10-Q 1 a2014q310q.htm 10-Q 2014 Q3 10Q



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

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
Commission file number 333-184233-14

ACELITY 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
Centaur Guernsey L.P. Inc.
(Former name, former address and former fiscal year, if changed since last report)

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
    Yes   ____         No      X     
         
As of November 4, 2014, there were 341,410,891.610 Class A-1 and 728,041.800 Class A-2 partnership units outstanding.   




TABLE OF CONTENTS

ACELITY L.P. INC.






2


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes statements that express our opinions, expectations, beliefs, plans, objectives, assumptions or projections regarding future events or future results and therefore are, or may be deemed to be, “forward-looking statements.” The forward-looking statements are based on our current expectations and projections about future events. Discussions containing forward-looking statements may be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors,” and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “predicts,” “projects,” “potential,” “continue,” “expects,” “anticipates,” “aims,” “future,” “intends,” “plans,” “believes,” “estimates,” or the negative of those terms and other variations of them or by comparable terminology.
These forward-looking statements are only predictions, not historical facts, and involve certain risks and uncertainties, as well as assumptions. Actual results, levels of activity, performance, achievements and events could differ materially from those stated, anticipated or implied by such forward-looking statements. The factors that could contribute to such differences include those discussed under the caption “Risk Factors.” You should consider each of the risk factors and uncertainties under the caption “Risk Factors” in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, among other things, in evaluating our prospects and future financial performance. The occurrence of the events described in the risk factors could harm our business, results of operations and financial condition. These forward-looking statements are made as of the date of this report. Except as required under federal securities laws and the rules and regulations of the Securities and Exchange Commission, we do not have any intention to update any forward-looking statements to reflect events or circumstances arising after the date of this report, whether as a result of new information, future events or otherwise.
TRADEMARKS, SERVICE MARKS AND COPYRIGHTS
3M® Tegaderm® is a licensed trademark of 3M Company; GRAFTJACKET® is a licensed trademark of Wright Medical Technology Inc; Novadaq®, 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 report 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 report does 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.
DEFINED TERMS
The following terms are used in this Quarterly Report on Form 10-Q unless otherwise noted or indicated by the context.
the terms the “Company,” “we,” “our,” and “us” refer to Acelity L.P. Inc., formerly known as Centaur Guernsey L.P. Inc. (“Acelity”) 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 Acelity.
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 - FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS
ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands)
 
September 30,
2014
 
December 31,
2013
 
(unaudited)
 
 
Assets:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
224,905

 
$
206,949

Accounts receivable, net
371,381

 
407,578

Inventories, net
184,590

 
181,567

Deferred income taxes
28,218

 
23,621

Prepaid expenses and other
39,604

 
53,161

Total current assets
848,698

 
872,876

 
 
 
 
Net property, plant and equipment
293,366

 
333,725

Debt issuance costs, net
83,926

 
102,054

Deferred income taxes
30,353

 
31,459

Goodwill
3,378,931

 
3,378,661

Identifiable intangible assets, net
2,429,166

 
2,549,201

Other non-current assets
4,950

 
4,669

 
$
7,069,390

 
$
7,272,645

 
 
 
 
Liabilities and Equity:
 
 
 
Current liabilities:
 
 
 
Accounts payable
57,575

 
50,316

Accrued expenses and other
410,725

 
328,975

Current installments of long-term debt
25,847

 
26,311

Income taxes payable
4,900

 
3,368

Deferred income taxes
28,512

 
2,199

Total current liabilities
527,559

 
411,169

 
 
 
 
Long-term debt, net of current installments and discount
4,830,009

 
4,865,503

Non-current tax liabilities
33,757

 
53,682

Deferred income taxes
859,078

 
1,003,784

Other non-current liabilities
124,542

 
40,432

Total liabilities
6,374,945

 
6,374,570

Equity:
 
 
 
General partner’s capital

 

Limited partners’ capital
700,485

 
900,218

Accumulated other comprehensive loss, net
(6,040
)
 
(2,143
)
Total equity
694,445

 
898,075

 
$
7,069,390

 
$
7,272,645


See accompanying notes to condensed consolidated financial statements.

4


ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands)
(unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 
 
 
 
 
 
 
Rental
$
190,465

 
$
191,041

 
$
532,258

 
$
569,449

Sales
298,186

 
249,520

 
869,103

 
719,675

Total revenue
488,651

 
440,561

 
1,401,361

 
1,289,124

 
 
 
 
 
 
 
 
Rental expenses
84,744

 
85,746

 
257,574

 
273,479

Cost of sales
86,314

 
66,151

 
251,923

 
181,707

Gross profit
317,593

 
288,664

 
891,864

 
833,938

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
163,176

 
152,053

 
510,122

 
518,478

Research and development expenses
15,879

 
17,961

 
51,602

 
56,140

Acquired intangible asset amortization
47,918

 
45,116

 
147,361

 
139,123

Wake Forest settlement

 

 
198,578

 

Impairment of goodwill and intangible assets

 
443,400

 

 
443,400

Operating earnings (loss)
90,620

 
(369,866
)
 
(15,799
)
 
(323,203
)
 
 
 
 
 
 
 
 
Interest income and other
23

 
217

 
245

 
1,279

Interest expense
(104,475
)
 
(101,398
)
 
(308,475
)
 
(315,144
)
Loss on extinguishment of debt

 
(200
)
 

 
(2,364
)
Foreign currency gain (loss)
9,599

 
(8,738
)
 
13,687

 
(11,935
)
Derivative instruments gain (loss)
1,630

 
(6,840
)
 
(2,670
)
 
3,200

Loss from continuing operations before income tax benefit
(2,603
)
 
(486,825
)
 
(313,012
)
 
(648,167
)
Income tax benefit
(766
)
 
(88,519
)
 
(112,075
)
 
(144,543
)
Loss from continuing operations
(1,837
)
 
(398,306
)
 
(200,937
)
 
(503,624
)
Loss from discontinued operations, net of tax

 
(255
)
 

 
(2,299
)
Net loss
$
(1,837
)
 
$
(398,561
)
 
$
(200,937
)
 
$
(505,923
)

See accompanying notes to condensed consolidated financial statements.

