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UNIVERSAL HOSPITAL SERVICES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following should be read in conjunction with the accompanying consolidated financial statements and notes. BUSINESS OVERVIEW Our Company Universal Hospital Services, Inc. ("we", "our", "us", the "Company", or "UHS") is a leading nationwide provider of health care technology management and service solutions to the United States health care industry. We provide our customers comprehensive health care technology management, service and clinical solutions that we believe help reduce capital and operating expenses, increase medical equipment and staff productivity, and support improved patient safety and outcomes. We commenced operations in 1939, originally incorporated in Minnesota in 1954 and reincorporated in Delaware in 2001. All of our outstanding capital stock is owned by UHS Holdco, Inc. ("Parent"), which acquired the Company in a recapitalization in May 2007. Parent is owned by affiliates of Irving Place Capital Merchant Manager III, L.P. ("IPC") and certain members of our management. UHS delivers health care solutions through three segments: Medical Equipment Solutions ("MES"), Clinical Engineering Solutions ("CES") and Surgical Services ("SS"). As of September 30, 2014, we owned or managed over 700,000 units of medical equipment consisting of approximately 450,000 owned or managed units in our MES segment, over 250,000 units of customer-owned equipment we managed in our CES segment and over 4,000 units of owned or managed mobile surgical equipment in our SS segment. Our diverse customer base includes more than 8,000 national, regional and local acute care hospitals and alternate site providers (such as long-term acute care hospitals, skilled nursing facilities, surgery centers, specialty hospitals, nursing homes and home care providers). We also have relationships with more than 200 medical device manufacturers, many of the nation's largest group purchasing organizations ("GPOs") and many health system integrated delivery networks ("IDNs"). All of our solutions leverage our nationwide network of 84 district service centers, five CES Centers of Excellence and an additional seven stand-alone SS service centers, together with our more than 75 years of experience managing and servicing all aspects of medical equipment. Our fees are paid directly by our customers rather than by direct reimbursement from third-party payors, such as private insurers, Medicare or Medicaid. We report our financial results in three segments. Our reporting segments consist of MES, CES and SS. We evaluate the performance of our reportable segments based on gross margin. The accounting policies of the individual reportable segments are the same as those of the entire company. In June 2014, Smith & Nephew announced that it had ceased commercial distribution of the RENASYS Negative Pressure Wound Therapy ("NPWT") product line in the United States following a request from the FDA to obtain additional regulatory clearances through the premarket notification 510(k) process with respect to certain design modifications made to the RENASYS product line. Subsequently, the FDA authorized limited distribution by Smith & Nephew of these products under a Certificate of Medical Necessity ("CMN") program. The Company is unable to predict when or whether Smith & Nephew will resume full commercial distribution of the RENASYS product line but it has been informed by Smith & Nephew that the 510(k) clearances for these products will take at least three months and probably longer, and that Smith & Nephew is requesting that customers using a CMN transition to alternative NPWT providers by no later than August 31, 2014. The RENASYS product line generated approximately $24 million in annual revenue for the prior twelve month period ended June 30, 2014 from device rental ($14 million) and disposable sales ($10 million) which was included in our MES segment. The net book value of the equipment approximates $4 million as of the end of September 2014. The Company is working with our customers to provide alternative solutions. In late July, the Company signed an agreement with a NPWT manufacturer to provide an alternative solution to our customers, and we have secured over $3 million in annualized rental revenue contracts with our customers. However, many of our customers have met, or may in the future seek to meet, their NPWT needs directly with other manufacturers or service providers. The Company's future financial results will be negatively impacted by the interruption of commercial distribution of the RENASYS product line and we anticipate losing the majority of the disposable portion of our revenue based on the new agreement with an alternative NPWT manufacturer. The gross margin on the disposable portion of the business is significantly lower than the overall MES segment gross margin. The potential impact will be highly 27 -------------------------------------------------------------------------------- Table of Contents dependent upon the outcome of the factors mentioned above. The Company is currently assessing the financial impact to our business and, while highly sensitive to the outcome of the above factors, the Company estimates the net loss in revenue at $7 to $9 million for 2014. In July 2014, the Company was notified that a national group purchasing organization ("GPO") awarded a sole source agreement to a competitor of the Company, for all peak need rental equipment, therapy surfaces (wound and pulmonary) and bariatric equipment. This GPO currently