10-Q 1 a201310q3q.htm 10-Q 2013 10Q 3Q



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

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
Commission file number 001-09913

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                                                                          Yes    X         No        

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
    Yes   ____         No      X     
         
As of November 13, 2013, there were 341,410,891.610 Class A-1 and 728,041.800 Class A-2 partnership units outstanding, all of which were held by affiliates.   



TABLE OF CONTENTS

CENTAUR GUERNSEY L.P. INC.






2

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes statements that express our opinions, expectations, beliefs, plans, objectives, assumptions or projections regarding future events or future results and therefore are, or may be deemed to be, “forward-looking statements.” The forward-looking statements are based on our current expectations and projections about future events. Discussions containing forward-looking statements may be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors,” and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “predicts,” “projects,” “potential,” “continue,” “expects,” “anticipates,” “aims,” “future,” “intends,” “plans,” “believes,” “estimates,” or the negative of those terms and other variations of them or by comparable terminology.
These forward-looking statements are only predictions, not historical facts, and involve certain risks and uncertainties, as well as assumptions. Actual results, levels of activity, performance, achievements and events could differ materially from those stated, anticipated or implied by such forward-looking statements. The factors that could contribute to such differences include those discussed under the caption “Risk Factors.” You should consider each of the risk factors and uncertainties under the caption “Risk Factors” in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, and in our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2013 and June 30, 2013, among other things, in evaluating our prospects and future financial performance. The occurrence of the events described in the risk factors could harm our business, results of operations and financial condition. These forward-looking statements are made as of the date of this report. Except as required under federal securities laws and the rules and regulations of the Securities and Exchange Commission, we do not have any intention to update any forward-looking statements to reflect events or circumstances arising after the date of this report, whether as a result of new information, future events or otherwise.
TRADEMARKS, SERVICE MARKS AND COPYRIGHTS
3M™ Tegaderm™ is a licensed trademark of 3M Company; GRAFTJACKET® is a licensed trademark of Wright Medical Technology Inc; Novadaq® and SPY® are licensed trademarks of Novadaq Technologies, Inc. Unless otherwise indicated, all other trademarks appearing in this report are proprietary to KCI Licensing, Inc., LifeCell Corporation, or Systagenix Wound Management (US), Inc., their affiliates and/or licensors. The absence of a trademark or service mark or logo from this report does not constitute a waiver of trademark or other intellectual property rights of KCI Licensing, Inc., LifeCell Corporation, or Systagenix Wound Management (US), Inc., their affiliates and/or licensors.
DEFINED TERMS
The following terms are used in this Quarterly Report on Form 10-Q unless otherwise noted or indicated by the context.
•
the terms the “Company,” “we,” “our,” and “us” refer to Centaur Guernsey L.P. Inc. (“Centaur”) and its consolidated subsidiaries.
•
the term “Merger” refers to the transaction completed on November 4, 2011, pursuant to which Kinetic Concepts, Inc. (“KCI”) was merged with Chiron Merger Sub, Inc., a subsidiary of Centaur.

3

PART I - FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS
CENTAUR GUERNSEY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands)
 
September 30,
2013
 
December 31,
2012
 
(unaudited)
 
 
Assets:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
362,919

 
$
383,150

Accounts receivable, net
368,900

 
355,718

Inventories, net
149,986

 
139,850

Prepaid expenses and other
59,499

 
39,511

Total current assets
941,304

 
918,229

 
 
 
 
Net property, plant and equipment
312,555

 
388,482

Debt issuance costs, net
101,766

 
96,476

Deferred income taxes
21,866

 
20,003

Goodwill
3,207,575

 
3,479,775

Identifiable intangible assets, net
2,343,525

 
2,666,201

Other non-current assets
4,054

 
5,598

 
$
6,932,645

 
$
7,574,764

 
 
 
 
Liabilities and Equity:
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
44,527

 
$
40,970

Accrued expenses and other
351,903

 
284,163

Current installments of long-term debt
24,101

 
23,383

Deferred income taxes
4,610

 
57,528

Total current liabilities
425,141

 
406,044

 
 
 
 
Long-term debt, net of current installments and discount
4,517,139

 
4,554,112

Non-current tax liabilities
46,461

 
44,465

Deferred income taxes
960,219

 
1,069,480

Other non-current liabilities
38,897

 
43,267

Total liabilities
5,987,857

 
6,117,368

Equity:
 
 
 
General partner’s capital
—

 
—

Limited partners’ capital
952,314

 
1,457,913

Accumulated other comprehensive loss, net
(7,526
)
 
(517
)
Total equity
944,788

 
1,457,396

 
$
6,932,645

 
$
7,574,764


See accompanying notes to condensed consolidated financial statements.

4

CENTAUR GUERNSEY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands)
(unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Revenue:
 
 
 
 
 
 
 
Rental
$
191,041

 
$
207,156

 
$
569,449

 
$
622,350

Sales
249,520

 
228,717

 
719,675

 
684,171

Total revenue
440,561

 
435,873

 
1,289,124

 
1,306,521

 
 
 
 
 
 
 
 
Rental expenses
85,746

 
100,810

 
273,479

 
348,387

Cost of sales
66,151

 
58,613

 
181,707

 
190,454

Gross profit
288,664

 
276,450

 
833,938

 
767,680

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
152,053

 
142,778

 
518,478

 
445,781

Research and development expenses
17,961

 
17,376

 
56,140

 
53,686

Acquired intangible asset amortization
45,116

 
49,733

 
139,123

 
172,260

Impairment of goodwill and intangible assets
443,400

 
—

 
443,400

 
—

Operating earnings (loss)
(369,866
)
 
66,563

 
(323,203
)
 
95,953

 
 
 
 
 
 
 
 
Interest income and other
217

 
174

 
1,279

 
630

Interest expense
(101,398
)
 
(117,920
)
 
(315,144
)
 
(353,107
)
Loss on extinguishment of debt
(200
)
 
—

 
(2,364
)
 
—

Foreign currency gain (loss)
(8,738
)
 
(5,258
)
 
(11,935
)
 
428

Derivative instruments gain (loss)
(6,840
)
 
(8,579
)
 
3,200

 
(28,473
)
Loss from continuing operations before income tax benefit
(486,825
)
 
(65,020
)
 
(648,167
)
 
(284,569
)
Income tax benefit
(88,519
)
 
(27,176
)
 
(144,543
)
 
(107,125
)
Loss from continuing operations
(398,306
)
 
(37,844
)
 
(503,624
)
 
(177,444
)
Gain (loss) from discontinued operations, net of tax
(255
)
 
2,032

 
(2,299
)
 
(3,680
)
Net loss
$
(398,561
)
 
$
(35,812
)
 
$
(505,923
)
 
$
(181,124
)

See accompanying notes to condensed consolidated financial statements.

5

CENTAUR GUERNSEY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Net loss
$
(398,561
)
 
$
(35,812
)
 
$
(505,923
)
 
$
(181,124
)
Unrealized investment gain, net of tax expense of $338 and $1,413 in 2013
541

 
—

 
2,257

 
—

Foreign currency translation adjustment, net of tax benefit (expense) of $(300) and $259 in 2013 and $(164) and $(438) in 2012
(5,131
)
 
1,597

 
(9,266
)
 
(1,587
)
Total comprehensive loss
$
(403,151
)
 
$
(34,215
)
 
$
(512,932
)
 
$
(182,711
)

See accompanying notes to condensed consolidated financial statements.

6

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

 
Nine months ended September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net loss
$
(505,923
)
 
$
(181,124
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Amortization of debt issuance costs and discount
26,356

 
24,417

Depreciation and other amortization
252,026

 
346,895

Loss on disposition of assets
3,189

 
—

Amortization of fair value step-up in inventory
—

 
25,021

Fixed asset and inventory impairment
30,259

 
22,116

Impairment of goodwill and intangible assets
443,400

 
—

Write-off of other intangible assets
16,885

 
—

Provision for bad debt
5,051

 
7,019

Loss on extinguishment of debt
2,164

 
—

Equity-based compensation expense
2,046

 
1,186

Deferred income tax benefit
(165,456
)
 
(132,639
)
Unrealized loss (gain) on derivative instruments
(5,729
)
 
27,770

Unrealized loss (gain) on revaluation of cross currency debt
8,174

 
(2,685
)
Change in assets and liabilities:
 
 
 
Decrease (increase) in accounts receivable, net
(23,046
)
 
10,675

Increase in inventories, net
(10,498
)
 
(7,270
)
Decrease (increase) in prepaid expenses and other
(17,137
)
 
3,281

Increase (decrease) in accounts payable
3,273

 
(9,445
)
Increase in accrued expenses and other
68,440

 
48,359

Increase in tax liabilities, net
2,021

 
2,299

Net cash provided by operating activities
135,495

 
185,875

 
 
 
 
Cash flows from investing activities:
 
 
 
Additions to property, plant and equipment
(59,868
)
 
(72,044
)
Increase (decrease) in inventory to be converted into equipment for short-term rental
(8,881
)
 
861

Dispositions of property, plant and equipment
1,052

 
1,673

Increase in identifiable intangible assets and other non-current assets
(4,273
)
 
(5,380
)
Net cash used by investing activities
(71,970
)
 
(74,890
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Capital contributions from limited partners
—

 
239

Distribution to limited partners
(1,572
)
 
(1,970
)
Repayments of long-term debt and capital lease obligations
(60,429
)
 
(17,483
)
Payment of debt issuance costs
(21,604
)
 
(578
)
Net cash used by financing activities
(83,605
)
 
(19,792
)
Effect of exchange rate changes on cash and cash equivalents
(151
)
 
308

Net increase (decrease) in cash and cash equivalents
(20,231
)
 
91,501

Cash and cash equivalents, beginning of period
383,150

 
215,426

Cash and cash equivalents, end of period
$
362,919

 
$
306,927


See accompanying notes to condensed consolidated financial statements

7

Notes to Condensed Consolidated Financial Statements

NOTE 1.     Summary of Significant Accounting Policies

(a)   Basis of Presentation and Principles of Consolidation

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP” or “the Codification”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial position and cash flows in conformity with GAAP. Operating results from interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. The condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of our results for the interim periods presented. Certain prior period amounts have been reclassified to conform to the 2013 presentation.

On August 15, 2012, KCI announced that it had entered into an asset purchase agreement with Getinge for the sale of KCI's Therapeutic Support Systems ("TSS") business (the “Agreement”). The transaction closed on November 8, 2012. The final adjusted purchase price paid by Getinge to KCI was $241.5 million. Under the terms of the Agreement, we agreed to provide transition services to Getinge after the close of the transaction. In accordance with the Codification, depreciation and amortization of the long-lived assets subject to the Agreement ceased as of August 15, 2012. Additionally, the results of the operations subject to the Agreement, excluding the allocation of general corporate overhead, are presented as discontinued operations in the condensed consolidated statements of operations for all periods presented. Discontinued operations amounts related to TSS also exclude incremental expenses related to our transition services agreement with Getinge and the service fee payable by Getinge under the transition services agreement.

The Company has two reportable operating segments which correspond to our two global businesses: KCI and LifeCell Corporation ("LifeCell"). We have two primary geographic regions for which we provide supplemental information: the Americas, which is comprised principally of the United States and includes Canada, Puerto Rico and Latin America; and EMEA/APAC, which is comprised of Europe, the Middle East, Africa and the Asia Pacific region.

The condensed consolidated financial statements appearing in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

(b)   Derivative Financial Instruments and Fair Value Measurements

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

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

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



8

(c)   Concentration of Credit Risk

We have a concentration of credit risk with financial institutions related to our derivative instruments. As of September 30, 2013, Morgan Stanley, UBS and HSBC were the counterparties on our interest rate protection agreements consisting of interest rate swap and cap agreements in notional amounts totaling $1.031 billion each. We use master netting agreements with our derivative counterparties to reduce our risk and use multiple counterparties to reduce our concentration of credit risk.

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

(d)   Recently Adopted Accounting Standards

In January 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-01 “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities." The objective of this guidance is to clarify offsetting disclosures that apply to accounting for derivatives and hedging, including bifurcated embedded derivatives, repurchase agreements, reverse repurchase agreements and securities lending transactions. This guidance is effective for fiscal years and interim periods beginning on or after January 1, 2013. The adoption of this update did not have a material impact on our results of operations, financial position or disclosures.

In January 2013, the FASB issued ASU No. 2013-02 “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." The objective of this guidance is to improve reporting of reclassifications out of accumulated other comprehensive income. The guidance does not change current requirements for reporting net income or other comprehensive income in financial statements. The guidance requires an entity to provide information about amounts reclassified out of accumulated other comprehensive income by component, and present either in the income statement or notes, significant amounts reclassified by the respective line items of net income. For public entities, this guidance is effective for reporting periods beginning after December 15, 2012. The adoption of this update did not have a material impact on our results of operations, financial position or disclosures.

(e)   Long-Lived Assets

When an event occurs that indicates the carrying value of long-lived assets might not be recoverable, we review property, plant and equipment for impairment using an undiscounted cash flow analysis. If an impairment occurs on an undiscounted basis, we compute the fair market value of the applicable assets on a discounted cash flow basis and adjust the carrying value accordingly. During the first nine months of 2013, we recorded a $30.3 million fixed asset impairment charge.

