BUSINESS
General
Kinetic Concepts, Inc. is a global medical technology company with leadership positions in advanced wound care and therapeutic surfaces. We design,
manufacture, market and service a wide range of proprietary products which can significantly improve clinical outcomes while reducing the overall cost of patient care by accelerating the healing
process or preventing complications. Our advanced wound care systems incorporate our proprietary V.A.C. technology, which has been clinically demonstrated to promote wound healing and reduce the cost
of treating patients with serious wounds. Our therapeutic surfaces, including specialty hospital beds, mattress replacement systems and overlays, are designed to address complications associated with
immobility and obesity, such as pressure sores and pneumonia. From 2000 to 2003, we increased revenue at a compound annual growth rate of 29.5%. Our revenue for the three months ended March 31,
2004 increased 34.6% from the three months ended March 31, 2003.
Clinical Applications
Our advanced medical systems and therapeutic surfaces address four principal clinical applications:
Wound Healing and Tissue Repair
Based on third-party research commissioned by KCI, we believe that of the more than 10 million wounds treated worldwide by doctors, hospitals and clinics
each year, approximately 10%-15% are complex, life threatening or difficult-to-treat conditions. Based on our analysis of this data, we estimate that the annual
market opportunity in the United States for V.A.C. systems is approximately one million patients, representing approximately
$2.3 billion in revenue. We also believe there is a comparably sized market for V.A.C. systems internationally based on our analysis of third-party data in Germany and the UK. We expect these
markets to continue to grow as a result of several factors, including the acceptance of V.A.C. therapy as a treatment for additional wound types, medical trends such as continued growth in the
incidence of diabetes, and the aging population. V.A.C. is now the leading revenue-generating product line used to treat these serious wounds.
In
the acute care setting, serious trauma wounds, failed surgical closures, amputations (especially those resulting from complications of diabetes), burns covering a large portion of the
body and serious pressure ulcers present special challenges to the physician. These are often deep and/or large wounds that are prone to serious infection and further complications due to the extent
of tissue damage or the compromised state of the patient's health. These wounds are often difficult—or in the worst cases, impossible—to treat quickly and successfully with
more conventional products. In addition, when surgeons use skin grafts to close wounds, a substantial portion of the closures are not fully effective. Physicians and hospitals need a therapy that
addresses the special needs of these wounds with high levels of clinical and cost effectiveness. Given the high cost and infection risk of treating these patients in health care facilities, the
ability to create healthy wound beds and reduce bacterial levels in the wound is particularly important. Our V.A.C. Classic and V.A.C.
ATS
systems are designed to meet these needs by
quickly reducing edema, managing exudate, reducing infection risk, and stimulating the growth of healthy, vascularized granulation tissue.
In
the extended care and home care settings, different types of wounds—with different treatment implications—present the most significant challenges. Although a
substantial number of acute wounds require post-discharge treatment, a majority of the challenging wounds in the home care setting are non-healing chronic wounds. These wounds
often involve physiologic and metabolic complications such as reduced blood supply, compromised lymphatic system or immune deficiencies that interfere with the body's normal wound healing processes.
Diabetic ulcers, arterial and venous insufficiency wounds and pressure ulcers are often slow-to-heal wounds. These wounds often develop due to a patient's impaired vascular and
tissue repair capabilities. These conditions can also inhibit the patient's healing process, and
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wounds
such as these often fail to heal for many months, and sometimes for several years. Difficult-to-treat wounds do not always respond to traditional therapies, such as
hydrocolloids, hydrogels and alginates. Physicians and nurses look for therapies that can promote the healing process and overcome the obstacles of the patients' compromised conditions. They also
prefer therapies that are easy to administer, especially in the home care setting, where full-time skilled care is generally not available. In addition, because many of these patients are
not confined to bed, they want therapies which are minimally disruptive to their lives. Our Mini V.A.C. and V.A.C. Freedom systems are designed to allow patients mobility to conduct normal lives while
their wounds heal.
Therapies to Treat Pulmonary Complications in the Intensive Care Unit
The most critically ill patient population is cared for in the intensive care unit, or ICU, of a hospital, where they can receive the most intense medical
attention. Patients seen in the ICU usually suffer from serious acute and chronic complications from a wide variety of diseases and traumatic injuries. These patients often have, or develop, pulmonary
complications, such as Acute Respiratory Distress Syndrome, directly resulting from their conditions or stemming from their impaired mobility. Mobility is essential to human physiology. When a patient
cannot mobilize normally, due to spinal cord injury, stroke, trauma or other medical condition, fluids tend to accumulate and the patient is at risk of developing pneumonia, blood clots and other
medical problems. Some ICU patients are in such acute distress that their organ systems are at risk of failure and many are on some type of life-support. In 2001, there were approximately
1.0 million ICU patients in the United States with pulmonary complications. Treating pulmonary complications requires special equipment and treatment methods. Because of the aggressive and
specialized treatments required to address these life-threatening conditions, daily patient care costs in the ICU are relatively high. Our Kinetic Therapy systems provide mobility to
patients who cannot mobilize by themselves. These systems are designed to meet the special needs of ICU patients and have been shown in independent clinical studies to reduce the incidence of certain
pulmonary complications and length of stay in the ICU. Our specialized therapies for ICU patients include the Roto Rest Delta, Triadyne II and TriaDyne Proventa for the prevention and treatment of
pulmonary complications associated with immobility.
Wound Treatment and Prevention
Our therapeutic surfaces for pressure relief and pressure reduction provide therapy in the treatment of pressure sores, burns, ulcers, skin grafts and other skin
conditions. They also help prevent the formation of pressure sores that develop in certain immobile individuals by reducing the amount of pressure on a patient's skin through the use of surfaces
supported by air, foam, silicon beads, or viscous fluid. Our products also help to reduce shear, a major factor in the development of pressure ulcers, by reducing the amount of friction between the
skin surface and the surface of the bed. In addition to providing pressure relief and pressure reduction, some of our products provide a pulsing of the surface cushions, known as pulsation therapy,
which helps improve blood and lymphatic flow to the skin. Some of our products further promote healing and reduce nursing time by providing an automated "wound care" turn of a minimum of 20 degrees.
Bariatric Care
We offer a line of bariatric products, which are designed to accommodate obese individuals by providing the support they need and enabling hospital staff to care
for them in a safe and dignified manner. Our bariatric care products generally are used for patients weighing from 300 to 600 pounds, although some are expandable and can accommodate patients weighing
up to 1,000 pounds. These individuals are often unable to fit into standard-sized beds and wheelchairs. Our most sophisticated bariatric care products can serve as a bed, chair, weight scale and
x-ray table, and they provide therapeutic functions like those in our wound treatment and prevention systems. Moreover, treating obese patients is a significant staffing issue for many
health care facilities because moving and handling obese patients
63
increases
the risk of injury to health care personnel. We believe that these products enable health care personnel to treat these patients in a manner that is safer for health care personnel and more
dignified for the patient.
Products
We offer a wide range of products in each clinical application to meet the specific needs of different subsets of the market, providing innovative, cost
effective, outcome driven therapies across multiple care settings.
Wound Healing and Tissue Repair
Our five wound healing and tissue repair systems incorporate our proprietary V.A.C. technology. A V.A.C. system consists of the therapy unit and four types of
disposables: a foam dressing, an occlusive drape, a tube system connecting the dressing to the therapy unit and a canister. The therapy unit consists of a pump that generates negative pressure and
internal software that controls and monitors the application of the therapy. The therapy can be programmed for individualized use. Recent advancements, which are incorporated in our
V.A.C.
ATS
and V.A.C. Freedom, enable the unit to flexibly control the time, rate and application of negative pressure to the wound and adapt its operations as it senses the progress of
the application of the therapy to the originally targeted levels. The V.A.C.
ATS
and V.A.C. Freedom units also respond in real time to problems encountered during use and alerts users to
any blockage or other interference with the pre-set protocol. The system has a number of on screen user assist features such as treatment protocols and suggestions to address specific
patient issues.
The
negative pressure therapy is delivered to the wound bed through a proprietary foam dressing cut to fit the wound size. The dressing is connected to the therapy unit through a tube
which both delivers the negative pressure and senses the pressure delivered to the wound surface. An occlusive drape covers the dressing and secures the foam, thereby allowing negative pressure to be
maintained at the wound site. Negative pressure can also be applied intermittently to the wound site, which we believe further accelerates the growth of granulation tissue. The canister collects the
fluids, or exudates, and helps reduce odors through the use of special filters. V.A.C. dressings are typically changed every 48 hours for non-infected wounds versus traditional
dressings which often require dressing changes one or more times per day. Our original V.A.C. dressings were designed either to maximize granulation tissue growth in large open wounds or to help close
superficial wounds where excessive granulation is undesirable. Newer versions address the unique physical characteristics of wounds such as diabetic foot ulcers and abdominal compartment syndrome.
Each
of our wound healing and tissue repair systems is targeted to meet the needs of specific care settings and wound or patient requirements.
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•
-
The V.A.C.
ATS
System
was introduced in 2002 to meet the acute
care requirements for a flexible, easy-to-use, high-capacity system that is effective with the largest and most challenging trauma, orthopedic reconstruction and
abdominal wounds. The V.A.C.