has agreements for the purchase or rental of this equipment with multiple vendors, including from the Company under agreements that are expiring December 31, 2014. Under these agreements, the Company supplies equipment to its GPO member customers. The Company generated approximately $26 million of business (over the prior twelve month period ended September 30) in the portions of the business covered under this new agreement which was included in our MES segment. In addition, the Company also maintains certain 360 solutions with customers that are members of this GPO. The Company is working with the national GPO and its members to develop an orderly transition and anticipates that this transition will occur over the next several months. The Company is currently assessing the financial impact to its business and the impact will be dependent upon several factors including the GPO members' willingness to contract with the Company as a non-contracted vendor and the ability of the new service provider to service all of these GPO members. The Company's future results will be negatively impacted by the loss of this agreement and, while highly sensitive to the factors mentioned above, the loss in revenue is estimated at $2 to $4 million for the balance of 2014 and estimated at $15 to $20 million on an annual basis. The Company anticipates either selling or redeploying approximately $6 to $8 million in excess equipment currently supporting the existing business, which will reduce the on-going maintenance capital expenditures. Medical Equipment Solutions Our MES segment accounted for $67.9 and $68.4 million, or approximately 63.7% and 65.6% of our revenues, for the three months ended September 30, 2014 and 2013, respectively and $216.8 and $215.1 million, or approximately 65.9% and 66.9% of our revenues, for the nine months ended September 30, 2014 and 2013, respectively. As of September 30, 2014, the MES segment owned or managed approximately 450,000 units of medical equipment ranging across hundreds of clinical categories, manufacturers and models. These solutions are provided primarily to hospitals and other acute care providers for use through their facilities, including the emergency room, operating room, critical care, intensive care, rehabilitation and general patient care areas. Our MES segment started more than 75 years ago as our leading medical equipment peak needs usage business and has transformed into providing comprehensive outsourced and on-site solutions that manage all aspects of medical equipment in a health care facility. We currently provide MES solutions to more than 8,000 acute care hospitals and alternate site providers in the United States, including some of the nation's premier health care institutions. Historically, we have purchased and owned directly the equipment used in our MES programs. We expect much of our future growth in this segment to be driven by our customers outsourcing more of their medical equipment needs and taking full advantage of our diversified product offering, clinical education and support, customized agreements and 360 On-site Managed Solutions. We have four primary solutions in our MES segment: · Supplemental and Peak Needs Usage Solutions; · Customized Equipment Agreements Solutions; · 360 On-site Managed Solutions; and · Specialty Medical Equipment Sales, Distribution and Disposal Solutions. Clinical Engineering Solutions Our CES segment accounted for $23.7 and $21.8 million, or approximately 22.3% and 20.9% of our revenues, for the three months ended September 30, 2014 and 2013, respectively and $68.5 and $65.0 million, or approximately 20.8% and 20.2% of our revenues, for the nine months ended September 30, 2014 and 2013, respectively. We offer a broad range of inspection, preventive maintenance, repair, logistic and consulting services through our team of over 370 technicians and professionals located throughout the United States in our nationwide network of service centers. We managed over 250,000 units of customer owned equipment as of September 30, 2014. In addition, as of September 30, 2014, we serviced approximately 450,000 units that we own or directly manage. 28 -------------------------------------------------------------------------------- Table of Contents Our CES segment leverages our over 75 years of experience and our extensive equipment database in repairing and maintaining a broad range of health care technologies. Historically, we have been our own largest customer for CES services in order to repair and maintain approximately 450,000 units that we own or directly manage. However, we believe our CES segment has significant future growth potential by offering non-capital based comprehensive solutions as a stand-alone or complementary alternative for customers that own medical equipment but lack the infrastructure, expertise, or scale to perform routine maintenance, repair, record keeping, and lifecycle analysis and planning functions. We also believe hospital and other facility-based clients will face increasing challenges in managing sophisticated medical equipment that requires connectivity and interoperability with information technology systems, compliance with the 10th revision of the International Statistical Classification of Diseases and Related Health Problems (ICD-10), regulatory requirements, integration with EMR, maintenance and management of software databases and management of other medical equipment patient information and safety features. We have three primary solutions in our CES segment: · Supplemental Maintenance and Repair Solutions; · 360 On-site Managed