5


ACELITY L.P. INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net loss
$
(1,837
)
 
$
(398,561
)
 
$
(200,937
)
 
$
(505,923
)
Unrealized investment gain (loss), net of tax benefit (expense) of $411 and $412 in 2014 and $(338) and $(1,413) in 2013
(657
)
 
541

 
(659
)
 
2,257

Foreign currency translation adjustment, net of tax benefit (expense) of $(279) and $(782) in 2014 and $(300) and $259 in 2013
(3,425
)
 
(5,131
)
 
(3,238
)
 
(9,266
)
Total comprehensive loss
$
(5,919
)
 
$
(403,151
)
 
$
(204,834
)
 
$
(512,932
)

See accompanying notes to condensed consolidated financial statements.

6


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

 
Nine months ended September 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net loss
$
(200,937
)
 
$
(505,923
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Amortization of debt issuance costs and discount
29,179

 
26,356

Depreciation and other amortization
234,514

 
252,026

Loss on disposition of assets

 
3,189

Amortization of fair value step-up in inventory
6,680

 

Fixed asset and inventory impairment

 
30,259

Impairment of goodwill and intangible assets

 
443,400

Write-off of other intangible assets

 
16,885

Provision for bad debt
11,613

 
5,051

Loss on extinguishment of debt

 
2,164

Equity-based compensation expense
2,966

 
2,046

Deferred income tax benefit
(127,799
)
 
(165,456
)
Unrealized gain on derivative instruments
(9,310
)
 
(5,729
)
Unrealized loss (gain) on revaluation of cross currency debt
(27,559
)
 
8,174

Change in assets and liabilities:
 
 
 
Decrease (increase) in accounts receivable, net
26,065

 
(23,046
)
Increase in inventories, net
(9,275
)
 
(10,498
)
Decrease (increase) in prepaid expenses and other
12,341

 
(17,137
)
Increase in accounts payable
7,402

 
3,273

Increase in accrued expenses and other
161,227

 
68,440

Increase (decrease) in tax liabilities, net
(12,076
)
 
2,021

Net cash provided by operating activities
105,031

 
135,495

 
 
 
 
Cash flows from investing activities:
 
 
 
Additions to property, plant and equipment
(46,760
)
 
(59,868
)
Increase in inventory to be converted into equipment for short-term rental
(3,289
)
 
(8,881
)
Dispositions of property, plant and equipment
2,251

 
1,052

Businesses acquired in purchase transaction, net of cash acquired
(4,613
)
 

Increase in identifiable intangible assets and other non-current assets
(9,351
)
 
(4,273
)
Net cash used by investing activities
(61,762
)
 
(71,970
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Settlement of profits interest units
(1,416
)
 

Distribution to limited partners

 
(1,572
)
Repayments of long-term debt and capital lease obligations
(19,863
)
 
(60,429
)
Payment of debt issuance costs

 
(21,604
)
Net cash used by financing activities
(21,279
)
 
(83,605
)
Effect of exchange rate changes on cash and cash equivalents
(4,034
)
 
(151
)
Net increase (decrease) in cash and cash equivalents
17,956

 
(20,231
)
Cash and cash equivalents, beginning of period
206,949

 
383,150

Cash and cash equivalents, end of period
$
224,905

 
$
362,919


See accompanying notes to condensed consolidated financial statements

7


Notes to Condensed Consolidated Financial Statements

NOTE 1.     Summary of Significant Accounting Policies

(a)   Basis of Presentation and Principles of Consolidation

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP” or “the Codification”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of results of operations, financial position and cash flows in conformity with GAAP. Operating results from interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. The condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of our results for the interim periods presented. Certain prior period amounts have been reclassified to conform to the 2014 presentation.

On November 8, 2012, KCI closed on the divestiture of its Therapeutic Support Systems ("TSS") business to Getinge AB. Under the terms of the sale agreement, we agreed to provide transition services to Getinge AB after the close of the transaction. Additionally, the results of the operations subject to the agreement, excluding the allocation of general corporate overhead, are presented as discontinued operations in the consolidated statements of operations for all periods presented. Discontinued operations amounts related to TSS also exclude incremental expenses related to our transition services agreement with Getinge AB and the service fee payable by Getinge AB under the transition services agreement.

The Company has two reportable operating segments: Advanced Wound Therapeutics and Regenerative Medicine. 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.

