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EX-31.2 - EXHIBIT 31.2 - Acelity L.P. Inc.a3122015q1cfocertification.htm
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EX-32.1 - EXHIBIT 32.1 - Acelity L.P. Inc.a3212015q1ceocfocertificat.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2015
Commission file number 333-184233-14

ACELITY L.P. INC.
(Exact name of registrant as specified in its charter)

Guernsey
 
98-1022387
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
12930 West Interstate 10
San Antonio, Texas               
 
78249
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code: (210) 524-9000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                           
Yes
X
 
No
 
                                        
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes
X
 
No
 
                                                                                                                                                                      
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
 
Accelerated filer
 
 
 
 
 
 
Non-accelerated filer
X
(Do not check if a smaller reporting company)
Smaller reporting company
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
Yes
 
 
No
X
         
As of April 30, 2015, there were 341,410,891.610 Class A-1 and 717,038.800 Class A-2 partnership units outstanding, all of which were held by affiliates.   




TABLE OF CONTENTS

ACELITY L.P. INC.






2


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes statements that express our opinions, expectations, beliefs, plans, objectives, assumptions or projections regarding future events or future results and therefore are, or may be deemed to be, “forward-looking statements.” The forward-looking statements are based on our current expectations and projections about future events. Discussions containing forward-looking statements may be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors,” and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “predicts,” “projects,” “potential,” “continue,” “expects,” “anticipates,” “aims,” “future,” “intends,” “plans,” “believes,” “estimates,” or the negative of those terms and other variations of them or by comparable terminology.
These forward-looking statements are only predictions, not historical facts, and involve certain risks and uncertainties, as well as assumptions. Actual results, levels of activity, performance, achievements and events could differ materially from those stated, anticipated or implied by such forward-looking statements. The factors that could contribute to such differences include those discussed under the caption “Risk Factors.” You should consider each of the risk factors and uncertainties under the caption “Risk Factors” in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, among other things, in evaluating our prospects and future financial performance. The occurrence of the events described in the risk factors could harm our business, results of operations and financial condition. These forward-looking statements are made as of the date of this report. Except as required under federal securities laws and the rules and regulations of the SEC, we do not have any intention to update any forward-looking statements to reflect events or circumstances arising after the date of this report, whether as a result of new information, future events or otherwise.
TRADEMARKS, SERVICE MARKS AND COPYRIGHTS
3M® Tegaderm® is a licensed trademark of 3M Company; GRAFTJACKET® is a licensed trademark of Wright Medical Technology Inc; Novadaq®, SPY®, and SPY ELITE® are licensed trademarks of Novadaq Technologies, Inc.; and Prontosan® Wound Irrigation Solution is a licensed trademark of B. Braun Medical, Inc. Unless otherwise indicated, all other trademarks appearing in this report are proprietary to KCI Licensing, Inc., LifeCell Corporation or Systagenix Wound Management IP Co B.V., their affiliates and/or licensors. The absence of a trademark or service mark or logo from this report does not constitute a waiver of trademark or other intellectual property rights of KCI Licensing, Inc., Systagenix Wound Management IP Co B.V., or LifeCell Corporation, their affiliates and/or licensors.
DEFINED TERMS
The following terms are used in this Quarterly Report on Form 10-Q unless otherwise noted or indicated by the context.
the terms the “Company,” “we,” “our,” and “us” refer to Acelity L.P. Inc. (“Acelity”) and its consolidated subsidiaries.
the term “Merger” refers to the transaction completed on November 4, 2011 pursuant to which Kinetic Concepts, Inc. was merged with Chiron Merger Sub, Inc. (“Merger Sub”), a direct subsidiary of Chiron Holdings, Inc. (“Holdings”) and an indirect subsidiary of Acelity Guernsey L.P. Inc.
the term “KCI” means Kinetic Concepts, Inc. and its subsidiaries.
the term “LifeCell” means LifeCell Corporation and its subsidiaries.
the term “Systagenix” means “Systagenix Wound Management B.V., its subsidiaries, and its former U.S.-based affiliate, Systagenix Wound Management (US), Inc.


3


PART I - FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS
ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands)
 
March 31,
2015
 
December 31,
2014
 
(unaudited)
 
 
Assets:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
250,509

 
$
183,541

Accounts receivable, net
365,124

 
370,483

Inventories, net
182,457

 
178,222

Deferred income taxes
70,515

 
63,025

Prepaid expenses and other
28,337

 
27,563

Total current assets
896,942

 
822,834

 
 
 
 
Net property, plant and equipment
277,653

 
288,048

Debt issuance costs, net
72,094

 
77,896

Deferred income taxes
30,466

 
31,692

Goodwill
3,378,298

 
3,378,298

Identifiable intangible assets, net
2,352,814

 
2,397,251

Other non-current assets
4,709

 
4,694

 
$
7,012,976

 
$
7,000,713

 
 
 
 
Liabilities and Equity:
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
55,946

 
$
51,827

Accrued expenses and other
395,514

 
343,484

Current installments of long-term debt
25,385

 
25,721

Income taxes payable
9,981

 
1,305

Deferred income taxes
103,135

 
113,658

Total current liabilities
589,961

 
535,995

 
 
 
 
Long-term debt, net of current installments and discount
4,774,787

 
4,815,290

Non-current tax liabilities
33,845

 
33,300

Deferred income taxes
799,334

 
792,157

Other non-current liabilities
165,909

 
163,258

Total liabilities
6,363,836

 
6,340,000

Equity:
 
 
 
General partner’s capital

 

Limited partners’ capital
666,285

 
670,787

Accumulated other comprehensive loss, net
(17,145
)
 
(10,074
)
Total equity
649,140

 
660,713

 
$
7,012,976

 
$
7,000,713


See accompanying notes to condensed consolidated financial statements.

4


ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands)
(unaudited)
 
Three months ended March 31,
 
2015
 
2014
Revenue:
 
 
 
Rental
$
172,839

 
$
164,977

Sales
271,211

 
277,658

Total revenue
444,050

 
442,635

 
 
 
 
Rental expenses
78,178

 
84,649

Cost of sales
73,414

 
81,390

Gross profit
292,458

 
276,596

 
 
 
 
Selling, general and administrative expenses
147,763

 
175,612

Research and development expenses
14,678

 
17,490

Acquired intangible asset amortization
45,877

 
50,689

Operating earnings
84,140

 
32,805

 
 
 
 
Interest income and other
147

 
95

Interest expense
(104,726
)
 
(102,195
)
Foreign currency gain
19,400

 
236

Derivative instruments loss
(3,348
)
 
(3
)
Loss from continuing operations before income tax expense (benefit)
(4,387
)
 
(69,062
)
Income tax expense (benefit)
144

 
(22,002
)
Loss from continuing operations
(4,531
)
 
(47,060
)
Earnings from discontinued operations, net of tax

 
677

Net loss
$
(4,531
)
 
$
(46,383
)

See accompanying notes to condensed consolidated financial statements.

5


ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three months ended March 31,
 
2015
 
2014
 
 
 
 
Net loss
$
(4,531
)
 
$
(46,383
)
Unrealized investment gain, net of tax expense of $628 in 2014

 
1,003

Foreign currency translation adjustment, net of tax expense of $635 in 2015 and $62 in 2014
(7,071
)
 
290

Total comprehensive loss
$
(11,602
)
 
$
(45,090
)

See accompanying notes to condensed consolidated financial statements.

6


ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

 
Three months ended March 31,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net loss
$
(4,531
)
 
$
(46,383
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Amortization of debt issuance costs and discount
9,968

 
9,668

Depreciation and other amortization
66,331

 
82,029

Amortization of fair value step-up in inventory

 
6,680

Provision for bad debt
1,827

 
4,101

Equity-based compensation expense
535

 
941

Deferred income tax benefit
(11,971
)
 
(44,674
)
Unrealized gain on derivative instruments
(315
)
 
(4,076
)
Unrealized loss (gain) on revaluation of cross currency debt
(32,429
)
 
241

Change in assets and liabilities:
 
 
 
Decrease in accounts receivable, net
5,362

 
20,806

Increase in inventories, net
(3,666
)
 
(7,302
)
Decrease (increase) in prepaid expenses and other
(774
)
 
17,546

Increase in accounts payable
4,363

 
6,473

Increase in accrued expenses and other
56,048

 
31,799

Increase in tax liabilities, net
11,525

 
4,997

Net cash provided by operating activities
102,273

 
82,846

 
 
 
 
Cash flows from investing activities:
 
 
 
Additions to property, plant and equipment
(10,491
)
 
(10,801
)
Increase in inventory to be converted into equipment for short-term rental
(3,356
)
 
(2,240
)
Dispositions of property, plant and equipment
678

 
377

Businesses acquired in purchase transactions, net of cash acquired

 
(4,613
)
Increase in identifiable intangible assets and other non-current assets
(1,821
)
 
(1,281
)
Net cash used by investing activities
(14,990
)
 
(18,558
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Distribution to limited partners
(55
)
 

Settlement of profits interest units
(517
)
 

Repayments of long-term debt and capital lease obligations
(6,415
)
 
(6,635
)
Debt issuance costs
(6,256
)
 

Net cash used by financing activities
(13,243
)
 
(6,635
)
Effect of exchange rate changes on cash and cash equivalents
(7,072
)
 
38

Net increase in cash and cash equivalents
66,968

 
57,691

Cash and cash equivalents, beginning of period
183,541

 
206,949

Cash and cash equivalents, end of period
$
250,509

 
$
264,640


See accompanying notes to condensed consolidated financial statements

7


Notes to Condensed Consolidated Financial Statements

NOTE 1.     Summary of Significant Accounting Policies

(a)   Basis of Presentation and Principles of Consolidation

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP” or “the Codification”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial position and cash flows in conformity with GAAP. Operating results from interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. The condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of our results for the interim periods presented. Certain prior period amounts have been reclassified to conform to the 2015 presentation.

