S-1 1 d666412ds1.htm S-1 S-1
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As filed with the Securities and Exchange Commission on April 17, 2019

Registration No. 333-                

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

KCI Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Texas   3841   83-3506466

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

 

 

12930 West Interstate 10

San Antonio, Texas 78249

(210) 524-9000

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

John T. Bibb

Executive Vice President, General Counsel

KCI Holdings, Inc.

12930 West Interstate 10

San Antonio, Texas 78249

(210) 524-9000

(Name, address, including zip code, and telephone number, including area code, of registrant’s agent for service)

 

 

With copies to:

 

Kenneth B. Wallach, Esq.

Simpson Thacher & Bartlett LLP

425 Lexington Avenue

New York, New York 10017

(212) 455-2000

 

Jason M. Licht, Esq.

Latham & Watkins LLP

555 Eleventh Street, NW

Washington, D.C. 20004

(202) 637-2200

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box:  

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of
securities to be registered
 

Proposed

maximum

aggregate

offering price(1)(2)

  Amount of
registration fee

Common Stock, $0.01 par value per share

  $100,000,000   $12,120

 

 

 

(1)   Includes                shares of common stock that the underwriters have the option to purchase. See “Underwriting.”

 

(2)   Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) promulgated under the Securities Act of 1933, as amended.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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Explanatory note

This Registration Statement on Form S-1, or this Registration Statement, is being filed by KCI Holdings, Inc., a newly formed Texas corporation, or the Registrant, in connection with a proposed registered public offering of shares of its common stock. Prior to the effectiveness of this Registration Statement, there will be a restructuring as a result of which KCI Holdings, Inc. will become the holding company of the business conducted by Acelity L.P. Inc. and its subsidiaries described in the prospectus that is part of this Registration Statement.


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is neither an offer to sell these securities nor a solicitation of an offer to buy these securities in any jurisdiction where the offer and sale is not permitted.

 

Subject to completion, dated April 17, 2019

Preliminary prospectus

                shares

 

 

LOGO

KCI Holdings, Inc.

Common stock

This is the initial public offering of common stock of KCI Holdings, Inc. We are offering                  shares of common stock and the selling shareholders named in this prospectus are offering                shares of common stock. We will not receive any proceeds from the sale of our common stock by the selling shareholders.

Prior to this offering, there has been no public market for our common stock. We expect that the initial public offering price of our common stock will be between $                 and $                 per share. We intend to apply to list our common stock on the New York Stock Exchange, or the NYSE, under the symbol “                .”

After the completion of this offering, funds advised by Apax Partners LLP and Apax Partners, L.P. and controlled affiliates of Canada Pension Plan Investment Board and Public Sector Pension Investment Board will continue to own a majority of the shares eligible to vote in the election of our directors. As a result, we will be a “controlled company” within the meaning of the corporate governance standards of the NYSE. See “Management—Controlled company exemption.”

Investing in our common stock involves risks. See “Risk factors” beginning on page 16 to read about factors you should consider before buying shares of our common stock.

Neither the Securities and Exchange Commission, or the SEC, nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

     
        Per share        Total  

Initial public offering price

     $                          $                    

Underwriting discounts and commissions(1)

     $                          $                    

Proceeds, before expenses, to us

     $                          $                    

Proceeds, before expenses, to the selling shareholders

     $                          $                    

 

 

 

(1)   See “Underwriting” for additional information regarding underwriting compensation.

To the extent that the underwriters sell more than                shares of our common stock, the underwriters have the option, for a period of 30 days from the date of this prospectus, to purchase up to                  additional shares of common stock from the selling shareholders. We will not receive any proceeds from the sale of our common stock by the selling shareholders pursuant to any exercise of the underwriters’ option to purchase additional shares.

The underwriters expect to deliver the shares against payment in New York, New York on or about                , 2019.

 

J.P. Morgan   Goldman Sachs & Co. LLC   BofA Merrill Lynch

                , 2019


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LOGO


Table of Contents

Table of contents

 

     Page  

Industry and market data

     iii  

Trademarks and service marks

     iii  

Basis of presentation

     iv  

Non-GAAP financial measures

     vi  

Summary

     1  

Risk factors

     16  

Forward-looking statements

     54  

Use of proceeds

     57  

Dividend policy

     58  

Capitalization

     59  

Dilution

     61  

Selected historical consolidated financial data

     63  

Management’s discussion and analysis of financial condition and results of operations

     66  

Business

     97  

Management

     127  

Executive compensation

     136  

Certain relationships and related party transactions

     170  

Principal and selling shareholders

     174  

Description of capital stock

     177  

Description of certain indebtedness

     186  

Shares eligible for future sale

     191  

Material United States federal income and estate tax consequences to non-U.S. holders

     193  

Underwriting

     197  

Legal matters

     205  

Experts

     205  

Where you can find more information

     205  

Index to financial statements

     F-1  

 

 

You should rely only on the information contained in this prospectus or in any free writing prospectus we may authorize to be delivered or made available to you. Neither we nor the underwriters have authorized anyone to provide you with different information. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus, or any free writing prospectus, as the case may be, or any sale of shares of our common stock.

 

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For investors outside the United States: we are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. Neither we nor the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside the United States.

 

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Industry and market data

Within this prospectus, we reference information and statistics regarding the negative pressure wound therapy, or NPWT, specialty surgical and advanced wound dressings, or AWD, industries. We have obtained this information and statistics from various independent third-party sources, including independent industry publications, reports by market research firms and other independent sources. Some data and other information contained in this prospectus, such as global market opportunities for NPWT and specialty surgical, are also based on management’s estimates and calculations, which are derived from our review and interpretation of internal surveys and independent sources. Data regarding the industries in which we compete and our market position and market share within these industries are inherently imprecise and are subject to significant business, economic and competitive uncertainties beyond our control, but we believe they generally indicate size, position and market share within these industries. While we believe such information is reliable, we have not independently verified any third-party information. While we believe our internal company research and estimates are reliable, such research and estimates have not been verified by any independent source. In addition, assumptions and estimates of our and our industries’ future performance are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk factors.” These and other factors could cause our future performance to differ materially from our assumptions and estimates. See “Forward-looking statements.”

Trademarks and service marks

We own a number of registered and common law trademarks and pending applications for trademark registrations in the United States and other countries, primarily through our subsidiaries KCI Licensing, Inc., KCI USA, Inc. and Systagenix Wound Management, Limited, including, for example: ABTHERATM Open Abdomen Negative Pressure Therapy, ACELITYTM, ACTIV.A.C.TM Therapy System, ADAPTICTM Non-Adhering Dressing, ADAPTIC TOUCHTM Non-Adhering Silicone Dressing, CELLUTOMETM Epidermal Harvesting System, INADINETM (PVP-I) Non Adherent Dressing, iOn HEALINGTM Mobile Application, iOn PROGRESSTM Remote Therapy Monitoring, KCITM, KERRACELTM Gelling Fiber Dressing, KERRACELTM Ag Gelling Fiber Dressing, KERRACONTACTTM Ag Dressing, KERRAFOAMTM Dressings, KERRAMAX CARETM Dressings, PREVENATM Incision Management System, PREVENA RESTORTM Incision Management System, PROMOGRANTM Matrix Wound Dressing, PROMOGRAN PRISMATM Matrix, SILVERCELTM Dressing Family, SNAPTM Therapy System, SYSTAGENIXTM, TIELLETM Dressing Family, V.A.C. DERMATACTM Drape, V.A.C. ® GRANUFOAMTM Dressing, V.A.C.® Therapy, V.A.C.ULTATM Therapy System, V.A.C. VERAFLOTM Therapy. Unless otherwise indicated, all trademarks appearing in this prospectus are proprietary to us, our affiliates and/or licensors. This prospectus also contains trademarks, trade names and service marks of other companies, which are the property of their respective owners. Solely for convenience, the trademarks, tradenames and service marks referred to in this prospectus may appear without the ® and ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensors to these trademarks, tradenames and service marks. We do not intend our use or display of other parties’ trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.

 

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Basis of presentation

The following terms are used in this prospectus unless otherwise noted or indicated by the context:

 

 

“2011 Take Private Transaction” means the corporate reorganization that resulted in LifeCell Corporation, formerly a 100% owned subsidiary of Kinetic Concepts, Inc., becoming a sister corporation of Kinetic Concepts, Inc. and the subsequent acquisition of Kinetic Concepts, Inc., LifeCell and their respective subsidiaries by the Sponsors, which was completed on November 4, 2011;

 

 

“advanced wound care” refers to both NPWT and AWD;

 

 

“Americas” region is comprised principally of the United States and also includes Canada, Puerto Rico and Latin America;

 

 

“Apax Funds” means funds advised by Apax Partners;

 

 

“Apax Partners” means Apax Partners LLP, Apax Partners, L.P. and other affiliates;

 

 

“CPPIB” means CPP Investment Board Private Holdings Inc., a wholly owned subsidiary of Canada Pension Plan Investment Board, and its affiliates;

 

 

“Crawford Healthcare” means Crawford Healthcare Holdings Limited;

 

 

“Existing Notes” means, collectively, the First Lien Notes and the Limited Third Lien Notes;

 

 

“First Lien Notes” means the 7.875% First Lien Senior Secured Notes due 2021, issued by Kinetic Concepts, Inc. and KCI USA, Inc.;

 

 

“GPOs” means group purchasing organizations;

 

 

“IDNs” means integrated delivery networks;

 

 

“International” region is comprised of Europe, the Middle East, Africa and Asia Pacific;

 

 

“KCI,” the “Company,” “we,” “us” and “our” mean (1) the business of Acelity L.P. Inc. and its subsidiaries prior to the Pre-IPO Restructuring and (2) KCI Holdings, Inc. and its consolidated subsidiaries following the Pre-IPO Restructuring;

 

 

“LifeCell” means LifeCell Corporation and its subsidiaries;

 

 

“Limited Third Lien Notes” means the 12.5% Limited Third Lien Senior Secured Notes due 2021, issued by Kinetic Concepts, Inc. and KCI USA, Inc.;

 

 

“LPA” means the Amended and Restated Limited Partnership Agreement of Chiron Guernsey Holdings L.P. Inc., dated as of November 4, 2011, as amended;

 

 

“Net Promoter Score” means a score of customer satisfaction measured on an 11 point scale, 0 to 10 using the question “How likely are you to recommend KCI to a friend or colleague?” Net Promoter Score is then calculated as the percentage of respondents that answered 9 or 10 (promoters) minus the percentage of respondents that answer 6 or below (detractors). Respondents that answer 7 or 8 are not considered in the calculation as they are considered neutral. The result can range from -100 to positive 100;

 

 

“Partnership” means Chiron Guernsey Holdings L.P. Inc.;

 

 

“Pre-IPO Restructuring” means the restructuring as a result of which KCI Holdings, Inc. will become the holding company of the business conducted by Acelity L.P. Inc. and its subsidiaries described in this prospectus, which restructuring will be effected prior to the effectiveness of the registration statement of which this prospectus forms a part;

 

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“product launches or introductions” means (1) introductions of new products, (2) introductions of enhancements to, extensions of or other variations of our existing products and (3) introductions of existing products in a new market or geography;

 

 

“PSP Investments” means Port-aux-Choix Private Investments II Inc., a subsidiary of Public Sector Pension Investment Board, and its affiliates;

 

 

“specialty surgical” means post-surgical incision management and open abdominal cavity management;

 

 

“Sponsors” means Apax Funds, CPPIB and PSP Investments; and

 

 

“Systagenix” means Systagenix Wound Management B.V., its subsidiaries and its former U.S.-based affiliate, Systagenix Wound Management (US), Inc.

In this prospectus, we refer to organic growth and underlying growth in our consolidated revenue and AWD revenue. We calculate organic growth by excluding from our consolidated revenue and/or AWD revenue, as applicable, on a constant currency basis, (x) revenues from Crawford Healthcare, which we acquired in June 2018, from the date of the acquisition to the 2018 fiscal year-end and (y) contract manufacturing revenue associated with the manufacturing facility in Gargrave, England, which we sold in October 2018. We calculate underlying growth in our consolidated revenue and/or AWD revenue, as applicable, on a constant currency basis, by (x) including in our 2018 and 2017 revenue, the historical revenue of Crawford Healthcare for the 2018 period prior to its acquisition by us and for 2017, respectively, and (y) excluding contract manufacturing revenue associated with the manufacturing facility in Gargrave, England.

Numerical figures included in this prospectus have been subject to rounding adjustments. Accordingly, numerical figures shown as totals in various tables may not be arithmetic aggregations of the figures that precede them.

All references to years in this prospectus, unless otherwise noted, refer to our fiscal years, which end on December 31.

 

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Non-GAAP financial measures

This prospectus contains “non-GAAP financial measures” that are financial measures that either exclude or include amounts that are not excluded or included in the most directly comparable measures calculated and presented in accordance with accounting principles generally accepted in the United States, or GAAP. Specifically, we make use of the non-GAAP financial measures “EBITDA from continuing operations” and “Adjusted EBITDA from continuing operations.”

EBITDA from continuing operations and Adjusted EBITDA from continuing operations have been presented in this prospectus as supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP, because we believe they assist investors and analysts in comparing our operating performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. Management believes EBITDA from continuing operations and Adjusted EBITDA from continuing operations are useful to investors in highlighting trends in our operating performance, while other measures can differ significantly depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which we operate and capital investments. Management uses EBITDA from continuing operations and Adjusted EBITDA from continuing operations to supplement GAAP measures of performance in the evaluation of the effectiveness of our business strategies, to make budgeting decisions, to establish discretionary annual incentive compensation and to compare our performance against that of other peer companies using similar measures. Management supplements GAAP results with non-GAAP financial measures to provide a more complete understanding of the factors and trends affecting the business than GAAP results alone.

EBITDA from continuing operations and Adjusted EBITDA from continuing operations are not recognized terms under GAAP and should not be considered as an alternative to net earnings (loss) attributable to Acelity L.P. Inc., net earnings (loss) or earnings (loss) from continuing operations, net of tax, as a measure of financial performance or cash flows provided by operating activities as a measure of liquidity, or any other performance measure derived in accordance with GAAP. Additionally, these measures are not intended to be a measure of free cash flow available for management’s discretionary use as they do not consider certain cash requirements such as interest payments, tax payments and debt service requirements. The presentations of these measures have limitations as analytical tools and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Because not all companies use identical calculations, the presentations of these measures may not be comparable to other similarly titled measures of other companies and can differ significantly from company to company. For a discussion of the use of these measures and a reconciliation of the most directly comparable GAAP measures, see “Summary—Summary historical consolidated financial and other data.”

As exchange rates are an important factor in understanding period-to-period comparisons, we believe in certain cases the presentation of results on a constant currency basis in addition to reported results helps improve investors’ ability to understand our operating results and evaluate our performance in comparison to prior periods. See “Management’s discussion and analysis of financial condition and results of operations—Use of constant currency.”

 

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Summary

This summary highlights selected information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider before deciding to invest in our common stock. You should read the entire prospectus carefully, including “Risk factors” and our consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment decision.

Our company

KCI is the leading global medical technology company focused on advanced wound care and specialty surgical applications. We market a broad range of negative pressure wound therapy, or NPWT, specialty surgical and advanced wound dressings, or AWD, products in approximately 90 countries. Our mission is to improve patients’ lives and change the practice of medicine by focusing on developing and commercializing advanced technological solutions that accelerate healing while reducing the overall cost of care. By offering a comprehensive range of complementary solutions that are used across the continuum of care and several clinical specialties, we have established KCI as the market leader throughout the healing process. We have also established and maintained our market leadership through our development of differentiated technology and best-in-class product offerings, our highly trained sales force, our strong clinical and economic data and our robust support infrastructure.

We are a global pioneer in advanced wound care and specialty surgical solutions. Our history of innovation began over 20 years ago with our introduction of the groundbreaking NPWT technology. We believe that our proven ability to identify and address unmet clinical needs for patients, providers and payers leads to the development of new products and markets. Our products are supported by extensive evidence of superior clinical and economic outcomes, which has increased adoption of our products and generated growth in these new markets. Our track record of successful innovation has accelerated over the last several years through key investments in new product and market development, which is driving strong organic revenue growth. We have also invested in strategic acquisitions, which have added complementary product lines to our business, to better meet the needs of our customers across the continuum of care.

Our business is focused on the development and commercialization of three main product lines:

Negative pressure wound therapy. Our NPWT product line consists of V.A.C. Therapy devices with advanced technologies and dressings marketed across multiple geographies and care settings. We believe our continuous innovation has enabled us to maintain global market leadership in NPWT for over 20 years. For patients suffering from acute or chronic wounds, such as diabetic foot ulcers, V.A.C. Therapy accelerates the wound healing process and reduces healing times to levels unattainable prior to the introduction of our technology. Over the last 20 years, there have been approximately 1,400 peer-reviewed published clinical studies on V.A.C. Therapy. We are currently on our fourth generation of NPWT devices and dressings. Our flagship NPWT devices include V.A.C.ULTA Therapy System and ACTIV.A.C. Therapy System. Our latest advancements in NPWT dressings include V.A.C. VERAFLO and V.A.C. VERAFLO CLEANSE CHOICE dressings, which enable the instillation of a wound cleansing solution in conjunction with NPWT. More recently, we launched several digital wound care initiatives, including a first-in-class technology that enables us to continuously monitor the delivery of NPWT to patients at home. This technology allows us to engage directly with patients and providers, resulting in increased patient compliance, which, in turn, leads to faster healing times and significant cost savings. For the year ended December 31, 2018, our NPWT product line generated $1.152 billion of revenue, representing 78.5% of our total revenue and 4.5% growth compared to 2017.

 

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Specialty surgical. Our specialty surgical product line consists of several products marketed under our PREVENA and ABTHERA brands in the acute care setting. We have leveraged our expertise in negative pressure technology to create and grow new markets with specialty surgical applications designed specifically for the surgical suite. We launched the first generation of the PREVENA Incision Management System and ABTHERA Open Abdomen Negative Pressure Therapy in 2009 and have maintained consistent market leadership by continuing to launch new generations of these products. PREVENA products employ negative pressure to manage closed surgical incisions and protect incisions from external contamination, while also removing fluid and infectious material, which has been shown in numerous published clinical trials to reduce the rate of surgical site complications in a variety of surgical procedures. ABTHERA is a temporary abdominal closure system used to manage patients with an open abdomen. In a 280 patient prospective study across 20 U.S. trauma centers, ABTHERA was shown to have a higher primary fascial closure rate versus the control, and the mortality rate for the ABTHERA group was reduced by greater than 50% compared to the control group. For the year ended December 31, 2018, our specialty surgical product line generated $137.3 million of revenue, representing 9.3% of our total revenue and 49.6% growth compared to 2017.

Advanced wound dressings. Our AWD product line consists of a comprehensive portfolio of dressings across all categories, including differentiated wound dressings in the categories of collagen, super-absorbents, foam, gelling fiber and contact layers. Our AWD product line is highly synergistic with our other product lines, helps manage acute and chronic wounds across the care continuum and is often used before or after use of our NPWT and specialty surgical products. Our PROMOGRAN PRISMA Matrix, a market-leading collagen dressing, is backed by extensive clinical evidence and is highly differentiated from other collagen products due to our proprietary processing technology. Our other innovative AWD brands include ADAPTIC, INADINE, KERRACEL, KERRAFOAM and KERRAMAX CARE dressings. For the year ended December 31, 2018, our AWD product line generated $169.0 million of revenue, representing 11.5% of our total revenue and 32.3% growth (or 12.0% organic growth) compared to 2017.

A critical component of marketing our portfolio of solutions and services is our sales organization of over 1,500 professionals working across multiple care settings and specialties, with over 900 professionals based in the United States. This direct sales infrastructure enables us to market our products to trained medical professionals in specific care settings in the United States, Canada, Western Europe, Japan and other key international markets. In other international markets where we do not have direct sales operations, we distribute our products through third parties. We have established strong relationships globally with key constituencies, including physicians, hospitals, post-acute facilities, GPOs, IDNs, payers and other key clinical and economic decision makers by offering innovative products, comprehensive customer service and clinical education. We believe the continuing expansion of our global sales force will provide us with significant opportunities for future growth as we increase our penetration of existing geographic markets and enter new ones.

For the year ended December 31, 2018, we generated revenue of $1.468 billion (representing 10.1% growth, or 8.4% underlying growth and 8.1% organic growth, compared to the prior year), loss attributable to Acelity L.P. Inc. of $137.5 million and Adjusted EBITDA from continuing operations of $441.0 million. For more information about how we calculate (i) organic growth and underlying growth, see “Basis of presentation,” and (ii) Adjusted EBITDA from continuing operations, see “—Summary historical consolidated financial and other data.”

 

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Industry overview

We operate in large and growing global markets for advanced wound care and specialty surgical applications.

 

 

Negative pressure wound therapy market: The global NPWT market was approximately $1.7 billion in 2017, and we believe the global market opportunity for NPWT is over $5 billion.

 

 

Specialty surgical market: We believe the addressable market for our current specialty surgical products and planned platform extensions is approximately $4 billion globally.

 

 

Advanced wound dressings market: The global AWD market was approximately $4 billion in 2017.

We believe that both the NPWT and specialty surgical markets are underpenetrated and represent significant growth opportunities for our differentiated products in growing global markets.

We believe growth of the advanced wound care markets will be driven by:

 

 

favorable global demographics and aging population;

 

 

rising rates of obesity, diabetes and other chronic conditions, resulting in greater incidence and complexity of wounds, such as venous insufficiency ulcers and diabetic foot ulcers;

 

 

increasing acceptance of technologies that favor value-based healthcare and reduce the length of hospital stays and readmissions;

 

 

broadening use of NPWT applications across underpenetrated wound types and market segments;

 

 

growing recognition of the need for differentiated AWD products that promote healing of complex and difficult-to-heal wounds; and

 

 

shift to advanced treatment protocols outside of the United States.

We believe growth in the specialty surgical market will be driven by:

 

 

rising volume of surgical procedures across the globe;

 

 

increasing awareness of and demand for surgical applications that reduce complications and can save lives;

 

 

greater emphasis on prevention of expensive complications related to surgical site infection;

 

 

continued growth in surgical procedures related to the aging population such as total knee arthroscopy;

 

 

an increase in patient participation in clinical treatment decisions for emotionally intensive procedures, such as breast reconstruction; and

 

 

increasing adoption of advanced treatment protocols outside of the United States.

Our strategic transformation

Since our 2011 Take Private Transaction, we have transformed our business into a more competitive and focused advanced wound care and specialty surgical leader, well-positioned for long-term growth. We have accomplished our strategic transformation through the following initiatives:

 

 

Refocusing our product portfolio and expanding our addressable wound care markets. We divested our non-core Therapeutic Support Systems business in 2012 and our LifeCell Regenerative Medicine business in

 

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2017. We expanded our addressable market in advanced wound care and entered the AWD business by acquiring Systagenix in 2013. We further augmented our product portfolio and technology offerings in AWD with several differentiated and market-leading products through the acquisition of Crawford Healthcare in 2018.

 

 

Creating new markets for our specialty surgical products. We launched the first generations of PREVENA and ABTHERA in 2009 and over the last ten years have invested in clinical and health economic studies that have revealed compelling data about their efficacy. Over this time we have invested in developing new markets for these products by expanding the portfolio around these core platforms, establishing robust medical education programs and building a focused commercial team to create awareness and drive demand. These efforts have resulted in a growing number of clinicians adopting PREVENA and ABTHERA to cost-effectively address patient challenges. We expect that more pre- and post-operative patients will continue to benefit from our specialty surgical applications and that these new markets will continue to grow rapidly as we further invest in and develop this large opportunity.

 

 

Strengthening our leadership team. Since 2017, we have appointed a new Chief Executive Officer and a new Chief Financial Officer, as well as several other senior executives. These leadership changes have brought significant experience to our business, while fostering a culture of innovation, investment, customer focus and operational discipline that has reinvigorated our growth.

 

 

Implementing our focused innovation model. We have made significant investments in innovation and product development to create new or improved technologies, while remaining focused on enhancing and extending our existing product lines. Our innovation teams are aligned by product focus to improve the speed and quality of delivering solutions that are well-tailored to the needs of our key customers across geographies and care settings. Since forming our innovation model in 2015, we have accelerated our rate of product launches and have successfully executed 42 product launches across our three product lines.

 

 

Strengthening operations through business transformation initiatives and other cost savings efforts. We undertook measures to enhance our operating performance through productivity improvements, product development support and other operations functions and augmenting access to product development resources, which continue to drive improved focus, performance and sustained cost savings. We have achieved significant cost savings through several initiatives, including the sale of our AWD manufacturing facility in the United Kingdom and the outsourcing of some of our information technology functions.

 

 

Continued improvements of our financial flexibility and capacity for investment and acquisitions. We reduced our leverage by prepaying debt with proceeds from the sale of LifeCell in 2017, resulting in improved cash flow from reduced interest expense. This has increased our financial flexibility for investments and acquisitions, including the acquisition of Crawford Healthcare in 2018.

Our competitive strengths

We believe the following competitive strengths have been instrumental to our success and position us for future growth:

 

 

Long history of market leading brands. We are the pioneers of NPWT technology, and our long-standing commitment to, and innovation in, the advanced wound care markets have enhanced the global recognition of all of our brands. We continue to be the market leader in NPWT, which includes top brands, such as the V.A.C.ULTA Therapy and ACTIV.A.C. Therapy Systems, V.A.C. VERAFLO dressings and the SNAP Therapy System. Our AWD product line offers well-recognized global brands, such as PROMOGRAN PRISMA Matrix and

 

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the ADAPTIC, INADINE, KERRACEL, KERRAFOAM and KERRAMAX CARE brand dressings. We leveraged our deep experience in NPWT technology to develop our specialty surgical product line, which offers market-leading brands such as PREVENA and ABTHERA. Our strong brands, supported by our innovative products and superior clinical and health economic outcomes data, strengthen our market leading positions.

 

 

Demonstrated ability to innovate and commercialize new products and solutions. We have a strong track record of innovation, with 42 product launches since 2015 and 10 product launches in 2018 alone. We believe we have one of the most extensive patent portfolios in both advanced wound care and negative pressure surgical incision management, consisting of over 3,400 issued patents and over 1,200 pending patent applications. With the implementation of our focused innovation model, we have introduced new technologies to the marketplace to address the unmet needs of our patients and clinicians. In addition, we have developed disruptive digital wound care solutions designed to meet the needs of our customers, enhance the effectiveness of our therapies and improve our service offerings. Our iOn PROGRESS Remote Therapy Monitoring remotely monitors ACTIV.A.C. Therapy for patients at home and allows us to engage directly with patients and providers, resulting in increased patient compliance, faster healing times and significant cost savings for our customers. Our iOn HEALING Mobile Application provides easy-to-use ordering options for customers and connects caregivers directly with our field representatives. Our history of successful innovation has been instrumental to our growth.

 

 

Clinically and economically superior outcomes. We believe the effectiveness of our offerings, as evidenced by a large body of scientific, clinical and health economic outcomes data, continues to drive expanding adoption of our products. We have accumulated over 1,400 peer-reviewed, published clinical studies specifically on our products across all three of our product lines. Many of these studies have established industry-leading health economic outcomes data for our product lines. For example, in a 2015 retrospective national claims database analysis from a major commercial payer, results showed compelling economic outcomes data in the outpatient setting for V.A.C. Therapy compared to other competitor NPWT products. The study showed that for more than 8,200 patient claims, twelve-month wound-related costs and all-cause costs for patients treated with V.A.C. Therapy were 27% lower than compared to the same costs for patients treated with a competitor NPWT product over the same time period. In addition, a study presented at the 2014 Symposium of Advanced Wound Care, of over 21,000 patients at 168 hospitals, demonstrated that patients treated with our NPWT product had shorter length of hospital stay, lower readmission rates, and fewer emergency room visits within 60 days of discharge compared to patients treated with a competitor NPWT. Similarly, a meta-analysis of 30 clinical trials including 11 randomized controlled trials has demonstrated that patients using PREVENA had a statistically significant reduction in the rate of surgical site infections compared to standard therapies, which in turn leads to lower total cost of care. We believe compelling clinical evidence is important in expanding adoption of our products.

 

 

Unique expertise in surgical applications. We are the pioneer and the global market leader in the commercialization of surgical applications for post-surgical incision management and open abdominal cavity management. As a result of a growing body of clinical evidence supporting reduced post-surgical complications and surgical site infections, we have experienced significant growth in demand for PREVENA from the clinical specialties of orthopedics, plastic surgery, general surgery, cardio-vascular and obstetrics in hospitals. We are also expanding the PREVENA technology platform to address post-surgical complications in complex surgeries, such as breast reconstruction and total knee replacement. We have driven this significant increase in adoption of our products in the surgical suite through investments we have made in new enhancements to the PREVENA product line, backed by clinical data and our clinical education initiatives.

