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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
PIK Toggle Notes. On May 31, 2007, Merger Sub issued $230.0 million aggregate original principal amount of 8.50% / 9.25% PIK Toggle Notes under the Second Lien Senior Indenture with Wells Fargo Bank, National Association, as trustee (the “Second Lien Senior Indenture”). See “Second Lien Senior Indenture” below. At the closing of the Transaction, as the surviving corporation in the Acquisition, we assumed all the obligations of Merger Sub under the Second Lien Senior Indenture.
For any interest payment period through June 1, 2011, the Company may, at its option, elect to pay interest on the PIK Toggle Notes entirely in cash (“Cash Interest”), entirely by increasing the principal amount of the outstanding PIK Toggle Notes, by issuing additional PIK Toggle Notes (“PIK Interest”) or 50% Cash Interest and 50% PIK Interest. Cash Interest on the PIK Toggle Notes accrues at the rate of 8.50% per annum. PIK Interest on the PIK Toggle Notes accrues at the rate of 9.25% per annum. After June 1, 2011, the Company is required to make all interest payments on the PIK Toggle Notes entirely as Cash Interest. All PIK Toggle Notes mature on June 1, 2015. Interest on the PIK Toggle Notes is payable semiannually in arrears on each June 1 and December 1, commencing on December 1, 2007.
We may redeem some or all of the PIK Toggle Notes at any time prior to June 1, 2011, at a price equal to 100% of the principal amount thereof, plus the applicable premium (as defined by the Second Lien Senior Indenture), plus accrued and unpaid interest, if any, to the date of redemption. In addition, on or before June 1, 2010, we may redeem up to 40% of the aggregate principal amount of the PIK Toggle Notes with the net proceeds of certain equity offerings.
Except as noted above, we cannot redeem the PIK Toggle Notes until June 1, 2011. Thereafter we may redeem some or all of the PIK Toggle Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if any, on the PIK Toggle Notes redeemed, to the applicable redemption date, if redeemed during the twelve-month period beginning on June 1 of the years indicated below, subject to the rights of noteholders:
Year | | Percentage | |
| 2011 | | | 104.250 | % |
| 2012 | | | 102.125 | % |
| 2013 and thereafter | | | 100.000 | % |
Upon the occurrence of a change of control, each holder of the PIK Toggle Notes has the right to require the Company to repurchase some or all of such holder’s PIK Toggle Notes at a price in cash equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest, and PIK Interest, if any, to the date of purchase.
Floating Rate Notes. On May 31, 2007, Merger Sub issued $230.0 million aggregate original principal amount of Floating Rate Notes under the Second Lien Senior Indenture with Wells Fargo Bank, National Association, as trustee. See “Second Lien Senior Indenture” below. Interest on the Floating Rate Notes is reset for each semi-annual interest period and is calculated at the current LIBOR rate plus 3.375%. At September 30, 2007, our LIBOR-based rate was 8.760%, which includes the credit spread noted above. Interest on the Floating Rate Notes is payable semiannually, in arrears, on each June 1 and December 1, commencing on December 1, 2007. At the closing of the Transaction, as the surviving corporation in the Acquisition, we assumed all the obligations of Merger Sub under the Second Lien Senior Indenture. The Floating Rate Notes mature on June 1, 2015.
We may redeem some or all of the Floating Rate Notes at any time prior to June 1, 2009, at a price equal to 100% of the principal amount thereof, plus the applicable premium (as defined by the Second Lien Senior Indenture), plus accrued and unpaid interest, if any, to the date of redemption. In addition, on or before June 1, 2009, we may redeem up to 40% of the aggregate principal amount of the Floating Rate Notes with the net proceeds of certain equity offerings.
Except as noted above, we cannot redeem the Floating Rate Notes until June 1, 2009. Thereafter we may redeem some or all of the Floating Rate Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if any, on the Floating Rate Notes redeemed, to the applicable redemption date, if redeemed during the twelve-month period beginning on June 1 of the years indicated below, subject to the rights of noteholders:
Year | | Percentage | |
| 2009 | | | 102.000 | % |
| 2010 | | | 101.000 | % |
| 2011 and thereafter | | | 100.000 | % |
| | | | | |
Upon the occurrence of a change of control, each holder of the Floating Rate Notes has the right to require the Company to repurchase some or all of such holder’s Floating Rate Notes at a price in cash equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase.
Interest Rate Swap. In June 2007 we entered into an interest rate swap agreement for $230.0 million, which has the effect of converting our $230.0 of Floating Rate Notes to fixed interest rates. The effective date for the swap agreement is December 2007, the beginning of the next semi-annual interest rate period; the expiration date is May 2012.
The interest rate swap agreement qualifies for cash flow hedge accounting under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. Both at inception and on an on-going basis we must perform an effectiveness test. In accordance with SFAS 133, the fair value of the swap agreement at September 30, 2007 is included as a cash flow hedge on our balance sheet. The change in fair value was recorded as a component of accumulated other comprehensive loss on our balance sheet since the instrument was determined to be an effective hedge at September 30, 2007. We do not expect any amounts to be reclassified into current earnings in the future due to ineffectiveness.
As a result of our swap agreement, we expect the effective interest rate on our $230.0 million Floating Rate Notes to be 9.065% from December 2007 through May 2012.
Second Lien Senior Indenture. Our PIK Toggle Notes and Floating Rate Notes (collectively, the “Notes”) are guaranteed, jointly and severally, on a second priority senior secured basis, by certain of our future domestic subsidiaries. We do not currently have any subsidiaries. The Notes are our second priority senior secured obligations and rank:
| · | equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness, and effectively senior to any such unsecured indebtedness to the extent of the value of collateral; |
| · | senior in right of payment to all of our and our guarantor’s existing and future subordinated indebtedness; |
| · | effectively junior to our senior secured credit facility and other obligations that are secured by first priority liens on the collateral securing the Notes or that are secured by a lien on assets that are not part of the collateral securing the Notes, in each case, to the extent of the value of such collateral or assets; and |
| · | structurally subordinated to any indebtedness and other liabilities (including trade payables) of any of our future subsidiaries that are not guarantors. |
The Second Lien Senior Indenture governing the Notes contains covenants that limit our and our guarantors’ ability, subject to certain definitions and exceptions, and certain of our future subsidiaries’ ability to:
| · | incur additional indebtedness; |
| · | pay cash dividends or distributions on our capital stock or repurchase our capital stock or subordinated debt; |
| · | issue redeemable stock or preferred stock; |
| · | issue stock of subsidiaries; |
| · | make certain investments; |
| · | transfer or sell assets; |
| · | create liens on our assets to secure debt; |
| · | enter into transactions with affiliates; and |
| · | merge or consolidate with another company. |
Senior Secured Credit Facility. In connection with the Transaction, the Company and Parent entered into a new first lien senior secured asset-based revolving credit facility providing for loans in an amount of up to $135.0 million pursuant to a credit agreement, dated as of May 31, 2007, with a group of financial institutions. The senior secured credit facility is available for working capital and general corporate purposes, including permitted investments, capital expenditures and debt repayments, on a fully revolving basis, subject to the terms and conditions set forth in the credit documents in the form of revolving loans, swing line loans and letters of credit.
The senior secured credit facility provides financing of up to $135.0 million, subject to a borrowing base calculated on the basis of certain of our eligible accounts receivable, inventory and equipment. As of September 30, 2007, we had $132.7 million of unused borrowing availability under our senior secured credit facility based on a borrowing base of $135.0 million and after giving effect to $2.3 million used for letters of credit.
The senior secured credit facility matures on May 31, 2013. Our obligations under the senior secured credit facility are secured by a first priority security interest in substantially all of our assets, excluding a pledge of our and Parent’s capital stock, any joint ventures and certain other exceptions. Our obligations under the senior secured credit facility are unconditionally guaranteed by our Parent.
The senior secured credit facility provides that we have the right at any time to request up to $50.0 million of additional commitments, but the lenders are under no obligation to provide any such additional commitments, and any increase in commitments will be subject to customary conditions precedent, such as an absence of any default or events of default. If we were to request any such additional commitments and the existing lenders or new lenders were to agree to provide such commitments, the senior secured credit facility size could be increased to up to $185.0 million, but our ability to borrow would still be limited by the amount of the borrowing base.
Borrowings under the senior secured credit facility accrue interest at our option:
| · | At a per annum rate equal to 0.75% above the rate announced from time to time by the agent as the “prime rate” payable quarterly in arrears; or |
| · | At a per annum rate equal to 1.75% above the adjusted LIBOR rate used by the agent. |
Overdue principal, interest and other amounts will bear interest at a rate per annum equal to 2% in excess of the applicable interest rate. The applicable margins of the senior secured credit facility will be subject to adjustment based upon leverage ratios. The senior secured credit facility also provides for customary letter of credit fees, closing fees, unused line fees and other fees.
The senior secured credit facility requires our compliance with various affirmative and negative covenants. Pursuant to the affirmative covenants, we and Parent will, among other things, deliver financial and other information to the agent, provide notice of certain events (including events of default), pay our obligations, maintain our properties, maintain the security interest in the collateral for the benefit of the agent and the lenders and maintain insurance.
Among other restrictions, and subject to certain definitions and exceptions, the senior secured credit facility restricts our ability to:
| · | declare or pay dividends and certain other restricted payments; |
| · | consolidate, merge or recapitalize; |
| · | make certain investments, loans or other advances; |
| · | enter into transactions with affiliates; |
| · | change our line of business; and |
| · | enter into hedging transactions. |
The senior secured credit facility also contains a financial covenant that is calculated if our available borrowing capacity is less than $15.0 million for a certain period. Such covenant consists of a minimum ratio of trailing four-quarter EBITDA to cash interest expense, as defined in the credit agreement dated May 31, 2007.
The senior secured credit facility specifies certain events of default, including among others, failure to pay principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, bankruptcy events, certain ERISA-related events, cross-defaults to other material agreements, change of control events, and invalidity of guarantees or security documents. Some events of default will be triggered only after certain cure periods have expired, or will provide for materiality thresholds. If such a default occurs, the lenders under the senior secured credit facility would be entitled to take various actions, including all actions permitted to be taken by a secured creditor and the acceleration of amounts due under the senior secured credit facility.
