-----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, LicW8mj1ruWMFiIM0Fqm31aSafFVGLiccH0wUT8Iv06+p9skJYeYJckHA4KHBARB vfAnblCwBRsIfcdMbdZxSg== 0001021408-02-009136.txt : 20020703 0001021408-02-009136.hdr.sgml : 20020703 20020702214340 ACCESSION NUMBER: 0001021408-02-009136 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020703 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: 1934 Act SEC FILE NUMBER: 333-56135 FILM NUMBER: 02695541 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 d10k.txt 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, 2001 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 95-1867330 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 599 Lexington Avenue, 18/th/ floor 10022 New York, New York (Zip Code) (Address of Principal Executive Offices) (212) 758-2555 (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 [_] No [X] 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 May 31, 2002, the number of shares of Common Stock, $.01 par value, outstanding (the only class of common stock of the registrant outstanding) was 9,144,293. 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. Fiscal Year Ended December 31, 2001 TABLE OF CONTENTS
Page ---- PART I ................................................................................................... 1 Item 1. Business ............................................................................... 1 Item 2. Properties ............................................................................. 7 Item 3. Legal Proceedings ...................................................................... 9 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 ... 14 Item 7A. Quantitative and Qualitative Disclosure About Market Risk .............................. 31 Item 8. Financial Statements ................................................................... 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............ 32 PART III ................................................................................................. 35 Item 10. Directors and Executive Officers of the Registrant ..................................... 35 Item 11. Executive Compensation ................................................................. 37 Item 12. Security Ownership of Certain Beneficial Owners and Management ......................... 41 Item 13. Certain Relationships and Related Transactions ......................................... 43 PART IV .................................................................................................. 45 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........................ 45 SIGNATURES ............................................................................................... S-1
ii PART I Item 1. Business. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 27A 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 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 Operations" 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. 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 and other factors 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." River Holding Corp. 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" or River") conducts all of its business through its majority-owned subsidiary, Hudson Respiratory Care Inc. and its subsidiaries (collectively, "Hudson RCI" or the "Company"). Consequently, the following discussion relates primarily to 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 7,000 distributors and alternate site service providers throughout the United States and in more than 90 countries worldwide. The Company has supplied the disposable respiratory care market for over 55 years and enjoys strong brand name recognition and leading market positions. The Company manufactures and markets approximately 2,000 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 in the United States from its extensive relationships with leading group purchasing organizations ("GPOs"), as large purchasing organizations play an increasingly important role in hospitals' purchasing decisions. The Company maintains three 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, the United Kingdom, France and Germany. 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 River Holding Corp. ("Holding"). In the past four years, the Company has completed a number of strategic acquisitions in order to expand its product line and geographic penetration, most significantly with the July 1999 acquisition of Hudson RCI AB (formerly Louis Gibeck AB), a Swedish company that manufactures and markets medical devices under the Gibeck brand. Hudson RCI's principal executive offices are located at 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589, and its 1 telephone number is (909) 676-5611. Holding's principal executive offices are located at 599 Lexington Drive, 18/th/ floor, New York, New York, 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 or 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 clinically desirable to humidify or medicate the gas prior to delivery to the patient. 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 clinical and economic 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 and infection control 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 reliable manufacturers with large, high quality 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 contracted 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 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. 2 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 four clinical categories: (i) oxygen therapy; (ii) aerosol therapy; (iii) humidification and filtration; and (iv) airway management. Although the Company's sales efforts differ depending on the clinical use of its products, management focuses on geographical segments for strategic decision making.
Category/Products Description - ------------------------------------------------ ---------------------------- Oxygen Therapy: oxygen masks, cannulae, oxygen Used to transport, regulate, deliver and analyze catheters, oxygen tubing, prefilled and therapeutic, supplemental oxygen to a patient. refillable humidifiers, oxygen regulators, Cylinder carts and bases are used to transport and cylinder carts and bases, oxygen stabilize oxygen cylinders. Regulators control the analyzers/monitors, oxygen sensors, and adaptors pressure and flow of oxygen from the primary gas and connectors. Sales for this category as a source to the patient. Oxygen masksand nasal percentage of total Company sales were 32.6%, cannulae cover the nose and mouth or fit inside the 34.6% and 40.0% for fiscal years 2001, 2000 and nostrils and are connected to an oxygen source via 1999, respectively. small diameter tubing through which oxygen flows. Oxygen analyzers, monitors and sensors are utilized to measure and monitor the oxygen concentration being delivered to the patient. Adaptors and connectors are frequently used in respiratory care and anesthesia to add accessories, modify configurations, and/or customize other related products to meet specific needs. Aerosol Therapy: aerosol masks, prefilled and Used to create and deliver aerosolized particles of refillable large volume nebulizers, aerosol liquid water, sodium chloride or medication solutions tubing, unit dose solutions, small volume to the patient's airways to dilute and mobilize nebulizers, peak flow meters, spacers/changers. secretions and/or dilate constricted breathing Sales for this category as a percentage of total passages. The peak flow meter is used to monitor the Company sales were 16.5%, 17.2% and 21.0% for patient's respiratory status before and after an fiscal years 2001, 2000 and 1999, respectively. aerosolized medication treatment. Spacers/Chambers are used as an adjunct to metered dose inhaler therapy to facilitate optimal treatment effectiveness. Humidification and Filtration: ConchaTherm Heated humidification systems actively heat and heated humidifiers and accessories, Humid-Heat humidify oxygen/air mixtures or anesthetic gases and accessories, AquaTherm and ThermaGard provided by a mechanical ventilator or anesthesia gas nebulizer heaters; Concha water, Concha Pak, machine or other gas source. Heat Moisture Exchangers Aqua+ and Humid-Vent HME's, and filters for (HMEs) passively conserve the heat and humidity in the critical care, anesthesia and pulmonary function. patient's exhaled breath for use during inspiration. Sales for this category as a percentage of total Breathing filters are used to protect patients, Company sales were 21.6%, 27.3% and 21.5% for caregivers and medical equipment from fiscal years 2001, 2000 and 1999, respectively. cross-contamination with bacteria and viruses. Airway Management: oral mairways, Sheridan(R) Used to secure and maintain an open airway and endotracheal tubes, incentive breathing unobstructed breathing passage; convey an oxygen/air exercisers
3
Category/Products Description - ------------------------------------------------- ---------------------------- (IBEs), disposable and re-useable mixture and/or anesthetic gas from a mechanical resuscitation bags, hyperinflation bags, ventilator, anesthesia gas machine to a patient; and breathing bags, air cushion masks, anesthesia artificially support ventilation during resuscitative circuits, heated-wire and conventional ventilator efforts. The infant CPAP system provides non-invasive circuits, gas sampling lines and filters, respiratory support to premature infants with catheter mounts and infant CPAP. Sales for this under-developed, immature lungs. category as a percentage of total Company sales were 29.2%, 20.9% and 17.5% for fiscal years 2001 2000 and 1999, respectively.
Sales, Marketing and Distribution The Company's main focus for operational management and strategic decisions is based on geographical segments. These are defined as the Domestic and European operations, each having their own, distinct management team. The Company has sales offices in Temecula, Sweden, Germany, France and the United Kingdom and two distribution facilities in the United States and one in Europe. The Company also employs sales representatives in Thailand, China and Australia. While a majority 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. 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 U.S. sales personnel currently call on approximately 5,900 hospitals and surgery centers, over 50 hospital distributors and over 3,000 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. In the current U.S. hospital 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 14 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 three of its major GPOs, Novation LLC, Consorta and HealthTrust Corporation. The Company's most significant GPO relationships are with AmeriNet Inc., Broadlane, Consorta, Health Services Corporation of America, HealthTrust Corporation and Novation LLC. 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 and web site 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 $2.2 million as of December 31, 2001 placed at service provider locations under this program. 4 The Company utilizes a network of over 50 hospital distributors, as well as over 3,000 alternate site distributors and end-users, 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 product lines. Owens & Minor Inc. is the Company's largest distributor, accounting for approximately $30.4 million or approximately 19.4% of total fiscal 2001 net sales, $32.2 Million or 20.2% of total fiscal 2000 net sales and $24.5 million or 19.0% 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's international distributors outside of the European Union ("EU"), Middle East and Africa place their orders directly with dedicated international customer service representatives. Customer orders are shipped from one of three warehouse locations. Sales strategies and marketing plans are tailored to each clinical product group 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 approximately 120 international distributors, typically on an exclusive basis within each market. Customers within Europe, the Middle East and Africa are serviced by the Company's Sweden office. Manufacturing and Assembly The Company operates three manufacturing 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 77 injection molding machines. During the past several years, many of the machines have been replaced with more efficient models, which have increased capacity. Tubing is produced on 11 extrusion lines: 6 corrugated, 4 vinyl and 1 repellitizer/regrinder. The Temecula facility uses approximately 19 million pounds of over 30 different kinds of resin annually; the most prominent are PVC, polyethylene, polypropylene and polystyrene. Sterile prefilled humidification and nebulization products are manufactured using 9 blow/fill/seal machines in the Company's facility in Arlington Heights, Illinois. The Company's Argyle, New York facility houses 4 extrusion lines, 4 blow molding machines and 8 assembly lines designed to produce the SHERIDAN(R) brand of endotracheal tubes. The SHERIDAN(R) product line was acquired in October, 2000 from Tyco Healthcare Group LP ("Tyco"). The Company leases approximately fifty percent of the Argyle facility from Tyco under a three year lease ending in October, 2003. During 2001, the Company made the decision to relocate the Argyle production facility to Tecate, Mexico, beginning in 2002 and anticipates completing the move by October, 2003. The Company's facility located in Ensenada, Mexico is primarily used for the assembly of certain products molded and/or extruded 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 HME and filter products marketed by the Company. The components assembled by the Malaysian operation are generally molded by outside vendors in Malaysia. The Company monitors the quality of its products at its manufacturing 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, Argyle, Arlington Heights, Kuala Lumpur and Ensenada. Certain Arlington Heights products are manufactured in a sterile environment and are certified sterile as a result of the production process. The Ensenada, Kuala Lumpur, Argyle and Arlington Heights facilities are certified as ISO 9002 compliant and the Temecula and Sweden facilities are certified as ISO 9001 compliant. 5 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 2001 were tubing grade PVC, clear PVC, LDPE-EVA, polypropylene, pre-cut elastic, mask grade PVC, acrylic resin, hose-end grade PVC, manual resuscitator assembly, and breathing bag assembly. The Company believes that it is able to purchase materials at a cost no higher than its competitors. 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 20 people, including 14 engineers. The Company's engineering 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. Significant products introduced in the last five years include the line of heat-moisture exchangers, the SHERIDAN(R) brand of endotracheal tubes, CONCHATHERM(R) IV heated humidification system, expansion of the Company's ventilator circuit and nebulizer line, a demand oxygen regulator and CONCHATHERM(R) 2000. CONCHATHERM(R) 2000 is a heated humidification system for the sleep apnea market. The Company constantly works to reduce costs through continuous process improvements. The Company incurred research and development expenses of approximately $2.0 million, $2.4 million and $2.0 million in fiscal 2001, 2000 and 1999, respectively. Competition The U.S. medical supply industry is characterized by intense competition. The Company's primary competitor in the respiratory care sector is Allegiance Healthcare (a subsidiary of Cardinal Health, Inc.) and its primary competitors in the anesthesia sector include Tyco, Smiths Industries Medical Systems, Inc. ("SIMS"), 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 design and 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 27 patents in the United States. Many of the U.S. patents have corresponding patents issued in Canada, Europe and various other countries. 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 FD&C 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 FD&C 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 6 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 pertinent sections of the Code of Federal Regulations, 21CFR GMP/QSR, 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 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 contract sterilization 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. 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 May 31, 2002, the Company employed approximately 2,342 employees, substantially all of whom were full-time employees. None of the Company's employees are 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 three 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 2005 with an option to extend an additional 5 years. Prefilled sterile solutions and electronics are manufactured in Arlington Heights. The Company leases a 73,000 square foot distribution warehouse in Elk Grove, Illinois under a lease that expires in May, 2010, and a 25,375 square foot distribution facility in Atlanta, Georgia under a lease that expires in February 2006. In August 2001, the Company made a decision to close the Atlanta distribution center. The company leases a 99,100 square foot distribution facility in Temecula, California under a lease that expires in September 2005. The Company leases sales and marketing offices in Stockholm, Sweden; Ashby de la Zouch, U.K.; Lyon, France; and Lohmar, Germany under leases that expire in September 30, 2002, April 25, 2006 and April, 2005, respectively. The Company leases a 33,260 square foot facility in Kuala Lumpur, Malaysia, under a lease that expires in July 2002. This facility primarily assembles finished products for the HME and filter product lines. The Company is currently in discussions with the owners of the Swedish and Malaysia properties and expects the leases to be renewed on a favorable basis. The Company also leases approximately fifty percent of an 80,218 square foot facility in Argyle, New York under a lease that expires in October, 2003. This facility manufacturers the SHERIDAN(R) line of endotracheal tubes. During 2001, the Company made a decision to relocate the endotracheal product line from its manufacturing plant in Argyle, New York to Tecate, Mexico. The Company has acquired an approximately 99,000 square foot facility in Tecate, under a lease that expires in March 2005. 7 The Company believes that its current facilities are adequate for its present level of operations. 8 Item 3. Legal Proceedings. The Company is not a party to any material lawsuits or other proceedings, including suits relating to product liability and patent infringement. While the results of the Company's existing 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. 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 Holding's Common Stock. As of June 21, 2001, Holding has 18 record holders of its Common Stock. Holding has not paid cash dividends on its Common Stock in the past two years, and does not intend to pay cash dividends on its Common Stock in the foreseeable future. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" for a discussion of restrictions on Holding's ability to pay cash dividends on its Common Stock. Item 6. Selected Financial Data. The selected fiscal year end historical financial data has been derived from the audited financial statements of the Holding and Hudson. The information contained in this table as of December 31, 2000 and 2001, and for each of the three years in the period ended December 31, 2001 should be read in conjunction with Hudson's and Holding's audited consolidated financial statements and notes thereto included elsewhere in this Report. River Holding Corp. (consolidated)
Fiscal Year --------------------------------------------------- 2001 2000 1999(a) 1998 (b) -------- -------- --------- -------- Operating Data: (amounts in thousands) Net sales .................................. $157,112 $159,278 $128,803 $ 76,232 Cost of sales .............................. 110,314 87,183 77,678 44,662 -------- -------- ------- -------- Gross profit ............................... 46,798 72,095 51,125 31,570 Operating expenses: Selling expenses ........................... 19,496 18,262 13,122 8,032 Distribution expenses ...................... 11,429 10,109 4,647 2,471 General and administrative expenses ........ 26,833 (c) 24,022 14,732 10,914 Impairment of goodwill ..................... 161,591 (d) -- -- -- Impairment of fixed assets ................. 4,712 (e) -- -- -- Amortization of Goodwill ................... 8,570 8,400 5,080 Research and development expenses .......... 2,043 2,388 2,038 726 -------- -------- ------- -------- Operating income (loss) .................... (187,876) 8,914 11,513 9,427 -------- -------- ------- -------- Other (income) and expenses: ............... -- -- -- Interest expense ........................... 20,542 21,089 17,263 11,100 Other (income) expense ..................... 1,563 1,159 1,332 (99) -------- -------- ------- --------- Total other expense ........................ 22,105 22,248 18,595 11,001 -------- -------- ------- -------- Income (loss) before provision for income taxes ................................... (209,981) (13,334) (7,082) (1,574) Provision for income taxes ................. 12,252 (f) 3,203 (1,508) (614) -------- -------- -------- --------- of debt) ................................ -- -- -- -- -------- -------- ------- -------- Net income (loss) .......................... $(222,233) $(16,537) $ (5,574) $ (960) ========= ======== ======= ========
10 Hudson Respiratory Care Inc. and Subsidiaries
Fiscal Year -------------------------------------------------------------- 2001 2000 1999(a) 1998 1997 --------- --------- --------- --------- --------- Operating Data: (amounts in thousands) Net sales ............................................. $ 157,112 $ 159,278 $ 128,803 $ 100,498 $ 99,509 Cost of sales ......................................... 108,054 84,923 75,418 56,802 54,575 --------- --------- --------- --------- --------- Gross profit .......................................... 49,058 74,355 53,385 43,696 44,934 Operating expenses: Selling expenses ...................................... 19,496 18,262 13,122 10,350 9,643 Distribution expenses ................................. 11,429 10,109 4,647 3,336 3,170 General and administrative expenses ................... 30,205 (j) 27,343 14,732 10,284 11,456 Impairment of goodwill ................................ 33,128 (d) -- -- -- -- Impairment of fixed assets ............................ 4,469 (e) -- -- -- -- Research and development expenses ..................... 2,043 2,387 2,031 976 1,072 Provision for equity participation plan ............... -- -- -- 63,939 (g) 6,954 Provision for retention payments ...................... -- -- -- 4,754 (h) -- --------- --------- --------- --------- --------- Operating income (loss) ............................... (51,712) 16,254 18,853 (49,943) 12,639 --------- --------- --------- --------- --------- Other (income) and expenses: .......................... -- -- -- Interest expense ...................................... 20,542 21,089 17,263 11,327 1,834 Other (income) expense ................................ 1,563 1,159 1,232 406 (638) --------- --------- --------- --------- --------- Total other expense ................................... 22,105 22,248 18,495 11,733 1,196 --------- --------- --------- --------- --------- Income (loss) before provision for income taxes ....... (73,817) (5,994) 358 (61,676) 11,443 Provision for income taxes ............................ 69,854 (k) 3,203 1,586 8,405 150 --------- --------- --------- --------- --------- Income (loss) before extraordinary item ............... (143,671) (9,197) (1,228) (70,081) 11,293 Extraordinary item (loss on extinguishment of debt) ... -- -- -- 104 (i) -- --------- --------- --------- --------- --------- Net income (loss) ..................................... $(143,671) $ (9,197) $ (1,228) $ (70,185) $ 11,293 ========= ========= ========= ========= =========
continued on following page 11 River Holding Corp. (consolidated)
Fiscal Year ------------------------------------------------------------ 2001 2000 1999(a) 1998 --------- --------- ---------- --------- Balance Sheet Data: (amounts in thousands) Total assets ................................................ $ 144,105 $ 361,036 $ 344,961 $ 262,709 Total debt .................................................. 226,147 221,914 211,694 159,000 Mandatorily-redeemable preferred stock ...................... 44,989 40,061 35,421 31,513 Shareholders' equity (deficit) .............................. (160,681) 62,927 78,393 59,653 Working capital ............................................. (288) 29,972 36,204 29,865 Other Financial Data: Net cash provided by (used in) operating activities ......... $ 5,564 $ 11,624 $ 7,097 $ 3,854 Net cash used in investing activities ....................... (9,017) (26,942) (75,818) (254,472) Net cash provided by (used in) financing activities ............................................... 7,330 16,220 71,529 251,125 Operating margin before EPP and Retention Payments (l) ...... (119.6)% 5.6% 8.9% 12.4% Depreciation and amortization ............................... $ 21,239 $ 20,051 $ 15,655 $ 8,507 Capital expenditures ........................................ 9,029 11,329 10,973 3,120 Ratio of earnings to fixed charges (m) ...................... -- x -- --x -- x Deficiency of earnings to cover fixed charges ............... $(209,981) $ (13,334) $ (7,082) $ (1,574) Ratio of earnings to fixed charges and preferred stock dividends (n) ............................................ -- x -- x -- x -- x Deficiency of earnings to cover fixed charges and preferred stock dividends .......................................... $(218,194) $ (21,067) $ (13,597) $ (5,761)
Hudson Respiratory Care Inc. and Subsidiaries
Fiscal Year --------------------------------------------------------------------- 2001 2000 1999(a) 1998 1997 --------- --------- ---------- --------- --------- Balance Sheet Data: (dollar amounts in thousands) Total assets ........................................... $ 137,055 $ 275,234 $ 251,819 $ 165,321 $ 77,554 Total debt ............................................. 226,147 221,914 211,694 159,000 20,250 Mandatorily-redeemable preferred stock ................. 44,989 40,061 35,421 31,513 -- Shareholders' equity (deficit) ......................... (167,821) (22,775) (14,649) (37,735) 22,515 Working capital ........................................ (160) 29,559 35,971 29,533 6,430 Other Financial Data: Net cash provided by (used in) operating activities .... $ 5,564 $ 10,379 $ 7,097 $ (83,024) $ 19,269 Net cash used in investing activities .................. (9,017) (26,941) (75,818) (6,444) (3,673) Net cash provided by (used in) financing activities .... 7,330 17,464 71,529 89,624 (16,398) Operating margin before EPP and Retention Payments (l) ........................................ (32.9)% 10.2% 14.6% 18.7% 19.7% Depreciation and amortization .......................... $ 12,224 $ 11,719 $ 8,315 $ 6,101 $ 5,847 Capital expenditures ................................... 9,029 11,329 10,973 3,111 4,659 Ratio of earnings to fixed charges (m) ................. -- x 0.7 x 1.0 x -- x 6.0 x Deficiency of earnings to cover fixed charges .......... $ (73,817) $ -- $ -- $ (61,676) $ -- Ratio of earnings to fixed charges and preferred stock dividends (n) ....................................... -- x 0.8 x -- x -- x 6.0 x Deficiency of earnings to cover fixed charges and preferred stock dividends ....................... $ (73,817) $ -- $ (6,160) $ (65,863) $ --
____________________ (a) Includes results of operations for (i) Hudson RCI AB, since it was acquired in July 1999, (ii) Medimex, since certain of its assets were acquired in October 1999 and (iii) VOLDYNE(R), since certain of its assets were acquired in November 1999. (b) Holding was formed to effect the recapitalization. Accordingly, operating data for 1998 presented for Holding is for the period 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 of Holding differ substantially when compared to those of the Company. All financial covenants have been calculated using the Company's accounts, and, accordingly, no comparative amounts for Holding are presented. (c) Consists of (i) general and administrative expenses of $24,007 and (ii) provision for bad debts of $2,826. 12 (d) Reflects impairment of goodwill based on management's analysis described in the "Fourth Quarter Charges" section of "Item 7 - Results of Operations" (e) Reflects write-off of certain assets management has determined have no value as described in the "Fourth Quarter Charges" section of "Item 7 - Results of Operations" (f) Includes the write-off of deferred taxes of $11,273 as described in the Fourth Quarter Charges section of the Results of Operations. (g) Reflects payments made under the equity participation plan ("EPP"), which was terminated upon consummation of the recapitalization in April 1998. (h) 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. (i) Reflects the write-off of deferred financing fees related to the payoff of outstanding debt under the Company's previous credit agreement. (j) Consist of (i) general and administrative expense of $23,889, (ii) amortization of goodwill of $3,490 and (iii) provision for bad debts of $2,826. (k) Includes the write-off of deferred taxes of $68,881 as described in the Fourth Quarter Charges section of the Results of Operations. (l) Represents ratio of operating income before EPP and retention payments to net sales. (m) 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. (n) 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 have been "grossed up" to a pre-income tax basis to provide comparability to other components of the ratio. 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Because Holding is a holding company with no operations, discussion throughout this section primarily relates to the Company. This 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. Balances and amounts unique to Holding are as follows: Holding's acquisition of a majority of the Company's stock was accounted for as a purchase. As a result of Holding's acquisition of the Company, Holding recorded property, plant and equipment at fair value. Additional expenses relating to amortization of goodwill of $5.0 million in 2001 and 2000, and additional depreciation related to the allocation of purchase price at fair value to depreciable assets of $2.2 million were recorded in 2001 and 2000. As of December 31, 2001 the remaining value of the step-up in basis to fair value was approximately $7.3 million. Goodwill resulting from the acquisition of the Company was recorded on the books of River and not pushed down to the Company, resulting in an additional 128.4 million of goodwill recorded at Holding. As a result of significant losses, both Holding and the Company recorded a goodwill impairment of $161.6 million and $33.1 million, respectively. Holding also has deferred tax assets stemming from the purchase of the Company. Holding recognized an $11.2 valuation allowance against those assets in 2001. As a result of an analysis of product lines during the fourth quarter of 2001, Holding and the Company concluded that it would no longer support a certain number of individual products, resulting in the related inventories of those products no longer having value. Holding and the Company recorded charges of $4.8 million and $4.6 million, respectively, related to the destruction of obsolete inventory resulting from this strategic decision. There are no other material differences between Holding consolidated and the Company. General 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. Recent Developments During 2001, management implemented several initiatives designed to improve the Company's proficiency with its new management information system, to decrease the Company's ongoing operating expenses, improve collections and administration of accounts receivables, and to reduce inventory levels. While the Company continues to experience some of the issues associated with the implementation of the new system, management believes customer service levels and relationships have improved since the business disruption resulting from difficulties in the implementation of the system in 2000. In the fourth quarter of 2001, River and the Company incurred charges of $186.2 million and $115.1 million, respectively, as described more completely in the "Fourth Quarter Charges" section of this item. As of December 31, 2001, based on the Company's financial results, the Company was not in compliance with certain financial covenants under its Credit Facility. As a result of this non-compliance and resulting defaults, on March 30, 2002, the Company did not make a scheduled term loan payment to the lenders as required under the Credit Facility and, as a result, the Company was prevented from making a scheduled interest payment to its Subordinated Note holders on April 15, 2002. 14 As of December 31, 2001, the Company's wholly-owned Swedish subsidiary, Hudson RCI AB, was not in compliance with certain financial covenants of the Hudson RCI AB bank facility. The Company and Hudson RCI AB are currently in discussions with the lender and expect to receive a waiver curing all defaults (see the "Liquidity and Capital Resources" section of this Item). Due to the uncertainty of receiving this waiver from the lenders, the Company has classified the entire Hudson RCI AB bank facility as a current liability on the consolidated balance sheet. The Credit Facility and Senior Subordinated notes are not cross-defaulted to the Hudson RCI AB bank facility. On May 14, 2002, the Company amended and restated the Credit Facility to (i) waive all existing events of default; (ii) extend the final maturity of the term and revolving facilities under the Credit Facility to June 30, 2004; (iii) amend existing term loan and acquisition facility amortization to $3.8 million in 2002, $9.3 million in 2003 and $37.0 million in 2004; and (iv) amend financial covenants. to include only a limitation on capital expenditures and a minimum EBITDA test. In connection with this amendment, the Company and HRC Holding, its wholly-owned subsidiary, issued a total of $20.0 million in senior unsecured notes to affiliates of Holding's majority stockholder. These notes bear interest at 12%, with interest and principal due upon maturity on December 31, 2004. During 2001, the Company made the decision to close the Argyle, New York facility and move its operations to a new facility located in Tecate, Mexico, beginning in 2002. It is anticipated that this move will cost approximately $4.6 million, of which $0.9 million relating to severance costs was recorded in 2001. Critical Accounting Policies Accounts Receivable: Management performs various analyses to evaluate accounts receivable balances to ensure that recorded amounts reflect estimated net realizable value. Management applies specified percentages to the accounts receivable aging to estimate the amount that will ultimately be uncollectible and, therefore, should be reserved. The percentages are increased as the accounts age. Management establishes and monitors these percentages through extensive analyses of historical realization data, accounts receivable aging trends, other operating trends, and the extent of contracted business and business combinations. Also considered are relevant business conditions, including general economic factors as they relate to the company's international customers. If indicated by such analyses, management may periodically adjust the uncollectible estimate and corresponding percentages. Further, focused reviews of certain large and/or problematic payors are performed to determine if additional reserves are required. In the fourth quarter of fiscal year 2001, management decided to not pursue certain aged accounts receivable for collection and to allocate resources to other customer receivables and collection activities. As a result, River and the Company provided for such identified accounts receivables totaling $2.2 million. Inventory: Inventories are stated at the lower of cost (first-in, first-out ("FIFO") method) or market. Management utilizes various analyses based on forecasts, historical sales and inventory levels to ensure that the current carrying value of inventory accurately reflects the current and expected requirements of the Company within a reasonable timeframe. During the fourth quarter of 2001, management embarked upon a new strategic initiative to eliminate certain products that were either unprofitable or marginally profitable. In addition, management initiated a similar strategic initiative to eliminate inventory on hand which exceeded more than a reasonable level of projected future demand. As a result of the above actions, River and the Company recorded a charge of $4.6 million in the fourth quarter related to the write-off and disposal of obsolete and excess inventory. Revenue Recognition: River recognizes revenue when product is shipped and title passes to customer, as the earnings process is substantially complete. River establishes reserves for sales returns and other allowances based on historical experience. River sells its products to its distributors without right of return based on a listed price. Distributors charge the service providers, or River's end customers, a contract price (which is determined by their GPO affiliation or individual contract price) plus a service margin. As is customary within the industry, River rebates the difference between the list price and the specific contract price to the distributor. River records revenue and 15 receivables net of rebatable amounts. In the event no rebate is payable, the amount is reversed and recognized as revenue. Deferred Taxes: River and the Company 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. As a result of significant losses in the fourth quarter and cumulative losses in recent years, management reevaluated its ability to realize the future benefit of its deferred tax assets in light of the historical operating results. Accordingly, River and the Company recorded a full valuation allowance against its deferred tax assets of approximately $11.3 and $68.9 million, respectively. Impairment of Goodwill and Other Intangibles: River and the Company periodically review the recoverability of the carrying value of goodwill, intangibles and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of these assets is determined by analysis of the asset's fair value by comparing the forecasted future net cash flows from the operations to which the assets relate, based on management's best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets. In addition, goodwill is assessed for recoverability at an entity level, based on fair value determined by estimated future cash flows discounted at a rate commensurate with the risk involved. In the fourth quarter of 2001, as a result of significant losses from operations, River and the Company recorded a goodwill impairment charge of approximately $161.6 million and $33.1 million, respectively. Recent Accounting Pronouncements Effective January 1, 2001, Holding adopted Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138. SFAS No. 133, as amended, 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. The adoption of this new standard did not have a material impact on Holding's consolidated financial statements. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. Any acquisitions made by Holding after June 2001 will be accounted for in accordance with SFAS 141. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill will no longer be amortized but will be assessed at least annually for impairment using a fair value methodology. River stopped amortizing goodwill, effective January 1, 2002 and, as a result, an equivalent charge for goodwill amortization will not be made in 2002. River is still evaluating the impact of the standard on impairment, which is expected to be completed by the end of the second quarter of 2002. The amortization of goodwill for 2001 was $8.6 million. Also in June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires entities to record the fair value of a liability for an 16 asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful live of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs gain or loss upon settlement. SFAS 143 is effective January 1, 2003. Holding does not expect the adoption of SFAS 143 to have a material impact on Holding's consolidated financial statements. In August 2001, the FASB issued SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - - Reporting the Effects of a Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 was effective January 1, 2002. The adoption of SFAS 144 is not expected to have a material impact on Holding's consolidated financial statements. 17 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 -------------------------------------------------------- 2001 2000 1999 --------- --------- --------- (dollars in thousands) Net sales .................................................... $ 157,112 $ 159,278 $ 128,803 Cost of sales ................................................ 108,054 84,923 75,418 --------- --------- --------- Gross profit ............................................. 49,058 74,355 53,385 Selling expenses ............................................. 19,496 18,262 13,122 Distribution expenses ........................................ 11,429 10,109 4,647 General and administrative expenses .......................... 23,889 20,917 12,829 Amortization of goodwill ..................................... 3,490 3,320 1,463 Impairment of goodwill ....................................... 33,128 -- -- Impairment of fixed assets ................................... 4,469 -- -- Research and development expenses ............................ 2,043 2,387 2,031 Provision for bad debts ...................................... 2,826 3,106 440 --------- --------- --------- Total operating expenses ..................................... 100,770 58,101 34,532 --------- --------- --------- Operating income (loss) ...................................... $ (51,712) $ 16,254 $ 18,853 ========= ========= ========= Fiscal Year -------------------------------------------------------- 2001 2000 1999 --------- --------- --------- Net sales .................................................... 100.0 % 100.0% 100.0% Cost of sales ................................................ 68.8 53.3 58.5 --------- --------- --------- Gross profit ............................................. 31.2 46.7 41.5 Selling expenses ............................................. 12.4 11.5 10.2 Distribution expenses ........................................ 7.3 6.3 3.6 General and administrative expenses .......................... 15.2 13.1 10.0 Amortization of goodwill ..................................... 2.2 2.1 1.1 Impairment of goodwill ....................................... 21.1 -- -- Impairment of fixed assets ................................... 2.8 -- -- Research and development expenses ............................ 1.3 1.5 1.6 Provision for bad debts ...................................... 1.8 2.0 0.3 --------- --------- --------- Total operating expenses ..................................... 64.1 36.5 26.8 --------- --------- --------- Operating income (loss) ...................................... (32.9)% 10.2% 14.7% ========= ========= =========
18 Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Net sales, reported net of rebates, were $157.1 million in 2001, a decrease of $2.2 million or 1.4% from 2001. On a consolidated basis, domestic hospital sales decreased by $5.5 million during 2001, or 5.9% as compared to 2000. The decrease in net sales is attributable to the following: (i) reduced seasonal demand worldwide for certain products due to mild levels of flu-related illnesses and unusually warm weather in the fourth quarter of 2001; (ii) lower than normal demand from U.S. hospitals following the September 11, 2001 terrorist attacks in New York and Washington as a result of reduced hospital admissions and lower levels of elective surgeries; and (iii) a decision by the Company in 2001 not to offer purchasing incentives at year end to distributors. Alternate site sales increased by $2.0 million or 8.8% due to market growth and lower prior year sales which were the result of shipping difficulties encountered in 2000 relating to the implementation of the management information system. Original Equipment Manufacturing ("OEM") sales decreased by $1.0 million or 16.3% during 2001, primarily due to changes in purchasing patterns from some of its OEM customers and their reduced demand as a result of the weak influenza season. European sales increased slightly by $0.3 million or 1.5% as compared to 2000 as a result of incremental sales of the SHERIDAN(R) product line (acquired in October 2000) as well as increased sales in certain European markets now served on a direct basis through the Company's European distribution center located in the Netherlands. Pacific Rim sales increased by $2.0 million or 21.5% as compared to 2000 as a result of incremental sales of the SHERIDAN(R) product line and continued growth in the use of the Company's products in this marketplace. The Company's gross profit for 2001 was $49.1 million, a decrease of $25.3 million or 34.0% from 2000. As a percentage of net sales, the Company's gross profit for 2001 was 31.2% as compared to 46.7% for 2000. This decrease was primarily due to the following: (i) sale of inventory recorded a higher net realizable value rather than manufacturing cost as a result of the SHERIDAN(R) acquisition; (ii) increased shipping costs as a result of shipping difficulties caused by problems associated with the new management information system; (iii) an unfavorable mix variance caused by higher sales of products with lower gross margins; (iv) higher level of unabsorbed manufacturing costs resulting from lower than expected demand and decreased inventories and (v) charges in the fourth quarter of 2001 relating to an initiative put in place to discontinue and dispose of less profitable products. Selling expenses were $19.5 million for 2001, a $1.2 million or 6.8% increase over 2000. This increase was primarily driven by additions to the sales and marketing departments to support recently acquired product lines, as well as an increase in fees associated with certain GPO's. As a percentage of sales, selling expenses were 12.4% in 2001 as compared to 11.5% in 2000. Distribution expenses were $11.4 million in 2001, which represents a $1.3 million or 13.1% increase over 2000. As a percentage of sales, distribution expenses were 7.3% in 2001 versus 6.3% in 2000. This increase was a result of the establishment of the European distribution center in the first quarter of 2001. General and administrative expenses were $23.9 million for 2001, an increase of $3.0 million or 14.3% over 2000. This increase resulted primarily from increased staffing levels required to maintain acceptable customer service levels and operate the business with the new management information system, expenses related to the closure of the Atlanta distribution center, higher depreciation associated with the new management information system and other professional fees and charges related to implementing the new management information system. Amortization of goodwill was $3.5 million in 2001, a $0.2 million or 5.1% increase over 2000. The increase was the result of a full year of amortization related to the SHERIDAN(R) acquisition made during the fourth quarter of 2000. As a result of significant losses in the fourth quarter, the Company reassessed future cash flows and determined that goodwill was not recoverable. Accordingly, the Company recorded a goodwill impairment charge of approximately $33.1 million. Research and development expenses were $2.0 million in 2001 as compared to $2.4 million in 2000, the result of eliminating several positions in the Company's facility operated by Hudson RCI AB, the Company's Swedish subsidiary, during 2001. 19 Interest expense was $20.5 million in 2001, a $0.5 million or 2.6% decrease from 2000. The decrease was primarily due to a general decrease in interest rates. Income tax provision was $69.8 million for 2001 as compared to $3.2 million in 2000. As a result of losses in the fourth quarter of 2001 and cumulative losses in recent years, the Company recorded a full valuation allowance of $68.9 million in 2001. Additional Quarterly Financial Information Summarized quarterly financial data for 2001 is as follows (amounts in thousands):
Quarters Ended ---------------------------------------------------------- March 31 June 30 September 30 December 31 -------- --------- ------------ ----------- net sales ........................................ $ 37,805 $ 40,801 $ 45,095 $ 33,411 Gross profit ..................................... 9,210 15,276 20,224 2,088 Net income (loss) ................................ (14,698) (7,653) 118 (200,000)
Fourth Quarter Charges The following is a summary of the charges incurred by Holding and the Company in the fourth quarter of 2001 (amounts in thousands):
Hudson Holding RCI ----------- ---------- Write-off of deferred tax asset ...................................... $ 11,293 $ 68,881 Goodwill impairment .................................................. 161,591 33,128 Impairment of fixed assets ........................................... 4,712 4,469 Destruction of obsolete inventory .................................... 4,582 4,582 Write-off of uncollectible accounts receivable ....................... 2,189 2,189 Distribution center closure .......................................... 930 930 Relocation of manufacturing facilities ............................... 900 900 ----------- ---------- Total fourth quarter charges ......................................... $ 186,197 $ 115,079 =========== ==========
As a result of significant losses in the fourth quarter and cumulative losses in recent years, Holding and the Company have reevaluated their ability to realize the future benefit of its net deferred tax assets held in light of the historical operating losses. Accordingly, Holding and the Company recorded a full valuation allowance against its deferred tax assets of approximately $11.3 Million and $68.9 million, respectively. As a result of significant losses in the fourth quarter, Holding and the Company have reassessed future cash flows and determined that goodwill was not recoverable. Accordingly, Holding and the Company recorded a goodwill impairment charge of approximately $161.6 million and $33.1 million, respectively. As a result of Holding and the Company's analysis of fixed assets in the fourth quarter, it was determined that certain machinery and equipment was no longer needed to support current business operations and had no value. Additionally, certain software development costs incurred in 2001 related to the management information system failed to achieve their intended results and, as a result, were determined to have no future value. As a result, Holding and the Company recorded an impairment charge of approximately $4.7 million and $4.5 million, respectively. As a result of an analysis of product lines during the fourth quarter of 2001, the Company concluded that it 20 would no longer support a certain number of individual products, resulting in the related inventories of those products no longer having value. The Company recorded charges of $4.6 million related to the destruction of obsolete inventory resulting from this strategic decision. The Company made a decision in the fourth quarter of 2001 to not pursue certain aged accounts receivable for collection and to allocate resources to other customer receivables and collection activities. As a result, the Company increased its provision for write-offs based on analysis of those aged customer receivables. The Company recorded a charge of approximately $0.9 million related to the fourth quarter closure of its Atlanta distribution center. This charge primarily consisted of future rent commitments. During fiscal 2001, the Company made a decision to relocate from its manufacturing operation in Argyle, New York to Tecate, Mexico. In addition, the Company made a decision to move certain product manufacturing from Temecula, California to Ensenada, Mexico. The Company recorded approximately $0.9 million in severance costs related to the relocations. During the fourth quarter of 2000, the Company embarked on a detailed review of the accounts receivable. Upon completion of such analysis, the Company recorded an additional $2.3 million of provision for bad debts to recognize certain accounts receivable, which became uncollectible in the fourth quarter. Year Ended December 31, 2000 Compared to Year Ended December 31, 1999 Net sales, reported net of rebates, were $159.3 million in 2000, an increase of $30.5 million or 23.7% over 1999. Of the $30.5 million increase, $9.2 million related to the VOLDYNE(R) incentive breathing exerciser product line acquisition made in November 1999, and $3.2 million was the result of the acquisition of the SHERIDAN(R) endotracheal tube product line in October of 2000. In addition, the Louis Gibeck AB (now Hudson RCI AB) acquisition, completed in July 1999, accounted for an additional $5.4 million of sales in 2000. For the base Hudson RCI business, alternate site sales increased $1.5 million or 7.1% as a result of the continued focus on this important and growing marketplace. Domestic hospital sales increased by $9.7 million or 13.0% as the result of new GPO relationships, as well as increased purchases from existing GPO relationships. Sales to Europe declined by $2.2 million or 18.0%, driven primarily by backorders and sales losses created during the implementation of a new management information computer system. Sales to Latin America increased by $0.4 million, while sales to the Pacific Rim increased by $2.6 million. OEM sales increased by $0.8 million or 18.6%, the result of new relationships with several customers. The Company's gross profit for 2000 was $74.4 million, an increase of $21.0 million or 39.3% from 1999. As a percentage of net sales, the Company's gross profit for 2000 was 46.7% as compared to 41.4% for 1999. This increase was primarily due to increased sales of higher profit margin products, such as the acquired Louis Gibeck AB and VOLDYNE(R) incentive breathing exerciser product lines. This was somewhat offset by increased freight costs required to service customer needs during a period of shipping difficulties caused by problems associated with the new computer system installation. Selling expenses were $18.3 million for 2000, a $5.1 million or 39.2% increase over 1999. This increase was primarily driven by the inclusion of full year results in 2000 of Hudson RCI AB, as well as establishment of sales offices in France and the United Kingdom during 2000. As a percentage of net sales, selling expenses were 10.2% and 11.5% in 1999 and 2000, respectively. Distribution expenses were $10.1 million in 2000, which represents a $5.5 million or 117.5% increase over 1999. This increase was caused by implementation of a second shift at all domestic distribution centers, increased overtime and the addition of a new distribution warehouse in Temecula, California. These increased costs were driven by shipping issues caused by the new system implementation, as well as higher volumes of products shipped during 2000 as compared to 1999. Additionally, freight for products shipped between distribution facilities increased significantly in order to meet increased demand, as well as to better serve customers affected by shipping problems associated with the new system implementation. 21 General and administrative expenses were $20.9 million for 2000, an increase of $8.0 million or 62.0% over 1999. This increase resulted primarily from increased staffing required to maintain acceptable customer service levels and operate the business with the new computer system. Additionally, due to increased aging of receivables resulting from lack of experience and visibility within the new management information system, the Company increased its reserves for doubtful accounts. In addition, general and administrative expense increases also resulted from the establishment of sales offices in France and the United Kingdom, as well as the full year effect of Hudson RCI AB. Amortization of goodwill was $3.3 million in 2000, a $1.9 million or 126.9% increase over 1999. This increase was driven primarily by the Hudson RCI AB and VOLDYNE(R) incentive breathing exerciser acquisitions in 1999, as well as the SHERIDAN(R) endotracheal tube product line acquisition in 2000. Research and development expenses were $2.4 million in 2000 as compared to $2.0 million in 1999. This increase is solely due to the inclusion of Hudson RCI AB results for a full year in 2000. Interest expense was $21.1 million in 2000, a $3.8 million or 22.2% increase over 1999. This increase was primarily due to increased borrowings to fund the Hudson RCI AB, VOLDYNE(R) incentive breathing exerciser and SHERIDAN(R) acquisitions. In addition, borrowings were higher under the working capital revolver due to increased working capital requirements that resulted from growth in the Company, as well as from issues relating to the new computer system implementation. The Company experienced significant changes in the composition and complexity of accounts receivable that were aggravated by the Company's implementation of its new ERP system. During the fourth quarter of 2000, the Company embarked on a detailed review of accounts receivable. Upon completion of such analysis, the Company recorded an additional $2.3 million of provision for bad debts to recognize certain accounts receivable, which became uncollectible in the fourth quarter. During 2000, the Company also experienced a shift in customer product and product mix to a higher rebate percentage. Similar to the problems associated with the allowance for doubtful accounts, the shift was obscured by difficulties associated with the implementation of the Company's new ERP system, which resulted in the Company's reevaluation of the amount of rebates recognized. 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. Liquidity and Capital Resources As the result of a number of factors affecting Holding in fiscal 2000 and 2001 resulting from the implementation of Holding's new information system, management undertook numerous actions during 2001 to improve the liquidity and improve the operating performance of Holding. Such actions included: elimination of a distribution warehouse, the elimination of non-essential management personnel, a reduction in inventory levels, aggressive collection and write-off of accounts receivable and other cost reduction measures as management deemed necessary to fund the operations of Holding, meet anticipated capital expenditures and make required payments of principal and interest on its debt. In addition, existing shareholders and key management personnel contributed a total of $10.1 million in new cash in the form of convertible subordinated debt and equity in 2001, and as discussed above, in May 2002, affiliates of Holding's majority stockholder partially invested an additional $20.0 million in senior unsecured notes, $12.0 million of which was exchanged for bank term loans previously acquired. Proceeds from these notes were used to pay interest due on the 22 Subordinated Notes, pay for expenses associated with the amendment of the Credit Facility and provide for ongoing working capital requirements. Based on these actions, as well as anticipated improved operating performance, management believes it will have sufficient sources of liquidity to meet its obligations for the remainder of 2002. If Holding does not generate sufficient cash flow from operations in line with its current forecasts, Holding would have to initiate measures to raise cash through asset sales, additional debt or equity issuances and/or curtail operations. Holding currently has no commitments for additional debt or equity and no assurance can be given as to whether or, on what terms, additional debt or equity investments could be secured if required. Failure to achieve expected cash flows or, if necessary, to obtain additional debt or equity investment would have a material adverse affect on Holding. The Company's primary sources of liquidity are cash flow from operations and borrowings under its working capital bank facility and, historically, investments from its shareholders. Cash provided by operations totaled $5.6 million, $10.4 million and $7.1 million in 2001, 2000 and 1999, respectively. The decrease from 2000 to 2001 is attributable to lower profitability and reduction in trade accounts payable offset in part by decreases in inventories and accounts receivable. The Company had operating working capital, excluding cash and short-term debt, of $13.3 million and $38.7 million as of the end of fiscal 2001 and 2000, respectively. Inventories were $25.2 million and $44.6 million as of the end of fiscal 2001 and 2000, respectively. In 2000, inventories increased to unplanned levels due to problems related to the implementation of a new management information system, as well as higher sales levels. The Company significantly reduced inventory levels in 2001, to levels more consistent with the current operating requirements of the Company, but 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 $19.3 million and $28.3 million at the end of fiscal 2001 and 2000, respectively. In 2001 and 2000, the Company recorded bad debt expense of $2.8 million and $3.1 million, respectively. The average days sales in accounts receivable outstanding was approximately 55 days for 2001, compared to 65 days for 2000 and 86 days for 1999. 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 increase gradually over time as alternate site and international sales become a larger percentage of the Company's total sales. The Company established a European distribution center in the first quarter of 2001. While this has had the effect of increasing inventory, the Company 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. Net cash used in investing activities was $9.0 million, $26.9 million and $75.8 million in 2001, 2000 and 1999, respectively. These funds were primarily used to finance customary purchases of property, plant and equipment in 2001, the SHERIDAN(R) endotracheal tube product line acquisition in 2000, and Hudson RCI AB and the VOLDYNE(R) incentive breathing exerciser product line acquisition in 1999, and for capital expenditures. Capital expenditures, consisting primarily of new manufacturing equipment purchases, computer systems purchases, production of heaters, and expansion of the Ensenada facility, totaled $9.0 million, $11.3 million and $11.0 million in 2001, 2000 and 1999, respectively. The higher levels of spending in 2000 and 1999 relate to the acquisition and implementation of a new computer system. The Company currently estimates that capital expenditures will be approximately $8.0 million in 2002, consisting primarily of additional and replacement manufacturing equipment and new heater placements. Net cash provided by financing was $7.3 million in 2001, reflecting net borrowings by the Company and the issuance of $3.0 million in Junior Preferred Stock and $100,000 in common stock. Net cash provided by financing activities in 2000 of $17.4 million, reflecting net borrowings and the issuance of $6.0 million in common stock, was used primarily to finance the Tyco SHERIDAN(R) endotracheal tube product line acquisition. Net cash provided by financing activities was $71.5 million in 1999, reflecting net borrowings and equity issuances by the Company, which was used primarily to finance the Hudson RCI AB, Medimex and VOLDYNE(R) acquisitions. As of December 31, 2001, the Company had outstanding $226.1 million of indebtedness, consisting of $115.0 million of Subordinated Notes, borrowings of $77.0 million under the Company's Credit Facility, $17.2 million in notes payable to affiliates and $16.9 million in outstanding borrowings under the bank facility of Hudson RCI AB, its Swedish subsidiary. 23 The following is a summary of the Company's consolidated contractual obligations as of December 31, 2001:
(amounts in thousands) Payments Due by Period ------------------------------------------------------------------- Less Than 1-3 4-5 After 5 Total 1 Year Years Years Years ---------- ------------ ------------ ------------ ----------- Long-term debt ................................ $ 226,147 $ 20,680 $ 88,201 $ 2,266 $ 115,000 Mandatorily redeemable preferred securities ... 44,989 -- -- -- 44,989 Leases and other commitments .................. 12,336 2,247 6,065 1,792 2,232 --------- --------- --------- --------- ----------- Total contractual obligations ............. $ 283,472 $ 22,927 $ 94,266 $ 4,058 $ 162,221 ========= ========= ========= ========= ===========
The Credit Facility currently consists of a $40.0 million Term Loan Facility and a $55.0 million Revolving Loan Facility of which up to $40.0 million (all of which has been borrowed and is outstanding) may be used for permitted acquisitions ("Acquisition Facility") and up to $15 million (the "Working Capital Portion") may be used for general corporate purposes (other than acquisitions). The Revolving Loan Facility has a letter of credit sub-limit of $7.5 million. The Term Loan Facility and Acquisition Facility, amended as discussed below, mature on June 30, 2004 and require quarterly principal installments totaling $3.8 million in 2002, $9.3 million in 2003 and $37.0 million in 2004. The Revolving Loan Facility matures on June 30, 2004. Total borrowings as of December 31, 2001 and 2000 were $55.0 million and $53.0 million under the Revolving Loan Facility and Acquisition Facility and $22.0 million and $29.5 million under the Term Loan Facility, respectively. As of December 31, 2001, the Company had utilized all available credit under the Revolving Credit Facility. No additional borrowing was available under the Term Loan Facility at December 31, 2001. The interest rate under the Credit Facility is based, at the option of the Company, upon either a Eurodollar rate or a base rate (as defined) plus a margin during the period and for the applicable type of loan as follows: Margin ------ Period and Loan Type Base Rate Eurodollar -------------------- --------- ---------- Through June 2002 Term and Working Capital 3.00% 4.00% Acquisition 3.25% 4.25% July 2002 through March 2003 Term and Working Capital 3.50% 4.50% Acquisition 3.75% 4.75% Thereafter Term and Working Capital 4.00% 5.00% Acquisition 4.25% 5.25% For periods after June 2002, the margins set forth above are subject to pricing reductions depending on the Company's then existing leverage ratio. 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 Holding or the Company in connection with an initial public offering or 100% of the net cash proceeds of an equity issuance by Holding or the Company other than in connection with an initial public offering (subject in each case to certain exceptions); (iii) 100% of the net 24 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 the Company and its subsidiaries and (v) 100% of the net proceeds from insurance recoveries and condemnations. The Revolving Loan Facility must be repaid upon payment in full of the Term Loan Facility. The Credit Facility is guaranteed by Holding and certain of the Company's subsidiaries. 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 restricted subsidiaries, including its Mexican subsidiaries; provided, that (except for the Mexican subsidiaries) 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, and (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) and (b) as amended a minimum EBITDA test. The Company was not in compliance with certain financial covenants of the Credit Facility as of December 31, 2001 and did not make the scheduled March 31, 2002 amortization payment of the Term Loan Facility on its due date. As a result, in early April, 2002, the lenders under the Credit Facility blocked the Company from making either the April 15, 2002 interest payment required under the Senior Subordinated Notes or the April 15, 2002 dividend payment required under the 11-1/2% Senior Exchangeable PIK Preferred Stock due 2010. On May 14, 2002, the Company and banks amended and restated the Credit Facility to (i) waive all existing events of default; (ii) extend the final maturity of the term and revolving facilities under the Credit Facility to June 30, 2004; (iii) amend existing Term Loan and Acquisition Facility amortization to $3.8 million in 2002, $9.3 million in 2003 and $37.0 million in 2004, and (iv) amend the financial covenants to include only a limitation on capital expenditures and a minimum EBITDA test. As a result of the amendment, the Company is currently in compliance with the terms and provisions of the Credit Facility. As of May 31, 2002, there was approximately $3.5 million of availability on the revolving Loan Facility under the Credit Facility. The Senior 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 Senior Subordinated Notes are general unsecured obligations of the Company and 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. As discussed above, the Company was prevented from making the April 15, 2002 interest payment to holders of the Senior Subordinated Notes pending the completion of the amendment to the Credit Facility on May 14, 2002. Because the Company made the interest payment due under the Senior Subordinated Notes within the 30-day grace period, no event of default occurred by reason thereof. The Company is currently in compliance with the terms and provisions of the Senior Subordinated Notes. In connection with the acquisition of Hudson RCI AB during 1999, one of the Company's subsidiaries borrowed $22.0 million under an unsecured 12% note payable to Holding's majority stockholder. The note is due August 1, 2006. During 1999, the Company paid approximately $14.5 million in principal on the note. In April 2001 an additional $6.0 million in principal on the note was repaid. Proceeds from the April 2001 repayment were then reinvested by Holding's majority stockholder in new notes issues by the Company, as described below. 25 During 2000, the Company borrowed an additional $2.0 million from Holding's majority stockholder under an unsecured 14% note payable due on demand. In August of 2001, this note was exchanged for a new long-term note as described below. In August 2001, the Company issued approximately $15.0 million of new unsecured senior subordinated convertible notes to affiliates for $7.0 million in cash and an exchange of $8.0 million in existing short-term unsecured notes. The new notes bear interest at 10% and are due in March 2005. The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to the Company's common stock at the demand of the holder. The notes are subordinated to borrowings under the Credit Facility and the new senior unsecured notes discussed below and rank pari-passu with the Senior Subordinated Notes. As of December 31, 2001 and May 31, 2002, the Company and its subsidiaries had a total of $17.2 million and $29.2, million, respectively, in notes outstanding due to affiliates. As part of the May 2002 amendment and restatement of the Credit Facility discussed above, the Company issued $12.0 million of the senior unsecured notes in exchange for $12.0 million of bank term loans purchased by affiliates of Holding's majority stockholder. Additionally, HRC Holding issued $8.0 million of unsecured senior notes to affiliates of Holding's majority stockholder. HRC Holding used the proceeds of the notes issued by it to acquire certain intercompany receivables from the Company. These notes bear interest at 12% annually with interest and principal due upon maturity on December 31, 2004. Proceeds from these transactions were used to pay the April 2002 interest due under the Subordinated Notes, fund expenses associated with the Amended and Restated Credit Facility and provide funds for ongoing general corporate purposes The Company, through its wholly-owned Swedish Subsidiary, Hudson RCI AB, has incurred bank debt in Sweden (the "HRCI AB Facility") that totaled $16.9 million as of December 31, 2001. The HRCI AB 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 1.25% to 1.85% (5.14% to 5.74% at December 31, 2001), matures in September 2005, and is guaranteed by Steamer Holding AB, Hudson RCI AB's parent, and is secured by the common stock of Hudson RCI AB. As of December 31, 2001, Hudson RCI AB was not in compliance with certain financial covenants under the HRCI AB Facility. The Company and Hudson RCI AB are currently in negotiations with the lender concerning an amendment curing these defaults and expects to receive from the lender a waiver curing all past covenant violations, but no assurance can be given that an agreement will be reached. Accordingly, the outstanding balance is classified as a current liability at December 31, 2001. The Company's Credit Facility and the Senior Subordinated Notes are not cross-defaulted to the Hudson RCI AB facility. If a waiver of such default is not obtained, the lender may pursue its remedies under the facility, including, among other things, immediate acceleration of all borrowings of the facility. In addition, the default entitles the lender to take control of all the common stock of Hudson RCI AB and its European parent companies. In April 1998, the Company issued to Holding 300,000 shares of the Company's 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 11-1/2% Senior Exchangeable PIK Preferred Stock due 2010 issued by Holding in connection with the recapitalization ("Holding Preferred Stock"). The Holding Preferred Stock has an aggregate liquidation preference of $30.0 million and bears interest at 11 1/2% per annum payable in kind until April 2003 and thereafter in cash. Under the terms of the Holding Preferred Stock, at the election of Holding, dividends may be paid in kind until April 15, 2003 and thereafter must be paid in cash. In August 2001, the Company issued 3,000 shares of Junior Convertible cumulative preferred stock (the "Hudson Junior Preferred Stock") to Holding for cash consideration of $3.0 million and Holding issued an aggregate of 3,000 shares of Junior Convertible cumulative preferred stock (the "River Preferred Stock") to Holding's majority stockholder and Helen Hudson Lovaas for cash consideration of $3.0 million. 26 RISK FACTORS Because Holding's only operations are through the Company, there are no risks other than those for the Company. As such, the following discussion relates solely to the Company. Substantial Leverage; Shareholders' Deficit As of December 31, 2001, the Company had $226.1 million of outstanding indebtedness and a shareholders' deficit of approximately $167.8 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. Restrictions on Ability to pay Cash Dividends As Holding is a holding Company, its primary source of liquidity is dividends or other distributions from Hudson RCI. Holding's only asset is its investment in Hudson RCI. The ability of Hudson RCI to pay cash dividends or make distributions to Holding when required is restricted by law or prohibited under the terms of Hudson RCI's debt instruments, including the Credit Facility. In addition, Holding is prohibited from paying cash dividends under the Credit Facility until April 2003, at which time it must pay cash dividends to holders of the Holding Preferred Stock. No assurance can be made that Hudson RCI will be able to pay cash dividends to Holding when required on the Holding Preferred Stock and, thus, Holding may not be able to make payments of cash dividends to the Holders of Holding Preferred Stock when required by the terms of the Holding Preferred Stock. As Holding is a holding company, its primary source of liquidity is dividends or other distributions from Hudson RCI. Holding's only asset is its investment in Hudson RCI. The ability of Hudson RCI to pay cash dividends or make distributions 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. In addition, Holding is prohibited from paying cash dividends under the Credit Facility until April 2003, at which time it must pay cash dividends to the holders of Holding Preferred Stock. Since Hudson RCI is prohibited from paying cash dividends to Holding, Holding may not be able to pay cash dividends to the Holders of Holding Preferred Stock when required by the terms of the Holding Preferred Stock. In the event that 27 Holding is unable to pay cash dividends to the holders of Holding Preferred Stock for two consecutive periods, the sole remedy of the holders is the ability to elect two members to Holding's Board of Directors. 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 payers 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. 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 2001, the Company's ten largest group purchasing arrangements accounted for approximately 38.7%. Distributors have also consolidated in response to cost containment. For fiscal 2001, 28 approximately 29.4% of the Company's net sales were to two distributors, Owens & Minor Inc. and McKesson, which accounted for 19.4% and 10.0%, 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. 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. The Company cannot predict the extent to which future legislative and regulatory developments concerning 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 Federal Food, Drug, and Cosmetic Act, as amended (the "FD&C 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 FD&C 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 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 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 pertinent sections of the Code of Federal Regulations, 21CFR GMP/QSR, 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 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 contract sterilization 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. In the event that such additional 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 26.0% of the Company's 2001 net sales and the Company intends to increase international sales as a percentage of total net sales. Foreign operations are subject to 29 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 sales operations in Germany, Sweden, the United Kingdom, France and other countries where sales are made in local currency. While the Company may choose to hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible, and 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 2001. The Company also maintains a manufacturing and assembly facility in Ensenada, Mexico and an assembly and distribution 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 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. 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 30 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. 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. 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 27 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. Energy Costs and Availability Over the past several years, there has been a shortfall of available electricity in several areas of California. This shortage has resulted in increased energy costs and temporary interruptions in electrical service in several geographic areas of California, including the area in which the Company maintains its headquarters and principal manufacturing center. Furthermore, the Company participates in a program with the utility that provides electricity to its California facilities whereby the Company receives discounted service rates in exchange for its consent to temporary interruptions in electrical service to the California facilities during peak periods of electricity use. There is a possibility that, with increased demand for electricity in California the cost of obtaining electricity for the Company's California facilities could continue to increase and electrical service could result in decreased productivity at the Company's California facilities. The Company has implemented at its California facility a generator capable of operating the administrative offices, including all computer systems, which are required to effectively conduct business at all locations in the United States and Mexico. Item 7A. Quantitative and Qualitative Disclosure About Market Risk. Because Holding's only operations are through the Company, there are no market risks other than those disclosed by the Company. As such the following discussion relates solely to the Company. Quantitative Disclosures. With the continued growth in Europe, 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, France and the United Kingdom and other countries where sales are made in local currency. The Company may hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible. The Company may also purchase forward contracts to hedge receivables denominated in foreign currency that are expected to be collected and converted into another currency. 31 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 of Financial Condition 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 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 $0.9 million. 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 (amended and restated as of December 31, 2001)
