-----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, LDFsPVfj7+coaBorFvNfdC0jN3+j6xdXiGMndcuk8kRqFL6obVbOgGQjonriESW9 VhneFotAluvYsNAjB7Ch3w== 0000898430-01-501957.txt : 20010816 0000898430-01-501957.hdr.sgml : 20010816 ACCESSION NUMBER: 0000898430-01-501957 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010815 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HUDSON RESPIRATORY CARE INC CENTRAL INDEX KEY: 0001061893 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 951867330 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 333-56097 FILM NUMBER: 1715991 BUSINESS ADDRESS: STREET 1: 27711 DIAZ RD STREET 2: P O BOX 9020 CITY: TEMECULA STATE: CA ZIP: 92589 BUSINESS PHONE: 9096765611 MAIL ADDRESS: STREET 1: 27711 DIAZ RD STREET 2: P O BOX 9020 CITY: TEMECULA STATE: CA ZIP: 92589 10-K 1 d10k.txt ANNUAL REPORT ON 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, 2000 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 333-56097 HUDSON RESPIRATORY CARE INC. (Exact name of registrant as specified in its charter) California 95-1867330 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 27711 Diaz Road, P.O. Box 9020 92589 Temecula, California (Zip Code) (Address of Principal Executive Offices) (909) 676-5611 (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 August 15, 2001, the number of shares of Common Stock, $.01 par value, outstanding (the only class of common stock of the registrant outstanding) was 10,391,435. 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 - -------------------------------------------------------------------------------- HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES Fiscal Year Ended December 31, 2000 TABLE OF CONTENTS
Page ---- PART I..................................................................................................... 1 Item 1. Business................................................................................ 1 Item 2. Properties.............................................................................. 8 Item 3. Legal Proceedings....................................................................... 8 Item 4. Submissions of Matters to a Vote of Security Holders.................................... 8 PART II.................................................................................................... 9 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................... 9 Item 6. Selected Financial Data................................................................. 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.... 11 Item 7A. Quantitative and Qualitative Disclosure About Market Risk............................... 23 Item 8. Financial Statements.................................................................... 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.... 24 PART III................................................................................................... 25 Item 10. Directors and Executive Officers of the Registrant...................................... 25 Item 11. Executive Compensation.................................................................. 27 Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 29 Item 13. Certain Relationships and Related Transactions.......................................... 30 PART IV.................................................................................................... 31 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 31 SIGNATURES................................................................................................. S-1
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 Hudson Respiratory Care Inc. or the respiratory care and anesthesia products industries to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These potential risks, uncertainties 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." The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments. General Hudson Respiratory Care Inc. ("Hudson RCI" or the "Company") is a leading manufacturer and marketer of disposable medical products utilized in the respiratory care and anesthesia segments of the domestic and international health care markets. The Company offers one of the broadest respiratory care and anesthesia product lines in the industry, including such products as oxygen masks, humidification systems, nebulizers, cannulae and tubing. In the United States, the Company markets its products to a variety of health care providers, including hospitals and alternate site service providers such as outpatient surgery centers, long-term care facilities, physician offices and home health care agencies. Internationally, the Company sells its products to distributors that market to hospitals and other health care providers. The Company's products are sold to over 3,000 distributors and alternate site service providers throughout the United States and in more than 75 countries worldwide. The Company has supplied the disposable respiratory care market for over 50 years and enjoys strong brand name recognition and leading market positions. The Company manufactures and markets over 2,500 respiratory care and anesthesia products. The Company believes that its broad product offering represents a competitive advantage over suppliers with more limited product offerings, as health care providers seek to reduce medical supply costs and concentrate purchases among fewer vendors. The Company also benefits competitively from its extensive relationships with leading group purchasing organizations (GPOs), as large purchasing organizations play an increasingly important role in hospitals' purchasing decisions. The Company maintains three manufacturing facilities and three 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. The Company has reduced its manufacturing and assembly costs through cost reduction programs, process improvements, equipment automation and upgrades and increased utilization of its Ensenada, Mexico and Kuala Lumpur, Malaysia facilities for labor-intensive operations. Hudson Oxygen Therapy Sales Company ("Hudson Oxygen"), Hudson RCI's predecessor, was founded in 1945. In 1988, Hudson Oxygen formed Industrias Hudson, a subsidiary that oversees the Company's assembly operation in Mexico. In 1989, Hudson Oxygen merged with Respiratory Care Inc. to form Hudson RCI. In April 1998, the Company consummated a recapitalization, pursuant to which it became a majority-owned subsidiary of River Holding Corp. ("Holding"). In the past three 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. Hudson RCI's principal executive offices are located at 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589, and its telephone number is (909) 676- 5611. 1 Industry Overview The worldwide market for disposable respiratory care and anesthesia products consists of the domestic hospital market, the alternate site market and the international market. Respiratory care and anesthesia principally involve the delivery of oxygen and anesthesia from a gas source, such as a mechanical ventilator or respirator, to the patient's pulmonary system. The gas is typically delivered to the patient through specialized tubing connecting to a cannula, mask or endotracheal tube. In addition, it is often necessary to humidify or medicate the gas. The market for respiratory care and anesthesia products, including disposable products, is expected to be positively impacted by demographic trends, both domestically and internationally. In the United States, changes in demographics, including an aging population, increased incidence and awareness of respiratory illnesses and heightened focus on cost- efficient treatment, have had a positive impact on the domestic respiratory care and anesthesia markets. There has been an increasing incidence of respiratory illnesses (such as asthma and emphysema), due in part to an increasingly susceptible aging population, environmental pollution, smoking-related illnesses and communicable diseases with significant respiratory impact, such as tuberculosis, HIV and influenza. The Company believes that the international respiratory care and anesthesia markets will experience many of the trends currently affecting domestic markets. In addition, many international markets have high incidences of communicable respiratory diseases and are becoming increasingly aware of the value of single-use, disposable products. The market for respiratory care and anesthesia products is also affected by trends involving the health care market generally. In particular, the overall trend towards cost containment has increased the desirability of disposable products relative to reusable products, and has influenced pricing, distribution channels, purchasing decisions and health care delivery methods. Efforts to contain rising health care costs have increased the preference for disposable medical products that improve the productivity of health care professionals and reduce overall provider costs. Health care organizations are evaluating modes of treatment that are less labor and/or technology intensive as a means of decreasing the cost of care, which can often result in increased disposable usage. In particular, increased utilization of disposable products can decrease labor and other costs associated with sterilizing reusable products. In addition, the risks of transmission of infectious diseases such as HIV, hepatitis and tuberculosis, and related concerns about the occupational safety of health care professionals, have also contributed to an increased preference for disposable single-use medical products. Cost containment has caused consolidation throughout the health care product supply channel, which has favored manufacturers with large product offerings and competitive pricing. In an effort to contain costs, service providers have consolidated to form GPOs, which take advantage of group buying power to obtain lower supply prices. This, in turn, has led to consolidation among distributors, who seek to provide "one-stop shopping" for these large buying groups. Distributors have also sought to concentrate purchases among fewer vendors in an effort to reduce supply costs. Since selection as a GPO provider and strong relationships with distributors are critical to many health care manufacturers, they have responded to these trends by providing a broad range of integrated products, combined with reliable delivery and strong after- sales support. Cost containment has also caused a migration of the decision making function with respect to supply acquisition from the clinician to the administrator. As clinicians lose influence and purchasing agents, materials managers and upper level management become more involved in the purchasing decision, a greater emphasis is placed on price relative to product features and clinical benefits. As a result of cost containment, health care is increasingly provided outside of traditional hospital settings through alternate health care sites, such as outpatient surgery centers, long-term care facilities, physician offices and 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 nine categories: (i) oxygen delivery; (ii) aerosol therapy; (iii) active and passive humidification; (iv) ventilatory support; (v) adaptors, connectors and filters; (vi) resuscitation; (vii) airway management; (viii) electronic monitoring; and (ix) durable equipment. Category/Products - ----------------- Oxygen Delivery: Oxygen Masks, Oxygen Cannulae, Oxygen Tubing Aerosol Therapy: AQUAPAK(R) Large Volume, Prefilled Nebulizers; Non-Prefilled Large Volume Nebulizer; UPDRAFT(R), UPDRAFT II(R), AVA-NEB(R) and MICRO MIST(R) Small Volume, Medication Nebulizers; Aerosol Tubing; AQUATHERM(R) and THERMAGARD(R) Nebulizer Heaters; AQUAPAK Prefilled Ultrasonic Cups; ADDIPAK(R) Prefilled Unit Dose Solutions; POCKETPEAK(R) Peak Flow Meter Active and Passive Humidification: CONCHATHERM(R) Heated Humidifiers, AQUA+(R) Hygroscopic Condenser Humidifiers, AQUAPAK Prefilled Humidifiers, Non-Prefilled, Reusable Humidifier, Non-Prefilled Disposable Humidifier, HUMID-HEAT(R) Heat-Moisture Exchangers Ventilatory Support: Conventional Ventilator Circuits, Heated-Wire Ventilator Circuits, Anesthesia Breathing Circuits, Air Cushion Anesthesia Masks, Infant CPAP Systems Adaptors, Connectors and Filters: A wide variety of adaptors and connectors; Main Flow Bacterial/Viral Filters; Pulmonary Function Filter Description - ----------- Used to deliver therapeutic, supplemental oxygen to a patient. Oxygen masks cover the nose and mouth. Nasal cannulae fit inside the nostrils. Both masks and cannulae are connected to an oxygen source via small diameter tubing through which oxygen flows. Used to create and deliver aerosolized particles of liquid water, sodium chloride or medication to the patient's airways to dilute and mobilize secretions and/or dilate constricted breathing passages. The peak flow meter is used to monitor the patient's respiratory status before and after an aerosolized medication treatment. Heated humidification systems actively heat and humidify oxygen/air mixtures or anesthetic gases provided by a mechanical ventilator or anesthesia gas machine. Hygroscopic condenser humidifiers passively conserve the heat and humidity in the patient's exhaled breath for use during inspiration. Prefilled and non- prefilled humidifiers are used to add water vapor to oxygen being provided to a patient via a mask or cannula. Used to convey an oxygen/air mixture and/or anesthetic gas from a mechanical ventilator or anesthesia gas machine to a patient during the temporary or long- term support of ventilation. The infant CPAP system provides non-invasive respiratory support to premature infants with under-developed, immature lungs. The 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. Filters are used to protect patients, 3 Category/Products - ----------------- Resuscitation: LIFESAVER(R) Reusable and Disposable Resuscitation Bags, Isolation Valves and Kits, LIFESAVER Tubes and Kits Airway Management: SOFTECH(R) Cuffed and Uncuffed Endotracheal Tubes; CATH- GUIDE(R), Color-Coded and DUAL-CHANNEL Oral Pharyngeal Airways; BITEGARDO(TM) Oral Bite Block; CATH-GUIDE Closed Suction Catheters; VOLDYNE(R) and TRI-FLO(R) Incentive Breathing Exercisers; SHERIDAN(R) Endotracheal Tubes Electronic Monitoring: Replacement oxygen sensors, Oxygen Monitors and Analyzers, VENTILARM II(R) Low-Pressure Alarms Durable Equipment: Oxygen Regulators; Cylinder Carts, Trucks and Stands; Portable Oxygen Units Description - ----------- Caregivers, and medical equipment from cross-contamination with bacteria and viruses. Used during cardiopulmonary resuscitation ("CPR") to adequately support and/or maintain the patient's ventilatory function. Assist in securing and maintaining an open airway and unobstructed breathing passage. They also can assure that the patient's ventilation can be maintained and that respiratory secretions can be adequately removed from the lungs. The oxygen sensors, monitors and analyzers are used to analyze and monitor the amount of oxygen being administered to a patient. The low-pressure alarm is used to detect a patient disconnect or a leak in the breathing circuit during mechanical ventilation. Used to regulate oxygen flow from cylinders, stabilize or transport oxygen or other gas cylinders, and provide a portable oxygen supply for emergency use. Sales, Marketing and Distribution The Company has sales offices in Temecula, Sweden, Germany, France and the United Kingdom. 