-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HkO8zununGVc78xlR9NWyCI5NjPHVrqeH02H9nbey2DdJWbROCN0Q6wHBoHW449T 4gK9FTz6HGpGSO9X127b8w== 0000898430-00-001282.txt : 20000417 0000898430-00-001282.hdr.sgml : 20000417 ACCESSION NUMBER: 0000898430-00-001282 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RIVER HOLDING CORP CENTRAL INDEX KEY: 0001061892 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 954674065 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-56135 FILM NUMBER: 602388 BUSINESS ADDRESS: STREET 1: 599 LEXINGTON AVE STREET 2: 18TH FL CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 2129582555 MAIL ADDRESS: STREET 1: 599 LEXINGTON AVE STREET 2: 18TH FL CITY: NEW YORK STATE: NY ZIP: 10022 10-K 1 FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________. Commission file number 333-56135 RIVER HOLDING CORP. (Exact name of registrant as specified in its charter) Delaware 95-4674065 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 599 Lexington Avenue, 18th Floor 10022 New York, New York (Zip Code) (Address of Principal Executive Offices) (212) 958-2555 (Registrant's telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] Not Applicable. As of March 30, 2000, the number of shares of Common Stock, $.01 par value, outstanding (the only class of common stock of the registrant outstanding) was 8,544,291. The registrant's Common Stock is not traded in a public market. Aggregate market value of the registrant's voting and nonvoting Common Stock: Not Applicable. Documents Incorporated by Reference: None ================================================================================ RIVER HOLDING CORP. AND SUBSIDIARIES Fiscal Year Ended December 31, 1999 TABLE OF CONTENTS
Page ---- PART I............................................................................................. 1 Item 1. Business............................................................................ 1 Item 2. Properties.......................................................................... 8 Item 3. Legal Proceedings................................................................... 8 Item 4. Submissions of Matters to a Vote of Security Holders................................ 9 PART II............................................................................................ 10 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 10 Item 6. Selected Financial Data............................................................. 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 12 Item 7A. Quantitative and Qualitative Disclosure About Market Risk........................... 26 Item 8. Financial Statements................................................................ 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 27 PART III........................................................................................... 28 Item 10. Directors and Executive Officers of the Registrant.................................. 28 Item 11. Executive Compensation.............................................................. 29 Item 12. Security Ownership of Certain Beneficial Owners and Management...................... 32 Item 13. Certain Relationships and Related Transactions...................................... 33 PART IV............................................................................................ 35 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K..................... 35 SIGNATURES......................................................................................... S-1
PART I Item 1. Business. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 27-A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include without limitation the words "believes," "anticipates," "estimates," "intends," "expects," and words of similar import. All statements other than statements of historical fact included in statements under "Item 1. Business," "Item 2. Properties," "Item 3. Legal Proceedings" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation" include forward-looking information and may reflect certain judgements by management. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of River Holding Corp. and Hudson Respiratory Care Inc. or the respiratory care and anesthesia products industries to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These potential risks, uncertainties include, but are not limited to, those identified in the "Risk Factors" section of this Form 10-K located at the end of "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments. General River Holding Corp. ("Holding") conducts all of its operations through its majority-owned subsidiary, Hudson Respiratory Care Inc. ("Hudson RCI" or the "Company"). The Company is a leading manufacturer and marketer of disposable medical products utilized in the respiratory care and anesthesia segments of the domestic and international health care markets. The Company offers one of the broadest respiratory care and anesthesia product lines in the industry, including such products as oxygen masks, humidification systems, nebulizers, cannulae and tubing. In the United States, the Company markets its products to a variety of health care providers, including hospitals and alternate site service providers such as outpatient surgery centers, long-term care facilities, physician offices and home health care agencies. Internationally, the Company sells its products to distributors that market to hospitals and other health care providers. The Company's products are sold to over 3,000 distributors and alternate site service providers throughout the United States and in more than 75 countries worldwide. The Company has supplied the disposable respiratory care market for over 50 years and enjoys strong brand name recognition and leading market positions. The Company manufactures and markets over 2,300 respiratory care and anesthesia products. The Company believes that its broad product offering represents a competitive advantage over suppliers with more limited product offerings, as health care providers seek to reduce medical supply costs and concentrate purchases among fewer vendors. The Company also benefits competitively from its extensive relationships with leading group purchasing organizations or GPOs, as large purchasing organizations play an increasingly important role in hospitals' purchasing decisions. The Company maintains two manufacturing facilities and two distribution facilities in the United States, assembly operations in Mexico and Malaysia and sales and marketing offices in the United States, Sweden and Germany. The Company has reduced its manufacturing and assembly costs through cost reduction programs, process improvement, equipment automation and upgrades and increased utilization of its Ensenada, Mexico facility for labor-intensive operations. Hudson Oxygen Therapy Sales Company ("Hudson Oxygen"), Hudson RCI's predecessor, was founded in 1945. In 1988, Hudson Oxygen formed Industrias Hudson, a subsidiary that oversees the Company's assembly operation in Mexico. In 1989, Hudson Oxygen merged with Respiratory Care Inc. to form Hudson RCI. In April 1998, the Company consummated a recapitalization, pursuant to which it became a majority-owned subsidiary of Holding. In the past five years, the Company has pursued a number of strategic acquisitions in order to expand its product line and geographic penetration, most significantly with the July 1999 acquisition of Louis Gibeck AB ("LGAB"), a Swedish company that manufactures and markets medical devices. Hudson RCI's principal executive offices are located at 27711 1 Diaz Road, P.O. Box 9020, Temecula, California 92589, and its telephone number is (909) 676-5611. Holding was incorporated in Delaware in January 1998. Holding's principal executive offices are located at 599 Lexington Avenue, 18th Floor, New York, New York 10022, and its telephone number is (212) 758-2555. Industry Overview The worldwide market for disposable respiratory care and anesthesia products consists of the domestic hospital market, the alternate site market and the international market. Respiratory care and anesthesia principally involve the delivery of oxygen and anesthesia from a gas source, such as a mechanical ventilator or respirator, to the patient's pulmonary system. The gas is typically delivered to the patient through specialized tubing connecting to a cannula, mask or endotracheal tube. In addition, it is often necessary to humidify or medicate the gas. The market for respiratory care and anesthesia products, including disposable products, is expected to be positively impacted by demographic trends, both domestically and internationally. In the United States, changes in demographics, including an aging population, increased incidence and awareness of respiratory illnesses and heightened focus on cost- efficient treatment, have had a positive impact on the domestic respiratory care and anesthesia markets. There has been an increasing incidence of respiratory illnesses (such as asthma and emphysema), due in part to an increasingly susceptible aging population, environmental pollution, smoking-related illnesses and communicable diseases with significant respiratory impact, such as tuberculosis, HIV and influenza. The Company believes that the international respiratory care and anesthesia markets will experience many of the trends currently affecting domestic markets. In addition, many international markets have high incidences of communicable respiratory diseases and are becoming increasingly aware of the value of single-use, disposable products. The market for respiratory care and anesthesia products is also affected by trends involving the health care market generally. In particular, the overall trend towards cost containment has increased the desirability of disposable products relative to reusable products, and has influenced pricing, distribution channels, purchasing decisions and health care delivery methods. Efforts to contain rising health care costs have increased the preference for disposable medical products that improve the productivity of health care professionals and reduce overall provider costs. Health care organizations are evaluating modes of treatment that are less labor and/or technology intensive as a means of decreasing the cost of care, which can often result in increased disposable usage. In particular, increased utilization of disposable products can decrease labor and other costs associated with sterilizing reusable products. In addition, the risks of transmission of infectious diseases such as HIV, hepatitis and tuberculosis, and related concerns about the occupational safety of health care professionals, have also contributed to an increased preference for disposable single-use medical products. Cost containment has caused consolidation throughout the health care product supply channel, which has favored manufacturers with large product offerings and competitive pricing. In an effort to contain costs, service providers have consolidated to form GPOs, which take advantage of group buying power to obtain lower supply prices. This, in turn, has led to consolidation among distributors, who seek to provide "one-stop shopping" for these large buying groups. Distributors have also sought to concentrate purchases among fewer vendors in an effort to reduce supply costs. Since selection as a GPO provider and strong relationships with distributors are critical to many health care manufacturers, they have responded to these trends by providing a broad range of integrated products, combined with reliable delivery and strong after- sales support. Cost containment has also caused a migration of the decision making function with respect to supply acquisition from the clinician to the administrator. As clinicians lose influence and purchasing agents, materials managers and upper level management become more involved in the purchasing decision, a greater emphasis is placed on price relative to product features and clinical benefits. As a result of cost containment, health care is increasingly provided outside of traditional hospital settings through alternate health care sites, such as outpatient surgery centers, long-term care facilities, physician offices and 2 patients' homes. Growth of the alternate site market is also attributable to advances in technology that have facilitated the delivery of care outside of the hospital, an increased number of illnesses and diseases considered to be treatable outside of the hospital and increased acceptance by the medical community of, and patient preference for, non-hospital treatment. Products The Company manufactures and markets products for use in respiratory care and anesthesia. The products for each market are similar and often overlap, as do the distribution channels. The Company groups its products into nine categories: (i) oxygen delivery; (ii) aerosol therapy; (iii) active and passive humidification; (iv) ventilatory support; (v) adaptors, connectors and filters; (vi) resuscitation; (vii) airway management; (viii) electronic monitoring; and (ix) durable equipment.
Category/Products Description - -------------------------------------- ---------------------------------------------- Oxygen Delivery: Oxygen Masks, Oxygen Used to deliver therapeutic, supplemental Cannulae, Oxygen Tubing oxygen to a patient. Oxygen masks cover the nose and mouth. Nasal cannulae fit inside the nostrils. Both masks and cannulae are connected to an oxygen source via small diameter tubing through which oxygen flows. Aerosol Therapy: AQUAPAK(R) Large Used to create and deliver aerosolized Volume, Prefilled Nebulizers; particles of liquid water, sodium chloride or Non-Prefilled Large Volume Nebulizer; medication to the patient's airways to dilute UPDRAFT(R), UPDRAFT II(R), AVA-NEB(R) and mobilize secretions and/or dilate and MICRO MIST(R) Small Volume, constricted breathing passages. The peak Medication Nebulizers; Aerosol Tubing; flow meter is used to monitor the patient's AQUATHERM(R) and THERMAGARD(R) respiratory status before and after an Nebulizer Heaters; AQUAPAK Prefilled aerosolized medication treatment. Ultrasonic Cups; ADDIPAK(R) Prefilled Unit Dose Solutions; POCKETPEAK(R) Peak Flow Meter Active and Passive Humidification: Heated humidification systems actively heat CONCHATHERM(R) Heated Humidifiers, and humidify oxygen/air mixtures or AQUA+(R) Hygroscopic Condenser anesthetic gases provided by a mechanical Humidifiers, AQUAPAK Prefilled ventilator or anesthesia gas machine. Humidifiers, Non-Prefilled, Reusable Hygroscopic condenser humidifiers passively Humidifier, Non-Prefilled Disposable conserve the heat and humidity in the Humidifier, HUMID-HEAT(R) patient's exhaled breath for use during Heat-Moisture Exchangers inspiration. Prefilled and non-prefilled humidifiers are used to add water vapor to oxygen being provided to a patient via a mask or cannula. Ventilatory Support: Conventional Used to convey an oxygen/air mixture and/or Ventilator Circuits, Heated-Wire anesthetic gas from a mechanical ventilator Ventilator Circuits, Anesthesia or anesthesia gas machine to a patient during Breathing Circuits, Air Cushion the temporary or long-term support of Anesthesia Masks, Infant CPAP Systems ventilation. The infant CPAP system provides non-invasive respiratory support to premature infants with under-developed, immature lungs.
3
Category/Products Description - -------------------------------------- ---------------------------------------------- Adaptors, Connectors and Filters: A The adaptors and connectors are frequently wide variety of adaptors and used in respiratory care and anesthesia to connectors; Main Flow Bacterial/Viral add accessories, modify configurations, Filters; Pulmonary Function Filter and/or customize other related products to meet specific needs. Filters are used to protect patients, caregivers, and medical equipment from cross-contamination with bacteria and viruses. Resuscitation: LIFESAVER(R) Reusable Used during cardiopulmonary resuscitation and Disposable Resuscitation Bags, ("CPR") to adequately support and/or maintain Isolation Valves and Kits, LIFESAVER the patient's ventilatory function. Tubes and Kits Airway Management: SOFTECH(R) Cuffed Assist in securing and maintaining an open and Uncuffed Endotracheal Tubes; airway and unobstructed breathing passage. CATH-GUIDE(R), Color-Coded and They also can assure that the patient's DUAL-CHANNEL Oral Pharyngeal Airways; ventilation can be maintained and that BITEGARD(TM) Oral Bite Block; CATH-GUIDE respiratory secretions can be adequately Closed Suction Catheters; VOLDYNE(R) removed from the lungs. and TRI-FLO(R) Incentive Breathing Exercisers Electronic Monitoring: Replacement The oxygen sensors, monitors and analyzers oxygen sensors, Oxygen Monitors and are used to analyze and monitor the amount of Analyzers, VENTILARM II(R) oxygen being administered to a patient. The Low-Pressure Alarms low-pressure alarm is used to detect a patient disconnect or a leak in the breathing circuit during mechanical ventilation. Durable Equipment: Oxygen Regulators; Used to regulate oxygen flow from cylinders, Cylinder Carts, Trucks and Stands; stabilize or transport oxygen or other gas Portable Oxygen Units cylinders, and provide a portable oxygen supply for emergency use.
Sales, Marketing and Distribution The Company has sales offices in Temecula, Sweden and Germany. While substantially all of the Company's domestic hospital sales are made to distributors, the Company's marketing efforts are focused on the health care service provider. In the alternate site market, the Company both sells and markets directly to the service provider. The Company's five largest alternate site accounts are Gulf South Medical Supply, Inc., Medline Industries, Inc., Moore Medical Corp., Redline Healthcare Corp. and VGM & Associates. Internationally, the Company sells its products to distributors that market to hospitals and other health care providers. See Note 10 to "Item 8. Financial Statements" for information with respect to international sales. The Company's sales personnel currently call on approximately 2,800 health care providers, 50 hospital distributors and 1,500 alternate site customers. Due to consolidation and cost pressures among the Company's customer base, the Company's target call point at the health care provider has been moving away from the clinician to include a purchasing manager or corporate executive. As of December 31, 1999, the Company had a sales backlog of approximately $2.6 million. 4 In the current market environment, GPO relationships are an essential part of access to the Company's target markets and the Company has entered into preferred supplier arrangements with 11 national GPOs. The Company is typically positioned as either a sole supplier of respiratory care disposables to the GPO, or as one of two suppliers. While these arrangements set forth pricing and terms for various levels of purchasing, they do not obligate either party to purchase or sell a specific amount of product. In addition, GPO affiliated hospitals often purchase products from other suppliers notwithstanding the existence of sole or dual source GPO arrangements. Further, these arrangements are terminable at any time, but in practice usually run for two to three years. The Company enjoys longer terms with two of its major GPOs, Novation LLC (which represents the 1998 consolidation of VHA, Inc. and University HealthSystem Consortium) and Columbia/HCA Healthcare Corporation. The Company's most significant GPO relationships are with AmeriNet Inc., Columbia/HCA Healthcare Corporation, Health Services Corporation of America, MedEcon Medical Services, Novation LLC and Purchase Connection Limited. Health care providers have responded to pressures to reduce their costs by merging with other members of their industry. The acquisition of a customer of the Company often results in the renegotiation of contracts, the granting of price concessions or in the loss of the customer. Alternatively, to the extent a customer of the Company grows through acquisition activity, the Company may benefit from increased sales to the larger entity. The Company markets its products primarily through consultative dialogue with health care providers, targeted print advertising, trade shows, selective promotional arrangements with distributors and the Company's heater lease program. To support sales of the entire line of humidification and ventilation products, the Company leases heaters to domestic customers without charge. The revenues from the sale of products used in connection with the operation of the heaters covers the amortization of the heater cost under the leases. The Company has heaters with a net book value of approximately $1.1 million placed at service provider locations under this program. The Company utilizes a network of over 3,000 hospital distributors, as well as additional alternate site distributors, to reach its markets. A number of these distributors carry competing product lines, but many are moving to select single supply sources for particular product groups. The Company has been selected as the FOCUS preferred vendor of respiratory disposables for Owens & Minor Inc. Such status gives preference to the shipping of the Company's products versus competing lines. Owens & Minor Inc. is the Company's largest distributor, accounting for approximately $24.5 million or approximately 19.0% of total fiscal 1999 net sales. The Company is seeking FOCUS status with its second largest distributor, McKesson General Medical, Inc. ("McKesson"). McKesson accounted for approximately $14.8 million or approximately 11.5% of total fiscal 1999 net sales. The Company provides a price list to its distributors which details base acquisition prices. Distributors receive orders from the service providers and charge the contract pricing (which is determined by their GPO affiliation or individual contract price) plus a service margin. As is customary within the industry, the Company rebates the difference between base acquisition price and the specific contract price to the distributor. The Company offers select large health care providers a reward for purchasing a broader selection of the Company's product lines. The program allows a rebate in the form of merchandise credit for purchasing minimum volumes from a selected group of products. The Company's international distributors place their orders directly with dedicated international customer service representatives based in Temecula. Customer orders are shipped from one of two warehouse locations. Sales strategies and marketing plans are tailored to each market with involvement of the distributor. Region and territory sales managers are responsible for the launch of products into their regions, including related support and training. The Company utilizes a network of 100 international distributors, typically on an exclusive basis within each market. Manufacturing and Assembly The Company operates two manufacturing facilities and two distribution facilities in the United States and assembly facilities in Ensenada, Mexico and Kuala-Lumpur, Malaysia. While the Company believes that it is operating at a high utilization rate, existing facilities could support increased capacity with additional machinery and workers. The Company's manufacturing facility in Temecula, California houses 76 injection molding machines, 67 of which are automated. During the past five years, 38 out of the 76 machines have been replaced with more efficient 5 models, which has increased capacity. Tubing is produced on 11 extrusion lines: 6 corrugated, 4 oxygen or "spaghetti," and 1 repellitizer/regrinder. The Temecula facility uses 12-14 million pounds of over 30 different kinds of resin annually; the most prominent are PVC, polyethylene and polypropylene. Sterile prefilled humidification and nebulization products and electronics are manufactured using 9 blow/fill/seal machines in the Company's facility in Arlington Heights, Illinois. The Company's facility located in Ensenada, Mexico is primarily used for the assembly of certain products molded at the Temecula facility. The facility is a maquiladora, and therefore there are minimal tariffs associated with the transport of products and components across the United States-Mexico border. The Company's facility located in Kuala-Lumpur, Malaysia assembles virtually all of the products marketed by the LGAB operation. The components assembled by the Malaysian operation are generally molded by outside vendors in Malaysia. The Company occasionally outsources production of certain products while it establishes its ability to penetrate a target market. Having achieved an acceptable level of penetration, the Company internalizes the manufacturing function in order to increase margins and improve quality control. The Company monitors the quality of its products at the Temecula, Arlington Heights, Ensenada and Malaysia facilities by statistical sampling and visual and dimensional inspection. The Company also inspects incoming raw materials for inconsistencies, rating its vendors on quality and delivery time. The Company is routinely audited by the FDA and has received no significant regulatory actions. The Company is in substantial compliance with the GMP/QSR regulations of the FDA and the United States and Mexico operations have qualified for an "advanced notification" program allowing the Company to be informed of FDA inspections in advance. The Company utilizes outside facilities for sterilization of products produced in Temecula and Ensenada. The Arlington Heights products are manufactured in a sterile environment and are certified sterile as a result of the production process. The Ensenada and Arlington Heights facilities are certified as ISO 9002 compliant and the Temecula facility is certified as ISO 9001 compliant. Suppliers and Raw Materials The Company's primary raw materials are various resins, which are formed into the Company's products. The top 10 purchased products in 1999 were Tubing Grade PVC, Clear PVC, LDPE-EVA, Polypropylene, Aluminum Cylinder, Pre-Cut Elastic, Non-Tubing Grade PVC, Cannula Blanks, Acrylic Resin and Hose-End Grade PVC. The Company believes that it is able to purchase materials at a cost no higher than its competitors. The Company does not have long-term supply contracts for any of its purchased raw materials. The Company believes that sufficient availability exists for its raw materials, as they consist of mainly readily available plastic resins. Research and Development The Company's research and development department consists of 17 people, including 11 engineers. The Company's research and development efforts are split between developing new products and process improvements to its manufacturing operations. The Company develops new products to expand its product line in anticipation of changes in demand. The Company has invested heavily in the anesthesia product line, as the Company continues to penetrate this market. The Company makes several new product introductions every year. Significant products introduced in the last five years include the line of heat- moisture exchangers, POCKETPEAK peak flow meter, SOFTECH endotracheal tubes, MICRO MIST small volume nebulizer and CONCHA IV heated humidification system. The Company constantly works to reduce costs through improved continued process improvements. The Company incurred research and development expenses of approximately $1.1 million, $1.0 million and $2.0 million in fiscal 1997, 1998 and 1999, respectively. 6 Competition The medical supply industry is characterized by intense competition. The Company's primary competitor in the respiratory care sector is Allegiance Corporation and its primary competitors in the anesthesia sector include Allegiance Corporation, The Kendall Company, Smiths Industries Medical Systems, Inc. and Vital Signs, Inc. Many of the products manufactured by the Company are available from several sources, and many of the Company's customers tend to have relationships with several manufacturers. The Company competes on the basis of brand name, product quality, breadth of product line, service and price. Patents and Trademarks The Company has historically relied primarily on its technological and engineering abilities and on its design and production capabilities to gain competitive business advantages, rather than on patents or other intellectual property rights. However, the Company does file patent applications on concepts and processes developed by the Company's personnel. The Company has 20 patents in the U.S. Many of the U.S. patents have corresponding patents issued in Canada, Europe and various Asian countries. The Company's success will depend in part on its ability to maintain its patents, add to them where appropriate, and develop new products and applications without infringing the patent and other proprietary rights of third parties and without breaching or otherwise losing rights in technology licenses obtained by the Company for other products. There can be no assurance that any patent owned by the Company will not be circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with claims of the scope sought by the Company, if at all. If challenged, there can be no assurance that the Company's patents (or patents under which it licenses technology) will be held valid or enforceable. In addition, there can be no assurance that the Company's products or proprietary rights do not infringe the rights of third parties. If such infringement were established, the Company could be required to pay damages, enter into royalty or licensing agreements on onerous terms and/or be enjoined from making, using or selling the infringing product. Any of the foregoing could have a material adverse effect upon the Company's business, financial condition or results of operations. Government Regulation and Environmental Matters The Company and its customers and suppliers are subject to extensive Federal and state regulation in the United States, as well as regulation by foreign governments, and the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company. Most of the Company's products are subject to government regulation in the United States and other countries. In the United States, the FDC Act and other statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, marketing, advertising and promotion of such products. Failure to comply with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution. Under the FDC Act and similar foreign laws, the Company, as a marketer, distributor and manufacturer of health care products, is required to obtain the clearance or approval of Federal and foreign governmental agencies, including the FDA, prior to marketing, distributing and manufacturing certain of those products. The Company may also need to obtain FDA clearance before modifying marketed products or making new promotional claims. Delays in receipt of or failure to receive required approvals or clearances, the loss of previously received approvals or clearances, or failures to comply with existing or future regulatory requirements in the United States or in foreign countries could have a material adverse effect on the Company's business. Foreign sales are subject to similar requirements. The Company is required to comply with the FDA's GMP/QSR Regulations, which set forth requirements for, among other things, the Company's manufacturing process, design control and associated record keeping, including testing and sterility. Further, the Company's plants and operations are subject to review and inspection by local, state, Federal and foreign governmental entities. The distribution of the Company's products may also be subject to state regulation. The impact of FDA regulation on the Company has increased in recent years as the Company has increased 7 its manufacturing operations. The Company's suppliers, including the sterilizer facilities, are also subject to similar governmental requirements. There can be no assurance that changes to current regulations or additional regulations imposed by the FDA will not have an adverse impact on the Company's business and financial condition in the future. The FDA also has the authority to issue special controls for devices manufactured by the Company, which it has not done to date. In the event that such special controls were issued, the Company's products would be required to conform, which could result in significant additional expenditures for the Company. The Company is also subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or infectious materials or substances and emissions of air pollutants. The Company owns and leases properties which are subject to environmental laws and regulations. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition or results of operations. In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company. Employees As of March 15, 2000, the Company employed approximately 1,950 employees, substantially all of whom were full-time employees. None of the Company's employees is represented by unions and the Company considers its employee relations to be good. Item 2. Properties. The Company owns approximately 30 acres of land in Temecula, California on which its headquarters, one of two principal manufacturing centers and three other buildings totaling approximately 245,000 square feet are located. Plastic and vinyl components and corrugated tubing are manufactured in Temecula and assembled into finished goods at a 77,000 square foot facility in Ensenada, Mexico. The Company owns the Ensenada facility and the underlying land is held in a 30-year trust that expires in 2019. The Company leases an 86,000 square foot manufacturing facility in Arlington Heights, Illinois under a lease that expires in 2000. Prefilled sterile solutions and electronics are manufactured in Arlington Heights. The Company also leases a 73,000 square foot distribution warehouse in Elk Grove, Illinois under a lease that expires in 2000, and a 25,375 square foot distribution facility in Atlanta, Georgia under a lease that expires in April 2001. The Company leases sales and marketing offices in Stockholm, Sweden and Lohman, Germany under leases that expire in April 2001 and April 2002, respectively. The Company also leases a 33,260 square foot facility in Kuala-Lumpur, Malaysia, under a lease that expires in July 2001. This facility primarily assembles finished products for the Swedish operation. The Company believes that its current facilities are adequate for its present level of operations. Management expects that the Arlington Heights and Elk Grove leases will be renewed on favorable terms. Item 3. Legal Proceedings. The Company is party to lawsuits and other proceedings, including suits relating to product liability and patent infringement. While the results of such lawsuits and other proceedings cannot be predicted with certainty, management does not expect that the ultimate liabilities, if any, will have a material adverse effect on the financial position or results of operations of the Company. 8 Item 4. Submissions of Matters to a Vote of Security Holders. None. 9 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. There is no established public trading market for the Company's Common Stock. As of March 30, 2000, Holding has 16 record holders of its Common Stock. Holding has not paid cash dividends to its shareholders in the past two years, and does not intend to pay cash dividends in the foreseeable future. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results Operations--Liquidity and Capital Resources" for a discussion of restrictions on Holding's ability to pay cash dividends. Item 6. Selected Financial Data. The selected fiscal year end historical financial data has been derived from the audited financial statements of the Company and Holding. The information contained in this table should be read in conjunction with the Company's audited consolidated financial statements and notes thereto.