ATS
incorporates advanced features and controls to provide flexibility to customize the treatment protocol to the requirements of different wound types and
physician preferences. It also incorporates our proprietary T.R.A.C. technology, which enables the system to monitor pressure at the wound site and automatically adjust system operation to maintain
the desired therapy protocol. The V.A.C.
ATS
also simplifies dressing changes and incorporates smart alarms that help ensure patient safety.
-
•
-
The V.A.C. Instill System
was introduced in 2003 to add additional therapy capability to V.A.C. systems. The V.A.C. Instill
combines the ability to instill fluids into the wound with V.A.C. therapy. Any fluid approved for topical use—including antibiotics, antiseptics and anesthetics—can be
instilled, making the system particularly well suited for infected and painful wounds. Future uses could include cytokines, growth factors, or other agents to stimulate wound healing. Because the
64
The
superior clinical efficacy of our V.A.C. systems is supported by an extensive collection of published clinical studies. V.A.C. systems have been reviewed in at least 126 peer
reviewed journal articles, 237 abstracts, 21 case studies and 35 textbook citations. Of these, the research for six articles and 13 abstracts was funded by research grants from KCI.
In
addition, we are conducting 10 prospective, randomized and controlled multicenter clinical studies specifically designed to provide statistically significant evidence of V.A.C.
therapy's clinical efficacy for treating a wide range of targeted wound types. These clinical studies are managed by our 28-member medical department.
Products Treating Pulmonary Complications in the ICU
Our Kinetic Therapy products include the TriaDyne Proventa, TriaDyne II, Roto Rest Delta and PediDyne Therapy System. The TriaDyne Therapy System product line is
used primarily in acute care settings and provides patients with four distinct therapies on an air suspension surface. The TriaDyne Therapy System applies Kinetic Therapy by rotating the patient up to
45 degrees on each side. There are three different modes of rotation: upper body only, full body rotation, and counter rotation, simultaneously rotating the patient's torso and lower body in opposite
directions to keep the patient centered on the patient surface. The TriDyne Therapy System also accommodates prone therapy with the proning accessory kit, percussion therapy to loosen mucous buildup
in the lungs and pulsation therapy to promote capillary and lymphatic flow. We have recently introduced an extension for the TriaDyne line which is designed to make it easier to move patients into the
prone position when lying on a hospital bed. The Roto Rest Delta is a specialty bed that can rotate a patient up to 62 degrees on each side for the treatment of severe pulmonary complications. The
Roto Rest Delta has been shown to improve the care of patients suffering from multiple trauma, spinal cord injury, severe pulmonary complications, respiratory failure and deep vein thrombosis. The
most advanced rotational therapy, Kinetic Therapy, has been clinically studied in at least 14 randomized clinical trials, 38 peer reviewed articles, 10 other published articles, 40 abstracts, 15 case
studies and three textbook citations. Of these, the research for 10 articles, 29 abstracts and 15 case studies was funded by research grants from KCI.
65
Wound Treatment and Prevention
We offer a wide variety of therapeutic surfaces for wound treatment and prevention, providing pressure relief, pressure reduction, pulsation, alternating
pressure, and a continuous turn of a minimum of 20 degrees. Most of our therapy beds and surfaces incorporate the exclusive use of GoreTex® fabric in the patient contact areas to provide
an ideal microclimate for skin protection and moisture control. Our pressure relief products include a variety of framed beds and overlays such as the KinAir III, KinAir MedSurg and KinAir IV framed
beds; the FluidAir Elite and FluidAir II bead beds; the FirstStep, FirstStep Plus, FirstStep Select, FirstStep Advantage and TriCell overlays, the AtmosAir family of non-powered, dynamic
mattress replacement and seating surfaces; and the RIK fluid mattress and overlay. Our pulsation products include the TheraPulse and TheraPulse ATP framed beds and the DynaPulse overlay. Our
alternating pressure or air cycling products include a powered model of the AtmosAir, and the Intercell. Our turn assist products include the KinAir IV, Therapulse ATP, and a powered AtmosAir model.
The
KinAir III, KinAir MedSurg and KinAir IV have been shown to provide effective skin care therapy in the treatment of pressure sores, burns and post-operative skin grafts
and flaps and to help prevent the formation of pressure sores and certain other complications of immobility. The
FluidAir Elite and FluidAir II support the patient on a low-pressure surface of air-fluidized beads providing pressure relief and shear relief for skin grafts or flaps, burns
and pressure sores. The FirstStep family of overlays is designed to provide pressure relief and help prevent and treat pressure sores. The AtmosAir family are for-sale mattress replacement
products that have been shown to be effective for the treatment and prevention of pressure sores in a series of hospital-based case studies. The proprietary AtmosAir with Self Adjusting Technology
("SAT") utilizes atmospheric pressure and gravity to deliver non-powered dynamic pressure relief. The RIK mattress and the RIK overlay are static, non-powered products that
provide pressure relief using a patented viscous fluid and a patented anti-shear layer. The Therarest mattress is a static pressure-reducing, for sale mattress used for the prevention of
pressure ulcers.
The
TheraPulse and TheraPulse ATP framed beds and the DynaPulse overlay provide a more aggressive form of treatment through a continuous pulsating action which gently massages the skin
to help improve capillary and lymphatic circulation in patients suffering from severe pressure sores, burns, skin grafts or flaps, swelling or circulatory problems. A less aggressive form of pulsation
known as alternating pressure or air cycling is provided by a powered version of the AtmosAir and Intercell.
The
KinAir IV, Therapulse ATP and a powered AtmosAir model all provide turn assist of a minimum of 20 degrees to each side. Turn Assist helps the caregiver reposition and/or turn a
patient in order to provide patient care and pressure relief.
Bariatric Care
Our bariatric products provide a range of therapy options and the proper support needed by obese patients and enable nurses to properly care for these patients in
a safe and dignified manner. The most advanced product in this line is the BariAir therapy system, which can serve as a bed, cardiac chair or x-ray table. The BariAir provides low air loss
pressure relief, continuous turn assist, percussion and step-down features designed for both patient comfort and nurse assistance. This product can be used for patients who weigh up to 850
pounds. We believe that the BariAir is the most advanced product of its type available today and because of this, it is our most frequently used bariatric product. It provides a risk management
platform for patients weighing up to 850 pounds. It is a front exit bed with the ability to convert to a cardiac chair position. In 1996, we introduced the FirstStep Select Heavy Duty overlay which,
when placed on a BariKare bed, provides pressure-relieving low air loss therapy. Our AirMaxxis product provides a therapeutic air surface for the home environment for patients weighing up to 650
pounds. The Maxxis 300 and Maxxis 400 provide a home care bariatric bed frame for patients weighing up to 600 pounds and 1,000 pounds, respectively.
66
The
newest product in our bariatric product line is the BariMaxx II. The BariMaxx II provides a basic risk management platform for patients weighing up to 1,000 pounds for those
customers looking for a set of features including built-in scales and an expandable frame at a lower cost. Additionally, the BariMaxx II side exit feature allows the caregiver to assist
patients in a more traditional exit of the bed. This is an important factor in a patient's rehabilitation and prepares them for facility discharge. Our bariatric beds are now combined with an
EZ-Lift patient transfer system and other accessories such as wheelchairs, walkers and commodes to create a complete bariatric offering.
Competitive Strengths
We believe we have the following competitive strengths:
-
•
-
Leading global market positions
. V.A.C. is the leading revenue-generating product line in the global advanced
wound care market. We are also the number two provider, based on revenue, of therapeutic surfaces in the United States and one of the largest providers in Europe. We believe that our market leadership
results from the demonstrated clinical efficacy of our products, our ability to help our customers reduce health care costs and our extensive relationships with healthcare providers and third-party
payers.
-
•
-
Superior clinical efficacy.
The superior clinical efficacy of our V.A.C. systems and our therapeutic surfaces is
supported by an extensive collection of published clinical studies. V.A.C. systems have been reviewed in at least 126 peer reviewed journal articles, 237 abstracts, 21 case studies and 35
textbook citations. Of these, the research for six articles and 13 abstracts was funded by research grants from KCI. Eight of the articles describe randomized, controlled clinical trials, or
RCTs, which are considered to be the highest standard for evidence of clinical effectiveness. Three of these studies addressed pressure ulcers with two showing superior wound size reduction with use
of V.A.C. along with improved healing processes and fewer complications. The third study, which was small (22 patients) and did not follow our recommended protocol, did not show superior
effectiveness for pressure ulcers. Two studies addressed diabetic foot ulcers, and showed superior wound size reduction for diabetic foot ulcers and suggest substantially faster times to definitive
closure. Three other studies showed superior results for open-wound-management of non-healing wounds, graft donor site re-epitheliazation and preparation of wounds requiring dermal reconstruction for
skin grafts. Some of the studies demonstrate that V.A.C. therapy also delivers significant cost savings to the health care system, generally ranging from $1,000 to $19,000 per patient depending on
wound type, and ranging from 6% to 38% of the cost of conventional care. Similarly, our most advanced rotational therapy, Kinetic Therapy, has been reviewed in at least 14 RCTs, 38 peer reviewed
articles, 10 other published articles, 40 abstracts, 15 case studies and three textbook citations. Of these, the research for 10 articles, 29 abstracts and 15 case studies was
funded by research grants from KCI.
-
•
-
Product innovation and commercialization.