 

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Strong commercial execution drives customer relationships. We have made significant investments in our global distribution network to span the continuum of care in order to sell our broad portfolio of complementary products. We have a deep commercial footprint with a global presence in approximately 90 countries through a mix of direct sales and distributors. We have developed extensive relationships with key opinion leaders, health systems, payers and clinicians serving more than 27,000 hospitals and facilities and 550 third-party payers. In addition, we conduct approximately 900 educational events annually, which educate more than 50,000 clinicians on our products. Our commercial execution is further supported by our extensive field service network and our Advantage Center, which offers 24-hour technical and clinical support, customer service and effective direct billing. Our unique customer service capabilities help drive customer satisfaction, as evidenced by our industry-leading Net Promoter Score of 72. Our commercial functions and relationships enable us to participate in the creation of standards of care, maximize customer satisfaction, promote compliance and have direct dialogue with patients, payers and clinicians.

 

 

Proven executive leadership team with a long-term track record of value creation. We are led by a dedicated and seasoned senior management team with significant industry experience, which has successfully executed our strategic transformation, maintained our market leadership position in NPWT, successfully launched new products and technologies and driven investment in new areas of growth. We believe our management has the vision and experience to successfully drive our future growth.

Our business strategy

We intend to grow our business by pursuing the following strategies:

 

 

Continued focus on innovation to grow our NPWT product line. We intend to increase global penetration of our NPWT products by continuing to focus on innovation to further differentiate our products. Following increased investments in product enhancements, clinical evidence generation and clinical education regarding the benefits of using our products, we have recently achieved increased growth in our NPWT product line. Recent launches of new product enhancements in our V.A.C.ULTA Therapy System and V.A.C. VERAFLO dressings, as well as the introduction of digital wound care solutions, have improved compliance with our therapies and outcomes, and have delivered meaningful reductions in the overall cost of wound care.

 

 

Continued investment in specialty surgical applications to increase penetration. We have invested significantly in product innovation, market development, clinical evidence generation and commercial execution to drive increased adoption of our specialty surgical applications. We have recently introduced enhancements to PREVENA and ABTHERA to increase ease-of-use and functionality. We have also made significant investments to identify key providers and facilities that can benefit from the use of our specialty surgical applications. We also plan to continue to enhance our specialty surgical portfolio, in particular for knee-replacement and breast reconstruction procedures to expand our customer base. Our goal is to make PREVENA the new standard of care for post-surgical incision management. We believe these investments will help drive continued growth in our specialty surgical product line.

 

 

Portfolio expansion and focused execution to increase market share in advanced wound dressings. Over the last several years, we acquired Systagenix and Crawford Healthcare to create a comprehensive portfolio of AWD products, with leading brands in the categories of collagen, contact layers, super-absorbent, foam, gelling fiber and contact layer dressings. We have also invested significantly in sales force expansion in key markets, which we believe has resulted in strong growth and increased market share. We plan to leverage our scale and

 

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expertise in portfolio development and commercial execution to increase market share in this large and attractive market.

 

 

Increase penetration in existing and new geographies. We believe there are attractive opportunities for our business to continue to grow and gain market share by increasing our penetration in our existing markets. We have successfully entered approximately 90 international markets through increased product registrations, tailored portfolio development, acquisitions, post-acute and community reimbursement initiatives and expansion of commercial channels and believe we have significant opportunity for continued growth in international markets. In 2018, 29.4% of our revenue was generated from outside the United States. We will continue to focus on deeper penetration of our existing markets both within and outside of the United States by leveraging our brands, our differentiated products and innovation capability, superior clinical evidence and our commercial execution capabilities, while also expanding our regulatory and sales efforts and pursuing global registrations to enter new markets and geographies.

 

 

Strategic acquisitions. We intend to continue to supplement our organic growth by identifying, acquiring and integrating businesses, technologies and products that enhance our product portfolio, while diversifying our customer base and increasing our global footprint. In addition, we will continue to focus on realizing operational efficiencies from our acquisitions by maintaining a low-cost global manufacturing footprint, eliminating duplicative operations and leveraging common resources across businesses.

Risks related to our business and this offering

Investing in our stock involves a high degree of risk. You should carefully consider the risks described in “Risk factors” before making a decision to invest in our common stock. If any of these risks actually occurs, our business, financial condition and results of operations may be materially adversely affected. In such case, the trading price of our common stock may decline and you may lose part or all of your investment. Below is a summary of some of the principal risks we face:

 

 

significant and continuing competition;

 

 

defects, failures or quality issues associated with our products, which could lead to product recalls or safety alerts, adverse regulatory actions, litigation, including product liability claims brought with or without merit, and negative publicity;

 

 

our ability to adhere to extensive and continuing regulatory compliance obligations;

 

 

the misuse or off-label use of our products;

 

 

failure of any of our clinical studies or third-party assessments to demonstrate desired outcomes in proposed endpoints;

 

 

pricing pressure as a result of cost-containment efforts of our customers, purchasing groups, distributors, third-party payers and governmental organizations;

 

 

our inability to obtain and maintain adequate levels of coverage and reimbursement for our current or future products or procedures using our products or any changes in U.S. and international regulations, policies, rules and expanded audit programs of third-party payers that reduce reimbursement and collection for our products;

 

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our inability to develop and obtain regulatory clearance or approval for new generations of products and enhancements to existing products and service offerings;

 

 

the implementation of healthcare reform in the United States;

 

 

our failure to protect, maintain and enforce our intellectual property;

 

 

our substantial indebtedness;

 

 

our status as a “controlled company” within the meaning of the NYSE rules and the rules of the SEC following the completion of this offering and, as a result, our reliance on available exemptions from certain corporate governance requirements afforded to stockholders of other companies that are subject to such requirements; and

 

 

our Sponsors control us and their interests may conflict with yours in the future.

Our sponsors

Apax Partners

Apax Partners is a leading global private equity advisor firm. Over its more than 40-year history, Apax Partners has raised and advised funds with aggregate commitments of $50 billion. The Apax Funds invest in companies across four global sectors of Healthcare, Tech & Telco, Services and Consumer. Apax Partners is one of the leading global investors in the healthcare sector, with the Apax Funds having invested over $9 billion in more than 80 healthcare companies. Investments include the wound care company Mölnlycke Health Care, the TriZetto Corporation in healthcare software, medical devices companies Candela, Vyaire Medical, Healthium as well as a number of global healthcare services companies such as Capio AB, Unilabs and Apollo Hospitals.

CPPIB

Canada Pension Plan Investment Board is one of the largest and fastest growing institutional investors in the world. It invests the funds not needed by the Canada Pension Plan to pay current benefits on behalf of 20 million Canadian contributors and beneficiaries. Headquartered in Toronto, with offices in London, Hong Kong, New York, Luxembourg, Mumbai, São Paulo and Sydney, Canada Pension Plan Investment Board is governed and managed independently of the Canada Pension Plan and at arm’s length from governments. As of December 31, 2018, Canada Pension Plan Investment Board had assets of C$368.5 billion. Current and previous healthcare private investments include Ascend Learning, IQVIA, Walgreens Boots Alliance, Diaverum, United Surgical Partners and LHP Hospital Group.

PSP Investments

Public Sector Pension Investment Board is one of Canada’s largest pension investment managers, with approximately C$158.9 billion of net assets under management as of September 30, 2018. Public Sector Pension Investment Board invests funds for the pension plans of the Public Service, the Canadian Forces, the Royal Canadian Mounted Police and the Reserve Force. Public Sector Pension Investment Board manages a diversified global portfolio including stocks, bonds and other fixed-income securities, and investments in private equity, real estate, infrastructure and natural resources. Public Sector Pension Investment Board has become increasingly global with more than half of its assets invested outside of Canada.

 

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Our corporate information

KCI Holdings, Inc. was incorporated in Texas on January 31, 2019. Prior to the effectiveness of the registration statement of which this prospectus forms a part, there will be a restructuring as a result of which KCI Holdings, Inc. will become the holding company of the business conducted by Acelity L.P. Inc. and its subsidiaries described in this prospectus.

Our principal offices are located at 12930 West Interstate 10, San Antonio, Texas 78249. Our telephone number is (210) 524-9000. We maintain a website at                .com. The reference to our website is intended to be an inactive textual reference only. The information contained on, or that can be accessed through, our website is not part of this prospectus.

 

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The offering

 

Issuer

KCI Holdings, Inc.

 

Common stock offered by us

                 shares

 

Common stock offered by the selling shareholders

                 shares

 

Option to purchase additional shares of common stock

The selling shareholders have granted the underwriters a 30-day option from the date of this prospectus to purchase up to                  additional shares of our common stock at the initial public offering price, less underwriting discounts and commissions.

 

Common stock to be outstanding immediately after this offering

                 shares

 

Use of proceeds

We estimate that the net proceeds to us from this offering will be approximately $                 million, assuming an initial public offering price of $                 per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. For a sensitivity analysis as to the offering price and other information, see “Use of proceeds.”

 

  We intend to use the net proceeds to us from this offering to redeem $            million aggregate principal amount of the First Lien Notes, including applicable premiums. See “Use of proceeds.”

 

  We will not receive any proceeds from the sale of shares of our common stock by the selling shareholders in this offering, including from any exercise by the underwriters of their option to purchase additional shares from the selling shareholders. The selling shareholders will receive all of the net proceeds and bear all commissions and discounts, if any, from the sale of our common stock by the selling shareholders. See “Principal and selling shareholders.”

 

Controlled company

Upon the closing of this offering, our Sponsors will own a majority of the shares eligible to vote in the election of our directors. We currently intend to avail ourselves of the controlled company exemption under the corporate governance standards of the NYSE.

 

Dividend policy

We have no current plans to pay dividends on our common stock. Any decision to declare and pay dividends in the future will be made at the sole discretion of our board of directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, including restrictions in the agreements governing our indebtedness, and other factors that our board of directors may deem relevant. See “Dividend policy.”

 

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Risk factors

Investing in shares of our common stock involves a high degree of risk. See “Risk factors” for a discussion of factors you should carefully consider before investing in shares of our common stock.

 

NYSE ticker symbol

“                 .”

In this prospectus, the number of shares of our common stock to be outstanding immediately after the consummation of this offering is based on                  shares of common stock outstanding as of                 , 2019 and does not reflect:

 

 

                 shares of common stock issuable upon the exercise of options and                  shares of common stock issuable upon the vesting of restricted stock units, which options and restricted stock units we expect to issue at the consummation of this offering, in the case of certain options, in connection with the conversion of the outstanding profits interest units; and

 

 

                 shares of common stock reserved as of the closing date of this offering for future issuance under our new Omnibus Incentive Plan, or the 2019 Omnibus Incentive Plan.

Unless we indicate otherwise or the context otherwise requires, this prospectus reflects and assumes:

 

 

the consummation of the Pre-IPO Restructuring;

 

 

no exercise of the underwriters’ option to purchase additional shares of our common stock;

 

 

an initial public offering price of $                 per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus;

 

 

the filing and effectiveness of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws immediately prior to the consummation of this offering; and

 

 

the                  -for-one reverse stock split of our common stock, which will occur prior to the consummation of this offering.

 

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Summary historical consolidated financial and other data

Set forth below is our summary historical consolidated financial and other data as of the dates and for the periods indicated. The summary historical financial data as of December 31, 2017 and 2018 and for the years ended December 31, 2016, 2017 and 2018 has been derived from our audited historical consolidated financial statements included elsewhere in this prospectus. The summary historical financial data as of December 31, 2016 has been derived from our audited historical consolidated financial statements not included in this prospectus. The results of operations for any period are not necessarily indicative of the results to be expected for any future period. Share and per share data in the table below has been retroactively adjusted to give effect to the                  -for-one reverse stock split, which will occur prior to the consummation of this offering.

On January 31, 2017, Acelity L.P. Inc. completed the sale of its LifeCell Regenerative Medicine business to Allergan Holdco US, Inc. for $2.9 billion in cash pursuant to the Stock Purchase Agreement, dated as of December 20, 2016, or the Stock Purchase Agreement. The assets and liabilities subject to the Stock Purchase Agreement were presented as held for sale in the consolidated balance sheet as of December 31, 2016. The results of the operations of the LifeCell Regenerative Medicine business, excluding the allocation of general corporate overhead, are presented as discontinued operations in the consolidated statements of operations for all periods presented. Interest expense allocated to discontinued operations was $185.1 million and $14.8 million for the years ended December 31, 2016 and 2017, respectively. No interest expense was allocated to discontinued operations for the year ended December 31, 2018. Loss on extinguishment of debt allocated to discontinued operations was $110.1 million for the year ended December 31, 2017. No loss on extinguishment of debt was allocated to discontinued operations for the year ended December 31, 2016 or the year ended December 31, 2018.

The data presented below is the historical consolidated financial and other data of Acelity L.P. Inc. and its subsidiaries. The summary historical consolidated financial data of KCI Holdings, Inc. has not been presented as KCI Holdings, Inc. is a newly incorporated entity, has had no business transactions or activities to date and had no assets or liabilities during the periods presented in this section.

You should read the following summary financial and other data below together with the information under “Selected historical consolidated financial data” and “Management’s discussion and analysis of financial condition and results of operations” and our audited consolidated financial statements and related notes thereto included elsewhere in this prospectus.

 

   
    Fiscal year ended December 31,  
     2016     2017     2018  
(in thousands, except per share amounts)                  

Operations Data:

     

Revenue:

     

Rental

  $ 637,943     $ 598,305     $ 605,270  

Sales

    760,604       734,665       862,730  
 

 

 

 

Total revenue

    1,398,547       1,332,970       1,468,000  

Rental expenses

    109,459       111,563       108,243  

Cost of sales

    204,760       187,752       225,733  
 

 

 

 

Gross profit

    1,084,328       1,033,655       1,134,024  

Selling, general and administrative expenses

    712,359       707,378       802,638  

Research and development expenses

    34,869       35,647       42,028  

 

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    Fiscal year ended December 31,  
     2016     2017     2018  
(in thousands, except per share amounts)                  

 

 

 

 

   

 

 

   

 

 

 

Acquired intangible asset amortization

    121,426       109,124       105,821  

Loss on sale of business

                16,941  
 

 

 

 

Operating earnings

    215,674       181,506       166,596  

Interest income and other

    1,095       7,052       2,554  

Interest expense

    (256,156     (181,597     (175,931

Loss on extinguishment of debt

    (64,325     (127,161      

Foreign currency gain (loss)

    11,577       (38,515     (564

Derivative instrument loss

    (1,743            
 

 

 

 

Loss from continuing operations before income tax expense (benefit)

    (93,878     (158,715     (7,345

Income tax expense (benefit)

    (32,940     (357,097     132,380  
 

 

 

 

Earnings (loss) from continuing operations, net of tax

    (60,938     198,382       (139,725

Earnings (loss) from discontinued operations, net of tax

    (57,399     1,654,230       2,058  
 

 

 

 

Net earnings (loss)

  $ (118,337   $ 1,852,612     $ (137,667
 

 

 

 

Less: Net loss attributable to noncontrolling interest

                (153
 

 

 

 

Net earnings (loss) attributable to Acelity L.P. Inc.

  $ (118,337   $ 1,852,612     $ (137,514
 

 

 

 

Pro Forma Per Share Data (unaudited):

     

Net earnings (loss) per common share:

     

Basic

  $       $       $    

Diluted

  $       $       $    

Weighted average shares

     

Basic

     

Diluted

     

Balance Sheet Data (end of period):

     

Cash and cash equivalents

  $ 148,747     $ 168,973     $ 214,078  

Working capital(1)

    318,378       478,164       391,080  

Total assets

    6,496,149       5,074,468       5,020,495  

Total debt(2)

    4,779,856       2,377,021       2,357,292  

Total equity

    584,718       2,350,357       2,158,557  

Cash Flow Data:

     

Net cash provided by operating activities—continuing operations(3)

  $ 62,317     $ 82,708     $ 218,941  

Net cash used in investing activities—continuing operations

    (67,001     (65,552     (150,197

Net cash provided by (used in) financing activities

    48,173       (2,788,739     (112,101

Capital expenditures

    (62,352     (57,094     (57,645

Other Financial Data (unaudited):

     

EBITDA from continuing operations(4)

  $ 353,211     $ 198,686     $ 341,423  

Adjusted EBITDA from continuing operations(4)

  $ 488,638     $ 427,021     $ 441,019  

 

 

 

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(1)   Working capital is defined as current assets, including cash and cash equivalents, minus current liabilities. Due to the timing of the sale of the LifeCell Regenerative Medicine business, all assets held for sale and liabilities related to assets held for sale were reflected as current assets and current liabilities on the consolidated balance sheet as of December 31, 2016. Working capital as of December 31, 2016, has been adjusted to exclude previously non-current assets and liabilities of $1.266 billion and $170.6 million, respectively, which were included in assets held for sale and liabilities related to assets held for sale on the consolidated balance sheet.

 

(2)   Total debt equals current and long-term debt, net of premium, discount and debt issuance costs, and capital lease obligations.

 

(3)   Net cash provided by operating activities from continuing operations for the years ended December 31, 2016 and 2017 was impacted by payments of $85.0 million and $30.0 million, respectively, pursuant to a Settlement and Release Agreement between Kinetic Concepts, Inc. and affiliates and Wake Forest University Health Sciences dated June 30, 2014.

 

(4)   We define EBITDA from continuing operations as net earnings (loss) attributable to Acelity L.P. Inc., plus loss (earnings) from discontinued operations, net of tax, interest expense, net of interest income, and depreciation and amortization. We define Adjusted EBITDA from continuing operations as EBITDA from continuing operations, as further adjusted to exclude foreign currency loss (gain), derivative instruments loss, management fees and expenses, equity-based compensation expense, acquisition, disposition and financing expenses, business optimization expenses and other expenses as permitted under our senior secured credit facilities. We describe these adjustments reconciling net earnings (loss) attributable to Acelity L.P. Inc. to Adjusted EBITDA from continuing operations in the table below.

We present EBITDA from continuing operations and Adjusted EBITDA from continuing operations because we believe they are useful indicators of our operating performance. Our management uses EBITDA from continuing operations and Adjusted EBITDA from continuing operations principally as a measure of our operating performance and believes that EBITDA from continuing operations and Adjusted EBITDA from continuing operations are useful to investors because they are frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We also believe EBITDA from continuing operations and Adjusted EBITDA from continuing operations are useful to our management and investors as a measure of comparative operating performance from period to period.

EBITDA from continuing operations and Adjusted EBITDA from continuing operations are non-GAAP financial measures and should not be considered as an alternative to net earnings (loss) attributable to Acelity L.P. Inc., net earnings (loss) or earnings (loss) from continuing operations, net of tax, as a measure of financial performance or cash flows from operations as a measure of liquidity, or any other performance measure derived in accordance with GAAP and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. In evaluating EBITDA from continuing operations and Adjusted EBITDA from continuing operations, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of EBITDA from continuing operations and Adjusted EBITDA from continuing operations should not be construed to imply that our future results will be unaffected by any such adjustments. Management compensates for these limitations by primarily relying on our GAAP results in addition to using EBITDA from continuing operations and Adjusted EBITDA from continuing operations supplementally.

Our EBITDA and Adjusted EBITDA measures have limitations as analytical tools, and you should not consider them in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

 

   

they do not reflect costs or cash outlays for capital expenditures or contractual commitments;

 

   

they do not reflect changes in, or cash requirements for, our working capital needs;

 

   

they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

   

they do not reflect period to period changes in taxes, income tax expense or the cash necessary to pay income taxes;

 

   

they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations;

 

   

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and they do not reflect cash requirements for such replacements; and

 

   

other companies in our industry may calculate these measures differently than we do, limiting their usefulness as comparative measures.

Because of these limitations, EBITDA from continuing operations and Adjusted EBITDA from continuing operations should not be considered as measures of discretionary cash available to invest in business growth or to reduce indebtedness.

 

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The following table provides a reconciliation of net earnings (loss) attributable to Acelity L.P. Inc. to EBITDA from continuing operations and Adjusted EBITDA from continuing operations for the periods presented:

 

   
     Fiscal year ended December 31,  
(in thousands)    2016     2017     2018  

Net earnings (loss) attributable to Acelity L.P. Inc.

   $ (118,337   $ 1,852,612     $ (137,514

Loss (earnings) from discontinued operations, net of tax

     57,399       (1,654,230     (2,058

Interest expense, net of interest income

     255,591       181,071       174,028  

Income tax expense (benefit)

     (32,940     (357,097     132,380  

Depreciation and amortization

     191,498       176,330       174,587  
  

 

 

 

EBITDA from continuing operations

   $ 353,211     $ 198,686     $ 341,423  

Adjustments:

      

Foreign currency loss (gain)(A)

   $ (11,577   $ 38,515     $ 564  

Derivative instruments loss(B)

     1,743              

Management fees and expenses(C)

     6,165       4,903       5,167  

Equity-based compensation expense

     3,526       3,628       8,218  

Acquisition, disposition and financing expenses(D)

     94,477       136,671       45,114  

Business optimization expenses(E)

     34,075       37,530       18,092  

Other(F)

     7,018       7,088       22,441  
  

 

 

 

Adjusted EBITDA from continuing operations

   $ 488,638     $ 427,021     $ 441,019  

 

 

 

(A)   Represents foreign currency gains and losses related to the revaluation of our Euro denominated Term B indebtedness as well as other transactions denominated in foreign currency.

 

(B)   Represents the revaluation of derivative instruments used to manage our interest rate and foreign currency risk.

 

(C)   Represents management fees and expenses paid under service agreements with our Sponsors and their affiliates.

 

(D)   Represents labor, travel, training, consulting and other costs associated with acquisition, disposition and financing activities, such as the acquisition of Systagenix, technology acquisitions, the repricing of our senior secured credit facilities and the refinancing of certain long-term debt. Financing expenses included $64.3 million and $127.2 million reported as loss on extinguishment of debt for the years ended December 31, 2016 and 2017, respectively, and $28.9 million reported within selling, general and administrative expenses for the year ended December 31, 2016 on the consolidated statements of operations.

 

(E)   Represents labor, travel, training, consulting and other costs associated exclusively with our business optimization initiatives.

 

(F)   Represents charges for litigation settlement, other non-cash charges and other unusual or nonrecurring charges or expenses.

 

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Risk factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below and the other information set forth in this prospectus before deciding to invest in shares of our common stock. If any of the following risks actually occurs, our business, financial condition and results of operations may be materially adversely affected. In such case, the trading price of our common stock could decline and you may lose all or part of your investment.

Risks related to our business

We face significant and continuing competition, which could adversely affect our operating results.

We face significant and continuing competition in our business, which is 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, economic outcomes, price and services provided by the manufacturer. Our ability to compete depends in large part on our ability to provide compelling economic benefits to our customers and payers, develop and commercialize new products and technologies and anticipate technological advances. We have historically maintained price premiums for our NPWT and specialty surgical products over competitive products. Our competitors often compete based on price, requiring us to continue to support our premiums by demonstrating the clinical advantages, as well as better economic outcomes, of our products. Product introductions or enhancements by competitors which may 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, deliver cost-effective clinical outcomes, expand our geographic reach, enhance our existing products and develop new products for the advanced wound care and specialty surgical markets.

We have experienced continuing pricing pressures from competitors and the challenges of declining reimbursement rates. Consolidation trends in the healthcare industry may also introduce new competitors or provide existing competitors with an enhanced ability to compete against our products. We may also face increased competition from companies re-entering our markets after temporary withdrawal due to regulatory, business or other reasons. We expect competition to remain intense as competitors introduce additional competing products in the advanced wound care and specialty surgical 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 or reduced pricing for our products and have a material adverse effect on our sales and profitability.

Defects, failures or quality issues associated with our products could lead to product recalls or safety alerts, adverse regulatory actions, litigation, including product liability claims brought with or without merit, and negative publicity that could erode our competitive advantage and market share and materially adversely affect our reputation, business, financial condition and results of operations.

Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Quality and safety issues may occur with respect to any of our products, and 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. The development, manufacturing and control of our products is subject to extensive and rigorous regulation by numerous government agencies, including the U.S. Food and Drug Administration, or the FDA, and similar foreign agencies. Compliance with these regulatory requirements, such as the FDA’s Quality System Regulation, or QSR, and adverse events/recall reporting requirements in the United States and other applicable regulations worldwide, is subject to continual review

 

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and is monitored rigorously through periodic inspections by the FDA and foreign regulatory authorities. We are required to report to the FDA when we receive or become aware of information that reasonably suggests that one or more of our products may have caused or contributed to a death or serious injury or malfunctioned in a way that, if the malfunction were to recur, could cause or contribute to a death or serious injury. The timing of our obligation to report is triggered by the date we become aware of the adverse event as well as the nature of the event. We may fail to report adverse events of which we become aware within the prescribed timeframe. We may also fail to recognize that we have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or removed in time from the use of the product. If we fail to comply with our reporting obligations, the FDA could take action, including issuance of warning letters and/or untitled letters, administrative actions, criminal prosecution, imposition of civil monetary penalties, revocation of our device clearance, seizure of our products or delay in clearance of future products.

The FDA and foreign regulatory authorities may also require post-market testing and surveillance to monitor the performance of approved products. Our manufacturing facilities and those of our suppliers and distributors are also subject to periodic regulatory inspections by the FDA, our European Notified Body and other regulatory entities. Our facilities and operations are designed to comply with all applicable international quality systems standards, including the International Organization for Standardization, or ISO, 13485. In order to receive permission to affix the CE mark to our products, we must obtain quality system certification, such as ISO 13485, and must otherwise have a quality management system that complies with the EU Medical Device Directive and new Medical Device Regulation due to take effect in 2020. These standards and regulations require, among other items, quality system controls that are applied to product design, component material, suppliers and manufacturing operations. These regulatory approvals and ISO certifications can be obtained only after a successful audit of a company’s quality system has been conducted by independent outside auditors. Periodic reexamination by an independent outside auditor is required to maintain these certifications. The Medical Device Single Audit Program, or MDSAP, is a program that allows the conduct of a single regulatory audit of a medical device manufacturer’s quality management system that satisfies the requirements of multiple regulatory jurisdictions (such as Australia, Brazil, Canada, Japan and the United States). In addition, under the MDSAP, our business was required by Health Canada to have a quality management system which complies with the requirements of the latest version of ISO 13485 (2016) and certified by a MDSAP audit organization or notified body by January 2019 to fulfill requirements for continued marketing and distribution of product in Canada. We have received certification for ISO 13485:2016, however, given the workload for notified bodies in connection with MDSAP compliance, Canada has provided a grace period for those who had applied for the MDSAP audit by the January 2019 deadline but not yet been audited. We timely submitted our audit application and qualify for such grace period, and the audits are scheduled to occur during 2019. If the FDA or a foreign authority were to find that we have failed to comply with any of these quality system 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, withdrawals, monetary penalties, consent decrees, injunctive actions to halt the manufacture or distribution of products, import detentions of products made outside the United States, restrictions on operations or other civil or criminal sanctions. Civil or criminal sanctions 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.

The FDA and foreign regulatory bodies have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture of a product or in the event that a product poses an unacceptable risk to health. The FDA’s authority to require a recall must be based on a finding that there is reasonable probability that the device could cause serious injury or death. We may also choose to voluntarily recall a product if any material deficiency is found or to remove or correct a product that violates FDA laws and regulations. A government-mandated or voluntary recall by us could occur as a result of an

 

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unacceptable risk to health, component failures, malfunctions, manufacturing defects, labeling or design deficiencies, packaging defects or other deficiencies or failures to comply with applicable regulations. Product defects or other errors may occur in the future.

Companies are required to maintain certain records of recalls and corrections, even if they are not reportable to the FDA. We may initiate voluntary withdrawals or corrections for our products in the future that we determine do not require notification of the FDA. If the FDA disagrees with our determinations, it could require us to report those actions as recalls and we may be subject to enforcement action. A future recall announcement could harm our reputation with customers, potentially lead to product liability claims against us and negatively affect our sales.

Our business also exposes us to product liability risks inherent in the testing, manufacturing, marketing and use of medical products. Regardless of merit, 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. Legal proceedings are inherently unpredictable, and any product liability claim brought against us, with or without merit, could divert management’s attention, could be costly to defend and could result in excessive verdicts and/or injunctive relief that may affect how we operate our business or 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 inability to maintain adequate insurance coverage could increase operating expenses and could materially adversely affect our business, financial position and results of operations.

In addition, we cannot predict the results of future legislative activity or future court decisions, any of which could increase regulatory investigations or our exposure to litigation. Any regulatory action or litigation, regardless of the merits, may result in substantial costs, divert management’s attention from other business concerns and place additional restrictions on our sales or the use of our products. In addition, negative publicity, including regarding a quality or safety issue, could damage our reputation, reduce market acceptance of our products, cause us to lose customers and decrease demand for our products. Any actual or perceived quality issues may also result in issuances of physician’s advisories against our products or cause us to conduct voluntary recalls. Any product defects or problems, regulatory action, litigation, negative publicity or recalls could disrupt our business and have a material adverse effect on our competitive position, financial condition and results of operations.

Our business is subject to extensive and continuing regulatory compliance obligations. If we fail to obtain and maintain necessary FDA clearances or international regulatory approvals or qualifications for our products and indications, if clearances for future products and indications are delayed or not issued, if we or any of our third-party suppliers or manufacturers fail to comply with applicable regulatory requirements, or if there are regulatory changes, our commercial operations could be harmed.

Our products are medical devices subject to extensive regulation by the applicable regulatory authorities where our products are or will be sold prior to their marketing for commercial use.