Solutions; and · Health Care Technology Advisory Solutions. Surgical Services Our SS segment accounted for $14.9 and $14.1 million, or approximately 14.0% and 13.5% of our revenues, for the three months ended September 30, 2014 and 2013, respectively and $43.9 and $41.5 million, or approximately 13.3% and 12.9% of our revenues, for the nine months ended September 30, 2014 and 2013, respectively. As of September 30, 2014, we owned or managed over 4,000 units of mobile surgical equipment in our SS segment, primarily used in the practice of general surgery, orthopedic surgery, otolaryngology, urology, obstetrics, gynecology, podiatry, dermatology and plastic/cosmetics. SS provides high end, state-of-the-art surgical equipment and associated products along with trained and certified Surgical Equipment Technologists ("technologists") to assist in the procedural operation of the equipment. We provide these services to over 1,000 acute care hospitals and surgery centers through our nationwide network of 84 district service centers and an additional seven stand-alone SS service centers. Our technologists work in the operating room ("O.R.") and support physicians and O.R. personnel. The services are offered on a per-procedure basis. Our technologists deliver, set up, and create a safe environment for hospital and clinical personnel operating the equipment and provide all necessary disposable materials needed. Our technologists work closely with our customers to confirm that all certifications and credentials meet requirements to provide on-site services. Our technologists also assist customers in the operation of facility-owned assets and supplement the training and staffing of their personnel. As of September 30, 2014, SS provided solutions in 42 states. We have two primary solutions in our SS segment: · On-Demand and Scheduled Usage Solutions; and · 360 On-site Managed Solutions. RESULTS OF OPERATIONS The following discussion addresses: · our financial condition as of September 30, 2014 and · the results of operations for the three-month and nine-month periods ended September 30, 2014 and 2013. This discussion should be read in conjunction with the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and the Management's Discussion and Analysis of Financial Condition and Results of Operations section included in our 2013 Annual Report on Form 10-K, filed with the Securities and Exchange Commission. 29 -------------------------------------------------------------------------------- Table of Contents The following table provides information on the percentages of certain items of selected financial data compared to total revenues for the three-month and nine-month periods ended September 30, 2014 and 2013. The table below also indicates the percentage increase or decrease over the prior comparable period. Percent to Total Revenues Percent Percent to Total Revenues Percent Three Months Ended September 30, Increase Nine Months Ended September 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) Revenue Medical equipment solutions 63.7 % 65.6 % (0.7) % 65.9 % 66.9 % 0.8 % Clinical engineering solutions 22.3 20.9 8.6 20.8 20.2 5.4 Surgical services 14.0 13.5 5.7 13.3 12.9 5.8 Total revenues 100.0 % 100.0 % 2.1 100.0 % 100.0 % 2.3 Cost of Revenue Cost of medical equipment solutions 30.2 29.8 3.5 29.7 29.5 3.2 Cost of clinical engineering solutions 17.5 15.6 14.5 16.5 15.6 8.6 Cost of surgical services 7.5 7.6 0.8 7.4 7.2 5.4 Medical equipment depreciation 16.7 17.6 (3.0) 17.0 17.0 2.4 Total costs of revenues 71.9 70.6 4.0 70.6 69.3 4.4 Gross margin 28.1 29.4 (2.6) 29.4 30.7 (2.4) Selling, general and administrative 24.9 26.0 (2.0) 25.9 27.1 (2.1) Restructuring, acquisition and integration expenses - - * 0.6 0.1 * Intangible asset impairment charge - - * 10.6 - * Operating income (loss) 3.2 3.4 * (7.7) 3.5 * Loss on extinguishment of debt - - * - 0.6 * Interest expense 12.5 13.3 (4.1) 12.1 13.0 (4.2) Loss before income taxes and noncontrolling interest (9.3) (9.9) * (19.8) (10.1) * Provision (benefit) for income taxes 0.2 (1.3) * (4.0) (0.1) * Consolidated net loss (9.5) % (8.6) % * (15.8) % (10.0) % * -------------------------------------------------------------------------------- *Not meaningful Consolidated Results of Operations for the three months ended September 30, 2014 compared to the three months ended September 30, 2013 Total Revenue Total revenue for the three months ended September 30, 2014 was $106.5 million, compared to $104.3 million for the three months ended September 30, 2013, an increase of $2.2 million or 2.1%. The increase was primarily due to additional revenue in our MES segment related to growth in our 360 On-site Managed Solutions ("360 solutions") of $3.4 million and growth in our CES segment of $1.9 million related to growth in our 360 solutions. These increases were partially offset by the decline in NPWT device rental and disposable sales due to the interruption of Smith & Nephew commercial distribution of the RENASYS product line. 30 -------------------------------------------------------------------------------- Table of Contents Cost of Revenue Total cost of revenue for the three months ended September 30, 2014 was $76.6 million compared to $73.7 million for the three months ended September 30, 2013, an increase of $2.9 million or 4.0%. The increase was primarily in our MES segment due to an increase in 360 solutions cost of $2.6 million and an increase in our CES 360 solutions cost of $1.7 corresponding with the 360 solutions revenue growth of $5.3 million. Gross Margin Total gross margin for the three months ended