(f)   Goodwill and Other Intangible Assets

Goodwill represents the excess purchase price over the fair value of net assets acquired. Goodwill is tested for impairment by reporting unit annually, or more frequently when events or changes in circumstances indicate that the asset might be impaired. Impairment of goodwill is tested by comparing the carrying value of the reporting unit to the reporting unit’s fair value. The carrying value of each reporting unit is determined by taking the reported net assets of the consolidated entity, identifying reporting unit specific assets (including goodwill) and liabilities and allocating shared operational and administrative assets and liabilities to the appropriate reporting unit, which is the same as the segment to which they are assigned. The fair value of each reporting unit is determined using discounted cash flow models using certain performance assumptions and appropriate discount rates determined by our management. To ensure the reasonableness of the estimated fair value of our reporting units, we also consider current industry market multiples. When it is determined that the carrying value of goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, the measurement of any impairment is determined and the carrying value is reduced as appropriate.

Identifiable intangible assets include developed technology, in process research and development, customer relationships, tradenames and patents. For intangible assets that are subject to amortization, we amortize the assets over the estimated economic or contractual life of the individual asset. When an event occurs that indicates the carrying value of definite-lived intangible assets might not be recoverable, we review the assets for impairment using an undiscounted cash flow analysis. If an impairment occurs on an undiscounted basis, we compute the fair market value of the applicable assets on a discounted cash flow basis and adjust the carrying value accordingly. Indefinite-lived intangibles are tested for impairment annually, or more frequently when events or changes in circumstances indicate that the assets might be impaired. If the carrying amount of the indefinite-lived intangible assets exceeds their fair value, an impairment is recognized in an amount equal to that excess.

9


The Company performed an interim impairment test on goodwill of its LifeCell reporting unit during the third quarter of 2013. In our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, we disclosed that in the event of an approximate 6% and 4% drop in the fair value of our LifeCell reporting unit and the fair value of our LifeCell identifiable intangible assets, respectively, the fair value of the LifeCell reporting unit and identifiable intangible assets would still exceed their book values as of October 31, 2012. The Company continued to monitor the close proximity of the reporting unit's carrying value compared to its fair value and, in the third quarter, determined it was required to complete the interim impairment test, as defined under GAAP. The results of the third quarter 2013 interim impairment test indicated that the estimated fair value of the LifeCell reporting unit was less than its carrying value; consequently, during the third quarter of 2013 we recorded a $272.2 million impairment of goodwill and a $171.2 million impairment of indefinite-lived intangible assets related to our LifeCell reporting unit.

During the third quarter and first nine months of 2013, write-offs of $3.5 million and $16.9 million, respectively, of other intangible assets were recorded due primarily to the discontinuation of certain projects.

(g)   Other Significant Accounting Policies

For further information on our significant accounting policies, see Note 1 of the notes to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

NOTE 2.     Business Acquisition

On July 30, 2013, KCI announced that it had signed a definitive share purchase agreement to acquire Systagenix, an established provider of advanced wound care ("AWC") products. The transaction closed on October 28, 2013. At the closing of the transaction, KCI paid a purchase price of $485.0 million, subject to adjustment, using $350.0 million of incremental borrowings under our existing senior secured credit facility along with cash on hand to fund the purchase price. The acquisition will be accounted for as a business combination using the acquisition method. Once our preliminary purchase price allocation has been completed, the purchase price will be allocated to the Systagenix tangible and identifiable intangible assets based on their estimated fair values as of the acquisition date. Any excess of the purchase price over the identifiable intangible and net tangible assets will be allocated to goodwill, which is not deductible for tax purposes.

Systagenix has a broad portfolio of innovative advanced wound care products with a focus on moist wound healing dressings - including PROMOGRAN PRISMA®, the collagen dressing market leader, TIELLE® (foam) and ADAPTIC® (non adherent contact layers). Systagenix's manufacturing, marketing and sales teams supply and distribute over 20 million advanced wound care dressings each month to more than 70 countries. The company, formerly part of Johnson & Johnson, generates annual revenue of approximately $200.0 million and has approximately 800 employees worldwide, including an experienced team of research and development scientists dedicated to advancing skin and wound care. Combining Systagenix's expertise with KCI's innovation pipeline and scale will create additional value for customers and help speed healing and reduce complications for patients.

NOTE 3.    Sale of Therapeutic Support Systems Assets

On August 15, 2012, KCI announced that it had entered into an asset purchase agreement with Getinge for the sale of KCI's TSS business. The transaction closed on November 8, 2012. The final adjusted purchase price paid by Getinge to KCI was $241.5 million. Under the terms of the Agreement, we agreed to provide transition services to Getinge after the close of the transaction. The historical results of operations of the disposal group, excluding the allocation of general corporate overhead, are reported as discontinued operations in the condensed consolidated statements of operations. Discontinued operations amounts related to TSS also exclude incremental expenses related to our transition services agreement with Getinge and the service fee payable by Getinge under the transition services agreement.

The Company utilized the net proceeds from the sale to fund the acquisition of Systagenix and internal investments, which satisfied our reinvestment requirement. Therefore, we do not anticipate having a repayment requirement in the fourth quarter associated with the sale of our TSS business.


10

The operating results of the TSS product portfolio included in discontinued operations are as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
—

 
$
52,673

 
$
—

 
$
168,107

Earnings (loss) before income tax expense (benefit)
$
(415
)
 
$
3,304

 
$
(3,738
)
 
$
(5,984
)
Income tax expense (benefit)
$
(160
)
 
$
1,272

 
$
(1,439
)
 
$
(2,304
)
Gain (loss) from discontinued operations, net of tax
$
(255
)
 
$
2,032

 
$
(2,299
)
 
$
(3,680
)


NOTE 4.     Supplemental Balance Sheet Data

(a)   Accounts Receivable, net

Accounts receivable consist of the following (in thousands):
 
September 30,
2013
 
December 31,
2012
Gross trade accounts receivable:
 
 
 
    Billed trade accounts receivable
$
382,538

 
$
370,708

Unbilled receivables
49,350

 
45,466

     Less:  Allowance for revenue adjustments
(69,546
)
 
(71,770
)
    Gross trade accounts receivable
362,342

 
344,404

Less:  Allowance for bad debt
(7,017
)
 
(4,768
)
    Net trade accounts receivable
355,325

 
339,636

Other receivables
13,575

 
16,082

 
$
368,900

 
$
355,718


(b)   Inventories, net

Inventories consist of the following (in thousands):
 
September 30,
2013
 
December 31,
2012
Finished goods and tissue available for distribution
$
100,873

 
$
96,573

Goods and tissue in-process
9,325

 
12,421

Raw materials, supplies, parts and unprocessed tissue
66,033

 
45,993

 
176,231

 
154,987

Less: Amounts expected to be converted into equipment for short-term rental
(14,118
)
 
(5,237
)
         Reserve for excess and obsolete inventory
(12,127
)
 
(9,900
)
 
$
149,986

 
$
139,850


11


NOTE 5.     Long-Term Debt

Long-term debt consists of the following (in thousands):
 
September 30,
2013
 
December 31,
2012
 
 
 
 
Senior Dollar Term D-1 Credit Facility (1) – due 2018
$
1,601,607

 
$
1,613,700

Senior Euro Term D-1 Credit Facility (1) – due 2018
332,186

 
327,022

Senior Term D-2 Credit Facility (1) – due 2016
319,339

 
321,750

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

 
1,750,000

12.5% Senior Unsecured Notes due 2019
612,000

 
650,000

3.25% Convertible Senior Notes due 2015
101

 
701

IBM Financing
2,271

 
—

     Notional amount of debt
4,617,504

 
4,663,173

 
 
 
 
Senior Dollar Term D-1 Credit Facility Discount, net of accretion
(32,100
)
 
(33,840
)
Senior Euro Term D-1 Credit Facility Discount, net of accretion
(11,033
)
 
(13,353
)
Senior Term D-2 Credit Facility Discount, net of accretion
(4,860
)
 
(7,064
)
Second Lien Senior Secured Notes Discount, net of accretion
(25,160
)
 
(27,827
)
Senior Unsecured Notes Discount, net of accretion
(3,111
)
 
(3,594
)
     Net discount on debt
(76,264
)
 
(85,678
)
 
 
 


Total debt, net of discount
4,541,240

 
4,577,495

Less:  Current installments
(24,101
)
 
(23,383
)
 
$
4,517,139

 
$
4,554,112

_____________________________
(1) On June 14, 2013, we entered into Amendment No. 2 to our senior secured credit facility. As a result of the amendment we created new classes of Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans, having the same rights and obligations as the Dollar Term C-1 Loans, Euro Term C-1 Loans and Term C-2 Loans as set forth in the Credit Agreement and Loan Documents, except as revised by the amendment.

Senior Secured Credit Facility

Our senior secured credit facility (the “Senior Secured Credit Facility”) includes a $200 million revolving credit facility (the “Revolving Credit Facility”). Amounts available under the Revolving Credit Facility are available for borrowing and reborrowing until maturity. At September 30, 2013 and December 31, 2012, no revolving credit loans were outstanding and we had outstanding letters of credit issued by banks which are party to the Senior Secured Credit Facility of $10.7 million and $11.5 million, respectively. In addition, we had $3.5 million and $4.6 million of letters of credit issued by a bank not party to the Senior Secured Credit Facility as of September 30, 2013 and December 31, 2012, respectively. The capacity of the Revolving Credit Facility is reduced for the $10.7 million and $11.5 million of letters of credit issued by banks which are party to the Senior Secured Credit Facility as of September 30, 2013 and December 31, 2012, respectively. The resulting availability under the Revolving Credit Facility was $189.3 million and $188.5 million at September 30, 2013 and December 31, 2012, respectively. Commitment fees accrue at a rate of 0.375% on the amounts available under the Revolving Credit Facility.

On June 14, 2013, we entered into Amendment No. 2 to our Senior Secured Credit Facility ("Amendment No. 2"). As a result of the amendment we created new classes of Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans, having the same rights and obligations as the Dollar Term C-1 Loans, Euro Term C-1 Loans and Term C-2 Loans as set forth in the Credit Agreement and Loan Documents, except as revised by the amendment. In connection with Amendment No. 2, Dollar Term C-1 Loans, Euro Term C-1 Loans and Term C-2 Loans were refinanced with Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans, respectively.

In connection with our acquisition of Systagenix, we borrowed $350.0 million of incremental term D-1 loans (the "Incremental Loans") incurred pursuant to Amendment No. 3 to our Senior Secured Credit Facility, dated as of October 28, 2013. The Incremental Loans were issued at a discount of $0.4 million. The interest rate and all other terms are identical to our previously-existing Dollar Term D-1 Loans.

12

Interest. Amounts outstanding under the Dollar Term D-1 Loans, the Term D-2 Loans and the Revolving Credit Facility (other than swing-line loans and unreimbursed drawings on letters of credit) bear interest, at our option, at a rate equal to either the base rate or the eurocurrency rate, in each case plus an applicable margin. Amounts outstanding under the Euro Term D-1 Loans bear interest at the eurocurrency rate, and swing-line loans and unreimbursed drawings on letters of credit bear interest at the base rate. As a result of Amendment No. 2, the new applicable margins are (i) for eurocurrency rate loans that are Dollar Term D-1 Loans, 3.50%, (ii) for base rate loans that are Dollar Term D-1 Loans, 2.50%, (iii) for eurocurrency rate loans that are Euro Term D-1 Loans, 3.75%, (iv) for base rate loans that are Euro Term D-1 Loans, 2.75%, (v) for eurocurrency rate loans that are Term D-2 Loans, 3.00%, and (vi) for base rate loans that are Term D-2 Loans, 2.00%. The Term D loans will have a eurocurrency rate floor of 1.00% and a base rate floor of 2.00%.

10.5% Second Lien Senior Secured Notes and 12.5% Senior Unsecured Notes

As required upon the closing of our 10.5% Second Lien Senior Secured Notes due 2018 (“10.5% Second Lien Notes”) and the 12.5% Senior Unsecured Notes due 2019 (“12.5% Unsecured Notes”), we have entered into registration rights agreements with respect to these notes. Pursuant to the terms of the registration rights agreements, we filed a registration statement (the “Registration Statement”) with respect to a registered exchange offer to exchange such notes for new notes with terms substantially identical in all material respects with the notes (except for the provisions relating to the transfer restrictions and payment of additional interest). On February 13, 2013, our Registration Statement was declared effective by the Securities and Exchange Commission (“SEC”), and our exchange offer was completed on March 15, 2013.

Because our Registration Statement was not declared effective by the SEC under the Securities Act and the exchange offer was not consummated within 365 days following the issuance of the notes (“Exchange Date”), and because we did not file a shelf registration statement covering resales of the notes within 30 days after the Exchange Date (each a “Notes Registration Default”), additional interest accrued on the aggregate principal amount of the notes from and including the date on which any such Notes Registration Default occurred to but excluding the date on which the Notes Registration Defaults were cured through the completion of the exchange offer. Under the terms of the registration rights agreements entered into with respect to these notes, additional interest was accrued at a rate of 0.25% and 0.50% from November 4, 2012 to February 4, 2013 and February 5, 2013 to March 15, 2013, respectively.

During the nine months ended September 30, 2013, we repurchased $38.0 million in principal of our 12.5% Unsecured Notes.

Covenants

As of September 30, 2013, we were in compliance with all covenants under our Senior Secured Credit Facility, 10.5% Second Lien Notes, 12.5% Unsecured Notes, and 3.25% Convertible Senior Notes due 2015 (“the Convertible Notes”).

For further information on our long-term debt, see Note 6 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.


