<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 26, 1998
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from .............. to ...........
Commission file number --
-----------------
RIVER HOLDING CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
-----------------
DELAWARE 95-4674065
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
599 LEXINGTON AVENUE, 18TH FLOOR 10022
NEW YORK, NEW YORK (Zip Code)
(Address of Principal Executive Offices)
(212) 958-2555
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report).
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [_] No [_] (Not applicable at this time)
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [_] No [_]
The number of shares of Common Stock, $.01 par value, outstanding (the only
class of common stock of the Company outstanding) was 6,300,000 on July 31,
1998.
================================================================================
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES
QUARTER ENDED JUNE 26, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements of River Holding Corp. (Unaudited)
Consolidated Balance Sheet as of June 26, 1998................................ 1
Consolidated Statements of Operations for the Three Months
Ended June 26, 1998 .......................................................... 3
Consolidated Statements of Cash Flows for the Three Months
Ended June 26, 1998 .......................................................... 4
Notes to Consolidated Financial Statements ................................... 6
Consolidated Financial Statements of Hudson Respiratory
Care, Inc. (Unaudited)
Consolidated Balance Sheets as of June 26, 1998 and
December 26, 1997 ............................................................ 10
Consolidated Statements of Operations for the Three Months
Ended June 26, 1998 and June 27, 1997 and for the Six Months
Ended June 26, 1998 and June 27, 1997 ........................................ 12
Consolidated Statements of Cash Flows for the Six Months
Ended June 26, 1998 and June 27, 1997 ........................................ 13
Notes to Consolidated Financial Statements ................................... 15
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................................... 20
Item 3. Quantitative and Qualitative Disclosures About Market Risks...................... 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................. 34
Item 2. Changes in Securities.............................................................. 34
Item 3. Defaults Upon Senior Securities.................................................... 34
Item 4. Submission of Matters to a Vote of Security Holders................................ 34
</TABLE>
<PAGE>
<TABLE>
<S> <C>
Item 5. Other Information.................................................................. 34
Item 6. Exhibits and Reports on Form 8-K................................................... 34
SIGNATURE............................................................................................ 35
</TABLE>
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED BALANCE SHEET - JUNE 26, 1998
------------------------------------------
ASSETS
------
(amounts in thousands)
<TABLE>
<CAPTION>
June 26
1998
-----------
(unaudited)
<S> <C>
CURRENT ASSETS:
Cash and short-term investments $ 5,667
Accounts receivable, less allowance for
doubtful accounts of $347 16,957
Inventories 15,125
Other assets 1,115
--------
Total current assets 38,864
--------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation and amortization 47,698
--------
OTHER ASSETS:
Deferred tax asset 15,076
Deferred financing costs, net 11,436
Intangible assets, net 4,186
Other assets 338
Goodwill, net 141,168
--------
172,204
--------
$258,766
========
</TABLE>
The accompanying notes are an integral part of
this consolidated balance sheet.
1
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED BALANCE SHEET - JUNE 26, 1998
------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
June 26
1998
-----------
(unaudited)
<S> <C>
CURRENT LIABILITIES:
Notes payable to bank $ 1,000
Accounts payable 4,401
Accrued liabilities 9,719
--------
Total current liabilities 15,120
--------
SENIOR SUBORDINATED NOTES PAYABLE 115,000
--------
NOTES PAYABLE TO BANK, net of current
portion 37,000
--------
Total liabilities 167,120
--------
MINORITY INTEREST -
MANDATORILY REDEEMABLE PREFERRED STOCK,
$100 par value: Authorized--300,000
shares, issued and outstanding--300,000
shares; liquidation preference: $30,000 29,000
Accrued preferred stock dividend, payable-in-kind 776
--------
29,776
--------
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, no par value:
Authorized--15,000,000 shares, issued and
outstanding--6,300,000 shares 63,000
Retained earnings (1,130)
--------
61,870
--------
$258,766
========
</TABLE>
The accompanying notes are an integral part of
this consolidated balance sheet.
2
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
FOR THE THREE MONTHS ENDED JUNE 26, 1998
----------------------------------------
(amounts in thousands)
<TABLE>
<CAPTION>
June 26
1998
-----------
(unaudited)
<S> <C>
NET SALES $22,432
COST OF SALES 12,169
-------
Gross profit 10,263
-------
OPERATING EXPENSES:
Selling 2,398
Distribution 1,249
General and administrative 2,603
Research and development 466
Amortization of goodwill 1,182
-------
7,898
-------
Income from operations 2,365
-------
OTHER INCOME AND (EXPENSES):
Interest expense (3,220)
Other, net 266
-------
(2,954)
-------
Loss before benefit for
income taxes (589)
BENEFIT FOR INCOME TAXES (Note 5) 235
-------
Net loss (354)
Preferred stock dividends 776
-------
Net loss available to common shareholders $(1,130)
=======
</TABLE>
The accompanying notes are an integral part of
this consolidated statement.
3
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE THREE MONTHS ENDED JUNE 26, 1998
----------------------------------------
(amounts in thousands)
<TABLE>
<CAPTION>
June 26
1998
--------
(unaudited)
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (354)
Adjustments to reconcile net income to net cash
provided by (used in) operating activities-
Depreciation and amortization 2,755
Changes in assets and liabilities, net of amounts
acquired or assumed:
Decrease in accounts receivable 1,784
Decrease in inventories 813
Increase in other current assets (195)
Increase in other assets (333)
Increase in accounts payable 1,319
Increase in accrued liabilities 4,223
--------
Net cash provided by operating activities 10,012
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Hudson Respiratory Care Inc. (248,000)
Purchases of property, plant and equipment (1,345)
--------
Net cash used in investing activities (249,345)
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to bank (2,000)
Proceeds from senior subordinated notes 115,000
Proceeds from borrowing of bank credit facility 40,000
Sale of common and preferred stock, net of
transaction costs 92,000
--------
Net cash provided by financing activities 245,000
--------
NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS 5,667
CASH AND SHORT-TERM INVESTMENTS, beginning of quarter -
--------
CASH AND SHORT-TERM INVESTMENTS, end of quarter $ 5,667
========
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
June 26
1998
--------
(unaudited)
<S> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the quarter for:
Interest $ 709
=====
Income taxes $ 66
=====
</TABLE>
The accompanying notes are an integral part of
this consolidated statement.
5
<PAGE>
RIVER HOLDING CORP. AND SUBSIDIARIES
------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
JUNE 26, 1998
-------------
(unaudited)
1. Financial Statements
--------------------
The condensed consolidated financial statements included herein have been
prepared by River Holding Corp. (Holding) and Hudson Respiratory Care, Inc. (the
Company), without audit, and include all adjustments which are, in the opinion
of management, necessary for a fair presentation of the financial position at
June 26, 1998, the results of operations for the three-month period ended June
26, 1998, and the cash flows for the three-month period ended June 26, 1998
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). All such adjustments are of a normal recurring nature. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. Although Holding
believes that the disclosures in such financial statements are adequate to make
the information presented not misleading, these consolidated financial
statements should be read in conjunction with the consolidated balance sheet of
Holding as of March 27, 1998 and with the Company's 1997 audited financial
statements and the notes thereto included in Holding's Form S-4 filed with the
SEC. The results of operations for the period presented are not necessarily
indicative of the results for a full year.
2. Recapitalization
-----------------
In April 1998, the Company consummated a plan pursuant to which a majority of
the Company was sold to Holding in accordance with an agreement and plan of
merger (the Recapitalization).
Key components of the Recapitalization include:
(1) common and preferred equity investments by Holding in consideration for an
80.8% ownership in the Company's common stock and preferred stock with an
initial liquidation preference of $30.0 million
(2) issuance by the Company of 9 1/8% senior subordinated notes with a par
value of $115.0 million, maturing in 2008 (see Note 7)
(3) execution by the Company of a new term loan facility and revolving loan
facility (see Note 7)
(4) repayment of existing indebtedness
(5) payment of amounts due under the Equity Participation Plan (see Note 6)
(6) payment for common shares acquired from the existing shareholder; this
shareholder retained a 19.2% interest in the common shares outstanding.
(7) potential contingent payments based on 1998 performance, payable to the
continuing shareholder and former participants in the Equity Participation
Plan.
The Company has terminated the Equity Participation Plan and has adopted a stock
purchase plan. The Company also plans to adopt a stock option plan Additionally,
Hudson's sole shareholder, who owned the remaining 21 percent of Industrias
Hudson, transferred this interest to the Company in consideration of one dollar.
Because of the commonality of ownership, the 21
6
<PAGE>
percent minority interest has been included in the financial statements for all
periods presented.
The investment by Holding was accounted for as a purchase and the purchase price
has been tentatively allocated as follows (amounts in thousands):
<TABLE>
<S> <C>
Assets:
Current assets and other $ 37,647
Property, plant and equipment 48,251
Deferred tax asset 15,076
Deferred financing costs 11,920
Goodwill 142,350
--------
255,244
Less liabilities:
Current liabilities 7,244
--------
Total purchase price paid $248,000
========
</TABLE>
The purchase price allocation is tentative pending further analysis of the
relative fair values of the assets acquired and liabilities assumed, and
analysis of the deferred tax asset. Goodwill is being amortized using a 30-year
life.