September 30, 2014 was $29.8 million, or 28.1% of total revenues, compared to $30.6 million, or 29.4% of total revenues, for the three months ended September 30, 2013, a decrease of $0.8 million or 2.6%. The decrease in gross margin as a percent of revenue for the quarter was primarily impacted by business mix with CES growth and an increase in repair and maintenance and service cost for certain program offerings. Medical Equipment Solutions (in thousands) Three Months Ended September 30, 2014 2013 Change % Change Total revenue $ 67,861 $ 68,355 $ (494) (0.7) % Cost of revenue 32,204 31,107 1,097 3.5 Medical equipment depreciation 16,340 17,189 (849) (4.9) Gross margin $ 19,317 $ 20,059 $ (742) (3.7) Gross margin % 28.5 % 29.3 % Total revenue in the MES segment decreased $0.5 million, or 0.7%, to $67.9 million in the third quarter of 2014 as compared to the same period of 2013. The decrease was primarily due to growth in our 360 solutions from both new programs and expansion of existing programs of $3.4 million, which was offset by a decrease related to the decline in NPWT device rental and disposable sales due to the interruption of Smith & Nephew commercial distribution of the RENASYS product line of approximately $3.0 million. Many of our 360 Solution customers utilize more than one of our equipment management program offerings in areas such as infusion, patient handling and negative pressure wound therapy. As of September 30, 2014, we had 203 such active programs, up from 181 as of December 31, 2013. Total cost of revenue in the segment increased $1.1 million, or 3.5%, to $32.2 million in the third quarter of 2014 as compared to the same period of 2013. This increase is due to an increase in costs to support growth in our 360 solutions of $2.6 million largely due to an increase in employee related expense of $1.3 million and an increase in repair and maintenance and service cost for certain program offerings, partially offset by lower cost of disposables. Medical equipment depreciation decreased $0.8 million, or 4.9%, to $16.3 million in the third quarter of 2014 as compared to the same period of 2013. The decrease in medical equipment depreciation was primarily due to reduced depreciation rate resulting from disposals of certain medical equipment. Gross margin percentage for the MES segment decreased from 29.3% in the third quarter of 2013 to 28.5% in the same period of 2014. Gross margin rate was impacted by an increase in repair and maintenance and service cost for certain program offerings, as well as growth in our 360 solutions, which has a lower margin rate than other medical equipment solutions. Future revenue will be negatively impacted by the loss of revenues resulting from the pending FDA 510(k) clearances on RENASYS NPWT product line and the loss of the agreement related to a national GPO. 31 -------------------------------------------------------------------------------- Table of Contents Clinical Engineering Solutions (in thousands) Three Months Ended September 30, 2014 2013 Change % Change Total revenue $ 23,717 $ 21,839 $ 1,878 8.6 % Cost of revenue 18,670 16,310 2,360 14.5 Gross margin $ 5,047 $ 5,529 $ (482) (8.7) Gross margin % 21.3 % 25.3 % Total revenue in the CES segment increased $1.9 million, or 8.6%, to $23.7 million in the third quarter of 2014 as compared to the same period of 2013. The increase was primarily due to growth in our managed 360 solutions, partially offset with weakness in services supporting key manufacturers. As of September 30, 2014, we had 360 solutions implemented in 142 programs in our CES segment, up from 131 programs as of December 31, 2013. Total cost of revenue in the segment increased $2.4 million, or 14.5%, to $18.7 million in the third quarter of 2014 as compared to the same period of 2013. The increase is primarily attributable to an increase in vendor expenses to support the revenue growth and mix shifts in type of service provided to customers. Gross margin percentage for the CES segment decreased from 25.3% in the third quarter of 2013 to 21.3% in the same period of 2014. The decrease was primarily due to a higher level of vendor expenses on supported equipment. Gross margin percentage will fluctuate based on the variability of third-party vendor expenses in our 360 solutions and supplemental service programs. Surgical Services (in thousands) Three Months Ended September 30, 2014 2013 Change % Change Total revenue $ 14,887 $ 14,084 $ 803 5.7 % Cost of revenue 7,982 7,921 61 0.8 Medical equipment depreciation 1,426 1,125 301 26.8 Gross margin $ 5,479 $ 5,038 $ 441 8.8 Gross margin % 36.8 % 35.8 % Total revenue in the SS segment increased $0.8 million, or 5.7%, to $14.9 million in the third quarter of 2014 as compared to the same period of 2013. The increase was driven by organic growth in our surgical services business. Total cost of revenue in the segment increased $0.1 million, or 0.8%, to $8.0 million in the third quarter of 2014 as compared to the same period of 2013. The increase was primarily attributable to an increase in employee related costs to support growth in our surgical services business. Medical equipment depreciation increased $0.3 million, or 26.8%, to $1.4 million in the third quarter of 2014 as compared to the same period of 2013. The increase was primarily due to additional medical equipment purchased. Gross margin percentage for the SS segment increased from 35.8% in the third quarter of 2013 to 36.8% in the same period of 2014. The increase in gross margin percentage was primarily driven by both higher leverage from volume growth and some shift to higher margin modalities. 