10-K 1 a201310k.htm 10-K 2013 10K

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

FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to section 12(g) of the Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
                                                                                                                                                                         Yes   ____         No    X       

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
                                                                                                                                                                         Yes   ____         No     X       

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   ____           No    X       
                                                                                                                                                                      
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  X    

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 March 7, 2014, 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.   
                                                                                                                                                           
Documents Incorporated by Reference: None



TABLE OF CONTENTS

CENTAUR GUERNSEY L.P. INC.


 
 
 
Page No.
 
 
 
 
PART I.
Item 1.
Business
 
Item 1A.
Risk Factors
 
Item 1B.
Unresolved Staff Comments
 
Item 2.
Properties
 
Item 3.
Legal Proceedings
 
Item 4.
Mine Safety Disclosures
 
 
 
 
PART II.
Item 5.
Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
 
Item 6.
Selected Financial Data
 
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risks
 
Item 8.
Financial Statements and Supplementary Data
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
Item 9A.
Controls and Procedures
 
Item 9B.
Other Information
 
 
 
 
PART III.
Item 10.
Directors, Executive Officers and Corporate Governance
 
Item 11.
Executive Compensation
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
 
Item 13.
Certain Relationships and Related Transactions and Director Independence
 
Item 14.
Principal Accounting Fees and Services
 
 
 
 
PART IV.
Item 15.
Exhibits and Financial Statement Schedules
 
 
 
 
SIGNATURES
 
 




2


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K. Except as required under federal securities laws and the rules and regulations of the SEC, we do not have any intention to update any forward-looking statements to reflect events or circumstances arising after the date of this Annual Report on Form 10-K, whether as a result of new information, future events or otherwise.
TRADEMARKS, SERVICE MARKS AND COPYRIGHTS
3M® Tegaderm® is a licensed trademark of 3M Company; GRAFTJACKET® is a licensed trademark of Wright Medical Technology Inc; Novadaq®, SPY®, and SPY ELITE® are licensed trademarks of Novadaq Technologies, Inc.; and Prontosan® Wound Irrigation Solution is a licensed trademark of B. Braun Medical, Inc. Unless otherwise indicated, all other trademarks appearing in this Annual Report on Form 10-K are proprietary to KCI Licensing, Inc., LifeCell Corporation or Systagenix Wound Management IP Co B.V., their affiliates and/or licensors. The absence of a trademark or service mark or logo from this Annual Report on Form 10-Kdoes not constitute a waiver of trademark or other intellectual property rights of KCI Licensing, Inc., Systagenix Wound Management IP Co B.V., or LifeCell Corporation, their affiliates and/or licensors.

MARKET AND INDUSTRY DATA AND FORECASTS

This Annual Report on Form 10-K includes industry data and forecasts that we obtained from industry publications and surveys, public filings and internal company sources. Industry publications and surveys and forecasts generally state that the information contained therein has been obtained from sources we believe to be reliable. Statements as to our ranking, market position and market estimates are based on independent industry publications, government publications, third party forecasts and management’s good faith estimates and assumptions about our markets and our internal research. We have not independently verified such third-party information nor have we ascertained the underlying economic assumptions relied upon in those sources. While we are not aware of any misstatements regarding our market, industry or similar data presented herein, such data involve risks and uncertainties and are subject to change based on various factors, including those discussed under the headings “Cautionary Statement Regarding Forward-Looking Statements” and “Risk Factors” in this Annual Report on Form 10-K.
DEFINED TERMS
The following terms are used in this Annual Report on Form 10-K 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. was merged with Chiron Merger Sub, Inc. (“Merger Sub”), a direct subsidiary of Chiron Holdings, Inc. (“Holdings”) and an indirect subsidiary of Centaur Guernsey L.P. Inc.
the term “Sponsors” means collectively investment funds advised by Apax Partners (“Apax”) and controlled affiliates of Canada Pension Plan Investment Board (“CPPIB”) and the Public Sector Pension Investment Board (“PSP Investments”) and certain other co-investors who control Centaur.
the term “KCI” means Kinetic Concepts, Inc. and its subsidiaries.
the term “LifeCell” means LifeCell Corporation and its subsidiaries.
the term “Systagenix” means “Systagenix Wound Management B.V., its subsidiaries, and its U.S.-based affiliate, Systagenix Wound Management (US), Inc.

3


PART I
ITEM 1. BUSINESS
Company Overview and Corporate Organization

Centaur is a non-operating holding company whose business is comprised of the operations of wholly-owned subsidiaries that commercialize our advanced wound therapeutics and regenerative medicine products. Centaur is controlled by our Sponsors. We operate our advanced wound therapeutics and regenerative medicine businesses through subsidiaries of KCI, LifeCell and Systagenix. Our global headquarters is based in San Antonio, Texas.

We are a leading global medical technology company devoted to the development and commercialization of innovative products and therapies designed to improve 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, long-term care facilities and patients’ homes. We are engaged in the rental and sale of our products throughout the United States and in over 75 countries worldwide through direct sales and indirect operations. Our primary businesses serve the advanced wound therapeutics and regenerative medicine markets.

We have two reportable operating segments which correspond to our two businesses: Advanced Wound Therapeutics ("AWT") and Regenerative Medicine. Our AWT business is conducted by KCI and its subsidiaries, including Systagenix, while our Regenerative Medicine business is conducted by LifeCell and its subsidiaries. We have two primary geographic regions: the Americas, which is comprised principally of the United States and includes Canada, Puerto Rico and Latin America; and EMEA/APAC, which is comprised of Europe, the Middle East, Africa and the Asia Pacific region.
For the year ended December 31, 2013, we generated revenue of $1.759 billion. Our AWT and Regenerative Medicine businesses generated approximately 73.4% and 26.6% of our total 2013 revenue, respectively. Revenue from our Americas and EMEA/APAC operations accounted for 80.6% and 19.4% of our total 2013 revenue, respectively.
As of December 31, 2013, we had approximately 5,550 employees worldwide, the majority of whom are located in North America. Other major concentrations of employees are located in Europe and at our manufacturing, research and development and engineering operations based in the U.K., Ireland and Belgium.

Competitive Strengths

We believe we have the following competitive strengths:
Leading Brands in Attractive Markets
We have built leading brands in the large and growing advanced wound therapeutics and regenerative medicine markets. Our product portfolio includes several top global brands such as V.A.C.®, AlloDerm®, Strattice® and Promogran®. Other well-regarded brands that are gaining adoption and market share include advanced devices such as VeraFlo™, Prevena® and ABThera®, as well as our Adaptic® and Tielle® wound dressings.
Complete Solutions Across the Continuum of Care
We have a portfolio of highly complementary products that can be used together or in sequence to address patient needs at different stages of healing from the operating room, to the hospital ward and in the home. This allows us to co-market and cross-sell our products across business lines, treatment protocols and care settings. Our advanced devices such as ABThera and Prevena are often used to help manage recovery and reduce complications from breast reconstruction and hernia repair surgical procedures in our Regenerative Medicine business. In addition, our advanced wound dressings such as Adaptic and Promogran are often used before, during and after V.A.C. therapy for the management of complex wounds.
Global Reach and Broad Customer Relationships
Our global sales operations are geographically diverse with direct sales in over 25 countries and indirect operations in an additional 50 countries. Our global sales organizations have deep clinical experience and have fostered strong relationships with prescribers, patients, caregivers and payers over the past three decades by providing a high degree of clinical support, education and consultation. We have extensive relationships and long term agreements with large group purchasing organizations and managed

4


care payers that give us increased access to patients and healthcare facilities that utilize our products. We have a unique sales and service infrastructure that allows us to meet the needs of health care facilities, caregivers, patients and payers to better manage patient outcomes across all care settings.

Improving Clinical Outcomes Through Innovation
We have a 35-year history of innovation and commercialization of best-in-class products and therapies that deliver superior clinical outcomes for patients. We continue to be global pioneers in negative pressure devices, advanced wound dressings and regenerative medicine, creating and growing new markets based on our ability to identify and address unmet clinical needs with products that advance the practice of medicine. We make substantial investments in developing clinical and economic data that demonstrate the superior clinical efficacy and outstanding value proposition of our products and therapies.
High Degree of Customer Satisfaction
Our focus on meeting customer needs has delivered high levels of customer satisfaction over a long period of time. We are dedicated to solving clinical problems for patients and caregivers, while at the same time reducing total health care costs for our customers and payers. We leverage a comprehensive set of skills and systems through our Advantage Center operation in the United States to manage customer service and reimbursement activities which provide our customers and payers with superior service. We have an extensive field service network and provide 24-hour technical and clinical support for our customers with an infrastructure designed to allow us to meet the most emergent medical needs of our customers and patients.
Our Business Strategy
We intend to execute on our vision of sustaining leadership positions in each of our businesses by focusing on the following strategic priorities:
Growing Volumes in Core Markets
We seek to build on leadership positions in our core markets of negative pressure wound therapy, advanced wound dressings, breast reconstruction and hernia repair. Demographic trends and increased incidence of chronic disease states are increasing demand in our core markets. We will utilize our best-in-class clinical and economic outcomes to meet expanding demand and grow volumes through increased adoption and penetration of our products, while leveraging our sales force channels across business lines to cross-promote our complementary portfolio of products. We offer flexible business and pricing models with the aim of increasing customer retention and market share gains.

Driving Adoption of Expansion Products
We have launched several impactful new technologies in the past two years, such as V.A.C. VeraFlo®, Prevena, ABThera, Revolve™ and CelluTome®, and we plan new products and line extensions across our product portfolio. We drive adoption of these expansion products by focusing on product differentiation and superior clinical efficacy. We continue to invest in new clinical data to drive therapy adoption and gain access to expanded medical procedures. Our clinical profile coupled with our economic value proposition provide a catalyst for increased adoption of our newer products and therapies.

Investing in Geographic Expansion

We are making substantial investments in geographic expansion to establish our products and therapies as leaders in high-growth markets to drive our continued success. In our AWT business, we continue to focus and invest in high-growth geographic segments such as Japan, Brazil, China, India, Turkey, South Africa and the Middle East. In Regenerative Medicine we are investing in the development of the breast reconstruction and hernia repair markets in Europe while evaluating new geographies. We seek to create and expand sustainable operations in these high-growth geographic segments while we expand availability of our product offerings and develop value brands and business models tailored to local market needs.

Portfolio Innovation
Our highly-skilled innovation teams place a great deal of emphasis on identifying the unmet needs of patients and care-givers, and we invest in projects that will deliver impactful clinical and economic benefits. We have a successful track record spanning over 35 years in commercializing novel technologies that change the clinical practice of medicine by addressing the critical unmet needs of clinicians, restoring the well-being of their patients and helping to reduce the overall cost of patient care.

5


  
Growing Through Acquisitions

We augment our organic innovation and development with acquisitions of new technologies and product platforms that are a good strategic fit for our business. We intend to build on our leadership positions through the evaluation of and investment in adjacent or enabling technologies and synergistic growth opportunities. We plan to leverage the strength of our core businesses and sales channels to commercialize newly-acquired technologies and product lines to meet the needs of patients and caregivers worldwide.

Operational Excellence

In an effort to implement our long-term strategy, our management team is focused on operational excellence, with a goal of improved operations and management systems which transform us into a more agile, progressive and global enterprise. We maintain a low cost global manufacturing footprint which helps drive profitability and strong cash flows. We continue to identify and implement efficiencies in our systems and operations through standardization and automation that translate into reduced costs and more effective decision-making.
Advanced Wound Therapeutics Business

Our AWT business is focused on the development and commercialization of advanced devices and advanced wound dressings and accounted for approximately $1.291 billion or 73.4% of our global revenue in 2013. Our AWT business is primarily engaged in commercializing several technology platforms, including negative pressure wound therapy (“NPWT”), negative pressure surgical management (“NPSM”) and epidermal harvesting. Our AWT dressings are used for the management of chronic and acute wounds. Our AWT business is primarily conducted by KCI and its operating subsidiaries, including Systagenix.

Advanced Devices

We are a global market leader in the commercialization of NPWT products across all care settings and the majority of our advanced wound therapeutics revenue is generated with NPWT products. Our NPWT product portfolio is built upon our proprietary V.A.C. technology, which promotes wound healing by delivering controlled and regulated negative pressure (a vacuum) to the wound bed through an open-cell foam dressing. Since its introduction, our V.A.C. technology has changed the way wounds are treated and managed. With more published clinical evidence than any competing offering, V.A.C. has been selected by prescribers as the treatment of choice for more than 8 million patients worldwide. Key brands within our NPWT product portfolio include the V.A.C.Ulta® with VeraFlo™, InfoV.A.C®, ActiV.A.C.®, and V.A.C.Via®.
 
Over the last 20 years, we have worked with the medical community to develop a significant body of clinical evidence demonstrating the superior efficacy of our NPWT products and we believe our products provide a significant technological advantage to patients and caregivers which helps reduce complications at a lower overall cost of care. Since we first introduced V.A.C. in 1996, over 870 clinical studies proving and supporting the clinical efficacy of our V.A.C. wound healing and tissue repair systems have been published in peer reviewed medical journals such as The Lancet, the International Wound Journal, the Journal of Wound Care and the Annals of Plastic Surgery. A recent study published in the Plastic and Reconstructive Surgery journal showed reduction in operating room visits and a decrease in hospital length of stay when using VeraFlo with Prontosan compared to V.A.C. in wounds that required hospital admission and surgical debridement. Encouraging results have also been noted in a published study using VeraFlo with saline instillation in the International Wound Journal. Recent compelling economic outcomes data on over 15,000 NPWT patient claims provided by Optum LifeSciences showed that total wound related costs for patients treated with our NPWT products cost 13% less to treat overall compared to patients treated by competitors' NPWT products. In addition, independent consensus conferences have issued guidelines for the use of NPWT for diabetic foot wounds, pressure ulcers, complex chest wounds, hospital-treated wounds and open abdominal wounds.

Our NPSM business is a rapidly growing franchise with products designed for use in the surgical setting. Our NPSM products employ negative pressure for use in the surgical setting for the management of complex open abdominal procedures and for the management of clean, closed incisions. Our key brands in NPSM are ABThera for the open abdomen and Prevena for incision management. Recent clinical studies have shown significant advantages to patients with our NPSM products. For example, recent clinical data on Prevena published in the Journal of Vascular Surgery demonstrated a significant decrease in the incidence of groin surgical site complications, and recent clinical data on ABThera published in the World Journal of Surgery states that a prospective cohort study observed a 50% reduction in 30-day all cause mortality and an increased 30-day primary fascial closure rate in patients who received ABThera versus the traditional Barker's vacuum pack technique for treatment of the open abdomen.


6


In 2013, we launched our CelluTome technology, a product designed for epidermal skin grafting with limited donor-site morbidity in the office or outpatient setting with minimal discomfort. This technology enables a consistent and reproducible harvest of autologous grafts of uniform thickness that are immediately applied to the wound bed. The CelluTome device utilizes gentle warmth and negative pressure to create epidermal microdomes which are then harvested and secured to a dressing. This allows for a user-friendly method for applying the grafts directly to the recipient site. This technology is designed to minimize pain and donor site trauma, with no need for anesthesia.

Advanced Wound Dressings
    
Our AWT business markets a comprehensive portfolio of advanced wound dressings which are focused on addressing chronic and acute wounds. Our dressings are also highly complementary to our wound care devices and therapies. Our advanced wound dressings are often used before, during and after the use of our NPWT therapies at various stages of healing. Our dressings are designed to maintain a moist wound healing environment and to protect the wound site from infection while managing exudate, pain and odor. Our dressings utilize a variety of materials and technologies such as collagen, foam, hydropolymer, silicon, hydrocolloids, hydrogels, alginates and non-adherent layers. We also incorporate antimicrobial materials into specialized dressings, such as silver and iodine.

Our Promogran brand is a market leading collagen dressing which helps promote wound healing by providing the benefits of collagen on the wound and maintaining a moist wound healing environment. In published scientific studies, Promogran has been proven to help restore the balance of the wound microenvironment, promoting granulation tissue and helping the wound close. Our Promogran line of products are often used for the treatment of diabetic foot ulcers, venous leg ulcers, and pressure ulcers, as well as traumatic and surgical wounds, all of which can be complex and difficult to manage. The clinical benefits of Promogran are further enhanced in our Promogran Prisma® line of dressings with the use of ionic silver, which helps protect against infection. In clinical practice Promogran Prisma has been demonstrated to protect against infection and promote healing in diabetic foot ulcers. Our Tielle foam dressings, Adaptic contact layer dressings, and Silvercel® antimicrobial dressings are also leading brands designed to provide patient comfort and maintain an optimal moist wound healing environment. Adaptic Touch® is often used in conjunction with NPWT to enhance the comfort and safety for patients in certain applications.

Customers

In U.S. acute care and long-term care facilities, we contract with healthcare facilities individually or through proprietary or voluntary group purchasing organizations (“GPOs”) that represent large numbers of hospitals and long-term care facilities. We bill these facilities directly for the rental and sale of our products. In the U.S. home care setting, we provide our AWT products and therapies to patients in the home and bill third-party payers, such as Medicare and private insurance, directly. For 2013, 2012 and 2011, U.S. Medicare placements accounted for 11%, 13% and 12%, of AWT revenue, respectively. In the U.S., we primarily distribute our advanced wound dressings through independent distributors. None of our individual customers or third party payers, other than U.S. Medicare, accounted for 10% or more of total AWT revenues for 2013, 2012 or 2011. Outside of the U.S., most of our AWT revenue is generated in the post-acute and acute care settings on a direct billing basis, or through sales to distributors in countries where we have indirect operations. Sales and rentals of AWT products accounted for approximately 73.4% of our total revenue in 2013. Geographically, the Americas and EMEA/APAC represented 75.0% and 25.0%, respectively, of total 2013 AWT revenue.

Sales and Marketing
Our AWT products are utilized in acute care hospitals and facilities, long-term care facilities and in the home. Because physicians and nurses are critical to the adoption and use of our advanced devices and dressings, a major element of our marketing focus is to educate and train these medical practitioners in the application of our products. We train clinicians on the specific knowledge necessary to drive optimal clinical outcomes, restore patient well-being and reduce the cost of patient care. Our AWT sales organizations include clinical consultants, all of whom are healthcare professionals. Their principal responsibilities are to make product rounds, consult on complex cases, train home health agencies and educate facility staff on the use of our therapies.

Competition

Key competitors to our AWT business include Convatec, Molnlycke, Spiracur, Genadyne, Hartmann, Coloplast and Smith & Nephew. In addition, there are several smaller regional companies that have introduced medical devices designed to compete with our products.

7


Seasonality
Historically, we have experienced a seasonal slowing of unit demand for our NPWT devices and related dressings beginning in the fourth quarter and continuing into the first quarter, which we believe has been caused by year-end clinical treatment patterns, such as the postponement of elective surgeries and increased discharges of individuals from the acute care setting around the winter holidays. We typically experience a slowing of demand for our AWT dressings in the fourth quarter. Although we do not know if our historical experience will prove to be indicative of future periods, similar slow-downs may occur in subsequent periods.
Regenerative Medicine Business    
Our Regenerative Medicine business is primarily focused on the development and commercialization of regenerative and reconstructive acellular tissue matrices for use in general and reconstructive surgical procedures to repair soft tissue defects. Key brands within our product portfolio include our human tissue based AlloDerm and porcine tissue based Strattice in various configurations designed to meet the needs of patients and caregivers. In addition to our acellular tissue matrices, our Regenerative Medicine business markets autologous fat grafting solutions, such as Revolve, and distributes SPY Elite, a real-time operating room-based tissue perfusion imaging system, both of which are complementary to our tissue matrix business. Regenerative Medicine accounted for approximately $468.2 million or 26.6% of our global revenue in 2013. The majority of our Regenerative Medicine revenue is generated in the United States and we continue efforts to penetrate new geographies. Our Regenerative Medicine business is primarily conducted by our LifeCell operating subsidiaries.