Fiscal Fiscal Fiscal Fiscal Fiscal There- 2002 2003 2004 2005 2006 after Total Value ------ ------ ------ ------ ------ ------ ----- ----- (Dollars in thousands) Fixed Rate Debt .......... $ -- $ -- $ 12,000 $ 14,951 $ 2,266 $115,000 $ 144,217 $ 106,317 Average Interest Rate --% --% --% % 9.0% 9.1% Variable Rate Debt ....... $ 20,680 $24,250 $ 37,000 $ -- $ -- $ -- $ 81,930 $ 81,930 Average Interest Rate 5.8% 5.4% 5.7% --% --% --%
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. On January 25, 2002, Holding dismissed Arthur Andersen LLP ("Andersen") as its independent accountant. Andersen provided both accounting and audit services to Holding and was the primary consultant for the implementation of the Company's SAP software platform. 32 The reports of Andersen on Holding's financial statements for the past two fiscal years contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles. Holding's Board of Directors approved the decision to change accountants on January 17, 2002, and the Audit Committee of the Board of Directors approved the decision to change accountants on January 25, 2002. The Board of Directors believes that it is in the best interests of Holding to make a change in Holding's certifying accountants. In connection with its audits for the two most recent fiscal years and through January 25, 2002, there have been no disagreements with Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Andersen, would have caused Andersen to make reference thereto in its report on the financial statements of Holding for such time periods, except as follows: During the audit of its financial statements for the year ended December 31, 2000, Holding had a disagreement with Andersen regarding the reserves for accounts receivable (doubtful accounts and rebates) as of December 31, 2000. Andersen informed Holding of its concerns as to the methodology utilized to establish the level of these reserves as well as that inadequate support had been provided for these reserves. Upon further review and analysis by Holding, and continuing discussions with Andersen, these reserves were adjusted, and backup substantiation developed, to the satisfaction of Andersen, which issued its report on River's financial statements for the year ended December 31, 2000. Members of the Audit Committee of the Board of Directors of Holding met with Andersen to discuss these matters. Holding believes that the concerns expressed by Andersen with respect to the foregoing issue have been addressed, as evidenced by the fact that Andersen has issued an unqualified report covering Holding's 2000 financial statements, and that Holding now has policies and procedures in place to properly establish reserve balances, and substantiation, in respect of its accounts receivable in accordance with GAAP. During the two most recent fiscal years and through January 25, 2002, except as described below, there have been no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K. Andersen informed Holding in a letter dated July 30, 2001 that the following material weaknesses in internal control existed during fiscal year ended December 31, 2000: Holding did not prepare on a timely basis reconciliations for substantially all of the Company's balance sheet accounts, and the Company's internal process for review and approval of reconciliations was informal and inconsistent. Holding's support for the required reserves for accounts receivable (doubtful accounts and rebates) was initially inadequate; upon further review, adjustments required to properly state such reserves as of December 31, 2000 were material to Holding's consolidated financial statements. Holding's consolidated financial statements were not prepared on a timely basis and eliminating entries were not initially well-supported. Holding had a shortage of accounting and finance personnel, and had retained accounting and finance personnel who lacked the appropriate expertise; as a result, Holding's former Chief Financial Officer was responsible for a disproportionate amount of the Holding's financial reporting process, and the efficiency, timeliness and accuracy of the Holding's financial reporting was adversely impacted. Members of the Audit Committee of the Board of Directors of Holding discussed these matters with Andersen. Except as described above, these conditions did not result in any disagreements or differences in opinion between the Company and Andersen. Andersen advised the Company in the July 30, 2001 letter that it understood that Holding had taken certain steps subsequent to December 31, 2000 to mitigate these material weakness conditions. 33 Holding provided Andersen with a copy of the disclosures made by Holding in this report and requested that Andersen furnish Holding with a letter addressed to the SEC stating whether or not Andersen agrees with the above statements, and if not, stating the respects in which it does not agree. A copy of such letter was filed as an exhibit to the 8-K report filed by Holding on February 1, 2002, in which Holding initially reported this change in auditors. New Independent Auditor On January 31, 2002, Holding engaged Deloitte & Touche LLP ("Deloitte") as Holding's new principal independent auditor to audit Holding's financial statements, to replace Andersen. During the two most recent fiscal years and through January 31, 2002, Holding has not consulted with Deloitte regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on Holding`s financial statements; or (ii) any matter that was either the subject of a disagreement (as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304 of Regulation S-K), or a reportable event (as described in Item 304(a)(1)(v) of Regulation S-K). 34 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 May 31, 2002: Name Age Position - ------------------------------ --- --------------------------------------- Charles A. French ............ 59 President, Chief Executive Officer and Director Lougene Williams ............. 57 Senior Vice President Patrick G. Yount ............. 42 Chief Financial Officer Ola G. Magnusson ............. 53 Senior Vice President Jeffery D. Brown ............. 44 Vice President, Marketing and Sales Helen Hudson Lovaas .......... 63 Director Jon D. Ralph ................. 37 Director Charles P. Rullman ........... 54 Director Ronald P. Spogli ............. 54 Director Sten Gibeck .................. 58 Director Charles A. French is President, Chief Executive Officer and a Director of the Company and Holding. Mr. French assumed these positions with both the Company and Holding in August 2001, and was a consultant to the Company since January 2001. Prior to joining the Company and Holding, he had been a private investor focused on healthcare and technology companies. Previously, he held senior management positions at Spectramed, Inc., Caremark, Inc. and Bentley Laboratories, Inc. Lougene Williams is a Senior Vice President of the Company and Holding 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. Patrick G. Yount became Holding's and the Company's Chief Financial Officer in March, 2001. Prior to joining the Company, he held the positions of Chief Financial Officer and Chief Operating Officer of Good Source Solutions - a nationwide distributor of specialty food items. Prior to joining Good Source Solutions in 1998, he held positions as a senior member of the Merchant Banking Group for Banque Paribas where we was employed in the San Francisco office from 1995 to 1998. Ola G. Magnusson is a Senior Vice President of the Company and Holding and serves as President of Hudson RCI AB in Sweden. Mr. Magnusson joined the Company in 1999 in connection with the acquisition of Louis Gibeck AB where he was the President and Chief Executive Officer since 1996. Prior to joining Louis Gibeck AB, Mr. Magnusson held several different positions, primarily in marketing with Pharmacia, a Swedish pharmaceutical company. Jeffery D. Brown, Vice President of Marketing and Sales of the Company and Holding, assumed this position in January, 2000. From 1997 to 2000 Mr. Brown served as the Company's Director of Sales. From 1993 to 1997, Mr. Brown served as National Sales Manager and from 1991 to 1993, as Regional Sales Manager . Mr. Brown has also held positions of National Account Manager from 1982 to 1991, and Territorial Sales Manager from 1980 to 1982. 35 Helen Hudson Lovaas is a director of the Company and became a director of Holding after consummation of the recapitalization in April 1998. 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 the Company and of Holding in connection with the recapitalization in April 1998. 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 Banking Division. Mr. Ralph is also a director of Century Maintenance Supply, Inc., and The Pantry, Inc. Charles P. Rullman became a director of the Company and of Holding in connection with the recapitalization in April 1998. 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 the Company and of Holding in connection with the recapitalization in April 1998. He is a founding Principal of Freeman Spogli, which was founded in 1983. Mr. Spogli is also a director of AFC Enterprises, Inc., Advance Auto Parts, Inc., Century Maintenance Supply, Inc., and Gaylan's Trading Co. Inc. Sten Gibeck became a director of the Company and of Holding in connection with the July 1999 acquisition of Hudson RCI AB. Mr. Gibeck has been employed by Hudson RCI AB 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 Hudson RCI AB. Directors of the Company and Holding are elected annually and hold office until the next annual meeting of stockholders and until their successors are duly elected and qualified. 36 Item 11. Executive Compensation. The following table sets forth the compensation for each of the fiscal years in the three-year period ended December 31, 2001 of the following persons: . Each individual who served as the chief executive officer or acted in a similar capacity during 2001; . The four most highly compensated executive officers other than the chief executive officer at December 31, 2001; and . Two former executive officers that would have been among the four most highly compensated executive officers at December 31, 2001 if they were still serving as officers at December 31, 2001. Compensation is presented only for the years in which each person was an executive officer. Summary Compensation Table
Annual Compensation ------------------------------------------------- Fiscal Other Annual All Other Salary Bonus Compensation Compensation Year (1) (2) ---------------------------------------------------------------------------- Charles A. French. ............ (3) 2001 $ 66,923 $ -- $ -- --- President and Chief Executive Officer Lougene Williams .............. 2001 $ 221,751 $ -- $ -- $ 10,200 Senior Vice President 2000 186,592 -- -- 10,500 1999 190,862 64,798 73,020 9,600 Jeffery D. Brown .............. (4) 2001 $ 157,701 -- $ -- $ 9,462 Vice President, Marketing & Sales 2000 126,023 -- -- 7,561 Patrick G. Yount ............. (5) 2001 $ 145,385 $ -- $ -- $ -- Chief Financial Officer Ola Magnusson ................ 2001 $ 105,963 $ -- $ 9,099 $ 53,331 Senior Vice President 2000 121,582 -- 10,087 61,901 1999 62,343 -- 5,564 127,828 Richard W. Johansen .......... (6) 2001 $ 310,918 $ -- $ -- 10,200 Former President and Chief Executive Officer 2000 290,438 -- -- 10,500 1999 294,945 53,100 177,334 9,600 Jay R. Ogram ................. (7) 2001 $ 234,985 $ -- $ -- $ 9,261 Former Chief Information Officer 2000 153,674 -- -- 9,220 1999 148,314 43,159 -- 8,889
- --------------------- (1) During 2001, no Named Executive Officer named received perquisites and other personal benefits, security 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. (3) Charles A French became Holding's and the Company's President and Chief Executive Officer in August 2001. The compensation amount shown is based on a partial year of employment at an annualized salary rate of $200,000. 37 (4) Prior to 2000, the Named Executive was not an officer of Holding and the Company. (5) Patrick G. Yount became Holding's and the Company's Chief Financial Officer in March 2001. His compensation shown is based on a partial year of employment at an annualized salary rate of $210,000. (6) Richard W. Johansen was terminated as President and Chief Executive Officer in September 2001. He remained on the Board until January 2002. His compensation is included because had Mr. Johansen been an executive officer at December 31, 2001, he would have been one of the four most highly compensated officers of Holding and the Company for the fiscal year ended December 31, 2001. (7) Jay R. Ogram was Chief Financial Officer until March 2001 at which time he became the Chief Information Officer. He resigned from Holding and the Company in January 2002. Executive Employment Agreements On April 7, 1998, the Company entered into employment agreements with Richard W. Johansen, Jay R. Ogram, Brian W. Morgan and Lougene Williams. 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 Holding and the Company receive no compensation as directors. Directors are reimbursed for their reasonable expenses in attending meetings. Management Bonus Plans The Company offers a management bonus plan for its executives and senior management. The plan is based solely on the financial goals of the Company. The goals for 2001 required the Company to reach a minimum of 95% of a budgeted EBITDA target. During 2001, the Company did not meet this objective and no bonuses were paid. The Company periodically offers additional incentive compensation to individuals who demonstrate superior performance. This compensation was not material in 2001. The Company has put a similar plan into place for 2002. 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. During 2001, the Company determined that the pension plan for 1999 and 2000 was not fully funded. Accordingly, the Company recorded $350,000 in associated penalties and fully funded the plan through 2000. The Company anticipates fully funding the 2001contribution in 2002. During 2002, the Company froze the current pension plan and developed a new plan that provides for discretionary funding determined annually by the Board of Directors. All other aspects of the new plan are substantially similar to the old plan. In addition, employees may contribute to a 401(k) plan that allows matching contributions by the Company. Employees must have six months of service to be eligible to participate in the 38 401(k) plan and may contribute up to 10% of their annual compensation, or 6% if the employee is a highly compensated participant. 39 Compensation Committee Interlocks and Insider Participation The Board of Directors Holding and the Company determines the compensation of the executive officers. During fiscal 2001, certain members of the Board of Directors determined the compensation of Holding's and the Company's Chief Executive Officer and certain members of the Board of Directors and Mr. French determined the compensation of Holding and 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 and Affiliates sells its shares to a third party. No additional shares of Holding common stock were sold under the Stock Subscription Plans in fiscal 2001. In 2001, the Board of Directors of Holding approved the adoption of a Stock Option Plan for eligible employees, officers and consultants of the Company. The plan allows for the issuance of up to 2,000,000 shares of Holding common stock pursuant to the exercise of incentive stock options or non-qualified options. The exercise price of options granted under the plan shall be set at fair market value at the time of the grant as determined by the Board of Directors. As of the date of this filing, no options have been granted under this plan. 40 Item 12. Security Ownership of Certain Beneficial Owners and Management. River Holding Corp. The following table sets forth certain information, as of May 31, 2002, 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, (i333ii) each director of Holding and (iv) all Named Executive Officers and directors of Holding as a group.
Shares of Shares of Shares of Shares of Junior Common Percent of Preferred Percent of Preferred Percent of Name of Beneficial Owner Stock Class Stock Class Stock Class - --------------------------------------------------- --------- ---------- --------- ---------- --------- ---------- Freeman Spogli & Co. Incorporated (1) ........... 8,352,771 88.4% 470,307 100% 2,308 76.9% Ronald P. Spogli (1) .......................... Charles P. Rullman (1) ........................ Jon D. Ralph (1) .............................. Richard W. Johansen (2)(4) ...................... 300,000 3.2% -- -- Sten Gibeck (4) ................................. 200,000 2.1% -- -- Lougene Williams (4) ............................ 100,000 1.1% -- -- Jay R. Ogram (4) ................................ 100,000 1.1% -- -- Jeffery D. Brown (3)(4) ......................... 25,000 * -- -- Charles A. French (4) ........................... -- -- -- -- Patrick G. Yount (4) ............................ -- -- -- -- Ola Magnusson (4) ............................... -- -- -- -- Helen Hudson Lovaas (4)(5) ...................... 69,200 * 692 23.1% All Named Executive Officers and directors of the Company as a group (9 individuals) ........ 9,146,971 96.9% 470,307 3,000 100.0%
___________________ * Less than 1%. (1) 1,441,251 shares, 58,749 shares and 6,621,791 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. Includes 230,800 shares of common stock issuable upon conversion of 2,308 shares of River Junior Preferred Stock. 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. 41 (3) Represents shares held of record by the Brown Family Trust dated 4/21/98 (the "Brown Trust"), of which Mr. Brown and his wife, Ellen Ann Brown, are the trustees. (4) The business address of these individuals is River Holding Corp., 599 Lexington Avenue, 18th Floor, New York, New York 10022. (5) Includes 69,200 shares of common stock issuable upon conversion of 692 shares of Junior Preferred Stock. Hudson Respiratory Care Inc. The following table sets forth certain information, as of May 31, 2002, 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 Hudson Shares of Shares of Junior Common Percent of Preferred Percent of Preferred Percent of Name of Beneficial Owner Stock Class Stock Class Stock Class - ------------------------------------------------- --------- ------------ --------- ---------- --------- ---------- River Holding Corp.(1) ....................... 9,454,293 30.6% 470,307 100% 3,000 100.0% Jon D. Ralph(1) ............................ Charles P. Rullman(1) ...................... Ronald P. Spogli(1) ........................ FS Equity Partners IV, LP (2) ................ 20,000,000 64.6% -- -- Jon D. Ralph (2) ........................... Charles P. Rullman (2) ..................... Ronald P. Spogli (2) ....................... Helen Hudson Lovaas(3) ....................... 1,500,000 4.8% -- -- Sten Gibeck(4) ............................... -- -- -- Richard W. Johansen(4) ....................... -- -- -- -- Lougene Williams(4) .......................... -- -- -- -- Jay R. Ogram(4) .............................. -- -- -- -- Charles A. French(4) ......................... -- -- -- -- Patrick G. Yount(4) .......................... -- -- -- -- Jeffrey D. Brown(4) .......................... -- -- -- -- Ola Magnusson(5) ............................. -- -- -- -- All Named Executive Officers and directors of the Company as a group (12 individuals) .... 30,954,293 100.00% 470,307 3,000 100.0%
_______________________ (1) As beneficial owner of 85.9% of the common stock of Holding, Freeman Spogli has the power to vote and dispose of the shares held by Holding. Includes 300,000 shares issuable upon the conversion of 3,000 shares of Junior Preferred Stock by Holding. 1,441,251 shares, 58,749 shares and 6,364,648 shares of common stock of Holding is 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 42 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. Holding has pledged all shares of the Company's capital stock held by it to secure its guarantee of the Company's obligations under the New Credit Facility. (2) Includes 20,000,000 shares of common stock issuable upon exercise of an immediately exercisable warrant (3) 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. (4) The business address of these individuals is Hudson Respiratory Care Inc., 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589. (5) The business address of this in dividual is Hudson AB, Central Vagen 1, P.O. Box 711, SE-194 27, Uplands Vasby, Sweden. Item 13. Certain Relationships and Related Transactions. Shareholders' Agreement Helen Hudson Lovaas (The "Continuing Shareholder") and Holding have entered into a Shareholders' Agreement, as amended (the "Shareholders' Agreement"). The Shareholder Agreement provides that i) Holding and the Continuing Shareholder have the right to purchase their pro rata share of certain new issuances, ii) in consideration for the contribution of consideration received from Holding for certain issuances of the common stock of Holding, the Company will issue an equivalent shares of Company common stock to Holding, iii) in the event of a sale of Company stock by Holding or Freeman Spogli, the Continuing Shareholder is obligated to sell all or part of her shares at the request of Holding and the Continuing Shareholder has the right to participate in such sale on a pro rata basis, iv) the restriction on the transferability of the shares for a two year period following the recapitalization and provides for a right of first offer on the Continuing Shareholder's common stock and v) in the event the Company participates in an IPO, the Company will exchange all of the Company's existing common stock for newly issued common stock. Note to Freeman Spogli In connection with the acquisition of Hudson RCI AB during 1999, one of the Company's subsidiaries borrowed $22.0 million under an unsecured 12% note payable to Holding's majority stockholder. The Note is due August 1, 2006. During 1999, the Company paid approximately $14.5 million in principal on the note. In April 2001, the Company repaid an additional $6.0 million in principal on the note. Proceeds from the repayment were then reinvested by Holding's majority stockholder in new notes issued by the Company, as described below. During 2000, the Company borrowed an additional $2.0 million from Freeman Spogli under an unsecured 14% note payable due on demand. In August of 2001, this note was exchanged for a new long term note as described below. In August 2001, the Company issued approximately $13.2 million of new unsecured senior subordinated convertible notes consisting of $5.2 million in new cash and an exchange of $8.0 million in existing short-term unsecured notes to Freeman Spogli. The notes bear interest at 10% and are due in March 2005. The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to common stock at the demand of the holder. The notes are subordinated to borrowings under the Credit Facility and rank pari-passu with the Senior Subordinated Notes. 43 As of December 31, 2001, the Company had an aggregate of $13.2 million in long-term notes payable to Freeman Spogli. In May 2002, the Company issued an additional $20 million in senior unsecured notes payable to Freeman Spogli. The notes bear interest at 12% annually with interest and principal due upon maturity at December 31, 2004. In May 2002, the Company issued warrants to purchase 20 million shares of the Company's common stock. 44 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 10-K. (a) Documents filed as part of this Report: Page (1) Financial Statements Financial Statements are filed as part of this Form 10-K .................................................... F-1 (2) Financial Statement Schedules 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 2.1(1) Agreement dated May 7, 1999 between Sten Gibeck, Hudson RCI and Holding. 2.2(1) Agreement dated May 7, 1999 between Euroventures Nordica I B.V., Hudson RCI and Holding. 2.3(1) Agreement dated May 7, 1999 between Forsakrings AB Skandia and Livforsakrings AB Skandia, Hudson RCI and Holding. 2.4(1) Agreement dated May 7, 1999 between Maud Gibeck, Hudson RCI and Holding. 2.5(1) Stock Subscription Agreement dated August 4, 1999 between Sten Gibeck, Holding, FSEP III, FSEP International and FSEP IV. 2.6(2) Asset Purchase Agreement dated September 18, 2000 between Hudson RCI and Tyco Healthcare Group L.P. 2.7(3) Amendment to Asset Purchase Agreement dated September 27, 2000 between Hudson RCI and Tyco Healthcare Group L.P. 2.8(4) Amendment No. 2 to Asset Purchase Agreement dated October 28, 2000 between Hudson RCI and Tyco healthcare Group L.P. 3.1(5) Amended and Restated Articles of Incorporation of Hudson RCI, as amended to date. 3.2(5) Bylaws of Hudson RCI. 4.1(5) 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(5) 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(7) Amended and Restated Credit Agreement dated as of May 14, 2002 among Hudson RCI, Holding, the lenders party thereto, and Deutsche Bank Trust Company Americas ("Deutsche Bank"), as administrative agent and collateral agent. 10.2(7) Form of Amended and Restated Security Agreement dated as of May 14, 2002 between Hudson RCI and Deutsche Bank. 10.3(5) Pledge Agreement dated as of April 7, 1998 (the "Pledge Agreement") between Holding and Bankers Trust. 10.4(5) 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(5) Holding Guarantee Agreement dated as of April 7, 1998 between Holding and Bankers Trust. 45 10.6(5) Indemnity, Subrogation and Contribution Agreement dated as of April 7, 1998 among Hudson RCI, Holding and Bankers Trust. 10.7(5) 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(5) Stock Subscription Agreement dated April 7, 1998 between Holding and River Acquisition Corp. 10.9(5) Employment Agreement dated April 7, 1998 between Hudson RCI and Richard W. Johansen. 10.10(5) Employment Agreement dated April 7, 1998 between Hudson RCI and Jay R. Ogram. 10.11(5) Employment Agreement dated April 7, 1998 between Hudson RCI and Lougene Williams. 10.12(5) Employment Agreement dated April 7, 1998 between Hudson RCI and Brian W. Morgan 10.13(7) Form of Nonrecourse Pledge Agreement dated as of May 14, 2002 among the Pledgor and Deutsche Bank, as collateral agent for the lenders. 10.14(6) Amendment No. 1 to Shareholders Agreement dated April 8, 1998 among Holding, the Hudson Trust, FSEP III, FSEP IV and Hudson RCI. 10.15(7) Tecate Facility Sub-Lease. 10.16(7) Form of Supplement No. 1 dated as of May 14, 2002, to the Pledge Agreement. 10.17(7) Form of Master Assignment and Exchange Agreement dated as of May 14, 2002 by and among Holding, Hudson RCI, the financials institutions listed on the signature pages thereof, Deutsche bank, as administrative agent for the lenders and FSEP IV. 10.18(7) Letter agreement dated August 17, 2001 between Hudson RCI and Charles French. 10.19(7) Form of Stock Option Plan 10.20(7) Form of Stock Option Agreement. 10.21(7) Receivables Purchase Agreement dated May 14, 2002 by and between Hudson RCI and HRC Holding. 12.1 Statement re Computation of Earnings to Fixed Charges Ratio (see page II-3 of this document). 21.1(7) Subsidiaries of Hudson RCI. 24.1 Power of Attorney (included on the signature pages hereof) -------------------- (1) Incorporated by reference to the exhibit designated by the same number in the Form 8-K filed by the Company on August 6, 1999 (date of earliest event: July 22, 1999) (File No. 333-56097). (2) Incorporated by reference to the exhibit designated by number 2.1 in the Form 8-K filed by the Company on November 13, 2000 (date of earliest event: October 28, 2000) (File No.: 333-56097). (3) Incorporated by reference to the exhibit designated by number 2.2 in the Form 8-K filed by the Company on November 13, 2000 (date of earliest event: October 28, 2000) (File No.: 333-56097). (4) Incorporated by reference to the exhibit designated by number 2.3 in the Form 8-K filed by the Company on November 13, 2000 (date of earliest event: October 28, 2000) (File No.: 333-56097). (5) Incorporated by reference to the exhibit designated by the same number in the Form S-4 filed by the Company on June 5, 1998 (File No. 333-56097). (6) Incorporated by reference to the exhibit designated by the same number in to the Form 10-K filed by the Company for the fiscal year ended December 25, 1998. (7) Incorporated by reference to the exhibit designated by the same number in to the Form 10-K filed by the Company for the fiscal year ended December 25, 2001. 46 (b) Current Reports on Form 8-K. None. 47 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HUDSON RESPIRATORY CARE INC. Date: June 28, 2002 By: /s/ Patrick G. Yount ---------------------------------------- Patrick G. Yount Chief Financial Officer and Secretary KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Patrick G. Yount 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 has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Charles A. French Chief Executive Officer and Director June 28, 2002 - ----------------------------------- Charles A. French (Principal Executive Officer) /s/ Patrick G. Yount Chief Financial Officer and Secretary June 28, 2002 - ----------------------------------- Patrick G. Yount (Principal Financial Officer) /s/ Helen Hudson Lovaas Director June 28, 2002 - ----------------------------------- Helen Hudson Lovaas /s/ Ronald P. Spogli Director June 28, 2002 - ----------------------------------- Ronald P. Spogli /s/ Charles P. Rullman Director June 28, 2002 - ----------------------------------- Charles P. Rullman /s/ Jon D. Ralph Director June 28, 2002 - ----------------------------------- Jon D. Ralph /s/ Sten Gibeck Director June 28, 2002 - ----------------------------------- Sten Gibeck
S-1 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-2 RIVER HOLDING CORP. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2001 PAGE - ---------------------------------------------------------------------- ---- Report of Independent Auditors .......................................................................................... F-2 Consolidated Balance Sheet as of December 31, 2001 ...................................................................... F-3 Consolidated Statements of Operations and Comprehensive Loss for the fiscal year ended December 31, 2001 ................................................................................................. F-4 Consolidated Statement of Stockholders' Deficit for the year ended December 31, 2001 .................................... F-5 Consolidated Statement of Cash Flows for the year ended December 31, 2001 ............................................... F-6 Notes to Consolidated Financial Statements .............................................................................. F-8 CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIODS ENDED DECEMBER 31, 2000, DECEMBER 31, 1999 AND DECEMBER 25, 1998 - ------------------------------------------------------------------------------------------------------------------ Report of Independent Public Accountants ................................................................................ F-24 Consolidated Balance Sheets as of December 31, 1999 and 2000 ............................................................ F-25 Consolidated Statements of Operations and Comprehensive Loss for the Period From April 7, 1998 (inception) to December 25, 1998 and for the years ended December 31, 1999 and 2000 .................................................... F-26 Consolidated Statements of Stockholders' Equity for the Period From April 7, 1998 (inception) to December 25, 1998 and for the years ended December 31, 1999 and 2000 .......................................................................... F-27 Consolidated Statements of Cash Flows for the Period From April 7, 1998 (inception) to December 25, 1998 and for the years ended December 31, 1999 and 2000 ........................................................................................ F-28 Notes to Consolidated Financial Statements .............................................................................. F-30
F-1 REPORT OF INDEPENDENT AUDITORS To the Board of Directors of River Holding Corp.: We have audited the accompanying consolidated balance sheet of River Holding Corp., (a Delaware Corporation) and subsidiaries as of December 31, 2001, and the related consolidated statements of operations and comprehensive loss, stockholders' deficit and cash flows for the year then ended. Our audit also included the financial statement schedule for the year ended December 31, 2001 listed in Item 14. These consolidated financial statements and the financial statement schedule are the responsibility of River Holding Corp.'s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of River Holding Corp. and subsidiaries as of December 31, 2001, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 2001 financial statement schedule, when considered in relation to the basic 2001 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. DELOITTE & TOUCHE LLP Costa Mesa, California May 15, 2002 F-2 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In thousands, except per share amounts) ASSETS
December 31, 2001 ----------- CURRENT ASSETS: Cash ................................................................................ $ 7,085 Accounts receivable, less allowance for doubtful accounts of $1,801 ................ 19,287 Inventories ........................................................................ 25,218 Other current assets ............................................................... 1,265 --------- Total current assets ...................................................... 52,855 --------- PROPERTY, PLANT AND EQUIPMENT, NET ................................................... 53,613 --------- GOODWILL, net of accumulated amortization of $18,357 ................................. 28,498 DEFERRED FINANCING COSTS, net of accumulated amortization of $5,981 .................. 8,316 OTHER ASSETS ......................................................................... 823 --------- Total assets .............................................................. $ 144,105 ========= LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable .................................................................. $ 14,943 Accrued liabilities ............................................................... 17,520 Notes payable to banks - current portion .......................................... 20,680 --------- Total current liabilities ................................................... 53,143 NOTE PAYABLE TO AFFILIATE ............................................................ 17,217 NOTES PAYABLE TO BANKS, net of current portion ....................................... 73,250 SENIOR SUBORDINATED NOTES PAYABLE .................................................... 115,000 OTHER NON-CURRENT LIABILITIES ........................................................ 1,187 --------- Total liabilities ................................................................. 259,797 --------- COMMITMENTS AND CONTINGENCIES (Note 7) MANDATORILY-REDEEMABLE PREFERRED STOCK: $0.01 par value: 1,800 shares authorized; 445 shares issued and outstanding; liquidation preference--$44,474 ................................................... 43,847 Accrued preferred stock dividends, payable in kind ................................... 1,142 --------- 44,989 --------- STOCKHOLDERS' DEFICIT: Common stock, no par value: 15,000 shares authorized; 9,144 shares issued and outstanding ....................................................................... 97,848 Junior preferred stock, $0.01 par value; 6 shares authorized; 3 shares issued and outstanding ..................................................................... 3,137 Other comprehensive loss-- Cumulative translation adjustment ...................... (234) Accumulated deficit ............................................................... (261,432) --------- Total stockholders' deficit ....................................................... (160,681) --------- Total liabilities, mandatorily-redeemable preferred stock and stockholders' deficit ........................................................... $ 144,105 ========= See notes to consolidated financial statements.