The condensed consolidated financial statements appearing in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

(b)   Derivative Financial Instruments and Fair Value Measurements

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

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

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



8


(c)   Concentration of Credit Risk
We have a concentration of credit risk with financial institutions related to our derivative instruments. As of September 30, 2014, Morgan Stanley, UBS and HSBC were the counterparties on our interest rate protection agreements consisting of interest rate swap agreements in notional amounts totaling $504.4 million each. We use master netting agreements with our derivative counterparties to reduce our risk and use multiple counterparties to reduce our concentration of credit risk.
We maintain cash and cash equivalents with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. These deposits bear minimal credit risk as they are maintained at financial institutions of reputable credit and generally may be redeemed upon demand.
(d)   Recently Adopted Accounting Standards
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11 “Income Taxes – Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry forward, a Similar Tax Loss, or a Tax Credit Carry forwards Exists” which provides that entities should present the unrecognized tax benefit as a reduction of the deferred tax asset for a net operating loss (“NOL”) or similar tax loss or tax credit carryforward rather than as a liability when the uncertain tax position would reduce the NOL or other carryforward under the tax law. The ASU is effective for annual and interim period for fiscal years beginning on or after December 15, 2013. The Company adopted this ASU effective January 1, 2014. The adoption of this update did not have a material impact on our results of operations, financial position or disclosures.
(e)   Recently Issued Accounting Standards
In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity". ASU No. 2014-08 changes the requirements for reporting discontinued operations and requires additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations - that is, a major effect on the organization's operations and financial results should be presented as discontinued operations. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment. Additionally, the ASU requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The amendments in the ASU are effective in the first quarter of 2015 for public organizations with calendar year ends. The Company is evaluating this update, however we do not anticipate that it will have a material effect on our results of operations, financial position or disclosures.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)". This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). This ASU supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition", and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, "Revenue Recognition-Construction-Type and Production-Type Contracts". In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (e.g., assets within the scope of Topic 360, "Property, Plant, and Equipment", and intangible assets within the scope of Topic 350, "Intangibles-Goodwill and Other") are amended to be consistent with the guidance on recognition and measurement (including the constraint on revenue) in this ASU. For a public entity, the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company is evaluating this update to determine if it will have a material effect on our results of operations, financial position or disclosures.
In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements — Going Concern (Subtopic 205-40).” The new guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016. Early adoption is permitted. The Company is evaluating this update, however we do not anticipate that the adoption of this guidance will have a material impact on our results of operations, financial position or disclosures.

9


(f)   Other Significant Accounting Policies
For further information on our significant accounting policies, see Note 1 of the notes to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.


NOTE 2.     Business Acquisition

On July 30, 2013, KCI announced that it had signed a definitive share purchase agreement to acquire Systagenix, an established provider of advanced wound care products. The transaction closed on October 28, 2013. The adjusted purchase price paid, net of cash and cash equivalents, was $478.7 million. The acquisition was accounted for as a business combination using the acquisition method and 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 preliminary allocation of the purchase price to the Systagenix tangible and identifiable intangible assets was based on their estimated fair values as of the acquisition date. The excess of the purchase price over the identifiable intangible and net tangible assets was allocated to goodwill, which is not deductible for tax purposes. The purchase price allocation is preliminary, pending the final determination of the fair value of certain assumed assets and liabilities. As these issues are identified, modified or resolved, resulting increases or decreases to the preliminary value of assets and liabilities are offset by a change to goodwill. Adjustments to these estimates will be included in the final allocation of the purchase price.

The following table represents the preliminary allocation of the purchase price (in thousands):
 
December 31,
2013
 
Adjustment
 
September 30,
2014
Goodwill
$
171,086

 
$
270

 
$
171,356

Identifiable intangible assets
 
 
 
 
 
   Customer relationships
103,301

 
 
 
103,301

   Developed technology
91,700

 
 
 
91,700

   Tradenames
56,800

 
 
 
56,800

   In-process research and development
1,766

 
 
 
1,766

Tangible assets acquired and liabilities assumed:
 
 
 
 
 
   Accounts receivable
50,807

 
 
 
50,807

   Inventories
27,450

 
 
 
27,450

   Other current assets
1,902

 
 
 
1,902

   Property, plant and equipment
44,016

 
 
 
44,016

   Other non-current assets
139

 
 
 
139

   Current liabilities
(34,752
)
 
(270
)
 
(35,022
)
   Other non-current liabilities
(79
)
 
 
 
(79
)
   Net deferred tax liability
(35,388
)
 
 
 
(35,388
)
         Total purchase price
$
478,748

 
$

 
$
478,748


Purchase accounting rules require that as certain pre-acquisition issues are identified, modified or resolved, resulting increases or decreases to the preliminary value of assets and liabilities are offset by a change in goodwill. Modifications to goodwill reflected in the “Adjustments” column above were primarily the result of assumed liabilities.


10


The following table reflects the unaudited pro forma condensed consolidated results of operations, as though the acquisition had occurred on January 1, 2012 (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2013
 
 
 
 
Pro forma revenue
$
494,869

 
$
1,446,634

Pro forma net loss
$
(394,675
)
 
$
(503,990
)

The unaudited pro forma condensed consolidated results of operations presented above are for illustrative purposes only and are not necessarily indicative of what actually would have occurred had the acquisition been in effect for the period presented, nor are they indicative of future operating results. 

In January 2014, LifeCell entered into an asset purchase agreement with TauTona Injector, LLC to purchase certain assets, including patents, know-how, and inventory. Under the terms of the asset purchase agreement, LifeCell made an initial cash payment of $3.0 million at the closing of the transaction. The asset purchase agreement also calls for additional payments by LifeCell of up to $31.5 million upon the achievement of certain milestones. During the first nine months of 2014, LifeCell paid $1.5 million under the asset purchase agreement related to milestone achievement. As of September 30, 2014, the accompanying condensed consolidated balance sheet included $6.9 million under the caption "accrued expenses and other" and $8.8 million under the caption "other non-current liabilities" related to future anticipated milestone payments.