We have a successful track record in pioneering new wound care and
therapeutic surface technologies. Our recent development and commercialization of both new V.A.C. systems and disposable dressing variations have strengthened KCI's leadership position in advanced
wound care. Our therapeutic surface technology originated with the introduction of the Roto Rest™ bed 27 years ago. Since that time, we have developed and commercialized a broad
spectrum of therapeutic surfaces, a number of which have significantly enhanced patient care. In addition, we have developed a broad portfolio of bariatric products to improve the care of obese
patients.
-
•
-
Broad V.A.C. patent portfolio.
We have patent protection for V.A.C. products, in the form of owned and licensed
patents, including at least 14 issued U.S. patents and at least 16 U.S. patent applications pending. Our base V.A.C. patents, which we license on an exclusive basis, do not begin to expire until 2013.
Our international patent portfolio (including owned and licensed patents) relating to current and prospective technologies in the field of V.A.C. therapy includes at least 75
67
issued
patents and more than 100 pending patent applications, with protection in Europe, Canada, Australia and Japan.
-
•
-
Broad reach and customer relationships.
Our worldwide sales team, consisting of approximately 1,225 individuals,
including approximately 620 employees with medical or clinical backgrounds, has strong relationships with our customers due to the clinical support and consultation we provide and our education and
training programs. We also have broad reach across all health care settings. In the United States, for example, we have relationships with over 3,000 acute care hospitals, over 4,600 extended care
facilities and approximately 8,500 home health care agencies and wound care clinics.
-
•
-
Extensive service center network.
With a network of 135 U.S. and 67 international service centers, we are able
to rapidly deliver our critically needed products to major hospitals in the United States, Canada, Australia and most major European countries. Our network gives us the ability to deliver our products
to any major Level I domestic trauma center within hours. This extensive network is critical to securing national GPO contracts and allows us to efficiently serve the home market directly. Our network
also provides a platform for the introduction of additional products.
-
•
-
Reimbursement expertise.
A significant portion of our V.A.C. revenue is derived from home placements, which are
reimbursed by third-party payers such as private insurance, managed care, Medicare and Medicaid. We have dedicated significant time and resources to develop capabilities and
expertise in third-party reimbursement, and we have developed systems to support and manage the deployment of our domestic and international sales and service efforts.
-
•
-
Strong management team.
Our management team has a diverse set of industry skills and global operating
experience, including backgrounds spanning the health care services and medical device industries, as well as expertise running complex organizations and managing rapid growth. Our executive officers
have an average of 20 years of experience in the health care industry.
Business Strategy
We intend to continue to grow our business and to improve our market position by pursuing the following strategies:
-
•
-
Continue to capture the current V.A.C. opportunity.
Based on third-party research commissioned by KCI, we
believe that we have only penetrated approximately 15-20%, based on revenue, of the U.S. market for V.A.C. systems and even less of the international market. We believe that we can
significantly increase our market penetration. We will continue to capitalize on our current strengths, including our sales and service infrastructure, our intellectual property portfolio, V.A.C.
product pipeline and demonstrated clinical efficacy. In addition, we have a number of strategic initiatives underway which will support this progress:
-
—
-
Establish V.A.C. therapy as standard of care
. Our objective is to establish V.A.C. therapy as standard of care
for each of seven targeted wound types, including diabetic ulcers and amputations, pressure ulcers, burns, trauma wounds, skin grafts, dehisced surgical wounds and abdominal compartment syndrome. We
are conducting ten prospective, randomized and controlled multicenter clinical studies specifically designed to provide statistically significant evidence of V.A.C. therapy's clinical efficacy for
treating each of these specified wound types. In addition, we have developed a strategy for communication, awareness and consensus building that targets each of the professional associations and key
opinion leaders whose support is essential for standard-of-care designation.
-
—
-
Increase penetration in home care markets
. We continue to enhance our contractual relationships with insurance
companies, which have already increased covered lives under contract from fewer than 20 million in mid-2000 to over 173 million as of April 30, 2004. Our physician
awareness and penetration initiatives are also important in the home markets, as
68
-
•
-
Maintain and expand our leadership position in therapeutic surfaces.
We intend to maintain our leadership
position in therapeutic surfaces by capitalizing on the growth opportunities in bariatrics and the ICU. We are also building on our expertise in Kinetic Therapy to introduce a new product which will
treat Acute Respiratory Distress Syndrome and Acute Lung Injury in the ICU.
-
•
-
Expand presence in international markets.
We are expanding our international marketing and sales efforts. We
have committed resources to expand our presence in under-penetrated markets, obtain standard-of-care designation in other countries and achieve reimbursement for home use of
V.A.C. systems. Recently, the German and Austrian associations for wound treatment have recognized V.A.C. therapy as the therapy of choice for several wound care indications.
-
•
-
Generate high returns on invested capital.
Our returns on invested capital have increased in each year since
1999, and averaged more than 25% over the last three years, despite our accelerated spending to capitalize on V.A.C. growth opportunities. Starting in the second half of 2002 we increased productivity
and achieved profit increases exceeding revenue growth. We will continue to focus on productivity enhancements, capital efficiency and other metrics to improve our performance.
Customers
We have broad reach across all health care settings. In the United States, for example, we have relationships with over 3,000 acute care hospitals, over 4,600
extended care facilities and approximately 8,500 home health care agencies and wound care clinics. As of April 30, 2004, we served approximately 2,200 medium to large hospitals in the United
States. Through our network of 135 U.S. and 67 international service centers, we are able to rapidly deliver our critically needed products to major hospitals in the United States, Canada, Australia
and most major European countries. This extensive network is critical to securing national GPO contracts and allows us to efficiently serve the home market directly. Our network also provides a
platform for the introduction of additional products.
Our
customers generally prefer to rent our V.A.C. systems and therapeutic surfaces and purchase the related disposable products, such as V.A.C. dressings. We believe that some of our
customers, who tend to be our larger customers, desire alternatives to rental for at least some of their business. We expect this trend to continue as V.A.C. penetration increases, and we are
exploring alternative models, such as a pilot long-term lease program that we are currently developing, so that we can respond to our customers' needs.
Billing and Reimbursement
We have extensive contractual relationships and reimbursement coverage for the V.A.C. in the United States. In acute and extended care, we have contracts with
nearly all major hospital, and most major extended-care group purchasing organizations. Hospitals and extended care facilities pay us directly for our services. In the home care market, we
provide V.A.C. products and services directly to patients and bill third-party payers, including Medicare and private insurance. V.A.C. systems are covered by Medicare Part B. We currently have
V.A.C. contracts with private insurance covering over 173 million member lives in the United States as of April 30, 2004. This represents more than one-half of all individuals covered by
private insurance in the United States and is more than eight times the number of member lives we had under contract as of mid-2000.
In
the home care market, we have developed a significant base of reimbursement expertise that consists of our experienced professionals and our relationships with payers across all care
settings and are enhancing our electronic systems to simplify the labor intensive and complex reimbursement process.
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Corporate Organization
Our business has two geographical operating segments: USA and International.
With
approximately 1,730 employees as of April 30, 2004, our USA division serves the domestic acute care, extended care and home care markets with the full range of our products.
The domestic division distributes our medical devices and therapeutic surfaces to over 3,000 acute care hospitals and more than 4,600 extended care facilities and also directly serves the home care
market through our service center network. Our USA division accounted for approximately 76%, 77%, 78% and 76% of our total revenue in the years ended December 31, 2003, 2002 and 2001 and for
the quarter ended March 31, 2004, respectively.
As
of March 31, 2004, our International division had direct operations in 16 foreign countries including Germany, Austria, the United Kingdom, Canada, France, the Netherlands,
Switzerland, Australia, Italy, Denmark, Sweden, Ireland, Belgium, Spain, Singapore and South Africa. The International division distributes our medical devices and therapeutic surfaces through a
network of 67 service centers. Our international corporate office is located in Amsterdam, The Netherlands. International manufacturing and engineering operations are based in the United Kingdom. In
addition, our International division serves the demands of a growing global market through relationships with approximately 60 active independent distributors in Latin America, the Middle East,
Eastern Europe and Asia. The International division consists of approximately 1,175 employees who are responsible for all sales, service and administrative functions within the various countries we
serve. Our International division accounted for approximately 24%, 23%, 22% and 24% of our total revenue in the years ended December 31, 2003, 2002 and 2001, and for the quarter ended
March 31, 2004, respectively.
Sales and Marketing Organization
Our worldwide sales organization consists of approximately 1,225 individuals, 620 of whom have medical or clinical backgrounds. Our sales organization is focused
by care setting. Since physicians and nurses are critical to the adoption and use of advanced medical systems, a major element of the sales force's responsibility is to educate and train these medical
practitioners in the application of our products, including the specific knowledge necessary to assure that the use of our systems results in optimal clinical and economic outcomes. In 2003, our sales
staff made more than 140,000 contacts with these targeted clinical decision-makers. We have approximately 330 clinical consultants, all of whom are
health care professionals, whose principal responsibilities are to make product rounds, consult on complex cases and assist facilities and home health agencies to develop their patient care protocols.
Our clinicians educate the hospital, long-term care facility or home health agency staff on the use of our products. In addition, we employ approximately 120 field-based specialists who
consult with our customers regarding the often demanding and complex paperwork required by Medicare and private insurance companies. In fulfilling the paperwork requirements, these specialists enhance
the overall productivity of our sales force.