River Holding Corp.(a) Hudson Respiratory Care --------------------------- ------------------------------------------------------ Fiscal Year ------------------------------------------------------ 1998 (As Restated; See Note 15 to the Inception Audited to Financial 12/25/98 1999 1995 1996 1997 Statements) 1999(b) ---------- -------- -------- --------- --------- ------------ -------- (dollars in thousands) Operating Data: Net sales................................. $ 76,232 $128,803 $ 86,825 $ 93,842 $ 99,509 $ 100,498 $128,803 Cost of sales............................. 44,662 77,678 49,896 52,189 54,575 56,802 75,418 ---------- -------- -------- --------- --------- --------- -------- Gross profit.............................. 31,570 51,125 36,929 41,653 44,934 43,696 53,385 Operating expenses: Selling expenses.......................... 8,032 13,122 8,283 8,961 9,643 10,350 13,122 Distribution expenses..................... 2,471 4,647 3,088 3,114 3,170 3,336 4,647 General and administrative expenses....... 7,129 14,732 9,769 11,277 11,456 10,284 14,732 Research and development expenses......... 726 2,031 1,257 1,184 1,072 976 2,031 Amortization of goodwill.................. 3,785 5,080 -- -- -- -- -- Provision for equity participation plan... -- -- 11,415 8,249 6,954 63,939 -- Provision for retention payments.......... -- -- -- -- -- 4,754(c) -- ---------- -------- -------- --------- --------- --------- -------- Operating income (loss)................... $ 9,427 $ 11,513 $ 3,117 $ 8,868 $ 12,639 $ (49,943) $ 18,853 Other (income) and expenses: Interest expense.......................... 11,100 17,263 2,424 2,177 1,834 11,327 17,263 Other (income) expense.................... (99) 1,322 811 (463) (638) 406 1,232 ---------- -------- -------- --------- --------- --------- -------- Total other expense....................... 11,001 18,595 3,235 1,714 1,196 11,733 18,495 ---------- -------- -------- --------- --------- --------- -------- Income (loss) before provision (benefit) for income taxes....................... (1,574) (7,082) (118) 7,154 11,443 (61,676) 358 Provision (benefit) for income taxes...... (614) (1,508) 280 73 150 8,405 1,586 ---------- -------- -------- --------- --------- --------- -------- Income (loss) before extraordinary item... (960) (5,574) (398) 7,081 11,293 (70,081) (1,228) Extraordinary item (loss on extinguishment of debt)................ -- -- -- -- -- 104(d) -- ---------- -------- -------- --------- --------- --------- -------- Net income (loss)......................... $ (960) $ (5,083) $ (398) $ 7,081 $ 11,293 $ (70,185) $(1,228) ========== ======== ======== ========= ========= ========= ========
continued on following page 10
River Holding Corp.(a) Hudson Respiratory Care --------------------- ------------------------------------------------------ Fiscal Year ------------------------------------------------------ 1998 (As Restated; See Note 15 to the Inception Audited to Financial 12/25/98 1999 1995 1996 1997 Statements) 1999(b) ---------- -------- -------- --------- --------- ------------ -------- (dollars in thousands) Other Financial Data: Net cash provided by (used in) operating activities............................. $ 3,854 $ 7,097 $ 15,939 $ 16,133 $ 19,269 $ (83,024) $ 7,097 Net cash used in investing activities..... $ (254,472) $(75,818) $ (6,088) $ (11,354) $ (3,673) $ (6,444) $(75,818) Net cash provided by (used in) financing activities............................. $ 251,125 $ 71,529 $(11,880) $ (3,668) $ (16,398) $ 89,624 $ 71,529 Adjusted EBITDA(e)........................ $ 17,934 $ 29,993 $ 21,205 $ 23,194 $ 25,440 $ 24,851 $ 29,993 Adjusted EBITDA margin(f)................. 23.5% 23.3% 24.4% 24.7% 25.6% 24.7% 23.3% Operating margin before EPP and Retention Payments(g)............................ 12.4% 8.9% 16.7% 18.2% 19.7% 18.7% 14.6% Depreciation and amortization(h).......... $ 8,507 $ 15,655 $ 6,820 $ 6,133 $ 5,847 $ 6,101 $ 8,315 Capital expenditures...................... $ 3,120 $ 10,973 $ 5,850 $ 6,395 $ 4,659 $ 3,111 $ 10,973 Ratio of Adjusted EBITDA to cash interest expense................................ 2.1x 1.7x 8.7x 10.7x 13.9x 2.3x 2.1x Ratio of total debt to Adjusted EBITDA.... 8.9x 7.1x 1.2x 1.2x 0.8x 6.4x 7.1x Ratio of earnings to fixed charges(i)..... (0.1)x -- 1.0x 3.7x 6.0x -- 1.0x Deficiency of earnings to cover fixed charges................................... $ (12,852) (7,082) -- -- -- $ (61,676) -- Ratio of earnings to fixed charges and preferred stock dividends(j)........... -- -- 1.0x 3.7x 6.0x -- -- Deficiency of earnings to cover fixed charges and preferred stock dividends.. $ (5,761) $ (13,597) -- -- -- $ (65,863) $ (6,160) Balance Sheet Data: Working capital........................... $ 29,865 $ 36,204 $ 18,641 $ 24,188 $ 6,430 $ 29,533 $ 35,971 Working capital as adjusted(k)............ 32,358 39,960 22,461 26,768 29,960 32,026 39,727 Total assets.............................. 262,709 344,961 64,387 76,910 77,554 165,321 251,819 Total debt................................ 159,000 211,694 25,364 28,146 20,250 159,000 211,694 Shareholders' equity (deficit)............ 59,653 (12,957) 19,112 19,872 22,515 (37,735) (14,649)
- ---------------------- (a) Holding was formed to effect the Recapitalization. Accordingly, operating data for 1998 presented for Holding is for the period from April 7, 1998 to December 25, 1998. Holding accounted for the acquisition of the Company using the purchase method of accounting, which was not pushed down to the accounts of the Company. Accordingly, the carrying amounts of certain assets and liabilities on the financial statements of Holding differ substantially when compared to those of the Company. All financial covenants are calculated using the Company's accounts, and, accordingly, no such comparative amounts for Holding are presented. (b) Includes results of operations for (i) LGAB, since it was acquired in July 1999, (ii) Medimex, since certain of its assets were acquired in October 1999 and (iii) Tyco, since certain of its assets were acquired in November 1999. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments." (c) Reflects retention payments made to substantially every employee of the Company in connection with the Recapitalization. These payments were intended to ensure the continued employment of all employees after the Recapitalization and no future payments are anticipated. (d) Reflects the write-off of deferred financing fees related to the payoff of outstanding debt under the Company's previous credit agreement. (e) Adjusted EBITDA represents income before depreciation and amortization, interest expense, income tax expense, charges related to the Equity Participation Plan, which was terminated upon consummation of the Recapitalization 11 and recognition of the portion of purchase price allocation related to acquired inventories. The Company has excluded payments under the Equity Participation Plan to present comparable figures for all historical periods presented. Adjusted EBITDA is not a measure of performance under generally accepted accounting principles, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with generally accepted accounting principles, or as a measure of profitability or liquidity. The Company has included information concerning Adjusted EBITDA as one measure of an issuer's historical ability to service debt. In addition, certain covenants in the Indenture are based upon a calculation analogous to Adjusted EBITDA. Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, income from operations or cash flow as an indication of the Hudson RCI's operating performance. For purposes of compliance with the Indenture, the Company's Consolidated Net Income and EBITDA will not be reduced by retention payments, payments made pursuant to the Equity Participation Plan or by the amount of any contingent payments made by the Company to former participants in the Equity Participation Plan. See "Certain Relationships and Related Transactions." (f) Represents ratio of Adjusted EBITDA to net sales. (g) Represents ratio of operating income before EPP and retention payments to net sales. (h) Includes amortization of deferred financing fees of $0.1 million in 1995 and $0.1 million in 1996, which should be excluded from depreciation and amortization in calculating Adjusted EBITDA since such fees are reflected below the operating income line. (i) For the purpose of determining the ratio of earnings to fixed charges, earnings consist of earnings before income taxes and fixed charges. Fixed charges consist of interest on indebtedness, the amortization of debt issue costs and that portion of operating rental expense representative of the interest factor. (j) For the purpose of determining the ratio of earnings to fixed charges and preferred stock dividends, earnings consist of earnings before income taxes and fixed charges. Fixed charges consist of interest on indebtedness, the amortization of debt issue costs and that portion of operating rental expense representative of the interest factor. Preferred stock dividends, consisting of amounts to be paid-in-kind, are also included in the pro forma fixed charge amounts. Preferred stock dividends have been "grossed up" to a pre-income tax basis to provide comparability to other components of the ratio. (k) Working capital as adjusted represents current assets, excluding cash, less current liabilities, excluding the current portion of long-term debt. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation. Because Holding is a holding company with no operations, the following discussion relates primarily to the Company. The following discussion of the Company's consolidated historical results of operations and financial condition should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included elsewhere in this Form 10-K. The following discussion and analysis includes periods before completion of the Recapitalization. General The Company has increased its net sales and improved its position within the disposable health care products market in recent years by increasing its respiratory care product offering, introducing disposable products for the anesthesia health care market, expanding its presence in international markets and establishing a position in the growing alternate site market. The Company's results of operations may fluctuate significantly from quarter to quarter as a result of a number of factors, including, among others, the buying patterns of the Company's distributors, GPOs and other purchasers of the Company's products, forecasts regarding the severity of the annual cold and flu season, announcements of new product introductions by the Company or its competitors, changes in the Company's pricing of its products and the prices offered by the Company's competitors, rate of overhead absorption due to variability in production levels and variability in the number of shipping days in a given quarter. 12 Recent Developments On November 8, 1999, the Company acquired certain assets of Tyco Healthcare Group LP ("Tyco"), including Tyco's incentive breathing exerciser and pulmonary function monitor product lines, for a cash purchase price of approximately $23.8 million. The Tyco acquisition was funded principally with proceeds from the Company's $60.0 million revolving line of credit. On October 8, 1999, the Company acquired certain assets of Medimex, a German distribution company that had previously distributed products for both the Company and LGAB, for a cash purchase price of $2.2 million. The assets were acquired through the Company's wholly-owned, non-guarantor subsidiary, HRCDAC Inc., and was funded with cash on hand. On July 22, 1999, the Company, through its indirect, wholly-owned subsidiary Steamer Holding AB, a company organized under the laws of Sweden ("Steamer"), acquired a majority of the outstanding capital stock of LGAB, a company organized under the laws of Sweden. Pursuant to a series of private purchases and a tender offer consummated pursuant to Swedish law, Steamer acquired 604,000 shares of Class A stock and 2,452,838 shares of Class B stock representing approximately 82.0% of the capital and 62.8% of the voting power of LGAB at a price of 115 Swedish krona (approximately $13.60 at the July 22 exchange rate) per share of Class A stock and Class B stock for an aggregate cash purchase price of approximately $45.5 million. In addition, on August 4, 1999, Steamer acquired an additional 483,750 shares of Class A stock of LGAB from River Holding Corp., a Delaware corporation and the parent of Steamer and the Company ("Holding"), which shares Holding acquired in a private transaction in exchange for 525,042 shares of common stock of Holding ("Holding Common Stock"). The exchange ratio for the Class A stock was the same as the effective price per share of the shares acquired in the tender offer. After giving effect to this exchange and the conversion of the Series A stock acquired by Steamer in the tender offer into Series B stock, Steamer holds approximately 99.0% of the capital and 100.0% of the voting power of LGAB. The Company intends that Steamer, through continuing purchases and a statutory freezeout and appraisal procedure under Swedish law, will acquire the remaining outstanding shares of LGAB as soon as practicable. The cash for the purchase price and certain related transaction costs was funded with (i) $22.0 million in gross proceeds from the sale of Holding Common Stock to the majority stockholder of Holding, (ii) a $22.0 million loan from the majority stockholder of Holding to Steamer's parent, HRC Holding Inc., a Delaware corporation and a wholly-owned subsidiary of the Company, and (iii) the funding of 50 million Swedish krona (approximately $5.9 million) pursuant to the terms of a loan facility agreement between Steamer and Svenska Handelsbanken AB. Founded in 1954, LGAB develops, manufactures and markets medical device products which humidify, heat and filter a patient's breathing gases during anesthesia and intensive care. LGAB is a market leader in the area of "heat moisture exchange" ("HME") products, with approximately 25% share of the world market. Following completion of the acquisition, the Company intends to continue LGAB's operations in substantially the same manner as conducted prior to the acquisition. In September 1998, the Company acquired certain assets of Gibeck, Inc., a subsidiary of LGAB, for approximately $3.35 million. Prior to the transaction, Gibeck, Inc. was engaged primarily in the business of manufacturing, marketing and selling disposable anesthesia supplies. In conjunction with that transaction, the Company became the exclusive North American distributor of LGAB's HME product line. In fiscal year 1997, Gibeck, Inc. reported net sales of approximately $12.3 million. The Company established a sales office located in Germany in the second quarter of 1999. It is anticipated that this operation will better equip the Company to more aggressively pursue the German market. The German operation had a negative impact on the Company's results of approximately $1.3 million in fiscal 1999. It is anticipated that the Company's earnings will be positively impacted for fiscal 2000 and beyond. 13 The Recapitalization On April 7, 1998, Hudson RCI consummated its Recapitalization pursuant to an Agreement and Plan of Merger pursuant to which River Acquisition Corp., a wholly-owned subsidiary of Holding merged with and into Hudson RCI, with Hudson RCI surviving as a majority-owned subsidiary of Holding (the "Merger"). Pursuant to the Recapitalization, Holding contributed approximately $93.0 million in equity capital into Hudson RCI (the "Holding Equity Investment") and a shareholder of Hudson RCI (the "Continuing Shareholder") retained common stock of Hudson RCI ("HCRI Common Stock") with a value of approximately $15.0 million (the "Rollover Equity"), based on the valuation of Hudson RCI used in the Recapitalization. In the Merger, a portion of the HRCI Common Stock was converted into the right to receive approximately $131.1 million in cash, and management received $88.3 million pursuant to the Company's Equity Participation Plan (the "Equity Participation Plan" or "EPP"). Following the Holding Equity Investment, Holding owned 80.8% of the outstanding HRCI Common Stock and the Continuing Shareholder owned the remaining 19.2%. The Holding Equity Investment was comprised of $63.0 million of common equity (the "Common Stock Investment") and $30.0 million of preferred equity (the "Preferred Stock Investment"). The Common Stock Investment was funded with a $55.0 million investment by affiliates of Freeman Spogli & Co. Incorporated ("Freeman Spogli"), and an $8.0 million investment by management of Hudson RCI. The Preferred Stock Investment was funded with proceeds from the sale of 11-1/2% Senior Exchangeable PIK Preferred Stock due 2010 (the "Holding Preferred Stock") with an aggregate liquidation preference of $30.0 million offered by Holding (the "Preferred Stock Offering"). Immediately following consummation of the Recapitalization, Freeman Spogli beneficially owned approximately 87.3% of the outstanding Holding Common Stock and management owned the remaining 12.7%. In connection with the Recapitalization and concurrently with the Preferred Stock Offering, Hudson RCI offered $115.0 million aggregate principal amount of 9-1/8% Senior Subordinated Notes due 2008 (the "Subordinated Notes") (the "Subordinated Notes Offering," and together with the Preferred Stock Offering, the "Offerings"). On April 7, 1998, Hudson RCI entered into an agreement (the "Credit Facility") providing for a $40.0 million secured term loan facility (the "Term Loan Facility"), which was funded in connection with the consummation of the Recapitalization, and a $60.0 million revolving loan facility (the "Revolving Loan Facility") which will be available for Hudson RCI's future capital requirements and to finance acquisitions. The Offerings and the application of the net proceeds therefrom, repayment of existing Hudson RCI debt payments to the Continuing Shareholder under the Recapitalization Agreement and to management, the Holding Equity Investment and the related borrowings under the Credit Facility are collectively referred to herein as the "Recapitalization." The Company and the shareholders that received distributions in the Recapitalization made an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended, to treat the Recapitalization as an asset purchase for tax purposes, which had the effect of significantly increasing the basis of the Company's assets, thus increasing depreciation and amortization expenses and other deductions for tax purposes and reducing the Company's taxable income in 1998 and subsequent years. The Recapitalization resulted in no change in the basis of the Company's assets and liabilities for financial reporting purposes. A deferred tax asset was recorded upon the Company's conversion from a Subchapter S corporation to a Subchapter C corporation, primarily resulting from the Section 338(h)(10) election. 14 Results of Operations The following tables set forth, for the periods indicated, certain income and expense items expressed in dollars and as a percentage of the Company's net sales.