United States

In the United States, our products are subject to extensive regulation by the FDA for development, testing, manufacturing, labeling, sale, marketing, advertising, promotion, distribution, import, export, shipping, establishment registration and device listing, record keeping, recalls and field safety corrective actions and post-market surveillance, including reporting of deaths or serious injuries and malfunctions that, if they were to recur, could lead to death or serious injury.

 

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Before a new medical device, or a new use of, or claim for, an existing product can be marketed in the United States, it must first receive either 510(k) clearance or premarket approval from the FDA, unless an exemption applies. Either process can be expensive and lengthy. In the 510(k) clearance process, before a device may be marketed, the FDA must determine that a proposed device is “substantially equivalent” to a legally-marketed “predicate” device, which includes a device that has been previously cleared through the 510(k) process, a device that was legally marketed prior to May 28, 1976, or pre-amendments device, a device that was originally on the U.S. market pursuant to an approved premarket approval application, or a PMA, and later down-classified, or a 510(k)-exempt device. To be “substantially equivalent,” the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data are sometimes required to support substantial equivalence. The FDA’s 510(k) clearance process usually takes from three to 12 months, but it can last longer. The process of obtaining premarket approval is much more costly and uncertain than the 510(k) clearance process and it generally takes from one to three years, or even longer, from the time the application is filed with the FDA. Our future products and enhancements or changes to such products may require marketing clearance or approval from the FDA. All products that we currently market in the United States have received 510(k) clearance for the uses for which they are marketed or are exempt from 510(k) clearance process.

Medical devices may be marketed only for the indications for which they are approved or cleared. We have obtained 510(k) clearance for the current treatments for which we offer our products, unless an exemption applies. However, our clearances can be revoked under certain circumstances. Changes or modifications to an FDA-cleared device that would affect its safety or effectiveness or that would constitute a major change or modification in its intended use may require a new 510(k) clearance or possibly premarket approval. We may not be able to obtain additional 510(k) clearances or premarket approvals for new products or for modifications to, or additional indications for, our existing products in a timely fashion, or at all. Delays in obtaining future clearances would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our revenue and future profitability. We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. If the FDA disagrees, and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the modified products.

In addition, the FDA may change its clearance and approval policies, adopt additional regulations or revise existing regulations, or take other actions which may prevent or delay approval or clearance of our future products under development. For example, in November 2018, FDA officials announced forthcoming steps that the FDA intends to take to modernize the premarket notification pathway under Section 510(k) of the Federal Food, Drug, and Cosmetic Act, or the FDCA. Among other things, the FDA announced that it plans to develop proposals to drive manufacturers using the 510(k) pathway toward the use of newer predicates. These proposals include plans to potentially sunset certain older devices that were used as predicates under the 510(k) clearance pathway, and to potentially publish a list of devices that have been cleared on the basis of demonstrated substantial equivalence to predicate devices that are more than 10 years old. The FDA has also published and has announced plans to continue to publish guidance to establish a premarket review “Safety and Performance” pathway for “manufacturers of certain well-understood device types” as an alternative to the 510(k) clearance pathway and that such premarket review pathway would allow manufacturers to rely on objective safety and performance criteria recognized by the FDA to demonstrate substantial equivalence, obviating the need for manufacturers to compare the safety and performance of their medical devices to specific predicate devices in the clearance process. These proposals have not yet been finalized or adopted, and the FDA announced that it would seek public feedback prior to publication of any such proposals, and may work with the U.S. Congress to implement such proposals through legislation. Accordingly, it is unclear the extent to which any proposals, if adopted, could impose additional regulatory requirements on us that could delay our

 

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ability to obtain new 510(k) clearances, increase the costs of compliance or restrict our ability to maintain our current clearances, or otherwise create competition that may negatively affect our business.

It is possible that if regulatory clearances or approvals to market a product are obtained from the FDA, the clearances or approvals may contain limitations on the indicated uses of such product and other uses may be prohibited. Product clearances or approvals by the FDA can also be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial clearance or approval. Furthermore, the FDA could limit or prevent the distribution of our products and the FDA has the power to require the recall of such products. FDA regulations depend heavily on administrative interpretation, and there can be no assurance that future interpretations made by the FDA or other regulatory bodies will not adversely affect our operations. We, and our facilities, may be inspected by the FDA from time to time to determine whether operations are in compliance with existing clearances and approvals along with applicable Current Good Manufacturing Practice regulations, including those relating to specifications, development, documentation, validation, testing, quality control, labeling and product distribution controls.

International

Sales of our products outside the United States are subject to foreign regulatory requirements that vary widely from country to country, including some regulatory requirements that we may not be fully aware, or that may change in ways that affect our ability to sell our products in those jurisdictions. Complying with international regulatory requirements can be an expensive and time-consuming process and approval is not certain. The regulatory process in foreign jurisdictions includes all the risks associated with obtaining FDA clearance, as well as additional risks not present in the FDA process. For example, the time required to obtain foreign clearance or approvals may be longer than that required for FDA clearance or approvals, and requirements for such clearances or approvals may significantly differ from FDA requirements, adding costs and variability, and foreign regulatory authorities may not approve our product for the same uses cleared by the FDA.

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, or the EC, 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 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. In April 2017 in the European Union, a new Medical Device Regulation was adopted to replace the existing Medical Device Directive. The Medical Device Regulation will apply after a three-year transition period and imposes stricter requirements for the marketing and sale of medical devices and grants Notified Bodies increased post-market surveillance authority. The Medical Device Regulation requires new certification by a Notified Body designated for the Medical Device Regulation. Individual nations may also impose unique requirements that may require supplemental submissions.

In the fourth quarter of 2017, our then-current European Notified Body, AMTAC Certification Services Limited, or AMTAC, notified us that certification codes covering our NPWT and specialty surgical product lines, would no longer be supported by AMTAC’s designation as a Notified Body as of January 5, 2018. Although we were in the process of transitioning to a new Notified Body, BSi, at the time that we received the AMTAC notification, our

 

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transition process could not be accelerated to meet the AMTAC withdrawal timeline. As such, we received an extension from our then-governing Competent Authority, the Medicines and Healthcare products Regulatory Agency, or MHRA, to allow CE marked products previously certified by AMTAC to remain on the market after January 5, 2018 until our transition to the new Notified Body is complete. We have currently received certification from BSi for all of our products marketed in the European Union, with the exception of our PREVENA line of products. For our PREVENA product line, we have operated, and intend to continue to operate, with CE marks certified by AMTAC under the MHRA extension agreement until our Notified Body transition is complete, which transition is pending and expected to be completed in 2019.

A company’s governing Competent Authority is set on a product line basis and as such, a company can have multiple governing Competent Authorities but only one per product line. The establishment of an Authorized Representative by product is required for each product line, and the location of that Authorized Representative dictates the assignment of Competent Authority. In preparation for the United Kingdom’s intended withdrawal from the European Union, or Brexit, we began a process to migrate our Authorized Representative from the United Kingdom to Ireland for all BSi CE marked products. This excluded our PREVENA line of products. With this change in the Authorized Representative, our governing Competent Authority changed from MHRA to Health Products Regulatory Authority, or HPRA, for all CE marked products, except our PREVENA line of products, for which we retained our Authorized Representative in the United Kingdom and as such, our Competent Authority designation. However, we are in discussions with MHRA as to whether it remains the Competent Authority for our PREVENA line of products. If MHRA were to modify or terminate the extension agreement, or if HPRA were determined to be the Competent Authority for our PREVENA line of products due to the change in Authorized Representative for other products and we were unable to obtain a similar extension agreement from HPRA, we may be unable to market our PREVENA line of products in the European Union until our transition to BSi is complete.

We are also required to update the labeling on our products to reflect the change in our Notified Body and our Authorized Representative. Such a transition in labeling is a costly, complex, and time-consuming process. We may not be able to continue to sell our products in some European markets until we have fully transitioned our labeling to reflect the new Notified Body. The new Notified Body allows a labeling transition of two years; however, certain European countries may not accept such transition timeline.

We may be unable to obtain or maintain regulatory qualifications, certifications, clearances or approvals in the countries outside the United States as we expand our product offerings globally, make changes to meet our business or operational needs, and/or respond to changes in foreign regulatory requirements and tax laws, including any such changes resulting from Brexit. We also may incur significant costs in attempting to obtain and in maintaining foreign regulatory approvals or qualifications. If we experience delays in receiving necessary qualifications, certifications, clearances or approvals to market our products outside the United States, or if we fail to receive those qualifications, certifications, clearances or approvals, we may be unable to market some of our products or enhancements in certain international markets effectively, or at all.

The FDA or applicable foreign regulatory authority can delay, limit or deny clearance or approval of a device for many reasons, including but not limited to:

 

 

our inability to demonstrate to the satisfaction of the FDA or the applicable regulatory entity or notified body that our products are safe or effective for their intended uses;

 

 

the disagreement of the FDA or the applicable foreign regulatory body with the design or implementation of our clinical trials or the interpretation of data from pre-clinical studies or clinical trials;

 

 

serious and unexpected adverse device effects experienced by participants in our clinical trials;

 

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the data from our pre-clinical studies and clinical trials may be insufficient to support clearance or approval, where required;

 

 

our inability to demonstrate that the clinical and other benefits of the device outweigh the risks;

 

 

the manufacturing process or facilities we use may not meet applicable requirements; or

 

 

the potential for approval or clearance policies, regulations or laws of the FDA or applicable foreign regulatory bodies to change significantly in a manner rendering our clinical data or regulatory filings insufficient for clearance or approval.

In addition, our failure to comply with applicable regulatory requirements could result in enforcement action by the FDA, state or foreign regulatory authorities, which may include any of the following sanctions:

 

 

warning letters or untitled letters, fines, injunctions, consent decrees and civil penalties;

 

 

repair, replacement, refunds, recalls, termination of distribution, administrative detention or seizure of our products;

 

 

operating restrictions or partial suspension or total shutdown of production;

 

 

refusing our requests for 510(k) clearance or premarket approval of new products, new intended uses, or modifications to existing products;

 

 

withdrawing 510(k) clearances or premarket approvals or foreign regulatory approvals that have already been granted, resulting in prohibitions on sales of our products; and

 

 

criminal prosecution.

The occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.

The misuse or off-label use of our products may harm our reputation in the marketplace, result in injuries that lead to product liability suits or result in costly investigations, fines or sanctions by regulatory bodies if we are deemed to have engaged in the promotion of these uses, any of which could be costly to our business.

The misuse or off-label use of our products may harm our reputation or the image of our products in the marketplace, result in injuries that lead to product liability suits, which could be costly to our business, or result in legal sanctions if we are deemed or alleged to have engaged in off-label promotion. Our promotion of our products must only use labeling, including advertising and promotional materials, that is consistent with the specific indication(s) for use included in the FDA clearance. The FDCA and the FDA’s regulations restrict the types of promotional communications that may be made about our products and if the FDA or other authorities determine that our promotional or training materials constitute the unlawful promotion of an off-label use, they could request that we modify our training or promotional materials and/or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, civil money penalties, seizure, injunction or criminal fines and penalties. Other federal, state or foreign governmental authorities might also take action if they consider our promotion or training materials to constitute promotion of an uncleared or unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement, or exclusion from participation in federal health programs. In that event, our reputation could be damaged, the use of our products in the marketplace could be impaired, and our business, results of operation and financial condition could be materially adversely affected.

In addition, there may be increased risk of injury if physicians or others attempt to use our products off-label. The FDA does not restrict or regulate a physician’s use of a medical product within the practice of medicine, and

 

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we cannot prevent a physician from using our products for an off-label use. The use of our product for indications other than those for which our products have been approved or cleared by the FDA may not effectively treat the conditions not referenced in product indications, which could harm our reputation in the marketplace among physicians and patients. Physicians may also misuse our products or use improper techniques if they are not adequately trained in the particular use, potentially leading to injury and an increased risk of product liability. Any of these events could harm our business, results of operations and financial condition.

Failure of any of our clinical studies or third-party assessments to demonstrate desired outcomes in proposed endpoints may result in adverse regulatory actions, reduce physician usage or reduce price, coverage and/or reimbursement for our products, which could have a negative impact on our 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 a clinical study conducted by us or others fails to demonstrate statistically significant results supporting performance, use benefits or compelling health economic outcomes from using 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 adverse events are reported during the conduct of a study, it could affect continuation of the study, product approval or clearance and product adoption. In addition, U.S. and foreign regulatory authorities routinely conduct audits of clinical studies and such audits may result in adverse regulatory actions. 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.

Pricing pressure as a result of cost-containment efforts of our customers, purchasing groups, distributors, third-party payers 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 IDNs, including accountable care organizations or public-based purchasing 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. 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 hospital sales and rentals in the United States 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 bidding process and the GPO and IDN contracting processes in the United States, we may not be able to obtain or maintain contract positions with major GPOs and IDNs across our product portfolio. In addition, while having a contract with a major purchaser for a given product category can facilitate sales, sales volumes of those products may not 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. The healthcare industry has been consolidating, and the consolidation among third-party payers into larger purchasing groups will increase their negotiating and purchasing power. Such consolidation may result in greater pricing pressure on us due to pricing concessions and may further

 

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exacerbate the risks described above. Failure to be included in contracts with these larger purchasing groups could have a material adverse effect on our business, financial condition and results of operations, including on sales and rental revenues.

In addition, many of our customers purchase our products directly and then bill third-party payers for their use of those products or for procedures using those products. Because there is often no separate reimbursement for supplies used in surgical procedures, the additional cost associated with the use of our products can affect the profit margin of the hospital or surgery center where the procedure is performed. Some of our target customers may be unwilling to adopt our products in light of the additional associated cost or may negotiate for lower pricing. Further, any decline in the amount payers are willing to reimburse our customers could make it difficult for existing customers to continue using or to adopt our products and could create additional pricing pressure for us. If we are forced to lower the price we charge for our products, our gross margins will decrease, which could have a material adverse effect on our business, financial condition and results of operations and impair our ability to grow our business.

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 outside the United States. Our failure to offer acceptable prices to these customers could adversely affect our sales and profitability in these markets.

Distributors of our products also have begun to negotiate terms of sale more aggressively to maintain or 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 materially adversely affect our business, financial condition and results of operations.

If we are unable to obtain and maintain adequate levels of coverage and reimbursement for our current or future products or the procedures using our products, or if changes in U.S. and international regulations, policies, rules and expanded audit programs of third-party payers reduce reimbursement and collections for our products, our commercial success may be severely hindered.

Successful sales of our products depend on the availability of coverage and adequate reimbursement from governmental and commercial third-party payers. Patients who are provided medical treatment for their conditions generally rely on third-party payers to reimburse all or part of the costs associated with their treatment. Adequate coverage and reimbursement from governmental healthcare programs, such as Medicare and Medicaid in the United States, and commercial payers are critical to product acceptance. In the United States, no uniform policy of coverage and reimbursement for our products or procedures using our products exists among third-party payers. As a result, obtaining coverage and reimbursement approval of our products or procedures using our products from a government or other third-party payer is a time-consuming and costly process that could require us to provide to each payer supporting scientific, clinical and cost-effectiveness data for the use of our products on a payer-by-payer basis, with no assurance that coverage and adequate reimbursement will be obtained. In addition, the determinations by a third-party payer whether to cover our products or procedures using our products and the amount it will reimburse for them are often made on an indication-by-indication basis. If commercial payers and government payers do not provide coverage of, or do not provide adequate reimbursement for, a substantial portion of the price of our products and the procedures using our products, providers may not order our products or perform the procedures using our products.

 

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In the U.S. home care market, we frequently bill third-party payers for our NPWT products. Each third-party payer makes its own decision as to whether to establish a policy to cover our products or enter into a contract with us and set the amount that it will reimburse for a product. Those negotiations are time-consuming and costly, and may not result in adequate coverage or reimbursement. In cases where there is no coverage policy or we do not have a contracted rate for reimbursement as a participating provider, the patient is typically responsible for all of or a greater share of the cost of the product, which may result in further delay of our revenue, increase our collection costs or decrease the likelihood of collection. Our claims for reimbursement from third-party payers may be denied upon submission, and we may need to take additional steps to receive payment, such as appealing the denials. Such appeals and other processes are time-consuming and expensive, and may not result in payment.

In the U.S. home care market, our NPWT products are eligible for Medicare Part B reimbursement, subject to Medicare rules and regulations. We participate in Medicare’s durable medical equipment competitive bidding program, which resulted in substantial reimbursement declines beginning in 2013. From time to time, CMS periodically initiates payment schedule changes and bidding programs that affect the home care NPWT portion of our business. The revenue from Medicare placements of durable NPWT products for many jurisdictions is set to a single unique payment amount under Medicare’s durable medical equipment competitive bidding program. This program may also result in loss of market access in some or all bidding areas. The next round of this program is anticipated to impact reimbursement rates and contracts as of January 1, 2021. See “Business—Healthcare initiatives and reimbursement.” During the years ended December 31, 2018 and 2017, we recorded revenue related to Medicare claims of approximately $81.5 million, or 5.6%, and $76.8 million, or 5.8%, of our total revenue, respectively.

The demand for our products is partly dependent on the regulations, policies and rules of third-party payers in the United States and internationally that reimburse us for the sale and rental of our products. If coverage or payment regulations, policies or rules of 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 providing our products could increase. Legislative, administrative or judicial reforms to the reimbursement systems in the United States and abroad, or adverse decisions by administrators or courts of any of these systems in coverage or reimbursement relating to our products, could reduce reimbursement for our products or result in the denial of coverage for those products. Examples of these reforms or adverse decisions include price regulation, competitive bidding, changes to coverage and payment policies, assessments or studies. Any of such reforms or adverse decisions resulting in restrictive reimbursement practices or denials of coverage could have an adverse impact on the acceptance of our products and the prices that our customers are willing to pay for them. The U.S. federal government continues to show significant interest in pursuing health care reform and reducing health care costs. On August 2, 2011, the Budget Control Act of 2011 was signed into law, which, among other things, reduced Medicare payments to providers by 2% per fiscal year, effective on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2027 unless additional Congressional action is taken. Similarly, commercial third-party payers may seek to reduce costs by limiting coverage or reducing reimbursement for our products. Any government-adopted reform measures or changes to commercial third-party payer coverage and reimbursement policies could cause significant pressure on the pricing of, and reimbursement for, health care products and services, including our products, which could decrease demand for our products, and adversely affect our sales and revenue. Reimbursement varies by country and 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.

Where we bill third-party payers, our documentation, billing and other practices are subject to scrutiny by government regulators, contractors and private payers and are subject to claims audits and reviews. We maintain the Centers for Medicare and Medicaid Services, or CMS, deemed accreditation in the United States

 

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through the Accreditation Commission for Health Care, or the ACHC. In addition to tri-annual ACHC reaccreditation survey visits, our U.S. Service Centers are also subject to numerous unannounced inspections, including by federal and state payers and state agency licensing inspections. To ensure compliance with U.S. reimbursement regulations, the Medicare regional contractors and other entities contracted by federal and state governments 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 refunds or recoupments of amounts previously paid to us. Similarly, if we retain an overpayment by a federal healthcare program, we could become subject to fines, penalties and liability under the False Claims Act. Third-party payers may perform audits of historically paid claims and attempt to recoup funds years after the funds were initially distributed if the third-party payers believe the funds were paid in error or determine that our products were medically unnecessary. If a third-party payer audits our claims and issues a negative audit finding, and we are not able to overturn the audit findings through appeal, the recoupment may result in a material adverse effect on our revenue. Additionally, in some cases commercial third-party payers for whom we are not a participating provider may elect at any time to review claims previously paid and determine the amount they paid was too much. In these situations, the third-party payer will typically notify us of their decision and then offset whatever amount they determine they overpaid against amounts they owe us on current claims. We cannot predict when, or how often, a third-party payer might engage in these reviews.

If we are unable to develop and obtain regulatory clearance or approval for new generations of products and enhancements to existing products and service offerings, our competitive position may be harmed.

Our ability to grow and compete effectively depends on the successful development, clearance or approval, introduction and commercialization of new generations of products and enhancements to existing products and services. The development of new or enhanced products is a complex, costly and uncertain process and requires us to anticipate customers’ and patients’ needs and emerging technology trends accurately and in a timely manner. We may experience research and development, technical and manufacturing, regulatory, marketing, distribution and other difficulties that could delay or prevent our introduction of new or enhanced products. The expansion of our services may also expose us to these and new risks.

The development of new or enhanced products and services may involve significantly higher development and compliance costs than anticipated. Additionally, we may not be able to obtain required clearance, approval and/or marketing authorization from the U.S. authorities, including the FDA, and foreign regulatory authorities for new products or modifications to existing products on a timely basis, or at all. The process of obtaining regulatory clearance, approval and/or marketing authorization from the FDA and comparable foreign bodies for new products, or for enhancements or modifications to existing products and services, 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, require further modifications, repairs or replacements and result in limitations on the indicated uses of our products. We may not be able to demonstrate the safety and efficacy of the new or enhanced products in clinical trials or obtain reimbursement approvals for our products and services. Our failure to obtain or maintain clearances or approvals for new or modified products or services or any substantial delay in obtaining such required approvals or clearances or any substantial increase in applicable regulatory or administrative requirements could materially delay our development and commercialization of new products and/or services and enhancements to existing products and/or services. In addition, the new or enhanced products or services may not be manufactured or provided at acceptable cost and with appropriate quality. New products or services may also expose us to, or increase our exposure to, a variety of regulations in the various countries we

 

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provide services and solutions, including regulations related to government payments, fraud and abuse, patient privacy, and the corporate practice of medicine. Compliance with these regulations may prove to be more costly than we anticipate, and we may not successfully comply with such regulations. We may not be able to market or distribute the products or services successfully and the new or enhanced products or services may fail to gain customer acceptance and may result in increased collection risks with third-party payers. If any of the foregoing events occurs, we may have to abandon a product or an enhancement in which we have invested substantial resources. 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 and services in a timely manner could have a material adverse effect on our competitive position, business, financial condition and results of operations.

The implementation of healthcare reform in the United States may adversely affect our business and financial results.

As part of the enactment of the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, or the PPACA, in 2013, we began paying an excise tax of 2.3% on our sales in the United States of certain medical devices we manufacture, produce or import. The Consolidated Appropriations Act of 2016 suspended the 2.3% excise tax on medical devices beginning on January 1, 2016 and on January 22, 2018, such suspension was extended to December 31, 2019, and will resume in 2020 absent further congressional action. The PPACA also authorized 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 increased fraud and abuse penalties and expanded the scope and reach of the False Claims Act and government enforcement tools, which may adversely impact healthcare companies. Recently, the current U.S. Administration and U.S. Congress have sought, and may seek in the future, to modify, repeal or otherwise invalidate all or a part of the PPACA and it remains unclear what new framework may emerge as a result of such efforts. In this regard, several legislative initiatives to repeal and replace the PPACA were proposed, but not adopted, in 2017, 2018 and 2019. However, the recently adopted The Tax Cuts and Jobs Act, or TCJA, eliminated the individual mandate under the PPACA, which has resulted in increased uncertainty regarding insurance premium prices for participants in insurance exchanges under the act, and may have other effects. For example, on December 14, 2018, a Texas U.S. District Court Judge ruled that the PPACA is unconstitutional in its entirety because the TCJA repealed the individual mandate. While the Texas District Court Judge, as well as the Trump Administration and CMS, have stated that the ruling will have no immediate effect pending appeal of the decision, it is unclear how this decision, subsequent appeals, and other efforts to repeal and replace the PPACA will impact the PPACA and our business.

The longer-term viability of, or the nature of any modification of, or legislative substitution for, the PPACA is highly uncertain. The current law or any future legislation could reduce medical procedure volumes, lower reimbursement for our products and impact the demand for our products or reduce the prices at which we sell our products. We cannot predict with any certainty what other impact implementation of the current or new legislation may have on our business. While the PPACA 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. We anticipate there will continue to be proposals by legislators at both the federal and state levels, regulators and commercial third-party payers to reduce costs while expanding individual healthcare benefits. Certain of these changes could impose additional limitations on the prices we will be able to charge for our products, the coverage of or the amounts of reimbursement available for our products from third-party payers, including government and commercial payers.

 

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If we are unsuccessful in protecting, maintaining and enforcing our intellectual property, our competitive position could be harmed.

We rely on a combination of patents, trademarks, trade secrets and contractual provisions to protect our intellectual property. Patents and our other intellectual property rights are important to our business and our ability to compete effectively with other companies. We seek to protect these, in part, through confidentiality agreements with employees, consultants, and other third parties. In general, our practice is to seek patent protection in both the United States and key foreign countries for patentable subject matter in our products and proprietary devices, 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 U.S. and foreign patents and have numerous U.S. and foreign patent applications pending. We are also a party to various license agreements pursuant to which third parties have granted certain patent rights to us in consideration for lump sum and/or royalty payments. It may be necessary in the future to seek or renew licenses relating to various aspects of our products or services.

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; that patents issued or licensed to us in the past or in the future will not be challenged or circumvented by competitors or others; that these patents will remain valid and enforceable or will be sufficient to preclude our competitors or others from introducing technologies similar to those covered by our patents and patent applications; that our competitors will not independently develop products or services that are equivalent or superior to ours; or that competitors will not otherwise gain access to or circumvent our trade secrets or other confidential information. 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 a market position in such countries by utilizing technologies that are similar to those developed or owned by or licensed to us. Moreover, we cannot guarantee we will successfully enjoin infringers. Competitors also may harm our sales by designing products that mirror the capabilities of our products or technology without infringing or otherwise violating our intellectual property rights. Confidentiality or other agreements to which we are a party may be breached, and the remedies thereunder may not be sufficient to protect our rights. We periodically receive notices alleging that our products or services infringe on third-party patents and other intellectual property rights. These claims may result in us entering settlement agreements, paying damages, discontinuing use or sale of accused products or ceasing other activities.

If we do not obtain and maintain 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 business, financial condition and results of operations.

Pending and future intellectual property litigation could be costly and disruptive and may have an adverse effect on our business, financial condition and results of operations.

We operate in an industry characterized by extensive 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, including regarding the validity or enforceability of such patents. At other times, we are party to litigation initiated by others who contend we infringe their patents. Defending intellectual property litigation is expensive and complex, takes significant time and diverts management’s attention from other business concerns, and the outcomes are difficult to predict. Any pending or future intellectual property litigation may result in significant damage awards, including treble damages

 

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under certain circumstances, and injunctions that could prevent the manufacture and sale of affected products or could force us to seek a license and/or make significant royalty or other payments in order to continue selling the affected products. As a healthcare supplier, we can expect to face additional claims of intellectual property infringement in the future. A successful claim of patent, trademark or other intellectual property infringement or misappropriation against us could materially adversely affect our business, financial condition and results of operations. In addition, we may find it necessary to initiate litigation to protect our trade secrets, to enforce our patent, copyright and trademark rights and to determine the scope and validity of the property rights of others. These types of litigation can be costly and time consuming. 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.

We may not successfully identify and complete acquisitions or divestitures on favorable terms or achieve anticipated synergies relating to any such transaction, and such transactions could result in unforeseen operating difficulties, regulatory issues 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. In regularly evaluating the performance of our business, we may also decide to sell a portion of our business, including a product line. We may be unable to find suitable acquisition candidates or identify divestiture opportunities. Even if we identify appropriate acquisition candidates or divestiture opportunities, we may be unable to complete the acquisitions or the divestitures on favorable terms, if at all. Future acquisitions may increase our debt or reduce our cash available for operations or other uses, and any divestitures may result in significant charge-offs or write-downs, including those related to goodwill and other intangible assets. 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. We may face additional risks related to unknown or contingent liabilities related to business practices of the acquired companies, including liabilities relating to, or arising out of, any actual or alleged violations or non-compliance of any applicable laws, regulations and rules by such acquired companies, environmental remediation expense, products liability, patent infringement claims or other unknown liabilities. In addition, we cannot be certain that the businesses we acquire will become profitable or remain so. Our future acquisitions may also lead to increased scrutiny and review of our company by governmental and other regulatory authorities. 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. If an acquired business fails to operate as anticipated or cannot be successfully integrated with our existing business, our business, financial condition and results of operations could be materially adversely affected. The process of divesting ourselves of a portion of our business could result in unforeseen expenditures and risks, including dissynergies in shared functions, as well as complexities in separating operations, services, products and personnel. Future divestitures may result in potential loss of key employees and disruption of our business. Any acquisitions or divestitures often require significant expenditures as well as significant management resources that cannot then be dedicated to other projects. Moreover, we may not realize the anticipated financial or other benefits of an acquisition or a divestiture, including our ability to achieve cost savings or revenue synergies.

Our failure to comply with false claims, anti-kickback, self-referral and program integrity laws may subject us to penalties and adversely affect our reputation, business, financial condition and results of operations.

