10-Q 1 d10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Form 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________. Commission file number - 333-56135 ________________ RIVER HOLDING CORP. (Exact name of registrant as specified in its charter) ________________ Delaware 95-4674065 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 599 Lexington Avenue, 18/th/ Floor 10022 New York, New York (Zip Code) (Address of Principal Executive Offices) (212) 758-2555 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report). Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [_] No [X] The number of shares of Common Stock, $0.01 par value, outstanding (the only class of common stock of the Company outstanding) was 9,144,293 on September 21, 2001. ================================================================================ RIVER HOLDING CORP. AND SUBSIDIARIES QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS

i RIVER HOLDING CORP. AND SUBSIDIARIES QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................................... 26 Item 2. Changes in Securities............................................................... 26 Item 3. Defaults Upon Senior Securities..................................................... 26 Item 4. Submission of Matters to a Vote of Security Holders................................. 26 Item 5. Other Information................................................................... 26 Item 6. Exhibits and Reports on Form 8-K.................................................... 26 SIGNATURE.............................................................................................. 27

ii RIVER HOLDING CORP. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS (Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements. 1 RIVER HOLDING CORP. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) (Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements 2 RIVER HOLDING CORP. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements. 3 RIVER HOLDING CORP. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements. 4 RIVER HOLDING CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2001 1. Financial Statements. The condensed consolidated financial statements -------------------- included herein have been prepared by River Holding Corp. ("Holding") and Hudson Respiratory Care Inc. ("Hudson" or the "Company"), without audit, and include all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position at June 30, 2001, and the results of operations and cash flows for the three and six-month periods ended June 30, 2000 and 2001 pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). All such adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Although Holding believes that the disclosures in such financial statements are adequate to make the information presented not misleading, the accompanying unaudited condensed, consolidated financial statements should be read in conjunction with Holding's 2000 audited financial statements and the notes thereto included in its Form 10-K filed with the SEC. The results of operations for the three and six-month period ended June 30, 2001 are not necessarily indicative of the results to be achieved for a full year. Holding has no operations apart from those conducted by its majority-owned subsidiary, the Company and its subsidiaries 2. Recent Accounting Pronouncements. In June 1998, the Financial Accounting -------------------------------- Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") as amended by SFAS No. 137 and SFAS No. 138, effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments. The statement requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The impact of adoption was not material to the financial statements. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. Holding will adopt SFAS 141 for all business combinations initiated after June 30, 2001. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill would no longer be amortized but would be assessed at least annually for impairment using a fair value methodology. Holding will adopt this statement for all goodwill and other intangible assets acquired after June 30, 2001 and for all existing goodwill and other intangible assets beginning January 1, 2002. Upon adoption of this standard on January 1, 2002, Holding will cease recording amortization of goodwill which would increase income before taxes in 2002 by approximately $11.6 million (assuming current goodwill amounts and currency exchange rates). Other than ceasing the amortization of goodwill, Holding does not anticipate that the adoption of SFAS 142 will have a significant effect on Holding's financial position or the results of operations as Holding does not currently anticipate any impairment charges for existing goodwill. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development 5 and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long- lived asset. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 (with earlier application being encouraged). Holding does not expect the adoption of SFAS 143 to have a material impact on Holding's financial condition and results of operations. 3. Inventories. Inventories consisted of the following (amounts in thousands): ----------- December 31, June 30, 2000 2001 ------------ ---------- Raw materials................................. $ 8,134 $ 7,090 Work-in-process............................... 6,591 5,161 Finished goods................................ 