disposable medical products that improve the productivity of
health care professionals and reduce overall provider costs. Health care
organizations are evaluating modes of treatment that are less labor and/or
technology intensive as a means of decreasing the cost of care, which can often
result in increased disposable usage. In particular, increased utilization of
disposable products can decrease labor and other costs associated with
sterilizing reusable products. In addition, the risks of transmission of
infectious diseases such as HIV, hepatitis and tuberculosis, and related
concerns about the occupational safety of health care professionals, have also
contributed to an increased preference for disposable single-use medical
products.
Cost containment has caused consolidation throughout the health care
product supply channel, which has favored manufacturers with large product
offerings and competitive pricing. In an effort to contain costs, service
providers have consolidated to form GPOs, which take advantage of group buying
power to obtain lower supply prices. This, in turn, has led to consolidation
among distributors, who seek to provide "one-stop shopping" for these large
buying groups. Distributors have also sought to concentrate purchases among
fewer vendors in an effort to reduce supply costs. Since selection as a GPO
provider and strong relationships with distributors are critical to many health
care manufacturers, they have responded to these trends by providing a broad
range of integrated products, combined with reliable delivery and strong after-
sales support.
Cost containment has also caused a migration of the decision making
function with respect to supply acquisition from the clinician to the
administrator. As clinicians lose influence and purchasing agents, materials
managers and upper level management become more involved in the purchasing
decision, a greater emphasis is placed on price relative to product features and
clinical benefits.
As a result of cost containment, health care is increasingly provided
outside of traditional hospital settings through alternate health care sites,
such as outpatient surgery centers, long-term care facilities, physician offices
and
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patients' homes. Growth of the alternate site market is also attributable to
advances in technology that have facilitated the delivery of care outside of the
hospital, an increased number of illnesses and diseases considered to be
treatable outside of the hospital and increased acceptance by the medical
community of, and patient preference for, non-hospital treatment.
Products
The Company manufactures and markets products for use in respiratory
care and anesthesia. The products for each market are similar and often overlap,
as do the distribution channels.
The Company groups its products into nine categories: (i) oxygen
delivery; (ii) aerosol therapy; (iii) active and passive humidification; (iv)
ventilatory support; (v) adaptors, connectors and filters; (vi) resuscitation;
(vii) airway management; (viii) electronic monitoring; and (ix) durable
equipment.
Category/Products Description
- -------------------------------------- ----------------------------------------------
Oxygen Delivery: Oxygen Masks, Oxygen Used to deliver therapeutic, supplemental
Cannulae, Oxygen Tubing oxygen to a patient. Oxygen masks cover the
nose and mouth. Nasal cannulae fit inside
the nostrils. Both masks and cannulae are
connected to an oxygen source via small
diameter tubing through which oxygen flows.
Aerosol Therapy: AQUAPAK(R) Large Used to create and deliver aerosolized
Volume, Prefilled Nebulizers; particles of liquid water, sodium chloride or
Non-Prefilled Large Volume Nebulizer; medication to the patient's airways to dilute
UPDRAFT(R), UPDRAFT II(R), AVA-NEB(R) and mobilize secretions and/or dilate
and MICRO MIST(R) Small Volume, constricted breathing passages. The peak
Medication Nebulizers; Aerosol Tubing; flow meter is used to monitor the patient's
AQUATHERM(R) and THERMAGARD(R) respiratory status before and after an
Nebulizer Heaters; AQUAPAK Prefilled aerosolized medication treatment.
Ultrasonic Cups; ADDIPAK(R) Prefilled
Unit Dose Solutions; POCKETPEAK(R)
Peak Flow Meter
Active and Passive Humidification: Heated humidification systems actively heat
CONCHATHERM(R) Heated Humidifiers, and humidify oxygen/air mixtures or
AQUA+(R) Hygroscopic Condenser anesthetic gases provided by a mechanical
Humidifiers, AQUAPAK Prefilled ventilator or anesthesia gas machine.
Humidifiers, Non-Prefilled, Reusable Hygroscopic condenser humidifiers passively
Humidifier, Non-Prefilled Disposable conserve the heat and humidity in the
Humidifier, HUMID-HEAT(R) patient's exhaled breath for use during
Heat-Moisture Exchangers inspiration. Prefilled and non-prefilled
humidifiers are used to add water vapor to
oxygen being provided to a patient via a mask
or cannula.
Ventilatory Support: Conventional Used to convey an oxygen/air mixture and/or
Ventilator Circuits, Heated-Wire anesthetic gas from a mechanical ventilator
Ventilator Circuits, Anesthesia or anesthesia gas machine to a patient during
Breathing Circuits, Air Cushion the temporary or long-term support of
Anesthesia Masks, Infant CPAP Systems ventilation. The infant CPAP system provides
non-invasive respiratory support to premature
infants with under-developed, immature lungs.
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Category/Products Description
- -------------------------------------- ----------------------------------------------
Adaptors, Connectors and Filters: A The adaptors and connectors are frequently
wide variety of adaptors and used in respiratory care and anesthesia to
connectors; Main Flow Bacterial/Viral add accessories, modify configurations,
Filters; Pulmonary Function Filter and/or customize other related products to
meet specific needs. Filters are used to
protect patients, caregivers, and medical
equipment from cross-contamination with
bacteria and viruses.
Resuscitation: LIFESAVER(R) Reusable Used during cardiopulmonary resuscitation
and Disposable Resuscitation Bags, ("CPR") to adequately support and/or maintain
Isolation Valves and Kits, LIFESAVER the patient's ventilatory function.
Tubes and Kits
Airway Management: SOFTECH(R) Cuffed Assist in securing and maintaining an open
and Uncuffed Endotracheal Tubes; airway and unobstructed breathing passage.
CATH-GUIDE(R), Color-Coded and They also can assure that the patient's
DUAL-CHANNEL Oral Pharyngeal Airways; ventilation can be maintained and that
BITEGARD(TM) Oral Bite Block; CATH-GUIDE respiratory secretions can be adequately
Closed Suction Catheters; VOLDYNE(R) removed from the lungs.
and TRI-FLO(R) Incentive Breathing
Exercisers
Electronic Monitoring: Replacement The oxygen sensors, monitors and analyzers
oxygen sensors, Oxygen Monitors and are used to analyze and monitor the amount of
Analyzers, VENTILARM II(R) oxygen being administered to a patient. The
Low-Pressure Alarms low-pressure alarm is used to detect a
patient disconnect or a leak in the breathing
circuit during mechanical ventilation.
Durable Equipment: Oxygen Regulators; Used to regulate oxygen flow from cylinders,
Cylinder Carts, Trucks and Stands; stabilize or transport oxygen or other gas
Portable Oxygen Units cylinders, and provide a portable oxygen
supply for emergency use.
Sales, Marketing and Distribution
The Company has sales offices in Temecula, Sweden and Germany. While
substantially all of the Company's domestic hospital sales are made to
distributors, the Company's marketing efforts are focused on the health care
service provider. In the alternate site market, the Company both sells and
markets directly to the service provider. The Company's five largest alternate
site accounts are Gulf South Medical Supply, Inc., Medline Industries, Inc.,
Moore Medical Corp., Redline Healthcare Corp. and VGM & Associates.
Internationally, the Company sells its products to distributors that market to
hospitals and other health care providers. See Note 10 to "Item 8. Financial
Statements" for information with respect to international sales. The Company's
sales personnel currently call on approximately 2,800 health care providers, 50
hospital distributors and 1,500 alternate site customers. Due to consolidation
and cost pressures among the Company's customer base, the Company's target call
point at the health care provider has been moving away from the clinician to
include a purchasing manager or corporate executive. As of December 31, 1999,
the Company had a sales backlog of approximately $2.6 million.
4
In the current market environment, GPO relationships are an essential
part of access to the Company's target markets and the Company has entered into
preferred supplier arrangements with 11 national GPOs. The Company is typically
positioned as either a sole supplier of respiratory care disposables to the GPO,
or as one of two suppliers. While these arrangements set forth pricing and terms
for various levels of purchasing, they do not obligate either party to purchase
or sell a specific amount of product. In addition, GPO affiliated hospitals
often purchase products from other suppliers notwithstanding the existence of
sole or dual source GPO arrangements. Further, these arrangements are terminable
at any time, but in practice usually run for two to three years. The Company
enjoys longer terms with two of its major GPOs, Novation LLC (which represents
the 1998 consolidation of VHA, Inc. and University HealthSystem Consortium) and
Columbia/HCA Healthcare Corporation. The Company's most significant GPO
relationships are with AmeriNet Inc., Columbia/HCA Healthcare Corporation,
Health Services Corporation of America, MedEcon Medical Services, Novation LLC
and Purchase Connection Limited.
Health care providers have responded to pressures to reduce their costs
by merging with other members of their industry. The acquisition of a customer
of the Company often results in the renegotiation of contracts, the granting of
price concessions or in the loss of the customer. Alternatively, to the extent a
customer of the Company grows through acquisition activity, the Company may
benefit from increased sales to the larger entity.
The Company markets its products primarily through consultative
dialogue with health care providers, targeted print advertising, trade shows,
selective promotional arrangements with distributors and the Company's heater
lease program. To support sales of the entire line of humidification and
ventilation products, the Company leases heaters to domestic customers without
charge. The revenues from the sale of products used in connection with the
operation of the heaters covers the amortization of the heater cost under the
leases. The Company has heaters with a net book value of approximately $1.1
million placed at service provider locations under this program.
The Company utilizes a network of over 3,000 hospital distributors, as
well as additional alternate site distributors, to reach its markets. A number
of these distributors carry competing product lines, but many are moving to
select single supply sources for particular product groups. The Company has been
selected as the FOCUS preferred vendor of respiratory disposables for Owens &
Minor Inc. Such status gives preference to the shipping of the Company's
products versus competing lines. Owens & Minor Inc. is the Company's largest
distributor, accounting for approximately $24.5 million or approximately 19.0%
of total fiscal 1999 net sales. The Company is seeking FOCUS status with its
second largest distributor, McKesson General Medical, Inc. ("McKesson").
McKesson accounted for approximately $14.8 million or approximately 11.5% of
total fiscal 1999 net sales. The Company provides a price list to its
distributors which details base acquisition prices. Distributors receive orders
from the service providers and charge the contract pricing (which is determined
by their GPO affiliation or individual contract price) plus a service margin. As
is customary within the industry, the Company rebates the difference between
base acquisition price and the specific contract price to the distributor. The
Company offers select large health care providers a reward for purchasing a
broader selection of the Company's product lines. The program allows a rebate in
the form of merchandise credit for purchasing minimum volumes from a selected
group of products. The Company's international distributors place their orders
directly with dedicated international customer service representatives based in
Temecula. Customer orders are shipped from one of two warehouse locations. Sales
strategies and marketing plans are tailored to each market with involvement of
the distributor. Region and territory sales managers are responsible for the
launch of products into their regions, including related support and training.
The Company utilizes a network of 100 international distributors, typically on
an exclusive basis within each market.
Manufacturing and Assembly
The Company operates two manufacturing facilities and two distribution
facilities in the United States and assembly facilities in Ensenada, Mexico and
Kuala-Lumpur, Malaysia. While the Company believes that it is operating at a
high utilization rate, existing facilities could support increased capacity with
additional machinery and workers.
The Company's manufacturing facility in Temecula, California houses 76
injection molding machines, 67 of which are automated. During the past five
years, 38 out of the 76 machines have been replaced with more efficient
5
models, which has increased capacity. Tubing is produced on 11 extrusion lines:
6 corrugated, 4 oxygen or "spaghetti," and 1 repellitizer/regrinder. The
Temecula facility uses 12-14 million pounds of over 30 different kinds of resin
annually; the most prominent are PVC, polyethylene and polypropylene. Sterile
prefilled humidification and nebulization products and electronics are
manufactured using 9 blow/fill/seal machines in the Company's facility in
Arlington Heights, Illinois.
The Company's facility located in Ensenada, Mexico is primarily used
for the assembly of certain products molded at the Temecula facility. The
facility is a maquiladora, and therefore there are minimal tariffs associated
with the transport of products and components across the United States-Mexico
border. The Company's facility located in Kuala-Lumpur, Malaysia assembles
virtually all of the products marketed by the LGAB operation. The components
assembled by the Malaysian operation are generally molded by outside vendors in
Malaysia.
The Company occasionally outsources production of certain products
while it establishes its ability to penetrate a target market. Having achieved
an acceptable level of penetration, the Company internalizes the manufacturing
function in order to increase margins and improve quality control.
The Company monitors the quality of its products at the Temecula,
Arlington Heights, Ensenada and Malaysia facilities by statistical sampling and
visual and dimensional inspection. The Company also inspects incoming raw
materials for inconsistencies, rating its vendors on quality and delivery time.
The Company is routinely audited by the FDA and has received no significant
regulatory actions. The Company is in substantial compliance with the GMP/QSR
regulations of the FDA and the United States and Mexico operations have
qualified for an "advanced notification" program allowing the Company to be
informed of FDA inspections in advance. The Company utilizes outside facilities
for sterilization of products produced in Temecula and Ensenada. The Arlington
Heights products are manufactured in a sterile environment and are certified
sterile as a result of the production process. The Ensenada and Arlington
Heights facilities are certified as ISO 9002 compliant and the Temecula facility
is certified as ISO 9001 compliant.
Suppliers and Raw Materials
The Company's primary raw materials are various resins, which are
formed into the Company's products. The top 10 purchased products in 1999 were
Tubing Grade PVC, Clear PVC, LDPE-EVA, Polypropylene, Aluminum Cylinder, Pre-Cut
Elastic, Non-Tubing Grade PVC, Cannula Blanks, Acrylic Resin and Hose-End Grade
PVC. The Company believes that it is able to purchase materials at a cost no
higher than its competitors. The Company does not have long-term supply
contracts for any of its purchased raw materials. The Company believes that
sufficient availability exists for its raw materials, as they consist of mainly
readily available plastic resins.
Research and Development
The Company's research and development department consists of 17
people, including 11 engineers. The Company's research and development efforts
are split between developing new products and process improvements to its
manufacturing operations. The Company develops new products to expand its
product line in anticipation of changes in demand. The Company has invested
heavily in the anesthesia product line, as the Company continues to penetrate
this market. The Company makes several new product introductions every year.
Significant products introduced in the last five years include the line of heat-
moisture exchangers, POCKETPEAK peak flow meter, SOFTECH endotracheal tubes,
MICRO MIST small volume nebulizer and CONCHA IV heated humidification system.
The Company constantly works to reduce costs through improved continued process
improvements. The Company incurred research and development expenses of
approximately $1.1 million, $1.0 million and $2.0 million in fiscal 1997, 1998
and 1999, respectively.
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Competition
The medical supply industry is characterized by intense competition.
The Company's primary competitor in the respiratory care sector is Allegiance
Corporation and its primary competitors in the anesthesia sector include
Allegiance Corporation, The Kendall Company, Smiths Industries Medical Systems,
Inc. and Vital Signs, Inc. Many of the products manufactured by the Company are
available from several sources, and many of the Company's customers tend to have
relationships with several manufacturers. The Company competes on the basis of
brand name, product quality, breadth of product line, service and price.
Patents and Trademarks
The Company has historically relied primarily on its technological and
engineering abilities and on its design and production capabilities to gain
competitive business advantages, rather than on patents or other intellectual
property rights. However, the Company does file patent applications on concepts
and processes developed by the Company's personnel. The Company has 20 patents
in the U.S. Many of the U.S. patents have corresponding patents issued in
Canada, Europe and various Asian countries. The Company's success will depend in
part on its ability to maintain its patents, add to them where appropriate, and
develop new products and applications without infringing the patent and other
proprietary rights of third parties and without breaching or otherwise losing
rights in technology licenses obtained by the Company for other products. There
can be no assurance that any patent owned by the Company will not be
circumvented or challenged, that the rights granted thereunder will provide
competitive advantages to the Company or that any of the Company's pending or
future patent applications will be issued with claims of the scope sought by the
Company, if at all. If challenged, there can be no assurance that the Company's
patents (or patents under which it licenses technology) will be held valid or
enforceable. In addition, there can be no assurance that the Company's products
or proprietary rights do not infringe the rights of third parties. If such
infringement were established, the Company could be required to pay damages,
enter into royalty or licensing agreements on onerous terms and/or be enjoined
from making, using or selling the infringing product. Any of the foregoing could
have a material adverse effect upon the Company's business, financial condition
or results of operations.
Government Regulation and Environmental Matters
The Company and its customers and suppliers are subject to extensive
Federal and state regulation in the United States, as well as regulation by
foreign governments, and the Company cannot predict the extent to which future
legislative and regulatory developments concerning its practices and products
for the health care industry may affect the Company. Most of the Company's
products are subject to government regulation in the United States and other
countries. In the United States, the FDC Act and other statutes and regulations
govern or influence the testing, manufacture, safety, labeling, storage, record
keeping, marketing, advertising and promotion of such products. Failure to
comply with applicable requirements can result in fines, recall or seizure of
products, total or partial suspension of production, withdrawal of existing
product approvals or clearances, refusal to approve or clear new applications or
notices and criminal prosecution. Under the FDC Act and similar foreign laws,
the Company, as a marketer, distributor and manufacturer of health care
products, is required to obtain the clearance or approval of Federal and foreign
governmental agencies, including the FDA, prior to marketing, distributing and
manufacturing certain of those products. The Company may also need to obtain FDA
clearance before modifying marketed products or making new promotional claims.
Delays in receipt of or failure to receive required approvals or clearances, the
loss of previously received approvals or clearances, or failures to comply with
existing or future regulatory requirements in the United States or in foreign
countries could have a material adverse effect on the Company's business.
Foreign sales are subject to similar requirements.
The Company is required to comply with the FDA's GMP/QSR Regulations,
which set forth requirements for, among other things, the Company's
manufacturing process, design control and associated record keeping, including
testing and sterility. Further, the Company's plants and operations are subject
to review and inspection by local, state, Federal and foreign governmental
entities. The distribution of the Company's products may also be subject to
state regulation. The impact of FDA regulation on the Company has increased in
recent years as the Company has increased
7
its manufacturing operations. The Company's suppliers, including the sterilizer
facilities, are also subject to similar governmental requirements. There can be
no assurance that changes to current regulations or additional regulations
imposed by the FDA will not have an adverse impact on the Company's business and
financial condition in the future. The FDA also has the authority to issue
special controls for devices manufactured by the Company, which it has not done
to date. In the event that such special controls were issued, the Company's
products would be required to conform, which could result in significant
additional expenditures for the Company.
The Company is also subject to numerous federal, state and local laws
and regulations relating to such matters as safe working conditions,
manufacturing practices, fire hazard control and the handling and disposal of
hazardous or infectious materials or substances and emissions of air pollutants.
The Company owns and leases properties which are subject to environmental laws
and regulations. There can be no assurance that the Company will not be required
to incur significant costs to comply with such laws and regulations in the
future or that such laws or regulations will not have a material adverse effect
upon the Company's business, financial condition or results of operations. In
addition, the Company cannot predict the extent to which future legislative and
regulatory developments concerning its practices and products for the health
care industry may affect the Company.
Employees
As of March 15, 2000, the Company employed approximately 1,950
employees, substantially all of whom were full-time employees. None of the
Company's employees is represented by unions and the Company considers its
employee relations to be good.
Item 2. Properties.
The Company owns approximately 30 acres of land in Temecula, California
on which its headquarters, one of two principal manufacturing centers and three
other buildings totaling approximately 245,000 square feet are located. Plastic
and vinyl components and corrugated tubing are manufactured in Temecula and
assembled into finished goods at a 77,000 square foot facility in Ensenada,
Mexico. The Company owns the Ensenada facility and the underlying land is held
in a 30-year trust that expires in 2019. The Company leases an 86,000 square
foot manufacturing facility in Arlington Heights, Illinois under a lease that
expires in 2000. Prefilled sterile solutions and electronics are manufactured in
Arlington Heights. The Company also leases a 73,000 square foot distribution
warehouse in Elk Grove, Illinois under a lease that expires in 2000, and a
25,375 square foot distribution facility in Atlanta, Georgia under a lease that
expires in April 2001. The Company leases sales and marketing offices in
Stockholm, Sweden and Lohman, Germany under leases that expire in April 2001 and
April 2002, respectively. The Company also leases a 33,260 square foot facility
in Kuala-Lumpur, Malaysia, under a lease that expires in July 2001. This
facility primarily assembles finished products for the Swedish operation.
The Company believes that its current facilities are adequate for its
present level of operations. Management expects that the Arlington Heights and
Elk Grove leases will be renewed on favorable terms.
Item 3. Legal Proceedings.
The Company is party to lawsuits and other proceedings, including suits
relating to product liability and patent infringement. While the results of such
lawsuits and other proceedings cannot be predicted with certainty, management
does not expect that the ultimate liabilities, if any, will have a material
adverse effect on the financial position or results of operations of the
Company.
8
Item 4. Submissions of Matters to a Vote of Security Holders.
None.
9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
There is no established public trading market for the Company's Common
Stock. As of March 30, 2000, Holding has 16 record holders of its Common Stock.
Holding has not paid cash dividends to its shareholders in the past two
years, and does not intend to pay cash dividends in the foreseeable future. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
Operations--Liquidity and Capital Resources" for a discussion of restrictions on
Holding's ability to pay cash dividends.
Item 6. Selected Financial Data.
The selected fiscal year end historical financial data has been derived
from the audited financial statements of the Company and Holding. The
information contained in this table should be read in conjunction with the
Company's audited consolidated financial statements and notes thereto.