32 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative and Interest Expense (in thousands) Three Months Ended September 30, 2014 2013 Change % Change Selling, general and administrative $ 26,539 $ 27,070 $ (531) (2.0) % Interest expense 13,264 13,834 (570) (4.1) -------------------------------------------------------------------------------- *Not meaningful Selling, General and Administrative Selling, general and administrative expense decreased $0.5 million, or 2.0%, to $26.5 million for the third quarter of 2014 as compared to the same period of 2013. The decrease was primarily due to decreases in payroll and incentive expenses. Selling, general and administrative expense as a percentage of total revenue was 24.9% and 26.0% for the quarter ended September 30, 2014 and 2013, respectively. Interest Expense Interest expense decreased $0.6 million to $13.3 million for the third quarter of 2014 as compared to the same period of 2013. This decrease was mainly attributable to the decrease in amortization of deferred financing costs combined with an increase in amortization of bond premium. Income Taxes Income taxes were an expense of $0.2 and a benefit of $1.3 million for the three months ended September 30, 2014 and 2013, respectively. The tax expense for the three months ended September 30, 2014 primarily relates to state minimum fees. The tax benefit for the three months ended September 30, 2013 primarily related to the reversal of a long-term liability created as a reserve against operating losses from an acquisition in 2011. The Company will continue to incur deferred tax expense in the future as tax amortization occurs. The expected tax benefit from operating loss during the three months ended September 30, 2014 was offset by the recording of additional valuation allowance. In future reporting periods, we will continue to assess the likelihood that deferred tax assets will be realizable. Consolidated Net Loss Consolidated net loss increased $1.2 million to $10.2 million in the third quarter of 2014 as compared to the same period of 2013. Net loss was impacted primarily by the tax benefit recorded in the third quarter of 2013. Consolidated Results of Operations for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 Total Revenue Total revenue for the nine months ended September 30, 2014 was $329.2 million, compared to $321.6 million for the nine months ended September 30, 2013, an increase of $7.6 million or 2.3%. The increase was primarily due to additional revenue in our MES segment related to growth in our 360 solutions of $12.1 million, partially offset by a decrease in peak need usage revenue of $5.6 million and the decline in NPWT device rental and disposable sales due to the interruption of Smith & Nephew commercial distribution of the RENASYS product line. Cost of Revenue Total cost of revenue for the nine months ended September 30, 2014 was $232.8 million compared to $222.9 million for the nine months ended September 30, 2013, an increase of $9.9 million or 4.4%. The increase was primarily in our MES segment due to an increase in 360 solutions cost of $6.7 million corresponding with the 360 solutions revenue growth 33 -------------------------------------------------------------------------------- Table of Contents and an impairment charge of $2.0 million primarily due to the planned sale of certain pumps and under-utilized patient handling equipment. Gross Margin Total gross margin for the nine months ended September 30, 2014 was $96.4 million, or 29.4% of total revenues, compared to $98.7 million, or 30.7% of total revenues, for the nine months ended September 30, 2013, a decrease of $2.3 million or 2.4%. The decrease in gross margin as a percent of revenue was primarily impacted by business mix with CES growth and the reduction in NPWT device rental and asset impairment charges. Medical Equipment Solutions (in thousands) Nine Months Ended September 30, 2014 2013 Change % Change Total revenue $ 216,771 $ 215,141 $ 1,630 0.8 % Cost of revenue 97,919 94,918 3,001 3.2 Medical equipment depreciation 51,843 50,620 1,223 2.4 Gross margin $ 67,009 $ 69,603 $ (2,594) (3.7) Gross margin % 30.9 % 32.4 % Total revenue in the MES segment increased $1.6 million, or 0.8%, to $216.8 million in the first nine months of 2014 as compared to the same period of 2013. The increase was primarily due to growth in our 360 solutions from both new programs and expansion of existing programs of $12.1 million, partially offset by decreases in peak need usage revenue of $5.6 million and the decline in NPWT device rental and disposable sales due to the interruption of Smith & Nephew commercial distribution of the RENASYS product line. Many of our 360 Solution customers utilize more than one of our equipment management program offerings in areas such as infusion, patient handling, and negative pressure wound therapy. As of September 30, 2014, we had 203 such active programs, up from 181 as of December 31, 2013. Peak need usage revenue was negatively impacted by soft patient census, rate concessions, and, to a lesser extent, conversion of customers to 360 solutions. Total cost of revenue in the segment increased $3 million, or 3.2%, to $97.9 million in the first nine months of 2014 as compared to the same period of 2013. This increase is due to an increase in costs to support growth in our 360 solutions of $6.7 million largely due to an increase in employee related expense of $4.2 million and an increase in repairs and maintenance and service costs for certain program offerings, partially offset by lower cost of disposables. Medical equipment