Fiscal Year ----------------------------------------------- 1997 1998 1999 ---- ---- ---- (dollars in thousands) Net sales............................................................ $99,509 $100,498 $128,803 Cost of sales........................................................ 54,575 56,802 75,418 ------- -------- -------- Gross profit....................................................... 44,934 43,696 53,385 ------- -------- -------- Selling expenses..................................................... 9,643 10,350 13,122 Distribution expenses................................................ 3,170 3,336 4,647 General and administrative expenses.................................. 11,456 10,284 14,732 Research and development expenses.................................... 1,072 976 2,031 Provision for equity participation plan.............................. 6,954 63,939 -- Provision for retention payments..................................... -- 4,754 -- ------- -------- -------- Total operating expenses............................................. 35,138 96,921 34,532 ------- -------- -------- Operating income (loss).............................................. 12,639 (49,943) 18,853 Add back: Provision for equity participation plan.................... 6,954 63,939 -- Add back: Provision for retention payments........................... -- 4,754 -- ------- -------- -------- Operating income before provision for equity participation plan and $19,593 $ 18,750 $ 18,853 provision for retention payments.................................... ======= ======== ========
15
Fiscal Year -------------------------------------------- 1997 1998 1999 ---- ---- ---- Net sales............................................................ 100.0% 100.0% 100.0% Cost of sales........................................................ 54.8 56.5 58.5 ------- -------- -------- Gross profit....................................................... 45.2 43.5 41.4 ------- -------- -------- Selling expenses..................................................... 9.7 10.3 10.2 Distribution expenses................................................ 3.2 3.3 3.6 General and administrative expenses.................................. 11.5 10.2 11.4 Research and development expenses.................................... 1.1 1.0 1.6 Provision for equity participation plan.............................. 7.0 63.6 -- Provision for retention payments..................................... -- 4.7 -- ------- -------- -------- Total operating expenses............................................. 35.3 96.4 26.8 ------- -------- -------- Operating income (loss).............................................. 12.7 (49.7) 14.6 Add back: Provision for equity participation plan.................... 7.0 63.6 -- Add back: Provision for retention payments........................... -- 4.7 -- ------- -------- -------- Operating income before provision for equity participation plan and 19.7% 18.7% 14.6% provision for retention payments.................................... ======= ======== ========
Year Ended December 31, 1999 Compared to Year Ended December 25, 1998 Net sales, reported net of accrued rebates, were $128.8 million in 1999, an increase of $28.3 million or 28.2% over 1998. Of the $28.3 million increase, approximately $6.1 million related to the acquisition of LGAB, $2.2 million related to the Tyco acquisition and $0.9 million related to the Medimex acquisition. In addition, the full effect in 1999 of the Gibeck, Inc. acquisition in September 1998 resulted in a sales increase of $7.6 million. For the base Hudson RCI business, domestic hospital sales increased by $3.3 million or 5.5%, due to increased demand at the hospital level, primarily the result of increased sales through certain GPOs. Alternate site sales increased by $4.4 million or 26.5% as the Company continued to focus its efforts on this growing market. International sales increased by $1.6 million or 9.1%, as growth in sales continued to Japan and Europe. This growth was partially offset by weakness in South America. Sales to customers in Southeast Asia have stabilized, remaining virtually unchanged over 1998. Canadian sales increased by approximately $0.3 million, due primarily to the efforts of a new distributor in that country. Approximately 30% of the Company's 1999 total net sales were to two distributors. The Company's gross profit for 1999 was $53.4 million, an increase of $9.7 million or 22.2% from 1998. As a percentage of net sales, the Company's gross profit was 41.4% for 1998 as compared to 43.5% for 1997. This decline was primarily due to the recognition of inventory revalued as a result of the LGAB acquisition, increased shipping costs as a result of sales of acquired Gibeck, Inc. products, and an unfavorable mix variance caused by increased sales of products at lower gross margins. This trend is expected to continue in the future if the preference for passive humidification products over higher margin active humidification products continues. This trend was partially offset by manufacturing cost reductions realized by the Company and higher gross margins of sales at LGAB. Selling expenses were $13.1 million for 1999, an increase of $2.7 million or 26.8% over 1998. This increase was due primarily to $1.2 million of costs associated with LGAB and $1.2 million as a result of the start-up of the German sales operation. In addition, sales and marketing expenses at Hudson RCI increased by approximately $0.3 million. As a percentage of net sales, selling expenses decreased to 10.2% as compared to 10.3% in 1998. 16 Distribution expenses were $4.6 million for 1999, an increase of $1.3 million or 39.0% over 1998. As a percentage of sales, distribution expenses increased to 3.6% as compared to 3.3% in 1998. The increase is primarily the result of the increased cost of freight between the Company's distribution facilities, the start up of a distribution facility in Atlanta and increased headcount. General and administrative expenses for 1999 were $14.7 million, an increase of $4.4 million or 43.3% over 1998. Of this increase, $2.0 million relates to expenses incurred at LGAB and $0.2 million as a result of the German operation. In addition, the company increased management bonuses and incurred certain non-recurring consulting expenses. As a percentage of net sales, general and administrative expenses were 11.4% in 1999 as compared to 10.2% in 1998. Research and development expenses were $2.0 million in 1999, an increase of $1.1 million or 108.2% over 1998. This increase was primarily due to the addition of LGAB research and development expenses of $0.7 million and increases in the Hudson RCI engineering staff. The provision for equity participation plan consists of accrued expenses and payments made to executives under the Equity Participation Plan. The Equity Participation Plan was terminated upon consummation of the Recapitalization and replaced with an executive stock purchase plan. See "Item 11. Executive Compensation--Stock Purchase Plan." No payments under the Equity Participation Plan were made in 1999 that were not provided for in 1998. In 1998, the provision for equity participation plan was $63.9 million, which included approximately $1.3 million in employer taxes relating to the distribution made under the Equity Participation Plan. The provision for retention payments, including related employer payroll taxes, was $4.8 million in 1998. These payments were made to substantially every employee in the Company and were intended to ensure the continued employment of all employees after the Recapitalization. No payments were made in 1999 and no future retention payments are anticipated. Interest expense was $17.3 million for 1999, an increase of $5.9 million over 1998. The increase was due to higher debt levels during 1999 as a result of the LGAB and Tyco acquisitions. Interest expense is expected to increase in 2000 reflecting a full year of interest expense at the higher debt level. Year Ended December 25, 1998 Compared to Year Ended December 26, 1997 Net sales, reported net of accrued rebates, were $100.5 million in 1998, an increase of $1.0 million or 1.0% over 1997. Domestic hospital sales declined by $3.1 million or 4.8%, due primarily to the decreased demand of $5.0 million from hospitals affiliated with the Premier GPO, as the Premier contract for respiratory supplies was awarded to a competitor in February 1997. This decline was partially offset by Gibeck sales of approximately $2.3 million. Average selling price of certain domestic hospital sales also declined slightly from 1997 to 1998 due to pricing terms of a contract entered into in 1997. Alternate site sales increased by $2.1 million or 14.4% as the Company continued to focus its efforts on this growing market. International sales increased by $1.1 million or 5.8%. Although good growth was experienced in Japan (approximately 35.0%), this was partially offset by general weakness in other parts of Southeast Asia. There is continued uncertainty in the outlook for sales in Southeast Asia in the near term. Sales in Europe were essentially flat as compared to 1997. Approximately 33% of the Company's 1998 total net sales were to two distributors. The Company's gross profit for 1998 was $43.7 million, a decline of $1.2 million or 2.7% from 1997. As a percentage of net sales, the Company's gross profit was 43.5% for 1998 as compared to 45.2% for 1997. This decline was primarily due to an unfavorable mix variance caused by increased sales of products at lower gross margins. This trend is expected to continue in the future if the preference for passive humidification products over higher margin active humidification products continues. This trend was partially offset by manufacturing cost reductions realized by the Company. 17 Selling expenses were $10.4 million for 1998, an increase of $0.7 million or 7.3% over 1997. This increase is primarily the result of higher fees paid to certain GPOs due to higher sales to their facilities. As a percentage of net sales, selling expenses increased to 10.3% as compared to 9.7% in 1997. Distribution expenses were $3.3 million for 1998, an increase of $0.1 million over 1997. As a percentage of sales, distribution expenses increased to 3.3% as compared to 3.2% in 1997. General and administrative expenses for 1998 were $10.3 million, a decrease of $1.2 million or 10.2% over 1997. This decrease is primarily the result of the elimination of certain costs associated with the Recapitalization and lower management bonuses. These declines were partially offset by legal expenses of approximately $300,000 relating to the successful defense of a patent infringement lawsuit. As a percentage of net sales, general and administrative expenses were 10.2% in 1998 as compared to 11.5% in 1997. Research and development expenses were $1.0 million in 1998 and were virtually unchanged from 1997. The provision for equity participation plan consists of accrued expenses and payments made to executives under the Equity Participation Plan. The Equity Participation Plan was terminated upon consummation of the Recapitalization and replaced with an executive stock purchase plan. See "Item 11. Executive Compensation--Stock Purchase Plan." In 1998, the provision for equity participation plan was $63.9 million, which included approximately $1.3 million in employer taxes relating to the distribution made under the Equity Participation Plan. The provision for retention payments, including related employer payroll taxes, was $4.8 million in 1998. These payments were made to substantially every employee in the Company and were intended to ensure the continued employment of all employees after the Recapitalization. No future retention payments are anticipated. Interest expense was $11.3 million for 1998, an increase of $9.5 million over 1997. The increase was due to higher debt levels during 1998 as a result of the Recapitalization. Interest expense is expected to increase in 1999 reflecting a full year of interest expense at the higher debt level. The net effect of the Company's conversion from S to C corporation status and the related Section 338(h)(10) election to increase the tax bases of assets in connection with the Recapitalization of $77.1 million was previously reflected in operations during the quarter ended June 26, 1998. This amount should have been reflected as a direct credit to retained earnings. This restatement has no impact on ending retained earnings for the periods presented. The impact of the restatement on the accompanying financial statements is as follows (amount in thousands):
As Originally Year Ended December 25, 1998 Reported Adjustments As Restated - ---------------------------- ---------- ----------- ------------ Net loss before provision for income taxes............ $(61,676) $ -- $(61,676) ======== ========== ======== Net income (loss) before extraordinary item........... $ 6,983 $(77,064) $(70,081) ======== ========== ======== Net income (loss)..................................... $ 6,879 $(77,064) $(70,185) ======== ========== ========
Seasonality The Company's results of operations exhibit some measure of seasonality. Generally, the Company's sales and EBITDA are higher in the first and fourth quarters and lower in the second and third quarters. This is due primarily to the higher incidence of breathing ailments, such as colds and flu, during the winter months, which results in increased hospitalization and respiratory care, especially among higher-risk individuals, such as infants and the elderly. Fourth quarter sales are generally the Company's highest, as distributors increase inventory in anticipation of the cold and flu seasons. First quarter results are generally affected by the length and severity of flu seasons. 18 Liquidity and Capital Resources The Company's primary sources of liquidity are cash flow from operations and borrowings under its working capital bank facility. Cash provided by operations totaled $19.3 million in 1997 and cash provided by operations before EPP payments and retention bonuses totaled $(57.2) million and $8.2 million in 1998 and 1999, respectively. The decline from 1997 to 1998 is primarily attributable to increased interest expense due to higher debt levels. The Company had operating working capital, excluding cash and short-term debt, of $30.0 million, $32.0 million and $39.7 million as of the end of fiscal 1997, 1998 and 1999, respectively. Inventories were $16.6 million, $18.0 million and $24.0 million as of the end of fiscal 1997, 1998 and 1999, respectively. In order to meet the needs of its customers, the Company must maintain inventories sufficient to permit same-day or next-day filling of most orders. Such inventories are higher than those that would be required for delayed filling of orders, thus adversely impacting liquidity. Over time, the Company expects its level of inventories to increase as the Company's sales in the international market increase. Accounts receivable, net of allowances, were $21.3 million, $25.8 million and $30.4 million at the end of fiscal 1997, 1998 and 1999, respectively. The average number of days sales in accounts receivable outstanding was approximately 85 days for 1999, compared to 84 days for 1998 and 77 days for 1997. The Company offers 30 day credit terms to its U.S. hospital distributors. Alternate site and international customers typically receive 60 to 90 day terms and, as a result, as the Company's alternate site and international sales have increased, the amount and aging of its accounts receivable have increased. The Company anticipates that the amount and aging of its accounts receivable will continue to increase. The Company established a sales office in Germany in the second quarter of 1999. While this will have the effect of increasing the Company's investment in inventories, management believes that it will also result in improved service to international customers as well as in lower international accounts receivable than would otherwise be the case because customers will receive products, and consequently pay for them, more quickly. In connection with the Recapitalization, the Company made cash payments under the Equity Participation Plan and for retention bonuses of $89.6 million in the year ended December 25, 1998, which it funded with the proceeds of the debt and equity transactions that were part of the Recapitalization. Net cash used in investing activities was $3.7 million, $6.4 million and $75.8 million in 1997, 1998 and 1999, respectively. These funds were primarily used to finance the acquisition of the custom anesthesia circuit product line in 1998, various acquisitions of businesses and for capital expenditures. Capital expenditures, consisting primarily of new manufacturing equipment purchases and expansion of the Ensenada facility, totaled $4.7 million, $3.1 million and $11.0 million in 1997, 1998 and 1999, respectively. The decrease in 1997 and 1998 resulted from temporary delays in projects that the Company completed in 1998 and 1999. The Company currently estimates that capital expenditures will be approximately $8.0 million in each of 2000 and 2001, consisting primarily of additional and replacement manufacturing equipment and new heater placements. Net cash used in financing activities was $16.4 million in 1997, which consisted primarily of repayment of debt and shareholder distributions principally to pay taxes on income passed through by the Company. Net cash provided by financing was $89.6 million in 1998, reflecting net borrowings by the Company. Net cash provided by financing activities was $71.5 million in 1999, which was used primarily to finance the LGAB and Tyco acquisitions. The Company has outstanding $211.7 million of indebtedness, consisting of $115.0 million of Subordinated Notes issued in connection with the Recapitalization, borrowings of $71.6 million under the Company's Credit Facility entered into in connection with the Recapitalization and $7.5 million in notes payable to affiliates. In addition, LGAB has $17.6 million in outstanding borrowings under its bank facility. The Credit Facility consists of a $40.0 million Term Loan Facility (all of which was funded in connection with the Recapitalization) and a $60.0 million Revolving Loan Facility. The Revolving Loan Facility has a letter of credit sublimit of $7.5 million. The Term Loan Facility matures on the sixth anniversary of the initial borrowing and, commencing June 30, 1999, requires quarterly principal installments of $3.0 million in 1999, $4.0 million in 2000, $7.0 million in 2001, $9.0 million in 2002, $11.0 million in 2003, and $10.0 million in 2004. The Revolving Loan Facility matures on the sixth anniversary of the initial borrowing. The interest rate under the Credit Facility is based, at the option of the Company, upon either a Eurodollar rate plus 2.50% per annum or a base rate (as defined) plus 1.50% 19 per annum, each less an applicable pricing adjustment (as defined). Borrowings under the Credit Facility are required to be prepaid, subject to certain exceptions, with (i) 75% (or 50% for years when the Company's ratio of Debt to EBITDA (as defined) is less than 5:1) of Excess Cash Flow (as defined), (ii) 50% of the net cash proceeds of an equity issuance by the Company in connection with an initial public offering or 100% of the net cash proceeds of an equity issuance by the Company other than in connection with an initial public offering, (iii) 100% of the net cash proceeds of the sale or other disposition of any properties or assets of Holding and its subsidiaries (subject to certain exceptions), (iv) 100% of the net proceeds of certain issuances of debt obligations of Hudson RCI and its subsidiaries and (v) 100% of the net proceeds from insurance recoveries and condemnations. The Revolving Loan Facility must be prepaid upon payment in full of the Term Loan Facility. As of December 31, 1999, the Company had available credit under the Revolving Loan Facility in the amount of $23.4 million ($16.8 million of which is restricted for use on future acquisitions). No additional borrowing is available under the Term Loan Facility. The Credit Facility is guaranteed by Holding and all existing and subsequently acquired or organized domestic and, to the extent no adverse tax consequences would result, foreign subsidiaries of the Company. The Credit Facility is secured by a first priority lien in substantially all of the properties and assets of the Company and the guarantors now owned or acquired later, including a pledge of all of the capital stock of the Company owned by Holding and all of the shares held by the Company of its existing and future subsidiaries; provided, that such pledge is limited to 65% of the shares of any foreign subsidiary to the extent a pledge of a greater percentage would result in adverse tax consequences to the Company. The Credit Facility contains covenants restricting the ability of Holding, the Company and the Company's subsidiaries to, among others, (i) incur additional debt, (ii) declare dividends or redeem or repurchase capital stock, (iii) prepay, redeem or purchase debt, (iv) incur liens, (v) make loans and investments, (vi) make capital expenditures, (vii) engage in mergers, acquisitions and asset sales, (viii) engage in transactions with affiliates. Hudson RCI is also required to comply with financial covenants with respect to (a) limits on annual aggregate capital expenditures (as defined), (b) a fixed charge coverage ratio, (c) a maximum leverage ratio, (d) a minimum EBITDA test and (e) an interest coverage ratio. The Subordinated Notes bear interest at the rate of 9-1/8%, payable semiannually on each April 15 and October 15, and will require no principal repayments until maturity. The Subordinated Notes are general unsecured obligations of the Company. The Subordinated Notes contain covenants that place limitations on, among other things, (i) the ability of the Company, any subsidiary guarantors and other restricted subsidiaries to incur additional debt, (ii) the making of certain restricted payments including investments, (iii) the creation of certain liens, (iv) the issuance and sale of capital stock of restricted subsidiaries, (v) asset sales, (vi) payment restrictions affecting restricted subsidiaries, (vii) transactions with affiliates, (viii) the ability of the Company and any subsidiary guarantor to incur layered debt, (ix) the ability of Holding to engage in any business or activity other than those relating to ownership of capital stock of the Company and (x) certain mergers, consolidations and transfers of assets by or involving the Company. In connection with the LGAB acquisition, the Company borrowed $22.0 million pursuant to an unsecured promissory note payable to Freeman Spogli. The note bears interest at 12.0% per annum, matures in August 2006, and requires semiannual interest payments. As of December 31, 1999, $7.5 million remained outstanding on the note. In connection with the LGAB acquisition, the Company assumed debt owed by LGAB under its bank facility (the "LGAB Facility"), which totaled $17.6 million as of December 31, 1999. The LGAB Facility, which is denominated in Swedish krona, bears interest at three-month STIBOR (the interest rate at or about 11:00 a.m. Stockholm time, two banking days before a draw-down date or the relevant interest period, quoted for deposits in krona) plus 0.75% to 1.75% (4.365% to 5.365% at December 31, 1999), matures in December 2003, and is secured by the common stock of LGAB. In connection with the Recapitalization, the Company issued to Holding 300,000 shares of its 11 1/2% Senior PIK Preferred Stock due 2010 with an aggregate liquidation preference of $30.0 million, which has terms and provisions materially similar to those of the Holding Preferred Stock (the "Mirror Preferred Stock"). At the election of the Company, dividends may be paid in kind until April 15, 2003 and thereafter must be paid in cash. 20 Holding is a holding company and will rely on dividends from Hudson RCI as its primary source of liquidity. Holding does not have and in the future will not have any assets other than the capital stock of Hudson RCI. The ability of Hudson RCI to pay cash dividends to Holding when required is restricted by law and restricted or prohibited under the terms of Hudson RCI's debt instruments, including the Credit Facility. No assurance can be made that Hudson RCI will be able to pay cash dividends to Holding when required on the Mirror Preferred Stock. The Company believes that after giving effect to the Recapitalization, the 1999 acquisitions and the incurrence of indebtedness related thereto, based on current levels of operations and anticipated growth, its cash from operations, together with other available sources of liquidity, including borrowings available under the Revolving Loan Facility, will be sufficient over the next twelve months to fund anticipated capital expenditures and acquisitions and to make required payments of principal and interest on its debt, including payments due on the Subordinated Notes and obligations under the Credit Facility. The Company intends to selectively pursue strategic acquisitions, both domestically and internationally, to expand its product line, improve its market share positions and increase cash flows. Financing for such acquisitions is available, subject to limitations, under the Credit Facility. Any significant acquisition activity by the Company in excess of such amounts would require additional capital, which could be provided through capital contributions or debt financing. The Company has no commitments for such acquisition financing and to the extent financing is unavailable, acquisitions may be delayed or not completed. Year 2000 Compliance The following discussion about the implementation of the Company's Year 2000 program, the costs expected to be associated with the program and the results the Company expects to achieve constitute forward-looking information. As noted below, there are many uncertainties involved with the Year 2000 issue, including the extent to which the Company will be able to adequately provide for contingencies that may arise, as well as the broader scope of the Year 2000 issue as it may affect third parties and the Company's key trading partners. Accordingly, the costs and results of the Company's Year 2000 program and the extent of any impact on the Company's results of operations could vary materially from that stated herein. A significant percentage of software that runs on most computers relies on two-digit date codes to perform computations and decision-making functions. Commencing on January 1, 2000, these computer programs may fail from an inability to interpret date codes properly, misinterpreting "00" as the year 1900 rather than 2000. The Company has completed the identification of all necessary internal software changes to ensure that it does not experience any loss of critical business functionality due to the Year 2000 issue. The Company has completed an assessment of all internal software, hardware and operating systems and has made all necessary hardware and software changes as a result of that assessment. The Company has not encountered any material Year 2000 problems to date and does not believe that its systems will encounter any material Year 2000 problems in the future. The Company's products are not subject to Year 2000 problems. The Company also relies, directly and indirectly, on the external systems of various independent business enterprises, such as its customers, suppliers, creditors, financial organizations, and of governments, for the accurate exchange of data and related information. The Company could be affected as a result of any disruption in the operation of the various third-party enterprises with which the Company interacts. The Company has contacted its key trading partners to assess its Year 2000 risk based upon the Year 2000 issues of its partners, and has developed contingency plans for a substantial number of its key trading partners. These contingency plans include the establishment of back-up vendors and back-up plans for communications with its customers and for the procurement of power and water at its Mexico facilities. The cost of establishing these contingency plans was not material. The total costs of the Year 2000 program are anticipated to be less than $100,000, some of which has been expended to date. The costs and time estimates of the Year 2000 project are based on the Company's best estimates. There can be no assurance that these estimates will be achieved and that planned results will be achieved. Risk factors include, but are not limited to, the retention of internal resources dedicated to the project and the successful completion of key business partners' Year 2000 projects. 21 Recent Accounting Pronouncements Statement of Financial Accountings Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" was issued in June 1998. Because the Company has no derivative instruments and does not engage in hedging activities, SFAS No. 133 is not expected to impact the Company materially. RISK FACTORS Substantial Leverage; Shareholders' Deficit As of December 31, 1999, the Company had $211.7 million of outstanding indebtedness and a shareholders' deficit of approximately $14.6 million. This level of indebtedness is substantially higher than the Company's historical debt levels and may reduce the flexibility of the Company to respond to changing business and economic conditions. In addition, subject to the restrictions in the Credit Facility and the indenture governing the Subordinated Notes (the "Indenture"), the Company may incur additional senior or other indebtedness from time to time to finance acquisitions or capital expenditures or for other general corporate purposes. See "--Liquidity and Capital Resources." The Credit Facility and the Indenture restrict, but do not prohibit, the payment of dividends by the Company to Holding to finance the payment of dividends on the Holding Preferred Stock. The Company's high degree of leverage may have significant consequences for the Company, including: (i) the ability of the Company to obtain additional financing for working capital, capital expenditures, acquisitions or other purposes, if necessary, may be impaired; (ii) a substantial portion of the Company's cash flow will be dedicated to the payment of interest and principal on its indebtedness and will not be available to the Company for its operations and future business opportunities; (iii) the covenants contained in the indenture and the Credit Facility will limit the Company's ability to, among other things, borrow additional funds, dispose of assets or make investments and may affect the Company's flexibility in planning for, and reacting to, changes in business conditions; (iv) indebtedness under the Credit Facility will be at variable rates of interest, which will cause the Company to be vulnerable to increases in interest rates; and (v) the Company's high degree of leverage may make it more vulnerable to a downturn in its business or the economy generally or limit its ability to withstand competitive pressures. If the Company is unable to generate sufficient cash flow from operations in the future to service its indebtedness, it may be required to refinance all or a portion of its existing debt or to obtain additional financing. There can be no assurance that any such actions could be effected on a timely basis or on satisfactory terms or that these actions would enable the Company to continue to satisfy its capital requirements. The Company's ability to meet its debt service obligations and to reduce its total indebtedness will be dependent upon the Company's future performance, which will be subject to general economic conditions and to financial, business and other factors affecting the operations of the Company, many of which are beyond its control. The terms of the Company's indebtedness, including the Credit Facility and the Indenture, also may prohibit the Company from taking such actions. Medical Cost Containment In recent years, widespread efforts have been made in both the public and private sectors to control health care costs, including the prices of products such as those sold by the Company, in the United States and abroad. Cost containment measures have resulted in increased customer purchasing power, particularly through the increased presence of GPOs in the marketplace and increased consolidation of distributors. Health care organizations are evaluating ways in which costs can be reduced by decreasing the frequency with which a treatment, device or product is used. Cost containment has also caused a shift in the decision-making function with respect to supply acquisition from the clinician to the administrator, resulting in a greater emphasis being placed on price, as opposed to features and clinical benefits. The Company has encountered significant pricing pressure from customers and believes that it is likely that efforts by governmental and private payors to contain costs through managed care and other efforts and to reform health systems will continue and that such efforts may have an adverse effect on the pricing and demand for the Company's products. There can be no assurance that current or future reform initiatives will not have a material adverse effect on the Company's business, financial conditions or results of operations. 