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NOTE 6.     Derivative Financial Instruments and Fair Value Measurements

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

Interest Rate Protection

At September 30, 2013 and December 31, 2012, we had three interest rate swap agreements to convert a portion of our outstanding variable rate debt to a fixed rate basis. These agreements become effective in December 2013, have not been designated as hedging instruments, and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period. The interest rate swap agreements have quarterly interest payments, receive rates based on the higher of three-month USD LIBOR or 1.25% and pay rates based on fixed rates, due on the last day of March, June, September and December. Once effective, the aggregate notional amount decreases quarterly by amounts ranging from $1.7 million to $56.4 million until maturity.

The following table summarizes our interest rate swap agreements (dollars in thousands):
Effective Dates
 
Original Notional Amount
 
Fixed Interest Rate
12/31/13-12/31/16
 
$512,633
 
2.256%
12/31/13-12/31/16
 
$512,633
 
2.249%
12/31/13-12/31/16
 
$512,633
 
2.250%

As of September 30, 2013 and December 31, 2012, we had interest rate cap agreements with initial notional amounts of $1.6 billion at a cost of $2.2 million that effectively limited the eurocurrency interest rate to 2% on a portion of the borrowings under our Senior Secured Credit Facility. The interest rate cap agreements expire on December 31, 2013.

Foreign Currency Exchange Rate Mitigation

At September 30, 2013 and December 31, 2012, we had foreign currency exchange contracts to sell or purchase $34.8 million and $59.1 million, respectively, of various currencies.

Fair Value Measurements

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

The carrying amount reported in the balance sheets for cash and cash equivalents, accounts receivable, accounts payable and long-term obligations, excluding our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt, including the 10.5% Second Lien Secured Notes, the 12.5% Unsecured Notes and the Convertible Notes approximates fair value. The fair value of our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt was $2.3 billion and $2.6 billion, respectively, at September 30, 2013. The fair value of our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt was $2.3 billion and $2.4 billion, respectively, at December 31, 2012. The fair value of our long-term debt was estimated based upon open-market trades at or near year end.

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

14


The following table sets forth the location and aggregate fair value amounts of all derivative instruments with credit-related contingent features (in thousands):
 
Asset Derivatives
 
Liability Derivatives
 
Balance
Sheet
Location
 
Fair Value
 
Balance
Sheet
Location
 
Fair Value
 
 
September 30,
2013
 
December 31,
2012
 
 
September 30,
2013
 
December 31,
2012
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
Prepaid expenses and other
 
$
—

 
$
—

 
Accrued expenses and other
 
$
330

 
$
—

Interest rate swap agreements
Other non-current assets
 
—

 
—

 
Other non-current liabilities
 
30,482

 
34,868

Interest rate cap agreements
Prepaid expenses and other
 
—

 
9

 
Accrued expenses and other
 
—

 
—

Foreign currency exchange contracts
Prepaid expenses and other
 
230

 
520

 
Accrued expenses and other
 
1,008

 
2,980

      Total derivatives
 
 
$
230

 
$
529

 
 
 
$
31,820

 
$
37,848


The following table summarizes the amount of gain (loss) on derivatives not designated as hedging instruments (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Interest rate swap agreements
$
(5,195
)
 
$
(6,313
)
 
$
4,057

 
$
(24,610
)
Interest rate cap agreements
(4
)
 
(118
)
 
(9
)
 
(1,563
)
Foreign currency exchange contracts
(1,641
)
 
(2,148
)
 
(848
)
 
(2,300
)
 
$
(6,840
)
 
$
(8,579
)
 
$
3,200

 
$
(28,473
)

Certain of our derivative instruments contain provisions that require compliance with the restrictive covenants of our Senior Secured Credit Facility. For further information regarding the restrictive covenants of credit facilities, see Note 6 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

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

No collateral has been posted by us in the normal course of business. If the credit-related contingent features underlying these agreements were triggered on September 30, 2013, we could be required to settle or post the full amount as collateral to the respective agreement counterparties.

We did not have any measurements of financial assets or financial liabilities at fair value on a nonrecurring basis at September 30, 2013 or December 31, 2012.



15

NOTE 7.     Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss are as follows (in thousands):
 
Accumulated
Foreign
Currency
Translation
Adjustment
 
Investment Gain
 
Accumulated
Other
Comprehensive
Income (Loss)
Balances at December 31, 2012
$
(517
)
 
$
—

 
$
(517
)
Unrealized investment gain, net of tax expense of $1,413
—

 
2,257

 
2,257

Foreign currency translation adjustment, net of tax benefit of $259
(9,266
)
 
—

 
(9,266
)
Balances at September 30, 2013
$
(9,783
)
 
$
2,257

 
$
(7,526
)

During the nine months ended September 30, 2013, there were no reclassification adjustments out of accumulated other comprehensive loss to net loss.

NOTE 8.     Commitments and Contingencies

LEGAL PROCEEDINGS

Intellectual Property Litigation

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

Smith & Nephew Litigation

In 1993, KCI exclusively licensed several patent applications from Wake Forest University relating to negative pressure wound therapy (“NPWT”) that ultimately issued in several countries. In the following years, KCI developed and began marketing V.A.C.® Therapy, the first commercially available NPWT system. In 2003, BlueSky Medical launched the first competitive NPWT system. Unlike KCI, BlueSky commercialized a gauze-based system that utilized pumps manufactured by Medela AG (“Medela”). Shortly thereafter, KCI and Wake Forest sued BlueSky and Medela for infringement of the patents KCI licensed from Wake Forest. Following a jury trial in the Federal District Court for the Western District of Texas (“Western District”) in 2006, a judgment was entered holding that BlueSky's gauze-based NPWT system did not infringe these patents. That judgment was appealed to the United States Court of Appeals for the Federal Circuit (“Federal Circuit”), which affirmed the judgment of the trial court. In April 2007, Smith & Nephew PLLC acquired BlueSky and began commercializing NPWT products. Shortly thereafter, in May 2007, KCI and Wake Forest filed a patent infringement lawsuit against Smith & Nephew asserting patent infringement. In January 2009, Smith & Nephew launched a foam-based NPWT system at which point KCI and Wake Forest amended their claims against Smith & Nephew to assert additional patent claims. This case was tried by a jury in February 2010. Following the trial, the jury found that the patent claims asserted were not invalid and also found that Smith & Nephew was infringing the asserted patent claims. However, in October 2010, the Western District granted a motion for judgment as a matter of law filed by Smith & Nephew and entered an order invalidating the Wake Forest patent claims asserted in the case. This decision followed the revocations of the UK and German equivalents of the Wake Forest patents and was later followed by the revocation of the Australian equivalent. The litigation resulting in these revocations is detailed below. Wake Forest appealed this decision to the Federal Circuit.


16

On August 13, 2012, the Court of Appeals for the Federal Circuit reversed the judgment of the District Court in the Smith & Nephew litigation, and remanded the case for resolution of several outstanding motions. The Court of Appeals ruled that the trial court was bound by the jury's advisory verdict on the legal question of obviousness because there was sufficient evidence to support the factual questions that were posed to them. It did not construe any prior art or rule that the patent claims are valid as a matter of law; rather, it held that Smith & Nephew failed to carry its burden of persuasion. Smith & Nephew subsequently filed a motion for rehearing en banc at the Federal Circuit Court of Appeals, arguing that the trial court cannot be bound by the advisory verdict of the jury on obviousness, because obviousness is a question of law. At least four amicus briefs were filed, including one from the Federal Circuit Bar Association, in support of Smith & Nephew's position. On November 1, 2012, Smith & Nephew announced it had reached a global settlement with Wake Forest to resolve all patent disputes between them related to NPWT. Following the settlement, the Federal Circuit appeal was dismissed.

Wake Forest Litigation

Since at least 2009, a host of companies began offering NPWT systems, both gauze-based and foam-based, across the globe. None of these companies licensed the Wake Forest patents prior to commercializing their products. To the contrary, several succeeded in having the patents declared invalid. These proceedings are also detailed herein.

In light of the multiple rulings declaring the patents invalid, KCI reassessed the validity of the patents and determined that continued payment of the royalties scheduled under the 1993 license agreement with Wake Forest was inappropriate. KCI withdrew from the Smith & Nephew litigation and on February 28, 2011, filed suit in the Western District of Texas seeking a declaratory judgment that, among other things, KCI no longer owes royalties to Wake Forest because the relevant patent claims are invalid or not infringed. Historical royalties under the license agreement, although disputed, were accrued through February 27, 2011 and are reflected in our consolidated financial statements. For the year ended December 31, 2010, royalty payments accrued or paid to Wake Forest under the license agreement totaled approximately $86 million. No royalty payments have been made to Wake Forest since July, 2010.

On March 18, 2011, Wake Forest provided KCI with written notice of termination of the license agreement and filed suit in Forsyth County Superior Court, North Carolina, alleging breach of contract by KCI. In its termination notice, Wake Forest demanded that KCI cease manufacturing and selling licensed products. KCI subsequently removed that action from state court to the Federal District Court for the Middle District of North Carolina, after which Wake Forest amended its complaint to add allegations of patent infringement. KCI moved to have the North Carolina case transferred to the Western District of Texas, and on August 26, 2011, the case was transferred to the Western District, where it was consolidated with KCI's existing suit. The Western District case was stayed pending a decision by the Court of Appeals for the Federal Circuit in the Smith & Nephew litigation described above.
    
On November 1, 2012, Smith & Nephew announced it had reached a global settlement with Wake Forest to resolve all patent disputes between them related to NPWT. Following the settlement, the Federal Circuit appeal was dismissed, and the stay in the case between KCI and Wake Forest was lifted. The case has been set for trial in April 2014. In January and February of 2013, Wake Forest and KCI filed their respective answers and counterclaims against each other. KCI is alleging breach of contract against Wake Forest for its refusal to negotiate in good faith to reduce the royalty rate under the license agreement following the several patent invalidity rulings and subsequent loss of market share by KCI. Because of the multiple rulings declaring the patents invalid and the August 13, 2012 decision in the Smith & Nephew litigation does not construe any prior art or rule that the patent claims are valid as a matter of law, KCI's assessment that the Wake Forest patents are invalid or not infringed by KCI's products has not changed. We continue to vigorously defend our positions in the case and KCI will continue to manufacture and sell V.A.C.® Therapy products. It is not possible to predict the outcome of this litigation nor is it possible to estimate any damages that may be awarded if we are unsuccessful in the litigation. We believe that any damages awarded as a reasonable royalty in this case would be substantially less than our previous royalty obligation to Wake Forest because the prior license agreement provided KCI with worldwide exclusive rights, whereas any infringement damages in the case would be based on US non-exclusive rights. We also believe our counter-claims against Wake Forest could further reduce our potential exposure to a damages award in the event we are unsuccessful on the liability issues of the case.

Because KCI believes the Wake Forest patents are invalid, KCI has not continued to enforce the Wake Forest Patents against alleged infringers. Instead, KCI has withdrawn from each of the cases described below that involve the Wake Forest patents.


17

Other US Intellectual Property Litigation

In May 2007, contemporaneous with the filing of the lawsuit against Smith & Nephew which is detailed above, KCI and Wake Forest filed a case against Medela, for the manufacture, use and sale of NPWT products alleging infringement of the Wake Forest patents. Medela responded by alleging, among other things, that the Wake Forest patents are invalid. Following the October 2010 judgment invalidating the claims in the Wake Forest patents, the case against Medela was stayed. Because KCI believes the Wake Forest patents are invalid, KCI filed an unopposed motion to withdraw from the case, which was granted by the court in February 2013. On May 14, 2013, Wake Forest and Medela filed a stipulation of dismissal with prejudice following settlement of the disputes between them.

In January 2008, KCI and Wake Forest filed a patent infringement lawsuit against Innovative Therapies, Inc. (“ITI”) in the U.S. District Court for the Middle District of North Carolina. The federal complaint alleged that a NPWT device introduced by ITI in 2007 infringed three Wake Forest patents. ITI responded by alleging, among other things, that the Wake Forest patents are invalid. Because KCI believes the Wake Forest patents are invalid, KCI filed a motion to dismiss its claims against ITI which the Court granted on August 30, 2013.

In December 2008, KCI, its affiliates and Wake Forest filed a patent infringement lawsuit against Boehringer Wound Systems, LLC, Boehringer Technologies, LP, and Convatec, Inc. in the U.S. District Court for the Middle District of North Carolina. The federal complaint alleged that a NPWT device manufactured by Boehringer and commercialized by Convatec infringed Wake Forest patents. In February 2009, the defendants filed their answer which includes affirmative defenses and counterclaims alleging non-infringement and invalidity of the Wake Forest patents. On June 3, 2013, the parties filed a stipulation of Dismissal with Prejudice.

In August 2013, Vital Needs International, L.P. ("Vital Needs") filed a Demand for Arbitration with the American Arbitration Association seeking to recover $100 million in damages against Kinetic Concepts, Inc. and KCI Licensing, Inc. based on a number of claims related to certain intellectual property rights sold by Vital Needs to KCI pursuant to an Acquisition Agreement dated June 2, 2006. Vital Needs alleges, among other things, breach of the Acquisition Agreement for failure to pay royalties on sales of KCI products. We do not believe any royalties are owed to Vital Needs for sales of KCI products, and we believe our defenses to Vital Needs' claims are meritorious. We intend to vigorously defend the arbitration, which is in its initial phase.