Our
international sales organization includes more than 415 employees in 16 foreign countries. In addition, in each foreign market where we have a presence, we sell our products through
our direct sales force or through local distributors with local expertise.
Selling,
marketing and advertising expenses in each of the periods below were as follows (dollars in thousands):
|
|
Year Ended December 31,
|
|
|
|
|
|
Three Months Ended
March 31, 2004
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
|
Selling
|
|
$
|
88,347
|
|
$
|
112,146
|
|
$
|
128,247
|
|
$
|
38,385
|
|
|
|
Percentage of total revenue
|
|
|
19
|
%
|
|
19
|
%
|
|
17
|
%
|
|
17
|
%
|
|
Marketing
|
|
$
|
13,109
|
|
$
|
19,240
|
|
$
|
24,815
|
|
$
|
8,381
|
|
|
|
Percentage of total revenue
|
|
|
3
|
%
|
|
3
|
%
|
|
3
|
%
|
|
4
|
%
|
|
Advertising
|
|
$
|
2,085
|
|
$
|
4,802
|
|
$
|
5,148
|
|
$
|
1,669
|
|
|
|
Percentage of total revenue
|
|
|
—
|
|
|
1
|
%
|
|
1
|
%
|
|
1
|
%
|
70
Service Organization
Our USA division has a national 24-hour, seven day-a-week customer service communications system, which allows us to quickly
and efficiently respond to our customers' needs. The domestic division distributes our medical devices and therapeutic surfaces to more than 3,000 acute care hospitals and more than 4,600 extended
care facilities through a network of 135 domestic service centers and also directly serves the home care market through our extensive service center network. Our USA division's network gives us the
ability to deliver our products to any major Level I domestic trauma center within hours. Our International division distributes our medical devices and therapeutic surfaces through a network of 67
service centers.
In
addition to delivery, pick-up, and technical support services, our service organization cleans, disinfects, and reconditions products between rentals. To assure
availability when products are needed, the service organization manages our rental fleet of approximately 50,000 units, deploying units to meet individual service center demand patterns while
maintaining high levels of rental asset utilization. Services are provided by approximately 790 people in the United States and more than 420 people internationally.
Research and Development
We have a successful track record in pioneering new wound care and therapeutic surface technologies through new product introductions and significant enhancements
to existing products. Our recent development and commercialization of both new V.A.C. systems and V.A.C. disposable dressing variations have established KCI as a leader in advanced wound care. Our
therapeutic surfaces technology originated with the introduction of the Roto Rest bed 27 years ago. Since that time, we have developed and commercialized a broad spectrum of therapeutic
surfaces, a number of which have
significantly enhanced patient care. In addition, we have developed a broad portfolio of bariatric products to improve the care of obese patients.
Our
primary focus for innovation is to increase the clinical and economic benefit of our products to our customers and their patients. In addition, we strive to make our products
user-friendly and increase their operational efficiency, both of which are critical in the demanding and sometimes short-staffed world of health care today. Significant investments in our
2003 research and development included:
-
•
-
new
wound healing systems and dressings tailored to the needs of different care settings and wound types;
-
•
-
new
technologies in wound healing and tissue repair;
-
•
-
new
applications of V.A.C. technology and enhanced therapeutic effectiveness through improved understanding of the V.A.C. systems' various mechanisms of action;
-
•
-
two
new therapeutic surfaces to address critical needs of patients with Acute Respiratory Distress Syndrome, and to provide neuroprotection for cardiac arrest and stroke
patients; and
-
•
-
significant
upgrades to several of our core therapeutic surfaces and bariatric products.
71
Expenditures
for research and development, including clinical trials, in each of the periods below, were as follows (dollars in thousands):
|
|
Year Ended December 31,
|
|
|
|
|
|
Three Months Ended
March 31, 2004
|
|
|
|
2001
|
|
2002
|
|
2003
|
|
|
Research and development spending
|
|
$
|
14,266
|
|
$
|
18,749
|
|
$
|
23,044
|
|
$
|
7,119
|
|
|
|
Percentage of total revenue
|
|
|
3
|
%
|
|
3
|
%
|
|
3
|
%
|
|
3
|
%
|
We intend to increase our research and development expenditures in absolute dollars and as a percentage of revenue. However, we expect that research and
development spending will remain a modest percentage of overall revenue.
Patents, Trademarks and Licenses
We rely on a combination of patents, copyrights, trademarks, trade secret and other laws, and contractual restrictions on disclosure, copying and transfer of
title, including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties, to protect our proprietary rights in our
products, new developments, improvements and inventions. We seek patent protection in the United States and abroad. We have more than 100 issued U.S. patents relating to our existing and prospective
lines of therapeutic surfaces and V.A.C. systems. We also have more than 50 pending U.S. patent applications. Many of our specialized beds, medical devices and services are offered under proprietary
trademarks and service marks. We have more than 45 trademarks and service marks registered with the United States Patent and Trademark Office. We also have agreements with third parties that provide
for the licensing of patented or proprietary technology.
We
have patent protection for our current V.A.C. products, in the form of owned and licensed patents, including at least 14 issued U.S. patents and at least 16 U.S. patent applications
pending. Our international patent portfolio (including owned and licensed patents) relating to current and prospective technologies in the field of V.A.C. therapy includes at least 75 issued patents
and more than 100 pending patent applications, with protection in Europe, Canada, Australia and Japan. Most of
the V.A.C. patents in our patent portfolio have an average life of 20 years from their date of filing. Our base V.A.C. patents do not begin to expire until 2013. We have multiple patents
covering unique aspects, and improvements to the V.A.C. system.
On
October 6, 1993, we entered into a license agreement with Wake Forest University that we rely on in connection with our V.A.C. business. Under this agreement, Wake Forest
University licensed to us on a worldwide, exclusive basis the right to use, lease, sell and sublicense its rights to certain patents that are integral to the technology that we incorporate in our
V.A.C. products. The term of the agreement continues for as long as the underlying patents are in effect, subject to Wake Forest University's right to terminate earlier if we fail to make required
royalty payments or are otherwise in material breach or default of the agreement.
Manufacturing
Our manufacturing processes for V.A.C. therapeutic units, therapeutic surfaces, mattress replacement systems and overlays involve producing final assemblies in
accordance with a master production plan. Assembly of our products is accomplished using (1) metal parts that are fabricated, machined, and finished internally, (2) fabric that is cut
and sewn internally and externally, and (3) plastics, electronics and other component parts that are purchased from outside suppliers. Internal fabrication, machining, finishing and sewing are
accomplished on modern equipment. Component parts and materials are obtained from industrial distributors, original equipment manufacturers and contract manufacturers. The majority of parts and
materials are readily available in the open market (steel, aluminum, plastics, fabric, etc.) for
72
which
price volatility is low. The manufacturing process is in compliance with ISO 9001 (1994), ISO 13485, and FDA Quality System Regulation.
We
contract for the manufacture of V.A.C. disposables through Avail Medical Products, Inc., a leading contract manufacturer of sterile medical disposables. We entered into a
sole-source agreement with Avail for our V.A.C. related disposable products, which became effective in October 2002 for our U.S. related orders and in May 2003 for our
international related orders. This supply agreement has a three-year term and was recently extended for an additional year. Approximately 15.6% of our total revenue for the year ended
December 31, 2003 and approximately 19.7% of our total revenue for the three months ended March 31, 2004 was generated from the sale of these disposable supplies. The terms of the supply
agreement provide that key indicators be provided to us that would alert us to Avail's inability to perform under the agreement. We, together with Avail, will maintain certain levels of
on-hand supply. In the event that Avail is unable to fulfill the terms of this agreement, we have identified other suppliers that could provide such inventory to meet our needs. However,
in the event that we are unable to replace a shortfall in supply, our revenue could be negatively impacted in the short term.
Working Capital Management
We maintain inventory to support customer needs in our service centers and in our manufacturing facility. For our surface and V.A.C. businesses, we maintain parts
and supplies inventory for replacement parts in both our service centers and manufacturing facilities. We also maintain inventory for conversion to our surface and V.A.C. rental fleet in our
manufacturing facilities. Our V.A.C. rental equipment cannot be used without the disposables that support the V.A.C. systems. As such, we buy and ship disposable inventory directly from our sole
supplier to the customer. We have commitments to purchase inventory from our sole disposable supplier as discussed in "—Manufacturing".
Our
payment terms with hospitals and extended care facilities are consistent with industry standards and provide for payment within 30 days. Our payment terms with third party
payers, including Medicare and private insurance, are consistent with industry standards and provide for payment within 45 days. A portion of our receivables relate to unbilled revenues arising
in the normal course of business, due to monthly billing cycles requested by our hospital or extended care facility customers or due to our internal paperwork processing procedures regarding billing
third party payers.
Competition
We believe that the principal competitive factors within our markets are clinical efficacy, cost of care, clinical outcomes and service. Furthermore, we believe
that a national presence with full distribution capabilities is important to serve large, national and regional health care group purchasing organizations, or GPOs. We have contracts with nearly all
major hospital GPOs and most major extended care GPOs for V.A.C. systems. The medical device industry is highly competitive and is characterized by rapid product development and technological change.
In order to remain competitive with other companies in our industry, we must continue to develop new cost-effective products and technologies.