Holding has no operations apart from those conducted through the Company and its
subsidiaries. Accordingly, the results of operations of Holding include
activities only from the date of investment through June 26, 1998. For this
purpose, the operations for the Company's second quarter commencing March 27,
1998 have been included. The effect of including the period from March 27, 1998
to the acquisition is, in the opinion of management, not material to the results
of operations.
The minority interest in the Company was initially recorded at zero and the
Company's losses for the period ended June 26, 1998 have been solely allocated
to Holding.
3. Inventories
-----------
Inventories consisted of the following (amounts in thousands):
<TABLE>
<CAPTION>
June 26
1998
-------
<S> <C>
Raw materials $ 3,602
Work-in-process 3,819
Finished goods 7,704
-------
$15,125
=======
</TABLE>
7
<PAGE>
4. Comprehensive Income
--------------------
In June 1997, FASB issued Statement of Financial Accounting Standards (SFAS) No.
130, "Reporting Comprehensive Income". This Statement requires that all items
that meet the definition of components of comprehensive income be reported in a
financial statement for the period in which they are recognized. This Statement
is effective for fiscal years beginning after December 15, 1997 and was adopted
by Holding.
The Company had no comprehensive income adjustments for the period ended June
26, 1998.
5. Income Taxes
------------
Holding is a C corporation and the Company became a C corporation upon the
occurrence of the Recapitalization discussed in Note 2. The deferred tax asset
results from different tax bases for financial reporting and income tax
purposes, primarily arising from the Recapitalization.
The effective income tax rate for the period ended June 26, 1998 approximates
the effective combined federal and state statutory rates.
6. Equity Participation Plan
--------------------------
In conjunction with the Recapitalization discussed in Note 2 the Company paid
additional amounts pursuant to the EPP. This plan has now been terminated.
7. Long-Term Debt
--------------
New Credit Facility
In connection with the Recapitalization, the Company entered into a new credit
agreement with a bank which provides for borrowings of up to $100,000,000. This
agreement consists of two separate facilities as follows:
Revolving credit- maximum borrowings of $60,000,000 with a letter of credit
sublimit of $7,500,000. This facility must be prepaid upon payment in full
of the Term Loan facility.
Term loan- maximum borrowings of $40,000,000, with quarterly installments
to be made through maturity.
Interest on the New Credit Facility is based, at the option of the Company, upon
either a eurodollar rate plus 2.25 percent, or a base rate plus 1.25 percent per
annum. A commitment fee of 0.50 percent per annum will be charged on the unused
portion of the New Credit Facility.
The agreement provides the bank a first security interest in substantially all
of the properties and assets of the Company and a pledge of 65% of the stock of
Industrias Hudson, the Company's principal subsidiary. The agreement also
requires the Company to maintain certain financial ratios and financial
covenants, as defined in the agreement, the most restrictive of which prohibit
additional indebtedness and limit dividend payments to the
Company's stockholders. Total borrowings as of June 26, 1998 were $38,000,000
under the Term Loan Facility and bear interest at 7.875 percent per annum.
8
<PAGE>
The New Credit Facility will mature on the sixth anniversary of the closing of
the Recapitalization.
As of June 26, 1998, the Company was not in compliance with certain financial
covenants of the New Credit Facility. The Company and lenders have subsequently
amended the applicable covenants.
Senior Subordinated Notes
Also related to the Recapitalization, the Company issued under an Indenture
$115,000,000 of senior subordinated notes (the Notes). The Notes are fully
transferable and will be general unsecured obligations of the Company,
subordinated in right of payment to all existing and future Senior Debt of the
Company.
Interest on the Notes will bear interest at a rate equal to 9-1/8 percent per
annum from their date of issuance. Interest is payable semi-annually on April 15
and October 15 of each year, commencing October 15, 1998. The Notes will mature
on April 15, 2008 and will be redeemable at the option of the Company, in whole
or in part, on or after April 15, 2003.
8. Preferred Stock
---------------
Upon consummation of the Recapitalization, Holding issued 300,000 shares of
Series B Senior Exchangeable Payable-In-Kind (PIK) Preferred Stock subject to
mandatory redemption at a liquidation preference of $100 per share, plus
accumulated and unpaid dividends, if any, on April 15, 2010.
Dividends on the preferred stock will accrue at the rate per share of 11-1/2
percent per annum. Amounts due will be payable in cash, except that on each
dividend payment date occurring on or prior to April 15, 2003, dividends may be
paid at Holding's option, by the issuance of additional shares of preferred
stock (including fractional shares). Dividends will be payable semi-annually on
April 15 and October 15 of each year commencing October 15, 1998. The preferred
stock will rank junior in right of payment to all obligations of Holding and its
subsidiaries.
9. Stockholders' Equity (deficit)
------------------------------
Stockholders' equity (deficit) reflects the following (dollar amounts only in
thousands):
<TABLE>
<CAPTION>
Common Stock
------------
Number of Retained
Shares Amount Earnings Total
------------ ------- --------- ---------
<S> <C> <C> <C> <C>
BALANCE, beginning - $ - $ - $ -
Sale of common stock 6,300,000 63,000 - 63,000
Net loss - - (1,130) (1,130)
------------ ------- -------- --------
BALANCE, June 26, 1998 6,300,000 $63,000 $(1,130) $(61,870)
============ ======= ======== ========
</TABLE>
9
<PAGE>
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
<TABLE>
<CAPTION>
ASSETS
------
(amounts in thousands)
June 26 December 26
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and short-term investments $ 5,667 $ 470
Accounts receivable, less allowance
for doubtful accounts of $347
and $258 at June 26, 1998 and
December 26, 1997, respectively 16,957 21,282
Inventories 15,125 16,613
Other assets 880 1,024
-------- -------
Total current assets 38,629 39,516
-------- -------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Land 2,044 2,044
Buildings 13,369 13,369
Leasehold improvements 1,322 1,322
Machinery and equipment 60,922 61,316
Furniture and fixtures 2,223 2,128
Construction in progress 1,620 1,592
-------- -------
81,500 81,771
Less--Accumulated depreciation and
amortization 49,583 48,728
-------- -------
31,917 33,043
-------- -------
OTHER ASSETS:
Deferred tax asset 78,526 127
Deferred financing costs, net 11,436 119
Intangible assets, net 4,186 4,317
Other assets 338 559
-------- -------
94,486 4,995
-------- -------
$165,032 $77,554
======== =======
</TABLE>
The accompanying notes are an integral part of
these consolidated balance sheets.
10
<PAGE>
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
(dollar amounts in thousands)
June 26 December 26
1998 1997
----------- ------------
(unaudited)
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable to bank $ 1,000 $ 4,000
Accounts payable 4,401 3,842
Accrued liabilities 9,719 5,244
Management bonus - 20,000
-------- -------
Total current liabilities 15,120 33,086
-------- -------
SENIOR SUBORDINATED NOTES PAYABLE 115,000 -
-------- -------
NOTES PAYABLE TO BANK, net of current
portion 37,000 16,250
-------- -------
ACCRUED EQUITY PARTICIPATION PLAN COSTS - 5,703
-------- -------
Total liabilities 167,120 55,039
-------- -------
MANDATORILY REDEEMABLE PREFERRED STOCK,
$100 par value: Authorized--300,000
shares; issued and outstanding--300,000
shares at June 26, 1998; liquidation
preference: $30,000 29,000 -
Accrued preferred stock dividend,
payable-in-kind 776 -
-------- -------
29,776 -
-------- -------
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, no par value:
Authorized--15,000,000 shares, issued and
outstanding--7,800,000 and 14,468,720 shares
at June 26, 1998 and December 26, 1997 63,410 3,789
Cumulative translation adjustment (464) (345)
Retained earnings (94,810) 19,071
-------- -------
(31,864) 22,515
-------- -------
$165,032 $77,554
======== =======
</TABLE>
The accompanying notes are an integral part of
these consolidated balance sheets.
11
<PAGE>
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(amounts in thousands)
Three Months Ended Six Months Ended
------------------ -------------------
June 26 June 27 June 26 June 27
1998 1997 1998 1997
--------- -------- ------- --------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
NET SALES $ 22,432 $25,106 $ 46,697 $49,093
COST OF SALES 12,116 13,148 25,142 25,388
-------- ------- -------- -------
Gross profit 10,316 11,958 21,555 23,705
-------- ------- -------- -------
OPERATING EXPENSES:
Selling 2,373 2,457 4,691 4,789
Distribution 1,249 1,286 2,698 2,547
General and administrative 2,603 2,552 5,676 5,498
Research and development 466 477 940 895
-------- ------- -------- -------
6,691 6,772 14,005 13,729
-------- ------- -------- -------
PROVISION FOR EQUITY PARTICIPATION
PLAN AND BONUSES 61,965 1,687 63,939 3,654
PROVISION FOR RETENTION BONUSES 4,754 - 4,754 -
-------- ------- -------- -------
Income (loss) from operations (63,094) 3,499 (61,143) 6,322
-------- ------- -------- -------
OTHER INCOME AND (EXPENSES):
Interest expense (3,220) (444) (3,640) (950)
Other, net (246) (5) (254) 645
-------- ------- -------- -------
(3,466) (449) (3,894) (305)
-------- ------- -------- -------
Income (loss) before provision
(benefit) for income taxes (66,560) 3,050 (65,037) 6,017
PROVISION (BENEFIT) FOR INCOME
TAXES (Note 5) (77,001) 121 (76,978) 260
-------- ------- -------- -------
Income before extraordinary items 10,441 2,929 11,941 5,757
EXTRAORDINARY ITEM-loss on
extinguishment of debt (Note 7) 104 - 104 -
-------- ------- -------- -------
Net income 10,337 2,929 11,837 5,757
Preferred stock dividends 776 - 776 -
-------- ------- -------- -------
Net income available to
common shareholders $ 9,561 $ 2,929 $ 11,061 $ 5,757
======== ======= ======== =======
Pro forma net income (loss)
assuming C corporation status
for income tax purposes (Note 5) $(40,469) $ 1,830 $(39,556) $ 3,610
======== ======= ======== =======
</TABLE>
The accompanying notes are an integral part of
these consolidated statements.