Our tissue matrices enjoy leadership positions in post-mastectomy breast reconstruction and complex abdominal wall repair. With recent advances in both technology and surgical technique, more women are choosing breast reconstruction procedures post-mastectomy and AlloDerm is a best-in-class choice for tissue reinforcement for device-based procedures utilizing tissue expanders and breast implants. AlloDerm has been used successfully in more than one million grafts and implants to date, and its clinical performance in breast reconstruction post-mastectomy has been reported in over 100 peer-reviewed articles, which is more than all competitive products combined.

Strattice is used primarily by surgeons to reinforce complex abdominal wall repairs; particularly the challenging ventral hernia repairs often encountered in the growing number of patients with multiple comorbidities and prior hernia repair surgeries. Recent clinical studies have shown that the use of Strattice in these difficult cases reduces the incidence of postoperative complications, including mesh explantation, infection, and small bowel obstruction. Additionally, an analysis from a U.S. national database of public and private claims reported that the use of biological matrices, such as Strattice, resulted in up to a five-fold decrease in complication rates and a two-fold decrease in total costs over an 18-month time period for the average complex abdominal wall reconstruction patient.

Our proprietary biomaterial processing for both AlloDerm and Strattice removes cells from dermal tissue, which minimizes patient rejection and enables our tissue matrices to ultimately transition into host tissue for a strong, natural repair. This unique processing allows our tissue matrices to support tissue regeneration without scar formation and allows for rapid revascularization, white cell migration, and cell repopulation, all of which may lead to increased resistance to infection at the surgical site. This is a key differentiator for our products when compared to synthetic implants and other competitive offerings. Our tissue matrix products also offer ease of use and minimize risk of some complications, including adhesions to the implant.

In addition to our tissue matrix products, we are the exclusive distributor in North America and other select geographies for both SPY and Revolve. SPY enables surgeons to see blood perfusion in tissue during surgical procedures, providing surgeons with real-time information that may be used to customize operative plans and optimize outcomes before the patient leaves the operating table. Revolve is a single-use, high volume autologous fat processing system engineered to yield rapid and reliable results. We expect to increase our presence and penetration into the autologous fat grafting market, and achieve sales and marketing synergies with existing and future Revolve customers, through the commercialization of the adipose tissue injector device recently acquired from TauTona.

Customers

Our tissue matrices, autologous fat grafting, and perfusion imaging products are used primarily by plastic, general, and colorectal surgeons. Hospitals and ambulatory surgical centers (“ASCs”) are the primary purchasers of our products, and we contract with healthcare facilities individually or through proprietary hospital groups, integrated delivery networks and GPOs that represent large numbers of hospitals and long-term care facilities. None of our customers or third party payers accounted for more than 10% or more of total Regenerative Medicine revenues for 2013, 2012 or 2011. Geographically, the Americas and EMEA/APAC represented approximately 95.8% and 4.2%, respectively, of total 2013 Regenerative Medicine revenue.

8



Sales and Marketing

We currently market our Regenerative Medicine products in the United States primarily for abdominal wall repair, breast reconstruction post-mastectomy, general reconstruction and cosmetic applications through our direct sales and marketing organization. Since 2009, we have commercialized Strattice in 17 countries in our EMEA geographic region, where we have initially contracted directly with hospitals for the use of Strattice in complex abdominal wall repair and breast reconstruction. Our sales representatives in the U.S. and EMEA are responsible for interacting with primarily plastic surgeons and general surgeons to educate them regarding the use and potential benefits of our tissue-related products. We are considered the benchmark in the industry for delivering professional medical education, including hands-on bioskill labs, national and international conferences, trade shows, and medical symposia featuring some of the most well-regarded and influential surgeons in their respective fields. We also participate in numerous national fellowship programs with world-renowned institutions.
 
In addition to our direct sales and marketing efforts, we partner with several companies for the sales and marketing of our acellular tissue matrices in dental, orthopedic, and urogynecoligical procedures. These partners include BioHorizons Implant Systems, Inc., Wright Medical, Boston Scientific, and Tornier for the distribution and marketing of our tissue matrix products in the United States and certain international markets. These partnered relationships accounted for approximately $14.3 million or 0.8% of our total 2013 revenue. LifeCell also manufactures GRAFTJACKET for wounds, which is distributed by our AWT business.
Competition
Our Regenerative Medicine products compete with various commercially available products made from synthetic materials or biologic materials of human or animal tissue origin. Our tissue matrix products compete with products marketed by such companies as Covidien, C.R. Bard Inc., Johnson & Johnson, Allergan, Atrium, W.L. Gore & Associates, Cook Inc., TEI Biosciences Inc., and Baxter International Inc.

International

Our AWT and Regenerative Medicine global sales operations are geographically diverse with direct sales in over 25 countries and indirect operations in an additional 50 countries. The principal markets, products and methods of distribution in our businesses' international operations vary with market size and stage of development. Our principal international markets are currently in Canada, western Europe, Japan and the Middle East, and we are currently expanding sales and marketing resources in order to capitalize on opportunities in other markets, such as emerging markets in the Asia Pacific region and Latin America. Generally, we maintain a geographically-based sales organization that we believe provides greater flexibility in international markets. For the years ended December 31, 2013, 2012, and 2011 approximately 19.4%, 18.9% and 19.9%, respectively, of total revenue was derived from EMEA/APAC markets.

Our international operations are subject to certain financial and other risks, and international operations in general present complex tax and cash management challenges. Relationships with customers and effective terms of sale frequently vary by country. Trade receivable balances in most countries outside the United States generally are outstanding for longer periods than in the United States, particularly in Europe. Political and economic instability are also important business concerns due to the potential for rapidly changing business conditions and currency exposure. Foreign currency exchange rate fluctuations can affect income and cash flows of international operations. The company attempts to hedge some of these currency exposures to help reduce the effects of foreign exchange fluctuations on the business. For more information, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk”, Note 7 of the notes to consolidated financial statements and Item 1A. “Risk Factors” included in this Form 10-K.

Acquisitions and Divestitures

In January 2014, we acquired intellectual property for an advanced Adipose Tissue Injector ("ATI") for improved fat grating procedures from the TauTona Group, a medical device incubator based in Menlo Park, California. The ATI is a battery-powered, single-use tool that was built to deliver fat at a controlled rate, which reduces the complexity of performing injections and allows the surgeon to focus on placement. By managing the pressure and flow rates during injection, the ATI minimizes damage to the injected fat and efficiently delivers the tissue to the injection site. With the ATI, we are expanding our offering for reconstructive and cosmetic procedures utilizing fat grafting technology.

9


In the fourth quarter of 2013, we closed the acquisition of Systagenix, an established provider of advanced wound therapeutics products. The adjusted purchase price paid, net of cash and cash equivalents, was $478.7 million. The purchase price was funded using $350.0 million of incremental borrowings under our existing senior secured credit facility along with cash on hand. The Systagenix portfolio of innovative wound care products comprises the majority of our advanced wound dressings business, discussed above. Systagenix, formerly part of Johnson & Johnson, generated annual revenue of approximately $205.5 million in 2013. Financial results of Systagenix are included within our consolidated financial statements for the period subsequent to the acquisition date. Combining Systagenix's advanced wound dressings with our KCI wound care business and innovation pipeline will enable us to create additional value for customers by providing more complete solutions for patients and clinicians.

In the fourth quarter of 2012, we entered into an exclusive distribution agreement with the GID Group for Revolve in the U.S., Canada and Australia. Revolve is a single patient-use, high volume autologous fat processing system designed for surgeons interested in providing their patients with natural, volume enhancement solutions.

In the fourth quarter of 2012, we acquired CelluTome, a technology designed for epidermal skin grafting with limited donor-site morbidity in the office or outpatient setting with minimal discomfort. This technology enables a consistent and reproducible harvest of autologous grafts of uniform thickness that are immediately applied to the wound bed. The technology's value in skin grafting procedures makes it a strategic fit into our advanced wound therapeutics business.

In the fourth quarter of 2012, we completed the divestiture of our legacy KCI TSS business to Getinge AB. The TSS business was comprised of specialized therapeutic support systems, including hospital beds, mattress replacement systems, overlays and patient mobility devices. At the closing of the divestiture, Getinge paid approximately $247 million for the assets of the TSS business. At the time of the divestiture, we entered into a transition services agreement with Getinge pursuant to which we will continue to provide certain financial and information technology services during 2014. The historical results of operations of the disposal group, excluding the allocation of general corporate overhead, are reported as discontinued operations in the consolidated statements of operations.

In January 2011, we entered into an agreement to license Wright Medical Technology, Inc.’s GRAFTJACKET brand name, which we use in marketing the LifeCell acellular human dermal-based regenerative tissue matrix for wound applications such as diabetic foot ulcers and venous stasis ulcers. Patients can be treated with GRAFTJACKET as part of the overall treatment regimen in a variety of care settings, including outpatient wound care clinics, physicians’ offices, or hospitals. GRAFTJACKET may be used in conjunction with NPWT, providing a convenient option in caring for chronic wounds.
In September 2010, we entered into an exclusive sales and marketing agreement with Novadaq Technologies, Inc. for the distribution of Novadaq's SPY in certain specified North American surgical markets. SPY enables surgeons to see blood perfusion in tissue during surgical procedures, providing surgeons with real-time information needed to modify operative plans and optimize outcomes before the patient leaves the operating table. In November 2011, we entered into an expanded agreement with Novadaq for vascular applications in North America and certain other markets including Europe, the Middle East and Japan.
Suppliers, Operations and Manufacturing

We distribute our AWT products with direct service infrastructure in the U.S. as well as through third party logistics providers in the U.S. and other markets where we have direct operations. We primarily rely on independent distributors in many of our international markets who generally control the importation and marketing of our product within their territories. In the U.S., we primarily distribute our advanced wound dressings through independent distributors.

The manufacture of our AWT devices and disposables is conducted at our manufacturing facilities in Athlone, Ireland, Peer, Belgium, and the manufacturing facilities of third-party contract manufacturers in Mexico. The manufacture of our AWT dressings is primarily conducted at our manufacturing facility in Gargrave, England. We plan to leverage our existing infrastructure and manufacturing capabilities to expand internal production for our AWT devices, disposables and dressings in the future. Our manufacturing processes for our AWT devices involve producing final assemblies in accordance with a master production plan. Assembly of our devices is accomplished using metal parts, plastics, electronics and other materials and component parts that are primarily purchased from outside suppliers. Our manufacturing processes and quality systems are intended to comply with appropriate FDA and International Organization for Standardization (“ISO”) requirements. Component parts and materials are obtained from industrial distributors, original equipment manufacturers and contract manufacturers. The majority of parts and materials are readily available in the open market (steel, aluminum, plastics, fabrics, polymers, etc.) for which price volatility is relatively low. Many raw materials used for our advanced wound dressings are sole source or conducted on a purchase order basis. Since the acquisition of Systagenix, we have undertaken an effort to qualify second source suppliers for key materials.


10


Our Regenerative Medicine manufacturing operations are located at a single location in Branchburg, New Jersey, with primary warehousing and distribution being conducted at a separate location in the immediate vicinity of the manufacturing plant. Warehousing and distribution of products supporting our EMEA Regenerative Medicine business are conducted from a distribution center in the Netherlands. We maintain inventory of our tissue matrix products for direct sales, and we periodically ship product to our distributors, which they maintain in inventory until final sale. Our autologous fat grafting and tissue perfusion products are manufactured at third-party suppliers in the U.S. and Canada.

Our Regenerative Medicine business is dependent on the availability of sufficient quantities of raw materials, including donated human cadaveric tissue, porcine tissue and other materials required for tissue processing. Our xenograft tissue matrix products are made from porcine skin tissue. We have two qualified porcine tissue suppliers. Our primary porcine tissue source is supplied by three separate breeding herd farms that are isolated for biosecurity. Our allograft tissue matrix products are made from donated human dermal tissue. We obtain all of our donated human cadaveric tissue from multiple tissue banks and organ procurement organizations in the United States. These tissue banks and organ procurement organizations are subject to federal and state regulations. We require supplying tissue banks and organ procurement organizations to comply with the guidelines of, and be registered by, the FDA. The National Organ Transplant Act ("NOTA") does not apply to xenograft tissue products; however, our materials and porcine tissue suppliers are subject to extensive regulatory requirements applicable to their operations, including oversight and regulation by the USDA. Most of our critical raw materials have secondary sources of supply. Where they do not, materials and solutions inventories are adjusted to ensure business continuity in case of a supplier disruption, and we are currently in the process of identifying and validating secondary sources.

Intellectual Property

To protect our proprietary rights in our products, new developments, improvements and inventions, we rely on a combination of patents, copyrights, trademarks, trade secrets and other intellectual property rights, and contractual restrictions on disclosure, copying and transfer of title, including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties. We seek patent protection in the United States and abroad. Many of our products and services are offered under proprietary trademarks and service marks. We have patent rights relating to its existing and prospective products in the form of owned and licensed patents. Most of the patents in our patent portfolio have a term of 20 years from their date of priority. We hold more than 1,830 patents and have over 1,700 patent applications pending in the United States and in certain other countries that relate to aspects of the technology used in many of our products. We do not consider our business to be materially dependent upon any individual patent. For additional information see “Item 1A. Risk Factors” and Note 13 of the notes to the consolidated financial statements for the year ended December 31, 2013.

Research, Development and Clinical Sciences

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, and new applications of negative pressure technology and advanced wound dressings. Our research and development program is also leveraging our core understanding of biological tissues in order to develop biosurgery products in our Regenerative Medicine business. We continue to focus our efforts in developing new cost-effective products and technologies that result in superior clinical outcomes. One of our primary focuses for innovation is to gain greater insights into areas of high clinical needs, where we can bring new product solutions with novel technologies to help clinicians address these problems. In addition, we strive to improve the value proposition of our products by increasing their clinical and economic benefits and by improving their ease of use. Expenditures for research and development, including clinical trials, in each of the periods below, were as follows (dollars in thousands):

 
Year ended December 31,
 
Year ended December 31,
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
2013
 
2012
 
 
 
Successor
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
 
 
Research and development expenses
$
75,624

 
$
71,859

 
$
14,117

 
$
69,601



11


Working Capital Management
We maintain inventory parts, supplies and finished goods to support customer needs in our service centers, manufacturing facilities and distribution warehouses. Our payment terms with health care facilities and third-party payers, including Medicare and private insurance are consistent with industry standards A portion of our receivables relate to unbilled revenues arising in the normal course of business. A portion of our revenues remain unbilled for a period of time due to monthly billing cycles requested by our customers or due to our internal paperwork processing and compliance procedures regarding billing third-party payers.

Government Regulation and Other Considerations

Our products are subject to regulation by numerous domestic and foreign government agencies, including the United States Food and Drug Administration (‘‘FDA’’), and various laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of our products. We are also governed by federal, state, local and international laws of general applicability, such as those regulating employee health and safety and the protection of the environment. Overall, the scope and extent of domestic and foreign laws and regulations applicable to our business is increasing.

United States Regulation of Medical Devices

All of our medical devices sold in the United States are subject to the Federal Food, Drug, and Cosmetic Act as implemented and enforced by the FDA. The FDA and, in some cases, other government agencies administer requirements covering the design, development, testing, safety, effectiveness, manufacturing, labeling, promotion, advertising, distribution and post-market surveillance of our products. Unless an exemption applies, each medical device that we market must first receive either premarket notification clearance (by filing a 510(k) submission) or premarket approval (by filing a premarket approval application (“PMA”)) from the FDA. In addition, certain modifications made to marketed devices also may require 510(k) clearance or approval of a PMA supplement. The process of obtaining FDA clearance or approval of a medical device can be lengthy and costly. The FDA’s 510(k) clearance process usually takes from three to 12 months, but it can take longer. The process of obtaining PMA approval is much more costly, lengthy, and uncertain, and is generally preceded by the conduct of a well-controlled clinical study. The PMA review and approval process generally takes from one to three years, but it can take longer.

In addition to regulations governing 510(k) and PMA submissions, we are subject to regulations governing the conduct of clinical investigations; device listing and establishment registration; the manufacture and control of our devices, as set forth in the Quality System Regulation (“QSR”); labeling; and promotion; reporting of adverse events and device malfunctions; post-approval restrictions or conditions, including post-approval study commitments; post-market surveillance requirements; and reporting requirements for product recalls, or corrections or removals in the field. Our manufacturing facilities, as well as those of certain of our suppliers, are subject to periodic and for-cause inspections by the FDA and other governmental authorities to verify compliance with the QSR and other regulatory requirements.

United States Regulation of Human Tissue Products

All of our human tissue products are subject to FDA regulatory requirements for human cells, tissues and cellular and tissue-based products (“HCT/Ps”). Certain HCT/Ps are regulated solely under Section 361 of the Public Health Service Act and are referred to as “Section 361 HCT/Ps,” while other HCT/Ps are subject to the FDA’s regulatory requirements for medical devices and/or biologics. A product that is regulated as a Section 361 HCT/P generally may be commercially distributed without prior FDA clearance or approval. However, all HCT/Ps, including Section 361 HCT/Ps, must comply with the FDA’s regulations for donor screening and Good Tissue Practices (“GTPs”), as described further below. We believe that allograft products, AlloDerm, Cymetra®, GRAFTJACKET and Repliform®, satisfy the FDA requirements for regulation solely as Section 361 HCT/Ps and, therefore, are not subject to FDA’s requirements for medical devices and biologics and do not require FDA clearance or approval prior to commercial distribution.

The FDA has established regulations for HCT/Ps (including Section 361 HCT/Ps) that require tissue donors to be screened and tested for relevant communicable diseases and require manufacturers of HCT/Ps to follow GTPs in their recovery, processing, storage, labeling, packaging and distribution of HCT/Ps to prevent the introduction, transmission or spread of communicable diseases. The FDA regulations for HCT/Ps also require us to report adverse reactions, and deviations from donor screening and other applicable requirements. Product listing and establishment registration requirements also apply to our HCT/Ps. The facilities we use to process our HCT/Ps are subject to periodic and for-cause inspections by the FDA and other governmental authorities to verify compliance with GTPs and these other regulatory requirements.


12


In addition to the FDA regulations applicable to our products, procurement of certain human organs and tissue is subject to other federal requirements, such as NOTA. A few but increasing number of states, including Florida, California, Oklahoma, Illinois, New York and Maryland, impose their own regulatory requirements on establishments involved in the processing, handling, storage and distribution of human tissue. LifeCell is also accredited by the American Association of Tissue Banks (“AATB”) and voluntarily complies with its guidelines. 

Other Regulatory Requirements

We are also subject to additional laws and regulations that govern our business operations, products and technologies, including:

federal, state and foreign anti-kickback laws and regulations, which generally prohibit payments to physicians or other purchasers of medical products as an inducement to purchase or prescribe a product;
the Stark law, which prohibits physicians from referring Medicare or Medicaid patients to a provider that bills these programs for the provision of certain designated health services if the physician (or a member of the physician’s immediate family) has a financial relationship with that provider;
federal and state laws and regulations that protect the confidentiality of certain patient health information, including patient records, and restrict the use and disclosure of such information, in particular, the Health Insurance Portability and Accountability Act of 1996, as amended by the Health Information Technology for Economic and Clinical Health Act;
the Physician Payments Sunshine Act, which requires public disclosure of the financial relationships of United States physicians and teaching hospitals with applicable manufacturers, including medical device and biologics companies;
the False Claims Act, which prohibits the submission of false or otherwise improper claims for payment to a federally funded health care program, and health care fraud statutes that prohibit false statements and improper claims to any third-party payor; and
the United States Foreign Corrupt Practices Act, which can be used to prosecute companies in the United States for certain improper arrangements with foreign government officials or other parties outside the United States.

Failure to comply with these laws and regulations could result in criminal liability, significant fines or penalties, negative publicity and substantial costs and expenses associated with investigation and enforcement activities. To assist in our compliance efforts, we adhere to many codes of ethics and conduct regarding our sales and marketing activities in the United States and other countries in which we operate. In addition, we have in place a dedicated Chief Compliance Officer and compliance team to implement, monitor and improve our internal business compliance programs and policies.