In
wound healing and tissue repair, we compete with other treatment methods offered by a number of companies in the advanced wound care business. These methods are substantially
different than the V.A.C. and include traditional wound care dressings, advanced wound care dressings (hydrogels, hydrocolloids, alginates), skin substitutes, products containing growth factors and
medical devices used for wound care. Many of these devices can be used to compete with the V.A.C. or as adjunctive therapy which complements the V.A.C. For example, caregivers may use one of our
V.A.C. systems to prepare a healthy wound bed in order to reduce the wound size, and then use a skin substitute to manage the wound to final closure. As the market for, and revenues generated by, the
V.A.C. expand, we believe additional competitors may introduce products designed to mimic the V.A.C. Recently, BlueSky Medical Corporation and several companies in Europe have introduced medical
devices which have been marketed to compete with the
73
V.A.C.
system. We have filed suit against BlueSky and related parties seeking to restrict the continued marketing and sale of their device, which we believe infringes our patent rights, and we have
obtained a preliminary injunction against MTG in Germany. (See "—Legal Proceedings").
With
respect to therapeutic surfaces for treatment of pulmonary complications in the ICU, wound treatment and prevention and bariatric care, our primary competitors are
Hill-Rom Company, Huntleigh Healthcare and Pegasus Limited. In the bariatric market, our primary competitors are Hill-Rom, Sizewise Rentals and Huntleigh Healthcare. We also
compete on a regional, local and market segment level with a number of smaller companies.
Market Outlook
Health Care Reform
Health care reform legislation will most likely remain focused on reducing the cost of health care. We believe that efforts by private payers to contain costs
through managed care and other efforts will continue in the future as efforts to reform the health care system continue. The Balanced Budget Act of 1997 (the "BBA") significantly reduced the annual
increases in federal spending for Medicare and Medicaid, changed the payment system for both skilled nursing facilities ("SNFs") and home health care services from cost-based to
prospective payment systems and allowed states greater flexibility in controlling Medicaid costs at the state level. Although certain increases in reimbursement payments have subsequently been
approved, the overall effect of the BBA continues to place increased pricing pressure on us and our customers. In particular, the changes in the method by which Medicare Part A reimburses SNFs
has dramatically changed the manner in which our SNF customers make rental and purchase decisions.
Certain
portions of the BBA were amended by the Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of 1999 (the "Refinement Act") and the Medicare, Medicaid and SCHIP Benefits
Improvement and Protection Act of 2000 ("BIPA"). In essence, the Refinement Act and BIPA attempted to lessen the detrimental economic impact which the BBA had on the health care industry. Regarding
SNF reimbursement, some payment relief had been provided under the Refinement Act and BIPA, however, some of the relief expired on September 30, 2002. Because that reimbursement relief was not
carried over into 2003, our therapeutic surfaces revenue in the extended care market is down approximately 9% for the year ended December 31, 2003 as compared to the same period in 2002.
On
December 8, 2003, the President signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("Modernization Act"), which includes revisions to payment
methodologies and other standards for items of DME. These revisions could have a direct impact on our business. At this time, we are unable to determine with precision whether and to what extent these
changes would be applied to our products and our business. Several provisions of the Modernization Act are significant. First, beginning in 2004 through 2008, the payment amounts for DME, including
V.A.C. systems will no longer be increased on an annual basis. Second, beginning in 2007, a competitive acquisition program will be phased in to replace the existing fee schedule payment methodology.
Third, supplier quality standards will be established for DME suppliers. The standards will be applied by independent accreditation organizations. Fourth, clinical conditions for payment will be
established for certain products.
On
February 11, 2003, the Centers for Medicare and Medicaid Services ("CMS," formerly the Health Care Financing Administration) made effective an interim final rule implementing
"inherent reasonableness" authority, which allows the agency and carriers to adjust payment amounts by up to 15% per year for certain items and services covered by Medicare Part B when the
existing payment amount is determined to be grossly excessive or grossly deficient. The regulation lists factors that may be used by CMS and the carriers to determine whether an existing reimbursement
rate is grossly excessive or grossly deficient and to determine what is a realistic and equitable payment amount. CMS may make a larger adjustment each year if they undertake prescribed procedures for
determining the appropriate payment amount for a particular service. Using this authority, CMS and the carriers may reduce reimbursement
74
levels
for certain items and services covered by Medicare Part B. This rule remains in effect after the Modernization Act.
In
addition, the BBA authorized CMS to explore possible ways of changing Medicare reimbursement rates so that they better reflect market levels. Specifically, the BBA authorized CMS to
implement up to five competitive bidding systems by December 31, 2002, to evaluate how competitive bidding would impact Medicare program payments, access, diversity of product selection and
quality. Under competitive bidding, CMS would change its approach to reimbursing products and services covered by Medicare Part B from the current fee schedule amount to an amount that would be
established through a bidding process between the agency and suppliers. Two systems covering eight products have been
completed and under the Modernization Act, starting in 2007, Medicare will begin to implement a nationwide competitive bidding program in ten high population metropolitan statistical areas ("MSAs"),
and in 2009, this program is to be expanded to 80 MSAs (and additional areas thereafter). We do not know what impact inherent reasonableness and competitive bidding would have on us or the
reimbursement of our products.
Health Insurance Portability and Accountability Act (HIPAA) Compliance
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") covers a variety of provisions which will impact our business including the privacy of
patient health care information, the security of that information and the standardization of electronic data transactions for billing. Sanctions for violating HIPAA include criminal penalties and
civil sanctions. The U.S. Department of Health and Human Services has promulgated regulations pursuant to a legislative mandate in HIPAA, which became effective in April 2003. In order to
ensure our compliance with the HIPAA regulations by the April 2003 deadline, KCI established a multi-disciplinary HIPAA Compliance Team, which defined the legal requirements, reviewed KCI's
prior HIPAA compliance efforts and developed a comprehensive compliance plan. We also designated a HIPAA Privacy Officer and HIPAA Information Security Officer to oversee the implementation of the
compliance plan and monitor modifications to the current regulations.
HIPAA
regulations regarding standardization of electronic data billing transactions will also impact our business. At the present time, we invoice third-party payers using a variety of
different systems. In 2003, we transitioned our billing systems to the American National Standard Institute format for electronic data billing transactions as required by HIPAA. In some instances, we
found it difficult to differentiate between products which are covered by a single billing code but have different prices. Therefore, we applied to CMS for additional product codes to support our
current billing practices. However, CMS may not establish any of the requested billing codes. We have been working with all business associates with whom we share protected health information in order
to make the transition to standardized billing codes as smooth as possible. However, the transition to standardized billing codes may create billing difficulties or business interruptions for us.
Our
cost of compliance with HIPAA could be significant. Moreover, although we believe our business practices comply with HIPAA, our practices may be challenged under these laws in the
future and such a challenge may have a material adverse effect on our business, financial condition or results of operations.
Consolidation of Purchasing Entities
The many health care reform initiatives in the United States have caused health care providers to examine their cost structures and reassess the manner in which
they provide health care services. This review, in turn, has led many health care providers to merge or consolidate with other members of their industry in an effort to reduce costs or achieve
operating synergies. A substantial number of our customers, including proprietary hospital groups, GPOs, hospitals, national nursing home companies and national home health care agencies, have been
affected by this consolidation. An extensive service and distribution network and a broad product line are key to servicing the needs of these larger provider networks. In addition, the consolidation
of health care providers often results in the re-negotiation of contracts and the
75
granting
of price concessions. Finally, as GPOs and integrated health care systems increase in size, each contract represents a greater concentration of market share and the adverse consequences of
losing a particular contract increases considerably.
Reimbursement of Health Care Costs
The demand for our products is dependent in part on the reimbursement policies of the various payers. In order to be reimbursed, products generally must be found
to be reasonable and necessary for the diagnosis or treatment of medical conditions and must otherwise fall within the payers' recognized categories of covered items and services. Our products are
either rented or purchased, principally by hospitals and SNFs which receive reimbursement for the products and services they provide from various public and private third-party payers, including
Medicare, Medicaid and private insurance programs. In the home care market, we provide our products and services to patients and bill insurance companies, including Medicare Part B and private
insurance.
The
importance of payer coverage policies was recently demonstrated by our experience with our V.A.C. technology in the home care setting. On October 1, 2000, a Medicare
Part B policy was approved, which provided for reimbursement codes, an associated coverage policy and allowable rates for the V.A.C. systems and V.A.C. disposable products in the home care
setting. The policy facilitated claims processing, permitted electronic claims submissions and created a more uniform claims review process. Because many payers look to Medicare for guidance in
coverage, a specific Medicare policy is often relied upon by other payers.
A
significant portion of our wound healing systems revenue is derived from home placements, which are reimbursed by both governmental and non-governmental third-party payers.
The
reimbursement process for home care placements requires extensive documentation, which has slowed the cash receipts cycle relative to the rest of the business.
In
light of increased scrutiny on Medicare spending, as well as revisions to payment methodologies imposed by the Modernization Act, the outcome of future coverage or payment decisions
for any of our products or services by governmental or non-governmental third-party payers remain uncertain.
Patient Demographics
U.S. Census Bureau statistics indicate that the 65-and-over age group is one of the fastest growing population segments and is expected to
be approximately 40 million by the year 2010. Management of wounds and circulatory problems is crucial for elderly patients. These patients frequently suffer from deteriorating physical
conditions and their wound problems are often exacerbated by circulatory problems, incontinence and poor nutrition.