On October 29, 2014, LifeCell entered into an agreement with Novadaq® Technologies Inc. (“Novadaq”) to transfer all marketing and distribution rights to the SPY® Elite System from LifeCell to Novadaq, effective November 30, 2014. In connection with the transfer, the parties agreed to terminate various distribution agreements entered into between 2010 and 2011. The results of the operations subject to the agreement, excluding the allocation of general corporate overhead, are presented as discontinued operations in the condensed consolidated statements of operations for all periods presented.

The Company has two reportable operating segments: Advanced Wound Therapeutics and Regenerative Medicine. We have two primary geographic regions: the Americas, which is comprised principally of the United States and includes Canada, Puerto Rico and Latin America; and EMEA/APAC, which is comprised of Europe, the Middle East, Africa and the Asia Pacific region.

The condensed consolidated financial statements appearing in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

(b)   Derivative Financial Instruments and Fair Value Measurements

We use derivative financial instruments to manage the economic impact of fluctuations in interest rates. We do not use financial instruments for speculative or trading purposes. Periodically, we enter into interest rate protection agreements to modify the interest characteristics of our outstanding debt. Our interest rate derivatives have not been designated as hedging instruments, and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period.

We also periodically use derivative financial instruments to manage the economic impact of fluctuations in currency exchange rates on our intercompany balances and corresponding cash flows and to manage our transactional currency exposures when our foreign subsidiaries enter into transactions denominated in currencies other than their local currency. We enter into foreign currency exchange contracts to manage these economic risks. These contracts are not designated as hedges; and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period. Although we use master netting agreements with our derivative counterparties, we do not offset derivative asset and liability positions in the condensed consolidated balance sheets.

All derivative instruments are recorded on the balance sheets at fair value. The fair values of our interest rate derivatives and foreign currency exchange contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly-quoted markets, which represent level 2 inputs as defined by the Codification.



8


(c)   Concentration of Credit Risk

We have a concentration of credit risk with financial institutions related to our derivative instruments. As of March 31, 2015, Morgan Stanley, UBS and HSBC were the counterparties on our interest rate protection agreements consisting of interest rate swap agreements in notional amounts totaling $484.7 million each. We use master netting agreements with our derivative counterparties to reduce our risk and use multiple counterparties to reduce our concentration of credit risk.

We maintain cash and cash equivalents with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. These deposits bear minimal credit risk as they are maintained at financial institutions of reputable credit and generally may be redeemed upon demand.

(d)   Recently Adopted Accounting Standards

In April 2014, the FASB issued ASU No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”. ASU No. 2014-08 changes the requirements for reporting discontinued operations and requires additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations - that is, a major effect on the organization’s operations and financial results should be presented as discontinued operations. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment. Additionally, the ASU requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The Company adopted this update effective January 1, 2015. We do not anticipate that it will have a material effect on our results of operations, financial position or disclosures.

(e)   Recently Issued Accounting Standards

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). This ASU supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition”, and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts”. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (e.g., assets within the scope of Topic 360, “Property, Plant, and Equipment”, and intangible assets within the scope of Topic 350, “Intangibles-Goodwill and Other”) are amended to be consistent with the guidance on recognition and measurement (including the constraint on revenue) in this ASU. For a public entity, the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. In April 2015, the FASB voted to propose to defer the effective date of this ASU by one year. The Company is evaluating ASU No. 2014-09 to determine if it will have a material effect on our results of operations, financial position or disclosures.

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements — Going Concern (Subtopic 205-40).” The new guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016. Early adoption is permitted. The Company is evaluating this update, however we do not anticipate that the adoption of this guidance will have a material impact on our results of operations, financial position or disclosures.

In January 2015, the FASB issued ASU No. 2015-01, "Income Statement -Extraordinary and Unusual Items (Subtopic 225-20)." The objective of this ASU is to simplify the income statement presentation requirements in Subtopic 225-20 by eliminating the concept of extraordinary items. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Eliminating the extraordinary classification simplifies income statement presentation by altogether removing the concept of extraordinary items from consideration. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Early application is permitted. The Company is evaluating this update, however we do not anticipate that the adoption of this guidance will have a material impact on our results of operations, financial position or disclosures.



9


On February 18, 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis." This update provides a revised consolidation model for all reporting entities to use in evaluating whether they should consolidate certain legal entities. All legal entities will be subject to reevaluation under this revised consolidation model. The revised consolidation model, among other things, (i) modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities, (ii) eliminates the presumption that a general partner should consolidate a limited partnership, and (iii) modifies the consolidation analysis of reporting entities that are involved with VIEs through fee arrangements and related party relationships. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Early application is permitted. The Company is evaluating this update, however we do not anticipate that the adoption of this guidance will have a material impact on our results of operations, financial position or disclosures.

In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest (Subtopic 835-30)" The objective of this ASU is to simplify the presentation of debt issuance costs in the balance sheet by requiring the presentation of debt issuance costs as a deduction from the carrying amount of the related debt liability instead of a deferred charge. The standard will be effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. As of March 31, 2015, the Company had $72.1 million of unamortized debt issuance costs recorded as a deferred charge.

(f)   Other Significant Accounting Policies

For further information on our significant accounting policies, see Note 1 of the notes to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2014.


NOTE 2.     Acquisitions and Divestitures

Acquisitions

There were no significant acquisitions during the three months ended March 31, 2015.

Divestitures

SPY® Elite System

On October 29, 2014, LifeCell Corporation entered into an agreement with Novadaq® Technologies Inc. (“Novadaq”) to transfer all marketing and distribution rights to the SPY® Elite System from LifeCell to Novadaq, effective November 30, 2014.

The operating results of the SPY® Elite System product portfolio included in discontinued operations are as follows (in thousands):
 
Three months ended March 31,
 
2014
 
 
Revenue
$
4,904

Earnings before income taxes
$
1,100

Income tax expense
$
423

Earnings from discontinued operations, net of tax
$
677




10


NOTE 3.     Supplemental Balance Sheet Data

(a)       Accounts Receivable, net

Accounts receivable consist of the following (in thousands):
 
March 31,
2015
 
December 31,
2014
Gross trade accounts receivable:
 
 
 
    Billed trade accounts receivable
$
394,896

 
$
396,329

Unbilled receivables
32,408

 
39,293

     Less:  Allowance for revenue adjustments
(62,117
)
 
(61,460
)
    Gross trade accounts receivable
365,187

 
374,162

Less:  Allowance for bad debt
(11,668
)
 
(13,087
)
    Net trade accounts receivable
353,519

 
361,075

Other receivables
11,605

 
9,408

 
$
365,124

 
$
370,483


(b)       Inventories, net

Inventories consist of the following (in thousands):
 
March 31,
2015
 
December 31,
2014
Finished goods and tissue available for distribution
$
130,141

 
$
127,253

Goods and tissue in-process
5,877

 
6,887

Raw materials, supplies, parts and unprocessed tissue
72,855

 
67,567

 
208,873

 
201,707

Less: Amounts expected to be converted into equipment for short-term rental
(10,871
)
 
(7,515
)
         Reserve for excess and obsolete inventory
(15,545
)
 
(15,970
)
 
$
182,457

 
$
178,222


11



NOTE 4.     Long-Term Debt

Long-term debt consists of the following (in thousands):
 
March 31,
2015
 
December 31,
2014
 
 
 
 
Senior Dollar Term E-1 Credit Facility – due 2018
$
1,922,374

 
$
1,927,241

Senior Euro Term E-1 Credit Facility – due 2018
259,847

 
293,746

Senior Term E-2 Credit Facility – due 2016
314,555

 
315,351

10.5% Second Lien Senior Secured Notes due 2018
1,750,000

 
1,750,000

12.5% Senior Unsecured Notes due 2019
612,000

 
612,000

3.25% Convertible Senior Notes due 2015
101

 
101

     Notional amount of debt
4,858,877

 
4,898,439

 
 
 
 
Senior Dollar Term E-1 Credit Facility Discount, net of accretion
(27,029
)
 
(24,241
)
Senior Euro Term E-1 Credit Facility Discount, net of accretion
(6,698
)
 
(7,376
)
Senior Term E-2 Credit Facility Discount, net of accretion
(3,297
)
 
(2,955
)
Second Lien Senior Secured Notes Discount, net of accretion
(19,131
)
 
(20,205
)
Senior Unsecured Notes Discount, net of accretion
(2,550
)
 
(2,651
)
     Net discount on debt
(58,705
)
 
(57,428
)
 
 
 


Total debt, net of discount
4,800,172

 
4,841,011

Less:  Current installments
(25,385
)
 
(25,721
)
 
$
4,774,787

 
$
4,815,290


Senior Secured Credit Facility

Our senior secured credit facility (the “Senior Secured Credit Facility”) includes a $200 million revolving credit facility (the “Revolving Credit Facility”). Amounts available under the Revolving Credit Facility are available for borrowing and reborrowing until maturity. At March 31, 2015 and December 31, 2014, no revolving credit loans were outstanding and we had outstanding letters of credit issued by banks which are party to the Senior Secured Credit Facility of $40.6 million and $39.0 million, respectively. In addition, we had $9.7 million and $11.4 million of letters of credit issued by a bank not party to the Senior Secured Credit Facility as of March 31, 2015 and December 31, 2014, respectively. The capacity of the Revolving Credit Facility is reduced for the $40.6 million and $39.0 million of letters of credit issued by banks which are party to the Senior Secured Credit Facility as of March 31, 2015 and December 31, 2014, respectively. The resulting availability under the Revolving Credit Facility was $159.4 million and $161.0 million at March 31, 2015 and December 31, 2014, respectively. Commitment fees accrue at a rate of 0.50% on the amounts available under the Revolving Credit Facility.