NOTE 3.     Supplemental Balance Sheet Data

(a)   Accounts Receivable, net

Accounts receivable consist of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Gross trade accounts receivable:
 
 
 
    Billed trade accounts receivable
$
397,743

 
$
418,804

Unbilled receivables
36,077

 
50,841

     Less:  Allowance for revenue adjustments
(58,839
)
 
(67,631
)
    Gross trade accounts receivable
374,981

 
402,014

Less:  Allowance for bad debt
(13,433
)
 
(8,483
)
    Net trade accounts receivable
361,548

 
393,531

Other receivables
9,833

 
14,047

 
$
371,381

 
$
407,578



11


(b)   Inventories, net

Inventories consist of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
Finished goods and tissue available for distribution
$
129,375

 
$
110,937

Goods and tissue in-process
10,176

 
12,994

Raw materials, supplies, parts and unprocessed tissue
67,541

 
71,876

 
207,092

 
195,807

Less: Amounts expected to be converted into equipment for short-term rental
(7,241
)
 
(3,952
)
         Reserve for excess and obsolete inventory
(15,261
)
 
(10,288
)
 
$
184,590

 
$
181,567



NOTE 4.     Long-Term Debt

Long-term debt consists of the following (in thousands):
 
September 30,
2014
 
December 31,
2013
 
 
 
 
Senior Dollar Term E-1 Credit Facility (1) – due 2018
$
1,932,108

 
$
1,946,708

Senior Euro Term E-1 Credit Facility (1) – due 2018
307,004

 
337,820

Senior Term E-2 Credit Facility (1) – due 2016
316,147

 
318,537

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

 
1,750,000

12.5% Senior Unsecured Notes due 2019
612,000

 
612,000

3.25% Convertible Senior Notes due 2015
101

 
101

     Notional amount of debt
4,917,360

 
4,965,166

 
 
 
 
Senior Dollar Term E-1 Credit Facility Discount, net of accretion
(25,938
)
 
(30,926
)
Senior Euro Term E-1 Credit Facility Discount, net of accretion
(8,224
)
 
(10,693
)
Senior Term E-2 Credit Facility Discount, net of accretion
(3,342
)
 
(4,486
)
Second Lien Senior Secured Notes Discount, net of accretion
(21,251
)
 
(24,222
)
Senior Unsecured Notes Discount, net of accretion
(2,749
)
 
(3,025
)
     Net discount on debt
(61,504
)
 
(73,352
)
 
 
 


Total debt, net of discount
4,855,856

 
4,891,814

Less:  Current installments
(25,847
)
 
(26,311
)
 
$
4,830,009

 
$
4,865,503

_____________________________
(1) On January 22, 2014, we entered into Amendment No. 5 to our senior secured credit facility. 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 governing credit agreement and loan documents, except as revised by Amendment No. 5.


12


Senior Secured Credit Facility

Our senior secured credit facility (the “Senior Secured Credit Facility”) includes a $200 million revolving credit facility (the “Revolving Credit Facility”). Amounts available under the Revolving Credit Facility are available for borrowing and reborrowing until maturity. At September 30, 2014 and December 31, 2013, no revolving credit loans were outstanding and we had outstanding letters of credit issued by banks which are party to the Senior Secured Credit Facility of $22.0 million and $21.2 million, respectively. In addition, we had $11.8 million and $12.6 million of letters of credit issued by a bank not party to the Senior Secured Credit Facility as of September 30, 2014 and December 31, 2013, respectively. The capacity of the Revolving Credit Facility is reduced for the $22.0 million and $21.2 million of letters of credit issued by banks which are party to the Senior Secured Credit Facility as of September 30, 2014 and December 31, 2013, respectively. The resulting availability under the Revolving Credit Facility was $178.0 million and $178.8 million at September 30, 2014 and December 31, 2013, respectively. Commitment fees accrue at a rate of 0.50% on the amounts available under the Revolving 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 governing credit agreement and loan documents, except as revised by Amendment No. 5. 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.

Interest. Amounts outstanding under the Dollar Term E-1 Loans, the Term E-2 Loans and the Revolving Credit Facility (other than swing-line loans and unreimbursed drawings on letters of credit) bear interest, at our option, at a rate equal to either the base rate or the eurocurrency rate, in each case plus an applicable margin. Amounts outstanding under the Euro Term E-1 Loans bear interest at the eurocurrency rate, and swing-line loans and unreimbursed drawings on letters of credit bear interest at the base rate. As a result of Amendment No. 5, the new applicable margins are (i) for eurocurrency rate loans that are Dollar Term E-1 Loans, 3.00%, (ii) for base rate loans that are Dollar Term E-1 Loans, 2.00%, (iii) for eurocurrency rate loans that are Euro Term E-1 Loans, 3.25%, (iv) for base rate loans that are Euro Term E-1 Loans, 2.25%, (v) for eurocurrency rate loans that are Term E-2 Loans, 2.50%, and (vi) for base rate loans that are Term E-2 Loans, 1.50%. The Term E loans will have a eurocurrency rate floor of 1.00% and a base rate floor of 2.00%.

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

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

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

Covenants

As of September 30, 2014, we were in compliance with all covenants under our Senior Secured Credit Facility, 10.5% Second Lien Notes, 12.5% Unsecured Notes, and 3.25% Convertible Senior Notes due 2015 (“the Convertible Notes”).