F-3 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (In thousands) Fiscal Year Ended December 31, 2001 ----------- NET SALES .................................................. $ 157,112 COST OF SALES .............................................. 110,314 ----------- Gross profit .......................................... 46,798 ----------- OPERATING EXPENSES: Selling ................................................. 19,496 Distribution ............................................ 11,429 General and administrative .............................. 24,007 Amortization of goodwill ................................ 8,570 Impairment of goodwill .................................. 161,591 Impairment of fixed assets .............................. 4,712 Research and development ................................ 2,043 Provision for bad debts ................................. 2,826 ----------- Total operating expenses .............................. 234,674 ----------- Loss from operations .................................... (187,876) Other expenses: Interest expense ........................................ 20,542 Other, net .............................................. 1,563 ----------- 22,105 ----------- Loss before provision for income taxes ..................... (209,981) PROVISION FOR INCOME TAXES ................................. 12,252 ----------- Net loss ................................................... (222,233) OTHER COMPREHENSIVE LOSS: Foreign currency translation gain .......................... 453 ----------- Comprehensive loss ...................................... $ (221,780) =========== See notes to consolidated financial statements. F-4 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT (In thousands)
Other Comprehensive Loss-- Cumulative Common Stock Junior Preferred Stock Translation Accumulated --------------------- ---------------------- Shares Amount Shares Amount Adjustment Deficit Total --------- --------- -------- --------- ----------- ----------- ---------- BALANCE, December 31, 2000 ................. 9,134 $ 97,748 -- $ -- $ (687) $ (34,134) $ 62,927 Issuance of common stock ................... 10 100 100 Issuance of junior preferred stock ......... 3 3,000 3,000 Pay-in-kind junior preferred stock dividends ................................. 137 (137) -- Foreign currency translation gain .......... 453 453 Issued or accrued pay-in-kind preferred stock dividends ........................... (4,928) (4,928) Net loss ................................... (222,233) (222,233) ------- --------- ------- --------- ----------- ----------- ---------- BALANCE, December 31, 2001 ................. 9,144 $ 97,848 3 $ 3,137 $ (234) $ (261,432) $ (160,681) ======= ========= ======= ========= =========== =========== ==========
See notes to consolidated financial statements. F-5 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In thousands)
Fiscal Year Ended December 31, 2001 ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss .......................................................... $(222,233) Adjustments to reconcile net loss to net cash provided by operating activities-- Depreciation and amortization ................................. 14,483 Amortization/write-off of deferred financing costs and other ...................................................... 6,756 Loss on disposal of equipment ................................. 681 Change in deferred tax asset .................................. 11,279 Provision for bad debts ....................................... 2,826 Impairment of goodwill ........................................ 161,591 Impairment of fixed assets .................................... 4,712 Changes in operating assets and liabilities: Accounts receivable ........................................... 6,916 Inventories ................................................... 17,304 Other current assets .......................................... 257 Other assets .................................................. 503 Accounts payable .............................................. (4,614) Accrued liabilities ........................................... 3,793 Other non-current liabilities ................................. 1,310 --------- Net cash provided by operating activities .................. 5,564 --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment ........................ (9,029) Proceeds from sale of property, plant and equipment ............... 12 --------- Net cash used in investing activities ............. (9,017) --------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable to bank ................................ (21,209) Proceeds from bank borrowings ..................................... 20,136 Additions to deferred financing costs ............................. (403) Proceeds from note payable to affiliate ........................... 14,951 Repayment of note payable to affiliate ............................ (8,000) Bank overdraft .................................................... (1,245) Net proceeds from sale of common, mandatorily-redeemable and junior preferred stock, net of transaction costs ........... 3,100 --------- Net cash provided by financing activities ............. 7,330 --------- Effect of exchange rate changes on cash .............................. (322) --------- NET INCREASE IN CASH ................................................. 3,555 CASH, beginning of year .............................................. 3,530 --------- CASH, end of year .................................................... $ 7,085 =========
See notes to consolidated financial statements. F-6 December 31, 2001 ------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for-- Interest .............................................. $ 18,856 ============= Income taxes .......................................... $ 2,315 ============= NON-CASH FINANCING ACTIVITIES: Payment of preferred dividends through issuance of stock .................................................. $ 4,703 ============= Capital lease obligation incurred for purchase of equipment .............................................. 295 ============= See notes to consolidated financial statements. F-7 RIVER HOLDING CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2001 1. General River Holding Corp. ("River") 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. River has no operations of its own, other than its investment in the Company. River's respiratory care and anesthesia product lines include such products as oxygen masks, humidification systems, nebulizers, cannulae and tubing. In the United States, River 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, River sells its products to distributors that market to hospitals and other health care providers. River's products are sold to distributors and alternate site service providers throughout the United States and internationally. River'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. Management Plans to Improve Financial Condition and Results of Operations The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the year ended December 31, 2001, River incurred a net loss of $222.2 million. River historically has had sufficient assets to continue operations despite the losses. As of December 31, 2001, the Company was in violation of certain financial covenants. Management believes that River's continuation as a going concern is dependent upon the Company's ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its financing agreements, to obtain additional financing as may be required and, ultimately to attain profitable operations. As further discussed in Note 12, on May 14, 2002, the Company reached an agreement with its senior lenders to amend the Credit Facility to bring the Company into compliance with all terms and provisions of this agreement. As part of this amendment, the Company issued $20.0 million in new senior term notes with warrants to River's majority shareholder. In addition, management has taken numerous actions to improve the operating performance of the Company. Such actions included: the elimination of a distribution warehouse, elimination of non-essential management personnel, reductions in inventory levels, aggressive collection of accounts receivable and elimination of individual products that did not attain acceptable levels of profitability. Management believes that the results of its plans and the agreement reached and funding received on May 14, 2002 discussed above will enable River to meet its ongoing obligations on a timely basis and continue operations for at least the next twelve months. F-8 Reporting Requirements River is privately owned and has no class of securities registered under the Securities Act of 1934 or any publicly traded equity securities. River complies with Securities and Exchange Commission filing requirements on a voluntary basis, as required in the indenture for its senior subordinated notes. 2. Summary of Significant Accounting Policies Fiscal Year-End River reports its operations on a calendar year basis, with the year ending on December 31. Principles of Consolidation The accompanying consolidated financial statements include the accounts of River and its wholly-owned subsidiaries. Intercompany account balances and transactions have been eliminated in consolidation. River and its wholly-owned subsidiaries are collectively referred to herein as River. Hudson and its wholly-owned subsidiaries are collectively referred to herein as the Hudson or the Company. Minority Interest River owns approximately 85% of Hudson, while an unrelated shareholder owns the remaining 15%. Because the stockholders' deficit of Hudson attributable to the minority shareholder exceeds their investment, the entire minority interest is allocated to the majority interest. Accounts Receivable Accounts receivable are stated net of allowances for doubtful accounts of approximately $1.8 million at December 31, 2001, for those accounts from which payment is not expected to be received, although services were provided and revenue was earned. Management performs periodic analyses to evaluate the net realizable value of accounts receivable. Specifically, management considers historical realization data, accounts receivable aging trends, other operating trends and relevant business conditions. Inventories Inventories are stated at the lower of cost (first-in, first-out (FIFO) method) or market. At December 31, 2001, inventories consisted of the following (amounts in thousands): Raw materials ............................... $ 7,377 Work-in-process ............................. 5,392 Finished goods .............................. 14,481 ----------- 27,250 Provision for obsolescence .................. (2,032) ----------- $ 25,218 =========== 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. River considers deterioration, obsolescence and historical trends in evaluating net realizable value of inventory. F-9 Internal Software Development Costs River capitalizes costs incurred to develop internal-use computer software in accordance with Statement of Position ("SOP") 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". Such costs are amortized on a straight-line basis over the economic useful lives of the software, which range from three to five years. River applies the provisions of SOP 98-1 in assessing any potential impairment of its capitalized software costs. Property, Plant and Equipment Property is stated at cost. Major renewals and betterments are capitalized while maintenance costs and repairs are expensed in the year incurred. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets or term of the related lease, if shorter. Estimated useful lives range from 3 to 7 years for furniture and fixtures; 5 to 7 years for machinery, equipment and purchased software; and 31.5 years for buildings. Total depreciation expense related to property was $10,993,000 for the year ended December 31, 2001. River reviews property for impairment whenever events or changes in circumstances indicate that an asset's book value exceeds the undiscounted expected future cash flows to be derived from that asset. Whenever undiscounted expected future cash flows are less than the book value, the asset will be reduced to fair value based on the net present value of the expected future cash flows, and an impairment loss will be recognized. Goodwill and Other Intangible Assets Goodwill and other intangible assets are amortized under a straight-line method over the estimated useful lives. River periodically reviews the recoverability of the carrying value of goodwill, intangibles and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of these assets is determined by analysis of the assets' fair value by comparing the forecasted future undiscounted net cash flows from the operations to which the assets relate, based on management's best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets. In addition, goodwill is assessed for recoverability at an entity level, based on fair value determined by estimated future cash flows, discounted at a rate commensurate with the risk involved. In the fourth quarter of 2001, as a result of significant losses from operations, River reassessed future cash flows and operating results and recorded a goodwill impairment charge of approximately $161,591,000. Amortization expense related to goodwill and other intangibles was approximately $8,570,000 for the year ended December 31, 2001. Revenue Recognition River recognizes revenue when product is shipped and title passes to the customer, as the earnings process is substantially complete. River establishes reserves for sales returns and other allowances based on historical experience. River sells its products to its distributors without right of return based on a listed price. Distributors charge the service providers, or River's end customers, a contract price (which is determined by their group purchasing organization affiliation or individual contract price) plus a service margin. As is customary within the industry, River rebates the difference between the list price and the specific contract price to the distributor. River records this revenue and receivables net of rebatable amounts. In the event no rebate is payable, the rebate amount is reversed and recognized as revenue. Income Taxes River 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 for recoverability 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-10 Foreign Currency Translation River uses the local currency as the functional currency of its foreign operating subsidiaries. Accordingly, all assets and liabilities at River's subsidiaries located 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. The resulting translation gains and losses are recorded as other comprehensive income (loss) in stockholders' deficit in the accompanying consolidated financial statements. Concentration of Credit Risk River sells its products primarily to customers in the United States of America and Europe. Historically, River has not experienced significant losses related to trade receivables from concentrations of individual customers or from groups of customers in any geographic area. Fair Value of Financial Instruments The fair value of long-term debt is determined based on quoted market prices for issues listed on exchanges. The carrying amounts of cash, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short maturity. 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. New Accounting Pronouncements Effective January 1, 2001, River adopted Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") as amended by SFAS No. 137 and SFAS No. 138. SFAS No. 133, as amended, 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. The adoption of this new standard did not have a material impact on River's consolidated financial statements. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principals Board ("APB") Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this statement are to be accounted for using one method, the purchase method. Any acquisitions made by River after June 2001 will be accounted for in accordance with SFAS 141. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill will no longer be amortized but will be assessed at least annually for impairment using a fair value methodology. River stopped amortizing goodwill, effective January 1, 2002, and as a result an equivalent charge for goodwill F-11 amortization will not be made in 2002. River is still evaluating the impact of the standard on impairment, which is expected to be completed by the end of the second quarter of 2002. The amortization of goodwill for 2001 was $8.6 million. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful live of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. SFAS 143 will become effective January 1, 2003. River does not expect the adoption of SFAS 143 to have a material impact on River's consolidated financial statements. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 143 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of a Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 became effective January 1, 2002. The adoption of SFAS 144 is not expected to have a material impact on River's consolidated financial statements. 3. Detail of Selected Balance Sheet Accounts Property, Plant and Equipment The following is a summary as of December 31, 2001 (amounts in thousands): Land .............................................. $ 4,007 Buildings ......................................... 11,964 Leasehold improvements ............................ 823 Machinery, equipment and purchased software ....... 62,367 Furniture and fixtures ............................ 1,938 ----------- 81,099 Less-- Accumulated depreciation and amortization .. (28,199) ----------- 52,900 Construction in process ........................... 713 ----------- Property and equipment, net ....................... $ 53,613 ===========
Accrued Liabilities Accrued liabilities consisted of the following as of December 31, 2001 (amounts in thousands): Payroll and related .................................. $ 5,784 Interest ............................................. 4,260 Vacation ............................................. 1,905 Taxes ................................................ 1,630 Pension .............................................. 1,077 Medical self-insurance ............................... 876 GPO fees ............................................. 821 Closure of distribution facility ..................... 738 Other ................................................ 429 ----------- $ 17,520 ===========
F-12 4. Mandatorily-Redeemable Preferred Stock In connection with the recapitalization in April 1998, River 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. The preferred stock is exchangeable for subsequent offerings of River preferred stock or subordinated notes. 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 River 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. Also in connection with the recapitalization in 1998, the Company entered into an agreement to issue preferred stock to River that would mirror the preferred stock issued by River to its shareholders. On May 14, 2002 the Company and the lenders amended and restated the Credit Facility (as discussed in Note 12) and under the terms of the amended and restated Credit facility, the Company is prohibited from paying cash dividends on its mandatorily-redeemable preferred stock. In the event that Holding is unable to pay cash dividends to the holders of Holding Preferred Stock for two consecutive periods, the sole remedy of the holders is the ability to elect two members to Holding's Board of Directors. The preferred stock is mandatorily redeemable as of 2010. Accordingly, River is accreting the original issuance costs of $1,000,000 over a 10 year period to PIK preferred stock to current redemption value on the consolidated financial statements through a charge to accumulated deficit. As of December 31, 2001 River had accreted to PIK preferred stock $373,000 of the issuance costs. The preferred stock ranks junior in right of payment to all obligations of River and its subsidiaries. River issued PIK preferred stock with a liquidation preference of approximately $4,703,000 to satisfy the dividend requirements in 2001. As of December 31, 2001, River accrued for PIK preferred stock dividends in the amount of $1,142,000. 5. Junior Preferred Stock In August 2001, River issued 3,000 shares of 12% Junior Convertible Cumulative Preferred Stock (the "Junior Preferred Stock") for cash consideration of $3,000,000. Each share of the Junior Preferred Stock may be redeemed from time to time, in whole or in part, at the option of River at the redemption price of 100% of the Liquidation Preference of the Junior Preferred Stock or $1,000 per share plus accumulated and unpaid dividends that would be payable on such shares of Junior Preferred Stock. F-13 6. Long-Term Debt Obligations The Company's long-term debt obligations as of December 31, 2001, as amended and restated (see Note 12) consist of the following (amounts in thousands): Borrowings under revolving credit facility ........................... $ 55,000 Term loan payable to domestic banks .................................. 10,000 Term loan payable to domestic banks to be exchanged for notes payable to affiliates .................................. 12,000 Term and revolving loan payable to Swedish bank ...................... 16,930 Senior subordinated notes ............................................ 115,000 Note payable to affiliate ............................................ 17,217 ---------- 226,147 Less--current portion ................................................ (20,680) ---------- Long-term debt ....................................................... $ 205,467 ==========
Credit Facility The Credit Facility as of December 31, 2001 consists of a $40.0 million Term Loan Facility and a $55.0 million Revolving Loan Facility. The Revolving Loan Facility permits borrowings of up to $40.0 million (all of which has been borrowed and is outstanding) which may be used for permitted acquisitions (the "Acquisition Facility") and up to $15 million (the "Working Capital " portion) which may be used for general corporate purposes (other than acquisitions). The Revolving Loan Facility has a letter of credit sublimit of $7.5 million. The Term Loan Facility matures on June 30, 2003 and requires quarterly principal installments totaling $3.0 million in 1999, $5.5 million in 2000, $7.5 million in 2001, $9.5 million in 2002 and $14.5 million in 2003. The Revolving Loan Facility matures on June 30, 2003. The interest rate under the Credit Facility is based, at the option of the Company, upon either a Eurodollar rate or a base rate (as defined) plus a margin during the period and for the applicable type of loan as follows:
Margin --------------------- Period and Loan Type Base Rate Eurodollar -------------------- --------- ---------- Through June 2002 Term and Working Capital .................................... 3.00% 4.00% Acquisition ................................................. 3.25% 4.25% July 2002 through March 2003 Term and Working Capital .................................... 3.50% 4.50% Acquisition ................................................. 3.75% 4.75% Thereafter Term and Working Capital .................................... 4.00% 5.00% Acquisition ................................................. 4.25% 5.25%
For periods after June 2002, the margins set forth above are subject to pricing reductions depending on the Company's then existing leverage ratio. F-14 The following summarizes interest rate data on the Credit Facility as of December 31, 2001: Revolving credit facility rate .................. 6.511% Term and acquisition loan facility rate ......... 5.938% Borrowings under the Credit Facility are required to be prepaid from Excess Cash Flow (as defined in the Credit Agreement). 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 River 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 is guaranteed jointly and severally by River and certain of River's subsidiaries. The Credit Facility contains covenants restricting the ability of River, 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, and (viii) engage in transactions with affiliates. The Company 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 Company was not in compliance with these covenants as of December 31, 2001. On May 14, 2002 the Company amended its Credit Facility with its senior lenders. Under this amendment, the lenders agreed to waive past violations of convents, amend future covenants, extend the final maturity to June 30, 2004 and reduce scheduled amortization of the Term Loan (see Note 12.) Total borrowings as of December 31, 2001 were $55.0 million under the Revolving Loan Facility and Acquisition Facility and $22.0 million under the Term Loan Facility. As of December 31, 2001, the Company had utilized all available credit under the Revolving Credit Facility. No additional borrowing is available under the Term Loan Facility. Senior Subordinated Notes The Company has $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 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 at a redemption price of 100.0% to 104.6% of face value depending on the date of the redemption. The Notes are guaranteed jointly and severally by Hudson Respiratory Care Inc. and its Mexican subsidiaries. The fair value of the Company's senior subordinated notes at December 31, 2001 was approximately $77.1 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 Hudson RCI AB during 1999, the Company borrowed $22.0 million under an unsecured 12% note payable to an affiliate of River'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. In April 2001, the Company repaid an additional $6.0 million in principal on the note. Proceeds from the repayment of this note were then reinvested by River's majority stockholder in new long term notes issued by the Company as described below. F-15 During 2000, the Company borrowed an additional $2.0 million from Holding's existing majority stockholder under an unsecured 14% note payable due on demand. In August of 2001, this note was exchanged for a new long-term note as described below. In August, 2001, the Company issued approximately $15.0 million of new unsecured senior subordinated convertible notes consisting of $7.0 million in new cash and an exchange of $8.0 million in existing short-term unsecured notes to certain managers and shareholders. The notes bear interest at 10% and are due in March 2005. The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to common stock at the demand of the holder. The notes are subordinated to borrowings under the Credit Facility and rank pari-passu with the Senior Subordinated Notes. The fair value of the notes to affiliate approximates the face value at December 31, 2001. In May of 2002, the Company issued an additional $20.0 million in senior notes payable to affiliates (see Note 12). Bank Notes Payable On March 21, 2001, River's primary European subsidiary, Hudson RCI AB, replaced its existing lending agreement denominated in Swedish krona with a new loan that allows for borrowings (the "Hudson AB Bank Notes") of up to approximately $17.0 million. The principal is amortized over 18 equal quarterly payments commencing June 30, 2001 with a final maturity of September 30, 2005. Interest is based on the STIBOR rate plus 1.25% to 1.85%, based on the outstanding balance of the loan. The loan is guaranteed jointly and severally by Hudson Euro SarL, a wholly-owned subsidiary of the Company and 100% owner of Hudson RCI AB and subsidiaries, Hudson RCI UK Ltd. and Hudson France S.A.S. The loan contains certain affirmative and restrictive provisions including, but not limited to, restrictions on additional indebtedness and compliance with certain financial covenants. The loan also restricts Hudson RCI AB's ability to dividend to its parent companies. At December 31, 2001, borrowings under the Hudson AB Bank Notes equaled $16.9 million. The interest rate on the Bank Notes Payable as of December 31, 2001 was 5.74%. At December 31, 2001, Hudson RCI AB was not in compliance with certain financial covenants of the Hudson AB Bank Notes. The Company and Hudson RCI AB are currently in discussions with the lender and expects the lender to agree to provide a waiver curing all defaults as of December 31, 2001. Due to the uncertainty of obtaining this waiver from the lenders, all amounts payable under the Hudson AB Bank Notes have been classified as current on the accompanying consolidated balance sheet. The following summarizes future principal amounts payable on all of the Company's debt at December 31, 2001 (amounts in thousands): 2002 ................... $ 20,680 2003 ................... 24,250 2004 ................... 49,000 2005 ................... 14,951 2006 ................... 2,266 Thereafter .............. 115,000 --------- $ 226,147 ========= F-16 7. Commitments and Contingencies River has capital and operating leases for certain facilities, automobiles and office equipment under non-cancelable leases, with the majority of the automobile leases having a term of one year with annual renewal provisions. Rental expense for the year ended December 31, 2001 amounted to $4,657,000. Generally, the facility leases include escalation clauses. The following is a schedule, by year, of the future minimum payments under capital and operating leases, together with the present value of the net minimum payments as of December 31, 2001 (in thousands). Capital lease amounts are included in the non-current liabilities line item on the accompanying consolidated balance sheet:
Capital Operating Leases Leases ------- --------- Year ending December 31, 2002 ............................................. $ 59 $ 2,188 2003 ............................................. 59 2,152 2004 ............................................. 59 2,087 2005 ............................................. 59 1,649 2006 ............................................. -- 896 Thereafter ....................................... -- 3,128 ------- --------- Total minimum lease payments ........................... 236 $ 12,100 ========= Less amount representing interest ...................... 53 ------- Total present value of minimum payment ................. 183 Less current portion of such obligations ............... 39 ------- Long-term obligations with interest rate of 11.0% ...... $ 144 =======
Assets recorded under capital leases as of December 31, 2001 are as follows (amounts in thousands): Machinery and equipment ......................... $ 297 Less accumulated depreciation ................... 31 ------- Property, plant and equipment, net .............. $ 266 =======
Self-Insurance River self-insures the majority of its medical benefit programs. Reserves for medical claim losses totaling approximately $876,000 at December 31, 2001 were established based upon estimated obligations and are included in accrued liabilities in the accompanying consolidated balance sheet. River maintains excess coverage on an aggregate claim basis. Effective November 1, 2001, River became self-insured for workers' compensation. Reserves for workers' compensation claim losses totaling approximately $350,000 at December 31, 2001 were established based upon estimated obligations and are included in accrued liabilities in the accompanying consolidated balance sheet. Legal River is not a party to any material lawsuits or other proceedings, including suits relating to product liability and patent infringement. While the results of the River's other existing lawsuits and 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 River. F-17 Other Financial instruments that potentially subject River to significant concentrations of credit risk consist principally of cash and accounts receivable. River places its cash investments with high-quality financial institutions and limits the amount of credit exposure to any one institution. 8. Income Taxes River is a C corporation. River's effective tax rate approximates the federal statutory rate of 34%. The components of the deferred tax asset as of December 31, 2001 are (amounts in thousands): Goodwill .......................................... $ 64,103 Net operating loss carryforwards .................. 32,921 Other ............................................. 3,988 Fixed assets ...................................... (5,468) ------------ 95,544 Valuation allowance .............................. (95,544) ------------ $ -- ============
As of December 31, 2001, River had net deferred tax assets before any valuation allowance of $95.5 million. This asset relates primarily to basis differences in goodwill and net operating loss carryforwards for tax purposes. As of December 31, 2001, River had federal and state net operating loss carryforwards of approximately $86.0 million and $59.0 million, which begin to expire in 2018 and 2003, respectively. Under SFAS No. 109, "Accounting for Income Taxes," River is required to place a valuation allowance against any deferred tax assets unless it is more likely than not that the asset will be realized. In accordance with this standard, River has placed a valuation allowance against its deferred tax assets of approximately $95.5 million as of December 31, 2001. The reconciliation of the actual tax expense to tax computed at the statutory federal rate for the year ended December 31, 2001 (amounts in thousands): Income taxes at statutory rate ..................... $ (71,394) Other. ............................................. 1,310 Taxes on foreign earnings .......................... 4,478 Increase in valuation allowance .................... 74,224 State income taxes net of federal effect ........... 3,634 ----------- $ 12,252 ===========
The provision for income taxes for the year ended December 31, 2001 consists of the following (amounts in thousands):
United States Foreign Total ------------- ------------ ----------- Current ............................... $ - $ 959 $ 959 Deferred .............................. 11,293 - 11,293 ------------- ------------ ----------- $ 11,293 $ 959 $ 12,252 ============= ============ ===========