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 12 to "Item 8. Financial Statements" for information with respect to international sales. The Company's sales personnel currently call on approximately 2,800 health care providers, 50 hospital distributors and 1,500 alternate site customers. Due to consolidation and cost pressures among the Company's customer base, the Company's target call point at the health care provider has been moving away from the clinician to include a purchasing manager or corporate executive. As of December 31, 2000, the Company had a sales backlog of approximately $3.9 million. In the current market environment, GPO relationships are an essential part of access to the Company's target markets and the Company has entered into preferred supplier arrangements with 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 two 4 of its major GPOs, Novation LLC (which represents the 1998 consolidation of VHA, Inc. and University HealthSystem Consortium) and HCA. The Company's most significant GPO relationships are with AmeriNet Inc., HealthTrust Corporation, Health Services Corporation of America, MHA, and Novation LLC. In 2000, the Company entered into a new, exclusive relationship with Consorta, the merger of the former DOC and SSM Catholic hospital organizations. Health care providers have responded to pressures to reduce their costs by merging with other members of their industry. The acquisition of a customer of the Company often results in the renegotiation of contracts, the granting of price concessions or in the loss of the customer. Alternatively, to the extent a customer of the Company grows through acquisition activity, the Company may benefit from increased sales to the larger entity. The Company markets its products primarily through consultative dialogue with health care providers, targeted print advertising, trade shows, selective promotional arrangements with distributors and the Company's heater lease program. To support sales of the entire line of humidification and ventilation products, the Company leases heaters to domestic customers without charge. The revenues from the sale of products used in connection with the operation of the heaters covers the amortization of the heater cost under the leases. The Company has heaters with a net book value of approximately $2.2 million as of December 31, 2000 placed at service provider locations under this program. The Company utilizes a network of over 3,000 hospital distributors, as well as additional alternate site distributors, to reach its markets. A number of these distributors carry competing product lines, but many are moving to select single supply sources for particular product groups. The Company has been selected as the FOCUS preferred vendor of respiratory disposables for Owens & Minor Inc. Such status gives preference to the shipping of the Company's products versus competing product lines. Owens & Minor Inc. is the Company's largest distributor, accounting for approximately $32.2 million or approximately 20.2% of total fiscal 2000 net sales. The Company provides a price list to its distributors which details base acquisition prices. Distributors receive orders from the service providers and charge the contract pricing (which is determined by their GPO affiliation or individual contract price) plus a service margin. As is customary within the industry, the Company rebates the difference between base acquisition price and the specific contract price to the distributor. The Company offers select large health care providers a reward for purchasing a broader selection of the Company's product lines. The program allows a rebate in the form of merchandise credit for purchasing minimum volumes from a selected group of products. The Company's international distributors outside of the EU, Middle East and Africa place their orders directly with dedicated international customer service representatives. Customer orders are shipped from one of two warehouse locations. Sales strategies and marketing plans are tailored to each market with involvement of the distributor. Region and territory sales managers are responsible for the launch of products into their regions, including related support and training. The Company utilizes a network of approximately 100 international distributors, typically on an exclusive basis within each market. Manufacturing and Assembly The Company operates three manufacturing facilities and three distribution facilities in the United States and assembly facilities in Ensenada, Mexico and Kuala Lumpur, Malaysia. While the Company believes that it is operating at a high utilization rate, existing facilities could support increased capacity with additional machinery and workers. The Company's manufacturing facility in Temecula, California houses 77 injection molding machines, 67 of which are automated. During the past five years, 31 out of the 76 machines have been replaced with more efficient models, which has increased capacity. Tubing is produced on 11 extrusion lines: 6 corrugated, 4 oxygen or "spaghetti," and 1 repellitizer/regrinder. The Temecula facility uses 12-14 million pounds of over 30 different kinds of resin annually; the most prominent are PVC, polyethylene and polypropylene. Sterile prefilled humidification and nebulization products 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. This 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. The Company expects to either renew the lease or relocate the production lines to another Company facility. 5 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 occasionally outsources production of certain products while it establishes its ability to penetrate a target market. Having achieved an acceptable level of penetration, the Company internalizes the manufacturing function in order to increase margins and improve quality control. The Company monitors the quality of its products at the Temecula, Arlington Heights, Argyle, Ensenada and Kuala Lumpur 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 facility is certified as ISO 9001 compliant. Suppliers and Raw Materials The Company's primary raw materials are various resins, which are formed into the Company's products. The top 10 purchased products in 2000 were Tubing Grade PVC, Clear PVC, LDPE-EVA, Polypropylene, Aluminum Cylinder, Pre-Cut Elastic, Non-Tubing Grade PVC, Cannula Blanks, Acrylic Resin and Hose-End Grade PVC. The Company believes that it is able to purchase materials at a cost no higher than its competitors. The Company does not have long-term supply contracts for any of its purchased raw materials. The Company believes that sufficient availability exists for its raw materials, as they consist of mainly readily available plastic resins. Research and Development The Company's research and development department consists of 18 people, including 11 engineers. The Company's research and development efforts are split between developing new products and process improvements to its manufacturing operations. The Company develops new products to expand its product line in anticipation of changes in demand. The Company has invested heavily in the anesthesia product line, as the Company continues to penetrate this market. The Company makes several new product introductions every year. Significant products introduced in the last five years include the line of heat-moisture exchangers, POCKETPEAK peak flow meter, SOFTECH endotracheal tubes, MICRO MIST small volume nebulizer and CONCHA IV heated humidification system. The Company constantly works to reduce costs through continuous process improvements. The Company incurred research and development expenses of approximately $1.0 million, $2.0 million and $2.4 million in fiscal 1998, 1999 and 2000, respectively. Competition The medical supply industry is characterized by intense competition. The Company's primary competitor in the respiratory care sector is Allegiance Healthcare 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 quality, breadth of product line, service and price. Patents and Trademarks 6 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 24 patents in the U.S. Many of the U.S. patents have corresponding patents issued in Canada, Europe and various other countries. The Company's success will depend in part on its ability to maintain its patents, add to them where appropriate, and develop new products and applications without infringing the patent and other proprietary rights of third parties and without breaching or otherwise losing rights in technology licenses obtained by the Company for other products. There can be no assurance that any patent owned by the Company will not be circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with claims of the scope sought by the Company, if at all. If challenged, there can be no assurance that the Company's patents (or patents under which it licenses technology) will be held valid or enforceable. In addition, there can be no assurance that the Company's products or proprietary rights do not infringe the rights of third parties. If such infringement were established, the Company could be required to pay damages, enter into royalty or licensing agreements on onerous terms and/or be enjoined from making, using or selling the infringing product. Any of the foregoing could have a material adverse effect upon the Company's business, financial condition or results of operations. Government Regulation and Environmental Matters The Company and its customers and suppliers are subject to extensive Federal and state regulation in the United States, as well as regulation by foreign governments, and the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company. Most of the Company's products are subject to government regulation in the United States and other countries. In the United States, the 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 clearances, the loss of previously received approvals or clearances, or failures to comply with existing or future regulatory requirements in the United States or in foreign countries could have a material adverse effect on the Company's business. Foreign sales are subject to similar requirements. The Company is required to comply with the FDA's GMP/QSR Regulations, which set forth requirements for, among other things, the Company's manufacturing process, design control and associated record keeping, including testing and sterility. Further, the Company's plants and operations are subject to review and inspection by local, state, Federal and foreign governmental entities. The distribution of the Company's products may also be subject to state regulation. The impact of FDA regulation on the Company has increased in recent years as the Company has increased its manufacturing operations. The Company's suppliers, including the sterilizer facilities, are also subject to similar governmental requirements. There can be no assurance that changes to current regulations or additional regulations imposed by the FDA will not have an adverse impact on the Company's business and financial condition in the future. The FDA also has the authority to issue special controls for devices manufactured by the Company, which it has not done to date. In the event that such special controls were issued, the Company's products would be required to conform, which could result in significant additional expenditures for the Company. The Company is also subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or infectious materials or substances and emissions of air pollutants. The Company owns and leases properties which are subject to environmental laws and regulations. There can be no assurance that the Company will not be required to incur 7 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 August 15, 2001, the Company employed approximately 2,700 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. 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, 2002, respectively. The Company leases a 33,260 square foot facility in Kuala Lumpur, Malaysia, under a lease that expires in July, 2001. This facility primarily assembles finished products for the HME and filter product lines. 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. The Company believes that its current facilities are adequate for its present level of operations. Item 3. Legal Proceedings. The Company is party to lawsuits and other proceedings, including suits relating to product liability and patent infringement. While the results of such lawsuits and other proceedings cannot be predicted with certainty, management does not expect that the ultimate liabilities, if any, will have a material adverse effect on the financial position or results of operations of the Company. Item 4. Submissions of Matters to a Vote of Security Holders. None. 8 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. There is no established public trading market for the Company's Common Stock. All of the Common Stock of the Company is held by Holding and the shareholder of the Company prior to the Recapitalization, described below. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Recapitalization." The Company has not paid cash dividends to Holding in the past two years, and does not intend to pay cash dividends to Holding 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 the Company's ability to pay cash dividends. Item 6. Selected Financial Data. The selected fiscal year end historical financial data has been derived from the audited financial statements of the Company. The information contained in this table should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included elsewhere in this Report.