10.125% Senior Notes. The 10.125% Senior Notes (“Senior Notes”) mature on November 1, 2011. Interest on the Senior Notes accrues at the rate of 10.125% per annum and is payable semiannually on each May 1 and November 1. The Senior Notes are redeemable, at the Company’s option, in whole or in part of, on or after November 1, 2007, at specified redemption prices plus accrued interest to the date of redemption.
On May 17, 2007, we entered into a supplemental indenture to our Indenture governing our Senior Notes, dated as of October 17, 2003, between the Company and Wells Fargo Bank, National Association, as trustee. The Indenture governs the terms of the Senior Notes. The supplemental indenture amended our Indenture.
In May 2007, in connection with the Transaction, we tendered for all of our outstanding Senior Notes, pursuant to their terms. On May 31, 2007, $235.0 million of our Senior Notes were purchased. We paid $253.1 million, including a call premium of $16.1 million and accrued interest of $2.0 million to complete the purchase. We used proceeds from the issuance of our Notes to redeem a portion of our Senior Notes.
The amendments set forth in the supplemental indenture (the “Amendments”) became operative after the Company purchased all of its Senior Notes validly tendered and not withdrawn pursuant to its tender offer and consent solicitation. As of May 11, 2007, holders of Senior Notes representing an amount greater than a majority of the principal amount of outstanding Senior Notes had validly tendered their Senior Notes and consented to the execution of the supplemental indenture. The Amendments eliminated from the Indenture:
| · | requirements to file reports with the Securities and Exchange Commission; |
| · | requirements to pay taxes; |
| · | limitations on the Company to use defenses against usury; |
| · | limitation on restricted payments; |
| · | limitation on payment of dividends and other payment restrictions affecting subsidiaries; |
| · | limitations on incurrence of indebtedness and issuance of preferred stock; |
| · | limitations on asset sales and requirements to repurchase the Senior Notes with excess proceeds thereof; |
| · | limitations on affiliate transactions; |
| · | limitations on the businesses in which the Company and its subsidiaries may engage; |
| · | requirements to preserve corporate existence; |
| · | requirements to purchase the Senior Notes upon a change of control; |
| · | limitation on the issuance of guarantees of indebtedness; |
| · | limitations on the payments for consent from holders of Senior Notes; |
| · | limitations on mergers, consolidation and sale of assets with respect to the Company; |
| · | limitations on mergers or consolidation of, or transfer of assets of, guarantors; and |
| · | certain events of default. |
On June 13, 2007 we purchased an additional $15.1 million of our remaining Senior Notes pursuant to their terms. We paid $15.9 million of cash, including a call premium of $0.7 million and accrued interest of $0.1 million to complete the purchase.
The Company has the right to redeem some or all of the remaining $9.9 million of Senior Notes at the redemption prices (expressed as a percentage of principal amount) set forth below, plus accrued and unpaid interest, if any, if redeemed during the twelve-month period beginning on November 1 of the years indicated below, subject to the rights of the noteholders:
Year | | Percentage | |
| 2007 | | | 105.063 | % |
| 2008 | | | 102.531 | % |
| 2009 and thereafter | | | 100.000 | % |
Termination of Our Amended Credit Agreement. In connection with the Transaction, we repaid all outstanding balances under our Amended Credit Agreement and terminated our Amended Credit Agreement.
Maturities of Long-Term Debt. At September 30, 2007, maturities of long-term debt during the period from October 1, 2007 through December 31, 2007 and for each of our fiscal years ending December 31, 2008 to 2012 and thereafter, are estimated as follows:
(in thousands) | | | |
| | | | |
| October 1, 2007 to December 31, 2007 | | $ | 798 | |
| 2008 | | | 2,821 | |
| 2009 | | | 1,765 | |
| 2010 | | | 1,109 | |
| 2011 | | | 10,238 | |
| 2012 | | | - | |
| Thereafter | | | 460,000 | |
| | | $ | 476,731 | |
| | Commitments and Contingencies |
The Company, in the ordinary course of business, could be subject to liability claims related to employees and the equipment that it rents and services. Asserted claims are subject to many uncertainties and the outcome of individual matters is not predictable with assurance. While the ultimate resolution of these actions may have an impact on the Company’s financial results for a particular reporting period, management believes that any such resolution would not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
The components of the Company's overall deferred tax assets and liabilities as of September 30, 2007 and December 31, 2006 are as follows:
(in thousands) | | September 30, 2007 (Successor) | | | December 31, 2006 (Predeccessor) | |
| Deferred tax assets | | | | | | | | |
| Accounts receivable | | $ | 531 | | | $ | 533 | |
| Accrued compensation and pension | | | 4,237 | | | | 3,807 | |
| Inventories | | | 208 | | | | 314 | |
| Other assets | | | 1,717 | | | | 804 | |
| Net operating loss carryforwards | | | 45,599 | | | | 29,293 | |
| Deferred tax assets | | | 52,292 | | | | 34,751 | |
| Valuation allowance | | | - | | | | (9,945 | ) |
| Net deferred tax asset | | | 52,292 | | | | 24,806 | |
| Deferred tax liabilities | | | | | | | | |
| Accelerated depreciation and amortization | | | (162,973 | ) | | | (27,233 | ) |
| Total deferred tax liabiliites | | | (162,973 | ) | | | (27,233 | ) |
| Net deferred tax liability | | $ | (110,681 | ) | | $ | (2,427 | ) |
The Company's deferred income taxes are recorded at an effective rate of 39.8%, which is not materially different than the statutory rate.
We adopted the provisions of FASB Interpretation No 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB No. 109” (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Based on our evaluation, we have concluded that there are no significant unrecognized tax benefits. Our evaluation was performed for the tax years ended December 31, 2003, 2004, 2005 and 2006, the tax years that remain subject to examination by major tax jurisdictions as of September 30, 2007. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.
We may from time to time be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to our financial results. In accordance with FIN 48, paragraph 19, the Company has elected to classify interest and penalties as a component of income tax expense.
Our operating segments consist of Medical Equipment Outsourcing, Technical and Professional Services, and Medical Equipment Sales and Remarketing. Certain operating information for our segments as well as a reconciliation of total Company gross margin to income (loss) before income tax follows:
Medical Equipment Outsourcing | |
(in thousands) | |
| | | Quarter-to-date | | | Year-to-date | |
| | | Three Months Ended September 30, | | | Three Months Ended September 30, | | | Four Months Ended September 30, | | | Five Months Ended May 31, | | | Nine Months Ended September 30, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Revenues | | $ | 49,988 | | | $ | 42,361 | | | $ | 66,683 | | | $ | 84,855 | | | $ | 131,079 | |
| Cost of revenue | | | 18,314 | | | | 14,822 | | | | 24,230 | | | | 27,694 | | | | 42,762 | |
| Movable medical equipment depreciation | | | 14,116 | | | | 9,459 | | | | 18,748 | | | | 18,512 | | | | 27,659 | |
| Gross margin | | $ | 17,558 | | | $ | 18,080 | | | $ | 23,705 | | | $ | 38,649 | | | $ | 60,658 | |
Technical and Professional Services | |
(in thousands) | |
| | | Quarter-to-date | | | Year-to-date | |
| | | Three Months Ended September 30, | | | Three Months Ended September 30, | | | Four Months Ended September 30, | | | Five Months Ended May 31, | | | Nine Months Ended September 30, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Revenues | | $ | 11,098 | | | $ | 7,459 | | | $ | 14,728 | | | $ | 14,800 | | | $ | 23,128 | |
| Cost of revenue | | | 8,158 | | | | 5,235 | | | | 10,684 | | | | 10,124 | | | | 15,942 | |
| Gross margin | | $ | 2,940 | | | $ | 2,224 | | | $ | 4,044 | | | $ | 4,676 | | | $ | 7,186 | |
Medical Equipment Sales and Remarketing | |
(in thousands) | |
| | | Quarter-to-date | | | Year-to-date | |
| | | Three Months Ended September 30, | | | Three Months Ended September 30, | | | Four Months Ended September 30, | | | Five Months Ended May 31, | | | Nine Months Ended September 30, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Revenues | | $ | 4,097 | | | $ | 4,749 | | | $ | 5,374 | | | $ | 7,867 | | | $ | 13,472 | |
| Cost of revenue | | | 3,610 | | | | 3,704 | | | | 4,822 | | | | 6,366 | | | | 10,140 | |
| Gross margin | | $ | 487 | | | $ | 1,045 | | | $ | 552 | | | $ | 1,501 | | | $ | 3,332 | |
Total Gross Margin and Reconciliation to Income (Loss) Before Income Taxes | |
(in thousands) | |
| | | Quarter-to-date | | | Year-to-date | |
| | | Three Months Ended September 30, | | | Three Months Ended September 30, | | | Four Months Ended September 30, | | | Five Months Ended May 31, | | | Nine Months Ended September 30, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Total gross margin | | $ | 20,985 | | | $ | 21,349 | | | $ | 28,301 | | | $ | 44,826 | | | $ | 71,176 | |
| Selling, general and administrative expense | | | 20,741 | | | | 15,633 | | | | 27,345 | | | | 28,692 | | | | 45,977 | |
| Transaction and related costs | | | 237 | | | | - | | | | 237 | | | | 26,891 | | | | - | |
| Interest expense | | | 11,231 | | | | 7,819 | | | | 15,031 | | | | 13,829 | | | | 23,523 | |
| Loss on extinguishment of debt | | | - | | | | - | | | | 1,041 | | | | 22,396 | | | | - | |
| Income (loss) before income tax | | $ | (11,224 | ) | | $ | (2,103 | ) | | $ | (15,353 | ) | | $ | (46,982 | ) | | $ | 1,676 | |
The components of net periodic pension costs are as follows:
(in thousands) | | Quarter-to-date | | | Year-to-date | |
| | | Three Months Ended September 30, | | | Three Months Ended September 30, | | | Four Months Ended September 30, | | | Five Months Ended May 31, | | | Nine Months Ended September 30, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Interest cost | | $ | 255 | | | $ | 244 | | | $ | 340 | | | $ | 421 | | | $ | 730 | |
| Expected return on plan assets | | | (295 | ) | | | (253 | ) | | | (393 | ) | | | (452 | ) | | | (757 | ) |
| Recognized net actuarial loss | | | - | | | | 67 | | | | - | | | | 73 | | | | 201 | |
| Service cost | | | - | | | | - | | | | - | | | | - | | | | - | |
| Total cost | | $ | (40 | ) | | $ | 58 | | | $ | (53 | ) | | $ | 42 | | | $ | 174 | |
(in thousands) | | | |
| Benefit obligations at fair value | | $ | 16,902 | |
| Assets held by defined benefit pension plan, at fair value | | | 14,603 | |
| Excess of benefit obligations over assets | | | 2,299 | |
| Less: previously recorded benefit plan obligations | |
| recorded by predecessor | | | (3,061 | ) |
| Adjustment to benefit plan obligations | | $ | (762 | ) |
Future benefit accruals for all participants were frozen as of December 31, 2002.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with the accompanying financial statements and notes.