F-18 9. Deferred Compensation and Benefit Plans Pension and 401(k) Plans The Company has a defined contribution pension plan covering substantially all its employees who are 21 years of age with two years of service. The Company contributes an amount equal to 6% of employees' basic compensation. Contribution expense relating to this plan totaled approximately $943,000 for the fiscal year ended December 31, 2001. During 2001, the Company determined that the pension plan for 1999 and 2000 was not fully funded. Accordingly, the Company recorded $350,000 in associated penalties and fully funded the plan through 2000. Additionally, the Company has a defined contribution 401(k) plan covering substantially all of its employees who are 21 years of age with 30 days of service. Participants may contribute up to 10% of base compensation to this plan, subject to certain Internal Revenue Code (IRC) limitations, each year. The Company makes no contributions under this plan. Deferred Compensation Effective December 1, 1994, the Company established a deferred compensation plan for certain key employees. As of December 31, 2001 no material amount of compensation has been deferred. Management Bonus Plans The Company offers a management bonus plan for its executives and senior management. The plan is based solely on the financial goals of the Company. The plan for 2001 required reaching a minimum of 95% of budgeted EBITDA. During 2001, the Company did not meet this objective and no bonuses were paid. The Company periodically offers additional incentive compensation to individuals who demonstrate superior performance. This compensation was not material in 2001. Stock Subscription Plans In April 1998, River adopted an Employee Stock Subscription Plan and an Executive Stock Subscription Plan (collectively, the "Stock Subscription Plans") pursuant to which executives of the River and the Company purchased 800,000 shares of common stock of River valued at $10.00 per share. The Stock Subscription Plans provide for a repurchase option in favor of River 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 the Company's initial public offering. The shares are also subject to a right of first refusal in favor of River, 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 River common stock were sold under the Stock Subscription Plans in fiscal 2001. Shareholder Agreement Helen Hudson Lovaas (The "Continuing Shareholder") and River have entered into a Shareholders' Agreement, as amended (the "Shareholders' Agreement"). The Shareholder Agreement provides that i) River and the Continuing Shareholder have the right to purchase their pro rata share of certain new issuances, ii) in consideration for the contribution of consideration received from River for certain issuances of the common stock of River, the Company will issue an equivalent shares of Company common stock to River, iii) in the event of a sale of Company stock by River or Freeman Spogli, the Continuing Shareholder is obligated to sell all or part of her shares at the request of River and the Continuing Shareholder has the right to participate in such sale on a pro rata basis, iv) the restriction on the transferability of the shares for a two year period following the recapitalization and provides for a right of first offer on the Continuing Shareholder's common stock and v) in the event the Company participates in an IPO, the Company will exchange all of the Company's existing common stock for newly issued common stock. In 2001, the Board of Directors of River approved adoption of a Stock Option plan for eligible employees, officers and consultants of River and the Company. The plan allows for the issuance of up to 2,000,000 of River common stock in the form F-19 of unqualified or incentive stock options under which shares shall have been reserved for by River. Exercise price shall be set at fair market value as determined by the Board of Directors. As of the date of this filing, no options have been granted under this plan. 10. Geographic, Segment and Major Customer Information River presents segment information externally based on how management uses financial data internally to make operating decisions and assess performance. River also reports information about the revenues derived from the enterprises' 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. River sells respiratory care products to distributors and medical facilities throughout the United States and internationally. During 2001, River had foreign sales of approximately $40,772,000, which constituted approximately 26.0% of total sales. River's percentage of sales by geographic region for the fiscal year ended December 31, 2001 is as follows: Domestic ................................................... 74.1% Europe ..................................................... 13.9 Pacific Rim (Japan, Southeast Asia, Australia/ New Zealand) ............................................... 7.2 Canada ..................................................... 1.6 Other international ........................................ 3.2 ------ 100.0% ====== River's percentage of sales by product category for the fiscal year ended December 31, 2001 is as follows: Oxygen therapy ............................................. 32.6% Airway management .......................................... 29.2 Humidification and filtration .............................. 21.6 Aerosol therapy ............................................ 16.6 ------ 100.0% ====== The following summarizes the net book value of fixed assets at the respective locations as of December 31, 2001 (amounts in thousands): Ensenada, Mexico ........................................... $ 1,229 Stockholm, Sweden .......................................... 422 Kuala Lumpur, Malaysia ..................................... 721 United States .............................................. 43,896 --------- $ 46,268 ========= For the fiscal year ended December 31, 2001, River had sales to one domestic distributor in the amount of $30,435,000, which represented approximately 19.4% of sales. Additionally River had sales to another domestic distributor of approximately $15,656,000, that accounted for approximately 10.0% of sales in 2001. 11. Subsidiaries Debt Guarantee and Segment Data River is the majority 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 Hudson RCI AB and subsidiaries. The following tables disclose the required consolidating financial information for the guarantor, including the Company, and non-guarantor subsidiaries (amounts in thousands): F-20 RIVER HOLDING CORP. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING BALANCE SHEET DATA
As of December 31, 2001 --------------------------------------------------- Non- Guarantor Guarantor Eliminations Total ------------- ----------- -------------- --------- CURRENT ASSETS: Cash ...................................... $ 4,713 $ 2,372 $ -- $ 7,085 Accounts receivable ....................... 13,989 5,298 -- 19,287 Receivables from non-guarantor ............ 6,515 -- (6,515) -- Inventories ............................... 20,377 7,030 (2,189) 25,218 Other current assets ...................... 2,758 13,553 (15,046) 1,265 ----------- ---------- ------------ ----------- Total current assets ................... 48,352 28,253 (23,750) 52,855 PROPERTY, PLANT AND EQUIPMENT, net ........... 52,470 1,143 -- 53,613 INTANGIBLE ASSETS, net .................... -- 28,498 -- 28,498 DEFERRED FINANCING COSTS, net ............. 8,316 -- -- 8,316 INVESTMENT IN NON-GUARANTOR SUBSIDIARIES ......................... 28,623 -- (28,623) -- OTHER ASSETS .............................. 599 224 -- 823 ----------- ---------- ----------- ----------- Total other assets ..................... 37,538 28,722 (28,623) 37,637 ----------- ---------- ------------ ----------- $ 138,360 $ 58,118 $ (52,373) $ 144,105 =========== ========== =========== ===========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable .......................... $ 13,761 $ 1,182 $ -- $ 14,943 Accrued liabilities ....................... 14,584 15,356 (12,420) 17,520 Notes payable to banks-current portion .... 3,750 16,930 -- 20,680 Payables to guarantor ..................... -- 6,515 (6,515) -- ----------- ---------- ----------- ----------- Total current liabilities .......... 32,095 39,983 (18,935) 53,143 NOTE PAYABLE TO AFFILIATE .................... 14,951 2,266 -- 17,217 NOTES PAYABLE TO BANKS, net of current portion .................................... 73,250 -- -- 73,250 SENIOR SUBORDINATED NOTES PAYABLE ............ 115,000 -- -- 115,000 OTHER NON-CURRENT LIABILITIES ................ 146 1,041 -- 1,187 ----------- ---------- ----------- ----------- Total liabilities ...................... 235,442 43,290 (18,935) 259,797 ----------- ---------- ----------- ----------- Mandatorily-redeemable preferred stock ....... 44,989 -- -- 44,989 STOCKHOLDERS' DEFICIT ........................ (142,071) 14,828 (33,438) (160,681) ------------ ---------- ----------- ----------- $ 138,360 $ 58,118 $ (52,373) $ 144,105 =========== ========== =========== ===========
F-21 RIVER HOLDING CORP. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING STATEMENT OF OPERATIONS
For the Year Ended December 31, 2001 ------------------------------------------------- Non- Guarantor Guarantor Eliminations Total ---------- ----------- ------------ ----------- NET SALES ....................................... $ 143,555 $ 28,319 $ (14,762) $ 157,112 COST OF SALES ................................... 108,049 15,749 (13,484) 110,314 ---------- --------- ---------- --------- Gross profit .................................... 35,506 12,570 (1,278) 46,798 OPERATING EXPENSES: Selling ...................................... 13,470 6,026 -- 19,496 Distribution ................................. 9,514 1,915 -- 11,429 General and administrative ................... 21,623 2,384 -- 24,007 Amortization of goodwill ..................... 6,641 1,929 -- 8,570 Impairment of goodwill ....................... 154,680 6,911 -- 161,591 Impairment of fixed assets ................... 4,712 -- -- 4,712 Research and development ..................... 1,015 1,028 -- 2,043 Provision for bad debts ...................... 2,768 58 -- 2,826 ---------- --------- ---------- ----------- Total operating expenses .................. 214,423 20,251 -- 234,674 ---------- --------- ---------- ----------- Income (loss) from operations ................... (178,917) (7,681) (1,278) (187,876) OTHER EXPENSES: Interest expense ............................. 18,890 1,652 -- 20,542 Other, net ................................... 1,005 675 (117) 1,563 ---------- --------- ---------- ----------- Total other expense ....................... 19,895 2,327 (117) 22,105 ---------- --------- ---------- ----------- Income (loss) before provision (benefit) for income taxes ................................... (198,812) (10,008) (1,161) (209,981) PROVISION (BENEFIT) FOR INCOME TAXES ......... 11,495 757 -- 12,252 ---------- --------- ---------- ----------- Net income (loss) .............................. $ (210,307) $ (10,765) $ (1,161) $ (222,233) ========== ========= ========== ===========
RIVER HOLDING CORP. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2001 ------------------------------------ Non- Guarantor Guarantor Total ----------- ------------ -------- Net cash provided by operating activities ............. $ 3,740 $ 1,824 $ 5,564 Net cash (used in) provided by investing activities ... (8,366) (651) (9,017) Net cash provided by financing activities ............. 8,902 (1,572) 7,330 Effect of exchange rate changes on cash ............... -- (322) (322) ----------- ---------- -------- NET INCREASE IN CASH .................................. 4,276 (721) 3,555 CASH, beginning of year ............................... 437 3,093 3,530 ----------- ---------- -------- CASH, end of year ..................................... $ 4,713 $ 2,372 $ 7,085 =========== ========== ========
F-22 12. Subsequent Events As of December 31, 2001, based on the Company's financial results, the Company was not in compliance with certain financial covenants under its Credit Facility. As a result of this non-compliance and resulting defaults, on March 30, 2002, the Company did not make a scheduled Term Loan payment to its senior lenders as required under the Credit Facility and, as a result, the Company was prevented from making a scheduled interest payment due its Subordinated Note holders on April 15, 2002. On May 14, 2002, the Company amended and restated the Credit Facility to (i) waive all existing events of default; (ii) extend the final maturity of the term and revolving facilities under the Credit Facility to June 30, 2004; (iii) amend existing term and acquisition loan amortization to $3.8 million in 2002 and $9.3 million in 2003 and $37.0 million in 2004; and (iv) amend financial covenants to include only a limitation on capital expenditures and a minimum EBITDA test. In connection with this amendment, the Company and HRC Holding, its wholly-owned subsidiary, issued a total of $20.0 million in senior unsecured notes to affiliates of River's majority stockholder, of which $12.0 million was used to pay down the Term Loan of the Credit Facility. These notes bear interest at 12%, with interest and principal due upon maturity on December 31, 2004. F-23 Arthur Andersen LLP ("Andersen") is the former auditor of the Holding. As a result of recent events at Andersen, Andersen declined Holding's request to reissue their audit report dated July 30, 2001 for the fiscal years ended December 31, 2000 and 1999 for inclusion in Holding's 10-K filing for the fiscal year ended December 31, 2001. As such, pursuant to the guidance given in the Temporary Final Rule and Final Rule: Requirements for Arthur Andersen LLP Auditing Clients, Release Nos. 33-8070; 34-45590; 35-27503; 39-2395; IA-2018; IC-25464; FR-62; File No. S7-03-02, Holding is filing this copy of the latest signed and dated accountant's report issued by Andersen for such periods. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of River Holding Corp.: We have audited the accompanying consolidated balance sheets of RIVER HOLDING CORP., (a Delaware Corporation) and subsidiaries as of December 31, 1999 and 2000, and the related consolidated statements of operations and comprehensive loss, stockholders' equity and cash flows for the period from April 7, 1998 (inception) to December 25, 1998, and the years ended December 31, 1999 and 2000. 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 River Holding Corp. and subsidiaries as of December 31, 1999 and 2000, and the results of their operations and their cash flows for the period from April 7, 1998 (inception) to December 25, 1998, and the years ended December 31, 1999 and 2000 in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP Orange County, California July 30, 2001 F-24 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) ASSETS
December 31, December 31, 1999 2000 -------------- -------------- CURRENT ASSETS: Cash ................................................................................ $ 2,917 $ 3,530 Accounts receivable, less allowance for doubtful accounts of $973 and $3,500 at December 31 1999 and 2000, respectively ........................................ 30,425 28,307 Inventories ...................................................................... 24,043 44,610 Other current assets ............................................................. 4,945 2,165 ---------- ---------- Total current assets ........................................................... 62,330 78,612 PROPERTY, PLANT AND EQUIPMENT, net ...................................................... 54,341 59,030 OTHER ASSETS: Deferred tax asset .................................................................. 11,342 11,502 Deferred financing costs, net of accumulated amortization of $2,253 and 3,245 at December 31, 1999 and 2000, respectively ................................. 11,134 9,587 Other assets ........................................................................ 222 1,189 Goodwill, net of accumulated amortization of $8,197 and $13,277 at December 31, 1999 and 2000, respectively ................................................... 205,592 201,116 ---------- ---------- Total other assets ............................................................. 228,290 223,394 ---------- ---------- Total assets .......................................................... $ 344,961 $ 361,036 ========== ==========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable to banks .............................................................. $ 6,673 $ 10,686 Accounts payable .................................................................... 6,268 20,420 Accrued liabilities ................................................................. 11,700 12,707 Note payable to affiliate ........................................................... -- 2,000 Other current liabilities ........................................................... 1,485 3,007 ---------- ---------- Total current liabilities ...................................................... 26,126 48,820 NOTE PAYABLE TO AFFILIATE ............................................................... 7,508 8,266 NOTES PAYABLE TO BANKS, net of current portion .......................................... 82,513 85,962 SENIOR SUBORDINATED NOTES PAYABLE ....................................................... 115,000 115,000 ---------- ---------- Total liabilities .............................................................. 231,147 258,048 ---------- ---------- COMMITMENTS AND CONTINGENCIES (Note 8) MANDATORILY-REDEEMABLE PREFERRED STOCK, $.01 par value: 1800 shares authorized; 356 and 398 shares issued and outstanding at December 31, 1999 and 2000, respectively; liquidation preference 35,558 and 39,783, respectively ........................................ 34,558 39,043 Accrued preferred stock dividends, payable in kind .................................. 863 1,018 ---------- ---------- 35,421 40,061 ---------- ---------- STOCKHOLDERS' EQUITY Common stock, no par value: 15,000 shares authorized; 8,544 and 8,887 issued and outstanding at December 31, 1999 and 2000, respectively ................ 91,748 97,748 Cumulative translation adjustment ................................................... (398) (687) Accumulated deficit ................................................................. (12,957) (34,134) --------- ---------- Total stockholders' equity ..................................................... 78,393 62,927 --------- ---------- Total liabilities, mandatorily-redeemable preferred stock and stockholders' equity ................................................ $ 344,961 $ 361,036 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements F-25 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE PERIOD FROM APRIL 7, 1998 (INCEPTION) TO DECEMBER 25, 1998 AND FOR THE YEARS ENDED DECEMBER 31, 1999 AND 2000 (In thousands)
1998 1999 2000 ------------- ------------ ----------- NET SALES ............................................... $ 76,232 $ 128,803 $ 159,278 COST OF SALES ........................................... 44,662 77,678 87,183 ------------- ------------ ----------- Gross profit ........................................ 31,570 51,125 72,095 ------------- ------------ ----------- OPERATING EXPENSES: Selling ............................................. 8,032 13,122 18,262 Distribution ........................................ 2,471 4,647 10,109 General and administrative .......................... 7,129 14,732 24,022 Amortization of goodwill ............................ 3,785 5,080 8,400 Research and development ............................ 726 2,031 2,387 ------------- ------------ ----------- 22,143 39,612 63,180 ------------- ------------ ----------- Income from operations ........................... 9,427 11,513 8,915 INTEREST EXPENSE AND OTHER .............................. 11,001 18,595 22,249 ------------- ------------ ----------- Loss before (benefit) provision for income taxes ........ (1,574) (7,082) (13,334) (BENEFIT) PROVISION FOR INCOME TAXES (Note 9) ........... (614) (1,508) 3,203 ------------- ------------ ----------- Net loss ................................................ (960) (5,574) (16,537) OTHER COMPREHENSIVE LOSS: Foreign currency translation loss ................... -- (398) (289) ------------- ------------ ----------- Comprehensive loss ...................................... $ (960) $ (5,972) $ (16,826) ============= ============ ===========
The accompanying notes are an integral part of these consolidated financial statements F-26 RIVER HOLDING CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
Cumulative Common Stock 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 Sale of common stock ....................... 343 6,000 -- -- 6,000 Pay-in-kind preferred stock dividends ...... -- -- -- (4,640) (4,640) Foreign currency translation loss .......... -- -- (289) -- (289) Net loss ................................... -- -- -- (16,537) (16,537) ----------- ----------- ------------ ------------- ------------- BALANCE, December 31, 2000 .................... 8,887 $ 97,748 $ (687) $ (34,134) $ 62,927 =========== =========== ============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements F-27 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 YEARS ENDED DECEMBER 31, 1999 AND 2000 (In thousands)
1998 1999 2000 ----------- ---------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss .................................................... $ (960) $ (5,574) $ (16,537) Adjustments to reconcile net loss to net cash provided by operating activities- Depreciation and amortization ............................. 8,507 15,655 19,059 Amortization of deferred financing costs .................. -- 1,374 992 (Loss) gain on disposal of equipment ...................... -- (5) 8 Change in deferred tax asset .............................. -- (1,709) (160) Changes in operating assets and liabilities: Accounts receivable ..................................... (7,089) (2,701) 2,118 Inventories ............................................. (1,215) (2,865) (12,351) Other current assets .................................... 316 (1,194) 2,780 Other assets ............................................ 526 13 (966) Accounts payable ........................................ 3,243 (741) 14,152 Accrued liabilities ..................................... 526 4,277 1,007 Other current liabilities ............................... -- 1,526 1,522 Other liabilities ....................................... -- (959) -- ---------- ---------- ---------- Net cash provided by operating activities ............. 3,854 7,097 11,624 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of majority interest in Hudson Respiratory Care Inc. ......................................................... (248,000) -- -- Purchase of property, plant and equipment .................... (3,121) (10,973) (11,329) Proceeds from sale of property, plant and equipment .......... -- 23 4 (Additions) retirements of intangible assets ................. -- (354) 1,828 Additions of deferred financing costs ........................ -- 154 555 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) (18,000) 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) (26,942) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable to bank ........................... (2,000) (17,355) (5,500) Proceeds from bank borrowings ................................ 46,000 59,376 12,962 Proceeds from senior subordinated notes payable .............. 115,000 -- -- Proceeds from note payable to affiliate ...................... -- 22,000 2,758 Repayment of note payable to affiliate ....................... -- (14,492) -- Net proceeds from sales of common and mandatorily-redeemable preferred stock, net of transaction costs .................. 92,125 22,000 6,000 ---------- ---------- ---------- Net cash provided by financing activities .............. 251,125 71,529 16,220 ---------- ---------- ---------- Effect of exchange rate changes on cash ........................... -- (398) (289) NET INCREASE IN CASH .............................................. 507 2,410 613 CASH, beginning of year ........................................... -- 507 2,917 ---------- ---------- ---------- CASH, end of year ................................................. $ 507 $ 2,917 $ 3,530 ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements F-28 1998 1999 2000 ---------------------- ----------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for- Interest ............................................... $ 8,742 $ 15,333 $ 17,726 =========== ========== =========== Income taxes ........................................... $ 1,699 $ 27 $ 898 =========== ========== =========== DETAILS OF ACQUISITIONS (Note 3): Acquisition price ......................................... $ 3,351 $ 79,499 $ 18,000 Less: Common stock issued for acquisition ................... -- (6,623) -- Cash acquired ......................................... -- (8,208) -- ----------- ---------- ----------- Net cash paid for acquisition ....................... $ 3,351 $ 64,668 $ 18,000 =========== ========== ===========
NON-CASH OPERATING ACTIVITIES: Net loss in 1999 and 2000 includes approximately $2,825,000 and $1,199,000 of non-cash expense related to the recognition of the portion of the 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 $9,765,000 from the date of issuance of the preferred stock through December 31, 2000; preferred stock with an approximate face value of $1,801,000 was issued in 1998, $3,757,000 was issued in 1999, $4,207,000 was issued in 2000. The accompanying notes are an integral part of these consolidated financial statements F-29 RIVER HOLDING CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 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. Holding has no operations of its own, except the Company. 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 3). 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 6) (3) Execution of a new term loan facility and revolving loan facility (see Note 6) (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 were due The Company has terminated the Equity Participation Plan and has adopted an executive stock purchase plan. Additionally, Hudson's sole shareholder prior to the Recapitalization, 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. F-30 On April 7, 1998, Holding acquired a majority interest in Hudson, as described above. The investment in Hudson by Holding was accounted for as a purchase and the purchase price was allocated as follows based on management's estimate of relative fair value of the assets acquired and liabilities assumed (amounts in thousands): 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 ========== The Recapitalization resulted in no change to the carrying amounts of the Company's existing assets and liabilities. The Company 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 purposes. Goodwill related to the Hudson acquisition is being amortized over a period of 25 years. 3. 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 $3.4 million. 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 ========== Hudson RCI AB On July 22, 1999, the Company acquired substantially all of the outstanding capital stock of Hudson RCI AB (formerly Louis Gibeck AB or "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 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. F-31 The acquisition of Hudson RCI AB was accounted for as a purchase and the purchase price was 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 Other assets ....................................... 2,939 Current liabilities ................................ (4,856) Non-current liabilities ............................ (4,123) Goodwill ........................................... 43,223 --------- $ 53,581 ========= Had this acquisition and the acquisition of certain assets of Gibeck, Inc. occurred at the beginning of 1999, the unaudited pro forma net sales, net loss before extraordinary item and net loss would be as follows (amounts in thousands): 1999 --------- Net sales ......................................... $139,494 Net loss .......................................... (6,295) Goodwill related to the Hudson RCI AB acquisition is being amortized over a period of 20 years. Acquisition of Product Lines 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. On October 28, 2000, the Company acquired certain assets of Tyco, including Tyco's Sheridan(R) endotracheal tube for a cash purchase price of approximately $18.0 million. 4. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements 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. Minority Interest Holding owns approximately 85% of Hudson, while an unrelated shareholder owns the remaining 15%. Because the stockholders' deficit of Hudson, attributable the minority shareholder exceeds their investment, the entire minority interest is allocated to the majority interest. 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. F-32 Inventories Inventories are stated at the lower of cost (first-in, first-out (FIFO) method) or market. At December 31, 1999 and December 31, 2000, inventories consisted of the following (amounts in thousands): 1999 2000 ----------- ---------- Raw materials .................. $ 5,901 $ 8,134 Work-in-process ................ 5,682 6,591 Finished goods ................. 12,460 29,885 ------------ ---------- $ 24,043 $ 44,610 ============ ========== 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. Foreign Currency Translation The Company uses 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. The Company's policy is to provide a reserve for estimated uncollectable trade accounts receivable. The Company has reserved approximately $3.5 million for such accounts as of December 31, 2000. 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 reported its operations on a 52-53 week fiscal year ending on the Friday closest to December 31 for the fiscal years ended December 25, 1998 and December 31, 1999. Beginning in 2000, the Company adopted calendar year reporting, with the year ending on December 31, 2000. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") as amended by SFAS No. 137 and SFAS No. 138, 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. The impact of adoption was not material to the financial statements. F-33 During the second quarter of fiscal year 2000, Emerging Issues Task Force (EITF) No. 00-10 "Accounting for Shipping and Handling Fees and Costs" was issued. EITF No. 00-10 clarifies the accounting treatment and classification of the Company's delivery revenues and expenses. The adoption of this EITF only affects the classification of certain revenues and costs related to delivery services and does not affect the Company's net loss. Delivery costs include direct and incremental costs incurred to warehouse and move product to the Company's customers. Since the Company records freight costs associated with delivery of product to customers as a component of cost of sales and warehousing costs as distribution expenses management believes the Company is in compliance with this pronouncement. During December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. Management believes the Company is in compliance with this pronouncement. In June 2001, FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The Company will adopt SFAS 141 for all business combinations initiated after June 30, 2001. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill would no longer be amortized but would be assessed at least annually for impairment using a fair value methodology. The Company will adopt this statement for all goodwill and other intangible assets acquired after June 30, 2001 and for all existing goodwill and other intangible assets beginning January 1, 2002. Upon adoption of this standard on January 1, 2002, the Company will cease recording amortization of goodwill which would increase income before taxes in 2002 by approximately $8.4 million. Other than ceasing the amortization of goodwill, the Company does not anticipate that the adoption of SFAS 142 will have a significant effect on its financial position or the results of our operations as the Company does not currently anticipate any impairment charges for existing goodwill. Also in June 2001, the FASB issued SFAS No. 143, "Accounting for Retirement Obligations." SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lesees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 (with earlier application being encouraged). Holding does not expect the adoption of SFAS 143 to have a material impact on Holding's financial condition and results of operations. 5. 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 $3,757,000 and $4,207,000 to satisfy the dividend requirements in 1999 and 2000, respectively. As of December 31, 1999 and December 31, 2000 the Company accrued for PIK preferred stock dividends in the amount of $863,000 and $1,018,000, respectively. F-34 6. Long-Term Debt Obligations Summary of Amounts Outstanding The Company's long-term debt obligations as of December 31, 1999 and 2000 consist of the following (amounts in thousands):
1999 2000 --------- --------- Borrowing under revolving credit facility ........... $ 36,600 $ 53,000 Term loan payable to domestic banks ................. 35,000 29,500 Term and revolving loan payable to Swedish bank ..... 17,586 14,148 Senior subordinated notes ........................... 115,000 115,000 Notes payable to affiliate .......................... 7,508 10,266 --------- --------- 211,694 221,914 Less: current portion ............................... (6,673) (12,686) --------- --------- Long term debt ...................................... $ 205,021 $ 209,228 ========= =========
Credit Facility In connection with the Recapitalization, the Company entered into a new credit agreement (the Credit Facility) 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 a 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 is charged on the unused portion of the Credit Facility. The following summarizes interest rate data on the Credit Facility as of December 31, 1999 and 2000: 1999 2000 ------------- ------------ Revolving credit facility .......... 8.5625% to 9.563% 10.0% Term loan facility rate ............ 8.75% 9.250% Total borrowings as of December 31, 2000 were $53.0 million and $29.5 million under the Revolving Credit Facility and Term Loan 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, a wholly-owned 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 and among other restrictions, prohibit additional indebtedness and limit dividend payments to the Company's stockholders. The Credit Facility is guaranteed by Holding. As of December 31, 2000, the Company had available credit under the Revolving Loan Facility in the amount of $7.0 million ($5.0 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 compliance as of December 31, 2000 (see Note 13). F-35 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, 2000 was approximately $69.0 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. Subsequent to December 31, 2000, the Company was in default of certain financial reporting requirements to the noteholders. Management believes that it has cured this default. Note Payable to Affiliate In connection with the acquisition of Hudson RCI AB 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. During 2000, the Company borrowed an additional $2 million from the existing majority shareholder under an unsecured 14% note payable due on demand. Bank Notes Payable The Company has bank borrowings of $14.1 million outstanding at December 31, 2000, which are denominated in Swedish Krona. The borrowings bear interest at the 3-month STIBOR plus 0.75% to 1.75% (4.884% to 5.884% at December 31, 2000), are due December 21, 2003 and are secured by the common stock of Hudson RCI AB. Future Debt Principal Payments As of December 31, 2000, future debt principal payments on the aforementioned debt are as follows (amounts in thousands): Fiscal Year Ending: ------------------ 2001 ................................... $ 12,686 2002 ................................... 11,444 2003 ................................... 13,444 2004 ................................... 55,944 2005 ................................... 5,130 Thereafter ............................. 123,266 ----------- $ 221,914 =========== F-36 7. Detail of Selected Balance Sheet Accounts Property, Plant and Equipment The following is a summary as of December 31, 1999 and 2000 (amounts in thousands):
1999 2000 -------- -------- Land ....................................................... $ 4,007 $ 4,007 Buildings .................................................. 11,077 11,874 Leasehold improvements ..................................... 296 296 Machinery, equipment and purchased software ................ 39,243 62,078 Furniture and fixtures ..................................... 1,427 1,921 -------- -------- 56,050 80,176 Less - Accumulated depreciation and amortization ........... (13,409) (22,215) -------- -------- 42,641 57,691 Equipment installation in progress ......................... 8,416 269 ERP software installation in progress ...................... 3,284 800 -------- -------- Property, plant and equipment, net ......................... $ 54,341 $ 59,030 ======== ========
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 ....................... Lessor of the useful life or lease term Machinery, equipment and purchased software .. 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 implemented the new ERP system on April 1, 2000. Total depreciation expense related to property, plant and equipment and amortization expense related to intangible and other assets was $8,507,000, $17,029,000 and $20,051,000 for the years ended December 25, 1998, December 31, 1999 and 2000, respectively. Accrued Liabilities and Accounts Payable Accrued liabilities consisted of the following as of December 31, 1999 and 2000 (amounts in thousands): 1999 2000 ------- ------- Interest .................................. $ 4,162 $ 3,605 Payroll and related ....................... 4,095 4,224 Vacation .................................. 1,509 1,824 Pension ................................... 1,353 1,767 Medical self-insurance .................... 577 569 Other ..................................... 4 718 ------- ------- $11,700 $12,707 ======= ======= F-37 Accounts payable includes a book overdraft of approximately $0.9 million and $1.2 million at December 31, 1999 and 2000. 8. Commitments and Contingencies The Company leases certain facilities, automobiles and office equipment under non-cancelable 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, 2000, the Company had future obligations under operating leases as follows (amounts in thousands): Fiscal Year Ending: ------------------ 2001 ............................. $ 2,534 2002 ............................. 2,290 2003 ............................. 2,099 2004 ............................. 1,914 2005 ............................. 1,378 Thereafter ....................... 4,023 ------------ $ 14,238 ============ Rental expense was approximately $1,506,000, $2,052,000 and $3,115,000 in fiscal 1998, 1999 and 2000, respectively. The Company self-insures the majority of its medical benefit programs. Reserves for losses totaling approximately $577,000 and $569,000 at December 31, 1999 and December 31, 2000, 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. 9. Income Taxes Holding is a C corporation and the Company became a C corporation upon occurence of the Recapitalization discussed in Note 1. Holding's effective income tax rate approximates the combined federal and statutory rate of 39%. During 1999, the Company revised its estimate of the combined effective tax rate to approximately 40%. The tax provision (benefit) for 1998, 1999 and 2000 consists of the following (amounts in thousands):