22 The Company's products are sold principally to a variety of health care providers, including hospitals and alternate site providers, that receive reimbursement for the products and services they provide from various public and private third party payors, including Medicare, Medicaid and private insurance programs. As a result, while the Company does not receive payments directly from such third party payors, the demand for the Company's products in any specific care setting is dependent in part on the reimbursement policies of the various payors in that setting. In order to be reimbursed, the products generally must be found to be reasonable and necessary for the treatment of medical conditions and must otherwise fall within the payor's list of covered services. In light of increased controls on Medicare spending, there can be no assurance on the outcome of future coverage or payment decisions for any of the Company's products by governmental or private payors. If providers, suppliers and other users of the Company's products are unable to obtain sufficient reimbursement, a material adverse impact on the Company's business, financial condition or operations may result. The Company expects that the trend toward cost containment that has impacted the domestic market will also be experienced in international health care markets, impacting the Company's growth in foreign countries, particularly where health care is socialized. Industry Consolidation; Customer Concentration Cost containment has resulted in significant consolidation within the health care industry. A substantial number of the Company's customers, including group purchasing organizations, hospitals, national nursing home companies and national home health care agencies, have been affected by this consolidation. The acquisition of any of the Company's significant customers could result in the loss of such customers by the Company, thereby negatively impacting its business, financial condition and results of operations. For example, in 1996, three GPOs that accounted for aggregate sales of approximately $11.0 million combined and, as a result of a decision of the combined entity to enter into a sole distributorship arrangement in 1997 with one of the Company's competitors, the Company has experienced some decrease in sales and may experience additional sales decreases in the future. In addition, the consolidation of health care providers often results in the renegotiation of terms and in the granting of price concessions. The Company's customer relationships, including exclusive or preferential provider relationships, are terminable at will by either party without advance notice or penalty. Because larger purchasers or groups of purchasers tend to have more leverage in negotiating prices, this trend has caused the Company to reduce prices and could have a material adverse effect on the Company's business, financial condition or results of operations. As GPOs and integrated health care systems increase in size, each relationship represents a greater concentration of market share and the adverse consequences of losing a particular relationship increases considerably. For fiscal 1999, the Company's ten largest group purchasing arrangements accounted for approximately 34% of the Company's total net sales. Distributors have also consolidated in response to cost containment. For fiscal 1999, approximately 30.5% of the Company's net sales were to two distributors, Owens & Minor Inc. and McKesson, which accounted for 19.0% and 11.5%, respectively, of the Company's net sales. The loss of the Company's relationship with these distributors would have a material adverse effect on the Company's business, financial condition and results of operations. Government Regulation The Company and its customers and suppliers are subject to extensive federal and state regulation in the United States, as well as regulation by foreign governments. Most of the Company's products are subject to government regulation in the United States and other countries. In the United States, the Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and other statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, marketing, advertising and promotion of such products. Failure to comply with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution. Under the FDC Act and similar foreign laws, the Company, as a marketer, distributor and manufacturer of health care products, is required to obtain the approval of federal and foreign governmental agencies, including the Food and Drug Administration ("FDA"), prior to marketing, distributing and manufacturing certain of those products, which can be time consuming and expensive. The Company may also need to obtain FDA clearance before modifying marketed products or making new promotional claims. Delays in receipt of or failure to receive 23 required approvals or clearances, the loss of previously received approvals or clearances, or failures to comply with existing or future regulatory requirements in the United States or in foreign countries could have a material adverse effect on the Company's business. Foreign sales are subject to similar requirements. The Company is required to comply with the FDA's "Quality System Regulations for Medical Devices," implementing "Good Manufacturing Practices" ("GMP/QSR Regulations"), which set forth requirements for, among other things, the Company's manufacturing process, design control and associated record keeping, including testing and sterility. Further, the Company's plants and operations are subject to review and inspection by local, state, federal and foreign governmental entities. The distribution of the Company's products may also be subject to state regulation. The impact of FDA regulation on the Company has increased in recent years as the Company has increased its manufacturing operations. The Company's suppliers, including sterilizer facilities, are also subject to similar governmental requirements. There can be no assurance that changes to current regulations or additional regulations imposed by the FDA will not have an adverse impact on the Company's business and financial condition in the future. If the FDA believes that a company is not in compliance with applicable regulations, it can institute proceedings to detain or seize products, issue a recall, impose operating restrictions, enjoin future violations and assess civil and criminal penalties against the company, its officers or its employees and can recommend criminal prosecution to the Department of Justice. Other regulatory agencies may have similar powers. In addition, product approvals could be withdrawn due to the failure to comply with regulatory standards or the occurrence of unforeseen problems following initial marketing. The FDA also has the authority to issue special controls for devices manufactured by the Company, which it has not done to date. In the event that such special controls were issued, the Company's products would be required to conform, which could result in significant additional expenditures for the Company. The Company is subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or infectious materials or substances and emissions of air pollutants. The Company owns and leases properties which are subject to environmental laws and regulations. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition or results of operations. In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company. Risks Related to International Sales; Foreign Operations Sales made outside the United States represented approximately 22.1% of the Company's 1999 net sales and the Company intends to increase international sales as a percentage of total net sales. Foreign operations are subject to special risks that can materially affect the sales, profits, cash flows and financial position of the Company, including increased regulation, extended payment periods, competition from firms with more local experience, currency exchange rate fluctuations and import and export controls. The Company has operations in Germany, Sweden, Japan and other countries where sales are made in local currency. While the Company plans to hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible, and to purchase forward contracts to hedge receivables denominated in foreign currency, there can be no assurance that the Company's hedging strategies will allow the Company to successfully mitigate its foreign exchange exposures. The Company's foreign exchange exposure has historically not been significant, and was not considered to be significant in fiscal 1999. The destabilization of the economies of several Asian countries in 1997 caused a decrease in demand for the Company's products throughout Southeast Asia, and future sales in that region are uncertain. In addition, adverse economic conditions in Asia could result in "dumping" of products similar to those produced by the Company by other manufacturers, both in Asian and other markets. The Company also maintains a manufacturing and assembly facility in Ensenada, Mexico and an assembly facility in Kuala-Lumpur, Malaysia and, as a result, is subject to operational risks such as changing labor trends and civil unrest in those countries. In the event the Company were required to transfer its foreign operations to the United States 24 or were otherwise unable to benefit from its lower cost foreign operations, its business, financial condition and results of operations would be adversely affected. Product Liability The manufacturing and marketing of medical products entails an inherent risk of product liability claims. Although the Company has not experienced any significant losses due to product liability claims and currently maintains umbrella liability insurance coverage, there can be no assurance that the amount or scope of the coverage maintained by the Company will be adequate to protect it in the event a significant product liability claim is successfully asserted against the Company. In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company. Dependence on Key Personnel; Management of Expanding Operations The Company's success will, to a large extent, depend upon the continued services of its executive officers. The loss of services of any of these executive officers could materially and adversely affect the Company. While the Company has employment agreements with it senior management team, these agreements may be terminated by either party, with or without cause. The Company's plans to expand its business may place a significant strain on the Company's operational and financial resources and systems. To manage its expanding operations, the Company may be required to, among other things, improve its operational, financial and management information systems. The Company may also be required to attract, train and retain additional highly qualified management, technical, sales and marketing and customer support personnel. The process of locating such personnel with the combination of skills and attributes required to implement the Company's strategy is often lengthy. The inability to attract and retain additional qualified personnel could materially and adversely affect the Company. Competition The medical supply industry is characterized by intense competition. Certain of the Company's competitors have greater financial and other resources than the Company and may succeed in utilizing these resources to obtain an advantage over the Company. The general trend toward cost containment in the health care industry has had the effect of increasing competition among manufacturers, as health care providers and distributors consolidate and as GPOs increase in size and importance. The Company competes on the basis of brand name, product quality, breadth of product line, service and price. Risks Generally Associated with Acquisitions An element of the Company's business strategy is to pursue strategic acquisitions that either expand or complement the Company's business. Acquisitions involve a number of special risks, including the diversion of management's attention to the assimilation of the operations and the assimilation and retention of the personnel of the acquired companies, and potential adverse effects on the Company's operating results. The Company may require additional debt or equity financing for future acquisitions, which may not be available on terms favorable to the Company, if at all. In addition, the Credit Facility and the Indenture contain certain restrictions regarding acquisitions. The Indenture restricts acquisitions to those companies in the same line of business as the Company, and requires that all such acquired companies be designated Restricted Subsidiaries (as defined therein). The Credit Facility restricts all acquisitions with the exception of Permitted Acquisitions (as defined therein), and limits, among other things, (i) the sum that may be paid in connection with any single acquisition to $30.0 million, (ii) the total amount outstanding of revolving credit indebtedness that can be incurred for acquisition purposes to $40.0 million, and (iii) the line of business of the acquired entity or assets. The inability of the Company to successfully finance, complete and integrate strategic acquisitions in a timely manner could have an adverse impact on the Company's ability to effect a portion of its growth strategy. 25 Patents and Trademarks The Company has historically relied primarily on its technological and engineering abilities and on its design and production capabilities to gain competitive business advantages, rather than on patents or other intellectual property rights. However, the Company does file patent applications on concepts and processes developed by the Company's personnel. The Company has 20 patents in the U.S. Many of the U.S. patents have corresponding patents issued in Canada, Europe and various Asian countries. The Company's success will depend in part on its ability to maintain its patents, add to them where appropriate, and to develop new products and applications without infringing the patent and other proprietary rights of third parties and without breaching or otherwise losing rights in technology licenses obtained by the Company for other products. There can be no assurance that any patent owned by the Company will not be circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with claims of the scope sought by the Company, if at all. If challenged, there can be no assurance that the Company's patents (or patents under which it licenses technology) will be held valid or enforceable. In addition, there can be no assurance that the Company's products or proprietary rights do not infringe the rights of third parties. If such infringement were established, the Company could be required to pay damages, enter into royalty or licensing agreements on onerous terms and/or be enjoined from making, using or selling the infringing product. Any of the foregoing could have a material adverse effect upon the Company's business, financial condition or results of operations. S Corporation Status The Company elected to be treated as an S corporation for federal and state income tax purposes for its taxable years beginning on or after January 1, 1987. Unlike a C corporation, an S corporation is generally not subject to income tax at the corporate level; instead, the S corporation's income is taxed on the personal income tax returns of its shareholders. The Company's status as an S corporation terminated upon consummation of the Recapitalization. If S corporation status were denied for any periods prior to such termination by reason of a failure to satisfy the S corporation election or eligibility requirements of the Internal Revenue Code of 1986, as amended, the Company would be subject to tax on its income as if it were a C corporation for these periods. Such an occurrence would have a material adverse effect on the Company's results. Item 7A. Quantitative and Qualitative Disclosure About Market Risk. Quantitative Disclosures. With the LGAB acquisition, the Company has greater foreign currency exposure with respect to its international operations. In the past, the Company's only international exposure was its manufacturing operation in Mexico. All sales were previously denominated in U.S. dollars. Currently, the Company has operations in Germany, Sweden, Japan and other countries where sales are made in local currency. The Company plans to hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible. The Company will also purchase forward contracts to hedge receivables denominated in foreign currency that are expected to be collected and converted into another currency. However, there can be no assurance that the Company's hedging strategies will allow the Company to successfully mitigate its foreign exchange exposures. The Company is exposed to certain market risks associated with interest rate fluctuations on its debt. All debt arrangements are entered into for purposes other than trading. The Company's exposure to interest rate risk arises from financial instruments entered into in the normal course of business that, in some cases, relate to the Company's acquisitions of related businesses. Certain of the Company's financial instruments are fixed rate, short-term investments which are held to maturity. The Company's fixed rate debt consists primarily of outstanding balances on the Subordinated Notes and its variable rate debt relates to borrowings under the Credit Facility (see "Item 7. Management's Discussion and Analysis and Results of Operations--Liquidity and Capital Resources"). With respect to the Company's fixed rate debt, changes in interest rates generally affect the fair value of such debt, but do not have an impact on earnings or cash flows. Because the Company generally cannot prepay its fixed rate debt prior to maturity, interest rate risk and changes in fair value should not have a significant impact on this debt until the Company is required to refinance. With respect to variable rate debt, changes in interest rates affect earnings and cash flows, but do not impact 26 fair value. The impact on the Company's interest expense in the upcoming year of a one-point interest rate change on the outstanding balance of the Company's variable rate debt would be approximately $892,000. The following table presents the future principal cash flows and weighted- average interest rates expected on the Company's existing long-term debt instruments. The fair value of the Company's fixed rate debt is estimated based on quoted market prices. Expected Maturity Date (as of December 31, 1999)
Fiscal Fiscal Fiscal Fiscal Fiscal There- Fair 2000 2001 2002 2003 2004 after Total Value ------ ------ ------- ------ ------ ------ ----- ----- (Dollars in thousands) Fixed Rate Debt... $ -- $ -- $ -- $ -- $ -- $122,500 $122,500 $99,700 Average Interest Rate.... -- -- -- -- -- 9.3% Variable Rate Debt $6,700 $11,000 $13,000 $15,000 $43,500 $ -- $ 89,200 $89,200 Average Interest Rate.... 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%
Qualitative Disclosures. The Company's primary exposure relates to (1) interest rate risk on long-term and short-term borrowings, (2) the Company's ability to pay or refinance long-term borrowings at maturity at market rates, (3) the impact of interest rate movements on the Company's ability to meet interest expense requirements and exceed financial covenants and (4) the impact of interest rate movements on the Company's ability to obtain adequate financing to fund future acquisitions. The Company manages interest rate risk on its outstanding long-term and short-term debt through the use of fixed and variable rate debt. While the Company can not predict or manage its ability to refinance existing debt or the impact interest rate movements will have on its existing debt, management evaluates the Company's financial position on an ongoing basis. Item 8. Financial Statements. See the Index included at "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K." Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . None. 27 PART III Item 10. Directors and Executive Officers of the Registrant. The following individuals are the executive officers and directors of Holding and Hudson RCI as of December 31, 1999:
Name Age Position - ----------------------------- ---- ------------------------------------------ Richard W. Johansen...... 48 President, Chief Executive Officer and Director Lougene Williams......... 55 Senior Vice President Jay R. Ogram............. 44 Chief Financial Officer Brian W. Morgan.......... 60 Vice President, Human Resources Helen Hudson Lovaas...... 61 Director Jon D. Ralph............. 35 Director Charles P. Rullman....... 51 Director Ronald P. Spogli......... 52 Director Sten Gibeck.............. 56 Director
Richard W. Johansen is President, Chief Executive Officer and Director of the Company and assumed the same positions with Holding after consummation of the Recapitalization. Mr. Johansen became President of the Company in 1993 and assumed the additional responsibilities of Chief Executive Officer in May 1997. From 1989 to 1993, he served as Vice President, Marketing and Sales for the Company following the 1989 acquisition of Respiratory Care Inc. by Hudson RCI. He held the same position with Respiratory Care Inc. as well as prior executive positions in the area of business development with its parent company, The Kendall Company. Lougene Williams is a Senior Vice President of the Company responsible for its product development, quality assurance and manufacturing operations, having served in this capacity since 1996, and assumed the same position with Holding after consummation of the Recapitalization. Prior to 1996, he was the Company's Vice President, Manufacturing, having held a similar position with Respiratory Care Inc. From 1976 to 1987, he held manufacturing management positions of increasing responsibility at various manufacturing plants of The Kendall Company. Jay R. Ogram is the Company's Chief Financial Officer, having served in this capacity since 1996, and assumed the same position with Holding after consummation of the Recapitalization. From 1984 until his assumption of Chief Financial Officer responsibilities, Mr. Ogram held prior positions as Accounting Manager and Vice President and Controller of the Company. Prior to joining the Company, he had held executive positions in financial management with a major health care company. Brian W. Morgan is Vice President, Human Resources, having held this position since 1989, and assumed the same position with Holding after consummation of the Recapitalization. Mr. Morgan held similar positions in human resources at Respiratory Care Inc. since 1978. Helen Hudson Lovaas is a director of the Company and became a director of Holding after consummation of the Recapitalization. Mrs. Lovaas began her career at the Company in 1961. She has been Chairman since 1987, when she inherited ownership of the Company and served as Chief Executive Officer from 1987 until May 1997. Mrs. Lovaas had served previously as the Vice President of Administration of Hudson Oxygen for 15 years. Jon D. Ralph became a director of Hudson RCI and of Holding in connection with the Recapitalization. Mr. Ralph joined Freeman Spogli in 1989 and became a Principal in January 1998. Prior to joining Freeman Spogli, Mr. Ralph spent three years at Morgan Stanley & Co. Incorporated where he served as an analyst in the Investment 28 Banking Division. Mr. Ralph is also a director of Century Maintenance Supply, Inc., Envirosource, Inc. and The Pantry, Inc. Charles P. Rullman became a director of Hudson RCI and of Holding in connection with the Recapitalization. Mr. Rullman joined Freeman Spogli as a Principal in 1995. From 1992 to 1995, Mr. Rullman was a General Partner of Westar Capital, a private equity investment firm specializing in middle-market transactions. Prior to joining Westar, Mr. Rullman spent twenty years at Bankers Trust Company and its affiliate BT Securities Corporation where he was a Managing Director and Partner. Mr. Rullman is also a director of The Pantry, Inc. Ronald P. Spogli became a director of Hudson RCI and of Holding in connection with the Recapitalization. He is a founding Principal of Freeman Spogli, which was founded in 1983. Mr. Spogli is also a director of AFC Enterprises, Inc., Century Maintenance Supply, Inc. and Envirosource, Inc. Sten Gibeck became a director of Hudson RCI and of Holding in connection with the July 1999 acquisition of LGAB. Mr. Gibeck has been employed by LGAB since 1965, and since 1997 has served as its Vice President of Research and Development. From 1971 through 1996, Mr. Gibeck served as the President of LGAB. Directors of Hudson RCI and of Holding are elected annually and hold office until the next annual meeting of stockholders and until their successors are duly elected and qualified. Item 11. Executive Compensation. The following table sets forth the compensation earned by the Company's Chairman and Chief Executive Officer and the three executive officers who earned salary and bonus in excess of $100,000 for services rendered in all capacities to the Company and its subsidiaries for the fiscal year ended December 31, 1999 (collectively, the "Named Executive Officers"). As of December 31, 1999, the Company had no other executive officers. Summary Compensation Table
Annual Compensation ------------------------------------- Other Annual All Other Fiscal Compensation Compensation Name and Principal Position Year Salary Bonus (1) (2) - ------------------------------------------------------------------------------------------------------------------ Richard W. Johansen........................ 1999 $294,945 $ 53,100 $ 177,334 $9,600 President and Chief Executive Officer 1998 265,500 131,567 14,853,967 9,000 1997 256,535 141,101 1,350,000 9,000 Lougene Williams........................... 1999 $190,862 $ 25,480 $ 73,020 $9,600 Senior Vice President 1998 182,000 64,257 6,116,222 9,000 1997 180,005 70,475 556,000 9,000 Jay R. Ogram............................... 1999 $148,314 $ 17,040 $ -- $8,889 Chief Financial Officer 1998 142,000 43,228 6,116,222 8,520 1997 140,250 48,357 556,000 8,394 Brian W. Morgan............................ 1999 $132,433 $ 15,268 $ 52,157 $7,946 Vice President, Human Resources 1998 127,320 38,506 4,527,873 7,634 1997 127,368 42,984 238,000 7,477
_____________________ 29 (1) Reflects amounts earned by the Named Executive Officers during 1997 and 1998 and paid in 1998 and 1999 under the Equity Participation Plan. During 1999, no executive officer named above received perquisites and other personal benefits, securities or property in an aggregate amount in excess of the lesser of $50,000 or 10% of the total of such officer's salary and bonus nor did any such officer receive any restricted stock award or stock appreciation right. (2) Represents payments by the Company under its defined contribution plan. Executive Employment Agreements On April 7, 1998, the Company entered into employment agreements with each of the Named Executive Officers. Each Named Executive Officer receives a base salary in an amount and on substantially the same terms and conditions as was being paid by the Company on that date and an annual cash bonus in accordance with the Company's existing incentive programs. Pursuant to the employment agreements, in the event that employment is terminated by the Company other than for cause (as such term is defined in the employment agreements), or if the Named Executive Officer resigns pursuant to a "qualifying resignation" (as such term is defined in the employment agreements), the Company will be required to pay such Named Executive Officer's base salary for a period of between 12 and 24 months. The employment agreements also provide for nondisclosure of confidential information, that the Named Executive Officer shall not engage in any prohibited activity (as such term is defined in the employment agreement) during the term of employment and that the Named Executive Officer will refrain from interfering with the Company's contractual relationships or soliciting the Company's employees for 12 months following the Named Executive Officer's termination. Compensation of Directors Directors of the Company receive no compensation as directors. Directors are reimbursed for their reasonable expenses in attending meetings. Management Bonus Plans The Company offers two management bonus plans for its executives, one for senior management and one for executive management. The plan for senior management is based on a combination of the financial goals of the Company and goals set for individual employees. The plan has minimum goals of 70% attainment for operating income and 75% attainment of the individual plan. The payout is based 70% on attainment of Company financial performance and 30% attainment of individual performance goals. The plan for executive management is based on the financial goals of the Company. The payout to an individual is based on his or her bonus level and the percentage attainment of the operating income goal for the Company. In order to participate, 70% of operating income must be achieved. Retirement Plans The Company sponsors two programs that assist its employees in planning for retirement. The Company offers a defined contribution pension plan that is funded by the Company. Employees must be at least 21 years of age and have completed two years of service to be eligible to participate in the pension plan. The Company annually contributes an amount equal to 6% of a participating employee's base earnings to a participant's account, prorated for any part of a year that a participant was ineligible for a contribution. The funding also includes a proportionate share of any increase or decrease in the fair market value of the assets in the trust fund as of the immediately preceding last day of the plan year. In addition, employees may contribute to a 401(k) plan that has no matching contributions by the Company. Employees must have six months of service to be eligible to participate in the 401(k) plan and may contribute up to 10% of their annual compensation, or 6% if the employee is a highly compensated participant. 30 Compensation Committee Interlocks and Insider Participation The Board of Directors of the Company determines the compensation of the executive officers. During fiscal 1999, Mr. Rullman determined the compensation of the Company's Chief Executive Officer and Mr. Rullman and Mr. Johansen participated in deliberations regarding the compensation of the Company's other executive officers. Stock Subscription Plans In April 1998, Holding adopted an Employee Stock Subscription Plan and an Executive Stock Subscription Plan (collectively, the "Stock Subscription Plans") pursuant to which executives of the Company purchased 800,000 shares of common stock of Holding valued at $10.00 per share. The Stock Subscription Plans provide for a repurchase option in favor of Holding upon termination of employment at stated repurchase prices. In addition, the Stock Subscription Plans provide for restrictions on the transferability of shares prior to the fifth anniversary of the Recapitalization or Hudson RCI's initial public offering. The shares are also subject to a right of first refusal in favor of Holding as well as obligations to sell at the request of Freeman Spogli and co- sale rights if Freeman Spogli sells its shares to a third party. No additional shares of Holding common stock were sold under the Stock Subscription Plans in fiscal 1999. 31 Item 12. Security Ownership of Certain Beneficial Owners and Management. River Holding Corp. The following table sets forth certain information, as of March 30, 2000, with respect to the beneficial ownership of capital stock of Holding by (i) each person who beneficially owns more than 5% of such shares, (ii) each of the Named Executive Officers, (iii) each director of Holding and (iv) all Named Executive Officers and directors of Holding as a group. The following table should be read in conjunction with the security ownership table for Hudson RCI.
Shares Percent Shares of Percent of Common of Preferred of Name of Beneficial Owner Stock Class Stock Class - ------------------------------------------------- ------------ ------------ ------------ ----------- Freeman Spogli & Co. Incorporated(1)............. 7,521,791 88.0% -- -- Ronald P. Spogli(1) Charles P. Rullman(1) Jon D. Ralph(1) Richard W. Johansen(2)(3)........................ 300,000 3.5% -- -- Sten Gibeck(3)................................... 210,000 2.5% -- -- Lougene Williams(3).............................. 100,000 1.2% -- -- Jay R. Ogram(3).................................. 100,000 1.2% -- -- Brian W. Morgan(3)............................... 15,000 * -- -- Helen Hudson Lovaas(3)........................... -- -- -- -- All named Executive Officers and directors of Holding as a group (9 individuals).............. 8,146,791 95.4% -- --
__________________ * Less than 1%. (1) 1,441,251 shares, 58,749 shares and 6,021,791 shares of common stock are held of record by FS Equity Partners III, L.P. ("FSEP III"), FS Equity Partners International, L.P. ("FSEP International") and FS Equity Partners IV, L.P. ("FSEP IV"), respectively. As general partner of FS Capital Partners, L.P. ("FS Capital"), which is general partner of FSEP III, FS Holdings, Inc. ("FSHI") has the sole power to vote and dispose of the shares owned by FSEP III. As general partner of FS&Co. International, L.P. ("FS&Co. International"), which is the general partner of FSEP International, FS International Holdings Limited ("FS International Holdings") has the sole power to vote and dispose of the shares owned by FSEP International. As general partner of FSEP IV, FS Capital Partners LLC ("FS Capital LLC") has the sole power to vote and dispose of the shares owned by FSEP IV. Messrs. Spogli and Rullman and Bradford M. Freeman, William M. Wardlaw, J. Frederick Simmons and John M. Roth are the sole directors, officers and shareholders of FSHI, FS International Holdings and Freeman Spogli & Co. Incorporated and such individuals, in addition to Mr. Ralph and Todd W. Halloran and Mark J. Doran, are the sole managing members of FS Capital LLC, and as such may be deemed to be the beneficial owners of the shares of the common stock and rights to acquire the common stock owned by FSEP III, FSEP International and FSEP IV. The business address of Freeman Spogli & Co. Incorporated, FSEP III, FSEP IV, FS Capital, FSHI, FS Capital LLC, and its sole directors, officers, shareholders and managing members is 11100 Santa Monica Boulevard, Suite 1900, Los Angeles, California 90025 and the business address of FSEP International, FS&Co. International and FS International Holdings is c/o Padget-Brown & Company, Ltd., West Winds Building, Third Floor, Grand Cayman, Cayman Islands, British West Indies. (2) Represents shares held of record by the Johansen Family Trust U/D/T dated 8/16/91 (the "Trust"), of which Mr. Johansen and his wife, Barbara L. Johansen, are the trustees. (3) The business address of these individuals is River Holding Corp., 599 Lexington Avenue, 18th Floor, New York, New York 10022. 32 Hudson RCI The following table sets forth certain information, as of March 31, 1999, with respect to the beneficial ownership of capital stock of the Company by (i) each person who beneficially owns more than 5% of such shares, (ii) each of the Named Executive Officers, (iii) each director of Hudson RCI and (iv) all Named Executive Officers and directors of Hudson RCI as a group.