BUSINESS OVERVIEW
Our Company
Universal Hospital Services, Inc. (“we”, “our”, the “Company”, or “UHS”) is the leading nationwide provider of medical equipment outsourcing and lifecycle services to the health care industry. Our customers include national, regional and local acute care hospitals, alternate site providers (such as nursing homes and home care providers) and medical equipment manufacturers. Our diverse medical equipment outsourcing customer base includes more than 3,850 acute care hospitals and approximately 3,550 alternate site providers. We also have relationships with more than 200 medical equipment manufacturers and many of the nation’s largest group purchasing organizations (“GPOs”) and integrated delivery networks (“IDNs”). All of our services leverage our nationwide network of offices and our more than 65 years of experience managing and servicing all aspects of movable medical equipment. Our fees are paid directly by our customers rather than from direct reimbursement from third party payors, such as private insurers or Medicare and Medicaid.
On May 31, 2007, UHS Holdco, Inc. (“Parent”) acquired all of the outstanding capital stock of the Company for approximately $712.0 million in cash less debt, tender premium and accrued interest and capitalized leases. Parent is owned by affiliates of Bear Stearns Merchant Manager III (Cayman), L.P. (together with its investing affiliates, “BSMB”) and certain members of our management, whom we collectively refer to as the “equity investors.” Parent and Merger Sub, a wholly owned subsidiary of Parent, were corporations formed by BSMB solely for the purpose of completing the Acquisition.
Before the closing of the Acquisition, the Company initiated a cash tender offer to purchase its $260.0 million outstanding aggregate principal amount of its 10.125% Senior Notes due 2011, which the Company completed for $235.0 million of such notes on May 31, 2007, and Merger Sub issued $230.0 million in aggregate principal amount of its Floating Rate Notes due 2015 and $230.0 million in aggregate principal amount of its PIK Toggle Notes due 2015 (The PIK Toggle Notes and the Floating Rate Notes are collectively referred to as the “Notes”). Concurrently with the closing of the Acquisition, Merger Sub merged with and into the Company, which was the surviving corporation and the Company assumed Merger Sub’s obligations with respect to the Notes and related Second Lien Senior Indenture.
The Agreement and Plan of Merger, dated as of April 15, 2007, by and among the Company, Parent and Merger Sub and related documents resulted in the occurrence of the events outlined in Note 5 in Part I of this Form 10-Q, which we collectively refer to as the “Transaction” or the “Acquisition.”
Although the Company continued as the surviving legal entity after the Acquisition, the accompanying statements of operations and cash flows present our results of operations and cash flows for the periods preceding the Acquisition (“predecessor”) and the periods succeeding the Acquisition (“successor”), respectively. All references to the three and nine months ended September 30, 2006 and for the five months ended May 31, 2007 refer to our predecessor results. All references to the three and four months ended September 30, 2007 refer to our successor results.
Technical and Professional Services Segment Medical Equipment Sales and Remarketing Segment |  | Medical Equipment Outsourcing Segment Technical and Professional Services Segment |
Our operating segments consist of Medical Equipment Outsourcing, Technical and Professional Services and Medical Equipment Sales and Remarketing. We evaluate the performance of our operating segments based on gross margin and gross margin before purchase accounting adjustments. The accounting policies of the individual operating segments are the same as those of the entire Company.
We have prepared our discussion of the results of operations for the three months and nine months ended September 30, 2007 and 2006 by comparing the results of operations of the predecessor for the three months and nine months ended September 30, 2006 to those of the successor for the three and four months ended September 30, 2007 and those of the predecessor for the five months ended May 31, 2007.
We present the non-GAAP financial measure gross margin, before purchase accounting adjustments, because we use this measure to monitor and evaluate the performance of our business and believe that the presentation of this measure will enhance users’ ability to analyze trends in our business and evaluate our performance relative to other companies in our industry. A reconciliation of the non-GAAP financial measure to its equivalent GAAP measure is included in the respective tables.
Medical Equipment Outsourcing Segment - Manage & Utilize
Our flagship business is our Medical Equipment Outsourcing segment, which accounted for $50.0 million, or approximately 76.7% of our revenues for the third quarter of 2007, $66.7 million, or approximately 76.8% of our revenues for the four months ended September 30, 2007 and $84.9 million, or approximately 78.9% of our revenues for the five months ended May 31, 2007. We own approximately 191,000 pieces of movable medical equipment, primarily in the categories of respiratory therapy, newborn care, critical care, patient monitors, and specialty beds and pressure area management. In our outsourcing programs, we provide our customers with the use of movable medical equipment for patient care use. We perform regular and preventative maintenance on the equipment and retain detailed records for documentation. We are responsible for all repairs, testing and cleaning of the equipment. Our service includes prompt replacement of any non-working equipment and the flexibility to upgrade technology as a customer’s product of choice changes. We have three primary outsourcing programs:
| · | Supplemental (Peak Needs) Outsourcing; |
| · | Long-Term Outsourcing; and |
| · | the Asset Management Partnership Program (“AMPP”). |
In March 2007, we entered into an agreement with Stryker Medical (“Stryker”), a division of Stryker Corporation, a major manufacturer of beds, stretchers and support surfaces, to provide their equipment to our customers for rent. Under this exclusive arrangement, Stryker retains ownership of the equipment and we share with Stryker the rental revenues we generate from our customers.
In October 2007, we entered into an agreement with the Advance Wound Management Division of Smith & Nephew, Inc. (“Smith & Nephew”), a global leader in arthroscopy and advanced wound management, to be the exclusive rental provider of the EZCARE™ and V1STA™ product systems to the acute care market in the continental United States, excluding certain grandfathered accounts. Under this agreement, Smith & Nephew retains ownership of the equipment and we share with Smith & Nephew the rental revenues we generate from our customers.
Given our scale and rental infrastructure, we believe that other equipment manufacturers may seek to enter into similar arrangements with us in the future enabling additional opportunities for growth with existing as well as new customers.
We have contracts in place with many of the leading national GPOs for both the acute care and alternate site markets. We also have agreements directly with national acute care and alternate site providers. We expect much of our future growth in this segment to be driven by our customers outsourcing more of their movable medical equipment needs and taking full advantage of our expanded offering of Long- Term Outsourcing agreements and AMPPs.
Technical and Professional Services Segment - Plan & Acquire; Maintain & Repair
Our Technical and Professional Services segment accounted for $11.1 million, or approximately 17.0%, of our revenues for the third quarter of 2007, $14.7 million, or approximately 17.0% of our revenues for the four months ended September 30, 2007 and $14.8 million, or approximately 13.8% of our revenues for the five months ended May 31, 2007. We leverage our more than 65 years of experience and our extensive equipment database in repairing and maintaining medical equipment. We offer a broad range of inspection, preventative maintenance, repair, logistic and consulting services through our team of over 325 technicians and professionals located in our nationwide network of district offices and service centers. Our technical and professional service offerings are less capital intensive than our Medical Equipment Outsourcing segment, and provide a complementary alternative for customers that wish to own their medical equipment, but lack the expertise, funding or scale to perform maintenance, repair and analytical functions. As part of our strategy to grow our Technical and Professional Services segment, we acquired the assets of the ICMS division of Intellamed on April 1, 2007.
Medical Equipment Sales and Remarketing Segment - Redeploy & Remarket
Our Medical Equipment Sales and Remarketing segment accounted for $4.1 million, or approximately 6.3% of our revenues for the third quarter of 2007, $5.4 million, or approximately 6.2% of our revenues for the four months ended September 30, 2007 and $7.9 million, or approximately 7.3% of our revenues for the five months ended May 31, 2007. This segment includes three business activities:
Medical Equipment Remarketing and Disposal. We are one of the nation’s largest buyers and sellers of pre-owned movable medical equipment. We also remarket used medical equipment to hospitals, alternate care providers, veterinarians and equipment brokers. We offer a wide range of equipment from our standard movable medical equipment to diagnostic, ultrasound and x-ray equipment.
Specialty Medical Equipment Sales and Distribution. We use our national infrastructure to provide sales and distribution for manufacturers of specialty medical equipment on a limited and exclusive basis. We currently sell equipment in many product lines including, but not limited to, continuous passive motion machines, patient monitors, patient transfer systems and infant security systems.
Sales of Disposables. We offer our customers single use disposable items. Most of these items are used in connection with our outsourced equipment. Although we do not view this as a core growth business, we offer these products as a convenience to customers and to complement our full medical equipment lifecycle offerings.
RESULTS OF OPERATIONS
The following discussion addresses:
| · | our financial condition as of September 30, 2007; |
| · | the results of operations for the three and four months ended September 30, 2007 and the five months ended May 31, 2007 and for the three and nine months ended September 30, 2006; and |
| · | the cash flows for the four months ended September 30, 2007, the five months ended May 31, 2007 and for the nine months ended September 30, 2006. |
This discussion should be read in conjunction with the financial statements included elsewhere in this Form 10-Q and the Management's Discussion and Analysis of Financial Condition and Results of Operations section included in our 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
In connection with the Transaction, the Company incurred significant indebtedness and is highly leveraged. See “Liquidity and Capital Resources.” In addition, the purchase price paid in connection with the Acquisition has been preliminarily allocated to state the acquired assets and liabilities at fair value. The preliminary accounting adjustments increased the carrying value of our property and equipment and inventory, established intangible assets for our customer relationships, supply agreement, trade names and trademarks, technology database and non-compete agreements and revalued our long-term benefit plan obligations, among other things. Subsequent to the Transaction, interest expense, non-cash depreciation and amortization charges have significantly increased. As a result, our successor financial statements subsequent to the Transaction are not comparable to our predecessor financial statements.