Fiscal Year ------------------------------------------------------------- 1996 1997 1998 1999(a) 2000 ------- ------- -------- -------- ---------- Operating Data: (dollars in thousands) Net sales............................................... $93,842 $99,509 $100,498 $128,803 $ 159,278 Cost of sales........................................... 52,189 54,575 56,802 75,418 84,923 ------- ------- -------- -------- ---------- Gross profit............................................ 41,653 44,934 43,696 53,385 74,355 Operating expenses: Selling expenses........................................ 8,961 9,643 10,350 13,122 18,262 Distribution expenses................................... 3,114 3,170 3,336 4,647 10,109 General and administrative expenses..................... 11,277 11,456 10,284 14,732 27,343 Research and development expenses....................... 1,184 1,072 976 2,031 2,387 Provision for equity participation plan................. 8,249 6,954 63,939 -- --- Provision for retention payments........................ -- -- 4,754(b) -- --- ------- ------- -------- -------- ---------- Operating income (loss)................................. 8,868 12,639 (49,943) 18,853 16,254 Other (income) and expenses: Interest expense........................................ 2,177 1,834 11,327 17,263 21,089 Other (income) expense.................................. (463) (638) 406 1,232 1,159 ------- ------- -------- -------- ---------- Total other expense..................................... 1,714 1,196 11,733 18,495 22,248 ------- ------- -------- -------- ---------- Income (loss) before provision for income taxes......... 7,154 11,443 (61,676) 358 (5,994) Provision for income taxes.............................. 73 150 8,405 1,586 3,203 ------- ------- -------- -------- ---------- Income (loss) before extraordinary item................. 7,081 11,293 (70,081) (1,228) (9,197) Extraordinary item (loss on extinguishment of debt)..... -- -- 104(c) -- --- ------- ------- -------- -------- ---------- Net income (loss)....................................... $ 7,081 $11,293 $(70,185) $ (1,228) $ (9,197) ======== ======= ======== ======== ==========
continued on following page 9
Fiscal Year ------------------------------------------------------ 1996 1997 1998 1999(a) ---------- ---------- ---------- --------- Other Financial Data: (dollars in thousands) Net cash provided by (used in) operating activities..................... $ 16,133 $ 19,269 $(83,024) $ 7,097 Net cash used in investing activities................................... $(11,354) $ (3,673) $ (6,444) $(75,818) Net cash provided by (used in) financing activities..................... $ (3,668) $(16,398) $ 89,624 $ 71,529 Adjusted EBITDA(d)...................................................... $ 23,194 $ 25,440 $ 24,851 $ 29,993 Adjusted EBITDA margin(e)............................................... 24.7% 25.6% 24.7% 23.3% Operating margin before EPP and Retention Payments(f)................... 18.2% 19.7% 18.7% 14.6% Depreciation and amortization(g)........................................ $ 6,133 $ 5,847 $ 6,101 $ 8,315 Capital expenditures.................................................... $ 6,395 $ 4,659 $ 3,111 $ 10,973 Ratio of Adjusted EBITDA to cash interest expense....................... 10.7x 13.9x 2.3x 2.1x Ratio of total debt to Adjusted EBITDA.................................. 1.2x 0.8x 6.4x 7.1x Ratio of earnings to fixed charges(h)................................... 3.7x 6.0x -- 1.0 Deficiency of earnings to cover fixed charges........................... -- -- $(61,676) -- Ratio of earnings to fixed charges and preferred stock dividends(i)..... 3.7x 6.0x -- 1.0 Deficiency of earnings to cover fixed charges and preferred stock dividends.............................................................. -- -- $(61,676) -- Balance Sheet Data: Working capital......................................................... $ 24,188 $ 6,430 $ 29,533 $ 35,971 Working capital as adjusted(j).......................................... 26,768 29,960 32,026 39,727 Total assets............................................................ 76,910 77,554 165,321 251,819 Total debt.............................................................. 28,146 20,250 159,000 211,694 Shareholders' equity (deficit).......................................... 19,872 22,515 (37,735) (14,649) 2000 ---------- Other Financial Data: Net cash provided by (used in) operating activities..................... $ 10,502 Net cash used in investing activities................................... $(26,941) Net cash provided by (used in) financing activities..................... $ 17,341 Adjusted EBITDA(d)...................................................... $ 29,172 Adjusted EBITDA margin(e)............................................... 18.3% Operating margin before EPP and Retention Payments(f)................... 10.2% Depreciation and amortization(g)........................................ $ 12,918 Capital expenditures.................................................... $ 11,329 Ratio of Adjusted EBITDA to cash interest expense....................... 1.65x Ratio of total debt to Adjusted EBITDA.................................. 7.6x Ratio of earnings to fixed charges(h)................................... -- Deficiency of earnings to cover fixed charges........................... $ (5,994) Ratio of earnings to fixed charges and preferred stock dividends(i)..... -- Deficiency of earnings to cover fixed charges and preferred stock dividends.............................................................. $(13,727) Balance Sheet Data: Working capital......................................................... $ 29,559 Working capital as adjusted(j).......................................... 38,715 Total assets............................................................ 275,234 Total debt.............................................................. 221,914 Shareholders' equity (deficit).......................................... (22,775)
- ------------------- (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) Tyco, since certain of its assets were acquired in November 1999. (b) 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. (c) Reflects the write-off of deferred financing fees related to the payoff of outstanding debt under the Company's previous credit agreement. (d) Adjusted EBITDA represents income before depreciation and amortization, interest expense, income tax expense, charges related to the Equity Participation Plan, which was terminated upon consummation of the Recapitalization, and recognition of the portion of purchase price allocation related to acquired inventories. The Company has excluded payments under the Equity Participation Plan to present comparable figures for all historical periods presented. Adjusted EBITDA is not a measure of performance under generally accepted accounting principles, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with generally accepted accounting principles, or as a measure of profitability or liquidity. The Company has included information concerning Adjusted EBITDA as one measure of an issuer's historical ability to service debt. In addition, certain covenants in the Indenture are based upon a calculation analogous to Adjusted EBITDA. Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, income from operations or cash flow as an indication of the Hudson RCI's operating performance. For purposes of compliance with the Indenture, the Company's Consolidated Net Income and EBITDA will not be reduced by retention payments, payments made pursuant to the Equity Participation Plan or by the amount of any contingent payments made by the Company to former participants in the Equity Participation Plan. See Item 13 "Certain Relationships and Related Transactions." (e) Represents ratio of Adjusted EBITDA to net sales. (f) Represents ratio of operating income before EPP and retention payments to net sales. 10 (g) Includes amortization of deferred financing fees of $0.1 million in 1995 and $0.1 million in 1996, which should be excluded from depreciation and amortization in calculating Adjusted EBITDA since such fees are reflected below the operating income line. (h) 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. (i) For the purpose of determining the ratio of earnings to fixed charges and preferred stock dividends, earnings consist of earnings before income taxes and fixed charges. Fixed charges consist of interest on indebtedness, the amortization of debt issue costs and that portion of operating rental expense representative of the interest factor. Preferred stock dividends, consisting of amounts to be paid-in-kind, are also included in the pro forma fixed charge amounts. Preferred stock dividends have been "grossed up" to a pre-income tax basis to provide comparability to other components of the ratio. (j) Working capital as adjusted represents current assets, excluding cash, less current liabilities, excluding the current portion of long-term debt. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion of the Company's consolidated historical results of operations and financial condition should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included elsewhere in this Form 10-K. The following discussion and analysis includes periods before completion of the Recapitalization. General The Company'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 Beginning in April 2000, the company experienced disruption to its operations resulting from difficulties in the implementation of a new management information system. Consequently, the Company's financial results for the year ended December 31, 2000 reflect increased freight, distribution and general and administrative expenses related to the system implementation. The Company also experienced liquidity pressures beginning in the fourth quarter of 2000 due to such expense increases, delays in collection of due receivables and unplanned increases in inventory related to difficulties in implementation and a lack of familiarity with the new system. Management has implemented a number of initiatives in 2001 designed to improve the Company's proficiency with the new management information system, decrease the Company's operating expenses, improve receivables collections and reduce inventory levels. Despite the disruption related to the system implementation, management believes it has generally maintained strong customer service levels and relationships. 11 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 ------------------------------ 1998 1999 2000 -------- -------- -------- (dollars in thousands) 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 -------- -------- -------- Selling expenses..................................................... 10,350 13,122 18,262 Distribution expenses................................................ 3,336 4,647 10,109 General and administrative expenses.................................. 10,125 13,269 24,023 Amortization of goodwill............................................. 159 1,463 3,320 Research and development expenses.................................... 976 2,031 2,387 Provision for equity participation plan.............................. 63,939 -- -- Provision for retention payments..................................... 4,754 -- -- -------- -------- -------- Total operating expenses............................................. 93,639 34,532 58,101 -------- -------- -------- Operating income (loss).............................................. (49,943) 18,853 16,254 Add back: Provision for equity participation plan.................... 63,939 -- -- Add back: Provision for retention payments........................... 4,754 -- -- -------- -------- -------- Operating income before provision for equity participation plan and provision for retention payments.................................... $ 18,750 $ 18,853 $ 16,254 ======== ======== ========
Fiscal Year --------------------------- 1998 1999 2000 ----- ----- ----- Net sales............................................................... 100.0% 100.0% 100.0% Cost of sales........................................................... 56.5 58.5 53.3 ----- ----- ----- Gross profit.......................................................... 43.5 41.4 46.7 ----- ----- ----- Selling expenses........................................................ 10.3 10.2 11.5 Distribution expenses................................................... 3.3 3.6 6.3 General and administrative expenses..................................... 10.2 10.3 15.1 Amortization of goodwill................................................ --- 1.1 2.1 Research and development expenses....................................... 1.0 1.6 1.5 Provision for equity participation plan................................. 63.6 -- -- Provision for retention payments........................................ 4.7 -- -- ----- ----- ----- Total operating expenses................................................ 93.2 26.8 36.5 ----- ----- ----- Operating income (loss)................................................. (49.7) 14.6 10.2 Add back: Provision for equity participation plan....................... 63.6 -- -- Add back: Provision for retention payments.............................. 4.7 -- -- ----- ----- ----- Operating income before provision for equity participation plan and provision for retention payments....................................... 18.7% 14.6% 10.2 %