Interest. On March 10, 2015, we entered into Amendment No. 6 to our Senior Secured Credit Facility (“Amendment No. 6”). In connection with Amendment No. 6, certain applicable rates were modified so that (i) Dollar Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.50% or an adjusted base rate plus 2.50%, (ii) Euro Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.75% or an adjusted base rate plus 2.75%, and (iii) Term E-2 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.00% or an adjusted base rate plus 2.00%. The Eurocurrency rate shall be subject to a floor of 1.00%, and the adjusted base rate shall be subject to a floor of 2.00%.

Covenants

As a result of Amendment No. 6, the financial covenants were amended to remove the interest coverage ratio in its entirety and to set the total leverage ratio for any test period to be no greater than 8.25:1.00. In addition, certain other covenants were amended, including with respect to the incurrence of incremental facilities and asset sales. As of March 31, 2015, we were in compliance with all covenants under our credit agreement and indentures.

For further information on our long-term debt, see Note 5 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

12




NOTE 5.     Derivative Financial Instruments and Fair Value Measurements

We are exposed to credit loss in the event of nonperformance by counterparties to the extent of the fair values of the outstanding interest rate swap agreements, interest rate cap agreements and foreign currency exchange contracts, but we do not anticipate nonperformance by any of the counterparties. All derivative instruments are recorded on the balance sheets at fair value. We do not use financial instruments for speculative or trading purposes.

Interest Rate Protection

At March 31, 2015 and December 31, 2014, we were party to three interest rate swap agreements which are used to convert a portion of our outstanding variable rate debt to a fixed rate basis. These agreements have not been designated as hedging instruments, and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period. The interest rate swap agreements have receive rates based on the higher of three-month USD LIBOR or 1.25% and pay rates based on fixed rates. Quarterly payments under the interest rate swap agreements are due on the last day of March, June, September and December. The aggregate notional amount decreases quarterly by amounts ranging from $1.7 million to $56.4 million until maturity.

The following table summarizes our interest rate swap agreements (dollars in thousands):
Effective Dates
 
Outstanding Notional Amount
 
Fixed Interest Rate
12/31/13-12/31/16
 
$484,667
 
2.256%
12/31/13-12/31/16
 
$484,667
 
2.249%
12/31/13-12/31/16
 
$484,667
 
2.250%

Foreign Currency Exchange Rate Mitigation

At March 31, 2015 and December 31, 2014, we had no outstanding foreign currency exchange contracts.

Fair Value Measurements

The Codification defines fair value as the exit price that would be received to sell an asset or paid to transfer a liability. The Fair Value Measurements and Disclosure topic of the Codification establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The carrying amount reported in the balance sheets for cash and cash equivalents, accounts receivable, accounts payable and long-term obligations, excluding our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt, approximates fair value. The fair value of our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt was $2.503 billion and $2.559 billion, respectively, at March 31, 2015. The fair value of our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt was $2.501 billion and $2.584 billion, respectively, at December 31, 2014. The fair value of our long-term debt was estimated based upon open-market trades at or near year end.

All of our derivatives, as of the reporting date, use inputs considered as Level 2. The interest rate swap agreements are valued using a discounted cash flow model that takes into account the present value of the expected future cash flows under the terms of the agreements by using market information available as of the reporting date, including prevailing interest rates and related forward interest rate curves.


13


The following table sets forth the location and aggregate fair value amounts of all derivative instruments with credit-related contingent features (in thousands):
 
Asset Derivatives
 
Liability Derivatives
 
Balance
Sheet
Location
 
Fair Value
 
Balance
Sheet
Location
 
Fair Value
 
 
March 31,
2015
 
December 31,
2014
 
 
March 31,
2015
 
December 31,
2014
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
Prepaid expenses and other
 
$

 
$

 
Accrued expenses and other
 
$
13,799

 
$
13,936

Interest rate swap agreements
Other non-current assets
 

 

 
Other non-current liabilities
 
7,889

 
8,067

      Total derivatives
 
 
$

 
$

 
 
 
$
21,688

 
$
22,003


The following table summarizes the amount of gain (loss) on derivatives not designated as hedging instruments (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
Interest rate swap agreements
$
(3,348
)
 
$
(75
)
Foreign currency exchange contracts

 
72

 
$
(3,348
)
 
$
(3
)

Certain of our derivative instruments contain provisions that require compliance with the restrictive covenants of our Senior Secured Credit Facility. For further information regarding the restrictive covenants of credit facilities, see Note 5 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

If we default under our credit facilities, the lenders could require immediate repayment of the entire outstanding principal balance. If those lenders require immediate repayment, we may not be able to repay them which could result in the foreclosure of substantially all of our assets. In these circumstances, the counterparties to the derivative instruments could request immediate payment or full collateralization on derivative instruments in net liability positions. Certain of our derivative counterparties are also parties to our Senior Secured Credit Facility.

No collateral has been posted by us in the normal course of business. If the credit-related contingent features underlying these agreements were triggered on March 31, 2015, we could be required to settle or post the full amount as collateral to the respective agreement counterparties.

We did not have any measurements of financial assets or financial liabilities at fair value on a nonrecurring basis at March 31, 2015 or December 31, 2014.


NOTE 6.     Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss are as follows (in thousands):
 
Accumulated
Foreign
Currency
Translation
Adjustment
 
Accumulated
Other
Comprehensive
Income (Loss)
Balances at December 31, 2014
$
(10,074
)
 
$
(10,074
)
Foreign currency translation adjustment, net of taxes of $635
(7,071
)
 
(7,071
)
Balances at March 31, 2015
$
(17,145
)
 
$
(17,145
)

During the three months ended March 31, 2015, there were no reclassification adjustments out of accumulated other comprehensive loss to net loss.

14




NOTE 7.     Commitments and Contingencies

Legal Proceedings

Intellectual Property Litigation

As the owner and exclusive licensee of patents, from time to time, we are a party to proceedings challenging these patents, including challenges in U.S. federal courts, foreign courts, foreign patent offices and the U.S. Patent and Trademark Office. Additionally, from time to time, we are a party to litigation we initiate against others we contend infringe these patents, which often results in counterclaims regarding the validity of such patents. At other times, we are party to litigation initiated by others who contend we infringe their patents. It is not possible to reliably predict the outcome of the proceedings described below. However, if we are unable to effectively enforce our intellectual property rights, third parties may become more aggressive in the marketing of competitive products around the world.

In August 2013, Vital Needs International, L.P. ("Vital Needs") filed a Demand for Arbitration with the American Arbitration Association seeking to recover in excess of $100 million in damages and legal fees against KCI entities based on a number of claims related to certain intellectual property rights sold by Vital Needs to KCI pursuant to a 2006 acquisition agreement. The arbitration hearing took place in January 2015, and the panel issued a favorable decision on April 10, 2015 ordering that Vital Needs take nothing by its claims.

In September 2013, LifeNet Health ("LifeNet") filed suit against LifeCell Corporation in the United States District Court for the Eastern District of Virginia, Norfolk Division. LifeNet alleges that two LifeCell products, Strattice and AlloDerm Ready to Use, infringe LifeNet’s U.S. Patent No. 6,569,200 ("the ‘200 Patent"). On November 18, 2014, a jury found that the ‘200 Patent was not invalid and was infringed and further awarded LifeNet a lump sum damages amount of $34.7 million. As a result of this decision, we recorded a liability of $34.7 million in the fourth quarter of 2014. We disagree with the result at this stage in the litigation and believe that LifeCell’s defenses to the claims are meritorious. LifeCell will continue to vigorously assert its defenses during the appeal stages of this litigation and intends to defend any further claims by LifeNet. LifeCell plans to appeal to the U.S. Federal Circuit Court of Appeals in Washington D.C. on multiple grounds.

Products Liability Litigation

LifeCell Corporation is a defendant in approximately 346 lawsuits filed by individuals alleging personal injury and seeking monetary damages for failed hernia repair procedures using LifeCell’s AlloDerm products. These cases have been consolidated for case management purposes in Middlesex County, New Jersey. The trial court has issued a pre-trial order incorporating the bellwether practice of trying the claims of some plaintiffs to determine the likelihood of settlement or to avoid relitigating common issues in every case. Following limited discovery, the parties have each selected two bellwether cases from which one case to be tried will be selected. Further discovery is proceeding on each of the four bellwether cases. Trial of the first bellwether case is currently scheduled for January 2016. Although it is not possible to reliably predict the outcome of the litigation, we believe that our defenses to these claims are meritorious and we will defend against these suits vigorously. Based on our existing insurance coverage and our defenses to these cases, we do not expect them to have a material impact on our results of operations or our financial position. Because discovery of damages has been limited to the four bellwether cases, we do not know the damages allegedly suffered by the remaining plaintiffs. As such, it is impossible to predict or estimate potential losses if our defenses to these cases are unsuccessful.