1998 1999 2000 ----------- ---------- ------------ Income taxes at a combined statutory rate of approximately 39% in 1998 and 40% in 1999 and 2000 .......................... $ (614) $ (2,833) $ (5,334) Domestic losses not benefited ..................................... -- -- 5,334 Foreign taxes ..................................................... -- -- 3,203 Foreign losses not benefited ...................................... -- 1,443 -- Other ............................................................. -- (118) -- ----------- ---------- ------------ $ (614) $ (1,508) $ 3,203 =========== ========== ============
F-38 The provision (benefit) for income taxes consists of the following (amounts in thousands):
United States Foreign Total -------------- ------------ ------------- 2000 Current ................................................ $ -- $ 3,203 $ 3,203 Deferred ............................................... -- -- -- -------------- ------------ ------------- -- $ 3,203 $ 3,203 ============== ============ ============= 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 and 2000 are (amounts in thousands):
1999 2000 --------- -------- Basis differences arising from Section 338(h)(10) election ................. $ 11,381 $ 8,092 Net operating loss carryforwards ........................................... 9,019 15,973 Liabilities and allowances not currently deductible for tax purposes ....... 2,443 4,199 Accelerated tax depreciation ............................................... (3,961) (4,181) Other ...................................................................... 266 343 -------- -------- 19,148 24,426 Valuation allowance ........................................................ (7,806) (13,084) -------- -------- $ 11,342 $ 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. 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 $810,000, $972,000 and $914,000 for the fiscal years ended 1998, 1999 and 2000, respectively. Deferred Compensation Effective December 1, 1994, the Company established a deferred compensation plan for certain key employees. As of December 31, 2000 no material amount of compensation has been deferred. 11. Geographic, Segment and Major Customer Information The Company presents segment information externally the same way management uses financial data internally to make operating decisions and assess performance. The Company also reports 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-39 The Company sells respiratory care products to distributors and medical facilities throughout the United States and internationally. During 1998, 1999 and 2000, the Company had foreign sales of approximately $20,148,000, $28,497,000 and $31,383,000 respectively, which constituted approximately 20.0%, 22.1% and 19.7% of total sales, respectively. The Company's percentage of sales by geographic region for the fiscal years ended 1998, 1999 and 2000 are as follows: 1998 1999 2000 ------- ------- ------- Domestic ................... 79.9% 77.9% 80.3% Europe ..................... 7.8 10.1 9.0 Pacific Rim ................ 6.2 6.1 5.8 Canada ..................... 2.0 1.9 1.6 Other International ........ 4.1 4.0 3.3 ------- ------- ------- 100.0% 100.0% 100.0% ======= ======= ======= The following summarizes the net book value of fixed assets at the respective locations as of December 31, 1999 and 2000 (amounts in thousands): 1999 2000 ------- ------- Ensenada, Mexico ................ $ 1,134 $ 1,137 Stockholm, Sweden ............... 342 291 Kuala Lumpur, Malaysia .......... 741 672 United States ................... 52,124 56,930 ------- ------- $54,341 $59,030 ======= ======= For the fiscal years ended 1998, 1999 and 2000, the Company had sales to one domestic distributor in the amount of $24,940,000, $24,491,000 and $32,184,000 which represented approximately 24.8%, 19.0% and 20.2% of sales, respectively. Additionally, the Company had sales to another domestic distributor of $14,775,000 and $16,936,000, that accounted for approximately 11.5% and 10.6% of sales in 1999 and 2000, respectively. F-40 12. Unaudited Consolidated Quarterly Data
1999 Quarters Ended -------------------------------------------------------------- March 26 June 25 September 24 December 31 -------------- --------------- -------------- ------------- Net Sales .................. $ 27,169 $ 27,274 $ 30,827 $ 43,533 Gross Profit .............. 11,729 11,531 12,309 15,556 Net Loss .................. (820) (774) (2,654) (1,326) 2000 Quarters Ended -------------------------------------------------------------- March 31 June 30 September 30 December 31 --------------- -------------- -------------- ------------- Net Sales ................. $ 40,807 $ 31,811 $ 41,111 $ 45,549 Gross Profit .............. 18,304 16,986 21,524 17,541 Net (loss) income ......... (498) (1,486) 562 (16,111)
13. Subsequent Events As discussed in Note 6, the Company was not in compliance with certain restrictive covenants of the Credit Facility at December 31, 2000. Subsequently, the Company amended its Credit Facility covenants so that under the amended terms, the Company was in compliance as of December 31, 2000 and expects to remain in compliance throughout the term of the agreement. As part of this amendment (1) the Company's shareholders committed to invest an additional $18 million, of which approximately $11.4 million was invested in April and May of 2001 and $6.5 million was invested in August of 2001 and (2) interest rate margins increased. On March 22, 2001, the Company replaced its existing lending agreement denominated in Swedish Krona with a new loan that allows for borrowings up to approximately $19,100,000. The principal is amortized over 18 equal quarterly payments commencing June 30, 2001. Interest is based on the STIBOR rate + 0% to 1.65%, based on the outstanding balance of the loan. The loan is secured by a pledge of Hudson Euro SarL stock, a wholly-owned subsidiary of the Company and 100% owner of Hudson RCI AB, Hudson RCI UK Ltd. and Hudson RCI France S.A.S. In April and May of 2001, the Company issued for cash unsecured senior subordinated convertible notes to certain managers and shareholders in the amount of $9,451,250. In August 2001, the Company issued for cash unsecured senior subordinated convertible notes to certain managers and stockholders in the amount of $3,500,000. The notes bear interest at 10% and are due in 2005. The interest may be paid or deferred to the due date at the option of the Company and are convertible to common stock at the demand of the note holder. Additionally, in August of 2001 existing shareholders purchased $3,000,000 in redeemable preferred stock of Holding (which Holding invested in preferred stock of the Company). F-41 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2001 PAGE - ---------------------------------------------------------------------- ---- Report of Independent Auditors ........................................................................ F-42 Consolidated Balance Sheet as of December 31, 2001 .................................................... F-43 Consolidated Statements of Operations and Comprehensive Loss for the year ended December 31, 2001 ..... F-44 Consolidated Statement of Stockholders' Deficit for the year ended December 31, 2001 .................. F-45 Consolidated Statement of Cash Flows for the year ended December 31, 2001 ............................. F-46 Notes to Consolidated Financial Statements ............................................................ F-48 Additional Unaudited Quarterly Financial Information .................................................. F-64 CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2000 - ---------------------------------------------------------------------- Report of Independent Public Accountants .............................................................. F-65 Consolidated Balance Sheets as of December 31, 1999 and December 31, 2000 ............................. F-66 Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 1998, December 31, 1999 and December 31, 2000 ................................... F-67 Consolidated Statements of Stockholders' Equity (Deficit) ............................................. F-68 Consolidated Statements of Cash Flows for the years ended December 31, 1998, December 31, 1999 and December 31, 2000 ...................................................... F-69 Notes to Consolidated Financial Statements ............................................................ F-71
F-42 REPORT OF INDEPENDENT AUDITORS To the Board of Directors of Hudson Respiratory Care Inc.: We have audited the accompanying consolidated balance sheet of Hudson Respiratory Care Inc., (a California Corporation) (a majority-owned subsidiary of River Holding, Inc.) and subsidiaries as of December 31, 2001, and the related consolidated statements of operations and comprehensive loss, stockholders' deficit and cash flows for the year then ended. Our audit also included the financial statement schedule for the year ended December 31, 2001 listed in Item 14. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Hudson Respiratory Care Inc. and subsidiaries as of December 31, 2001, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 2001 financial statement schedule, when considered in relation to the basic 2001 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. DELOITTE & TOUCHE LLP Costa Mesa, California May 15, 2002 F-43 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES (a majority-owned subsidiary of River Holding, Inc.) CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)
ASSETS December 31, 2001 ------------ CURRENT ASSETS: Cash .............................................................................. $ 7,085 Accounts receivable, less allowance for doubtful accounts of $1,801 ............... 19,287 Inventories ....................................................................... 25,218 Other current assets .............................................................. 1,483 --------- Total current assets ..................................................... 53,073 --------- PROPERTY, PLANT AND EQUIPMENT, net .................................................. 46,268 --------- INTANGIBLE ASSETS, net .............................................................. 28,498 DEFERRED FINANCING COSTS, net of accumulated amortization of $5,981 ................. 8,316 OTHER ASSETS ........................................................................ 900 --------- Total assets ............................................................. $ 137,055 ========= LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable ................................................................. $ 15,251 Accrued liabilities .............................................................. 17,302 Notes payable to banks - current portion ......................................... 20,680 --------- Total current liabilities .................................................. 53,233 NOTE PAYABLE TO AFFILIATE ........................................................... 17,217 NOTES PAYABLE TO BANKS, net of current portion ...................................... 73,250 SENIOR SUBORDINATED NOTES PAYABLE ................................................... 115,000 OTHER NON-CURRENT LIABILITIES ....................................................... 1,187 --------- Total liabilities .............................................................. 259,887 --------- COMMITMENTS AND CONTINGENCIES MANDATORILY-REDEEMABLE PREFERRED STOCK: $0.01 par value: 1,800 shares authorized; 445 shares issued and outstanding; liquidation preference--$44,474 .................................................. 43,847 Accrued preferred stock dividends, payable in kind .................................. 1,142 --------- 44,989 --------- STOCKHOLDERS' DEFICIT: Common stock, no par value: 15,000 shares authorized; 10,654 shares issued and outstanding .................................................................... 98,258 Junior preferred stock, $0.01 par value; 6 shares authorized; 3 shares issued and outstanding ................................................................... 3,137 Other comprehensive loss-- Cumulative translation adjustment ..................... (698) Accumulated deficit .............................................................. (268,518) --------- Total stockholders' deficit .................................................... (167,821) --------- Total liabilities, mandatorily-redeemable preferred stock and stockholders' deficit ............................................. $ 137,055 =========
See notes to consolidated financial statements F-44 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES (a majority-owned subsidiary of River Holding, Inc.) CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (In thousands) Fiscal Year Ended December 31, 2001 -------------- NET SALES ............................................. $ 157,112 COST OF SALES ......................................... 108,054 -------------- Gross profit ..................................... 49,058 -------------- OPERATING EXPENSES: Selling ............................................ 19,496 Distribution ....................................... 11,429 General and administrative ......................... 23,889 Amortization of goodwill ........................... 3,490 Impairment of goodwill ............................. 33,128 Impairment of fixed assets ......................... 4,469 Research and development ........................... 2,043 Provision for bad debts ............................ 2,826 -------------- Total operating expenses ......................... 100,770 -------------- Loss from operations ............................... (51,712) OTHER EXPENSES: Interest expense ................................... 20,542 Other, net ......................................... 1,563 -------------- 22,105 -------------- Loss before provision for income taxes ................ (73,817) PROVISION FOR INCOME TAXES ............................ 69,854 -------------- Net loss .............................................. (143,671) OTHER COMPREHENSIVE LOSS: Foreign currency translation gain ..................... 453 -------------- Comprehensive loss ................................. $ (143,218) ============== See notes to consolidated financial statements. F-45 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES (a majority-owned subsidiary of River Holding, Inc.) CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT (In thousands)
Other Comprehensive Loss-- Cumulative Common Stock Junior Preferred Stock Translation Accumulated ------------------- ---------------------- Shares Amount Shares Amount Adjustment Deficit Total ------- --------- -------- ---------- ------------ ----------- ----------- BALANCE, December 31, 2000 ............ 10,644 $ 98,158 $ (1,151) $ (119,782) $ (22,775) Issuance of common stock .............. 10 100 100 Issuance of junior preferred stock .... 3 $ 3,000 3,000 Pay-in-kind junior preferred stock dividends ........................... 137 (137) -- Foreign currency translation gain ..... 453 453 Issued or accrued pay-in-kind preferred stock dividends ........... (4,928) (4,928) Net loss .............................. (143,671) (143,671) ------- --------- -------- --------- ------------ ----------- ----------- BALANCE, December 31, 2001 ............. 10,654 $ 98,258 3 $ 3,137 $ (698) $ (268,518) $ (167,821) ======= ========= ======== ========= ============ =========== ===========
See notes to consolidated financial statements. F-46 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES (a majority-owned subsidiary of River Holding, Inc.) CONSOLIDATED STATEMENT OF CASH FLOWS (In thousands)
Fiscal Year Ended December 31, 2001 ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ...................................................... $(143,671) Adjustments to reconcile net loss to net cash provided by operating activities-- Depreciation and amortization ............................. 12,223 Amortization/write-off of deferred financing costs and other ................................................... 1,676 Loss on disposal of equipment ............................. 681 Change in deferred tax asset .............................. 68,881 Provision for bad debts ................................... 2,826 Impairment of goodwill .................................... 33,128 Impairment of fixed assets ................................ 4,469 Changes in operating assets and liabilities: Accounts receivable ....................................... 6,916 Inventories ............................................... 17,304 Other current assets ...................................... 257 Other assets .............................................. 503 Accounts payable .......................................... (4,614) Accrued liabilities ....................................... 3,675 Other non-current liabilities ............................. 1,310 --------- Net cash provided by operating activities ............. 5,564 --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment .................... (9,029) Proceeds from sale of property, plant and equipment ........... 12 --------- Net cash used in investing activities ......... (9,017) --------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable to bank ............................ (21,209) Proceeds from bank borrowings ................................. 20,136 Additions to deferred financing costs ......................... (403) Proceeds from note payable to affiliate ....................... 14,951 Repayment of note payable to affiliate ........................ (8,000) Bank overdraft ................................................ (1,245) Net proceeds from sale of common, mandatorily-redeemable and junior preferred stock, net of transaction costs ....... 3,100 --------- Net cash provided by financing activities ......... 7,330 --------- Effect of exchange rate changes on cash .......................... (322) --------- NET INCREASE IN CASH ............................................. 3,555 CASH, beginning of year .......................................... 3,530 --------- CASH, end of year ................................................ $ 7,085 =========
See notes to consolidated financial statements. F-47 December 31, 2001 ------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for-- Interest .................................................. $18,856 ======= Income taxes .............................................. $ 2,315 ======= NON-CASH FINANCING ACTIVITIES: Payment of preferred dividends through issuance of stock ..... $ 4,703 ======= Capital lease obligation incurred for purchase of equipment... 295 ======= See notes to consolidated financial statements. F-48 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES (a majority-owned subsidiary of River Holding, Inc.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2001 1. General 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 is a majority-owned subsidiary of River Holding Corp., a Delaware corporation ("River"). River has no operations of its own, other than its investment in the Company. 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. Management Plans to Improve Financial Condition and Results of Operations The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the year ended December 31, 2001, the Company incurred a net loss of $143.7 million. The Company historically has had sufficient assets to continue operations despite the losses. As of December 31, 2001, the Company was in violation of certain financial covenants. Management believes that the Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its financing agreements, to obtain additional financing as may be required and, ultimately to attain profitable operations. As further discussed in Note 12, on May 14, 2002, the Company reached an agreement with its senior lenders to amend the Credit Facility to bring the Company into compliance with all terms and provisions of this agreement. As part of this amendment, the Company issued $20 million in new senior term notes with warrants to the Company's majority shareholder. In addition, management has taken numerous actions to improve the operating performance of the Company. Such actions included: the elimination of a distribution warehouse, elimination of non-essential management personnel, reductions in inventory levels, aggressive collection of accounts receivable and elimination of individual products that did not attain acceptable levels of profitability. Management believes that the results of its plans and the agreement reached and funding received on May 14, 2002 discussed above will enable the Company to meet its ongoing obligations on a timely basis and continue operations for at least the next twelve months. F-49 Reporting Requirements The Company is privately owned and has no class of securities registered under the Securities Act of 1934 or any publicly traded equity securities. The Company complies with Securities and Exchange Commission filing requirements on a voluntary basis, as required in the indenture for its senior subordinated notes. 2. Summary of Significant Accounting Policies Fiscal Year-End The Company reports its operations on a calendar year basis, with the year ending on December 31. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Hudson and its wholly-owned subsidiaries. Intercompany account balances and transactions have been eliminated in consolidation. Hudson and its wholly-owned subsidiaries are collectively referred to herein as the Company. Accounts Receivable Accounts receivable are stated net of allowances for doubtful accounts of approximately $1.8 million at December 31, 2001, for those accounts from which payment is not expected to be received, although services were provided and revenue was earned. Management performs periodic analyses to evaluate the net realizable value of accounts receivable. Specifically, management considers historical realization data, accounts receivable aging trends, other operating trends and relevant business conditions. Inventories Inventories are stated at the lower of cost (first-in, first-out (FIFO) method) or market. At December 31, 2001, inventories consisted of the following (amounts in thousands): Raw materials ........................................ $ 7,377 Work-in-process ...................................... 5,392 Finished goods ....................................... 14,481 --------- 27,250 Provision for obsolescence ........................... (2,032) --------- $ 25,218 ========= 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. The Company considers deterioration, obsolescence and historical trends in evaluating net realizable value of inventory. Internal Software Development Costs The Company capitalizes costs incurred to develop internal-use computer software in accordance with Statement of Position ("SOP") 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". Such costs are amortized on a straight-line basis over the economic useful lives of the software, which range from three to five years. The Company applies the provisions of SOP 98-1 in assessing any potential impairment of its capitalized software costs. F-50 Property, Plant and Equipment Property is stated at cost. Major renewals and betterments are capitalized while maintenance costs and repairs are expensed in the year incurred. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets or term of the related lease, if shorter. Estimated useful lives range from 3 to 7 years for furniture and fixtures; 5 to 7 years for machinery, equipment and purchased software; and 31.5 years for buildings. Total depreciation expense related to property was $8,733,000 for the year ended December 31, 2001. The Company reviews property for impairment whenever events or changes in circumstances indicate that an asset's book value exceeds the undiscounted expected future cash flows to be derived from that asset. Whenever undiscounted expected future cash flows are less than the book value, the asset will be reduced to fair value based on the net present value of the expected future cash flows, and an impairment loss will be recognized. Goodwill and Other Intangible Assets Goodwill and other intangible assets are amortized under a straight-line method over the estimated useful lives. The Company periodically reviews the recoverability of the carrying value of goodwill, intangibles and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of these assets is determined by analysis of the assets' fair value by comparing the forecasted future undiscounted net cash flows from the operations to which the assets relate, based on management's best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets. In addition, goodwill is assessed for recoverability at an entity level, based on fair value determined by estimated future cash flows, discounted at a rate commensurate with the risk involved. In the fourth quarter of 2001, as a result of significant losses from operations, the Company reassessed future cash flows and operating results and recorded a goodwill impairment charge of approximately $33,128,000. Amortization expense related to goodwill and other intangibles was approximately $3,490,000 for the year ended December 31, 2001. Revenue Recognition The Company recognizes revenue when product is shipped and title passes to the customer, as the earnings process is substantially complete. The Company establishes reserves for sales returns and other allowances based on historical experience. The Company sells its products to its distributors without right of return based on a listed price. Distributors charge the service providers, or the Company's end customers, a contract price (which is determined by their group purchasing organization affiliation or individual contract price) plus a service margin. As is customary within the industry, the Company rebates the difference between the list price and the specific contract price to the distributor. The Company records this revenue and receivables net of rebatable amounts. In the event no rebate is payable, the rebate amount is reversed and recognized as revenue. 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 for recoverability 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. Foreign Currency Translation The Company uses the local currency as the functional currency of its foreign operating subsidiaries. Accordingly, all assets and liabilities at the Company's subsidiaries located 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. The resulting translation gains and losses are recorded as other comprehensive income (loss) in stockholders' deficit in the accompanying consolidated financial statements. F-51 Concentration of Credit Risk The Company sells its products primarily to customers in the United States and Europe. Historically, the Company has not experienced significant losses related to trade receivables from concentrations of individual customers or from groups of customers in any geographic area. Fair Value of Financial Instruments The fair value of long-term debt is determined based on quoted market prices for issues listed on exchanges. The carrying amounts of cash, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short maturity. 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. New Accounting Pronouncements Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138. SFAS No. 133, as amended, 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. The adoption of this new standard did not have a material impact on the Company's consolidated financial statements. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principals Board ("APB") Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. Any acquisitions made by the Company after June 2001 will be accounted for in accordance with SFAS 141. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill will no longer be amortized but will be assessed at least annually for impairment using a fair value methodology. The Company stopped amortizing goodwill, effective January 1, 2002, and as a result an equivalent charge for goodwill amortization will not be made in 2002. The Company is still evaluating the impact of the standard on impairment, which is expected to be completed by the end of the second quarter of 2002. The amortization of goodwill for 2001 was $3.5 million. Also in June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the F-52 capitalized cost is depreciated over the useful live of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. SFAS 143 will become effective January 1, 2003. The Company does not expect the adoption of SFAS 143 to have a material impact on the Company's consolidated financial statements. In August 2001, the FASB issued SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - - Reporting the Effects of a Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 became effective January 1, 2002. The adoption of SFAS 144 is not expected to have a material impact on the Company's consolidated financial statements. 3. Detail of Selected Balance Sheet Accounts Property, Plant and Equipment The following is a summary as of December 31, 2001 (amounts in thousands): Land ............................................... $ 2,044 Buildings .......................................... 15,965 Leasehold improvements ............................. 1,849 Machinery, equipment and purchased software ........ 91,078 Furniture and fixtures ............................. 2,900 --------- 113,836 Less-- Accumulated depreciation and amortization ... (68,281) --------- 45,555 Construction in process ............................ 713 --------- Property and equipment, net ........................ $ 46,268 ========= Intangible Assets The following is a summary of the components of intangible assets as of December 31, 2001 (amounts in thousands): Goodwill ........................................... $ 37,354 Other identifiable intangibles ..................... 4,022 --------- 41,376 Less-- Accumulated amortization .................... (12,878) --------- $ 28,498 ========= Deferred Financing Costs, net The following is a summary of the components of deferred financing costs as of December 31, 2001 (amounts in thousands): Deferred financing costs ........................... $ 14,297 Less: Accumulated amortization ..................... (5,981) --------- Deferred financing costs, net ...................... $ 8,316 ========= F-53 Accrued Liabilities Accrued liabilities consisted of the following as of December 31, 2001 (amounts in thousands): Payroll and related ............................ $ 5,784 Interest ....................................... 4,260 Vacation ....................................... 1,905 Taxes .......................................... 1,630 Pension ........................................ 1,077 Medical self-insurance ......................... 876 GPO fees ....................................... 821 Closure of distribution facility ............... 738 Other .......................................... 211 ---------- $ 17,302 ========== 4. Mandatorily-Redeemable Preferred Stock In connection with the recapitalization in April 1998, 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. The preferred stock is exchangeable for subsequent offerings of Company preferred stock or subordinated notes. 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 stock is mandatorily redeemable as of 2010. Accordingly, the Company is accreting the original issuance costs of $1,000,000 over a 10 year period to PIK preferred stock to current redemption value on the consolidated financial statements through a charge to accumulated deficit. As of December 31, 2001, the Company had accreted to PIK preferred stock $373,000 of the issuance costs. The preferred stock ranks 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 $4,703,000 to satisfy the dividend requirements in 2001. As of December 31, 2001, the Company accrued for PIK preferred stock dividends in the amount of $1,142,000. 5. Junior Preferred Stock In August 2001, the Company issued 3,000 shares of 12% Junior Convertible Cumulative Preferred Stock (the "Junior Preferred Stock") to River for cash consideration of $3,000,000. Each share of the Junior Preferred Stock may be redeemed from time to time, in whole or in part, at the option of the Company at the redemption price of 100% of the Liquidation Preference of the Junior Preferred Stock or $1,000 per share plus accumulated and unpaid dividends that would be payable on such shares of Junior Preferred Stock. F-54 6. Long-Term Debt Obligations The Company's long-term debt obligations as of December 31, 2001, as amended and restated (see Note 12) consist of the following (amounts in thousands): Borrowings under revolving credit facility ........... $ 55,000 Term loan payable to domestic banks .................. 10,000 Term loan payable to domestic banks to be exchanged for notes payable to affiliates ................... 12,000 Term and revolving loan payable to Swedish bank ...... 16,930 Senior subordinated notes ............................ 115,000 Note payable to affiliate ............................ 17,217 --------- 226,147 Less--current portion . .............................. (20,680) --------- Long-term debt ....................................... $ 205,467 ========= Credit Facility The Credit Facility as of December 31, 2001 consists of a $40.0 million Term Loan Facility and a $55.0 million Revolving Loan Facility. The Revolving Loan Facility permits borrowings of up to $40.0 million (all of which has been borrowed and is outstanding) which may be used for permitted acquisitions (the "Acquisition Facility") and up to $15 million (the "Working Capital " portion) which may be used for general corporate purposes (other than acquisitions). The Revolving Loan Facility has a letter of credit sublimit of $7.5 million. The Term Loan Facility matures on June 30, 2003 and requires quarterly principal installments totaling $3.0 million in 1999, $5.5 million in 2000, $7.5 million in 2001, $9.5 million in 2002 and $14.5 million in 2003. The Revolving Loan Facility matures on June 30, 2003. The interest rate under the Credit Facility is based, at the option of the Company, upon either a Eurodollar rate or a base rate (as defined) plus a margin during the period and for the applicable type of loan as follows: Margin --------------------- Period and Loan Type Base Rate Eurodollar -------------------- --------- ---------- Through June 2002 Term and Working Capital ............ 3.00% 4.00% Acquisition ......................... 3.25% 4.25% July 2002 through March 2003 Term and Working Capital ............ 3.50% 4.50% Acquisition ......................... 3.75% 4.75% Thereafter Term and Working Capital ............ 4.00% 5.00% Acquisition ......................... 4.25% 5.25% For periods after June, 2002, the margins set forth above are subject to pricing reductions depending on the Company's then existing leverage ratio. F-55 The following summarizes interest rate data on the Credit Facility as of December 31, 2001: Revolving credit facility rate .................. 6.511% Term and acquisition loan facility rate ......... 5.938% Borrowings under the Credit Facility are required to be prepaid from Excess Cash Flow (as defined in the Credit Agreement). 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 is guaranteed jointly and severally by River Holding Inc. ("Holding") and certain of the Company's subsidiaries. 