Shares of Common Percent Shares of Percent Name of Beneficial Owner Stock of Class Preferred Stock of Class - ----------------------------------------------------------------------------------------------------------- River Holding Corp.(1)........................ 8,544,291 85.1% 355,630 100% Jon D. Ralph(1)............................ Charles P. Rullman(1)...................... Ronald P. Spogli(1)........................ Helen Hudson Lovaas(2)........................ 1,500,000 14.9% -- -- Sten Gibeck(3)................................ -- -- -- -- Richard W. Johansen(3)........................ -- -- -- -- Lougene Williams(3)........................... -- -- -- -- Jay R. Ogram(3)............................... -- -- -- -- Brian W. Morgan(3)............................ -- -- -- -- All Named Executive Officers and directors of the Company as a group (9 individuals)....... 10,044,291 100.0% 355,630 100.0%
- ----------------- (1) As beneficial owner of 88.0% of the Common Stock of Holding, Freeman Spogli will have the power to vote and dispose of the shares held by Holding. See footnote (i) at "--River Holding Corp." Holding has pledged all shares of the Company's capital stock owned by it to secure its guarantee of the Company's obligations under the Credit Facility. (2) Represents 1,073,560 shares held of record by the Helen Lovaas Separate Property Trust U/D/T dated 7/16/97 ("Trust No. 1") and 426,440 shares held of record by the Helen Lovaas Trust No. 2 U/D/T dated as of January 10, 2000 ("Trust No. 2"). As sole trustee of Trust No. 1, Mrs. Lovaas has the sole power to vote and dispose of the shares owned by Trust No. 1. As co- trustee of Trust No. 2, Mrs. Lovaas has shared power to vote and dispose of the shares owned by Trust No. 2. The address of each of Trust No. 1 and Trust No. 2 is c/o Hudson Respiratory Care Inc., 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589. (3) The business address of these individuals is Hudson Respiratory Care Inc., 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589. Item 13. Certain Relationships and Related Transactions. Shareholders' Agreement The Continuing Shareholder and Holding have entered into a Shareholders' Agreement, as amended (the "Shareholders' Agreement"). Under the Shareholders' Agreement, Holding and the Continuing Shareholder have the right to purchase their pro rata share of certain new issuances of capital stock by Hudson RCI. In addition, the Shareholders' Agreement provides that upon certain issuances of common stock of Holding to employees of the Company, and contribution of the consideration received for such issuance to Hudson RCI, an equivalent number of shares of Hudson RCI's common stock will be issued to Holding. The Shareholders' Agreement provides for restrictions on the transferability of the shares held by the Continuing Shareholder for a period of two years following the consummation of the Recapitalization, and provides for a right of first offer on the Continuing Shareholder's common 33 stock. In addition, the agreement provides that upon sales by Holding of common stock of Hudson RCI or by Freeman Spogli of common stock of Holding, the Continuing Shareholder is obligated to sell all its shares of common stock at the request of Holding and the Continuing Shareholder has the right to participate in such sale on a pro rata basis. If Hudson RCI engages in an initial public offering with respect to its common stock, the Shareholders' Agreement provides that Holding will exchange all of the common stock of Hudson RCI it holds for newly issued common stock of Hudson RCI and the Mirror Preferred Stock (as defined below) will be exchanged, at Holding's option, into Company Preferred Stock or Company Exchange Debentures, which in turn will be exchanged for Exchange Preferred Stock. Holding will then liquidate and distribute Hudson RCI's common stock to its common holders. Hudson RCI will grant unlimited piggyback registration rights (after an initial public offering) to Freeman Spogli and the Continuing Shareholder and, commencing six (6) months after the initial public offering, three (3) demand registrations to Freeman Spogli, and one demand registration to the Continuing Shareholder. The Shareholders' Agreement provides that the parties thereto will vote their shares to elect Helen Hudson Lovaas to the Board of Directors. Note to Freeman Spogli In July 1999 in connection with the LGAB acquisition, the Company borrowed $22.0 million pursuant to an unsecured promissory note payable to Freeman Spogli. The note bears interest at 12.0% per annum, matures in August 2006, and requires semiannual interest payments. In fiscal 1999, approximately $14.5 million in principal was paid on the note. As of December 31, 1999, $7.5 million remained outstanding on the note. 34
PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) Documents filed as part of this Report: Page (1) Financial Statements Financial Statements of River Holding Corp. and Hudson Respiratory Care Inc. are filed as part of this Form 10-K........................................... F-1 (2) Financial Statement Schedules for Holding Report of Independent Public Accountants..................................... II-1 Schedule II -- Valuation and Qualifying Accounts............................. II-2 All other schedules have been omitted because they are not applicable, not required, or the information is included in the consolidated financial statements or notes thereto. (3) Exhibits
Exhibit Number Description - ------- ----------- 2.1(10) Agreement dated May 7, 1999 between Sten Gibeck, Hudson RCI and Holding. 2.2(10) Agreement dated May 7, 1999 between Euroventures Nordica I B.V., Hudson RCI and Holding. 2.3(10) Agreement dated May 7, 1999 between Forsakrings AB Skandia and Livforsakrings AB Skandia, Hudson RCI and Holding. 2.4(10) Agreement dated May 7, 1999 between Maud Gibeck, Hudson RCI and Holding. 2.5(10) Stock Subscription Agreement dated August 4, 1999 between Sten Gibeck, Holding, FSEP III, FSEP International and FSEP IV. 3.1(1) Certificate of Incorporation of Holding, as amended to date. 3.2(1) Amended and Restated Bylaws of Holding. 3.3(3) Amended and Restated Articles of Incorporation of Hudson RCI. 3.4(4) Amended and Restated Bylaws of Hudson RCI. 4.1(2) Indenture dated as of April 7, 1998 among Hudson RCI, Holding and United States Trust Company of New York, as Trustee, with respect to the 9-1/8% Senior Subordinated Notes due 2008 (including form of 9- 1/8% Senior Note due 2008). 4.2(2) Exchange Indenture dated as of April 7, 1998 among Hudson RCI, Holding and United States Trust Company of New York, as Trustee, with respect to the 11-1/2% Subordinated Exchange Debentures due 2010 (including form of 11-1/2% Senior Subordinated Exchange Debenture due 2010). 10.1(2) Credit Agreement dated as of April 7, 1998 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust Company ("Bankers Trust"). 10.2(2) Security Agreement dated as of April 7, 1998 between Hudson RCI and Bankers Trust. 10.3(2) Pledge Agreement dated as of April 7, 1998 between Holding and Bankers Trust. 35 Exhibit Number Description - ------- ----------- 10.4(2) Deed of Trust, Security Agreement, Fixture Filing and Assignment of Leases and Rents dated April 7, 1998 between Hudson RCI and Chicago Title Insurance Company fbo Bankers Trust. 10.5(2) Holding Guarantee Agreement dated as of April 7, 1998 between Holding and Bankers Trust. 10.6(2) Indemnity, Subrogation and Contribution Agreement dated as of April 7, 1998 among Hudson RCI, Holding and Bankers Trust. 10.7(2) Shareholders Agreement dated April 7, 1998 among Holding, The Helen Hudson Lovaas Separate Property Trust U/D/T dated July 17, 1997 (the "Hudson Trust"), FS Equity Partners III, L.P. ("FSEP III"), FS Equity Partners International, L.P. ("FSEP International"), FS Equity Partners IV, L.P. ("FSEP IV"), and Hudson RCI. 10.8(1) 1998 Employee Stock Subscription Plan dated April 7, 1998. 10.9(1) 1998 Executive Stock Subscription Plan dated April 7, 1998. 10.10(1) Form of Stock Subscription Agreement for 1998 Employee Stock Purchase Plan. 10.11(1) Form of Stock Subscription Agreement for 1998 Executive Stock Subscription Plan. 10.12(1) Stock Subscription Agreement dated April 7, 1998 among Holding, FSEP III, FSEP IV, and FSEP International. 10.13(5) Stock Subscription Agreement dated April 7, 1998 between Holding and River Acquisition Corp. 10.14(6) Form of Amendment No. 1 to Credit Agreement dated as of July 30, 1998 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 10.15(1) Form of Exchange Preferred Stock Certificate. 10.16(5) Amendment No. 1 to Shareholders Agreement dated April 8, 1998 among Holding, the Hudson Trust, FSEP III, FSEP IV and Hudson RCI. 10.17(8) Form of Amendment No. 2 to Credit Agreement dated as of March 12, 1999 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 10.18(11) Amendment No. 3 to Credit Agreement dated as of June 17, 1999 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 12.1 Statement re Computation of Earnings to Fixed Charges Ratio. 21.1 Subsidiaries of Holding (River Holding Corp.). 21.2(12) Subsidiaries of Hudson RCI 24.1 Power of Attorney (included in the signature pages hereof). 27.1 Financial Data Schedule. ______________ (1) Incorporated by reference to the exhibit designated by the same number in the Form S-4 filed by River Holding Corp. on June 5, 1998 (File No. 333-56135). (2) Incorporated by reference to the exhibit designated by the same number in the Form S-4 filed by Hudson RCI on June 5, 1998 (File No. 333-56097) (the "Hudson RCI S-4"). (3) Incorporated by reference to the exhibit designated by exhibit number 3.1 in the Hudson RCI S-4. (4) Incorporated by reference to the exhibit designated as exhibit number 3.2 in the Hudson RCI S-4. (5) Incorporated by reference to the exhibit designated as exhibit number 10.8 in the Hudson RCI S-4. 36 (6) Incorporated by reference to the exhibit designated as exhibit number 10.13 in Amendment No. 1 to Form S-4 filed by Hudson RCI on August 3, 1998 (File No. 333-56097). (7) Incorporated by reference to the exhibit designated as exhibit 10.14 in the Annual Report on Form 10-K of Hudson RCI dated March 25, 1999 (the "Hudson RCI 1998 Form 10-K"). (8) Incorporated by reference to the exhibit designated as exhibit 10.15 in the Hudson RCI 1998 Form 10-K. (9) Incorporated by reference to the exhibit designated by the same number in the Hudson RCI 1998 Form 10-K. (10) Incorporated by reference to the exhibit designated by the same number in the Form 8-K filed by Hudson RCI on August 6, 1999 (date of earliest event: July 22, 1999) (File No. 333-56097). (11) Incorporated by reference to the exhibit designated as exhibit number 10.16 in the Annual Report on Form 10-K of Hudson RCI dated March 30, 1999 (the "Hudson RCI 1999 10-K"). (12) Incorporated by reference to the exhibit designated as exhibit number 21.1 in the Hudson RCI 1999 10-K. (b) Current Reports on Form 8-K. None. 37 RIVER HOLDING CORP. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS
PAGE ---- CONSOLIDATED FINANCIAL STATEMENTS OF RIVER HOLDING CORP. - ------------------------------------------------------- Report of Independent Public Accountants................................................................... F-2 Consolidated Balance Sheets as of December 25, 1998 and December 31, 1999.................................. F-3 Consolidated Statements of Operations for the period from April 7, 1998 (Inception) to December 25, 1998 and for the year ended December 31, 1999......................................................... F-4 Consolidated Statements of Stockholders' Equity for the for the period from April 7, 1998 (Inception) to December 25, 1998 and for the year ended December 31, 1999................................................. F-5 Consolidated Statements of Cash Flows for the period from April 7, 1998 (Inception) to December 25, 1998 and for the year ended December 31, 1999......................................................... F-6 Notes to Consolidated Financial Statements................................................................. F-8 CONSOLIDATED FINANCIAL STATEMENTS OF HUDSON RESPIRATORY CARE INC. - ----------------------------------------------------------------- Report of Independent Public Accountants................................................................... F-18 Consolidated Balance Sheets as of December 25, 1998 and December 31, 1999.................................. F-19 Consolidated Statements of Operations for the years ended December 26, 1997, December 25, 1998 and December 31, 1999..................................................................................... F-20 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 26, 1997, December 25, 1998 and December 31, 1999............................................................... F-21 Consolidated Statements of Cash Flows for the years ended December 26, 1997, December 25, 1998 and December, 31, 1999.................................................................................... F-22 Notes to Consolidated Financial Statements................................................................. F-24
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of River Holding Corp.: We have audited the accompanying consolidated balance sheets of RIVER HOLDING CORP., (a Delaware Corporation) and subsidiaries as of December 25, 1998 and December 31, 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for the period from April 7, 1998 (Inception) to December 25, 1998 and for the year ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of River Holding Corp. and subsidiaries as of December 25, 1998 and December 31, 1999, and the results of their operations and their cash flows for the period from April 7, 1998 (Inception) to December 25, 1998 and for the year ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP Orange County, California March 24, 2000 F-2 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) ASSETS
December 25, December 31, 1998 1999 ------------ ------------ CURRENT ASSETS: Cash........................................................................................ $ 507 $ 2,917 Accounts receivable, less allowance for doubtful accounts of $794 and $973 at December 25, 1998 and December 31, 1999, respectively..................................... 25,829 30,425 Inventories................................................................................. 18,024 24,043 Other current assets........................................................................ 1,049 4,945 -------- -------- Total current assets....................................................................... 45,409 62,330 Property and equipment, net.................................................................. 46,857 54,341 OTHER ASSETS: Deferred tax asset.......................................................................... 9,634 11,342 Deferred financing costs, net of accumulated amortization of $1,000 and $2,253 at December 25, 1998 and December 31, 1999, respectively.................................. 11,917 11,134 Other assets................................................................................ 235 222 Goodwill, net of accumulated amortization of $3,746 and $8,197 at December 25, 1998 and December 31, 1999, respectively.................................................. 148,657 205,592 -------- -------- Total other assets......................................................................... 170,443 228,290 -------- -------- Total assets.............................................................................. $262,709 $344,961 ======== ======== LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable to banks...................................................................... $ 3,000 $ 6,673 Accounts payable............................................................................ 6,324 6,268 Accrued liabilities......................................................................... 6,219 11,700 Other current liabilities................................................................... - 1,485 -------- -------- Total current liabilities.................................................................. 15,543 26,126 NOTE PAYABLE TO STOCKHOLDER, net of current portion.......................................... - 7,508 NOTES PAYABLE TO BANKS, net of current portion............................................... 41,000 82,513 SENIOR SUBORDINATED NOTES PAYABLE............................................................ 115,000 115,000 -------- -------- Total liabilities......................................................................... 171,543 231,147 -------- -------- COMMITMENTS AND CONTINGENCIES (Note 7) MANDATORILY-REDEEMABLE PREFERRED STOCK, $.01 par value: 1,800 shares authorized; 318 and 356 shares issued and outstanding at December 25, 1998 and December 31, 1999, respectively; liquidation preference--$31,802 and $35,558 respectively.............................................. 30,802 34,558 Accrued preferred stock dividends, payable in kind........................................... 711 863 -------- -------- 31,513 35,421 -------- -------- STOCKHOLDERS' EQUITY: Common stock, no par value: 15,000 shares authorized; 6,313 and 8,544 shares issued and outstanding at December 25, 1998 and December 31, 1999, respectively...................... 63,125 91,748 Cumulative translation adjustment........................................................... - (398) Accumulated deficit......................................................................... (3,472) (12,957) -------- -------- Total stockholders' equity................................................................. 59,653 78,393 -------- -------- Total liabilities, mandatorily-redeemable preferred stock and stockholders' equity........ $262,709 $344,961 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. F-3 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 25, 1998 AND FOR THE YEAR ENDED DECEMBER 31, 1999 (In thousands)
1998 1999 ---- ----- NET SALES......................................................................... $76,232 $128,803 COST OF SALES..................................................................... 44,662 77,678 ------- -------- Gross profit.................................................................... 31,570 51,125 ------- -------- OPERATING EXPENSES: Selling.......................................................................... 8,032 13,122 Distribution..................................................................... 2,471 4,647 General and administrative....................................................... 7,129 14,732 Research and development......................................................... 726 2,031 Amortization of goodwill......................................................... 3,785 5,080 ------- -------- Total operating expenses........................................................ 22,143 39,612 ------- -------- Income from operations.......................................................... 9,427 11,513 OTHER EXPENSES: Interest expense................................................................. 11,100 17,675 Other, net....................................................................... (99) 920 ------- -------- 11,001 18,595 ------- -------- Loss before benefit for income taxes.............................................. (1,574) (7,082) BENEFIT FOR INCOME TAXES (Note 8)................................................. (614) (1,508) ------- -------- Net loss.......................................................................... (960) (5,574) OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation loss................................................ - (398) ------- -------- Comprehensive loss................................................................ $ (960) $ (5,972) ======= ========
The accompanying notes are an integral part of these consolidated financial statements. F-4 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 31, 1998 AND FOR THE YEAR ENDED DECEMBER 31, 1999 (In thousands)
Common Stock Cumulative ------------------ Translation Accumulated Shares Amount Adjustment Deficit Total ------- -------- ------------ ------------ --------- BALANCE, April 7, 1998............................................... - $ - $ - $ - $ - Sale of common stock.............................................. 6,313 63,125 - - 63,125 Pay-in-kind preferred stock dividends............................. - - - (2,512) (2,512) Net loss.......................................................... - - - (960) (960) ----- ------- -------- -------- ------- BALANCE, December 25, 1998........................................... 6,313 63,125 - (3,472) 59,653 Sale of common stock.............................................. 2,231 28,623 - - 28,623 Pay-in-kind preferred stock dividends............................. - - - (3,911) (3,911) Foreign currency translation loss................................. - - (398) - (398) Net loss.......................................................... - - - (5,574) (5,574) ----- ------- -------- -------- ------- BALANCE, December 31, 1999........................................... 8,544 $91,748 $(398) $(12,957) $78,393 ===== ======= ======== ======== =======
The accompanying notes are an integral part of these consolidated financial statements. F-5 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 25, 1998 AND FOR THE YEAR ENDED DECEMBER 31, 1999 (In thousands)
1998 1999 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss............................................................. $ (960) $ (5,574) Adjustments to reconcile net loss to net cash provided by operating activities-- Depreciation and amortization..................................... 8,507 15,655 Amortization of deferred financing costs.......................... - 1,374 Gain on disposal of equipment.................................... - (5) Change in deferred tax asset..................................... - (1,709) Changes in operating assets and liabilities: Increase in accounts receivable............................... (7,089) (2,701) Increase in inventories....................................... (1,215) (2,865) (Increase) decrease in other current assets................... 316 (1,194) Decrease in other assets...................................... 526 13 Increase (decrease) in accounts payable....................... 3,243 (741) Increase in accrued liabilities............................... 526 4,277 Increase in other current liabilities......................... - 1,526 Increase (decrease) in other liabilities...................... - (959) --------- -------- Net cash provided by operating activities................... 3,854 7,097 --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of majority interest in Hudson Respiratory Care Inc...... (248,000) - Purchases of property, plant and equipment........................... (3,121) (10,973) Proceeds from sale of property, plant and equipment.................. - 23 Increase in notes receivable and intangible assets................... - (354) Additions of deferred financing costs................................ - 154 Acquisition of certain assets of Gibeck, Inc......................... (3,351) - Acquisition of certain assets of Medimex............................. - (2,168) Acquisition of certain assets of Tyco................................ - (23,750) Acquisition of Louis Gibeck AB stock, net of cash acquired of $8,208........................................................ - (38,750) --------- -------- Net cash used in investing activities....................... (254,472) (75,818) --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable to bank................................... (2,000) (17,355) Proceeds from bank borrowings........................................ 46,000 59,376 Proceeds from senior subordinated notes payable...................... 115,000 - Proceeds from note payable to stockholder............................ - 22,000 Repayment of note payable to stockholder............................. - (14,492) Net proceeds from sale of common and mandatorily-redeemable preferred stock, net of transaction costs........................... 92,125 22,000 --------- -------- Net cash provided by financing activities................... 251,125 71,529 --------- -------- Effect of exchange rate changes on cash - (398) NET INCREASE IN CASH AND CASH EQUIVALENTS 507 2,410 CASH AND CASH EQUIVALENTS, beginning of period........................ - 507 --------- -------- CASH AND CASH EQUIVALENTS, end of period.............................. $ 507 $ 2,917 ========= ========
F-6
1998 1999 ---- ---- (in thousands) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for-- Interest....................................................... $8,742 $15,333 ====== ======= Income taxes................................................... $1,699 $ 27 ====== ======= DETAILS OF ACQUISITIONS (Note 2): Acquisition price................................................. $3,351 $79,499 Less: Common stock issued for acquisition............................. - (6,623) Cash acquired................................................... - (8,208) ------ ------- Net cash paid for acquisitions.............................. $3,351 $64,668 ====== =======
NON-CASH OPERATING ACTIVITIES: Net loss in 1999 includes approximately $2,825,000 of non-cash expense related to the recognition of the portion of purchase price allocation related to acquired inventories. NON-CASH FINANCING ACTIVITIES: The Company satisfies its preferred dividend requirements by the issuance of additional shares of preferred stock. Such accrued dividend requirements totaled $6,421,000 from the date of issuance of the preferred stock through December 31, 1999; preferred stock with an approximate face value of $1,801,000 was issued in 1998, $3,757,000 was issued in 1999 and $863,000 will be issued in 2000. Holding issued common stock to an affiliate of its existing majority shareholder in partial consideration for the contribution of Louis Gibeck AB stock (see Note 2). The accompanying notes are an integral part of these consolidated financial statements. F-7 RIVER HOLDING CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999 1. Company Background River Holding Corp. ("Holding"), is a Delaware corporation formed to purchase and hold a majority interest in Hudson Respiratory Care Inc. ("Hudson" or the "Company"), a California corporation founded in 1945. Hudson is a manufacturer and marketer of disposable medical products utilized in the respiratory care and anesthesia segments of the domestic and international health care markets. The Company's respiratory care and anesthesia product lines include such products as oxygen masks, humidification systems, nebulizers, cannulae and tubing. In the United States, the Company markets its products to a variety of health care providers, including hospitals and alternate site service providers such as outpatient surgery centers, long-term care facilities, physician offices and home health care agencies. Internationally, the Company sells its products to distributors that market to hospitals and other health care providers. The Company's products are sold to distributors and alternate site service providers throughout the United States and internationally. The Company's respiratory product operations are conducted from its primary facility in Temecula, California, facilities in Arlington Heights and Elk Grove, Illinois, and a facility in Ensenada, Mexico. The Company's anesthesia product operations are conducted from facilities located principally in Sweden and Malaysia, which were acquired in July 1999 (see Note 2). Recapitalization In April 1998, the Company consummated a plan pursuant to which a majority interest in the Company was sold in accordance with an agreement and plan of merger (the "Recapitalization"). Key components of the Recapitalization included: (1) Common and preferred equity investments in consideration for an 80.8% ownership in the Company's common stock and preferred stock with an initial liquidation preference of $30.0 million (see Note 4) (2) Issuance of 9-1/8% senior subordinated notes with a par value of $115.0 million, maturing in 2008 (see Note 5) (3) Execution of a new term loan facility and revolving loan facility (see Note 5) (4) Repayment of existing indebtedness (5) Payment of amounts due under the Equity Participation Plan (6) Payment for common shares acquired from the existing shareholder; this shareholder retained a 19.2% interest in the common shares outstanding (7) Potential contingent payments based on 1998 performance, payable to the continuing shareholder and former participants in the Equity Participation Plan; however, as a result of the Company's 1998 performance, no additional amounts are due. The Company has terminated the Equity Participation Plan and plans to adopt an executive stock purchase plan and a stock option plan. Additionally, Hudson's sole shareholder, who owned the remaining 21.0% of Industrias Hudson ("Industrias"), a subsidiary of the Company, transferred this interest to the Company in consideration of one dollar. Because of the commonality of ownership, the 21.0% minority interest has been included in the financial statements for all periods presented. On April 7, 1998, Holding acquired a majority interest in Hudson, as discussed above. The investment in Hudson by Holding was accounted for as a purchase and the purchase price has been allocated as follows based upon management's estimate of relative fair value of assets acquired and liabilities assumed (amounts in thousands): F-8
Assets acquired: Current assets and other.................................. $ 33,044 Property, plant and equipment............................. 47,821 Deferred tax asset........................................ 9,020 Deferred financing costs.................................. 12,917 Goodwill.................................................. 152,442 -------- 255,244 Less liabilities assumed: Current liabilities....................................... 7,244 -------- Total purchase price paid................................... $248,000 ========
Goodwill is being amortized using a 30-year life. Holding has no operations apart from those conducted by Hudson. The accompanying consolidated statement of operations for 1998 includes the results of Hudson for the period from March 27, 1998 to December 25, 1998 (Hudson's fiscal second, third and fourth quarters). Management believes the impact of including Hudson's results of operation for the period from March 27, 1998 to April 7, 1998 is not material to the accompanying consolidated financial statements. The minority interest in the Company was initially recorded at zero and the Company's losses for the periods ended December 25, 1998 and December 31, 1999 have been solely allocated to Holding. 2. Acquisitions Gibeck, Inc. During 1998, the Company acquired certain assets of Gibeck Inc. ("Gibeck"), a subsidiary of Louis Gibeck AB, for a cash purchase price of $3,351,000. Gibeck engages primarily in the business of manufacturing, marketing, and selling custom anesthesia circuits. The acquisition was accounted for as a purchase and the purchase price was allocated as follows (amounts in thousands): Goodwill........................... $1,817 Inventory.......................... 871 Machinery and equipment............ 663 ------ $3,351 ======