International Intellectual Property Litigation

In June 2007, Medela filed a patent nullity suit in the German Federal Patent Court against Wake Forest's German patent corresponding to European Patent No. EP0620720 (“the '720 Patent”). In March 2008 and February 2009, Mölnlycke Health Care AB and Smith & Nephew, respectively, joined the nullity suit against the '720 Patent. In March 2009, the German Federal Patent Court ruled that the claims of the '720 Patent were invalid and revoked the German patent corresponding to the '720 Patent. A hearing on Wake Forest's appeal, previously set for April 26, 2012 was postponed and reset for February 13, 2013. The nullity complaints were withdrawn the morning of the scheduled hearing pursuant to a settlement between Wake Forest and the nullity plaintiffs, and the hearing did not take place. Although the patent's statutory term expired in November 2012, the withdrawal of the nullity complaints resulted in a reinstatement of the '720 Patent in Germany. As a result, on July 10, 2013, KCI filed a separate suit to nullify the German part of the '720 Patent.

In March 2009, KCI and its affiliates and Wake Forest filed a patent infringement lawsuit asserting the Australian counterpart to the Wake Forest Patents against Smith & Nephew in the Federal Court of Australia, requesting preliminary injunctive relief to prohibit the commercialization of a Smith & Nephew negative pressure wound therapy dressing kit. A full trial on validity and infringement of the Wake Forest patent involved in the case was held in 2010. In September 2011, the Federal Court ruled the asserted claims to be invalid and not infringed by Smith & Nephew's product. Wake Forest appealed the decision and oral arguments were heard before the appellate court in May 2012. Following the settlement between Wake Forest and Smith & Nephew described above, the Federal Court dismissed the appeal on November 30, 2012 without addressing Wake Forest's appeal, and remitted the case to the lower court for costs and damages relating to the initial action filed in 2009. The dismissal renders the ruling of non-infringement and invalidity of the asserted claims final. The patent's statutory term expired in November 2012.


18

LifeCell Litigation

AlloDerm Cases

LifeCell Corporation is a party to approximately 330 lawsuits filed by individuals alleging personal injury and seeking monetary damages for failed hernia repair procedures using LifeCell Corporation's AlloDerm products. These cases have been consolidated for case management purposes in Middlesex County, New Jersey. The cases are in the early stages of litigation, and none have been set for trial. Although it is not possible to reliably predict the outcome of the litigation, we believe that our defenses to these claims are meritorious and we will defend against these suits vigorously. We have insurance that covers these claims and lawsuits. Recently, we resolved a dispute with our primary products liability carrier and these consolidated cases are being treated as a single occurrence and therefore do not require the exhaustion of a separate self-insured retention to trigger coverage. Based on our existing insurance coverage and our defenses to these cases, we do not expect them to have a material impact on our results of operations or our financial position. As these cases are in their early stages with much discovery still to be conducted, the plaintiffs have yet to set forth their alleged damages. As such, it is impossible for the Company to predict or estimate potential losses if our defenses to these cases are unsuccessful.

Repliform Cases

LifeCell Corporation has recently been named in approximately 80 lawsuits in Middlesex County, Massachusetts, but has been served with only 40 of the suits. In addition, LifeCell has been sued in State court in Delaware and Minnesota, as well as federal district court in Minneapolis and the Northern District of Texas. The cases were filed by individuals alleging personal injury and seeking monetary damages for failed gynecological procedures using products sold by Boston Scientific. The LifeCell cases in Middlesex County, Massachusetts were filed in the M Session of the Superior Court, which consists of a number of cases involving Boston Scientific synthetic mesh products. We do not believe LifeCell is a proper party to these lawsuits and are therefore seeking to dismiss these suits. In the event the suits are not dismissed we intend to defend these suits vigorously. We likewise intend to defend the non-Massachusettes cases vigorously. We have insurance that covers these claims and lawsuits.

LifeNet Health Case

On September 6, 2013, LifeNet Health ("LifeNet") filed suit against LifeCell Corporation in the United States District Court for the Eastern District of Virginia, Norfolk Division. LifeNet alleges that two LifeCell products, Strattice™ Reconstructive Tissue Matrix and AlloDerm®RTM Ready to Use, infringe LifeNet’s U.S. Patent No. 6,569,200 ("the ‘200 Patent"). LifeNet alleges that LifeCell has been aware of the ‘200 Patent and its infringement since 2009 and acted willfully in continuing to infringe the ‘200 Patent thereafter. LifeNet seeks monetary damages including treble damages for willful infringement, together with costs and prejudgment and post judgment interest as well as a finding that the case is exceptional and an award of costs and reasonable attorneys fees. LifeCell was served with the complaint on October 15, 2013 and intends to vigorously defend this case.
Other Litigation
    
In February 2009, KCI received a subpoena from the U.S. Department of Health and Human Services Office of Inspector General (“OIG”) seeking records regarding our billing practices under the local coverage policies of the four regional Durable Medical Equipment Medicare Administrative Contractors (“DME MACs”). KCI cooperated with the OIG's inquiry and provided substantial documentation to the OIG and the U.S. Attorneys' office in response to its request. The government's inquiry stemmed from the filing under seal of two qui tam actions against KCI on March 20, 2008 and September 29, 2008 by two former employees in the U.S. District Court, Central District of California, Western Division.  These cases are captioned United States of America, ex rel. Steven J. Hartpence v. Kinetic Concepts, Inc. et al ("Hartpence Matter") and United States of America, ex rel. Geraldine Godecke v. Kinetic Concepts, Inc., et al ("Godecke Matter"). The complaints contend that KCI violated the Federal False Claims Act by billing in a manner that was not consistent with the Local Coverage Determinations issued by the DME MACs and seek recovery of monetary damages. Following the completion of the government's review and its decision declining to intervene in such suits, the live pleadings were ordered unsealed on May 3, 2011.  After reviewing the allegations, KCI filed motions seeking the dismissal of the suits on multiple grounds.  On January 30, 2012, the Court granted KCI's motions dismissing all of the claims in the Hartpence Matter and dismissing all of the claims in the Godecke Matter with the exception of a retaliation claim, which has been stayed pending the appeal of the dismissed claims.  On February 27, 2012 and June 15, 2012, respectively, Hartpence and Godecke each filed a Notice of Appeal to the U.S. Court of Appeals for the Ninth Circuit seeking to reverse the dismissal of their claims by the trial court.  On December 11, 2012, KCI moved the Ninth Circuit to disqualify counsel in the Hartpence and Godecke matters from representing relators on appeal due to their possession and use of KCI's privileged documents.  The Ninth Circuit granted the parties agreed motion to stay the briefing of the merits of the appeals pending resolution of the disqualification motion and on February 25, 2013, remanded KCI's disqualification motion to the U.S. District Court for disposition. On May 20, 2013, the District Court granted KCI's disqualification motions and counsel for both Godecke and Hartpence were disqualified.

19

On July 19, 2013 the Ninth Circuit Court of Appeals issued an Order requiring counsel for Godecke and Hartpence to withdraw from the appeals or show cause why they should not be disqualified. Godecke and Hartpence have retained new counsel to represent them on appeal. The Ninth Circuit has not issued a briefing schedule.

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

OTHER COMMITMENTS AND CONTINGENCIES

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

We also are subject to routine pre-payment and post-payment audits of medical claims submitted to Medicare. These audits typically involve a review, by Medicare or its designated contractors and representatives, of documentation supporting the medical necessity of the therapy provided by us. While Medicare requires us to obtain a comprehensive physician order prior to providing products and services, we are not required to, and do not as a matter of practice require, or subsequently obtain, the underlying medical records supporting the information included in such claim. Following a Medicare request for supporting documentation, we are obligated to procure and submit the underlying medical records retained by various medical facilities and physicians. Obtaining these medical records in connection with a claims audit may be difficult or impossible and, in any event, all of these records are subject to further examination and dispute by an auditing authority. Under standard Medicare procedures, we are entitled to demonstrate the sufficiency of documentation and the establishment of medical necessity, and we have the right to appeal any adverse determinations. If a determination is made that our records or the patients' medical records are insufficient to meet medical necessity or Medicare reimbursement requirements for the claims subject to a pre-payment or post-payment audit, we could be subject to denial, recoupment or refund demands for claims submitted for Medicare reimbursement. In the event that an audit results in discrepancies in the records provided, Medicare may be entitled to extrapolate the results of the audit to make recoupment demands based on a wider population of claims than those examined in the audit.
 


20

NOTE 9.     Segment Information

The Company is engaged in the rental and sale of advanced wound care systems and regenerative medicine products and has operations in more than 25 countries. We have two reportable operating segments which correspond to our two global businesses: KCI and LifeCell. Our two global operating segments also represent our reporting units as defined by the Codification. In most countries where we operate, certain aspects of our two businesses are supported by the same administrative staff, systems and infrastructure and, as such, we have allocated these costs between the businesses based on allocation methods including headcount, revenue and other methods as deemed appropriate. We measure segment profit (loss) as operating earnings (loss), which is defined as income (loss) before interest and other income, interest expense, foreign currency gains and losses, derivative instruments gains and losses and income taxes. All intercompany transactions are eliminated in computing revenue and operating earnings (loss).

On November 8, 2012, Getinge purchased certain assets and assumed certain liabilities comprising KCI's TSS product business. The historical results of operations of the TSS business, excluding the allocation of general corporate overhead, are reported as discontinued operations in the condensed consolidated statements of operations. Discontinued operations amounts related to TSS also exclude incremental expenses related to our transition services agreement with Getinge and the service fee payable by Getinge under the transition services agreement.

Information on segments and a reconciliation of consolidated totals are as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Revenue:
 
 
 
 
 
 
 
KCI
$
320,879

 
$
329,651

 
$
944,526

 
$
986,157

LifeCell
119,682

 
106,222

 
344,598

 
320,364

Total revenue
$
440,561

 
$
435,873

 
$
1,289,124

 
$
1,306,521

 
 
 
 
 
 
 
 
Operating earnings (loss):
 
 
 
 
 
 
 
KCI
$
126,837

 
$
114,833

 
$
327,018

 
$
277,191

LifeCell
30,093

 
28,864

 
91,159

 
75,503

Non-allocated costs:
 
 
 
 
 
 
 
General headquarter expense (1)
(6,335
)
 
(5,520
)
 
(59,447
)
 
(19,545
)
Equity-based compensation
(850
)
 
(197
)
 
(2,046
)
 
(1,186
)
Merger and restructuring-related expenses (2)
(31,112
)
 
(21,684
)
 
(97,518
)
 
(63,750
)
Acquired intangible asset amortization (3)
(45,099
)
 
(49,733
)
 
(138,969
)
 
(172,260
)
Impairment of goodwill and intangible assets (4)
(443,400
)
 
—

 
(443,400
)
 
—

Total non-allocated costs
(526,796
)
 
(77,134
)
 
(741,380
)
 
(256,741
)
Total operating earnings (loss)
$
(369,866
)
 
$
66,563

 
$
(323,203
)
 
$
95,953

_____________________________
(1)
The third quarter and nine months ended September 30, 2013 includes write-offs of $3.5 million and $16.9 million, respectively, of other intangible assets due primarily to the discontinuation of certain projects. The nine months ended September 30, 2013 also includes a $30.3 million fixed asset impairment charge. The third quarter and nine months ended September 30, 2012 includes $9.7 million and $22.1 million, respectively, of impairment charges associated with certain production equipment at our AHS manufacturing plant and inventory associated with our V.A.C. Via product.
(2)
Represents expenses related to the Merger including buyer and seller transaction costs, management fees and restructuring-related expenses.
(3)
Includes amortization of acquired intangible assets related to our Merger in November 2011.
(4)
During the third quarter of 2013, we recorded a $272.2 million impairment of goodwill and a $171.2 million impairment of indefinite-lived intangible assets related to our LifeCell reporting unit.



21

NOTE 10.     Guarantor Condensed Consolidating Financial Statements

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

(4)
upon the achievement of investment grade status by the10.5% Second Lien Notes or 12.5% Unsecured Notes; provided that such guarantee shall be reinstated upon the reversion date.
In the event of a bankruptcy, liquidation or reorganization of any non-guarantor subsidiary, such non-guarantor subsidiary will pay the holders of its debt and other liabilities, including its trade creditors, before it will be able to distribute any of its assets to us. In the future, any non-U.S. subsidiaries, immaterial subsidiaries and subsidiaries that we designate as unrestricted subsidiaries under the 10.5% Second Lien Notes and 12.5% Unsecured Notes indentures will not guarantee the 10.5% Second Lien Notes or 12.5% Unsecured Notes. As of September 30, 2013, there were no restrictions on the ability of subsidiary guarantors to transfer funds to the parent company.