LifeCell Corporation has been named as a defendant in approximately 178 lawsuits in state and federal courts alleging personal injury and seeking monetary damages for failed gynecological procedures using a human tissue product processed by LifeCell and sold by one of LifeCell’s distributors, Boston Scientific, under the name Repliform. There are approximately 173 LifeCell cases filed in a consolidated docket in Middlesex County, Massachusetts. The cases are in the initial phase and no discovery has occurred. Three cases are pending in a multi-district federal case in West Virginia that is proceeding very slowly. The remaining cases are in Delaware and Minnesota. None of these cases are proceeding at this time. We intend to defend these suits vigorously, and do not expect them to have a material impact on our results of operations or our financial position. As these cases are in their early stages it is not possible to predict or estimate potential losses if our defenses to these cases are unsuccessful.


15


Other Litigation
    
In 2009, KCI received a subpoena from the U.S. Department of Health and Human Services Office of Inspector General (“OIG”) seeking records regarding our billing practices under the local coverage policies of the four regional Durable Medical Equipment Medicare Administrative Contractors (“DME MACs”). KCI cooperated with the OIG's inquiry and provided substantial documentation to the OIG and the U.S. Attorneys' office in response to its request. The government's inquiry stemmed from the filing under seal of two 2008 qui tam actions against KCI by two former employees in the U.S. District Court, Central District of California, Western Division. These cases are captioned United States of America, ex rel. Steven J. Hartpence v. Kinetic Concepts, Inc. et al, and United States of America, ex rel. Geraldine Godecke v. Kinetic Concepts, Inc., et al. The complaints contend that KCI violated the Federal False Claims Act by billing in a manner that was not consistent with the Local Coverage Determinations issued by the DME MACs and seek recovery of monetary damages. Following the completion of the government's review and its decision declining to intervene in such suits, the live pleadings were ordered unsealed in 2011. After reviewing the allegations, KCI filed motions seeking the dismissal of the suits on multiple grounds.  In 2012, the Court granted KCI's motions dismissing all of the claims under the False Claims Act. The cases are on appeal in the U.S. Court of Appeals for the Ninth Circuit and oral argument was in July 2014 before a 3 member panel. On January 16, 2015, the Ninth Circuit entered an order scheduling oral argument en banc before the U.S. Court of Appeals for the Ninth Circuit. Oral argument en banc proceeded before the Ninth Circuit in March 2015, and we are awaiting their opinion. We believe that our defenses to the claims in the Hartpence and Goedecke cases are meritorious and that we have no liability under the False Claims Act for their allegations. However, it is not possible to predict the outcome of this litigation nor is it possible to estimate any damages that may be awarded if we are unsuccessful in the litigation.

We are a party to several additional lawsuits arising in the ordinary course of our business. Additionally, the manufacturing and marketing of medical products necessarily entails an inherent risk of product liability claims. We maintain multiple layers of product liability insurance coverage and we believe these policies and the amounts of coverage are appropriate and adequate.
 
Other Commitments and Contingencies

As a healthcare supplier, we are subject to extensive government regulation, including laws and regulations directed at ascertaining the appropriateness of reimbursement, preventing fraud and abuse and otherwise regulating reimbursement under various government programs. The marketing, billing, documenting and other practices are all subject to government oversight and review. To ensure compliance with Medicare and other regulations, regional carriers often conduct audits and request patient records and other documents to support claims submitted by us for payment of services rendered to customers.

We also are subject to routine pre-payment and post-payment audits of durable medical equipment (“DME”) claims submitted to Medicare Part B. These audits typically involve a complex medical review, by Medicare or its designated contractors and representatives, of documentation supporting the therapy provided by us. While Medicare requires us to obtain a comprehensive physician order prior to providing products and services, we are not required to obtain the written medical record in advance of therapy as long as the underlying medical records reported to us support the coverage criteria and medical necessity information included in such claim. Following a Medicare request for supporting documentation, we are obligated to procure and submit the underlying medical records retained by various clinical providers, medical facilities and prescribers. Obtaining these medical records in connection with a claims audit may be challenging and, in any event, all of these records are subject to further examination, interpretation and dispute by an auditing authority. Under standard Medicare procedures, we are entitled to demonstrate the sufficiency of documentation and the establishment of medical necessity, and we have the right to appeal any adverse determinations. If a determination is made that our records or the patients’ medical records are insufficient to meet medical necessity or Medicare reimbursement requirements for the claims, we could be subject to denial or overpayment demands for claims submitted for Medicare reimbursement. In the rare event that an audit results in major discrepancies of claims records which lacked proof of medical necessity, Medicare may be entitled to take additional corrective measures, including: extrapolation of the results of the audit across a wider population of claims, submitting recoupment demands for claims other than those examined in the audit, or placing the organization on a full prepayment review. These audits have increased over the last two years from being negligible to approximately 10% of our claims.  While eventually receiving payment on a high percent of the claims subject to these audits, payment timeliness may range from a few months up to a year resulting in increasing Medicare accounts receivable balances.

On June 30, 2014, KCI entered into a settlement agreement with Wake Forest  University Health Sciences to fully and finally resolve the historical patent and royalty disputes between them relating to negative pressure wound therapy. As of March 31, 2015, the accompanying consolidated balance sheet included $83.8 million under the caption “accrued expenses and other” and $105.7 million under the caption “other non-current liabilities” representing the net present value of payments under the Settlement Agreement discounted using our incremental borrowing rate as the discount rate. 



16


NOTE 8.     Segment Information

The Company is engaged in the rental and sale of advanced wound therapeutics and regenerative medicine products in over 75 countries worldwide through direct sales and indirect operations. We have two reportable operating segments which correspond to our two businesses: Advanced Wound Therapeutics and Regenerative Medicine. Our Advanced Wound Therapeutics business is conducted by KCI and its subsidiaries, including Systagenix, while our Regenerative Medicine business is conducted by LifeCell and its subsidiaries. In most countries where we operate, certain aspects of our two businesses are supported by the same administrative staff, systems and infrastructure and, as such, we have allocated these costs between the businesses based on allocation methods including headcount, revenue and other methods as deemed appropriate. We measure segment profit (loss) as operating earnings (loss), which is defined as income (loss) before interest and other income, interest expense, foreign currency gains and losses, derivative instruments gains and losses and income taxes. All intercompany transactions are eliminated in computing revenue and operating earnings (loss).

Information on segments and a reconciliation of consolidated totals are as follows (in thousands):
 
Three months ended March 31,
 
2015
 
2014
Revenue:
 
 
 
Advanced Wound Therapeutics
$
337,259

 
$
330,795

Regenerative Medicine
104,169

 
106,656

Other operations (1)
2,622

 
5,184

Total revenue
$
444,050

 
$
442,635

 
 
 
 
Operating earnings (loss):
 
 
 
Advanced Wound Therapeutics
$
112,885

 
$
85,669

Regenerative Medicine
34,019

 
29,908

Other operations (1)
447

 
671

Non-allocated costs:
 
 
 
General headquarter expense
(1,423
)
 
(1,590
)
Equity-based compensation
(535
)
 
(941
)
Business optimization and transaction-related expenses (2)
(15,376
)
 
(30,223
)
Acquired intangible asset amortization (3)
(45,877
)
 
(50,689
)
Total non-allocated costs
(63,211
)
 
(83,443
)
Total operating earnings
$
84,140

 
$
32,805

(1)
Represents contract manufacturing operations conducted at our manufacturing facility in Gargrave, England.
(2)
Represents restructuring-related expenses associated with our business optimization initiatives as well as management fees and costs associated with acquisition, disposition and financing activities.
(3)
Represents amortization of acquired intangible assets related to our Merger in November 2011, our acquisition of Systagenix in October 2013 and other technology acquisitions.




17


NOTE 9.     Guarantor Condensed Consolidating Financial Statements

Our 10.5% Second Lien Notes and 12.5% Unsecured Notes are fully and unconditionally guaranteed, jointly and severally, by us and each of our material 100% owned subsidiaries, other than the subsidiaries that are co-issuers of the notes, foreign subsidiaries and subsidiaries whose only assets are investments in foreign subsidiaries. The non-guarantor subsidiaries do not have any payment obligations under the 10.5% Second Lien Notes or 12.5% Unsecured Notes. Subject to the terms of the10.5% Second Lien Notes and 12.5% Unsecured Notes indentures, the guarantee of a subsidiary guarantor will terminate upon:
 
(1)
a sale or other disposition (including by way of consolidation or merger) of the capital stock of such guarantor or the sale or disposition of all or substantially all the assets of such subsidiary guarantor (other than to the Company or a restricted subsidiary) otherwise permitted by the 10.5% Second Lien Notes or 12.5% Unsecured Notes indentures,
 
(2)
the designation in accordance with the 10.5% Second Lien Notes or 12.5% Unsecured Notes indenture of the guarantor as an unrestricted subsidiary or the occurrence of any event after which the guarantor is no longer a restricted subsidiary,
 
(3)
defeasance or discharge of the 10.5% Second Lien Notes or 12.5% Unsecured Notes, or

(4)
upon the achievement of investment grade status by the 10.5% Second Lien Notes or 12.5% Unsecured Notes; provided that such guarantee shall be reinstated upon the reversion date.

In the event of a bankruptcy, liquidation or reorganization of any non-guarantor subsidiary, such non-guarantor subsidiary will pay the holders of its debt and other liabilities, including its trade creditors, before it will be able to distribute any of its assets to us. In the future, any non-U.S. subsidiaries, immaterial subsidiaries and subsidiaries that we designate as unrestricted subsidiaries under the 10.5% Second Lien Notes and 12.5% Unsecured Notes indentures will not guarantee the 10.5% Second Lien Notes or 12.5% Unsecured Notes. As of March 31, 2015, there were no restrictions on the ability of subsidiary guarantors to transfer funds to the parent company.