Obesity
is increasingly being recognized as a serious medical complication. In 2002, approximately 1.3 million patients in U.S. hospitals had a primary or secondary diagnosis of
obesity. Obese patients tend to have limited mobility and are, therefore, at risk for circulatory problems and skin breakdown.
76
Properties and Facilities
Our corporate headquarters are currently located in a 170,400 square foot building in San Antonio, Texas, which was originally purchased in January 1992.
In June 1997, we acquired a 2.6-acre tract of land adjacent to our corporate headquarters. There are four buildings on the land which contain an aggregate of approximately 40,000
square feet. In August 2002, we sold our corporate headquarters facility and adjacent land and buildings under a 10-year sale/leaseback arrangement. We utilize approximately 143,000
square feet of the headquarters building with the remaining space being leased to unrelated entities. We also lease approximately 28,300 square feet of the adjacent buildings that are used for general
corporate purposes. In addition, in October 2001, we entered into a 66-month lease of office space at another location in San Antonio to be used as our customer service center. We
lease approximately 88,500 square feet of office space under this lease.
We
conduct domestic manufacturing, shipping, receiving, engineering and storage activities in a 171,100 square foot facility in San Antonio, Texas, which we purchased in
January 1988, and an adjacent 32,600 square foot facility purchased in 1993. Our operations are conducted with approximately 75% cumulative utilization of plant and equipment. We also lease two
storage facilities in San Antonio, Texas. We lease approximately 135 domestic distribution centers, including each of our seven regional headquarters.
Internationally,
we lease approximately 67 service centers. Our international corporate office is located in Amsterdam, The Netherlands. International manufacturing and engineering
operations are based in the United Kingdom and Belgium. The United Kingdom plant is approximately 24,800 square feet and the Belgium plant is approximately 19,600 square feet. The plants operate with
100% cumulative utilization of plant and equipment.
The
following is a summary of our major facilities:
Location
|
|
Description
|
|
Division
|
|
Owned or
Leased
|
KCI Tower
8023 Vantage Drive
San Antonio, TX
|
|
Corporate Headquarters
|
|
Corporate
|
|
Leased
|
KCI Manufacturing
4958 Stout Drive
San Antonio, TX
|
|
Manufacturing Plant
|
|
Corporate
|
|
Owned
|
KCI North
5800 Farinon Drive
San Antonio, TX
|
|
Customer Service Center
|
|
KCI USA
|
|
Leased
|
Parktoren, 6th Floor
van Heuven Goedhartlaan 11
1181 LE Amstelveen
The Netherlands
|
|
International Corporate Headquarters
|
|
KCI International
|
|
Leased
|
KCII Manufacturing, Unit 12
11 Nimrod Way, Wimborne
Dorset, United Kingdom
|
|
Manufacturing Plant
|
|
KCI International
|
|
Leased
|
KCII Manufacturing
Ambachtslaan 1031
3990 Peer, Belgium
|
|
Manufacturing Plant
|
|
KCI International
|
|
Leased
|
77
Employees
As of April 30, 2004, we had 4,288 employees, and 1,579 of these employees are located in San Antonio, Texas and perform functions associated with
corporate, manufacturing, finance and administration. Our employees are not represented by labor unions and we consider our employee relations to be good.
Government Regulation
United States
Our products are subject to regulation by numerous governmental authorities, principally the United States Food and Drug Administration, or the FDA, and
corresponding state and foreign regulatory agencies. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates the clinical testing,
manufacture, labeling, distribution, sale and promotion of medical devices. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of
marketing clearances or approvals and criminal prosecution. The FDA also has the authority to demand the repair, replacement or refund of the cost of any device that we manufacture or distribute that
violates statutory or regulatory requirements.
In
the United States, medical devices are classified into one of three classes (Class I, II or III) on the basis of the controls deemed necessary by the FDA to reasonably ensure
their safety and effectiveness. Although many Class I devices are exempt from certain FDA requirements, Class I devices are subject to
general controls (for example, labeling, pre-market notification and adherence to the Quality System Regulation). Class II devices are subject to general and special controls (for
example, performance standards, post-market surveillance, patient registries and FDA guidelines). Generally, Class III devices are high-risk devices that receive
significantly greater FDA scrutiny to ensure their safety and effectiveness (for example, life-sustaining, life-supporting and implantable devices, or new devices which have
been found not to be substantially equivalent to legally marketed Class I or Class II devices). Before a new medical device can be introduced in the market, the manufacturer must
generally obtain FDA clearance ("510(k) clearance") or pre-market application ("PMA") approval. All of our current products have been classified as Class I or Class II
devices, which typically are marketed based upon 510(k) clearance or related exemptions. A 510(k) clearance will generally be granted if the submitted information establishes that the proposed device
is "substantially equivalent" in intended use and technological characteristics to a legally marketed Class I or Class II medical device or to a Class III device on the market
since May 28, 1976, for which PMA approval has not been required. A PMA approval requires proof to the FDA's satisfaction of the safety and effectiveness of a Class III device. A
clinical study is generally required to support a PMA application and is sometimes required for a 510(k) pre-market notification. For "significant risk" devices, such clinical studies
generally require submission of an application for an Investigational Device Exemption, or IDE. The FDA's 510(k) clearance process usually takes from four to twelve months, but may take longer. The
PMA approval process is much more costly, lengthy and uncertain. The process generally takes from one to three years, however, it may take even longer.
Devices
that we manufacture or distribute are subject to pervasive and continuing regulation by the FDA and certain state agencies, including record-keeping requirements and mandatory
reporting of certain adverse experiences resulting from use of the devices. Labeling and promotional activities are subject to regulation by the FDA and, in certain circumstances, by the Federal Trade
Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses and the FDA scrutinizes the labeling and advertising of medical devices to ensure
that unapproved uses of medical devices are not promoted.
78
Manufacturers
of medical devices for marketing in the United States are required to adhere to applicable regulations, including the Quality System Regulation ("QSR," formerly the Good
Manufacturing Practice regulation), which imposes design, testing, control and documentation requirements. Manufacturers must also comply with the Medical Device Reporting ("MDR") regulation, which
generally requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a
death or serious injury if it were to recur. We are subject to routine inspection by the FDA and certain state agencies for compliance with QSR requirements, MDR requirements and other applicable
regulations.
Fraud and Abuse Laws
We may also be subject to federal and state physician self-referral laws. Federal physician self-referral legislation (commonly known as
the Stark Law) prohibits, subject to certain exceptions, physician referrals of Medicare and Medicaid patients to an entity providing certain "designated health services" if the physician or an
immediate family member has any financial relationship with the entity. A person who engages in a scheme to circumvent the Stark Law's referral prohibition may be fined up to $100,000 for each such
arrangement or scheme. The penalties for violating the Stark Law also include civil monetary penalties of up to $15,000 per referral and possible exclusion from federal health care programs such as
Medicare and Medicaid. The Stark Law also prohibits the entity receiving the referral from billing any good or service furnished pursuant to an unlawful referral, and any person collecting any amounts
in connection with an unlawful referral is obligated to refund such amounts. Various states have corollary laws to the Stark Law, including laws that require physicians to disclose any financial
interest they may have with a health care provider to their patients when referring patients to that provider. Both the scope and exceptions for such laws vary from state to state.
We
may also be subject to federal and state anti-kickback laws. Section 1128B(b) of the Social Security Act, commonly referred to as the Anti-Kickback Law,
prohibits persons from knowingly and willfully soliciting, receiving, offering or providing remuneration, directly or indirectly, to induce either the referral of an individual, or the furnishing,
recommending, or arranging for a good or service, for which payment may be made under a federal health care program such as Medicare and Medicaid. The Anti-Kickback Law is broad, and it
prohibits many arrangements and practices that are otherwise lawful in businesses outside of the health care industry. The U.S. Department of Health and Human Services ("DHHS") has issued regulations,
commonly known as safe harbors, that set forth certain provisions which, if fully met, will assure health care providers and other parties that they will not be prosecuted under the federal
Anti-Kickback Law. Although full compliance with these provisions ensures against prosecution under the federal Anti-Kickback Law, the failure of a transaction or arrangement
to fit within a specific safe harbor does not necessarily mean that the transaction or arrangement is illegal or that prosecution under the federal Anti-Kickback Law will be pursued. The
penalties for violating the Anti-Kickback Law include imprisonment for up to five years, fines of up to $25,000 per violation and possible exclusion from federal health care programs. Many
states have adopted laws similar to the federal Anti-Kickback Law, and some of these state prohibitions apply to referral of patients for health care services reimbursed by any source, not
only federal health care programs such as Medicare and Medicaid.
In
addition, HIPAA created two new federal crimes: (i) health care fraud and (ii) false statements relating to health care matters. The health care fraud statute prohibits
knowingly and willfully executing or attempting to execute a scheme or artifice to defraud any health care benefit program, including private payers. The false statements statute prohibits knowingly
and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment
for health care benefits, items or services. This statute applies to any health benefit plan, not just Medicare and Medicaid. Additionally, HIPAA granted expanded enforcement authority to the DHHS and
the U.S. Department of Justice ("DOJ") and provided enhanced
79
resources
to support the activities and responsibilities of the DHHS's Office of the Inspector General ("OIG") and the DOJ by authorizing large increases in funding for investigating fraud and abuse
violations relating to health care delivery and payment.