Louis Gibeck AB On July 22, 1999, the Company acquired substantially all of the outstanding capital stock of Louis Gibeck AB ("LGAB") and subsidiaries, a Swedish company engaged primarily in the business of manufacturing, marketing and selling respiratory and anesthesia equipment. The purchase price was approximately $53.6 million, which included cash consideration of approximately $45.5 million (including approximately $8.2 million of cash acquired), a non-cash contribution of shares of common stock of Holding for approximately $6.6 million and transaction expenses of approximately $1.5 million. The acquisition was funded with (i) a $22.0 million common stock sale to Holding's existing majority stockholder (ii) a $22.0 million, 12% per annum unsecured note payable to an affiliate of Holding's existing majority stockholder due August 1, 2006 and (iii) a $5.9 million unsecured bank loan bearing interest at the bank's reference rate plus 1/4% per annum due July 30, 2006. The acquisition of LGAB was accounted for as a purchase and the purchase price was preliminarily allocated based upon management's estimate of the assets acquired and liabilities assumed as follows (amounts in thousands): F-9 Cash............................. $ 8,208 Accounts receivable.............. 1,823 Inventories...................... 5,161 Fixed assets..................... 1,206 Other assets..................... 2,939 Current liabilities.............. (4,856) Non-current liabilities.......... (4,123) Goodwill......................... 43,223 ------- $53,581 =======
The Company is evaluating estimates made in conjunction with the purchase price allocation, which may change in the near term. Had this acquisition and the acquisition of certain assets of Gibeck, Inc. occurred at the beginning of the current fiscal year, the unaudited pro forma net sales, net loss before extraordinary item and net loss would be as follows (amounts in thousands):
December 31, 1999 ----------------- (unaudited) Net sales............................ $139,494 Net loss before extraordinary item... (6,295) Net loss............................. (6,295)
Acquisition of Product Line On November 8, 1999, the Company acquired certain assets of Tyco Healthcare Group LP ("Tyco"), including Tyco's incentive breathing exerciser and pulmonary function monitor product lines, for a cash purchase price of approximately $23.8 million. The acquisition was accounted for as a purchase and the purchase price was allocated as follows (amounts in thousands): Goodwill..................................... $18,750 Machinery and equipment...................... 3,000 Deposit...................................... 2,000 ------- $23,750 =======
Acquisition of Distributor In October 1999, the Company acquired certain assets of Medimex, a German distributor of respiratory products, for a cash purchase price of approximately $2.2 million. The acquisition was accounted for as a purchase and the purchase price was allocated as follows (amounts in thousands): Goodwill......................... $1,300 Inventory........................ 900 ------ $2,200 ======
3. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements and related notes include the accounts of River Holding Corp. and its wholly-owned subsidiaries. All significant intercompany account balances and transactions have been eliminated in consolidation. Use of Estimates F-10 The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories Inventories are stated at the lower of cost (first-in, first-out (FIFO) method) or market. At December 25, 1998 and December 31, 1999, inventories consisted of the following (amounts in thousands):
1998 1999 ---- ---- Raw materials.......................... $ 5,127 $ 5,901 Work-in-process........................ 5,926 5,682 Finished goods......................... 6,971 12,460 ------- ------- $18,024 $24,043 ======= =======
Raw materials principally consist of bulk resins. Work-in-process and finished goods include raw materials, labor and overhead costs. Certain finished goods are purchased for resale and are not manufactured. As of December 25, 1998, the Company changed its method for allocating manufacturing overhead costs for all domestic production. The Company now allocates such costs based on machine hours rather than direct labor hours. As the Company has increased the automation of its processes, management believes this method is preferable to its prior method. Under APB Opinion No. 20, "Accounting Changes," this change is considered to be a change in estimate indistinguishable from a change in method. Accordingly, the effect of $1,085,000 for the year ended December 25, 1998 is reflected in operating income as a reduction to cost of sales. Foreign Currency Translation The Company follows the principles of Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation," generally using the local currency as the functional currency of its operating subsidiaries. Accordingly, all assets and liabilities outside the United States are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date. Income and expense items are translated at the weighted-average exchange rate prevailing during the period. Beginning in the second quarter of 1998, the Company commenced using the U.S. dollar as the functional currency of its Mexican operations since Mexico was considered a highly inflationary economy. Management believes that the effect of not using the U.S. dollar as the functional currency from January 1, 1997 was not material to the financial statements. Beginning in January 1999, Mexico was no longer considered a highly inflationary economy and, accordingly, the Company resumed using the Mexican Peso as the functional currency. Revenue Recognition The Company recognizes revenue when product is shipped. The Company establishes reserves for sales returns and other allowances based on historical experience. Income Taxes The Company and Holding apply the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities are determined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates and laws. Additionally, deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. F-11 Fiscal Year-End The Company and Holding report their operations on a 52-53 week fiscal year ending on the Friday closest to December 31. The fiscal years ended December 26, 1997 and December 25, 1998 were both 52-week years. The fiscal year ended December 31, 1999 was a 53-week year. Post-Employment and Post-Retirement Benefits The Company and Holding do not provide post-employment or post-retirement benefits to employees. Accordingly, SFAS No. 112, "Employers' Accounting for Post-employment Benefits", and SFAS No. 106, "Employers' Accounting for Post- retirement Benefits", have no impact on the Company's financial statements. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, which is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments. The statement requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Management has not yet determined the impact this standard will have on the Company or Holding. Reclassifications Certain reclassifications have been made in the 1998 statements to conform to the 1999 presentation. 4. Preferred Stock Upon consummation of the Recapitalization, Holding issued 300,000 shares of Series B Senior Exchangeable Payable-In-Kind ("PIK") Preferred Stock subject to mandatory redemption at a liquidation preference of $100 per share, plus accumulated and unpaid dividends, if any, on April 15, 2010. Net proceeds from the original issuance were $29.0 million. Dividends on the preferred stock accrue at the rate per share of 11-1/2% per annum. Amounts due are payable in cash, except that on each dividend payment date occurring on or prior to April 15, 2003, dividends may be paid at Holding's option, by the issuance of additional shares of preferred stock (including fractional shares). Dividends will be payable semi-annually on April 15 and October 15 of each year commencing October 15, 1998. The preferred stock will rank junior in right of payment to all obligations of Holding and its subsidiaries. Holding issued PIK preferred stock with a liquidation preference of approximately $1,801,000 and $3,762,000 to satisfy the dividend requirements in 1998 and 1999, respectively. As of December 25, 1998 and December 31, 1999, Holding accrued for PIK preferred stock dividends in the amount of $711,000 and $863,000, respectively. The ability of Holding to pay cash dividends on its preferred stock is dependent upon Hudson's ability to pay cash dividends to Holding. There can be no assurance that Hudson will make such divided payments. 5. Long-Term Debt Obligations Summary of Amounts Outstanding The Company's long-term debt obligations as of December 25, 1998 and December 31, 1999 consist of the following (amounts in thousands): F-12
1998 1999 ---- ---- Borrowings under revolving credit facility.. $ 38,000 $ 36,600 Term loan payable to domestic banks......... 6,000 35,000 Term loan payable to Swedish bank........... - 17,586 Senior subordinated notes................... 115,000 115,000 Note payable to affiliate................... - 7,508 -------- -------- 159,000 211,694 Less current portion........................ (3,000) (6,673) -------- -------- Long-term debt.............................. $156,000 $205,021 ======== ========
Credit Facility In connection with the Recapitalization, the Company entered into a new credit agreement with a bank group, which provides for borrowings of up to $100 million. This agreement consists of two separate facilities as follows: 1.) Revolving credit--maximum borrowings of $60.0 million with a letter of credit sub-limit of $7.5 million. This facility must be prepaid upon payment in full of the Term Loan facility. 2.) Term loan--maximum borrowings of $40.0 million with quarterly installments to be made through maturity. Interest on the Credit Facility is based, at the option of the Company, upon either an optional eurodollar rate (as defined) plus 2.25%, or a base rate (as defined) plus 1.25% per annum. A commitment fee of 0.50% per annum will be charged on the unused portion of the Credit Facility. The following summarizes interest rate data on the Credit Facility as of December 25, 1998 and December 31, 1999:
1998 1999 ---- ---- Eurodollar rate......................................................... 5.1875% 6.0625% Base rate............................................................... 7.75% 8.5% Term loan facility rate................................................. 7.4375% 8.75% Revolving credit facility rate.......................................... 7.8125% to 8.5625% to 9% 10%
Total borrowings as of December 31, 1999 were $35.0 million and $36.6 million under the Term Loan Facility and Revolving Credit Facility, respectively. The Credit Facility will mature on April 7, 2004. The agreement provides the bank a first security interest in substantially all of the properties and assets of the Company and a pledge of 65% of the stock of Industrias, a subsidiary of the Company. The agreement also requires the Company to maintain certain financial ratios and financial covenants, as defined in the agreement, the most restrictive of which prohibit additional indebtedness and limit dividend payments to the Company's stockholders. As of December 31, 1999, the Company had available credit under the Revolving Loan Facility in the amount of $23.4 million ($16.8 million of which is restricted for use on future acquisitions). No additional borrowing is available under the Term Loan Facility. The Company is required under restrictive covenants of the Credit Facility Agreement to maintain certain financial ratios, and meet certain operating cash flow tests for which the Company was not in total compliance as of December 25, 1998. Subsequently, the Company amended its Credit Facility Agreement so that under the amended terms it was in compliance at December 25, 1998. The Company was in compliance with all amended restrictive covenants as of December 31, 1999. Senior Subordinated Notes Also related to the Recapitalization, the Company issued under an Indenture $115.0 million of senior subordinated notes (the "Notes"). The Notes are fully transferable and are general unsecured obligations of the Company, subordinated in right of payment to all existing and future senior debt, as defined, of the Company. F-13 The Notes bear interest at a rate equal to 9-1/8% per annum from the date of issuance of the Notes. Interest is payable semi-annually on April 15 and October 15 of each year, commencing October 15, 1998. The Notes will mature on April 15, 2008 and will be redeemable at the option of the Company, in whole or in part, on or after April 15, 2003. The fair value of the Company's senior subordinated notes at December 31, 1999 was approximately $92.2 million. The fair value is estimated based on the quoted market prices for issues listed on exchanges and is not intended to, and does not, represent the underlying fair value of the Company. Note Payable to Affiliate In connection with the acquisition of LGAB during 1999, the Company borrowed $22.0 million under an unsecured 12.0% note payable to an affiliate of Holding's existing majority stockholder. The note is due August 1, 2006. During 1999, the Company paid approximately $14.5 million in principal on the note. Bank Notes Payable The Company has bank borrowings of $17.6 million outstanding at December 31, 1999, which are denominated in Swedish krona. The borrowings bear interest at the 3-month STIBOR (the interest rate at or about 11:00 a.m. Stockholm time, two banking days before the draw-down date or the relevant interest period, quoted for deposits in krona) plus 0.75% to 1.75% (4.365% to 5.365% at December 31, 1999), are due December 21, 2003 and are secured by the common stock of LGAB. Future Debt Principal Payments As of December 31, 1999, future debt principal payments on the aforementioned debt are as follows (amounts in thousands):
Fiscal Year Ending: ------------------- 2000............................................. $ 6,673 2001............................................. 11,019 2002............................................. 13,019 2003............................................. 15,019 2004............................................. 43,456 Thereafter....................................... 122,508 -------- $211,694 ========
6. Detail of Selected Balance Sheet Accounts Property, Plant and Equipment The following is a summary as of December 25, 1998 and December 31, 1999 (amounts in thousands):
1998 1999 ---- ---- Land.................................... $ 4,007 $ 4,007 Buildings............................... 10,898 11,077 Leasehold improvements.................. 296 296 Machinery and equipment................. 31,979 39,243 Furniture and fixtures.................. 1,243 1,427 ------- -------- 48,423 56,050 Less -- Accumulated depreciation and (4,298) (13,409) amortization........................... ------- -------- 44,125 42,641 Equipment installation in progress...... 2,732 8,416 ERP software installation in progress... - 3,284 ------- -------- Property and equipment, net............. $46,857 $ 54,341 ======= ========
Depreciation of property, plant and equipment is provided using both straight-line and declining-balance methods over the following estimated useful lives: F-14
Buildings......................... 31.5 years Leasehold improvements............ Shorter of the useful life or lease term Machinery and equipment........... 5 to 7 years Furniture and fixtures............ 7 years
Upon retirement or disposal of depreciable assets, the cost and related accumulated depreciation are removed and the resulting gain or loss is reflected in income from operations. Major renewals and betterments are capitalized while maintenance costs and repairs are expensed in the year incurred. ERP software installation costs are capitalized in accordance with Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The Company expects to "go live" on the new ERP system approximately April 1, 2000. Total depreciation and amortization expense was approximately $8,507,000 and $15,655,000 for the years ended December 25, 1998 and December 31, 1999, respectively. Accrued Liabilities Accrued liabilities consisted of the following as of December 25, 1998 and December 31, 1999 (amounts in thousands):
1998 1999 ---- ---- Interest........................... $2,315 $ 4,162 Payroll and related................ 742 4,095 Vacation........................... 1,176 1,509 Pension............................ 809 1,353 Medical self-insurance............. 394 577 Other.............................. 783 4 ------ ------- $6,219 $11,700 ====== =======
7. Commitments and Contingencies The Company leases certain facilities, automobiles and office equipment under noncancellable leases, with the majority of the automobile leases having a term of one year with annual renewal provisions. All of these leases have been classified as operating leases. As of December 31, 1999, the Company had future obligations under operating leases as follows (amounts in thousands):
Fiscal Year Ending: -------------------- 2000............................... $ 681 2001............................... 297 2002............................... 297 2003............................... 109 2004............................... 82 ------ $1,466 ======
Rental expense was approximately $1,506,000 and $2,052,000, in fiscal 1998 and 1999, respectively. The Company self-insures the majority of its medical benefit programs. Reserves for losses totaling approximately $394,000 and $577,000 at December 25, 1998 and December 31, 1999, respectively, are established currently based upon estimated obligations and are included in accrued liabilities in the accompanying balance sheets. The Company maintains excess coverage on an aggregate claim basis. The Company is party to lawsuits and other proceedings, including suits relating to product liability and patent infringement. While the results of such lawsuits and other proceedings cannot be predicted with certainty, management does not expect that the ultimate liabilities, if any, will have a material adverse effect on the financial position or results of operations of the Company. F-15 8. Income Taxes Holding is a C corporation and the Company became a C corporation upon the occurrence of the Recapitalization discussed in Note 1. Holding's effective income tax rate for 1998 approximates the combined federal and state statutory rates of 39%. During 1999, the Company revised its estimate of the combined effective income tax rate to approximately 40%. The tax provision (benefit) for 1998 and 1999 consists of the following (amounts in thousands):
1998 1999 ------- -------- Income taxes at combined statutory rate of approximately 39% and 40% in 1998 and 1999, respectively................................................ $ (614) $(2,833) Foreign losses not benefited................................................. - 1,443 Other........................................................................ - (118) ------- ------- $ (614) $(1,508) ======= =======
The provision (benefit) for income taxes consists of the following (amounts in thousands):
United States International Total 1999 ------------- ------------- ----- Current..................................... $ - $ 340 $ 340 Deferred.................................... (1,370) (478) (1,848) -------- -------- -------- $(1,370) $ (138) $(1,508) ======== ======== ======== 1998 Current..................................... $ - $ - $ - Deferred.................................... (614) - (614) -------- ------- -------- $ (614) $ - $ (614) ======== ======= ========
The components of the deferred tax asset as of December 31, 1999 are (amounts in thousands):
December 25, December 31, 1998 1999 ----------- ----------- Basis differences arising from Section 338(h)(10) election................... $15,052 $11,381 Net operating loss carryforwards............................................. 5,595 9,019 Liabilities and allowances not currently deductible for tax purposes......... 1,170 2,443 Accelerated tax depreciation................................................. (4,743) (3,961) Other........................................................................ 262 266 ------- ------- 17,336 19,148 Valuation allowance.......................................................... (7,702) (7,806) ------- ------- $ 9,634 $11,342 ======= =======
Net operating loss carryforwards expire on various dates through 2019. In management's opinion, the net deferred tax asset is more likely than not to be realized. 9. Deferred Compensation and Benefit Plans Pension Plan The Company has a defined-contribution pension plan covering substantially all its employees. Amounts charged to expense relating to this plan totaled approximately $810,000 and $972,000 for the fiscal years ended 1998 and 1999, respectively. Deferred Compensation Effective December 1, 1994, the Company established a deferred-compensation plan for certain key employees. As of December 25, 1998 and December 31, 1999 no material amount of compensation has been deferred. 10. Geographic, Segment and Major Customer Information The Company has adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes new standards for reporting operating segments of publicly held companies. This approach requires the Company to present segment information externally the same way management uses financial data internally to make operating decisions and assess performance. SFAS No. 131 also requires that all public business enterprises report information about the revenues derived from the enterprise's products or services (or groups of similar products and services), about the countries in which the enterprise earns revenues and holds assets and about major customers regardless of whether that information is used in making operating decisions. The Company sells respiratory care products to distributors and medical facilities throughout the United States and internationally. During 1998 and 1999, the Company had foreign sales of approximately $20,148,000 and $28,497,000 respectively, which constituted approximately 20.0% and 22.1% of total sales, respectively. The Company's percentage of sales by geographic region for the fiscal years ended 1998 and 1999 were as follows:
1998 1999 ---- ---- Domestic...................................................... 79.9% 77.9% Europe........................................................ 7.8 10.1 Pacific Rim (Japan, Southeast Asia, Australia/New Zealand).... 6.2 6.1 Canada........................................................ 2.0 1.9 Other international........................................... 4.1 4.0 ----- ----- 100.0% 100.0% ===== =====
F-16 Although the information presented above for the period from April 7, 1998 (Inception) to December 25, 1998 reflects full twelve-month activity for Hudson, management does not believe that the corresponding percentage relationships in the nine-month activity for Holding would be materially different. The following summarizes the net book value of fixed assets at the respective locations as of December 25, 1998 and December 31, 1999 (amounts in thousands):
December 25, December 31, 1998 1999 ---- ---- Ensenada, Mexico........................................ $ 1,060 $ 1,134 Stockholm, Sweden....................................... - 342 Kuala Lumpur, Malaysia.................................. - 741 United States........................................... 45,797 52,124 ------- ------- $46,857 $54,341 ======= =======
For the fiscal years ended 1998 and 1999, the Company had sales to one domestic distributor in the amount of $24,940,000 and $24,491,000, respectively, which represented approximately 24.8% and 19.0% of sales, respectively. Additionally, the Company had sales to another domestic distributor of $10,265,000 and 14,775,000 that accounted for approximately 10.2% and 11.5% of sales in 1998 and 1999, respectively. 11. Unaudited Consolidated Quarterly Data
1998 Quarters Ended --------------------------------------- June 26 September 25 December 25 --------- ------------- ------------ (amounts in thousands) Net sales................................................. $24,265 $ 22,130 $29,837 Gross profit.............................................. 11,239 10,316 10,015 Net income (loss)......................................... 1,498 (3,444) 986 1999 Quarters Ended --------------------------------------------------- March 26 June 25 September 24 December 31 -------- -------- ------------ ----------- (amounts in thousands) Net sales................................................ $27,169 $27,274 $ 30,827 $ 43,533 Gross profit............................................. 11,729 11,531 12,309 15,556 Net income (loss)........................................ (820) (774) (2,654) (1,326)
F-17 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Hudson Respiratory Care Inc.: We have audited the accompanying consolidated balance sheets of HUDSON RESPIRATORY CARE INC., (a California Corporation) and subsidiaries as of December 25, 1998 and December 31, 1999, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows (as restated, see Note 15) for the years ended December 26, 1997, December 25, 1998 and December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hudson Respiratory Care Inc. and subsidiaries as of December 25, 1998 and December 31, 1999, and the results of their operations and their cash flows for the years ended December 26, 1997, December 25, 1998 and December 31, 1999 in conformity with accounting principles generally accepted in the United States. As more fully described in Note 15 to the financial statements, the net effect of the Company's conversion from S to C corporation status and the related Section 338(h)(10) election to increase the tax bases of assets in connection with the Recapitalization of $77,064,000 was previously reflected in operations during the quarter ended June 26, 1998. This amount should have been reflected as a direct credit to retained earnings. The restatement had no impact on ending retained earnings for the periods presented. /s/ ARTHUR ANDERSEN LLP Orange County, California March 24, 2000 F-18 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) ASSETS
December December 25, 1998 31, 1999 ----------- ----------- CURRENT ASSETS: Cash....................................................................................... $ 507 $ 2,917 Accounts receivable, less allowance for doubtful accounts of $794 and $973 at December 25, 1998 and December 31, 1999, respectively................................................ 25,829 30,425 Inventories................................................................................ 18,024 24,043 Other current assets....................................................................... 716 4,612 ---------- ---------- Total current assets.................................................................... 45,076 61,997 PROPERTY, PLANT AND EQUIPMENT, net........................................................... 32,732 42,476 OTHER ASSETS: Intangible assets, net..................................................................... 4,955 66,970 Deferred financing costs, net of accumulated amortization of $1,000 and $2,253 at December 25, 1998 and December 31, 1999, respectively............................................ 11,917 11,134 Deferred tax asset......................................................................... 70,329 68,943 Other...................................................................................... 312 299 ---------- ---------- Total other assets...................................................................... 87,513 147,346 ---------- ---------- Total assets................................................................... $ 165,321 $ 251,819 ========== ========== LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Notes payable to banks.................................................................... $ 3,000 $ 6,673 Accounts payable.......................................................................... 6,324 6,168 Accrued liabilities....................................................................... 6,219 11,700 Other current liabilities................................................................. - 1,485 ---------- ---------- Total current liabilities............................................................... 15,543 26,026 NOTE PAYABLE TO AFFILIATE.................................................................... - 7,508 NOTES PAYABLE TO BANKS, net of current portion............................................... 41,000 82,513 SENIOR SUBORDINATED NOTES PAYABLE............................................................ 115,000 115,000 ---------- ---------- Total liabilities....................................................................... 171,543 231,047 ========== ========== COMMITMENTS AND CONTINGENCIES (Note 7) MANDATORILY-REDEEMABLE PREFERRED STOCK, $.01 par value: 1,800 shares authorized; 318 and 356 shares issued and outstanding at December 25, 1998 and December 31, 1999, respectively; liquidation preference--$31,802 and $35,558 respectively (Note 4)....................................................... 30,802 34,558 Accrued preferred stock dividends, payable in kind......................................... 711 863 ---------- ---------- 31,513 35,421 ========== ========== STOCKHOLDERS' EQUITY (DEFICIT): Common stock, no par value: 15,000 shares authorized; 7,813 and 10,044 shares issued and outstanding at December 25, 1998 and December 31, 1999, respectively................ 63,535 92,158 Cumulative translation adjustment......................................................... (464) (862) Accumulated deficit....................................................................... (100,806) (105,945) ---------- ---------- Total stockholders' equity (deficit).................................................... (37,735) (14,649) ---------- ---------- Total liabilities, mandatorily-redeemable preferred stock and stockholders' equity (deficit) ....................................................................... $ 165,321 $ 251,819 ========== ==========
The accompanying notes are an integral part of these consolidated balance sheets. F-19 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands)