Participation in state, federal and foreign healthcare programs requires us to comply with laws, regulations and guidelines regarding the way in which we conduct business, interact with physicians and submit claims. Our arrangements with healthcare providers, third-party payers and customers may expose us to broadly applicable

 

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fraud and abuse and other healthcare laws and regulations that affect the business and financial arrangements and relationships through which we market and sell our products. The laws that affect our ability to operate include, but are not limited to:

 

 

the federal Anti-Kickback Statute, which prohibits, among other things, any person or entity from knowingly and willfully soliciting, receiving, offering or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, to induce or reward either the referral of an individual for, or the purchase, order or recommendation of an item or service reimbursable, in whole or in part, under a federal healthcare program, such as the Medicare and Medicaid programs. The term “remuneration” has been broadly interpreted to include anything of value. There are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution: however these are drawn narrowly. Additionally, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. Violations are subject to civil and criminal fines and penalties up to $100,000 for each violation, plus up to three times the remuneration involved, imprisonment of up to ten years, and exclusion from government healthcare programs. In addition, the PPACA codified case law that a claim including items or services resulting from a violation of the Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the False Claims Act;

 

 

the Stark Law, which prohibits a physician from making a referral for certain designated health services covered by the Medicare or Medicaid program, including Durable Medical Equipment Prosthetics Orthotics and Supplies, if the physician or an immediate family member of the physician has a financial relationship with the entity providing the designated health services and prohibits that entity from billing, presenting or causing to be presented a claim for the designated health services furnished pursuant to the prohibited referral, unless an exception applies. Penalties for violating the Stark Law include denial of payment, civil monetary penalties and exclusion from the federal health care programs. Failure to refund amounts received as a result of a prohibited referral on a timely basis may constitute a false or fraudulent claim and may result in civil penalties and additional penalties under the False Claims Act;

 

 

federal civil and criminal false claims laws and civil monetary penalty laws, such as the False Claims Act, which can be enforced by private citizens through civil qui tam actions, prohibits individuals or entities from, among other things, knowingly presenting, or causing to be presented through distribution of template medical necessity language or other coverage and reimbursement information, false, fictitious or fraudulent claims for payment or approval by the federal government, including federal health care programs, such as Medicare and Medicaid, and knowingly making, using or causing to be made or used a false record or statement material to a false or fraudulent claim, or knowingly making a false statement to improperly avoid, decrease or conceal an obligation to pay money to the federal government. Private individuals can bring qui tam actions on behalf of the government and such individuals, commonly known as whistleblowers, may share in amounts paid by the entity to the government in fines or settlement. When an entity is determined to have violated the False Claims Act, the government may impose civil fines and penalties, plus treble damages, and exclude the entity from participation in Medicare, Medicaid and other federal healthcare programs. 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 “Business—Legal proceedings.” Any adverse ruling or settlement in such qui tam actions could materially adversely affect our business, financial condition and results of operation;

 

 

the federal transparency requirements under the Physician Payments Sunshine Act, created under the PPACA, which requires, among other things, certain manufacturers of drugs, devices, biologics and medical supplies reimbursed under Medicare, Medicaid or the Children’s Health Insurance Program, or CHIP, to annually report to CMS information related to payments and other transfers of value provided to physicians, certain other healthcare professionals, and teaching hospitals and physician ownership and investment

 

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interests, including such ownership and investment interests held by a physician’s immediate family members. Failure to submit required information may result in civil monetary penalties for all payments, transfers of value or ownership or investment interests that are not timely, accurately and completely reported in an annual submission, and may result in liability under other federal laws or regulations;

 

 

the Health Insurance Portability and Accountability Act of 1996, or HIPAA, which, among other things, imposes criminal liability for executing or attempting to execute a scheme to defraud any healthcare benefit program, including private third-party payers, knowingly and willfully embezzling or stealing from a healthcare benefit program, willfully obstructing a criminal investigation of a healthcare offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation, in connection with the delivery of or payment for healthcare benefits, items or services. Like the Anti-Kickback Statute, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation; and

 

 

state and foreign law equivalents of each of the above federal laws, such as anti-kickback and false claims laws, that may impose similar or more prohibitive restrictions, and may apply to items or services reimbursed by any payers, including private insurers and patients; state transparency reporting and compliance laws; and state laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and which may not have the same effect, thus complicating compliance efforts.

These laws affect our sales, marketing and other promotional activities by limiting the kinds of financial arrangements we may have with hospitals, physicians or other potential purchasers of our products. They particularly impact how we structure our sales offerings, including discount practices, customer support, education and training programs, physician consulting, research grants and other service arrangements. These laws are broadly written, and it is often difficult to determine precisely how these laws will be applied to specific circumstances. Because of the complex and far-reaching nature of these laws, regulatory agencies may view these transactions as prohibited arrangements that must be restructured, or discontinued, or for which we could be subject to other significant penalties. We could be adversely affected if regulatory agencies interpret our financial relationships with providers and purchasers who may influence the ordering of and use of our products to be in violation of applicable laws.

The scope and enforcement of each of these laws is uncertain and subject to rapid change in the current environment of healthcare reform. Governmental authorities often reserve the right to conduct audits and investigations of our business practices to assure our compliance with legal requirements. It is possible that governmental authorities may conclude that our business practices, including our customer arrangements and our arrangements with physicians who provide consulting services or attend our training programs, do not comply with current or future statutes, regulations, agency guidance or case law involving applicable healthcare laws. Responding to investigations can be time and resource-consuming and can divert management’s attention from the business. Any such investigation or settlement could increase our costs or otherwise have an adverse effect on our business.

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 criminal and civil penalties, which could be severe, including, for example, significant civil, criminal and administrative penalties, damages, fines, disgorgement, individual imprisonment, exclusion from government funded healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, additional reporting obligations and oversight if we become subject to a corporate integrity agreement or other agreement to resolve allegations of non-compliance with these laws, and the curtailment or restructuring of our operations, any of which could substantially disrupt our operations. Furthermore, since we rely and many of our customers rely on

 

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reimbursement from Medicare, Medicaid and other governmental programs to cover a substantial portion of our and their expenditures, our exclusion from such programs as a result of a violation of these laws could have a material adverse effect on our business, financial condition and results of operations.

Our collection, use and disclosure of individually identifiable information, including health and/or employee information, is subject to state, federal and foreign privacy and security regulations, and our failure to comply with those regulations or to adequately secure the information we hold could result in significant liability or reputational harm.

We are subject to federal, state and foreign data protection laws and regulations. In the United States, numerous federal and state laws and regulations, including federal health information privacy laws, state data breach notification laws, state health information privacy laws, and federal and state consumer protection laws (e.g., Section 5 of the Federal Trade Commission Act), that govern the collection, use, disclosure, and protection of health-related and other personal information could apply to our operations or the operations of our collaborators.

HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their implementing regulations, imposes privacy, security and breach reporting obligations with respect to individually identifiable health information upon entities, such as health plans, healthcare clearinghouses and certain healthcare providers, that submit certain covered transactions electronically, or covered entities, and their respective business associates, which are persons or entities that perform services for, or on behalf of, a covered entity that involve the use or disclosure of protected health information, or PHI. Certain portions of our business involve the delivery and direct billing of our products to federally funded programs, including Medicare and Medicare Advantage Plans. This portion of our business requires that we collect PHI for purposes of establishing medical necessity and filing claims for reimbursement, as well as other treatment and healthcare operations activities. As a result, this portion of our business is considered a covered entity for purposes of HIPAA and we are directly liable for compliance with HIPAA. In addition, certain portions of our business, such as the cloud-based software digital health applications and our facility rental services in support of delivery, placement and pickup of our products, are subject to HIPAA as a business associate of our covered entity clients. To provide our covered entity clients with services that involve the use or disclosure of PHI, HIPAA requires us to enter into business associate agreements that require us to safeguard PHI in accordance with HIPAA, and as such, we are also directly liable for compliance with HIPAA in our role as a business associate. Furthermore, the portion of our business that is considered a covered entity also has business associates, such as third-party vendors or consultants, that perform services involving the use of PHI.

Penalties for violations of HIPAA regulations include civil and criminal penalties which are enforced by the Office for Civil Rights within the Department of Health and Human Services, or HHS. HITECH amended HIPAA to make civil and criminal penalties directly applicable to business associates, and gave state attorneys general new authority to file civil actions for damages or injunctions in U.S. federal courts to enforce HIPAA and seek attorneys’ fees and costs associated with pursuing federal civil actions. Covered entities must notify affected individuals “without unreasonable delay and in no case later than 60 calendar days after discovery of the breach” if their unsecured PHI is subject to an unauthorized access, use or disclosure. State breach laws generally impose shorter breach notification time frames. In some states, affected individuals must be notified within five days. If a breach affects 500 patients or more, covered entities must report it to HHS and local media without unreasonable delay, and HHS will post the name of the breaching entity on its public website. If a breach affects fewer than 500 individuals, the covered entity must log it and notify HHS at least annually. HIPAA further requires business associates to notify covered entity clients “without unreasonable delay and in no case later than 60 calendar days after discovery of the breach.” Our business associate agreements may require us to notify the covered entity in a shorter time frame, in order to comply with state breach law requirements. If we are unable to properly protect the privacy and security of health information entrusted to us, our solutions may be perceived as not secure, we may incur significant liabilities and customers may curtail their use of, or stop

 

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using, our solutions. In addition, if we fail to comply with the terms of our business associate agreements with our clients, we are liable not only contractually but also directly under HIPAA. If the third-party business associates that the covered entity portion of our business works with violate applicable laws, contractual obligations or suffer a security breach, such violations may also put us in breach of our obligations under privacy laws and regulations and/or could in turn have a material adverse effect on our business.

State privacy, security and breach notification laws and regulations apply to both PHI and personally identifiable information, or PII, and payment card information, or PCI, is subject to certain other laws, regulations and industry standards. Various states, such as California and Massachusetts, have implemented privacy laws and regulations, such as the California Confidentiality of Medical Information Act, that impose restrictive requirements regulating the use and disclosure of health information and other personally identifiable information. These laws and regulations are not necessarily preempted by HIPAA, particularly if a state affords greater protection to individuals than HIPAA. Where state laws are more protective, we have to comply with the stricter provisions. In addition to fines and penalties imposed upon violators, some of these state laws also afford private rights of action to individuals who believe their personal information has been misused. California’s patient privacy laws, for example, provide for penalties of up to $250,000 and permit injured parties to sue for damages. California has also recently adopted the California Consumer Privacy Act of 2018, or CCPA, which will become effective in January 2020. The CCPA has been characterized as the first “GDPR-like” privacy statute to be enacted in the United States because it mirrors a number of the key provisions of the European Union General Data Protection Regulation, or GDPR, described below. The CCPA establishes a new privacy framework for covered businesses by creating an expanded definition of personal information, establishing new data privacy rights for consumers in the State of California, imposing special rules on the collection of consumer data from minors, and creating a new and potentially severe statutory damages framework for violations of the CCPA and for businesses that fail to implement reasonable security procedures and practices to prevent data breaches. Penalties for violations of the CCPA will include civil penalties. The interplay of federal and state laws may be subject to varying interpretations by courts and government agencies, creating complex compliance issues for us and our clients and potentially exposing us to additional expense, adverse publicity and liability.

In addition to complying with applicable U.S. law, the collection, use, access, disclosure, transmission and storage of PHI and other sensitive data is subject to regulation in other jurisdictions in which we do business or expect to do business in the future, and data privacy and security laws and regulations in some such jurisdictions may be more stringent than those in the United States. European Union member states and other jurisdictions have adopted data protection laws and regulations, which impose significant compliance obligations. Laws and regulations in these jurisdictions apply broadly to the collection, use, storage, disclosure, transfer and security of personal information that identifies or may be used to identify an individual, such as names, contact information, and sensitive personal data such as health data. These laws and regulations are subject to frequent revisions and differing interpretations, and have generally become more stringent over time. For example, in April 2016, the EU Parliament adopted the GDPR, which went into effect in May 2018. The GDPR implements, among other things, more stringent operational requirements for processors and controllers of personal data, including, for example, expanded disclosures about how personal information is to be used, limitations on retention of information and mandatory data breach notification requirements. Failure to comply with the requirements of GDPR and the applicable national data protection laws of the European Union member states may result in fines of up to 20,000,000 or up to 4% of the total worldwide annual turnover of the preceding financial year, whichever is higher, and other administrative penalties. Further, the United Kingdom’s vote in favor of Brexit has created uncertainty with regard to data protection regulation in the United Kingdom. In particular, it is unclear whether the United Kingdom will enact data protection legislation equivalent to the GDPR and how data transfers to and from the United Kingdom will be regulated.

 

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In recent years, U.S. and European lawmakers and regulators have also expressed concern over electronic marketing and the use of third-party cookies, web beacons and similar technology for online behavioral advertising. In the European Union, informed consent is required for the placement of a cookie on a user’s device. The current European Union laws that cover the use of cookies and similar technology and marketing online or by electronic means are under reform. A draft of the new ePrivacy Regulation was announced on January 10, 2017 and is targeted to become applicable in 2019. Unlike the current ePrivacy Directive, this will be directly implemented into the laws of each of the European Union member states, without the need for further enactment. The ePrivacy Regulation alters rules on third-party cookies, web beacons and similar technology for online behavioral advertising and imposes stricter requirements on companies using these tools. The draft also extends the strict opt-in marketing rules with limited exceptions to business to business communications and significantly increases penalties.

The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive data from unauthorized access, use or disclosure, our information technology and infrastructure and those of our third-party service providers, may be vulnerable to attacks by hackers or viruses or breached due to employee error, malfeasance, or other malicious or inadvertent disruptions. Any such breach or interruption could compromise our or our third-party service providers’ networks and the information stored therein could be accessed by unauthorized parties, publicly disclosed, lost, or stolen. Any such access, breach, or other loss of information could result in legal claims or proceedings, and liability under federal or state laws that protect the privacy and security of personal information.

Any failure or perceived failure by us or our service providers to comply with privacy or security laws, policies, legal obligations or industry standards or any security incident that results in the unauthorized release or transfer of sensitive data may result in governmental enforcement actions and investigations, fines and penalties, litigation and/or adverse publicity, including by consumer advocacy groups, and could cause our customers to lose trust in us, which could have an adverse effect on our reputation, our ability to compete and our business. Such failures could have a material adverse effect on our financial condition and operations. Changes in laws or regulations associated with the enhanced protection of certain types of sensitive data, along with increased customer demands for enhanced data security infrastructure, could greatly increase our cost of providing our services, decrease demand for our products and services, reduce our revenue and/or subject us to additional liabilities. Further, as regulatory focus on privacy issues continues to increase and laws and regulations concerning the protection of personal information expand and become more complex, these potential risks to our business could intensify.

Because we depend upon a limited group of third-party suppliers and manufacturers and, in most 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 rentals and sales of our products.

We obtain some of our finished products and components from a limited group of suppliers, and we purchase most of our raw materials from single sources for reasons of quality assurance, cost-effectiveness, availability or constraints resulting from regulatory requirements. For example, we rely on a limited number of suppliers to source foam and drapes used in our products. For us to be successful, our suppliers must be able to provide us with products and components in substantial quantities, in compliance with regulatory requirements, in accordance with agreed upon specifications, at acceptable costs and on a timely basis. Our efforts to maintain a continuity of supply and high quality and reliability may not be successful on a timely basis or at all. 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

 

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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. Transitioning to a new supplier could be time-consuming and expensive, may result in interruptions in our operations and product delivery, could affect the performance specifications of our products or could require that we modify the design of those systems.

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, financial condition and results of operations. Any casualty, natural disaster or other 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, financial condition and results of operations. In addition, if the change in manufacturer results in a significant change to any product, a new 510(k) clearance from the FDA or similar international regulatory authorization may be necessary before we implement the change, which could cause substantial delays.

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, excise and other indirect taxes, currency exchange rates, and government regulation. Certain of these factors may be heightened as a result of changing political climates and the modification or introduction of other governmental policies with potentially adverse effects. 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 to fully recover these 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.

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

Our and third parties’ 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. We manufacture our NPWT and specialty surgical devices and related consumables at our manufacturing facilities in Athlone, Ireland and Peer, Belgium, and the manufacturing facilities of two third-party contract manufacturers in Mexico. Our AWD products are primarily manufactured at a third-party manufacturing facility in Gargrave, England, supplemented by a network of other third-party contract manufacturers located mainly in the United Kingdom and some in the United States. 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 the 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

 

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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 our key manufacturer’s production could have a negative impact on our sales or profitability. 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 business, financial condition and results of operations.

If we are not successful in managing our inventory balances and inventory shrinkage, our inventory holding costs could increase or we could lose sales, either of which could have a material adverse effect on our business, financial condition and results of operations.

While we must maintain sufficient inventory levels to operate our business successfully and meet our customers’ demands, we must be careful to avoid amassing excess inventory. Changing customer demands, supplier backorders and uncertainty surrounding new product launches expose us to increased inventory risks. Demand for products can change rapidly and unexpectedly, including the time between when the product is ordered from the supplier to the time it is offered for sale. We carry a wide variety of products and must maintain sufficient inventory levels of the products we sell. We may be unable to sell certain products in the event that customer demand changes. Our inventory holding costs will increase if we carry excess inventory. However, if we do not have a sufficient inventory of a product to fulfill customer orders, we may lose orders or customers, which may adversely affect our business, financial condition and results of operations. If we fail to effectively manage our inventory, we may have to take markdowns and discounts to dispose of obsolete or excess inventory or record potential write-downs or other charges relating to the value of such obsolete or excess inventory. In addition, certain of our products are subject to expiration and as such, these products may expire before they can be sold. We cannot assure you that we can accurately predict customer demand and events and avoid over-stocking or under-stocking products.

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 and 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, financial condition and 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, including applicable anti-bribery and anti-corruption laws. 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. We do not have local staff in many of the areas covered by independent distributors, which may make it difficult for us to monitor our distributors’ performance. 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 our products, or legal liability.

 

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Our international business operations are subject to risks and uncertainties, 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. Certain of these risks may be heightened as a result of changing political climates. Sales outside of the United States represented approximately $431.1 million, or 29.4%, of our total revenue for the year ended December 31, 2018, and $348.3 million, or 26.1%, of our total revenue for the year ended December 31, 2017, 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 rigorous protection of intellectual property in some countries outside the United States;

 

 

more stringent data privacy and security measures in some countries outside the United States;

 

 

trade protection measures, quotas, embargoes, import and export licensing requirements, duties, tariffs or surcharges, including those that may be imposed as a result of Brexit;

 

 

changes in foreign regulatory requirements and tax laws, including any such changes resulting from Brexit;

 

 

alleged or actual violations of the Foreign Corrupt Practices Act of 1977, or the FCPA, and other anti-bribery and anti-corruption laws, rules and regulations 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 payer pathways;

 

 

difficulty in establishing, staffing and managing non-U.S. operations;

 

 

complex tax and cash management issues;

 

 

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 U.S. dollar strengthens in relation to the currencies, such as the Euro, of other countries where we sell our products, our U.S. 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 financial condition and results of operations.

The potential United Kingdom exit from the European Union as a result of the United Kingdom triggering Article 50 of the Treaty on European Union could harm our business, financial condition or results of operations.

On March 29, 2017, the United Kingdom triggered Article 50 of the Treaty on European Union by notifying the European Council of its intention to withdraw from the European Union. Negotiations have commenced to determine the future terms of the United Kingdom’s relationship with the European Union, including the terms of trade between the United Kingdom and the European Union. The effects of Brexit will depend on any agreements the United Kingdom makes to retain access to European Union markets either during a transitional

 

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period or more permanently. Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the United Kingdom determines which European Union laws to replace or replicate. There is uncertainty as to the manner and timing of the withdrawal and depending on the outcome, we may have a material and adverse impact to our business.

The announcement of Brexit also created (and the actual exit of the United Kingdom from the European Union may create future) global economic uncertainty. The actual exit of the United Kingdom from the European Union could cause disruptions to and create uncertainty surrounding our business. Any of these effects of Brexit (and the announcement thereof), and others we cannot anticipate, could harm our business, financial condition or results of operations. For example, certain of our products are manufactured in the United Kingdom and may require new inventory locations or agreements between the United Kingdom and the European Union when Brexit occurs. The market and sale of our products are subject to pre-market authorization by a Notified Body, and we have recently migrated applicable Notified Body certificates from the United Kingdom to the Netherlands in preparation for Brexit. Correspondingly we have also designated a new Authorized Representative in Ireland for all BSi CE marked products in preparation for Brexit and as a result our governing Competent Authority has changed from MHRA to HPRA for all CE marked products, except for our PREVENA line of products, for which we retained our Authorized Representative in the United Kingdom and as such, our Competent Authority designation. See “—Our business is subject to extensive and continuing regulatory compliance obligations. If we fail to obtain and maintain necessary FDA clearances or international regulatory approvals or qualifications for our products and indications, if clearances for future products and indications are delayed or not issued, if we or any of our third-party suppliers or manufacturers fail to comply with applicable regulatory requirements, or if there are regulatory changes, our commercial operations could be harmed.”

Our international operations subject us to risks relating to the FCPA and other anti-corruption and anti-bribery laws, international trade restrictions and anti-money laundering laws, the violation of which could subject us to penalties and other adverse consequences.

We are subject to the FCPA, the United Kingdom’s Bribery Act of 2010 and other anti-bribery laws, rules and regulations around the world. The anti-bribery laws generally prohibit covered entities and their intermediaries from engaging in bribery or making other prohibited payments, offers or promises to foreign officials for the purpose of obtaining or retaining business or other advantages. In addition, the FCPA and other anti-bribery laws impose recordkeeping and internal controls requirements on publicly traded corporations and their foreign affiliates. 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 our dealings with such entities present anti-bribery risk. As a substantial portion of our revenue is, and we expect will continue to be, from jurisdictions outside of the United States, we face significant risks if we fail to comply with the FCPA and other laws that prohibit improper payments, offers or promises of payment to foreign governments and their officials and political parties by us and other business entities for the purpose of obtaining or retaining business or other advantages. In many foreign countries, particularly in countries with developing economies, some of which represent key markets for us, it may be a local custom that businesses operating in such countries engage in business practices that are prohibited by the FCPA or other laws and regulations. Despite our training and compliance programs, our internal control policies and procedures may not always protect us from violating anti-corruption laws or from acts committed by our employees or by third-parties, including but not limited to our distributors. Therefore, there can be no assurance that our employees and agents, and those companies to which we outsource certain of our business operations, have not and will not take actions that violate our policies or applicable laws, for which we may be ultimately held responsible. Any violation of anti-bribery laws or allegation of such violations could result in severe criminal or civil sanctions, which could have a material adverse effect on our reputation, business, results of operations and financial condition.

 

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We are subject to the export controls and economic sanctions rules and regulations of the United States, including, but not limited to, the Export Administration Regulations, administered and enforced by the Department of Commerce, as well as other export controls administered and enforced by the U.S. government and economic sanctions administered and enforced by the Office of Foreign Assets Control of the Department of the Treasury. We are also subject to similar export control and economic sanctions regimes of other jurisdictions in which we conduct business. These regulations limit our ability to market, sell, distribute or otherwise transfer our products or technology to or otherwise deal with prohibited countries or persons. Our operations may also expose us to risk of violating the anti-money laundering laws, rules and regulations of the jurisdictions in which we conduct business. A determination that we have failed to comply, whether knowingly or inadvertently, may result in substantial penalties, including fines and enforcement actions and civil and/or criminal sanctions, the disgorgement of profits and the imposition of a court-appointed monitor, as well as the denial of export privileges, and may have an adverse effect on our reputation, business, results of operations and financial condition.

We are continually seeking ways to make our cost structure, business processes and systems more efficient, including by moving activities from higher-cost to lower-cost locations, outsourcing certain business processes and functions, and implementing new business information systems. Problems with the execution of these activities could have an adverse effect on our business, operating results and financial condition. In addition, we may not achieve the expected benefits of these initiatives.

We continuously seek to make our cost structure and business processes more efficient, including by moving our business activities from higher-cost to lower-cost locations, outsourcing certain business processes and functions, and implementing changes to our business information systems. These efforts involve a significant investment of financial and human resources and significant changes to our current operating processes. We have initiated a plan to outsource significant information technology functions to third parties during 2018, including significant elements of our information technology infrastructure, and as a result we are managing relationships with third parties who have access to our confidential information. The size and complexity of our information technology systems and those of our third-party vendors may make such systems potentially vulnerable to service interruptions. Our internal information technology systems, as well as those systems maintained by third-party providers, may be subjected to computer viruses or other malicious codes, unauthorized access attempts, service interruptions, and cyber-attacks, including infiltration of data centers, any of which, if successful, could result in data leaks or otherwise compromise our confidential or proprietary information and disrupt our operations. We have recently initiated a plan to outsource certain back-office, service and support functions. This plan does involve some workforce reductions as functions are transitioned to a third-party vendor, along with transformation efforts through automation and technology investments.

Our business also generates and/or maintains sensitive information, such as patient data and other personal information. The size and complexity of our third-party vendors’ systems and the large amounts of confidential information that is present at their sites also makes them potentially vulnerable to security breaches from inadvertent or intentional actions by our employees, partners or vendors, or from attacks by malicious third parties. Cyber-attacks continue to increase in sophistication and frequency. Additionally our systems and network infrastructure are vulnerable to interruption due to fire, power loss, system malfunctions and the level of protection and disaster recovery capability varies from site to site and across facilities maintained by third-party vendors. While we have invested in our systems and the protection of our data (including through network monitoring, preventive security controls, employee training and security policies) to reduce the risk of an intrusion or interruption and monitor our systems on an ongoing basis for any current or potential threats, there can be no assurances that our protective measures will prevent future security breaches that could have a significant impact on our business, reputation, results of operations, financial condition and/or liquidity.

 

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In addition, as we move operations into lower-cost jurisdictions and outsource certain business processes, we become subject to new regulatory regimes and lose control of certain aspects of our operations and, as a consequence, become more dependent upon the systems and business processes of third-parties. If we are unable to move our operations, outsource business processes and implement new business information systems in a manner that complies with local law and maintains adequate standards, controls and procedures, the quality of our products and services may suffer and we may be subject to increased litigation risk, either of which could have an adverse effect on our business, operating results and financial condition.

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 these and other transformational initiatives. In addition, these actions and potential future improvement efforts 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 initiatives, or any other initiatives 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.

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 use, storage, generation, handling, transportation and disposal of hazardous substances or wastes, the cleanup of hazardous substance releases, exposure to hazardous substances 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 cease the operations of an enterprise if it is operating in violation of environmental law. Even if our operations are and were conducted in compliance with environmental laws, we may incur liability relating to the cleanup of hazardous substance releases (including releases at properties we formerly occupied, releases caused by prior occupants of properties we currently own, and releases at offsite waste disposal facilities we used for the treatment or disposal our of waste). Some European countries impose environmental taxes or require manufacturers to take back used products at the end of their useful life. In addition, some jurisdictions regulate or restrict the materials that manufacturers may use in their products and require the redesign or labeling of products. New laws and regulations, violations of or amendments to existing 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 operations or the operations of our third-party suppliers as a result of violations of or liabilities under these laws or regulations could have an adverse effect on our business and financial condition.

Our ability to use certain tax attributes to offset future income tax liabilities may be subject to limitations.

We have certain net operating losses and other tax attributes, as described in Note 8 to our audited consolidated financial statements included elsewhere in this prospectus. In general, under Section 382 and 383 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses, or NOLs, or tax credits to offset future taxable income. If we undergo an ownership change in connection with or after this offering, our ability to utilize federal NOLs or tax credits could be limited by Section 382 and 383 of the Code. Although we believe that this offering will not result in an immediate ownership change for purposes of

 

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Section 382 of the Code, no assurance can be given in this regard. Additionally, future changes in our stock ownership, many of which are outside of our control, could result in an ownership change under Section 382 and 383 of the Code. We do not expect the amount of our federal net operating losses at the time of the offering to be material. Our NOLs or credits may also be impaired under state tax law. Accordingly, we may not be able to utilize a material portion of our federal and state NOLs or credits. Our ability to utilize our NOLs or credits is conditioned upon our attaining profitability and generating U.S. federal and state taxable income. Valuation allowances have been provided for a substantial portion of deferred tax assets related to our state NOLs.

In addition, other tax attributes, such as interest carryforwards and foreign tax credit carry forwards are also subject to various limits on their use under the Code. We have established valuation allowances for our interest carry forwards and foreign tax credit carry forwards to reflect these limitations and their anticipated impact on our ability to utilize these tax attributes post the adoption of the TCJA in the United States.

Changes in tax laws, unfavorable resolution of tax contingencies, or exposure to additional income tax liabilities could have a material impact on our results of operations or financial condition.

We are subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions. We are subject to on-going tax audits in various 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 and have established contingency reserves for material, known tax exposures. However, the calculation of such tax exposures involves the application of complex tax laws and regulations in many jurisdictions, as well as interpretations as to the legality under European Union state aid rules of tax advantages granted in certain jurisdictions. Therefore, there can be no assurance that we will accurately predict the outcomes of these disputes or other tax audits or that issues raised by tax authorities will be resolved at a financial cost that does not exceed our related reserves and the actual outcomes of these disputes and other tax audits could have a material impact on our results of operations or financial condition.

Changes in tax laws and regulations, or their interpretation and application, in the jurisdictions where we are subject to tax could materially impact our effective tax rate. For example, the TCJA was enacted on December 22, 2017 and we expect the U.S. Treasury to continue to issue future notices and regulations under the TCJA. Certain provisions of the TCJA and the regulations issued thereunder could have a significant impact on our future results of operations as could interpretations made by the Company in the absence of regulatory guidance and judicial interpretations. In addition, in 2018, we established valuation allowances against certain deferred tax assets (including interest carry forwards and foreign tax credit carry forwards) to reflect certain limitations on these assets and their anticipated impact on our ability to utilize these tax assets following the adoption of the TCJA. We are continuing to examine the impact of TCJA, and as the expected impact of certain aspects of the legislation is unclear and subject to change, we note that the TCJA could adversely affect our business and financial condition.