Under
separate statutes, submission of claims for payment or causing such claims to be submitted that are "not provided as claimed" may lead to civil money penalties, criminal fines and
imprisonment, and/or exclusion from participation in Medicare, Medicaid and other federally funded state health programs. These false claims statutes include the federal False Claims Act, which
prohibits the knowing filing of a false claim or the knowing use of false statements to obtain payment from the U.S. federal government. When an entity is determined to have violated the False Claims
Act, it must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Suits filed under the False
Claims Act, known as "qui tam" actions, can be brought by any individual on behalf of the government and such individuals (known as "relators" or, more commonly, as "whistleblowers") may share in the
amounts paid by the entity to the government in fines or settlement. In addition, certain states have enacted laws modeled after the federal False Claims Act. Qui tam actions have increased
significantly in recent years causing greater numbers of health care companies to have to defend false claim actions, pay fines or be excluded from the Medicare, Medicaid or other federal or state
health care programs as a result of an investigation arising out of such action. Because we directly submit claims for payment for certain of our products, we are subject to these false claims
statutes, and, therefore, could become subject to "qui tam" actions.
The
OIG has taken certain actions, which suggest that arrangements between manufacturers or suppliers of durable medical equipment or medical supplies and SNFs (or other providers) may
be under continued scrutiny. In June 1995, the OIG issued a Special Fraud Alert setting forth fraudulent and abusive practices that the OIG had observed in the home health industry. Later that
same year, OIG issued another Special Fraud Alert describing certain relationships between SNFs and suppliers that the OIG viewed as abusive under the federal Anti-Kickback Law. In
July 1999, the OIG published OIG compliance program guidance for the durable medical equipment, prosthetics, orthotics and supply ("DMEPOS") industry developed by the OIG in cooperation with,
and with input from, the Health Care Financing Administration ("HCFA"), which is now known as the Centers for Medicare and Medicaid Services, the DOJ and representatives of various trade associations
and health care practice groups. The guidance identifies specific areas of DMEPOS industry operations that may be subject to fraud and abuse. Furthermore, the OIG Work Plan for 2004 focused on
compliance of durable medical equipment suppliers with Medicare rules and regulations. These initiatives create an
environment in which there will continue to be significant scrutiny regarding compliance with federal and state fraud and abuse laws.
Several
states also have referral, fee splitting and other similar laws that may restrict the payment or receipt of remuneration in connection with the purchase or rental of medical
equipment and supplies. State laws vary in scope and have been infrequently interpreted by courts and regulatory agencies, but may apply to all health care products or services, regardless of whether
Medicaid or Medicare funds are involved.
Claims Audits
The industry in which we operate is generally characterized by long collection cycles for accounts receivable due to complex and time-consuming
documentation requirements for obtaining reimbursement from private and governmental third-party payers. Such protracted collection cycles can lead to delays in obtaining reimbursement. Moreover, the
four durable medical equipment regional carriers ("DMERCs"), private entities that contract to serve as the government's agents for the processing of claims for products and services provided under
Part B of the Medicare program for home use, and Medicaid agencies periodically conduct pre-payment and post-payment reviews and other audits of claims submitted.
Medicare and Medicaid agents are under increasing pressure to scrutinize health care claims more closely. Reviews and/or similar audits or investigations of our claims and related documentation could
result in
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denials
of claims for payment submitted by us. Further, the government could demand significant refunds or recoupments of amounts paid by the government for claims which, upon subsequent
investigation, are determined by the government to be inadequately supported by the required documentation.
ISO Certification
Due to the harmonization efforts of a variety of regulatory bodies worldwide, certification of compliance with the ISO 9000 series of International Standards
("ISO Certification") has become particularly advantageous and, in certain circumstances, necessary for many companies in recent years. We received ISO 9001 and EN46001 Certification in the fourth
quarter of 1997 and Medical Device Agency registration in the fourth quarter of 2002 and therefore are certified to apply the CE mark for direct selling and distributing of our products within the
European community. In addition, we received certification for ISO 13485 in the fourth quarter of 2002 and certification with Health Canada and, therefore, are certified to sell and distribute our
products within Canada.
Environmental Laws
We are subject to various federal, state and local environmental laws and regulations that govern our operations, including the handling and disposal of
nonhazardous and hazardous substances and wastes, and emissions and discharges into the environment. Failure to comply with such laws and regulations could result in costs for corrective action,
penalties or the imposition of other liabilities. We also are subject to laws and regulations that impose liability and cleanup responsibility for releases of hazardous substances into the
environment. Under certain of these laws and regulations, such liabilities can be imposed for cleanup of previously owned or operated properties, or properties to which substances or wastes were sent
from current or former operations at our facilities. From time to time, we have incurred costs and obligations for correcting environmental noncompliance matters and for cleanup of certain of our
properties and third party sites. We believe we have complied with our environmental obligations to date in all material respects and that such liabilities will not have a material adverse effect on
our business or financial performance. However, such liabilities in the future may have a material adverse effect on our business or financial performance.
Other Laws
We are subject to numerous federal, state and local laws and regulations relating to such matters as safe working conditions, manufacturing practices and fire
hazard control.
International
Sales of medical devices outside of the United States are subject to regulatory requirements that vary widely from country to country. Pre-market
clearance or approval of medical devices is required by certain countries. The time required to obtain clearance or approval for sale in a foreign country may be longer or shorter than that required
for clearance or approval by the FDA and the requirements vary. Failure to comply with applicable regulatory requirements can result in loss of previously received approvals and other sanctions and
could have a material adverse effect on our business, financial condition or results of operations.
We
operate in multiple tax jurisdictions both inside and outside the United States. In the normal course of our business, we will undergo reviews by taxing authorities regarding the
tariff classifications of our products and the amount of tariffs we pay on the importation and exportation of these products. Foreign and domestic tariffs have not had a material impact on our results
of to date, however, our profitability could be harmed if foreign governments impose additional unanticipated tariffs.
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Reimbursement
Our products are rented and sold principally to hospitals, extended care facilities and directly to patients who receive payment coverage for the products and
services they utilize from various public and private third-party payers, including the Medicare and Medicaid programs and private insurance plans. In the home care market, we provide our products and
services to patients and bill insurance companies, including Medicare Part B and private insurance. As a result, the demand and payment for our products are dependent, in part, on the
reimbursement policies of these payers. The manner in which reimbursement is sought and obtained for any of our products varies based upon the type of payer involved and the setting to which the
product is furnished and in which it is utilized by patients.
We
believe that government and private efforts to contain or reduce health care costs are likely to continue. These trends may lead third-party payers to deny or limit reimbursement for
our products, which could negatively impact the pricing and profitability of, or demand for, our products.
Medicare
Medicare is a federally funded program that provides health coverage primarily to the elderly and disabled. Medicare is composed of four parts: Part A,
Part B, Part C and Part D. Medicare Part A (hospital insurance) covers, among other things, inpatient hospital care, home health care and skilled nursing facility services.
Medicare Part B (supplementary medical insurance) covers various services, including those services provided on an outpatient basis. Medicare Part B also covers medically necessary
durable medical equipment and medical supplies. Medicare Part C, also known as "Medicare Advantage," offers beneficiaries a choice of various types of health care plans, including several
managed care options. Medicare Part D is the new Voluntary Prescription Drug Benefit Program, which becomes effective in 2006. The Medicare program has established guidelines for the coverage
and reimbursement of certain equipment, supplies and support services. In general, in order to be reimbursed by Medicare, a health care item or service furnished to a Medicare beneficiary must be
reasonable and necessary for the diagnosis or treatment of an illness or injury or to improve the functioning of a malformed body part and not otherwise excluded by statute. Effective
October 1, 2000, we received Medicare Part B
reimbursement codes, an associated coverage policy and allowable rates for our V.A.C. systems and related disposables in the home care setting.
The
methodology for determining the amount of Medicare reimbursement of our products varies based upon, among other things, the setting in which a Medicare beneficiary receives health
care items and services. Most of our products are furnished in a hospital, skilled nursing facility or the beneficiary's home.
Hospital Setting
Since the establishment of the prospective payment system in 1983, acute care hospitals are generally reimbursed for certain patients by Medicare for inpatient
operating costs based upon prospectively determined rates. Under the prospective payment system, or PPS, acute care hospitals receive a predetermined payment rate based upon the Diagnosis-Related
Group, or DRG, which is assigned to each Medicare beneficiary's stay, regardless of the actual cost of the services provided. Certain additional or "outlier" payments may be made to a hospital for
cases involving unusually high costs or lengths of stay. Accordingly, acute care hospitals generally do not receive direct Medicare reimbursement under PPS for the distinct costs incurred in
purchasing or renting our products. Rather, reimbursement for these costs is included within the DRG-based payments made to hospitals for the treatment of Medicare-eligible inpatients who
utilize the products. Long-term care and rehabilitation hospitals also are now paid under a PPS rate that does not directly account for all actual services rendered. Since PPS payments are
based on predetermined rates, and may be less than a hospital's actual costs in furnishing care, hospitals have incentives to lower their inpatient operating costs by utilizing equipment and supplies,
such as our products, that will reduce the length of inpatient stays, decrease labor or otherwise lower their costs.