29,885 22,240 ------------ ---------- $ 44,610 $ 34,491 ============ ========== 4. Bank Borrowings by Hudson Euro SarL. ----------------------------------- On March 21, 2001, the Company replaced its existing lending agreement denominated in Swedish krona with a new loan that allows for borrowings up to $19.1 million. The principal is amortized over 18 equal quarterly payments commencing June 30, 2001. Interest is based on the STIBOR rate + 0% to 1.65%, based on the outstanding balance of the loan. The loan is secured by Hudson Euro SarL a wholly-owned subsidiary of the Company and 100% owner of Hudson RCI AB, Hudson RCI UK Ltd. and Hudson France S.A.S. 5. Subsequent Events. ----------------- The Company was not in compliance with certain restrictive covenants of the Credit Facility at June 30, 2001. Subsequently, the Company amended its Credit Facility covenants so that under the amended terms, the Company was in compliance as of June 30, 2001 and expects to remain in compliance throughout the term of the agreement. As part of the amendment (1) the Company's shareholders invested an additional $18 million, of which approximately $8.6 million was invested in April and May of 2001 (consisting of approximately $2.6 million of new cash investment and $6.0 million of exchanged indebtedness) and $9.5 million was invested in August of 2001 (consisting of $6.5 million of new cash investment and $3.0 million of exchanged indebtedness), and (2) interest rate margins increased. In August 2001, the Company issued for cash unsecured senior subordinated convertible notes to certain managers and shareholders in the amount of $3,500,000. The notes bear interest at 10% and are due in 2005. The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to common stock at the demand of the holder. Additionally, in August 2001, the Company issued for $3,000,000 cash an additional 300,000 shares of redeemable preferred stock of Holding (which Holding invested in preferred stock of the Company). 6 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES UNAUDITIED CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS (Dollar Amounts in Thousands)

The accompanying notes are an integral part of these condensed statements. 7 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS LIABILITIES, MANDATORILY-REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) (Dollar Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements 8 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (Dollar Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements. 9 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar Amounts in Thousands)

The accompanying notes are an integral part of these condensed consolidated statements. 10 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2001 1. Financial Statements. The condensed consolidated financial statements -------------------- included herein have been prepared by the Company, without audit, and include all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position at June 30, 2001, and the results of operations and cash flows for the six-month periods ended June 30, 2000 and June 30, 2001 pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). All such adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Although the Company believes that the disclosures in such financial statements are adequate to make the information presented not misleading, the accompanying unaudited condensed, consolidated financial statements should be read in conjunction with the Company's 2000 audited financial statements and the notes thereto included in its Form 10-K filed with the SEC. The results of operations for the six-month period ended June 30, 2001 are not necessarily indicative of the results to be achieved for a full year. 2. Recent Accounting Pronouncements. In June 1998, the Financial Accounting -------------------------------- Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") as amended by SFAS No. 137 and SFAS No. 138, effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments. The statement requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The impact of adoption was not material to the financial statements. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The Company will adopt SFAS 141 for all business combinations initiated after June 30, 2001. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill would no longer be amortized but would be assessed at least annually for impairment using a fair value methodology. The Company will adopt this statement for all goodwill and other intangible assets acquired after June 30, 2001 and for all existing goodwill and other intangible assets beginning January 1, 2002. Upon adoption of this standard on January 1, 2002, the Company will cease recording amortization of goodwill which would increase income before taxes in 2002 by approximately $6.5 million. Other than ceasing the amortization of goodwill, the Company does not anticipate that the adoption of SFAS 142 will have a significant effect on our financial position or the results of our operations as the Company does not currently anticipate any impairment charges for existing goodwill. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long- lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of 11 fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 (with earlier application being encouraged). The Company does not expect the adoption of SFAS 143 to have a material impact on the Company's financial condition and results of operations. 3. Inventories. Inventories consisted of the following (amounts in thousands): ----------- December 31, June 30, 2000 2001 ------------ -------------- Raw materials.................................. $ 8,134 $ 7,090 Work-in-process................................ 6,591 5,161 Finished goods................................. 29,885 22,240 ------------ -------------- $ 44,610 $ 34,491 ============ ============== 4. Subsidiaries Guaranteeing Debt and Segment Data. The Company is the 100% ----------------------------------------------- owner of certain subsidiaries that do not guarantee the Company's senior subordinated notes and certain bank debt. The following tables disclose required consolidating financial information for guarantor, including the Company, and non-guarantor subsidiaries (amounts in thousands): 12 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEET

13 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEET

14 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

15 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

16 HUDSON RESPIRATORY CARE INC. AND SUBSIDIARIES GUARANTOR AND NON-GUARANTOR SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

The Company operates in two segments: North American operations (guarantor) and international operations (non-guarantor). The financial data of these two segments closely approximates the guarantor/non-guarantor information set forth above and, accordingly, separate segment data is not provided. 5. Subsequent Events. ------------------ The Company was not in compliance with certain restrictive covenants of the Credit Facility at June 30, 2001. Subsequently, the Company amended its Credit Facility covenants so that under the amended terms, the Company was in compliance as of June 30, 2001 and expects to remain in compliance throughout the term of the agreement. As part of the amendment (1) the Company's shareholders invested an additional $18 million, of which approximately $8.6 million was invested in April and May of 2001 (consisting of approximately $2.6 million of new cash investment and $6.0 million of exchanged indebtedness) and $6.5 million was invested in August of 2001 (consisting of $6.5 million of new cash investment and $3.0 million of exchanged indebtedness), and (2) interest rate margins increased. In August 2001, the Company issued for cash unsecured senior subordinated convertible notes to certain managers and shareholders in the amount of $3,500,000. The notes bear interest at 10% and are due in 2005. The interest may be paid or deferred to the due date at the option of the Company and the notes are convertible to common stock at the demand of the holder. Additionally, in August 2001, the Company issued for $3,000,000 cash an additional 300,000 shares of redeemable preferred stock of Holding (which Holding invested in preferred stock of the Company). 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As River Holding Corp. ("Holding") is a holding company with no operations, the following discussion relates to Hudson Respiratory Care Inc. (the "Company" or "Hudson RCI"). The following discussion or the Company's consolidated historical results of operations and financial condition should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included elsewhere in this Form 10-Q. Forward-Looking Statements This Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Such statements relating to future events and financial performance are forward-looking statements involving risks and uncertainties that are detailed from time to time in the Company's Securities and Exchange Commission filings. General The Company has increased its net sales and improved its position within the disposable health care products market in recent years by increasing its respiratory care product offering, introducing disposable products for the anesthesia health care market, expanding its presence in international markets and establishing a position in the growing alternate site market. The Company's results of operations may fluctuate significantly from quarter to quarter as a result of a number of factors, including, among others, the buying patterns of the Company's distributors, group purchasing organizations ("GPOs") and other purchasers of the Company's products, forecasts regarding the severity of the annual cold and flu season, announcements of new product introductions by the Company or its competitors, changes in the Company's pricing of its products and the prices offered by the Company's competitors, rate of overhead absorption due to variability in production levels and variability in the number of shipping days in a given quarter. Recent Developments Beginning in April 2000, the company experienced disruption to its operations resulting from difficulties in the implementation of a new management information system. Consequently, the Company's financial results for the quarter ended June 30, 2001 reflect increased freight, distribution, and general and administrative expenses related to the system implementation. The Company also experienced liquidity pressures beginning in the fourth quarter of 2000 due to such expense increases, delays in the collection of due receivables and unplanned increases in inventory related to difficulties in implementation and a lack of familiarity with the new system. Management has implemented a series of initiatives in 2001 designed to improve the Company's proficiency with the new management information system, decrease the Company's operating expenses, improve receivables collections and reduce inventory levels. Despite the disruption related to the system implementation, management believes it has generally maintained strong customer service levels and relationships. 18 Results of Operations The following tables set forth, for the periods indicated, certain income and expense items expressed in dollars and as a percentage of the Company's net sales.

Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000 Net sales, reported net of accrued rebates, were $40.8 million in the second quarter of 2001 as compared to $31.8 million in the second quarter of 2000, an increase of $9.0 million or 28.3%. Domestic hospital sales increased by $2.6 million or 12.7% due to shipping difficulties encountered in the second quarter of 2000 relating to the implementation of the new management information system. Additionally, sales in the second quarter of 2001 reflect sales of the acquired SHERIDAN(R) product line. Alternate site sales increased by $1.0 million or 19.3%, the result of shipping difficulties associated with the new management information system in the second quarter of 2000. International sales increased by $4.9 million or 102%, the result of shipping difficulties associated with the new management information system in the second quarter of 2000, as well as sales of the acquired SHERIDAN(R) product line. OEM sales increased by $0.5 million due to changes in purchasing patterns from some of its OEM customers. The Company's gross profit for the second quarter of 2001 was $15.8 million, a decrease of $1.1 million or 6.7% from the second quarter of 2000. As a percentage of sales, gross profit was 38.8% and 53.4% for the second quarter of 2001 and 2000, respectively. This decrease was primarily due to the recognition of inventory revalued as a 19 result of the Tyco SHERIDAN(R) acquisition, increased shipping costs as a result of shipping difficulties caused by problems associated with the new management information system, underabsorption of manufacturing overhead as a result of an aggressive plan to reduce inventories by slowing production and an unfavorable mix variance caused by higher sales of products with lower gross margins. Selling expenses were $5.8 million for the second quarter of 2001, a $1.9 million increase over the second quarter of 2000. This increase was due primarily to increases in staffing levels required to support additional product lines and costs associated with the France and U.K. sales offices established in fiscal 2000. As a percentage of net sales, selling expenses were 14.1% in the second quarter of 2001 as compared to 12.2% in the second quarter of 2000. Distribution expenses were $2.2 million for the second quarter of 2001, an increase of $0.2 million or 11.5% over the second quarter of 2000. As a percentage of sales, distribution expenses decreased to 5.4% in the second quarter of 2001 as compared to 6.3% in the second quarter of 2000. The increase is primarily the result of the increased cost of freight between the Company's distribution facilities, increased headcount to operate the new management information system and additional expenses related to the establishment of an expanded Temecula distribution facility. However, this increase would have been greater if not offset by high levels of overtime in the second quarter of 2000, the result of difficulties with the implementation and lack of experience with the new management information system. General and administrative expenses were $5.3 million in the second quarter of 2001, an increase of $0.4 million or 7.5% over the second quarter of 2000. This increase resulted primarily from increased staffing levels required to maintain acceptable customer service levels and operate the business with the new management information system. As a percentage of net sales, general and administrative expenses were 12.9% in the second quarter of 2001 as compared to 15.4% in the second quarter of 2000. Research and development expenses were $0.4 million for the second quarter of 2001, a decrease of $0.2 million from the second quarter of 2000. Interest expense and other was $6.3 million for the second quarter of 2001, as compared to $5.1 million in the second quarter of 2000. The increase was due to higher debt levels as a result of the Tyco SHERIDAN(R) acquisition and increased borrowings for working capital requirements. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Net sales, reported net of accrued rebates, were $78.6 million in the first six months of 2001 as compared to $72.6 million in the first six months of 2000, representing an increase of $6.0 million or 8.2%. Domestic hospital sales were $45.4 million for the first six months of 2001, a decrease of $0.1 million or 0.3% from the first six months of 2000. Shipping difficulties in the second quarter of 2000 and sales in 2001 of the SHERIDAN(R) product line, acquired in the fourth quarter of 2000, were offset by a weak influenza season in early 2001. Alternate site sales increased by $1.2 million or 10.9%, the result of shipping difficulties in the second quarter of 2000 relating the implementation of the management information system. International sales increased by $4.9 million or 36.9%, the result of 2001 sales of SHERIDAN products as well as the shipping difficulties seen in the second quarter of 2000. OEM sales were $2.4 million in the first six months of 2001, unchanged from the first six months of 2000. The Company's gross profit for the first six months of 2001 was $25.6 million, a decrease of $9.7 million or 27.4% from the first six months of 2000. As a percentage of sales, the gross profit was 32.6% and 48.0% for the first six months of 2001 and 2000, respectively. This decrease was primarily due to the recognition of inventory revalued as a result of the Tyco SHERIDAN(R) acquisition, increased shipping costs as a result of shipping difficulties caused by problems associated with the new management information system, underabsorption of manufacturing overhead as a result of an aggressive plan to reduce inventories by slowing production, and an unfavorable mix variance caused by higher sales of products with