International Regulation

Internationally, the regulation of medical devices is complex. These laws range from comprehensive device approval requirements for some or all of our products to requests for product data or certifications. Inspection of and controls over manufacturing, as well as monitoring of device-related adverse events, also are components of most of these regulatory systems. Most of our business is subject to varying degrees of governmental regulation in the countries in which we operate, and the general trend is toward increasingly stringent regulation. For example, the European Commission (“EC”) has harmonized national regulations for the control of medical devices through European Medical Device Directives with which manufacturers must comply. Under these regulations, manufacturing plants must have received quality system certification from a “Notified Body” in order to sell products within the member states of the European Union. Medical devices deemed to be in the high risk classification, such as Strattice, further undergo a distinct design review by the Notified Body. Certification allows manufacturers to affix a “CE” mark to the products. Products covered by the EC regulations that do not bear the CE mark may not be sold or distributed within the European Union. Although the more variable national requirements under which medical devices were formerly regulated have been substantially replaced by the European Union Medical Devices Directive, individual nations can still impose unique requirements that may require supplemental submissions.

To be sold in Japan, most medical devices must undergo thorough safety examinations and demonstrate medical efficacy before they are granted approval through a pre-market approval application, or “shonin.” The Japanese government, through the Ministry of Health, Labour, and Welfare (MHLW), regulates medical devices under the Pharmaceutical Affairs Law (PAL). Oversight for medical devices is conducted through the Pharmaceutical and Medical Devices Agency (PMDA), a government organization responsible for scientific review of market authorization applications, and inspection and auditing of manufacturers to ensure compliance with clinical, laboratory, and manufacturing practice requirements. Penalties for a company’s noncompliance with PAL could be severe, including revocation or suspension of a company’s business license and criminal sanctions. We are subject to inspection for compliance by both these agencies.

13



The regulation of our human tissue products outside the United States varies by country and is complex and constantly evolving. A limited amount of our human tissue products are currently distributed in several countries internationally. Certain countries where we do not currently sell our human tissue products regulate human tissue products as pharmaceutical products, which would require us to make extensive filings and obtain regulatory approvals before selling our product in such countries. Certain countries classify our products as human tissue for transplantation but may restrict its import or sale. Certain foreign countries have laws similar to NOTA. These laws may restrict the amount that we can charge for our products and may restrict our ability to export or distribute our products to licensed not-for-profit organizations in those countries. Other countries have no applicable regulations regarding the import or sale of human tissue products similar to our products, creating uncertainty as to what standards we may be required to meet.

In many of the other foreign countries in which we market our products, we may be subject to requirements affecting, among other things:

product standards and specifications;
packaging;
labeling;
quality systems;
imports;
tariffs;
duties; and
taxes.

Many of the requirements applicable to our devices and products in these countries are similar to those of the FDA. In some regions, the level of government regulation of medical devices is increasing, which can lengthen time to market and increase registration and approval costs. In many countries, the national health or social security organizations require the Company’s products to be qualified before they can be marketed and considered eligible for reimbursement.

Health Care Initiatives and Reimbursement

Government and private sector initiatives to control the increasing cost of health care, including price regulation and competitive pricing, coverage and payment policies, comparative and cost-effectiveness analyses, technology assessments and managed-care arrangements, are continuing in many geographies where we do business, including the United States, Europe and Japan. As a result of these changes, the marketplace has placed increased emphasis on the delivery of more cost-effective medical therapies. For example, government programs, private health care insurance and managed-care plans have attempted to control costs by limiting the amount of reimbursement they will pay for procedures or treatments, and some third-party payors require their pre-approval before new or innovative devices or therapies are utilized by patients. These various initiatives have created increased price sensitivity over medical products generally and may impact demand for our products. A substantial portion of advanced wound therapeutic and regenerative medicine product placements are subject to reimbursement coverage from various public and private third-party payers, including government-funded programs, and other publicly-funded health plans in foreign jurisdictions. As a result, the demand and payment for our products are dependent, in part, on the reimbursement policies of these payors. Payment by government entities for our products in the United States is subject to regulation by the Centers for Medicare and Medicaid Services (“CMS”) and comparable state agencies responsible for reimbursement and regulation of health care items and services. Reimbursement schedules regulate the amount the United States government will reimburse hospitals and doctors for the care of persons covered by Medicare. This includes in some instances determining whether specific technologies, and their correlating procedures, are covered, and if so, what the payment rate may be. Changes in current reimbursement levels could have an adverse effect on market demand and our pricing flexibility.

In the U.S. home care market, our NPWT products are subject to Medicare Part B reimbursement and many U.S. commercial insurers have adopted coverage criteria similar to Medicare standards. For the year ended December 31, 2013, U.S. Medicare placements of our NPWT products represented approximately 8.1% of our total revenue. We maintain U.S. Medicare accreditation through the Accreditation Commission for Health Care (“ACHC”), which exempts us from routine surveys by State survey agencies to determine compliance with Medicare requirements. Our U.S. Service Centers are subject to various inspections each year that are conducted by ACHC inspectors. From time to time, CMS periodically initiates payment schedule changes and bidding programs that affect our home care NPWT business. The competitive bidding programs are being rolled out gradually to increasingly larger portions of the U.S, and have included an increasing number of product categories. Our revenue from U.S. Medicare placements of NPWT products is now subject to Medicare’s durable medical equipment competitive bidding program. On January 30, 2013, as part of this competitive bidding program initiative, CMS announced new reimbursement rates for Medicare

14


patients in the home, which became effective July 1, 2013. This program resulted in an average reimbursement decline of 41% for NPWT across the 91 major metropolitan areas currently subject to the competitive bidding program, which represent approximately 40% of our U.S. Medicare Part B business. Reimbursement for the NPWT business has also been impacted by the competitive bidding program in an additional 9 areas as of January 1, 2014, with a similar reimbursement decline of 42%. Additionally, as of March 2013, sequestration cuts of 2% have been implemented to all Medicare Part A and B fee-for-service payments, including items under Medicare competitive bidding contracts that began on 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.

Health care cost containment efforts have also prompted domestic hospitals and other customers of medical device manufacturers to consolidate into larger purchasing groups to enhance purchasing power, and this trend is expected to continue. The medical device industry has also experienced some consolidation, partly in order to offer a broader range of products to large purchasers. As a result, transactions with customers are larger, more complex and tend to involve more long-term contracts than in the past. These larger customers, due to their enhanced purchasing power, may attempt to increase the pressure on product pricing.

Foreign governments also impose regulations in connection with their health care reimbursement programs and the delivery of health care items and services. We are continuing our efforts to obtain expanded reimbursement for our products and related disposables in foreign jurisdictions. These efforts have resulted in varying levels of reimbursement for our products from private and public payers in multiple jurisdictions, primarily in the acute care setting. Generally, our NPWT products are covered and reimbursed in the inpatient hospital setting and to some extent, depending on the country, in post-acute or community-based care settings (Austria, Switzerland and some regions in Italy). However, in certain countries, such as Germany, the U.K., France and Spain, post-acute care coverage and reimbursement are largely provided on a case-by-case basis and multiple efforts are underway with certain countries to secure consistent coverage and reimbursement policies in community-based outpatient care settings. In targeted countries, we are utilizing accepted “coverage with evidence” mechanisms in close cooperation with local clinicians and clinical centers, government health ministry officials and, in some cases, private payers to obtain the necessary evidence to support adequate coverage and reimbursement. Overall, the prospects of achieving broader global coverage and reimbursement for our products in both acute and post-acute settings are dependent upon the controls applied by governments and private payers with regard to rising healthcare costs. We believe that our plans to achieve positive coverage and reimbursement decisions for our products outside the United States are supported by the growing requirements to provide supporting clinical and economic evidence.

Health Care Reform

In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act were enacted into law in the United States, which included a number of provisions aimed at improving the quality and decreasing the costs of healthcare. Under the legislation, it is expected that expanded healthcare coverage will be made available to an additional 30 million Americans. The increased costs to the U.S. government are expected to be funded through a combination of payment reductions for providers over time and several new taxes. The legislation imposes, among other things, an excise tax of 2.3% of any entity that manufactures or imports medical devices offered for sale in the United States beginning in 2013. We are now subject to this excise tax on our sales of certain medical devices we manufacture, produce or import. In fiscal year 2013, we paid approximately $13.5 million related to the medical device tax. We currently expect the impact of the tax to be less than 1.0% of total revenue in fiscal year 2014. The legislation also provides for the establishment of an Independent Payment Advisory Board that could recommend changes in Medicare payment under certain circumstances beginning in 2014. In addition, the legislation authorizes certain voluntary demonstration projects around development of bundling payments for acute, inpatient hospital services, physician services, and post acute services for episodes of hospital care and also increases fraud and abuse penalties and expands the scope and reach of the Federal False Claims Act and government enforcement tools, which may adversely impact healthcare companies. The new law or any future legislation could reduce medical procedure volumes, lower reimbursement for our products, and impact the demand for our products or the prices at which we sell our products.

Availability of Securities and Exchange Commission Filings

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act, as amended, are available free of charge on our website at www.kci1.com, as soon as reasonably practicable after we file or furnish such information to the SEC. Information contained on our website is not incorporated by reference to this report.



15


ITEM 1A.      RISK FACTORS

Risks Related to Our Business
We face significant and increasing competition, which could adversely affect our operating results.
We face significant and increasing competition in each of our businesses, which are characterized by rapid technological change and significant price competition. Market share can shift as a result of technological innovation and other business factors. Our customers consider many factors when selecting a product, including product reliability, clinical outcomes, product availability, price and services provided by the manufacturer. Our ability to compete will depend in large part on our ability to develop and acquire new products and technologies as well as anticipate technology advances. Product introductions or enhancements by competitors which have advanced technology, better features or lower pricing may make our products obsolete or less competitive. As a result, we will be required to devote continued efforts and financial resources to bring our products under development to market, expand our geographic reach, enhance our existing products and develop new products for the advanced wound therapeutics and regenerative medicine markets. In addition, we have seen increasing price competition as more competitors have entered the market and customers are being challenged by declining reimbursement rates. We expect competition to increase over time as competitors introduce additional competing products in the advanced wound therapeutics and regenerative medicine markets and continue expanding into geographic markets where we currently operate. Our failure to compete effectively could result in loss of market share to our competitors and have a material adverse effect on our sales and profitability. Our competitive position can also be adversely affected by product problems, physician advisories and safety alerts, reflecting the importance of product quality in the medical device industry.

We are subject to stringent domestic and foreign medical device and HCT/P regulation and any adverse regulatory action may materially adversely affect our financial condition and business operations.

The development, manufacture, sale, and distribution of our products are subject to extensive and rigorous regulation by numerous government agencies, including the FDA and comparable foreign agencies. To varying degrees, each of these agencies monitors and enforces compliance with laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of our medical devices and tissue matrices.

We cannot be certain that we will receive required approval or clearance from the FDA and foreign regulatory agencies for new products or modifications to existing products on a timely basis, or at all. The process of obtaining marketing approval or clearance from the FDA and comparable foreign bodies for new products, or for enhancements or modifications to existing products, could:

take a significant amount of time;
require the expenditure of substantial resources;
involve rigorous pre-clinical and clinical testing, as well as increased post-market surveillance;
involve modifications, repairs or replacements of our products; and
result in limitations on the indicated uses of our products.

The failure to receive approval or clearance for significant new products or modifications to existing products or any substantial delay in obtaining any required approval or clearance could have a material adverse effect on our financial condition and results of operations.

The FDA also could disagree with our conclusion that certain Regenerative Medicine products are Section 361 HCT/Ps not subject to FDA premarket clearance or approval requirements. If the FDA were to determine that any of these products required premarket clearance or approval as devices or biologics, this could disrupt our existing marketing of these products and have a material adverse effect on our financial condition and results of operations. Noncompliance with federal or state requirements relating to procurement of certain human organs and tissue also could disrupt our operations and have a material adverse effect on our financial condition and results of operations.

We also are subject to FDA regulations governing the manufacture and control of our products, product labeling and advertising, reporting of adverse events, and reporting of recalls. Compliance with these and other applicable regulatory requirements is subject to continual review and is monitored rigorously through periodic inspections by the FDA. If the FDA were to find that we have failed to comply with any of these requirements, it could institute a wide variety of enforcement actions, ranging from a public warning letter to more severe sanctions, such as product recalls or seizures, monetary penalties, consent

16


decrees, injunctive actions to halt the manufacture or distribution of products, or other civil or criminal penalties. Civil or criminal penalties could be assessed against our officers, employees, or us. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products. In addition, any negative publicity and product liability claims resulting from any adverse regulatory action could have a material adverse effect on our financial condition and results of operations.

In addition, device manufacturers are permitted to promote products solely for the uses and indications set forth in the approved product labeling. A number of enforcement actions have been taken against manufacturers that promote products for “off-label” uses, including actions alleging that federal health care program reimbursement of products promoted for "off-label" uses are false and that fraudulent claims are made to the government. The failure to comply with “off-label” promotion restrictions can result in significant financial penalties and in a corporate integrity agreement with the federal government that imposes significant administrative obligations and costs, and potential exclusion from federal health care programs.

Foreign governmental regulations have become increasingly stringent and more common, and we may become subject to even more rigorous regulation by foreign governmental authorities in the future. Penalties for a company's noncompliance with foreign governmental regulation could be severe, including revocation or suspension of a company's business license and criminal sanctions. Any domestic or foreign governmental medical device law or regulation imposed in the future may have a material adverse effect on our financial condition and business operations.

If we are unable to develop new generations of products and enhancements to existing products, our competitive position may be harmed.

Our success is dependent upon the successful development, introduction and commercialization of new generations of products and enhancements to existing products. Innovation in developing new product lines and in developing enhancements to our existing products is required for us to grow and compete effectively. The success and completion of development of any new products remains subject to all the risks associated with the commercialization of new products based on innovative technologies, including unanticipated technical or manufacturing problems, extended lead times in obtaining required regulatory and reimbursement approval of new products, the possibility of significantly higher development costs than anticipated, our ability to anticipate and satisfy customer needs in a timely manner with relevant technology, and gaining customer acceptance. Innovation through enhancements and new products requires significant capital commitments and investments on our part, which we may be unable to recover. Our failure to introduce new and innovative products in a timely manner could have an adverse effect on our business, results of operations, financial condition and cash flows.
Our current and future products are subject to regulation by the FDA and other national, federal and state governmental authorities. We may be required to undertake time-consuming and costly development and clinical activities and seek regulatory clearance or approval for expanded clinical applications for current products and new products. Clearance and/or approval might not be granted for a new or modified product or expanded uses of existing products on a timely basis, if at all.
Any substantial increase in applicable regulatory or administrative requirements that are imposed on us could potentially delay our development and commercialization of new medical device products. Also, our determination that our allograft products are eligible for regulation as human cellular and tissue-based product is limited to their current intended uses. In the future, we may wish to market our allograft products for new intended uses, which may require premarket clearance or approval under FDA medical device or biologic regulations, and which could be time consuming and costly. Our failure to maintain clearances or approvals for existing products or to obtain clearance or approval for new or modified products could adversely affect our results of operations and financial condition.

Even if we are able to develop, manufacture and obtain regulatory approvals and clearances for our new products, the success of those products depends on market acceptance, which could be affected by several factors, including (i) the availability of alternative products from our competitors; (ii) the price and reliability of our products relative to that of our competitors; (iii) the reimbursement provided for our products; (iv) the timing of our market entry; and (v) our ability to market and distribute our products effectively.

The adoption of healthcare reform in the U.S. may adversely affect our business and financial results.
As part of the enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act, we are now subject to an excise tax of 2.3% on our sales of certain medical devices we manufacture, produce or import. In fiscal year 2013, we paid approximately $13.5 million related to the medical device tax. We currently expect the impact of the tax to be less than 1.0% of total revenue in fiscal year 2014. In addition, the legislation authorizes certain voluntary

17


demonstration projects around development of bundling payments for acute, inpatient hospital services, physician services, and post acute services for episodes of hospital care and also increases fraud and abuse penalties and expands the scope and reach of the Federal Civil False Claims Act and government enforcement tools, which may adversely impact healthcare companies. The new law or any future legislation could reduce medical procedure volumes, lower reimbursement for our products, and impact the demand for our products or the prices at which we sell our products.

We cannot predict with any certainty what other impact this legislation may have on our business. Legislative or administrative reforms to the U.S. or international reimbursement systems that significantly reduce reimbursement for procedures using our products and therapies or deny coverage for such procedures, or adverse decisions relating to our products by administrators of such systems in coverage or reimbursement issues, could result in reduced demand for our products and increased downward pricing pressure, which could adversely affect our business. While this legislation is intended to expand health insurance coverage to uninsured persons in the United States, the impact of any overall increase in access to healthcare on sales of our products remains uncertain. It is also possible that this legislation will result in lower reimbursements for our products. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payors. Insurers may also refuse to provide any coverage of uses of approved products for medical indications other than those for which the FDA has granted market approvals, all of which may have a material adverse effect on our business, financial condition and results of operations.
 
Cost-containment efforts of our customers, purchasing groups, third-party payors and governmental organizations could adversely affect our sales and profitability.

Many existing and potential customers for our products within the United States are members of GPOs and integrated delivery networks (“IDNs”), including accountable care organizations, and our business is partly dependent on major contracts with these organizations. Our products can be contracted under national tenders or with larger hospital GPOs. The healthcare industry has been consolidating, and as a result, transactions with customers are larger and more complex. GPOs and IDNs negotiate pricing arrangements with healthcare product manufacturers and distributors and offer the negotiated prices to affiliated hospitals and other members. GPOs and IDNs typically award contracts on a category-by-category basis through a competitive bidding process. The majority of our AWT hospital sales and rentals are made pursuant to contracts with GPOs and IDNs. At any given time, we are typically at various stages of responding to bids and negotiating and renewing GPO and IDN agreements; including, agreements that would otherwise expire. Bids are generally solicited from multiple manufacturers or service providers with the intention of obtaining lower pricing. Due to the highly competitive nature of the tender process and the GPO and IDN contracting processes, we may not be able to obtain or maintain contract positions with major GPOs and IDNs across our product portfolio. Failure to be included in certain of these agreements could have a material adverse effect on our business, including sales and rental revenues.

While having a contract with a major purchaser, such as a GPO, IDN or public-based purchasing organization for a given product category can facilitate sales, such contract positions can offer no assurance that sales volumes of those products will be maintained. For example, GPOs and IDNs are increasingly awarding contracts to multiple suppliers for the same product category. Even when we are the sole contracted supplier of a GPO or IDN for a certain product category, members of the GPO or IDN generally are free to purchase from other suppliers. Furthermore, GPO and IDN contracts typically are terminable without cause upon 60 to 90 days’ notice. Accordingly, although we have multiple contracts with many major purchasing organizations, the members of such groups may choose to not purchase from us.

Distributors of our products also have begun to negotiate terms of sale more aggressively to increase their profitability. Failure to negotiate distribution arrangements having advantageous pricing and other terms of sale could cause us to lose market share and would adversely affect our business, results of operations, financial condition and cash flows.

Outside the United States, we have experienced pricing pressure from centralized governmental healthcare authorities due to efforts by such authorities to lower healthcare costs. Implementation of healthcare reforms and competitive bidding contract tenders may limit the price or the level at which reimbursement is provided for our products and adversely affect both our pricing flexibility and the demand for our products. Healthcare providers may respond to such cost-containment pressures by substituting lower cost products or other therapies for our products. We frequently are required to engage in competitive bidding for the sale of our products to governmental purchasing agents and hospital groups. Our failure to offer acceptable prices to these customers could adversely affect our sales and profitability in these markets.