depreciation increased $1.2 million, or 2.4%, to $51.8 million in the first nine months of 2014 as compared to the same period of 2013. The increase in medical equipment depreciation was primarily due to an impairment charge of $2.0 million taken on excess infusion equipment sold in the second quarter of 2014 and under-utilized patient handling equipment charge, offset by reduced depreciation rate resulting from impairment and disposals of certain medical equipment. Gross margin percentage for the MES segment decreased from 32.4% in the first nine months of 2013 to 30.9% in the same period of 2014. This decrease was primarily attributable to the increase in depreciation related to the impairment charges. Gross margin rate was also impacted by the growth in our 360 solutions, which has a lower margin rate than other medical equipment solutions. Future revenue will be negatively impacted by the loss of revenues resulting from the pending FDA 510(k) clearances on RENASYS NPWT product line and the loss of the agreement related to a national GPO. 34 -------------------------------------------------------------------------------- Table of Contents Clinical Engineering Solutions (in thousands) Nine Months Ended September 30, 2014 2013 Change % Change Total revenue $ 68,505 $ 65,000 $ 3,505 5.4 % Cost of revenue 54,454 50,120 4,334 8.6 Gross margin $ 14,051 $ 14,880 $ (829) (5.6) Gross margin % 20.5 % 22.9 % Total revenue in the CES segment increased $3.5 million, or 5.4%, to $68.5 million in the first nine months of 2014 as compared to the same period of 2013. The increase was primarily due to growth in our managed 360 solutions partially offset by rate concessions. As of September 30, 2014, we had 360 solutions implemented in 142 programs in our CES segment, up from 131 programs as of December 31, 2013. Total cost of revenue in the segment increased $4.3 million, or 8.6%, to $54.5 million in the first nine months of 2014 as compared to the same period of 2013. The increase is primarily attributable to increases in employee related costs and vendor expenses to support the revenue growth and mix shifts in type of service provided to customers. Gross margin percentage for the CES segment decreased from 22.9% in the first nine months of 2013 to 20.5% in the same period of 2014. The decrease was primarily due to a higher level of employee related costs and vendor expenses on supported equipment. Gross margin percentage will fluctuate based on the variability of third-party vendor expenses in our 360 solutions and supplemental service programs. Surgical Services (in thousands) Nine Months Ended September 30, 2014 2013 Change % Change Total revenue $ 43,890 $ 41,486 $ 2,404 5.8 % Cost of revenue 24,418 23,175 1,243 5.4 Medical equipment depreciation 4,153 4,050 103 2.5 Gross margin $ 15,319 $ 14,261 $ 1,058 7.4 Gross margin % 34.9 % 34.4 % Total revenue in the SS segment increased $2.4 million, or 5.8%, to $43.9 million in the first nine months of 2014 as compared to the same period of 2013. The increase was driven by organic growth in our surgical services business. Total cost of revenue in the segment increased $1.2 million, or 5.4%, to $24.4 million in the first nine months of 2014 as compared to the same period of 2013. The increase was primarily attributable to an increase in employee-related costs to support growth in our surgical services business of $0.8 million. Medical equipment depreciation increased $0.1 million, or 2.5%, to $4.2 million in the first nine months of 2014 as compared to the same period of 2013. Gross margin percentage for the SS segment increased from 34.4% in the first nine months of 2013 to 34.9% in the same period of 2014. The increase in gross margin percentage was primarily attributable to higher leverage from volume growth and some shift to higher margin modalities. 35 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative, Restructuring, Acquisition and Integration Expenses, Loss on Extinguishment of Debt and Interest Expense (in thousands) Nine Months Ended September 30, 2014 2013 Change % Change Selling, general and administrative $ 85,416 $ 87,246 $ (1,830) (2.1) % Restructuring, acquisition and integration expenses 1,820 236 1,584 * Intangible asset impairment charge 34,900 - 34,900 * Loss on extinguishment of debt - 1,853 (1,853) * Interest expense 39,922 41,657 (1,735) (4.2) -------------------------------------------------------------------------------- *Not meaningful Selling, General and Administrative Selling, general and administrative expense decreased $1.8 million, or 2.1%, to $85.4 million for the first nine months of 2014 as compared to the same period of 2013. The decrease was primarily due to a decrease in consulting expense, bad debt and payroll related expenses. Selling, general and administrative expense as a percentage of total revenue was 25.9% and 27.1% for the nine months ended September 30, 2014 and 2013, respectively. Restructuring, Acquisition and Integration Expenses Restructuring, acquisition and integration expenses increased $1.6 million for the first nine months of 2014 as compared to the same period of 2013. The increase was primarily due to additional charges to realign the management team. Intangible Asset Impairment Charge During the second quarter of 2014, the Company became aware that future financial results of the Company will be negatively impacted by the loss of revenues resulting from pending FDA 510(k) clearances on RENASYS NPWT product line and the loss of the agreement related to a national GPO. The Company applies a fair value based impairment test to the net book