The following tables provide a summary of selected financial data as a percentage of total revenues for all periods presented:
| | | Quarter-to-Date | |
| | | Percent of Total Revenues | |
| | | Three Months | | | Three Months | |
| | | Ended | | | Ended | |
| | | September 30, | | | September 30, | |
| | | 2007 | | | 2006 | |
Revenue | | (Successor) | | | (Predecessor) | |
| Medical equipment outsourcing | | | 76.7 | % | | | 77.6 | % |
| Technical and professional services | | | 17.0 | | | | 13.7 | |
| Medical equipment sales and remarketing | | | 6.3 | | | | 8.7 | |
| Total revenues | | | 100.0 | % | | | 100.0 | % |
| | | | | | | | | |
Cost of Revenue | | | | | | | | |
| Cost of medical equipment outsourcing | | | 28.1 | | | | 27.2 | |
| Cost of technical and professional services | | | 12.5 | | | | 9.6 | |
| Cost of medical equipment sales and remarketing | | | 5.5 | | | | 6.8 | |
| Movable medical equipment depreciation | | | 21.7 | | | | 17.3 | |
| Total costs of medical equipment outsourcing, technical and professional services and medical equipment sales and | | | | | | | |
| remarketing | | 67.8 | | | | 60.9 | |
| Gross margin | | | 32.2 | | | | 39.1 | |
| | | | | | | | | |
| Selling, general and administrative | | | 31.8 | | | | 28.6 | |
| Transaction and related costs | | | 0.4 | | | | - | |
| Operating income | | | - | | | | 10.5 | |
| | | | | | | | | |
| Interest expense | | | 17.2 | | | | 14.3 | |
| Loss before income taxes | | | (17.2 | ) | | | (3.8 | ) |
| | | | | | | | | |
| Provision (benefit) for income taxes | | | (6.6 | ) | | | 0.3 | |
| Net loss | | | (10.6 | )% | | | (4.1 | )% |
| | | Year-to-date | |
| | | Percent of Total Revenues | |
| | | Four Months | | | Five Months | | | Nine Months | |
| | | Ended | | | Ended | | | Ended | |
| | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
Revenue | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Medical equipment outsourcing | | | 76.8 | % | | | 78.9 | % | | | 78.2 | % |
| Technical and professional services | | | 17.0 | | | | 13.8 | | | | 13.8 | |
| Medical equipment sales and remarketing | | | 6.2 | | | | 7.3 | | | | 8.0 | |
| Total revenues | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
| | | | | | | | | | | | | |
Cost of Revenue | | | | | | | | | | | | |
| Cost of medical equipment outsourcing | | | 27.9 | | | | 25.8 | | | | 25.5 | |
| Cost of technical and professional services | | | 12.3 | | | | 9.4 | | | | 9.5 | |
| Cost of medical equipment sales and remarketing | | | 5.6 | | | | 5.9 | | | | 6.0 | |
| Movable medical equipment depreciation | | | 21.6 | | | | 17.2 | | | | 16.5 | |
| Total costs of medical equipment outsourcing, technical and professional services and medical | | | | | | | | | | | |
| equipment sales and remarketing | | 67.4 | | | | 58.3 | | | | 57.5 | |
| Gross margin | | | 32.6 | | | | 41.7 | | | | 42.5 | |
| | | | | | | | | | | | | |
| Selling, general and administrative | | | 31.5 | | | | 26.7 | | | | 27.4 | |
| Transaction and related costs | | | 0.3 | | | | 25.0 | | | | - | |
| Operating income (loss) | | | 0.8 | | | | (10.0 | ) | | | 15.1 | |
| | | | | | | | | | | | | |
| Interest expense | | | 17.3 | | | | 12.9 | | | | 14.0 | |
| Loss on extinguishment of debt | | | 1.2 | | | | 20.8 | | | | - | |
| Income (loss) before income taxes | | | (17.7 | ) | | | (43.7 | ) | | | 1.1 | |
| | | | | | | | | | | | | |
| Provision (benefit) for income taxes | | | (6.8 | ) | | | 0.5 | | | | 0.4 | |
| Net income (loss) | | | (10.9 | )% | | | (44.2 | )% | | | 0.7 | % |
Results of Operations for the Third Quarter 2007 (successor) Compared to the Third Quarter 2006 (predecessor)
Medical Equipment Outsourcing Segment – Manage & Utilize | | | | | | |
(in thousands) | | Three Months | | | Three Months | |
| | | Ended | | | Ended | |
| | | September 30, | | | September 30, | |
| | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | |
| Total revenue | | $ | 49,988 | | | $ | 42,361 | |
| Cost of revenue | | | 18,314 | | | | 14,822 | |
| Movable medical equipment depreciation | | | 14,116 | | | | 9,459 | |
| Gross margin | | $ | 17,558 | | | $ | 18,080 | |
| | | | | | | | | |
| Gross margin % | | | 35.1 | % | | | 42.7 | % |
| | | | | | | | | |
| Gross margin | | $ | 17,558 | | | $ | 18,080 | |
| Purchase accounting adjustments, primarily non-cash charges related to step-up in carrying value of moveable medical equipment | | | 4,211 | | | | - | |
| Gross margin, before purchase accounting adjustments | | $ | 21,769 | | | $ | 18,080 | |
| | | | | | | | | |
| Gross margin %, before purchase accounting adjustments | | | 43.5 | % | | | 42.7 | % |
Total revenue in the Medical Equipment Outsourcing was $50.0 and $42.4 million for the quarters ended September 30, 2007 and 2006, respectively. During the quarter ended September 30, 2007, we were successful in adding approximately 125 outsourcing customers through organic and competitive takeaway in our acute care and AMPP customer base and generating incremental business from new and existing technology in our fleet.
Total cost of revenue in the segment was $18.3 and $14.8 for the quarters ended September 30, 2007 and 2006, respectively. Cost of revenue in this segment relates primarily to employee related expenses, equipment repair and maintenance charges related to our movable medical equipment fleet, occupancy and freight charges. Cost of revenue for the quarter ended September 30, 2007 includes $0.6 million of purchase accounting adjustments, primarily related to losses on disposals of equipment which was revalued in conjunction with the Transaction. During the quarter ended September 30, 2007, we experienced robust rental demand from new and existing customers and incurred additional repair and maintenance and other expenses associated with increased rental activity.
Movable medical equipment depreciation was $14.1 and $9.5 million for the quarters ended September 30, 2007 and 2006, respectively. During the quarter ended September 30, 2007, we experienced increased movable medical equipment purchases to meet customer demand. In addition, movable medical depreciation for the quarter ended September 30, 2007 includes $3.6 million of charges relating to purchase accounting adjustments.
Gross margin percentage for the Medical Equipment Outsourcing segment was 35.1% and 42.7% for the quarters ended September 30, 2007 and 2006, respectively. Gross margin percentage for the quarter ended September 30, 2007 was negatively impacted by purchase accounting adjustments relating primarily to our movable medical equipment fleet.
Gross margin percentage, before purchase accounting adjustments, was 43.5% and 42.7% for the quarters ended September 30, 2007 and 2006, respectively.
Technical and Professional Services Segment – Plan & Acquire; Maintain & Repair | | | | |
(in thousands) | | Three Months | | | Three Months | |
| | | Ended | | | Ended | |
| | | September 30, | | | September 30, | |
| | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | |
| Total revenue | | $ | 11,098 | | | $ | 7,459 | |
| Cost of revenue | | | 8,158 | | | | 5,235 | |
| Gross margin | | $ | 2,940 | | | $ | 2,224 | |
| | | | | | | | | |
| Gross margin % | | | 26.5 | % | | | 29.8 | % |
| | | | | | | | | |
| Gross margin | | $ | 2,940 | | | $ | 2,224 | |
| Purchase accounting adjustments, primarily non-cash charges related to favorable lease commitments | | | 7 | | | | - | |
| Gross margin, before purchase accounting adjustments | | $ | 2,947 | | | $ | 2,224 | |
| | | | | | | | | |
| Gross margin %, before purchase accounting adjustments | | | 26.6 | % | | | 29.8 | % |
Total revenue in the Technical and Professional Services segment was $11.1 and $7.5 million for the quarters ended September 30, 2007 and 2006, respectively. Revenue for the quarter ended September 30, 2007 includes results from our acquisition of the assets of the ICMS division of Intellamed on April 1, 2007 and was also negatively impacted due to continued sales force attention on converting new customers in our medical equipment outsourcing segment, as well as selected contract terminations.
Total cost of revenue in the segment was $8.2 and $5.2 million for the quarters ended September 30, 2007 and 2006, respectively. Cost of revenue consists primarily of employee related expense, occupancy charges and vendor expenses. Cost of revenue for the quarter ended September 30, 2007 includes additional employee related and vendor expenses related to our acquisition of the ICMS division of Intellamed.
Gross margin percentage for the Technical and Professional Services segment was 26.5% and 29.8% for the quarters ended September 30, 2007 and 2006, respectively. The decline in the quarter ended September 30, 2007 is primarily attributable to lower gross margin percentage results from the acquisition of the assets of the ICMS division of Intellamed.
Medical Equipment Sales and Remarketing Segment – Redeploy & Remarket | | | | |
(in thousands) | | Three Months | | | Three Months | |
| | | Ended | | | Ended | |
| | | September 30, | | | September 30, | |
| | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | |
| Total revenue | | $ | 4,097 | | | $ | 4,749 | |
| Cost of revenue | | | 3,610 | | | | 3,704 | |
| Gross margin | | $ | 487 | | | $ | 1,045 | |
| | | | | | | | | |
| Gross margin % | | | 11.9 | % | | | 22.0 | % |
| | | | | | | | | |
| Gross margin | | $ | 487 | | | $ | 1,045 | |
| Purchase accounting adjustments, primarily non-cash charges related to step-up in carrying value of inventories and our movable medical equipment fleet | | | 380 | | | | - | |
| Gross margin, before purchase accounting adjustments | | $ | 867 | | | $ | 1,045 | |
| | | | | | | | | |
| Gross margin %, before purchase accounting adjustments | | | 21.2 | % | | | 22.0 | % |
Total revenue in the Medical Equipment Sales and Remarketing segment was $4.1 and $4.7 million for the quarters ended September 30, 2007 and 2006, respectively. Robust rental demand diverted equipment for sale to our medical equipment outsourcing segment during the quarter ended September 30, 2007.
Total cost of revenue in the segment was $3.6 and $3.7 million for the quarters ended September 30, 2007 and 2006, respectively. Cost of revenue in this segment consists primarily of cost of inventory, equipment sold and occupancy charges. During the quarter ended September 30, 2007, purchase accounting adjustments of $0.4 million, primarily related to the increase in the carrying amount of inventory ($0.1 million) and movable medical equipment ($0.3 million), impacted cost of revenue.