For further information on our long-term debt, see Note 6 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.


13


NOTE 5.     Derivative Financial Instruments and Fair Value Measurements

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

Interest Rate Protection

At September 30, 2014 and December 31, 2013, we had three interest rate swap agreements to convert a portion of our outstanding variable rate debt to a fixed rate basis. These agreements that became effective in December 2013, have not been designated as hedging instruments, and as such, we recognize the fair value of these instruments as an asset or liability with income or expense recognized in the current period. The interest rate swap agreements have quarterly interest payments, receive rates based on the higher of three-month USD LIBOR or 1.25% and pay rates based on fixed rates, due on the last day of March, June, September and December. The aggregate notional amount decreases quarterly by amounts ranging from $1.7 million to $56.4 million until maturity.

The following table summarizes our interest rate swap agreements (dollars in thousands):
Effective Dates
 
Outstanding Notional Amount
 
Fixed Interest Rate
12/31/13-12/31/16
 
$504,367
 
2.256%
12/31/13-12/31/16
 
$504,367
 
2.249%
12/31/13-12/31/16
 
$504,367
 
2.250%

Previously held interest rate cap agreements expired on December 31, 2013.

Foreign Currency Exchange Rate Mitigation

At September 30, 2014, we had no outstanding foreign currency exchange contracts. At December 31, 2013, we had foreign currency exchange contracts to sell or purchase $14.3 million of various currencies.

Fair Value Measurements

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

The carrying amount reported in the balance sheets for cash and cash equivalents, accounts receivable, accounts payable and long-term obligations, excluding our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt, including the 10.5% Second Lien Secured Notes, the 12.5% Unsecured Notes and the Convertible Notes approximates fair value. The fair value of our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt was $2.5 billion and $2.6 billion, respectively, at September 30, 2014. The fair value of our borrowings under our Senior Secured Credit Facility and fixed rate long-term debt was $2.6 billion and $2.7 billion, respectively, at December 31, 2013. The fair value of our long-term debt was estimated based upon open-market trades at or near year end which represent Level 2 inputs.

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


14


The following table sets forth the location and aggregate fair value amounts of all derivative instruments with credit-related contingent features (in thousands):
 
Asset Derivatives
 
Liability Derivatives
 
Balance
Sheet
Location
 
Fair Value
 
Balance
Sheet
Location
 
Fair Value
 
 
September 30,
2014
 
December 31,
2013
 
 
September 30,
2014
 
December 31,
2013
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
Prepaid expenses and other
 
$

 
$

 
Accrued expenses and other
 
$
13,938

 
$
345

Interest rate swap agreements
Other non-current assets
 

 

 
Other non-current liabilities
 
9,426

 
31,906

Foreign currency exchange contracts
Prepaid expenses and other
 

 
146

 
Accrued expenses and other
 

 
569

      Total derivatives
 
 
$

 
$
146

 
 
 
$
23,364

 
$
32,820


The following table summarizes the amount of gain (loss) on derivatives not designated as hedging instruments (dollars in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Interest rate swap agreements
$
1,630

 
$
(5,195
)
 
$
(2,732
)
 
$
4,057

Interest rate cap agreements

 
(4
)
 

 
(9
)
Foreign currency exchange contracts

 
(1,641
)
 
62

 
(848
)
 
$
1,630

 
$
(6,840
)
 
$
(2,670
)
 
$
3,200


Certain of our derivative instruments contain provisions that require compliance with the restrictive covenants of our Senior Secured Credit Facility. For further information regarding the restrictive covenants of credit facilities, see Note 6 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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

No collateral has been posted by us in the normal course of business. If the credit-related contingent features underlying these agreements were triggered on September 30, 2014, we could be required to settle or post the full amount as collateral to the respective agreement counterparties.

We did not have any measurements of financial assets or financial liabilities at fair value on a nonrecurring basis at September 30, 2014 or December 31, 2013.



15


NOTE 6.     Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss are as follows (in thousands):
 
Accumulated
Foreign
Currency
Translation
Adjustment
 
Investment Gain
 
Accumulated
Other
Comprehensive
Income (Loss)
Balances at December 31, 2013
$
(4,384
)
 
$
2,241

 
$
(2,143
)
Unrealized investment loss, net of tax benefit of $412

 
(659
)
 
(659
)
Foreign currency translation adjustment, net of tax expense of $782
(3,238
)
 

 
(3,238
)
Balances at September 30, 2014
$
(7,622
)
 
$
1,582

 
$
(6,040
)

During the nine months ended September 30, 2014, there were no reclassification adjustments out of accumulated other comprehensive loss to net loss.


NOTE 7.     Commitments and Contingencies

Legal Proceedings

Intellectual Property Litigation

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

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 the discovery 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 arbitration.
    
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, that LifeCell's products do not infringe the '200 Patent, and that the patent is invalid. The case has proceeded rapidly in the Eastern District of Virginia. The trial began in Norfolk on November 3, 2014. 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.


16


On June 30, 2014, KCI entered into a settlement and release agreement (the “Settlement Agreement”) with Wake Forest  University Health Sciences to fully and finally resolve the pending patent disputes between them relating to negative pressure wound therapy. As of September 30, 2014, the accompanying condensed consolidated balance sheet included $81.5 million under the caption "accrued expenses and other" and $102.8 million under the caption "other non-current liabilities" representing the net present value of payments under the Settlement Agreement discounted using our incremental borrowing rate as the discount rate.  As a result, we recorded patent settlement charges of $198.6 million in the second quarter of 2014 representing the net present value of payments under the Settlement Agreement, net of the $63.2 million previously existing accrual.