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




22

Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Balance Sheet
September 30, 2013
(in thousands)
(unaudited)
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
398

 
$
138,790

 
$
—

 
$
223,731

 
$
—

 
$
362,919

Accounts receivable, net
—

 
184,370

 
73,382

 
111,148

 
—

 
368,900

Inventories, net
—

 
63,219

 
92,060

 
78,178

 
(83,471
)
 
149,986

Prepaid expenses and other
—

 
41,376

 
5,913

 
342,209

 
(329,999
)
 
59,499

Intercompany receivables
166

 
1,400,317

 
2,270,890

 
149,321

 
(3,820,694
)
 
—

Total current assets
564

 
1,828,072

 
2,442,245

 
904,587

 
(4,234,164
)
 
941,304

Net property, plant and equipment
—

 
297,648

 
82,391

 
197,071

 
(264,555
)
 
312,555

Debt issuance costs, net
—

 
101,766

 
—

 
—

 
—

 
101,766

Deferred income taxes
—

 
—

 
—

 
21,866

 
—

 
21,866

Goodwill
—

 
2,483,240

 
724,335

 
—

 
—

 
3,207,575

Identifiable intangible assets, net
—

 
380,314

 
1,809,207

 
154,004

 
—

 
2,343,525

Other non-current assets
—

 
424

 
186

 
94,344

 
(90,900
)
 
4,054

Intercompany loan receivables
—

 
785,000

 
404,586

 
—

 
(1,189,586
)
 
—

Intercompany investments
948,376

 
406,067

 
406,253

 
—

 
(1,760,696
)
 
—

 
$
948,940

 
$
6,282,531

 
$
5,869,203

 
$
1,371,872

 
$
(7,539,901
)
 
$
6,932,645

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$
—

 
$
16,089

 
$
12,540

 
$
15,898

 
$
—

 
$
44,527

Accrued expenses and other
—

 
234,359

 
238,528

 
61,948

 
(182,932
)
 
351,903

Intercompany payables
3,934

 
788,613

 
2,508,621

 
519,526

 
(3,820,694
)
 
—

Current installments of long-term debt
—

 
22,760

 
1,341

 
—

 
—

 
24,101

Income taxes payable
—

 
1,495

 
—

 
(1,495
)
 
—

 
—

Deferred income taxes
—

 
(34,267
)
 
42,519

 
(3,642
)
 
—

 
4,610

Total current liabilities
3,934

 
1,029,049

 
2,803,549

 
592,235

 
(4,003,626
)
 
425,141

Long-term debt, net of current installments and discount
—

 
4,516,223

 
916

 
—

 
—

 
4,517,139

Non-current tax liabilities
—

 
42,084

 
—

 
4,377

 
—

 
46,461

Deferred income taxes
—

 
56,892

 
852,886

 
50,441

 
—

 
960,219

Other non-current liabilities
218

 
37,242

 
298

 
1,139

 
—

 
38,897

Intercompany loan payables
—

 
402,433

 
785,000

 
2,153

 
(1,189,586
)
 
—

Total liabilities
4,152

 
6,083,923

 
4,442,649

 
650,345

 
(5,193,212
)
 
5,987,857

 
 
 
 
 
 
 
 
 
 
 
 
Total equity
944,788

 
198,608

 
1,426,554

 
721,527

 
(2,346,689
)
 
944,788

 
$
948,940

 
$
6,282,531

 
$
5,869,203

 
$
1,371,872

 
$
(7,539,901
)
 
$
6,932,645




23

Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Balance Sheet
December 31, 2012
(in thousands)
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
398

 
$
276,788

 
$
—

 
$
105,964

 
$
—

 
$
383,150

Accounts receivable, net
—

 
174,534

 
58,244

 
122,940

 
—

 
355,718

Inventories, net
—

 
94,345

 
71,676

 
60,635

 
(86,806
)
 
139,850

Deferred income taxes
—

 
38,451

 
—

 
3,642

 
(42,093
)
 
—

Prepaid expenses and other
—

 
25,083

 
6,591

 
294,437

 
(286,600
)
 
39,511

Intercompany receivables
166

 
1,337,915

 
2,149,981

 
147,473

 
(3,635,535
)
 
—

Total current assets
564

 
1,947,116

 
2,286,492

 
735,091

 
(4,051,034
)
 
918,229

Net property, plant and equipment
—

 
281,950

 
79,049

 
190,419

 
(162,936
)
 
388,482

Debt issuance costs, net
—

 
96,476

 
—

 
—

 
—

 
96,476

Deferred income taxes
—

 
—

 
—

 
20,003

 
—

 
20,003

Goodwill
—

 
2,483,240

 
996,535

 
—

 
—

 
3,479,775

Identifiable intangible assets, net
—

 
441,620

 
2,045,091

 
179,490

 
—

 
2,666,201

Other non-current assets
—

 
324

 
186

 
95,988

 
(90,900
)
 
5,598

Intercompany loan receivables
—

 
800,000

 
366,134

 
—

 
(1,166,134
)
 
—

Intercompany investments
1,459,261

 
302,027

 
409,702

 
—

 
(2,170,990
)
 
—

 
$
1,459,825

 
$
6,352,753

 
$
6,183,189

 
$
1,220,991

 
$
(7,641,994
)
 
$
7,574,764

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$
—

 
$
17,869

 
$
13,093

 
$
10,008

 
$
—

 
$
40,970

Accrued expenses and other
—

 
172,356

 
236,838

 
62,226

 
(187,257
)
 
284,163

Intercompany payables
2,361

 
723,096

 
2,389,863

 
520,215

 
(3,635,535
)
 
—

Current installments of long-term debt
—

 
23,383

 
—

 
—

 
—

 
23,383

Income taxes payable
—

 
(1,452
)
 
—

 
1,452

 
—

 
—

Deferred income taxes
—

 
—

 
99,621

 
—

 
(42,093
)
 
57,528

Total current liabilities
2,361

 
935,252

 
2,739,415

 
593,901

 
(3,864,885
)
 
406,044

Long-term debt, net of current installments and discount
—

 
4,554,112

 
—

 
—

 
—

 
4,554,112

Non-current tax liabilities
—

 
36,711

 
—

 
7,754

 
—

 
44,465

Deferred income taxes
—

 
115,652

 
888,597

 
65,231

 
—

 
1,069,480

Other non-current liabilities
68

 
41,360

 
375

 
1,464

 
—

 
43,267

Intercompany loan payables
—

 
366,135

 
800,000

 
—

 
(1,166,135
)
 
—

Total liabilities
2,429

 
6,049,222

 
4,428,387

 
668,350

 
(5,031,020
)
 
6,117,368

 
 
 
 
 
 
 
 
 
 
 
 
Total equity
1,457,396

 
303,531

 
1,754,802

 
552,641

 
(2,610,974
)
 
1,457,396

 
$
1,459,825

 
$
6,352,753

 
$
6,183,189

 
$
1,220,991

 
$
(7,641,994
)
 
$
7,574,764







24

Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the three months ended September 30, 2013
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
—

 
$
155,893

 
$
1,513

 
$
33,635

 
$
—

 
$
191,041

Sales
—

 
77,659

 
224,426

 
159,142

 
(211,707
)
 
249,520

Total revenue
—

 
233,552

 
225,939

 
192,777

 
(211,707
)
 
440,561

Rental expenses
—

 
62,928

 
4,010

 
53,891

 
(35,083
)
 
85,746

Cost of sales
30

 
123,481

 
142,946

 
57,512

 
(257,818
)
 
66,151

Gross profit (loss)
(30
)
 
47,143

 
78,983

 
81,374

 
81,194

 
288,664

Selling, general and administrative expenses
820

 
66,834

 
44,169

 
40,261

 
(31
)
 
152,053

Research and development expenses
—

 
8,010

 
6,742

 
3,209

 
—

 
17,961

Acquired intangible asset amortization
—

 
19,625

 
17,907

 
7,584

 
—

 
45,116

Impairment of goodwill and intangible assets
—

 
—

 
443,400

 
—

 
—

 
443,400

Operating earnings (loss)
(850
)
 
(47,326
)
 
(433,235
)
 
30,320

 
81,225

 
(369,866
)
Non-operating intercompany transactions
—

 
(8,076
)
 
49,735

 
(60,212
)
 
18,553

 
—

Interest income and other
—

 
17,852

 
3,062

 
97

 
(20,794
)
 
217

Interest expense
—

 
(104,402
)
 
(17,756
)
 
(34
)
 
20,794

 
(101,398
)
Loss on extinguishment of debt
—

 
(200
)
 
—

 
—

 
—

 
(200
)
Foreign currency gain (loss)
—

 
(14,433
)
 
(38
)
 
5,733

 
—

 
(8,738
)
Derivative instruments loss
—

 
(6,840
)
 
—

 
—

 
—

 
(6,840
)
Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(850
)
 
(163,425
)
 
(398,232
)
 
(24,096
)
 
99,778

 
(486,825
)
Income tax expense (benefit)
—

 
(51,104
)
 
(34,535
)
 
(2,880
)
 
—

 
(88,519
)
Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(850
)
 
(112,321
)
 
(363,697
)
 
(21,216
)
 
99,778

 
(398,306
)
Equity in earnings (loss) of subsidiaries
(397,711
)
 
48,780

 
(20,950
)
 
—

 
369,881

 
—

Earnings (loss) from continuing operations
(398,561
)
 
(63,541
)
 
(384,647
)
 
(21,216
)
 
469,659

 
(398,306
)
Earnings (loss) from discontinued operations, net of tax
—

 
(331
)
 
(1
)
 
266

 
(189
)
 
(255
)
Net earnings (loss)
$
(398,561
)
 
$
(63,872
)
 
$
(384,648
)
 
$
(20,950
)
 
$
469,470

 
$
(398,561
)
Total comprehensive income (loss)
$
(403,151
)
 
$
(68,462
)
 
$
(389,238
)
 
$
(25,540
)
 
$
483,240

 
$
(403,151
)



25



Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the three months ended September 30, 2012
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
—

 
$
164,641

 
$
1,741

 
$
40,774

 
$
—

 
$
207,156

Sales
—

 
74,943

 
103,716

 
151,225

 
(101,167
)
 
228,717

Total revenue
—

 
239,584

 
105,457

 
191,999

 
(101,167
)
 
435,873

Rental expenses
—

 
62,877

 
1,526

 
61,744

 
(25,337
)
 
100,810

Cost of sales
18

 
89,027

 
34,023

 
58,201

 
(122,656
)
 
58,613

Gross profit (loss)
(18
)
 
87,680

 
69,908

 
72,054

 
46,826

 
276,450

Selling, general and administrative expenses
191

 
75,731

 
32,926

 
33,978

 
(48
)
 
142,778

Research and development expenses
—

 
6,268

 
8,977

 
2,131

 
—

 
17,376

Acquired intangible asset amortization
—

 
22,308

 
18,687

 
8,738

 
—

 
49,733

Operating earnings (loss)
(209
)
 
(16,627
)
 
9,318

 
27,207

 
46,874

 
66,563

Non-operating intercompany transactions
—

 
5,318

 
132,861

 
(131,367
)
 
(6,812
)
 
—

Interest income and other
—

 
18,532

 
3,063

 
18

 
(21,439
)
 
174

Interest expense
—

 
(120,964
)
 
(18,375
)
 
(20
)
 
21,439

 
(117,920
)
Foreign currency gain (loss)
—

 
(6,651
)
 
170

 
1,223

 
—

 
(5,258
)
Derivative instruments loss
—

 
(8,579
)
 
—

 
—

 
—

 
(8,579
)
Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(209
)
 
(128,971
)
 
127,037

 
(102,939
)
 
40,062

 
(65,020
)
Income tax expense (benefit)
—

 
(22,700
)
 
14,055

 
(18,531
)
 
—

 
(27,176
)
Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(209
)
 
(106,271
)
 
112,982

 
(84,408
)
 
40,062

 
(37,844
)
Equity in earnings (loss) of subsidiaries
(35,603
)
 
28,741

 
(83,578
)
 
—

 
90,440

 
—

Earnings (loss) from continuing operations
(35,812
)
 
(77,530
)
 
29,404

 
(84,408
)
 
130,502

 
(37,844
)
Earnings (loss) from discontinued operations, net of tax
—

 
(1,468
)
 
627

 
830

 
2,043

 
2,032

Net earnings (loss)
$
(35,812
)
 
$
(78,998
)
 
$
30,031

 
$
(83,578
)
 
$
132,545

 
$
(35,812
)
Total comprehensive income (loss)
$
(34,215
)
 
$
(77,401
)
 
$
31,628

 
$
(81,981
)
 
$
127,754

 
$
(34,215
)

26

Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the nine months ended September 30, 2013
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
—

 
$
461,605

 
$
4,766

 
$
103,078

 
$
—

 
$
569,449

Sales
—

 
221,296

 
640,681

 
481,490

 
(623,792
)
 
719,675

Total revenue
—

 
682,901

 
645,447

 
584,568

 
(623,792
)
 
1,289,124

Rental expenses
13

 
186,426

 
12,180

 
167,226

 
(92,366
)
 
273,479

Cost of sales
84

 
221,212

 
396,855

 
177,420

 
(613,864
)
 
181,707

Gross profit (loss)
(97
)
 
275,263

 
236,412

 
239,922

 
82,438

 
833,938

Selling, general and administrative expenses
1,949

 
269,490

 
136,734

 
110,515

 
(210
)
 
518,478

Research and development expenses
—

 
23,366

 
23,263

 
9,511

 
—

 
56,140

Acquired intangible asset amortization
—

 
61,276

 
54,274

 
23,573

 
—

 
139,123

Impairment of goodwill and intangible assets
—

 
—

 
443,400

 
—

 
—

 
443,400

Operating earnings (loss)
(2,046
)
 
(78,869
)
 
(421,259
)
 
96,323

 
82,648

 
(323,203
)
Non-operating intercompany transactions
—

 
52,176

 
108,489

 
(112,565
)
 
(48,100
)
 
—

Interest income and other
—

 
54,046

 
9,188

 
166

 
(62,121
)
 
1,279

Interest expense
—

 
(324,163
)
 
(52,974
)
 
(128
)
 