As a result of the guarantee arrangements, we are presenting the following condensed consolidated balance sheets, statements of operations and comprehensive income (loss), and statements of cash flows of the issuer, the guarantor subsidiaries and the non-guarantor subsidiaries.




18


Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Balance Sheet
March 31, 2015
(in thousands)
(unaudited)
 
Acelity L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
398

 
$
50,055

 
$

 
$
200,056

 
$

 
$
250,509

Accounts receivable, net

 
181,254

 
66,017

 
117,853

 

 
365,124

Inventories, net

 
106,137

 
116,069

 
93,585

 
(133,334
)
 
182,457

Deferred income taxes

 
58,059

 
10,594

 
1,862

 

 
70,515

Prepaid expenses and other

 
14,178

 
2,902

 
246,711

 
(235,454
)
 
28,337

Intercompany receivables
166

 
2,000,335

 
2,448,575

 
72,599

 
(4,521,675
)
 

Total current assets
564

 
2,410,018

 
2,644,157

 
732,666

 
(4,890,463
)
 
896,942

Net property, plant and equipment

 
301,139

 
68,201

 
142,645

 
(234,332
)
 
277,653

Debt issuance costs, net

 
72,094

 

 

 

 
72,094

Deferred income taxes

 

 

 
30,466

 

 
30,466

Goodwill

 
2,483,240

 
732,138

 
162,920

 

 
3,378,298

Identifiable intangible assets, net

 
285,726

 
1,770,658

 
296,430

 

 
2,352,814

Other non-current assets

 
1,261

 
186

 
94,162

 
(90,900
)
 
4,709

Intercompany loan receivables

 
755,000

 
431,626

 

 
(1,186,626
)
 

Intercompany investments
656,463

 
409,245

 
319,910

 

 
(1,385,618
)
 

 
$
657,027

 
$
6,717,723

 
$
5,966,876

 
$
1,459,289

 
$
(7,787,939
)
 
$
7,012,976

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$

 
$
17,307

 
$
12,703

 
$
25,936

 
$

 
$
55,946

Accrued expenses and other

 
286,332

 
233,481

 
67,683

 
(191,982
)
 
395,514

Intercompany payables
7,258

 
1,310,017

 
2,695,544

 
508,856

 
(4,521,675
)
 

Current installments of long-term debt

 
25,385

 

 

 

 
25,385

Income taxes payable

 
555

 
4,123

 
5,303

 

 
9,981

Deferred income taxes

 

 
103,135

 

 

 
103,135

Total current liabilities
7,258

 
1,639,596

 
3,048,986

 
607,778

 
(4,713,657
)
 
589,961

Long-term debt, net of current installments and discount

 
4,774,787

 

 

 

 
4,774,787

Non-current tax liabilities

 
9,852

 
6,276

 
17,717

 

 
33,845

Deferred income taxes

 
111,338

 
641,696

 
46,300

 

 
799,334

Other non-current liabilities
629

 
114,499

 
48,262

 
2,519

 

 
165,909

Intercompany loan payables

 
423,357

 
755,000

 
8,269

 
(1,186,626
)
 

Total liabilities
7,887

 
7,073,429

 
4,500,220

 
682,583

 
(5,900,283
)
 
6,363,836

 
 
 
 
 
 
 
 
 
 
 
 
Total equity
649,140

 
(355,706
)
 
1,466,656

 
776,706

 
(1,887,656
)
 
649,140

 
$
657,027

 
$
6,717,723

 
$
5,966,876

 
$
1,459,289

 
$
(7,787,939
)
 
$
7,012,976




19


Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Balance Sheet
December 31, 2014
(in thousands)
 
Acelity L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
398

 
$
41,027

 
$
1,499

 
$
140,617

 
$

 
$
183,541

Accounts receivable, net

 
179,872

 
67,355

 
123,256

 

 
370,483

Inventories, net

 
73,904

 
110,355

 
93,765

 
(99,802
)
 
178,222

Deferred income taxes

 
52,868

 
10,157

 

 

 
63,025

Prepaid expenses and other

 
11,106

 
6,851

 
247,606

 
(238,000
)
 
27,563

Intercompany receivables
166

 
1,854,033

 
2,432,299

 
48,267

 
(4,334,765
)
 

Total current assets
564

 
2,212,810

 
2,628,516

 
653,511

 
(4,672,567
)
 
822,834

Net property, plant and equipment

 
315,691

 
69,801

 
164,838

 
(262,282
)
 
288,048

Debt issuance costs, net

 
77,896

 

 

 

 
77,896

Deferred income taxes

 

 

 
31,692

 

 
31,692

Goodwill

 
2,483,240

 
732,138

 
162,920

 

 
3,378,298

Identifiable intangible assets, net

 
299,575

 
1,788,661

 
309,015

 

 
2,397,251

Other non-current assets

 
1,161

 
186

 
94,247

 
(90,900
)
 
4,694

Intercompany loan receivables

 
760,000

 
429,856

 

 
(1,189,856
)
 

Intercompany investments
667,530

 
360,292

 
223,581

 

 
(1,251,403
)
 

 
$
668,094

 
$
6,510,665

 
$
5,872,739

 
$
1,416,223

 
$
(7,467,008
)
 
$
7,000,713

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$
245

 
$
16,298

 
$
14,463

 
$
20,821

 
$

 
$
51,827

Accrued expenses and other

 
218,793

 
244,829

 
74,380

 
(194,518
)
 
343,484

Intercompany payables
6,441

 
1,181,383

 
2,634,149

 
512,792

 
(4,334,765
)
 

Current installments of long-term debt

 
25,721

 

 

 

 
25,721

Income taxes payable

 

 

 
1,305

 

 
1,305

Deferred income taxes

 

 
113,658

 

 

 
113,658

Total current liabilities
6,686

 
1,442,195

 
3,007,099

 
609,298

 
(4,529,283
)
 
535,995

Long-term debt, net of current installments and discount

 
4,815,290

 

 

 

 
4,815,290

Non-current tax liabilities

 
9,404

 
6,203

 
17,693

 

 
33,300

Deferred income taxes

 
106,440

 
637,777

 
47,940

 

 
792,157

Other non-current liabilities
695

 
113,368

 
48,172

 
1,023

 

 
163,258

Intercompany loan payables

 
420,294

 
760,000

 
9,562

 
(1,189,856
)
 

Total liabilities
7,381

 
6,906,991

 
4,459,251

 
685,516

 
(5,719,139
)
 
6,340,000

 
 
 
 
 
 
 
 
 
 
 
 
Total equity
660,713

 
(396,326
)
 
1,413,488

 
730,707

 
(1,747,869
)
 
660,713

 
$
668,094

 
$
6,510,665

 
$
5,872,739

 
$
1,416,223

 
$
(7,467,008
)
 
$
7,000,713







20


Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the three months ended March 31, 2015
 
Acelity L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$

 
$
149,698

 
$

 
$
23,141

 
$

 
$
172,839

Sales

 
83,737

 
239,691

 
229,663

 
(281,880
)
 
271,211

Total revenue

 
233,435

 
239,691

 
252,804

 
(281,880
)
 
444,050

Rental expenses
21

 
75,873

 
3,467

 
41,365

 
(42,548
)
 
78,178

Cost of sales
43

 
89,496

 
159,253

 
87,974

 
(263,352
)
 
73,414

Gross profit (loss)
(64
)
 
68,066

 
76,971

 
123,465

 
24,020

 
292,458

Selling, general and administrative expenses
471

 
68,519

 
36,716

 
42,308

 
(251
)
 
147,763

Research and development expenses

 
5,617

 
4,896

 
4,165

 

 
14,678

Acquired intangible asset amortization

 
13,880

 
19,456

 
12,541

 

 
45,877

Operating earnings (loss)
(535
)
 
(19,950
)
 
15,903

 
64,451

 
24,271

 
84,140

Non-operating intercompany transactions

 
(1,682
)
 
30,849

 
(29,190
)
 
23

 

Interest income and other

 
16,762

 
3,063

 
103

 
(19,781
)
 
147

Interest expense

 
(107,782
)
 
(16,718
)
 
(7
)
 
19,781

 
(104,726
)
Foreign currency gain (loss)

 
35,006

 
(1,593
)
 
(14,013
)
 

 
19,400

Derivative instruments loss

 
(3,348
)
 

 

 

 
(3,348
)
Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(535
)
 
(80,994
)
 
31,504

 
21,344

 
24,294

 
(4,387
)
Income tax expense (benefit)

 
415

 
141

 
(412
)
 

 
144

Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(535
)
 
(81,409
)
 
31,363

 
21,756

 
24,294

 
(4,531
)
Equity in earnings (loss) of subsidiaries
(3,996
)
 
48,953

 
21,756

 

 
(66,713
)
 

Earnings (loss) from continuing operations
(4,531
)
 
(32,456
)
 
53,119

 
21,756

 
(42,419
)
 
(4,531
)
Earnings (loss) from discontinued operations, net of tax

 

 

 

 

 

Net earnings (loss)
$
(4,531
)
 
$
(32,456
)
 
$
53,119

 
$
21,756

 
$
(42,419
)
 
$
(4,531
)
Total comprehensive income (loss)
$
(11,602
)
 
$
(39,527
)
 
$
46,048

 
$
14,685

 
$
(21,206
)
 
$
(11,602
)



21




Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the three months ended March 31, 2014
 