lower gross margins. In addition, certain non- recurring, unfavorable inventory adjustments occurred in the first quarter of 2001 as a result of a lack of familiarity with the new management information system. Selling expenses were $10.6 million for the first six months of 2001, a $2.9 million increase over the first six months of 2000. This increase was due primarily to increases in staffing levels required to support additional product 20 lines and costs associated with the France and U.K. sales offices established in fiscal 2000. As a percentage of net sales, selling expenses were 13.4% in the first six months of 2001 as compared to 10.6% in the first six months of 2000. Distribution expenses were $5.0 million for the first six months of 2001, an increase of $1.5 million or 44.3% over the first six months of 2000. As a percentage of sales, distribution expenses increased to 6.4% in the first six months of 2001 as compared to 4.8% in the first six months of 2000. The increase is primarily the result of the increased cost of freight between the Company's distribution facilities, increased headcount to operate the new management information system and additional expenses related to the establishment of an expanded Temecula distribution facility. General and administrative expenses were $10.2 million in the first six months of 2001, an increase of $1.9 million or 22.4% over the first six months of 2000. This increase resulted primarily from increased staffing levels required to maintain acceptable customer service levels and operate the business with the new management information system. As a percentage of net sales, general and administrative expenses were 13.0% in the first six months of 2001 as compared to 11.5% in the first six months of 2000. Research and development expenses were $0.9 million for the first six months of 2001, a decrease of $0.3 from the first six months 2000. Interest expense was $13.8 million for the first six months of 2001, as compared to $10.4 million in the first six months of 2000. The increase was due to higher debt levels as a result of the Tyco SHERIDAN(R) acquisition and increased borrowings for working capital. Liquidity and Capital Resources The Company's primary sources of liquidity are cash flow from operations, borrowings under its working capital bank facility and historically, investments from shareholders. Cash provided by (used in) operations totaled $3.0 million and $(13.0) million in the first six months of 2000 and 2001, respectively. The decrease from the second quarter of 2000 to the second quarter of 2001 is primarily attributable to decreased operating income, increased interest expense due to higher debt levels and a decline in accounts payable. For the three months ended June 30, 2001, the Company reduced trade payables by approximately $8.6 million. This was partially offset by a $10.1 million reduction in inventories. The Company had operating working capital, excluding cash and short-term debt, of $38.7 million and $38.2 million as of December 31, 2000 and June 30, 2001, respectively. Inventories were $44.6 million and $34.5 million as of December 31, 2000 and June 30, 2001, respectively. In order to meet the needs of its customers, the Company must maintain inventories sufficient to permit same-day or next-day filling of most orders. Such inventories are higher than those that would be required for delayed filling of orders, thus adversely impacting liquidity. Over time, the Company expects its level of inventories to increase as the Company's sales in the international market increase. Accounts receivable, net of allowances, were $28.3 million and $28.7 million at December 31, 2000 and June 30, 2001, respectively. The Company typically offers 30 day credit terms to its U.S. hospital distributors. Alternate site and international customers typically receive 60 to 90 day terms and, as a result, as the Company's alternate site and international sales have increased, the amount and aging of its accounts receivable have increased. The Company anticipates that the amount and aging of its accounts receivable will continue to increase as the alternate site and international markets become a larger percentage of the Company's overall sales. During the six months ended June 30, 2001, net cash provided by investing activities was $2.0 million, reflecting purchases of manufacturing equipment, offset by exchange losses from foreign affiliates. The Company currently estimates that capital expenditures will be approximately $8.0 million in each of 2001 and 2002, consisting primarily of additional and replacement manufacturing equipment and new heater placements. During the six months ended June 30, 2001, net cash provided by financing was $7.2 million, reflecting principally additions of notes payable to affiliates and additional bank borrowings, in each case net of repayments. This was somewhat offset by repayment of certain notes payable to affiliates. On March 21, 2001, the Company replaced its existing lending agreement denominated in Swedish krona with a new loan that allows for borrowings up to $19.1 million. The principal is amortized over 18 equal quarterly payments commencing June 30, 2001. Interest is based on the STIBOR rate + 0% to 1.65%, based on the outstanding balance of 21 the loan. The loan is secured by Hudson Euro SarL, a wholly-owned subsidiary of the company and 100% owner of Hudson RCI AB, Hudson RCI UK Ltd. and Hudson France S.A.S. As of June 30, 2001, The Company had outstanding $228.0 million of indebtedness, consisting of $115.0 million of Subordinated Notes, borrowings of $81.0 million under the Company's Credit Facility, $13.7 million in