62,121

 
(315,144
)
Loss on extinguishment of debt
—

 
(2,364
)
 
—

 
—

 
—

 
(2,364
)
Foreign currency gain (loss)
—

 
(8,953
)
 
(251
)
 
(2,731
)
 
—

 
(11,935
)
Derivative instruments gain
—

 
3,200

 
—

 
—

 
—

 
3,200

Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(2,046
)
 
(304,927
)
 
(356,807
)
 
(18,935
)
 
34,548

 
(648,167
)
Income tax expense (benefit)
—

 
(97,201
)
 
(38,718
)
 
(8,624
)
 
—

 
(144,543
)
Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(2,046
)
 
(207,726
)
 
(318,089
)
 
(10,311
)
 
34,548

 
(503,624
)
Equity in earnings (loss) of subsidiaries
(503,877
)
 
104,040

 
(10,136
)
 
—

 
409,973

 
—

Earnings (loss) from continuing operations
(505,923
)
 
(103,686
)
 
(328,225
)
 
(10,311
)
 
444,521

 
(503,624
)
Loss from discontinued operations, net of tax
—

 
(2,725
)
 
(3
)
 
175

 
254

 
(2,299
)
Net earnings (loss)
$
(505,923
)
 
$
(106,411
)
 
$
(328,228
)
 
$
(10,136
)
 
$
444,775

 
$
(505,923
)
Total comprehensive income (loss)
$
(512,932
)
 
$
(113,420
)
 
$
(335,237
)
 
$
(17,145
)
 
$
465,802

 
$
(512,932
)



27



Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the nine months ended September 30, 2012
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
—

 
$
495,299

 
$
4,507

 
$
122,544

 
$
—

 
$
622,350

Sales
—

 
218,950

 
312,106

 
388,453

 
(235,338
)
 
684,171

Total revenue
—

 
714,249

 
316,613

 
510,997

 
(235,338
)
 
1,306,521

Rental expenses
2

 
227,119

 
4,088

 
201,240

 
(84,062
)
 
348,387

Cost of sales
54

 
196,056

 
108,774

 
174,747

 
(289,177
)
 
190,454

Gross profit (loss)
(56
)
 
291,074

 
203,751

 
135,010

 
137,901

 
767,680

Selling, general and administrative expenses
1,142

 
244,705

 
96,903

 
103,765

 
(734
)
 
445,781

Research and development expenses
—

 
20,222

 
26,676

 
6,788

 
—

 
53,686

Acquired intangible asset amortization
—

 
81,085

 
59,273

 
31,902

 
—

 
172,260

Operating earnings (loss)
(1,198
)
 
(54,938
)
 
20,899

 
(7,445
)
 
138,635

 
95,953

Non-operating intercompany transactions
—

 
71,692

 
261,173

 
(352,936
)
 
20,071

 
—

Interest income and other
—

 
55,260

 
9,188

 
100

 
(63,918
)
 
630

Interest expense
—

 
(362,215
)
 
(54,725
)
 
(85
)
 
63,918

 
(353,107
)
Foreign currency gain (loss)
—

 
2,470

 
318

 
(2,360
)
 
—

 
428

Derivative instruments gain (loss)
—

 
(28,473
)
 
—

 
—

 
—

 
(28,473
)
Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(1,198
)
 
(316,204
)
 
236,853

 
(362,726
)
 
158,706

 
(284,569
)
Income tax expense (benefit)
—

 
(61,959
)
 
(16,897
)
 
(28,269
)
 
—

 
(107,125
)
Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(1,198
)
 
(254,245
)
 
253,750

 
(334,457
)
 
158,706

 
(177,444
)
Equity in earnings (loss) of subsidiaries
(179,926
)
 
(73,757
)
 
(338,090
)
 
—

 
591,773

 
—

Earnings (loss) from continuing operations
(181,124
)
 
(328,002
)
 
(84,340
)
 
(334,457
)
 
750,479

 
(177,444
)
Earnings (loss) from discontinued operations, net of tax
—

 
(8,761
)
 
4,100

 
(3,633
)
 
4,614

 
(3,680
)
Net earnings (loss)
$
(181,124
)
 
$
(336,763
)
 
$
(80,240
)
 
$
(338,090
)
 
$
755,093

 
$
(181,124
)
Total comprehensive income (loss)
$
(182,711
)
 
$
(338,350
)
 
$
(81,827
)
 
$
(339,677
)
 
$
759,854

 
$
(182,711
)



28




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

 
For the nine months ended September 30, 2013
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Cash flows from operating activities:
 
 
 
 
 
 
 
 
 
 
 
   Net earnings (loss)
$
(505,923
)
 
$
(106,411
)
 
$
(328,228
)
 
$
(10,136
)
 
$
444,775

 
$
(505,923
)
   Adjustments to reconcile net earnings (loss) to net cash provided (used) by operating activities
3,619

 
249,757

 
397,283

 
35,915

 
(45,156
)
 
641,418

    Net cash provided (used) by operating activities
(502,304
)
 
143,346

 
69,055

 
25,779

 
399,619

 
135,495

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

 
(145,714
)
 
(14,556
)
 
(98,591
)
 
191,164

 
(67,697
)
   Decrease (increase) in identifiable intangible assets and other non-current assets
—

 
(70
)
 
(4,474
)
 
271

 
—

 
(4,273
)
    Net cash provided (used) by investing activities
—

 
(145,784
)
 
(19,030
)
 
(98,320
)
 
191,164

 
(71,970
)
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
 
 
   Distribution to limited partners
(1,572
)
 
—

 
—

 
—

 
—

 
(1,572
)
   Repayments of long-term debt and capital lease obligations
—

 
(60,446
)
 
—

 
17

 
—

 
(60,429
)
Payment of debt issuance costs
—

 
(21,604
)
 
—

 
—

 
—

 
(21,604
)
Proceeds (payments) on intercompany loans
—

 
51,298

 
(53,452
)
 
2,154

 
—

 
—

Proceeds (payments) on intercompany investments
503,876

 
(104,808
)
 
3,427

 
188,288

 
(590,783
)
 
—

   Net cash provided (used) by financing activities
502,304

 
(135,560
)
 
(50,025
)
 
190,459

 
(590,783
)
 
(83,605
)
Effect of exchange rate changes on cash and cash equivalents
—

 
—

 
—

 
(151
)
 
—

 
(151
)
Net increase (decrease) in cash and cash equivalents
—

 
(137,998
)
 
—

 
117,767

 
—

 
(20,231
)
Cash and cash equivalents, beginning of period
398

 
276,788

 
—

 
105,964

 
—

 
383,150

Cash and cash equivalents, end of period
$
398

 
$
138,790

 
$
—

 
$
223,731

 
$
—

 
$
362,919









29



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

 
For the nine months ended September 30, 2012
 
Centaur Guernsey L.P. Inc. Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Cash flows from operating activities:
 
 
 
 
 
 
 
 
 
 
 
   Net earnings (loss)
$
(181,124
)
 
$
(336,763
)
 
$
(80,240
)
 
$
(338,090
)
 
$
755,093

 
$
(181,124
)
   Adjustments to reconcile net loss to net cash provided (used) by operating activities
3,154

 
439,770

 
(123,522
)
 
153,344

 
(105,747
)
 
366,999

    Net cash provided (used) by operating activities
(177,970
)
 
103,007

 
(203,762
)
 
(184,746
)
 
649,346

 
185,875

Cash flows from investing activities:


 


 


 


 


 


   Net additions to property, plant and equipment
—

 
(57,203
)
 
(42,323
)
 
(39,328
)
 
69,344

 
(69,510
)
   Decrease (increase) in identifiable intangible assets and other non-current assets
—

 
87

 
(5,486
)
 
19

 
—

 
(5,380
)
    Net cash provided (used) by investing activities
—

 
(57,116
)
 
(47,809
)
 
(39,309
)
 
69,344

 
(74,890
)
Cash flows from financing activities:


 


 


 


 


 


   Capital contributions from limited partners
239

 
—

 
—

 
—

 
—

 
239

   Distribution to limited partners
(1,970
)
 
—

 
—

 
—

 
—

 
(1,970
)
   Repayments of long-term debt and capital lease obligations
—

 
(17,508
)
 
—

 
25

 
—

 
(17,483
)
Proceeds (payments) on intercompany loans
—

 
(120,557
)
 
45,537

 
75,020

 
—

 
—

Payment of debt issuance costs
—

 
(578
)
 
—

 
—

 
—

 
(578
)
Proceeds (payments) on intercompany investments
179,688

 
196,745

 
206,034

 
136,223

 
(718,690
)
 
—

   Net cash provided (used) by financing activities
177,957

 
58,102

 
251,571

 
211,268

 
(718,690
)
 
(19,792
)
Effect of exchange rate changes on cash and cash equivalents
—

 
—

 
—

 
308

 
—

 
308

Net increase (decrease) in cash and cash equivalents
(13
)
 
103,993

 
—

 
(12,479
)
 
—

 
91,501

Cash and cash equivalents, beginning of period
411


142,652


—


72,363


—

 
215,426

Cash and cash equivalents, end of period
$
398

 
$
246,645

 
$
—

 
$
59,884

 
$
—

 
$
306,927





30

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes included in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed in our “Risk Factors.” (Part II, Item 1A.), including those previously disseminated in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and each of the Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2013 and June 30, 2013.
GENERAL

We are a leading global medical technology company devoted to the discovery, development, manufacturing and marketing of innovative, high-technology therapies and products that have been designed to leverage the body’s innate ability to heal, thus improving clinical outcomes while helping to reduce the overall cost of patient care. We have an infrastructure designed to meet the specific needs of medical professionals and patients across all healthcare settings, including acute care hospitals, extended care organizations and patients’ homes, both in the United States and abroad. Our primary businesses serve the advanced wound care and regenerative medicine markets. We are owned by investment funds advised by Apax Partners and controlled affiliates of Canada Pension Plan Investment Board and the Public Sector Pension Investment Board and certain other co-investors.

KCI is focused on the development and commercialization of advanced wound care therapies based on our negative pressure technology platform which employs negative pressure in a variety of applications to promote wound healing through unique mechanisms of action and to speed recovery times while reducing the overall cost of treating patients with complex wounds. In addition, we continue to pursue development opportunities within the broader wound care market for technology outside of NPWT.
 
LifeCell is focused on the development and commercialization of regenerative and reconstructive acellular tissue matrices for use in reconstructive, orthopedic, and urogynecologic surgical procedures to repair soft tissue defects, as well as for reconstructive and cosmetic procedures.  Existing products include our human-based AlloDerm® Regenerative Tissue Matrix (“AlloDerm”) and porcine-based Strattice™ Reconstructive Tissue Matrix (“Strattice”) in various configurations designed to meet the needs of patients and caregivers. In addition, LifeCell distributes SPY Elite, a real-time tissue perfusion assessment system. The majority of our LifeCell revenue is generated from the clinical applications of challenging hernia repair and post-mastectomy breast reconstruction.

Historically, we have experienced a seasonal slowing of KCI unit demand beginning in the fourth quarter and continuing into the first quarter which we believe has been caused by year-end clinical treatment patterns, such as the postponement of elective surgeries and increased discharges of individuals from the acute care setting around the winter holidays.  LifeCell has also historically experienced a similar seasonal slowing of sales in the first and third quarter of each year.  Although we do not know if our historical experience will prove to be indicative of future periods, similar slow-downs may occur in subsequent periods.

RECENT DEVELOPMENTS

Acquisition of SystagenixTM 

On July 30, 2013, KCI announced that it had signed a definitive share purchase agreement to acquire Systagenix, an established provider of advanced wound care ("AWC") products. The transaction closed on October 28, 2013. At the closing of the transaction, KCI paid a purchase price of $485.0 million, subject to adjustment. The purchase price was funded by a combination of cash on hand and using $350.0 million of incremental term D-1 loans (the "Incremental Loans") incurred pursuant to Amendment No. 3 to our Senior Secured Credit Facility, dated as of October 28, 2013. The Incremental Loans were issued at a discount of $0.4 million. The interest rate and all other terms are identical to our previously-existing Dollar Term D-1 Loans.

Systagenix has a broad portfolio of innovative AWC products with a focus on moist wound healing dressings - including PROMOGRAN PRISMA®, the collagen dressing market leader, TIELLE® (foam) and ADAPTIC® (non adherent contact layers). Systagenix's manufacturing, marketing and sales teams supply and distribute over 20 million advanced wound care dressings each month to more than 70 countries. The company, formerly part of Johnson & Johnson, generates annual revenue of approximately $200.0 million and has approximately 800 employees worldwide, including an experienced team of research and development scientists dedicated to advancing skin and wound care. Combining Systagenix's expertise with KCI's innovation pipeline and scale will create additional value for customers and help speed healing and reduce complications for patients.