For the Years Ended ---------------------------------------------------- December 25, 1998 (As December 26, Restated; See December 31, 1997 Note 15) 1999 -------------- ---------------- --------------- NET SALES..................................................... $ 99,509 $ 100,498 $ 128,803 COST OF SALES 54,575 56,802 75,418 ------------- ---------- ------------- Gross profit............................................. 44,934 43,696 53,385 ------------- ---------- ------------- OPERATING EXPENSES: Selling.................................................... 9,643 10,350 13,122 Distribution............................................... 3,170 3,336 4,647 General and administrative................................. 11,456 10,284 14,732 Research and development................................... 1,072 976 2,031 ------------- ---------- ------------- Total operating expenses................................. 25,341 24,946 34,532 ------------- ---------- ------------- PROVISION FOR EQUITY PARTICIPATION PLAN AND RETENTION PAYMENTS................................................... (6,954) (68,693) - ------------- ---------- ------------- Income (loss) from operations............................ 12,639 (49,943) 18,853 OTHER INCOME AND (EXPENSES): Interest expense........................................... (1,834) (11,327) (17,263) Other, net................................................. 638 (406) (1,232) ------------- ---------- ------------- (1,196) (11,733) (18,495) ------------- ---------- ------------- Income (loss) before provision for income taxes and extraordinary item............................................ 11,443 (61,676) 358 PROVISION FOR INCOME TAXES.................................... 150 8,405 1,586 ------------- ---------- ------------- Income (loss) before extraordinary item....................... 11,293 (70,081) (1,228) EXTRAORDINARY ITEM-loss on extinguishment of debt............. - 104 - ------------- ---------- ------------- Net income (loss)............................................. 11,293 (70,185) (1,228) OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation loss.......................... (148) (119) (398) ------------- ---------- ------------- Comprehensive income (loss)................................... $ 11,145 $ (70,304) $ (1,626) ============= ========== ============= Pro forma net income (loss) assuming conversion to C corporation for income tax purposes (Note 8).................. $ 6,866 $ (37,006) ============= ==========
The accompanying notes are an integral part of these consolidated financial statements. F-20 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands)
Retained Earnings (Accumulated Common Stock Cumulative Deficit)(As -------------------- Translation Restated; Shares Amount Adjustment See Note 15) Total -------- ------- ---------- ----------- -------- BALANCE, December 27, 1996........................ 14,469 $ 3,789 $ (197) $ 16,280 $ 19,872 Stockholder distributions....................... - - - (8,502) (8,502) Foreign currency translation loss............... - - (148) - (148) Net income...................................... - - - 11,293 11,293 ------- --------- --------- ---------- ---------- BALANCE, December 26, 1997........................ 14,469 3,789 (345) 19,071 22,515 Stockholder redemption.......................... (12,969) (3,379) - (124,244) (127,623) Foreign currency translation loss............... - - (119) - (119) Recapitalization investment..................... 6,300 63,000 - - 63,000 Issuance of common stock........................ 13 125 - - 125 Pay-in-kind preferred stock dividends........... - - (2,512) (2,512) Effect of Section 338(h)(10) election on deferred taxes.................................. - - 77,064 77,064 Net loss........................................ - - - (70,185) (70,185) ------- --------- --------- ---------- ---------- BALANCE, December 25, 1998........................ 7,813 63,535 (464) (100,806) (37,735) Issuance of common stock to parent for cash and contribution of Louis Gibeck AB Stock....... 2,231 28,623 - - 28,623 Foreign currency translation loss............... - - (398) - (398) Pay-in-kind preferred stock dividends........... - - - (3,911) (3,911) Net loss........................................ - - - (1,228) (1,228) ------- --------- --------- ---------- ---------- BALANCE, December 31, 1999........................ 10,044 $ 92,158 $ (862) $ (105,945) $ (14,649) ======= ========= ========= ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. F-21 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For the Years Ended --------------------------------------------- December 25, 1998 (As December 26, Restated; See December 31, 1997 Note 15) 1999 ------ -------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)............................................. $ 11,293 $(70,185) $ (1,228) Adjustments to reconcile net income to net cash provided by (used in) operating activities-- Depreciation and amortization............................ 5,847 6,101 8,315 Amortization/write-off of deferred financing costs and other.............................................. - 1,119 1,374 (Gain) loss on disposal of equipment..................... (618) 14 (5) Change in deferred tax asset............................. - 6,735 1,385 Changes in operating assets and liabilities: Increase in accounts receivable.......................... (550) (4,547) (2,701) Increase in inventories.................................. (2,596) (1,411) (2,865) (Increase) decrease in other current assets.............. 96 437 (1,194) (Increase) decrease in other assets...................... (100) 247 13 Increase (decrease) in accounts payable.................. (12) 2,482 (741) Increase (decrease) in accrued liabilities............... (130) 1,687 4,277 Increase (decrease) in management bonus accrual.......... 20,000 (20,000) - Increase (decrease) in other current liabilities......... - - 1,426 Increase (decrease) in other non-current liabilities..... - - (959) Increase (decrease) in accrued equity participation...... (13,961) 83,939 - plan (EPP)............................................... Payment of EPP liabilities and retention bonuses......... - (89,642) - -------- -------- -------- Net cash provided by (used in) operating activities........................................... 19,269 (83,024) 7,097 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment.................... (4,659) (3,111) (10,973) Proceeds from sale of property, plant and equipment........... 1,068 18 23 Increase in notes receivable and intangible assets............ (82) - (354) Additions of deferred financing costs......................... - - 154 Acquisition of certain assets of Gibeck, Inc.................. - (3,351) - Acquisition of certain assets of Medimex...................... - - (2,168) Acquisition of certain assets of Tyco......................... - - (23,750) Acquisition of Louis Gibeck AB stock, net of cash acquired of $8,208............................................ - - (38,750) -------- -------- -------- Net cash used in investing activities................ (3,673) (6,444) (75,818) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable to bank............................ (14,396) (43,250) (17,355) Proceeds from bank borrowings................................. 6,500 67,000 59,376 Stockholder distributions..................................... (8,502) - - Additions to deferred financing costs......................... - (12,918) - Redemption of stockholder interest............................ - (127,623) - Proceeds from senior subordinated notes payable............... - 115,000 - Proceeds from note payable to affiliate....................... - - 22,000 Repayment of note payable to affiliate........................ - - (14,492) Net proceeds from sale of common and mandatorily-redeemable preferred stock, net of transaction costs............................................. - 91,415 22,000 -------- -------- -------- Net cash (used in) provided by financing activities........................................... (16,398) 89,624 71,529 -------- -------- -------- Effect of exchange rate changes on cash.......................... (148) (119) (398) NET (DECREASE) INCREASE IN CASH.................................. (950) 37 2,410 CASH, beginning of period........................................ 1,420 470 507 -------- -------- -------- CASH, end of period.............................................. $ 470 $ 507 $ 2,917 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-22
For the Years Ended ----------------------------------------------- December 25, 1998 (As December 26, Restated; See December 31, 1997 Note 15) 1999 ------ ------------- ----- (In thousands) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for-- Interest.......................................... $ 1,969 $ 8,742 $ 15,333 ========== ========== ========== Income taxes...................................... $ 243 $ 1,699 $ 27 ========== ========== ========== DETAILS OF ACQUISITIONS (Note 2): Acquisition price................................... $ - $ 3,351 $ 79,499 Less: Common stock issued for acquisition............... - - (6,623) Cash acquired..................................... - - (8,208) ---------- ---------- ---------- Net cash paid for acquisitions.............. $ - $ 3,351 $ 64,668 ========== ========== ==========
NON-CASH OPERATING ACTIVITIES: Net income includes approximately $2,825,000 of non-cash expense related to the recognition of the portion of purchase price allocation related to acquired inventories. NON-CASH FINANCING ACTIVITIES: The Company satisfies its preferred dividend requirements by the issuance of additional shares of preferred stock. Such accrued dividend requirements totaled $6,421,000 from the date of issuance of the preferred stock through December 31, 1999; preferred stock with an approximate face value of $1,801,000 was issued in 1998, $3,757,000 was issued in 1999 and $863,000 will be issued in 2000. The Company issued common stock to its parent in partial consideration for the contribution of Louis Gibeck AB stock (see Note 2). The accompanying notes are an integral part of these consolidated financial statements. F-23 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999 1. Company Background Hudson Respiratory Care Inc. ("Hudson" or the "Company"), a California corporation founded in 1945, is a manufacturer and marketer of disposable medical products utilized in the respiratory care and anesthesia segments of the domestic and international health care markets. The Company's respiratory care and anesthesia product lines include such products as oxygen masks, humidification systems, nebulizers, cannulae and tubing. In the United States, the Company markets its products to a variety of health care providers, including hospitals and alternate site service providers such as outpatient surgery centers, long-term care facilities, physician offices and home health care agencies. Internationally, the Company sells its products to distributors that market to hospitals and other health care providers. The Company's products are sold to distributors and alternate site service providers throughout the United States and internationally. The Company's respiratory product operations are conducted from its primary facility in Temecula, California, facilities in Arlington Heights and Elk Grove, Illinois, and a facility in Ensenada, Mexico. The Company's anesthesia product operations are conducted from facilities located principally in Sweden and Malaysia, which were acquired in July 1999 (see Note 2). Recapitalization In April 1998, the Company consummated a plan pursuant to which a majority interest in the Company was sold in accordance with an agreement and plan of merger (the "Recapitalization"). Key components of the Recapitalization included: (1) Common and preferred equity investments in consideration for an 80.8% ownership in the Company's common stock and preferred stock with an initial liquidation preference of $30.0 million (2) Issuance of 9-1/8% senior subordinated notes with a par value of $115.0 million, maturing in 2008 (see Note 5) (3) Execution of a new term loan facility and revolving loan facility (see Note 5) (4) Repayment of existing indebtedness (5) Payment of amounts due under the Equity Participation Plan (see Note 10) (6) Payment for common shares acquired from the existing shareholder; this shareholder retained a 19.2% interest in the common shares outstanding (7) Potential contingent payments based on 1998 performance, payable to the continuing shareholder and former participants in the Equity Participation Plan; however, as a result of the Company's 1998 performance, no additional amounts were due. The Company has terminated the Equity Participation Plan and plans to adopt an executive stock purchase plan and a stock option plan. Additionally, Hudson's sole shareholder, who owned the remaining 21.0% of Industrias Hudson ("Industrias"), a subsidiary of the Company, transferred this interest to the Company in consideration of one dollar. Because of the commonality of ownership, the 21.0% minority interest has been included in the financial statements for all periods presented. The Company effected a 245:1 stock split concurrent with the Recapitalization. The stock split has been reflected in the stock amounts shown herein. F-24 The Recapitalization resulted in no change to the carrying amounts of the Company's existing assets and liabilities. The Company has recorded a deferred tax asset due to the conversion from S to C corporation status and a tax election to revalue the basis of assets and liabilities for tax purpose s. 2. Acquisitions Gibeck, Inc. During 1998, the Company acquired certain assets of Gibeck Inc. ("Gibeck"), a subsidiary of Louis Gibeck AB, for a cash purchase price of $3,351,000. Gibeck engages primarily in the business of manufacturing, marketing, and selling custom anesthesia circuits. The acquisition was accounted for as a purchase and the purchase price was allocated as follows (amounts in thousands): Goodwill..................................... $1,817 Inventory.................................... 871 Machinery and equipment...................... 663 ------ $3,351 ======
Louis Gibeck AB On July 22, 1999, the Company acquired substantially all of the outstanding capital stock of Louis Gibeck AB ("LGAB") and subsidiaries, a Swedish company engaged primarily in the business of manufacturing, marketing and selling respiratory and anesthesia equipment. The purchase price was approximately $53.6 million, which included cash consideration of approximately $45.5 million (including approximately $8.2 million of cash acquired), a non-cash contribution of shares of common stock of River Holding Corp., a Delaware corporation and the Company's parent, of $6.6 million and transaction expenses of approximately $1.5 million. The acquisition was funded with (i) a $22.0 million common stock sale to the Company's existing majority shareholder, (ii) a $22.0 million, 12.0% per annum unsecured note payable to an affiliate of the Company's existing majority shareholder due August 1, 2006 and (iii) a $5.9 million unsecured bank loan bearing interest at the bank's reference rate plus 1/4% per annum due July 30, 2006. The acquisition of LGAB was accounted for as a purchase and the purchase price was preliminarily allocated based upon management's estimate of the assets acquired and liabilities assumed as follows (amounts in thousands): Cash......................................... $ 8,208 Accounts receivable.......................... 1,823 Inventories.................................. 5,161 Fixed assets................................. 1,206 Current liabilities.......................... (4,856) Non-current liabilities...................... (4,123) Other assets................................. 2,939 Goodwill..................................... 43,223 ------- $53,581 =======
The Company is evaluating estimates made in conjunction with the purchase price allocation, which may change in the near term. Had this acquisition and the acquisition of certain assets of Gibeck, Inc. occurred at the beginning of the current and prior fiscal years, the unaudited pro forma net sales, net loss before extraordinary item and net loss would be as follows (amounts in thousands): F-25
Years Ended --------------------------------------- December 25, December 31, 1998 1999 ---- ---- Net sales............................................... $122,819 $139,494 Net loss before extraordinary item...................... (66,344) (1,949) Net loss................................................ (66,448) (1,949)
Acquisition of Product Line On November 8, 1999, the Company acquired certain assets of Tyco Healthcare Group LP ("Tyco"), including Tyco's incentive breathing exerciser and pulmonary function monitor product lines, for a cash purchase price of approximately $23.8 million. The acquisition was accounted for as a purchase and the purchase price was allocated as follows (amounts in thousands): Goodwill........................................................... $18,750 Machinery and equipment............................................ 3,000 Deposit............................................................ 2,000 ------- $23,750 =======
Included in other current assets at December 31, 1999 are approximately $1.1 million of the remaining deposit and approximately $1.4 million due from the seller for certain year-end sales made on behalf of the Company. Acquisition of Distributor In October 1999, the Company acquired certain assets of Medimex, a German distributor of respiratory products, for a cash purchase price of approximately $2.2 million. The acquisition was accounted for as a purchase and the purchase price was allocated as follows (amounts in thousands): Goodwill..................................... $1,300 Inventory.................................... 900 ------ $2,200 ======
3. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements and related notes include the accounts of Hudson and its wholly-owned subsidiaries. All significant intercompany account balances and transactions have been eliminated in consolidation. Hudson and its wholly-owned subsidiaries are collectively referred to herein as the Company. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories Inventories are stated at the lower of cost (first-in, first-out (FIFO) method) or market. At December 25, 1998 and December 31, 1999, inventories consisted of the following (amounts in thousands):
1998 1999 ---- ---- Raw materials........................................................... $ 5,127 $ 5,901 Work-in-process......................................................... 5,926 5,682 Finished goods.......................................................... 6,971 12,460 ------- ------- $18,024 $24,043 ======= =======
F-26 Raw materials principally consist of bulk resins. Work-in-process and finished goods include raw materials, labor and overhead costs. Certain finished goods are purchased for resale and are not manufactured. As of December 25, 1998, the Company changed its method for allocating manufacturing overhead costs for all domestic production. The Company now allocates such costs based on machine hours rather than direct labor hours. As the Company has increased the automation of its processes, management believes this method is preferable to its prior method. Under Accounting Principles Board ("APB") Opinion No. 20, "Accounting Changes," this change is considered to be a change in estimate indistinguishable from a change in method. Accordingly, the effect of $1,085,000 for the year ended December 25, 1998 is reflected in operating income as a reduction to cost of sales. Foreign Currency Translation The Company follows the principles of Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation," generally using the local currency as the functional currency of its operating subsidiaries. Accordingly, all assets and liabilities outside the United States are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date. Income and expense items are translated at the weighted-average exchange rate prevailing during the period. Beginning in the second quarter of 1998, the Company commenced using the U.S. dollar as the functional currency of its Mexican operations since Mexico was considered a highly inflationary economy. Management believes that the effect of not using the U.S. dollar as the functional currency from January 1, 1997 was not material to the financial statements. Beginning in January 1999, Mexico was no longer considered a highly inflationary economy and, accordingly, the Company resumed using the Mexican Peso as the functional currency. Revenue Recognition The Company recognizes revenue when product is shipped. The Company establishes reserves for sales returns and other allowances based on historical experience. Income Taxes The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities are determined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates and laws. Additionally, deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Fiscal Year-End The Company reports its operations on a 52-53 week fiscal year ending on the Friday closest to December 31. The fiscal years ended December 26, 1997 and December 25, 1998 were both 52-week years. The fiscal year ended December 31, 1999 was a 53-week year. Post-Employment and Post-Retirement Benefits The Company does not provide post-employment or post-retirement benefits to employees. Accordingly, SFAS No. 112, "Employers' Accounting for Post- employment Benefits", and SFAS No. 106, "Employers' Accounting for Post- retirement Benefits", have no impact on the Company's financial statements. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, which is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments. The statement requires that every derivative F-27 instrument be recorded in the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Management has not yet determined the impact that adoption of this standard will have on the Company. Reclassifications Certain reclassifications have been made in the 1997 and 1998 statements to conform to the 1999 presentation. 4. Preferred Stock In connection with the Recapitalization, the Company issued 300,000 shares of mandatorily-redeemable 11-1/2% senior exchangeable pay-in-kind ("PIK") preferred stock due 2010. Net proceeds from the original issuance were $29.0 million. Dividends are payable semi-annually in arrears on April 15 and October 15 each year. Dividends will be payable in cash, except on dividend payment dates occurring on or prior to April 15, 2003, for which the Company has the option to issue additional shares of preferred stock (including fractional shares) having an aggregate liquidation preference equal to the amount of such dividends. The preferred stock will rank junior in right of payment to all obligations of the Company and its subsidiaries. The Company issued PIK preferred stock with a liquidation preference of approximately $1,801,000 and $3,762,000 to satisfy the dividend requirements in 1998 and 1999, respectively. As of December 25, 1998 and December 31, 1999 the Company accrued for PIK preferred stock dividends in the amount of $711,000 and $863,000, respectively. 5. Long-Term Debt Obligations Summary of Amounts Outstanding The Company's long-term debt obligations as of December 25, 1998 and December 31, 1999 consist of the following (amounts in thousands):
1998 1999 ---- ---- Borrowings under revolving credit facility..... $ 38,000 $ 36,600 Term loan payable to domestic banks............ 6,000 35,000 Term loan payable to Swedish bank.............. - 17,586 Senior subordinated notes...................... 115,000 115,000 Note payable to affiliate...................... - 7,508 -------- -------- 159,000 211,694 Less current portion........................... (3,000) (6,673) ------- -------- Long-term debt................................. $156,000 $205,021 ======== ========
Credit Facility In connection with the Recapitalization, the Company entered into a new credit agreement with a bank group, which provides for borrowings of up to $100.0 million. This agreement consists of two separate facilities as follows: 1.) Revolving credit--maximum borrowings of $60.0 million with a letter of credit sub-limit of $7.5 million. This facility must be prepaid upon payment in full of the Term Loan facility. 2.) Term loan--maximum borrowings of $40.0 million with quarterly installments to be made through maturity. Interest on the Credit Facility is based, at the option of the Company, upon either an optional eurodollar rate (as defined) plus 2.25%, or a base rate (as defined) plus 1.25% per annum. A commitment fee of 0.50% per annum will be charged on the unused portion of the Credit Facility. The following summarizes interest rate data on the Credit Facility as of December 25, 1998 and December 31, 1999: F-28
1998 1999 ---- ---- Eurodollar rate......................................................... 5.1875% 6.0625% Base rate............................................................... 7.75% 8.5% Term loan facility rate................................................. 7.4375% 8.75% Revolving credit facility rate.......................................... 7.8125% to 8.5625% to 9.0% 10.0%
Total borrowings as of December 31, 1999 were $35.0 million and $36.6 million under the Term Loan Facility and Revolving Credit Facility, respectively. The Credit Facility will mature on April 7, 2004. The agreement provides the bank a first security interest in substantially all of the properties and assets of the Company and a pledge of 65.0% of the stock of Industrias. The agreement also requires the Company to maintain certain financial ratios and financial covenants, as defined in the agreement, the most restrictive of which prohibit additional indebtedness and limit dividend payments to the Company's stockholders. The Credit Facility is guaranteed by the Company's parent. As of December 31, 1999, the Company had available credit under the Revolving Loan Facility in the amount of $23.4 million ($16.8 million of which is restricted for use on future acquisitions). No additional borrowing is available under the Term Loan Facility. The Company is required under restrictive covenants of the Credit Facility Agreement to maintain certain financial ratios, and meet certain operating cash flow tests for which the Company was not in total compliance as of December 25, 1998. Subsequently, the Company amended its Credit Facility Agreement so that under the amended terms it was in compliance at December 25, 1998. The Company was in compliance with all amended restrictive covenants as of December 31, 1999. Senior Subordinated Notes Also related to the Recapitalization, the Company issued under an Indenture $115.0 million of senior subordinated notes (the "Notes"). The Notes are fully transferable and are general unsecured obligations of the Company, subordinated in right of payment to all existing and future senior debt, as defined, of the Company. The Notes bear interest at a rate equal to 9-1/8% per annum from the date of issuance of the Notes. Interest is payable semi-annually on April 15 and October 15 of each year, commencing October 15, 1998. The Notes will mature on April 15, 2008 and will be redeemable at the option of the Company, in whole or in part, on or after April 15, 2003. The Notes are guaranteed by Industrias. The fair value of the Company's senior subordinated notes at December 31, 1999 was approximately $92.2 million. The fair value is estimated based on the quoted market prices for issues listed on exchanges and is not intended to, and does not, represent the underlying fair value of the Company. Note Payable to Affiliate In connection with the acquisition of LGAB during 1999, the Company borrowed $22.0 million under an unsecured 12% note payable to an affiliate of the Company's existing majority stockholder. The note is due August 1, 2006. During 1999, the Company paid approximately $14.5 million in principal on the note. Bank Notes Payable The Company has bank borrowings of $17.6 million outstanding at December 31, 1999, which are denominated in Swedish Krona. The borrowings bear interest at the 3-month STIBOR (the interest rate at or about 11:00 a.m. Stockholm time, two banking days before the draw-down date or the relevant interest period, quoted for deposits in krona) plus 0.75% to 1.75% (4.365% to 5.365% at December 31, 1999), are due December 21, 2003 and are secured by the common stock of LGAB. F-29 Future Debt Principal Payments As of December 31, 1999, future debt principal payments on the aforementioned debt are as follows:
Fiscal Year Ending: ------------------- 2000....................................................... $ 6,673 2001....................................................... 11,019 2002....................................................... 13,019 2003....................................................... 15,019 2004....................................................... 43,456 Thereafter................................................. 122,508 -------- $211,694 ========
6. Detail of Selected Balance Sheet Accounts Property, Plant and Equipment The following is a summary as of December 25, 1998 and December 31, 1999 (amounts in thousands):
1998 1999 ---- ---- Land........................................... $ 2,044 $ 2,044 Buildings...................................... 14,899 15,078 Leasehold improvements......................... 1,322 1,322 Machinery and equipment........................ 60,691 65,667 Furniture and fixtures......................... 2,205 4,227 -------- -------- 81,161 88,338 Less -- Accumulated depreciation and (51,161) (57,740) amortization.................................. -------- -------- 30,000 30,598 Equipment installation in progress............. 2,732 8,481 ERP software installation in progress.......... - 3,397 -------- -------- Property and equipment, net.................... $ 32,732 $ 42,476 ======== ========
Depreciation of property, plant and equipment is provided using the straight-line method over the following estimated useful lives:
Buildings...................................... 31.5 years Leasehold improvements......................... Shorter of the useful life or lease term Machinery and equipment........................ 5 to 7 years Furniture and fixtures......................... 3 to 7 years