Gross margin percentage for the Medical Equipment Sales and Remarketing segment was 11.9% and 22.0% for the quarters ended September 30, 2007 and 2006, respectively. Purchase accounting adjustments impacted the gross margin percentage for the quarter ended September 30, 2007.
Gross margin percentage before purchase accounting adjustments for the Medical Equipment Sales and Remarketing segment was 21.1% and 22.0% for the quarters ended September 30, 2007 and 2006, respectively. Margins and activity in this segment fluctuate based on equipment availability and the transactional size and nature of the business.
Selling, General and Administrative, Transaction and Related Costs and Interest Expense | | | | |
| | | | | | | |
(in thousands) | | Three Months | | | Three Months | |
| | | Ended | | | Ended | |
| | | September 30, | | | September 30, | |
| | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | |
| Selling, general and administrative | | $ | 20,741 | | | $ | 15,633 | |
| Transaction and related costs | | | 237 | | | | - | |
| Interest expense | | | 11,231 | | | | 7,819 | |
Selling, General and Administrative
Selling, general and administrative expense was $20.7 and $15.6 million for the quarters ended September 30, 2007 and 2006, respectively. Selling, general and administrative expenses consist primarily of employee-related expenses, professional fees, occupancy charges, bad debt expense and depreciation and amortization. Expenses during the quarter ended September 30, 2007 include $4.0 million of charges related to the amortization of our intangible assets which were recorded at fair value in connection with the Transaction and non-cash stock-based compensation expense related to the 2007 Stock Option Plan of Parent of $1.0 million. Expenses during the quarter ended September 30, 2006 include $0.4 million related to our 2003 Stock Option Plan. Selling, general and administrative expense as a percentage of total revenue was 31.8% and 28.6% for the quarters ended September 30, 2007 and 2006, respectively.
Transaction and Related Costs
We incurred $0.2 million of expenses in connection with the Transaction during the quarter ended September 30, 2007. These expenses consisted primarily of accounting and legal charges.
Interest Expense
Interest expense was $11.2 and $7.8 million for the quarters ended September 30, 2007 and 2006, respectively. Interest expense during the quarter ended September 30, 2007 includes interest charges related to the increased debt issued in connection with the Transaction, partially offset by lower average interest rates.
Income Taxes
Income tax (benefit) expense was ($4.3) and $0.1 million for the quarters ended September 30, 2007 and 2006, respectively. The Company moved from a net deferred tax asset position prior to the Transaction, where tax expense related primarily to minimum state taxes due to valuation allowances established for net operating losses not recognized, to a net deferred tax liability position after the Transaction. Management believes the valuation allowance is no longer necessary as we determined that it was more likely than not that the benefits of these deferred tax assets will be realized.
Net Loss
Net loss was $6.9 and $2.2 million for the quarters ended September 30, 2007 and 2006, respectively. Net loss for the quarter ended September 30, 2007 was impacted by Transaction related purchase accounting adjustments and interest associated with our Notes, partially offset by robust revenues in our Medical Equipment Outsourcing Segment and income tax benefit.
Results of Operations for the Four Months Ended September 30, 2007 (successor) and Five Months Ended May 31, 2007 (predecessor) compared to the Nine Months Ended September 30, 2007 (predecessor)
Medical Equipment Outsourcing Segment – Manage & Utilize | | | | | | | | | |
(in thousands) | | Four Months | | | Five Months | | | Nine Months | |
| | | Ended | | | Ended | | | Ended | |
| | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Total revenue | | $ | 66,683 | | | $ | 84,855 | | | $ | 131,079 | |
| Cost of revenue | | | 24,230 | | | | 27,694 | | | | 42,762 | |
| Movable medical equipment depreciation | | | 18,748 | | | | 18,512 | | | | 27,659 | |
| Gross margin | | $ | 23,705 | | | $ | 38,649 | | | $ | 60,658 | |
| | | | | | | | | | | | | |
| Gross margin % | | | 35.5 | % | | | 45.5 | % | | | 46.3 | % |
| | | | | | | | | | | | | |
| Gross margin | | $ | 23,705 | | | $ | 38,649 | | | $ | 60,658 | |
| Purchase accounting adjustments, primarily non-cash charges related to step-up in carrying value of moveable medical equipment | | | 5,721 | | | | - | | | | - | |
| Gross margin, before purchase accounting adjustments | | $ | 29,426 | | | $ | 38,649 | | | $ | 60,658 | |
| | | | | | | | | | | | | |
| Gross margin %, before purchase accounting adjustments | | | 44.1 | % | | | 45.5 | % | | | 46.3 | % |
Total revenue in the Medical Equipment Outsourcing was $66.7, $84.9 and $131.1 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. During the four months ended September 30, 2007 and five months ended May 31, 2007, we were successful in adding approximately 200 and 300 outsourcing customers, respectively, through organic and competitive takeaway in our acute care and AMPP customer base. During each of the aforementioned 2007 periods we also generated incremental business from new and existing technology in our fleet.
Total cost of revenue in the segment was $24.2, $27.7 and $42.8 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Cost of revenue in this segment relates primarily to employee related expenses, equipment repair and maintenance charges related to our movable medical equipment fleet, occupancy and freight charges. Cost of revenue for the four months ended September 30, 2007 includes $0.7 million of charges relating to losses on disposals of equipment which was revalued in conjunction with the Transaction. During each of the aforementioned 2007 periods, we experienced robust rental demand from new and existing customers and incurred additional repair and maintenance and other expenses associated with increased rental activity.
Movable medical equipment depreciation was $18.7, $18.5 and $27.7 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. During each of the aforementioned 2007 periods we experienced increased movable medical equipment purchases to meet customer demand. Movable medical equipment depreciation for the four months ended September 30, 2007 includes $5.0 million of charges relating to purchase accounting adjustments. In May 2007, we determined that certain pieces of respiratory equipment in our movable medical equipment fleet were impaired as defined by SFAS 144, Accounting for the Disposal of Long-Lived Assets, and we wrote-off all $0.9 million of this equipment’s remaining net book value.
Gross margin percentage for the Medical Equipment Outsourcing segment was 35.5%, 45.5% and 46.3% for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Gross margin percentage for the four months ended September 30, 2007 was negatively impacted by purchase accounting adjustments relating primarily to our movable medical equipment fleet. During each of the aforementioned 2007 periods, lower pricing related to new GPO contracts, higher labor costs and increased depreciation had a negative impact on margins.
Gross margin percentage, before purchase accounting adjustments was 44.1%, 45.5% and 46.3% for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. During each of the aforementioned 2007 periods, lower pricing related to new GPO contracts, higher labor costs and increased depreciation had a negative impact on margins.
Technical and Professional Services Segment – Plan & Acquire; Maintain & Repair | | | | | | | |
(in thousands) | | Four Months | | | Five Months | | | Nine Months | |
| | | Ended | | | Ended | | | Ended | |
| | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Total revenue | | $ | 14,728 | | | $ | 14,800 | | | $ | 23,128 | |
| Cost of revenue | | | 10,684 | | | | 10,124 | | | | 15,942 | |
| Gross margin | | $ | 4,044 | | | $ | 4,676 | | | $ | 7,186 | |
| | | | | | | | | | | | | |
| Gross margin % | | | 27.5 | % | | | 31.6 | % | | | 31.1 | % |
| | | | | | | | | | | | | |
| Gross margin | | $ | 4,044 | | | $ | 4,676 | | | $ | 7,186 | |
| Purchase accounting adjustments, primarily non-cash charges related to favorable lease commitments | | | 12 | | | | - | | | | - | |
| Gross margin, before purchase accounting adjustments | | $ | 4,056 | | | $ | 4,676 | | | $ | 7,186 | |
| | | | | | | | | | | | | |
| Gross margin %, before purchase accounting adjustments | | | 27.5 | % | | | 31.6 | % | | | 31.1 | % |
Total revenue in the Technical and Professional Services segment was $14.7, $14.8 and $23.1 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Revenue for the four months ended September 30, 2007 and five months ended May 31, 2007 include results from our acquisition of the assets of the ICMS division of Intellamed on April 1, 2007 and were negatively impacted due to continued sales force attention on converting new customers in our medical equipment outsourcing segment as well as selected contract terminations.
Total cost of revenue in the segment was $10.7, $10.1 and $15.9 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Cost of revenue consists primarily of employee related expenses, vendor expenses and occupancy charges. Cost of revenue for the four months ended September 30, 2007 and five months ended May 31, 2007 include additional employee related and vendor expenses related to our acquisition of the assets of the ICMS division of Intellamed on April 1, 2007.
Gross margin percentage for the Technical and Professional Services segment was 27.5%, 31.6% and 31.1% for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. The decline for the four months ended September 30, 2007 is primarily attributable to lower gross margin percentage results from the acquisition of the assets of the ICMS division of Intellamed.
Medical Equipment Sales and Remarketing Segment – Redeploy & Remarket | | | | |
(in thousands) | | Four Months | | | Five Months | | | Nine Months | |
| | | Ended | | | Ended | | | Ended | |
| | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Total revenue | | $ | 5,374 | | | $ | 7,867 | | | $ | 13,472 | |
| Cost of revenue | | | 4,822 | | | | 6,366 | | | | 10,140 | |
| Gross margin | | $ | 552 | | | $ | 1,501 | | | $ | 3,332 | |
| | | | | | | | | | | | | |
| Gross margin % | | | 10.3 | % | | | 19.1 | % | | | 24.7 | % |
| | | | | | | | | | | | | |
| Gross margin | | $ | 552 | | | $ | 1,501 | | | $ | 3,332 | |
| Purchase accounting adjustments, primarily non-cash charges related to step-up in carrying value of inventories | | | 523 | | | | - | | | | - | |
| Gross margin, before purchase accounting adjustments | | $ | 1,075 | | | $ | 1,501 | | | $ | 3,332 | |
| | | | | | | | | | | | | |
| Gross margin %, before purchase accounting adjustments | | | 20.0 | % | | | 19.1 | % | | | 24.7 | % |
Total revenue in the Medical Equipment Sales and Remarketing segment was $5.4, $7.9 and $13.5 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Robust rental demand diverted equipment for sale to our medical equipment outsourcing segment during each of the aforementioned 2007 periods.