12
<PAGE>
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(amounts in thousands)
Six Months Ended
----------------------
June 26 June 27
1998 1997
---------- ---------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 11,837 $ 5,937
Adjustments to reconcile net income to net cash
provided by (used in) operating activities-
Depreciation and amortization 2,992 2,901
Writeoff of deferred financing fees 104 -
Gain on disposal of equipment (54) (630)
Deferred tax asset benefit (78,450) -
Provision for equity participation plan (EPP) 63,939 3,654
(Increase) decrease in accounts receivable 4,325 3,763
(Increase) decrease in inventories 1,488 (1,571)
Decrease in other current assets 195 61
(Increase) decrease in other assets 221 (192)
Increase (decrease) in accounts payable 559 (787)
Increase (decrease) in accrued liabilities 4,475 (863)
Payments of EPP liabilities (89,642) -
--------- --------
Net cash provided by (used in)
operating activities (78,011) 12,273
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (1,646) (2,049)
Proceeds from sale of property, plant and equipment - 1,060
Increase in cash surrender value of life insurance - (5)
--------- --------
Net cash used in investing activities (1,646) (994)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable to bank (43,250) (6,602)
Proceeds from borrowings on bank credit facility 61,000 -
Additions to deferred financing costs (11,920) -
Redemption of stockholder interest (128,321) -
Shareholder distributions - (7,143)
Proceeds from senior subordinated debt 115,000 -
Sale of common and preferred stock,
net of transaction costs 92,000 -
--------- --------
Net cash provided by (used in)
financing activities 84,509 (13,745)
--------- --------
Effect of exchange rate changes on cash 345 7
--------- --------
NET INCREASE (DECREASE) IN CASH AND
SHORT-TERM INVESTMENTS 5,197 (2,459)
CASH AND SHORT-TERM INVESTMENTS, beginning of period 470 1,419
--------- --------
CASH AND SHORT-TERM INVESTMENTS, end of quarter $ 5,667 $ (1,040)
========= ========
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended
-----------------
June 26 June 27
1998 1997
------- -------
(unaudited)
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid during the quarter for:
Interest $1,399 $1,053
====== ======
Income taxes $ 66 $ 117
====== ======
</TABLE>
The accompanying notes are an integral part of
these consolidated statements.
14
<PAGE>
HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES
---------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
JUNE 26, 1998
-------------
(unaudited)
1. Financial Statements
--------------------
The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, and include all adjustments which are,
in the opinion of management, necessary for a fair presentation of the financial
position at June 26, 1998, the results of operations for the three-month and
six-month periods ended June 27, 1997 and June 26, 1998, and the cash flows for
the six-month periods ended June 27, 1997 and June 26, 1998 pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC). All such
adjustments are of a normal recurring nature. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. Although the Company believes that the
disclosures in such financial statements are adequate to make the information
presented not misleading, these consolidated financial statements should be read
in conjunction with the Company's 1997 audited financial statements and the
notes thereto included in its Form S-4 filed with the SEC. The results of
operations for the three-month and six-month periods ended June 27, 1997 and
June 26, 1998 are not necessarily indicative of the results for a full year.
2. Recapitalization
-----------------
In April 1998, the Company consummated a plan pursuant to which a majority of
the Company was sold in accordance with an agreement and plan of merger (the
Recapitalization).
Key components of the Recapitalization include:
(1) common and preferred equity investments in consideration for an 80.8%
ownership in the Company's common stock and preferred stock with an initial
liquidation preference of $30.0 million
(2) issuance of 9 1/8% senior subordinated notes with a par value of $115.0
million, maturing in 2008 (see Note 8)
(3) execution of a new term loan facility and revolving loan facility (see Note
8)
(4) repayment of existing indebtedness
(5) payment of amounts due under the Equity Participation Plan
(see Note 6)
(6) payment for common shares acquired from the existing shareholder; this
shareholder retained a 19.2% interest in the common shares outstanding.
(7) potential contingent payments based on 1998 performance, payable to the
continuing shareholder and former participants in the Equity Participation
Plan.
The Company has terminated the Equity Participation Plan and has adopted a stock
purchase plan. The Company also plans to adopt a stock option plan.
Additionally, Hudson's sole shareholder, who owned the remaining 21 percent of
Industrias Hudson, transferred this interest to the Company in consideration of
one dollar. Because of the commonality of ownership, the 21
15
<PAGE>
percent minority interest has been included in the financial statements for all
periods presented.
The Company effected a 245:1 stock split concurrent with the Recapitalization.
The stock split has been reflected in the stock amounts shown herein.
The Recapitalization resulted in no change to the carrying amounts of the
Company's assets and liabilities.
3. Inventories
-----------
Inventories consisted of the following (amounts in thousands):
<TABLE>
<CAPTION>
June 26 December 26
1998 1997
------- -----------
<S> <C> <C>
Raw materials $ 3,602 $ 4,802
Work-in-process 3,819 4,681
Finished goods 7,704 7,130
------- -------
$15,125 $16,613
======= =======
</TABLE>
4. Comprehensive Income
--------------------
In June 1997, FASB issued Statement of Financial Accounting Standards (SFAS) No.
130, "Reporting Comprehensive Income". This Statement requires that all items
that meet the definition of components of comprehensive income be reported in a
financial statement for the period in which they are recognized. This Statement
is effective for fiscal years beginning after December 15, 1997 and was adopted
by the Company in the quarter ended March 27, 1998.
The Company had comprehensive income for the three-month and six-month periods
ended June 27, 1997 and June 26, 1998 as follows (amounts in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- ------------------
June 26 June 27 June 26 June 27
1998 1997 1998 1997
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Net income $9,524 $2,929 $11,024 $5,757
Other comprehensive income:
Foreign currency translation
gain (loss) - (21) (119) 7
------ ------ ------- ------
Comprehensive income $9,524 $2,908 $10,905 $5,764
====== ====== ======= ======
</TABLE>
16
<PAGE>
5. Income Taxes
------------
The Company became a C corporation upon consummation of the transaction
discussed in Note 2. Accordingly, the Company has presented pro forma net income
(loss) amounts to reflect a provision for income taxes at a combined effective
rate of approximately 40%, after consideration of permanent differences between
financial reporting and income tax amounts. The pro forma amounts presented do
not include the one-time effect of the conversion to C corporation status
reflected in the June 1998 financial statements.
The actual provision for income taxes for the three-month and six-month periods
in 1998 reflect that the Company was a C corporation for a portion of the period
presented. The conversion from S corporation to C corporation resulted in a one-
time benefit of $78,526,000 in the quarter ended June 26, 1998.
The tax provision (benefit) for the three and six-month periods ended June 26,
1998 consists of the following (amounts in thousands):
<TABLE>
<CAPTION>
Three Six
Months Months
--------- ---------
<S> <C> <C>
Income taxes at combined statutory rate
of 40 percent $(26,980) $(26,370)
Effect of earnings during S corporation
period and S corporation state income
tax liability arising from Section
338(h)(10) election 28,505 27,918
Benefit of recordation of deferred tax
asset upon conversion to C corporation
status (78,526) (78,526)
-------- --------
$(77,001) $(76,978)
======== ========
</TABLE>
6. Equity Participation Plan
-------------------------
In March 1998, the Company paid previously-accrued bonuses totaling $20 million,
plus related payroll taxes. These payments were funded by additional borrowings
under the existing credit facility. The provision for equity participation plan
costs on an interim basis is based upon the expected provision for the year as a
percentage of income before the provision for Equity Participation Plan costs.
In conjunction with the Recapitalization discussed in Note 2 the Company paid
additional amounts pursuant to the Equity Participation Plan. This plan has now
been terminated.
17
<PAGE>
7. Extraordinary Item
------------------
In accordance with the Recapitalization, the Company recorded an extraordinary
loss on the extinguishment of the existing debt related to the write-off of
unamortized deferred finance fees of $104,000.
8. Long-Term Debt
--------------
New Credit Facility
In connection with the Recapitalization, the Company has entered into a new
credit agreement with a bank which provides for borrowings of up to
$100,000,000. This agreement consists of two separate facilities as follows:
Revolving credit - maximum borrowings of $60,000,000 with a letter of
credit sublimit of $7,500,000. This facility must be prepaid upon payment
in full of the Term Loan facility.