Additionally, the U.S. Congress, government agencies in non-U.S. jurisdictions where we and our affiliates do business and the Organization for Economic Co-operation and Development, or OECD, have recently focused on issues related to the taxation of multinational corporations. One example is in the area of “base erosion and profit shifting,” where profits are claimed to be earned for tax purposes in low-tax jurisdictions, or payments are made between affiliates from a jurisdiction with high tax rates to a jurisdiction with lower tax rates. The OECD has released several components of its comprehensive plan to create an agreed set of international rules for fighting base erosion and profit shifting. As a result, the tax laws in the United States and other countries in which we and our affiliates do business could change on a prospective or retroactive basis and any such changes could materially adversely affect our results of operations or financial condition.

 

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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. We may not able to retain the services of individuals whose knowledge and skills are important to our business. 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 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 have a material adverse effect on our business, financial condition and results of operations.

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. 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 adversely impact our business, financial condition, results of operations and liquidity.

If any of our operations are found not to comply with applicable antitrust or competition laws, our business may suffer.

Our operations are subject to applicable antitrust and competition laws in the jurisdictions in which we conduct our business. These laws prohibit, among other things, anticompetitive agreements and practices. There is a risk based upon the leading position of certain of our business operations that we could, in the future, be the target of investigations by government entities or actions by private parties challenging the legality of our business practices. Depending on the outcome of any future claims or investigations, we may be required to change the way we offer particular products or services, which could result in material disruptions to and costs incurred by our business, and we may be subject to substantial fines, penalties, damages or an injunction or other equitable remedies. Future claims or investigations (regardless of outcome) may also affect how parties interact with us. Further, agreements that infringe these antitrust and competition laws may be void and unenforceable, in whole or in part, or require modification in order to be lawful and enforceable. Any antitrust or competition-related claim or investigation could be costly for our company in terms of time and expense

 

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incurred defending such claims or investigations. In addition, if we are unable to enforce our commercial agreements, whether at all or in material part, our business, financial position, results of operations and liquidity could be adversely affected.

Risks related to our indebtedness

Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations.

We have a significant amount of indebtedness. As of December 31, 2018, prior to giving effect to this offering and the use of proceeds therefrom, we had approximately $2.376 billion of aggregate principal amount of indebtedness outstanding, substantially all of which was secured indebtedness, and an additional $293.9 million of availability 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 us, including:

 

 

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 from our foreign subsidiaries to accommodate debt service payments;

 

 

expose us to the risk of increased interest rates as certain of our borrowings, including borrowings under our term loan facilities, are at variable rates, and we may not be able to enter into interest rate swaps and any swaps we enter into may not fully mitigate our interest rate risk;

 

 

restrict us from capitalizing on business opportunities;

 

 

make it more difficult to satisfy our financial obligations, including payments on our indebtedness;

 

 

being unable to fully take a current or future tax deduction for interest expense on our debt;

 

 

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 senior secured credit facilities and the indentures governing the Existing 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.

We may be able to incur significant additional indebtedness in the future. Although the credit agreement governing our senior secured credit facilities and the indentures governing the Existing Notes contain restrictions on the incurrence of additional indebtedness by us, such restrictions are subject to a number of

 

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qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. Also, these restrictions 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 will increase.

We will require a significant amount of cash to service our debt, and our ability to generate cash depends on many factors beyond our control and any failure to meet our debt service obligations could materially adversely affect 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 effect 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 senior secured credit facilities and the indentures governing the Existing 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 senior secured credit facilities and the Existing Notes.

Our debt instruments restrict our current and future operations, particularly our ability to respond to changes or to take certain actions.

The credit agreement governing our senior secured credit facilities and the indentures governing the Existing Notes impose significant operating and financial restrictions and limit our 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 acquisitions, investments, loans and advances;

 

 

sell or otherwise dispose of assets;

 

 

incur liens;

 

 

enter into transactions with affiliates;

 

 

enter into agreements restricting our subsidiaries’ ability to pay dividends;

 

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consolidate, merge or sell all or substantially all of our assets; and

 

 

engage in certain fundamental changes, including changes in the nature of our business.

The senior secured credit facilities also contain a springing financial covenant requiring us to meet a certain leverage ratio, subject to certain equity cure rights. See “Description of certain indebtedness.” 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 are 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 financial condition and results of operations could be adversely affected.

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 adversely affect our business, financial condition and results of operations.

If there were an event of default under any of the agreements relating to our outstanding debt, the holders of the defaulted debt could cause all amounts outstanding with respect to that debt to be due and payable immediately. Our assets or cash flow may not be sufficient to fully repay borrowing under our outstanding debt instruments if accelerated upon an event of default. Further, if we are unable to repay, refinance or restructure our secured debt, the holders of such debt could proceed against the collateral securing such debt. 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 debt could have a materially adverse effect on our business, financial condition and results of operations.

Risks related to this offering and ownership of our common stock

We will be a “controlled company” within the meaning of the rules of the applicable stock exchange and the rules of the SEC and, as a result, qualify for, and intend to rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to shareholders of other companies that are subject to such requirements.

After completion of this offering, our Sponsors will continue to control a majority of the voting power of our outstanding common stock. As a result, we will be a “controlled company” within the meaning of the corporate governance standards of the NYSE. Under these rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements, including the requirement that:

 

 

a majority of our board of directors consist of “independent directors” as defined under the rules of the NYSE;

 

 

our director nominees be selected, or recommended for our board of directors’ selection by a nominating/governance committee comprised solely of independent directors; and

 

 

the compensation of our executive officers be determined, or recommended to our board of directors for determination, by a compensation committee comprised solely of independent directors.

 

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Following this offering, we intend to utilize these exemptions. As a result, we may not have a majority of independent directors and our nominating and governance committee and compensation committee may not consist entirely of independent directors. Accordingly, you may not have the same protections afforded to shareholders of companies that are subject to all of the corporate governance requirements of the NYSE.

Our Sponsors control us and their interests may conflict with yours in the future.

Immediately following this offering, our Sponsors will beneficially own                 % of our common stock, or                 % if the underwriters exercise in full their option to purchase additional shares. Our Sponsors will be able to control the election and removal of our directors and thereby determine our corporate and management policies, including potential mergers or acquisitions, payment of dividends, asset sales, amendment of our certificate of formation or bylaws and other significant corporate transactions for so long as our Sponsors and their affiliates retain significant ownership of us. This concentration of our ownership may delay or deter possible changes in control of the Company, which may reduce the value of an investment in our common stock. So long as our Sponsors continue to own a significant amount of our combined voting power, even if such amount is less than 50%, our Sponsors will continue to be able to strongly influence or effectively control our decisions and, so long as our Sponsors and their affiliates collectively own at least                 % of all outstanding shares of our stock entitled to vote generally in the election of directors, they will be able to appoint individuals to our board of directors under the shareholders agreement that we expect to enter into in connection with this offering. See “Certain relationships and related party transactions—Shareholders agreement.” The interests of our Sponsors may not coincide with the interests of other holders of our common stock.

In the ordinary course of their business activities, our Sponsors and their affiliates may engage in activities where their interests conflict with our interests or those of our shareholders. Our certificate of formation will provide that none of our Sponsors, any of their affiliates or any director who is not employed by us (including any non-employee director who serves as one of our officers in both his director and officer capacities) or his or her affiliates will have any duty to refrain from engaging, directly or indirectly, in the same business activities or similar business activities or lines of business in which we operate. Our Sponsors also may pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. In addition, our Sponsors may have an interest in pursuing acquisitions, divestitures and other transactions that, in their judgment, could enhance their investment, even though such transactions might involve risks to you.

In addition, the Sponsors and their affiliates will be able to determine the outcome of all matters requiring shareholder approval and will be able to cause or prevent a change of control of our company or a change in the composition of our board of directors and could preclude any acquisition of our company. This concentration of voting control could deprive you of an opportunity to receive a premium for your shares of common stock as part of a sale of our company and ultimately might affect the market price of our common stock.

We will incur increased costs and become subject to additional regulations and requirements as a result of becoming a public company, and our management will be required to devote substantial time to new compliance matters, which could lower our profits or make it more difficult to run our business.

As a public company, we will incur significant legal, regulatory, finance, accounting, investor relations and other expenses that we have not incurred as a private company, including costs associated with public company reporting requirements and costs of recruiting and retaining non-executive directors. We also have incurred and will incur costs associated with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, and related rules implemented

 

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by the SEC, and the NYSE. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. Our management will need to devote a substantial amount of time to ensure that we comply with all of these requirements, diverting the attention of management away from revenue-producing activities. These laws and regulations also could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as our executive officers. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory action and potentially civil litigation.

Failure to comply with requirements to design, implement and maintain effective internal controls could have a material adverse effect on our business and stock price.

As a privately-held company, we were not required to evaluate our internal control over financial reporting in a manner that meets the standards of publicly traded companies required by Section 404(a) of the Sarbanes-Oxley Act, or Section 404.

As a public company, we will have significant requirements for enhanced financial reporting and internal controls. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. If we are unable to establish or maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations on a timely basis, result in material misstatements in our consolidated financial statements and harm our operating results. In addition, we will be required, pursuant to Section 404, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting in the second annual report following the completion of this offering. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. Testing and maintaining internal controls may divert our management’s attention from other matters that are important to our business. Our auditors will be required to issue an attestation report on effectiveness of our internal controls in the second annual report following the completion of this offering.

In connection with the implementation of the necessary procedures and practices related to internal control over financial reporting, we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. In addition, we may encounter problems or delays in completing the remediation of any deficiencies identified by our independent registered public accounting firm in connection with the issuance of their attestation report. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Any material weaknesses could result in a material misstatement of our annual or quarterly consolidated financial statements or disclosures that may not be prevented or detected.

We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 or our independent registered public accounting firm may not issue an unqualified opinion. If either we are unable to conclude that we have effective internal control over financial

 

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reporting or our independent registered public accounting firm is unable to provide us with an unqualified report, investors could lose confidence in our reported financial information, which could have a material adverse effect on the trading price of our common stock.

There may not be an active, liquid trading market for shares of our common stock, which may cause shares of our common stock to trade at a discount from the initial offering price and make it difficult to sell the shares of common stock you purchase.

Prior to this offering, there has not been a public trading market for shares of our common stock. We cannot predict the extent to which investor interest in us will lead to the development of a trading market or how active and liquid that market may become. If an active and liquid trading market does not develop or continue, you may have difficulty selling your shares of our common stock at an attractive price or at all. The initial public offering price per share of common stock will be determined by agreement among us, the selling shareholders and the representatives of the underwriters, and may not be indicative of the price at which shares of our common stock will trade in the public market after this offering. The market price of our common stock may decline below the initial offering price and you may not be able to sell your shares of our common stock at or above the price you paid in this offering, or at all.

Our stock price may change significantly following this offering, and you may not be able to resell shares of our common stock at or above the price you paid or at all, and you could lose all or part of your investment as a result.

Even if a trading market develops, the market price of our common stock may be highly volatile and could be subject to wide fluctuations. You may not be able to resell your shares at or above the initial public offering price due to a number of factors such as those listed in “—Risks related to our business” and the following:

 

 

results of operations that vary from the expectations of securities analysts and investors;

 

 

results of operations that vary from those of our competitors;

 

 

changes in expectations as to our future financial performance, including financial estimates and investment recommendations by securities analysts and investors;

 

 

changes in economic conditions for companies in our industry;

 

 

changes in market valuations of, or earnings and other announcements by, companies in our industry;

 

 

declines in the market prices of stocks generally, particularly those of medical technology companies;

 

 

additions or departures of key management personnel;

 

 

strategic actions by us or our competitors;

 

 

announcements by us, our competitors, our suppliers or our distributors of significant contracts, price reductions, new products or technologies, acquisitions, dispositions, joint marketing relationships, joint ventures, other strategic relationships or capital commitments;

 

 

changes in preference of our customers and our market share;

 

 

changes in general economic or market conditions or trends in our industry or the economy as a whole;

 

 

changes in business or regulatory conditions;

 

 

future sales of our common stock or other securities;

 

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investor perceptions of or the investment opportunity associated with our common stock relative to other investment alternatives;

 

 

the public’s response to press releases or other public announcements by us or third parties, including our filings with the SEC;

 

 

changes or proposed changes in laws or regulations or differing interpretations or enforcement thereof affecting our business;

 

 

announcements relating to litigation or governmental investigations;

 

 

guidance, if any, that we provide to the public, any changes in this guidance or our failure to meet this guidance;

 

 

the development and sustainability of an active trading market for our stock;

 

 

changes in accounting principles; and

 

 

other events or factors, including those resulting from information technology system failures and disruptions, natural disasters, war, acts of terrorism or responses to these events.

Furthermore, the stock market may experience extreme volatility that, in some cases, may be unrelated or disproportionate to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our actual operating performance. In addition, price volatility may be greater if the public float and trading volume of our common stock is low.

In the past, following periods of market volatility, stockholders have instituted securities class action litigation. If we were to become involved in securities litigation, it could have a substantial cost and divert resources and the attention of executive management from our business regardless of the outcome of such litigation.

Investors in this offering will suffer immediate and substantial dilution.

The initial public offering price per share of common stock will be substantially higher than our as adjusted net tangible book value (deficit) per share immediately after this offering. As a result, you will pay a price per share of common stock that substantially exceeds the per share book value of our tangible assets after subtracting our liabilities. In addition, you will pay more for your shares of common stock than the amounts paid by our existing shareholders. Assuming an initial public offering price of $                 per share of common stock, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, you will incur immediate and substantial dilution in an amount of $                 per share of common stock. If the underwriters exercise their option to purchase additional shares, you will experience additional dilution. See “Dilution.”

You may be diluted by the future issuance of additional common stock in connection with our incentive plans, acquisitions or otherwise.

After this offering we will have approximately                 shares of common stock authorized but unissued. Our amended and restated certificate of formation to become effective immediately prior to the consummation of this offering will authorize us to issue these shares of common stock and options relating to common stock for the consideration and on the terms and conditions established by our board of directors in its sole discretion, whether in connection with acquisitions or otherwise. We have reserved shares for issuance under our 2019 Omnibus Incentive Plan. See “Executive compensation—KCI Holdings, Inc. 2019 Omnibus Incentive Plan.” Any common stock that we issue, including under our 2019 Omnibus Incentive Plan or other equity incentive plans that we may adopt in the future, would dilute the percentage ownership held by the investors who purchase

 

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common stock in this offering. In the future, we may also issue our securities in connection with investments or acquisitions. The amount of shares of our common stock issued in connection with an investment or acquisition could constitute a material portion of our then-outstanding shares of our common stock. Any issuance of additional securities in connection with investments or acquisitions may result in additional dilution to you.

Because we have no current plans to pay cash dividends on our common stock, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.

We have no current plans to pay cash dividends on our common stock. The declaration, amount and payment of any future dividends will be at the sole discretion of our board of directors, and will depend on, among other things, general and economic conditions, our financial condition and results of operations, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax and regulatory restrictions and implications on the payment of dividends by us to our shareholders or by our subsidiaries to us, including restrictions under our senior secured credit facilities, the Existing Notes and other indebtedness we may incur, and such other factors as our board of directors may deem relevant. See “Dividend policy.”

As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than your purchase price.

KCI Holdings, Inc. is a holding company with no operations of its own and, as such, it depends on its subsidiaries for cash to fund all of its operations and expenses, including future dividend payments, if any.

Our operations are conducted entirely through our subsidiaries and our ability to generate cash to meet our debt service obligations or to make future dividend payments, if any, is highly dependent on the earnings and the receipt of funds from our subsidiaries via dividends or intercompany loans. We do not currently expect to declare or pay dividends on our common stock for the foreseeable future; however, to the extent that we determine in the future to pay dividends on our common stock, the agreements governing our indebtedness may restrict the ability of our subsidiaries to pay dividends or otherwise transfer assets to us. In addition, Texas law may impose requirements that may restrict our ability to pay dividends to holders of our common stock.

Future sales, or the perception of future sales, by us or our existing shareholders in the public market following this offering could cause the market price for our common stock to decline.

The sale of substantial amounts of shares of our common stock in the public market, or the perception that such sales could occur, including sales by our Sponsors, could harm the prevailing market price of shares of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

Upon completion of this offering we will have a total of                  shares of our common stock outstanding. Of the outstanding shares, the                  shares sold in this offering (or                  shares if the underwriters exercise their option to purchase additional shares) will be freely tradable without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act, except that any shares held by our affiliates, as that term is defined under Rule 144 of the Securities Act, or Rule 144, including our directors, executive officers and other affiliates (including our Sponsors), may be sold only in compliance with the limitations described in “Shares Eligible for Future Sale.”

The remaining outstanding                  shares of common stock held by our existing shareholders after this offering will be subject to certain restrictions on resale. We, our executive officers, directors and certain of our significant shareholders, including the selling shareholders, will sign lock-up agreements with the underwriters that will, subject to certain customary exceptions, restrict the sale of the shares of our common stock and certain other securities held by them for 180 days following the date of this prospectus. Any two of J.P. Morgan

 

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Securities LLC, Goldman Sachs & Co. LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated may, in their sole discretion and at any time without notice, release all or any portion of the shares or securities subject to any such lock-up agreements. See “Underwriting” for a description of these lock-up agreements.

Upon the expiration of the lock-up agreements described above, all of such                  shares (or              shares if the underwriters exercise in full their option to purchase additional shares), representing     % (or     % if the underwriters exercise in full their option to purchase additional shares) of the common stock outstanding after this offering, will be eligible for resale in a public market, subject, in the case of shares held by our affiliates, to volume, manner of sale and other limitations under Rule 144. We expect that our Sponsors will be considered affiliates upon the expiration of the lock-up period based on their expected share ownership (consisting of                  shares), as well as their board nomination rights. Certain other of our shareholders may also be considered affiliates at that time.

In addition, pursuant to a registration rights agreement, each of the Sponsors has the right, subject to certain conditions, to require us to register the sale of their shares of our common stock under the Securities Act. See “Certain Relationships and Related Party Transactions—Registration Rights Agreement.” By exercising its registration rights and selling a large number of shares, a Sponsor could cause the prevailing market price of our common stock to decline. Following completion of this offering, the shares covered by registration rights would represent approximately    % of our total common stock outstanding (or    % if the underwriters exercise in full their option to purchase additional shares). Registration of any of these outstanding shares of common stock would result in such shares becoming freely tradable without compliance with Rule 144 upon effectiveness of the registration statement. See “Shares Eligible for Future Sale.”

We intend to file one or more registration statements on Form S-8 under the Securities Act to register shares of our common stock or securities convertible into or exchangeable for shares of our common stock issued pursuant to our 2019 Omnibus Incentive Plan. Any such Form S-8 registration statements will automatically become effective upon filing. Accordingly, shares registered under such registration statements will be available for sale in the open market. We expect that the initial registration statement on Form S-8 will cover                  shares of our common stock.

As restrictions on resale end, or if the existing shareholders exercise their registration rights, the market price of our shares of common stock could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them. These factors could also make it more difficult for us to raise additional funds through future offerings of our shares of common stock or other securities.

If securities analysts do not publish research or reports about our business or if they downgrade our stock or our sector, our stock price and trading volume could decline.

The trading market for our common stock will rely in part on the research and reports that industry or financial analysts publish about us or our business. We do not control these analysts. Furthermore, if one or more of the analysts who do cover us downgrade our stock or our industry, or the stock of any of our competitors, or publish inaccurate or unfavorable research about our business, the price of our stock could decline. If one or more of these analysts ceases coverage of the Company or fail to publish reports on us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline.

 

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Anti-takeover provisions in our organizational documents and Texas law might discourage or delay acquisition attempts for us that you might consider favorable.

Our amended and restated certificate of formation and amended and restated bylaws, or collectively, our amended and restated organizational documents, will contain provisions that may make the merger or acquisition of the Company more difficult without the approval of our board of directors. Among other things:

 

 

although we do not have a shareholder rights plan, these provisions would allow us to authorize the issuance of undesignated preferred stock in connection with a shareholder rights plan or otherwise, the terms of which may be established and the shares of which may be issued without shareholder approval, and which may include supermajority voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;

 

 

these provisions provide for a classified board of directors with staggered three-year terms;

 

 

these provisions require advance notice for nominations of directors by shareholders and for shareholders to include matters to be considered at our annual meetings;

 

 

these provisions prohibit shareholder action by less than unanimous written consent from and after the date on which our Sponsors and their affiliates beneficially own, in the aggregate, less than 50% of our outstanding shares of common stock;

 

 

these provisions provide for the removal of directors only for cause and only upon affirmative vote of holders of at least 662/3% of the shares of common stock entitled to vote generally in the election of directors if our Sponsors and their affiliates beneficially own, in the aggregate, less than 50% of our outstanding shares of common stock; and

 

 

these provisions require the amendment of certain provisions only by the affirmative vote of at least 662/3% of the shares of common stock entitled to vote generally in the election of directors if our Sponsors and their affiliates beneficially own, in the aggregate, less than 50% of our outstanding shares of common stock.

Further, as a Texas corporation, we are also subject to provisions of Texas law, which may impair a takeover attempt that our shareholders may find beneficial. These anti-takeover provisions, other provisions under Texas law and provisions that will be included in our amended and restated organizational documents could discourage, delay or prevent a transaction involving a change in control of the Company, including actions that our shareholders may deem advantageous, or negatively affect the trading price of our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors of your choosing and to cause us to take other corporate actions you desire.

Additionally, our amended and restated organizational documents will provide that the federal and state courts located in Bexar County, Texas will be the exclusive forum for (a) any actual or purported derivative action or proceeding brought on our behalf; (b) any action asserting a claim of breach of fiduciary duty by any of our directors or officers; (c) any action asserting a claim against us or our directors or officers arising pursuant to the Texas Business Organizations Code, or the TBOC, our amended and restated certificate of formation or our amended and restated bylaws; or (d) any action asserting a claim against us or our officers or directors that is governed by the internal affairs doctrine. By becoming a shareholder of our Company, you will be deemed to have notice of and have consented to the provisions of our amended and restated organizational documents related to choice of forum. The choice of forum provision in our amended and restated organizational documents may limit our shareholders’ ability to obtain a favorable judicial forum for disputes with us. Alternatively, if a court were to find the choice of forum provision contained in our amended and restated organizational documents to be inapplicable or unenforceable in an action, we may incur additional costs

 

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associated with resolving such action in other jurisdictions, which could adversely affect our operating results and financial condition.

Our board of directors will be authorized to issue and designate shares of our preferred stock in additional series without shareholder approval.

Our amended and restated certificate of formation will authorize our board of directors, without the approval of our shareholders, to issue                  shares of our preferred stock, subject to limitations prescribed by applicable law, rules and regulations and the provisions of our amended and restated certificate of formation, as shares of preferred stock in series, to establish from time to time the number of shares to be included in each such series and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. The powers, preferences and rights of these additional series of preferred stock may be senior to or on parity with our common stock, which may reduce its value.

 

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Forward-looking statements

This prospectus includes forward-looking statements that reflect our current views with respect to, among other things, our operations and financial performance. Forward-looking statements include all statements that are not historical facts. These forward-looking statements are included throughout this prospectus, including in the sections entitled “Summary,” “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations” and “Business” and relate to matters such as our industry, business strategy, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources and other financial and operating information. We have used the words “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “future,” “will,” “seek,” “foreseeable,” the negative version of these words or similar terms and phrases to identify forward-looking statements in this prospectus.

The forward-looking statements contained in this prospectus are based on management’s current expectations and are not guarantees of future performance. The forward-looking statements are subject to various risks, uncertainties, assumptions or changes in circumstances that are difficult to predict or quantify. Our expectations, beliefs, and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs and projections will result or be achieved. Actual results may differ materially from these expectations due to changes in global, regional or local economic, business, competitive, market, regulatory and other factors, many of which are beyond our control. We believe that these factors include but are not limited to those described under “Risk factors” and the following:

 

 

significant and continuing competition;

 

 

defects, failures or quality issues associated with our products, which could lead to product recalls or safety alerts, adverse regulatory actions, litigation, including product liability claims brought with or without merit, and negative publicity;

 

 

our ability to adhere to extensive and continuing regulatory compliance obligations;

 

 

the misuse or off-label use of our products;

 

 

failure of any of our clinical studies or third-party assessments to demonstrate desired outcomes in proposed endpoints;

 

 

pricing pressure as a result of cost-containment efforts of our customers, purchasing groups, distributors, third-party payers and governmental organizations;

 

 

our inability to obtain and maintain adequate levels of coverage and reimbursement for our current or future products or procedures using our products or any changes in U.S. and international regulations, policies, rules and expanded audit programs of third-party payers that reduce reimbursement and collection for our products;

 

 

our inability to develop and obtain regulatory clearance or approval for new generations of products and enhancements to existing products and service offerings;

 

 

the implementation of healthcare reform in the United States;

 

 

our failure to protect, maintain and enforce our intellectual property;

 

 

pending and future intellectual property litigation;

 

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our failure to successfully identify and complete acquisitions or divestitures on favorable terms or achieve anticipated synergies relating to any such transaction, and any unforeseen operating difficulties, regulatory issues and expenditures from any such transaction;

 

 

our failure to comply with false claims, anti-kickback, self-referral and program integrity laws;

 

 

our failure to comply with state, federal and foreign privacy and security regulations;

 

 

our dependence upon a limited group of third-party suppliers and manufacturers and, in most cases, exclusive suppliers for products essential to our business;

 

 

increased prices for, or unavailability of, raw materials or sub-assemblies used in our products;

 

 

a natural or man-made disaster, which strikes our or a third-party’s manufacturing facilities;

 

 

our ability to successfully manage inventory balances and inventory shrinkage;

 

 

disruption to our distribution operations;

 

 

risks our international business operations are subject, including risks arising from currency exchange rate fluctuations;

 

 

the potential impact of Brexit on our business;

 

 

our failure to comply with the FCPA, and other anti-corruption and anti-bribery laws, international trade restrictions and anti-money laundering laws associated with our activities outside the United States;

 

 

problems with the execution of our efforts to make our cost structure, business processes and systems more efficient;

 

 

our compliance with environmental, health and safety laws and regulations that could require us to incur material costs;

 

 

our ability to use certain tax attributes to offset future tax liabilities;

 

 

changes in tax laws, unfavorable resolution of tax contingencies, or exposure to additional income tax liabilities;

 

 

our ability to attract and retain key personnel;

 

 

adverse changes in general domestic and global economic conditions and instability and disruption of credit markets;

 

 

our failure to comply with applicable antitrust or competition laws;

 

 

our substantial indebtedness;

 

 

our ability to generate sufficient cash flow to satisfy our significant debt service obligations; and

 

 

restrictions imposed by our debt agreements that limit our flexibility in operating our business.

These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this prospectus. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, our actual results may vary in material respects from those projected in these forward-looking statements.

 

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Any forward-looking statement made by us in this prospectus speaks only as of the date of this prospectus and are expressly qualified in their entirety by the cautionary statements included in this prospectus. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, investments or other strategic transactions we may make. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable securities laws.

 

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Use of proceeds

We estimate that we will receive net proceeds of approximately $                 million from the sale of                  shares of our common stock in this offering, assuming an initial public offering price of $                 per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use the net proceeds to us from this offering to redeem $             million aggregate principal amount of the First Lien Notes, including applicable premiums. As of December 31, 2018, $590.0 million of the First Lien Notes were outstanding. In March 2019, we optionally redeemed $73.6 million aggregate principal amount of the First Lien Notes. The First Lien Notes mature on February 15, 2021 and bear interest at a rate of 7.875% per annum. For a further description of the First Lien Notes, see “Description of certain indebtedness.”

An increase (decrease) of 1,000,000 shares from the expected number of shares to be sold by us in this offering, assuming no change in the assumed initial offering price per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, would increase (decrease) our net proceeds from this offering by $                 million. A $1.00 increase (decrease) in the assumed initial offering price of $                 per share, based on the mid-point of the estimated price range set forth on the cover page of this prospectus, would increase (decrease) the net proceeds to us from this offering by $                 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. To the extent we raise more proceeds in this offering than currently estimated, we will redeem additional amounts of the First Lien Notes. To the extent we raise less proceeds in this offering than currently estimated, we will reduce the amount of the First Lien Notes that will be redeemed.

We will not receive any proceeds from the sale of shares of our common stock in this offering by the selling shareholders, including from any exercise by the underwriters of their option to purchase additional shares from the selling shareholders. The selling shareholders will bear the underwriting commissions and discounts, if any, attributable to their sale of our common stock, and we will bear the remaining expenses.

 

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Dividend policy

We currently expect to retain all future earnings for use in the operation and expansion of our business and have no current plans to pay dividends on our common stock. The declaration, amount and payment of any future dividends will be at the sole discretion of our board of directors, and will depend on, among other things, general and economic conditions, our financial condition and results of operations, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax and regulatory restrictions and implications on the payment of dividends by us to our shareholders or by our subsidiaries to us, including restrictions under our senior secured credit facilities and other indebtedness we may incur, and such other factors as our board of directors may deem relevant.