Acelity L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$

 
$
135,764

 
$

 
$
29,213

 
$

 
$
164,977

Sales

 
65,869

 
202,032

 
208,466

 
(198,709
)
 
277,658

Total revenue

 
201,633

 
202,032

 
237,679

 
(198,709
)
 
442,635

Rental expenses
43

 
68,791

 
2,148

 
54,111

 
(40,444
)
 
84,649

Cost of sales
6

 
65,341

 
115,064

 
92,834

 
(191,855
)
 
81,390

Gross profit (loss)
(49
)
 
67,501

 
84,820

 
90,734

 
33,590

 
276,596

Selling, general and administrative expenses
893

 
79,282

 
46,653

 
48,887

 
(103
)
 
175,612

Research and development expenses

 
5,622

 
6,744

 
5,124

 

 
17,490

Acquired intangible asset amortization

 
16,425

 
20,172

 
14,092

 

 
50,689

Operating earnings (loss)
(942
)
 
(33,828
)
 
11,251

 
22,631

 
33,693

 
32,805

Non-operating intercompany transactions

 
(6,626
)
 
(8,282
)
 
(8,007
)
 
22,915

 

Interest income and other

 
17,200

 
9,828

 
30

 
(26,963
)
 
95

Interest expense

 
(112,016
)
 
(17,137
)
 
(5
)
 
26,963

 
(102,195
)
Foreign currency gain (loss)

 
(460
)
 
(46
)
 
742

 

 
236

Derivative instruments loss

 
(3
)
 

 

 

 
(3
)
Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(942
)
 
(135,733
)
 
(4,386
)
 
15,391

 
56,608

 
(69,062
)
Income tax expense (benefit)

 
(79,988
)
 
31,834

 
26,152

 

 
(22,002
)
Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(942
)
 
(55,745
)
 
(36,220
)
 
(10,761
)
 
56,608

 
(47,060
)
Equity in earnings (loss) of subsidiaries
(45,441
)
 
(50,750
)
 
(10,761
)
 

 
106,952

 

Earnings (loss) from continuing operations
(46,383
)
 
(106,495
)
 
(46,981
)
 
(10,761
)
 
163,560

 
(47,060
)
Earnings (loss) from discontinued operations, net of tax

 

 
677

 

 

 
677

Net earnings (loss)
$
(46,383
)
 
$
(106,495
)
 
$
(46,304
)
 
$
(10,761
)
 
$
163,560

 
$
(46,383
)
Total comprehensive income (loss)
$
(45,090
)
 
$
(105,202
)
 
$
(45,011
)
 
$
(9,468
)
 
$
159,681

 
$
(45,090
)





22





Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Cash Flows
(in thousands)
(unaudited)

 
For the three months ended March 31, 2015
 
Acelity L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Cash flows from operating activities:
 
 
 
 
 
 
 
 
 
 
 
   Net earnings (loss)
$
(4,531
)
 
$
(32,456
)
 
$
53,119

 
$
21,756

 
$
(42,419
)
 
$
(4,531
)
   Adjustments to reconcile net earnings (loss) to net cash provided (used) by operating activities
1,107

 
45,550

 
52,538

 
13,987

 
(6,378
)
 
106,804

    Net cash provided (used) by operating activities
(3,424
)
 
13,094

 
105,657

 
35,743

 
(48,797
)
 
102,273

Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
 
 
   Net additions to property, plant and equipment

 
(23,421
)
 
(2,285
)
 
588

 
11,949

 
(13,169
)
   Decrease (increase) in identifiable intangible assets and other non-current assets

 
(130
)
 
(1,820
)
 
129

 

 
(1,821
)
    Net cash provided (used) by investing activities

 
(23,551
)
 
(4,105
)
 
717

 
11,949

 
(14,990
)
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
 
 
   Distribution to limited partners
(55
)
 

 

 

 

 
(55
)
   Settlement of profits interest units
(517
)
 

 

 

 

 
(517
)
   Repayments of long-term debt and capital lease obligations

 
(6,446
)
 

 
31

 

 
(6,415
)
Debt issuance costs

 
(6,256
)
 

 

 

 
(6,256
)
Proceeds (payments) on intercompany loans

 
8,063

 
(6,770
)
 
(1,293
)
 

 

Proceeds (payments) on intercompany investments
3,996

 
24,124

 
(96,281
)
 
31,313

 
36,848

 

   Net cash provided (used) by financing activities
3,424

 
19,485

 
(103,051
)
 
30,051

 
36,848

 
(13,243
)
Effect of exchange rate changes on cash and cash equivalents

 

 

 
(7,072
)
 

 
(7,072
)
Net increase (decrease) in cash and cash equivalents

 
9,028

 
(1,499
)
 
59,439

 

 
66,968

Cash and cash equivalents, beginning of period
398

 
41,027

 
1,499

 
140,617

 

 
183,541

Cash and cash equivalents, end of period
$
398

 
$
50,055

 
$

 
$
200,056

 
$

 
$
250,509









23




Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Cash Flows
(in thousands)
(unaudited)

 
For the three months ended March 31, 2014
 
Acelity L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Cash flows from operating activities:
 
 
 
 
 
 
 
 
 
 
 
   Net earnings (loss)
$
(46,383
)
 
$
(106,495
)
 
$
(46,304
)
 
$
(10,761
)
 
$
163,560

 
$
(46,383
)
   Adjustments to reconcile net loss to net cash provided (used) by operating activities
941

 
54,197

 
62,506

 
42,868

 
(31,283
)
 
129,229

    Net cash provided (used) by operating activities
(45,442
)
 
(52,298
)
 
16,202

 
32,107

 
132,277

 
82,846

Cash flows from investing activities:


 


 


 


 


 


   Net additions to property, plant and equipment

 
(20,324
)
 
(2,031
)
 
(12,414
)
 
22,105

 
(12,664
)
Businesses acquired in purchase transactions, net of cash acquired

 

 
(4,500
)
 
(113
)
 

 
(4,613
)
   Decrease (increase) in identifiable intangible assets and other non-current assets

 
(29
)
 
(1,187
)
 
(65
)
 

 
(1,281
)
    Net cash provided (used) by investing activities

 
(20,353
)
 
(7,718
)
 
(12,592
)
 
22,105

 
(18,558
)
Cash flows from financing activities:


 


 


 


 


 


   Repayments of long-term debt and capital lease obligations

 
(6,619
)
 

 
(16
)
 

 
(6,635
)
Proceeds (payments) on intercompany loans

 
36,602

 
(18,830
)
 
(17,772
)
 

 

Proceeds (payments) on intercompany investments
45,442

 
50,744

 
10,228

 
47,968

 
(154,382
)
 

   Net cash provided (used) by financing activities
45,442

 
80,727

 
(8,602
)
 
30,180

 
(154,382
)
 
(6,635
)
Effect of exchange rate changes on cash and cash equivalents

 

 

 
38

 

 
38

Net increase (decrease) in cash and cash equivalents

 
8,076

 
(118
)
 
49,733

 

 
57,691

Cash and cash equivalents, beginning of period
398


87,771


118


118,662



 
206,949

Cash and cash equivalents, end of period
$
398

 
$
95,847

 
$

 
$
168,395

 
$

 
$
264,640





24


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes included in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed in our “Risk Factors” (Part II, Item 1A.), including those previously disseminated in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.
GENERAL

We are a leading global medical technology company devoted to the development and commercialization of innovative products and therapies designed to improve outcomes while helping to reduce the overall cost of patient care. Our primary businesses serve the advanced wound therapeutics and regenerative medicine markets and we are engaged in the rental and sale of our products throughout the United States and in over 75 countries worldwide through direct sales and indirect operations. We are owned by investment funds advised by Apax Partners and controlled affiliates of Canada Pension Plan Investment Board and the Public Sector Pension Investment Board and certain other co-investors.

Our Advanced Wound Therapeutics business is focused on the development and commercialization of advanced wound therapeutics devices and dressings and accounted for approximately $337.3 million or 76.0% of our global revenue in the first quarter of 2015. Our Advanced Wound Therapeutics business is primarily engaged in commercializing several technology platforms, including negative pressure wound therapy (“NPWT”), advanced dressings, negative pressure surgical management (“NPSM”) and epidermal harvesting. Our advanced wound therapeutics dressings are used for the management of chronic and acute wounds. Our Advanced Wound Therapeutics business is primarily conducted by KCI and its operating subsidiaries, including Systagenix. Key brands in our Advanced Wound Therapeutics business include the V.A.C. NPWT line of products, Prevena, ABThera, CelluTome, Promogran, Tielle, and Adaptic.
 
Our Regenerative Medicine business is primarily focused on the development and commercialization of regenerative and reconstructive acellular tissue matrices for use in general and reconstructive surgical procedures to repair soft tissue defects. Key brands within our product portfolio include our human tissue based AlloDerm and porcine tissue based Strattice in various configurations designed to meet the needs of patients and caregivers. In addition to our acellular tissue matrices, our Regenerative Medicine business markets autologous fat grafting solutions, such as Revolve, which complement our tissue matrix business. Regenerative medicine accounted for approximately $104.2 million or 23.5% of our global revenue in the first quarter of 2015.

Other revenue consists of contract manufacturing operations performed at our manufacturing facility in Gargrave, England and accounted for approximately $2.6 million or 0.5% of our global revenue in the first quarter of 2015.