Upon retirement or disposal of depreciable assets, the cost and related accumulated depreciation are removed and the resulting gain or loss is reflected in income from operations. Major renewals and betterments are capitalized while maintenance costs and repairs are expensed in the year incurred. ERP software installation costs are capitalized in accordance with Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The Company expects to "go live" on the new ERP system approximately April 1, 2000. Total depreciation and amortization expense was $5,947,000, $6,101,000 and $8,315,000 for the years ended December 26, 1997, December 25, 1998 and December 31, 1999, respectively. Intangible Assets, net Amortization of intangible assets is provided using the straight-line method over the applicable amortization period. During 1999, the Company wrote- off certain fully-amortized patents. The following is a summary of the components of intangible assets as of December 25, 1998 and December 31, 1999 (amounts in thousands): F-30
Useful lives 1998 1999 ------------ ---- ---- Covenant not-to-compete....................................... 5 to 7 years $ 3,500 $ 3,500 Patents....................................................... 15 years 3,183 472 Goodwill...................................................... 15 to 20 years 3,737 67,834 Other......................................................... 5 to 20 years 133 133 ------- -------- 10,553 71,939 Less -- Accumulated amortization.................................... (5,598) (4,969) ------- -------- $ 4,955 $ 66,970 ======= ========
Accrued Liabilities Accrued liabilities consisted of the following as of December 25, 1998 and December 31, 1999 (amounts in thousands):
1998 1999 ---- ---- Interest....................................... $2,315 $ 4,162 Payroll and related............................ 742 4,095 Vacation....................................... 1,176 1,509 Pension........................................ 809 1,353 Medical self-insurance......................... 394 577 Other.......................................... 783 4 ------ ------- $6,219 $11,700 ====== =======
7. Commitments and Contingencies The Company leases certain facilities, automobiles and office equipment under noncancellable leases, with the majority of the automobile leases having a term of one year with annual renewal provisions. All of these leases have been classified as operating leases. As of December 31, 1999, the Company had future obligations under operating leases as follows (amounts in thousands): Fiscal Year Ending: -------------------- 2000........................................... $ 681 2001........................................... 297 2002........................................... 297 2003........................................... 109 2004........................................... 82 ------ $1,466 ======
Rental expense was approximately $1,132,000, $1,506,000 and $2,052,000, in fiscal 1997, 1998 and 1999, respectively. The Company self-insures the majority of its medical benefit programs. Reserves for losses totaling approximately $394,000 and $577,000 at December 25, 1998 and December 31, 1999, respectively, were established based upon estimated obligations and are included in accrued liabilities in the accompanying balance sheets. The Company maintains excess coverage on an aggregate claim basis. The Company is party to lawsuits and other proceedings, including suits relating to product liability and patent infringement. While the results of such lawsuits and other proceedings cannot be predicted with certainty, management does not expect that the ultimate liabilities, if any, will have a material adverse effect on the financial position or results of operations of the Company. 8. Income Taxes Effective November 1, 1987, the stockholder of Hudson elected S corporation status under the Internal Revenue Code, such that income of the Company is taxed directly to the stockholder for both federal and state income tax purposes. Hudson's provision for income taxes and income taxes payable was limited to the California S corporation tax of 1.5%. F-31 The Company became a C corporation upon consummation of the transaction discussed in Note 1. Accordingly, the Company has presented pro forma net income (loss) amounts to reflect a provision for income taxes at a combined effective rate of approximately 39% in 1998, after consideration of permanent differences between financial reporting and income tax amounts. The pro forma amounts presented do not include the one-time effect of the conversion to C corporation status reflected in the June 1998 financial statements. During 1999, the Company revised its estimate of the combined effective income tax rate to approximately 40%. The actual provision for income taxes for 1998 reflects that the Company was a C corporation for a portion of the period presented. The conversion from S to C corporation status and the related Section 338(h)(10) election to increase the tax bases of assets in connection with the Recapitalization resulted in a one-time net benefit of $77,064,000 in the quarter ended June 26, 1998 which was recorded directly to retained earnings (see Note 15). From the date of the Recapitalization, the Company is included in the consolidated income tax returns of its parent. The Company provides for income taxes on a stand-alone basis in accordance with SFAS No. 109, "Accounting for Income Taxes," pursuant to an informal tax-sharing agreement. During the fourth quarter of 1998, management evaluated the Company's subsequent actual performance relative to certain budget projections which were originally used to evaluate the realizability of the deferred tax asset established at the time of the Recapitalization. Based upon this assessment, management provided a valuation allowance of $8,477,000 in the fourth quarter to reduce the deferred tax asset to an amount that management believes to be realizable under the requirements of SFAS No. 109. This change in estimate was included in the deferred tax provision for the year ended December 25, 1998. The tax provision (benefit) for 1998 and 1999 consists of the following (as restated; see Note 15) (amounts in thousands):
1998 (As Restated; See Note 15) 1999 ------- ---- Income taxes at combined statutory rate of approximately 39% and 40% in 1998 and 1999, respectively................................................ $(24,094) $ 143 Effect of earnings during S corporation period and other................... 24,022 - Foreign losses not benefited............................................... - 1,443 Valuation allowance........................................................ 8,477 - -------- ------ $ 8,405 $1,586 ======== ======
The provision (benefit) for income taxes consists of the following (amounts in thousands):
United States International Total ------------- ------------- ----- 1999 Current....................................................... $ - $ 340 $ 340 Deferred...................................................... 1,724 (478) 1,246 ------ ----- ------ $1,724 $(138) $1,586 ====== ====== ====== 1998 Current....................................................... $ - $ - $ - Deferred...................................................... 8,405 - 8,405 ------ ----- ------ $8,405 $ - $8,405 ====== ===== ====== 1997 Current....................................................... $ 74 $ - $ 74 Deferred...................................................... 76 - 76 ------ ----- ------ $ 150 $ - $ 150 ====== ===== ======
The 1998 tax provision results primarily from the valuation allowance discussed previously. As of December 31, 1999, the Company has recorded a net deferred tax asset of $69.0 million primarily related to basis differences between financial reporting and tax purposes arising from the Section 338(h)(10) election to increase the tax bases of assets in connection with the Recapitalization (see Note 1), which in management's opinion is more likely than not to be realized. As of December 31, 1999, the Company had a United States net operating loss carryforward of approximately $26.6 million. The components of the deferred tax asset as of December 31, 1999 are (amounts in thousands): F-32 Basis defferences arising from Section 338(h)(10) election....... $68,873 Net operating loss carryforwards................................. 10,640 Other............................................................ (2,093) ------- 77,420 Valuation allowance.............................................. (8,477) ------- $68,943 =======
9. Related-Party Transactions Amounts included in the consolidated financial statements with respect to transactions with companies controlled by officers, the stockholders or members of their immediate families are as follows (amounts in thousands):
December 26, December 25, December 31, 1997 1998 1999 ---- ---- ---- Purchases..................................................... $1,465 $128 $ - ====== ==== ==== Notes and advances receivable................................. $ 157 $ 91 $100 ====== ==== ====
10. Deferred Compensation and Benefit Plans Pension Plan The Company has a defined-contribution pension plan covering substantially all its employees. Amounts charged to expense relating to this plan totaled approximately $836,000, $810,000 and $972,000 for the fiscal years ended 1997, 1998 and 1999, respectively. Deferred Compensation Effective December 1, 1994, the Company established a deferred compensation plan for certain key employees. As of December 31, 1999 no material amount of compensation has been deferred. Equity Participation Plan Effective January 1, 1994, the Company's Board of Directors adopted the Equity Participation Plan, as amended (the "Plan"). This Plan provided certain key employees and independent contractors deferred compensation based upon the Company's value, as defined in the agreement. Benefits earned by participants were based upon a formula with a specified minimum benefit accruing each year for each participant, and benefits were accrued and charged to compensation in the year earned. As of the fiscal years ended 1997 and 1998, the Company has recorded $5,703,000 and $63,940,000, respectively, related to amounts earned by the Plan participants. In fiscal 1998, the Company declared bonuses totaling $20.0 million that resulted in a corresponding decrease in amounts payable under the Plan. The effect of the bonuses was to accelerate the timing of payments to the participants. Effective with the Recapitalization, all amounts owed to participants were paid out and the plan was terminated. Total amounts paid in 1998 were $89,642,000. 11. Extraordinary Item In accordance with the Recapitalization, the Company recorded an extraordinary loss on the extinguishment of the existing debt related to the write-off of unamortized deferred finance fees of $104,000. 12. Geographic, Segment and Major Customer Information The Company has adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 establishes new standards for reporting operating segments of publicly held companies. This approach requires the Company to present segment information externally the same way management uses financial data internally to make operating decisions and assess performance. SFAS No. 131 also requires that all public business enterprises report information about the revenues derived from the enterprise's products or services (or groups of similar products and services), about the countries in which the enterprise earns revenues and holds assets and about major customers regardless of whether that information is used in making operating decisions. F-33 As discussed in Note 14, the non-guarantor subsidiaries consist principally of LGAB and subsidiaries (whose operations are principally international). The Company operates in two segments as defined by SFAS No. 131: United States operations and international operations. The financial data of these two segments closely approximates the guarantor/non-guarantor information set forth in Note 14 and, accordingly, no additional segment data has been provided. The Company sells respiratory care products to distributors and medical facilities throughout the United States and internationally. During 1997, 1998 and 1999, the Company had foreign sales of approximately $19,008,000, $20,148,000, and $28,497,000 respectively, which constituted approximately 19.1%, 20.0% and 22.1% of total sales, respectively. The Company's percentage of sales by geographic region for the fiscal years ended 1997, 1998 and 1999 were as follows:
1997 1998 1999 ------ ------ ------ Domestic...................................................... 80.9% 79.9% 77.9% Europe........................................................ 7.5 7.8 10.1 Pacific Rim (Japan, Southeast Asia, Australia/New Zealand).... 5.7 6.2 6.1 Canada........................................................ 1.8 2.0 1.9 Other international........................................... 4.1 4.1 4.0 ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== =====
The following summarizes the net book value of fixed assets at the respective locations as of December 25, 1998 and December 31, 1999 (in thousands):
December 25, December 31, 1998 1999 ---- ---- Ensenada, Mexico........................................... $ 1,060 $ 1,134 Stockholm, Sweden.......................................... - 342 Kuala Lumpur, Malaysia..................................... - 741 United States.............................................. 31,672 40,259 ------- ------- $32,732 $42,476 ======= =======
For the fiscal years ended 1997, 1998 and 1999, the Company had sales to one domestic distributor in the amount of $29,852,000, $24,940,000 and $24,491,000 which represented approximately 30.0%, 24.8% and 19.0% of sales, respectively. Additionally, the Company had sales to another domestic distributor of $10,265,000 and 14,775,000 that accounted for approximately 10.2% and 11.5% of sales in 1998 and 1999, respectively. 13. Unaudited Consolidated Quarterly Data
1998 Quarters Ended -------------------------------------------------------------- June 26 (As Restated; See March 27 Note 15) September 25 December 25 -------- ------------- ------------ ----------- Net sales................................................. $24,265 $ 22,432 $22,130 $31,671 Gross profit.............................................. 10,431 9,600 9,843 13,824 Income (loss) before extraordinary item................... 1,498 (66,623) (243) (4,713) Net income (loss)......................................... 1,498 (66,727) (243) (4,713)
1999 Quarters Ended ------------------------------------------------- March 26 June 25 September 24 December 31 -------- -------- ------------- ------------ Net sales................................................. $27,169 $27,274 $30,827 $43,533 Gross profit.............................................. 11,389 11,414 12,185 18,397 Income (loss) before extraordinary item................... 281 327 (1,554) (282) Net income (loss)......................................... 281 327 (1,554) (282)
F-34 14. Subsidiaries Debt Guarantee and Segment Data The Company is the 100% owner of certain subsidiaries, which do not guarantee the Company's senior subordinated notes. The non-guarantor subsidiaries consist principally of the assets, liabilities and operations of LGAB and subsidiaries. The following tables disclose the required consolidating financial information for the guarantor, including the Company, and non- guarantor subsidiaries (amounts in thousands): HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING BALANCE SHEET
As of December 31, 1999 ---------------------------------------------------- Non- ---- Guarantor Guarantor Adjustments Total --------- --------- ----------- ----- ASSETS CURRENT ASSETS: Cash..................................................... $ 184 $ 2,733 - $ 2,917 Accounts receivable...................................... 28,329 2,096 - 30,425 Inventories.............................................. 21,124 4,065 (1,146) 24,043 Other current assets..................................... 4,578 16,673 (16,639) 4,612 -------- ------- -------- -------- Total current assets................................... 54,215 25,567 (17,785) 61,997 PROPERTY, PLANT AND EQUIPMENT, net........................ 41,335 1,141 - 42,476 OTHER ASSETS: Intangible assets, net................................... 22,770 44,200 - 66,970 Deferred financing costs, net............................ 10,749 385 - 11,134 Deferred tax asset....................................... 68,600 223 120 68,943 Investment in non-guarantor subsidiaries................. 29,245 - (29,245) - Other assets............................................. 833 162 (696) 299 -------- ------- -------- -------- Total other assets..................................... 132,197 44,970 (29,821) 147,346 -------- ------- -------- -------- $227,747 $71,678 $(47,606) 251,819 ======== ======= ======== ========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES: Notes payable to bank.................................... $ 5,500 $ 1,173 $ - $ 6,673 Accounts payable......................................... 6,625 1,559 (2,016) 6,168 Accrued liabilities...................................... 8,344 3,356 - 11,700 Other current liabilities................................ 458 10,876 (9,849) 1,485 -------- ------- -------- -------- Total current liabilities.............................. 20,927 16,964 (11,865) 26,026 NOTE PAYABLE TO AFFILIATE................................. - 13,906 (6,398) 7,508 NOTES PAYABLE TO BANK, net of current portion............. 66,100 16,413 - 82,513 SENIOR SUBORDINATED NOTES................................. 115,000 - - 115,000 -------- ------- -------- -------- Total liabilities...................................... 202,027 47,283 (18,263) 231,047 -------- ------- -------- -------- Mandatorily-redeemable preferred stock.................... 35,421 - - 35,421 STOCKHOLDERS' EQUITY (DEFICIT)............................ (9,701) 24,395 (29,343) (14,649) -------- ------- -------- -------- $227,747 $71,678 $(47,606) $251,819 ======== ======= ======== ========
F-35 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING STATEMENT OF OPERATIONS
For the Year Ended December 31, 1999 ---------------------------------------------------- Non- ---- Guarantor Guarantor Adjustments Total ---------- --------- ----------- ----- NET SALES................................................. $121,796 $ 9,500 $(2,493) $128,803 COST OF SALES............................................. 71,146 6,465 (2,193) 75,418 -------- ------- ------- -------- Gross profit.............................................. 50,650 3,035 (300) 53,385 OPERATING EXPENSES: Selling.................................................. 10,649 2,473 - 13,122 Distribution............................................. 4,647 - - 4,647 General and administrative............................... 12,231 2,501 - 14,732 Research and development................................. 1,362 669 - 2,031 -------- ------- ------- -------- Total operating expenses 28,889 5,643 - 34,532 -------- ------- ------- -------- Income (loss) from operations............................. 21,761 (2,608) (300) 18,853 OTHER INCOME AND (EXPENSES): Interest expense......................................... (16,023) (1,240) - (17,263) Other, net............................................... (633) (599) - (1,232) -------- ------- ------- -------- Total other income (expense)........................... (16,656) (1,839) - (18,495) -------- ------- ------- -------- Income (loss) before provision (benefit) for income taxes. 5,105 (4,447) (300) 358 PROVISION (BENEFIT) FOR INCOME TAXES..................... 2,183 (477) (120) 1,586 -------- ------- ------- -------- Net income (loss)......................................... $ 2,922 $(3,970) $ (180) $ (1,228) ======== ======= ======== ======== Depreciation and amortization (a)......................... $ 6,531 $ 4,609 $ - $ 11,140 ======== ======= ======== ======== Adjusted EBITDA (b)....................................... $ 28,292 $ 2,001 $ (300) $ 29,993 ======== ======= ======== ========
(a) Includes approximately $2,825,000 of non-cash expense related to the recognition of the portion of purchase price allocation related to acquired inventories. (b) Adjusted EBITDA represents income before depreciation and amortization, interest expense, income tax expense and recognition of the portion of purchase price allocation related to acquired inventories. Adjusted EBITDA is not a measure of performance under accounting principles generally accepted in the United States, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with accounting principles generally accepted in the United States, or as a measure of profitability or liquidity. HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 1999 ------------------------------------- Non- ---- Guarantor Guarantor Total ----------- --------- ----- Net cash provided by operating activities................................. $ 6,108 $ 989 $ 7,097 Net cash used in investing activities..................................... (34,928) (40,890) (75,818) Net cash provided by financing activities................................. 28,197 43,332 71,529 Effect of exchange rate changes on cash................................... - (398) (398) -------- -------- -------- NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS........................... (623) 3,033 2,410 CASH, beginning of period................................................. 507 - 507 -------- -------- -------- CASH, end of period....................................................... $ (116) $ 3,033 $ 2,917 ======== ======== ========
F-36 As discussed above, the non-guarantor subsidiaries consist principally of LGAB and subsidiaries (whose operations are principally international). The Company operates in two segments: United States operations and international operations. The financial data of these two segments closely approximates the guarantor/non-guarantor information set forth above and, accordingly, separate additional segment data is not provided. 15. Restatement The net effect of the Company's conversion from S to C corporation status and the related Section 338(h)(10) election to increase the tax bases of assets in connection with the Recapitalization of $77,064,000 was previously reflected in operations during the quarter ended June 26, 1998. This amount should have been reflected as a direct credit to retained earnings. The restatement had no impact on ending retained earnings for the periods presented. The impact of the restatement on the accompanying financial statements is as follows (amounts in thousands):
As Originally Year Ended December 25, 1998 Reported Adjustments As Restated ---------------------------- -------- ------------ ------------ Net loss before provision for income taxes............. $(61,676) $ $(61,676) ========= ========= ========= Net income (loss) before extraordinary item.......... $ 6,983 $(77,064) $(70,081) ======== ========= ========= Net income (loss).................................... $ 6,879 $(77,064) $(70,185) ======== ======== ========
F-37 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. RIVER HOLDING CORP. Date: April 14, 2000 By: /s/ Jay R. Ogram --------------------- Jay R. Ogram Chief Financial Officer and Secretary KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jay R. Ogram his true and lawful attorney-in-fact with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in and any all capacities, to sign any and all amendments to this Report on Form 10-K and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Richard W. Johansen Chief Executive Officer and April 14, 2000 - --------------------------------- Director (Principal Executive Richard W. Johansen Officer) /s/ Jay R. Ogram Chief Financial Officer and April 14, 2000 - --------------------------------- Secretary (Principal Financial Jay R. Ogram Officer) /s/ Helen Hudson Lovaas Director April 14, 2000 - --------------------------------- Helen Hudson Lovaas /s/ Ronald P. Spogli Director April 14, 2000 - --------------------------------- Ronald P. Spogli /s/ Charles P. Rullman Director April 14, 2000 - --------------------------------- Charles P. Rullman /s/ Jon D. Ralph Director April 14, 2000 - --------------------------------- Jon D. Ralph /s/ Sten Gibeck Director April 14, 2000 - --------------------------------- Sten Gibeck
S-1 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. HUDSON RESPIRATORY CARE INC. Date: April 14, 2000 By: /s/ Jay R. Ogram ------------------- Jay R. Ogram Chief Financial Officer and Secretary KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jay R. Ogram his true and lawful attorney-in-fact with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in and any all capacities, to sign any and all amendments to this Report on Form 10-K and to file same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Richard W. Johansen Chief Executive Officer and April 14, 2000 - ------------------------------- Director (Principal Executive Richard W. Johansen Officer) /s/ Jay R. Ogram Chief Financial Officer and April 14, 2000 - ------------------------------- Secretary (Principal Financial Jay R. Ogram Officer) /s/ Helen Hudson Lovaas Director April 14, 2000 - ------------------------------- Helen Hudson Lovaas /s/ Ronald P. Spogli Director April 14, 2000 - ------------------------------- Ronald P. Spogli /s/ Charles P. Rullman Director April 14, 2000 - ------------------------------- Charles P. Rullman /s/ Jon D. Ralph Director April 14, 2000 - ------------------------------- Jon D. Ralph /s/ Sten Gibeck Director April 14, 2000 - ------------------------------- Sten Gibeck
S-2 Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act No annual report or proxy material has been sent to security holders. S-3 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ---------------------------------------- To the Board of Directors of River Holding Corp.: We have audited in accordance with accounting standards generally accepted in the United States, the financial statements of RIVER HOLDING CORP. (a Delaware corporation) and subsidiaries included in this Form 10-K and have issued our report thereon dated March 24, 2000. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index above is the responsibility of the company's management and is presented for purposes of complying with Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ ARTHUR ANDERSEN LLP Orange County, California March 24, 2000 II-1 RIVER HOLDING CORP. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (Amounts in thousands)
Balance at Balance at Beginning Charges to End of of Period Expenses Write-offs Period ------------- ------------ ----------- ----------- Description - ----------- For the Year Ending December 31, 1999: Allowance for doubtful accounts receivable............................ $(794) $(440) $261 $(973) ======== ======== ======== ======== For the Year Ending December 25, 1998: Allowance for doubtful accounts receivable............................ $(258) $(586) $ 50 $(794) ======== ======== ======== ======== For the Year Ending December 26, 1997: Allowance for doubtful accounts receivable............................ $(111) $(182) $ 35 $(258) ======== ======== ======== ========
II-2 EX-12.1 2 STATEMENT RE COMPUTATION OF EARNINGS EXHIBIT 12.1 RATIO SUPPORT RATIO OF EARNINGS TO FIXED CHARGES
Hudson RCI Holding ------------------------------------------- --------------- As Inception to Restated 12/25/98 1999 1995 1996 1997 1998 1999 -------- ---- ---- ---- ---- ---- ---- Earnings: Pre-tax Income (1,574) (7,082) (118) 7,154 11,443 (61,676) 358 Fixed Charges: Interest Expense 10,273 17,263 2,424 2,177 1,834 11,327 17,263 Amort. of Debt Expense 635 -- 147 59 62 -- -- Interest Factor of Rental Expense 370 684 355 369 377 502 684 ------- ------ ----- ----- ------ ------- ------ Total Fixed Charges 11,278 17,947 2,926 2,605 2,273 11,829 17,947 ------- ------ ----- ----- ------ ------- ------ Total Earnings Before Fixed Charges 9,704 10,865 2,808 9,759 13,716 (49,847) 18,305 ------- ------ ----- ----- ------ ------- ------ Ratio of earnings to -- -- 1.0 3.7 6.0 1.0 fixed charges Deficiency of earnings to cover fixed charges (1,574) (7,082) (61,676)
RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
Hudson RCI Holding --------------------------------------------------- ---------------------- As Inception to Restated 12/25/98 1999 1995 1996 1997 1998 1999 -------- ---- ---- ---- ---- ---- ---- Earnings: Pre-Tax Income (1,574) (7,082) (118) 7,154 11,443 (61,676) 358 Fixed Charges: Interest Expense 10,273 17,263 2,424 2,177 1,834 11,327 17,263 Amort. of Debt Expense 635 -- 147 59 62 -- -- Interest Factor of Rental Expense 370 684 355 369 377 502 684 Preferred Stock Dividend Expense 4,187 6,515 -- -- -- 4,187 6,518 -------- -------- ------ ------ ------ ------ ------ Total Fixed Charges 15,465 24,462 2,926 2,605 2,273 16,016 24,465 -------- -------- ------ ------ ------ ------ ------ Total Earnings Before Fixed Charges $(13,891) (17,380) 2,808 9,759 13,716 (49,847) 18,305 -------- -------- ------ ------ ------ ------ ------ Ratio of earnings to -- -- 1.0 3.7 6.0 -- -- fixed charges and preferred stock dividends Deficiency of earnings to (5,761) (13,597) (65,863) (6,160) cover fixed charges and preferred stock dividends
Computation if Interest Factor of Rental - ---------------------------------------- Holding ----------------- Inception Hudson RCI t0 ----------------------------------------- 12/25/98 1999 1995 1996 1997 1998 1999 -------- ---- ---- ---- ---- ---- ---- Operating rental expense 1,110 2,052 1,065 1,106 1,132 1,506 2,052 Interest Factor 33% 33% 33% 33% 33% 33% 33% ----- ----- ----- ----- ----- ----- ----- Total 370 684 355 369 377 502 684 ===== ===== ===== ===== ===== ===== ===== Computation of Preferred Stock Expense - -------------------------------------- Holding ----------------- Inception Hudson RCI to -------------------------------------------- 12/15/98 1999 1995 1996 1997 1998 1999 -------- ---- ---- ---- ---- ---- ---- Preferred stock expense 2,512 3,909 -- -- -- 2,512 3,911 Tax effect (1.0-.40) 60% 60% 60% 60% 60% 60% 60% ----- ----- --- --- --- ----- ----- 4,187 6,518 -- -- -- 4,187 6,518 ===== ===== === === === ===== =====
EX-21.1 3 SUBSIDIARIES OF RIVER HOLDING CORP. EXHIBIT 21.1 SUBSIDIARIES OF RIVER HOLDING CORP. ----------------------------------- Name of Entity Jurisdiction - --------------------------------------------------------------------------- Hudson Respiratory Care Inc. California Industrias Hudson Mexico HRC Holding Inc. Delaware (HRC Holding Inc. is a holding company for 6 foreign corporations and 1 domestic corporation that collectively operate the Registrant's Swedish operations) EX-27.1 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM RIVER HOLDING CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS 12-MOS DEC-31-1999 DEC-25-1998 DEC-26-1998 DEC-27-1997 DEC-31-1999 DEC-25-1998 2,917 507 0 0 30,425 25,829 (973) (794) 24,043 18,024 62,330 45,076 67,750 51,155 (13,409) (4,298) 345,543 262,709 (26,126) (15,543) (115,000) (115,000) (34,558) (31,513) 0 0 (91,748) (63,125) 12,863 3,472 (345,543) (262,709) (128,803) (100,498) (128,803) (100,498) 77,678 42,188 39,612 24,617 1,332 728 0 0 17,263 10,273 7,082 1,574 1,999 (614) 5,083 960 0 0 0 0 0 0 5,083 960 0 0 0 0
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