Products Liability Litigation

LifeCell Corporation is a defendant in approximately 335 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 each selected four bellwether cases from which one case to be tried will be selected. Discovery is proceeding on each of the bellwether cases. Trial of the first bellwether case is currently 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. 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 fact discovery is proceeding in these cases, 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.

LifeCell Corporation has been named as a defendant in approximately 175 lawsuits in state and federal courts in Massachusetts, Delaware, Minnesota, New York and Texas (federal court cases have been 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 one of LifeCell’s distributors, Boston Scientific, under the name Repliform. There are approximately 170 LifeCell cases filed in a consolidated docket in Middlesex County, Massachusetts. The cases are in the initial phase and no discovery has occurred. We intend to defend these suits vigorously. 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 it is not possible to predict or estimate potential losses if our defenses to these cases are unsuccessful.

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 and oral argument was in July 2014. The appellate panel that heard the argument recently asked for briefing on whether the case should be heard en banc before the U.S. Court of Appeals for the Ninth Circuit. Both parties denied that there was need for en banc consideration. We await the opinion of the court. 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.
 

17


Other Commitments and Contingencies

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

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

18


  
NOTE 8.     Segment Information

The Company is engaged in the rental and sale of advanced wound therapeutics and regenerative medicine products in over 75 countries worldwide through direct sales and indirect 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. In most countries where we operate, certain aspects of our two businesses are supported by the same administrative staff, systems and infrastructure and, as such, we have allocated these costs between the businesses based on allocation methods including headcount, revenue and other methods as deemed appropriate. We measure segment profit (loss) as operating earnings (loss), which is defined as income (loss) before interest and other income, interest expense, foreign currency gains and losses, derivative instruments gains and losses and income taxes. All intercompany transactions are eliminated in computing revenue and operating earnings (loss).

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

Information on segments and a reconciliation of consolidated totals are as follows (in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 
 
 
 
 
 
 
Advanced Wound Therapeutics
$
377,181

 
$
320,879

 
$
1,064,815

 
$
944,526

Regenerative Medicine
111,470

 
119,682

 
336,546

 
344,598

Total revenue
$
488,651

 
$
440,561

 
$
1,401,361

 
$
1,289,124

 
 
 
 
 
 
 
 
Operating earnings (loss):
 
 
 
 
 
 
 
Advanced Wound Therapeutics
$
131,286

 
$
126,854

 
$
322,543

 
$
327,172

Regenerative Medicine
34,253

 
30,093

 
99,025

 
91,159

Non-allocated costs:
 
 
 
 
 
 
 
General headquarter expense (1)
(2,257
)
 
(6,335
)
 
(7,464
)
 
(59,447
)
Equity-based compensation
(863
)
 
(850
)
 
(2,966
)
 
(2,046
)
Merger and restructuring-related expenses (2)
(23,881
)
 
(31,112
)
 
(80,998
)
 
(97,518
)
Acquired intangible asset amortization (3)
(47,918
)
 
(45,116
)
 
(147,361
)
 
(139,123
)
Wake Forest settlement

 

 
(198,578
)
 

Impairment of goodwill and intangible assets (4)

 
(443,400
)
 

 
(443,400
)
Total non-allocated costs
(74,919
)
 
(526,813
)
 
(437,367
)
 
(741,534
)
Total operating earnings (loss)
$
90,620

 
$
(369,866
)
 
$
(15,799
)
 
$
(323,203
)
_____________________
(1)
The third quarter and nine months ended September 30, 2013 includes write-offs of $3.5 million and $16.9 million, respectively, of other intangible assets due primarily to the discontinuation of certain projects. The nine months ended September 30, 2013 also includes a $30.3 million fixed asset impairment charge.
(2)
Represents restructuring-related expenses as well as expenses related to the Merger, including management fees.
(3)
2014 includes amortization of acquired intangible assets related to our acquisition of Systagenix in October 2013 and our Merger in November 2011. 2013 includes amortization of acquired intangible assets related to our Merger in November 2011.
(4)
During the third quarter of 2013, we recorded a $272.2 million impairment of goodwill and a $171.2 million impairment of indefinite-lived intangible assets related to our Regenerative Medicine reporting unit. These amounts have been excluded from Regenerative Medicine operating earnings as management excludes these charges from operating earnings when making operating decisions about the business.

19



NOTE 9.     Guarantor Condensed Consolidating Financial Statements

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

(4)
upon the achievement of investment grade status by the 10.5% Second Lien Notes or 12.5% Unsecured Notes; provided that such guarantee shall be reinstated upon the reversion date.

In the event of a bankruptcy, liquidation or reorganization of any non-guarantor subsidiary, such non-guarantor subsidiary will pay the holders of its debt and other liabilities, including its trade creditors, before it will be able to distribute any of its assets to us. In the future, any non-U.S. subsidiaries, immaterial subsidiaries and subsidiaries that we designate as unrestricted subsidiaries under the 10.5% Second Lien Notes and 12.5% Unsecured Notes indentures will not guarantee the 10.5% Second Lien Notes or 12.5% Unsecured Notes. As of September 30, 2014, there were no restrictions on the ability of subsidiary guarantors to transfer funds to the parent company.