Our customers include acute care hospitals, ambulatory surgical centers, and long-term care facilities, with whom we contract directly or through group purchasing organizations (“GPOs”). We bill these facilities directly for the rental and sale of our products. In the U.S. home care setting, we provide products and therapies to patients in the home and bill third-party payers, such as Medicare and private insurance, directly. Outside of the U.S., most of our revenue is generated in the acute care setting. Our sales and marketing organizations are focused on the training and education of care-givers on the proper application of our products and therapies, particularly with general, plastic and orthopedic surgeons, as well as wound ostomy care nurses. We also drive adoption of our products with the support of extensive clinical efficacy data, as well as the economic value proposition of our products to reduce the overall cost of care.



25


RESULTS OF OPERATIONS
We have two reportable operating segments which correspond to our two businesses: Advanced Wound Therapeutics and Regenerative Medicine. Our Advanced Wound Therapeutics business is conducted by KCI and its subsidiaries, including Systagenix, while our Regenerative Medicine business is conducted by LifeCell and its subsidiaries. Other revenue consists of contract manufacturing operations performed at our manufacturing facility in Gargrave, England. We have two primary geographic regions: the Americas, which is comprised principally of the United States and includes Canada, Puerto Rico and Latin America; and EMEA/APAC, which is comprised of Europe, the Middle East, Africa and the Asia Pacific region.
Historically, we have experienced a seasonal slowing of unit demand for our NPWT devices and related dressings beginning in the fourth quarter and continuing into the first quarter, which we believe has been caused by year-end clinical treatment patterns, such as the postponement of elective surgeries and increased discharges of individuals from the acute care setting around the winter holidays. We typically experience a slowing of demand for our advanced wound therapeutics dressings in the fourth quarter. Although we do not know if our historical experience will prove to be indicative of future periods, similar slow-downs may occur in subsequent periods.
Revenue for each of our geographic regions in which we operate is disclosed for each of our businesses. Certain prior period amounts have been reclassified to conform to the 2015 presentation.
Revenue by Operating Segment

The following table sets forth, for the periods indicated, business unit revenue as well as the percentage change in each line item, comparing the first quarter of 2015 to the first quarter of 2014 (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
Advanced Wound Therapeutics revenue:
 
 
 
 
 
Rental
$
172,839

 
$
164,977

 
4.8
 %
Sales
164,420

 
165,818

 
(0.8
)
Total – Advanced Wound Therapeutics
337,259

 
330,795

 
2.0

 
 
 
 
 
 
Regenerative Medicine revenue:
 
 
 
 
 
Sales
104,169

 
106,656

 
(2.3
)
 
 
 
 
 
 
Other revenue:
 
 
 
 
 
Sales
2,622

 
5,184

 
(49.4
)
 
 
 
 
 
 
Total consolidated revenue:
 
 
 
 
 
Rental
172,839

 
164,977

 
4.8

Sales
271,211

 
277,658

 
(2.3
)
Total consolidated revenue
$
444,050

 
$
442,635

 
0.3
 %

The increase in total revenue for the first quarter of 2015 as compared to the prior-year period was due to higher Advanced Wound Therapeutics rental revenue, partially offset by lower Regenerative Medicine revenue and Advanced Wound Therapeutics sales revenue. Foreign currency exchange rate movements negatively impacted worldwide revenue by 3.9% compared to the prior-year period.

The increase in worldwide Advanced Wound Therapeutics revenue from the prior-year period was attributable primarily to increased NPWT volumes, partially offset by lower average pricing due to increased competition, healthcare reform and declining reimbursement. Foreign currency exchange rate movements negatively impacted worldwide Advanced Wound Therapeutics revenue during the first quarter of 2015 by 4.7% compared to the prior-year period.


26


The decline in worldwide Regenerative Medicine revenue from the prior-year period was due primarily to decreased volumes of abdominal wall repair procedures using biologics as some customers are choosing lower cost alternatives. Foreign currency exchange rate movements negatively impacted worldwide Regenerative Medicine revenue by 1.3% compared to the prior-year period.

Revenue by Geography

The following table sets forth, for the periods indicated, rental and sales revenue by geography as well as the percentage change in each line item, comparing the first quarter of 2015 to the first quarter of 2014 (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
 
 
 
 
 
 
Americas revenue:
 
 
 
 
 
Rental
$
153,308

 
$
140,023

 
9.5
 %
Sales
192,762

 
190,080

 
1.4

Total – Americas
346,070

 
330,103

 
4.8

 
 
 
 
 
 
EMEA/APAC revenue:
 
 
 
 
 
Rental
19,531

 
24,954

 
(21.7
)
Sales
78,449

 
87,578

 
(10.4
)
Total – EMEA/APAC
97,980

 
112,532

 
(12.9
)
 
 
 
 
 
 
Total consolidated revenue:
 
 
 
 
 
Rental
172,839

 
164,977

 
4.8

Sales
271,211

 
277,658

 
(2.3
)
Total consolidated revenue
$
444,050

 
$
442,635

 
0.3
 %


Revenue Relationship

The following table sets forth, for the periods indicated, the percentage relationship of each item to total revenue in the period, as well as the changes in each line item:
 
Three months ended March 31,
 
2015
 
2014
 
Change
 
 
 
 
 
 
 
Advanced Wound Therapeutics revenue
76.0
%
 
74.7
%
 
130

bps
Regenerative Medicine revenue
23.5
%
 
24.1
%
 
(60
)
bps
Other revenue
0.5

 
1.2

 
(70
)
bps
Total consolidated revenue
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
Americas revenue
77.9
%
 
74.6
%
 
330

bps
EMEA/APAC revenue
22.1

 
25.4

 
(330
)
bps
Total consolidated revenue
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
Rental revenue
38.9
%
 
37.3
%
 
160

bps
Sales revenue
61.1

 
62.7

 
(160
)
bps
Total consolidated revenue
100.0
%
 
100.0
%
 


 



27


Rental Expenses

The following table presents rental expenses for the periods indicated as well as the percentage change in each line item, comparing the first quarter of 2015 to the first quarter of 2014 (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
 
 
 
 
 
 
Rental expenses
$
78,178

 
$
84,649

 
(7.6
)%

Rental, or field, expenses are comprised of both fixed and variable costs including facilities, field service, sales force compensation and royalties associated with our rental products. Rental expenses during the first quarter of 2015 decreased from the prior-year period due primarily to a decrease in depreciation related to the fixed asset step up associated with purchase accounting, partially offset by an increase in operational expenses related to the sales force.

Cost of Sales

The following table presents cost of sales as well as the percentage change in each line item, comparing the first quarter of 2015 to the first quarter of 2014 (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
 
 
 
 
 
 
Cost of sales
$
73,414

 
$
81,390

 
(9.8
)%

Cost of sales includes manufacturing costs, product costs and royalties associated with our “for sale” products. The decrease in cost of sales in the first quarter of 2015 compared to the prior-year period was due primarily to $6.7 million of additional cost of sales recorded in the first quarter of 2014 associated with the Systagenix acquisition purchase accounting adjustments related to the step up in value of inventory.

Gross Profit Margin

The following table presents the gross profit margin (calculated as gross profit divided by total revenue for the periods indicated):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
 
 
 
 
 
 
 
Gross profit margin
65.9
%
 
62.5
%
 
340

bps

The gross profit margin increase during the first quarter of 2015 compared to the prior-year period was due primarily to $6.7 million of additional cost of sales recorded in the first quarter of 2014 related to the inventory step up and a decrease in depreciation expense related to the fixed asset step up associated with purchase accounting.


28


Selling, General and Administrative Expenses

The following table presents selling, general and administrative expenses and the percentage relationship to total revenue (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
 
 
 
 
 
 
 
Selling, general and administrative expenses
$
147,763

 
$
175,612

 
(15.9
)%

Selling, general and administrative (“SG&A”) expenses generally include administrative labor, incentive and sales compensation costs, insurance costs, professional fees, depreciation, bad debt expense and information systems costs, but exclude rental sales force compensation costs. The decrease in SG&A is due primarily to lower selling-related costs and savings associated with our integration efforts. Salary-related expenses decreased due to lower employee headcount. Expenses associated with business optimization and integration activities also declined compared to the prior year period.

Research and Development Expenses

The following table presents research and development expenses and the percentage relationship to total revenue (dollars in thousands):
 
Three months ended March 31,
 
2015
 
2014
 
% Change
 
 
 
 
 
 
 
Research and development expenses
$
14,678

 
$
17,490

 
(16.1)%
As a percent of total revenue
3.3
%
 
4.0
%
 
(70
)
bps

Research and development expenses relate to our investments in clinical studies and the development of new and enhanced products and therapies. Our research and development efforts include the development of new and synergistic technologies across the continuum of wound care, including tissue regeneration, preservation and repair, as well as new applications of negative pressure technology. Our research and development program is also leveraging our core understanding of biological tissues in order to develop biosurgery products in our Regenerative Medicine business.

Acquired Intangible Asset Amortization

We have recorded identifiable intangible assets in connection with the 2011 merger, the 2013 Systagenix acquisition and various technology acquisitions. During the first quarters of 2015 and 2014, we recorded $45.9 million and $50.7 million, respectively, of amortization expense associated with these identifiable intangible assets.

Interest Expense

Interest expense increased to $104.7 million in the first quarter of 2015 compared to $102.2 million in the prior-year period due to accretion of the Wake Forest settlement liability related to the settlement and release agreement with Wake Forest entered into during the second quarter of 2014.

Foreign Currency Gain (Loss)

Foreign currency transaction gains were $19.4 million and $0.2 million during the first quarter of 2015 and 2014, respectively. The revaluation of the Term E-1 EURO loan to U.S. dollars represented a foreign currency transaction gain of $32.4 million during the first quarter of 2015 compared to a loss of $0.2 million in the prior-year period. Excluding the revaluation of the Term E-1 EURO loan to U.S. dollars, we recognized foreign currency exchange losses of $13.0 million during the first quarter of 2015 compared to a gain of $0.5 million in the prior-year period due to significant fluctuations in the Euro exchange rate.
.