12 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 Tyco incentive breathing exerciser product line acquisition made in November 1999, and $3.2 million was the result of the acquisition of the Tyco 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 ERP 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 Tyco 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 system implementation. 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 118% 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. 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. General and administrative expenses were $24.0 million for 2000, an increase of $10.8 million or 81.0% 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 & 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 127% increase over 1999. This increase was driven primarily by the Hudson RCI AB and Tyco incentive breathing exerciser acquisitions in 1999, as well as the Tyco 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, Tyco incentive breathing exerciser and Tyco SHERIDAN(R) acquisitions. In addition, borrowings were higher under the working capital revolver due to increased 13 working capital requirements that resulted from growth in the Company as well as from issues relating to the new computer system implementation. Year Ended December 31, 1999 Compared to Year Ended December 25, 1998 Net sales, reported net of accrued rebates, were $128.8 million in 1999, an increase of $28.3 million or 28.2% over 1998. Of the $28.3 million increase, approximately $6.1 million related to the acquisition of Hudson RCI AB, $2.2 million related to the Tyco acquisition and $0.9 million related to the Medimex acquisition. In addition, the full effect in 1999 of the Gibeck, Inc. acquisition in September 1998 resulted in a sales increase of $7.6 million. For the base Hudson RCI business, domestic hospital sales increased by $3.3 million or 5.5%, due to increased demand at the hospital level, primarily the result of increased sales through certain GPOs. Alternate site sales increased by $4.4 million or 26.5% as the Company continued to focus its efforts on this growing market. International sales increased by $1.6 million or 9.1%, as growth in sales continued in Japan and Europe. This growth was partially offset by weakness in South America. Sales to customers in Southeast Asia have stabilized, remaining virtually unchanged over 1998. Canadian sales increased by approximately $0.3 million, due primarily to the efforts of a new distributor in that country. Approximately 30% of the Company's 1999 total net sales were to two distributors. The Company's gross profit for 1999 was $53.4 million, an increase of $9.7 million or 22.2% from 1998. As a percentage of net sales, the Company's gross profit was 41.4% for 1999 as compared to 43.5% for 1998. This decline was primarily due to the recognition of inventory revalued as a result of the Hudson RCI AB acquisition, increased shipping costs as a result of sales of acquired Gibeck, Inc. products, and an unfavorable mix variance caused by increased sales of products at lower gross margins. This trend is expected to continue in the future if the preference for passive humidification products over higher margin active humidification products continues. This trend was partially offset by manufacturing cost reductions realized by the Company and higher gross margins of sales at Hudson RCI AB. Selling expenses were $13.1 million for 1999, an increase of $2.7 million or 26.8% over 1998. This increase was due primarily to $1.2 million of costs associated with Hudson RCI AB and $1.2 million as a result of the start-up of the German sales operation. In addition, sales and marketing expenses at Hudson RCI increased by approximately $0.3 million. As a percentage of net sales, selling expenses decreased to 10.2% as compared to 10.3% in 1998. Distribution expenses were $4.6 million for 1999, an increase of $1.3 million or 39.0% over 1998. As a percentage of sales, distribution expenses increased to 3.6% as compared to 3.3% in 1998. The increase is primarily the result of the increased cost of freight between the Company's distribution facilities, the start up of a distribution facility in Atlanta and increased headcount. General and administrative expenses for 1999 were $13.3 million, an increase of $3.1 million or 31.1% over 1998. Of this increase, $2.0 million relates to expenses incurred at Hudson RCI AB and $0.2 million as a result of the German operation. In addition, the company increased management bonuses and incurred certain non-recurring consulting expenses. As a percentage of net sales, general and administrative expenses were 11.4% in 1999 as compared to 10.2% in 1998. Amortization of goodwill was $1.5 million in 1999, a $1.3 million or 820% increase over 1998. This was solely driven by the Hudson RCI AB and Tyco incentive breathing exerciser acquisitions. Research and development expenses were $2.0 million in 1999, an increase of $1.1 million or 108.2% over 1998. This increase was primarily due to the addition of Hudson RCI AB research and development expenses of $0.7 million and increases in the Hudson RCI engineering staff. The provision for equity participation plan consists of accrued expenses and payments made to executives under the Equity Participation Plan. The Equity Participation Plan was terminated upon consummation of the Recapitalization and replaced with an executive stock purchase plan. See "Item 11. Executive Compensation--Stock Subscription Plans." No payments under the Equity Participation Plan were made in 1999 that were not provided for in 1998. In 1998, the 14 provision for equity participation plan was $63.9 million, which included approximately $1.3 million in employer taxes relating to the distribution made under the Equity Participation Plan. The provision for retention payments, including related employer payroll taxes, was $4.8 million in 1998. These payments were made to substantially every employee in the Company and were intended to ensure the continued employment of all employees after the Recapitalization. No payments were made in 1999 and no future retention payments are anticipated. Interest expense was $17.3 million for 1999, an increase of $5.9 million over 1998. The increase was due to higher debt levels during 1999 as a result of the Hudson RCI AB and Tyco acquisitions. 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 The Company's primary sources of liquidity are cash flow from operations, borrowings under its working capital bank facility and, historically, investments from its shareholders. Cash provided by (used in) operations before EPP payments and retention bonuses totaled $(57.3) million, $7.1 million and $11.6 million in 1998, 1999 and 2000, respectively. The increase from 1999 to 2000 is attributable to decreased working capital, primarily increased trade payables. Subsequent to year end, trade payables have been reduced significantly. The Company had operating working capital, excluding cash and short-term debt, of $39.7 million and $38.7 million as of the end of fiscal 1999 and 2000, respectively. Inventories were $24.0 million and $44.6 million as of the end of fiscal 1999 and 2000, respectively. In 2000, inventories increased to unplanned levels due to problems related to the implementation of the new management information system as well as higher sales levels. The Company has significantly reduced inventory levels in 2001, but over time, the Company expects its level of inventories to increase as the Company's sales in the international market increase. As of June 30, 2001, inventory levels were approximately $33.8 million. Accounts receivable, net of allowances, were $30.4 million and $28.3 million at the end of fiscal 1999 and 2000, respectively. The average number of days sales in accounts receivable outstanding was approximately 67 days for 2000, compared to 80 days for 1999 and 86 days for 1998. The Company offers 30 day credit terms to its U.S. hospital distributors. Alternate site and international customers typically receive 60 to 90 day terms and, as a result, as the Company's alternate site and international sales have increased, the amount and aging of its accounts receivable have increased. The Company anticipates that the amount and aging of its accounts receivable will continue to increase gradually over time as alternate site and international markets become a larger percentage of the Company's overall sales. The Company established a European distribution center (EDC) in the fourth quarter of 2000. While this will have the effect of increasing the Company's investment in inventories, management believes that it will also result in improved service to international customers as well as in lower international accounts receivable than would otherwise be the case because customers will receive products, and consequently pay for them, more quickly. Net cash used in investing activities was $6.4 million, $75.8 million and $26.9 million in 1998, 1999 and 2000, respectively. These funds were primarily used to finance the acquisition of the custom anesthesia circuit product line in 1998, Hudson RCI AB and the Tyco incentive breathing exerciser product line in 1999 and the Tyco SHERIDAN(R) endotracheal tube product line in 2000 and for capital expenditures. Capital expenditures, consisting primarily of new manufacturing equipment purchases, computer systems purchases and expansion of the Ensenada facility, totaled $3.1 million, $11.0 million and $11.3 million in 1998, 1999 and 2000, respectively. The increase in 1999 and 2000 relates to the acquisition and implementation of a new computer system. The Company currently estimates that capital 15 expenditures will be approximately $8.0 million in each of 2001 and 2002, consisting primarily of additional and replacement manufacturing equipment and new heater placements. Net cash provided by financing was $89.6 million in 1998, reflecting net borrowings by the Company. Net cash provided by financing activities was $71.5 million in 1999, reflecting net borrowings and equity issuances by the Company, which was used primarily to finance the Hudson RCI AB and Tyco acquisitions. Net cash provided by financing activities in 2000 of $16.2 million, reflecting net borrowings, was used primarily to finance the Tyco SHERIDAN(R) endotracheal tube product line acquisition. As of December 31, 2000, The Company had outstanding $221.9 million of indebtedness, consisting of $115.0 million of Subordinated Notes, borrowings of $82.5 million under the Company's Credit Facility, $10.3 million in notes payable to affiliates and $14.1 million in outstanding borrowings under the bank facility of Hudson RCI AB, its Swedish subsidiary. The Credit Facility currently consists of a $40.0 million Term Loan Facility (all of which was funded in connection with the Recapitalization) 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 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 sublimit of $7.5 million. As of January, 2001 the Company had fully utilized the Working Capital Portion of the Revolving Loan Facility. The Term Loan Facility matures on June 30, 2003 and, commencing June 30, 1999, 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. 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 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. 16 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 subsidiaries; provided, that such pledge is limited to 65% of the shares of any foreign subsidiary to the extent a pledge of a greater percentage would result in adverse tax consequences to the Company. The Credit Facility contains covenants restricting the ability of Holding, the Company and the Company's subsidiaries to, among others, (i) incur additional debt, (ii) declare dividends or redeem or repurchase capital stock, (iii) prepay, redeem or purchase debt, (iv) incur liens, (v) make loans and investments, (vi) make capital expenditures, (vii) engage in mergers, acquisitions and asset sales, 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), (b) a fixed charge coverage ratio, (c) a maximum leverage ratio, (d) a minimum EBITDA test and (e) an interest coverage ratio. As of December 31, 2000, the Company was not in compliance with certain of these restrictive covenants. The Company has obtained an amendment to the Credit Facility waiving all non-compliance. The Subordinated Notes bear interest at the rate of 9-1/8%, payable semiannually on each April 15 and October 15, and will require no principal repayments until maturity. The Subordinated Notes are general unsecured obligations of the Company. The Subordinated Notes contain covenants that place limitations on, among other things, (i) the ability of the Company, any subsidiary guarantors and other restricted subsidiaries to incur additional debt, (ii) the making of certain restricted payments including investments, (iii) the creation of certain liens, (iv) the issuance and sale of capital stock of restricted subsidiaries, (v) asset sales, (vi) payment restrictions affecting restricted subsidiaries, (vii) transactions with affiliates and (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 of December 31, 2000, the Company had $10.3 million outstanding pursuant to unsecured promissory notes payable to affiliates of Freeman Spogli. The notes bear interest at 12.0% per annum and 14.0% per annum, respectively and mature in August 2006. The Company, through its wholly-owned Swedish Subsidiary, Hudson RCI AB, has incurred bank debt in Sweden (the "HRCI AB Facility") that totaled $14.1 million as of December 31, 2000. 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 0.75% to 1.75% (4.884% to 5.884% at December 31, 2000), matures in December 2003, and is guaranteed by Steamer Holding AB, Hudson RCI AB's parent, and is secured by the common stock of Hudson RCI AB. In connection with the Recapitalization, the Company issued to Holding 300,000 shares of its 11-1/2% Senior Exchangeable 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. At the election of the Company, dividends may be paid in kind until April 15, 2003 and thereafter must be paid in cash. As the result of a number of factors affecting the Company in fiscal 2000, management has taken numerous actions during 2000 and 2001 including elimination of a distribution warehouse, elimination of non-essential management personnel, reduction in inventory levels, aggressive collection efforts of accounts receivable and other cost reduction measures as management deemed necessary to fund the operations of the Company, meet anticipated capital expenditures and make required payments of principal and interest on its debt, including payments due on the Subordinated Notes and obligations under the Credit Facility. Management does not believe the restructuring charges referred to above will be material to the Company. In addition, existing shareholders and key management personnel contributed approximately $11.6 million in the form of convertible subordinated debt and equity in April and May of 2001 and will contribute an additional $3.5 million in convertible subordinated debt and $3.0 million in mandatorily-redeemable preferred stock of Holding, which Holding will invest in preferred stock of the Company in August of 2001 in order to improve the Company's liquidity position. Based on these actions, as well as anticipated improved operating performance, management believes it will have sufficient sources 17 of liquidity to meet its obligations for a period of at least 18 months. Recent 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 income (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 they already comply 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, 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. 18 RISK FACTORS Substantial Leverage; Shareholders' Deficit As of December 31, 2000, the Company had $221.9 million of outstanding indebtedness and a shareholders' deficit of approximately $22.8 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. 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 19 conditions and must otherwise fall within the payer'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 payers. 