Total cost of revenue in the segment was $4.8, $6.4 and $10.1 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Cost of revenue in this segment consists primarily of cost of inventory and equipment sold and occupancy charges. During the four months ended September 30, 2007, purchase accounting adjustments of $0.5 million, primarily related to the increase in the carrying amount of inventory ($0.2 million) and movable medical equipment ($0.3 million), impacted cost of revenue.
Gross margin percentage for the Medical Equipment Sales and Remarketing segment was 10.3%, 19.1% and 24.7% for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. The impact of purchase accounting adjustments impacted gross margin percentage for the four months ended September 30, 2007. Margins during each of the aforementioned 2007 periods were negatively impacted by larger individual sales with lower margins.
Gross margin percentage, before purchase accounting adjustments, for the Medical Equipment Sales and Remarketing segment were 20.0%, 19.1% and 24.7% for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Margins and activity in this segment will fluctuate based on the transactional nature of the business.
Selling, General and Administrative, Transaction and Related Costs, Interest Expense and Loss on Extinguishment of Debt | |
| | | | | | | | | | |
(in thousands) | | Four Months | | | Five Months | | | Nine Months | |
| | | Ended | | | Ended | | | Ended | |
| | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Selling, general and administrative | | $ | 27,345 | | | $ | 28,692 | | | $ | 45,977 | |
| Transaction and related costs | | | 237 | | | | 26,891 | | | | - | |
| Interest expense | | | 15,031 | | | | 13,829 | | | | 23,523 | |
| Loss on extinguishment of debt | | | 1,041 | | | | 22,396 | | | | - | |
Selling, General and Administrative
Selling, general and administrative expense was $27.3, $28.7 and $46.0 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Selling, general and administrative expenses consist primarily of employee-related expenses, professional fees, occupancy charges, bad debt expense and depreciation and amortization. Expenses during the four months ended September 30, 2007 include $5.4 million of charges related to the amortization of our intangible assets which were recorded at fair value in connection with the Transaction and non-cash stock-based compensation expense related to the 2007 Stock Option Plan of Parent of $1.4 million. Expenses during the five months ended May 31, 2007 and nine months ended September 30, 2006, each include $1.2 million of expense related to our 2003 Stock Option Plan. Selling, general and administrative expense as a percentage of total revenue was 31.5%, 26.7% and 27.4% for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively.
Transaction and Related Costs
We incurred $0.2 and $26.9 million of expenses in connection with the Transaction during the four months ended September 30, 2007 and five months ended May 31, 2007, respectively. During the four months ended September 30, 2007, these expenses consisted primarily of accounting and legal fees. During the five months ended May 31, 2007, these expenses consisted primarily of accounting, legal, investment banking advisory and restructuring expenses totaling $13.7 million, expensed BSMB fees of $6.5 million and stock-based compensation expense related to the accelerated vesting of options under our 2003 Stock Option Plan of $6.7 million.
Interest Expense
Interest expense was $15.0, $13.8 and $23.5 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Interest expense during the four months ended September 30, 2007 included interest charges related to the increased debt issued in connection with the Transaction, partially offset by lower average interest rates.
Loss on Extinguishment of Debt
During the four months ended September 30, 2007, we incurred $1.0 million of expense related to the purchase of $15.0 million of our 10.125% Senior Notes. The expense consisted of a call premium of $0.7 million and the write-off of $0.3 million of unamortized deferred financing costs.
During the five months ended May 31, 2007, we incurred $22.4 million of expense related to the purchase of $235.0 million of our 10.125% Senior Notes and the termination of our Amended Credit Agreement. The expense consisted of call premiums of $16.1 million related to our 10.125% Senior Notes and the write-off of $6.3 million of unamortized deferred financing costs related to our 10.125% Senior Notes and Amended Credit Agreement.
Income Taxes
Income tax (benefit) expense was $(5.9), $0.5 and $0.5 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. The Company moved from a net deferred tax asset position prior to the Transaction, where tax expense related primarily to minimum state taxes due to valuation allowances established for net operating losses not recognized, to a net deferred tax liability position after the Transaction. Management believes the valuation allowance is no longer necessary as we determined that it was more likely than not that the benefits of these deferred tax assets will be realized.
Net Income (Loss)
Net income (loss) was $(9.5), $(47.5) and $1.2 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Net loss for the four months ended September 30, 2007 was impacted by Transaction related purchase accounting adjustments and interest associated with our Notes, partially offset by robust revenues in our Medical Equipment Outsourcing Segment and income tax benefit. Net loss for the five months ended May 31, 2007, was impacted by $26.9 million of transaction and related costs and $22.4 million of loss on the extinguishment of debt.
EBITDA
Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was $26.5, $(10.3) and $58.9 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. EBITDA for the four months ended September 30, 2007 was primarily impacted by purchase accounting adjustments related to the Transaction and loss on the extinguishment of debt. EBITDA for the five months ended May 31, 2007, was primarily impacted by transaction and related expenses and loss on the extinguishment of debt. Both 2007 periods benefited from robust customer demand in our movable medical equipment outsourcing segment.
EBITDA is not intended to represent an alternative to operating income or cash flows from operating, financing or investing activities (as determined in accordance with generally accepted accounting principles (“GAAP”)) as a measure of performance, and is not representative of funds available for discretionary use due to our financing obligations. EBITDA, as defined by us, may not be calculated consistently among other companies applying similar reporting measures. EBITDA is included because it is a widely accepted financial indicator used by certain investors and financial analysts to assess and compare companies, and a version of EBITDA is an integral part of our debt covenant calculations. Management believes that EBITDA provides an important perspective on our ability to service our long-term obligations, our ability to fund continuing growth, and our ability to continue as a going concern. A reconciliation of operating cash flows to EBITDA is included below:
| | | Four Months | | | Five Months | | | Nine Months | |
| | | Ended | | | Ended | | | Ended | |
(in thousands) | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| Net cash provided by (used in) operating activities | | $ | (5,136 | ) | | $ | 34,318 | | | $ | 43,610 | |
| Changes in operating assets and liabilities | | | 21,124 | | | | (27,711 | ) | | | (5,773 | ) |
| Other and non-cash expenses | | | 1,401 | | | | (31,258 | ) | | | (3,002 | ) |
| Income tax expense | | | (5,898 | ) | | | 492 | | | | 522 | |
| Interest expense | | | 15,031 | | | | 13,829 | | | | 23,523 | |
| EBITDA | | $ | 26,522 | | | $ | (10,330 | ) | | $ | 58,880 | |
Supplemental Information: | | Four Months | | | Five Months | | | Nine Months | |
(dollars in thousands) | | Ended | | | Ended | | | Ended | |
| | | September 30, | | | May 31, | | | September 30, | |
| | | 2007 | | | 2007 | | | 2006 | |
| | | (Successor) | | | (Predecessor) | | | (Predecessor) | |
| | | | | | | | | | |
| | | | | | | | | | |
| EBITDA | | $ | 26,522 | | | $ | (10,330 | ) | | $ | 58,880 | |
| | | | | | | | | | | | | |
| Net cash provided by (used in) operating activities | | $ | (5,136 | ) | | $ | 34,318 | | | $ | 43,610 | |
| Net cash used in investing activities | | | (348,885 | ) | | | (48,060 | ) | | | (31,973 | ) |
| Net cash provided by (used in) financing activities | | | 354,021 | | | | 13,742 | | | | (11,637 | ) |
| Movable medical equipment depreciation | | | 18,748 | | | | 18,512 | | | | 27,659 | |
| Non-movable medical equipment depreciation | | | 2,717 | | | | 3,113 | | | | 4,670 | |
| | | | | | | | | | | | | |
| Other operating data: | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Movable medical equipment owned (approximate units at end of period) | | | 191,000 | | | | 185,000 | | | | 168,000 | |
| Offices (at end of period) | | | 80 | | | | 79 | | | | 79 | |
| Number of outsourcing hospital customers (approximate number at end of period) | | | 3,850 | | | | 3,800 | | | | 3,450 | |
| Number of total outsourcing customers (approximate number at end of period) | | | 7,400 | | | | 7,200 | | | | 6,500 | |
SEASONALITY
Quarterly operating results are typically affected by seasonal factors. Historically, our first and fourth quarters are the strongest, reflecting increased customer utilization during the fall and winter months.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are expected to be cash flows from operating activities and borrowings under our senior secured credit facility which matures in May 2013. It is anticipated that our principal uses of liquidity will be to fund capital expenditures related to purchases of movable medical equipment, provide working capital, meet debt service requirements and finance our strategic plans.
We require substantial cash to operate our Medical Equipment Outsourcing programs and service our debt. Our outsourcing programs require us to invest a significant amount of cash in movable medical equipment purchases. To the extent that such expenditures cannot be funded from our operating cash flow, borrowing under our senior secured credit facility or other financing sources, we may not be able to conduct our business or grow as currently planned.
If we are unable to generate sufficient cash flow from operations in order to service our debt, we will be forced to take actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing our debt or seeking additional equity capital. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to repay our debt at maturity, we may have to obtain alternative financing, which may not be available to us.
Net cash provided by (used in) operating activities was $(5.1), $34.3 and $43.6 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. During the four months ended September 30, 2007, net cash used in operating activities was impacted primarily by the payment of accrued expenses related to the Transaction.
Net cash used in investing activities was $348.9, $48.1 and $32.0 million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. Net cash used in investing activities was impacted by the Acquisition of Universal Hospital Services, Inc. by Parent during the four months ended September 30, 2007. During the five months ended May 31, 2007, net cash used in investing activities was impacted by the acquisition of the assets of the ICMS division of Intellamed and capital expenditures for movable medical equipment related to robust demand in our medical equipment outsourcing segment.
Net cash provided by (used in) financing activities was $354.0, $13.7 and $(11.6) million for the four months ended September 30, 2007, five months ended May 31, 2007 and nine months ended September 30, 2006, respectively. During the four months ended September 30, 2007, net cash provided by financing activities benefited from the issuance of our Notes and cash equity contributions, partially offset by cash outlays related to the purchase of the debt of predecessor.