River
Holding
Corp.(a) Hudson Respiratory Care
--------------------------- ------------------------------------------------------
Fiscal Year
------------------------------------------------------
1998
(As
Restated;
See Note 15
to the
Inception Audited
to Financial
12/25/98 1999 1995 1996 1997 Statements) 1999(b)
---------- -------- -------- --------- --------- ------------ --------
(dollars in thousands)
Operating Data:
Net sales................................. $ 76,232 $128,803 $ 86,825 $ 93,842 $ 99,509 $ 100,498 $128,803
Cost of sales............................. 44,662 77,678 49,896 52,189 54,575 56,802 75,418
---------- -------- -------- --------- --------- --------- --------
Gross profit.............................. 31,570 51,125 36,929 41,653 44,934 43,696 53,385
Operating expenses:
Selling expenses.......................... 8,032 13,122 8,283 8,961 9,643 10,350 13,122
Distribution expenses..................... 2,471 4,647 3,088 3,114 3,170 3,336 4,647
General and administrative expenses....... 7,129 14,732 9,769 11,277 11,456 10,284 14,732
Research and development expenses......... 726 2,031 1,257 1,184 1,072 976 2,031
Amortization of goodwill.................. 3,785 5,080 -- -- -- -- --
Provision for equity participation plan... -- -- 11,415 8,249 6,954 63,939 --
Provision for retention payments.......... -- -- -- -- -- 4,754(c) --
---------- -------- -------- --------- --------- --------- --------
Operating income (loss)................... $ 9,427 $ 11,513 $ 3,117 $ 8,868 $ 12,639 $ (49,943) $ 18,853
Other (income) and expenses:
Interest expense.......................... 11,100 17,263 2,424 2,177 1,834 11,327 17,263
Other (income) expense.................... (99) 1,322 811 (463) (638) 406 1,232
---------- -------- -------- --------- --------- --------- --------
Total other expense....................... 11,001 18,595 3,235 1,714 1,196 11,733 18,495
---------- -------- -------- --------- --------- --------- --------
Income (loss) before provision (benefit)
for income taxes....................... (1,574) (7,082) (118) 7,154 11,443 (61,676) 358
Provision (benefit) for income taxes...... (614) (1,508) 280 73 150 8,405 1,586
---------- -------- -------- --------- --------- --------- --------
Income (loss) before extraordinary item... (960) (5,574) (398) 7,081 11,293 (70,081) (1,228)
Extraordinary item (loss on
extinguishment of debt)................ -- -- -- -- -- 104(d) --
---------- -------- -------- --------- --------- --------- --------
Net income (loss)......................... $ (960) $ (5,083) $ (398) $ 7,081 $ 11,293 $ (70,185) $(1,228)
========== ======== ======== ========= ========= ========= ========
continued on following page
10
River
Holding
Corp.(a) Hudson Respiratory Care
--------------------- ------------------------------------------------------
Fiscal Year
------------------------------------------------------
1998
(As
Restated;
See Note 15
to the
Inception Audited
to Financial
12/25/98 1999 1995 1996 1997 Statements) 1999(b)
---------- -------- -------- --------- --------- ------------ --------
(dollars in thousands)
Other Financial Data:
Net cash provided by (used in) operating
activities............................. $ 3,854 $ 7,097 $ 15,939 $ 16,133 $ 19,269 $ (83,024) $ 7,097
Net cash used in investing activities..... $ (254,472) $(75,818) $ (6,088) $ (11,354) $ (3,673) $ (6,444) $(75,818)
Net cash provided by (used in) financing
activities............................. $ 251,125 $ 71,529 $(11,880) $ (3,668) $ (16,398) $ 89,624 $ 71,529
Adjusted EBITDA(e)........................ $ 17,934 $ 29,993 $ 21,205 $ 23,194 $ 25,440 $ 24,851 $ 29,993
Adjusted EBITDA margin(f)................. 23.5% 23.3% 24.4% 24.7% 25.6% 24.7% 23.3%
Operating margin before EPP and Retention
Payments(g)............................ 12.4% 8.9% 16.7% 18.2% 19.7% 18.7% 14.6%
Depreciation and amortization(h).......... $ 8,507 $ 15,655 $ 6,820 $ 6,133 $ 5,847 $ 6,101 $ 8,315
Capital expenditures...................... $ 3,120 $ 10,973 $ 5,850 $ 6,395 $ 4,659 $ 3,111 $ 10,973
Ratio of Adjusted EBITDA to cash interest
expense................................ 2.1x 1.7x 8.7x 10.7x 13.9x 2.3x 2.1x
Ratio of total debt to Adjusted EBITDA.... 8.9x 7.1x 1.2x 1.2x 0.8x 6.4x 7.1x
Ratio of earnings to fixed charges(i)..... (0.1)x -- 1.0x 3.7x 6.0x -- 1.0x
Deficiency of earnings to cover fixed
charges................................... $ (12,852) (7,082) -- -- -- $ (61,676) --
Ratio of earnings to fixed charges and
preferred stock dividends(j)........... -- -- 1.0x 3.7x 6.0x -- --
Deficiency of earnings to cover fixed
charges and preferred stock dividends.. $ (5,761) $ (13,597) -- -- -- $ (65,863) $ (6,160)
Balance Sheet Data:
Working capital........................... $ 29,865 $ 36,204 $ 18,641 $ 24,188 $ 6,430 $ 29,533 $ 35,971
Working capital as adjusted(k)............ 32,358 39,960 22,461 26,768 29,960 32,026 39,727
Total assets.............................. 262,709 344,961 64,387 76,910 77,554 165,321 251,819
Total debt................................ 159,000 211,694 25,364 28,146 20,250 159,000 211,694
Shareholders' equity (deficit)............ 59,653 (12,957) 19,112 19,872 22,515 (37,735) (14,649)
- ----------------------
(a) Holding was formed to effect the Recapitalization. Accordingly, operating
data for 1998 presented for Holding is for the period from April 7, 1998 to
December 25, 1998. Holding accounted for the acquisition of the Company
using the purchase method of accounting, which was not pushed down to the
accounts of the Company. Accordingly, the carrying amounts of certain
assets and liabilities on the financial statements of Holding differ
substantially when compared to those of the Company. All financial
covenants are calculated using the Company's accounts, and, accordingly, no
such comparative amounts for Holding are presented.
(b) Includes results of operations for (i) LGAB, since it was acquired in July
1999, (ii) Medimex, since certain of its assets were acquired in October
1999 and (iii) Tyco, since certain of its assets were acquired in November
1999. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Recent Developments."
(c) Reflects retention payments made to substantially every employee of the
Company in connection with the Recapitalization. These payments were
intended to ensure the continued employment of all employees after the
Recapitalization and no future payments are anticipated.
(d) Reflects the write-off of deferred financing fees related to the payoff of
outstanding debt under the Company's previous credit agreement.
(e) Adjusted EBITDA represents income before depreciation and amortization,
interest expense, income tax expense, charges related to the Equity
Participation Plan, which was terminated upon consummation of the
Recapitalization
11
and recognition of the portion of purchase price allocation related to
acquired inventories. The Company has excluded payments under the Equity
Participation Plan to present comparable figures for all historical periods
presented. Adjusted EBITDA is not a measure of performance under generally
accepted accounting principles, and should not be considered as a substitute
for net income, cash flows from operating activities and other income or
cash flow statement data prepared in accordance with generally accepted
accounting principles, or as a measure of profitability or liquidity. The
Company has included information concerning Adjusted EBITDA as one measure
of an issuer's historical ability to service debt. In addition, certain
covenants in the Indenture are based upon a calculation analogous to
Adjusted EBITDA. Adjusted EBITDA should not be considered as an alternative
to, or more meaningful than, income from operations or cash flow as an
indication of the Hudson RCI's operating performance. For purposes of
compliance with the Indenture, the Company's Consolidated Net Income and
EBITDA will not be reduced by retention payments, payments made pursuant to
the Equity Participation Plan or by the amount of any contingent payments
made by the Company to former participants in the Equity Participation Plan.
See "Certain Relationships and Related Transactions."
(f) Represents ratio of Adjusted EBITDA to net sales.
(g) Represents ratio of operating income before EPP and retention payments to
net sales.
(h) Includes amortization of deferred financing fees of $0.1 million in 1995 and
$0.1 million in 1996, which should be excluded from depreciation and
amortization in calculating Adjusted EBITDA since such fees are reflected
below the operating income line.
(i) For the purpose of determining the ratio of earnings to fixed charges,
earnings consist of earnings before income taxes and fixed charges. Fixed
charges consist of interest on indebtedness, the amortization of debt issue
costs and that portion of operating rental expense representative of the
interest factor.
(j) For the purpose of determining the ratio of earnings to fixed charges and
preferred stock dividends, earnings consist of earnings before income taxes
and fixed charges. Fixed charges consist of interest on indebtedness, the
amortization of debt issue costs and that portion of operating rental
expense representative of the interest factor. Preferred stock dividends,
consisting of amounts to be paid-in-kind, are also included in the pro forma
fixed charge amounts. Preferred stock dividends have been "grossed up" to a
pre-income tax basis to provide comparability to other components of the
ratio.
(k) Working capital as adjusted represents current assets, excluding cash, less
current liabilities, excluding the current portion of long-term debt.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation.
Because Holding is a holding company with no operations, the following
discussion relates primarily to the Company. The following discussion of the
Company's consolidated historical results of operations and financial condition
should be read in conjunction with the consolidated financial statements of the
Company and the notes thereto included elsewhere in this Form 10-K. The
following discussion and analysis includes periods before completion of the
Recapitalization.
General
The Company has increased its net sales and improved its position
within the disposable health care products market in recent years by increasing
its respiratory care product offering, introducing disposable products for the
anesthesia health care market, expanding its presence in international markets
and establishing a position in the growing alternate site market.
The Company's results of operations may fluctuate significantly from
quarter to quarter as a result of a number of factors, including, among others,
the buying patterns of the Company's distributors, GPOs and other purchasers of
the Company's products, forecasts regarding the severity of the annual cold and
flu season, announcements of new product introductions by the Company or its
competitors, changes in the Company's pricing of its products and the prices
offered by the Company's competitors, rate of overhead absorption due to
variability in production levels and variability in the number of shipping days
in a given quarter.
12
Recent Developments
On November 8, 1999, the Company acquired certain assets of Tyco
Healthcare Group LP ("Tyco"), including Tyco's incentive breathing exerciser and
pulmonary function monitor product lines, for a cash purchase price of
approximately $23.8 million. The Tyco acquisition was funded principally with
proceeds from the Company's $60.0 million revolving line of credit.
On October 8, 1999, the Company acquired certain assets of Medimex, a
German distribution company that had previously distributed products for both
the Company and LGAB, for a cash purchase price of $2.2 million. The assets were
acquired through the Company's wholly-owned, non-guarantor subsidiary, HRCDAC
Inc., and was funded with cash on hand.
On July 22, 1999, the Company, through its indirect, wholly-owned
subsidiary Steamer Holding AB, a company organized under the laws of Sweden
("Steamer"), acquired a majority of the outstanding capital stock of LGAB, a
company organized under the laws of Sweden. Pursuant to a series of private
purchases and a tender offer consummated pursuant to Swedish law, Steamer
acquired 604,000 shares of Class A stock and 2,452,838 shares of Class B stock
representing approximately 82.0% of the capital and 62.8% of the voting power of
LGAB at a price of 115 Swedish krona (approximately $13.60 at the July 22
exchange rate) per share of Class A stock and Class B stock for an aggregate
cash purchase price of approximately $45.5 million. In addition, on August 4,
1999, Steamer acquired an additional 483,750 shares of Class A stock of LGAB
from River Holding Corp., a Delaware corporation and the parent of Steamer and
the Company ("Holding"), which shares Holding acquired in a private transaction
in exchange for 525,042 shares of common stock of Holding ("Holding Common
Stock"). The exchange ratio for the Class A stock was the same as the effective
price per share of the shares acquired in the tender offer. After giving effect
to this exchange and the conversion of the Series A stock acquired by Steamer in
the tender offer into Series B stock, Steamer holds approximately 99.0% of the
capital and 100.0% of the voting power of LGAB. The Company intends that
Steamer, through continuing purchases and a statutory freezeout and appraisal
procedure under Swedish law, will acquire the remaining outstanding shares of
LGAB as soon as practicable.
The cash for the purchase price and certain related transaction costs
was funded with (i) $22.0 million in gross proceeds from the sale of Holding
Common Stock to the majority stockholder of Holding, (ii) a $22.0 million loan
from the majority stockholder of Holding to Steamer's parent, HRC Holding Inc.,
a Delaware corporation and a wholly-owned subsidiary of the Company, and (iii)
the funding of 50 million Swedish krona (approximately $5.9 million) pursuant to
the terms of a loan facility agreement between Steamer and Svenska Handelsbanken
AB.
Founded in 1954, LGAB develops, manufactures and markets medical device
products which humidify, heat and filter a patient's breathing gases during
anesthesia and intensive care. LGAB is a market leader in the area of "heat
moisture exchange" ("HME") products, with approximately 25% share of the world
market. Following completion of the acquisition, the Company intends to continue
LGAB's operations in substantially the same manner as conducted prior to the
acquisition.
In September 1998, the Company acquired certain assets of Gibeck, Inc.,
a subsidiary of LGAB, for approximately $3.35 million. Prior to the transaction,
Gibeck, Inc. was engaged primarily in the business of manufacturing, marketing
and selling disposable anesthesia supplies. In conjunction with that
transaction, the Company became the exclusive North American distributor of
LGAB's HME product line. In fiscal year 1997, Gibeck, Inc. reported net sales of
approximately $12.3 million.
The Company established a sales office located in Germany in the second
quarter of 1999. It is anticipated that this operation will better equip the
Company to more aggressively pursue the German market. The German operation had
a negative impact on the Company's results of approximately $1.3 million in
fiscal 1999. It is anticipated that the Company's earnings will be positively
impacted for fiscal 2000 and beyond.
13
The Recapitalization
On April 7, 1998, Hudson RCI consummated its Recapitalization pursuant
to an Agreement and Plan of Merger pursuant to which River Acquisition Corp., a
wholly-owned subsidiary of Holding merged with and into Hudson RCI, with Hudson
RCI surviving as a majority-owned subsidiary of Holding (the "Merger").
Pursuant to the Recapitalization, Holding contributed approximately
$93.0 million in equity capital into Hudson RCI (the "Holding Equity
Investment") and a shareholder of Hudson RCI (the "Continuing Shareholder")
retained common stock of Hudson RCI ("HCRI Common Stock") with a value of
approximately $15.0 million (the "Rollover Equity"), based on the valuation of
Hudson RCI used in the Recapitalization. In the Merger, a portion of the HRCI
Common Stock was converted into the right to receive approximately $131.1
million in cash, and management received $88.3 million pursuant to the Company's
Equity Participation Plan (the "Equity Participation Plan" or "EPP"). Following
the Holding Equity Investment, Holding owned 80.8% of the outstanding HRCI
Common Stock and the Continuing Shareholder owned the remaining 19.2%.
The Holding Equity Investment was comprised of $63.0 million of common
equity (the "Common Stock Investment") and $30.0 million of preferred equity
(the "Preferred Stock Investment"). The Common Stock Investment was funded with
a $55.0 million investment by affiliates of Freeman Spogli & Co. Incorporated
("Freeman Spogli"), and an $8.0 million investment by management of Hudson RCI.
The Preferred Stock Investment was funded with proceeds from the sale of 11-1/2%
Senior Exchangeable PIK Preferred Stock due 2010 (the "Holding Preferred Stock")
with an aggregate liquidation preference of $30.0 million offered by Holding
(the "Preferred Stock Offering"). Immediately following consummation of the
Recapitalization, Freeman Spogli beneficially owned approximately 87.3% of the
outstanding Holding Common Stock and management owned the remaining 12.7%.
In connection with the Recapitalization and concurrently with the
Preferred Stock Offering, Hudson RCI offered $115.0 million aggregate principal
amount of 9-1/8% Senior Subordinated Notes due 2008 (the "Subordinated Notes")
(the "Subordinated Notes Offering," and together with the Preferred Stock
Offering, the "Offerings").
On April 7, 1998, Hudson RCI entered into an agreement (the "Credit
Facility") providing for a $40.0 million secured term loan facility (the "Term
Loan Facility"), which was funded in connection with the consummation of the
Recapitalization, and a $60.0 million revolving loan facility (the "Revolving
Loan Facility") which will be available for Hudson RCI's future capital
requirements and to finance acquisitions.
The Offerings and the application of the net proceeds therefrom,
repayment of existing Hudson RCI debt payments to the Continuing Shareholder
under the Recapitalization Agreement and to management, the Holding Equity
Investment and the related borrowings under the Credit Facility are collectively
referred to herein as the "Recapitalization."
The Company and the shareholders that received distributions in the
Recapitalization made an election under Section 338(h)(10) of the Internal
Revenue Code of 1986, as amended, to treat the Recapitalization as an asset
purchase for tax purposes, which had the effect of significantly increasing the
basis of the Company's assets, thus increasing depreciation and amortization
expenses and other deductions for tax purposes and reducing the Company's
taxable income in 1998 and subsequent years. The Recapitalization resulted in no
change in the basis of the Company's assets and liabilities for financial
reporting purposes. A deferred tax asset was recorded upon the Company's
conversion from a Subchapter S corporation to a Subchapter C corporation,
primarily resulting from the Section 338(h)(10) election.
14
Results of Operations
The following tables set forth, for the periods indicated, certain
income and expense items expressed in dollars and as a percentage of the
Company's net sales.
Fiscal Year
-----------------------------------------------
1997 1998 1999
---- ---- ----
(dollars in thousands)
Net sales............................................................ $99,509 $100,498 $128,803
Cost of sales........................................................ 54,575 56,802 75,418
------- -------- --------
Gross profit....................................................... 44,934 43,696 53,385
------- -------- --------
Selling expenses..................................................... 9,643 10,350 13,122
Distribution expenses................................................ 3,170 3,336 4,647
General and administrative expenses.................................. 11,456 10,284 14,732
Research and development expenses.................................... 1,072 976 2,031
Provision for equity participation plan.............................. 6,954 63,939 --
Provision for retention payments..................................... -- 4,754 --
------- -------- --------
Total operating expenses............................................. 35,138 96,921 34,532
------- -------- --------
Operating income (loss).............................................. 12,639 (49,943) 18,853
Add back: Provision for equity participation plan.................... 6,954 63,939 --
Add back: Provision for retention payments........................... -- 4,754 --
------- -------- --------
Operating income before provision for equity participation plan and $19,593 $ 18,750 $ 18,853
provision for retention payments.................................... ======= ======== ========
15
Fiscal Year
--------------------------------------------
1997 1998 1999
---- ---- ----
Net sales............................................................ 100.0% 100.0% 100.0%
Cost of sales........................................................ 54.8 56.5 58.5
------- -------- --------
Gross profit....................................................... 45.2 43.5 41.4
------- -------- --------
Selling expenses..................................................... 9.7 10.3 10.2
Distribution expenses................................................ 3.2 3.3 3.6
General and administrative expenses.................................. 11.5 10.2 11.4
Research and development expenses.................................... 1.1 1.0 1.6
Provision for equity participation plan.............................. 7.0 63.6 --
Provision for retention payments..................................... -- 4.7 --
------- -------- --------
Total operating expenses............................................. 35.3 96.4 26.8
------- -------- --------
Operating income (loss).............................................. 12.7 (49.7) 14.6
Add back: Provision for equity participation plan.................... 7.0 63.6 --
Add back: Provision for retention payments........................... -- 4.7 --
------- -------- --------
Operating income before provision for equity participation plan and 19.7% 18.7% 14.6%
provision for retention payments.................................... ======= ======== ========
Year Ended December 31, 1999 Compared to Year Ended December 25, 1998
Net sales, reported net of accrued rebates, were $128.8 million in
1999, an increase of $28.3 million or 28.2% over 1998. Of the $28.3 million
increase, approximately $6.1 million related to the acquisition of LGAB, $2.2
million related to the Tyco acquisition and $0.9 million related to the Medimex
acquisition. In addition, the full effect in 1999 of the Gibeck, Inc.
acquisition in September 1998 resulted in a sales increase of $7.6 million. For
the base Hudson RCI business, domestic hospital sales increased by $3.3 million
or 5.5%, due to increased demand at the hospital level, primarily the result of
increased sales through certain GPOs. Alternate site sales increased by $4.4
million or 26.5% as the Company continued to focus its efforts on this growing
market. International sales increased by $1.6 million or 9.1%, as growth in
sales continued to Japan and Europe. This growth was partially offset by
weakness in South America. Sales to customers in Southeast Asia have stabilized,
remaining virtually unchanged over 1998. Canadian sales increased by
approximately $0.3 million, due primarily to the efforts of a new distributor in
that country. Approximately 30% of the Company's 1999 total net sales were to
two distributors.
The Company's gross profit for 1999 was $53.4 million, an increase of
$9.7 million or 22.2% from 1998. As a percentage of net sales, the Company's
gross profit was 41.4% for 1998 as compared to 43.5% for 1997. This decline was
primarily due to the recognition of inventory revalued as a result of the LGAB
acquisition, increased shipping costs as a result of sales of acquired Gibeck,
Inc. products, and an unfavorable mix variance caused by increased sales of
products at lower gross margins. This trend is expected to continue in the
future if the preference for passive humidification products over higher margin
active humidification products continues. This trend was partially offset by
manufacturing cost reductions realized by the Company and higher gross margins
of sales at LGAB.
Selling expenses were $13.1 million for 1999, an increase of $2.7
million or 26.8% over 1998. This increase was due primarily to $1.2 million of
costs associated with LGAB and $1.2 million as a result of the start-up of the
German sales operation. In addition, sales and marketing expenses at Hudson RCI
increased by approximately $0.3 million. As a percentage of net sales, selling
expenses decreased to 10.2% as compared to 10.3% in 1998.
16
Distribution expenses were $4.6 million for 1999, an increase of $1.3
million or 39.0% over 1998. As a percentage of sales, distribution expenses
increased to 3.6% as compared to 3.3% in 1998. The increase is primarily the
result of the increased cost of freight between the Company's distribution
facilities, the start up of a distribution facility in Atlanta and increased
headcount.
General and administrative expenses for 1999 were $14.7 million, an
increase of $4.4 million or 43.3% over 1998. Of this increase, $2.0 million
relates to expenses incurred at LGAB and $0.2 million as a result of the German
operation. In addition, the company increased management bonuses and incurred
certain non-recurring consulting expenses. As a percentage of net sales, general
and administrative expenses were 11.4% in 1999 as compared to 10.2% in 1998.
Research and development expenses were $2.0 million in 1999, an
increase of $1.1 million or 108.2% over 1998. This increase was primarily due to
the addition of LGAB research and development expenses of $0.7 million and
increases in the Hudson RCI engineering staff.
The provision for equity participation plan consists of accrued
expenses and payments made to executives under the Equity Participation Plan.
The Equity Participation Plan was terminated upon consummation of the
Recapitalization and replaced with an executive stock purchase plan. See "Item
11. Executive Compensation--Stock Purchase Plan." No payments under the Equity
Participation Plan were made in 1999 that were not provided for in 1998. In
1998, the provision for equity participation plan was $63.9 million, which
included approximately $1.3 million in employer taxes relating to the
distribution made under the Equity Participation Plan.
The provision for retention payments, including related employer
payroll taxes, was $4.8 million in 1998. These payments were made to
substantially every employee in the Company and were intended to ensure the
continued employment of all employees after the Recapitalization. No payments
were made in 1999 and no future retention payments are anticipated.
Interest expense was $17.3 million for 1999, an increase of $5.9
million over 1998. The increase was due to higher debt levels during 1999 as a
result of the LGAB and Tyco acquisitions. Interest expense is expected to
increase in 2000 reflecting a full year of interest expense at the higher debt
level.
Year Ended December 25, 1998 Compared to Year Ended December 26, 1997
Net sales, reported net of accrued rebates, were $100.5 million in
1998, an increase of $1.0 million or 1.0% over 1997. Domestic hospital sales
declined by $3.1 million or 4.8%, due primarily to the decreased demand of $5.0
million from hospitals affiliated with the Premier GPO, as the Premier contract
for respiratory supplies was awarded to a competitor in February 1997. This
decline was partially offset by Gibeck sales of approximately $2.3 million.
Average selling price of certain domestic hospital sales also declined slightly
from 1997 to 1998 due to pricing terms of a contract entered into in 1997.
Alternate site sales increased by $2.1 million or 14.4% as the Company continued
to focus its efforts on this growing market. International sales increased by
$1.1 million or 5.8%. Although good growth was experienced in Japan
(approximately 35.0%), this was partially offset by general weakness in other
parts of Southeast Asia. There is continued uncertainty in the outlook for sales
in Southeast Asia in the near term. Sales in Europe were essentially flat as
compared to 1997. Approximately 33% of the Company's 1998 total net sales were
to two distributors.
The Company's gross profit for 1998 was $43.7 million, a decline of
$1.2 million or 2.7% from 1997. As a percentage of net sales, the Company's
gross profit was 43.5% for 1998 as compared to 45.2% for 1997. This decline was
primarily due to an unfavorable mix variance caused by increased sales of
products at lower gross margins. This trend is expected to continue in the
future if the preference for passive humidification products over higher margin
active humidification products continues. This trend was partially offset by
manufacturing cost reductions realized by the Company.
17
Selling expenses were $10.4 million for 1998, an increase of $0.7
million or 7.3% over 1997. This increase is primarily the result of higher fees
paid to certain GPOs due to higher sales to their facilities. As a percentage of
net sales, selling expenses increased to 10.3% as compared to 9.7% in 1997.
Distribution expenses were $3.3 million for 1998, an increase of $0.1
million over 1997. As a percentage of sales, distribution expenses increased to
3.3% as compared to 3.2% in 1997.
General and administrative expenses for 1998 were $10.3 million, a
decrease of $1.2 million or 10.2% over 1997. This decrease is primarily the
result of the elimination of certain costs associated with the Recapitalization
and lower management bonuses. These declines were partially offset by legal
expenses of approximately $300,000 relating to the successful defense of a
patent infringement lawsuit. As a percentage of net sales, general and
administrative expenses were 10.2% in 1998 as compared to 11.5% in 1997.
Research and development expenses were $1.0 million in 1998 and were
virtually unchanged from 1997.
The provision for equity participation plan consists of accrued
expenses and payments made to executives under the Equity Participation Plan.
The Equity Participation Plan was terminated upon consummation of the
Recapitalization and replaced with an executive stock purchase plan. See "Item
11. Executive Compensation--Stock Purchase Plan." In 1998, the provision for
equity participation plan was $63.9 million, which included approximately $1.3
million in employer taxes relating to the distribution made under the Equity
Participation Plan.