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, and (viii) engage in transactions with affiliates. The Company 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 Company was not in compliance with these covenants as of December 31, 2001. On May 14, 2002 the Company amended its Credit Facility with its senior lenders. Under this amendment, the lenders agreed to waive past violations of convents, amend future covenants, extend the final maturity to June 30, 2004 and reduce scheduled amortization of the Term Loan (see Note 12.) Total borrowings as of December 31, 2001 were $55 million under the Revolving Loan Facility and Acquisition Facility and $22 million under the Term Loan Facility. As of December 31, 2001, the Company had utilized all available credit under the Revolving Credit Facility. No additional borrowing is available under the Term Loan Facility. As of December 31, 2001 the fair value of the Term Loan facility and Revolving Credit facility approximated the face value. Senior Subordinated Notes The Company has $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 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 at a redemption price of 100.0% to 104.6% of face value depending on the date of the redemption. The Notes are guaranteed jointly and severally by Hudson Respiratory Care Inc. and its Mexican subsidiaries. The fair value of the Company's senior subordinated notes at December 31, 2001 was approximately $77.1 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 Hudson RCI AB 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. In April 2001, the Company repaid an additional $6.0 million in principal on the note. Proceeds from the repayment of this note were then reinvested by the Company's majority shareholder in new long term notes issued by the Company as described below. F-56 During 2000, the Company borrowed an additional $2.0 million from the existing majority shareholder under an unsecured 14% note payable due on demand. In August of 2001, this note was exchanged for a new long-term note as described below. In August, 2001, the Company issued approximately $15.0 million of new unsecured senior subordinated convertible notes consisting of $7.0 million in new cash and an exchange of $8.0 million in existing short-term unsecured notes to certain managers and shareholders. The notes bear interest at 10% and are due in March 2005. The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to common stock at the demand of the holder. The notes are subordinated to borrowings under the Credit Facility and rank pari-pasu with the Senior Subordinated Notes. The fair value of the notes to affiliate approximates the face value. In May of 2002, the Company issued an additional $20.0 million in senior notes payable to affiliates (see note 12). Bank Notes Payable On March 21, 2001, the Company's primary European subsidiary, Hudson RCI AB, replaced its existing lending agreement denominated in Swedish krona with a new loan that allows for borrowings (the "Hudson AB Bank Notes") of up to approximately $17.0 million. The principal is amortized over 18 equal quarterly payments commencing June 30, 2001 with a final maturity of September 30, 2005. Interest is based on the STIBOR rate plus 1.25% to 1.85%, based on the outstanding balance of the loan. The loan is guaranteed jointly and severally by Hudson Euro SarL, a wholly-owned subsidiary of the Company and 100% owner of Hudson RCI AB and subsidiaries, Hudson RCI UK Ltd. and Hudson France S.A.S. The loan contains certain affirmative and restrictive provisions including, but not limited to, restrictions on additional indebtedness and compliance with certain financial covenants. The loan also restricts Hudson RCI AB's ability to dividend to its parent companies. At December 31, 2001, borrowings under the Hudson AB Bank Notes equaled $16.9 million. The interest rate on the Bank Notes Payable as of December 31, 2001 was 5.74%. At December 31, 2001, the Company was not in compliance with certain financial covenants of the Hudson AB Bank Notes. The Company is currently in discussions with the lender and expects the lender to agree to provide a waiver curing all defaults as of December 31, 2001. Due to the uncertainty of obtaining this waiver from the lenders, all amounts payable under the Hudson AB Bank Notes have been classified as current on the accompanying consolidated balance sheet. The following summarizes future principal amounts payable on all of the Company's debt at December 31, 2001 (amounts in thousands): 2002 ................. $ 20,680 2003 ................. 24,250 2004 ................. 49,000 2005 ................. 14,951 2006 ................. 2,266 Thereafter ........... 115,000 --------- $ 226,147 ========= 7. Commitments and Contingencies The Company has capital and operating leases for certain facilities, automobiles and office equipment under non-cancelable leases, with the majority of the automobile leases having a term of one year with annual renewal provisions. Rental expense for the year ended December 31, 2001 amounted to $4,657,000. Generally, the facility leases include escalation clauses. F-57 The following is a schedule, by year, of the future minimum payments under capital and operating leases, together with the present value of the net minimum payments as of December 31, 2001 (in thousands). Capital lease amounts are included in the non-current liabilities line item on the accompanying consolidated balance sheet: Capital Operating Leases Leases ---------- ---------- Year ending December 31, 2002 .............................. $ 59 $ 2,188 2003 .............................. 59 2,152 2004 .............................. 59 2,087 2005 .............................. 59 1,649 2006 .............................. -- 896 Thereafter ........................ -- 3,128 --------- ---------- Total minimum lease payments ............... 236 $ 12,100 ========== Less amount representing interest .......... 53 --------- Total present value of minimum payment ..... 183 Less current portion of such obligations ... 39 --------- Long-term obligations with interest rate of 11.0% ...................................... $ 144 ========= Assets recorded under capital leases as of December 31, 2001 are as follows (amounts in thousands): Machinery and equipment ............ $ 297 Less accumulated depreciation ...... 31 --------- Net property, plant and equipment .. $ 266 ========= Self-Insurance The Company self-insures the majority of its medical benefit programs. Reserves for medical claim losses totaling approximately $876,000 at December 31, 2001 were established based upon estimated obligations and are included in accrued liabilities in the accompanying consolidated balance sheet. The Company maintains excess coverage on an aggregate claim basis. Effective November 1, 2001, the Company became self-insured for workers' compensation. Reserves for workers' compensation claim losses totaling approximately $350,000 at December 31, 2001 were established based upon estimated obligations and are included in accrued liabilities in the accompanying consolidated balance sheet. Legal The Company is not a party to any material lawsuits or other proceedings, including suits relating to product liability and patent infringement. While the results of the Company's other existing lawsuits and 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. Other Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and accounts receivable. The Company places its cash investments with high quality financial institutions and limits the amount of credit exposure to any one institution. F-58 8. Income Taxes 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 the asset and liability method pursuant to an informal tax-sharing agreement. The components of the deferred tax asset as of December 31, 2001 are (amounts in thousands): Basis differences arising from Section 338(h)(10) election .......................................... $ 64,102 Net operating loss carryforwards .................. 32,785 Other ............................................. 1,285 ----------- 98,172 Valuation allowance ............................... (98,172) ----------- $ -- =========== As of December 31, 2001, the Company had net deferred tax assets before any valuation allowance of $98.2 million. This asset relates primarily to basis differences in goodwill and net operating loss carryforwards for tax purposes. As of December 31, 2001, the Company had federal and state net operating loss carryforwards of approximately $86.0 million and $56.0 million, which begin to expire in 2018 and 2003, respectively. Under SFAS No. 109, "Accounting for Income Taxes," the Company is required to place a valuation allowance against any deferred tax assets unless it is more likely than not that the asset will be realized. In accordance with this standard, the Company has placed a valuation allowance against its deferred tax assets of approximately $98.2 million as of December 31, 2001. The reconciliation of the actual tax expense to tax computed at the statutory federal rate for the year ended December 31, 2001 (amounts in thousands): Income taxes at statutory rate .................... $ (25,098) Other. ............................................ 4,298 Foreign taxes ..................................... 959 Valuation allowance ............................... 89,695 ----------- $ 69,854 =========== The provision for income taxes for the year ended December 31, 2001 consists of the following (amounts in thousands): United States Foreign Total Current ......................... $ - $ 959 $ 959 Deferred ........................ 68,895 - 68,895 ----------- -------- ---------- $ 68,895 $ 959 $ 69,854 =========== ========= ========== F-59 9. Deferred Compensation and Benefit Plans Pension and 401(k) Plans The Company has a defined-contribution pension plan covering substantially all its employees who are 21 years of age with two years of service. The Company contributes an amount equal to 6% of employees' basic compensation. Contribution expense relating to this plan totaled approximately $943,000 for the fiscal year ended December 31, 2001. During 2001, the Company determined that the pension plan for 1999 and 2000 was not fully funded. Accordingly, the Company recorded $350,000 in associated penalties and fully funded the plan through 2000. Additionally, the Company has a defined contribution 401(k) plan covering substantially all of its employees who are 21 years of age with 30 days of service. Participants may contribute up to 10% of base compensation to this plan, subject to certain Internal Revenue Code (IRC) limitations, each year. The Company makes no contributions under this plan. Deferred Compensation Effective December 1, 1994, the Company established a deferred compensation plan for certain key employees. As of December 31, 2001 no material amount of compensation has been deferred. Management Bonus Plans The Company offers a management bonus plan for its executives and senior management. The plan is based solely on the financial goals of the Company. The plan for 2001 required reaching a minimum of 95% of budgeted EBITDA. During 2001, the Company did not meet this objective and no bonuses were paid. The Company periodically offers additional incentive compensation to individuals who demonstrate superior performance. This compensation was not material in 2001. Stock Subscription Plans In April 1998, River 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 River valued at $10.00 per share. The Stock Subscription Plans provide for a repurchase option in favor of River 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 River, 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 River common stock were sold under the Stock Subscription Plans in fiscal 2001. Shareholder Agreement Helen Hudson Lovaas (The "Continuing Shareholder") and River have entered into a Shareholders' Agreement, as amended (the "Shareholders' Agreement"). The Shareholder Agreement provides that i) River and the Continuing Shareholder have the right to purchase their pro rata share of certain new issuances, ii) in consideration for the contribution of consideration received from River for certain issuances of the common stock of River, the Company will issue an equivalent shares of Company common stock to River, iii) in the event of a sale of Company stock by River or Freeman Spogli, the Continuing Shareholder is obligated to sell all or part of her shares at the request of River and the Continuing Shareholder has the right to participate in such sale on a pro rata basis, iv) the restriction on the transferability of the shares for a two year period following the recapitalization and provides for a right of first offer on the Continuing Shareholder's common stock and v) in the event the Company participates in an IPO, the Company will exchange all of the Company's existing common stock for newly issued common stock. In 2001, the Board of Directors of River approved adoption of a Stock Option plan for eligible employees, officers and consultants of the Company. The plan allows for the issuance of up to 2,000,000 of River common stock in the form of F-60 unqualified or incentive stock options under which shares shall have been reserved for by River. Exercise price shall be set at fair market value as determined by the Board of Directors. As of the date of this filing, no options have been granted under this plan. 10. Geographic, Segment and Major Customer Information The Company presents segment information externally based on how management uses financial data internally to make operating decisions and assess performance. The Company also reports 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 has two operating and reporting segments: United States, or guarantor, and international or non-guarantor (see Note 11 for segment disclosure). The non-guarantor subsidiaries consist principally of Hudson RCI AB and subsidiaries (whose operations are principally international). Under SFAS 131, "Disclosures about Segments of an Enterprise and Related Information," the Company's operating segments are the same as its reporting segments. The Company sells respiratory care products to distributors and medical facilities throughout the United States and internationally. During 2001, the Company had foreign sales of approximately $40,772,000, which constituted approximately 26.0% of total sales. The Company's percentage of sales by geographic region for the fiscal year ended December 31, 2001 is as follows: Domestic ........................................... 74.1% Europe ............................................. 13.9 Pacific Rim (Japan, Southeast Asia, Australia/ New Zealand) ....................................... 7.2 Canada ............................................. 1.6 Other international ................................ 3.2 ----- 100.0% ===== The Company's percentage of sales by product category for the fiscal year ended December 31, 2001 is as follows: Oxygen therapy ................................... 32.6% Airway management ................................ 29.2 Humidification and filtration .................... 21.6 Aerosol therapy .................................. 16.6 ---------- 100.0% ========== The following summarizes the net book value of fixed assets at the respective locations as of December 31, 2001 (amounts in thousands): Ensenada, Mexico ................................. $ 1,229 Stockholm, Sweden ................................ 422 Kuala Lumpur, Malaysia ........................... 721 United States .................................... 43,896 ------------ $ 46,268 ============ For the fiscal year ended December 31, 2001, the Company had sales to one domestic distributor in the amount of $30,435,000, which represented approximately 19.4% of sales. Additionally, the Company had sales to another domestic distributor of approximately $15,656,000, that accounted for approximately 10.0% of sales in 2001. F-61 11. 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 Hudson RCI AB 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 DATA
As of December 31, 2001 ------------------------------------------------------ Non- Guarantor Guarantor Eliminations Total ----------- ------------- ---------------- ----------- ASSETS CURRENT ASSETS: Cash ......................................... $ 4,713 $ 2,372 $ -- $ 7,085 Accounts receivable .......................... 13,989 5,298 -- 19,287 Receivables from non-guarantor ............... 6,515 -- (6,515) -- Inventories .................................. 20,377 7,030 (2,189) 25,218 Other current assets ......................... 2,976 13,553 (15,046) 1,483 ----------- ---------- ------------ ----------- Total current assets ...................... 48,570 28,253 (23,750) 53,073 PROPERTY, PLANT AND EQUIPMENT, net .............. 45,125 1,143 -- 46,268 INTANGIBLE ASSETS, net ....................... -- 57,743 (29,245) 28,498 DEFERRED FINANCING COSTS, net ................ 8,316 -- -- 8,316 INVESTMENT IN NON-GUARANTOR SUBSIDIARIES ............................ 28,623 -- (28,623) -- OTHER ASSETS ................................. 676 224 -- 900 ----------- ---------- ----------- ----------- Total other assets ........................ 37,615 57,967 (57,868) 37,714 ----------- ---------- ------------ ----------- $ 131,310 $ 87,363 $ (81,618) $ 137,055 =========== ========== =========== ===========
LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable ............................. $ 14,069 $ 1,182 $ -- $ 15,251 Accrued liabilities .......................... 14,366 15,356 (12,420) 17,302 Notes payable to banks - current portion ..... 3,750 16,930 -- 20,680 Payables to guarantor ........................ -- 6,515 (6,515) -- ----------- ---------- ----------- ----------- Total current liabilities ................. 32,185 39,983 (18,935) 53,233 NOTE PAYABLE TO AFFILIATE ....................... 14,951 2,266 -- 17,217 NOTES PAYABLE TO BANKS, net of current portion .. 73,250 -- -- 73,250 SENIOR SUBORDINATED NOTES PAYABLE ............... 115,000 -- -- 115,000 OTHER NON-CURRENT LIABILITIES ................... 146 1,041 -- 1,187 ----------- ---------- ----------- ----------- Total liabilities ......................... 235,532 43,290 (18,935) 259,887 ----------- ---------- ----------- ----------- Mandatorily-redeemable preferred stock .......... 44,989 -- -- 44,989 STOCKHOLDERS' DEFICIT ........................... (149,211) 44,073 (62,683) (167,821) ------------ ---------- ----------- ----------- $ 131,310 $ 87,363 $ (81,618) $ 137,055 =========== ========== =========== ===========
F-62 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING STATEMENT OF OPERATIONS
For the Year Ended December 31, 2001 ------------------------------------------------ Non- Guarantor Guarantor Eliminations Total --------- --------- ------------ --------- NET SALES ................................................... $ 143,555 $ 28,319 $ (14,762) $ 157,112 COST OF SALES ............................................... 105,789 15,749 (13,484) 108,054 --------- --------- --------- --------- Gross profit ................................................ 37,766 12,570 (1,278) 49,058 OPERATING EXPENSES: Selling .................................................. 13,470 6,026 -- 19,496 Distribution ............................................. 9,514 1,915 -- 11,429 General and administrative ............................... 21,505 2,384 -- 23,889 Amortization of goodwill ................................. 1,561 1,929 -- 3,490 Impairment of goodwill ................................... 26,217 6,911 -- 33,128 Impairment of fixed assets ............................... 4,469 -- -- 4,469 Research and development ................................. 1,015 1,028 -- 2,043 Provision for bad debts .................................. 2,768 58 -- 2,826 --------- --------- --------- --------- Total operating expenses .............................. 80,519 20,251 -- 100,770 --------- --------- --------- --------- Income (loss) from operations ............................... (42,753) (7,681) (1,278) (51,712) OTHER EXPENSES: Interest expense ......................................... 18,890 1,652 -- 20,542 Other, net ............................................... 1,005 675 (117) 1,563 --------- --------- --------- --------- Total other expense ................................... 19,895 2,327 (117) 22,105 --------- --------- --------- --------- Income (loss) before provision (benefit) for income taxes ... (62,648) (10,008) (1,161) (73,817) PROVISION (BENEFIT) FOR INCOME TAXES ..................... 69,097 757 -- 69,854 --------- --------- --------- --------- Net income (loss) ........................................... $(131,745) $ (10,765) $ (1,161) $(143,671) ========= ========= ========= =========
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2001 ------------------------------------- Non- Guarantor Guarantor Total ---------- --------- --------- Net cash provided by operating activities ............... $ 3,740 $ 1,824 $ 5,564 Net cash (used in) provided by investing activities ..... (8,366) (651) (9,017) Net cash provided by financing activities ............... 8,902 (1,572) 7,330 Effect of exchange rate changes on cash ................. -- (322) (322) ------- ------- ------- NET INCREASE IN CASH .................................... 4,276 (721) 3,555 CASH, beginning of year ................................. 437 3,093 3,530 ------- ------- ------- CASH, end of year ....................................... $ 4,713 $ 2,372 $ 7,085 ======= ======= =======
F-63 12. Subsequent Events As of December 31, 2001, based on the Company's financial results, the Company was not in compliance with certain financial covenants under its Credit Facility. As a result of this non-compliance and resulting defaults, on March 30, 2002, the Company did not make a scheduled Term Loan payment to its senior lenders as required under the Credit Facility and, as a result, the Company was prevented from making a scheduled interest payment due its Subordinated Note holders on April 15, 2002. On May 14, 2002, the Company amended and restated the Credit Facility to (i) waive all existing events of default; (ii) extend the final maturity of the term and revolving facilities under the Credit Facility to June 30, 2004; (iii) amend existing term and acquisition loan amortization to $3.8 million in 2002 and $9.3 million in 2003 and $37.0 million in 2004; and (iv) amend financial covenants to include only a limitation on capital expenditures and a minimum EBITDA test. In connection with this amendment, the Company and HRC Holding, its wholly-owned subsidiary, issued a total of $20.0 million in senior unsecured notes to affiliates of River's majority stockholder, of which $12.0 million was used to pay down the Term Loan of the Credit Facility. These notes bear interest at 12%, with interest and principal due upon maturity on December 31, 2004. F-64 Additional Unaudited Quarterly Financial Information Unaudited Consolidated Quarterly Data Summarized quarterly financial data for 2001 is as follows (amounts in thousands):
Quarters Ended ----------------------------------------------------------- March 31 June 30 September 30 December 31 ----------- ------------ ------------ ----------- Net sales ......................................... $ 37,805 $ 40,801 $ 45,095 $ 33,411 Gross profit ...................................... 9,775 15,840 20,789 2,654 Net income (loss) ................................. (12,863) (5,819) 1,953 (126,942)
Fourth Quarter Adjustments As a result of significant losses in the fourth quarter and cumulative losses in recent years, the Company has reevaluated its ability to realize the future benefit of its net deferred tax assets held in light of the historical operating losses. Accordingly, the Company recorded a full valuation allowance against its deferred tax assets of approximately $68.9 million. As a result of significant losses in the fourth quarter, the Company reassessed future cash flows and determined that goodwill was not recoverable. Accordingly, the Company recorded a goodwill impairment charge of approximately $33.1 million. As a result of the Company's analysis of fixed assets in the fourth quarter, it was determined that certain machinery and equipment was no longer needed to support current business operations and had no value. Additionally, certain software development costs incurred in 2001 related to the management information system failed to achieve their intended results and, as a result, were determined to have no future value. As a result, the Company recorded an impairment charge of approximately $4.5 million. As a result of an analysis of product lines during the fourth quarter of 2001, the Company concluded that it would no longer support a certain number of individual products, resulting in the related inventories of those products no longer having value. The Company recorded charges of $4.6 million related to the destruction of obsolete inventory resulting from this strategic decision. The Company made a decision in the fourth quarter of 2001 to not pursue certain aged accounts receivable for collection and to allocate resources to other customer receivables and collection activities. As a result, the Company increased its provision for write-offs based on analysis of those aged customer receivables. The Company recorded a charge of approximately $0.9 million related to the fourth quarter closure of its Atlanta distribution center. This charge primarily consisted of future rent commitments. During fiscal 2001, the Company made a decision to relocate from its manufacturing operation in Argyle, New York to Tecate, Mexico. In addition, the Company made a decision to move certain product manufacturing from Temecula, California to Ensenada, Mexico. The Company recorded approximately $0.9 million in severance costs related to the relocations. F-65 Arthur Andersen LLP ("Andersen") is the former auditor of the Company. As a result of recent events at Andersen, Andersen declined the Company's request to reissue their audit report dated July 30, 2001 for the fiscal years ended December 31, 2000 and 1999 for inclusion in the Company's 10-K filing for the fiscal year ended December 31, 2001. As such, pursuant to the guidance given in the Temporary Final Rule and Final Rule: Requirements for Arthur Andersen LLP Auditing Clients, Release Nos. 33-8070; 34-45590; 35-27503; 39-2395; IA-2018; IC-25464; FR-62; File No. S7-03-02, the Company is filing this copy of the latest signed and dated accountant's report issued by Andersen for such periods. 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 31, 1999 and 2000, and the related consolidated statements of operations and comprehensive loss, stockholders' equity (deficit) and cash flows for the years ended December 25, 1998, December 31, 1999 and 2000. 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 31, 1999 and 2000, and the results of their operations and their cash flows for the years ended December 25, 1998, December 31, 1999 and 2000 in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP Orange County, California July 30, 2001 F-66 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)
ASSETS December December 31, 1999 31, 2000 ----------- ---------- CURRENT ASSETS: Cash .......................................................................................... $ 2,917 $ 3,530 Accounts receivable, less allowance for doubtful accounts of $973 and $3,500 at December 31, 1999 and 2000, respectively ............................................................. 30,425 28,307 Inventories ................................................................................... 24,043 44,610 Other current assets .......................................................................... 4,612 1,832 --------- --------- Total current assets ....................................................................... 61,997 78,279 --------- --------- PROPERTY, PLANT AND EQUIPMENT, net .............................................................. 42,476 49,425 --------- --------- OTHER ASSETS: Intangible assets, net ........................................................................ 66,970 67,573 Deferred financing costs, net of accumulated amortization of $2,528 and $4,306 at December 31, 1999 and December 31, 2000, respectively ............................................... 11,134 9,587 Deferred tax asset ............................................................................ 68,943 69,105 Other assets .................................................................................. 299 1,265 --------- --------- Total other assets ......................................................................... 147,346 147,530 --------- --------- Total assets ........................................................................... $ 251,819 $ 275,234 ========= ========= LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Notes payable to banks ....................................................................... $ 6,673 $ 10,686 Accounts payable ............................................................................. 6,168 20,320 Accrued liabilities .......................................................................... 11,700 12,707 Notes payable to affiliates .................................................................. - 2,000 Other current liabilities .................................................................... 1,485 3,007 --------- --------- Total current liabilities .................................................................. 26,026 48,720 NOTE PAYABLE TO AFFILIATE, net of current portion ............................................... 7,508 8,266 NOTES PAYABLE TO BANKS, net of current portion .................................................. 82,513 85,962 SENIOR SUBORDINATED NOTES PAYABLE ............................................................... 115,000 115,000 --------- --------- Total liabilities .......................................................................... 231,047 257,948 --------- --------- COMMITMENTS AND CONTINGENCIES (Note 7) MANDATORILY-REDEEMABLE PREFERRED STOCK, $.01 par value: 1,800 shares authorized; 356 and 398 shares issued and outstanding at December 31, 1999 and 2000, respectively; liquidation preference--$35,558 and $39,783 respectively (Note 4) ........................................................................ 34,558 39,043 Accrued preferred stock dividends, payable in kind .............................................. 863 1,018 --------- --------- 35,421 40,061 STOCKHOLDERS' EQUITY (DEFICIT): Common stock, no par value: 15,000 shares authorized; 10,044 and 10,387 shares issued and outstanding at December 31, 1999 and 2000, respectively ................................. 92,158 98,158 Cumulative translation adjustment ............................................................ (862) (1,151) Accumulated deficit .......................................................................... (105,945) (119,782) --------- --------- Total stockholders' equity (deficit) ....................................................... (14,649) (22,775) --------- --------- Total liabilities, mandatorily-redeemable preferred stock and stockholders' equity (deficit) ............................................................................ $ 251,819 $ 275,234 ========= =========
The accompanying notes are an integral part of these consolidated balance sheets. F-67 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (In thousands)
For the Years Ended --------------------------------------------- December 25, December 31, December 31, 1998 1999 2000 ------------- ------------- ------------- NET SALES ............................................... $ 100,498 $ 128,803 $ 159,278 COST OF SALES ........................................... 56,802 75,418 84,923 --------- --------- --------- Gross profit ....................................... 43,696 53,385 74,355 --------- --------- --------- OPERATING EXPENSES: Selling .............................................. 10,350 13,122 18,262 Distribution ......................................... 3,336 4,647 10,109 General and administrative ........................... 10,125 13,269 24,023 Amortization of goodwill ............................. 159 1,463 3,320 Research and development ............................. 976 2,031 2,387 --------- --------- --------- Total operating expenses ........................... 24,946 34,532 58,101 --------- --------- --------- PROVISION FOR EQUITY PARTICIPATION PLAN AND RETENTION PAYMENTS ............................................. (68,693) - - (Loss) Income from operations ...................... (49,943) 18,853 16,254 OTHER EXPENSES: Interest expense ..................................... (11,327) (17,263) (21,089) Other, net ........................................... (406) (1,232) (1,159) --------- --------- --------- (11,733) (18,495) (22,248) --------- --------- --------- (Loss) income before provision for income taxes and extraordinary item ................................... (61,676) 358 (5,994) PROVISION FOR INCOME TAXES .............................. 8,405 1,586 3,203 --------- --------- --------- Loss before extraordinary item .......................... (70,081) (1,228) (9,197) EXTRAORDINARY ITEM-loss on extinguishment of debt ....... 104 - - --------- --------- --------- Net loss ................................................ (70,185) (1,228) (9,197) OTHER COMPREHENSIVE LOSS: Foreign currency translation loss .................... (119) (398) (289) --------- --------- --------- Comprehensive loss ...................................... $ (70,304) $ (1,626) $ (9,486) ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-68 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands)
Cumulative Retained Earnings Common Stock Translation (Accumulated ----------------------- Shares Amount Adjustment Deficit Total ---------- ---------- ----------- ----------------- ----- BALANCE, December 25, 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 Hudson RCI AB Stock (see Note 2) ........................................ 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) Issuance of common stock to parent for cash ...... 343 6,000 - - 6,000 Foreign currency translation loss ................ - - (289) - (289) Pay-in-kind preferred stock dividends ............ - - - (4,640) (4,640) Net loss ......................................... - - - (9,197) (9,197) --------- --------- --------- --------- --------- BALANCE, December 31, 2000 ......................... 10,387 $ 98,158 $ (1,151) $(119,782) $ (22,775) ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-69 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For the Years Ended --------------------------------------------- December 25, December 31, December 31, 1998 1999 2000 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss .................................................. $ (70,185) $ (1,228) $ (9,197) Adjustments to reconcile net loss to net cash (used in) provided by operating activities-- Depreciation and amortization ........................ 6,101 8,315 11,719 Amortization/write-off of deferred financing costs and other ........................................... 1,119 1,374 991 Loss (gain) on disposal of equipment ................. 14 (5) 9 Change in deferred tax asset ......................... 6,735 1,385 (161) Changes in operating assets and liabilities: Accounts receivable .................................. (4,547) (2,701) 2,118 Inventories .......................................... (1,411) (2,865) (12,351) Other current assets ................................. 437 (1,194) 2,780 Other assets ......................................... 247 13 (966) Accounts payable ..................................... 2,482 (741) 14,152 Accrued liabilities .................................. 1,687 4,277 1,008 Management bonus accrual ............................. (20,000) - - Other current liabilities ............................ - 1,426 1,522 Other non-current liabilities ........................ - (959) - Accrued equity participation plan (EPP) .............. 83,939 - - Payment of EPP liabilities and retention bonuses ..... (89,642) - - --------- --------- --------- Net cash (used in) provided by operating activities ..................................... (83,024) 7,097 11,624 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment ................ (3,111) (10,973) (11,329) Proceeds from sale of property, plant and equipment ....... 18 23 4 (Advances) collections on notes receivable and other ...... - (200) 2,384 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) (18,000) Acquisition of Louis Gibeck AB stock, net of cash acquired of $8,208 ........................................ - (38,750) - --------- --------- --------- Net cash used in investing activities ............ (6,444) (75,818) (26,941) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable to bank ........................ (43,250) (17,355) - Proceeds from bank borrowings ............................. 67,000 59,376 7,461 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 2,758 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 6,000 --------- --------- --------- Net cash provided by financing activities ........ 89,624 71,529 16,219 --------- --------- --------- Effect of exchange rate changes on cash ...................... (119) (398) (289) NET INCREASE IN CASH ......................................... 37 2,410 613 CASH, beginning of year ...................................... 470 507 2,917 --------- --------- --------- CASH, end of year ............................................ $ 507 $ 2,917 $ 3,530 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-70
For the Years Ended ----------------------------------------- December 25, December 31, December 31, 1999 1999 2000 ------ ------ ------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for-- Interest ..................................... $ 8,742 $ 15,333 $ 17,726 ======== ======== ======== Income taxes ................................. $ 1,699 $ 27 $ 898 ======== ======== ======== DETAILS OF ACQUISITIONS (Note 2): Acquisition price .............................. $ 3,351 $ 79,499 $ 18,000 Less: Common stock issued for acquisition .......... - (6,623) - Cash acquired ................................ - (8,208) - -------- -------- -------- Net cash paid for acquisitions ......... $ 3,351 $ 64,668 $ 18,000 ======== ======== ========