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 2000, the Company's ten largest group purchasing arrangements accounted for approximately 34% of the Company's total net sales. Distributors have also consolidated in response to cost containment. For fiscal 2000, approximately 30.8% of the Company's net sales were to two distributors, Owens & Minor Inc. and McKesson, which accounted for 20.2% and 10.6%, respectively, of the Company's net sales. The loss of the Company's relationship with these distributors would have a material adverse effect on the Company's business, financial condition and results of operations. Government Regulation The Company and its customers and suppliers are subject to extensive federal and state regulation in the United States, as well as regulation by foreign governments. Most of the Company's products are subject to government regulation in the United States and other countries. In the United States, the Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and other statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, marketing, advertising and promotion of such products. Failure to comply with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution. Under the FDC Act and similar foreign laws, the Company, as a marketer, distributor and manufacturer of health care products, is required to obtain the approval of federal and foreign governmental agencies, including the Food and Drug Administration ("FDA"), prior to marketing, distributing and manufacturing certain of those products, which can be time consuming and expensive. The Company may also need to obtain FDA clearance before modifying marketed products or making new promotional claims. Delays in receipt of or failure to receive required approvals or clearances, the loss of previously received approvals or clearances, or failures to comply with existing or future regulatory requirements in the United States or in foreign countries could have a material adverse effect on the Company's business. Foreign sales are subject to similar requirements. The Company is required to comply with the FDA's "Quality System Regulations for Medical Devices," implementing "Good Manufacturing Practices" ("GMP/QSR Regulations"), which set forth requirements for, among 20 other things, the Company's manufacturing process, design control and associated record keeping, including testing and sterility. Further, the Company's plants and operations are subject to review and inspection by local, state, federal and foreign governmental entities. The distribution of the Company's products may also be subject to state regulation. The impact of FDA regulation on the Company has increased in recent years as the Company has increased its manufacturing operations. The Company's suppliers, including sterilizer facilities, are also subject to similar governmental requirements. There can be no assurance that changes to current regulations or additional regulations imposed by the FDA will not have an adverse impact on the Company's business and financial condition in the future. If the FDA believes that a company is not in compliance with applicable regulations, it can institute proceedings to detain or seize products, issue a recall, impose operating restrictions, enjoin future violations and assess civil and criminal penalties against the company, its officers or its employees and can recommend criminal prosecution to the Department of Justice. Other regulatory agencies may have similar powers. In addition, product approvals could be withdrawn due to the failure to comply with regulatory standards or the occurrence of unforeseen problems following initial marketing. The FDA also has the authority to issue special controls for devices manufactured by the Company, which it has not done to date. In the event that such special controls were issued, the Company's products would be required to conform, which could result in significant additional expenditures for the Company. The Company is subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices, fire hazard control and the handling and disposal of hazardous or infectious materials or substances and emissions of air pollutants. The Company owns and leases properties which are subject to environmental laws and regulations. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition or results of operations. In addition, the Company cannot predict the extent to which future legislative and regulatory developments concerning its practices and products for the health care industry may affect the Company. Risks Related to International Sales; Foreign Operations Sales made outside the United States represented approximately 19.7% of the Company's 2000 net sales and the Company intends to increase international sales as a percentage of total net sales. Foreign operations are subject to special risks that can materially affect the sales, profits, cash flows and financial position of the Company, including increased regulation, extended payment periods, competition from firms with more local experience, currency exchange rate fluctuations and import and export controls. The Company has sales operations in Germany, Sweden, the United Kingdom, France and other countries where sales are made in local currency. While the Company plans to hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible, and to purchase forward contracts to hedge receivables denominated in foreign currency, there can be no assurance that the Company's hedging strategies will allow the Company to successfully mitigate its foreign exchange exposures. The Company's foreign exchange exposure has historically not been significant, and was not considered to be significant in fiscal 2000. The Company also maintains a manufacturing and assembly facility in Ensenada, Mexico and an assembly facility in Kuala Lumpur, Malaysia and, as a result, is subject to operational risks such as changing labor trends and civil unrest in those countries. In the event the Company were required to transfer its foreign operations to the United States or were otherwise unable to benefit from its lower cost foreign operations, its business, financial condition and results of operations would be adversely affected. 21 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 additional debt or equity financing for future acquisitions, which may not be available on terms favorable to the Company, if at all. In addition, the Credit Facility and the Indenture contain certain restrictions regarding acquisitions. The Indenture restricts acquisitions to those companies in the same line of business as the Company, and requires that all such acquired companies be designated Restricted Subsidiaries (as defined therein). The Credit Facility restricts all acquisitions with the exception of Permitted Acquisitions (as defined therein), and limits, among other things, (i) the sum that may be paid in connection with any single acquisition to $30.0 million, (ii) the total amount outstanding of revolving credit indebtedness that can be incurred for acquisition purposes to $45.0 million, and (iii) the line of business of the acquired entity or assets. The inability of the Company to successfully finance, complete and integrate strategic acquisitions in a timely manner could have an adverse impact on the Company's ability to effect a portion of its growth strategy. 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 22 personnel. The Company has 25 patents in the U.S. Many of the U.S. patents have corresponding patents issued in Canada, Europe and various Asian countries. The Company's success will depend in part on its ability to maintain its patents, add to them where appropriate, and to develop new products and applications without infringing the patent and other proprietary rights of third parties and without breaching or otherwise losing rights in technology licenses obtained by the Company for other products. There can be no assurance that any patent owned by the Company will not be circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with claims of the scope sought by the Company, if at all. If challenged, there can be no assurance that the Company's patents (or patents under which it licenses technology) will be held valid or enforceable. In addition, there can be no assurance that the Company's products or proprietary rights do not infringe the rights of third parties. If such infringement were established, the Company could be required to pay damages, enter into royalty or licensing agreements on onerous terms and/or be enjoined from making, using or selling the infringing product. Any of the foregoing could have a material adverse effect upon the Company's business, financial condition or results of operations. S Corporation Status The Company elected to be treated as an S corporation for federal and state income tax purposes for its taxable years beginning on or after January 1, 1987. Unlike a C corporation, an S corporation is generally not subject to income tax at the corporate level; instead, the S corporation's income is taxed on the personal income tax returns of its shareholders. The Company's status as an S corporation terminated upon consummation of the Recapitalization. If S corporation status were denied for any periods prior to such termination by reason of a failure to satisfy the S corporation election or eligibility requirements of the Internal Revenue Code of 1986, as amended, the Company would be subject to tax on its income as if it were a C corporation for these periods. Such an occurrence would have a material adverse effect on the Company's results. Energy Costs and Availability Over the past year, 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. During the past several months, the cost of obtaining energy for the Company's California facilities has increased and electrical service to those facilities has been temporarily interrupted on several occasions. 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 likelihood that, with the increased demand for electricity in California during the summer months ahead, the cost of obtaining electricity for the Company's California facilities will continue to increase and interruptions in electrical service could result in decreased productivity at the Company's California facilities. The Company has implemented at its California facilities 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. Quantitative Disclosures. With the Hudson RCI AB acquisition, the Company has greater foreign currency exposure with respect to its international operations. In the past, the Company's only international exposure was its manufacturing operation in Mexico. All sales were previously denominated in U.S. dollars. Currently, the Company has operations in Germany, Sweden, Japan and other countries where sales are made in local currency. The Company plans to hedge its foreign currency exposures by attempting to purchase goods and services with the proceeds from sales in local currencies where possible. The Company may also purchase forward contracts to hedge receivables denominated in foreign currency that are expected to be collected and converted into another currency. However, there can be no assurance that the Company's hedging strategies will allow the Company to successfully mitigate its foreign exchange exposures. 23 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 $932,000. The following table presents the future principal cash flows and weighted- average interest rates expected on the Company's existing long-term debt instruments. The fair value of the Company's fixed rate debt is estimated based on quoted market prices. Expected Maturity Date (as of December 31, 2000)
Fiscal Fiscal Fiscal Fiscal Fiscal There- Fair 2001 2002 2003 2004 2005 after Total Value ------ ------ ------ ------ ------ ------ ------- ------- (Dollars in thousands) Fixed Rate Debt........... $ 2,000 $ -- $ -- $ -- $ -- $123,266 $125,266 $ 79,266 Average Interest Rate.. 14.0% -- -- -- 9.5% Variable Rate Debt........ $10,686 $11,444 $13,444 $55,944 $ 5,130 $ -- $ 96,648 $ 96,648 Average Interest Rate.. 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%
Qualitative Disclosures. The Company's primary exposure relates to (1) interest rate risk on long-term and short-term borrowings, (2) the Company's ability to pay or refinance long-term borrowings at maturity at market rates, (3) the impact of interest rate movements on the Company's ability to meet interest expense requirements and exceed financial covenants and (4) the impact of interest rate movements on the Company's ability to obtain adequate financing to fund future acquisitions. The Company manages interest rate risk on its outstanding long-term and short-term debt through the use of fixed and variable rate debt. While the Company can not predict or manage its ability to refinance existing debt or the impact interest rate movements will have on its existing debt, management evaluates the Company's financial position on an ongoing basis. Item 8. Financial Statements. See the Index included at "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K." Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None. 24 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 August 15, 2001: Name Age Position - ---------------------------- --- -------------------------------------------------- Richard W. Johansen............. 49 President, Chief Executive Officer and Director Lougene Williams................ 56 Senior Vice President Patrick G. Yount................ 41 Chief Financial Officer Jay R. Ogram.................... 46 Chief Information Officer Brian W. Morgan................. 61 Vice President, Human Resources Ola G. Magnusson................ 52 Senior Vice President Jeffery D. Brown................ 43 Vice president, Marketing and Sales Helen Hudson Lovaas............. 62 Director Jon D. Ralph.................... 37 Director Charles P. Rullman.............. 52 Director Ronald P. Spogli................ 53 Director Sten Gibeck..................... 57 Director