notes payable to affiliates and $18.4 million in outstanding borrowings under the bank facility of Hudson RCI AB. The Credit Facility currently consists of a $40.0 million Term Loan Facility and a $55.0 million Revolving Loan Facility of which up to $40.0 million (all of which has been borrowed and is outstanding) may be used for permitted acquisitions and up to $15 million (the "Working Capital Portion") may be used for general corporate purposes (other than acquisitions). The Revolving Loan Facility has a letter of credit sublimit of $7.5 million. As of January, 2001 the Company had fully utilized the Working Capital Portion of the Revolving Loan Facility. The Term Loan Facility matures on June 30, 2003 and, commencing June 30, 1999, requires quarterly principal installments totaling $3.0 million in 1999, $5.5 million in 2000, $7.5 million in 2001, $9.5 million in 2002 and $14.5 million in 2003. The Revolving Loan Facility matures on June 30, 2003. The interest rate under the Credit Facility is based, at the option of the Company, upon either a Eurodollar rate or a base rate (as defined) plus a margin during the period and for the applicable type of loan as follows: Margin ---------------- Period and Loan Type Base Rate Eurodollar -------------------- --------- ---------- Through June, 2002 Term and Working Capital 3.00% 4.00% Acquisition 3.25% 4.25% July, 2002 through March, 2003 Term and Working Capital 3.50% 4.50% Acquisition 3.75% 4.75% Thereafter Term and Working Capital 4.00% 5.00% Acquisition 4.25% 5.25% For periods after June, 2002, the margins set forth above are subject to pricing reductions depending on the Company's then existing leverage ratio. Borrowings under the Credit Facility are required to be prepaid, subject to certain exceptions, with (i) 75% (or 50% for years when the Company's ratio of Debt to EBITDA (as defined) is less than 5:1) of Excess Cash Flow (as defined), (ii) 50% of the net cash proceeds of an equity issuance by Holding or the Company in connection with an initial public offering or 100% of the net cash proceeds of an equity issuance by Holding. Holding or the Company other than in connection with an initial public offering (subject in each case to certain exceptions), (iii) 100% of the net cash proceeds of the sale or other disposition of any properties or assets of Holding and its subsidiaries (subject to certain exceptions), (iv) 100% of the net proceeds of certain issuances of debt obligations of the Company and its subsidiaries and (v) 100% of the net proceeds from insurance recoveries and condemnations. The Revolving Loan Facility must be repaid upon payment in full of the Term Loan Facility. The Credit Facility is guaranteed by Holding and certain of the Company's subsidiaries. The Credit Facility is secured by a first priority lien in substantially all of the properties and assets of the Company and the guarantors now owned or acquired later, including a pledge of all of the capital stock of the Company owned by Holding and all of the shares held by the Company of its existing and future subsidiaries; provided, that such pledge is limited to 65% of the shares of any foreign subsidiary to the extent a pledge of a greater percentage would result in adverse tax consequences to the Company. 22 The Credit Facility contains covenants restricting the ability of Holding, the Company and the Company's subsidiaries to, among others, (i) incur additional debt, (ii) declare dividends or redeem or repurchase capital stock, (iii) prepay, redeem or purchase debt, (iv) incur liens, (v) make loans and investments, (vi) make capital expenditures, (vii) engage in mergers, acquisitions and asset sales, and (viii) engage in transactions with affiliates. Hudson RCI is also required to comply with financial covenants with respect to (a) limits on annual aggregate capital expenditures (as defined), (b) a fixed charge coverage ratio, (c) a maximum leverage ratio, (d) a minimum EBITDA test and (e) an interest coverage ratio. As of December 31, 2000, the Company was not in compliance with certain of these restrictive covenants. Subsequently, the Credit Facility has been amended and all non-compliance was cured. The Subordinated Notes bear interest at the rate of 9-1/8%, payable semiannually on each April 15 and October 15, and will require no principal repayments until maturity. The Subordinated Notes are general unsecured obligations of the Company. The Subordinated Notes contain covenants that place limitations on, among other things, (i) the ability of the Company, any subsidiary guarantors and other restricted subsidiaries to incur additional debt, (ii) the making of certain restricted payments including investments, (iii) the creation of certain liens, (iv) the issuance and sale of capital stock of restricted subsidiaries, (v) asset sales, (vi) payment restrictions affecting restricted subsidiaries, (vii) transactions with affiliates and (viii) the ability of the Company and any subsidiary guarantor to incur layered debt, (ix) the ability of Holding to engage in any business or activity other than those relating to ownership of capital stock of the Company and (x) certain mergers, consolidations and transfers of assets by or involving the Company. As of June 30, 2001, the Company had $10.3 million outstanding pursuant to unsecured promissory notes payable to affiliates of Freeman Spogli, the Company's majority shareholder. The notes bear interest at 12.0% per annum to 14.0% per annum, mature in August 2006. Of these notes, $2.0 million require semiannual interest payments. The Company, through Hudson RCI AB, has incurred bank debt in Sweden (the "HRCI AB Facility") that totaled $14.1 