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

20





Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Balance Sheet
September 30, 2014
(in thousands)
(unaudited)
 
Acelity L.P. Inc.
Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
398

 
$
52,380

 
$
9,445

 
$
162,682

 
$

 
$
224,905

Accounts receivable, net

 
176,575

 
68,807

 
125,999

 

 
371,381

Inventories, net

 
84,637

 
102,912

 
102,779

 
(105,738
)
 
184,590

Deferred income taxes

 
503

 
28,218

 

 
(503
)
 
28,218

Prepaid expenses and other

 
17,067

 
5,851

 
269,706

 
(253,020
)
 
39,604

Intercompany receivables
166

 
1,862,339

 
2,387,963

 
122,512

 
(4,372,980
)
 

Total current assets
564

 
2,193,501

 
2,603,196

 
783,678

 
(4,732,241
)
 
848,698

Net property, plant and equipment

 
329,753

 
72,274

 
170,434

 
(279,095
)
 
293,366

Debt issuance costs, net

 
83,926

 

 

 

 
83,926

Deferred income taxes

 

 

 
30,353

 

 
30,353

Goodwill

 
2,483,240

 
732,771

 
162,920

 

 
3,378,931

Identifiable intangible assets, net

 
314,331

 
1,792,989

 
321,846

 

 
2,429,166

Other non-current assets

 
1,204

 
186

 
94,460

 
(90,900
)
 
4,950

Intercompany loan receivables

 
765,000

 
423,424

 

 
(1,188,424
)
 

Intercompany investments
700,033

 
393,091

 
404,273

 

 
(1,497,397
)
 

 
$
700,597

 
$
6,564,046

 
$
6,029,113

 
$
1,563,691

 
$
(7,788,057
)
 
$
7,069,390

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$

 
$
20,028

 
$
14,670

 
$
22,877

 
$

 
$
57,575

Accrued expenses and other

 
285,492

 
245,327

 
75,308

 
(195,402
)
 
410,725

Intercompany payables
5,526

 
1,065,538

 
2,676,774

 
625,142

 
(4,372,980
)
 

Current installments of long-term debt

 
25,847

 

 

 

 
25,847

Income taxes payable

 

 

 
5,849

 
(949
)
 
4,900

Deferred income taxes

 

 
13,692

 
15,323

 
(503
)
 
28,512

Total current liabilities
5,526

 
1,396,905

 
2,950,463

 
744,499

 
(4,569,834
)
 
527,559

Long-term debt, net of current installments and discount

 
4,830,009

 

 

 

 
4,830,009

Non-current tax liabilities

 
10,790

 
4,847

 
18,120

 

 
33,757

Deferred income taxes

 
73,003

 
730,816

 
55,259

 

 
859,078

Other non-current liabilities
626

 
113,416

 
9,424

 
1,076

 

 
124,542

Intercompany loan payables

 
417,432

 
765,000

 
5,992

 
(1,188,424
)
 

Total liabilities
6,152

 
6,841,555

 
4,460,550

 
824,946

 
(5,758,258
)
 
6,374,945

 
 
 
 
 
 
 
 
 
 
 
 
Total equity
694,445

 
(277,509
)
 
1,568,563

 
738,745

 
(2,029,799
)
 
694,445

 
$
700,597

 
$
6,564,046

 
$
6,029,113

 
$
1,563,691

 
$
(7,788,057
)
 
$
7,069,390




21


Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Balance Sheet
December 31, 2013
(in thousands)
 
Acelity L.P. Inc.
Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
398

 
$
87,771

 
$
118

 
$
118,662

 
$

 
$
206,949

Accounts receivable, net

 
184,723

 
71,457

 
151,398

 

 
407,578

Inventories, net

 
54,809

 
101,779

 
101,751

 
(76,772
)
 
181,567

Deferred income taxes

 
14,991

 
6,610

 
2,020

 

 
23,621

Prepaid expenses and other

 
35,832

 
5,434

 
321,427

 
(309,532
)
 
53,161

Intercompany receivables
166

 
1,687,528

 
2,326,181

 
21,241

 
(4,035,116
)
 

Total current assets
564

 
2,065,654

 
2,511,579

 
716,499

 
(4,421,420
)
 
872,876

Net property, plant and equipment

 
311,122

 
80,963

 
223,987

 
(282,347
)
 
333,725

Debt issuance costs, net

 
102,054

 

 

 

 
102,054

Deferred income taxes

 

 

 
31,459

 

 
31,459

Goodwill

 
2,483,240

 
732,771

 
162,650

 

 
3,378,661

Identifiable intangible assets, net

 
361,640

 
1,829,452

 
358,109

 

 
2,549,201

Other non-current assets

 
715

 
192

 
94,662

 
(90,900
)
 
4,669

Intercompany loan receivables

 
990,972

 
404,688

 

 
(1,395,660
)
 

Intercompany investments
901,902

 
432,884

 
372,093

 

 
(1,706,879
)
 

 
$
902,466

 
$
6,748,281

 
$
5,931,738

 
$
1,587,366

 
$
(7,897,206
)
 
$
7,272,645

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$

 
$
15,266

 
$
14,929

 
$
20,121

 
$

 
$
50,316

Accrued expenses and other

 
185,790

 
246,977

 
77,843

 
(181,635
)
 
328,975

Intercompany payables
4,110

 
852,892

 
2,559,407

 
618,707

 
(4,035,116
)
 

Current installments of long-term debt

 
26,311

 

 

 

 
26,311

Income taxes payable

 

 
3,368

 

 

 
3,368

Deferred income taxes

 