18


Changes in U.S. and international reimbursement regulations, policies and rules, or their interpretation, could reduce reimbursement and collections or adversely affect the demand for our products and negatively impact our global expansion efforts.

The demand for our products is highly dependent on the regulations, policies and rules of third-party payers in the United States and internationally, including the U.S. Medicare and Medicaid programs, as well as private insurance and managed care organizations that reimburse us for the sale and rental of our products. If coverage or payment regulations, policies or rules of existing third-party payers are revised in any material way in light of increased efforts to control healthcare spending or otherwise, the amount we may be reimbursed or the demand for our products may decrease, or the costs of furnishing or renting our products could increase.

Due to the increased scrutiny and publicity of government efforts to contain rising healthcare costs, we may be subject to future assessments or studies by U.S. and foreign healthcare, safety and reimbursement agencies, which could lead to changes in reimbursement policies that adversely affect our business. Any unfavorable results from assessments or studies could result in reduced reimbursement or prevent us from obtaining reimbursement from third-party payers and could reduce the demand or acceptance of our products and therapies. If we are unable to obtain expanded reimbursement for our products in foreign jurisdictions, our international expansion plans could be delayed and our plans for growth could be negatively impacted.

In the United States, the reimbursement of our products by Medicare is subject to review by government contractors that administer payments under federal healthcare programs. For the year ended December 31, 2013, U.S. Medicare placements of our NPWT products represented approximately 8.1% of our total revenue. Changes to Medicare policies, including the launch and expansion of the competitive bidding program, can have a significant impact on our business. These changes can also include revisions in the interpretation or application of Medicare contractor coverage policies or adverse administrative coverage determinations. Such changes can lead to denials of our claims for payment and/or requests to recoup alleged overpayments made to us for our products. Such determinations and changes can often be challenged only through an administrative appeals process. In the event that our interpretations of coverage policies in effect at any given time are inconsistent with administrative coverage determinations, we could be subject to recoupment or refund of all or a portion of any disputed amounts as well as penalties, which could exceed our related revenue realization reserves, and could negatively impact our revenue from Medicare placements in the United States. We are participating in Medicare’s durable medical equipment competitive bidding program, which resulted in substantial reimbursement declines in 100 major metropolitan areas. Any expansion of the competitive bidding program or further price reductions could have an adverse impact on our financial results. For more information on the competitive bidding program, see “Item 1: Business.”

We are also subject to claims audits by government regulators, contractors and private payers. Our documentation, billing and other practices are subject to scrutiny by regulators, including claims audits. To ensure compliance with U.S. reimbursement regulations, the Medicare regional contractors and other government contractors periodically conduct audits of billing practices and request medical records and other documents to support claims submitted by us for payment of services rendered to our customers, which in some cases involve a review of claims that can be several years old. Such audits may also be initiated as a result of recommendations made by government agencies. Our agreements with private payers also commonly provide that payers may conduct claims audits to ensure that our billing practices comply with their policies. These audits can result in delays in obtaining reimbursement, denials of claims, or demands for significant refunds or recoupments of amounts previously paid to us. For more information on claims audits, see Note 13 of the notes to the consolidated financial statements for the year ended December 31, 2013.

If we are unsuccessful in protecting and maintaining our intellectual property, our competitive position could be harmed.
We rely on a combination of patents, trademarks, copyrights, trade secrets and nondisclosure agreements to protect our proprietary intellectual property. Patents and our other proprietary rights are essential to our business and our ability to compete effectively with other companies is dependent upon the proprietary nature of our technologies. We seek to protect these, in part, through confidentiality agreements with employees, consultants, and other third parties. We pursue a policy of generally obtaining patent protection in both the United States and key foreign countries for patentable subject matter in our proprietary devices and also attempt to review third-party patents and patent applications to the extent publicly available to develop an effective patent strategy, avoid infringement of third-party patents, identify licensing opportunities and monitor the patent claims of others. We currently own numerous United States and foreign patents and have numerous patent applications pending. We are also a party to various license agreements pursuant to which patent rights have been obtained or granted in consideration for cash, cross-licensing rights or royalty payments.

19


Our efforts to protect our intellectual property and proprietary rights may not be sufficient. We cannot be sure that our pending patent applications will result in the issuance of patents to us, that patents issued to or licensed by us in the past or in the future will not be challenged or circumvented by competitors, that these patents will remain valid or sufficiently broad to preclude our competitors from introducing technologies similar to those covered by our patents and patent applications, or that competitors will not otherwise gain access to our confidential information or trade secrets. In addition, our ability to enforce and protect our intellectual property rights may be limited in certain countries outside the United States, which could make it easier for competitors to capture market position in such countries by utilizing technologies that are similar to those developed or licensed by us. Competitors also may harm our sales by designing products that mirror the capabilities of our products or technology without infringing our intellectual property rights. If we do not obtain sufficient protection for our intellectual property, or if we are unable to effectively enforce our intellectual property rights, our competitiveness could be impaired, which would limit our growth and future revenue and could have a material adverse effect on our financial condition and results of operations.

Pending and future patent litigation could be costly and disruptive and may have an adverse effect on our financial conditions and results operations.

We operate in an industry characterized by extensive patent litigation. Defending intellectual property litigation is expensive and complex and outcomes are difficult to predict. We are currently party to several intellectual property litigation disputes described in more detail in see “Item 3. Legal Proceedings” and Note 13 of the notes to the consolidated financial statements for the year ended December 31, 2013. Any pending or future patent litigation may result in significant damage awards, including treble damages under certain circumstances, and injunctions that could prevent the manufacture and sale of affected products or force us to make significant royalty payments in order to continue selling the affected products. At any given time, we are involved as either a plaintiff or a defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time. As a healthcare supplier, we can expect to face additional claims of patent infringement in the future. A successful claim of patent or other intellectual property infringement against us could adversely affect our results of operations and financial condition.

In February 2011 KCI filed suit in U.S. Federal District Court for the Western District of Texas seeking a declaratory judgment that, among other things, KCI no longer owes royalties to Wake Forest University under a 1993 patent license agreement because the relevant patent claims previously licensed to KCI by Wake Forest are invalid or not infringed. The patents that are the subject of the litigation expire in June 2014. 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, a royalty payment of $44.2 million was paid to Wake Forest for the semi-annual period January 1, 2010 through June 30, 2010, and from July 1, 2010 through December 31, 2010 an additional $49.6 million of royalty obligations were accrued consistent with past practice. Amounts accrued, but unpaid from January 1, 2011 through February 27, 2011, were approximately $13.6 million. Due to the pending dispute and KCI’s claims against Wake Forest, the accrued amounts were not paid to Wake Forest. No royalty payments have been made to Wake Forest since August 2010. In the event that we are unsuccessful in this litigation, we may be required to pay substantial royalty damages to Wake Forest relating to NPWT product revenue for the period from July 2010 through June 2014. Wake Forest is also seeking treble damages in the case, which if awarded, could materially impact our results of operations and financial condition. For a more complete description of the Wake Forest litigation and other intellectual property litigation, see "Item 3. Legal Proceedings" and Note 13 of the notes to the consolidated financial statements for the year ended December 31, 2013.

We may not successfully identify and complete acquisitions on favorable terms or achieve anticipated synergies relating to any acquisitions, and such acquisitions could result in unforeseen operating difficulties and expenditures, require significant management resources and require significant charges or write-downs.

We regularly review potential acquisitions of complementary businesses, technologies, services and products. We may be unable to find suitable acquisition candidates to expand our business. Even if we identify appropriate acquisition candidates, we may be unable to complete the acquisitions on favorable terms, if at all. Future acquisitions may increase our debt or reduce our cash available for operations or other uses. In addition, the process of integrating an acquired business, technology, service or product into our existing operations requires significant efforts, including the coordination of information technologies, research and development, sales and marketing, operations, manufacturing and finance. These efforts could result in unforeseen difficulties and expenditures. Integration of an acquired company often requires significant expenditures as well as significant management resources that cannot then be dedicated to other projects. In addition, we may face additional risks related to unknown or contingent liabilities related to business practices of the acquired companies, environmental remediation expense, products liability, patent infringement claims or other unknown liabilities.


20


Moreover, we may not realize the anticipated financial or other benefits of an acquisition, including our ability to achieve cost savings or revenue synergies. Our failure to manage successfully and coordinate the growth of the combined company could also have an adverse impact on our business. In addition, we cannot be certain that the businesses we acquire will become profitable or remain so. We also could experience negative effects on our results of operations and financial condition from acquisition-related charges, amortization of intangible assets and asset impairment charges, and other issues that could arise in connection with, or as a result of, the acquisition of an acquired company or business. For example, in 2013 we recognized impairment charges of $443.4 million related to impairment of LifeCell goodwill and intangible assets, which KCI acquired in 2008. If an acquired business fails to operate as anticipated or cannot be successfully integrated with our existing business, our results of operations and financial condition could be adversely affected. See Note 2 of the notes to the consolidated financial statements for the year ended December 31, 2013 for a discussion of our recent acquisition of the Systagenix business.

We may not realize the expected benefits from our restructuring initiatives and continuous improvement efforts, and they may result in unintended adverse impacts to our business.

Over the last two years, we have undertaken several restructuring and realignment initiatives to reduce our overall cost base and improve efficiency. We have recently announced a business realignment plan to combine our business units into one centrally-managed operating company as well as to unify certain support functions. The actions initiated under our business realignment plans include outsourcing of certain service and support functions, workforce reductions, and other efforts to streamline our business. While these changes are part of a comprehensive plan to, among other things, accelerate our growth, reduce costs and leverage economies of scale, we may not realize the expected benefits of our restructuring initiatives and continuous improvement efforts. In addition, these actions and potential future restructuring actions could yield unintended consequences, such as distraction of management and employees, business disruption, reduced employee morale and productivity and unexpected additional employee attrition, including the inability to attract or retain key personnel. These consequences could negatively affect our business, financial condition and results of operations. If we do not successfully manage our current restructuring activities, or any other restructuring activities that we may take in the future, any expected efficiencies and benefits might be delayed or not realized, and our operations and business could be disrupted. In addition, the costs associated with implementing restructuring activities might exceed expectations, which could result in additional future charges.

Divestitures of some of our businesses or product lines may adversely affect our business, results of operations and financial condition.

In regularly evaluating the performance of our businesses, we may decide to sell a business or product line. Even if we identify a divestiture opportunity, we may be unable to complete the divestiture on favorable terms, if at all. Any divestitures may result in significant charge-offs or write-downs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our business, results of operations and financial condition. The process of divesting ourselves of a business or product line could result in unforeseen expenditures and risks, including dissynergies in shared functions, as well as complexities in separating operations, services, products and personnel. Divestitures often require the diversion of management's attention from other business concerns and the disruption of our business, and could result in potential loss of key employees. We may not be able to successfully manage these or other significant risks related to divesting a business or product line. See Note 3 of the notes to the consolidated financial statements for the year ended December 31, 2013 for a discussion of the recent divestiture of the TSS business.

Our failure to comply with program integrity laws may subject us to penalties and adversely affect our financial condition and results of operations.

Participation in federal healthcare programs requires us to comply with laws regarding the way in which we conduct business, as well as the way in which we submit claims. These laws include the False Claims Act, which attaches per-claim liability and treble damages to the filing of false or improper claims for federal payment. Since 2009, we have been party to litigation arising out of qui tam allegations of violations of the False Claims Act. For more information regarding this litigation, see “Item 3. Legal Proceedings.” There are also laws that attach criminal liability to unlawful inducements for the referral of business reimbursable under federally-funded healthcare programs, known as the anti-kickback laws, and those that attach repayment and monetary damages to instances where healthcare service providers seek reimbursement for providing certain services to a patient who was referred by a physician that has certain types of direct or indirect financial relationships with the service provider, known as the Stark law. Additionally, we are subject to the Sunshine Act, which requires that we annually disclose to CMS all transfers of value (subject to limited exclusions) to certain physicians and teaching hospitals, as such terms are defined in statute and regulation. Failure to accurately disclose these transfers could subject us to certain monetary penalties.


21


The laws applicable to us are subject to evolving interpretations. If a governmental authority were to conclude that we are not in compliance with applicable laws and regulations, we and our officers and employees could be subject to severe criminal and civil penalties, including, for example, exclusion from participation as a supplier of product to beneficiaries covered by Medicare and Medicaid. Furthermore, since many of our customers rely on reimbursement from Medicare, Medicaid and other governmental programs to cover a substantial portion of their expenditures, our exclusion from such programs as a result of a violation of these laws could have a material adverse effect on our financial condition and results of operations.

To avoid such penalties, we operate consistent with the AdvaMed Code of Ethics on Interactions with Health Care Professionals which provides guidance on marketing and other practices in our relationships with healthcare professionals and/or product purchasers. We also adhere to many similar codes in countries outside the United States. In addition, we have in place and are continuously improving our internal business integrity and compliance program and policies.

Failure of any of our clinical studies or third-party assessments to demonstrate desired outcomes in proposed endpoints may reduce physician usage or result in pricing pressures that could have a negative impact on business performance.

We regularly conduct clinical studies designed to test a variety of endpoints associated with product performance and use across a number of applications. If, as a result of poor design, implementation or otherwise, a clinical study conducted by us or others fails to demonstrate statistically significant results supporting performance or use benefits or comparative or cost effectiveness of our products, physicians may elect not to use our products as a treatment for conditions that may benefit from them. Furthermore, in the event of an adverse clinical study outcome, our products may not achieve “standard-of-care” designations, where they exist, for the conditions in question, which could deter the adoption of our products. Also, if serious device-related adverse events are reported during the conduct of a study it could affect continuation of the study, product approval and product adoption. If we are unable to develop a body of statistically significant evidence from our clinical study program, whether due to adverse results or the inability to complete properly designed studies, domestic and international public and private payers could refuse to cover our products, limit the manner in which they cover our products, or reduce the price they are willing to pay or reimburse for our products. In the case of a pre-approval study or a study required by a regulatory body as a condition of clearance or approval, a regulatory body can revoke, modify or deny clearance or approval of the study and/or the product in question.

Because we depend upon a limited group of suppliers and, in some cases, exclusive suppliers for products essential to our business, we may incur significant product development costs and experience material delivery delays if we lose any significant supplier, which could materially impact the rental and sales of our products.

We obtain some of our finished products and components from a limited group of suppliers, and we purchase certain supplies from single sources for reasons of quality assurance, cost-effectiveness, availability, or constraints resulting from regulatory requirements. While we work closely with suppliers to assure continuity of supply and maintain high quality and reliability, these efforts may not be successful. Manufacturing disruptions experienced by our suppliers may jeopardize our supply of finished products and components. Due to the stringent regulations and requirements of the FDA and other similar non-U.S. regulatory agencies regarding the manufacture of our products, we may not be able to quickly establish additional or replacement sources for certain components or materials. A change in suppliers could require significant effort or investment in circumstances where the items supplied are integral to product performance or incorporate unique technology. A reduction or interruption in manufacturing, or an inability to secure alternative sources of raw materials or components, could have a material effect on our business, results of operations, financial condition and cash flows. Due to our substantial indebtedness, one or more of our suppliers may refuse to extend us credit with respect to our purchasing or leasing equipment, supplies, products or components, or may only agree to extend us credit on significantly less favorable terms or subject to more onerous conditions. This could significantly disrupt our ability to purchase or lease required equipment, supplies, products and components in a cost-effective and timely manner and could have a material adverse effect on our business. Any casualty, natural disaster or other significant disruption of any of our sole-source suppliers’ operations, or any unexpected loss of any existing exclusive supply contract could have a material adverse effect on our business.

Increased prices for, or unavailability of, raw materials or sub-assemblies used in our products could adversely affect our profitability or revenues.

Our profitability is affected by the prices of the raw materials and sub-assemblies used in the manufacture of our products. These prices may fluctuate based on a number of factors beyond our control, including changes in supply and demand, general economic conditions, labor costs, fuel related delivery costs, competition, import duties, tariffs, currency exchange rates, and government regulation. Due to the highly competitive nature of the healthcare industry and the cost containment efforts of our customers and third-party payers, we may be unable to pass along cost increases for key components or raw materials through higher prices to our customers. If the cost of key components or raw materials increases, and we are unable fully to recover these

22


increased costs through price increases or offset these increases through other cost reductions, we could experience lower margins and profitability. Significant increases in the prices of raw materials or sub-assemblies that cannot be recovered through productivity gains, price increases or other methods could adversely affect our results of operations. Moreover, pursuant to the conflict minerals requirements promulgated by the SEC as a part of Dodd-Frank, we are required to report on the source of any conflict minerals used in our products as well as the process we use to determine the source of such materials. We will incur expenses as we work with our suppliers to evaluate the source of any conflict minerals in our products, and compliance with these requirements could adversely affect the sourcing, supply, and pricing of our raw materials.

If a natural or man-made disaster strikes our manufacturing facilities, we will be unable to manufacture our products for a substantial amount of time and our sales and profitability will decline.

Our facilities and the manufacturing equipment we use to produce our products would be costly to replace and could require substantial lead-time to repair or replace. The manufacture of all of our tissue regenerative medicine products is conducted exclusively at our sole manufacturing facility in Branchburg, New Jersey, and our adipose autologous grafting and tissue perfusion products are manufactured at third-party suppliers in the U.S. and Canada. The manufacture of our NPWT disposable supplies is conducted at our manufacturing facilities in Athlone, Ireland and Peer, Belgium, and the manufacturing facilities of third-party contract manufacturers in Mexico. The manufacture of our advanced wound dressings is conducted at our manufacturing facility in Gargrave, England. Regulatory approvals of our products are limited to one or more specifically approved manufacturing facilities. If we fail to produce enough of a product at a facility, or if our manufacturing process at that facility is subject to a temporary or permanent facility shut-down caused by casualty (property damage caused by fire or other perils), regulatory action, or other unexpected interruptions, we may be unable to deliver that product to our customers or to identify and validate alternative sources for the affected product on a timely basis, which would impair our results of operations. Disruption of our third-party manufacturers’ facilities could arise for a variety of reasons, including technical, labor or other difficulties, equipment malfunction, contamination, failure to follow specific protocols and procedures, destruction of, or damage to, any facility (as a result of natural disaster, use and storage of hazardous materials or other events), quality control issues, bankruptcy of the manufacturer or other reasons. Any of these disruptions in the production of our key manufacturers could have a negative impact on our sales or profitability. We take precautions to safeguard the facilities, including security, health and safety protocols, appropriate inventory coverage, business continuity plans and off-site backup and storage of electronic data. Additionally, we maintain property insurance that includes coverage for business interruption. However, a natural disaster such as a fire or flood could affect our ability to maintain ongoing operations and cause us to incur additional expenses. Insurance coverage may not be adequate to fully cover losses in any particular case. Accordingly, damage to a facility or other property due to fire, flood or other natural disaster or casualty event could materially and adversely affect our revenues and results of operations.

Disruption to our distribution operations could adversely affect our business.
We utilize third-party logistics providers to distribute our products in all of our geographic markets. Especially because our distribution operations are largely dependent upon third parties, any prolonged disruption in the operations of our existing distribution providers, whether due to technical, labor or other difficulties, equipment malfunction, contamination, failure to follow specific protocols and procedures, destruction of or damage to any facility (as a result of natural disaster, use and storage of hazardous materials or other events) or other reasons, could have a material adverse effect on our business, prospects, financial condition or results of operations. We rely on independent distributors in many of our international markets who generally control the importation and marketing of our product within their territories. We generally grant exclusive rights to these distributors and rely on them to understand local market conditions, to diligently sell our products and to comply with local laws and regulations. The operation of local laws and our agreements with distributors can make it difficult for us to change quickly from a distributor who we feel is underperforming. If we do terminate an independent distributor, we may lose our product registrations and customers who have been dealing with that distributor. Because we do not have local staff in many of the areas covered by independent distributors, it may be difficult for us to detect failures in our distributors’ performance or compliance. Actions by independent distributors that are beyond our control could result in flat or declining sales in that territory, harm to the reputation of our company or its products, or legal liability.
Quality problems with our products and services could harm our reputation for producing high-quality products and erode our competitive advantage, sales, and market share.

Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our future operating results will depend on our ability to sustain an effective quality control system and effectively train and manage our employee base with respect to our quality system. Our quality system plays an essential role in determining and meeting customer requirements, preventing defects and improving our products and services. While we have a network of quality systems throughout our business lines and facilities, quality and safety issues may occur with respect to any of our products. A quality or

23


safety issue may result in a public warning letter from the FDA, product recalls or seizures, monetary sanctions, injunctions to halt manufacturing and distribution of products, civil or criminal sanctions, refusal of a government to grant clearances or approvals or delays in granting such clearances or approvals, import detentions of products made outside the United States, restrictions on operations or withdrawal or suspension of existing approvals. Negative publicity regarding a quality issue could damage our reputation, cause us to lose customers, or decrease demand for our products. Any of the foregoing events could disrupt our business and have an adverse effect on our results of operations and financial condition.

Our international business operations are subject to risks, including risks arising from currency exchange rate fluctuations, which could adversely affect our operating results.

Our operations outside the United States, are subject to certain legal, regulatory, social, political, and economic risks inherent in international business operations. Sales outside of the United States represented approximately $411.4 million, or 23%, of our total revenue for the year ended December 31, 2013 and $394.5 million, or 23%, of our total revenue for the year ended December 31, 2012, and we expect that non-U.S. sales will contribute significantly to future growth. The risks associated with our operations outside the United States include:

local product preferences and product requirements;
less stringent protection of intellectual property in some countries outside the United States;
more stringent data privacy and protection measures in some countries outside the United States;
trade protection measures and import and export licensing requirements;
changes in foreign regulatory requirements and tax laws;
alleged or actual violations of the Foreign Corrupt Practices Act of 1977, and similar local commercial anti-bribery and anti-corruption laws in the foreign jurisdictions in which we do business;
changes in foreign medical reimbursement programs and policies, and other healthcare reforms;
government-mandated austerity programs limiting spending;
changes in government-funded tenders and payor pathways;
difficulty in establishing, staffing and managing non-U.S. operations;
complex tax and cash management issues;
potential tax costs associated with repatriating cash from our non-U.S. subsidiaries;
political and economic instability and inflation, recession or interest rate fluctuations; and
longer-term receivables than are typical in the United States, and greater difficulty of collecting receivables in certain foreign jurisdictions.

We are also exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates. If the United States dollar strengthens in relation to the currencies of other countries such as the Euro, where we sell our products, our United States dollar reported revenue and income will decrease. Additionally, we incur significant costs in foreign currencies and a fluctuation in those currencies’ value can negatively impact manufacturing and selling costs. Changes in the relative values of currencies occur regularly and, in some instances, could have an adverse effect on our results of operations and financial condition. While we enter into foreign currency exchange contracts designed to reduce the short-term impact of foreign currency fluctuations, we cannot eliminate the risk, which may adversely affect our expected results.

Most of our customer relationships outside of the United States are with governmental entities and we could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act (“FCPA”) and similar worldwide anti-bribery laws in non-U.S. jurisdictions.

The FCPA and similar worldwide anti-bribery laws in non-U.S. jurisdictions generally prohibit companies from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Because of the predominance of government-sponsored healthcare systems around the world, most of our customer relationships outside of the United States are with governmental entities and are therefore subject to such anti-bribery laws. Our policies mandate compliance with these anti-bribery laws. We operate in many parts of the world that have experienced governmental corruption to some degree, and in certain circumstances strict compliance with anti-bribery laws may conflict with local customs and practices. Despite our training and compliance programs, our internal control policies and procedures may not always protect us from reckless or criminal acts committed by our employees or other third-parties, including, distributors. Violations of anti-bribery laws, or allegations of such violations, could disrupt our business and result in a material effect on our results of operations, financial condition and cash flows.


24


We rely on the performance of our information technology systems, the failure of which could have an adverse effect on our business and performance.

Our business requires the continued operation of sophisticated information technology systems and network infrastructure. These systems are vulnerable to interruption by fire, power loss, system malfunction, computer viruses, cyber-attacks and other events, which may be beyond our control. Systems interruptions could reduce our ability to accept customer orders, manufacture our products, or provide service for our customers, and could have an adverse effect on our operations and financial performance. The level of protection and disaster-recovery capability varies from site to site, and there can be no guarantee that any such plans, to the extent they are in place, will be totally effective. In addition, security breaches of our information technology systems could result in the misappropriation or unauthorized disclosure of confidential information belonging to us, our employees, partners, customers, or our suppliers, which may result in significant costs and potential government sanctions. In particular, if we are unable to adequately safeguard individually identifiable health information, we may be subject to additional liability under domestic and international laws respecting the privacy and security of health information.

We also are pursuing initiatives to modernize our information technology systems and processes. Many of our business lines use disparate systems and processes, including those required to support critical functions related to our operations, sales, and financial reporting. We are implementing new systems to better streamline and integrate critical functions, which we expect to result in improved efficiency and, over time, reduced costs. While we believe these initiatives provide significant opportunity for us, they do expose us to inherent risks. We may suffer data loss or delays or other disruptions to our business, which could have an adverse effect on our results of operations and financial condition. If we fail to successfully implement new information technology systems and processes, we may fail to realize cost savings anticipated to be derived from these initiatives.

We may not be able to maintain our competitive advantages if we are not able to attract and retain key personnel.
Our success depends to a significant extent on our ability to attract and retain key members of our executive, technical, sales, marketing and engineering staff. While we have taken steps to retain such key personnel, there can be no assurance that we will be able to retain the services of individuals whose knowledge and skills are important to our businesses. Our success also depends on our ability to prospectively attract, expand, integrate, train and retain qualified management, technical, sales, marketing and engineering personnel. Because the competition for qualified personnel is intense, costs related to compensation and retention could increase significantly in the future. Additionally, integration of acquired companies and businesses, such as Systagenix, can be disruptive and may lead to the departure of key employees. If we were to lose a sufficient number of our key employees and were unable to replace them in a reasonable period of time, these losses could seriously damage our business.
Adverse changes in general domestic and global economic conditions and instability and disruption of credit markets could adversely affect our operating results, financial condition or liquidity.

We are subject to risks arising from adverse changes in general domestic and global economic conditions, including recession or economic slowdown and disruption of credit markets. During 2008, the global economy was impacted by the effects of the global financial crisis. This global financial crisis, including the European sovereign debt crisis, caused extreme disruption in the financial markets, including diminished liquidity and credit availability. Subsequently, economic conditions have improved and the financial markets can today be characterized as healthy with general availability of credit. However, there can be no assurance that there will not be deterioration in the global economy in the future. We believe an economic downturn could generally decrease hospital census and the demand for elective surgeries. Also, any future financial crisis, could make it more difficult and more expensive for hospitals and health systems to obtain credit, which may contribute to pressures on their operating margins. In addition, any economic deterioration would likely result in higher unemployment and reduce the number of individuals covered by private insurance, which may result in an increase in 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 U.S. Medicaid or Medicare. If economic conditions deteriorate and unemployment 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.

Any disruption in the credit markets could impede our access to capital, which could be further adversely affected if we are unable to maintain our current credit ratings. Should we have limited access to additional financing sources, we may need to defer capital expenditures or seek other sources of liquidity, which may not be available to us on acceptable terms if at all. Similarly, if our suppliers face challenges in obtaining credit or other financial difficulties, they may be unable to provide the materials required to manufacture our products. All of these factors related to global economic conditions, which are beyond our control, could negatively impact our business, results of operations, financial condition and liquidity.

25


We are exposed to product liability claims that may materially and adversely affect our revenues and results of operations.
Our businesses expose us to product liability risks inherent in the testing, manufacturing, marketing and use of medical products. We are, and may be in the future, subject to product liability claims and lawsuits, including potential class actions or mass tort claims, alleging that our products have resulted or could result in an unsafe condition or injury. Any product liability claim brought against us, with or without merit, could be costly to defend and could result in settlement payments and adjustments not covered by or in excess of insurance. In addition, we may not be able to obtain insurance on terms acceptable to us or at all because insurance varies in cost and can be difficult to obtain. The legal expenses associated with defending against product liability claims, the obligation to pay a product liability claim in excess of available insurance coverage, or the ability to maintain adequate insurance coverage could increase operating expenses and could materially and adversely affect our results of operations and financial position.
We are involved in a number of legal proceedings. For example, LifeCell is currently named as a defendant in approximately 330 lawsuits filed by individuals alleging personal injury and seeking monetary damages for failed hernia repair procedures using LifeCell’s AlloDerm products. We are also named defendants in 106 cases related to Repliform, a human tissue product sold by Boston Scientific, one of our distributors. Legal proceedings are inherently unpredictable, and the outcome can result in excessive verdicts and/or injunctive relief that may affect how we operate our business, or we may enter into settlements of claims for monetary damages that exceed our insurance coverage, if any. In addition, we cannot predict the results of future legislative activity or future court decisions, any of which could lead to an increase in regulatory investigations or our exposure to litigation. Any such proceedings or investigations, regardless of the merits, may result in substantial costs, the diversion of management’s attention from other business concerns and additional restrictions on our sales or the use of our products, and potentially harm our reputation, which could disrupt our business and have an adverse effect on our results of operations and financial condition.
Our operations are subject to environmental, health and safety laws and regulations that could require us to incur material costs.
Our manufacturing operations worldwide and those of our third-party suppliers are subject to many requirements under environmental, health and safety laws concerning, among other things, the generation, handling, transportation and disposal of hazardous substances or wastes, the cleanup of hazardous substance releases, and emissions or discharges into the air or water. Violations of these laws can result in significant civil and criminal penalties and incarceration. Most environmental agencies also have the power to shut down an operation if it is operating in violation of environmental law. Some European countries impose environmental taxes or require manufacturers to take back used products at the end of their useful life, and others restrict the materials that manufacturers may use in their products and require redesign and labeling of products. We have management programs and processes in place that are intended to minimize the potential for violations of these laws. New laws and regulations, violations of these laws or regulations, stricter enforcement of existing requirements, or the discovery of previously unknown contamination could require us to incur costs, become the basis for new or increased liabilities, and cause disruptions to our operations that could be material. Any significant disruption in our third party suppliers' operations as a result of violations of these laws or regulations could also have an adverse effect on our operations and financial condition.
Changes in tax laws or exposure to additional income tax liabilities could have a material impact on our financial condition and results of operations.

We are subject to income taxes as well as non-income based taxes, in both the U.S. and various jurisdictions outside the U.S. We are subject to ongoing tax audits in the U.S. and other jurisdictions. Tax authorities may disagree with certain positions we have taken and assess additional taxes. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the actual outcomes of these audits could have a material impact on our consolidated earnings and financial condition. Additionally, changes in tax laws or tax rulings could materially impact our effective tax rate. For example, recent legislation imposed on medical device manufacturers a 2.3% excise tax on U.S. sales of medical devices beginning in January 2013. Proposals for fundamental U.S. corporate tax reform, if enacted, could have a material impact on our future results of operations.



26


Risks Related to Our Capital Structure
The interests of our Equity Sponsors may differ from the interests of holders of our 10.5% Second Lien Senior Secured Notes due 2018, 12.5% Senior Unsecured Notes due 2019 and Convertible Senior Notes due 2015 (collectively, the “Notes”).
As a result of the 2011 going-private transaction, our equity sponsors and their affiliates beneficially own most of the outstanding equity of our company. The interests of the Sponsors may differ from our interest and from those of holders of our Notes in material respects. For example, the Sponsors may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their overall equity portfolios, even though such transactions might involve risks to holders of our Notes. The Sponsors are in the business of making investments in companies, and may from time to time in the future, acquire interests in businesses that directly or indirectly compete with certain portions of our business or are suppliers of our customers. The companies in which one or more of the Sponsors invest may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. Additionally, the Sponsors may determine that the disposition of some or all of their interests in our company would be beneficial to the Sponsors at a time when such disposition could be detrimental to the holders of our Notes. If we encounter financial difficulties, or we are unable to pay our debts as they mature, the interests of our equity holders might conflict with those of the holders of our Notes. In that situation, for example, the holders of our Notes might want us to raise additional equity from our equity holders or other investors to reduce our leverage and pay our debts, while our equity holders might not want to increase their investment in us or have their ownership diluted and instead choose to take other actions, such as selling our assets. The Sponsors have no obligation to provide us with financing and are able to sell their equity ownership in our parent company at any time. Moreover, the Sponsors' ownership of our company may have the effect of discouraging offers to acquire control of our company.

Our substantial indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under the Notes.

We have a significant amount of indebtedness. At December 31, 2013, we and our subsidiaries had approximately $4,965 million (excluding original issue discount) of aggregate principal amount of indebtedness outstanding, of which $4,353 million was secured indebtedness, $612 million was unsecured indebtedness, and an additional $179 million of unused commitments available to be borrowed under our Revolving Credit Facility. Our substantial level of indebtedness increases the risk that we may be unable to generate cash sufficient to pay amounts due in respect of our indebtedness. Our substantial indebtedness could have other important consequences to our debt holders and significant effects on our business. For example, it could:
make it more difficult for us to satisfy our obligations with respect to the Notes and our other debt;
increase our vulnerability to adverse changes in general economic, industry and competitive conditions;
require us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
require us to repatriate cash for debt service from our foreign subsidiaries resulting in dividend tax costs or require us to adopt other disadvantageous tax structures to accommodate debt service payments;
restrict us from capitalizing on business opportunities;
make it more difficult to satisfy our financial obligations, including payments on the Notes;
place us at a competitive disadvantage compared to our competitors that have less debt; and
limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other general corporate purposes.

In addition, the credit agreement governing our credit facilities and the indentures governing the Notes contain, and the agreements governing future indebtedness may contain, restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all of our indebtedness.

27


Despite our current level of indebtedness, we may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage.
We may be able to incur significant additional indebtedness in the future. Although the indentures governing the Notes and the credit agreement governing our credit facilities limit our ability and the ability of our present and future subsidiaries to incur additional indebtedness, the terms of the credit facilities and the indentures permit us to incur significant additional indebtedness. Moreover, all amounts outstanding at any time under our credit facilities are effectively senior to the notes to the extent of the value of the collateral. In addition, the credit agreement governing our credit facilities and the Indentures do not prohibit us from incurring obligations that do not constitute indebtedness as defined therein. To the extent that we incur additional indebtedness or such other obligations, the risk associated with our substantial indebtedness described above, including our possible inability to service our debt, will increase. In addition, because our credit facilities bear interest at variable rates of interest, we are exposed to risk from fluctuations in interest rates. We may enter into interest rate swaps that involve the exchange of floating for fixed rate interest payments in order to reduce interest rate volatility. However, we may not maintain interest rate swaps with respect to all of our variable rate indebtedness, and any swaps we enter into may not fully mitigate our interest rate risk, or may create additional risks.
To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control and any failure to meet our debt service obligations could harm our business, financial condition and results of operations.
Our ability to make payments on and to refinance our indebtedness and to fund working capital needs and planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other factors that are beyond our control.
If our business does not generate sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs, we may need to refinance all or a portion of our indebtedness on or before the maturity thereof, sell assets, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse effect on our operations. In addition, we may not be able to affect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance our indebtedness will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments, including the credit agreement governing our credit facilities and the indentures governing the Notes, may limit or prevent us from taking any of these actions. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on commercially reasonable terms or at all. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to refinance or restructure our obligations on commercially reasonable terms or at all, would have an adverse effect, which could be material, on our business, financial condition and results of operations, as well as on our ability to satisfy our obligations in respect of the credit facilities or the Notes.
Our failure to comply with the agreements relating to our outstanding indebtedness, including as a result of events beyond our control, could result in an event of default that could materially and adversely affect our financial condition and results of operations.
If there were an event of default under any of the agreements relating to our outstanding indebtedness, the holders of the defaulted debt could cause all amounts outstanding with respect to that debt to be due and payable immediately. We cannot guarantee that our assets or cash flow would be sufficient to fully repay borrowings under our outstanding debt instruments if accelerated upon an event of default. Further, if we are unable to repay, refinance or restructure our indebtedness under our secured debt, the holders of such debt could proceed against the collateral securing that indebtedness. In addition, any event of default or declaration of acceleration under one debt instrument could also result in an event of default under one or more of our other debt instruments. As a result, any default by us on our indebtedness could have a material adverse effect on our business and could impact our ability to make payments under the Notes.

28


The credit agreement governing our credit facilities and the indentures governing the Notes will restrict our current and future operations, particularly our ability to respond to changes or to take certain actions.
The credit agreement governing our credit facilities and the indentures governing the Notes will impose significant operating and financial restrictions and limit our ability and our other restricted subsidiaries' ability to:
incur additional indebtedness and guarantee indebtedness;
pay dividends or make other distributions in respect of, or repurchase or redeem, capital stock;
prepay, redeem or repurchase certain debt;
make loans and investments;
sell or otherwise dispose of assets;
sell stock of our subsidiaries;
incur liens;
enter into transactions with affiliates;
enter into agreements restricting our subsidiaries’ ability to pay dividends; and
consolidate, merge or sell all or substantially all of our assets.

As a result of these covenants and restrictions, we are and will be limited in how we conduct our business, and we may be unable to raise additional debt or equity financing to compete effectively or to take advantage of new business opportunities. In addition, we will be required to maintain specified financial ratios and satisfy other financial condition tests. The terms of any future indebtedness we may incur could include more restrictive covenants. We cannot guarantee that we will be able to maintain compliance with these covenants in the future and, if we fail to do so, that we will be able to obtain waivers from the lenders and/or amend the covenants.
Our failure to comply with the restrictive covenants described above as well as others contained in our future debt instruments from time to time could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms, our results of operations and financial condition could be adversely affected.

ITEM 1B.      UNRESOLVED STAFF COMMENTS

None.

29




ITEM 2.      PROPERTIES

Our principal office is owned by us and is located in San Antonio, Texas. In addition, we lease office space in San Antonio, Texas, Bridgewater, New Jersey, and Gatwick, England, which are used for sales and marketing, customer service, research and development facilities, information technology, and for general corporate purposes. We also lease our service centers in countries where we have direct operations. We conduct our Regenerative Medicine manufacturing operations, including tissue processing, warehousing and distribution at two leased facilities in Branchburg, New Jersey, which includes office, laboratory, manufacturing and warehouse space. We maintain AWT manufacturing and engineering operations in the United States, the United Kingdom, Ireland and Belgium. We believe that all buildings, machinery and equipment are in good condition, suitable for their purposes and are maintained on a basis consistent with sound operations and that our current facilities will be adequate to meet our needs for 2014.

The following is a summary of our primary facilities:

 
 
 
 
 
 
Owned
Location
 
Description
 
Segment
 
or Leased
 
 
 
 
 
 
 
San Antonio, TX
 
Corporate Headquarters
 
Corporate
 
Owned
 
 
 
 
 
 
 
Bridgewater, NJ
 
LifeCell Offices
 
Regenerative Medicine
 
Leased
 
 
 
 
 
 
 
Gatwick, England
 
Systagenix Offices
 
AWT
 
Leased
 
 
 
 
 
 
 
Branchburg, NJ
 
Manufacturing Plant
 
Regenerative Medicine
 
Leased
 
 
 
 
 
 
 
Branchburg, NJ
 
Distribution Center
 
Regenerative Medicine
 
Leased
 
 
 
 
 
 
 
San Antonio, TX
 
R&D and Medical Facility
 
AWT
 
Leased
 
 
 
 
 
 
 
San Antonio, TX
 
Billings, Collections and Customer Service
 
AWT
 
Leased
 
 
 
 
 
 
 
San Antonio, TX
 
Information Technology and Training
 
Shared Services
 
Leased
 
 
 
 
 
 
 
San Antonio, TX
 
Technical Service Center
 
AWT
 
Leased
 
 
 
 
 
 
 
Budapest, Hungary
 
Financial and Other Shared Services
 
Shared Services
 
Leased
 
 
 
 
 
 
 
Dorset, England
 
R&D and Administrative Offices
 
AWT
 
Leased
 
 
 
 
 
 
 
Athlone, Ireland
 
Manufacturing Plant
 
AWT
 
Leased
 
 
 
 
 
 
 
Peer, Belgium
 
Manufacturing Plant
 
AWT
 
Leased
 
 
 
 
 
 
 
Gargrave, England
 
Manufacturing Plant
 
AWT
 
Owned

30



ITEM 3. 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.