million as of June 30, 2001. The HRCI AB Facility, which is denominated in Swedish krona, bears interest at three-month STIBOR plus 0.75% to 1.75% (4.884% to 5.884% at June 30, 2001), matures in December 2003, and is guaranteed by Steamer Holding AB, Hudson RCI AB's parent, and is secured by the common stock of Hudson RCI AB. The Company has issued to Holding 300,000 shares of its 11-1/2% Senior Exchangeable PIK Preferred Stock due 2010 with an initial aggregate liquidation preference of $30.0 million, which has terms and provisions materially similar to those of the 11 1/2% Senior Exchangeable PIK Preferred Stock due 2010 issued by Holding. At the election of the Company, dividends may be paid in kind until April 15, 2003 and thereafter must be paid in cash. As the result of a number of factors affecting the Company in fiscal 2000, management has taken numerous actions during 2001 including elimination of a distribution warehouse, elimination of non-essential management personnel, reduction in inventory levels, aggressive collection efforts of accounts receivable and other cost reduction measures as management deemed necessary to fund the operations of the Company, meet anticipated capital expenditures and make required payments of principal and interest on its debt, including payments due on the Subordinated Notes and obligations under the Credit Facility. Management does not believe the restructuring charges referred to above will be material to the Company. In addition, existing shareholders and key management personnel contributed approximately $14.9 million in the form of convertible subordinated debt and equity in October 2000, April, May and August of 2001 and contributed an additional $3.0 million in redeemable preferred stock of Holding (which Holding will invest in preferred stock of the Company) in August of 2001, in order to improve the Company's liquidity position. Based on these actions, as well as anticipated improved operating performance, management believes it will have sufficient sources of liquidity to meet its obligations for a period of at least 18 months. 23 Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138, effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments. The statement requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The impact of adoption was not material to the financial statements. In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"). This Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. Holding will adopt SFAS 141 for all business combinations initiated after June 30, 2001. Also in June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." This pronouncement addresses, among other things, how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill would no longer be amortized but would be assessed at least annually for impairment using a fair value methodology. Holding will adopt this statement for all goodwill and other intangible assets acquired after June 30, 2001 and for all existing goodwill and other intangible assets beginning January 1, 2002. Upon adoption of this standard on January 1, 2002 Holding will cease recording amortization of goodwill which would increase income before taxes in 2002 by approximately $11.6 million. Other than ceasing the amortization of goodwill, Holding does not anticipate that the adoption of SFAS 142 will have a significant effect on Holding's financial position or the results of operations as Holding does not currently anticipate any impairment charges for existing goodwill. Also in June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 (with earlier application being encouraged). Holding does not expect the adoption of SFAS 143 to have a material impact on Holding's financial condition and results of operations. 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS There have been no material changes in Holding's market risk exposure from that reported in Holding's 10-K for the fiscal year ended December 31, 2000. 25 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES On April 17, 2001, Holding sold 7,501 shares of its common stock, as adjusted, to Jerry Burns for total cash consideration to Holding of $75,010, and sold 2,501 shares of its common stock, as adjusted, to Paul Vallina for total cash consideration to Holding of $25,010; each sale was made pursuant to Holding's 1998 Employee Stock Subscription Plan. The issuances of common stock referenced above were exempt from registration as issuances made pursuant to a compensatory benefit plan under Rule 701 of the Securities Act of 1933, as amended. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 4.3 (1) Form of Senior Subordinated Convertible Promissory Note Due 2005. 4.4 (1) Certificate of Determination of Preferences of 12% Junior Convertible Cumulative Preferred Stock of the Company. 10.19 (1) Subordination Agreement dated as of April 17, 2001 among the Company, FS Equity partners IV, L.P., Bankers Trust Company and the Subordinated Creditors party thereto. 10.20 (1) Amendment No. 5 to and Limited Waiver of Certain Provisions of the Credit Agreement dated as of July 30, 2001 among the Company, Holding and the lenders party thereto. (b) Reports on Form 8-K None. ______________________ (1) Incorporated by reference to the exhibit designated by the same number in the form 10-Q filed by the Company for the quarter ended June 30, 2001 (File No.: 333-56097). 26 SIGNATURE Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. RIVER HOLDING CORP., a Delaware corporation September 21, 2001 By: /s/ Patrick G. Yount ---------------------------------- Patrick G. Yount Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 27

RIVER HOLDING CORP 10-Q