Term loan - maximum borrowings of $40,000,000, with quarterly installments
to be made through maturity.
Interest on the New Credit Facility is based, at the option of the Company, upon
either a eurodollar rate plus 2.25 percent, or a base rate plus 1.25 percent per
annum. A commitment fee of 0.50 percent per annum will be charged on the unused
portion of the New Credit Facility.
The agreement provides the bank a first security interest in substantially all
of the properties and assets of the Company and a pledge of 65% of the stock of
Industrias Hudson, the Company's principal subsidiary. The agreement also
requires the Company to maintain certain financial ratios and financial
covenants, as defined in the agreement, the most restrictive of which prohibit
additional indebtedness and limit dividend payments to the Company's
stockholders.
Total borrowings as of June 26, 1998 were $38,000,000 under the Term Loan
Facility and bear interest at 7.875 percent per annum. The New Credit Facility
will mature on the sixth anniversary of the closing of the Recapitalization.
As of June 26, 1998, the Company was not in compliance with certain financial
covenants of the New Credit Facility. The Company and lenders have subsequently
amended the applicable covenants.
Senior Subordinated Notes
Also related to the Recapitalization, the Company issued under an Indenture
$115,000,000 of senior subordinated notes (the Notes). The Notes are fully
transferable and are general unsecured obligations of the Company, subordinated
in right of payment to all existing and future senior debt, as defined, of the
Company.
Interest on the Notes bear interest at a rate equal to 9-1/8 percent per annum
from their date of issuance. Interest is payable semi-annually on April 15 and
October 15 of each year, commencing October 15, 1998. The Notes will mature on
April 15, 2008 and will be redeemable at the option of the Company, in whole or
in part, on or after April 15, 2003.
18
<PAGE>
9. Preferred Stock
---------------
Upon consummation of the Recapitalization, the Company issued 300,000 shares of
Senior Exchangeable Payable-In-Kind (PIK) Preferred Stock subject to mandatory
redemption at a liquidation preference of $100 per share, plus accumulated and
unpaid dividends, if any, on April 15, 2010.
Dividends on the preferred stock will accrue at the rate per share of 11 1/2
percent per annum. Amounts due will be payable in cash, except that on each
dividend payment date occurring on or prior to April 15, 2003, dividends may be
paid at the Company's option, by the issuance of additional shares of preferred
stock (including fractional shares). Dividends will be payable semi-annually in
arrears on April 15 and October 15 of each year commencing October 15, 1998. The
preferred stock will rank junior in right of payment to all obligations of the
Company and its subsidiaries.
10. Stockholders' Equity (Deficit)
------------------------------
Stockholders' equity (deficit) reflects the following (dollar amounts only in
thousands):
<TABLE>
<CAPTION>
Common Stock
---------------------- Cumulative
Number of Translation Retained
Shares Amount Adjustment Earnings Total
------------ -------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE, December 26, 1997 14,468,720 $ 3,789 $(345) $ 19,071 $ 22,515
Foreign currency translation
adjustment - - (119) - (119)
Stockholder redemption (12,968,720) (3,379) - (124,942) (128,321)
Recapitalization investment 6,300,000 63,000 - - 63,000
Net income - - - 11,061 11,061
----------- ------- ----- --------- ---------
BALANCE, June 26, 1998 7,800,000 $63,410 $(464) $ (94,810) $ (31,864)
=========== ======= ===== ========= =========
</TABLE>
19
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
As River Holding Corp. ("Holding") is a holding company with no operations,
the following discussion relates to Hudson Respiratory Care Inc. (the "Company"
or "Hudson RCI"). The following discussion of the Company's consolidated
historical results of operations and financial condition should be read in
conjunction with the consolidated financial statements of the Company and the
notes thereto included elsewhere in this Form 10-Q. The following discussion
and analysis covers periods before completion of the Recapitalization, as
described below. See "Risk Factors" for a further discussion relating to the
effect that the transactions described herein may have on the Company.
FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains certain "forward-looking statements" as defined
in the Private Securities Litigation Reform Act of 1995. Such statements
relating to future events and financial performance are forward-looking
statements involving risks and uncertainties that are detailed from time to time
in the Company's Securities and Exchange Commission filings.
GENERAL
The Company is a leading manufacturer and marketer of disposable medical
products utilized in the respiratory care and anesthesia segments of the
domestic and international health care markets. The Company's principal
products include oxygen masks, humidification systems, nebulizers, cannulae and
tubing. In the United States, the Company markets its products to a variety of
health care providers, including hospitals and alternate site service providers
such as outpatient surgery centers, long-term care facilities, physician offices
and home health care agencies. Internationally, the Company sells its products
to distributors who market to hospitals and other health care providers. In
1997, 63.6% of the Company's net sales were generated from the domestic hospital
market, 19.1% from the export market, 14.7% from alternate site provider market
and 2.7% from OEM and other markets. The Company's products are sold to over
2,500 distributors and alternate site service providers throughout the United
States and in more than 75 countries worldwide.
The Company developed and introduced disposable products for the anesthesia
market starting in 1995. Since that time, sales of anesthesia products have
increased and in 1997 contributed $6.5 million in net sales. Net sales from new
respiratory and anesthesia products introduced since 1992 represented
approximately 18% of the Company's total net sales in fiscal 1997. In 1994, the
Company established a sales force dedicated to sales of the Company's products
to international markets. The international sales effort has focused largely on
major and growing markets for the Company's products. In fiscal 1997, the
Company's products were sold to health care providers and distributors in more
than 75 international markets representing $19.0 million in net sales. With the
increasing trend toward providing health care outside of traditional hospital
settings and the rapid growth of alternate site health care providers, the
Company established in 1995 an independent sales force dedicated to this market.
Sales of products to alternate site distributors and/or health care providers
represented approximately $14.6 million in net sales in fiscal 1997.
The Company's results of operations may fluctuate significantly from
quarter to quarter as a result of a number of factors, including, among others,
the buying patterns of the Company's distributors, general purchasing
organizations ("GPOs") and other purchasers of the Company's products, forecasts
regarding the severity of the annual cold and flu season, announcements of new
product introductions by the Company or
20
<PAGE>
its competitors, changes in the Company's pricing of its products and the prices
offered by the Company's competitors, rate of overhead absorption due to
variability in production levels and variability in the number of shipping days
in a given quarter.
Results for the second quarter of 1998 were adversely impacted because,
among other things, of the decrease in demand from hospitals affiliated with the
Premier GPO, as the Premier contract for respiratory supplies was awarded to a
competitor of the Company, and the discontinuance of a distribution-related
strategic alliance in Germany with an international health care supplier. As a
result, the Company was not in compliance with certain covenants under the New
Credit Facility, so certain of the financial covenants in the New Credit
Facility were amended.
THE RECAPITALIZATION
On April 7, 1998, Hudson RCI consummated its recapitalization pursuant to
an Agreement and Plan of Merger pursuant to which River Acquisition Corp., a
wholly-owned subsidiary of Holding merged with and into Hudson RCI, with Hudson
RCI surviving as a majority-owned subsidiary of Holding (the "Merger").
Pursuant to the Recapitalization, Holding contributed approximately $93.0
million in equity capital into Hudson RCI (the "Holding Equity Investment") and
a shareholder of Hudson RCI (the "Continuing Shareholder") retained common stock
of Hudson RCI with a value of approximately $15.0 million (the "Rollover
Equity"), based on the valuation of Hudson RCI used in the Recapitalization. In
the Merger, a portion of the Hudson RCI common stock was converted into the
right to receive approximately $131.1 million in cash, and management received
$88.3 million pursuant to the Company's Equity Participation Plan (the "Equity
Participation Plan"). Following the Holding Equity Investment, Holding owned
80.8% of the outstanding common stock of Hudson RCI and the Continuing
Shareholder owned 19.2% of the outstanding common stock of Hudson RCI.
The Holding Equity Investment was comprised of $63.0 million of common
equity (the "Common Stock Investment") and $30.0 million of preferred equity
(the "Preferred Stock Investment"). The Common Stock Investment was funded with
a $55.0 million investment by affiliates of Freeman Spogli & Co. Incorporated
("FS&Co."), and an $8.0 million investment by management of Hudson RCI. The
Preferred Stock Investment was funded with proceeds from the sale of 11 1/2%
Senior Exchangeable PIK Preferred Stock due 2010 (the "Holding Preferred Stock")
with an aggregate liquidation preference of $30.0 million offered by Holding
(the "Preferred Stock Offering"). Immediately following consummation of the
Recapitalization, FS&Co. beneficially owned approximately 87.3% of the
outstanding common stock of Holding and management owned the remaining 12.7%.
In connection with the Recapitalization and concurrently with the Preferred
Stock Offering, Hudson RCI offered $115.0 million aggregate principal amount of
9 1/8% Senior Subordinated Notes due 2008 (the "Subordinated Notes")(the
"Subordinated Notes Offering," and together with the Preferred Stock Offering,
the "Offerings").
On April 7, 1998, Hudson RCI entered into an agreement (the "New Credit
Facility") providing for a $40.0 million secured term loan facility (the "Term
Loan Facility"), which was funded in connection with the consummation of the
Recapitalization, and a $60.0 million revolving loan facility (the "Revolving
Loan Facility") which will be available for Hudson RCI's future capital
requirements and to finance acquisitions.