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Certain
specialty hospitals also use our products. Such specialty hospitals are exempt from the PPS and, subject to certain cost ceilings, are reimbursed by Medicare on a reasonable cost
basis for inpatient operating and capital costs incurred in treating Medicare beneficiaries. Consequently, such hospitals may have additional Medicare reimbursement for reasonable costs incurred in
purchasing or renting our products. There has been little experience with PPS for long-term care and rehabilitation hospitals. A final rule for rehabilitation hospital PPS became effective
on January 1, 2002. A final ruling was published in August 2002 implementing PPS for long-term care hospitals with a phased-in transition period, effective October 1,
2002. We cannot predict the impact of the rehabilitation hospital PPS or the long-term care hospital PPS on the health care industry or on our financial position or results of operations.
Skilled Nursing Facility Setting
On July 1, 1998, reimbursement for SNFs under Medicare Part A changed from a cost-based system to a prospective payment system which is
based on resource utilization groups ("RUGs"). Under the RUGs system, a Medicare patient in a SNF is assigned to a RUGs category upon admission to the facility. The RUGs category to which the patient
is assigned depends upon the medical services and functional support the patient is expected to require. The SNF receives a prospectively determined daily payment based upon the RUGs category assigned
to each Medicare patient. These payments are intended generally to cover all inpatient services for Medicare patients, including routine nursing care, capital-related costs associated with the
inpatient stay and ancillary services. Effective July 2002, the daily payments were based on the national average cost. Although the Refinement Act and BIPA increased the payments for certain
RUGs categories, certain provisions of the Refinement Act and BIPA covering these payment increases expired on September 30, 2002 and, in effect, the RUGs rates for the most common categories
of SNF patients decreased. Because the RUGs system provides SNFs with fixed daily cost reimbursement, SNFs have become less inclined to use products which had previously been reimbursed as variable
ancillary costs.
Home Setting
Our products are also provided to Medicare beneficiaries in home care settings. Medicare, under the Part B program, reimburses beneficiaries, or suppliers
accepting an assignment of the beneficiary's Part B benefit, for the purchase or rental of DME for use in the beneficiary's home or a home for the aged (as opposed to use in a hospital or
skilled nursing facility setting). As long as the Medicare Part B coverage criteria are met, certain of our products, including air fluidized beds, air-powered flotation beds,
alternating pressure air mattresses and our V.A.C. systems and related disposables are reimbursed in the home setting under the DME category known as "Capped Rental Items." Pursuant to the fee
schedule payment methodology for this category, Medicare pays a monthly rental fee (for a period not to exceed 15 months for products other than the V.A.C. system, for which the base treatment
period generally does not exceed four months) equal to 80% of the established allowable charge for the item. The patient (or his or her insurer) is responsible for the remaining 20%. The Modernization
Act provides for revisions to the manner in which payment amounts are to be calculated over the next five years (and thereafter). We cannot predict the full impact of the new law on our financial
position or results of operations, which may be impacted negatively.
Medicaid
The Medicaid program is a cooperative federal/state program that provides medical assistance benefits to qualifying low income and medically needy persons. State
participation in Medicaid is optional and each state is given discretion in developing and administering its own Medicaid program, subject, among other things, to certain federal requirements
pertaining to eligibility criteria and minimum categories of services. The Medicaid program finances approximately 50% of all care provided in nursing facilities nationwide. We sell or rent our
products to nursing facilities for use in furnishing care to Medicaid recipients. Typically, nursing facilities receive Medicaid reimbursement directly from states for the incurred
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costs.
However, the method and level of reimbursement, which generally reflects regionalized average cost structures and other factors, varies from state to state and is subject to each state's budget
constraints. Current economic conditions have resulted in reductions in funding for many state Medicaid programs. Consequently, states are revising their policies for coverage of durable medical
equipment in long-term care facilities and the home. We cannot predict the impact of the policy changes on our Medicaid revenue.
Private Payers
Many third-party private payers, including indemnity insurers, employer group health insurance programs and managed care plans, presently provide coverage for the
purchase and rental of our products. The scope of coverage and payment policies varies among third-party private payers. Furthermore, many such payers are investigating or implementing methods for
reducing health care costs, such as the establishment of capitated or prospective payment systems.
We
believe that government and private efforts to contain or reduce health care costs are likely to continue. These trends may lead third-party payers to deny or limit reimbursement for
our products, which could negatively impact the pricing and profitability of, or demand for, our products.
Legal Proceedings
On February 21, 1992, Novamedix Limited, or Novamedix, filed a lawsuit against us in the United States District Court for the Western District of Texas,
San Antonio Division. Novamedix manufactures a product that directly competes with one of our vascular products, the PlexiPulse. The suit alleges that
the PlexiPulse infringes several patents held by Novamedix, that we breached a confidential relationship with Novamedix and a variety of ancillary claims. Novamedix seeks injunctive relief and
monetary damages. A judicial stay which was in effect with respect to all patent claims in this case has been lifted. On April 12, 2004, a federal Magistrate completed a review of our motion
for summary judgment. In his Memorandum and Recommendation on the summary judgment motions in the case, the Magistrate recommended to the Federal District Court Judge that one of Novamedix's cause of
action for false advertising be significantly limited and that one of Novamedix's patent infringement damage theories be denied for summary judgment purposes. The Magistrate recommended that
(a) the remainder of KCI's motions for summary judgment be denied and (b) KCI's interpretation of an important phrase in certain of the Novamedix claims be rejected. We expect to appeal
the Magistrate's recommendation. Although it is not possible to reliably predict the outcome of this litigation or the damages, which could be awarded, we believe that our defenses to these claims are
meritorious and that the litigation will not have a material adverse effect on our business, financial condition or results of operations.
On
July 1, 1998, Mondomed N.V. filed an opposition in the Opposition Division of the European Patent Office to a European patent owned by Wake Forest University, which we license
for our V.A.C. system. They were joined in this opposition by Paul Hartmann A.G. on December 16, 1998. The patent was upheld at a hearing before a European Patent Office Opposition Division
Panel on December 9, 2003, pursuant to a written interlocutory decision issued May 19, 2004. The decision corrects the patent to expand the range of pressures covered by the patent
claims from 0.10 - 0.99 atmospheres to 0.01 - 0.99 atmospheres and modifies the patent claims to provide that the "screen means" is polymer foam.
Under European patent law, the "screen means" would include equivalents to polymer foam. The screen means in the patent, among other things, helps to remove fluid from within and around the wound,
distributes negative pressure within the wound, enhances the growth of granulation tissue and prevents wound overgrowth. In our V.A.C. systems, the foam dressing placed in the wound serves as the
screen means. We use two different types of polymer foams as the screen means in our V.A.C. systems. Any party to the Opposition is entitled to appeal the decision. We may appeal the new screen means
definition established by the panel. If we choose to appeal, we believe it will take two to three years to complete the appeal process. During the pendency of an appeal, the original patents would
remain in place. We believe that this decision will not affect our U.S. patents. (See "Risk Factors—Risks Related to Our Business—
Our
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intellectual property is very important to our competitive position, especially for our V.A.C. products. If we are unsuccessful in protecting our intellectual property, particularly our rights to the
Wake Forest patents that we rely on in our V.A.C. business, or are sued by third parties for alleged infringement, our competitive position would be harmed
").
On
January 4, 2002, Safe Bed Technologies Company, or Safe Bed, filed a lawsuit against us in the United States District Court for the Northern District of Illinois, Eastern
Division. The suit alleges that certain of our therapeutic surfaces products, including the TriaDyne and BariAir products, infringe a Safe Bed patent. We have asserted counterclaims for declarations
of non-infringement and patent invalidity. Although it is not possible to reliably predict the outcome of this litigation or the damages which could be awarded, we believe that we have
meritorious defenses to Safe Bed's claim and that the litigation will not have a material adverse effect on our business, financial condition or results of operations.
On
August 28, 2003, KCI, KCI Licensing Inc., KCI USA, Inc. and Wake Forest University Health Sciences filed a lawsuit against BlueSky Medical Corporation, Medela AG,
Medela, Inc. and Patient Care Systems, Inc. in the United States District Court for the Western District of Texas, San Antonio Division alleging infringement of multiple claims under two
V.A.C. patents, arising from the manufacturing and marketing of a medical device by BlueSky. In addition to patent infringement, we have asserted causes of action for breach of contract, tortious
interference and unfair competition. BlueSky and Medela, Inc. have filed answers to the complaint and have asserted counterclaims against us for declarations of non-infringement and
patent invalidity. Patient Care Systems, Inc. has filed an answer, but has not asserted any counterclaims. Medela AG has filed a motion to dismiss based on lack of personal jurisdiction. Such
motion has not been ruled upon by the Court. A trial date for the lawsuit has been set for June 2005. Although it is not possible to reliably predict the outcome of this litigation, we believe
our claims are meritorious.
We
are a party to several additional lawsuits arising in the ordinary course of our business. Provisions have been made in our financial statements for estimated exposures related to
these lawsuits. We anticipate that the legal fees incurred in connection with the litigation discussed above will be immaterial. In the opinion of management, the disposition of these matters will not
have a material adverse effect on our business, financial condition or results of operations.
The
manufacturing and marketing of medical products necessarily entails an inherent risk of product liability claims. We currently have certain product liability claims pending for which
provision has been made in our financial statements. Management believes that resolution of these claims will not have a material adverse effect on our business, financial condition or results of
operations. We have not experienced any significant losses due to product liability claims and management believes that we currently maintain adequate liability insurance coverage.
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