31

RESULTS OF OPERATIONS
We have two reportable operating segments which correspond to our two global businesses: KCI and LifeCell. We have two primary geographic regions for which we provide supplemental information: the Americas, which is comprised principally of the United States and includes Canada, Puerto Rico and Latin America; and EMEA/APAC, which is comprised of Europe, the Middle East, Africa and the Asia Pacific region. For additional discussion on segment and operation information, see Note 9 of the notes to the condensed consolidated financial statements.
Revenue for each of our geographic regions in which we operate is disclosed for each of our businesses. Certain prior period amounts have been reclassified to conform to the 2013 presentation.
Revenue by Operating Segment

The following table sets forth, for the periods indicated, business unit revenue as well as the percentage change in each line item, comparing the third quarter and first nine months of 2013 to the third quarter and first nine months of 2012 (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
KCI revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
189,528

 
$
205,415

 
(7.7
)%
 
$
564,683

 
$
617,843

 
(8.6
)%
Sales
131,351

 
124,236

 
5.7

 
379,843

 
368,314

 
3.1
 %
Total – KCI
320,879

 
329,651

 
(2.7
)
 
944,526

 
986,157

 
(4.2
)%
 
 
 
 
 
 
 
 
 
 
 
 
LifeCell revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
1,513

 
1,741

 
(13.1
)
 
4,766

 
4,507

 
5.7
 %
Sales
118,169

 
104,481

 
13.1

 
339,832

 
315,857

 
7.6
 %
Total – LifeCell
119,682

 
106,222

 
12.7

 
344,598

 
320,364

 
7.6
 %
 
 
 
 
 
 
 
 
 
 
 
 
Total consolidated revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
191,041

 
207,156

 
(7.8
)
 
569,449

 
622,350

 
(8.5
)%
Sales
249,520

 
228,717

 
9.1

 
719,675

 
684,171

 
5.2
 %
Total consolidated revenue
$
440,561

 
$
435,873

 
1.1
 %
 
$
1,289,124

 
$
1,306,521

 
(1.3
)%

The increase in total revenue for the third quarter of 2013 as compared to the prior-year period was due to higher LifeCell sales revenue, partially offset by lower KCI rental revenue. Foreign currency exchange rate movements did not have a significant impact on worldwide revenue compared to the prior year periods.

The decline in worldwide KCI revenue from the comparable prior-year periods was attributable primarily to lower rental revenue in established markets, partially offset by increased revenues from expansion products and certain markets outside the U.S. The lower rental revenue in established markets resulted from a combination of lower volumes and lower average pricing. We anticipate our average global pricing will decline moderately in the future as our competitors market products designed to compete with KCI's offering. Foreign currency exchange rate movements did not have a significant impact on worldwide KCI revenue compared to the prior year periods.
 
The growth in worldwide LifeCell revenue over the prior-year periods was due primarily to increased sales volumes of our products. Foreign currency exchange rate movements did not have a significant impact on worldwide LifeCell revenue.



32

Revenue by Geography

The following table sets forth, for the periods indicated, rental and sales revenue by geography as well as the percentage change in each line item, comparing the third quarter and first nine months of 2013 to the third quarter and first nine months of 2012 (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
Americas revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
161,992

 
$
171,934

 
(5.8
)%
 
$
480,606

 
$
516,161

 
(6.9
)%
Sales
198,458

 
182,656

 
8.7

 
571,985

 
543,136

 
5.3
 %
Total – Americas
360,450

 
354,590

 
1.7

 
1,052,591

 
1,059,297

 
(0.6
)%
 
 
 
 
 
 
 
 
 
 
 
 
EMEA/APAC revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
29,049

 
35,222

 
(17.5
)
 
88,843

 
106,189

 
(16.3
)%
Sales
51,062

 
46,061

 
10.9

 
147,690

 
141,035

 
4.7
 %
Total – EMEA/APAC
80,111

 
81,283

 
(1.4
)
 
236,533

 
247,224

 
(4.3
)%
 
 
 
 
 
 
 
 
 
 
 
 
Total consolidated revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
191,041

 
207,156

 
(7.8
)
 
569,449

 
622,350

 
(8.5
)%
Sales
249,520

 
228,717

 
9.1

 
719,675

 
684,171

 
5.2
 %
Total consolidated revenue
$
440,561

 
$
435,873

 
1.1
 %
 
$
1,289,124

 
$
1,306,521

 
(1.3
)%


Revenue Relationship

The following table sets forth, for the periods indicated, the percentage relationship of each item to total revenue in the period, as well as the changes in each line item:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
Change
 
2013
 
2012
 
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
KCI revenue
72.8
%
 
75.6
%
 
(280
)
bps
 
73.3
%
 
75.5
%
 
(220
)
bps
LifeCell revenue
27.2

 
24.4

 
280

bps
 
26.7

 
24.5

 
220

bps
Total consolidated revenue
100.0
%
 
100.0
%
 
 
 
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Americas revenue
81.8
%
 
81.4
%
 
40

bps
 
81.7
%
 
81.1
%
 
60

bps
EMEA/APAC revenue
18.2

 
18.6

 
(40
)
bps
 
18.3

 
18.9

 
(60
)
bps
Total consolidated revenue
100.0
%
 
100.0
%
 
 
 
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rental revenue
43.4
%
 
47.5
%
 
(410
)
bps
 
44.2
%
 
47.6
%
 
(340
)
bps
Sales revenue
56.6

 
52.5

 
410

bps
 
55.8

 
52.4

 
340

bps
Total consolidated revenue
100.0
%
 
100.0
%
 


 
 
100.0
%
 
100.0
%
 
 
 



33

Rental Expenses

The following table presents rental expenses for the periods indicated as well as the percentage change in each line item, comparing the third quarter and first nine months of 2013 to the third quarter and first nine months of 2012 (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
Rental expenses
$
85,746

 
$
100,810

 
(14.9
)%
 
$
273,479

 
$
348,387

 
(21.5
)%

Rental, or field, expenses are comprised of both fixed and variable costs including facilities, field service, sales force compensation and royalties associated with our rental products. Rental expenses during the third quarter and first nine months of 2013 decreased from the prior-year periods due primarily to a decrease in depreciation related to the fixed asset step up associated with purchase accounting and a reduction in operational expenses due to cost control measures.

Cost of Sales

The following table presents cost of sales as well as the percentage change in each line item, comparing the third quarter and first nine months of 2013 to the third quarter and first nine months of 2012 (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
$
66,151

 
$
58,613

 
12.9
%
 
$
181,707

 
$
190,454

 
(4.6
)%

Cost of sales includes manufacturing costs, product costs and royalties associated with our “for sale” products. The increase in cost of sales in the third quarter of 2013 compared to the prior-year period was due primarily to increased sales volumes, partially offset by $3.0 million of additional cost of sales recorded in the third quarter of 2012 associated with purchase accounting adjustments related to the step up in value of inventory. Cost of sales decreased for the first nine months of 2013 compared to the prior year period due primarily to $25.0 million of cost of sales recorded in the first nine months of 2012 associated with purchase accounting adjustments related to the step up in value of inventory, partially offset by increased sales volumes.

Gross Profit Margin

The following table presents the gross profit margin (calculated as gross profit divided by total revenue for the periods indicated):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit margin
65.5
%
 
63.4
%
 
210

bps
 
64.7
%
 
58.8
%
 
590

bps

The gross profit margin increase during the third quarter and first nine months of 2013 compared to the prior-year periods was due primarily to a decrease in depreciation related to the fixed asset step up and lower cost of sales related to the inventory step up associated with purchase accounting and a reduction in operational expenses due to cost control measures.

Selling, General and Administrative Expenses

The following table presents selling, general and administrative expenses and the percentage relationship to total revenue (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selling, general and administrative expenses
$
152,053

 
$
142,778

 
6.5
%
 
$
518,478

 
$
445,781

 
16.3
%


34

Selling, general and administrative (“SG&A”) expenses generally include administrative labor, incentive and sales compensation costs, insurance costs, professional fees, depreciation, bad debt expense and information systems costs, but exclude rental sales force compensation costs. The increase in SG&A expenses during the first nine months of 2013 compared to the prior-year periods is due primarily to a fixed asset impairment charge of $30.3 million and an increase in restructuring-related expenses. Additionally, during the third quarter and first nine months of 2013, write-offs of $3.5 million and $16.9 million, respectively, of other intangible assets were recorded due primarily to the discontinuation of certain projects. During the third quarter and first nine months of 2012, SG&A expenses included impairment charges of $9.7 million and $22.1 million, respectively, associated with certain production equipment at our KCI manufacturing plant and inventory associated with our V.A.C.Via product.

Research and Development Expenses

The following table presents research and development expenses and the percentage relationship to total revenue (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development expenses
$
17,961

 
$
17,376

 
3.4
%
 
$
56,140

 
$
53,686

 
4.6
%
As a percent of total revenue
4.1
%
 
4.0
%
 
10

bps
 
4.4
%
 
4.1
%
 
30

bps

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

Acquired Intangible Asset Amortization

In connection with the 2011 merger, we recorded $2.89 billion of identifiable intangible assets during the fourth quarter of 2011. During the third quarters of 2013 and 2012, we recorded $45.1 million and $49.7 million, respectively, of amortization expense associated with these acquired intangible assets. During the first nine months of 2013 and 2012, we recorded $139.1 million and $172.3 million, respectively, of amortization expense associated with these acquired intangible assets.

Impairment of Goodwill and Intangible Assets

During the third quarter of 2013 we recorded a $272.2 million impairment of goodwill and a $171.2 million impairment of indefinite-lived intangible assets related to our LifeCell reporting unit.

Interest Expense

Interest expense decreased to $101.4 million and $315.1 million in the third quarter and first nine months of 2013, respectively, compared to $117.9 million and $353.1 million in the comparable prior-year periods due to lower average debt balances at lower interest rates.

Foreign Currency Gain (Loss)

Foreign currency transaction losses were $8.7 million and $11.9 million during the third quarter and first nine months of 2013, compared to a loss of $5.3 million and a gain of $0.4 million, respectively, in the prior-year comparable periods. The revaluation of the Term D-1 EURO loan to U.S. dollars represented $12.5 million and $8.2 million of the foreign currency transaction losses recorded during the third quarter and first nine months of 2013, respectively. The revaluation of the Term D-1 EURO loan to U.S. dollars represented a foreign currency transaction loss of $6.5 million recorded during the third quarter of 2012 and a $2.7 million foreign currency transaction gain recorded during the first nine months of 2012.


35

Derivative Instruments Gain (Loss)

During the third quarter and first nine months of 2013, we recorded a derivative instruments loss of $6.8 million and a gain of $3.2 million, respectively, compared to losses of $8.6 million and $28.5 million in the comparable prior-year periods due primarily to fluctuations in the value of our interest rate derivative instruments.

Gain (Loss) from Discontinued Operations

During the third quarter and first nine months of 2013, we recorded losses from discontinued operations, net of tax, of $0.3 million and $2.3 million, respectively, compared to a gain of $2.0 million and a loss of $3.7 million during the corresponding periods of the prior year.

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

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

Sources of Capital

Based upon the current level of operations, we believe our existing capital resources, as well as cash flows from operating activities and availability under our Revolving Credit Facility will be adequate to meet our anticipated cash requirements for at least the next twelve months. Cash flows related to discontinued operations were not material for the first nine months of 2013 and 2012 and therefore have not been separately disclosed in the condensed consolidated statements of cash flows. We do not anticipate the absence of cash flows from discontinued operations to significantly affect our liquidity and capital resources. During the first nine months of 2013 and 2012, our primary source of capital was cash from operations. The following table summarizes the net cash provided and used by operating activities, investing activities and financing activities (in thousands):
 
Nine months ended September 30,
 
2013
 
2012
Net cash provided by operating activities
$
135,495

 
$
185,875

Net cash used by investing activities
(71,970
)
 
(74,890
)
Net cash used by financing activities
(83,605
)
 
(19,792
)
Effect of exchange rates changes on cash and cash equivalents
(151
)
 
308

Net increase (decrease) in cash and cash equivalents
$
(20,231
)
 
$
91,501


As of September 30, 2013 and December 31, 2012, our principal sources of liquidity consisted of $362.9 million and $383.2 million, respectively, of cash and cash equivalents. We also had availability of $189.3 million and $188.5 million under our Revolving Credit Facility as of September 30, 2013 and December 31, 2012, respectively.

Capital Expenditures

During the first nine months of 2013 and 2012, we made capital expenditures of $59.9 million and $72.0 million, respectively. Capital expenditures during the first nine months of 2013 related primarily to expanding the rental fleet and information technology projects and purchases. Capital expenditures during the first nine months of the prior year related primarily to expanding the rental fleet, the construction of our global headquarters building, and information technology projects and purchases.


36

Senior Secured Credit Facility

The following table sets forth the amounts owed under the Senior Secured Credit Facility, the effective interest rates on such outstanding amounts, and the amount available for additional borrowing thereunder, as of September 30, 2013 (dollars in thousands):
Senior Secured Credit Facility
 
Maturity
Date
 
Effective
Interest
Rate
 
Amount
Outstanding (1)
 
Amount Available
for Additional
Borrowing
 
Senior Revolving Credit Facility
 
November 2016
 
—
%
 
$
—

 
$
189,334

(2) 
Senior Dollar Term D-1 Credit Facility
 
May 2018
 
5.00
%
(3) 
1,569,507

 
—

 
Senior Euro Term D-1 Credit Facility
 
May 2018
 
5.59
%
(3) 
321,153

 
—

 
Senior Term D-2 Credit Facility
 
November 2016
 
4.54
%
(3) 
314,479

 
—

 
   Total
 
 
 
 
 
$
2,205,139

 
$
189,334

 
_____________________
(1)
Amount outstanding includes the original issue discount.
(2)
At September 30, 2013, the amount available under the Revolving Credit Facility reflected a reduction of $10.7 million of letters of credit issued by banks which are party to the Senior Secured Credit Facility. In addition, we have $3.5 million of letters of credit issued by a bank not party to the Senior Secured Credit Facility.
(3)
The effective interest rate includes the effect of the original issue discount. Excluding the original issue discount, our nominal interest rate as of September 30, 2013 was 4.50% on the Senior Dollar Term D-1 Credit Facility, 4.75% on the Senior Euro Term D-1 Credit Facility and 4.00% on the Senior Term D-2 Credit Facility.