21
<PAGE>
The Offerings and the application of the net proceeds therefrom, repayment
of existing Hudson RCI debt payments to the Continuing Shareholder under the
Recapitalization Agreement and to management, the Holding Equity Investment and
the related borrowings under the New Credit Facility are collectively referred
to herein as the "Recapitalization."
On April 7, 1998, the Company consummated the Recapitalization. The
Company and the shareholders that received distributions in the Recapitalization
made an election under Section 338(h)(10) of the Internal Revenue Code of 1986,
as amended, to treat the Recapitalization as an asset purchase for tax purposes,
which will have the effect of significantly increasing the basis of the
Company's assets, thus increasing depreciation and amortization expenses and
other deductions for tax purposes and reducing the Company's taxable income in
1998 and subsequent years. For Holding purposes, the acquisition was accounted
for under the purchase method. Because less than "substantially all" of the
common stock of the Company, as defined in SEC Staff Accounting Bulletin Topic
5J, was acquired, the purchase price was not pushed down to the accounts of the
Company. Accordingly, the Recapitalization resulted in no change in the basis of
the Company's assets and liabilities for financial reporting purposes.
RESULTS OF OPERATIONS
The following tables set forth, for the periods indicated, certain income
and expense items expressed in dollars and as a percentage of the Company's net
sales.
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTH PERIOD ENDED
(UNAUDITED) (UNAUDITED)
------------------------- --------------------------
JUNE 27, JUNE 26, JUNE 27, JUNE 26,
1997 1998 1997 1998
----------- ----------- ------------- -----------
(dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C>
Net sales.......................................... $25,106 $ 22,432 $49,093 $ 46,697
Cost of sales...................................... 13,148 12,116 25,388 25,142
----------- ----------- ------------- -----------
Gross profit....................................... 11,958 10,316 23,705 21,555
Selling expenses................................... 2,457 2,373 4,789 4,691
Distribution expenses.............................. 1,286 1,249 2,547 2,698
General and administrative expenses................ 2,552 2,603 5,498 5,676
Research and development expenses.................. 477 466 895 940
Provision for equity participation plan............ 1,687 61,965 3,654 63,939
----------- ----------- ------------- -----------
Total operating expenses........................... 8,459 68,656 17,383 77,944
----------- ----------- ------------- -----------
Operating income (loss)............................ 3,499 (58,340) 6,322 (56,389)
Add back: Provision for equity participation plan 1,687 61,965 3,654 63,939
Add back: Provision for retention bonuses.......... -- 4,754 -- 4,754
----------- ----------- ------------- -----------
Operating income before provisions for equity
participation plan and retention bonuses ......... $ 1,812 $ 8,379 $ 2,668 $ 12,304
=========== =========== ============= ===========
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTH PERIOD ENDED
------------------------- --------------------------
JUNE 27, JUNE 26, JUNE 27, JUNE 26,
1997 1998 1997 1998
----------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Net sales........................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales....................................... 52.4 54.0 51.7 53.8
----------- ----------- ------------- -----------
Gross profit..................................... 47.6 46.0 48.3 46.2
Selling expenses.................................... 9.8 10.6 9.8 10.0
Distribution expenses............................... 5.1 5.6 5.2 5.8
General and administrative expenses................. 10.2 11.6 11.2 12.2
Research and development expenses................... 1.9 2.1 1.9 2.0
Provision for equity participation plan............. 6.7 276.2 7.4 136.9
----------- ----------- ------------- -----------
Total operating expenses............................ 33.7 306.1 35.4 166.9
----------- ----------- ------------- -----------
Operating income (loss)............................. 13.9 (260.1) 12.9 (120.8)
Add back: Provision for equity participation plan... 6.7 276.2 7.4 136.9
Add back: Provision for retention bonuses........... -- 21.2 -- 10.2
----------- ----------- ------------- -----------
Operating income before provisions for equity
participation plan and retention bonuses........... 7.2 % 37.4 % 5.4 % 26.3 %
=========== =========== ============= ===========
</TABLE>
Three Months Ended June 26, 1998 Compared to Three Months Ended June 27, 1997
Net sales, reported net of accrued rebates, were $22.4 million in the
second quarter of 1998, a decrease of $2.7 million or 10.7% from the same
quarter in 1997. Domestic hospital sales declined by $1.5 million or 10.0%, due
primarily to the decrease in demand in hospitals affiliated with the Premier GPO
as the Premier contract for respiratory supplies was awarded to a competitor in
February 1997. Export sales declined by $1.6 million or 30.7%, primarily due to
loss of sales in southeast Asia as a result of the Asian economic crisis and a
slowdown in shipments to the European market due to delays in the availability
of product with new common European ("CE") labeling and inventory reduction
programs by a large European distributor. Substantially all of the Company's
high volume products are now in compliance with CE labeling requirements and the
shortfall represents a shift of sales from the second quarter to the third
quarter of 1998. These shortfalls were partially offset by an increase in
alternate site sales of $0.3 million or 9.8% as the Company continues to focus
its sales efforts in this growing market.
Selling expenses, consisting primarily of sales force salaries, were $2.4
million for the second quarter of 1998, a decrease of $0.1 million from the
second quarter of 1997. As a percentage of net sales, selling expenses increased
to 10.6% in the second quarter of 1998 as compared to 9.8% in the second quarter
of 1997 due to the decrease in sales volumes.
Distribution expenses, consisting primarily of freight charges from the
Company's warehouses to its domestic customers, were $1.2 million in the second
quarter of 1998, a decrease of $37,000 or 2.8% from the second quarter of 1997.
The decrease was primarily due to the lower sales volumes in the second quarter
of 1998 as compared to 1997, partially offset by increased freight rates.
General and administrative expenses consist primarily of salaries and other
expenses for corporate management, finance, accounting, regulatory and human
resources. General and administrative expenses for the second quarter of 1998
were $2.6 million and were flat as compared to the same quarter in 1997.
23
<PAGE>
Retention bonuses of $4.8 million, including related employer payroll
taxes, were paid in the second quarter of 1998 to substantially every employee
in the Company. These bonuses were intended to ensure the continued employment
of all employees after the Recapitalization and no future payments are
anticipated.
Research and development expenses for the second quarter of 1998 were
$0.5 million, a decrease of $11,000 over the second quarter of 1997.
The provision for Equity Participation Plan consists of accrued expenses
and payments made to executives under the Equity Participation Plan. In the
second quarter of 1998, as a result of the Recapitalization, the expense was
$62.0 million, which included approximately $1.3 million in employer payroll
taxes relating to the final distribution under the Equity Participation Plan
made on April 7, 1998. The Equity Participation Plan was terminated upon
consummation of the Recapitalization and replaced with an executive stock
purchase plan and stock option plan.
Interest expense was $3.2 million for the second quarter of 1998, an
increase of $2.8 million over the second quarter of 1997. This increase was due
to higher debt levels during the second quarter of 1998 as a result of the
Recapitalization.
Income tax expense reflects the effects of the termination of the Company's
S corporation status upon the Recapitalization. The Company now provides for
federal and state income taxes as a C corporation, although actual payments are
expected to be substantially less than provided amounts due to the tax bases in
assets provided by the Section 338(h)(10) election.
Six Months Ended June 26, 1998 Compared to Six Months Ended June 27, 1997
Net sales, reported net of accrued rebates, were $46.7 million in the first
six months of 1998, a decrease of $2.4 million or 4.9% from the same period in
1997. Domestic hospital sales declined by $2.9 million or 9.3%, due primarily to
the decrease in demand in hospitals affiliated with the Premier GPO as the
Premier contract for respiratory supplies was awarded to a competitor in
February, 1997. Export sales declined by $0.2 million or 2.2%, primarily due to
loss of sales in southeast Asia as a result of the Asian economic crisis and a
slowdown in shipments to the European market due to delays in availability of CE
labeled product and inventory reduction programs by a large European
distributor. Substantially all of the Company's high volume products are now in
compliance with CE labeling requirements and the shortfall represents a shift of
sales from the second quarter to the third quarter of 1998. These shortfalls
were partially offset by an increase in alternate site sales of $0.7 million or
9.5% as the Company continues focus its sales efforts in this growing market.
Selling expenses were $4.7 million for the first half of 1998, a decrease
of $0.1 million from the first half of 1997. As a percentage of net sales,
selling expenses increased to 10.0% in the first half of 1998 as compared to
9.8% in the first half of 1997 due to the lower sales volumes.
Distribution expenses were $2.7 million in the first half of 1998, an
increase of $0.2 million or 5.6% from the first half of 1997. The increase was
primarily due to increased freight rates.
General and administrative expenses for the first half of 1998 were $5.7
million, a $0.2 million increase over the second quarter of 1997. This increase
is due to payment of $300,000 in legal fees relating to the successful defense
of a patent infringement lawsuit.
24
<PAGE>
Retention bonuses of $4.8 million, including related employer payroll
taxes, were paid in the second quarter of 1998 to substantially every employee
in the Company. These bonuses were intended to ensure the continued employment
of all employees after the Recapitalization and no future payments are
anticipated.