29


Derivative Instruments Gain (Loss)

During the first quarter of 2015, we recorded a derivative instruments loss of $3.3 million million due primarily to fluctuations in the value of our interest rate derivative instruments. During the first quarter of 2014, the derivative instruments loss was not material.

Earnings (Loss) from Discontinued Operations

No gains or losses from discontinued operations were recorded in the first quarter of 2015. During the first quarter of 2014, we recorded a gain from discontinued operations, net of tax, of $0.7 million related to the disposition of our SPY assets.


LIQUIDITY AND CAPITAL RESOURCES
General
We require capital principally for working capital requirements, capital expenditures and debt service requirements. Additionally, from time to time, we may use capital for acquisitions and other investing and financing activities. Working capital is required principally to finance accounts receivable and inventory. Our working capital requirements vary from period-to-period depending on manufacturing volumes, the timing of shipments and the payment cycles of our customers and payers.

We may from time to time seek to retire or purchase our outstanding debt through cash purchases, open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

Sources of Capital

Based upon the current level of operations, we believe our existing capital resources, as well as cash flows from operating activities and availability under our Revolving Credit Facility will be adequate to meet our anticipated cash requirements for at least the next twelve months. Cash flows related to discontinued operations were not material for the first quarter of 2014 and therefore have not been separately disclosed in the condensed consolidated statements of cash flows. We do not anticipate the absence of cash flows from discontinued operations to significantly affect our liquidity and capital resources. During the first quarters of 2015 and 2014, our primary source of capital was cash from operations. The following table summarizes the net cash provided and used by operating activities, investing activities and financing activities (in thousands):
 
Three months ended March 31,
 
2015
 
2014
Net cash provided by operating activities
$
102,273

 
$
82,846

Net cash used by investing activities
(14,990
)
 
(18,558
)
Net cash used by financing activities
(13,243
)
 
(6,635
)
Effect of exchange rates changes on cash and cash equivalents
(7,072
)
 
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Net increase in cash and cash equivalents
$
66,968

 
$
57,691


As of March 31, 2015 and December 31, 2014, our principal sources of liquidity consisted of $250.5 million and $183.5 million, respectively, of cash and cash equivalents. We also had availability of $159.4 million and $161.0 million under our Revolving Credit Facility as of March 31, 2015 and December 31, 2014, respectively.

Capital Expenditures

During the first quarters of 2015 and 2014, we made capital expenditures of $10.5 million and $10.8 million, respectively. Capital expenditures during the first quarters of 2015 and 2014 related primarily to expanding the rental fleet and information technology projects and purchases.


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Senior Secured Credit Facility

The following table sets forth the amounts owed under the Senior Secured Credit Facility, the effective interest rates on such outstanding amounts, and the amount available for additional borrowing thereunder, as of March 31, 2015 (dollars in thousands):
Senior Secured Credit Facility
 
Maturity
Date
 
Effective
Interest
Rate
 
Amount
Outstanding (1)
 
Amount Available
for Additional
Borrowing
 
Senior Revolving Credit Facility
 
November 2016
 
%
 
$

 
$
159,424

(2) 
Senior Dollar Term E-1 Credit Facility
 
May 2018
 
5.00
%
(3) 
1,895,345

 

 
Senior Euro Term E-1 Credit Facility
 
May 2018
 
5.67
%
(3) 
253,149

 

 
Senior Term E-2 Credit Facility
 
November 2016
 
4.69
%
(3) 
311,258

 

 
   Total
 
 
 
 
 
$
2,459,752

 
$
159,424

 
_____________________
(1)
Amount outstanding includes the original issue discount.
(2)
At March 31, 2015, the amount available under the Revolving Credit Facility reflected a reduction of $40.6 million of letters of credit issued by banks which are party to the Senior Secured Credit Facility. In addition, we have $9.7 million of letters of credit issued by a bank not party to the Senior Secured Credit Facility.
(3)
The effective interest rate includes the effect of the original issue discount. Excluding the original issue discount, our nominal interest rate as of March 31, 2015 was 4.50% on the Senior Dollar Term E-1 Credit Facility, 4.75% on the Senior Euro Term E-1 Credit Facility and 4.00% on the Senior Term E-2 Credit Facility.

On March 10, 2015, we entered into Amendment No. 6 to our Senior Secured Credit Facility (“Amendment No. 6”). In connection with Amendment No. 6, certain applicable rates were modified such that (i) Dollar Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.50% or an adjusted base rate plus 2.50%, (ii) Euro Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.75% or an adjusted base rate plus 2.75%, and (iii) Term E-2 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.00% or an adjusted base rate plus 2.00%. The Eurocurrency rate shall be subject to a floor of 1.00%, and the adjusted base rate shall be subject to a floor of 2.00%. Repayments of Dollar Term E-1 Loans, Euro Term E-1 Loans or Term E-2 Loans within 12 months of the effective date of Amendment No. 6 in connection with a repricing transaction will be subject to a 1.0% prepayment premium. As a result of Amendment No. 6, the financial covenants were amended to remove the interest coverage ratio in its entirety and to set the total leverage ratio for any test period to be no greater than 8.25:1.00. In addition, certain other covenants were amended, including with respect to the incurrence of incremental facilities and asset sales.

10.5% Second Lien Senior Secured Notes

In November 2011, we issued $1.750 billion aggregate principal amount of second lien senior secured notes due 2018 (the “10.5% Second Lien Notes”). Interest on the 10.5% Second Lien Notes accrues at the rate of 10.5% per annum and is payable semi-annually in cash on each May 1 and November 1 through the maturity date. The 10.5% Second Lien Notes were issued at a discount resulting in an effective interest rate of 10.87%.

12.5% Senior Unsecured Notes

In November 2011, we issued $750.0 million aggregate principal amount of senior unsecured notes due 2019 (the “12.5% Unsecured Notes”); $612.0 million of which are still outstanding. Interest on the 12.5% Unsecured Notes accrues at the rate of 12.50% per annum and is payable semi-annually in cash on each May 1 and November 1through the maturity date. The 12.5% Unsecured Notes were issued at a discount resulting in an effective interest rate of 12.62%.


Covenants

As of March 31, 2015, we were in compliance with all covenants under our credit agreement and indentures.

For further information on our long-term debt, see Note 5 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.


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Interest Rate Protection

At March 31, 2015 and December 31, 2014, we were party to three interest rate swap agreements to convert $1.454 billion and $1.463 billion, respectively, of our outstanding variable rate debt to a fixed rate basis. The aggregate notional amount of the interest rate swaps decreases quarterly by amounts ranging from $1.7 million to $56.4 million until maturity. Our interest rate protection agreements have not been designated as hedging instruments, and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period.

For further information on our interest rate protection agreements, see Note 5 of the notes to the condensed consolidated financial statements.

Contractual Obligations
There have been no material changes, outside of the ordinary course of business, in our outstanding contractual obligations since December 31, 2014.

Critical Accounting Estimates
For a description of our critical accounting estimates, please see our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 under the heading Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates."

Recently Issued Accounting Standards

See note 1(e) of the notes to condensed consolidated financial statements included in this report for a discussion of recently issued accounting standards.



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including fluctuations in interest rates and variability in currency exchange rates. There have been no material changes from the risk factors disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2014. For a description of our policies, procedures and internal processes governing our management of market risk and the use of financial instruments to manage our exposure to such risk, please see our Annual Report for the fiscal year ended December 31, 2014 under the heading “Quantitative and Qualitative Disclosures About Market Risk.”


ITEM 4.     CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. Our management, with the participation of the principal executive officer and our principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting. There have not been any changes in our internal control over financial reporting (as such term is defined by paragraph (d) of Rule 13a-15) under the Exchange Act, during the first fiscal quarter of 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


PART II - OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS
Incorporated in this Item 1, by reference, are the legal proceedings described in Note 7 of the notes to condensed consolidated financial statements included in this report under the heading "Commitments and Contingencies: Legal Proceedings."


ITEM 1A.      RISK FACTORS

There have been no material changes from the risk factors disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2014.





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ITEM 6. EXHIBITS
A list of all exhibits filed or included as part of this quarterly report on Form 10-Q is as follows:
 
 
Exhibit
Number
Description
3.1
Declaration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.2
Certificate of Registration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.4 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.3
Amended and Restated Limited Partnership Agreement of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
†31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated May 1, 2015.
†31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated May 1, 2015.
†32.1
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated May 1, 2015.
 
 
 
†      Exhibit filed herewith.


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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Antonio, State of Texas on May 1, 2015.
 
ACELITY L.P. INC.
 
(REGISTRANT)
 
 
 
Date: May 1, 2015
By:
/s/ Joseph F. Woody
 
 
Joseph F. Woody
 
 
Principal Executive Officer
 
 
(Duly Authorized Officer)
 
 
 
 
 
 
Date: May 1, 2015
By:
/s/ Thomas W. Casey
 
 
Thomas W. Casey
 
 
Principal Financial Officer
 
 
(Duly Authorized Officer)



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EXHIBITS

Exhibit
Number
Description
3.1
Declaration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.2
Certificate of Registration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.4 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.3
Amended and Restated Limited Partnership Agreement of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
†31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated May 1, 2015.
†31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated May 1, 2015.
†32.1
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated May 1, 2015.
 
 
 
†      Exhibit filed herewith.



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