The provision for retention payments, including related employer
payroll taxes, was $4.8 million in 1998. These payments were made to
substantially every employee in the Company and were intended to ensure the
continued employment of all employees after the Recapitalization. No future
retention payments are anticipated.
Interest expense was $11.3 million for 1998, an increase of $9.5
million over 1997. The increase was due to higher debt levels during 1998 as a
result of the Recapitalization. Interest expense is expected to increase in 1999
reflecting a full year of interest expense at the higher debt level.
The net effect of the Company's conversion from S to C corporation
status and the related Section 338(h)(10) election to increase the tax bases of
assets in connection with the Recapitalization of $77.1 million was previously
reflected in operations during the quarter ended June 26, 1998. This amount
should have been reflected as a direct credit to retained earnings. This
restatement has no impact on ending retained earnings for the periods presented.
The impact of the restatement on the accompanying financial statements is as
follows (amount in thousands):
As
Originally
Year Ended December 25, 1998 Reported Adjustments As Restated
- ---------------------------- ---------- ----------- ------------
Net loss before provision for income taxes............ $(61,676) $ -- $(61,676)
======== ========== ========
Net income (loss) before extraordinary item........... $ 6,983 $(77,064) $(70,081)
======== ========== ========
Net income (loss)..................................... $ 6,879 $(77,064) $(70,185)
======== ========== ========
Seasonality
The Company's results of operations exhibit some measure of
seasonality. Generally, the Company's sales and EBITDA are higher in the first
and fourth quarters and lower in the second and third quarters. This is due
primarily to the higher incidence of breathing ailments, such as colds and flu,
during the winter months, which results in increased hospitalization and
respiratory care, especially among higher-risk individuals, such as infants and
the elderly. Fourth quarter sales are generally the Company's highest, as
distributors increase inventory in anticipation of the cold and flu seasons.
First quarter results are generally affected by the length and severity of flu
seasons.
18
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash flow from
operations and borrowings under its working capital bank facility. Cash provided
by operations totaled $19.3 million in 1997 and cash provided by operations
before EPP payments and retention bonuses totaled $(57.2) million and $8.2
million in 1998 and 1999, respectively. The decline from 1997 to 1998 is
primarily attributable to increased interest expense due to higher debt levels.
The Company had operating working capital, excluding cash and short-term debt,
of $30.0 million, $32.0 million and $39.7 million as of the end of fiscal 1997,
1998 and 1999, respectively. Inventories were $16.6 million, $18.0 million and
$24.0 million as of the end of fiscal 1997, 1998 and 1999, respectively. In
order to meet the needs of its customers, the Company must maintain inventories
sufficient to permit same-day or next-day filling of most orders. Such
inventories are higher than those that would be required for delayed filling of
orders, thus adversely impacting liquidity. Over time, the Company expects its
level of inventories to increase as the Company's sales in the international
market increase. Accounts receivable, net of allowances, were $21.3 million,
$25.8 million and $30.4 million at the end of fiscal 1997, 1998 and 1999,
respectively. The average number of days sales in accounts receivable
outstanding was approximately 85 days for 1999, compared to 84 days for 1998 and
77 days for 1997. The Company offers 30 day credit terms to its U.S. hospital
distributors. Alternate site and international customers typically receive 60 to
90 day terms and, as a result, as the Company's alternate site and international
sales have increased, the amount and aging of its accounts receivable have
increased. The Company anticipates that the amount and aging of its accounts
receivable will continue to increase. The Company established a sales office in
Germany in the second quarter of 1999. While this will have the effect of
increasing the Company's investment in inventories, management believes that it
will also result in improved service to international customers as well as in
lower international accounts receivable than would otherwise be the case because
customers will receive products, and consequently pay for them, more quickly.
In connection with the Recapitalization, the Company made cash payments
under the Equity Participation Plan and for retention bonuses of $89.6 million
in the year ended December 25, 1998, which it funded with the proceeds of the
debt and equity transactions that were part of the Recapitalization.
Net cash used in investing activities was $3.7 million, $6.4 million
and $75.8 million in 1997, 1998 and 1999, respectively. These funds were
primarily used to finance the acquisition of the custom anesthesia circuit
product line in 1998, various acquisitions of businesses and for capital
expenditures. Capital expenditures, consisting primarily of new manufacturing
equipment purchases and expansion of the Ensenada facility, totaled $4.7
million, $3.1 million and $11.0 million in 1997, 1998 and 1999, respectively.
The decrease in 1997 and 1998 resulted from temporary delays in projects that
the Company completed in 1998 and 1999. The Company currently estimates that
capital expenditures will be approximately $8.0 million in each of 2000 and
2001, consisting primarily of additional and replacement manufacturing equipment
and new heater placements.
Net cash used in financing activities was $16.4 million in 1997, which
consisted primarily of repayment of debt and shareholder distributions
principally to pay taxes on income passed through by the Company. Net cash
provided by financing was $89.6 million in 1998, reflecting net borrowings by
the Company. Net cash provided by financing activities was $71.5 million in
1999, which was used primarily to finance the LGAB and Tyco acquisitions.
The Company has outstanding $211.7 million of indebtedness, consisting
of $115.0 million of Subordinated Notes issued in connection with the
Recapitalization, borrowings of $71.6 million under the Company's Credit
Facility entered into in connection with the Recapitalization and $7.5 million
in notes payable to affiliates. In addition, LGAB has $17.6 million in
outstanding borrowings under its bank facility.
The Credit Facility consists of a $40.0 million Term Loan Facility (all
of which was funded in connection with the Recapitalization) and a $60.0 million
Revolving Loan Facility. The Revolving Loan Facility has a letter of credit
sublimit of $7.5 million. The Term Loan Facility matures on the sixth
anniversary of the initial borrowing and, commencing June 30, 1999, requires
quarterly principal installments of $3.0 million in 1999, $4.0 million in 2000,
$7.0 million in 2001, $9.0 million in 2002, $11.0 million in 2003, and $10.0
million in 2004. The Revolving Loan Facility matures on the sixth anniversary of
the initial borrowing. The interest rate under the Credit Facility is based, at
the option of the Company, upon either a Eurodollar rate plus 2.50% per annum or
a base rate (as defined) plus 1.50%
19
per annum, each less an applicable pricing adjustment (as defined). Borrowings
under the Credit Facility are required to be prepaid, subject to certain
exceptions, with (i) 75% (or 50% for years when the Company's ratio of Debt to
EBITDA (as defined) is less than 5:1) of Excess Cash Flow (as defined), (ii) 50%
of the net cash proceeds of an equity issuance by the Company in connection with
an initial public offering or 100% of the net cash proceeds of an equity
issuance by the Company other than in connection with an initial public
offering, (iii) 100% of the net cash proceeds of the sale or other disposition
of any properties or assets of Holding and its subsidiaries (subject to certain
exceptions), (iv) 100% of the net proceeds of certain issuances of debt
obligations of Hudson RCI and its subsidiaries and (v) 100% of the net proceeds
from insurance recoveries and condemnations. The Revolving Loan Facility must be
prepaid upon payment in full of the Term Loan Facility. As of December 31, 1999,
the Company had available credit under the Revolving Loan Facility in the amount
of $23.4 million ($16.8 million of which is restricted for use on future
acquisitions). No additional borrowing is available under the Term Loan
Facility.
The Credit Facility is guaranteed by Holding and all existing and
subsequently acquired or organized domestic and, to the extent no adverse tax
consequences would result, foreign subsidiaries of the Company. The Credit
Facility is secured by a first priority lien in substantially all of the
properties and assets of the Company and the guarantors now owned or acquired
later, including a pledge of all of the capital stock of the Company owned by
Holding and all of the shares held by the Company of its existing and future
subsidiaries; provided, that such pledge is limited to 65% of the shares of any
foreign subsidiary to the extent a pledge of a greater percentage would result
in adverse tax consequences to the Company.
The Credit Facility contains covenants restricting the ability of
Holding, the Company and the Company's subsidiaries to, among others, (i) incur
additional debt, (ii) declare dividends or redeem or repurchase capital stock,
(iii) prepay, redeem or purchase debt, (iv) incur liens, (v) make loans and
investments, (vi) make capital expenditures, (vii) engage in mergers,
acquisitions and asset sales, (viii) engage in transactions with affiliates.
Hudson RCI is also required to comply with financial covenants with respect to
(a) limits on annual aggregate capital expenditures (as defined), (b) a fixed
charge coverage ratio, (c) a maximum leverage ratio, (d) a minimum EBITDA test
and (e) an interest coverage ratio.
The Subordinated Notes bear interest at the rate of 9-1/8%, payable
semiannually on each April 15 and October 15, and will require no principal
repayments until maturity. The Subordinated Notes are general unsecured
obligations of the Company. The Subordinated Notes contain covenants that place
limitations on, among other things, (i) the ability of the Company, any
subsidiary guarantors and other restricted subsidiaries to incur additional
debt, (ii) the making of certain restricted payments including investments,
(iii) the creation of certain liens, (iv) the issuance and sale of capital stock
of restricted subsidiaries, (v) asset sales, (vi) payment restrictions affecting
restricted subsidiaries, (vii) transactions with affiliates, (viii) the ability
of the Company and any subsidiary guarantor to incur layered debt, (ix) the
ability of Holding to engage in any business or activity other than those
relating to ownership of capital stock of the Company and (x) certain mergers,
consolidations and transfers of assets by or involving the Company.
In connection with the LGAB acquisition, the Company borrowed $22.0
million pursuant to an unsecured promissory note payable to Freeman Spogli. The
note bears interest at 12.0% per annum, matures in August 2006, and requires
semiannual interest payments. As of December 31, 1999, $7.5 million remained
outstanding on the note.
In connection with the LGAB acquisition, the Company assumed debt owed
by LGAB under its bank facility (the "LGAB Facility"), which totaled $17.6
million as of December 31, 1999. The LGAB Facility, which is denominated in
Swedish krona, bears interest at three-month STIBOR (the interest rate at or
about 11:00 a.m. Stockholm time, two banking days before a draw-down date or the
relevant interest period, quoted for deposits in krona) plus 0.75% to 1.75%
(4.365% to 5.365% at December 31, 1999), matures in December 2003, and is
secured by the common stock of LGAB.
In connection with the Recapitalization, the Company issued to Holding
300,000 shares of its 11 1/2% Senior PIK Preferred Stock due 2010 with an
aggregate liquidation preference of $30.0 million, which has terms and
provisions materially similar to those of the Holding Preferred Stock (the
"Mirror Preferred Stock"). At the election of the Company, dividends may be paid
in kind until April 15, 2003 and thereafter must be paid in cash.
20
Holding is a holding company and will rely on dividends from Hudson RCI
as its primary source of liquidity. Holding does not have and in the future will
not have any assets other than the capital stock of Hudson RCI. The ability of
Hudson RCI to pay cash dividends to Holding when required is restricted by law
and restricted or prohibited under the terms of Hudson RCI's debt instruments,
including the Credit Facility. No assurance can be made that Hudson RCI will be
able to pay cash dividends to Holding when required on the Mirror Preferred
Stock.
The Company believes that after giving effect to the Recapitalization,
the 1999 acquisitions and the incurrence of indebtedness related thereto, based
on current levels of operations and anticipated growth, its cash from
operations, together with other available sources of liquidity, including
borrowings available under the Revolving Loan Facility, will be sufficient over
the next twelve months to fund anticipated capital expenditures and acquisitions
and to make required payments of principal and interest on its debt, including
payments due on the Subordinated Notes and obligations under the Credit
Facility. The Company intends to selectively pursue strategic acquisitions, both
domestically and internationally, to expand its product line, improve its market
share positions and increase cash flows. Financing for such acquisitions is
available, subject to limitations, under the Credit Facility. Any significant
acquisition activity by the Company in excess of such amounts would require
additional capital, which could be provided through capital contributions or
debt financing. The Company has no commitments for such acquisition financing
and to the extent financing is unavailable, acquisitions may be delayed or not
completed.
Year 2000 Compliance
The following discussion about the implementation of the Company's Year
2000 program, the costs expected to be associated with the program and the
results the Company expects to achieve constitute forward-looking information.
As noted below, there are many uncertainties involved with the Year 2000 issue,
including the extent to which the Company will be able to adequately provide for
contingencies that may arise, as well as the broader scope of the Year 2000
issue as it may affect third parties and the Company's key trading partners.
Accordingly, the costs and results of the Company's Year 2000 program and the
extent of any impact on the Company's results of operations could vary
materially from that stated herein.
A significant percentage of software that runs on most computers relies
on two-digit date codes to perform computations and decision-making functions.
Commencing on January 1, 2000, these computer programs may fail from an
inability to interpret date codes properly, misinterpreting "00" as the year
1900 rather than 2000. The Company has completed the identification of all
necessary internal software changes to ensure that it does not experience any
loss of critical business functionality due to the Year 2000 issue. The Company
has completed an assessment of all internal software, hardware and operating
systems and has made all necessary hardware and software changes as a result of
that assessment. The Company has not encountered any material Year 2000 problems
to date and does not believe that its systems will encounter any material Year
2000 problems in the future. The Company's products are not subject to Year 2000
problems.
The Company also relies, directly and indirectly, on the external
systems of various independent business enterprises, such as its customers,
suppliers, creditors, financial organizations, and of governments, for the
accurate exchange of data and related information. The Company could be affected
as a result of any disruption in the operation of the various third-party
enterprises with which the Company interacts. The Company has contacted its key
trading partners to assess its Year 2000 risk based upon the Year 2000 issues of
its partners, and has developed contingency plans for a substantial number of
its key trading partners. These contingency plans include the establishment of
back-up vendors and back-up plans for communications with its customers and for
the procurement of power and water at its Mexico facilities. The cost of
establishing these contingency plans was not material.
The total costs of the Year 2000 program are anticipated to be less
than $100,000, some of which has been expended to date. The costs and time
estimates of the Year 2000 project are based on the Company's best estimates.
There can be no assurance that these estimates will be achieved and that planned
results will be achieved. Risk factors include, but are not limited to, the
retention of internal resources dedicated to the project and the successful
completion of key business partners' Year 2000 projects.
21
Recent Accounting Pronouncements
Statement of Financial Accountings Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities" was issued in
June 1998. Because the Company has no derivative instruments and does not engage
in hedging activities, SFAS No. 133 is not expected to impact the Company
materially.
RISK FACTORS
Substantial Leverage; Shareholders' Deficit
As of December 31, 1999, the Company had $211.7 million of outstanding
indebtedness and a shareholders' deficit of approximately $14.6 million. This
level of indebtedness is substantially higher than the Company's historical debt
levels and may reduce the flexibility of the Company to respond to changing
business and economic conditions. In addition, subject to the restrictions in
the Credit Facility and the indenture governing the Subordinated Notes (the
"Indenture"), the Company may incur additional senior or other indebtedness from
time to time to finance acquisitions or capital expenditures or for other
general corporate purposes. See "--Liquidity and Capital Resources." The Credit
Facility and the Indenture restrict, but do not prohibit, the payment of
dividends by the Company to Holding to finance the payment of dividends on the
Holding Preferred Stock.
The Company's high degree of leverage may have significant consequences
for the Company, including: (i) the ability of the Company to obtain additional
financing for working capital, capital expenditures, acquisitions or other
purposes, if necessary, may be impaired; (ii) a substantial portion of the
Company's cash flow will be dedicated to the payment of interest and principal
on its indebtedness and will not be available to the Company for its operations
and future business opportunities; (iii) the covenants contained in the
indenture and the Credit Facility will limit the Company's ability to, among
other things, borrow additional funds, dispose of assets or make investments and
may affect the Company's flexibility in planning for, and reacting to, changes
in business conditions; (iv) indebtedness under the Credit Facility will be at
variable rates of interest, which will cause the Company to be vulnerable to
increases in interest rates; and (v) the Company's high degree of leverage may
make it more vulnerable to a downturn in its business or the economy generally
or limit its ability to withstand competitive pressures. If the Company is
unable to generate sufficient cash flow from operations in the future to service
its indebtedness, it may be required to refinance all or a portion of its
existing debt or to obtain additional financing. There can be no assurance that
any such actions could be effected on a timely basis or on satisfactory terms or
that these actions would enable the Company to continue to satisfy its capital
requirements. The Company's ability to meet its debt service obligations and to
reduce its total indebtedness will be dependent upon the Company's future
performance, which will be subject to general economic conditions and to
financial, business and other factors affecting the operations of the Company,
many of which are beyond its control. The terms of the Company's indebtedness,
including the Credit Facility and the Indenture, also may prohibit the Company
from taking such actions.
Medical Cost Containment
In recent years, widespread efforts have been made in both the public
and private sectors to control health care costs, including the prices of
products such as those sold by the Company, in the United States and abroad.
Cost containment measures have resulted in increased customer purchasing power,
particularly through the increased presence of GPOs in the marketplace and
increased consolidation of distributors. Health care organizations are
evaluating ways in which costs can be reduced by decreasing the frequency with
which a treatment, device or product is used. Cost containment has also caused a
shift in the decision-making function with respect to supply acquisition from
the clinician to the administrator, resulting in a greater emphasis being placed
on price, as opposed to features and clinical benefits. The Company has
encountered significant pricing pressure from customers and believes that it is
likely that efforts by governmental and private payors to contain costs through
managed care and other efforts and to reform health systems will continue and
that such efforts may have an adverse effect on the pricing and demand for the
Company's products. There can be no assurance that current or future reform
initiatives will not have a material adverse effect on the Company's business,
financial conditions or results of operations.
22
The Company's products are sold principally to a variety of health care
providers, including hospitals and alternate site providers, that receive
reimbursement for the products and services they provide from various public and
private third party payors, including Medicare, Medicaid and private insurance
programs. As a result, while the Company does not receive payments directly from
such third party payors, the demand for the Company's products in any specific
care setting is dependent in part on the reimbursement policies of the various
payors in that setting. In order to be reimbursed, the products generally must
be found to be reasonable and necessary for the treatment of medical conditions
and must otherwise fall within the payor's list of covered services. In light of
increased controls on Medicare spending, there can be no assurance on the
outcome of future coverage or payment decisions for any of the Company's
products by governmental or private payors. If providers, suppliers and other
users of the Company's products are unable to obtain sufficient reimbursement, a
material adverse impact on the Company's business, financial condition or
operations may result.
The Company expects that the trend toward cost containment that has
impacted the domestic market will also be experienced in international health
care markets, impacting the Company's growth in foreign countries, particularly
where health care is socialized.
Industry Consolidation; Customer Concentration
Cost containment has resulted in significant consolidation within the
health care industry. A substantial number of the Company's customers, including
group purchasing organizations, hospitals, national nursing home companies and
national home health care agencies, have been affected by this consolidation.
The acquisition of any of the Company's significant customers could result in
the loss of such customers by the Company, thereby negatively impacting its
business, financial condition and results of operations. For example, in 1996,
three GPOs that accounted for aggregate sales of approximately $11.0 million
combined and, as a result of a decision of the combined entity to enter into a
sole distributorship arrangement in 1997 with one of the Company's competitors,
the Company has experienced some decrease in sales and may experience additional
sales decreases in the future. In addition, the consolidation of health care
providers often results in the renegotiation of terms and in the granting of
price concessions. The Company's customer relationships, including exclusive or
preferential provider relationships, are terminable at will by either party
without advance notice or penalty. Because larger purchasers or groups of
purchasers tend to have more leverage in negotiating prices, this trend has
caused the Company to reduce prices and could have a material adverse effect on
the Company's business, financial condition or results of operations. As GPOs
and integrated health care systems increase in size, each relationship
represents a greater concentration of market share and the adverse consequences
of losing a particular relationship increases considerably. For fiscal 1999, the
Company's ten largest group purchasing arrangements accounted for approximately
34% of the Company's total net sales. Distributors have also consolidated in
response to cost containment. For fiscal 1999, approximately 30.5% of the
Company's net sales were to two distributors, Owens & Minor Inc. and McKesson,
which accounted for 19.0% and 11.5%, respectively, of the Company's net sales.
The loss of the Company's relationship with these distributors would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Government Regulation
The Company and its customers and suppliers are subject to extensive
federal and state regulation in the United States, as well as regulation by
foreign governments. Most of the Company's products are subject to government
regulation in the United States and other countries. In the United States, the
Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and other
statutes and regulations govern or influence the testing, manufacture, safety,
labeling, storage, record keeping, marketing, advertising and promotion of such
products. Failure to comply with applicable requirements can result in fines,
recall or seizure of products, total or partial suspension of production,
withdrawal of existing product approvals or clearances, refusal to approve or
clear new applications or notices and criminal prosecution. Under the FDC Act
and similar foreign laws, the Company, as a marketer, distributor and
manufacturer of health care products, is required to obtain the approval of
federal and foreign governmental agencies, including the Food and Drug
Administration ("FDA"), prior to marketing, distributing and manufacturing
certain of those products, which can be time consuming and expensive. The
Company may also need to obtain FDA clearance before modifying marketed products
or making new promotional claims. Delays in receipt of or failure to receive
23
required approvals or clearances, the loss of previously received approvals or
clearances, or failures to comply with existing or future regulatory
requirements in the United States or in foreign countries could have a material
adverse effect on the Company's business. Foreign sales are subject to similar
requirements.
The Company is required to comply with the FDA's "Quality System
Regulations for Medical Devices," implementing "Good Manufacturing Practices"
("GMP/QSR Regulations"), which set forth requirements for, among other things,
the Company's manufacturing process, design control and associated record
keeping, including testing and sterility. Further, the Company's plants and
operations are subject to review and inspection by local, state, federal and
foreign governmental entities. The distribution of the Company's products may
also be subject to state regulation. The impact of FDA regulation on the Company
has increased in recent years as the Company has increased its manufacturing
operations. The Company's suppliers, including sterilizer facilities, are also
subject to similar governmental requirements. There can be no assurance that
changes to current regulations or additional regulations imposed by the FDA will
not have an adverse impact on the Company's business and financial condition in
the future. If the FDA believes that a company is not in compliance with
applicable regulations, it can institute proceedings to detain or seize
products, issue a recall, impose operating restrictions, enjoin future
violations and assess civil and criminal penalties against the company, its
officers or its employees and can recommend criminal prosecution to the
Department of Justice. Other regulatory agencies may have similar powers. In
addition, product approvals could be withdrawn due to the failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
marketing. The FDA also has the authority to issue special controls for devices
manufactured by the Company, which it has not done to date. In the event that
such special controls were issued, the Company's products would be required to
conform, which could result in significant additional expenditures for the
Company.
The Company is subject to numerous federal, state and local laws and
regulations relating to such matters as safe working conditions, manufacturing
practices, fire hazard control and the handling and disposal of hazardous or
infectious materials or substances and emissions of air pollutants. The Company
owns and leases properties which are subject to environmental laws and
regulations. There can be no assurance that the Company will not be required to
incur significant costs to comply with such laws and regulations in the future
or that such laws or regulations will not have a material adverse effect upon
the Company's business, financial condition or results of operations. In
addition, the Company cannot predict the extent to which future legislative and
regulatory developments concerning its practices and products for the health
care industry may affect the Company.
Risks Related to International Sales; Foreign Operations
Sales made outside the United States represented approximately 22.1% of
the Company's 1999 net sales and the Company intends to increase international
sales as a percentage of total net sales. Foreign operations are subject to
special risks that can materially affect the sales, profits, cash flows and
financial position of the Company, including increased regulation, extended
payment periods, competition from firms with more local experience, currency
exchange rate fluctuations and import and export controls. The Company has
operations in Germany, Sweden, Japan and other countries where sales are made in
local currency. While the Company plans to hedge its foreign currency exposures
by attempting to purchase goods and services with the proceeds from sales in
local currencies where possible, and to purchase forward contracts to hedge
receivables denominated in foreign currency, there can be no assurance that the
Company's hedging strategies will allow the Company to successfully mitigate its
foreign exchange exposures. The Company's foreign exchange exposure has
historically not been significant, and was not considered to be significant in
fiscal 1999.