Based on the level of operating performance expected in 2007, we believe our cash from operations, together with additional borrowings under our senior secured credit facility, will meet our liquidity needs for the foreseeable future, exclusive of any borrowings that we may make to finance potential acquisitions. However, if during that period or thereafter we are not successful in generating sufficient cash flows from operations or in raising additional capital when required in sufficient amounts and on terms acceptable to us, our business could be adversely affected. As of September 30, 2007, we had $132.7 million of unused borrowing availability under our senior secured credit facility based on a borrowing base of $135.0 million and after giving effect to $2.3 million used for letters of credit. Our levels of borrowing are further restricted by the financial covenants set forth in our senior secured credit facility agreement and the second lien senior indenture governing our Notes, which covenants are summarized below. As of September 30, 2007, the Company was in compliance with all covenants under the senior secured credit facility.
Contractual Obligations. The following is a summary as of September 30, 2007, of our future contractual obligations:
(in thousands) | | Payments due by period | |
Contractual Obligations | | Total | | | October 1, 2007 to December 31, 2007 | | | 2008 | | | | 2009-2010 | | | | 2011-2012 | | | 2013 and beyond | |
| Long-term debt principal obligations | | $ | 476,731 | | | $ | 798 | | | $ | 2,821 | | | $ | 2,874 | | | $ | 10,238 | | | $ | 460,000 | |
| Interest on Senior Notes | | | 4,363 | | | | 503 | | | | 1,007 | | | | 2,014 | | | | 839 | | | | - | |
Interest on Notes (1) | | | 269,093 | | | | 19,849 | | | | 40,400 | | | | 80,799 | | | | 80,799 | | | | 47,246 | |
| Interest on capital lease obligations | | | 520 | | | | 89 | | | | 253 | | | | 174 | | | | 4 | | | | - | |
| Operating lease obligations | | | 29,633 | | | | 1,464 | | | | 5,323 | | | | 8,497 | | | | 6,410 | | | | 7,939 | |
| Purchase obligations | | | 11,858 | | | | 11,858 | | | | - | | | | - | | | | - | | | | - | |
Pension obligations (2) | | | 140 | | | | - | | | | 140 | | | | - | | | | - | | | | - | |
| Total contractual obligations | | $ | 792,338 | | | $ | 34,561 | | | $ | 49,944 | | | $ | 94,358 | | | $ | 98,290 | | | $ | 515,185 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Other commercial commitments: | | | | | | | | | | | | | | | | | | | | | | | | |
| Stand by letter of credit | | $ | 2,342 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| (1) | In June 2007, we entered into an interest rate swap agreement that will be accounted for as a cash flow hedge. The interest rate swap agreement is effective for periods beginning in December 2007 to May 2012. Interest rates through the interest rate swap agreement period were prepared using our expected effective interest rate. Interest rates subsequent to the termination date of the interest rate swap agreement have not been included as we cannot reasonably estimate future interest payments (See “Interest Rate Swap” below.) |
| (2) | While our pension liability at September 30, 2007 was approximately $1.6 million, we cannot reasonably estimate required payments beyond 2008 due to changing actuarial and market conditions. |
Financing Structure. Our major sources of funds are comprised of $230.0 million PIK Toggle Notes, $230.0 million Floating Rate Notes, $135.0 million senior secured credit facility and $9.9 million 10.125% Senior Notes. In connection with the Transaction, we purchased a portion of our 10.125% Senior Notes and terminated our Amended Credit Agreement.
PIK Toggle Notes. On May 31, 2007, Merger Sub issued $230.0 million aggregate original principal amount of 8.50% / 9.25% PIK Toggle Notes under the Second Lien Senior Indenture with Wells Fargo Bank, National Association, as trustee. See “Second Lien Senior Indenture” below. At the closing of the Transaction, as the surviving corporation in the Acquisition, we assumed all the obligations of Merger Sub under the Second Lien Senior Indenture.
For any interest payment period through June 1, 2011, the Company may, at its option, elect to pay Cash Interest, PIK Interest or 50% Cash Interest and 50% PIK Interest. Cash Interest on the PIK Toggle Notes accrues at the rate of 8.50% per annum. PIK Interest on the PIK Toggle Notes accrues at the rate of 9.25% per annum. After June 1, 2011, the Company is required to make all interest payments on the PIK Toggle Notes entirely as Cash Interest. All PIK Toggle Notes mature on June 1, 2015. Interest on the PIK Toggle Notes is payable semiannually in arrears on each June 1 and December 1, commencing on December 1, 2007. As of September 30, 2007, we intend to make future payments in the form of Cash Interest.
We may redeem some or all of the PIK Toggle Notes at any time prior to June 1, 2011, at a price equal to 100% of the principal amount thereof, plus the applicable premium (as defined by the Second Lien Senior Indenture), plus accrued and unpaid interest, if any, to the date of redemption. In addition, on or before June 1, 2010, we may redeem up to 40% of the aggregate principal amount of the PIK Toggle Notes with the net proceeds of certain equity offerings.
Except as noted above, we cannot redeem the PIK Toggle Notes until June 1, 2011. Thereafter we may redeem some or all of the PIK Toggle Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if any, on the PIK Toggle Notes redeemed, to the applicable redemption date, if redeemed during the twelve-month period beginning on June 1 of the years indicated below, subject to the rights of noteholders:
Year | | Percentage | |
| 2011 | | | 104.250 | % |
| 2012 | | | 102.125 | % |
| 2013 and thereafter | | | 100.000 | % |
Upon the occurrence of a change of control, each holder of the PIK Toggle Notes has the right to require the Company to repurchase some or all of such holder’s PIK Toggle Notes at a price in cash equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest, and PIK Interest, if any, to the date of purchase.
Floating Rate Notes. On May 31, 2007, Merger Sub issued $230.0 million aggregate original principal amount of Floating Rate Notes under the Second Lien Senior Indenture with Wells Fargo Bank, National Association, as trustee. See “Second Lien Senior Indenture” below. Interest on the Floating Rate Notes is reset for each semi-annual interest period and is calculated at the current LIBOR rate plus 3.375%. At September 30, 2007, our LIBOR-based rate was 8.760%, which includes the credit spread noted above. Interest on the Floating Rate Notes is payable semiannually, in arrears, on each June 1 and December 1, commencing on December 1, 2007. At the closing of the Transaction, as the surviving corporation in the Acquisition, we assumed all the obligations of Merger Sub under the Second Lien Senior Indenture. The Floating Rate Notes mature on June 1, 2015.
We may redeem some or all of the Floating Rate Notes at any time prior to June 1, 2009, at a price equal to 100% of the principal amount thereof, plus the applicable premium (as defined by the Second Lien Senior Indenture), plus accrued and unpaid interest, if any, to the date of redemption. In addition, on or before June 1, 2009, we may redeem up to 40% of the aggregate principal amount of the Floating Rate Notes with the net proceeds of certain equity offerings.
Except as noted above, we cannot redeem the Floating Rate Notes until June 1, 2009. Thereafter we may redeem some or all of the Floating Rate Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if any, on the Floating Rate Notes redeemed, to the applicable redemption date, if redeemed during the twelve-month period beginning on June 1 of the years indicated below, subject to the rights of noteholders:
Year | | Percentage | |
| 2009 | | | 102.000 | % |
| 2010 | | | 101.000 | % |
| 2011 and thereafter | | | 100.000 | % |
| | | | | |
Upon the occurrence of a change of control each holder of the Floating Rate Notes has the right to require the Company to repurchase some or all of such holder’s Floating Rate Notes at a price in cash equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase.
Interest Rate Swap. In June 2007, we entered into an interest rate swap agreement for $230.0 million, which has the effect of converting our $230.0 of Floating Rate Notes to fixed interest rates. The effective date for the interest rate swap agreement is December 2007, the beginning of the next semi-annual interest rate period; the expiration date is May 2012.
The interest rate swap agreement qualifies for cash flow hedge accounting under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. Both at inception and on an on-going basis, we must perform an effectiveness test. In accordance with SFAS 133, the fair value of the interest rate swap agreement at September 30, 2007 is included as a cash flow hedge on our balance sheet. The change in fair value was recorded as a component of accumulated other comprehensive loss on our balance sheet since the instrument was determined to be an effective hedge at September 30, 2007. We do not expect any amounts to be reclassified into current earnings in the future due to ineffectiveness.
As a result of our interest rate swap agreement, we expect the effective interest rate on our $230.0 million Floating Rate Notes to be 9.065% from December 2007 through May 2012.
Second Lien Senior Indenture. Our Notes are guaranteed, jointly and severally, on a second priority senior secured basis, by certain of our future domestic subsidiaries. We do not currently have any subsidiaries. The Notes are our second priority senior secured obligations and rank:
| · | equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness, and effectively senior to any such unsecured indebtedness to the extent of the value of collateral; |
| · | senior in right of payment to all of our and our guarantor’s existing and future subordinated indebtedness; |
| · | effectively junior to our senior secured credit facility and other obligations that are secured by first priority liens on the collateral securing the Notes or that are secured by a lien on assets that are not part of the collateral securing the Notes, in each case, to the extent of the value of such collateral or assets; and |
| · | structurally subordinated to any indebtedness and other liabilities (including trade payables) of any of our future subsidiaries that are not guarantors. |
The Second Lien Senior Indenture governing the Notes contains covenants that limit our and our guarantors’ ability, subject to certain definitions and exceptions, and certain of our future subsidiaries’ ability to:
| · | incur additional indebtedness; |
| · | pay cash dividends or distributions on our capital stock or repurchase our capital stock or subordinated debt; |
| · | issue redeemable stock or preferred stock; |
| · | issue stock of subsidiaries; |
| · | make certain investments; |
| · | transfer or sell assets; |
| · | create liens on our assets to secure debt; |
| · | enter into transactions with affiliates; and |
| · | merge or consolidate with another company. |
Senior Secured Credit Facility. In connection with the Transaction, the Company and Parent entered into a new first lien senior secured asset-based revolving credit facility providing for loans in an amount of up to $135.0 million pursuant to a credit agreement, dated as of May 31, 2007 with a group of financial institutions. The senior secured credit facility is available for working capital and general corporate purposes, including permitted investments, capital expenditures and debt repayments, on a fully revolving basis, subject to the terms and conditions set forth in the credit documents in the form of revolving loans, swing line loans and letters of credit.
The senior secured credit facility provides financing of up to $135.0 million, subject to a borrowing base calculated on the basis of certain of our eligible accounts receivable, inventory and equipment. As of September 30, 2007, we had $132.7 million of unused borrowing availability under our senior secured credit facility based on a borrowing base of $135.0 million and after giving effect to $2.3 million used for letters of credit.