Because we are a holding company, our ability to pay dividends depends on our receipt of cash dividends from our operating subsidiaries, which may further restrict our ability to pay dividends as a result of the laws of their jurisdiction of organization, agreements of our subsidiaries or covenants under any existing and future outstanding indebtedness we or our subsidiaries incur. Certain of our subsidiaries are subject to the credit agreement governing our senior secured credit facilities and the indentures governing the Existing Notes, each containing covenants that limit such subsidiaries’ ability to make restricted payments, including dividends, and take on additional indebtedness. See “Description of certain indebtedness” for a description of the restrictions on our ability to pay dividends.

 

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Capitalization

The following table sets forth our cash and cash equivalents and capitalization as of December 31, 2018:

 

 

Acelity L.P. Inc. and its consolidated subsidiaries on an actual basis; and

 

 

KCI Holdings, Inc. and its consolidated subsidiaries on an as adjusted basis to give effect to (1) the Pre-IPO Restructuring, (2) the                  -for-one reverse stock split, which will occur prior to the consummation of this offering and (3) the issuance of                  shares of our common stock offered by us in this offering at an assumed initial public offering price of $                 per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, and the application of the net proceeds to us therefrom as described under “Use of proceeds.”

You should read this table in conjunction with the information contained in “Use of proceeds,” “Selected historical consolidated financial data,” “Management’s discussion and analysis of financial condition and results of operations” and “Description of certain indebtedness” as well as the audited consolidated financial statements and related notes thereto included elsewhere in this prospectus.

 

   
     As of December 31, 2018  
(In thousands, except par value)    Actual    

As adjusted(1)

 

Cash and cash equivalents

   $ 214,078     $                    
  

 

 

 

Debt(2):

    

Senior Secured Credit Facilities:

    

Revolving Credit Facility(3)

   $     $    

Senior Dollar Term B Credit Facility—due 2024

     1,068,725    

Senior Euro Term B Credit Facility—due 2024

     269,433    

7.875% First Lien Senior Secured Notes due 2021

     590,000    

12.5% Limited Third Lien Senior Secured Notes due 2021

     445,061    

Other debt

     2,685    
  

 

 

 

Total debt

   $ 2,375,904     $    
  

 

 

 

Shareholders’ equity:

    

Common stock, $0.01 par value per share                 shares authorized, actual;                 shares issued and outstanding, actual;                 shares authorized, as adjusted;                 shares issued and outstanding, as adjusted

   $     $    

Additional paid-in capital

        

Accumulated deficit

        

General partner’s capital

        

Limited partners’ capital

     2,173,784    

Accumulated other comprehensive loss, net

     (15,102  
  

 

 

 

Total Acelity L.P. Inc. equity

     2,158,682    
  

 

 

 

Noncontrolling interest

     (125  
  

 

 

 

Total equity (deficit)

     2,158,557    
  

 

 

 

Total capitalization

   $ 4,534,461     $    

 

 

 

(1)  

To the extent we change the number of shares of common stock sold by us in this offering from the shares we expect to sell or we change the initial public offering price from the assumed initial public offering price of $                per share, the mid-point of the estimated price range set

 

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forth on the cover page of this prospectus, or any combination of these events occurs, the net proceeds to us from this offering and each of additional paid-in capital, total equity and total capitalization may increase or decrease. A $1.00 increase (decrease) in the assumed initial public offering price of $                per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, would increase (decrease) the net proceeds that we receive in this offering and each of additional paid-in capital, total equity and total capitalization by approximately $                , assuming the number of shares offered by us remains the same as set forth on the cover page of this prospectus and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. An increase (decrease) of 1,000,000 shares in the expected number of shares to be sold by us in this offering, assuming no change in the assumed initial public offering price of $                per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, would increase (decrease) our net proceeds from this offering and each of additional paid-in capital, total equity and total capitalization by approximately $                after deducting the underwriting discount and commissions and estimated offering expenses payable by us. To the extent we raise more proceeds in this offering, we will redeem additional amounts of the First Lien Notes. To the extent we raise less proceeds in this offering, we will reduce the amount of the First Lien Notes that will be redeemed.

 

(2)   The amounts shown above exclude discounts, net of accretion, of approximately $4.1 million, $0.5 million and $0.9 million on Dollar Term B Credit Facility, Euro Term B Credit Facility and the Limited Third Lien Notes, respectively, and exclude premium, net of accretion, of approximately $4.9 million on the First Lien Notes. The as adjusted column gives effect to the write-off of approximately $                million of unamortized debt transaction costs and redemption premiums in connection with the redemption of $                million of the First Lien Notes with net proceeds from this offering. See “Use of proceeds.” For a further description of our senior secured credit facilities, the First Lien Notes and the Limited Third Lien Notes, see “Description of certain indebtedness.”

 

(3)   At December 31, 2018, we had no borrowings under our revolving credit facility and we had outstanding letters of credit issued by banks which are party to the senior secured credit facilities of $6.1 million. The resulting availability under the revolving credit facility was $293.9 million at December 31, 2018.

 

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Dilution

If you invest in our common stock in this offering, your ownership interest in us will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the as adjusted net tangible book value (deficit) per share of our common stock after giving effect to this offering. Dilution results from the fact that the per share offering price of the common stock is substantially in excess of the book value per share attributable to the shares of common stock held by existing securityholders.

Our net tangible book deficit as of December 31, 2018 was approximately $1,966 million, or $                 per share of our common stock. We calculate net tangible book deficit per share by taking the amount of our total tangible assets, reduced by the amount of our total liabilities, and then dividing that amount by the total number of shares of common stock outstanding.

After giving effect to (i) the Pre-IPO Restructuring, (ii) our sale of                shares in this offering at an assumed initial public offering price of $                 per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us and (iii) the application of the net proceeds to us from this offering as set forth under “Use of Proceeds,” our as adjusted net tangible book value (deficit) as of December 31, 2018 would have been $                million, or $                 per share of our common stock. This amount represents an immediate increase in net tangible book value (or a decrease in net tangible book deficit) of $                per share to existing shareholders and an immediate and substantial dilution in net tangible book value (deficit) of $                 per share to new investors purchasing shares in this offering at the assumed initial public offering price.

The following table illustrates this dilution on a per share basis:

 

 

Assumed initial public offering price per share

   $                    

Net tangible book deficit per share as of December 31, 2018

  

Increase in tangible book value per share attributable to new investors

  
  

 

 

 

As adjusted net tangible book value (deficit) per share after giving effect to this offering

  
  

 

 

 

Dilution per share to new investors

   $    

 

 

Dilution is determined by subtracting as adjusted net tangible book value (deficit) per share of common stock after the offering from the initial public offering price per share of common stock.

Assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, a $1.00 increase (decrease) in the assumed initial public offering price of $                 per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, would increase (decrease) the tangible book value attributable to new investors purchasing shares in this offering by $                 per share and the dilution to new investors by $                  per share and increase (decrease) the as adjusted net tangible book value (deficit) per share after giving effect to this offering by $                 per share.

The following table summarizes, as of December 31, 2018, the differences between the number of shares purchased from us, the total consideration paid to us, and the average price per share paid by existing shareholders and by new investors. As the table shows, new investors purchasing shares in this offering will pay an average price per share substantially higher than our existing shareholders paid. The table below assumes an initial public offering price of $                 per share, which is the mid-point of the estimated price range set

 

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forth on the cover page of this prospectus, for shares purchased in this offering and excludes underwriting discounts and commissions and estimated offering expenses payable by us:

 

       
      Shares purchased      Total consideration      Average price
per share
 
   Number      Percent      Amount      Percent  
     (in thousands)  

Existing shareholders

                        %      $                                          %      $                    

New investors

              

Total

                        %      $                                          %      $                    

 

 

If the underwriters were to exercise in full their option to purchase                  additional shares of our common stock from us, the percentage of shares of our common stock held by existing shareholders who are directors, officers or affiliated persons as of December 31, 2018 would be                  % and the percentage of shares of our common stock held by new investors would be                 %.

Assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, a $1.00 increase (decrease) in the assumed initial offering price of $                per share, which is the mid-point of the estimated price range set forth on the cover page of this prospectus, would increase (decrease) total consideration paid by new investors, total consideration paid by all shareholders and average price per share paid by all shareholders by $                 million, $                 million and $                 per share, respectively.

To the extent that we grant equity awards to our employees in the future and those awards are exercised or vest or other issuances of common stock are made, there will be further dilution to new investors.

 

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Selected historical consolidated financial data

Set forth below is our selected historical consolidated financial data as of the dates and for the periods indicated. The selected historical financial data as of December 31, 2017 and 2018 and for the years ended December 31, 2016, 2017 and 2018 has been derived from our audited historical consolidated financial statements included elsewhere in this prospectus. The selected historical financial data as of December 31, 2014, 2015 and 2016 and for the years ended December 31, 2014 and 2015 has been derived from our historical consolidated financial statements not included in this prospectus. The results of operations for any period are not necessarily indicative of the results to be expected for any future period. Share and per share data in the table below has been retroactively adjusted to give effect to the                  -for-one reverse stock split, which will occur prior to the consummation of this offering.

On January 31, 2017, Acelity L.P. Inc. completed the sale of its LifeCell Regenerative Medicine business to Allergan Holdco US, Inc. for $2.9 billion in cash pursuant to the Stock Purchase Agreement. The assets and liabilities subject to the Stock Purchase Agreement were presented as held for sale in the consolidated balance sheet as of December 31, 2016. The results of the operations of the LifeCell Regenerative Medicine business, excluding the allocation of general corporate overhead, are presented as discontinued operations in the consolidated statements of operations for all periods presented. Interest expense allocated to discontinued operations was $172.3 million, $182.1 million, $185.1 million and $14.8 million for the years ended December 31, 2014, 2015, 2016 and 2017, respectively. No interest expense was allocated to discontinued operations for the year ended December 31, 2018. Loss on extinguishment of debt allocated to discontinued operations was $110.1 million for the year ended December 31, 2017. No loss on extinguishment of debt was allocated to discontinued operations for the years ended December 31, 2014, 2015, 2016 or 2018.

The data presented below is the historical consolidated financial and other data of Acelity L.P. Inc. and its subsidiaries. The selected historical consolidated financial data of KCI Holdings, Inc. has not been presented as KCI Holdings, Inc. is a newly incorporated entity, has had no business transactions or activities to date and had no assets or liabilities during the periods presented in this section.

You should read the following financial information together with the information under “Capitalization” and “Management’s discussion and analysis of financial condition and results of operations” and our audited consolidated financial statements and related notes thereto included elsewhere in this prospectus.

 

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($ in thousands, except per share amounts)    Fiscal year ended December 31,  
      2014     2015     2016     2017     2018  

Operations data:

          

Revenue:

          

Rental

   $ 675,422     $ 679,589     $ 637,943     $ 598,305     $ 605,270  

Sales

     762,828       753,718       760,604       734,665       862,730  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     1,438,250       1,433,307       1,398,547       1,332,970       1,468,000  

Rental expenses

     131,583       111,898       109,459       111,563       108,243  

Cost of sales

     204,125       200,119       204,760       187,752       225,733  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     1,102,542       1,121,290       1,084,328       1,033,655       1,134,024  

Selling, general and administrative expenses

     714,706       676,101       712,359       707,378       802,638  

Research and development expenses

     40,591       35,596       34,869       35,647       42,028  

Acquired intangible asset amortization

     147,931       132,561       121,426       109,124       105,821  

Loss on sale of business

                             16,941  

Wake Forest settlement

     198,578                          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating earnings

     736       277,032       215,674       181,506       166,596  

Interest income and other

     3,667       415       1,095       7,052       2,554  

Interest expense

     (240,434     (243,050     (256,156     (181,597     (175,931

Loss on extinguishment of debt

                 (64,325     (127,161      

Foreign currency gain (loss)

     20,460       9,447       11,577       (38,515     (564

Derivative instruments gain (loss)

     (5,183     (4,959     (1,743            
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from continuing operations before income tax expense (benefit)

     (220,754 )      38,885       (93,878 )      (158,715 )      (7,345 ) 

Income tax expense (benefit)

     (79,908     20,971       (32,940     (357,097     132,380  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) from continuing operations, net of tax

     (140,846 )      17,914       (60,938 )      198,382       (139,725 ) 

Earnings (loss) from discontinued operations, net of tax

     (87,821     (62,946     (57,399     1,654,230       2,058  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss)

   $ (228,667 )    $ (45,032 )    $ (118,337 )    $ 1,852,612     $ (137,667 ) 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net loss attributable to noncontrolling
interest

                             (153
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings (loss) attributable to Acelity L.P. Inc.

   $ (228,667 )    $ (45,032 )    $ (118,337 )    $ 1,852,612     $ (137,514 ) 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share Data (unaudited):

          

Net earnings (loss) per common share:

          

Basic

   $       $       $       $       $    

Diluted

   $       $       $       $       $    

Weighted average shares

          

Basic

          

Diluted

          

Balance Sheet Data (end of period):

          

Cash and cash equivalents

   $ 183,541     $ 88,409     $ 148,747     $ 168,973     $ 214,078  

Working capital(1)

     337,472       261,192       318,378       478,164       391,080  

Total assets

     6,817,240       6,608,495       6,496,149       5,074,468       5,020,495  

Total debt(2)

     4,763,969       4,742,954       4,779,856       2,377,021       2,357,292  

Total equity

     662,519       607,595       584,718       2,350,357       2,158,557  

Cash Flow Data:

          

Net cash provided by operating activities — continuing operations(3)

   $ 104,488     $ 46,131     $ 62,317     $ 82,708     $ 218,941  

Net cash used in investing
activities — continuing operations

     (67,758     (118,966     (67,001     (65,552     (150,197

Net cash provided by (used in) financing activities

     (28,735     (41,121     48,173       (2,788,739     (112,101

Capital expenditures

     (59,528     (63,068     (62,352     (57,094     (57,645

 

 
(1)  

Working capital is defined as current assets, including cash and cash equivalents, minus current liabilities. Due to the timing of the sale of the LifeCell Regenerative Medicine business, all assets held for sale and liabilities related to assets held for sale are reflected as current assets and current liabilities on the consolidated balance sheet as of December 31, 2016. Working capital as of December 31, 2016, has been adjusted to

 

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exclude previously non-current assets and liabilities of $1.266 billion and $170.6 million, respectively, which are included in assets held for sale and liabilities related to assets held for sale on the consolidated balance sheet.

 

(2)   Total debt equals current and long-term debt, net of premium, discount and debt issuance costs, and capital lease obligations.

 

(3)   Net cash provided by operating activities from continuing operations for the years ended December 31, 2015, 2016 and 2017 was impacted by payments of $85.0 million, $85.0 million and $30.0 million, respectively, pursuant to a Settlement and Release Agreement between Kinetic Concepts, Inc. and affiliates and Wake Forest University Health Sciences dated June 30, 2014.

 

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Management’s discussion and analysis of financial condition

and results of operations

The following discussion and analysis of our financial condition and results of operations should be read together with “Summary—Summary historical consolidated financial and other data,” “Selected historical consolidated financial data” and the consolidated financial statements and related notes thereto included elsewhere in this prospectus. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including but not limited to those described in the “Risk factors” section of this prospectus. Actual results may differ materially from those contained in any forward-looking statements. You should read “Forward-looking statements” and “Risk factors.”

Overview

KCI is the leading global medical technology company focused on the development and commercialization of advanced wound care and specialty surgical solutions. Our mission is to improve patients’ lives and change the clinical practice of medicine with solutions that speed healing, reduce complications, create economic value and promote ease-of-use for clinicians. We offer a broad range of NPWT, specialty surgical and AWD products that can be used across clinical applications, care settings and clinician specialties. We have a strong history of innovation and market leadership with established competitive advantages in the advanced wound care and specialty surgical markets. By offering a range of complementary solutions that are often used together or in sequence across the treatment continuum, we are able to address patients’ needs throughout the healing process and offer healthcare providers a single source for addressing such needs.

Our ability to develop and commercialize market-leading products in advanced wound care and surgical applications is enabled by focus and expertise across our NPWT, specialty surgical and AWD product lines.

 

 

Our negative pressure wound therapy product line includes several pump and dressing technology platforms, including multiple V.A.C. Therapy device variants which address patients suffering from traumatic, surgical or chronic wounds, such as diabetic foot ulcers in the acute care and post-acute care settings. We are also focused on developing specialized and more efficacious NPWT dressings, such as V.A.C. VERAFLO CLEANSE CHOICE dressings, to address the needs of patients with complications or difficult-to-heal wounds. We have also recently launched several digital wound care solutions, including iOn PROGRESS Remote Therapy Monitoring, which monitors over 20,000 patients through engagement with over 30 managed care organizations. iOn PROGRESS enables KCI to directly engage patients, promoting improved patient therapy compliance and product usability, which have been shown to lead to faster healing times and overall cost savings. For the year ended December 31, 2018, our NPWT product line generated $1.152 billion of revenue, representing 78.5% of our total revenue and 4.5% growth compared to 2017.

 

 

Our specialty surgical product line currently consists of several products marketed under our PREVENA Incision Management and ABTHERA Open Abdomen Negative Pressure Therapy brands in the acute care setting. These innovative surgical solutions were developed by leveraging our expertise in negative pressure technology. Similar to V.A.C. Therapy, our PREVENA and ABTHERA products have improved clinical protocols because of demonstrated clinical benefit compared to the standard of care. We launched the first generation of PREVENA in 2009 and have continuously improved our offering through innovation. The PREVENA platform includes several patented configurations that manage closed surgical incisions, protecting the incision from external contamination while removing fluid and infectious material. A meta-analysis of 30 clinical trials including 11 randomized controlled trials has demonstrated that patients using PREVENA had a statistically significant reduction in the rate of surgical site infections compared to standard therapies. Increasingly, surgeons are making PREVENA a part of their regular post-operative treatment protocols in

 

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order to reduce the incidence and high cost associated with post-surgical complications. ABTHERA, which was first launched in 2009, is a temporary abdominal closure system used to manage patients with an open abdomen. In a 280 patient prospective study across 20 U.S. trauma centers, ABTHERA was shown to have a higher primary fascial closure rate versus the control, and the mortality rate for the ABTHERA group was reduced by greater than 50% compared to the control group. For the year ended December 31, 2018, our specialty surgical product line generated $137.3 million of revenue, representing 9.3% of our total revenue and 49.6% growth compared to 2017.

 

 

Our advanced wound dressings product line includes wound dressing technologies for managing chronic and acute wounds. Our AWD products are designed to maintain a moist wound environment, while managing exudate, to promote healing and to protect the wound site from infection. We participate in several AWD product categories, including foams, hydrocolloids, alginates, anti-microbials, collagens, super-absorbents, and non-adherent layers among others. With our 2013 and 2018 acquisitions of Systagenix and Crawford Healthcare, KCI now offers an innovative and differentiated portfolio of AWD broadly across categories which are complementary to our NPWT and specialty surgical product lines. We offer several leading brands in the acute and post-acute settings, including PROMOGRAN PRISMA Matrix, KERRAMAX CARE superabsorbent dressings, and ADAPTIC contact layer dressings. For the year ended December 31, 2018, our AWD product line generated $169.0 million of revenue, representing 11.5% of our total revenue and 32.3% growth compared to 2017.

KCI is a global company with approximately 29.4% and 26.1% of our revenues generated outside the United States for the years ended December 31, 2018 and 2017, respectively. Our products are available in approximately 90 countries. We have invested in direct sales and marketing channels and distributors in order to expand our presence in these markets to meet the needs of our customers and payers across clinical applications, care settings and clinician groups. A critical component of marketing our portfolio of solutions and services is our expansive and highly trained sales organization. We have over 1,500 highly trained sales professionals, over 900 of whom are based in the United States, equipped with differentiated, best-in-class product offerings, strong clinical and economic evidence, and a robust support and service infrastructure. This sales infrastructure enables us to market our products directly with trained medical professionals in specific care settings in the United States, Canada, Western Europe and key emerging markets.

We also have established strong relationships globally with key constituencies, including doctors, acute and post-acute facilities, GPOs, IDNs, private insurance and public payers. We maintain strong relationships with key clinical and economic decision makers of our customers by offering innovative products that continue to meet and exceed clinician expectations, while providing economic value and reducing the cost of care. We also support our customers with extensive customer (field) service operations in the United States and other key geographies, offering 24-hour technical and clinical support, customer service, and highly effective billing operations. Our unique customer service capabilities drive customer satisfaction, as evidenced by our industry-leading Net Promoter Score of 72. Our clinical education team works with clinicians to develop best practices for patient healing across a complex continuum of care. We conduct approximately 900 educational events annually, which educate more than 50,000 clinicians each year on the effective use of our products to help patients in need.

Since 2011, we have transformed our business into a more competitive and focused advanced wound care and specialty surgical leader. We have expanded our product portfolio through innovation and acquisitions, while divesting non-core assets. We have deleveraged our balance sheet and increased our investment capacity and operational efficiency through strategic divestitures. These actions, together with efficiencies obtained through business transformation initiatives, have enabled us to increase our focus and investment in innovation, expand our sales and marketing efforts globally, and significantly enhance our clinical education programs. We believe

 

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these actions have led to increased adoption of our products, and have established a solid foundation to support future growth and leverage our infrastructure in an effective and cost-efficient manner.

On January 31, 2017, we completed the sale of the LifeCell Regenerative Medicine business to Allergan Holdco US, Inc. for $2.9 billion in cash. The LifeCell Regenerative Medicine business is reported in this prospectus as discontinued operations in accordance with Accounting Standards Codification, or ASC, 205-20 “Presentation of financial statements—Discontinued operations.” With the divestiture of the LifeCell Regenerative Medicine business, we have one reportable operating segment which corresponds to our Advanced Wound Therapeutics business.

Material trends and uncertainties

We believe growth in the advanced wound care markets (and our NPWT and AWD product lines) will be driven by the following factors:

 

 

Favorable global demographics and aging population. The global population aged 65 and older is expected to grow from approximately 610 million people in 2015 to approximately 1.2 billion people by 2035. There is a strong correlation between age and more severe chronic and surgical wounds, increasing demand for wound care products.

 

 

Rising rates of obesity, diabetes and other chronic conditions. According to the World Health Organization, worldwide obesity has nearly tripled since 1975, and in 2016, more than 1.9 billion adults, 18 years and older, were overweight, 650 million of whom were obese. According to the International Diabetes Federation, the number of people with diabetes is expected to rise from 425 million in 2017 to 629 million by 2045. Obesity and diabetes can cause other chronic conditions, such as venous insufficiencies that can impair the healing process. Higher incidence of these chronic conditions and co-morbidities in turn lead to greater incidence and complexity of wounds, such as diabetic foot ulcers, venous leg ulcers and pressure ulcers.

 

 

Increasing acceptance of innovative technologies and protocols for complex wound treatment. Education and awareness of the benefits of new wound care technologies and proper wound care protocols have increased as medical institutions and professionals look to reduce healthcare costs by decreasing the length of hospital stays and reducing the risk of infection and readmission. This expanded acceptance of best practices has resulted in a shift away from traditional wound care modalities and increasing demand for advanced wound care treatments backed by clinical and economic evidence.

 

 

Shift to advanced treatment protocols outside of the United States. In many markets outside the United States, the incidence of chronic wounds continues to be under-addressed. As the middle class continues to grow in emerging markets, we expect there will be an increased adoption of advanced wound care due to access to better healthcare and greater awareness of the cost-effectiveness of advanced wound therapies for chronic wounds. In addition, in certain developed markets in Europe, there is increased momentum to provide healthcare in post-acute settings. As these post-acute settings develop further, we believe there will be increased adoption of advanced wound care.

 

 

Shift in revenue mix from rental products toward for-sale products. Historically, we have derived a significant portion of our revenue from the rental of our NPWT devices in the market for chronic and acute wounds. Over the last several years, we have introduced newer, higher priced consumables in our NPWT product line, which have experienced growth and have resulted in a shift of our overall revenue mix toward sales. Our customers determine whether to rent or purchase based on, among other considerations, their cost of capital, inventory management and maintenance capabilities. While our rental revenue in NPWT has grown over the last two years, our sales revenue in NPWT has increased at a faster rate, and we expect this

 

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trend to continue. Unlike our NPWT product line, our specialty surgical products are primarily for-sale products. Our AWD products are for-sale only. As our premium NPWT consumables, specialty surgical and AWD product lines continue to experience growth, we believe our revenue mix will continue to shift toward sales, consistent with the last three years. In the years ended December 31, 2018, 2017 and 2016, our rental revenue has represented approximately 41.2%, 44.9% and 45.6% of our total revenue, respectively.

We believe growth in surgical applications benefitting from our products will be driven by the following factors:

 

 

Rising volume of surgical procedures across the globe. Broadly and within the surgical indications we will target, historical data suggests that procedural volume will continue to grow low and mid-digits globally, driven in part by the growth in over 65 population and increased prevalence and incidence of targeted disease states.

 

 

Increasing awareness of surgical applications that reduce complications and can save lives. Education and awareness of the benefits of new surgical device technologies and proper post-surgical protocols have increased as medical institutions and professionals look to address the alarming increased incidence of hospital-acquired infections and the emergence of super-bugs. Government and private payers are also beginning to utilize recognition and financial incentives for facilities and providers with reduced infection rates, while reducing coverage and reimbursement for hospital-acquired conditions and readmissions. This has led to increasing interest in technologies that have been shown with clinical evidence to help reduce mortality and post-surgical complications.

 

 

Favorable global demographics and aging population. We expect that the global increases in population over the next 20 years will lead to continued growth in surgical procedures, such as total knee arthroscopy and hip replacement surgery.

 

 

Increasing personal involvement of patients in their care. Many patients undergoing highly personal and traumatic surgical procedures such as post-mastectomy breast reconstruction and certain gynecological procedures are increasing their education and participation in clinical decisions for these emotionally intensive procedures. Avoiding complications following these types of surgeries is even more important for patients than it is for facilities seeking to reduce complications on a facility level.

 

 

Shift to advanced treatment protocols outside of the United States. In emerging markets and developed markets outside the U.S., newer surgical technologies have been introduced in recent years. We expect there will continue to be increased adoption of specialty surgical applications as awareness of the clinical and economic benefits as well as best-practice medical protocols for the use of specialty surgical applications expands.

We have also managed our business in light of the following challenges:

 

 

Decreasing reimbursement levels by third-party payers. In recent years, we have experienced downward pressure on price and reimbursement levels for NPWT in the post-acute setting, primarily in the United States from public and private third-party payers. In the United States, where our NPWT revenue from Medicare represented approximately 5.6% of total revenue in 2018, we have experienced significant declines in reimbursement levels over the last five years under the CMS Competitive Bidding Program. Decreases in Medicare and lower competitive pricing have led to private payers seeking increased discounts on post-acute care NPWT placements. In light of these challenges, we have succeeded in moderating price reductions with private payers through the promotion of our differentiated technologies, clinical data, cost savings and new digital applications to improve patient care and management of treatment episodes.

 

 

Increased competition. We have faced increased competition due to an increased number of entrants into our key markets. While we have created new and rapidly-growing markets in advanced wound care and

 

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specialty surgical applications, and have sustained market leadership in many categories, our success has attracted significant aggressive competition around the world. Several of our marquee advanced wound care and specialty surgical devices and dressing configurations are priced at a significant premium to our competition’s products. Other companies often compete with us primarily on the basis of price rather than product differentiation. Our strategy to moderate the impact of price competition continues to be based on technological advantages, efficacy, and proven clinical and economic data showing reduced overall cost of care due to reduced complications and readmissions for customers using our products, when compared to the competitive offerings.

 

 

Cost containment efforts of aggregated purchasing groups in acute care. The consolidation of buying power for our acute care customers into larger purchasing groups, such as GPOs and IDNs, has increased their negotiating and purchasing power. As GPO and IDN contracts come up for renewal we have seen increased negotiation focus on price due to procurement practices of these groups. These negotiations have resulted in moderate price reductions over time, while we have succeeded in increasing adoption of newer, higher priced technologies on contract renewals, while product volumes continue to increase.

 

 

Changes in the regulatory landscape. In Europe and the United States, we expect significant changes to regulatory processes in light of new legislation and the potential withdrawal of the UK from the European Union. Changes to medical device regulations and privacy laws may result in additional cost and compliance complexities for existing products as well as slower clearance or approval times for new product introductions and line extensions.

Components of and key factors influencing our results of operations

In assessing the performance of our business, we consider a variety of performance and financial measures. We believe the items discussed below provide insight into the factors that affect these key measures.

Revenue

We derive our revenue from sales and rentals of our NPWT, specialty surgical and AWD products to acute care and post-acute care settings, including long-term care hospitals, skilled nursing facilities and wound care clinics, or directly to patients for use in their homes. Our customers determine whether to rent or purchase our products based on, among other considerations, their cost of capital, inventory management and maintenance capabilities. Revenue from rentals were approximately 52.4%, 54.1% and 55.1% of total NWPT revenue for the years ended December 31, 2018, 2017 and 2016.

Several factors affect our reported revenue in any period, including product, payer and geographic sales mix, sales of durable medical devices, operational effectiveness, pricing realization, marketing and promotional efforts, timing of orders and shipments associated with tenders, competition, business acquisitions and changes in foreign currency exchange rates.