Richard W. Johansen is President, Chief Executive Officer and Director of the Company and assumed the same positions with Holding after consummation of the Recapitalization. Mr. Johansen became President of the Company in 1993 and assumed the additional responsibilities of Chief Executive Officer in May 1997. From 1989 to 1993, he served as Vice President, Marketing and Sales for the Company following the 1989 acquisition of Respiratory Care Inc. by Hudson RCI. He held the same position with Respiratory Care Inc. as well as prior executive positions in the area of business development with its parent company, The Kendall Company. Lougene Williams is a Senior Vice President of the Company responsible for its product development, quality assurance and manufacturing operations, having served in this capacity since 1996, and assumed the same position with Holding after consummation of the Recapitalization. Prior to 1996, he was the Company's Vice President, Manufacturing, having held a similar position with Respiratory Care Inc. From 1976 to 1987, he held manufacturing management positions of increasing responsibility at various manufacturing plants of The Kendall Company. Patrick G. Yount became 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 their San Francisco office from 1995 to 1998. Jay R. Ogram is the Company's Chief Information Officer, having been appointed to this position in March, 2001. Mr. Ogram served as the Company's Chief Financial Officer from 1996 to 2001. From 1984 until his assumption of Chief Financial Officer responsibilities, Mr. Ogram held prior positions as Accounting Manager and Vice President and Controller of the Company. Prior to joining the Company, he had held executive positions in financial management with a major health care company. Brian W. Morgan is Vice President, Human Resources, having held this position since 1989, and assumed the same position with Holding after consummation of the Recapitalization. Mr. Morgan held similar positions in human resources at Respiratory Care Inc. since 1978. 25 Jeffery D. Brown, Vice President of Marketing and Sales, assumed this position in January, 2000. From 1997 to 2000 Mr. Brown served as the Company's Director of Sales, from 1993 to 1997 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. Ola G. Magnusson is a Senior Vice President 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. Helen Hudson Lovaas is a director of the Company and became a director of Holding after consummation of the Recapitalization. Mrs. Lovaas began her career at the Company in 1961. She has been Chairman since 1987, when she inherited ownership of the Company and served as Chief Executive Officer from 1987 until May 1997. Mrs. Lovaas had served previously as the Vice President of Administration of Hudson Oxygen for 15 years. Jon D. Ralph became a director of Hudson RCI and of Holding in connection with the Recapitalization. Mr. Ralph joined Freeman Spogli in 1989 and became a Principal in January 1998. Prior to joining Freeman Spogli, Mr. Ralph spent three years at Morgan Stanley & Co. Incorporated where he served as an analyst in the Investment Banking Division. Mr. Ralph is also a director of Century Maintenance Supply, Inc. and The Pantry, Inc. Charles P. Rullman became a director of Hudson RCI and of Holding in connection with the Recapitalization. Mr. Rullman joined Freeman Spogli as a Principal in 1995. From 1992 to 1995, Mr. Rullman was a General Partner of Westar Capital, a private equity investment firm specializing in middle-market transactions. Prior to joining Westar, Mr. Rullman spent twenty years at Bankers Trust Company and its affiliate BT Securities Corporation where he was a Managing Director and Partner. Mr. Rullman is also a director of The Pantry, Inc. Ronald P. Spogli became a director of Hudson RCI and of Holding in connection with the Recapitalization. He is a founding Principal of Freeman Spogli, which was founded in 1983. Mr. Spogli is also a director of AFC Enterprises, Inc., Century Maintenance Supply, Inc. and Gaylan's Trading Co. Inc. Sten Gibeck became a director of Hudson RCI 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 Hudson RCI and of Holding are elected annually and hold office until the next annual meeting of stockholders and until their successors are duly elected and qualified. 26 Item 11. Executive Compensation. The following table sets forth the compensation earned by the Company's Chief Executive Officer and the Company's four most highly compensated executive officers who earned salary and bonus in excess of $100,000 for services rendered in all capacities to the Company and its subsidiaries for the fiscal year ended December 31, 2000 (collectively, the "Named Executive Officers"). As of December 31, 2000, the Company had one other executive officer whose salary and bonus for fiscal year ended December 31, 2000 was less than the salary and bonus of the Named Executive Officers. Summary Compensation Table
Annual Compensation --------------------------------------------- Other Annual All Other Fiscal Salary Bonus Compensation Compensation Year (1) (2) ----------------------------------------------------------------------- Richard W. Johansen....................... 2000 $ 290,438 $ -- $ -- $ 10,500 President and Chief Executive Officer 1999 294,945 143,039 177,334 9,600 1998 265,500 53,100 14,853,967 9,600 Lougene Williams.......................... 2000 $ 186,592 $ -- $ -- $ 10,500 Senior Vice President 1999 190,862 64,798 73,020 9,600 1998 182,000 25,480 6,116,222 9,000 Jay R. Ogram.............................. 2000 $ 153,674 $ -- $ -- $ 9,220 Chief Information Officer (3) 1999 148,314 43,159 -- 8,889 1998 142,000 17,040 6,116,222 8,520 Brian W. Morgan........................... 2000 $ 130,288 $ -- $ -- $ 7,817 Vice President, Human Resources 1999 132,433 38,538 52,157 7,946 1998 127,320 15,268 4,527,873 7,634 Jeffrey D. Brown.......................... 2000 $ 126,023 $ -- $ -- $ 7,561 Vice President, Marketing & Sales (4)
- ----------------------------- (1) Reflects amounts earned by the Named Executive Officers during 1997 and 1998 and paid in 1998 and 1999 under the Equity Participation Plan. During 1999, no executive officer named above received perquisites and other personal benefits, securities or property in an aggregate amount in excess of the lesser of $50,000 or 10% of the total of such officer's salary and bonus nor did any such officer receive any restricted stock award or stock appreciation right. (2) Represents payments by the Company under its defined contribution plan. (3) Prior to 2001, Jay R. Ogram was the Company's Chief Financial Officer. (4) Prior to 2000, the Named Executive Officer was not an officer of the Company. Executive Employment Agreements On April 7, 1998, the Company entered into employment agreements with each of the Named Executive Officers, except Jeffery D. Brown. 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 27 in the employment agreements), the Company will be required to pay such Named Executive Officer's base salary for a period of between 12 and 24 months. The employment agreements also provide for nondisclosure of confidential information, that the Named Executive Officer shall not engage in any prohibited activity (as such term is defined in the employment agreement) during the term of employment and that the Named Executive Officer will refrain from interfering with the Company's contractual relationships or soliciting the Company's employees for 12 months following the Named Executive Officer's termination. Compensation of Directors Directors of the Company receive no compensation as directors. Directors are reimbursed for their reasonable expenses in attending meetings. Management Bonus Plans The Company offers two management bonus plans for its executives, one for senior management and one for executive management. The plan for senior management is based on a combination of the financial goals of the Company and goals set for individual employees. The plan has minimum goals of 70% attainment for operating income and 75% attainment of the individual plan. The payout is weighted such that 70% on attainment of Company financial performance and 30% attainment of individual performance goals. The plan for executive management is based on the financial goals of the Company. The payout to an individual is based on his or her bonus level and the percentage attainment of the operating income goal for the Company. In order to participate, 70% of operating income must be achieved. Retirement Plans The Company sponsors two programs that assist its employees in planning for retirement. The Company offers a defined contribution pension plan that is funded by the Company. Employees must be at least 21 years of age and have completed two years of service to be eligible to participate in the pension plan. The Company annually contributes an amount equal to 6% of a participating employee's base earnings to a participant's account, prorated for any part of a year that a participant was ineligible for a contribution. The funding also includes a proportionate share of any increase or decrease in the fair market value of the assets in the trust fund as of the immediately preceding last day of the plan year. In addition, employees may contribute to a 401(k) plan that has no matching contributions by the Company. Employees must have six months of service to be eligible to participate in the 401(k) plan and may contribute up to 10% of their annual compensation, or 6% if the employee is a highly compensated participant. Compensation Committee Interlocks and Insider Participation The Board of Directors of the Company determines the compensation of the executive officers. During fiscal 2000, Mr. Rullman determined the compensation of the Company's Chief Executive Officer and Mr. Rullman and Mr. Johansen participated in deliberations regarding the compensation of the Company's other executive officers. Stock Subscription Plans In April 1998, Holding adopted an Employee Stock Subscription Plan and an Executive Stock Subscription Plan (collectively, the "Stock Subscription Plans") pursuant to which executives of the Company purchased 800,000 shares of common stock of Holding valued at $10.00 per share. The Stock Subscription Plans provide for a repurchase option in favor of Holding upon termination of employment at stated repurchase prices. In addition, the Stock Subscription Plans provide for restrictions on the transferability of shares prior to the fifth anniversary of the Recapitalization or Hudson RCI's initial public offering. The shares are also subject to a right of first refusal in favor of Holding as well as obligations to sell at the request of Freeman Spogli and co- sale rights if Freeman Spogli sells its shares to a third party. No additional shares of Holding common stock were sold under the Stock Subscription Plans in fiscal 2000. 28 Item 12. Security Ownership of Certain Beneficial Owners and Management. The following table sets forth certain information, as of August 15, 2001, 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 Shares of Common Percent Preferred Percent Name of Beneficial Owner Stock of Class Stock of Class - --------------------------------------------------------------- --------- -------- -------- -------- River Holding Corp.(1)....................................... 8,887,148 85.6% 397,694 100% Jon D. Ralph(1) Charles P. Rullman(1) Ronald P. Spogli(1) Helen Hudson Lovaas(2)....................................... 1,500,000 14.4% -- -- Sten Gibeck(3)............................................... -- -- -- -- Richard W. Johansen(3)....................................... -- -- -- -- Lougene Williams(3).......................................... -- -- -- -- Jay R. Ogram(3).............................................. -- -- -- -- Brian W. Morgan(3)........................................... -- -- -- -- All Named Executive Officers and directors of the Company as a group (9 individuals).......................... 10,387,148 100.0% 397,694 100.0%
- --------------------------- (1) As beneficial owner of 88.0% of the common stock of Holding, Freeman Spogli will have the power to vote and dispose of the shares held by Holding. 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 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) 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. 29 (3) The business address of these individuals is Hudson Respiratory Care Inc., 27711 Diaz Road, P.O. Box 9020, Temecula, California 92589. Item 13. Certain Relationships and Related Transactions. Shareholders' Agreement The Continuing Shareholder and Holding have entered into a Shareholders' Agreement, as amended (the "Shareholders' Agreement"). Under the Shareholders' Agreement, Holding and the Continuing Shareholder have the right to purchase their pro rata share of certain new issuances of capital stock by Hudson RCI. In addition, the Shareholders' Agreement provides that upon certain issuances of common stock of Holding to employees of the Company, and contribution of the consideration received for such issuance to Hudson RCI, an equivalent number of shares of Hudson RCI's common stock will be issued to Holding. The Shareholders' Agreement provides for restrictions on the transferability of the shares held by the Continuing Shareholder for a period of two years following the consummation of the Recapitalization, and provides for a right of first offer on the Continuing Shareholder's common stock. In addition, the agreement provides that upon sales by Holding of common stock of Hudson RCI or by Freeman Spogli of common stock of Holding, the Continuing Shareholder is obligated to sell all its shares of common stock at the request of Holding and the Continuing Shareholder has the right to participate in such sale on a pro rata basis. If Hudson RCI engages in an initial public offering with respect to its common stock, the Shareholders' Agreement provides that Holding will exchange all of the common stock of Hudson RCI it holds for newly issued common stock of Hudson RCI and the Mirror Preferred Stock (as defined below) will be exchanged, at Holding's option, into Company Preferred Stock or Company Exchange Debentures, which in turn will be exchanged for Exchange Preferred Stock. Holding will then liquidate and distribute Hudson RCI's common stock to its common holders. Hudson RCI will grant unlimited piggyback registration rights (after an initial public offering) to Freeman Spogli and the Continuing Shareholder and, commencing six (6) months after the initial public offering, three (3) demand registrations to Freeman Spogli, and one demand registration to the Continuing Shareholder. The Shareholders' Agreement provides that the parties thereto will vote their shares to elect Helen Hudson Lovaas to the Board of Directors. Note to Freeman Spogli In July 1999 in connection with the Hudson RCI AB acquisition, the Company borrowed $22.0 million pursuant to an unsecured promissory note payable to Freeman Spogli. The note bears interest at 12.0% per annum, matures in August 2006, and requires semiannual interest payments, which can be deferred to maturity date at the option of the Company. In fiscal 1999, approximately $14.5 million in principal was paid on the note. In fiscal 2000, an additional $2.0 million was borrowed, which is due on demand. As of December 31, 2000, $10.3 million remained outstanding on the note. 30 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) Documents filed as part of this Report:
Page (1) Financial Statements Financial Statements 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(5) Credit Agreement dated as of April 7, 1998 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. as arranger, advisor and syndication agent, and Bankers Trust Company ("Bankers Trust") as administrative agent and collateral agent. 10.2(5) Security Agreement dated as of April 7, 1998 between Hudson RCI and Bankers Trust. 10.3(5) Pledge Agreement dated as of April 7, 1998 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. 10.6(5) Indemnity, Subrogation and Contribution Agreement dated as of April 7, 1998 among Hudson RCI, Holding and Bankers Trust.