NON-CASH OPERATING ACTIVITIES: Net income includes approximately $2,825,000 and $1,199,000 of non-cash expense related to the recognition of the portion of the purchase price allocation related to acquired inventories in 1999 and 2000, respectively. 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 $9,765,000 from the date of issuance of the preferred stock through December 31, 2000; preferred stock with an approximate face value of $1,801,000 was issued in 1998, $3,757,000 was issued in 1999, $4,207,000 was issued in 2000. The Company issued common stock to its parent in partial consideration for the contribution of Hudson RCI AB stock (see Note 2). The accompanying notes are an integral part of these consolidated financial statements. F-71 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 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 is a wholly-owned subsidiary of River Holding Corp., a Delaware corporation ("River"). River has no operations of its own, except the Company. 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 has adopted an executive stock purchase plan. Additionally, Hudson's sole shareholder prior to the Recapitalization, 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 for all periods presented. F-72 The Recapitalization resulted in no change to the carrying amounts of the Company's existing assets and liabilities. The Company 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 purposes. 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 $3.4 million. 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 ========== Hudson RCI AB On July 22, 1999, the Company acquired substantially all of the outstanding capital stock of Hudson RCI AB (formerly Louis Gibeck AB or "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 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 Hudson RCI AB was accounted for as a purchase and the purchase price was 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 Other assets ........................... 2,939 Current liabilities .................... (4,856) Non-current liabilities ................ (4,123) Goodwill ............................... 43,223 ---------- $ 53,581 ========== F-73 Had this acquisition and the acquisition of certain assets of Gibeck, Inc. occurred at the beginning of 1998 and 1999, the unaudited pro forma net sales, net loss before extraordinary item and net loss would be as follows (amounts in thousands):
Year 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)
Goodwill related to the Hudson RCI AB acquisition is being amortized over a period of 20 years. Acquisition of Product Lines 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. On October 28, 2000, the Company acquired certain assets of Tyco, including Tyco's Sheridan(R) endotracheal tube for a cash purchase price of approximately $18.0 million. 3. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements 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 31, 1999 and December 31, 2000, inventories consisted of the following (amounts in thousands): 1999 2000 ---- ---- Raw materials ....................... $ 5,901 $ 8,134 Work-in-process ..................... 5,682 6,591 Finished goods ...................... 12,460 29,885 --------- --------- $ 24,043 $ 44,610 ========= ========= F-74 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. Foreign Currency Translation The Company uses 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. The Company's policy is to provide a reserve for estimated uncollectable trade accounts receivable. During 2000, the Company provided approximately $3.5 million for such accounts. 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 reported its operations on a 52-53 week fiscal year ending on the Friday closest to December 31 for the fiscal years ended December 25, 1998 and December 31, 1999. Beginning in 2000, the Company adopted calendar year reporting, with the year ending on December 31, 2000. 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 and SFAS No. 138, 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. The impact of adoption was not material to the financial statements. During the second quarter of fiscal year 2000, Emerging Issues Task Force (EITF) No. 00-10 "Accounting for Shipping and Handling Fees and Costs" was issued. EITF No. 00-10 clarifies the accounting treatment and classification of the Company's delivery revenues and expenses. The adoption of this EITF only affects the classification of certain revenues and costs related to delivery services and does not affect the Company's net loss. Delivery costs include direct and incremental costs incurred to warehouse and move product to the Company's customers. Since the Company records freight costs associated with delivery of product to customers as a component of cost of sales and warehousing costs as distribution expenses management believes the Company is in compliance with this pronouncement. F-75 During December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. Management believes the Company is in compliance with this pronouncement. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The Company will adopt SFAS 141 for all business combinations initiated after June 30, 2001. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill would no longer be amortized but would be assessed at least annually for impairment using a fair value methodology. The Company will adopt this statement for all goodwill and other intangible assets acquired after June 30, 2001 and for all existing goodwill and other intangible assets beginning January 1, 2002. Upon adoption of this standard on January 1, 2002 The Company will cease recording amortization of goodwill which would increase net income in 2002 by approximately $2.8 million, net of income taxes. Other than ceasing the amortization of goodwill, The Company does not anticipate that the adoption of SFAS 142 will have a significant effect on our financial position or the results of our operations as The Company does not currently anticipate any impairment charges for existing goodwill. Reclassifications Certain reclassifications have been made in the 1998 and 1999 statements to conform to the 2000 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 $3,757,000 and $4,207,000 to satisfy the dividend requirements in 1999 and 2000, respectively. As of December 31, 1999 and December 31, 2000 the Company accrued for PIK preferred stock dividends in the amount of $863,000 and $1,018,000, respectively. 5. Long-Term Debt Obligations Summary of Amounts Outstanding F-76 The Company's long-term debt obligations as of December 31, 1999 and December 31, 2000 consist of the following (amounts in thousands):
1999 2000 ---- ---- Borrowings under revolving credit facility ..................... $ 36,600 $ 53,000 Term loan payable to domestic banks ............................ 35,000 29,500 Term and revolving loan payable to Swedish bank ................ 17,586 14,148 Senior subordinated notes ...................................... 115,000 115,000 Note payable to affiliate ...................................... 7,508 10,266 ------------ ---------- 211,694 221,914 Less--current portion .......................................... (6,673) (12,686) ------------ ---------- Long-term debt ................................................. $ 205,021 $ 209,228 ============ ==========
Credit Facility In connection with the Recapitalization, the Company entered into a new credit agreement (the Credit Facility) 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 a 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 is charged on the unused portion of the Credit Facility. The following summarizes interest rate data on the Credit Facility as of December 31, 1999 and 2000:
1999 2000 ---- ---- Revolving credit facility rate ................. 8.5625% to 9.563% 10.0% Term loan facility rate ........................ 8.75% 9.250%
Total borrowings as of December 31, 2000 were $53.0 million and $29.5 million under the Revolving Credit Facility and Term Loan 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, a wholly-owned 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 and among other restrictions, 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, 2000, the Company had available credit under the Revolving Loan Facility in the amount of $7.0 million ($5.0 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 compliance as of December 31, 2000 (see Note 15). F-77 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, 2000 was approximately $69.0 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. Subsequent to December 31, 2000, the Company was in default of certain financial reporting requirements to the noteholders. Management believes that it has cured this default. Note Payable to Affiliate In connection with the acquisition of Hudson RCI AB 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. During 2000, the Company Borrowed an additional $2 million from the existing majority shareholder under an unsecured 14% note payable due on demand. Bank Notes Payable The Company has bank borrowings of $14.1 million outstanding at December 31, 2000, which are denominated in Swedish Krona. The borrowings bear interest at the 3-month STIBOR plus 0.75% to 1.75% (4.884% to 5.884% at December 31, 2000), are due December 21, 2003 and are secured by the common stock of Hudson RCI AB. Future Debt Principal Payments As of December 31, 2000, future debt principal payments on the aforementioned debt are as follows (amounts in thousands): Fiscal Year Ending: ------------------- 2001 ..................................... $ 10,686 2002 ..................................... 11,444 2003 ..................................... 13,444 2004 ..................................... 55,944 2005 ..................................... 5,130 Thereafter 125,266 ---------- $ 221,914 ========== F-78 6. Detail of Selected Balance Sheet Accounts Property, Plant and Equipment The following is a summary as of December 31, 1999 and December 31, 2000 (amounts in thousands):
1999 2000 ---- ---- Land ............................................... $ 2,044 $ 2,044 Buildings .......................................... 15,078 15,875 Leasehold improvements ............................. 1,322 1,322 Machinery, equipment and purchased software ........ 65,667 90,789 Furniture and fixtures ............................. 4,227 2,883 --------- -------- 88,338 112,913 Less-- Accumulated depreciation and amortization ... (57,740) (64,556) --------- -------- 30,598 48,357 Equipment installation in progress ................. 8,481 268 ERP software installation in progress .............. 3,397 800 -------- -------- Property and equipment, net ........................ $ 42,476 $ 49,425 ======== ========
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 ........................... Lesser of the useful life or lease term Machinery, equipment and purchased software ...... 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 implemented the new ERP system on April 1, 2000. Total depreciation expense related to property, plant and equipment and amortization expense related to intangible and other assets was $6,101,000, $8,315,000 and $11,719,000 for the years ended December 25, 1998, December 31, 1999 and December 31, 2000, respectively. Intangible Assets and Deferred Financing Costs, 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 31, 1999 and December 31, 2000 (amounts in thousands):
Useful lives 1999 2000 ------------ ---- ---- Covenant not-to-compete ........................ 5 to 7 years $ 3,500 $ 3,500 Patents ........................................ 15 years 472 68 Goodwill ....................................... 15 to 20 years 67,834 69,927 Other .......................................... 5 to 20 years 133 133 -------- --------- 71,939 73,628 Less-- Accumulated amortization ................ (4,969) (6,055) -------- --------- $ 66,970 $ 67,573 ======== =========
Deferred financing costs are amortized using the straight-line method over the period of the related debt. F-79 Management reviews Goodwill on a regular basis for possible impairment. Management knows of no factors at December 31, 2000 which may affect the impairment recorded of long-lived assets. Accrued Liabilities and Accounts Payable Accrued liabilities consisted of the following as of December 31, 1999 and December 31, 2000 (amounts in thousands):
1999 2000 ---- ---- Interest ........................................ $ 4,162 $ 3,605 Payroll and related ............................. 4,095 4,224 Vacation ........................................ 1,509 1,824 Pension ......................................... 1,353 1,767 Medical self-insurance .......................... 577 569 Other ........................................... 4 718 -------- --------- $ 11,700 $ 12,707 ======== =========
Accounts payable includes a book overdraft of approximately $0.9 million and $1.2 million at December 31, 1999 and 2000. 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, 2000, the Company had future obligations under operating leases as follows (amounts in thousands): Fiscal Year Ending: ------------------ 2001 .......................... $ 2,534 2002 .......................... 2,290 2003 .......................... 2,099 2004 .......................... 1,914 2005 .......................... 1,378 Thereafter .................... 4,023 -------- $ 14,238 ========
Rental expense was approximately $1,506,000, $2,052,000 and $3,115,000 in fiscal 1998, 1999 and 2000, respectively. The Company self-insures the majority of its medical benefit programs. Reserves for losses totaling approximately $577,000 and $569,000 at December 31, 1999 and December 31, 2000, 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. F-80 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%. 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 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 second quarter of 1998 which was recorded directly to retained earnings. 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 the asset and liability method 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 are more likely than not to be realizable. This change in estimate was included in the deferred tax provision for the year ended December 25, 1998. The effective tax rate for 1998, 1999 and 2000 consists of the following (amounts in thousands):
1998 1999 2000 ---- ---- ---- Income taxes at combined statutory rate of approximately 40% ... $ (24,094) $ 143 $ (2,398) Domestic losses not benefited. ................................. 24,022 - 2,730 Foreign taxes .................................................. - 1,443 2,871 Valuation allowance ............................................ 8,477 - - ---------- ---------- --------- $ 8,405 $ 1,586 $ 3,203 ========== ========== =========
F-81 The provision (benefit) for income taxes consists of the following (amounts in thousands):
United States Foreign Total ------------- ------- ----- 2000 Current ........................................... $ - $ 3,203 $ 3,203 Deferred .......................................... - - - ----------- ----------- ----------- $ - $ 3,203 $ 3,203 =========== =========== =========== 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 =========== =========== ===========
The 1998 tax provision results primarily from the valuation allowance discussed previously. As of December 31, 2000, the Company has recorded a net deferred tax asset of approximately $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, 2000, the Company had a United States net operating loss carryforward of approximately $34.0 million. The components of the deferred tax asset as of December 31, 1999 and December 31, 2000 are (amounts in thousands):
1999 2000 ---- ---- Basis differences arising from Section 338(h)(10) election ............................................. $ 68,873 $ 66,933 Net operating loss carryforwards ...................... 10,640 11,927 Other ................................................. (2,093) (1,278) ----------- ----------- 77,420 77,582 Valuation allowance ................................... (8,477) (8,477) ----------- ----------- $ 68,943 $ 69,105 =========== ===========
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 25, December 31, December 31, 1998 1999 2000 ---- ---- ---- Purchases $ 128 $ - $ - =========== ============ ============== Notes and advances receivable $ 91 $ 7,608 $ 10,366 =========== ============ ==============
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 $810,000, $972,000 and $914,000 for the fiscal years ended 1998, 1999 and 2000, respectively. F-82 Deferred Compensation Effective December 1, 1994, the Company established a deferred compensation plan for certain key employees. As of December 31, 2000 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 year ended 1998, the Company recorded $68,693,000 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 in 1998. 12. Geographic, Segment and Major Customer Information The Company presents segment information externally the same way management uses financial data internally to make operating decisions and assess performance. The Company also reports 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. As discussed in Note 14, the non-guarantor subsidiaries consist principally of Hudson RCI AB 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 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 1998, 1999 and 2000, the Company had foreign sales of approximately $20,148,000, $28,497,000 and $31,383,000 respectively, which constituted approximately 20.0%, 22.1% and 19.7% of total sales, respectively. The Company's percentage of sales by geographic region for the fiscal years ended 1998, 1999 and 2000 are as follows:
1998 1999 2000 ---- ---- ---- Domestic ....................................................... 79.9% 77.9% 80.3% Europe ......................................................... 7.8 10.1 9.0 Pacific Rim (Japan, Southeast Asia, Australia/New Zealand ...... 6.2 6.1 5.8 Canada ......................................................... 2.0 1.9 1.6 Other international ............................................ 4.1 4.0 3.3 -------- -------- ------- 100.0% 100.0% 100.0% ======== ======== ========
F-83 The following summarizes the net book value of fixed assets at the respective locations as of December 31, 1999 and December 31, 2000 (amounts in thousands):
December 31, December 31, 1999 2000 ----------- ----------- Ensenada, Mexico ........................... $ 1,134 $ 1,137 Stockholm, Sweden .......................... 342 291 Kuala Lumpur, Malaysia ..................... 741 672 United States .............................. 40,259 47,325 ---------- -------- $ 42,476 $ 49,425 ========== ========
For the fiscal years ended 1998, 1999 and 2000, the Company had sales to one domestic distributor in the amount of $24,940,000, $24,491,000 and $32,184,000 which represented approximately 24.8%, 19.0% and 20.2% of sales, respectively. Additionally, the Company had sales to another domestic distributor of $14,775,000 and $16,936,000, that accounted for approximately 11.5% and 10.6% of sales in 1999 and 2000, respectively. 13. Unaudited Consolidated Quarterly Data
1998 Quarters Ended ---------------------------------------------------- March 27 June 26 September 25 December 25 --------- ------- ------------ ----------- Net sales ....................................... $ 24,265 $ 22,432 $ 22,130 $ 31,671 Gross profit .................................... 10,431 9,600 9,843 13,822 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)
2000 Quarters Ended ------------------------------------------------------ March 31 June 30 September 30 December 31 --------- ------- ------------ -------------- Net sales ....................................... $ 40,807 $ 31,811 $ 41,111 $ 45,549 Gross profit .................................... 18,304 16,986 21,524 17,541 Income (loss) before extraordinary item ......... 1,599 (385) 1,662 (12,073) Net income (loss) ............................... 1,599 (385) 1,662 (12,073)
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 Hudson RCI AB and subsidiaries. The following tables disclose the required consolidating financial information for the guarantor, including the Company, and non-guarantor subsidiaries (amounts in thousands): F-84 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 banks ....................... $ 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 BANKS, net of current portion .. 66,100 16,413 - 82,513 SENIOR SUBORDINATED NOTES PAYABLE ............... 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-85 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING BALANCE SHEET
As of December 31, 2000 --------------------------------------------------- Non- Guarantor Guarantor Adjustments Total --------- --------- ----------- ----- ASSETS CURRENT ASSETS: Cash ............................................................ $ 437 $ 3,093 $ - $ 3,530 Accounts receivable ............................................. 32,665 4,395 (8,753) 28,307 Inventories ..................................................... 38,703 7,973 (2,066) 44,610 Other current assets ............................................ 6,350 52,467 (56,985) 1,832 --------- --------- --------- --------- Total current assets ......................................... 78,155 67,928 (67,804) 78,279 PROPERTY, PLANT AND EQUIPMENT, net ................................. 48,260 1,165 - 49,425 OTHER ASSETS: Intangible assets, net .......................................... 27,719 39,854 - 67,573 Deferred financing costs, net ................................... 9,587 - - 9,587 Deferred tax asset .............................................. 68,881 224 - 69,105 Investment in non-guarantor subsidiaries ........................ 29,245 - (29,245) - Other assets .................................................... 294 971 - 1,265 --------- --------- --------- --------- Total other assets ........................................... 135,726 41,049 (29,245) 147,530 --------- --------- --------- --------- $ 262,141 $ 110,142 $ (97,049) $ 275,234 ========= ========= ========= ========= LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Notes payable to banks .......................................... $ 7,500 $ 3,186 $ - $ 10,686 Accounts payable ................................................ 24,758 4,711 (9,149) 20,320 Accrued liabilities ............................................. 9,420 3,287 - 12,707 Other current liabilities ....................................... 1,242 22,764 (20,999) 3,007 --------- --------- --------- --------- Total current liabilities .................................... 42,920 33,948 (30,148) 46,720 NOTES PAYABLE TO AFFILIATE ......................................... 2,000 8,266 - 10,266 NOTES PAYABLE TO BANKS, net of current portion ..................... 75,000 10,962 - 85,962 SENIOR SUBORDINATED NOTES PAYABLE .................................. 115,000 - - 115,000 OTHER NON-CURRENT LIABILTIES ....................................... - 1,095 (1,095) - --------- --------- --------- --------- Total liabilities ............................................ 234,920 54,271 (31,243) 257,948 --------- --------- --------- --------- MANDATORILY-REDEEMABLE PREFERRED STOCK ............................. 40,061 - - 40,061 STOCKHOLDERS' EQUITY (DEFICIT) ..................................... (12,840) 55,871 (65,806) (22,775) --------- --------- --------- --------- $ 262,141 $ 110,142 $ (97,049) $ 275,234 ========= ========= ========= =========
F-86 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 ................................ 11,815 1,454 - 13,269 Amortization of goodwill .................................. 416 1,047 - 1,463 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 EXPENSES: Interest expense .......................................... (16,023) (1,240) - (17,263) Other, net ................................................ (633) (599) - (1,232) --------- --------- --------- --------- Total other 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. F-87 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING STATEMENT OF OPERATIONS
For the Year Ended December 31, 2000 ------------------------------------------------------ Guarantor Non-Guarantor Adjustments Total --------- ------------- ----------- ----- NET SALES ........................................... $ 145,786 $ 33,536 $ (20,044) $ 159,278 COST OF SALES ....................................... 87,092 16,875 (19,044) 84,923 ----------- ----------- ---------- --------- Gross profit ........................................ 58,694 16,661 (1,000) 74,355 OPERATING EXPENSES: Selling .......................................... 12,434 5,828 - 18,262 Distribution ..................................... 9,566 543 - 10,109 General & Administrative ......................... 20,659 3,364 - 24,023 Amortization of goodwill ......................... 1,281 2,039 - 3,320 Research and development ......................... 1,072 1,315 - 2,387 ----------- ------------ ----------- ---------- Total operating expenses ....................... 45,012 13,089 - 58,101 ----------- ------------ ----------- ---------- Income (loss) from operations ....................... 13,682 3,572 (1,000) 16,254 OTHER INCOME AND (EXPENSES): Interest expense ................................. (18,506) (2,583) - (21,089) Other, net ....................................... (205) (556) (398) (1,159) ----------- ----------- ----------- ---------- Total other income (expense) .................. (18,711) (3,139) (398) (22,248) ----------- ----------- ----------- ---------- Income (loss) before provision (benefit) for income taxes ............................................. (5,029) 433 (1,398) (5,994) PROVISION (BENEFIT) FOR INCOME TAXES ............. - 3,203 - 3,203 ----------- ----------- ----------- ---------- Net income (loss) ................................... $ (5,029) $ (2,770) $ (1,398) $ (9,197) =========== ============ =========== ========== Depreciation and amortization (c) .................. $ 10,450 $ 2,468 $ - $ 12,918 =========== =========== =========== ========== Adjusted EBITDA (d) ................................ $ 24,132 $ 6,040 $ (1,000) $ 29,172 =========== =========== =========== ==========
___________________________________ (c) Includes approximately $1,199,000 of non-cash expense related to the recognition of the portion of purchase price allocation related to acquired inventories. (d) 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. F-88 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the Year Ended December 31, 1999 --------------------------------------- Guarantor Non-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 ............................................. (623) 3,033 2,410 CASH, beginning of year .......................................... 507 - 507 ----------- ----------- ----------- CASH, end of year ................................................ $ (116) $ 3,033 $ 2,917 =========== =========== ===========
For the Year Ended December 31, 2000 ---------------------------------------- Guarantor Non-Guarantor Total --------- ------------- ----- Net cash provided by operating activities ........................ $ 11,804 $ (180) $ 11,624 Net cash used in investing activities ............................ (29,329) 2,388 (26,941) Net cash provided by financing activities ........................ 17,778 (1,559) 16,219 Effect of exchange rate changes on cash .......................... - (289) (289) ----------- ----------- ----------- NET INCREASE IN CASH ............................................. 253 360 613 CASH, beginning of year .......................................... 184 2,733 2,917 ----------- ----------- ----------- CASH, end of year ................................................ $ 437 $ 3,093 $ 3,530 =========== =========== ===========
15. Subsequent Events On March 21, 2001, the Company replaced its existing lending agreement denominated in Swedish Krona with a new loan that allows for borrowings up to approximately $19,100,000. The principal is amortized over 18 equal quarterly payments commencing June 30, 2001. Interest is based on the STIBOR rate + 0% to 1.65%, based on the outstanding balance of the loan. The loan is secured by a pledge of Hudson Euro SarL stock, a wholly-owned subsidiary of the Company and 100% owner of Hudson RCI AB, Hudson RCI UK Ltd. and Hudson RCI France S.A.S. In April and May of 2001, the company issued for cash unsecured senior subordinated convertible notes to certain managers and shareholders in the amount of $9,451,250 and will issues an additional $3,500,000 in August of 2001. The notes bear interest at 10% and are due in 2005. The interest may be paid or deferred to the due date at the option of the Company and are convertible to common stock at the demand of the note holder. Additionally, in August of 2001 the Company will issue for $3,000,000 cash an additional 30,000 shares of mandatorily-redeemable preferred stock. As discussed in Note 5, the Company was not in compliance with certain restrictive covenants of the Credit Facility at December 31, 2000. On July 30, 2001, the Company amended its Credit Facility covenants so that under the amended terms, the Company was in compliance as of December 31, 2000 and expects to remain in compliance until December 31, 2001. As part of this amendment (1) the Company's shareholders agreed to invest an additional $3 million in senior subordinated convertible notes of the Company (2) certain maturities were extended and (3) interest rate margins increased. F-89 RIVER HOLDING CORP. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (Amounts in thousands)
Balance at Balance at Beginning of Charges to End of Period Expenses Write-offs Period ------------ ---------- ---------- ---------- Description - ----------- For the Year Ended December 31, 2001: Allowance for doubtful accounts receivable .............................. $ (3,500) $ (2,826) $ 4,525 $ (1,801) ============ ========== ========== ==========
II-1 Arthur Andersen LLP ("Andersen") is the former auditor of Holding. As a result of recent events at Andersen, Andersen declined Holding's request to reissue their audit report dated July 30, 2001 for the fiscal years ended December 31, 2000 and 1999 for inclusion in Holding's 10-K filing for the fiscal year ended December 31, 2001. As such, pursuant to the guidance given in the Temporary Final Rule and Final Rule: Requirements for Arthur Andersen LLP Auditing Clients, Release Nos. 33-8070; 34-45590; 35-27503; 39-2395; IA-2018; IC-25464; FR-62; File No. S7-03-02, Holding is filing this copy of the latest signed and dated accountants' report issued by Andersen for such periods. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of River Holding Corp.: We have audited in accordance with auditing 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 July 30, 2001. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying Schedule II -- Valuation and Qualifying Accounts listed in the index above is the responsibility of the company's management and is presented for purposes of complying with the 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 those 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 July 30, 2001 RIVER HOLDING CORP. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (Amounts in thousands)
Balance at Balance at Beginning of Charges to Write-offs End of Period Expenses Period ------------- -------------- ----------- ------------ For the Year Ended December 31, 2000: Allowance for doubtful accounts .......... $ (973) $ (3,106) $ 579 $ (3,500) ============= ============== =========== ============ For the Year Ended December 31, 1999: Allowance for doubtful accounts receivable ............................. $ (794) $ (440) $ 261 $ (973) ============= ============== =========== ============
II-2 EXHIBIT 12.1 Ratio Support Ratio Of Earnings To Fixed Charges
River Holding Corp. ------------------------------------------ Inception to Dec 25, 1998 1999 2000 2001 --------- --------- ------ ------- Earnings: Pre-tax income (loss) ..................... $ (1,574) $ (7,082) $(13,334) $ (209,981) Fixed charges ............................. Interest expense .......................... 10,273 17,263 21,089 20,542 Amortization of debt expense .............. 635 -- -- -- Interest factor of rent expense ........... 370 684 1,028 1,537 ---------- --------- -------- ---------- Total fixed charges ....................... 11,278 17,947 22,127 22,079 ---------- --------- -------- ---------- Total earnings (loss) before fixed charges ......................... 9,704 10,865 8,783 (187,902) ---------- --------- -------- ----------- Ratio of earnings (loss) to fixed charges ......................... -- -- -- -- Deficiency of earnings to cover fixed charges ......................... (1,574) (7,082) (13,334) (209,981)
Hudson RCI -------------------------------------------------------- 1997 1998 1999 2000 2001 -------- --------- --------- ------ --------- Earnings: Pre-tax income (loss) ..................... $ 11,443 $ (61,676) $ 358 $ (5,994) $ (73,817) Fixed charges ............................. Interest expense .......................... 1,834 11,327 17,263 21,089 20,542 Amortization of debt expense .............. 62 -- -- -- -- Interest factor of rent expense ........... 374 497 677 1,038 1,537 ------- --------- --------- ------ -------- Total fixed charges ....................... 2,270 11,824 17,940 22,127 22,079 ------- --------- --------- ------ -------- Total earnings (loss) before fixed charges ......................... 13,713 (49,852) 18,298 16,133 (51,738) ------- --------- --------- ------ -------- Ratio of earnings (loss) to fixed charges ......................... 6.0 -- 1.0 - -- Deficiency of earnings to cover fixed charges ......................... -- (61,676) -- (5,994) (73,817)
II-3 Ratio of Earnings to Fixed Charges and Preferred Dividends
River Holding Corp. --------------------------------------------- Inception to Dec 25, 1998 1999 2000 2001 ---------- -------- --------- -------- Earnings: Pre-tax income (loss) .................. $ (1,574) $ (7,082) $ (13,334) $(209,981) Fixed charges Interest expense ....................... 10,273 17,263 21,089 20,542 Amortization of debt expense ........... 635 -- -- -- Interest factor of rent expense ........ 370 684 1,028 1,537 Preferred stock dividend expense ....... 4,187 6,515 7,733 8,213 ---------- -------- --------- --------- Total fixed charges .................... 15,465 24,462 29,850 30,292 ---------- -------- --------- --------- Total earnings (loss) before fixed charges ...................... 13,891 17,380 16,516 (179,689) ---------- -------- --------- --------- Ratio of earnings (loss) to fixed charges ...................... -- -- -- -- Deficiency of earnings to cover fixed charges ................ (5,761) (13,597) (21,067) (218,194)
Hudson RCI ------------------------------------------------------------ 1997 1998 1999 2000 2001 ---------- ---------- ---------- ------ --------- Earnings: Pre-tax income (loss) .................. $ 11,443 $ (61,676) $ 358 $ (5,994) $ (73,817) Fixed charges Interest expense ....................... 1,834 11,327 17,263 21,089 20,542 Amortization of debt expense ........... 62 -- -- -- -- Interest factor of rent expense ........ 374 497 677 1,028 1,537 Preferred stock dividend expense ....... -- 4,187 6,518 7,733 8,213 --------- --------- ---------- --------- --------- Total fixed charges .................... 2,270 16,011 24,458 29,850 30,292 --------- --------- ---------- --------- --------- Total earnings (loss) before fixed charges ...................... 13,713 (45,665) 24,816 23,856 (43,525) --------- --------- ---------- --------- --------- Ratio of earnings (loss) to fixed charges ...................... 6.0 -- 1.0 -- -- Deficiency of earnings to cover fixed charges ................ -- (61,676) -- (5,994) (73,817)
II-4 Computation of Interest Factor of Rental
River Holding Corp. ------------------------------------------- Inception to Dec 25, 1998 1999 2000 2001 -------- --------- --------- --------- Operating rental expense $ 1,110 $ 2,052 $ 3,115 $ 4,657 Interest factor 33% 33% 33% 33% -------- --------- --------- --------- Total $ 366 $ 677 $ 1,028 $ 1,537 ======== ========= ========= =========
Hudson RCI -------------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Operating rental expense $ 1,132 $ 1,506 $ 2,052 $ 3,115 $ 4,657 Interest factor 33% 33% 33% 33% 33% -------- -------- -------- -------- -------- Total $ 374 $ 497 $ 677 $ 1,028 $ 1,537 ======== ======== ======== ======== ========
Computation of Preferred Stock Expense
River Holding Corp. ------------------------------------------- Inception to Dec 25, 1998 1999 2000 2001 -------- -------- -------- -------- Preferred stock dividend expense $ 2,512 $ 3,911 $ 4,640 $ 4,928 Tax effect (1.0 - .40) 60% 60% 60% 60% -------- -------- -------- -------- Total $ 4,187 $ 6,518 $ 7,733 $ 8,213 ======== ======== ======== ========
Hudson RCI -------------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- Preferred stock dividend expense $ -- $ 2,512 $ 3,911 $ 4,640 $ 4,928 Tax effect (1.0 - .40) 60% 60% 60% 60% 60% -------- -------- -------- -------- -------- Total $ -- $ 4,187 $ 6,518 $ 7,733 $ 8,213 ======== ======== ======== ======== ========
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