value of goodwill and intangible assets with indefinite lives on an annual basis and on an interim basis if events or circumstances indicate that an impairment loss may have occurred. The review of indefinite-life intangibles for impairment during the second quarter of 2014 indicated that the carrying value of trade names in the MES segment exceeded its estimated fair values. As a result, the Company performed an interim impairment test and recorded a preliminary non-cash impairment charge of $34.9 million during the second quarter of 2014. The calculation of the preliminary impairment charge contains significant judgments and estimates including weighted average cost of capital, future revenue, profitability, cash flows and fair values of assets and liabilities. The finalization of the second quarter impairment charge and the result of the third quarter impairment review resulted in no changes to the second quarter preliminary charge. Loss on Extinguishment of Debt For the nine months ended 2013, we wrote off $1.9 million of unamortized deferred financing costs related to redemption of our floating rate notes. Interest Expense Interest expense decreased $1.7 million to $39.9 million for the first nine months of 2014 as compared to the same period of 2013. This decrease was mainly attributable to the decrease in amortization of deferred financing costs combined with an increase in amortization of bond premium. 36 -------------------------------------------------------------------------------- Table of Contents Income Taxes Income taxes were a benefit of $13.2 and $0.4 million for the nine months ended September 30, 2014 and 2013, respectively. The tax benefit for the nine months ended September 30, 2014 primarily relates to intangible asset impairment charge, partially offset by state minimum fees. The tax benefit for the nine months ended September 30, 2013 primarily relates to two items along with state minimum fees. The first item was to record a deferred tax liability for adjustments in connection with the tax amortization of indefinite-life goodwill. The second item was to reverse a long-term liability created as a reserve against operating losses from an acquisition in 2011. The Company will continue to incur deferred tax expense in the future as tax amortization occurs. The expected tax benefit from operating loss during the nine months ended September 30, 2014 was offset by the recording of additional valuation allowance. In future reporting periods, we will continue to assess the likelihood that deferred tax assets will be realizable. Consolidated Net Loss Consolidated net loss increased $20.6 million to $52.4 million in the first nine months of 2014 as compared to the same period of 2013. Net loss was impacted primarily by the intangible asset impairment charge recorded in the second quarter of 2014. EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") was $84.6 and $82.4 million for the nine months ended September 30, 2014 and 2013, respectively. EBITDA for the nine months ended September 30, 2014, was impacted by growth in our SS segment combined with lower selling, general and administrative expenses and a decrease in loss on extinguishment of debt, partially offset by an increase in restructuring expense. Future cash flows from operations will be negatively impacted by the loss of revenues resulting from the pending FDA 510(k) clearances on RENASYS NPWT product line and the loss of agreement related to a national GPO. In addition to using EBITDA internally as a measure of operational performance, we disclose it externally to assist analysts, investors and lenders in their comparisons of operational performance, valuation and debt capacity across companies with differing capital, tax and legal structures. EBITDA, however, is not a measure of financial performance under accounting principles generally accepted in the United States of America ("GAAP") and should not be considered as an alternative to, or more meaningful than, net income as a measure of operating performance or to cash flows from operating, investing or financing activities or as a measure of liquidity. Since EBITDA is not a measure determined in accordance with GAAP and is thus susceptible to varying interpretations and calculations, EBITDA, as presented, may not be comparable to other similarly titled measures of other companies. EBITDA does not represent an amount of funds 37 -------------------------------------------------------------------------------- Table of Contents that is available for management's discretionary use. A reconciliation of net loss attributable to UHS to EBITDA is included below: Nine Months Ended September 30, (in thousands) 2014 2013 Net loss attributable to Universal Hospital Services, Inc. $ (52,811) $ (32,382) Interest expense 39,922 41,657 Benefit for income taxes (13,232) (398) Depreciation, assets impairment and amortization of intangibles 75,860 73,570 Intangible asset impairment charge 34,900 - EBITDA $ 84,639 $ 82,447 Other Financial Data: Net cash provided by operating activities $ 35,277 $ 35,478 Net cash used in investing activities (41,223) (45,149) Net cash provided by financing activities 5,946 9,671 Other Operating Data (as of end of period): Medical equipment (approximate number of owned outsourcing units) 269,000 274,000 District service centers 84 83 SS stand-alone service centers 7 7 Centers of Excellence 5 6 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 Original Notes and Add-on Notes - 7.625%. On August 7, 2012, we issued $425.0 million in aggregate principal amount of 7.625% Second Lien Senior Secured