 

 
2,199

 

 
2,199

Total current liabilities
4,110

 
1,080,259

 
2,824,681

 
718,870

 
(4,216,751
)
 
411,169

Long-term debt, net of current installments and discount

 
4,865,503

 

 

 

 
4,865,503

Non-current tax liabilities

 
28,850

 
4,284

 
20,548

 

 
53,682

Deferred income taxes

 
231,713

 
718,930

 
53,141

 

 
1,003,784

Other non-current liabilities
281

 
38,667

 
334

 
1,150

 

 
40,432

Intercompany loan payables

 
399,690

 
780,000

 
215,970

 
(1,395,660
)
 

Total liabilities
4,391

 
6,644,682

 
4,328,229

 
1,009,679

 
(5,612,411
)
 
6,374,570

 
 
 
 
 
 
 
 
 
 
 
 
Total equity
898,075

 
103,599

 
1,603,509

 
577,687

 
(2,284,795
)
 
898,075

 
$
902,466

 
$
6,748,281

 
$
5,931,738

 
$
1,587,366

 
$
(7,897,206
)
 
$
7,272,645







22


Condensed Consolidating Parent Company, Co-Issuers,
Guarantor and Non-Guarantor Statement of Operations and Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
For the three months ended September 30, 2014
 
Acelity L.P. Inc.
Parent Company
 
Kinetic Concepts, Inc. and KCI USA, Inc. Borrower
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Rental
$

 
$
160,147

 
$
1,622

 
$
28,696

 
$

 
$
190,465

Sales

 
79,951

 
271,166

 
239,133

 
(292,064
)
 
298,186

Total revenue

 
240,098

 
272,788

 
267,829

 
(292,064
)
 
488,651

Rental expenses

 
76,656

 
4,843

 
49,544

 
(46,299
)
 
84,744

Cost of sales
28

 
87,277

 
180,777

 
91,044

 
(272,812
)
 
86,314

Gross profit (loss)
(28
)
 
76,165

 
87,168

 
127,241

 
27,047

 
317,593

Selling, general and administrative expenses
835

 
72,295

 
43,676

 
46,583

 
(213
)
 
163,176

Research and development expenses

 
5,771

 
6,130

 
3,978

 

 
15,879

Acquired intangible asset amortization

 
15,077

 
19,731

 
13,110

 

 
47,918

Wake Forest settlement

 

 

 

 

 

Operating earnings (loss)
(863
)
 
(16,978
)
 
17,631

 
63,570

 
27,260

 
90,620

Non-operating intercompany transactions

 
5,702

 
(895
)
 
(15,994
)
 
11,187

 

Interest income and other

 
18,955

 
3,062

 
88

 
(22,082
)
 
23

Interest expense

 
(107,529
)
 
(17,305
)
 
(1,723
)
 
22,082

 
(104,475
)
Foreign currency gain (loss)

 
27,996

 
(783
)
 
(17,614
)
 

 
9,599

Derivative instruments gain

 
1,630

 

 

 

 
1,630

Earnings (loss) from continuing operations before income taxes (benefit) and equity in earnings (loss) of subsidiaries
(863
)
 
(70,224
)
 
1,710

 
28,327

 
38,447

 
(2,603
)
Income tax expense (benefit)

 
12,787

 
(11,289
)
 
(2,264
)
 

 
(766
)
Earnings (loss) from continuing operations before equity in earnings (loss) of subsidiaries
(863
)
 
(83,011
)
 
12,999

 
30,591

 
38,447

 
(1,837
)
Equity in earnings (loss) of subsidiaries
(974
)
 
44,971

 
30,591

 

 
(74,588
)
 

Earnings (loss) from continuing operations
(1,837
)
 
(38,040
)
 
43,590

 
30,591

 
(36,141
)
 
(1,837
)
Earnings (loss) from discontinued operations, net of tax

 

 

 

 

 

Net earnings (loss)
$
(1,837
)
 
$
(38,040
)
 
$
43,590

 
$
30,591

 
$
(36,141
)
 
$
(1,837
)
Total comprehensive income (loss)
$
(5,919
)
 
$
(42,122
)
 
$
39,508

 
$
26,509

 
$
(23,895
)
 
$
(5,919
)



23




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

 
$
155,893

 
$
1,513

 
$
33,635

 
$

 
$
191,041

Sales

 
77,659

 
224,426

 
159,142

 
(211,707
)
 
249,520

Total revenue

 
233,552

 
225,939

 
192,777

 
(211,707
)
 
440,561

Rental expenses

 
62,928

 
4,010

 
53,891

 
(35,083
)
 
85,746

Cost of sales
30

 
123,481

 
142,946

 
57,512

 
(257,818
)
 
66,151

Gross profit (loss)
(30
)
 
47,143

 
78,983

 
81,374

 
81,194

 
288,664

Selling, general and administrative expenses
820

 
66,834

 
44,169

 
40,261

 
(31
)
 
152,053

Research and development expenses

 
8,010

 
6,742

 
3,209

 

 
17,961

Acquired intangible asset amortization

 
19,625

 
17,907

 
7,584

 

 
45,116

Impairment of goodwill and intangible assets

 

 
443,400

 

 

 
443,400

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

 
81,225

 
(369,866
)
Non-operating intercompany transactions

 
(8,076
)
 
49,735

 
(60,212
)
 
18,553

 

Interest income and other

 
17,852

 
3,062

 
97

 
(20,794
)
 
217

Interest expense

 
(104,402
)