Intellectual Property Litigation

In February 2011 KCI filed suit in U.S. Federal District Court for the Western District of Texas seeking a declaratory judgment that, among other things, KCI no longer owes royalties to Wake Forest University under a 1993 patent license agreement because the relevant patent claims previously licensed to KCI by Wake Forest are invalid or not infringed. The patents that are the subject of the litigation expire in June 2014. 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, a royalty payment of $44.2 million was paid to Wake Forest for the semi-annual period January 1, 2010 through June 30, 2010, and from July 1, 2010 through December 31, 2010 an additional $49.6 million of royalty obligations were accrued consistent with past practice. Amounts accrued, but unpaid from January 1, 2011 through February 27, 2011, were approximately $13.6 million. Due to the pending dispute and KCI’s claims against Wake Forest, the accrued amounts were not paid to Wake Forest. No royalty payments have been made to Wake Forest since August 2010. In the event that we are unsuccessful in this litigation, we may be required to pay substantial royalty damages to Wake Forest relating to NPWT product revenue for the period from July 2010 through June 2014. Wake Forest is also seeking treble damages in the case, which if awarded, could materially impact our results of operations and financial condition.

In 2011, in light of the multiple rulings in various jurisdictions including the U.S., declaring the Wake Forest 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 as a co-plaintiff with Wake Forest from pending litigation against Smith & Nephew (and later withdrew from litigation against other defendants such as Convatec, Medela and Innovative Therapies, Inc.), and filed the declaratory judgment action in February 2011. In March 2011, Wake Forest provided KCI with written notice of termination of the license agreement and demanded that KCI cease manufacturing and selling licensed products. Wake Forest has counterclaimed against KCI alleging breach of contract and patent infringement.
 
During 2012 and 2013, Wake Forest announced that it had reached settlements with several of our competitors, including Smith & Nephew, Medela, and Convatec relating to prior patent infringement litigation to resolve all patent disputes between them related to NPWT. The Wake Forest litigation is progressing and is set for trial in July 2014. KCI alleges breach of contract against Wake Forest for its refusal to negotiate in good faith to reduce the royalty rate under the 1993 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 subsequent decisions, KCI's assessment that the Wake Forest patents are invalid or not infringed by KCI's products remains unchanged.

We continue to vigorously litigate our positions in the Wake Forest litigation and KCI will continue to manufacture and sell V.A.C. 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 U.S. 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.

    

31



In a case related to the U.S. Wake Forest litigation, in 2013, KCI filed suit in the German Federal Patent Court against Wake Forest’s German patent corresponding to European Patent No. EP0620720 (“the '720 Patent”) relating to NPWT. In a 2009 trial between Wake Forest, Mölnlycke Health Care AB and Smith & Nephew, the ‘720 patent was declared invalid and revoked by the German court. Wake Forest appealed the decision. Following the settlements described above, the suits filed against Wake Forest’s German patent were withdrawn prior to the appeal being heard and the ‘720 patent was reinstated without a ruling on Wake Forest’s appeal. Although the patent’s statutory term expired in November 2012, KCI is seeking a final revocation of the ‘720 patent in Germany.

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 KCI entities based on a number of claims related to certain intellectual property rights sold by Vital Needs to KCI pursuant to a 2006 acquisition agreement. Vital Needs alleges, among other things, breach of the contract 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. The arbitration is currently set for January 2015. It is not possible to predict the outcome of this arbitration, nor is it possible to estimate any damages that may be awarded if we are unsuccessful in the litigation.
    
In September 2013, LifeNet Health ("LifeNet") filed suit against LifeCell Corporation in the United States District Court for the Eastern District of Virginia, Norfolk Division. LifeNet alleges that two LifeCell products, Strattice and AlloDerm Ready to Use®, infringe LifeNet’s U.S. Patent No. 6,569,200 ("the ‘200 Patent"). 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. We believe that our defenses to the LifeNet claims are meritorious and that the patents that are the subject of the litigation are invalid, or are not infringed by LifeCell’s 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.

Products Liability Litigation

LifeCell Corporation is a defendant in approximately 330 lawsuits filed by individuals alleging personal injury and seeking monetary damages for failed hernia repair procedures using LifeCell’s AlloDerm products. These cases have been consolidated for case management purposes in Middlesex County, New Jersey. The trial court has issued a pre-trial order incorporating the bellwether practice of trying the claims of some plaintiffs to determine the likelihood of settlement or to avoid relitigating common issues in every case. Following limited discovery, the parties have recently selected four bellwether cases from which the first case to be tried will be selected. Full discovery will now proceed on the four selected cases. Trial of the first case is scheduled for September 2015. 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. 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 to predict or estimate potential losses if our defenses to these cases are unsuccessful.

Since 2012, LifeCell Corporation has been named as a defendant in approximately 106 lawsuits in state and federal courts in Massachusetts, Delaware, Minnesota, and Texas (subsequently transferred to West Virginia multidistrict litigation docket) alleging personal injury and seeking monetary damages for failed gynecological procedures using a human tissue product processed by LifeCell and sold by Boston Scientific, one of our distributors. The LifeCell cases in Middlesex County Massachusetts were initially filed in a multidistrict action (the M Session) involving numerous synthetic mesh manufacturers and synthetic products. LifeCell filed a motion to dismiss claiming it was an improper party to the M Session because it relates to synthetic mesh products which we do not manufacture. Following a hearing, the trial court (1) created a separate docket for LifeCell’s products, (2) granted plaintiffs leave to amend their pleadings, and (3) granted LifeCell leave to file another motion to dismiss. LifeCell has filed its renewed motion to dismiss and a hearing on the motion is set for March 14, 2014. In the litigation pending elsewhere the courts have stayed Life Cell’s answer until a ruling on the motion to dismiss is made by the Massachusetts court. In the event the suits are not dismissed we intend to defend them vigorously. We have insurance that covers these claims and lawsuits. 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 and it is not clear that LifeCell is a proper party to the cases, it is not possible to predict or estimate potential losses if our defenses to these cases are unsuccessful.
  

32



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

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




ITEM 4.      MINE SAFTEY DISCLOSURES

Not applicable.


PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Centaur's partnership units are not currently traded on a public market. No dividends were declared in 2013, 2012 or 2011. The terms of our Notes and our senior credit agreement currently restrict our ability to declare and pay cash dividends. See Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.


33


ITEM 6. SELECTED FINANCIAL DATA
The following tables summarize our consolidated financial data for the periods presented. You should read the following financial information together with the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes to those consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. The selected consolidated balance sheet data for fiscal years 2012 and 2013 and the selected consolidated statement of operations data for the period from January 1, 2011 through November 3, 2011, the period from November 4, 2011 through December 31, 2011 and fiscal years 2012 and 2013 are derived from our audited consolidated financial statements included elsewhere in this report. The selected consolidated statement of operations data for fiscal years 2009 and 2010 and the selected consolidated balance sheet data for fiscal years 2009, 2010 and 2011 are derived from our audited consolidated financial statements not included in this report. Reclassifications have been made to our results from prior years to conform to our current presentation (in thousands).
 
Fiscal Year Ended December 31,
 
Period from January 1 through November 3,
 
Period from November 4 through December 31,
 
Fiscal Year Ended December 31,
 
2009
 
2010
 
2011
 
2011(1)
 
2012
 
2013
 
Predecessor
 
Predecessor
 
Predecessor
 
Successor
 
Successor
 
Successor
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated statement of operations data:
 
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$
919,359

 
$
911,866

 
$
746,816

 
$
142,962

 
$
822,201

 
$
750,252

Sales
768,956

 
831,574

 
756,596

 
161,802

 
924,252

 
1,008,659

Total revenue   
1,688,315

 
1,743,440

 
1,503,412

 
304,764

 
1,746,453

 
1,758,911

Rental expenses
465,937

 
468,975

 
350,912

 
85,142

 
443,446

 
358,595

Cost of sales
225,680

 
229,522

 
190,927

 
43,761

 
249,338

 
261,569

Gross profit 
996,698

 
1,044,943

 
961,573

 
175,861

 
1,053,669

 
1,138,747

Selling, general and administrative expenses
502,765

 
530,718

 
565,512

 
217,717

 
602,781

 
696,175

Research and development expenses
91,467

 
85,591

 
69,601

 
14,117

 
71,859

 
75,624

Acquired intangible asset amortization
40,634

 
37,426

 
29,519

 
16,459

 
220,984

 
188,571

Impairment of goodwill and intangible assets

 

 

 

 

 
443,400

Operating earnings (loss)
361,832

 
391,208

 
296,941

 
(72,432
)
 
158,045

 
(265,023
)
 
 
 
 
 
 
 
 
 
 
 
 
Interest income and Other
819

 
851

 
972

 
148

 
829

 
1,602

Interest expense(2)   
(104,918
)
 
(87,053
)
 
(61,931
)
 
(105,052
)
 
(466,622
)
 
(419,877
)
Loss on extinguishment of debt

 

 
 

 

 
(31,481
)
 
(2,364
)
Foreign currency gain (loss)
4,202

 
(4,769
)
 
131

 
21,783

 
(13,001
)
 
(22,226
)
Derivative instruments gain (loss)
(8,206
)
 
269

 
(2,909
)
 
(9,473
)
 
(31,433
)
 
1,576

Earnings (loss) from continuing operations before income taxes (benefit)
253,729

 
300,506

 
233,204

 
(165,026
)
 
(383,663
)
 
(706,312
)
Income taxes (benefit)
92,848

 
89,668

 
74,367

 
(46,330
)
 
(150,048
)
 
(150,957
)
Earnings (loss) from continuing operations
160,881

 
210,838

 
158,837

 
(118,696
)
 
(233,615
)
 
(555,355
)
Earnings (loss) from discontinued operations, net of tax
67,821

 
45,246

 
32,101

 
3,827

 
92,198

 
(3,303
)
Net earnings (loss)
$
228,702

 
$
256,084

 
$
190,938

 
$
(114,869
)
 
$
(141,417
)
 
$
(558,658
)


34


 
Fiscal Year Ended December 31,
 
2009
 
2010
 
2011(1)

 
2012
 
2013
 
Predecessor
 
Predecessor
 
Successor
 
Successor
 
Successor
Consolidated balance sheet data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
263,157

 
$
316,603

 
$
215,426

 
$
383,150

 
$
206,949

Working capital
417,327

 
512,388

 
479,913

 
512,185

 
461,707

Total assets
3,038,565

 
3,075,999

 
7,921,379

 
7,574,764

 
7,272,645

Total debt(3)
1,306,493

 
1,105,062

 
4,663,402

 
4,579,592

 
4,893,316

Total shareholders’ equity
1,177,471

 
1,483,079

 
1,593,444

 
1,457,396

 
898,075

    
(1)
Amounts include the impact of the Merger in November 2011.
(2)
Amount for the period from November 4, 2011 through December 31, 2011 (successor) includes $32.3 million of fees associated with the Merger-related bridge financing.
(3)
Total debt equals current and long-term debt and capital lease obligations.


35


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K. 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 I, Item 1A.).
OVERVIEW

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

Our advanced wound therapeutics ("AWT") business is focused on the development and commercialization of AWT devices and dressings and accounted for approximately $1.291 billion or 73.4% of our global revenue in 2013. Our AWT business is primarily engaged in commercializing several technology platforms, including negative pressure wound therapy (“NPWT”), negative pressure surgical management (“NPSM”) and epidermal harvesting. Our AWT dressings are used for the management of chronic and acute wounds. Our AWT business is primarily conducted by KCI and its operating subsidiaries, including Systagenix. Key brands in our AWT business include the V.A.C. NPWT line of products, Prevena, ABThera, CelluTome, Promogran, Tielle, and Adaptic.
 
Our Regenerative Medicine business is primarily focused on the development and commercialization of regenerative and reconstructive acellular tissue matrices for use in general and reconstructive surgical procedures to repair soft tissue defects. Key brands within our product portfolio include our human tissue based AlloDerm and porcine tissue based Strattice in various configurations designed to meet the needs of patients and caregivers. In addition to our acellular tissue matrices, our Regenerative Medicine business markets autologous fat grafting solutions, such as Revolve, and distributes SPY Elite, a real-time operating room-based tissue perfusion imaging system, both of which are complementary to our tissue matrix business. Regenerative medicine accounted for approximately $468.2 million or 26.6% of our global revenue in 2013.
Our customers include acute care hospitals, ambulatory surgical centers, and long-term care facilities, with whom we contract directly or through group purchasing organizations (“GPOs”). We bill these facilities directly for the rental and sale of our products. In the U.S. home care setting, we provide products and therapies to patients in the home and bill third-party payers, such as Medicare and private insurance, directly. Outside of the U.S., most of our revenue is generated in the acute care setting. Our sales and marketing organizations are focused on the training and education of care-givers on the proper application of our products and therapies, particularly with general, plastic and orthopedic surgeons, as well as wound ostomy care nurses. We also drive adoption of our products with the support of extensive clinical efficacy data, as well as the economic value proposition of our products to reduce the overall cost of care.
Acquisitions and Divestitures

In the fourth quarter of 2013, we closed the acquisition of Systagenix, an established provider of advanced wound therapeutics products. The adjusted purchase price paid, net of cash and cash equivalents, was $478.7 million. The purchase price was funded using $350.0 million of incremental borrowings under our existing senior secured credit facility along with cash on hand. The Systagenix portfolio of innovative wound care products comprises the majority of our advanced wound dressings business, discussed above. Systagenix, formerly part of Johnson & Johnson, generated annual revenue of approximately $205.5 million in 2013. Financial results of Systagenix are included within our consolidated financial statements for the period subsequent to the acquisition date. Combining Systagenix's advanced wound dressings with our KCI wound care business and innovation pipeline will enable us to create additional value for customers by providing more complete solutions for patients and clinicians.


36


In the fourth quarter of 2012, we completed the divestiture of our legacy KCI TSS business to Getinge AB. The TSS business was comprised of specialized therapeutic support systems, including hospital beds, mattress replacement systems, overlays and patient mobility devices. At the closing of the divestiture, Getinge paid approximately $247 million for the assets of the TSS business. At the time of the divestiture, we entered into a transition services agreement with Getinge pursuant to which we will continue to provide certain financial and information technology services during 2014. The historical results of operations of the disposal group, excluding the allocation of general corporate overhead, are reported as discontinued operations in the consolidated statements of operations.

Healthcare and Reimbursement Reform

Significant reforms to the U.S. healthcare system were adopted in the form of the Patient Protection and Affordable Care Act of 2010 (the “PPACA”). The PPACA requires, among other things, medical device companies to pay a 2.3% excise tax on most U.S. medical device sales beginning in 2013. During 2013, the company paid excise taxes totaling $13.5 million.

In the U.S. home care market, our NPWT products are subject to Medicare Part B reimbursement and many U.S. insurers have adopted coverage criteria similar to Medicare standards. For the year ended December 31, 2013, U.S. Medicare placements of our NPWT products represented approximately 8.1% of our total revenue. In 2013, a portion of our revenue from U.S. Medicare placements of NPWT products was subject to Medicare’s durable medical equipment competitive bidding program. Beginning July 1, 2013, this program resulted in an average reimbursement decline of 41% for NPWT across 91 major metropolitan areas, covering approximately 40% of our U.S. Medicare Part B volumes. CMS's DME Competitive Bidding Round One Re-Compete program impacted 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% applied 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.    
RECENT DEVELOPMENTS
On January 22, 2014, we entered into Amendment No. 5 to our Senior Secured Credit Facility ("Amendment No. 5"). As a result of the amendment, we created new classes of Dollar Term E-1 Loans, Euro Term E-1 Loans and Term E-2 Loans, having the same rights and obligations as the Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans as set forth in the Credit Agreement and Loan Documents, except as revised by the amendment. Dollar Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.00% or an adjusted base rate plus 2.00%. Euro Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.25% or an adjusted base rate plus 2.25%.  Term E-2 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 2.50% or an adjusted base rate plus 1.50%.  The Eurocurrency rate shall be subject to a floor of 1.00%, and the adjusted base rate shall be subject to a floor of 2.00%. We paid fees of $1.8 million as a result of this amendment.

37


RESULTS OF OPERATIONS
We have two reportable operating segments which correspond to our two businesses: Advanced Wound Therapeutics ("AWT") and Regenerative Medicine. Our AWT business is conducted by KCI and its subsidiaries, including Systagenix, while our Regenerative Medicine business is conducted by LifeCell and its subsidiaries. We have two primary geographic regions: the Americas, which is comprised principally of the United States and includes Canada, Puerto Rico and Latin America; and EMEA/APAC, which is comprised of Europe, the Middle East, Africa and the Asia Pacific region.
Historically, we have experienced a seasonal slowing of unit demand for our NPWT devices and related dressings beginning in the fourth quarter and continuing into the first quarter, which we believe has been caused by year-end clinical treatment patterns, such as the postponement of elective surgeries and increased discharges of individuals from the acute care setting around the winter holidays. We typically experience a slowing of demand for our AWT dressings in the fourth quarter. Although we do not know if our historical experience will prove to be indicative of future periods, similar slow-downs may occur in subsequent periods.
Revenue for each of our geographic regions in which we operate is disclosed for each of our businesses. Certain prior period amounts have been reclassified to conform to the 2013 presentation.
The Year ended December 31, 2013 (Successor) compared to the Year ended December 31, 2012 (Successor)
Revenue by Operating Segment

The following table sets forth, for the periods indicated, business unit revenue (in thousands):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Advanced Wound Therapeutics revenue:
 
 
 
Rental
743,818

 
$
815,560

Sales
546,909

 
496,698

Total – Advanced Wound Therapeutics
1,290,727

 
1,312,258

 
 
 
 
Regenerative Medicine revenue:
 
 
 
Rental
6,434

 
6,641

Sales
461,750

 
427,554

Total – Regenerative Medicine
468,184

 
434,195

 
 
 
 
Total consolidated revenue:
 
 
 
Rental
750,252

 
822,201

Sales
1,008,659

 
924,252

Total consolidated revenue
$
1,758,911

 
$
1,746,453


The increase in total revenue for 2013 as compared to the prior year was due to higher Regenerative Medicine sales revenue, partially offset by lower AWT rental revenue. Foreign currency exchange rate movements did not have a significant impact on worldwide revenue compared to the prior year.

The decline in worldwide AWT revenue from the prior year was attributable primarily to lower rental revenue in established markets, partially offset by revenues from the Systagenix acquisition in the fourth quarter and increased revenue 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 due to increased competition, healthcare reform and declining reimbursement. Foreign currency exchange rate movements did not have a significant impact on worldwide AWT revenue compared to the prior year periods.
 

38


The growth in worldwide Regenerative Medicine revenue over the prior year was due primarily to increased volumes of abdominal wall repair procedures due to demographic shifts and increased volumes of breast reconstruction procedures utilizing our products. Foreign currency exchange rate movements did not have a significant impact on worldwide Regenerative Medicine revenue.

For additional discussion on segment and operation information, see Note 15 of the notes to the consolidated financial statements for the year ended December 31, 2013.