Notes due 2020 (the "Original Notes") under an indenture dated as of August 7, 2012 (the "2012 Indenture"). On February 12, 2013, we issued $220.0 million in aggregate principal amount of 7.625% Second Lien Senior Secured Notes due 2020 (the "Add-on Notes", and along with the Original Notes, the "2012 Notes") as "additional notes" pursuant to the 2012 Indenture. The 2012 Notes mature on August 15, 2020. The 2012 Indenture provides that the 2012 Notes are our second lien senior secured obligations and are fully and unconditionally guaranteed on a second lien senior secured basis by our existing and certain of our future 100%-owned domestic subsidiaries. Our principal sources of liquidity are expected to be cash flows from operating activities and borrowings under our senior secured credit facility, which provides for loans in an amount of up to $235.0 million, subject to our borrowing base. See Note 8, Long-Term Debt for details related to our senior secured credit facility. It is anticipated that our principal uses of liquidity will be to fund capital expenditures related to purchases of medical equipment, provide working capital, meet debt service requirements and finance our strategic plans. We require substantial cash to operate our medical equipment solutions programs and service our debt. Our outsourcing programs require us to invest a significant amount of cash in 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, 38 -------------------------------------------------------------------------------- Table of Contents 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. Future cash flows from operations will be negatively impacted by the loss of revenues resulting from the pending FDA 510(k) clearances on RENASYS NPWT product line and the loss of the agreement related to a national GPO. Net cash provided by operating activities was $35.3 and $35.5 million for the nine months ended September 30, 2014 and 2013, respectively. Net cash used in investing activities was $41.2 and $45.1 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease in net cash used in investing activities was primarily due to higher proceeds from sale of medical equipment, partially offset by higher medical equipment purchases to support the growth in 360 solutions during 2014 compared to the same period of 2013. Net cash provided by financing activities was $5.9 and $9.7 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease in net cash provided by financing activities was primarily due to lower net borrowings in 2014 compared to the same period of 2013. Based on the level of operating performance expected in 2014, we believe our cash from operations and 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, 2014, we had $129.4 million of availability under the senior secured credit facility based on a borrowing base of $182.2 million less borrowings of $49.2 million and after giving effect to $3.6 million used for letters of credit. As of September 30, 2013, we had $143.4 million of availability under the senior secured credit facility based on a borrowing base of $191.8 million less borrowings of $44.2 million and after giving effect to $4.2 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 2012 Indenture governing our 2012 Notes, as described in Note 8, Long-Term Debt. The Company was in compliance with all financial covenants for all periods presented. RECENT ACCOUNTING PRONOUNCEMENT See Item 1 of Part I, Note 2, Recent Accounting Pronouncements. SAFE HARBOR STATEMENT Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: We believe statements in this Quarterly Report on 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 competitors' activities; · our customers' patient census or service needs; · global economic conditions' effect on our customers; · our ability to maintain existing contracts or contract terms and enter new contracts with customers; · uncertainties as to the effect of non-renewal of existing contracts; · consolidation in the health care industry and its effect on prices; · our relationships with key suppliers; · our ability to change the manner in which health care providers procure medical equipment; · the absence of long-term commitments and cancellations by or disputes with customers; · our dependence on key personnel; · our ability to identify and manage acquisitions; · increases in expenses related to our pension plan; 39 -------------------------------------------------------------------------------- Table of Contents · our cash flow fluctuation; · the increased credit risks associated with doing business with home care providers and nursing homes; · the risk of claims associated with medical equipment we outsource and service; · increases costs we cannot pass through; · the failure of any management information system; · the inherent limitations on internal controls of our financial reporting; · the uncertainty surrounding health care reform initiatives; · the federal Privacy law risks; · the federal Anti-Kickback law risks; · changes to third-party payor reimbursement for health care items and services; · potential other new healthcare laws or regulations; · our customers operate in a highly regulated environment; · our fleet's risk of recalls or obsolescence; · our substantial debt service obligations; · our need for substantial cash to operate and expand our business as planned; and · our history of net losses and substantial interest expense. For further information on risk applicable to us, please see the disclosure regarding the risk factors as set forth in Item 1A of Part II of this Quarterly Report on Form 10-Q. |