Senior Secured Credit Facility

On June 14, 2013, we entered into Amendment No. 2 to our senior credit facility. As a result of the amendment we created new classes of Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans, having the same rights and obligations as the Dollar Term C-1 Loans, Euro Term C-1 Loans and Term C-2 Loans as set forth in the Credit Agreement and Loan Documents, except as revised by the amendment. In connection with the amendment, Dollar Term C-1 Loans, Euro Term C-1 Loans and Term C-2 Loans were refinanced with Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans, respectively. Amounts outstanding under the Dollar Term D-1 Loans, the Term D-2 Loans and the Revolving Credit Facility (other than swing-line loans and unreimbursed drawings on letters of credit) bear interest, at our option, at a rate equal to either the base rate or the eurocurrency rate, in each case plus an applicable margin. Amounts outstanding under the Euro Term D-1 Loans bear interest at the eurocurrency rate, and swing-line loans and unreimbursed drawings on letters of credit bear interest at the base rate. As a result of Amendment No. 2, the new applicable margins are (i) for eurocurrency rate loans that are Dollar Term D-1 Loans, 3.50%, (ii) for base rate loans that are Dollar Term D-1 Loans, 2.50%, (iii) for eurocurrency rate loans that are Euro Term D-1 Loans, 3.75%, (iv) for base rate loans that are Euro Term D-1 Loans, 2.75%, (v) for eurocurrency rate loans that are Term D-2 Loans, 3.00%, and (vi) for base rate loans that are Term D-2 Loans, 2.00%. The Term D loans will have a eurocurrency rate floor of 1.00% and a base rate floor of 2.00%.

In connection with our acquisition of Systagenix, we borrowed $350.0 million of incremental term D-1 loans (the "Incremental Loans") incurred pursuant to Amendment No. 3 to our Senior Secured Credit Facility, dated as of October 28, 2013. The Incremental Loans were issued at a discount of $0.4 million. The interest rate and all other terms are identical to our previously-existing Dollar Term D-1 Loans.

10.5% Second Lien Senior Secured Notes

In November 2011, we issued $1.75 billion aggregate principal amount of 10.5% Second Lien Notes due 2018. Interest on the 10.5% Second Lien Notes accrues at the rate of 10.50% per annum and is payable semi-annually in cash on each May 1 and November 1, beginning on May 1, 2012, to the persons who are registered holders at the close of business on April 15 and October 15 immediately preceding the applicable interest payment date. The 10.5% Second Lien Notes were issued at a discount resulting in an effective interest rate of 10.87%. Under the terms of the registration rights agreements entered into with respect to these notes, additional interest was accrued at a rate of 0.25% and 0.50% from November 4, 2012 to February 4, 2013 and February 5, 2013 to March 15, 2013, respectively, due to delays in the effectiveness of our registration statement.


37

12.5% Senior Unsecured Notes

In November 2011, we issued $750.0 million aggregate principal amount of senior 12.5% Unsecured Notes due 2019; $612.0 million of which are still outstanding. Interest on the 12.5% Unsecured Notes accrues at the rate of 12.50% per annum and is payable semi-annually in cash on each May 1 and November 1, beginning on May 1, 2012, to the persons who are registered holders at the close of business on April 15 and October 15 immediately preceding the applicable interest payment date. The12.5% Unsecured Notes were issued at a discount resulting in an effective interest rate of 12.62%. Under the terms of the registration rights agreements entered into with respect to these notes, additional interest was accrued at a rate of 0.25% and 0.50% from November 4, 2012 to February 4, 2013 and February 5, 2013 to March 15, 2013, respectively, due to delays in the effectiveness of our registration statement.

Convertible Senior Notes

In 2008, we issued $690.0 million aggregate principal amount of 3.25% convertible senior notes due 2015.  The Convertible Notes are governed by the terms of an indenture dated as of April 21, 2008 (the “Convertible Notes Indenture”). As a result of the Merger, the holders of the Convertible Notes have the right to require us to repurchase some or all of their Convertible Notes as provided in the Convertible Notes Indenture. The repurchase price is the principal amount of the Convertible Notes plus accrued interest. As of September 30, 2013, $101,000 aggregate principal amount of the notes remained outstanding.

Covenants

As of September 30, 2013, we were in compliance with all covenants under our Senior Secured Credit Facility, 10.5% Second Lien Notes, 12.5% Unsecured Notes, and the Convertible Notes.

For further information on our long-term debt, see Note 6 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

Interest Rate Protection

At September 30, 2013 and December 31, 2012, we had three interest rate swap agreements to convert $1.5 billion of our outstanding variable rate debt to a fixed rate basis. These agreements become effective on December 31, 2013. Once effective, the aggregate notional amount decreases quarterly by amounts ranging from $1.7 million to $56.4 million until maturity. As of September 30, 2013 and December 31, 2012, we had interest rate cap agreements with remaining notional amounts of $1.6 billion that effectively limits the eurocurrency rate to 2% on a portion of the borrowings under our Senior Secured Credit Facility. Our interest rate protection agreements have not been designated as hedging instruments, and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period.

For further information on our interest rate protection agreements, see Note 6 of the notes to the condensed consolidated financial statements.

Contractual Obligations
There have been no material changes, outside of the ordinary course of business, in our outstanding contractual obligations since December 31, 2012.

38


OTHER MATTERS
We are party to lawsuits arising in the ordinary course of our business. Additionally, the manufacturing and marketing of medical products necessarily entails an inherent risk of product liability claims. We maintain multiple layers of product liability insurance coverage and we believe these policies and the amounts of coverage are appropriate and adequate. For additional discussion of our legal proceedings, see Note 8 of the notes to the condensed consolidated financial statements.

The U.S. and global economies continue to show signs of weakness. We believe the economic downturn may generally decrease hospital census and the demand for elective surgeries. Also, the global financial crisis, continuing high levels of unemployment and general economic uncertainties have made it more difficult and more expensive for hospitals and health systems to obtain credit which may contribute to pressures on their operating margins. We believe that rising unemployment reduces the number of individuals covered by private insurance which has resulted in a noticeable increase in our charity-care placements and may increase the cost of uncompensated care for hospitals. Higher unemployment may also result in a shift in reimbursement patterns as unemployed individuals switch from private plans to public plans such as Medicaid or Medicare. If the economic downturn persists and unemployment remains high or increases, any significant shift in coverage for the unemployed may have an unfavorable impact on our reimbursement mix and may result in a decrease in our overall average unit prices.
 
For the year ended December 31, 2012, U.S. Medicare placements of our NPWT products represented approximately 9.6% of our total revenue. In the future, KCI's revenue from U.S. Medicare placements of NPWT products is expected to be subject to Medicare’s durable medical equipment competitive bidding program. On January 30, 2013, Centers for Medicare and Medicaid Services (“CMS”) announced new reimbursement rates for Medicare patients in the home, which become effective July 1, 2013. This program resulted in an average reimbursement decline of 41% for NPWT across 91 major metropolitan areas, which represent approximately 40% of our U.S. Medicare Part B business. CMS's DME Competitive Bidding Round One Re-Compete program will impact an additional 9 areas, beginning January 1, 2014, with a similar reimbursement decline of 42%. Additionally, in March 2013, CMS announced that sequestration cuts of 2% will apply to all Medicare Part A and B fee-for-service payments, including items under Medicare competitive bidding contracts, beginning April 1, 2013. CMS applies the 2% reduction to all claims after determining coinsurance and any applicable deductible and Medicare secondary payment adjustments. The sequestration cut is in place for 10 years (until 2021) unless Congress acts.
Critical Accounting Estimates
For a description of our critical accounting estimates, please see our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 under the heading Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates."

Recently Issued Accounting Standards

In January 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-01 “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities." The objective of this guidance is to clarify offsetting disclosures that apply to accounting for derivatives and hedging, including bifurcated embedded derivatives, repurchase agreements, reverse repurchase agreements and securities lending transactions. This guidance is effective for fiscal years and interim periods beginning on or after January 1, 2013. The adoption of this update did not have a material impact on our results of operations, financial position or disclosures.

In January 2013, the FASB issued ASU No. 2013-02 “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." The objective of this guidance is to improve reporting of reclassifications out of accumulated other comprehensive income. The guidance does not change current requirements for reporting net income or other comprehensive income in financial statements. The guidance requires an entity to provide information about amounts reclassified out of accumulated other comprehensive income by component, and present either in the income statement or notes, significant amounts reclassified by the respective line items of net income. For public entities, this guidance is effective for reporting periods beginning after December 15, 2012. The adoption of this update did not have a material impact on our results of operations, financial position or disclosures.

39


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including fluctuations in interest rates and variability in currency exchange rates. There have been no material changes from the risk factors disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012. For a description of our policies, procedures and internal processes governing our management of market risk and the use of financial instruments to manage our exposure to such risk, please see our Annual Report for the fiscal year ended December 31, 2012 under the heading “Quantitative and Qualitative Disclosures About Market Risk.”


ITEM 4.     CONTROLS AND PROCEDURES

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

Changes in Internal Control over Financial Reporting. There have not been any changes in our internal control over financial reporting (as such term is defined by paragraph (d) of Rule 13a-15) under the Exchange Act, during the third fiscal quarter of 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


40



PART II - OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS
Incorporate in this Item 1, by reference, are the legal proceedings described in note 8 of the notes to condensed consolidated financial statements included in this report under the heading "Commitments and Contingencies: Legal Proceedings."


ITEM 1A.      RISK FACTORS

Except with respect to the following new risk factors described below, there have been no material changes from the risk factors disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012.
We may not recognize the benefits of the Systagenix Acquisition.

We may not realize the expected benefits of the Systagenix Acquisition because of integration difficulties and other challenges. The success of the Systagenix Acquisition will depend, in part, on our ability to realize all or some of the anticipated synergies and other benefits from integrating Systagenix's business with our existing businesses. The integration process may be complex, costly and time-consuming. The difficulties of integrating the operations of Systagenix's business include, among others:
    
•failure to implement our business plan for the combined business;
•
unanticipated issues in integrating manufacturing, logistics, information, communications and other systems;
•
possible inconsistencies in standards, controls, procedures and policies, and compensation structures between Systagenix's structure and our structure;
•failure to retain key customers and suppliers;
•unanticipated changes in applicable laws and regulations;
•failure to retain key employees;
•operating risks inherent in Systagenix's business and our business; and
•unanticipated issues, expenses and liabilities.

We may not be able to maintain the levels of revenue, earnings or operating efficiency that each of KCI and Systagenix had achieved or might achieve separately. In addition, we may not accomplish the integration of Systagenix's business smoothly, successfully or within the anticipated costs or time frame. Moreover, the markets in which Systagenix operates may not experience the growth rates expected and any further economic downturn affecting Europe could negatively impact Systagenix's business. If we experience difficulties with the integration process or if the Systagenix business or the markets in which it operates deteriorate, the anticipated cost savings, growth opportunities and other synergies of the Systagenix Acquisition may not be realized fully, or at all, or may take longer to realize than expected. In such case, our business, financial condition and results of operations may be negatively impacted.

We face risks associated with the Share Purchase Agreement in connection with the Systagenix Acquisition.

In connection with the Systagenix Acquisition, we will be subject to substantially all the liabilities of Systagenix that are not satisfied on or prior to the closing date. There may be liabilities that we underestimated or did not discover in the course of performing our due diligence investigation of Systagenix. Under the Share Purchase Agreement, the Seller has agreed to provide us with a limited set of representations and warranties. Our sole remedy from the Seller for any breach of those representations and warranties is an action for indemnification. A portion of the purchase price will be held in escrow following the closing date to satisfy indemnification claims that we may have under the Share Purchase Agreement.



41


ITEM 6. EXHIBITS
A list of all exhibits filed or included as part of this quarterly report on Form 10-Q is as follows:
 
 
Exhibit
Number
Description
3.1
Declaration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.2
Certificate of Registration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.4 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.3
Amended and Restated Limited Partnership Agreement of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
†31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 13, 2013.
†31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 13, 2013.
†32.1
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated November 13, 2013.
 
 
 
†      Exhibit filed herewith.


42

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Antonio, State of Texas on November 13, 2013.
 
CENTAUR GUERNSEY L.P. INC.
 
(REGISTRANT)
 
 
 
Date: November 13, 2013
By:
/s/ Joseph F. Woody
 
 
Joseph F. Woody
 
 
Principal Executive Officer
 
 
(Duly Authorized Officer)
 
 
 
 
 
 
Date: November 13, 2013
By:
/s/ Robert P. Hureau
 
 
Robert P. Hureau
 
 
Principal Financial Officer
 
 
(Duly Authorized Officer)



43

EXHIBITS

Exhibit
Number
Description
3.1
Declaration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.2
Certificate of Registration of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.4 to our Registration Statement on Form S-4 filed on October 1, 2012).
3.3
Amended and Restated Limited Partnership Agreement of Centaur Guernsey L.P. Inc. (filed as Exhibit 3.3 to our Registration Statement on Form S-4 filed on October 1, 2012).
†31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 13, 2013.
†31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 13, 2013.
†32.1
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated November 13, 2013.
 
 
 
†      Exhibit filed herewith.



44