Research and development expenses for the first half of 1998 were $0.9
million, an increase of $45,000 over the first half of 1997.
In the first half of 1998, the provision for Equity Participation Plan was
$63.9 million, which included approximately $1.3 million in employer payroll
taxes relating to the distribution made under the Equity Participation Plan.
Interest expense was $3.6 million for the first half of 1998, an increase
of $2.7 million over the first half of 1997. This increase was due to higher
debt levels during the first half of 1998 as a result of the Recapitalization.
Income tax expense reflects the effects of the termination of the Company's
S corporation status upon the Recapitalization. The Company now provides for
federal and state income taxes as a C corporation, although actual payments are
expected to be substantially less than provided amounts due to the tax bases in
assets provided by the Section 338(h)(10) election.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are cash flow from operations
and borrowing under its working capital facility. Cash provided by operations
before EPP payments totaled $12.3 million in the six months ended June 27, 1997
and $12.2 million in the six months ended June 26, 1998. The Company had
operating working capital, excluding cash and short-term debt, of $18.8 million
at June 26, 1998. Inventories were $16.6 million and $15.1 million at December
26, 1997 and June 26, 1998, respectively. In order to meet the needs of its
customers, the Company must maintain inventories sufficient to permit same-day
or next-day filling of most orders. Over time, the Company expects its level of
inventories to increase as the Company's sales in the international market
increase. Accounts receivable, net of allowances, were $21.3 million and $17.0
million at December 26, 1997 and June 26, 1998, respectively. The Company offers
30 day credit terms to its U.S. hospital distributors. Alternate site and
international customers typically receive 60 to 90 day terms and, as a result,
as the Company's alternate site and international sales have increased, the
amount and aging of its accounts receivable have increased. As a result, the
Company anticipates that the amount and aging of its accounts receivable will
continue to increase. The Company is exploring the utilization in 1998 or 1999
of a distribution warehouse outside of the United States. While this will have
the effect of increasing the Company's investment in inventories, it may also
result in improved service to international customers as well as in lower
international accounts receivable than would otherwise be the case because
customers will receive products, and consequently pay for them, more quickly.
In connection with the Recapitalization, the Company made cash payments
under the Equity Participation Plan of $88.3 million in the six months ended
June 26, 1998, which it funded with the proceeds of the debt and equity
transactions that were part of the Recapitalization.
During the six months ended June 27, 1997, net cash used in investing
activities was $1.0 million, reflecting purchases of property. During the six
months ended June 26, 1998, net cash used in investing activities was $1.6
million, primarily for capital expenditures. The Company currently
25
<PAGE>
estimates that capital expenditures will be approximately $6.0 million in each
of 1998 and 1999, consisting primarily of additional and replacement
manufacturing equipment and new heater placements.
During the six months ended June 27, 1997, net cash used in financing
activities was $13.7 million, consisting primarily of repayment of debt and
shareholder distributions. During the six months ended June 26, 1998, net cash
provided by financing was $83.9 million reflecting net borrowing by the Company.
The Company has outstanding $153.0 million of indebtedness, consisting of
$115.0 million of Subordinated Notes issued in connection with the
Recapitalization and borrowings of $38.0 million under the New Credit Facility
entered into in connection with the Recapitalization. The New Credit Facility
consists of a $40.0 million Term Loan Facility (all of which was funded in
connection with the Recapitalization) and a $60.0 million Revolving Loan
Facility. The Subordinated Notes bear interest at the rate of 9 1/8%, payable
semiannually, and will require no principal repayments until maturity. The Term
Loan Facility matures on the sixth anniversary of the initial borrowing and
requires principal repayments of between $3.0 million and $11.5 million each
year until maturity, commencing on June 30, 1999. The Revolving Loan Facility
matures on the sixth anniversary of the initial borrowing and bears interest
based on a spread over either a eurodollar or base rate.
In connection with the Recapitalization, the Company issued to Holding
300,000 shares of its 11 1/2% Senior PIK Preferred Stock due 2010 with an
aggregate liquidation preference of $30.0 million, which has terms and
provisions materially similar to those of the Holding Preferred Stock and the 11
1/2% Senior Exchangeable PIK Preferred Stock of the Company. At the election of
the Company, dividends may be paid in kind until April 15, 2003 and thereafter
must be paid in cash. At the election of Holding, dividends on the Holding
Preferred Stock may be paid in kind until April 15, 2003 and thereafter must be
paid in cash.
The Company believes that after giving effect to the Recapitalization and
the incurrence of indebtedness related thereto, based on current levels of
operations and anticipated growth, its cash from operations, together with other
available sources of liquidity, including borrowings available under the
Revolving Loan Facility, will be sufficient over the next several years to fund
anticipated capital expenditures and acquisitions and to make required payments
of principal and interest on its debt, including payments due on the
Subordinated Notes and obligations under the New Credit Facility. The Company
intends to selectively pursue strategic acquisitions, both domestically and
internationally, to expand its product line, improve its market share positions
and increase cash flows. Financing for such acquisitions is available, subject
to limitations, under the New Credit Facility. Any significant acquisition
activity by the Company in excess of such amounts would require additional
capital, which could be provided through capital contributions or debt
financing. The Company has no commitments for such acquisition financing and to
the extent financing is unavailable, acquisitions may be delayed or not
completed.
RISK FACTORS
SUBSTANTIAL LEVERAGE; SHAREHOLDERS' DEFICIT
As of June 26, 1998, Hudson RCI had $153.0 million of outstanding
indebtedness and a shareholders' deficit of $31.9 million. This level of
indebtedness is substantially higher than the Company's historical debt levels
and may reduce the flexibility of the Company to respond to changing business
and economic conditions. In addition, subject to the restrictions in the New
Credit Facility, the
26
<PAGE>
certificate of designation for the Holding Preferred Stock (the "Certificate of
Designation") and the indenture governing the Subordinated Notes (the
"Indenture"), the Company may incur additional senior or other indebtedness from
time to time to finance acquisitions or capital expenditures or for other
general corporate purposes. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
The New Credit Facility, the Certificate of Designation and the Indenture
restrict, but do not prohibit, the payment of dividends by Hudson RCI to Holding
to finance the payment of dividends on the Holding Preferred Stock.
The Company's high degree of leverage may have important consequences for
the Company and the holders of Holding Preferred Stock including: (i) the
ability of the Company to obtain additional financing for working capital,
capital expenditures, acquisitions or other purposes, if necessary, may be
impaired; (ii) a substantial portion of the Company's cash flow will be
dedicated to the payment of interest and principal on its indebtedness and will
not be available to the Company for its operations and future business
opportunities; (iii) the covenants governing the Holding Preferred Stock and
those contained in the Indenture and the New Credit Facility will limit the
Company's ability to, among other things, borrow additional funds, dispose of
assets or make investments and may affect the Company's flexibility in planning
for, and reacting to, changes in business conditions; (iv) indebtedness under
the New Credit Facility will be at variable rates of interest, which will cause
the Company to be vulnerable to increases in interest rates; (v) the Certificate
of Designation, the Indenture and the New Credit Facility contain financial and
restrictive covenants, the failure to comply with which may result in an event
of default which, if not cured or waived, could have a material adverse effect
on the Company; (vi) the indebtedness outstanding under the New Credit Facility
is secured and such indebtedness as well as indebtedness of Hudson RCI under the
Subordinated Notes matures prior to the mandatory redemption date or maturity of
the Holding Preferred Stock; (vii) the Company may be substantially more
leveraged than certain of its competitors, which may place the Company at a
competitive disadvantage; and (viii) the Company's high degree of leverage may
make it more vulnerable to a downturn in its business or the economy generally
or limit its ability to withstand competitive pressures. If the Company is
unable to generate sufficient cash flow from operations in the future to service
its indebtedness, it may be required to refinance all or a portion of its
existing debt or to obtain additional financing. There can be no assurance that
any such actions could be effected on a timely basis or on satisfactory terms or
that these actions would enable the Company to continue to satisfy its capital
requirements. The Company's ability to meet its debt service and preferred
stock dividend and redemption obligations and to reduce its total indebtedness
will be dependent upon the Company's future performance, which will be subject
to general economic conditions and to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
The terms of the Company's indebtedness, including the New Credit Facility and
the Indenture, and the terms of the Holding Preferred Stock also may prohibit
the Company from taking such actions.
HOLDING'S ABILITY TO PAY DIVIDENDS; HOLDING COMPANY STRUCTURE
The ability of Holding to pay any dividends is subject to applicable
provisions of state law and its ability to pay cash dividends on the Holding
Preferred Stock will be subject to the terms of the New Credit Facility, which
restricts Holding's ability to pay dividends, and any other indebtedness of
Holding then outstanding. Under Delaware law, Holding is permitted to pay
dividends on its capital stock, including the Holding Preferred Stock, only out
of its surplus, or in the event that it has no surplus, out of its net profits
for the year in which a dividend is declared or for the immediately preceding
fiscal year. Surplus is defined as the excess of a company's total assets over
the sum of its total liabilities plus the par value of its outstanding capital
stock. In order to pay dividends in cash, Holding must have surplus or net
profits equal to the full amount of the cash dividend at the time such dividend
is declared. Holding cannot predict
27
<PAGE>
what the value of its assets or the amount of its liabilities will be in the
future and, accordingly, there can be no assurance that Holding will be able to
pay cash dividends on the Holding Preferred Stock. In addition, Holding may be
subject to Section 2115 of the California Corporations Code. If so, under
California law, certain provisions of the California Corporations Code will be
applicable to Holding, including those relating to the payment of dividends.