Revenue by Geography

The following table sets forth, for the periods indicated, rental and sales revenue by geography (in thousands):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Americas revenue:
 
 
 
Rental
633,555

 
$
682,868

Sales
783,369

 
733,489

Total – Americas
1,416,924

 
1,416,357

 
 
 
 
EMEA/APAC revenue:
 
 
 
Rental
116,697

 
139,333

Sales
225,290

 
190,763

Total – EMEA/APAC
341,987

 
330,096

 
 
 
 
Total consolidated revenue:
 
 
 
Rental
750,252

 
822,201

Sales
1,008,659

 
924,252

Total consolidated revenue
$
1,758,911

 
$
1,746,453



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:
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Advanced Wound Therapeutics revenue
73.4
%
 
75.1
%
Regenerative Medicine revenue
26.6

 
24.9

Total consolidated revenue
100.0
%
 
100.0
%
 
 
 
 
Americas revenue
80.6
%
 
81.1
%
EMEA/APAC revenue
19.4

 
18.9

Total consolidated revenue
100.0
%
 
100.0
%
 
 
 
 
Rental revenue
42.7
%
 
47.1
%
Sales revenue
57.3

 
52.9

Total consolidated revenue
100.0
%
 
100.0
%



39


Rental Expenses

The following table presents rental expenses for the periods indicated (in thousands):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Rental expenses
$
358,595

 
$
443,446


Rental 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 2013 decreased from the prior year due primarily to a decrease in depreciation related to the fixed asset step up associated with purchase accounting related to the Merger and a reduction in operational expenses due to cost control measures.

Cost of Sales

The following table presents cost of sales (in thousands):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Cost of sales
$
261,569

 
$
249,338


Cost of sales includes manufacturing costs, product costs, royalties and the step up in value associated with purchase accounting adjustments associated with our “for sale” products.  The increase in cost of sales in 2013 compared to the prior year was due primarily to increased sales volumes, partially offset by a $22.3 million net decrease in cost of sales related to the sale of inventory subject to a step up in value associated with purchase accounting adjustments.

Gross Profit Margin

The following table presents the gross profit margin (calculated as gross profit divided by total revenue for the periods indicated):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Gross profit margin
64.7
%
 
60.3
%

The gross profit margin increase during 2013 compared to the prior year 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):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Selling, general and administrative expenses
$
696,175

 
$
602,781

As a percent of total revenue
39.6
%
 
34.5
%

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

40


rental sales force compensation costs. The increase in SG&A expenses during 2013 compared to the prior year is due primarily to a fixed asset impairment charge of $30.6 million and an increase in restructuring-related expenses. Additionally, during 2013, write-offs of $16.9 million of other intangible assets were recorded due primarily to the discontinuation of certain projects. During 2012, SG&A expenses included impairment charges of $22.1 million associated with certain production equipment at our AWT 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):
 
Year ended December 31, 2013
 
Year ended December 31, 2012
 
 
 
 
 
 
Research and development expenses
$
75,624

 
$
71,859

As a percent of total revenue
4.3
%
 
4.1
%

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

Acquired Intangible Asset Amortization

In connection with the Merger, we recorded $2.89 billion of identifiable intangible assets during the fourth quarter of 2011. In 2013, we recorded an additional $253.6 million of identifiable intangibles in connection with our acquisition of Systagenix. We recognized $188.6 million and $221.0 million of amortization expense related to these acquired intangible assets during the years ended December 31, 2013 and 2012, respectively.

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 Regenerative Medicine reporting unit.

Interest Expense

Interest expense decreased to $419.9 million in 2013 compared to $466.6 million in the prior year due to lower average debt balances at lower interest rates.

Foreign Currency Gain (Loss)

Foreign currency transaction losses were $22.2 million during 2013 compared to $13.0 million in the prior year. The revaluation of the Term D-1 EURO loan to U.S. dollars represented $14.5 million and $6.3 million of the foreign currency transaction losses recorded during 2013 and 2012, respectively.

Derivative Instruments Gain (Loss)

During 2013, we recorded a derivative instruments gain of $1.6 million compared to a loss of $31.4 million in the prior year due primarily to fluctuations in the value of our interest rate derivative instruments.

Gain (loss) from Discontinued Operations

Earnings from discontinued operations, net of tax, were $3.3 million for 2013 compared to a gain of $92.2 million for 2012 related to the disposition of TSS assets. During 2012, we recognized a $93.9 million gain from the disposition of TSS assets, which is included in earnings from discontinued operations. See Note 3 of the notes to consolidated financial statements for the year ended December 31, 2013 for additional information on discontinued operations.


41


The Year ended December 31, 2012 (Successor), the Period from November 4, 2011 through December 31, 2011 (Successor) and the Period from January 1, 2011 through November 3, 2011 (Predecessor)
Revenue by Operating Segment

The following table sets forth, for the periods indicated, business unit revenue (in thousands):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Advanced Wound Therapeutics revenue:
 
 
 
 
 
Rental
815,560

 
142,506

 
745,457

Sales
496,698

 
88,643

 
436,504

Total – Advanced Wound Therapeutics
1,312,258

 
231,149

 
1,181,961

 
 
 
 
 
 
Regenerative Medicine revenue:
 
 
 
 
 
Rental
6,641

 
456

 
1,359

Sales
427,554

 
73,159

 
320,092

Total – Regenerative Medicine
434,195

 
73,615

 
321,451

 
 
 
 
 
 
Total consolidated revenue:
 
 
 
 
 
Rental
822,201

 
142,962

 
746,816

Sales
924,252

 
161,802

 
756,596

Total consolidated revenue
$
1,746,453

 
$
304,764

 
$
1,503,412


The decline in worldwide Advanced Wound Therapeutics revenue in 2012 was attributable primarily to lower rental revenue and disposable and therapy unit sales volumes in established markets, partially offset by increased revenue from new products including Prevena, GRAFTJACKET and V.A.C.Ulta as well as higher rental and sales volumes from our expansion markets. The lower rental and disposable sales revenue in established markets resulted primarily from a combination of lower hospital procedural volumes and lower average pricing. We anticipate our average global pricing to decline moderately in the future as our competitors market products designed to compete with our product portfolio. Foreign currency exchange movements unfavorably impacted total Advanced Wound Therapeutics revenues during 2012 compared to the prior year.

The growth in Regenerative Medicine revenue over the prior-year periods was due primarily to increased demand for our acellular tissue matrix products as a result of continued market penetration and geographic expansion driven by revenue from the commercial launch of AlloDerm Ready to Use. Foreign currency exchange rate movements did not have a significant impact on worldwide Regenerative Medicine revenue.

For additional discussion on segment and operation information, see Note 15 of the notes to the consolidated financial statements for the year ended December 31, 2013.



42


Revenue by Geography

The following table sets forth, for the periods indicated, rental and sales revenue by geography (in thousands):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Americas revenue:
 
 
 
 
 
Rental
682,868

 
118,492

 
616,376

Sales
733,489

 
127,479

 
585,340

Total – Americas
1,416,357

 
245,971

 
1,201,716

 
 
 
 
 
 
EMEA/APAC revenue:
 
 
 
 
 
Rental
139,333

 
24,470

 
130,440

Sales
190,763

 
34,323

 
171,256

Total – EMEA/APAC
330,096

 
58,793

 
301,696

 
 
 
 
 
 
Total consolidated revenue:
 
 
 
 
 
Rental
822,201

 
142,962

 
746,816

Sales
924,252

 
161,802

 
756,596

Total consolidated revenue
$
1,746,453

 
$
304,764

 
$
1,503,412


The change in total revenue compared to the prior-year was due to lower Advanced Wound Therapeutics revenue, partially offset by higher Regenerative Medicine revenue. Foreign currency exchange movements had a slightly unfavorable impact on total revenue during 2012 compared to the prior year.

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:
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Advanced Wound Therapeutics revenue
75.1
%
 
75.8
%
 
78.6
%
Regenerative Medicine revenue
24.9

 
24.2

 
21.4

Total consolidated revenue
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
Americas revenue
81.1
%
 
80.7
%
 
79.9
%
EMEA/APAC revenue
18.9

 
19.3

 
20.1

Total consolidated revenue
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
Rental revenue
47.1
%
 
46.9
%
 
49.7
%
Sales revenue
52.9

 
53.1

 
50.3

Total consolidated revenue
100.0
%
 
100.0
%
 
100.0
%



43


Rental Expenses

The following table presents rental expenses for the periods indicated (in thousands):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Rental expenses
$
443,446

 
$
85,142

 
350,912

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 as a percent of total rental revenue during 2012 and the period from November 4 through December 31, 2011 increased from the prior period due primarily to depreciation expense associated with the purchase accounting adjustments related to the step up in value of rental medical equipment ("RME") related to the Merger, which totaled $102.9 million and $21.4 million for 2012 and the period from November 4, 2011 through December 31, 2011, respectively, or 12.5% and 14.9% of total rental revenue, respectively, partially offset by lower product royalty costs on NPWT revenue associated with our previous license agreement with Wake Forest University for which we ceased accruing royalties in the first quarter of 2011.

Cost of Sales

The following table presents cost of sales (in thousands):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Cost of sales
$
249,338

 
$
43,761

 
190,927

Cost of sales includes manufacturing costs, product costs and royalties associated with our “for sale” products. Cost of sales for 2012 and the period from November 4 through December 31, 2011 includes cost of sales associated with the purchase accounting adjustments related to the step up in value of inventory related to the Merger, which totaled $25.5 million and $7.3 million for 2012 and the period from November 4, 2011 through December 31, 2011, respectively, or 2.8% and 4.8% of total sales revenue, respectively, and lower product royalty costs on NPWT revenue associated with our previous license agreement with Wake Forest University. The decrease in our cost of sales as a percent of sales revenue during the period from January 1, 2011 through November 3, 2011 was due primarily to lower product royalty costs on NPWT revenue associated with our previous license agreement with Wake Forest University and improved yields for Regenerative Medicine .

Gross Profit Margin

The following table presents the gross profit margin (calculated as gross profit divided by total revenue for the periods indicated):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Gross profit margin
60.3
%
 
57.7
%
 
64.0
%

The gross profit margin decrease during 2012 and the period from November 4 through December 31, 2011 was due primarily to depreciation expense of $102.9 million and $21.4 million, respectively, and cost of sales of $25.5 million and $7.3 million, respectively, associated with the purchase accounting adjustments related to the step up in value of RME and inventory. This decrease was partially offset by lower royalty expense associated with our previous license agreement with Wake Forest University and higher gross margins associated with Regenerative Medicine. During 2012 and the period from November 4, 2011 through December 31, 2011, we did not record any royalty expense associated with our previously-existing licensing agreement with Wake Forest University. During the period from January 1, 2011 through November 3, 2011, we recorded $13.1 million in royalty expense associated with our previously-existing licensing agreement with Wake Forest University.

44



Selling, General and Administrative Expenses

The following table presents selling, general and administrative expenses and the percentage relationship to total revenue (dollars in thousands):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Selling, general and administrative expenses
$
602,781

 
$
217,717

 
$
565,512

As a percent of total revenue
34.5
%
 
71.4
%
 
37.6
%

SG&A expenses include administrative labor, incentive and sales compensation costs, insurance costs, professional fees, depreciation, bad debt expense and information systems costs, but excludes rental sales force compensation costs. SG&A increased during the period from November 4, 2011 through December 31, 2011 due primarily to charges, before taxes, related to the Merger, including $99.4 million of transaction costs and management fees and $35.2 million of restructuring and other costs. Additionally, the Company incurred higher selling and marketing costs associated with our Regenerative Medicine division and higher costs associated with geographic expansion. During the period from January 1 through November 3, 2011, the Company incurred significant charges, before taxes, related to the Merger, including $55.0 million of additional share-based compensation expense to settle in-the-money equity awards to employees and non-employee directors and $39.0 million of transaction costs.

Research and Development Expenses

The following table presents research and development expenses and the percentage relationship to total revenue (dollars in thousands):
 
Year ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
 
 
 
Successor
 
Successor
 
Predecessor
 
 
 
 
 
 
Research and development expenses
$
71,859

 
$
14,117

 
69,601

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

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

Acquired Intangible Asset Amortization

In connection with the Merger, we recorded $2.89 billion of identifiable intangible assets and recognized $188.6 million and $16.5 million of amortization expense during the year ended December 31, 2012 and the period from November 4, 2011 through December 31, 2011, respectively. Prior to the Merger, we recorded $486.7 million of identifiable definite-lived intangible assets during the second quarter of 2008 in connection with the LifeCell acquisition. Intangible asset amortization expense associated with the LifeCell acquisition was $29.5 million during the period from January 1, 2011 through November 3, 2011.

Interest Expense

Interest expense increased to $419.9 million during 2012 due to higher average debt balances at higher interest rates, and higher expense associated with interest rate swap and cap agreements. Interest expense increased to $105.1 million during the period from November 4, 2011 through December 31, 2011 due to one-time commitment fees of $32.3 million associated with Merger-related bridge financing, higher average debt balances at higher interest rates, and higher expense associated with interest rate swap and cap agreements.

45



Foreign Currency Gain (Loss)

During the year ended December 31, 2012, foreign currency transaction losses were $13.0 million due primarily to significant volatility in the foreign currency markets. Foreign currency transaction gains were $21.8 million during the period from November 4, 2011 through December 31, 2011, of which $6.8 million related to the revaluation of the Term B-1 EURO loan to U.S. dollars, due primarily to significant volatility in the foreign currency markets. During the period from January 1, 2011 through November 3, 2011, foreign currency transaction losses were $0.1 million due primarily to significant volatility in the foreign currency markets.

Earnings from Discontinued Operations

Earnings from discontinued operations, net of tax, were $92.2 million, $3.8 million and $32.1 million for the year ended December 31, 2012, the period from November 4, 2011 through December 31, 2011 and the period from January 1, 2011 through November 3, 2011, respectively, related to the disposition of TSS assets. During 2012, we recognized a $93.9 million gain from this transaction, which is included in earnings from discontinued operations. See Note 3 of the notes to consolidated financial statements for the year ended December 31, 2012 for additional information on discontinued operations.

LIQUIDITY AND CAPITAL RESOURCES
We expect to fund our operations through a combination of internally generated cash from operations and from occasional borrowings under our Revolving Credit Facility. Our primary uses of cash are working capital requirements, capital expenditures and debt service requirements. We anticipate that cash generated from operations together with amounts available under our Revolving Credit Facility will be sufficient to meet our future working capital requirements, capital expenditures and debt service obligations as they become due. However, our ability to fund future operating expenses and capital expenditures and our ability to meet future debt service obligations or refinance our indebtedness will depend on our future operating performance which will be affected by general economic, financial and other factors beyond our control. See “Risk Factors—Risks Relating to our Capital Structure—To service our indebtedness, we will require a significant amount of cash.” Our ability to generate cash depends on many factors beyond our control, and any failure to meet our debt service obligations could harm our business, financial condition and results of operations. For further information on the terms of our Revolving Credit Facility, see Note 6 of the notes to the consolidated financial statements for the year ended December 31, 2013.
On November 8, 2012, KCI closed on the divestiture of its TSS business to Getinge AB. The final adjusted purchase price paid by Getinge to KCI was $241.5 million. The Company had one year of the close date to reinvest all of the net proceeds or otherwise use any remaining amount to repay its long-term debt obligations. The Company utilized the net proceeds from the sale to fund the acquisition of Systagenix and internal investments, which satisfied our reinvestment requirement.
Historical — General
We require capital principally for working capital requirements, capital expenditures and debt service requirements. Additionally, from time to time, we may use capital for acquisitions and other investing and financing activities. Working capital is required principally to finance accounts receivable and inventory. Our working capital requirements vary from period-to-period depending on manufacturing volumes, the timing of shipments and the payment cycles of our customers and payers. Our capital expenditures consist primarily of manufactured rental assets, manufacturing equipment, computer hardware and software, expenditures related to leasehold improvements and expenditures related to our global corporate headquarters building.

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.

46



Sources of Capital

Based upon the current level of operations, we believe our existing cash 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 years ended December 31, 2013, and 2012, the period from January 1, 2011 through November 3, 2011 and the period from November 4, 2011 through December 31, 2011 and therefore have not been separately disclosed in the 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 2013, our primary source of capital was cash from operations and cash from financing activities related to our acquisition of Systagenix. During 2012, our primary source of capital was cash from operations and proceeds from the disposition of TSS assets held for sale. During the period from January 1, 2011 through November 3, 2011 and the period from November 4, 2011 through December 31, 2011, 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):
 
Year Ended December 31, 2013
 
Year Ended December 31, 2012
 
Period from
November 4
through
December 31, 2011
 
Period from
January 1
through
November 3, 2011
 
Successor
 
Successor
 
Successor
 
Predecessor
Net cash provided (used) by operating activities
$
136,779

 
$
162,693

 
$
(77,574
)
 
$
487,968

Net cash provided (used) by investing activities
(563,822
)
 
144,535

 
(5,208,991
)
 
(122,657
)
Net cash provided (used) by financing activities
250,602

 
(140,200
)
 
4,792,031

 
28,953

Effect of exchange rates changes on cash and cash equivalents
240

 
696

 
(1,925
)
 
1,018

Net increase (decrease) in cash and cash equivalents
$
(176,201
)
 
$
167,724

 
$
(496,459
)
 
$
395,282


As of December 31, 2013 and 2012, our principal sources of liquidity consisted of $206.9 million and $383.2 million, respectively, of cash and cash equivalents and availability under our Revolving Credit Facility. The availability under the Revolving Credit Facility was $178.8 million and $188.5 million at December 31, 2013 and 2012, respectively, and was reduced for $21.2 million and $11.5 million, respectively, of letters of credit issued by banks which are party to the Senior Secured Credit Facility. In addition, we had $12.6 million and $4.6 million of letters of credit issued by a bank not party to the Senior Secured Credit Facility as of December 31, 2013 and 2012, respectively.

Capital Expenditures

During the years ended December 31, 2013 and 2012 (Successor), the period of November 4, 2011 through December 31, 2011 (Successor), and the period of January 1, 2011 through November 3, 2011 (Predecessor), we made capital expenditures of $80.9 million, $91.6 million, $36.0 million and $98.6 million, respectively. Capital expenditures during the year ended December 31, 2013 (Successor) related primarily to expanding the rental fleet and information technology projects and purchases. Capital expenditures during the year ended December 31, 2012 (Successor), the period of November 4, 2011 through December 31, 2011 (Successor), and the period of January 1, 2011 through November 3, 2011 (Predecessor) related primarily to expanding the rental fleet, the construction of our global headquarters building, and information technology projects and purchases.

Senior Secured 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.



47


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 December 31, 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
 
%
 
$

 
$
178,798

(2) 
Senior Dollar Term D-1 Credit Facility
 
May 2018
 
4.92
%
(3) 
1,915,782

 

 
Senior Euro Term D-1 Credit Facility
 
May 2018
 
5.59
%
(3) 
327,127

 

 
Senior Term D-2 Credit Facility
 
November 2016
 
4.54
%
(3) 
314,051

 

 
   Total
 
 
 
 
 
$
2,556,960

 
$
178,798

 
(1)
Amount outstanding includes the original issue discount.
(2)
At December 31, 2013, the amount available under the revolving portion of our Senior Secured Credit Facility reflected a reduction of $21.2 million of letters of credit issued by banks which are party to the Senior Secured Credit Facility. In addition, we have $12.6 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 December 31, 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.

On January 22, 2014, we entered into Amendment No. 5 to our Senior Secured Credit Facility ("Amendment No. 5"). As a result of the amendment we created new classes of Dollar Term E-1 Loans, Euro Term E-1 Loans and Term E-2 Loans, having the same rights and obligations as the Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans as set forth in the Credit Agreement and Loan Documents, except as revised by the amendment. In connection with Amendment No. 5, Dollar Term D-1 Loans, Euro Term D-1 Loans and Term D-2 Loans were refinanced with Dollar Term E-1 Loans, Euro Term E-1 Loans and Term E-2 Loans, respectively. Dollar Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.00% or an adjusted base rate plus 2.00%. Euro Term E-1 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 3.25% or an adjusted base rate plus 2.25%.  Term E-2 Loans bear interest at a rate equal to, at KCI’s election, a Eurocurrency rate plus 2.50% or an adjusted base rate plus 1.50%.  The Eurocurrency rate shall be subject to a floor of 1.00%, and the adjusted base rate shall be subject to a floor of 2.00%. We paid fees of $1.8 million as a result of this amendment.  