31 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(6) Form of Amendment No. 1 to Credit Agreement dated as of July 30, 1998 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 10.14(7) 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) Form of Amendment No. 2 to Credit Agreement dated as of March 12, 1999 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 10.16(8) Amendment No. 3 to Credit Agreement dated as of June 17, 1999 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 10.17 Amendment No. 4 to the Credit Agreement dated as of August 11, 2000 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 10.18 Consent and Waiver No. 2 to Credit Agreement dated as of September 1, 2000 among Hudson RCI, Holding, the lenders party thereto, Salomon Brothers Inc. and Bankers Trust. 12.1 Statement re Computation of Earnings to Fixed Charges Ratio. 21.1 (8) 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 Amendment No. 1 to Form S-4 filed by the Company on August 3, 1998 (File No. 333-56097). (7) Incorporated by reference to the exhibit designated by the same number in the Form 10-K filed by the Company for the fiscal year ended December 25, 1998 (File No. 333-56097). (8) Incorporated by reference to the exhibit designated by the same number in the Form 10-K filed by the Company for the fiscal year ended December 31, 1999 (File No.: 333-56097). (b) Current Reports on Form 8-K. None. 32 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS PAGE - --------------------------------- ---- Report of Independent Public Accountants...................................................................................... 2 Consolidated Balance Sheets as of December 31, 1999 and December 31, 2000..................................................... 3 Consolidated Statements of Operations and Comprehensive Loss for the years ended December 25, 1998, December 31, 1999 and December 31, 2000.................................................................................................... 4 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 25, 1998, December 31, 1999 and December 31, 2000........................................................................................................ 5 Consolidated Statements of Cash Flows for the years ended December 25, 1998, December 31, 1999 and December 31, 2000.......... 6 Notes to Consolidated Financial Statements.................................................................................... 8
F-1 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 HUDSON RESPIRATORY CARE INC. 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............................................................ 4,612 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-3 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-4 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands)
Retained Common Stock Cumulative Earnings -------------------- 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-5 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-6
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-7 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-8 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-9 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-10 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-11 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-12 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). Senior Subordinated Notes F-13 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 ========
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
F-14 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. 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
F-15 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. F-16 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. 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. F-17 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 ======== ====== =======
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 ==== ====== =======
F-18 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. 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. F-19 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% ====== ====== ======
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)
F-20 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): 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-21 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 Note payable to affiliate............... 2,000 - - 2,000 Other current liabilities............... 1,242 22,764 (20,999) 3,007 --------- ---------- ---------- --------- Total current liabilities............ 44,920 33,948 (30,148) 48,720 NOTES PAYABLE TO AFFILIATE net of current.. - 8,266 - 8,266 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-22 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-23 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONSOLIDATING STATEMENT OF OPERATIONS
For the Year Ended December 31, 2000 -------------------------------------------------------------- Non- Guarantor 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-24 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 1999 ------------------------------------ Non- Guarantor Guarantor Total -------- --------- ----- Net cash provided by operating activities........... $ 6,108 $ 989 $ 7,097 Net cash used in investing activities............... (34,928) (40,890) (75,818) Net cash provided by financing activities........... 28,197 43,332 71,529 Effect of exchange rate changes on cash............. - (398) (398) -------- -------- -------- NET INCREASE IN CASH................................ (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 ------------------------------------ Non- Guarantor 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 issue additional notes in the amount of $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-25 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Hudson Respiratory Care Inc.: We have audited in accordance with auditing standards generally accepted in the United States, the financial statements of HUDSON RESPIRATORY CARE INC. (a California 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 II-1 HUDSON RESPIRATORY CARE INC. 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 Ending December 31, 2000: Allowance for doubtful accounts receivable................................. $(973) $(3,106) $579 $(3,500) ===== ======= ==== ======= For the Year Ending December 25, 1999: Allowance for doubtful accounts receivable................................. $(794) $ (440) $261 $ (973) ===== ======= ==== ======= For the Year Ending December 26, 1998: Allowance for doubtful accounts receivable................................. $(258) $ (586) $ 50 $ (794) ===== ======= ==== =======
II-2 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: August 15, 2001 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/ Richard W. Johansen Chief Executive Officer and Director August 15, 2001 - --------------------------- (Principal Executive Officer) Richard W. Johansen /s/ Patrick G. Yount Chief Financial Officer and Secretary August 15, 2001 - --------------------------- (Principal Financial Officer) Patrick G. Yount /s/ Helen Hudson Lovaas - --------------------------- Director August 15, 2001 Helen Hudson Lovaas /s/ Ronald P. Spogli - --------------------------- Director August 15, 2001 Ronald P. Spogli /s/ Charles P. Rullman - --------------------------- Director August 15, 2001 Charles P. Rullman /s/ Jon D. Ralph - --------------------------- Director August 15, 2001 Jon D. Ralph /s/ Sten Gibeck - --------------------------- Director August 15, 2001 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 EX-10.17 3 dex1017.txt AMENDMENT NO. 4 TO CREDIT AGREEMENT Exhibit 10.17 AMENDMENT NO.4 TO CREDIT AGREEMENT This AMENDMENT NO.4 TO CREDIT AGREEMENT is made and entered into as of August 11,2000, by and among HUDSON RESPIRATORY CARE INC., a California corporation (the "Borrower"), RIVER HOLDING CORP., a Delaware corporation ("Holding") and the Required Lenders (as defined in Article I of the Credit Agreement). RECITALS A. The Borrower, Holding, the Lenders (as defined in Article I of the Credit Agreement), Salomon Brothers Inc, as Arranger, Advisor and Syndication Agent, and Bankers Trust Company, as Administrative Agent and Collateral Agent, entered into a Credit Agreement dated as of April7, 1998 (as amended and otherwise modified to the date hereof, the "Credit Agreement"). Capitalized terms used herein and not otherwise defined shall have the meanings assigned to them in the Credit Agreement. B. The Borrower requested certain changes to the Credit Agreement. C. The Required Lenders are willing to so amend the Credit Agreement on the terms and conditions set forth herein. D. The Borrower, Holding and the Required Lenders are entering this Amendment pursuant to Section 9.08(b) of the Credit Agreement. AGREEMENTS In consideration of the foregoing Recitals, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower, Holding and the Required Lenders agree as follows: 1. Definitions. (a) The definition of "Capital Expenditures" is amended in its entirety to read: "Capital Expenditures" means capital expenditures of the Borrower and its Subsidiaries determined in accordance with GAAP, excluding a cumulative amount of up to $4,000,000 of SAP Computer Capital Expenditures. (b) The table in the definition of "Pricing Adjustment" is amended in its entirety to read:
Category 1 Category 2 Category 3 Category 4 Category 5 Debt/ Adjusted Debt/Adjusted Debt/Adjusted EBITDA Ratio EBITDA Ratio EBITDA Ratio Debt/Adjusted EBITDA less than 5.5:1.0 less than 4.75:1.0 less than 4.0:1.0 and Debt/Adjusted Ratio greater than or and greater than or and greater than or greater than or equal EBITDA Ratio equal to 5.5:1.0 equal to 4.75:1.0 equal to 4.0:1.0 to 3.5:1.0 less than 3.5:1.0 ---------------- ----------------- ---------------- ---------- ----------------- Commitment 0% 0% 0% .0625% .125% Fees ABR Loans 0% .250% .500% .750% 1.000% Eurodollar 0% .250% .500% .750% 1.000% Loans
(C) The following definitions are inserted in Section 1.01 of the Credit Agreement in alphabetical order: "Holdco" means collectively HRC Holding, Inc., a Delaware corporation, and Hudson Euro Co S.a.r.l., a Luxembourg corporation. "SAP Computer Capital Expenditures" means Capital Expenditures for the installation of the Borrower's SAP computer system, including hardware costs, SAP licensing fees, implementation consulting, and internally capitalized labor, in each case incurred on or before June 30, 2000. 2. Interest on Loans. Sections 2.06(a) and (b) of the Credit Agreement are amended in their entirety to read: (a) Subject to the provisions of Section 2.07, the Loans comprising each ABR Borrowing, including each Swingline Loan, shall bear interest (computed on the basis of the actual number of days elapsed over a year of 365 or 366 days, as the case may be, when the Alternate Base Rate is determined by reference to the Prime Rate and over a year of 360 days at all other times) at a rate per annum equal to the Alternate Base Rate plus 2.00% less the applicable Pricing Adjustment. (b) Subject to the provisions of Section 2.07, the Loans comprising each Eurodollar Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of360 days) at a rate per annum equal to the Adjusted Eurodollar Rate for the Interest Period in effect for such Borrowing plus 3.00% less the applicable Pricing Adjustment. 3. Use of Proceeds. Section 3.13(e) is amended in its entirety to read as follows: (e) Notwithstanding anything in this Agreement to the contrary, but subject to Section 2.01(b), not more than $45,000,000 of the Aggregate Revolving Credit Exposure outstanding at any time may be used by the Borrower for purposes of Permitted Acquisitions pursuant to Section 6.04(c), and not more than (i) until December 31,2000, $20,000,000, 2 (ii) thereafter, (A) $15,000,000 if the Debt/Adjusted EBITDA Ratio of the Borrower measured as of the most recently completed fiscal quarter is greater than 4.25:1.00, and (B) otherwise, $20,000,000, of the Aggregate Revolving Credit Exposure outstanding at any time may be used by the Borrower for any corporate purpose other than Permitted Acquisitions pursuant to Section 6.04(c). 4. Debt/Adjusted EBITDA Ratio. Section 6.09 of the Credit Agreement is amended in its entirety to read as follows: Section 6.09. Debt/Adjusted EBITDA Ratio. The Debt/Adjusted EBITDA Ratio shall not exceed the following amounts as of the ends of fiscal quarters of the Borrower ending nearest to the following dates:
Fiscal Quarter Debt/Adjusted EBITDA Ratio Ending Nearest -------------------------------------------------------------------------------------------- to 1998 1999 2000 2001 2002 2003 2004 -------------------------------------------------------------------------------------------- March 31 6.40:1.00 5.60:1.00 4.90:1.00 3.75:1.00 3.50:1.00 3:50:1.00 June 30 6.75:1:00 6.40:1.00 6.00:1.00 4.50:1.00 3.75:1.00 3.50:1.00 September 30 6.75:1:00 6.20:1.00 5.50:1.00 4.25:1.00 3.75:1.00 3.50:1.00 December 31 6.40:1.00 6.00:1.00 5.25:1.00 4.00:1.00 3.50:1.00 3.50:1.00 --------------------------------------------------------------------------------------------
and thereafter, 3.50:1.00. 5. Interest Coverage Ratio. Sections 6.11(c) and (d) of the Credit Agreement are amended in their entirety to read as follows: (c) The ratio of (i) the EBITDA for the period of four fiscal quarters ending nearest to December 31, 1998 to (ii) the product of 1.33 times the Consolidated Interest Expense for the period of three fiscal quarters ending nearest to December 31, 1998, shall not be less than 1.60:1.00. (d) The ratio of EBITDA to Consolidated Interest Expense for the period of four fiscal quarters ending nearest to each of the following dates, shall not be less than the following ratios: 3
Fiscal Quarter Ending Consolidated Interest Coverage Ratio Nearest to --------------------------------------------------------------------------------- 1999 2000 2001 2002 2003 2004 --------------------------------------------------------------------------------- March 31 1.55:1.00 1.80:1.00 2.00:1.00 2.75:1.00 3.00:1:00 3.00:1:00 June 30 1.55:1.00 1.70:1.00 2.20:1.00 2.75:1.00 3.00:1:00 September 30 1.65:1.00 1.70:1.00 2.30:1.00 2.75:1.00 3.00:1:00 December 31 1.65:1.00 1.85:1.00 2.50:1.00 3.00:1.00 3.00:1:00 --------------------------------------------------------------------------------- and thereafter, 3.00:1.00.
6. Fixed Charge Coverage Ratio. Section 6.12 of the Credit Agreement is amended in its entirety to read as follows: SECTION 6.12. Fixed Charge Coverage Ratio. The Fixed Charge Coverage Ratio as of the end of the period of four fiscal quarters ending nearest to the following dates shall not be less than the following ratios, beginning with the fiscal quarter ending nearest to March 31, 1999:
Fiscal Quarter Ending Fixed Charge Coverage Ratio Nearest to ---------------------------------------------------------------------------------- 1999 2000 2001 2002 2003 2004 ---------------------------------------------------------------------------------- March 31 1.05:1.00 1.00:1.00 1.10:1.00 1.20:1.00 1.20:1.00 1.20:1.00 June 30 1.00:1.00 1.00:1.00 1.15:1.00 1.20:1.00 1.20:1.00 September 30 1.00:1.00 1.00:1.00 1.15:1.00 1.20:1.00 1.20:1.00 December 31 1.00:1.00 1.05:1.00 1.20:1.00 1.20:1.00 1.20:1.00 ---------------------------------------------------------------------------------- and thereafter, 1.20:1.00.