The destabilization of the economies of several Asian countries in 1997
caused a decrease in demand for the Company's products throughout Southeast
Asia, and future sales in that region are uncertain. In addition, adverse
economic conditions in Asia could result in "dumping" of products similar to
those produced by the Company by other manufacturers, both in Asian and other
markets.
The Company also maintains a manufacturing and assembly facility in
Ensenada, Mexico and an assembly facility in Kuala-Lumpur, Malaysia and, as a
result, is subject to operational risks such as changing labor trends and civil
unrest in those countries. In the event the Company were required to transfer
its foreign operations to the United States
24
or were otherwise unable to benefit from its lower cost foreign operations, its
business, financial condition and results of operations would be adversely
affected.
Product Liability
The manufacturing and marketing of medical products entails an inherent
risk of product liability claims. Although the Company has not experienced any
significant losses due to product liability claims and currently maintains
umbrella liability insurance coverage, there can be no assurance that the amount
or scope of the coverage maintained by the Company will be adequate to protect
it in the event a significant product liability claim is successfully asserted
against the Company. In addition, the Company cannot predict the extent to which
future legislative and regulatory developments concerning its practices and
products for the health care industry may affect the Company.
Dependence on Key Personnel; Management of Expanding Operations
The Company's success will, to a large extent, depend upon the
continued services of its executive officers. The loss of services of any of
these executive officers could materially and adversely affect the Company.
While the Company has employment agreements with it senior management team,
these agreements may be terminated by either party, with or without cause.
The Company's plans to expand its business may place a significant
strain on the Company's operational and financial resources and systems. To
manage its expanding operations, the Company may be required to, among other
things, improve its operational, financial and management information systems.
The Company may also be required to attract, train and retain additional highly
qualified management, technical, sales and marketing and customer support
personnel. The process of locating such personnel with the combination of skills
and attributes required to implement the Company's strategy is often lengthy.
The inability to attract and retain additional qualified personnel could
materially and adversely affect the Company.
Competition
The medical supply industry is characterized by intense competition.
Certain of the Company's competitors have greater financial and other resources
than the Company and may succeed in utilizing these resources to obtain an
advantage over the Company. The general trend toward cost containment in the
health care industry has had the effect of increasing competition among
manufacturers, as health care providers and distributors consolidate and as GPOs
increase in size and importance. The Company competes on the basis of brand
name, product quality, breadth of product line, service and price.
Risks Generally Associated with Acquisitions
An element of the Company's business strategy is to pursue strategic
acquisitions that either expand or complement the Company's business.
Acquisitions involve a number of special risks, including the diversion of
management's attention to the assimilation of the operations and the
assimilation and retention of the personnel of the acquired companies, and
potential adverse effects on the Company's operating results. The Company may
require additional debt or equity financing for future acquisitions, which may
not be available on terms favorable to the Company, if at all. In addition, the
Credit Facility and the Indenture contain certain restrictions regarding
acquisitions. The Indenture restricts acquisitions to those companies in the
same line of business as the Company, and requires that all such acquired
companies be designated Restricted Subsidiaries (as defined therein). The Credit
Facility restricts all acquisitions with the exception of Permitted Acquisitions
(as defined therein), and limits, among other things, (i) the sum that may be
paid in connection with any single acquisition to $30.0 million, (ii) the total
amount outstanding of revolving credit indebtedness that can be incurred for
acquisition purposes to $40.0 million, and (iii) the line of business of the
acquired entity or assets. The inability of the Company to successfully finance,
complete and integrate strategic acquisitions in a timely manner could have an
adverse impact on the Company's ability to effect a portion of its growth
strategy.
25
Patents and Trademarks
The Company has historically relied primarily on its technological and
engineering abilities and on its design and production capabilities to gain
competitive business advantages, rather than on patents or other intellectual
property rights. However, the Company does file patent applications on concepts
and processes developed by the Company's personnel. The Company has 20 patents
in the U.S. Many of the U.S. patents have corresponding patents issued in
Canada, Europe and various Asian countries. The Company's success will depend in
part on its ability to maintain its patents, add to them where appropriate, and
to develop new products and applications without infringing the patent and other
proprietary rights of third parties and without breaching or otherwise losing
rights in technology licenses obtained by the Company for other products. There
can be no assurance that any patent owned by the Company will not be
circumvented or challenged, that the rights granted thereunder will provide
competitive advantages to the Company or that any of the Company's pending or
future patent applications will be issued with claims of the scope sought by the
Company, if at all. If challenged, there can be no assurance that the Company's
patents (or patents under which it licenses technology) will be held valid or
enforceable. In addition, there can be no assurance that the Company's products
or proprietary rights do not infringe the rights of third parties. If such
infringement were established, the Company could be required to pay damages,
enter into royalty or licensing agreements on onerous terms and/or be enjoined
from making, using or selling the infringing product. Any of the foregoing could
have a material adverse effect upon the Company's business, financial condition
or results of operations.
S Corporation Status
The Company elected to be treated as an S corporation for federal and
state income tax purposes for its taxable years beginning on or after January 1,
1987. Unlike a C corporation, an S corporation is generally not subject to
income tax at the corporate level; instead, the S corporation's income is taxed
on the personal income tax returns of its shareholders. The Company's status as
an S corporation terminated upon consummation of the Recapitalization. If S
corporation status were denied for any periods prior to such termination by
reason of a failure to satisfy the S corporation election or eligibility
requirements of the Internal Revenue Code of 1986, as amended, the Company would
be subject to tax on its income as if it were a C corporation for these periods.
Such an occurrence would have a material adverse effect on the Company's
results.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
Quantitative Disclosures. With the LGAB acquisition, the Company has
greater foreign currency exposure with respect to its international operations.
In the past, the Company's only international exposure was its manufacturing
operation in Mexico. All sales were previously denominated in U.S. dollars.
Currently, the Company has operations in Germany, Sweden, Japan and other
countries where sales are made in local currency. The Company plans to hedge
its foreign currency exposures by attempting to purchase goods and services with
the proceeds from sales in local currencies where possible. The Company will
also purchase forward contracts to hedge receivables denominated in foreign
currency that are expected to be collected and converted into another currency.
However, there can be no assurance that the Company's hedging strategies will
allow the Company to successfully mitigate its foreign exchange exposures.
The Company is exposed to certain market risks associated with interest
rate fluctuations on its debt. All debt arrangements are entered into for
purposes other than trading. The Company's exposure to interest rate risk
arises from financial instruments entered into in the normal course of business
that, in some cases, relate to the Company's acquisitions of related businesses.
Certain of the Company's financial instruments are fixed rate, short-term
investments which are held to maturity. The Company's fixed rate debt consists
primarily of outstanding balances on the Subordinated Notes and its variable
rate debt relates to borrowings under the Credit Facility (see "Item 7.
Management's Discussion and Analysis and Results of Operations--Liquidity and
Capital Resources"). With respect to the Company's fixed rate debt, changes in
interest rates generally affect the fair value of such debt, but do not have an
impact on earnings or cash flows. Because the Company generally cannot prepay
its fixed rate debt prior to maturity, interest rate risk and changes in fair
value should not have a significant impact on this debt until the Company is
required to refinance. With respect to variable rate debt, changes in interest
rates affect earnings and cash flows, but do not impact
26
fair value. The impact on the Company's interest expense in the upcoming year of
a one-point interest rate change on the outstanding balance of the Company's
variable rate debt would be approximately $892,000.
The following table presents the future principal cash flows and weighted-
average interest rates expected on the Company's existing long-term debt
instruments. The fair value of the Company's fixed rate debt is estimated based
on quoted market prices.
Expected Maturity Date
(as of December 31, 1999)
Fiscal Fiscal Fiscal Fiscal Fiscal There- Fair
2000 2001 2002 2003 2004 after Total Value
------ ------ ------- ------ ------ ------ ----- -----
(Dollars in thousands)
Fixed Rate Debt... $ -- $ -- $ -- $ -- $ -- $122,500 $122,500 $99,700
Average Interest Rate.... -- -- -- -- -- 9.3%
Variable Rate Debt $6,700 $11,000 $13,000 $15,000 $43,500 $ -- $ 89,200 $89,200
Average Interest Rate.... 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%
Qualitative Disclosures. The Company's primary exposure relates to (1)
interest rate risk on long-term and short-term borrowings, (2) the Company's
ability to pay or refinance long-term borrowings at maturity at market rates,
(3) the impact of interest rate movements on the Company's ability to meet
interest expense requirements and exceed financial covenants and (4) the impact
of interest rate movements on the Company's ability to obtain adequate financing
to fund future acquisitions. The Company manages interest rate risk on its
outstanding long-term and short-term debt through the use of fixed and variable
rate debt. While the Company can not predict or manage its ability to refinance
existing debt or the impact interest rate movements will have on its existing
debt, management evaluates the Company's financial position on an ongoing basis.
Item 8. Financial Statements.
See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K."
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .
None.
27
PART III
Item 10. Directors and Executive Officers of the Registrant.
The following individuals are the executive officers and directors of
Holding and Hudson RCI as of December 31, 1999:
Name Age Position
- ----------------------------- ---- ------------------------------------------
Richard W. Johansen...... 48 President, Chief Executive Officer and Director
Lougene Williams......... 55 Senior Vice President
Jay R. Ogram............. 44 Chief Financial Officer
Brian W. Morgan.......... 60 Vice President, Human Resources
Helen Hudson Lovaas...... 61 Director
Jon D. Ralph............. 35 Director
Charles P. Rullman....... 51 Director
Ronald P. Spogli......... 52 Director
Sten Gibeck.............. 56 Director
Richard W. Johansen is President, Chief Executive Officer and Director of
the Company and assumed the same positions with Holding after consummation of
the Recapitalization. Mr. Johansen became President of the Company in 1993 and
assumed the additional responsibilities of Chief Executive Officer in May 1997.
From 1989 to 1993, he served as Vice President, Marketing and Sales for the
Company following the 1989 acquisition of Respiratory Care Inc. by Hudson RCI.
He held the same position with Respiratory Care Inc. as well as prior executive
positions in the area of business development with its parent company, The
Kendall Company.
Lougene Williams is a Senior Vice President of the Company responsible for
its product development, quality assurance and manufacturing operations, having
served in this capacity since 1996, and assumed the same position with Holding
after consummation of the Recapitalization. Prior to 1996, he was the Company's
Vice President, Manufacturing, having held a similar position with Respiratory
Care Inc. From 1976 to 1987, he held manufacturing management positions of
increasing responsibility at various manufacturing plants of The Kendall
Company.
Jay R. Ogram is the Company's Chief Financial Officer, having served in
this capacity since 1996, and assumed the same position with Holding after
consummation of the Recapitalization. From 1984 until his assumption of Chief
Financial Officer responsibilities, Mr. Ogram held prior positions as Accounting
Manager and Vice President and Controller of the Company. Prior to joining the
Company, he had held executive positions in financial management with a major
health care company.
Brian W. Morgan is Vice President, Human Resources, having held this
position since 1989, and assumed the same position with Holding after
consummation of the Recapitalization. Mr. Morgan held similar positions in
human resources at Respiratory Care Inc. since 1978.
Helen Hudson Lovaas is a director of the Company and became a director of
Holding after consummation of the Recapitalization. Mrs. Lovaas began her
career at the Company in 1961. She has been Chairman since 1987, when she
inherited ownership of the Company and served as Chief Executive Officer from
1987 until May 1997. Mrs. Lovaas had served previously as the Vice President of
Administration of Hudson Oxygen for 15 years.
Jon D. Ralph became a director of Hudson RCI and of Holding in connection
with the Recapitalization. Mr. Ralph joined Freeman Spogli in 1989 and became a
Principal in January 1998. Prior to joining Freeman Spogli, Mr. Ralph spent
three years at Morgan Stanley & Co. Incorporated where he served as an analyst
in the Investment
28
Banking Division. Mr. Ralph is also a director of Century Maintenance Supply,
Inc., Envirosource, Inc. and The Pantry, Inc.
Charles P. Rullman became a director of Hudson RCI and of Holding in
connection with the Recapitalization. Mr. Rullman joined Freeman Spogli as a
Principal in 1995. From 1992 to 1995, Mr. Rullman was a General Partner of
Westar Capital, a private equity investment firm specializing in middle-market
transactions. Prior to joining Westar, Mr. Rullman spent twenty years at
Bankers Trust Company and its affiliate BT Securities Corporation where he was a
Managing Director and Partner. Mr. Rullman is also a director of The Pantry,
Inc.
Ronald P. Spogli became a director of Hudson RCI and of Holding in
connection with the Recapitalization. He is a founding Principal of Freeman
Spogli, which was founded in 1983. Mr. Spogli is also a director of AFC
Enterprises, Inc., Century Maintenance Supply, Inc. and Envirosource, Inc.
Sten Gibeck became a director of Hudson RCI and of Holding in connection
with the July 1999 acquisition of LGAB. Mr. Gibeck has been employed by LGAB
since 1965, and since 1997 has served as its Vice President of Research and
Development. From 1971 through 1996, Mr. Gibeck served as the
President of LGAB.
Directors of Hudson RCI and of Holding are elected annually and hold office
until the next annual meeting of stockholders and until their successors are
duly elected and qualified.
Item 11. Executive Compensation.
The following table sets forth the compensation earned by the Company's
Chairman and Chief Executive Officer and the three executive officers who earned
salary and bonus in excess of $100,000 for services rendered in all capacities
to the Company and its subsidiaries for the fiscal year ended December 31, 1999
(collectively, the "Named Executive Officers"). As of December 31, 1999, the
Company had no other executive officers.
Summary Compensation Table
Annual Compensation
-------------------------------------
Other Annual All Other
Fiscal Compensation Compensation
Name and Principal Position Year Salary Bonus (1) (2)
- ------------------------------------------------------------------------------------------------------------------
Richard W. Johansen........................ 1999 $294,945 $ 53,100 $ 177,334 $9,600
President and Chief Executive Officer 1998 265,500 131,567 14,853,967 9,000
1997 256,535 141,101 1,350,000 9,000
Lougene Williams........................... 1999 $190,862 $ 25,480 $ 73,020 $9,600
Senior Vice President 1998 182,000 64,257 6,116,222 9,000
1997 180,005 70,475 556,000 9,000
Jay R. Ogram............................... 1999 $148,314 $ 17,040 $ -- $8,889
Chief Financial Officer 1998 142,000 43,228 6,116,222 8,520
1997 140,250 48,357 556,000 8,394
Brian W. Morgan............................ 1999 $132,433 $ 15,268 $ 52,157 $7,946
Vice President, Human Resources 1998 127,320 38,506 4,527,873 7,634
1997 127,368 42,984 238,000 7,477
_____________________
29
(1) Reflects amounts earned by the Named Executive Officers during 1997 and 1998
and paid in 1998 and 1999 under the Equity Participation Plan. During 1999,
no executive officer named above received perquisites and other personal
benefits, securities or property in an aggregate amount in excess of the
lesser of $50,000 or 10% of the total of such officer's salary and bonus nor
did any such officer receive any restricted stock award or stock
appreciation right.
(2) Represents payments by the Company under its defined contribution plan.
Executive Employment Agreements
On April 7, 1998, the Company entered into employment agreements with each
of the Named Executive Officers. Each Named Executive Officer receives a base
salary in an amount and on substantially the same terms and conditions as was
being paid by the Company on that date and an annual cash bonus in accordance
with the Company's existing incentive programs. Pursuant to the employment
agreements, in the event that employment is terminated by the Company other than
for cause (as such term is defined in the employment agreements), or if the
Named Executive Officer resigns pursuant to a "qualifying resignation" (as such
term is defined in the employment agreements), the Company will be required to
pay such Named Executive Officer's base salary for a period of between 12 and 24
months. The employment agreements also provide for nondisclosure of
confidential information, that the Named Executive Officer shall not engage in
any prohibited activity (as such term is defined in the employment agreement)
during the term of employment and that the Named Executive Officer will refrain
from interfering with the Company's contractual relationships or soliciting the
Company's employees for 12 months following the Named Executive Officer's
termination.
Compensation of Directors
Directors of the Company receive no compensation as directors. Directors
are reimbursed for their reasonable expenses in attending meetings.
Management Bonus Plans
The Company offers two management bonus plans for its executives, one for
senior management and one for executive management. The plan for senior
management is based on a combination of the financial goals of the Company and
goals set for individual employees. The plan has minimum goals of 70%
attainment for operating income and 75% attainment of the individual plan. The
payout is based 70% on attainment of Company financial performance and 30%
attainment of individual performance goals. The plan for executive management
is based on the financial goals of the Company. The payout to an individual is
based on his or her bonus level and the percentage attainment of the operating
income goal for the Company. In order to participate, 70% of operating income
must be achieved.
Retirement Plans
The Company sponsors two programs that assist its employees in planning for
retirement. The Company offers a defined contribution pension plan that is
funded by the Company. Employees must be at least 21 years of age and have
completed two years of service to be eligible to participate in the pension
plan. The Company annually contributes an amount equal to 6% of a participating
employee's base earnings to a participant's account, prorated for any part of a
year that a participant was ineligible for a contribution. The funding also
includes a proportionate share of any increase or decrease in the fair market
value of the assets in the trust fund as of the immediately preceding last day
of the plan year. In addition, employees may contribute to a 401(k) plan that
has no matching contributions by the Company. Employees must have six months of
service to be eligible to participate in the 401(k) plan and may contribute up
to 10% of their annual compensation, or 6% if the employee is a highly
compensated participant.
30
Compensation Committee Interlocks and Insider Participation
The Board of Directors of the Company determines the compensation of the
executive officers. During fiscal 1999, Mr. Rullman determined the compensation
of the Company's Chief Executive Officer and Mr. Rullman and Mr. Johansen
participated in deliberations regarding the compensation of the Company's other
executive officers.
Stock Subscription Plans
In April 1998, Holding adopted an Employee Stock Subscription Plan and an
Executive Stock Subscription Plan (collectively, the "Stock Subscription Plans")
pursuant to which executives of the Company purchased 800,000 shares of common
stock of Holding valued at $10.00 per share. The Stock Subscription Plans
provide for a repurchase option in favor of Holding upon termination of
employment at stated repurchase prices. In addition, the Stock Subscription
Plans provide for restrictions on the transferability of shares prior to the
fifth anniversary of the Recapitalization or Hudson RCI's initial public
offering. The shares are also subject to a right of first refusal in favor of
Holding as well as obligations to sell at the request of Freeman Spogli and co-
sale rights if Freeman Spogli sells its shares to a third party. No additional
shares of Holding common stock were sold under the Stock Subscription Plans in
fiscal 1999.
31
Item 12. Security Ownership of Certain Beneficial Owners and Management.
River Holding Corp.
The following table sets forth certain information, as of March 30, 2000,
with respect to the beneficial ownership of capital stock of Holding by (i) each
person who beneficially owns more than 5% of such shares, (ii) each of the Named
Executive Officers, (iii) each director of Holding and (iv) all Named Executive
Officers and directors of Holding as a group. The following table should be
read in conjunction with the security ownership table for Hudson RCI.
Shares Percent Shares of Percent
of Common of Preferred of
Name of Beneficial Owner Stock Class Stock Class
- ------------------------------------------------- ------------ ------------ ------------ -----------
Freeman Spogli & Co. Incorporated(1)............. 7,521,791 88.0% -- --
Ronald P. Spogli(1)
Charles P. Rullman(1)
Jon D. Ralph(1)
Richard W. Johansen(2)(3)........................ 300,000 3.5% -- --
Sten Gibeck(3)................................... 210,000 2.5% -- --
Lougene Williams(3).............................. 100,000 1.2% -- --
Jay R. Ogram(3).................................. 100,000 1.2% -- --
Brian W. Morgan(3)............................... 15,000 * -- --
Helen Hudson Lovaas(3)........................... -- -- -- --
All named Executive Officers and directors of
Holding as a group (9 individuals).............. 8,146,791 95.4% -- --
__________________
* Less than 1%.
(1) 1,441,251 shares, 58,749 shares and 6,021,791 shares of common stock are
held of record by FS Equity Partners III, L.P. ("FSEP III"), FS Equity
Partners International, L.P. ("FSEP International") and FS Equity Partners
IV, L.P. ("FSEP IV"), respectively. As general partner of FS Capital
Partners, L.P. ("FS Capital"), which is general partner of FSEP III, FS
Holdings, Inc. ("FSHI") has the sole power to vote and dispose of the shares
owned by FSEP III. As general partner of FS&Co. International, L.P.
("FS&Co. International"), which is the general partner of FSEP
International, FS International Holdings Limited ("FS International
Holdings") has the sole power to vote and dispose of the shares owned by
FSEP International. As general partner of FSEP IV, FS Capital Partners LLC
("FS Capital LLC") has the sole power to vote and dispose of the shares
owned by FSEP IV. Messrs. Spogli and Rullman and Bradford M. Freeman,
William M. Wardlaw, J. Frederick Simmons and John M. Roth are the sole
directors, officers and shareholders of FSHI, FS International Holdings and
Freeman Spogli & Co. Incorporated and such individuals, in addition to Mr.
Ralph and Todd W. Halloran and Mark J. Doran, are the sole managing members
of FS Capital LLC, and as such may be deemed to be the beneficial owners of
the shares of the common stock and rights to acquire the common stock owned
by FSEP III, FSEP International and FSEP IV. The business address of
Freeman Spogli & Co. Incorporated, FSEP III, FSEP IV, FS Capital, FSHI, FS
Capital LLC, and its sole directors, officers, shareholders and managing
members is 11100 Santa Monica Boulevard, Suite 1900, Los Angeles, California
90025 and the business address of FSEP International, FS&Co. International
and FS International Holdings is c/o Padget-Brown & Company, Ltd., West
Winds Building, Third Floor, Grand Cayman, Cayman Islands, British West
Indies.
(2) Represents shares held of record by the Johansen Family Trust U/D/T dated
8/16/91 (the "Trust"), of which Mr. Johansen and his wife, Barbara L.
Johansen, are the trustees.
(3) The business address of these individuals is River Holding Corp., 599
Lexington Avenue, 18th Floor, New York, New York 10022.
32
Hudson RCI
The following table sets forth certain information, as of March 31, 1999,
with respect to the beneficial ownership of capital stock of the Company by (i)
each person who beneficially owns more than 5% of such shares, (ii) each of the
Named Executive Officers, (iii) each director of Hudson RCI and (iv) all Named
Executive Officers and directors of Hudson RCI as a group.
Shares of
Common Percent Shares of Percent
Name of Beneficial Owner Stock of Class Preferred Stock of Class
- -----------------------------------------------------------------------------------------------------------
River Holding Corp.(1)........................ 8,544,291 85.1% 355,630 100%
Jon D. Ralph(1)............................
Charles P. Rullman(1)......................
Ronald P. Spogli(1)........................
Helen Hudson Lovaas(2)........................ 1,500,000 14.9% -- --
Sten Gibeck(3)................................ -- -- -- --
Richard W. Johansen(3)........................ -- -- -- --
Lougene Williams(3)........................... -- -- -- --
Jay R. Ogram(3)............................... -- -- -- --
Brian W. Morgan(3)............................ -- -- -- --
All Named Executive Officers and directors of
the Company as a group (9 individuals)....... 10,044,291 100.0% 355,630 100.0%
- -----------------
(1) As beneficial owner of 88.0% of the Common Stock of Holding, Freeman Spogli
will have the power to vote and dispose of the shares held by Holding. See
footnote (i) at "--River Holding Corp." Holding has pledged all shares of
the Company's capital stock owned by it to secure its guarantee of the
Company's obligations under the Credit Facility.
(2) Represents 1,073,560 shares held of record by the Helen Lovaas Separate
Property Trust U/D/T dated 7/16/97 ("Trust No. 1") and 426,440 shares held
of record by the Helen Lovaas Trust No. 2 U/D/T dated as of January 10, 2000
("Trust No. 2"). As sole trustee of Trust No. 1, Mrs. Lovaas has the sole
power to vote and dispose of the shares owned by Trust No. 1. As co-
trustee of Trust No. 2, Mrs. Lovaas has shared power to vote and dispose of
the shares owned by Trust No. 2. The address of each of Trust No. 1 and
Trust No. 2 is c/o Hudson Respiratory Care Inc., 27711 Diaz Road, P.O. Box
9020, Temecula, California 92589.