Gross profit and gross profit margin

Gross profit is calculated as total revenue less rental expenses and cost of sales, and generally increases as revenue increases. Rental expenses are comprised of both fixed and variable costs including facilities, field service, depreciation of our rental medical equipment assets and royalties associated with our rental products.

Cost of sales includes manufacturing costs, depreciation, product costs and royalties associated with our “for sale” products. The changes in our cost of sales correspond with the changes in sales revenue. We expect our cost of sales to change due primarily to changes in sales volumes and product sales mix.

 

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Gross profit margin is calculated as gross profit divided by total revenue. Our gross profit margin is affected by product and geographic mix, sales and rental mix, realized pricing of our products and therapies, the efficiency of our manufacturing operations and the costs of materials used to make our products. Regulatory actions, including healthcare reimbursement schemes, which may require costly expenditures or result in pricing pressure, may decrease our gross profit margin.

Selling, general and administrative expenses

Selling, general and administrative, or SG&A, expenses generally include administrative labor, incentive and sales compensation costs, insurance costs, professional fees, depreciation, bad debt expense and information systems costs.

Research and development expenses

Research and development, or R&D, expenses relate to our investments in clinical studies and the development of new and enhanced products and therapies, including depreciation on equipment and facilities used by technical staff. Our R&D efforts include the development of new and synergistic technologies across the continuum of wound care. While our R&D expenses fluctuate from period to period based on the timing of specific research, clinical studies, product launches, development and testing initiatives, we generally expect these costs will increase in absolute terms over time as we continue to expand our product portfolio and add related personnel.

Income taxes

We account for income taxes using an asset and liability approach. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized.

In determining whether a valuation allowance for deferred tax assets is necessary, management analyzes both positive and negative evidence related to the realization of deferred tax assets and, inherent in that, assesses the likelihood of sufficient future taxable income. Management also considers the expected reversal of deferred tax liabilities, except those for indefinite-lived intangibles, and analyzes the period in which these would be expected to reverse in order to determine whether the taxable temporary difference amounts serve as an adequate source of future taxable income to support realizability of the deferred tax assets. Based upon this analysis, we believe the taxable temporary difference amounts provide sufficient future taxable income for utilization of the deferred tax assets, net of valuation allowances.

We have provided for additional tax on certain unrepatriated earnings that we intend to distribute in the future and have recorded a deferred tax liability in the amount of $0.4 million. Our intent is to permanently reinvest the remaining funds outside of the United States and our current plans do not demonstrate a need to repatriate the cash, other than from current earnings, to fund our U.S. operations. However, if these funds were repatriated, we would be required to accrue and pay applicable U.S. taxes (if any) and withholding taxes payable to various countries. It is not practicable to estimate the tax impact of the reversal of the outside basis difference, or the repatriation of cash due to the complexity of its hypothetical calculation.

Equity modifications

Many of our outstanding long-term incentive compensation grants are comprised of profits interest units which generally vest upon a service condition or the achievement of certain performance criteria and the occurrence of certain corporate transactions. We expect that the vesting terms of these performance-vesting profits

 

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interest units will be modified as described in “Executive compensation—Executive long-term incentives—Equity conversions and modifications.” In connection with such modifications, the Company expects to recognize an aggregate charge ranging from approximately $             to $            .

Use of constant currency

As exchange rates are an important factor in understanding period-to-period comparisons, we believe in certain cases the presentation of results on a constant currency basis in addition to reported results helps improve investors’ ability to understand our operating results and evaluate our performance in comparison to prior periods. Constant currency information compares results between periods as if exchange rates had remained constant period-over-period. We use results on a constant currency basis as one measure to evaluate our performance. In this prospectus, we calculate constant currency by calculating current-year results using prior-year foreign currency exchange rates. We generally refer to such amounts calculated on a constant currency basis as excluding or adjusting for the impact of foreign currency, or being on a constant currency basis. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not measures of performance presented in accordance with GAAP.

Items affecting comparability

The comparability of our operating results for 2018, 2017 and 2016 presented herein has been affected by the following items:

 

 

our acquisition of Crawford Healthcare, which closed on June 8, 2018, increased our revenue and cost of sales;

 

 

acquisition, disposition and financing expenses, including costs associated with the acquisition of Crawford Healthcare and disposition of Systagenix Wound Management Manufacturing, Limited with the manufacturing facility in Gargrave, England, or Systagenix Manufacturing, in 2018, the disposition of the LifeCell Regenerative Medicine business in 2017, and amendments to and refinancing of our long-term debt in 2017 and 2016; and

 

 

business optimization expenses, including labor, travel, training, consulting and other costs associated exclusively with our business optimization initiatives;

A summary of the effect of these items on earnings (loss) from continuing operations before income tax expense (benefit) for each period is noted below ($ in thousands):

 

   
     Year ended December 31,  
      2018      2017      2016  

Acquisitions, dispositions and financing expenses

   $ 45,114      $ 136,671      $ 94,477  

Business optimization expenses

     18,092        37,530        34,075  

 

  

 

 

    

 

 

    

 

 

 

The following discussion of results of operations highlights the significant changes in operating results arising from these items and transactions.

 

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Results of operations

The following table sets forth, for the periods indicated, our results of operations ($ in thousands):

 

   
     Year ended December 31,  
      2018     2017     2016  

Revenue:

      

Rental

   $ 605,270     $ 598,305     $ 637,943  

Sales

     862,730       734,665       760,604  
  

 

 

 

Total revenue

     1,468,000       1,332,970       1,398,547  

Rental expenses

     108,243       111,563       109,459  

Cost of sales

     225,733       187,752       204,760  
  

 

 

 

Gross profit

     1,134,024       1,033,655       1,084,328  

Selling, general and administrative expenses

     802,638       707,378       712,359  

Research and development expenses

     42,028       35,647       34,869  

Acquired intangible asset amortization

     105,821       109,124       121,426  

Loss on sale of business

     16,941              
  

 

 

 

Operating earnings

     166,596       181,506       215,674  

Interest income and other

     2,554       7,052       1,095  

Interest expense

     (175,931     (181,597     (256,156

Loss on extinguishment of debt

           (127,161     (64,325

Foreign currency gain (loss)

     (564     (38,515     11,577  

Derivative instruments loss

                 (1,743
  

 

 

 

Loss from continuing operations before income tax expense (benefit)

     (7,345     (158,715 )      (93,878 ) 

Income tax expense (benefit)

     132,380       (357,097     (32,940
  

 

 

 

Earnings (loss) from continuing operations, net of tax

     (139,725     198,382       (60,938 ) 

Earnings (loss) from discontinued operations, net of tax

     2,058       1,654,230       (57,399
  

 

 

 

Net earnings (loss)

     (137,667     1,852,612       (118,337 ) 

Less: Net loss attributable to noncontrolling interest

     (153            
  

 

 

 

Net earnings (loss) attributable to Acelity L.P. Inc.

   $ (137,514   $ 1,852,612     $ (118,337 ) 

 

  

 

 

   

 

 

   

 

 

 

 

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The year ended December 31, 2018, compared to the year ended December 31, 2017

Revenue by product line

The following table sets forth, for the periods indicated, revenue and the percentage changes by product line between the periods ($ in thousands):

 

   
     Year ended December 31,  
     2018 (GAAP)      2018
(Constant
currency)
     2017 (GAAP)      As reported
% change
     Constant
currency

% change(1)
 

Advanced Wound Therapeutics revenue:

              

NPWT

   $ 1,151,793      $ 1,149,274      $ 1,102,477        4.5%        4.2%  

Specialty surgical

     137,293        136,919        91,772        49.6%        49.2%  

AWD

     169,039        167,387        127,765        32.3%        31.0%  
  

 

 

       

Total – Advanced Wound Therapeutics

     1,458,125        1,453,580        1,322,014        10.3%        10.0%  
  

 

 

       

Other revenue

     9,875        9,363        10,956        (9.9)%        (14.5)%  
  

 

 

       

Total consolidated revenue

   $ 1,468,000      $ 1,462,943      $ 1,332,970        10.1%        9.8%  

 

 

 

(1)   Represents percentage change between 2018 non-GAAP constant currency revenue and 2017 GAAP revenue.

Negative pressure wound therapy

NPWT revenue for 2018 increased $49.3 million, or 4.5%, as reported on a GAAP basis, and $46.8 million, or 4.2%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $2.5 million, or 0.3%, compared to the prior year. Excluding the impact of foreign currency exchange rate movements, revenue for 2018 increased compared to the prior year due primarily to higher sales of consumables associated with increased rental volumes and sales of durable medical devices in the Americas, as well as higher sales of consumables in International.

Specialty surgical

Specialty surgical revenue for 2018 increased $45.5 million, or 49.6%, as reported on a GAAP basis, and $45.1 million, or 49.2%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $0.4 million, or 0.4%, compared to the prior year. Excluding the impact of foreign currency exchange rate movements, revenue for 2018 increased compared to the prior year due primarily to PREVENA growth in the Americas, associated with increased adoption supported by a growing body of clinical evidence that demonstrates a reduction in surgical site complications when using PREVENA versus standard of care dressings, as well as higher sales to European distributors after resetting our distributor sales channel in 2017.

Advanced wound dressings

AWD revenue for 2018 increased $41.3 million, or 32.3%, as reported on a GAAP basis, and $39.6 million, or 31.0%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $1.7 million, or 1.3%, compared to the prior year. Crawford Healthcare, which was acquired in June 2018, contributed approximately 19.1% to the increase in revenue compared to the prior year, on a constant currency basis. Excluding the impact of foreign currency exchange rate movements and the acquisition of Crawford Healthcare, revenue for 2018 increased compared to the prior year due primarily to higher sales to European distributors and double-digit growth in PROMOGRAN Matrix in the Americas.

 

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Other

Other revenue decreased $1.1 million, as reported on a GAAP basis, and decreased $1.6 million, on a constant currency basis, compared to the prior year. Other revenue consists of contract manufacturing revenue. Contract manufacturing operations were sold as part of the disposition of Systagenix Manufacturing in October 2018.

Revenue by geography

The following table sets forth, for the periods indicated, revenue and the percentage changes by geography between the periods ($ in thousands):

 

   
     Year ended December 31,  
     2018 (GAAP)      2018
(Constant
currency)
     2017 (GAAP)      As reported
% change
     Constant
currency

% change(1)
 

Americas

   $ 1,115,614      $ 1,117,346      $ 1,054,722        5.8%        5.9%  

International

     352,386        345,597        278,248        26.6%        24.2%  
  

 

 

       

Total consolidated revenue

   $ 1,468,000      $ 1,462,943      $ 1,332,970        10.1%        9.8%  

 

 

 

(1)   Represents percentage change between 2018 non-GAAP constant currency revenue and 2017 GAAP revenue.

Americas

Americas revenue for 2018 increased $60.9 million, or 5.8%, as reported on a GAAP basis, and $62.6 million, or 5.9%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements unfavorably impacted revenue by $1.7 million, or 0.1%, compared to the prior year. Crawford Healthcare, which was acquired in June 2018, contributed approximately 0.6% to the increase in revenue compared to the prior year, on a constant currency basis. Excluding the impact of foreign currency exchange rate movements and the acquisition of Crawford Healthcare, revenue for 2018 increased compared to the prior year due primarily to specialty surgical sales, led by growth in PREVENA, and higher sales of consumables associated with increased rental volumes and sales of durable medical devices.

International

International revenue for 2018 increased $74.1 million, or 26.6%, as reported on a GAAP basis, and $67.3 million, or 24.2%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $6.8 million, or 2.4%, compared to the prior year. Crawford Healthcare contributed approximately 6.7% to the increase in revenue compared to the prior year, on a constant currency basis. Excluding the impact of foreign currency exchange rate movements and the acquisition of Crawford Healthcare, revenue for 2018 increased compared to the prior year due primarily to double-digit growth in Europe after resetting our distributor sales channel in 2017 and higher sales of consumables in other international regions.

 

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Revenue relationship

The following table sets forth, for the periods indicated, the percentage relationship of each item to total revenue in the period:

 

   
     Year ended December 31,  
      2018      2017  

NPWT

     78.5%        82.7%  

Specialty surgical

     9.3%        6.9%  

AWD

     11.5%        9.6%  

Other revenue

     0.7%        0.8%  
  

 

 

 

Total consolidated revenue

     100.0%        100.0%  
  

 

 

 

Americas

     76.0%        79.1%  

International

     24.0%        20.9%  
  

 

 

 

Total consolidated revenue

     100.0%        100.0%  

 

 

Gross profit and gross profit margin

The following table presents the gross profit and gross profit margin (calculated as gross profit divided by total revenue) for the periods indicated ($ in thousands):

 

   
     Year ended December 31,  
      2018      2017  

Gross profit

   $ 1,134,024      $ 1,033,655  

Gross profit margin

     77.2%        77.5%  

 

 

Gross profit margin of 77.2% in 2018 was comparable to 77.5% in 2017. Cost of sales for 2018 increased due primarily to higher sales. Foreign currency exchange rate movements unfavorably impacted cost of sales for 2018 by $1.4 million compared to the prior year. Rental expenses for 2018 decreased due primarily to a refund received for medical device taxes and reduced costs associated with maintenance of rental medical equipment, mostly offset by increased field service costs. Foreign currency exchange rate movements unfavorably impacted rental expenses for 2018 by $0.7 million compared to the prior year.

Selling, general and administrative expenses

The following table presents SG&A expenses and the percentage relationship to total revenue ($ in thousands):

 

   
     Year ended December 31,  
      2018      2017  

Selling, general and administrative expenses

   $ 802,638      $ 707,378  

As a percent of total revenue

     54.7%        53.1%  

 

 

SG&A expenses increased by $95.3 million in 2018 compared to the prior year. Foreign currency exchange rate movements unfavorably impacted SG&A expenses for 2018 by $2.0 million, compared to the prior year. Excluding the impact of foreign currency exchange rate movements, the increase in SG&A expenses was due primarily to expansion of our U.S. sales force and increased investments in medical education, SG&A expenses associated with Crawford Healthcare, which was acquired in June of 2018, higher incentive compensation and insurance fees. SG&A expenses in the prior year included expenditures associated with restructuring our distributor network following the sale of the LifeCell Regenerative Medicine business and organizational restructuring activities.

 

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Research and development expenses

The following table presents R&D expenses and the percentage relationship to total revenue ($ in thousands):

 

   
     Year ended December 31,  
      2018      2017  

Research and development expenses

   $ 42,028      $ 35,647  

As a percent of total revenue

     2.9%        2.7%  

 

 

R&D expenses increased by $6.4 million in 2018 compared to the prior year due primarily to continued focus on innovation to drive long-term growth. Foreign currency exchange rate movements unfavorably impacted R&D expenses for 2018 by $0.3 million, compared to the prior year.

Acquired intangible asset amortization

We have recorded identifiable intangible assets in connection with the 2011 Take Private Transaction, the 2013 Systagenix acquisition, the 2018 Crawford Healthcare acquisition and various technology acquisitions. During the years ended December 31, 2018, and 2017, we recognized $105.8 million and $109.1 million, respectively, of amortization expense associated with these intangible assets.

Loss on sale of business

Loss on sale of business of $16.9 million for the year ended December 31, 2018 was due to the sale of Systagenix Manufacturing which includes an allocation of goodwill.

Interest expense

Interest expense decreased to $175.9 million in 2018 compared to $181.6 million in the prior year due primarily to the redemption of the 9.625% Second Lien Senior Secured Notes due 2021 and 12.5% Senior Notes due 2019 in February 2017.

Loss on extinguishment of debt

During 2017, we recorded $127.2 million of loss on extinguishment of debt associated with redemption of a portion of our 9.625% Second Lien Senior Secured Notes due 2021 and our 12.5% Senior Notes due 2019. During 2017, the loss on extinguishment of debt included breakage costs, the write off of net debt issuance costs and the write off of unamortized net discount of $84.5 million, $9.4 million and $33.3 million, respectively.

Foreign currency gain (loss)

Foreign currency transactions resulted in losses of $0.6 million during 2018 compared to losses of $38.5 million in the prior year. The revaluation of our Euro Term B Facility to U.S. dollars represented $13.6 million of foreign currency transaction gains during 2018 compared to losses of $34.7 million in the prior year. Excluding the revaluation of our Euro Term B Facility to U.S. dollars, we recognized foreign currency exchange losses of $14.2 million during 2018, compared to losses of $3.8 million in the prior year.

Income tax expense (benefit)

Income tax expense from continuing operations was $132.4 million for 2018, compared to income tax benefit from continuing operations of $357.1 million in the prior year. The change was due primarily to finalizing our

 

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accounting for the tax effects of the TCJA which resulted in recording valuation allowances on certain deferred tax assets. In 2017, we recorded provisional amounts for certain enactment date-effects of the TCJA by applying guidance in SAB 118 because we had not yet completed our enactment-date accounting for these effects. In 2018 we finalized our accounting for the tax effects of the TCJA in accordance with SAB 118 guidance and recorded cumulative tax adjustments of $97.7 million, primarily related to valuation allowances that have been established, partially offset by remeasurement of deferred tax liabilities, as a result of proposed regulations and guidance related to the TCJA that were issued during 2018.

Earnings from discontinued operations

Earnings from discontinued operations, net of tax, was $2.1 million for the year ended December 31, 2018, compared to $1.654 billion for the year ended December 31, 2017, which included the gain on the sale of the LifeCell Regenerative Medicine business of $1.728 billion.

Net earnings (loss) attributable to Acelity L.P. Inc.

Net loss attributable to Acelity L.P. Inc. was $137.5 million for 2018, compared to net earnings attributable to Acelity L.P. Inc. of $1.853 billion in the prior year. The change was due primarily to the gain on the sale of the LifeCell Regenerative Medicine business in 2017, changes in income taxes resulting from the TCJA, and the loss on extinguishment of debt associated with redemption of our previously-existing senior secured credit facilities, our 9.625% Second Lien Senior Secured Notes due 2021 and our 12.5% Senior Notes due 2019.

The year ended December 31, 2017 compared to the year ended December 31, 2016

Revenue by product line

The following table sets forth, for the periods indicated, revenue and the percentage changes by product line between the periods ($ in thousands):

 

   
     Year ended December 31,  
     

2017

(GAAP)

    

2017

(Constant

currency)

    

2016

(GAAP)

    

As

reported

% change

   

Constant

currency
%  change(1)

 

Advanced Wound Therapeutics revenue:

             

NPWT

   $ 1,102,477      $ 1,099,692      $ 1,154,137        (4.5 )%      (4.7 )% 

Specialty surgical

     91,772        91,682        88,809        3.3  %      3.2  % 

AWD

     127,765        128,198        144,595        (11.6 )%      (11.3 )% 
  

 

 

      

Total – Advanced Wound Therapeutics

     1,322,014        1,319,572        1,387,541        (4.7 )%      (4.9 )% 
  

 

 

      

Other revenue

     10,956        11,506        11,006        (0.5 )%      4.5  % 
  

 

 

      

Total consolidated revenue

   $ 1,332,970      $ 1,331,078      $ 1,398,547        (4.7 )%      (4.8 )% 

 

 

(1) Represents percentage change between 2017 non-GAAP constant currency revenue and 2016 GAAP revenue.

Negative pressure wound therapy

NPWT revenue for 2017 decreased $51.7 million, or 4.5%, as reported on a GAAP basis, and $54.4 million, or 4.7%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $2.8 million, or 0.2%, compared to the prior year. Medicare pricing and an

 

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unfavorable contract award, which resulted in an indirect supplier model for supplying the post-acute market, unfavorably impacted revenue by $34.2 million, or 3.0%, compared to the prior year on a constant currency basis. Excluding the impact of foreign currency exchange rate movements and Medicare pricing impacts, revenue for 2017 decreased compared to the prior year due primarily to lower sales of consumables in International.

Specialty surgical

Specialty surgical revenue for 2017 increased $3.0 million, or 3.3%, as reported on a GAAP basis, and $2.9 million, or 3.2%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $0.1 million, or 0.1%, compared to the prior year. Excluding the impact of foreign currency exchange rate movements, revenue for 2017 increased compared to the prior year due primarily to growth in the Americas, led by PREVENA, mostly offset by lower sales in Europe as we changed certain distributors and other distributors reduced their inventory due to underperformance.

Advanced wound dressings

AWD revenue for 2017 decreased $16.8 million, or 11.6%, as reported on a GAAP basis, and $16.4 million, or 11.3%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements unfavorably impacted revenue by $0.4 million, or 0.3%, compared to the prior year. Excluding the impact of foreign currency exchange rate movements, revenue for 2017 decreased compared to the prior year due primarily to lower sales in Europe as we changed certain distributors and other distributors reduced their inventory due to underperformance, partially offset by high single-digit growth in the Americas, led by PROMOGRAN Matrix.

Other

Other revenue decreased $0.1 million, as reported on a GAAP basis, and increased $0.5 million, on a constant currency basis, compared to the prior year. Other revenue consists of contract manufacturing.

Revenue by geography

The following table sets forth, for the periods indicated, revenue and the percentage changes by geography between the periods ($ in thousands):

 

   
     Year ended December 31,  
     

2017

(GAAP)

     2017
(Constant
currency)
    

2016

(GAAP)

     As
reported
% change
    Constant
currency%
change(1)
 

Americas

   $ 1,054,722      $ 1,052,912      $ 1,066,890        (1.1 )%      (1.3 )% 

International

     278,248        278,166        331,657        (16.1 )%      (16.1 )% 
  

 

 

      

Total consolidated revenue

   $ 1,332,970      $ 1,331,078      $ 1,398,547        (4.7 )%      (4.8 )% 

 

 

(1) Represents percentage change between 2017 non-GAAP constant currency revenue and 2016 GAAP revenue.

Americas

Americas revenue for 2017 decreased $12.2 million, or 1.1%, as reported on a GAAP basis, and $14.0 million, or 1.3%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements favorably impacted revenue by $1.8 million, or 0.2%, compared to the prior year. Excluding the impact of

 

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foreign currency exchange rate movements, revenue for 2017 decreased compared to the prior year due primarily to lower pricing of NPWT, partially offset by higher specialty surgical sales, led by growth in PREVENA, and higher AWD sales, led by PROMOGRAN Matrix.

International

International revenue for 2017 decreased $53.4 million, or 16.1%, as reported on a GAAP basis, and $53.5 million, or 16.1%, on a constant currency basis, compared to the prior year. Foreign currency exchange rate movements had an insignificant impact on revenue compared to the prior year. Excluding the impact of foreign currency exchange rate movements, revenue for 2017 decreased across all product lines compared to the prior year due primarily to lower sales in Europe as we changed certain distributors and other distributors reduced their inventory due to underperformance, partially offset by higher rental revenue from NPWT and sales of related consumables in other international regions.

Revenue relationship

The following table sets forth, for the periods indicated, the percentage relationship of each item to total revenue in the period:

 

   
     Year ended December 31,  
      2017      2016  

NPWT

     82.7%        82.5%  

Specialty surgical

     6.9%        6.4%  

AWD

     9.6%        10.3%  

Other revenue

     0.8%        0.8%  
  

 

 

 

Total consolidated revenue

     100.0%        100.0%  
  

 

 

 

Americas

     79.1%        76.3%  

International

     20.9%        23.7%  
  

 

 

 

Total consolidated revenue

     100.0%        100.0%  

 

 

Gross profit and gross profit margin

The following table presents the gross profit and gross profit margin (calculated as gross profit divided by total revenue) for the periods indicated ($ in thousands):

 

   
     Year ended December 31,  
      2017      2016  

Gross profit

   $ 1,033,655      $ 1,084,328  

Gross profit margin

     77.5%        77.5%  

 

 

Gross profit margin of 77.5% was comparable in 2017 and 2016. Cost of sales for 2017 decreased due primarily to volume changes associated with resetting the sale and inventory channel with certain of our European distributors. Foreign currency exchange rate movements favorably impacted cost of sales for 2017 by $0.5 million compared to the prior year period. Rental expenses for 2017 increased due primarily to higher service fees with our contracted partner related to an increase in rental volumes. Foreign currency exchange rate movements unfavorably impacted rental expense for 2017 by $0.3 million compared to the prior year.

 

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Selling, general and administrative expenses

The following table presents SG&A expenses and the percentage relationship to total revenue for the periods indicated ($ in thousands):

 

   
     Year ended December 31,  
      2017      2016  

Selling, general and administrative expenses

   $ 707,378      $ 712,359  

As a percent of total revenue

     53.1%        50.9%  

 

 

SG&A expenses decreased by $5.0 million in 2017 compared to the prior year due primarily to expenses incurred in connection with our debt transaction during 2016, partially offset by expenses incurred in connection with restructuring our distributor network following the sale of the LifeCell Regenerative Medicine business and organizational restructuring activities. Foreign currency exchange rate movements unfavorably impacted SG&A expenses for 2017 by $0.8 million, compared to the prior year.

Research and development expenses

The following table presents R&D expenses and the percentage relationship to total revenue ($ in thousands):

 

   
     Year ended December 31,  
                2017                2016  

Research and development expenses

   $ 35,647      $ 34,869  

As a percent of total revenue

     2.7%        2.5%  

 

 

R&D expenses increased by $0.8 million in 2017 compared to the prior year. Foreign currency exchange rate movements favorably impacted R&D expenses for 2017 by $0.3 million, compared to the prior year.

Acquired intangible asset amortization

We have recorded identifiable intangible assets in connection with the 2011 Take Private Transaction, the 2013 Systagenix acquisition and various technology acquisitions. During the years ended December 31, 2017 and 2016, we recognized $109.1 million and $121.4 million, respectively, of amortization expense associated with these intangible assets.

Interest expense

Interest expense related to the long-term debt that we repaid using proceeds from the sale of the LifeCell Regenerative Medicine business was allocated to discontinued operations. Interest expense allocated to discontinued operations was $14.8 million and $185.1 million for the years ended December 31, 2017 and 2016, respectively. Excluding amounts allocated to discontinued operations, interest expense decreased to $181.6 million in 2017 compared to $256.2 million in the prior year due to the use of a portion of the proceeds from our new senior secured credit facilities to redeem in full the remaining outstanding aggregate principal amount of 9.625% Second Lien Senior Secured Notes due 2021 and 12.5% Senior Notes due 2019.

Loss on extinguishment of debt

Loss on extinguishment of debt related to long-term debt that we repaid using proceeds from the sale of the LifeCell Regenerative Medicine business was allocated to discontinued operations. Loss on extinguishment of debt allocated to discontinued operations was $110.1 million for the year ended December 31, 2017. No loss on extinguishment of debt was allocated to discontinued operations for the year ended December 31, 2016.

 

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During 2017, excluding amounts allocated to discontinued operations, we recorded $127.2 million of loss on extinguishment of debt associated with redemption of a portion of our 9.625% Second Lien Senior Secured Notes due 2021 and our 12.5% Senior Notes due 2019. During 2017, the loss on extinguishment of debt included breakage costs, the write off of net debt issuance costs and the write off of unamortized net discount of $84.5 million, $9.4 million and $33.3 million, respectively. During 2016, we recorded $64.3 million of loss on extinguishment of debt associated with amendments to our senior secured credit facilities and the refinancing of our Second Lien Senior Secured Notes. During 2016, the loss on extinguishment of debt included breakage costs, the write off of net debt issuance costs and the write off of unamortized net discount of $43.0 million, $9.7 million and $11.6 million, respectively.

Foreign currency gain (loss)

Foreign currency transactions resulted in losses of $38.5 million during 2017 compared to gains of $11.6 million in the prior year. The revaluation of our Euro Term B Facility to U.S. dollars represented $34.7 million of foreign currency transaction losses during 2017 compared to gains of $7.3 million in the prior year. Excluding the revaluation of our Euro Term B Facility to U.S. dollars, we recognized foreign currency exchange losses of $3.8 million during 2017, compared to gains of $4.3 million in the prior year.

Derivative instruments loss

During 2016, we recorded a derivative instruments loss of $1.7 million due primarily to fluctuations in the value of the previously-existing interest rate derivative instruments. All interest rate derivative agreements not designated as hedging instruments expired on December 31, 2016.

Income tax benefit

The income tax benefit from continuing operations was $357.1 million for 2017, compared to $32.9 million in the prior year. The change was due primarily to the income tax benefit from the adoption of the TCJA and the change in pretax loss.

At December 31, 2017, we had not completed our accounting for the tax effects of the TCJA; however, in certain cases, as described below, we made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. In other cases, we were not able to make a reasonable estimate and continued to account for those items based on our existing accounting under ASC 740, and the provision of the tax laws that were in effect immediately prior to enactment. For the items for which we were able to determine a reasonable estimate, we recognized a provisional deferred tax benefit of $100.0 million related to the change in federal corporate tax rates applicable to our deferred tax liabilities, and $202.5 million related to the net reversal of prior amounts accrued for taxes on unremitted earnings of certain subsidiaries. We also recorded a provisional income tax expense of $1.0 million related to the tax on the deemed repatriation of the deferred foreign earnings of certain non-U.S. subsidiaries (toll charge). The toll charge is payable over eight years and therefore we recorded $0.1 million in current income taxes payable and $0.9 million in non-current tax liabilities.