These provisions, which are more restrictive than analogous provisions of
Delaware law, would permit Holding to pay dividends only if the amount of
retained earnings immediately prior to the dividend equals or exceeds the amount
of the dividend, or if immediately after payment of the dividend the sum of
Holding's assets is 1 1/4 times its liabilities and its current assets at least
equal its current liabilities (or, if Holding's average earnings before income
taxes and interest expense for the two preceding fiscal years was less than its
average interest expense for those fiscal years, Holding's current assets must
be at least 1 1/4 times its current liabilities).
Holding is a holding company, and its ability to pay dividends on the
Holding Preferred Stock is dependent upon the receipt of dividends from its
direct and indirect subsidiaries. Holding has no assets other than the capital
stock of Hudson RCI and the terms of the New Credit Facility, the Indenture and
the Certificate of Designation prohibit Holding from engaging in any business
activity other than owning the capital stock of Hudson RCI. Hudson RCI is a
party to the New Credit Facility and the Indenture, each of which imposes
restrictions on Hudson RCI's ability to pay dividends to Holding. The New
Credit Facility prohibits the Company from paying cash dividends before April
15, 2003, and any payment of dividends will be subject to the satisfaction of
certain financial conditions set forth in the Indenture. The ability of Hudson
RCI and its subsidiaries to comply with such conditions may be affected by
events that are beyond the control of the Company. The breach of any such
conditions could result in a default under the Indenture and/or the New Credit
Facility, and in the event of any such default, the holders of the Subordinated
Notes or the lenders under the New Credit Facility could elect to accelerate the
maturity of all the Subordinated Notes or the loans under the New Credit
Facility. If the maturity of the Subordinated Notes or the loans under the New
Credit Facility were to be accelerated, all such outstanding debt would be
required to be paid in full before Hudson RCI or its subsidiaries would be
permitted to distribute any assets or cash to Holding. There can be no
assurance that the assets of Hudson RCI would be sufficient to repay all of such
outstanding debt and to meet Holding's obligations under the Holding Preferred
Stock. Future borrowings by Hudson RCI can be expected to contain restrictions
or prohibitions on the payment of dividends by Hudson RCI and its subsidiaries
to Holding. In addition, under California law, a subsidiary of a company is
permitted to pay dividends on its capital stock only if the amount of the
subsidiary's retained earnings immediately prior to the dividend equals or
exceeds the amount of the dividend or if immediately after payment of the
dividend the sum of the subsidiary's assets is 1 1/4 times its liabilities and
its current assets at least equal its current liabilities (or, if Holding's
average earnings before income taxes and interest expense for the two preceding
fiscal years was less than its average interest expense for those fiscal years,
Holding's current assets must be at least 1 1/4 times its current liabilities).
California law does not permit the board of directors of the subsidiary to
revalue its assets to create retained earnings. As of June 26, 1998, Hudson RCI
had a retained deficit of $93.2 million. In addition, indebtedness outstanding
under the New Credit Facility is secured by substantially all of the assets of
the Company (including the capital stock of Hudson RCI owned by Holding). The
Certificate of Designation for the Holding Preferred Stock permits Holding to
pay dividends in additional shares of Holding Preferred Stock prior to April 15,
2003. Holding does not expect to pay cash dividends prior to such time and
there can be no assurance that Holding will have the funds necessary to pay cash
dividends on the Holding Preferred Stock at any time.
28
<PAGE>
MEDICAL COST CONTAINMENT
In recent years, widespread efforts have been made in both the public and
private sectors to control health care costs, including the prices of products
such as those sold by the Company, in the United States and abroad. Cost
containment measures have resulted in increased customer purchasing power,
particularly through the increased presence of GPOs in the marketplace and
increased consolidation of distributors. Health care organizations are
evaluating ways in which costs can be reduced by decreasing the frequency with
which a treatment, device or product is used. Cost containment has also caused
a shift in the decision making function with respect to supply acquisition from
the clinician to the administrator, resulting in a greater emphasis being placed
on price, as opposed to features and clinical benefits. The Company has
encountered significant pricing pressure from customers and believes that it is
likely that efforts by governmental and private payors to contain costs through
managed care and other efforts and to reform health systems will continue and
that such efforts may have an adverse effect on the pricing and demand for the
Company's products. There can be no assurance that current or future reform
initiatives will not have a material adverse effect on the Company's business,
financial conditions or results of operations.
The Company's products are sold principally to a variety of health care
providers, including hospitals and alternate site providers, that receive
reimbursement for the products and services they provide from various public and
private third party payors, including Medicare, Medicaid and private insurance
programs. As a result, while the Company does not receive payments directly
from such third party payors, the demand for the Company's products in any
specific care setting is dependent in part on the reimbursement policies of the
various payors in that setting. In order to be reimbursed, the products
generally must be found to be reasonable and necessary for the treatment of
medical conditions and must otherwise fall within the payor's list of covered
services. In light of increased controls on Medicare spending, there can be no
assurance on the outcome of future coverage or payment decisions for any of the
Company's products by governmental or private payors. If providers, suppliers
and other users of the Company's products are unable to obtain sufficient
reimbursement, a material adverse impact on the Company's business, financial
condition or operations may result.
The Company expects that the trend toward cost containment that has
impacted the domestic market will also be experienced in international health
care markets, impacting the Company's growth in foreign countries, particularly
where health care is socialized.
INDUSTRY CONSOLIDATION; CUSTOMER CONCENTRATION
Cost containment has resulted in significant consolidation within the
health care industry. A substantial number of the Company's customers,
including group purchasing organizations, hospitals, national nursing home
companies and national home health care agencies, have been affected by this
consolidation. The acquisition of any of the Company's significant customers
could result in the loss of such customers by the Company, thereby negatively
impacting its business, financial condition and results of operations. For
example, in 1996, three GPOs that accounted for aggregate sales of approximately
$11.0 million combined and, as a result of a decision of the combined entity to
enter into a sole distributorship arrangement in 1997 with one of the Company's
competitors, the Company has experienced some decrease in sales and may
experience additional sales decreases in the future. In addition, the
consolidation of health care providers often results in the renegotiation of
terms and in the granting of price concessions. The Company's customer
relationships, including exclusive or preferential provider relationships, are
terminable at will by either party without advance notice or penalty. Because
larger purchasers or groups of purchasers tend to have more leverage in
negotiating prices, this trend has caused
29
<PAGE>
the Company to reduce prices and could have a material adverse effect on the
Company's business, financial condition or results of operations. As GPOs and
integrated health care systems increase in size, each relationship represents a
greater concentration of market share and the adverse consequences of losing a
particular relationship increases considerably. For fiscal 1996, the Company's
ten largest group purchasing arrangements accounted for approximately 40% of the
Company's total net sales, and management believes that such arrangements
accounted for a similar percentage of net sales for fiscal 1997. Distributors
have also consolidated in response to cost containment. For fiscal 1997,
approximately 30% of the Company's net sales were to a single distributor, Owens
& Minor Inc. The loss of the Company's relationship with this distributor would
have a material adverse effect on the Company's business, financial condition
and results of operations.
GOVERNMENT REGULATION
The Company and its customers and suppliers are subject to extensive
Federal and state regulation in the United States, as well as regulation by
foreign governments. Most of the Company's products are subject to government
regulation in the United States and other countries. In the United States, the
Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and other
statutes and regulations govern or influence the testing, manufacture, safety,
labeling, storage, record keeping, marketing, advertising and promotion of such
products. Failure to comply with applicable requirements can result in fines,
recall or seizure of products, total or partial suspension of production,
withdrawal of existing product approvals or clearances, refusal to approve or
clear new applications or notices and criminal prosecution. Under the FDC Act
and similar foreign laws, the Company, as a marketer, distributor and
manufacturer of health care products, is required to obtain the approval of
Federal and foreign governmental agencies, including the Food and Drug
Administration ("FDA"), prior to marketing, distributing and manufacturing
certain of those products, which can be time consuming and expensive. The
Company may also need to obtain FDA clearance before modifying marketed products
or making new promotional claims. Delays in receipt of or failure to receive
required approvals or clearances, the loss of previously received approvals or
clearances, or failures to comply with existing or future regulatory
requirements in the United States or in foreign countries could have a material
adverse effect on the Company's business. Foreign sales are subject to similar
requirements.
The Company is required to comply with the FDA's "Quality System
Regulations for Medical Devices" implementing "Good Manufacturing Practices"
("GMP/QSR Regulations"), which set forth requirements for, among other things,
the Company's manufacturing process, design control and associated record
keeping, including testing and sterility. Further, the Company's plants and
operations are subject to review and inspection by local, state, Federal and
foreign governmental entities. The distribution of the Company's products may
also be subject to state regulation. The impact of FDA regulation on the
Company has increased in recent years as the Company has increased its
manufacturing operations. The Company's suppliers, including sterilizer
facilities, are also subject to similar governmental requirements. There can be
no assurance that changes to current regulations or additional regulations
imposed by the FDA will not have an adverse impact on the Company's business and
financial condition in the future. If the FDA believes that a company is not in
compliance with applicable regulations, it can institute proceedings to detain
or seize products, issue a recall, impose operating restrictions, enjoin future
violations and assess civil and criminal penalties against the company, its
officers or its employees and can recommend criminal prosecution to the
Department of Justice. Other regulatory agencies may have similar powers. In
addition, product approvals could be withdrawn due to the failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
marketing. The FDA also has the authority to issue special controls for devices
manufactured by the Company, which it has not done to date.