7. Binding Effect and Effectiveness. This Amendment may be executed in as many counterparts as may be convenient and shall become binding when the Borrower, Holding and the Required Lenders have each executed and delivered at least one counterpart, and shall become legally binding (and with respect to the amendments made in items 1 (b) and 2, immediately effective; with respect to the amendment to the definition of "Holdco", with retrospective effect from June 17, 1999); and with respect to each other amendment herein, with retrospective effect from June 30,2000) upon satisfaction of the following conditions precedent: (a) The Borrower shall have paid to each Lender that executes this Amendment at or before 12:00 noon, Los Angeles time, on August 11,2000, an amendment fee equal to 0.25% of such Lender's Revolving Credit Commitment and outstanding Term Loans as of the date of this Amendment. 4 (b) The Borrower shall have paid to the Administrative Agent all fees which are due and payable to the Administrative Agent under the Credit Agreement as amended. 8. Governing Law. This Amendment shall be a contract made under and governed by the laws of the State of New York, without regard to the conflicts of law provisions thereof 9. Reference to Credit Agreement. Except as amended hereby, the Credit Agreement shall remain in full force and effect and is hereby ratified and confirmed in all respects. On and after the effectiveness of the amendment to the Credit Agreement accomplished hereby, each reference in the Credit Agreement, to "this Agreement", "hereunder", "hereof', "herein" or words of like import, and each reference to the Credit Agreement shall be deemed a reference to the Credit Agreement, as amended hereby, as the case may be. 5 IN WITNESS WHEREOF, the parties hereto have cause this amendment to be duly executed by their respective officers as of the date first above written. HUDSON RESPIRATORY CARE INC., by: /s/ Jay R. Ogram --------------------------------------- Name: Jay R. Ogram Title: Chief Financial Officer RIVER HOLDING CORP. by: /s/ Jay R. Ogram --------------------------------------- Name: Jay R. Ogram Title: Chief Financial Officer Acknowledged by: BANKERS TRUST COMPANY, as Administrative agent and Collateral Agent by: /s/ Mary Jo Jolly --------------------------------------- Name: Mary Jo Jolly Title: Assistant Vice President SALOMON BROTHERS INC, as Arranger, Advisor and Syndication Agent, By: /s/ Timothy L. Freeman --------------------------------------- Name: Timothy L. Freeman Title: Managing Director 6 LENDERS ------- BANKERS TRUST COMPANY, by: /s/ Mary Jo Jolly --------------------------------------- Name: Mary Jo Jolly Title: Assistant Vice President CITICORP USA, INC., by: /s/ Timothy L. Freeman --------------------------------------- Name: Timothy L. Freeman Title: Managing Director BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, by: --------------------------------------- Name: Title: BANK OF TOKYO-MITSUBISHI TRUST COMPANY, by: /s/ Nicholas J. Campbell, Jr. --------------------------------------- Name: Nicholas J. Campbell, Jr. Title: Vice President BHF (USA) CAPITAL CORP., by: /s/ Hans. J. Scholtz --------------------------------------- Name: Hans. J. Scholtz Title: Vice President by: /s/ Thomas J. Scifo --------------------------------------- Name: Thomas J. Scifo Title: Vice President BANK AUSTRIA CREDITANSTALT CORPORATE FINANCE, INC., by: /s/ Patrick Rounds --------------------------------------- Name: Patrick Rounds Title: Senior Vice President 7 by: /s/ Geoffrey C. Headington ---------------------------------------- Name: Geoffrey C. Headington Title: Senior Associate WELLS FARGO BANK, NA., by: /s/ S. Michael St. Geme --------------------------------------- Name: S. Michael St. Geme Title: Vice President ROYAL BANK OF CANADA, by: /s/ S. Lori Ross --------------------------------------- Name: Lori Ross Title: Manager SOCIETE GENERALE, by: /s/ J. Staley Stewert --------------------------------------- Name: J. Staley Stewert Title: Director IMPERIAL BANK, by: /s/ Ray Valdama ---------------------------------------- Name: Ray Valdama Title: Senior Managing Director NATIONS BANK, N.A., as successor to NationsBank of Texas, N.A., by: --------------------------------------- Name: Title: 8 EX-10.18 4 dex1018.txt CONSENT AND WAIVER NO. 2 CREDIT AGREEMENT Exhibit 10.18 CONSENT AND WAIVER NO. 2 dated as of September 1, 2000 (this "Consent and Waiver"), to the Credit Agreement dated as of April 7, 1998 (as amended and otherwise modified to the date hereof, the "Credit Agreement"), among HUDSON RESPIRATORY CARE INC., a California corporation (the "Borrower"), RIVER HOLDING CORP., a Delaware corporation ("Holding"), the Lenders (as defined in therein), SALOMON BROTHERS INC, as Arranger, Advisor and Syndication Agent (in such capacity, the "Syndication Agent"), and BANKERS TRUST COMPANY, a New York banking corporation, as administrative agent (in such capacity, the "Administrative Agent") and as collateral agent (in such capacity, the "Collateral Agent") for the Lenders. A. Pursuant to the Credit Agreement, the Lenders have extended and agreed to extend credit to the Borrower and the Issuing Bank has agreed to issue letters of credit for the account of the Borrower, in each case pursuant to the terms and subject to the conditions set forth in the Credit Agreement. B. The Borrower has informed the Administrative Agent that it intends to acquire certain assets of Tyco Healthcare Group LP as described in Annex I. C. The Borrower has requested that the Required Lenders waive compliance by the Borrower of clause (j)(i) of the definition of the term "Permitted Acquisition" in the Credit Agreement (concerning the Pro Forma Debt/Pro Forma EBITDA ratio) and Section 2.13(c)(ii) of the Credit Agreement (concerning the mandatory prepayments of Loans with proceeds of Equity Issuances), to the extent necessary to consummate the Acquisition. D. The Required Lenders are willing to grant such consent and limited waiver pursuant to the terms and subject to the conditions set forth herein. E. Capitalized terms used and not otherwise defined herein or in Annex I shall have the meanings assigned to them in the Credit Agreement. Accordingly, in consideration of the mutual agreements herein contained and other good and valuable consideration, the sufficiency and receipt of which are hereby acknowledged, the parties hereto agree as follows: SECTION 1. Consent and Waiver. The Required Lenders hereby waive compliance by the Borrower with the provisions of clause ()(i) of the definition of the term "Permitted Acquisition" in the Credit Agreement and Section 2.13(c)(ii) of the Credit Agreement to the extent, but only to the extent necessary to consummate the Acquisition; provided, however, that (a) the Acquisition shall be consummated as provided in Annex I; (b) the Borrower shall be in compliance with all other provisions of the Credit Agreement; (c) the Borrower shall have on or before September 8, 2000, paid each Lender that executes and delivers this Consent and Waiver at or before 12:00 noon (Los Angeles time), on September 6, 2000, a fee in the amount of 0.05% of the sum of such Lender's unused Revolving Credit Commitment and outstanding Loans; and (d) the Borrower shall have, before or concurrently with the Acquisition, paid each Lender a fee in the amount of 0.075% of the sum of such Lender's unused Revolving Credit Commitment and outstanding Loans. SECTION 2. Representations and Warranties. To induce the other parties hereto to enter into this Consent and Waiver, the Borrower represents and warrants to each other party hereto that: (a) this Consent and Waiver has been duly authorized, executed and delivered by it and constitutes its legal, valid and binding obligation, enforceable in accordance with its terms; (b) before and after giving effect to this Consent and Waiver, the representations and warranties set forth in Article III of the Credit Agreement are true and correct in all material respects on and as of the date hereof with the same effect as though made on and as of the date hereof, except to the extent such representations and warranties expressly relate to an earlier date; (c) before and after giving effect to this Consent and Waiver, no Default or Event of Default has occurred and is continuing; and (d) after giving effect to the Acquisition, the Borrower and its Subsidiaries will have sufficient financial liquidity for conducting its customary business. SECTION 3. Effectiveness. This Consent and Waiver shall not become effective until such time as the Administrative Agent shall have received counterparts hereof which, when taken together, bear the signatures of the Borrower and the Required Lenders. This Consent and Waiver shall cease to be effective if the Acquisition has not been consummated on or before November 30, 2000. SECTION 4. Effect of Consent and Waiver. Except as expressly set forth herein, this Consent and Waiver shall not by implication or otherwise limit, impair, constitute a waiver of, or otherwise affect the rights and remedies of the Lenders, the Administrative Agent or the Borrower under the Credit Agreement or any other Loan Document, and shall not alter, modify, amend or in any way affect any of the terms, conditions, obligations, covenants or agreements contained in the Credit Agreement or any other Loan Document, all of which are ratified and affirmed in all respects and shall continue in full force and effect. Nothing herein shall be 2 deemed to entitle the Borrower to a consent to, or a waiver, amendment, modification or other change of, any of the terms, conditions, obligations, covenants or agreements contained in the Credit Agreement or any other Loan Document in similar or different circumstances. After the date hereof, any reference to the Credit Agreement shall mean the Credit Agreement as modified hereby. This Consent and Waiver shall constitute a "Loan Document" for all purposes of the Credit Agreement and the other Loan Documents. SECTION 5. Expenses. The Borrower agrees to pay the reasonable out-of- pocket costs and expenses incurred by the Administrative Agent and the Collateral Agent in connection with the preparation of this Consent and Waiver and the transactions contemplated hereby, including the reasonable fees, charges and disbursements of counsel for the Administrative Agent and the Collateral Agent. SECTION 6. Acknowledgment of Guarantors. Each of the Guarantors listed on Annex I hereto hereby acknowledges receipt of and notice of, and consents to the terms of, this Consent and Waiver. SECTION 7. Counterparts. This Consent and Waiver may be executed in any number of counterparts and by different parties hereto on separate counterparts, each of which when so executed and delivered shall be deemed an original, but all of which together shall constitute a single instrument. Delivery of an executed counterpart of a signature page of this Consent and Waiver by facsimile transmission shall be as effective as delivery of a manually executed counterpart hereof. SECTION 8. Applicable Law. THIS CONSENT AND WAIVER SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK. SECTION 9. Headings. The headings of this Consent and Waiver are for purposes of reference only and shall not limit or otherwise affect the meaning hereof 3 IN WITNESS WHEREOF, the parties hereto have cause this amendment to be duly executed by their respective officers as of the date first above written. HUDSON RESPIRATORY CARE INC., by: /s/ Jay R. Ogram ----------------------------- Name: Jay R. Ogram Title: Chief Financial Officer RIVER HOLDING CORP. by: /s/ Jay R. Ogram ----------------------------- Name: Jay R. Ogram Title: Chief Financial Officer Acknowledged by: BANKERS TRUST COMPANY, as Administrative agent and Collateral Agent by: /s/ Mary Jo Jolly ----------------------------- Name: Mary Jo Jolly Title: Assistant Vice President SALOMON BROTHERS INC, as Arranger, Advisor and Syndication Agent, By: /s/ Timothy L. Freeman ----------------------------- Name: Timothy L. Freeman Title: Managing Director LENDERS ------- BANKERS TRUST COMPANY, by: ----------------------------- Name: Title: CITICORP USA, INC., by: /s/ Timothy L. Freeman ------------------------------ Name: Timothy L. Freeman Title: Managing Director BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, by: /s/ Helen Wilson ------------------------------ Name: Helen Wilson Title: Senior Vice President BANK OF TOKYO-MITSUBISHI TRUST COMPANY, by: ----------------------------- Name: Title: BHF (USA) CAPITAL CORP., by: /s/ Thomas J. Scifo ----------------------------- Name: Thomas J. Scifo Title: Vice President by: /s/ Nina Zhou ----------------------------- Name: Nina Zhou Title: Associate BANK AUSTRIA CREDITANSTALT CORPORATE FINANCE, INC., by: ----------------------------- Name: Title: 5 by: ---------------------------- Name: Title: WELLS FARGO BANK, NA., by: /s/ S. Michael St. Geme ---------------------------- Name: S. Michael St. Geme Title: Vice President ROYAL BANK OF CANADA, by: ----------------------------- Name: Title: SOCIETE GENERALE, by: /s/ J. Staley Stewert ------------------------------ Name: J. Staley Stewert Title: Director IMPERIAL BANK, by: /s/ Ray Valdama ------------------------------ Name: Ray Valdama Title: Senior Managing Director 6 EX-12.1 5 dex121.txt RATIO OF EARNINGS TO FIXED CHARGES EXHIBIT 12.1 Ratio Support Ratio Of Earnings To Fixed Charges
Hudson RCI ------------------------------------------------------------------ As Restated 1996 1997 1998 1999 2000 -------- ------- -------- -------- -------- Earnings: Pre-tax income 7,154 11,443 (61,676) 358 (5,994) Fixed Charges Interest expense 2,177 1,834 11,327 17,263 21,089 Amortization of debt expense 59 62 - - - Interest factor of rent expense 365 374 497 677 1,038 -------- ------- -------- -------- -------- Total fixed charges 2,601 2,270 11,824 17,940 22,127 -------- ------- -------- -------- -------- Total earnings before fixed charges 9,755 13,713 (49,852) 18,298 16,133 -------- ------- -------- -------- -------- Ratio of earnings to fixed Charges 3.8 6.0 - 1.0 - Deficiency of earnings to cover fixed charges (61,676) (5,994)
Ratio of Earnings to Fixed Charges and Preferred Dividends
Hudson RCI ------------------------------------------------------------------ As Restated 1996 1997 1998 1999 2000 -------- ------- -------- -------- -------- Earnings: Pre-tax income 7,154 11,443 (61,676) 358 (5,994) Fixed charges Interest expense 2,177 1,834 11,327 17,263 21,089 Amortization of debt expense 59 62 - - - Interest factor of rent expense 365 374 497 677 1,038 Preferred stock dividend expense - - 4,187 6,518 7,733 Total fixed charges 2,601 2,270 16,011 24,458 29,860 -------- ------- -------- -------- -------- Total earnings before fixed charges 9,755 13,713 (49,665) 24,816 16,133 -------- ------- -------- -------- -------- Ratio of earnings to fixed charges 3.8 6.0 - 1.0 - Deficiency of earnings to cover fixed charges (61,676) - (13,727)
Computation of Interest Factor of Rental
Hudson RCI ------------------------------------------------------------------ 1996 1997 1998 1999 2000 -------- ------- -------- -------- -------- Operating rental expense 1,106 1,132 1,506 2,052 3,115 Interest factor 33% 33% 33% 33% 33% -------- ------- -------- -------- -------- Total 365 374 497 677 1,028 ======== ======= ======== ======== ========
Computation of Preferred Stock Expense
Hudson RCI ------------------------------------------------------------------ 1996 1997 1998 1999 2000 -------- ------- -------- -------- -------- Preferred stock dividend expense - - 2,512 3,911 4,640 Tax effect (1.0 - .40) 60% 60% 60% 60% 60% -------- ------- -------- -------- -------- Total - - 4,187 6,518 7,733 ======== ======= ======== ======== ========
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