10.5% Second Lien Senior Secured Notes

In November 2011, we issued $1.75 billion aggregate principal amount of second lien senior secured notes due 2018 (the "10.5% Second Lien Notes"). Interest on the 10.5% Second Lien Notes accrues at the rate of 10.50% 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.

12.5% Senior Unsecured Notes

In November 2011, we issued $750.0 million aggregate principal amount of senior unsecured notes due 2019 (the "12.5% Unsecured Notes"); $612.0 million of which are still outstanding. Interest on the 12.5% Unsecured Notes accrues at the rate of 12.50% per annum and is payable semi-annually in cash on each May 1 and November 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 12.5% 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.


48


Convertible Senior Notes

In 2008, we issued $690.0 million aggregate principal amount of 3.25% convertible senior notes due 2015 (the “Convertible Notes”). The Convertible Notes are governed by the terms of an indenture dated as of April 21, 2008 (the “Indenture”). In connection with the Merger, the holders of the Convertible Notes had the right to require us to repurchase some or all of their Convertible Notes. As of December 31, 2013, $101,000 aggregate principal amount of the notes remained outstanding.

Covenants

As of December 31, 2013 and 2012, the Senior Secured Credit Facility required we have a total leverage ratio of not to exceed 8.1:1 and 8.3:1, respectively, and an interest coverage ratio of at least 1.2:1 and 1.1:1, respectively. As of December 31, 2013 and 2012, our actual total leverage ratio was 6.0:1 and 5.6:1, respectively, and our interest coverage ratio was 1.9:1 and 1.6:1, respectively. As of December 31, 2013 and 2012, we were in compliance with all covenants under the Senior Secured Credit Facility. As of December 31, 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 for the year ended December 31, 2013.

Interest Rate Protection

At December 31, 2013 and 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 became effective on December 31, 2013. The aggregate notional amount of the interest rate swaps decreases quarterly by amounts ranging from $1.7 million to $56.4 million until maturity. In November 2011, we entered into interest rate cap agreements with initial notional amounts of $1.6 billion that effectively limited the eurocurrency rate to 2% on a portion of the borrowings under our Senior Secured Credit Facility. These interest rate cap agreements expired December 31, 2013. 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 7 of the notes to the consolidated financial statements for the year ended December 31, 2013.

Contractual Obligations
We are committed to making cash payments in the future on long-term debt, capital leases, operating leases, licensing agreements and purchase commitments. We have not guaranteed the debt of any other party. The following table summarizes our contractual cash obligations as of December 31, 2013 for each of the years indicated (in thousands):
 
2014
 
2015-2016
 
2017-2018
 
Thereafter
 
Total(1)
Long-term debt obligations(2)   
$
26,311

 
$
361,328

 
$
3,965,527

 
$
612,000

 
$
4,965,166

Interest on long-term debt obligations(2)   
377,738

 
749,782

 
626,158

 
64,600

 
1,818,278

Capital lease obligations
526

 
992

 

 

 
1,518

Operating lease obligations
21,949

 
28,551

 
16,637

 
30,843

 
97,980

Licensing agreements
6,250

 
2,500

 
1,250

 

 
10,000

Purchase obligations
7,224

 
6,500

 

 

 
13,724

Related party management fees(3)
5,148

 
10,296

 
10,296

 
24,882

 
50,622

Total   
$
445,146

 
$
1,159,949

 
$
4,619,868

 
$
732,325

 
$
6,957,288

(1) This excludes our liability of $53.7 million for unrecognized tax benefits. We cannot make a reasonably reliable estimate of the amount and period of related future payments for such liability.
(2) Amounts and timing may be different from our estimated interest payments due to potential voluntary prepayments, borrowings and interest and foreign currency rate fluctuations.
(3) Represents fees for strategic and consulting services paid to entities affiliated with the Sponsors. For further discussion of related party management fees, see Note 14 of the notes to the consolidated financial statements for the year ended December 31, 2013.

49


Critical Accounting Estimates
Critical accounting estimates as those that are, in management's opinion, very important to the portrayal of our financial condition and results of operations and require our management's most difficult, subjective or complex judgments. In preparing our financial statements in accordance with U.S. generally accepted accounting principles, we must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex. Consequently, actual results could differ from our estimates. The accounting policies that are most subject to important estimates or assumptions are described below. Also, see Note 1 of the notes to the consolidated financial statements for the year ended December 31, 2013.

Revenue Recognition and Accounts Receivable Realization

We recognize revenue in accordance with the Revenue Recognition topic of the Codification when each of the following four criteria are met:

1)
a contract or sales arrangement exists;
2)
products have been shipped and title has transferred or services have been rendered;
3)
the price of the products or services is fixed or determinable; and
4)
collectibility is reasonably assured.

We recognize rental revenue based on the number of days a product is used by the patient/organization, (i) at the contracted rental rate for contracted customers and (ii) generally, retail price for non-contracted customers.  Sales revenue is recognized when products are shipped and title has transferred.  In addition, we establish realization reserves against revenue to provide for adjustments including capitation agreements, estimated credit memos, volume discounts, pricing adjustments, utilization adjustments, product returns, cancellations, estimated uncollectible amounts and payer adjustments based on historical experience. In addition, revenue is recognized net of administrative fees paid to group purchasing organizations (“GPOs”).

The Americas trade accounts receivable consist of amounts due directly from acute and extended care organizations, third-party payers (“TPP”), both governmental and non-governmental, and patient pay accounts.  Included within the TPP accounts receivable balances are amounts that have been or will be billed to patients once the primary payer portion of the claim has been settled by the TPP.  EMEA/APAC trade accounts receivable consist of amounts due primarily from acute care organizations.

The TPP reimbursement process in the United States requires extensive documentation, which has had the effect of slowing both the billing and cash collection cycles relative to the rest of the business, and therefore, could increase total accounts receivable.  Because of the extensive documentation required and the requirement to settle a claim with the primary payer prior to billing the secondary and/or patient portion of the claim, the collection period for a claim in our home care business may, in some cases, extend beyond one year prior to full settlement of the claim.

We utilize a combination of factors in evaluating the collectibility of our accounts receivable. For unbilled receivables, we establish reserves to allow for expected denied or uncollectible items.  In addition, items that remain unbilled for more than a specified period of time, or beyond an established billing window, are reserved against revenue.  For billed receivables, we generally establish reserves using a combination of factors including historic adjustment rates for credit memos and canceled transactions, historical collection experience, and the length of time receivables have been outstanding.  The reserve rates vary by payer group.  In addition, we record specific reserves for bad debt when we become aware of a customer's inability or refusal to satisfy its debt obligations, such as in the event of a bankruptcy filing. If circumstances change, such as higher than expected claims denials, post-payment claim recoupments, a material change in the interpretation of reimbursement criteria by a major customer or payer, or payment defaults or an unexpected material adverse change in a major customer's or payer's ability to meet its obligations, our estimates of the realizability of trade receivables could be reduced by a material amount.  A hypothetical 1% change in the collectibility of our billed receivables at December 31, 2013 would impact pre-tax earnings (loss) by an estimated $1.7 million.


50


Inventory

Advanced Wound Therapeutics inventories

Prior to the completion of the Merger on November 4, 2011, inventories were stated at the lower of cost or market (net realizable value), with cost being determined on a first-in, first-out basis. On November 4, 2011, inventories were recorded at fair value with the application of purchase accounting adjustments, with subsequent additions to inventory recorded at the lower of cost or market (net realizable value), with cost being determined on a first-in, first-out basis. On October 28, 2013, inventories purchased as part of our acquisition of Systagenix were recorded at fair value with the application of purchase accounting adjustments, with subsequent additions to inventory recorded at the lower of cost or market (net realizable value), with cost being determined on a first-in, first-out basis. Costs include material, labor and manufacturing overhead costs. Inventory expected to be converted into equipment for short-term rental is reclassified to property, plant and equipment. We review our inventory balances quarterly for excess sale products or obsolete inventory levels. Inventory quantities of sale-only products in excess of anticipated demand are considered excess and are reserved at 100%. For rental products, we review both product usage and product life cycle to classify inventory as active, discontinued or obsolete. Obsolescence reserve balances are established on an increasing basis from 0% for active, high-demand products to 100% for obsolete products. The reserve is reviewed and, if necessary, adjustments are made on a monthly basis. We rely on historical information and production planning forecasts to support our reserve and utilize management's business judgment for "high risk" items, such as products that have a fixed shelf life. Once the value of inventory is reduced, we do not adjust the reserve balance until the inventory is sold or otherwise disposed.

Regenerative Medicine inventories

Prior to the completion of the Merger on November 4, 2011, inventories were stated at the lower of cost or market (net realizable value), with cost being determined on a first-in, first-out basis. On November 4, 2011, inventories were recorded at fair value with the application of purchase accounting adjustments, with subsequent additions to inventory recorded at the lower of cost or market (net realizable value), with cost being determined on a first-in, first-out basis. Inventories on hand include the cost of materials, freight, direct labor and manufacturing overhead. We record a provision for excess and obsolete inventory based primarily on inventory quantities on hand, the historical product sales and estimated forecast of future product demand and production requirements. In addition, we record a provision for tissue that will not meet tissue standards based on historic rejection rates.

Long-Lived Assets

Prior to the completion of the Merger on November 4, 2011, property, plant and equipment was stated at cost. On November 4, 2011, property, plant and equipment was recorded at fair value with the application of purchase accounting adjustments, with subsequent additions to property, plant and equipment recorded at cost. On October 28, 2013, property, plant and equipment purchased as part of our acquisition of Systagenix was recorded at fair value with the application of purchase accounting adjustments, with subsequent additions to property, plant and equipment recorded at cost. Betterments, which extend the useful life of the equipment, are capitalized. Depreciation on property, plant and equipment is calculated on the straight-line method over the estimated useful lives (20 to 30 years for buildings and between three and seven years for most of our other property and equipment) of the assets. If an event were to occur that indicates the carrying value of long-lived assets might not be recoverable, we would review property, plant and equipment for impairment using an undiscounted cash flow analysis and if an impairment had occurred on an undiscounted basis, we would compute the fair market value of the applicable assets on a discounted cash flow basis and adjust the carrying value accordingly.

Goodwill and Other Intangible Assets

Business combinations are accounted for under the acquisition method. The total cost of an acquisition is allocated to the underlying identifiable net assets, based on their respective estimated fair values as of the acquisition date. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.


51


Goodwill is tested for impairment by reporting unit annually as of October 31, or more frequently when events or changes in circumstances indicate that the asset might be impaired. Examples of such events or circumstances include, but are not limited to, a significant adverse change in legal or business climate, an adverse regulatory action or unanticipated competition.

Impairment 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 current industry market multiples as well as discounted cash flow models using certain assumptions about expected future operating performance and appropriate discount rates determined by our management. To ensure the reasonableness of the estimated fair value of our reporting units, we perform a reconciliation of the estimated fair value of our consolidated entity to the total estimated fair value of all our reporting units. The assumptions used in estimating fair values and performing the goodwill impairment test are inherently uncertain and require management judgment. 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. We amortize our identifiable definite lived intangible assets over 2 to 20 years, depending on the estimated economic or contractual life of the individual asset. For indefinite-lived identifiable intangible assets, impairment is tested by comparing the carrying value of the asset to the fair value. When it is determined that the carrying value of identifiable intangible assets 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.

The results of the third quarter 2013 interim impairment test indicated that the estimated fair value of the Regenerative Medicine 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 identifiable intangible assets related to our Regenerative Medicine reporting unit. There were no impairments of goodwill or identifiable intangible assets during 2012 or 2011.

Our estimates of discounted cash flows may differ from actual cash flows due to, among other things, economic conditions, changes to our business model or changes in operating performance. Significant differences between these estimates and actual cash flows could materially affect our future financial results. These factors increase the risk of differences between projected and actual performance that could impact future estimates of fair value of all reporting units. In the event of an approximate 24% and 5% drop in the fair value of our KCI reporting unit and the fair value of our KCI indefinite-lived identifiable intangible assets, respectively, the fair value of the KCI reporting unit and indefinite-lived identifiable intangible assets would still exceed their book values as of October 31, 2013. Additionally, in the event of an approximate 7% and 2% drop in the fair value of our Regenerative Medicine reporting unit and the fair value of our Regenerative Medicine indefinite-lived identifiable intangible assets, respectively, the fair value of the Regenerative Medicine reporting unit and indefinite-lived identifiable intangible assets would still exceed their book values as of October 31, 2013. The carrying value of our Systagenix reporting unit and indefinite-lived identifiable intangible assets approximated their respective fair values as of October 31, 2013.

Income Taxes

Deferred income taxes are accounted for in accordance with the “Income Taxes” Topic of the FASB Accounting Standards Codification which requires the asset and liability method, whereby deferred tax assets and liabilities are recognized based on the tax effects of temporary differences between the financial statements and the tax bases of assets and liabilities, as measured by current enacted tax rates. When appropriate, we evaluate the need for a valuation allowance to reduce our deferred tax assets.

We also account for uncertain tax positions in accordance with the “Income Taxes” Topic of the FASB Accounting Standards Codification. Accordingly, a liability is recorded for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

We have established a valuation allowance to reduce deferred tax assets associated with foreign net operating losses, certain state net operating losses and certain foreign deferred tax assets to an amount whose realization is more likely than not. We believe that the remaining deferred income tax assets will be realized based on reversals of existing taxable temporary differences and expected repatriation of foreign earnings. Accordingly, we believe that no additional valuation allowances are necessary.


52


Legal Proceedings and Other Loss Contingencies

We are subject to various legal proceedings, many involving routine litigation incidental to our business. The outcome of any legal proceeding is not within our complete control, is often difficult to predict and is resolved over very long periods of time. Estimating probable losses associated with any legal proceedings or other loss contingencies is very complex and requires the analysis of many factors including assumptions about potential actions by third parties. Loss contingencies are disclosed when there is at least a reasonable possibility that a loss has been incurred and are recorded as liabilities in the consolidated financial statements when it is both (1) probable or known that a liability has been incurred and (2) the amount of the loss is reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. If a loss contingency is not probable or cannot be reasonably estimated, a liability is not recorded in the consolidated financial statements.

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.



53


ITEM 7A. 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. We have established policies, procedures and internal processes governing our management of market risk and the use of financial instruments to manage our exposure to such risk.

Interest Rate Risk

We have variable interest rate debt and other financial instruments which are subject to interest rate risk that could have a negative impact on our business if not managed properly. We have a risk management policy which is designed to reduce the potential negative earnings effect arising from the impact of fluctuating interest rates. We manage our interest rate risk on our borrowings through interest rate swap and cap agreements which effectively convert a portion of our variable rate borrowings to a fixed rate basis, thus reducing the impact of changes in interest rates on future interest expenses. We do not use financial instruments for speculative or trading purposes.

The table below provides information as of December 31, 2013 about our long-term debt and interest rate derivatives, both of which are sensitive to changes in interest rates. For long-term debt, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For interest rate derivatives, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity dates. Weighted average interest rates of our interest rate derivatives are based on the nominal amounts which are used to calculate the contractual payments to be exchanged under the contract (dollars in thousands):

 
Expected Maturity Date as of December 31, 2013
 
 
 
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
 
Total
 
Fair Value(1)
Long-term debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate
$
101

 
$

 
$

 
$

 
$
1,750,000

 
$
612,000

 
$
2,362,101

 
$
2,693,774

Weighted average interest rate
3.250
%
 
%
 
%
 
%
 
10.500
%
 
12.500
%
 
11.018
%
 
 
Variable rate
$
26,210

 
$
26,210

 
$
335,118

 
$
23,000

 
$
2,192,527

 
$

 
$
2,603,065

 
$
2,614,886

Weighted average interest rate(2)
4.471
%
 
4.471
%
 
4.471
%
 
4.471
%
 
4.471
%
 
4.471
%
 
4.471
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps(3) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Variable to fixed-notional amount
$
74,900

 
$
83,300

 
$
1,379,700

 
$

 
$

 
$

 
$
1,537,900

 
$
(31,906
)
Average pay rate
2.252
%
 
2.252
%
 
2.252
%
 
%
 
%
 
%
 
2.252
%
 
 
Average receive rate(4)
%
 
1.250
%
 
1.250
%
 
%
 
%
 
%
 
1.250
%
 
 
_____________________
(1)
The fair value of our fixed rate debt is based on a limited number of trades and does not necessarily represent the purchase price of the entire portfolio.
(2)
The weighted average interest rate for all periods presented represents the nominal weighted average interest rate as of December 31, 2013. These rates reset quarterly.
(3)
Interest rate swaps relate to the variable rate debt under long-term debt. The aggregate fair value of our interest rate swap agreements of $31.9 million was negative and was recorded as a long-term liability at December 31, 2013. The interest rate swap agreements were not effective until December 2013.
(4)
The average receive rate for future periods are based on the current period rates. These rates reset quarterly.


54



Foreign Currency and Market Risk

We have direct operations in the United States, Canada, Western Europe, Australia, New Zealand, Japan, Singapore, India, Hong Kong, Turkey, Brazil and South Africa, and we conduct additional business through distributors primarily in Latin America, the Middle East, Eastern Europe and Asia. Our foreign operations are generally measured in their applicable local currencies. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we have operations. Exposure to these fluctuations is managed primarily through the use of natural hedges, whereby funding obligations and assets are both managed in the applicable local currency.

We face transactional currency exposures related to when our foreign subsidiaries enter into transactions denominated in currencies other than their local currency. These nonfunctional currency exposures relate primarily to existing intercompany receivables and payables arising from intercompany purchases of manufactured products. We enter into foreign currency exchange contracts to mitigate the impact of currency fluctuations on transactions and anticipated cash flows denominated in nonfunctional currencies, thereby limiting risk that would otherwise result from changes in exchange rates. The periods of the foreign currency exchange contracts correspond to the periods of the exposed transactions and anticipated cash flows but generally do not extend beyond 12 months. We also face exposure to foreign currency fluctuations related to the Euro denominated portion of our Senior Secured Credit Facility.

At December 31, 2013, we had outstanding foreign currency exchange contracts to sell or purchase approximately $14.3 million of various currencies. Based on our overall transactional currency rate exposure, movements in the currency rates will not materially affect our financial condition. We are exposed to credit loss in the event of nonperformance by counterparties on their outstanding foreign currency exchange contracts.

International operations reported operating profit of $58.8 million for the year ended December 31, 2013. We estimate that a 10% fluctuation in the value of the U.S. dollar relative to these foreign currencies as of and for the year ended December 31, 2013, would change our net earnings (loss) for the year ended December 31, 2013 by approximately $5.9 million. Our analysis does not consider the implications that such fluctuations could have on the overall economic activity that could exist in such an environment in the United States or the foreign countries or on the results of operations of our foreign entities.


55


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm


The Board of Directors of Chiron Holdings GP, Inc.
We have audited the accompanying consolidated balance sheets of Centaur Guernsey L.P. Inc. and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows of Centaur Guernsey L.P. Inc. and subsidiaries for the years ended December 31, 2013 and 2012 and the period from November 4, 2011 through December 31, 2011 (successor), and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows of Kinetic Concepts, Inc. and subsidiaries for the period from January 1, 2011 through November 3, 2011 (predecessor). Our audits also included the financial statement schedule listed in the index at Item 15(a). These financial statements and schedule are the responsibility of Centaur Guernsey L.P. Inc.'s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Centaur Guernsey L.P. Inc. and subsidiaries at December 31, 2013 and 2012, the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows of Centaur Guernsey L.P. Inc. and subsidiaries for the years ended December 31, 2013 and 2012, and the period from November 4, 2011 through December 31, 2011, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows of Kinetic Concepts, Inc. and subsidiaries for the period from January 1, 2011 through November 3, 2011 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth within.