(3) The business address of these individuals is Hudson Respiratory Care Inc.,
27711 Diaz Road, P.O. Box 9020, Temecula, California 92589.
Item 13. Certain Relationships and Related Transactions.
Shareholders' Agreement
The Continuing Shareholder and Holding have entered into a Shareholders'
Agreement, as amended (the "Shareholders' Agreement"). Under the Shareholders'
Agreement, Holding and the Continuing Shareholder have the right to purchase
their pro rata share of certain new issuances of capital stock by Hudson RCI.
In addition, the Shareholders' Agreement provides that upon certain issuances of
common stock of Holding to employees of the Company, and contribution of the
consideration received for such issuance to Hudson RCI, an equivalent number of
shares of Hudson RCI's common stock will be issued to Holding. The
Shareholders' Agreement provides for restrictions on the transferability of the
shares held by the Continuing Shareholder for a period of two years following
the consummation of the Recapitalization, and provides for a right of first
offer on the Continuing Shareholder's common
33
stock. In addition, the agreement provides that upon sales by Holding of common
stock of Hudson RCI or by Freeman Spogli of common stock of Holding, the
Continuing Shareholder is obligated to sell all its shares of common stock at
the request of Holding and the Continuing Shareholder has the right to
participate in such sale on a pro rata basis. If Hudson RCI engages in an
initial public offering with respect to its common stock, the Shareholders'
Agreement provides that Holding will exchange all of the common stock of Hudson
RCI it holds for newly issued common stock of Hudson RCI and the Mirror
Preferred Stock (as defined below) will be exchanged, at Holding's option, into
Company Preferred Stock or Company Exchange Debentures, which in turn will be
exchanged for Exchange Preferred Stock. Holding will then liquidate and
distribute Hudson RCI's common stock to its common holders. Hudson RCI will
grant unlimited piggyback registration rights (after an initial public offering)
to Freeman Spogli and the Continuing Shareholder and, commencing six (6) months
after the initial public offering, three (3) demand registrations to Freeman
Spogli, and one demand registration to the Continuing Shareholder. The
Shareholders' Agreement provides that the parties thereto will vote their shares
to elect Helen Hudson Lovaas to the Board of Directors.
Note to Freeman Spogli
In July 1999 in connection with the LGAB acquisition, the Company borrowed
$22.0 million pursuant to an unsecured promissory note payable to Freeman
Spogli. The note bears interest at 12.0% per annum, matures in August 2006, and
requires semiannual interest payments. In fiscal 1999, approximately $14.5
million in principal was paid on the note. As of December 31, 1999, $7.5
million remained outstanding on the note.
34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents filed as part of this Report:
Page
(1) Financial Statements
Financial Statements of River Holding Corp. and Hudson Respiratory Care Inc.
are filed as part of this Form 10-K........................................... F-1
(2) Financial Statement Schedules for Holding
Report of Independent Public Accountants..................................... II-1
Schedule II -- Valuation and Qualifying Accounts............................. II-2
All other schedules have been omitted because they are not applicable, not required,
or the information is included in the consolidated financial statements or notes thereto.
(3) Exhibits
Exhibit
Number Description
- ------- -----------
2.1(10) Agreement dated May 7, 1999 between Sten Gibeck, Hudson RCI and
Holding.
2.2(10) Agreement dated May 7, 1999 between Euroventures Nordica I B.V.,
Hudson RCI and Holding.
2.3(10) Agreement dated May 7, 1999 between Forsakrings AB Skandia and
Livforsakrings AB Skandia, Hudson RCI and Holding.
2.4(10) Agreement dated May 7, 1999 between Maud Gibeck, Hudson RCI and
Holding.
2.5(10) Stock Subscription Agreement dated August 4, 1999 between Sten
Gibeck, Holding, FSEP III, FSEP International and FSEP IV.
3.1(1) Certificate of Incorporation of Holding, as amended to date.
3.2(1) Amended and Restated Bylaws of Holding.
3.3(3) Amended and Restated Articles of Incorporation of Hudson RCI.
3.4(4) Amended and Restated Bylaws of Hudson RCI.
4.1(2) Indenture dated as of April 7, 1998 among Hudson RCI, Holding and
United States Trust Company of New York, as Trustee, with respect to
the 9-1/8% Senior Subordinated Notes due 2008 (including form of 9-
1/8% Senior Note due 2008).
4.2(2) Exchange Indenture dated as of April 7, 1998 among Hudson RCI,
Holding and United States Trust Company of New York, as Trustee,
with respect to the 11-1/2% Subordinated Exchange Debentures due
2010 (including form of 11-1/2% Senior Subordinated Exchange
Debenture due 2010).
10.1(2) Credit Agreement dated as of April 7, 1998 among Hudson RCI,
Holding, the lenders party thereto, Salomon Brothers Inc. and
Bankers Trust Company ("Bankers Trust").
10.2(2) Security Agreement dated as of April 7, 1998 between Hudson RCI and
Bankers Trust.
10.3(2) Pledge Agreement dated as of April 7, 1998 between Holding and
Bankers Trust.
35
Exhibit
Number Description
- ------- -----------
10.4(2) Deed of Trust, Security Agreement, Fixture Filing and Assignment of
Leases and Rents dated April 7, 1998 between Hudson RCI and Chicago
Title Insurance Company fbo Bankers Trust.
10.5(2) Holding Guarantee Agreement dated as of April 7, 1998 between
Holding and Bankers Trust.
10.6(2) Indemnity, Subrogation and Contribution Agreement dated as of April
7, 1998 among Hudson RCI, Holding and Bankers Trust.
10.7(2) Shareholders Agreement dated April 7, 1998 among Holding, The Helen
Hudson Lovaas Separate Property Trust U/D/T dated July 17, 1997
(the "Hudson Trust"), FS Equity Partners III, L.P. ("FSEP III"), FS
Equity Partners International, L.P. ("FSEP International"), FS
Equity Partners IV, L.P. ("FSEP IV"), and Hudson RCI.
10.8(1) 1998 Employee Stock Subscription Plan dated April 7, 1998.
10.9(1) 1998 Executive Stock Subscription Plan dated April 7, 1998.
10.10(1) Form of Stock Subscription Agreement for 1998 Employee Stock
Purchase Plan.
10.11(1) Form of Stock Subscription Agreement for 1998 Executive Stock
Subscription Plan.
10.12(1) Stock Subscription Agreement dated April 7, 1998 among Holding,
FSEP III, FSEP IV, and FSEP International.
10.13(5) Stock Subscription Agreement dated April 7, 1998 between Holding
and River Acquisition Corp.
10.14(6) Form of Amendment No. 1 to Credit Agreement dated as of July 30,
1998 among Hudson RCI, Holding, the lenders party thereto, Salomon
Brothers Inc. and Bankers Trust.
10.15(1) Form of Exchange Preferred Stock Certificate.
10.16(5) Amendment No. 1 to Shareholders Agreement dated April 8, 1998 among
Holding, the Hudson Trust, FSEP III, FSEP IV and Hudson RCI.
10.17(8) Form of Amendment No. 2 to Credit Agreement dated as of March 12,
1999 among Hudson RCI, Holding, the lenders party thereto, Salomon
Brothers Inc. and Bankers Trust.
10.18(11) Amendment No. 3 to Credit Agreement dated as of June 17, 1999 among
Hudson RCI, Holding, the lenders party thereto, Salomon Brothers
Inc. and Bankers Trust.
12.1 Statement re Computation of Earnings to Fixed Charges Ratio.
21.1 Subsidiaries of Holding (River Holding Corp.).
21.2(12) Subsidiaries of Hudson RCI
24.1 Power of Attorney (included in the signature pages hereof).
27.1 Financial Data Schedule.
______________
(1) Incorporated by reference to the exhibit designated by the same
number in the Form S-4 filed by River Holding Corp. on June 5,
1998 (File No. 333-56135).
(2) Incorporated by reference to the exhibit designated by the same
number in the Form S-4 filed by Hudson RCI on June 5, 1998 (File
No. 333-56097) (the "Hudson RCI S-4").
(3) Incorporated by reference to the exhibit designated by exhibit
number 3.1 in the Hudson RCI S-4.
(4) Incorporated by reference to the exhibit designated as exhibit
number 3.2 in the Hudson RCI S-4.
(5) Incorporated by reference to the exhibit designated as exhibit
number 10.8 in the Hudson RCI S-4.
36
(6) Incorporated by reference to the exhibit designated as exhibit number
10.13 in Amendment No. 1 to Form S-4 filed by Hudson RCI on August 3, 1998
(File No. 333-56097).
(7) Incorporated by reference to the exhibit designated as exhibit 10.14 in
the Annual Report on Form 10-K of Hudson RCI dated March 25, 1999 (the
"Hudson RCI 1998 Form 10-K").
(8) Incorporated by reference to the exhibit designated as exhibit 10.15 in
the Hudson RCI 1998 Form 10-K.
(9) Incorporated by reference to the exhibit designated by the same number in
the Hudson RCI 1998 Form 10-K.
(10) Incorporated by reference to the exhibit designated by the same number in
the Form 8-K filed by Hudson RCI on August 6, 1999 (date of earliest
event: July 22, 1999) (File No. 333-56097).
(11) Incorporated by reference to the exhibit designated as exhibit number
10.16 in the Annual Report on Form 10-K of Hudson RCI dated March 30, 1999
(the "Hudson RCI 1999 10-K").
(12) Incorporated by reference to the exhibit designated as exhibit number 21.1
in the Hudson RCI 1999 10-K.
(b) Current Reports on Form 8-K.
None.
37
RIVER HOLDING CORP. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS OF RIVER HOLDING CORP.
- -------------------------------------------------------
Report of Independent Public Accountants................................................................... F-2
Consolidated Balance Sheets as of December 25, 1998 and December 31, 1999.................................. F-3
Consolidated Statements of Operations for the period from April 7, 1998 (Inception) to December 25,
1998 and for the year ended December 31, 1999......................................................... F-4
Consolidated Statements of Stockholders' Equity for the for the period from April 7, 1998 (Inception) to
December 25, 1998 and for the year ended December 31, 1999................................................. F-5
Consolidated Statements of Cash Flows for the period from April 7, 1998 (Inception) to December 25,
1998 and for the year ended December 31, 1999......................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-8
CONSOLIDATED FINANCIAL STATEMENTS OF HUDSON RESPIRATORY CARE INC.
- -----------------------------------------------------------------
Report of Independent Public Accountants................................................................... F-18
Consolidated Balance Sheets as of December 25, 1998 and December 31, 1999.................................. F-19
Consolidated Statements of Operations for the years ended December 26, 1997, December 25, 1998 and
December 31, 1999..................................................................................... F-20
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 26, 1997,
December 25, 1998 and December 31, 1999............................................................... F-21
Consolidated Statements of Cash Flows for the years ended December 26, 1997, December 25, 1998 and
December, 31, 1999.................................................................................... F-22
Notes to Consolidated Financial Statements................................................................. F-24
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
River Holding Corp.:
We have audited the accompanying consolidated balance sheets of RIVER
HOLDING CORP., (a Delaware Corporation) and subsidiaries as of December 25, 1998
and December 31, 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for the period from April 7, 1998
(Inception) to December 25, 1998 and for the year ended December 31, 1999. These
financial statements 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of River Holding Corp. and
subsidiaries as of December 25, 1998 and December 31, 1999, and the results of
their operations and their cash flows for the period from April 7, 1998
(Inception) to December 25, 1998 and for the year ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 24, 2000
F-2
RIVER HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
ASSETS
December 25, December 31,
1998 1999
------------ ------------
CURRENT ASSETS:
Cash........................................................................................ $ 507 $ 2,917
Accounts receivable, less allowance for doubtful accounts of $794 and $973 at
December 25, 1998 and December 31, 1999, respectively..................................... 25,829 30,425
Inventories................................................................................. 18,024 24,043
Other current assets........................................................................ 1,049 4,945
-------- --------
Total current assets....................................................................... 45,409 62,330
Property and equipment, net.................................................................. 46,857 54,341
OTHER ASSETS:
Deferred tax asset.......................................................................... 9,634 11,342
Deferred financing costs, net of accumulated amortization of $1,000 and $2,253
at December 25, 1998 and December 31, 1999, respectively.................................. 11,917 11,134
Other assets................................................................................ 235 222
Goodwill, net of accumulated amortization of $3,746 and $8,197 at December 25,
1998 and December 31, 1999, respectively.................................................. 148,657 205,592
-------- --------
Total other assets......................................................................... 170,443 228,290
-------- --------
Total assets.............................................................................. $262,709 $344,961
======== ========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable to banks...................................................................... $ 3,000 $ 6,673
Accounts payable............................................................................ 6,324 6,268
Accrued liabilities......................................................................... 6,219 11,700
Other current liabilities................................................................... - 1,485
-------- --------
Total current liabilities.................................................................. 15,543 26,126
NOTE PAYABLE TO STOCKHOLDER, net of current portion.......................................... - 7,508
NOTES PAYABLE TO BANKS, net of current portion............................................... 41,000 82,513
SENIOR SUBORDINATED NOTES PAYABLE............................................................ 115,000 115,000
-------- --------
Total liabilities......................................................................... 171,543 231,147
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 7)
MANDATORILY-REDEEMABLE PREFERRED STOCK,
$.01 par value: 1,800 shares authorized; 318 and 356 shares issued and outstanding at
December 25, 1998 and December 31, 1999, respectively; liquidation
preference--$31,802 and $35,558 respectively.............................................. 30,802 34,558
Accrued preferred stock dividends, payable in kind........................................... 711 863
-------- --------
31,513 35,421
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, no par value: 15,000 shares authorized; 6,313 and 8,544 shares issued and
outstanding at December 25, 1998 and December 31, 1999, respectively...................... 63,125 91,748
Cumulative translation adjustment........................................................... - (398)
Accumulated deficit......................................................................... (3,472) (12,957)
-------- --------
Total stockholders' equity................................................................. 59,653 78,393
-------- --------
Total liabilities, mandatorily-redeemable preferred stock and stockholders' equity........ $262,709 $344,961
======== ========
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
RIVER HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 25, 1998 AND
FOR THE YEAR ENDED DECEMBER 31, 1999
(In thousands)
1998 1999
---- -----
NET SALES......................................................................... $76,232 $128,803
COST OF SALES..................................................................... 44,662 77,678
------- --------
Gross profit.................................................................... 31,570 51,125
------- --------
OPERATING EXPENSES:
Selling.......................................................................... 8,032 13,122
Distribution..................................................................... 2,471 4,647
General and administrative....................................................... 7,129 14,732
Research and development......................................................... 726 2,031
Amortization of goodwill......................................................... 3,785 5,080
------- --------
Total operating expenses........................................................ 22,143 39,612
------- --------
Income from operations.......................................................... 9,427 11,513
OTHER EXPENSES:
Interest expense................................................................. 11,100 17,675
Other, net....................................................................... (99) 920
------- --------
11,001 18,595
------- --------
Loss before benefit for income taxes.............................................. (1,574) (7,082)
BENEFIT FOR INCOME TAXES (Note 8)................................................. (614) (1,508)
------- --------
Net loss.......................................................................... (960) (5,574)
OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation loss................................................ - (398)
------- --------
Comprehensive loss................................................................ $ (960) $ (5,972)
======= ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
RIVER HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 31, 1998 AND FOR
THE YEAR ENDED DECEMBER 31, 1999
(In thousands)
Common Stock Cumulative
------------------ Translation Accumulated
Shares Amount Adjustment Deficit Total
------- -------- ------------ ------------ ---------
BALANCE, April 7, 1998............................................... - $ - $ - $ - $ -
Sale of common stock.............................................. 6,313 63,125 - - 63,125
Pay-in-kind preferred stock dividends............................. - - - (2,512) (2,512)
Net loss.......................................................... - - - (960) (960)
----- ------- -------- -------- -------
BALANCE, December 25, 1998........................................... 6,313 63,125 - (3,472) 59,653
Sale of common stock.............................................. 2,231 28,623 - - 28,623
Pay-in-kind preferred stock dividends............................. - - - (3,911) (3,911)
Foreign currency translation loss................................. - - (398) - (398)
Net loss.......................................................... - - - (5,574) (5,574)
----- ------- -------- -------- -------
BALANCE, December 31, 1999........................................... 8,544 $91,748 $(398) $(12,957) $78,393
===== ======= ======== ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
RIVER HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 25, 1998 AND
FOR THE YEAR ENDED DECEMBER 31, 1999
(In thousands)
1998 1999
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................. $ (960) $ (5,574)
Adjustments to reconcile net loss to net cash provided by operating
activities--
Depreciation and amortization..................................... 8,507 15,655
Amortization of deferred financing costs.......................... - 1,374
Gain on disposal of equipment.................................... - (5)
Change in deferred tax asset..................................... - (1,709)
Changes in operating assets and liabilities:
Increase in accounts receivable............................... (7,089) (2,701)
Increase in inventories....................................... (1,215) (2,865)
(Increase) decrease in other current assets................... 316 (1,194)
Decrease in other assets...................................... 526 13
Increase (decrease) in accounts payable....................... 3,243 (741)
Increase in accrued liabilities............................... 526 4,277
Increase in other current liabilities......................... - 1,526
Increase (decrease) in other liabilities...................... - (959)
--------- --------
Net cash provided by operating activities................... 3,854 7,097
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of majority interest in Hudson Respiratory Care Inc...... (248,000) -
Purchases of property, plant and equipment........................... (3,121) (10,973)
Proceeds from sale of property, plant and equipment.................. - 23
Increase in notes receivable and intangible assets................... - (354)
Additions of deferred financing costs................................ - 154
Acquisition of certain assets of Gibeck, Inc......................... (3,351) -
Acquisition of certain assets of Medimex............................. - (2,168)
Acquisition of certain assets of Tyco................................ - (23,750)
Acquisition of Louis Gibeck AB stock, net of cash acquired of
$8,208........................................................ - (38,750)
--------- --------
Net cash used in investing activities....................... (254,472) (75,818)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to bank................................... (2,000) (17,355)
Proceeds from bank borrowings........................................ 46,000 59,376
Proceeds from senior subordinated notes payable...................... 115,000 -
Proceeds from note payable to stockholder............................ - 22,000
Repayment of note payable to stockholder............................. - (14,492)
Net proceeds from sale of common and mandatorily-redeemable
preferred stock, net of transaction costs........................... 92,125 22,000
--------- --------
Net cash provided by financing activities................... 251,125 71,529
--------- --------
Effect of exchange rate changes on cash - (398)
NET INCREASE IN CASH AND CASH EQUIVALENTS 507 2,410
CASH AND CASH EQUIVALENTS, beginning of period........................ - 507
--------- --------
CASH AND CASH EQUIVALENTS, end of period.............................. $ 507 $ 2,917
========= ========
F-6
1998 1999
---- ----
(in thousands)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the period for--
Interest....................................................... $8,742 $15,333
====== =======
Income taxes................................................... $1,699 $ 27
====== =======
DETAILS OF ACQUISITIONS (Note 2):
Acquisition price................................................. $3,351 $79,499
Less:
Common stock issued for acquisition............................. - (6,623)
Cash acquired................................................... - (8,208)
------ -------
Net cash paid for acquisitions.............................. $3,351 $64,668
====== =======
NON-CASH OPERATING ACTIVITIES:
Net loss in 1999 includes approximately $2,825,000 of non-cash expense
related to the recognition of the portion of purchase price allocation
related to acquired inventories.
NON-CASH FINANCING ACTIVITIES:
The Company satisfies its preferred dividend requirements by the issuance
of additional shares of preferred stock. Such accrued dividend
requirements totaled $6,421,000 from the date of issuance of the preferred
stock through December 31, 1999; preferred stock with an approximate face
value of $1,801,000 was issued in 1998, $3,757,000 was issued in 1999 and
$863,000 will be issued in 2000.
Holding issued common stock to an affiliate of its existing majority
shareholder in partial consideration for the contribution of Louis Gibeck
AB stock (see Note 2).
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
RIVER HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. Company Background
River Holding Corp. ("Holding"), is a Delaware corporation formed to
purchase and hold a majority interest in Hudson Respiratory Care Inc. ("Hudson"
or the "Company"), a California corporation founded in 1945. Hudson is a
manufacturer and marketer of disposable medical products utilized in the
respiratory care and anesthesia segments of the domestic and international
health care markets. The Company's respiratory care and anesthesia product
lines include such products as oxygen masks, humidification systems, nebulizers,
cannulae and tubing. In the United States, the Company markets its products to
a variety of health care providers, including hospitals and alternate site
service providers such as outpatient surgery centers, long-term care facilities,
physician offices and home health care agencies. Internationally, the Company
sells its products to distributors that market to hospitals and other health
care providers. The Company's products are sold to distributors and alternate
site service providers throughout the United States and internationally. The
Company's respiratory product operations are conducted from its primary facility
in Temecula, California, facilities in Arlington Heights and Elk Grove,
Illinois, and a facility in Ensenada, Mexico. The Company's anesthesia product
operations are conducted from facilities located principally in Sweden and
Malaysia, which were acquired in July 1999 (see Note 2).
Recapitalization
In April 1998, the Company consummated a plan pursuant to which a majority
interest in the Company was sold in accordance with an agreement and plan of
merger (the "Recapitalization").
Key components of the Recapitalization included:
(1) Common and preferred equity investments in consideration for an 80.8%
ownership in the Company's common stock and preferred stock with an
initial liquidation preference of $30.0 million (see Note 4)
(2) Issuance of 9-1/8% senior subordinated notes with a par value of $115.0
million, maturing in 2008 (see Note 5)
(3) Execution of a new term loan facility and revolving loan facility (see Note
5)
(4) Repayment of existing indebtedness
(5) Payment of amounts due under the Equity Participation Plan
(6) Payment for common shares acquired from the existing shareholder; this
shareholder retained a 19.2% interest in the common shares outstanding
(7) Potential contingent payments based on 1998 performance, payable to the
continuing shareholder and former participants in the Equity
Participation Plan; however, as a result of the Company's 1998
performance, no additional amounts are due.
The Company has terminated the Equity Participation Plan and plans to adopt
an executive stock purchase plan and a stock option plan. Additionally, Hudson's
sole shareholder, who owned the remaining 21.0% of Industrias Hudson
("Industrias"), a subsidiary of the Company, transferred this interest to the
Company in consideration of one dollar. Because of the commonality of ownership,
the 21.0% minority interest has been included in the financial statements for
all periods presented.
On April 7, 1998, Holding acquired a majority interest in Hudson, as
discussed above. The investment in Hudson by Holding was accounted for as a
purchase and the purchase price has been allocated as follows based upon
management's estimate of relative fair value of assets acquired and liabilities
assumed (amounts in thousands):
F-8
Assets acquired:
Current assets and other.................................. $ 33,044
Property, plant and equipment............................. 47,821
Deferred tax asset........................................ 9,020
Deferred financing costs.................................. 12,917
Goodwill.................................................. 152,442
--------
255,244
Less liabilities assumed:
Current liabilities....................................... 7,244
--------
Total purchase price paid................................... $248,000
========
Goodwill is being amortized using a 30-year life.
Holding has no operations apart from those conducted by Hudson. The
accompanying consolidated statement of operations for 1998 includes the results
of Hudson for the period from March 27, 1998 to December 25, 1998 (Hudson's
fiscal second, third and fourth quarters). Management believes the impact of
including Hudson's results of operation for the period from March 27, 1998 to
April 7, 1998 is not material to the accompanying consolidated financial
statements.
The minority interest in the Company was initially recorded at zero and the
Company's losses for the periods ended December 25, 1998 and December 31, 1999
have been solely allocated to Holding.
2. Acquisitions
Gibeck, Inc.