The senior secured credit facility matures on May 31, 2013. Our obligations under the senior secured credit facility are secured by a first priority security interest in substantially all of our assets, excluding a pledge of our and Parent’s capital stock, any joint ventures and certain other exceptions. Our obligations under the senior secured credit facility are unconditionally guaranteed by our Parent.
The senior secured credit facility provides that we have the right at any time to request up to $50.0 million of additional commitments, but the lenders are under no obligation to provide any such additional commitments, and any increase in commitments will be subject to customary conditions precedent, such as an absence of any default or events of default. If we were to request any such additional commitments and the existing lenders or new lenders were to agree to provide such commitments, the senior secured credit facility size could be increased to up to $185.0 million, but our ability to borrow would still be limited by the amount of the borrowing base.
Borrowings under the senior secured credit facility accrue interest at our option:
| · | At a per annum rate equal to 0.75% above the rate announced from time to time by the agent as the “prime rate” payable quarterly in arrears; or |
| · | At a per annum rate equal to 1.75% above the adjusted LIBOR rate used by the agent. |
Overdue principal, interest and other amounts will bear interest at a rate per annum equal to 2% in excess of the applicable interest rate. The applicable margins of the senior secured credit facility will be subject to adjustment based upon leverage ratios. The senior secured credit facility also provides for customary letter of credit fees, closing fees, unused line fees and other fees.
The senior secured credit facility requires our compliance with various affirmative and negative covenants. Pursuant to the affirmative covenants, we and Parent will, among other things, deliver financial and other information to the agent, provide notice of certain events (including events of default), pay our obligations, maintain our properties, maintain the security interest in the collateral for the benefit of the agent and the lenders and maintain insurance.
Among other restrictions, and subject to certain definitions and exceptions, the senior secured credit facility restricts our ability to:
| · | declare or pay dividends and certain other restricted payments; |
| · | consolidate, merge or recapitalize; |
| · | make certain investments, loans or other advances; |
| · | enter into transactions with affiliates; |
| · | change our line of business; and |
| · | enter into hedging transactions. |
The senior secured credit facility also contains a financial covenant that is calculated if our available borrowing capacity is less than $15.0 million for a certain period. Such covenant consists of a minimum ratio of trailing four-quarter EBITDA to cash interest expense, as defined in the credit agreement dated May 31, 2007.
The senior secured credit facility specifies certain events of default, including among others, failure to pay principal, interest or fees, violation of covenants, inaccuracy of representations or warranties, bankruptcy events, certain ERISA-related events, cross-defaults to other material agreements, change of control events, and invalidity of guarantees or security documents. Some events of default will be triggered only after certain cure periods have expired, or will provide for materiality thresholds. If such a default occurs, the lenders under the senior secured credit facility would be entitled to take various actions, including all actions permitted to be taken by a secured creditor and the acceleration of amounts due under the senior secured credit facility.
10.125% Senior Notes. The Senior Notes mature on November 1, 2011. Interest on the Senior Notes accrues at the rate of 10.125% per annum and is payable semiannually on each May 1 and November 1. The Senior Notes are redeemable, at the Company’s option, in whole or in part of, on or after November 1, 2007, at specified redemption prices plus accrued interest to the date of redemption.
On May 17, 2007, we entered into a supplemental indenture to our Indenture governing our Senior Notes, dated as of October 17, 2003, between the Company and Wells Fargo Bank, National Association, as trustee. The Indenture governs the terms of the Senior Notes. The supplemental indenture amended the Indenture.
In May 2007, in connection with the Transaction, we tendered for all of our outstanding Senior Notes, pursuant to their terms. On May 31, 2007, $235.0 million of our Senior Notes were purchased. We paid $253.1 million, including a call premium of $16.1 million and accrued interest of $2.0 million to complete the purchase. We used proceeds from the issuance of our Notes to redeem a portion of our Senior Notes.
The amendments set forth in the supplemental indenture (the “Amendments”) became operative after the Company purchased all of its Senior Notes validly tendered and not withdrawn pursuant to its tender offer and consent solicitation. As of May 11, 2007, holders of Senior Notes representing an amount greater than a majority of the principal amount of outstanding Senior Notes had validly tendered their Senior Notes and consented to the execution of the supplemental indenture. The Amendments eliminated from the Indenture:
| · | requirements to file reports with the Securities and Exchange Commission; |
| · | requirements to pay taxes; |
| · | limitations on the Company to use defenses against usury; |
| · | limitation on restricted payments; |
| · | limitation on payment of dividends and other payment restrictions affecting subsidiaries; |
| · | limitations on incurrence of indebtedness and issuance of preferred stock; |
| · | limitations on asset sales and requirements to repurchase the Senior Notes with excess proceeds thereof; |
| · | limitations on affiliate transactions; |
| · | limitations on the businesses in which the Company and its subsidiaries may engage; |
| · | requirements to preserve corporate existence; |
| · | requirements to purchase the Senior Notes upon a change of control; |
| · | limitation on the issuance of guarantees of indebtedness; |
| · | limitations on the payments for consent from holders of Senior Notes; |
| · | limitations on mergers, consolidation and sale of assets with respect to the Company;, |
| · | limitations on mergers or consolidation of, or transfer of assets of, guarantors; and |
| · | certain events of default. |
On June 13, 2007, we purchased an additional $15.1 million of our remaining Senior Notes, pursuant to their terms. We paid $15.9 million of cash including a call premium of $0.7 million and accrued interest of $0.1 million to complete the purchase.
The Company has the right to redeem some or all of the remaining $9.9 million of Senior Notes at the redemption prices (expressed as a percentage of principal amount) set forth below, plus accrued and unpaid interest, if any, if redeemed during the twelve-month period beginning on November 1 of the years indicated below, subject to the rights of the noteholders:
Year | Percentage |
| 2007 | 105.063% |
| 2008 | 102.531% |
| 2009 and thereafter | 100.000% |
Termination of Our Amended Credit Agreement. In connection with the Transaction, we repaid all outstanding balances and terminated our Amended Credit Agreement.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which permits entities to elect to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. This election is irrevocable. The provisions of SFAS 159 are effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of SFAS 159, but believe the adoption of SFAS 159 will not have a material impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements No. 87, 88, 106 and 123(R) (“SFAS 158”). SFAS 158 requires employers to recognize the under funded or over funded status of a defined benefit post retirement plan as an asset or liability in its statements of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. Additionally, SFAS 158 requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. The provisions of SFAS 158 are effective as of the end of the fiscal year ending after June 15, 2007. We are currently evaluating the impact of SFAS 158, but believe the adoption of SFAS 158 will not have a material impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The provisions of SFAS 157 are effective for fiscal years beginning after November 15, 2007. We believe the adoption of SFAS will not have a material impact on our financial position or results of operations.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: We believe statements in this Form 10-Q looking forward in time involve risks and uncertainties. The following factors, among others, could adversely affect our business, operations and financial condition, causing our actual results to differ materially from those expressed in any forward-looking statements:
| · | our history of net losses and substantial interest expense; |
| · | our need for substantial cash to operate and expand our business as planned; |
| · | our substantial outstanding debt and debt service obligations; |
| · | restrictions imposed by the terms of our debt; a decrease in the number of patients our customers are serving; |
| · | our ability to effect change in the manner in which healthcare providers traditionally procure medical equipment; |
| · | the absence of long-term commitments with customers; our ability to renew contracts with GPOs and IDNs; |
| · | changes in reimbursement rates and policies by third-party payors; |
| · | the impact of health care reform initiatives; |
| · | the impact of significant regulation of the health care industry and the need to comply with those regulations; |
| · | difficulties or delays in our continued expansion into certain of our businesses/geographic markets and developments of new businesses/geographic markets; |
| · | additional credit risks in increasing business with home care providers and nursing homes; |
| · | impacts of equipment product recalls or obsolescence; and |
| · | increases in vendor costs that cannot be passed through to our customers. |
See the risk factors discussed under Part II, Item 1A of our quarterly report on Form 10-Q for the quarter ended June 30, 2007.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our primary exposure to market risk is interest rate risk associated with our debt. We use both fixed and variable rate debt as sources of financing. At September 30, 2007, we had approximately $476.7 million of total debt outstanding. After taking into account the effect of our interest rate swap agreement, we had no debt bearing variable rate interest.
In June 2007, we entered into an interest rate swap agreement for $230.0 million, which has the effect of converting our $230.0 of Floating Rate Notes to fixed interest rates. The effective date for the interest rate swap agreement is December 2007, the beginning of the next semi-annual interest rate period; the expiration date is May 2012.
The interest rate swap agreement qualifies for cash flow hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”). Both at inception and on an on-going basis, we must perform an effectiveness test. In accordance with SFAS 133 the fair value of the interest rate swap agreement at September 30, 2007 is included as a cash flow hedge on our balance sheet. The change in fair value was recorded as a component of accumulated other comprehensive loss on our balance sheet since the instrument was determined to be an effective hedge at September 30, 2007. We do not expect any amounts to be reclassified into current earnings in the future due to ineffectiveness.
As a result of our interest rate swap agreement, we expect the effective interest rate on our $230.0 million Floating Rate Notes to be 9.065% from December 2007 through May 2012.
As of September 30, 2007, we have no other material exposure to market risk.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 15d-15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
(b) Changes in internal control over financial reporting
During the first nine months of 2007, there has been no change in our internal control over financial reporting (as defined in Rule 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may become involved in litigation arising out of operations in the normal course of business. As of September 30, 2007, we were not a party to any pending legal proceedings the adverse outcome of which could reasonably be expected to have a material adverse effect on our operating results, financial position, or cash flows.
Item 1A. Risk Factors
Our business faces many risks. Any of the risks discussed elsewhere in this Form 10-Q or our other filings with the SEC, including our risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2006 and in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, could have a material impact on our business, financial condition or results of operations. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
Not applicable.
Item 6. Exhibits
Number | | Description |
| 31.1 | | Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002. |
| 31.2 | | Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002. |
| 32.1 | | Certification of Gary D. Blackford Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | | Certification of Rex T. Clevenger Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 12, 2007
| | Universal Hospital Services, Inc. |
| | |
| | By /s/ Gary D. Blackford |
| | Gary D. Blackford, |
| | Chairman of the Board and Chief Executive Officer |
| | (Principal Executive Officer and Duly Authorized Officer) |
| | By /s/ Rex T. Clevenger |
| | Rex T. Clevenger, |
| | Executive Vice President and Chief Financial Officer (Principal Financial Officer) |
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