The provisional estimates recorded in the 2017 consolidated financial statements were based on all available information and our initial analysis and interpretation of the legislation under the TCJA based upon official guidance issued through March 31, 2018. These estimates represented amounts for which our accounting was incomplete, but a reasonable estimate could be determined. Given the complexity of the TCJA, the proximity of the enactment date to the Company’s year end, anticipated guidance from the U.S. Treasury, and the potential for additional guidance from the SEC or the Financial Accounting Standards Board, the amounts recorded in the

 

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consolidated financial statements as of and for the year ended December 31, 2017 related to the TCJA were provisional in nature and were adjusted in 2018. SEC guidance provided for a measurement period for up to one year from the enactment date of the TCJA for which adjustments to provisional amounts may be recorded as a component of tax expense or benefit in the period the adjustment is determined.

Earnings (loss) from discontinued operations

Earnings from discontinued operations related to the sale of the LifeCell Regenerative Medicine business, net of tax, were $1.654 billion for the year ended December 31, 2017, compared to losses from discontinued operations, net of tax, of $57.4 million for the year ended December 31, 2016. Earnings from discontinued operations for the year ended December 31, 2017, includes the gain on the sale of the LifeCell Regenerative Medicine business of $1.728 billion.

Net earnings (loss) attributable to Acelity L.P. Inc.

Net earnings attributable to Acelity L.P. Inc. was $1.853 billion for 2017, compared to net loss attributable to Acelity L.P. Inc. of $118.3 million in the prior year. The change was due primarily to the gain on the sale of the LifeCell Regenerative Medicine business and the income tax benefit from the adoption of the TCJA, partially offset by increased loss on extinguishment of debt associated with repayment of our previously existing senior secured credit facilities, our 9.625% Second Lien Senior Secured Notes due 2021 and our 12.5% Senior Notes due 2019.

Liquidity and capital resources

Our primary uses of cash are 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.

Historically, our primary source of liquidity has been cash flow from operations. In addition, we also have a senior revolving credit facility to provide us with an additional source of liquidity. We anticipate that cash generated from operations together with amounts available under our senior revolving credit facility will be sufficient to meet our future working capital requirements, capital expenditures and debt service obligations as they become due for the foreseeable future. Our liquidity requirements are significant, primarily due to debt service requirements. To the extent additional funds are necessary to meet our long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through the incurrence of additional indebtedness, additional equity financings or a combination of these potential sources of funds. In the event that we need access to additional cash, we may not be able to access the credit markets on commercially acceptable terms or at all. 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, including those described under “Risk factors.”

As of December 31, 2018, prior to giving effect to this offering and the use of proceeds therefrom, our cash and cash equivalents were $214.1 million and we had approximately $2.376 billion of aggregate principal amount of indebtedness outstanding, with an additional $293.9 million availability under our senior revolving credit facility, which represents the full available amount under the senior revolving credit facility, less $6.1 million in

 

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outstanding letters of credit issued by banks which are party to the senior secured credit facilities. We also can incur additional indebtedness, including secured indebtedness, if certain specified conditions are met under the credit agreement governing the senior secured credit facilities and the indentures governing the Existing Notes.

On April 11, 2018, Acelity L.P. Inc. declared and paid a cash distribution of approximately $90.0 million in accordance with its Third Amended and Restated Partnership Agreement dated September 1, 2014. On February 3, 2017, Acelity L.P. Inc. also declared and paid a cash distribution of approximately $100.0 million in accordance with its partnership agreement.

Additionally, we and our Sponsors may from time to time seek to retire or purchase our outstanding debt through open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, may involve the use of cash and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts could materially affect our liquidity.

Cash flows

The following table summarizes the net cash provided (used) by operating activities, investing activities and financing activities for the periods indicated ($ in thousands):

 

   
     Year ended December 31,  
      2018     2017     2016  

Net cash provided by operating activities—continuing operations

   $ 218,941     $ 82,708     $ 62,317  

Net cash provided by operating activities—discontinued operations

           32,702       25,929  
  

 

 

 

Net cash provided by operating activities

   $ 218,941     $ 115,410     $ 88,246  
  

 

 

 

Net cash used by investing activities—continuing operations

   $ (150,197   $ (65,552   $ (67,001

Net cash provided (used) by investing activities—discontinued operations

     96,903       2,754,198       (7,600
  

 

 

 

Net cash provided (used) by investing activities

   $ (53,294 )    $ 2,688,646     $ (74,601 ) 
  

 

 

 

Net cash provided (used) by financing activities

   $ (112,101   $ (2,788,739   $ 48,173  

Effect of exchange rate changes on cash and cash equivalents

     (8,441     4,909       (1,480
  

 

 

 

Net increase in cash and cash equivalents

   $ 45,105     $ 20,226     $ 60,338  

 

 

Operating activities

For the year ended December 31, 2018, net cash provided by operating activities from continuing operations was $218.9 million, compared to $82.7 million for the year ended December 31, 2017. Net cash provided by operating activities from continuing operations for 2017 were unfavorably impacted by interest payments associated with our 9.625% Second Lien Senior Secured Notes due 2021 and 12.5% Senior Notes due 2019 and the final payment under our June 2014 settlement agreement with Wake Forest University Health Sciences, or Wake Forest, in the amount of $30.0 million.

For the year ended December 31, 2017, net cash provided by operating activities from continuing operations was $82.7 million, compared to $62.3 million for the year ended December 31, 2016. Net cash provided by operating activities from continuing operations for 2017 and 2016 was impacted by payments of $30.0 million and $85.0 million, respectively, pursuant to a June 2014 settlement agreement with Wake Forest. The payment made to Wake Forest in 2017 was the final payment due under the settlement agreement.

 

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Investing activities

For the year ended December 31, 2018, net cash used by investing activities from continuing operations was $150.2 million, compared to $65.6 million for the year ended December 31, 2017. Net cash used by investing activities from continuing operations for 2018 was impacted by net cash paid for the acquisition of Crawford Healthcare, partially offset by the net proceeds received from the sale of Systagenix Manufacturing. Net cash provided by investing activities from discontinued operations was comprised primarily of escrowed funds received in 2018 from the sale of the LifeCell Regenerative Medicine business and the net proceeds received from the sale of the LifeCell Regenerative Medicine business to Allergan Holdco US, Inc. in 2017.

For the year ended December 31, 2017, net cash used by investing activities from continuing operations was $65.6 million, compared to $67.0 million for the year ended December 31, 2016. Net cash used by investing activities from continuing operations was comparable to the prior year and was primarily comprised of capital expenditures. For the year ended December 31, 2017, net cash provided by investing activities from discontinued operations was comprised primarily of the net proceeds received from the sale of the LifeCell Regenerative Medicine business.

Financing activities

For the year ended December 31, 2018, net cash used by financing activities was $112.1 million, compared to $2.789 billion for the year ended December 31, 2017. Net cash used by financing activities for the year ended December 31, 2017 was due primarily to repayment of our previously existing senior secured credit facilities, our 9.625% Second Lien Senior Secured Notes due 2021 and 12.5% Senior Notes due 2019, partially offset by proceeds from our new senior secured credit facilities entered into in February 2017.

For the year ended December 31, 2017, net cash used by financing activities was $2.789 billion, compared to net cash provided by financing activities of $48.2 million for the year ended December 31, 2016. Net cash used by financing activities for the year ended December 31, 2017 was due primarily to repayment of our previously existing senior secured credit facilities, our 9.625% Second Lien Senior Secured Notes due 2021 and 12.5% Senior Notes due 2019, partially offset by proceeds from our new senior secured credit facilities entered into in February 2017.

Capital expenditures

During the years ended December 31, 2018, 2017 and 2016, we made capital expenditures for continuing operations of $57.6 million, $57.1 million and $62.4 million, respectively. Capital expenditures during the years ended December 31, 2018, 2017 and 2016 related primarily to rental fleet additions and information technology projects and purchases.

Debt

Senior secured credit facilities

In connection with the sale of the LifeCell Regenerative Medicine business, our previously existing senior secured credit facility was terminated and the obligations thereunder released in full on February 3, 2017. Also on February 3, 2017, Kinetic Concepts, Inc. and its subsidiary, KCI USA, Inc., as Borrowers, and Chiron Holdings, Inc., entered into a credit agreement with Bank of America, N.A., as administrative and collateral agent, Bank of America, N.A., Barclays Bank PLC, Goldman Sachs Bank USA, JPMorgan Chase Bank, N.A., Suntrust Robinson Humphrey, Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc. and Royal Bank of Canada, as

 

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joint lead arrangers and bookrunners, and the lenders party thereto from time to time. The new senior secured credit facilities consisted of $1.085 billion Dollar Term B Loans, or the Senior Dollar Term B Credit Facility, 239.0 million Euro Term B Loans, or the Senior Euro Term B Credit Facility, and a $300.0 million revolving credit facility. See “Description of certain indebtedness.”

The following table sets forth the amounts owed under the senior secured credit facilities, the effective interest rates on such outstanding amounts, and the amount available for additional borrowing thereunder, as of December 31, 2018 ($ in thousands):

 

         
Senior Secured Credit Facilities   

Maturity

date

    

Effective

interest

rate

   

Amount

outstanding(1)

    

Amount
available

for additional

borrowing

 

Senior Revolving Credit Facility

     February 2022        —%     $      $ 293,941 (2)  

Senior Dollar Term B Credit Facility

     February 2024        6.14% (3)       1,064,640         

Senior Euro Term B Credit Facility

     February 2024        4.04% (3)       268,922         
       

 

 

 

Total

        $ 1,333,562      $ 293,941  

 

 

 

(1)   Amounts outstanding are net of the remaining original issue discount of approximately $4.1 million and $0.5 million on the Senior Dollar Term B Credit Facility and Senior Euro Term B Credit Facility, respectively.

 

(2)   At December 31, 2018, the amount available under the revolving portion of our senior secured credit facilities reflected a reduction of $6.1 million of letters of credit issued by banks which are party to the senior secured credit facilities.

 

(3)   The effective interest rate includes the effect of the original issue discount. Excluding the original issue discount, our nominal interest rate, which is reset at the end of each quarter, as of December 31, 2018, was 6.05% on the Senior Dollar Term B Credit Facility and 4.00% on the Senior Euro Term B Credit Facility.

7.875% First Lien senior secured notes due 2021

On February 9, 2016, Kinetic Concepts, Inc. and KCI USA, Inc., or collectively the Notes Issuers, co-issued $400.0 million aggregate principal amount of 7.875% First Lien Senior Secured Notes due 2021. On June 22, 2016, the Notes Issuers co-issued an additional $190.0 million aggregate principal amount of First Lien Notes.

Interest on the First Lien Notes accrues at the rate of 7.875% per annum and is payable semi-annually in arrears on each February 15 and August 15, beginning on August 15, 2016, to the persons who are registered holders at the close of business on February 1 and August 1 immediately preceding the applicable interest payment date. The First Lien Notes issued on February 9, 2016 were issued at par and the First Lien Notes issued on June 22, 2016 were issued at a premium to par. These First Lien Notes have an effective interest rate of 7.45%.

The First Lien Notes are guaranteed, jointly and severally, on a senior secured basis, by each of Kinetic Concepts, Inc.’s subsidiaries (other than KCI USA, Inc.) (i) to the extent such entities guarantee indebtedness under the senior secured credit facilities or (ii) that are wholly owned domestic subsidiaries that (a) guarantee any other indebtedness of the Notes Issuers or any guarantor, including under the Limited Third Lien Notes or (b) incur any indebtedness under the senior secured credit facilities. The First Lien Notes and related guarantees are secured on a first-priority basis by security interests in all of the Notes Issuers’ and the guarantors’ assets that secure our senior secured credit facilities on a first-priority basis.

The Notes Issuers may redeem some or all of the First Lien Notes at redemption prices (expressed as percentages of the principal amount) equal to 101.969% from February 15, 2019 through February 14, 2020, and at par thereafter, plus accrued and unpaid interest, if any, to the redemption date. See “Description of certain indebtedness.”

In March 2019, we optionally redeemed $73.6 million aggregate principal amount of the First Lien Notes. We intend to use the net proceeds to us from this offering to redeem $             million of the First Lien Notes. To the

 

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extent we raise more proceeds in this offering than currently estimated, we will redeem additional amounts of the First Lien Notes. To the extent we raise less proceeds in this offering than currently estimated, we will reduce the amount of the First Lien Notes that will be redeemed. See “Use of proceeds.”

12.5% Limited third lien senior secured notes due 2021

On October 6, 2016, the Notes Issuers co-issued approximately $445.1 million aggregate principal amount of 12.5% Limited Third Lien Senior Secured Notes due 2021. Interest on the Limited Third Lien Notes accrues at the rate of 12.5% per annum and is payable semiannually in arrears on each May 1 and November 1, beginning on November 1, 2016, 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 Limited Third Lien Notes are guaranteed, jointly and severally, on a senior secured basis, by Acelity L.P. Inc., Acelity, Inc., Chiron Holdings, Inc. and each of Acelity L.P. Inc.’s other subsidiaries (other than the Notes Issuers) to the extent such entities incur or guarantee indebtedness under the senior secured credit facilities or guarantee any other indebtedness of the Notes Issuers or any guarantor, including the First Lien Notes. LifeCell Corporation was an initial guarantor of the Limited Third Lien Notes, but in connection with the sale of the LifeCell Regenerative Medicine business, was released from its guarantee of the Limited Third Lien Notes. The Limited Third Lien Notes are secured on a third priority basis by a perfected security interest in substantially all of the Notes Issuers’ and the guarantors’ tangible and intangible assets (subject to certain exceptions), including U.S. registered intellectual property and all of the capital stock of each of Acelity L.P. Inc.’s direct and indirect wholly-owned material restricted subsidiaries, including the Notes Issuers (limited, in the case of foreign subsidiaries and domestic foreign holding companies, to 65% of the voting capital stock of material foreign subsidiaries and domestic foreign holding companies); provided, that the maximum principal amount of the Limited Third Lien Notes and the related guarantees that are secured by third-priority security interests are $150.0 million.

At any time prior to May 1, 2019, the Notes Issuers, at their option, may redeem up to 100% of the Limited Third Lien Notes with the net cash proceeds of certain equity offerings, at a redemption price equal to 112.500% of the aggregate principal amount of the Limited Third Lien Notes being redeemed plus accrued and unpaid interest, if any.

At any time prior to May 1, 2019, the Notes Issuers, at their option, may redeem all or part of the Limited Third Lien Notes at a redemption price equal to 100% of the aggregate principal amount of the Limited Third Lien Notes to be redeemed, plus a make-whole premium plus accrued and unpaid interest, if any, to the date of redemption.

At any time on or after May 1, 2019, the Notes Issuers, at their option, may redeem the Limited Third Lien Notes, in whole or in part, at the following redemption prices (expressed as percentage of the principal amount) if redeemed during the twelve-month period commencing on May 1 of the year set forth below, plus, in each case, accrued and unpaid interest thereon, if any, to the date of redemption:

 

   
Year    Price  

2019

     109.375%  

2020 and thereafter

     100.000%  

 

 

As of December 31, 2018, we were in compliance with all covenants under the credit agreement governing the senior secured credit facilities and the indentures governing the Existing Notes.

 

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Interest rate protection

At December 31, 2018, we were party to two interest rate swap agreements which are used to convert $802.1 million of our outstanding variable-rate debt to a fixed-rate basis. These agreements, which extend through March 2021, have been designated as cash flow hedge instruments. As such, we recognize the fair value of these instruments as an asset or liability with the changes in fair value recorded in accumulated other comprehensive income until the underlying transaction affects earnings, and are then reclassified to earnings in the same account as the hedged transaction as long as the derivative is highly effective. At inception, all derivatives are expected to be highly effective. Quarterly payments under the interest rate swap agreements are due on the last day of March, June, September and December. The aggregate notional amount decreases quarterly by amounts ranging from $3.3 million to $63.4 million until maturity.

For further information on our interest rate protection agreements, see Note 6 of the notes to the consolidated financial statements included elsewhere in this prospectus.

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, 2018, prior to giving effect to this offering and the use of proceeds therefrom, for each of the periods indicated ($ in thousands):

 

           
      Less than 1
year
     1-3 years      3-5 years      More than 5
years
     Total(1)  

Long-term debt obligations(2)

   $ 13,838      $ 1,062,231      $ 29,269      $ 1,270,566      $ 2,375,904  

Interest on long-term debt obligations(2)

     178,627        331,913        144,128        6,839        661,507  

Capital lease obligations

     18        22        18               58  

Operating lease obligations

     11,320        16,708        8,631        13,381        50,040  

Purchase obligations

     40,530        65,895        45,103               151,528  

Related party management fees(3)

     4,852        9,704        8,896               23,452  
  

 

 

 

Total

   $ 249,185      $ 1,486,473      $ 236,045      $ 1,290,786      $ 3,262,489  

 

 

 

(1)   This excludes our liability of $32.6 million for unrecognized tax benefits as well as other liabilities related to indemnification associated with acquisitions and divestitures. We cannot make a reasonably reliable estimate of the amount and period of related future payments for such liabilities.

 

(2)   Amounts and timing may be different from our estimated 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. See “Certain relationships and related party transactions.”

Off-balance sheet arrangements

We did not have any material off-balance sheet arrangements as of December 31, 2018.

Critical accounting estimates

Critical accounting estimates are 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 GAAP, we must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and

 

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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.

Revenue recognition and accounts receivable realization

We recognize rental revenue in accordance with the Financial Accounting Standards Board, or the FASB, Accounting Standards Codification Topic 840, or ASC 840, “Leases.” For the years ended December 31, 2017 and 2016, we recognized sales revenue in accordance with Topic 605, “Revenue Recognition,” when each of the following four criteria were met: (1) a contract or sales arrangement existed; (2) products were shipped and title transferred or services were rendered; (3) the price of the products or services was fixed or determinable; and (4) collectability was reasonably assured. As of January 1, 2018, we recognize sales revenue in accordance with Topic 606, or ASC 606, “Revenue from Contracts with Customers.” We market our products primarily through a direct sales force. In certain international markets, we market our products through independent distributors. Our arrangements generally include deliverables associated with delivery of products recognized under ASC 606, and rental of durable medical devices, recognized under ASC 840, and typically state the price and quantity of the associated deliverables.

For deliverables associated with rental of durable medical devices, we recognize rental revenue based on the length of time a device is used by the patient/organization, (i) at the contracted rental rate for contracted customers and (ii) generally, retail price for non-contracted customers. Our leases are short-term in nature, generally providing for daily or monthly pricing, and are all classified as operating leases.

For deliverables associated with delivery of products, a five-step process is applied to determine the amount and timing for revenue recognition. The five-step process is as follows:

Step 1: Identify the contract with a customer

Our revenues from products sold and services provided to customers are primarily generated from contracts with customers. Contracts are accounted for using the portfolio method as allowable under ASC 606, whereby contracts with similar terms and performance obligations are grouped together for the application of estimates and assumptions used for the recognition of revenues. The Company does not believe that the application of the portfolio method results in a materially different outcome than applying ASC 606 to the individual contracts. Incremental costs of obtaining a contract are expensed when incurred under FASB ASC Topic 340, “Other Assets and Deferred Costs,” as the amortization period of any asset that otherwise would have been recognized would have been one year or less.

Step 2: Identify the performance obligations in the contract

Our contracts with customers generally include performance obligations associated with delivery of products. The Company also offers extended warranties and maintenance contracts for its durable medical devices. For warranties with a duration longer than the standard product warranty (generally one year), a separate performance obligation exists. If promised goods or services are deemed to be immaterial, we do not assess whether they are performance obligations.

Step 3: Determine the transaction price

Rebates are provided to certain customers, including GPOs and distributors. Rebates may also be given to customers for administrative fees, volume sales, government requirements (i.e. Medicaid) or other program specific incentives. Provisions for rebates (charge backs), as well as sales discounts and returns are accounted for as reduction of sales when revenue is recognized and are included in the allowance for revenue adjustments within trade accounts receivable or accrued liabilities, as applicable. Rebates are estimated based on contract

 

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terms, historical experience and trend analysis. In estimating rebates, the Company considers the lag time between the point of sale and the payment of the distributor’s rebate claim, distributor-specific sales trend analysis, distributor inventory available, contractual commitments, including stated rebate rates and other relevant information. Reserves are adjusted to reflect differences between estimated and actual experience and such adjustments are recorded as a reduction of sales in the period of adjustment. Other reserves are established against revenue for anticipated credit memos associated with transactions such as canceled orders, service date changes, billing errors and situations where we have not fulfilled our performance obligations. These reserves are based on historical experience. The transaction price is equal to the total consideration the Company expects to receive in return for the goods or services, net of rebates, discounts, pricing concessions and interest.

Step 4: Allocate the transaction price to the performance obligations in the contract

Our contracts with customers typically state the price and quantity of the associated deliverables. The transaction price is allocated to product sales based on the quantity sold and per unit price and to extended warranties and maintenance contracts based on the periods covered and per period price. Occasionally, extended warranties and maintenance contracts are included in the unit price of the goods sold. For contracts where the price and quantity of the associated deliverables are not stated separately, the transaction price is allocated to all deliverables using the relative standalone selling price method.

Step 5: Recognize revenue when (or as) the Company satisfies a performance obligation

The Company generally recognizes revenues for product sales upon delivery of the product to the customer, which is the point at which the customer has obtained control and the performance obligation has been satisfied, we have a present right to payment for the product, the customer has legal title to the product, we have transferred physical possession of the asset and the customer has the significant risks and rewards of ownership of the goods. For certain customers, including distributors, the Company maintains consignment inventory at the customer’s location. The Company recognizes revenues and costs associated with consignment inventory upon the notification of usage by the customer. For extended warranties and maintenance contracts revenue is recognized ratably over the term of the agreement.

In certain markets we contract with customers to provide both rental of durable medical devices and a specified number of the related consumables supplies for an “all-inclusive” package price during the rental term. For these contracts, consideration under the arrangement is allocated between the rental and sales components based on the relative time-based rental price and the price of consumables when sold separately.

For contracts which have an effective term of less than one year, and for contracts with no stated order quantities, the Company has elected to apply the practical expedient as it relates to the disclosure of its remaining performance obligations, since the variable consideration for these contracts is constrained as to the quantities of goods or services to be rendered.

The trade accounts receivable in the United States consist of amounts due directly from acute and extended care organizations, third-party payers, or TPP, both governmental and non-governmental, third-party distributors 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. Trade accounts receivable outside of the United States consist of amounts due primarily from acute care organizations and third-party distributors.

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

 

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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 collectability 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 collectability of our trade receivables at December 31, 2018 would impact pre-tax earnings (loss) by an estimated $3.4 million.

Inventory

Inventories are recorded at the lower of cost or net realizable value, with cost being determined on a first-in, first-out basis. Costs include material, labor, freight 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 monthly for excess sale products or obsolete inventory levels. Any for-sale product inventory that has excess inventory greater than the average shelf life is also reserved at 100%. For inventory associated with our rental medical equipment, 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 that specific reserve balance until the inventory is sold or otherwise disposed.

Long-lived assets

Property, plant and equipment are stated 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 (30 years for buildings and between 3 and 7 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 acquired assets and assumed liabilities are recognized 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

 

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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.

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 its fair value. The fair value of the 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. 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 5 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.

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 the reporting unit and indefinite-lived identifiable intangible assets. In the event of an approximate 25% and 9% drop in the fair value of our reporting unit and the fair value of our indefinite-lived identifiable intangible assets, respectively, the fair value of the reporting unit and indefinite-lived identifiable intangible assets would still exceed their book values as of October 31, 2018.

Income taxes

Deferred income taxes are accounted for in accordance with FASB Accounting Standards Codification Topic 740, or ASC 740, “Income Taxes,” 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 ASC 740. 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 U.S. excess interest deduction carry forward, U.S. foreign tax credits, 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

 

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differences, future earnings and inclusions of foreign income in the U.S. tax return. Accordingly, we believe that no additional valuation allowances are necessary. See Note 8 to the consolidated financial statements included elsewhere in this prospectus for further information and discussion of our income tax provision and balances, including discussion of the impacts of the TCJA enacted in December 2017.

We have provided for additional tax on certain unrepatriated earnings that we intend to distribute in the future and have recorded a deferred tax liability in the amount of $0.4 million. Our intent is to permanently reinvest the remaining funds outside of the United States and our current plans do not demonstrate a need to repatriate the cash, other than from current earnings, to fund our U.S. operations. However, if these funds were repatriated, we would be required to accrue and pay applicable U.S. taxes (if any) and withholding taxes payable to various countries. It is not practicable to estimate the tax impact of the reversal of the outside basis difference, or the repatriation of cash due to the complexity of its hypothetical calculation.

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 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 financial statements.

Recently issued accounting standards

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The objective of this ASU is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and increasing disclosure requirements to include key information about leasing arrangements. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases (with the exception of short-term leases) at the commencement date. When measuring assets and liabilities arising from a lease, a lessee should include payments to be made in optional periods, and optional payments to purchase, only if the lessee is reasonably certain to exercise the option. This new guidance continues to differentiate between finance leases and operating leases; there have been no significant changes in the recognition, measurement, and presentation of expenses and cash flows. The FASB has issued additional amendments to Topic 842 which follow the same transition guidance as ASU No. 2016-02. This standard, and subsequent amendments, will be effective for annual reporting periods beginning after December 15, 2018 and for interim periods within those fiscal years. Early adoption is permitted. The standard must be applied using a modified retrospective transition approach for leases existing either (a) at, or entered into after, the beginning of the earliest comparative period presented in the financial statements recognizing a cumulative-effect adjustment to the opening balance of retained earnings at the beginning of the earliest comparative period presented, or (b) at the adoption date, recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We have established a team to review our current accounting policies and practices, assess the effect of the standard on our lease contracts and identify potential differences. The Company plans to adopt this update using a modified retrospective approach for leases existing at the adoption date. We are evaluating this standard and related guidance and interpretations;

 

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however, we expect the adoption of this standard will result in the recognition of a significant component of our future minimum lease payments, disclosed in Note 7 of the notes to the consolidated financial statements included elsewhere in this prospectus, as right-of-use assets and lease liabilities on our balance sheet as well as additional disclosures. We do not anticipate this standard will have a material effect on our results of operations.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This standard simplifies the subsequent measurement of goodwill, including eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under the amendments in this update, the goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This standard will be effective for goodwill impairment tests in fiscal years beginning after December 15, 2019. 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.

In August 2017, the FASB issued ASU No. 2017-12 “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The objective of the ASU is to better align hedge accounting with an organization’s risk management activities in the financial statements. In addition, the ASU simplifies the application of hedge accounting guidance in areas where practice issues exist. Specifically, the amendments permit more flexibility in hedging interest rate risk for both variable rate and fixed rate financial instruments, and introduce the ability to hedge risk components for nonfinancial hedges. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early application is permitted in any interim period after issuance of the ASU for existing hedging relationships on the date of adoption and the effect of adoption should be reflected as of the beginning of the fiscal year of adoption. 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.

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This standard allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the enactment of the TCJA. This ASU is effective for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. The amendments in this update should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the TCJA is recognized. The Company will adopt this update on January 1, 2019, resulting in the reclassification of $1.9 million of income tax expense from accumulated other comprehensive loss to limited partners’ capital.

In August 2018, the FASB issued ASU No. 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This standard requires a customer in a hosting arrangement that is a service contract to capitalize certain implementation costs as if the arrangement was an internal-use software project, which requires capitalization of certain costs incurred only during the application development stage and costs to be expensed during the preliminary project and post-implementation stage. This ASU is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. This ASU may be applied prospectively to all implementation costs incurred after the date of adoption or retrospectively. The Company is evaluating this update to determine if it will have a material effect on its results of operations, financial position or disclosures.

 

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Seasonality

Historically, we have experienced a seasonal slowing of unit demand for our products 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. 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.

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 financial effects arising from the impact of fluctuating interest rates. We manage our interest rate risk on our borrowings through interest rate swap 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, 2018 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 ($ in thousands):

 

   
    Expected Maturity Date as of December 31, 2018  
     2019     2020     2021     2022     2023     Thereafter     Total     Fair Value(1)  
Long-term debt                

Fixed rate

  $ 253     $     $ 1,035,061     $ 1,145     $ 954     $ 334     $ 1,037,747     $ 1,069,806  

Weighted average interest rate

    3.000         9.864     6.000     6.000     6.000     9.853  

Variable rate

  $ 13,585     $ 13,585     $ 13,585     $ 13,585     $ 13,585     $ 1,270,232     $ 1,338,157     $ 1,303,065  

Weighted average interest rate(2)

    5.640     5.640     5.640     5.640     5.640     5.640     5.640  

Interest rate swaps(3)

               

Variable to fixed-notional amount

  $ 58,275     $ 73,275     $ 670,500     $           $     $ 802,050     $ 15,995  

Average pay rate

    1.667     1.667     1.667                 1.667  

Average receive rate(4)

    2.803     2.803     2.803                 2.803  

 

 

 

(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, 2018. These rates reset quarterly.

 

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(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 $16.0 million was positive. At December 31, 2018, $8.3 million was recorded as a current asset and $7.7 million was recorded as a long-term asset.

 

(4)   The average receive rate for future periods are based on the current period rates. These rates reset quarterly.

Foreign currency and market risk <