During 1998, the Company acquired certain assets of Gibeck Inc. ("Gibeck"),
a subsidiary of Louis Gibeck AB, for a cash purchase price of $3,351,000. Gibeck
engages primarily in the business of manufacturing, marketing, and selling
custom anesthesia circuits. The acquisition was accounted for as a purchase and
the purchase price was allocated as follows (amounts in thousands):
Goodwill........................... $1,817
Inventory.......................... 871
Machinery and equipment............ 663
------
$3,351
======
Louis Gibeck AB
On July 22, 1999, the Company acquired substantially all of the outstanding
capital stock of Louis Gibeck AB ("LGAB") and subsidiaries, a Swedish company
engaged primarily in the business of manufacturing, marketing and selling
respiratory and anesthesia equipment. The purchase price was approximately
$53.6 million, which included cash consideration of approximately $45.5 million
(including approximately $8.2 million of cash acquired), a non-cash contribution
of shares of common stock of Holding for approximately $6.6 million and
transaction expenses of approximately $1.5 million.
The acquisition was funded with (i) a $22.0 million common stock sale to
Holding's existing majority stockholder (ii) a $22.0 million, 12% per annum
unsecured note payable to an affiliate of Holding's existing majority
stockholder due August 1, 2006 and (iii) a $5.9 million unsecured bank loan
bearing interest at the bank's reference rate plus 1/4% per annum due July 30,
2006.
The acquisition of LGAB was accounted for as a purchase and the purchase
price was preliminarily allocated based upon management's estimate of the assets
acquired and liabilities assumed as follows (amounts in thousands):
F-9
Cash............................. $ 8,208
Accounts receivable.............. 1,823
Inventories...................... 5,161
Fixed assets..................... 1,206
Other assets..................... 2,939
Current liabilities.............. (4,856)
Non-current liabilities.......... (4,123)
Goodwill......................... 43,223
-------
$53,581
=======
The Company is evaluating estimates made in conjunction with the purchase
price allocation, which may change in the near term.
Had this acquisition and the acquisition of certain assets of Gibeck, Inc.
occurred at the beginning of the current fiscal year, the unaudited pro forma
net sales, net loss before extraordinary item and net loss would be as follows
(amounts in thousands):
December 31, 1999
-----------------
(unaudited)
Net sales............................ $139,494
Net loss before extraordinary item... (6,295)
Net loss............................. (6,295)
Acquisition of Product Line
On November 8, 1999, the Company acquired certain assets of Tyco Healthcare
Group LP ("Tyco"), including Tyco's incentive breathing exerciser and pulmonary
function monitor product lines, for a cash purchase price of approximately $23.8
million. The acquisition was accounted for as a purchase and the purchase price
was allocated as follows (amounts in thousands):
Goodwill..................................... $18,750
Machinery and equipment...................... 3,000
Deposit...................................... 2,000
-------
$23,750
=======
Acquisition of Distributor
In October 1999, the Company acquired certain assets of Medimex, a German
distributor of respiratory products, for a cash purchase price of approximately
$2.2 million. The acquisition was accounted for as a purchase and the purchase
price was allocated as follows (amounts in thousands):
Goodwill......................... $1,300
Inventory........................ 900
------
$2,200
======
3. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements and related notes
include the accounts of River Holding Corp. and its wholly-owned subsidiaries.
All significant intercompany account balances and transactions have been
eliminated in consolidation.
Use of Estimates
F-10
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
certain estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.
Inventories
Inventories are stated at the lower of cost (first-in, first-out (FIFO)
method) or market. At December 25, 1998 and December 31, 1999, inventories
consisted of the following (amounts in thousands):
1998 1999
---- ----
Raw materials.......................... $ 5,127 $ 5,901
Work-in-process........................ 5,926 5,682
Finished goods......................... 6,971 12,460
------- -------
$18,024 $24,043
======= =======
Raw materials principally consist of bulk resins. Work-in-process and
finished goods include raw materials, labor and overhead costs. Certain
finished goods are purchased for resale and are not manufactured.
As of December 25, 1998, the Company changed its method for allocating
manufacturing overhead costs for all domestic production. The Company now
allocates such costs based on machine hours rather than direct labor hours. As
the Company has increased the automation of its processes, management believes
this method is preferable to its prior method. Under APB Opinion No. 20,
"Accounting Changes," this change is considered to be a change in estimate
indistinguishable from a change in method. Accordingly, the effect of $1,085,000
for the year ended December 25, 1998 is reflected in operating income as a
reduction to cost of sales.
Foreign Currency Translation
The Company follows the principles of Statement of Financial Accounting
Standards ("SFAS") No. 52, "Foreign Currency Translation," generally using the
local currency as the functional currency of its operating subsidiaries.
Accordingly, all assets and liabilities outside the United States are translated
into U.S. dollars at the rate of exchange in effect at the balance sheet date.
Income and expense items are translated at the weighted-average exchange rate
prevailing during the period.
Beginning in the second quarter of 1998, the Company commenced using the
U.S. dollar as the functional currency of its Mexican operations since Mexico
was considered a highly inflationary economy. Management believes that the
effect of not using the U.S. dollar as the functional currency from January 1,
1997 was not material to the financial statements. Beginning in January 1999,
Mexico was no longer considered a highly inflationary economy and, accordingly,
the Company resumed using the Mexican Peso as the functional currency.
Revenue Recognition
The Company recognizes revenue when product is shipped. The Company
establishes reserves for sales returns and other allowances based on historical
experience.
Income Taxes
The Company and Holding apply the asset and liability method in recording
income taxes, under which deferred income tax assets and liabilities are
determined, based on the differences between the financial reporting and tax
bases of assets and liabilities and are measured using currently enacted tax
rates and laws. Additionally, deferred tax assets are evaluated and a valuation
allowance is established if it is more likely than not that all or a portion of
the deferred tax asset will not be realized.
F-11
Fiscal Year-End
The Company and Holding report their operations on a 52-53 week fiscal year
ending on the Friday closest to December 31. The fiscal years ended December
26, 1997 and December 25, 1998 were both 52-week years. The fiscal year ended
December 31, 1999 was a 53-week year.
Post-Employment and Post-Retirement Benefits
The Company and Holding do not provide post-employment or post-retirement
benefits to employees. Accordingly, SFAS No. 112, "Employers' Accounting for
Post-employment Benefits", and SFAS No. 106, "Employers' Accounting for Post-
retirement Benefits", have no impact on the Company's financial statements.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137, which is effective for fiscal years beginning after June 15, 2000.
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments. The statement requires that every derivative instrument be recorded
in the balance sheet as either an asset or liability measured at its fair value,
and that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Management has not
yet determined the impact this standard will have on the Company or Holding.
Reclassifications
Certain reclassifications have been made in the 1998 statements to conform
to the 1999 presentation.
4. Preferred Stock
Upon consummation of the Recapitalization, Holding issued 300,000 shares of
Series B Senior Exchangeable Payable-In-Kind ("PIK") Preferred Stock subject to
mandatory redemption at a liquidation preference of $100 per share, plus
accumulated and unpaid dividends, if any, on April 15, 2010. Net proceeds from
the original issuance were $29.0 million. Dividends on the preferred stock
accrue at the rate per share of 11-1/2% per annum. Amounts due are payable in
cash, except that on each dividend payment date occurring on or prior to April
15, 2003, dividends may be paid at Holding's option, by the issuance of
additional shares of preferred stock (including fractional shares). Dividends
will be payable semi-annually on April 15 and October 15 of each year commencing
October 15, 1998. The preferred stock will rank junior in right of payment to
all obligations of Holding and its subsidiaries.
Holding issued PIK preferred stock with a liquidation preference of
approximately $1,801,000 and $3,762,000 to satisfy the dividend requirements in
1998 and 1999, respectively. As of December 25, 1998 and December 31, 1999,
Holding accrued for PIK preferred stock dividends in the amount of $711,000 and
$863,000, respectively. The ability of Holding to pay cash dividends on its
preferred stock is dependent upon Hudson's ability to pay cash dividends to
Holding. There can be no assurance that Hudson will make such divided payments.
5. Long-Term Debt Obligations
Summary of Amounts Outstanding
The Company's long-term debt obligations as of December 25, 1998 and
December 31, 1999 consist of the following (amounts in thousands):
F-12
1998 1999
---- ----
Borrowings under revolving credit facility.. $ 38,000 $ 36,600
Term loan payable to domestic banks......... 6,000 35,000
Term loan payable to Swedish bank........... - 17,586
Senior subordinated notes................... 115,000 115,000
Note payable to affiliate................... - 7,508
-------- --------
159,000 211,694
Less current portion........................ (3,000) (6,673)
-------- --------
Long-term debt.............................. $156,000 $205,021
======== ========
Credit Facility
In connection with the Recapitalization, the Company entered into a new
credit agreement with a bank group, which provides for borrowings of up to $100
million. This agreement consists of two separate facilities as follows:
1.) Revolving credit--maximum borrowings of $60.0 million with a letter of
credit sub-limit of $7.5 million. This facility must be
prepaid upon payment in full of the Term Loan facility.
2.) Term loan--maximum borrowings of $40.0 million with quarterly
installments to be made through maturity.
Interest on the Credit Facility is based, at the option of the Company,
upon either an optional eurodollar rate (as defined) plus 2.25%, or a base rate
(as defined) plus 1.25% per annum. A commitment fee of 0.50% per annum will be
charged on the unused portion of the Credit Facility. The following summarizes
interest rate data on the Credit Facility as of December 25, 1998 and December
31, 1999:
1998 1999
---- ----
Eurodollar rate......................................................... 5.1875% 6.0625%
Base rate............................................................... 7.75% 8.5%
Term loan facility rate................................................. 7.4375% 8.75%
Revolving credit facility rate.......................................... 7.8125% to 8.5625% to
9% 10%
Total borrowings as of December 31, 1999 were $35.0 million and $36.6
million under the Term Loan Facility and Revolving Credit Facility,
respectively. The Credit Facility will mature on April 7, 2004.
The agreement provides the bank a first security interest in substantially
all of the properties and assets of the Company and a pledge of 65% of the stock
of Industrias, a subsidiary of the Company. The agreement also requires
the Company to maintain certain financial ratios and financial covenants, as
defined in the agreement, the most restrictive of which prohibit additional
indebtedness and limit dividend payments to the Company's stockholders.
As of December 31, 1999, the Company had available credit under the
Revolving Loan Facility in the amount of $23.4 million ($16.8 million of which
is restricted for use on future acquisitions). No additional borrowing is
available under the Term Loan Facility.
The Company is required under restrictive covenants of the Credit Facility
Agreement to maintain certain financial ratios, and meet certain operating cash
flow tests for which the Company was not in total compliance as of December 25,
1998. Subsequently, the Company amended its Credit Facility Agreement so that
under the amended terms it was in compliance at December 25, 1998. The Company
was in compliance with all amended restrictive covenants as of December 31,
1999.
Senior Subordinated Notes
Also related to the Recapitalization, the Company issued under an Indenture
$115.0 million of senior subordinated notes (the "Notes"). The Notes are fully
transferable and are general unsecured obligations of the Company, subordinated
in right of payment to all existing and future senior debt, as defined, of the
Company.
F-13
The Notes bear interest at a rate equal to 9-1/8% per annum from the date
of issuance of the Notes. Interest is payable semi-annually on April 15 and
October 15 of each year, commencing October 15, 1998. The Notes will mature on
April 15, 2008 and will be redeemable at the option of the Company, in whole or
in part, on or after April 15, 2003.
The fair value of the Company's senior subordinated notes at December 31,
1999 was approximately $92.2 million. The fair value is estimated based on the
quoted market prices for issues listed on exchanges and is not intended to, and
does not, represent the underlying fair value of the Company.
Note Payable to Affiliate
In connection with the acquisition of LGAB during 1999, the Company
borrowed $22.0 million under an unsecured 12.0% note payable to an affiliate of
Holding's existing majority stockholder. The note is due August 1, 2006. During
1999, the Company paid approximately $14.5 million in principal on the note.
Bank Notes Payable
The Company has bank borrowings of $17.6 million outstanding at December
31, 1999, which are denominated in Swedish krona. The borrowings bear interest
at the 3-month STIBOR (the interest rate at or about 11:00 a.m. Stockholm time,
two banking days before the draw-down date or the relevant interest period,
quoted for deposits in krona) plus 0.75% to 1.75% (4.365% to 5.365% at December
31, 1999), are due December 21, 2003 and are secured by the common stock of
LGAB.
Future Debt Principal Payments
As of December 31, 1999, future debt principal payments on the
aforementioned debt are as follows (amounts in thousands):
Fiscal Year Ending:
-------------------
2000............................................. $ 6,673
2001............................................. 11,019
2002............................................. 13,019
2003............................................. 15,019
2004............................................. 43,456
Thereafter....................................... 122,508
--------
$211,694
========
6. Detail of Selected Balance Sheet Accounts
Property, Plant and Equipment
The following is a summary as of December 25, 1998 and December 31, 1999
(amounts in thousands):
1998 1999
---- ----
Land.................................... $ 4,007 $ 4,007
Buildings............................... 10,898 11,077
Leasehold improvements.................. 296 296
Machinery and equipment................. 31,979 39,243
Furniture and fixtures.................. 1,243 1,427
------- --------
48,423 56,050
Less -- Accumulated depreciation and (4,298) (13,409)
amortization........................... ------- --------
44,125 42,641
Equipment installation in progress...... 2,732 8,416
ERP software installation in progress... - 3,284
------- --------
Property and equipment, net............. $46,857 $ 54,341
======= ========
Depreciation of property, plant and equipment is provided using both
straight-line and declining-balance methods over the following estimated useful
lives:
F-14
Buildings......................... 31.5 years
Leasehold improvements............ Shorter of the useful life or lease
term
Machinery and equipment........... 5 to 7 years
Furniture and fixtures............ 7 years
Upon retirement or disposal of depreciable assets, the cost and related
accumulated depreciation are removed and the resulting gain or loss is reflected
in income from operations. Major renewals and betterments are capitalized while
maintenance costs and repairs are expensed in the year incurred. ERP software
installation costs are capitalized in accordance with Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." The Company expects to "go live" on the new ERP
system approximately April 1, 2000.
Total depreciation and amortization expense was approximately $8,507,000
and $15,655,000 for the years ended December 25, 1998 and December 31, 1999,
respectively.
Accrued Liabilities
Accrued liabilities consisted of the following as of December 25, 1998 and
December 31, 1999 (amounts in thousands):
1998 1999
---- ----
Interest........................... $2,315 $ 4,162
Payroll and related................ 742 4,095
Vacation........................... 1,176 1,509
Pension............................ 809 1,353
Medical self-insurance............. 394 577
Other.............................. 783 4
------ -------
$6,219 $11,700
====== =======
7. Commitments and Contingencies
The Company leases certain facilities, automobiles and office equipment
under noncancellable leases, with the majority of the automobile leases having a
term of one year with annual renewal provisions. All of these leases have been
classified as operating leases. As of December 31, 1999, the Company had future
obligations under operating leases as follows (amounts in thousands):
Fiscal Year Ending:
--------------------
2000............................... $ 681
2001............................... 297
2002............................... 297
2003............................... 109
2004............................... 82
------
$1,466
======
Rental expense was approximately $1,506,000 and $2,052,000, in fiscal 1998
and 1999, respectively.
The Company self-insures the majority of its medical benefit programs.
Reserves for losses totaling approximately $394,000 and $577,000 at December 25,
1998 and December 31, 1999, respectively, are established currently based upon
estimated obligations and are included in accrued liabilities in the
accompanying balance sheets. The Company maintains excess coverage on an
aggregate claim basis.
The Company is party to lawsuits and other proceedings, including suits
relating to product liability and patent infringement. While the results of such
lawsuits and other proceedings cannot be predicted with certainty, management
does not expect that the ultimate liabilities, if any, will have a material
adverse effect on the financial position or results of operations of the
Company.
F-15
8. Income Taxes
Holding is a C corporation and the Company became a C corporation upon the
occurrence of the Recapitalization discussed in Note 1. Holding's effective
income tax rate for 1998 approximates the combined federal and state
statutory rates of 39%. During 1999, the Company revised its estimate of the
combined effective income tax rate to approximately 40%.
The tax provision (benefit) for 1998 and 1999 consists of the following
(amounts in thousands):
1998 1999
------- --------
Income taxes at combined statutory rate of approximately 39% and 40% in
1998 and 1999, respectively................................................ $ (614) $(2,833)
Foreign losses not benefited................................................. - 1,443
Other........................................................................ - (118)
------- -------
$ (614) $(1,508)
======= =======
The provision (benefit) for income taxes consists of the following
(amounts in thousands):
United States International Total
1999 ------------- ------------- -----
Current..................................... $ - $ 340 $ 340
Deferred.................................... (1,370) (478) (1,848)
-------- -------- --------
$(1,370) $ (138) $(1,508)
======== ======== ========
1998
Current..................................... $ - $ - $ -
Deferred.................................... (614) - (614)
-------- ------- --------
$ (614) $ - $ (614)
======== ======= ========
The components of the deferred tax asset as of December 31, 1999 are
(amounts in thousands):
December 25, December 31,
1998 1999
----------- -----------
Basis differences arising from Section 338(h)(10) election................... $15,052 $11,381
Net operating loss carryforwards............................................. 5,595 9,019
Liabilities and allowances not currently deductible for tax purposes......... 1,170 2,443
Accelerated tax depreciation................................................. (4,743) (3,961)
Other........................................................................ 262 266
------- -------
17,336 19,148
Valuation allowance.......................................................... (7,702) (7,806)
------- -------
$ 9,634 $11,342
======= =======
Net operating loss carryforwards expire on various dates through 2019. In
management's opinion, the net deferred tax asset is more likely than not to be
realized.
9. Deferred Compensation and Benefit Plans
Pension Plan
The Company has a defined-contribution pension plan covering substantially
all its employees. Amounts charged to expense relating to this plan totaled
approximately $810,000 and $972,000 for the fiscal years ended 1998 and 1999,
respectively.
Deferred Compensation
Effective December 1, 1994, the Company established a deferred-compensation
plan for certain key employees. As of December 25, 1998 and December 31, 1999 no
material amount of compensation has been deferred.
10. Geographic, Segment and Major Customer Information
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 establishes new standards for
reporting operating segments of publicly held companies. This approach requires
the Company to present segment information externally the same way management
uses financial data internally to make operating decisions and assess
performance. SFAS No. 131 also requires that all public business enterprises
report information about the revenues derived from the enterprise's products or
services (or groups of similar products and services), about the countries in
which the enterprise earns revenues and holds assets and about major customers
regardless of whether that information is used in making operating decisions.
The Company sells respiratory care products to distributors and medical
facilities throughout the United States and internationally. During 1998 and
1999, the Company had foreign sales of approximately $20,148,000 and $28,497,000
respectively, which constituted approximately 20.0% and 22.1% of total sales,
respectively. The Company's percentage of sales by geographic region for the
fiscal years ended 1998 and 1999 were as follows:
1998 1999
---- ----
Domestic...................................................... 79.9% 77.9%
Europe........................................................ 7.8 10.1
Pacific Rim (Japan, Southeast Asia, Australia/New Zealand).... 6.2 6.1
Canada........................................................ 2.0 1.9
Other international........................................... 4.1 4.0
----- -----
100.0% 100.0%
===== =====
F-16
Although the information presented above for the period from April 7, 1998
(Inception) to December 25, 1998 reflects full twelve-month activity for Hudson,
management does not believe that the corresponding percentage relationships in
the nine-month activity for Holding would be materially different.
The following summarizes the net book value of fixed assets at the
respective locations as of December 25, 1998 and December 31, 1999 (amounts in
thousands):
December 25, December 31,
1998 1999
---- ----
Ensenada, Mexico........................................ $ 1,060 $ 1,134
Stockholm, Sweden....................................... - 342
Kuala Lumpur, Malaysia.................................. - 741
United States........................................... 45,797 52,124
------- -------
$46,857 $54,341
======= =======
For the fiscal years ended 1998 and 1999, the Company had sales to one
domestic distributor in the amount of $24,940,000 and $24,491,000,
respectively, which represented approximately 24.8% and 19.0% of sales,
respectively. Additionally, the Company had sales to another domestic
distributor of $10,265,000 and 14,775,000 that accounted for approximately 10.2%
and 11.5% of sales in 1998 and 1999, respectively.
11. Unaudited Consolidated Quarterly Data
1998 Quarters Ended
---------------------------------------
June 26 September 25 December 25
--------- ------------- ------------
(amounts in thousands)
Net sales................................................. $24,265 $ 22,130 $29,837
Gross profit.............................................. 11,239 10,316 10,015
Net income (loss)......................................... 1,498 (3,444) 986
1999 Quarters Ended
---------------------------------------------------
March 26 June 25 September 24 December 31
-------- -------- ------------ -----------
(amounts in thousands)
Net sales................................................ $27,169 $27,274 $ 30,827 $ 43,533
Gross profit............................................. 11,729 11,531 12,309 15,556
Net income (loss)........................................ (820) (774) (2,654) (1,326)
F-17
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Hudson Respiratory Care Inc.:
We have audited the accompanying consolidated balance sheets of HUDSON
RESPIRATORY CARE INC., (a California Corporation) and subsidiaries as of
December 25, 1998 and December 31, 1999, and the related consolidated statements
of operations, stockholders' equity (deficit) and cash flows (as restated, see
Note 15) for the years ended December 26, 1997, December 25, 1998 and December
31, 1999. These financial statements 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hudson Respiratory Care
Inc. and subsidiaries as of December 25, 1998 and December 31, 1999, and the
results of their operations and their cash flows for the years ended December
26, 1997, December 25, 1998 and December 31, 1999 in conformity with accounting
principles generally accepted in the United States.
As more fully described in Note 15 to the financial statements, the net
effect of the Company's conversion from S to C corporation status and the
related Section 338(h)(10) election to increase the tax bases of assets in
connection with the Recapitalization of $77,064,000 was previously reflected in
operations during the quarter ended June 26, 1998. This amount should have been
reflected as a direct credit to retained earnings. The restatement had no impact
on ending retained earnings for the periods presented.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 24, 2000
F-18
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
ASSETS
December December
25, 1998 31, 1999
----------- -----------
CURRENT ASSETS:
Cash....................................................................................... $ 507 $ 2,917
Accounts receivable, less allowance for doubtful accounts of $794 and $973 at December 25,
1998 and December 31, 1999, respectively................................................ 25,829 30,425
Inventories................................................................................ 18,024 24,043
Other current assets....................................................................... 716 4,612
---------- ----------
Total current assets.................................................................... 45,076 61,997
PROPERTY, PLANT AND EQUIPMENT, net........................................................... 32,732 42,476
OTHER ASSETS:
Intangible assets, net..................................................................... 4,955 66,970
Deferred financing costs, net of accumulated amortization of $1,000 and $2,253 at December
25, 1998 and December 31, 1999, respectively............................................ 11,917 11,134
Deferred tax asset......................................................................... 70,329 68,943
Other...................................................................................... 312 299
---------- ----------
Total other assets...................................................................... 87,513 147,346
---------- ----------
Total assets................................................................... $ 165,321 $ 251,819
========== ==========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Notes payable to banks.................................................................... $ 3,000 $ 6,673
Accounts payable.......................................................................... 6,324 6,168
Accrued liabilities....................................................................... 6,219 11,700
Other current liabilities................................................................. - 1,485
---------- ----------
Total current liabilities............................................................... 15,543 26,026
NOTE PAYABLE TO AFFILIATE.................................................................... - 7,508
NOTES PAYABLE TO BANKS, net of current portion............................................... 41,000 82,513
SENIOR SUBORDINATED NOTES PAYABLE............................................................ 115,000 115,000
---------- ----------
Total liabilities....................................................................... 171,543 231,047
========== ==========
COMMITMENTS AND CONTINGENCIES (Note 7)
MANDATORILY-REDEEMABLE PREFERRED STOCK,
$.01 par value: 1,800 shares authorized; 318 and 356 shares issued and outstanding at
December 25, 1998 and December 31, 1999, respectively; liquidation preference--$31,802
and $35,558 respectively (Note 4)....................................................... 30,802 34,558
Accrued preferred stock dividends, payable in kind......................................... 711 863
---------- ----------
31,513 35,421
========== ==========
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, no par value: 15,000 shares authorized; 7,813 and 10,044 shares issued
and outstanding at December 25, 1998 and December 31, 1999, respectively................ 63,535 92,158
Cumulative translation adjustment......................................................... (464) (862)
Accumulated deficit....................................................................... (100,806) (105,945)
---------- ----------
Total stockholders' equity (deficit).................................................... (37,735) (14,649)
---------- ----------
Total liabilities, mandatorily-redeemable preferred stock and stockholders'
equity (deficit) ....................................................................... $ 165,321 $ 251,819
========== ==========
The accompanying notes are an integral part of these consolidated balance
sheets.