30
<PAGE>
In the event that such special controls were issued, the Company's products
would be required to conform, which could result in significant additional
expenditures for the Company.
The Company is subject to numerous federal, state and local laws and
regulations relating to such matters as safe working conditions, manufacturing
practices, fire hazard control and the handling and disposal of hazardous or
infectious materials or substances and emissions of air pollutants. The Company
owns and leases properties which are subject to environmental laws and
regulations. There can be no assurance that the Company will not be required to
incur significant costs to comply with such laws and regulations in the future
or that such laws or regulations will not have a material adverse effect upon
the Company's business, financial condition or results of operations. In
addition, the Company cannot predict the extent to which future legislative and
regulatory developments concerning its practices and products for the health
care industry may affect the Company.
RISKS RELATED TO INTERNATIONAL SALES; FOREIGN OPERATIONS
Sales made outside the United States represented approximately 19.1% of the
Company's 1997 net sales and the Company intends to increase international sales
as a percentage of total net sales. Foreign operations are subject to special
risks that can materially affect the sales, profits, cash flows and financial
position of the Company, including increased regulation, extended payment
periods, competition from firms with more local experience, currency exchange
rate fluctuations and import and export controls. Sales of the Company's
products are denominated in U.S. dollars. The destabilization of the economies
of several Asian countries in 1997 caused a decrease in demand for the Company's
products throughout Southeast Asia, and future sales in that region are
uncertain. In addition, adverse economic conditions in Asia could result in
"dumping" of products similar to those produced by the Company by other
manufacturers, both in Asian and other markets.
The Company also maintains a manufacturing and assembly facility in
Ensenada, Mexico and, as a result, is subject to operational risks such as
changing labor trends and civil unrest in that country. In the event the
Company were required to transfer its Ensenada operations to the United States
or were otherwise unable to benefit from its lower cost Mexican operation, its
business, financial condition and results of operations would be adversely
affected.
PRODUCT LIABILITY
The manufacturing and marketing of medical products entails an inherent
risk of product liability claims. Although the Company has not experienced any
significant losses due to product liability claims and currently maintains
umbrella liability insurance coverage, there can be no assurance that the amount
or scope of the coverage maintained by the Company will be adequate to protect
it in the event a significant product liability claim is successfully asserted
against the Company. In addition, the Company cannot predict the extent to
which future legislative and regulatory developments concerning its practices
and products for the health care industry may affect the Company.
DEPENDENCE ON KEY PERSONNEL; MANAGEMENT OF EXPANDING OPERATIONS
The Company's success will, to a large extent, depend upon the continued
services of its executive officers. The loss of services of any of these
executive officers could materially and adversely affect the Company. While the
Company has employment agreements with it senior management team, these
agreements may be terminated by either party, with or without cause.
31
<PAGE>
The Company's plans to expand its business may place a significant strain
on the Company's operational and financial resources and systems. To manage its
expanding operations, the Company may be required to, among other things,
improve its operational, financial and management information systems. The
Company may also be required to attract, train and retain additional highly
qualified management, technical, sales and marketing and customer support
personnel. The process of locating such personnel with the combination of
skills and attributes required to implement the Company's strategy is often
lengthy. The inability to attract and retain additional qualified personnel
could materially and adversely affect the Company.
COMPETITION
The medical supply industry is characterized by intense competition.
Certain of the Company's competitors have greater financial and other resources
than the Company and may succeed in utilizing these resources to obtain an
advantage over the Company. The general trend toward cost containment in the
health care industry has had the effect of increasing competition among
manufacturers, as health care providers and distributors consolidate and as GPOs
increase in size and importance. The Company competes on the basis of brand
name, product quality, breadth of product line, service and price.
RISKS GENERALLY ASSOCIATED WITH ACQUISITIONS
An element of the Company's business strategy is to pursue strategic
acquisitions that either expand or complement the Company's business.
Acquisitions involve a number of special risks, including the diversion of
management's attention to the assimilation of the operations and the
assimilation and retention of the personnel of the acquired companies, and
potential adverse effects on the Company's operating results. The Company may
require additional debt or equity financing for future acquisitions, which may
not be available on terms favorable to the Company, if at all. In addition, the
New Credit Facility and the Indenture contain certain restrictions regarding
acquisitions. The Indenture restricts acquisitions to those companies in the
same line of business as the Company, and requires that all such acquired
companies be designated Restricted Subsidiaries (as defined therein). The New
Credit Facility restricts all acquisitions with the exception of Permitted
Acquisitions (as defined therein), and limits, among other things, (i) the sum
that may be paid in connection with any single acquisition to $30.0 million,
(ii) the total amount outstanding of revolving credit indebtedness that can be
incurred for acquisition purposes to $40.0 million, and (iii) the line of
business of the acquired entity or assets. The inability of the Company to
successfully finance, complete and integrate strategic acquisitions in a timely
manner could have an adverse impact on the Company's ability to effect a portion
of its growth strategy.
PATENTS AND TRADEMARKS
The Company has historically relied primarily on its technological and
engineering abilities and on its design and production capabilities to gain
competitive business advantages, rather than on patents or other intellectual
property rights. However, the Company does file patent applications on concepts
and processes developed by the Company's personnel. The Company has 18 patents
in the U.S. and two patents pending. Many of the U.S. patents have
corresponding patents issued in Canada, Europe and various Asian countries. The
Company is currently preparing several patent applications covering intellectual
property associated with the closed suction catheter product and advanced
humidification devices. The Company's success will depend in part on its
ability to maintain its patents, add to them where appropriate, and to develop
new products and applications without infringing the patent and other
proprietary rights of third parties and without breaching or otherwise losing
rights in technology licenses obtained by the Company for other products. There
can be no assurance that any patent owned by the
32
<PAGE>
Company will not be circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to the Company or that any of the
Company's pending or future patent applications will be issued with claims of
the scope sought by the Company, if at all. If challenged, there can be no
assurance that the Company's patents (or patents under which it licenses
technology) will be held valid or enforceable. In addition, there can be no
assurance that the Company's products or proprietary rights do not infringe the
rights of third parties. If such infringement were established, the Company
could be required to pay damages, enter into royalty or licensing agreements on
onerous terms and/or be enjoined from making, using or selling the infringing
product. Any of the foregoing could have a material adverse effect upon the
Company's business, financial condition or results of operations.
S CORPORATION STATUS
The Company elected to be treated as an S corporation for federal and state
income tax purposes for its taxable years beginning on or after January 1, 1987.
Unlike a C corporation, an S corporation is generally not subject to income tax
at the corporate level; instead, the S corporation's income is taxed on the
personal income tax returns of its shareholders. The Company's status as an S
corporation terminated upon consummation of the Recapitalization. If S
corporation status were denied for any periods prior to such termination by
reason of a failure to satisfy the S corporation election or eligibility
requirements of the Internal Revenue Code of 1986, as amended, the Company would
be subject to tax on its income as if it were a C corporation for these periods.
Such an occurrence would have a material adverse effect on the Company's
results.
YEAR 2000 COMPLIANCE
The Company has upgraded its information system capabilities such that it
does not believe that its systems will encounter any material "year 2000"
problems. The issue surrounding the year 2000 is whether computer systems will
properly recognize date sensitive information when the year changes to 2000, or
"00." Systems that misinterpret the two-digit date "00" as the year 1900 instead
of the year 2000 could generate erroneous data or fail. The Company's products
are not subject to year 2000 problems. The Company also relies, directly and
indirectly, on the external systems of various independent business enterprises,
such as its customers, suppliers, creditors, financial organizations, and of
governments, both domestically and internationally, for the accurate exchange of
data and related information. The Company could be as affected as a result of
any disruption in the operation of the various third-party enterprises with
which the Company interacts. The Company has not assessed the status of such
third-party enterprises' information systems, nor the materiality, nature or
potential impact on the Company of year 2000 issues confronted by such third
parties to the extent the same affect the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Not Applicable.
33
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
On April 7, 1998, in connection with the Recapitalization, Holding sold (i)
300,000 shares of Holding Preferred Stock for a total cash consideration to
Holding of $30,000,000 and (ii) 6,300,000 shares of Holding common stock for a
total cash consideration to Holding of $63,000,000.
Holding believes that the transactions set forth above were exempt from the
registration and prospectus delivery requirements set forth in the Securities
Act in reliance on Section 4(2) thereof, because all of the sales were made
in transactions not involving a public offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
34
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
RIVER HOLDING CORP.
a Delaware corporation
August 10, 1998 By: /s/ Jay R. Ogram
____________________________________
Jay R. Ogram
Chief Financial Officer
(Duly Authorized Officer and Principal Financial
Officer)
35
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