F-19
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
For the Years Ended
----------------------------------------------------
December 25,
1998 (As
December 26, Restated; See December 31,
1997 Note 15) 1999
-------------- ---------------- ---------------
NET SALES..................................................... $ 99,509 $ 100,498 $ 128,803
COST OF SALES 54,575 56,802 75,418
------------- ---------- -------------
Gross profit............................................. 44,934 43,696 53,385
------------- ---------- -------------
OPERATING EXPENSES:
Selling.................................................... 9,643 10,350 13,122
Distribution............................................... 3,170 3,336 4,647
General and administrative................................. 11,456 10,284 14,732
Research and development................................... 1,072 976 2,031
------------- ---------- -------------
Total operating expenses................................. 25,341 24,946 34,532
------------- ---------- -------------
PROVISION FOR EQUITY PARTICIPATION PLAN AND RETENTION
PAYMENTS................................................... (6,954) (68,693) -
------------- ---------- -------------
Income (loss) from operations............................ 12,639 (49,943) 18,853
OTHER INCOME AND (EXPENSES):
Interest expense........................................... (1,834) (11,327) (17,263)
Other, net................................................. 638 (406) (1,232)
------------- ---------- -------------
(1,196) (11,733) (18,495)
------------- ---------- -------------
Income (loss) before provision for income taxes and
extraordinary item............................................ 11,443 (61,676) 358
PROVISION FOR INCOME TAXES.................................... 150 8,405 1,586
------------- ---------- -------------
Income (loss) before extraordinary item....................... 11,293 (70,081) (1,228)
EXTRAORDINARY ITEM-loss on extinguishment of debt............. - 104 -
------------- ---------- -------------
Net income (loss)............................................. 11,293 (70,185) (1,228)
OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation loss.......................... (148) (119) (398)
------------- ---------- -------------
Comprehensive income (loss)................................... $ 11,145 $ (70,304) $ (1,626)
============= ========== =============
Pro forma net income (loss) assuming conversion to C
corporation for income tax purposes (Note 8).................. $ 6,866 $ (37,006)
============= ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-20
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
Retained Earnings
(Accumulated
Common Stock Cumulative Deficit)(As
-------------------- Translation Restated;
Shares Amount Adjustment See Note 15) Total
-------- ------- ---------- ----------- --------
BALANCE, December 27, 1996........................ 14,469 $ 3,789 $ (197) $ 16,280 $ 19,872
Stockholder distributions....................... - - - (8,502) (8,502)
Foreign currency translation loss............... - - (148) - (148)
Net income...................................... - - - 11,293 11,293
------- --------- --------- ---------- ----------
BALANCE, December 26, 1997........................ 14,469 3,789 (345) 19,071 22,515
Stockholder redemption.......................... (12,969) (3,379) - (124,244) (127,623)
Foreign currency translation loss............... - - (119) - (119)
Recapitalization investment..................... 6,300 63,000 - - 63,000
Issuance of common stock........................ 13 125 - - 125
Pay-in-kind preferred stock dividends........... - - (2,512) (2,512)
Effect of Section 338(h)(10) election on
deferred taxes.................................. - - 77,064 77,064
Net loss........................................ - - - (70,185) (70,185)
------- --------- --------- ---------- ----------
BALANCE, December 25, 1998........................ 7,813 63,535 (464) (100,806) (37,735)
Issuance of common stock to parent for cash
and contribution of Louis Gibeck AB Stock....... 2,231 28,623 - - 28,623
Foreign currency translation loss............... - - (398) - (398)
Pay-in-kind preferred stock dividends........... - - - (3,911) (3,911)
Net loss........................................ - - - (1,228) (1,228)
------- --------- --------- ---------- ----------
BALANCE, December 31, 1999........................ 10,044 $ 92,158 $ (862) $ (105,945) $ (14,649)
======= ========= ========= ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-21
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Years Ended
---------------------------------------------
December 25,
1998 (As
December 26, Restated; See December 31,
1997 Note 15) 1999
------ -------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................. $ 11,293 $(70,185) $ (1,228)
Adjustments to reconcile net income to net cash provided
by (used in) operating activities--
Depreciation and amortization............................ 5,847 6,101 8,315
Amortization/write-off of deferred financing costs
and other.............................................. - 1,119 1,374
(Gain) loss on disposal of equipment..................... (618) 14 (5)
Change in deferred tax asset............................. - 6,735 1,385
Changes in operating assets and liabilities:
Increase in accounts receivable.......................... (550) (4,547) (2,701)
Increase in inventories.................................. (2,596) (1,411) (2,865)
(Increase) decrease in other current assets.............. 96 437 (1,194)
(Increase) decrease in other assets...................... (100) 247 13
Increase (decrease) in accounts payable.................. (12) 2,482 (741)
Increase (decrease) in accrued liabilities............... (130) 1,687 4,277
Increase (decrease) in management bonus accrual.......... 20,000 (20,000) -
Increase (decrease) in other current liabilities......... - - 1,426
Increase (decrease) in other non-current liabilities..... - - (959)
Increase (decrease) in accrued equity participation...... (13,961) 83,939 -
plan (EPP)...............................................
Payment of EPP liabilities and retention bonuses......... - (89,642) -
-------- -------- --------
Net cash provided by (used in) operating
activities........................................... 19,269 (83,024) 7,097
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment.................... (4,659) (3,111) (10,973)
Proceeds from sale of property, plant and equipment........... 1,068 18 23
Increase in notes receivable and intangible assets............ (82) - (354)
Additions of deferred financing costs......................... - - 154
Acquisition of certain assets of Gibeck, Inc.................. - (3,351) -
Acquisition of certain assets of Medimex...................... - - (2,168)
Acquisition of certain assets of Tyco......................... - - (23,750)
Acquisition of Louis Gibeck AB stock, net of cash
acquired of $8,208............................................ - - (38,750)
-------- -------- --------
Net cash used in investing activities................ (3,673) (6,444) (75,818)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to bank............................ (14,396) (43,250) (17,355)
Proceeds from bank borrowings................................. 6,500 67,000 59,376
Stockholder distributions..................................... (8,502) - -
Additions to deferred financing costs......................... - (12,918) -
Redemption of stockholder interest............................ - (127,623) -
Proceeds from senior subordinated notes payable............... - 115,000 -
Proceeds from note payable to affiliate....................... - - 22,000
Repayment of note payable to affiliate........................ - - (14,492)
Net proceeds from sale of common and
mandatorily-redeemable preferred stock, net of
transaction costs............................................. - 91,415 22,000
-------- -------- --------
Net cash (used in) provided by financing
activities........................................... (16,398) 89,624 71,529
-------- -------- --------
Effect of exchange rate changes on cash.......................... (148) (119) (398)
NET (DECREASE) INCREASE IN CASH.................................. (950) 37 2,410
CASH, beginning of period........................................ 1,420 470 507
-------- -------- --------
CASH, end of period.............................................. $ 470 $ 507 $ 2,917
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-22
For the Years Ended
-----------------------------------------------
December 25,
1998 (As
December 26, Restated; See December 31,
1997 Note 15) 1999
------ ------------- -----
(In thousands)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for--
Interest.......................................... $ 1,969 $ 8,742 $ 15,333
========== ========== ==========
Income taxes...................................... $ 243 $ 1,699 $ 27
========== ========== ==========
DETAILS OF ACQUISITIONS (Note 2):
Acquisition price................................... $ - $ 3,351 $ 79,499
Less:
Common stock issued for acquisition............... - - (6,623)
Cash acquired..................................... - - (8,208)
---------- ---------- ----------
Net cash paid for acquisitions.............. $ - $ 3,351 $ 64,668
========== ========== ==========
NON-CASH OPERATING ACTIVITIES:
Net income includes approximately $2,825,000 of non-cash expense related to
the recognition of the portion of purchase price allocation related to
acquired inventories.
NON-CASH FINANCING ACTIVITIES:
The Company satisfies its preferred dividend requirements by the issuance
of additional shares of preferred stock. Such accrued dividend requirements
totaled $6,421,000 from the date of issuance of the preferred stock through
December 31, 1999; preferred stock with an approximate face value of
$1,801,000 was issued in 1998, $3,757,000 was issued in 1999 and $863,000
will be issued in 2000.
The Company issued common stock to its parent in partial consideration for
the contribution of Louis Gibeck AB stock (see Note 2).
The accompanying notes are an integral part of these consolidated financial
statements.
F-23
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. Company Background
Hudson Respiratory Care Inc. ("Hudson" or the "Company"), a California
corporation founded in 1945, is a manufacturer and marketer of disposable
medical products utilized in the respiratory care and anesthesia segments of the
domestic and international health care markets. The Company's respiratory care
and anesthesia product lines include such products as oxygen masks,
humidification systems, nebulizers, cannulae and tubing. In the United States,
the Company markets its products to a variety of health care providers,
including hospitals and alternate site service providers such as outpatient
surgery centers, long-term care facilities, physician offices and home health
care agencies. Internationally, the Company sells its products to distributors
that market to hospitals and other health care providers. The Company's products
are sold to distributors and alternate site service providers throughout the
United States and internationally. The Company's respiratory product operations
are conducted from its primary facility in Temecula, California, facilities in
Arlington Heights and Elk Grove, Illinois, and a facility in Ensenada, Mexico.
The Company's anesthesia product operations are conducted from facilities
located principally in Sweden and Malaysia, which were acquired in July 1999
(see Note 2).
Recapitalization
In April 1998, the Company consummated a plan pursuant to which a majority
interest in the Company was sold in accordance with an agreement and plan of
merger (the "Recapitalization").
Key components of the Recapitalization included:
(1) Common and preferred equity investments in consideration for an 80.8%
ownership in the Company's common stock and preferred stock with an
initial liquidation preference of $30.0 million
(2) Issuance of 9-1/8% senior subordinated notes with a par value of
$115.0 million, maturing in 2008 (see Note 5)
(3) Execution of a new term loan facility and revolving loan facility (see
Note 5)
(4) Repayment of existing indebtedness
(5) Payment of amounts due under the Equity Participation Plan (see Note
10)
(6) Payment for common shares acquired from the existing shareholder; this
shareholder retained a 19.2% interest in the common shares
outstanding
(7) Potential contingent payments based on 1998 performance, payable to
the continuing shareholder and former participants in the Equity
Participation Plan; however, as a result of the Company's 1998
performance, no additional amounts were due.
The Company has terminated the Equity Participation Plan and plans to adopt
an executive stock purchase plan and a stock option plan. Additionally, Hudson's
sole shareholder, who owned the remaining 21.0% of Industrias Hudson
("Industrias"), a subsidiary of the Company, transferred this interest to the
Company in consideration of one dollar. Because of the commonality of ownership,
the 21.0% minority interest has been included in the financial statements for
all periods presented.
The Company effected a 245:1 stock split concurrent with the
Recapitalization. The stock split has been reflected in the stock amounts shown
herein.
F-24
The Recapitalization resulted in no change to the carrying amounts of the
Company's existing assets and liabilities. The Company has recorded a deferred
tax asset due to the conversion from S to C corporation status and a tax
election to revalue the basis of assets and liabilities for tax purpose s.
2. Acquisitions
Gibeck, Inc.
During 1998, the Company acquired certain assets of Gibeck Inc. ("Gibeck"),
a subsidiary of Louis Gibeck AB, for a cash purchase price of $3,351,000. Gibeck
engages primarily in the business of manufacturing, marketing, and selling
custom anesthesia circuits. The acquisition was accounted for as a purchase and
the purchase price was allocated as follows (amounts in thousands):
Goodwill..................................... $1,817
Inventory.................................... 871
Machinery and equipment...................... 663
------
$3,351
======
Louis Gibeck AB
On July 22, 1999, the Company acquired substantially all of the outstanding
capital stock of Louis Gibeck AB ("LGAB") and subsidiaries, a Swedish company
engaged primarily in the business of manufacturing, marketing and selling
respiratory and anesthesia equipment. The purchase price was approximately
$53.6 million, which included cash consideration of approximately $45.5 million
(including approximately $8.2 million of cash acquired), a non-cash contribution
of shares of common stock of River Holding Corp., a Delaware corporation and the
Company's parent, of $6.6 million and transaction expenses of approximately $1.5
million.
The acquisition was funded with (i) a $22.0 million common stock sale to
the Company's existing majority shareholder, (ii) a $22.0 million, 12.0% per
annum unsecured note payable to an affiliate of the Company's existing majority
shareholder due August 1, 2006 and (iii) a $5.9 million unsecured bank loan
bearing interest at the bank's reference rate plus 1/4% per annum due July 30,
2006.
The acquisition of LGAB was accounted for as a purchase and the purchase
price was preliminarily allocated based upon management's estimate of the assets
acquired and liabilities assumed as follows (amounts in thousands):
Cash......................................... $ 8,208
Accounts receivable.......................... 1,823
Inventories.................................. 5,161
Fixed assets................................. 1,206
Current liabilities.......................... (4,856)
Non-current liabilities...................... (4,123)
Other assets................................. 2,939
Goodwill..................................... 43,223
-------
$53,581
=======
The Company is evaluating estimates made in conjunction with the purchase
price allocation, which may change in the near term.
Had this acquisition and the acquisition of certain assets of Gibeck, Inc.
occurred at the beginning of the current and prior fiscal years, the unaudited
pro forma net sales, net loss before extraordinary item and net loss would be as
follows (amounts in thousands):
F-25
Years Ended
---------------------------------------
December 25, December 31,
1998 1999
---- ----
Net sales............................................... $122,819 $139,494
Net loss before extraordinary item...................... (66,344) (1,949)
Net loss................................................ (66,448) (1,949)
Acquisition of Product Line
On November 8, 1999, the Company acquired certain assets of Tyco
Healthcare Group LP ("Tyco"), including Tyco's incentive breathing exerciser and
pulmonary function monitor product lines, for a cash purchase price of
approximately $23.8 million. The acquisition was accounted for as a purchase and
the purchase price was allocated as follows (amounts in thousands):
Goodwill........................................................... $18,750
Machinery and equipment............................................ 3,000
Deposit............................................................ 2,000
-------
$23,750
=======
Included in other current assets at December 31, 1999 are approximately
$1.1 million of the remaining deposit and approximately $1.4 million due from
the seller for certain year-end sales made on behalf of the Company.
Acquisition of Distributor
In October 1999, the Company acquired certain assets of Medimex, a German
distributor of respiratory products, for a cash purchase price of approximately
$2.2 million. The acquisition was accounted for as a purchase and the purchase
price was allocated as follows (amounts in thousands):
Goodwill..................................... $1,300
Inventory.................................... 900
------
$2,200
======
3. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements and related notes
include the accounts of Hudson and its wholly-owned subsidiaries. All
significant intercompany account balances and transactions have been eliminated
in consolidation. Hudson and its wholly-owned subsidiaries are collectively
referred to herein as the Company.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
certain estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.
Inventories
Inventories are stated at the lower of cost (first-in, first-out (FIFO)
method) or market. At December 25, 1998 and December 31, 1999, inventories
consisted of the following (amounts in thousands):
1998 1999
---- ----
Raw materials........................................................... $ 5,127 $ 5,901
Work-in-process......................................................... 5,926 5,682
Finished goods.......................................................... 6,971 12,460
------- -------
$18,024 $24,043
======= =======
F-26
Raw materials principally consist of bulk resins. Work-in-process and
finished goods include raw materials, labor and overhead costs. Certain
finished goods are purchased for resale and are not manufactured.
As of December 25, 1998, the Company changed its method for allocating
manufacturing overhead costs for all domestic production. The Company now
allocates such costs based on machine hours rather than direct labor hours. As
the Company has increased the automation of its processes, management believes
this method is preferable to its prior method. Under Accounting Principles Board
("APB") Opinion No. 20, "Accounting Changes," this change is considered to be a
change in estimate indistinguishable from a change in method. Accordingly, the
effect of $1,085,000 for the year ended December 25, 1998 is reflected in
operating income as a reduction to cost of sales.
Foreign Currency Translation
The Company follows the principles of Statement of Financial Accounting
Standards ("SFAS") No. 52, "Foreign Currency Translation," generally using the
local currency as the functional currency of its operating subsidiaries.
Accordingly, all assets and liabilities outside the United States are translated
into U.S. dollars at the rate of exchange in effect at the balance sheet date.
Income and expense items are translated at the weighted-average exchange rate
prevailing during the period.
Beginning in the second quarter of 1998, the Company commenced using the
U.S. dollar as the functional currency of its Mexican operations since Mexico
was considered a highly inflationary economy. Management believes that the
effect of not using the U.S. dollar as the functional currency from January 1,
1997 was not material to the financial statements. Beginning in January 1999,
Mexico was no longer considered a highly inflationary economy and, accordingly,
the Company resumed using the Mexican Peso as the functional currency.
Revenue Recognition
The Company recognizes revenue when product is shipped. The Company
establishes reserves for sales returns and other allowances based on historical
experience.
Income Taxes
The Company applies the asset and liability method in recording income
taxes, under which deferred income tax assets and liabilities are determined,
based on the differences between the financial reporting and tax bases of assets
and liabilities and are measured using currently enacted tax rates and laws.
Additionally, deferred tax assets are evaluated and a valuation allowance is
established if it is more likely than not that all or a portion of the deferred
tax asset will not be realized.
Fiscal Year-End
The Company reports its operations on a 52-53 week fiscal year ending on
the Friday closest to December 31. The fiscal years ended December 26, 1997 and
December 25, 1998 were both 52-week years. The fiscal year ended December 31,
1999 was a 53-week year.
Post-Employment and Post-Retirement Benefits
The Company does not provide post-employment or post-retirement benefits to
employees. Accordingly, SFAS No. 112, "Employers' Accounting for Post-
employment Benefits", and SFAS No. 106, "Employers' Accounting for Post-
retirement Benefits", have no impact on the Company's financial statements.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137, which is effective for fiscal years beginning after June 15, 2000.
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments. The statement requires that every derivative
F-27
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value, and that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. Management has not yet determined the impact that adoption of this standard
will have on the Company.
Reclassifications
Certain reclassifications have been made in the 1997 and 1998 statements to
conform to the 1999 presentation.
4. Preferred Stock
In connection with the Recapitalization, the Company issued 300,000 shares
of mandatorily-redeemable 11-1/2% senior exchangeable pay-in-kind ("PIK")
preferred stock due 2010. Net proceeds from the original issuance were $29.0
million. Dividends are payable semi-annually in arrears on April 15 and October
15 each year. Dividends will be payable in cash, except on dividend payment
dates occurring on or prior to April 15, 2003, for which the Company has the
option to issue additional shares of preferred stock (including fractional
shares) having an aggregate liquidation preference equal to the amount of such
dividends. The preferred stock will rank junior in right of payment to all
obligations of the Company and its subsidiaries.
The Company issued PIK preferred stock with a liquidation preference of
approximately $1,801,000 and $3,762,000 to satisfy the dividend requirements in
1998 and 1999, respectively. As of December 25, 1998 and December 31, 1999 the
Company accrued for PIK preferred stock dividends in the amount of $711,000 and
$863,000, respectively.
5. Long-Term Debt Obligations
Summary of Amounts Outstanding
The Company's long-term debt obligations as of December 25, 1998 and
December 31, 1999 consist of the following (amounts in thousands):
1998 1999
---- ----
Borrowings under revolving credit facility..... $ 38,000 $ 36,600
Term loan payable to domestic banks............ 6,000 35,000
Term loan payable to Swedish bank.............. - 17,586
Senior subordinated notes...................... 115,000 115,000
Note payable to affiliate...................... - 7,508
-------- --------
159,000 211,694
Less current portion........................... (3,000) (6,673)
------- --------
Long-term debt................................. $156,000 $205,021
======== ========
Credit Facility
In connection with the Recapitalization, the Company entered into a new
credit agreement with a bank group, which provides for borrowings of up to
$100.0 million. This agreement consists of two separate facilities as follows:
1.) Revolving credit--maximum borrowings of $60.0 million with a letter
of credit sub-limit of $7.5 million. This facility
must be prepaid upon payment in full of the Term
Loan facility.
2.) Term loan--maximum borrowings of $40.0 million with quarterly
installments to be made through maturity.
Interest on the Credit Facility is based, at the option of the Company,
upon either an optional eurodollar rate (as defined) plus 2.25%, or a base rate
(as defined) plus 1.25% per annum. A commitment fee of 0.50% per annum will be
charged on the unused portion of the Credit Facility. The following summarizes
interest rate data on the Credit Facility as of December 25, 1998 and December
31, 1999:
F-28
1998 1999
---- ----
Eurodollar rate......................................................... 5.1875% 6.0625%
Base rate............................................................... 7.75% 8.5%
Term loan facility rate................................................. 7.4375% 8.75%
Revolving credit facility rate.......................................... 7.8125% to 8.5625% to
9.0% 10.0%
Total borrowings as of December 31, 1999 were $35.0 million and $36.6
million under the Term Loan Facility and Revolving Credit Facility,
respectively. The Credit Facility will mature on April 7, 2004.
The agreement provides the bank a first security interest in substantially
all of the properties and assets of the Company and a pledge of 65.0% of the
stock of Industrias. The agreement also requires the Company to maintain
certain financial ratios and financial covenants, as defined in the agreement,
the most restrictive of which prohibit additional indebtedness and limit
dividend payments to the Company's stockholders. The Credit Facility is
guaranteed by the Company's parent.
As of December 31, 1999, the Company had available credit under the
Revolving Loan Facility in the amount of $23.4 million ($16.8 million of which
is restricted for use on future acquisitions). No additional borrowing is
available under the Term Loan Facility.
The Company is required under restrictive covenants of the Credit Facility
Agreement to maintain certain financial ratios, and meet certain operating cash
flow tests for which the Company was not in total compliance as of December 25,
1998. Subsequently, the Company amended its Credit Facility Agreement so that
under the amended terms it was in compliance at December 25, 1998. The Company
was in compliance with all amended restrictive covenants as of December 31,
1999.
Senior Subordinated Notes
Also related to the Recapitalization, the Company issued under an Indenture
$115.0 million of senior subordinated notes (the "Notes"). The Notes are fully
transferable and are general unsecured obligations of the Company, subordinated
in right of payment to all existing and future senior debt, as defined, of the
Company.
The Notes bear interest at a rate equal to 9-1/8% per annum from the date
of issuance of the Notes. Interest is payable semi-annually on April 15 and
October 15 of each year, commencing October 15, 1998. The Notes will mature on
April 15, 2008 and will be redeemable at the option of the Company, in whole or
in part, on or after April 15, 2003. The Notes are guaranteed by Industrias.
The fair value of the Company's senior subordinated notes at December 31,
1999 was approximately $92.2 million. The fair value is estimated based on the
quoted market prices for issues listed on exchanges and is not intended to, and
does not, represent the underlying fair value of the Company.
Note Payable to Affiliate
In connection with the acquisition of LGAB during 1999, the Company
borrowed $22.0 million under an unsecured 12% note payable to an affiliate of
the Company's existing majority stockholder. The note is due August 1, 2006.
During 1999, the Company paid approximately $14.5 million in principal on the
note.
Bank Notes Payable
The Company has bank borrowings of $17.6 million outstanding at December
31, 1999, which are denominated in Swedish Krona. The borrowings bear interest
at the 3-month STIBOR (the interest rate at or about 11:00 a.m. Stockholm time,
two banking days before the draw-down date or the relevant interest period,
quoted for deposits in krona) plus 0.75% to 1.75% (4.365% to 5.365% at December
31, 1999), are due December 21, 2003 and are secured by the common stock of
LGAB.
F-29
Future Debt Principal Payments
As of December 31, 1999, future debt principal payments on the
aforementioned debt are as follows:
Fiscal Year Ending:
-------------------
2000....................................................... $ 6,673
2001....................................................... 11,019
2002....................................................... 13,019
2003....................................................... 15,019
2004....................................................... 43,456
Thereafter................................................. 122,508
--------
$211,694
========
6. Detail of Selected Balance Sheet Accounts
Property, Plant and Equipment
The following is a summary as of December 25, 1998 and December 31, 1999
(amounts in thousands):
1998 1999
---- ----
Land........................................... $ 2,044 $ 2,044
Buildings...................................... 14,899 15,078
Leasehold improvements......................... 1,322 1,322
Machinery and equipment........................ 60,691 65,667
Furniture and fixtures......................... 2,205 4,227
-------- --------
81,161 88,338
Less -- Accumulated depreciation and (51,161) (57,740)
amortization.................................. -------- --------
30,000 30,598
Equipment installation in progress............. 2,732 8,481
ERP software installation in progress.......... - 3,397
-------- --------
Property and equipment, net.................... $ 32,732 $ 42,476
======== ========
Depreciation of property, plant and equipment is provided using the
straight-line method over the following estimated useful lives:
Buildings...................................... 31.5 years
Leasehold improvements......................... Shorter of the useful life or lease
term
Machinery and equipment........................ 5 to 7 years
Furniture and fixtures......................... 3 to 7 years
Upon retirement or disposal of depreciable assets, the cost and related
accumulated depreciation are removed and the resulting gain or loss is reflected
in income from operations. Major renewals and betterments are capitalized while
maintenance costs and repairs are expensed in the year incurred. ERP software
installation costs are capitalized in accordance with Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." The Company expects to "go live" on the new ERP
system approximately April 1, 2000.
Total depreciation and amortization expense was $5,947,000, $6,101,000 and
$8,315,000 for the years ended December 26, 1997, December 25, 1998 and December
31, 1999, respectively.
Intangible Assets, net
Amortization of intangible assets is provided using the straight-line
method over the applicable amortization period. During 1999, the Company wrote-
off certain fully-amortized patents. The following is a summary of the
components of intangible assets as of December 25, 1998 and December 31, 1999
(amounts in thousands):
F-30
Useful lives 1998 1999
------------ ---- ----
Covenant not-to-compete....................................... 5 to 7 years $ 3,500 $ 3,500
Patents....................................................... 15 years 3,183 472
Goodwill...................................................... 15 to 20 years 3,737 67,834
Other......................................................... 5 to 20 years 133 133
------- --------
10,553 71,939
Less -- Accumulated amortization.................................... (5,598) (4,969)
------- --------
$ 4,955 $ 66,970
======= ========
Accrued Liabilities
Accrued liabilities consisted of the following as of December 25, 1998 and
December 31, 1999 (amounts in thousands):
1998 1999
---- ----
Interest....................................... $2,315 $ 4,162
Payroll and related............................ 742 4,095
Vacation....................................... 1,176 1,509
Pension........................................ 809 1,353
Medical self-insurance......................... 394 577
Other.......................................... 783 4
------ -------
$6,219 $11,700
====== =======
7. Commitments and Contingencies
The Company leases certain facilities, automobiles and office equipment
under noncancellable leases, with the majority of the automobile leases having a
term of one year with annual renewal provisions. All of these leases have been
classified as operating leases. As of December 31, 1999, the Company had future
obligations under operating leases as follows (amounts in thousands):
Fiscal Year Ending:
--------------------
2000........................................... $ 681
2001........................................... 297
2002........................................... 297
2003........................................... 109
2004........................................... 82
------
$1,466
======
Rental expense was approximately $1,132,000, $1,506,000 and $2,052,000, in
fiscal 1997, 1998 and 1999, respectively.
The Company self-insures the majority of its medical benefit programs.
Reserves for losses totaling approximately $394,000 and $577,000 at December 25,
1998 and December 31, 1999, respectively, were established based upon estimated
obligations and are included in accrued liabilities in the accompanying balance
sheets. The Company maintains excess coverage on an aggregate claim basis.
The Company is party to lawsuits and other proceedings, including suits
relating to product liability and patent infringement. While the results of such
lawsuits and other proceedings cannot be predicted with certainty, management
does not expect that the ultimate liabilities, if any, will have a material
adverse effect on the financial position or results of operations of the
Company.
8. Income Taxes
Effective November 1, 1987, the stockholder of Hudson elected S corporation
status under the Internal Revenue Code, such that income of the Company is taxed
directly to the stockholder for both federal and state income tax purposes.
Hudson's provision for income taxes and income taxes payable was limited to the
California S corporation tax of 1.5%.
F-31
The Company became a C corporation upon consummation of the transaction
discussed in Note 1. Accordingly, the Company has presented pro forma net income
(loss) amounts to reflect a provision for income taxes at a combined effective
rate of approximately 39% in 1998, after consideration of permanent differences
between financial reporting and income tax amounts. The pro forma amounts
presented do not include the one-time effect of the conversion to C corporation
status reflected in the June 1998 financial statements. During 1999, the Company
revised its estimate of the combined effective income tax rate to approximately
40%.
The actual provision for income taxes for 1998 reflects that the Company
was a C corporation for a portion of the period presented. The conversion from S
to C corporation status and the related Section 338(h)(10) election to increase
the tax bases of assets in connection with the Recapitalization resulted in a
one-time net benefit of $77,064,000 in the quarter ended June 26, 1998 which was
recorded directly to retained earnings (see Note 15).
From the date of the Recapitalization, the Company is included in the
consolidated income tax returns of its parent. The Company provides for income
taxes on a stand-alone basis in accordance with SFAS No. 109, "Accounting for
Income Taxes," pursuant to an informal tax-sharing agreement.
During the fourth quarter of 1998, management evaluated the Company's
subsequent actual performance relative to certain budget projections which were
originally used to evaluate the realizability of the deferred tax asset
established at the time of the Recapitalization. Based upon this assessment,
management provided a valuation allowance of $8,477,000 in the fourth quarter to
reduce the deferred tax asset to an amount that management believes to be
realizable under the requirements of SFAS No. 109. This change in estimate was
included in the deferred tax provision for the year ended December 25, 1998.
The tax provision (benefit) for 1998 and 1999 consists of the following (as
restated; see Note 15) (amounts in thousands):
1998
(As Restated; See
Note 15) 1999
------- ----
Income taxes at combined statutory rate of approximately 39% and 40% in
1998 and 1999, respectively................................................ $(24,094) $ 143
Effect of earnings during S corporation period and other................... 24,022 -
Foreign losses not benefited............................................... - 1,443
Valuation allowance........................................................ 8,477 -
-------- ------
$ 8,405 $1,586
======== ======
The provision (benefit) for income taxes consists of the following (amounts
in thousands):
United States International Total
------------- ------------- -----
1999
Current....................................................... $ - $ 340 $ 340
Deferred...................................................... 1,724 (478) 1,246
------ ----- ------
$1,724 $(138) $1,586
====== ====== ======
1998
Current....................................................... $ - $ - $ -
Deferred...................................................... 8,405 - 8,405
------ ----- ------
$8,405 $ - $8,405
====== ===== ======
1997
Current....................................................... $ 74 $ - $ 74
Deferred...................................................... 76 - 76
------ ----- ------
$ 150 $ - $ 150
====== ===== ======
The 1998 tax provision results primarily from the valuation allowance
discussed previously. As of December 31, 1999, the Company has recorded a net
deferred tax asset of $69.0 million primarily related to basis differences
between financial reporting and tax purposes arising from the Section 338(h)(10)
election to increase the tax bases of assets in connection with the
Recapitalization (see Note 1), which in management's opinion is more likely than
not to be realized. As of December 31, 1999, the Company had a United States net
operating loss carryforward of approximately $26.6 million.
The components of the deferred tax asset as of December 31, 1999 are
(amounts in thousands):
F-32
Basis defferences arising from Section 338(h)(10) election....... $68,873
Net operating loss carryforwards................................. 10,640
Other............................................................ (2,093)
-------
77,420
Valuation allowance.............................................. (8,477)
-------
$68,943
=======
9. Related-Party Transactions
Amounts included in the consolidated financial statements with respect to
transactions with companies controlled by officers, the stockholders or members
of their immediate families are as follows (amounts in thousands):
December 26, December 25, December 31,
1997 1998 1999
---- ---- ----
Purchases..................................................... $1,465 $128 $ -
====== ==== ====
Notes and advances receivable................................. $ 157 $ 91 $100
====== ==== ====
10. Deferred Compensation and Benefit Plans
Pension Plan
The Company has a defined-contribution pension plan covering substantially
all its employees. Amounts charged to expense relating to this plan totaled
approximately $836,000, $810,000 and $972,000 for the fiscal years ended 1997,
1998 and 1999, respectively.
Deferred Compensation
Effective December 1, 1994, the Company established a deferred compensation
plan for certain key employees. As of December 31, 1999 no material amount of
compensation has been deferred.
Equity Participation Plan
Effective January 1, 1994, the Company's Board of Directors adopted the
Equity Participation Plan, as amended (the "Plan"). This Plan provided certain
key employees and independent contractors deferred compensation based upon the
Company's value, as defined in the agreement. Benefits earned by participants
were based upon a formula with a specified minimum benefit accruing each year
for each participant, and benefits were accrued and charged to compensation in
the year earned. As of the fiscal years ended 1997 and 1998, the Company has
recorded $5,703,000 and $63,940,000, respectively, related to amounts earned by
the Plan participants.
In fiscal 1998, the Company declared bonuses totaling $20.0 million that
resulted in a corresponding decrease in amounts payable under the Plan. The
effect of the bonuses was to accelerate the timing of payments to the
participants.
Effective with the Recapitalization, all amounts owed to participants were
paid out and the plan was terminated. Total amounts paid in 1998 were
$89,642,000.
11. Extraordinary Item
In accordance with the Recapitalization, the Company recorded an
extraordinary loss on the extinguishment of the existing debt related to the
write-off of unamortized deferred finance fees of $104,000.
12. Geographic, Segment and Major Customer Information
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS 131 establishes new standards for
reporting operating segments of publicly held companies. This approach requires
the Company to present segment information externally the same way management
uses financial data internally to make operating decisions and assess
performance. SFAS No. 131 also requires that all public business enterprises
report information about the revenues derived from the enterprise's products or
services (or groups of similar products and services), about the countries in
which the enterprise earns revenues and holds assets and about major customers
regardless of whether that information is used in making operating decisions.
F-33
As discussed in Note 14, the non-guarantor subsidiaries consist principally
of LGAB and subsidiaries (whose operations are principally international). The
Company operates in two segments as defined by SFAS No. 131: United States
operations and international operations. The financial data of these two
segments closely approximates the guarantor/non-guarantor information set forth
in Note 14 and, accordingly, no additional segment data has been provided.
The Company sells respiratory care products to distributors and medical
facilities throughout the United States and internationally. During 1997, 1998
and 1999, the Company had foreign sales of approximately $19,008,000,
$20,148,000, and $28,497,000 respectively, which constituted approximately
19.1%, 20.0% and 22.1% of total sales, respectively. The Company's percentage of
sales by geographic region for the fiscal years ended 1997, 1998 and 1999 were
as follows:
1997 1998 1999
------ ------ ------
Domestic...................................................... 80.9% 79.9% 77.9%
Europe........................................................ 7.5 7.8 10.1
Pacific Rim (Japan, Southeast Asia, Australia/New Zealand).... 5.7 6.2 6.1
Canada........................................................ 1.8 2.0 1.9
Other international........................................... 4.1 4.1 4.0
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
The following summarizes the net book value of fixed assets at the
respective locations as of December 25, 1998 and December 31, 1999 (in
thousands):
December 25, December 31,
1998 1999
---- ----
Ensenada, Mexico........................................... $ 1,060 $ 1,134
Stockholm, Sweden.......................................... - 342
Kuala Lumpur, Malaysia..................................... - 741
United States.............................................. 31,672 40,259
------- -------
$32,732 $42,476
======= =======
For the fiscal years ended 1997, 1998 and 1999, the Company had sales to
one domestic distributor in the amount of $29,852,000, $24,940,000 and
$24,491,000 which represented approximately 30.0%, 24.8% and 19.0% of sales,
respectively. Additionally, the Company had sales to another domestic
distributor of $10,265,000 and 14,775,000 that accounted for approximately 10.2%
and 11.5% of sales in 1998 and 1999, respectively.
13. Unaudited Consolidated Quarterly Data
1998 Quarters Ended
--------------------------------------------------------------
June 26 (As
Restated; See
March 27 Note 15) September 25 December 25
-------- ------------- ------------ -----------
Net sales................................................. $24,265 $ 22,432 $22,130 $31,671
Gross profit.............................................. 10,431 9,600 9,843 13,824
Income (loss) before extraordinary item................... 1,498 (66,623) (243) (4,713)
Net income (loss)......................................... 1,498 (66,727) (243) (4,713)
1999 Quarters Ended
-------------------------------------------------
March 26 June 25 September 24 December 31
-------- -------- ------------- ------------
Net sales................................................. $27,169 $27,274 $30,827 $43,533
Gross profit.............................................. 11,389 11,414 12,185 18,397
Income (loss) before extraordinary item................... 281 327 (1,554) (282)
Net income (loss)......................................... 281 327 (1,554) (282)
F-34
14. Subsidiaries Debt Guarantee and Segment Data
The Company is the 100% owner of certain subsidiaries, which do not
guarantee the Company's senior subordinated notes. The non-guarantor
subsidiaries consist principally of the assets, liabilities and operations of
LGAB and subsidiaries. The following tables disclose the required consolidating
financial information for the guarantor, including the Company, and non-
guarantor subsidiaries (amounts in thousands):
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
CONSOLIDATING BALANCE SHEET
As of December 31, 1999
----------------------------------------------------
Non-
----
Guarantor Guarantor Adjustments Total
--------- --------- ----------- -----
ASSETS
CURRENT ASSETS:
Cash..................................................... $ 184 $ 2,733 - $ 2,917
Accounts receivable...................................... 28,329 2,096 - 30,425
Inventories.............................................. 21,124 4,065 (1,146) 24,043
Other current assets..................................... 4,578 16,673 (16,639) 4,612
-------- ------- -------- --------
Total current assets................................... 54,215 25,567 (17,785) 61,997
PROPERTY, PLANT AND EQUIPMENT, net........................ 41,335 1,141 - 42,476
OTHER ASSETS:
Intangible assets, net................................... 22,770 44,200 - 66,970
Deferred financing costs, net............................ 10,749 385 - 11,134
Deferred tax asset....................................... 68,600 223 120 68,943
Investment in non-guarantor subsidiaries................. 29,245 - (29,245) -
Other assets............................................. 833 162 (696) 299
-------- ------- -------- --------
Total other assets..................................... 132,197 44,970 (29,821) 147,346
-------- ------- -------- --------
$227,747 $71,678 $(47,606) 251,819
======== ======= ======== ========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Notes payable to bank.................................... $ 5,500 $ 1,173 $ - $ 6,673
Accounts payable......................................... 6,625 1,559 (2,016) 6,168
Accrued liabilities...................................... 8,344 3,356 - 11,700
Other current liabilities................................ 458 10,876 (9,849) 1,485
-------- ------- -------- --------
Total current liabilities.............................. 20,927 16,964 (11,865) 26,026
NOTE PAYABLE TO AFFILIATE................................. - 13,906 (6,398) 7,508
NOTES PAYABLE TO BANK, net of current portion............. 66,100 16,413 - 82,513
SENIOR SUBORDINATED NOTES................................. 115,000 - - 115,000
-------- ------- -------- --------
Total liabilities...................................... 202,027 47,283 (18,263) 231,047
-------- ------- -------- --------
Mandatorily-redeemable preferred stock.................... 35,421 - - 35,421
STOCKHOLDERS' EQUITY (DEFICIT)............................ (9,701) 24,395 (29,343) (14,649)
-------- ------- -------- --------
$227,747 $71,678 $(47,606) $251,819
======== ======= ======== ========
F-35
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
CONSOLIDATING STATEMENT OF OPERATIONS
For the Year Ended December 31, 1999
----------------------------------------------------
Non-
----
Guarantor Guarantor Adjustments Total
---------- --------- ----------- -----
NET SALES................................................. $121,796 $ 9,500 $(2,493) $128,803
COST OF SALES............................................. 71,146 6,465 (2,193) 75,418
-------- ------- ------- --------
Gross profit.............................................. 50,650 3,035 (300) 53,385
OPERATING EXPENSES:
Selling.................................................. 10,649 2,473 - 13,122
Distribution............................................. 4,647 - - 4,647
General and administrative............................... 12,231 2,501 - 14,732
Research and development................................. 1,362 669 - 2,031
-------- ------- ------- --------
Total operating expenses 28,889 5,643 - 34,532
-------- ------- ------- --------
Income (loss) from operations............................. 21,761 (2,608) (300) 18,853
OTHER INCOME AND (EXPENSES):
Interest expense......................................... (16,023) (1,240) - (17,263)
Other, net............................................... (633) (599) - (1,232)
-------- ------- ------- --------
Total other income (expense)........................... (16,656) (1,839) - (18,495)
-------- ------- ------- --------
Income (loss) before provision (benefit) for income taxes. 5,105 (4,447) (300) 358
PROVISION (BENEFIT) FOR INCOME TAXES..................... 2,183 (477) (120) 1,586
-------- ------- ------- --------
Net income (loss)......................................... $ 2,922 $(3,970) $ (180) $ (1,228)
======== ======= ======== ========
Depreciation and amortization (a)......................... $ 6,531 $ 4,609 $ - $ 11,140
======== ======= ======== ========
Adjusted EBITDA (b)....................................... $ 28,292 $ 2,001 $ (300) $ 29,993
======== ======= ======== ========
(a) Includes approximately $2,825,000 of non-cash expense related to the
recognition of the portion of purchase price allocation related to acquired
inventories.
(b) Adjusted EBITDA represents income before depreciation and amortization,
interest expense, income tax expense and recognition of the portion of
purchase price allocation related to acquired inventories. Adjusted EBITDA
is not a measure of performance under accounting principles generally
accepted in the United States, and should not be considered as a substitute
for net income, cash flows from operating activities and other income or
cash flow statement data prepared in accordance with accounting principles
generally accepted in the United States, or as a measure of profitability
or liquidity.
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 1999
-------------------------------------
Non-
----
Guarantor Guarantor Total
----------- --------- -----
Net cash provided by operating activities................................. $ 6,108 $ 989 $ 7,097
Net cash used in investing activities..................................... (34,928) (40,890) (75,818)
Net cash provided by financing activities................................. 28,197 43,332 71,529
Effect of exchange rate changes on cash................................... - (398) (398)
-------- -------- --------
NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS........................... (623) 3,033 2,410
CASH, beginning of period................................................. 507 - 507
-------- -------- --------
CASH, end of period....................................................... $ (116) $ 3,033 $ 2,917
======== ======== ========
F-36
As discussed above, the non-guarantor subsidiaries consist principally of
LGAB and subsidiaries (whose operations are principally international). The
Company operates in two segments: United States operations and international
operations. The financial data of these two segments closely approximates the
guarantor/non-guarantor information set forth above and, accordingly, separate
additional segment data is not provided.
15. Restatement
The net effect of the Company's conversion from S to C corporation status
and the related Section 338(h)(10) election to increase the tax bases of assets
in connection with the Recapitalization of $77,064,000 was previously reflected
in operations during the quarter ended June 26, 1998. This amount should have
been reflected as a direct credit to retained earnings. The restatement had no
impact on ending retained earnings for the periods presented. The impact of the
restatement on the accompanying financial statements is as follows (amounts in
thousands):
As Originally
Year Ended December 25, 1998 Reported Adjustments As Restated
---------------------------- -------- ------------ ------------
Net loss before provision for income taxes............. $(61,676) $ $(61,676)
========= ========= =========
Net income (loss) before extraordinary item.......... $ 6,983 $(77,064) $(70,081)
======== ========= =========
Net income (loss).................................... $ 6,879 $(77,064) $(70,185)
======== ======== ========
F-37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.
RIVER HOLDING CORP.
Date: April 14, 2000 By: /s/ Jay R. Ogram
---------------------
Jay R. Ogram
Chief Financial Officer and Secretary
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Jay R. Ogram his true and lawful attorney-in-fact
with full power of substitution and resubstitution, for him or her and in his or
her name, place and stead, in and any all capacities, to sign any and all
amendments to this Report on Form 10-K and to file same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agents, and each of
them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Richard W. Johansen Chief Executive Officer and April 14, 2000
- --------------------------------- Director (Principal Executive
Richard W. Johansen Officer)
/s/ Jay R. Ogram Chief Financial Officer and April 14, 2000
- --------------------------------- Secretary (Principal Financial
Jay R. Ogram Officer)
/s/ Helen Hudson Lovaas Director April 14, 2000
- ---------------------------------
Helen Hudson Lovaas
/s/ Ronald P. Spogli Director April 14, 2000
- ---------------------------------
Ronald P. Spogli
/s/ Charles P. Rullman Director April 14, 2000
- ---------------------------------
Charles P. Rullman
/s/ Jon D. Ralph Director April 14, 2000
- ---------------------------------
Jon D. Ralph
/s/ Sten Gibeck Director April 14, 2000
- ---------------------------------
Sten Gibeck
S-1
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.
HUDSON RESPIRATORY CARE INC.
Date: April 14, 2000 By: /s/ Jay R. Ogram
-------------------
Jay R. Ogram
Chief Financial Officer and Secretary
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Jay R. Ogram his true and lawful attorney-in-fact
with full power of substitution and resubstitution, for him or her and in his or
her name, place and stead, in and any all capacities, to sign any and all
amendments to this Report on Form 10-K and to file same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agents, and each of
them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Richard W. Johansen Chief Executive Officer and April 14, 2000
- ------------------------------- Director (Principal Executive
Richard W. Johansen Officer)
/s/ Jay R. Ogram Chief Financial Officer and April 14, 2000
- ------------------------------- Secretary (Principal Financial
Jay R. Ogram Officer)
/s/ Helen Hudson Lovaas Director April 14, 2000
- -------------------------------
Helen Hudson Lovaas
/s/ Ronald P. Spogli Director April 14, 2000
- -------------------------------
Ronald P. Spogli
/s/ Charles P. Rullman Director April 14, 2000
- -------------------------------
Charles P. Rullman
/s/ Jon D. Ralph Director April 14, 2000
- -------------------------------
Jon D. Ralph
/s/ Sten Gibeck Director April 14, 2000
- -------------------------------
Sten Gibeck
S-2
Supplemental Information to be Furnished With Reports Filed Pursuant to
Section 15(d) of the Act by Registrants Which Have Not Registered Securities
Pursuant to Section 12 of the Act
No annual report or proxy material has been sent to security holders.
S-3
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Board of Directors of
River Holding Corp.:
We have audited in accordance with accounting standards generally accepted in
the United States, the financial statements of RIVER HOLDING CORP. (a Delaware
corporation) and subsidiaries included in this Form 10-K and have issued our
report thereon dated March 24, 2000. Our audit was made for the purpose of
forming an opinion on the basic financial statements taken as a whole. The
schedule listed in the index above is the responsibility of the company's
management and is presented for purposes of complying with Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Orange County, California
March 24, 2000
II-1
RIVER HOLDING CORP.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(Amounts in thousands)
Balance at Balance at
Beginning Charges to End of
of Period Expenses Write-offs Period
------------- ------------ ----------- -----------
Description
- -----------
For the Year Ending December 31, 1999:
Allowance for doubtful accounts
receivable............................ $(794) $(440) $261 $(973)
======== ======== ======== ========
For the Year Ending December 25, 1998:
Allowance for doubtful accounts
receivable............................ $(258) $(586) $ 50 $(794)
======== ======== ======== ========
For the Year Ending December 26, 1997:
Allowance for doubtful accounts
receivable............................ $(111) $(182) $ 35 $(258)
======== ======== ======== ========
II-2